economics

Felix Salmon points to this chart, which is a head-scratcher:

[F]rom 1985 through about 2002, it was just as common for the S&P earnings yield to be lower than the Treasury yield as it was for the yields to be the other way around…

In 2002, everything changed. The spread between the two jumped up to a very high level and stayed there, all the way through the onset of the financial crisis. This was the Great Moderation.

He can’t figure it out but concludes that it must mean it’s time to buy stocks. I’m too much of a believer in EMH to think that it’s that black-and-white.

Here’s a follow-up that peels away all of the apples-and-oranges issues from comparing government debt to corporate equity.

We’ve elminated a lot of the gap. Now what is probably the answer is becoming clear.

Nick Rowe focuses on the fact that stocks are more ‘real’ and less ‘nominal’ than bonds. I like this explanation a lot. I predict, then, that there should be no gap unless the market misestimates inflation.

So let’s eyeball-shift that graph.

Imagine that blue line nudged up by expected inflation all the way back. There’s probably a reverse gap in the 60s and 70s (high and rising inflation? Check) and a lockstep march downwards during the Great Moderation (predictable disinflation? Check.).

And today? Today we’re staring down the barrel of deflation, folks. No more shift. No gap.

Ever seen this show?

It’s amazing how much money you can save if you 30 hours a week figuring out what corporations are trying to liquidate.  Vitamin water, candy, household toiletries, cans of tuna and dog food… delish.

Do companies view this as an expense? Is there a marginal cost to food that needs to be replaced by incoming inventory? Just-in-time, baby.

This didn’t exist in the Great Depression: one reason why our society is immensely less vulnerable than it has ever been. You can buy $1,500 of groceries for $5 just by clipping coupons? Great Stagnation my ass. That’s not captured by median income measures.

Another fascinating comparison popped up when they showed a couponer living in a New York suburb.  It sounded like much harder work than those living in Ohio, Arizona or Idaho: lower ceilings, lower total coupon limits, more deposits and taxes.

Why is it so easy to live in these smaller communities?

Another trick: everyone has gigantic pantries with “one year’s supply” of just about every piece of crap food you can imagine. Apparently things only tend to go on sale once every six months. Gotta stock up.

Scott Sumner presses his crusade:

The Fed has picked such a bizarre and convoluted strategy that it is difficult for markets to predict which way the economy will go.

And the reference to Ryan Avent quoting Tyler Cowen was good, too:

 Those looking for a positive, pro-inflation sign in the statement could point to the three dissenters, he noted; clearly enough changed in the report to drive the more hawkish members (whatever the merits of their view) to find the shift objectionable. However, he noted that its ambiguity was suggestive of a Fed facing intense pressure from two sides, and wishing to put itself in a position to avoid blame for failure but take credit for success.

Totally confusing. You know we’re in a crisis when the markets go nuts with every fed statement.

Technocrats look at the fed as the holiest of technocratic institutions. It’s a kind of mount Olympus for economists who believe economists deserve a seat at the policy making table.

Unfortunately we’re zero for two in massive crises that have been (or will eventually be) seen as preventable with monetary policy. The fed is a reactionary institution. Like all political institutions.

But what would the fed to do correct/prevent crises? The best framework I’ve come across for figuring this out is Scott Sumner’s holy focus on NGDP.

It makes sense: NGDP is revenue. It’s the most easily measured (and understood) economic variable.

The point is that even though ultimately inflation is the only variable under the mechanical control of the fed, the expectations for inflation are incredibly important in the real economy. In practice, therefore, the fed affects the real economy today by signalling the path of prices tomorrow.

If this path changes for some reason, the economy is thrown into disarray. “Disarray” means investment plummets, unemployment spikes and recession strikes.

Obviously everyone knows about when the path of prices is shifted upwards (70s-80s). But problems are perhaps more serious when it shifts downwards.

That’s what happened in the 30s.  And that’s what’s happening today.

Here is Stephen Gordon:

increased productivity – as it is usually measured – is not a sufficient condition for higher standards of living. It’s not even necessary. For instance, the post-2001 fall in Canadian productivity is simply a mathematical artifact of an income-increasing sectoral reallocation of capital and labour.

And Tyler Cowen comments on the great graph:

Falling TFP in mining reflects Canada’s move from “suck it up with a straw” oil to complex, high cost extraction tar sands projects and the like.  They have moved down this curve a long, long way.

Yet Canada still prospers: someone is willing to pay for all the time and trouble they put into extraction, because the other natural resource options are costlier at the relevant margin.  Another way to make the point is that this graph, and the embedded story of productivity, is very bad news for someone, just not Canada, at least not so far.

I left a comment on MR asking whether this might be a good thing, and here’s my logic:

The cost of resources is going up because they are scarce. Since that’s happening regardless of how the resources get extracted, what’s the problem with increasing costs of extraction? They’re just moving money from the bottom line to the expense line. A socialist dream: surely this is ‘job creation’ at its best!

Now I’m not so sure. Let’s say that in the future, productivity improvements (or supply discoveries, or substitution) reduce the demand for, say, oil, casuing the price to drop. It isn’t going to be able to drop much farther than the cost of this expensive extraction though, which means that we have a new floor to the price of oil. Not good.

