Saturday, May 31, 2008

Making a Mountain out of a Molehill

Recent headlines suggest that the U.S. economy is spiraling into an abyss. The housing, financial, and manufacturing sectors are suffering greatly. However, ongoing recoveries in these sectors (some more than others) are fueling a new-found momentum in the U.S. economy. All of the sudden, things are not looking so bleak.

But were things ever so bleak? Just a month ago, headlines were saturated with talk of recession, but now many economists are claiming that we may just “skirt” a recession. Recent 5.0% unemployment and 0.9% growth certainly cannot be compared to 6.9% unemployment and -7.8% growth during the recession of 1980. Why the sudden change of energy? The Fed got it right this time.

Except for Volcker’s disinflation period (1981-1983), monetary policy has been either too little or too much.

Wrong (Figure 1): The Fed (led by William McChesney Martin, Jr.) started tightening at the end of the 60’s. The 1960’s was a decade of strong growth, fueled by a War and loose government spending. Inflation started creeping up, and the Fed began tightening – resulting in a loss of output, or a recession.

Wrong (Figure 1): The Fed (led by Arthur Burns) resumed tightening in the middle of the 70’s. During a period of a slowdown in productivity, where firms were producing less and less per hour, the Fed began to tighten in order to control inflation. Add an energy shock created by OPEC (Organization for Petroleum Exporting Countries), where the price of oil rose sharply, and a recession results. Unemployment hit 9%, and GDP fell by 3.4%. Economic theory says that the Fed was partly to blame for the recession

Right (Figure 1): The Fed (led by Paul Volcker) tightened in the early 80’s. Surging from another shock to the oil market, inflation hit double digits in 1981 (13.5%). Paul Volcker led a historical movement to reduce inflation in America, raising interest rates until inflation subsided by 1983 (3.2%). The result: 26 years of low inflation.

Wrong (Figure 2): The Fed (led by Alan Greenspan) loosened in the early 00’s. A terrorist attack on American soil, financial stress from a stock-market crash, and accounting scandals (Enron) caused a recession. Alan Greenspan lowered interest rates to combat economic hardship. Amid record-low inflation and unemployment, Greenspan continued to ease (lower the interest rate) until the interest rate hit 1% in 2004. Many argue that his excessive easing led to the housing bubble that led to a financial crisis starting in August 2008.

Right (Figure 2): The Fed (led by Ben Bernanke) loosened just enough…let’s hope. Recent Fed actions have been innovative and direct. Specifically, the Fed needed to target directly the financial stress caused initially by the housing bust and assets related to that sector, where the stress was unlikely to abate with standard Fed policy (simply lowering rates). In order to get cash to the banks and primary dealers (large investment banks), the Fed increased the number of monetary policy options from 3 to 6. The new options (TAF, TSLF, and primary dealer credit) targeted the financial crisis directly, and the financial markets have since shown signs of stabilization. However, at the same time, the Fed lowered interest rates (one of the 6 policies available) in order to help non-financial businesses, workers, and the rest of the economy along. The Fed target interest rate sits at 2%, and may be lowered just slightly in 2008, but then the Fed will likely raise it in order to avoid a run-up in inflation. The Fed created new policy options, and the interest rate did not get too low.

However, key risks remain. Gas prices are at record highs (3.99 per gallon as of 5/26/08) and food prices are rising. Only time will tell how record oil prices and recent monetary policy (the Fed) will affect future economic growth.

The media paints the picture of a mountainous recession, but it may simply be a mole hole of slow growth that we must conquer. The Fed is creative and seemingly cogent enough to get the economy through its current stress.

Monday, May 26, 2008

Outlook for teenage jobs is not good

The article, Toughest Summer Job This Year is Finding One, argues that many American teenagers are suffering from the recent softening of the labor market. In April, the workforce lost 20,000 jobs, and in some parts of the nation, this trend in job loss is greatly affecting teenagers. The article downplays the loss in teenage jobs stemming from heightened competition with legal and/or illegal immigrants.

Highlighted in the article are three reasons for the recent loss of teenage jobs. First, adult workers are taking the jobs as the economy grows very slowly. Second, teenagers are increasingly spending their summers preparing for competitive college applications. Third, Mexican immigrants are competing for some of the same jobs.

