Thursday, July 31, 2014

Is There A Good Way To Stop Corporate Inversions?

The increase in corporate inversions has triggered debate in Washington.  Some argue that cutting the corporate tax rate is the solution, and others are considering changes in laws that make it more difficult for corporations to reincorporate in lower tax nations.  There is a good description of the issues on both sides of the debate in this article.


Why Are Customers and Employees Rallying In Support Of A Fired CEO

One of the most successful grocery chains in America is on strike.  Customers and employees are protesting the firing of its CEO.  There are not many firms in America where that would happen today.  This article on the Market Basket protests in New England has made it into the national press because it is unique.  It flies in the face of the dominant business ethic in America which holds that maximizing shareholder value is the mission of the corporation.  The deposed CEO has operated the successful firm based upon a strikingly different view of the corporate mission.  He claims that the key to the firm's success has been building a link between its employees and its customers.  While other firms, which often claim that "employees are their greatest asset", cut employee benefits and downsize in order to maximize shareholder value, Market Basket has demonstrated that the old fashioned ideas held by Market Basket's CEO can be a key to success in business.  The owners of Market Basket have prospered under this form of management. A community of shared interest has been established between the employees and its customers. 

The firing of the CEO at Market Basket has little to do with the firm's performance.  There has been a long history of disputes between the members of the family which own Market Basket.  One wing of the family gained control over the board and fired the leader of the other family wing.  This kind of thing often happens in family held firms.  The fired CEO is currently engaged in discussions with the other wing of the family about the price of a payout that is in the $1.5 billion range.  Some members of the controlling family would like to take the money and run. They have little interest in running a business.

Wednesday, July 30, 2014

Details On 4% Growth Rate In Spring Quarter

The good news is the 4% growth rate was higher than most forecasts.  The details in this article indicate that the economy is still puttering along.  Inventories increased 1.66% and accounted for much of the gain in GDP.  Its better when the gains come from final sales rather than inventory.  The average real annual growth rate excluding inventories has been around 2.4% since the end of the official recession.  During a typical business cycle recovery the growth rate is usually much faster.  We have not made much progress in reducing the output gap.  The economy not growing fast enough to reduce the gap between potential GDP and actual GDP.  It also means that output could expand without creating price inflation.

Is There A Real Debate Among Economists About The Obama Stimulus?

This survey of top economists about the effect of the Obama stimulus indicates that there is less debate about the impact of the stimulus within the profession than there is among the general public. Much of the general public believes that stimulus did not reduce unemployment, and they also believe that the resulting budget deficit has led to unsustainable government debt.  Few believe that the stimulus might have been too small, or that less of the stimulus should have been devoted to tax cuts.  Economists are more likely to debate the size and content of the stimulus rather than its efficacy.

The lack of consensus about the Obama stimulus among the general public is not the result of disagreement within the economics profession. There is wide agreement about its immediate impact, and some uncertainty about longer term effects.  The public depends upon the media for its information.  The right wing media constantly attacked the stimulus and government deficits for several years.  The mainstream media play a different game.  It gives equal time to both sides of the debate.  Given the consensus within the profession, this is like giving equal time to those who argue that the earth is flat.

Tuesday, July 29, 2014

St Louis Fed Study Shows That Chasing Stock Returns Is Poor Strategy

Many investors chase returns in the equity market.  They increase investments in mutual funds when stock prices have increase and they sell when performance deteriorates. That is a losing strategy. Investors who buy and hold mutual funds earn a 5% annual return during 7 year periods.  That implies a 40% return over the period.  This study confirms the views of investors like Warren Buffet who does not try to time the market.  He buys stocks that represent a good value,  and he holds them as long as the firm maintains its strategic position in an industry.  I doubt that Buffet watches CNBC.

West Agrees To Widen Sanctions Against Russia

Recent events in Ukraine has encouraged Europe to join with the US to widen sanctions against economic interests in Russia.  Europe has been more connected to Russia economically and it has been more difficult for them to agree on sanctions.  Germany has the strongest economic relationships with Russia but recent events have motivated it to agree to strong sanctions.  The UK has banking relationships with Russia and France sells military equipment to Russia.  They resisted sanctions until the downing of the Malaysian airline in Ukraine.

Why Not A Maximum Wage To Reverse Income Inequality?

Many are comfortable with a minimum wage because it provides a floor which enables some to earn a subsistence wage.  If a minimum wage makes sense, why not use a maximum wage to reverse the inequality trend that is particularly acute in the US and the UK?  It is pretty clear that there is a market failure in the US and the UK because there is no reason to believe that these executives are more productive than those in other western nations.  Some of the issues that arise from this discussion are interesting.

One issue is whether there is really a market that determines CEO wage levels.  There may be no market failure if there is no real market in which corporate boards compete for the most productive CEO's on price.  The market for wages in most corporations is internal.  The share of wages going to top management is determined internally by corporate boards.  They justify their decisions by using compensation consultants who provide comparative data on CEO compensation in their industry.  Few corporate boards conclude that their CEO is not in the top quartile for their industry.

