Relevant and even prescient commentary on news, politics and the economy.

Recessionary signals… (Guest post)

Guest post by Bruce Carman.

He first comments on an article from Jeremy Grantham who says that a coming bubble is likely.

“. . . There are massive reserves of labor in the official unemployment plus room for perhaps a 2% increase in labor participation rates as discouraged workers potentially get drawn into the workforce by steady growth in the economy. There is also lots of room for a pick-up in capital spending that has been uniquely low in this recovery, and I use the word ‘uniquely’ in its old-fashioned sense, for such a slow recovery in capital spending has never, ever occurred before.

“. . . I would be licking my lips at an economy that seems to have enough slack to keep going for a few years.”

(Now Bruce Carman writes…)
I suspect that Grantham does not understand the implications of effective demand. He assumes much more slack in the economy than there likely is.

I infer that he also assumes that the economy won’t experience the risk of recession until after the Fed raises rates and the yield curve inverts. But the yield curve does not invert before recessions and bear markets during debt-deflationary regimes, as in the 1830s-40s, 1880s-90s, 1930s-40s, Japan since 1998, and the US and most of the rest of the world in 2008 to date. Japan has experienced 4 bear markets and 3 recessions since the country’s yield curve last inverted in 1992. The US experienced a similar pattern from 1931 to the early to mid-1950s.

Japan 10-Year JGB and 3-Month Yield Spread 1989

Moreover, the price of oil has accelerated YTD, yoy, and q-q annualized, resulting in CPI accelerating from 1.5% at the end of 2013 to 2.5% YTD and 3.8% q-q annualized for Q2, accelerating to a rate faster than yoy and annualized nominal GDP and reducing q-q annualized real income and wages for Q2 to ~0%. Therefore, we are experiencing a mini-oil shock (by duration so far) to an economy at a much slower secular trend rate of growth, risking no real growth or recessionary conditions most economists do not perceive (not publicly, in any case).

Oil Consumption to Wages

With the secular trend rate of real final sales per capita since 2000 and 2007 having decelerated from 2% to 0.8%, the US economy is much more vulnerable than otherwise to weather, energy, fiscal, and geopolitical shocks that cause periodic or consecutive q-q annualized contractions as occurred in Q1.
Thus, it appears that at the slow trend rate of real final sales/GDP, the US economy cannot withstand an acceleration of price inflation beyond 1.5-2% without stall speed or contraction. This is occurring in the context of the Fed implicitly targeting a 2% inflation rate, whereas some economists propose the wildly misguided policy of the Fed targeting 4-6% inflation to reduce the real interest rate burden from debt service. This would further obliterate real purchasing power of earned income for the bottom 90%.

Real Profits and DPI 10-Quarter

As of the latest data releases for Q2, I have real final sales/GDP in the 2.1-2.5% range q-q annualized for Q2, which is 1.5% yoy, 0.8% yoy per capita, no growth or a slight contraction YTD, and no growth for 3 quarters running for real final sales per capita. This cyclical pattern of deceleration is historically recessionary.

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Complicit in the Horror that is Gaza

The great Yitzhak Rabin has been long forgotten, assassinated by the Israeli ultranationalist, Yigal Amir–a forerunner of the cruel Zionist Netanyahu and the she-devil, Ayled Shaked. But the Zionist hard right would not have risen to power if it had not help from the West. Among those who blindly walk behind the Israeli tanks, the bombers, the gunships that now plow a bloody path through Gaza are The New York Times whose coverage consistently echoes Zionist talking points; the mad Christian right who proudly tour illegal settlements, praying nightly for the Second Coming; Republican and Democratic senators that simply cannot give Israel enough weaponry and take as gospel anything the crazy Zionists say.

What senator or Congressman has raised his or her voice against the settlements? What senator or Congressman objected to the latest Netanyahu claim that the Palestinians are cleverly using the telegenically dead to bulk the body count? What senator, Congressman, President, or Prime Minister or Secretary of State has called such a remark as obscene? Has The New York Times?

