Slow and Unbalanced Growth in the United States

Like a pig in mud, I love to root around in the data. A macro guy loves it when the BEA releases another quarter’s worth of GDP.  Like a goat on top of a waste dump, you just never know what you will find. So you just dig in.

And I did just that. The data for the third quarter of 2014 was recently released and now that the smoke has cleared, I thought I might spend a perfectly fine afternoon seeing what I could see. And the results are pretty interesting. Have you heard the term “unbalanced growth”? The US economy looks today like a teenager with a pea-size head and arms that drag on the ground. We can only hope that things equalize in the future!

I use the Q3 results to do some comparison analysis. I could wait a few months to do this exercise but I could also wait to bite into that super-hot slice of pizza too. So we could get a collective burnt roof of our mouth here by focusing on the third quarter. But what I do here is as kosher as a Wolfies hot corned beef sandwich on rye. So not to worry.

The first thing I noticed is that the annualized value of real GDP reached $16.2 trillion in 2014 Q3. Now that is a pile of stuff. Back in 1999 Q3 Real GDP was $12.1 trillion. So in those 15 years we increased national output by about a third. Even if we compare today’s output to 2007 Q3 right before the recession started, we are enjoying 7% more than 7 years ago.

7% more in seven years is nothing to write home about but it does establish that even after a major recession and an ensuing slow growth period, we are producing a large amount of output today – considerably more than the outputs of the past.  Again – I am not making a case that things are wonderful in Macroland. But the most recent data establishes the fact that we are producing more than ever.

That fact might not be surprising but it gets a lot more fun when you bring out the Hookah. Err I mean the rest of the data. As you probably know, real GDP has several major components – based on the buyer – households, firms, governments, and the foreign sector.

So let’s see how these sectors contributed to the larger amount of production in the USA. That is, who is responsible for buying about a third more when we compare 2014 to 1999? I summarize with the table below.

The table has component shares of Real GDP. If the share of a category was 10% in 1999 and then 10% again in 2014 – that means that that buying by that group kept up with GDP. The share did not change in those 15 years because it kept up. So in the final column in the table – a POSITIVE SIGN means that category was growing FASTER than Real GDP in those 15 years. A NEGATIVE SIGN means it grew SLOWER than Real GDP. 

What do we see from the table? First, we definitely have unbalanced growth. Second, while consumer good spending was a leading sector, the growth was coming mainly out of durable consumer goods like autos. Spending on nondurable goods like food and clothing did not keep up with RGDP as its share of spending fell. Third, while the federal government purchased a larger share of the nation’s output, state and local governments’ share fell by 2.7%. Finally and perhaps most importantly, gross private domestic investment’s share fell from 18.5% to 16.8% of GDP. Yes spending increased, but it grew considerably slower than real GDP for the last 15 years. As you know this category is the key to future innovation and productivity. While there was a marginal increase in the share of business purchases of equipment, it was the structures part of investment that lagged. Similarly on the retail side, residential housing’s share fell by 2.2% of Real GDP. Finally while exports' share rose by 3.5%, imports share rose by 2.7% and therefore net exports increased by only 0.7%.

Keep in mind that Real GDP increased by about 33% in 15 years. But that amounted to an average of less than 2% per year. All those categories in the table with a MINUS sign, therefore, grew more slowly than 2% per year. The slow growth economy of the last 15 years essentially was propelled by the Federal government (shares of defense and non-defense increased by similar percentages ) and household spending on durable goods and was held back by State and Local Government spending and the construction of business and residential buildings.

One could conclude the slow economic growth was caused by a highly unbalanced growth and recovery. One could also conclude that whatever policies offered to promote recovery have not worked. The Keynesian spending multiplier is premised on the idea that while stimulus might be aimed at a single sector, the results would spread across the economy. Such has not happened and it might help if policymakers try to understand why.

Table. Share of Real GDP in Q3 in 1999 and 2014 and Change

from Q3 1999 to Q3 2014

                                               1999  2014  CHG

Exports                                      9.7   13.1     3.5

PCE                                         64.6   67.9     3.3

Durable Goods                          5.9     8.8     2.9

Imports                                    12.9   15.8     2.7

Investment in Equipment          5.6     6.3     0.7

Federal Government                  6.8     7.1     0.3

State and Local Gov.               13.6   11.0   -2.6

Residential Investment              5.3     3.1   -2.2

Investment in Structures           4.1      2.8   -1.7

Gross Private Investment        18.5   16.8   -1.7

Non-Durable Goods                14.9   14.6   -0.3

Guest Blogger Chuck Trzcinka The Psychology of the Minimum Wage

Chuck Trzcinka is Professor of Finance and James and Virginia Cozad Faculty Fellow of the IU Kelley School of Business.

