Friday, October 17, 2014

Economics isn't about what is fair...

Yesterday, I reminded my undergraduate economics students that modern economics, with its quantitative bias, is not about what is "fair" in life. While we can use economics to identify what isn't "fair" and how to better allocate resources, at its core economics is the study of efficiently allocating scarce resources. Math is not moral; it is an amoral aspect of economics that should be informed by philosophical inquiries.

For example, quantitative economics can answer when a person is "unproductive" and "inefficient" within the system. But, economics does not answer if it is moral to reallocate resources from the unproductive to either the currently or potentially productive members of a community. Raw numbers tell us the money spent on extending the last year or two of life might be best spent on educating the young. But is that the right way to approach problems?

Economic models do not tell us if stock market gains driven by low interest rates and stock buybacks funded by lower borrowing costs are morally right. What the models do tell us is that those with stocks do benefit from low interest rates more than those without equity holdings. The judgment of "fairness" is beyond the scope of economic models — fairness is philosophical and, inherently, political.

I'd argue that economics often leads us to the "worst" choices when we apply only mathematics and statistics in a manner that seeks to optimize capital and resource efficiencies. Instead, we must ask much larger questions about what we want, what we consider utility for ourselves and others.

With my biases of culture and experience, I'm a believer in markets, with their bubbles and flaws and asymmetrical transfers of knowledge. Central planning is "efficient" in theory… and lousy in practice.

Statistics alone can tell me what I "should" do to maximize whatever it is I want to maximize, but most of us want to make "inefficient" choices that conflict with what we consider our core values from time to time.

Eugene Fama has argued that markets are efficient over time. The trends are what we study, not the day-by-day, minute-by-minute human transactions. Days are unpredictable, but years or decades tend to follow trend lines. That is because all those unreasonable, irrational, emotional choices we make average out over time.

Markets, free and open, let me decide if I want to "waste" money on my pets, my cars, my games, my lawn. Markets let me decide to eat expensive meals I don't "need" and buy clothes (like ties) that serve no logical purpose. I've long theorized an economist could prove that the production and wearing of ties costs the global economy, diverting resources better allocated to other needs. But, I don't want to be told that I can't buy nice silk ties.

The math of behavioral economics studies we have done to predict what we will do. It doesn't tell us what we should do. The math of macro monetary economics doesn't tell us what interest rates should be, only what they will likely be in specific circumstances. Models are information. What we do with that information is much different question.

If you want to allocate a resource "fairly" you have to make a moral choice, a judgment, of what is fair and why. Mathematics cannot do that for you.

Friday, October 10, 2014

Inflation that Isn't... Why?

Where's the inflation? Where's the run-up in bond rates?

Despite high debt, unsustainable long-term social spending, unfunded pension liabilities, and numerous other fiscal challenges, the U.S. bond market is strong and interest rates remain low.

Companies are facing increasing energy costs, unstable global situations, falling unemployment, rising minimum wages in larger cities, and a regulatory landscape that has shifted.

The Tea Party and the Occupy movements aren't exactly in the mood to reform corporate taxes, and the politicians reliant on both extremes aren't going to collaborate to improve the business climate in any meaningful way. (Yes, there are areas of agreement among most economists, across the political and theoretical spectrum, that good policy isn't good politics.)

If business costs and risks are rising, prices should be rising. With all levels of government fiscally unsound (and ungovernable), bond vigilantes should be circling. In theory, inflation should be creeping up with so many unfavorable variables. Yet, inflation is meaningless.

I discussed this situation with an economist from an investment firm, certainly no Keynesian, and I've also explored these questions with academic colleagues.

From my colleagues in business and academia, I've assembled a list of many theories on why there's neither bond inflation nor extreme consumer inflation.

Mild inflation is considered "good" in many ways by economists. Inflation devalues current debts, for example. This helps people and governments assume debt for socially beneficial investments. Governments selling bonds at a low interest rate to build roads that current receipts might not cover is something economists (generally) agree is sound policy. Inflation devalues the debt, making repayment a lower percentage of tax receipts. But, high inflation and rising bond rates make government invest risky, and debt repayment can ruin a government.

People want their houses, land, bank accounts, and wages to increase in perceived value. We could argue how real such increases are, and over the psychological value of inflation, but economists generally concur that our current global economies, two to four percent inflation is manageable.

And now, the theories on why there's minimal inflation:

1. Slack in the labor market. Yes, unemployment has fallen and 200,000 or so jobs have been created each month for almost two years, but underemployment and workforce participation rates indicate significant slack. Although skilled labor is tight, and wages are rising in places like North Dakota, overall there's little pressure to hire more people and pay higher wages.

2. Automation is working… in place of people. With emerging market factories opting for machines and software over once-cheap employees, the machines are rising. This allows companies to replace people or to avoid hiring new people. Some economists argue that since there are no mass layoffs, automation isn't hurting the economy. This is the same mistake made when considering higher wages: hiring deferred hurts economic growth, but it also reduces inflationary pressure.

Understand that automation and optimization are unavoidable. In nations with aging, shrinking populations, automation might be a great thing — allowing fewer young people to provide for their elders. But, automation that displaces workers or assumes roles of people never hired goes back to item 1.

3. Best of the worst economies. The United States and its various governments are among the best risks for investors. We're a safe haven in a world experiencing turmoil. This keeps U.S. bond rates low. Even a handful of large municipal bankruptcies didn't affect the muni bond market. If you want a safe, tax-free investment, bonds remain okay. Not great, but okay.

