Posts Tagged 'Donald Trump'

The Trump Rally

Published December 18, 2016 David Beckworth , Irving Fisher , loanable-funds theory 7 Comments
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David Beckworth has a recent post about the Trump stock-market rally. Just before the election I had a post in which I pointed out that the stock market seemed to be dreading the prospect of a Trump victory, based on the strong positive correlation between movements in the dollar value of the Mexican peso and the S&P 500, though, in response to a comment by one of my readers, I did partially walk back my argument. As the initial returns and exit polls briefly seemed to be pointing toward a Clinton victory, the correlation between the peso and the S&P 500 (futures) seemed to be very strong and getting stronger, and after the returns started to point increasingly toward a Trump victory, the strong correlation between the peso and the S&P 500 remained all too evident, showing a massive decline in both the peso and the S&P 500. But what seemed like a Trump panic was suddenly broken, when Mrs. Clinton phoned Trump to concede and Trump appeared to claim victory with a relatively restrained and conciliatory statement that calmed the worst fears about a messy transition and the potential for serious political instability. The survival of a Republican majority in the Senate was perhaps viewed as a further positive sign and strengthened hopes for business-friendly changes in the US corporate and personal taxes. The earlier losses in S&P 500 futures were reversed even without any recovery in the peso.

So what explains the turnaround in the reaction of the stock market to Trump’s victory? Here’s David Beckworth:

I have a new piece in The Hill where I argue markets are increasingly seeing the Trump shock as an inflection point for the U.S. economy:

It seems the U.S. economy is finally poised for robust economic growth, something that has been missing for the past eight years. Such strong economic growth is expected to cause the demand for credit to increase and the supply of savings to decline

Though this is not the main point, I will just register my disagreement with David’s version of how interest rates are determined, which essentially restates the “loanable-funds” theory of interest determination, which is often described as the orthodox alternative to the Keynesian liquidity preference theory of interest rates. I disagree that it is the alternative to the Keynesian theory. I think that is a very basic misconception perpetrated by macroeconomists with either a regrettable memory lapse or an insufficient understanding of, the Fisherian theory of interest rates. In the Fisherian theory interest rates are implicit in the intertemporal structure of all prices, they are therefore not determined in any single market, as asserted by the loanable-funds theory, any more than the price level is determined in any single market. The way to think about interest-rate determination is to ask the following question: at what structure of interest rates would holders of long-lived assets be content to continue holding the existing stock of assets? Current savings and current demand for credit are an epiphenomenon of interest-rate determination, not a determinant of interest rates — with the caveat that every factor that influences the intertemporal structure of prices is one of the myriad determinants of interest rates.

Together, these forces are naturally pushing interest rates higher. The Fed’s interest rate hike today is simply piggybacking on this new reality.

If “these forces” is interpreted in the way I have suggested in my above comment on David’s previous sentence, then I would agree with this sentence.

Here are some charts that document this upbeat economic outlook as seen from the treasury market. The first one shows the treasury market’s implicit inflation forecast (or “breakeven inflation”) and real interest rate at the 10-year horizon. These come from TIPs and have their flaws, but they provide a good first approximation to knowing what the bond market is thinking. In this case, both the real interest rate and expected inflation rate are rising. This implies the market expects both higher real economic growth and higher inflation. The two may be related–the higher expected inflation may be a reflection of higher expected nominal demand growth causing real growth. The higher real growth expectations are also probably being fueled by Trump’s supply-side reforms.

beckworth_interest_rates

I agree that the rise in real interest rates may reflect improved prospects for economic growth, and that the rising TIPS spread may reflect expectations of at least a small rise in inflation towards the Fed’s largely rhetorical 2-percent target. And I concur that a higher inflation rate could be one of the causes of improving implicit forecasts of economic growth. However, I am not so sure that expectations of rising inflation and supply-side reforms are the only explanations for rising real interest rates.

