Archive for June 2016


Trump: Even worse than we thought

Over the past year, I’ve been stunned to discover that Trump seems to have absolutely no redeeming qualities.  Even Nixon was intelligent.  Herbert Hoover was a highly competent manager.  Trump seems to be bad in just about every way a person can be judged:

1.  Pathological liar.

2.  Utterly ignorant of policy issues.

3.  Wrong on most policy issues.

3.  Bigoted and sexist.

4.  Highly vindictive.

5.  Distrusts expertise.

6.  Obnoxious personality.

7.  Has no taste.

Now we find that things are even worse than we imagined.  Surely a New York businessman who made lots of money in real estate must at least be a good manager.  Nope, he’s perhaps the worst manager ever to run for President of the United States.  Here’s The Economist:

THROUGHOUT the presidential primary contest, Donald Trump’s claim to be self-funding his campaign always drew loud cheers. Part boast—“I’m like, really rich” he would smirk—and part a badge of incorruptibility, the claim allowed the property developer to paint all his Republican rivals as puppets of special interests. Voters at campaign rallies would reliably cite his supposedly vast wealth, and the independence it brought, as one of their biggest reasons for trusting the businessman.

Loyal Trump supporters forgave their champion when he secured the nomination and abruptly changed his tune, boasting in early May that he would create a “world-class finance organisation” to solicit donors and fill war chests for himself and for the Republican Party. The same Trump loyalists will doubtless shrug off headlines that greeted the release of campaign-finance reports for the month of May, showing that he raised just $3.1m from donors and has just $1.3m cash on hand—sums dwarfed by Mrs Clinton’s campaign, which raised over $26m in May and started June with $42.5m in cash on hand. Mr Trump himself sounded defiant, asserting that he could spend “unlimited” sums of his own money if needs be.

That’s a mindbogglingly poor performance for a Presidential candidate, it’s what you’d expect of a Congressional candidate. And a substantial portion of the funds raised are used not to promote his campaign, but rather to enrich his own businesses, such as “Mar-a-Lago”:

Screen Shot 2016-06-26 at 10.21.12 AM

So he’s also corrupt.  Fundraising is one of the first cases where we’ve been able to judge Trump’s ability to get things done.  And he failed miserably.  In retrospect, this should not have been a surprise.  Contrary to widespread opinion, Trump has not had a successful business career, rather he’s been really lucky.  First he inherited $40 million from his dad, back in the 1970s.  If he’d just put the money into an index fund he would have done about as well as he’s actually done.  (We don’t know exactly how rich he is, and he won’t provide adequate documentation.)

But it’s even worse than that.  In the 1970s, the New York economy was a mess, and most people were very pessimistic about the city’s future.  In the decades since, New York has boomed and its property market has done far better than anyone dreamed possible during the 1970s.  An aggressive property speculator with a fortune to work with, and a willingness to be so leveraged that his businesses would endure occasional bankruptcies, should have massively outperformed the S&P500 during New York’s boom years.  He should be “really, really rich”, but he isn’t.  Which is why he’s raising money from suckers and using the funds to augment his personal wealth.

In Scotland, we saw another example of his appalling incompetence.  He claims to be the sort of nationalist that will “put America first” but he doesn’t even know how to do that:

Had he been in touch with his foreign policy advisers about the Brexit vote and its impact on the United States? “I speak to foreign policy advisers all the time. But the advice has to come from me,” Trump said. But, he added, what good were foreign policy advisers anyway? “What have these policy advisers done for us? Other than get big fees? It’s an embarrassment. The whole world is a mess. These people don’t have it. Honestly, most of them are no good.”

When informed that this vote had caused a sharp drop in global asset prices, he denied the obvious:

Though his staff had said he just wanted to talk golf, Trump quickly disregarded that edict, reaffirming his praise for the British vote to exit the European Union. Asked about the turmoil it has caused in the global financial markets, Trump replied that it was “too bad” but downplayed the role the so-called Brexit decision had played in riling the American stock market. He suggested there were larger factors involved. “A lot of bad decisions, a lot of bad things happening in this world,” Trump said.

