The Impact of Trump's EU Tariffs

As part of his trade war on the rest of the world, President Trump proposes to impose 100% tariffs on a variety of European goods, such as cheese, meats, olive oil, wine, pasta and olives.  Here's the impact of those tariffs.

          OUT                                   IN

          Brie                                      Velveeta

          Prosciutto                            Spam

          Italian virgin olive oil        Pure vegetable oil

          Anything with an                Any grape-flavored
          appellation d'origine          beverage with a kick in      
          controlee                               a bottle with a twist-off cap

          Imported Italian pasta      SpaghettiO's

          Olives                                    pickle slices

Bon appetit.

Why Donald Trump Can't Stop a Recession

A recession may be on the horizon.  The Federal Reserve doesn't think so.  Some others do.  Only time will tell who is right.  But if there is a recession, President Trump can't stop it before the 2020 election. 

The principal tool for the President to fight a recession would be to partner with Congress and put together a package of spending bills that would increase federal expenditures.  This sort of program, called fiscal policy, sometimes includes tax cuts, but not always.  The greatest fiscal stimulus in U.S. history, military spending for World War II, included a massive tax increase and an even greater increase in deficit spending.  The result was both victory in the war and an economic revival at home. 

Today, however, there is an almost complete absence of agreement between the President and the Democrats in the House as to how to deploy fiscal policy.  Although both sides speak of infrastructure spending, agreement on the fine points and details has remained elusive since the President was inaugurated and won't be achieved before November 2020.  For more than the past 20 years, the federal budgetary process has been largely dysfunctional, and it has grown more so as political divisiveness has increased.  With only one full budget cycle remaining before the election, it's simply too late to implement fiscal measures in time.

To make things worse, the President would likely seek a tax cut as part of the stimulus package.  But, having alienated the Democrats by ramrodding through the 2017 tax cuts with nary a shred of consideration for Democratic views, the President has essentially no good will left with the House majority when it comes to tax policy.  The Democrats will agree to tax changes only if there is a substantial rollback of the 2017 cornucopia of tax cuts for the wealthy, and the President won't agree to that.  So no deal on tax legislation is possible.

Of course, central banks can endeavor to combat recessions.  But the President does not control central bank policy.  Monetary policy and other economic management measures such as quantitative easing and the setting of bank reserves lie within the purview of the Federal Reserve.  The President attempts to influence the Fed with shrill demands on Twitter for much more aggressive interest rate cuts than the Fed seems inclined to make.  But the Fed strives to maintain its independence, and the President would be wise to back off.  If the financial markets lose confidence in the independence and integrity of the Federal Reserve, stocks will crater and the economy will get a tummy ache.   Moreover, Fed interest rate adjustments often take 18 months or longer to affect the economy.  Although they may almost instantaneously be reflected in asset prices in the financial markets, they take a long time to wend their way through the processes of the economy.  There isn't enough time before November 2020 for interest rate cuts to have a big impact. 

The prospects for a recession remain uncertain.  Unemployment is at a 50-year low, a remarkable development that no doubt informs the Fed view of the economy.  The stock market is dancing near its all-time highs.  Transportation and manufacturing are slowing, and the business community is pulling back on new investment because of confusion and caution arising from President Trump's trade wars.  It's difficult to tell how things will go.  But if a recession is coming, it's coming.

President Trump: the Fed's Biggest Moral Hazard

Perhaps the Federal Reserve's biggest problem today is that it has a moral hazard problem with President Trump.  A moral hazard is a situation in which a person can take risks without having to bear the full consequences of those risks.  For example, when stock market investors think the Federal Reserve will cut interest rates to prop up the economy and the stock market should things go downward, they are more willing to buy stocks because they expect a bailout from the Fed.  This can lead to over-investment in stocks and greater potential for an asset bubble that can later burst painfully.

President Trump's trade war with China has created uncertainty.  The economy is slowing and the stock market has been trending downward for several weeks.  Trump has been haranguing the Fed to cut interest rates, evidently in the belief that such cuts can offset the negative impact of his trade war.  There is considerable debate among economists and others whether the Fed can actually prop up the economy and stocks while the President exchanges volleys of tariffs and other trade restrictions with China.  Perhaps the Fed can soften the impact, but it seems doubtful the Fed can do more than slow down the negative impacts of the trade war.  When the Fed lowers rates in what is already a low-rate environment, that signals things are going to be bad.  Businesses pull back, slowing hiring and investment.  Consumers spend less..  The rate cuts could produce a self-fulfilling prophecy.

However, as long as President Trump believes the Fed can offset the damage his trade war does, he has no incentive to act prudently.  He may instead proceed recklessly and then turn to the Fed to put out the fires he starts.  This is an extremely concerning instance of moral hazard, and one for which there is no easy solution (because the President doesn't seem to understand economic reality).  The President could trigger an economic downturn and a bear market with no certainty that he could secure a good trade deal.  And we'd all pay the price.

How to Stimulate the Economy

With current economic indicators mostly signaling a slowdown in the economy--and perhaps a recession--a lot of attention is focused on stimulating the economy. The dialogue revolves around central bank accommodation (via lowering interest rates and bond purchases in the form of quantitative easing) and fiscal policy (i.e., deficit spending).  Fiscal measures are essentially impossible because of political gridlock.  And central banks, having devoted the past decade to accommodation, have only limited ammo left.  So what can stave off recession and renew economic growth?

There's no simple answer.  But one important factor is the availability of inexpensive energy.  Modern life is dependent on vast amounts of cheap energy.  The Industrial Revolution that created our high tech lives was the result of the development of inexpensive ways to harness and utilize large amounts of energy.

Let's begin in A.D. 1700.  Living standards in A.D. 1700 worldwide were about the same as they were in A.D. 700 and 300 B.C.  In other words, things had hardly improved over thousands of years.  But within the 150 years following 1700, people had developed the steam engine and learned how to harness electricity for commercial use.  These developments were followed by new ways to extract large amounts of fossil fuels that could be sold inexpensively.  Then, after 200 years (i.e., by 1900), people had developed the internal combustion engine.  The internal combustion engine could be used widely in transportation, manufacturing and many other ways.  Large scale generation and distribution of electricity became feasible, and the widespread availability of electric motors greatly enhanced living standards.  Economic growth and improvement of living standards accelerated at an exponential pace.  In essence, access to inexpensive energy sources (carbon based fuels and electricity) triggered a monumental amount of economic growth and a phenomenal rise in living standards in a historically short amount of time.  Of course, we now have pollution and other byproducts of the Industrial Revolution to contend with.  But the simple truth is the astounding economic growth of the past 300 years resulted to a large degree from ever increasing access to cheap energy.  Cheap energy and the technology developed to exploit it made modern life possible.   

