Escape From Planet ZIRP

Elena Steier

Elena Steier

Good luck to us.

Reprinted from Barron’s:

Escape From Planet ZIRP


Can the Fed ever stop stimulating the economy? 

A whole lot of worried people, especially investment managers, are asking the Federal Reserve the question Gen. David Petraeus asked about the war in Iraq. “Tell me how this ends,” the general said in 2003 as he led the 101st Airborne Division toward Baghdad.

His ignorance was prescient. The American-led military coalition defeated the Iraqi army, but there was no effective plan for occupying the country or replacing the enemy government. A quick victory turned into a long counterinsurgency.

Petraeus actually went on to help end the U.S.’s role in the war by managing a change of strategy to buy a little peace—a window of opportunity through which the U.S. military could escape before the country caught fire all over again.

Think of Federal Reserve Chairman Ben Bernanke as the general of American finance. He is the boss of the central bank. More than any other financial leader, his policies created the apparent victory over the economy during the recent unpleasantness. To save the world, the Fed bought Treasuries the way the military burned jet fuel and gasoline.

The Fed now occupies the commanding heights of the U.S. economy and doesn’t know how to withdraw. Money markets, bond markets, and stock markets chafe under the thumb of the Fed’s zero-interest-rate policy, known as ZIRP. Values in all three are dependent on the Fed’s continuing to supply free money through quantitative easing, known prosaically as QE.

These have become essential to American finance as we now know it. We have no general but the Fed, no strategy but hanging on.

Wall Street is not an army; it is a mob that sells bonds and stocks and dollars whenever somebody looks up from his array of computer-display screens and asks, “Tell me how this ends.” When Bernanke or some other central banker starts to explain, the mob’s fingers start to move on computer keyboards and markets tank, as happened last week and on May 22, and will probably happen each time Bernanke speaks about trimming or tapering or reducing QE and ZIRP.

For it’s plain to see how this ends—or rather, how it doesn’t end. Under the relentless pressure of free money, the U.S. unemployment rate gradually falls toward the goal of 6.5%. The Fed slows and then stops buying Treasury debt and starts selling its accumulated hoard. Money comes out of the real economy. Interest rates rise, and unemployment rises again. Bernanke’s successor declares the nth stage of quantitative easing and continues to ZIRP the economy for a few more months. Repeat ad libitum, ad nauseam.

As long as the Fed holds responsibility for the economy, the recovery will be fragile. And as long as the recovery is fragile and incomplete, the Fed’s monetary policy will be responsible for boosting the economy.

What’s needed is a new strategy—an escape from planet ZIRP. It will be at least as difficult to manage as the escape from Iraq.

Petraeus directed a surge of military manpower and a surge of bribe money to open the exit window and keep it open long enough for the Americans to declare victory and depart.

The Fed could declare victory and depart from managing the economy, but it would be politically difficult, unless the U.S. hits a fiscal wall.

Maybe the least bad alternative would be for Bernanke to get serious about inflating, creating a false boom in stocks and housing and gold and other assets. He could do that by dropping $100 bills from helicopters or by ceasing to pay interest on excess reserves.

This disaster would leave room for a disciplinarian to reprise the role of former Fed Chairman Paul Volcker—raising interest rates, tamping down credit growth, and accepting the fact that a recession is preferable to endless manipulation of money.

This is neither the easiest nor the best policy. It just provides political cover for a new Volcker to help us escape from planet ZIRP and return to planet Earth.

Robbing Piggy Banks

Credit: William Waitzman for Barron's

Credit: William Waitzman for Barron’s

This is excerpted from an article in this week’s Barron’s Magazine:

President Obama Thinks Your IRA Is Too Big


The White House budget proposes limiting contributions to tax-deferred retirement accounts for the wealthy. The complexities are head-spinning.

When President Barack Obama released his fiscal 2014 budget in April, it included a proposal to set a cap on tax-advantaged retirement savings for wealthy individuals. In the scheme of the larger budget, let alone the partisan rancor sure to engulf any negotiations, it was small potatoes. But consternation — then uproar and outrage — followed. The failure of Americans generally to save enough for retirement is well documented, and needs no repeating. But even those people lucky enough to have built up seven-figure nest eggs are feeling squeezed by the trifecta of low interest rates, volatile markets, and increased life expectancies, which have put a big dent in how much they can withdraw each year without risking running out of cash. They felt like they were being targeted for having saved diligently and been financially successful.


It appears Mr. Obama believes this is a good way to mitigate the winner-take-all nature of success in a free society. Yes, we must do something to spread the benefits of economic success, but one can only marvel at how wrong-minded this suggested tax policy is. Retirement saving is a private good, which means you and I can choose to save just as much as we wish and there is a well-developed market of choices that meet our individual needs. People have company pensions, savings accounts, annuities, 401ks, and many other investment vehicles with which to accomplish this. On the public side we have the entitlement program of Social Security. When originated in 1935, the Social Security Act was meant to be a complementary public pension system to insure that people with inadequate savings or unfortunate financial circumstances did not suffer abject poverty. It was NEVER meant to be the sole source of retirement support for the entire population.