Some argue that shareholders should be more aggressive in limiting CEO compensation.  There are several problems with that suggestion.  CEO's receive most of their compensation in the form of stock option grants.  That was done in order to link CEO compensation to increases in shareholder value.  Moreover, Wall Street likes this arrangement.  The reports of their analysts have an important effect on the direction of a firm's stock price.  The criteria that they use to evaluate corporate performance provide Wall Street with a measure of control over corporate decision making.  For example, during the dotcom boom Wall Street analysts provided World Com with positive reviews because the CEO was serial acquirer of other firms. They earned huge fees from his business.  World Com failed and the CEO ended up in jail.  The Wall Street analyst did not go to jail.  The criteria used by Wall Street analysts today may have changed but CEO's are very sensitive to the short term performance goals that are in favor today. 

Since corporate governance is not likely to change, and the influence of Wall Street and the shareholder value ethic is very powerful, we cannot expect changes in CEO compensation to be modified by internal forces,  any changes will have to come from external forces.  The changes in CEO compensation may have been triggered by tax policies in the US.  A reduction in the top marginal tax rate may have encouraged CEO's to pursue higher wages, and the reduction in taxes on dividends, and on capital gains from stock sales, has also encouraged CEO's to promote their financial interests.  Some argue that more progressive tax policies might be the best way to reduce income inequality.  That may be accurate but it will be very difficult in our current environment.  The first problem is that corporate executives can direct campaign contributions to favored candidates.  The second problem is that nation states compete with each other on tax policy.  Corporate executives can, and do find ways to limit the ability of nation states to determine tax policies.

Why Credit Collection Is A Big Business In The US

Over 220 million Americans have a credit file at one of more of the credit reporting agencies in the US.  A recent study found that 35% of Americans with a credit file have at least one debt that has been referred to a collection agency.  That does not include mortgage debt and it excludes 22 million low income citizens who do not have a credit history.

The findings in this study are similar to those reported by the Fed in 2004.  Apparently,  this is not a new problem in the US.  On the other hand, the consequences for those with debts under collection are serious.  It is harder for them to access new credit and many employers use data from the credit agencies when making hiring decisions.  Many of the debts under collection are under $100 and the average debt under collection is only a little over $1,000.

Structuring Inversions Is A Billion Dollar Business For Wall Street

Wall Street banks have been advising their corporate clients on ways to avoid taxes for a long time.  Inversions are the latest method.  US corporations purchase a foreign company in a low tax state and reincorporate in that state.  This reduces US tax revenues substantially.  The share of US tax revenues from corporations has dropped considerably over the last 40 years.  That means that the tax burden is shifted to Americans who are unable to employ the tax avoidance tactics used by corporations and the super-rich.  This is just another business for the Wall Street banks.  Some bankers don't like doing inversions but they claim that a competitor will do it if they refuse.  That is the excuse that many bankers used when they competed in the mortgage backed security business.  Corporations justify tax avoidance by arguing that they are necessary in a competitive global market.  They claim that US corporate tax rates make them uncompetitive.  Its hard to believe that claim when corporate profits are at an all time high.  Moreover, the corporate tax code is riddled with loopholes that reduce the effective corporate tax rate substantially.  

Monday, July 28, 2014

Having Fun With The Idea That Corporations Are People

The US Supreme Court has declared that corporations are people: the court granted them the protection of free speech under that assumption, and it also extended freedom of religion to corporations.  This article takes the court's position on corporations to some of its logical extremes.  It leads to quite a bit of good humor.

Sunday, July 27, 2014

Why Growth In Employment In Britain Is Not Good News

The government is very proud about falling unemployment data in Britain.  This article explains why its not really good news.  The explanation is quite familiar to economists but the government does not seem to be worried about it.  That is because it believes that a falling unemployment rate will help the government to win elections.

The increase in the employment rate would be a good thing if output was increasing along with rising employment.  That is not happening in Britain.  That means that the labor productivity rate is falling.  The implication of low productivity growth is that wages will also decline.  This is especially acute when productivity is growing faster in other nations.  Britain has been falling behind other nations in productivity growth and is becoming less competitive as a result.

Saturday, July 26, 2014

Save The Economy By Protecting The Environment

Robert Rubin was a Secretary of the Treasury under Bill Clinton and a top executive on Wall Street.  He has become very concerned about climate change because we tend to think about it in the wrong way.  It is a mistake to think about climate change mitigation as a trade off between economic prosperity and the cost of mitigation.  He argues that the cost of inaction exceeds the cost of action.  Moreover, climate change is a present danger and not a future risk. For example,  the damages from Hurricane's Katrina and Sandy were $193 billion.  The carbon that we emit today has a long half live.  Some of the damages to the environment may become irreversible if we fail to take the necessary actions today.  In order to save our economy we need to protect the environment upon which the economy depends.

Rubin does not discuss the actions that need to be taken to protect the environment from climate change, but he argues that we need to change our accounting to recognize the costs of inaction.  He argues that the risks are not incorporated in most of our business plans.  The SEC suggests that they be included, but it is optional.  The SEC should mandate the inclusion of the risks from climate change in corporate business plans.  Government will have to spend large sums in response to the damages spawned by climate change.  These costs are not included in government budgets.  Paying for the damages from climate change will force governments to raise taxes or cut spending on other programs.  The costs from likely damages from climate change should be included in government budgets so that we can measure the cost of inaction.  Rubin also argues that we should alter the way in which we measure economic output.  We view GDP as the best available measure of the economy but it does not include the costs to society of the externalities associated with producing the output.  It includes the costs associated with extraction of raw materials from nature but it fails to account for the depletion of natural resources.  These resources are not infinite.