Why is energy so important to economic growth?  Because energy is a key input into all economic activity.  From manufacturing to transportation to farming to fast food to government offices to hair salons to slimy corporate lawyers peddling excuses for their greedy clients to sordid lobbyists plotting to kill health insurance coverage for all to the performances of rock stars in large arenas, energy is an input into essentially all economic activity.  If the cost of energy is lowered, all economic activity gets a boost and economic growth in all sectors of the economy is facilitated.  

It's no accident that America's economy grew briskly in recent years concurrently with a drop in the price of natural gas, solar and wind energy, and to some degree, oil.  The proliferation of fracking not only has capped the price of oil, but also created demand for a lot of drilling equipment, trucks of various kinds, and so on.  So it boosted the manufacturing and transportation sectors. 

We use enormous amounts of energy stored in the past to make our current lives more comfortable and enjoyable.  We now understand we can't keep relying so much on energy from fossil fuels.  We have to develop more sustainable lifestyles.  However, in order to maintain and improve our lives, we need to continue our access to cheap energy in better ways.  After decades of frustration, solar and wind energy have actually become cheaper than fossil fuels.  That is a very positive development.  More technological advance is needed. 

The policies needed continue the availability of cheap energy would be varied and sometimes controversial.  Increased federal funding of basic research is an obvious one, although the GOP has done much to cut this from the federal budget.  Republicans seem fear science.  But ignorance will not spur economic growth.

Building more gas pipelines is obviously controversial to the NIMBY crowd.  But we do need better distribution systems for gas--and electricity as well.  All the windmills and solar farms in the Plains states won't do much good without power lines to transport the electricity to the big cities that need the power.  These power lines entail a huge NIMBY problem.  But this will have to be dealt with somehow, because distribution systems have to be enhanced if there is to be growth.  We need not bow to big, bullying energy and power companies and give them everything they want.  But we should acknowledge the need for better distribution systems.

Fostering greater fuel efficiency also helps to lower energy costs.  It may not lower the stated price per unit, but it reduces the number of units people have to buy.  So it would help to pursue efficiency as well as reduce unit costs.  One hidden cost of efficiency, though, is people consume more energy when it effectively becomes cheaper--many ordinary cars and SUVs today have engines that are as powerful as those in the muscle cars of the 1960's, since engine technology has improved so much, and people drive more miles per year.  So greater efficiency isn't an improvement if it doesn't reduce the use of fossil fuels.

There are many other factors besides energy that affect economic growth.  But a lot aren't controllable by any branch of the government.  Energy policy, though, can be implemented through government.

In the 1940's, 50's and 60's, the U.S. had ultra-high marginal tax rates, not that much deficit spending (the government focused on reducing the deficit, not increasing it), a rather inactive Fed, relatively high wages that provided for a comparatively equitable distribution of wealth and income--and an era of brisk economic growth and low unemployment.  This is an era still remembered as a golden age in America.  Why?  Because oil was damn cheap.  What happened after the first OPEC oil embargo in 1973?  A decade of economic stagnation followed by decades of economic uncertainty.  When we had cheap energy, we had lots of prosperity.  When energy rose sharply in price, prosperity as we had enjoyed it went away and still hasn't returned.  We don't need to sell our souls to the fossil fuels companies.  But we need to recognize that our standard of living and future improvements to our standard of living are dependent on access to cheap energy.  And we need to find responsible and sustainable ways to keep that gravy train rolling.

To Increase Inflation, Increase Incomes

The Federal Reserve Board is desperate to increase inflation to 2% per year.  It believes that a 2% level of inflation will promote economic growth by giving businesses greater pricing power and the ability to repay debt with less valuable dollars.  Right now, inflation as measured in the way the Fed prefers, runs about 1.6% per year, and remains stubbornly below 2%.

There's no economic research that definitively shows anything magical about 2% inflation being the key to the Goldilocks economy (i.e., not too hot and not too cold).  The figure is just a guess.  But if we were to accept that 2% has miraculous powers, then why has inflation persisted in staying lower?  With unemployment levels running at historic lows of about 3.6%, one would expect inflation to be moving up briskly.

Economists believe consumer expectations have a large role in determining the rate of inflation.  If people expect inflation, then there will be inflation.  If people don't expect inflation, they will resist price increases and inflation will be hard to come by.  Right now, inflation expectation are low.

Why would people today have such low expectations for price increases?  Perhaps the most obvious reason would be because they don't have the money to pay increased prices.  Wages, adjusted for the mild inflation we've had, have stagnated for decades.  The middle class, who are key consumers in the national economy, just aren't bringing in any more.  So they not surprisingly feel that they can't pay more and would resist price increases.  If the Fed wants to pump up inflation, it should hope that people get paid more.

With unemployment reaching an astonishingly low 3.6% level, one might think employers would pay more to get new hires and keep existing employees.  But that's not happening much.  Here and there, pay is jumping up.  But on the whole, incomes are mostly in a rut.  There pretty much is nothing the Fed can do to increase worker pay.  But it shouldn't hold its breath waiting for inflation to boost the economy. 

Trump Nationalizes Harley-Davidson

President Trump has started a trade war in recent days.  He's imposed tariffs on imports that have been rejoined with countertariffs on American goods.  Among the ripostes delivered to Trump's tariffs have been countertariffs from the EU.  The EU measures led Harley-Davidson, the Milwaukee-based maker of iconic motorcycles, to announce that it would shift some production overseas.

President Trump did not take kindly to this news.  He declared in a tweet, "A Harley-Davidson should never be built in another country--never!"  Then he stated that if Harley-Davidson shifted production overseas, "they will be taxed like never before."  (See https://www.cnbc.com/2018/06/26/trump-says-harley-davidson-using-trade-tensions-as-an-excuse.html.)  Trump seems to be saying that he would impose stiff tariffs on Harleys made overseas when they are imported into the U.S.

