I Don’t Know Whether I’m Smart or Clueless

With respect to the previous post about China, it occurred to me right after I posted it that I actually did say something very much like what Batson said.

Here’s me, in a panel discussion, in October 2008 (a month after the Lehmann bankruptcy, when the Great Recession went from mild to horrible):

This latest round of trouble started about a month or so after the Olympic construction got finished. Essentially, the biggest expansionary fiscal policy project in the world just ended (official Chinese numbers are always dubious, but Rabinovitch 2008 reports spending of no less than $40 billion). If we are going to think seriously that a fiscal stimulus package coming out of Washington is going to boost the economy, then in order to retain our credibility we need to also acknowledge that the Chinese just slammed on the brakes of the global economy (note that the popularized dollar value of the Obama stimulus package is much larger). Experts may argue about the importance of that to other economies, so it should be emphasized that Olympic spending is a lot more like textbook fiscal policy than any of the stimulus proposals that have come out of Washington (see Colander 2007). [pg. 63]

The Beijing Olympics began on August 8, 2008. I have inside information: a very old friend was an architect on one of the stadiums, and told me they finished his venue on the morning of August 9 … with events starting that afternoon. Athletes were arriving while the architects were doing their final sign-offs.

Anyway, within a month of a minor downturn turning much worse, and within two months of the largest fiscal stimulus going on in the world at that time … I was saying something very much like what Batson said about housing construction in China.

So I do not know if I’m smart of clueless. But that’s the way macroeconomics is — lots of details and clues that critical thinkers have trouble assimilating, and too many “just-so stories” spread by other academics, the media, politicians, and bureaucrats.

Maybe China’s Growth Slowdown Is Easy to Understand

Academic economists (like me) get pessimistic about China for two big reasons:

• Structural problems — basically, the country has some (definitely more than one) recognizable organizational problems that are hard to solve and likely to slow growth, and
• The Middle Income Trap — basically, that most countries seem to stall at middle incomes (like Brazil), rather than cruise right through to higher incomes (like South Korea). So the odds for China just aren’t good to start with.

Andrew Batson (an economics consultant and reporter, on the ground in Hong Kong) has a different take.

I have to confess to some frustration with some of the recent commentary on China coming from academic economists. …But I think on China there is a tendency for some people to look past “simple” issues … Again, usually I’m all in favor of complex, historically nuanced explanations–but you can go too far with this stuff. Sometimes it’s really not that complicated.

He follows with a list of structural explanations which, if you’re paying attention, sound like the stuff I say in class all the time.

What I found amazing about these analyses is that they fail to even mention the most straightforward and direct explanation of why China’s growth is much slower today than it was in say, 2010 or 2007. It’s not like it’s a secret. From about 2003 to about 2010 China had the biggest construction boom of modern times and probably in all of human history. Then in 2011-12 the construction boom ended. That’s it. Really, that’s all you need to know.

…

None of the various structural reforms being debated today will do anything to change the fact that in the near term, China does not need to build a lot more housing. And that therefore business for companies related to housing construction (and there’s lots of those) will be poor.

I have to admit, I think he’s got a good point. So maybe I’ll back off on China a bit (don’t count it though). What really got me was his discussion of what critics of China think China ought to do if it actually has those structural problems:

If you think China is succumbing … the proper response is a set of carefully calibrated structural and institutional reforms. If growth ends up worse than expected, you put the blame on the government for not taking the right policy prescriptions.

I find that very convincing because it’s an argument about why my thinking about China may be weaker than I’d like to believe.* Batson is pointing out that if you think China’s government got them into this mess, then you also think they can get China out. But that contradicts the general assertion I make in class that politicians/bureaucrats … just don’t have that much control over the economy. Either they do or the don’t, but you can’t have it both ways.

Read the whole thing here.

Via Marginal Revolution.

* Macroeconomics is all about critical thinking skills. If you’re not introspective about how you interpret events, you’re going to have trouble in your career when you face news issues that don’t fit into your intellectual framework.

Real GDP Growth for 2014 IV

The first draft of GDP for 2014 IV came out this morning.

It’s not pretty: an annualized growth rate of real GDP of 0.7% per year. That’s not below zero, so it’s not recession territory. But, it is below the threshold — around the population growth rate of 2% per year — than needs to be exceeded for people to feel good about the economy.

For the whole year, real growth was 2.4%. Nominal growth was 3.4%, so inflation was about 1%.

A Bad Sign

The government of China is investigating the head of it’s own National Bureau of Statistics for corruption. This bit from the BBC sounds Orwellian:

The Central Commission for Discipline Inspection said that Wang Baoan was "suspected of serious violation of discipline", a phrase that usually refers to corruption.

It gave no further details of the investigation.

…

The announcement came hours after he held a media briefing on the state of China's economy.

Here’s a CV for Wang Baoan. His briefing was about capital outflows being more than double what was forecast for last year. Here’s what the South China Morning Post (the big newspaper in Hong Kong) said.:

The sound bites were broadcast on state radio’s main daily news bulletin. But minutes later the news presenter read out a brief statement about the investigation into Wang. The apparently hasty arrangement is rare given the tight editorial and censorship procedures at top state media.

It’s possible that this genuinely related to a criminal issue.

However, it’s more likely that this is about either 1) Wang not producing lower and more realistic GDP growth numbers, or 2) Wang being the one who wanted lower and more realistic numbers and being shut up for saying so. Who knows?

Why Do Technology Firms Hire Economists? (Not Required)

Majoring in economics? Silicon Valley (and other tech centers) hire quite a few. Susan Athey (a really big name economist from Stanford, who’s on the board of a lot of tech firms, and a consultant on retainer for Microsoft) provides some information about that in this post from Quora.

How Do They Decide When the Economy Peaked?

We know economies peak and trough. Who decides on those dates?

Many people (even countries) use the convention that 2 or more consecutive quarters of declining real GDP is what makes for a recession. This has the advantage of transparanecy. But its disadvantages are that you’ll probably be waiting 7-9 months for that GDP data. Also, some country’s GDP data is sketchy.

In the U.S., we have an official committee that provides official dates. It’s called the NBER Business Cycle Dating Committee. NBER is short for National Bureau of Economic Research. This is a private group of economists, mostly from top universities. The committee is composed of several top macroeconomists. They typically pin down dates of peaks and troughs a few months after they occur.

Over the decades, they have looked at a huge number of variables. Most of them have the false negative and false positive. Over the last 20 years or so, they’ve settled on four that they think are better than the rest. Do note that these four are coincident indicators: they peak and trough when the whole economy does. The Committee is not doing forecasts, so they’re not looking for leading indicators (and, of course, everyone tries to avoid lagging indicators … like the unemployment rate). Those four variables are:

• Non-farm employment (farms are excluded because they have big seasonal fluctuations)
• Industrial production (most of the economy isn’t industrial, but this is easy to measure and available monthly)
• Real retail sales (the two previous series are real by definition)
• Real personal income excluding transfer payments (because including transfer payments would smooth out personal income).

Here’s how these four look since the last trough:

This graph is copied from the excellent page entitled “The Big Four Economic Indicators: Real Personal Income for November” at advisorperspectives.com. As of the November data (the December data should be out any day now), only industrial production is showing signs of weakness. It’s been doing that for over a year.

Keep in mind that because these are coincident indicators, that if they all started going down this month, we’d probably call that the peak. We’d then expect them all to continue dropping until around the trough.

Here’s what they’re doing right now, if we measure each variable as a percentage off its peak, and then average those figures. (It’s a little tricky, but in the table above, this would be the sum of all the green entries in a column, minus the pink entries in that column, minus all the immediately precedings and uninterrupted pink periods — because no new peak has been set for those series. So that’s 0.18 + 0.34 + 0.25 – 0.90 – 0.16 – 0.02 = –0.31).