The political support for raising the minimum wage stems from psychology not economics. The economics is abundantly clear-the minimum wage cuts jobs. The higher the minimum the more the harm. The Congressional Budget Office released a survey of economic studies last year and concluded that raising the minimum wage to $10.10 will reduce employment by between 500,000 to 1,000,000 jobs. When you increase the cost of something, business will find ways to reduce its contribution. For example, McDonalds has added 7,000 touch-screen kiosks in its European stores. Furthermore, the survey showed that over 70% of those receiving the minimum wage are not from poor families. The CBO argued that a better way to help is to raise the “earned income tax credit” would have little effect on jobs.

So raising the minimum wage, even having a minimum wage in the first place, makes no economic sense, but it is unquestionably politically popular. Voters soundly rejected Democrats in Tuesday's election but embraced a visible plank in the party's platform by backing minimum wage hikes in four Republican-leaning states and two cities. By January, more than half the states will have higher wage floors than the federal government. Voters in Alaska, Arkansas, Nevada and South Dakota passed ballot initiatives raising the minimum wage to $9.75 an hour even as they swept Republican Senate and gubernatorial candidates into office. All told, the initiatives will raise minimum hourly earnings for 609,000 low-wage workers, according to the National Employment Law Project.

            Why is it so popular if it doesn’t help the poor? The reason is that it makes us feel better. Psychologists use a concept called “cognitive dissonance” to describe a situation where facts confront our most basic views. For example, young people are reluctant to save for retirement because this means accepting that they will grow old. Similarly, when we interact with low wage workers it makes most of us uncomfortable. They only have skills that command a wage below what we think is below a “living wage”. It is certainly below our living wage. The low wage confronts our belief that we are living in a “fair” economy.  Our response is psychologically to reduce the source of dissonance. If we raise the minimum wage we will either eliminate the job or have a higher wage worker. We will not ever meet a low wage worker and we will believe that the economy is more fair and just. The minimum wage is really about making those who are wealthier feel better.

The problem of course is the economics. The poor would be far better off if the minimum wage was lowered or eliminated and we expanded the earned income tax credit. But then our idea of “fairness” would be challenged by low wage workers. We would never think to ask any of these people why they were willing to work for a low wage since this conversation is uncomfortable. It’s better to get government to impose a wage floor and never meet them. 

Guest Blogger Buck Klemkosky: The QE Punch Bowl Has Been Taken Away. Is the Party Over?

William McChesney Martin, former chair of the Federal Reserve Board, famously stated that “the job of the Fed is to take away the punch bowl when the party is still going.” A quote from the 1960s, but very relevant today as the Fed voted in October to end the third quantitative easing (QE3) program.

At the end of six years of QE programs, the Fed had purchased $3.9 trillion of mortgage-backed securities and Treasury bonds, increasing its balance sheet from $800 billion to $4.7 trillion. This represents 26 percent of U.S. Gross Domestic Product (GDP), a historically high amount, relative and absolutely. But the Fed is not alone. The Bank of Japan just announced its QE program will be expanded and its balance sheet is already 57 percent of Japan’s GDP. The European Central Bank has just started a QE program and its balance sheet, at 21 percent of Euro GDP, will certainly get larger.

What did the Fed do before QE? For 95 years of its 101-year existence, the Fed exerted monetary control through short-term interest rates, supplying credit to the banking system to lower rates or withholding credit to increase rates via open market operations. The Fed also has the right to change reserve requirements for the banking system, the amount of cash and other liquid assets banks need as a percent of deposits, and the discount rate, the amount the banks pay to borrow reserves from the Fed. The Fed also has used selective credit controls and moral suasion. The short-term interest rate targeted by the Fed is called the “Fed funds” rate which is based on interest rates for overnight loans between U.S. banks. This rate was fairly easy to manipulate when there were $30 billion-$40 billion of excess reserves in the banking system. At present the Fed is targeting a range of 0 to .25 annual rate for the Fed funds rate.

What are the implications of Fed monetary policy since the new unconventional tool of quantitative easing has been initiated? The big question now is whether the Fed will be able to raise the Fed funds rate in the future. As the Fed went through the three QE programs, it purchased bonds from banks and others and paid for them by crediting bank reserve accounts at the Fed. To the banks these reserve balances were as good as cash that could be lent out or invested. Because of the slow-growth economy, low loan demand, Dodd-Frank and other issues, the banks left much of the reserves at the Fed recreating $2.7 trillion of excess reserves, those not needed to support deposits. With that magnitude of excess funds in the system, the Fed will find it challenging to raise interest rates via traditional methods. There is no longer a viable Fed funds market. Plus the Fed has already announced that it will maintain its $4.5 billion balance sheet so selling a lot of bonds to drain liquidity from the system is not an option. What to do? The Fed could raise the interest rate on bank reserves. However, this may not be politically feasible because it would be boosting bank profits, including those of foreign banks with U.S. deposits, with no risk on the part of the banks. Another alternative would be to target other short-term bank borrowing markets such as the Eurodollar, Libor, commercial paper and repo markets. 

