Policy Persistence and Stupidity

Almost four years ago in August of 2015, I wrote the below blog entitled Humpty Dumpty Monetary Policy.  No insult to Humpty but those clowns at the Fed were wrong in 2015 and they are even "wronger" today.

https://larrydavidsonspoutsoff.blogspot.com/2015/08/humpty-dumpty-monetary-policy.html

It is amazing how persistent stupidity can be. We have a new head of the Fed and we have a much stronger economic situation, yet the people at the Fed have decided that the only way to do their business is to run interest rates lower than a limbo dancer in Nassau.

Sure, the Fed spent a little time letting interest rates rise above zero, but that's not exactly what I would call normalcy. Any of you who have seen me after downing my usual nightly supply of JDs might question my ability to know normalcy when I see it -- but any of you who are trying to save for retirement or even for a new back yard trampoline know that zero interest rates are not your friend.

You argue -- Larry the Fed raised rates a jillion times in the last couple of years. Larry retorts. Friends, look at the markets today. The rate on a 10 year government bond is about 2% as I write. 2%! Really! You call that high? Factor in an inflation rate of prices of 2% and you get what? Yes math genius. You get a ZERO return. Factor in an inflation rate of 3% and well I don't want to say anything negative. Hmmm -- so much for that trampoline.

Read the articles in the newspapers lately -- this Fed board member and that board member are sooooo worried about the economy they must consider lowering rates. If zero real rates won't solve the problem, will minus 2%? I think not. Like pushing the blood back into a hole in your arm won't fix your medical problem, -2% interest rates won't do a thing for our problems today. What is wrong with those educated bimbos running the Fed?

And if that isn't bad enough, Pelosi and Trump have finally decided to agree about something. Apparently they both love nude hot tub parties. No just kidding. Yikes, please gouge my eyes out. To what are they agreeing? A government with trillion dollar deficits each year and a national debt soon to exceed the size of the entire economy is better than a Bob Dylan 8-track to them. That is truly sad and dangerous. No insult to Bob Dylan or 8-tracks intended.

Do I sound like I am yelling? I hope not. But come on dudes -- have we ever had a worse Fed and government? Ever?

Recessions and Business Costs

Last week I started a voyage in thinking about how constraints might cause a recession. If the US economy grew especially fast for a while, it would use up resources whose scarcity would create the seeds of the next recession. While there was some evidence to support that view, it clearly was not present for most of the World War II recessions.

So now I try a second approach to recessions. While strong growth could cause resource scarcity, it is possible to measure that inadequacy of resources in terms of their costs. I chose three typical measures of business costs and examined how they changed before the seven recessions: worker earnings, the price of oil, and a broad measure of business input costs known as the producer price index. To measure the buildup of the costs, I took a five-quarter moving average. The table below shows the five-quarter percentage change of each of these costs and adds a fourth column for the sum of them.  

What can we learn from this table?

First, the largest number on the table is the 118.4% for the cost buildup total right before the 1981-82 recession. While most of that came from oil prices, notice that the 7.7% increase for earnings and the 14.3% for PPI are large numbers for those categories over time. One could say that business costs were rising widely and rapidly before that recession.

Only the 2001 recession comes close to the 1981-82 number with a score of 59.2%. The cost rise before that recession was mostly the 53.7% increase in oil prices. The PPI was barely budging (3.7%) and worker earnings were up only (1.8%).

The 1973-74 and 1979-80 recessions are widely known to be oil-induced recessions. But the table does not show that. For one thing, right before both those recessions, earnings and the PPI were rising rapidly. Notice that oil does not appear to be a contributing factor. But that is because of some strange things going on with respect to timing. The 1973-74 recession was famous for the Nixon Wage and Price Controls, which put ceilings on oil prices, among other things. Oil prices and inflation generally soared, but only after the recession had already begun. It took a while for energy prices to build again, but build they did, with the biggest increases coming in 1980 and thereafter.

The 1990-91 and the 1969-70 recessions were preceded by little business cost buildup.

That leaves the big momma recession of 2008-09, and there we see no buildups in cost except for maybe oil. But we know there was much more to that one with respect to housing and finance. 

That leaves us thinking about when the next recession will come. If it comes in 2019 we see only rising oil prices as a main culprit. Our simple look at past recessions suggest that business costs can lead to recessions, but we see very little going on with earnings or the PPI before 2019.

Perhaps the recession will come from well-known risks like trade wars, global factors, or finance. But so far those factors are risks and not real trends. As far as I'm concerned, I see no recession in our near future.

