Inflation options

From the lovely Minneapolis Fed website that computes probabilities from option prices.  

What about Japan?

What about Japan? It's a question I often hear from advocates of fiscal expansion. Japan has huge debts and no crisis or inflation (so far). Doesn't that prove the US can borrow a ton more money painlessly? 

I offer two new points today: 1) Not every high debt country is so happy. 2) Just what did Japan get for all its fiscal stimulus? Indeed, I will start asking "What about Japan?" Japan seems a tough case for those who advocate that fiscal stimulus will save us from secular stagnation, or that huge spending programs bring prosperity in other dimensions.   

1. Picking and choosing

Here, fresh from the April IMF Fiscal Monitor  is the list of top 30 countries sorted by debt to GDP ratios. I boldfaced larger countries. 

Yes, Japan is up there at 256% of GDP. The champion is Venezuela however. Sudan and Eritrea are not particularly known for economic prosperity. Greece and Italy are not held up as examples to follow either. Serial defaulter Argentina is behind the US already. 

If Japan is sustainable, that doesn't mean all large debts are sustainable. It means there's something different about Japan than the other countries on the list -- or ones now lower down on the list because they already defaulted or had crises. 

2. So what did Japan get for all that debt anyway? 

It was not always thus. Japan started borrowing heavily in the 1990s from a debt/GDP ratio of 63%. (For some reason the IMF does not have US data before 2002.) 

Those debts come from deficits, of 5-10% of GDP every year. Since 2006, the US has been behaving a lot like Japan, or more so. We only have less debt because the US ran surpluses through the 1990s. 

Japan has had perpetually low GDP growth, low inflation and zero interest rates since the 1990s. I view it as low "supply" growth, but it ought to be the poster child for "secular stagnation" fans. 

So I turn the question around: If massive deficits, including lots of "infrastructure"  are going to boost the US economy, why did they not do so for Japan? 

Update

In response to tweets about why is Japan different from the US,  

I did not want to repeat old points. Japan's debt is long-term, held by domestic people, pensions and central bank. US debt is short-term, held by foreign central banks and financial institutions. Our debt is much more prone to run, and a rise in interest rates will feed quickly into the budget. Japan also has accumulated assets from trade surpluses; we have the opposite. Japan's debt is held by old people and subject to estate tax. A lot of Japanese hold bank accounts, as mutual funds and similar investment vehicles familiar in the US are less prevalent. Bank accounts flow in to reserves, backed by Treasury debt. 

More importantly, Japan  does not have looming unfunded Social Security and Medicare, underfunded pensions, contingent liabilities (Fannie and Freddy guarantee most home mortgages, who is going to pay student loans?) bailout guarantees and more.

 Sustainability is about debt vs. ability to repay; about future deficits;  not debt alone.

Japan's slow growth for three decades comes from microeconomics, taxes, regulations, demographics, slow productivity, not money, stimulus, "aggregate demand." 

Proxies

A correspondent asked for comment on the new ESG trend among asset managers. For example, BlackRock, and the recent Exxon upheaval with two new green directors (here, but cautionary WSJ coverage here, pointing out how empty the whole Exxon affair really is).  I'm sad to see even Vanguard (which has a lot of my money) going along on this...trend. 

Could you offer some thoughts about the trend of asset managers voting more critically this year? Are the big fund firms like BlackRock getting too far removed from the wishes of their customers? Other analysts say that BlackRock and other ESG-minded fund firms are only following the wishes of their younger investors who care more about those themes, maybe that makes it all ok?

My answer: 

As a private property fan, if the owners of a company want to spend its money on pointless virtue signaling, or important but unprofitable save-the-planet and cure-racial-injustice initiatives (depending on your point of view),  that’s up to them. I would rather get rid of the whole corrupt non-profit status anyway and see lots of organizations organized as corporations devoted to causes right and left. 

The issue here is representation. A very small minority is making these decisions on the behalf of a large and unrepresented majority. For example, if you have a company 401(k) managed by a plan, invested in a mutual fund, who hires out their proxy voting to a service, the decision to trade money for social good, and just what constitutes social good, is a long way removed from your preferences. (Me and Vanguard, for example.) 

