What Else? Brexit

Everyone is talking about Brexit. It reminds me of the conversation I overheard after the NBA Championship. One person remarked about how he was very sure that the Cavaliers would win despite being down in the beginning of the series. His curious friend asked why. He said it was the uniforms. He really loved the uniforms.

When an event gets elevated to infinite coverage in the media we all think we need to have strong opinions despite not knowing a thing about it. That’s how I feel about Brexit. EVERYONE is part of the national obsession to have an opinion about it. I cannot believe how much has been written or spoken about it since the results of the referendum were known. What are we to think?

As in the NBA example above, a beginning step would be to know answers to some basic questions. What is the NBA? What are the rules of basketball? Why do players constantly touch each other and then get irritated when the little men in the striped uniforms blow whistles?

There are a lot of similar questions we might ask pertaining to Brexit before we start having opinions about its impacts on us. What is the EU and why would any self-respecting country ever join it when national sovereignty is at stake? What is the UK? Is it in Kentucky?

Today’s post has two objectives. First and foremost I want to provide some background and write about the EU and the UK. The upshot is that while national sovereignty is at issue, the loss portrayed by the LEAVE group was highly exaggerated. The LEAVE group has as much to fear from its own government's ideological tendencies than it had from some centralizing devil called Europe.Second I want to make the point that compared to other crises suffered in the near-past, this one is almost totally psychological.

Let’s start with the second objective. Nothing has happened except to announce that a referendum declared that Brits want out of something called the European Union. While the UK government will probably go along with the popular will, it will take a while. So let’s be clear. For a while nothing has happened. Stocks of dotcom companies did not find reality. The load of bad subprime mortgages did not become impossible to bear. No government raised taxes or reduced pension spending.

Nothing bad happened in the way of the usual macro suspects. What happened is that a country decided to not be in the European Union. So the first point is that nothing happened to directly cause crashing stock and foreign exchange markets not to mention the price of a gallon of gasoline.  Okay -- the British government has become less functional. Is that a plus or a minus? Really! 

Aha you say – but markets did crash and babies cried. And that’s my point. It is mostly psychological. It is all expectations! What happened is that a bunch of soccer rowdies decided to quit the EU club sometime in the near future. And that set off a lot of concern. I am not making fun of the concerns. They have some basis. But keep in mind that Brexit will be gradual and it will be in the best interest of most parties involved to make it work smoothly and to try to minimize the many impacts that will arise as the divorce takes place. Recall that President Obama advising Brits to stay in the EU said some threatening things. But now that the decision has been made he is already promising to find ways to make the transition work.

I am not forecasting the future but what I am saying is that the alarm bells may be a little too shrill for the reality. Brexit is not the end of the world and Brexit will unfold with many impacts in many places and we will deal with them. Let the markets take a big breath.

Now for the background. A basketball is a round thing that you bounce on the floor and then shoot through a little hoop. 

Now for the United Kingdom. Straight from Wikipedia (https://en.wikipedia.org/wiki/United_Kingdom )

The United Kingdom is a constitutional monarchy with a parliamentary system of governance.^[12] …The UK consists of four countries: England, Scotland, Wales, and Northern Ireland.^[15] The latter three have devolved administrations,^[16] each with varying powers,^[17][18] based in their capitals, Edinburgh, Cardiff, and Belfast, respectively. The nearby Isle of Man, Bailiwick of Guernsey and Bailiwick of Jersey are not part of the United Kingdom, being Crown dependencies with the British Government responsible for defence and international representation.^[19]

Most relevant is that the UK (often called Britain or Great Britain) is a sovereign state in Europe and is mostly composed of England, Wales, Scotland, and Northern Ireland but not Ireland or Puerto Rico or Texas. The UK joined something called the European Economic Community (EEC) in January of 1973 and then in June 1975 another vote solidified its membership in Europe. As of last week Britain will be the first country to reverse a decision to join the EU. Apparently the English wanted Brexit but not so clearly in the other countries in the UK. So that brings up a possible change in the make-up of the UK itself.

Moving along, what is the EU? The EU was a club of 28 sovereign nations. In the future it will have 27 members. The beginnings of European integration came after WWII when Belgium, the Netherlands, and Luxembourg joined France, and Germany, and Italy in something called the European Coal and Steel Community. The basic idea was that maybe if they cooperated on economics they would quit starting world wars. It worked pretty well and a very quick history is that they moved on from coal and steel to the idea of a single largely unimpeded market across Europe.

Until last week more and more countries embraced the idea of a free market in Europe. And they joined the EU. Sure Germany was the economic heavy weight. But like most free trade areas, the rest joined because of the expected benefits arising from fewer trade barriers and the removal of tariffs. Not all was tea and crumpets – with the single market came incursions into national sovereignty. Then came the euro currency that was adopted by 19 of the 28 countries (and not by Britain). Some thought a single currency made sense in a single marketplace. Others see it as too much togetherness. Now some want a single fiscal policy. So far no cigar on that one.

So you see the story, right? A free single market makes a lot of sense. That is the glue of the EU. Giving up too much power to Europe is not always popular in any given country or countries. But keep this one fact in mind. The institutional design of the EU is to protect national sovereignty. As in any club you join you win some decisions and you lose others. So long as the benefits of club membership are great enough then you stay in the club.

Quit snoring. I am almost finished. Like the US, the EU has executive, legislative, and judicial branches. All the institutions are run by representatives of the sovereign states. For example, the Council of Ministers is literally a group that consists of the government ministers of each EU country. The EU Parliament members are voted for in each country by the citizens of that country. The point is that EU legislation and rules are legislated and approved in each country before they can become EU law. 

Most rules must have unanimous support from all 28 states. In the very relevant situation of immigration, a country has the right to opt out of any or all EU agreements. This link lists all the area of EU governance that require all 28 states to have unanimous support 
https://en.wikipedia.org/wiki/Voting_in_the_Council_of_the_European_Union#Unanimity

Whew. Where is my bottle of scotch? Er I mean JD. 

