Links: Biased scholars, odd fed policy and a Keynesian prediction

1. Megan McArdle points out that the Obama administration may be appointing an agenda driven researcher to the consumer financial protection agency.  If Obama wants to throw a bone to someone who has fought the progressive fight in trying to bend public opinion towards the creation of the agency, Elizabeth Warren looks like the obvious choice. However, if Obama is still in the mood to appoint competent technocrats over political allies, he may want to think twice about picking her.

2. Scott Sumner highlights a 2001 Pimco article by Paul McCulley about "opportunistic disinflation".  This is the theory that the Fed should not try to control inflation outright but that they should take advantage and lock in the decreased inflation expectations that occur after positive supply shocks and recessions by tightening before inflationary expectations return to prior levels. Scott's view it that this opportunistic disinflation policy is procyclical and therefore leads to the monetary policy mistake of allowing a deflationary downturn to get much worse than it should and that this policy exacerbated the recent recession.

To me, this type of approach suggests that the reason the Fed doesn't do more is that it isn't confident that it can easily fine tune inflation expectations, only stabilize them. It could also be that it is politically easier for the Fed to shift inflation expectations when it is not clear to everyone that they are shifting policy.  Either way, taking the policy of "opportunistic disinflation" seriously leads to a better understanding of Fed policy.

3. David Henderson analyzes a famous Keynesian's prediction of post WWII economic collapse.  The collapse, predicted due to a drastic drop in government spending, showed up in GDP (which includes private spending) but not in private consumption.  The 1945-1947 economic performance is on anecdote that suggests that austerity isn't always going to have knock on effects of large negative multipliers. 

The Resurgence of Chinese SOEs?

A paper on the Chinese housing market (See FT, econbrowser, MR for more details) highlights that its market has gone up almost 800% since 2003 Q1. In contrast, the Shanghai A share market and Chinese real GDP are both up about 90% since Q1 2003.

 While the paper highlights a potential bubble, What is more interesting to me is from the chart the FT takes from the paper.  They find that the market is being taken over by Central State Owned Enterprises (SOEs).  These SOE developers have been driving up the price of the housing market, paying on average 27% more for similar properties.  


It is worrisome to see SOEs start to dominate an economy that was growing precisely because they had reduced the impact of SOEs in their economy. A large part of their convergence growth can be attributed to their switch from a communist towards a neoliberal system. A good rule of thumb is that the smaller the impact of SOEs, the richer the area. The trend of decreasing SOE employment has been a positive driver of China’s economy since the Asian crisis in 1998*.

In China’s response to the crisis, workers at state owned enterprises have stabilized and even increased slightly from its bottom in 2008.

During an economic downturn, it makes sense that the transition from SOEs towards the private sector would slow down. However, if there is a crisis and a resurgence of SOEs, then that could be one more reason to be worried about China’s long term future.



*The causation can also be said to go the other way, as decrease in SOEs is also due to China’s liberalization of the economy which allowed private companies to force SOE’s to privatize or be uncompetitive.

Just so stories

Scott Sumner highlights the coincidences that must occur in order for someone to believe that the marginal tax rates don't impact the supply side of the economy.

Yes, the huge increase in the top MTR under Hoover and Roosevelt didn’t raise much revenue, but that was because it “just so happened” that America’s income distribution got much more equal after 1930.  No supply-side effects there.  And yes, the Reagan tax cuts on the rich were actually associated with more revenue, but that’s because it “just so happened” that the income distribution got much less equal after 1980.  And yes the Europeans don’t actually raise much more revenue than we do, despite higher tax rates, but that’s because it “just so happens” that Europeans work less.  You say they work less for tax reasons?  Don’t be silly—it “just so happens” the Germans and French have lazy, happy-go-lucky cultures.  You say the French worked as hard as Americans in the 1960s?  It “just so happens” this distinctive French culture developed only in the past few decades, when their tax rates rose far above American levels.

As he highlights, just because one side ignores the supply side effects of the MTR doesn't mean that the politicians who make outlandish claims about the benefits of tax cuts should be taken any more seriously. Tax cuts might pay for themselves if they occur with spending cuts, but this is not a short term calculation.

Jeremy Siegel begs the question

In a July 15th New York Times piece, Jeremy Siegel emphasizes that investors should remain bullish. He makes his classic bullish argument based on stock returns from 1802 forward (which is based on potentially flawed index data), and then makes another argument relying on more recent data:

If post-World War II patterns hold for the future, he calculated last week, prospects for stock investments are excellent: there would be a 96.6 percent probability of a positive return for the next 5 years, going up to 100 percent for 10- and 20-year periods. Average real returns would be stellar — about 11 percent annually in holding periods from 1 to 20 years.

