Hard data beats sentiment in Q1

For the past 3 months there’s been a raging battle between the Atlanta Fed and the New York Fed.  The Atlanta Fed relies mostly on hard data when predicting GDP growth, whereas the New York Fed puts relatively more weight on consumer sentiment.  Republicans became much more optimistic after Trump was elected, so the sentiment indicators pointed to much stronger growth than the hard data indicators.  The following graph shows the huge divergence that developed in recent weeks:

Screen Shot 2017-04-28 at 10.14.15 AMThe actual growth was only 0.7%, which was much closer to the bearish Atlanta Fed’s 0.2%, than the New York’s Fed’s bullish 2.8%.  This reminds me a bit of the post-Brexit vote growth in the UK.

I don’t like either hard data or sentiment; I like market forecasts.  Unfortunately we lack a NGDP futures market (I’m working on setting one up again, and will have an announcement soon), but we do have some market indicators.  The preceding graph and the following quotation were from an April 12 article:

Tying in with the earlier point, the rally in the ten-year bond is consistent with the Atlanta Fed’s forecast for low growth in Q1.

So the bond market seemed to sense that growth was weakening.

Is it too early to attribute any of this to Trump?  I’d say so.  But the Trumpistas all crowed in early February when the strong January jobs report came in.  This was attributed to the magic powers of Trump, despite the fact that he had not even taken office when the January survey was conducted.  I don’t know how they’ll reconcile this GDP report with their dreamy predictions of 4% growth as far as the eye can see, but I’m sure they’ll think of something.

There’s likely to be some bounce back in Q2 (poorly measured seasonality depressed Q1), but I’m sticking with my view that America’s new trend RGDP growth rate is 1.2%, or 1.5% if Trump succeeds in getting his supply-side reforms passed.

PS.  Core PCE is up 2% over the past year, so the Fed is hitting both its price and employment targets.  For the moment, they are fulfilling their dual mandate. That’s a problem for Trump, who needs some Arthur Burns-style recklessness to paper over his personal incompetence when it comes to developing supply-side policy reforms.

Update:  I got the core PCE inflation data from the FT.  Ant1900 points out the true figure is 1.7%, still below target.

PPS.  I have a new post at Econlog explaining job shortages.

Après moi le déluge

Somehow Donald Trump ended up in the White House–an outcome that seemed to surprise even him.  Now he needs to figure out what to do next.  (No, the campaign promises don’t provide any sort of coherent guide.)  Early indications are that Trump will try to implement policies that are popular, at the cost of imposing burdens on future generations (via global warming or massive deficits or a health insurance death spiral or a loss of US foreign policy credibility.)

The Financial Times reports that Trump’s proposed tax cuts would balloon the deficit:

The package would be hugely costly if it ever saw the light of day — suggesting that it was more a mechanism for signalling the direction the administration wants to take, rather than a detailed set of proposals. Estimates from the Committee for a Responsible Federal Budget suggest the measures would cost $5.5tn over a 10-year period, with the corporate tax cut the most expensive measure.

The proposal does contain lots of good ideas, such as eliminating the deductibility of state and local taxes (which would hurt me, but is still a good idea.)  It would also eliminate the AMT and death taxes, both long overdo.  Unfortunately, Trump doesn’t seem willing to pay for any of this.  It’s like someone who wants to eat ice cream and skip the vegetables. Trump seems opposed to cutting government spending, and also opposed to proposals such as eliminating the tax deductibility of health insurance and mortgage interest.  He’s also opposed to the border adjustment tax.

[I also oppose the BAT.  But I’d still prefer the Brady bill, despite that provision, as it at least tries to be deficit neutral.  Even better would be a carbon tax, and/or a higher payroll tax on high wage earners.]

In an optimal fiscal policy, the debt/GDP ratio rises during periods of high unemployment and falls during periods of low unemployment.  Trump’s proposal would cause the debt ratio to rise even in good times, and to soar in recessions. And that’s not even accounting for the looming demographic nightmare of boomers retiring.  This is a deeply irresponsible proposal.  Rather that rejecting the proposal, Congress should keep the good stuff and raise additional funds by closing loopholes.  In addition to the ones mentioned above, I’d close the deduction for interest paid by businesses.  Instead, I expect Congress to oppose even the one good idea, ending the deductibility of S&L taxes.  I hope I’m wrong, but I expect a really bad bill to come out of Congress.