Private retirement savings help mitigate dependence on the Social Security trust fund and there is probably a reasonable argument to be made over raising the retirement age and means-testing. But our tax policies have deliberately tried to encourage private savings to increase national savings. This proposal endeavors to go backwards, presumably under some misguided notion of “fairness.” One must also assume that this president believes the government is the best or only vehicle to tax and redistribute the benefits of economic success. But it makes far more sense to extend the tax benefits of saving to the lower and middle income classes rather than seek to restrain the savings of the successful. For example, why limit contributions? The only reason not to do so must be some misplaced desire to increase tax revenues to grow the public sector. But the private economy has proven far more efficient in the provision of goods and services and the desire of some in Washington to increase our dependence on inefficient public goods is counter-productive to our material well-being as well as our personal freedoms. Private savings are a source of capital and one feels the need to constantly remind our political class of the meaning of “capital-ism” with pointed references to the etymology of the word.  One wonders if the thinking in Washington ever gets that far.

Bernanke Rides the Bull_ _ _ _


As one juices the bull, one is also forced to wade through the bovine excrement. Someday we’ll look back and wonder how insane this all was. Some people in this world still believe in financial alchemy.

From the WSJ:

It’s Ben Bernanke’s economy, and everyone else is along for the ride.

That reality has been clearer than ever in recent days, as financial markets lurch while awaiting the Federal Reserve Chairman’s next monetary intimation, and now with President Obama’s Monday hint that he may not reappoint Mr. Bernanke to another four-year term.

The recent market turmoil follows Mr. Bernanke’s suggestion to Congress last month that the Fed could start reducing its $85 billion in monthly bond purchases later this year if growth is strong enough. There’s a lot of wiggle room in “could,” but the market reaction has nonetheless been sharp. The 2013 rally in stocks took a pause, bond yields have climbed, and capital has flowed out of emerging markets. All of this reverses what happened when Mr. Bernanke announced his open-ended bond buying last year.

This is a portent of what is likely to be continuing ferment when the Fed finally unwinds its extraordinary monetary interventions. The biggest question about the Fed’s policy of near-zero interest rates and unlimited quantitative easing has always been: What happens when the music stops?

Mr. Bernanke’s answer is that the Fed has the “tools” to unwind, and it will use them when the economy is healthy enough. The Fed says this means a jobless rate of 6.5% or lower (from 7.6% today) and presumably a durable housing recovery. With some “open-mouth operations” to signal its intentions, the Fed thinks it can manage a gradual adjustment that avoids inflation or bursting asset bubbles. We all wish it will be so.

But as the central-banking proverb holds, it is easier to get on the bull than to get off. The eternal problems are timing and political will. Knowing when to get off is hard enough when the only major variable is the traditional fed funds rate. It is harder still when the variables include a promise of near-zero rates into mid-2015 and a Fed balance sheet that has nearly quadrupled in five and a half years to $3.4 trillion.

A crowd will always form in Washington and on Wall Street to say it’s too soon to stop, and those voices are already urging the Fed not to signal any reduction in bond buying at this week’s Open Market Committee meeting. They say there may be a housing recovery, but it isn’t solid enough. The jobless rate is falling, but not fast enough. And with little sign of inflation (0.1% in May, 1.4% over the past year), we’re told that any reduction in purchases runs the risk of falling prices.

The deflation fear can be especially beguiling, as Mr. Bernanke knows. In 2003 Fed Chairman Alan Greenspan and a certain new Fed Governor named Ben Bernanke cited deflation risks to justify holding the fed funds rate at 1% for an entire year even as the economy was accelerating to a nearly 4% growth rate. This was the original sin that did so much to produce the housing bubble and financial panic.

Our view is that the sooner the Fed begins to unwind, the better. Its interventions were necessary amid panic and recession in 2008-2009. But the recovery reached its fourth anniversary this month. And while growth remains subpar, it isn’t clear that monetary policy can do more to increase it.

The Fed can’t repeal ObamaCare, which is a deadweight burden on job creation. It can’t repeal the tax increases that hit in January, notably on small businesses. And it can’t repeal the waves of new regulation that the Obama Administration continues to impose across the economy. The miracle is that growth is as strong as it is, which speaks to the private innovation that continues to take place in energy, biotech, digital devices, big data and more.

Meanwhile, the longer QE and near-zero rates continue, the more risks accumulate. The longer investors scramble for yield, the greater the risks of misallocated capital and bubbles we may not see until it is too late. Savers have been punished for a half decade already, while low-interest rates have made it easier for politicians to spend with too little consequence.

Which brings us to Mr. Bernanke’s future when his second term expires in 2014. Mr. Obama told Charlie Rose of PBS on Monday that the Fed chief “has already stayed a lot longer than he wanted or he was supposed to.” This suggests that Mr. Obama may prefer to name a new Chairman, and the pressure within his party is great to choose Fed Governor and economist Janet Yellen. She would be the first woman Fed chief and is known to favor even more expansionary monetary policy than Mr. Bernanke does.

The political virtue of choosing Ms. Yellen is that Mr. Obama would have a loyalist in the job and thus no ability to dodge responsibility if the Fed gets it wrong. On the other hand, Mr. Bernanke made the decision to hop on this bull and ride it for more than four years. There would be rough justice in seeing if he really can manage a smooth dismount.

How the Fed Screwed the Pooch


This is how the casino works for the casino bosses. From the WSJ:

All eyes are on this week’s FOMC meeting—will the ‘tapering’ of bond-buying finally kick in? Then what? … We are in an age where the eight male and four female members of the FOMC are responsible for whether securities markets float or sink.


Jamie Dimon got the world’s attention June 6 when he told an audience in China that securities market behavior in the months ahead is likely to be “scary and volatile.”