The graph below illustrates the state of the labor force for workers aged 16-19. There are two visible trends. First, when the economy is in a recession, the share of teenage workers to the size of the population falls and unemployment rises, confirming the fist reason for teenage job loss. As the economy slumps, adult workers willing to work are preferred to teenage workers, and teenagers lose jobs. Second, the share rebounded and unemployment fell following the troughs of three recessions: two in 1980-‘82 and 199-‘91. As the economy rebounds, the adult workers move up in the work force, leaving jobs for teenagers, and teenagers gain jobs.

However, since the latest recession (2001), the share of teenage workers to the size of the population has fallen and not hit a bottom. There is a more structural element at work, rather than a simple economic slump explaining the loss of teenage jobs. Some of the explanation may lie in the fact that teenagers are increasingly preparing for college, and not seeking employment, but this reason is likely to explain only a small portion of the recent downturn. It is more likely that both legal and illegal immigrants are taking the jobs from the teenagers.

The 2007 Hispanic share of the population rose to 15.1% from 12.6% in 2000. The trend is obvious: a higher Hispanic population coincides with loss of teenage jobs since over the same period, the share of teenage workers to the total population has fallen steadily. Teenagers are loosing jobs to the rising Hispanic population. The question is: will the share hit a trough? According to the Census projections, that is unlikely, since the Hispanic population will grow to 24.4% by 2050.

This article should add a point on the “con” side of the immigration list. When immigrant workers are taking jobs from the teenage workforce, American citizens suffer.

Currently, both Hillary Clinton and Barack Obama call for immigration reform. Both focus on the loss in well-being when the U.S. immigration policies separate families. Senator Obama specifically highlights Mexico; he proposes aiding economic reform in Mexico in order to reduce the incentive for illegal immigration. Hillary Clinton advocates making the transition smoother for those families immigrating to the U.S. All three Presidential hopefuls (Obama, Clinton, and McCain) advocate to varying degrees tightened border control, but only McCain is making that his top priority.

It is wrong for politicians to push aside statistics like an increasingly unemployed teenage workforce to focus on the immigrant population.

Tuesday, May 20, 2008

The PPI report has a mean face

Inflation is running rampant across the globe. As energy prices rise 16% over the year and food prices rise 5% over the year, the U.S. may have dodged the bullet in April with lower-than-expected inflation. Last week, the most popular measure of core inflation (headline inflation minus food and energy inflation), the CPI, fell to 2.4%.

However, today’s April report of the Producer Price Index (PPI) measure of inflation threw a wrench in the hope for stable inflation. Usually this measure of inflation follows the more popular measure of inflation, the Consumer Price Index (CPI). Overall PPI inflation fell, but its core inflation rose for the first time in two months.

PPI inflation is often referred to as wholesale inflation. It represents the prices that firms charge when a good is shipped off to the retailer, rather than the price of the good that is sold by the retailer (CPI). The PPI and the CPI are related in theory. As the prices of inputs (gas, electricity, labor, etc) rise, firms should raise their prices to consumers; the PPI should predict future movements in the CPI.

The reality is that the PPI and the CPI only sometimes move together, and often the PPI is much more volatile than the CPI. The relationship between the two measures of inflation is evident, but not an axiom.

Recently PPI inflation and CPI inflation have fallen. On the surface, that is a good thing as prices are decelerating. However, the underlying data has a meaner face. At the producer level (the PPI), prices other than food and energy are starting to rise, indicating that future retail prices (CPI) may rise as well.

Light motor trucks and passenger cars rose 1.3% and 0.4% in April following declines in March. Commercial furniture rose 1.8%, household furniture 0.9%, household glassware 1.5% and cosmetics rose 0.3%, just to name a few. On the flip side, communication equipment dropped 0.4% and computers fell again 0.5%. On balance this means that non food and energy goods prices are rising, or core inflation is on the move.

The imminent threat is there. In a world of rising inflationary pressures, this month’s PPI inflation report may point to rising prices of consumer goods across the board, and not just for food and energy. Going forward it will be more expensive for a dinner out, a movie ticket, a pair of jeans, a car (truck), furniture, and that’s just to name a few.

Please leave your comments. Best, Nontruths

Saturday, May 17, 2008

The Fed is partly to blame for the slide of the U.S. dollar

A slowdown in foreign economic growth from key economies is beneficial to the U.S. because the value of the U.S. dollar (US$) would rise. Unfortunately, key foreign growth has not slowed enough and the US$ will likely remain at a low value (depreciated) for some time. The Federal Reserve Bank (Fed) was too loose in its recent monetary actions (lowering the interest rate 3.25% since September 2007), quickening the slide of the US$.

