After the previous post, Carl made the following comment:

I have a hard time believing it’s because “fiscal policy is unsustainable”. It’s been unsustainable for decades.

Here’s the data for 1947-2007:

So no, fiscal policy has not been unsustainable for decades.  The debt ratio fell from 80% of GDP in 1947 to 35% of GDP in 2007.  That’s not to say that there were no long term fiscal challenges in 2007—the looming retirement of baby boomers was an issue that needed to be addressed.

However it is not true that a longer life expectancy creates major problems for fiscal policy.   Living longer need not cause health care costs to rise dramatically, if people are also healthier.  To some extent the costs simply occur later in life.  The much bigger problem is that we now spend far more on the same health problems that we spent less on in the past. Singapore does not.

And greater longevity need not increase the pension burden, as long as the retirement age reflects improvements in health.  Longer life spans may create a problem if we don’t handle them in a sensible way, but that’s up to us.  Thus we could set the Social Security retirement age equal to the average life expectancy in America, minus 12 years.

Today, the debt burden is nearly back up to 80% of GDP, and likely headed much higher.  The problem today is that fiscal policy is currently unsustainable—we are running massive and growing deficits late in an expansion.  It was certainly not unsustainable when we were rapidly reducing the ratio of debt to GDP under Bill Clinton.

PS.  My previous post title should not be taken as a prediction of recession.  I do not expect another recession in the near future.  I would emphasize that the level of stock prices is still pretty high, even after the recent drop.

I suppose I ought to say something about recent stock market turmoil, even though I don’t have any great insights.  (I recommend John Cochrane’s recent post.)

I generally divide shocks up into two types.  There are negative demand shocks, like 1929 and 2008.  Then there are real shocks, when the market crashes without any big drop in NGDP growth expectations.  That might have been the case in 1987 and 2000, although I’m not certain.

As far as I can tell, the recent market decline seems more like a real shock.  I don’t see any sign of slower NGDP growth expectations.  The Hypermind market is almost unchanged, and there’s not much change in nominal bond yields or TIPS spreads.  If anything, bond yields have risen, which is not reflective of declining NGDP growth expectations.

So if it’s a real shock, then what caused it?  Keep in mind that thus far the decline has been modest, less than 10%.  And that follows a huge stock price run-up.  So don’t look for a huge real shock, merely something that means investors are still quite optimistic, just a bit less optimistic than a week ago.  It’s all about levels.

One possible culprit is an increasing sense that things are “unsustainable”.  Here are a couple areas where that perception may be building:

1.  Perhaps RGDP growth is unsustainable.  Unemployment has fallen to 4.1%, the working age population is growing very slowly, immigration reform seems unlikely, and nominal wage growth is accelerating.  The recent 2.9% wage growth number seemed to hit stocks.

2. Perhaps fiscal policy is unsustainable.  The GOP passed a big tax cut (which will end up costing much more than estimated.)  After you do that, you are supposed to tighten up on spending if you are the small government party.  Instead they basically took off all the restraints on spending.  The deficit is about to get much worse.  And when the next recession hits?  Don’t even think about it.

[Remember when Blair and Brown enacted a big fiscal stimulus at a time when the UK was booming in the early 2000s?  And then there was no money for fiscal stimulus when the Great Recession hit.  That’s basically the current GOP.]

I don’t have a lot of confidence that fear of unsustainable trends is what caused the recent market setback, but I can’t see any other plausible culprits.  Have I missed anything?

I view The Economist as the best magazine in the world, which is why I like to pick on them so much.  I recently came across a couple examples of faith-based reasoning at the Economist.  Here’s a piece on the recent recovery in Japan:

JAPAN’S economy has been so sickly for so long that many have stopped looking for signs of recovery. And yet, on close examination, they are there. Years of massive fiscal and monetary stimulus seem to be having some effect. Unemployment is below 3%—the lowest rate in 23 years—and wages are rising, at least for casual workers. Prices are creeping up, too, albeit by much less than the Bank of Japan’s 2% inflation target.

Yikes!  Massive fiscal stimulus?  In fact, Abenomics has involved a sharp contraction in fiscal policy, mostly due to a large increase in their national sales tax.  Budget deficits are shrinking dramatically.  Yes, fiscal policy was expansionary in the 1990s and early 2000s, but that corresponded to perhaps the worst 19 year performance in aggregate demand ever seen in a developed economy, with NGDP actually falling between 1993 and 2012.  It’s only since the beginning of 2013 that Japanese NGDP has shown signs of life:

Then I came across this headline on Bitcoin:

Manias, panics and Initial Coin Offerings

Crypto-coin mania illustrates the crazy and not-so-crazy sides of bubbles

In fact, it would be hard to find a more perfect refutation of the bubble hypothesis than Bitcoin. And yet somehow The Economist sees Bitcoin as a good example of a bubble.