What “reforms” is Trump promising? I’m not sure actually, but here is a list of possibilities: 1) reducing and simplifying corporate tax rates, 2) reducing and simplifying personal tax rates, 3) deregulation, 4) tougher enforcement of immigration laws, 5) deportation of an undetermined number of illegal immigrants, 6) aggressively protectionist international trade policies.

I think that there is a broad consensus in favor of reducing corporate tax rates. Not only is the 35% marginal rate on corporate profits very high compared to the top corporate set by other countries, the interest deduction is a perverse incentive favoring debt rather than equity financing. As I pointed out in a post five years ago, Hyman Minsky, one of the favorite economists of the left, was an outspoken opponent of corporate income taxation in general, precisely because it encourages debt rather than equity financing. I think that the Obama administration would have been happy to propose reducing the corporate tax rate as part of a broader budget deal, but no broader deal with the Republican majority in Congress was possible, and a simple reduction of the corporate tax rate would have been difficult for Obama to sell to his own political base without offering them something that could be described as reducing inequality. So cutting the top corporate tax rate would almost certainly be a good thing (but subject to qualification by the arguments in the next paragraph), and expectations of a reduction in the top corporate rate would tend to raise stock prices, though the effect on stock prices would be moderated by increased issues of new corporate stock.

Reducing and simplifying corporate and personal tax rates seems like a good thing, but there’s at least one problem. Not all earnings of taxable income is socially productive. Lots of earned income is generated by completely, or partially, unproductive activities associated with private gains that exceed social gains. I have written in the past about how unproductive many types of information gathering and knowledge production is (e.g., here, here, here, and here). Much of this activity enables the person who acquires knowledge or information to gain an information advantage over people with whom he transacts, so the private return to the acquisition of such knowledge is greater than the social gain, because the gain to one party to the trade comes not from an increase in output but by way of a transfer from the other less-informed party to the transaction.

The same is true — to a somewhat lesser extent, but the basic tendency is the same – of activity aimed at the discovery of knew knowledge over which an intellectual property right can be exercised for a substantial length of time. The ability to extract monopoly rents over newly discovered knowledge is likely to confer a private gain on the discoverer greater than the social gain accruing from the discovery, because the first discoverer to acquire exclusive rights can extract the full value of the discovery even though the marginal benefit accruing to the discovery is only the value of the new knowledge over the elapsed time between the moment of the discovery and the moment when the discovery would have been made, perhaps soon afterwards, by someone else. In general, there is a whole range of income accruing to a variety of winner-takes-all activities in which the private gain to the winner greatly exceeds the social gain. A low marginal rate of income taxation increases the incentive to engage in such socially wasteful winner-takes-all activities.

Deregulation can be a good thing when it undermines monopolistic price-fixing and legally imposed entry barriers entrenching incumbent suppliers. A lot of regulation has historically been of this type. But although it is convenient for libertarian ideologues to claim that monopoly enhancement or entrenchment characterizes all government regulation, I doubt that most current regulations are for this purpose. A lot of regulation is aimed at preventing dishonest or misleading business practices or environmental pollution or damage to third-parties. So as an empirical matter, I don’t think we can say whether a reduction in regulation will have a net positive or a net negative effect on society. Nevertheless, regulation probably does reduce the overall earnings of corporations, so that a reduction in regulation will tend to raise stock prices. If it becomes easier for corporations to emit harmful pollution into the atmosphere and into our rivers, lakes and oceans, the reductions in private costs enjoyed by the corporations will be capitalized into their stock prices while the increase in social costs will be borne in a variety of ways by all individuals in the country or the world. Insofar as stock prices have risen since Trump’s election because of expectations of a roll back in regulation, it is not clear to me at least whether that reflects an increase in net social welfare or a capitalization of the value of enhanced rights to engage in socially harmful conduct.

The possible effects of changes in immigration laws, in the enforcement of immigration laws and in trade policies seem to me far too murky at this point even to speculate upon. I would just observe that insofar as the stock market has capitalized the effects of Trump’s supposed supply-side reforms, those reforms would have tended to reduce, not increase, inflation expectations. So it does not seem likely to me that whatever increase in stock prices we have seen so far reflects a pure supply-side effect.