Brazilian Inflation

This marvelous plot comes from an interesting article, The Monetary and Fiscal History of Brazil, 1960-2016 by Joao Ayres, Marcio Garcia, Diogo A. Guillén, and Patrick J. Kehoe. The article is part of the Becker-Friedman Institute Project, complete with a big and now easily available data collection effort, and forthcoming book. 

If you want a deep historical and economic analysis of fiscal and monetary interactions, this is an amazing resource. And it summarizes historical episodes that North Americans just might want to know more about soon! 

(HT Ricardo Reis who pointed it out in a great discussion last week, that I will post as soon as it's available.) 

NBER monetary economics is up to date

I just got the program for the upcoming NBER summer institute monetary economics conference program.  Who says academics aren't up to the minute on policy issues? This will be interesting. 

 

r less than g seminar

 I gave an Economic policy working group talk at Hoover on Wednesday, on a little essay "r<g" with some earlier thoughts from "low interest rates and government debt" If the above embed doesn't work, it's on the Hoover webpage here.

Does an interest rate lower than the growth rate of the economy mean that debt is a free lunch, or at least a really cheap snack? I don't think so. Major points: the r<g scenarios of one-time borrowing or financing a small deficit are irrelevant for the US actual fiscal issues of perpetual huge deficits and exploding debt. I also grapple with the economics. An economy can have a well defined debt equals present value of surpluses, in which deficits must be repaid, yet show E(r)<E(g). The usual finite horizon discount factor tricks can blow up. Toward the end Markus Brunnermeier catches a subtlety important to my characterization of his work, which I will fix in the next draft, though the existing points seem to go through. (Thanks Markus for showing up and pointing it out.)  

I started with a bit of a snarky comment which I now regret, that r<g had fallen out of favor relative to "we have to pay for it, raise the corporate tax." I gather the big budget to be announced Friday moves discussion of "debt sustainability" away from debt to GDP ratios and to interest costs. So r<g, just how long it will last, and just what falls apart when it changes is like, will be back full force in the policy arena. 

Lots of r<g papers are being written with many subtle mechanisms. This is an effort to get to basics. 

Weisbach advice

I got a chance to see the page proofs of Michael Weisbach's upcoming book, "The Economists' Craft."  This leapt out at me from the preface: 

A second observation I have made over the years is that, perhaps because of a lack of good advice, many scholars, both doctoral students and faculty members, constantly make the same mistakes. Far too many publicly circulated papers contain incredibly long, mind-numbingly dull literature surveys; introductions that go on and on before they tell the reader what the point of the paper is and why the reader should bother to waste her time on it; data descriptions containing insufficient detail for a third party to replicate the results; tables that are unnecessary, badly labeled, or hard to understand; or overly dry prose written in the passive voice and apparently designed to put the reader to sleep. In addition, many scholars manage their time so badly when giving presentations that they do not get to the main results of their paper until the last five minutes of the talk. Their presentations are often poorly designed, with slides that are incomprehensible or even unreadable owing to their use of fonts so small that participants sitting more than a few rows back cannot read them. Young faculty routinely mismanage their career by not having a coherent research agenda, not getting their papers to journals, or not making connections with people in their field who teach at other universities. Sometimes they do not even bother to show up for seminars in their field at their own university.

 So true. This book's contrary advice will be very useful. 

The price of indulgences, 2021

 

Source. My correspondent provides the answer: 

5bps: IVV (column #3) (iShares Core S&P 500 ETF)

15bps: ESGU (column #1)  (iShares ESG Aware MSCI USA ETF) 

30bps: LCTU (column #2) (BlackRock U.S. Carbon Transition Readiness ETF) “Sea change” quote from BlackRock here 

I have not independently checked, though the answer hardly matters. The fees and portfolios tell the story. Obviously any claim that this ESG portfolio will outperform after fees is ... strained. 

When I did my Senate testimony on financial regulation and climate change, someone (I forget who)  suggested that financial regulators need to really crack down on ESG, carbon, diversity, and other virtue claims by investment managers and large corporations. I heartily agree. Of course, we have different motivations.  I got the sense that the person suggesting it wanted to make sure companies really did keep all their virtuous promises. I think that being forced to document their virtue, with criminal penalties for securities fraud hanging in the balance, would show just how empty this whole exercise is. 

