Gone again

I will not be posting to this site for the foreseeable future.  I will leave it public for a while, but I have already stripped out some of the more political stuff.  There was lots of that, eh? These past nine months have been painful. I have also removed the stuff that was purely short-term, like commenting on a release.

I will probably make the site private again. If I do, you are free to request access and if I see the request I can’t imagine refusing. But I am not sure what value you might get from that, as there will be no new content.

Again, thanks to all those who read this blog. I am moving on to other projects now.  Bye.

Kevin Warsh for Fed chair?

Update on September 11, 2017

This piece on Medium does a good job of documenting what a zero this guy Warsh is.   My original position was that Warsh, being a zero, might be less threatening than say, John Taylor, who seems more clearly a negative.  But with Trump set to ruin the whole Fed leadership, zero seems more troubling than it did.  Too weak to matter seems less a feature, as time has moved on and some events have played out.

Original post

Former Fed governor Kevin Warsh is apparently in the running to be the new Fed chair when Presidente Trompe kicks Yellen out of the seat for being a Democrat in 2018.

According to Tim Duy, that partly explains why Warsh has recently resumed his bad habit of stinking up the WSJ op-ed page with pointless thought pieces.

Tim Duy does yeoman service going through each of Warsh’s claims in the op-ed and sorting them between wrong and not applicable. That must have been tedious work for Tim, because I assume it is more fun to just let your own ideas rip. But I guess it is good somebody is staying on top of these guys. No. Wrong. Factually incorrect. Incoherent. Ok, now you’re just making shit up. False. She didn’t say that.

I don’t have much to add to Tim’s piece, but maybe just a bit to subtract. Warsh chides the Fed for not having a “strategy” to achieve its objectives, which is a bit odd because Warsh wants the Fed to change one of its objectives so that it will retroactively have achieved it. (If they can’t hit 2% inflation, then why not go for a range of 1-2%? *) Tim responds that the Fed has a strategy, but that Warsh “just refuses to see it.”

I know what Tim is getting at. Warsh is intentionally mischaracterizing the Fed leadership so that he can criticize it. But I don’t think the Fed’s strategy is obvious, because the Fed leadership has decided to depict that strategy as more systematic and less ad hoc than it actually is.

FWIW, I don’t have a problem with the ad hoc approach: it is better to recognize that you don’t really know what you are doing than to act like you do.  This is macro and it is not like things are all settled.  But the Fed has been telling fibs, and these noble lies have begun to pile up to the point where people are noticing.

For example, as I have mentioned a couple times, for some reason the Fed leadership likes to pretend that they are being guided by Taylor-type policy rules but that the appropriate estimate of the neutral rate of interest to apply within them has been shifting.  I would rule that interpretation out on Occam’s Razor grounds and because Taylor-type rules cannot be applied near the zero bound. Yellen occasionally, including most recently, hints at the latter issue, but just not forcefully enough for my taste.

I was pleased, then, to see these two authors at Vox make the point that the neutral rate of interest is a useless guide to the conduct of monetary policy, although they do not share my take on Taylor-type rules more generally. I would add that Yellen is aware of this issue with the neutral rate and that her whole discussion is a deflection.

This fits into a broader pattern of obfuscation. So maybe Tim dwelt a bit too heavily on the idea that the Fed has a strategy that any honest person could easily see.  Admittedly that is a minor point. I don’t want to just link to Tim and say read this. Where is the fun in that?

Beyond that I have a couple half-baked thoughts on Kevin Warsh, which probably aren’t worth much, but I will throw them on the wall anyway.

  • I don’t really understand why Kevin Warsh wants to be Fed chair. They say that job is the second most powerful in DC. But I am not in that camp, because the Fed chair’s marching orders are pretty clearly determined by other people. The Fed chair has a privileged ability to work on economic puzzles and then to act on the solution he or she comes up with. That would seem to appeal to somebody with a background in economics, rather than whatever background Kevin Warsh claims to have. I met him once. He seems mostly like a smooth talker, and I might have detected him dialing up a southern accent for effect.
  • If Warsh were Fed chair, would the organization respect him? He would have gotten the job in part by mischaracterizing what the Fed does and arguably arrogating a position that should have gone to a more talented and dedicated student of monetary economics.  Normally the staff and governors assume the chair knows the broader sitch better than they do. That would not apply in Warsh’s case, so it could be weird that way.
  • I wonder if that might make Warsh less bad than, say, John Taylor. Taylor has a strong academic pedigree and can speak with authority on monetary policy issues. I think what he says with that authority is dangerously wrong, but it is not like he would fail to command respect. Maybe it would be better to have an airhead that sensible people could more easily push around?  In this regard, Warsh might have one of my favorite attractions of a liberal. We liberals know we don’t know.  Therefore, we have no no principles, but do have a 50% chance of accidentally  doing the right thing. That is a pretty high batting average for government work. Conservatives, in contrast, are solemnly committed to doing stupid shit.  In fact, they take pride in acting on little to no information, as Trump did in Yemen. They call that being “decisive.” Warsh might turn out to be a good liberal in the sense of the term implying weakness.

