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How Not to Do Income-Disparity Statistics

June 10, 2019 4 comments

I am a statistics snob. It unfortunately means that I end up sounding like a cynic most of the time, because I am naturally skeptical about every statistic I hear. One gets used to the fact that most stats you see are poorly measured, poorly presented, poorly collected, or poorly contexted. I actually play a game with my kids (because I want them to be shunned as sad, cynical people as well) that I call “what could be wrong with that statistic.” In this game, they have to come up with reasons that the claimed implication of some statistic is misleading because of some detail that the person showing the chart hasn’t mentioned (not necessarily nefariously; most users of statistics simply don’t understand).

But mostly, bad statistics are harmless. I have it on good authority that 85% of all statistics are made up, including that one, and another 12.223% are presented with false precision, including that one. As a result, the only statistic that anyone believes completely is the one they are citing themselves. So, normally, I just roll my eyes and move on.

Some statistics, though, because they are widely distributed or widely re-distributed and have dramatic implications and are associated with a draconian prescription for action, deserve special scrutiny. I saw one of these recently, and it is reproduced below (original source is Ray Dalio, who really ought to know better, although I got it from John Mauldin’s Thoughts from the Frontline).

Now, Mr. Dalio is not the first person to lament how the rich are getting richer and the poor are getting poorer, or some version of the socialist lament. Thomas Piketty wrote an entire book based on bad statistics and baseless assertions, after all. I don’t have time to tackle an entire book, and anyway such a work automatically attracts its own swarm of critics. But Mr. Dalio is widely respected/feared, and as such a simple chart from him carries the anti-capitalist message a lot further.[1]

I quickly identified at least four problems with this chart. One of them is just persnickety: the axis obviously should be in log scale, since we care about the percentage deviation and not the dollar deviation. But that is relatively minor. Here are three others:

  1. I suspect that over the time frame covered by this chart, the average age of the people in the top group has increased relative to the average age of the people in the bottom group. In any income distribution, the top end tends to be more populated with older people than the bottom end, since younger people tend to start out being lower-paid. Ergo, the bottom rung consists of both young people, and of older people who haven’t advanced, while the top rung is mostly older people who have Since society as a whole is older now than it was in the 1970s, it is likely that the average age of the top earners has risen by more than the average age of the bottom earners. But that means the comparison has changed since the people at the top now have more time to earn, relative to the bottom rung, than they did before. Dalio lessens this effect a little bit by choosing 35-to-64-year-olds, so new graduates are not in the mix, but the point is valid.
  2. If your point is that the super-wealthy are even more super-wealthier than they were before, that the CEO makes a bigger multiple of the line worker’s salary than before, then the 40th percentile versus 60th percentile would be a bad way to measure it. So I assume that is not Dalio’s point but rather than there is generally greater dispersion to real earnings than there was before. If that is the argument, then you don’t really want the 40th versus the 60th percentile either. You want the bottom 40% versus the top 40 percent except for the top 1%. That’s because the bottom of the distribution is bounded by zero (actually by something above zero since this chart only shows “earners”) and the top of the chart has no bound. As a result, the upper end can be significantly impacted by the length of the upper tail. So if the top 1%, which used to be centi-millionaires, are now centi-billionaires, that will make the entire top 40% line move higher…which isn’t fair if the argument is that the top group (but not the tippy-top group, which we all agree are in a category by themselves) is improving its lot more than the bottom group. As with point 1., this will tend to exaggerate the spread. I don’t know how much, but I know the direction.
  3. This one is the most insidious because it will occur to almost nobody except for an inflation geek. The chart shows “real household income,” which is nominal income (in current dollars) deflated by a price index (presumably CPI). Here is the issue: is it fair to use the same price index to deflate the incomes of the top 40% as we use to deflate the income of the bottom 40%? I would argue that it isn’t, because they have different consumption baskets (and more and more different, as you go higher and higher up the income ladder). If the folks at the top are making more money, but their cost of living is also going up faster, then using the average cost of living increase to deflate both baskets will exaggerate how much better the high-earners are doing than the low-earners. This is potentially a very large effect over this long a time frame. Consider just two categories: food, and shelter. The weights in the CPI tell us that on average, Americans spend about 13% of their income on food and 33% on shelter (these percentages of course shift over time; these are current weights). I suspect that very low earners spend a higher proportion of their budget on food than 13%…probably also more than 33% on shelter, but I suspect that their expenditures are more heavily-weighted towards food than 1:3. But food prices in real terms (deflated by the CPI) are basically unchanged over the last 50 years, while real shelter prices are up about 37%. So, if I am right about the relative expenditure weights of low-earners compared to high-earners, the ‘high-earner’ food/shelter consumption basket has risen by more than the ‘low-earner’ food/shelter consumption basket. Moreover, I think that there are a lot of categories that low-earners essentially consume zero of, or very small amounts of, which have risen in price substantially. Tuition springs to mind. Below I show a chart of CPI-Food, CPI-Shelter, and CPI-College Tuition and Fees, deflated by the general CPI in each case.