I am more inclined to believe that the recent increases in stock prices and inflation expectations reflect expectations that Trump will fulfill his commitments to conduct irresponsible fiscal policies generating increased budget deficits, which the Republican majorities in Congress will now meekly accept and dutifully applaud, and that Trump will be able either to cajole or intimidate enough officials at the Federal Reserve to accommodate those policies or will appoint enough willing accomplices to the Fed to overcome the opposition of the current FOMC.

Trump’s Economic Advisers and Me

Published August 8, 2016 David Malpass , Uncategorized , Wall Street Journal 3 Comments
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Donald Trump announced his stable of 13 economic advisers last Friday. Most of them are professional business types — hedge fund managers, bankers, financiers, real-estate men, one oil man — who have contributed heavily to Trump’s campaign.  Three of the advisers — Peter Navarro, Stephen Moore, and David Malpass — have some background as professional economists. Peter Navarro is a Harvard Ph. D. and a professor of economics and public policy at the University of California at Irvine, Tyler Cowen recently wrote a short piece about him for Bloomberg. Stephen Moore is a visiting fellow at the Heritage Foundation, a former member of the Wall Street Journal editorial board and a frequent contributor of op-ed pieces to the editorial page of the Wall Street Journal and other publications. David Malpass was undersecretary in the Treasury Department during the Reagan administration and later was chief economist at Bear Stearns before starting his own consulting firm.

I don’t know any of these people, but as it happens, I have written about both Moore and Malpass on this blog. In fact, both of my posts were written almost exactly five years ago in August 2011; they were both provoked — I choose that verb carefully — by op-ed pieces they wrote for the Wall Street Journal editorial page.

The first post (“There They Go Again” on 8/5/2011) was about Malpass. Here’s what I had to say about him.

In today’s Wall Street Journal, David Malpass, who, according to the bio, used to be a deputy assistant undersecretary of the Treasury in the Reagan administration, and is now President of something called Encima Global LLC (his position as Chief Economist at Bear Stearns was somehow omitted) carries on about the terrible damage inflicted by the Fed on the American economy.

The U.S. is practically alone in the world in pursuing a near-zero interest rate and letting its central bank leverage to the hilt to buy up the national debt. By choosing to pay savers nearly nothing, the Fed’s policy discourages thrift and is directly connected to the weakness in personal income.

Where Mr. Malpass gets his information, I haven’t a clue, but looking at the table of financial and trade statistics on the back page of the July 16 edition of the Economist, I see that in addition to the United States, Japan, Switzerland, Hong Kong, and Singapore, had 3-month rates less than 0.5%.  Britain, Canada, and Saudi Arabia had rates between 0.5 and 1%. . . .

As for Malpass’s next sentence, where to begin?  I won’t dwell on the garbled syntax, but, even if that were its intention, the Fed is obviously not succeeding in discouraging thrift, as private indebtedness has been falling consistently over the past three years.  The question is whether it would be good for the economy if people were saving even more than they are now, and the answer to that, clearly, is:  not unless there was a great deal more demand by private business to invest than there is now.  Why is business not investing?  Despite repeated declamations about the regulatory overkill and anti-business rhetoric of the Obama administration, no serious observer doubts that the main obstacle to increased business investment is that expected demand does not warrant investments aimed at increasing capacity when existing capacity is not being fully utilized. . . .

From here Malpass meanders into the main theme of his tirade which is how terrible it is that we have a weak dollar.

One of the fastest, most decisive ways to restart U.S. private-sector job growth would be to end the Fed’s near-zero interest rate and the Bush-Obama weak-dollar policy. As Presidents Reagan and Clinton showed, sound money is a core growth strategy—the fastest and most effective way to tell world capital that the U.S. is back in business.

