What’s Happening to the World Economy?

A recession is coming. With the sudden 1000+ point drop in the Dow Jones Industrial Average today, following another major devaluation of China’s currency (8 percent?  My God, 8 percent?), and the incessant weaknesses in the U.S. labor force during this weakest of all recoveries, the signs of a new recession are all here. But remember, a recession is always coming.

The first instinct is to wonder if the Federal Reserve should press ahead with raising the core interest rate during its September meeting. To do so in the face of so much volatility — and what feels like an imminent recession — seems to be completely counter to the basic folk wisdom of monetary policy. A central bank should lower, not raise, interest rates during the down cycle, right? I suppose that folk wisdom is correct, but beware panic thinking. Some thoughts, very briefly:

  1.  Just because the stock valuations are volatile does not mean the US economy is recessing. That’s a huge leap. Indeed, the quick bounce back in stock prices today shows that there are plenty of buyers ready to scoop up equity from panic sellers. Don’t lose sight of low unemployment, steady GDP growth, and other fundamentals.
  2. China’s devaluation (and the weakness in oil and other commodity prices) confirms global weaknesses. At a minimum, these signs indicate that other leading economies are weaker than the U.S. economy.
  3. Both previous points beg the question why U.S. interest rates are set to zero. I would argue that the zero rate has many large, second order costs. It is a major burden on other currencies, for one. By keeping US rates low, the Fed is effectively weakening the dollar relative to other currencies. There is no escaping the fact that the Fed is a central player in the currency trials — putting pressure on China, Japan, and Europe to keep their rates (and pegs) lower still. That seems destabilizing to me, and the blowback is finally here.

I think the Fed missed its optimal moment to raise rates. Zero was and still is too stimulative. A healthier U.S. economy demands a return to normalcy with interest rates, and I’m frustrated that the insistence on high asset prices may cause a crash. Today was a warning. Let’s hope it is not too late for the Fed to get rates normal.

Banking Freedom, Yes. Fiscal Union, No.

Is there a way to save the Greek people without saving the socialist government structure of Greece? Yes, according to an op-ed in today’s WSJ by UCLA economist Andrew Atkeson and my Hoover colleague John Cochrane.

When Europeans can put their money into well-diversified pan-European banks, protected from interference from national governments, inevitable sovereign defaults will not spark runs, or destroy local banks and economies.

It’s painful to imagine the innocent Greek worker who has only one option for saving her money — the local bank — which then tells that person she is no longer allowed access to her own money! The personal capital of the Greek people is being held hostage by their socialist government. Wow.

So is the right solution to give that government bailout money from the German people?  The American people? The smart alternative is to allow the Greek people to save in any bank in the world, meaning that any bank in the world should be free to open branches in Athens and other Greek cities. As John has written before, this freedom is what makes government debt in Illinois and Puerto Rico different from Greece.

In Balance, we make a similar observation in Chapter 10 “Europa: Unity and Diversity.” Recognizing that too many issues are oversimplified as less-v-more and good-v-evil, the nature of freedom and the state is ambiguous on centralized authority. Parsing the degree of centralization that optimizes prosperity differs across different institutions: speech, banking, immigration, taxation, and so on. While we generally should err toward decentralization, John makes a case that monetary union (or rather, currency union) is a good thing. In Balance, we wrote,

One difference between European and American integration is much more fundamental, yet it has received little attention. …The bank account of a citizen in Lansing, Michigan, is not threatened by confiscation or default of the Michigan statehouse. That same security does not comfort the bank accounts of the people of Athens.

Critics have warned that a currency union without a fiscal union is inherently flawed. That is hogwash. Glenn and I described (on page 209) six distinct policy layers of economic integration.

  1. Trade
  2. Monetary (aka Currency)
  3. Labor
  4. Regulation
  5. Banking
  6. Fiscal

Too many experts think of integration as an all-or-nothing choice. They may favor incremental steps toward integration with trade agreements (as we do), but ultimately their bias is for ultimate integration of all layers (as we do not), especially fiscal union. Fiscal union can be benignly described as strong states subsidizing weaker/poorer states, but I hear that as glossy language for a full transfer of control over the authority to tax and spend.

