Archive for September 2015


China’s retail boom

In my view many pundits are excessively pessimistic about the Chinese economy, focusing too much on the weakness in heavy industry and exports. Offsetting that weakness is booming growth in retail sales, as Chinese incomes rise very rapidly. BTW, if China really is doing so poorly, then precisely WHY are Chinese incomes growing so rapidly?  There are possible answers — fast rising unemployment or fast rising inflation — but I see no evidence of either.  Here’s a recent report from Forbes:

Beijing’s National Bureau of Statistics reported that retail sales in China jumped 10.8% in August compared to the same month last year. That was substantially better than every consensus estimate. Analysts had predicted sales would come in at 10.5%, the same increase as July’s.

Most observers are bullish about consumption as the next driver of the Chinese economy. The dominant narrative tells us China is in a transition from investment-led growth to growth propelled by consumer spending. The oft-cited Andy Rothman, now at Matthews Asia, calls the country “the world’s best consumption story.”

The evidence supporting that proposition looks compelling. Apple, from the first indications of a few hours ago, immediately sold out its iPhone 6S and iPhone 6S Plus in China. Express parcel deliveries were up 47% in July compared to the same month in 2014. Box office revenues? For the first eight months of this year, theyskyrocketed 48.5% from the corresponding period last year.

Consumption contributed 50.2% of growth of gross domestic product in 2014. In the first half of this year, it accounted for 60.0% of GDP.

In recent years it has become trendy in China to buy goods online.  Alibaba is by far the largest online retailer, so I thought I’d take a look at its numbers:

Screen Shot 2015-09-15 at 8.50.45 AMThat graph is a bit misleading for two reasons.   First, the latest figures are actually 2015:2, not 2016:1 (their fiscal year ends in March.)  And second, growth is expected to slow modestly in Q3 due to the stock market plunge.  But clearly the trend is very strong, and other online retailers show the same pattern:

Three Chinese Internet companies””Alibaba, Tencent Holdings Ltd. and Baidu Inc.””are now among the world’s largest in market capitalization. The industry’s rise has come even as China’s economic growth has slowed from its double-digit pace of a decade ago.

Some other competitors are expressing caution, though many are signaling still-strong growth. Executives at Alibaba rival Inc. said last month that they expect third-quarter revenue growth of between 49% and 54%””compared with a year-earlier 61%””reflecting a “conservative outlook in light of the recent Chinese stock-market correction and the slowing macroeconomic conditions.”

Of course just as in America, some of this growth is coming at the expense of brick and mortar firms, and there are indications that sales are flat for many ordinary retailers.  But don’t underestimate the importance of online; Alibaba alone now sells more than $100 billion dollars per quarter.  If we assume the entire online sector is around $150 billion per quarter, then growth in that sector (year-over-year) is probably on the order of $50 billion per quarter, or $200 billion per year. Thus online growth alone can explain about half of the growth in China’s $4 trillion retail sector.

This relatively sunny view of Chinese retailing is one argument in favor of the Fed raising rates in September, although on balance I still think that would be a mistake.  (Of course if China were actually sliding into recession, a rate increase now would be a mistake of epic proportions.)  I strongly agree with Ray Dalio’s recent take:

Ray Dalio, the founder of the world’s largest hedge fund Bridgewater Associates, said the firm believes the next big move by the Federal Reserve will be to loosen U.S. monetary policy, not tighten it.

In a client note sent out on Monday, Dalio said the Fed is paying too much attention to the short-term ups and downs of the business cycle rather than the longer-term ramifications of central banks driving interest rates to zero, which now leaves them no room to act if worldwide deflation takes hold.

“The ability of central banks to ease is limited, at a time when the risks are more on the downside than the upside and most people have a dangerous long bias,” said Dalio, who helps manage $162 billion at Bridgewater. “Said differently, the risks of the world being at or near the end of its long-term debt cycle are significant.”

.  .  .

Dalio said the Fed has overemphasized the importance of the cyclical short-term business cycle in its desire to raise rates, but has been less attentive to the longer-term trend toward deflation.

He said the Fed will react “to what happens,” suggesting it should undertake more quantitative easing, or QE, but he isn’t positive of that, given Fed officials’ desire to raise rates.

Dalio warns of global disinflation, slow global economic growth, and the lingering risk aversion that is behind the proclivity to hold cash despite its significant negative real returns.

