Wednesday, December 26, 2018

Trump's Shot Landed on the Wrong Fairway

The below graph was taken from my friend FRED at the St Louis Fed. It plots monthly inflation rates (the percentage change in the Consumer Price Index) starting around 1950. It is an ugly graph because it crams so much information into one small space. I won't discuss any of the data points but will ask you to look at this graph and decide if inflation seems to be a big problem. Or does it look like inflation is accelerating in a dangerous way?

Aside from making me happy, why do such harm to your aging eyes? Because all the crapola I am reading these days says that the Fed must raise interest rates to head off an impending disastrous bout of ghastly inflation. Interesting dilemma -- the Fed's policy to head off inflation seems more upsetting to our economy than the actual inflation. Its like buying an automatic weapon to keep your neighbor out of your backyard and then shooting yourself in the foot.

There's nothing wrong with the Fed wanting to raise interest rates to restore normalcy to rates. There is also nothing wrong with trying to lose weight. But that doesn't mean you go on a diet right after a major medical procedure. Give yourself a few days to recover -- then go on the diet.

I wrote a brilliant piece for this blog back on June 16, 2015. In the post I made the point that most recessions followed after the Fed tightened policy and raised rates following increases in the inflation rate. So it is not silly to wonder what will happen if the Fed continues on this path of fighting an inflation acceleration that isn't even there.

One more point. President Trump criticized the Fed but for the wrong reasons. If the Fed is the golfer with no short game then Trump is the golfer who hits the ball a very long way but one cannot predict on which fairway it will land. If Trump thinks the main reasons the stock market is tanking has to do with minuscule increases in the Federal Funds Rate then he is truly ignorant of economics.

I hope you got everything you wanted for Christmas.

Wednesday, December 19, 2018

Markets are Stupid?

First, this blog is still not fully ready to go again but I just couldn’t help myself today. Today the Fed raised interest rates as planned and the stock markets went bananas. Does it make sense that the market would fall apart when the Fed raised interest another smidge?

My answer is no.

First, we have known since the ice age that the Fed was going to raise rates in December. If markets are so smart and forward leaning—why did the market swoon today?

Second, except for banks no one really cares about the rate they raised—it is called The Federal Funds Rate (FFR).  Go to your local bank and ask them to let you borrow money at the FFR. Be ready for roaring laughter.

Third, what matters is what happens to interest rates that you, me, and your local steel mill pay when they borrow. I hate to tell you this but most of those rates have been falling lately – not rising. Yup, the FFR went up but critical interest rates are low.

Fourth, we might feel sorry for banks if their cost of funds (FFR) goes up but mortgage rates do not go up and their revenues and profits decline. But they can’t really do much about it since they have no real power today to raise rates. The markets won’t allow it.

Fifth, what matters to the stock market and to most of us is the strength of the economy. The economy is strong now. I won’t go into all the data because you read about it all the time. Output, employment, wages…they are all strong. Yes, there are many risks to the growth but so far, they are risks and not realities.

Sixth what also matters is inflation. We don’t want it to come roaring back. Will it? Hardly. Check out energy markets lately. I bought gas yesterday. Wow! I love it. The world economy – Germany, France, Japan, China – all these countries are experiencing slower economic growth. This is not the kind of time when inflation soars. If inflation fails to soar – there is no reason for the Fed to raise interest rates anyway.

The markets swooned. But there is nothing to swoon about. The Fed can want to raise rates but in today’s global environment the December policy is about as important as a snow shovel in Tucson in June.

Big Question -- will markets get smarter or dumber? 

Hope you have a Christmas and New Year.

Tuesday, November 13, 2018

Under Construction

Dear friends,

This blog is currently under construction and may remain that way until 2019.

I wish you all the most wonderful holidays and Happy New Year and look forward to reconnecting with you in January.

In the meantime, notice there are almost 500 posts to look at. Scroll down and on the right you can choose by date when published or by label (topic).  This is almost as good as Dr Seuss.

Alternatively,  if you would like to discuss global macro just contact me at my email address

Very best,


Tuesday, November 6, 2018

The Economy in 2018 and 2019

The US Bureau of Economic Analysis (BEA) reports Gross Domestic Product
on a quarterly basis. The most recent report came out on Friday, October 26. They like to put it out on Friday morning to ruin the weekend for most us. Who said economics is not the dismal science?