It is difficult to assess the effectiveness and impact of the QE programs as we never know what would have happened if there had been no QE programs. It is also difficult to differentiate between the impact of the QE programs and the zero interest rate policy the Fed has maintained since late 2008. But certainly the QE programs have reinforced expectations that short-term interest rates would not be raised as they have not been to date. The S&P 500 closed at an all-time high in November, the U.S. Treasury 30-year rate and mortgage rates were below 4 percent, the yield on the 10-year Treasury was below 2.5 percent, unemployment was 5.9 percent and the Shiller Case housing index has rebounded 25 percent since the lows of 2011. So it has been successful by some measures. But, the economy has grown only by 2.2 percent annually since the recession ended in June 2009, way below past economic recoveries. Inflation has also remained subdued, averaging 1.4 percent annually since the recession ended. The Fed has a 2 percent inflation target and inflation has been below the target for 29 straight months. The Fed remains concerned about the economy and the deflation that Europe and Japan have already experienced.

Some think that QE is a dangerous monetary tool because of unpredictable side effects. One would include igniting inflation and inflationary expectations beyond the Fed’s 2 percent target if banks stimulate the economy with their $2.7 trillion of excess reserves. A second would be financial instability as investors take on more risk reaching for yield and creating asset bubbles. A third is that the huge Fed balance sheet may interfere with conventional monetary policy and tools in the future. Only time will tell whether the side effects and effectiveness of the QE programs are understated or overstated. The debate may go on for years.

Whenever the Fed choses to do so, the task of raising interest rates has gotten more difficult and risky. When will that happen? The consensus seems to be mid-2015 at the earliest and perhaps not until 2016. When it happens, let’s just hope that the QE punch bowl doesn’t leave the economy and investors with a hangover. Or the punch bowl may need to be refilled (QE4) to keep the party going.

Trick or Treat -- The Fed's Balance Sheet

Like many of you I have been reading all the articles written about the US Fed ending its quantitative easing program. There is enough stuff there to choke Mr. Ed the talking horse. As I was reading it occurred to me that I am a total monetary geek. I was still wearing parachute pants when I took my first course in money and banking. Since then I have become a Fed Watcher and can’t wait until the minutes of the last meeting of the open market committee.

So let me say that I was mystified that little of what was written in the last week focused on one critical aspect of the Fed’s balance sheet. And there was a lot written. Much was a postmortem on quantitative easing. Did it work or not? And while looking at the past is always valued, we should spend equal time thinking about how the end of quantitative easing will affect the future.

The frustrating thing is that what was written about the future uses too many code words. I don’t know how many times I have read that quantitative easing has increased the size of the Fed’s balance sheet. How many of you know the definition of a balance sheet? How many of you took Professor Gamonida’s accounting class at Georgia Tech and learned about balance sheets? Aha – not many of you. How many of you have ever learned a thimble full of information about the Fed’s balance sheet? Aha!

So in the name of global harmony and to the tune of the Georgia Tech Fight Song, I will quickly and easily introduce you to the arcane basics of Federal Reserve Accounting – and more importantly explain why a key issue is being ignored.

The first thing to note about balance sheets is that they are not found on your mattress under the quilt. A balance sheet brings together much of your financial stuff. On one side its lists the value of all the good stuff like your cool Converse Chuck Taylors, what’s left in your bank account after your spouse went for her weekly facial, saving your saving account balance, your house, your car, cash stuffed in your pillow, and your Uncle Charles. Just kidding, your Uncle Charles in not an asset. All the other good items you own are called assets.

Your balance sheet also has another column that lists all your ouch stuff. Mostly that’s what you owe. So if you owe $46,000 on your Yugo, then the $46,000 loan is called a liability. You have liabilities or debts under such categories as credit card debt, car loans, mortgages, college loans, and so on. The money you owe to Pete your gambling friend is often not included in public balance sheets.  If your assets do not equal your liabilities there is always a balancing item that makes your assets equal your liabilities plus balancing item. But we don’t need that fact to go forward.

Are we going forward? Are you awake?

The Fed has a balance sheet. It is very cool. The main asset the Fed holds is bonds. The Fed at last count has close to $4.5 trillion of bonds. Wow.  $4.5 trillion could buy a lot of chicken wings at Buffa Louie’s. Most of these are government bonds with short-term maturities. But since quantitative easing started, more and more of these bonds are longer-term government bonds and housing market derivatives.