The point being that if you look only at incomes, then you are getting an impression from Dalio’s chart – even if my objection #1 and #2 are unimportant – that the lifestyles of the top 40% are improving by lots more than the lifestyles of the bottom 40%. But there is an implicit assumption that these two groups consume the same things, or that the prices of their relative lifestyles are changing similarly. I think that would be a hard argument. What should happen to this chart, then, is that each of these lines should be deflated by a price index appropriate to that group. We would find that the lines, again, would be closer together.

None of these objections means that there isn’t a growing disparity between the haves and the have-nots in our country. My point is simply that the disparity, and moreover the change in the disparity, is almost certainly less than it is generally purported to be with the weakly-assembled statistics we are presented with.


[1] Mr. Mauldin gamely tried to object, but the best he could do was say that capitalists aren’t good at figuring out how to share the wealth. Of course, this isn’t a function of capitalists. The people who decide how to distribute the wealth in capitalism are the consumers, who vote with their dollars. Bill Gates is not uber-rich because he decided to keep hundreds of billions of dollars away from the huddling masses; he is uber-rich because consumers decided to pay hundreds of billions of dollars for what he provided.

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Categories: Economics, Politics, Rant, Theory

Tariffs are Good for Inflation

The news of the day today – at least, from the standpoint of someone interested in inflation and inflation markets – was President Trump’s announcement of a new tariff on Canadian lumber. The new tariff, which is a response to Canada’s “alleged” subsidization of sales of lumber to the US (“alleged,” even though it is common knowledge that this occurs and has occurred for many years), ran from 3% to 24% on specific companies where the US had information on the precise subsidy they were receiving, and 20% on other Canadian lumber companies.

In related news, lumber is an important input to homebuilding. Several home price indicators were out today: the FHA House Price Index for new purchases was up 6.43% y/y, the highest level in a while (see chart, source Bloomberg).

The Case-Shiller home price index, which is a better index than the FHA index, showed the same thing (see chart, source Bloomberg). The first bump in home price growth, in 2012 and 2013, was due to a rebound to the sharp drop in home prices during the credit crisis. But this latest turn higher cannot be due to the same factor, since home prices have nearly regained all the ground that they lost in 2007-2012.

Those price increases are in the prices of existing homes, of course, but I wanted to illustrate that, even without new increases in materials costs, housing costs were continuing to rise faster than incomes and faster than prices generally. But now, the price of new homes will also rise due to this tariff (unless the market is slack and so builders have to absorb the cost increase, which seems unlikely to happen). Thus, any ebbing in core inflation that we may have been expecting as home price inflation leveled off may be delayed somewhat longer.