Update: To be clear, I'm all for the free market. If people want to pay 30 bps for glossy feel-good marketing materials (click the above link) attached to their S&P500 fund, more power to them and the producers of such materials. Of course, central banks who have spent 30 years bemoaning "bubbles," "overpricing" "speculative enthusiasms" might not want to be piling on to such efforts. Again. 

Cruz on crony capitalism

Senator Ted Cruz wrote a blistering Wall Street Journal Op-Ed decrying CEOs who pander to Democrats by making profoundly uninformed public statements. He announced that he will no longer take money from their corporate political action committees. And, he states

This time, we won’t look the other way on Coca-Cola’s $12 billion in back taxes owed. This time, when Major League Baseball lobbies to preserve its multibillion-dollar antitrust exception, we’ll say no thank you. This time, when Boeing asks for billions in corporate welfare, we’ll simply let the Export-Import Bank expire.

Cruz' statement is unintentionally devastating. So what about last time? 

So there it is in front of us, in writing, from a major politician. Political support, and campaign cash bought $12 billion tax breaks, antitrust exemptions, and Ex-Im subsidies. From Republicans. So much for any public policy pretense. And if those CEOs just figured out who has the power to hand out goodies now, and the Democrat's demands for public obeisance as well as cash, well, it's a lot harder to object that the CEOs fall in line.  

Infrastructure and jobs

William Gropper, Construction of the Dam, 1938

To many on the left, it's always 1933. Building "roads and bridges" will "create jobs," soaking up the mass army of unemployed desperate for work that they seem to see. 

Driving around though, I notice that we build roads with big machines, not lots of people. And construction jobs are high-skill jobs, not people with shovels. "Shovel-ready" itself is a misnomer. Nobody uses shovels on a construction site anymore, they use a backhoe. Neither you, reading this, nor I, nor an unemployed Wal-Mart greeter or bartender could do much of anything useful on a road construction site. 

On a lark, I went to the Bureau of Labor Statistics to see just how many people are employed on roads and bridge construction. 

	Latest	Feb-Mar change
Total nonfarm	144,120.0	916
Construction of buildings	1,689.3	17.8
Heavy and civil engineering construction	1,062.9	27.3
Water and sewer system construction	183.8
Oil and gas pipeline construction	134.9
Power and communication system construction	211.3
Highway street and bridge construction	338.3
Specialty trade contractors	4,714.2	65.0

For perspective, total nonfarm employment is 144 million people, up nearly a million in the last month. That's a lot, usually 200,000 is a good month. Well, we're recovering fast from the pandemic. In case you didn't hear the pounding of nails, building construction employees 1.6 million people, with 4.7 million more in the trades. (We're not so much building new housing as building in new places.) 

Total unemployment is 9.7 million right now, down from 23 million at its peak. 

Roads and bridges employ 338,000 people. The total is a half of this month's gain alone.  We could use some water construction here in California, though it's not going to happen, and with only 184,000 people employed there looks to be room to expand. 135,000 are building oil and gas pipelines. Uh-oh.

Inflation and expectations at NRO

Essay at National Review Online. 

Inflation: The Ingredients Are in the Pot, and the Fire Is On. (But will it boil?) 

John H. Cochrane and Kevin A. Hassett

The end of the COVID-19 recession is in sight. If the Atlanta Fed’s real-time estimate of 8.3 percent Q1 growth proves accurate, real GDP is only four-tenths of a percent below the all-time high from Fall 2019. And the vaccinated, post-COVID boom is on the way. Most people have money, and are ready to spend it. Yet unprecedented fiscal and monetary “stimulus” continues.

Is persistent inflation around the corner? Inflation and commodity prices are up sharply. The latest Michigan survey shows people expect 3.7 percent inflation next year. Shortages of everything from lumber to semiconductors have raised input prices for businesses, while the percentage of small businesses reporting that they cannot find qualified workers is at a record high. The ingredients are in the pot, and the fire is on.

But will the pot boil? Since 2008, observers have warned of imminent inflation, yet inflation has barely budged.

Inflation is hard to foresee, because inflation today depends in large part on what people expect of inflation in the future. If businesses expect higher prices and wages next year, they raise prices now. If workers expect higher prices and wages next year, they demand higher wages now.

