A quick note on the rise of dollar il-liquidity. Worrisome? Not worrisome??

June 20th, 2018 at 3:44 pm

Between the fiscal stimulus, the Fed, and the tax cuts (which are, of course, a big source of the stimulus), the global supply of dollars is getting squeezed, which is, according to various reports, pressuring some emerging market economies (EMs). How seriously should we take this and what might its impact be on the US economy? To telegraph my conclusion, I suspect these developments will lead to higher US interest rates and a stronger dollar than would otherwise occur. The stronger dollar, in tandem with the fiscal stimulus, could put upward pressure on the trade deficit, even with all the tariffs intended to push the other way. Neither derails the recovery, but they are risks.

There’s been a number of recent articles worrying about the impact of “dollar il-liquidity” in EMs. We’ve got the Fed raising rates and reducing its balance sheet, both of which reduce the supply of dollars. But we also have the tax cut bill in play. Because this beast is deficit-financed to the tune of $2 trillion over 10 years, with deficits this year and next of ~5% of GDP, the US Treasury has had to kick up its debt issuance to fund the damn thing.

Then there’s the repatriation of corporate dollars from abroad. According to this AM’s FT:

“US companies repatriating profits drained more dollars from global markets in the first quarter of the year than did the Federal Reserve’s actions to shrink its balance sheet, according to data that suggests embattled emerging markets cannot simply blame the Fed for their plight.”

So, there’s a diminished global supply of $’s and more of the currency is flowing into the Treasury to make up the difference between Federal revenues and outlays. These dynamics push up interest rates and the value of the dollar, the latter of which raises the cost of debt service in countries with dollar-denominated debt, including EMs, large and small.

Economist Brad Setser wrote about the problem, noting that the chair of India’s central bank, “rather remarkably—even called on the U.S. Federal Reserve to slow the pace of its quantitative tightening to give emerging economies a bit of a break. (He could have equally called on the Administration to change its fiscal policy so as to reduce issuance, but the Fed is presumably a softer target.)”

I won’t belabor this, as it’s all very speculative, but while rising rates and the stronger dollar will put pressure on some EMs (not all–see Setser), US monetary and fiscal policies are not the only, or even the main, drivers of capital flows in and out of their countries. This was the point of a recent, tight speech by Fed Chair Powell, featuring figures like those below showing a) there’s no obvious, negative correlation between the Fed’s policy rate and EM cap flows (you don’t see flows go down as the policy rate goes up), and b) there’s a much better fit between relative EM growth rates and flows (AE=advanced economies).

There’s just a lot of moving parts that determine exchange rates, capital flows, and financial market conditions. Powell notes, for example, “that although the Fed has raised its target interest rate six times since December 2015 and has begun to shrink its balance sheet, overall U.S. domestic financial conditions have gotten looser, in part due to improving global conditions and central bank policy abroad.”

That said, Powell fails to deal at all with the recent, cyclically-weird U.S. fiscal expansion, which, as the FT quote above suggests, is playing a significant role in sucking up global dollars. So, I think there’s a case to be made that our fiscal and monetary policies are creating some global stress, but I’d also submit that this is all the highly expected, and–again, except for the dumb tax cut–thoroughly telegraphed outcome of policy “normalization” and the re-pricing of riskier assets relative to safer ones.

If some EMs are stressed by dollar il-liquidity, how does that redound to us? Dollar-denominated EM debt is not particularly inflated, and, as GS economist David Mericle points out [no link], “the largest EM dollar borrowers now tend to be exporters and commodity producers whose revenues are largely dollar denominated too, reducing the risk of currency mismatch” (i.e., they’re somewhat insulated from the stronger dollar). Simply put, EM conditions deserve to be on the watch list, but there doesn’t seem to be too much US contagion risk.

