Friday, June 24, 2016

I woke up…it was a Brexit morning

Clueless is what clueless does… Financial markets and their pollsters got it completely wrong.  The ‘Out’ vote was largely about immigration and dissatisfaction with it and the ‘remain’ faction never ‘got’ that nor tried to combat it. Their tactic was to threaten financial and economic chaos and now they will have to go eyeball to the eyeball with those dire warning statements- which are probably greatly exaggerated. There is message here beyond just the UK…


What’s good for the goose is good for the gander

But what goes around comes around. The U.K. is the United Kingdom not the magic kingdom. And with this vote the U.K, may be posed to get smaller as Scotland is now likely to take a second go at leaving the U.K. What is good for the goose is good for the gander. U.K. claims to Gibraltar are being challenged by Spain, now that the U.K. will be politically OUT of EU. The stage is reset for all sorts of new arrangements to be put in play.


EU to E-MOO or are they cowed?

The EU is telling the U.K. to leave quickly to dispel the air of uncertainty quickly (i.e. don’t let the door hit you in the butt on the way out). And while they will not want to treat the U.K. too well they will not want to treat it too shabbily either. The U.K. is an important trading partner with the rest of Europe and everyone will want to keep that connection. But if the EU makes it too easy and without consequences to leave there could be others to take that route. The U.K. and Denmark got opt out clauses to join the EU and not EMU. For everyone else EU membership is supposed to be the stepping stone to EMU. So how will that work in the future? Can EU set as a membership condition the aspiration to EMU? Does EMU still look that attractive? 



As for geopolitics all European nations went their own way politically although there was also an EU position. The UK will get its full voice back in the international area and they have been a strong U.S. ally. That is a good thing. An ‘independent’ U.K. does not weaken Europe as much as it gives it another independent voice and one-less opinion to bargain with inside EU to craft a single position. 


EU and EMU: now more than ever the Deutsche Zone

The U.K. leaving EU raises the risk that someone else will leave EU…or even EMU. It shifts the balance of power between EU non-EMU members and EMU members who are also EU members. With the U.K. out, the EMU has a huge weight in the EU. The Germans have acted in a way to make EMU membership as unpleasant as possible for everyone else. If there ever was a question about whose culture would prevail in EMU there is no question anymore. Other member countries cannot afford to be out of step with most competitive country in EMU. Germany controls EMU. And Germany’s response to membership has been to run a fiscal budget surplus and run and even lower than 2% inflation rate –stepping up pressure on fellow members in EMU to follow Germany or to slip further behind it.  Germany also has enforced selectively the rules governing the ECB so as to bring maximum pressure on its fellow members. What this does is to make the EMU rule of 2% inflation an upper bound for everyone else particularly after their poor policies in the early days of EMU. Clearly Germany has been a deflationary force in EMU although everyone talks of joining EMU as being growth-enhancing. How about that?





In the wake of Brexit. No one is bankrupt. It is not like Lehman bros. Although sterling has fallen sharply there is no new FX deal to cut. The BOE is independent. There is no need to extract it from the ECB. There are no bailouts to be done. There is no central bank or treasury propping up of anything. In short the U.K’s flexible exchange rate will buffer the economy. A lower sterling will stimulate UK growth. U.K. industry groups have been quick to call for new deal to keep trade flowing Vis a Vis Europe. Europe will be reeling and wonder about further consequences.


The potential Zombie opts out

Questions about London as a financial center may continue for some time. But the EU was flirting with a transactions tax that might have killed London as a financial center anyway had it stayed in. London has bought its freedom form that but at an unknown price. 


Markets gyrate

There are knee jerk reactions in Fx markets and in stock market. But on balance it is in everyone’s interest not to cut off their nose to spite their face. It would make sense that Europe and UK would try to keep commercial ties more or less intact.


It’s’s de-lovely… its decoupling?

The risk here is that there could be more de-coupling. And the act of de-coupling per se is risky. Scotland may leave the U.K. making the U.K a smaller economy and there could be other more painful disassociations in Europe as well. But leaving EMU would be much more painful making that knock-on effect a more remote possibility. Still the U.K. leaving is a shock to the system and it STOPS a move to persistent, mindless, knee-jerk integration.

The globalization hobgoblin

I think a stronger subliminal message here is dissatisfaction with the pressures of various sorts from globalization. For the U.K. immigration was the big risk. But even today commentators are talking about the potential impact on trade and trade-reducing deals.