“Our risk is that they could be so committed to their highly advertised tightening path that it will be difficult for them to change to a significantly easier path if that should be required,” Dalio said.

That final comment is especially important.  This was precisely the mistake the Fed made in mid-2008, when many at the Fed assumed their next move would be higher.  It was really hard for them to re-orient their thinking to the need for a rate cut, and hence they did not cut rates during the May through September period, when interest rate cuts were desperately needed.  This effective tightening made the recession (which had already begun) much worse.

This time the probable consequences would be more benign, a slowdown in growth and undershooting the inflation target, not recession. But it would leave the Fed with fewer options when the next recession occurs.

HT:  Ben


Evidence that central bankers cannot be trusted

There’s a great new Wall Street Journal article that begins as follows:

In the seven years since the world’s central banks responded to the financial crisis by slashing interest rates, more than a dozen banks in the advanced world have tried to raise them again. All have been forced to retreat.

But it’s never their fault:

Riksbank Deputy Governor Per Jansson, in a 2014 speech, responded to critics saying, “with hindsight, it is clear that monetary policy could have been somewhat more expansionary if we had known that inflation would be as low as it is now.” But, he said, “This is a natural and unavoidable consequence of the fact that monetary policy has to be based on forecasts, which are uncertain.”

Former ECB President Jean-Claude Trichet, who pushed eurozone rates up in 2011, said he needed to react to rising inflation driven by commodity prices and a threat that households and businesses might expect higher inflation rates in the future. The ECB’s mandate was for inflation near 2%, and the ECB delivered “exactly what we promised” during his term, he said in an interview. Subsequent rate reductions happened after he left and the inflation backdrop shifted, he said. Mr. Trichet said he used other measures to combat financial turmoil, including bond purchases and emergency loans to banks.

Per Jansson doesn’t tell the WSJ readers that the Riksbank’s own internal inflation forecast predicted failure, as inflation was expected to remain below target even without a rate increase.  Lars Svensson was so exasperated he resigned in protest. The Riksbank was clearly violating its legal mandate to target inflation.

Regarding Trichet, I don’t know whether to laugh or cry.  Imagine someone named Trichet racing to the edge of the Grand Canyon at 100 mph. Besides him sits Mr. Draghi.  Just before he reaches the edge of the canyon, Trichet rips off the steering wheel and hands it to Draghi.  Here, you drive.  And then he jumps out the window.

Heh, we hit the inflation target under my watch, it was my replacement who fell short.  Don’t blame me.

For years, the Paul Krugmans of the world have been telling us the Eurozone Depression is so deep that monetary policy isn’t enough, we also need fiscal stimulus. At the same time the Trichets of the world are raising rates to prevent eurozone overheating.  You can’t make this stuff up, it’s just too bizarre.

Who am I to question the wisdom of the central bankers of the world?  They are often much more distinguished than I am.  In fact, I don’t trust my own judgment; I presume that Yellen and Fischer are much better monetary economists than I am. But it seems the markets also think the Fed is wrong:

Fed officials now say they plan to move gradually. But their expectations for rates could still be too high. Officials in June estimated the Fed would raise the short-term federal-funds rate from near zero now to 1.625% by the end of 2016 and to 2.875% by the end of 2017.

Investors have a different view. Fed-funds futures markets, where traders place bets on the outlook for the central bank’s benchmark interest rate, put the Fed target at under 1% at the end of 2016 and under 1.5% at the end of 2017. In anticipation of the Fed’s next policy meeting, some officials have said they expect to reduce their projections for rates in the future. Their projections for where rates will end up in the long run have drifted down by a half percentage point in the past three years.

Yup, they’ve “drifted down” and they’ll keep drifting down, as long as central bankers think they are smarter than the markets.

As you read the following, think about how the real risk free interest rate is determined in global markets.  Then ask yourself how much success the Fed is likely to have against this backdrop:

Mario Draghi’s promise that the European Central Bank is willing to step up its stimulus if needed is resonating with economists, who see the euro-area recovery as too shallow to be sustained.

More than two-thirds of respondents in a Bloomberg survey predict the ECB’s president will expand or extend the 1.14 trillion-euro ($1.3 trillion) quantitative-easing program, and almost all of those say he’ll do so within nine months. While an increasing number of respondents see the economy improving for now, they’re also fretting that the upturn won’t last long.