Cost Pressures*
Recession	Earnings	Oil	PPI	Sum
1969/70	4.7	1.2	2.0	7.9
1973/74	7.4	1.0	4.2	12.6
1979/80	8.1	4.1	8.4	20.6
1981/82	7.7	96.4	14.3	118.4
1990/91	3.7	1.6	4.8	10.2
2001	3.7	53.7	1.8	59.2
2008/2009	3.9	12.8	4.3	21.0
2019/20	2.6	25.5	4.4	32.6

Average                4.2                  11.4         3.7          19.3

* These percentages are for the five quarters before the beginning
quarter of each recession

Excess and Recession

Two weeks ago  Professor Klemkosky congratulated our US economy for reaching its tenth birthday. I hope you lit 10 candles and sang the traditional song and had at least one JD toast.  It turns out that recessions don’t usually get that old so many of us are wondering just how long this thing can go. I was warned a long time ago that one should not forecast recessions with a calendar. And I won’t today join that crowd and predict a coming economic tsunami.

Biological and medical science helps us to understand why most of us won’t live past 80 much less reach 100.  There exists a lot of science that helps us to explain why our bodies and minds finally get old and cease to function. Sadly, there is no such science to help us understand why expansions do not usually hit their fifth anniversary much less their eleventh. There is, of course, a lot of pop science but like pop music, pop science has its limitations and annoyances.

Consider what seems to be accepted lore when it comes to recessions. Like a runner in the last mile of a marathon, the economy gets pooped because it runs out of gas. The runner keeps asking her body to take more steps, but the process of running the first 25 miles has eliminated a lot of internal resources. The carbs are gone. The fat is gone. The tank gets empty.

Even worse is when the runner tries to catch up to the top runner and sprints to the finish line. The picture is not pretty.

Why not apply this runner stuff to the economy? In that case we would say a recession comes after a time period of strong growth in which we deplete a lot of resources. As we try to keep the economy running hot, it finally simply cannot grow as fast because we have fewer extra resources laying around to bring into the production process. The economy then sags.

It’s a very intuitive narrative. I decided it was time for me to get back into the data. This time I looked at some macro statistics that might shed some light on this resources/recession story. I could have tried a lot of different approaches, but I chose this one. This blog is not a dissertation and it isn’t even a good journal article. So whatever conclusions I draw here today should be subject to a lot of hemming and hawing if not outright laughing and giggling. But it is food for thought and your reactions might lead to subsequent attempts to marshal data relevant to our topic of recessions running out of steam.

The table below assembles some real GDP data for out purposes. I am looking at macroeconomic growth before each of the seven recessions in the USA between 1969 and 2019. In the first column is a number that I calculated to represent the strength of recent macroeconomic growth. I calculated the average of the growth in the economy for the 10 quarters before the start of each recession. The simple idea is that a large number suggests a strong tax on resources before the beginning of the recession. 

Notice that before the 73/74 recession the economy grew by 6 percent per year on average. That’s very strong growth. Notice also that the economy averaged growing at a mere 1.9% per year in the 10 quarters before the beginning of the 81/82 recession.

These  seven numbers in the first column alone do not shed enough light on former growth rates of the economy and a resulting recession. Sometimes the economy grows rapidly before a recession; sometimes it does not. Here is where we could try a lot of other approaches and I chose one.

The second column in the table is the average annual growth rate of the US economy in the 10 quarters before the most current 10 quarters. Comparing column 1 to column 2 let’s us see if the economy grew faster in the latest 10 quarters before each recession. It creates a little more perspective than just looking at column 1. The third column subtracts column 2 from column 1. A negative result means the US economy grew slower in the latest 10 quarters compared to the previous 10. What do these additional numbers tell us?

First, the 1973/74 10 quarter growth average was not only large absolutely but it was much stronger than the 2% annual growth rate prior to that. Clearly there was a strong increase in economic growth before that recession.

Second, the case of the 81/82 recession shows that the 1.9% rate of growth was not only low in the 10 quarters before that recession but it was also very low compared to the annual growth in the previous 10 quarters of 5.3% per year.

These first two points suggest that both stronger and weaker economic growth can precede a recession. The resources issue is thus unresolved.

In four of the seven recessions, the economy slowed in the 10 quarters before the recession compared to the ten quarters before that.

