The Fed, Persistence, and Global Imbalance

Has the world gone crazy? Congress decided to pass a continuing resolution for the budget without all the usual muss and fuss. Obama is being quietly applauded by many people in both parties for his stronger military stance in Syria. Soon we will read that Hillary Clinton and Rush Limbaugh are quietly dating.

I take all this personally as a slight against macroeconomics. Macro has clearly gone persona-non-grata. I can’t even find lonely shut-ins willing to talk about recessions or hyperinflations.  Apparently someone contacted the Fed and asked them to take up the slack and say some incomprehensible things. Have you read some of these stories? One line of thought is that the markets are ignoring the Fed. EVERYONE knows the Fed will soon start increasing interest rates so what is there to get excited about? Another line quotes experts who are absolutely sure that as soon as rates rise, the economy is going to return to a recession. The stock market mirrors these divergent views from day to day, 

What makes all this the more complicated and confusing is that the Fed has not announced when or if it will begin to raise rates. Forward guidance is tossed around as if it were a quarter-pounder with cheese. Honey, I am thinking of losing weight. Since you baked all those cookies I will have to eat them but be sure that if you do bake more cookies I will not eat one of them. You can count on that. 

Janet Yellen the head of the Fed recently said that while she does not see interest rates rising anytime soon she is definitely on to the possibility that once the overall economy returns to normalcy, rates will begin to rise and she will have to let them rise. Some people in the market today find that reassuring. If the economy is normal, then it seems silly to continue trying to keep interest rates near zero.  Bravo.

Of course there is more to it. The overall economy to you and me looks a lot like a huge elephant looks to a tiny ant crawling on the elephant. That ant cannot see the whole elephant and its idea of an elephant will be based on what particular part of the elephant it finds itself. Charles – be nice. Some of you guys are coming from a perspective wherein you think the economy is very fragile. You can point with vivid imagery and color to a lot of deficiencies in productivity, labor markets, and so on. 

You see bubbles about to burst. To you, any admission that interest rates are going to rise translates into weak seams turning into cracks and crack-ups.

So where are we really? As I said, no one knows the whole elephant and no one knows how much pressure the economy can withstand. But that doesn’t mean one cannot hold an opinion and mine is that rates will not spike upwards and the economy will withstand less pronounced increases.

Let me explain and support this forecast with a few ideas. First, the fifties were not good at forecasting the 60s nor were the 60s a good way to predict the 70s. Macroeconomics has grown and changed as history required. While much of the current models is valuable, there are key parts that will need changing before Macro leads to better predictions in the future. Models predicting that higher interest rates will doom us may be very wrong. Second, given the financial crisis and the following recession and slow growth period, I am betting on inertia or persistence to dominate the near future. Your spouse has persistence. Your spouse will remind you to push the toilet seat down every time you go to the toilet. 

Persistence in the economy means that a little healing from yesterday permits a little more healing today. The world economy got a huge smack in 2007/08 by way of a financial crisis. Such is NOT the kind of macro shock that can be fixed with a little tax here and some government spending there.  Durable behaviors guiding saving, investing, and other fundamentals got whacked. Financial hits take time to heal. When your savings have been depleted it takes time to return to financial health. For some the return has taken many years. For others there are still many years left to go. Then you add all the new regulations affecting a broad swatch of financial markets and you create even more impact and uncertainty with regard to timing. It is now late 2014 and we are well into that game. It should unfold on its present course.

Finally is the idea of relative strength. It is no secret that as we in the USA are lumbering along, some other major economic players are in much worse shape. Whether we look to Europe, Asia, or South America it is hard to see anything like US growth.  This means a lot of things. But one thing is sure – we are a long way from the kind of global synchronized economic expansion that raised prices and interest rates in the years before the financial crisis. New to our policymakers in 2014 is the idea that US economic growth will not be accompanied by growth elsewhere. Thus we can grow and have ample global sources for commodities, equipment, savings, labor and so on. We will and can continue to lumber ahead without the usual business cycle drag of significantly higher inflation and interest rates.

The markets are correct to ignore the Fed’s multi-headed hydra. The Fed has a lot of mouths speaking these days saying a lot of different things. No matter what Janet Yellen says, rates will rise in the near future but they will not rise enough to cause major disruptions. The Fed has the luxury of a little time to get rid of excesses. It should use that global blessing to get its balance sheet in balance. Waiting too long to stop ISIS was a mistake. Waiting too long to let interest rates rise won't be the right decision either. 

Blogging Trivia

Since I am traveling and getting a bit lazy in my old age I thought I would give you a change of pace this week with some facts about this blog space.

I started blogging right after retiring from the Kelley School of Business in March of 2010. So the blog is about 4.5 years old.

The blog activity has accomplished what I had hoped. It gives me an excuse to hide in my home office and pretend to be working. It is also a way to keep up communications with friends, relatives, neighbors, former students, pole dancers, and other colleagues. 

During the last 4.5 years, with help from guest bloggers, we posted 267 articles that have received approximately 65,000 page views. We accomplished that without nudity or free drug distribution. 

People often respond to the blog with comments – we have posted approximately 2,100 comments. I have rejected very few comments – rejections come mostly because they feature advertisements.

Some people prefer to respond to my posts privately via email, threats of violence,  or gifts of JD. Either way is appreciated. 

While we can rightly support or not support various politicians, economists, ideas, policies, etc -- my blogging experience has taught me that nothing is simple in the real world and there is plenty of room for adults to hold on to their cherished beliefs. I am always amazed at how many ways there is to look at any fact or issue. Someone once said something like -- the more you  know the more you realize you don't know. That statement seems pretty true to me. Of course, there is always the problem of finding yourself in the garage and not knowing why you are there. That gets even trickier if you don't have a garage. 

None of that, however, keeps me from thinking that either side of the debate has to give up strong beliefs. Taking sides and arguing hard is the best way to learn. As such I enjoy my blogging and feel that I have benefited from our interactions. I hope you have too. 

Yes, I do enjoy Jack Daniels but will accept donations of any sort of brown liquor.

While the great majority of the viewers are from the USA, the remaining top destinations are South Korea, Ukraine, Russia, the UK, France, Germany, and China. 