The ECB’s Governing Council has already shown concern that a slowdown in global trade will erode exports, a pillar of the regional recovery, before domestic demand is strong enough to compensate. The central bank this month cut its growth and inflation forecasts and Draghi told reporters that QE is flexible in size, duration and composition. In contrast, the Federal Reserve may raise its interest rates as soon as this week.

“QE risks becoming a semi-permanent feature,” said Gianluca Sanna, a portfolio manager at Banca Monte dei Paschi di Siena SpA in Milan. “While it’s certainly true that the euro zone is indeed going through a phase of decent, maybe even above-potential, output growth, chances are that there is nothing self-sustaining in what we are seeing right now and the euro zone ends up again in a low-growth environment with inflation dangerously close to zero.”

I very much hope I’m wrong, just as I hope I’m wrong in my prediction that Chinese growth will come in well below the consensus.

HT:  Foosion

Don’t tell me the facts, I’ve already made up my mind

On some days that’s my impression of the economics profession.  They’ve made up their minds that the financial crisis (not tight money) caused the recession.  When I point to the huge decline in NGDP growth, they insist that’s not monetary policy. They say, “It was a fall in velocity, not tight money.”  And yet that’s not true, base velocity was actually rising as the Fed drove the economy into recession.  As you can see from the following graph, the Fed gradually squeezed growth in the monetary base, until by early 2008 the year-over-year percentage growth rate of the base had fallen to about 1%.  This gradually squeezed year over year NGDP growth, which slowed to 2% by mid-2008 (and much worse later on.)

Screen Shot 2015-09-13 at 3.26.15 PM

Just to be clear, I’m not suggesting the monetary base is a good way of thinking about the stance of monetary policy, it’s not.  I’m just pointing out that the “concrete steppes” people who insist it’s not the Fed’s fault if V falls, only if the Fed does something concrete with the base, themselves never bother to look for concrete steps.  If you tell them that the onset of the recession can easily be accounted for by this concrete action, they’ll still deny the Fed caused the recession. They’ve already made up their minds. Facts simply don’t matter.

Others will insist that monetary policy is all about interest rates. If you ask “real or nominal” they’ll say real rates.  Real rates did fall in the early stages of the recession, as is often the case, but then something really weird happened.  Real yields on 5 year TIPS soared between the spring and fall of 2008, as unemployment began to rise sharply.  If you point this out, they’ll still deny there was any tight money, because they’ve made up their minds that tight money could not possibly be to blame.

Screen Shot 2015-09-13 at 2.53.43 PM

The economics profession considers the Fed to be sort of like the Pope, basically infallible, except for tiny errors induced by data lags.  Any shock to AD can’t possible be caused by the Fed, because they fix problems, they don’t cause problems.  Here’s James Alexander, posing a question to Tony Yates:

I think Yates’ course might be interesting but would it really help me with my questions.. The blogsphere is alive with debate on them and sometimes academic papers are referred to, but most seem unsatisfactory in one way or another.

Anyway, would they help answer this question: Would you ever create a model that included occasional, but deeply random tightening and loosening of monetary policy by central banks?

To this one he [Yates] answered: “Yes, if you thought central banks faced measurement error in real time, or changes in committee membership that meant changes in the preferences of the median committee voter. Have a look. Large literature on just that.”

I think Yates is expressing the mainstream view.  We can draw an AS/AD diagram, and ask our students what would happen to AD if there were an expansionary or contractionary monetary shock.  But deep down the profession doesn’t believe those shocks are important.  Rather they think there are non-monetary AD shocks, which central banks offset with more or less skill.  But surely central banks wouldn’t just create a negative AD shock out of thin air?  The ECB wouldn’t just suddenly raise interest rates in July 2008, or April 2011, would they?  Bueller, are you paying attention?

This faith in central bankers is what I reject.  I see no reason at all to assume that 2007-09 was not a massive negative AD shock, caused by a series of central bank errors of commission and omission.  These occur due to a complex mixture of data lag problems (correctly identified by Yates), ignoring market signals, and a deeply flawed model of monetary economics that focuses on growth rates, not levels.  All three flaws came together in 2008.  First the economy began to slump.  That’s the data lag.  Then the markets recognized the problem, but the Fed still did not. That’s ignoring market signals (i.e. Sept. 2008).  Then when even the Fed realized the problem, they refused to commit to bring NGDP (or even the price level) back up to the previous 5% (or 2%) trend line.  Put these three together and you get a massive negative monetary shock and the Great Recession.

