Happy Birthday and Déjà Vu All Over Again

I am trying something new this week. To be honest, it is mostly because I am lazy and there wasn’t that much to write about this week. Second, I wanted a chance to underscore my brilliance with respect to my past thinking. Third, I am approaching a blog birthday of nine years. Some of you have been reading my stuff for 9 years. Wow – you are true gluttons for punishment. Finally, I have a very wise friend who suggested this to me. And no, that friend is not Jack Daniels.

Below is the link to a piece I wrote in March of 2010. The full title of that post is The Whack-a-Mole Recovery or Good News is Bad New Until the Good News Really is Good News. I do have a way with words, don’t I?

The reason I chose that post for this little experiment is because that’s where the dart hit the board. No, not really, I am not allowed to have pointed objects anymore.  I chose it because it shows how the same themes show up over and over. Nine years is, apparently,  not enough time for us to move on to something new. Its like no time has elapsed. We are saying the same things over and over!

Back then we were worried that the Fed would drive up interest rates and hurt the economy. Back then we were worried that the economy would not sustain a recovery. Back then we were very worried about dis-functional government and a large government debt. 

And so on. But I don’t want to steal the whole show here.

Just take out your bottle of JD and slowly pour it over a huge ice cube into your favorite whisky glass. Enjoy.

https://larrydavidsonspoutsoff.blogspot.com/2010/03/whack-mole-recovery-or-good-news-is-bad.html

The Macro 10 in the Era of Trump

I thought it might be an interesting exercise to look at some key US data stretching back to early 2017. When I use the word "early", I am communicating the idea that the exact date of comparisons might differ a bit for each of the 10 measures of the economy. Some are daily data from the second week of February. The others are mostly monthly data -- sometimes January to January sometimes February to February The main idea is that I am trying to compare early 2017 to early 2019.

Maybe you will be surprised. I don't know. There's no real story here. As always, the economy's strength is measured in many ways, and sometimes these measures conflict with each other. Let's try it anyway. Maybe I should have added more items than the 10 I chose. For example, I have not included the government debt or government spending or any measures tied to Gross Domestic Product. These are generally quarterly data and we won't have that information until April.

• The top of the table presents two key exchange rates. Over this two-year time period the dollar rose against both currencies -- the yen by 3.1% and the euro by 6.2%. 
• Interest rates on government bonds have oscillated but been pretty stable. The rate on a 10-year government bond was unchanged. The 30-year rate rose from 2.4% to 2.6%.
• Both the inflation rate and the unemployment rate declined. The decline in the unemployment rate from 4.7% to 4% was probably more meaningful than the small decline in the inflation rate. 
• Employment rose by 3.4% ending up at 150.5 million persons. 
• The price of a barrel of crude oil fell to a little less than $53, declining about 5%.
• Stock markets did quite well. The Dow Jones Average was up almost 22%; the S&P 500 by 17%.

Seems like a yawner to me. What do you think? Is our economy falling apart? Do you see red flags on the horizon? True, I didn't put everything in the table. But you have to admit that these 10 indicators cover a lot of territory. Do you have a better top 10?

	2017	2019	Change
Yen per dollar	113.2	109.7	-3.1
Dollars per euro	106.4	113	6.2
10 Year Treasury	2.4	2.6	0.2
30 Year Treasury	3	3	0.0
Inflation Rate*#	2.1	1.9	-1.2
Unemployment Rate*	4.7	4	-0.7
Employment	145.7	150.6	3.4
Crude Oil	55.68	52.71	-5.3
S&P 500	2316	2708	16.9
Dow Jones	20,620	25,106	21.8
*Change in the percent
The remaining changes are percentage changes #The inflation rate is the rate over the past 12 months in February

Are US Financial Assets Getting Riskier?

A critical yet almost secret set of global macro statistics has to do with global financial flows. When is the last time you heard the Five debating global financial flows? The truth is these financial flows are cooler than a large chocolate-covered Dairy Queen at midnight after a night at the Grill.

