(What’s Left of) Our Economy: Why the Fed is Still (Really) Dovish on Economic Stimulus

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CCP Virus, coronavirus, COVID 19, Employment, Federal Reserve, global financial crisis, Great Recession, interest rates, Jerome Powell, lockdowns, monetary policy, moral hazard, QE, quantitative easing, recovery, stimulus, taper, transitory, Wuhan virus, {What's Left of) Our Economy

Yesterday, I tweeted that the Federal Reserve’s just-published statement on its policy plans looked pretty dovish – that is, signaling a continued determination to keep pouring massive amounts of stimulus into the U.S. economy. Most every other student of the economy worth heeding read exactly the opposite into the message and some related materials it issued – including Chair Jerome Powell’s statement at his subsequent press conference that the central bank could start easing off the accelerator as early as November. (One notable exception:  CNBC’s Steve Liesman.)  

Here’s why I’m right – at least in the most important senses – and why the dovishness I see isn’t great news for the American economy at all over any serious length of time.

The folks reading hawkishness into the Fed’s stance pointed to three main reasons for their conclusion, and I’d be the last person to ignore them. First, the policy statement did declare that “moderation” in the central banks’ bond-buying program, known as “quantitative easing” (QE) “may soon be warranted” if the economy’s progress “continues broadly as expected.” That’s a big change even from the July statement’s analysis:

“Last December, the [Fed] indicated that it would continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage-backed securities by at least $40 billion per month until substantial further progress has been made toward its maximum employment and price stability goals. Since then, the economy has made progress toward these goals, and the [Fed] will continue to assess progress in coming meetings.”

Second, at the press conference, Powell not only hinted at a November start for the so-called “taper” of Fed bond buying.  He added that the process could conclude “around the middle of next year.” So although the change is expected to occur gradually, the Fed is indicating it won’t take forever to accomplish. 

Third, in a regularly issued graphic summary of their (anonymous) future expectations (called the “dot plot”), fully half of these policymakers made clear they anticipated that next year would also see the interest rate they control begin rising. As Powell told the press, taking this step would mean that these Fed officials had seen much more economic progress than that required for the taper of bond purchases they appear ready to begin.

I actually agree that this evidence adds up to more Fed “hawkishness.” But “more” clears only a very low bar for an institution that’s been super-dovish for the better part of the last decade and a half (since it decided to fight the Great Recession following the 2007-08 global financial crisis by opening up the stimulus spigots to an unheard of extent).

In other words, a Fed that for many more months will be continuing to spur growth and employment by purchasing tens of billions of dollars of bonds every month (only less than the current $120 billion) still looks pretty devoted to easy money to me.

At least as important, Powell in particular made clear that the Fed’s expectations for ending what are, after all, measures taken to counter the Covid-induced economic emergency are so fragile that he and his colleagues could change their minds as soon as the current recovery – which has been strong by most measures – veers off track.

It’s true that at the press conference, the Chair stated that all it would take for him to decide that employment was still improving enough to support a prompt beginning of tapering would be a “reasonably good” and “decent” official U.S. jobs report come out next month – not a “knockout, great, super strong” result. (Powell already believes that the nation’s inflation record – the Fed’s other main “taper test” has already been good enough to warrant reducing those bond purchases.)

But aside from questions about how Powell defines “reasonably good,” etc., his remarks show that he (along with his policymaking colleagues, over whom he wields considerable influence) still believes that a single poor jobs report, or similar discouraging development, would suffice to keep the economy on its exact same monumental levels of literal life support even though the patient has long exited the emergency room.

And these exacting standards for merely reducing current stimulus gradually (which, as the Chair himself noted, would still leave its asset holdings “elevated” and “accommodative”) tell me at least that, however well the economy performs, the Fed will be remaining on a super easy-money course pretty much indefinitely.

The one development that could change this picture significantly: a big, sustained takeoff of inflation.

But if Powell’s right (which I believe he is), then the current burst of higher prices results from “transitory” developments peculiar to the dramatic stop-start dynamics created by the pandemic and its policy and behavioral fall-out. Prices, therefore, should start normalizing before too long.

So what’s the problem? First, if the Fed is afraid that the U.S. economy can’t prosper adequately without what are essentially massive government subsidies, that’s a pretty damning indictment of that economy’s ability to generate satisfactory levels of growth and employment and living standards improvements more or less on its own.

Even more important, even if this Fed judgment is wrong, clearly it’s going to keep the stimulus flowing at historically unheard of rates, and historically, anyway, super easy-money has undermined financial stability – and disastrously – by creating what economists call “moral hazard.” That’s the condition in which over-abundant, dirt-cheap resources produce any number of reasons for using these resources foolishly (i.e., unproductively). After all, they drive down the economic penalties for making these mistakes to rock bottom levels by all but eliminating interest costs.

And an economy that uses resources so inefficiently is bound to run into big trouble before too long and suffer punishing and lingering after-effects. If you’re skeptical, think back to that devastating financial crisis and Great Recession – which weren’t so long ago – and to the slowest U.S. recovery in decades that followed. If that’s not persuasive enough, ask yourself why even the easy-money pushers at the Fed are talking about tapering in the first place.

