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

One trend toward a Recession: yoy %change of U3 & U6

This graph shows yoy %change for the U-3 and U-6 rates for unemployment. (link)

rec2

They are on a normal trend of a business cycle where they bottom out and then head upwards. When the trend starts to go positive, a recession is imminent. The trend is just now hitting 0% which in the last two business cycles signaled a recession about 3 to 9 months ahead of time.

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Yellen wants to understand effective demand

Janet Yellen gave a speech where she posed 4 questions to economists in general seeking answers… The first question she asked was this…

“The Influence of Demand on Aggregate Supply
The first question I would like to pose concerns the distinction between aggregate supply and aggregate demand: Are there circumstances in which changes in aggregate demand can have an appreciable, persistent effect on aggregate supply?

“Prior to the Great Recession, most economists would probably have answered this question with a qualified “no.” They would have broadly agreed with Robert Solow that economic output over the longer term is primarily driven by supply–the amount of output of goods and services the economy is capable of producing, given its labor and capital resources and existing technologies. Aggregate demand, in contrast, was seen as explaining shorter-term fluctuations around the mostly exogenous supply-determined longer-run trend.”

Janet Yellen is really asking for research into effective demand. She sees a weakness in aggregate demand affecting aggregate supply… or potential output. That is effective demand, but she cannot even use the term effective demand because economists do not understand it.

I have been researching effective demand for 4 years. I have seen really a complete lack of understanding of what effective demand is among economists. It surprises me that Janet Yellen would be calling for research on its dynamics.

She does not really understand effective demand yet though. She goes on in her speech about hysteresis which is a short-term shock which produces a long-run affect. Effective demand is not a short-run shock. It is based on the relative strength of labor share to profit share. A lower labor share sets a lower limit upon potential output. And the drop in labor share is not short-term. It has been constant for years since the crisis.

I have models that can be built on by other researchers. It truly is important for economics to finally understand and define effective demand.

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A glitch in the IS-LM model

Many top economists use the IS-LM model to support low interest rates. The LM curve of the IS-LM model is built upon a model of financial markets.

mdms

In the graph above, money supply has been pushed far to the right to keep interest rates low. The model implies that the money supply would eventually have to be reduced in order to raise interest rates, but the Fed has other ways to raise interest rates.

But there is a glitch to pushing the money supply so far to the right. Low interest rates help unproductive firms stay in business. And we have had low interest rates for years now.

What is the glitch?

There are more unproductive firms doing business… and the economy has become dependent upon them. Not good…

The Wall Street Journal had an article showing how inequality is growing between identical workers, because productivity differences between firms even in the same industry have widened. (link) So there is evidence that low productive firms have become more prevalent.

Creative destruction is an important part of a proper interest rate cycle. Proper interest rates keep low productive firms at lower levels. These low productive firms drag on productivity, wage growth, investment and potential growth. A higher prevalence of unproductive firms supports the case for low interest rates. But the purpose of low interest rates was not to increase unproductive firms but to keep them from crashing too fast. Now they are not being allowed to crash at all. Thus, the glitch.

An efficient economy where resources are allocated to maximize net social benefits must have a proper interest rate cycle for creative destruction.

The Fed missed the interest rate cycle this business cycle, so the prevalence of low productive firms has increased. It will be very difficult to raise interest rates because the economy now depends on these low productive firms.

A rise in interest rates will push many unproductive firms over the edge and start a cascading downward of the economy. The economy has become more sensitive to interest rate hikes due to an increased prevalence of unproductive firms.

Interest rates will have to go through a properly disciplined cycle to get the benefits of creative destruction. Or the unproductive firms will be pushed out anyway as profit rates decrease at the end of this business cycle. Either way, there will be pain for some.

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Is the US at Full Employment?

This is a common question. It is important to know if an economy is at full employment. However, the question is wrong. or at least the way it is answered is wrong…

Full employment is based on employment of labor. However, full employment must consider both labor and capital since they are both resources for production.  You might see a situation where capital reaches full employment before labor. Actually that is what I always see. Then labor becomes more fully employed as capital stops being employed. That is a normal process for a business cycle.