* Warsh confuses two issues here. First, he wrongly implies that the Fed is slavishly committed to hitting precisely 2% over some horizon, rather than on average over time. To get around this non-issue, he proposes a range, which is redundant. Second, he then makes the center of the range 1.5%, rather than 2%. But he does not explain why he wants to lower the inflation objective. Tim says it would just give Warsh a reason to raise interest rates. It is nothing beyond that.  That would fit, so maybe. To me, the simpler point is that Warsh is confusing issues.

Foolproof wrongness detector

Here is a Bloomberg story covering Mohamed El-Erian’s view that the Fed will have to tighten to ward off a bubble and that investors are not prepared for that.  I think that view is ridiculous, which I will get to in a second.

First, though, forecasting the economy, Fed and market is really hard. If you try to do it, then you will almost certainly embarrass yourself, repeatedly if you keep at it.

But have you ever noticed that guys getting their Fed and market calls/guesses right have NEVER been heard to say, well I think the Fed needs to tighten here to stop an incipient equity bubble?

No, that view is invariably expressed by people who have been too hawkish on the Fed and too bearish on the market, often because they got inflation wrong to boot.

We all make mistakes and the temptation to cover them up is strong. But asserting the Fed will add a variable to bail you out is so transparent.  If you see somebody making that claim, there is no need to look. You can know ahead of time that they have been wrong, at least recently.


The Fed’s preferred way of thinking about inflation is not working, not that Fed officials were ever so confident in the Phillips Curve as they pretended. And in response to this, the Fed finds itself in the awkward position of having to “probe” lower on unemployment / tighter in labor markets to see where / if they might get an inflation response.

This is quite dodgy for them because it involves admitting that they (like me) don’t really know what is going on and taking the risk of letting the labor market shoot beyond full employment.  I would not want to be them just now.

But it seems ridiculous to assert that they will want to complicate the task even further, by adding yet another objective to their list, one over which they have little control.  And yet you see that assertion all the time. Practically speaking, its main value is to signal that the asserter has recently been wrong-footed by the Fed.

I ask myself, why does this bug me so much? Ahhh, probably just jealousy that El-Erian and his ilk hog all the attention.  It’s not like these wrong views are going to have any influence. The issues with the Fed and equities are elsewhere. So far as I can tell, people making actual decisions get that.

An aside on the participation rate

JW Mason has revived a debate about the size of the US output gap and the role that depressed labor force participation might play in it. See here for Mason’s paper along with his discussion of its reception.  And then see here for a somewhat testy exchange over the issue.

Just by way of a very brief history, the consensus initially held that the lower participation rate after 2007 was mainly cyclical.  Then some orthodox types at the Fed etc. convinced us that the decline was largely demographic and therefore structural. And most recently, the pendulum has begun to swing back again, in the sense that the doves have become louder. I am not sure if the more orthodox types have really conceded.

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(There was also a side debate about whether the high unemployment rate itself was structural or cyclical. The structural guys in that debate were mostly an embarrassment to the profession, so the less said about that motivated reasoning the better.  That “debate” is over.)

What I find odd about this discussion is the confidence with which many of its participants express themselves.  There is a good chance that one of these highly-confident analysts will end up having been right, but it is hard for me to know which one.  And I doubt I am alone.

A few years ago, when the orthodox types were ascendant, I remember seeing some analysis “showing” that the decline of the participation rate was almost entirely structural, with a big contribution coming from demographics.

One element of that work – sorry, no link, have forgotten – that really struck me at the time was how the economist(s) put trend-lines on cohort-specific participation rates and just breezily assumed that those trend lines were structural.

But trends change, and unexpectedly if you don’t know their source.  I would be willing to bet you a pizza that JW Mason saw that work and just rolled his eyes.  Maybe he can give you the link.

The strong-form of this mistake is to call changes in cohort-specific behaviors “demographics”, on the grounds that identifying them requires looking at cohorts. The great thing about that take is that it makes literally everything demographics. Yeah, if you define demographics as everything, then that sure was demographics!

If I recall correctly, the paper I am having trouble recalling was not doing quite that.  It separated demographics from structural forces applying to various cohorts, presumably independent of the size of those cohorts.  But those trend lines were still pretty brazen.

On the flip, side it is supposed now to be obvious that the labor market is not at full employment until the employment population ratio returns at least to 62%. Do we really know that?

A couple years ago, Blanchflower and Levin presented (not anew) a comprehensive measure of labor market slack that took into account not only the deviation of U3 from its estimated natural level, but also the participation rate shortfall and the number of people working part time for economic reasons. When they produced the metric, it gave a dove signal.