I try to organize the blog posts by subject. On the right-hand-side of the blog is a list of those topics. I didn’t count them but I am guessing the number of topics is just under 100. For each blog post I usually assign two or three topics.

The top 6 posts in terms of number of page views are:

The G20 Blame Game, September 10, 2013

Negative Real Interest Rates Cannot Exist, June 3, 2012

Inflation History Lesson: From the Frying Pan to the Fire and Back Again, May 21, 2013

Why We are Lousy Investors by Guest Blogger Robert Klemkosky, April 23, 2013

Let the Money Weaning Begin, November 12, 2013

Don’t Stop Believein’ by Guest Blogger Jerry Lynch, September 3, 2013             

Interest Rate Hysteria

As I write today, the 30 Year Fixed Rate on Mortgages is about 4.2%. Though MORT30 averaged higher than that in 2010 and 2011, it was below that rate recently and there is much concern that it, like other rates is soon headed upward. When I say there is concern I could also say there is near hysteria.  As I often like to do I checked some historical data and find little reason for undo concern.

Don’t get me wrong. If mortgage rates climb some people will be hurt. Change in any economic indicator has a tendency to penalize some while helping others. Prices of weed in Seattle have gone up since legalization and many puffers would probably prefer to go back to the good old days when the government was not taking its “fair” share of the profits. Inasmuch, prices and interest rates always cut in at least two ways. As you know, however, I am a card-carrying macroeconomist and as such am less worried about distribution and more interested in how indicators impact the whole economy.

Luckily we have macro indicators like real GDP that represent the macro performance of an economy. My data analysis looks at how changes in MORT30 have impacted real GDP.  And while this might sound heretical, I am seeing little concern raised by more than 40 years of annual data (1971 to 2013). That is, while it sounds obvious that increases in MORT30 ought to be terribly bad for the growth of the national economy, there is really very little relevant evidence to back that up.  Today some of us are very worried that the Fed will change policy, jerk interest rates upward, and return us to a terrible recession. The data do not support such a worry.

First I look at recession years. Did rising interest rates cause these recessions?  There have been 6 recessions encompassing parts of nine years since 1970. In three of those recessions -- 1973-74, 1980 and 1982, MORT30 increased and confirmed our worries. But it is important to point out that those years from 1973 to 1981 showed dramatic increases in inflation and MORT30 had reached over 16% by 1981. MORT30 increased from 7.5% in 1971 to 13.7% by 1980 and then 16.54% by 1981 (these rates are annual averages meaning that rates were even higher in some parts of those years). It is questionable how relevant those recessions are to today’s situation of low inflation expectations and interest rates.

In none of the three remaining recessions (1990, 2000, and 2007/2008) was there any interest rate increase during the recession. In most cases MORT30 was falling during or immediately before those recessions. It is seems unclear from this recession analysis that higher interest rates will cause another recession in today’s environment.

Second, I examine the time periods when real GDP growth declined. Did rising interest rates cause slower annual growth? There were 22 years between 1970 and 2013 when the growth rate of the economy declined. That is, the growth of real GDP in those 22 years was less than in the previous year. In nine of those 22 years interest rates rose in that year. Of those nine times when the interest rate rose during a slow growth period, in only five of those cases did MORT30 rise by more than 100 basis points in the year before and the year of the slowdown. In one case MORT30 fell by 222 basis points in those two years before and during the slowdown. There must have been something else contributing to the economic slowdowns in those 22 years. 

In the other 13 slower growth years MORT30 was falling.  If we combine the year of the slowdown with the year before, we find only one year in which there was a substantial rate rise of more than 50 basis points over those two years.

The great majority of recessions and one-year slowdowns are not associated with rising interest rates. Increases in interest rates did have large impacts on real GDP back when rates were historically high and rising but not so much when rates were more normal.

Finally, we turn to the times after 1980 when MORT30 rose more than a few points. What happened to real GDP in those years? 

1993-1994 MORT30 rose from 7.3% to 8.4%. In 1994 the rise of 110 basis points was associated with real GDP growth rising from 2.7% in 1993 to 4% in 1994. Growth did slow in 1995 to 2.7% as interest rates were declining in that year.

1998- 2000 MORT30 rose from 6.9% in 1998 to 8.1% in 2000. That was an increase of 111 basis points in two years. In each of those three years real GDP was increasing at rates above 4% (4.4, 4.7, 4.1). Real GDP grew at only 1% in 2001 but rates were declining in that year.

2005-2006   MORT30 rose from 5.9% to 6.4% for an increase of about 54 basis points that year. In those two years real GDP growth was 3.3% and then 2.7%. By 2007 economic growth fell to 1.8%  and by 2007 we were in a full blown recession.  That recession was attributed to a financial crisis emanating from a bubble in the real estate markets.

Rising mortgage rates do not bode ill for the economy. Often the rising rates are more a symptom of an expanding economy and less a precursor of a coming economic slowdown. Clearly the record is sketchy at best. Most clear is the danger of rising rates in a hyper-inflationary environment.  Lacking such a situation, the Fed can go ahead and let rates start to rise and not worry about economic fragility. The economy is growing and can take the hit. A bigger risk is that by waiting too long to let rates return to normality the Fed threatens a much bigger spike in rates and a return to some of the gloomier days of the 1970s.

I loved my 8-track player, disco music, and my Travolta-like dance moves but I am in no hurry to return to the 1970s.

The Strategy Hoax and ISIS

I am going to get a strategy soon. No you aren’t. My Mommy is bigger than your Mommy. Come on guys, you can do better than that.

The media is punch drunk on strategy. Republicans, of course, are giddy over the President’s admission that he has no strategy for ISIS in Syria.  The President is resolute that it takes time to design a strategy and as soon as he convenes important meetings with leaders on seventeen planets, he will announce exactly how he and they will both destroy and contain ISIS.

All of this manic depressive chatter gets us absolutely nowhere and therefore makes the problem worse. You say – Larry, how can you argue with strategy? Strategy is obvious. Strategy is like breakfast in the morning. Peyton Manning would not start a game without a strategy. Samsung Electronics has a clear and present strategy to destroy Apple. Jack Daniels plans to take over the world. No organization can exist without a strategy.