Repeatedly pressed on what he would say to Americans worried about their retirement accounts, Trump straightened his white “Make America Great Again” hat, which had come loose atop his head. “Americans are very much different. This shouldn’t even affect them,” he replied.

Yes, that’s right.  There are lots of “bad things” happening in the world, which cause the S&P500 futures to plunge by more than 5% during a few minutes very late on a Thursday evening, at the exact same moment as the Betfair probability of Brexit suddenly soared from low numbers to near 100%.  Trump doesn’t need “experts” to tell him how the UK decision will damage the retirement accounts of Americans (like me), he already knows all this by himself.  He’s an expert on Brexit, despite the fact that he had no view on the issue just a few weeks earlier:

Asked if he thought Britain would be better of if it left, he said: “I don’t know, you’d have to ask them. I just think they may leave.”

Trump’s not even a competent nationalist.  When there is a conflict between the best interests of the US, and the nationalist faction of another country, he sides with the other country.  Trump certainly won’t make America’s retirement accounts great again, unless he starts standing up for America’s interests, not the Brits.  At least Obama stood up for the USA.

Even more ridiculous, he thought the Scots voted for Brexit:

Just arrived in Scotland. Place is going wild over the vote. They took their country back, just like we will take America back. No games!

Earth to Trump, Scotland voted 62% against Brexit, and may well leave the UK due to this decision, which means Britain will no longer be “Great”. What does he think about that?

Make sure you follow the right crowd

Over at Econlog, I have a post explaining why Brexit is not about Britain.  That’s clearly not the conventional view, if you read the pundits.  Philo asked this question:

Scott, you really do think for yourself, rather than just following the crowd–for example, the crowd of economists. (That means you are a genius or–somewhat more likely–a crank.) All the more surprising, then, that, in some of your epistemological posts, you advise *us*, your readers, to *follow the crowd*!

The best way for me to explain this issue is to point to those European stock markets that fell by 3 times as much as British stocks.  The French and German markets were down around 7% or 8%, while the southern markets fell even more sharply. In contrast, the British market was only down 2.75%.  This has been called the biggest day in British history since WWII, but it’s probably not that big a deal for the UK economy.

So yes, pay attention to the crowd, but make sure it’s the crowd who puts their money where their mouth is.  That would be the asset markets, plus Bryan Caplan.

I’m also seeing a lot of confusion about the nature of uncertainty.  Unlikely things happen every day; it’s no big deal.  Every time the Dow moves more than 1% in a day, that’s an unlikely event.  A couple weeks ago, Cleveland was down 3-1, and had about a 5% chance of winning it all.  They did.  So when something with a 25% chance occurs, it’s no big deal.  One in every 4 elections sees an upset of that magnitude.

Let’s think about what the markets are telling us.  In my view the 7% or 8% fall in European stocks should be viewed as a 20% chance of a catastrophic eurozone breakup as a result of Brexit (as compared to the previous probability) in which case markets might plunge 30%, and an 80% chance that this crisis will be papered over, as previous Greek crises were papered over, and markets recover. I think this confuses people, as the 7% or 8% fall is almost certain to be “wrong”, ex post.  Either stocks should have fallen 30%, or almost not at all.

Those who see Brexit as a “real shock” that disrupts British trade are missing the big picture.  (Here I agree with Krugman; changes in trade rules at the margin are not of much macroeconomic significance, although they are certainly unwelcome if protectionist.)  The conventional pundits who focus on Britain have no explanation for the stock market figures I cited, and probably attribute it to “irrationality”, or “fear”.  It much simpler than that—the eurozone is a dysfunction monetary regime, and the UK pound is not.   (I suspect that’s why the Japanese market fell sharply—the BOJ is an increasingly dysfunctional institution, which has recently seemed to give up on its goal of 2% inflation.)