On the blog, “Seeking Alpha,” market analyst Joseph Stuber theorized that the J.P. Morgan Chase CEO was sending out a message on behalf of the Federal Reserve that it is mulling an early wind-down of its latest round of quantitative easing and that things might get rocky. Whether or not the Fed was sending a signal, markets have been skittish in advance of the Federal Open Market Committee meeting that ends on Wednesday. Will the Fed really begin “tapering” its $85 billion monthly purchase of Treasury and federal-agency bonds? A lot of people are waiting to hear.

We are in an age where the eight male and four female members of the FOMC are responsible for whether securities markets float or sink. Traders around the world who in better times considered a range of variables now focus on a single one, Federal Reserve policy.

“It’s a different world when central banks are managing interest rates,” said Mr. Dimon in China. And this world can indeed become “scary.”

Unsurprisingly, bond markets have been dampened by the guessing about the Fed’s policy intentions. Buyers were unenthusiastic at last week’s Treasury auction of 10-year Treasury notes. The market price of 10-year Treasurys has fallen despite the massive Fed purchases.

More troubling is the behavior of the stock market. Traders last week blamed uncertainty about the FOMC for the sharp ups and downs on the New York Stock Exchange. The Dow Jones Industrial Average dropped 105.9 points for the week. Volatility resumed on Monday, with a 183-point spread between the high and low point of the Dow, as it recovered from last week’s loss.

In the bygone days of free markets, stocks tended to move counter to bonds as investors switched from one to the other to maximize yield. But in the new world of government rigging, they often head in the same direction. That’s not good for investors. [Note: We’ve CREATED this world with bad economic policies.]

Stocks have had a big ride under the Fed’s near-zero interest rate policy as investors have accepted greater risks for better returns than those available on bonds. But there may be another reason for the stock run-up. The Fed’s huge bond purchases may impact stocks directly. Hence, the 15,000 Dow may be a bubble that will deflate if the Fed starts “tapering.”

To understand the possible connection, follow the money. Because the Fed makes its Treasury bond purchases from the “primary dealer” banks, the proceeds boost the banks’ deposits at the Fed far in excess of the reserves legally required. Since the QE4 buying program began last December, excess reserves have burgeoned by more than a half-trillion dollars to just short of $2 trillion. To encourage the banks to hold this money so that it won’t enter the credit markets and destroy the value of the dollar, the Fed pays the banks a quarter of a percentage point interest on their deposits.

But it may not be that easy to contain $2 trillion in inflationary cash—and some analysts believe that excess reserves are a direct factor in the run-up in stocks. Their arguments are abstruse, involving such possibilities as “hypothecation” of those deposits, that is, using them as collateral to raise money in the “shadow banking” market for investment in stocks.

Banks have constant dealings in the shadow market with nonbank entities like money-market and hedge funds and other big money pools. It’s not a big stretch to imagine them using excess reserve deposits as collateral to raise money.

A modicum of support for such theories comes obliquely from New York Fed President William Dudley, a member of the FOMC. In a February speech, he raised concerns about the failure of the massive Dodd-Frank financial reform legislation to adequately regulate shadow banking. Mr. Dudley complained that Dodd-Frank actually raised the risks to the financial system by barring Fed intervention if a shadow bank is in danger of failure. He was referring to the huge business that money-market funds do in raising collateral for “tri-party repos,” where third parties manage the temporary sale and repurchase of securities that banks use to raise short-term cash.

The Fed president apparently was concerned about a “run” on one of the parties if the collateral goes sour. He wasn’t talking about hypothecating excess reserves, but who’s to say that tri-party repos are the limit of Fed concerns about shadow banking.

Aside from direct Fed influence, there is another reason to be concerned about a stock-market bubble—leverage. Margin debt at the New York Stock Exchange reached a record high of $384 billion in April, which means that the stock market is getting heavy support from borrowed money. [Thanks Mr. Fed!]

With a decline in bond values despite the Fed’s buying spree, and the possibility that Fed policy has also inflated stocks, the FOMC faces some tough issues this week. Surely, it can’t go on forever adding more trillions to its balance sheet and the excess reserves of the banks. But what happens when it stops? How scary will it be?

That’s an enormous puzzle for the 12 ordinary mortals on the committee to try to solve. The superhuman task derives from the grandiose belief by Chairman Ben Bernanke and his White House supporters that the Fed is capable of superhuman feats, like running the global economy.


‘Winner Take All’ Economy Mirrors Music Industry


The issue of the Winner-Take-All economy was raised by economist Alan Krueger in a speech at Cleveland’s Rock and Roll Hall of Fame. Krueger explains how globalization and technology are the two major forces driving income and wealth inequality in the world today. Unfortunately, Krueger identifies the cause, but completely fumbles the solution.

The maldistribution of the gains from globalization and technology cannot be solved by increasing wage incomes because the major driver of the increase in wealth to the 1% is the ownership of financial capital. This capital combines with the exploding supply of labor in the developing world to drive up residual profits while driving down world wages. Policies to reverse this by favoring domestic labor unions only hamper national growth in a competitive world economy where capital is highly mobile and seeks out the highest risk-adjusted rate of return. The only solution is to increase the participation of the workforce in risk-taking capital investment and capital accumulation (think entrepreneurship). The present policies of the Obama administration and the Federal Reserve impede this participation and are hollowing out the middle class. If anyone has benefited from these policies, it is the 1% in the financial sector.

The following is reprinted from the WSJ with a link to the original remarks by Krueger.

…four key factors driving the “superstar” economy: technology, scale, luck and an erosion of social norms that compress prices and incomes.

By Sudeep Reddy

The U.S. economy is looking increasingly like the music industry: a small sliver of people are capturing the largest gains.

