Sunday, March 5, 2017

Fed should hug you with alligator arms

Schematic of Fed policy

Fed Schematic (1) How the Fed thinks the world works

Unemployment    Labor
   Rate      ---à    marketà Wages -à Prices à Fed Funds -à ActivityàPrices

Fed Schematic (2) How Policy Works in this world

Rate -à Labor Market    -à Wages-à Pricesà   Fed Funds
                                        IMPACT ON WAGES and PRICES                                               

Schematic (3)  How the Fed/economy has really been working                                                                                                     

Rate -à             ???        -à Wages-à Pricesà   Fed Funds
                  Fed skips wait for pass-through, assumes it and hikes Fed Funds
                                    on the basis of a low U3-rate alone

Since the Fed believes that the world works one way {Schematic (1)} it makes policy on that belief.
Seeing the unemployment rate so low, the Fed assumes that the process is underway and DOES NOT WAIT to see inflation emerge before it hikes rates Schematic (2). But we have a PROLIFERATION of information that question whether that transitional process is really still operative, Schematic (3).

Evidence suggests that the unemployment rate is not the same variable it used to be…

Participation rate changes show some of the labor force characteristics are changing
As the labor force ages its characteristics change’ productivity changes, many aspects change
Not surprisingly…

There has been a big shift. The participation rate has come to explain the bulk of the shift in the unemployment rate. This did not used to be the case (see below). This shift should cause us to wonder the nature of unemployment rate itself. If shifting demographics rather than rising employment or falling unemployment is the main determinate of the rate of unemployment, hasn’t the nature of that rate changed? It is a question the Fed seems to entertain in policy discussions and in speeches BUT NOT in the application of policy itself.   That’s odd.   

In addition there have been non-demographic shocks as people, not just those in the upper age cohorts, have reduced their willingness to participate in the labor force as either employed or unemployed persons. The U6 rate is more inclusive as it encompasses a broader view of what people are jobless. 

While the unemployment rate (U3) has fallen, the U6 rate has not fallen nearly as much. The charts (above and below) show very different views of the world. The U3 rate is rarely lower and so the Fed fears (AKA is ‘sure’) that schematic number one is in play. It is ready to act as in schematic number 2 to jump interest rates on the reality of a low U3 rate fearing inflation is coming… But the unemployment rate ratio of U6 to U3 shows us that the U6 rate has not fallen nearly as much.  It reminds us that by a different measure there is a lot more slack in the economy than U3 suggests. By that I do not just mean that the U6 is higher. It is both absolutely and relatively higher. The ratio is higher. And that is significant. If there is more slack a lower U3 rate might not create so much wage pressure. Anticipatory rate hikes might be ill conceived.

U3 is rarely lower. And the Fed is worried that such a low unemployment rate implies with NEAR CERTAINTY inflation is on the way. So the Fed is taking the OPPORTUNITY of growth that it sees as being more stable and reliable to HIKE interest rates from super low levels. Still the chart above also informs us of another interesting peculiarity. In the Post-War period when the U3 rate has been this low a recession has been ‘just around the corner.’ In fact recessions have occurred from much higher levels of unemployment than what we have today. On average since 1950, recession has occurred with about 2 ½ years of the Unemployment rate (U3) first breaking the 4.8% mark. But lead times have been as short as two months and as long as nearly five years. So there is the question of if the Fed thinks that the old U3 rate is just the same old thing or not? Does this explain why the Fed is hiking rates? Is it because it fears a recession is around the corner and the Fed feels a need to get rates higher? Does it really fear inflation? …Inflation that is not really developing? What is the Fed’s real rationale for what it is doing? I get the sense that the Fed is running words past us that derive from an old paradigm that no longer works and is not relevant.

How we should measure the unemployment rate has become a controversial subject, but we also know that what the unemployment rate DOES has shifted. In short the Fed’s policy of leap-frogging the impact of the low unemployment rate to head off inflation (that may not be in train) is a policy tact without strong rationale anymore. For an institution with more economists than you can shake a stick at this is a brazen disregard of some basic economic facts. Let’s look at some. 