All recessions have to start somewhere, so maybe this little downturn we’re in is the start of something. But, for now, we’re not down enough to be too worried. We probably need to get to at least –2.5 to really think recession. For December, you can see that we’re still waiting for one number, whose components come come out on February 1. So far, we’re at –1.34.

Those components are:

• Personal Income = 15,617.6 for November
• Personal Current Transfer Receipts = 2699.7 for November
• Personal Consumption Expenditures: Chain-type Price Index = 109.782 for November.

Subtract the second from the first, multiply by 100, and divide by the third to get the NBER’s preferred number which was 11,766.9 in November. The –1.34 means we’re off the trouble zone by 0.66%, or maybe a bit more. That works out to a drop of 77.7 in this index. So roughly, we should be thinking we’ve peaked with a figure of 11,690, and we probably won’t have any doubts if it’s 30 or 40 points lower than that.

More On Forecasting a Peak

Stock markets are not the only thing that delivers poor forecasts of recessions. Check out this chart:

What these three charts show is how off its most recent maximum value each of the series is. So if a series is growing steadily, setting a new maximum each month when the new data comes out, then the curve will be pegged at zero. But if the series continues to decline off its peak, it will get lower and lower.

These charts also shade the postwar recessions.

So, what do we see. First off, all three series are off their most recent peaks.

Perhaps more importantly, none of these series appears to go down much before the business cycle peak (the left side of each shaded band). That implies, if you think these are all good variables for forecasting, that we’re already in a recession. Does it feel that way to you?

Having said that, and repeated my warnings about false positives and false negatives, the evidence here doesn’t look very good.

• The stock price drop is a positive signal (that we are in recession). There have only been 4 large false positives since World War II.
• Profits perform a bit worse: there have been 10 false positives since World War II. But most of those occurred when the stock market did not confirm the signal.
• The drop in industrial production is small enough that I’m not going to say it’s sending out a positive signal. But, we just started peaking for this expansion, and we’re seeing a dropoff at the same time that corporate profits are falling. That’s not good.

This was drawn from an article entitled “Recession Warnings May Not Come to Pass” that appeared in the January 25 issue of The Wall Street Journal. Read the whole thing.

How Will China Finesse the Trilemma?

There’s an old joke about operations management and engineering: cheap, fast, and good … pick two. The joke is that bad managers try to get all three, and frequently end up with none of them.

There’s an international macroeconomic version of that pundits took to calling “the trilemma” a few years back.

It says that a country can’t have all three of the following things at once: a flexible monetary policy, free flows of capital, and a fixed exchange rate.

The situation that China is in right now is that they have officially given up on the fixed exchange rate, but haven’t been too willing to let it float freely either. And they’re worried about capital outflows. And they’re using their monetary policy tools to try and control both.

This has been tried before. Heck, it gets tried by several countries every year. It usually doesn’t turn out well.

Do note that the article makes clear that capital outflows are not necessarily a bad thing. That’s basic economics, but personally, I’d like to give world leaders a quiz on that one … my guess is that most of them would get it wrong.

Read the article entitled “China’s Capital Flight” in the January 14 issue of Bloomberg BusinessWeek.

Bad Data to Better Data

Bad guys that get to the top of governments like to suppress the collection of decent macroeconomic data: it helps to cover up their misdeeds.

Twelve years ago Argentina elected a couple who turned out to be international poster children for bad government: the Kirchners. She’s been out since the fall.

The new government in Argentina is already cleaning up their macroeconomic data. Read “Argentina’s President Macri Throws Open the Books” in the January 14 issue of Bloomberg BusinessWeek.

Perspective On the BRICS and the G-7

Economic power is shifting. But, to believe some people in the legacy media the rich countries have already been supplanted by the up-and-comers. Don’t believe the hype.

The G-7 is the deprecated name of the 7 big, developed economies, that dominated the global economy from the 60’s through the 90’s: America, Japan, Germany, the UK, France, Italy, and Canada in order of size.

BRICS is the trendy new acronym to collectively describe 5 large, but still less developed economies: Brazil, Russia, India, China, and South Africa. Those are not in order of size, but rather in an order to produce an easy to remember (and pronounce) acronym. I also think there’s some wishful thinking involved in this list. Note that there’s one country from every region. And it includes Russia, which is, at best, a fading power. It also includes South Africa, which … umm … really shouldn’t be on the list unless someone said you have to have an African country. Also note that it excludes some countries that are probably big enough to get on the list, but are already from a represented region (for example, Pakistan, Vietnam, Nigeria, Ukraine, Mexico, and so on).

As always, be aware that eye-catching graphics often … don’t say that much. This is a perfect example: if you look closely, the two panels show the exact same thing.

Keep in mind that what’s being shown here is proportions. All of these country’s economies are getting bigger. What’s being shown here is who is getting bigger faster, and who isn’t.

Anyway, the proportion of the global economy in the G-7 has been dropping. And the proportion in the BRICS has been going up. That’s a good thing: not in and of itself, or because it shows “diversity”, but because the G-7 used to be such a big proportion because so much of the world was grossly mismanaged. We should want the BRICS to be a larger share because it’s humane. Period.

Having said all that, the focus on groups obscures what’s really a story about two countries. Yes, the BRICS proportion is going up, but that’s mostly coming from China. The other countries are laregely stagnant. And yes, while the proportion in the G-7 has gotten smaller, and really all of the countries have seen their proportions go down, the big loser is Japan.

This chart accompanied a piece entitled “BRICS’ New World Order Is Now On Hold” that appeared in the January 20 isse of The Wall Street Journal.

Global Poverty

This “heat map” gives some sense of global poverty, by shading the proportions of the population living on $700 per year or less.

The panel at the top left shows the really important piece of information: global poverty is down, over the last 25 years, by the most substantial amount in history. Anyone who tells you that things are getting worse on the planet is simply not telling you the truth.

The panel at the bottom left shows that most of the improvements have come in Asia. There’s still more poor people there, but a small proportion than there used to be.

The shading on the map shows the remaining problem arras. Not surprisingly, this is mostly in sub-Saharan Africa. Having said that, there are brighter spots dotted all over Africa. Maps like this used to be fairly solid all across that region.

This accompanied an article entitled “Slow Growth Clouds Fight Against Poverty” that appeared in the January 20 issue of The Wall Street Journal.

The Economy Is Underperforming Relative to Forecasts

This graphic shows the U.S. economy underperforming over the last several years.

These graphics are getting more common, and can be hard to read.

The actual performance of the economy is the gray steps in the middle.

The colored bands are the forecasts made by a bunch of different forecasters. The color shows the year when they were made. The band go as far to the right as those forecasters predicted out into the future.

What we see is that:

• In 2011, the gray bands forecast growth to be higher than it was in 2012 and 2013.
• In 2012, the blue bands shows forecasts that are less optimistic than the previous year, and which still generally are too high for 2013-2015.
• In 2013, the yellow bands show even more pessimistic forecasts, that are still to high. And so on for 2014 and maybe 2015.

There’s a couple of ways to look at this.

One is that the economy is underperforming. If that’s the case, the evidence we develop in class (as Case 5 in March) will show that this is because we continue to be hit by negative shocks. One negative shock after another is hard to reconcile with anything other than poor policy choices.

A second way is to view the forecasters as being systematically wrong. I’ll assert that we should dismiss this: individuals forecasters can be wrong, but groups of forecasters tend to do pretty well, so I’m incredulous that a bunch of them has been too high year after year.