Procrastination

Larry, would you please take out the trash? Sure honey, I will as soon as I’m finished writing this blog.

I noticed the trash is still there and the truck will be here in the morning. No probs babe, I will get to it as soon as I finish my nachos.

It is almost bed time and guess what – trash still here. I know, it ain’t no big thing. As soon as Two Broke Girls is over I will jump on it.

It is now 6 am and the truck will be here any minute. Groovy, as soon as I stop watching Two Broke Girls reruns, I will jump on it.

Honey, the truck just left. Well, there wasn’t that much trash anyway, I promise to get on it next week.

Sound familiar? I am referring to the Fed. When will Ms Yellen and her gang of procrastinators realize that you cannot postpone the inevitable forever? Yup, they did it again. This time the excuse is Brexit. Or was it a one-month earth-shaking slowdown in employment? Or was it George Bush?

Come on Fed-dudes. Can you for a minute distance yourself from your super-hero selves and get real? Think about what you are doing to exacerbate serious and harmful imbalances in this country.

Imbalances? Um ask anyone who wants to save for the future how they are doing? They either get a negative interest rate or they have to take ridiculous risk just to be a prudent saver. Seriously, do you not see the harm in this? And then there is the promotion of all sorts of borrowing  at historically miniscule costs. Didn’t we just have a financial crisis? And you want to promote more risky borrowing? Wow. With a Fed like this who needs corrupt bankers?

Inflation? I know the Fed has been quite generous with money and yet no inflation. But do we really expect that to last forever? Are there not signs that wage growth is picking up? Will inflation never return as the Fed continues to float the US economy?

And for what? Hi honey I just decided to do the healthy thing and lose some unwanted blubber. I plan to lose a quarter of a pound a month this year. Nice going dear. Why would the markets go wild after such an announcement? The Fed is not jacking rates to 22.0%. They are talking about 0.25%. All together now… 0.25%... 0.25%...0.25%. Try it to the tune of Gloria. Chords – E, D, A.

And then there is the question of when. If not now, when? I know you might have forgotten that there is an election coming but if they are not going to raise the rate today, then surely raising it in September is much too close to the election. And don’t forget the opening of football season. No way Nolan. You cannot raise rates right before IU plays the FIU Golden Panthers on September 1. And then there is Groundhog Day. 

This last idiotic non-move by the Fed proves that our leadership needs to be replaced. Some of my reactionary friends want to replace the Fed with a gold standard. But gold standards notoriously fail when governments fail. So long as we have a government that has abdicated its financial role we are stuck with a miserable but finely coordinated policy of financial neglect. Way to go government. Give me a G! Give me an O. Nevermind. 

This gets me back to my wail of last week. We don’t need gold. We need some common sense. We need a government that has watched one bankruptcy after the next. Aren’t you glad you don’t hold Puerto Rican bonds? Why does not our government learn? Both the government and the Fed are putting us in a situation of financial jeopardy. Maybe they want another crisis? Then they can once again don their super hero costumes, point the finger of blame at banks and greedy capitalists, and continue on their confident but destructive ways.

Moderates, it is time to reclaim our country. (If you don’t know what that means, see my post from last week or send money.)

Better Than a Stick in the Eye

“Better than a stick in the eye” means an outcome is not very good but it is better than getting something much worse. No one wants to get a stick in the eye. Logic dictates that we try to do better than the stick but right now it appears that we’d rather have the stick. 

No I have not emptied another bottle of JD. I am thinking about economic policy and the coming presidential election. Now that Hillary Clinton seems even more likely to be the Democratic candidate the barbs are flying between her and Donald Trump. He is dangerous and incoherent; she is immoral and corrupt. Your mother wears combat boots. Your father is dumber than Papa Q. Bear (of the Berenstain Bears).  

I am hoping that somewhere down the line these two candidates will actually talk about policy but I am also hoping that the JD genie delivers a case to my front door. The question is not why these two people prefer to shout at each other. The question is why we voters put up with it.

Why are we so entertained or enamored by rude, colorful language in the people who say they want to be President of the USA? Will they continue this when in office? Will Hillary decry that her pecs are bigger than Putin’s? Will the Donald say his hands are larger than Dolly Parton’s?

The last time I looked US economic growth was lackluster, capital spending is literally falling, and the Fed decided to put off returning to a normal policy regime because the economy appears too fragile to withstand a 0.15 increase in the federal funds rate. You would think that these candidates would be seriously debating what to do about falling labor productivity, workers leaving the labor force, soaring national debt, and Jason’s new addiction to smoking meats.

Doing all that hard work would be better than a stick in the eye yet we prefer the stick. Why? I guess because we have gotten to the point where answering the real questions is either boring or just too hard. What to do about productivity? Wow, talk about a sleeper. Go down Main Street of your town and ask 50 people what they would do about declining US productivity. Then ask those same people to name 7 types of weed or all the members of the SF Warriors including the names of the managers. I think you see what I mean.

But I think there are enough of us who really care enough to want some real debate. I am going to get in trouble with just about everyone I know for saying the following but I think it is true.

·      Monetary policy might be much too expansionary right now but that policy will always be used by politicians to stimulate a weak economy. Can't we find something in between?

·       Fiscal policy is leading to unsustainable national debts but again, deficit spending is ingrained in national thinking for a weak economy. Is there no middle ground? 

·       Legal abortion is here to stay. We might argue about making it a little easier or harder to get. But it is not going away.

·       China might not abide by all agreed trade rules but it cannot be ignored.

·       Immigrants – legal are not – who have been in this country for decades might deserve a sympathetic ear even as we realize that a country has to protect its borders.

.

I could go on and on but you get the drift. We have serious policy issues and they are not going to be resolved by sticking things in our adversary’s eyes.   We have had enough of that already. For two years the Democrats held a majority and used it. Ever since Republicans have tried to counter everything Democrats did. There is much shouting and accusing and little in the way of governing. If we keep that up for another 8 years, what is going  to happen with all our issues?

