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

Trump is kind of punking Ryan

What games is Trump playing with Paul Ryan?

When I worked in a medium security prison as a counselor, we would call this a form of asexual punking. This is when a gang leader puts down a member in front of others so that they kowtow to the authority of the gang leader without question.

Trump wants total loyalty from other republicans and he is going about getting it like a gang leader would.

 

 

 

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Trump puts down mother of crying baby

Trump put down the mother of a crying baby after he said not to worry about it. He said that she didn’t understand and waved her off with his hand.

He also said that the baby was “young, beautiful and healthy… that’s what we like.” What is he referring to in the video? Young women?

Trump is weird…

 

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Trump calls for Khizr Khan’s wife to speak while his wife plagiarizes Michelle Obama

Trump is all twisted up in trying to seem intelligent about Khizr Khan’s wife speaking. He thinks his wife is being submissive to her husband as if somehow that is culturally wrong.

He accused Khizr Khan of not writing his own speech. Yet it turns out that he wrote the speech with his wife. They speak together.

Then we have Trump’s own wife plagiarizing Michelle Obama in her convention speech.

Trump is in no position to say that Khizr Khan’s wife should speak on her own, when his own wife could not.

“It’s a kind of arrogance to be so certain you’re past redemption.” ― Ellis Peters

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Trump’s behavior is Bullying according to stopbullying.gov

The #1 priority in our schools is to stop bullying. Any administrator in our school system, by law, must drop anything and everything that they are doing to deal with a situation of bullying. That is the law.

If Trump becomes president, his bullying behavior will cause bullying to increase in our schools.

Yet the bigger problem is that his bullying will create conflicts nationally and internationally that will lead to serious and lasting problems. That is the result of bullying unless it is stopped.

Below is the definition of bullying from stopbullying.gov. (US Department of Health & Human Services)

Bullying Definition

An unhappy teen boy walks away from bullying girls. Bullying is unwanted, aggressive behavior among school aged children that involves a real or perceived power imbalance. The behavior is repeated, or has the potential to be repeated, over time. Both kids who are bullied and who bully others may have serious, lasting problems.

In order to be considered bullying, the behavior must be aggressive and include:

  • An Imbalance of Power: Kids who bully use their power—such as physical strength, access to embarrassing information, or popularity—to control or harm others. Power imbalances can change over time and in different situations, even if they involve the same people.
  • Repetition: Bullying behaviors happen more than once or have the potential to happen more than once.

Bullying includes actions such as making threats, spreading rumors, attacking someone physically or verbally, and excluding someone from a group on purpose.

Types of Bullying

There are three types of bullying:

  • Verbal bullying is saying or writing mean things. Verbal bullying includes:
    • Teasing
    • Name-calling
    • Inappropriate sexual comments
    • Taunting
    • Threatening to cause harm
  • Social bullying, sometimes referred to as relational bullying, involves hurting someone’s reputation or relationships. Social bullying includes:
    • Leaving someone out on purpose
    • Telling other children not to be friends with someone
    • Spreading rumors about someone
    • Embarrassing someone in public
  • Physical bullying involves hurting a person’s body or possessions. Physical bullying includes:
    • Hitting/kicking/pinching
    • Spitting
    • Tripping/pushing
    • Taking or breaking someone’s things
    • Making mean or rude hand gestures

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“Character Defining Moment” for Trump: Golf Tournament in Mexico

The PGA moved a golf tournament from one of Trump’s courses to Mexico City. Trump was upset. Trump said, “If I become your president, this stuff is all gonna stop.”

It is clear in his immediate reaction to the decision that he plans to use the power of the presidency for his own personal business interests. In Trump’s own words from the video below, “Not good.”

And to say that the golfers should have kidnapping insurance is something that a bully would say to create conflict. He puts down the opposition to create conflict on his terms. Then he works to win the conflict. That is how a bully works.

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A Case for a 3% Inflation Target

There have been calls for a 4% inflation target. But a 3% target would work better. Let me show you why.

I will use this chart that plots net profit rate with core inflation… (quarterly data since 1958!!!)

Net profit rate = Corporate profit rate – nominal interest rate

inf corp8

The plot has hugged and slid along two resistance lines since 1958. Below there is resistance to fall into deflation at the 0% inflation line. To the left is a resistance line for a 0% profit rate over the real cost of money.

Let me explain how that real cost of money boundary is calculated.

  • First… corporate profit rate – nominal interest cost gives net profit rate.
  • Second… When inflation is equal and opposite to the net profit rate, the real profit rate is 0%.

