Has there ever been a better time for consumers of news?  In a single day, Trump will do three or four different things that are more bizarre or more appalling that Obama on his worst day in office:

1.  I’ve argued for quite some time that Trump’s a banana republic-type leader, but now he doesn’t even seem to be hiding that fact.  The President now describes convicted felons as “good people”, but only when they don’t cooperate with law enforcement.  If they do cooperate with authorities, then they are bad people.  The “no snitching” movement has moved from neighborhoods dominated by criminal gangs all the way to the White House.

2.  Trump unleashes a non-stop torrent of insults at his Attorney General, but they refuses to fire him.

3.  Trump campaigns on the idea that the US should not focus on namby-pamby issues such as human rights, rather we should focus on Making America Great Again, and cozy up to tyrants like Putin.  Then Trump suddenly tells the Secretary of State to look into doing something about the treatment of South African farmers.  Huh?  Of all the hundreds of oppressed groups around the world, why would Trump suddenly care about South African farmers? After all, most of the South African farmers than are being murdered are black, and he’s never shown the slightest interest in the welfare of blacks.  The Economist has a theory:

On August 23rd, after watching a Fox News segment, President Donald Trump tweeted about illegal “farm seizures”, which the ANC opposes, and the “large scale killing” of farmers, by which he presumably does not mean the black farm workers most likely to be victims of rural crime.

I wonder where the Economist got that idea?

[S]tories about the dastardly plot against white farmers (which, again, doesn’t actually exist) have shown up on alt-right, white nationalist, and neo-Nazi websites including AltRight.com (which is run by white nationalist Richard Spencer), VDare, American Renaissance, and Stormfront.

Lauren Southern with the European alt-right group Identity Evropa made a documentaryabout the subject. An alt-right podcast called White Rabbit Radio has an episode about it. So does American Renaissance’s Jared Taylor’s podcast. It’s also a hot topic on the pro-Trump Reddit forum r/TheDonald.

But the conspiracy theory quickly moved from the darker corners of the internet into the slightly-more-mainstream-but-still-pretty-seedy corners of the internet: As Wilson notes, Ann Coulter tweeted in June 2017 that the “only real refugees” are “White South African farmers facing genocide.” Breitbart has covered it extensively, as has the Russian government propaganda outlet RT. And, of course, so has Fox News’s Tucker Carlson.

Perhaps it was inevitable, then, that it would make its way to Trump sooner or later.

4.  As if that’s not enough, yesterday we also discover that Trump’s friend Pecker (how do CNN anchors keep a straight face when reading the news?) has a safe at the National Enquirer full of stories they bought and then refused to publish in order to protect Trump.  An actual, physical safe.

The crazy news stories are now coming so fast they pile up on each other, reducing the impact.  Like Venezuelans under Chavez, we are becoming numb to the insanity.

Admittedly these examples are a hodgepodge.  The 2nd and 4th examples are not important, merely weird.  The first example shows that Trump’s got the ethics of a third world dictator, or a Mafia don.  And the third story shows he’s a white nationalist, but we have dozens of other reasons to already believe that.   In any case, following the news has become vastly more interesting than under Obama.  And in politics, “interesting” generally does not end well.

The interwar gold standard is one of the most complex and interesting case studies in all of macroeconomics.  I’ve devoted much of my life to studying this issue.  It is difficult to wade through all the complexities without eventually getting off course, focusing on the wrong issues and misinterpreting key facts.  I’m pleased to say that Hu McCulloch’s brilliant new essay at Alt-M is one of the very best descriptions of this period that I have ever read.  I agree with well over 90% of his judgments, including all of the key points.  Here I’ll focus on a few small points where I disagree.