As one who taught for 169 years in a business school, I can hardly argue with the last paragraph. But the truth is that there are times when you can’t have a strategy – or at least you can’t meaningfully advocate one. You might think of other examples but I have one to press upon you today. When you wait too long to create a strategy and everything starts to fall apart – it is time to have either a Hail Mary or an escape route. College Joe doesn’t need an overall educational strategy when he gets his math test back with an F on it. What he needs to figure out is if he can find a way to bribe his math teacher. When the barn is burning, you don’t think about how to prepare your horse to win the Kentucky Derby. Get a hose and call the fire department.

See my point?  There is no strategy for ISIS in Syria or Ellettsville. There is no strategy because the horse is out of the barn. There is no strategy because we have let the problem get to where US leadership will not tolerate a solution.

The President seems to want a solution that involves political pressure either among Iraqis, regional players or perhaps NATO. But no such solution is possible – at least not for two hundred years or so. Whether you call it destruction or containment – that bunch of yahoos is not going to win a Parcheesi game.

More war-like approaches expounded by many hawkish Republicans are probably too late as well. Giving Kurds more modern equipment might help some but even with US air power to create cover, it is dubious to think that the Kurds, the Iraqis, and other partners will have the will to overcome a very motivated, entrenched, and determined ISIS. In the end, any such military solution will have to involve US troops and much more air cover. As in Vietnam many years ago, neither party in the US has the stomach to do the kind of bombing that might be effective in removing ISIS. There would be much too much collateral damage for either party to withstand.

So there you are. If there are no good tactical choices then it is hard to envision a strategy. I had one email interchange with a thoughtful friend and we started using words like bullies and worse bullies. Do we want help from Iran and Syria to topple ISIS? My friend says yes and he might be right. But we made friends with Russia as the Allies toppled Hitler.That seemed like the right choice since Hitler was a real menace. Like in our present dilemma the US waited too long to enter World War II – and for more than 60 years we had to deal with a Russian bear.  Maybe we could have stopped Hitler without selling our souls to Russia. Ask a Baltic friend how she enjoyed the Soviet experience. Then ask a Ukrainian.

What do we learn from all this? First, hesitation is often wrong. When something walks and quacks like a duck then it is a duck. ISIS is like kudzu*. Once it gets into your garden it will take over the whole neighborhood. If you wait to create an alliance with neighbors or you hope science will soon invent a new weed killer, then you will soon be choking in kudzu. Second, once you are forced to act quickly, don’t argue about strategy. That just slows the solution even more – and guarantees that no solution will be very effective. We may need to get help from dangerous places. We may need to harm civilians. We may need to live with dangerous consequences for decades. Quit arguing about strategy, make some tactical decisions, and get out a fire hose.

*From Wikipedia:Kudzu (/ˈkʊdzuː/, also called Japanese arrowroot^[1][2]) is a group of plants in the genus Pueraria, in the pea family Fabaceae, subfamily Faboideae. They are climbing, coiling, and trailing perennial vines native to much of eastern Asia, southeast Asia, and some Pacific Islands.^[2] The name comes from the Japanese name for the plants, kuzu (クズ or 葛^?), which was written "kudzu" in historical romanizations. Where these plants are naturalized, they can be invasive and are considered noxious weeds. The plant climbs over trees or shrubs and grows so rapidly that it kills them by heavy shading.^[3]

Inversions and Globalization

I learned how to invert a matrix in college and I have never been the same. Which is one reason that all this political talk about inversions brings back some pretty sweaty moments at Georgia Tech. Some people think corporate inversions show that some American companies are not good citizens. Others use this occasion as a means to discuss corporate taxes and to point out how and why US taxes are too high. Still others shrug their shoulders and admit that inversions are part of a larger process going on and will be with us with or without taxes or flag waving.

What a nice way to start. I now have everyone mad at me!  But the truth is that a larger process called globalization is going on. Globalization has been going on a long time but clearly it took a leap forward after the Cold War melted.  Distance matters when it comes to trading things. If you live here, you trade more with Bloomington's Big Red Liquors than with a similar store in Seattle. But it is also true that when you take a little trip to Indianapolis to visit Aunt Hillary, you might go to Costco – since you don’t have one yet in Bloomington. Why don’t Bloomingtonians drive to Indianapolis every day for their JD if Costco is so good? Answer: the cost of distance. Whether you value your time or gas or wear and tear on your car or the chance of getting into a wreck in Martinsville, the cost of distance makes you buy most things close to home.

What happens if the cost of distance dramatically decreases?? Answer: you widen the size of your market.  The end of the cold war reduced the cost of distance. After the cold war it was safer to travel to more places. As formerly non-capitalist countries entered into global competition and offered lower priced goods it was as if someone had “shortened the road” there. Innovations and technological progress in shipping, communications, and travel also lowered the costs of doing business across continents and countries. Of course reductions in regulations, taxes, and corruption added a recognition of the improved ease and cost of transactions at distance.

Globalization is a word that describes how International trades have mushroomed since around 1990. It isn’t just greedy business people who trade more. Lower distance costs have promoted more tourism. Imagine in 1985 the Chinese being the largest groups of worldwide travelers. Churches cooperate more. International organizations meet and work together more. Governments find it easier to use Skype or Korean Air – to facilitate more frequent meetings.

That’s the backdrop. Globalization has slowed but it continues today.  In macroeconomics we often measure globalization through what are called the Balance of Payments Accounts (BOPA). These accounts measure legal cross-border transactions of an economic nature. If you are awake you noticed the word legal – so we are already admitting these measures are not perfect. But based on a lot of different information sources, nations routinely measure trade in goods, services, dividends, interest, charitable giving, bonds, stocks, bank accounts, real estate, corporate ownership positions, derivatives, and more. This information comes out quarterly. And yes, it often gets revised over time.

Pertinent to the question of inversions is the part of the BOPA called the Financial and Capital Accounts (FCA). FCA measure changes in international transactions that relate to cross-border trades in financial instruments and capital, including acquiring and merging with foreign companies. These trades are summarized in the International Investment Position (IIP). It is the IIP that is relevant to put today’s concern about inversions into perspective. You can find the kind of information I quote below at the Bureau of Economic Analysis (  http://www.bea.gov/international/index.htm#iip ).

