Sunday, August 31, 2014

What The Great Recession Has Taught Us About Macroeconomics

A number of articles have been written about the failure of macroeconomic models to predict the Great Recession.  Nobody is more familiar with those models than Olivier Blanchard who has been a top economist at the IMF.  He provides an understandable description of the assumptions in those models, and he explains why the Great Moderation had deluded economists into believing that the models were able to deal with economic shocks.  There were "dark corners" in the models but most economists believed that they could be ignored.  In this article he argues that: " We were much closer to the dark corners, and that they were darker than we had thought".  He describes the dark corners as well as some of the efforts that are being made to deal with them.  In particular, finance is being incorporated into the models but we may still have to deal with dark corners.  We are a long way from the days of the Great Moderation.

Saturday, August 30, 2014

The Capitalist's Dilemma

The Harvard Business Review published this study on how corporations make investment decisions.  It shows that corporate investments are primarily directed towards cost reduction.  Presumably, it is easier to satisfy investors by meeting quarterly financial targets such as return on assets, discounted cash flow etc., than it is to sell them on investments that will have a longer term payout.  Its also job insurance for the CEO, and less job security for those on corporate payrolls.  Economists use all kinds of aggregate data in efforts to explain high levels of unemployment and stagnant growth in median household wages.  The basic decisions that effect these measures are made at the institution level by corporate executives.  It is important to understand how these decisions are made.

Some CEO's take a longer term perspective when they make investment decisions.  This article, published in the McKinsey Quarterly, was written by the CEO of Unilever.  He explains what Unilever did to shift its focus to a 10 year plan that was designed to build a more sustainable and profitable enterprise.  Part of the solution was to target shareholders who have a longer term investment horizon.  This was not easy because 75% of the capital on US stock exchanges is held by pension funds.  The mangers of these funds are measured on quarterly performance.  Unilever sought out longer term investors just like they target customer groups in their consumer marketing.  These investors want proof of progress against the 10 year plan, but the progress is not measured simply by standard accounting metrics.

Friday, August 29, 2014

The Decay Of American Politics

Economists often get involved in politics because many of the decisions that need to be made are about the economy.  They realize that our political system has become polarized and dysfunctional, but they are not well schooled in political science.   This article was written by a political scientist.  It provides an excellent description of the origins and the evolution of the US political system.  It was designed to counter the abuse of authority that was characteristic of monarchies in Europe.  Checks and balances were built into the system that limited the power of the executive to manage the system.  Moreover,  there is not a clear delineation of authority between state, local and federal government agencies on numerous matters.  To make matters worse, disagreements within the legislature are often transformed into legal issues that delegate political matters to the judicial system.  In a polarized society, such as we have today,  almost any political decision is subject to judicial review. 

We would be in a better position to fix our dysfunctional political system if more of us had a detailed understanding of how the system has broken down.  Public contempt for government has never been higher but it is incapable of fixing itself.  The many actors in the system have adapted to the ways in which the system has evolved.  It works just fine for those who have the understanding and the means to engineer the system on their behalf.  It does a poor job of representing the interests and  concerns of the public at large.

Wednesday, August 27, 2014

Predatory Capitalism

Predators usually focus their attention on the most vulnerable prey to which they have access.  Predatory capitalism is the name given to businesses which earn profits by taking advantage of vulnerable human prey.  Our recent financial crisis was partially the result of predatory capitalism.  Lenders provided mortgages to vulnerable households who did not have the income to service their debt.  The sold the mortgages to bankers who packaged them into securities which they sold to poorly informed investors.  This article describes another form of predatory capitalism.  The public sector has found a way to shift the cost of government services to the poor.  It is a form of privatization in which the private sector performs the services that were once performed by government, and the cost of those services is shifted to the poor.  For example, some of the costs of monitoring citizens on probation are shifted to those on probation.  The are required to pay fees for some of those services and the penalties for non-payment are very high.  The services providers then act like bill collectors who have a powerful weapon.  They can send those who can't make the payments to jail.  Similarly, many judicial services are provided by private firms and the costs are shifted to the poor.  For example, some courts require the poor to pay for public defenders.  Furthermore, in many states private firms run some of the prisons.  They receive funding from the government for those services but they charge prisoners for some of the services that are not funded by government.

This article only touches on the extent of the privatization of government services that are essentially predatory.  The growth of for-profit colleges and trade schools is perhaps the major form of predation.  The poor take out education loans that are subsidized by government in the hope of getting jobs that are promised.  Most of them either fail to graduate or fail to get the promised jobs upon graduation.

What Is The Purpose Of The Publicly Held Corporation?

This article provides an answer to the question raised in the title of this post.  It argues that the major purpose of the publicly held corporation is to reward investors. That includes top corporate executives who are also major shareholders.  It supports that conclusion by showing how corporations have been using their profits.  Between 2003 and 2012 the 449 corporations in S&P 500 during that period used 54% of their profits to buyback their own stock.  That reduces the number of shares outstanding which increases the price to earnings ratio.  That, in turn, boosts share prices.  They also returned 37% of their profits to shareholders in the form of dividends.  That leaves only 9% of profits for other purposes such as R&D, capital expansion and employee wage increases. It is no wonder that unemployment remains high and median wage growth has been stagnant.  The system operates to redistribute income from workers to investors.