Luckily, they perform this ritual only once a quarter. This adds to the excitement – we have to wait three whole months to find out how the economy did. On October 26we found out how much the US economy produced in the third quarter. Tuna – the third quarter is not a football game. It is July, August, and September.

In the October 26 report, we learned that we produced $20.7 trillion worth of goods and services valued at current prices. If we valued that mountain of stuff at constant (2012) prices, we say that Real GDP was $18.7 trillion in the third quarter of 2018. Real GDP is a measure of how much got produced so we usually focus on that amount. The press release reported that the $18.7 trillion was 3.5% higher than in the previous quarter on an annualized basis. It also reported that the $18.7 trillion was 3% higher than in the third quarter of 2017.

Already your eyes are starting to glaze over and you are reaching for your JD. But hold on. This is cool stuff. The 3.5% one-quarter change is a little like the Colts kicking a field goal against the Pats at the end of the third quarter. Since I haven’t told you the full score, you don’t know very much. The 3.5% rate for the third quarter has meaning but it doesn’t tell you enough. The 3.0% is a little more helpful since it is basically telling you how the economy has been doing over a whole year.

But even that isn’t enough if what you want to know is how the economy did in 2018 compared to how it did in 2017. Are we slowing down? Speeding up? For that we have to live another quarter and wait until the magic date near the end of January. At that time we will know the fourth quarter and the whole year.

But we can get close today if we compare the sum of the first three quarters of 2018 to the sum of the first three quarters of 2017. The numbers in the table below show that real GDP rose by 2.5% in the three quarters of 2018 compared to the fourth quarter of 2017. The 1.9% says the economy grew by 1.9% from the end of 2016 to the third quarter of 2017. The 0.6% shows that growth in the first three quarters of 2018 was higher than the same period in 2017. We can conclude that the economy grew faster in 2018 than it grew in 2017.

The table includes all the key parts of real GDP -- so we can look deeper into what were the strong/weak sources of that growth increase. As you move your finger down the CHG column, look for the biggest positive numbers:
  • The biggest number is the 4.0 for intellectual property rights. After growing at 4% in the first three quarters of 2017, this category grew by 8% in the first three quarters of 2018. 
  • The 3.3% for net exports means the opposite of how it looks. It is telling us that net exports got more negative in 2018 compared to 2017, because exports of goods slowed while our imports of goods increased. This is a subtraction from output!
What other categories were stronger in 2018 than 2017? The 2.8% for national defense spending was one; the 2.2% for business structures was another.

Among the categories that grew slower in 2018 than in 2017 were:
            -3.7% Business Fixed Investment: Equipment
            -3.3% Residential investment
            -1.2% Consumer Durable goods
            -1.5% Exports of Services
            -0.4% Exports of goods

As we think about the final months of 2018 and 2019, it helps to think how the first three quarters of 2018 went. The big winner was business spending on intellectual property. Business also revved up spending on structures but equipment spending slowed dramatically. Consumer spending on durable goods also declined in 2018 and our exports of goods and services geared down. The trade balance was a larger drag on the economy. 

It is very clear that many of the important drivers of economic growth were contributing much less in 2018 compared to 2017. It will be interesting to see how the fourth quarter changes this picture. Will all of 2018 turn out to be better than all of 2017? 

Table. Real GDP Comparisons Based on Three Quarters*

*The number for 2017 is the percentage change from 2016 IV to 2017 III.
*The number for 2018 is the percentage change from 2017 IV to 2018 III.

Net exports are generally very negative in value. The positive value for the changes, therefore mean a worsening of the trade balance, i.e., a larger negative number.

2017 2018  CHG
        Gross domestic product 1.9 2.5 0.6
Personal consumption expenditures 1.7 2.1 0.3
    Goods 2.9 2.6 -0.2
        Durable goods 4.5 3.3 -1.2
        Nondurable goods 2.0 2.3 0.3
    Services 1.2 1.8 0.6
Gross private domestic investment 4.8 5.1 0.3
    Fixed investment 4.1 3.5 -0.7
        Nonresidential 5.0 5.1 0.1
            Structures 2.5 4.7 2.2
            Equipment 7.1 3.3 -3.7
            Intellectual property products 4.0 8.0 4.0
        Residential 1.1 -2.2 -3.3
    Change in private inventories na na na
Net exports of goods and services 1.1 4.4 3.3
    Exports 3.0 2.2 -0.8
        Goods 2.6 2.2 -0.4
        Services 3.8 2.3 -1.5
    Imports 2.5 2.8 0.3
        Goods 2.4 3.0 0.6
        Services 3.0 1.9 -1.0
Government consumption expenditures and gross investment -0.4 1.8 2.3
    Federal 0.3 2.4 2.1
        National defense 0.5 3.4 2.8
        Nondefense -0.1 1.0 1.2
    State and local -0.9 1.5 2.3

Tuesday, October 30, 2018

Cause and Effect and Interest Rates

As humans, we struggle with cause and effect, and it is understandable that President Trump does too.