Thursday, July 24, 2014

The Prosecution of Christians In Parts Of Iraq Controlled by ISIS

This NYT editorial is critical of the Maliki government in Iraq.  ISSI, which is an offshoot of Al Guada, has been persecuting Christians and has given them an ultimatum to convert to Islam, or to leave the part of Iraq that it controls.  The editorial suggests that Parliament remove Maliki and replace him with a leader that can unite the country, and strengthen the military which has been unable to prevent the advance by ISIS.  Iraq had such a leader before he was removed after the invasion of Iraq by the US.  His methods of controlling the various factions in Iraq were brutal.  It is doubtful that a new leader in Iraq can defeat ISIS and unite the country in the process.  The editorial board of the NYT is engaged in wishful thinking.  Iraq is not ready for a George Washington to unite the country and create a democracy. 

The elder George Bush was encouraged to depose Iraq's dictator after our first war with Iraq.  He was advised against opening a hornet's nest in Iraq, and he decided against those who supported regime change in Iraq.  He also advised his son against making the mistake that he avoided.  We have been living with the mistake made by the junior Bush for eight years.  Al Quada which was not a force in Iraq has become more powerful in Iraq and elsewhere in the Mideast.  We have been left with a broken and dangerous situation in Iraq and in the Mideast as a result one of the worst foreign policy decisions in our history.  I am reminded that George Bush's popularity soared after the invasion of Iraq.  Putin's popularity in Russia has also risen dramatically after his interventions in Ukraine.  It is not surprising that leaders take advantage of military power when the public responds as it does to a display of national power.

The Facebook Money Machine

This article explains why Facebook's stock price is booming.  It is a cash machine that will enable it to purchase promising tech firms.  Facebook, is like other businesses that make money by selling ad space, but it is different in important ways.  Facebook has an operating margin of 42%; it costs them very little to provide the services that make its product available to advertisers.  Unlike other ad platforms which have to pay for expensive content and produce a physical product, Facebook's clients provide the content which is delivered over the Internet.  Moreover, it commands 22% of the rapidly growing mobile ad market.  This should not be surprising given the huge number of regular visits to Facebook by hundreds of millions of users across the globe.  Facebook also provides advertisers with user profiles that allow them to target ads to the most promising prospects for their products.  In this way, they are also like google, which has also used its cash hoard to purchase promising start ups.

Macroeconomics At A Crossroads

This article describes the disconnect between academic macroeconomics and its application to the real world.  Academic macro is dominated by the development of models based upon microeconomics.  The assumption is that models of the economy, and the business cycle, can be developed using what micro economics tells us about how economic agents will behave in particular situations.  These models are not used in industry, and they are not used by financial institutions.  They are used by some central banks, and organizations like the IMF,  but they are not used by the Federal Reserve.  There are many forms of these models (DSGE) but they have not been useful in managing the business cycle.  The Fed still uses statistical models based upon correlation which were abandoned by academics in the 1980's who decided to build models based upon the "natural science" of microeconomics. 

It is unlikely that academics will abandon efforts to develop a "science of macroeconomics" based upon their understanding of human cognition.  They may give up on their efforts to model the entire economy and develop more specific models that might be useful in more specific applications.  The Fed will probably continue to use the older models that have been abandoned by academics to manage interest rates and the business cycle.  Given this situation, it should not be surprising that economists have different views about economic policy choices available to central banks and to government.  They don't share the same economic assumptions, and their views are also shaped by their political philosophies.  For example, one group of economists would like the Fed to raise its inflation target above 2%.  That will lower the real rate of interest (the nominal rate minus the inflation rate) and facilitate economic growth.  The other group believes that higher inflation and lower real interest rates are both dangerous and ineffective. 

Tuesday, July 22, 2014

Stock Price Growth In US Driven by Cost Savings Not Revenue Growth

This graph shows that margin growth has been driving the growth in earnings per share.  Corporations have been cutting costs in order to increase margins and boost stock prices.

They have also been cutting investment spending which also boosts margins.  This raises a question about sustaining the growth in stock prices.  At some point cost cutting will become less effective and sales will have to increase in order to boost profits and stock prices.  Cutting back on investment spending, however,  impairs the ability to expand sales.  Many corporations have replaced investment spending with acquisitions that might increase revenues.  They also tend to engage in layoffs following acquisition's. For example, Microsoft announced a very large layoff following an acquisition. Wall Street liked the announcement and Microsoft got a good boost in its stock price. Its no wonder that job growth has been weak relative to the growth in corporate earnings.

Why We Should Be Glad That The US Government Is Not Like Argentina's Government

The government of Argentina has taken actions to impair the independence of its central bank and it has also caused its statistical agency to report inflation numbers desired by its president.  Many conservatives in the US would like to impair the independence of the Federal Reserve, and many claim that the US Bureau of Labor Statistics (BLS) misreports unemployment and inflation data at the behest of the Obama Administration.  In other words, critics of the Obama Administration  claim that the US government operates like the government in Argentina.

This article is critical of on the claims made by right wing conspiracy theorists in the US who claim the BLS under reports inflation in the US.  It does a good job of explaining some of the difficulties that arise in the measurement of CPI and it concludes that the measurement of household rents, which represent 30% of the CPI, has elevated the CPI in the US.  Rents have increased in the US because the large numbers of foreclosures has increased the demand for rental properties.