(What’s Left of) Our Economy: New U.S. Figures Show Inflation is Looking More Transitory

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CCP Virus, coronavirus, COVID 19, deflation, Delta variant, Federal Reserve, inflation, interest rates, lockdowns, monetary policy, QE, quantitative easing, recession, recovery, reopening, Wuhan virus, {What's Left of) Our Economy

Normally, a 5.28 percent annual U.S. inflation rate for July reported today by the Labor Department wouldn’t be seen as good news. Ditto a comparable 4.24 increase in prices excluding food and energy (the so-called core rate, which strips out these categories supposedly because they’re so unusually volatile and don’t necessarily reflect the forces influencing prices overall).

Since these times aren’t normal, due to the CCP Virus pandemic, and since they may well not return to normal for quite a while, due to alarm over the latest, highly infectious Delta strain, times may not become normal any time soon, “We’ll take it for now” strikes me as the only reasonable reaction.

In terms of how U.S. leaders, including the Federal Reserve, should react, tentativeness is justified, too. But the new figures add to the evidence that the recent surge in U.S. inflation is likely to be a “transitory” phenomenon (as Fed-speak calls it) that doesn’t warrant any significant monetary policy moves to cool off the economy (like raising interest rates or moderating or reducing the central banks’ monthly bond purchases – the so-calle Quantitative Easing, or QE, program).

As I’ve argued previously (see, e.g. here), the year-on-year numbers actually prove little – because the virus and the recession and curbs on economic activity it prompted weakened prices to such a remarkable degree, and because the relatively quick reopening starting in late spring, 2020, and the historically explosive growth it ignited, generated such strong catch up. Think of a coiled spring getting released.

Skeptical? From February through July, 2020, overall prices in America dropped on net, and such deflation marked core prices from February through June.

That’s why I look instead at the month-to-month price increases this year. And they definitely point to a significant recent slowing inflation by both measures. Here are the sequential numbers for the overall rate reported today (known as the “Consumer Price Index for All Urban Consumers,” or CPI-U for short);

December-January: 0.26 percent

January-February:   0.35 percent

February-March:     0.62 percent

March-April:           0.77 percent

April-May:              0.64 percent

May-June:               0.90 percent

June-July:                0.47 percent

What’s at least as important as recent signs of inflation slowing is the absence of signs of inflation taking off. They matter because expectations of inflation themselves can become major inflation fuel by causing businesses to boost purchases of inputs above normal rates to avoid greater expenses down the road. The resulting spiral effect can be difficult to halt without the Fed literally slamming the brakes on the entire economy and even producing a recession.

Now here are the monthly increases for core inflation:

December-January: 0.03 percent

January-February:   0.10 percent

February-March:     0.34 percent

March-April:           0.92 percent

April-May:              0.74 percent

May-June:               0.88 percent

June-July:               0.33 percent

The pattern isn’t identical to that for overall inflation, but it’s pretty similar.

The other main body of evidence arguing for abnormally high inflation turning out to be temporary has to do with some of the main engines of the recent price increases. As noted in last month’s post, the surge-y June inflation figures were led by products and services like used cars and trucks (up 10.5 percent month-to-month), vehicle rentals (up 5.2 percent), and hotel and motel rates (up 7.9 percent). These results could be traced either to the stop-start nature of the economy during the pandemic period and consequent bottlenecks and shortages, or to the arrival of the vacation season to a nation long afflicted with cabin fever and hoping that the virus was being beaten.

The July monthly price changes for these items? Used vehicle prices inched up a bare 0.2 percent, vehicle rental prices actually sank by 4.6 percent, and hotel and motel room prices cooled to 6.8 percent. Clearly the latter remain high. But airline fares, whose monthly price increases had already fallen from 10.2 percent in April to seven percent in May to 2.7 percent in June became 0.1 percent cheaper in July.

There’s no guarantee of course that the July numbers will continue the inflation-slowdown trend. But the bad news is that the main reason is anything but good. It has to do with the distinct possibility that the rapid Delta-induced increase in CCP Virus cases will keep prompting a return to business restrictions and behavior curbs that will undermine economic growth. In turn, that would greatly complicate business’ efforts to pass on whatever cost increases they’re dealing with.

If this pattern takes hold, the rising price spiral dynamic could shift into reverse, bringing the economy back to the deflationary days of 2020. And even worse – this kind of spiral can be harder to break than inflationary spirals. For in these circumstances, consumers and businesses hold off on many purchases because they believe prices will drop even further – and production and hiring therefore fall off, too.

In addition, if robust growth continues, along with inflation it views as unacceptably high, the Fed could seek to stabilize prices by slamming on those economic brakes.   

For now, though, the July inflation numbers should be seen as encouraging.  They may amount to favors that are small (and transitory themselves), but they’re still worth being grateful for. 

(What’s Left of) Our Economy: Why Investors Shouldn’t Blame U.S. Workers for Inflation

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bonds, budget deficits, Federal Reserve, Financial Crisis, inflation, interest rates, manufacturing, monetary policy, quantitative easing, recession, recovery, stock market, stocks, wage inflation, {What's Left of) Our Economy

Thanks to the U.S. government’s new inflation data, we can cross one often fingered culprit off the list of developments being blamed for the recent turbulence in American, and therefore global, financial markets – wage inflation. For by a crucial indicator, real hourly pay in the United States is not only failing to lead prices upward – it’s been trailing overall inflation recently and indeed has been in recession lately by one commonsense standard.

Of course, market turmoil (like most big developments) springs from several, overlapping reasons. The first is one I discussed last Friday, and which I consider the most important: Investors fear that the Federal Reserve and other world central banks will start tightening monetary policy faster than expected, in order to prevent (more of) the kinds of reckless investments that tend to mushroom when credit is super cheap, and that can often trigger financial crises like the near global meltdown roughly a decade ago. (Happy Anniversary!)

