I work for a small internet retailer. Since most of our orders come from Amazon, we literally get paid when we ship the order. If most of our employees called in sick or self-quarantined themselves for several weeks, our company would collapse. Larger businesses may have a bit more flexibility but they would be severely damaged. When I look at this chart, I see a lot of Chinese people who are not going to work. China’s pandemic is bad for businesses in and out of China. Shortly, we will find out how intertwined the global economies really are when China’s economy contracts.
In a response to the post, Should We Upgrade Our Assessment of Obama’s Economic Record?, I wrote:
I think the Obama economy was a non-traditional economy so evaluating it using traditional quantitative measures will be quite difficult. I suspect some economists would go so far as to describe the Obama economy as a “grand experiment”. Let me highlight some of the non-traditional aspects of this economy that separate it from past traditional economies.
- The combination of zero interest rates and quantitative easing is not something we have done before. Other countries tried this and got hyperinflation. This was America’s first time with this “experiment” and we got low inflation. This tactic was extremely risky. We got lucky!
- For the last eighteen years, American companies have consistently reported better earnings with almost no growth in sales. An underlying theme for this earnings growth was various financial engineering schemes. Instead of investing in capital equipment or employees, we invested in stock buybacks. There is nothing like zero interest rates to encourage stock buybacks and prop up the stock price. Traditionally American companies earnings grew because of productivity growth and great products.
- Another interesting divergence with tradition was the sector driving GDP growth. In the Obama economy, it was the growth of health care and almost no growth of traditional areas, such as home building and retail. For a consumer-driven economy like the United States, this is probably a bad omen for economic growth.
So we had a non-traditional economy, what difference does it make? The policies in the first two years saddled America with a lot of debt and slow economic growth. The solution to this problem is faster economic growth. So why did the Obama administration fail to enact policies that unleashed the animal spirits of the economy? They had six years to figure this out. As James Carville once said its “the economy, stupid“. The Trump administration figured this out in less than two years. It won’t take too many quarters of over 3% GDP growth to come to the conclusion that the “grand experiment” was a policy failure that fortunately we can overcome. The good news is that the “grand experiment” is over and we can go back to being America again. The question that goes to the heart of the question on Obama’s economic record is, am I better off than eight years ago? Am I better off than two years ago? Yes, I am. Real economic growth with low inflation solves a lot of problems.
Last weekend my son said he was binge watching movies about the 2008 financial crisis such as The Big Short. Despite this movie watching, he seemed to be struggling with the government’s proposed fixes for the crisis. I think he wants to believe that the government was trying to do the right thing but his gut is telling him something else. It has been eight years and our gut says we still have “too big to fail” banks and a derivative market with unknown financial risks. It looks like we did not fix anything but chose to kick the can down the road. The traditional approach to a financial crisis is to separate the good assets into a good bank and the bad assets into a bad bank. The good bank is smaller and less risky. The shareholders take the financial hit under this approach. Instead of this approach, our government chose policies very similar to those that led to Japan’s Lost Decade.
Like most economic problems, Japan’s lost decade was largely caused by speculation during its boom cycle. Record low interest rates fueled stock market and real estate speculation that sent valuations soaring throughout the 1980s. In fact, property and public company valuations more than tripled to the point where a small area in Tokyo was worth more than the entire State of California.
When the Finance Ministry realized that the bubble was unsustainable, it raised interest rates to try and stem the speculation. The moved quickly led to a stock market crash and debt crisis, as many debts fueled by the rampant speculation turned out bad. Finally, the issues manifested themselves in a banking crisis that led to consolidation and several government bailouts.
Sensing my son’s struggles I offered three resources that should provide him with additional insight into the crisis.
Unlike the typical explanation that corporate greed caused the crisis, the majority opinion said:
In our inquiry, we found dramatic breakdowns of corporate governance, profound lapses in regulatory oversight, and near fatal flaws in our financial system.
There were two dissenting opinions.
- The first dissenting opinion focused on a worldwide credit and housing bubble that was largely composed of nontraditional mortgages and supported by questionable credit ratings.