Trump's message is clear:  don't move production overseas.  He is, in effect, trying to usurp the authority of Harley's management and board of directors to run the company and make decisions that they believe to be in the best interests of the company and its shareholders.  When the government takes control of a company, that's nationalization.  While Trump isn't trying make all the decisions for management; most likely, it's still up to them what brand of coffee to provide in the employee lounge and which employees get reserved parking spots.  But when it comes to crucial matters that could affect the survival of the company, Trump evidently has an office in the executive suite, and it may be the biggest corner office.

The notion of a Republican President dictating to a private corporation how to run its business is bizarre.  There was once a time when the Republican Party stood for the principles of free enterprise and the private ownership of property.  But no more.  America's businesses now seem to have a new purpose:  to make President Trump look good.  And they had better do it well or they evidently will be taxed like never before.

Where Is the Stock Market Headed?

With the Dow Jones Industrial Average having dropped over 2,000 points since its peak a week and a half ago, this is the $64,000 (or more) question.  The recent market surge resulted to a large degree from too much optimism.  Market players have selectively focused on the good news (strengthening economy, big corporate tax cut, rising employment levels), while shrugging off the bad news (growing signs of inflation, rising interest rates, and increasing political discord).  Life is like a rose--pretty petals, but thorns as well.  If you ignore the thorns, you'll get an ouchie sooner or later.

So what happens after today's ouchie (1175 points off the Dow)?  The recent market surge seems similar to the valuation-driven bull markets of 1987 and 2000, which resulted in sizable drops of 25% to 30% in the Dow followed by gradual recoveries that took two to three years.  But we should bear in mind an earlier drop off. In 1973, the stock market (measured by the S&P 500) peaked after a long run up, not unlike the one we've had since 2009.  Then, it declined some 40% or more and didn't recover until some seven years later.  The 1970s were also a time of rising inflation and political scandal (Watergate), with the only resignation of a President.  Political turmoil affects economies and stock markets (look at Venezuela, where a lot of folks can't even get a square meal because of political strife).

Expect more market turmoil tomorrow, the next week, the next month, and maybe the next year.  The market could easily drop some more.  We're running out of good news.  There may be little major legislation coming out of Washington, given the political quagmire.  The Fed may go easy on the tightening, but it's not going to cut interest rates simply to support stock prices.  It's already done that, perhaps too much--and today's drop was likely a consequence.  The economy seems to be slowly gaining altitude.  But there's nothing going on that will provide it a quick major boost.  The federal government can't increase the deficit, given its recent deficit-funded splurge with the tax cut bill.  Corporations seem not to be rushing to increase reinvestment of their tax savings.  The Trump administration may spark a trade war with China and other nations.  And the stability of the federal government cannot, in these times that try our souls, be taken for granted.

History teaches that it's not a great idea to sell your stocks in an effort to staunch losses.  People who try to time the market generally fail to get back in and enjoy the resurge that will likely come (although the resurge could be a long time coming). Instead, try to spend less and save more.  Keep your investments diversified.  And don't stop knocking on wood.

Why You Should Worry About the Rising Stock Market

The stock market keeps rising, setting new records just about every week.  The S&P 500 has risen over 15% since Election Day 2016, and shows no signs of slowing down.  That's an annualized rate of over 20% a year, which is exceptionally good for an aged bull market as we have.

The election of Donald Trump as President was seen as a major reason for the rally.  He promised infrastructure spending, tax reform and other measures that should stimulate the economy.  But his Presidency has sunk into a quagmire of chaos, incoherence and unpredictability. These, coupled with the legal risks emanating from special counsel Robert Mueller's investigation, should have triggered market retrenchment.  But stocks have hardly blinked before levitating some more.  Whatever is driving the market, it doesn't have much to do with the Trump Presidency.

Accommodative monetary policy in Europe and Japan is also said to be a reason for the market's buoyancy.  Foreign central banks have been printing money, and some of it supposedly has found its way into the U.S. markets.  But the dollar has been falling recently, indicating liquidity is flowing out of our markets, not in. That's not a formula for a rally.

Corporate earnings, although pretty decent, aren't dramatically better than last fall.  They don't explain the lighter-than-air quality of stocks today.

So what's going on?  Let's consider that over half of all stock market transactions consist of computerized trading.  Machines are trading with machines, using algorithms known to very few.  These algorithms verge on alchemy.  They rely on statistical correlations that may or may not hold true in the future.  These correlations can be disrupted by unexpected government policy, political upheaval or conflict, economic change (such as the effective collapse of OPEC as a functional cartel), and technological change (such as the fracking that just blew up OPEC).  They also utilize artificial intelligence, seeking to learn from their ongoing experiences in the market and modifying their algorithms as a result of what they learn.  Thus, the humans may have difficulty anticipating what the programs will do tomorrow.  And the programs may produce a positive or negative synergy or other interaction that humans have not foreseen.

Computerized trading is opaque.  That is, in real time, no one knows for sure if a trade or a series of trades involved a machine or two machines or none.  One should avoid anthropomorphism in today's stock markets.  In other words, one should not ascribe human motives, intentions or characteristics to market activity.  There may be no reason comprehensible to humans for today's stock prices.  When computers use artificial intelligence to trade stocks, the valuation of financial assets may be fundamentally changed, and changed beyond human comprehension.  You may think that stock prices are whacked out--and you could be correct from the human perspective.

Homilies like stocks are excellent long term investments and will protect against inflation were derived at a time when people dominated the financial markets and established the asset valuations on which these notions were based.  If machines that function opaquely suddenly become dominant, how can humans understand the valuations determined by the machines?  More succinctly, how can you tell what's a good price and what's a bad price anymore?

There are many more questions than answers in a machine-dominated market.  When the market keeps setting new record highs in machine-dominated trading, be careful.  We are bravely, or not, going where no investors have gone before.  And no one really knows what's going to happen.

Will Donald Trump Be a Traitor to His Class?

The most important legislative priorities of the Trump administration--tax and health insurance reform--will be enacted within a matter of months.  Both of these measures will greatly impact the working class whites who propelled Trump to the White House--either for better or for worse.

Preliminary assessments of the proposed tax reform indicate that taxes for the middle class will drop about a couple hundred dollars.  One percenters can look forward to many thousands in tax savings.  This isn't exactly what folks in small town America were hoping for.  To make up for the loss of income tax revenues from these cuts, the President may endorse a border adjustment tax (basically, a tariff on imports that would likely increase the prices of the inexpensive food and goods that low and moderate income Americans rely on).  To many, this might feel like another kick in the teeth.