These changes in corporate behavior were not accidental.  They have occurred in response to government policies and corporate governance.  They also contribute to the financialization of our economy.  Corporate America and Wall Street are joined at the hip.  Corporations are managed as financial assets and Wall Street plays a role in determining the value of those assets.

In 1981 Ronald Regan's SEC removed a rule that limited corporate share buybacks.  That eliminated a legal barrier to what we observe today.  Tax policies also contributed to these changes.  Capital gains on stocks and corporate dividends used to be taxed as ordinary income.   Now they are taxed at rates well below income from wages.  It is not surprising that corporate executives and other investors prefer to receive their incomes from capital gains and dividends instead of from wages.

Exxon provides one example of how this story plays out.  Exxon used 83% of its net income for stock buybacks and dividend payouts. 73% of CEO compensation at Exxon is stock based.  Corporate governance at Exxon reflects the financialization of the corporation.  The incentive system is consistent with that purpose.  Managing the stock price aligns top management with its largest shareholders.  It also aligns the corporation with Wall Street analysts and investment bankers.  They are primarily concerned with earnings per share and quarterly performance against that target.

Tuesday, August 26, 2014

Why Do So Many Graduates From Elite Colleges End Up on Wall Street Or In Consulting?

Wall Street banks and top consulting firms restrict their recruiting efforts to America's elite colleges.  There are many bright and competent candidates at less prestigious colleges but the banks and consulting firms burnish their brands by capturing the brand value of our elite colleges.  This article (via Manan Shukla) describes the process used by the banks and consulting firms to dominate the recruiting systems at elite colleges.  It also describes the process by which students from our elite colleges end up competing for jobs that were unfamiliar to them as freshman.  Its part of the socialization process at our elite colleges.

Monday, August 25, 2014

Central Bankers Have Reached A New Consensus: Weak Labor Markets Are A Greater Problem Than Risk Of Inflation

The annual Federal Reserve meeting at Jackson Hole included central bankers from the UK, Japan and the EU.  They all agreed that weak labor markets were a problem despite declining unemployment rates.  They used to believe that falling unemployment rates led to a greater risk of inflation.  That is no longer true.  That is because wages should be rising as labor markets tighten.  Wage growth has been stagnant.  The unemployment rate is no longer an useful measure of inflation risk.  The Fed, for example, has developed a multi-factor measure of labor market strength that is more useful than the headline unemployment rate.  Central bankers are looking for more ways to improve the labor market.  Inflation risk has been put on the back burner.

Lindau Conference Economists Highly Critical Of Economic Policies That Are Wrong And Bad For Economy

"Anyone who fears inflation is stupid" was one of the comments at the Lindau meeting in which Angela Market gave the Keynote Address.  Nobel Laureate Christopher Sims told the audience that monetarists who believe the expansion of debt is like an expansion of money that produces inflation are wrong.  He argued that QE by central banks has not created a risk of inflation because it has not increased consumption.  Households understand that governments will have to deal with their debt burdens in the future.  The implication that governments will have to raise taxes and/or reduce spending has encouraged households to save more of their income. 

Nobel Laureate Vern Smith, who is not a Keynesian,  provided another reason for the slowdown in consumer spending.  Households are investing in housing which is considered to be a safe investment.  Even before the sub prime housing bubble, home prices were above their long run average relative to median income.  They are half way back to where they were in their peak in 2001.

Nobel Laureate Peter Diamond told the audience that government austerity policies are criminal.  Governments can borrow at zero real interest to make investments that will make their economies more productive in the future.  Instead they are letting human capital and infrastructure erode.  That will make western economies less competitive in the future.

I doubt that Angela Markel welcomed these comments from Nobel Laureates.  She is stuck with the austerity policies that she has advocated.  Political sentiment in Germany, and in many eurozone nations is not supportive of monetary and fiscal policies that would integrate the eurozone. 

French Prime Minister Threatens To Dissolve Cabinet

The French government is in disarray.  Its economic minister blamed austerity policies for the poor economy.  The Prime Minister threatened to dissolve the government if President Hollande retained the economic minister.  France is hamstrung by eurozone policies which require a 3% deficit to GDP ratio.  Since GDP has not been growing government spending cannot grow.  The center right party in France has no answer for the economy as well.  The far right is only party in France with political momentum. 

Sunday, August 24, 2014

Greg Mankiw Explains Why The Corporate Tax And The Income Tax Should Be Eliminated

Greg Mankiw blames corporate inversions on the high corporate tax rate in the US.  Corporate executives are only doing their job when they device schemes to avoid taxes.  In reality they have no national identity.  Efforts by nation states to tax their profits ignores the realities of our global economy.  Apparently, taxes which pay for the services provided by nation states, that are essential to the operation of the economy, should be shifted away from multinational corporations which are superior to nation states.  While we are at it, we should also eliminate income taxes.  They should be replaced by a consumption tax.  This is consistent with his view that we should not tax "good things" like income,  we should tax "bad things" like consumption.  That would shift the tax burden from those who are able to save most of their income to those who spend most of their income.  It also assumes a strange notion of the purpose of an economy.  Providing incomes, which are unequally distributed, is more important than providing goods and services that can be consumed.

