Tuesday, June 26, 2018

Can't Get No Satisfaction

No data this week. No macroeconomics this week. On to “Other Stuff.”

In their 1965 song Can’t Get No Satisfaction*, The Rolling Stones sang something like “When I’m drivin in my car, and a man comes on the radio. He’s tellin me more and more about some useless information. Supposed to fire my imagination…”

How prophetic! While this topic has bothered me for quite a while, it really came home to roost this last week with respect to the Kim/Trump Summit. I have never heard the same crapola repeated so often in the media within a week.

But let’s back up. I love the fact that we have freedom of the press. They should be free to decide what to report and how many times to report it. That’s their business decision, and they are free to do that. But that does not mean that their decisions are always good, and in the case of the last week I think their decisions were horrible.

What happened to the good old days of news with Walter Cronkite? We had Ralph Renick in Miami, but it was the same thing. They told us what was going on in the USA and to some extent in the world, too. When it was time to render an opinion, the lights flashed and horns blared (exaggeration), and we all understood this was not news. It was Ralph’s opinion about something. Lights would stop and then back to the news.

But even more important than the distinction between news and opinion was that Ralph was not a professor of a music or of a foreign language. In music and foreign languages, one learns and becomes accomplished through practice. And then more practice. It is normal in music and language learning that you would do the same thing over and over and over. You expected that. Donde esta la biblioteka? I must have said that 10,000 times in 10th grade Spanish class. I am currently learning to play the guitar. I learned how to do a G chord. Four years later, I am still struggling with mastering the G chord. And no Tuna – I don’t mean G string!

You think I am on my fourth JD but I am not. My point is that the press – whether on the left or right – have decided that it isn’t enough to give us their opinion. They have to hammer it in. And then cement it in. Apparently all the other stuff that is going on in the world isn’t worth their time and effort. They would rather spend their endless hours of news time hammering in simple opinion themes.

In the last couple of weeks, how many times have you heard that Trump was giving a world stage to dictator Kim? How many times did we hear that we will retain sanctions until Kim has totally dismantled all his nuclear weapons including his Lionel train set? How many times does it take?

Keep in mind that in all the lead-up to the meeting between Kim and Trump, there was actually very little news. Yes, there is a meeting. Yes, it is in Singapore. Yes, Trump said he will insist on a total end to Kim’s nuclear war capability. Yes, Kim wears a striped suit and has a cool haircut. But that was about it. After the meeting, there was a very short meeting summary that said almost nothing. How many times can a reporter tell you that a summary was short and said nothing? Apparently 10,000 times would be okay. Most of us can repeat the main left and right talking points about Kim/Trump in our sleep.

Is there nothing going on in the world that we are subjected to repeats of the exact same information and themes multiple times each day in multiple media? Why do we hear over and over the minutia of Hillary’s emails, Trump’s Russia conspiracy, Comey’s latest burp, and so on. Does the press really think that most of us could not get through a day without having them enflame us with these ongoing but sloth-like sagas? Why can’t we have a moratorium on all this and ask the appropriate bodies to decide if Trump should do an extra 10 push-ups while Hillary goes to Charm School? Shut out all the daily noise. Wait for a decision. Then report it. In the meantime, shut up. Please. 

Then maybe we could receive some in depth and thoughtful insights into why we can’t win a war on poverty or crime or can’t seem to balance the nation’s budget. Or maybe we could learn more about why some Italians might want to follow Britain in exiting the European Union. Give us the news and give us your opinion. But please, stop being the good language professor. It's getting really boring. La bioblioteka es enfrente de la iglesia.

*Otis Redding made a wonderful rendition of this song too. Not sure which one I like more. 

Tuesday, June 19, 2018

The Fed and the Next Recession

I had so much fun last week graphing wage changes that it spilled over to another graph this week. This time, the graph plots interest rates.

Why interest rates? Because interest rates are interest-ing? Ha ha. Of course they are interesting. But a better reason to focus on interest rates today is because the worry-warts are screaming that the Fed is going to send us straight to recession hell. While many of you hate the Fed and wish we were back in the good old days of the gold standard when there was no Fed or when the Fed was reduced to less importance than a milk delivery driver, the rest of us are less extreme. But we do worry that the Fed is prone to over-reacting, thereby becoming the winner of the contest for the most severe unintended consequences. We worry in 2018 that inflation will begin rising, the Fed will raise interest rates, and the economy will come crashing down around our ears.