There’s no need for any state to surrender fiscal authority to the central government. The fifth layer is far enough for optimal efficiency. That’s banking union, which is more properly understood as banking freedom from the perspective of individual citizens. Local cities and states do their people no favors by holding sovereign power to control and confiscate the private assets held in local banks.  It’s nice to see Atkeson and Cochrne putting more attention and historical background on this issue. The final word is theirs:

The United States offers a precedent. … In the 1980s, the U.S. deregulated banks to allow extensive branch and interstate banking, further isolating local banks from local troubles.

… Europe needs well-diversified, pan-European banks, which must treat low-grade government debt just as gingerly as they treat low-grade corporate debt. Call it a banking union, or, better, open banking. The Greek tragedy can serve to revive the long-dormant but necessary completion of Europe’s admirable common-currency project.

Are jobless claims overheating?

Watching the U.S. labor markets, I have long been impressed that initial jobless claims are one of the best real-time indicators of the health of the overall economy. And right now, they are white hot.


When the economy is normal, there are 300k to 350k claims for unemployment insurance filed across the nation.  When claims rise above 400k, it is a sure sign of recession. Often, it takes months or years into a recovery for claims to drop down below that red line again. However, it is rare for claims to drop below 300k. Very rare for that level to be sustained.

In the past 4 decades, it has happened 4 times:

  • 1987 (briefly) and 1988
  • 1998 – 2000
  • 2005 for a few weeks
  • The past nine months (Sep 2014 – June 2015)

What’s really extraordinary is when jobless claims fall below 275.  That’s where they have been for the past 14 weeks. The only other time claims went below that line was in the second quarter of 2000, right before the dot-com bubble burst.

I have no idea if white-hot jobless claims trend is alarming, but I have every confidence that it means the labor market is strengthening faster than most realize. The wage inflation data may not show it yet, but I fully expect higher wages and labor force participation in the months ahead.

UPDATE: I posted in a new version of the chart, saved on the WordPress site instead of just pasted in from excel.  Hope you all can see it.

Contextualizing GDP growth in the U.S.

Today the Bureau of Labor Statistics published the first look at Q1 Gross Domestic Product and its components. The headline number was revealed to be a surprisingly low 0.2 percent. This is alarming, but not just because it defied the consensus prediction. Any single estimate, especially a preliminary one, is not in itself alarming. What’s alarming is the trend.

Take a look at the following image of the past six quarters’ GDP growth rate and its main components (expressed in terms of how each component adds up to the aggregate GDP number):

image (2)

We see weak Consumption growth, above all.  The net exports number is negative, but that won’t last (more on that below) and besides it was negative last quarter, too. What surprises me is the disappearance of Investment. Realize that a year ago the economy wasn’t just stalling, it was contracting. Rather than get worked up about one quarter, let’s look at the whole recovery to date.

In the next chart, consider how the current recovery’s average growth rate (and average component growth rates) compares to previous expansions.  I calculated each of the expansions based on NBER business cycle dates, trough to peak.

image (1)

What do we see?

1.  The new normal (this expansion) does not look very healthy. Overall, the GDP growth rate is half of the rate in the 80s expansion.  Even more interesting is what looks like a clear linear trend of slower overall GDP growth from 4.4 to 3.8 to 2.9 to the current 2.2.  But why?  Keep in mind that the lengths of the periods being averaged are not equal. The 80s expansion is the 3rd longest in US history at 108 months, while the 90s expansion is the 1st longest at 128 months.  In contrast, the 2000s expansion is “merely” 81 months which, oddly, is also the length of the current expansion.

2. Net exports are a non-story. Currently, the impact of net exports is a mild reduction to topline GDP growth in recent years, maybe 0.1 percentage points, the same as every previous expansion.  Moreover, you don’t find the gains of trade in these topline figures, rather they come from cost efficiency in intermediate goods. Regardless, people spinning blame for weak growth this quarter or this year on Greece or China are not checking their history.  We’re lucky there IS a China (there essentially wasn’t one in the 1980s). Scapegoating foreigners is always lame, but especially here.