Recall that back in 2012 when Bitcoin was trading at $12, the Economist was already calling it a bubble:

These curious capabilities make Bitcoins a combination of a commodity and a fiat currency (creating the coins is referred to as “mining” and they have value only because people accept them). But boosters inflated a Bitcoin bubble. Shortly after the currency launched, articles spread around the internet arguing that Bitcoins would protect wealth from hyperinflation and that early adopters would make a fortune. The dollar price of a Bitcoin currency unit climbed from a few cents in 2010 to a peak of nearly $30 in June 2011 (see chart), according to data compiled by Mt Gox, a popular online Bitcoin exchange. Inevitably, the currency then crashed back down, bottoming out at $2 in November 2011.

Inevitably?  Do the writers at The Economist have no sense of shame?  It’s bad enough that they prevented me from becoming filthy rich by purchasing bitcoin back in 2012, but after being spectacularly wrong about it being a bubble in 2012, they continue to make the same predictions over an over again, year after year.  Bitcoin could fall 99% tomorrow and the Economist would still be completely wrong about it being a bubble.  Please, I beg you, just stop trying to predict asset prices.  I don’t buy the Economist for investment tips.

As each day goes by the four anti-EMH arguments from 2009 (when I started blogging) look weaker and weaker.  NASDAQ 5000?  It just soared past 6700.  (Roughly 5000 in real terms)  Housing prices?  They’re soaring again.  Hedge funds and college endowments outperform?  Not any more.  Bitcoin is a bubble at $30?  Where can I buy some at that price.

But of course none of this will matter.  People don’t believe in fiscal stimulus and bubbles because of the facts, as the evidence strongly refutes these theories.  Rather it seems like soaring prices are a bubble, and it seems like big government spending programs should boost the economy.  Thus people will continue to believe these myths no matter how much evidence piles up against.

PS.  And it’s even worse.  When Bitcoin prices finally plunge (and they will at some point, as all highly volatile asset prices do) then the bubbleheads will think they were right all along, even as they’ve been wrong all along.

It’s hopeless.

Consider the following:

Last year they [older evangelicals] flipped from being the voter group most likely to say personal morality mattered in a president, to being the group least likely to say that.

I wonder why?

Or consider this:

Negotiations were still under way on Capitol Hill early this week as Kevin Brady, chair of the House ways and means committee, spearheads work on complex calculations to stay within the limits Congress set for the legislation — an increase in the deficit of no more than $1.5tn over 10 years.

So let me get this straight.  We had a deficit of $666 billion in FY2017 (the work of the devil), and we are in the 9th year of an economic expansion, and consumer confidence is at a 17-year high, and unemployment is 4.2%, and demographics point to rapid growth in the national debt in future decades, and the GOP in its infinite wisdom has decided that now is a good time for another $1.5 trillion expansion in our national debt, on top of the currently unsustainable trajectory?

Remind me about how awful the Obama deficits were?  Freedom Caucus?  Tea Party?  Anyone?

We need tax reform, not tax cuts.

PS.  I enjoyed this—thought you might too:

In a speech, John McCain said the following:

“To fear the world we have organized and led for three-quarters of a century, to abandon the ideals we have advanced around the globe, to refuse the obligations of international leadership and our duty to remain “the last best hope of earth” for the sake of some half-baked, spurious nationalism cooked up by people who would rather find scapegoats than solve problems, is as unpatriotic as an attachment to any other tired dogma of the past that Americans consigned to the ash heap of history.”

That’s a mouthful of a sentence — and an excellent one. But not according to another Arizona Republican, Kelli Ward. John McCormack of The Weekly Standard reported on a campaign event of hers. She said she would Make America Great Again by serving “as a conservative, as a populist, as an Americanist, as a scurrilous nationalist.”

John McCain and Jeff Flake are the old GOP.  It look like scurrilous nationalists such as Kelli Ward are the new face of the Republican Party.  I wonder what Lincoln would think of the fact that it’s now Republicans that view people like Robert E. Lee as patriots.

And let’s not forget Alabama’s embarrassing Roy Moore, who is being endorsed by the so-called “libertarian” leaning GOP senators such as Paul, Cruz and Lee:

“Moore’s attitudes toward homosexual citizens goes far beyond merely not wanting them to have ‘special rights,’ ” wrote Reason’s Brian Doherty, a biographer of the Paul family. “Moore, as he declared from the bench in the that 2002 case, believes all American homosexuals who have a sex life in line with their preferences are for that very reason criminals. The Paul endorsement is a depressing sign of how much personal liberty America’s political class, even the supposedly freedom-oriented ones, are willing to give up in exchange for lip service to tax cuts.”

A GOP that fails to do tax reform, but embraces bigots like Moore is not a pretty sight.  But that’s where we are today.

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

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

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

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

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

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

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

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

1.  Why Europe still needs cash

2.  Why trade deficits aren’t about trade

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