What you read about over and over is that the Fed’s balance sheet rose from just under $900 billion to about $4.5 trillion. Fed assets exploded because of QE. And like your waistline after a six month luxury cruise, the amount is still with us. In the name of colossal calamity, the Fed bought an extra $3 trillion or so of bonds and still holds them. As of last week they are no longer buying more bonds. But the stockpile remains.

Much of what you read focuses on this stockpile. Will the Fed let it slowly mature and just burn the cash when they receive interest and principle? Or will the Fed quickly get rid of all those bonds? Clearly if they did the latter it could be disruptive to credit markets. So the Fed is in a bond pickle and that’s what everyone seems to be talking about.

But that leaves out one spectacular element. Why did the Fed buy all those bonds in the first place? Is the Fed a bondoholic? Aha! They bought all those bonds because that is how they flood the economy with money. Between say 2009 and today, the Fed added about $3 trillion of money to the economy. The hope was that all that extra money would lead to bank loans, spending, and economic growth. But what happened was that after averaging almost zero in 2007 and 2008, bank excess reserves rose to about $2.8 trillion today. That is, banks did not loan out much of that money. They asked the Fed to hold onto it for them. Perhaps holding it for a better day when people really want to borrow money. Meanwhile the Fed is sitting on money that the economic system has shown it doesn't want.

All this information about money and bank reserves is what is found in that second column of the Fed’s balance sheet and is called liabilities of the Fed. And that is what is not being talked about much in the papers. Your kids came home from trick or treating with a mountain of candy. What are you going to do with all that stuff? Your kids do not need all that candy and Fed and the banking system do not need all those excess reserves. 

The Fed could quickly get rid of those reserves but they worry it will disrupt markets. The way to reduce the excess reserves is for the Fed to sell their assets. All that selling could be disruptive to bond markets sending bond prices down and rates up. Yellen and her gang do not want to be held responsible for driving up rates. So what is there to worry about? The Fed is holding a bunch of money for banks who don’t want to use it. No big deal. Right? Wrong. As the economy recovers, borrowers will return to banks. And banks will have an almost limitless fund to make those loans. It is like all that Halloween candy. You can hide it from the kids for a while, but sooner or later they will find it and you will soon have a problem on your hands. Better to trash the candy on November 1.

QE was a travesty because we all knew this would happen. The Fed has put itself in a no win situation. It made a big announcement last week to stop doing stupid things. But now it is stuck with a mountain of stupid things. I guess we never learn.

Taming the Deflation Dragon

The Deflation Dragon is roaring and Keynesians are licking their chops. Like those who promote fad diets and weight loss pills, Keynesians are appealing to your inner anxiety and love of easy solutions rather than telling you the truth about what ails the world economy. A typical article on this topic is one that appeared at Bloomberg.com last week --  http://www.bloomberg.com/news/2014-10-22/currency-wars-evolve-with-goal-of-avoiding-deflation.html

This Bloomberg article does a few things. First it does a nice job of reporting deflation changes in various spots around the world. There is plenty of it. I have no argument there. Second, it connects exchange rate depreciation wars with these deflation occurrences. Finally the article concludes that if exchange rate depreciations will not successfully end deadly deflations, then we should deal with it with “whatever means is necessary.”

Clearly more people are coming to the conclusion that widespread deflation needs to be reckoned with and that typical Keynesian approaches that boost aggregate demand must be administered. These approaches include depreciating your exchange rate, goosing money and credit, and having larger government deficits and debt.

The intuition is simple but deceptive. Draw a supply and demand curve diagram. Shift the demand curve downward. Notice the resulting lower equilibrium price. Now shift the demand curve rightward. Viola – the equilibrium price rises back to normal. Furthermore, equilibrium output (and presumably employment) increases. QED. Demand is the problem. The problem is evidenced by deflation or falling prices. The problem is rectified by increasing demand. Don’t you just love economics! Now I can drink my JD and spend the rest of the day watching leaves fall.

I agree with the whole Supply and Demand story but disagree with how the world can best push that lagging Demand Curve back to a better position.  Conventional Keynesian wisdom reflexively wants the government to manage the Demand Curve through exchange rate, monetary, and fiscal policies. But in 2015 world economic problems require a very different potion. Even the master of all this theory – J.M. Keynes, if alive today would have looked at today’s situation and balked at the traditional Keynesian remedies.

Why would Keynes balk with Keynesianisms? Because Keynes lucidly and powerfully expressed the idea that confidence and fear were important motivators. When writing about the Great Depression it was Keynes who explained that monetary policy would be like “pushing on a string.” This meant you could push money into the system but because of lacking confidence, banks or firms or households would simply hold onto the money. They would save or hoard it. They would not spend it. He called that “the liquidity trap.”