So let’s start at the beginning. God created heaven and the earth. No, not that far back. We are used to getting international statistics. Even President Trump talks about the trade deficit. We import goods and services from other countries. You might buy an extra cool BMW in Indianapolis but the car was probably made in Germany. That’s called a US import. The US sells goods and services to people all over the world. Goods and services produced here and sold abroad are called US exports. If a person in Riga is sipping a cool JD on the rocks, then the US exported that glorious drink to Latvia.

If US imports are greater than US exports we call that a trade deficit. Even Nolan knows about trade deficits, and he is only 5.9 years old. We read about trade deficits all the time. Every paper reports monthly changes in trade deficits, and I've even seen trade deficit written on a bathroom wall.

Trade deficits are the beginning but not the end of trade. We also trade financial things like bonds, stocks, real estate, and parts of companies. Already, I see you napping, Tuna. But please stay awake. Remember the Dairy Queen reference above. This stuff is going to blow your shorts off. Okay – Tunas don’t wear shorts.

Nowadays, the financial surplus and the change in the financial surplus are the big sharks in town. Note the following:

• A trade deficit means money flows out of the US.

• A financial surplus means that money flows back into the US.

• What goes up must come down – and what goes out must come back in.

It's pretty simple. If we buy a bunch of BMWs we have to send dollars abroad to buy them. When we sell J&D to Latvians, dollars come back to the US. But if we buy more BMWs than we sell JD, then some of the money stays abroad.

Aside from using those dollars as wallpaper in German bratwurst stands, those extra dollars find their way back to the US when foreigners buy US stocks, bonds, etc. And when it comes back like that it creates a international financial account surplus.

We don’t yet have fourth quarter data but I can tell you these changes happened from the third quarter of 2017 to the third quarter of 2018:

• Financial outflows from the US declined from $374b to $132b.

• Financial inflows into the US declined from $504b to $152b.

• Net financial inflows went from a net inflow of $130b to a net inflow of $20b.

What do we learn from this? First during that year, both financial inflows and outflows declined. One could say there was less international financial trade in 2018 than in 2019. Second, the decline in inflows was much larger than the decline in outflows and thus the net amount of money coming back into American financial accounts fell by more than $100b. The majority of this decline came in what is labelled Portfolio Investment in funds shares and debt securities. Another significant decline came from ta reduction in Bank Loans to foreigners.

There are two reasons for this decline in financial trading. First, the US trade deficit in September of 2018 was only about $20 billion larger than in 2017. Thus, we needed less financial inflow to cover the dollar outflow caused by the trade deficit. Second, it might be a warning that foreigners are becoming less interested in US financial assets. Maybe US assets are getting riskier, and foreigners would rather buy financial investments elsewhere.

Now you are experts on international trade. Please send money or JD to me ASAP.

War on Poverty

I want to tread very lightly today. Writing about poverty is a lot like writing about legalizing pot – people can get very heated up about it, and the topic has more angles than an I.M. Pei building.

More than likely we can’t even agree on a proper definition of poverty. Below I paste a standard government definition of poverty now apparently used by both the Census and the Office of Management and Budget. I want to start our conversation today with some data and some simple points. You can, if you so desire, add and subtract as you see fit.

I will begin with some points about wars and then move on to some data. You can take it from there.  

The simple point about war is that you usually want to win it. When I played the card game War with my brother, I never won but I definitely wanted to win. Of course, countries sometimes get into real wars and lose. But I doubt that was the purpose. And so it goes with the war on poverty. One would think that Lyndon B. Johnson had in mind reducing the number of poor people in America. Even if he couldn’t reduce the number of poor people, I suspect he would have said he wanted the poverty rate to fall over time. The poverty rate is the percentage of people in a population who are poor.

And so we turn to the data. It is from the US Bureau of the Census and the full citation is below. The most remarkable numbers are the number of poor people from 1959 to 2017. The number of poor people in 1959 were 39,490. In 2017 the number was 39,698. War on poverty? Hmmm. More poor people in 2017 than in 1959.