3.  The components do not show weakness in Investment during our era.To be honest, I thought “I” would be revealed as weaker today relative to recoveries past. To the contrary, what’s most different in the expansion since 2009 is the weaker Consumption and Government.

I wasn’t satisfied with the second chart because it doesn’t put each recovery in context of the depth of the recession the economy “bounces back” from.  This is important because in 2009, the White House and CEA were claiming that the recovery was likely to be very strong because the recession had been very deep. Greg Mankiw posted an astute comment on his blog at the time which has been on my mind ever since: “The purpose of this picture is to show that deeper-than-average recessions are followed by faster-than-average recoveries. ” (read it here). Naturally, he was attacked by Paul Krugman for daring to question what was unquestionable: the certainty of a strong recovery (stronger still thanks to the Stimulus).

It is striking that the debate raged for a year or two – there’s always tomorrow, right? — but nobody believes today what apparently everybody believed in 2009.  This really begs the question, why is the economy NOT rebounding back to trend?  My Hoover colleague, John “Grumpy” Cochrane, has some interesting things to say about unit roots and trends, but the bottom line is that the very idea of Potential GDP has become slightly metaphysical. I have mixed feelings about it.

The third chart provides some useful context, and in this one you should know the recessions are of roughly equal duration (4-6 quarters).  Now THIS is a picture worth a thousand words:

image (3)

The ’01 recession is an odd duck — average GDP growth was bizarrely positive, albeit tiny. Consumption growth was not derailed at all.  If you believe that boom is proportional to bust, then the mildness of the 00s expansion makes sense. But that means the current expansion does not. And the very sharp drop in Consumption in the 08 recession and current recovery signal that something permanent shifted negatively during the financial crisis.

A final, vital piece of context is that all growth is good growth. What I mean is that our collective focus on “weak growth” is an oxymoron. Even the weakest growth means that the economy is richer than it was the quarter before. By comparing 2015 to 1985, the actual underlying economies are radically different in ways from the composition of the labor force to the nature of money itself. But still, I’m left with a sense that the engine of US growth — our institutions — have changed for the worse. That’s alarming.

Thoughts on Jobs Day

Today’s jobs report is a lot like the last one and the one before: mixed signals.  The unemployment rate is unchanged at 5.5 percent. Payroll growth is positive but timid at 126,000 when economists had apparently expected twice that.  Seven cents were added to the average hourly wage, which is faster than normal. And finally, worst of all, continuing the trend of the past 5 years, the labor force declined by nearly 100,000 people.

Those are mixed signals, but it is exactly what I expected. The most alarming central fact of the economy’s new normal is that it is bleeding people. Here’s a quick and dirty facts from BLS data on the labor force participation rate overall (LFPR) and the rate for people between the ages of 25-54.  This disproves the contention that the change is just about demographics.

-3.5  = Change in LFPR since 2007
-2.2  = Change in LFPR 25-54 since 2007
+1.1  = Change in Unemployment rate since 2007

When the Federal Reserve looks at today’s report, it has to conclude that this may be as good as it gets. Frankly, you do not want to see the unemployment rate get much lower than 5.5 or else it will signal an overheating economy.  The last time the unemployment rate went below 5 percent, it was 2005. But they were being pushed down by ultra low (at the time) interest rates set by the Fed in 2003. Real estate markets were inflated. Starting in mid 2004 – when the unemployment rate was exactly what it is today (5.5%) – the Fed began raising interest rates, which it did multiple times to cool the engine. We all know how that ended. Consider:

-3.4  = Change in LFPR since 2004
-1.8  = Change in LFPR 25-54 since 2004
+0.0  = Change in Unemployment rate since 2004

This is the new normal. So why is LFPR down three and a half percent?  That’s the magic question.