There is a link in this article to a tweet by Jack Welch, the former GE CEO, who accused the BLS of under reporting the unemployment rate just prior to the 2012 election at the request of the Obama Administration. Welch refers to the Obama Administration as the "Chicago guys" which connects Obama to the shady history of how government may have operated under Democratic mayors in the past.  Welch has become one of the leading right wing conspiracy theorists in the US.  His thoughts have found their way to the editorial pages of Rupert Murdock's Wall Street Journal.  

We have lots of problems in the US, but one of the things that we should be thankful for is that we are not like Argentina.  We should be glad that US institutions like the Fed and the BLS maintain their independence, even when they are under heavy pressure to serve politicians.  Right wing conspiracy theorists may be projecting their own way of thinking about the operation of government onto the Obama Administration. 

Sunday, July 20, 2014

Why Did the CBO Lower Its Forecast For Long Run Interest Rates?

The Congressional budget office lowered its projection of long run interest rates from 3% in 2013 to 2.5% in its current forecast.  The lower rate is also below to average interest rate of 3.1% between 1990 and 2007.   Interest rates have an important effect on the long term US budget outlook since the national debt is expected to rise and interest payments will demand an increasing share of federal spending.  The CBO forecast improves the long run budget outlook in the US.  Lower interest rates also increase the value of financial assets.

The CBO looked at factors that might increase interest rates along with factors that might lower them in making its forecast.  It is interesting to consider their analysis of the factors that drive interest rates:

Factors That Lead To Higher Interest Rates

  • Government borrowing demand increases along with its debt burden.  This crowds out funds available for private investment and makes investment more expensive
  • As developing countries become richer they will consume more and send less of their savings to the US
  • Higher returns on capital will increase the demand for capital in the private economy
Factors That Cause Interest Rates To Fall

  • The demand for safe assets like US bonds has increased due to the financial crisis
  • Lower growth in total factor productivity will reduce investment demand 
  • Rising income inequality increases the savings rate because wealthy individuals save a greater share of their income
The CBO forecast implies that the factors driving interest rates lower are more powerful than those that would increase interest rates.

Saturday, July 19, 2014

The Power And Consequences Of Market Fundamentalism

Karl Polanyi wrote a critique of market fundamentalism in The Great Transformation.  His critique has relevance to what we observe today.  A new book is reviewed in this article that applies Polanyi's critique to the revival of market fundamentalism, and its political ramifications, that we observe today.  Polanyi argued that the idea of self regulated market is utopian and that efforts to achieve that ideal would have dystopian consequences.  He worried that market instability leads to counter movements that produce political instability.  The Great Depression created opportunities for the rise of fascism in much of Europe, and it created the environment for the New Deal in the US.  Similarly, today the Great Recession has led to market instabilities that have unleashed reaction from the left and from the right in Europe and in the US.  It is difficult to determine the eventual outcome of these movements, but political instability seems to follow from market instability.  This raises questions about what government might do to stabilize the economy.  Market fundamentalists tend to blame government regulations for market instability.  Others argue that the deregulation of the financial system led to the crisis.  Polanyi argues that this debate has no meaning.  There is no such thing as a market system that operates in the absence of government.  The basic question for Polanyi is how the rules that enable the market to function are determined, and who benefits from the rules.

Polanyi's critique of market fundamentalism go well beyond the false issue of regulation versus deregulation.  He argues that the concept of a self-regulated market requires a means by which self regulation can be accomplished.  This led to the idea of social naturalism.  That is, natural forces, like those we observe in the natural sciences, enable the economy to self regulate.  Polanyi credits Malthus and Ricardo with the discovery of the natural force that regulate the economy.  That principle is scarcity.  The basic idea is that leisure is the natural tendency of mankind.  That is counterbalanced by the need for subsistence.  People will give up leisure for labor as long as wages provide the only means for subsistence.  It is the scarcity of the means for subsistence that disciplines the labor force and enables the operation of a labor market based upon the pricing and availability of wages.

The implication of this form of social naturalism is that the discipline of scarcity must be maintained.  All forms of social welfare in which government programs supplement wages in order to provide basic necessities violate this rule.  For example, unemployment insurance encourages workers to live off of the dole.  We have high unemployment because workers refuse to take the available jobs.  There is no such thing as a shortage of available jobs.  There can be a skill mismatch, but it is assumed that the shortage of jobs is only a temporary phenomenon.  Of course, any notion of a minimum wage, or cooperative bargaining over wages levels, violates the basic principle of a free market for labor.

Polanyi believes that markets are necessary for any functioning society.  He strongly objects, however, to the evolution of a market economy into a market society.  We have a market society when everything is turned into a commodity that should be bought and sold in a market.  Market fundamentalists minimize the idea of public goods.  Public education should be replaced by private education; Social Security should be privatized;  consumer directed healthcare is viewed as the best way to reform our healthcare system because it enables the price system to ration consumption;  government operated toll roads ought to be sold to private road operators,  etc. etc. etc.

Polanyi's classic critique of market fundamentalism helps us to view current events with a more critical eye.  Unfortunately, his book is not easy to read.  The book under review in this article helps us to understand the problems of market fundamentalism and to apply Polanyi's critique to our current economic and political issues. 

Friday, July 18, 2014

Will Corporate Tax Cuts Help The Middle Class?