McCulloch argues that the fundamental problem was that European gold demand plunged during WWI, as countries sold off gold and printed money to finance the war.  This sharply reduced the value of gold, which meant a higher price level in countries (such as the US) still on the gold standard.  Furthermore, it was almost inevitable that once the international gold standard got back on its feet, the value of gold would gradually return to its prewar level.  This would mean substantial deflation in countries such as the US and the UK.  McCulloch illustrates this idea with a graph:

McCulloch cites Clark Johnson and Doug Irwin, who showed that the adjustment process was made more unstable by the big surge in French gold demand in the late 1920s and early 1930s.  He suggests that, (assuming that we stayed with gold) the best feasible outcome was a more gradual deflation over many years, until the global price level got back on track.

That’s a perfectly valid way of looking at the picture, and indeed is one of the plausible counterfactuals that I discuss in my own book on the Depression.  But I do slightly quibble with this statement:

However, given that the U.S. had a fixed exchange rate relative to gold and no control over Europe’s misguided policies, it was stuck with importing the global gold deflation — regardless of its own domestic monetary policies. The debt/deflation problem undoubtedly aggravated the Depression and led to bank failures, which in turn increased the currency/deposit ratio and compounded the situation. However, a substantial portion of the fall in the U.S. nominal money stock was to be expected as a result of the inevitable deflation — and therefore was the product, rather than the primary cause, of the deflation. The anti-competitive policies of the Hoover years and FDR’s New Deal (Rothbard 1963, Ohanian 2009) surely aggravated and prolonged the Depression, but were not the ultimate cause.

He’s right about the banking problems, and also about the New Deal, but I believe he lets the Fed (and Federal government more broadly) off the hook a bit too easily.  Here are a few points to keep in mind:

1.   The Fed was created partly because the US no longer wanted a “classical gold standard” where the government played no role in preventing crises.  The Fed did in fact exercise countercyclical policies during the 1920s. (Whether effectively is a complicated question.)

2.  The US had enormous gold reserves in 1929, nearly 40% of the global total.

3.  Legal gold reserve ratios could and should be adjusted during a crisis, and indeed Hoover did get Congress to ease the Fed’s gold requirements during early 1932.

4.  When the US left the gold standard during 1933, it still had by far the world’s largest gold reserves.  I seem to recall that Richard Timberlake once said something to the effect that there’s no shame in losing the gold standard after a valiant effort, what’s shameful is not even trying to stabilize the economy by using “emergency” gold reserves, before completely abandoning the system. When the US left gold in 1933, we still had by far the world’s largest gold reserves.

As an analogy, if in 1912 there was a regulation that all cruise ships should have 20 lifeboats on deck, that does not mean that the lifeboats should remain on deck after hitting an iceberg.  Later on, McCulloch indicates that he does understand this problem:

Unfortunately, however, there was often a misguided assumption that central banks (and private banks) should suspend redemptions whenever the legal reserve requirement was not met. This gave them an incentive to hold a substantial amount of excess, or “free,” reserves over and above the legal requirement. Instead, it should have been understood that a bank is obligated to meet its demand liabilities, so long as it has any reserves at all, and that a “reserve requirement” means that it may extend or renew credit to the government and/or the private sector only if it has reserves in excess of the “required” level.

At a minimum, the Fed should have been far more aggressive in doing whatever it took to engineer a gradual deflation after 1926, say 2%/year, rather than allow double-digit deflation after 1929.  I believe the Fed had enough resources to do this, even singlehandedly.  If you are skeptical of this claim, keep in mind the following facts:

1. Fed policy during the first year of the Depression (October 1929-October 1930) was extremely tight.  The gold reserve ratio rose sharply at the same time that France and the UK were also increasing their gold ratios.  This was the proximate cause of the first year of the Depression.  An expansionary Fed policy would have made the 1930 slump much milder.