Greg Mankiw has established himself as one of the economists best able to apply his knowledge of economics on behalf of his clients.  He also puts his naivety about how corporations operate on public display.  They have been using a variety of schemes to transfer their profits from high tax states to low tax states with impunity.  Corporate inversions are simply another way of doing what they have been doing for years.  Moreover,  the net tax rate paid by US corporations is consistent with the net tax rates paid by corporations in other industrial states.

Saturday, August 23, 2014

Is There A Natural Rate Of Unemployment?

Economists assume that there is a natural rate of unemployment.  It is the rate at which lowering the rate would increase inflation.  This article ridicules that idea.  It argues that unemployment is man made.  That is, institutional and government policies create unemployment.  It also attacks the concept of labor market flexibility.  Implicit in that idea is the notion that markets would clear, and unemployment would fall,  if labor markets were more flexible.  That is, labor should be free to move to where the demand for labor was unsatisfied. However, flexibility in many cases is not desirable.  For example,  computer generated scheduling of work hours is good for employers, but it creates hardships for workers.  They are forced to adjust their schedules to adapt to the irregularity of demand. Businesses also benefit from policies which do not restrict layoffs by employers.  What's good for business owners is not always good for employees.  Flexibility should be two sided.

Labor policies in Germany provide a good example of the benefits from cooperative labor market flexibility.  Agreements between management and labor unions have allowed firms to adapt the number of hours worked to changes in demand.  Labor and management both benefit from reductions in hours worked per employee instead of layoffs.  The unemployment rate is not necessarily "natural" it often determined by institutional and government policy.

Wednesday, August 20, 2014

Bank Of America Agrees To $17 Billion Penalty For Selling Fraudulant Securities

Bank of America was hit with the largest penalty for selling toxic securities to investors.  Most of the bad securities were from Countrywide which BoA acquired along with Merrill Lynch during the financial crisis.  They did the government a favor that prevented Countrywide and Merrill from going into bankruptcy, but they were not aware of the size of the liabilities that they were getting when they made the acquisitions.  Countrywide's CEO had to pay a large fine because of the bad mortgages that were made on his watch.  Countrywide paid most of his legal fees and a good share of the fine.  He walked away from one of the biggest frauds in history with most of the wealth that he acquired during his reign as Countrywide's  top crook.  No criminal charges were filed by the Justice Department.

What We Learned From The Justice Department's Civil Suits Against Wall Street Banks

The Justice Department has boasted about the large fines that it collected from Wall Street banks that packaged faulty mortgages into toxic securities that they sold to investors.  The banks agreed to the fines but received a favor in return.  The full details of what they did were not disclosed to the public.  Moreover, none of the executives at the banks were prosecuted for fraud.  The shareholders of the banks paid for the damages done to the economy.  Justice was not served, and a bad precedent has been set.  Bank executives understand that they will not be held accountable for future misdeeds that enable them to earn multimillion dollar bonuses at the expense of shareholders and the public.  Corporate directors have also learned that they will not be penalized for their failure to protect shareholders or the public from harm.

How Migration Between US States Has Changed Over Time

Migration between states has changed over time.  You can find how migration patterns have changed over time by using the interactive graphs available for each state.

Tuesday, August 19, 2014

US Corporate Tax Code Does Not Make US Firms Uncompetitive

A recent study of the US corporate tax code shows that US multinationals have found ways around the corporate tax code.  They are so good at this that their effective tax is much lower than the tax rate that they regularly criticize.  It is also lower than the real taxes paid by their competitors.  That does not mean that the tax code should not be made more efficient.  It is riddled with inefficiencies and distortions that have been put their by friendly politicians.  That is why it would be difficult to reform the tax code.  There would be a battle between corporate interest groups over which loopholes should be removed.  The bottom line is that we should take corporate squealing about the high corporate tax rate in the US with a grain of salt.

Monday, August 18, 2014

Balanced Budget Fundamentalism And Economic Recovery

Fiscal policy mandated in the EZ has been contractionary.  Raising taxes and cutting government spending when interest rates are at the zero lower bound is contractionary.  Its nearly impossible for nations like France and Italy reduce their debt to GDP ratio to 3% when there is no growth, and even shrinkage, in GDP.  Wren-Lewis believes that the majority of academic economists believe that fiscal austerity is the wrong medicine in our current situation.  He offers several explanations for the devotion to fiscal austerity among politicians.  They seem to be obsessed with the prospect of inflation even when the risk of deflation is much higher and more difficult to reverse once it sets in.

He argues that the economic advisers to the political elite are part of the problem.  They ignore much of what they have learned about economic theory and they provide intellectual support for the solutions preferred by the politicians.  He also believes that the commitment to austerity is stronger in Europe than it has been in the US because of the sovereign debt crisis in Europe.  The bond vigilantes never threatened the ability of the US government to finance its debt.  On the other hand, the public in the US has always responded well to politicians who argue that they can balance the budget.  Ronald Reagan ran for election on that platform.  He even proposed a balanced budget amendment to the Constitution.  In practice, however, budget deficits during his administration reached historical highs.  His tax cuts did not increase tax revenues, as he argued, and he did not cut federal spending.  This did not lower his standing with the public which has a short attention span.  The Cameron government also did well in the UK election by focusing public attention on deficit reduction.  Fiscal prudence is a virtue that the public can understand.