The more likely pressure stems from the US trade imbalance. The strengthening dollar, the capital inflows from EMs seeking safer and higher yielding US debt, and the stimulus at our close-to-full-employment conditions all put upward pressure on the trade deficit, even with the Trumpian tariffs in play. A higher trade deficit isn’t a macro-problem right now (though even at strong demand, it means fewer factory jobs; it effects the composition of jobs, not the number), but if there’s a shock out there, that imbalance could worsen the damage.

Not to mention how much it will piss off the President.

A few lynx

June 18th, 2018 at 4:26 pm

Over at WaPo, I provide the anatomy of a revealing moment from Federal Reserve Chair Jay Powell’s press conference last week. A tough question landed him in the cul-de-sac one finds oneself in when one tries to defend a specific unemployment rate as the “natural rate.” In fact, the question asked of Powell was, “how is the Fed going to get from 3.5% to 4.5% unemployment?” To which I add: “and why would they want to?!”

In terms of estimating the “natural rate,” I’m still touting this figure from Obama’s CEA of their estimate of the rate with exploding confidence intervals (from my paper on the importance of strong labor demand for the Hamilton Project). In the context of my WaPo piece, the relevant takeaway from the figure is: “I guarantee you that neither the Fed’s very smart staff nor any other economist can reliably tell you whether the “natural” rate is 3.5 or 4.5 percent.”

I’m writing something about the increasing need for a national service program in the age of Trump. So, I was interested to see this compelling piece arguing for a new CCC from my old Obama admin colleague Robert Gordon.

Part of the hypothesis here is that we have to do something to learn more about our commonalities across class, race, politics, nationality, etc. I try to be careful not to stray from my econo-lane, but I can’t just dither along about the natural rate and 25 basis point rate hikes when the policy of my country is to separate immigrant children from their parents. Obviously, scribbling isn’t enough; one must do more. But the least any of us with a pen and a platform can do is to shout about this horrific injustice.

 

Q&A on that crazy G7 meeting: Trump, Trade, Tariffs, and Trouble

June 10th, 2018 at 10:23 am

Trump at the G7 meeting? What could go wrong?

Apparently, his Orangeness gave the leaders of the free world a heavy dose of peak Trump this Saturday at the G7 meeting.

Basically, nothing newsworthy is supposed to happen at these meetings. The leaders spend a day or two together discussing mutual interests, and at the end of the summit, they release an anodyne statement renewing their vows to work together to promote cooperation and trade.

Not this time. The summit was quickly tagged the G6 plus 1 and you can guess the identity of the (very) odd guy out. Perhaps the NY Times headline can give you a flavor of how this played out: Trump Refuses to Sign G-7 Statement and Calls Trudeau ‘Weak;’ Tells Abe “Sushi Sucks!” [OK, I made up that last bit, but the rest is there in black and white.]

I can’t speak to the diplomatic screw-up herein, though this outcome was predictable given the escalation of trade disputes in recent months, like Trumping up national security risks as a reason to put tariffs on imports from Canada and the EU.

But a number of trade issues came up in the summit, so here’s a brief Q&A on the issues to which I pay attention.

Q: Is the global trading system as broken as team Trump says it is?

A: Not at all. Global trade flows have grown steadily over time, tariffs and non-tariff barriers have come down (though all the G7 countries, including our own, maintain many tariffs; see below). Exports and imports were 25 percent of GDP back in the 1960s; now they’re 60 percent. These flows have introduced robust supply chains that support international commerce in goods, services, and finance. They contribute to lower prices and faster growth than would otherwise occur. Views may certainly differ as to the upsides and downsides of this evolution, but you’d be hard pressed to find an economist outside of the Trump administration who’d argue the system is broken.

Q: So, is Trump just over-emphasizing trade’s downsides?

A: Perhaps he is, but for decades before he came on the scene, too few politicians acknowledged the reality that trade engendered benefits and costs. Before Trump, from the center-left to the center-right, politicians’ answer to people’s complaints about the damage from foreign competition to their livelihoods and communities was yet another trade deal with the false promise that this one would really help them. Trump recognized the political power of a populist attack on elites’ refusal to acknowledge the downsides and he continues to press that attack.