I yelled at a student one day as I was driving on campus and almost hit him crossing in front of me. Clearly, he almost caused an accident. He chased me down and yelled at me for driving too fast. He told me that I almost caused the accident. Hmmm. Was he the cause and I the effect? Or was it just the opposite? With no police officer or bystanders around to adjudicate, I guess I will never know.

Monetary policy is even murkier as it relates to cause and effect. You may have heard that the Fed has decided to normalize interest rates in the USA. After keeping rates near zero for many years, the Fed has been using its levers to raise something called the Federal Funds Rate (FFR). It is believed that when the FFR rises, it pushes or pulls lots of other rates up. Thus, one might believe that when the Fed raises the FFR, it causes increases in interest rates on cars, houses, business loans, and so on.

It is also true that any of those interest rates can rise without any actions of the Fed. That is because interest rates are market variables. If people decide they want more chili dogs and fewer cheeseburgers, this can drive the price of hot dogs up and cheeseburgers down. We call that a market phenomenon. Similar forces are at play with respect to loans and interest rates. If the economy strengthens, more people want to use loans to buy houses and cars. Companies often want to borrow more so they can expand their businesses to meet the demands of a stronger economy. A rising economy, therefore, tends to raises interest rates on all sorts of loans.

With respect to cause and effect, we have learned two things. Thing 1 – the Fed can impact interest rates. Thing 2 – the economy can affect interest rates.

There is a Thing 3 worth mentioning. You alert folks might have noticed that the government has decided that it should borrow more because it spends more than it takes in taxes. I wrote about that recently. As of this year the Fed needs to borrow around $800 billion just to cover its deficit in 2018. That annual amount is heading toward $1 trillion per year. The government will be floating a bunch of treasury bonds to borrow all that money.

I could go on with other things affecting interest rates in the USA – putting pressure on them to rise. But most of us can’t balance three things in our increasingly senile brains, so let’s stop there. The point is that the Fed is only one of the three. Even if the Fed stopped its current policy of interest rate normalcy, these other factors would keep driving interest rates upward.

So what should we do? In one sense of cause and effect, rising interest rates are bad because they make buying cars, houses, and other things more expensive. But notice with Thing 2 that one cause of rising interest rates is a strong economy. Interest rates rising are the effect and not the cause. Clearly, we don’t want to have a policy to weaken the economy to bring interest rates down. So let them rise.

If interest rates are rising because of government debt, then that’s a different story. We can and should try to reduce interest rates in this case for two reasons. First, the cause is not a strong economy. Second, government deficits and debt are very worrisome risk factors on their own. Thus we can kill two birds with one stone. Reduce government debt, and this will reduce the risks of high government debt and reduce interest rates.

Forget the Fed. They are not the cause of much of anything as they try to restore normalcy. Let the economy grow at a reasonable rate, and let’s manage our government debt. If we do all that, we will likely forget interest rates and enjoy a better economy. 

Tuesday, October 16, 2018

Stock Prices and Recessions

As some of you financial wizards might be aware, we had some volatility in the US stock market recently. Those of you with some memory left will recall that the stock market tanked about ten years ago and scared even Charlie the Tuna.

Friends of my age might have a load of stocks. If stock prices fall and stay low, then our retirements are going to see fewer Mediterranean cruises. You younger folks are still building your nest eggs and will find that a poor stock market threatens your retirements too -- if not your ability to send your kids to college. So I decided to look into stock price changes. I used the S&P 500, which is an average of the prices of 500 stocks. I could have used the Dow Jones or some other index and probably would have come to similar conclusions.

Below I analyze annual changes in the S&P 500 from 1970 to 2017. Nathan is counting on his fingers right now but my calculator says that is 48 years. 48 years is a long time. The Bee Gees and Barry Manilow were top recording artists in 1970.