If credit becomes more expensive, then economic growth and corporate profits will struggle to maintain their current rates of increase, and stocks will become less attractive investments, all else equal. In addition, the very increase in interest rates almost certain to result from such central bank “tightening” heightens the appeal of bonds and dims that of equities.

To complicate matters further, another engine of higher rates might be a combination of the great increase in federal budget deficits likely from the new tax cuts proposed by the Trump administration and passed by Congress, and the big-spending budget deal reached by the lawmakers and the President. The consequent budget gap will boost federal borrowing needs (and all else equal, push up the rates Washington will need to pay lenders for all this new debt) at a time when the U.S. central bank has started selling the ginormous amount of government bonds it’s been purchasing and holding since late 2008 (a practice called “quantitative easing) in order to halt the Great Recession and speed up recovery . This version of tightening – which also stems from financial stability concerns – will raise the supply of bonds even further.

The second reason for the turmoil is investor concern that rising inflation will spur central banks to raise rates regardless of the above financial stability concerns – because excessive inflation can produce its own economic disaster. And in fact, the proximate cause of the current bout of market instability seems to be those very inflation fears, and in particular, the possibility of wage inflation.

Higher compensation costs could deal their own blow to stock prices by reducing corporate profits; or by sending upward price pressures rippling throughout the entire economy (as companies tried to pass higher costs on to their customers either elsewhere in the business world or in consumer ranks); or through some combination of the two. (Interestingly, the chances seem pretty low that companies could absorb higher wages through greater efficiency, as productivity improvement has been very slow at best recently.)

So that’s why today’s widely anticipated (to put it mildly) U.S. government inflation data is so important. The inflation figures were somewhat “hotter” than most investors were predicting. But it couldn’t be clearer that wage inflation has nothing to do with these higher prices.

The numbers that most observers – whether investors or not – are looking at are the year-on-year numbers, and they do seem to signal some wage inflation. From January, 2017 to last month, the Labor Department’s headline reading showed a 2.14 percent rise in prices nationwide, and a 1.85 percent increase in “core” prices (which stripped out from the headline food and energy prices because they’re considered so volatile in the short-term that they can generate readings regarded as somewhat misleading).

During that same year, wages adjusted for inflation for the overall private sector were up 0.75 percent – which means they rose faster than overall prices. Moreover, between previous Januarys, real wages actually declined fractionally (by 0.09 percent). So in principle, investors (and other economy watchers) have reasons to be nervous about wage inflation.

But a more recent time frame tells a very different story. For since last May, private sector wages have been down on net. Although the cumulative decline is only 0.19 percent, this means that on a technical basis, real wages are in recession. (I feel justified in using this term because when economists talk about growth, a decline for two consecutive quarters is defined as a recession. So a six-month cumulative downturn seems close enough.) Indeed, more accurately, real wages are still in recession, since this development was apparent last month, too.

And the latest month-to-month figures indicate that real wage pressure is weakening, not strengthening. From December to January alone, they dropped by 0.19 percent, after rising by that amount from November to December.

The picture looks even grimmer when you go back to the start of the current economic recovery – in mid-2009. Since then, real private sector wages have risen by only 4.07 percent. And that’s over more than eight years!

But private sector real wages are practically torrid when they’re compared with inflation-adjusted pay in manufacturing. Such compensation has been in technical recession for two full years, as it’s fallen by 0.09 percent since January, 2016. On a monthly basis, after-inflation manufacturing pay plummeted by 0.46 percent in January, its worst such performance since August’s 0.64 percent tumble. At least the December figure was revised up – though only from a 0.09 percent dip to a 0.09 percent increase.

Over the current economic recovery’s eight-plus years, real manufacturing wages have risen by a mere 0.37 percent – less than a tenth as fast as those of the private sector overall.

Yet although inflation – and especially wage inflation – doesn’t seem to warrant a quicker pace of Federal Reserve interest rate hikes (or even the current, “gradual” pace), a case can still be made for tightening on a financial stability basis. And those massive federal deficits, which will need to be funded by equally massive increases in bond supplies, seem here to stay for many years. So as has been the case for so long, assuming these moves do slow U.S. economic growth, American workers appear certain to pay many of the costs for disastrous policy mistakes they never made.

(What’s Left of) Our Economy: Big New Signs of Re-Bubble-Ization

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2016 elections, Allison Schrager, auto loans, balance sheets, Ben Bernanke, Bloomberg, bubbles, bubbles Federal Reserve, credit, credit cards, debt, Financial Crisis, Fox Business Debate, Goldman Sachs, housing, interest rates, leverage, loans, Matt Phillips, mortgages, quantitative easing, Quartz, revolving credit, Tracy Alloway, zero interest rate policy, ZIRP, {What's Left of) Our Economy

One of the more praiseworthy features of the Fox Business Republican debate was the discussion of the last mega-financial crisis and how to prevent a repeat. Although at their debate on CNN the Democratic presidential candidates were quizzed on the bubble and its bursting and possible remedies, the Milwaukee event marked the first time these subjects came up for the Republicans.

Better late than never, but that’s pretty strange given that the last bubbles inflated and the crisis broke out on the GOP’s watch. In fact, it’s downright disturbing. For a new meltdown remains by far the greatest economic threat to America’s future due to the Federal Reserve’s overly easy money policies – despite the latest reassurances from former Fed Chair Ben Bernanke that such warnings are ludicrous. Maybe not so coincidentally, two important new signs of re-bubble-ization have just appeared.

