Bernanke's Speech and its implications

What the world needs now?

It’s not love sweet love.

Bernanke in the speech he gave today, besides looking at the circumstances of Asian economies in the business cycle, the ostensible topic of his speech, returned to a theme he has visited in the past. This is the danger of persisting imbalances: surpluses and deficits alike.

While he was very vague about how this should be approached, he was again clear on what needs to be achieved. High savings countries need to consume more and reduce the gap between savings and investment at home. High spending countries need to save more. There is a little something for everyone.

At the same time there is little evidence that any country is taking up a stand to pursue these objectives. Yet the risks are growing

Perspective on imbalances

One issue is that under the gold standard there were rules to the game. Deficit countries were forced to adjust because under the gold standard they lost gold reserves if they let current account deficits persist. No one wanted to run out of gold. So deficit counties usually hiked interest rates and slowed their economies down, contracting imports in the process to rebalance their trade, maybe they even ran a recession. While that system was disciplined it was also confining and it had the side effect that it rewarded countries that had gold mines. The current loose FX system that has few rules and none enforced has been short on discipline – very short. Hence imbalances have arisen, persisted and become enlarged in way that they never could under the gold standard.

G-20 not up to the challenge

The G-20 tried to consider a US treasury proposed to accomplish these same ‘Bernanke’ objectives when it last met. The proposal got lip service only. Absent some concerted effort to accomplish the goals of adjusting savings/investment imbalances, the pressure for adjustment will fall on the exchange rate.

Connections and linkages

The imbalances are one of the reasons for the dollar to be losing ground. The exchange rate is a remedy for US BOP ills since a weaker dollar will choke off US exports and spur US imports. But the dollar’s drop brings other tensions to the surface. Moreover, it is unlikely that the dollar can fall enough to purge the US structural deficit problem. The need for some sort of coordinated effort involving the realization of enlightened self-interest is long overdue. Yet the world’s most important economies are not about to cut any deals. Each sees its current state as in some way optimal for its own needs even though the whole picture is one of a very dysfunctional economic community.

The risk

History suggests that the sorts of problems that arise in the wake of these huge imbalances persisting and being extended are not minor inconveniences. Yet there is no agreement even on pursuing the goals that Bernanke has spoken of repeatedly and that were put on the table at the recent G-20 meeting. Growing payment imbalances have ended badly whether it was due to OPEC countries’ rising wealth, rising Japanese trade surpluses or China’s huge foreign exchange reserve accumulation. We can only wonder if the fallout from these imbalances will get worse as the imbalances themselves get bigger and they are getting bigger - in absolute terms and larger relative to GDP.

Can’t have your Egg Foo Yung and eat it too

China has goals that are bizarre. They are mutually inconsistent. It wants a weak currency to keep its competiveness in tact yet it does not want to keep accumulating dollar assets of which it has in abundance. But if it does not purchase those dollar investments, its currency will rise in value. The lack of a foreign exchange system with clear rules allows China to act like this lost soul with deeply conflicted goals.

The point, the risk, the dysfunction

To be sure Bernanke’s point is a sharp one. No one can tell you when we must get off this path onto one like the one Bernanke urges. By not adjusting, and letting a normal business cycle recovery occur led by US growth with surging US imports and a widening US current account deficit we are playing with fire. It’s a prescription for something bad to happen. It’s like high blood pressure. No one knows what price you pay for it, but we know it puts you more at risk to various health issues. So why leave this problem untreated when we have options and when better systemic health is in everyone’s best interest? That is the unanswered question.

A Noble Nobel Prize in Economics

Math gods! Economics has become too much about math. I find it curious that economics, which is social science is being vilified for being pushed in the direction of being a social science. Huh?

Curriculum: When I received my PhD in Econ over 30-Years ago Harvard was in a snit about dropping its history of thought requirement. B-schools have been short on ethics training. If it ain't math or quantitative it ain't worth studying.

NOT! - I can't you tell how glad I was that I read Koopman's "Three essays' in graduate school!!??

