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

Poor areas of the Dominican Republic

This post is a follow-up to the article by Felix Santana Garcia, The People Lie Helpless. Here are some photos of areas where the poor live in the Dominican Republic. Granted the poverty there is a result of many years of poor economic guidance in terms of marginal social benefits and marginal social costs. Their economy has years of low labor share of income, scarce social safety net programs, high inequality and government corruption.

RD 2Dominican Republic Slum Housing RD 3

If you look close here in the streets near the river, you will see flooding through the houses.

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Recession Detection using Effective Demand limit

I worked with Dwaine Van Vuuren of Recession Alert a few months ago on using the effective demand limit to detect recessions. He said the effective demand limit gave the best detection of a recession he had ever seen. He said he had seen hundreds. I want to show you one graph he came up with.

This graph is a measure of the gap between real GDP and the effective demand limit. I already showed how this limit will signal a recession in a prior post. This graph from Dwain goes deeper.

The graph shows the “Percent change over one year” of the gap between real GDP and the effective demand limit. The gap was made negative (flipped upside down basically) so that the plot would show a recession down below. (recessions shaded in) (graph up to 1stQ-2013)


Link to Graph

The pink line marks the threshold at 1.6%. In every single case, when the plot broke below the pink line, a recession was currently happening or imminent. The bottom red line was added because of the false positive in 1997. My view is that there was distorted data for 1997.

Apparently from Dwaine, this is a very reliable method to detect a recession. He has since used the effective demand limit to make even better methods to detect a recession, but I will leave it to him to share and publish that work.

The basic explanation of this graph is that the year-over-year gap between real GDP and the effective demand limit narrows above 0% in the graph and gets wider below 0%. An economy recovers from a recession over 0%. (note: When the plot goes back down to 0%, it is concluded that the recovery (within the effective demand constraint) is over.)

A recession is signaled after the gap has narrowed to 0% and then starts widening again. Once the y-o-y “rate” of widening surpasses the threshold, 1.6% in graph, a recession is tumbling in.

As of the 1st quarter 2013, we were not in a recession.

Related reading on business cycles

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Why is inflation so low?… asks Menzie Chinn

Menzie Chinn over at Econbrowser posted on low inflation today. His argument is that there is still lots of slack from real GDP being way below potential real GDP and from high unemployment. The idea is that abundant slack depresses prices.

Inflation is generated as slack capacity is utilized. It’s the normal result of labor market forces in an expanding business cycle. Increased money from business expansion progressively chases fewer goods through marginally declining production.

Normally, slack production is balanced by weak liquidity in the hands of consumers. But there is a deeper problem here than Menzie points to. He is pointing to a present situation of slack capacity, but the problem of slack capacity is so much broader and deeper, because liquidity in the hands of consumers is at a much lower level permanently now. So even if you have spare capacity and slack in the economy, inflation would still trend low.

I will explain using this log graph of inflation, unit labor costs and labor share. (1970 to present) The graph is based on the equation

Inflation = unit labor costs/labor share

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Putting money in the hands of people without creating more debt

People need money. That is the purpose of the Fed’s loose monetary policy. But there is no transmission mechanism that gets money into the hands of people.

Money is predominantly created in the economy through loans and credit from banks. Banks have to make loans or extend credit in order for people to have more money, more liquidity, in their hands. Banks simply have not been making enough loans to sectors of the economy where the money will end up in people’s hands.

People could have more money if their wages were increased in real terms. However, real wages are not increasing. Increasing wages is much better than extended credit for consumption demand, because extended credit is an injection into the circular flow of the economy that must be offset by a leakage. In other words, leveraged consumption will eventually be balanced by de-leveraging. Wages are not a debt, but rather a debt paid to labor for having done work. Labor is then free to consume without compromising future wages. On the other hand, extended credit for consumption eventually leads to a leakage from the circular flow because it is a debt that compromises future consumption by labor.

There are efforts to put money in the hands of people by creating local currencies and mutual credit groups. You can watch two video documentaries about this subject. 1) The Money Fix … 2) 97% owned (from Britain). These two videos contain profound truths about money.

And there is also the Basic Income movement. The idea of a basic income or insured living wage goes back to Beatrice Webb who helped found the London School of Economics. The obvious purpose of a Basic Income is to put money in the hands of people so they can survive, eat, clothe themselves and find shelter. The broader purpose of a basic income is to insure a liquidity foundation in the economy. With a stronger insured foundation for liquidity of people in general, the demand constraints in the economy that I and others write about would not be such a problem.