But the tariff hike is symptomatic of a policy that provokes deeper concern among market participants. As I’ve pointed out previously, de-globalization (aka protectionism) is a significant threat to inflation not just in the United States, but around the world. While I am not worried that most of Trump’s proposals would result in a “reflationary trade” due to strong growth – I am not convinced we have solved the demographic and productivity challenges that keep growth from being strong by prior standards, and anyway growth doesn’t cause inflation – I am very concerned that arresting globalization will. This isn’t all Trump’s fault; he is also a symptom of a sense among workers around the world that globalization may have gone too far, and with no one around who can eloquently extol the virtues of free trade, tensions were likely to rise no matter who occupied the White House. But he is certainly accelerating the process.

Not only do inflation markets understand this, it is right now one of the most-significant things affecting levels in inflation markets. Consider the chart below, which compares 10-year breakeven inflation (the difference between 10-year Treasuries and 10-year TIPS) to the frequency of “Border Adjustment Tax” as a search term in news stories on Google.

The market clearly anticipated the Trumpflation issue, but as the concern about BAT declined so did breakevens. Until today, when 10-year breakevens jumped 5-6bps on the Canadian tariff story.

At roughly 2%, breakevens appear to be discounting an expectation that the Fed will fail to achieve its price inflation target of 2% on PCE (which would be about 2.25% on CPI), and also excluding the value of any “tail outcomes” from protectionist battles. When growth flags, I expect breakevens will as well – and they are of course not as cheap as they were last year (by some 60-70bps). But from a purely clinical perspective, it is still hard to see how TIPS can be perceived as terribly rich here, at least relative to nominal Treasury bonds.

Profits and Health Care: A Beneficial Connection

March 17, 2017 4 comments

I usually try to avoid political commentary in this space, because it has become so personal to so many people. If I point out that a particular program of the “left” is smart, or cleverly put together, then half of my readership is annoyed; if I point out the same about the right, then half of my readership is angry. It doesn’t really make sense to waste article space except on those occasions when a policy has a clear effect on inflation over time, such as when the structure of the ACA made it clear that it would put upward pressure on inflation (as I pointed out in 2013) or in response to someone else’s flawed analysis of a policy, as I did last year when I tackled the San Francisco Fed for their weak argument about how the ACA would hold down inflation because the government would demand lower prices. Actually, there is no policy I have written about more than the ACA over the years – but again, this was economic commentary and not political commentary.

This article will be short, but different in that I am writing it to express frustration with the absolute lack of intellectual clarity on the part of the Republicans in making a particular argument that immediately impacts the debate over health care but also extends far into other policies. And, because the argument is simple, direct, and has tremendous empirical support, I couldn’t restrain myself. I expect this article will not be picked up and syndicated in its usual channels since it isn’t directly about economics or markets, but it needed to be said.

I’ve been stewing about this topic since Tuesday (March 14th), when I happened to catch part of the daily White House press briefing. Press Secretary Sean Spicer was asked a question about the President’s health care proposal, and tap danced away from the question:

Q    Thanks, Sean.  You mentioned the call with the CEO of Anthem Health.  Can you tell me what this proposal of the President means for health insurance companies?  Will their profits go up or down under the President’s proposal?

SPICER:  Well, I don’t think that’s been the focus of the President’s proposal.  It’s not about them, it’s about patients.  But I think what it means for them is that they finally get to create more choice and more plans and allow people to choose a plan that fits them.  Right now, they don’t have that choice.  And, frankly, in more and more markets, companies like Anthem, UnitedHealth, Signa are pulling out — Aetna — because they don’t have the choice and because of the government mandate.  I think what we want to do is allow competition and choice to exist so that they can offer more options for the American people.

Q    But will those companies make more money under the President’s plan or less?

SPICER:  I don’t know the answer to that.  That’s not been the focus of what we’re doing now.  And at the end of the day, right now they’re pulling out of market after market, leaving the American people with fewer and fewer choices.  So right now it’s not a question of — from the last I checked, I think many of them were doing pretty well, but it’s the American people and its patients that are losing under the current system.  So I think that there’s a way you can do a little of both.