Here is an example…

  • Net profit rate = 5% corporate profit rate – 3% nominal interest rate = 2%

So the profit rate is 2% over the nominal cost of money. But then we make core inflation -2% to take away that net profit rate.

  • Core inflation = -1 * 2% net profit rate = -2%
  • Zero real profit rate = 2% net profit rate + -2% core inflation = 0%

So basically the line with a -1 slope that crosses through the origin of the x and y axes, gives the line where the real profit rate goes to zero %.

ok… back to the graph…

Opposing Forces in the Graph

How might we explain the steadfast movement of the data points along the two resistance lines.

Well, we know that there is a resistance to fall into deflation, and there is resistance by corporations to have negative real profit rates.

How can we view the forces at play?

inf corp6

There are forces to increase profits which try to push the data points away from a 0% real profit rate.

There are forces which counteract the forces to increase profits, namely, labor power, perfect competition and price inertia.

inf corp7

These counterbalancing forces work against the forces by corporations to increase profits for themselves.

So for 58 years, the pattern has been solid!!! The data points moved within a definable range.

Could the data points break out into a new pattern farther away from the resistance lines? I do not think so… It has never happened in 58 years of data. The forces are pushed into a balance in the range defined by the red zone in the graphs.

A 4% Inflation Target?

So what if the Fed tried to have a 4% inflation target, like Paul Krugman advises? The zone of a 4% inflation target would probably be like this…

inf corp9

As the green zone sits at a net profit rate of 0%, we could logically conclude that the nominal cost of money would equal any corporate profit rate as a general rule. So if corporate profit rates get back up to 9% in the next recovery, we would assume a nominal interest cost over 7% so that the forces are balanced at a 4% inflation target.

There would never be a nominal interest rate of 7% if inflation was 4%. It is not going to happen. So then we assume a nominal interest rate of 2% to 4%, which would imply an upper limit on the corporate profit rate in a range of 2% to 4%. So corporate profit rates would have to come down a lot in the next business cycle.

Corporations are going to fight tooth and nail against the 4% inflation target.

What about a 2% inflation target?

inf corp11

Actually a 2% inflation target feeds right into the hands of corporations. They can have high profit rates above 9% and the forces still be balanced along the 0% core inflation line. The Fed helps them by keeping nominal rates near 0% due to the stubborn low levels of inflation which correspond to high net profit rates. Also, higher profit rates lead to lower labor share and lower effective demand.

The forces from corporations to push net profits as far right as possible have succeeded greatly in the last two business cycles. But they have succeeded too well, and the economy is sick because of it. A 2% inflation target has created an environment for this between the forces described above.

A 3% Inflation Target?

inf corp10

A 3% inflation target would be met with  nominal rates from 1% to 3%, which would imply corporate profit rates in a range of 3% to 5%. This is a healthier balance than what we have now. And healthier than a 4% inflation target which implies a monetary policy tending to seem too tight.

It seems more reasonable to have a 3% inflation target. Very high corp. profit rates would be avoided. Lower profit rates would imply higher labor share, which would increase the Effective Demand on the business cycle. Then there would be higher utilization of labor and capital.

The main idea is that a 3% inflation target would better avoid the part of the zone that slides rightward holding inflation rates at stubbornly low levels.  Then the Fed thinks they have to keep nominal rates low to try and raise inflation. But the inflation rate is basically just stuck low in a balance between the forces described above.

A 3% inflation target would lift us out of that low level inflation zone and give us moderate nominal rates. Corporate profit rates would be healthier for the economy as a whole.

Conclusion

So it is a good idea to raise the inflation target. The graphs above suggest that a 2% inflation target is too low, a 4% inflation target is too high, and a 3% inflation target would be more balanced.

The big question is… How do we get out of this rut of low inflation levels? I think the Fed has to raise nominal rates to start bringing down net profit rates, so that corporations feel the need to counteract with the force of inflation (y-axis) to support their profit rates.

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Exponential Decay of Inflation

Yesterday, I wrote about the connection between inflation and corporate profits. (link) I posted this graph. (quarterly data since 1958 to 1st quarter 2016)

inf corp5

The graph shows how inflation drops as net corporate profits rise.

Net corporate profit rate = Corporate profits/GDP – nominal interest rate

The trend line (bright red curving downward) implies an exponential decay of inflation. We have been at the decay extreme since the crisis. Currently the net profit rate has backed off a bit from the extreme to around 6% to 7%.