That’s the view from the White House’s resident expert in the economics of rock and roll, who is wrapping up a tour as chairman of the president’s Council of Economic Advisers.

Alan Krueger, who became a leading scholar in Rockonomics long before his time in the Obama administration, says in a speech Wednesday evening at the Rock and Roll Hall of Fame in Cleveland that the U.S. is “increasingly becoming a ‘winner-take-all’ economy,” following the long experience of the music industry.

“Over recent decades, technological change, globalization and an erosion of the institutions and practices that support shared prosperity in the U.S. have put the middle class under increasing stress,” he says, according to his prepared remarks. “The lucky and the talented — and it is often hard to tell the difference — have been doing better and better, while the vast majority has struggled to keep up.

In Cleveland speech, titled “Land of Hope and Dreams: Rock and Roll, Economics, and Rebuilding the Middle Class,” Mr. Krueger outlines the key income trends in the music industry across recent decades:

The music industry has undergone a profound shift over the last 30 years. The price of the average concert ticket increased by nearly 400% from 1981 to 2012, much faster than the 150% rise in overall consumer price inflation. And prices for the best seats for the best performers have increased even faster.

At the same time, the share of concert revenue taken home by the top 1% of performers has more than doubled, rising from 26 percent in 1982 to 56 percent in 2003. The top 5 percent take home almost 90 percent of all concert revenues.

This is an extreme version of what has happened to the U.S. income distribution as a whole. The top 1% of families doubled their share of income from 1979 to 2011. In 1979, the top 1% took home 10 percent of national income, and in 2011 they took home 20%. By this measure, incomes in the entire U.S. economy today are almost as skewed as they were in the rock ‘n roll industry when Bruce Springsteen cut “Born in the U.S.A.”

He highlights four key factors driving the “superstar” economy: technology, scale, luck and an erosion of social norms that compress prices and incomes.

On the latter point, Mr. Krueger says: “As inequality has increased in society in general, norms of fairness have been under pressure and have evolved. Prices have risen for the best seats at the hottest shows — and made it possible for the best artists to make over $100 million for one tour — but this has come with a backlash from many fans who feel that rock ‘n roll is straying from its roots. And this is a risk to the entire industry.”

Those four same forces shaping the music industry are also shaping the U.S. economy, Mr. Krueger says. The end result: 84% of the total income growth in the U.S. from 1979 to 2011 went to the top 1% of families. All the income growth from 2000 to 2007 went to the top 1%.

Mr. Krueger runs through the most important research and trends in income inequality in the U.S. over the past century. Read his full remarks here.

More Fed Critics


Reposted from John Taylor’s blog, EconomicsOne:

In a new piece called “Quantitative Quicksand” published in Project Syndicate, Allan Meltzer argues that the U.S. recovery would be better off if the Fed had not engaged in quantitative easing.  The banks are just loaning the extra liquidity to credit worthy borrowers and the government, rather than to the smaller businesses that need it.  The economic problems lie elsewhere. In the meantime the risks of not being able to exit smoothly from the Quantitative Quicksand (what a great title) are mounting.

Meltzer is one of many economists and policy makers—on both sides of the political spectrum—who have been speaking or writing on the risks and the already-realized downsides of the Fed’s recent policy.

Just last week Paul Volcker weighed in at the Economic Club of New York, arguing that the exit problems are indeed tough while the benefits of the policy are “limited and diminishing.” Volcker also makes the case for getting rid of the dual mandate because of the risks it too causes. The recent market volatility over tapering—exiting from the quicksand—is just an early realization of the risks that many have long been warning about.


I wholeheartedly agree with both constructive criticisms.

Rethinking Money

money-symbolsFor any of you who are too busy trying to make it to notice, we have a world-wide problem with government-issued (fiat) money. This article offers an interesting new conceptualization of virtual currencies that might weaken governments and strengthen individual freedoms world-wide. That should get the statists all in a tizzy.

From the WSJ:

Free-Market Money, Courtesy of the Web

Bitcoin was just the start for virtual currencies. Cloud-computing certificates, anyone?


The digital currency called Bitcoin may or may not survive long-term, but it has already succeeded on one front: making people think seriously about alternative forms of money. More such alternatives to traditional currency will likely emerge.

The attraction of the Bitcoin is not just the anonymity it provides to users (an anonymity that the U.S. government has alleged some users have employed for money laundering). Bitcoin is also secure against traditional forms of counterfeiting. More important, the Bitcoin is designed to be scarce and thus immune to inflation. There is a limit to the number of Bitcoins—21 million—that is determined by a transparent rule and not by the whim of a central banker.

Gold used to serve this purpose. It was a commodity that was relatively scarce and not easily mined, thus reducing the risk of inflation. That valuable function has been superseded by today’s paper moneys. In this sense, Bitcoin is an electronic version of gold.

In the future, it is likely that other digital alternatives to currency will emerge, each one competing in the market to satisfy the needs of users. The possibilities are limited only by the imagination. Here is one:

Cloud-computing companies could issue certificates convertible into an hour of premium computing. Prices for other services could be quoted in terms of these certificates. The analogy is to traditional gold-backed currency, which was redeemable into physical gold at the option of the owner. While the dollar price of an hour of premium computing would vary with market conditions, the certificate would be guaranteed to always convert into one hour of premium computing. The maxim “time is money” would take on a new meaning.

