Trade Tantrums

I lamented in the last weeks that there are few voices in government to stand-up for budgetary and monetary control. This week my complaint is about international trade. Whether it is Trump or Sanders or Clinton – the story is pretty much the same. Americans are being hurt by free trade and we have to put an end to that.

This unified wail against trade is expected in slow growth times like we are living through. It is always easier to point the finger of blame and redirect rage at external forces. It is easier to do that than to admit that an economic behemoth like the United States can only linger in slow growth because of our own domestic policy failures. It might be comforting to some that the US is joining other countries in complaining about unfair competition. But it doesn’t help matters. Economists have long pointed to the disastrous effects of the Smoot-Hawley tariffs as a major contributor to the severity of the Great Depression. Protectionism can be devastating. 

As I showed in a previous post, the US has been hurt much less than other countries in the aftermath of the last global crisis. China is a shadow of its former self. Other developing countries that saddled their success to commodities trade are experiencing very slow if not negative growth. Europe grows slower than escargot. We complain when those countries allow their exchange rates to decline or engage in other emergency trade protection measures to resuscitate their economies. But the truth is that we in the US will gain much more than we lose if we ignore those misguided diversions from sanity.

So we ought to stop pointing fingers abroad and instead lead the world by example. And the example is to show that competition is good – whether it plays out domestically or in wider global markets. Since many Americans do not buy that story, let me work on it here today. The story has two parts. One is economics and common sense. The other part has to do with history.

Let’s discuss history and change. Most of us do not want to go back to the days when we washed our clothes by hand using tubs, scrub boards, and clotheslines or when we asked Mary the telephone operator to put our call through to Aunt Bee. We don’t want the textiles industry back in New England. We like modernity and most of us appreciate change that makes our lives easier and better. Transitions can be painful but in retrospect the pain has produced enormous gain.  

It is true that low skill manufacturing has all but disappeared in the US since the baby boom was born. But somehow as that was unfolding gradually over time, the economy grew and employment growth has been nothing short of spectacular. Much of the employment gains went to high valued added manufacturing and to services. And while services do include many low paid jobs they also include many very good ones in technology, scientific research, communications, health services, entertainment, energy, travel, shipping, tourism, finance, banking and much more. It surprises people that while manufacturing jobs have disappeared in the US, manufacturing output has not. US Manufacturing has grown at the same pace as the overall economy for the past 60 years. To say that manufacturing has disappeared in the US is wrong. Manufacturing has survived because US firms and locations have fought to maintain competitive.

Industrialization in America has been nothing short of spectacular as hordes of men and women have found good jobs and ample incomes. And while most of that process was domestic, part of that industrialization has been the phenomenon of globalization. It is the same process but it overlaps borders. No we don’t make many or any televisions in America anymore. How could we when an American factory worker wants to earn $50,000 per year and we can pay a Vietnamese worker $2,000 to produce the same TVs.

Vietnam is just one of many countries that offer advantages for low skill production. Somewhere around the early 1990s the world changed. Whether it was the breakup of the Soviet Union, the economic changes in China, or the demise of Latin American dictatorships and self-sufficiency programs – the next quarter of a century produced a dramatic increase in output and trade. Countries that never traded started to. Countries that traded only with their best regional friends began looking globally for markets.

That major historical change is not going away. And while it benefited the people in emerging market countries it also benefits us every day. We import goods that we could not possibly make as cheaply. We export to countries that need what we can make.  And investors have found new and successful global trading opportunities. If the US stock market is not making money for you – you can more easily buy emerging market stocks.  And vice versa. Call it diversification. Call it globalization. Or just call it good. 

It is true that in times like now when growth is so slow, our first instinct is to blame and protect. But it is also true that we cannot protect ourselves from dozens of countries whose inhabitants want to make $50,000 per year. The only way to truly protect our rich civilization in the US is to maximally exploit our advantages and opportunities. Do we not have world class scientists, companies, workers, infrastructure, and so on? Of course we do. No one should cry for America. But what we need to do is employ all our assets in ways that create competitive products and grow wonderful jobs. 

The future promises new and innovative processes, products, and markets. As people in emerging nations succeed and earn larger incomes, they will spend some of this new wealth at Apple, Microsoft, and Google. We need to focus on getting better and on how we can be the very best at what the world wants to buy. We do this by opening markets not by closing them. 

The Suckling Fed: A Central Bank Acting without License

One of the problems with monetary policy these days is that it seems level-headed and responsible and yet there is still something sadly wrong with it.  It seems correct and rational because the economy continues to have risk factors and we have a Fed with very powerful tools. So why not let the Fed continue to support the economy?

The answer is that while it all seems warm and fuzzy, there isn’t any real precedent or theory to support this kind of behavior. Pardon my little walk through history to make my case.

The Fed joined the central bank game in 1913. It didn’t have much to do during the Gold Standard days. After WWII we had something called the Gold Exchange Standard and the Fed was supposed to be pretty passive in that system too – though some people would argue that it was Fed activism that caused the US to have to embarrassingly admit they screwed up a very lovely system. President Nixon notoriously closed the Gold Window because we could not continue to honor our pledge to buy gold for $32 an ounce. We had depreciated the dollar and had to end the system or go broke.  

When I first learned monetary theory in the olden days of yore, there was a very simple idea that guided monetary policy. An economy needs money to make transactions. The Fed should make sure there is enough money to sustain a normal pace of economic growth. That was pretty simple. The Fed was not supposed to deliver babies or groceries or pizza. It was supposed to let money grow at a nice easy pace commensurate with long-run growth. Snore.

If you are still awake you might point out that the modern Fed has a dual mandate to keep inflation below 2% while pursuing a fully employed economy. That’s true but even those words do not support what the Fed has been doing the last few years. There is a difference between being a lender of last resort and being a lender of first resort. Let me explain.

Even some ardent conservatives believe the Fed should be the lender of last resort. That means that when we have an emergency that requires liquidity in the economy, most of us believe the Fed should provide that liquidity.  When the emergency vehicle comes to your house you are glad it contains a medical professional who will administer to your heart attack. The Fed performed that role in the beginning of the recent financial crisis. Give them a gold star. They did the right thing. It helped.

But just because the emergency doctor gets your heart going it does not mean you want her sitting in your living room watching reality TV and eating your butter drenched popcorn on a daily basis. Dude, go home. I am okay. Go help someone else.  