Some Democrats say that when they are restored to power they are going to ram all their stuff down our throats. Some Republicans say the same. Finally back in power we Republicans are going to undo everything Obama did.

Really? Is that what governing is supposed to be all about? I don’t think so. I think there are enough of us who think that way so we need to be heard. We can begin by stuffing a bunch of $100 bills in a pillow case and mailing them to me. Okay nevermind that one. But for a start we should stop supporting candidates who won’t debate real issues. We should stop supporting candidates who continue to call each other names. Having real debates about issues is not a lot of fun but it is definitely better than a stick in the eye. 

Perhaps we should threaten a voter's strike. If our current crop of candidates knows that they are going to lose votes from moderates, perhaps they will moderate. Let them fight for moderates by explaining what they are going to do to solve our current economic mess. If they won't and they continue to feed the polar frenzy, then we should make it very clear that we won't vote for the jerks.  Don't they have something to gain by retaining and attracting moderates?  What happens if the moderates organize a revolt?  

Do you have a better idea? Naw. You Ds fear Trump so much that you'll stick with candidates who appear more reasonable yet haven't said one sensible thing about solving our economic problems. You Rs will let Trump say anything because you think Hillary will name the wrong people to the Supreme Court or will be pushed to support liberal causes. And while you do all that people drop out of the labor force, banks and firms sit on their resources, and productivity gets lower than a limbo stick in Nassau. If we don't demand sensible policies then the polar extremes will continue to destroy this country. Whew, I need a large ice cube and a cold glass. 

Padded Bras, Idiotologies, and Government Regulation

After my last diatribe about supply-side economics a business friend of mine gently reminded me that I left out the impact of government regulation. So immediately I decided to write something about the impact of government regulation and warn my 17 readers about the evils of government. I was stoked.

But then it dawned on me that this is 2016 and the year of a presidential election. It also dawned on me that the candidates have waged a war or revolution against most things large – large companies and large government. And revolutionaries don’t care much about careful analysis – or for that matter, any analysis. They prefer to have rallies and shout slogans and be especially proud of themselves for defying the man.

So I immediately felt a sense of reluctance. Who really cares about the impact of government? We have our ideological camps and the camps already have well-rehearsed slogans. One camp says to regulate those greedy, immoral corporations. The other camp screams that governments are morally bankrupt and bought and paid for by those corporations. Between revolutionary zeal and warring idiotologies (not a misspelling) why should I spend time writing “on the one hand this and on the other hand that”?

Why? Because it feels good. It tastes better than a fried egg on toast. I started writing these blogs back in 2010 because I felt like spouting off. So why should things be any different in 2016? Okay I have less hair and can’t remember where I left my keys but why should any of that matter?

So onward with regulation.  My main point is that many of us who are not Rand Paul supporters immediately side with the pro-government regulation camp. Even Adam Smith believed that competition needed some oversight from the government. Smith believed competition is a very benign force for society. Business people might like to talk-up competition but some would prefer less of it. And I recall reading about market failure and how such failures mean that markets are not always self-medicating. I loved the topic of externalities – wherein an innocent third party gets negatively affected by business activity. A great example is the business on a river that pollutes the river making padded bras for ladies and as a result poor Nathan’s drinking water tastes like hydraulic fluid.

And the rest of us nod when our friends point out that police and fire protection are forms of government intervention. Naturally we want someone to objectively oversee the process of making sausages and medical devices. And we know that financial scam artists like The Fonz who misrepresent the benefits of reverse mortgages should be examined for head lice and their truth-telling.

So it is pretty clear that government regulation, like pole dancing, has a good side. Government regulation is here to stay and for many good reasons. But like pole dancing, it is worth pondering at least now and then if there is bad side. Looking for bad sides is not an activity cherished by many of us. How could there be a bad side of government regulation? After all, the mission is correct and government workers are underpaid servants of the people. Think of those nice workers at the airport who so gently and caringly pat you down as you shed your shoes, wallets, nail clippers, weed pipes, and other vestiges of your human dignity.

So the case is pretty strong for government regulation and even daring to analyze it makes me seem suspicious to many people. Larry don’t attack our government! But golly gee I am not attacking anyone. I simply want to ask some questions – is it possible that governments don’t necessarily make things better? If corporations can’t fix problems, then why are governments naturally better? Is it possible that governments sometimes have nice people but that temptation leads them down the wrong path? No, I am not going to answer all those questions. I am just saying…just because business creates problems it does not necessarily mean that something called government is the better solution.

Citizens evaluate government all the time. Private toll roads replace free government roads from time to time because it is believed that markets provide more efficient outcomes especially when Government George’s cousin Bob owns the local asphalt plant. Formerly Soviet Bloc countries have privatized many of their corporations as part of programs to create more efficient outcomes for their workers and consumers. I often wonder why I can’t choose Singapore Airlines to fly from Indianapolis to Seattle. Surely Delta customers would benefit from a bit more competition for domestic airlines.

It is okay to stay focused on government. It is possible that government has unintended side effects. It is possible that government over-does its mandate. It is desirable to scrutinize government as much as we watch over business. I won’t repeat any of the estimates of the costs of government regulation on the average firm and customer – because they are probably exaggerated. But they are real. Yup, we want a clean and safe environment. But we also don’t want to throw the baby out with the dirty bath water. Government regulations impede productivity and they raise business costs and negatively impact our nation’s economic growth. That’s for sure. We need to regulate government so that we get it just right – plenty of safety and plenty of growth!

When Aggregate Demand Policy Isn't Enough

Charlie’s motor scooter wouldn’t start. He checked the spark plug and it was okay. He checked the fuel line and it was in place. He even checked tire pressure. Exasperated he went inside to watch Baywatch reruns and drink a PBR. Peter asked him if there was any gas in the tank and sure enough there wasn’t. Problem solved. They filled the tank and rode off into the sunset. 