Let’s start with one fact. At the end of the first quarter of 2014 foreigners owned US assets worth $29.1 trillion. That’s a lot of Taco Bells. Of course it wasn’t all Taco Bells. Foreigners owned approximately $16 trillion of US bonds and stocks. Add to that $5.7 trillion for enough ownership in US companies to give foreign owners some managerial control. While we are worried about money flowing out of the US please note that between 2012 and 2013, foreigners increased their ownership of US assets by about $2 trillion.

And we reciprocated the interest. By Q1 2014 we owned $23.6 trillion assets abroad, up from $22.5 trillion the year before. You own me. I own you. That’s part of globalization. Furthermore – in the last year you owned even more of us and we owned even more of you.

Some of you accountants are saying, hold on a minute. Who owns more of whom? We calculate the Net IIP by subtracting what foreigners own of us from what we own of them. The result in Q1 2014 was -$5.5 trillion. Foreigners owned $5.5 trillion more of us than we owned of them. Some people interpret this as a bad thing. Note the negative sign. Negative signs are usually interpreted negatively. J  But it sounds pretty cool to me. Foreigners like our US assets. Would you rather be in Argentina where people wouldn’t buy your assets with a ten foot pole?

Anyway, this -$5.5 trillion suggests an imbalance in which we have future financial obligations or debts to pay internationally. That could be viewed negatively but won’t be a problem so long as people believe we can pay those foreign debts. But there is more to it. All this buying of our assets leads to needs for dollars which leads to a robust demand for dollars that makes the value of the dollar higher than it might be otherwise. So this Net IIP isn’t all good. If American companies invested more abroad, it would reduce this imbalance – making us less of an international debtor and perhaps improving our competitiveness.

I know this is getting complicated. And it is. Politicians who call our companies traitors for inversions are doing what politicians always do – making up simple stories to please some of the voters. Don’t be fooled. Companies will continue to react to the cost of distance. Taxes may impact the cost of distance but taxes are only one of many factors. Let companies do what they think is right for their stakeholders and in the end they will do what is right for America. Let's not call them nasty names until they actually break laws. 

Unemployment Whack-A-Mole: Fed Futility?

What goes down must come up?

Let's suppose your friend told you about a great new diet that promised to get your weight back down to normal. Cool, eh. Now let's suppose you talked to a bunch of people who all told you the same thing -- after losing a lot of weight  on this diet they would always regain it again -- and often would end up weighing more than when they began. I would stay away from that diet. The story for the unemployment rate is not too different from this diet. The chart below helps you see the similarity.

The Fed has a dual mandate. In addition to controlling inflation it is also supposed bring about full employment. Since we don't know how to measure full employment this at least means the Fed is trying to reduce the unemployment rate. As long as UN is higher than some pre-ordained amount or so long as labor market conditions do not signal imminent inflation, the Fed stays with its mission to reduce UN.

Listening to the FED one  might think that the goal of low unemployment is something you can shoot for and then attain. Once attained all that work should pay off for a while. While  it is true that reductions can last for a while, what is also true is that once you drive the UN rate too low -- it spits back at you. Just look at the graph below. Notice the sudden upward spikes that quickly undo almost all the good that came before.

• In 1953 UN almost doubled in one year from 2.9% to 5.6%
• In 1958 it jumped from 4.3% to 6.8%
• Between 1969 and 1971 it jumped from 3.5% to 6%
• Between 1979 and 1981 it increased from 5.9% to 7.6%
• Between 1950 and today there were at least nine periods in which the unemployment gradually fell from a high level only to bounce back to an equally  high level. 
• If you draw a trend line through the whole chart it suggests that whatever process was making UN go up and down over time was raising the average unemployment rate in the long-run
• Drawing a trend line after 1980 you get a downward slope or a flat slope. But the minimum unemployment rates are still much higher than in the pre-1970s. 

 Notice that most of the Fed discussions these days revolve around whether or not rising inflation is imminent. So long as inflation is not ever present, the Fed seems confident that its focus on unemployment is without risk. But today's story and chart has said nothing about inflation. Today we are discussing UN and UN. The relevant question is when does Ms. Yellen stop pushing UN down? This chart says it isn't clear exactly when to stop. Before the 1970s if the Fed stopped pushning at 4% or 5% UN, they might have averted a resumption of high UN. But notice how all that changed in the 1970s. In that decade pushing UN below 6% was dangerous. 

With UN at about 6% today, Ms Yellen suggests that we look at other labor indicators as she continues with her hand on the throttle. Sixty years of UN suggests she refocus policy before we find ourselves with another horrible spike in UN -- one that will leave us with few policy tools left to employ. 

The problem we see playing out over and over is not hard to understand. Which is better when cutting down a large dead tree: a chain saw or a hundred unemployed workers with nail files? While the latter seems inefficient but human -- it is not. Unemployed workers want real solutions not temporary band-aids. The labor market can be temporarily satisfied by bursts of money but the real fixes to sustained increases in unemployment have to follow from the real causes of the unemployment problem. What is causing UN to fall so slowly in the USA? Why are people dropping out of the labor force? Why are wages so slow to increase? I doubt any of this has to do with too little money in the economy. Focus on those things and maybe we won't have to suffer another terrible UN spike in 2015. 

Income Inequality and Economic Growth

Dad, can I have some money? Why do you need it honey? Because my friend got hurt and it makes me sad and if I bought a chocolate bar I might feel better. In that case, honey, here’s a five dollar bill. I hope you feel better soon. Come on. That is the dumbest reason ever given for wanting money from Dad and no kid would ever try it. But alas, Alan Blinder is up to his old tricks again and his article amounts to asking for that chocolate bar, “The Supply-Side Case for Government Redistribution,”” Wall Street Journal, August 15, 2014, page A13.

On July 1 I wrote a post Blindly Following Alan Blinder Over a Poverty Cliff. In that case I reviewed Blinder’s desires to expand most social programs aimed at low income persons.  Blinder never bothers with evaluating these programs and just cavalierly advocates expansion. If one billion wasn’t enough then we should try 2 billion.  In this August article Blinder gets more brazen when he concludes that long-run economic growth can and should be expanded if we spend more money on social programs.