So basically, he is saying that “If stocks are in a favorable environment, they are going to go up.” Considering the current economic environment is one in which the very capital unfriendly sector of health care looks to be the biggest driver of GDP growth in the developed world, the long term outlook on stocks should not be so sanguine. The bearish response included in the article wasn't much better, as even one of the people responding to Siegel, Lubas Pastor, takes the equity premium that is necessary for Siege's argument as a given.

“It’s important to realize that stocks should produce higher returns, because they’re riskier.”

As Eric Falkenstein shows, the argument for an equity premium is not as straightforward as many finance professors like to think. Too bad this more accurate point of view was nowhere to be found in this article.

HT: Mankiw

PPP GDP per capita Adjusted for Health Care Spending

I decided to apply the Robin Hanson theory of health care spending, that on the margin it is wasted, to compare the United States GDP to that of other countries.  Luckily, there is easy access to data on PPP adjusted per capita health care dollars from the OECD on Wikipedia. I compared the US 2007 GDP to the twenty richest OECD countries*, adjusted and unadjusted for healthcare spending.

So on this measure, the United States is not as far ahead of other countries as people think. Using 2009 IMF data, Switzerland actually has a higher PPP adjusted GDP assuming that each country’s health care expenditure is of similar utility.  Singapore does far better than most countries at holding down expenses and is already richer on a PPP per capita basis, so it looks even better by this comparison.  If the CBO forecasts about the nature of GDP growth are right, the US’s semi-wasteful spending on health care is only going to be more significant going forward.

*I excluded Luxembourg and for Japan health care spending I used the 2006 WHO numbers.

Analyzing the trend of corporate cash hoarding

Via MR via Ezra Klein Barry Ritholtz points out that the increase in corporate cash is not some new thing.

“1) The average cash-to-assets ratio for corporations more than doubled from 1980 to 2004. The increase was from 10.5% to 24% over that 24 year period. That was the findings of a 2006 study by professors Thomas W. Bates and Kathleen M. Kahle (University of Arizona) and René M. Stulz (Ohio State). When looking for an explanation, the professors found that the biggest was an increase in risk.

Indeed, the phenomena of corporate cash piling up has been going on for a long long time. You can date it back to the beginning of the great bull market in 1982 to 86, went sideways til the end of the 1990 recession. It has been straight up since then, peaking with the Real Estate market in 2006. The financial crisis caused a major drop in the amount of accumulated cash, but it has since resumed its upwards climb.

2) The total cash numbers numbers are somewhat skewed by a handful of companies with a massive cash hoard. Exxon Mobil, GE, Microsoft, Apple, Google, Cisco, Johnson & Johnson, Verizon, Altria, EMC, Disney, Oracle, etc.”

Tyler Cowen believes that because this issue has been around for a while, “there is less to this issue than meets the eye.”  Whether or not corporate cash piling up matters depends on the reasons behind the pile up, of which there are a few.

1. Corporate earnings overseas are not brought back due to tax implications.

2. Corporations are hedging against an increased perception of risk.

3. Lack of attractive investment opportunities.

4. The average new successful company is successful because it knows how to grow, and these types of companies are more likely to hold onto cash than companies run by CEOs who are focused on maximizing shareholder value via more direct means. Over time, the largest companies will be more likely to be the cash hoarders who don’t pay dividends.

5. There have been more very successful IPOs recently and recent IPOs are more likely to hoard cash.

6. The success of companies in #4 and #5 reduces the pressure on other CEOs to keep their cash levels relatively low.

7. Tangible assets have declined in value relative to non-tangible assets, so some companies hold more cash to keep up a safety cushion of real assets.

8. The total amount of cash is increasing in tandem with the total amount of assets.

To address #1, congress passed the American Jobs Creation Act, which reduced the US tax rate on repatriated earnings of foreign subsidiaries from 35% to 5.25% in 2004 and 2005, encouraged corporations to repatriate foreign earnings and invest (many decided to increase their share buy backs) but since that ended it wouldn’t be surprising if the foreign earnings started to pile up.

I decided to go to the flow of funds and look at the data myself, normalizing it for total assets. It turns out that cash and near cash assets, the pink line, hasn’t deviated from its long run mean. The main trend is the decline in tangible assets and the rise of miscellaneous assets.

Source: Fed Flow of Funds. Note: These are only domestic assets, leaving out foreign earnings held overseas. Near cash assets include deposits, currency, money market, security RPs, commercial paper, treasuries, Agency & GSE back securities and municipals.

It is likely that miscellaneous assets include cash-like assets, in order to square these results with those of Bates, Kahle and Stulz in their 2009 paper “Why Do U.S. Firms Hold So Much More Cash than They Used To?” mentioned by Ritholtz in his post. This study, unlike the Flow of Funds data in the chart below, also includes cash held at foreign subsidiaries.