2.  More importantly, the really big increases in gold demand during the early 1930s came from four sources, three of which were endogenous—caused by the Depression itself.  The one exogenous factor was France’s decision to raise its gold ratio.  One endogenous cause was the extra gold needed to back base money created during the banking crises that began in October 1930.  Without a deep depression, the banking crises might never have occurred, and certainly would have been far milder.  Second, many gold bloc central banks accumulated large gold reserves partly in consequence of the Depression itself.  Indeed even part of France’s increase in gold hoarding was motivated by the Depression.  Thus it rapidly replaced dollar and pound reserves with gold after the UK left the gold standard in September 1931, and people began to fear the US would also eventually devalue.  Third, private gold hoarding increased strongly after 1930, once people correctly began to see that various countries were likely to eventually devalue.  All three of these causes of sharply higher gold demand were entirely endogenous, and largely explain why things got worse so dramatically after 1929.

Think in terms of the butterfly effect in chaos theory.  A modestly more expansionary Fed policy in 1930 could have prevented much of the gold hoarding related to panicky investors fearing devaluation, panicky bank depositors fearing bank failures and panicky governments fearing their paper forex reserves would be devalued.  I believe the Fed could have engineered a soft landing, where prices fell at a gradual pace, as European nations gradually rebuilt the international gold standard.

Having said all of that, there’s a good argument against the views I just expressed.  This policy regime would have required a high level of wisdom by the central bank.  But if central banks were that wise, there would be no point in having the gold standard in the first place.  You’d just have fiat money, and then have them target the price level.  Furthermore, if the wise policy I sketched began well into the Depression then it would have been increasingly difficult to implement, increasingly likely to lead to a run on the dollar where the US ran out of gold.  Thus it would have been easier to implement in 1930 than 1931, and easier to do in 1931 than 1932.  So there a lot of truth in McCulloch’s claim that given the institutional set-up of this period, the disruption to the gold standard caused by WWI was the root cause of the big interwar deflation.  Certainly Friedman and Schwartz gave too little attention to this problem.

I would also slightly quibble with this:

H. Clark Johnson views the non-monetary demand for gold as a destabilizing factor during the 1920s and points a particularly accusatory finger at India (pp. 46-8). However, the non-monetary demand for gold actually stabilizes prices under a gold standard, since it will reduce the inflation that occurs when monetary demand is reduced (as during the early 1920s), and its reversal will mitigate the deflation that occurs when monetary demand has increased (as at the end of the 1920s and early 1930s).

That’s generally true, and was true in 1930, when the Depression raised the value of gold and reduced private gold demand.  Less private gold demand is stabilizing during a depression.  But private gold demand began rising sharply after mid-1931, and in several other gold hoarding episodes right through 1933.  These bouts of private gold hoarding were caused by fear of devaluation, and this prevented the normal stabilizing properties of the gold standard from having their usual effect.  Although I have not studied the mid-1890s, I believe something similar occurred when silver agitation created fears that the US might abandon gold.

My third quibble has to do with the conclusion, where McCulloch makes a few brief comments about the Great Recession.  He does not place enough emphasis on the role of tight money at the Fed, which drove NGDP sharply lower during 2008-09.

But these are small points.  If you want a quick explanation of what went wrong during the interwar period, read McCulloch’s essay.  If this whets your appetite and you want a more complete explanation . . . well you know where to look:

HT: John Hall

I have a new piece at The Hill.  Here’s an excerpt:

The biggest puzzle is what the Trump administration is trying to achieve with its trade war. Is it a move to pressure the Chinese to open up their economy, thus reducing barriers to U.S. trade and investment? Maybe, but it was precisely the opening of the Chinese economy that first created the “China shock.”

Indeed, China was no threat at all to U.S. firms when its economy was closed under the leadership of Chairman Mao. An even more open China would create an even bigger shock, resulting in even more economic dislocation in the Rust Belt. Presumably, Ohio manufacturing workers who supported candidate Trump were not hoping China would buy more Hollywood films and computer software, so that America could buy more auto parts from China.

Read the whole thing.