Broader concerns

LET ME MAKE THIS PERFECTLY CLEAR. Free trade is the best of all worlds. But we don’t live there any more than we live on Mars. This vote is also is a wake-up call to bureaucrats who think they can scare us with flawed analysis and threats. This is a boost to unconventional candidates and to the candidacy of Donald Trump in the U.S. This is another nail in the coffin of analysis by polling. How did that work?


I do not look to SLOW international trade but to reconfigure it. And I believe this vote takes us a step closer to that.


How we got here…

China and the rest of Asia grew through a strategy of export-led growth. That meant they were set to tap into demand in the developing economies and ride piggyback to stronger growth. But as China grew into ‘Baby Huey’ its piggyback ride became piggish. The burden of China’s ride has disrupted growth in the West. China has been able to produce and not consume and there is nothing in economics about having specialized production and consumption countries that leads to a stable result. 


Asia has co-opted the FREE TRADE model in favor of an export-led growth model and that must be changed. But TOO MANY OPINION LEADERS have simply drunk the Kool Aide of any trade instead of insisting on Free Trade.  Asia needs to change to grow (mostly) on the back of tis (own) demand.  U.S. corporations have to invest in the U.S. not just in their offices abroad. And this suggests to me that there is a lot of exchange rate re-alignment that is needed. But China is against it as are a number of Asian and Latin American economies and as are a lot of U.S. corporations who have investments in Asia and intend to benefit from exporting back to the US using cheap Chinese (et al) labor. Like Brexit this will be hard to do and expect the ‘experts’ to be against it.’ It may take an outsider to do it.


Our intelligentsia has done us wrong. And now people may be much less likely to believe its leaders and experts. The way may no longer be shut..


I am not so negative on Brexit. EMU and EU were becoming a straightjacket, run by bureaucrats. What Brexit tells us is that trends can change. Brexit is a breath of fresh air. The U.K. may pay a greater price for it they thought: but at what price freedom? How can the price be too high?      


Brexit morning…

I woke up, it was a Brexit morning

and the first thing that I saw

was the pound falling like a rock

and David Cameron’s fall


news flowed in like butterscotch

and smothered all my senses

pessimism came, it stayed for the day

and it knocked the markets senseless



Now the curtain opens on a portrait of the next day

And the street is paved with passers by

Commerce flies, bureaucrats cry,

But freedom’s come to stay

Won’t you wake up!

It’s a Brexit morning


Tuesday, June 21, 2016

How Fed policy ran amok by focusing on ‘the wrong stuff’

How Fed policy ran amok by focusing on ‘the wrong stuff’
(AKA our ever-changing job market)
The Fed has been making policy with a strong reference to the job market. While we have heard all sorts of criticism about the flaws in GDP, some have acted as though job market data are equivalent to the Holy Grail. Several Fed officials recently have even said quite explicitly that jobs data trump GDP. In what way is that?

All data are subject to revisions of various sorts. And jobs data can be revised and can surprise as they did last month. Apart from that, job data can look friendly and familiar and yet be distant and misleading. With the labor force participation rate so low and the not-in-the-labor-force cohort so large plus myriad demographic changes who can say that we know what these current labor force metrics mean? Can you? The Fed though it could. But it couldn’t.

I am quite serious. Consider the table below: 

This table presents labor market data for the labor force and unemployment rate for those age 25 and up. It provides four exhaustive categories for labor: (1) Less than a high school diploma, (2) high school diploma no college (3) college but less than a BA (4) BA and higher degrees.  Roughly we have unskilled, low-skilled, semi-skilled and highly-skilled categories.

The table shows how the composition of the labor market by those four categories has shifted. When data on these metrics began in 1992, 13% of the labor force was in the lowest skill group. In May of 2016 that proportion is down to 7.6%.  The top-skill, BA-plus category used to comprise 26% of the labor force, now it comprises 38.9% of it. The proportion that is low-skilled is now slightly lower and the semi-skilled group is proportionately higher.

Despite all the job openings that cannot be filled in the JOLTS report, the labor market is much more educated or skilled than it used to be. Still that is not working –apparently there is a skills mismatch. It’s like having enough silverware to set the dinner table for eight but with too many spoons and not enough knives. It doesn’t work. Even if they are the highest quality silver, a spoon is not a knife. 

But, what is still working is that higher education levels are correlated with lower rates of unemployment. If our labor market were of the composition it had been in 1992 the current unemployment rate for all workers age 25 and over would be 4.4% instead of the current 3.9% - one half of one percentage point higher. It appears that our labor market gauge is no longer so easy to read. But it’s good news. It’s like having a gas gauge that is shifted so that the tank is not nearly as empty as the gauge is near ‘E’. You are not as at risk as you think you are to having to walk for more gas...  