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I have roughly simulated it through today and find that it now shows that the labor market is at full employment.  Probably that is wrong. No estimate is precisely correct  — and who knows if the concept of labor market “slack” even necessarily refers to anything.

But I was struck by Blanchflower insisting that he now realizes he needs to update that metric, presumably to show some more slack.  I am guessing — guessing only — that Blanchflower may no longer be so confident outsourcing estimates of the natural participation rate to CBO, particularly now that the CBO-estimated structural rate has declined to where the part rate actually is.

Not really knowing what it is doing, and realizing that it does not know what it is doing, the Fed is probably going to “probe” for an inflation trigger.  They still have some faith in the concept of full employment (and its effects) and they suspect we are probably somewhere near it. So they would really prefer to avoid having demand growth accelerate here.  This is why tightening is even on the agenda.

But they seem to act like they are resigned to seeing the labor market tighten further, if that is the right word, and I would guess they will remain so until they see some effect on the price side.

Fed not going to attack equites

In the past 24 hours, Bloomberg has reported twice that stocks are resilient.  The first was a news story arguing that stocks don’t seem to go down even when there is a bad news.

And the second was a BV piece by Mohamed El-Erian urging markets to ignore risks that his headline writer suggests they already are ignoring.

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Probably best to dismiss the fears he claims markets don’t even have. Sound.

There was some great purple prose in the El-Erian piece that you might want to take a moment to enjoy.  But it too was basically: markets should be lower and are not.  On technical grounds, that could be taken as contrarily bullish for the short run.

In contrast, Business Insider reports this morning that the Fed has fired off a “stark warning” about overvaluation in markets.  Presumably the Fed’s view is important, not just because they are smart, but because they have the power to do something about that overvaluation.

What is going on here? Are markets resilient or overvalued and about to attract some unwelcome attention from the Fed.  I have a few thought on that.

First and least controversially, the bull and bear takes are not actually opposing sides of the one argument.  The bulls are (were?) mentioning a technical condition that they think they see, which presumably would be relevant at short horizons.

The Fed minutes, in contrast reference a fundamental: valuation, which is a weak force and one that applies at longer horizons.   Historically, US stocks have done better when starting from  low valuations.  (Amusingly, though, over long horizons stock have always done well. [1]  Resolving that is beyond my pay grade. Requires taking a strong view on the importance of survivorship bias.)

The second point is more controversial, oddly to me, but it is one on which I have a strong view.  I would assign zero importance to the idea that the Fed would ever actually do anything about equity market overvaluation, even if the minutes were to imply that policy makers were expressing concern.

Of course, the highlighted passage from the minutes reflects a concern only of the staff, which weakens its importance, presumably even among those who wrongly believe the Fed might tighten if policy makers were concerned about this.

The staff provided its latest report on potential risks to financial stability, indicating that it continued to judge the vulnerabilities of the U.S financial system as moderate on balance. This overall assessment incorporated the staff‘s judgment that, since the April assessment, vulnerabilities associated with asset valuation pressures had edged up from notable to elevated, as asset prices remained high or climbed further, risk spreads narrowed, and expected and actual volatility remained muted in a range of financial markets. However, the staff continued to view vulnerabilities stemming from financial leverage as well as maturity and liquidity transformation as low, and vulnerabilities from leverage in the nonfinancial sector appeared to remain moderate.

Emphasis added

That is a thorny discussion on which I have been plenty tedious over the years. For now, let me just say that I am so far batting 1000 on that and that the most eloquent expression of the argument will be delivered with the passage of time itself.

For now, fwiw, I just totally ignore the idea that the Fed will do anything to address a bubble in the equity market. They might address a bubble elsewhere, but not with monetary policy, even there.

But leaving aside the Fed’s (boldly) presumed authority on this issue or the debate about whether they might act on it, what is the evidence that equities are even overvalued?

I approach this issue with some humility and trepidation because I have been arguing for the past couple years that equities look about fairly priced to deliver positive but subpar returns over the longer haul.  The effect of weaker growth prospects is at least fully offset within a market DDM by low Treasury real yields, and the low level of economic volatility seems to be the tie breaker favoring a higher multiple.  But all this says that they can stay full to deliver the low returns consistent with the slow growth and lack of case for a high “risk” premium.

In the event, I should have gone with Antonio Fatas who said, nope, they are sccreaming cheap!  Leaving aside whether he was/is right on the merits, my wealth would be higher had I assumed he was!

But just because I have been wrong for two years does not mean I should change my view. Having spend some (the minority) time on the sell side, I am made of sterner stuff than just that!  As I see it, there is not really much reason to change my take.   Wake me up when bond yields are about to spike or a recession is imminent. Even then, could probably only get flat.  You need to be smarter than I am to pay what seems to be the premium.