The first was reported by Quartz’s Matt Phillips, who pointed out that the Federal Reserve’s latest figures on Americans’ borrowing behavior showed that consumers in September took out an all-time record $28.9 billion in new loans in September. In the process, they broke a record set 14 years ago, and increased their credit outstanding by the greatest percentage since 1943 – when these records started to be kept. And even if you adjust for inflation, household borrowing is at lofty levels historically.

Many economists view such increases as a bullish economic sign – signaling that Americans are so confident about their future prospects (and repayment potential) that they’re willing to take on more debt. That may be true, but the data on wages and incomes strongly indicate that this confidence is really overconfidence. And if interest rates really are going to be raised by the Federal Reserve, even gradually, this overconfidence may be tomfoolery.

Also not so bullish – the makeup of these new loans. As economist Allison Schrager has sagely pointed out, not all borrowing decisions are created equal, even for individuals with comparable incomes. Some, like student loans, are arguably sensible investments in one’s own human capital and potential (though signs of diminished returns from a college education seem to be popping up everywhere). Others, like mortgages, are arguably sensible investments in an asset that could well appreciate in value (though the inflation and bursting of the housing bubble should have taught everyone that real estate is no longer a sure thing). And still other loans simply finance consumption – which lacks any capacity to increase one’s wealth.

Unfortunately, much of the September surge in consumer borrowing was in auto and credit card debt – which won’t bring any financial benefits.

The second sign of reb-bubble-ization was reported by Bloomberg News’ Tracy Alloway, who covered a Goldman Sachs study showing that leverage levels in Corporate America are at their highest levels in a decade – during the bubble years. In other words, thanks largely to the super-easy monetary policy pursued by the Federal Reserve since the crisis peaked, even though corporate profits have surged to new records, American business has gone on such a frantic shopping spree that its debt load has grown much faster. Indeed, according to Goldman Sachs, these debts are now at twice the levels they hit in the pre-crisis era.

Just as with consumers, rising interest rates could wreak havoc with the balance sheets of U.S. companies. And just as with consumers, relatively little of this borrowing is being devoted to strengthening these firms in what might be called the old-fashioned way – i.e., through the development of new products and services. Instead, much of this new debt has been used to fund mergers and acquisitions, and stock buybacks.

The Fox Business debate, however, does deserve criticism in one sense. It followed an entirely conventional course in focusing on crisis-proofing American finance by improving Wall Street regulation. Certainly such improvement has been warranted. But the financial crisis was rooted in weaknesses in the real economy. Until presidential candidates start presenting realistic plans for fostering more good jobs and the incomes they generate, and for spurring more production and the earnings they generate – which would reduce the need for binge borrowing in the first place – a new financial crisis looks much more like a matter of “when,” not “if.”

(What’s Left of) Our Economy: New Data Showing the Fed Really has Worsened Inequality

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asset prices, Bank of America, Ben Bernanke, bubbles, Federal Reserve, finance, housing, inequality, interest rates, Janet Yellen, QE, quantitative easing, recovery, stocks, Wall Street, zero interest rate policy, ZIRP, {What's Left of) Our Economy

Here’s a shock! A study claiming that the Federal Reserve’s historically unprecedented easy money policies have supercharged Wall Street (and the rich) and left Main Street (and the rest) in the dust! And it comes from Wall Street!

The debate over how the central bank’s zero interest rate policy (ZIRP) and quantitative easing bond-buying program (QE) has impacted inequality in America has been just as heated as the debate over how these decisions have impacted economic growth and the prospects for recreating real national prosperity.

The critics charge that easy money has greatly widened the rich-poor gap, largely by boosting incentives to buy and own stocks, and thereby fueling a long, powerful bull market that has overwhelmingly benefited the wealthy because they dominate stock ownership.

The mainstream Fed position was stated by Chair Janet Yellen at the September press conference following the decision to keep interest rates on hold:

“It is true that interest rates affect asset prices, but they have a complex effect through balance sheets, through liabilities and assets. To me, the main thing that an accommodative monetary policy does is put people back to work. And since income inequality is surely exacerbated by a high—having high unemployment and a weak job market that has the most profound negative effects on the most vulnerable individuals, to me, putting people back to work and seeing a strengthening of the labor market that has a disproportionately favorable effect on vulnerable portions of our population, that’s not something that increases income inequality.”

Her predecessor, Ben Bernanke, has made similar points, albeit with more reservations.

A new study from Bank of America, however, contains some data strongly indicating that the Fed’s critics deserve to win this clash hands down. For example, the B of A researchers examined the fate of various possible uses of $100 since the Fed began massively supporting the U.S. economy after the collapse of Lehman Brothers in the fall of 2008. The main findings? A $100 dollar investment in a standard stock and bond portfolio during this time would have more than doubled in value. But a $100 dollar wage would be worth only 14 percent more.

The same methodology also reveals that the financial system is channeling much more credit to the wealthy than to the rest. Thus for every $100 they raised at the start of 2010, venture capital and private equity funds are now raising $275. But for every $100 of mortgage credit extended in America since then, just $61 is being loaned and accepted today. And prime real estate in the nation has appreciated in value more than ten times as much as all U.S. residential real estate.

