Archive for July 2018


Maybe it’s my jet lag . . .

and my cold . . . but I just don’t get this Conor Sen Bloomberg article:

Trump Wants the Fed to Roll Back the U.S. Economy

Higher interest rates could revive manufacturing and exports. That will hurt consumers and workers.

I’m only at the subtitle, but already lost.  How do higher interest rates boost manufacturing and exports?  And if they did, why would that hurt workers?

One of the main ways the Fed has won its credibility on inflation has been setting interest rates higher, sometimes much higher, than the inflation rate. This was most extreme in 1984, when short-term interest rates spent much of the year over 10 percent while consumer price inflation (stripping out food and energy) finished the year under 5 percent.  When investors and savers can get a “free lunch” by earning a high inflation-adjusted return in Treasuries, they’re incentivized to do so rather than invest in new production or consuming goods and services, both of which would put upward pressure on inflation.

This is reasoning from a price change.  Real rates were high in the mid-1980s precisely because growth was strong.  And buying Treasuries is not an alternative to producing consumer and investment goods.  That’s mixing up financial investment with physical investment.  For instance, suppose America had a massive corporate investment boom financed by corporate bonds.  Then you’d see lots of bond buying and lots of physical investment at the same time.  They are not alternatives.  A better argument would have been that Reagan’s fiscal deficits crowded out private investment.

But this has broader distortionary effects in the economy. On a global level, if investors can earn a high real interest rate on U.S. assets, they’re going to do so, which all else equal will drive the dollar higher in foreign exchange markets than it otherwise would be. The dollar being artificially higher will make U.S. exports less competitive in global markets, leading to larger trade deficits.

Distortionary?  Artificial?  Sorry, but Volcker and Greenspan were targeting inflation at about 4% from 1982-90.  There was nothing “artificial” about the resulting interest rates, they were simply the result of market forces.  The Fed does not set the real interest rate over an extended period of time.  Again, the fiscal deficits might have played a role (although even that factor was probably less important than widely believed at the time.)

In other words, the Fed established its credibility on inflation over the past few decades by setting real interest rates at a high level, which helped to orient the economy around financial activities, consumption and imports rather than production, labor and exports.

These are not either/or scenarios.  Consumption is not an alternative to production, labor etc.  Consumption is an alternative to investment.  Indeed consumption often booms during periods of high employment, such as the late 1960s and the late 1990s.  The same is true of financial activities.  And production is an alternative to leisure, not an alternative to consumption.  And real interest rates have not in fact been high over the “past few decades”.  They were high in the 1980s and have been low since 2001.

Trump wants a different model. It’s what his tariff threats seek to accomplish: making the U.S. economy more production-oriented rather than consumption-oriented. And he wants monetary policy to help do the same thing. If the Fed stops increasing interest rates over the next few quarters, then we’ll never get those high real interest rates in this economic cycle that we’ve gotten in past cycles. This should put downward pressure on the dollar, making U.S. exports more competitive, but at the cost of cheaper imports for U.S. consumers.

Where to begin?  How does downward pressure on the dollar lead to cheaper imports for U.S. consumers?  How does Trump’s tariff model lead to a more “production-oriented” economy?  Are low tariff countries like Singapore, Switzerland and Germany not production-oriented?  And how can monetary policy make the US more production-oriented? Isn’t money neutral in the long run? Where’s the long run aggregate supply curve in this model?

Update:  Several commenters suggested I misinterpreted the phrase “at the cost of cheaper imports”.  Perhaps it was meant to imply that imports would get more expensive.  I.e., “at the cost of more expensive imports for consumers”.

In the long run, if trade and monetary policy leads the U.S. economy to be somewhat less consumption-oriented and more investment-oriented, that’s something we can handle.

How could monetary policy have any long run impact on the share of GDP going to investment?  Is Sen arguing that monetary policy has a long run impact on real interest rates?