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Simon Wren-Lewis’ Car Trouble is actually a Traffic Jam… Get off the highway and take an alternative economic route

http://3.bp.blogspot.com/_jNY_8-aJvLc/TJhfB6oNDGI/AAAAAAAAAyo/RznCaIm35us/s1600/232.jpg

Traffic jam in Beijing, China.

Simon Wren-Lewis writes about the difference between how the neofiscalists and market monetarists view the solution to the world’s economic woes. Basically, neofiscalists are ready to use whatever is necessary. Market monetarists limit themselves to creative monetary policy. He uses a car analogy.

“To understand why I do get annoyed with MM, let me use another car analogy. We are going downhill, and the brakes do not seem to be working properly. I’m sitting in the backseat with a representative of MM. I suggest to the driver that they should keep trying the brake pedal, but they should also put the handbrake on. The person sitting next to me says “That is a terrible idea. The brake pedal should work. Maybe try pressing it in a different way. But do not put on the handbrake. The smell of burning rubber will be terrible. The brake pedal should work, that is what it is designed for, and to do anything else just lets the car manufacturer off the hook”

The car, as it is built, is actually working like it is supplied to work. All the brakes work.The problem with the car is much deeper.

Fiscal and monetary policies are both ineffective against the true problem… which is a declining demand for labor, weak real wages and low labor share.
The problem is that we are all stuck in a traffic jam on the highway. Everyone is going slow. And everyone is trying to get to the same destination. There is a bottleneck slowing down traffic. Our economies have more engine power, but the we are forced to go slow.
Neither the brakes, nor the handbrake solve the problem. The solution is not to stop the car. You are in stop-and-go traffic. Even all the cars around you (other countries) are having the same problem. Even if you managed to stop the car, someone would crash into you from behind.

Neither fiscal spending nor monetary policy can move the car faster when stuck in a traffic jam. Neither will increase the deeper problem of weak labor.

The solution is to get off the highway and take an alternative route… an alternative economic system that cultivates more local ownership of businesses and capital by labor. The people of each country must benefit from the profits of their natural resources. The rich are not sharing the wealth from the natural resources that should belong to the people, not a select few.

  • Labor needs more economic power.
  • Labor needs more capital ownership.
  • Taxes on capital must be raised.
  • Tax evasion by the rich and corporations must be stopped.

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Corporate “inversions” shift the tax burden to us

Corporate “inversions” are back in the news again, as multinational corporations try every “creative” way they can to get out of paying their fair share of taxes for being located in the United States. With inversions, the idea is to pretend to be a foreign company even though it is physically located and the majority of its shareholders are in the U.S.

“What’s that?” you say. At its base, what happens with an inversion is that a U.S. corporation claims that its head office is really in Ireland, the Cayman Islands, Jersey, etc. Originally, all you had to do was say that your headquarters was abroad. Literally.

Now, the rules require you to have at least 20% foreign ownership to make this claim, but companies as diverse as Pfizer, AbbVie, and Walgreen’s are set to run rings around this low hurdle. The basic idea is that you take over a smaller foreign company and pay for it partly with your own company’s stock to give the shareholders of the foreign takeover target at least a 20% ownership stake in your company.

Thus, with pharmaceutical company AbbVie’s takeover of the Irish company Shire (legally incorporated in the even worse tax haven Jersey), Shire’s shareholders will own about 25% of the new company, thereby qualifying to take advantage of the inversion rules. It expects that its effective tax rate will decline from 22.6% in 2013 to 13% in 2016. Yet nothing will actually change in the new company: it will still be headquartered in Chicago, and the overwhelming majority of shareholders will be American.

As David Cay Johnston points out, even some staunch business advocates like Fortune magazine are calling this tax dodge “positively un-American.” Further, as he notes, Walgreen’s wants to still benefit from filling Medicare and Medicaid prescriptions even if it ceases to pay much in U.S. corporate income tax. In other words, it will get all the benefits of being in the U.S., including lucrative government contracts, without paying for the costs of government.