Your minds are spinning. Is this the only way to test if strong or stronger growth causes resource restrictions that lead to recessions? Clearly not. Why choose 10 quarters? What happens to the results if I chose 8? Or 12? Or maybe real GDP is not sufficient for the task. Perhaps we could compare real GDP growth to a measure of total productive capacity like potential Real GDP? Or maybe one could examine prices of key resource inputs like labor or energy.

This case is not closed. But it was fun getting it started. After 10 quarters, is the US economy going to run into resource constraints that lead to a recession? Or is that pop science? If not resource constraints, then what else might cause the eighth recession since the early 1960s. 

Notice I have a line in the table for the 2019 recession. If one started in 2019 it would not be because of resource constraints. The economy has been averaging around 2.6% per year over the last 10 quarters and the last 20 years. I don’t see a recession coming because of that.

Table

Recession    Average Annual Change Real GDP 
Years    10 QTRS**         10 QTRS***    Diff

69/70                3.7                             5.6                -1.9
73/74                6.0                             2.0                 4.0
80                     4.7                             4.1                 0.6
81/82                1.9                             5.3                -3.4
90/91                3.8                             3.9                -0.1
01                     4.4                             4.4                  0.0
08/09                2.4                             3.7                -1.3
19*                   2.6                             2.6                  0.0

* 2019 is not a recession year. This line assumed a recession began in that year.   
** 10 Quarters before the recession began
*** 10 Quarters previous                 

Tax the Rich

Last week there seemed to be a renewed effort by several people, including some very rich ones, to advance the idea that we need to increase taxes on the rich. Of particular interest is a wealth tax which would be added to the existing structure of income, property, inheritance, and other taxes.

The basic idea is that the rich are, well, rich. I recall the comic book character Stooge McDuck. He was very rich and he loved to enjoy many moments in his vault playing with his money. That image of the rich apparently has stuck with a lot of people these days and it makes it a lot easier to want to remove some of those coins from Scrooge's vault.

But I kid of course. One too many JDs this morning and all that.

But the truth is that the nation or at least some of us seem very interested in helping the rich part with their income and assets. The main idea seems to be that the rich won’t miss their money very much and there is a ton of good we can do with the resources. We can write off student loans, help the poor, save the planet, and much more.

So I wanted to think about all this a little more today. The first point an economist might make is to bring up the idea of the diminishing marginal utility of income. Let’s call this DMU since it is a huge mouthful to keep saying that over and over. DMU is a real thing and most freshmen at most universities are harangued about DMU by their wonderfully charming and entertaining graduate teaching assistants. It is a simple idea. If you are poor and I give you $10,000 dollars, you will be happier. If I give you $10k more on top of that, you will be happier but the increase in your happiness is not as big as the first tranche. By the time I have given you $1 million, the next $10k is hardly noticeable – the extra satisfaction you derive is negligible.

So it is true that by taking more taxes from the very rich, they might not notice it a lot. DMU explains why.

You cannot say that I didn’t start out on the left foot. But from here it gets more sketchy.

What happens when you take money from the rich?

The rich definitely give a lot of money to charity. What if the rich decide that they only want to spend a given amount for charitable private and national purposes and reduce their charitable giving by the extra amount of the taxes? Think of the United Way or your local Boys & Girls Club. What if we get free student loans but we have to reduce the activities of local charities?

What else does Scrooge do with all his coins? For one thing, we know that the rich don’t really bathe in vaults of money. They stay rich because they invest their money wisely – or at least try to do so. They often earn handsome rewards, but do the rest of us benefit from their investments?

I would think we do.

These investments can be directly spent on bricks and mortar – maybe a factory in your town.

These investments can show up in saving accounts in banks – and that money is loaned when you buy a car or a company borrows money to modernize operations, do research into new technology, or buy new equipment.

That money goes into bond markets meaning that companies and governments have a pool of funds for their needs, and this puts pressure on interest rates to stay low.

Much of the rich’s money goes into stock markets. Our pensions and other assets enjoy appreciation and growth when there is a strong demand for stocks.

There is the incentive issue too. We enjoy the fruits of entrepreneurship in small and large companies. We love it when companies solve problems, and we get better products and services. We love it when competitive companies innovate and reduce the prices we pay for all sorts of goods and services. Much of those activities come because capitalists love to improve things -- but it also comes because they love making money that they can use for all sorts of things. Paying taxes reduces how much they get to keep. Is there a point at which tax rates get so high that they would rather avoid all the pain of invention and sit all day at Peet's? Or go across the street and have a JD at TG?

You get the main point here. Whether it is local charities or various other uses of the money held by the rich, there are very widespread and measurable benefits to society.

