Poor - the four letter word

A well-researched piece from The Economist's print edition (it's available online) that tries to pose fundamental questions on America's attitude to its poor. Lots of gems in here, including two charts that I've lifted from the article:

"A child from a family in America’s bottom quintile of earners is markedly less likely than a child born into the top quintile to be ready for school at five. He is less likely to graduate from high school with decent grades; he is more likely while still of school age to become a parent or be convicted of a crime. Degrees and high earnings are even less probable."

And this is what's scary about the crisis-induced unemployment rate:

"As well as declines in wages, the crisis brought a sharp reduction in the proportion of the population of working age in the workforce. In the early 2000s the proportion was between 62% and 63%. By 2010 it was below 59%. The longer someone is out of work the harder it becomes to get back in, which could turn the temporary macroeconomic problem of high unemployment in the slump into a structural shift towards poverty."

This reminds me of an article I read today on how economists got income inequality wrong despite all the attention it had garnered in recent years. But that's wrong. There's a lot of work still being done and more importantly, income inequality isn't an economic problem without being a social one that draws us back to moral roots at times. That's why it's hard to consider it a problem to be straightforwardly solved.

Praise the FT!

Why must the Financial Times exist?

Read on...

From Weisenthal at Business Insider, this is from the Nomura Research Institute's Chief Economist Richard Koo (and speaking of Koo, here's a must read), 

"Seeing that the dangers of balance sheet recessions had not been mentioned in any of the televised presidential debates, I made a point of writing an introductory article about them for a major US newspaper. However, the article was rejected as being too difficult for a general readership.

I then submitted the piece to another major US daily, with the same result.

Soon after, I was fortunate enough to receive a request from the Financial Times for just such an article, and this time it was quickly accepted. The article was published in last Monday’s paper under the title “Explain the disease, then US citizens will feel better.”"

I find this quite ridiculous, even though I have no idea which two newspapers are being referred to. What I find hard to believe is the difficulty of the concept. Much more believable is the denial of what accepting a balance-sheet recession would mean - i.e: the role of government to complement private sector deleveraging...which means that one of the dailies should definitely be the Wall Street Journal. The other one is anyone's guess!

More on India's Fiscal Situation

This is from the Kelkar-chaired "Roadmap for Fiscal Consolidation", I finally skimmed through most of the report. India is very very different and a lot what the report states is undeniably and uncomfortably true. For example,

"...a growth slowdown is inefficient, inequitable, and potentially politically destabilizing. It is the poor and the unemployed who will suffer the most in the event of sluggish growth and consequent political instability."

and

"Cross-country benchmarking suggests that India is clearly an outlier in terms of major fiscal indicators and currently has the least room for counter-cyclical fiscal policy response if conditions take a turn for the worse in global markets, second only to Egypt among 27 major emerging markets, measured in terms of inflation, real interest rates, exchange rates, current account deficits, cyclically adjusted budget balances and general government debt levels."

Perhaps the most important bit, and credit to the committee for seeming doomsdayish in their analysis, is:

"The twin deficits hypothesis implies that, given a certain level of private savings, an increase in the government deficit will have to be balanced by either a reduction in private investment or an increase in the Current Account Deficit (CAD.) The CAD then needs to be financed through external capital inflows, government external debt or drawdown of foreign exchange reserves. Government’s funding of the deficit through domestic sources tends to be inflationary. Even when the government does not explicitly use seigniorage, if the central bank has to auction government bonds and have adequate takers it needs to create enough liquidity. The RBI indicates that it has been doing so in recent years. This increase in liquidity can be inflationary….

Growth is faltering and inflation seems to be embedded. The external payment situation is flashing red lights. The global economy is likely to be more turbulent, making financing of the large external payment deficits very challenging. Potentially, if no action is taken, we are likely to be in a worse situation than in 1991 for several reasons. Energy prices are at much more elevated levels while our import dependence is now even greater. The Indian economy now is much more open and global developments have greater impact than before. India’s “demographic bulge” demands higher growth to meet the rising aspirations of our young generation. In order [sic] words, our economy may be encountering a 'perfect storm.'"

What Indian policy needs is a technocratic invasion, followed by a paradigm shift in power. But, demographics don't allow this and neither does the overall parliamentary structure and process. Moreover, political entrenchment has long since been a way of life and will continue to be so; foresight is frowned upon and comes with the risk of a loss in power that no one wants to take. One can only remember that if voluntary fiscal adjustment seems painful and inequitable, imagine how bad involuntary consolidation could be.

The Name's Bond, Vigilante Bond

I don't see where exactly the line is drawn with respect to bond vigilantism. After all, what it comes down to is the premise that investors can have an impact on economic policy by selling off bonds and refusing to buy them, thus sending prices plummeting and yields soaring.

That's been the fear from a significant portion of the think tank and it hasn't really garnered enough opposition as far as I've noticed. Let's be clear though, do 'vigilantes' set bond prices? I would say no, Cullen Roche at Seeking Alpha plays it safer with an 'it depends'. In fact, he likens the situation to a person walking an untrained dog. The dog tries to lead the walker (investors/traders) lead the Fed (front-running), but the Fed "as supplier of reserves to the banking system, can ALWAYS control the price of bonds".

In any case, Krugman is most vocal about this and he brings us back to basic macro and the IS-LM model. He seems to insinuate that the chorus coming from the fearful ones is clouded by the impression that the US has a fixed exchange rate and a simple macro model illustrates the difference.