PS.  I was recently interviewed by the Frankfurter Allgemeine.  Here is an excerpt:

Screen Shot 2015-09-13 at 4.36.35 PM

The article is gated, and costs 2 euros.  (Most of the article discusses Larry Summers, not me.)

Which issues are important (to me)?

I sometimes say that inequality is not one of the top issues facing America. Several commenters asked me what I thought were the top issues. I find it hard to rank issues as to their relative importance, but as of today I’d say there are 4 issues that I regard as being of primary importance to America. (BTW, I care much more about foreign issues.)  I’ll put my own policy views in parentheses:

Most important issues (no particular order):

1.  US Military intervention (I’m mostly against it)

2.  Immigration (more, more, more)

3.  War on Drugs  (end it, let out 400,000 prisoners)

4.  Right to Die  (I’m for it, read Scott Alexander if you don’t think it’s important.)

Second level issues, still very important:

1.  Abortion  (pro-choice)

2.  Health care  (deregulate it, plus vouchers for the poor)

3.  Arms control  (favor reduction in nuclear stockpiles, ideally global elimination)

4.  Existential risk  (plan for it, don’t know enough to say how)

Third tier, still very important issues:

1.  Military budget  (cut in half)

2.  Monetary policy  (NGDPLT)

3.  Prostitution  (legalize it)

4.  Education (universal vouchers, with a dramatic reduction in total spending)

5.  Occupational licensing  (end it, ALL of it)

6.  Global warming  (carbon tax, geoengineering as last resort)

7.  Tax reform  (progressive consumption tax)

8.  Economic Inequality  (low wage subsidies, end cigarette taxes)

9.  War on terror  (downgrade to skirmish on terror)

10.  Intellectual property rights  (weaken protection)

11.  Lawsuits   (make it easier to sign away your right to sue)

Fourth tier, but still somewhat important:

1.  International trade barriers  (end them)

2.  Domestic trade barriers (car dealers, taxis, etc.—end them.)

3.  Financial system (stop encouraging lending)

4.  Land use  (allow greater density)

5.  Farming  (end farm subsidies)

6.  Water  (use market prices)

7.  Eminent domain  (for infrastructure, not condos)

8.  Firefighting  (Privatize, and close 1/2 of fire stations)

9.  High speed rail  (Build the Texas proposal, reject the California project.)

10.  $7.25 Minimum wage  (against it, and regarding the $15 nation-wide proposal, bump up to a higher tier of importance)

Other issues:

1.  Dueling  (Too young to have a useful opinion)

2.  Microaggression  (Too old to have a useful opinion.)

3.  Affirmative consent  (Too old to have a useful opinion.)

4.  Age of consent  (How should I know? I came of age during the (dissolute) 1970s, and went on my first date as a junior in college.)

I used a utilitarian criterion.  On another day, I’d put many of these in totally different categories, but that’s how I feel today.  On many of the key issues I’m not really with either party, but perhaps lean a bit Dem on the top issues.  I vote libertarian.  I left out some issues like feminism, racial equality, gay rights, etc., because it’s hard to pin down the specific public policy issues that are relevant today.  Thus instead of feminism I have abortion and prostitution, issues that especially impact women.  Obviously I support the gains that various groups have made over time in achieving greater respect and legal rights.  I suspect that animal rights should be high on the list, but don’t know much about the issue.

PS.  The importance of an issue reflects the interaction if its intrinsic importance, and the plausibility of changing the outcome with different public policies.

PPS.  Regarding inequality, commenter Justin D recently said:

And why concede that income inequality is an issue worth thinking about at all? Shouldn’t the real concern be whether people have basic needs? People are unequal in an enormous variety of ways – attractiveness, health, intelligence, confidence, etc., and some of these are more important than income. I’d gladly trade places with a person earning 20% of my income but in perfect health.

I mostly agree with that, especially the final sentence.  But I can’t quite concede that economic inequality is not a problem worth thinking about, even if other types of inequality are far more damaging. Many of those can’t be addressed (easily) by public policy.  Yes, poverty in the US is a modest problem (especially compared to other countries, and other periods of history) but it is still a problem.  In contrast, forcing Larry Ellison to downshift from a 500-foot yacht to a 400-foot yacht is an utterly trivial problem.  If we can solve a small problem by creating another utterly trivial problem—then do it!  In addition, addressing the inequality issue makes it easier to promote market friendly reforms elsewhere.