That’s a nice happy ending. It illustrates that sometimes the solution is right there in front of your face. Many of the usual suspects are not always culpable. So stop badgering them and move on. While this advice pertains to many things, it seems very obvious right now with respect to economic growth. Our predilection is to focus on aggregate demand (AD). Keeping the budget deficit and/or monetary expansion hot is a macro tool for stimulating AD.

This idea goes at least back to J.M. Keynes who thought that a modern economy, like your teenage child, has a natural tendency to stay below its potential. He concluded and became famous for his idea to prime the pump. Taken from an agricultural application, Keynes said that all the engine needs is a wee bit of fuel and it will start running. Once the engine starts running the gas will more easily flow from the tank through the carburetor. Problem fixed.

I am not sure how we got from a wee bit of temporary stimulus to massive and perpetual government deficits but let’s say that Keynesians expanded the master’s ideas. If a little stimulus is not enough then it seems logical to try more of it. But like Charlie’s dilemma above, when a lot of stimulus does not appear to work it does not mean we should move to a “whole lot more AD stimulus.”

There are two parts to this issue of what to do when stimulus seems to not be working. First, are you sure it isn’t working? Second, what else can you do to fix the problem?

Many of the articles I am reading are starting to concede that you can have too much of a good thing. I can show you too many graphs of monetary indicators – reserves, excess reserves, narrow money – that all pretty much show the same thing. There is a s-load of money out there. Doubling excess reserves won’t do a thing to solve the problems of today’s economy.  And measures of government fiscal deficits and debts are no different. As economists project the course of future debt it shows no signs of reversal despite being at least double what me might call normal. All that stimulus and virtually no one proudly boasts that it has or will cause the economy to return to stronger growth.

Worse yet from the AD side is that since money is so abundant, interest rates so low, the government debt so high – we have collectively backed ourselves into an AD corner. If AD does worsen, we have very little room to use AD policy to counter such possible downturns. Do we take national debt from 80% of GDP to 150%? Can you speak Greek?

Okay I have beaten up enough on AD. If AD is not going to save the day, then what will? The answer is in the economist’s usual toolbox. Economists explain everything from sex to sympathy with demand and supply. We think this is a balanced approach to many issues – so why not macro too?

AS completes a market analysis. While AD represents the buyers in a market, AS is identified with the suppliers. In a market system, what motivates and allows the suppliers to bring more or less to market for sale? To begin with suppliers need inputs. Depending on what is being produced they may need a building, energy, workers, police protection, raw materials, parts, equipment, trucks, and so on. That and their own labor costs money. A business usually has to assemble all this stuff before it brings the first item to market for sale. So businesses always take risk. They have to lay out money and then they have to hope that someone will want to buy the fruits of their labor.

How much should they produce? While many new businesses do not earn any profits for years the main idea is that the owner or owners get a return for taking this risk as well as for the time they put into this business. If demand and market price turn out to be very low for their product or service, then the return is not going to be very high. If the market price is low enough it might not cover costs and would warrant no production and a shutdown. But as market price rises, this satisfies the owner and makes him or her more willing to supply more output.

This shows that demand is critical to output and this idea works at the national level – more AD and a higher national price level tend to stimulate higher national output. But there is much, more to story. What matters too is the productivity and the costs associated with the productive inputs. Imagine that your workers went to a Prince/Michael Memorial Show last night and came to work today full of vim and vigor. Working at the same compensation package they manage to Moon Walk their way to much higher output per person. The consequence is that each unit of output costs less for you to produce. It makes your company more competitive. You can offer a better price to buyers. And thus your profits and your incentives to produce increase.

The upshot is that anything that increases productivity stimulates more output. The opposite is true of increased costs. Whether it is an increase in wages, compensation, energy, taxes, or the price of any productive input, it tends to raise your costs per unit and reduces your competitiveness. Thus a firm tends to reduce output when costs rise relative to productivity.

While it might sound wrong to some of you to support a policy centered on improving business profits, the possibilities are pretty attractive in the sense that policies designed to raise business productivity and to reduce unnecessary business burdens and costs could go a long way to returning profits to normal, to raising the optimism of managers, and to increasing output, employment and earnings. Given that the usual AD stuff is not succeeding it might not be a bad option. Or instead we could go back to shouting at each other. 

Fed Policy, Red Bull, and Buddha

Will the Fed raise interest rates? Will I gain one pound after eating the giant pork chop at Le Petit Cochon? Answer: Who cares? Apparently the market seems to care more about interest rates than my waistline. So let’s work on that question today.

Thanks to my friends at the St Louis Fed I was able to download a chart from their lovely FRED service. This graph charts an interest rate – the 10 Year Treasury Constant Maturity Rate (or let’s call it Ted). Ted tells you what you could earn on a riskless asset with a 10 year maturity. It also seems to be at the heart of something called the interest rate yield curve. I see some of you are dosing. So let’s try one more time – this graph of Ted shows you an interest rate that represents interest rates on all sorts of assets. Ted is like the popular guy you know. If Ted goes to the Player’s Pub then everyone goes there. If Ted goes to the IU Opera, then the crowd goes to see the Flying Dutchman (highly recommended for people suffering sleep deprivation).

The Fed does not directly control Ted. But smart people watch Ted to gauge how the Fed’s actions will affect all sorts of interest rates. I love the below graph of Ted. I could write about it until the cows come in even though I don’t even have one cow.

The graph shows Ted from well before 1970 to now. It shows how Ted behaved over a long period of time and over lots of short periods of time. It shows Ted before, during, and after recessions.

Ted got really heavy as a youngster and peaked out at around 15% in 1982. Then he went on a diet and has been losing ever since. Sure he falls off the Dick’s Burgers wagon now and then but he keeps getting svelter and svelter.