 

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Inflation & Corporate Profits

Is there a relationship between Inflation and Corporate Profits? I think so. But I do not know of anyone talking about the relationship, so I will.

The point I want to make is that corporations control prices. They set prices. They are not just price-takers. Corporations will change prices with an eye on their profits. In the aggregate, we will see changes in inflation. I will also finish by saying that the Fed feels the Fed rate can rise because firms still have a large profit cushion with which to absorb a rate increase.

Let’s set up the relationship between inflation and corporate profits.

First, see corporate profits as a corporate profit rate. (Fred data)

Corporate profit rate = Corporate profits/GDP

Then, get a nominal interest rate.

Mixed nominal interest rate = 0.56*effective Fed rate + 0.44*10-year treasury rate

To get this equation I optimized the fit of many nominal rates to the analysis, see graph #3 below. It gives the highest R Squared for the exponential trend line in graph #3 below. (rates used were effective Fed rate and treasuries at intervals of 3 months. 1 year, 3 years, 5 years and 10 years.) The treasuries at 3 months, 1 year, 3 years and 5 years dropped out as non-influential. Only the effective Fed rate and the 10-year treasury showed influence with the coefficients in the equation, 0.56 and 0.44 respectively. I used solver in Excel to maximize the fit.

This graph compares the mixed nominal rate with the Fed rate.

inf corp1

Graph #1

I will use the orange line as the mixed nominal rate for the analysis below.

Now that we have a nominal interest rate, we need to get the real interest rate.

Real interest rate = Mixed nominal rate – inflation rate

Inflation rate = CPI without food and energy

I do not use expected inflation. As Krugman & Wells wrote in their Economics book, 2015 edition…

“The expectations of borrowers and lenders about future inflation rates are normally based on recent experience.” page 729

Corporations will borrow money, lend money or simply invest their own money as long as the opportunity cost of money is covered. Of course they seek the best returns, but the opportunity cost must be covered first.

When a corporation invests money, they only need to make more than the cost of the real interest rate, which is the nominal rate minus core inflation. Here is a graph of the difference between the corporate profit rate and the real rate.

inf corp3

Graph #2

Graph #2 shows that there is normally enough of a profit rate for a positive difference in favor of corporations to beat the real rate. The Volcker recession of the 80’s pushed firms to the edge so that they would slow down inflation.

Which brings us to firms controlling inflation.

When firms are pushed against the lower bound of the real rate, they will maintain enough inflation to not fall below the cost of the real rate. Inflation will actually push the real rate farther down. But there are forces that do not like inflation… namely the banks. The return on their loans will be nibbled away by inflation.

Yet if the profit return on investment starts to go below the cost of the real rate, firms will raise prices in the aggregate. We saw this happen during the Volcker recession from graph #2 where the plot did not fall much below the zero lower bound.

Yes, inflation was falling during the Volcker recession, but at a pace controlled by firms to keep their profit rates above the cost of the real rate… in the aggregate of course.

Notice in graph #2 how the profit rate has been building a bigger and bigger cushion over the cost of the real rate since the 80’s. Inflation has been dropping over that time. There is less pressure over time for firms to create inflation to protect their profit rates in the aggregate. So much so, that deflation starts to come into the picture. Maybe firms have enough room to actually cut prices to gain market share and still keep a nice profit rate.

To see this another way, the next graph pulls out inflation from graph #2 and puts it on the y-axis. Corporate profit rate minus the mixed nominal rate are on the x-axis. The down-sloping straight dark red line now represents the zero lower bound of the real cost of money which was the horizontal x-axis in graph #2. So the data points want to stay to the right of the dark red straight line.

inf corp4

Graph #3… (note: The bright red exponential trend line has its R squared optimized with the coefficients for the Fed rate and 10-year treasury, 0.56 and 0.44 respectively.)

The #1 in graph #3 points to where Volcker set in motion his recession in the second half of 1980. The data points were getting ready to fall in a Southeasterly direction. But nominal rates began to rise pushing the data points to the left. Inflation did not change, but the plot moved directly toward the lower bound of the real rate. Firms began to contract. A recession started. The #2 points to where the plot fell along the real rate boundary. Profit rates held pretty steady during that time. It was the nominal interest rates and inflation that fell together at a pace to keep aggregate profit returns above the real rate boundary barely.

Now as the plot in graph #3 goes Southeast down along the real rate boundary, an economy could just slide into deflation, but it doesn’t. Why? There is resistance near the 0% inflation line. Actually firms can increase their profits by going to the right away from the real cost boundary. The farther away from the real cost boundary, the more profits firms enjoy.