Q: Is that why, after the meeting, he said, “We’re like the piggy bank that everybody’s robbing!”?

A: That’s Trump making a fundamental mistake that he won’t stop making: arguing that winning at trade means getting rid of our trade deficit. He views our trade deficit as a scorecard, and no one’s going to convince him otherwise.

And yet, the vast majority of economists, who view our long imbalanced trade accounts as either wholly benign—“hey, if foreigners want to support our consuming more than we produce, let ‘em!”—or as evidence of hyper-acquisitive Americans under-saving, are also wrong about the trade deficit. As Ken Austin and Michael Pettis explain, such thinking “is an egregious error of both logic and mathematics.”

In other words, once again, Trump is onto something, but is distorting its importance and attacking the problem in a way sure to do more harm than good.

In strong economies, like today’s, our trade deficit—a hefty -3.2 percent of GDP ($640 billion)—clearly isn’t preventing us from closing in on full employment. Still, even in a strong job market, a deficit of that magnitude does mean fewer jobs in export sectors, as consumers’ demands for manufactured goods are met with imports instead of out of domestic production. And in weak economies, the trade deficit can be a further drag on growth.

It’s not that our trading partners are “robbing the U.S. piggy bank” as much as jamming it full of their excess savings. World trade must balance, so when those with whom we trade produce more than they consume, or save more than they invest, other countries must do the opposite: consume more than they produce and spend more than we save, i.e., run trade deficits. And because the U.S. dollar dominates other currencies in global commerce, “other countries” are us.

So, when they send us their excess savings (capital inflows), our trade deficit goes up. It makes no more sense to yell at Americans for dis-saving than it does to yell at the Chinese, Germans (and the Taiwanese, the Koreans, and others) for saving too much.

Sometimes those capital inflows get put to good use, sometimes they just inflate bubbles. But they always strengthen the dollar and thus put competitive pressures on our exporting sector.

Q: Wait up. So, now you’re saying Trump’s right, and he should be getting up in everybody’s grill like he just did at the G7? Couldn’t you please stop with the “on-the-one-hand-on-the-other-hand” for a minute and give it to us straight?

A: Sorry, and I hear you, but the topic is nuanced. Here it is as straight as I can put it.

Our persistent trade deficits remain a problem, both in terms of job quality and excess, bubble-inducing financial flows. But they won’t be and never have been solved by tariffs. Instead, we must a) not allow the dollar to be overpriced, b) invest in our export sector, and c) really help the people and places who’ve been hurt by trade. Details here and here.

Q: So, Trump’s wrong on tariffs? Are you saying his assertion that those seemingly mild-mannered Canadians place a 270 percent tax on milk imports is false?!

A: He’s right about that! But again, he’s missing the bigger picture and his tariff war will backfire.

This is another way in which team Trump on the policy community are talking past each other. Economists will tell you all day, correctly, that average tariffs in G7 economies have come down a great deal and are all in the low single-digit percentages. I myself recently made that argument to a senator from a big exporting state. He immediately countered with a long list of examples like the milk one above.

The fact is that all countries, including our own, protect certain sectors. We do less of it than others, but we have tariffs of “350 percent on smoking tobacco, 130 percent on peanuts and 99 percent on prepared groundnuts” and 25 percent on imported light trucks.

So, when Trump rails, as he did at the meeting, between proposing a “tariff-free G7” versus “we’re going to stop trading with them,” he’s way out of his depth. Every tariff has a lobby behind it, if not a culture (the French countryside is dotted with lovely family farms that could not survive without protective tariffs and subsidies). They are an ingrained part of the trading system, they’re not a problem on average, and the realistic play here is to accept that reality and try to negotiate them down in trade deals.