Inflation has been so low for so long that most Americans understandably see persistent inflation as ancient history, and that any blip up today will quickly be reversed.

Yet faith that our government will take prompt action to reverse inflation seems increasingly unfounded.

The Federal Reserve’s new policy framework and its officials’ speeches are eerily reminiscent of the early 1970s, and repudiate the standard lessons of that experience. One may rightly worry that should inflation emerge, the Fed could repeat mistakes of the 1970s.

Vaccines and liability

I learned something from the New York Times lead editorial on Sunday. Why are we not shipping mega quantities of vaccines to countries like India? 

... as the vaccines came to market, some vaccine makers insisted on sweeping liability protections that further imperiled access for poorer countries. The United States, for example, is prohibited from selling or donating its unused doses, as Vanity Fair has reported, because the strong liability protections that drugmakers enjoy here don’t extend to other countries...

Pfizer has reportedly not only sought liability protection against all civil claims — even those that could result from the company’s own negligence — but has asked governments to put up sovereign assets, including their bank reserves, embassy buildings and military bases, as collateral against lawsuits. 

Well, you can sort of see the problem. You're a drug company. You sell a billion units of a brand new drug -- still on emergency use authorization in the US -- to, say, India. 10 people get a rare blood clot that may or may not be due to your vaccine. Local courts sue you for a gazillion dollars. Who wouldn't want liability protection? 

As the Europeans allowed trillions of GDP and quite a few lives to vanish while they haggled over a few billion in cost of vaccines, perhaps the onus on countries should be, to say, we want your vaccine, we understand it's brand new and there may be risks, we'll take them?  

The NYT is, predictably, full of bad ideas. 

Summers at FT

Martin Wolf's FT interview with Larry Summers is a great read. It would be a great read for its articulate numeracy if Larry were a Republican, stepping down from the Trump CEA or Treasury. That he is on the the other team makes it ever more poignant. 

If you look at the economy at the beginning of this year, prevailing forecasts were that Covid would reduce wages and salaries to American households by $20bn-$30bn a month, with that figure declining over the year. So, that would be a $250bn-$300bn hole in wages and salaries over the course of the year.

So, I look at this hole and then I see $900bn of stimulus in the December package, $1.9tn of stimulus in the recently passed package and $2tn in the savings overhang, which is also likely to be spent. I see the Fed with its foot on the accelerator as hard as any Fed has ever done....

So, I look at that dwindling hole. Then I look at expenditures that aren’t hard to add into the multiple trillions, and I see substantial risk that the amount of water being poured in vastly exceeds the size of the bathtub.

Wait Larry, aren't you Mr. Secular Stagnation, Hysterisis, borrow and spend? 

More inequality

Paul Graham adds interesting thoughts on inequality, looking at the Forbes 100. Maybe we don't have enough inequality, and maybe the rise in inequality (especially of wealth) since the 1970s represents too little inequality then, not too much now. Contra the usual in politics, a change is not always a problem, but sometimes for the better. How? Read on. 

Contra the mantra of inherited wealth, the super-rich in America today largely earned their way there from middle class, by starting new companies. They did not inherit wealth. The rich did not get richer. They were superseded by the (fabulously) nouveau-riche. 

In 1982 the most common source of wealth was inheritance. Of the 100 richest people, 60 inherited from an ancestor. There were 10 du Pont heirs alone. By 2020 the number of heirs had been cut in half, accounting for only 27 of the biggest 100 fortunes.

Why would the percentage of heirs decrease? Not because inheritance taxes increased. In fact, they decreased significantly during this period. The reason the percentage of heirs has decreased is not that fewer people are inheriting great fortunes, but that more people are making them.

How are people making these new fortunes? Roughly 3/4 by starting companies and 1/4 by investing. Of the 73 new fortunes in 2020, 56 derive from founders' or early employees' equity (52 founders, 2 early employees, and 2 wives of founders), and 17 from managing investment funds.

...

 the main source of new fortunes now is starting companies, and when you look at the data, you see big changes there too. ....

Inequality mirage?

David Splinter and Gerald Auten gave last week's Hoover Economic Policy Working Group seminar, summarizing their past and some work in progress on the distribution of income.  Link in case the above embed does not work. A recent paper. Splinter's web page. 

