It’s the Fed, Stupid!

A Messaging Tip For The Donald: It’s The Fed, Stupid!

The Fed’s core policies of 2% inflation and 0% interest rates are kicking the economic stuffings out of Flyover AmericaThey are based on the specious academic theory that financial gambling fuels economic growth and that all economic classes prosper from inflation and march in lockstep together as prices and wages ascend on the Fed’s appointed path.

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The New Old World Order

I cite this article because it is quite insightful of the failed political culture in the modern democratic West and particularly the failures of US party elites. It also exposes the larger historical forces at work that suggest the road forward may be rather rocky.

For me this 2016 moment resonates with historical analogies such as the Savonarolan episode in Renaissance Florence that I wrote about in The City of Man, the dissolution of the Weimar Republic in 1930s Germany, and the Iranian Fundamentalist Revolution in 1979. We haven’t reached those precipices yet, but all arrows point in that direction unless we come to grips with our current failures of both modern liberalism and neo-conservatism.

Donald Trump Does Have Ideas—and We’d Better Pay Attention to Them

The post-1989 world order is unraveling. Here are 6 ideas Trump has to replace it.

Politico, September 15, 2016

Ideas really don’t come along that often. Already in 1840, Alexis de Tocqueville observed that in America, “ideas are a sort of mental dust,” that float about us but seldom cohere or hold our attention. For ideas to take hold, they need to be comprehensive and organizing; they need to order people’s experience of themselves and of their world. In 20th-century America, there were only a few ideas: the Progressivism of Wilson; Roosevelt’s New Deal; the Containment Doctrine of Truman; Johnson’s War on Poverty; Reagan’s audacious claim that the Cold War could be won; and finally, the post-1989 order rooted in “globalization” and “identity politics,” which seems to be unraveling before our ey.es.

Yes, Donald Trump is implicated in that unraveling, cavalierly undermining decades worth of social and political certainties with his rapid-fire Twitter account and persona that only the borough of Queens can produce. But so is Bernie Sanders. And so is Brexit. And so are the growing rumblings in Europe, which are all the more dangerous because there is no exit strategy if the European Union proves unsustainable. It is not so much that there are no new ideas for us to consider in 2016; it is more that the old ones are being taken apart without a clear understanding of what comes next. 2016 is the year of mental dust, where notions that stand apart from the post-1989 order don’t fully cohere. The 2016 election will be the first—but not last—test of whether they can.
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If you listen closely to Trump, you’ll hear a direct repudiation of the system of globalization and identity politics that has defined the world order since the Cold War. There are, in fact, six specific ideas that he has either blurted out or thinly buried in his rhetoric: (1) borders matter; (2) immigration policy matters; (3) national interests, not so-called universal interests, matter; (4) entrepreneurship matters; (5) decentralization matters; (6) PC speech—without which identity politics is inconceivable—must be repudiated.

These six ideas together point to an end to the unstable experiment with supra- and sub-national sovereignty that many of our elites have guided us toward, siren-like, since 1989. That is what the Trump campaign, ghastly though it may at times be, leads us toward: A future where states matter. A future where people are citizens, working together toward (bourgeois) improvement of their lot. His ideas do not yet fully cohere. They are a bit too much like mental dust that has yet to come together. But they can come together. And Trump is the first American candidate to bring some coherence to them, however raucous his formulations have been.

***

(Blog Note: It’s Not about Trump.)

Most of the commentary about Trump has treated him as if he is a one-off, as someone who has emerged because of the peculiar coincidence of his larger-than-life self-absorption and the advent of social media platforms that encourage it. When the world becomes a theater for soliloquy and self-aggrandizement, what else are we to expect?
But the Trump-as-one-off argument begins to fall apart when we think about what else happened in politics this year. First of all, Trump is not alone. If he alone had emerged—if there were no Bernie Sanders, no Brexit, no crisis in the EU—it would be justifiable to pay attention only to his peculiarities and to the oddities of the moment. But with these other uprisings occurring this year, it’s harder to dismiss Trump as a historical quirk.

Furthermore, if he had been just a one-off, surely the Republican Party would have been able to contain him, even co-opt him for its own purposes. After all, doesn’t the party decide? The Republican Party is not a one, however, it is a many. William F. Buckley Jr. and others invented the cultural conservatism portion of the party in the 1950s, with the turn to the traditionalism of Edmund Burke; the other big portion of the party adheres to the free-market conservatism of Friedrich Hayek. The third leg of the Republican Party stool, added during the Reagan years, includes evangelical Christians and Roman Catholics of the sort who were still unsure of the implications of Vatican II. To Burke and Hayek, then, add the names John Calvin and Aristotle/Thomas Aquinas. Anyone who really reads these figures knows that the tension between them is palpable. For a time, the three GOP factions were able to form an alliance against Communism abroad and against Progressivism at home. But after the Cold War ended, Communism withered and the culture wars were lost, there has been very little to keep the partnership together. And if it hadn’t been Trump, sooner or later someone else was going to come along and reveal the Republican Party’s inner fault lines. Trump alone might have been the catalyst, but the different factions of the GOP who quickly split over him were more than happy to oblige.

There is another reason why the Republican Party could not contain Trump, a perhaps deeper reason. Michael Oakeshott, an under-read political thinker in the mid-20th century, remarked in his exquisite essay, “Rationalism in Politics,” that one of the more pathological notions of our age is that political life can be understood in terms of “principles” that must be applied to circumstances. Politics-as-engineering, if you will. Republicans themselves succumbed to this notion, and members of the rank and file have noticed. Republicans stood for “the principles of the constitution,” for “the principles of the free market,” etc. The problem with standing for principles is that it allows you to remain unsullied by the political fray, to stand back and wait until yet another presidential election cycle when “our principles” can perhaps be applied. And if we lose, it’s OK, because we still have “our principles.” What Trump has been able to seize upon is growing dissatisfaction with this endless deferral, the sociological arrangement for which looks like comfortable Inside-the-Beltway Republicans defending “principles” and rank-and-file Republicans far from Washington-Babylon watching in horror and disgust.