I guess in Bloomberg world, high interest rates lead to more manufacturing and exports, which hurts workers.  Low interest rates lead to more production, which helps workers.  But consumers must pay the “cost” of cheaper imports from the weaker dollar.

Am I missing something?

HT: Ramesh Ponnuru

A new NGDP prediction market

I finally limped home from a long trip, with a bad cold.  The trip actually started well, as I taught a few classes at Alternative Money University from July 15-18, at the Cato Institute in DC.  Thanks to George Selgin, Lydia Mashburn and the other people at Cato for organizing an outstanding program.  And a special thanks to the students, who restored my faltering faith in humanity.  A number of them seemed very interested in pursuing market monetarist research ideas.  Given that there were students from schools like MIT, Chicago and Stanford, that bodes well for the future.  AMU was probably the most personally rewarding experience I’ve had since I started blogging, far more so than the flurry of publicity I received back around 2012.

Basil Halperin was one of the students at AMU, and he recently did a blog post describing a new NGDP futures market at Augur:

[A]n NGDP futures market is now live on the Augur blockchain. The specific contract is simply a binary option: will the growth rate in NGDP from 2018Q1 to 2019Q1 be greater than 4.5%?

The current price/probability implied by this contract can be viewed on the Augur aggregator website just search “NGDP’, or the permalink is here.

. . .

For those unfamiliar, Augur is a new cryptocurrency project – it launched just last Thursday – built on the Ethereum platform that allows holders of its currency, “REP”, to create prediction markets. To speculate on such markets, an investor must use the Ethereum cryptocurrency (ETH).

The platform is decentralized: for everyone who wants to bet that NGDP growth will exceed 4.5%, there must be a counterparty who takes the other side of the bet. That is, the creators of Augur are not acting as market makers for the contract. The price of the contract will move to equilibrate supply and demand in a decentralized market: if the price is 0.7 ETH, that indicates that the market gives a 70% (risk-neutral) probability that NGDP will exceed 4.5%.

Read the entire post, it is quite interesting.

BTW, about 18 months ago I did a few posts (here and here) discussing Basil’s research on NGDP targeting.  He has a bright future.

I spent this past weekend going back and forth between an old folks home and an IHOP in Arizona.  Because the AC at the IHOP was giving me a fever and chills, I dressed up with three layers of shirts and long pants before walking in 105 degree heat to the restaurant (fortunately just a block away.) With nothing else to do, I read Eliezer Yudkowsky’s excellent book Inadequate Equilibria.

It’s hard to summarize the book in a single sentence, but here are a few themes:

1. Whereas financial markets are highly efficient, many of our other institutions are poorly designed—inadequate equilibria.

2.  While it’s generally unwise to believe that one can beat the stock market, we are often too modest in deferring to existing institutions, or conventional wisdom on a given issue.

3.  We need to rely on both theory and data.  Be a hedgehog and a fox.

The book explores when we should be willing to believe that we have an idea that others have overlooked.  It might be a public policy idea, a start-up company idea, a new medical treatment, or a new academic theory.

One example cited by Yudkowsky is treatments for Seasonal Affective Disorder (SAD), which afflicts millions of people.  He experimented with stringing up 130 LED lights in his home as a way of helping his wife, and it seemed to be sort of successful.  Then he discussed all the reasons why the market might not be expected to produce this treatment.

While reading the book, I could not stop thinking about NGDP predictions markets.  In the past I’ve argued that the failure of the government to set up and subsidize such a market is an example of near criminal negligence.  In Yudkowsky I’ve found a kindred spirit—someone who is outraged by things that the vast majority of people couldn’t care less about, like the ingredients that go into hospital formula for infants, or the fact that many doctors are too lazy to wash their hands as often as they should.

I’ve talked to many economists, and I have yet to hear a single plausible excuse for the lack of a federally subsidized NGDP prediction market.  Not one.  People just sort of shrug, because the cause doesn’t pull on our heartstrings like those kids separated from their parents on the border.