The education composition of the labor force has lowered the unemployment rate by one half of one percentage point. And this is only one demographic feature I have isolated. There are other features that are correlated with the rate of unemployment that can be analyzed in this way, among them age, sex, race and more. As we get compositional shifts in these areas either the structural unemployment rates among these various attributes will shift or the impact on the overall unemployment rate will shift or both will shift.

This is why the Fed has seemed so out of step. It has focused on and has been fearful about the rate of unemployment. Just because the rate sort of seems like the same thing it has always been does not mean that its attributes have not changed. The evidence for education is that the unemployment rate is going to look a lot lower just because of who is in the labor force now compared to who is no longer in it. 

As arguments go this one sees the labor force as tilted to more skill and more education. But what it also suggests is that the less skilled and less educated have been squeezed out. We do not have the same data on the attributes of those who are not-in-the-labor–force for example so we can’t really tell.

And, as the minimum wage rises, it is likely that firms will find ways to hire more skilled workers at higher wages possibly using technology solutions to eliminate jobs and become more streamlined and that could result in an even higher skilled labor force.

Try to understand the labor force development as a dynamic process, where supply and demand combine to determine who is in it and who is out. Always bear in mind that compositional characteristics of those NOT in the labor force may be quite different from those who are in the labor force and that might keep those who are on the sidelines on the sidelines.

The table also gives us some notion of how much slack we might have left in this labor market. 

For example since January 1992 the overall unemployment rate has been lower than its May 2016 level 23% of the time and it has fallen an additional 19% from its current level (minimum rate =3.8%) to its low. 

For each of our age cohorts the unemployment rate has been lower: over 20.1% of the time for the lowest skills group, 48.5% of the time for the second lowest skill group, 37.5% of the time for the semi-skilled and 41.0% of the time for the high skill group. Interestingly despite the focus on skills shortages the highly educated group does not have a really low rate of unemployment relative to its own historic standards-especially relative to the other categories- it is in fact the least tight on this metric.

The percentages of time that each cohort’s rate has been lower also echoes the next set of statistics which concern how much farther these cohorts’ unemployment rates can fall to get back to their respective lows (since 1992). The answer is that unskilled unemployment can fall the least, by only 18.3%, and all the other categories can fall in a relatively tight range of from 37.3% to 38.5% further-all about the same order of magnitude. Oddly it is the unemployment rate among the unskilled that is the relative lowest (has the least far to fall to hit its all-time low).

This prompts us to ask why? Are these ‘unskilled’ workers truly scare? Or are they so low-paid that they more easily leave the labor force and become no longer counted as unemployed because government support programs may look more attractive than the low paid wage?

Apply 1992 weights to all the historic data and we find that the lowest age 25 and up unemployment rate allows for a 30.4% fall while the lowest 2016 weigh pattern would foresee a further drop of 32.1%. The 1992 reweighed unemployment rates are lower than their actual May 2016 level 25.2% of the time while the 2016-weighted data have been lower 26.9% of the time. Under the up-to-date weights the unemployment rate can fall by more.

Any way you slice it the new-view of the labor market does not seem quite so tight. There is still some further 30% or more that unemployment rates can fall in order to get back to previous cycle lows looking at a fixed compositional weight for the labor market.

Moreover, we can look at a decomposed Phillips curve over the last three cycles to gain some further insight on what risks we may face in terms of wage repercussions.  

In the chart above we show wage changes (one year % change in Average Hourly Earnings) Vs the unemployment rate for this cycle and for the average of the last two cycles. We present these data by arraying them by lining them up starting with when the unemployment rate first reached 6% in each cycle, possibly creating some wage tension.  We color code the two cycles with unemployment dark blue and wages light blue in the two previous ‘averaged’ cycles and with unemployment dark green and wage light green in the current cycle. What we see is that the unemployment rate has been falling MUCH FASTER in this cycle after it reached 6% compared to the last two cycles. But that at this lower unemployment rate the wage gains in the last cycle would have been much higher at 4% instead of around 2.5%, currently.

Of course there is still evidence here that the Phillips Curve is ‘working.’ The unemployment rate is falling and wages are rising, but the relationship is much diminished. Since the Fed was basing its policy decisions on this relationship the fact that it has been muted had caused Fed policy plans to become overly aggressive.

In short the Fed was simply too worried too soon about the level of the unemployment rate. And we have given several reasons above why this is might be so.