Every politician loves the middle class.  That is because most of the electorate belongs to the middle class.  Consequently, politicians often argue that their economic policy proposals are good for the middle class.  Jared Bernstein was at a congressional hearing on proposals to cut corporate taxes.  The tax cuts were defended by arguing that they would be good for the middle class.  In this article Bernstein shows that corporate tax cuts do not trickle down to the middle class.  The corporate tax code needs to be reformed, but there are better ways to do it than to lower the tax rate under the pretense that it will benefit the middle class.

Bernstein does not elaborate on the real corporate tax problem in this article, but it is part of a more general problem.  We have a global economy and our large corporations operate within that economy.  They maximize shareholder value by deriving as many benefits as they can from the nation states in which they operate, but they don't don't want to pay taxes for the services provided by the state.  They do what they can to can to get the state in which they are incorporated to shape the operation of the global economy to meet their needs, and most national governments believe that it is in their interest to do so, but they are holding a weak hand.  Their jurisdiction is bounded by geography.  Our large corporations have a global playfield.  In particular, they have found ways to use that playfield to their advantage on tax policy.  Its a race to the bottom on tax policy unless national governments work together to prevent it.

The Intellectual Edifice Of Right Wing Reaction To Government Activism And Democracy

Martin Feldstein was the Chair of the Harvard Economics Department and an economic adviser to Ronald Reagan.  He also was the head of National Bureau of Economic Research.  He left his mark on Harvard and helped to shape conservative economic ideology.  Brad DeLong lists many citations from Feldstein during his tenure as an economic spokesperson for the right.  They are still with us today.  Feldstein has been arguing that inflation is just around the corner for the last five years.  He opposes the activism of the Federal Reserve, progressive taxation, government regulation etc. etc.

Government activism is particularly distrustful when it reflects the wishes of ordinary people.  Sometimes democracy does what it supposed to do and government responds to its citizens.  Samuel Huntington played an important role as a critic of "too much democracy".  He lays bare one of the fundamental pillars of conservative political ideology.  That is, respect for hierarchy and disrespect for social activism that threatens the authority of the hierarchy.  The activism of the 1960's inspired the conservative reactions that became visible under Reagan and Thatcher.  Too much democracy undermines the aristocracy that is at the heart of conservative ideology.  DeLong provides us with a list of Huntington's political ideology which blends nicely with Feldstein's worship of an economic system that is not distorted by government efforts to redistribute the output in a more democratic fashion.

Wednesday, July 16, 2014

The Difficult Road Ahead In The Eurozone

This article provides an analysis of the economic problem in the eurozone and concludes that the only way out of the problem is to engineer a "Goldilocks Economy".  Rapid growth would be bad for the banking system and so would very slow growth.  The only workable solution is one with moderately low growth.  That is because the banking crisis is the real problem in the eurozone.  The other problem is Treaty on Stability, Coordination and Governance which limits policy options on the periphery.

The eurozone crisis was blamed on irresponsible sovereign debt and austerity was the chosen solution to sovereign debt problem.  Austerity would reduce public debt levels and inspire confidence.  That has not worked.  Greek debt as a percent of GDP was 105% in 2008.  Today it is 175% and GDP has dropped by 25%.  Over the same period Portugal's ratio has increased from 62% to 129%; Spain's has risen from 36% to 93% and Ireland's ratio has increased from 25% to 123%.  Consumer confidence is down and business confidence has not risen in the eurozone as a whole.  Moreover, unemployment levels outside of the export driven Northern nations remain at high levels.

It was politically easier to blame public debt for the economic problems in the EZ than to focus on the problems in the banking sector.  The banks were loading up on sovereign debt and borrowing short term by using the bonds as collateral.  They used the borrowed funds to make long term loans at higher interest rates.  This source of liquidity dried up when sovereign bonds lost their AAA ratings.  The ECB provided liquidity through its Long Term Refinancing Operations (LTRO).  Banks could borrow from the ECB at 1%.  For example, Spanish banks could borrow at 1% and purchase Spanish bonds the paid 7%.  That helped to restore their balance sheets by replacing bad loans with profitable assets.  The ECB also promised to purchase sovereign bonds if necessary.  The prices on sovereign bonds rose rapidly and interest rates declined.  For example,  the interest rate on French 10 year treasuries is lower than that of US 10 year bonds.

The banking recovery is at risk if the economy grows rapidly.  The ECB would have to increase interest rates to combat the risk of inflation.  That would lower the value of the sovereign bonds that helped to restore their balance sheets.  Consequently, the banks must find ways to make profitable loans in period of only moderate economic growth.  That is the "Goldilocks Dilemma".  The economy must grow at a lukewarm rate so that banks can work their way towards solvency. 

The Treaty on Stability, Coordination and Governance places limits on fiscal policy.  Austerity is built into the treaty.  High levels of unemployment in the periphery nations will be around for a long time according to this analysis.

Tuesday, July 15, 2014

Secular Stagnation Versus A Deep and Prolonged Business Cycle

Larry Summers revived the concept of secular stagnation which argues that we are in for an extended period of slower economic growth.  His argument hinges on the relationship between the real interest rate and economic growth.  The real interest rate has been very low for many years and even a negative real interest rate has failed to accelerate the growth rate.  David Beckworth shows that the risk free interest rate has been pretty steady over a number of years and that should be used as the natural rate of interest.  Moreover, the risk free interest rate correlates with the business cycle over an extended time period.  He also argues that positive demographic trends will stimulate growth along with rising productivity.  He concludes that we in the throes of a bad business cycle and that we will return to normal levels of growth just as we did after the Great Depression.  Which crystal ball do you prefer?