So, we are all riveted on interest rates. And if we looked at interest rates in the summer of 2018 and compared those rates to those in mid-2016 or even mid-2017, we might get a wee bit scared. But the point of today is to create a longer historical perspective.

First, let’s define the interest rates plotted below. Both are market rates* on government securities. The top line is the rate on 30-year Treasury Constant Maturity Bonds. The bottom line is the rate on the 10-year Treasury Constant Maturity Bond. Neither of these is a policy variable directly controlled by the Fed. But both are very popular and are generally taken to be barometers of market interest rates. Many market rates are influenced or tied to the 10-year rate. The 30-year rate is a good proxy for longer-term bonds in general.

If the Fed implements a policy to raise interest rates, it usually conducts an open market operation whose intent is to change something called the Federal Funds Rate (FFR). A change in the FFR then raises the cost of funds and ought to impact many market interest rates. A successful Fed policy, therefore, will result in a wide swath of interest rates changing even though the Fed only directly controls the FFR. It is possible, however, that many of these market rates do not behave as the Fed desires.

The graph shows that market rates have risen in predictable fashion in 2017 and 2018 as the Fed raised the FFR. The FFR was set at virtually zero from around 2009 through most of 2015. Notice, however, the roller-coaster rides of both rates in the chart. The trend of both rates was clearly downward but there were very clear episodes of rising/falling cycles within that downward trend. With the FFR constant, there must be other things that affected interest rates. Notice the increases in rates around 2011 and then again in 2012 to 2014. Both of those periods saw rates rise and then fall by about as much as they rose. All this happened with a near zero FFR. 

If these other things could be important from 2009 to 2015, then presumably they might be important in 2018 and beyond. That is, if the Fed decides to raise the FFR rate in 2018, perhaps market rates will not follow. Perhaps other factors will keep rates from rising or even contribute to a fall. And this means knee-jerk forecasts that a Fed tightening cycle will lead to a recession could also be wrong.

What are these other factors that might prevent market interest rates from rising as the FED increases the FFR? First, consider real GDP growth in the US. Rapid growth often puts pressure on financial markets as the demand for loans exceeds the supply. But who is seriously forecasting strong economic growth in the US? While some forecasters imagine faster growth emanating from the recent tax cuts, few of them think growth will remain strong for very long. A barrage of studies worry that low productivity and labor supply growth imply weak US growth for the foreseeable future. Look at the diagram. The 30-year rate is barely rising compared to the 10-year bond.

Second, interest rates often reflect expectations of future inflation. Higher expected inflation means a lender gets paid back in dollars that are worth less. So they demand a higher interest rate today to compensate for the loss of buying power tomorrow. It is true that some forecasters believe that inflation is going to increase in the USA, but few see reasons for sustained higher inflation in the future.

Third, the value of the dollar is important for interest rates. If the dollar declines in value relative to other key currencies, this leads to more inflation in the USA. If one believes the dollar will fall in the future, this means investors will want to move out of US assets. The selling of these US assets raises interest rates. The dollar has not been depreciating lately. It has been rising in value. This reduces inflation and interest rates. Believing the dollar will continue to rise also lowers interest rates*.

Fourth is the risk scenario in other countries. As investors worry about economic problems in Europe (Italy, Britain ) and Asia (Korea, Japan), they increasingly want to invest in the USA. Even with warts in the USA, what matters is who has the bigger warts. The more negative news you read about Europe and Asia, the more the global appetite for US assets increases. This drives the price of US bonds upward and reduces interest rates. 

In summary: Modest US economic growth, stable inflationary expectations, a higher value of the dollar, and economic riskiness in Europe and Asia should all combine to put downward pressure on interest rates.

I cannot predict the future any better than you can. Some folks want you to believe that Fed policy will raise market interest rates and take the air out of the US economy. While Fed policy sometimes works that way, 2018 and 2019 are not typical years. It is altogether possible that the Fed will continue raising the FFR, and the result will be a continued slow growth economy with relatively stable inflation and interest rates. 

*Students often have trouble with idea that higher bond prices mean lower market interest rates. This is because we forget the these bonds have a fixed coupon yield or return. One bond might promise 5% to the holder. Thus a $100 bond gives whoever buys the bond $5 each year. If you buy such a bond in the open market on a bad day when the price is only $50 then you get $5 interest on your $50 investment. That's a 10% return! The lower market price for the bond means a higher market interest rate. If you buy the bond on a big day for the bond market, you might pay $200. You still get interest of $5 and therefore your market return is only 2.5%. So we get the general rule -- the higher the market price of the bond the lower the market return. The lower the market price of the bond the higher the market return. 