Since 2005, the US$ has been steadily losing value relative to many of our trading partners. Recently, the US$ bounced back against the Japanese Yen, but continues to lose value against other key currencies like the Chinese Yuan, British Pound, and the Eurozone Euro.

Source: data from Federal Reserve Bank of St. Louis

There are three culprits of the depreciation US$:

  1. The slowdown of the U.S. economy.
  2. The rising price of crude oil.
  3. The Fed’s decisions to lower the interest rate.

1. Foreign investors became nervous about U.S. investments when the sub-prime financial crisis began in August 2007 and the U.S. economy slowed. As the expected economic strength of the U.S. declined, foreign investors across the world sold off U.S. assets (stocks and bonds), and consequently, flooded the foreign currency market with US$. The value of the US$ declined sharply.

2. The rising price of crude oil has had a significant impact on the value of the US$ because the world buys and sells crude oil in US$. So, as the value of the US$ falls, sellers of crude oil raise their price in order keep profits at the same level. Foreign economies with the bulk of the oil reserves (Saudi Arabia, Qatar, Venezuela, United Arab Emirates, Kuwait to name a few) have raised the price of oil in order to accommodate a declining US$. It should be noted here that this is different from OPEC (the above countries are members of this organization) cutting production to drive up the price of oil.

3. Recent actions by the U.S. central bank (the Fed) has had a substantial impact on the value of the US$ since September 2007. Commencing on September 18, 2007, the federal funds rate, the Fed’s target interest rate, has fallen from 5.25% to 2%.

  • The Fed lowers its target rate in order to stimulate a similar downward-momentum in other rates that apply to businesses and consumers.

Saving rates fall, car loan rates fall, mortgage rates fall, and consequently, people save less and buy more cars and more houses, etc. This is good for the economy if it is in a rut. Likewise, lowering the federal funds rate also causes foreign investors to sell off US$. As saving rates fall with the lower interest rate, foreign investors pull out of the U.S. financial markets, dragging down the value of the US$.

The only way to counteract the Fed’s cause of the falling US$ is for other key economies to lower their target rates as well. For example, if the European Central Bank (ECB), the central bank of the Eurozone, lowered its target rate, then there would be no need for investors to move money from the U.S. to Germany (let’s say) because both saving rates are falling. So, we hope that growth in foreign economies slows enough to force important foreign central banks to lower their target rates.

The Bank of England has lowered its policy rate, but just by 0.75% since March 9, 2007. The ECB has been reluctant to lower its rate, sticking with 4.0%. But this is not enough. If growth in these economies suffers, then the central banks may be forced to lower their target rates. Unfortunately, growth is stronger than expected in the U.K., Canada, the Eurozone, and Japan, and amid the high global inflation rates, there is no imminent need for the central banks to lower their interest rates.

The Fed lowered interest rates too much. It certainly has control over their policy rate, but has no control over the price of oil or growth of key foreign economies. It was just too much.

Thus, the US$ will maintain its depreciated value until one of the following happens:

  1. The U.S. economy improves significantly – unlikely for a while (at least into 2009)
  2. The pressure on the price of crude oil falls – unlikely for a while (perhaps back to $100/barrel by the end of 2008).
  3. A global economic slowdown occurs – not looking good.

Please leave any comments that you may have. Nontruths

Monday, May 12, 2008

On the merits of NAFTA

Put a goods-producing (manufacturing) worker in the room with a service-producing (financial services) worker, and the subject of NAFTA will almost certainly come up. The trade pact, NAFTA, was signed by Canada, the U.S., and Mexico and initiated on January 1, 1994. Recently, and in times of stress in the manufacturing sector, focus in the election has swayed away from the wars and toward economic topics such as losing manufacturing jobs to Mexico.

The common misconception is that the U.S. is worse off since the inception of NAFTA. In general, free trade is beneficial – it allows countries to specialize in the goods that they are best at producing. This means, if it is less costly for Canada to produce an auto part, then they will do that and the U.S. will import it for a cheaper price than if it was produced domestically. In general, free trade is a good thing, benefiting all countries involved.

However, NAFTA is not short of its critics, such as our Democratic candidates and much of the manufacturing industry. Let’s look at the data and some common misconceptions.

Misconception 1:

1. The U.S. is worse off since the inception of NAFTA. The figure below shows U.S. average income growth (how much better off the average person is year to year) spanning the years 1988 to 2008. Except for two recessions (1990-’91 and 2001), economic has been quite volatile, and rather strong the years after the signing of NAFTA…could there be a correlation?