The goal of looking at 48 years is to give you an idea of what happened over a pretty long period -- as well as what didn't happen. In that way, you can use history to form an opinion about what might happen in the future. Of course, Nolan knows that the past is no guarantee of the future except maybe in fire engines, but if we don't use the past I am not sure how we can evaluate the future.

During the 48 years between 1970 and 2017, there were 6 recessions. The years included in those recessions are listed in the table below. Next to the year is the percentage change in the S&P 500 of that year. Some observations:
  1. These recessions occupied at least part of 12 of the 48 years.
  2. In 6 of those 12 recession years, the S&P 500 value decreased*. The largest decrease was the 38% in 2008.
  3. The smallest decrease was the 7% decline in 1990.
  4. In the 1970 recession, the S&P rose by a very small amount.
  5. In all of the 6 recessions except for 2001, there was at least one year when the S&P 500 increased in value. (For the 2001 recession, stocks fell in 2002 and 2003!) After a recession starts and the S&P declines, it usually increases in the last year of the recession. For example, the S&P rose by 32% at the end of the 73-75 recession.
  6. The S&P 500 fell in three years that were not recessions -- 1977 (-12%), 1994 (-2%), and 2015 (-1%). That means in the 36 years that were not recession years, the S&P 500 increased in 33 of those years.
  7. The S&P fell 11 times in the 48 years period – 8 times during the 12 recessions years and 3 times in the 36 non-recession years.
What do we learn from all this?
  • Stock prices fall mostly in recessions but can decline in other years too. 
  • Stock prices fall in the beginning of a recession and generally begin rising in the last year of the recession. 
  • If there is no recession, it is highly likely that stocks will not decline. 
Will the future follow the past? There is no way to know. And sadly, it is not easy to predict when the next recession will begin in the USA. But today we are not in a recession and so long as that remains true, the likelihood is that stock prices will not decline. Since they just recently decreased, the likelihood is that the decrease will be temporary.

The table includes only recession years as defined by the National Bureau of Economic Research. Stock prices come from Wikipedia.

Year     %Change
1970      0.10

1973       -17
1974       -30
1975      +32

1980      +26
1981       -10
1982      +15

1990        -7
1991      +26

2001      -13

2008      -38
2009      +23

*When I write that the market fell in a particular year, I am basing that on the change of the market index for one year relative to the previous year. The index might have fallen many times in a year but if the value of the year was higher than the previous year, it would be considered as an increase. 

Trade War

Trade negotiation is inevitable, while trade wars are rare. Will today’s actions lead to a trade war? Much of the discussion of a looming trade war comes from those who emphasize that the US has a trade deficit with many countries. This means that we buy more from those countries than they buy from us. Thus, they have much more to risk in a trade war. We buy a lot from them and if we stop buying it will harm those countries mortally. 

There is nothing wrong with that logic except that it is incomplete. It focuses only on the bilateral relations between us and them. The bigger picture examines the importance of trade to the USA and its main trading partners. 

Let’s begin with a review of the countries that purportedly take advantage of us in the USA. President Trump’s goal is to reduce bilateral trade deficits. Below I list the biggest bilateral US trade deficits in billions of dollars in 2017:

            China             $375
            Mexico              71
            Japan                 69
            Germany           64
            Vietnam             38
            Ireland               38
            Italy                   32
            Malaysia            25
            India                  23
            South Korea      23

(Also among the top 15 countries are Thailand, Canada, Taiwan, France, and Switzerland.)

According to President Trump those countries are the “bad actors.” Notice that China holds a special distinction because the US trade deficit with that one country roughly equals the trade deficit with the next nine. China and the others, according to the logic discussed above, ought to cave soon because they sell so much to the USA. If we tax all that inflow to the US, it could hurt them a lot.

Let’s widen the story. Think about the importance of trade to these countries. The next table shows the total trade deficit of each country – the trade deficit of each country with the rest of the world. That deficit is presented as a percentage of each country’s GDP. Note that the corresponding number for the USA in 2017 was 2.8%.
            China             Surplus
            Mexico             1.4
            Japan                3.9
            Germany       Surplus
            Vietnam            6.2
            Ireland              0.9
            Italy                  1.4
            Malaysia           3.0
            India                 6.4
            S. Korea        Surplus

The point? These countries, except China, Germany, and South Korea, have trade deficits too.  How willing do you think they will be to making their deficits larger so that the US can have a smaller one?