PS.  Trump also wants to slash the tax rate for billionaire property developers (like Trump) from 39.6% to 15%, barely half the rate I have to pay.  Sad!

PPS.  Here are some good articles that I don’t have time to blog on:

1.  Why Europe still needs cash

2.  Why trade deficits aren’t about trade

3.  Why China may be growing faster than the official GDP numbers suggest

How Trump plans to boost the housing industry

Slate.com has an article discussing how Trump’s policies are impacting the housing industry:

Competition for labor in the housing market has been intense for some time, in part because the flow of immigrants from Latin America has decreased and in part because many people who worked in housing during the boom found other work during the bust. But with the government now openly hostile to the presence of these workers, and starting to deport some of them, it is becoming that much harder. . . .

As the Dallas Morning News notes, between 2012 and 2016, wages for Texas construction workers rose 21.2 percent, compared with 12 percent for all construction jobs in the U.S., and 2.2 percent for all jobs in the state. In Collin County, home to Plano and McKinney, construction workers make $98,000. And that was before the new administration began its immigration crackdown. The Dallas-Plano-Irving metropolitan area is short about 18,000 construction workers—about 20 percent of the total. Which means that many homebuilders literally can’t find people to do the job, and the rest must attempt to pass on higher costs to their customers.

. . .  And on Monday, as Commerce Secretary Wilbur Ross dolefully announced the tariffs of 20 percent on Canadian soft lumber, homebuilders were hit with another price increase. . . . The National Association of Home Builders said that Canadian wood prices could rise 6.4 percent as a result, thus boosting the price of the typical new home by $1,236.

There have been barrels of ink spilled discussing the plight of America’s non-college educated men.  As is so often the case, things are far more complicated than they seem.

Speaking of housing, when I was younger the left would sometimes argue that there was something unethical about living in McMansions—too big a carbon footprint.  The new left says that the real villains are those who choose to live in small houses:

According to an article in the “intersectional” blog The Establishment, people who don’t have to live in tiny houses living in tiny houses is a “troubling” example of “poverty appropriation.”

In an article titled “The Troubling Trendiness of Poverty Appropriation,” July Westhale explains that she grew up in poverty in a small immigrant town in California, where she lived in a small house because she had to — and that she’s finding herself getting a little offended by people who are living in small houses because they want to.

“This background, this essential part of who I am, makes it particularly difficult to stomach the latest trend in ‘simple’ living  –  people moving into tiny homes and trailers,” Westhale writes.

Here’s another no-no:

And it’s not just the Tiny House Movement. No, Westhale also has a problem with certain bars and restaurants “appropriat[ing] . . . low income communities” through trailer-park themes and “trashy” menu items such as tater tots.

I relied heavily on a diet of tater tots while in college and grad school. But then I suppose I was poor back then, so it was OK.

PS.  They’re actually not that bad, if dipped in ketchup.

PPS.  Recall when Trumpistas told us that we had to support Trump because Hillary was a left-wing supporter of big government?  Now you see Trumpistas rooting for Le Pen, who makes Hillary seem like Milton Friedman by comparison.  National socialism is back in style.

How bad is the Italian debt situation?

Tyler Cowen recently linked to a John Cochrane post, discussing Larry Kotlikoff’s views on public debt sustainability.  Here’s Cochrane:

(By the way, if you’re feeling superior and taking comfort that Europe will go first off the cliff, Kotlikoff disagrees. Europe’s debts are larger, but their social programs are better funded, so their fiscal gaps are much lower than ours. The winner, it turns out, is Italy with a negative fiscal gap. Answering the obvious question, Kotlikoff offers

“What explains Italy’s negative fiscal gap? The answer is tight projected control of government- paid health expenditures plus two major pension reforms that have reduced future pension benefits by close to 40 percent.”Don’t get sick or old in Italy, but perhaps buying their bonds is not such a bad idea.)

I am a bit skeptical of that claim; so I decided to check with God, er . . . I mean I decided to check with the ultimate arbiter of truth, the asset markets:

Screen Shot 2017-04-24 at 4.13.10 PMAs you can see, Italian 10-year bonds offer considerably higher yields than German, French and Dutch bonds, and even higher yields than Spanish bonds. Italy has a massive public debt (third largest in the world), an economy that has shown almost no growth since 2000, and a very dysfunctional political system (which the voters recently decided not to reform.)