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This is hokey, crude and low-conviction stuff. Whether the earnings yield should be “adjusted” for potential growth is an ugly issue that I have not resolved. Separately, please don’t interpret the blue line being above the black line in the last chart as evidence that equities are cheap. Maybe they are, but that is not the point of the chart — or my view.

They look unexciting but not overvalued, certainly not demonstrably enough for the Fed to act. And the reasons for this have not changed either. So here is just an update of the chart, reflecting some new data and a sell-side like decision in this case to show you just the half century over which my very crude proxy has behaved roughly as one might expect.  (Prior to the mid-1960s, you cannot link the estimated premium to economic vol, even roughly.)

[1] I need to get short because stocks are 1 ½ sigmas above avarage valuation. And from here they have historically generated… … um  let me look that up … … oh +4% real over time?

Is this recovery really the weakest?

Brad Delong takes Taylor, Hubbard Cogan and Warsh (THCW) to task for implying that the weak growth achieved, roughly, under President Obama is an anomaly and reflects a uniquely bad policy backdrop.  Delong points out, convincingly in my view, that the growth slowdown is a long-term trend and that THCW are guilty of data mining.

Having gotten into a bit of a lather over this, Delong then digs up some evidence that roughly this same cast of characters misstated the impact of the Obama stimulus by assuming that it would be met by Fed rate hikes which, yes, would have blunted its effect. But the whole point of such stimulus was to offset liquidity trap, which means that assuming the Fed offset was dirty pool.

That liquidity trap would prevail was borne out by events, but it is also something that should have been known in 2009.  Moreover, and related, any fiscal expansion that forced the US out of liquidity trap would have been a success, virtually by definion, at least on the mainstream macro logic that these economists all claim to accept.

Delong has an irritating tendency not just to disagree with people but to imply that their disagreement with him reflects some sort of professional misconduct.  One should be more polite and extend the benefit of the doubt, arguably. But on the other hand, one has a limited numbers of hours in a day and days in a lifetime. So I actually value knowing when economists are full of shit and making it up. On this, opinions will vary.

That is all just by way of introducing my reaction to the very first sentence in THCW, which got my back up and inclined me to side with Delong, which – in fairness – I would have anyway.

Since the economic recovery began eight years ago, the rate of economic growth has averaged only two percent per year, the weakest economic expansion since World War II.

Strictly speaking, this sentence is true, because the average strength of an economic recovery or expansion is conventionally measured only while that upswing is ongoing.  And by this point in time of the “Bush” cycle the economy was collapsing, which on THCW reasoning does not count.

But there is another way to put this.  Right up until the economy started melting, yes it was stronger under Bush than Obama. Good to know. And right up until John Wilkes Booth assassinated Lincoln, he was a beloved DC actor.

Neither Bush nor Obama actually caused GDP.  But the way THCW choose just to describe the agreed facts, in their very first sentence, seems intentionally misleading to me. So, yeah, I can see why Delong is harsh.  I got his point after ONE sentence of THCW.

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Note that the chart above depicts the two weakest cycles in postwar era.  That these two weakest have been recent fits both THCW (anomalous) and Delong (trend).  Note also that I overlay the “Bush” cycle onto the time scale of the current expansion. By this “point” in the last expansion, it was over.  The data for Last Cycle are shown overlaid only to December 2016, because the next two observations are actually this expansion.  

Uh-oh, now the innumerate bulls are using the CESI

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I really doubt the guy who made this chart knows or remotely cares how the Citi Economic Surprise Index is built.  But the chart and related discussion (not shown) are an example of one of the three ways this silly little indicator is abused.

In this case, buddy derives satisfaction from the fact it has “bottomed.”  This is a mistake common among innumerate dummies, as I have gone over on several prior occasions. (By construction, the index is fated to rise when deeply negative, even if we know nothing of the future evolution of the economy. And realization of that inevitability tells us nothing about the future of the economy and perhaps nothing even of its recent past.)

Separately, Bush Junior once asked famously, is our children learning? Based on this bit of correspondence from a friend, I would have to say, yes they is.

This sh_t kills me.  No one denies the US economy is on solid footing; there might be a debate on whether we are accelerating but there are very few if any at all who think we are on the precipice of recession.  The comedy is this Citi Surprise Index, so now it’s turned up but even when it was falling off a cliff earlier in the year stocks went up regardless.  So who even cares?

Other People’s Stuff II

Updated: September 12, 2017

America’s got talent!   I tend to think of military intervention as a last resort and to be avoided. But there is a five-step-program sense in which military intervention might be appropriate here.  Randy, we have gathered all your friends here because we love you and want to stop you embarrassing yourself with such weak behavior. Perhaps you could get a job in the private sector?  The internet is forever “lads.” Ew.