Saturday, August 16, 2014

The President Of The Minneapolis Federal Reserve Explains Why Low Rate Of Inflation is Bad

The US Federal Reserve has a mission to promote price stability and full employment.  Historically, central banks have focused on fighting inflation, which happens when the demand for goods and services exceeds the supply of goods and services that are being produced.  Most central banks have an inflation target of 2%.  They do a good job of reducing inflation when it exceeds the 2% target.  Today we have a different problem.  Inflation is below 2% in the US, Japan and much of Europe.  The President of the Minneapolis Fed argues that the below target rate of inflation provides a signal that  should not be ignored by central banks.  It means that there is not sufficient demand for the goods and services that the economy is able to produce.  He supports the use of unconventional monetary policy to satisfy the Fed's mission of promoting full employment.  Our problem today is price deflation in response to inadequate demand.

How Do We Explain Secular Stagnation?

The Centre for Economic Policy Research, based in London, consists of 900 research economists primarily from Europe.  It has published this E-Book which includes a number of articles on the problem of secular stagnation.  Some of the explanations are supply side arguments which claim that that we are experiencing a decline in potential GDP.  Others are demand side arguments which claim that weak demand is responsible for slower economic growth.  In any case, the E-Book contains the viewpoints of some of the most prominent economists from around the world.  It should be required reading for those who want to understand our slow recovery from the Great Recession.

A Supply Side Argument Against Inequality

Supply side economics has been based upon the claim that making some people rich is good for poor people.  That is the trickle down theory, promoted by Ronald Reagan,  for which there is no supporting evidence,  is still an article of faith in the GOP.  This article makes a supply side case for income redistribution to the poor so that it trickles up to the rich.  It also promotes political equality.

Redistributing income to poor helps the rich because it fosters economic growth.  Poverty destroys human capital formation.  Improving education and healthcare for the poor makes more and better human capital available.

Poor citizens are also deprived of political power in system in which money can purchase political power.  An income redistribution system that reduces income inequality also reduces political inequality.

Friday, August 15, 2014

Which Free Market Theorist Was Least Bad: Friedman or Hayec?

Brad DeLong and Robert Solow are supporters of market economies in which governments make efforts to ameliorate some the problems inherent in market economies.  Milton Friedman and F. Hayec favored free market economies with a very restricted role for government involvement in the economy.  Robert Solow compares the views of Friedman and Hayec and concludes that there was a good Hayec and a bad Hayec.  He concludes that the good Hayec was better than the bad Friedman.  Brad DeLong considers Solow's argument and concludes the opposite.  He is less critical of Friedman and more critical of the bad Hayec.

The ideas of Friedman and Hayec still shape many of the economic debates that we have today.  The criticisms of social democracy are a legacy from Friedman and Hayec.  This article provides an historical perspective on today's debates that is well worth reading. 

Why There Is No Place For Moderation Or Democracy In The Mid-East

This article describes the chaos in the Mid-East as a war between oppressive governments and the culture of vengeance that results from oppression.   There are few moderates to be found in governments, and certainly not among the rebel groups seeking revenge.  None of the rebel groups are advocates for democracy.  The US invaded Iraq with a mission of building a democratic state with a free market economy.  That mission failed.  Its hard to see what Western nations can do today to end the civil wars in the area if this description of the chaos is even close to being accurate.  Unfortunately, politicians in the US continue to blame the chaos in the Mid-East on ineffective US policies.  They have no solution for the problem other than sabre rattling.

Wednesday, August 13, 2014

Will Your Children Have A Better Life Than You Have Had?

A recent NBC/WSJ poll found that 76% of US citizens believe that their children will not have a better future than they have had.  Surprisingly, the pessimism is universal. It is not subject to race, gender, political party, or wealth effects.  Pessimism has replaced the optimism about the future that was universal prior to the late 1990's.  There is no single explanation for the lost optimism that was always part of our culture, but political dysfunction may play a major role. If governments cannot agree on solutions for simple problems, many fear that government will be unable to solve the more complex problems that we will face in the future.

Record Daily Waterfall From Storm In NYC

Records are made to be broken, but they are not usually broken by as much as the daily rainfall record in NYC from yesterday's storm.  The old record was 6.7 inches, the new record set yesterday is 13 inches.  That almost doubles the previous record!!  This is just another example of extreme changes in weather patterns that are being experienced in the US and around the globe.  While NYC broke the rainfall record, many western states are breaking drought records.

Free Trade Theory, Globalization and International Trade Agreements

Free trade theory, which had its origins during the period in which Britain developed its colonial empire, is regarded as gospel by most economists today.  The assumption is that everyone is better off with free trade.  If every nation capitalizes on its comparative advantage, global productivity will increase, and more goods will be available at lower cost.  Trade theory has developed since the Ricardian era in which the doctrine of comparative advantage was written in stone by economists.  However, trade between nations is nothing like it was 200 years ago.  The big change is that manufacturing capital is mobile.  Capital can be moved almost anywhere.  That enables corporations to locate production in nations that provide cost advantages, as well as enabling entry into foreign markets.  Investments in foreign nations is not without risks.  This article, argues that trade agreements no longer focus on reducing tariffs, which are a barrier to trade; they are designed to facilitate the mobility of capital and to protect investors.

