Beware Of Gifts Not Borne To Greeks
A month ago, in my column analyzing the January Employment report, I noted that there had been rumors that the EU would put together a bailout package for Greece over the ensuing weekend. Not much has really changed in the last month, has it? We are still talking about whether Greece will be able to defer its problems (no one really thinks that they are solvable in the near-term) long enough to prevent an acute crisis. Tomorrow German Chancellor Angela Merkel will meet with the Greek Prime Minister, but it appears to be mostly a photo op; according to an article in the online Wall Street Journal, Germany is not bringing the Greeks any gifts:
BERLIN (Dow Jones)–It is Greece’s responsibility to solve its budget problems on its own and Chancellor Angela Merkel will make this “very clear” in her meeting with Greek Prime Minister Georgios Papandreou Friday, German Economics Minister Rainer Bruederle said Thursday.
One thing that has changed, I suppose, is that we seem not to be worrying about Greece any more. The Nintendo Generation likes to see results quickly, or their attention drifts (that is one thing that politicians these days really count on!). No blowup in a month? Okay, move on to the next thing.
Global geopolitics is a “confidence game” in the original sense of the phrase: politicians play to be our confidantes and try and persuade us not to worry about little things. Little things like Greece defaulting, the tenability of the European Union, bank solvency, economic growth and inflation.
And so we hear the endless repetition of talking points designed to anesthetize us into believing that the talking points must be true if everyone is saying them, or (almost as good) to exhaust us into thinking that we don’t even care any more.
The Federal Reserve, once it commenced its Age of Openness, was destined to move one of two ways from that unsustainable (and mistaken) plateau: they could either become closed again, keep their own counsel and make decisions without needing to show everyone how unsuccessful they actually are at macroeconomic forecasting, or they could enter an Age of Persuasion, in which they attempt to actively influence economic outcomes by trying to convince economic actors to behave in the way that would be convenient to the Committee.
So today, Chicago Fed President Evans said he expects 3-3.5% growth this year with a “modest” decline in unemployment and stable inflation. He declares that the recession is over (albeit in a “narrow, technical sense”) and that while monetary policy cannot remain accommodative for too long, the end of accommodation is “probably quite a ways away.” The message is: don’t worry, things are getting better; please behave as if the recession is over and become more confident. Bond people: don’t worry about inflation, because we won’t remain accommodative for too long; equity people: don’t worry because inflation is stable and rates are going to stay low for a while anyway.
The Fed earnestly believes, we are led to think, that there can be no inflation with this large an output gap, and they want us to think so as well since “inflation expectations” play such an important role in their models. But if they really thought that inflation depended mainly on the output gap, then wouldn’t they be quite irresponsible to not print as much money as possible right now, since there is no downside? What restraint they have shown over the last year – and the growth rate of money aggregates has come way down from what it was during the crisis – is inconsistent with the expressed belief that the output gap dominates as a cause of inflation and that money is more or less inert. The truth is that they’re not sure (it isn’t settled science, after all), but if they behave as if they aren’t sure then how in the world are they going to persuade Congress that they should have the power they have? They need to at least appear assured of the efficacy of their policies.
These musings may appear a bit off-point, but a reading of Federal Reserve history makes it hard to conclude anything other than that the institution is very often feeling its way when making really big, important calls about how to manage the economy. The “science” of economics is still so new, and the difficulty of proving anything from noisy data so difficult, that it would be remarkable if the Fed had the powers that they actually represent that they have. This is all fresh in my mind because I recently finished reading The Federal Reserve And the Bull Markets: From Benjamin Strong to Alan Greenspan, a great book for historians and Fed watchers (warning before you click on the link, though: the book is $110). The exhaustively-annotated book gives you a great feel for how Ben Strong, William McChesney Martin Jr., and Alan Greenspan actually felt about their roles. Lots has been written about Greenspan, although I didn’t realize that when he was Chairman of the Council of Economic Advisers in the mid-1970s he said:
“My view is that what is missing in Keynes’ general theory is a significant negative effect on the marginal efficiency capital from the types of actions that are implicit in very large fiscal stimulus. I can argue, and do indirectly through the hurdle rate of return, that substantial fiscal stimulus, working through inflation and a number of other things, sharply depresses effective private demand; while it may be expansionary in the short-run, it is not over the long-run and usually is counterproductive.” (citation is to Hargrove & Morley, eds, The President and the Council of Economic Advisers: Interview with the Chairmen)
(I quote that here mainly because a reader of this column said I didn’t understand Keynes when I said basically the same thing. I am not a fan of Greenspan but I imagine he understood Keynes.)
While I know a reasonable amount about Greenspan, I was delighted (and educated) by the deep historical research and analysis of Strong and Martin. The purpose of the book is to analyze these three Fed Chairmen, all of whom presided over lengthy equity bull markets, both in terms of their stated goals and in terms of their actions taken as Fed chiefs. It is remarkable how often these men railed about speculative excess but seemed powerless to know what to do with it or what their actions to restrain a runaway market might do in collateral damage to the economy. Moreover, the econometric modeling showed that Fed policy in terms of the policy rate itself responded only slightly to speculative excess: in the case of the Martin Fed, every 5% overvaluation in stocks produced a 14bps increase in the Fed funds rate; for the Greenspan Fed that was 18bps but their basic fitted model still indicated that policy was still too loose in 1999-2000 by some 150bps.
Again, the point isn’t that Chairmen are prone to let the stock market get overvalued, but that the Fed in general often isn’t sure what to do. This is why they really ought to keep their mouths shut and work it out behind closed doors; and it is also why observers should take everything they say that sounds definitive with a big shaker of salt. The Fed is really not worried at all about inflation while Unemployment is so high, we hear, although they may be concerned down the road a bit. If that is true, it is monetary malpractice because at the very least they ought to be worried about it. If it is false, then they’re just saying that to make us feel better. And that doesn’t make me feel better.
Now, I’m not saying that I could do a better job (or keep my mouth shut). But I think that I have a good respect for what I don’t know. For example, I have no idea what Payrolls will show tomorrow and I am dang glad I do not have to make a prediction. The consensus estimate is -50,000. But there are two large, indeterminate forces working at cross-purposes: the weather, which Goldman economists think could drop 100k from the number, and hiring for the decennial Census, which may add around 30,000. The important point is that whatever the usual variance we consider “normal noise” around the trend, it is significantly higher this month.
The January Employment report was pretty strong overall. The -20,000 jobs lost was worse than expectations, but the Unemployment Rate plummeted to 9.7% from 10.0% and, importantly, the decline came from a drop in the number of unemployed persons rather than from a rise in the Civilian Labor Force. This tends to give more confidence that the decline in the ‘Rate was at least partly real, which is probably why consensus expectations are only for a small bounce to 9.8%. Another decline in the ‘Rate, which I do not expect, would be serious news indeed. But the caveat to everything that we think we know from last month is that it was the January report, and subject to wider-than-usual error bars for that reason.
Personally, because of the recent decline in the absolute surveys I would be tempted to take the “under” on Payrolls and the “over” on the ‘Rate, but I have very low confidence in that guess and I wouldn’t even put a dollar on it.
Stocks today, with the 0.4% rally, moved the right direction technically, but are still within the range of the last three days. Neither stocks nor bonds, that is, are in a secure place where the market can take whatever the economic data throws at it. That is to say that the number will likely call the tune not only for the day, but probably for the next week, if it differs from expectations (as I said, there should be big error bars on the number but I don’t believe the market will respond cautiously). If the economists actually have gotten fairly close to the data, though, then perhaps it’s okay to turn one eye to the EU and see if anyone comes bearing gifts for the Greeks.