my doxy

Orthodoxy is my doxy; heterodoxy is your doxy.
--William Warburton

Commentary on politics, finance, and sometimes other tidbits when I can't restrain myself.

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Wednesday, February 11, 2004
 

Why isn't the US at full employment?



No one thinks that the US is currently at full employment--job growth well below population growth, rising long-term unemployment, and stagnant wages would seem to make this clear. But why? When have US monetary and fiscal policy ever been looser than they are now?


I am not certain that anyone knows the answer to this question, but I think we need to look at the usual suspect, "price-stickiness", or perhaps price-stickiness enhanced by other kinds of stickiness.


First, people are well-known to exhibit price-stickiness in the wages they will accept--they have an idea of how much their work is worth, and are not inclined to take jobs which pay significantly less than that. It may be that some people's notion of their value was inflated during the strong economy of the 1995-2000 period. It may be that wages in their sector of the economy are being deflated by domestic or foreign competition, or by technological change. In any case, unless they are in dire straits, people are not likely to quickly take a job which does not meet their expectations, even if their expectations no longer correspond to reality.


Second, people are well-known to exhibit sector-stickiness--an industrial worker is unlikely to consider switching to a health-care job until other industrial options are exhausted. Also, credentials and experience in one sector are likely not easily transferrable to another.


Third, the American population is aging, and very likely is less likely to migrate within the US for employment reasons than in the past--we could call this geographic stickiness. In the 80's we saw the "black tag people" moving from Michigan to Texas for work, because the Michigan economy was very depressed and Texas was booming, but now there don't seem to be any really strong regional job markets in the US, so even if people were so inclined, they might not know where to go.


It may also be that the relative strength in the asset markets (especially the residential property market) may enable people to live without work for longer than has historically been the case.


Now the thing about stickiness arguments is that stickiness isn't expected to last forever--people get retrained, expectations adjust, geographic attachments wane--but there isn't really any way to know how long those things might take. And as the economy keeps shifting, we can expect that people will continue to go through this process. The US does have some programs in place to help, but it seems clear that they are inadequate--I suspect that if widespread concern about trade and outsourcing are not to completely screw up the world economy, the US needs to get a better system of worker assistance in place.


Thursday, June 05, 2003
 

Easings appear to be on schedule



As was expected, the ECB eased a half-point today, and I just read that the T-bill has a 93% chance of a .25 % easing in June priced in.


I suspect there will be more to come.


Wednesday, June 04, 2003
 

Avoid Treasuries



Note: My wife hates it when I give investment advice--I can't help it today.

If you are not a central bank or a trader, buying T-notes or bonds at current quotes is unwise. If you can't stand not owning bonds, buy a short corporate fund--it will stink less. You can buy TIPS if you want--the return isn't too good down here, but it would be safer.


The only way buying T-securities at these prices could be a good idea is if there is deflation or near-deflation for quite a while. That is doubtful (see previous post). Presumably the reason rates have gotten this low is that central banks (including the Fed) are buying them. They don't need to make profits, but I presume you would prefer to. This is not the way.

In the early eighties, when bonds had double-digit yields, people avoided them--the experience of the 70's said they were "certificates of confiscation". Now, most likely, they really will be.

Monday, June 02, 2003
 

Deflation in the US--I think not



There has been a lot of talk in the press about the possibility of a general deflation in the US; even Fed Chairman Greenspan has lent it credence,although as a remote possibility.


It is possible this could happen if nothing was being done about it, but I do not think that is likely.


One of the benefits of the federal government issuing TIPS is that it gives us an easy way of telling what the market thinks inflation is going to be, by looking at the rate spread between regular Treasury securities and their inflation-protected equivalents. Currently, the market seems to be pricing in an inflation rate of 1.5% - 2%, so it appears that market participants do not expect deflation.


The Fed has made it clear that they will use whatever means are necessary to prevent deflation. It is possible that they would not be willing to live with the consequences of those means, but my current presumption is that when the Fed prints a lot of money, and the dollar continues to fall, the Europeans, Japanese, and Chinese will not want their currencies to rise too much against the dollar, and will have to inflate their currencies as well. We have already seen Japan intervene to keep the yen from rising too much, and it would not be surprising to see a ECB rate cut next week. China and much of the rest of Asia is maintain a de facto currency peg to the dollar, and you would probably see increased Asian central bank purchases of US debt used to recycle the excess dollars those countries accumulate.