- The second dissenting opinion focused on government housing policy and is best summarized with this statement.
As a result of these policies, by the middle of 2007, there were approximately 27 million subprime and Alt-A mortgages in the U.S. financial system —half of all mortgages outstanding— with an aggregate value of over $4.5 trillion.
Senator Warren’s Letter About the Unindicted
In 2016 a part of the Financial Crisis Inquiry report was declassified that indicated that nine people were referred to the Judicial Department for possible indictment. According to Senator Warren these people were “former Fannie Mae CEO Daniel Mudd, former Fannie Mae CFO Stephen Swad, former Citigroup CEO Chuck Prince, former Citigroup Board of Directors Executive Committee Chair Robert Rubin, former Citigroup CFO Gary Crittenden, former AIG CEO Martin Sullivan, AIG CFO Stephen Bensinger, former Merrill Lynch CEO Stanley O’Neal, and former Merrill Lynch CFO Jeffrey Edwards-may have violated securities or other laws. Mr. Prince and Mr. Rubin were each cited in two referrals.” If President Obama was correct in describing the 2008 financial crisis as “the worst economic downturn since the Great Depression” then someone should have been indicted. By comparison, the 1980s S&L crisis resulted in 839 convictions.
Full Measure Video About The Immaculate Corruption
Last week I was shocked to find that Google had banned the latest PragerU YouTube video as hate speech. As a regular listener to PragerU videos I was curious to see the video that went over the edge. From my experience hate speech is definitely not PragerU’s style. The video in question, Was Born To Hate Jews, is by a devout Muslim who describes his transformation of someone who hated Jews to gradual acceptance. Some Muslims might disagree with this man’s opinion but it was not hate speech. When did one Muslim’s decision to accept that Jews are okay and do not need to be wiped off the map become hate speech to Google?
That incident led me to question the subject of ‘fake news’. A Washington Post article, Russian propaganda effort helped spread ‘fake news’ during election, experts say, had started off this mess. In one of the great faux pas of modern journalism the Washington Post said,
One of them was PropOrNot, a group that insists on public anonymity, which issued a report identifying more than 200 websites that, in its view, wittingly or unwittingly published or echoed Russian propaganda.
Okay, let see if I understand this correctly. The Washington Post is saying that ‘fake news’ during the recent elections came from Russian propaganda efforts. This is a considerably different story than the one portrayed by NPR in their story, We Tracked Down A Fake-News Creator In The Suburbs. Here’s What We Learned. The Washington Post went one step further and relied on a list from an anonymous source, PropOrNot. I hate to complain about the lack of journalistic standards but you have to ask the question. At what point did they get a little concerned that this organization might be a ‘fake news’ site just like the ones they were complaining about?
Is The PropOrNot List ‘Fake News’ Sites?
Someone had to do this and obviously the Washington Post was not up to the task. So I went over to the PropOrNot site and took a look at the list. The first thing I noticed was that the list was not ‘fake news’ sites by the NPR standard. The second thing I noticed was that I read several of the sites on a regular basis on the list. They are:
All of these sites express dissenting opinions. Many of the sites express libertarian opinions. From a cursory review of the list I can detect at least three themes, managed economies, Anti-War, and Truth in Government.
Managed Economy Theme
The first group, Stockman’s Contra Corner, oftwominds.com site, and zerohedge.com, are critical of our government’s attempt to manage the economy. Their writings have more in common with the old Keynes versus Hayek debate. The most famous person in this group is former Congressman, Mr. Stockman, who wrote a New York Times bestseller, The Great Deformation: The Corruption of Capitalism in America. Ironically these free market oriented writings are critical of Russia’s managed economy.
The second group, Lew Rockwell, antiwar.com, and the ronpaulinstitute.org, probably got included on the list due to their libertarian, anti-war dissents. Lew Rockwell and former Congressman Ron Paul are Mises Institute board members who are critical of the government’s efforts at regime change. Ironically both President-elect Trump, President Obama, and most of the Democratic party are critical of past regime change policies. It is a pretty big stretch to say that this group’s complaint about regime change “unwittingly echoed Russian propaganda”.