More importantly: do we really want primary industries sucking up more and more of our human capital? This is the opposite of innovation. Society is best off when smart people are inventing new things and eliminating inefficiencies, not creating them.

Why don’t we just make the laws more complicated so we can employ more accountants, lawyers and politicians? No thanks.

I’m reminded of the problem with innovation: who wants to be in the industry that is destroyed or automated? What do you do then?

Watch out for ideas that make it look like progress doesn’t need to be a bit painful. They’re seductive bastards.

Wow, what a report.

That link leads to a fantastic summary of the Euro area’s trouble. There is no pleasant scenario on the horizon.

Here is my big-to-small picture summary:

Currency unions are really tough to make work. See this (short) and this (long) from Krugman. There are economic benefits to joining up (lower transaction costs and higher trade/specialization) but, as we’re finding out, a gigantic loss in flexibility in a crisis.

Countries not in a currency union, like Iceland, can just let their currency devalue when they hit the buffers. This drives up the cost of imports (ie inflation), which crushes the real wage and lowers the standard of living. Newly competitive export industries and domestic suppliers pick up the slack and get everything started again. It takes a bit of time and pain, but it’s pretty straightforward.

Members of a currency union can’t do this, so they to relay on other stabilization mechanisms. The two biggies are labor-market integration and fiscal integration. As an example, remember that the USA is a currency union, too, while I borrow Krugman’s analogy.

Let’s say Nevada had a similar crisis to Ireland.

Nevadans that lose their jobs can move to California (um, bad example) or North Dakota. Nevadans speak the same language and share a pretty similar culture, so that’s pretty easy. Bingo, labor market integration. We’ve reduced the unemployment burden in Nevada because the whole state shrinks to fit its economy. Moreover, Nevadans that stay put benefit from a social safety net provided by the feds (medicare, medicaid, unemployment insurance, etc). That’s fiscal integration.

You need fiscal and labor market integration for currency unions to work.

BUT.

The Germans are NEVER going to pay for Greek medicare. Not with Michael Lewis painting evocative pictures of Greeks as free-riding crooks. And change the laws all you like, but different languages make immigration really difficult.

So the Euro was risky all along? Yep. But they also made it worse when they designed the financial system. The article above has a great example: the ECB accepts sovereign debt as collateral for loans and started out not distinguishing among sovereign names. They later changed this to adjust for risk, but “these adjustments were minor”.

What does this mean? Well this means that a bank can buy a bunch of Greek debt (at, say 10%) and park it with the ECB as collateral for a 2%  loan. Big spread.

Greek bonds are therefore much more attractive to institutions that can use this trick. This lowers interest on Greek bonds but concentrates Greek credit risk in the Eurozone. I can only imagine the happy-clappy atmosphere these kind of ridiculous rules were forged in.

So you have a shaky system supercharged with systemic risk that you’re politically welded to. Eurocrats don’t want to admit the whole thing was a mistake and, besides, there are some quirky problems with breaking up the Eurozone:

Let’s say German banks get a bit freaked out about Irish bonds. They sell those bonds to an Irish bank (probably the only market makers left) and take their Euros home. Weirdly, though, the Irish bank doesn’t pay the German bank.

What happens is that German central bank pays the German bank the money and the Irish bank pays the Irish central bank. This means that now the Irish central bank owes the German central bank the money.

That, apparently, is a loan that is not meant to be paid back. What might be seen as a de-linking of the system actually concentrates the credit risk of Ireland with the German government. Now pretend it isn’t Germany but Italy that is suddenly more exposed to Ireland. Systemic risk piling onto systemic risk.

Get the picture?

The Euro was conceived as a way of bringing the stability of the Northern financial systems to the wayward southerners. The Euro, therefore, was really meant to behave just like the USD. And it has. The problem is that the longer everyone sits in the purgatory of politically squeezed half-assed bailouts, the longer the list of problem countries gets.

Eventually, the inmates take over the asylum and the Euro becomes more like the Italian Lira or the Greek Drachma than the German Dmark (more here). The idea I hadn’t heard until today was that maybe Greece and Ireland should stay in the Euro.

It’s Germany that’s the outlier now.

Here’s an Op-Ed polemic trying to rally thinking folks to the idea that the social safety net for the elderly is the problem.

I tend to agree. People on the social dime will simply have to deal with getting a lesser standard of care than they do today. Does that mean that, in the interests of fairness, EVERYONE gets a lesser standard of care? It might. That’s how it works in most other countries.

I’ll be clear about two things from my experience of moving here from Canada:

1. The US health system is hands down a billion times better…
2. if you have decent access.

Pick two. Or none. No other solution is affordable.

The flip side of THIS is that it’s amazing that people are taking so much of their compensation in the form of astronomically expensive health insurance (by global standards).

But what’s the end game? What precedent is there in history for democratically disenfranchising a fifth of the population, not to mention the fact that everyone plans on becoming elderly eventually. Ask everyone that had their pensions in Enron stock what they think of the idea of a gigantic negative savings shock later in life.