As I told The Fiscal Times, if companies like these get their tax burden reduced, there are only three possible reactions that can occur: someone else (i.e., you and me) will pay more taxes; the government must run a higher deficit; or government programs must be cut. Of course, there is a limitless number of combinations of these three changes that can result, but one or more of them has to happen.

What can we do about this? One obvious answer to to raise the bar for foreign ownership to at least 50%+ to call a company foreign. Even more comprehensive, as reported by Citizens for Tax Justice, would be to continue to consider a company “American” for tax purposes as long as it had “substantial operations” in the United States and was managed from the United States. Furthermore, the Obama Administration has proposed limiting the amount of deductions American companies can take for interest paid on loans “from” their foreign subsidiaries, thereby preventing what is often called “profit stripping.” Another idea, from Senator Bernie Sanders, would be to bar such companies from government contracts.

The whole concept of “inversions” no doubt sounds very arcane to the average person. But one of the bills to rein them in is estimated to raise $20 billion in tax revenue over the next 10 years. The stakes are substantial, so we need to take a minute to wrap our head around it if we want to head off yet another way in which the tax burden is shifted to the middle class.

Cross-posted from Middle Class Political Economist.

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Children from Central America Surge Across Our Border: Congress Must Now Decide Whether to Change the Immigration Law that George W. Bush Signed in 2008

by Maggie Mahar

If you think fertilized eggs are people but refugee kids aren’t, you’re going to have to stop pretending your concerns are religious– Syd’s SoapBox

News reports have been filled with conflicting theories explaining why tens of thousands of unaccompanied children from Honduras, El Salvador and Guatemala, have been streaming into the U.S.  Some observers say that their parents are sending them here, so that they can take advantage of the social services and free education available in the U.S. Others argue that they are not coming here willingly, but that they have been forced to flee gang violence in their home countries that ranges from murder to rape. Still others charge that President Obama’s lax immigration policy has drawn these migrants to the U.S.

Unfortunately many of the reports circulating in the media and the blogosphere are not backed up by evidence. Even worse, the American Immigration Council  (AIC) says, “some are intentionally aimed at derailing the eventual overhaul of our broken immigration system.”

I have been fact-checking those reports for more than two weeks.  Below, a summary of you need to know as we debate this tangled story.

The AIC recently released a report, based on documented interviews with more than 350 children from El Salvador which states that  “crime, gang threats, or violence appear to be the strongest determinants for childrens’ decisions to emigrate.”

Typically, the gangs try to recruit children. If they refuse, they and/or family members are shot.

The United Nations High Commissioner for Refugees (UNHCR) offers charts showing how that in 2012, the murder rate in Honduras in was a whopping 30 percent higher than UN estimates of the civilian casualty rate at the height of the Iraq war. The charts  also reveal that, statistically speaking, Honduras, Guatemala and El Salvador are twice as dangerous for civilians as was Iraq.

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Anchored Perceived Inflation or How Fox News Helped Obama

This will be a vague confused post related to the question of why the great recession didn’t lead to deflation in the USA. From 2003 through 2007 there was low CPI inflation about 2% to 3%. A huge recession, sluggish recovery and gigantic persistent output gap caused inflation to drop into the range from 1% to 3%. Core PCE inflation (the increase in the deflator of personal consumption excluding food and energy) fell from sticking close to 2% to fluctuating in the range of 1% to 2%. The standard low brow backward looking forecasting equation relates the change in inflation to the output gap. It completely failed to fit the data.

There are two candidate explanations for this surprising behavior of inflation. One is that there is strong downward nominal rigidity — it is very hard to convince firms to cut prices and, especially, to convince workers to accept wage cuts. Importantly, in this story, the change in prices or wages matters not the change minus expected inflation. Decades ago, James Tobin noted that the story can explain persistent low positive inflation if there are many sectors with high demand in some causing rising wages and prices and low demand in others causing zero changes.

Another quite different explanation is that expected future inflation has a very important role in wage and price setting and that inflation expectations are anchored. The story is that people persistently expect future inflation of about 3%. This model requires nominal stickiness, but there is nothing special about zero change in dollar wages. This story is strongly supported by the fact that the median respondent in the Michigan University/IPSOS Reuters survey persistently expected future inflation of almost exactly 3% in almost all surveys since mid 2009.