Any number of commentators (and prominent Republican Party members) have said that Trump is an anti-ideas candidate. If we are serious about understanding our political moment, we have to be very clear about what this can mean. It can mean Trump’s administration will involve the-politics-of-will, so to speak; that the only thing that will matter in government will be what Trump demands. Or, it can mean that Trump is not a candidate who believes in “principles” at all. This is probably the more accurate usage. This doesn’t necessarily mean that he is unprincipled; it means rather that he doesn’t believe that yet another policy paper based on conservative “principles” is going to save either America or the Republican Party. In Democracy in America, Tocqueville was clear that the spirit of democracy is not made possible by great ideas (and certainly not by policy papers), but rather by practical, hands-on experience with self-governance. Ralph Waldo Emerson’s mystical musings in his essay, “Experience,” corroborate this. American democracy will not be rejuvenated by yet another policy paper from the Inside-the-Beltway gang. What I am not saying here is that Trump has the wisdom of an Oakeshott, a Tocqueville or an Emerson. What I am saying is that Trump is that quintessentially American figure, hated by intellectuals on both sides of the aisle and on the other side of the Atlantic, who doesn’t start with a “plan,” but rather gets himself in the thick of things and then moves outward to a workable idea—not a “principled” one—that can address the problem at hand, but which goes no further. That’s what American businessmen and women do. (And, if popular culture is a reliable guide to America, it is what Han Solo always does in Star Wars movies.) We would do well not to forget that the only school of philosophy developed in America has been Pragmatism. This second meaning of being an anti-ideas candidate is consonant with it.

If, as some have said, Trump’s only idea is, “I can solve it,” then we are in real trouble. The difficulty, of course, is that in this new, Trumpean moment when politics is unabashed rhetoric, it is very difficult to discern the direction a Trump administration will take us. Will he be the tyrant some fear, or the pragmatist that is needed?

It’s not unreasonable to think the latter. This is because, against the backdrop of post-1989 ideas, the Trump campaign does indeed have a nascent coherence. “Globalization” and “identity politics” are a remarkable configuration of ideas, which have sustained America, and much of the rest of the world, since 1989. With a historical eye—dating back to the formal acceptance of the state-system with the treaty of Westphalia in 1648—we see what is so remarkable about this configuration: It presumes that sovereignty rests not with the state, but with supra-national organizations—NAFTA, WTO, the U.N., the EU, the IMF, etc.—and with subnational sovereign sites that we name with the term “identity.” So inscribed in our post-1989 vernacular is the idea of “identity” that we can scarcely imagine ourselves without reference to our racial, gender, ethnic, national, religious and/or tribal “identity.” Once, we aspired to be citizens who abided by the rule of law prescribed within a territory; now we have sovereign “identities,” and wander aimlessly in a world without borders, with our gadgets in hand to distract us, and our polemics in mind to repudiate the disbelievers.

What, exactly, is the flaw with this remarkable post-1989 configuration of ideas? When you start thinking in terms of management by global elites at the trans-state level and homeless selves at the substate level that seek, but never really find, comfort in their “identities,” the consequences are significant: Slow growth rates (propped up by debt-financing) and isolated citizens who lose interest in building a world together. Then of course, there’s the rampant crony-capitalism that arises when, in the name of eliminating “global risk” and providing various forms of “security,” the collusion between ever-growing state bureaucracies and behemoth global corporations creates a permanent class of winners and losers. Hence, the huge disparities of wealth we see in the world today.

The post-1989 order of things fails to recognize that the state matters, and engaged citizens matter. The state is the largest possible unit of organization that allows for the political liberty and economic improvement of its citizens, in the long term. This arrangement entails competition, risk, success and failure. But it does lead to growth, citizen-involvement, and if not a full measure of happiness, then at least the satisfactions that competence and merit matter.

Trump, then, with his promise of a future in which the integrity of the state matters, and where citizens identify with the state because they have a stake in it rather than with identity-driven subgroups, proposes a satisfying alternative.

This is also why it would be a big mistake to underestimate Trump and the ideas he represents during this election. In the pages of the current issue of POLITICO Magazine, one author writes: “The Trump phenomenon is about cultural resentment, anger and most of all Trump. It’s primal-scream politics, a middle finger pointed at The Other, a nostalgia for a man-cave America where white dudes didn’t have to be so politically correct.”
I have no doubt that right now, somewhere in America (outside the Beltway), there are self-congratulatory men, probably white, huddled together in some smoky man-cave, with “Make America Great Again” placards on their John-Deere-tractor-mowed lawns.
But do not mistake the part for the whole. What is going on is that “globalization-and-identity-politics-speak” is being boldly challenged. Inside the Beltway, along the Atlantic and Pacific coasts, there is scarcely any evidence of this challenge. There are people in those places who will vote for Trump, but they dare not say it, for fear of ostracism. They think that identity politics has gone too far, or that if it hasn’t yet gone too far, there is no principled place where it must stop. They believe that the state can’t be our only large-scale political unit, but they see that on the post-1989 model, there will, finally, be no place for the state. Out beyond this hermetically sealed bicoastal consensus, there are Trump placards everywhere, not because citizens are racists or homophobes or some other vermin that needs to be eradicated, but because there is little evidence in their own lives that this vast post-1989 experiment with “globalization” and identity politics has done them much good.

