No Powell Put

If market participants thought there was going to be Powell Put coming out of today's FOMC meeting, they were sorely disappointed as the the S&P 500 sold off by 92 points (850 Dow points) from the timing of the 2:00 PM announcement of  an increase in the Fed Funds rate by 25 basis points to the intraday low.  Perhaps more important 10-Year Treasury Yields declined by 9 basis points intraday. Put bluntly, the markets now believe that the Fed is making a major policy mistake. Powell's money quote during his press conference was "policy at this point doesn't need to be accommodative."  

My sense is that the markets are protesting too much. After all the Fed downgraded the potential for rate hikes next year from four to two, lowered it long term federal funds rate estimate from 3.0%-2.8%. He also noted that the Fed will continue to be data dependent which means the Fed doesn't have to do anything at all next year. He buttressed that point by stating the Fed policy is now at the low end of neutral for the Fed Funds rate. This is way more dovish than last September, but with the 13% sell-off in stock prices since then the market wanted more.

Nowhere is it written that the path to interest rate normalization would be trouble free. The markets are now paying the price for a 10 year policy of extraordinary monetary ease.  My instant analysis is that both stocks and bonds over-reacted, but higher volatility will be here to stay.

One last point the Fed did downgrade its GDP growth outlook from 2.5% to 2.3% next year, getting close to our UCLA Forecast of 2.1%. However the Fed is at 2.0% for 2020 while we are at 1.0%.

And What did you do in the Trade War?

With his proposed tariffs on $50-$60 billion of Chinese goods, it seems that President Donald Trump wants to start a trade war. As if on cue the S&P 500 dropped 2.5% today and export oriented Boeing and Caterpillar declined by more than 5%. To be sure the U.S. has serious issues with China with respect to trade in general and intellectual property specifically, shooting first and asking questions later is hardly the best way to settle a trade dispute.

As a result investors are rightly worrying about the broad imposition of tariffs on China on inflation and growth. Simply put a tariff is a tax that will increase inflation and slow growth as the Chinese retaliate against American made goods. It is a recipe for stagflation that will hardly be good for stocks.

Of course Trump's announcement could be an opening gambit in a very complex negotiation. That was the case with his steel and aluminum tariffs a month ago. He has since exempted our major trading partners in those commodities namely Canada, Mexico, Brazil and South Korea. Thus it is no surprise that the steel and aluminum stocks have given back all of the gains they made on the initial tariff news. But make no mistake Trump is playing with fire, and a good chunk of the global trading structure could burn down. 

My Amazon Review of Nancy Forbes' and Basil Mahon's "Faraday, Maxwell and the Electromagnetic Field: How Two Men Revolutionized Physics"

The Electromagnetic Underpinning of Economic Growth

The world doesn’t need another review of Nancy Forbes’ and Basil Mahon’s wonderful book. However, after thinking about it, I believe that the explosion in economic growth from 1870-1970 discussed by Robert J. Gordon in his “The Rise and Fall of American Growth” would never have happened were it not for Michael Faraday and James Clerk Maxwell. 

http://shulmaven.blogspot.com/2016/02/my-amazon-review-of-robert-j-gordons.html

What Forbes and Mahon describe are the lives of Faraday and Maxwell and how through their experiments they came to discover some of the most fundamental secrets in nature. What Maxwell does in his 1873 “Treatise and Electricity and Magnetism” is to put a mathematical foundation underneath Faraday’s brilliant experiments. The rest is history. The world became electrified, radio and mass communications became of age and only 32 years later, building on their foundations, Einstein publishes his essays on relativity and the photoelectric effect.

The science is so monumental that it offers support for Gordon’s thesis that the economic growth achieved from 1870-1970 was based on a series of one-off events.

For the full Amazon URL see:

https://www.amazon.com/review/R5ZMT2LIUV3T7/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv

My Amazon Review of Robert J. Gordon's "The Rise and Fall of American Growth"

It’s All about Growth

Northwestern economics professor Robert Gordon has a written a mostly very good and a very long book (762 pages in the print edition) on the history of economic growth in the United States from 1870 to the present. In his view it is all about the rise and fall of total factor productivity (the gains in output not due to increased labor and capital inputs, or if you will technological improvements). I know this sound very boring, but he explains the growth in output in terms of how it affected the daily home and work lives of average Americans. In other words he tells a very good story as to how the typical American moved from a completely disconnected life without indoor plumbing in 1870 to a fully connected life with water, sewerage, electricity, radio and telephones by 1940. The American of 1940 would not recognize the life of an American in 1870 while the American of today would readily recognize the life of a typical 1940 American.

To him much of this improvement is due to what he calls the second industrial revolution which was brought into being by the widespread adoption of electricity and the internal combustion engine. along with indoor plumbing remade the economy. In a way his book is a paean to industrial capitalism whose innovations brought about this revolution. Further, although it is hard to believe today, the introduction of the automobile in the early 1900s was the clean technology of its day. Simply put the major cities of the country were knee deep in horse poop and horse piss that local residents struggled to avoid. They were literally swimming in pollution.

Compare this to the third industrial revolution we are experience today involving information technology, computers and communications. Sure those technologies have improved our lives, but how do they compare to indoor plumbing and electric lights. Gordon demonstrates through a careful analysis of the data that the information revolution peaked from 1996-2004 and has since slowed down. Specifically Moore’s Law which states computer chip capacity doubles every 18-24 months which held from the late 1960s to the early 2000s broke down in the past decade to a pace of doubling every four to six years.