Spicer’s response was the usual drivel that the Republicans have adopted when they run in fear from any question that includes the word “profits.” To summarize, the question was basically, “you’re doing this to throw a sop to fat-cat insurance companies, aren’t you?” and the answer was “we don’t think about that. No idea. Profits? Who said anything about profits? It’s about patients and choice. And, if anyone gets more profits, it wasn’t on purpose and we didn’t have anything to do with it.”

But this was actually a softball question, and the answer ought to have been something like this:

Q    But will those companies make more money under the President’s plan or less?

BIZARRO SPICER: Well, I hope so. After all, the insurance companies want every person in America to have health care – which is the same thing that we want – because the more people they sell their product to, the more money they can make. The insurance companies want to sell insurance to every person in the U.S. The insurance companies also want costs to be lower, and constantly strive to lower the cost of care, because the lower that costs are, the more profit they can make in the short run. But they don’t want lower costs at the expense of health – clearly, the best outcome for their profits is that most people covered by insurance are healthy and so don’t require the insurance they’ve paid for. So, if we just get out of the way and let companies strive for better profits, we are likely to get more coverage, lower costs, and a healthier population, and that is the goal of the President’s plan.

The reason we don’t already have these things is that laws we have previously passed don’t allow insurance companies to offer certain plans, to certain people, which both sides want but which politicians think are “unfair” for one reason or another. Trying to create a certain preconceived Utopian outcome while limiting profits of insurance companies is what caused this mess in the first place.

If you want to beautify gardens in this city, does it make sense to limit the amount of money that gardeners can make? If you did, you would find fewer gardens got tended, and gardeners would not strive to make improvements that they didn’t get paid for. We can see this clearly with gardeners. Why is it so hard to understand with the companies that tend to the nation’s health? Next question.

For some reason, Republicans think that saying “profits are good” is the same thing as saying “greed is good” and leads to caricatures of conservatives as cigar-smoking industrialists. But while at some level it is the desire for a better material outcome – which I suppose is greed, but aren’t there degrees of greed? – that drives the desire for profit, we cannot dismiss the power of self-interest as a motive force that has the effect of improving societal outcomes. “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest,” after all.

Of course, Republicans must also remember that profit without competition is a different animal. If an insurance company creates an innovation that lowers medical care costs, but does not face competitive pressure, then the benefit of the innovation accrues to the company alone. There is no pressure in such circumstances for the company to lower the price to the customer. But consider what happened to air fares after the deregulation of 1978, or to the cost of telephone service when the AT&T monopoly was broken up in 1984, as competition was allowed and even encouraged. Competition, and the more brutal the better, is what causes companies to strive for an edge through innovation, and it’s also what causes the benefit of that edge to eventually be accrued by the end customer. The government didn’t invent cell phones. Motorola did, in order to try and gain an edge against AT&T,[1] but until the telephone monopoly was broken up there were no commercial versions of the cell phone. The first cell phones cost $10,000 in 1983, about $25,000 in today’s dollars, but now they are ubiquitous and cost about 2% as much in real terms. But this didn’t happen because of a government program to drive down the cost of cell phones. It was the profit motive, combined with competition. All that government did was create the conditions that allowed innovation and competition to happen. And wouldn’t we like health care to be as ubiquitous and cheap as cell phones are?

This is not a hard thing to get right. It isn’t hard for people to understand. But for some reason, it seems incredibly hard for politicians to believe.

Note that nothing I have written here should be construed as an opinion about the President’s health care plan, which I have not read. My remarks are only meant to reflect on the utter inability of Republicans to properly convey the reasons that a different approach – one where the government’s involvement is lessened, rather than increased – would make more sense.

[1] The first cell phone call was made by the inventor, Martin Cooper at Motorola, who called his competition with it: the head of the cellular program at AT&T. According to him, he said “Joel, I’m calling you from a cellular phone, a real cellular phone, a handheld, portable, real cellular phone” and he said it got really quiet on the other end of the line.