The opposition to the post-1989 order is not just happening here in America; it is happening nearly everywhere. The Brexit vote stunned only those who believe in their bones that the very arc of history ends with “globalization” and identity politics.
The worry is that this powerful, growing disaffection with the status quo—both within Europe and elsewhere—will devolve into nefarious nationalism based on race, ethnicity or religion. To combat this, we are going to have to find constructive ways to build a new set of ideas around a very old set of ideas about sovereignty—namely, that the state and the citizens inside it matter. If we don’t find a way to base nationalism on a healthy understanding of what a liberal state is and what it does and expects from citizens to make it work well, dark nationalism, based on blood and religion, will prevail—again.
Nothing lasts forever. Is that not the mantra of the left? Why, then, would the ideas of globalization and identity politics not share the fate of all ideas that have their day then get tossed into the dust-bin of history?

***
Of course, when new ideas take hold, old institutional arrangements face upheaval or implosion. There is no post-election scenario in which the Republican Party as we knew it prior to Trump remains intact. The Republicans who vote for Hillary Clinton will not be forgotten by those who think Trump is the one chance Republicans have to stop “globalization-and-identity-politics-speak” cold in its tracks. And neither will Inside-the-Beltway Republicans forget those in their party who are about to pull the lever for Trump. One can say that Trump has revealed what can be called The Aristotle Problem in the Republican Party. Almost every cultural conservative with whom I have spoken recently loves Aristotle and hates Trump. That is because on Aristotelian grounds, Trump lacks character, moderation, propriety and magnanimity. He is, as they put it, “unfit to serve.” The sublime paradox is that Republican heirs of Aristotle refuse to vote for Trump, but will vote for Clinton and her politically left-ish ideas that, while very much adopted to the American political landscape, trace their roots to Marx and to Nietzsche. Amazingly, cultural conservatives who have long blamed Marx and Nietzsche (and German philosophy as a whole) for the decay of the modern world would now rather not vote for an American who expressly opposes Marx and Nietzsche’s ideas! In the battle between Athens, Berlin and, well, the borough of Queens, they prefer Athens first, Berlin second and Queens not at all. The Aristotle Problem shows why these two groups—the #NeverTrumpers and the current Republicans who will vote for Trump—will never be reconciled.

There are, then, two developments we are likely to see going forward. First, cultural conservatives will seriously consider a political “Benedict Option,” dropping out of the Republican Party and forming a like-minded Book Group, unconcerned with winning elections and very concerned with maintaining their “principles.” Their fidelity is to Aristotle rather than to winning the battle for the political soul of America. The economic conservatives, meanwhile, will be urged to stay within the party—provided they focus on the problem of increasing the wealth of citizens within the state.

The other development, barely talked about, is very interesting and already underway, inside the Trump campaign. It involves the effort to convince Americans as a whole that they are not well-served by thinking of themselves as members of different “identity groups” who are owed a debt that—surprise!—Very White Progressives on the left will pay them if they loyally vote for the Democratic Party. The Maginot Line the Democratic Party has drawn purports to include on its side, African-Americans, Hispanics, gays, Muslims and women. (Thus, the lack of embarrassment, really, about the “basket of deplorables” reference to Trump supporters.) To its credit, the Democratic Party has made the convincing case, really since the Progressive Era in the early part of the 20th century, that the strong state is needed to rearrange the economy and society, so that citizens may have justice. Those who vote for the Democratic Party today are not just offered government program assistance, they are offered political protections and encouragements for social arrangements of one sort or another that might not otherwise emerge.

But where does this use of political power to rearrange the economy and society end? Continue using political power in the service of “identity politics” to reshape the economy and society and eventually both of them will become so enfeebled that they no longer work at all. The result will not be greater liberty for the oppressed, it will be the tyranny of the state over all. Trump does have sympathies for a strong state; but correctly or incorrectly, he has managed to convince his supporters that a more independent economy and society matters. In such an arrangement, citizens see their first support as the institutions of society (the family, religion, civic associations), their second support as a relatively free market, and their third support as the state, whose real job is to defend the country from foreign threats. Under these arrangements, citizens do not look upward to the state to confirm, fortify and support their “identities.” Rather, they look outward to their neighbor, who they must trust to build a world together. Only when the spell of identity politics is broken can this older, properly liberal, understanding take hold. That is why Trump is suggesting to these so-called identity groups that there is an alternative to the post-1989 worldview that Clinton and the Democratic Party are still pushing.

Now that Trump has disrupted the Republican Party beyond repair, the success of the future Republican Party will hang on whether Americans come to see themselves as American citizens before they see themselves as bearers of this or that “identity.” The Very White Progressives who run the Democratic Party have an abiding interest in the latter narrative, because holding on to support of entire identity groups helps them win elections. But I do not think it can be successful much longer, in part because it is predicated on the continual growth of government, which only the debt-financing can support. Our debt-financed binge is over, or it will be soon. The canary in the coal mine—now starting to sing—is the African-American community, which has, as a whole, been betrayed by a Democratic Party that promises through government largesse that its burden shall be eased. Over the past half-century nothing has been further from the truth, especially in high-density inner-city regions. While it receives little media attention, there are African-Americans who are dubious about the arrangement by which the Democratic Party expects them to abide. A simultaneously serious and humorous example of this is the long train of videos posted on YouTube by “Diamond and Silk.” To be sure, the current polls show that Trump has abysmal ratings among minorities. If he wins the election, he will have to succeed in convincing them that he offers an alternative to permanent government assistance and identity politics consciousness-raising that, in the end, does them little good; and that through the alternative he offers there is a hope of assimilation into the middle class. A tall order, to be sure.