Notably, in period after period a majority of survey participants have been surprised by actual inflation lower than their forecast. This is a new phenomenon, in the past median forecasts weren’t perfect or even optimal given available data, but they weren’t persistently off in the same direction.

Finally, I get to what I want to add. In theoretical macroeconomics it is assumed that recent past inflation is known to all and not a matter of controversy. In the literature on surveys there is increasing discussion of inflation perceptions as well as inflation forecasts. When people are asked how much prices have increased on average over the past year, they give different answers. They don’t repeat the official estimate. It is clear that many people just don’t believe the official numbers.

For non link clickers, I note that I have linked to two Krugman posts separated only by a friday night music post. But Krugman doesn’t link them. In one post cranks insist that official inflation indices understate inflation. In the other workers and employers are assumed to know about past inflation. I think one very appealing explanation of why workers haven’t accepted markedly lower real wages in spite of persistently high unemployment is that workers are convinced that they have accepted markedly lower real wages because of high unemployment.

I am assuming that, like inflation expectations, inflation perceptions have delinked from reality recently. I really really should find data on perceived inflation (which is out there somewhere). I also have to come up with a story for why this happened just in time to save us from deflation.

I give the credit to Fox news. A large fraction of people in the US rely on Fox News (often indirectly as repeated by friends and relatives). They are out of touch with reality — there expectations and perceptions are what Roger Ailes wants them to be. He thinks inflation is bad even though in a depressed economy in the liquidity trap it is good. Therefore Fox News convinces people that inflation has been and will be high. The representative consumer is only partly living in the Fox bubble so perceived and expected inflation are moderate. Then finally actual inflation is low but positive.

It fits the facts which I reported. You decide.

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Labor supply is the Effective Demand limit

ED and labor market 7

Sorry, Krugman and others. This just ain’t going to happen.

More on the labor-market model using labor share. I want to look at productivity to make the case that the labor supply curve is actually the effective demand limit in the model. (link to previous article)
Start with the equation…
labor share = real wage/productivity

We have all seen that over the years, real wages have not kept pace with productivity. OK… we have seen the fall in labor share.
As productivity increases, labor share falls. We move down and to the right on the labor demand curve. More labor is demanded with productivity increases. Labor is relatively cheaper. More productivity would imply more employment from a demand perspective.
Yet what happens on the labor supply side? More productivity will lead to less labor being supplied. Labor is cheaper and some people choose not to supply their labor at a lower price. They may choose to be employers of labor instead.
But there is a flip-side to the labor-market model above. The flip-side is the consumption market. The labor supplied in the model above becomes the consumption demand in the consumption market. Lower labor share becomes lower demand for consumption. The upward sloping labor supply curve reflects the demand constraints from lower labor share. That is the effective demand limit.

For example, let’s say that labor share is dropping and labor demand increases to the right beyond the crossing point of supply and demand. Let’s say that increased employment gives increased production. More employment means more consumption, right? Labor demand would be happy right? Isn’t labor supplying all that the firms desire? And still, more people are being employed. Isn’t this what Krugman, Baker and others want? Don’t they want more employment in spite of the lower labor share? Are they not envisioning an unemployment rate to the right of the labor supply curve? Well, their logic implies that labor share would increase if employment was pushed beyond its natural limit. Well, ok… but the model above shows that as labor share increases, less labor would be demanded and we would return to the crossing point of supply and demand anyway. Thus, there is an effective demand limit upon employment.

In the above model, the labor supply curve is actually the effective demand limit curve.
You will not be able to have a “free-market” situation where labor is supplied to the right of the labor supply curve. Why?
Firms would be producing beyond the capacity of labor to purchase the production. Profit rates would start to drop and firms would back off from hiring the relatively cheaper labor. Production would have to decrease either by reversing productivity gains or by paying higher real wages relative to productivity. (see labor share equation above) Either way you would return to the labor supply curve. A lower unemployment rate would not manifest, unless it was war-time or some forced-labor type economy.
So productivity has its effective demand limit. Krugman and others do not see this yet.