More Problems: Stylized facts about the unemployment rate…

The main relationship that maps the unemployment rate and its changes into inflation works through wages and is called the Phillips curve. But the Phillips Curve relationship has become flat. It has shifted down and it does not depict a very POWERFUL relationship between unemployment and inflation. It certainly does not begin to explain why the Fed is so dogmatically out of sorts about the low rate of unemployment.     On the chart above the unemployment rate can fall from 7% to 4% and wage rate inflation will rise from about 2% to about 2.7%. However, the lowest unemployment rate we have seen since 1950 is 2.5%.... a rate that low would result in a drop in the unemployment rate by only another 2.3 percentage points, and some modest additional wage pressure. Is that what the Fed fears?

In addition, other relationships have shifted. Here we see that there is still a relationship to wages through a heightened quit rate but that that relationship is also is less powerful. It has shifted downward and the slope depicting the impact of change in the quit rate on the change in wage inflation is diminished as well (the slope of the line is flatter). Market power has shifted away from the worker even when the job market tightens. Firms are reluctant to raise wages because of international competition and are further empowered to hold back wages hikes because technology has given them more options. Note that we get these muted relationships even though, in recent years, government legislation has had a role in pushing wages up though increases in the minimum wage rate as the unemployment rate fell.  Those hikes are still in progress.

Moreover the ‘trigger’ for inflation creation in this model is a dropping unemployment rate and the chart above shows that the pace of the unemployment rate drop has slowed to crawl and we might even wonder if it is still in train…

Conclusions, observations and a policy recommendations
In the 1980s when inflation was high the Fed adopted a monetary approach to monitoring inflation and to setting monetary policy. In the early 1980s Fed policy tightness rose and fell on things like money supply and bank reserves. Under Alan Greenspan the Fed lost its theoretical focus and began heuristically to follow his mantra which was that inflation should be as low and close to zero as is practically possible. Under Ben Bernanke the Fed drifted on the same path for a short while until Bernanke got the Fed to adopt inflation targeting on the heels of the same approach used by the ECB and the BOE. This policy, which like Greenspan’s method, is output oriented (targeting inflation itself) rather than input oriented (aimed at controlling the money supply and bank reserves that create inflation). Inflation targeting is also meant to corral the benefits of focusing expectations on the target. If the central bank has credibility and demonstrates that it hits its inflation target, the more likely it is that the transactors in the economy will build that expectation into what they are doing so that the target becomes more robust and more easily achievable.  

Leader as follower- Janet Yellen’s recent speech (March 3, 2017) began on the note the Fed likes to reinforce which is that the Fed is merely following the mandate laid down by Congress. But in fact the Fed has a great deal of flexibility in how it achieves its dual mandate for price stabilization and sustaining low unemployment. The Fed has chosen to use inflation targeting and to adopt all the layers of communication problems that resulted when it chose to implement Congress’ directives by dabbling with the notion of employing policy guidance.

Fed policy makes more sense than the rationale for Fed policy…The Fed insists on a policy paradigm that focuses on its ability to achieve its unemployment rate and inflation objectives. These are two goals that often find themselves in opposition. For now the Fed is in the position of having both metrics reasonably close to their goals. For the moment the Fed acts as if the unemployment rate can’t fall much further (or that it shouldn’t) and that inflation is still not quite high enough, but is almost (…and soon will be). However, all that is a lot of hair-splitting. The ongoing bump up for inflation is oil-price-related which the Fed has told us it usually tries to ‘look through’ (as the ECB is doing). Core inflation is really not rising. And the unemployment objective is for a rate that is flawed and of unknown merit as we document above. Core inflation shows little pressure and is a bit farther below its target of 2% than the headline (which is at 1.9%). But in economics given leads and lags and other variabilities one has to conclude that inflation is reasonably close to target. YES… it is technically below target and has been below target for many, many, months (57, but who’s counting?). Still, policy is really close to being in its ‘sweet spot. Policymaking is about looking ahead even if one does not drink the Fed’s Kool Aid on its need to forecast ahead. By looking at the position of the economy in the business cycle and at the level of the rate of unemployment, the Fed can make assessments of trends and of economic needs and decide on the fine tuning of making policy.  So what should the Fed be doing?