Mr. Malpass served in the Reagan administration, so I would have expected him to know something about what happened in that administration.  Obviously, my expectations were too high.  According to the Federal Reserve’s index of trade weighted dollar exchange rate, the dollar exchange rate stood at 95.66 when Reagan took office in January 1981 and at 90.82 when Reagan left office 8 years later.  Now it is true that the dollar rose rapidly in Reagan’s first term reaching about 141 in May 1985, but it fell even faster for the remainder of Reagan’s second term. . . .

Then going in for the kill, Mr. Malpass warns us not to repeat Japan’s mistakes.

Only Japan, after the bursting of its real-estate bubble in 1990, has tried anything similar to U.S. policy. For close to a decade, Tokyo pursued a policy of amped-up government spending, high tax rates, zero-interest rates and mega-trillion yen central-bank buying of government debt. The weak recovery became a deep malaise, with Japan’s own monetary officials warning the U.S. not to follow their lead.

Funny, Mr. Malpass seems to forget that Japan also pursued the sound money policy that he extols. . . . In April 1990, the yen stood at 159 to the dollar.  Last week it was at 77 to the dollar.  Sounds like a strong yen policy to me. . . .

I will just note that, given Mr. Malpass’s affection for a strong dollar, it seems a bit odd that Trump, who constantly rails against currency manipulation and devaluations by other countries, which tend to raise the exchange value of the dollar against those currencies, has chosen Malpass as an economic adviser and that Malpass has agreed to advise Trump, who seems to want anything but a strong dollar. But then again, it’s a strange world that we are now living in.

Then almost two weeks after Malpass’s little masterpiece, along came Mr. Moore with another gem of the kind that the Wall Street Journal editorial page specializes in. The result was that I wrote this post (“The Wall Street Editorial Page is a Disgrace” 8/18/2011).

Stephen Moore has the dubious honor of being a member of the editorial board of The Wall Street Journal.  He lives up (or down) to that honor by imparting his wisdom from time to time in signed columns appearing on the Journal’s editorial page.  His contribution in today’s Journal (“Why Americans Hate Economics”) is noteworthy for typifying the sad decline of the Journal’s editorial page into a self-parody of obnoxious, philistine anti-intellectualism.

Mr. Moore begins by repeating a joke once told by Professor Christina Romer, formerly President Obama’s chief economist, now on the economics department at the University of California at Berkeley.  The joke, not really that funny, is that there are two kinds of students:  those who hate economics and those who really hate economics.  Professor Romer apparently told the joke to explain that it’s not true.  Mr. Moore repeats it to explain why he thinks it really is.  Why does he?  Let Mr. Moore speak for himself:  “Because too often economic theories defy common sense.”  That’s it in a nutshell for Mr. Moore:  common sense — the ultimate standard of truth.

So what’s that you say, Galileo?  The sun is stationary and the earth travels around it?  You must be kidding!  Why any child can tell you that the sun rises in the east and moves across the sky every day and then travels beneath the earth at night to reappear in the east the next morning.  And you expect anyone in his right mind to believe otherwise.  What?  It’s the earth rotating on its axis?  Are you possessed of demons?  And you say that the earth is round?  If the earth were round, how could anybody stand at the bottom of the earth and not fall off?  Galileo, you are a raving lunatic.  And you, Mr. Einstein, you say that there is something called a space-time continuum, so that time slows down as the speed one travels approaches the speed of light.  My God, where could you have come up with such an idea?  By that reasoning, two people could not agree on which of two events happened first if one of them was stationary and the other traveling at half the speed of light.  Away with you, and don’t ever dare speak such nonsense again, or, by God, you shall be really, really sorry.

The point of course is not to disregard common sense — that would not be very intelligent — but to recognize that common sense isn’t enough.  Sometimes things are not what they seem – the earth, Mr. Moore, is not flat – and our common sense has to be trained to correspond with a reality that can only be discerned by the intensive application of our reasoning powers, in other words, by thinking harder about what the world is really like than just accepting what common sense seems to be telling us.  But once you recognize that common sense has its limitations, the snide populist sneers — the stock-in-trade of the Journal editorial page — mocking economists with degrees from elite universities in which Mr. Moore likes to indulge are exposed for what they are:  the puerile defensiveness of those unwilling to do the hard thinking required to push back the frontiers of their own ignorance.