Ptolemy is dead - Are markets gods? Do all the planets rotate around them? Is there nothing about morality and ethics B-leaders need to know? What about anyone knowing about history (in this case economic history) and 'human behavior', read 'consumer behavior' (woo-hoo social science social science!)? Can the world really be subsumed in a series of equations (Issac Asimoz- read his Foundation series)? Maybe if the equations are complex enough. Maybe it's not just Sci-Fi, but it still is for now. But I doubt we are at that level of understanding for either human behavior or math, indeed I know it.

Math guys may get Econ PhDs from MIT but they work for Social Science wonks - Anyone who does policy work knows the importance of the non-math stuff. Public policy-trained economics often occupy high level jobs since success at some level is more about understanding politics, motivations and advertising (spin) than about having the best quality 't' or 'F' statistic. In any even I am far too suspicious of that quant work since the people with the same opinions keep 'proving' that they right even though guys on the other side keep 'proving' that 'they' are really wrong.

From X + Y = Z to the X-factor -- While 'The Journals' may cringe at this, in my grad work I'd taken a course in law and economics that a was a very useful way to put the quantitative stuff in its place. Up to now the 'quant' stuff was like The Blob, absorbing everything in sight. Models have a role, but its not to be placed on the altar. Broadening what economics is and does is a good thing. This Nobel prize does that.

Our inabilities are many - The inability to construct non explosive derivatives (Danger Will Robinson!, danger!) out of something as simple as a home mortgage should tell you that Quant economists exaggerate their abilities. My Dad helped people buy and sell homes for over 30-Years and never blew anyone up. I guess it takes a village...one of idiots who think they are rocket scientists. If that seems off point then assess our ability to forecast something as fundamental as an exchange rate or even productivity.

Oh, yeah we can forecast things with trend. Good for us. Economics may have been taken down a notch to some but it seems to have found its soul with this award... these awards. I admit to being heartened more by the subject matter rewarded than by the fact that a woman won (shared)the top prize. Good for her, but better for what she did.

Policy Stinks

Policy STINKS! I don’t need no stinking stimulus…if it’s like this

I was critical of the stimulus plan from DAY ONE. The CBO scored it poorly. My point was and is that the plan had more ‘agenda’ than ‘stimulus’. So, one big Bronx cheer for Democrats that packed a roughly $850bln plan with stuff that was Democrat or friends-of-Democrat (FOD) friendly. More and more it’s looking like they spent a TON of (our!) money with little effect-sound familiar? Republicans do not have the patent on that! And- as you would expect the Democrat’s tack is to blame Republicans for it… (oh, their recession is worse than we thought. But in doing this don’t forget the role of the House and Senate ‘banking committees’ in making and changing the rules that destabilized markets since they each were headed by…Democrats). I hope no one let’s them off the hook for this. ALL politicians are the SAME. We have ONE party in America and it is run by the lobbyists. Moreover, just as the stimulus plan was crude and half-hearted from the start, the President, all on his own, has been reluctant to be a positive force. He has sourly met even pieces of good news. Then he switched his interest to health care reform and has been trying to sell THAT as an economic stimulus plan (sorry, that’s pretty lame, even if we like you).

Yeah! We lose the Olympics and gain a modicum of fiscal respectability - And then Mr O took time out to go to Denmark to plump for one of the biggest money losing schemes in the world that comes periodically (well second to the money spent and misallocated in election year cycles anyway), The Olympics! Why was that so important? Is Chicago in such great fiscal shape that it wanted to lose $6bln or so by staging the games? Or since Barack is from there, did Chicago think it could toddle right over to DC and Mr O would arrange for them to get the money from us? So Rio ‘won’ the Olympics...did it really win or did it just get stuck for the bill at the next global sports party? Hey, party in Rio, Lula’s buying!

A Chicken in every pot

As the G-20 meets the US is said to be in favor of 'a new wold economic order' It's not clear how that will work out. The idea is for big deficit countries, like the US, to save more and for trade surplus countries (exporters) to stimulate more domestic demand. It does make sense. Remember that some time ago Bernanke framed the problem as the other countries saving too much instead of as the the US consuming too much. But it's all part of the same phenomenon.

So how do you get here from here? What policies will the US propose to raise US savings? Will it put a VAT tax into play to discourage all consumption including imports? (Ouch!) Will it subsidize savings accounts with more tax breaks? What is the plan to achieve the rhetorical end sought by the Obama Administration? And what are the incentives for Germany, Japan and other surplus county exporters? What would their governments do to to spur consumption at home?