As a result of looking at this graph of Ted for at least 100 hours you can come away wondering if there is something called a normal interest rate for our times. Despite what the Fed might do or not do in the coming weeks, one story is the long-term trend since 1982 towards lower rates. Perhaps rates will go even lower for yet another phase of this trend?

Or you might say that the downward trend has to end sometime. Negative interest rates are possible but it seems strange to think of negative interest rates as the new normal. It would be like going into a Whole Foods and being told that they will pay you $10 to take home a dozen natural cage free no hormone no antibiotics Omega-3 Nest laid, vegetarian diet certified human raised and handled extra-large eggs.

So let’s ignore the trend. The other thing you might note is that Ted generally rises before recessions. These recession-inducing interest rate increases might have been a natural result of a rapidly growing economy or the direct result of an intended (or not intended) Fed policy. If you have on your reading glasses you can see the shaded vertical bars representing recessions and look at how many of those bars were preceded by a rising Ted. Aha – the culprit has been found and so the recession cure is right before our very eyes. Do not let the Fed push Ted up and we won’t get another recession!

Not so fast Nathan. If you squint and look even harder you can find a number of time periods in which Ted rose but did not lead to a recession. So now we have it – rising Ted causes recessions at times and does not cause recessions at other times.

This brings us back to our current dilemma. We are all waiting for the Fed’s decision as to whether they will raise interest rates another smidge in June or July or whenever. The second Rufus gets a whiff of a rumor of such an interest rate increase, Rufus calls in the dogs and the markets go crazy. But seriously, what is wrong with these markets? 

Looking at the chart, have you noticed how low interest rates are? Are we really serious that another 15-25 basis point increase is going to throw us into a tizzy? Whatever that policy might do to Fred in coming months its value will still remain on such a low portion of the graph that you can hardly see the increase.  Imagine how people felt when the Fed engineered the 15% rate in the early 1980s? Now that increase was noticeable!

Graphs and data do not prove anything. But they sure have a way of putting things into perspective. Janet Yellen, her colleagues, and a lot of financial people need to put down their Red Bulls, take a deep breath, and say Om next to a babbling brook. Get on with normalizing monetary policy and try a little quiet meditation. 

Summers Misleads with Secular Stagnation Tilt

Larry Summers recently peered into his cob-webbed trunk of worn out economic ideas and found something that was discarded with Dad’s WWII army uniform – the concept of SS. For those of you unfamiliar with Lucky Cigarettes and Bing Crosby, secular stagnation basically means that your economy has a disease that implies it will forever grow at a rate slower than your mailman on the day the Social Security checks arrive.

SS was coined after WWII. Alvin Hansen thought that the US would go back into a depression since defense spending would be greatly reduced at the end of the war. The logic was clear – Great Depression – war spending up – war spending down – Great Depression. It didn’t actually happen that way and despite three recessions in the 1950s, the US was off and running like Forest Gump.

You cannot blame Summers for wanting to dust this baby off and try it out again. We had a great recession in 2008/2009 and ever since we have had lackluster economic growth in the US. If my fingers are correct it has been about seven years since that recession technically ended. It ended and we had no real recovery stage. And the expansion stage would not put pho on the table for most of us. So Summers is right to wonder if maybe this time we have contracted SS.

Summers is as predictable as Charlie Sheen at a Margarita Bar, but he is also nuanced. He was a college President and you learn a lot of skills in that kind of job. Summers new emphasis on the long-run issue of SS appears to have distanced him from the usual mantra about short-run demand. But he is like the pickpocket who attracts your glance toward one hand while he empties your IU Credit Union Account with the other.

Summers doesn’t exactly say why it is that the government debt shifted to twice its long run average (as a percent of GDP), and increasing debt even more is perfectly fine for long-run economic growth. Recall that he wants to end SS. Hopefully he wants to end it in the next decade but you’d never know it. For example, he wants to stop SS in its tracks with more spending on the environment and education. I don’t care what political colors you wear – there is no way to connect the dots here – you can spend a lot more on both of those things and you might get your pug to leap through a gas-fired ring six feet off the ground. But how long will it really take to get the growth needle to move after more of this kind of spending?

He also wants to tax the rich and redistribute the proceeds to the poor and middle class. Again, that’s a nice thought. It might even increase spending in the short-run. But in what circus do you call that long-run economics? I remember the kid’s comic book wherein Scrooge McDuck (Donald’s Uncle) sat in his vault and played in the money. So it makes sense to give some of that money to poorer people. But please – don’t tell me this is a means to permanent raise the growth of the economy.

Finally, Summers want to increase infrastructure spending. Most of us nod and say that’s a cool thing to do. And despite its budget-busting implications it can logically be classified as long-run policy. But please do not tell me that it is going to do much for growth in my lifetime. Remember in 2008 the term “shovel-ready" projects? 

We learned what many of us knew – government spending is a long and tortuous (and corrupt?) road. Correct me if I am wrong but it took five years before a healthy portion of that money legislated in the last recession was actually spent on something. You know the deal – someone has to advertise for bids and then someone has to type them out on nice typing paper using an Underwood typewriter. Then all the stamps must be licked and pressed on envelopes. Okay I am joshing with you but you get the point. It takes a while to select the contractors and then they have to get geared up to do the work. Bribes must be paid and checks cleared. Then the checks roll and the magic happens. Hold on to your kiddies -- the Summers express is ready to take-off.

I have hit my six million word allotment for the day. While our liberal and revered soothsayers are talking long-run policy or not, the truth is that they are asking for the same policies they always ask for. These policies are not working. A real durable supply-side policy is possible that might find compromises by all the parties that address our current economic slowdown. But you are not going to get it from the usual hacks. Their faux SS argument means little. It is time to try something else. 

Macro and the Perfect Storm

I am currently teaching two macro courses at the University of Washington in Seattle. I get free purple rain wear and as much Starbucks coffee as I can drink. It’s a nice deal. I can harass MBA students and my son’s family during my stay here. What could be better than that?