And that is the root of the problem with the Fed. Janet does not want to go home and leave us along. You might say – but she has plenty of support and authority from modern macroeconomics. Neo-Keynesians and even a few monetarists might agree that the Fed can provide stimulus and support for an economy entering a recession. The Keynesians have models that show a little bit of stimulus can go a long way. Monetarists might fret that such actions would cause higher inflation but both groups of economists admit that stimulus could be effective in moving us away from the worst of the recession.

But what none of them can show with or without models is why the Fed needs to keep suckling the baby. You and I know of mothers who are breast feeding their kids at age 14. Hey gal, it is time to give up on that. Enough is enough. I could not possibly do better than you in imagining all the reasons why breast feeding beyond even three years old could have some negative impacts down the line. Summarizing:

·        The Fed should be lender of last resort --- yes

·        The should stimulate the economy in a recession – maybe

·        The Fed should keep stimulating the economy until every last man and woman is employed – No No No.

·        The Fed should keep stimulating the economy until inflation rages --- No No No

Our Fed has absolutely no historical or theoretical support for what they are doing today. Can you name a time when the Fed successfully engineered the economy six years after the previous recession? They are freelancing in the worst way. Remember when the Fed chair used to meet with Congress annually and lecture the legislatures about prudent budgets and runaway debt? No longer. The ideal of an independent fiscally responsible Fed is sadly gone. 

Instead today what we have is a Fed that supports the government in its progressive agenda. What they are doing has no support in economics. What they are doing today is everything about progressive ideology. It is a sad precedent for the Fed and for the country. Maybe you haven’t noticed but despite all their so-called good work, the Fed remains skeptical about the economy. Instead they should admit that they are out of their province. Instead, they should be back yelling at Congress to fix what’s really wrong with the economy. They should be restoring more normal interest rates and money. They should leave us alone. 

US Governement: Liars and Thieves?

Mom, I need a bigger allowance. Honey, Pops and I gave you a bigger allowance last week because you said you had to pay off your debt to the cannabis store. I know Mom, but when I went to the store I saw some really cool edibles and now I owe them even more money.

Stupid, eh. But now replace the word Mom with tax-payer and the word Honey with the US Government. President Obama and his cast of stooges make no sense. If we go along with this nonsense then we deserve whatever happens to us in the future. 

Congress is going to give the President a short-term budget with higher military spending and he is going to veto the bill unless they also add more spending on domestic programs – and make all of it permanent. You’d think that we have a deficiency of government spending in this country.

Recall – we have a national debt that soared when the government “rescued” us in the wake of a world financial crisis. Former Fed Chair Bernanke is now making a pot of gold out of a book and book tour giving us his version of what happened when the Fed went arm in arm with our Government during those hairy days. At least someone is getting rich from all this craziness. But I digress. Our national debt (held by the public) went from about $5 trillion in 2007 to $9 trillion in 2010 and then kept on growing. It was almost $13 trillion in 2014. Nice going dudes – you almost tripled the national debt in a mere 7 years. We thought the increase was going to be temporary. Hmm. Read on.

Have you heard the US government moaning and worrying about all that debt? Have you heard the President pointing his finger at Congress demanding that they not imperil our fine land with debt, pointing out all the possible long-term unintended consequences of a major increase in debt? Did the Republican Party engineer a major austerity program? You might think we had such a thing when you hear about budget caps but nothing could be farther from the truth.

Like the kid on cannabis, we are spending more and more and we are getting deeper in debt. You think I am making up stories? Go to the CBO website and you will see that without any of the currently discussed spending additions being proposed, the debt will reach $16 trillion in 2019 and then $20 trillion in 2024. Watch the politicians in coming days…wringing their hands over the horrible austerity we Americans have had to endure. But austerity means falling debt so there is something wrong with this story. 

As you listen to them explain why we need more spending (and taxes) just look at the data below.

Total Federal government spending will increase by 5.3% per year for five years and then by 5.5% per year for the five years after that. Does this sound like an austere budget? Those increases are per year. Imagine if your wage went up 5-6% per year. Starting with $3.5 trillion in 2014 total spending will have risen to $5.7 trillion in 10 years. Poor Poor government. How can they possibly live on an increase of $2.2 trillion?

Point of emphasis – these numbers are estimated by the bipartisan CBO based on spending bills already passed – spending will grow faster if the Ds and Rs and O get together on a deal to spend even more.

Table. CBO Projections for Government Spending based on current budget law. Yearly amounts are in billions of dollars. Changes are percent change per year. 

                         2014   2019  2024  2014   2019

                                                          to        to

                                                       2019   2024

Mandatory       2,099  2,783  3,586    6.5      5.8

Discretionary   1,179  1,222  1,362    0.7      2.3

Net Interest         229     437     710  18.2     12.5

Total                 3,506  4,443  5,657    5.3      5.5

And by the way, your tax bill is not going to go down. This rapid spending has consequences for both higher tax revenues AND a larger debt. The government’s tax revenue will rise from about $3 trillion in 2014 to $4.8 trillion in 2024. In 2024 the government deficit is estimated to be almost $900 billion in that one year alone. Above I explained that the total debt will rise from $13 billion in 2014 to $20 trillion  in 2024. 

I am getting dizzy. Where is the JD when you need it?

Total spending is composed of mandatory, discretionary, and net interest. Mandatory spending is ongoing and determined by past laws. Social Security, Medicare, Medicaid, Obamacare subsidies, disability insurance are the main programs that fall into that category. Notice that Mandatory spending is the biggest part of spending at $2,1 trillion in 2014. It will increase by 6.5% per year for five years and then by 5.8% per year in the remainder of the decade. Does that sound like austerity to you?

Discretionary spending is a smaller component that includes a lot of other things including defense and many non-defense programs. After rising by less than 1% per year for five years it will then increase by 2.3% per year. Program recipients might complain about the rate of growth -- but even these programs are scheduled to grow if past legislation is extended to the future. 

Check out Net Interest which will grow by an average of about 15% per year for the next 10 years. Beginning at a humble $229 billion it will balloon to more than $700 billion in 2024 alone.

Don’t fall for those politicians who scare you by showing you real declines in some heart-rending discretionary programs. They control every line item in the budget. They have already signed off on $800 billion more annual spending on mandatory programs between 2014 and 2019. If they took even a meager $100 billion off that increase, they could add it to Discretionary programs that are most hurt. If they shifted that $100 billion then we would be spending $1322 billion in that category in 2019 and the growth rate in the first five years would jump from 0.7% per year to 2.4% per year.