Health insurance reform is turning out to be a very tough nut to crack.  President Trump has said he wants to preserve the protections that many low and moderate income Americans count on--guaranteed acceptance, coverage against pre-existing medical conditions, and subsidies for those unable to pay full freight.  But these conditions are very expensive.  How will the President cover the costs?  There seems to be little consideration of progressive taxation of the wealthy or increasing the federal debt.  Yet there's no free lunch.  One possible "solution," so to speak, would be to offer low cost policies with skimpy coverage--prior medical conditions would be covered but total coverage might go only up to $25,000 or $50,000 a year.  This would be expedient, but would effectively deprive people of coverage when they needed it the most.

On top of this, the President's desire to turn Medicaid into a program of block grants for the states has significant potential to reduce coverage for the low income.  Many of these people voted for him.  Where will they go for care without health insurance? Medicaid covers around 74 million Americans--almost 1 in 4.  Cuts to this program could mean many millions of people mad at the President.

President Trump's problems are exacerbated by his proposal to increase military spending by $54 billion.  Where will this money come from?  The Republicans in Congress won't agree to more deficit spending.  So the President can either raise taxes, or piss off many millions of voters by cutting other federal programs.

Donald Trump is President at a time when stark choices are necessary.  He was elected as an insurgent.  But he's stacked his cabinet with establishment Republican types, people who have no demonstrated concern or sympathy for his core constituents.  The Republicans who control Congress gave him scant and faint-hearted support during his campaign.  But today they stack the legislative agenda with bills that would make the rich richer and offer the working class hardly more than a crumb or two--and stale ones at that.  

If the President really wants to help his constituents, he'll have to be a traitor to his class.  He'll have to offer substantial improvements in life to the working class, and sorry to say, but wealthier people will have to pay for them.  America got itself into its current mess by believing that somehow everyone can get more of everything all the time at no cost to anyone else.  The last two large nations to subscribe to this notion--the Soviet Union and Communist China--had to abandon their illusions and now struggle with the consequences of the their wishful thinking.

Franklin Delano Roosevelt, the greatest President of the Twentieth Century, was labelled a traitor to his class.  And he was.  He endorsed legislation like Social Security and a strengthening of protections for workers and labor unions that uplifted many millions of ordinary Americans out of poverty and into the middle class.  The cost was born to a large degree by a sharp increase in federal income taxes paid by the well-to-do.  The rich grumbled and plotted against him.  But he ushered in the prosperity of the 1950's and 1960's, now viewed as a golden age in America.  America's perceived decline from those days also correspond with ever increasing inequality of wealth and income.  If Donald Trump really wants to make America great again, he'll have to make it great for the working class.  That isn't the direction he's been going in since his inauguration.  The next few months, when his most consequential legislative initiatives will be enacted, will likely make him both a traitor--either to his core constituents or to his class--and a hero--to the wealthy, many of whom didn't support him but are glad to free-ride on his policies and program, or to the working class that vaulted him into office.  The choice is his.

Donald Trump's Head Fakes

Donald Trump loves Twitter.  At least, so it would seem with his irrepressible use of the 140-character megaphone.  It grabs peoples' attention, particularly the attention of the press.  A 140-character message is usually easy to grasp and react to.  Not much work for a reader or a reporter.

But what's the purpose of his tweeting?  During the election, he tweeted or retweeted about a deceased Muslim veteran, a former Miss Universe, assertions by white supremacists, and other things that contravened the social values of the Democratic electorate, provoking vigorous and extended efforts by his opponent to argue that he was unfit for the Presidency.

Meanwhile, back on Main Street, Trump was holding rallies and talking about jobs, jobs and jobs.  He kept his eye on the ball (i.e., the economy, stupid), while diverting his opponent with social values head fakes.  She took the bait, and lost sight of the fact that economic distress drives elections more than the character flaws of candidates.  She paid for her mistakes.

Now, Trump has tweeted that flag burners should be imprisoned and lose their citizenship.  Surely he knows that flag burning is protected by the First Amendment to the Constitution and cannot be punished with criminal prosecution or deprivation of citizenship. So why tweet?  Could it be that he wants to divert attention from other things he's doing?  His tax proposals look like they'll make the rich a lot richer, and maybe even increase taxes on some members of the middle class.  His possible changes to Medicaid might leave some folks less well-insured.  His infrastructure proposal seems to focus more on giving businesses tax breaks than fixing the roads and bridges that are in the worst shape.  He's promised to repeal Obamacare, and to roll back financial regulatory reforms of the Dodd-Frank Act.

If you're concerned about what soon-to-be President Trump is going to do, watch out for his head fakes.  Don't be diverted by transparent attempts to yank your chain.  Focus on the big stuff, the things that will change things fundamentally.  Keep your eye on the bottom line, because that's what our incoming businessman President will do.

Happy Halloween, America

This may be the scariest Halloween ever.  Two ghouls are in the lead for the Presidency.  They claim to be people, but that seems to be just a masquerade.  Even in their guises as humans, they are horrifying.  Parents could use their names to scare children to eat their vegetables and do their homework.  But then the children would have nightmares.  The parents already do.

The financial markets are being inflated by the Federal Reserve into a monstrous bubble, a bloated spectral presence that could bring back the demons and vampires of the 2008 financial crisis.  Pension plans, annuities and long term care insurance are being scared to death by ultra-low interest rates.  Anyone hoping to retire is hanging garlic over their front doors.

Overseas, demons, banshees and poltergeists bedevil us.  The Middle East is a seething mass of murderous conflict, seemingly a nightmare from which we can't wake up.  North of the Middle East, a fiendish demon toils at midnight, boiling eye of newt, toe of frog, wool of bat, and tongue of dog into a toxic mix that he flings in all directions while chanting diabolically in a language not heard since ancient times.  In North Korea, a beast with curved horns labors with a crooked smile revealing jagged teeth to find ways to deliver inferno thousands of miles.

Our industrialized economy spews noxious fumes that heat the Earth hotter and hotter.  Everything we ingest--food, water, and air--causes cancer or heart disease.  Even sweetness itself, in the form of sugar and other natural sweeteners, silently stalks our health. 