In today’s column, Mr. Moore directs his ridicule at a number of Keynesian nostrums that I would not necessarily subscribe to, at least not without significant qualification.  But Keynesian ideas are also rooted in certain common-sense notions, for example, the idea that income and expenditure are mutually interdependent, the income of one person being derived from the expenditure of another.  So when Mr. Moore simply dismisses as “nonsensical” the idea that extending unemployment insurance to keep the unemployed from having to stop spending, he is in fact rejecting an idea that is no less grounded in common sense than the idea that paying people not to work discourages work.  The problem is that our common sense cuts in both directions.  Mr. Moore likes one and wants to ignore the other.  (continue reading here).

So, no question about it, Mr. Trump, the man who chose Corey Lewandowski and then Paul Manafort to run his campaign, and selected Meredith McIver to work with Melania Trump on her speech to the Republican convention, proves again that he is a great judge of talent.

What’s so Bad about the Gold Standard?

Published April 13, 2016 Bank of France , Ben Bernanke , gold standard , Great Depression , Hawtrey , Paul Krugman , Smoot-Hawley tariff 17 Comments
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Last week Paul Krugman argued that Ted Cruz is more dangerous than Donald Trump, because Trump is merely a protectionist while Cruz wants to restore the gold standard. I’m not going to weigh in on the relative merits of Cruz and Trump, but I have previously suggested that Krugman may be too dismissive of the possibility that the Smoot-Hawley tariff did indeed play a significant, though certainly secondary, role in the Great Depression. In warning about the danger of a return to the gold standard, Krugman is certainly right that the gold standard was and could again be profoundly destabilizing to the world economy, but I don’t think he did such a good job of explaining why, largely because, like Ben Bernanke and, I am afraid, most other economists, Krugman isn’t totally clear on how the gold standard really worked.

Here’s what Krugman says:

[P]rotectionism didn’t cause the Great Depression. It was a consequence, not a cause – and much less severe in countries that had the good sense to leave the gold standard.

That’s basically right. But I note for the record, to spell out the my point made in the post I alluded to in the opening paragraph that protectionism might indeed have played a role in exacerbating the Great Depression, making it harder for Germany and other indebted countries to pay off their debts by making it more difficult for them to exports required to discharge their obligations, thereby making their IOUs, widely held by European and American banks, worthless or nearly so, undermining the solvency of many of those banks. It also increased the demand for the gold required to discharge debts, adding to the deflationary forces that had been unleashed by the Bank of France and the Fed, thereby triggering the debt-deflation mechanism described by Irving Fisher in his famous article.

Which brings us to Cruz, who is enthusiastic about the gold standard – which did play a major role in spreading the Depression.

Well, that’s half — or maybe a quarter — right. The gold standard did play a major role in spreading the Depression. But the role was not just major; it was dominant. And the role of the gold standard in the Great Depression was not just to spread it; the role was, as Hawtrey and Cassel warned a decade before it happened, to cause it. The causal mechanism was that in restoring the gold standard, the various central banks linking their currencies to gold would increase their demands for gold reserves so substantially that the value of gold would rise back to its value before World War I, which was about double what it was after the war. It was to avoid such a catastrophic increase in the value of gold that Hawtrey drafted the resolutions adopted at the 1922 Genoa monetary conference calling for central-bank cooperation to minimize the increase in the monetary demand for gold associated with restoring the gold standard. Unfortunately, when France officially restored the gold standard in 1928, it went on a gold-buying spree, joined in by the Fed in 1929 when it raised interest rates to suppress Wall Street stock speculation. The huge accumulation of gold by France and the US in 1929 led directly to the deflation that started in the second half of 1929, which continued unabated till 1933. The Great Depression was caused by a 50% increase in the value of gold that was the direct result of the restoration of the gold standard. In principle, if the Genoa Resolutions had been followed, the restoration of the gold standard could have been accomplished with no increase in the value of gold. But, obviously, the gold standard was a catastrophe waiting to happen.