These observations are not to be confused as a ringing endorsement for a Republican Party that does not yet exist, and perhaps never will exist. But they are warning, of sorts, about impending changes that cannot be laughed off. The Republicans have at least been given a gift, in the disruption caused by Trump. The old alliances within it were held together by a geopolitical fact-on-the-ground that no longer exists: the Cold War. Now long behind us, a new geopolitical moment, where states once again matter, demands new alliances and new ideas. With the defeat of Bernie Sanders in the primaries, Democrats have been denied their gift, and will lumber on, this 2016, with “globalization-and-identity-politics-speak,” hoping to defend the world order that is predicated on it. If Sanders had won, the Democrats would have put down their identity politics narrative and returned to claims about “class” and class consciousness; they would have put down the banner of Nietzsche and taken up the banner of Marx, again. And that would have been interesting! Alas, here we are, with, on the one hand, tired old post-1989 ideas in the Democratic Party searching for one more chance to prove that they remain vibrant and adequate to the problems at hand; and on the other, seemingly strange, ideas that swirl around us like mental dust waiting to coalesce.

 

Helicopter Money

Central bank “Helicopter Money” is to the economy what helicopter parents are to their unfortunate children. This from Bloomberg View:

`Helicopter Money’ Is Coming to the U.S.

Aug 5, 2016 5:41 AM EDT

Several years of rock-bottom interest rates around the world haven’t been all bad. They’ve helped reduce government borrowing costs, for sure. Central banks also send back to their governments most of the interest received on assets purchased through quantitative-easing programs. Governments essentially are paying interest to themselves.

What is Helicopter Money? 

Since the beginning of their quantitative-easing activities, the Federal Reserve has returned $596 billion to the U.S. Treasury and the Bank of England has given back $47 billion. This cozy relationship between central banks and their governments resembles “helicopter money,” the unconventional form of stimulus that some central banks may be considering as a way to spur economic growth.

I’m looking for more such helicopter money — fiscal stimulus applied directly to the U.S. economy and financed by the Fed –no matter who wins the Presidential election in November.

It’s called helicopter money because of the illusion of dumping currency from the sky to people who will rapidly spend it, thereby creating demand, jobs and economic growth. Central banks can raise and lower interest rates and buy and sell securities, but that’s it. They can thereby make credit cheap and readily available, yet they can’t force banks to lend and consumers and businesses to borrow, spend and invest. That undermines the effectiveness of QE; as the proverb says, you can lead a horse to water, but you can’t make it drink.

Furthermore, developed-country central banks purchase government securities on open markets, not from governments directly. You might ask: “What’s the difference between the Treasury issuing debt in the market and the Fed buying it, versus the Fed buying securities directly from the Treasury?” The difference is that the open market determines the prices of Treasuries, not the government or the central bank. The market intervenes between the two, which keeps the government from shoving huge quantities of debt directly onto the central bank without a market-intervening test. This enforces central bank discipline and maintains credibility.

In contrast, direct sales to central banks have been the normal course of government finance in places like Zimbabwe and Argentina. It often leads to hyperinflation and financial disaster. (I keep a 100-trillion Zimbabwe dollar bank note, issued in 2008, which was worth only a few U.S. cents as inflation rates there accelerated to the hundreds-of-million-percent level. Now it sells for several U.S. dollars as a collector’s item, after the long-entrenched and corrupt Zimbabwean government switched to U.S. dollars and stopped issuing its own currency.)

Argentina was excluded from borrowing abroad after defaulting in 2001. Little domestic funding was available and the Argentine government was unwilling to reduce spending to cut the deficit. So it turned to the central bank, which printed 4 billion pesos in 2007 (then worth about $1.3 billion). That increased to 159 billion pesos in 2015, equal to 3 percent of gross domestic product. Not surprisingly, inflation skyrocketed to about 25 percent last year, up from 6 percent in 2009.

To be sure, the independence of most central banks from their governments is rarely clear cut. It’s become the norm in peacetime, but not during times of war, when government spending shoots up and the resulting debt requires considerable central-bank assistance. That was certainly true during World War II, when the U.S. money supply increased by 25 percent a year. The Federal Reserve was the handmaiden of the U.S. government in financing spending that far exceeded revenue.

Today, developed countries are engaged not in shooting wars but wars against chronically slow economic growth. So the belief in close coordination between governments and central banks in spurring economic activity is back in vogue — thus helicopter money.

All of the QE activity over the past several years by the Fed, the Bank of England, the European Central Bank, the Bank of Japan and others has failed to significantly revive economic growth. U.S. economic growth in this recovery has been the weakest of any post-war recovery. Growth in Japan has been minimal, and economies in the U.K. and the euro area remain under pressure.

The U.K.’s exit from the European Union may well lead to a recession in Britain and the EU as slow growth turns negative. A downturn could spread globally if financial disruptions are severe. This would no doubt ensure a drop in crude oil prices to the $10 to $20 a barrel level that I forecast in February 2015. This, too, would generate considerable financial distress, given the highly leveraged condition of the energy sector.

Both U.S. political parties seem to agree that funding for infrastructure projects is needed, given the poor state of American highways, ports, bridges and the like. And a boost in defense spending may also be in the works, especially if Republicans retain control of Congress and win the White House.

Given the “mad as hell” attitude of many voters in Europe and the U.S., on the left and the right, don’t be surprised to see a new round of fiscal stimulus financed by helicopter money, whether Donald Trump or Hillary Clinton is the next president.

Major central bank helicopter money is a fact of life in war time — and that includes the current global war on slower growth. Conventional monetary policy is impotent and voters in Europe and North America are screaming for government stimulus. I just hope it doesn’t set a precedent and continue after rapid growth resumes — otherwise, the fragile independence of major central banks could go the way of those in banana republics.