Introducing macro to a new group of MBAs is always challenging. People choose to attend MBA programs to pursue careers in marketing, finance, accounting, and so on. They do not come to business schools to study macroeconomics. The wisdom at many MBA programs is that macro is a tool these students need. Alternatively it is an excellent means to punish them for past sins. Whichever is true, my 119 years of teaching macro at Kelley has left me with a lot of scars and a lot of great memories.

Teaching macro today is even more challenging. Just as capitalism and free trade are under the microscope, so is macro. Events since the popping of the housing and stock market bubbles have left many people ready for revolution. Bernie wants to replace markets with more government control. Trump  wants to replace free trade with Trumpian Trade.  Congress won’t approach anything that resembles an economic plan and the central banks around the world think low or negative interest rates are beneficial despite Keynes’ warnings about liquidity traps.

Meanwhile the average bloke thinks the economy is either broken beyond repair or run by rich, selfish people. They are ready for revolution and macro is part of the heap they want to toss out and replace with something better. I am not ready to give in to a premature burial for macro but I realize that students will not take for granted that studying a dying science is worthwhile. I can’t say “shut up and eat your macro; it is good for you.”So it is up to me to try to motivate why they should spend the time and energy on macro.

Part of understanding the strengths of macro is to admit its weaknesses.  Macro lopes along. The basics of supply and demand stay the same but when the world changes, macro must too. One kind of macro seemed to be helpful in the 60s until inflation picked up. Macro wasn’t too sure about itself in the 70s but then new theories helped to improve its explanatory power as time wore on. We invented the word stagflation around that time to name a new unsatisfactory phenomenon. Macro was not so good at explaining the impacts of energy price increases and then decreases – so we had to dress it up a little more to improve predictability when energy or for that matter when food prices went haywire. Macro clearly was not ready to deal with a dot.com bust and then years later with housing and stock price bubbles. Macro is having a struggle today to digest globalization, declining productivity, and labor market disappointments. 

Macro is evolutionary. I remember being a young graduate student (with hair and teeth) and hearing a professor proclaim that macro knew everything it had to know. We had Keynesian macroeconometric models that could forecast the economy almost perfectly. What hubris!  That bubble burst in the late 60s as inflation rose and kept rising. The world is always changing.  Macro’s charge is so broad that its models have to incorporate many variables and many phenomena. So it is easy to understand why macro models will never be perfect. But even when they are bad, they are helpful. When they are bad economists scurry around until they figure out how to make them better. As we scurry the picture is not pretty – sort of like making sausage.

Right now we find ourselves in that sausage-making stage. Watching all this most of us would prefer a nice banana. In the meantime we have to make decisions. Households have to find ways to save money for the future. Business firms must decide when to build another store or factory. Multinational corporations have to position supply-chains. Investors have to come up with a mix of stocks, bonds, and other investments. As we remake the macro sausage none of those decisions are easy and they can be very frustrating. It’s hard to know which Ark to choose when the water is rising.

In the meantime as we filter through what will someday be the next stage of the macro model, the old model helps us make at least imperfect decisions. Supply and demand are concepts that help us think through the haze. We can apply supply and demand tools to any market. For example, the world has a very pronounced tendency to favor demand-side remedies. But in 2016 it looks like traditional monetary and fiscal policy thinking are not working. That does not mean macro is a  failure. It means that policymakers can think about supply approaches. 

Some politicians are promoting revolution where revolution is just short-hand for more government control and oversight.  Maybe more of that is necessary these days but macro always warns about unintended negative consequences. What happens to international trade when we treat Mexicans (or Chinese)  as naughty step-children? What happens when we penalize companies for making global decisions? What happens when bankers feel a constant threat of legal action over everyday banking decisions? 

I don’t blame anyone for feeling seasick. The world economy today is like a small boat in a perfect storm in which the boat never stops moving up and down. A bubble bursts in 2007. A recession hits in 2008 in the US. It spreads to the rest of the world and then the economic waves of their downturns reverberate to our shores. Policymakers get active and we get cash for clunkers – another wave. In Europe they stimulate and then turn to austerity. Bam again. Earthquakes and tsunamis. Bam. Energy prices decline. Bam. Negative news about China. Bam. None of this is usual or normal or easy.

We are seasick but it is not time to desert the boat. Even a perfect storm subsides. It exits slowly and as we recover the scenery is cloudy and unclear. And yet we have to go on making decisions. I am happy to teach my courses and to write my blog and keep reminding us that while macro is not perfect, it can be helpful and is among the tools we all need to keep making decisions in a complicated and uncertain world. 

From Each According to his Ability to Each according to his Needs

Though it stems from former socialist writers, the statement in today’s title has been widely attributed to another famous socialist Karl Marx. A broader statement would include these three points which I stole from Wikipedia (https://en.wikipedia.org/wiki/From_each_according_to_his_ability,_to_each_according_to_his_needs )

I. Nothing in society will belong to anyone, either as a personal possession or as capital goods, except the things for which the person has immediate use, for either his needs, his pleasures, or his daily work.
II. Every citizen will be a public man, sustained by, supported by, and occupied at the public expense.
III. Every citizen will make his particular contribution to the activities of the community according to his capacity, his talent and his age; it is on this basis that his duties will be determined, in conformity with the distributive laws.

While all of us would agree that this statement is highly utopian it does express some values that we all might share. It is nice to think of us giving what we are cable of giving and taking only what we need; sharing the rest. It is like the experience of being on a college basketball team. Clearly some guys are taller than others; some faster; some better shots. They each contribute in different ways. They each get a similar scholarship. They share in the glory when they win. Go team!

From this start you might think that this posting is about socialism. But it isn’t directly. In our seemingly reasonable request to make things more fair today we have lost sight of another dimension of society. Fairness and equity are critical as are clean air and freedom from fear. This list of social desirables is important and long. But in focusing so hard on these requirements of society we sometimes forget and perhaps do not even know about the main lessons and real constraints of economics.