Truth In Government
Wikileaks and several other truth sites represent the truth in government group. Wikileaks is the only site who I might concede wittingly helped Russian propaganda. Although Russia may have been involved in getting the emails to wikileaks, the emails are not ‘fake news’. I went to the wikileaks.org site and confirmed that the DKIM signature said that the emails had not been altered. In the greatest irony of the fake news cycle, the Podesta and DNC emails were so damaging to the Democratic party election chances because they were true news stories.
How Much Do You Need To Write About Russia To Be Included On The PropOrNot List?
Maybe sites make the list because they write a lot about Russia. It is pretty obvious why pravda.ru and rt.com made the list but why did nakedcapitalism.com make the list? Its title implies that it devoted a lot more time discussing capitalism rather than Russia. Was this false advertising? Since the site displays a topic list with the number of posts pertaining to each subject, I downloaded the list and did some calculations. Russia was 47th on the list. The Russian posts amounted to only 0.47% of the 61,907 posts. They were just behind CEO compensation and well behind Europe(28th) and China(30th). Looking at these numbers it is difficult for me to see how this site got on the PropOrNot list. Maybe this is why the folks at nakedcapitalism are suing PropOrNot.
Tyler Cowen wrote an interesting post, Which macroeconomic theories will rise and fall in status because of Donald Trump?, that explored the potential rise or fall of macroeconomic theories under the Trump administration. I decided to jump on the bandwagon and offer my suggestions. Here are his choices and comments.
1. “The multiplier is high.” That seems ready to decline in status.
2. “Even wasteful expenditures can boost demand and help pull us out of secular stagnation.” Ditto. “We need to do stimulus right” will make a comeback. And I see “the distributional effects of stimulus really matter” lurking around the corner.
3. “Tax cuts aren’t as good as government spending.” That actually may rise in status, especially if Congress gets the bargain they want — lots of tax cuts — rather than what Trump wants.
4. The notion of how a credibly irresponsible leader can improve macro performance won’t get cited as much.
5. Austrian-like theories of how there can be a boom in the short run, yet with great long-run dangers, will return to prominence, albeit with modifications to the original Austrian story.
6. Criticizing countries with trade surpluses will decline in status.
7. The efficient markets hypothesis will decline in status. It imposes too much discipline on our judgments of leaders and their policies. The more certain we are of our own judgments, the more that evidence contradicting those judgments should be downgraded. Right?
My Choices For Macroeconomic Rise Or Downfall
- Zero Interest Rate Policy(ZIRP). We have sufficient evidence to conclude that a Zero Interest Rate Policy does not stimulate the economy. ZIRP stabilizes a financial crisis when it is timely, targeted, and temporary. It is not a substitute for a good, long term monetary and fiscal policies.
- Financial Engineering. The zero interest rate policy encouraged many companies to borrow money to buy back stock. Now the Federal Reserve is planning to raise interest rates. How are these self liquidating companies planning to raise sales without borrowing even more money?
- Wall Street Bailout of 2008. The longer we go with stagnant wages and slow GDP growth the more the bailout resembles Japan’s Lost Decade. Hopefully, if we have a recession our policy leaders will not continue to borrow failed ideas from the Japanese.
- All Bubbles Matter. The Wall Street bailout did not reduce the systemic risk posed by the derivatives market. Now we get to watch the European Union deal with the systemic risk posed by Deutsche Bank and multiple Italian banks. At some point we have to admit Keynesian economics is more prone to bubbles than Austrian economics.
Two weeks ago I posted my top question for both Presidential candidates so I decided to expand on that question and post my second question.
If we have a recession in your first term, what will you as President do differently with economic policies than was done in 2008?
The reason for this question is that the economy is weak and the chance for a recession is increasing.
- Deutsche Bank and JP Morgan said in June that the chance of a recession in the next twelve months is between 36% and 60%.
- The 1% GDP growth for the first two quarters of 2016 is sufficiently weak that a slight miss can easily drive the GDP negative and unemployment up.