The long and the short of it is that this government is spending too much of our money on government programs. While it cannot do much to reduce spending on interest, it can address all of our important needs without adding a dime to whatever is already in the pipeline. Don’t be fooled by these jackals. Ask them how a larger national debt is going to expand employment and help the average guy and gal. If they want to spend more on X, then they should spend less on Y. That's their job. We should tell them to do that. 

Loopholes and Loonies

I love it when people use the word "loophole". It sounds so devious. I don't have a loophole but the rest of you big meanies have lots of them. I looked it up and here is what Wikipedia says

A loophole is an ambiguity or inadequacy in a system, such as a law or security, which can be used to circumvent or otherwise avoid the intent, implied or explicitly stated, of the system.

That makes a loophole sounds pretty ominous. And so I found something on the Internet by Redditt when I searched for famous loopholes:

     You can legally drink with your parents anywhere alcohol is served regardless of your age,

     Park your car in your neighbor's property and the company can not repossess your car

     Put a few safety features on your golf cart and you can get the same tax rebate intended for full-fledged electric cars

    You can sue someone who has a liability waiver

These loopholes underscore the negatives of a definition that uses words like inadequacy, circumvent, avoid intent, etc. Kids are not supposed to order a JD on the rocks but apparently a parent can order one and give it to little Nolan at any bar and grill on the planet.  Now that’s a loophole.

So when I hear politicians and  most recently in the WSJ (Wall Street Journal, October 2, 2015, page A13) Alan Blinder infer that tax loopholes are egregious and destroy fairness, it makes me wonder how we could have created such an evil tax system.

So I wondered. I drank a little and wondered a little more. As usual these politicians and their hacks are using inflammatory words trying to fool us stupid voters. So let’s step back a little and figure out where all this is coming from.

Many politicians want to reduce tax rates. Hey Joe – I am going to reduce your tax rate. Gee Mr Congressman, thanks so much. I love you.

When you reduce a tax rate and tax revenues fall, then you have a larger government deficit.  Since we have a really big deficit and we often espouse smaller ones – this creates a conflict for Ms Congressman. But Ms Congressman isn’t a Congressman for lack of verbal verbosity. She fixes the problem by increasing taxes on people who usually won’t vote for him or her.  Cool formula – reduce tax rates on people you like and raise taxes on those you don’t. But even that does not sound good to Mr Congressman who wants a lot of votes. So he doesn’t say he is going to raise taxes – he says he is going to make things fairer and more efficient by reducing tax loopholes. Now that sounds cool to everyone.

That is where the loopholes thing comes into your TV and other news outlets. And here is where the disinformation campaign goes to work. Recall that we have a government. If we are naive we believe that somehow this wonderful government is fair and impacts us all the same. It taxes us each the same and then spends the proceeds on each of us equally.  Ha ha. If you believe that I am willing to sell you the Edgestar wine cooler that died one day after the one-year warranty expired.

Anyway, if you live on planet Earth you know that the government has many reasons why it never treats us equally. And if you were crazy enough to purchase a copy of the US Federal Tax Code you would see there are many reasons why Congress has passed tax and spending laws to favor some groups of people over others. If you are one of those people – perhaps a poor person who receives a disability payment or who uses the earned income tax credit – you would not go down Main Street proudly shouting that you have a tax LOOPHOLE that costs America tax payers about $60 bill per year. 

The dilemma we face at the end of 2015 because Mrs Congressman decided to put budget stuff off until the very end of the year is what to do about a budget in the year before a national Presidential Election. Candidates want to say they want more fairness and efficiency in the tax code and promise you they will close loopholes. But loopholes ain’t loopholes. These “loopholes” are carefully reasoned and voted upon parts of government. Not one of them that matters will be taken lightly. Not one of them can be erased by a Cheshire grin or a loud voice. But alas, these pusillanimous politicians who want to say they are for fairness and small government deficits will not close any real loopholes and of course will not continue to control government spending.

I am not against tax reform and am not against lower tax rates. I simply believe that tax reform and closing loopholes is much harder than it sounds. If politicians were more honest they would more directly say they are looking for ways to raise taxes to offset the loss of revenue that comes when they reduce tax rates. But alas such honesty is not easily found, even after an extended visit by the Pope. 

I end with a list of the largest tax breaks or “loopholes” to show you that this stuff has nothing to do with the Wikipedia definition I cited above. This list of the top 15 and the five year dollar value estimates come from Forbes. The numbers are billions of dollars estimated over five years. Imagine who might not like the removal of any one of these. Imagine the blow back associated with removing any of these so-called loopholes: 

Employee Paid Health Insurance $760

Lower Rate for Capital Gains  $616

State and Local Government deductions $431

Mortgage Interest Deductions $379

Tax-free Medicaid Benefits  $358

Workplace Retirement Benefits $336

Earned Income Tax Credit $326

Childcare Credit $292

Capital Gains Death Exclusions $258

Insurance Exchange Subsidies $238

Charity  $224

Interest on Municipal bonds $217

Employer Paid Benefits $193

Cafeteria Plan Benefits $193

Untaxed Social Security Benefits $180

Perspectives on World Growth

As you know I like JD and I like data. Taken together, they can produce an interesting evening. The challenge with data is that while there is sometimes a wonderful story among the dollar signs and dots, finding it and then explaining it can be an excruciating process. Even if candidates didn’t say idiotic things about international policy, there is plenty of fun rooting through the numbers published about our trading partners. Our friend Mr Trump is going to do unmentionable things to China as he teaches them a lesson or two. I am not sure that Mr Trump understands much about China or he wouldn’t say such things. But this little exercise today is not really about China or Mr Trump. It is about what happened to our world lately and our place in the future.

That’s a lot to promise so let me slim today’s goal down a little. I looked at one economic indicator for 200+ countries. I expect you to memorize those numbers for a 40 year time time period stretching from 1973 to 2013. My calculator says that is about 8,000 data points. Ha ha. Just kidding. After looking at all that data I chose 22 countries and looked at growth during two six year time periods – 2001 to 2007 and from 2007 to 2013. The data comes from the United Nations and unfortunately does not extend into 2014 and 2015. But you gotta do what you gotta do. Right?