A third way, and one which you need to be aware but which I am not encouraging you to put at the top of your list, is that the economy is fine but what we’re measuring is missing more stuff than it used to. Please go check out the post “What’s Wrong with America Right Now? Is It the Economy, or Is It Us?”, and pay particular attention to the Thanksgiving allegory given towards the end.

A Neat Graphic for Global Perspective

This was in a special section called “Outlook” of The Wall Street Journal on January 20. At one level, we are concerned with understanding the gross size of different economies. But at another, we’re concerned about proportions of the global economy. That’s what this one is all about.

The color scheme is common through all 9 panels: the U.S. is dark pink; Asian countries are in blue with India towards the center, Japan on the right, and China in the middle; and Europe is in the middle in shades of gray.

The vertical scope is the last 25 years, with the distant past at the top.

The top left panel shows GDP. The U.S. is a somewhat smaller fraction than it used to be. The big loser is Japan, and the big gainer is China — although China is not yet as important as Japan was 25 years ago.

The middle left shows population, which is always pretty stable. India and China have always been the most populous, but India is slowly taking the lead. Most Americans are surprised to find out that we’re the 3rd most populous country, and amongst developed countries we’re the ones with the consistently highest population growth rate (yeah Mormons!, yeah evangelical Christians, yeah immigration!).

The middle panel shows air traffic: a good indicator of development. Here, we see a shift towards Asia over the last generation. Directly to the right of that is shipping. There’s been a huge surge towards Asia here. Of course, this is export driven, but a lot of it is also the warm, temperate, western Pacific, and the ability to build brand new harbors to service container ships (which are a new thing over the last generation or two, and revolutionary at that).

The bottom row is reserved for the bad news.

The left panel shows refugees. Not surprisingly, Afghanistan, Iraq, and Somalia are the fat ones there, and Syria is the big new one at the bottom. Do note that the refugee problem in Afghanistan was at least as large before America got heavily involved there as it is now. And we’ve been out of Somalia for 25 years, and have avoided Syria. Also note that there are several refugee problems that have been solved, so it isn’t like these things are intractable.

The middle panel shows remittances: payments made to the home country from citizens working overseas. Asia is big here, and most of that is people working in the Middle East. Do note that remittances to Mexico actually peaked 10 years ago. Politicians have been leading from behind long before Obama made it trendy: they’re most worried about immigration, when economists will tell you that it’s a story that’s getting stale.

The last panel, at the bottom right, shows carbon dioxide emissions. If you’re worried about that sort of thing, there’s really no point in worrying about anything other than China right now.

This accompanied an article entitled “Global Economy Loses Steam”.

9 Out of 5 Again

More on declining stock markets around the world, and whether they may or may not be indicative of a recession. Do note that this sort of ambiguity is really useful to journalists because it gives them more to write about.

… Why pay attention to the financial indexes that, as the old joke goes, have predicted 9 out of the past 5 recessions? There are three possible reasons the market selloff could be cause for concern.

The first is that a recession is coming but has yet to show up in the data. The U.S. seems due: Its economic expansion is now the fourthlongest since World War II, and the stock market is a leading, albeit error-prone, recession indicator.

But hard economic data are not behaving as they would before a recession. …

Do keep in mind that recessions do not die of old age. This is one of those ideas that people keep trotting out and that macroeconomists are really tired of explaining just isn’t there in the data.

What about the rest of the world?

…

Surveys of purchasing managers from around the world compiled by J.P. Morgan Chase and Markit show that overall economic activity slowed a bit in December but to a level consistent with normal, long-term trend growth.

So, China’s not doing great, Brazil is in the dumps, but everyone else is muddling through OK.

The third and most plausible possibility is that markets are losing confidence in policy makers, driven in particular by events in China and the U.S.

…

“We collectively lost faith in ability of the Chinese authorities to always do the right thing,” says Angel Ubide, a former hedge-fund manager now at the Peterson Institute for InternationalEconomics. By contrast, the Federal Reserve is transparent and independent. The problem is markets disagree with its plans.

This is not a big factor for macroeconomists. We know that policymakers can influence economies, but that influence isn’t very big to begin with.

Read the whole thing. In the print version of the January 21 issue of The Wall Street Journal it’s entitled “The Selloff May Not Mean a Recession”.

Keynes Investment Returns (Not Required)

There’s an old joke that the difference between an economics major and a finance major is that the finance major still thinks they can beat the market.

Keynes was well-known in his time as a successful investor (do not make the casual mistake being dismissive of Keynes, whether you like his conclusions or not, he’s one of those people that forgot more than the rest of us will ever know).

Anyway, there’s some (cute) recent research that even Keynes didn’t beat the market much. If you’re interested, here’s a short and non-technical discussion from the January 12 issue of The New York Times entitled “Keynes: Great Economist, Mediocre Currency Trader”, a little longer but technically accessible piece at Vox entitled “The returns to currency speculation: Evidence from Keynes the trader”.

State of the Union: The Data

How is the U.S. economy doing right now? Data helps. But keep in mind that journalists may not understand the data that well, and then if there’s a graphic sometimes it will get corrupted by artistic concerns. After principles, you are at the point where you should start picking up problems with data that’s presented to you. Check out this graphic:

This data was reported to summarize the performance of recent presidents in their 8th year. Except that it forgets about Bush I everywhere except the bottom panel – which shows approval rating rather than economic data. You’ll have trouble getting the economics right if you can’t consistently include all the presidents.

Also, keep in mind that presidents probably don’t do much to influence the economy. So it’s a good way to group year’s together … but don’t read too much into it.

Let’s start at the top left. Presidents are probably not responsible for the recessions that happen to occur when they’re in office. This makes Clinton look better than he was (the economy has almost 2 years to get going after the recession before he came into office). And Bush II inherited a recession, before he got hit with a second one, and that probably makes him look worse than he was. Slope over the majority of that graph is probably the best way to compare them. On that count, Clinton and Reagan look better than either Obama or Bush II. By the way, most of that memory of Reagan being so great is that steeper portion in the middle of his tenure.

Now go to the top right. This shows stock market indices. One of the things you should learn in this class is that you probably shouldn’t look at this at all for any macroeconomic insight: too many false positives and false negatives. And that goes both ways: using the stock market to predict the economy, or the economy to predict the stock market.

Now go to the middle left. You’ll note that consumer confidence roughly tracks the employment data directly above it. So there’s not much new here.

Digression: macroeconomists are not sure what to make of consumer confidence. It’s human nature to want to explain recessions with one or a few variables, but instead it seems to require a big list. Consumer confidence is on that list. But the only recession where it seems to have been the primary factor was the one in 1991-2. And that’s not shown in the chart!

Lastly, go to the middle panel on the right, which shows gas prices. This is an easy one: it doesn’t say adjusted for inflation, so these are nominal prices of gas, not the real price. So this is close to useless. Of course, gas costs more under Obama and Bush — the dollars used to pay for it aren’t worth as much.

All in all, it’s kind of sad (because some journalist probably worked hard on this), but a good student should recognize that … there isn’t much here. Democrats will not be happy to see that Obama doesn’t look much better than Bush II. And Republicans will not be happy to see that Clinton outdid Bush II, and was more than comparable to Reagan. I think both of those assessments are accurate, but there’s a lot of other data that could have supported that position.

This chart accompanied an article called “Obama to Note Work Yet to Be Done” that appeared in the January 12 issue of The Wall Street Journal (in preparation for his last State of the Union address).

Is This a Peak?

Is the U.S. economy peaking? Maybe. Some people think it is.

I am a bad person to ask on this one. Yes, this is my field of expertise. But personally, I tend to be too optimistic. So I tend to miss peaks as they’re happening.