- Health Services Grew Almost 12 Times Faster Than Non-Health GDP. Since 2015 the increase in health care spending has resulted in flat retail sales. This health care driven economy is different than the consumer driven economy we have experience with. The health care driven economy has very narrow benefits to the overall economy compared to the consumer driven economy. Based on the GDP numbers over the last year and a half, it looks like we can have either a health care driven economy or a consumer driven economy but not both.
- I think after 8 years of zero interest rates the wealth given to the banks did not trickle down to the American people.
The crucial distinction between a recession in 2008 and 2017 is that there are few if any policy options left.
- With interest rates between 0% or 0.25% there is almost no benefit from lowering rates.
- Weakening the dollar to increase exports is a risky policy, too. It could cause capital flight and increased interest rates.
- It has been a Chinese goal to replace the dollar with the SDR as the reserve currency. To achieve that objective China will trade in a portion of its dollar debt for SDR based debt. This will probably cause increased interest rates.
- Can the Federal Reserve continue to expand its balance sheet in a rising interest rate environment without international repercussions?
- Can we learn anything about potential policies addressing a 2017 recession from Mr. Trump’s casino problems in Atlantic City?
My second question is what will you as President do differently concerning health care policies than was done in the Affordable Care Act?
The reason for this question is that if the ACA cannot continue in its present form so how do we address a sustainable reform?
- The health exchanges of the Affordable Care Act are probably in a death spiral.
- President Obama, Mr. Gruber, and other Affordable Care Act supporters have a trust problem with the middle class. The lies they told the middle class about the Affordable Care Act may be forgiven but they are not forgotten. Lying has consequences.
- We have two separate health care problems, a spending problem on high cost chronic care customers and an insurance problem with the healthy customers.
- The big idea for the Affordable Care Act was to dump high cost chronic care patients on the smallest health insurance market. A smarter idea would be move to high cost chronic care patients to either Medicaid or Medicare and let the health exchange work like a free market for healthy customers. If society has a moral obligation to provide affordable health care to high cost patients than it makes sense to spread these costs across a much broader base. Making a small group of healthy customers pay society’s cost for the high cost patients is the recipe for a death spiral.
- We have an extremely complex way of subsidizing health insurance.. The Affordable Care Act prepays health insurance subsidies to insurance companies for low income people and uses the IRS to check compliance. If we are concerned about making a more efficient health care system than a simple re-design would avoid the money spent by the IRS on compliance.
- As a person who started work in 1976 I have always had the option of affordable health insurance. As a recently as 2011 health insurance cost me $311 a month. By 2016 my grandfathered plan had increased 76% over my 2011 premium of $311 to $547. This increase is much greater than the increase in inflation and is an extravagant increase for a person who has not filed an insurance in over 16 years. The situation in the exchanges is unfortunately much worse. The lowest cost 2016 bronze plan would cost me $1,025 a month. This is 87% higher than my 2016 grandfathered plan and far higher than the 8.05% the IRS had declared as affordable. Despite being the perfect insurance customer I can no longer find affordable health insurance. In 2017 I will go without health insurance.
- According to a study from the Mercatus Center the states that expanded Medicaid under the Affordable Care Act have seen enrollment higher than expected and the cost of individual enrollees has been more expensive than projected.
When I saw the nice graph Curtis Miller created showing that productivity detached from wages in 1973, I was curious if I could duplicate it in FRED. Nothing against R but creating a graph in FRED is fast and easy since much of the Bureau of Labor Statistics data is available. After a little searching I found both series and indexed them to 1947.(Oops! I used the wrong series. I should have used the Business Sector: Real Output Per Hour of All Persons (OPHPBS) and Real Compensation Per Hour [RCPHBS].) The graph is similar to the one Curtis created except it pushes the date when productivity detached from wages back to the first quarter of 1970.
Although David Stockman argued in his book, The Great Deformation, that the era of sound money ended around this time, I am not comfortable with the idea that dumb spending policies should have an impact on real wages and productivity. I am not surprised but it does make me wonder. Is the adoption of fiat currencies and the expansion of the welfare state the reason we are seeing reduced real wages despite improving productivity?