The focus of this article is on NAFTA which integrated the US, Mexico and Canada into a single market.  While the focus is on NAFTA it argues that trade agreements that are currently being negotiated in the Atlantic and Pacific regions have a similar design and a common purpose.  NAFTA was not good for workers in Mexico, and it was not good for labor in the US.  Labor productivity improved in Mexico and manufacturing jobs were created.  However, manufacturing wages have been stagnant in Mexico.  They are only 2.3% above their level in 1994.  Moreover, 1.9 million agricultural jobs were lost in Mexico due to imports from US agribusiness firms.  NAFTA also served one of the primary purposes of trade agreements.  It reduced the bargaining power of labor. The free mobility of capital has restrained wage growth in the US.

The conclusion is that trade agreements are designed to serve corporate interests.  They protect the rights of the investor class by limiting the ability of national governments to regulate critical aspects of their political economies.  It assumes that national governments are willing to give up sovereign control over their economies because they are under the control of the investor class.  They advocate a form of globalization that limits the power and authority of the nation state.  Its hard to understand why governments would be so willing to become a junior partner in the development of international treaties.  They must believe that what is good for their multinational corporations is good for their country (or perhaps for their political party). 

Tuesday, August 12, 2014

SEC Charges State Of Kansas With Security Fraud

The SEC found that Kansas issued bonds to investors without disclosing material information about its unfunded pension liability.  This is the second blow to the states finances.  Moody's downgraded its debt because of large budget deficit that resulted from tax cuts.  The governor sold the tax cuts to the legislature by arguing that the tax cuts would increase tax revenues by stimulating economic growth.  The Kansas economy shrunk after the tax cuts instead of growing.  Ronald Reagan made the same argument that the governor made during his administration with the same result.  This is a zombie idea that conservatives can not give up.

Lindau Meeting Will Focus On Rising Inequality

The Lindau Meeting, that will be held August 20-23,  will focus its attention on inequality and the usefulness of economics.  There will 17 Nobel Laureates in attendance along with many younger students of economic science.  Angela Markel will give the Keynote Address, and several notable economists will deliver lectures on various aspects of inequality.

Does Ending Unemployment Benefits Increase Employment?

Congress decided not to extend unemployment benefits beyond the 26 week period in which the unemployed would receive benefits.  The decision was based upon the assumption that more of the unemployed would seek work when their benefits were terminated.  A liberal think tank and a conservative think tank did some research on this question and they reached the same conclusion.  Employment did not increase as a result of the policy decision by Congress.  One of the explanations for that result is that the unemployed must continue to look for work in order to receive benefits.  When the benefits were terminated many of the unemployed became discouraged and dropped out of the labor force.

How Do We Explain Lower Air Temperatures Over The Last 15 Years?

Global warming denialists claim that air temperatures have not risen over the last 15 years.  They use that as evidence to support their denial of global warming.  Scientists cannot explain why air temperatures have not risen over the last 15 years, but they realize that the oceans have always absorbed heat and that ocean temperatures are rising.  This article describes the technology that is enabling scientists to measure water temperatures miles below the ocean surfaces.  Our ability to measure water temperatures even further below the ocean surface will continue to improve.  That will enable scientists to make even more precise estimates in their models which reflect the impact of the increasing concentration of greenhouse gases in the atmosphere.

Sunday, August 10, 2014

Tom Friedman Interviews President Obama On Foreign Policy In Mid-East

Friedman asked the president most of the questions that need to be asked about the problems in the Mid-East.  The short answer is that the US will not provide military support for leaders who are unwilling to make the political compromises that are necessary to create a community.  Unfortunately, political leaders do not take the long term perspective that will enable different interest groups to live together.  They tend to use power to secure short term control that is not sustainable.  Interest groups which feel that they have been treated unjustly will never surrender completely.  Iraq provides a good example.  Their leaders did not attempt to unite the country.  They depended on the US to keep them in power.  The US is not going to provide military power to keep a government in power that is unwilling to unite the country.

The president believes that he made his biggest mistake in Libya.  They US helped to depose its leader but we failed to provide the support that was needed to restore political stability.  We now have the problem of dealing with a failed state that exports political unrest.

The president views the unwillingness of leaders in the Mid-East to seek political compromise as a warning to politicians in the US.  The US has enormous advantages that could be squandered if its political system moves in the direction in which it has been headed.  Winner take all politics is a threat to our democratic form of government.

Friday, August 8, 2014

The Presidential Election In Turkey

This article offers its description on Turkey's first presidential election campaigns.  Each of the candidates is running with a populist platform.  Their versions of populism have different flavors but populist slogans are dominant in the campaigns.

Growth in Wages May Increase Pressure From Inflation Hawks In Central Banks

Central banks have a dual mission: they want to keep the inflation rate around a target rate of 2%; they also want to avoid recessions.  A slight increase in the rate of wage growth in the US and in the UK has encouraged inflation central bankers, who worry primarily about inflation, to advocate an increase in interest rates.  Growth in real wages will stimulate consumption and increase the risk of inflation.  This article argues that growth in real wages would be good for the economy and that the risk of inflation is not high in our current situation.  The article also reminds us that we had rapid wage growth, low unemployment and negligible inflation during the Clinton Administration. That happy situation led to the only federal budget surpluses in our recent history.

