Foreign holdings of US debt have been coming down a bit. Is that a problem?

February 7th, 2019 at 11:27 am

I remember when foreign ownership of U.S. government debt amounted to very little, as shown on the left end of the figure below (the share of total publicly held debt owned by foreigners).

Source: US Treasury

I next remember that this share was growing rapidly, closing in on half about a decade ago. What I didn’t know was that the share has been falling back a bit. In fact, it’s about 10 percentage points off of its peak.

I discovered this because I went to look at the data as part of the broader conversation I’ve been engaged in regarding the lack of attention to and concern about our growing fiscal imbalances, an unusual dynamic what with the economy closing in on full employment.

In the course of that conversation, some have raised the concern that because a significant share of our debt is held be foreign investors, we face risks that were not invoked in earlier decades.

There’s the “sudden stop” scenario that’s been deeply damaging to emerging economies, when foreign inflows quickly shut down, slamming the currency and forcing painful interest rate hikes.

There’s a less pressing but still concerning risk that foreign investors’ demand for US debt would fall at a time like the present, when the Treasury needs to borrow aggressively to finance our obligations in the face of large tax cuts and deficit spending. That scenario could lead to “crowd out,” as public debt competes with private debt for scarce funds, pushing up yields.

At the very least, it leads to more national income leaking out in debt service than when those shares in the figure were lower.

How serious are these concerns?

In contemplating this question, I see the WSJ has an interesting piece out this AM on this very question. One factor in play they note is that China’s share of our sovereign debt has fallen by half, from 14 to 7 percent. That reflects both China’s decline in dollar reserve holdings, and more internal investment. Also, the piece notes the role of the stronger dollar and the resulting increased price of holding dollar assets.

But the key point re our own debt and rate dynamics is this one:

“Deficit hawks have suggested government bond yields could jump if foreign investors shed their holdings of U.S. debt, which in turn could push up the cost of other debt throughout the economy, such as mortgages and business loans. Those warnings haven’t come to pass.”

The fact that Treasury yields remain low confirms that part of the story. Also, as Krugman and others have maintained, it just doesn’t make a ton of sense that countries with large dollar holdings would undertake actions, like dumping US debt, to debase their holdings. And, if they did, the cheaper dollar would make our exports more competitive.

So, while I worry more about our weird, upside-down fiscal stance right now than most progressives, the declining trend at the end of the figure above doesn’t give me too much pause.

January Jobs: Another upside surprise shows the benefits of closing in on full employment.

February 1st, 2019 at 9:46 am

The US labor market just keeps on rolling along, turning in one good jobs report after another. Payroll gains continue to outpace expectations, wages are handily beating inflation while not pushing it up much, participation continues to suggest more room-to-run than most economists expected, and even the slight uptick in the unemployment rate last month, to 4 percent, was likely a temporary blip caused by the government shutdown (more detail on that below). The underemployment rate, which also spiked last month, was another temporary victim of the shutdown, causing a sharp, temporary increase in involuntary part-timers (those working part-time who want to work full-time). These measures of increased slack should fully reverse in coming months, assuming the government remains open, of course.

Payrolls were up 304,000 in the first month of 2019, well ahead of economists’ expectations for a gain of about 170,000, and the jobless rate ticked up a tenth to 4 percent. As noted, the uptick in the jobless rate is likely due to the shutdown and should fully reverse next month. The big jobs number for December was revised down significantly, from 312K to 222K, and other revisions to today’s report (e.g., a small annual benchmark revision) suggest that we should smooth out the monthly data to better discern the underlying signal.

In other words, cue the JB/KB (Kathleen Bryant, who does all the work on this report) monthly smoother! It shows average monthly payroll gains over the past 3 months to be a very robust for this stage of the expansion: 241,000. The other bars, which take monthly averages over longer periods, are around the same height, implying an underlying monthly trend slightly north of 200,000. This is well above what most economists believed sustainable, given estimates of “supply-side constraints,” i.e., the size of the available labor pool. Importantly, it appears this constraint is less binding than many thought, meaning there’s more room-to-run in the job market, and that we’re closing in on, but not yet at, full employment.

Participation measures are a bit hard to compare this month because of changes to the population weights in the survey (the weights are used to make the survey sample representative of the national population), but data provided in the report suggest participation ticked up in January to 63.2 percent, the highest rate since September 2013. The closely watched prime-age employment rate ticked up significantly for men, from 86.1 to 86.5 percent, and was up one-tenth of a point for women as well, from 73.4 to 73.5 percent (again, this monthly number should be handled with care due to the weighting change, but the underlying, positive trend is real and important).