I chose to focus on GDP per capita in dollars. Those numbers are pretty simple and straightforward.  Per capita means that we are looking at national output per person. The UN uses standard market exchange rates to convert all foreign GDPs to dollars. These are nominal GDP figures so they have not been adjusted for inflation. You can find several similar versions of GDP to make these kinds of comparisons. I won’t go into all that and admit my results may be influenced by my choices for countries, time periods, exchange rates, price deflator, and of course the color of my wallpaper. My results are not surprising so I will stick with my choice. I invite readers to explain how my choices might have biased my results.

There are a couple of perspectives that come from doing this exercise. First is that emerging markets are very different from their richer trading partners. Much of what we are seeing in 2015 and will see in coming years stems from these differences. China is a prime example. China might have a really big economy today, but the per capita figures show it is the 20^th richest (from among the 22 countries I chose) in terms of output produced per person. In GDP per capita China ranks just above Vietnam and India but below Cuba. Its $6,626 output per person in 2013 is a far cry from the US citizen who earned almost $53,000.

Okay – I hear my friends saying that emerging markets have not matured and much of what gets produced is outside young markets and gets traded in black markets. Thus much of what they produce never gets measured by the UN. But even if that is true, it surely does not explain the huge difference between China and the USA. China has a big GDP because it has 1.4 billion citizens. When you average production over all those people – urban and rural – they are much poorer than Greeks, Argentinians, Russians, Venezuelans, Brazilians, Turks and Mexicans.  So when a politician expects China or any number of developing countries to behave just like the richer countries, they are comparing apples and apple brandy.

As I show below, China has had very dramatic economic growth. Like many other emerging or developing nations, China remains relatively poor but is catching up. They are catching up to the richer countries because they have transformed their economic systems away from inefficient centrally planned and/or autocratically controlled closed systems – to more open and more market-oriented ones. As you can see below, this has worked to produce amazing growth. As you can also see they still have a long way to go to match the income of people in the wealthier nations.

I once used the terminology “low hanging fruit”. Low hanging fruit means that it is sometimes easy to get started and to make gains – but as you move higher up the tree it gets harder and harder. That is the experience of most of these countries. China’s problems today illustrate the low hanging fruit point. For one thing mathematics shows that rapid growth is simply the result of having growth relative to a very low starting point (ie the denominator of a division). A $100 increase in GDP looks huge if your GDP was once $10. It doesn’t look so great if your GDP was $1,000. For another thing it is simply harder to move up the ladder of transformation. If people are used to getting government subsidized bread for 10 cents a loaf – they resist politically when the government removes the subsidy. China has much to change to be truly market-oriented -- but there is great resistance now for every step they take. 

I could go on and one but let’s try to keep you awake with the numbers I promised.

First comes size.

Two countries earned less than $2k per person in 2013 – Vietnam and India. Cuba.

S. Africa and China were under $10k

In 2013 US and Canada led the group of richer countries with around $53k per person. Germany, UK, and France were in the $40ks and Japan, HK and Italy were in the $30ks.

I chose two comparison periods of five years length – 2001 to 2007 and 2007 to 2013.For these two periods I looked at total percent change – not the average annual change.

The early period showed strong growth for most countries. Russia's GDP per person grew by 331%. With triple digit growth in order behind Russia were Turkey, China, Greece, Brazil, India, S. Africa, Spain, Vietnam and S. Korea. 

Mexico, the US, Hong Kong, and Japan grew by less than 40% in those five years.

Argentina contracted by 2%,

Only three of the twenty-two countries picked up the growth pace in the 2007 to 2013 period: Japan, Vietnam, and Argentina. Japan’s growth went from 4% to 13%. Neither number is very impressive. Argentina grew by 7% after decreasing by 2%. Vietnam grew faster than 100% in both time periods.

China grew faster than 150% in both time periods! But then China has made major news since 2013 by growing much slower.

Most countries had slower growth in the past six years compared to the former.  Four countries had negative rates in the latter period – Greece, UK, Spain, and Italy. France grew by only 2% over these six years. The US, Germany, South Africa, South Korea, Mexico, Japan grew by 10-15%. For these latter countries the growth in the second period was at most a third of the growth in the first one. Remember, these are growth rates for the whole period -- not per year. 10-15% nominal GDP growth over five years is not good. 

That’s a lot of food for thought. But the numbers clearly show a few things. First, emerging markets once led the growth parade. Second, they have a very long way to go to catch-up to the richer nations in terms of income. Third, growth in all countries was pretty much smashed by the last global recession. Fourth, voters and citizens around the world feel imperiled by recent economic events and will put a lot of emphasis on growth. This leaves a lot of room for policy mistakes. 

Table Country Comparisons: GDP Percapita

Level in 2013 and Growth Rates 2001-2007 and 

2007 to 2013

2013	01 to 07	07 to13	Country
14,760	-2	75	Argentina
11,199	130	56	Brazil
52,270	87	18	Canada
6,626	157	152	China
38,039	24	25	Hong Kong
6,985	83	35	Cuba
42,339	84	2	France
45,091	76	10	Germany
21,768	133	-24	Greece
1,548	128	49	India
35,243	82	-5	Italy
38,528	4	13	Japan
10,293	39	12	Mexico
26,482	105	12	Republic of Korea
14,680	331	62	Russian Federation
6,936	126	15	South Africa
29,685	116	-10	Spain
10,972	205	18	Turkey
42,423	88	-13	United Kingdom
52,392	29	10	United States
12,213	69	47	Venezuela
1,868	105	128	Viet Nam

Optimism and Confidence: Rocky Balboa for President

Despite friends discouraging him from returning to the ring, Rocky Balboa says “it ain’t about how hard you hit, it’s about how hard you can get hit and keep moving forward and that blaming others won’t help.” There have now been six Rocky movies but the theme is often the same. Rocky shows confidence and optimism in the face of adversity. Imagine if Rocky has not been so confident. Imagine if the football coach at halftime told his team – you guys are really bad and there is absolutely no way you will ever catch up to that other team. Let’s go get a JD.

Sports stories are filled with successful comebacks. So is life. Back luck or poor judgment knocks you down. And then you dust yourself off and get back up and try again. Confidence and optimism are central to that process. Without it, we languish and remain in difficult territory. Even if we get a boost up from an external source – it takes a positive outlook to keep it going.