Can’t Blame Trump for Everything

November 15, 2016 Leave a comment

So much has happened since the Presidential election – and almost none of it very obvious.

The plunge in equities on Donald Trump’s victory was foreseeable. The bounce was also foreseeable. The fact that the bounce completely reversed the selloff and took the market to within a whisker of new all-time highs was not, in my mind, an easy prediction. I understand that Mr. Trump intends to lower corporate tax rates (and he should, since it is human beings – owners, customers, and employees – that end up paying those taxes; taxing a company is just a way to hide the fact that more taxes are being layered on those human beings). And I understand that lowering the corporate tax rate, if it happens, is generally positive for corporate entities and the people who own them. I’m even willing to concede that, since Mr. Trump is – no matter what his faults – certainly more capitalism-friendly than his opponent, his election might be generally positive for equity values.

But the problem is that equities are already, to put it generously, “fully valued” for very good outcomes with Shiller multiples that are near the highest ever recorded.

I think that investors tend to misunderstand the role that valuation plays when investing in public equities. Consider what has happened to the economy over the last eight years under President Obama: if you had known in 2008 that growth would be anemic, debt would balloon, government regulation would increase dramatically, taxes would increase, and a new universal medical entitlement would be lashed to the backs of the American taxpayer/consumer/investor, would you have invested heavily in equities? Yet all stocks did was triple. The reason they did so was that they started from fairly low multiples and went to extremely high multiples. This was not unrelated to the fact that the Fed took trillions of dollars of safe securities out of the market, forcing investors (through the “Portfolio Balance Channel”) into risky securities. By analogy, might stocks decline over the next four years even if the business climate is more agreeable? You betcha – and, starting from these levels, that’s not terribly unlikely.

I am less surprised with the selloff in global bond markets, and not really surprised much at all with the rally in inflation breakevens. As I’ve said for a long time, fixed-income is so horribly mispriced that you should only hold bonds if you must hold bonds, and then you should only hold TIPS given how cheap they were. Because of their sharp outperformance, 10-year TIPS are now only about 40-50bps cheap compared to nominal bonds (as opposed to 110 or so earlier this year), and so it’s a much closer call. They are not relatively as cheap as they were, but they are absolutely less expensive as real rates have risen. 10-year real rates at 0.37% aren’t anything to write home about, but that is the highest yield since March.

Some analysis I have seen attributes the large increase in market-based measures of inflation expectations on Mr. Trump’s victory. For example, 10-year breakevens have risen 20bps, from about 1.70% to about 1.90%, since Mr. Trump sealed the win (see chart, source Bloomberg).

usggbe

I think we have to be careful about blaming/crediting Mr. Trump for everything. While breakevens rose in the aftermath of the election, you can see that they were rising steadily before the election as well, when everyone thought Hillary Clinton was a sure thing. Moreover, breakevens didn’t just rise in the US, but globally. That’s a very strange reaction if it is simply due to the victory of one political party in the US over another. It is not unreasonable to think that some rise in global inflation might happen, if Trump is bad for global trade…but that’s a pretty big reach, and something that wouldn’t happen for some time in any event.

In my view, the rise in global inflation markets is easy to explain without resorting to Trump. As the previous chart illustrates, it has been happening for a while already. And it has been happening because global inflation itself is rising (although a lot of that at the moment is optics, since the prior collapse of energy prices is starting to fall out of the year-over-year figures).

The bond market and the inflation market are acting, actually, like the Great Unwind was kicked off by the election of Donald Trump. We all know what the Great Unwind is, right? It’s when the imbalances created and nurtured by global central banks and fiscal authorities over the last couple of decades – but especially in the last eight years – are unwound and conditions return to normal. But if pushing those imbalances had a soothing, narcotic effect on markets, we all suspect that removing them will be the opposite. Higher rates and inflation and more volatility are the obvious outcomes.