- US. Bureau of Labor Statistics, Nonfarm Business Sector: Real Output Per Hour of All Persons [OPHNFB], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/OPHNFB, September 13, 2016.
- US. Bureau of Labor Statistics, Nonfarm Business Sector: Real Compensation Per Hour [COMPRNFB], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/COMPRNFB, September 13, 2016.
When I read Paul Krugman’s op-ed, Bull Market Blues, I realized I had at least three ideas that explained the bull market blues better than his idea that “stock prices reflect profits, not overall incomes”. Here are my top three ideas.
Federal Reserve’s Co-dependent Relationship With The Stock Market
By far the biggest impact on stock prices has been the question of when will the Federal Reserve stop its zero interest rate policy. To buyers and sellers in the stock market the latest speculation about the Federal Reserve decision is far more important than either actual profits or profit guidance. Almost every week there is a financial reporter saying the market has gone up or down based on speculations about Federal Reserve actions. This link is stronger now than at any time in the history of the Federal Reserve. After seven years a large group of buyers and sellers have cynically embraced the thought that the zero interest rate policy has created a stock market bubble and is the only thing holding up higher stock prices. Although the Federal Reserve loathes to admit it, it is their fear of declining stock prices that caused their policies to devolve into this co-dependency relationship. Now they are stuck with a policy that can written off as “trickle down economics” for banks but is increasingly necessary to keep the stock market bubble intact. It reminds me of the Federal Reserve easy money policies during the 1920s and we know how that stock market bubble ended. There is nothing that gives me the blues more than to see how quickly the Federal Reserve backs off of a rate increase when the stock market tumbles for a couple of days. It is as if the Federal Reserve cares more about the stock market than the economy. At some point the Federal Reserve will regain its focus on the economy and all of us will have to endure the stock market blues until we can purge the market of its excesses.
The FANG Portfolio
In 2015 the S&P 500 would have declined if not for the FANG portfolio, Facebook, Amazon, Netflix, and Google. Despite Mr. Krugman’s belief that stock prices reflect profits these companies are prime examples of growth stocks that are richly valued by their expected profit growth and not their minuscule profits. They also represent the leading edge of the Unicorn Companies who have rich valuations and almost no earnings. To paraphrase former Federal Reserve chairman, Allan Greenspan, there seems to be an irrational exuberance for these unicorn companies. As an example of this irrational exuberance, Salesforce.com has almost never had a profitable quarter and presently sports a price to earnings ratio of -4,213. How does this company deserve a market capitalization of $54 billion and get its name on the tallest building west of the Mississippi?
One of the interesting trends since the last economic expansion that was based on productivity gains has been the growth in financial engineering tricks. Since financial engineering was one of the technologies that enabled the sub-prime mortgage bubble and the 2008 stock market crash, it is foolish to overlook its importance. Despite reforms from the 2008 crash financial engineering remains largely intact, profitable, and does not require many people to implement. To many companies it is more attractive than investing in productivity improving ideas such as direct capital expenses and employees. It is also one of the main reasons middle class wage increases have stagnated since 2000. In its most recent incarnation many companies have taken advantage of low interest rates to buy back their own stock in an effort to raise their stock price. The executives and stock holders of these companies realize they will be rewarded with higher stock prices despite the fact the sales for the company are unchanged. If the best investment idea for these companies is to buy back their own stock, it is also a condemnation of these executives whose primary job is to grow sales and reduce costs via new products, greater innovation, and productivity. The worst case scenario is that one of these days the Federal Reserve will be successful at creating higher interest rates and inflation and these companies will have too much debt to invest in new products and productivity improving ideas.
After eight years of benign neglect I was hopeful that this would be the election cycle that the Democratic party would get a clue about middle class problems. When you go over to the Hillary Clinton For President site you see her “eight ways we can give American families a raise“.
- Cut middle-class taxes.
- Make college affordable.
- Raise the minimum wage.