Monday, July 14, 2014

CitiGroup Agrees to Pay $7 Billion Penalty For Selling Toxic Securities

The $7 billion penalty that CitiGroup agreed to pay was based upon evidence that it sold mortgage backed securities to customers despite the knowledge that investors would suffer large losses.  The agreement reached with CitiGroup does not prevent the government from pursuing criminal charges against individuals or the bank.  However, the Justice Department has seldom prosecuted banks on criminal charges.  Essentially, it would put banks out of business.

The government may also decided to prosecute Bank Of America on similar charges.  BOA is fighting against prosecution on the grounds that it should not be liable for the behavior of Merrill Lynch which sold toxic mortgage securities to investors prior to its acquisition by BOA.  It purchased Merrill under pressure from the government which wanted to avoid a dangerous bankruptcy.

Kansas Governor Defends Ruinous Tax Cuts

Sam Brownback and Republican legislature in Kansas promised that the huge tax cuts that it made would actually increase tax revenue in the state.  Now the state has to cut spending in response to a huge decline of $338 million in tax revenue.  Instead of admitting that the tax cut failed to promote the promised growth that would lead to increased tax revenue Governor Brownback clings to his belief in what many call voodoo economics.  He claims that the operation was a success but that the patient takes time to heal.  This is a classic case of faith based economic thinking.  True believers like Brownback cling to their beliefs despite disconfirming evidence.

Saturday, July 12, 2014

College Educated Wage Gap Widens Over 21 Years

This graph shows the growth in inflation adjusted median household income between 1991 and 2012.  Households with a bachelors degree or above are doing about as well as they did in 1991.  The wage gap has widened, however, because the median income of households with less education has declined by 15-20% since 1991.

Thursday, July 10, 2014

Kenneth Arrow Interview On The Market System

Kenneth Arrow was awarded a Nobel Prize in economics at the age of 51.  He is clearly regarded as one of the most influential US economists in recent history.  The University of Notre Dame posted an excerpt of an interview of Kenneth Arrow that is worth reading.

Arrow argues that any economic system should be evaluated in terms of two criteria.  Since any society should be concerned about the welfare of all of its citizens,  the distributional aspects of the system must be considered.  He argues that many European societies are better at meeting the distribution criterion than we are in the US.  They have social welfare programs that mitigate some of the distribution problems in the market system.

The purported advantage of the market system is its efficiency.  Most economics textbooks are heavily weighted towards the efficiency criterion.  The distributional aspects of the system are often excluded because they are not part of a "positive science".  Economic science is unable to evaluate the fairness of the system in terms of the distribution criterion.  The distribution criterion is considered to be part of a "normative science" in which values play an important role.

Arrow was critical of the communist system because it was a tyranny.  On the other hand, most of the Eastern European countries that adopted the market system did not make the case for efficiency of the market system.  He argues that the typical market economy is not very efficient.  He compares the efficiency of the market system to what Churchill said about democracy.  That is, it is the worst system except for every other system.

Arrow understands the importance of "human capital" in the economy.  Clearly, the state plays many important roles in any economy.  It provides the infrastructure and most of the formal education.  He believes, however, that the family plays a critical role in human capital formation.  He believed that the break up in the family has had a negative effect on the development of human capital.  He does not pretend that he can explain what has led to the break up in the family structure, but he suggests that it might have something to do with the extreme individualism that he observes in modern society.  There are probably better explanations for what Arrow observed about the family, but his point is well taken.  The family is a critical component in the development of human capital.  Moreover, he does not believe that government can do much about the problem.  Others might argue that the break down in the family structure may be related to the distributional problems that economists typically avoid. Its difficult for families, that struggle to satisfy subsistence needs, to invest in human capital formation.  Its also true that many European nations provide more assistance to families.  They provide day care services, which are very expensive in the US, they also provide greater access to healthcare and to higher education.

Wednesday, July 9, 2014

What Did We Learn From The Shut Down Of Corinthian College?

Corinthian was one of the largest for-profit colleges in America.  A federal investigation showed that the college engaged in false advertising and it targeted its marketing toward low income families that would be most sensitive to the college's misleading ads that promised high paying jobs upon graduation.  The government decided to shut down federal aid to the college for 21 days following its investigation which discovered many problems in the ways in which it conducted business.  The college concluded that it could no longer operate without the federal funds for even 21 days.  Many for-profit colleges receive as much of 90% of their revenue from federal aid to students.  In the case of Corinthian College, the government was funding a business that was based upon fraudulent practices.  Corinthian College is not unique in the way that it operates.  It is one of many for-profit colleges that engage is similar business practices.  They are protected by lobbyists who have been successful it getting Congress to prevent the Department of Education from doing its job to prevent predatory behavior.

An Examination Of How Decisions Are Made To Offshore Production

This article was prompted by a decision that Phillips made to offshore production from a highly efficient light bulb plant in Sparta, Tennessee to Mexico.  The plant management team did an analysis and concluded that it would purchase the plant from Phillips.  They had no trouble raising the money to finance the purchase because the plant was more cost competitive than the plant that Phillips was relocating in Mexico.  Factory labor costs are only 10-15% of the total wholesale price, and Phillips was going to incur costs as a result of relocating that would make it uncompetitive in very competitive market.

