Austerity is Hot

Warning – No matter how hard I tried I could not write on this topic in less than three encyclopedias. 

Here’s the plan. Those of you who don’t have six months to read this veritable Gone with the Wind masterpiece, I have divided the post into two parts. Read down to the repeated happy faces (JJJJJJ) and stop. Those of you who apparently do not have a life may keep reading to see what groovy facts I used to support my conclusions…

Austerity is hotter than a Britney Spears /Beyonce hook-up. I wrote about austerity on May 1 and then my guest blogger Robert Klemkosky said more last week. Robert Barro piled on in the Wall Street Journal (May 10, page A15, “Stimulus Spending Keeps Failing”). No matter how you come at it, much of the wailing about austerity is overdone and inappropriate. It reflects the ongoing misdirected love of the Keynesian short-run. Barro makes two points. First he used Germany and Sweden as two examples of cases wherein governments imposed fiscal austerity while “sustaining comparatively strong growth.” So austerity must have some benefits. Second, he pointed out strong biases which accept the validity of Keynesian stimulus without requiring strong supporting empirical evidence. He likened preferences for more stimulus (and less austerity) to religion.  Amen.

Let’s back-up a minute and define what we are talking about. What do we mean by austerity? Let’s face it – austerity is a pretty austere word! Dictionary.com says austerity means “severe in manner or appearance; uncompromising, strict, forbidding; rigorously self-disciplined and severely moral….” L Makes you want to weep. Had enough? Want to say uncle? If that is what austerity means then most of us would rather run and hide than be austere. It sounds a lot like my fourth grade teacher at Coconut Grove elementary School, Mrs. Montgomery.

Luckily there is more to this term austerity. Wikipedia helps – it says

            “In economics, austerity is a loose term referring to policy of deficit-cutting by lowering spending often via a reduction in the amount of benefits and public services provided.^[1] Austerity policies are often used by governments to try to reduce their deficit spending^[2] and are sometimes coupled with increases in taxes to demonstrate long-term fiscal solvency to creditors.^[3] "Austerity" was named the word of the year by Merriam-Webster in 2010.^[4] However, regarding policies designed to address fiscal problems, a more accurate term is fiscal consolidation^[5], whereas "austerity" may as well mean countercyclical policies, eg in periods of high inflation. Critics argue that, in periods of high unemployment, austerity policies are counter-productive, because deficit cutting reduces GDP (which typically means less tax revenue to pay off the debt); and that short-term stimulus is necessary to deal with deficits in the long-term.…”

Wikipedia took that definition from a Paul Krugman article titled “Europe’s Economic Suicide”. Despite the source it is okay and useful and gets us on the right road. It does a couple of things. First it gets us to a way to measure austerity by looking at government budget positions. Second, it makes clear that we have more than one way to look at government budget positions. According to this definition it is okay (J) to have a policy of austerity if inflation is the country’s main problem but it is not okay (L) to reduce government deficits if the country’s main economic disease is recession and/or high unemployment. It hints, furthermore, that austerity might be a way to demonstrate to creditors a commitment to long-term fiscal solvency.

This definition puts any country in a real quandary if it has a debt problem AND high unemployment. A real debt problem implies that creditors are worried that the country in question may not pay its debts. Stimulus driven larger deficits make creditors even more uneasy and makes it harder to borrow what it needs to finance those larger deficits. Therein is the rub. Therein is Greece. Therein will be the US. Therein is a really cool word.

My analysis below the happy faces comes up with two conclusions. First, this austerity worry is a red herring. According to IMF statistics there has been much talk but very little action with respect to austerity. The evidence supports just the opposite of austerity – countries have piled on stimulus. Except for Greece, there has been very little austerity. These dour faced commentators who decry the negative economic impacts of austerity can find it in one and only one place – Greece. Now those folks have done austerity. Of course, only Greece REALLY needed it. Greece had a major government deficit problem even before the global crisis of 2008. While most countries fit the case that Keynesian stimulus was more popular than paying creditors right away, Greece did not. Their structural government deficit (this is a precise term that is defined more below) went from -10% of GDP in 2007 to -17% in 2009. Greece was a basket-case before the global recession and therefore was an even bigger problem once it joined the others in a cornucopia of government stimulus. But then Greece quickly moved to reduce their deficit to -6.8% of GDP. That was a major move to fiscal austerity.

My second conclusion is that despite historical amounts of government stimulus, there is no real evidence, a la Robert Barro, to support a further round of economic stimulus. While I would agree that too much austerity too quickly might not be prudent in Greece or anywhere else, the data nowhere supports the view that another round of solvency-threatening increases in government deficits is warranted. These deficits were not successful for many reasons – many reasons that I have been writing about for years now. The deficits do not in any way attack the root causes of the global recession and therefore have nothing better than fleeting impacts. Worst, they raise the specter of financial calamity and in so doing undermine the very goals they hope to achieve.

So there you have it. Austerity hardly exists today and doing the opposite of austerity – the chosen mantra of liberal politicians everywhere – will not work. It is too bad that government officials would rather lob austerity bombs back and forth at each other rather than sit down and patiently design policies that actually correspond to widely known financial and structural  problems.

One last point. Some of you would like to rip my brain out right through my eyeballs. Let me point out that the above summary does not stand on its own. The data and analysis below helps you see the basis for my conclusions…

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The fun starts here.I looked at International Monetary Fund (IMF) data on government deficits and conclude that very little austerity has been tried. That is, there is much ado about almost nothing. There is much concern and worry about austerity that simply has not happened yet. Or as austerity’s defense lawyer might proclaim to the jurors – ladies and gentlemen my client is not guilty!

So why is everyone so sure that austerity is behind the world’s most current economic crisis?  As in many of my previous posts I liken the wailing about government cuts to a disconnection between “cuts” and what amount to sensible retractions of temporary changes. It is as if these folks believe that no matter how much government spending is increased – there is never any case to be made to bring down temporary increases to something more sensible. It is like me when I gain five pounds in a week and promise to only gain three pounds next week. Would it really be that hard to lose one of those five pounds? 

Some of you are answering YES it would be that hard. You believe that the recent economic slowdowns in Europe, China, Brazil, and other places warrant more economic stimulus. You would say that now is not the right time to withdraw stimulus…or to even discuss reducing it. You want to wait until the dust settles a bit before pulling the rug out from under a very fragile world economy. To that I would say a couple things. First, aside from Greece, almost no one has shown any predilection to seriously reduce stimulus. The data below will support that little austerity has been tried. Second, there is some data to support the idea that more austerity is planned by a larger number of countries. But please notice that the plans do not involve reducing stimulus until 2013. The world economic recession started in late 2007 and was over before the end of 2009. That means we have given stimulus 4-6 years to work. If that is not evidence to make one rethink the effectiveness of more stimulus, I am not sure what would be. Some of you might retort that it just shows they didn’t try enough stimulus. The data below show massive stimulus. Please!

The data I use comes from the online version of the data appendix to the April 2012 IMF World Economic Outlook.  http://www.imf.org/external/pubs/ft/weo/2012/01/pdf/tblpartb.pdf   I used data from Table B7. Advance Economies: General Structural Balances. 

General Structural Balances are the closest measurements we have for changes in a government’s budget position based on intended legislated policy decisions.  The widely reported data on government budget balances are also impacted by automatic changes in government spending and taxes that arise because spending and revenues can change without any real changes in policy. When a country experiences slower growth, for example, under existing laws more will spent on open ended social programs and less revenue is collected from firms and individuals who report smaller incomes. The structural budget balance ignores those automatic changes and reports only changes in government spending and taxation that are the result of new legislation. Thus the structural balance better measures the intent to change policy.