It is pretty clear that banks can be too big too fail and require liquidity to keep the economy alive. But is it understood that people as a group are too big to fail too? People require liquidity too. The economy is dying because people require more liquidity. I support efforts to increase money in the hands of people that do not depend upon creating debt.


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The People Lie Helpless, by Felix Santana Garcia

This is an article published yesterday by an acquaintance of mine who lives in the Dominican Republic, Felix Santana Garcia. He writes a weekly article for an online newspaper there. (I translated the article from Spanish.)

The People Lie Helpless

* The author is a financial manager and university professor. Living in Santo Domingo.

In recent years the Dominican people have lost their courage and spirit of defense to the extent that the authorities will increase costs, expenses and prices, and they do not flinch or react to protect themselves from measures that are adverse to their limited or low family budget. The people act as if anesthetized or masochistic.

It is surprising to see that every week fuel prices increase steadily. All goods and services in one way or another are impacted by these increases and the Dominican people whether healthy or hard-worker don’t raise their voice in protest.

The reason may have to do with the opposition that today is divided in some cases and in others silenced by corrupting money.

While inflation is reported from January to May 2013 at 1.72% and the annualized (May 2012 to May 2013) 4.99%, the people see in the markets that this is not so as the prices of a basket of necessary household items is estimated at more than RD $ 25,000.00. The situation is made worse because in many households with more than four members one person barely works with a net income of only RD $ 7,000.00.

No surprise to anyone to see how people entering the malls and supermarkets come out with one little pillow or perhaps empty handed, except for employees of public and private administrations who come out with lofty and luxurious emoluments and associated accessories.

So far this year, there are no signs of improvement in the pronounced inactivity of the economy that is on the verge of falling into recession, despite the injection of RD $ 20,000 million easing of reserve requirements and RD $ 9,000 million of assumed budget savings.

Nothing has been able to push the car of the Dominican economy and all because of the abysmal fiscal deficit over RD $ 205,000 million. All the while Mr. Leonel Fernández, the intellectual and material author of such deficit, has not been invited to go through the Dominican courts when for less foul or violations of the laws of the United States and Mainland China, a common citizen or a senior official would be processed to even the extreme of the death penalty.

For this, there are many Dominican families who are now deprived of a crust of bread and a mabí (sugar water, popularly known as tennis water) if not a glass of milk to sustain their lives.

Whole families with sorrow, eat something only once a day, others have to go to bed with a grain of salt under the tongue and a glass of water, in some cases non-potable water, living below the poverty line. This includes families who will never even reach the point of balance (equality between income and expenditure before taxes and interest, that is if they have a loan).

While all this happens, employees and high officials and the people related to the Executive party of the government enjoy high incomes and cushy benefits that allow them to eat and drink like kings and enjoy good resorts and travel abroad.

Poverty increases as an expense of correcting irregularities among other public finances over the past years. What a shame that it is the dispossessed people who are paying the costs of a party to which they were not invited and the party has not ended yet.

Neither was it felt in the shops or on public roads on mothers day or fathers day and many other traditional celebrations, as the purchasing power is at a minimum. So people only spend money when they find a bit on a piece banana only to live poorly.

The Defender of the people is not present, as this problem has no office or budget in the government, but neither is the Pro-consumer present as seen previously. It is forbidden to punish violators of the laws who sell expired products at inflated prices.

Definitely the people are defenseless, and perhaps, due to a poor diet, the people have no strength to raise their voice in protest, so that if the living forces, now dead, are not resuscitated as recently seen in Brazil by corruption and the high cost of living, soon the Dominican people will be a nation of the dead, ghosts or zombies.

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Productivity really is demand constrained

To find out if productivity is really demand constrained, let’s look to see what happens when productivity is up against the effective demand limit. We will find that productivity stops and sits for a number of years. First we get the data and build the model.

The data will come from this graph at FRED. The graph shows real GDP (Y), effective demand (E) and total labor hours (L) all indexed to 2005=100.

Prod graph 11
Graph #1

The light orange line is labor hours (nonfarm business sector), which are still at the same level of 15 years ago. Yet, real GDP (blue line) has risen over that time. So the basic story is that we have been more productive with the same labor hours. Here is a graph to show that real GDP used to rise with increased labor hours. However, since the 1990’s, real GDP has increased even though labor hours have not (total plot 1967 to 2013).