These results (and others in the study) hardly end the debate over the Fed and inequality. Bernanke and Yellen still make powerful “counterfactual”-based arguments – i.e., claiming that as bad as the situation is now, it would be even worse had the central bank not acted so decisively. And B of A’s possible motives need to be noted. Generally speaking, the financial sector has been campaigning strongly for a Fed rate hike because rock bottom interest rates have greatly reduced the profitability of lending.  (In that respect, this report may not be such a shock.)

But the B of A study should greatly increase the burden on the Fed to demonstrate that its monetary policies haven’t been little more than a boondoggle for the nation’s upper classes – not to mention a flop in and possibly an obstacle to restoring genuine economic health.

(What’s Left of) Our Economy: A Gathering Storm?

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Alan Greenspan, bottom line growth, bubbles, China, commodities, currency, currency wars, devaluation, emerging markets, executive compensation, Federal Reserve, Financial Crisis, free trade agreements, George W. Bush, infrastructure, interest rates, Janet Yellen, mergers and acquisitions, Obama, productivity, profits, quantitative easing, recovery, secular stagnation, stimulus, stock buybacks, stock markets, stocks, top line growth, Trade, valuations, yuan, {What's Left of) Our Economy

The wild swings of stock markets around the world today should caution anyone against reading too much into recent global financial turmoil. As should be obvious to everyone – but is so easy to forget – these stock market declines are anything but the first that have been seen, and they’re anything but the worst that have been seen. The same goes for the economic situation in China and elsewhere – which matters much more.

But although this clearly is no end-of-the-world moment or even close, the latest news is a warning that the dangerous weaknesses that plunged the world into genuinely terrifying financial crisis and then savage recession just seven years ago have only been papered over, and have begun worsening again. More seriously, the United States and the rest of the world look much less capable of resisting powerful downdrafts.

Just to review very quickly, as I see it, the last crisis resulted fundamentally not from failures to regulate Wall Street adequately, the housing bubble, or any largely financial conditions. These were simply symptoms of mounting weaknesses in America’s real economy stemming largely from disastrously shortsighted trade policies. Both major parties became so enamored with offshoring-friendly trade deals and other policies that they sent overseas a critical mass of the U.S. productive base, and therefore a critical mass of the income-earning opportunities available to middle- and working-class families.

The George W. Bush administration, the Congress, and the Federal Reserve under then-Chairman Alan Greenspan could have reversed or even slowed this trade policy approach in order to restore these crucial domestic sources of income- and wealth-creation. Instead, they decided to double down on the offshoring. But to enable consumers (who are after all voters) to preserve their living standards, they decided to create then-unprecedented amounts of easy money, which made possible substituting borrowings (typically based on the bubble-ized home prices) for inadequate paychecks. Until that bubble’s inevitable bursting, the results were widely praised as having produced an economy whose “fundamentals” were “strong.“

Once the crisis struck, the Fed and other major world central banks have sought to reestablish and preserve national and global economic momentum through yet greater money printing and thus credit-creation. National governments in the United States (during President Obama’s first year in office) and especially in China lent a big hand through stimulus programs aimed at creating new government-supported demand for goods and services, and therefore for workers.

Seven years later, the results are in, and it’s fair to say that they have produced growth and employment levels that keep lagging historical standards not only in the United States, but everywhere. In fact, largely because the Fed so quickly and energetically capitalized on its massive credit-creation powers, America is a conspicuous out-performer. But as I’ve also pointed out, the makeup of the U.S. economy still strongly resembles that of the housing- and consumption-heavy bubble decade, which is why a more compelling description of America’s situation is not “ho-hum recovery” but “secular stagnation.” This concept, popularized by former Clinton-era Treasury Secretary and Obama chief economic adviser Larry Summers, holds that the nation has lost so much productive oomph that it’s forced to rely on Fed-created bubbles for whatever growth it can muster – and thus to run the ongoing risks of bubble-bursting as well.

Something, though, has clearly changed in recent weeks. The one-word description is “China” but the real answer is of course much more complicated, and looks to be a function of a seemingly fatal flaw of global easy-money policies: They’ve fostered way too little productive, growth-boosting investment, and way too much mal-investment. The latter has barely kept growth in positive territory but that’s gifted Wall Street and executives at big publicly traded companies with huge windfalls thanks to a (so far) mutually reinforcing cycle of share buybacks and rising stock prices that has supercharged their largely stock price-based pay. Other uses for cash and credit that have seemed more tempting than servicing economically fragile and in many cases still-cautious American consumers included buying up other companies and, mainly for Wall Street, simply parking the money at the Fed, where big finance firms could earn a bit of interest on trillions of dollars for doing absolutely nothing.

But still other distorted investment choices have included so-called emerging markets. In those lower income countries, higher levels of risk brought attractive levels of return, but investors (and not just financiers) were also impressed with relatively high growth rates. And that’s where much of the latest round of troubles is rooted.

Several big and chronic weaknesses and vulnerabilities of these countries – including China – were largely overlooked. First, because incomes were comparatively low, these countries were never able to grow mainly by turning out goods and services for their own populations. Growing fast enough to spur significant economic progress required finding markets “where the money is,” which meant abroad generally and disproportionately in the United States. When growth in the United States merely kept slogging along, many of the new factories that were built with American consumers in mind began looking awfully risky.