4. Generally benignly neglectful government. Our political system is in disarray, with gridlock at all levels. Yes, this creates some uncertainty, but not as much as some claim. As the business economist told me, no government action is at least predictable. Real uncertainty would be if we couldn't predict which party would have clear majorities in the House and Senate. Instead, we know that no majority will control the Senate, Republicans will control the House, and the President Obama has two more year. In other words… nothing significant is changing for at least two years and, barring a major electoral wave in 2016, gridlock is the norm.

Stability means companies have some certainty in the United States. Like being the best of the indebted economies, we're among the best of the worst governments. Not a point of pride, but it helps control inflation and bond vigilantes.

5. Domestic energy production. Energy, especially oil prices, affects inflation across product and service categories. How much domestic energy production, and increased energy efficiency, are counteracting other pressures is unclear, but these are helping control producer prices.

6. Frugal consumers, extravagant consumers. The consumer market is bifurcated, with the low-end consumers struggling. These consumers are keeping cars longer, buying fewer durable goods, and doing their best on flat or even declining salaries. These consumers, however, are masked by the steady consumption of the high-end consumers. Walmart shoppers become Dollar Store shoppers; Kroger gives way to Aldi. People are adjusting to lingering effects of the Great Recession… and that offsets inflationary pressures.

The economy grows, thanks to the high-end consumers. It grows slowly, though.

7. Weak housing market. The single-family, owner-occupied, mid-range housing market is weak. Housing demand being soft reduces inflationary pressures. Studies now show some people migrating from the pricier cities to lower-cost metro areas. House prices are rising, steadily, but demand limps along.

Other Theories

There are lots of theories on what happened and what's happening in the United States economy. Models failed to predict the Great Recession, and models haven't accurately predicted a recovery. Things are a mess, and might be a mess for many years to come.

I've read academic papers and institutional reports suggesting quantitative easing by the Federal Reserve, though potentially increasing inflation by devaluing the dollar, was absorbed by the equities market. The rich got richer, without any corresponding inflation. The access liquidity raised stock prices.

There is a theory that inflation is understated by the Consumer and Producer Price Indices. Prices of volatile food and energy being removed, and purchasing patterns changing among low-end consumers, leads to low official inflation rates, while the inflation in our daily lives is significant.

Whatever is happening, there will be consequences for fiscal mismanagement and political inaction. I doubt there will be hyper or even extreme inflation unless investors find a better place than the United States for their money.

The odds of that are pretty slim. Thankfully.

Friday, October 3, 2014

Even in the richest 3%, there's a growing wealth gap

The "one percent" of income earners, and even the one-tenth of top one percent, might be the only segment in the United States that has caught up to pre-recession income and growth levels. Though I never support wealth redistribution, clearly the opportunity curve is… broken. If the middle and upper-middle class cannot advance, it's unlikely the economy can move forward for all citizens.
Even in the richest 3%, there's a growing wealth gap

Robert Frank | @robtfrank
Friday, 5 Sep 2014 | 3:13 PM ET CNBC.com

America's millionaire population hasn't grown significantly in 10 years, according to new government data, suggesting that not everyone at the top is benefiting from the recovery.

The latest Surveys of Consumer Finance from the Federal Reserve paints the familiar picture of widening income inequality in America. The wealthiest 3 percent of households control 54.4 percent of the nation's wealth, up from 51.8 percent in 2009.

But the gains are highly concentrated at the top of the top 3 percent. And as a whole, American millionaire households—those with a total net worth of $1 million or more—have not fared as well, either in the recession or the recovery.
According to the new Federal Reserve data, there were 11.53 million millionaire households in the U.S. in 2013, down from 11.98 million in 2010 and below the 11.65 million millionaire households in 2004. (The numbers are inflation adjusted).

In other words, it's been a lost decade for America's millionaire population.

Even in percentage terms, the millionaire population is the lowest in a decade. Only 9.4 percent of American households had $1 million or more in assets in 2013, down from a peak of 10.4 percent in 2004 and even below the levels in 2001.
How would a classical liberal address these data? I can only write for myself, but clearly the market is distorted to favor financial sectors and investors instead of active entrepreneurship and risk taking. We penalize earning an income, while we allow investors more favorable tax rates.

We must encourage job creation, job expansion, education, and innovation. Our system, over-regulated and over-taxed at the points that could and should advance economic growth, needs to stop favoring some over others, at all income and wealth levels.

Government policies that are inequitable contribute to the slow pace of economic recovery. Everyone should be seeing opportunities increase, but that's not the case.

A colleague reminded me that the bond market is overwhelmingly the domain of the wealthy. And the bond market, especially government bonds, is rigged with all manner of tax incentives to encourage lending of money to governments. The wealthy do "invest" in government, and reap the benefits of these investments in the form of interest paid to them from the taxes of the middle and upper-middle classes.

We have to ask if it is fair to tax any income at a lower rate than other forms of income.

There are other reasons the extremely wealthy are doing better, including:
  • Quantitative easing that has helped push equities higher, benefiting the investment class.
  • Recovering real estate values, with a massive influx of cash purchases of properties.
  • Structural changes in the employment market, favoring special skills. 
We should ask ourselves if government policies are exacerbating the recovery and the inequity of opportunity. I believe the answer to that is yes, which is why I wouldn't look to good solutions from political leaders.