Computing has become a fundamental element of virtually every technology, a common currency, so to speak, of doing business in today’s economy. Cloud-computing companies provide on-demand storage and computing at a price that varies with market conditions and the computing speed required. They compete on price and the quality and reliability of their cloud, which can be accessed from anywhere in the world at any time. Competition forces the companies to continually upgrade to the latest generation of computers and data-storage facilities.

Cloud-computing certificates could be redeemed at any time. The owner of a one-hour certificate, for example, could convert the certificate today or wait 18 months when presumably an hour of computing time would be able to do twice as much because of the increased computing speed that comes from Moore’s Law.

The certificates would never expire, so the owner need never convert them. Unlike gift certificates, they would not be fixed in price to a certain dollar value but to a fixed amount of computing time. If the public gained confidence that the cloud-computing companies were not flooding the market with certificates, the certificates might be viewed as stable and liquid enough to circulate as money. If the certificates were freely transferrable, they could come to be used to buy any product or service, or be saved as a stable store of value.

As confidence and familiarity in the certificates grew, the certificates could even be used as a basis for credit or any other thing that dollars are used for. Certificates would have an advantage over Federal Reserve-produced dollars as their supply and price would be completely dictated by the market.

During slow economic times, cloud-computing companies would have less incentive to expand their clouds and would reduce the number of certificates they issued. The reverse would happen in better economic times. The certificates would have an advantage over the Bitcoin: They could be converted into something of value, instead of just being based on relative scarcity.

It is impossible to predict what kinds of money a truly free market will create in an increasingly digitized world. But we can be confident in predicting that just as markets improve the quality of all products, they will do the same for money.

ZIRPing: Is It Working?


Nope. From the WSJ:

The Hidden Jobless Disaster

At the present slow pace of job growth, it will require more than a decade to get back to full employment defined by prerecession standards.

…the various programs of quantitative easing (and other fiscal and monetary policies) have not been particularly effective at stimulating job growth. Consequently, the Fed may want to reconsider its decision to maintain a loose-money policy until the unemployment rate dips to 6.5%.


The market tanked Wednesday on bad preliminary job news. And so, when Friday’s jobs report is released, the unemployment rate and the number of new jobs will come in for close scrutiny. Then again, they always attract the most attention. Even the Federal Reserve focuses on the unemployment rate, announcing on a number of occasions that a rate of 6.5% will indicate when it is time to start raising interest rates and winding down the Fed’s easy-money policies.

Yet the unemployment rate is not the best guide to the strength of the labor market, particularly during this recession and recovery. Instead, the Fed and the rest of us should be watching the employment rate. There are two reasons.

First, the better measure of a strong labor market is the proportion of the population that is working, not the proportion that isn’t. In 2006, 63.4% of the working-age population was employed. That percentage declined to a low of 58.2% in July 2011 and now stands at 58.6%. By this measure, the labor market’s health has barely changed over the past three years.

Second, the headline unemployment rate, what the Bureau of Labor Statistics calls “U3,” uses as its numerator the number of individuals who are actively seeking work but do not have jobs. There is another highly relevant measure that captures what is going on in the economy. “U6” counts those marginally attached to the workforce—including the unemployed who dropped out of the labor market and are not actively seeking work because they are discouraged, as well as those working part time because they cannot find full-time work.

Every time the unemployment rate changes, analysts and reporters try to determine whether unemployment changed because more people were actually working or because people simply dropped out of the labor market entirely, reducing the number actively seeking work. The employment rate—that is, the employment-to-population ratio—eliminates this issue by going straight to the bottom line, measuring the proportion of potential workers who are actually working.

During the past three decades the relation between unemployment and employment has been almost perfectly inverse. (See the nearby chart.) When the employment-to-population ratio rises, the unemployment rate falls. When the unemployment rate rises, the employment-to-population ratio falls. Even the turning points are aligned. Consequently, the unemployment rate has been a very good proxy for the employment rate. But that relationship has completely broken down during the most recent recession.

While the unemployment rate has fallen over the past 3½ years, the employment-to-population ratio has stayed almost constant at about 58.5%, well below the prerecession peak. Jobs are always being created and destroyed, and the net number of jobs over the last 3½ years has increased. But so too has the size of the working-age population. Job growth has been just slightly better than what it takes to keep the employed proportion of the working-age population constant. That’s why jobs still seem so scarce.

The U.S. is not getting back many of the jobs that were lost during the recession. At the present slow pace of job growth, it will require more than a decade to get back to full employment defined by prerecession standards.

The striking deficiency in jobs is borne out by the Bureau of Labor Statistics’ Job Openings and Labor Turnover Survey. Despite declining unemployment rates, the number of hires during the most recent month (March 2013) is almost the same as it was in January 2009, the worst month for job losses during the entire recession (4.2 million then, 4.3 million now).

Why have so many workers dropped out of the labor force and stopped actively seeking work? Partly this is due to sluggish economic growth. But research by the University of Chicago’s Casey Mulligan has suggested that because government benefits are lost when income rises, some people forgo poor jobs in lieu of government benefits—unemployment insurance, food stamps and disability benefits among the most obvious. The disability rolls have grown by 13% and the number receiving food stamps by 39% since 2009.

These disincentives to seek work may also help explain the unusually high proportion of the unemployed who have been out of work for more than 26 weeks. The proportion of unemployed who are long-termers reached 45% in April 2010 and again in March 2011. It is still above 37%. During the early 1980s, when the economy experienced a comparable recession, the proportion of long-term unemployed never exceeded 27%.

The Fed may draw two inferences from the experience of the past few years. The first is that it may be a very long time before the labor market strengthens enough to declare that the slump is over. The lackluster job creation and hiring that is reflected in the low employment-to-population ratio has persisted for three years and shows no clear signs of improving.