Next, let’s turn to imports. If President Trump had his way, we wouldn’t import anything, except for maybe Cognac and a cigar or two. But he wants the bad actors to buy more from us. He wants them to import more. Below I report each country’s imports as a percentage of its GDP. US imports were 15% of GDP in 2017.

 China               18%
            Mexico            40
            Japan               15
            Germany         40
            Vietnam          99
            Ireland            88
            Italy                28
            Malaysia        64
            India               22
            South Korea   38

The point? These countries love imports even more than we do. But how much more can a country import when it already has a trade deficit? How much more of US exports can they consume?

It is nice to think that we are being taken advantage of by the rest of the world. But the larger truth is that many countries have trade deficits and already import a lot of goods and services. This reality is surely going to stiffen their backs as the US tries to solve its own trade problems by limiting imports to the US and raising exports to the rest of the world.


Tuesday, October 9, 2018

The End of the World?

No, my friends, I am not writing about the Supreme Court. I am not even writing about Donald Trump. I am writing in response to months, if not years, of hand-wringing by some of my friends about various unfolding trends that promise something akin to the end of the world.

Artificial intelligence (AI), productivity, globalization, and the demise of baby boomers are among trends that cause all sorts of consternation if not hyperventilation. I won’t argue that these trends won't disturb our happy society. I won’t even argue that they are not already affecting many people in many places.

Concern for these and other issues is legitimate. What I am saying today is that, while there is much truth to the fact that we have considerable challenges ahead, the end of the world is nowhere in sight. Our biggest challenge is to decide as a nation what we can do so that jobs continue to exist and people are paid enough to keep the economy growing. This is our biggest challenge because it will take thoughtful policy in a very complicated US and global economy. There will always be more than one way to resolve these issues. In a world where politicians would rather spit that compromise, it is hard to see how they can be trusted to do the right thing. Whatever they could do won’t be perfect but sadly it is not clear that they are capable of anything besides giving hateful interviews to greedy media organizations.

But we do have time and it is possible that sanity might return to the political arena. Maybe it will take a severe recession or a flood of Biblical proportions, but there is at least some hope. In the meantime, I suggest we look at some data to reassure ourselves that the end of the world has not already come.

On the first line of the table below are numbers for the productivity of the private non-farm business sector. These are index numbers representing productivity in 2006 and 2018, and then the percentage change in the index over those 13 years. Notice that productivity in the business sector rose by around 15%.

The second line has comparable numbers for employment. The employment numbers are for all employees of non-farm businesses. They are in millions. In 2006, we had 137 million employees in the US. That number took a big dip in the recession down to 130 million in 2010 but then reached 148 million in early 2018. That amounted to an 8.5% increase.

The final row is the employment cost index. This index measures changes in wages and benefits of private industry workers. Starting at an index value of 102.1 in 2006, wages and benefits rose to almost 133 by 2018. That’s an increase of 30 percent.

The upshot of this little table is that we are nowhere near falling off the earth. While these numbers were clearly affected in a negative way by a very scary recession, they show that productivity grew, employment grew, and the wages and benefits of workers increased even faster.

I purposely leave you with this impression of growth. I could have compared this time to previous ones. I could have compared the wages and benefits change to inflation. I could have dissected the employment numbers by manufacturing versus services. There is a lot more I could have done to put changes from 2006 to 2018 in a more complete perspective. But I save that for other posts and other purposes.

I am not trying to say that this is the rosiest of times. I am not trying to say that we don’t need to get to work on solutions. But what I have tried to do with this little table is to suggest that we stop panicking. This is not the worst of all possible worlds. I am no Pangloss but then, again I am no Martin either (characters in Voltaire’s Candide). Pessimism might be warranted by some things we see today – but pessimism surely will not provide the answers. This glass is definitely half-full. How can we get policymakers to work together for us -- to make the glass even more half-full?

2006         2018       %Change
Productivity            94.4        108.2          14.6
Employment         136.5        148.1             8.5
Wages & Benefits 102.1        132.5           29.8
Note: The values are for the first quarters of these years.

Tuesday, October 2, 2018

CBO Budget Projections as of April 2018

The Congressional Budget Office provides projections of federal government outlays and revenues. This projection process is thought to be a bipartisan effort. I thought it would be useful to share their latest projections for discussion. I won't say a lot in this post. Just present the facts. My table below was constructed without the aid of JD by me based on 10-year projections found at the website indicated below. Since 10 years is a very long time, I thought it would be better to focus on the five-year period, 2018 to 2023.