Prod graph 12
Graph #2

OK… then how can productivity be demand constrained when real GDP keeps rising in spite of the fact that labor is not increasing their hours to earn more income? In other words, wouldn’t a demand constraint be dependent upon labor hours? Well, no…

Productivity is normally determined by dividing real GDP output (Y) by total labor hours (L).

Productivity = Y / L

Now to show when productivity is constrained by effective demand, we divide effective demand (E) by total labor hours (L) to get the effective demand limit per labor hour. The reason is that what is produced in an hour cannot surpass the hourly effective demand limit. We will check the data to see if this reasoning holds up.

Real hourly effective demand = E / L

(Note: Effective demand has the equation,  E = Y * e/T …………. e = effective labor share, T = TFUR, total factor utilization rate (employment rate * capital utilization)

Real hourly effective demand, E / L = Y / L * e/T

Real hourly effective demand, E / L = productivity * e/T

Real hourly effective demand allows us to compare effective demand with hourly measurements, like productivity, real hourly compensation, capital used per hour, etc.

Now, what happens if we graph productivity (Y/L) against real hourly effective demand (E/L)? (Data in graph is given by quarters from 1967 to 2013.)

Prod graph 13
Graph #3

This graph is a scatter plot using the data from graph #1. Let’s first look at the red line which represents the effective demand limit. A basic principle of effective demand is that real GDP is constrained below effective demand. Thus the red line sets the theoretical effective-demand limit for productivity.

The blue line is how productivity has moved with real hourly effective demand. Productivity is how much production is produced (in real 2005 dollar terms) per hour. Real hourly effective demand is the potential demand per hour for hourly production.  In theory, productivity per hour should be limited by the hourly effective demand limit; Production would not go over the demand constraint. Thus, the plot in graph #3 should stay below the red line. In other words, productivity should stay below the effective demand constraint.

And what do we see in graph #3? The plot of productivity does in fact stay below the effective demand limit (red line). Productivity will bounce along the effective demand limit.

Using effective demand gives a wonderful way to view the behavior of productivity. Normally real GDP is plotted against effective demand. However, productivity moves differently than real GDP because of the variability in labor hours.

Yet, the most interesting part of this graph is how productivity behaves when it is close to the effective demand limit. Productivity stalls for a number of years… 3 to 4 years. We find that during those 3 to 4 years, productivity does not increase much at all. Effective demand will not move much either.

It is impossible to see in the graph, but there are numerous dots all bunched together in the spots where productivity stalls at the effective demand limit. I only count the dots up against the red line. You cannot see them all in the graph. For example, between 1994 and 1997, you see what looks like two dots peaking over the red line. There are actually 16 dots in that little space between those two dots; that is 16 quarters… 4 years of productivity being completely stationary and demand constrained.

If you look at the spot of 1977 to 1979, you will see a line that heads straight toward the effective demand limit and comes straight back. There are in fact 20 dots in that little line that sticks out. That is 20 quarters or 5 years worth of data. In other words, productivity and hourly effective demand moved in a perfectly straight little line to the effective demand limit and back over 5 years. This relationship between productivity and effective demand has never been seen before. It certainly is interesting.

When productivity increases up and toward the left in the graph (meaning hourly effective demand is declining while productivity increases), productivity eventually hits the effective demand limit and stops. Productivity sits against the effective demand limit  for a number of years until the tide turns and effective demand starts to increase. Then productivity can start increasing. In effect, effective demand has to start increasing first in order for productivity to start increasing. Then, hourly effective demand and productivity will increase together moving in the direction of the effective demand limit (red line).

Lots of words to describe a simple process. Let me boil it down. Productivity is often constrained by effective demand.

Let’s look at current data at the end of the plot. We see that productivity has come close to the effective demand limit again and has stalled out in the same spot for 2 years. Productivity itself has stalled for over 3 years. I will state three conclusions…

  1. Productivity is being compressed by the effective demand limit again.
  2. Productivity is not going to be increasing soon unless effective demand reverses its decline.
  3. For those, like Ray Dalio, who say that productivity will increase as the economy recovers, they will be disappointed. The implication is that the economy instead will have to grow upon an increase in credit-fueled consumption.


Other relate posts at Effective Demand blog

Demand determined output: Getting the definition correct

Productivity is Demand Constrained

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Productivity is Demand Constrained

I was watching a video from the World Economic Forum 2013  in Davos, Switzerland. The video is a panel discussion on the subject, “No growth, easy money, the new normal”. The World Economic Forum 2013 took place in January 2013. It is basically a discussion of monetary policy in dealing with the crisis.