So Keynes established why fear made monetary policy ineffective. Living today and seeing how governments have backed themselves into huge debt corners, he might also conclude that fiscal policy won't work in an environment where governments were defaulting on debt. I am not sure what Keynes would say today about exchange rate policy but such policy is not one that every country can employ. This is a zero-sum game. If one country depreciates its currency to stimulate demand for its products, then another country has to endure an appreciation and a reduction in demand for its goods and services. Already the US is getting unhappy with Japan and other countries that are making gains at US expense.

Larry you are so depressing! I am not. I am fun! There is a solution to deflation but it involves not calling the 800 number for another fast acting pill. Think about what most countries have been through in the last years. Think about the real credit and financial problems faced by household, firms, and governments. It might sound humane and nice to tell US families that they can now borrow 97% of the price of a new house with less stringent income requirements. But surely all those stories about under-water mortgages are still fresh enough to make potential home buyers know that this is not an attractive option.  Basically it is snake oil.

The solution is the same one the doctor gives to the patient undergoing rehab. Keep at it. Keep doing those exercises and someday you will regain better use of that limb. There is no easy way. There is no pill or diet. Just keep sweating and grunting and pushing to get stronger.

Today the sweating and grunting has a lot to do with reducing previous levels of debt among households, firms and governments. Either under- or over-regulation of what the IMF calls legacy problems are also part of the problem of uncertainty and insufficient demand. Under-regulation means that governments should do more to clear up financial, housing, and other problems. Over-regulation means they have done too much and have handicapped the very patients doing the rehab. Do those exercises with a 100 pound sack of potatoes on your back!

Nutshell. Deflation does exist and is a challenge. Aggregate demand is deficient in many places and needs to be prodded upward. Aggregate demand will only be worsened by policies that do not address fundamental problems. Most Keynesian remedies fall into that category. Policies that are tough but will make us stronger are what we need. We need to cleanup debt. We need to give workers and companies stronger incentives and remove impediments to work, innovate, and produce. The IMF pays lip service to such “restructuring” policies but alas in the real world the snake oil salesman seems to have more influence. 

The Fed, the IMF, and Stock Market Gyrations

The Fed spoke last week and the markets looked like a food-o-holics meeting at a Hardees Restaurant. I am not exactly sure what that means but I am trying to paint a picture of chaos. Got it?

What is a little different this time is that we are getting a refresher lesson in international macro. The bad news is that international forces could weaken the US economy. While we are used to news about how events in Syria and Iraq threaten us, the latest salvo has to do with exchange rates and softness in the world economy. We point our fingers at various allies when it comes to them lagging at supplying ground troops in Syria and Iraq – and now we point our fingers at China, Germany,  the EU, and various other places for not doing enough to buy our US exports. Those places are blamed for not stimulating spending enough and have let their currencies depreciate too much against the dollar.

Since the US government is incapable of managing the US economy the Fed is left as the last bastion of help to defend Main and Wall Streets. And the markets loved the idea that the Fed is truly “left” or liberal enough to think that keeping interest rates near zero for a while longer will make all the difference in the world.  It is strange that zero interest rates have been unable to spur the economy sufficiently when foreign countries were stronger – and now that our neighbors are weaker we cheer the same policies. Wow – please give me more of that allergy medicine now that I am really sick. It didn’t work for mild symptoms so maybe now it will have me dancing the jig since I am really sick. Huh?

What is interesting about all the light and fury last week is that there wasn’t any real news about the global economy. It is no secret that the dollar has been appreciating and no secret that much of Europe and Asia were struggling with growth. But aha – a report was published last week that underscored what we already knew. Somehow that underscoring of the old information was the news. Joe is 5’2” and cannot play for the Indiana Pacers. His girlfriend tells Joe that he probably won’t get a contract from the Pacers. Joe immediately becomes despondent and orders a case of JD.

The report that was published last week is the semi-annually published IMF World Economic Outlook. The October 2014 report is now widely available. Some of you believe all sorts of horrible things about the International Monetary Fund and have already changed the channel. But these reports from the IMF are well regarded and many economists and analysts come close to spiritual rebirth each time a new report is published. So let’s take a little walk down IMF Outlook lane and (  http://www.imf.org/external/pubs/ft/survey/so/2014/NEW100714A.htm ) and see what these folks told us that made us so crazy last week.

Let’s start with report’s Table 1 which lists annual growth rates for real GDP for various geographies. The last column of the table tells by how much the IMF revised its 2015 forecasts since July. Thus, the only real news is in that last column. Below I duplicate some of their findings for next year:

·        World economic growth revised down from 4.0% to 3.8%. Note 3.8% in 2015 is faster growth than in 2012, 2013, and 2014. Notice also that 3.8% is almost exactly equal to the average world growth of 3.9% per year from 1996 to 2005.

·        USA no revision – remained at 3.1% for 2015.

·        Euro Area revised down by -.02 to 1.3%. That 1.3% in 2015 compares to negative growth in 2012 and 2013 and 0.8% in 2014.