Economic Policy Report Card: C-

Today’s headlines:

Still anemic: U.S. growth picks up to only 0.8%

U.S. economic growth between January and March was 0.8% compared to the same time frame a year ago. That’s better than the initial estimate of 0.5%, which came in April, but still pretty sluggish.

unemployment-grads-cartoon1

US created 38,000 jobs in May vs. 162,000 expected

Job creation tumbled in May, with the economy adding just 38,000 positions, casting doubt on hopes for a stronger economic recovery as well as a Fed rate hike this summer.

The Labor Department also reported Friday that the headline unemployment fell to 4.7 percent. That rate does not include those who did not actively look for employment during the month or the underemployed who were working part time for economic reasons. A more encompassing rate that includes those groups held steady at 9.7 percent.

The drop in the unemployment rate was primarily due to a decline in the labor force participation rate, which fell to a 2016 low of 62.6 percent, a level near a four-decade low. The number of Americans not in the labor force surged to a record 94.7 million, an increase of 664,000.

growth chart

We’ve been predicting such disappointing results of ineffectual monetary and fiscal policies since this blog began back in August of 2011. And providing corroborating evidence along the way. Yet our policy experts continue to double-down on failed policies.

The problem is that when a nation inflates asset bubbles like we did with commodities, houses, stocks, and bonds over the past 20 years, there is no silver-lining policy correction that does not involve some  economic pain for the body politic. We had that awakening in 2008, but since then we have merely jumped on the same train by pumping out cheap credit for 8+ years.

Perhaps a medical metaphor works here. When prescribing antibiotics to combat an infection one can use small doses to avoid side-effects or one large overkill dose to knock-out the offending bacteria. The first treatment is the conservative, prudent approach that seeks a gradual recovery. The second risks a sudden shock to the system that kills off the infection so the patient can begin healing.

In medicine we’ve discovered that the gradual treatment can enable the bacteria to evolve and resist the antibiotics, making them ineffectual. In a nutshell, this is what we have done with economic policy, especially monetary policy that has distorted interest rates for more than 15 years.

The conservative approach marked by bailouts and government bail-ins has kept the patient flat on his back for 8 years. The more disciplined approach would have shocked the economy severely but gotten the patient out of the recovery room much quicker. We’ve seen that with other countries, like Iceland, that were forced to swallow their medicine in one quick dose.

But, of course, that would have meant a lot of politicians would have lost their cozy jobs. That may happen anyway after the next election.

Disconnects

…between central bank policies, economic growth and unemployment. Stockman distinctly and colorfully explains why we are experiencing 1-2% growth these days. I’m not sure any of the candidates for POTUS have a good answer for this…It’s a sad commentary on our intellectual and political leaders.

Losing Ground In Flyover America, Part 2

In fact, the combination of pumping-up inflation toward 2% and hammering-down interest rates to the so-called zero bound is economically lethal. The former destroys the purchasing power of main street wages while the latter strip mines capital from business and channels it into Wall Street financial engineering and the inflation of stock prices.

In the case of the 2% inflation target, even if it was good for the general economy, which it most assuredly is not, it’s a horrible curse on flyover America. That’s because its nominal pay levels are set on the margin by labor costs in the export factories of China and the EM and the service sector outsourcing shops in India and its imitators.

Accordingly, wage earners actually need zero or even negative CPI’s to maximize the value of pay envelopes constrained by global competition. Indeed, in a world where the global labor market is deflating wage levels, the last thing main street needs is a central bank fanatically seeking to pump up the cost of living.

So why do the geniuses domiciled in the Eccles Building not see something that obvious?

The short answer is they are trapped in a 50-year old intellectual time warp that presumes that the US economy is more or less a closed system. Call it the Keynesian bathtub theory of macroeconomics and you have succinctly described the primitive architecture of the thing.

According to this fossilized worldview, monetary policy must drive interest rates ever lower in order to elicit more borrowing and aggregate spending. And then authorities must rinse and repeat this monetary “stimulus” until the bathtub of “potential GDP” is filled up to the brim.

Moreover, as the economy moves close to the economic bathtub’s brim or full employment GDP, labor allegedly becomes scarcer, thereby causing employers to bid up wage rates. Indeed, at full employment and 2% inflation wages will purportedly rise much faster than consumer prices, permitting real wage rates to rise and living standards to increase.

Except it doesn’t remotely work that way because the US economy is blessed with a decent measure of free trade in goods and services and virtually no restrictions on the flow of capital and short-term financial assets. That is, the Fed can’t fill up the economic bathtub with aggregate demand because it functions in a radically open system where incremental demand is as likely to be satisfied by off-shore goods and services as by domestic production.

This leakage through the bathtub’s side portals into the global economy, in turn, means that the Fed’s 2% inflation and full employment quest can’t cause domestic wage rates to rev-up, either. Incremental demands for labor hours, on the margin, are as likely to be met from the rice paddies of China as the purportedly diminishing cue of idle domestic workers.

Indeed, there has never been a theory so wrong-headed. And yet the financial commentariat, which embraces the Fed’s misbegotten bathtub economics model hook, line and sinker, disdains Donald Trump because his economic ideas are allegedly so primitive!

The irony of the matter is especially ripe. Even as the Fed leans harder into its misbegotten inflation campaign it is drastically mis-measuring its target, meaning that flyover American is getting  an extra dose of punishment.

On the one hand, real inflation where main street households live has been clocking in at over 3% for most of this century. At the same time, the Fed’s faulty measuring stick has led it to keep interest pinned to the zero bound for 89 straight months, thereby fueling the gambling spree in the Wall Street casino. The baleful consequence is that more and more capital has been diverted to financial engineering rather than equipping main street workers with productive capital equipment.