The IMF data I am using reflects actual recorded structural budgets for 30 Advanced Economies from 2007 to 2011. It then forecasts the same information for each country for 2012 and 2013. In 2007 before the full onset of the global recession, these countries averaged structural government deficits of about -1.6% of their combined GDPs. Seven of these countries had structural budget surpluses in 2007; 22 had deficits, and one country had incomplete data. The deficits ranged from -1% for Australia to -8% for Ireland and -10% for Greece.  Thus most countries were in good shape but Ireland and Greece were not.  Only six countries had deficits that exceeded 3% of GDP. One would expect small deficits or surpluses in a strong year like 2007.

By 2010 these governments had time to change fiscal policy in response to a severe economic downturn and they did.  Some countries reached maximum budget stimulus in 2009 – others in 2010. At the maximum in 2009 or 2010, 22 countries had structural government deficits greater than 3%. Only Luxembourg, Finland and Korea had surpluses – though their surpluses were considerably smaller than in 2007. Thus – all countries in the IMF Table stimulated their economies. Whereas the average structural deficit in 2007 was -1.6% it had more than tripled to -5.2%. The biggest structural deficits were registered by Greece (-17%), Ireland (-12%), Portugal (-9%), Spain (-9%) and Japan (-8%).  Emphasis – their actual deficits were larger. Recall that I am quoting structural deficits.

What matters more for measuring intended policy stimulus is the CHANGE in the Structural Balance between 2007 and the maximum year. Below are some of the changes that underscore the intended fiscal stimulation. Whereas there was a more-than-tripling of stimulus for the whole group, Spain’s structural deficit increased about 7 times! Australia and New Zealand had large swings to stimulus that took them from surplus to large deficits. Notice that a swing of 5% means 5% of GDP. This is unambiguous stimulus. A swing of 5% of GDP is a major stimulus for any country. The table below shows this swing to stimulus for selected countries.

                                                2007    Max     Change

All countries                -1.6      -5.2      -3.4%

            Spain                           -1.1      -9.1      -8.0

            Greece                       -10.0    -17.3    -7.3

            New Zealand                 2.1     -4.5      -6.6

Japan                           -2.2      -8.1      -5.9

Australia                        1.0      -4.6      -5.6

            Portugal                       -3.8      -8.8      -5.0

US                               -2.8      -7.8      -5.0

            Ireland                          -8.0      -11.9    -3.9

To what extent did these countries move to austerity after reaching maximum stimulus in 2009/2010? To answer that question I examine the structural budget balance changes between the max year and 2011; and between the max year and 2013. If austerity had been imposed by 2011 then that would mean the structural budget position would have returned to its value in 2007. That is, if full austerity was in place by 2011, the structural balance would have widened during the recession and then gone back to its original value when the recession was over.

In the case of Greece, the structural deficit was down to -6.8% in 2011. Since it was -10% in 2007 and -17.3% in 2010 , this is a remarkable move towards austerity. But the data do not show that kind of result in general. The average for all countries was a structural budget deficit of -3.8% in 2011 of GDP. This means that there was 2.2% more stimulus remaining than the -1.6% in 2007. Below I describe the austerity changes by country. The details can be found in the table below.

No Austerity: 4 countries had no change in structural budget balance between the max value and the value in 2011. They had removed no stimulus. Thus they had no austerity.

Minimal Austerity: 9 Countries reduced their deficits from the maximum value attained in 2009 or 2010 by 0% to 20%. For example, Italy’s deficit fell from a peak of -3.6% of GDP in 2009 to -2.9% in 2011. That amounted to 0.7% of GDP during a two-year period or a 19% reduction in the structural deficit from its value in 2009. For the other 8 countries in this group, the declines were smaller.

Moderate Austerity: 11 countries reduced their deficits by between 25% and 50%. Malta, for example, was able to reduce its deficit from -5.4% in 2010 to -2.9% in 2011.

A total of 24 countries, therefore, did not halve their peak deficit by 2011. They did not go half-way toward removing the large stimulus to government from 2007 to the peak value.

Large Percentage but small absolute Austerity: 4 countries had very small deficits or surpluses at the max in 2009 or 2010. They had very small surpluses or deficits in 2011 too. In some cases the changes look large in terms of percentage changes but in no case was there a large change in the deficit or surplus. For example, Korea’s surplus went from 0.7% of GDP in 2009 to a surplus of 2.4% in 2011. That amounts to a 243% change but represents a 1.7% of GDP move over two years.

Country	Max Stimulus	2011	Austerity	% Austerity	Comment
New Zealand	-4.5	-4.5	0	0	No austerity
Japan	-8.1	-8.1	0	0	No austerity
Netherlands	-4.6	-4.6	0	0	No austerity
Denmark	-0.6	-0.6	0	0	No austerity
Norway	-5.8	-5.6	-0.2	3	Less than 20% Aus
US	-7.8	-7.2	-0.6	8	Less than 20% Aus
Cyprus	-6	-5.5	-0.5	8	Less than 20% Aus
Advanced	-5.8	-5.2	-0.6	10	Less than 20% Aus
Australia	-4.6	-4.1	-0.5	11	Less than 20% Aus
Canada	-4.1	-3.6	-0.5	12	Less than 20% Aus
Luxembourg	-0.8	-0.7	-0.1	13	Less than 20% Aus
Belgium	-4.4	-3.7	-0.7	16	Less than 20% Aus
Italy	-3.6	-2.9	-0.7	19	Less than 20% Aus
Euro	-4.4	-3.2	-1.2	27	27% to 46% Aus
Spain	-9.1	-6.5	-2.6	29	27% to 46% Aus
Other Advanced	-2.1	-1.5	-0.6	29	27% to 46% Aus
Slovak	-7.5	-5.3	-2.2	29	27% to 46% Aus
UK	-9	-6.3	-2.7	30	27% to 46% Aus
Slovenia	-5	-3.4	-1.6	32	27% to 46% Aus
France	-5	-3.4	-1.6	32	27% to 46% Aus
Ireland	-11.9	-8	-3.9	33	27% to 46% Aus
Austria	-3.6	-2.4	-1.2	33	27% to 46% Aus
Portugal	-8.8	-5.7	-3.1	35	27% to 46% Aus
Malta	-5.4	-2.9	-2.5	46	27% to 46% Aus
Germany	-2.2	-1	-1.2	55	Large % but small
Greece	-17.3	-6.8	-10.5	61	Very large Aus
Sweden	-1.2	0.2	-1.4	117	Large % but small
Korea	0.7	2.4	-1.7	243	Large % but small
Finland	-0.1	0.5	-0.6	600	Large % but small
Estonia	Na	na	Na	na	NA
Average	-5.3	-3.8	-1.5	na
Median	-4.6	-3.7	-0.7	29

What about beyond 2011? The IMF estimated structural budget balances for these countries in 2013. As you might expect, they forecast continued improvements in budgets. By 2013 the IMF sees 14 countries at or better than the structural deficits they had in 2007. That is, the IMF sees about half of these countries returning to the deficit levels of 2007 by 2013. Among those with the best forecasted austerity performances through 2013 are Greece, Italy, Ireland, and Portugal. The countries that remain with higher deficits and less austerity in 2013 are Japan, New Zealand, Luxembourg, Canada, Norway, and Finland.

While these future projections were done in early 2012, much has been happening in the EU that would put these improvements in doubt. Inasmuch, I would guess that if the IMF did the forecast process again today, it would estimate even less improvement in structural budgets in 2013. Thus they would find even less austerity between 2011 and 2013. 

This data suggests several things. First, there is no wild and crazy movement toward less government stimulus and more austerity when measured by changes in structural budget balances since 2007. Greece remains alone in this category. Greece needed austerity because it stood alone in terms of fiscal laxity before and during the recession. Second, there is no clear relationship between economic recovery and government stimulus/austerity. Germany had little stimulus and significant austerity and was among the strongest in terms of economic growth. The US had plenty of stimulus and little austerity and also had above average economic growth – though not necessarily any better than Germany’s. Third, countries doing the most austerity are not easy to categorize. For example, Spain had a dose of austerity which only reduced 29% of the stimulus before it; Ireland’s austerity removed a third government stimulus; Greece’s austerity removed more than the increases generated during the recession.