I think the above is something most of us believe. It is common sense. Without confidence and optimism it is hard to understand how things get done. Imagine thousands of entrepreneurs each day complaining and moaning how they have no chance of succeeding. Imagine scientists and engineers confronting each day pessimistically.

If all the above is common sense, then it makes me wonder why our national policymakers cling to unnecessarily pessimistic scenarios about the US economy. The press says that Bernie Sanders brilliantly outlines the failures of capitalism and the needs for government to save us from a sad economic future. The Fed clings to stories about how the US economy remains so fragile that it could not withstand a 20 basis point increase in interest rates. Recent stories last week reported Census income figures showing how economic performance since the last recession has been stagnant. Hello! All these folks want you to be pessimistic about the US economy.

Why? I don’t know but I can offer up some guesses. Each party wants to blame the other one for the lackluster growth. Each party will out-shout the other in claiming the other has destroyed America. As for the Fed – they want to blame China or Greece or anyone – and pretend that they continue to be the only real hope for the US economy despite a continuing policy that exaggerates imbalances and creates at best substandard growth.

Someone asked me the other day what I would do if I was Janet Yellen. I said I would quit frowning and perhaps wear more red. I would look the camera straight in the eye and explain why we people in the US are the luckiest people on the planet. And then I would recite every good thing about the US economy. And then I would say – I am going to raise interest rates today BECAUSE the US economy is so strong. Yes, the US economy is strong and it can withstand a meager 20-30 basis point increase in rates.

This is the kind of thing Rocky Balboa heard in his head when he stepped into the ring against a very tough opponent. Rocky’s emotions soared and he was confident that he could win. Yes, Yellen can look at the economy and find worrying trends. But surely there are many positive trends that support economic growth and strength.

John Maynard Keynes understood confidence. Keynesian economics grew out of two ideas that had everything to do with confidence. The so-called liquidity trap meant that the Fed was unable to make policy succeed simply because people believed Fed policy would fail. People held on to money instead of spending it. Does that sound familiar? This is why Keynes was so skeptical about using monetary policy.

Keynes preferred Fiscal Policy. He preferred it because of what he called the low value of the marginal efficiency of capital. He said the MEC was low because of external factors that were keeping buyers away from spending. A low MEC meant that firms were unwilling to buy more plant and equipment. They were pessimistic about the future. Keynes believed that a temporary increase in government spending would raise spirits. The government is here to help. In the Great Depression this might have made sense. He believed that a temporary injection of spending by the government would improve the MEC and firms would expand productive capacity, increase employment, and then generate more income and spending.

That was then. Since that time when Keynes believed in optimism about government spending we have had government deficit after government deficit. Government has grown much faster than the economy. We find ourselves in 2015 with a very large government and an even larger government debt with absolutely no plans to reduce it. Today people have come full circle. Today many people get more pessimistic when they hear that the government is coming to the rescue.

There is a very strong macroeconomic case to be made now that says that monetary policy will not work because of the liquidity trap and fiscal policy won’t work because it will have a deleterious impact on the MEC.

We have had a nice half century or more of Keynesian experimentation. While we have people like Paul Krugman and Bernie Sanders who think we need even more of that experimentation, we have a growing number of people who understand that Keynesian policy has become the problem rather than the solution. Lack of success in the years since 2009 created skepticism about even more of the same kind of policies. And that skepticism actually dooms future attempts at monetary and fiscal policies as people just sit on their money.

So where does that leave us? First, the Fed needs to eliminate the liquidity trap. The only way to do that is to mop up all that money they spewed. Second, the government needs to raise the MEC. Today the way to raise the MEC is to create a more positive outlook among large and small firms alike. The government needs to stop perpetuating a myth that says that workers lose when firms gain. Emasculating firms is not the best way to increase jobs and raise wages.  If it was the best way, we would all be living in Cuba and Venezuela. Take that Bernie Sanders! 

Lesson 10 The Value of the Dollar is the Steve Martin of EconoWorld

Steve Martin is a wild and crazy guy. So is the value of the dollar. There is much being said about the value of the dollar of late. So I thought I would look at it a little more.  My conclusion is that it is wild and crazy. That means that undo concern about recent highs in the value of the dollar could be misplaced. Here today gone tomorrow might be apt.  Let’s see what you think.

But first, let’s admit that the value of the dollar is an elusive concept. You have a dollar in your hot little hand. What is its value? In buying a JD, one measly dollar is worth a drip or two. Or a dollar might get you a really large handful of red jelly beans. Point – the value of the dollar depends on what you are buying. When it comes to domestic spending we have something called the Consumer Price Index. We use it to judge how much a dollar will buy in terms of all the goods and services consumers usually buy. No Charlie – it does not include pole dancing.

When the prices of things you usually buy rise quickly you lament that the value of your dollar is going down. When prices fall, you are happy that your dollar stretched further.

The above is all correct but it mostly pertains to spending on domestic goods and services in the US. There is an international aspect of the value of the dollar because in order to buy things abroad, you first have to buy foreign currency. So we talk about the value of the dollar as it relates to buying euros, yens, or loonies. If today I can get more euros or yens or loonies with my pretty green dollar – then today I say that the dollar strengthened – the value increased.

Since we trade with many nations, we are concerned with how the dollar’s value is changing with respect to an average of the currencies of our main trading partners. Those main trading partners include Mexico, Canada, China, the UK, the Bermuda Triangle and more. The Trade Weighted U.S. dollar measures how the dollar is faring against the currency values of our main trading partners.

So let’s call the value of the dollar – TWMTP. If you want to say it out loud – say TwaMooTooPoo. But have at least one JD before you try to say that. Below is what I learned about the value of dollar by looking at the data from 1973 to 2014. In 1973 I was starting my PhD program at UNC and my son Jason was born. But that is a whole other story.

In January of 1973 TWMTP had a value of 108. As of July 2015 it was 92. A lot of JD has gone under the bridge during those 42 years. I will say more about some of those years – but my first point is that at 92 – the dollar fell by about 15%  relative to 1973. So if someone tells you that the dollar is very strong right now you can look her in the eye and say – compared to when Jason was born, the dollar weakened by 15%. No offense meant to Jason. 

There must be more to the story. In April of 2011, TWMTP was 68. That was pretty low. In the past four years the dollar recovered to 92. So you could say --  okay smarty pants the dollar appreciated by 35% in the past four years so the dollar is strengthening. The dollar is clearly high and strengthening during the past four years. This is behavior that has some people bothered. A 35% appreciation seems bad to them – but where is it going to go from here?