The Phillips decision raised questions about the process used by management when they decided to offshore 70,000 US plants.  Two Harvard professors interviewed 1,767 executives who participated in relocation decisions, and they concluded that rigorous processes for making those decisions were far from universal.  Hidden costs were underestimated, and some of the advantages from locating in the US were ignored.  There seemed to be a bias against keeping plants in the US.

One of the motivations for offshoring is that Wall Street has a positive view of offshoring.  They give a short bump to the stock price after relocation decisions are made.  In the Phillips case, a strategic decision was made to concentrate manufacturing.  Once that decision was made it followed that the Sparta plant must be relocated in order to be consistent with the strategy.  The decision making process in many organizations is also affected by a firms culture.  Junior executives who are more directly involved in relocation decisions are reluctant to raise questions when they perceive that top management is in favor of offshoring production.  Many offshoring decisions may have resulted from a colossal failure of due diligence. 

The UN Blueprint For Cutting Carbon Emissions

This article describes the UN plan for reaching a per capita carbon emission goal that would enable us to reach our global temperature change target.  The UN plan will end the type of negotiations that have failed in the past.  Each nation will commit to the per capita carbon tonnage goal.  That clears the way for a discussion of the technologies required to reach that goal.  Carbon capture and storage, along with nuclear energy would be a big part of any plan.  We have to stop using coal to produce electricity and we have to use electricity to fuel automobiles.  In essence, we have to find ways to make use of existing technologies on a much larger scale.  We also have to figure out how to fund the technical programs that will be required.  US leadership will be necessary and China will have to determine a path away from dependence on heavy industry.  None of this will be easy, but climate change denial is over at the national leadership level.  The US is the only country left with a cadre of well paid climate change deniers.  The Republican Party is moving away from promoting climate change denial as an electoral ploy.

Tuesday, July 8, 2014

Why The Mafia Wants To Incorporate And Move To Wall Street

This article made me LOL.  It is a good lead in to the article that I posted below about major banks which violate the law. It features characters from The Godfather during a meeting in which Michael Corleone explains why they should incorporate and take advantage of globalization and the limited liability of corporations.  This should become a classic.

Are Artificially Low Interest Rates Producing Artificially High Asset Prices?

The popular media are full of stories about the sins being committed by central banks.  They claim that central banks are keeping interest rates "artificially" low and that is leading to "artificially" high asset prices.  Paul Krugman explains why these claims are nonsense. 

In the first place, the economics profession does not recognize the concept of artificially high interest rates.  It uses the concept of the natural rate of interest which holds that the rate of interest that does not lead to inflation is the natural rate of interest.  Since there is little indication of inflation in nations where central bank policy rates are low, our current interest rates are at the level that we should expect with low inflation.  Central banks have helped to set inflation expectations through their policies and the market expects inflation rates to be low.  Investors are willing to pay higher prices for safe assets as long as they expect inflation to remain low.

Stock prices have also risen during this period of low interest rates and low inflation.  Does that mean that stock prices are "artificially" high?  Corporate profits have also been high and the price to earnings ratio is close to its long term average.  Market fundamentals seem to explain the rise in stock prices.  It does not seem that stock investors have been taking on excessive risks because interest rates are too low.

Currency Depreciation And Slow Export Growth in Japan

Economic theory suggests that a currency devaluation should make a nation's exports more price competitive and stimulate export demand.  The Japanese yen has depreciated by 30% versus the US dollar but Japanese exports to the US has declined modestly during this period.  This study by the Federal Reserve Bank Of New York explains why a substantial currency devaluation has not increased Japanese exports to the US.

Many Japanese firms invoice US importers in US dollars.  That actually increases margins in Japan.  The dollars received in Japan translate into higher yen margins.  Another factor is that Japanese exporters are also large importers of raw materials and energy.  Therefore, their cost of production increases.  Higher product costs limit the advantage gained by currency devaluation.  Japanese firms are also protective of their large market shares in the US market.  They are willing to accept lower prices to maintain market share.

This article does not discuss Japanese competition with foreign competitors in the US market but that may also have contributed to slower growth in exports to the US.  In particular,  firms like Samsung and LG have been successful in the US consumer electronics market.  Hyundai and Kia have also been successful in the US auto market.  They have competed with Japanese products on quality as well as on price.

The Prosecution of European Banks That Violated US Law Shifts To Germany

The US has been investigating the operations of European banks for over a decade.  In 2009 the British bank Lloyds struck an agreement for deferred prosecution.  That was followed by agreements with other major banks in Britain.  HSBC, Standard Chartered and Barclays also struck agreements on the violation US banking laws.  Credit Suisse, the largest bank in Switzerland, and ING a large bank in The Netherlands also accepted deferred prosecution agreements and paid substantial penalties.

The major banks in France have also been under investigation.  Credit Agricole and Societe Generale are under investigation and BNP Paribus agreed to a $8.9 billion penalty and a criminal charge.

The most recent investigation involves Germany's second largest bank Commerzbank.  It is subject to a $500 million penalty.

The European banks were using the NYC offices to funnel dollars on behalf of clients in Iran and Sudan in violation of sanctions imposed on those countries by the US.  The largest US bank Citigroup is also under investigation for laundering money through its Mexican subsidiary for a drug cartel.  JP Morgan Chase also agreed to a $2 billion penalty for aiding and abetting the Madoff Ponzi scheme.