What Janet Yellen should do for her winter vacation: change the way she operates: The Fed should be focusing less on the hairsplitting notion of getting inflation back to 2% and on getting each of its variables precisely on target and focus more on having policy get rates back into a configuration that looks more like normalcy. Since growth is simply not going to get as strong as it used to, GDP growth around 2% is now good-to-normal. The Fed should be less concerned about whether the labor market is going to tighten, raise wages and boost inflation and instead be more focused on the fact that its main policy variables - even with all their issues- are relatively close to where they ‘should’ be and declare victory so policy can carefully -CAREFULLY- nudge the Fed funds rate back toward normal. The Fed in displaying the DOTS should focus MORE on a POLICY corridor from the dots than on the median or average of the dots (trimmed or otherwise). I know many will read this and say but that is what they are doing. Yes, it is sort of…. But this is not the justification that the Fed is using and the policy approach is important. The Fed has to step out of the particular partition of the Japanese lunchbox of policy options it has set for itself and look at the whole lunch. If it were to do this it could free itself of the straight jacket of the language it has adopted and actually have the flexibility to implement policy within essentially the same framework. Right now policy is too myopic, too literal, too mechanistic and too technically oriented on policy parameters of unknown quality. The Fed needs to stop pretending that the job market, the unemployment rate and the Phillips curve are a good way to run policy. They certainly are not. And the sooner that the Fed jumps off that band wagon the better.

It’s not brain’s about alligator arms (or, more simply, STOP Over-reaching!)
The Fed needs to use a blunter pencil when assessing its own performance. If we knew that
(1) 2% were exactly the right inflation rate,
(2) the PCE were the exact right inflation gauge,
(3) the U3 rate were the right unemployment rate and
(4) where the proper U3 level stood,
then, policy would be (somewhat) easier to conduct.

But in fact we know none of these things - NONE. That’s why I think that Fed should declare victory and move on to focus on the right path or speed for getting the Fed funds rate back to (or toward) normal without destabilizing growth. That, right now, is the key policy problem not whether the core PCE is going to climb three tenths of a percentage point in the next two years….really! The Fed has been framing this as a question of where r-star is. And in reality r-star (r*) is in the Fed’s spot light more than the Fed’s two policy ‘targets.’ R-star is the interest rate (natural rate of interest) that is neutral or stable-growth-low-inflation-preserving at full resource utilization. Thus the question now is not whether inflation is exactly at 2% but if there is some reasonable expectation, not a real true forecast, but a reasonable expectation that it will rise there by 20XX as growth progresses accordingly.  Obviously since inflation is ‘bit lean now’ the Fed could allow a slightly faster growth rate and do this by keeping (rt


Monday, November 21, 2016

7 Pitfalls For Donald Trump

7 Pitfalls For Donald Trump

The order of policy implementation matters...Trump will get it wrong.
Trade tariffs and competitiveness- The reason NAFTA fails and China obstructs  
Tax-cut stimulus to be haunted by the 47%...remember them?
Infrastructure stimulus: loved but lacking
Success depends on whether it’s a ‘U-6’ or a ‘U-3’ world
Reality bytes – tech remains a problem for jobs
Demographics, trade, and the 47% stalk the multipliers
See full article at link below

Tuesday, October 25, 2016

Fed rate hikes matter

Fed rate hikes matter

There are two extreme schools of thought on the Fed. One is that because of the size of its balance sheet it controls everything: the level of interest, the yield curve, all of it. Another view is that the Fed does not matter because the market still can poke through the veil of secrecy and get rates where it wants them. If the Fed has a different view from the market and it lower rates too much the market will steepen the yield curve. If the Fed over tightens, the yield curve inverts to compensate.