I am not sure what the issue is over Italy’s austerity. Italy’s structural deficit did not increase very much so there was little to remove. Italy’s structural deficit went from -3.2% in 2007 to -3.6% in 2009 and then down to -2.9% in 2011. In contrast the US structural deficit went from -2.8% in 2007 to -7.8% in 2010. It remained at 7.2% in 2011. Why are people focusing on Italy and ignoring the US so much?

As the world economy weakens in 2012 it is likely that the government budget numbers will look much worse than the structural budget data published by the IMF. So the level of alarm about deficits in any of these countries might be higher pitched than this data might indicate. But the question of intended stimulus versus intended policy austerity is unaffected by this dimension. It remains that much stimulus was added and much remains – very little of what we have seen governments implement can be called austerity. The Greeks appear to be the only exception.  Perhaps they could dial it back a bit. The rest should pay attention to their knitting.  

Bond Markets Will Rule

 Thanks to Buck Klemkosky for being our guest blogger this week. Buck has been the dean of the SKK Graduate School of Business at Sungkyunkwan University, Seoul, since 2004. SKK GSB is the top MBA program in Korea and one of the top programs in Asia. Previously he was a finance professor and served as associate dean and chair of the finance department at the Indiana University Kelley School of Business. He follows the markets closely as a money manager as well. A version of this article in the Korea Times appeared on Dec. 11, 2011.

Recent elections in Europe show popular support for anti-austerity fiscal programs. But the results of elections may not be the final arbitrator of fiscal policies, especially in Europe. As contagion spreads from country to country, it appears as if the bond markets will be the primary force imposing discipline on European governments, central banks and commercial banks.

Two of the primary signals for sovereign debt problems are credit spreads and credit insurance. Investors compare sovereign bond yields to those of Germany or the U.S. to assess the probability of sovereign debt default or some sort of restructuring. As credit default spreads widen, the market places a higher probability on potential default. Investors also pay attention to how much it costs to insure against sovereign debt default in the credit default swap market.

Of course, politicians don’t like discipline, especially market-imposed discipline. Their first reaction is to blame higher bond yields on evil speculators. But politicians lose sight of what markets do. One of their primary functions is to process information and set prices for financial assets. For bonds with fixed coupon rates, the bond price determines the yield to maturity, if investors buy today and hold the bond to maturity. Once the coupon rate is set, if investors want a higher yield because of higher default risk, they can get it only by buying the bond at a discounted price. So there is an inverse relationship between bond yield and bond price. Bond investors also do not have to buy the bond and hold to maturity. They can anticipate or speculate on changed in yield and hold for time period less than maturity.

Burt the basic question is: Should you trust the markets? If you believe that the bond market for sovereign debt efficiently processes information, then bond prices do reflect public and private information. This is referred to as the Efficient Market Hypothesis in finance. Informational efficiency is a matter of degree, but research shows that bond markets are fairly efficient at processing information and setting prices and yields.

What does it take to have an efficient bond market, even with speculators? Foremost, you need a large number, not all, of investors who are rational and compete for information to value bonds. The incentive to search for and analyze information comes from trying to maximize returns for a given level of risk. Markets can also be efficient even with speculators present as long as they have diversity of opinion, independence of thought and use multiple sources of information. Speculators invest their own capital and assume risk, so they have a big incentive to get it right. So speculators do not necessarily separate the financial markets from the real economy or make prices more volatile than economic fundamentals warrant. Speculation also does not necessarily cause asset bubbles (irrational markets). So the collective wisdom of markets and the self-interests of investors can provide the most efficient prices.

Of course, hindsight shows that asset bubbles do occur:  technology stocks (1996-2000), housing in many parts of the world (1996-2006) and various commodities. But the bond markets have not been as subject to irrational exuberance and collective investor euphoria as other asset classes. If bond yields don’t reflect economic fundamentals in many countries today, it is because central banks have kept interest rates abnormally low as a monetary tool to help slow-growth economics.

Governments have proposed or imposed various rules and regulations to curb perceived speculation: place a tax on financial transactions, ban short selling, put position limits on derivatives contracts and eliminate or curtail the use of some products such as credit default swaps. Most of these are imposed with little empirical evidence as it is easier to blame speculators than to address real economic problems such as deficits, promises that can’t be met and sovereign debt.

What the bond markets are telling us is that the euro zone has massive problems that probably can’t be fixed in the short term. The PIGS (Portugal, Ireland, Greece and Spain) have been replaced by the PIIGS (add Italy). The source of the financial contagion has been the European Central Bank and the politicians doing too little too late.  While politicians in some countries worry about moral hazard by reducing incentives to reduce deficits and restructure economies, others believe that austerity programs will cause recessions and widen deficits and increase the sovereign debt problem.

The interconnectedness of European banks and sovereign debt has created a perfect storm in which investors are losing confidence in some euro zone countries and banks.  Investors realize that some of the countries are too big to fail, but also perhaps too big to save, given what has been proposed thus far. The probabilities of the collapse of the single euro zone currency have increased and will continue until bold actions are taken to stop the contagion. Confidence has to be restored decisively.

So European politicians and bankers have not liked what has been happening in the bond markets. More than one has denounced the markets and stated the need to establish or re-establish the primacy of government policy over the markets. But the bond vigilantes are a tough group. If they could speak with one voice, it would be: “The markets aren’t the problem. It’s the banks and the politicians who caused the mess. If you don’t like what we, the markets, do, don’t borrow money in the bond markets.”

As James Carville, advisor to President Clinton, famously stated, “He wanted to be reincarnated as the bond market so he could intimidate everyone.” Market discipline will work when everything else fails, especially politicians and government.

Asian Kiss Part 2

I don’t usually follow one post with another one so quickly but it seems necessary in this case since I lumped two countries together in a way that just needs some correction. As some of you have pointed out, my last post was titled Asia but was really about Seoul, Korea and very little about Hanoi, Vietnam.

So since I was apparently too easy on my friends from Vietnam, let me try to playfully misrepresent their country and irritate them too.

While I did get an all-expenses-paid visit to Vietnam in 1972, I was asked to stay in the south. But most of my recent reflections stem from several visits to the north – Hanoi in particular.

I think I made the point that Koreans eat a lot of kimchi. The closest counterpart I can come up with for Vietnam is pho. Pho does not rhyme with Mo – it more rhymes with Duh. If you know the Vietnamese alphabet you know this because of the little thingy they put over the o in pho. Anyway, Vietnamese people eat pho at any and all meals. It seems to be a favorite for breakfast which is not easy for a westerner to take since we do not usually eat hot soup for breakfast. Pho is basically a broth that comes with noodles and you can add stuff to it. Most popular additions include basil, mint leaves, lime, bean sprouts, and hot peppers. Pho can also come with beef, chicken, meat balls, and various seafood.

A big difference between Korea and Vietnam is the stage of development or the average income level. These measured differentials seem misleading to me but Koreans earn about 10 times what Vietnamese earn.  Vietnam is a poor country with a single communist party. Korea is a high income capitalist nation. Vietnam’s long and skinny country has a population of more than 90 million. South Korea is a rocky and mountainous home to a little less than 50 million. So these are two very different countries!

I mentioned in my previous post that sidewalks can be dangerous places. This is true in both countries but there are major differences. In Seoul, you have to watch out for the motor scooters. In places in Vietnam you not only have to watch for motor bikes but there is the errant water buffalo, chicken, or draping power lines.

That brings me to driving. Traffic is very tricky in Seoul. In Seoul the problem is mostly the density of cars. Lots of cars. Modern cars. There are just too many cars in the streets. The second issue in Seoul is “fender-first”. While we Americans defer to a car ahead of us, most of the time we do not constantly compete for the front row position with the rest of the cars. In Seoul, two cars will do anything to get their fender one centimeter ahead of the other guy. Once that centimeter is establish, he/she has the right of way and will move his car, bus, 16-wheeler in the lane the other guy is occupying. The other guy will have to pull back and yield. This basically means that in Seoul any time you drive you feel like you are in the annual Indy 500 race.  