This post raises more general questions about wage growth and economic policies.  Economic policy in Europe, for example, has been driven by constraint in wage growth.  The assumption is that cost reductions will lead to export driven economic growth.  Its also possible to stimulate domestic demand by providing households with higher wages.  That strategy is not popular with business leaders, particularly in the US.  The growth in corporate profits in the US is highly correlated with stagnant growth in wages.  That could stimulate the economy if corporations invested their profits, but corporate investment as a percent of GDP has been tracking downward during the recovery.  Corporations have found other uses for their profits.  They have been increasing dividends to shareholders and buying back their own stock.  They have also been trying to grow corporate revenues through acquisitions and mergers.  The slow recovery in the US has been constrained by slow growth in personal consumption and by slow growth in business investment.  Fiscal policy has also been a problem.  Government spending as a percent of GDP is well below the trend that it was on during the previous 15 years.

President Obama Announces Military Intervention In Iraq

The president reluctantly announced limited military intervention in Iraq.  He felt a need to prevent ISIS from conquering his Kurdish supporters and he chose to provide humanitarian assistance to a trapped religious group.  The civil war in Syria has spilled over to Iraq and its government requested military assistance.  This seems to be another problem without a solution.  US military intervention seems to increase the number of militants in the area.

Wednesday, August 6, 2014

Do Hedge Funds And Private Equity Outperform The Market?

The efficient market hypothesis argues that knowledge is equally available to investors.  Therefore, it is difficult for investors to consistently provide a return that exceeds the market rate of return.  In other words, if we assume that markets are efficient, it is unlikely for an investor to consistently beat the market.  Of course hedge funds and private equity funds argue that they can beat the market.  They are able to earn large fees because sometimes they do place a winning bet that gets a lot of publicity.  A book was written about the billion dollar bet that John Paulson made against a mortgage backed security.  There has been less publicity about the failed bets that Paulson made which have reduced the equity in his fund by 50%.  Leverage works both ways.  Paulson won big on one highly leveraged bet and he lost big on others.  Hedge fund managers may accept the idea that the average return of hedge funds does not beat the market but they argue that they an exception to the average. This article makes an argument that is slightly different from the efficient market critique.  It reviews data which suggest another conclusion.  They may beat the market rate of return but they do not beat the market net of the fees that they charge.  Moreover, there is a lot of inconsistency in their returns.  Their is a high beta within hedge funds and private equity investments.  Investors in these funds must learn to live with inconsistent returns.

Thank Goodness For The Federal Reserve

A liberal Republican wrote the title for this post.  He never thought that he would have ever uttered it. In this article he contrasts the aggressive effort by the Fed to prevent a potential depression.  He does not agree with all of the Fed's policies but at least they did something in response to a crisis.  On the other hand,  Congress was missing in action.  Instead of responding to the crisis in a positive fashion, Congress made the recession worse.  The blame for the congressional failure falls primarily on the Republicans.  The Democrats might have responded too weakly, but the Republicans did the opposite of what they did during the previous recession under George Bush.  Instead of using fiscal policy to stimulate the economy, as they did when Bush was in office,  they used fiscal policy to contract the economy.  This is apparent when one looks at public spending during the recession.  The decline in public spending has been the major source of lower GDP. 

Perhaps it was wrong to argue that the Fed was aggressive in response to the recession and that Congress was not.  Congress was certainly aggressive in making the recession worse.

Walgreen's Decides Against An Inversion

Walgreen's acquired the remaining shares of Alliance Boots that it did not own, but it decided not to reincorporate outside of the US.  Walgreen's has been under pressure from a large shareholder to increase its profits.  It could have done so by cutting its US taxes by reincorporating in a low tax state.  Walgreen's decided to reduce costs instead of cutting its tax burden. One of the reasons for its decision was a concern for its reputation in the US.  Most of its revenues come from its large retail operation in the US.  It was under pressure from the government, which funds much of the consumer spending on the drugs that it sells, and it is also aware of the negative public reaction that an inversion would have on its brand.  It is an American icon and it would have been costly to tarnish its image with the public. 

Google, Facebook, Yahoo, Microsoft Etc. Are The New Venture Capitalists

The venture capital industry functions by raising money and investing in start ups.  They hope to take the successful start ups public and get a good return on their investments.  The tech giants are loaded with cash and they are buying up technology start ups with promise.  They don't count on making money by taking them public.  They are becoming conglomerates.  Many of the businesses that they acquire are outside of their primary business which is providing the cash.  This article describes the pros and cons of this transformation.  We have gone through the conglomeration process in the past and it turned out to be a failure.  This time it may be different.  The tech giants may be smarter than the conglomerates that preceded them.  At the very least, they understand the technology better than most people and they are acquiring intellectual capital at a rapid rate.  Intellectual capital may be replacing physical capital as the foundation for modern capitalism.

Tuesday, August 5, 2014

A Good Discussion On Corporate Stock Buybacks and Dividend Payouts

This is a link to a good discussion of buybacks and dividend payouts.  This may have an effect on stock prices but business fundamentals are the most important driver of stock returns for most firms.  It does raise questions, however, about over leverage.  Corporations have been taking advantage of low interest rates and they have used much of that debt to buyback shares and increase dividend payouts.  That makes them less able to respond to a bad business cycle.

Standard & Poor's Report Argues That Income Inequality Is Bad For The Economy

Conservatives often refute claims about the problem of income inequality by discrediting the source.  This report on income inequality comes from a source that cannot be easily dismissed.  Standard & Poor's is an internationally respected organization that is not associated with a particular political ideology.  This report provides an extensive review on the growth in income inequality and concludes that it has reached a point at which it inhibits economic growth.  It also reviews some of the ways in which the problem might be addressed.