Reality- Between these two extremes there is the reality which I believe is that the Fed sets the short rate and influences the long rates – how much influence remains a matter of debate. But I do not think that the Fed pegs all rates yet it does disrupt many of them in a way that may render the yield curve and the rate spreads as much less useful barometers on the markets and on the economy compared to more ‘normal’ times. Markets can be fooled by what the Fed does and says and markets can be misled as well.  

Mystifying monetary policy- With the economy fragile, growing slowly, productivity weak, inflation still undershooting and the outlook uncertain, it would not be a good time for the Fed to mystify markets but that is what it seems to be headed for.

The WSJ view as an example of what is wrong- A recent WSJ article (here) just jumbled together the ideas of the Fed guiding markets, communicating clearly, and having made up its mind about December while fluffing past the notion of the Fed being data-dependent. 

Two schools on the Fed- Interestingly a number of Fed critics think that the Fed is doing the economy a disservice by keeping rates so low. Another group fears that the Fed is ready hike them too soon or too quickly or by too-much altogether. I am in that latter group.   

The 2015 paradigm- In my view, the Fed got itself into trouble in 2016 by what it did at the end of 2015- hiking rates prematurely.  Amid great fanfare, calling the period of special accommodation over, the Fed raised rates in December about 10-months ago even though its own stipulations for a rate hike had not been met. But since many (all!) Fed officials had said at one time or another last year that they expected to raise rates in 2015, the Fed felt obligated to do just that – even though to do it required that the Fed violate its own rules. To accommodate and justify that rate hike that the Fed claimed to make policy based on its view of the intermediate term and where it ‘deemed’ growth, inflation rates and unemployment were going. That is how, with oil prices in the midst of spiraling lower and lower, the Fed was still able to move to hike rates in December of 2015. That is something that will always look like a really foolish mystery to future Fed historians. How could the Fed think it was on path to meet its inflation objective with oil prices in near freefall?  

The 2016 question: Now what is the Fed going to use to justify a rate hike in December 2016? It will pass on a rate hike in November because of the elections but will state a different reason. That is allowable central bank misdirection. But (a) with growth still weak, (b) inflation under shooting - (c) not accelerating- and with (d) the unemployment rate having stopped its relentless move lower and (e) having backed up from its lows, what will be the Fed’s excuse/reason for hiking rates this time?  

And why does it make a difference?

Why rate hikes make a difference
International fragility and feedback- While the Fed has from time to time talked about the importance of the international economy and on two occasions in the past year actually swerved policy (allegedly) for international reasons, the Fed’s expressed view of the importance of the international economy misses the point. The point is not that international turbulence should stay the Fed’s hand (Sept of 2015 and early 2016). Nor is the point that Brexit was a risk and a reason for policy to hit the pause button. Not that I am not arguing that those decisions were wrong, just that they miss the point. Yellen has talked of how monetary policies are more connected in some way which is curious because under floating rates monetary policies are supposed to be more independent. But that is getting somewhat closer to the point.  

Structure, impact and policy diffusion- There are several aspects on internationalization that the Fed seems to almost completely ignore. The first (1) is the way in which trade already had changed the structure of the U.S. economy and made it more vulnerable. The strong dollar already makes it hard for the U.S. to produce anything at home for export or even in competition with imports. Technology should be an equal opportunity disruptor but it has disrupted the U.S. more because of its high wages and uncompetitive exchange rate. A Fed rate hike (2) will make all that worse by moving the dollar higher, making it even less competitive. But that is not all it will do, (3) a stronger dollar will drive up the foreign currency cost of all commodities, oil included, and that puts downward pressure on dollar prices. A strong dollar will spread the U.S. rate hike globally; it is globally deflationary at a time that other central banks are trying to jump start inflation. Is that a good idea?  In summary, I am concerned not so much about the Fed hiking rates and about that impact on the US economy as I am concerned about the feedback effects in the international community

And it is  NEVER about just one 25bp rate hike-. However, do not dismiss the prospect of a Fed rate hikes as unimportant at home. Many have asked, “what’s the trouble with one 25bp rate hike?” Well that was December 2015 and you tell me, “what followed?” It was one 25bp rate hike… followed by chaos. Some of that chaos was Fed-generated as Stanley Fischer came forth with his great theory of why the markets were wrong and what the Fed would really do. Stanley will still be eating crow for Thanksgiving this year (…with a wonderful dessert of humble pie) he has so much stocked in his refrigerator after that dead wrong analysis- road-kill crow.