Just as bad, many of these emerging market countries themselves got greedy. Their governments and central banks took advantage of low global interest rates by trying to juice extra growth and rising incomes by offering easy credit to their consumers, home-builders, and other businesses, too. But they weren’t able to borrow sufficiently in their own currencies, and many jumped at the chance to take on abundant dollar-denominated debt – including companies that could borrow on their own, without working directly through their governments. Moreover, many of these low-income countries (and some wealthy counterparts, like Australia and Canada) had gotten an added boost from China’s seemingly endless demand for their raw materials, which produced the lion’s share of their growth. But they failed to use earnings from the resulting high commodity prices to diversify their economies and take at least a few eggs out of that basket.

Lately, both China and the Federal Reserve have hit the emerging world with several punishing whammies. China itself continued to depend heavily on exports for its growth, and therefore started slowing itself as global demand continued disappointing. Its performance was additionally undermined by a decision to let permit the yuan to strengthen, in order to win it reserve currency status and greater long-term economic independence.

Beijing had also been trying to subsidize more growth led by domestic demand. But as with other third world countries, because Chinese incomes remain so low even after impressive pay raises, massive amounts of stimulus ranging from infrastructure and housing investment to (most recently) stock market manipulation did more to saddle that country with immense debts than to keep growth and job-creation at levels that were both economically acceptable, and politically essential – i.e., strong enough to keep the masses reasonably happy.

If official data is close to accurate (hardly a certainty), China’s growth rate is still world-class. But even its recent decline from previous blistering levels clearly has been enough to ravage global demand for fuels, industrial metals, and foodstuffs alike – and in turn the economic prospects of the commodity producers. Since the economic prospects of these erstwhile johnny-one-note high-riders began worsening so markedly, foreign investors began pulling money out, putting downward pressure on their currencies, and consequently on their ability to import – including from the United States. At the same time, China’s own recent yuan devaluation deepened this predicament – by further diminishing the PRC’s own purchasing power, and by reducing the price competitiveness of all the finished goods that the commodity producers and their more manufacturing-oriented third world counterparts needed to sell.

If anything, the Fed’s impact on the developing world has been still more destructive. Like the United States, much and even most of its recent growth has depended on artificially cheap credit. But unlike the United States, it can’t borrow in its own currencies. As a result, these countries are exposed to exchange-rate risk (created mainly by the rising dollar) as well as to interest rate risk (which can be created not only by the actual Fed interest rate hike that Chairman Janet Yellen and colleagues have been promising, but by a perception of impending hikes that reduces the third world’s creditworthiness and thus their access to affordable new money.

The real U.S. economy is more than capable of staying relatively unscathed by this global turmoil. For despite the best efforts of American leaders, it’s still less reliant on trade, foreign investment, and the well-being of the rest of the world than practically any other economy. U.S. stock markets, by contrast, could be in for greater trouble, which could be the single most important reason for their recent drop (keeping in mind that their levels are always determined by a great variety of long and short-term influences).

The reason? Among the major props for stocks during the current feeble U.S. recovery has been American companies’ remarkable ability to grow profits despite the real economy’s woes. As widely noted, much of this growth has been on the bottom line – resulting from greater efficiencies rather than better revenues. Human ingenuity’s power should never be underestimated, but by the same token, it’s hard to believe that infinite amounts of blood can be drawn from that stone. Indeed, faltering recent American productivity performance strongly indicates that diminishing returns are in store for these efforts. Emerging markets, with their historically high growth rates and gargantuan populations, have long been viewed as business’ best future hope for accelerated top line growth, and so far they’ve performed well enough to justify considerable confidence.

This latest set of emerging market troubles, including China’s, signals that this ace in the hole really isn’t – which understandably raises questions about whether current stock valuations can be sustained. As usual, please take all forecasting efforts, including mine, with a big boulder of salt. But it seems to me at least conceivable that, just as Wall Street has for years comforted itself by observing that “the stock market is not the economy,” unless Washington screws up royally, Main Street will start becoming grateful for this divide.

But that doesn’t mean that a healthy speed up in the recovery is in sight. Speculation has abounded lately that the Fed might not only postpone those interest rate hikes but need to launch another round of bond-buying – i.e. “quantitative easing.” Yet why a new influx of easy money would generate more sustainable growth than its predecessors isn’t at all apparent.  Washington could return to greatly increased deficit spending, but with so much of U.S. consumer and business demand being satisfied by imports, and with foreign currency devaluations likely to continue, the growth and employment benefits seem more certain than ever to leak overseas.  In principle, this new spending could be targeted on domestic infrastructure, but however popular this idea has been in Washington, it hasn’t yet been popular enough to produce enacted programs, and the intensifying presidential cycle could well turn into a new obstacle.

What about tariffs on imports, which could spur growth by cutting the trade deficit – and without budget-busting tax cuts or stimulus programs? As usual, they’re completely off the table. Indeed, new trade agreements, and therefore higher deficits and even slower growth, appear to be next on that front – though perhaps not until both Democrats and Republicans are safely past the next election.

That leaves fostering an unhealthy speed up in the recovery – kicking the can down the road yet again secular stagnation-style, for the usual unspecified reasons expecting meaningfully different results, and acting surprised when crisis clouds begin gathering anew.        