One reason for this is that peaks and troughs are names that are poorly chosen. To me, peaks are sharp, and troughs are not.

But, in real time, peaks are hard for the public to feel, and troughs are more distinct. It’s like the tops of the business cycle are mountains, but old, rounded ones. And the business cycle lows points aren’t wide flat valleys between mountains, but the bottom of steep canyons.

Anyway, some people are wondering. Read “Behind the Pain: Misplaced Faith” in the January 14 issue of The Wall Street Journal.

I Told You So (not required)

This came from an NPR report about yesterday’s poor performance of U.S. stock markets:

ZARROLI: Well, it was funny, I was watching today and a lot of stock market pundits are now sort of officially talking about recession, using that word. But you don't hear that from economists, really. And it sort of is a reminder of the fact that the stock market is not the same as the economy. I mean, you can have the stock market going down when the economy is not. There's an old saying, the stock market has predicted nine of the past five recessions. [emphasis added]

SHAPIRO: (Laughter).

ZARROLI: You know, so it can go down when the economy is still doing OK, and - but it is something to watch, definitely, …

Earlier in the report, this remark was also made:

… And also, you know, economies all over the world are weakening - too much capacity, not enough demand. You have hot growth countries like China slowing down and then other countries like Brazil entering a deep recession. …

The audio and transcript are here.

An “Oh Sh*t Moment”? And the 67% Interest Rate

When planes crash, they listen to the cockpit voice recorder. There’s a dark joke that’s based in fact: a lot of times the last words they here are “Oh ****”. Fill that in with the expletive of your choice.

World financial markets had one of those moments last night in America/this morning in China.

The thing is, a lot of journalists don’t know enough macroeconomics, and neither do their readers. Journalists don’t write about what they don’t know, and they don’t write if their readers don’t know what they’re reading.

So, there is some stuff written about this. It’s a news item today, but it’s not a headline like it should be.

What happened? This morning in Hong Kong (last evening in Utah) a key interest rate was driven up to 67%. It’s back down now, but still a lot higher than normal.

There’s a ton going on here, so let’s review some facts, and how things work in practice.

Banks lend reserves to each other. This is a good practice, that keeps them all liquid. Those loans are mostly overnight — a bank that’s short on reserves one day might be flush with them the next, as deposits and withdrawals are made. Overnight bank to bank loans are very safe, and therefore have a very low interest rate.*

China’s currency has been depreciating. This has gotten to be pretty steady over the last few months: it’s worth less one day than it was before. So, there’s a pattern.

How do currencies depreciate (or appreciate)? Currency markets are huge: global, 24/7, digital and nearly instantaneous, billions of dollars of one currency traded for billions of dollars of another one all to lock in several hundred dollars of profit on a minor advantage. Think about that, a currency trader, fresh out of a place like SUU, working for a big financial firm and making at most $100K per year has to generate about $500 dollars in revenue every day for the firm to cover their salary and benefits — and they have to do that with gigantic trades of other peoples’ money with very thin opportunities.

Why do currencies depreciate? This is tougher. There’s a lot of cash in the world (mostly kept track of digitally rather than physically), and most investors of cash (mostly large financial firms that lend to producers and governments) need to keep several varieties on hand: dollars, renminbi, yen, euros, pounds, and so on. All day long their traders are trying to figure out if they need a little more or a little less of each one. The thing is, they trade one currency for another, because they want all of them in cash all the time. And they also support any sort of non-financial investor that needs to get money into a country to invest there, or out of a country to invest somewhere else. When there are more people trying to get cash out of a country than into it, they will give up more of the currency they’re trying to get rid of for less of the one they want. That’s a depreciation.

What’s going on in China is that, at the gross level cash is flowing in to make investments, at the gross level cash is flowing out so people can make investments elsewhere, and on net the outflows are greater than the inflows, so the value of the currency is dropping. Why would this be happening:? Because it’s fairly easy to see that China isn’t doing very well. That doesn’t mean it’s doing terrible, or will do worse, or anything catastrophic. It just means that relative to other places, it doesn’t look too good right now.

China used to have fixed exchange rates. Now it has flexible exchange rates. When you have fixed exchange rates, the government agrees to honor all exchanges of currency at a constant rate. If you’re country is in good shape, money comes in faster than it leaves. And those people who want to get money in are willing to give up extra, say, dollars, to get fewer renminbi. Because the government is doing those trades, it accumulates dollars and other foreign currencies. That big pile of foreign monies is called foreign exchange reserves (or just foreign exchange). Over the last few decades, China has accumulated a lot of foreign exchange.

But now China has flexible exchange rates, and the game is different.

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Everything I had ready for class is above the line. This stuff below is all new after class (except for the footnote). I tried to mostly write this post in an order that would seem sensible as you try to figure this all out.

How are flexible exchange rates executed differently than fixed exchange rates? Well, in fixed exchange, one trader is always the government, and they are telling you how much of your currency they’ll take for each unit of theirs. Even if you are trading privately with someone else, you both know that you can always go to the government and get a set price, so you won’t deviate much from that. But, under flexible exchange, the two parties are negotiating, and there’s nothing pinning down the exchange rate … except that both parties know what others are offering, and what was done recently, so they’re not just guessing.

Now, go back to fixed exchange. The government sets the rate. If, at that rate, investors are trying to get their money into the country faster than they are getting out, the government accumulates foreign exchange. But if the investors change direction, the government spends/loses that foreign exchange as they maintain that exchange rate that’s no longer quite right. If things get bad enough, the government can set a new exchange rate (a devaluation), or they can lose their foreign exchange so fast that there’s a crisis.

What China did is play the fixed exchange rate game well over the last few decades (and accumulated foreign exchange). Then they switched to flexible exchange, and were probably hoping they’d get to keep all that foreign exchange (and maybe even spend it on something else).

Except that now China has flexible exchange, and the only way to keep an exchange rate that’s flexible at some value you find desirable is to buy and sell in the foreign exchange market just like any other trader.

So, the point that Shan made in class that China has a target for the exchange rate is true, but it’s only sensible to have a target if you have the foreign exchange to keep your exchange rate near that target. China does. For now. But no country has enough foreign exchange to do that forever. The policy discussion inside at the top in China is 1) should we keep letting our currency depreciate (which has pluses and minuses), or 2) do we spend some of this foreign exchange we were saving for a rainy day … because now the rainy day is here.

In sum, China has flexible exchange rates right now, but flexible means they can go both ways on their own, and China doesn’t like the way the exchange rates are moving … and they can slow that down or stop it by acting like they have rates that are more fixed, but it’s going to cost them.

It’s time to start tieing all this together.

Now, on to Hong Kong. Hong Kong still operates somewhat separately from the way the rest of China does. And because of it’s colonial history, location, and wealth, Hong Kong is a financial center for all of Asia and China in particular. So, banks and financial firms in Hong Kong are the ones making most of the overnight loads of reserves denominated in Chinese currency.

And there’s more investors trying to get money out of China than in, and they’re doing most of this through Hong Kong.

And maybe we’re starting to see some herd behavior that might lead to an asset bubble. This would happen if investors are not trying to get out of China because their business fundamentals have gotten worse, but because they’re following the herd of others trying to get their money out of China. We usually think of asset bubbles as situations where the prices are going in one directoin irrationally. You never know for sure, but maybe there’s some of this going with China’s exchange rate right now. The thing is, even if the price movements are irrational, a rational trader can still make money off of them. And, if a rational trader is doing the same thing as the herd of irrational traders, then the irrational traders are encouraged to keep doing what they’re doing.