Splinter and Auten are very even handed, just-the-facts, economists. I'll pass on their facts. Grumpy interpretations are my own. 

It is a fact generally accepted that income inequality has grown a lot recently, and this is a "problem" to be "solved." So what if the great inequality crisis simply isn't true? Let's leave aside whether income is a good measure (it isn't), let's just look at the fact, has income inequality substantially increased? 

No. Here is the headline result. In their careful redoing of the numbers, the top 1% share of income has barely budged since the 1970s. (And, by the way, if you think the mid 1970s economy was the great happy prosperity we should try to reestablish, you're too young to remember the 1970s.)

Now we get in to a deep under the hood exercise about costing up income, and where did Piketty and Saez go wrong. The video has some of that. The papers have more, and a long list of back and forth, including comparisons with many other studies. I'll name just a few.

Omitted income.   Piketty Saez leave out many kinds of income. Auten Splinter attribute all national income to somebody.  Before 1986 many wealthy people were incorporated.  Leaving out corporate income biases the early shares down. Auten Splinter fix that. Pre-tax and transfer income! Who cares about pre-tax income! Auten Splinter calculate income after taxes at the top -- lower -- and including transfers at the bottom -- higher. Demographics. Marriage rates have fallen, so Auten Splinter calculate income by individuals. Benefits! They include benefits like employer-provided health insurance.

One can quibble, but one can quibble. At least this cornerstone "fact" of political debate is a lot less sure than it looks. 

If the rich aren't getting richer, the poor aren't getting poorer:

Nuclear power and growth

Jason Crawford's "Roots of Progress" blog on what happened to nuclear power is an important read for many reasons, among them economic growth, climate, and regulation. It's a review of Why Nuclear Power Has Been a Flop by Jack Devanney which goes on my must-read list. 

Perhaps the important economic question of our time is this: Is growth over? Are we running out of ideas? Or is our decades-long growth slowdown the result of an increasingly sclerotic, over-regulated, crony-capitalist rent-seeking political system? Nuclear power offers an interesting case study. 

Through the 1950s and ‘60s, costs were declining rapidly. A law of economics says that costs in an industry tend to follow a power law as a function of production volume: that is, every time production doubles, costs fall by a constant percent (typically 10 to 25%). This function is called the experience curve or the learning curve. Nuclear followed the learning curve up until about 1970, when it inverted and costs started rising:

Plotted over time, with a linear y-axis, [note mulitplicative scale in the last graph] the effect is even more dramatic. Devanney calls it the “plume,” as US nuclear constructions costs skyrocketed upwards

 

Read carefully. US construction costs exploded in the 1970s. South Korean construction costs did not. The blue points do not continue because the US simply stopped building nuclear power plants, not because we solved the cost disease. 

This chart also shows that South Korea and India were still building cheaply into the 2000s. Elsewhere in the text, Devanney mentions that Korea, as late as 2013, was able to build for about $2.50/W.

The standard story about nuclear costs is that radiation is dangerous, and therefore safety is expensive. The book argues that this is wrong: nuclear can be made safe and cheap. It should be 3 c/kWh—cheaper than coal.

The post goes on about the safety issue, which you should read but I won't summarize. 

The point for us: Here is a clear case of an end of growth. We know the cause. We did not run out of ideas. Regulation killed this industry. 

 the NRC approval process now takes several years and costs literally hundreds of millions of dollars.

Why? Among other causes, Crawford lists beautiful parables of incentives gone wrong (Second economic lesson for today.)  

Inflation expectations

This post follow's last week's post on inflation levels prompted by the big March increases in CPI and PPI, and the CEA tweetstorm response. (Also a longer post on the chance of inflation.)

WIN button from the Ford Administration

Is inflation coming?   The CEA goes on to 

Over the longer-term, a key determinant of lasting price pressures is inflation expectations. 

And takes comfort that survey expectations don't see a large increase in inflation. But when did survey expectations ever predict inflation?  In fact most research on surveys, especially in finance,  is used to claim people are dumb and terrible at predicting the stock market and other variables. 

The CEA goes on to 

An increase in inflation expectations from an abnormally low level is a welcome development.  But inflation expectations must be carefully monitored to distinguish between the hotter but sustainable scenario versus true overheating. 