The top of my table presents the usual suspects for government budgeting -- spending, deficits, and debt. I ignored tax revenues in this piece so I could focus mostly on spending or outlays. The bottom of my table gives some details about what are called "mandatory" versus "discretionary" outlays. The first column gives projections for 2018. The second column reports the same information for 2023. The final column is the percent change over that five-year period.

First, the top of the table. Total outlays will rise by 45% in the five years from 2018 to 2023. If you divide 45 by 5 you get 9. Nathan, you do not need to get your calculator. Ignoring compounding, the math implies a 9% average annual increase over five years. I know you will get a 9% raise each year over the next five years. Right? Notice that GDP is expected to rise by only 32% over those years.

On the third line is net interest outlays expected to be paid on the nation's debt. Those expenses will more than double -- a 145% increase from $316 billion in 2018 to $774 billion in 2023. In terms of dollars, the $458 billion increase is the largest for any subcategory of spending. Notice that the national debt is expected to increase from $20 trillion to $26.6 trillion over that time period. And interest rates will rise as well. The table shows that we will make no effort to reverse the increase in debt. The already high annual federal government deficit of $804 in 2018 will increase to more than a trillion dollars in 2023.  Yup -- a one-year government deficit of over a trillion dollars in 2023.

Mandatory spending will gobble up most of the 45% increase of all outlays. While there are a large number of Mandatory Programs, you can see from the table that almost all of that increase is expected to go to spending on Social Security (Old-Age and Survivors), Medicare, and Medicaid. The remaining Mandatory Programs are peanuts compared to what we spend on the big three. Discretionary spending will rise by 16% in comparison. Discretionary spending includes defense and other programs that must be legislated by Congress.

I won't ruin your perfectly nice day by going through all the categories. I will let you do that on your own with your favorite beverage. But notice how so many perfectly lovely programs are being squeezed out because we have to pay more for the big three.

This puts liberals in a bad spot. How do liberals balance the squeezing out of so many programs by three social programs they also love? You conservatives should not be so happy either. While these figures do not have all of defense spending, they do show that military is being squeezed too. How do you get more of what you want out of government and not have these nasty deficits and debts? Seems like being between a rock and a hard place.

Five-Year Projections of Outlays by the CBO 2018 to 2023 as of April 2018. The below link has 10 year projections from which I took these five years. 

Data in columns 1 and 2 are in millions of dollars. Since fiscal year 2018 was not finished in April, 2018 is considered to be a projection. 

2018 2023 % Chg
Mandatory 2,546 3,760 48
Discretionary 1,280 1,481 16
Net Interest        316     774 145
Total Outlays 4,142  6,015 45
Deficit      -804 -1,352 68
Debt held by public 15,688 24,338 55
GDP 20,103 26,595 32
Mandatory Outlays
Old-Age and Survivors Insurance 840 1,155 37
Disability Insurance 144 176 22
Medicare 707 1,032 46
Medicaid 383 493 29
Exchange subsidies and
   related spending 58 76 31
Children's Health Insurance Program 16 13 -15
Earned income, child, and etc 87 99 14
Supplemental Nutrition Assis. Prog 69 65 -6
Supplemental Security Income 51 64 24
Unemployment compensation 30 47 57
Family support and foster care 32 33 4
Child nutrition 24 30 24
Civilian Retirement 102 122 20
Military Retirement 54 70 28
Income security for Veterans 83 111 34
Agriculture  17 15 -15
Deposit insurance -14 -8 -46
MERHCF 10 13 26
Fannie Mae and Freddie Mac 0 2 NA
Higher education -4 7 NA
Discretionary Outlays
Defense 622 710 14
Non Defense 658 771 17

Tuesday, September 25, 2018

The Phillips Curve Rides Again

Just when you think the Phillips Curve vanished, it reappears. For those of you who have managed to steer clear of the concept known as the Phillips Curve until now, I would suggest pouring a nice JD over some rocks and watching the grass grow. For those of you who might be even a little curious about this Phillips Curve thing, then read on.

Phillips was one of those New Zealand economists with a lot of initials (A.B.H. aka A.W.H., aka Bill, aka William) before his last name who got famous by noting that there appeared to be a relationship between Ozzie and Harriett – no just kidding – between Ricky and Lucy – just kidding again – between the unemployment rate and wage changes.