The problem with gold is, first of all, that it removes flexibility. Given an adverse shock to demand, it rules out any offsetting loosening of monetary policy.

That’s not quite right; the problem with gold is, first of all, that it does not guarantee that value of gold will be stable. The problem is exacerbated when central banks hold substantial gold reserves, which means that significant changes in the demand of central banks for gold reserves can have dramatic repercussions on the value of gold. Far from being a guarantee of price stability, the gold standard can be the source of price-level instability, depending on the policies adopted by individual central banks. The Great Depression was not caused by an adverse shock to demand; it was caused by a policy-induced shock to the value of gold. There was nothing inherent in the gold standard that would have prevented a loosening of monetary policy – a decline in the gold reserves held by central banks – to reverse the deflationary effects of the rapid accumulation of gold reserves, but, the insane Bank of France was not inclined to reverse its policy, perversely viewing the increase in its gold reserves as evidence of the success of its catastrophic policy. However, once some central banks are accumulating gold reserves, other central banks inevitably feel that they must take steps to at least maintain their current levels of reserves, lest markets begin to lose confidence that convertibility into gold will be preserved. Bad policy tends to spread. Krugman seems to have this possibility in mind when he continues:

Worse, relying on gold can easily have the effect of forcing a tightening of monetary policy at precisely the wrong moment. In a crisis, people get worried about banks and seek cash, increasing the demand for the monetary base – but you can’t expand the monetary base to meet this demand, because it’s tied to gold.

But Krugman is being a little sloppy here. If the demand for the monetary base – meaning, presumably, currency plus reserves at the central bank — is increasing, then the public simply wants to increase their holdings of currency, not spend the added holdings. So what stops the the central bank accommodate that demand? Krugman says that “it” – meaning, presumably, the monetary base – is tied to gold. What does it mean for the monetary base to be “tied” to gold? Under the gold standard, the “tie” to gold is a promise to convert the monetary base, on demand, at a specified conversion rate.

Question: why would that promise to convert have prevented the central bank from increasing the monetary base? Answer: it would not and did not. Since, by assumption, the public is demanding more currency to hold, there is no reason why the central bank could not safely accommodate that demand. Of course, there would be a problem if the public feared that the central bank might not continue to honor its convertibility commitment and that the price of gold would rise. Then there would be an internal drain on the central bank’s gold reserves. But that is not — or doesn’t seem to be — the case that Krugman has in mind. Rather, what he seems to mean is that the quantity of base money is limited by a reserve ratio between the gold reserves held by the central bank and the monetary base. But if the tie between the monetary base and gold that Krugman is referring to is a legal reserve requirement, then he is confusing the legal reserve requirement with the gold standard, and the two are simply not the same, it being entirely possible, and actually desirable, for the gold standard to function with no legal reserve requirement – certainly not a marginal reserve requirement.

On top of that, a slump drives interest rates down, increasing the demand for real assets perceived as safe — like gold — which is why gold prices rose after the 2008 crisis. But if you’re on a gold standard, nominal gold prices can’t rise; the only way real prices can rise is a fall in the prices of everything else. Hello, deflation!

Note the implicit assumption here: that the slump just happens for some unknown reason. I don’t deny that such events are possible, but in the context of this discussion about the gold standard and its destabilizing properties, the historically relevant scenario is when the slump occurred because of a deliberate decision to raise interest rates, as the Fed did in 1929 to suppress stock-market speculation and as the Bank of England did for most of the 1920s, to restore and maintain the prewar sterling parity against the dollar. Under those circumstances, it was the increase in the interest rate set by the central bank that amounted to an increase in the monetary demand for gold which is what caused gold appreciation and deflation.

About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner

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