The second is that the various programs of quantitative easing (and other fiscal and monetary policies) have not been particularly effective at stimulating job growth. Consequently, the Fed may want to reconsider its decision to maintain a loose-money policy until the unemployment rate dips to 6.5%.

Understanding Risk Really Matters


This is an excellent topic to mull over. Risk-taking is the foundation of all innovation and wealth creation. From the WSJ, comments below…

Risk-Averse Culture Infects U.S. Workers, Entrepreneurs


Americans have long taken pride in their willingness to bet it all on a dream. But that risk-taking spirit appears to be fading.

Fewer Americans are changing jobs. Companies are hoarding more cash. And the proportion of new businesses has fallen. The result? A less dynamic economy.

Three long-running trends suggest the U.S. economy has turned soft on risk: Companies add jobs more slowly, even in good times. Investors put less money into new ventures. And, more broadly, Americans start fewer businesses and are less inclined to change jobs or move for new opportunities.

The revival of the housing market has been all over the news in the past weeks but as MarketWatch’s Jim Jelter explains, there are three other areas of the economy that are doing better than you think.

The changes reflect broader, more permanent shifts, including an aging population and the new dominance of large corporations in many industries. They also may help explain the increasingly sluggish economic recoveries after the past three recessions, experts said.

“The U.S. has succeeded in part because of its dynamism, its high pace of job creation and destruction, and its high pace of churning of workers,” said John Haltiwanger, a University of Maryland economist who has studied the decline in American entrepreneurship. “The pessimistic view is we’ve lost our mojo.”

Companies that gamble on new ideas are more likely to fail, but also more likely to hit it big. Entrepreneurs face long odds, but those that achieve success create jobs for many others.

As important, say economists, are small acts of risk-taking: workers who quit their jobs to find better ones, companies that expand payrolls and families that move from sluggish economic regions to ones with low unemployment rates.

Multiplied across the U.S. economy, these acts of faith and ambition help speed money, talent and resources to where they are needed.

Of course, too much risk-taking can be dangerous, as the financial crisis showed. And with the stock market soaring, some types of risk are displaying signs of a strong pos-tcrisis rebound. Indeed, the Federal Reserve said it was watching for signs that easy-money policies are leading investors to take excessive risks.

Playing It Safe

But a broad cross section of U.S. economists, from a range of academic disciplines and political persuasions, agree that a specific and necessary kind of risk-taking is on the decline. Historically, risk-taking that supports high rates of churn—lots of hiring and firing, company formation and destruction—gives economies more flexibility to adapt to changing markets.

Maxim Schillebeeckx is the kind of ambitious young American who has long propelled the U.S. economy. A 28-year-old doctoral student in genetics at Washington University in St. Louis, Mr. Schillebeeckx also has a graduate degree in economics. He helped create a student-led consulting firm to provide scientific advice to local startups.

But despite his enthusiasm for entrepreneurship and his experience in startups, Mr. Schillebeeckx said he planned to look for the safety of work in consulting or private equity, rather than launch his own company or work for a new venture.

“I’m pretty risk averse, personally,” Mr. Schillebeeckx said. “On the entrepreneurial side, you have to be willing to jump off the deep end.”

Mr. Haltiwanger and other economists said this decline in risk-taking—both by companies and individuals—has coincided with a broader slowing of the U.S. economy, particularly for new jobs.

In the eight recessions from the end of World War II through the end of the 1980s, it took the U.S. a little more than 20 months, on average, for employment to return to its pre-recession peak. But after the relatively shallow recession of the early 1990s, it took 32 months for payrolls to rebound fully.

After the even milder recession of 2001, it took four years. Today, nearly four years after the end of the last recession, employment has yet to reach its pre-crisis peak.

Economists have proposed various explanations for the series of slower rebounds, including the rise of outsourcing and automation that have allowed companies to produce more with fewer workers.

Pockets of the U.S. economy still burn with a risk-taking spirit. Google, Apple and Facebook reshaped the technology sector, creating new categories of products and services. Energy companies and their investors bet billions of dollars on new drilling techniques that have unlocked new reserves of domestic oil and natural gas. Such coastal cities as San Francisco and Boston, and college towns like Boulder, Colo., and Austin, Texas, boast vibrant communities of entrepreneurs and investors.

But risk-taking seems more concentrated than years past, by industry and by region, said Dane Stangler, director of research and policy at the Ewing Marion Kauffman Foundation, a Kansas City, Mo., nonprofit that studies entrepreneurship.

“We absolutely see geographic divergence,” he said. “We’ve got these hotbeds of startups, but you just don’t see the same level of activity in other areas of the country.”

That is a problem for regions left behind. Cities with high levels of entrepreneurial activity had significantly better job growth than those that relied more heavily on existing businesses, according to findings by Harvard economist Edward Glaeser and two colleagues that were published last year.

Entrepreneurship is a numbers game that draws a handful of winners from a crowd of participants, Mr. Haltiwanger said. He and other researchers have found that a relatively small number of fast-growing companies create a disproportionate number of new jobs. But such companies are almost impossible to identify ahead of time.

Little about Sam Walton’s Bentonville, Ark., five-and-dime store suggested Wal-Mart would one day become the world’s leading retail chain. Little about Jeff Bezos’s online bookstore suggested Amazon’s future as the Web’s biggest commercial hub.

The problem with fewer Americans starting businesses is that there are fewer chances for the next Amazon or Wal-Mart—or even the successful small- or medium-size business.