While we know that some of these steps need to be made what if we cannot agree on the nuts and bolts or enabling policy coordination?

Well, that's why God invented exchange rates.

Exchange rates are supposed to rebalance these imbalances. The dollar has been kept too strong for too long in the face of widening deficits. The adjustment system has failed to work; it failed to choke off this huge volume of imports. China's FX rate has been too low The EMU rate has been too low, the yen has been too low. So if this initiative fails you can expect the dollar to be one of the factors to move to create what policymakers refuse to create on their own.

One deliciously ironic things is that everyone complains and wonders about foreigners continuing to buy our debt. But buying less of it is exactly the remedy. It was the continued aggressive purchases of dollar assets that supported the dollar and kept it from falling in the face of huge deficits. Had the dollar fallen, US exports would have been stronger and imports weaker with a resulting favorable impacts on the trade balance.

We have gotten too deep into this hole because some countries- without thinking - were willing to buy huge amounts of US-based financial paper. Those purchases supported the dollar and financed the US deficit and financed their own continuing trade surpluses.

In economics all the pieces usually fit together. They do again in this case. So we should watch the G-20 closely and see if the policymakers have any workable ideas or if the grandiose rhetoric will go down in flames in the foreign exchange market.

stay tuned

America the beautiful-pessimistic, but beautiful

Yes, in America, the land of the free and the home of the brave, no one can seem to muster the backbone to be optimistic on the economy. By this I do not mean ‘stick out your neck’ optimistic, just not so pessimistic that you extrapolate every trend to the downside.

I recently heard an economist say that the recovery was going to be slow because the recession has been so bad.

Huh?

Charting JOB recoveries - For most recessions the employment low point comes quite close to the end of recession, falling early in the recovery. But in the 1990 and 2001 recoveries the employment low points occurred well into their recovery period. That is not an issue here since we center all series indexed to their respective cycle lows in employment.

Job patterns around the business cycle - So instead of using the business cycle to mark time let's look at jobs dropping from their cycle peaks and rising from their cycle lows and ignore the business cycle dating. This treatment gets us away form those notions and in doing so it shows a different and seldom spoken aspect of job losses in and around recession periods. Job losses and gains tend to be symmetrical around business cycle periods. That is if we lose jobs in a slow U-shaped drop, we put them back on in a slow U-shaped rise. If we lose jobs in vigorous V-shaped drop we tend to put then back on is a vigorous V-shaped rise. We do not have ‘V-shaped’ drops coupled with ‘U-shaped’ rises.

The Real Deal gets the RAW DEAL - So the real answer is that if the job losses are severe in recession we should expect the recovery job gains to be strong. And the losses have been (and still are) severe in this recession so why are so few economists willing to talk of a strong recovery when history so clearly points to that as the MOST LIKELY CASE SCENARIO?

Pessimists rule!

Hold the presses…never mind - So why do pessimists rule? It’s an intriguing question. I think part of it is that ‘dog bites man and man might get rabies and could die,’ is a better story than ‘dog bites man, man get tetanus shot goes on his way and is healthy’.

The perils of forecasting - In recession it is never clear how we get to recovery. In expansion periods the economist that predicts recession is a pariah no one believes. Every cycle someone is right and often that person is right for the wrong reason.

The PARIAH MESSIAH - In this cycle the Pariah Messiah forecast was that housing would bring down the consumer and the economy. Instead housing has been an ongoing issue but it was the loan instruments, leveraging and reckless lending that crashed the financial institutions that still do not want to lend. They then shut out credit to each other sapped the markets of liquidity doomed jumbo loan financing and changed the terms and conditions of home financing in a way that bludgeoned housing and sucker-punched autos, both big ticket items that required bank involvement. Also oil at nearly $150/bbl did not help. No the doom-forecasters for the most part, got the doom they forecasted but the causes were completely different from what they had warned.

Paradox of thrift not of theft

Actually it will be the consumer to lead us to recover regardless of people saying it won't. And as for the needed rise in the savings rate that may happen and it will slow spending but it will not doom us to a paltry recovery.

The first thing to understand is that we know about the paradox of thrift and no nation has ever saved its way to damnation (boom, gloom and doom report aside). A higher savings rate will not rob us of our growth, there is so much more at work here than just the need to hike the savings rate.