PS.  A recent NBER paper by Zhi Wang, Shang-Jin Wei, Xinding Yu, and Kunfu Zhu reversed the finding of the famous Autor, Dorn and Hanson paper on the “China shock”.  Here is the abstract:

The United States imports intermediate inputs from China, helping downstream US firms to expand employment. Using a cross-regional reduced-form specification but differing from the existing literature, this paper (a) incorporates a supply chain perspective, (b) uses intermediate input imports rather than total imports in computing the downstream exposure, and (c) uses exporter-specific information to allocate imported inputs across US sectors. We find robust evidence that the total impact of trading with China is a positive boost to local employment and real wages. The most important factor is employment stimulation outside the manufacturing sector through the downstream channel. This overturns the received wisdom from the reduced-form literature and provides statistical support for a key mechanism hypothesized in general equilibrium spatial models.

I don’t “believe” either result.  The science of economics has not advanced to the point where it’s possible to have a high level of confidence in these sorts of empirical studies.

PPS.  Off topic, this made me smile:

Trump has moaned to donors that Powell didn’t turn out to be the cheap-money Fed guy he wanted. The president repeated the effort this week in an interview with Reuters, adding the ridiculous claim that the euro is manipulated and the more credible notion that China is massaging the yuan. (The European Central Bank rarely intervenes directly in currency markets; when the ECB does, it’s usually with the Fed.)

Where to begin:

1. Trump had a choice between Yellen and Powell.  I suggested Yellen, as she had done a very good job.  Trump’s advisors said he shouldn’t pick Yellen because she’s not a Republican.  So Trump picked Powell, even though he was slightly more hawkish than Yellen.  Trump is tribal and assumes everyone else in the world is just as corrupt as he is.  He thought Powell would be “better” because he’d want to help a Republican president.  And now Trump is shocked to find out that Powell is not his lapdog.  (Actually it’s too soon to know for sure, as Trump also wrongly assumes that higher interest rates mean tighter money.  But we can cut him some slack, as lots of other people make the same mistake.)

2. I also smiled at the notion that the ECB doesn’t intervene in the currency market.  Of course they have a 100% monopoly on the entire supply side of the euro currency market.  Yes, I understand the reporter meant “foreign exchange market” when he said “currency”.  But even that’s a bit misleading, as ECB policy does affect the forex value of the euro, and there have been ECB actions in recent years that were clearly aimed at depreciating the euro.  Ditto for the Fed and the Chinese central bank.  Still, the reporter is correct in claiming that Trump has no grounds to complain about ECB policy; I wish he had made the same point about China.

PPPS.  Another day, another two convictions of close Trump advisors.  In one case it was for for a crime that Trump ordered him to commit.  Trump’s now as deeply enmeshed in scandal as Nixon was back in 1974.  The good news for Trump is that none of this matters.  Trump’s support is in the low 40s and it will not decline at all.  There was no Nixon cult—his supporters abandoned him in droves.  But the Trump cult would support him if he murdered someone in the middle of Times Square, at least that’s what Trump himself claims.  As long as those 40% of voters stick with Trump, frightened GOP Congressmen will do the same.  Trump is safe.

Still, it will be fun watching the scandal play out—lots more to come!

PPPPS.  Focus on the blue line, as the yellow line partly reflected the worsening economy.

A few weeks ago I gave a 90-minute talk to some high school and college students in a summer internship program at UC Irvine.  Most (but not all) had taken basic intro to economics.  I need to boil everything down to 90 minutes, including money, prices, business cycles, interest rates, the Great Recession, how the Fed screwed up in 2008, and why the Fed screwed up in 2008.  Not sure if that’s possible, but here’s the outline I prepared:

1.  The value of money (15 minutes)

2.  Money and prices  (20 minutes)

3.  Money and business cycles (25 minutes)

4.  Money and interest rates (15 minutes)

5.  Q&A (15 minutes)

Intro

Inflation is currently running at about 2%.  It’s averaged 2% since 1990.  That’s not a coincidence, the Fed targets inflation at 2%.  But it’s also not normal.  Inflation was much higher in the 1980s, and still higher in the 1970s.  In the 1800s, inflation averaged zero and there were years like 1921 and 1930-32 where it was more like negative 10%!