Yudkowsky is similarly exasperated.  Where others see nice shiny hospitals that “help people”, Eliezer sees a monstrous medical industrial complex that needlessly destroys lives.  And he sees these sorts of failures all over the place:

If you truly perceived the world through the eyes of a conventional cynical economist, then the horrors, the abominations, the low- hanging fruits you saw unpicked would annihilate your very soul.

Of course all this refers to the “normal” state of affairs in America, pre-Trump.

In any case, I highly recommend the book. It’s one of those books where the question of whether the author is “right” or “wrong” is almost beside the point; what’s interesting is how Yudkowsky approaches questions.

Here’s a review by Robin Hanson, another by Scott Alexanderand another by Scott AaronsonIf I were made king of the world, I’d probably just turn it over to those four bloggers.  I’m not sure what they’d do, but I pretty sure that none of them would put their ego ahead of the well-being of billions of people.

Bubble world is here

Lance Roberts has a new post with a neat graph:

Screen Shot 2018-07-13 at 7.11.59 PMI like the term “everything bubble”.  For a number of years I’ve been claiming that the 21st century would be full of “bubbles” that were not actually bubbles.  In other words, asset valuations would be higher than expected based on traditional valuation methods, but nonetheless justified.  This is from the spring of 2015:

In the 21st century, pundits will be unable to see anything other than recessions and “bubbles.”  There will no longer be periods of stable growth without “bubbles,” like the 1960s.  Of course bubbles don’t actually exist, but low interest rates as far as the eye can see means that asset prices will look bubble-like unless artificially depressed by a tight monetary policy that drives the economy into recession.

Of course we were told back in 2015 that this was all an artificial bubble due to QE, which is now being withdrawn as the Fed raises rates.  And yet asset prices keep rising.

Back in 2011 I challenged Robert Shiller’s pessimistic take on stock prices:

But (seriously) are stocks now overvalued?  Because I’m an efficient markets-type, the only answer I can give is no.   So why does Robert Shiller say yes?  Apparently because the P/E ratio is relatively high by historical standards.  And he showed that for much of American history investors did better buying stocks when P/Es were low than when P/E ratios were high.  Of course hindsight is 20-20.

I’d rather not get into the minutia of all the various ways of calculating P/E ratios.  And I have no idea where stocks are going from here.  Instead I’d like to focus on three arguments for relatively high P/E ratios in the 21st century American economy (however you’d like to measure them):

Of course I was careful not to predict rising stock prices, as if I had been successful it would lower my reputation.  I’m an EMH guy who claims it’s impossible to forecast stock prices.  But I did challenge Shiller’s claim that P/E ratios were too high in 2011.  That judgement may have been valid in the 20th century, but performance in past centuries is no guarantee of performance in the current century.

Again, the 21st century is the “bubble” century.

PS.  I was amused by this exchange in a recent NPR interview of Jay Powell:

Ryssdal: Let me ask you then about inflation and about prices which are as you say starting to tick up to where the Federal Reserve wants it to be. I’ll note here that we’re talking at 8:24 in the morning on the day that consumer prices come out. They come out in six minutes. With the caveat that this is going to air now in five, six hours from now, whatever it is, you have the number in your back pocket, you know what the number is. Inflation CPI?

Powell: Well, let’s just say that I do get a look in advance at these things. Yes.

Ryssdal: You’re not going to tell me what it is even though we are not going to air this until —

Powell: Definitely not. Definitely not.

Ryssdal: Score one for the chairman’s adherence to the rules.

Powell: Not going to say anything that would suggest what it might be.

Not even a tweet?

HT:  Pat Horan

The market and the Fed

Stephen Williamson recently made this observation:

As a side note, I thought the part of the FOMC discussion where the staff gives a presentation relating to an alternative indicator – the difference between the current fed funds rate and what the market thinks the future fed funds rate will be – was good for a chuckle. If the FOMC thinks the market knows more about what it’s going to do than what it knows about what it’s going to do, we’re all in trouble.