This brings us to short trading. A short trade is where you pay someone a little money now to borrow their asset, with the promise to return it at some set date in the future. It helps if the asset is fungible (this means that you don’t have to return the exact same unit of the asset, but can repay with some other unit of the asset — so dollar bills are an example of a fungible asset). How do you make money off of a short trade? Basically, it’s a bet that the price of the asset is going to go down. Because what you do is borrow the asset, and immediately sell it, then buy it back later on when its price is lower, and pocket the difference.

So if the value of the renminbi is falling day after day, you can make money short trading. To do this, you’d borrow others renminbi today, trade those for some other currency, then tomorrow you’d buy cheaper renminbi, and pay off your loan.

And, who’s loaning renminbi? Banks in Hong Kong with excess reserves. Normally they loan those to other banks, but if they can loan them to a currency trader and get more money for them, then why not?

Journalists and bureaucrats like to call this speculation. I think that’s nasty. They’re trying to tack a moral cost on to a smart business transaction.

And what is that smart transaction? It’s using the Hong Kong banks as a source of funds to short the renminbi because — irrational or not — a lot of investors are trying to get out of China. These traders are just trying to get into China today so they can get out tomorrow too. It’s not immoral, but it’s certainly not typical (which can make it easier to convince people with your sketchy claim that it is immoral).

Now another player has come into this market. Here’s the players:

• Banks with excess reserves, who trade with banks with insufficient reserves, to be paid pack with reserves tomorrow (plus a little extra). That little extra they pay back is expresses as an interest rate.
• Banks with excess reserves, who trade with currency traders who give them a little extra of something desirable today (like dollars), to pay them back the same amount of reserves tommorow.
• Banks with excess reserves, who trade with the government of China who gives them a little extra of something desirable today (like foreign exchange), to pay them back the same amount of reserves tommorow.

What China has done is change the word “little” in the third bullet point to “a whole lot more” to outbid the currency traders in the second bullet point. This means the banks who are short on reserves in the first bullet point have to pay a lot more back tomorrow (which is expressed as a higher interest rate). China can keep doing this as long as they either want to spend their foreign exchange reserves, or as long as they have foreign exchange reserves to spend.

This is kind of like a pack of dogs fighting a bear. The dogs have annoyed the bear, and it just swatted them really hard. The bear won this round. Does that mean it will win the fight? Simon Rabinovitch, from Boston University had a good tweet summing this up:

Better for a central bank to be feared or respected? China opts for the former …

This next bit will sound a little vacuous, but it’s true: governments always win foreign exchange fights until they lose. The thing is, government officials tend to think they’ll never lose. Which is why depreciations often lead to crises. I’ll be quoting from here down from this piece at Seeking Alpha (they may want a free registration, and I would not worry about doing that).

Central banks trade short-term outbreaks of calm for long-run continued problems of inefficiency and imbalance. Market forces, including speculation, is trying to trade short run disorder and turmoil, sometimes very nasty, in order to find a more suitable long-run balance.

Is this an “oh sh*t” moment? Who knows. Here’s what we do know.

• There are problems in the non-financial part of China’s economy.
• This is leading to problems in the financial part of China’s economy.
• The financial sector is nimbler than just about any non-financial industry, so the problems snowball more quickly.
• There probably is some short trading being funded through otherwise normal banking in Hong Kong.
• Traders making rational moves are being labeled as speculators.
• China’s government made a big play targeted at those traders, and didn’t care if it hurt banks that were short on reserves in the process.

A big picture insight that you won’t get until you kinda’ sorta’ understand this whole post, is that the government of China is unlikely to have taken that last step unless it had taken a lot of other steps targeted at the top of the list … and given up on them.

If the PBOC [i.e., China’s central bank] was desperate last week, the catalog of words describing their likely stance this week is unbelievably short (pun intended). In the handbook of central bank operations, when conditions truly spiral out of control, the first entry in that chapter says to blame speculators. Primary among them, subchapter one in the handbook, are the short sellers.

… amount to are acts of proclaimed exhaustion; the central bank or central financial authority has no other options left …

This relates to the post from earlier this week that Xi Jinpeng and his administration may be micromanagers that are being overtaken by events they can’t handle.

In attacking the speculative aspects of these currency repressions, central banks never answer the question that should be addressed from the very start: why are speculators "attacking" in the first place? … Speculation is but one mechanism by which imbalance is brought back to a steady state. It is a violent, messy and disorderly method, but cuttingly effective which is why short speculation makes for such a good, public target.

For now, this move seems to have worked. Sometimes that happens. Sometimes not.

Do you see now why this is not a big news item? It’s not easy to figure out. If you want to keep up on it, you can go to Google, put in “hibor” as your search term, then click on the “News” link at the top, and see what’s new.

* Do note that the rate did not go up to 67%/day, so that you borrow 100 today and repay 167 tomorrow. Instead, that 67% is per year, and is calculated as what you’d get if you could get that overnight rate for 365 days in a row, and compounded it each day. It’s good practice to work out what the rate per day actually was.

How Much Should We Trust GDP Data?

I wouldn’t say it’s normal for me to start out a semester by trashing GDP, or by picking on a particular country like China. But, I did.

It’s well-known amongst macroeconomists that many countries’ data is less than accurate.

It turns out there a service that actually keeps track of this. Of course, it can’t tell you a better number for a country’s GDP (because asserting that it’s innaccurate is different from knowing what is accurate).

World Economics, a consulting firm based in London, publishes the Data Quality Index for GDP (along with quite a bit of other interesting and unusual data).

Their index weights 5 factors that affect the quality of GDP measurement: 1) how often the base year is updated, 2) how up-to-date are their accounting standards, 3) how big is their informal economy, 4) per capita real GDP (as a proxy for how well-funded government statisticians are), and 5) corruption.

Who’s the best? Switzerland. America is # 2 (we’re below Switzerland because we’re a little more corrupt). China is in the middle of the pack; the biggest contributor to their low rank is corruption.

What’s the Recent Labor Market History?

This graphic is an interesting way to summarize how labor markets have done over the last 15 years:

Unfortunately, like a lot of infographics that emphasize cool over utility, there are som pitfalls. In particular, people are predisposed to thinking higher is better, and the yellow and red ribbon shows a decidedly mixed message if that’s what you’re inclined to think. But … maybe not.

In principle, what you’re seeing here is a cool idea. Take the numbers from each year, and rank them from best (at the top), to worst (at the bottom). Then put a number of series side-by-side, to increase data density. Lastly, tie it all together by highlighting the current year (although doing that in warning colors of bright yellow and red is … problematic).

On the left, the job gain numbers are pretty good. They should be adjusted for the fact that the population is a little larger today than it was in the earlier years. This would tend to move the more recent years down a bit. Also, this is job gains relative to the year before. It’s really easy to gain jobs when the economy is coming out of a deep hole, so putting the recent years above those from a decade ago (when we were expanding out of a much milder recession that created less slack) may not be appropriate.

Second from the left is the unemployment rate. The number we have right now is pretty good, and we should feel good about that. Having said that, we’re too quick to forget that Bush beat the current number twice.

That panel should be compared with the one that is second from the right (the fact that they are not right next to each other is a tip off that what you’re seeing here is a victory of artistry over relevance). Anyway, this panel shows that for those people in prime working age, we don’t have as much participation as we used to. (Also note that there are some typos in the dates on this figure: 2005-08 are mislabeled and mixed in with the 2002-03 numbers). Also, we hear some stuff (correctly) that labor force participation is down because baby boomers are retiring: that is correct, but that’s not what’s shown here. Instead, this is something called the labor force to population ratio. How is that unemployment and that ratio are down at the same time? It’s telling us that some people aren’t that interested in working (note that there is no moral judgement there about whether that’s a good thing or not). The way to think about those two numbers is that of the population that should be working, about 80% of them want to work, and of that 80%, about 5% of those are unemployed. But given that the 80% figure is off a couple of points from where it has been, it means that the unemployment rate would be higher if those people were more interested in working.