As we indicated in Part 1, even the Fed’s preferred inflation measuring stick——the PCE deflator less food and energy—has risen at a 1.7% rate for the last 16 years and 1.5% during the 6 years. Yet while it obsesses about a trivial miss that can not be meaningful in the context of an open economy, it fails to note that actual main street inflation—led by the four horseman of food, energy, medical and housing—–has been running at 3.1% per annum since the turn of the century.

After 16 years the annual gap, of course, has ballooned into a chasm. As shown in the graph, the consumer price level faced by flyover America is now actually 35% higher than what the Fed’s yardstick shows to the case.

Flyover CPI vs PCE Since 1999

Stated differently, main street households are not whooping up the spending storm that our monetary central planners have ordained because they don’t have the loot. Their real purchasing power has been tapped out.

To be sure, real growth and prosperity stems from the supply-side ingredients of labor, enterprise, capital and production, not the hoary myth that consumer spending is the fount of wealth. Still, the Fed has been consistently and almost comically wrong in its GDP growth projections because the expected surge in wages and consumer spending hasn’t happened.

growth chart

Statistical Fixations

Martin Feldstein is nowhere near as excitable as David Stockman on Fed manipulations (link to D.S.’s commentary), but they both end up at the same place: the enormous risks we are sowing with abnormal monetary policies. The economy is not nearly as healthy as the Fed would like, but pockets of the economy are bubbling up while other pockets are still deflating. There is a correlation relationship, probably causal.

The problem with “inflation targeting” is that bubble economics warps relative prices and so the correction must drive some prices down and others up. In other words, massive relative price corrections are called for. But inflation targeting targets the general price level as measured by biased sample statistics – so if the Fed is trying to prop up prices that previously bubbled up and need to decline, such as housing and stocks, they are pushing against a correction. The obvious problem has been these debt-driven asset prices, like stocks, government bonds, and real estate. In the meantime, we get no new investment that would increase labor demand.

The global economy needs to absorb the negative in order to spread the positive consequences of these easy central bank policies. The time is now because who knows what happens after the turmoil of the US POTUS election?

Ending the Fed’s Inflation Fixation

The focus is misplaced—and because it delays an overdue interest-rate rise, it is also dangerous.

By MARTIN FELDSTEIN
The Wall Street Journal, May 17, 2016 7:02 p.m. ET

The primary role of the Federal Reserve and other central banks should be to prevent high rates of inflation. The double-digit inflation rates of the late 1970s and early ’80s were a destructive and frightening experience that could have been avoided by better monetary policy in the previous decade. Fortunately, the Fed’s tighter monetary policy under Paul Volcker brought the inflation rate down and set the stage for a strong economic recovery during the Reagan years.

The Federal Reserve has two congressionally mandated policy goals: “full employment” and “price stability.” The current unemployment rate of 5% means that the economy is essentially at full employment, very close to the 4.8% unemployment rate that the members of the Fed’s Open Market Committee say is the lowest sustainable rate of unemployment.

For price stability, the Fed since 2012 has interpreted its mandate as a long-term inflation rate of 2%. Although it has achieved full employment, the Fed continues to maintain excessively low interest rates in order to move toward its inflation target. This has created substantial risks that could lead to another financial crisis and economic downturn.

The Fed did raise the federal-funds rate by 0.25 percentage points in December, but interest rates remain excessively low and are still driving investors and lenders to take unsound risks to reach for yield, leading to a serious mispricing of assets. The S&P 500 price-earnings ratio is more than 50% above its historic average. Commercial real estate is priced as if low bond yields will last forever. Banks and other lenders are lending to lower quality borrowers and making loans with fewer conditions.

When interest rates return to normal there will be substantial losses to investors, lenders and borrowers. The adverse impact on the overall economy could be very serious.
A fundamental problem with an explicit inflation target is the difficulty of knowing if it has been hit. The index of consumer prices that the Fed targets should in principle measure how much more it costs to buy goods and services that create the same value for consumers as the goods and services that they bought the year before. Estimating that cost would be an easy task for the national income statisticians if consumers bought the same things year after year. But the things that we buy are continually evolving, with improvements in quality and with the introduction of new goods and services. These changes imply that our dollars buy goods and services with greater value year after year.

Adjusting the price index for these changes is an impossibly difficult task. The methods used by the Bureau of Labor Statistics fail to capture the extent of quality improvements and don’t even try to capture the value created by new goods and services.

The true value of the national income is therefore rising faster than the official estimates of real gross domestic product and real incomes imply. For the same reason, the official measure of inflation overstates the increase in the true cost of the goods and services that consumers buy. If the official measure of inflation were 1%, the true cost of buying goods and services that create the same value to consumers may have actually declined. The true rate of inflation could be minus 1% or minus 3% or minus 5%. There is simply no way to know.

With a margin of error that large, it makes no sense to focus monetary policy on trying to hit a precise inflation target. The problem that consumers care about and that should be the subject of Fed policy is avoiding a return to the rapidly rising inflation that took measured inflation from less than 2% in 1965 to 5% in 1970 and to more than 12% in 1980.

Although we cannot know the true rate of inflation at any time, we can see if the measured inflation rate starts rising rapidly. If that happens, it would be a sign that true inflation is also rising because of excess demand in product and labor markets. That would be an indication that the Fed should be tightening monetary policy.

The situation today in which the official inflation rate is close to zero implies that the true inflation rate is now less than zero. Fortunately this doesn’t create the kind of deflation problem that would occur if households’ money incomes were falling. If that occurred, households would cut back on spending, leading to declines in overall demand and a possible downward spiral in prices and economic activity.

Not only are nominal wages and incomes not falling in the U.S. now, they are rising at about 2% a year. The negative true inflation rate means that true real incomes are rising more rapidly than the official statistics imply. [Sounds good, huh? Not quite. Read Stockman’s analysis.]