2. The U.S. became a service-producing economy because of NAFTA. This is rather false. NAFTA certainly allowed us to specialize and trade the goods that we are best at with Mexico and Canada, but it was the rest of the world (about 5 billion more buyers of U.S. goods) that asked for more of our service goods. The figure below shows that the share of service production started to rise relative to goods production well after NAFTA was signed.

3. On average, earnings in manufacturing are higher, and workers in that sector are better off. The figure below shows the real average weekly earnings for different U.S. production sectors before and after NAFTA. Real earnings means that the effects of rising prices from 1979-2008 has been extracted. Thus, $12 is the same in terms of the amount it can buy in 1979 and in 2008. The figure shows that since 1979, real wages in manufacturing have been falling, while those in financial and professional services have been rising. And yes, this trend started after the signing of the NAFTA treaty.

There has been plenty of time to start training oneself to move out of the suffering industries (manufacturing) and into the higher paying industries (financial services or information). Let’s also note that the only reason that manufacturing pay has stayed so high is because workers are protected by unions (formal agreements to keep wages above a certain level). The labor market trends are here to stay: get out of manufacturing and into finance, education, health, or even construction!

4. NAFTA is bad. No free trade pact can be bad, and as I discussed above, all countries involved benefit. Sure, there are always details to be hammered out, but in the long run, it is a step in the right direction. Case study: one of the causes of the Great Depression (when the unemployment rate rose to 25% and American saving was wiped out) is because of high U.S. tariffs, effectively eliminated trade. Case study: In 1808 Jefferson effectively closed trade with the British and pushed America into poverty (the act was repealed). Is that what we really want?

Please leave any comments that you may have! Nonthruths

Chart Sources: All data comes from my research, the Bureau of Labor Statistics, the Census Bureau, and the Bureau of Economic Analysis.

Tuesday, May 6, 2008

Follow up: The costs of universal health care are too large!

In the article, The costs of universal health care are too large!, I argued that there are two types of costs: (1) the explicit cost of paying for the program, and (2) the job loss associated with a regulated health care system.

The second cost is simply a function of regulation. Under a universal health care system, the government would have more control over what types of technologies are used, what fees to charge, and implicitly what the pay is for a medical professional. The average income in the medical profession would fall.

The Wall Street Journal ran a report entitled Medical Specialties Hit by a Growing Pay Gap on May 5, arguing that some fields of specialization are becoming extinct due to loss of income in that field. The fields being affected are those dealing with patients and performing fewer surgeries (e.g., Neurology, Geriatrics). As incomes in these fields have decreased, the supply of labor (i.e., specialists) shrank, and patients suffer.

Source: Wall Street Journal

The Wall Street Journal cites that 140 of the 400 remaining neuro-opthamologists in the U.S. will retire, and in four years, only 20 new residents have emerged. This is a problem that will certainly not improve under a universal health care system.

Under a universal health care system, incomes will almost certainly fall, bringing with them, the number and quality of medical professionals. Basic economics says that if the wage offered by a business (hospital) falls, the pool of workers from which it hires will contain a larger share of lower-skilled workers (doctors). The best and the brightest opt out for other fields of interest, leaving the lower-tier professionals. So, not only will medical professionals leave the industry, but the pool of medical professional changes. In short, the U.S. will no longer have the best and the brightest.

Please leave any comments/questions that you may have. Best, Nontruths

Sunday, May 4, 2008

The costs of universal health care are too large!

Growing health care costs is an issue important to families, workers, and especially, politicians. Along with higher prices for both energy and food, health care costs are rising and fewer individuals can afford to purchase insurance.

The Presidential candidates have turned their attention to short-term issues such as economics, health care, and prices, and away from longer-term issues such as climate change and war. Not that the latter are less important, but with the economy just barely breaking positive growth (0.6% annually) and prices rising at alarming rates (4.0% annually), short-term economics is what is on the American voters’ minds.

Medical costs are rising faster than average prices: 4.6% compared to 4.0%, respectively. The NY Times notes that as health care costs rise, fewer are insured. John McCain’s solution to this problem is “dollars should be put back into their [the families’] hands.” He proposes a new tax credit (up to $5000) to aid in health-care costs. Barack Obama and Hillary Clinton both propose sweeping health care reform (of differing degrees) to a universal health care system.

John McCain’s proposal is not “sweeping reform,” but definitely has holes. A tax credit certainly does not solve the problem of rising health care costs and falling coverage, and simply transfers the burden to the American tax payer. The universal health care system proposed by Barack Obama and Hillary Clinton will address the problem of coverage directly, and likewise transfers the costs to the American taxpayer, and the costs are likely much higher than they suggest.