How Richard Nixon's Legacy Has Corrupted The Party Of Lincoln.

Richard Nixon was a clever politician.  He realized that Lyndon Johnson's embrace of the civil rights movement would turn many against the Democratic Party.  His "Southern Strategy" was successful; it turned the Dixiecrat's in the South into Republicans.  This article explains how Nixon's strategy has placed a heavy burden on the GOP.  It has become the anti-modernity party.  It is defined by what it opposes.  It is devoid of new ideas that are consistent with a challenging future that will demand new ideas.  It selects politicians to run for government offices whose mission is to weaken the ability of government to function. 

How We Could Use Carbon Dividends To Reduce Carbon Emissions

This article describes a unique approach to the reduction of carbon emissions.  It has several unique advantages.  It does not provide more tax revenue to government; that should please Republicans.  It also functions like a progressive tax.  Democrats might like that idea.  More importantly, it removes one of the most powerful objections to climate policy.  Most people don't respond well to proposals that require them to endure present pain in order to provide benefits to future generations.  They get immediate benefits from the dividend payouts.

How The US And China Engage With Africa

The US and China have very different approaches to Africa.  At a very general level, the US views Africa as a breeding ground for terrorist groups. Its efforts in Africa have a strong counter-terrorism flavor.  China's efforts in Africa appear to be more commercial.  It has invested heavily in commercial projects and infrastructure projects that are funded by its import-export bank.  It also views Africa as a huge consumer market for the low cost products that it manufactures.  Its military interests are focused on protecting its investments and the large numbers of Chinese that either work on these projects, or have migrated to Africa in search of business opportunities. 

Africa is complicated continent with many immature developing nations and numerous transnational conflicts.  This article provides a lot detail and how China and the US are dealing with the opportunities and challenges in Africa.  The following post by David Brooks provides almost no detail, and it views Africa as battleground between contrasting economic and political ideologies.  His readers will have learned nothing from reading his op-ed about what is really happening in Africa.  The US and China have a common interest in stabilizing the continent.  It is not a battleground between competing ideologies.

The Battle For Africa And The Ideological War With China

David Brooks likes big ideas.  In this article he turns a success story in Africa into a big idea.  His big idea is that China is gaining prestige in many African nations and that its version of "authoritarian capitalism" is winning the ideological war against "democratic capitalism" which is purported to be the US system of capitalism.  The Chinese system is autocratic and centralized; the US system is democratic and decentralized according to Brooks.  It would be a shame if African nations adopted the Chinese system over the US system.  We need to provide more demonstrations of the successful application of "democratic and decentralized capitalism" in Africa.

David Brooks' big idea comes from reading a book about Africa.  He lives in the US but he seems not to understand his own country.  Perhaps he should read more about what has happened to representative government and democratic capitalism in the US.  He could start with an article in today's NYT which describes the inability of government to provide safe drinking water for 500,000 residents of Toledo, Ohio.  The city's water supply comes from Lake Erie which has been polluted by toxic algae.  The city was forced to restrict the use of water from Lake Erie for two days.  That is not a new problem in Ohio, and it is not a unique problem.  Other lakes are being polluted by individual capitalists who put their own interests above those of the greater community.  The overuse of phosphorus fertilizers and improper disposal of animal waste by farmers is the major cause of pollution in Lake Erie.  The farmers and the fertilizer industry are represented in government by lobbyists;  they have been more successful in limiting the ability of government to control pollution than the 500,000 residents of Toledo want government to prevent the pollution of its source of water.  That is not how "democratic capitalism" is supposed to work, but it is a fair description of what has been happening to that system in the US.  There is a strong tension between democracy and hierarchical systems.  Hierarchy has no interest in a vigorous democracy.

Brooks also has a love affair with decentralization.  He contrasts decentralized decision making with the command and control system that is used in China, and in  other authoritarian regimes.  He does not seem to understand that most of the large corporations in America operate under a centralized command and control system.  Corporate strategy is set at the highest levels of the corporation and managers at lower levels of the corporation are required to meet financial targets that are aligned with the strategy.  There are lots of discussions between top management, and the management lower in the hierarchy, but there is no question as to where the real authority lies.  That system seems to work reasonably well for large corporations, and countries like China seem to have emulated that system effectively.  Its hard to understand what "democratic capitalism" means to David Brooks.

My point is not that we should emulate China in America.  David Brooks should turn his sights on his own country and stop reading books.  He might start by telling us how government should respond to the pollution of Lake Erie, and by suggesting the changes in our political system that will limit the ability of lobbyists to constrain government decision making.

Monday, August 4, 2014

Which Sectors Are Responsible For The Output Gap In US?

The output gap in the US is around $800 billion.  That is the amount by which spending is below potential spending in a full employment economy.  Some sectors of the economy are performing better than might be expected, but the increased spending in these sectors does not compensate for the shortfall in other sectors.  This article compares spending in each of sector of the economy with the average spending in each sector between 1993 and 2013.  This identifies the sectors that are primarily responsible for the output gap.