The Federal Reserve should now eliminate the explicit inflation target policy that it adopted less than five years ago. The Fed should instead emphasize its commitment to avoiding both high inflation and declining nominal wages. That would permit it to raise interest rates more rapidly today and to pursue a sounder monetary policy in the years ahead.

inflation-vs-employment

The Economics of Change

When non-economists start talking about the limits to economic growth, we often enter the bizarro world.

For example, here is a YouTube video titled: Economic Growth, Climate Change and Environmental Limits

https://www.youtube.com/watch?v=AQscc1HYjhU

I suppose this is because growth is most easily understood by our biological experience as a living organism – we are born small and end up bigger. The universe is expanding. But from an economic point of view that definition can be challenged.

When our skeletal bodies stop expanding, sometime around our late teenage years, do we stop growing? Or is growth merely measured in change over time? Certainly we see ourselves growing in wisdom, knowledge, emotional understanding, etc. In fact, economic growth statistics, like gross domestic product (GDP), are actually measures of year-over-year change, not necessarily physical expansion.

For instance, when we recycle old, used goods into new goods, we measure positive economic growth in terms of GDP, yet there may be no physical expansion at all. If your old car is recycled into steel, rubber, and glass and a new, more efficient electric car is produced from those materials, we have engineered positive economic growth, but there is no extra car on the road. A more absurd example would be if we paid a worker to dig a hole in the backyard, then paid another worker to fill it in. Both activities would register as positive GDP growth (workers’ income), but there will be no physical expansion of something created, only the loss of energy. (The Second Law of thermodynamics still applies.)

Economic growth is merely the conversion of energy into different forms so that all living organisms can adapt to a changing environment in order to survive and thrive. Positive growth is merely a measure of doing this successfully. That is certainly a good thing. It means that future growth will probably be less focused on expansion of markets and more on preserving certain scarce resources like clean air, water, and a sustainable biosphere. That is economic growth.

Just consider then what an anti-growth agenda implies: a universe frozen in time. In other words, a dead universe.

Beyond Piketty’s Capital

Income-USA-1910-2010

What Ben Franklin and Billie Holiday Could Tell Us About Capitalism’s Inequalities

It has now been two years since French economist Thomas Piketty published his tome, Capital in the Twenty-First Century, and one year since it was published in English, raising a fanfare of praise and criticism. It has deserved both, most notably for “putting the distributional question back at the heart of economic analysis.”[1] I would imagine Professor Piketty is also pleased by the attention his work has garnered: What economist doesn’t secretly desire to be labeled a “rock-star” without having to sing or pick up a guitar to demonstrate otherwise?

Piketty’s study (a collaborative effort, to be sure) is an important and timely contribution to economic research. His datasets across time and space on wealth, income, and inheritances provide a wealth of empirical evidence for future testing and analysis. The presentation is long, as it is all-encompassing, tackling an ambitious, if not impossible, task. But for empirics alone, the work is commendable.

Many critics have focused on methodology and the occasional data error, but I will dispense with that by accepting the general contour of history Piketty presents as accurate of real trends in economic inequality over time. And that it matters. Inequality is not only a social and political problem, it is an economic challenge because extreme disparities break down the basis of free exchange, leading to excess investment lacking productive opportunities.[2] (Piketty ignores the natural equilibrium correctives of business/trade cycles, presumably because he perceives them as interim reversals on an inevitable long term trend.) I have followed Edward Wolff’s research long enough to know there is an intimate causal relationship between capitalist markets and material outcomes. I believe the meatier controversy is found in Piketty’s interpretations of the data and his inductive theorizing because that tells us what we can and should do, if anything, about it. Sufficient time has passed for us to digest the criticisms and perhaps offer new insights.

Read the full essay, formatted and downloadable as a pdf…

———————–

[1] Distributional issues are really at the heart of our most intractable policy challenges. Not only are wealth and income inequalities distributional puzzles, so are hunger, poverty, pollution, the effects of climate change, etc. Unfortunately, the profession tends to ignore distributional puzzles because the necessary assumptions of high-order mathematical models that drive theory rule out dynamic network interactions that characterize markets. Due to these limitations, economics is left with the default explanations of initial conditions, hence the focus on natural inequality, access to education, inheritance, etc. General equilibrium theory (GE) also assumes distributional effects away: over time prices and quantities will adjust to correct any maldistributions caused by misallocated resources. For someone mired in poverty or hunger, it’s not a very inspiring assumption.

[2] As opposed to distributional problems, modern economics is very comfortable studying and prescribing economic growth. Its mathematical models provide powerful tools to study and explain the determinants of growth. This is why growth is often touted as the solution to every economic problem. (When you’re a hammer, everything looks like a nail.) But sustainable growth relies on the feedback cycle within a dynamic market network model, so stable growth is highly dependent on sustainable distributional networks.

The Ironies of ZIRP

fed-rate-zero

This is an excellent explanation of the behavioral illogic of Zero Interest Rate Policies being imposed by the major central banks of the world. If only they paid more attention to how they were increasing perceived risks and uncertainty in markets.

From Barrons:

Low Interest Rates: A Self-Defeating Strategy

Instead of encouraging spending and boosting the economy, low rates can lead people to squirrel more money away to meet their retirement or other goals.

April 17, 2015
When I think back on all the crap I learned in grad school, it’s a wonder I can think at all, to paraphrase Paul Simon. And that also goes for what was drummed into me as an undergraduate, way back when we used Kodachrome film to take photographs with Nikon cameras, instead of iPhones (and Eastman Kodak was among the elite 30 Dow industrials).Among those shibboleths was that low interest rates always stimulate the economy. Reduced borrowing costs make it easier for folks to buy houses and companies to invest and expand. Lower yields on savings cut the incentives for consumers to stash their cash in the banks like Scrooge and instead make them more inclined to go out and spend and have a good time. And all that spending should tend to push up prices and, in due time, set up the next cycle of rising rates.