Fender first applies in Vietnam too but cars are not the main issue in Vietnam.  There the issue is motorbikes. Motorbikes are as thick as professors at a poetry reading. Seriously you have never seen so many motorbikes in your life. For many people the motorbike is like a family sedan. It is not uncommon to see the whole family on one motorbike and I don’t mean just the immediate family. Of course motorbikes also function as trucks. You have not seen anything until you have seen a Vietnamese motorbike loaded with 16 live pigs – or 16 tons of steel.  Barnum and Bailey have little to compete with Vietnamese motorbikes.

The second critical aspect of Vietnamese driving is the rules and/or following the rules. In Seoul taxi drivers and other people in a hurry will sometimes run red lights or pass in the oncoming lane. It is done more than here in Bloomington. So there is some lack of obedience to the rules in Korea. Often this behavior seems rational. For example sitting at a traffic light that is three light years away from anything in the middle of the desert seems crazy. But we Americans and Swiss follow rules. Koreans are a little more flexible. Well, if Koreans are flexible we might say that the Vietnamese are double-jointed.

Here’s the thing that gets you driving in Vietnam…cars coming out of a side street never stop – they don’t even brake. I am not sure if they have the legal right of way but it seems that way. Imagine you are tooling down some major road in the US and some yahoo comes out of a side street in front of you. What would you do?  If your seat belt was on and your insurance was paid up you would probably quit texting and slam right into him to show him how stupid he is. At the least you would tailgate him for 700 miles and then shoot him the finger when you finally passed him. That never happens in Hanoi. People are ALWAYS turning in front of you. And when I say people I mean cars, motorbikes, water buffalo, etc.  And you are always letting them do it. It is you who has the full field of view and it is you who is expected to cheerfully swerve, jam on the breaks or do whatever is necessary to let him/her into your lane.

The other cool thing about Hanoi is walking across the street. You might think that because the drivers have a red light and because the pedestrian signal gives you the green that you would be safe to walk with your ipod glaring in your bad ear as you day dream about your latest professional conquest. No No No. Just because you seem to have the right of way it does not mean that anyone is going to stop. Motor bikes and cars view the traffic signals as guidelines and not as pronouncements of the Supreme Court. But it is very safe to walk across even the busiest of streets in Hanoi if you know how to do it. Just like the cars coming out of side streets, you the pedestrian do not stop. If you want to get to the other side of the street, take a big breathe and start walking. The vehicles will not hit you. They will come close to you but they will swerve and miss you. The first few times it feels a little like walking the plank in accountant-infested waters. But I swear on John Maynard Keynes that so long as you walk at a measured pace and so long as you give the eye to oncoming traffic you will make it to the other side of the street without harm.

One final thing about driving is the honking in Vietnam. In the US honking is the equivalent of a four-letter word from one car to another. We honk to tell another driver he is a very bad person. We often honk out of frustration. In Vietnam the honking never stops. Honking is a warning system. Perhaps they honk so much because drivers do not use their rear-view mirrors enough? Perhaps they honk because they might be passing in the oncoming lane. I don’t know the origin but I do know that Vietnamese drivers are continuously telling the other drivers where they are and that they are in the process of passing you. It seems like a reasonable system especially if you can turn off your hearing aid. After a while you either get used to it or it drives you crazy.

Okay, now that I have written a little more about Vietnam I am expecting even more hate mail. J

As I said in the past post, I feel lucky to have met so many kind and generous people in Seoul and Hanoi. I look forward to seeing them again!

Asia Meets America and They Kiss

Some of you know that I have been spending more time in Asia – especially Korea and Vietnam. Some of you have asked me from time to time what it is like to live in Asia. My blog says that it is about macro and other stuff – so to make that a true statement I ought to write about other stuff sometimes. Other stuff could include lots of things including my attitude towards garden weeds, wild deer that eat our hostas, and why I am not fully appreciated by my friends and family. So maybe writing about Asian reflections is not a bad idea.

Before I get into all this I want to apologize to all my Asian and non-Asian friends if I fall into well-known traps of stereotyping or saying something wrong or something just plain stupid. But it makes no sense to even get into this question if we can’t stereotype a little bit. For example, if I wanted to write about differences between men and women you gotta admit – va va voom – that men and women are different. We might be alike in many ways but please EXCUSE ME for knowing that we are different. So it is the same thing with respect to Asians and Americans. Many Koreans have much in common with many Hoosiers. But come on – it is okay to say we are not exactly the same. Right?

So where do I start? I guess you have to start with an important difference so let me bring up kimchi. Koreans eat kimchi seventeen times a day and the really cool thing is that the constitution gives every Korean a kimchi refrigerator regardless of height, weight, religion, or economic status. When you go to a Korean restaurant you will usually get an unlimited amount of kimchi. Finish the tiny little bowl of kimchi in front of you and like magic, it is refilled. The kimchi angels keep it flowing. In fact, a typical Korean meal will have several bowls of different kinds of kimchi and other shared items that resemble roots, twigs, and tiny Michelin tires.  Of course you can also find kimchi in many delicious soups, stews, pancakes, fried rice, and nachos!

This gets us to another huge difference between our cultures – and that is the concept of double-dipping. There is no concept of double-dipping in Korea. In America if Larry plunges his fork into the group dish of nachos a second time, he will immediately be taken to the back of the restaurant and beaten by gangs of Manners Police. In America we believe that putting my fork back in the bowl once it has ventured near my bacteria-filled mouth area constitutes a crime against humanity. Koreans somehow know about the concept of bacteria yet you can sit with many of them at a meal and allow your metal chop sticks to plunge numerous times into the same shared bowls of delicious side dishes. This may have something to do with the strong sense of family and national pride shared by Koreans. In their culture if you think you might be sick or contagious, you would probably not attend a shared meal and you would probably wear a face mask around all day to protect your colleagues and relatives.

Koreans get close to each other. Women often walk arm and arm. Men will stand close to you when speaking with you. Americans usually prefer to stand back. In Korea standing back means you are not interested enough and might never get on that airplane, bus, taxi, or subway. To a Korean standing back means you do not have a great urge to get on the vehicle. If for example, you leave what you think is one foot between you and the gate, 1,000 Koreans will move ahead of you in that space. As an American you think they are rude and have unfairly crowded ahead of you to gain advantage. I don’t think so. They see you as not being in a hurry about getting on. They see the inefficiency of leaving a gap in the line. If you drive a motor bike in Hanoi you see the same thing. How many motor bikes can fit across a two lane intersection? My guess is about 100,000. Do not leave one inch of space between your car or bike and the one in front of you. An alert Vietnamese biker will go through a wall to fill a void if he sees it. This may have something to do with the fact that Seoul and Hanoi have little space for humans after you subtract the ubiquitous mountains. Space is at a premium when you compare it to the vast expanses of land in the USA. You can drive through North Dakota all day and see more Elk than actual human beings.

And then there is the art of walking down a perfectly calm sidewalk. Americans think that sidewalks are for people and for people on skateboards. That is a very limiting concept. In Asia a motor bike or a water buffalo go wherever they like. They are permitted to roam and run lights and they do that regularly. But they are also permitted to jump onto sidewalks at will. So don’t think because you are taking Fido for a walk on his leash that you somehow own the sidewalk in Hanoi or Seoul. 