The tight job market continues to generate near-cyclical highs in terms of year-over-year wage gains. Overall private hourly wage growth fell back slightly to 3.2 percent, from 3.3 percent in both November and December. For middle-wage workers–the 80 percent of the workforce in blue-collar or non-managerial jobs–wage growth was 3.4 percent. My estimate for January inflation (the official change does not get released until later this month) is 1.6 percent, driven down by low energy prices. That implies mid-level, real wage gains of 1.8 percent, a solid increase in buying power for these workers, many of whom have long been left behind (of course, we’re talking averages here, and we know that even now, significant pockets of labor slack still persist in some places around the country).

This positive trend in wage growth is captured in the figures below, which use 6-month moving averages to smooth out the jumpy, underlying series. The acceleration is notable. The third figure, which includes my inflation forecast, zeros in on the growing gap between rising nominal wage gains for mid-wage workers and falling price movements. The gap between the two lines represents the real gains touted above.

This gap will like close somewhat as energy prices rise, but I expect some level of real wage gains to persist. Another important point about these real gains: given that productivity growth is running at around 1 percent, when real wages grow faster than output per hour, the share of national income shifts from profits to compensation. As much research has revealed, this share has long shifted in the other direction–the wage share has been historically low, meaning the profit share has been high. In other words, the current tight labor market appears to be delivering a long awaited re-balancing of these shares.

As noted, the government shutdown is likely playing a small, temporary role in today’s report, though mostly in the unemployment rate. In terms of direct impact, the BLS reports that both furloughed and unpaid federal government workers should be counted in the payroll data, though furloughed workers should be counted as temporarily unemployed in the household data, the survey which yields the unemployment rate. Indirect, or spillover effects, such as a private-sector restaurant worker on temporary layoff because she works near a national park that was closed during the shutdown, could also be in play in today’s data. That said, the strong topline jobs number underscores the BLS commissioner’s statement today: “Our evaluation of the establishment survey data indicates that there were no discernible impacts of the partial federal government shutdown on the January estimates of employment, hours, or earnings.”

I’ll have more to say later about some of the guts of the report, but especially once we remove temporary shutdown effects from some of the household survey indicators, we’re left with unequivocal evidence of a few very important facts. First, in an economy with too little worker bargaining power and too much inequality, the benefits of closing in on full employment are powerful and equalizing. And second, Chair Powell and the FOMC were smart to put interest-rate hikes on hold. There’s non-inflationary room-to-run in this job market!

No correlation between top tax rates and growth rates

January 28th, 2019 at 8:51 am

In a piece in WaPo today, I note in passing that there’s no persistent correlation between top tax rates and growth rates across the US time series, nor in oft-cited international data from Saez et al. This is widely understood among empirical public finance folks, but just in case, here are a few figures.

As Krugman did the other day, I’m using top marginal income tax rates and 10-year, annualized growth rates of real GDP per capita.

First, as Paul’s figure suggests, here’s a scatterplot that looks pretty random. One can, of course, plunk a regression line in there, and it has the “wrong” slope (higher rates associated with faster growth). To be clear, I neither think nor claim that higher top rates lead to faster growth (though such a case is sometimes made). These are just correlations. More on that in a moment.

Sources: TPC, BEA

In fact, 2o-year rolling correlations have a little something for everyone, which again, shows the absence of any systematic relationship supporting the high-top-rates-kill-growth story.

Sources: TPC, BEA

These are very simplistic ways to look at this, not at all dispositive. However, deeper looks yield similar results.

Moreover, I wouldn’t dismiss the simple correlations. My experience in this sort of work is that if the correlations aren’t there at this level over long time periods, you often–not always, of course–have torture the data to find them. In they are there, then you must check to see if the correlation is a function of a statistical problem (e.g., serial correlation) or a missing control variable. But if they’re not, it’s often telling you the argument that they are is going to be a heavy lift, very possibly involving more confirmation bias than honest analysis.

There’s heightened nervousness about the next recession and there are signs pointing in both directions.

January 11th, 2019 at 3:34 pm

I can’t turn around without seeing or hearing people worrying more about the next recession.