I know that we like certainty, but the truth is that we just don’t know what will happen.  We don’t even know whether Britain will leave the EU.  I think it will, but I’d guess there’s at least a 25% chance that Scotland won’t, and at least a 5% chance that the negotiations about how to do so will drag on for several years, by which times the voters will be asked once again.  The young favored staying by a 3 to 1 margin, so time is on the side of those Brits who favor a cosmopolitan UK. Every day another Little Englander dies off, and another pro-EU Brit turns 18. Recall that in Europe, every time the voters of a country voted the “wrong way” on an EU referendum, they were asked to re-vote until they “got it right”.  Again, I think Britain will leave, but nothing is certain in the world of politics (as I learned when I said Trump had no chance of getting the nomination.)

Here’s the wisest way to view market forecasts:

1.  Market reactions will almost always later be shown to have been “wrong”.  But which way?

2.  Nonetheless, market forecasts are the best read we have on the implications of any shock, including Brexit.

PS.  If you believe the claims I made in my earlier “You’re not special” post, then objectively speaking it’s more likely that I’m a crank than a genius.  Keep that in mind, and read all my posts with a very skeptical eye.

PPS.  Those who claim that Britain may have done the rest of the world a favor by providing a cautionary tale for a withdrawal from globalization better take another look at those stock markets.  There are cautionary tales of illiberalism out there, like Venezuela, but don’t assume the UK will become one of them.

Risk off

At this point (midnight) the global economy has been hit by a negative monetary shock, one of the biggest in years.  Here’s what to watch tomorrow:

1. Does the crisis show signs of spreading to the PIIGS?

2.  What do the world’s central banks do, especially the ECB and the BOJ?

Janet Yellen has to be really, really happy that they got a bad jobs number and didn’t move in June, as a rate increase in June combined with this would have been a huge shock to the global economy.  If I read the fed funds futures correctly, they are now forecasting low rates for essentially forever.  T-bond prices must be soaring.  David Beckworth says we are a monetary superpower—well we are now a lot more super than even 3 hours ago.

I’d emphasize that this is an almost purely a monetary shock—in real terms it makes little difference whether the UK is in or out of the EU (especially in places like the US and Japan).  It’s monetary.  That means the ultimate effect depends ENTIRELY on how the central banks react.  Do they show imagination and leadership, or . . . do they keep acting the way they’ve been acting since 2007.  We won’t have to wait long for an answer.  (Obviously the markets believe that the central banks will not rise to the occasion.)

The odds of a global recession in 2017 just increased, by at least a few percentage points (albeit still less than 50-50).  I think this also makes it slightly more likely that Trump will win, although he’s clearly still the underdog.  We saw the second straight example in the UK of the right outperforming the polls–ironically this one will probably cost Cameron his job.

Because it was possible to watch markets move as Betfair prices change, we can see that the vote represented a 120 point swing on the S&P 500, which is almost 6% (as compared to a definite remain vote—say 2010 vs. 2130 on the S&P).

Can’t wait for tomorrow!  Lots of excitement ahead.


Demystifying NeoFisherism

James Bullard has a new paper out discussing the NeoFisherian perspective on interest rates.  According to the NeoFisherian view, holding interest rates at a low level for a long period of time will lead to persistently low inflation rates. That’s because (according to the Fisher effect) nominal interest rates tend to be correlated with inflation rates, at least in the long run.

James Bullard says he used to hold the opposite view:

Indeed, during the past six years I have warned, along with many others, that the Committee’s ZIRP has put the U.S. economy at considerable risk of future inflation. In fact, my monetarist background urges me to continue to make this warning right now!

Actually, Milton Friedman would have been dismissive of that view:

Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy.

Instead, the view that Bullard attributes to monetarists is actually the Keynesian/Austrian view.  It’s Keynesians and Austrians who reason from a price change.  They are the ones who insist that low interest rates are expansionary.