The macroeconomics of the situation has been just too unstable to work. That is an admission that there are too many compositional shifts in the labor force for us to treat all changes in the unemployment rate as equivalent in nature to WHAT THEY HAVE BEEN IN THE PAST.

But there are macroeconomic diagnostics to reveal this too. It’s just that the Fed has scrupulously (unscrupulously?) avoided presenting them.

The Beveridge Curve

What: The Beveridge curve shows a SHIFTED relationship between job openings and the unemployment rate.
Meaning: it now takes MORE job openings to reduce the rate of unemployment
Missed analysis: While everyone has been ‘oohing and aahing’ over the high count of job openings, economists  have missed the fact that it takes more job openings to reduce the rate of unemployment than it used to (and to create a hire). In other words ‘openings’ are worth less than they used to be.
This macroeconomic diagnostic, The Beveridge Curve, has been ignored

Economics usually does not dirty its hands with such things. But because there are so many changes in the economy it is no longer wise to deal in such aggregated data. Yet that is exactly what macroeconomic models do. It is much wiser to decompose the data to see what the macro data really mean in times such as these and not to simply swallow the model forecast hook line and sinker. When we take the time to do that we find that the job market data are really not as reliable as many assumed.

We can make the same points about nonfarm payroll data as we have about the unemployment rate. And those criticisms may be more familiar. Economists (some) have been long complaining of the quantity of low skill jobs being created. We have a service sector economy and it churns out more low low-skill low-paid jobs. Indeed, this is one of the reasons that productivity growth is so poor. Low productivity growth is not an exogenous development. Productivity is low also because investment is low. Investment is low because the US skill pool seems to be lacking some of the more specific skills needed despite the proliferation of highly educated workers. Moreover, the strong dollar makes the US uncompetitive (makes US wages higher in foreign currency terms) and this scares off investment. We have many interrelated problems here. But it comes down to trying to understand the micro-economic foundations of the macro-economic failures. Not all failures will simply reverse themselves. Economies do not necessarily grow out of them into success stories.

The Fed simply does not seem to have spent enough time or effort trying to understand why its pet macroeconomic statistically sophisticated metrics had stopped working. The answer is always that the devil is in the details. It was the same answer this time around.            

Yellen’s 6/21/2016 Testimony Before Senate Banking Committee

Yellen’s 6/21/2016 Testimony

Before Senate Banking Committee

Fed Chair Janet Yellen is testifying before one of the Fed oversight committees today, the Senate Banking Committee. One question has been which Janet Yellen would appear. It looks like we got ma┼łana Janet, the more dovish one.

Same old same old…
The Fed’s June meeting issued a policy statement that sounded like the one that came before it. The Fed released a number of economic projections made by committee members that continued to erode the outlook for growth and that kept the inflation ‘forecasts’ below their policy objective.  

And, SURPRISE (!) at the same Fed meeting
The surprise at the June meeting of just days ago was the tone in the Fed Chair’s post-meeting press conference and the new SEPs by individual committee members about their constrained forecasts for the path of the Fed funds rate in years ahead.  Yellen’s tone and comments in the Q&A were much more dovish that the past official policy statements have been and the ‘presser’ was fully in sympathy with the new much lower path for Fed funds that individual members laid out. Today’s testimony is very much in that same spirit.

Much less reliance on forward guidance…REALLY??!!
Somewhat paradoxically in her testimony today Yellen has said that the Fed is relying much less on forward guidance than it did in the past and she has distanced the Fed further from these estimates.

This seems WRONG. After all it was the SEP interest rate forecasts that moved markets not the June policy statement and it was Yellen’s tone at the press conference.  

SEP Fed funds rates are not coordinated
It is true that the FOMC member outlooks are prepared before the FOMC meets and do not reflect and stamp of approval from the committee itself. Each forecast relies on each member’s own assessments so each one is actually based on a different forecast and a personal view for the economy. In some sense pooling them together is like adding up apples and oranges. But, of course, we do this all the time by comparing various private sectors forecasts- the blue chip is one well known such example.

Fed swears off cake…
It seems to me that if most Fed members think in isolation that the rate path for Fed funds is now lower if we were to pool them together and force a consensus we would get the same result.  The Fed here seems to want to have its cake and eat it too or rather to deny that it has any ownership of this cake and asserts that it has no intent to take even a bite. 

So why are these scenarios presented to us?

I have no problem with the Fed denial that the midpoint or average or any summary statistic from these Fed funds projections represents an official outlook by the Fed. But denying that there is any forward guidance here seems a bit Pollyannaish.   Clearly, there is forward guidance here.