But, you say, the population has grown enormously since 1959. We need to look at the poverty rate. So, let’s do that. In 1959, the rate was 22.4% of the population. That was very high but by 1969 it was down to 12.1% of the population. One might have proclaimed victory over poverty insofar as the years from 1959 to 1969 go.

But guess what? The rate in 2017 was 12.3%. In the almost half a century since 1969, the rate did not fall again. Despite all the programs we have put in place in those 48 years, we still have the same percentage of our population in poverty.

One might argue that 12% means success. We can’t really do much better than that. But judging from the cries for increasing poverty programs, many people must think that 12% is not a good number. People want it lower than that. The war on poverty has not, apparently, been won in the last 48 years.

The poverty rate did not stay at 12.3% in all those years. The poverty rate was generally lower in expansion years. It was as low as 11.1%, for example, in 1973. During recessions the rate increased. In 2010, it hit 15.1% of the population. So since around 1969, we have a poverty rate that has been anchored at about 12% but rises and falls cyclically.

I went to an Organization for Economic Cooperation and Development (OECD) website and found a comparison of poverty rates across 40 countries for 2017. The USA had the third highest poverty rate, only better than Costa Rica and S.Africa. Apparently other countries have found ways to do better.  (https://data.oecd.org/inequality/poverty-rate.htm )

So what? My conservative friends would say many things. The threshold definition of poverty is pretty high – around $30,000 today -- and that doesn’t even include support from some welfare programs. They might say that the poor today are much better off than the poor yesterday. They would argue against taxing the rich more to continue or expand the war on poverty. My liberal buddies would argue otherwise. They would point out that people are really hurting, and our definition of poverty does not include people who might be a smidge over the line, yet suffering similar consequences.

My question is this. Is it not possible to do better with the money we use now to help people in poverty? Is it not possible to better understand the real and structural factors that move people into poverty temporarily and those that “sentence” them to unending poverty? Is there a difference between programs that make poverty tolerable and those that end it? I have a feeling that if we quit shouting at each other we might actually be able to understand the enemy in the war and do a better job of actually winning the war. A stalemate seems so wrong.

Poverty Definition: Following the Office of Management and Budget's (OMB) Statistical Policy Directive 14, the Census Bureau uses a set of money income thresholds that vary by family size and composition to determine who is in poverty. If a family's total income is less than the family's threshold, then that family and every individual in it is considered in poverty. The official poverty thresholds do not vary geographically, but they are updated for inflation using the Consumer Price Index (CPI-U). The official poverty definition uses money income before taxes and does not include capital gains or noncash benefits (such as public housing, Medicaid, and food stamps).

SOURCE: U.S. Bureau of the Census, Current Population Survey, Annual Social and Economic Supplements.   For information on confidentiality protection, sampling error, nonsampling error, and definitions, see www2.census.gov/programs-surveys/cps/techdocs/cpsmar18.pdf. Footnotes are available at www.census.gov/topics/income-poverty/poverty/guidance/poverty-footnotes/cps-historic-footnotes.html.

Bringing Jobs Back to America

When the children grow up and leave the nest to go to college or take jobs, parents are often relieved. But they also miss their brats. Few of them, however, take serious steps to bring them home again. Birds leave the nest for good reason and so do the children.

It is, therefore, clear that bringing something back home is not always good or desirable. And so it is with jobs.  The trouble is with the word in my title “Back”. Having a strong job market does not necessarily mean bringing the jobs back. A strong job market and a healthy economy is a very desirable thing and it is possible that bringing jobs back might not be the best way to accomplish that.

I recently read an article that explained that the US dollar’s role as a reserve currency is our main employment problem. If the dollar was no longer the world’s key reserve currency then jobs would come roaring back. How silly can you get?