I know the rich also use their money to buy yachts and caviar and spoil their rotten children. But another yacht creates employment and even a weekend in Vegas provides jobs for dealers, Uber drivers, and cleaning personnel. I don't believe for a minute that the rich do not enjoy incredible lifestyles -- but that is not the whole story. 

What’s left to say has to do with the idea that our government can use the money in even better ways than the rich. Sure we might have a little less of this or that when the rich change their priorities – but just imagine all the good that will come if incomes are more equal, we write off student loans, we give people better education, and so on.

Here is where we should all be from Missouri the Show Me State. We all learned about snake oil salesmen. We are taught that snake oil can sound really enticing. Is it not possible that those who speak the loudest about taxing the rich are people who will themselves gain power and riches in doing so? Why do we trust them so much when they have so much to gain?

Worse than that is just the reality of government in the face of immense and ongoing challenges. Do we really trust those clowns to do better than the last batch of clowns? Why now, with a little more money, will we solve problems of education, poverty, and environment? Will a little more money suddenly solve what decades of money has not been able to eliminate much less reduce? 

Do you really believe that adding even more money into poverty programs is going to miraculously successfully reduce inequality of income? Have we really figured out how to use public money to reduce the incidence of poverty when decades of poverty programs have done nothing but increase the rolls of poverty? Is it really fair to write off the loans of mostly people taking graduate work at private institutions when we didn’t do that for past generations of students? Will we be willing and able to provide such education for free for all future ones?

I’m not rich and I don’t care if we tax the rich. But if we do, I’d like to make sure that the net result is positive. The rich will reorient how they use their money. Are we sure those changes won’t make people worse off? Clearly the uses of the new monies could have wonderful results. But are these snake oil salespeople bent on convincing us that they have learned something new that will really reduce our nation’s problems? I haven't heard it yet. You? Show me how and why it will work this time. 

Ten Years And Counting by Guest Blogger Robert C. Klemkosky, Professor Emeritus of Finance, IU Kelley School of Business

This July, the U.S. will set a record for the longest economic expansion in 100 years, assuming a recession doesn’t start, which is highly unlikely. Since WWII, there have been 11 economic expansions that have lasted an average of 58 months; the longest one previously was 120 months from 1991 to 2001 and the shortest 12 months from 1980-81. The current expansion is more than twice as long as the U.S. norm but it’s nowhere near a world record. China and Australia are in their 28^th year, and India and Taiwan both have experienced more than 20 years of economic expansion. Several European countries and South Korea and Japan have also experienced economic expansions of more than 10 years.

While this U.S. expansion has longevity, it has lacked rigor in terms of economic growth; the growth of gross domestic product (GDP), the final output of goods and services, has been an anemic 2.2% annually, the slowest of any economic expansion since WWII. The expansion has benefitted some sectors of the economy more than others: Jobs have been created for 104 consecutive months as more than 20 million jobs have been added to the workforce. This has probably been the most notable achievement of the current expansion. The unemployment rate of 3.6% is at a 50-year low, down from 10% in 2010, and the 7.45 million job openings are at the highest level relative to unemployment of 5.82 million since records began in 2000. At the end of 2009, there were 15.1 million unemployed and only 2.49 job openings. The manufacturing sector has added 1.1 million jobs since 2009. There is a worker shortage.

That’s the good news. But wage growth has been anemic; average hourly earnings averaged 2-2.5% for much of the expansion and only recently have been above 3% but still below the 50-year average of 4.1%. As a result, labor’s share of national income has fallen from 69.9% to 66.4%. Almost half the increase in jobs is due to those aged 65 and older, some because the new 65 is the old 55 but others based on need. The labor force participation rate at 82.1% for those aged 25-54 is below 2007 levels, providing some slack in the labor force.

While Main Street may not have prospered, the net worth of households has surged from $57.8 trillion to $108.6 trillion in the last decade. This has been due to appreciating stock and home prices, and bonds to a lesser extent; the median price of an existing home has increased from $182,000 in 2009 to $277,700 today, and the S&P 500 has risen 336% since March 2009. The yield on the 10-year Treasury bond fell from above 4% in June 2008 to 2.05% today; as yields fell, bond prices increased, creating wealth for bond holders. This wealth creation has not been distributed evenly throughout society as only 54% of households own stocks and 64.3% own homes. This has created record high wealth inequality in the country. Today, according to the World Inequality Database, the top 0.1% of U.S. households control 20% of U.S. wealth, the top 1% control 36% and the top 10% control 74%. This means the bottom 90% control 26% of the wealth, the bottom 50% have zero wealth and the bottom 30% have negative wealth. The middle class, the middle 40%, control 8% of the wealth. Wealth inequality will be a major political issue going forward.