Long standing Fed criticism:
Let me repeat a criticism I have often lodged about the Fed. It has no inflation commitment. It says that the economy operates better with inflation at 2% but is has no commitment to hit a 2% target over any time horizon. It has a mandate for full employment but it has no precise definition of full employment or any promise to make that happen in any technical way (no target for nonfarm jobs growth or for the unemployment rate). The Fed’s treatment of its SEP Fed funds rate is in this spirit. While there is no specific number promised for unemployment and no specific horizon to hit a 2% inflation rate the Fed has some very specific numbers laid out for future Fed funds rates but it wants them to have NO OFFICIAL standing at all.  

The Fed: an attitude for latitude
All of this gives the Fed a great deal of latitude to make policy and I think goes a long way to explain why Fed communication so often goes off track. Moreover, since policy is made by committee it serves the Fed’s need to forge a policy consensus to have as vague a policy commitment as possible.

Cautious Yellen
In Yellen’s remarks today we see a lot of the cautious Janet Yellen from the post FOMC meeting press conference. When pressed under questioning she talked about headwinds as being the reason that the Fed funds rate is so far below the Taylor Rule rate that otherwise might prevail. However, when pressed about the prospect of recession by year-end she asserted that such a risk was quite low.

Still: Fed under pressure
In separate harangues Yellen has been pressured over the five banks that have failed the ‘living will’ mandate. There is also concern about ongoing banking sector consolidation and about the regulatory impact on small banks. In addition the Fed was criticized on grounds of having poor diversity. There are women in high positions at the Fed but no people of color. Elizabeth Warren wants Congress to take a hard look at the regional bank president selection process in order to get more diversity.


Sunday, June 5, 2016

The Irrelevancy Paradigm

The Spin Cycle is not just a setting on your washer…
In the wake of a very weak payroll and hours-worked report with very mild wage inflation and a shrinking breadth of job creation we are now being inundated with the latest and greatest spin by the greatest spin-meisters and practitioners of Voodoo economics of our age. Please pay attention and enjoy the performance!

For the most part these spinners of nonfactoids align with one party or another or one ideology or another (more or less the same thing) and proceed to ‘dis’ (disparage) the things in the report that they do not like or do not want to deal with. Or they simply fabricate a scenario to frame it, control it, and portray it as part of their own long-lost paradigm and as such completely understandable.   

Masters at work…
I am particularly in the thralls of analysis that portrays the weak payroll report Vs the dropping unemployment rate (household report) as the logical paradigm of an economy at full employment (true believers must genuflect, here).

A spin cycle… on the dryer?
As always spin must have some fact behind it and this combination does. But as for most items that are spun these particular ‘facts’ do not apply to this ‘case.’         

Law Vs Economics
Lawyers are taught early on that if the facts are on your side you argue the facts. If they are not, you argue the law. In other words if you are defending ‘the accused’ and can prove he did not do it and has a rock-solid alibi you present that case. If you cannot, you try to make the prosecutor’s case seem flimsy by challenging his expert witnesses, the applicability of the law under which your guy is being charged or the provenance of evidence being offered.

Economists are doing more or less these same things.

The Bait-
This notion that the recent unemployment rate drop and job slowdown is a natural phenomenon that occurs as an economy reaches full employment (genuflect again please) is a near religious belief in economics. Yes, it is true, but its application to THESE FACTS is wrong: hence ‘the spin.’ 

The Switch
The ISM surveys one for manufacturing and another for non-manufacturing have been showing progressively less activity (‘less’ as in not more). Each of them is lower than their respective May readings less than 40% of the time and YET –AND YET- Los PhD’s de Spin-o-nomics- are arguing that this is a full employment effect we are witnessing! It is actually hilarious.  I don’t think I have ever witnessed a more bare-faced lie in all my time as a professional economist (PhD circa 1977) so that is saying something.

ISM 101
Now you may know a thing or two about ISMs but chance are you only know a thing or two about them so let me round out your education on ISMs. MOST PEOPLE treat them as though they are BINARY in nature- really. The most frequently said thing I hear from people when I tell them that the ISMs are (both) slowing and are stronger more than 60% of the time is this: that they are above ‘50.’ Well they are. That’s true. And since these are diffusion indices, a value about 50 means more respondents to the survey see things expanding than contracting. But, consider this: if you are on your death bed and your pulse is dropping and your breath is labored it is reassuring for the doctor to say well, you are still breathing? I think not.  In real life The ISM’s take on a spectrum of values from 100 to zero- these signals are weakening! While they still each speak of growth in each sector for manufacturing and nonmanufacturing they also speak of sectors that usually are growing faster, in fact much faster. And one of them is deteriorating fast. The non-manufacturing gauge for May fell in May relative to April so fast in one month that it has only done so faster 5% of the time historically…Nothing says no problem-o like that? Right? The economy is still breathing-gasping but breathing!