The NeoFisherians had a perfect opportunity to fix this flaw in macroeconomics, but instead fell into the trap of making exactly the opposite mistake.  NeoFisherism is also an exercise in reasoning from a price change, but in their case they assume that low rates are disinflationary, not inflationary.  That is, they assume that low rates are tight money, whereas Keynesians and Austrians tend to assume it’s easy money.  It’s neither.

If the NeoFisherians are going to make any headway convincing outsiders, then need to do two things that Bullard failed to do in his paper:

1.  Discuss the Keynesian/Austrian/Monetarist view of the liquidity effect.  Why have central bankers assumed for decades, even for hundreds of years, that lower rates are expansionary?  Are they really that delusional?  There are literally 100s of natural experiments where central banks adjusted interest rates unexpectedly.  In each case we can observe the market reactions. How do exchange rates react? How do commodity prices react? How do TIPS spreads react? The Bullard paper, and other papers I’ve seen on NeoFisherism, simply glosses over these key questions. But these are exactly the questions that skeptics would want answered.

2.  NeoFisherians need to provide a plausible example of a shift toward lower rates leading to a lower inflation environment.  The example provided by Bullard is not at all persuasive, for reasons outlined by Ryan Avent:

Where I think Mr Bullard begins to go off course is in treating the Fed’s behaviour like a zero-interest-rate peg. Yes, interest rates have been below 0.5% for nearly eight years, and the Fed has consistently promised to raise rates gradually. But it has promised to raise rates gradually, which is not the sort of thing a zero-rate targeting central bank would do. More importantly, markets have believed that the Fed would raise rates. When the fed fund futures contract for July 2016 began trading back in 2013, markets reckoned that the interest rate set at the July meeting would be in the neighbourhood of 1.5% to 2%. That was in line with the dots published by the Fed at the time. The Fed told markets that rates were going up, and markets saw no reason to disbelieve.

As it turned out, both markets and the Fed were far too optimistic; over time the expected path of rate hikes has been both pushed forward into the future and it has flattened. Markets now think that the fed fund rate will be no higher than 1% three years hence. Maybe this shift has occurred because the Fed has signalled more strongly that it is pursuing a zero-rate peg, but I doubt it; in every published projection since 2013, the dots have continued to rise up to some “normal” rate well above zero.

I would argue that Mr Bullard is wrong; it is not the case that the Fed is choosing low rates and inflation expectations are therefore converging toward a low level. I would argue that the Fed has been targeting very low inflation, and falling inflation expectations imply much lower interest rates in future.

This dynamic is there back in 2013. In its projections the Fed indicates that rates will rise steadily, even as it projects that inflation will be extraordinarily low, just over 1% in 2013, converging, finally, toward 2% by the end of 2015. Essentially every set of Fed projections since then has shown the same thing. It allowed its QE programmes to end despite too-low inflation, and it raise its interest rate in December despite too-low inflation. The Fed has signalled very strongly that markets should expect inflation to remain at very low levels, indeed, below target. It would be shocking if inflation expectations hadn’t trended inevitably downward.

Now return to the Fisher equation. If the global real interest rate is in the neighbourhood of 0% and expected inflation is in the neighbourhood of 1%, that suggests the Fed will have an extremely difficult time raising nominal interest rates beyond 1%. Mr Bullard has the regime right, but the causation wrong. The Fed has driven the economy into this rut in its determination to keep inflation low.

I agree with Ryan Avent, except that last part about the difficulty the Fed would have in raising inflation.

In fact, there is a good example of NeoFisherian in action, which occurred just last year.  As we will see, it is consistent with my previously expressed interpretation of NeoFisherism, and not consistent with the views of either NeoFisherians, or anti-NeoFisherians.  The truth is orthogonal to the debate.  Both sides are missing the point.  Whether low rates are expansionary or contractionary depends entirely on whether they are achieved via an expansionary or a contractionary monetary policy.