So is the US at full employment? As I see it, the economy reached full employment in the second half of 2014, when capital utilization was optimized.

The bottom line in the graph is the optimization of capital in the economy. When the line reaches zero, a resource is optimized for profits.

The top line is the optimization of labor. The graph shows that capital is always optimized but labor never is. So in essence, capital always reaches full employment but labor does not.

Still, labor and capital need to be taken together to see full employment. The economy has reached full employment considering labor and capital, but employment of labor can still increase even after full employment of capital. The economy is on the other side of full employment going through a subtle cascading process into a contraction.

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Stan Fischer has curve upside-down

Stan Fischer, vice-chairman of the Fed, gave a speech yesterday. (link) He said this…

“As we noted in our statement, we continue to expect that the evolution of the economy will warrant some gradual increases in the federal funds rate over time to achieve and maintain our objectives. That assessment is based on our view that the neutral nominal federal funds rate–that is, the interest rate that is neither expansionary nor contractionary and keeps the economy operating on an even keel–is currently low by historical standards. With the federal funds rate modestly below the neutral rate, the current stance of monetary policy should be viewed as modestly accommodative, which is appropriate to foster further progress toward our objectives. But since monetary policy is only modestly accommodative, there appears little risk of falling behind the curve in the near future, and gradual increases in the federal funds rate will likely be sufficient to get monetary policy to a neutral stance over the next few years.”

I have highlighted the ideas that I will focus on.

Fischer is saying that the current Fed nominal rate is just below the neutral nominal rate. I agree. However, the neutral nominal rate has been falling. It appears he thinks it is rising. Here is a graph explaining what I mean.

updown

The orange line shows the actual Effective Fed rate. The violet line shows my estimate of the neutral nominal rate according to the business profit cycle of effective demand. The graph shows my estimate a bit above the actual Fed rate, but it is trending downward (falling blue arrow).

Fischer also estimates that the neutral rate is a bit above the current Fed rate, so he says that monetary policy is modestly accommodative. However, he believes that the neutral nominal rate is rising (rising red arrow) because he says there is little risk of falling behind the curve.

One of us sees the curve upside-down and I believe it is he. He sees the curve going up, while I see it going down. The business cycle is showing signs of coming to an end. Profits are coming down for over a year. Unemployment is flat-lining. Auto sales have peaked. Year-over-year change in non-farm employment is trending down. There are more signals that the business cycle is decaying into a contraction.

Fischer believes that the Fed rate can rise safely at some point. But from my point of view, any rise in the Fed rate will bump against a falling nominal neutral rate.

The Fed has been behind the curve for years and did not know it, basically because they do not have a grasp of potential GDP. Here is my estimation of the Real output gap against the CBO’s. My estimation is based on comparing an effective labor share number against capacity utilization, which is optimized when the business cycle reaches its peak. Capacity utilization has alreacy been optimized in this business cycle.

output gap

The CBO sees real GDP still about $300 billion below potential. They see the curve still rising. Whereas I see that the output gap has already gone through a normal business cycle peak shown in the rose-highlighted area. I see the output gap already falling toward a contraction. Therefore, I see the curve going down.

The Fed should not raise the Fed rate. Monetary policy will tighten on its own as the business cycle further decays over time.

 

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A leader must see Beauty of the Spirit first

I am from Hawaii. I went to high school with Obama. I was a senior when he was a junior.

In Hawaii, there are people from every culture and race of the world. There is respect for other people and cultures. It is the best training ground to develop appreciation for other cultures and body types.

I can see Hawaii in Obama every time I look at him. It is a respect for people. A “kick back” attitude.

Yet I know that if Trump were to watch the video below, he would not see a beautiful lady, because he looks at her weight, not the love in her eyes and her spirit.

Yet I know that Obama would see beauty in the woman dancing in this video… Life is more beautiful when one sees the diverse beauty of Spirit in people first…

 

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