We need to figure out how the Fed has succeeded in targeting inflation at 2%, then why this was the wrong target, and finally how this mistake (as well as a couple freshman-level errors) led to the Great Recession.

1. Value of Money  

Like any other product, the real value of money changes over time.

But . . . the nominal price of money stays constant, a dollar always costs $1

Value of money = 1/P (where P is price level (CPI, etc.))

Thus if price level doubles, value of a dollar falls in half.

Analogy:

Year      Height    Unit of measure   Real height

1980      1 yard           1.0                1 yard

2018      6 feet            1/3               2 yards

Switching from yards to feet makes the average size of things look three times larger.  This is “size inflation”.  But this boy’s measured height increased 6-fold, which means he even grew (2 times) taller in real terms.

Year      Income    Price level  Value of money   Real Income

1980     $30,000        1.0               1.0               $30,000

2018    $180,000       3.0               1/3               $60,000

The dollar lost 2/3rds of its purchasing power between 1980 and 2018, as the average thing costs three times as much.  This is “price inflation”.  But some nominal values increase by more than three times, such as this person’s income, which means the income doubled in real terms, or in purchasing power.

Punch line:  Don’t try to explain inflation by picking out items that increased in price especially fast, say rents or gas prices, rather think of inflation as a change in the value of money.  Focus on what determines the value of money . . .

2.  Money and the Price Level

. . . which, in a competitive market is supply and demand:

Demand for Money: How much cash people prefer to hold.

Who determines how much money you carry in your wallet?  You?  Are you sure?  Is that true for everyone?

Who determines the average cash holding of everyone in the economy?  The Fed.

How can we reconcile these two perceptions?  They are both correct, in a sense.

Helicopter drop example:  Double money supply from $200 to $400/capita

==> Excess cash balances

==>attempts to get rid of cash => spending rises => AD rises => P rises

==>eventually prices double.  Back in equilibrium.

Now it takes $400 to buy what $200 used to buy.  You determine real cash holdings (the purchasing power in your wallet), while the Fed determines average nominal cash holdings (number of dollars).

Punch line:  Fed can control the price level (value of money), by controlling the money supply.

What if money demand changes?  No problem, adjust money supply to offset the change.

Fed has used this power to keep inflation close to 2% since 1991.  Before they tried, inflation was all over the map.  After they tried, they succeeded in keeping the average rate close to 2%.  That success would have been impossible if Fed did not control price level.

But, inflation targeting is not optimal:

3.  Money and business cycles

Suppose I do a study and find that on average, 40 people go to the movies when prices are $8, and 120 people attend on average when prices are $12.  Is this consistent with the laws of supply and demand?  Yes, completely consistent. But many students have trouble seeing this.

Explanation:  When the demand for movies rises, theaters respond with higher prices.  The two data points lie along a single upward-sloping supply curve.

Implication:  Never reason from a price change.  A rise in prices doesn’t tell us what’s happening in a market.  It could be more demand or less supply.  The same is true of the overall price level.  Higher inflation might indicate an overheating economy (too much AD), or a negative supply shock:

In mid-2008, the Fed saw inflation rise sharply and worried the economy was overheating.  It was reasoning from a price change. In fact, prices rose rapidly because aggregate supply was declining.  It should have focused on total spending, aka “aggregate demand”, for evidence of overheating:

M*V = P*Y = AD = NGDP

This represents total spending on goods and services.  Unstable NGDP causes business cycles.

Example: mid-2008 to mid-2009, when NGDP fell 3%:

Here we assume that nominal GDP was $20 trillion in 2008, and then fell in 2009, causing a deep recession and high unemployment.