Future exchange rates are not easy to predict.  The annual mean change of TWMTP over the last 42 years was -0.4%. If you use the past mean as a predictor of the future, then it says you predict no change next year – or zero percent. In those years since 1973, the dollar increased in 19 years and it decreased 22 times. The annual standard deviation was approximately 6%. That’s pretty wild and crazy. And the range of those annual changes was impressive. TWMTP rose by a high of 10.5% in 1982. It fell the most in 1986 when it depreciated by 18%. Now that is a roller coaster. So if our worry and consternation is about a high and rising value of the dollar in the future – our recent bout of appreciating dollars may or may not have much staying power.

But that isn’t the whole story. Within that 42 year span, there have been some long waves of exchange rate change.  Check out these waves (please don't get sea-sick):

            Jan 1973 to June 1980       -14%

            June 1980 to Feb 1985      +56%

            Feb 1985 to March 1995   -44%

            March 1995 to Jan 2002   +36%

            Jan 2002 to April 2011     -62%

            April 2011 to July 2015    +35%

These long waves of change lasted as long as a decade! Of course during any of these longer time periods the value of the dollar wriggled up and down often.

This background helps us phrase the question about the future. Yes the dollar has increased in value during the last four years. Does that mean we are on a long wave of dollar appreciation? The dollar is 35% higher than in 2011. But notice at 92 it is still well below the 110 that prevailed in January of 2002 and the 108 that existed in 1973. In fact the current reading of 92 is lower than approximately half of the years between 1973 and 2015.

Since the statistics give us little to bet on in the way of future changes in the value of the dollar – that leaves us with theory.  So long as our trading partners struggle and we look like an attractive investment location – it's hard to imagine the dollar falling in value very much. But how long can that continue? Is US policy that good and foreign policy so terrible that global investments will keep flowing to dollars and US investments? It seems not so long ago that the reverse was happening. We were worried that the yuan and the euro would steal the dollar's thunder. 

Lesson 9 US Exports of Goods and Services to the World

I was annoyed by the stock market last week but was unprepared for the Indiana Hoosiers football team giving up 47 points to the Salukis of Southern Illinois. Yes, they did win in the last seconds but even that was mostly the result of divine intervention. So it was not easy choosing a topic for the blog this week.

What I should write about is Cari Ray. I had the outstanding privilege of watching her perform Saturday night after the football game and came away thinking this genius woman must be a combination of Bob Dylan, Janis Joplin, Linda Ronstadt, and possibly Carol King. Her song words make you cry and laugh and her voice is like peppered velvet. Okay I had a JD or two – but if you don’t believe me click on this link and make up your own mind. https://www.reverbnation.com/cariray

Instead I decided to move on to Lesson 9 and exports. I have written on that topic several times usually trying to explain why it is so hard to use trade as a way to grow the economy. The post today follows that tradition and uses recent events to underscore the main lesson. Despite having enough holes to sink a battleship, the US economy is not really the story. Today we cast our eyes offshore to identify the sources of US economic problems. Donald Trump likes to castigate China. According to the Donald, China either cheats or it tries to irritate us by going into a recession. How dare they annoy us by going through a recession! But it isn’t just China. Look the other direction and watch how slowly Europe is growing. How insensitive of them to grow so slowly. And then – while I am on a roll – all those emerging markets have their nerve encountering government corruption and the predicted results of having one-horse (commodity) economies.

Do you get my drift? We wonderful US citizens are being saddled by the rest of the world. Our little Engine that Could is being held back by all those foreigners. This post today is to try to put some of that into a perspective. I focus on one part of the story – the part that seems compelling to many people. These problems in the rest of the world hit us in the USA because we export goods and services to them. We are kind and generous and we sell our pots and pans and ipods and banking services to people in China, Vietnam, and S. Korea. Now they have the audacity to have wounded economies. Never mind that these economic problems cause severe dislocation and poverty in those countries – what we focus on is the audacity they have in buying less from the USA. We cannot use our own errant monetary and fiscal policies to prop up the economies of our trading partners – so we mostly complain, accuse, and advance trade policies (like exchange rate manipulation and free trade agreements) that have a zero chance of being effective in today's global economic environment.

For our lesson today I went to bea.gov and found some US export data. Here are some things I learned. In 2014 US exports of goods and services to the world equaled about $2.3 trillion. Most of it – 69% was goods and the remainder was services (travel, banking, etc). The $2.3 trillion amounted to 13.5% of GDP that year.  Despite slow global growth, that share has generally increased from about 9% in 2002 to more than 13% each year since 2011.  So exports have been a healthy component of the US economy. But while healthy – they are clearly not the dominant force. Spending on domestically produced goods and services (consumer and business goods and services) averages about 70% of GDP (assuming we net out imported goods from domestic sales).

Result – export sales are a relatively small but important and growing part of US sales.

Despite growing faster than GDP, US exports sales to the world have slowed. In the five years between 2009 and 2014, exports of goods and services increased by 47%, slower than the 66% growth between 2002 and 2007 (pre-global recession).

The table below shows the geographical sources of the decline. But first, some facts from the table.

The 29 countries that make up the European Union bought the most of any destination -- $498 billion in 2014.

The largest EU buyers were the UK, Germany, France and Italy – the four of them totaled $273 billion in 2014.

The largest single-country buyers of US products in 2014 were our NAFTA partners. Canada bought $375 billion and Mexico purchased another $241 billion.

China ($167 billion) and Japan ($114 billion) were the next largest buyers of US goods and services followed by Brazil, S. Korea, India and Saudi Arabia. None of the remaining countries bought more than $26 billion goods and services from the US in 2014.

The heavy-weight countries when it comes to buying US goods and services, therefore are Canada, Mexico, China, the UK, Japan, Germany, Brazil, France, and S. Korea.

Finally consider how things have changed. I offer two rates of growth of export sales in the table below. The first number is the percentage change before the world recession – from 2002 to 2007. The second number is after the recession between 2009 to 2014. Both are five year time periods.

These numbers show that growth to these key destinations for US goods in services fell to every destination except for Mexico and Japan. In the earlier time period exports to Mexico rose by 40% only to rise by 78% in the five years from 2009 to 2014. Exports to Japan were basically slow in  both time periods but picked up marginally.