I have the opposite perspective; we are in big trouble if the FOMC thinks it knows more than the market about what it will do to rates in the future.

Back in late 2015, the Fed began raising their target interest rate.  At the time, they anticipated another 4 rate increases in 2016.  Markets were skeptical, expecting only about one rate increase in 2016.  In fact, rates were not raised again until the very end of 2016.  That’s because economic growth and inflation during 2016 were below Fed expectations.  The markets were correct on this occasion (not always).

If you want an efficient estimate of the future path of interest rates, look at the market forecast, not the “dot plot”.  The dot plots are primarily useful as a measure of how deluded FOMC members are in their appraisal of the economy.  Because they were too optimistic in late 2015, they set rates too high.  That slowed the recovery, and probably tilted the (very close) election toward Trump.  And now, to quote Williamson, “we’re all in trouble”.

Interest rates are now higher than in 2016, but monetary policy is actually more expansionary than two years ago.  To Williamson’s credit, he is one of the few economists who seems to understand how this can be possible.

HT:  Tyler Cowen.

Things that smart people don’t know

It would be interesting to make a list of things that smart people don’t know.  Unfortunately, I don’t have enough paper or barrels of ink.  One of my favorites is trade, where smart people think China is an outlier.  Actually, only tiny Belgium has more balanced trade than China:

Screen Shot 2018-07-09 at 2.16.19 PM

Why don’t smart people know this?  Because they don’t bother looking at the data.

Another misconception is that trade deficits are bad.  This article at National Interest caught my eye:

Trump is right to push on trade. A simple return to anything resembling a balanced international trading system would result in massive gains for the United States. What presidential advisors Peter Navarro and Wilbur Ross call the deficit drag depresses the American economy by about 3 percent overall. That is to say, if international trade were balanced, the American economy would be 3 percent larger than it is now.

I had to read this twice, to make sure my eyes weren’t deceiving me.  The Navarro/Ross argument is based on this equation:

GDP = C + I + G + (X-M)

They assume that if X-M is negative 3% of GDP, then this causes GDP to fall by 3%.  Actually it has no effect, because the negative caused by subtracting M (imports) is exactly balanced by a positive to C + I (consumption and investment).  Every time you buy an imported car, consumption rises by the amount of the purchase.  Every time someone buys an imported truck, investment rises by the amount of the purchase.  If you switch from imports to domestic cars, the labor to produce those domestic cars doesn’t just magically appear on the scene, it gets diverted from some other type of production.  Can reducing the trade deficit boost total aggregate demand? No, for standard monetary offset reasons.  But even if I’m wrong, higher AD has no long run impact on employment, for standard “natural rate” reasons.

Yup, this is all just EC101. And yes, Trump’s top economic officials do not know this stuff.  It reminds me of when freshmen in economics get lost trying to write an answer to an essay question:  “Demand goes up so price rises.  The higher price causes demand to fall.  The fall in demand then lowers the price, which causes demand to increase . . .”  Eventually they give up and stop writing, hoping for the curve to allow them to pass the course.

Irving Kristol, who was a supply-sider, founded The National Interest back in 1985.  Perhaps it’s fortunate he passed away in 2009, and did not have to see what happened to his neoconservative journal.  The article was titled:

Trump Is Right: The U.S. Can’t Lose a Trade War

BTW, Trump supporters who care about trade deficits (do they even exist?) might be interested in knowing that Trump’s policies are making the US trade deficit larger.  Or maybe they don’t care.  In fairness, it’s not growing as fast as the budget deficit, which is now rising rapidly. During an expansion.

PS.  The comment section after my previous post reminded me of an old joke.  A guy tells his friend that he has an uncle who insists that there’s an alien from Alpha Centauri who wears a sport coat with pink polka dots, and that lives in a tiny teapot on his fireplace mantle.  The friend responds, “Oh come on, how likely is it that someone from Alpha Centauri would rear pink polka dots.”

Commenters thought the best way to respond to Trump’s latest outrage was to discuss the merits of breastfeeding.

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