Current Affairs

A fast rail link that China had said it would build to Beijing from Moscow is in doubt because China, which is an expert at such construction, is demanding that Russia pay for it. The nearly 500-mile first leg, between Moscow and Kazan, was scheduled to open before the 2018 World Cup in Russia. But work has yet to start, and it is unlikely to, Ms. Hill said. “The Russians won’t have the money to pay for it, and the Chinese are not going to do it for free,” she said.

The leaders of the two countries seem to have soured on their earlier friendship.  And here is my earlier post on the New Silk Road.

A conference on Gordon Tullock’s economic, political, and legal research is being held in Founders Hall of George Mason’s Arlington Campus on Friday October 2 and Saturday October 3, 2015.

TullockGordon Tullock was one of the founders of the field of research that came to be called Public Choice.  He was coauthor of one of the most important books in the field, the Calculus of Consent (with Nobel Prize winner James Buchanan) and the first to point out the losses associated with rent seeking. He was also among the first researchers to use economic tools to analyze the law, trial procedures, and judicial systems. His research includes theories of the origin of the state and constitutional governance, the impossibility of revolution, legal systems, government failure, and the economics of science itself. Beyond his own research he was an institution builder. He was the founding editor of the journal Public Choice, a premiere outlet for research on public choice. He helped to launch the Public Choice Society and the European Public Choice Society. He is among the most influential economists never to win the Nobel Prize.

Looks like an excellent conference and event. More information and RSVP here.

I worry about the carry trade

by on September 4, 2015 at 12:09 am in Current Affairs, Economics | Permalink

Remember, in a global economy with multiple currencies, or an economy with lots of price variation, the notion of a single “real interest rate” is tricky.  The standard Fisherian story implies real interest rate near-neutrality across a wide set of expected monetary policy decisions.  Say expected inflation goes up, the nominal interest rate goes up, and the real rate stays constant, except for a small liquidity effect.

But that story will not apply across the board.  If, for instance, you live and consume in Jakarta, and you do not hold a PPP theory of the exchange rate, as indeed you should not, well, borrowing in dollars just got more expensive in real terms (with complicated qualifiers depending on forward rates which in reality don’t predict future currency movements so well).  Or if the Fed lowers nominal rates, your real borrowing rate goes down, maybe by more or less the same percentage amount as the nominal rate went down for the Americans.

And if those Indonesians are optimistic about the performance of their own currency vis-a-vis the U.S. dollar, crikey! — their current real interest rates from dollar borrowing appear to be very low indeed.  And if we are considering the individuals who hold disproportionate shares of non-USD currencies, almost by definition they are overly optimistic about the non-USD currencies.

And there are yet further complications which the nice weather today prevents me from outlining (what if those Indonesians are the marginal investors and they push around the market price for the Americans?)

All of which makes the Fed’s job much tougher.  Here is the latest from Bloomberg:

Since the 2008 financial crisis, companies across emerging markets have been borrowing dollars and converting them into local currencies as part of a massive carry trade. This practice has helped U.S. dollar shadow banking go global as the effects of near-zero U.S. interest rates seep into all corners of the world economy.

That’s the main finding of a new report released Thursday by the Bank for International Settlements, an institution in Basel, Switzerland, known as the central bank for central banks.

The paper, co-authored by Valentina Bruno, a finance professor at American University, and BIS Economic Adviser and Head of Research Hyun Song Shin, serves as a follow-up to a report released by the bank in January that found firms outside the U.S. have borrowed $9 trillion in U.S. dollars, up from $6 trillion before the global financial crisis.

To be sure, we do not know how harmful these practices might be, or not.  Here is FT coverage of the same:

By doing so companies become shadow banks, financial intermediaries moving dollars into local economies. Note, manufacturers do not have to explicitly act like hedge fund managers. Simply depositing funds with a local bank will help it to extend credit to other customers, while buying local commercial paper provides funds to domestic businesses.

The realisation prompts further questions. If it becomes more expensive to borrow in dollars, because say China fears prompt less dollar lending, will the corporate carry trade stop? Will it matter if it does?

I simply wish to reiterate that, no matter how many times commentators cite the low rate of price inflation, there are risks on both sides of the Fed’s forthcoming monetary policy decision.

Here is my much earlier post on monetary policy and the carry trade.  Beware the too-rapid acceptance of the strict Fisherian equation!  Once again, we do not live in a representative agent world and furthermore the multiplicity of agents speak a variety of languages and use a variety of currencies.