Fed fears make for bad policy moves- And that is just another reason why we should be wary of Fed policy pronouncements or forward guidance: the Fed simply is making it up as it goes along. It has little wisdom to impart, and worse, members have an agenda. They now fear anything from inflation to bubbles. They are not sure which is worse but they are sure that this will end badly and that there is something to fear and nothing like slamming policy into reverse to fix it.  

Not Ptolemy Copernicus or Kepler: the Big Bang radiates! -  Rates are important. Interest rates sit at the center of the international economy’s perceptions. They impact exchange rates. They are links to current and future consumption and investment. They have a role is setting inflation expectations. This is the last place that the Fed needs to be spreading mischief. If it is appropriate for the U.S. to raise rates it should be sure – very sure- because there will be repercussions of a significant nature from abroad, too. Last year’s hike should have made that clear. But I get the sense that the Fed has not learned much from that episode and instead treats it like a one-off event instead of like the endogenous response to the Fed’s own actions that it was.   

A mind is a terrible thing to waste…a waist is a terrible thing to mind…In short I fear that the Fed has grown and learned very little. It still seems to regard its new tool box as adequate, or it is willing to act as though it does. It seems to be willing to be bold with policy and inventive with its forecasts despite the economy’s circumstances and its past lack of forecast ‘suck-cess.’ In the guise of lifting rates to get away from the zero bound threat the Fed is flirting with that very problem and may force us to deal with it very soon instead of just to think about it hypothetically. Rate hikes are important because they are dangerous. Play with fire at your own risk. Ask yourself this…if there were no Fed what would the markets be doing with rates in this environment?  I don’t think that marching higher is a likely result. Do you?         

General central banking rules-  

My bottom line is that the central bank should have reasons for what it does. It should make these reasons known and be true to them. If it expresses a model or point of view its policy enactments need to be consistent with that view. Central bank policy should not cram the square peg of policy change into the round hole of what I said I’d do. Policy should be easy to understand and should not take much hairsplitting to explain why the bank acted as it did. Policies should flow freely out of the central bank’s policy ‘map’. No right hand turns from the left hand lane.     

Monday, July 4, 2016

Draghi’s dilemma delivers depressing

Draghi’s dilemma delivers depressing dilly

Mario Draghi has an idea. Well he has a fragment of an idea. He has a fragment of an idea he would like to turn into a policy initiative someplace.  His idea is that countries should be careful about transmitting distortions overseas from their own policies because they are growing at different speeds. It has some basis in fact but also a vague scatterbrain cast to it like a Saturday Night Live spoof of a real policy maker’s speech. He must have been in an amazing state of denial when he thought up those remarks…here they are:

“In a globalized world, the global policy mix matters—and will likely matter more as our economies become more integrated,” Mr. Draghi said. “The speed with which monetary policy can achieve domestic goals inevitably becomes more dependent on others.”
-- Mario Draghi

Draghi rambled on because he did not want to say directly what he was directly thinking. So he rambled on and tried not say what was really on his mind, that was of course:

Please don’t hurt me!  

He was worried about that villain of international monetary policy, Janet Yellen and her monetary policy plan to hike rates in 2016…to do it as much as four times. Reverberations from that would wrack the EMU economy. But of course a central banker can’t single out a fellow banker so he spoke in these broad generalities, in vague generalities. He tried to make it sound like something academic or rhetorical maybe a theoretic construct.  He tried that but it came out sounding very confused and whiney.  

That is because it was illogical and confused.

Some background…
The G-7 had a go at trying to mutually manipulate exchange rates. They gave that up for the notion that each country would run the best policies it could for its own economy. But now that is not working either. The world trading system is broken and so this is the sort of thing that will happen.  