The other challenging difference about peacefully walking down sidewalks is the preferred side. Americans ALWAYS stick to the right side. That is a very orderly and efficient concept. Always stick to the right. Even if you have to knock some fool over – get to the right. In fact we are so wed to walking on the right that if some evil communistic person is walking toward you on your side of the sidewalk you will quickly conclude that he/she needs a lesson in sidewalk directional etiquette – wherein you walk right over that elderly woman spilling all the items in her pushcart everywhere.  Asians seem to prefer walking on the left. But that is not a hard and fast rule. They are more fluid than we are.  Koreans seem to have a sixth sense about not running into each other. Since I don’t always know whether they will go left or right, I am conscious of them all the time. So I look a little like a high school running back on the sidewalk – dodging left then right then left again.  It’s pretty cool. I have to think about it. They seem to just bob and float in a great wave of humanity. They sting like a butterfly and float like a bee. Or something like that.

The next important thing to remember in Korea is who pours beer for whom.  The boss never pours his own beer. Unless you are the youngest and least ranked person at the table, it is a pretty cool concept. This reflects, I think, another aspect of a culture that shows respect and a strong sense of social togetherness. It is not enough that you spend an evening swapping stories or explaining the concept of diminishing marginal utility, In Asia there is a constant reminder of mutual dependence as each person at the table watches the other’s glass with the intent of making sure no glass goes empty.  Adding to this sense of camaraderie are the frequent toasts. Americans might have a special toast at the beginning or end of an event. Koreas keep toasting until everyone is pretty much toasted.

One Korean colleague was telling me something the other day about scientific tests that showed that Koreans look at a painting differently than a westerner. He said that westerners look immediately at the middle or point of focus – the place where the main action or story is. Koreans, in contrast, do not look there – they tend to look at the periphery and the area surrounding the central focus. One interpretation is that this is yet another piece of evidence of the strong social cohesion of Asians. The periphery defines or is integrated with the main actor or central focus. To westerners the art has a message or an individual focus. To the Asian this central focus is just one part of a greater consciousness.

As I said in the beginning above, stereotypes can be very misleading. If anything my time in Asia makes me that much more appreciative and aware of the best and worst of all cultures.  The individual focus and spirit of western countries has numerous and wonderful attributes but we all know that when taken to the extreme, selfishness can be an undeniable liability. The stronger social and interdependence of Asian cultures provides some very beautiful and efficient ways of interaction yet blind allegiance to unearned respect can blemish that approach. I feel very lucky to have been able to spend time in Asia and have the opportunity to learn and experience the truth that friendship means the same thing in every culture.  

Okay, I am sure I goofed up somewhere. Let me know what you think!

Flawed Keynesian Analysis Based on Confused Terminology

Larry Summers is a former US Secretary of the Treasury and is now a professor at Harvard. He is also an unabashed Keynesian who apparently will use any means to support ongoing stimulus. His latest nonsense was published by the Financial Times on Monday, April 30^th on page 11, “Growth not austerity is the best remedy for Europe.”

He might as well have added apple pie and mom into the headline. Notice that austerity means stern, severe in appearance, uncompromising, forbidding. Clearly austerity does not sound like anything you’d like to dance with on Saturday night at the Player’s Pub in Bloomington Indiana. Growth is just the opposite. We all want to grow – what could be better than growth in spirituality, wealth, height, etc. I tend to grow around the waist line but let’s not go there.

So saying you are for growth and not austerity doesn’t take a background like Summers’. So what is he really saying? Basically he is saying that he wants even more stimulus in Europe. How can I conclude that?

Let’s get back to the term, growth. Growth has two definitions or meanings. First, growth has a very general meaning in macroeconomics. We say the economy grew by 2.2% last quarter because the value of real GDP in the first quarter of 2012 was higher than the value produced in the fourth quarter of 2011. It was higher by about 0.55% but when we annualize the figure it becomes 2.2%. Economic growth according to the general definition simply means a rising real GDP. To say that growth is the best remedy makes no sense. It makes no sense because one has to explain what will cause the growth. Will the strong European growth be induced by Adam Smith’s invisible hand? By another round of monetary expansion? By more government spending or tax cuts?  By imposing supply-side economics or restructuring?

His article is pretty clear that the solution is more spending during a time of large government debt. He clearly discounts any value from supply-side programs, “there will ultimately be a need to raise retirement ages, reform sclerosis-inducing regulations and restructure benefit programs.” But he is very clear that he is NOT recommending any supply-side programs now.  Those are not seen as generating growth but as something to do later. He explains that income is driven by demand. Austerity is bad because it drives down spending, income, and the ability to pay off creditors. He boldly says austerity makes it impossible for a country to pay its debts. More spending, in contrast, makes it possible. Is this convoluted or what?

Really this is what the former Secretary of the US Treasury is telling us. Let me repeat it.

• Spending less makes the debt problem worse

     ·      Spending more is the best way for a debtor country to pay off its debts.

·          

I hope he explains this to the investing public. They will be fascinated. When Spain decides to have much bigger deficits, Summers predicts investors will all join in a chorus of gumbya as they buy as many Spanish bonds as they can find. Seriously, nowhere in his article does he even raise the possibility that spending more in Europe could elicit a very negative response from world investors that would shake even the Sagrada Familia.

There is more to this that bond vigilantes. Growth has a second meaning in macroeconomics. Economic Growth Models are used by economists to explain what causes a country’s GDP to grow in the long-run. These models do NOT focus on short-term fluctuations. You might wonder how fast the US economy is going to growth in the next 10 years.  The US CBO thinks the US will grow by about 2.3% per year between 2011 and 2021. See this at page 2 of  http://www.cbo.gov/sites/default/files/cbofiles/ftpdocs/120xx/doc12039/economictables[1].pdf

Many of us would have a little more interest if Summers’ title was referring to this definition of growth. Why? Because if he is referring to longer-term trends, then this brings us a little closer to a meaningful policy interpretation. That is because most long-term growth models explain and predict a country’s economic growth with concepts like labor growth, capital growth, and productivity (see page 2 of the above link for this kind of detail). These long-term growth models usually are devoid of any demand-side variables like government deficits or money growth. Thus, to achieve a higher sustained rate of growth policy needs to focus on ways to improve labor supply, capital supply, innovation and anything that might make labor and/or capital more productive.

We do not usually associate monetary or fiscal policy with the sustained growth of labor, capital, and productivity.  Monetary and fiscal policy are Keynesian inventions used to fine-tune aggregate demand temporarily. What I refer to in past blogs as restructuring or supply-side policies – and the things Summer’s mentioned as policies that we can try later – these are the things that are usually associated with creating higher sustained levels of economic activity.

So if we want to get out of our current slow growth trap the answer is not more spending. The answer is more supply-side policies designed to improve outcomes in labor markets, capital markets, efficiency, and innovation. But there is one more point. Clearly austerity is an important part of a supply-side approach. If we want more growth then we need more austerity, not less. Why do I say this? After all, I quoted definitions above that describe austerity as something pretty ugly. The answer is that it sometimes takes something ugly to get to the other side of your problems.

Yes, spending less will probably create predictable downside short-run changes in spending and incomes and employment. But many countries have already ventured into this phase and will soon be emerging. Spanish unemployment is deplorable but Spain has encountered these kinds of unemployment levels before and lived to see a better day. It is like the reformed smoker who gets half-way through his prescribed regime only to smoke a couple of Camels to celebrate his month of abstinence. They should stick with the austerity so its benefits have time to work.

What is not consistent with Summers’ ideology and he never mentions is the well-known remedial affects of austerity. Why would a country ever be willing to go through austerity? You don’t do it for fun. You do it because it addresses what is wrong with your country. If financial excess caused the recession and knocked the government’s finances out of whack, then one has to reverse the financial excesses. Europe is trying to create financial regulations to address private financial excesses. But it makes no sense to address private finances while you are making government debt dramatically worse. Shifting financial excess to government excess can only work for a while. To heal, a country must convince the world and its own citizens that it will pay its debts.