Those of you who are not familiar with economic literature or colonoscopies should know that there is nothing written much-less proved or demonstrated about poverty programs causing economic growth. There are reams of articles written about the reverse – the impact of economic growth on poverty – but alas as Alan Blinder was hitting his deadline for the WSJ, he came up with a new and earth-shattering economic truth. If you want to increase economic growth then you should spend more money on programs for the poor.

Many of you will say that it sounds intuitive that helping the poor will create more economic growth. Widely shared economic growth models explain changes in long-term economic growth with several key indicators – labor, capital, and productivity. If turning a poor under-educated and unskilled person into a new and productive worker in the labor force can be accomplished, then the growth model shows how and why poverty programs might lead to stronger economic growth. And the reverse would be true too – rising poverty leading to fewer good workers in the work force would be bad for a country’s economic growth.

But just like needing chocolate to make you happy because your friend fell off her bicycle makes sense at some level, poverty programs simply are not an explanation for economic growth. The proof is in the pudding. Blinder made this whole thing up last week. Please someone show me in a journal or a book or a classroom or on a bathroom wall at an Irish Pub in Itaewon where economists have some sort of evidence to support the relevance of this idea.

There are several ironies here beyond lack of scientific rigor and evidence. First, Blinder says he wants to talk about the Supply-side as a means to promote stronger economic growth. Please pass me more JD. Isn't he among a group of liberal economists who routinely decry and label supply-side policy in the most horrible terms like trickle-down, Trojan Horse, and more? Second, Blinder says in the article about the ethical issue of poor people, “Either side can talk until it’s blue in the face without convincing the other.” Blinder apparently believes that ethics is not going to solve the poverty problem. 

Third, Blinder then goes on to minimize the case for improving national spending.  He argues that most people spend the same. Thus if you take $100 away from a person making $200,000 per year and give it to someone with $20,000 income per year – it would have no net effect on national spending. Thus poverty and income redistribution programs get no support from Blinder for ethics and spending.

And so we are left, according to Blinder, with economic growth. Help the poor more and the economy will grow stronger and faster.  And we better do it fast because we are becoming more unequal all the time. An afterthought of his article is that this inequality is exploding in both economic and political terms. That means we are all going to suffer because this will hurt economic growth even more. This is nonsense. I personally feel better about helping the poor because it is the right thing to do. And as I said in the last post, we do that best by first evaluating the programs we already have. We have 50 years of experience with such programs. An honest evaluation would find strengths and weaknesses. Why can’t we do such an evaluation before adding more fuel to the fire? 

Trade with Africa – More Trade or Foreign Aid?

Last week the President not only met as planned with 50 or more leaders from Africa but he followed it up with a major budget proposal and a press conference. Despite wanting to watch my favorite shows on Fox Business News and the Bourbon Channel, I got the pleasure of our President announcing some new and important initiatives. If you read this blog with one or more eyes open, you know that I love trade. And I even stuck up for the US EX-IM bank because it facilitates more US exports. I love to hear plans to increase US trade – exports, imports, capital and more. So I had to listen to the President.

Meanwhile Russians were putting more troops in position to fight in Ukraine, Christians were being murdered in Iraq, Israelis were fighting in Gaza, and Republicans were doing all sorts of evil in America. So given all the items on the President’s agenda, you have to admit that Africa must be very important to the US for the President to pour out another half-million words on TV.

I decided that I haven’t bored you readers with data in a while and I was curious how the President was going to do really great things empowering Africans to help themselves and to buy a bunch more of our exported goods. To preface this data mining experiment let’s start with a few points. First, we are engaged and have long been engaged with giving foreign aid in Africa and many countries. But this speech and the $33 billion the President wants to send to Africa is not being marketed as more foreign aid. This is all about creating more business for American companies and workers. According to his speech, this is all about trade – not aid. 

Second, if it is about trade, then there ought to be some bang for the buck. A policy to increase US exports (or imports or capital) ought to have some impact. Third, it not only has to have some impact but it also ought to have the best impact. Okay so a policy might increase country A’s purchases of US goods by 49%. But if that 49% increase amounts to a tiny amount of dollar orders for Kentucky bourbon compared to a similar policy in country B, then you might prefer to direct the order to country B since that will generate more US sales, employment and profits. 

What I illustrate below is that President Obama’s new plan for Africa is mostly about more foreign aid. Africa is not a good place to increase US trade. If it is about trade – we would be better off spending that $33 billion elsewhere.

Let’s start with goods and services exports. The US wants Africa to buy more US stuff. In the first six months of 2014, the US exported $804 billion goods and services to the world. Africa bought $19 billion. The whole continent of Africa bought 2.3% of US exports. In contrast this is what other regions bought (in billions):

            

            World                                 $804

   North America                      273

   Europe                                 170

            Pacific Rim                           119

            South/Central America            91

            OPEC                                    39

            Africa                                     19

Egypt and South Africa were the two largest African buyers of US goods and services, buying $3.6 and $3.1 billion respectively. If we doubled exports to those countries it wouldn’t amount to a hill of beans to US workers operating in a $15 trillion dollar economy producing a couple trillion dollars in exports each year. 

The US Bureau of Economic Analysis (BEA.gov) also publishes direct investment data by country destination. Direct investment (plant, equipment, etc)  by US companies in the world in 2013 amounted to $4.7 trillion. That’s how much “capital” our companies owned abroad. That ownership increased by about 25% between 2010 and 2013. Below are comparison figures that put US business investment in Africa in a global perspective. First is the amount for 2013 in trillions of dollars and in parentheses is the percent change between 2010 and 2013:

            Europe                     $2.607   (28%)

            Asia Pacific                 .695  (22%)

            Islands  W. Hemis        .601   (16%)

            Canada                        .358   (25%)

            S. America                  .169   (23%)

            C. America                  .113   (15%)

            Africa                          .060   (  9%)

            Middle East                 .045   (32%)

           

When it comes to US business investments across the globe, Africa has not been a major destination. It stands out on this table for two reasons – the small amount and the very low growth rate of 9% in three years. One has to ask a question when seeing this – why haven’t companies been more interested in Africa and what is it about the President’s new program that will change those reasons substantially?