This seems innocuous enough, but then real American economists decided to make Phillips even more famous by making the Phillips Curve the truly greatest thing ever in macroeconomics and skateboarding. The first thing they did was replace the wage variable with prices. Thus, they pondered a relationship between the unemployment rate and inflation (the percentage change in prices). I don’t think they got permission from Phillips to make this change but that’s all history now. 

Next they gave the relationship a theoretical foundation. Fancy words – theoretical foundation. The truth is that a monkey with the latest iPhone could have dug up this theory. But sometimes simple things catch on. And they catch on when they support the latest trend in macroeconomics. Recognizing that I am a bit north of my 70th birthday, please understand that when I talk about the latest trends, I am usually referring to the 1960s.

Unlike pink poodle skirts and flat-tops, macroeconomic trends stay around a while. My point today is that the Phillips Curve comes and goes in popularity, but as I was reading the Bible – err I mean the Wall Street Journal – this week it occurred to me that the Phillips Curve had risen from the dead again.

Before I get into those juicy headlines, let’s at least review the basics of the Phillips Curve. Below is a Phillips Curve diagram. The most popular aspect of it is the negative slope that reveals the inverse relationship between inflation and unemployment. Or in more common language, when one of them goes up the other one of them goes down. Sort of like a seesaw.

One might ponder further and say something like, “why?” Why is there a seesaw relationship? The answer comes from short-run macroeconomics and the part of it we call aggregate demand (AD). When households or firms or movie actors decide to buy more stuff, firms get very happy and respond by producing and selling more stuff. To produce more stuff they need more workers and so the unemployment rate goes down. As they hunt for more workers, they raise wages and then they must pass some or all of that wage increase on to their prices. 

Thus when AD increases – unemployment goes down and inflation goes up. Or when AD decreases – unemployment goes up and inflation goes down. Are you seasick from the seesaw yet? That’s basically it. Stay awake Fuzzy.

The big deal is that this little bit of theory is what is behind our love of using monetary and fiscal policy to rev up spending in a flagging economy. Monetary and fiscal policies are designed to pump up AD and therefore save the world from high unemployment – though at a cost of higher inflation.

To get these results, the Phillips Curve is not allowed to move around. It must sit still. Stay Phillips Curve. Stay. Good Phillips Curve. When the Phillips Curve does start to mosey around on the diagram, it messes up the nice seesaw and it ruins the simple world of monetary and fiscal policy. So when the Phillips Curve is jumping to and fro, we forget it exists. But when it sits nicely we take it for a walk.

The last 10 years or so, most economists would rather talk about soccer than Phillips Curves. The unemployment rates around the world went down – but the inflation rate just sat there like a squirrel on Zoloft. That is a sad story for the Phillips Curve. Bad Phillips Curve. 

But all that is changing now. Take Turkey for example. I was going to use Ham instead but we are actually talking about the country, Turkey. The central bank of Turkey recently decided to raise interest rates. And the government got steamed. Why was the government so mad? Because they believe that the rise in interest rates will reduce borrowing for spending and that will cause firms to produce less and fire a lot of workers. Of course, the country would benefit by a slide down the Phillips Curve to lower inflation rates. But the possibility of the higher unemployment rate was too much to risk. Clearly the government of Turkey believes in the Phillips Curve.

Japan is another example of the reincarnation of Phillips. Japan has been bathing in zero or negative inflation for decades. It now seems that inflation is making a comeback – a humble comeback but a comeback nevertheless. So should they be concerned with rising inflation and pull back on stimulus? And risk a rise in the unemployment rate? It's all about Phillips. A decision to curtail inflation will cause higher unemployment if you believe in the stationary seesaw.

It goes without saying that the same discussion is happening in the USA. The Fed has been moving interest rates upward for more than a year now and they plan to keep raising them in 2018 and 2019. A return to normal interest rates, like a return to normal temperatures after sitting in a beer refrigerator for hours, makes sense. But that bit of logic is trampled by the Phillips Curve. The curve was missing in action for 10 years but now all of a sudden it is more popular than a soju in Insadong. Surely if the Fed raises rates a couple more notches, the unemployment rate will rise. Surely if the Fed worries about inflation rising, unemployment will rise.

Okay. Enough about Phillips Curves. Next week I discuss the Davidson Curve. Just kidding again. Who moved my JD?