Noah Feldman goes after Senator Feinstein for anti-Catholic bias in her questioning of a potential judge.  According to Feldman, Feinstein hinted that American Catholics’ first allegiance might not be to the USA its constitution. It must be the distorting influence of AIPAC, the American Irish Political Action Committee!   The argument resonated with me because, as the joke goes, I don’t believe in God, but I’m sure as hell a Catholic. I would add only that I don’t believe in the church either. Anyhow, a much better argument would have been that while Catholics are fine, there are already far too many of them on the Supreme Court already. I like beer, but realize it should not be the only item in your diet.  In fact, the ruling right-wing conservative junta has long been wall to wall papist, with Gorsuch just extending the pattern.  It is almost like SCOTUS stands for Several Catholics of the United States.  So rather than dissing Catholics, the much more polite thing to do would be to insist on more Jews, Congregationalists or — best yet — atheists.

Brad Delong takes Michael Boskin to task for lying about easily-confirmable facts from the early 1990s. (Sorry the link is to Delong’s site and not to the post specifically.)  I admire Delong for being willing to wade through this stuff.  But I am not so sturdy.  Instead, I wonder why guys like Mike Boskin would need to lie like this.  I get ideology: have some of that myself.  I also get lying if that is required to feed your family. But why do these established guys put so little weight on their dignity?  Is seventy-something Mike Boskin, prosperous and still respected, expecting some sort of reward for staying on message?  I don’t get it.  Partisanship is the easy answer. But why so strong? Weird.

I enjoyed this piece from Barry Ritholtz reviewing The Unpersuadables,  a book from 2014 covering, among other things, how evolution has selected for some traits that might not work so great (Ritholtz adds) in financial markets.  The ideas are not new, but Ritholtz tries to link them to investing in a way that seems sensible, if not particularly conclusive.  I’ll probably pick that book up.  My only pushback is that Ritholtz, or maybe his editor or illustrator, buys into the wrong view that evolution is “progress.” It ain’t. Environments change and with them the species best adapted to survive.  There is one thing that Ritholtz did not mention that I will.  Behavioral finance type errors aside, I really suspect that some fund managers are suited to some environments and not to others. For the past decade, global macro funds have sucked air. I doubt the people there got stupid or that their luck ran out.   The environment changed is all. They blame QE for having distorted everything, which is funny, because that is only evidence that they are not now seeing it. Still,  to me, you can hold your head high if you killed it when you saw it and then did not later get killed by it.  Guys like that still have claim to have beat the EMH. I dunno. I think that is a fun thought, even if totally wrong!

From Economist’s View (a source I use often), I see that Tim Duy has a blog post debunking the idea that a surplus of multiple job holders is evidence that the labor market has not really approached full employment. Tim’s contribution is to point out that the number of multiple job holders is actually quite low when expressed as a ratio to total employment (or the labor force, I would add).  Surely, this is tied for the easiest debunking of macro BS achieved this quarter.  I have often noticed the utter lack of quality control on Wall Street. Explains the first 5 years of my career — plus 08!  One bit of free advice to Tim, though.  Just because there are dumb arguments for X circulating does not mean that X is untrue. In 08, I was pretty expert on why MEW was not the main driver of consumption.  Spent a lot of time documenting that, which would have been better spent looking into the CDO tower of doom.

Bloomberg has a long piece describing the business culture over at my Westport neighbors, Bridgewater.  I will spare you the discussion of “Principles”, but this anecdote is pretty fun and the concluding parenthetical part reminds me for some reason of Kim Jong Un, who is also in the news.  “One former employee, who left after less than two years and would speak only on the condition of anonymity, recounted a Maoist-like struggle session where a young male ­employee was berated by a group of peers and superiors for not being good enough. Instead of helping him improve or getting rid of him, they needed to “get in sync” about the employee’s perceived inadequacies, he says. The encounter ended, he adds, with the man firing himself. (Bridgewater says it isn’t familiar with this episode and that in its most recent quarterly employee survey, 99.4 percent of respondents said communication is open and honest and their manager cares for them in a way that’s meaningful and genuine.)” The employees later went on all to shoot 17 holes in one at the civic golf course, Longshore.

I learned some nice history from Cass Sunsteins “plain answer to the Trump pardon question.”  In particular, Sunstein relates an exchange between Madison and Mason seeming to prove that the Framers took a dim view of the president pardoning those whose crimes he may have “advised.”  Seen in this light, Donald Trump ought not pardon his co-conspirators.  That would be against the spirit of the constitution, in Sunstein’s view. But I think Sunstein’s historical account actually drives at a conclusion that is opposed to the one he favors.  If you read his piece carefully, you will see that Madison tried to comfort Mason on his fear of abuse of the pardoning power by assuring Mason that in the event of such an abuse the ability of Congress to impeach would provide the obvious remedy. This raises two important points, the first of which Sunstein glosses over.  Re the first, Sunstein is implying that Madison — whom he takes to be authoritative on this issue — accepts that there is no constitutional constraint against abusing the right of pardon, except that of impeachment.  Clearly, that puts him much closer to Trump apologists than to, say,  for example, Laurence Tribe who rejects that the legal right of pardon is absolute.  Second, and more as a point of context, if Sunstein is right about Madison and if Madison is in fact authoritative, then this is quite a failure of foresight on behalf of the Framers, who are meant to have been so prescient.  Clearly, James Madison could not have foreseen — and did not foresee — a Congress so utterly devoid of concern for limited government as the current GOP version.  And speculating wildly, well beyond my competence, I would say that you can’t mostly blame Congress for the current malaise.  The American people themselves are being recklessly indifferent to the survival  of their constitution.  Another Framer, Ben Franklin, warned famously that the US might not be able to keep its republic. That guy had vision!