Of course the United States should take in more Syrians, but we are not the only laggard:

Of the 4 million Syrians who have fled their country since the war began, including hundreds of thousands who have poured into Europe, the number who have been resettled in Britain could fit on a single London Underground train — with plenty of seats to spare.

Just 216 Syrian refugees have qualified for the government’s official relocation program, according to data released last week.

By the way, not long ago there were over 1.2 million Iraqi refugees in Syria (pdf), I wonder how they figure in all the recent numbers we are seeing.

Before the 1920s, large numbers of Syrians (Syrian-Lebanese) emigrated to Brazil, most of all to Sao Paulo, with a second and smaller wave coming in the 1950s.  As of March:

Since 2013 when Brazil opened its doors, 1,740 Syrian refugees have been registered in the country – far more than in the US.

But still that is not many compared to the preexisting total.  According to the above link, Brazil has about 15 million Arabs and about three million people of Syrian descent, and by virtually all accounts this connection has benefited the rest of Brazil too, not just the migrants.

Here is my earlier post Will Latin America Stay Underpopulated for Another Century?  And can you guess where that top photo is from?

In academia, no, but in the real world perhaps:

Electricity generated by US wind farms fell 6 per cent in the first half of the year even as the nation expanded wind generation capacity by 9 per cent, Energy Information Administration records show.

The reason was some of the softest air currents in 40 years, cutting power sales from wind farms to utilities…

“We never anticipated a drop-off in the wind resource as we have witnessed over the past six months,” David Crane, chief executive of power producer NRG Energy, told analysts last month…

Standard and Poor’s put a negative outlook on bonds issued by two wind farm companies as their revenues tracked wind speeds lower.

“Although our current expectation is that the wind resource will revert back to historical averages, at this time it is unclear when that will happen,” the rating agency said.

Wind generated 4.4 per cent of US electricity last year, up from 0.4 per cent a decade earlier. But this year US wind plants’ “capacity factor” has averaged just a third of their total generating capacity, down from 38 per cent in 2014. EIA noted that slightly slower wind speeds can reduce output by a disproportionately large amount.

The Gregory Meyer FT article is here.  Here are some earlier articles on wind speeds slowing down, some of them appear to be reputable.  According to this recent article, for parts of 2015 wind speeds may be 20-50 percent below average in the American West.  Caveat emptor, but food for thought.

There seems to be genuine uncertainty about what the Fed will do, or not do, this September.

At a superficial glance, the good news scenario is if the Fed’s decision doesn’t matter much for the markets.  Woe unto you if your economy is so fragile that a quarter point or so in the short rate, mixed in with some cheap talk, were to matter so much.

So if at first prices were to stay steady, following any Fed decision, then equities should jump in price.  That is the “no news is good news” theory, so to speak.  It’s a better state of the world if it is common knowledge that the Fed’s actions don’t matter so much in a particular setting.

What if prices jump right away, following a Fed decision?  The market might then see that price jumps rely on the Fed making good decisions, whatever those might be.  The risk premium might then go up.  It is even possible that prices should on net fall in response to that, but in any case it seems that some further price adjustment is in order, perhaps in the downward direction.  (That ought to come rapidly.)

Most generally, it seems the initial price move, in response to the Fed’s choice, cannot itself be correct, but that first price move must itself induce further price movements.  The price move in response to the Fed’s decision is the economy telling us how much it is relying on the Fed, which right now we do not know.

Maybe the Fed would like to know this too.

I’ve covered these ideas before a number of times, but now the Chinese slowdown is common knowledge, so let’s put them in one place:

1. You can’t invest 45-50 percent of your gdp very well forever.  It’s amazing how long China’s run has been, but it is over.  The quality of their marginal investments is now low and that means their growth rate will be much lower too.  The low hanging fruit is gone, at least for the time being.  They might later on resurrect some new low-hanging fruit through institutional reform, we’ll see if they end up stuck in the middle income trap but right now they are at a sharp discontinuity.

2. There is no simple way to switch to a “consumption-driven” economy without the growth rate both falling and staying permanently lower.  Structural reforms are absolutely called for, but in this context they represent a surrender to a lower rate of growth and thus they are especially difficult to pull off in a politically sustainable manner.

3. The Chinese have been growing at ten percent or nearly ten percent for about thirty-five years.  More than a generation of Chinese is used to treating the risk premium as if they don’t have to worry about it.  I shudder to think what economic and also political decisions have been made on that basis.