Google Trends: Web search for “next recession”

Source: Google Trends

My peeps at the Indicator have a nice podcast on the topic. The WSJ points out that more than half of economists they surveyed expect a downturn by 2020, which, in case you live under a rock, the article helpfully notes is an election year.

The reasons for the heightened anxiety are:
–Slower global growth, particularly in China (also Europe and Japan). Remember how Apple’s market cap fell 10 percent in one day a couple of weeks ago. That was on the news that their China sales were down. We’re all connected, man…also, trade war.

–Higher interest rates and the flat yield curve. Interest rates are up, which acts like a brake on growth and they’re up more for short- than long-term rates, meaning the yield curve is flat, though not inverted (inversions provide reliable recession warnings, though they don’t say precisely when).

–High levels of US sovereign and corporate debt could provoke a credit crisis. High private sector debt levels can proceed a deep and sudden credit contraction, and high government debt can lead to the perception of diminished fiscal space, discussed below.

–Overheating risk and the Fed. This has maybe faded in recent weeks as the Fed has sounded pretty dovish of late, while inflation–actual and expected–looks decidedly nonthreatening. But with historically low unemployment and bigger-than-expected job gains, there’s always some nervousness of the return of that 70s show, with inflation taking off and the Fed having to slam on the brakes.

–Trumpian cray-cray. I mentioned the trade war. Then there’s the shutdown. And…how can I say this?…our current leadership fails to inspire confidence in this (or any other) space.

These are all real things, but here’s a realer thing: economists can’t tell you with any authority when the next recession is coming. If you forced me to take a stand, I’d stand with Powell. Heather Long reports the following:

“I don’t see a recession” in 2019, Powell said Thursday in an interview at the Economic Club of Washington, D.C. “The U.S. economy is solid. It has good momentum coming into this year.”

To be clear, the “solid U.S. economy” still leaves too many people and places behind, and real middle-wages, incomes and earnings haven’t been nearly as strong as, say, corporate profitability.

Just to be a contrarian, let me tell you about a few indicators that underscore Powell’s near-term optimism.

First, economist Jan Hatzius from Goldman Sachs has long emphasized the private sector balance sheet (those of us of a certain age recall that the great Keynesian economist Wynne Godley emphasized this metric).  Jan writes that: “…a financial deficit in the private sector—i.e., an excess of private sector spending over private sector income—…makes aggregate demand highly vulnerable to disruptions in asset prices or the supply of credit.”

Well, private balance sheets look pretty good–they’re around their historical average. Hatzius calls this “an unusually benign reading this deep into an expansion” and adds that “it is not only the household sector that runs a surplus but also the nonfinancial corporate sector, which is reassuring given the concerns around leveraged loans and corporate credit more broadly.”

I agree. However, the figure does show that this balance can spike pretty quickly, so here’s some positive indicators to which I’d give more weight: the strong labor market, rising real wages, and their correlation with real consumer spending. The figure below plots the yearly change in real aggregate earnings–real wage*jobs*hrs/wk–for middle-wage workers against consumer spending, which, ftr, is just under 70 percent of US GDP. To be fair, this is a much less forward looking indicator than say, the yield curve, but here’s the punchline: unless you have a story about the US job market heading south in a big way this year, I don’t think you have much of a near-term recession story.

Sources: BEA, BLS

Moreover, my labor market story goes the other way. I suspect unemployment–a lagging indicator–falls further this year and that the combination of strong labor markets and low energy prices leads to decent real wage gains. In fact, just this AM, we learned the real, mid-level hourly wages rose 1.3 percent in 2018, its strongest showing since August 2016.

To be clear, in much of my analysis, I have emphasized the expected slowing of growth later this year as fiscal stimulus fades. But, again, it’s not obvious that this doesn’t mean a return to the pre-stimulus trend growth rate of around 2 percent as opposed to a recession.

Finally, while we just can’t know when and why the next downturn will hit, we can get a sense of whether we’re ready for it (listen to the Indicator link above on this question). I say we’re not (though if we did the stuff in here, we could be). Monetary space may be constrained by an historically low federal funds rate, and if the debt/GDP level is =>80 percent, which may well be the case, history shows that the fiscal authorities, politically constrained by this higher-than-average debt level, tend to do less by way of discretionary, counter-cyclical offsets.