Rule number one of Spin-o-nomics: Hey, when you want to ‘reassure people’ set the hurdle low.

Truth or disaster?
There is nothing reassuring here. There is something odd in the unemployment rate that’s for sure and everyone knows it but pretends it isn’t true. For example if the unemployment rate is so low why is wage growth so tepid? If it is so hard to find workers - and IF demand is solid- why are hours-worked so weak and falling? Why aren’t hours expanding to use existing (allegedly-scarce) labor more thoroughly? Try arguing those facts to a sensible conclusion.

E-Pop goes the weasel!
The employment population ratio is low and falling. Adam Smith wrote in the first chapter of his famous book ‘Wealth of Nations’ that one of the characteristics of a wealthy nation was being one with a large proportion of its population at work. Oops…

Man overboard? Optimism overboard!
We have people leaving the job market like rats jumping off a sinking ship and these economists want you to take a cruise on the Good Ship rat-trap!  Really everything is fine!

Always some confusion
There are always some plus and minus data. Yes, several recent housing reports have been strong (a very weather-dependent, volatile sector). Yes PCE (personal consumption expenditures, a large part of GDP) rose sharply in April. But in May vehicle sales went flat again. We are in a span of having two very weak quarters of GDP growth back-to-back. Some ‘rebound’ in GDP may still leave the US in a ‘hole’ relative to trend. The broad weakness in manufacturing and in services sets a poor tone for economic prospects overall. 

Context: Global mess!
The global economy is a mess with monetary policy overused and impotent (not to be confused with ‘important’) fiscal policy held hostage just about everywhere. And international trade is being used as the lever of choice to pry growth out of its torpor. The only problem is that everyone is trying to use this lever against everyone else.

About the US slowdown and labor ‘shortage’
In the US, growth is slowing and it is not because we hit ‘full employment.’ People have left the workforce and perceived labor markets ‘tightness’ is a supply thing not an excess demand thing. Some workers are aging. Some are unskilled and unsuited for the jobs of this century.  Some are just being priced-out of the market by cheaper labor abroad. And the economic mechanism to stop this and to reignite growth in the US is broken-broken and not being fixed.  But consider this… we have a low-skill dependent economy and lots of people dropping out of the labor force- how do you explain that? What I mean by that is that most of the US job growth has been in low-skill jobs. So with the employment population ratio so low how can we say there is a labor supply problem? Our main jobs are in bedpans, burgers and shelf re-stocking. Really? We are running out of people to do those things? God help us… (genuflect for real here)  Oh, we are running out of people that want to do those things or that want to do them at the prevailing wage rate. Yes. And still wages are barely rising.

Crunch time
We have very unbalanced very unhealthy growth and have had it for some time. I keep repeating that the US has run nothing but current account deficits since the early 1980s. We do NOT have a competitive economy. So when the international crunch comes we get crunched.  

Paradigm confusion And technology dislocation
The economy is NOT best understood as being in a typical economic paradigm. We are still in a transitional global economy where the international adjustment mechanisms are not working-AND ARE NOT BEING FIXED.  We have a disequilibrium situation. We also are drowning under Schumpeterian waves of ‘creative destruction.’ In addition to weak demand and cheaper sources of foreign supply we have technology putting the screws to everyone. Just last week there was an article about how Foxconn the Taiwanese firm that operates in China and assembles phones for Apple and Samsung (among other things) has just displaced a large block of Chinese workers (60,000) with robots.  

Well what do you THINK happens in a world where CHINESE labor is not cheap enough?         

Riddle me that?

Falling behind
The US is simply falling behind. Yet, most US corporations are doing ‘fine’ because they have put their best and newest technologies to work in ASIA! Of course, labor is cheaper there! Why invest in the US where costs are so high? No wonder US wages CAN’T rise. The push to hike minimum wages in the US is the most misguided public policy since the mandate to replace all vehicles with square wheels (OK I made that one up…). But it is a dumb move given our circumstance and almost as stupid as the fake policy I cite.   

Clueless in Washington (regardless of the party)
US government and Fed policies continue to err by not realizing the constraint the global economy places on the US economy. By putting on blinders and resorting to old tired and irrelevant policy paradigms US policy-makers continue to come up with the wrong analysis and the wrong remedies.