It recently occurred to me that Switzerland circa January 2015 is an almost perfect example of NeoFisherianism is action.   In previous posts I argued that the perfect NeoFisherian policy had two parts:

1.  A promise to gradually appreciate the currency against a major currency, which would reduce interest rates via the Interest Parity Theorem.

2.  A simultaneous once and for all large appreciation in the currency, which would exert a contractionary impact on prices that was large enough to prevent an immediate rise in the price level from the lower interest rates caused by step #1.

So step #1 reduces long run inflation via the PPP effect, and step #2 prevents Dornbusch-style overshooting in the short run.  The Swiss didn’t announce precisely this policy, but the policy they did announce was virtually identical in all meaningful respects—and it had exactly the effect predicted by the NeoFisherians (but not for the reasons they assume).  Here’s what Switzerland did to interest rates in January 2015:

Screen Shot 2016-06-22 at 4.50.53 PMNotice that interest rates fell from 1/8% to negative 3/4%, almost immediately. Because of interest parity, that created an expectation that the Swiss franc would gradually appreciate over time, which leads investors to expect lower trend inflation in Switzerland, compared to neighboring countries.

But how did the Swiss authorities make sure this decrease in interest rates had a contractionary impact?  The answer is simple; they did a simultaneous, once and for all, massive appreciation in the SF.  Not a formal appreciation through government fiat, but rather by switching from artificial peg of 1.2 SF to the euro, to a floating exchange rate.  The market (correctly) took this as a signal of tighter money, and the SF promptly rose by about 10% to 15% against the euro.  But they could have achieved the same effect by simply revaluing the SF upward by the same amount, by fiat.

The upshot of all this activity was a sharp decline in Swiss inflation:

Screen Shot 2016-06-22 at 6.23.45 PMA skeptic might argue that inflation fell for some other reason, say falling oil prices. That might be part of it, but on the very day the new policy was announced, I recall people predicting slower RGDP growth and lower inflation, and they were correct.  I’m confident that if a Swiss CPI futures market had existed, then CPI futures would have declined on this policy change.

So the Swiss got exactly the result predicted by the NeoFisherians.  A Keynesian skeptic will say; “Yes, both interest rates and inflation fell, but the lower interest rates did not actually cause the lower inflation.  Indeed ceteris paribus the lower interest rates raised inflation, but the sharp appreciation of the SF put even more downward pressure on inflation.”

The problem with this argument is that whenever market interest rates decline, things are never ceteris paribus.  Let’s take the standard Keynesian interpretation of an open market purchase.  Say the Fed unexpectedly increases the monetary base by 2%, and this causes nominal interest rates to decline.  Is the policy inflationary?  Probably yes, but not for the reason that Keynesians assume.  Other things equal, the lower interest rates will tend to lower velocity, and hence will tend to lower inflation.  More than 100% of the heavy lifting for higher NGDP comes from the 2% increase in the base, and less than 0% comes from the lower interest rates.

The preceding point isn’t even controversial; it’s part of the standard monetary economics 101 literature.  But macro has moved so far in an interest rate oriented direction that many people have forgotten these basic truths, or else they never even learned them.  Blame Woodford if you wish.  I blame almost the entire profession.  In any case, yes, it’s actually the appreciation of the SF, not the lower interest rates, which causes lower inflation.  But it’s also true that it’s the increase in the money supply, not the lower interest rates, that cause higher inflation in the standard Keynesian policy case.

Some will complain that my example only works in the special case of exchange rate manipulation, and that NeoFisherism does not work in a closed economy.  Not so. Instead of a sudden appreciation of the SF, the Swiss could have achieved the same contractionary result by combining lower interest rates with:

1.  Lower official gold prices (A reverse of FDR’s 1933 technique).

2.  A promise to increase the money supply at a slower rate, from now until the end of time.

3.  A lower price of NGDP futures contracts (which would first have to be created.)

4.  Appointing a crazy hawk like Bob Murphy to be head of the SNB.

Basically, you need to combine a lower interest rate with something else that creates the expectation of tighter money going forward.