Equity investors don’t seem to fear the Great Unwind, even though stock multiples are one of the clearest beneficiaries of government largesse over the last eight years. As mentioned above, I can see the argument for better business conditions, even though margins are still very wide. But I’m skeptical that better business conditions can overcome the headwinds posed by higher rates and inflation. Still, that’s what equity investors are believing at the moment.

*

A couple of administrative announcements about upcoming (free!) webinars:

On Thursday, November 17th (aka CPI Day), I will be doing a live webinar at 9:00ET talking about the CPI report and putting it in context. You can register for that webinar, and the ensuing Q&A session, here. After the presentation, a recording will be available on TalkMarkets.

On consecutive Mondays spanning November 28, December 5, and December 12, at 11:00ET, I will be doing a series of one-hour educational seminars on inflation. The first is “How Inflation Works;” the second is “Inflation and Asset Classes;” and the third is “Inflation-aware Investing.” These webinars will also have live Q&A. After each session, a recording will be available on Investing.com.

Each of these webinars is financially sponsored by Enduring Investments.

How Obama Helped Trump Win the White House

October 27, 2016 8 comments

At this writing, Presidential Candidate Donald Trump is trailing Hillary Clinton in most assessments of the political map. While it is much closer than the 6-point spread in the national polling indicates (if all of the “toss-up” states on Real Clear Politics flip to Trump, rather than to Clinton as they now lean, then Trump scores a fairly easy victory), the winner-take-all betting markets put Clinton’s chance of victory near 90%. To be fair, though, let’s remember that the betting markets had the Brexit vote failing with similar certainty, even though the polls were similarly close.[1]

The October surprises, which by now are no surprise, have had essentially no effect. The jaded and cynical US public yawned at tales of Trump’s peccadilloes and the shocking, shocking tale that Clinton may have padded her pockets by selling influence while in office. And so…it’s over?

Well, not so fast. While the public now dismisses as normal behavior the sorts of things that we would fire an employee for (or divorce a spouse for) if they happened to people around us, and seems content to elect a flawed candidate regardless of the outcome on November 8th, there is something that they do care about, and deeply: their own money.

It is incredible to me, since I am just as cynical as the rest of the electorate, that when the Affordable Care Act was passed the open enrollment date was systematically placed just a few days before Election Day. That was either great confidence (“this is going to be great! They’ll love us and vote for us!”), great hubris (“it doesn’t matter whether this works, the sheeple will vote for us anyway”) or great carelessness (“oh, rats, didn’t think of that”). Because we now know that over the next several days, millions and millions of Americans will receive letters explaining to them that their existing plan will be outrageously more expensive in 2017 – in some cases, premiums will double – or may not be available at all.

I suspect that a taxpayer in North Carolina, who sees his premium jump 40%, is going to suddenly take notice of the Presidential election and wonder which candidate is more likely to solve that problem. Now, before you write your hate mail to me, let me note and acknowledge a few facts:

  1. I am not voting for either of the two major party candidates. I’m no Trump stooge. I think they’re both awful candidates. This article is just a commentary on what I think will happen, not cheerleading for an outcome I want to happen.
  2. Some voters will not see any change in their premiums because their subsidies will rise an equivalent amount to the premium. But,
    1. Most people who are squarely in the middle class will not get these subsidies. On the calculator at https://www.healthcare.gov, I can see that a family of four in New Jersey, earning $45,000, should not expect to be eligible for a premium tax credit or other savings. According to the Pew Research Center, a family of four with a $45,000 pre-tax income is in the lowest 25% of New Jersey residents arranged by income.
    2. Furthermore, someone who continues to get a subsidy is not likely to be as motivated to go out and vote for a continuation of the status quo as a person who is seeing a 40% rise is motivated to go out and vote for change. So, this is likely to cause a major change in the degree of motivation for one party compared with the other.
  3. Many voters will, instead, get a letter that their existing plan will no longer be offered, and this too will cause angst and anger.
  4. Voters who are covered by an employer plan are not immune just because the “employer pays.” When an employer’s cost for employee insurance rises 40%, that employer will either lay off workers, make them cover more of their own premium costs, or hold down other costs…such as salary increases.