Perspective! - The next thing is to gain some perspective. Pessimists say that consumers can’t spend and incomes can’t grow. But all this misses the point. The point is that 6.9million fewer jobs exist in the nonfarm payroll and there are 7million fewer employed compared to the peak in the household survey of employment.

What happens to those people?

Tradition! History (see graph above) tells us they get put back to work. If so they get jobs and get incomes. They amount to about 5% of total employment. So their return to the labor force is liable to be a key element driving incomes higher. Remember income is not just the product of current people working times their wage; it’s all the people currently working plus those brought back to work times the number of hours they work times their wages. And that is just for the wage component of income. And wage as salary income revives so will profits, rents and so on.

The arithmetic of pessimists- Productivity has remained strong in this cycle. If population growth is 1% per year and productivity is 1.5%, then we can grow at 2.5% per year –and that is at the lower work week with 5% of the workforce remaining unemployed. But that won’t happen.

The arithmetic of realism - The work week will go back up further boosting growth during that transition. The SEVEN MILLION unemployed will go back to work. If they are hired at an astonishingly slow pace and if it takes five years to re-employ them, then growth can look like this FOR FIVE YEARS IN A ROW: 1% for population 1.5% for productivity and 1% point more per year for five years as we put the unemployed back to work. That’s 3.5% per year. And we still get a transitional bounce on top of that as the work week segueways itself back up to normal.

Let me add that we have a government stimulus program of growing impact to help make this happen in 2010.

Pessimists must be related to ostriches - I cannot for the life of me understand what the pessimists are thinking – are they thinking? Do they think that the seven million unemployment are going to go bury themselves at Forest Lawn and disappear forever? It’s not just a matter of looking at my job growth chart. It’s a matter of thinking about this country and what is likely to happen. Life goes on. People pick themselves up and go on with their lives. Sometimes dreams are shattered. But writing-off the recession job-losers as if they will disappear is a big mistake. If the jobs in Detroit are gone for good then, new ones will be formed or people will move. Houses may become abandoned. But those people will go somewhere else and they will work. We saw this in the wake of the first oil price bubble when prices went back down and whole unlived in apartment complexes in Texas were bulldozed. Texas survived. Look at the evisceration of Louisiana after the floods. Whole neighborhoods are gone but the people are elsewhere rebuilding their lives.

OHHH but it will be different this time - Maybe it will be different this time; maybe it will be slower this time. Usually jobs are put back on faster than they are lost. But the reason to dump pessimism is strong. The great pool of formerly employed will be a powerful job-creating force. Don’t forget the supply side. These people will want to work. The one differing factor is that there may be ‘some displaced workers’ close enough to age of retirement to not reenter the labor force. That is a difference with past cycles and it could impede the tendency to rehire this time around. Still, that should be small potatoes.

Why credit the ephemeral? Two Gripes:

One gripe...

There is no doubt that cash for clunkers ($4C) has helped the economy. Just look at the auto sales.

And in selling cars, inventories were drawn and will be rebuilt spurring production, putting people back to work, stimulating income growth. Amen.

Finally a plan that worked...but for whom?

Some of these people going back to work will be Americans. You see, a lot of Japanese-made and Koerean-made cars were bought in the $4C program. That will come out imports eventually and that will blunt the impact on GDP while putting Koreans and Japanese back to work.

As for the big stimulus plan (Obama-nomics) its impact has just begun to uncoil. It will make its big strike in 2010. Our data are barely from mid-year 2009.

But the WSJ and others want to chalk the progrss up to stimulus.

Yet stimulus is not the only reason for a rebound. All recessions -even severe ones- end. We have offered several different calculations on how they end. We have shown/argued that when recessions are severe and job losses are severe recoveries tend to be strong ('recovery' refers to the first 12 months or so after recession ends). Separately we have shown that if we look at job losses per se in business cycles but not tied to the cycle timing itself, job gains tend to follow about as rapidly as the losses that had preceded them. That finding is independent of stimulus.

It is the automatic self-correcting aspect of the economy at work. And we do not deny that government might play a role in getting the economy to make that turn. But once the turn gets in gear natural forces are at work.