Looking at the data in the paper more closely, it looks as if numbers #2, #4 and #7 are very important. All of these are related to high tech firms replacing old school manufacturing firms which paid more dividends, had relatively stable cash flows and required more tangible assets.


Although the increased hoarding of cash may be a common trend, there is more to this issue than meets the eye.

Links, with commentary

1. Some people might think that Bryan Caplan is ranking how reasonable people are, but he is actually ranking how many of the same priors these people share with him.

 Felix Salmon points us to a fund that is designed to go long tail risk, the kicker is that they expect to lose 12% to 18% in non-tail event years. It is unclear how much the truly provides diversification benefits for hedge fund investors, since its correlation with funds trying to make steady returns via the opposite method may be too close to negative one.  At the very least, it may hedge them against the tail risk in funds that they don't know are producing a majority of their returns via the opposite strategy.

3. Scott Sumner uses ideas similar to Krugman's reply to the ECB's pro-austerity positions to critique Krugman's uncritical examination of the Eichengreen, et al, study on depression multipliers.  Since that is one too many links, the basic summary is that the ECB found time periods when fiscal austerity was associated with recovery. However, Krugman believed that these examples of austerity working occurred in tandem with either a shirt towards trade surpluses or a weaker monetary policy. The ECB didn't control for these positive factors when discussing how austerity might help, since the whole world can't go into a trade surplus nor can they devalue their currency against everyone else.  However, Sumner points out that the same critique of ignoring monetary stimulus applies to many of the depression multipliers calculated in the Eichengreen, et al, study.  

The combination of the ECB view and Krugman's critique makes a good case for a compromise of monetary stimulus and fiscal responsibility. The main problem with this approach is that it doesn't serve the interests of either major party in any way. The democrats would rather find arguments for stimulating the economy with spending, and the republicans would prefer tax cuts. Furthermore, the republicans are very suspicious of any form of inflationary monetary policy, as they correctly recognize that it is a tax on capital while the democrats would worry that pushing for monetary stimulus, which will raise asset prices, will make them look like friends of the rich on Wall Street.

4. Greg Mankiw has an article in the New York Times on the Trilemma of International Finance. The idea is that a country can have two of the following: Openness to flows of international capital, monetary policy as a tool to stabilize the economy and stability in the currency exchange rate. 

Three major players made three different choices:

US: Openness and monetary policy
China: Monetary policy and currency stability
Europe's monetary union: Openness and currency stability (The Bundesbank.. I mean ECB has until recently only been there to preserve price stability, as opposed to the Fed's mandate to "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.")

Due to these fundamental different economic choices, when there is dialogue between these countries they are often talking past each other because they are assuming that their choice is the optimal one.  However, when the ECB got involved in the Greek bailout and the preemptive bailout of the other PIIGS they moved towards the US's choice. If China starts to float their currency, they'll move towards either Europe or the US, although that seems like it will be a very slow process.

The Jobs Picture

Most people know that private sector jobs have been increasing, although recently at a slower rate than expected.

The question is where new jobs are going to come from. In order to get a clear picture, we need to figure out how jobs have been lost.  The Business Employment Dynamics (BED) survey from the Bureau of Labor Statistics (BLS) has some good data, though it is only quarterly and updated through September 2009. The y axis for the below charts are in thousands of people.

The drop in job creation has occurred due to fewer expanding companies.

The main source of job losses has come from company downsizing as opposed to a spike in bankruptcies.

The BLS’s Job Openings and Labor Turnover Survey gives more recent data (Up to April), and sheds a little more light on where the job losses are coming from. Job gains have occurred because separations have trended downwards, while hiring has only picked up marginally.

Job opening data is a little bit more optimistic.

However, the data for separations is a little less optimistic, the overall job picture is only looking good because people aren’t quitting their jobs at a normal rate. If quits were at normal levels then the private sector would be losing jobs.

All of these charts would look a little bit different if looked at in the rate space, since the population has been increasing the numbers would all look a little less significant.  On a ten or twenty year basis, looking at levels isn’t going to skew the results by more than 10%, but when looking at time frames over a fifty year period, using levels rather than percentages significantly exaggerates the situation.

IQ, patience & risk aversion

The more intelligent a person is, the less risk averse and more patient they are. The study, "Are Risk Aversion and Impatience
Related to Cognitive Ability?" done by Thomas Dohmen, Armin Falk, David Huff man and Uwe Sunde found a significant relationship between these variables when they surveyed a thousand German participants drawn from the general population. 

If this relationship holds across countries and on an aggregate level, it would suggest that countries with low average IQ's have additional barriers to overcome.  It might even suggest that countries with lower average IQ's implement policies of forced savings to increase the focus on the long run, though given how corrupt the governments of these countries are any policy that actually gets implemented is likely to be inefficient at the margin.

(No HT for the study, because I forgot where I found this study.)