“It just means that there are fewer new companies that are creating jobs, fewer new companies that are competing for workers,” said Lina Khan, an economist who has studied the decline in entrepreneurship for the New America Foundation, a Washington think tank. “Traditionally being able to start your own business has been a path to upward mobility.”

Fewer Americans are choosing that path. In 1982, new companies—those in business less than five years—made up roughly half of all U.S. businesses, according to census data. By 2011, they accounted for just over a third. Over the same period, the share of the labor force working at new companies fell to 11% from more than 20%.

Both trends predate the recession and have continued in the recovery.

Investors, meanwhile, appear to be losing enthusiasm for startups. Total venture capital invested in the U.S. fell nearly 10% last year and has yet to return to its pre-recession peak, said PricewaterhouseCoopers.

The share of capital going to new business ventures has fallen even faster, PricewaterhouseCoopers data show, and is more concentrated: Silicon Valley took 40% of venture funding in 2012, up from about 30% in the late 1990s.

The decline in risk-taking is reflected in U.S. migration: Americans move less often, with rates of interstate migration falling for at least 20 years, according to census data. They also have less workplace wanderlust: 53% of adults last year held the same job for at least five years, up from 46% in 1996, according to the Labor Department. The share of workers who voluntarily left their jobs in a given year plummeted to 16.1% in 2009 from 25.2% in 2006 and remains well below prerecession levels, Labor Department data show.

Economists at the Federal Reserve Board of Governors found the falling rate of interstate migration over the long-term correlated strongly with the decline in job changes. In other words, Fed researchers said, people are moving less because they are changing jobs less.

Recent declines in moving may be tied to the collapse of the housing market, which left millions of homeowners owing more than their homes were worth, making it harder to relocate. But the longer trend predated the latest housing bust. Researchers have proposed such explanations as changing demographics and two-income households, which could make it harder for families to move.

Companies, too, are taking fewer risks. Rather than expanding payrolls, for example, they are keeping more cash on hand—5.7% of their assets at the end of 2012, up from under 3% three decades earlier, said the Federal Reserve, a rise that accelerated after the recession. Workers are hired more slowly, particularly at newer companies, Labor Department data show.

Andy Gugar opened Mercado’s restaurant in Tyler, Texas, in 1987, with a second location a year later. By the early 2000s, the chain, known as Posados Café, had a dozen locations in Texas and Louisiana.

Since then, expansion has slowed. The chain now has 16 locations and brings in about $38 million per year in sales. Scott Nordon, Posados’s chief operating officer, said the chain might one day reach 20 or 25 restaurants but was in no rush.

“We don’t want to have 100 stores,” he said. “There’s no pressure for us to grow. If we see an opportunity, guess what, we’re going to take advantage of it. But if it doesn’t, we’re content.”

The conservative strategy predates the recession, Mr. Nordon said, but the financial crisis and the current weak economy have reinforced the view. The company plans to pay off debts over the next four years and will fund any expansion with cash. “Longevity is the name of the game,” he said.

Economists aren’t sure what is behind the decline in risk-taking. Among the possible explanations are the rising cost of health care, which makes it riskier to quit a job and more expensive to hire more employees; increased state and local licensing requirements that serve as barriers to newcomers—one recent study found that roughly 29% of U.S. employees required a government license or certificate in 2008, up from less than 5% in the 1950s; and immigration rules that deter would-be entrepreneurs from other countries.

An aging population is also cited. Young people are more prone to start companies or move for jobs. But the slowdown in risk-taking began before the baby boom generation began to retire. [Blogger Note: But we would expect a demographic slowdown in risk-taking to start long before retirement when the median age of baby boomers passed through the middle aged productivity years. In other words, long before 2008] And even younger workers change jobs less often.

One barrier for prospective entrepreneurs may be the growing dominance of large corporations in nearly every industry, which make it tough for new ventures to gain a foothold. A small bookstore no longer needs just a better selection or a friendlier staff than the crosstown competition—it also has to compete with national chains and, increasingly, such Internet retailers as Amazon. [This is winner-take-all consolidation.]

For the first time since such records have been kept, the Census found in 2008 that more Americans worked for big businesses—those with at least 500 workers—than small ones. The trend has continued since.

The work of running family businesses has also scared off younger generations, said Henry Hutcheson, president of Family Business USA, which advises these businesses.

“The lure and ease of joining a blue chip firm, where you get a good job and a decent salary, just seems to be overwhelming,” he said. “People are saying, ‘I can go take over my dad’s garden center and I can go run this thing and work seven days a week and be there from dawn until dusk, or I can go manage a Home Depot and they’re going to pay me $150,000 and I’ll get weekends and vacation.’ ”

Tony Raney faced that choice. Until a year ago, Mr. Raney worked for the small chain of appliance stores his family operates in Wilkesboro, N.C. After watching his stepfather work nights and weekends, Mr. Raney had second thoughts, especially since national chains offered lower prices. “It’s a lot riskier to be an independent business owner,” he said. “Big business is out to get you.”

A year ago, Mr. Raney left the family business for a data-entry job at a national appraisal firm. “I feel safer,” he said. “I have no desire to show up and be the head of the corporation. I just want to show up and do the job.”