A second gripe...

Treating indicators as fact...

I also wonder about the ADP. I see it being reported as though Moses brought its number to market on stone tablets. I'd sure prefer to hold my judgement on job growth until I see the real figures. We know that the purveyors of the ADP survery are 'full of themselves' and have even spoken of how their survey is better than the one conducted by the Labor Dept. Sorry if I don't sign on for that Kool Aid-drinking fest. Last month ADP was well off the mark. This month the ADP shows continued improvement compared to is error-laden report of last month. Unlike the WSJ, I will reserve comment on how fast job improvement is coming along until I see real numbers from the Labor Dept.

However, on the positive side, the ISM MFG report did show a turn to growth in its survey and its employment gauge improved in August. Well, ADP says it is better than the ISM results but (big BUTT) that boasting all comes from in-sample observation-hitting. In real time ADP is missing the diminishing job losses and it it really missed the slip to outsized job losses as the recesssion became intense.

I'd reallly caution the Journal to speak speculatively of what the ADP indicates instead of treating it like manna from heaven. It's been more like Manny from Brooklyn.

I remain optimistic that improvement continues at a rapid pace and look forward to seeing that view borne out in the Friday jobs report.

A counter point to the U of M Sentiment Report

Or, How bait and switch takes its toll on confidence...

Cynicism: The commentary in the core of the U of M report has some elements that are a bit brighter but it also contains some really dark observations, conclusions and worst of all extrapolations. It is my own conclusion arrived at by looking at the responses to these surveys in the business cycle that they do not always turn up very sharply when economic conditions begin to improve. While people do know their own communities very well, when the news is bleak people tend to be skeptical. Sometimes even good trends are not to be believed.

Extrapolation: In the U of M commentary Richard Curtin Director of the Reuters/Uof M Surveys of Consumers refers to a ray of hope accompanied by the grimmest assessment by consumers of their personal finances since the 'Great Depression'. Thanks for that DICK. Has U of M really been polling people continuously for that long, or was that hyperbole?

Counterpoint on Depression: What can we make of Curtin's remark? First in the weekly ABC consumer comfort poll we can note that the personal finance index is up strongly over the last eight weeks and while it is not by any means in 'great shape' that personal finance index resides in the bottom 15 percentile of its range, a range that does not include the Great Depression but extends back to 1986. To the ABC survey this is not the worst personal financial environment since the Great Depression; it's improving and its not even the worst since 1986.

Unemployment yet to peak: REALLY? -- Next Curtin noted that consumers did see fewer layoffs and thought that unemployment was stabilizing but that it still would peak at over 10%. Man, I wonder what sort of macro-models these men-in-the street are using? 500 equations? 1,000 equations? How would they even know this crap unless they gleaned it from the press, a press that has been predisposed to feature news reports each more pessimistic than the last. So is this question really about what is being reported or what people can parrot back? AWK... Polly want a job AWKK!

NO INCOME GAINS!! Only one in four consumers anticipated any income gains at all in the year ahead. Even with 'low inflation' just 13% anticipated any inflation- adjusted income gains during the year ahead.

Wait one minute! Reality check! This is a curious result to me. Consider this: while municipalities and states are under pressure government workers are generally protected from inflation. Municipal unions are strong and 17% of workers are employed by state, local or the Federal government. That's nearly one-in-five. Next there are retirees whose Social Security payments are indexed by the CPI. And then there is everybody else. Do those numbers make much sense with that survey result?

Other results to compare- The Conference Board does not ask about inflation- adjusted income but its survey asks about income expectations. Positive expectations responses rose to 10.6% from 10.1% in August a monthly rise not a drop. The lowest reading from the Conference Board came in March 2009 when only 7.8% of respondents thought that incomes would rise. There are no inflation adjusted results per se in tha report but the Conference Board survey continues to see inflation expected above 5%. So when Curtin asks in the U of M survey about pay increases above the rate of inflation the response is an interesting one but we don't really know what it means.

Are people matching the correct inflation metric to their own expected pay results? We just don't know.