Slate runs a piece discussing how Democrats are getting all hot and bothered these days over military types.  It is hard to attack the Democratic candidate for being (typically) “effete” if she can land an F-18 on an aircraft carrier and has done bombing raids over Iraq and Afghanistan, etc.  In my view, there are two things going on here.  First, it is a sad comment on the current political culture that prospective supporters of either major party, including the one on centre/centre/left, believe that military types are uniquely qualified to comment on policy and to govern.  It seems this has long been a strand in US politics, even though it is contrary to the spirit republicanism and civilian government.  But it seems stronger now.  Second, the Democrats want to take back Congress.  Doing so may require dealing with the country as it actually is, rather than as it might be in some ideal state.  The country needs urgently to weaken Republican control, so I say by all means — win.   But this taste for genteel fascism, even among Democrats, is a sad comment on the country and a bad omen.

Don’t keep it too simple: Updated

Update on August 11

I wanted to add a couple charts to document the tension discussed in the text below.  My timing is determined by being back at a proper computer and by the release of the jobs data and then CPI for July.

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We are arguably in the range of full employment.  The Blanchflower-Levin proxy takes account of the gap between the participation rate and its estimated “natural” level and the share of people working part time for economic reasons — as well as the conventional U3.

It shows we are the equivalent of about 20 bps too high on unemployment still, although easily within estimation error of “full employment.” We don’t really know, but it is no longer a no brainer that there is plenty of slack. We also don’t know about the importance of slack. Heck, there is a lot we don’t know. We used to know that there was a strong case for the Fed being dovish, although man did people deny we needed it — and believe we had it.

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Based on the CPI and PPI reports for July, JPM (which tend to be good at this) estimate that the core PCE deflator will have been up about 1/2 of 0.1% during the same month. Assuming the Dallas Trimmed Mean is up a similar amount, a couple of my usual charts would update as indicated above. I show the Dallas Fed for completeness — and to tweak the hawks — not because I think Dallas has some super secret sauce. If you ignore more falling than quickly rising prices, then yeah the inflation rate recently looks marginally higher. Who cares?

Anyhow, that’s the tension, which I take a stab at trying to resolve — or figuring out how the Fed will try — below.

Original post

I noticed this week that Bloomberg Prophets published a couple pieces on the Fed’s strategy that had diametrically opposed views of the central bank’s main priority, but reflected a common desire to boil the inevitable complexity down to the one thing.

Here is Jason Schenker telling us to ignore the labor market data and to focus only on the inflation numbers, which are an indirect measure of labor market tightness anyway.

Although the July employment report was strong, it does nothing to fundamentally change the outlook for the Federal Reserve. And employment reports in future months are likely to similarly take a back seat to the most critical trigger factor for monetary policy: inflation — or lack thereof.

And here is Tim Duy, saying pretty much the exact opposite about the focus, while also insisting that the whole debate can be radically simplified:

As far as rate policy is concerned, the Fed remains fixated on the idea that the U.S. economy is near full employment. The unemployment rate currently stands at 4.4 percent, below policy makers’ median estimate of the natural rate of unemployment of 4.7 percent. Moreover, central bankers believe that the pace of jobs growth is sufficient to place continued downward pressure on unemployment, allowing them to look through weak inflation as only transitory.

(Tim reiterates these ideas following the jobs report here.)

I am no fan of the idea that we can write down a simple rule relating the optimal policy rate to some sort of weighted average of the position of the labor market and core inflation. See here, here, here, and here for my disses of the Taylor Rule and its ilk.

But, while Taylor and like are too reductionist to work in the current environment, it would seem to me to be even more unrealistic to boil the Fed’s focus down to one variable or economic condition. Instead, here is — inevitably roughly — what seems to be going on.

The Fed seems to have accepted that its earlier assessment that the labor market had effectively achieved full employment was probably premature. And I suspect they are having extreme doubts about the validity of the Phillips Curve framework itself, which is central in the Fed’s inflation forecast and in the pretense that it can manage two objectives with (let’s be honest) one instrument.