And if interest rates ever hit zero, money would be free, which should mean the economy should be like an open bar—a real party. Then think about what would happen if rates went where they never had gone before—below zero percent and into negative territory. Lenders would be paying borrowers, rather than the other way around.

This isn’t some alternate universe, but rather what’s actually happening in Europe. As The Wall Street Journal reported last week, some borrowers in Spain had the rates on their mortgages fall below zero, which meant the bank owed them money. That comes as approximately one-third of all European government bonds carry negative yields.

Those are mainly short-to-intermediate maturities whose yields have followed the European Central Bank’s minus 0.20% deposit rate into negative territory. But, by week’s end, the benchmark 10-year German bund yield seemed inexorably headed below zero, as it set another record closing low of 0.073%, according to Tradeweb. At that return, investors would double their money in a mere 1,000 years.

But the boom that the textbooks predict is nowhere in evidence. That’s not a surprise to Jason Hsu, vice chairman and co-founder of Research Affiliates and also a card-carrying Ph.D. and adjunct professor at UCLA. As a frequent visitor to Japan over more than a decade, he’s had a chance to observe firsthand the effect of near-zero interest rates.

In the complete opposite of what classical economics teaches, low returns actually have induced Japanese consumers to spend less, he says. As the aging population saves more to get to a threshold of assets needed for retirement, firms seeing no spending are loath to spend, invest, or hire. “This is a bad spiral that never was predicted,” Jason explains (appropriately enough, over a sushi lunch).

This had always been assumed to reflect both the demographics and cultural traits of Japan. But that world view will have to be revised, as there’s evidence of the same thing happening in Europe, he adds, with Germans reacting to zero interest rates by saving more. This behavioral dimension helps explain the tepid payoff from the unprecedented “financial repression” that has taken interest rates to zero and below.

The restraints on spending from forcing savers to save more in a low-rate environment has been a theme sounded by a number of critics, including David Einhorn, the head of Greenlight Capital, a hedge fund. At a recent Grant’s Interest Rate Observer conference, he quoted Raghuram Rajan, the head of India’s central bank, who, in a lecture at the Bank for International Settlements in 2013, spoke of the plight of someone nearing retirement and facing losses on savings (from two bear markets this century) and low prospective returns. That “can imply low real interest rates are contractionary—savers put more aside as interest rates fall in order to meet the savings they think they will need when they retire.” Indeed, according to a widely cited estimate by Swiss Re, U.S. savers have foregone some $470 billion in interest earnings since 2008.

That conundrum was quantified in a report by David P. Goldman, head of Americas research at Reorient Capital in Hong Kong. A saver who accumulates assets for retirement through stocks would want to “annuitize” or convert that wealth into a stream of income for retirement. “But the amount of income investors can expect to receive from an equity portfolio converted into bonds actually has fallen over the past 18 years,” he writes.

At the peak of the stock market in 2000, Goldman calculates that one unit of the Standard & Poor’s 500 annually earned the real equivalent of $1,900 (adjusted for inflation, in 1982 dollars) when invested in Baa (medium-grade) corporate bonds. At the market’s recovery in 2007, one unit of the S&P would earn $1,300; now, it’s only $1,100.

The same goes for home prices. A house bought for $500,000 in 2000 and sold today and reinvested in Baa bonds would yield $16,000 annually in 1982 dollars, versus $22,000 when it was bought 15 years ago. Bottom line: “Assets have soared, but the prospective interest on these assets has shrunk.”

Which means that even the affluent top 20% of Americans (who accounted for 61% of domestic consumption in 2012, up from 53%, according to data cited by Goldman) who actually have assets are more cautious about spending than a naïve view of the wealth effect might suggest, he concludes.

To be fair, what we learned about interest rates and the economy were predicated on “normal” levels. A decline in mortgage rates from, say, 7% to 5% could reliably be counted on to set off a rebound. That would lower the monthly payment on a $300,000, 30-year loan by nearly 25%, to around $1,600 from $2,000. First-time home buyers then might qualify to get into a house; the sellers could trade up to nicer digs; those who stayed put could refinance and cut their payment or take down more money to pay off other debt or spend on a car, boat, or college tuition.

It may be that, as interest rates—which represent the time value of money [plus the risk premium for uncertain outcomes]—approach zero, their impact is distorted, just as time is distorted as the speed of light is approached, according to Einstein.

Financial repression that has depressed rates to levels that are unprecedented in history is having unpredictable effects, which shouldn’t be entirely unexpected. Even if we didn’t learn about them in school.

The Bull Market Bull

bullx-large

From David Stockman’s blog:

Never has there been a more artificial—-indeed, phony—–gain in the stock market than the 215% eruption orchestrated by the Fed since the post-crisis bottom six years ago today. And the operative word is “orchestrated” because there is nothing fundamental, sustainable, logical or warranted about today’s S&P 500 index at 2080.

In fact, the fundamental financial and economic rot which gave rise to the 672 index bottom on March 9, 2009 has not been ameliorated at all. The US economy remains mired in even more debt, less real productive investment, fewer breadwinner jobs and vastly more destructive financialization and asset price speculation than had been prevalent at the time of the Lehman event in September 2008.

Indeed, embedded in Friday’s allegedly “strong” jobs report is striking proof that the main street economy is the very opposite of bullish. In January 2015 there were still 2 million fewer full-time, full-pay “breadwinner” jobs in the US economy than there were before the crisis in December 2007.

breadwinner

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