 The answer is pretty simple. By and large, African countries are dictatorships that score high in corruption and low on income. Not all African countries are the same. But spend an hour Googling lists of countries by corruption, or income per capita, or percent of people below the poverty line – and African countries are always well represented. A richer country like Egypt can be used as an example. According to the World Bank, Egypt’s income per capita is about $11,000 (South Africa was listed at about $13,000). Cubans make $19,000 and Puerto Ricans earn $35,000. Germans collect about $43,000 per year. With respect to people living in poverty, Nigeria had about 55% of the population labelled as poor. Egypt and S. Africa were more like 23-25%.  Naturally the same countries scored high on indexes of corruption.

Tourists love the diversity of colors and cultures in Africa. But such diversity is not great for US companies who want to penetrate new markets. In Africa there are 54 countries. It is believed that Nigeria alone has more than 500 languages/dialects. Our President says he wants to create more trade across the continent. But diversity in South America should be a caution to what can be expected in Africa. While South American companies have become more global in recent years they have not done it by trading with each other. Often they are more trade-loyal to their colonial pasts than to their regional presents.

The President cited many statistics that show that some Africa countries are growing and could become better trade partners. But let’s be honest – growing from a low base is one thing. Large enough to matter is another. Either call that $33 billion foreign aid and try to give it in ways that will reward and promote less corruption and more democracy and enterprise – or call it trade promotion and give it somewhere that is more apt to bring a strong return in US trade and employment. The last I checked we still have a huge national debt, a slowly growing economy,  and little room to employ precious national  resources inefficiently. 

Monetary Fables and Sand Traps

It is said so many times now it is almost a mantra – Then Fed engineered a recovery for Wall Street, leaving Main Street and most of us to suffer or at least languish. The intuition is easy. Think of Ms. Yellen in a helicopter spewing hundred dollar bills over banks that collect them in giant bins and then hide them in big vaults away from public view. What money does leak out of the banks goes to purchase bonds and stocks and sustains a financial bubble or at least a rally. Fed behavior also keeps interest rates limbo low and cause reallocations of portfolios away from money and into more risky bonds and stocks with higher promised returns. Firms are not allowed to borrow and expand and therefore employment does not increase and both consumer and business spending remain in the doldrums.

I would be surprised if this story has not already made its way into Dr. Seuss or other children’s books.   It has appealing though contradictory themes. The big bad Fed is a lackey of the right wing helping to keep the upper 1% as rich as possible while regular folks suffer. Alternatively the Fed is a willing compatriot of the liberal left, but alas needs to do even more to complete the task. The Fed pumps money into the economy willy nilly praying each evening to Paul Krugman that money will work wonders for Main Street. Surely if the Fed continues on this course and pumps in ENOUGH money, the economy will be saved. Imagine Paul Krugman in tights with a large S on his chest.

Neither of these stories is correct. 

Let’s take the first one. The first one is based on the idea that when the Fed injects money into the system it somehow prefers the filthy lucre to end up in risky financial markets instead of supporting loans that expand the economy.  This one is pretty silly. I don’t know of one money and banking book that suggests any reasons why the Fed would want the rich to get richer at the expense of the rest of us. Historically it is hard to find times when the intention of a loose monetary policy was to avoid real loans and pump up stock markets.

As for the second story, it is true that there is a lot of hope and faith when it comes to money’s magical impacts on employment and output. But this current episode goes beyond hope and even Paul Krugman seems to have lost his tights. Historical amounts of money have been pumped into the US economy and rates have been kept at zero levels for a long time. Yet, the economy stalls. John M Keynes, the great one, recognized the limits of money when he cleverly invented the so-called liquidity trap. Modern Keynesians agreed a long time ago that once a country enters the trap it is like a monetary Bermuda Triangle in which everything gets sucked onto a giant hole never to be seen again. Money can approach savior status but not when expectations are tender. It makes no sense to keep pouring money into this economy and it makes no sense for money to pull us out of slow growth. This is what Keynes and his band of merry Keynesians said to Maid Marian and Friar Tuck.

Most textbooks and Fed statements suggest some very clear avenues about money. The money mechanism is simple but it is full of traps. Here is the usual story.

·        The Fed sends a check to a bondholder in exchange for his bond. Bond interest rates fall.

·        The check is deposited in his bank.

·        Banks have more money and do not need to borrow to raise funds and the Federal Funds Rate (FFR) falls.

·        Since the FFR is a cost of funds, this causes other interest rates to fall.  

·        Households and firms hop on the first bus to their banks to borrow money.

·        With these low-priced loans consumers buy durable goods and firms buy capital goods.

·        All this spending causes firms to hire more workers and expand output.

·        Christmas comes early.

If the above sounds like a fairy tale to you it is because you have learned about the traps – all the things that could go wrong so that none of the above actually happens on your planet. So here is a brief list of these traps:

·        Liquidity Trap: Bondholders are more than happy to sell their bonds to the Fed so bond returns do not fall much.

·        Deposit Trap: Worried about banks, investors do not deposit checks in the banks. Money might leak out directly to shadow banks or financial investments.

·        Loan Trap: either banks do not trust borrowers or borrowers are too indebted to even ask, so loans do not increase.

·        Spending Trap: No loans, no spending.

·        Employment Trap: even if households and firms do begin to want more goods and services, firms may be pessimistic about the future and not want to make permanent increases in employment or output.

·        Uncertainty Trap: so long as policymakers keep trying to make things better – and they don’t get better – firms and households become even more uncertain and conservative in their decisions.

·        Left tackle Trap: when the left tackle feigns a missed block and the defender comes rushing in for glory and finds that the left guard is there to smash him to the ground.

My first point is that the Fed need not be a lackey of the left or the right if it somehow misread a golf course full of traps. Why do so many golfers end up in sand traps? Because they know they need to take risks to come from behind. They need a low score and at the moment they are way behind the leaders. With unemployment at 10% and a mandate to reduce it, the Fed chose a risky path that ended up with us in a lot of traps. Because the recession was not your run-of-the-mill downturn, the Fed did not anticipate a lot of the traps. Once in the traps we lose. You would think that recognition of such mistakes would be influential but this risky behavior carries on even today. The Fed remains unwilling to reverse its risky policy.

Which brings us to my last point before I sit down to a large bowl of JD. Yes, I know I forgot to mention JD in my last post and I got several angry letters from JD Distilleries worldwide. My last point is all this concern on the part of the Fed that without their continued hose full of money pouring on the economy, interest rates are going to rise to the stratosphere and the economy will come crumbling down. What gall. Does the Fed really have all that control over the economy? No and for several reasons.