4. The Chinese economic response to the dwindling of their low-hanging fruit is sharp rather than smooth because there is a sudden revision of expectations, as people realize the risk premium isn’t zero after all.  And seeing the others see that causes the new set of beliefs to spread pretty quickly.  That is a very painful process for a macroeconomy, and it is not well captured by simple AD-AS analysis, although of course it has implications for both AD and AS.

5. I would not so quickly infer that the Chinese government is stupid when it comes to economics.  It is true their actions do not correspond to what professional economists would recommend.  But they are painted into a very unpleasant corner and have lots of interest groups to feed.  Their observed response is possibly explained by some kind of public choice-constrained, nested game, internal conflict-driven seventh-best response.  They were smart a few years ago, and they are still smart now.  That doesn’t mean they will end up doing a good job.

6. Avoid mood affiliation!  You can be a pessimist about the Chinese recession now without being a) a pessimist about China in the longer run, or b) a pessimist about Chinese political stability.  Those are separate albeit related questions, and you are not forced to have the same mood response to all of them.

Keep this primer on hand at all times.  It is more useful than trying to twist the C + I + G tautology into a series of causal statements about China.

In Mississippi, 7.3% of all workers in the state are manufacturing workers who make less than $15 an hour. Losing many of these jobs would have a serious negative impact on the state.

Because of its sample size, the CPS is of more limited use for small geographies. However, there is a relatively large number of observations for Los Angeles County, CA. Almost 400,000 manufacturing workers live in the county, and 55% of them make less than $15 an hour. Many of these workers will be affected by $15 minimum wages that have been approved for the City of Los Angeles and the unincorporated parts of Los Angeles County.

This data suggest that if the minimum wage was increased to $15 an hour across the U.S., it would impact a significant number of manufacturing workers, with some states being hit harder than others. This reflects the fact that lifting the minimum wage to $15 an hour would not just be quantitatively larger than previous U.S. experience, but qualitatively different in that it would affect a different set of workers and industries. Leisure/hospitality and retail make up 54% of the workers who make less than $8 an hour, but only 34% of those making less than $15 an hour. As the minimum wage rises it affects other sectors. For manufacturing, at least, the effect is likely to be greater.

That is from Adam Ozimek, more at the link.

I will be doing a Conversations with Tyler with Luigi next Wednesday, eight days from now (do sign up!).  He is a brilliant and multi-faceted economist, and an Italian — what should I ask him?

The culture that is Iceland (Syria)

by on September 1, 2015 at 9:31 am in Current Affairs | Permalink

Ten thousand Icelanders have offered to welcome Syrian refugees into their homes, as part of a Facebook campaign launched by a prominent author after the government said it would take in only a handful.

After the Icelandic government announced last month that it would only accept 50 humanitarian refugees from Syria, Bryndis Bjorgvinsdottir encouraged fellow citizens to speak out in favour of those in need of asylum. In the space of 24 hours, 10,000 Icelanders – the country’s population is 300,000 – took to Facebook to offer up their homes and urge their government to do more.

The full story is here.  And here is one such message:

“I’m a single mother with a 6-year-old son… We can take a child in need. I’m a teacher and would teach the child to speak, read and write Icelandic and adjust to Icelandic society. We have clothes, a bed, toys and everything a child needs. I would of course pay for the airplane ticket,” wrote Hekla Stefansdottir in a post.

From the FT:

The likes of Zambia, Ethiopia, Rwanda, Kenya, Ghana, Senegal, and Ivory Coast have all issued foreign currency dominated sovereign bonds in recent years.

Ghana is one African nation with a history of debt crises (pdf), and also dating back to the 1980s (pdf).  Tanzania was another offender, both current and past (pdf), and for a while a lot of lending to Africa dried up and that limited the number of possible debt crises.  But now…?

Here is Amadou Sy at Brookings, telling us it is not yet time to worry.  Here is the African Development Bank worrying a bit more than that:

Today, a third of African countries have debt to GDP ratios in excess of 40 percent. The outstanding sovereign debt for Africa as a whole increased 2.6 times between 2009Q2 and 2015Q2. In contrast, total debt in developing countries rose 2.3 times over the same period. The appreciation of the dollar has raised the nominal currency values of dollar denominated debts. Thus Africa’s outstanding bond debt is already 29 percent higher today in real terms than it would have been had the dollar remained at its March 2011 level…

Here is Andrew England at the FT:

A recent note by Fathom Consulting highlighted a 40 per cent year-on-year dip in Chinese imports from Africa for July. Martyn Davies, chief executive of Frontier Advisory, a group that specialises in Africa-China investment, says there is anecdotal evidence of an easing in Chinese activity on the continent. “The hurdle rates of Chinese sovereign wealth investment, or part sovereign wealth fund invested projects in Africa have been raised so the capital is more discerning and seeks greater profitability,” he says.