The smiling assassin

Picture a crime movie where the killer is arrested.  After hours of being grilled under a hot incandescent bulb, he breaks down and confesses, sobbing as he describes how he murdered his wife so he could get the insurance money and run off with a another woman.  It would be very odd if the killer calmly confessed to that crime, with the demeanor of someone describing a walk in the park, or taking the kids out to fly a kite. You expect remorse. Indeed a calm demeanor might be taken as evidence of insanity; maybe the killer didn’t even understand what he had done.

Let’s set the stage.  It’s early October 2008.  It’s been three weeks since Lehman failed, and the global economy is starting to fall apart.  There are scary stories about trade plunging all over the world.  The stock market is crashing, falling continuously during the first 10 days of October, often by large amounts.  TIPS spreads are plunging. Commodity prices are plunging.  Commercial real estate is beginning to fall sharply, after surviving the initial subprime crisis.  Unemployment is rising sharply.  What does the Fed decide to do?  Commenter Beefcake sent me to the San Francisco Fed, for its explanation.

Before the crisis, Congress passed the Financial Services Regulatory Relief Act of 2006 authorizing the Federal Reserve to begin paying interest on reserves held against certain types of deposit liabilities. The legislation was supposed to go into effect beginning October 1, 2011. However, during the financial crisis, the effective date was moved up by three years through the Emergency Economic Stabilization Act of 2008.4 This was important for monetary policy because the Federal Reserve’s various liquidity facilities5 initiated during the financial crisis caused upward pressure on excess reserves and placed downward pressure on the Federal funds rate. To counteract these pressures, on October 6, 2008, the Federal Reserve Board announced that it would begin paying interest on depository institutions’ reserve balances.

Well there you are, what could be more sensible?  I’m impressed at the audacity of the Fed, if nothing else.  This is the explanation they provide in their “education” department.  I suppose the average man on the street would nod his head, thinking, “It sure looks like the Fed knew what they were doing.”

There’s just one problem, the Fed is describing a murder, the killing of the economy. Don’t be fooled by the calm tone of this explanation.  They are describing a policy that they themselves indicate was rushed into service three years early in order to prevent interest rates from falling.  Its entire purpose was to prevent monetary stimulus, to make money tighter.

Their explanation is that the money that was being put into the banking system to rescue Wall Street threatened to also reduce interest rates thus easing monetary policy. But that could have the side effect of also rescuing Main Street!  The Fed was so horrified by the thought of a cut in interest rates at the time the economy was falling off a cliff that they begged Congress to let them move earlier on IOR.

You might wonder why the Fed simply didn’t wave its magic wand, and set rates where they wanted them.  Actually, before they had the legal option of doing IOR, the Fed had no magic wand. It only seemed like they could directly control interest rates.  In fact, they controlled the monetary base, and used changes in the base to influence interest rates.  When they sharply boosted the base to rescue the banks in September 2008, they had no way of stopping interest rates from falling all the way to zero.

The week this happened I went absolutely ballistic, and essentially became a different person.  (After not have a strong opinion on monetary policy for the previous 25 years) I went down to Harvard to ask the top macroeconomists what the hell the Fed was doing, something I never would have done before 2008.

Now inevitably someone will cite Paul Krugman, who likes to point out that central banks are quite capable of driving the economy into a zero rate trap without IOR. The Japanese did it in the 1990s, and the Fed did it in the 1930s. That’s true but irrelevant. The fact that people can also be murdered with knives does not prove that a man standing over a dead body with a smoking revolver in his hand is not guilty of murder.

Others will say that one decision is no big deal; it’s the future path of policy that matters.  That’s also true, but decisions can tell us a lot about the Fed’s mindset, and hence the likely future path of policy.  As Tim Duy recently pointed out, the reason the markets care so much about the measly quarter point increase is not the direct effects on the economy, but rather what it tells us about the Fed’s reaction function.

The October 8, 2008 rise in IOR was neither a necessary nor sufficient condition to produce the Great Recession.  But it was one important part of the story, which began in 2008 and still has not ended.  Believe it or not a rate rise in September 2015 would help cause the recession of 2008, as the severity of that recession was partly caused by the perception that the Fed would raise rates before we got back to the previous NGDP trend line.  (An idea Krugman developed back in 1998.) And now the Fed is about to confirm that perception.

PS.  Now reread the final sentence of the opening paragraph.

PPS.  I have a new post at Econlog on a related issue.