Monsters Under the Bed

The head of the Fed, Jerome Powell, was quoted as saying he didn't want to take his eye off the ball before we actually finish the job. I will let him mix metaphors but I won't let him get away with the main idea that is driving his policy. 

The eye in this case is monetary policy and interest rates. The ball is the strength of the economy. Powell believes the economy is not yet strong enough to raise interest rates above zero. Did you hear that....above zero? No interest rate increases for a good while. Nada. Zero.

To bolster this mixing of metaphors, he gets back to economics when he and his minions brilliantly conclude that there is a difference between actual data and forecasts of actual future data. No kidding? Unless they have a crystal ball -- we all know they do not know what is around the corner. We NEVER know what is around the corner. What they are really saying is what I used to tell my mother at bedtime. Mom, I am sure there are invisible monsters hiding under my bed. My mother always replied -- honey, there are no monsters. There are only good fairies. 

So there we have it. Our leaders at the Fed see monsters in our future. Despite their own forecasts and the forecasts of others, they prefer to believe there are monsters under our national economic bed. 

Why take such a strong position? They seem to be saying that good news is bad news. That is, if the good economic fairies actually produce stronger growth, then that stronger growth will be bad for future growth. What? I am not kidding. That is what they are saying. Apparently the current good economic growth is flimsy enough that as soon as prices and interest rates begin their eventual rise back to something more normal (ie not zero!), it will be like a punch in the stomach and the economy will fall to pieces. Poor Humpty Dumpty. All the king's horses...you know the sad story.

They argue that doing too little now just ain't enough. Keep going. Despite historically high government deficits and debt and despite a tidal wave of new money, they have to keep the pedal to the metal.

Nowhere in their explanation is any real mention of what could happen if you keep the pedal to the metal. I suppose the Andretti's could tell them some stories about the risks associated with taking too many turns too fast.  Or what happens when you want to cook an omelet and you forget to turn the heat down a bit after warming up the pan? Not enough heat won't cook the omelet -- for sure. But leaving the temperature on high will surely burn it. 

Our Fed has taken a stance. They are going to keep the monetary pedal to the metal as our government stimulates more and more. Once you vigorously defend that approach to policy -- when do you back off the pedal? How strong does the economy have to be before they raise interest rates a hair? I am not confident they know when to turn the dial the other way. Hope you enjoy your omelet. 

Income Distribution

The information to make the table below was taken from the US Census.

It reports the share of total income by income class. The bottom fifth refers to those at the bottom of the income scale. They earned at most $28k in 2019. Those in the top fifth earned more than $143,000 in 2019. While the chart reports five groups that each represented 20% of the population, the final row has a richer group -- those in the top 5%. 

The numbers in the table show how shares of income changed between 1967 and 2019. 

Before I get to the changes, it helps to know where we started. A lot has happened since 1967 when I was a junior at Georgia Tech. In 1967, the poorest 20% earned only 4% of the income. The poorest 60% only captured 32.1% of all earnings. In 1967, the top 5% of earners accounted for 17.2% of income earned.

Clearly, as far back as 1967, the distribution of income was not very equal.

What has changed since 1967?

The share of income going to the poorest group fell from 4.1% to 3.1%. The decline was spread evenly over the two time periods (1967 to 1993 and 1994 to 2019). 

The income share going to the top 20% of earners rose by 7.3% over the whole period but 5.3% of that came before 1994. 

Share changes for the remaining groups largely occurred in the first period relative to the second. 

What we can conclude from the data is that change was more pronounced before 1994 and has slowed since then. 

Comparing more recent data doesn't change anything. The same patterns emerge.

One point to make about this data. People moved in and out of these income classes every year. So the category is not the same people each year. But the lowest 20% is always comprised of the people at the bottom of the income scale. 

What else? To those people who believe something has fundamentally changed lately to change or worsen distribution income, I say that maybe they need to look further. A half-century of data supports the idea that not much has changed.

While the column of figures under 2019 is not very pretty, it does not very much differ from those numbers under 1967 or 1993. Should we want to make the numbers under column 2045 look a lot better, we might want to do some harder work to understand what is going on here.  

Between 1967 and today a lot of words and much money have been devoted to making the income distribution less unequal. Yet, things have not changed much. What is missing here? We put a man on the moon. Why can't we make incomes more equal?

1967      1993      2019      Change 

                                                                   Whole  First      Second

Bottom               4.0         3.6         3.1         -0.9       -0.4       -0.5

Second                10.8       9.0         8.3         -2.5       -1.8       -0.7

Third                   17.3       15.1       14.1       -3.2       -2.2       -1.0

Fourth                 24.2       23.5       22.7       -1.5       -0.7       -0.8

Fifth                     43.6       48.9       51.9       +8.3     +5.3      +3.0

Top 5%                17.2       21.0       23.0       +5.8     +3.8     +2.0

Which Scenario Do You Prefer?

Which is it?

Scenario 1. Inflation is rising. This pushes interest rates up. Rising interest rates raise the cost of borrowing and reduce spending. Lower spending decreases profits and causes firms to produce less and hire fewer workers. Lower profits reduce the value of the firm and cause the stock market to collapse. 

Scenario 2. Piles of accumulated savings, expansionary monetary and fiscal policies, and continued progress against the Covid virus cause people to expect a strengthening economy. This leads to expectations about higher future profits as firms not only produce more but also are emboldened to raise prices. Banks raise interest rates as this sanguine scenario causes firms to borrow money to finance economic expansion. 