Can consumer finances really be that grim? While the ABC poll has a consumer finance index that is improving over an eight week period, the U of M survey has the smallest number of respondents saying their finances had improved at all, at 16%. This is interesting. We know house prices are still falling but that the drop has slowed. Stocks are up more than 20% (or much more) from their lows back in March of this year. Average hourly earnings rose in July and the work week got a bit longer (that is for July not August and the U of M survey is for August). In previous research I have found that in looking at the Conference Board data, income expectations responses are closely linked to the inflation environment. The fact that U of M has a question on income relative to inflation does not settle the matter for me, its a better question than the one asked by the Conference Board, perhaps, but not one whose response I would necessarily take to the bank - or what used to be a bank. So what is really going on here? Isn't some of this income response just people admitting that inflation is low?

Bad for this stage THIS STAGE OF WHAT?? Curtin says that 'at this stage' in past recoveries consumers have usually sensed the gains... Okay DICK, what stage of the recovery are you assuming we are in? My reading of these surveys -and granted I do not have the detailed data you do - but in terms of what is made public it seems that your index measures are up from their lows as they should be. After that, early recovery performance is not very well behaved. The end-recession/early-recovery game is not a very stable or consistent one. And since economists are only saying that the recession may have ended in June, we are only two months or so into the recovery period. Are you basing you comments on TWO MONTH"S DATA, DICK? These are two months in which your survey is much sourer than are others. And in these sorts of periods the values for sentiment, the current situation and expectations can turn around like crazy.

Another pessimist feeds his flock - I add Curtin to the forces who are conjuring up analysis that is far too dismal. No wonder people feel so bad. First of all his survey is worse of that the ABC or the Conference Board survey. Second of all, his voice on the matter is, I think, way too glum. Does he really have survey results back to the Great Depression on a consistent sample to make the statement he made? NO! More spin-o-nomics here I'm afraid.

Pessimistic public figures set the tone for U of M respondents - After the first GDP release for Q2 growth showed GDP losses in Q2 were trimmed to 1% the President came out and said there would still be months of recession left. Now Curtin is telling us that in August people are glum. I wonder why? Do they know something or are they reading the papers? One problem with the survey is all these forward-looking questions that we cannot expect people to know anything about. Contrarily, I am impressed that when people are asked reasonably, to evaluate things that they can see and that they can know about, they detect improvement. But when you ask them to forecast the future what do we get? We get the responses from people who just heard the President days ago say that it's not a recovery yet so they act like it's not a recovery yet when they present their expectations.

Questioning the results: I would ask Mr Curtin why with stocks soaring, the U of M current personal finance index fell to 58 in August from 70 in July? Job losses slowed sharply in July - we do not know about August. Layoffs have been at a reduced pace for several months, and, in the survey itself, respondents said that trend continued. What is driving these bad survey results? I find them astonishing and, moreover, not very credible.

At turning points: I have concluded in my own research that in the Conference Board index the business conditions survey made the most cyclical sense. The business conditions responses are the stronger ones in this report from U of M this month, too. I think the consumer is being raked over the coals in part by politicians looking to get approval for their next big spending agenda.

VENTING I'M VENTING!! YOU WON'T LIKE ME WHEN I'M VENTING - Let me vent on one such item here. The Obama economic team tells us we cannot stabilize the economy without heath care reform. They talk about huge future medical demands on the system. They use this as an excuse to get support for their medical reform bill. One problem: that bill does not solve the problem. If the problem is the size of the medical deficits in the future, it makes those worse. The kind of health care reform we need is not on the table. It may never be on the table. But this is Obama and friends playing bait and switch.

BAIT AND SWITCH - Yes, this is exactly the kind of bait and switch economics that has gotten us in trouble again and again and has pumped up the deficit. Former President George W. Bush fired one of his economic experts when that expert said (in what proved to be quite a correct assessment) that the war in Iraq was going to cost much, much more than the White House said. The White House knew it but it pressed ahead with its agenda not wanting to be derailed by a public that would trip over an inconvenient fact. Now in the Obama administration inconvenient facts again are being submerged. If you ever wondered why I can't bring myself to join a political party, this is it.

Feeling alright? not feelin' so good myself... No wonder consumers feel so crappy, so confused, so mislead, they are the sheep that are led to slaughter. This is not how politics and economics in America are supposed to work. The consumer is supposed to have the facts to deal with to make a decision, not so much spin he can't get a handle on it.

That's part of the problem.