·        Japan revised down by -.2 to 0.8%. This is the slowest growth rate in the last three years.

·        Canada revised up 0.1 to 2.4%, highest in three years

·        Mexico revised up .1% to 3.5% faster than the last two years but down from 2012.

·        China no revision at 7.1% but lower than the average of about 7.6% over the last three years.

So this is what we are all getting blathered about? These are the revisions that contributed to a huge stock sell-off last week? Basically the US forecast was unchanged while NAFTA as a whole improved. Improved! The US and its closest trading partners had better forecasts for 2015 than from last July. Europe’s growth was knocked down a bit from July but growth is expected to improve in 2015 – Europe will have stronger growth than experienced in the last three years! Japan and China will have off years but notice that the world economy is predicted to grow faster than it has for three years.

There are some who say that the tone and words used in the IMF Report were more startling than the numbers I described above. So let’s see what the IMF said in its Forward – the part most people read.

It is easy to summarize. The IMF believes there are two problems facing the world right now. One is continuing to deal with the legacies of the past financial crisis. That means dealing with government debt and high unemployment. The second problem is that potential GDP is slowing.  Because of these two factors, confidence is declining.

The overall message says nothing about new shocks that might have caused them to revise downward their forecasts for 2015. Why have financial legacies and potential growth deteriorated since July? The truth is that the IMF simply saw some bad months in some bad places and decided to jump on the bandwagon of negativity. If growth is getting worse in Japan or the EU or Brazil – then surely they will continue to get even worse. Or will they?

Which brings us to the IMF’s policy remedies. First, despite noting government debt risks and pointing out that current Keynesian policies have not succeeded, the IMF wants countries to use even more Keynesian aggregate demand expansion to stimulate economic growth. Spend on infrastructure and if that isn’t enough then spend on “whatever”. Second, they recommend to most countries to use structural fiscal policies that improve the workings of labor markets, commodity markets, financial markets, government over-regulation and so on.

What I recommend is that the IMF not publish global forecasts until they actually have something to say. The above stuff is nonsense if not drivel. They want more Keynesian stimulus when it hasn’t worked and when it will explode national debt problems. They want to solve long-term issues with monetary policy that keeps interest rates low. They have been advising countries to restructure and free up their economic systems for decades with little result. Is Putin’s Russia really going to embrace more capitalism now that the IMF has asked them to do it for the hundredth time?

Despite all the geopolitical and other risks, the world economy is growing at an improving rate. Not all countries are sharing in that growth but that is usually the case. The last thing we need is for the IMF or anyone else screaming that the sky is falling. 

Guest Blog by Buck Klemkosky*: As the World Turns

Intro by Larry Davidson

I was in the process of writing something about recent global events when Buck beat me to it. I still have plans to write about the recent IMF World Economic Outlook report that was released last week. But in the meantime Buck brings up two very recent and potentially threatening global trends. The first one finds that the value of the dollar is rising lately and is creating new challenges for a still fragile US economy. Buck explains why dollar value changes are not that simple, however. The other interesting issue concerns global commodity prices. Most of us worry when prices of energy, steel, copper, aluminum, and various other commodities rise too much. But what happens when international prices of these items begin to decline?  I hope you enjoy Buck's take on these things.

The Dollar is Back

In the last year, the U.S. dollar has appreciated (strengthened) 10 percent against the euro and 15 percent against the Japanese yen. Most of the decline in the euro has been in the last six months, while the yen has fallen almost 40 percent in the last two years. It is not just the euro or yen either. The U.S. Dollar Index, which measures the value of the dollar again a basket of currencies, has climbed to its highest level in more than four years. Even the venerable Swiss franc has fallen 9 percent against the dollar since June, as well as emerging market currencies. About the only currency that hasn’t changed is the Chinese yuan, which is controlled by the government and unofficially pegged to the U.S. dollar.

Why do we care about the value of the dollar relative to other currencies? A strong dollar makes foreign goods cheaper and thus helps control inflation. However, a strong dollar also makes exports more costly and thus less competitive, resulting in slower economic growth. It has been estimated that a strengthening of the dollar by 10 percent reduces economic growth by 1 percent. It always pays to invest in a country with a strong currency, so a strong dollar had made U.S. financial assets more attractive to foreign investors; it has helped lower bond yields and other interest rates and supported stock prices.

Why is the dollar so strong? The U.S. has experienced better economic growth than either Europe or Japan. Both are on the verge of recession and have lower inflation or deflation and lower interest rates. The European Central Bank has initiated a bond purchase program, and Japan has an ongoing one just as the U.S. Fed will stop its program this month. Plus the Fed has already given guidance that U.S. interest rates will be increased in the future, while Europe and Japan have given no such guidance. In a broader context, the dollar remains the world’s primary reserve currency and a safe harbor in terms of crisis and geopolitical risks. The dollar will continue to anchor the world’s financial system in the foreseeable future. In the shorter term, one will not notice the effects of a stronger dollar unless traveling abroad; things will be cheaper.