The Fed is going to let the unemployment rate drift lower until they see a response on the inflation side, whether it be in prices or maybe wages.  This approach must be extremely unsatisfying to them, which — of course — they will (implausibly) describe as a “communication” challenge, to bury that they are in fact flying nearly blind.  The state of the world and macroeconomics is not their fault, so they feel free to fib a bit.

Frustration and fibs aside, low inflation is making them tolerate the likely prospect of the labor market tightening to above full employment, as they estimate it.  But their sense that we are probably somewhere near full employment is why tightening is even on the agenda.

Their objective right now is to slow — not reverse — the tightening of the labor market and to avoid the risk of eventually having to hit their brakes hard.  Achieving this will be tricky, and may to require the funds rate to rise much. Again, see Taylor-does-not- work.

Yeah, that’s complicated, vague, hard to explain and betrays a lot of ignorance at the Fed (and elsewhere).

Credit impulse vs automatic x-leveraging

In this post, I want to argue briefly that Jason Benderly’s automatic deleveraging / releveraging framework is superior to Deutsche Banks’s notion of the credit impulse, even though the arithmetic involved in each concept is similar.

I won’t get into great detail here, because that would be tedious and because I don’t want to steal Benderly’s intellectual property.  My points here might be interesting to those of you who already have access to these approaches and wonder why they are sometimes deployed to support different macro outlooks.

For the rest of you, if this interests, I suggest you get in touch with Jason at Applied Global Macro Research.  His deleveraging thesis was very helpful back when the bears were worried about deleveraging, before — for example — Bridgewater woke up, smelled the coffee and retroactively called it “beautiful.”  (Oops would have been more honest, especially from a firm favoring radical transparency.)

Incidentally, the timing of this post reflects JPM’s calendar-Q2 results and the contemporaneous upturn recently of bank lending growth.  It is not that there has been some meaningful inflection in the economy itself.

Ok, on to my simple point.

The main contribution of DB’s credit impulse perspective is to look at the right derivative, the one that correctly relates credit to aggregate demand growth.   The deleveraging bears wanted to look at the ratio of total credit outstanding to GDP, note that the line was going down, and draw dire implications.  DB (and perhaps others) corrected that wrong intuition with its credit impulse.

They pointed out (and still do) that the flow of aggregate demand supported by credit is determined by the flow of credit itself.  If that flow quickens, then the contribution to growth should quicken and — if you think credit determines, which I don’t — nominal demand growth should speed up.

Closely related, if the flow starts off extremely depressed, then its quickening might leave the ratio of credit to nominal demand on a declining trend, and yet the contribution of the credit impulse might still be positive.

This ain’t rocket science, but doing the arithmetic here correctly can steer you away from some pretty big mistakes. The most costly mistake was the notion that deleveraging meant the rate of growth of credit-financed spending would be low.

One problem with the credit impulse perspective, though, is that it is too often presented as causal and leading.  For example, if the credit pulse is positive, then we should be bullish the economy and vice versa. That gets the causation wrong, IMV, and leaves some useful information on the table, which Benderly’s automatic deleveraging / releveraging perspective picks up.

For Benderly’s approach, let’s just focus on the deleveraging idea, which was probably the more helpful, although both were helpful. And then let’s just say that releveraging is the converse.

As mentioned, automatic deleveraging starts with a bit of arithmetic very close to the credit impulse approach. But it is fussier about relating credit growth to the components of aggregate demand that are actually credit-financed (basically all forms of investment). And more to the point, it gets causation right, by my lights anyways.

If the flow of spending in credit-intensive components of aggregate demand is currently at a depressed level, then we can make two forecasts. First, we can project, that the ratio of credit outstanding to nominal demand will continue to fall “automatically”, pretty much irrespective of the outlook for nominal demand growth.

Second and very closely related, we can then insist that there is no logical contradiction between a high-conviction view that deleveraging (as conventionally defined) will continue and an upbeat view on the economy. *  There is no need to wait until the credit flow data — measured even as impulse  — have turned before getting upbeat.   This was the key advantage that Benderly had over DB.

That was then, and this is now.  In the current environment, credit-financed spending ** has recovered towards normal levels relative to the broader economy and so automatic deleveraging has predictably been replaced by releveraging.  I say “predictably” because I predicted it and actually mentioned to Jason that he might want to update his perspective to emphasize releveraging.  The student had learned from that master and had seized the pebble!

So US credit growth seems likely now to outpace overall GDP growth, for at least as long as investment (of all sorts) spending continues to track with GDP or slightly stronger, which probably means basically til the eve of the next recession.  I guess that is “good” if you are cheering for credit growth.

But it is no more bullish the economy than deleveraging was bearish.  In fact, to the extent that maintaining the flow of credit-intensive spending requires a bit more credit growth, if makes the economy slightly more exposed to any disruption in the flow of credit, from the supply or demand side.