It’s not a question of whether the Keynesians or the NeoFisherians are right—I don’t agree with either group.  It’s a question of which types of monetary policy shocks produce which results.  I see three interesting cases:

1.  The Keynesian case:  In this case, an easy money policy causes a reduction in both short and long-term interest rates.  Inflation tends to rise.

2.  The NeoFisherian case:  In this case, a tight money policy causes a fall in short and long-term interest rates.  Inflation tends to fall.

3.  The Monetarist case:  In this case, an easy money policy causes short-term rates to fall and long-term rates to rise.  Inflation tends to rise.

As soon as you are able to visualize the monetarist case as being a hybrid Keynesian/NeoFisherian case, you know you are on the right track. If you see the monetarist case as being short run Keynesian and long run NeoFisherian, then you “get it.” If not, reread the post.

PS.  I’ve already indicated that January 2015 in Switzerland was a NeoFisherian case.  I’d add that the January 2001, September 2007 and December 2007 Fed FOMC policy announcements were all Monetarist cases.  Short and long rates moved in opposite directions. There are also lots of Keynesian examples, but I can’t recall one at the moment.

PPS.  I’ve simplified things by assuming that central banks normal lower rates by open market purchases, that is, an increase in the base.  They can also reduce market interest rates by lowering the tax on bank reserves, i.e. by lowering IOR. Nothing important changes in this case, but it’s even harder to see the irrelevancy of interest rates when monetary policy shifts from base supply control to base demand control.

PPPS.  I may turn this post into a paper, so I’d appreciate any serious feedback.

Long run NGDP growth and long term nominal interest rates

If you had to write down a simple model of long-term nominal interest rates, you might start with long run expected NGDP growth, although as we’ll see it’s actually a lot more complicated.  Here are some recent data on NGDP growth over the past 8 years, and 10-year bond yields:

Country   NGDP growth rate   10-year yield

USA               2.75%                1.69%

Eurozone        1.17%                0.05%  (German)

Britain           2.41%                 1.28%

Japan           -0.21%                -0.15%

Australia        4.15%                 2.15%

In the first three cases, bond yields are a bit over 1% below long-term NGDP growth.  If we applied that to Japan, you’d expect negative 1.25% bond yields.  Why are actual rates so much higher (less negative) in Japan?

1.  Perhaps the zero lower bound prevents deeply negative nominal rates.  This is the best argument for Abenomics–the Japanese Treasury has been paying excessive interest on its debt.  They need at least Eurozone levels of NGDP growth, to get equilibrium bond yields up to zero.

2.  Perhaps rates are not lower because NGDP growth has recently established a higher trend, under Abenomics.  Bond yields are a forward-looking variable.

3.  Perhaps what matters is NGDP/person growth, not NGDP growth.  Thus Texas and Illinois have the same risk free rate, even though Texas’s population (and NGDP) are probably growing about 2 percentage points faster than Illinois.  Japan has a falling population, and hence growth in its NGDP per person is closer to European levels.

I’d guess all three factors matter, and others as well.

Australia is sort of the opposite of Japan.  In Australia, NGDP growth has recently slowed, not accelerated.  And they have faster than average population growth.  Those factors might help to explain why nominal bond yields are 2 percentage points behind NGDP growth.

Even so, there’s a very strong correlation between long run NGDP growth and long term interest rates.  It’s up to each central bank to determine the long run NGDP growth rate, and by implication the long-term bond yield.  If you want higher interest rates, ask for easier money.

PS.  A few corrections on recent posts:

1.  Commenter BJ Terry pointed out that in my recent Bullard post I misunderstood they way he used the term ‘regime’. I thought Bullard meant policy regime, but after reading his paper it’s clear he means macroeconomic regime (expansion or contraction).

2.  When I wrote the recent post on the Modi government, I was unaware of a decision to liberalize foreign investment regulations, which was announced yesterday. I hope my post was wrong.