If you want to see the problem areas for US exports, look at the rest of the key destinations. Our biggest trading destination, the EU, was the main culprit with sales growing only 24% between 2009 and 2014 after increasing  by 77% in the earlier time period.

China is an interesting case. While export sales to China grew at a blistering pace of 175% in the earlier period, they were still growing by 91% in the final five years. So China helps explain some of the US export slowdown but it is hard to scold China when they are still buying US goods and services faster than anyone on the chart. At that rate our exports to China would double every five years.

So let’s get real. The rest of the world does not want to grow more slowly. The rest of the world hurts more than we do when they cannot find ways to increase income. Whether it is China or Germany of Canada – there is a little the US can gain by sticking a finger in the eyes of trading partners. Politicians like to simplify. But none of this is simple. Rather, Us policymakers should spend time working on our own real deficiencies. Last week I discussed how our policy makers are out of the traditional bullets but there is much we can do at home. Perhaps we could do better at world trade if we focused on what makes US companies more powerful and competitive.

Table

US Exports in billions of dollars

Numbers in parentheses are five year percentage changes in export sales to each destination (from 2002 to 2007/from 2009 to 2014)

Destination            

United Kingdom     $118              (69/21)        

Germany                     78              (76/14)

France                         51              (41/18)

Italy                            26               (54/23)

Rest of EU                273                  (na)

European Union             $498       (77/24)

Canada                             375       (57/51)

Mexico                             271       (40/78)

China                               167        (175/91)

Japan                               114        (23/26)

Brazil                                 71        (93/78)

S. Korea                             67        (62/56)

India                                   37        (224/43)

Saudi Arabia                      27        (100/57)

            

Lesson 8 Macroeonomic Policy: Out Of Bullets?

Yesterday: General Sir – the enemy keeps coming should we keep firing at them? Yes, Private keep firing. But Sir, I am running low on ammo and most of the enemy intruders are the weak ones carrying no weapons. Private – I said keep firing. You never know when one those weaklings might hit you on the head with a broom stick.

Today: General Sir, I am now out of ammo and a whole new army is coming at me. What should I do? General? Are you there General? What should I do General? Click. Buzz.

When the market fell last week, it became more and more obvious that our policy makers are out of bullets. Which brings up the topic of what we mean by Macroeconomic Policy. So this is another lesson on macro for all you folks who tell me that you only understand one out of seven words in my posts. It is also an opportunity to crow about what  I have been calling jeopardy for years.

My parents never tired of warning me about jeopardy – meaning that today’s decisions can put you in a vulnerable place. My mother would shout, Larry quit playing Party Doll on your Victrola over and over and over. Do your math homework. If you don’t do your math homework you will someday be a horrible guitar player with no source of financial stability.

So I learned the concept of jeopardy at a young age. And that explains why I have been writing for at least five years about how the US Government and the Fed have put the nation at jeopardy. And this also explains why we are now in a very risky economic state because we may be facing tough times ahead and our policy makers are out of policy bullets.

Liberal or conservative, there is room to believe in the efficacy of national macroeconomic policy. But let’s start at the beginning using some questions.

What is macro policy? Macro policy is aimed at making national policy variables approach desired ends. It is not about specific industries or specific companies or specific regions. National policy ends are economic growth, low inflation and unemployment, and so on.

What are the options for macro policy? In most macro courses we teach that there are these four policy areas: Monetary Policy, Demand-side Fiscal Policy, Supply-side Fiscal Policy, and International Trade Policy.

Monetary Policy consists of the Fed managing interest rates and money. Demand-side Fiscal Policy involves the government (Congress and President) implementing policies designed to impact spending in the economy. Supply-side Fiscal Policy is about the government legislating policies that improve incentives to produce goods and services – more efficiently and in greater volumes. International trade policies are not popular in the US but generally involve countries trying to improve their competitiveness so they can sell more goods abroad. These policies include exchange rate manipulation as well as policies like Free Trade Agreements that would make US goods more desired by the rest of the world.

So are we out of policy bullets? If not out of bullets we are getting close to zero balance.

Fed policy is easy to start with. As you know the Fed has spewed a lot of money into the system and lowered interest rates to zero. None of that inspired a strong recovery. The Fed admits to economic weakness every time they explain the economy is too anemic to return to normal policies. So if a future shock weakens the US economy the Fed has little left that it can do. Any new monetary policy that would lead to negative interest rates or new rounds of quantitative easing would signal weakness and would worry world investors. You saw a little bit of that in the stock market last week.

How about Demand-side Fiscal Policy? The story is similar. The US government reacted to the past world economic crisis with huge increases in spending accompanied by policies to reduce tax rates. This was meant to prevent the economy from tanking. 

This activity took us into new territory when it comes to national debt. Without throwing around big numbers let’s just say that the relative size of our nation’s debt more than doubled and so far the debt burden is planned to get even higher in the future. When times improve we are supposed to reduce debt. But that never happened. Now as we approach a possible new economic contraction the government has no room to increase spending and/or reduce taxes. Do we want the national debt to double again? If we do try to use Demand-side Fiscal policy, then this will be taken as a sign of extreme alarm by world investors. We do not want that. I won’t even bring up Greece here. But I think you get my drift. Greece is clearly out of bullets. They don’t even have a slingshot.

How about International Trade Policy? I think we are out of bullets there since problems abroad mean that other countries are not buying much from the rest of the world and definitely are not buying from us. The value of the dollar is rising – not falling. Free trade agreements won’t do much to solve a crisis since the fundamentals mean that foreigners will not be buying more goods from us. They can barely buy goods from themselves.

What a pessimistic picture. Or is it? I left out one type of macro policy – Supply-side Fiscal Policy. Talk about tainted meat! Supply-side policy is an interesting alternative but it is saddled with cuss words like Reaganomics, Trojan Horse, Trickle-Down, and more. Liberals light up and glow when they use these terms. Sort of like when you got mad at your friend in third grade and called him a poopy-head. 

But SSFP -- let's call it that since it is less provocative -- is simple and straight-forward economics. Like bitters -- SSFP is not perfect for every situation but bitters is a necessary ingredient to make an awesome JD Old Fashioned. SSFP does wonders when suppliers of goods and services are reluctant to produce. SSFP attacks disincentives to produce. SSFP looks at things that unnecessarily add to business costs. SSFP is NOT about getting consumers to buy more. But it ends up increasing demand if it promotes firms to compete better and harder. 