- Support unions.
- Rebuild our infrastructure.
- Boost manufacturing jobs.
- Invest in clean energy.
- Lower child care costs.
Most of these suggestions will not help me at all. Two of these suggestions, rebuilding our infrastructure and boosting manufacturing jobs, might help me indirectly. This is such a meh group of ideas you have to wonder what drove them away from bread and butter issues for the middle class like the economy, government corruption, jobs, immigration, and the rising cost of health care. It just not me saying this. The most recent Gallup poll asked, What do you think is the most important problem facing this country today? The top four issues listed were the economy in general, dissatisfaction with government, unemployment/jobs, and immigration. I hate to say it but the non-politician, Mr. Trump, seems to know the issues bothering the country and the professional politician, Ms. Clinton, does not!
Her next suggestion was to put Bill Clinton “in charge of revitalizing the economy“. The problem I have with Mr. Clinton’s economic record is that his success depended largely on the on the productivity gains from expanding the use of personal computers in the work place. By the time he left office there were no more places left where productivity would improve from using personal computers. If you look at recent year to year productivity gains, you can see that the decline in the personal computer business from 2000 to 2010 matches the decline in productivity gains. If you believe that productivity growth results in real economic growth for the middle class then you can understand why the lack of productivity gains coupled with a financialization bubble has made life miserable for the middle class. If we assume that the financialization bubble over the last 8 years is over then we are left with searching for productivity gains in an increasingly socialist economy. Something has got to give and sadly Ms. Clinton is clueless!
I struggle to explain the current economy. Gone are the days of inventory-driven booms and busts. We hated the layoffs but at least the economic boom was robust and benefited everyone. It was the rising tide that lifted all boats. Now it seems that neither good or bad economic news affects the economy. We have several years of lousy retail sales growth that does not seem to matter. We are “experiencing the strongest streak of employment growth since the 1990’s” but that does not seem to matter. Almost all of our economic and job growth comes the health care sector but that does not matter. Even lower prices for gasoline do not matter. This is not my father’s economy. The doldrums we are experiencing seems to have more in common the crisis of confidence that President Carter spoke about in his “Malaise” speech but with one significant difference. Based on recent history it looks like the traditional correlation between jobs and economic growth is considerably weaker than in President Carter’s economy. I am not alone in my confusion. Lance Roberts voices similar concerns in his article, Is There A Problem With The BLS Employment Reports?
IF we were truly experiencing the strongest streak of employment growth since the 1990’s, should we not be witnessing:
- Surging wage growth as a 4.9% unemployment rate gives employees pricing power?
- Economic growth well above 3% as 4.9% unemployment leads to stronger consumption?
- A rise in imports as rising consumption leads to demand for goods.
- Falling inventories as sales outpace production.
- Rising industrial production as demand for goods increases.
Obviously Mr. Roberts was expecting a much stronger correlation between job and economic growth than we are seeing. The more interesting question has to be, why are businesses hiring when it looks like that hiring more people does not translate into growing sales?
Charles Smith shows in this chart the growing disconnect between jobs and economic growth has been going on for a long time.
Over the last forty years we have chosen to become a country less dependent on labor. Part of this decline can be explained that global trade has encouraged countries like the United States to ship low wage jobs to countries with lower labor costs. A good portion of our textile business went over seas for this reason. Ironically this “land of opportunity” has less opportunities for low wage jobs than ever before and an even bigger problem with middle class jobs. Every developed country is desperately trying to hold on to its middle class jobs and, in some cases such as China, increase them. So if you believe financial engineering bubble is over then we are left with growing the economy in a way my father would be comfortable with, growing the middle class by encouraging product development at small and medium size businesses. The heavy hand of government regulations combined with increased cronyism seems to have been more advantageous to the firms that got most of their earnings from financial engineering rather than product development. The millennials and Hispanics need to start sifting through the policies that worked in the past and tweak them for this new generation. So if the health and wealth of America depends largely on the health and wealth of the middle class, what are the competitive advantages that will convince businesses to keep their middle class jobs in America?