Musical chairs model:  NGDP is the total revenue available to businesses to pay wages and salaries.  Because wages are “sticky”, or slow to adjust, a fall in NGDP leads to fewer jobs, at least until wages can adjust.  This is a recession.

It’s like the game of musical chairs.  If you take away a couple chairs, then when the music stops several contestants will end up sitting on the floor.

The Fed needs to keep NGDP growing about 4%/year, by adjusting M to offset any changes in V (velocity of circulation).

Punch line:  Don’t focus in inflation, NGDP growth is the key to the business cycle

Why did the Fed mess up in 2008? Two episodes of reasoning from a price change:

1.  The 2008 supply shock inflation was wrongly viewed as an overheating economy.

2.  Low interest rates were wrongly viewed as easy money.

4.  Money and Interest Rates

Below is the short and long run effects of an increase in the money supply, and then a decrease in the money supply.  Notice that easy money causes rates to initially fall, then rise much higher.  Vice versa for a tight money policy.

When the money supply increases, rates initially decline due to the liquidity effect. The opposite occurs when the money supply is reduced.

However, in the long run, interest rates go the opposite way due to the income and Fisher effects:

Income effect: Expansionary monetary policy leads to higher growth in the economy, more demand for credit, and higher interest rates.

Fisher effect:  Expansionary monetary policy leads to higher inflation, which causes lenders to demand higher interest rates.

In 2008, the Fed thought lower rates represented the liquidity effect from an easy money policy.

Actually, during 2008 we were seeing the income and Fisher effects from a previous tight money policy.

Don’t assume that short run means “right now” and long run means “later”.  What’s happening right now is usually the long run effect of monetary policies adopted earlier.

Punchline:  Don’t assume low rates are easy money and vice versa.  Focus on NGDP growth to determine stance of monetary policy.  That’s what matters.

(I actually ended up covering about 90% of what I intended to cover, skipping the yardstick metaphor.)

Let’s consider Paraguay, a country that has traditionally been dominated by two parties, the Colorados and the Liberals.  I’ll make up a hypothetical set of facts, and you tell me the most plausible way to interpret this imaginary scenario:

1.  Manuel Suarez of the Colorado Party is elected president.

2.  Almost all Liberals view Suarez as a dishonest, vindictive demagogue.

3.  The leading Colorado intellectuals and pundits view Suarez as a dishonest, vindictive demagogue.

4.  Roughly 80% of former leaders of the Colorado party (who are now retired from politics) view Suarez as a dishonest, vindictive demagogue.

5.  Roughly 10% of current Colorado politicians criticize Suarez as if he were a dishonest, vindictive demagogue.

6.  In private, most Colorado politicians view Suarez as a dishonest, vindictive demagogue, even while supporting him publicly in order to please their constituents.

7.  Most Colorado voters do not view Suarez as a dishonest, vindictive demagogue.  These voters support Suarez on virtually all issues, regardless of whether his views represent traditional Colorado positions.

Suppose you were a French, Australian or Egyptian political scientist, examining the political situation in Paraguay.  You have no emotional tie to either the Colorados or the Liberals.  You are examining the situation as dispassionately as one might study an ant farm.  Which hypothesis would you regard as most plausible:

A.  Suarez is a dishonest, vindictive demagogue.

B.  Suarez is not a dishonest, vindictive demagogue.  Rather he’s very much misunderstood by the elites in Asuncion, of both parties, who follow him most closely.  Only his cult-like following among ordinary voters of one political party see him for what he is.

PS.  AP had a good piece on how GOP politicians view the Trump cult.  I almost broke out laughing when I read the concluding paragraph:

“The Trump phenomenon is going to end at some point in time. That might be six years, that might be two years, that might be sooner. No one knows,” the former Ohio GOP chairman said. “When it does end, it’s the job of a lot of us … to make sure that the party is still populated by good, honest, decent candidates and officeholders who we can continue to be proud of.”

“still”?