Alfred Hitchcock never made a movie so scary.  The real world would scare the bejesus out of Vincent Price.  If Stephen King needs inspiration, he can simply pick up a newspaper.  The truth is we have Halloween year round.  The only thing that happens on October 31 is people wear costumes.  The rest of the time, we can only try to stay safe, if that's possible.  Happy Halloween, America.

Would the Fed Please Shut Up?

At the beginning of 2016, the Federal Reserve Board anticipated four quarterly interest rate hikes for the year.  Three quarters of the way through the year, the Fed hasn't lift rates even once.  And it's far from certain it will in December.

Why such a divergence between expectations and reality?  In a nutshell, because economists can't predict the future.  Essentially all leading and well-regarded economists get it wrong when they try to predict future economic growth.  Since the Fed is an economist-driven agency, it devotes a lot of time and energy to being wrong.  And it has been wrong early and often this year.  It's probably wrong in suggesting a significant likelihood of a December increase.  The truth is it has no way (i.e., zero percent probability) of knowing whether or not it will raise rates in December.  Its capacity for error has been copiously demonstrated and its "guidance" is worth less than a palm reader's prognostications.

Who benefits from the Fed's "guidance"?  Not investors, who only profit if they disbelieve what the Fed says.  Not consumers, whose bank accounts and certificates of deposit, money market accounts, bond holdings, pensions, and long term care insurance policies are being devastated by the perpetuation of Lilliputian interest earnings.  Those who would prepare for the future with life insurance and annuities face ever-escalating costs.  Comfortable retirement is increasingly available only for those who have both very high incomes and a ferocious propensity to save.  Everyone else will become a burden on public retirement financing.  Anyone who thinks the government will be balancing the budget by cutting the cost of Social Security and Medicare is chilling on angel dust.  Tax increases and more deficit spending will be necessary--full stop, end of discussion.  The bulk of retirees will be largely or entirely dependent on the government and any thought of cutting retirement benefits will prompt a political insurgency that would make this year's election look like a circle of kindergartners singing Kumbaya.

There are people who benefit from the Fed's "guidance."  Speculators, who make fast money bets on what some Fed official or other will say in the next three days.  Derivatives dealers, who write contracts for those who want to hedge or speculate about the Fed's "guidance."  Pundits and journalists, who try to say something profound about every cough or facial tic from one Fed official or another.  Stock and bond market dealers, who profit when the market churns each time a Fed governor smiles or frowns.  In other words, Wall Street is making money off of this.  But the "guidance" isn't making an overall contribution to the well-being of society.

The Fed used to be pretty discrete.  Back in the 1950's and 60's, we had robust growth, low unemployment, and ebullient optimism, all without a stream of prattle from the Fed.  There's no obvious need for the Fed to yack, yack, yack all the time.  We could do without all the false expectations created by inaccurate Fed prognostications.  Would the Fed just please shut up?

Brexit and the Globalization Bubble

The stock market has returned to pre-Brexit levels.  So the crisis is over and everything is fine.  After all, if you're not losing money, what's the problem?  Let's think about what craft beer to try next.

Actually, Brexit is still very much affecting the financial markets.  The British pound is moribund.  The Euro isn't looking pretty.  And the Yen is strong, much to the unhappiness of the Japanese, who want a weak currency that gives them an advantage in exporting.  The bond market continues to show a flood of financial refugees into U.S. Treasury securities.  The crisis isn't over.

The volatility in stocks was more about short term speculation over the outcome of the Brexit vote, than about Brexit itself.  Shortly before the vote, much of the fast money crowd had placed large bets on the UK voting to remain.  When the vote went the other way, the speculators had to unwind their now stinky positions muy pronto.  But this volatility didn't reflect the impact of Brexit itself.  Brexit will take years, and its impact is largely unknowable at this time since we don't yet know the terms of the UK's decampment.

The EU is talking tough about the terms of divorce.  That's perhaps an understandable emotional reaction.  After all, the EU is afraid that the insurgents in other member nations will engineer more exits.  Taking a tough line, it apparently thinks, discourages further desertions. 

But the EU is missing the point.  What impelled a majority of British voters to choose exfiltration was that globalization and the benefits of the EU were oversold.  Britons were promised a glowing future if they cozied up to continental Europeans, who they haven't really trusted since before the Hundred Years War.  EU membership may have boosted British GDP, but there was a problem with most of the boost going to a small number of people who were doing pretty well to begin with.  And there was a perception that the EU's open borders policy allowed immigration that took jobs away from native-born Britons.  All this occurred under a legal regime in which many Britons felt they had no voice.  They apparently felt that, contrary to the principles of democracy, they, although voters, were being ruled instead of ruling. 

By playing tough with the terms of Britain's exit, the EU fails to address the real, legitimate grievances leading to Britain's vote.  The truth is that globalization is an oversold political bubble and the bubble is bursting.  Those with grievances aren't confined to the UK; they can be found throughout the other 27 member nations.  A punitive approach to the terms of Brexit could leave both the UK and the EU poorer, while the forces of insurgency would continue unabated.

The distribution of wealth isn't merely something for social scientists to study.  It really matters--politically and economically.  The elites who have led the way toward globalization must find ways to improve the lives and fortunes of all, or face much bigger problems than Brexit. 

This is true in America as well as across the pond.  Donald Trump hopes to emulate the Leave campaign.  Hillary Clinton has gotten a certain amount of mileage  from running as not-Donald-Trump.  But she is one of the elites who has pushed globalization.  She now purports to have changed her mind, but only after severe pressure exerted by Bernie Sanders.  It's not hard to wonder if she's really changed her stripes.  The widespread perception of her untrustworthiness will hinder her ability to convince the blue collar voters in swing states that she's really on their side.  She doesn't inspire or excite hardly anyone.  If she doesn't acknowledge the overselling of globalization in a clear and convincing way, and offer real relief for the distressed, Trump may yet strut to the tune of Hail to the Chief.

Ask Not What Your Country Can Spend For You

Ask what you can spend for your country.  At least, some folks might like it if you did.  The Federal Reserve is in trouble.  The economy is meandering.  Unemployment levels have reached full employment, but labor force participation levels are low.  The Fed accentuates the negative and projects gloom about employment.  Wages stagnate, and, net of inflation, are lower than a generation ago.  The dollar is strong, which encourages imports while discouraging inflation. The Consumer Price Index is dropping, leading some to conclude that we have deflation.  This conclusion is a classic example of how statistics mislead.  Prices are higher if you take out energy costs.  If the price of everything except energy is going up, and energy is dropping a lot, do we really have deflation?  Or a misleading statistic?

