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Wednesday, October 19, 2011

Transcript 463: Forecast Interest Rates

Today on the podcast, interest rates. And the return of Idiot of the Week. Plus some audio from Robert Shiller, advocating direct employment of people in public works, the true Keynesian prescription.
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First, Shiller. We like this audio because it uses the best metaphor for the economy and government – the family farm. We’ve used it before, and welcome its introduction to polite society. Here from Weekend Business with Jeff Sommer.

Well, part of the jobs bill was infrastructure investment. And another part of the bill was raising taxes to pay for it. There were other parts, too, but let's focus on those.

On a farm, there are times when unemployment becomes a problem. Notably, in the winter, right? There's no crops to plant. There's no fertilizer to use. There's no harvesting to do. So, what do you think a farm does? Well, people don't want to sit around doing nothing, so they fix the barn, or they build a bridge over the creek. Or whatever. And I think that's what this part of the Obama American Jobs Act was doing. It was putting people to work on sensible projects that are not being done.

Going back to the Nineteenth Century, this idea seems obvious to many people. Unemployed people doing nothing is a huge waste of human talent. And so they came up with all kinds of infrastructure ideas. You know, building canals, or dams, or railroads, or improving harbors. And some of those were done, but they had a bit of a problem. I think it's the same problem we are facing right now.

It's not "the Republicans." It's a long-standing attitude in this country that we don't tax some people to bail out others. Taxing the rich to bail out the poor, unemployed, has never been that popular in this country. There is a lot of opposition to tax increases.

You see, the thing that I am emphasizing is that if you take the part of the bill, the infrastructure and tax increase part of the bill, it was more than balanced budget. Those parts together would have helped cure the deficit as well. People are really opposed to tax increases and deficit spending. But I think in the new political environment, this could change. Because these demonstrations are having an effect.

You know, this crisis might last for years. We might have unemployment over nine percent three years from now. People are tired of this. It's been already four years since the recession began. And I think the political winds could change. I am not going to take it as a given that we can never do sensible things like raise taxes on higher-income people and put unemployed people back to work. That's sensible, and I think the American people may well support that.
Indeed, you hear people say, “Why can’t the government be more like me and my household? I don’t spend more than I make.” Well, if you have a mortgage, you are spending more than you make. Your indebtedness is right on par with many of the most profligate of national governments. You could sell your house, you say. Well, the government could sell Yellowstone Park or the Interstate Highway System, or a host of natural monopolies.

The point is, like a farm family, we have old people, young people, infrastructure needs, a future to plan for, and a complex of activities that are simplified out of existence in the household metaphor. We are not just going to work, collecting a paycheck, and coming home to pay the bills. We don’t have to worry about protecting ourselves from the neighbors, building roads to work, educating our children in-house, providing for the old people’s health and retirement, and so on, all of which – and more – you need to include in your calculations if you are going to do away with the support of public goods in your self-righteousness.


And now, Howard Davidowitz, Idiot of the Week. Appearing with Tom Keene and a doorpost,
DAVIDOWITZ: The single most important thing I did say is that receipts on American ports for retail merchandise were lighter than last year. That's important. That means that retailers are not optimistic about holiday. They're receiving less merchandise.

PRUITT: Well, we were talking with Dana Telsey earlier about how the inventory is pretty much already here, and any retailer who wants more is going to have to scramble. It will have to be air freighted in. It's going to cost more.

DAVIDOWITZ: I don't agree that it's already here. I thinks that's a little loony. It's certifiably mad. But the point is that it's not nearly all here. No retailer in his right mind would have it all here. A lot of it is here. But you can chart what's been received up to now, and that's what I'm talking ... If you chart it up to now, Retailers are planning on a conservative season, which I think is smart. I think it's a function of what American industry has done in this recession. They've been magnificent. They've fixed their balance sheet. They've been conservative. They've loaded with cash. Contrast with that with our deranged and dysfunctional, bought and paid for federal government, and look at their performance versus the performance of American industry. It's day and night.

I don’t know if you followed that. Davidowitz started out with how receipts are down in ports, and then laid into fellow analyst Telsey for saying retailers have their stock on hand already, before admitting that retailers have a lot of their stock on hand already. That petulance is not, of course, what got him featured on today’s Idiot of the Week. He is featured for his nonsense on how government should be like business.

We’re not going to repeat the analysis from last week, or the week before, that demonstrates that the profits Davidowitz so proudly claims for business come directly from the government deficits he cites as spawn of the blind bureaucrat

Instead, we are going to affirm that it is a good idea, on the eve of another government bailout of the financial sector, to review what government might do if it were truly run like a business.
  • It might charge fair market value for its roads and education and use of airwaves. 
  • It might exploit its power to tax in order to balance its budget, and likely it would go where the money is, to the wealthy. 
  • It might position its advocates on the boards of private companies like private companies position theirs in the legislatures of governments, particularly in the U.S., where such offices are up for sale through campaign donations.

Wouldn’t it be fun to see Bernie Sanders on the board of Exxon? In any event, with the power of taxation – universal (in theory) coercive revenue collection – government has no reason to be in arrears relative to private companies. A simple 50% profits tax, for example …

You might argue that the shareholders of government are the citizens and each one gets a vote – again ignoring the one dollar one vote policy in place in the U.S. – so maximizing shareholder value would mean the opposite of trickle down, which is a theory that helping the few will somehow … Well, you get the point. Run the government like a business? We say, go for it, but remember who the shareholders are and remember to wring the corruption out of the boardroom.