Yes, economists are probably at fault for not teaching and spreading their ideas better. So let me give it a try. I am out of JD and I need to do something.

Let’s start with that college basketball team. The team and its many loud and obnoxious supporters,  followers and mascots want to win. Players do not put in all those practice hours and risk life and limb for the fun of it. They want to win. And to win they have to play like a team. And that means they should make use of the best talents of all their players. But it does not usually mean that all players get treated exactly alike. The star gets dates with the best looking cheerleaders and sometimes gets a free steak or expensive automobile from an overzealous fan. In some schools the star player forgets to attend classes and somehow all that is overlooked despite being labelled a “student”. 

The best high school players are recruited and while they love to play basketball, being on a winning team is what the best ones desire. They want to be stars and get all that goes along with that.

Glad I got that off my chest. You might be wondering how this relates to economics. Imagine that you were one of the first persons to see the world and there were no stores and no factories and no means to easily get things. Yet, you have to live. You have to survive. So you and your buddies design a system so you can eat, have shelter, warmth, protection, watch porn channels, and so on. This is the challenge that economics deals with. How do people get what they need and want? There are a bunch of resources lying around out there. Like the basketball team players you want to find the best way to achieve these goals. You want to get the most consumption with the least amount of effort and/or cost. In other words, why be wasteful? Get what we need in the best possible way.

Economists call this efficiency. And like Marx, economists concerned with efficiency want people to use their highest skills. But unlike Marx, market economists do not assume that people will employ their skills fully unless they are rewarded to do so. If society wants more bananas, then we want more pickers working on banana trees and fewer working on guava trees. If most of them are hanging around the guava fields (or Truffles Bar), an announcement that they would earn more income picking bananas reallocates pickers to bananas away from other work options. Firms can pay these workers more because they can pass along the higher labor costs to the consumer who is willing to pay a higher price to get more bananas. Workers do not usually do this and undergo all the costs of change out of the goodness of their hearts.

Let’s suppose workers hate banana trees or that they have to undergo special training to pick bananas. Inasmuch it might take large increase in wages (or benefits) to attract the resources into bananas. Accordingly prices of bananas would have to push even higher.

Later, when we decide we want to have i-phones, a similar process attracts more labor and capital into producing funny little devices that allow us to tweet inane messages as we peel bananas…at the expense of perhaps fewer hoppy beers.  

Notice that as long as workers (and other resources) are freely mobile and firms are free to switch products and keep the proceeds of their labors, this process works – and it works fluidly. It does not take any one single person to make it work. Hey dudes, Charlie’s Banana Farm is looking for workers and they are giving your kids free kindergarten if you work for Charlie. If information is free and if firms and workers are free this system is on autopilot.

This quick discussion of economic efficiency has two points related to our economy. First, efficiency does not require a central planner. Second, the process of efficiency demands unequal rewards.

There is a lot more to say but let’s stop here with one more point. No, market efficiency does not always work perfectly. Evil lurks in capitalism But whatever the negatives arising from such evil they must be compared against the mistakes made by sometimes evil and misguided central planners. Fairness sells in the political marketplace. Efficiency puts the food on the table. 

Jack Daniels Fishing Story

A little fun today. You know I have a proclivity towards Jack Daniels. So I thought I would share this JD Fishing Story sent to me by friend Jim C. 

The Jack Daniels Fishing Story

I finally got around to going fishing this morning but after a while I ran out of worms.

Then I saw a cottonmouth with a frog in his mouth, and frogs are good bass bait.

Knowing the snake couldn’t bite me with the frog in his mouth, I grabbed him right behind the head, took the frog and put it in my bait bucket.

Now the dilemma was how to release the snake without getting bit.

I grabbed my bottle of Jack Daniels and poured a little whiskey in its mouth.

His eyes rolled back, he went limp, I released him into the lake without incident, and carried on my fishing with the frog.

A little later, I felt a nudge on my foot.

There was that same snake with two frogs in his mouth.

Guest Blogger Buck Klemkosky Slow and Steady Job Growth Not Enough

The U.S. Labor Department announced job growth of 215,000 for March in line with expectations. Given a working-age population of over 200 million, it doesn’t seem to be a significant number of jobs. But 215,000 new jobs are the net increase of many moving parts.

Annually, the U.S. creates a little less than 13 million jobs, but also destroys about 10 million jobs. If there was a net increase of 215,000, it means that approximately 1.05 million jobs were created and 833,000 destroyed for the net increase of 215,000 in March. Even during the Great Recession, 10 million jobs were created annually but unfortunately 16 million jobs were destroyed. In the U.S., job creation peaked out at 16 million in 2000 and hit 14 million in 2006, so the economy has not recovered in terms of job creation. Fortunately job destruction of 10 million is a three-decade low.

Since the labor market hit bottom in February 2010, a net of 14.4 million jobs have been created over the 73 months, a record for the longest period of sustainable job growth. The unemployment rate rose to 5.0% in March from 4.9% in February. As perverse as it may sound, the rise in the unemployment rate was considered good news because the civilian labor force participation rate increased to 63% from a 39-year low of 62.4% in September, meaning more people are entering the work force. The labor participation rate of workers ages 25-54 was 81.2% in the first quarter, a three-year high, but still down from 83.3% in 2007. There still is some slack in the labor market.

The mood of many Americans doesn’t reflect the lowest unemployment rate in nearly a decade. While a net 14.4 million jobs have been created, only 5.6 million new jobs have been created since January 2008, which was the job peak before the Great Recession of 2008-2009. Job growth relative to population growth makes the 14.4 million look less impressive. The U.S. working-age population grew by 15.8 million since 2010 and 20 million since 2008. Job creation has not kept up with population growth. The Labor Department also reported that average hourly earnings increased 2.25% in March, relative to a year ago. This is below the last 6-month average of 2.5% but better than the 2.0% annual average over the prior four years.