 

(What’s Left of) Our Economy: Why China’s Devaluation is a Huge, and Very Dangerous, Deal

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2016 elections, Bernie Sanders, bubbles, China, Congress, currency, currency manipulation, debt, Democrats, devaluation, Donald Trump, exchange rates, export-led growth, exports, Federal Reserve, Financial Crisis, Global Imbalances, Hillary Clinton, Janet Yellen, Obama, protectionism, QE, quantitative easing, Republicans, TPP, Trade, Trans-Pacific Partnership, yuan, ZIRP, {What's Left of) Our Economy

China’s de facto currency devaluation last night has sent a vitally important message to the President Obama and his trade policy advisers, to a Congress that has just endorsed his strategy for handling currency issues in the proposed Pacific Rim trade deal, and to presidential contenders in both major parties. Their reactions will go far toward determining whether China’s renewed exchange-rate protectionism will further slow the already sluggish American and global economic recoveries, or worse, generate more central bank stimulus that further addicts the nation and world to unhealthy, credit-fueled growth. Indeed, downplaying and coddling a weaker yuan – which could well be cheapened further – may further widen the kinds of international economic and financial imbalances that set the stage for the last global financial crisis.

Constructively dealing with Beijing’s gambit will require correctly understanding its origins and likely effects. This latest example of currency manipulation is not mainly a Chinese attempt to regain competitiveness following the yuan’s rising exchange rate versus export-oriented Asian rivals. Taiwan, Korea, Japan, and others are also seeing their exports fall due to weakening growth in their major final-consumption markets – which are outside Asia. Indeed, China’s trade surplus year-to-date is up more than 200 percent over 2014’s absolute record level. And China’s move into higher value manufacturing – including production of previously imported components of advanced consumer electronics products it once mainly assembled – is proceeding apace.

Instead, China’s decision greatly to widen the yuan’s trading band reflects a determination to boost its economy by increasing its market share even in a world where growth has stagnated or shifted into reverse. As such it’s a quintessential example of beggar-thy-neighbor trade predation. China’s intentions should also be obvious from the devaluation’s timing – two days after the release of trade figures showing a much worse-than-expected year-on-year drop in July exports. And if Beijing really considered the global economy a win-win proposition, it would have sought to juice its own expansion by stimulating domestic demand yet again, which could have helped both foreign-based producers as well as China-based producers. Devaluation, by contrast, bolsters the latter at the former’s expense.

As a result, contrary to many optimistic interpretations, the sluggish global macro picture does not limit the devaluation’s potential to inflict damage on the United States or the rest of the world. In fact, China’s devaluation decision – which is by no means sure to stop with this initial step – arguably could destabilize global finances more dangerously than during the bubble decade. Then, the lopsided financial flows resulting from China’s massive trade surpluses with the United States provided the critical mass of cheap credit that supercharged the intertwined American housing and consumer sectors – and eventually pushed the entire world to the brink. But then, too, U.S. and global growth were stronger. And the Fed and other central banks hadn’t yet created previously undreamed of floods of credit to stave off disaster.

Yet containing the effect of China’s mercantilism this time, without yet more massive – and even reckless – U.S. debt creation, will require the kind of push-back emphatically rejected so far by President Obama and by most Congressional Republicans. Clearly influenced by multinational company interests whose China production benefits from an artificially cheap yuan and other Chinese export subsidies, America’s Democratic and Republican leaders have opposed both sanctioning currency manipulation either unilaterally or through Mr. Obama’s proposed Trans-Pacific Partnership trade agreement (TPP). But they’ve also received cover from no less than Federal Reserve Chair Janet Yellen. She has endorsed the claim that combating currency manipulation could expose the United States to international retaliation because central bank easing – like the Fed’s quantitative easing (QE) and zero interest rate (ZIRP) policies – puts downward pressure on currencies.

The aforementioned timing of China’s action, however, makes this case much harder to make. So does the now greater likelihood that an American failure to respond on either front could well flash a bright devaluation green light before other trading powers – including present and future TPP countries – thinking of continuing (as in the case of Japan) or embarking on this course. Consequently, expect greater pressure on Congress to reject any TPP emerging from ongoing negotiations that lacks strong, enforceable currency manipulation curbs.

One almost certain source of this pressure – this year’s crop of presidential candidates.

As a long-time trade policy critic, Vermont Senator Bernie Sanders seems sure to weigh in quickly on China’s decision and the TPP, and will find a receptive audience among his Capitol Hill Democratic colleagues. He and other Democrats are also bound to turn up the heat on rival White House hopeful Hillary Clinton, whose trade policy and TPP positions have been more ambiguous. After weeks of refusing to comment on the TPP – whose development she must have shaped as President Obama’s first Secretary of State – Clinton declared that a final deal must “address” currency manipulation “either directly or indirectly.” But although this statement left the presumptive Democratic nominee with lots of wiggle room, it also left this flank highly exposed.

At the same time, Congressional Democrats need to remember that currency manipulation is hardly the only protectionist policy pursued by China at the expense of domestic U.S. businesses and their employees, and that even tough currency measures in the TPP text hardly ensures solving the problem. After all, many current and prospective members (like Japan and China, respectively) have vital interests in ensuring that this option remains available. As a result, whatever the merits, they’ll be highly likely to block American currency actions in the treaty’s dispute resolution mechanism. Legislative currency sanctions supporters on both sides of the aisle, therefore, will need to press just as hard for unilateral U.S. currency responses, too.

The politics on the Republican side are clearer. Front-runner Donald Trump has blasted U.S. trade policy with China as a disaster, and has just gotten a huge supply of fresh ammunition. His GOP White House rivals have all supported these China policies with varying degrees of enthusiasm. Will they start backing off? Will they continuing ignoring the subject, even though China’s trade predation inflicts nearly all of its damage on a private sector they claim to prize? Much will depend on whether conservative talk radio and Fox News decide to give this issue any coverage – and of course on whether Trump can keep focused on this subject and stay out of personal feuds.  If he can, he could display more seriousness on critical China issues than most of the rest of the American political establishment – low bar though that is.   