Massachusetts, led by Mitt Romney, initiated a universal health care “experiment” in 2007. All residents in the state of MA are required to be insured, and if they cannot afford it on their own, the state will subsidize it. Sounds great, right? Well, one year later a health care budget gap of $100 million must be accounted for by July 1 (two months from now), adding to the already $1.2 billion dollar gap in the $28 billion dollar budget. Point: it is expensive to pay for universal health care, and barring all economic downturns, the government’s ability to budget for the system unlikely. Massachusetts is appealing to the federal government and certain state tax increases (like adding to the cigarette tax) to cover the health-care budget gap.

Someone must pay for a universal health care system. When the budget for such a system is underestimated – who is going to pay for the slack?

Another issue is at stake here: the labor force. The unemployment rate fell last month to 5.0%, and national payrolls fell only slightly (only 0.01% of the labor force). One of the industries that keeps the labor market strong during times of economic stress is health care. During this economic downturn, the health care industry hiring workers, while other industries like retail and manufacturing, are firing workers.

Why interfere with an industry that is clearly adding jobs to the American economy and driving growth? Initiating universal health care will likely cause workers to seek alternate, privatized markets with more incentives (i.e., higher incomes). The quality of health care may suffer, and job-loss in the industry may occur. By going to a universal health care system, the economy will lose jobs in an industry that is keeping us afloat.

Do you have any questions/comments? Please write them below. Nontruths

Thursday, May 1, 2008

Why reducing the gasoline tax is stupid!

The article, Clinton Gas-Tax Proposal Criticized, was published in the Washington Post on May 1, 2008.

The American economy is currently suffering. With crude oil hitting $120/barrel early this week (it has since subsided to $112/barrel), gasoline prices are skyrocketing. Since March 24, 2008, the average price of gasoline in the U.S. has risen 34 cents to $3.60/gallon. Americans are allocating a growing share of their hard-earned money toward gas and heat, and away from clothing, education, and food. It hurts!

In order to help the average consumer along, both Hillary Clinton and John McCain pledge to lower the gasoline tax during the summer. They figure that with a lower tax, the price of gas would fall, and consumers would have more money to allocate to other goods. There are two large problems with this proposal (repealing the gas tax):

  1. Repealing the gas tax, as stated by Greg Mankiw in the Washington Post, will not result in a lower price of gas.
  2. If the price of gas did fall, consumers would have less incentive to change their behavior.

First, the price of gas will not fall. The way that gasoline is produced identifies the supply of gas as inelastic. Based on factors of the production process (i.e., the large size of the oil refineries), the supply of gas does not respond significantly to any change in the price of gas. For example, Exxon and Shell expect the price of gas to be high indefinitely, so they build new refineries in order to accrue higher profits with larger production. This takes time – a long time! So, during the meantime, there is not a whole lot that they can do, except produce at full capacity. Since the supply of gasoline is produced in this manner, that means the reduction in the gasoline tax will result in only a small decrease in the price of gas at the pump.

Most of the tax that Shell or Exxon will not pay the government falls back to their pockets, raising revenues for the refineries. Why use a crook to bring your daily earnings to the bank when you know that he/she will steal your money along the way! The government is inherently putting money into the hands of the suppliers, and taking it away from the consumer. You know, in the end, it will be the taxpayer that will pay for the tax relief.

Second, lowering the price of gas by repealing the tax (see the first point above: this will not happen) gives Americans a reason not to change their behavior. Just months ago, many of the Primary candidates were advocating climate change and raising environmental quality. If the price of gasoline fell, then people would not need to shift their behavior toward more environmentally friendly behavior like taking the bus, walking to the grocery store for a quart of milk, turning down the hot water heater, powering down the computer, etc.

Since August 2007, the price of gas has been rising, and Americans have been buying less gasoline! Why give a strawberry ice cream cone to the diabetic child after they stop begging for it?

If the desired effect is to reduce emissions and lower the dependency for oil, the government should leave the gasoline tax as it is. When the price of gas begins to ease with the reversion of crude oil prices, then they should slap a new tax on.

I, on the other hand, do not believe that the government should attempt to dictate our gas usage; let the market work it out. This is a perfect example! If there is a shortage of oil supply (due to strong international demand), the price of oil rises, the price of gas and heat rise, and we use less. It’s that simple.

Thank you for reading. I would like to hear your questions/comments. Nontruths