Spending on new residential housing is a major contributor to the output.  That is not surprising given the bursting of the real estate bubble.  The Fed has been keeping interest rates low but low interest rates are not a sufficient stimulus in our current environment.  Underwater households are unable to participate in the market.  They can't afford to sell their home and purchase a new home because they have negative equity in their existing home.  This is unfortunate because historically the Fed has been able to use monetary policy as tool to stimulate the economy during a recession and to slow the economy down when inflation is the problem.

The government sector, including federal spending along with state and local spending, is responsible for the major portion of the output gap.  Government spending is $307.7 below its historical rate.  The government sector and residential housing account for $547.1 billion of the output gap.  It will take time for the residential housing market to return to normal, but the decline in government spending is the result of public policy decisions.

Consumer spending durable products is also well below its historical average but consumers typically avoid spending on big ticket items like automobiles when they are concerned about job security.  Spending on major households appliances also declines in relation to new housing starts. Business investment is also well below average but business investment tends to respond to demand signals which they don't see.  They are using their cash to pay out dividends and repurchase their stock.

Sunday, August 3, 2014

A Primer On Air Temperature And Melting Polar Ice

Changes in air temperature do not reflect the full impact of climate change.  A simple example explains why.  Suppose that you put ice in pot of water on a hot stove and measure the water temperature.  You will find the water temperature will not change until the ice is melted.  The heat from the stove is used to melt the ice.  After the ice is melted the water temperature will rise until all of the water is turned into vapor. We can extend this example to the melting of polar ice. The heat from the sun is melting polar ice fields.  After the ice is melted the water will no longer absorb all of the heat from the sun.  At that point, air temperatures will rise more rapidly.  Until we reach that point, however, air temperatures will not accurately reflect the warming that is taking place.  The increase in ocean water temperatures provides a better signal for global warming.

The Republican Brain Trust On Climate Change

A US Senator proposed a resolution which simply stated that climate change was real.  A Republican Senator from Oklahoma blocked the resolution.  He defended his dissent by arguing that the global temperature has not increased over the last 15 years, and he reported that 9,000 scientists had signed a petition which stated that climate change was not real.  A colleague sharply rebutted his claims.  A normal person would have been embarrassed by the rebuttal but the senator from Oklahoma "was not for changing".

Some US Senators have gone beyond the senator from Oklahoma who clings to the weak climate change denial strategy.  Paul Ryan, and Marco Rubio are much smarter than the senator from Oklahoma.  They do not deny the reality of climate change; they take the position that the US government does not have the power to prevent climate change.  That argument takes two forms: Since climate change is a global problem, the US government can't reverse the process.  The other claim is that natural forces are responsible for climate change.  Furthermore, Ryan argues that government efforts to prevent climate change are an excuse to increase the role of government in the economy and to increase taxes.

There are several Republicans in the Senate who do not agree with their esteemed colleagues on the reality of climate change or on the inability of government to do anything about climate change.  They remain silent on this issue because climate change denial, and opposition to any proposals from the Obama Administration, are central issues in the GOP campaign platform.  Winning elections is more important than fighting climate change.

Friday, August 1, 2014

Why US Stock Prices May Have Sold Off Thursday

There are lots of problems that may have contributed to recent sell off in the stock market.  Many believe that a greater than expected rise in wages may be the culprit.  The Fed will end its zero interest policy sooner than expected if wages rise faster than its forecast.  Wage growth means that the market has become tighter and the risk of inflation becomes greater.  Higher interest rates are not good for credit markets which indirectly affect the stock market.

Old and Big Is Good For Business

This study explains why Warren Buffet invests in established firms which dominant market share in their industries.  Most of the growth in revenue and employment in the US has come from older and larger firms.  Entrepreneurship has not been all that it is cracked up to be in the US.

I worked for a computer firm that experienced rapid growth, and became the second largest computer company in the world.  Our CEO, and founder, was asked if things were better when the company was much smaller.  His response was very quick.  He said that it was great to be a start up but it was much better to be big.  He no longer had to worry about raising money for investments.  He liked having a pile of cash to use anyway that he wanted.  He also had a worldwide infrastructure and a well known brand that opened up new markets for the firm.  Big is good, but technology changes quickly in the computer industry.  Size not provide insurance in high tech industries.  IBM, for example, has survived and prospered by transforming itself into a services company.  Most of its profits come from services that it provides for its large customer base.  It took many years and several failed CEO's to respond to changes in the hardware business.  Size has been good for IBM.

A Tale Of Two Middle Classes And Globalization

Globalization has been good for the middle class in many parts of Asia.  Their incomes have improved substantially as a result of globalization in absolute terms, but they still have a long way to go relative to the middle class in rich Western nations.  Unfortunately, there has been little growth in middle class incomes in rich nations like the US, Germany and Japan during since the onset of rapid globalization in the 1980's.  Most of the income growth in rich nations has gone to those at the top of the economic pyramid.  They have become disinterested in economic growth rates since they do not benefit from it.

There are two bad scenarios that follow from the tale of two middle classes:  We can have plutocracy and globalization, or we can have populism and a reversal of globalization in rich nations.  We need an alternative to "Hobson's choice".

One alternative to is to redistribute income to the middle class in rich countries.  A better alternative, according to this article, would be larger investments in public goods in rich countries.  The question is whether either of these alternatives is politically possible in rich countries.  Globalization and democracy may be the victims of political inaction in rich nations that have ceded political control to the super rich.