Such a policy mix is not sustainable, and probably will have various drawbacks in the longer-term, but it is almost certain to prevent deflation.


The strongest objection to this scenario that I am aware of is the fact that Japan has tried to reflate and it hasn't been able to--some would say it is in a liquidity trap where monetary policy is ineffective.


There are three main reasons why I think Japan is different:

  • Japan was first

  • Japanese production and consumption patterns are very different

  • Japanese demographics are very different



  • but going into those details will require a separate post.




    Tuesday, March 18, 2003
     

    WorldCom writedowns--dumb money or victim of technology



    Brad DeLong references the New York Times discussion of WorldCom's recent writedown of $80 billion, including $35 billion in tangible assets. The basic question is: why was capital so badly misallocated?

    Gretchen Morgenson in the Times doesn't appear to have a view on that, except that it was "dumb money". DeLong seems to think it was technological change, specifically the advent of DWDM. It could have been either of these things, but if we look at when WorldCom actually spent the money, we have to lean toward the "dumb money" argument, probably with some fraud thrown in. WorldCom had capital expenditures of over $31 billion from 1998 to 2001. Using Google, we can determine that Ciena complained in early 1998 their orders were going to be weaker because "WorldCom's long-distance capacity deployment currently is ahead of schedule due to aggressive DWDM rollout during 1997." So we can't really believe this was unknown to Worldcom while they were spending that additional $31 billion.

    Of course, we also know that WorldCom charged billions of dollars of current expenses to its capital accounts, so the numbers I am using for capex may be inflated relative to what WorldCom actually bought, but it still appears that the bulk of WorldCom's capital investment was made after they knew about DWDM. Dumb.


    Saturday, January 11, 2003
     

    Milton Friedman's dividend tax alternative



    I don't generally expect to agree with Milton Friedman on policy issues, as our philosophies differ quite a bit, but if this description of his views in Gene Epstein's column on the Bush tax proposal in the January 13 Barron's is correct, I completely agree with him on the following:

    "Milton Friedman describes a much fairer approach: Abolish the corporate income tax, whicle taxing interest income to bondholders at ordinary rates. And require stockholders to pay a personal income tax on their pro rata share of the company's earnings, regardless of how much is paid as dividends and how much retained."

    This is essentially the same way that S corporations are currently taxed. The main argument against this was that accounting for the phantom (reported but necessarily received) income seemed like a pain, but compared to the problems in accounting for how much US corporate tax was paid on the earnings being paid as a dividend or, worse, embedded in a capital gain over an arbitrary number of years, as the Bush proposal would require, it seems like a walk in the park, and has the advantage, as one would expect of a proposal by Prof. Friedman, of being economically defensible.

    It would also make shareholders less willing to let corporations reinvest earnings, which based upon historical observation is probably all to the good. Under the Bush plan and the current system, shareholders have an incentive to prefer corporations keep their excess cash, which they hope will morph into lightly-taxed capital gains. Unfortunately, cash hoards tend to be converted into unsuccessful expansions or dumb acquisitions--what Peter Lynch calls di-worse-ification--as corporate managers tend to prefer increasing the size of their domains to maximizing shareholder returns.


    Sunday, January 05, 2003
     

    Why oil prices aren't so interesting



    As promised in the previous post, a short discussion of why oil prices are less important to the US economy than some people seem to think they are. (I may be referring to people who seem to think that taking over Iraqi oil fields would be an economic boon to the US.).


    The US uses about 20M barrels of oil/day, or about 7300M barrels/yr. This means that a $10 increase in crude price increases the price of crude by $73B. That sounds like a lot of money, and it is. But remember a few things:


    1) About half of that is a transfer inside the US--primarily from the Northeast and drivers to oil companies. It shouldn't be expected to have a major impact on overall economic activity.


    2) High crude prices tend to depress refining margins, so the oil companies tend to give some of it back to consumers.


    3) The US economy is really big. GDP is more than $10000B/yr. The US merchandise trade deficit in 2002 hasn't been released yet, but it was certainly over $400B. The deficit for fuels (mostly oil) was probably about $100B. It isn't plausible that the $10/barrel change of $35B-$40B would make much difference to the US economy.