Going forward Gordon is a “techno-pessimist.” He views the 1870-1970 period as a one off event. The recent slowdown in productivity and economic growth certainly supports his view. Whether he is right, or not, only time will tell. Where I would disagree with Gordon is that he labels the rise of income inequality as an impediment to growth. To me that is a stretch because during his golden age of 1870-1940 there were two distinct periods of high and rising income inequality. The first was the gilded age of 1895-1910 and second was the roaring twenties. During those two time periods the standard of living for the average American grew rapidly and it is hard to see in the data that it was an impediment to growth especially when Gordon admits the official data grossly understated overall economic growth.

I know that this review has hardly done justice to Gordon’s magisterial work. I highly recommend it for those interested in how our lives came to be.

For the full Amazon URL see:

https://www.amazon.com/review/R13GCQ9VTKYY3S/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv

My Amazon Review of Thomas Piketty's, "Capital in the Twenty-First Century"

Thomas Piketty has written a big data-driven book and an important book about the growing unequal distribution of wealth and income in advanced capitalist societies. However, never once does he mention in his 685 pages why rising inequality matters. For Piketty it is a given. Although Piketty is not a Marxist he wears his social democratic identity on his sleeve with such a statement as “the evil genie of capitalism will be put back in its bottle.” (P.350)  To him the 1914-1970 period where income inequality was on the wane was a brief hiatus between the Gilded Age and Belle Époque of 1890-1910 to what he perceives as the new gilded age of today. After all from 1970 to 2010 the share of income going to the top 1% of the income distribution increased from 9% to 19.8% in the United States.

What interests Picketty is what a Marxist would describe as the laws of motion of capitalist society. For Picketty it is the concept that the pure return of capital (r) is greater the overall economic growth rate (g).  He demonstrates that the pre-tax real return on capital is roughly constant approximating 5% and in most cases economic growth is well below that. For him there is no falling rate of profit.

In order for capital to grow faster than income both the tax rate on capital income (dividends, capital gains, interest and rents) and the propensity to save has to be low. Otherwise the retained return on capital would fall to or below the growth rate in the economy. Thus as long as the retained return is above the growth rate of the economy the capital/income ratio increases faster than the economy and the share of income derived from capital rises. And here is the punchline because capital is more concentrated than wage income; income inequality has to rise over time. This notion explains English and French inequality, but unfortunately it is not a good explanation for what has happened in the U.S. where the labor income of the top 1% has exploded.

Returning to the history, income inequality significantly declined from 1914-1950 and then stabilized for another 20 years. Why did this happen?  Answer: two very destructive wars and a depression. Simply put capital (and millions of lives) was destroyed and the income from it disappeared. Along the way tax rates sky rocketed and growth collapsed. Similarly during the Great Recession of 2008-09 inequality was reduced as stock prices and real estate values crashed. Unfortunately the collateral damage on the average worker was far greater than it was for the owners of capital. Witness the more than complete recovery in stock prices and wages for the top 1% post-2009 while average wages have stagnated. The cure was far worse than the disease.

Although Picketty denies it, the laws of motion in the United States differ from Europe. Here as Picketty notes we have witnessed the rise of the super-manager who has captured an increasing portion of labor income. The share of wages going to the top 1% increased from 5.1% in 1970 to 10.9% in 2010 accounting for half the gain in their total income share over that time period. I would argue the wage share gain is far greater than that because in the late 20^th Century and in recent year’s human capital is monetized into financial capital. The return to Bill Gates’, Mark Zuckerberg’s, Sergey Brin’s  human capital  comes not only from their salaries and the ordinary income that comes from the exercise of stock options, but also from their initial ownership positions in the companies they founded. For example according to the Forbes 400 list the wealth of such corporate founders amounts to $72 billion for Microsoft’s Bill Gates, $41 billion for Oracle’s Larry Ellison, $27 billion for Amazon’s Jeff Bezos, $25 billion for Google’s Larry Page, $19 billion for Facebook’s Mark Zuckerberg and $7 billion for Tesla’s Elon Musk. Is this the 19^th Century wealth of an Andrew Carnegie or a John D. Rockefeller whose assets were tied up physical plant? I think not. In the new world of capitalism intellectual property is valued more highly than physical capital.

Moreover Picketty’s 19^th century view of capital is the role of real estate in national wealth. Real estate holdings accounted for more than 60% of French capital, more than 50% of British capital and more than 40% of U.S. capital. True it not the landed wealth of the 18^th century, but it is the 21^st century urban version of it.  This is important because if Picketty is really serious about equalizing the distribution of wealth he would advocate a radical reduction in the planning constraints that artificially increase real estate values in the great urban centers of New York, London, Paris, Los Angeles, San Francisco and Washington, D.C. It would be far more beneficial to do that than to impose income tax rates of from 60% -80% on the top 10% and the progressive wealth tax he advocates. While higher tax rates on capital would arguably reduce economic growth, an easing of planning constraints would increase it. I know Picketty would argue that the post war economy grew rapidly in during the postwar era in regime of high tax rates. That is true, but much of the growth came from a recovery from the depression and World War II. Recall that, although high, the tax burden dropped from its war time peaks.

All told Thomas Picketty has written a book that is and will continue to be much discussed. It should be the subject of serious debate and readers should note that the book is not an all-encompassing treatment of inequality. He ignores the role of assortative mating at the top where, for example an investment banker marries a corporate lawyer, and the role of single-parent households at the bottom of the income distribution. But any economist who quotes Jane Austen and Honore de Balzac has to have a lot going for him.

For the amazon URL see:

http://www.amazon.com/review/R365VSU9UE3P37