But we digress. The Fed has greatly reduced its quantitative easing measures, since they didn't seem to be doing much good any more.  It's holding short term interest rates lower than a snake's belly.  But it can't do more.  The Fed is now low on ammo and can't expend what it has left; it has to hold something in reserve in case the economy belly flops.

There's no possibility of fiscal stimulus.  The federal government tied its budget into knots with the sequestration law, which requires automatic spending cuts each year through 2021.  Congress and the White House can get around the cuts by passing specific legislation providing for something other than sequestration.  But, given how the daily love fest between Congress and the White House consists of brickbats, but not bouquets, the chance for fiscal stimulus is lower than short term interest rates.

That leaves you, dear consumer.  The U.S. economy is about 70% consumption, and if consumers don't consume, the economy reaches for one of those little airline bags.  So spend, spend, spend.

Right?  Come on, right?

Or maybe not.  Consumers learned the hard way after the 2008 financial crisis that lavish spending and debt accumulation are shortcuts to financial ruin, and that saving improves the quality of your sleep.  Just because the Fed made it cheap to borrow doesn't mean borrowing is a good idea--soda is inexpensive but drinking a lot of it is a very bad idea.  If the Fed can't move short term interest rates above a complete goose egg, you have to suspect that maybe the Fed knows that the economy is a complete goose egg.  In which case, the last thing you want to do is spend freely.

We live with a contradiction:  our individual financial health requires acting in a way that is unhelpful to near term economic growth.  But those who are prudent can get through hard economic times, and it makes sense to put self and family first.  This leaves policy makers with controversial choices--negative interest rates, easing immigration restrictions to bring in educated, ambitious foreigners, and even more hotly debated measures (can you say Ex-Im Bank?).  How likely are these?

The truth is government policy is largely played out.  The economy will have to rise or fall based mostly on its own.  The next surge of growth, whenever that is, will probably come in a rush of technological innovation that may be hard to foresee.  Until then, the economy will likely meander.  If you're building up your savings and preparing for a tough slog, you'll probably be okay.  Ask not what you can spend for your country.  Ask what you can save for yourself and your family.

Is the Federal Reserve Wrecking Retirement?

We're now in the 7th year of Federal Reserve induced ultra low interest rates.  The Fed has kept short term rates at zero (actually negative, once you take inflation into account) through monetary policy.  Long term rates fell as well, especially after the Fed devoted years to quantitative easing (i.e., purchasing bonds in the open market).  Those people old-fashioned enough to actually save money have been bedeviled by the near-absence of interest income.  While some have been desperate enough to gamble with risky investments like junk bonds in order to generate more income, many and perhaps most have simply tightened their belts and spent less.  After all, if you're not getting any interest income, the last thing you want to do is spend down your principal.  That's like eating the seed corn--there will be no more harvests once the seed corn is gone.

Insidiously, the years-long pandemic of low long term interest rates has undermined retirements.  Pension funds, insurance companies and other persons and entities trying to provide for America's retirees have historically depended on long term bonds to provide a stable source of predictable income.  Pensions funds, insurance companies offering annuities, and other providers of retirement income tend to have relatively predictable obligations (i.e., the payouts they must make to current and future retirees), and look for predictable sources of funding to ensure that they can meet their obligations.  U.S. Treasury securities, agency bonds and high quality corporates were the bread and butter of retirement funding.  But these same stable long term investments have since the 2008 financial crisis been paying lower and lower interest rates. It's getting harder and harder to finance defined benefits.  While pension funds, insurance companies, municipalities and the like have sometimes turned to stocks and alternative investments, the volatility of these alternatives makes them a poor substitute for the plain vanilla fixed-rate, meat-and-potatoes high quality bond.

Of course, pension providers could contribute more funding to pension plans to make up for the shortfall in interest income.  But how many corporations, states and municipalities do you see leading the charge to put extra profits or taxpayer dollars into pension plans?  Many seem to be looking for spots on the increasing crowded sides of the road to dump current and future pensioners.

Corporations have curtailed and terminated defined benefit pension plans.  States and municipalities are in the process of doing the same.  Multi-employer pension plans are going belly up like fish in a toxic waste spill.  Soon, almost all of America's workers will be left with largely self-funded defined-contribution retirement plans, like the 401(k), or with self-funded retirements using IRAs.  Experience teaches that self-funded retirements are usually not as stable or comfortable as retirements funded with defined benefit pensions.  And that's just for the 40% of Americans who have any retirement savings at all.  As for the 60% who have none (as in zero, zilch, nada), the opulence of life on Social Security beckons. 

To be sure, Fed policy isn't the only reason why interest rates are low.  Economic and political instability in many other parts of the world are driving capital into safe dollar-denominated investments.  Low inflation tends to keep interest rates low.  But the Fed, as the single most powerful force in the money markets, has played a crucial role in eradicating high long term rates.

While Wall Street, corporate America, the 1% and many of the unemployed have benefited to varying degrees from the Fed's suppression of positive interest rates, there is, as economics teaches, no free lunch. There are costs to persistently low interest rates, and much of the cost has fallen on those middle and modest income workers who have or hoped for a defined benefit retirement.  Okay, so we already know the wealthy enjoy a heads-we-win, tails-those-little-people-lose advantage.  But we shouldn't buy into the Fed's story that it's creating stability to prevent a Great Depression.  What the Fed has done is transfer losses and instability that could have manifested themselves in another Great Depression, to many of America's current and future retirees, whose golden years may now be more unpredictable and depressed than they had hoped. 

Economic Consequences of the Mid-Term Elections

The economic consequences of yesterday's mid-term elections will be zero.  In order to boost the economy, the federal government would have to raise taxes, cut spending or both.  Even though President Obama now faces a majority Republican Senate as well as House, he won't agree to major tax cuts and the Republicans won't agree to major increases in spending.  So the fiscal impact of the mid-term elections will be effectively zero.  With the federal deficit lower than the historical average of 3% of GDP, there's room for fiscal stimulus but no political impetus for it.

Modest spending boosts may come from an increased military role for the U.S. in the Middle East.  Trying to suppress ISIS is becoming a game of whack-a-mole.  And American air power may have to target an al-Qaeda affiliate called the al Nusra front as well.  But such mission creep will be constrained as there is no public support for a resumption of ground warfare by U.S. troops.  The defense budget won't provide major stimulus.