The key here, as mentioned above, is the difference in the floating and constant exchange rate. Krugman goes on to argue that if the exchange rate is free to float, a 'vigilante attack' is in fact, expansionary.
Here are the basics (though it's hard to explain it easier than he does!):

The first equation is a simple linear function relating the demand for domestically produced goods and services to the interest rate and the exchange rate. Thus,

y = -ai + be (where y is real GDP, i is the interest rate, and e is the log(exch. rate) in terms of foreign currency - rise = depreciation (expansionary)

Immediately, one would point out the use of nominal terms and the convenient inflation ignoring that goes on here but simplicity is the key here and inflationary expectations...well...don't make things simpler.

If the exchange rate is fixed, then the second term of the equation above is constant and i is automatically a function of the willingness of international investors to hold securities. If i* is a riskless foreign security, then the domestic i = i* + p where p is the risk premium demanded.

On a downward sloping curve of real GDP versus interest rate, a rise in i automatically leads to a drop in y - i.e: economic contraction. But this is with a fixed exchange rate. 

If i is set by Fed policy (according to a phantom Taylor-rule for example) - i = r*y, then there will be expected arbitrage across borders that can be expressed by:

i = i* + d(e*-e) + p; where d(e*-e) [think of d as delta] expresses the expected 
depreciation. Rearranging gives us:

e = e* + (i* - i + p)/d.

It's simple now, put this expression for e back into the original linear function and you get:

y = -ai + be* + (b/d)(i* - i + p)

Clearly, the interest rate changes AD by:
a) raising domestic demand
b) depreciating the exchange rate and increasing net exports

On the IS graph with a constant policy-rule upward sloping curve, the IS curve shifts to the right outward over a loss of confidence, increasing the risk premium, depreciating the exchange rate and increasing demand - there's the expansion. 

Summarily, a loss of confidence wouldn't cause a rise in rates but a fall in the dollar (better competitiveness). That's not an easy sell but it's an undeniable factor when looking at the bond market. What about the distinction in short and long-term rates? Take a guess. 

Krugman thinks it's still difficult to imagine a contraction. Moreover, there's no issue of foreign denominated debt so it's hard to see where the fear comes from. 

Of course there are numerous other factors at play here (depreciation isn't the end-all solution to economic woe!) but first instinct would tell anyone with common sense that vigilante fears are almost unwarranted in the short-term. 

Fear in the long-run however, is a different matter altogether.

Below Zero

This from Quartz from Mankiw from an anonymous graduate student of his - on the zero bound and ineffectiveness of monetary policy - why can't the Fed go below zero in ways other than going below zero?

Like picking a random number out of a hat and announcing that all currency with a serial number ending with that number would cease to be legal tender. On a whole, the expected return on existing currency would be -10% (0 to 9) and the Fed could set at -2% which is far more attractive than the former. 

Anyway, I'm not getting into why this wouldn't work apart from the obvious reasons. But this is a theoretical thought that is absolutely inapplicable in a fiat world. I suppose for good reason did Mankiw leave the name unrevealed!

The M's

Through all the doomsday inflationary forecasts coming over from the right on QE, something made me remember (though I don't recall it at the time) - the Fed stopped tracking/publishing/releasing M3 data back in 2006. A bit of background details on the money supply definitions for the US - 

M0 is basically your physical currency including coins. (Fed Reserve notes + US Notes + Coins)

The Monetary Base (MB) is M0 + Fed Reserve Deposits

M1 is M0 + demand deposits, traveller's cheques and checkable deposits

M2 is M1 + Savings Accounts, Money Market Accounts, Retail MMFs and small CDs

M3 is M2 + all CDs (includes institutional mmf balances), eurodollar deposits and repos

M4 includes the above as well as commercial  paper

In any case, the Fed's reasoning was that the benefit of what M3 provided wasn't enough to offset the cost of tracking it or something like that. John William's at Shadowstats however, has a compilation of M3 estimates. I have no idea what assumptions have been made or whether any constants have been used to estimate data from eurodollar deposits or for that matter, how repurchase agreements were factored in. But here's what it looks like:

That's what's there to know about the financial sector money multiplier - a deep contraction clearly observed for broader forms of money. Clearly, M3 growth has been much lower since Oct 2008 than before that. Indeed, the monetary base almost triples in size and M1 almost doubles, but M2 growth averaging the past five years has been about the same as before, and M3 growth much less than before. 

One would automatically think that euro-data will look similar. Atleast a straightforward inference of direction could be made. You wouldn't be wrong: 

M1 and M3 definitions are broadly similar - 

• M1: Currency in circulation + overnight deposits
• M2: M1 + deposits with an agreed maturity up to 2 years + deposits redeemable at a period of notice up to 3 months.
• M3: M2 + repurchase agreements + money market fund (MMF) shares/units + debt securities up to 2 years

From '08 onwards, there's perfect asymmetry in the y-o-y growth rates uptill '10 before M1 growth normalizes, so to speak. 

But coming back to the US money supply, it's clear that official M3 measures might not be that useless after all.

Glasner on Currency Manipulation

David Glasner has a winding but ultimately interesting read about currency manipulation including this stinger, 

"...Mary Anastasia O’Grady’s assertion that Ben Bernanke is guilty of currency manipulation, ...based on the fact that Bernanke is expanding the US money supply, is clearly incompatible with Max Corden’s exchange-rate-protection model. In Corden’s model, undervaluation is achieved by combining a tight monetary policy that sterilizes (by open-market sales!) the inflows induced by an undervalued exchange rate. But, according to Mrs. O’Grady, Bernanke is guilty of currency manipulation, because he is conducting open-market purchases, not open-market sales! So Mrs. O’Grady has got it exactly backwards.  But, then, what would you expect from a member of the Wall Street Journal editorial board?"

And for a follow-up, here's more on the PBC reserve requirements and sterilization talk.