SSFP tools are many. The best tool for today comes from examining what is constraining businesses right now. Why aren't firms hiring more workers? Why are firms reluctant to purchase new capital equipment and software? Why are some firms moving their assets abroad? Answer those questions and then use SSFP to remove the impediments. I won't prioritize the answers but clearly there are many areas of policy we can examine including minimum wage increases, environmental regulation, Dodd-Frank banking regulation, Obama-Care impacts on employment, and corporate taxation. 

My liberal friends will scream that we need all those taxes and regulations. Don't interpret me as saying we need to get rid of them. But just acknowledge that if we are truly out of policy bullets, then some small backtracking on these priorities could be very useful in getting this train wreck of any economy back on its rails. As J. Cash would sing -- Look Yonder Coming -- Coming down that railroad track.  It's the SSFP Special bringing my baby back! Humming is permitted. 

Where Have All The Workers Gone? By Guest Blogger Buck Klemkosky

In June 2015, employers added 223,000 jobs and the unemployment rate fell from 5.5% to 5.3% – the lowest rate since April 2008. In July, employers added another 215,000 jobs, but the unemployment rate stayed at 5.3%. Why would adding about the same number of jobs lower the unemployment in June but not July? The primary reason was that 432,000 people dropped out of the labor force in June and a much smaller number in July.

One of the unexplained phenomena of the six-year economic recovery and expansion has been millions of people dropping out of the labor force. The Bureau of Labor Statistics (BLS) has been tracking the labor-force participation rate since 1975. BLS tracks the number of workers eligible to work, including all those 16 years and older who are not in the military and not institutionalized, mostly those in jail or prisons. In July, the BLS reported that 93.8 million Americans were not in the labor force or wanting to be in the labor force as the participation rate was at 62.6%, a 38-year low. There were 58.6 million Americans not in the labor force in 1975 when the BLS began keeping records, 80 million in 2008, 90 million in July 2013 and 93.8 million today.

It is estimated there are 250.9 million in the civilian population 16 years and older, not in the military or in institutions. Of those, 157.1 million participated in the labor force by either holding a job or actively seeking one, of which 148.7 million were employed. This is how the labor participation rate of 62.6% is calculated. At the end of 2007, the participation rate was 67%. If the participation rate was still 67% , there would be 168 million Americans working or seeing work – about 11 million more than today. The question is why aren’t those 11 million working or seeking work?

Part of the question may seem obvious; people are retiring, especially the Baby Boomers, the 75 million born between 1946 and 1964. Every day, about 10,000 Baby Boomers turn 65. While the absolute number of Americans over 65 who have retired has increased, the labor-force participation rate of those 65 or older has actually increased. The participation rate for those ages 55-64 has also increased, driven almost exclusively by the increased labor-force participation of women. Those retiring after age 55 can account for 2-3 million of the 11 million missing workers.

Another logical explanation of the lower labor-force participation rate is the larger number of those aged 16-25 who are in college or training programs. This is part of the Generation Y or Millennial Generation, those born between 1980 and 2000, which is larger in absolute numbers than the Baby Boomers. According to the Organization for Economic Cooperation and Development (OECD), the percentage of the U.S. population in that age group not in education, training or employed has increased from 12% in 2007 to 15% at the end of 2014. So there are more than 1 million younger people who are not working, seeking work or getting an education. They are discouraged about job prospects and have dropped out of the labor force.

The prime working age is 25-54 and that is the core of the U.S. workforce. In July, 77.1% of this group was employed, better than the 75% employed at the bottom of the labor force in 2010. However, it is still 2.8% lower than the 79.9% prime-age employment rate of December 2007. While the Great Recession was harder on prime-age men than women, the recovery rate was better for men than women. Still there are 3% fewer prime-age males working today than in December 2007 and 2.2% fewer prime-age women. While many in the age group are undoubtedly also seeking employment if not working, it appears that this may be more structural than cyclical. In 2000 the employment rate for workers aged 25-54 was 81.6% up from 72.5% in 1982, but has since fallen to 77.1%, so there are several million Americans in the prime working age of 25-54 not working or seeking work.

If college and retirement can’t explain the millions of workers who have dropped out of the labor force, what can? Government programs and incentives can explain part of the missing workers. There are 11 million people in the U.S. who receive Social Security disability benefits today versus 5 million in 2000. While not all of these people are of prime working age, the majority are, so this accounts for many of the workers missing from the labor force. Other programs such as the Affordable Care Act also have provided disincentives to work as insurance is now available to those not working or seeking work. Food stamp recipients are also at an all-time high, 30 million more than in 2000, and some of the missing workers may be subsisting on this entitlement program.

The U.S. was supposed to become a cashless society. But the amount of cash in the U.S. economy has grown to $1.4 trillion today, 2.6 times the amount of cash in the economy in 2000. Cash has grown much faster than either GDP or the population. This suggests a growing underground economy that has evolved to be worth an estimated $2 trillion. Given 120 million households in the U.S., this underground economy works out to more than $16,000 per household. Many workers exist in this $2 trillion cash-based economy and avoid taxation, government regulations or being accounted for in the labor force.

Education, retirement and disability can account for about half of the 11 million potential workers. The other half are missing in action. If not, the unemployment rate would be higher than 5.3%. Adding just part-time workers who want to work full time to the unemployed takes the rate, known as U6, to 10.4%. Adding those who have dropped out of the labor force would take the unemployment rate much higher.

This missing workers phenomenon seems to be basically a U.S. issue. Since 2000, America’s labor-force participation rate has declined more than in any other developed country, even though the U.S. economy has fared better. And the U.S. is one of only three countries out of 38 developed countries with a declining labor-force participation rate. In the longer term it is important to get the participation rate up because growth of real GDP is a function of growth in number of workers and growth in real output per worker. For the decade 2005-2014, the annual growth of the working-age population, 16-64, was only 0.7%. This was one of  the reasons for the subpar economic growth of 1.8% annually in that decade. The BLS forecasts the growth of the working-age population to be 0.4% annually in the 2015-2024 decade. Getting the missing workers back into the economy is essential for U.S. long-term economic growth. If a declining work force is not enough of a problem, productivity growth per worker as well as wage growth are also at multi-year lows. But that is another story.