Tuesday, June 12, 2018

Wage Growth in a Tight Labor Market

Much has already been written about the employment report for May 2018 that was published on Friday, June 1. The unemployment rate, like your friendly mole, once again dug deeper and went to an 18-year low of 3.8%. This means that the labor market is growing tighter, which means that firms are finding it harder to find the right employees. There are many articles being written now about this business challenge as firms use innovative ways to try to attract new employees or to hold on to existing ones. Of course, a common approach to attracting and keeping workers is raising wages and benefits. 

Wages, therefore, become a critical economic variable these days. This week I decided to look at wage behavior in the USA to see if there are signs of firms using wages to ameliorate labor market tightness. The graph at the bottom looks at monthly percentage changes in average earnings for all employees. 

Reading graphs is definitely an art form. I ain't Picasso but let's give it a shot. Each dot on this graph records how much earnings grew in that month. If you go to the very last dot on the graph, it says that in May of 2018 earnings grew by 0.298 compared to the value in April of 2018. The one-month percentage change was 0.298%. For sake of our eyeballs, let's round up and call that a one-month increase of about 0.3% in May. If that one-month increase lasted for a full year, then wages would increase by about 3.6%. 

That's a big if and is only suggested so that we can put the one-month gain into an annual perspective. If Lebron scored 12 points in the first quarter of a game, he scored 12 points! But we could say something like -- dude, that's like scoring 48 points in a whole game. Wow. Groovy. He may or may not score 48 in that game but the 48 gives us another way of understanding the 12 he did score in Q1. 

Whew. I am thirsty. So if you read the above, you know that the 0.298 increase in May of 2018 is about a 3.5% annualized increase. That sounds pretty good. If the cost of living went up by 2% in May, then you might be happy that your wages grew faster than your expenses. 

The reason I placed the whole graph below is that we can evaluate the most current increase better by looking at past changes. This graph has monthly ups and downs from April of 2006 to May of 2018, so we can compare over a 13-year period. My task today is to evaluate the 0.298 of May 2018. 

Is it the highest point on the graph? 
     Absolutely not. Just in the last couple of years there were many months that had stronger growth in earnings. 

Is it the lowest point on the graph? 
     Absolutely not. There are even more months in which earnings grew much slower than 0.298. 

Is there any pattern to the monthly changes? 
     It looks like whack-a-mole to me. Most ups are followed swiftly by downs and vice versa.

Do you observe an upward or downward trend in the dots? 
     From about April 2006 through June 2010, there seems to be a downward trend. That is, on average, wage growth seemed to decline. Wages were growing but at a slower pace.  
     But from June 2010 to about October 2011, the wage growth picked up. From my eyeball, it appears that the average monthly percentage change during that time was about 0.2 or an annual rate of about 2.4%. 
     Then from 2012 to now, there appears to be no discernible trend change in earnings. For six years, we got ups and downs around a mean that suggests wage change at about 2.4% per year. If you removed the crazy negative data point in October of 2017, you might see some increase in trend starting around October of 2016. Of course, you might also see pink elephants.

Why go through all this madness? Because there is nothing like the data. You will see a lot of interesting and intelligent articles about wage change in the USA. Smart people will discuss the May data point and tell you that the 3.5% growth in May is higher than the 2.4% rate that prevailed over the last eight years. These folks may want to convince you that wages are spiraling higher -- and maybe they are. But looking at this graph from beginning to end does not make me very confident that we are on a new upward trend. I remain skeptical that the 3.5% means much of anything. I wonder what we will learn in July about June. 

Tuesday, June 5, 2018

Inflation: Viva la Difference?

Venezuela has been in the news a lot lately. While the news has covered a lot of different issues from food shortages to returned prisoners, I was very impressed with their inflation rate. According to the International Monetary Fund, the inflation rate of Venezuela in 2017 was 2,818.4 percent*. That got me wondering about the state of inflation around the globe. The US has experienced remarkably low inflation in the past decade; it came in at 2.1 percent in 2017. Are most countries like the US or more like Venezuela?