    4) People may be confused because it used to be more important. In 1978, (not chosen at random) US oil use was almost as high as it is today--about 18.5M barrels/day, but the GDP was only about $2300B. Oil was around $14/bbl, soon to double. That amounted to a $94B hit, or almost 4% of GDP (actually it was a bit less, as consumption declined, but close enough). To get a 4% hit today, you would need more than a $50 change in the price of oil.


    So while lower oil prices would be a net positive for the US (and would deprive certain odious regimes of income, which wouldn't be a bad thing either) it probably wouldn't have an very noticible effect on the US economy, and hence shouldn't be expected to be a major stimulating factor in 2003.


     
    My New Year's blog resolution is to get one article posted each week. That may not happen, but here's one for this week.


    US unemployment will almost certainly rise in 2003.



    I don't have any very profound reason for believing this--it is pretty obvious. However, if it isn't yet obvious to you, you might want to read this.

  • The world economy stinks.

    On the same day that the ISM report was released, a truly awful report was released from Germany, and the rest of Europe doesn't look all that much better. Japan isn't recovering, and although it may start to clean up its sick banks, that isn't going to be over with soon enough to help much with this year. With slack throughout the world, any increased demand in the US will be diffused throughout the world economy, reducing its effect in the US.

  • US data doesn't currently support the idea of a strong recovery this year.

    The best indicators I am aware of for this are published by the Economic Cycles Research Institute. Their leading indicators show us skirting a second recession, but there is nothing there to indicate that we will be doing any kind of rapid growing either.

  • State governments are really hurting.

    Because almost all states have some kind of balanced-budget requirement, it is certain that there will be both net losses of jobs in state employment and reductions in state purchases.

  • Monetary policy is probably pretty much played out.

    Short-term interest rates are already very low, and further cuts could increase the risk of a dollar crash, so further Fed cuts are not to be expected at this time. There are other means, such as buying assets other than the Treasury securities they usually buy to pump money into the system, that the Federal Reserve could resort to, but these are untried and unless there is an actual second recession, I doubt they will be tried this year. If they are tried, it will mean the economy is doing even worse than I am predicting.

  • The Administration stimulus package probably won't be very stimulative.

    The Administration has even decided not to call it a stimulus package--the official term is now a "growth" package, and although it isn't clear exactly what its provisions will be, it looks like a big chunk of it will be spent on dividend tax relief which we can expect to provide essentially no stimulus. There some talk of providing new support to the states, which would help, but it appears to be spread over 10 years, which should pretty much render it meaningless this year. Policies which would be immediately helpful such as a payroll tax reduction seem to have been ruled out.

  • Technology spending doesn't appear ready to pick up

    The Goldman Sachs survey, which has been pretty accurate, showed that corporate executives expect a sharp downturn in technology spending in 2003, presumably because corporate budgetting has been done and they didn't end up with as much money for such purchases as they had expected earlier. It should be noted that this survey correctly picked up the increase in such spending in the 4th quarter.

  • Strong productivity growth isn't helping employment.

    US productivity is growing rapidly, and although that should be good news in the long run, in the short run, it means that a given amount of economic growth produces fewer new jobs than it would otherwise. In the 60's, Okun's Law said that 3% growth was the dividing line between unemployment rising and falling. In 2002, growth appears to have been 3% or more, yet unemployment rose. I expect that it would probably take at least 4% growth in 2003 to stabilize unemployment, and I think we will get less than that.

  • Exogenous shocks are unlikely to be helpful.

    The weather, Korea, Iraq, Venezuela, and al-Qaeda are all more likely to be negative rather than positive factors during 2003, if only because uncertainty tends to restrain spending and investment. The only good thing that is likely to happen is that oil prices may drop somewhat. Despite frequently heard blather to the contrary, oil price fluctuations within their range of the past decade or two (as opposed to oil supply disruptions) are just not that important to most of the US economy anymore. I will try to find the time to do some rough calculations on the impact of oil price reductions in a separate post, but I don't expect even a rapid and successful war in Iraq to make a big difference in the US economy this year.

  • Conclusion: Unemployment is headed up.

    Between the overall economic weakness and the severe state budget problems, I am confident that unemployment will continue to rise for much if not all of 2003, and I'm guessing it will reach 7% by the end of the year.