First, all those traps listed above suggest the Fed often has little control. Second, there are huge money and financial markets out there that determine asset prices and rates in the USA and globally. If participants in those markets think rates are going to rise in the future, then they will make trades that push the rates up today. There is little to nothing the Fed can do to offset a major change in market psychology. Think of the little Dutch kid with his finger in the dyke. His T-shirt reads "I am the Fed."  In Dutch, of course. 

Finally why would the psychology change to make participants more certain that rates are going to rise? For one thing, the US economy is gathering steam. Among the many positive indicators was the recent announcement that labor costs are rising. All that money outstanding will eventually have to go somewhere. Some of the above traps will disappear – banks will make more loans, firms will replace decaying equipment, and households will buy more cars and JD. Firms will hire more workers. Prices might be under control, but there is no way for them to go except up. The best guess is for higher inflation and that too will drive up interest rates. This is not magic. This is what usually happens during an economic expansion. Rates return to normal with or without the Fed's love or encouragement. 

The Fed knows rates are going to rise and it can’t do a thing about it. It should give up this silly game of hubris and just back away. Pull that money out before it causes a fire! The longer the Fed waits, the more the negative backwash. Get on with it. The markets are ready for a return to normalcy. And I am ready for that JD. 

Corporate Inversions, Profits and Taxes

How many of you vote yes for inversions? What? What the hell is an inversion? I looked at Wikipedia and found that inversions occur in music, arts, natural sciences, mathematics, and just about everything. Typically it means you have turned things backwards or stood things on their heads. For example, the air nearest to the earth’s surface is warmer because solar radiation warms the earth’s surface. In a temperature inversion the air gets warmer, instead, at higher levels. When temperature inversions occur we get a lot of awful things like smog entrapment and freezing rain.

As such it seems almost obvious that the President would want to halt business inversions going on today. In a business inversion a successful domestic company decides it wants to move its headquarters to a foreign country. Imagine if GM decided it wanted to move its headquarters to Cuba! Now that would be an inversion! One way to conduct an inversion is to merge or be acquired by a foreign company. Suppose Toyota bought GM. In that case GM’s productive and other activities would continue in America – but GM America would become a subsidiary of a Japanese company.

Why would a US company do such a thing? According to the President the reason is taxes. Where a company like GM pays its taxes is an important issue. Many American companies are global and increasingly so. This means they have international activities all over the world. Important for the inversion issue is where they sell their goods. If GM sells cars in Hungary – then the sales revenue flows directly to a GM subsidiary in Hungary. The subsidiary is technically a Hungarian company because the Hungarian government licenses it to do business within Hungarian borders – but it is run by GM.

So American companies have sales in many different countries. The sales revenue goes to pay for business costs. Typically the American companies will report and pay profits taxes in those countries. If there is anything remaining after all that the rest of the revenue flows back to America. When and if it flows back, it is taxed again by the USA. According to an Economist Magazine article (http://www.economist.com/news/leaders/21608751-restricting-companies-moving-abroad-no-substitute-corporate-tax-reform-how-stop ) , the US is the only large rich country to tax these repatriated earnings. And since the US has the highest corporate tax rates of most major countries, US companies feel put upon and dislike the extra taxes they have to pay. An inversion, accordingly, feels good to these companies. Becoming a foreign company means they no longer have to pay the extra taxes. According to the article, most large countries have gone to a territorial tax system and few pay double taxes as in the USA.

Please notice one thing that is often not said or written adequately in inversion discussions. This has nothing to do with corporate taxes paid or earned on sales within the USA. With or without an inversion, US sales and operations will be taxed as usual. Inversions only have to do with repatriations of the already-taxed profits in other countries.

Still, the President and others do not want to reverse these tax laws. They want US companies to pay significant tax rates on repatriated earning despite being taxed once already in other countries. Instead they prefer to introduce new and more stringent regulations on how and where US companies can merge or be acquired by other companies. Interesting is the signal sent by these new regulations. The US government proposes to allow inversions in cases where real managerial control is NOT kept by the US company. That is, if the foreign merger results in the US company losing control to a larger foreign entity over its decisions, then that is okay. Talk about perverse! This is a true inversion in logic. Okay US company – we do not want you to control your operations. Let’s let the foreign company really take you over. All that risk is incurred so that the government gets a little more from the repatriated foreign earnings. Wow – now that is really backward and dangerous. You put at risk ALL the earnings and taxes of the US companies for the sake of chicken feed.

One more thing. Most mergers and acquisitions are notoriously difficult, complicated, and uncertain endeavors for large corporations. Most of them fail. Companies spend huge sums of money trying to predict the many impacts of corporate marriages. Just like in human marriages much is unknown about your partner in a corporate marriage. Despite sometimes spending billions most of these corporate marriages fail. It is not reasonable to conclude that any of the high profile large company inversions causing the President’s concern were solely done to reduce US taxes. Taxes might matter, yes, but the overwhelming reasons for inversions are for strategic reasons.

And why not for strategic reasons? It is no secret that business is increasingly global. As the President acknowledges, he would love to increase US export sales. This is because few serious companies can be profitable without taking advantage of a huge world marketplace. He wants to find ways to encourage US companies to seek out and successfully enter these international markets. He wants to do this because more profitable US companies hire more workers, pay better wages, give more to charity, and more. So why does he say he wants to motivate more exports one day and then the next day penalize the profits of these same companies with an extraordinary corporate tax system?

I vote for inversions. If the President wants more tax revenues, let him try another way that doesn’t damage the competitiveness of US companies and US exports in general. Focusing on tax loopholes and tax reform might be a place to get started. 

Exports Are Cool but Geographically Challenged

Exports are cool. Not cool enough to be in the lyrics of any rock song I know of but definitely cool enough that President Obama declared in 2010 his goal was to double USA exports to the world. I wrote about that in this blog space a while ago. It looks even less doable now than it did a while ago. So here I go again! I have some new data that shines a light on why it is next to impossible to make large gains in exports now.

It also suggests that attacking the EX-IM bank right now would be highly counter-productive. 