In the middle is real GDP growth, and the story here is not so good. Only the growth in 2003 (at the very top) is “strong” for the U.S.

Lastly, I’ll discuss the panels on wage growth and inflation. There are two pitfalls here. First, they should be next to each other so we can compare them. Secondly, the yellow and red ribbon going downward might make the casual reader think that somehow low inflation is a bad thing. Of course, that’s idiotic … but like I said, this is a victory of artistry over understanding. Anyway, what we want is for wage growth to exceed inflation. So these two panels tell us that 2015 was a pretty good year. This is what we would have liked to have seen over the last several years, and that was a reason why people felt so lousy about the recovery back then. Unfortunately, there’s more bad editing here, so some of the years are mislabeled, and it’s hard to tell which ones were comparable to this past one.

This is drawn from an article entitled “Hurdles Persist Despite Job Gains” that appeared in the January 9 issue of The Wall Street Journal.

“Almost Comical Ineptitude”

One additional concern about Chinese economic performance over the last couple of years is micromanagement.

The lessons macroeconomics can offer politicians and bureaucrats are few and far between. The one thing we know for sure is that there are far more governments who have pulled their economies downwards than there are ones that have pushed their economies upwards. The textbook political advice sounds a lot better on paper than it works in practice.

Which brings us to my recent series of posts on China. In China, they change the group at the top every ten years. They claim to rule by consensus, but who’s at the top still matters. They’ve had Xi Jinpeng for just over 3 years now. And what we’ve learned is that Xi appears to have control issues.

Here is Andrew Browne, from an opinion column in the January 9 issue of The Wall Street Journal entitled "Xi Jinping’s Micromanaging Leaves Markets in the Lurch":

A defining characteristic of Xi Jinping, the Chinese president, is his controlling personality.

Mao reigned with godlike aloofness. Deng Xiaoping left the details to underlings. Mr. Xi, by contrast, takes charge of everything; he’s an inveterate micromanager.

Amid the mayhem of China’s markets this week, one dysfunction stands out: bureaucratic confusion. …

Part of the problem, it seems, is a policy-making bottleneck. Mr. Xi has reversed a collective-type leadership process inherited from Mr. Deng and concentrated decision-making authority in his own hands.

But he’s thinly stretched.

For the last couple of decades, the # 1 guy in China has run the politics, and the # 2 guy has run the economy. Not now:

As a consequence, Premier Li Keqiang’s job has shrunk. His immediate predecessors ran the economy; he doesn’t enjoy the same autonomy. If things go seriously wrong, though, he might end up as a convenient scapegoat. Other highly competent economic leaders look less like decision makers and more like cheerleaders for policy concocted above their heads.

Do note this is the same Li Keqiang mentioned in my other post as known for not trusting the GDP numbers produced by his own government. Maybe he was on to something.

Recall that I noted this was an opinion piece. He echoes what I said in class on Friday:

Conventional analysis holds that the Chinese stock market doesn’t have much connection to the underlying economy, and therefore the wider world shouldn’t be too worried about the latest gyrations.

But this misses the point. Investors have a right to feel concerned …

Note that his tone is a little different than mine: he’s saying investors should be concerned, but he didn’t say that macroeconomists should be. But then the author gets serious:

Instead, we’ve seen almost comical ineptitude, the most recent example being the introduction of circuit breakers to reduce volatility in the stock market.

The measure had been fast-tracked by the securities regulator after the stock-market wobbles made Mr. Xi look more vulnerable than at any time since coming to power in 2012. But the circuit breakers had to be abandoned after only four days—because they made volatility much worse.

“It’s Amateur Hour!” writes the Shanghai-based economist Jonathan Anderson of the Emerging Advisors Group.

…

The regulatory confusion reflects a contradiction at the heart of Chinese economic policy making, one that has Mr. Xi’s stamp all over it. On the one hand, the Chinese leadership wants efficient markets to help pull China through the transition to consumer-led growth. Yet Beijing doesn’t really trust free markets and prefers guiding them with regulation.

It’s these bureaucratic interventions, poorly conceived and badly implemented, that now threaten the most damage.

None of this is a guarantee that China will go into a long stall. But, the whole reason macroeconomists bring this sort of thing up is that there are quite a few countries that have gone into long stalls when they hit a middle income level of development comparable to where China is right now (just look at Brazil’s slow moving trainwreck this year with everyone watching the countdown to the Olympics in Rio this summer). The relatively smooth sailing that, say, South Korea did going through this phase a generation ago is the exception not the norm.

What Should We Be Worrying About In China (and India Too)?

China’s economy is the second or third biggest in the world (don’t believe anyone who says it is currently larger than America’s, and it’s reasonable to be suspicious that it’s larger than Japan’s).

One of the many problems with China’s macroeconomy is that the official data is systematically overstated. This is problem is well-known to economists (probably the best source on this is a blog called Balding’s World, which posts about overstatement of Chinese economic performance every few weeks). Do note that I’m not saying that China isn’t doing OK, just that it’s foolish to believe the official numbers.

Surprisingly, it’s even known to high ranking officials in the Chinese government.

No less than the second in command of China, the Premier Li Keqiang, has stated that Chinese GDP data is unreliable and “man-made”. To put this in perspective, the current Premier of China, second in command for the entire country, leading economic policy formulation, a Phd in economics, having spent essentially all his career inside public administration in various posts throughout China advises you not to trust GDP figures …

Li has even recommended that people look at highly disaggregated data, like electricity usage. When you do, the picture is not that rosy.

China is not the first country to do this. A lot of militarism by the United States during the Cold War is not attributed to the fact that our CIA was not sufficiently critical of the announced economic statistics coming out of the Soviet Union.

And, just this past week, news came out that India is gaming its GDP numbers too (because it wants to be seen as being as important as China).

In the end, I’m not saying we should throw out the GDP numbers of various countries, or that fraud is widespread. I am saying that some suspiciousness is always warranted. For most developed countries, there’s zero evidence of fraud. But, if it’s a less-developed country where you’re suspicious of the government or leaders to begin with, perhaps you should be suspicious of the numbers too. It’s no different than asking a kid how tall they are (where they almost always overstate their height), or a dieter how much weight they’ve lost: if you’re trying to change, improve, or catch-up, there’s a very common human tendency to overstate your success.

So, should we be worried about China (or India)? I think the answer is yes. These are big economies, and they haven’t been performing too well the last couple of years. Keep an eye on commodity prices. For example, we’ve seen the price of oil drop by over 50% over the last couple of years. Most of that is from the development of horizontal drilling (and less importantly, fracking) in the U.S. But don’t fool yourself that this isn’t covering up for weak demand from China. If that isn’t convincing, look at other commodity prices. They’re all dropping, while the U.S. is expanding, and Europe and Japan are holding steady. The demand of someone big must be off, and who’s left? China. India, Brazil. Russia.

The Gambler’s Fallacy and the Chinese Stock Market Crash of 2015

Innumeracy is pretty common.

One example of this is commonly called the gambler’s fallacy. It goes like this: if you make one bet and go up by 60%, bet it all on a second bet and lose 40%, most people think you’re actually ahead. The fallacy is that you’re not.

Think about it: suppose you start with $100. Your first bet wins you $60, so you now have $160. On the second bet you lose 40% of that, or $64. Subtract that out, and you have $96. You’re down 4% over the two bets.