Monetary policy is the only real game in town, and central bankers are the croupiers.  The Fed has just ended quantitative easing in the face of 3% plus growth by the economy, but there's nothing that stands in its way if it wants to fire up the monetary printing press again.  Just the push of a few computer keys, and the QE program is up and running again.  The Japanese central bank has recently placed a lot of QE chips on the table, putting a punch bowl on the table even as the Fed takes one away. 

The newly empowered Republicans in the Senate will probably increase pressure on the Fed to step back from accommodation.  That would be a fool's errand, as there is nothing the Republicans could actually do over the next two years to substitute for the loss of Fed accommodation.  If Republican pressure on the Fed slows the economy to stall speed, look for smashing Democratic victories in the 2016 Presidential and Congressional elections.

The Turmoil of Economic Inequality

Of all the potential dangers of economic inequality--slow growth, reduced upward mobility, and so on--social destabilization is the most worrisome.  This is when people say, "Enough.  We're not waiting for things to happen.  We're making them happen.  Our way."

The pro-democracy demonstrations in Hong Kong were nominally over Chinese attempts to limit the freedom of Hong Kong's elections by vetting candidates.  Only pro-Beijing candidates need apply. But growing economic inequality in Hong Kong fueled the anger of the demonstrators.  Wealthy Chinese are buying up prime real estate in Hong Kong, pushing prices beyond the reach of the local middle class.  The wealthiest Hong Kong residents are, like the 1% elsewhere, growing disproportionately richer.  Job and other opportunities for many others are looking bleaker.  Middle class Hong Kong residents began to see less and less for themselves in the status quo.  They didn't take things quietly.

Democracy is a mechanism by which the 99% push back against the growing wealth and power of the 1%.  Without democracy, oligarchs and plutocrats flourish.  China has an authoritarian government, whose powerful members and their families are intertwined with China's economic elite.  The ordinary citizens of Hong Kong have no voice in the northern capital.  Public protest is only way for them to be heard.

Modern day mandarins in Beijing no doubt shivered when protest banners unfurled in Hong Kong.  Since the days of dynastic China, rebellions against the central government have usually ignited in southern China.  Far from the seat of power, the discontented more readily questioned claims to the Mandate of Heaven.  Indeed, both of the rebellions that unseated the last emperor, and then the Chinese Nationalist government (now a vestige on Taiwan), began south of the Yangtze River.  In recent weeks, Communist cadres have no doubt been taking more business trips to warmer climes.

Turmoil from economic inequality is not limited to Hong Kong.  In the city by the bay, middle and lower income San Franciscans have bristled at the invasion of the geeks from the Silicon Valley.  Young technocrats have driven up real estate prices and Yuppified neighborhoods that heretofore took pride in their eccentricity.  Charter buses used for commuting by the options-compensated have been attacked by the not-so-well compensated.  The so-called trickle-down theory isn't entirely benign.  Capitalism has losers, and the losers will push back.

America is a democratic nation, although increasingly dominated by Big Money as a result of U.S. Supreme Court decisions striking down various limits on campaign contributions.  Democratic Party get-out-the-vote efforts in 2008 and 2012 have held the forces of wealth at bay for now.  But countries tend to work best when they have a government of the people, by the people and for the people.  Economic inequality cannot continue to increase indefinitely; and consequently, it won't.  The only question will be how it ends.  Let's hope it doesn't end badly.

The Student Debt Dilemma

Some predict that student debt will be the next asset bubble that will make the financial markets crash.  That's unlikely, but student debt is a huge and growing problem that gnaw away at economic growth until something changes.

Student debt won't bubble and burst like mortgages because the impact of losses wouldn't be centralized in the financial system.  The reason why mortgages, and their kissing cousins, mortgage-backed derivatives, almost blew up the world's financial system in 2008 is that when the ship hit the sand, the impact of losses was concentrated on the largest financial institutions, in particular an insurance company called AIG.  These institutions would have been rendered insolvent toute de suite, and the financial system would have been engulfed by a roaring flushing sound.

Some 20% or so of student loans are in default, and very possibly many more will never be fully repaid (for various reasons, it's sometimes possible to avoid default by paying small amounts of student loans but not be repaying fast enough ever to fully pay off the debt).  The impact of these losses will be spread out over time, and much if not most of it will fall on the U.S. government.  Which means that taxpayers will bear a lot of the burden, along with private investors.  But it will be a diffuse, albeit large, burden rolling out over years and decades.  There won't be a sharp poke in the eye at a discrete moment in time that will trigger a financial crisis.

But the aggregate amount of student debt keeps growing (it's over $1 trillion now), and the burden of repayment is growing commensurately (especially since interest rates on federal loans will float, and given today's ultra low rates, they can float only in one direction).  The burden of defaults and other nonpayment will also grow.  It's anecdotally said that student loans are holding up everything for many young adults--marriage, car purchases, home purchases, having children, and so on).  Maybe it makes sense that the sharing economy (car sharing, bike sharing, and the various iterations of the rental economy) is booming.  Young people can't afford to buy things, so they purchase the use of things for short periods of time.  This may be good for the environment, but it hinders economic growth.  If the burden of student loans becomes heavy enough, the impact could be lifelong, and entire lives could end partially unlived.

Student loans are almost impossible to discharge in bankruptcy.  It's easy to get federal loans--you just need to be admitted to an accredited institution--so there's an understandable reason for making them hard to ditch.  Otherwise, taxpayers could be asked to give free college educations to vast numbers of people.  And college educations provide lifelong benefits, so it's arguably fair to ask people to repay college loans, even if it takes a lifetime.

But student debt has become a bear trap for those who default.  Of course, their credit scores are knocked down.  That seems fair enough, but that's also where the kidney punches start.  Many employers won't hire a person with credit problems.  If you are laid off and then default on your student loans, you may not be able to get a new job to repay them.  Sometimes, you lose a professional license (like a nurse's license), which makes it even more difficult to find a job to repay the loan.  Defaulted loans continue to bear interest and penalties are imposed for default, thus ballooning the amount you have to repay.  So, if you have significant student debt, here's what you have to do:  (a) never lose a job; (b) never get so sick that you have to take major time off from work; (c) tell your aging parents that you can't help support them in their old age; (d) tell your spouse he or she can never lose a job, get so sick that they have to take major time off from work, and provide no support to their aging parents; and (e) never do anything that would otherwise result in default.  Getting to like rice and beans, network television broadcast to a TV with rabbit ears, and knitting your own socks, would also be good.