Commodity Prices Tank

The closely watched Bloomberg Commodity Index, which tracks 20 commodity prices, has fallen in recent weeks to a four-year low. And the fall has been broad-based, including agricultural, energy and metal prices. How things have changed; between 2000 and 2011 commodity prices tripled, referred to as the commodity super-cycle, and there was talk of eventual shortages of almost all commodities. Since then commodity prices have fallen by about 25 percent, and 11 percent since June alone. The only commodities not to experience price declines have been cocoa, coffee, cattle and hogs.

Commodity prices are a function of supply and demand and both have had an impact this year. On the demand side, annual global economic growth has slowed from 5 percent to 3 percent this year. Global growth may not improve much in the short term as the Eurozone, Japan and other emerging countries are teetering on the brink of recession. China, the largest user of most commodities in recent year, is struggling to achieve annual growth of 7 percent. Christine Lagarde, head of the International Monetary Fund, recently declared that the global economic recovery was “brittle, uneven and beset by risks” and slow global growth may be the norm for a long time.

The supply side may be summarized by two words: “supply glut.” Agricultural commodities have benefited from good growing weather, record acreage planted and high yields, resulting in bumper crops and the lowest prices in seven years. The oversupply of most metals can be blamed on the huge investments made at peak prices to satisfy China’s appetite for raw materials and recovering global economic growth. Oil prices have fallen 16 percent since June and are at the lowest level since 2012. Much of this decline can be attributed to the shale boom in the U.S. as it replaces Saudi Arabia as the largest oil producer in the world. The U.S. imports less oil today – 3 million barrels daily – then it did two years ago. Oil prices would be lower if countries such as Libya, Iraq, Iran and Venezuela could produce at full capacity.

What are the positive and negatives of falling commodity prices? It depends on whether a country is a net importer of commodities or a net exporter. Producing countries that export suffer when prices drop and could be a drag on global economic growth. For the net importing countries, falling commodity prices are like a tax cut, leaving households with more disposable income. Since many commodities, such as oil, are priced in dollars, the stronger dollar helps the U.S. but hurts other countries where currencies have weakened again the dollar. In general, falling commodity prices are probably signaling slower global economic growth.


*Buck is Market Strategist at Wallington Asset Management.

Is the Stock Market Over-Valued?

The stock market swooned last week and has been bouncing around ever since. “Surely the market is over-valued” is a comment that you hear frequently.  Agreement with such a statement means that many people will be very worried because it implies that stocks have peaked and will stop rising.  Retirees never like to hear that since their future incomes are tied to future growth in stock values. But all of us are concerned – no one wants to see wealth disappear. Simply – whether you are young and beginning to save or old enough to be on a regular diet of prunes – it hurts when stock prices stop rising. It hurts even more when they fall.

So what is the truth here? Are stocks going to stop rising? Fall? Or is all of this nonsense and stocks will continue rising?

Below you will see why I am not pessimistic about stocks. But let’s begin at the beginning. What does it mean when people say stocks are over-valued? If your boss tells you that you are over-valued, you know it isn’t a compliment and it probably means no wage increase is imminent. The word “value” is a common one that most of us understand. All things have value. Even my old pair of jeans has value to someone. 

Value, however, can be a tricky thing. How about those old jeans? Some of my well-dressed friends would toss a pair of old jeans as soon as the fading begins. In contrast, my hippie friends won’t even wear a new pair of jeans until they have washed them enough times that they are not only faded but have holes in the knees. Point – the same product might have very different values to different people.

Economists recognize this dilemma but point out that markets are places where values are assigned through prices. If a house sells for 1 million dollars, that’s the value of the house. The seller may be unhappy with that price and the buyer ecstatic – but the economist records $1 million. That’s the price at which both parties agreed to the transaction.  So – implicit values can be almost anything but market price is an objective criterion widely accepted as value. If we want to know if stocks are over-valued then we use stock prices. 

What does it mean for stock prices to be under-valued? There is no single meaning. The popular way is to use something called a price/earnings ratio. P/E has two parts – a stock price and an earning figure. Think of a single firm. Suppose its stock price closed at $100.  When you buy that stock for $100 you are hoping it will be a good investment. For the moment forget the capital gain you might receive by buying low today and selling high in the future. What’s left is a dividend you might receive from that share. Let’s suppose the earnings of the company are only $1. In that case, since dividends reflect earnings, the most you would expect to receive for your $100 investment is $1. That’s a 1% return. Ugh.  That stock is over-valued at $100. If you had paid $20 for the stock, then your return would have been a much better 5%.