There are several reasons for the wealth inequality. One, there is also income inequality, which fosters wealth inequality. And second, the Fed’s policy of near-zero interest rates and quantitative easing, the purchasing of more than $3.5 trillion of U.S. Treasury and mortgage-backed securities, has kept interest rates at historically low levels. This has supported high stock and bond prices as well as housing prices. The Fed has pursued this loose monetary policy because of the anemic economic growth and low inflation. The Fed set a 2% inflation target in 2012 because they were worried about deflationary pressures and lowered inflationary expectations. The Fed’s preferred inflation gauge, the personal-consumption expenditure price index, has been at or above 2% only eight months since then, and core inflation, excluding volatile food and energy prices, has exceeded 2% only two months. The U.S. has experienced moderate inflation for the last two decades and especially during the current economic expansion, which has helped real (inflation-adjusted) wages.

Debt was a major cause of the 2008-09 financial crisis especially in the household and financial sectors. One would think that a lesson would be learned from the financial crisis but debt is at an all-time high of 230% of GDP. Most of this increase in debt relative to GDP can be attributed to the federal government and corporate sectors. Government public debt has more than doubled from 34.8% of GDP in 2007 to 76.8% in fiscal year 2018. It used to be that the government was supposed to run fiscal surpluses during economic expansions but that hasn’t happened since fiscal years 1999-2001. 

The U.S. government fiscal deficit is heading toward a trillion dollars per fiscal year with no political will to reduce it. The Congressional Budget Office projects federal debt to be 145% of GDP by 2050, almost another doubling. As The Wall Street Journal recently headlined, “Washington Puts Aside Fears and Embraces Debt.” U.S. non-financial business debt rose to $15 trillion in 2018 from $9 trillion in 2007, taking advantage of historically low interest rates. They have made government and business debt manageable thus far, but a large upward spike will be painful. The financial sector has reduced its debt and leverage due to new laws and regulations. The household sector has more debt today but only 76.4% of GDP versus 98% in 2008. Mortgage debt, which was the problem during the 2001-07 economic expansion, is about the same, but student, auto, and credit card debt is much larger today. Households have had a personal savings rate of 7.01% during this expansion versus 4.68% during the last one from 2001-07. Historically low interest rates have forced higher savings rates to overcome what some refer to as financial repression for savers, encouraging more risk taking.

While the U.S. is celebrating 10 years of uninterrupted economic growth, many are in no mood to celebrate as the fruits of the expansion have not been equally distributed. This has led to populism, anti-globalism and losing faith in capitalism. A recent Gallup Poll showed only 45% of young adults had a favorable view of capitalism versus 51% for socialism. Among all adults, 56% have a favorable view of capitalism, the lowest since 2010.

An economic recession does not appear imminent so the U.S. will set a new record for the longevity of an economic expansion. The underperformance of economic growth for this expansion may be the primary reason for its longevity; there are no price pressures or imbalances and bubbles in the economy or financial markets. The question is whether 2% economic growth is the new norm or can be ramped up higher as in 2018. Many, like Harvard economist Lawrence Summers, believe the U.S. economy is in a period of secular stagnation with sustainable subpar growth. The Fed also believes the economic growth potential is around 2.0%, based on slow growth in the workforce plus subpar growth in productivity.

How and when will it end? It is difficult to determine whether this expansion is mid-cycle or late-cycle; the only certainty is what Yogi Berra may have said: “It’s later than it used to be.” Economic expansions don’t normally die of old age; it takes outside forces like the Fed raising interest rates and starting a run-of-the-mill cyclical recession, supply side shocks like oil in the 1970s or a financial crisis like that of 2007-09 to end an expansion. Many economists and CEOs believe the risks of a recession are growing. When a recession does occur, the public will not know about it officially for six or more months. The National Bureau of Economic Research has a Business Cycle Dating Committee that will decide when it starts. Many believe that two quarters of negative economic growth automatically qualifies as a recession, but there is no such rule of thumb in the U.S. The committee will look at many data points and metrics. Yogi Berra may also have said, “It's hard to predict, especially the future,” as economists don’t have a good record of forecasting recessions before they happen. If it happens, let’s hope the recession is short and mild. They are a normal part of capitalism.