Convincing the world of this financial improvement means that creditors will accept more reasonable interest rates. It means that companies will be able to borrow and invest more profitably. It means foreign investors will be more willing to invest in the economy. It means a lot of good things that can only improve growth. But austerity might not be enough. Combining austerity with supply-side remedies would be a powerful double punch that will support both short-term and long-run economic growth. Summers could not have the prescription more wrong! We need more austerity, not less. We need supply-side policies now, not later.

Exchange rates, my bicycle pump, and a rubber crutch

My front bicycle tire went flat. So I took out my trusty bicycle pump and put more air into the tire. Each day my tire would go flat overnight. I kept putting more air into it. It was getting flatter sooner and sooner and so in desperation I decided to get a new pump. Guess what – that didn’t make any difference. The tire kept getting flat. Why? Because the tire had a hole it that kept getting bigger and bigger. The problem was not the pump. The problem was the tire.

Some of you are saying. Davidson – you don’t even have a bicycle. But the truth is that I do though it does not have a hole in its tire. Some of you are saying – where is the macro? So here it is. I believe that exchange rates are like my bicycle pump. The pump might be the remedy for some minor adjustments in tire pressure but it is no match for a fundamental problem like a hole in the tire. A bicycle pump is not a solution to a hole in a tire and the exchange rate has nothing to do with a country’s competitiveness. If you want to fix a country or fix the international trade of a country you should not try to do it with a bicycle pump or with a change in the exchange rate.

This point has some relevance to us all because many people prefer to believe the opposite. Some folks would love to see Greece leave the Eurozone so it could have its wonderful drachma back. Depreciating the drachma, the story goes, will restore Greece’s competitiveness and it again will be the world’s greatest exporter of gyros and historic buildings. Other people would love to see China appreciate its renminbi so that the US dollar would depreciate – and restore US company’s competitiveness in exporting Playboy Magazines and slot machines. Brazil wants the US to stop printing money and thereby making the dollar depreciate and hurting Brazil’s ability to export caiparinhas and topless beaches.

There is some rationale for using an exchange rate to help offset short-term and relatively minor changes in a country’s competitiveness. An exchange rate tells you how much your currency is worth in terms of other currencies. So when the dollar goes from obtaining 1300 Korean won one day to getting 1400 the next day, we say the dollar appreciated against the won (and the won depreciated against the dollar). In this case someone with dollars can now get with $1 the 1300 won creampuff they usually get on the way to the bus stop on Monday and Wednesday mornings at Anguk Station plus have another 100 won left over. With the new exchange rate (1400 instead of 1300) that $1 can buy even more Korean stuff. That is, you can now get the usual cream puff and a new Equus. Okay – a new Equus costs more than 100 won but hopefully you get the point here. Big rule –

o   If your currency depreciates, your goods and services can be obtained with fewer amounts of foreign currency. Thus your stuff looks cheaper to the rest of the world.

o   If your currency appreciates, your goods and services can be obtained only with more foreign currency. Thus your stuff looks more expensive to the rest of the world.

o   Many governments are driven by the fact that they want their goods and services to appear more competitive to foreigners – so they often favor depreciating the currency.

These three facts help us to explain why (1) the Greeks might want to have a drachma that they can depreciate, (2) why the US wants China to let its renminbi appreciate, and (3) why the Brazilians want the dollar to appreciate. Like the bicycle pump and the tire, these desires are founded by short-sighted and incomplete analysis. And therefore, they are probably not going to lead to the results they want.

For example, let’s explore why these ideas could be self-defeating. Let’s suppose Brazil gets its wish and the US manipulates foreign exchange markets in a way that the value of the dollar rises and the value of Brazil’s currency, the real, falls. The governments could accomplish this by selling reals and buying more dollars in foreign exchange markets – that is the US or Brazil buys enough dollars to significantly appreciate the dollar (depreciate the real). This tends to help Brazil’s exports. But the story doesn’t end there. In doing this action, dollars move out of the economic system and reals move in. That is – the US money supply decreases and the Brazilian money supply increases. Left in place, these monetary changes should tend to increase inflation in Brazil and reduce it in the USA. Thus while the exchange rate manipulation seems to favor Brazilian goods – the implied monetary changes tend to do just the opposite. And to make things worse – both countries may not enjoy the fact that an international action has caused them to change their monetary policy. It is like each country loses control over its own monetary policy whenever it tries to manipulate its exchange rate.

If you are still following me (yawn) you might say that if the country doesn’t like the loss of control over their money, they can always offset or neutralize the international impact described above with a domestic monetary policy operation. In the above case the US money supply is decreasing so the Fed can use its usual tools to increase the money supply. The Brazilian Central Bank can absorb some of the excess reals by a domestic operation that decreases its money supply. This has some merit but notice that this too is temporary. The tire has a hole in it. That is, whatever caused the trade imbalance between the US and Brazil will continue. What appears to be a one-time event becomes a more continuous one with the US constantly encountering disinflation and increasing its money supply and Brazil facing inflation and then tightening its money supply. If you are still awake you can see how crazy all this is.

This is because there is a hole in the tire with respect to trade. Brazil says that their trade problem is caused because of a highly accommodative US monetary policy that causes a global depreciation of the dollar. If this is correct, then the solution is for the US economy to return to normal monetary growth and interest rates. Of course, Brazil might consider that at least part of their loss in competitiveness comes from a world slowdown that has reduced the global demand for the commodities that Brazil exports. The hole in Brazil’s tire is, therefore pretty big. It may take some time for the US and the world to return to strong growth In the meantime, Brazil can work harder at internal factors that might promote its global competitiveness. But simply manipulating exchange rates is going to do very little and most likely will lead to reduced competitiveness as monetary effects increase Brazilian inflation and worsen their situation.

The same can be said of the issues with respect to Greece and the Eurozone and the issues between the US and China. Greece needs a currency depreciation like it needs a hole in the head. If Greece wants to be in the EU then it needs to try to be more like other EU countries. When Greece gets is labor and product markets as well as its government wages and pensions a little closer to the average EU country, then perhaps it has a chance of overcoming imbalances in its dual deficits in trade and government accounts. If Greece even pretends a tiny bit like it is going along with the prescription, both the EU and the IMF will likely continue to help them. That will buy them time to get fixed. The drachma and a depreciation might also give them time but notice that they still would need to fix their problems. And in the meantime all hell would break loose in Greece when they left the Eurozone.

The same can be said about the US and China. In this case there is a 16-wheeler full of tire holes. No one REALLY believes that a further depreciation of the dollar against the renminbi is going to succeed in restoring the trade balance. The US has had global trade deficits for decades despite a trade-weighted dollar that has done nothing but decline. Most economists believe the US saves too little and China saves too much. Neither of these tendencies is going to change anytime soon. Depreciating the dollar will likely do nothing but cause inflation in the US as we pump even more dollars all over the world. The US needs to pay attention to saving and to the other adjustments that could make us more productive, innovative, and competitive. China needs to rebalance its economy away from saving toward more consumption. Only when these savings imbalances are corrected in the US and China will headway be made with the trade balance with China and the world.

The exchange rate is a rubber crutch. Countries need to tend to their knitting or tire mending. 

Employment, US Profits, Jack Rabbits, and the Elephant

I recall the story about the blind-folded man who had never seen an elephant was asked to guess and describe an elephant by touching only one small part of it. One can only imagine which part of the elephant the blind-folded man touched as he tried to decide what an elephant looks like. If 1000 blind-folded people touched different parts of the elephant one can begin to see the chaos and humor in this project – and the various guesses made as to the shape, texture, and size of this elephant.

This is the way I think about the national economy. This is why one of my favorite “spouts” relates to the ways journalists, economists, politicians, and others react each day to the news that peppers them with information.  Let’s call the direction of the economy the “elephant”. The direction of any nation’s economy has so many pieces to it that no one person can digest it all. Thus, we all sample or taste little pieces of the economic growth day to day as a way to form an opinion about its direction. Once we sample enough and feel confident, then we can make decisions that are based on our view of the elephant. If the pieces of the puzzle are diverse, lack tangency or are otherwise unconnected, then we might go for some time without any strong feeling for the direction of the economy. Our decisions would reflect this indecision about the elephant.