Ono top of that, the Federal Reserve wants to keep a 2% inflation target, which firms love. Firms are fine with a low inflation rate, but the Fed keeps dropping the Fed rate trying to get firms to raise inflation. But firms are fine with low inflation. As well, as firms stay close to the 2% inflation target, they are able to increase their profits even more.

There is a some temptation by many firms to keep prices low in order to battle for market share, but firms in the aggregate are simply enjoying very high profit rates since the crisis. But the increased relative temptation to hold down prices contributes to what seems like “stubbornly” low inflation. It’s just that firms are not concerned about profits enough to raise prices.

Look at #3 in graph #3. It points to where inflation jumped up a bit . You can also see  this in graph #2 where the plot went so high to a maximum at the end of 2011.

Firms may not need to raise prices; they are far from the real cost lower boundary. Yet firms can increase their profit cushion over the cost of the real rate by raising prices. It is likely that the uncertainty in 2011 and 2012 prompted firms to maximize their profit rates as much as possible. Yet, even though the uncertainty has backed off, firms are still enjoying an environment of high profit rates over the real cost of money. They have been taking advantage of the situation in my opinion.

Graph #3 implies that inflation is low because firms have much weaker price pressures with such high profit rates over the real cost of money. So it seems logical that the Fed still wants to raise the Fed rate which would still raise the Mixed nominal rate used above. Firms have lots of profit cushion to absorb the Fed rate increase.

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Equation to Forecast the Profit Rate Cycle

As a recovery gets underway after a recession, wouldn’t it be nice to have an equation that would forecast the peak of the profit rate cycle? Well, below is one.

Profits are a function of labor share. If labor share rises, the profit rate will decline.

Profits are also a function of optimizing the utilization of capital or labor. Profits will peak when the utilization of either capital or labor is optimized. In the United States, the optimization of capital always takes precedent over the optimization of labor.

With that in mind, here is the equation…

Corporate profit rate = a*((c + e – (d – s)*c2*e2)/s + b

c = capacity utilization
e = (1 – unemployment rate)
s = effective labor share, (labor share index * 0.76)
a, b and d are coefficients determined by regressions on real data.

This equation can be used to forecast the profit rate cycle. All you need are the coefficients a, b and d… an estimate of where labor share will be through the biz cycle… and a way to estimate when capacity utilization will be optimized.

Let’s see how this down…

First the regression results to determine a, b and d. Quarterly data from 1967 to 2016 is used. (link to data for Corporate Profit rate). The part of the equation highlighted in blue above is regressed against quarterly corporate profit rates varying the variable d within the blue section.

regress

Adjusted R square is 82.4%. P-values very small. According to this best regression fit…

a = 0.3370
b = -0.5140
d = 1.453

The Adjusted R square is over 87% by using data from 1998 to present. Yet, this is a workable equation for this post.

Corporate profit rate = 0.3370*((c + e – (1.453 – s)*c2*e2)/s – 0.5140

So how would you use this equation?

Apart from estimating what the actual aggregate profit rate might be, it would be better to estimate the peak of the profit rate cycle to guide such things as investing and monetary policy.

When the derivative of this equation is equal to zero, you have reached the top of the profit rate cycle. Here is the derivative in terms of capacity utilization. (Capacity utilization is used instead of employment since capital, and not labor, is always optimized by corporations.)

Derivative in terms of c = 0.3370*(1 – (1.453 – s) * 2*c*e2)/s

You can see from this graph that the derivative reliably reaches its limit near zero. It may not have reached its zero limit this biz cycle due to OPEC lowering the price of oil a bit before.

zerod

Let’s forecast the profit rate cycle for the next biz cycle.

Let’s assume that effective labor share will equal 78%. What about employment? Well, capital will optimize when unemployment is between 4.5% and 6.2%. Let’s use 5.5% unemployment as the place where capital utilization will optimize. (Note: Capital optimized when unemployment was at 6.1% in this biz cycle.)

0 = 0.3370*(1 – (1.453 – 0.78) * 2*c*0.9452)/0.78

Solve for c…

c = 83.2%

So when capacity utilization gets close to 83%, assuming unemployment and effective labor share are on target, profit rates will be peaking.

As well, the Fed should have already started raising the Fed rate by that time because they really do not want to raise it much afterward when the profit rate is declining.

As the next recession fades and the recovery starts, we will get a better picture of where labor share, capacity utilization and unemployment are trending.

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