This analysis ignores some of the direct policy causes that adversely affect risk-taking behavior. Such policies include:

  1. Greater uncertainty over government tax, regulatory, and monetary policies;
  2. Increased capital taxes, lowering risk-adjusted hurdle rates of return and decreasing capital accumulation;
  3. Low interest rates that distort prices across the economy, enable excessive borrowing and asset speculation, but decrease savings accumulation and seed capital;
  4. A government subsidized housing bubble that has hampered labor mobility;
  5. Increased employer healthcare costs;
  6. Higher corporate taxes in a competitive world market;
  7. Political failure to address entitlement reform.

The list is not exhausted. Combined with demographic changes, globalized labor supplies, political cronyism, and excessive public sector spending, is it any wonder that people have tamped down on their animal spirits? As this blog has documented extensively, misguided central bank policy has turned investment risk-taking into casino gambling on asset speculation. Things won’t really improve until we normalize our market economy and policymakers are taking us farther afield.

Fed Policy Is a Drag


Can’t put it any clearer than this. From the WSJ:

Fed Policy Is a Drag on Recovery

The stock market is soaring. Yet real median income has fallen 5%, unheard of for a recovery.


Former Federal Reserve Chairman Paul Volcker said in a speech to the Economic Club of New York on Wednesday that the Fed should not be asked to “accommodate misguided fiscal policies” and “will inevitably fall short.” He outlined a preferred monetary policy based on orthodox central banking aimed at a stable currency in order to maximize employment. “Credibility is an enormous asset,” he said. “Once earned, it must not be frittered away.” Those words are true and timely.

As this month’s stock and bond market gyrations showed, traders are obsessively focused on every nuance of the Fed’s monetary plans. Billions of dollars are at stake for Wall Street, which profits mightily from the Fed’s bond buying and cheap credit.

The problem is the broader economy’s poor performance in growth and jobs. The Fed, which was once a key proponent of market-based economic policies, has forced U.S. interest rates to near zero for four-and-a-half years with no plans to stop. It has bought nearly $3 trillion in bonds, with the express goal of channeling credit to the government, government-owned enterprises and large corporations in the hope that this will boost employment.

The Fed’s bond-market interventions probably helped during the 2008 crisis when markets had frozen, but after that the economy would have done much better without them. Recoveries are normally fast and broad once markets are allowed to clear and begin operating. Quarterly growth topped 9% in 1983 after a deep recession and 7% in 1996 leading into President Clinton’s re-election. Interest rates were high, yet median incomes were rising sharply.

Growth in the current recovery only rose above 4% once, in the fourth quarter of 2011, and averaged just 2% per year in its first four years versus 5% in the same period of the 1980s recovery, 3.2% in the 1990s recovery and 2.9% in the 2000s recovery. The underperformance over the past four years translates into more than three million jobs that should have been created but weren’t, an economic disaster that lowered real median incomes by 5%.

The disastrous state of affairs was rationalized as a “new normal” following the Great Recession, but the reality is that poor policy choices hurt growth. Tax-and-spend policies sapped investment, and the Fed’s low rates and bond purchases damaged markets, hurt savers and channeled credit to the government at the expense of job creators. It’s a zero-sum process that should be stopped because of the bad effect on growth and jobs.

Incredibly, as Fed Chairman Ben Bernanke alluded to in his May 22 congressional testimony, the Fed is now angling to create a semi-permanent control dial with which the Fed can increase its $85 billion in monthly bond purchases when growth slows and reduce them if growth ever speeds up. This creates maximum uncertainty for the private sector, giving an advantage to traders, the government and the rich but hurting growth and long-term investors.

Washington thrives on the impression that the economy and markets are dependent on the Federal Reserve and deficit spending. This is the wrong lesson. More likely, past government excesses—trillions added to the national debt and the Fed’s liabilities—lowered the growth rate. The economy and markets would adjust and be better off without them.

One line of Fed criticism has emphasized money printing and an inflation risk. This is off target and, with inflation low, gives the Fed an opening to keep going. When the Fed buys bonds, it pays for them with liabilities to banks called excess reserves. There’s no creation of new money in the private sector. The M2 money supply, the measure of bank deposits often used by monetarists to anticipate inflation, is unaffected. Private-sector credit grew only 0.8% from the end of 2008 through the end of 2012, whereas credit to the government grew 58%.

Rather than money printing that turns into cash, the excess reserves are, in effect, an IOU from the Fed. Interest is paid on them and they aren’t spent or used by banks to increase lending. This distinguishes current policy from the inflationary 1960s and 1970s, when the Fed created reserves that banks used as backing for multiple loans and rapid growth in private-sector credit.

The stronger criticism is that the Fed’s policy is contractionary, harming growth. The Fed’s intention is that the low bond rates it provides the government will spill over to big corporations and banks, who in turn will help the little guy. This trickle-down monetary policy has contributed to very fast growth in corporate profits, part of the explanation for the record stock market, but also to weak GDP growth and declining middle-class incomes. The extra credit the Fed channeled to government and big corporations meant less credit elsewhere in the economy, a contractionary influence since most new jobs come from small businesses.

Still, three important developments may lift the economy despite the Fed, forcing it to taper its bond purchases and allow the recovery to accelerate. First, the Jan. 2 tax bill removed the risk of tax rate increases—on income, dividends, estates and the alternative minimum tax—that depressed growth in 2010-12. Second, most businesses are encouraged by the sequester and the idea of the government tackling spending, however clumsily. Third, private credit has started to grow, helped by thousands of new nonbank lenders. Total credit grew at a 5.6% annual rate in the fourth quarter of 2012 after contracting for much of 2009-12.

But whether the economy turns up or not, it should be clear that the Fed’s unprecedented and far-reaching monetary policy has been a drag, not a stimulus.