In Scenario 1 we start with what we are observing in markets today -- rising inflation and interest rates. In Scenario 1 we are very worried that the rising inflation and interest rates are going to lead to negative outcomes in output, employment, and the stock market. Scenario 1, therefore, might be part of a case for why national policy should be more expansionary. 

Notice that Scenario 2 is driven by an optimistic expectation about the economy. The economy will be strong enough to produce more without further expansionary national policies. While it is true that inflation and interest rates rise in Scenario 2, these increases are not expected to slam the economy into reverse. Instead, they are seen as a part of a strong economic expansion. Surely rising interest rates and inflation might nip at spending increases, but these detractions are seen as minor compared to the spending increases generated in the expansion. Scenario 2 asks for no additional national expansionary policies. Past policies have generated enough growth and momentum. 

So which is it? Do you like Scenario 1 and prefer more government stimulus? Or is Scenario 2 more to your liking with its lack of need for additional national stimulus? 

You can't have both. Suppose you pick Scenario 1 and 2 is correct? What are the results for the economy?

Suppose you pick Scenario 2, and 1 is really correct? How does that combo impact the economy?

I am guessing that our current government believes in Scenario 1. They worry that the economy is going to fail. Rising inflation and interest rates are going to kill a weak recovery. They will pile on more stimulus. I worry that they are wrong and they will end up stimulating too much! Wait until you see inflation and interest rates soar!

Blog Post March 9, 2021 The Magnificent Seven

March 9 – The Magnificent Seven

Dear friends,

I am taking the week off. My friend Barbara and I are going to visit a place called Port Townsend.  I hope you have a great week.

Since your hunger for knowledge never ends, I decided I would give you some nice choices this week.

Below are the most popular articles from my blog since its inception.

Notice a couple things.

               I started the blog in 2010. The Tuna was a tiny Tunnini back then.

               I posted about 600 articles during those years.

               Below are seven that were by far the most popular.

               Notice that three of them were guest posts written by some good friends.

Want to be a guest blogger? Just let me know.

Here are the Top Seven.

The G20 Blame Game

https://larrydavidsonspoutsoff.blogspot.com/2013/09/the-g20-blame-game.html

Negative Real Interest Rates Cannot Exist. Or Can They?

https://larrydavidsonspoutsoff.blogspot.com/2012/06/negative-real-interest-rates-cannot.html

Bear Case by Guest Blogger John Succo

https://larrydavidsonspoutsoff.blogspot.com/2014/01/bear-case-by-guest-blogger-john-succo.html

Navarro in Neverland by Guest Blogger Chuck Trzcinka

https://larrydavidsonspoutsoff.blogspot.com/2017/03/navarro-in-neverland-by-guest-blogger.html

Peas, Stuffed Cabbage Balls, and the No-Camp Camp of Economic Policy

https://larrydavidsonspoutsoff.blogspot.com/2016/11/peas-stuffed-cabbage-balls-and-no-camp.html

Why We are Lousy Investors by Guest Blogger Robert Klemkosky

https://larrydavidsonspoutsoff.blogspot.com/2013/04/why-we-are-lousy-investors-by-guest.htm 

Ozzie and Harriet Would be Mortified 

https://larrydavidsonspoutsoff.blogspot.com/2016/09/ozzie-and-harriet-would-be-mortified.html

Enjoy!

See you next week.  

 

 

Interest Rates and Inflation

Last week the various stock market indices did some back flips, apparently because, like a vegan pizza, investors didn't much like the taste of interest rates. Of course the actual rate on that day went up so little that you couldn't find it among the spilled popcorn crumbs left over after my TV watching. 

So I decided to look at a little recent history. Below you will see a graph of the monthly inflation rate (annualized monthly changes of the consumer price index) and the monthly rate on 10 year Treasuries. Inflation is the crazy jagged line. The interest rate looks a bit calmer, perhaps on Prozac, in contrast. 

Getting away from the colorful TV messages and one-day fluctuations offers a nice calm way to think about what is going on out there. More specifically, do recent changes in inflation and/or interest rates offer some message, any message, about what might be around the corner? 

Looking way to the right on the diagram -- in the yellow inflation zone -- you see some crazy gyrations in the monthly inflation rate. Early in the recession you get a deep spike downward that reverses itself. The final points in the graph are more instructive. Notice how the latest inflation information falls between the two lines -- thus it is averaging around 2.5%. I am purposely not reporting the figures with all those decimal points to instead focus on general directions. 

If a monthly inflation rate has a lot of folks hot and bothered, start looking to the left on the chart. How does 2.5% compare to past time periods? Clearly, you can see a lot of data points that landed higher than 2.5% -- and many that were even a lot higher than the 5% line. So whatever might be going on now is nothing like we have seen many times in the last 20 years. If you think it is fun to count data points -- just go back a couple of years -- say 20 points -- how many of those were above 2.5%? 

The other line on the chart is a very popular version of interest rates. The 10 Year Treasury rate is the Tom Cruise of interest rates. It looks kind of sleepy but if you look closely you can see that it was pretty high on the left of the chart and then gradually came down until it hit a new low in the last recession. Notice, like a banana on its back, it seems to be trying to slope up. But come on, folks. There is not a lot there to convince us that we are headed to interest rate hell.

Yes, of course, inflation and interest rates ought to rise from the recent floor. But if the US economy could have long time intervals between recessions wherein the inflation rate often exceeded 2.5% why are we acting so crazy about a one-day interest rate peak of 1.5%?