But  if after "carefully monitoring," when it becomes impossible to make excuses, it looks like inflation is breaking out, what do you do then? 

Inflation levels

 March inflation is up. The CEA delivered a historic tweetstorm. It starts with 

temporary factors: base effects, supply chain disruptions, and pent-up demand, especially for services

I'm glad for once to have nailed a forecast: That Fed and Administration's first response to inflation would be to invoke "temporary" factors, just as in the 1970s.  We'll see how that pans out. 

The CEA goes on to "base effects,"

In the near-term, we and other analysts expect to see “base-effects” in annual inflation measures. Such effects occur when the base, or initial month, of a growth rate is unusually low or high..

This unusually large price decrease early in the pandemic made April 2020 a low base. 

Since this is about the past, we can say something more definite. Yes, if you start from a low base, you can see a lot of growth. To get around the arbitrariness, let's look at price levels. Here is the recent CPI (blue) and CPI less food and energy (red). These are the levels of the CPI -- conceptually how many dollars it takes today ($271) to buy what $100 bought in 1983.  

The last few months uptick is clearly visible. You can find your own "base month" by drawing a line. Yes, a line from last April to today shows an unusually higher slope, because last April was unusually low. 

But to the extent that we're just seeing "reflation," a return of prices to normal after a steep covid-induced recession, the graph suggests that was over last summer. "Reflation" was over by September. Draw your own trends -- that's why I left some history in. 

Conversations: covid and (separately) nonprofits

 I did a few fun video conversations last week. 

This is a conversation with Ryan Bourne, Megan McArdle, and Alex Tabarrok on economics and the year of covid. Direct link if the above embed doesn't work. 

The conversation  is occasioned by the publication of Ryan's excellent book Economics in One Virus.  I am often asked for recommendations of general readable economics books. (i.e. no equations.) This is a gem. 

Then I had a nice conversation with Mike Hartmann at The Giving Review, link here with transcript, (slightly edited, please refer to that if you want to quote me. The above is just a screenshot, you have to go to the link). 

We explored my view that the US should eliminate the whole non-profit business, most of all the tax deductibility of contributions to non-profits, but also (less importantly) the non-profit corporate form. While many non-profits do a lot of good (my employer!) the system has become obscenely perverted, mostly as a tax-supported vehicle for political action, but also a tax dodge available only to the super duper wealthy, and a means of protection from the market for corporate control for flabby institutions. I trust that genuine useful charities will still attract donations -- maybe more -- from the substitution effect than they lose without tax deductions. 

I've long been meaning to gather facts and figures to see if this salty opinion makes as much sense as I think it does, and I'm glad to learn about Philanthropy Daily, a resource that will be helpful.

Oh yes also a great GoodFellows with Bjorn Lomborg on climate. I love talking to Bjorn. He has an extensive command of the facts and science, and he's still an optimist that facts and science will actually make a dent in this debate. As global warming moved to climate change to climate crisis to climate justice to climate risks (financial) I'm less optimistic, but hope must be let out of Pandora's box.  Also 

with Bari Weiss on media, censorship, free speech and assorted issues. Direct links, podcast  versions, and more all here. 

Ip on Bidenomics

Greg Ip has a great column in the WSJ on Bidenomics.  It's not long, it's so well written that it's hard to condense the good parts, and you should really read it all. 

There is an intellectual framework to Bidenomics, and with that a scarily more durable move on economic policy. 

There used to be 

"certain rules about how the world worked: governments should avoid deficits, liberalize trade and trust in markets. Taxes and social programs shouldn’t discourage work."

By contrast President Biden's (really his team's) "embrace of bigger government" is founded on different economic ideas. To wit, abridged: 

Growth

Old view: Scarcity is the default condition of economies: the demand for goods, services, labor and capital is limitless, their supply is limited. ...faster growth requires raising potential by increasing incentives to work and invest. Macroeconomic tools—monetary and fiscal policy—are only occasionally needed to deal with recessions and inflation.

New view: Slack is the default condition of economies. Growth is held back not by supply but chronic lack of demand, calling for continuously stimulative fiscal and monetary policy. J.W. Mason.. said, that “‘depression economics’ applies basically all of the time.”

I guess I'm an old fogie.