Wages are subdued primarily because labor productivity remains close to zero. Productivity is weak because corporations have not invested in efficiency-enhancing equipment and may be substituting labor for capital because of low wages. Also the cause of the productivity problem may be structural; the service sector of the economy has become more dominant relative to the goods sector, and it is more difficult to increase productivity in the service sector. Also, less experienced millennials are replacing more experienced baby boomers in the work force.

Regardless of stimulative monetary and fiscal policies, the key to enhancing economic growth lies in the labor market. Economic output is a function of the number of workers times the productivity of each worker. The civilian labor participation rate needs to continue on its upward trajectory and labor productivity must improve. Increases in both are needed to get U.S. economic growth out of its lethargic 2.1% pace. Labor-force growth of 2% and productivity increases of 1% would produce a more desired 3% economic growth.

The Minimum Wage: Science versus Ideology

Wouldn’t it be cool if you could throw a bag full of stuff into the air and it would stay there, suspended in the air. It would be cool and it could probably help a lot of people. But science says “what goes up must come down.” We don’t argue with science and while man-made elevators and forklifts have been invented to lift things for us – one still can’t throw a sock full of rocks into the air and hope it will stay up there.

Even if we had a lobby group and a new political party decrying the mean and arbitrary nature of the Law of Gravity, that wouldn’t change matters. We are stuck with the science. You shake your head and wonder how many JDs I have thrown into the air tonight. But the truth is that we are witnessing these days the tragic retraction of science and reason in our lives. Perhaps because economic well being is tougher to achieve now we want to reject a lot of complicated talk about economic issues. We just want action. We want results. We don’t want "on the one hand this and on the other hand that". 

And so we have political candidates who will tell us anything – anything that makes us feel better. Trump will build a wall. Cruz will bomb the bad guys. Hillary will make women taller. Bernie will give us free education. We will raise the minimum wage and people will live better.

There is nothing wrong with wanting more equality and safety but these politicians focus their energy on ideology and goals without taking the time to explain exactly how and why their actual policies might bring about these results without throwing the baby out with the dirty bath water.. Using ideology and wishful statements, of course, worsens the country directly because it often pits us against each other. The last I heard this was a country with shared values and interests. We depend on each other.  It makes no sense to think that anything will be resolved by making us even more separate and resentful.

The solution to all this is as it always has been -- science. Think about it. Maybe you were not the brightest science student in school. But the evidence that we trust science is everywhere. Biotech drugs are finding new ways to cure cancer. We can hope for a cancer cure, but I like the odds of Lilly's biologists working on this problem. Or take Moore’s Law which explains why you can get more and more power out of smaller and smaller computer chips. Again, hope has little to do with all this power and convenience we obtain.

So if biology, chemistry, physics and the other sciences are so helpful, why are we so willing to reject or ignore the learning from economics? We often rely on economic laws. Many businesses know that the quantity they sell will depend on, among other things, the incomes of consumers and the prices of their goods.  Business firms also understand that a lack of resources makes it harder and more costly to produce goods and services. Economics is a soft science in the sense that the predictions might not always be right on the money, but predictions are based on generally accepted basics and logic.

A good example of all this is the recent legislation in California (and other places) raising the minimum wage to $15 an hour. Asked why this legislation is necessary, the promoters explained that it is unfair for people in California to make less than $15 per hour. The general answer is about fairness and not about science. Science be damned – it sounds very desirable to think that a government can raise a magic wand and make people’s lives better.

Economic science does not care who you are. In physics the focus is on atoms or subatomic particles. In economics we focus on people. But in neither case are we driven by fairness. What we care about is doing what is best for the community or the system. Consider some of these economic facts. First, the wage of a person is determined by the impersonal forces of supply and demand. We have seen it many times. When nurses are scarce, the wages of nurses rise. Is this fair to cab drivers? When people switch from coal to natural gas coal miners are needed less and their wages fall. None of this is about fairness. It is about using economic science to explain why wages and prices vary across people and places and over time. Prices and wages are signals -- precious signals that allocate goods and services from one place to another as needed. We don't need government czars telling every company what to produce. Markets perform these functions day after day. 

Second, raising the minimum wage begs the question – to what amount? If raising it to $15 per hour improves fairness, why not raise it to $20 per hour? The nice thing about the market is that wages move to resolve imbalances. But when your local Mayor is grubbing for votes, she talks about things like a living wage or some such thing. Apparently a person cannot live unless every member of his family is making the government determined living wage. And what does it take to live, anyway? I hope they include JD in that bundle of goods. 

Third, let’s keep in mind the fairness involved with everyone. Suppose there are people making $15 per hour today. When you raise some people to $15 then you have to raise those people to what? $20? And the people who were making $20 must be raised to $25? And so on. So now you have the government determining everyone's wage. Can we really do that? Unless of course you want everyone to make $15 per hour. Is that fair? 

Fourth, a part of economic science is the theory of the firm. If firms have to pay workers more, they have three choices – take lower profits, reduce the number of employees hired, or raise prices. If firms raise prices of their goods and services the minimum wage worker has not in fact been helped. If the prices of the goods you buy go up by a similar amount as your wages, then your wage still buys the same amount. Of course if owners or other workers are harmed, then you have clearly harmed someone in the name of fairness for someone else. What happens when those people react to those harms? Will that be good for the minimum wage workers? 

There is plenty more to say but that should suffice for today. The minimum wage is not about fairness. It is about helping or pleasing some voters at the expense of other voters. The minimum wage distorts science in the same way that using leaches cures modern diseases. The minimum wage is not proved to be fair or to improve the lives of workers. Governments cannot tell a worker what he or she is worth. A worker’s worth reflects education, training, experience, contacts, and an abundance of luck with respect to supply and demand. If you want to help poor people, it would be much less destructive to use other methods that more directly address education, training, contacts, and luck.