Here is my previous post on which countries are most likely to experience the next financial crises.

Macau fact of the day

by on August 31, 2015 at 6:55 am in Current Affairs, Economics | Permalink

Gross domestic product in Macau, China’s semi-autonomous gambling haven, fell by more than a quarter in the three months to June as the junket-fuelled growth model comes under attack from Beijing.

The economy contracted by a whopping 26.4 per cent in the second quarter, following declines of 24.5 per cent in the first quarter and 17.2 per cent in the last quarter of 2014.

Stunning as the figure is, it’s not surprising, nor does it signal a collapse for the economy. Macau’s unemployment rate is just 1.8 per cent as construction booms and millions of Chinese visitors cross the border to shop, play some baccarat and attend an increasingly diverse array of Las Vegas style entertainment shows.

That is from Fast FT.

Remember back in 2009, and a bit thereafter (pdf), when so many people were praising China’s very activist, multi-trillion fiscal stimulus?

Yet some of us at the time insisted this would only push off and deepen China’s adjustment problems.  There was already excess capacity and high debt and favored state-owned industries, and the stimulus was making all of those problems worse and only postponing a needed adjustment.  The Chinese incipient contraction was based on structural problems, not a simple lack of aggregate demand.  As I wrote in 2012:

To keep its investments in business, the Chinese government will almost certainly continue to use political means, like propping up ailing companies with credit from state-owned banks. But whether or not those companies survive, the investments themselves have been wasteful, and that will eventually damage the economy. In the Austrian perspective, the government has less ability to set things right than in Keynesian theories.

Furthermore, it is becoming harder to stimulate the Chinese economy effectively. The flow of funds out of China has accelerated recently, and the trend may continue as the government liberalizes capital markets and as Chinese businesses become more international and learn how to game the system. Again, reflecting a core theme of Austrian economics, market forces are overturning or refusing to validate the state-preferred pattern of investments.

How’s that debate going?  While the final outcome remains uncertain, Austrian-like perspectives on China are looking pretty good these days.

Just as you go to war with the army you’ve got, so must a country conduct fiscal stimulus with the policy instruments it has.  And most forms of Chinese fiscal stimulus make their imbalances worse rather than better.  Yet dreams of fiscal stimulus as an answer to the macro problems on the table never die:

Sangwon Yoon writes for Bloomberg:

China is sliding into recession and the leadership will not act quickly enough to avoid a major slowdown by implementing large-scale fiscal policies to stimulate demand, Citigroup Inc.’s top economist Willem Buiter said.

The only thing to stop a Chinese recession, which the former external member of the Bank of England defines as 4 percent growth on “the mendacious official data” for a year, is a consumption-oriented fiscal stimulus program funded by the central government and monetized by the People’s Bank of China, Buiter said.

“Consumption-oriented” is the key word there.  I don’t blame Buiter for speaking precisely, but few readers will pick up on his careful use of words.  Still, switching to more consumption is a surrender to lower rates of economic growth, not a way of keeping the growth rate high.  That is a good idea, but a funny kind of stimulus.

In the meantime, the consumption sector in China seems to be faring poorly.  On the way up, investment rose at the expense of consumption, but on the way down they are falling together.  Funny how things like that work out, and it does suggest that a consumption-oriented stimulus maybe can break the fall but it won’t restore prosperity.

It’s striking how little recent discussion I’ve seen of China’s much-heralded fiscal stimulus of 2008-2009.

This is an object lesson in relying too much on short-run macro models, or models in which sticky prices are the only imperfections, or models where the quality of investment is not a factor.  Whatever you think of the American Great Recession, the Chinese case is very, very different.

A mistake by representatives of the Business Loop 70 Community Improvement District means a sales tax increase the district needs to thrive will require approval by a single University of Missouri student.

On Feb. 28, Jen Henderson, 23, became the sole registered voter living within the community improvement district, or CID, meaning she is the only person who would vote on a half-cent sales tax increase for the district.