As for postponing trade with G7 or any other large trading partner, it’s a meaningless claim. This is his standard “Art of the Deal, You’re Fired” crap that is great fun on TV (if that’s your thing), but meaningless in this context.

Moreover, his steel and aluminum tariffs, along with similar threats and actions will only hurt the many more Americans in industries that use these metals as inputs than those that produce them, while at the same time inviting retaliation in the form of higher tariffs on U.S. imports.

Q: So, where does this go next?

A: Nowhere good, I’m afraid. To circle back to the top, the system isn’t broken, so misguided attempts to fix it will likely backfire. That could mean higher trade deficits and higher prices, but I’d guess these are marginal impacts, given that none of this bluster will majorly disrupt ongoing trade flows, and given our relatively low exposure to trade (we do a lot less of it than the other G7 countries; imports are just 15 percent of our GDP and only about 10 percent of consumer spending, less than half that of other G7 economies).

The worst thing about all this, aside from the diplomatic disruptions, is that Trump identified a real problem and was elected, at least in part, to do something about it. But neither he nor his team knows what to do.

And now they’re headed for North Korea…

Catching up with the lynx

June 4th, 2018 at 9:14 am

Over a WaPo today: As you’d expect, I’m not at all happy to see the rollbacks in financial market regulations. But, given our ability to willfully forget the last financial meltdown, they’re far from unexpected. One of my key points here is that the powerful, rich finance lobby faces little in terms of countervailing pushback. That is, this isn’t good D’s outnumbered by bad R’s. Note also recommendation for a small tax on financial transactions. I plan to amp that up in coming weeks.

The strong jobs report at the end of last week confirmed that the job market remains on track. There was even a pop in middle-wage workers’ paychecks. Here’s some noodling on three things that could throw the recovery off track: Fed mistake, trade war, and supply constraints. I think the last one poses the biggest risks.

Note that I left out bursting finance bubble from the list of recovery de-railers. That’s because I don’t see near-term evidence of excessive speculation and under-priced risk. My concerns in this space are longer term.

Finally, while I don’t think Trump’s trade war is our biggest risk (unlike the respondents to this Twitter poll), I do think there’s risks from his chaotic trade policies becoming unbound. Heretofore, they’ve been more bark than bite, but as the protectionists become empowered, I don’t expect their actions to actually help working people. Instead, I expect them to needlessly piss off allies, dampen exports, raise prices on imports, and hurt workers in domestic industries that use the taxed metals as inputs. And there are millions more of those workers than there are in domestic steel and aluminum production.

“…these tariffs and their phony national security rationale won’t come close to helping most workers displaced by imbalanced trade. They won’t lead to investments in new, potentially competitive industries, like green battery production or other renewable technologies. They won’t create significant job opportunities in places that have been left behind, even at our current low unemployment . They won’t provide the apprenticeship, earn-while-you-learn program needed to train a displaced coal miner to be an MRI technician. They won’t roll back the wasteful, regressive tax cuts that robbed the Treasury of the resources to invest in public goods, from infrastructure to human capital.”

May Jobs: Another solid month; Lowest black unemployment rate on record; Wage growth ticks up for mid-wage workers.

June 1st, 2018 at 9:26 am

Payrolls rose 223,000 last month, beating expectations of 190,000, and the unemployment rate ticked down to 3.8 percent, its lowest level since April 2000, and before that, a level much more commonly seen in the 1960s. (At 3.75 percent, the jobless rate just missed falling two-tenths).

[Before the release, President Trump tweeted that he was looking forward to the jobs numbers. Since certain top officials, including the president, see the report on Thursday night, his tweet telegraphed the positive report, a highly unusual occurrence.]

The unemployment rate for African-Americans fell to 5.9 percent, an historical low point by a wide margin. Typically, the black unemployment rate is twice the white rate. But persistently tight labor markets are especially helpful for minority workers, as they make it more costly for employers to discriminate. In May, the black/white ratio was 1.7, still too high, but lower than average, underscoring the relative gains to less-advantaged workers.