Now with the ECB’s back against the wall and the Germans holding the key to the lock box of fiscal policy Draghi is without options. He is doing QE and interest rates are negative. He has even appealed for more efficiency. He is afraid that rate hikes in the US could swamp him like a man in a small dingy as a freighter goes by. Please make no wake. But the problem here is not with the potential wake maker. It’s with the guy in the dingy who has no business being there.

The idea that the US is at fault for wanting to hike rates seems preposterous: US inflation is low but climbing and the unemployment rate is quite low. Yet, the fact that the US is the one more at risk because Europe has launched a policy of negative rates is, in fact, much truer but almost never voiced.  Money is pouring into the US pushing rates down at time that they might be better served going up. Why should the needs of the European business cycle take precedence over the needs on the US business cycle in the making of US policy?

Riddle me that one bat man...or super Mario. Where does this idea come from? What is its precedent?

Arguably ECB policies have been much more distortive to global events than US policy. Although with the dollar as a much more powerful reserve unit, and the numeraire for commodity prices, its potential to spread its effects globally takes on greater impact when the Fed moves. Higher U.S. rates would send a deflationary chill across the rest of the world and, in this environment that could be enough to make a difference. I can understand Draghi’s fear. But does he really want to influence the conduct of US policy?

First of all the idea of a US policy move is fanciful –still only hypothetical- while the EMU negative interest rate policy is a reality. Their reality is affecting the US economic situation and the US policy-trade-offs. And so what is the US supposed to do? It is in a different position in its business cycle than Europe. Should policy stand still and let bad stuff happen in the US? Germany is actually a member of the EMU and what is it doing with its own substantial fiscal flexibility? How much is it helping its own cause? (i.e. zero).

It is not clear to me at all what Draghi expects or why except this...

Don’t hurt me, Janet. Please…  

Draghi did not say anything profound. He offered no resolution to any problem. In fact he seems to have made something up… Why does Europe’s policy goal become more dependent on overseas events necessarily? There is a business cycle conflict and we have had countries with business cycles out of sync before. One thing EMU/EU could do is use fiscal policy. But the Germans have put that off limits and because of that the US needs to alter its money policy to fit into Europe’s policy pickle?  Frankly I don’t get it. I don’t see it. And I think it is an example of how fouled up Europe has become. At the European Summit members were gaming Scotland about its EU ambitions to aggravate the U.K. But instead they aggravated Spain that has its own separatist regions to be concerned about and quashed the notion of making an offer to Scotland for its own reasons. These bureaucratic machinations are unbecoming of a major currency bloc. Its leadership is showing their pettiness. The EU should be focused on what it can do to help the ECB instead wasting energy trying to make the UK miserable over Brexit.  

Europe seems to see its problems as exacerbated by what everyone else does. The UK’s Brexit decision has Europeans hopping mad. US monetary policy is causing them problems. Of course, their own inaction in the Middle East allowed ISIS and the migrant problem to get out of hand. Europe wants to blame Greece for being a migrant entry point, but what can Greece do?

At some point Europe has to face the music, take its share of the blame, and choose among the policy options it has. Taking policy options off the table is not a good idea. But the Germans and much of the rest of EMU have different ideas about policy. Germany is engaged in a show of force to make the rest of Europe pay for past fiscal transgressions. Europe is being disciplined by Germany and Draghi wants the US to take off some of the pressure. Meanwhile, European bureaucrats are playing stupid tricks on one another as Italian banks are reeling from a post Brexit stock sell-off. Here again Europe wants the Italians to follow-the EU protocols on bank bailouts. Renzi has all but given them a Bronx cheer on the notion of letting shareholders step up to feel the pain, that - THAT – is not going to happen in Italy. But what will happen is still unclear.

Isn’t that interesting? None of it bodes well for the future. Markets may be settling down in the Brexit as a reality era. But there are still lots of hurdles to go over and it seems few adults to do it. The market turbulence is unlikely to be over soon with leadership like this.  


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