In a related article by Yang Liu, she talks about the higher unemployment and labor shortage in China. She asks the question of how you can have labor shortage and higher unemployment together. Her answer revolves around matching efficiencies. But the model above explains the conundrum too.
China has been pushing productivity to higher and higher levels. Labor share there has fallen tremendously over the years. Basically real wages have not kept up with the productivity gains. No surprise there. So what is going on? As Chinese productivity continues to increase, China is pushing down and to the left on the labor supply curve. Unemployment will tend to increase (at least not decrease). But also you will see more people leaving the labor market. As she says in her article, there is great demand for labor. Well, yes, when labor share is low, labor demand is greater. But there is an effective demand limit in China too. There must also be many firms that are not hiring which balances in the aggregate the firms that want to hire. For all that the Chinese firms would love to have endless cheap labor, they have hit the effective demand limit of their labor supply. Profit rates will decline if they push further. This coincides with the United States currently hitting its own effective demand limit, since the United States is a large part of the Chinese economy.

My view is that China and the United States are going to trip over the effective demand limit. They are simply trying to push employment beyond labor supply’s effective demand limit. They do not see the limit. But with each passing day, they will see it within the next 9 months.

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SEC Commissioner Calls FSOC "Vast Left Wing Conspiracy"

Yves Smith writes:

SEC Commissioner Calls FSOC “Vast Left Wing Conspiracy”

We witnessed a new outburst of Banking Industry Persecution Complex yesterday from SEC Commissioner Michael Piwowar, who was speaking before an assembly of fellow inmates at the American Enterprise Institute. Piwowar has made it clear in previous speeches that he is opposed to provisions of Dodd Frank that call for the designation of systemically important financial institutions known in the trade as SIFIs, or among the laity, TBTF. He’s also tried claiming the Financial Stability Oversight Council is a threat to the SEC’s power. This is ludicrous since the SEC has never been a banking regulator and its influence is vastly less than that of the Fed and Treasury, and even less than that of the FDIC and OCC, which aren’t subject to Congressional appropriations. As former SEC chairman Arthur Levitt wrote in considerable detail in his memoir, Take on the Street, he’d regularly have Congresscritters, particularly Joe Lieberman, threaten to cut the SEC’s budget every time he tried getting serious about regulations. So Piwowar’s claims about the SEC’s power are either disingenuous or unhinged.

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Boomers, Gen X and Y…wealth transfer

The Washington Post   reports:

While the youngest boomers are still in their forties, the generation as a whole is shifting from one of net savers to one of net spenders. And what that leads to is the fact that over the coming decades, wealth is expected to transfer between generations at only an increasing rate.

So by 2018, Generation X and Y, or those folks in their twenties, thirties, and forties, are projected to hold 28 trillion dollars in collective net worth; nearly three times what it was just ten years ago. And those two generations also represent 105 million people, 30% more than the massive baby boomer generation.

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Loser Liberalism

By Dean Baker (2011)

Progressives need a fundamentally new approach to politics. They have been losing not just because conservatives have so much more money and power, but also because they have accepted the conservatives’ framing of political debates. They have accepted a framing where conservatives want market outcomes whereas liberals want the government to intervene to bring about outcomes that they consider fair.

This is not true. Conservatives rely on the government all the time, most importantly in structuring the market in ways that ensure that income flows upwards. The framing that conservatives like the market while liberals like the government puts liberals in the position of seeming to want to tax the winners to help the losers.
This “loser liberalism” is bad policy and horrible politics. Progressives would be better off fighting battles over the structure of markets so that they don’t redistribute income upward. This book describes some of the key areas where progressives can focus their efforts in restructuring market so that more income flows to the bulk of the working population rather than just a small elite.

By releasing The End of Loser Liberalism: Making Markets Progressive under a Creative Commons license and as a free download, Baker walks the walk of one of his key arguments — that copyrights are a form of government intervention in markets that leads to enormous inefficiency, in addition to redistributing income upward. (Hard copies are available for purchase, at cost)

The end of loser liberalism

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