Tuesday, September 18, 2018

The Goods Trade Deficit Part 2

Last week I discussed the persistent US international trade deficit in goods. I concluded with two points. First, if the goods deficit really is a bad thing, a new approach might be necessary now after 47 years of trying has only made it worse. Second, I suggested that the goods deficit might not really be such a bad thing and that we might focus our policy efforts elsewhere. To make this second point I briefly made some points about trade in services and various assets.

This week I’d like to follow up with the idea that the trade deficit might not be such a bad thing.

To start with, discussions of US International Trade are supported by figures collected by the US Bureau of Economic Analysis and found in what is called the Balance of Payments (BOP). That’s a very misleading term and ought to be replaced by something like Stuff People Don’t Know about International Transactions (SPDKIT).

Even if this is likely to put the Tuna to sleep and cause Nathan to hyperventilate, I am going to educate you goonies about the BOP. I will do this with the below table which reports results for 2017. Once everyone is totally asleep I will then come back to the reason why all this supports my idea that the goods deficit is not such a horrible thing.  

First, the goods deficit of  ($808) billion is shown at the top of the table.

Second, just below the goods numbers are the services numbers. While some people like to say services can be aptly defined by what people at McDonalds do, services is a much broader category with some very sophisticated outputs and very high wage inputs. Services include at least the following industries – travel, transportation, finance, banking, education, retail and wholesale trade. Services account for about 70% of the US national output of about $21 trillion dollars. Notice that we had a trade surplus in services of $255 billion in 2017.

Third, the US is actively engaged in buying and selling financial assets. For example, Germans buy US government bonds and US citizens buy stocks of British companies. The table lists three types of cross-country investments which show purchases of Financial Portfolios, Bank Loans and Deposits, and Direct Investments. Financial Portfolios relate mostly to when we buy each other’s stocks and bonds. Direct Investments are when we buy each other’s companies. Loans and Deposits are self-explanatory.

Adding together the balances of these three financial accounts gives you a total surplus of $353 billion. Adding together the surpluses of these three plus services gives you a total surplus of $608 billion.

Tired of adding and subtracting?

One point of this exercise is that there is much more to international trade than goods imports and exports. Clearly a goods deficit of more than $800 billion has negative impacts. It does directly impact employment and it does manage to send US dollars out of the US. But a surplus in services does just the opposite. It increases jobs in the USA and it brings dollars back into the USA.

The story is similar for trade in assets. The financial surpluses show that foreigners love adding US bonds and stocks to their portfolios and they love buying ownership positions in US companies. The benefits should be obvious. When they buy ownership in companies they make it easier for these companies to raise money for investment purposes.

When foreigners buy US bonds and stocks they strengthen these markets too. As they drive stock prices up they lower the cost of capital to firms. As they buy government and private bonds they lower US interest rates and reduce the US cost of capital.

This latter point is more important than one might think. In the US we don’t love to save. We love to spend. As a result, capital is scarce and the cost of capital is higher than it should be. As foreigners bring their savings to the US they augment or pool capital and make it easier and less costly for us top borrow and invest.

This is getting a bit long so let’s wrap up. There is more to trade and to US health than goods. If we worry too much about goods we might threaten these other valuable activities. If bad policy on goods trade makes foreigners move their savings away from the US, then a lot of Americans will suffer as the stock market swoons and the cost of capital rises. Finally, global competition for US goods is not going to end with China. So long as developing countries want to compete with us and so long as their workers make only fractions of what our workers make, we will have a difficult time competing with them. Rather than bring all this activity home we should decide what we do best and what will sustain our workforce in the decades to come. 

Table (In billions of dollars)

Exports of Goods                              1,553
Imports of Goods                              2,361
     Goods Balance                                    (808)

Exports of Services                              798
Imports of Services                              543
     Services Balance                                  255

US Portfolio Investments Abroad       587
Foreign Portfolio Investments in US  799             
     Portfolio Investment Balance            212

US Loans/Deposits from Abroad       219
Loans/Deposits to Foreigners in US  384 
     Loans/Deposits Balance                     165

US Direct Investments Abroad          379
Foreign Direct Investments in US     355
    Net Foreign Direct Investments        (24)

NOTE: This presentations leaves out several smaller items that compose the US BOP Accounts so that we can concentrate on the main items. This presentation also does not mention that some of these items are part of the Current Account while others are part of the Financial and Capital Account.