This indecision reflects a very conservative reaction to information gathering. This conservative approach envisions a person as being reluctant to make decisions until he or she feels that she has a dominant view of the economy. But that’s not the way all people behave. Less conservative behaviors magnify the importance of the latest piece of information. I just ate a huge piece of chocolate cake (with chocolate icing). From that I might deduce that I am on my way to being the new fat man at the circus. Tomorrow I have a bowl of kimchi jjigae laden with tofu. That would make me feel slim and healthy and I might enroll in the next Iron Man event. It sounds ridiculous that on two adjacent days I might want to check myself into the fat-reduction clinic and enroll in an Iron Man contest. But it seems to me that this is exactly the way people behave and think when it comes to the national economy.

Headlines this week and last week reflected what happened to US employment, business profits, and what will happen to inflation, retails sales and other economic barometers in the US and abroad. Each announcement brought a barrage of new conclusions about the progress of the economy. This barrage came despite the fact that one month’s worth of information is about as reliable as a fly perched on the end of the elephant’s nose. Does an elephant look like a fly? I don’t think so.  I thought the top was going to fly off the US economy last week when the employment number came in under expectations. Republicans peed in their pants as they faulted Obama’s policies and leadership. Republican point – this data point proves the economy is losing steam.  Democrats pointed out how despite the slowdown in March, they have rescued the economy from the evil policies of George Bush and Dr. No.  This one data point to Democrats reflected a general trend of rising strength in the economy.  This one data point relating to US employment in March 2012 became the focus of millions of words, electronic or otherwise. It’s like the blindfolded guy who happened to touch the weiner of the elephant explaining to us all what an elephant looks like.

The Financial Times wrote a very nice piece (Monday, April 9 “US job figures become a fickle political football) in which they pointed out many reasons why one’s month worth of employment figures tell us absolutely nothing about the health of the economy or the direction of employment. Yup I am not exaggerating. Nothing. Zip. Yet our experts spent days using that data point as if it meant everything. Why? Because some people think that if they react to every piece of news they can beat the rest of us to the jewels and gold. These folks are the pouncers. Data comes out. Pouncers draw quick conclusions and pounce. Tomorrow new data comes out and then they pounce again.

I am not trying to say that the pouncers are any better or worse than the non-pouncers. I am just saying they exist and they or their actions or their spokespeople make us non-pouncers sometimes think we are missing the boat – or the elephant. I am in Asia today and I am writing on a Monday morning August 9. I am wondering how the stock market will perform in the US when it opens in about 6 hours. The pouncers have declared the US a bad place to invest this week. The negative interpretations of the pouncers to the employment disaster and to the expected declines in business profits makes me worried that my precious retirement account will be worth less in a couple of hours.  So the pouncers are making me wonder if I should be buying or selling today. If they are right that these bits of news are part of a more long-term US decline, I might want to sell today. But if they are wrong and these news bits mean nothing – then maybe I should use the expected stock market decline as a buying opportunity. Since I am not a pouncer I will probably ignore the whole thing and ponder my next bottle of Soju.

One more example has to do with the profits or earning announcements of this week. The reports are saying that profits are falling and I can see why someone might be concerned about falling business profits. It does not bode well for employment or the economy in general. But if you read a little closer you find that the profits are regressing back to their means. That is, this means that profits are expected to fall to something normal and sustainable. To me the words normal and sustainable suggest a good outcome. Yet the fact that profits are falling seems to be dominating the idea that they are converging on sustainable and normal. Once again, the jack rabbits (I got tired of pouncers) are ready to hop at every piece of news. The word “decline” can be understood by anyone. The phrase “regressing to the mean” is somehow less easy to comprehend and less definitive. Thus even though the profit news is not necessarily bad, the rabbits are ready to sell and possibly in numbers. Perhaps they are wrong and this is another buy opportunity for the rest of us. After all, the rabbits have to have someone to sell to.

Okay so the elephant is hard to discern with the bits and pieces of information. But that does not mean that one cannot come to more realistic conclusions about the general direction of the national economy. For one thing, one can pounce or hop (or do a jig) after pulling together enough information over enough time. It is possible to ignore all the individual daily announcements and pull together what you learned over the span of a quarter or over six months. The last bit of information you received on April 17 might sway you more than the one you got on January 17, but surely you will get a better feel for the general momentum in the economy using three-six months of data than from one day’s. Second, it really helps to have a little understanding about cause and effect and global macroeconomics. The US profits figure for one month surely pales in importance to an understanding of the effects of shocks and policies that have impacts that last for months or years. What are the experts saying about the impacts of oil prices? What do they say about China’s economic growth? Is the EU making any progress with sovereign default? Will the US election cycle and the lack of any serious attention to deficit and debt cause economic problems?

It seems to me that we do not have to be pouncers or jack rabbits. Maybe some people prefer that approach. But it is possible to use more information in an intelligent way to make our important decisions. This approach might not sell daily newspapers but hopefully if followed it will create a larger perspective about  the chaos that follows news announcements.

New Age of Supply-Side Economics Part II.

Last week I spent some time trying to convince you that the Age of KE (Keynesian Economics) was being replaced by a new Age of SSE (Supply-Side Economics). I had so much fun bonking KE on the head that I ran out of juice and could not get to the best part – convincing you that SSE and SSE Policy are not evil monsters born of Bill O’Reilly and Ayn Rand but are legitimate policy options already being considered and tried in many nations. In fact, polite people these days are stressing policies of restructuring and/or rebalancing and these are really buzz words for SSE Policy. To bring all this out of the closet, let’s make a big point here:

            SSE Policy =  Restructuring

            SSE Policy =  Rebalancing

I feel a lot better now. I hope you do too.

But let’s start from the beginning. In a recent post I emphasized that economics is generally a discussion about demand and supply. It hardly makes any sense to talk only about demand. If you want to discuss procreation you talk about males and females. It makes no sense to focus on just one sex. As they say – it takes two to Tango. So the first thing to note here is that macro can and should focus on both of these main parts of markets – demand and supply. This is exciting stuff, eh? But it shouldn’t be. Why did macroeconomics survive for about 60 years ignoring SSE and SSE Policy?

This reminds me of the Internet joke that is going around now about the mother whose tiny daughter asks her what a virgin is. After stammering around for quite a while saying embarrassing things about sex to a five year old the mother takes a breath and the daughter asks her a second question. Mom, if that is what virgin means, what is extra virgin? Apparently her first question was about olive oil. It was not about sex.

That joke actually has nothing to do with this post but I have learned from experience that my readership improves proportionally to the number of times I write the words sex or oil prices.

The supply curve represents the actions of business firms as they decide how much to produce. Firms tend to supply more (and hire more workers) whenever their leaders envision a future with product prices and worker productivity rising relative to business costs. This is the kind of time period when firms see better returns on their investment. This kind of sanguine future supports the risks of investing in more capital, labor, and technology. It works in reverse too. If the macroeconomic environment is expected to be typified by wages and other business costs rising faster than product prices and productivity, firms are not going to buy more equipment, hire more labor, or otherwise invest in output expansion. They might, in that case, plan to reduce output.

Consider where we find the US and much of the world’s economy in early 2012. Huge government debt creates worry about riskiness of finance and is retarding company investments. Huge overhangs of money create a worry of future inflation and the eventual proportional increases in wages and business costs. So long as monetary and fiscal stimulus remain stretched it is hard to persuade business firms to produce more. Add to that a number of new government regulatory bodies producing literally thousands of pages of new business regulations. 

It is not surprising to find that the supply curve is hiding in the corner. It might sound backward to Keynesians – but one way to juice up the nation’s output is to convince these firms that wage inflation or interest rate escalation is not around the corner. Or convince these firms that the government is going to take firm control over the nation’s debts and will quickly clarify the details of regulatory compliance. Such a prudent macroeconomic policy would – therefore – lead to more certainty and optimism on the part of business firms and should cause them to hire more workers and produce more. 