Henderson says she feels negative about the tax idea, “but has not made a decision about how to vote. Henderson said her concerns include vague project outlines, Gartner’s pay, Business Loop improvements she said will help businesses but not nearby residents and how an additional sales tax would affect low-income people purchasing groceries and other necessities.”

For the pointer I thank Austin Vernon.

Should the Fed tighten?

by on August 30, 2015 at 12:14 am in Current Affairs, Economics | Permalink

1. I do not know what the Fed should do, and I do not know what the Fed will do.  I don’t even like that phrase “should the Fed tighten?,” but the superior “what kind of multi-dimensional expectational monetary path should the Fed indicate?” is awkward.

2. Starting in 2008, I thought money was too tight during 2007-2011, and in general I am not afraid of upping the dose of inflation, ngdp, however you wish to express it.  I have never had “tight money” in my blood, so to speak.

3. There is good evidence from vacancies and the like that labor markets are fairly tight right now, equities are high and apparently China-robust, and we just had a gdp report of 3.8%.  So something other than more monetary loosening ought not to be out of the question.  Those variables simply cannot be irrelevant for the Fed’s current choice.

4. There is not a stable Phillips curve.  So the lack of strong price inflation does not carry clear labor market implications, nor does it mean we can boost employment through looser money.

5. Often I buy the “asymmetry argument.”  That suggests more price inflation probably won’t hurt us much, but monetary tightening could damage labor markets, so why tighten?  Paul Krugman among others makes this argument.

6. Now the risks look fairly symmetric.  The first reason is that zero short rates for so long might be encouraging excess risk-taking in the financial sector.  This can be the “reach for yield” argument, which in spite of its lack of replicable econometric support commands a lot of loyalty from serious observers within the financial sector itself.

7. The second reason for symmetric risks is that zero short rates for so long might be encouraging zombie companies:

The end of ultra-low interest rates may bode ill for the productivity of British businesses, which is already poor. Output per hour is still lower than before the crisis of 2007, whereas in America and even France it has grown. Tight monetary policy should be bad for productivity, since it makes business investment more expensive. As the cost to businesses of borrowing has fallen by more than half since 2008, investment by firms has risen by 20%. The worry now is that dearer borrowing will curb the investment binge, making productivity even more dismal.

Yet there is another side to the productivity equation. Kristin Forbes, a member of the MPC, points out that, as in Japan in the 1990s, cheap borrowing may allow inefficient “zombie firms” to survive for longer than they normally would. In Britain interest payments as a share of profits have fallen from about 25% in 2009 to 10% today, bringing down company liquidations with them. As they stagger on, zombie firms hold down average productivity levels in their industry and, as a result, put a lid on wage growth. Rising interest rates could slowly start to sort the wheat from the chaff.

That is from from The Economist and of course you can adapt it for an American context.

8. Those two arguments might be meaningful with only a chance of say fifteen percent each, but that still would put the risks in a broadly symmetric position.  I don’t see that the critics have made the case that a mere quarter point rate increase should be so damaging.

9. The contrarian in me rebels when I see article after article, blog post after blog post, consider the monetary policy problem in only two dimensions, namely as would be expressed by a Phillips curve.  See #4.  The “nice view” of monetary policy, as Faust and Leeper suggest (pdf), is probably wrong.

10. If I were at the Fed, I would consider a “dare” quarter point increase just to show the world that zero short rates are not considered necessary for prosperity and stability.  Arguably that could lower the risk premium and boost confidence by signaling some private information from the Fed.  But it’s a risk too — what if the zero rates are necessary?

11. The prospect of a stronger dollar, and the subsequent hit on American exports, remains a domestic reason not to let rates rise.  I doubt if it is a global Benthamite reason, but it is probably a reason held by some within the Fed.

12. The biggest piece of information here is that both Janet Yellen and Stanley Fischer both seem genuinely uncertain as to what the Fed should do.  No, they haven’t been absorbed by the hard money Borg.  They have their own version of these arguments and it seems they see the risks as being relatively symmetric, and thus the correct monetary policy choice is far from obvious.  No one has yet said anything that is smarter or more potent in Bayesian terms than what they probably are thinking.

13. Let’s say the Fed did decide to allow rates to rise.  How exactly would they make that happen?  How hard would it prove to accomplish?  That’s an under-discussed angle to all of this.  And the Fed might either wish to postpone this curiosity or get it over with, another set of symmetric risks.

We’ll know more soon.