Irrelevant Paradigms -Speed bumps on the road to truth
The May employment report analysis is just one the most recent and of the most glaring examples of this. Here it is in a nutshell I (don’t) think therefore I am (wrong).   I spin, therefore I get consulting work and affect policy and I am employed. I am useful when I Spin because I have a paradigm to blame the other party. But in fact what I am when I do this is a speed bump on the road to truth or a long detour in the wrong direction. And the US economy is running out of time. And time is one thing you cannot spin, beg, borrow or steal. It simply is.  We Americans have work to do and no one to lead us. No direction to go. No clue about what to do. And we are being misled about what is wrong. What’s worse is  that we are being divided along ideological lines when that ideology does not address the real problem! It’s no wonder that the American public smells a rat and has been supporting ‘out of the money’ candidates. Maybe a long shot will come in in November. Something has to give…         


Thursday, February 25, 2016

Evaluating the Fed...By the Numbers: Why it is Failing

Why the Fed is blowing it
Incorrect priorities lead to incorrect conclusions

I have been offering piecemeal rankings week by week of the topical indicators of the week, ranking them in their recent historic context. My conclusion has consistently been that economic variables are far too weak to justify Fed policy. I have weekly calculations (performed on ranked growth rates going back to 2010) for data since late October of last year that produce this same result/conclusion week by week without fail. And yet the Fed hiked rates in December and it continues to assert that its program of rate hikes is still on path even though that path might take a lower gradient. What gives?  

In the table above I have finally taken the full approach by ranking a broad set of 50 variables instead of just taking whatever was offered up new, week-by-week. Again I rank variables on their growth rates or levels since January of 2010 to date and I have sorted them into groups and averaged their standings to create readings on different measures. These group rankings are revealing. And not surprisingly they give substance to a criticism I have been levying at the Fed for some time. But here we have data to support it and context for the Fed’s missteps.

The Fed has a labor market centric view of the world. And, while the world outside the labor market is unraveling, the labor variables have remained relatively strong. This means that the Fed, with its blinders on, views what appears as a strong economy (through the lens of that strong labor market). However, when we look at other variables what we observe is a much weaker U.S. economy and one that would hardly support the policy that the Fed chose to pursue in December and is still pursing.

The table above shows that the labor market variables over about the last 70 months have an average ranking in the top 5% of their queue of data since January 2010. No wonder the Fed sees a strong economy. However, the next strongest sector is housing which has only a 53 percentile standing. After that it is services with a 43 percentile standing. After services the consumer sector has a 33 percentile standing. After the consumer sector price trends have a 26 percentile standing. After price indicators, the general economy, including trade, has a 16 percentile standing. With a 9 percentile standing, the factory sector comes in as the weakest of all. There is no surprise there.  

So the factory sector has been weaker only 9% of the time since January of 2010. And only two of these seven categories have rankings that push them above their medians in what has been a disappointing economic recovery. And the strongest of these categories is - SURPRISE - the one the Fed has chosen to target for its policy focus, the labor market. It’s as though there is some bizarre form of Goodhart’s law at work. The Fed chooses to target the labor market and the labor market stops being representative of the economy.

The Fed decision to make the labor market primary in its analysis of the economy is why policy is running amok. In the last FOMC minutes the Fed even included language defending the use of the labor market as a focus over and above GDP figures (GDP is not used in the table above since I have only used indicators with a monthly frequency).

The Fed has set up a straw man choice (labor vs GDP) to justify the use of labor data (GDP is too often revised). But, focusing on the labor market is not the best forward looking indicator-and there are many other choices. We do not have to accept the Fed’s strawman. Right now, for example, the growth in the index of leading economic indicators leaves it ranking in the 39th percentile of its historic queue of growth rates back to 1969. The coincident index sits in its 34th percentile. Needless to say, the LEI’s strength is not very comforting. Of course, it has slowed like this before without signaling recession. But this is a significant slowing and it is occurring with the Fed’s gas pedal still nearly to the floor… and the Fed has few options to do more should the economy sour. Since the Fed has no latitude to help should things continue to slide, that limitation should be part of the policy decision.

As I have said before, this the most disturbing thing about Fed policy. It is not that I think that Fed policy is wrong. It is that, objectively, the Fed’s policy course is dangerous since it assumes that the economy will not backslide in an environment where everything already is backsliding except the ONE INDICATOR that the Fed has chosen to focus upon (the job market). If the Fed has chosen badly in terms of its focus or in terms of its forecast there is no fallback position for policy. And several Fed members are quite dogmatically attuned to keeping rates moving up because they are convinced that they must make up for past sins and that inflation is gaining on them. This is the view that (1) rates were too low for too long, or that (2) the Fed balance sheet is just too big or (3) that the unemployment rate is just too low. This spectrum of ‘just-toos’ brings Monetarist and Keynesians together in a love fest of agreement and gnashing of teeth over inflation risks and so obseesed with teh past that they cannot see what is happening or appreciate that the future might different from what they obsess over. That’s why they call it an obsession.