The rationale is something like this. Countries sit on a bunch of dollars. They are nice to have around in the case that their government ruins their economy and destroys the value of their own currency. This desire to have dollars, therefore, leads to countries buying more dollars and raising the price of the dollar. The latter induces people to buy fewer American goods and more Chinese, Cuban, Estonian, and Vietnamese goods. If only they held fewer dollars, the value of the dollar would fall and the world would orgy on American-made goods. American workers would have so many jobs that they would dance their way through life like Zorba on the beach.

Okay I got a little sarcastic. Sorry. But it really is a silly theory. Does the reserve currency story have some truth? Of course. But that does not mean it is very important in the overall picture of exchange rates and where people like to buy their goods and services. Take exchange rates first. Reserves are but one of many things that impact the demand for US dollars. The value of the dollar seesaws by the minute and by the month because of many key determinants.

For example, global investors love to earn money and they look around for places to invest. When America’s economy seems strong or when the Fed policy leads to juicier bond or stock returns – folks all over the world sell their own currencies and buy dollars so they can buy US assets and get richer. Interesting that good news in US financial markets that raises the value of the dollar might be very important when it comes to hurting exports of US goods and services. Solution – mess up the US economy so it looks weak – that will help US exports of goods and services. I would not recommend this.

The second point is to think more broadly about why people trade goods across countries. Is the exchange rate the only thing impacting trade? Of course not. When we make decisions about sourcing goods we worry about such things as quality and price and those two things depend on many factors. What technology is employed? What design is used? How expensive is the labor? What is the shipping cost? How much do firms have to pay in the way of taxes or how are their costs affected by government regulations? How much does water and energy cost? And the list goes on.

Like many good stories, this one about bringing jobs back to America is more complicated than some people make out.  The reserve currency gambit is silly because it takes one out of hundreds of factors and pretends it is prominent. There is a simple way to look at all this. Americans average somewhere around $60,000 income per year. To make American workers worth that amount in a sustainable way, it makes no sense to compete with Vietnam on low-skilled manufacturing or with any country that has an ability to make a particular good or service better and cheaper than we can make it.

Does that mean we give up? No. It means we use our considerable resources to make the things we are the best at. It won’t be easy but we already do it all the time. Our prowess in digital is amazing. We have new companies popping up like JD at a tailgate party. We will need a smart and determined set of policies that support that effort. We need to think how we reshape government resources and incentives so they support an effort to be the very best at producing things that can generate good pay for many employees. 

We also need to continue to press cases against cheaters. It is one thing for the Rams to be tougher and smarter than Patriots – but if New England cheats, then the Rams still might not win. If China or any other country cheats -- then it is harder for the rest of us to make gains. 

Debt Bomb

Thanks to alert blog-buddy Johnny H the General, I saw this article that quoted our Federal Reserve Chairman Powell warning that government deficits are not a good thing: https://www.cnbc.com/2019/01/10/fed-chairman-powell-says-he-is-very-worried-about-growing-amount-of-us-debt.html

In reading that article and trying to keep up with this ongoing saga called government, I decided that I should try to provide some background. Like making a perfect Old Fashioned, this discussion of government debt and deficits can be daunting. I was taking a poll in a Sanibel haunt last night and learned from a gentle person teetering on his stool that a perfect Old Fashioned had to have sugar in it. So, of course, that sent me into professor mode, and I almost finished my lecture by midnight.

Let’s begin at the beginning. A government deficit occurs whenever the government spends more than it takes in taxes. Like you, the government might spend more than it earns in a given month. The government has a deficit. You have an unpaid charge on your Visa bill. Assuming you never did such things in the past, that deficit now means you have a debt. You owe the credit card company. The government facilitates its debt by selling a government bond to you, me, or Young Jin. 

Next month, if you don’t have as many JDs and manage to keep your spending below your income, you might have a surplus that you can use to payoff your debt. The debt went up and then the debt went down.

The trouble comes when you do not have a surplus. That is, every month you spend more than you earn. The debt increases every month by the amount of the deficit. This is easily solved when the mafia sends a well-dressed representative to your house and removes your collection of authentic German nutcrackers.