Simply put, unless you are living under a rock you are aware of these dramatic changes in insurance costs and coverage. If you’re one of the few lucky ones to be subsidized (and even more if you’re lucky to have a cheap plan that you wouldn’t have had to get at all before the ACA passed), then you’re probably going to like the current regime. You may even be grateful, and go out to vote your thanks. But this is a small (and expensive!) minority of the electorate. The vast majority is going to see painful and drastic changes in the health care landscape. And they’re going to see it right about now. Again, what is really amazing to me is that the program designers made November 1st the notification deadline for re-enrollment letters.

Aside from the effect on the election, which I think might be dramatic, we need to also think about the effect on the economy. The good news is that while medical care inflation is likely to keep rising, the large jump this year is possibly a one-off effect because the ACA is removing subsidies of insurance companies that previously caused insurance to look cheaper than it really was. But that won’t help this year’s politicians.

The large rise in premiums, incidentally, is also going to have a depressing effect on economic growth next year because it hits the middle of the income distribution the hardest. If Bill Gates sees his insurance costs go up 40%, it’s no big deal. But if Fred the plumber from Poughkeepsie sees his insurance costs go up 40%, he’s going to be buying less of something else that is discretionary. Cars, clothes, meals out perhaps?

The election is mere days away. If Trump wins, despite his every effort to make himself unelectable, he will have one person to thank most profusely: President Obama.

[1] Remember that the betting markets work like options – as time to maturity goes to zero, gamma at the strike price goes to infinity. That is, with no time left the value of the Clinton option – which, since it’s a binary option, is the same as its delta – goes from 100% if she wins by 1 vote in a state that puts her 1 electoral vote over Trump, to 0% if she loses by 1 vote in that same state. Six months ago, one vote would have no effect on option price; but if we are around the strike as we are now even small changes can have large effects on price.

Categories: ACA, Politics

Greece: We Get It

July 5, 2015 2 comments

“When in the Course of human events it becomes necessary for one people to dissolve the political bands which have connected them with another and to assume among the powers of the earth, the separate and equal station to which the Laws of Nature and of Nature’s God entitle them, a decent respect to the opinions of mankind requires that they should declare the causes which impel them to the separation.

“We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness. — That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed, — That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their Safety and Happiness.”

Greece has voted ‘no.’ It should not surprise us that this has happened. The only surprise is that it took this long for “one people to dissolve the political bands which have connected them with another.”

Make Hay While the Sun Doesn’t Shine

February 27, 2014 14 comments

Today new Fed Chairman Janet Yellen jumped on the bandwagon in blaming the recent growth slowdown on the weather.

Here’s what I have to say about the news and the weather.

First, although it’s becoming quite passé to point this out, the weather should account for a slowdown in economic activity – but, since economists were aware of the weather (presumably), it is less clear that it should account for a surprise in the amount of slowdown we are seeing. The chart below (source: Bloomberg) shows the Citibank economic surprise index, which measures how much recent data have exceeded (positive) or fallen short (negative) of expectations. It is not a measure of growth, per se, but merely of the direction in which economists are missing. I have plotted both the US index and the Eurozone index.

cesis

Obviously, economists were far too pessimistic about the numbers in December and January (reflecting data from October to December, and data kept exceeding their estimates. But now they are over-exuberant. So it isn’t that the numbers are falling short; it’s that they’re falling short of where economists (who can presumably recognize snow) thought they would be incorporating the known weather drags. That could simply mean the weather had a worse impact on real people than the bow-tied set thought it would. Or it could mean data is weaker than it ought to be.