Meanwhile incoming data make a different point altogether.

The table at the top shows that economic data have been weak- almost everything outside of jobs data has been weak. What are the odds that the jobs data will lead us out of the wilderness while everything else remains weak or gets weaker? Probably not very good... This is where I start calling the Fed dogmatic and accuse it of not really being data-dependent, as it claims it is, unless data dependency means that it depends on what data they want to look at. Oh. Now I get it. 

 Data classification used for these calculations is

Sunday, February 21, 2016

Where is the Fed’s objectivity?

Objective evaluation of last 2 week’s data
Where is the Fed’s objectivity?

So here is a summary table:

I focus on the RANK of the 12 mo. percent change of all data since May of 2011. We rank each series on its growth over that period. Based on that frame of reference, all monthly reports from the last 2-weeks, average a standing in their 25th percentile. They have been this low or lower since May of 2011 only one –quarter of the time. Price data have been this low or lower 29% of the time. Activity data have been this low of lower 21% of the time. MFG data have been this low or lower 12% of the time. Inventory growth has been this low or lower only 1.8% of the time. U of M sentiment has been this low or lower only 17% of the time.

These all are very weak readings! What the heck is the FED looking at?

Recession signals- Not yet
Does any of this signal recession? No.

The economy is in recession only about 6% of the time. But readings that are in or at the bottom quartile of their range are not reassuring readings. And to be clear the Fed is planning to hike rate with these indicators on weakening trends. That is what is most outrageous and disconnected from reality. It’s not just these levels of the growth rates; it’s the growth plus its momentum. Seven of 20 indicators were lower month to month in their most recent observation. Nine of them are lower year over year. Eleven indicators (out of 20!) are actually below their respective 20th percentiles. Only one is above its 80th percentile – that is real negative asymmetry. These are extremely skewed results – skewed to weakening.

And some these are important reports like industrial production, retail sales, the index of leading indicators, consumer sentiment, the NFIB survey and others. It’s not a collection of dribs and drabs of data.

No wiggle room/No Room To Move Vs the vast expanse of space on the upside
With the Fed having virtually no wiggle room to ease, as this economic slippage continues, it is an outrageously dangerous strategy for the Fed to not at least announce that policy is on hold. The ‘MINI-MAX’ rule says when policy is in an uncertain environment it can be a good strategy to act so as to MINIMIZE the effects of a policy decision SHOULD the wrong policy direction be chosen. Where do you think the Fed stands relative to this rule?

Dead WRONG. But hey, maybe the Fed policy tilt actually is right? Maybe it will draw to an inside straight and all will be forgiven…and then again maybe not. That’s why the ‘mini-max’ rule was developed because…MAYBE NOT.  What is the Fed’s forecasting record like anyway?

There is NOTHING dangerous about slowing the tightening cycle… should the economy continue to grow and if inflation pressures were to mount the Fed has so much room (infinite) to move on the upside compared to almost no room on the downside- there is no risk (Queue John Mayall. ‘Room to Move’ Here).  The Fed is driving close to the edge here...and for what reason? 

Smell the handwriting on the wall…
I find this policy obstinacy an astonishing choice. Especially since GLOBAL forces are pushing BACK at inflation. I have called the Fed dogmatic. Some call it ideological, some say it has hubris. Others call it arrogant. All of these descriptions express frustration with a Fed that refuses to smell the handwriting on the wall (I’m just guessing here that they can’t read it)...

Frustration with the Fed mounts
There is a group of economists –of no particular ideological purity- that is increasingly frustrated with a Fed that embarked on a tightening policy, lacking the justification that it had set for itself to move.

Let’s pretend?
Still, it moved and now it has momentum. A policy choice was made and now the Fed wants to stick to it and it is seemingly reluctant to pause and admit that it may have made a mistake and moved too soon like so many other central banks before it IN THIS VERY CYCLE. Is the Fed really whistling past the graveyard because it thinks it can protect its reputation by compounding one bad decision with another?  This is a high stakes riverboat double or nothing Fed policy gamble, and there is no payoff commensurate with the risk that the Fed is taking. So…why is it doing this? Under most circumstances ‘Let’s Pretend’ is not a policy option.