What goofs people up is the inclination to take an arithmetic average of net growth rates, rather than a geometric average of gross growth rates. In this case, the net growth rates are +60% and –40%. Average them together and you get +10%. The arithmetic is correct, but it’s the wrong method to use for growth rates. Instead you should multiply the gross growth rates. These are +160%, and 60%. Multiply them and you get 96%.

A ton of what we’re going to do for the rest of the semester has to do with dealing with growth rates properly, so this is an excellent and easy example.

AND, it showed up in graphical form in that chart of stock prices from the front page of Friday’s issue of The New York Times. Check it out:

If you’d put 100 into the Shanghai exchange in January 2015, you’d have had about 160 by June, and you’d be back down to a little below 100 by January 2016.

Why Don’t We Worry About the Stock Market In Macroeconomics?

The big news the first week of class is the ongoing crash of Chinese stock markets. Here’s an excellent chart that appeared on the front page of Friday’s issue of The New York Times:

Interestingly, the “big” crash of this week is just at the end there. There were actually quite a few of these last summer.

This was a big enough deal that some of the students in class knew the news off the top of their heads. And pretty much everyone in the class was aware of, or believed, the urban myth that stock market crashes cause recessions.*

Now, stock markets are not uninformative about future macroeconomic outcomes. But, like most leading indicators … they’re not really very good on their own, and they don’t improve much when we combine them together. Instead, business cycle peaks and troughs remain highly unpredictable.

The terminology of medical testing is useful here (because most people are familiar with it, but don’t get that it represents some pretty serious underlying statistical thinking). What we’d like to see out of a medical test is (true) positives and (true) negatives. A (true) positive means that the test tells you that you have the disease when you really do. A (true) negative means that the test tells you that you don’t have the disease when you really don’t have it. All tests deliver some true positives and negatives. What differentiates a better test from a worse test is how many false positive and false negatives it has. A false positive means the test says you have the disease when you don’t. A false negative means the test tells you that you’re healthy when you’re not.

The problem with using the stock market as a predictor of the real economy is that it delivers a real lot of false positives and false negatives. Paul Samuelson, who won the Nobel Prize in 1971, said this best in an interview in Newsweek in 1965:

The stock market has forecast nine of the last five recessions.

The bottom line is that you should keep an eye on the Chinese (and other) stock markets, but don’t worry about it too much.

* “Urban myth” is the current slang for this sort of thing. But in economics, when we worry about whether people believe things that may or may not make economic sense, but which don’t have a very solid foundation, we call it “folk economics”. 

The Current State of Obamacare (Not Required)

I’ve posted this mostly for curiosity. There isn’t anything in here specifically relevant to the class this semester, but generally speaking the financing of healthcare is a macroeconomic issue (and students are curious about it).

Anyway, a reporter sent big name healthcare wonk (Bob Laszewski) a set of questions, and he posted the answers on his blog Health Care Policy and Marketplace Review.

Whether you’re pro or con, the healthcare market was not really ever well:

… These [Obamacare] structures haven't proven to be any more successful that in the last iteration in the late 1990s. But time will tell and I really hope we can get it right this time and finally find a viable way to get away from fee-for-service reimbursement.

The problem continues to be that people who don’t need healthcare don’t buy insurance for healthcare (as Homer would say “Doh!”):

I worry more about the really poor take-up rates for the healthy people who have not signed up in the 200% of federal poverty level and above brackets than I worry about the percentage of the young who have signed up. Way too much emphasis is put on this age 18-to-35 statistic. Yes, they are more often healthy but under Obamacare the youngest pay one-third the premium of the oldest. We really need the healthy to sign up in much bigger numbers, that have so far been holding out, more than we need the young.

There’s a part missing in that above quote: what Obamacare needs is the older people (who are charged more) but are still healthy (and therefore don’t cost as much) to pay up, so that they can cover the costs of the unhealthy people. But we all know why they don’t do that:

Here is one such comment I got last week: "I have had more people this year weeping and overwhelmed at the astronomical premiums, even WITH subsidies and cost sharing. Many say, 'But that's a mortgage payment."

Just as an FYI, the health insurance premiums SUU pays for my family of four already exceeds my mortgage payment.

The White House is part of the problem:

I have said for some time that the Obama administration by itself could fix much--but not all--of what is wrong with the Obamacare insurance business model if they would just get out of denial and get to work on some practical solutions.

…

… No one in the industry, including me, thinks Obamacare will be repealed. But it needs major repair.

Co-ops, one of the cornerstones of Obamacare, have been collapsing over the last year:

The co-ops proved what can happen when you don't get the list of these things right from the beginning.

… This is just a really bad business plan and they are undercapitalized.

Saying they are in trouble because Republicans cut their risk corridor payments is like saying a derelict boat sank because of a bad storm.

FWIW: the budget Congress passed over the break included wording (attributed to Senator Rubio) that denied increases in the size of that “risk corridor” (the risk corridor is the amount of money Congress allotted to cover the problems in the co-ops).

But, we may be stuck with it:

… Democrats can't admit Obamacare is broken and Republicans can't admit it won't be repealed.

Via Marginal Revolution.

Why Is Macro So Hard? Absence of Cognitive Dissonance

We all know what cognitive dissonance is: it’s having two thoughts that are in conflict with each other, and feeling uncomfortable about it because you’re starting to recognize there’s a problem.

Regarding macroeconomics, a lot of people believe things that inconsistent with each other: they don’t seem to have any sense of cognitive dissonance at all. Here’s Mark Perry:

He drew this from a post Don Boudreaux made at Café Hayek:

… I had a pleasant if brief conversation with a Danish-American woman. A fair summary of her views about government-provided welfare is the following:

(1) It’s a “right-wing myth” (her term) that generous unemployment and long-term disability compensation payments from government diminishes work effort. “People’s economic decisions are more complicated,” she insisted, than “right-wingers” believe them to be.

(2) A (the?) chief cause of crime is inadequate income. Welfare payments reduce criminal activity.

These two positions are widely held, and are typically held simultaneously by the same person – as, for example, they are held simultaneously by this woman. Yet there is a fierce – although largely unnoticed – tension between (1) and (2). (1) says that people don’t respond very much to monetary incentives; (2) says that people respond very much to monetary incentives. Put differently, according to (1), the prospect of receiving money from government does not significantly diminish the amount of effort people exert to get income from non-governmental sources, while (2) says that the prospect of receiving money from government does indeed significantly diminish the amount of effort people exert to get income from non-government sources.

Either incentives matter, or they don’t. But they can’t matter when it’s convenient to you, and not matter when it isn’t.

Why Is Macro So Hard? Overconfidence

This is related to my earlier post that part of what makes macro so hard is the metacognition deficit of policymakers.
Related to this is an argument set forth by Ram (there’s a primer below the quote):

I'd contend that the main problem in America is that the public, including its highly educated members, is social-scientifically ignorant. Most people I talk to about policy do not even realize that there is anything non-trivial about policy analysis. They want the government to make sure that four phases of rigorously designed RCTs be performed before drugs are made available to the public, for fear of unintended consequences of intervening on a complex system like the human body, yet they think they understand the consequences of highly complex interventions on human societies by introspection alone. Not only do they think they understand the consequences of alternative policy choices, but they're so confident that their understanding is right and that its truth is so obvious that the only explanation for disagreement is evil intentions. When I point out that on virtually every policy issue, at least somewhat compelling arguments for many conflicting points of view have been made by relevant experts, people usually react in disbelief or denial, or immediately retreat to questioning the motives of these experts ("of course they say that, they're on the payroll of Big Business" or whatever). These patterns of speech and behavior are uniformly distributed across the political spectrum, even if intelligence and knowledge of well-established facts is not. Even many experts in particular areas of social science evince no awareness of the lack of expert consensus on almost anything in their field, and give the impression of unanimity to an unknowing public.