Second point: just because the weather was bad should not be taken as carte blanche for the economy to collapse. If the economy was really as strong as equity investors seem to think, should weather be able to derail it so easily? Yes, weather makes it harder to detect the natural rhythm of what is going on, but it wasn’t as if that was easy to begin with. The danger is, as I suggested a week and a half ago, when all news can only be neutral or good. That’s a bad sign for once the weather normalizes again and it gets impossible to shrug off bad news as easily.

Third point: was the weather as bad in Europe? Because, as you can see from the chart above, economists have also been missing on the optimistic side for European figures. To be sure, they’ve been missing by less, and the numbers surprised less on the positive side over the last couple of months, but I don’t know that the Polar Vortex ought to be affecting Italy as seriously as it is affecting Chicago.

All of which is simply to say that the weather isn’t going to be bad forever, so … make hay while the sun doesn’t shine, I guess. Stocks are flat on the year, the hard way (but commodities are +6.5%, measured by the DJ-UBS index; according to our valuation estimates, that should be the normal case over the next few years rather than the rarity it has been over the last few).

It is interesting, too, that as bad as the weather effect has been on the construction industry and sales it hasn’t really impacted the price dynamics at all. The chart below (source: Bloomberg) shows Existing Home Sales in white, and the year/year change in median sales prices of existing single-family homes. Sales are 14% off their highs (seasonally-adjusted, which you should take with a grain of salt due to the unseasonal weather, but notice that the decline started in August when the snow was appreciably lighter), yet prices are still rising at nearly 11% year/year.

ehsl and prices

Now, a housing bull will say that these are the opposite faces of the same coin. They would say, “because there is so little inventory available – according to the NAR, only 1.9mm homes are for sale, which is higher than last winter but otherwise the lowest since 2002 – prices are rising and fewer are being sold because of the shortage of supply.” This is certainly possible, although I wonder at where all of the ‘shadow supply’ and bank REO property got off to so quickly, especially since the pace of existing home sales (and new home sales) remain at such low fractions of the pace prior to 2007 (existing home sales is currently 64% of the peak rate in 2005; new home sales are at 34% of the 2005 peak). How do you get rid of inventory without selling it?

The housing market continues to be a conundrum, but without a doubt prices are rising. And, also without a doubt, rising home prices are beginning to push rents higher. More economists are raising their forecasts for core inflation looking forward over the next year. Of course, readers of this column know that this is old news here. Speaking of which, Enduring Investments’ Quarterly Inflation Outlook for Q1 has been published. Institutional investors and others interested in our services can register for this private report on our website by filling out the contact form and requesting access to the blog.

Finally, I want to make one observation about the complete impotence of the Republicans to respond to the Democrats’ push for a higher minimum wage. It is terribly distressing to see such bad economics from one party (in this case, the Democrats) and such utter lack of common sense responses to bad economics from the other party (in this case, the Republicans). Here is the only question that needs to be answered: if raising the minimum wage has only salutatory effects on the economy and on the working class, then why not raise it to $1000/hour? Why not $10,000 per hour? Surely, if raising the minimum wage is good, then raising it more can’t be bad. Republicans should be amending the bill to make the minimum wage $10,000/hour.

The obvious answer is that if the minimum wage was $10,000/hour, no one would hire anybody – and we all know that, and even Democrats know that, and we all know why: because there is almost no one in the country who can produce enough goods or services to be worth $10,000/hour. If you are hiring people, you have to decide whether you will get enough out of them to afford their labor and still stay in business. The answer is obvious at $10,000. But it’s the same question at $10: can this group of workers produce enough so that I can afford to pay them all $10? If not, they will not be earning $10/hour but $0/hour (or at least some of them will be). We know exactly what would happen with a $10,000/hour minimum wage, and it’s easy to demonstrate it. But the Republicans are absolutely inarticulate on this point, and on most points, and that is why they keep losing arguments where they have the stronger position.

Housekeeping Note: earlier this week I published an article on the Mt. Gox/bitcoin fiasco. If you didn’t see the note (it didn’t get out on all of the syndication channels), you can find it here.

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