(What’s Left of) Our Economy: It’s Not Just Inequality

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carried interest, family formation, Federal Reserve, housing, Immigration, inequality, lobbying, median income, millennials, offshoring, private equity, quantitative easing, recession, stock buybacks, tax loopholes, Trade, wages, {What's Left of) Our Economy

Folks at the Social Contract‘s Writers’ Workshop seemed so pleased with my talk on sources of inequality in the U.S. that it seemed worth sharing on RealityChek. Here goes.

Inequality clearly has been a major preoccupation of Americans this year, especially in the chattering classes. The most talked-about economics book in recent memory focused on the subject (Thomas Piketty’s Capital in in the Twenty-First Century). And although some polling evidence indicates that Main Street-ers are more concerned with jumpstarting economic growth than with reducing the rich-poor gap, politicians such as President Obama and likely presidential contender Hillary Clinton have called narrowing the gap a major national priority.

But for all the attention the subject has received, two important points are still generally overlooked. First, inequality is far from America’s leading income-related challenge nowadays. After adjusting for inflation, the median incomes of Americans aren’t simply falling behind those of the top one percent or however the affluent are labeled. They’re falling, period.

In other words, the vast majority of Americans have gotten poorer in absolute terms according to the broadest measure of economic well-being (which includes benefits, rental and investment income, and other earnings as well as wages and salaries). Moreover, this decline didn’t start during the financial crisis and Great Recession. It dates back 25 years. And it’s continued into the recovery. At least as striking, although the nation has suffered worse economic times in its history, never before has such income deterioration lasted so long.

As never before, then, Americans are confronted with the question, “Why is a national economy developed and organized in the first place if not to help most people improve their lives?” An economy in which living standards are falling for the majority for more than two decades is an economy that can only be labeled a failure.

But not only is America’s income problem worse than widely recognized (at least by the powers-that-be). The roots of this problem are more numerous and widespread than commonly supposed. And those inequality engines that have been identified look even stronger, and work in a greater number of ways, than originally thought.

For example, critics of U.S. trade policy have long argued that recent American trade deals and related policy decisions have worsened income inequality by providing too many incentives for businesses to ship lucrative middle class jobs overseas. But it’s increasingly clear that jobs don’t actually need to be exported for these policies to drive down worker incomes. Simply making the offshoring option widely available to employers has surely curbed employees’ wage demands, much less willingness to strike.

Open Borders-style immigration policies, it should be equally clear, have pressured incomes on the bottom rungs of the U.S. economic ladder by flooding their job markets with millions of poorly skilled and educated foreign-born competitors. But such policies also fuel inequality, as I wrote in Fortune this summer, by increasing the demand for public services whose costs the rich can often evade or limit by their ability to exploit tax loopholes.

But the list of inequality engines hardly stops there. For example, even aside from immigration issues, tax loopholes tend to benefit the wealthy disproportionately because they reflect the kind of lobbying power that less wealthy Americans can rarely mobilize. One prime example: how private equity fund partners have persuaded Washington to tax the vast bulk of their earnings at the low long-term capital gains rate rather than at the much higher income rate.

And speaking of American finance, let’s not forget how regulations encourage publicly held companies to use debt to buy back enormous amounts of their own stock. These purchases of course boost stock prices and massively benefit top executives – who often are compensated with stock or paid based on share performance. But they can often harm non-managerial workers because they further divorce corporate financial performance from the vigor of the real economy whose fortunes they once depended on. Thus they tend to undercut business’ actual and perceived stakes in broadly based and shared national prosperity.

Once the equity markets began recovering in spring of 2009, largely due to cost-cutting that super-charged profits despite ongoing economic malaise, CEOs and their boards unquestionably realized that their company’s fates were no longer closely connected to those of their customers. And when investors began worrying about the sustainability of such bottom-line growth, the buyback spree enabled Corporate America to persist with customer- and worker-light strategies.

Macro-economic forces are also helping to weaken wages and incomes for huge percentages of the American people. On top of the recession’s impact on the entire economy, it’s been widely noted that it and the historically weak recovery have taken an especially heavy toll on younger Americans. Forced to postpone family formation and first-time home-buying, the typical millennial will face unprecedented obstacles to amassing the kind of nest egg that has underlay middle class and working class prosperity for decades.

Finally, just as stock buybacks have loosened the relationship between Corporate America and the rest of the economy, the Federal Reserve’s quantitative easing measures have loosened the relationship between those who do and don’t own capital, and inevitably fostered neglect of the latter. The main purpose of the Fed’s bond-buying has been to lower the returns on safe assets like treasury bills to induce investors to abandon them for riskier, higher-yielding assets with greater potential to quicken economic growth.

The growth effects have disappointed even the Fed, it’s just been learned. But QE has been a roaring success in boosting asset prices across the board, and thus immensely enriching those who owned them already or were capable of buying them.

My audience at the Writers’ Workshop consisted mainly of activists who have worked long and hard on the remarkably successful campaign to prevent a dramatic and disastrous loosening of controls over American immigration flows. I ended by congratulating them on their ability to resist the combined forces of Big Business, organized labor, the White House, the leaders of both major political parties, and Big Media – and by telling them how fervently I hoped that their counterparts working to dismantle other engines of income deterioration would get their acts together as effectively.