Some of you are waving your hands! Larry – when you pay $100 for a stock you have it for more than one year. So what matters is not just one year of dividends or earnings – but what happens to earnings over the future. And for that question/comment you get a gold star. But that’s what gets us into trouble with this price/earnings approach. The current price and earnings data are known but are not perfect. But to use future earnings brings in unknowns and expectations and lots of different opinions. Ron might think a stock is vastly under-priced because he sees large increases in future earnings. James is more pessimistic about earnings and thinks today’s stock is highly over-priced.

So while the price/earnings approach is one that is widely used – it isn’t perfect for determining when and if the stock market will fall or rise in the future. It is a valuable approach but it leaves room for other ways to think about stock prices. Since I am about as boring as a rock in a stream, I like intuitive simple approaches. Consider some facts about the market. Here I am using the S&P500 price index. I downloaded data for the time period from 1950 to September 2014 from a website (https://finance.yahoo.com/q/hp?s=%5EGSPC+Historical+Prices ).  I then graphed the data. I converted all this daily data to annual averages. My limited abilities mean I couldn’t get the graph on this page. But you can find a graph at the link above.

·        Similar to my waist size – the S&P500 has had up and down cycles many times but it has trended upward.

·        The value of the S&P index in 1950 was about 17 and now hovers at about 2000. You math jocks can figure out the rate of return of $100 invested in 1950.  It is a pretty big number. If you gave that money to Uncle Charlie (or Uncle Sam) in that year, your return might not have been so good.

·        During those years there were many times when the market surged ahead only to return to more sober (lower) values. Many analysts point out a period from the early 1970s to the early 1980s when the market was essentially flat. But that is about the only time since 1950 when the market did not pop back in a more reasonable period of time.

·        Looking at the graph from 1995 to 2000 and then from 2003 to 2007 the increases where spectacular. Both peaks were followed by declines that lasted 2-3 years. The declines were followed by more increases.

·        There were also interesting time periods when stock prices rose precipitously but did not fall for extended time periods. If you start in about 1975 the market rises through the early 2000s with several major spurts followed by shorter setbacks.

The above points are pretty well known but they do underscore one fact – market gains always have setbacks but those time periods vary greatly in their intensity from a couple of months to several years. Gains do not necessarily imply a seriously stagnant market price.

Now one more point. If you put money into the S&P500 in 1995 or 1996 and held it until it reached 2000 last month – your annualized continuously compounded yield would have been around 7%. That annual appreciation is very much in line with stock returns over a much longer period. An average market, therefore, is expected to give you about 7% per year. Now consider the recent time periods of so-called explosive growth. If you invested money in the year (first column below) and sold when the market hit 2000 recently*, your investment would have earned the average compounded rate (column 2) over those number of years (column 3):

1997      4.5%   17

1998      4.3%   16

1999      3.0%   15

2000      2.4%   14

2001      5.2%   13

2002      7.8%   12

2003      6.5%   11

2004      6.0%   10

2005      5.6%    9

2006      5.2%    8

2007      3.9%    7

2008      9.4%    6

2009    13.6%    5

2010    15.1%    4

2011    20.9%    3

2012    17.8%    2

2013    18.9%    1

*Rates of return in the table are calculated from September of each year given through September of 2014.

From the above table you can see dramatic growth of the last five years. Those are indeed spectacular returns. But if your eyes move up the table you see that even with these fantastic stock increases, the annual average returns from money invested anytime between 1997 and 2007 yielded below historical averages. Thus even with spectacular growth of the last few years – the longer term returns in the market are well below average.

What do you make of this? The answer is that there is no way to know the future. Price/earnings ratios are interesting but don’t tell the whole story. Returns of the last five years are indeed spectacular. But even with stock price increases in those five years, money that got invested 7 to 17 years ago are not impressive. Stocks could rise several more years before that money earned the average annual return.

Will the market peak soon and swoon? Will it remain at present levels for 10 years? I don’t know. But the answer is clearly not a slam dunk. 

Econo-Quickie: Good News is Now Good News

This is a bit of an experiment today with my blog. Usually I stick to my long and boring Tuesday posting . Today I am seeing how you will respond to an off-cycle quickie. Charles -- no wise cracks.

Anyway, I was taken by the fact that the employment release this morning was strong -- employment grew more than expected and the nation's unemployment rate fell below 6% for the first time since some of you were wearing short pants.

In the recent past such "good" news was taken as a bad sign for the stock market. That's because good economic news might cause the Fed to quit holding interest rates down. And rising interest rates are thought to be bad for the market. But yikes. As I type the market is almost up 1% and some of the talking heads are saying stocks are rising because of good employment  news. So my question to you is -- if good news used to be bad news -- then why is good news now taken as good news?

Aren't we having fun? :-)

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]