Such austerity would be a terrible mistake, for a lot of reasons. Depending on the depth of the downturn, it’s a great way to consign millions of people and families to unnecessary job and income losses. And such losses, depending on how deep they are, have been shown to leave lasting scars on people well into their post-recession lives. Also, as I wrote yesterday, Blanchard’s new work shows the fiscal and welfare costs of public debt to be far below where the convention debate places them (and in my framework, countercyclical offsets in recession are definitely GD–read the piece).

I’ll continue to heed all the warnings of my fellow tradesmen and women–no question, there are headwinds now that were not upon the land a year ago. But I’ll be more guided by the fact that nobody can time a recession, while anyone who’s paying attention can raise trenchant warnings about whether we’re ready for it, wherever it is.

Blanchard on public debt and interest rates; also: thanks, MMTers!

January 10th, 2019 at 12:58 pm

There’s a deservedly nice bit of buzz about a new paper by tony economist Olivier Blanchard. My WaPo piece today takes you through the argument, along with a heavy dose of my own interpretation, one familiar to OTE readers.

“The key points are disarmingly simple, and they’re ones I have written about before in this column. Part one is this: When a country’s growth rate is higher than the interest rate on its debt, the fiscal costs of sustaining its debt levels are somewhere between zero and low. The reason is that even if the government does not raise taxes to offset its higher debt, the ratio of debt to gross domestic product will decrease rather than explode over time. Part two: For most of the period covered by Blanchard’s research (1950-now in the United States), g>r, i.e., the GDP growth rate has exceeded the interest rate (same with the U.K., the euro area and Japan).”

I then discuss a nuanced aspect of the work. Because private capital accumulation is diminished in higher public debt scenarios, the return on capital investment must also be part of this cost/benefit analysis. In my interpretation, this leads to a conclusion that regardless of how low the interest rate on debt is, we still need to distinguish between the utility of borrowing what I call “good debt” and “bad debt.”

Here, I’d like to briefly discuss two thoughts I left out of the Post piece.

The first is in regard to the political economy implications of Blanchard’s findings. In a better world, these findings would lead fiscal policy makers to think more realistically about public debt. But in the real world, where every idea becomes a weapon in the arsenal of partisan politics, deficits are largely a political, not an economic tool.

R’s shout about them when they rise on the D’s watch and ignore them on their own watch. Because D’s have long been too sensitive to accusations of fiscal profligacy and R’s just don’t care about any of that, this has led to austerity in years when we needed the fiscal stimulus and visa versa now, or what I call “upside-down Keynesianism.” I go through the numbers/evidence here.

I don’t expect Blanchard’s evidence to change these dynamics because they’re not about fiscal costs, they’re about political posturing. But that doesn’t mean nothing will change!

A lot of the fear-mongering and deficit attention disorder is driven by deficit scolds outside of government. The pressure from MMT’ers (my next point), Blanchard’s analysis, similar historical work I cite from Kogan et al, and, most importantly, the lack of crowd-out or other predicted economic distortions from deficits, all make it harder for the austerians to be taken seriously by neutral observers. See, for example, David Leonhardt, a evidence-based columnist known for pitching it down the middle, in today’s NYT.

As I (and Blanchard) argue, this doesn’t mean deficits don’t matter. Again, see my GD/BD discussion. But this feels a bit like the minimum wage debate in the early 1990s when Card and Krueger came out with Myth and Measurement, their path-breaking work disproving the widely assumed connection between minimum wages and pervasive job losses. About 10 years later, the reality of their findings became broadly accept knowledge and the result has been much better policy in this space.

Thus, if progressive/empirical economists keep pushing on this more nuanced, realistic view of public debt, perhaps policy will be smarter in 10 years. Sorry if that’s a wait, but given the stickiness of lame ideas, you either play the long game or no game.

Next, I didn’t say anything about MMT but much of the discussion around the Blanchard buzz makes the correct point that the MMT’ers played an important, admirable role in elevating these issues. I’ve raised some questions about their model and Josh Barro’s new piece provides an excellent take on their perspective at this interesting moment in fiscal thought.

Much of the analysis shows that MMTers are advocating Keynesianism with a few wrinkles, like their argument that if fiscal stimulus does generate overheating, the Congress should reduce price pressures with a tax increase, which leads most of us to ask, “what’s plan B?”

But their relentless hammering against mindless deficit reduction has been a key force in the ongoing, salutary rethink of these relations, for which we should all thank them!