In the case of the government, the solution is a bit more complicated. Our national debt in the USA is about $20-something trillion. Yes, Tuna, trillion is a very big number. We are a large and wealthy country, so we seem to be able to handle that debt. No sweat. That debt is held by people both inside and outside the USA. So long as they get their monthly interest payments, they are cool.

What our Fed Chair was saying in his article is that two contingencies worry him. First, his own Federal Reserve buddies are engaged in a project of raising interest rates. This means that the club we call government (I refuse to capitalize that word) is going to have to pay even more dollars every month to bondholders. The second worry is that the USA economy might go into a recession. Just like shining our shoes, recessions tend to come now and then. When a recession comes, it reduces our national income, and we are less rich and less able to pay off our debts.

But you say, Balderdash! We are a rich and powerful country. So what if we have a little bitty recession and interest rates go up a smidge? Well, keep saying that. Ask your Greek friends or maybe your Venezuelan friends what happens when the world decides that you might not pay your lenders. You say, Balderdash again! Those are foreign places, not the USA.

Mr. Powell says he is not convinced it makes a difference. Once we look vulnerable, people will sell US bonds like hotcakes at Denny’s on a Tuesday night. Once the door is opened a crack, all hell will break loose. You don't want to be the last person holding a worthless US government bond! US interest rates will soar, the stock market will crumble, and the value of the dollar will be lower than scum on a snail’s belly.

The Fed will eventually raise interest rates to a normal level. A recession will eventually hit. In the meantime, our government is whistling Dixie. What a bunch of morons. Reduce the deficit dudes. You don’t have a lot of time. Reduce it.

Government Shutdown

We are going through the pain of a government shutdown. It is painful for me since it is harder to find macro data on federal government sites. But my pain is tiny compared to people who are really feeling important life-changing consequences.

So today I ask why?

Apparently the $5 billion proposed to build a wall is more important than everything the federal government does. We have all sorts of problems. We have too many people in poverty. We have too many people with insufficient livelihoods. We have poor infrastructure, and we have terrorists killing people all over the planet. But who cares about doing something about all that? Let's shut down the government over a $5 billion wall.

Do I have that wrong?

Since I was in a playful mood this morning and had not yet ingested my first JD, I decided to do the little table below. The first column shows how much we plan to spend in fiscal year 2019 on major programs. The numbers are in billions of dollars. The second column shows how much we could spend on each of those items if we allocated the $5 billion to that category instead of a wall. The third column compares the second column to the first in percentage terms.

Notice that we plan to spend $4.4 trillion for all federal government programs in FY 2019. A reallocation of the $5 billion would not change that total. So the change is zero dollars and zero percent. But even if that total could go from $4,407 billion to $4,412 billion -- the percentage increase would be very close to zero. This indicates that the $5 billion is virtually nothing when you compare it to all government spending. Why has nothing become everything?

Federal Government Spending USA FY 2019
Billions of dollars
	2019	2019'	%Increase
Healthcare	1,225	1,230	0.41
Pensions	1,108	1,113	0.45
Defense	949	954	0.53
Interest	363	368	1.38
Welfare	348	353	1.44
Education	113	118	4.42
Other	110	115	4.55
Transportation	94	99	5.32
General	53	58	9.43
Protection	42	47	11.90
Wall	5	0	na
Total	4,407	4,407	0.00

Data Dots and Thoughts

Lately some of us have been discussing interest rates. I made the point they were falling despite the Fed raising the Federal Funds Rate (FFR). Some of you believe that interest rates are rising. So I decided to put down my JD for a minute and check with Fred at the Saint Louis Fed.

The chart below shows the rate on 30 year mortgages since 2007. The chart happily says we are both right if you look at the graph in more than one way. That's the nice thing about graphs -- if you look hard enough you can find a historical time period that fits what you told your friends while teetering on a bar stool at 11 pm. I won't name any bars in Bloomington except to note that the bartenders at Finch's Roost, the Malibu and Uptown Cafe now know how to make a Larry Old Fashioned.