I have suppressed here any discussion of the distinction between credit supply and demand — in order to simplify.  I have assumed that credit demand is largely endogenous to real-side developments, while ignoring supply, which — in fairness — has not been a major determinant of wiggles in the economy post crisis.  That could change obviously.  The discussion around it is a separate one left for another time, but it is not necessarily unimportant.

This post just goes over the difference between x-leveraging and impulse.  The latter seems to do the arithmetic properly, but the former has the additional advantage of getting the direction of causation right and is more helpful for forecasting.

* After the crisis, Benderly had an upbeat view of the economy, partly because of his insight into automatic deleveraging. And for the part of the economy where credit was relevant (and which the stock market disproportionately capitalizes) he was spectacularly right.  GDP growth was been held back largely by weakness in credit non-intensive spending, particularly during the early post-crisis period during which Benderly was pushing automatic deleveraging.

** This is more true of business investment than household outlays on housing and durables, which have recovered from their lows by briefly achieving quite strong growth, but remain fairly low in level terms by historical standards. I will update the relevant charts when I have access to more tech.

The debt debate is relevant now

Take a look at the chart below.  I suspect it might generate a couple reactions in many of you.

The first could be, wow those are some ugly colors right there.  Fair point. Green for go and red for stop is pretty cheesy.

The second might be, stop trying to scare the shit out of us: you sound like Larry Kotlikoff or –even worse — Stan Druckenmiller before Trump got elected and it was all ok for some weird reason.

But please bear with me. I am not one of those guys.  In my view, the US has plenty of fiscal capacity, and I was actually down with attempts at fiscal stimulus when the US economy was in liquidity trap, and stimulus would not all predictably be just offset by the Fed.

Screen Shot 2017-05-30 at 10.13.39 AMThe point of the chart is only to say that the question of fiscal capacity is relevant now, particularly with the US Congress debating whether to implement fiscal “stimulus” — to Fed rate hikes 😉 — which may or may not be be offset by cuts to entitlement programs.  We could easily imagine a combination of policy changes that would push the federal debt/GDP ratio to a record high within a decade. Is that ok? Opinions vary.

Some economists will tell you that this does not matter and that obsessing about the path of the debt/GDP ratio just reflects a misunderstanding of how the payments system works. For example, MMT holds that the US fiscal capacity is not limited by the size of the debt per se, although the deficit may need to be tightened occasionally if aggregate demand growth is running too hot.

An alternative, weaker-form, argument to which I subscribe is that the US has plenty of spare fiscal capacity. Any mistakes made today are not likely to cause immediate trouble, but would be unhelpful from a longer-term perspective.

Moreover, we ought not rely on the bond market “vigilantes” to warn us if we are acting improperly.  Among other considerations, the bond market might easily price the (contractionary) effects of eventually dealing with the deficit through orthodox means. The bond market vigilante story is not only stupid and demonstrably wrong, but it is also an affinity fraud.  “Clients” like to hear how heroic and important to society they are.

MMT seems right, then, that the bond market will not freak out soon, at least not over the debt.  It is just that the reasons for this — and the implication – are different from what MMT would describe.

We can reserve that important debate for another time. The purpose of this brief post is just to point out that this debate is currently relevant. It is not some abstract academic thing that looms 20 years out.

One caveat here is that my take on the importance of this issue is not falsifiable, which I readily concede is a big weakness.  If I am right about this, and if we get the ill-timed fiscal stimulus — to Fed rate hikes 😉 — anyway, it is easily conceivable that the bond market stays serene, with yields backing up only by enough to stabilize the macro backdrop in the short to medium term. That result would be consistent with both MMT and my take.

I am not sure what to do about that. In real time, which is what matters for policy implementation, this stuff is just not falsifiable, at least if my view of the world is right. [1] But I will have some speculations and argument about this later.

[1] If the fiscal alarmists were right, then the rising debt would trigger an immediate crisis in the bond market, followed presumably the need for a correction, which would be painful. But, fwiw, I share with MMT enthusiasts the view that those guys are nuts and/or totally full of shit about what they even believe. They have gone utterly silent since the election, predictably.


Screen Shot 2017-05-30 at 9.17.20 AM

Here is a picture of CBO’s long-term baseline, out to 2040. I did not want to go out all the way to 2040 in my simulations because I did not want to appear alarmist. We all agree that such runaway debt is unlikely to happen, which is actually the serious point I want to make.  If the debt cannot run away, then we need to consider now what that means for  policy and not just pretend that the “payments system” will make it all ok.

But this chart gives you a sense of the longer-term history. And unsurprisingly, the CBO forecast numbers look like my second highest simulation.  No additional fiscal ease; passive widening of the deficit in response to “demographics” and real rates back to the economy’s growth rate.

One final point, yes, there is great uncertainty around these numbers.  But if the base case is both fair and troubling, then I am not sure that symmetrical uncertainty around that would be a feature.


The prevalence of “and” in this note is less than 2%. Drop the mic.