My guess is that if you were to convince a supposedly non-utilitarian person that their (e.g.) deontological prescriptions might have terrible consequences, then they would revisit them. Anti-consequentialism is easy to maintain so long as you believe the consequences of your proposals are desirable, but most would fold if convinced otherwise. [the emphasis is not mine]

There’s some highbrow language in here, so let me translate a bit for potential students.

When Ram uses the word “non-trivial” about policy choices, what is meant is that many people think policy choices are trivially easy: this one’s right, that one’s wrong, choose the right one. Does this sound like Donald Trump? When Ram says people don’t recognize that the choices are non-trivial, it means that there are lists of pros and cons that have to be weighed without solid information. It’s not completely guesswork, but some of it might be.

When Ram mentions RCTs, the point is the ridiculous level of testing that for-profit corporations have to go through to “prove” that their medications are safe (even though any yahoo down the road can sell you a poisonous plant and call it a medicinal herb without even having a license).

When Ram mentions introspection, what’s meant is “thinking about it a bit”. For example, Obamacare is an example of multiple “highly complex interventions in human societies”. But how many people do you know that have spent much time thinking about whether Obamacare will work or not, before deciding that they’re for it or against it?

Ram says that many people believe the “truth is so obvious that the only explanations for disagreement is evil intentions.” Is that an argument President Obama has used repeatedly?

Ram writes “if you were to convince a … person that their (e.g.) deontological prescriptions might have terrible consequences, then they would revisit them.” Deontological is college-level word that means that you justify the correctness of your actions because you followed the rules or orders. (You know, that’s the excuse the Germans made about things the Nazis did). The prescriptions are recommended policy actions (just like your doctor might give you recommended medication directions). So, what’s being said here is actually rather hopeful: if you can convince people that the bad policy choice they made was because they were just following orders, they might reconsider it.

Lastly, Ram mentions “anti-consequentialism”. You’ve probably heard the old saw: the ends justify the means. That’s consequentialist: it means that it’s OK to do something bad initially if it ends up good on net. For example, parents call this tough love. To be anti-consequentialist is to think that the means or motivations are all that count: basically, if you think you’re doing good, then you are. Ram is saying that only worrying about motivations rather than consequences (thus, being anti-consequentialist) is an easy viewpoint to stick with if you’re not inclined to ever check the results. At least on Iraq, it’s fair to say the Bush administration was anti-consequentialist. Tie this altogether, and what Ram is saying (and what I’m applying to macroeconomics) is that world is a messy place, with a lot of gray areas, and there are way to many people acting as if the gray areas don’t exist at all.

This appeared in the comments to The Money Illusion, posted by Scott Sumner at EconLog.

First We Screw Up, Then We Have Lunch (On Someone Else’s Tab)

The class spent a lot of Spring 2015 discussing the economic crisis in Greece.

A leading player in that was the Greek finance minister Yanis Varoufakis. He was widely viewed as obstructionist, and unwilling to negotiate seriously with other countries in Europe. Eventually he was fired by his own government.

… Mr Varoufakis infuriated almost all of his European negotiating partners. "We had countless discussions with him," remembered Pierre Moscovici, the European commissioner for economic affairs.

"These discussions were vain, pointless and academic. He only wanted to play for time, not make concrete proposals."

Now he makes a ton of money on the lecture circuit.

An email from an agent of the London Speaker Bureau, published by Proto Thema, an Athens weekly, said that Mr Varoufakis now charges $60,000 (£40,000) for one speech given “outside of Europe”. The sacked minister has a sliding scale of fees, according to the email. Mr Varoufakis will speak anywhere inside Europe for $5,000 (£3,000) – and he will give a university lecture for $1,500 (£1,000).

“The man who contributed to the Greek economy’s catastrophe by obstructing talks with international creditors and leading the country to capital controls is making a mint,” said Proto Thema.

The email reminds anyone thinking of booking Mr Varoufakis that he would also "require business class travel, accommodation, airport and ground transfers, meals and incidentals".

The next time someone asks you why politicians pursue policies for their countries that don’t make economic sense, ask yourself if they may be making economic sense for the politician.

Lovesong for Satoshi Nakamoto Whitepaper [sic]

Learn a tiny little bit about blockchains (and Bitcoin).

Why should a macroeconomist care? OpenBazaar is the most public manifestation of Darknet markets. People with control issues like to think that Silk Road was the end of the story; I view it as the end of the beginning.

Remember, you heard it here first.

When you hear inequality activists like Piketty advocate global wealth taxes, think about why he would be so concerned about getting at wealth that’s gotten beyond particular national borders. When you hear politicians grouse about profits that are not repatriated, think about how they view the world if taxes are their source of funding. When you hear about inversions (Pfizer is currently in the news about this), think about whether physical location is an important as virtual presence.

The macroeconomic news story for the rest of your life is going to be that governments have made expensive promises based on political borders scratched out over the physical world, without recognizing that their tax base is going virtual. Marc Andreessen’s most famous quote is “software is eating the world”. It ate the market for compact discs in less than 5 years. It’s going to eat discretionary government spending over the next generation.

P.S. Not sure why there’s that other stuff appended to the end of the video.

Horrifying Graphic with Useful Information

This is cringeworthy:it’s what happens when you give people better graphing tools than they know how to handle.*

But, it shows some cool data for macroeconomics. What you’re seeing here is GDP growth last year on a city by city basis. Green is better, red is worse. And, because a color wasn’t good enough, we have spikes to show positive growth (but nothing to show negative growth — go figure). Also, recall that GDP growth has to beat population growth for us to feel good about the world: that’s not just green, but more like green with the two palest shades dropped out: so, forget about the southwest. Also, keep in mind that this is just cities, so the white space means nothing.

So, what can we see here? Well, first off, growth is uneven. This is normal. Secondly, there are some places that are actually getting worse. This is also normal: even in the biggest booms, there’s usually a few places lagging behind. Otherwise, we’ve got lots of good, dark green spikes, across the country. There’s a big swatch running from Houston through Seattle that’s doing great. Florida is doing well too. The midwest also seems OK. But, there’s a big arc running from Iowa, down to the central Gulf coast, and back up through Boston that could be doing better.

* The problem(s) with a figure like this are pretty well known. First, don’t tilt the map: that emphasizes the south at the expense of the north. Second, don’t emphasize just half your story (with the spikes). Third, because of the tilt, the height of the spikes is no longer proportional to the actual changes. Fourth, because they tilted it, and used spikes, the bases of the spikes look fatter in the south, distorting perceptions. Lastly, lots of analysis will miss this point (so I’m not picking on this figure specifically anymore), but there isn’t a sense of anything being proportional to population here. Even in 2015, the northeast (taken as a whole) makes California’s population look minute … and there’s no sense of that at all here.

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The day after I wrote the above post, The Wall Street Journal published a similar, and better, graphic. But, they must not want to share it, because it took a lot of internet time (at least 5 minutes) to figure out where they’d hidden away this image. And, of course, they’ve hidden the labels.

But you can still pick up the story. It’s showing the unemployment rate by county, with shades of gray being essentially full employment, and shades of blue being places that could still improve a bit.

I can’t even give you a decent link to this. What I can tell you is that it appeared with the title “Uneven Job Market”. But that’s not really an article, so it’s not clear to me that you’d find that title in Google a few months down the road. It appeared on page A8 of the January 4, 2016 edition.

Via Newmark’s Door.