Before I get to that data it helps to see why the President and others think exports are so cool.  An export exists when a business firm on US soil produces a good or service and sells it to someone living outside of US soil. These people might be Canadians buying auto parts from Kokomo Indiana, Mexicans buying industrial equipment from Columbus Indiana, or UK citizens purchasing an Amtrak ticket that will take them from Indianapolis’ Union Station to the Grand Canyon.  You might say that such sales amount to the same thing as when the buyer lives on US soil – but you would be only partially right.

The important difference is the impact that exports have on our national ability to grow. USA buyer purchases are ultimately limited by what they earn. Let’s suppose you can earn $100 and you spend locally $80. The rest goes into saving or to goods and services produced abroad.  From time to time you can spend more than $80 but it can't last. The “equilibrium” spending for income of $100 is $80.  Now let’s imagine that a foreigner decides to buy from us and we are able to hire more people to produce these extra goods and services. The foreigner, therefore, expands how much our nation produces and how much income we earn.

So long as foreigners want our goods and services, this export sale permanently increases national output beyond what our own citizens earn. It raises our incomes as well. The increased income means we can buy more domestic and foreign goods. This is what is so cool about exports.

Trace the steps…more exports…more output…more income…more domestic spending…even more output.

If a country like Germany or Japan or the USA is able to win the global competition for goods and services, it can use this ongoing competitiveness as a way of permanently increasing its output and economic growth.  If you are still reading and are somewhat awake you might say something like – hold on fella. Whoa Nellie. Won’t other less competitive countries get a little irritated and make unhappy noises? The answer is yes. We have a term “beggar they neighbor” to characterize countries like China who are notorious for playing the export game. But the truth is that while the others feel jilted they can always reduce the unwanted impacts by raising the competitiveness of their own products and services. And while China is well-known for using exports for growth, there are many countries that use this strategy to a lesser degree and therefore are not as notorious. The game goes on.

So exports are cool and we in the USA would like to beggar our neighbors. But the data have not been kind to the President’s goals for expansion. Notice that before the recession hit, US exports were exploding. Between 2003 and 2008 USA exports of goods and services in current dollars increased by 81%. In the five years after the recession started, from 2008 to 2013, exports increased by only 24%. That is quite a slowdown. While it is true that exports declined in 2009, they have increased in every other year and totaled $2.28 trillion in 2013. They have, however, been growing slowly.

If your horse is running too slowly you give it more JD. Right? Or you do something to speed it up. In past blogs I have pooh poohed efforts to reduce the value of the dollar among other policy remedies. In this blog my focus is geography. Before you come up with a solution for exports it might be a good idea to see which countries are buying more or less from the USA. Luckily the Bureau of Economic Analysis has data on USA exports by country destination.

It might surprise you but Canada and Mexico are the largest purchasers of US products. Apparently closeness counts when it comes to kissing and international trade. In the table below I list some key export destinations – countries and world regions. The table order is in terms of how much each destination bought from the USA in 2008 (because I inter-mix countries with regions the totals do not add).

The table below has three columns. The first column tells you export sales from the USA in 2008. The second tells you the percentage change in exports for two different time periods: between 2008 and 2013/ and 2003 to 2008. The final column tells you how much higher USA exports would have been “if” they had grown at the rate from 2003 to 2008. It shows you how much dollar exports we lost because of the slowdown in the past five years.

Some takeaways from the table:

·       

The 28 countries of the European Union accounted for the largest share of US exports in 2008. After growing by 86% between 2003 and 2008, the EU barely increased its purchases from the USA in the next five years.

·        You can understand the overall EU changes by looking down the table at the UK and Germany. Those countries were buying less USA goods and services in 2013 than they bought in 2008. That performance came after very strong increases in the previous five years of 67% and 81% respectively.

·        Nafta partners, Canada and Mexico, were the largest country destinations of USA goods and services in 2008. They bought more from the USA in the time period from 2008 to 2013, but the decline in growth was much less pronounced than for Europe. Similarly S. Korea and the Newly Industrialized Countries (NICs) slowed in their USA purchases but had relatively strong rates.

·        OPEC and China had the fastest purchases from the USA in 2003 to 2008, 153% and 233% respectively. During the next five years OPEC’s purchases of USA goods and services fell off dramatically while China’s continued growing at 84%.

·        Japan had the slowest growth of USA purchases in first five year period (31%) which fell to growth of only 6% in the last five years.

·        The final column shows what the USA lost because of these slower growth rates of exports. For example, if USA exports to these regions or countries had maintained the pace from 2003 to 2008, exports to the EU and NAFTA between 2008 and 2013 would have been much higher: $404 billion and $129 billion higher, respectively.

Between 2008 and 2013 total USA exports of goods and services to the world rose by about $440 billion. This table shows that a repeat of the growth during 2003 to 2008 would have added another $434 billion just from the EU and NAFTA in 2008 to 2013.

USA Export growth fell during the global recession but then grew slowly thereafter. While we might want to discuss national competitiveness or the overall value of the dollar or unfair trade practices – this little exercise today says that our export challenge is very much geographically oriented. Europe struggles with post crisis economic growth. OPEC is trying to adapt to new competition. Other countries, including S. Korea and China are not growing like they used to. Japan languishes.

This little exercise suggests that raising US exports will be neither easy nor global. It won’t be easy because most of our main trading partners continue to be weak. It will not be easy or global because the problems or issues in each country are not the same. Mexico is not Germany and Canada is not the UK. Discussions about the US EX-IM bank suggest old-style thinking. Europe has demonstrated its importance to US exports – but without some US financial assistance to EU buyers of USA products, it is hard to see why or how they can afford to buy even what they are buying now. We won’t double USA exports in the near future but our policies should realistically address a country/regional set of issues.

          Table. USA Export Destination

                      2008           %

                    Exports      Chg*    Higher?

        Billions                     billions

EU                   471          1/86          404

Canada            308        19/56           114

Mexico            178        44/53             15

NICs               147        34/56             32

UK                  114         -5/67             81

Japan               107          6/31             27

OPEC               92        22/233          192

China                87        84/153            59

Germany           83         -9/81              75

S. Korea           50        28/57               15

Brazil                45        56/183             56

% Chg column has two numbers. Both are percentage 

changes over a five year period. The first is from 

2008 to 2013. The second is from 2003 to 2008.