So there’s your first SSE Policy—focus attention on reversing stimulus from the Fed and from the Government. Focus policy on reducing the uncertainty of future regulations.  

Reversing stimulus and regulatory burdens, however, are just the tip of the iceberg when it comes to SSE Policy. SSE is a holistic attitude toward economic well-being. This attitude recognizes that economic well-being comes from companies that create more and better jobs. And those companies exist and thrive when they compete, manage, and innovate as they meet existing and new needs of the world’s citizens. We somehow delude ourselves into thinking that somehow government manufactures economic welfare. Blackberry and Nokia are two recent examples of many. Samsung and Hyundai also offer testimony to the importance of companies. I admit that at some point in the history of these firms a government might have had some influence over their development. But the reality today is that no government can save Blackberry and Nokia from the ferocious surge of competition unleashed by Apple products. And no global electronics or auto producers can safely laugh off the challenge from Samsung and Hyundai. Firms come and go. The best ones meet the demands of the public. The best ones create employment opportunities and income growth.  

This holistic attitude has no room for KE. Instead it provides the kind of national atmosphere that strengthens competitive response. This agenda has at least the following components:

• •       Increasing national saving so that firms will find ample funds with low cost of capital
• •       A more flexible labor market that builds and motivates a skilled labor force and allows firms to flexibly hire and fire workers
• •       Laws and regulations that promote and facilitate innovation and entrepreneurship
• •       Low tax rates on income and removal of barriers that impede investment and the process of translating scientific advancement into new products and services
• •       State of the art infrastructure that supports all of the above with respect to communication, transportation, scientific research, education, training, etc.

My KE friends worry that the above list ignores one important thing – income distribution. The above looks like another party for the rich. Most of the ideas above seem to fit a trickle down story that the rich benefit directly greatly from a SSE Policy and only a few crumbs get dispersed to everyone else. Some of my KE friends would say that we have tried some of these things in the past and the poor get farther and farther behind. To my KE friends I would say that you are wrong for a couple of reasons. First the lives of most poor people in America today are infinitely better than what they were 100 years ago. The benefits of income and general living standards (including health, safety, etc) came because business firms have grown and provided millions of jobs and increases in real incomes.

Second, if the rich have benefited disproportionately in the last 10-20 years – it is not because we did too much of the above SSE Programs – but because we did too little. The US economy is in a global competitive dogfight that shows no signs of abating. Instead of unleashing our resources our corporate-government elite sat in private meetings off-microphone and restrained our companies. Corporatism reins in America as witnessed by the penchant for bailing out huge corporations. Meanwhile we become less and less able to unleash furious competition as we piss and moan and fight among ourselves about bailing out this group or that one. America is a great country with great people. A strong and clear SSE Policy is all we have to stay in the race.

The New Age of Supply-side Economics and Policy

Blame it on James and Fuzzy. In commenting on my post last week they both agreed I was not a nut-job. I am now emboldened by their trust and have focused my attention on Come and Go. Some of you remember the 50s song by the Dell-Vikings, Come and Go With Me. While the song has nothing to do with economics the words Come & Go suggest that things like Keynesian Economic Policy will come and go. And in this blog please underline the word GO. It is time for Keynesianism to go and I try to explain why here in less than half a million words. I am selling PUTS on Keynesianism. Please send your money directly to the IU Credit Union in my name.

Everything comes and goes. My baby boomer friends personally remember the Age of the Dinosaur. The smart brontosauri who saw the end coming transformed themselves into elephants and business school deans and survive until today. Look around and notice – no dinos. The Age of Dinosaurs is over. Similarly, the Age of Peyton Manning is over. Forward-looking Indianapolis Colts players and coaches jumped to other professional football teams or became lawyers. But look. No more Manning at the Colts. The age is over. Kaput. Adios. On Yong he ka sayo.

The above lucid examples and your local funeral parlor prove that nothing lasts forever (except for Nancy Pelosi and Jerry Lewis). And this truth applies to Keynesian Economics (KE). Just like horses were replaced by cars and my comb gave way to a nose and ear hair clipper, KE is giving way to something else. And even though you have sworn a pledge to never say these words – Supply-side economics (SSE) – I brazenly predict that SSE will soon replace KE. You readers who are still awake may have noticed I got tired of typing and have replaced the longer phrases for the abbreviations KE and SSE.

This is bad news for Larry Summers, Paul Krugman, Martin Wolf and a host of other sweet but misguided guys I have written about in this blog. I shouldn’t be so harsh. KE had its place in history. There were time periods when the harm done by KE Policy was possibly over ridden by the benefits. But give your kid a bath too many times in one day and he gets wrinkled and itchy. Baths are like lots of things – just the right amount at just the right time can be really good. But too many baths or a bath at the wrong time or a three day soak in the tub just causes problems down the road.

Sometimes it takes a while for people to discover the end of an Age. Think of all the diets you have been on. You don’t really know squat about nutrition. But you keep trying to lose weight. You probably keep trying similar diets only to discover that no matter how many pounds you lose you always gain back that many plus 10. The body is a very complicated and uncertain system. It takes a while before we finally figure out that some of us are born with a cookie monster inside of us. To rid yourself of this cookie monster you have to buy special cookie monster dust. That is the only thing that will work. But don’t tell anyone I told you.

The point is that the economy is pretty complicated and even after about 60 years of experience with KE we are just now seeing why it must come to an end. It had its time and it probably succeeded a few times. But it has hit its limit and the ball game is over.

How do I know the ball game is over? I can think of at least four good reasons why The Age of KE is over. First, the essence of KE Policy is managing spending. It involves finding ways to get people to spend more during a recession. Well, after a Whopper Super-Size government stimulus, people are still reluctant to take the bait and will not spend much more.

Second, KE Policy has backed itself into a corner. Whether the government does more demand stimulus or less, people are not going to spend more. With less stimulus (or what people are calling more austerity) the obvious result is not more spending. But doing even more stimulus won’t increase spending because most people will associate higher government stimulus with economic failure and increased uncertainty. They may also associate more stimulus with higher inflation and increased debt – equally worrisome and bad for confidence and spending.

Third, if one takes the time to read Keynes, he believed monetary policy could not revive spending in a severe recession because people have low confidence. If Keynes was alive today, he probably would abolish KE himself since he would apply his negativity abut monetary policy to fiscal policy too.

Finally, one reason KE is wrong today is that it has its eye on the wrong ball. The problem today is not a lack of spending. The problems today involve the adverse impacts of globalization, aging, sovereign debt, industrialization, excessive leverage, deer over-population, and male pattern baldness. These are problems that need myriad and targeted solutions. If you were experiencing fever and high temperature because of multiple breakdowns in your heart, liver, foot, brain and several other places – you might be a little skeptical of a doctor who advised you to take a larger dose of aspirin…or of any other single treatment.

So KE had its day and there is no hope for its continued influence. Betting on KE to solve today’s problems is a loser. The Put is in. It is time to buy SSE and SSE Policy. SSE Policy is the perfect way to directly attack US problems. But talking about SSE Policy is like talking about someone passing gas. It just isn’t done in polite company. SSE Policy has been called a lot of names: Trojan Horse, Voodoo Economics, and Trickle Down to name a few. Those are not nice things to call an economic policy. Each phrase, however, exhibits a real reservation people have about SSE and each term is worth addressing. But calling SSE Policy a bad name or referring to a president as a bad actor and or a cowboy does not automatically disqualify SSE Policy. So let me explain why. 

I see that I am coming close to using up my weekly allocation of JD. And I am at my word limit too. So let’s postpone the positive story about SSE and SSE Policy to next week.  So take a little time off – pet the wife and kiss the dog and otherwise enjoy the week.