In the video (about 20 minute point), Ray Dalio who founded Bridgewater Associates says that future growth will have to be low-debt growth. The issue then becomes productivity and how countries become competitive. The next speaker, Brian Moynihan, CEO of Bank of America, then says that the labor force that an American business employs in the United States is not related to its business prospects due to the nature of globalization. Labor and sales are found globally. In effect, businesses can fulfill their demand and their general business plan globally.

After the 30 minute point, Brian Moynihan says the economic issue is really becoming a demand issue. There is plenty of liquidity within the financial sector, but the demand for production is not there. Ray Dalio then supports that idea by saying that the liquidity will somehow make its way into purchases… purchases of goods and services, equities, gold, you name it.

Ray Dalio (47 minute point) states 3 conditions for a good recovery that “debt doesn’t rise faster than income, that income doesn’t grow faster than productivity and productivity grows at a decent pace”.

Their argument is based on productivity increasing. But productivity is a complicated issue. Even in the United states, productivity has flat-lined for the past 3 years. Let’s look at some of the headwinds using 2 equations for productivity.

Productivity = National income / Total labor hours

We can see that if national income increases, then productivity will increase. But in order for productivity to rise faster than national income, total labor hours must increase but increase slower than national income. Thus economic growth will be productivity-led and not debt-led. This is what Ray Dalio describes.

There is a careful balance here between making the economy more productive with machines and computers, and also employing more labor. The tricky part is that machines and computers are requiring less labor. So certain companies may be more productive with machines, but if this becomes an overall trend, it may be very hard to increase total labor hours enough that growth will not be debt-led.

The second equation for productivity…

Productivity = Real hourly compensation / Labor share

There is a problem here. In order for productivity to increase, real hourly compensation must rise relative to labor share. They can both fall, it is just that real hourly compensation must then fall slower.

Can we even imagine wages and such falling more?… Yes.

At the 3:40 minute point, the panel member from France says that France is going forward with a plan to reduce labor costs by 4% in 2013, 6% in 2014, in order to be more competitive. The panel members generally agree that competitiveness is key to each country moving forward. We can assume that there is pressure to keep labor costs controlled in each country to maintain their competitiveness.

So, by looking at the second equation above, if real hourly compensation falls and productivity is expected to rise, then labor share would have to fall even further. The result would be more profits for corporations. But there is an even more troubling problem. If you lower real compensation, you tend to lower demand. Yet, they already said above that the issue going forward is demand.


OK… let’s hope that real hourly compensation rises at least in the United States. My view is that labor share has already anchored into an effective labor share of 73.4%. So labor share is now a constant. This is based on the following graph…

Monetary polciy 8
Graph #1

The lines come from an equation to analyze the relationship between labor share and the TFUR (labor utilization * capital utilization). The line goes to zero when effective labor share (els) and TFUR are equal.

Reflective Fed rate curve = els*(els-TFUR)/(1+TFUR)

The green line in graph #1 shows that effective labor share was anchored around 80% through all business cycles from 1975 to 2001. Since 2001, the line has shifted to the blue line, which now shows an effective labor share anchor of 73.4%. The point is that labor share is now anchored into the dynamics of the present business cycle and will be hard to shift up or down from here. The reason is competitiveness. As productivity grew, labor share dropped in order for business to stay competitive with real hourly compensation under control.

So, it will be hard to raise labor share due to a need for competitiveness. But then where is the demand going to come from? Ray Dalio (46:20 minute point) says that spending can be in money or credit. He says that if credit picks up, then money, meaning the liquidity in the system, can decrease. Central banks want to decrease the liquidity at some point to prevent inflation. While he says spending is the important thing, he basically says that the spending has to be balanced with the productivity growth rate. However, he also said that national income has to rise faster than debt. So there seems to be a problem in his argument, because he is pointing to the rise in credit/debt as part of the excess liquidity solution, but debt has to grow slower than income growth.

Now, if real hourly compensation has to be controlled for competitiveness, and labor share has already anchored in for this business cycle, then demand will somehow have to be increased with credit. However, as the economy starts to pick up, there will be a rise in some interest rates. We have already seen a rise in mortgage rates. A rise in interest rates related to purchases will be a headwind against demand.