The failure to control credit and the decision to leave financing to the markets and their manipulators is the great failure. It is the genesis of the great financial crisis, and its legacy is the huge burden of debt that now crushes prospects for an orthodox recovery. The invisibility of financing and financing structures – as we’ve noted before – is what made the orthodox forecasters blind to the biggest economic event of the generation. And the unwillingness to deal with the misallocation of credit in a ruthless and rational way is what prevents policy-makers from putting the crisis behind us and real recovery in front. Instead we limp from crisis to crisis, always choosing to burden the future with more debt, always choosing to socialize the losses of the powerful and privatize the suffering of the powerless.

(click on the chart for a larger image in a new window)

Source: New York Times, Analysis of Current Population Survey data by Gordon W. Green, Jr., and John F. Coder, Sentier Research.(click on the chart for a larger image in a new window)

Today on the Forecast, we look at interest rates. We are forecasting interest rates to continue to trend downward. But we do not put much stock in the importance of interest rates to the real economy or see monetary policy as playing a positive role in recovery.

For several reasons:

1. Credit availability is not described by how low interest rates are. Particularly in the mortgage market, where banks once so happily lent to anyone and were even willing to lend the down payment. Banks will not now finance anyone who needs financing. They resist refinancing even the best risks, in fact, so as to keep the old higher interest mortgages paying. Not too different from squeezing credit card holders. But the point is, mortgages may be at four percent, but you can’t get one if you need it.

2. Low rates delight the market players who can finance their stacks of chips cheaply. This means speculation, and it means higher prices in commodities like oil and food and basic materials. This means higher and volatile prices for consumers than would be the case in a supply-demand market. Which means decreased consumer confidence and reduced private demand.

3. It is not ultimately the supply of credit that is the problem, it is the demand for credit.

4. Real interest rates for assets may actually be high when nominal rates are low. Deflation in the prices for investment goods means a zero nominal rate is actually positive. Two bullets on this:
  • It doesn’t seem that long ago that markets were efficient, by the accounts of the fundamentalists, and incorporated new information with seamless efficiency. Outguessing the market was futile according to Eugene Fama and the Chicago School, and better to be passive. Now it seems that investors are stupid and their information is deluded when they take the two percent ten-year Treasuries. They need to be coaxed by the enlightened fund managers. Well, maybe investors are not so stupid. Housing as a surrogate for investment goods? Prices are dropping. A hundred dollars in a ten-year at two percent yields five percent versus a house that drops three percent in value….
  • Consumer price inflation is not relevant to calculating real interest rates. As we’ve said, if it were any more than commodity speculation, inflation in wages and incomes would be rising, too.
5. It is a lot easier to stall an economy with hikes in interest rates than it is to restart it by lowering rates. This is, again, because demand comes first. It is the demand for products and thus investment goods driven by the prospect of profit that causes people to invest. It is not the supply price of inputs.
You can see this on today’s chart. We’ve mapped GDP on the right axis with an inverted scale. So it should be going in the same direction as interest rates. And it does in many of the negative cases. The well-worn plot has been: The Fed sees inflation in its tea leaves, myopically searches for its only button, the big red EASY button, and punches it. The economy stalls. Our chart goes back only to 1991, but the pattern is similar since the Fed became the independent authority over monetary policy in 1951.

In our chart, the dot.com bust as well as the latest greatest recession both were triggered in part by the inability to lay off the interest rate button. Parenthetically, in both cases, rising energy prices were accomplices, and in fact, it was the real … ah … short-sightedness of the Fed in not seeing that its inflation fears were rooted in the price of oil that compounded the blunder of raising rates.

There is more in our chart. First, we see that one recovery was actually helped by lower interest rates. That was the recovery of 1992. The Budget Deal raised taxes and the Three Amigos – Greenspan, Summers and Rubin – brought rates down. Millions of homeowners refinanced, producing billions in new demand. Interest rates went back up in 1994, but GDP stayed strong – Plus Four was the norm through the 90’s.

And – yes – low oil prices. Don’t forget the Gulf War oil prices helped trigger the 1991 recession and then, not exclusively through the brilliance of Bill Clinton, oil prices came down to the $15 per barrel range throughout most of his presidency. That’s one-five. Fifteen. Dollars a barrel.

And further on. yes, in 2009 GDP bounced back up – or down in our inverted scale – as an apparent response to interest rates. But was it the rate of interest? No. It was the federal stimulus and the massive give-aways to the financial sector.

What else do you see?

Interest rates in the boom of the 1990s were substantially higher – five to eight percent for Treasury ten-years, seven to nine percent for triple A bonds and 30-year mortgages. They are now stretching toward two for ten-year notes and four for mortgages and triple A paper.

But you see the pogo stick at the Fed. Six percent effective federal funds rate PLUS in ’91. Three percent in ’92. Six percent in ’94, followed by a little bit of stability in the five to six range, before going up to six point five in 1999 to trigger the recession of 2001 and then diving from six and a half to one and three-quarters in 2001, finally settling in at one percent on into 2004 as a way of throwing gasoline on the housing bubble. Then? Bernanke to five plus in 2006 and Wile E. Coyote down to the zero of today.

And you see the bars for QE I and QE II. These quantitative easings were happy news for stock markets, but for the real economy, not so much. Yes, the intended interest rates did come down, though not really in sync with the QE’s, but no, the push on housing and other investment has not been observed.

Below is a chart from the Federal Reserve describing the QE’s in terms of the Fed’s balance sheet. You see the pig of direct loans to banks that was gulped in September ’08, subsequently passed in favor of the cow that is the mortgage backed securities. Which at one point were intended to be resold, but which now are apparently a permanent feature of the balance sheet, since the only buyer of MBS’s is the government. And while retaining the cow, the Fed added the long-term treasuries beginning in the fall of ’10, to no great effect on anything except financial markets.

And you see our forecast at the end, an extension of the trends because there is no reason for optimism on either the recovery front or the monetary policy front.

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