What will happen is, eventually, substantial relief will be given by Congress to student loan defaulters.  The exact scope and terms of the relief aren't easily predicted.  But it will happen.  Why?  Because the problem has become too big, and full repayment is increasingly unlikely for too many borrowers.  Since students from middle and lower income classes are the most likely to take out loans, the burdens are distributed in a regressive way.  Sooner or later, that will find expression in the ballot box.  When too many people labor under the burden of student loans, their combined political voices will overwhelm the lobbyists and influence peddlers employed by the student loan industry and the educational institutions that free-ride on easy educational credit.

There's a precedent for allowing student loans to be discharged in bankruptcy--that's bankruptcy itself.  When Lord Cornwallis' Redcoats surrendered at Yorktown in 1781, there was no such thing as bankruptcy.  Debtors were not only expected to repay their debts in full, but could be imprisoned until they did so.  As one might expect, the use of debtors prisons wasn't always fruitful.  A debtor in prison couldn't work or otherwise do much to repay.  But debtors were commonly imprisoned in the belief that the world was a better place for it.

However, as America grew into a bustling, vibrant industrial nation, voices of reform argued for giving debtors a chance for a fresh start.  Freed from old debt, individuals could more fully participate in the economy and provide for their families, thus strengthening future generations.  Creditors pushed backed, contending that a man's word should be his bond and that shiftless, lazy and prevaricating deadbeats shouldn't be able to hoodwink those that extended credit in good faith.  But the voices of reform won the debate, and America became one of the early adopters of the concept of bankruptcy.

Permitting bankruptcy shifts risks, placing more of the burden of default on creditors and less on borrowers.  As a consequence, market forces led creditors to adjust their practices, raising interest rates on all borrowers and eventually adopting the credit scoring system.  In effect, all borrowers pay for the defaults of some, but all borrowers have the option of bankruptcy.  Since you never know when life may blow up in your face, this may not be so bad.

The student loan crisis will eventually impel something similar. The sheer, growing size of the problem will force change.  Student loans increasingly are no longer just the problem of some, but the problem of many, most and perhaps even all. Of course, if student loans become dischargeable in bankruptcy, other changes will result.  Interest rates on the loans would likely increase, so that all borrowers cover the costs of defaults.  And educational institutions may be required to pay a portion of defaulted loans--at least for those students who don't graduate, so that colleges don't accept applicants who are unlikely to graduate and then free ride off the loan revenues from those students.  These changes would be appropriate, since taxpayers shouldn't have to fund handouts for the educational sector. 

The current student loan crisis is yet another illustration of the problems of easy credit.  Easy credit at first seems like a bargain, and everyone loves it.  But there's no free lunch, and the costs of easy credit will eventually emerge.  When the problem becomes so severe that it cannot continue in the present form, then it will change.

Fed Guidance in a Fog

The terrain is getting foggier and foggier for the Federal Reserve.  Most recently, GDP barely grew (at an annual rate of 0.1% for the first quarter of 2014).  But nonfarm employment grew by 288,000 jobs in April, a pretty good pace.  And the unemployment rate dropped to 6.3%.  Not that many Fed Open Market Committee meetings ago, an unemployment level of 6.3% would have been below the point where the Fed's guidance dictated a rise in short term interest rates.  But rising rates would make the stock market pout and sulk.  So the Fed has backed away from firm benchmarks for monetary policy and is electrically sliding its way toward a strictly "data-based" policy.  What does that mean?  Apparently, it means whatever the Fed thinks the data indicates it should do in order to promote full employment. But if the data is becoming less clear, then what?

For more than a decade, the Fed has worked to provide greater transparency.  That's perceived to be a good thing because it tells the financial markets what to expect.  Presumably, investors will make wiser decisions if they better understand the lay of the land.  But transparency also encourages risk-taking.  If you know what the central bank will do, you can layer on more speculative bets because one factor that might blow you up now seems predictable.  This perhaps unintended consequence of transparency tends to lock the Fed into its guidance, and limit its options, because if you do something other than what you say, all the hedge funds, big banks and other speculators might get hosed.  And then the specter of a systemic tummy ache would loom. 

With the data getting murkier as the economy recovery sputters along, the Fed has become less transparent.  Most likely, this isn't accidental, as the Open Market Committee no doubt can see that the data is telling them less and less, and benchmarks don't mean what they used to mean.  The gamblers in the stock markets can't be happy, as the odds have become harder to calculate.  Fed policy now depends on the data, and recent data resembles a pushmi-pullyu.  

The Fed still hums the low interest rate melody even though it doesn't sing the lyrics any more.  That's a pretty good pacifier for the stock market, at least for now.  But with foreign affairs descending into the mosh pit (who wants to bet Vlad the Invader won't strike again?), and the economic recovery constantly shifting back and forth between first and second gears, the data--and consequently the Fed's guidance--will probably get foggier.

The Shrinking Deficit: a Plus for the Market

The federal deficit is projected by the Congressional Budget Office to be just under $500 billion this fiscal year (the year ending Sept. 30, 2014). (See http://www.cnbc.com/id/101581648.) That's a lot of money, but only one-third the deficit of five years ago.  In other words, the deficit is lower by a trillion dollars, compared to half a decade ago.  That's a whopping huge drop, which leaves this year's deficit at 2.8% of GDP, below its historical norm of 3%.

When deficits fall, the government competes less in the credit markets against private sector borrowers.  This makes it easier for private interests to secure investment capital, a key predicate to economic growth.

Stocks tend to rise during periods of falling federal deficits.  The late 1940s and the 1950s are one example.  The 1990s are another.  The fact that stocks have risen steadily from their 2009 lows indicates that we are in another period of falling deficits and rising stocks. 

The future direction of the deficit is unclear.  The CBO predicts that it will fall a bit more next year and then begin to rise.  However, five years ago CBO didn't come close to predicting the deficit reduction we now have.  The weird, dysfunctional cognitive dissonance that is today's federal governance somehow managed to produce this beneficial result.  Who knows whether it might stumble its way to more good outcomes.  If the deficit stays moderate (near 3%), the markets will probably benefit.  While there are many other factors fueling volatility today, the federal deficit, improbably, isn't one of them.