The European and American banks cited in this article risked their reputations in the pursuit of easy profits.  Finding ways to get around US laws has been one of their strategic advantages.  This a sad commentary on the international banking industry.

The Hand Of God And Economic Growth

The upset victory of David Brat over Eric Cantor many be a sign of the future for the Republican Party.  It has been successful as a coalition between those who believe in free markets and Christian fundamentalists.  Brat's electoral success suggests that the future of the Republican Party may be not be a coalition between free marketers and Christian fundamentalists.  Its base may become more like David Brat who believes that the source of economic growth is a free market system operated by virtuous Christians.

David Brat convinced the voters in his district that his opponent was not virtuous.  He accused Eric Cantor of "crony capitalism" by connecting him to Wall Street bankers who supported his campaign.  The bankers failed because they are not virtuous and government efforts to rescue the bankers will not work either.  Free markets do not need government regulation; they work best when the people running them are virtuous.

The business wing of the Republican Party has consistently blamed government for our economic problems.  The economy would work fine as long as we let customers, competition and shareholders provide the required market discipline.  The role of government is to enforce property rights by writing laws and providing resources to defend those rights.  God was not essential in the operation of the economy but it was a good idea to court the Christian fundamentalists who voted for them in elections.  Many of the Tea Partiers who voted for David Brat believe that Christian virtues are an essential ingredient for free market capitalism.

We live in a real world in which bankers continue to act badly and markets also break down when participants are virtuous.  Government cannot provide a substitute for failed virtue.  We need government to make markets work but we also have to find ways to limit the growth in "crony capitalism".  That is, can we build a government that we can trust?

Friday, July 4, 2014

Economics 101 And Recovery From Recession

John Cochrane is a supply side economist.  He and other supply side economists blame our slow recovery from the Great Recession on shocks that cause business investment to decline.  Typically, the shocks to business investment are attributed to government policies that create uncertainty about the future. They also believe that government efforts to stimulate demand will be ineffective or harmful.  Demand side economists have a different perspective on the business cycle.  They believe that recessions are caused by cuts in spending.  Central banks are the first line of defense in a recession. They can cut interest rates which encourage business investment and consumer spending.  However, when interest rates have been cut to zero,  and we still have unemployed resources, demand side economists believe that fiscal policies should be used to stimulate economic activity.  That can be accomplished by increasing government spending and/or by cutting taxes.

Noah Smith understands that there is no simple way to end the debate between supply side and demand side economists that has long history.  In this article, he uses simple supply and demand graphs to illustrate what should happen to prices during a recession.  They show that prices should rise when the supply curve moves to the left.  That is, we should have price inflation.  In fact, supply siders have been forecasting price inflation for last several years and it has not happened.  Instead we have seen a decline in prices.  That is exactly what happens when the demand curve moves to the left following a shock to demand.  Smith argues that this simple illustration shows that demand side explanations are more intuitive than those used by supply siders.  That does not settle the debate, but it does explain why demand siders continue to advocate the use of fiscal policies to stimulate demand.  I suggest a test that anyone can use to test their intuitions about this debate.  Pretend that you are a business person, and consider each of the factors that supply siders use to explain why you are not spending money to increase capacity.  Then ask yourself what you would do if you saw an increase in demand for your products or services. 

When you have finished this task please enjoy the holiday in the US and the world cup matches over the weekend.  

Wednesday, July 2, 2014

The Long Term Damage From Deep Recessions

Moderate recessions are a part of what economists call the business cycle.  Economies normally recover from recessions without suffering any longer term economic damage.  This time it might be different.  This paper provides data from OECD countries which indicates that the damage from the Great Recession may be more serious.  It argues that the recession has decreased the potential output as well as the growth rate of potential output in many OECD nations.  It also makes an effort to describe the channels by which the potential output has been seriously damaged. 

This article suggests that the damage to potential output is partially explained by public policy decisions.  It shows a positive relationship between the degree of austerity and the decline in potential output.  The damage may not be irreversible.

Economic Warfare And The Value Of Old Ideas

Ezra Klein's blog (Vox) is being criticized by conservatives because it uses "old ideas" from the era of demand side economics to frame policy recommendations.  Paul Krugman finds this rather strange.  Supply side ideas are also very old ideas but conservatives prefer them to demand side ideas.  That would be fine if supply side ideas worked better than demand side ideas.  According to Krugman, demand side explanations for our current economic problems have worked better than old supply side arguments.  The conservative preference for supply side economics is an ideological preference that is insensitive to empirical realities.  In any case, it is foolish for conservatives to argue that one set of old ideas is better than another set of old ideas.  They need to come up with a better argument against Ezra Klein's blog.

Keynes made an interesting comment in his General Theory about economic ideas.  His comment was about the rapid ascendency of David Ricardo's economic ideas in Britain.  Keynes argued that Ricardo's ideas were well received by powerful interests in Britain who benefited from them.  The implication is that economic ideas are not independent from the dominant political culture in a nation.  Economists, and their ideas,  provide the intellectual justification for the existing social order.  Supply side economics, which holds that government efforts to stimulate demand in a recession are counterproductive,  derives its power from sources outside of the academy.  Economists who wish to curry favor with the power elite serve a role similar to the priesthood which made the case for the divine rights of kings in another era.