Gerrymandering Misunderstood

The Washington Post has a short article about gerrymandering with a deeply flawed graphic. By that, I mean the graphic implies that the most partisan district lines are the ideal.  How crazy is that? One hand at the Post is writing (for decades) that partisanship has gotten out of control, but the other hand says that partisanship in extreme districts is the answer.

This chart’s “1. Perfect representation” system is deeply flawed — it has 5 extreme incumbents who will never face a challenger. Not perfect at all. It looks a lot like the incumbency-protection gerrymander in California from 2002-2012. It is the kind of system the monopoly parties love, candidates hate, and where people are irrelevant.

Two Wrongs, One Right on Obama’s Immigration Action

If the road to Hell is paved with good intentions, what is the destination for the road paved with bad intentions? Federal Court, it seems.

President Obama’s action on immigration reform – granting temporary legal status to millions of illegal immigrants – was an overreach of his authority, and worse, intended to create a political fight rather than a policy solution. After insisting for six years that the only path forward was a huge “comprehensive” law, Obama dropped a dozen incremental White House memorandums in late November. Then it ran into a little problem called the Law. On Monday, U.S. District Judge Andrew S. Hanen suspended the Obama actions until a federal lawsuit, filed by 26 states, is resolved.

The President made two mistakes in taking executive action. First was a simple overreach of his authority. He has no right to make a carpet grant of legal status, let alone issue work permits to people in the country illegally. Second was choosing to wage partisan warfare over an issue that has been begging for compromise leadership. The one thing Obama has on his side is economics – granting legal status to migrant workers will, in fact, be good for the U.S. economy, for immigrants, and even for American citizens.

Why did the President never offer his incremental reforms as legislation? Why not consult with Congress? Why not compromise? Why make the legal status a temporary three years?  Why, at every turn, frame the issue as a partisan impasse and blame Republicans? The answer is that the White House is driven by politics. It has consistently used false choices and red herrings when discussing immigration. Now the double talk is being exposed.

At the crux of this issue is the idea of granting a work permit to migrants. A work permit is the middle ground compromise — it’s not deportation (obviously) nor is it a path to citizenship. Those latter two options are the false choices constantly debated over the past decade. Ironically, when comprehensive reform was considered in Congress in 2007, Senator Barack Obama was among the many Democrats  who stripped the work visa idea from the legislation in order to poison the consensus. They wanted to keep the fight going, to polarize the electorate rather than change policy. And he infuriated Ted Kennedy.

Now the migrant work permit is the centerpiece of Obama’s overreach. It’s one thing to defer action and not deport a man. It’s altogether a different to have the machinery of government produce a work permit for that man. The White House wants the media to believe that spending hundreds of millions of dollars processing paperwork and issuing work permits is a blanket non-action, but it’s an unbelievable fiction. Judge Hanen knows it, and he knows that once the work permits were issued it would create an impossible mess. He was right to stop it before the case is fully resolved, and the White House is insincere to pretend it’s no big deal.

The White House rationale for executive action has been its “limited resources.” But on Christmas day, the New York Times reported that DHS “was immediately seeking 1,000 new employees to work in an office building to process ‘cases filed as a result of the executive actions on immigration.’ The likely cost: nearly $8 million a year in lease payments [for a new operations center just outside of Washington, DC] and more than $40 million for annual salaries.” Limited resources is such a flimsy excuse.

The shame of it is that immigration is an issue ripe for compromise and consensus. If the President would have offered to work with Congress on legislation that rejects the false deportation-vs-citizenship choice, and instead offered legal status & work visas, we would be talking about the very real benefits of immigration to the U.S. economy. The President could have chosen to appear shoulder to shoulder with George W. Bush in a joint call for compromise – like Ted Kennedy once did with Bush on education reform. Obama could cite a dozen, or a hundred, Republican leaning economists who support work permits for migrants; support green cards for engineers, scientists and entrepreneurs; support streamlining the DHS; and even support allowing more than a million new legal immigrants to come to the United States each year. Here’s my own case for greater immigration.

Is it too late for Obama to offer bi-partisan compromise? I sure hope not. Or has that whole “post-partisan” road been a fiction, too?