While my goal today is less about policy and more about simple comparisons, it won’t hurt starting out with a little background about inflation, its causes, and its consequences. Inflation is a straightforward concept. It is a macro concept that measures how much prices are changing in a nation. It is calculated by averaging together the prices of a bunch of things we usually buy. The Consumer Price Index is one of many measures of inflation. It looks at changes in the prices of the goods and services we most often purchase. Thus, we often speak of it as a measure of the nation’s cost of living.

When the cost of living is rising faster than our incomes, the buying power of our income falls. This raises caution because it means people find it harder to continue buying the same quantity/quality of goods and services. Some people think a little bit of inflation is good but when it reduces our ability to buy we get concerned. You could think of this in terms of inflation stages. Low inflation is okay and might be beneficial as most of us look forward to our wages rising, and firms often find life easier when their prices are increasing. When inflation gets higher, we begin to worry about purchasing power. When inflation accelerates even faster, we get even more concerned. At even higher rates, it creates additional concerns if it causes trading partners to shun our high-priced goods. It would cause alarm if it was a signal of deeper economic problems and foreigners decide to stop investing in our country.

With that brief background we wonder what was going on with respect to inflation in the world in 2017. The table below contains inflation information I took from the IMF. The information is divided by the six regions of the world. These regions account for 150 countries and sub-regions.

The first column contains the name of each region. Look below the table for the full region titles. In the ( ) is the number of countries and sub-regions reported in each region. The Advanced Countries include 40 countries/sub-regions.

The third column in the table labeled AVG gives the average inflation rate for all the countries in that region. The table is ordered by these inflation rates. In 2017, the Advanced Nations' inflation rate averaged 1.7%. The region with the highest inflation rate in 2017 was the Middle East. Those 23 countries averaged 7.2% inflation in 2017. 

Clearly, from the table, emerging markets experienced significantly higher inflation than that of the Advanced Nations.

The second (Low or L) and fourth columns (high or H) show you the range experienced by countries in each of the regions. One Advanced Nation experienced deflation in 2017 of 0.5%. The highest inflation rate experienced by any Advanced Nation in 2017 was 3.8%. Notice the range of inflation rates for Emerging Asia – from 2.2% deflation to 7.5% inflation.

The number that sticks out the most in the table is the 2,818.4% inflation rate experienced by Venezuela in Latin America. The 30% rate for the Middle East came from two countries: Egypt and Libya.  

The fifth column in the table is a measure of the inflation dispersion within each region. It tells you how many of the countries in that region had inflation rates of 3% or less. Of the 40 advanced countries, 93% had inflation rates of 3% or less in 2017. In contrast, only 15% of the CIS countries experienced 3% inflation or less. Despite the 12% inflation rate of Turkey, 92% of the countries in Emerging Europe had inflation of 3% or less.

These numbers raise more questions than we can possibly answer today. They communicate the idea that inflation in 2017 was experienced in highly varying degrees around the world. In some countries, prices fell while they were rising by almost 3,000% in others. Despite world trade and despite globalization, there is no such thing as a common inflation experience. While a casual viva la difference might sound like fun, the underlying point is that inflation has consequences, and both the causes and consequences of inflation are alive and well. We breathe easier in the USA with such low inflation. But the world in 2017 shows that when the right mistakes are made, damaging inflation could be closer than you think. 

           Inflation Rates, 2017
Regions             L      Avg     H          3%
Advan (40)     -0.5     1.7      3.8        93%
Em Asia (30)  -2.2     2.8     7.5         56%
LA & C (32)   -0.2    4.1** 2,818.4   53%
CIS (13)           2.5     4.7     13.7       15%
Em Eur (12)    0.7     6.8     11.9       92%
Mid East (23) -1.0     7.2     30.0       48%

*The data I used for this post came from the IMF’s World Economic Outlook for April 2018. More precisely, they come from Appendix Tables A6 and A7. The inflation measure quoted here is the annual percentage change in the Consumer Price Index. The complete names for the regions are:

Advanced Nations

Emerging and Developing Asia  - China, India Vietnam and others

Latin America and the Caribbean – Argentina, Brazil, and others

Commonwealth of Independent States  -- Russia and others

Emerging and Developing Europe – Turkey, Croatia, Hungary, and others

Middle East, North Africa, Afghanistan, Pakistan – Egypt, Saudi Arabia, and others

**The 4.1% average for Latin America excludes the very high inflation rates for Venezuela and Argentina