I greatly respect Kotlikoff, and even more so John Cochrane.  But I respect the markets far more than any mere mortal.   So unlike Kotlikoff and Cochrane, I remain relatively pessimistic about the Italian debt situation.

PS.  I am back from 5 days in Turks and Caicos (is there a law in the Caribbean mandating nothing but Bob Marley music at resorts?), and I am starting to get caught up.

I have a new post on Bretton Woods as an example of the guardrails approach to policy, and another post commenting on the French elections.

My guardrails post is intended to address tiresome criticism of NGDP targeting by people who have never bothered to actually read what I have written on the topic. No, neither the current lack of interest in NGDP futures trading nor the risk of market manipulation pose any kind of problem for the system I am actually advocating.  (Unless you believe, “Bretton Woods could not possibly have worked because speculators would have manipulated the market.”)

Most shocks don’t matter

Over the past 18 months we’ve seen three major shocks, each of which were expected to have a significant impact on growth:

1.  The late 2015 Chinese yuan devaluation/capital outflow shock

2.  Brexit

3.  The Trump election

Many people expected the Chinese economy to slow sharply in 2016.  It didn’t.

Many people expected the UK economy to slow sharply after mid-2016.  It didn’t.

Many people expected growth and inflation to rise significantly after Trump was elected.

The third prediction still might come true, but this FT article suggests that investors are moving away from the “reflation” trade.

We are nearing the anniversary of a great market turning point. Like most such turning points, it was not obvious as such at the time, but in early July last year markets reached the lowest point of their fear of deflation — falling prices amid a stagnating economy — and started to position for reflation.

The shock of last summer’s Brexit referendum brought bond yields, the market’s most direct expression of its belief in deflation, to a historic low. The rebound started as the effects of China’s economic stimulus were felt, while it grew clear that Brexit had not sparked a financial crisis.

It gathered momentum after Donald Trump’s victory in the US presidential election. The theory was that the Trump administration would pick up the baton from China, which looks over-leveraged and will soon need to ease off its stimulus, and would bring in its own growth-friendly policies, including tax cuts and infrastructure spending. From “reflation off”, we moved emphatically to “reflation on”.

Stock markets have risen this year, but 2017 has seen a gradual shift back to “deflation-off”. Short-term inflation expectations have moved sharply in recent weeks. The bond market’s implicit forecast for US inflation over the next two years, once at 2.15 per cent, has dropped to 1.35 per cent.

In each case I expected some effect, but less than the consensus.  In the case of China and Brexit, even the very mild slowdowns I predicted proved too bearish. I’ve learned my lesson from Brexit, and in the future will pay no attention to “uncertainty shocks”.  Always a skeptic, I am now convinced that uncertainty has virtually no significant business cycle effects.  And never bet against Chinese growth. Someday it will falter, but no one can predict when.

[In macro, the forecast most likely to be true is, “Not much will change”.  However the way to build a reputation is to forecast dramatic changes.  You will usually be wrong, but the public will forget those mistakes and give you undeserved praise on the few occasions when you are correct.]

I’m sticking with my prediction that Trump’s policies might lead to a couple tenths of a percent faster NGDP growth.  Monetary offset will keep inflation close to 2%, and Trump’s supply-side reforms are likely to be modest (at best).  An extra couple of tenths of one percent NGDP growth is so small it will be almost impossible to tell if I am correct—especially given that growth is likely to slow as we approach full employment.  If there is a recession, however, or 5%-6% NGDP growth persisting for a few years, then I will clearly be wrong.

Maybe the French will give us another shock later today.

PS.  I still believe that Brexit itself will reduce UK growth.  This post discusses the effect of pre-Brexit uncertainty, not Brexit itself, which is still years away.

PPS.  I believe the US should withdraw from the IMF.  Not because the IMF is not good enough for the US, rather because America is not good enough for the IMF. If we don’t leave, I hope the other IMF members expel us:

Finance ministers and central bankers from around the world have dropped a pledge to resist protectionism, in a further sign that the new US administration’s stance on trade is shifting the global debate.

The group from International Monetary Fund member countries issued a statement on Saturday saying they would “promote a level playing field in international trade” but did not reiterate a previous commitment to “resist all forms of protectionism”.

The change of stance mirrors a similar move made by the finance ministers and central bank governors of the G20 countries after they met in Baden-Baden in March. On that occasion, the US was unwilling to endorse forthright language on protectionism.