Where was I ? Oh yea -- mortgage rates. I chose the mortgage rate because even Nathan understands mortgage rates. I chose the 30 year rate but the 15 year rate would tell us pretty much the same story. I also decided to start the charts in 2007 so we get a nice before and after photo. Notice the shaded area from 2008 to mid-2009 is the great recession. In case you were wondering, the rate before 2007 was generally higher than the 6ish rate right before the recession.

Most of us don't care that much about rates of the past. If you want to borrow money today you are going to pay around 4.5% -- the last dot on the chart. If you want to borrow money next week or next year then the whole chart might help you think about what rates are possible for sometime ahead in 2019.

What might you conclude about the future?

     Focusing on the last few dots you might wonder if rates are going to fall further. There is a tiny little downward trend going on. Will it continue?

     If you go back to early 2017 you see an upward trend interrupted by several months of downward movement. So you might wonder if that upward trend will continue into the future. Notice that by looking at previous upward trends (e.g. 2011 and 2013) the upward movement of the rate was followed by a negative trend.

      If you look at today's rate of 4.5%, it's lower than most of the dots before 2012  but higher than nearly all the dots after 2012.

     If you turn the graph sideways and the changes are left and right instead of up and down -- it kinda looks like a drunk stumbling down the sidewalk on Kirkwood Avenue in Bloomington.

Data is fun but it isn't the whole story. The above exercise is tedious if not frustrating. This is where analysis comes in. I hate to use the word "theory" because many of you skeptics get even more skeptical. But I like theory and it helps us think more about all these dots. What causes the mortgage rate to rise and fall? Thinking about all the causes might shed some light on the above speculations.

Applying theory to this discussion doesn't solve it because there will be differences of opinions about the importance of each causal factor we might discuss. But it does have the benefit of widening the discussion. For example, if the Fed raises the FFR, that increases of cost of money to the IU Credit Union and raises the interest rate. But if global economic changes imply less demand for borrowing, then that would have the opposite effect on interest rates. Which effect will be bigger in the future?

I think the global effect will dominate and rates are going to continue falling. Some of you hold the opposite opinion. Neither the data nor the theory can crown the winner. I guess we will just have to wait and see.

Happy New Year

In the spirit of HAPPY New Year, I thought it might be fun to have a little contest. 

There is always something to be happy about if you work at it. Right now, it seems especially hard. I could list all the things that we are worried about and that list is not inconsequential. We have good reason to be worried about many things.

But then it occurred to me that while worries go through cycles with highs and lows, there is always room for worry if not outright fear. I remember a lot of those times and wonder about your experiences.

I recall:

• being a young boy in the 1950s who regularly participated in nuclear attack exercises at Coconut Grove Elementary School wherein we had to sit under our school desks after the alarm sounded.
• being a teenager at Ponce De Leon Junior High School in Miami when Kennedy faced down a Russian ship with missiles headed to Cuba.
• getting drafted in 1968 and then being shipped to Vietnam in 1972.
• leaving the military only to experience Nixon’s Wage and Price Controls and the resulting high inflation of the early 1970s.
• sitting in long lines hoping to buy 5 gallons of gasoline during the energy crises in 1974 and then 1979.
• my dissertation committee at the University of North Carolina not accepting my dissertation in 1976 right before I went to Indiana to be a professor.
• watching inflation rise in the latter 1970s and getting a mortgage on my first home with an interest rate of 14%.
• a world recession and stock market collapse right before I retired from teaching at Indiana University.

Somehow I lived through all that and life went on. Things seem really crappy today but I am guessing we will waddle through as always. JD helps a bit so keep that in mind as well. 

So I am wondering, what is your list? What did you endure in your lifetime? How did you get through the bad stuff?

Now don't you feel better?  :-)

HAPPY NEW YEAR!

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.

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.

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 davidso@indiana.edu

Very best,

Larry

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 26, we 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

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 government 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. 

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.