Given the noisiness of these monthly data, our patented jobs smoother looks at average monthly employment gains over 3, 6, and 12-month intervals. As shown below, the trend in payroll growth is running at around 180K-200K per month, a solid trend that, if it persists, is strong enough to continue pushing down the unemployment rate.

Wage growth picked up slightly, up 2.7 percent overall and 2.8 percent for middle-wage workers. This too is a positive sign, as the tight labor market pushes up wage growth. The figures show yearly wage gains for all private sector workers and for the 82 percent that are blue-collar production workers and non-managers in services. The smooth trend in the first figure shows little by way of recent acceleration. Hourly wages were up 2.7 percent last month, a bit faster than the latest reading on consumer inflation of 2.4 percent.

The other figure, however, for middle-wage workers, shows a bit of a trend increase, as wage growth has accelerated in recent months and was 2.8 percent in May. This is once again consistent with the tight labor market disproportionately helping the least advantaged.

If it sticks, this “trend is our friend,” as is the solid payroll jobs’ trend. But is there anything out there that could whack it? The Fed could raise interest rates too quickly, but, barring a sharp acceleration in prices, which I judge to be unlikely, I believe they will be careful not to make this mistake. Trump’s trade war could, and probably will, escalate. That’s slightly worrisome, but remember, relative to other countries, the US is somewhat insulated to trade shocks as our imports as a share of GDP are only 15 percent, compared to at least twice that in Europe.

The biggest constraint to the jobs trend is labor supply. If the supply of available workers dries up, that will definitely constrain both job and overall economic growth. However, I’ve argued that this constraint may be less binding than many economists believe to be the case (yes, the May labor force barely budged, but these monthly numbers are especially noisy).

Employment rates of prime-age workers (25-54) were flat last month, but they’ve been climbing and have recovered 4.4 out of 5.5 percentage points, or 80%, of their losses since the recession. Historically, this indicator has flattened before recessions, but, May’s result aside, it has been growing lately for both genders, suggesting more room to run. We also know that there is considerable geographical variation in labor market tightness, so while some cities may be close to tapped out, supply-wise, other places are clearly not. At least thus far, these dynamics, combined with low productivity growth and weak worker bargaining power, have constrained wage and price growth.

I recently pointed out the prime-age employment rate is a better predictor of recent wage growth (nominal, i.e., before inflation) than the unemployment rate. The figure below (which does not include this month’s data) shows the results of a simple statistical model that predicts the annual wage growth of non-supervisory workers (the one that grew 2.8 percent over the past year). I run the model through 2014 and then predict wage growth based on a slack variable and lagged wage growth.

Source: BLS, my estimates.

What it shows is that variables that are more inclusive of slack do a better job of predicting wage growth. The unemployment rate says wages should be growing about 3.5 percent right now. The more slack-inclusive underemployment rate (U6) is a little more pessimistic/realistic but the men’s prime-age employment rate, which shows the most slack, does the best.

There are many caveats to this simple exercise–the differences are all within a margin of error and a more complete model would include the slow productivity growth that is putting downward pressure on wage growth. But it does provide some useful information. The notion that labor supply is fully tapped in the U.S. is not well supported by these monthly jobs reports. First, the persistently strong monthly payroll numbers are inconsistent with seriously binding supply constraints. Second, the employment rate for prime-aged workers doesn’t appear to have topped out. Third, while some price and wage pressures are building, these capacity indicators are not flashing red by a long shot.

Thus, especially from the Fed’s perspective, the assumption that there’s still room to run–that labor supply is not clearly exhausted–is the right one to make. The gains to African-Americans must be preserved and built upon. Same with that tick up in wage growth for mid-wage workers. Remember, in an economy with little union power, tremendous finance power, and thereby, far too much inequality, the best friend working people have is a persistently tight labor market.