Then, how does effective demand play into this? The problem is that effective demand is already putting a limit on productivity. I have already said above that labor share dropped so that productivity could be competitive by keeping real hourly compensation under control. Yet, there is a limit to how far labor share can drop, because effective demand also drops. And if effective demand drops all the way to real GDP, the economy will come to a screeching halt. Effective demand is already so low that we do have a new normal at a lower level of labor and capital utilization.

So labor share has found a niche to sit in… effective labor share anchoring in at 73.4% or so. The effective demand limit has anchored in. If labor share were to fall more, the economy would screech to a halt. If labor share were to rise, real hourly compensation would have to rise to keep productivity constant or rising. Yet, a rise in real hourly compensation will be difficult in an environment of high unemployment and global competitiveness.

Ray Dalio says that productivity must rise, but the only way to express an increase in productivity is through a rise in real hourly compensation. Labor share is already anchored in. Well then, this will be interesting. How many countries are going to raise their real hourly compensation?

In conclusion, there are many contradictions in what the panel members say. They are hopeful, but… the constraints of demand, credit, productivity, competitiveness and labor compensation are going to be very tricky to work out just right. The economy is in a delicate balance going forward. The question now lies in which countries will respond to social unrest with higher wages. And then how will business respond to maintain their competitiveness?

(Note: Competitiveness means profit maximization for corporations. Higher wages contradict maximum profits. Wages have been set according to the private costs of business, instead of the social costs of labor. Somehow societies will have to find a way to raise wages to a level corresponding to the social cost of labor. Meanwhile both Wal-mart and McDonalds are fighting the living wage.)



HODMRD. Davos 2013 Bloomberg) No Growth, Easy Money The New Normal. 7/18/2013. Retrieved from

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Robert Shiller: Raise taxes on rich if inequality gets worse

Here is a 12 minute video on youtube of an interview from Davos, Switzerland, with Robert Shiller from Yale University.

He says in the video that taxes should be raised on the rich if inequality gets worse. He seems content with the current level of inequality.

He says that economics is not an exact science. We cannot know the future with certainty.

All in all, he seems pretty relaxed about the future of the economy.



BollyWoodEvent. Economics is not exact science Robert J Shiller. 7/24/2013. Retrieved from

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Machines are labor, but they don’t buy gifts

CNBC has a video on youtube about the concern over machines replacing people. They actually touch upon many relevant aspects of the issue… high unemployment, increasing corporate profits, productivity of machines, rising real GDP, stagnating median household incomes, low minimum wages and even social instability.

Replacing people with machines, like paying lower real wages, is a fallacy of composition  It can be more profitable for an individual business to replace people with machines and pay less wages, but if more and more businesses do this, people overall will have less income and less purchasing power to buy the finished goods of production.

Production seeks demand. Demand depends on people getting paid for producing. So even though there may be a balanced trade off in production as utilization of capital rises and utilization of labor falls, production will be progressively limited by weaker demand.

The United States has a demand-constrained economy.  The fact that some people are being replaced by machines is only part of the story. We will explore the subject of macro-economic demand here on Angry Bear blog in future posts.


TheBankNews. The Great Divide Economics of Wall Street. 7/22/2013.



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Investing in the New Normal – interviews from John Mauldin

A quick post about a video that came out on July 17th on youtube. It is a video over one hour long where John Mauldin has a series of interviews with Mohamed El-Erian, David Rosenberg, Barry Ritholtz, John Hussman and Kyle Bass. These economists give their insights into “investing in the New Normal” economy. The New Normal economy grows slower with higher unemployment. They give their insights into where the global economy is going. I am not endorsing any view presented in the video. Yet, the views are being made available for you to evaluate.

However, Barry Ritholtz makes a point about what a recession is for… You have to clean out the inefficient businesses, let the efficient businesses survive by their merit, and start building the economy over again. John Hussman makes the point that the Fed’s monetary policy has been undermining the quality of investment by encouraging speculation. They have a lively and informative discussion.

The interview with Kyle Bass takes place at a level that most people never see in economics and the media. He has the capacity to make economists change their interpretations of reality.

I also want to add this link to a document produced by Kyle Bass, Hayman Capital Management L.P., that was circulated on twitter. Kyle Bass has important insights into Japan and China in this document. I find the insights of Kyle Bass quite intriguing.



Bass, Kyle. Abenomics: Lost in Translation. Scribd. June 5, 2013. Accessed July 21, 2013.

Mauldin, John. John Mauldin’s ‘Investing In The New Normal’ – FULL VERSION. July 17, 2013. Accessed July 22, 2013.


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