1 Big Thing: macro policy is getting it all wrong
Today’s lead topic is pulling from multiple threads from the last twenty-four hours. And the gist of those threads is that policy makers have got it all wrong when it comes to macro. Yesterday, in the daily I touched on this theme with the economists’ prediction that Fed policy would be the genesis of the next downturn. But here are a few more threads, both forward and backward-looking.
The first one is on the last recession. And here’s the part that best highlights the premise:
More clues that Alesina, Ardagna, Reinhart, and Rogoff got everything wrong can be found in the real world, where the Obama administration’s modest stimulus package, while too small to fix the Great Recession entirely, did make things much better. Conversely, the European countries that subjected themselves to severe austerity regimens saw their employment and production collapse, just like Keynes would have predicted. Greece, in particular, has suffered economic disaster considerably worse than the Great Depression in terms of output and unemployment.
The author calls this “The biggest policy mistake of the last decade“.
Why this matters: take away the Keynesian vs. anti-Keynesian framing of the original post for a second. And what you’re left with is a foreboding that the next recession is likely to play out with the same arguments over the right macro policy – to the detriment of growth and employment.
In the US, we are in ultra-stimulus mode on the fiscal side. And the Fed has already said it intends to offset that. As the economists I highlighted yesterday argue, this could make for some serious nail biting in the next year or two; the Fed is likely to overdo it. At the same time, the argument over fiscal policy will be playing out as the deficit soars. And perhaps, the recession will be deeper than expected as a result.
In Europe, the message is clear: Maastricht hurdles matter. The rules of 3% deficits and 60% government debt to GDP can be bent only so much before austerity kicks in. Let’s see how this plays out for economic growth and sovereign bond markets, especially in Italy.
2. Economists warn on dominance of US corporate giants
From a macro perspective, part of the problem may be antitrust. This is the second thread on macro policy. The Financial Times has an interesting piece up about the fall in labor’s share of income and the simultaneous rise of corporate profits.
A group of researchers including David Autor of Massachusetts Institute of Technology and David Dorn of the University of Zurich have found that, as the economic weight of a small number of highly profitable and innovative “superstar” companies has increased, workers’ slice of the overall pie has fallen.
This may have contributed to a fall in labour’s share of income that has been particularly noticeable in the US since the beginning of the 2000s. At the same time, corporate profitability has surged to record highs.
This is the argument in favor of questioning the rise of corporate giants. The FT article is fairly even-handed in drawing from both sides of the argument. Here’s the chart.
Why this matters: From a political perspective, the fact that corporations are doing so well in a period of falling wage earner share of GDP is toxic. It foments a sense in wage earners of inequity that they will take with them to the ballot box. For this reason, I again want to stress it is not a foregone conclusion that the next economic downturn will be shallow and uneventful.
I also think this bears on likely regulatory responses, especially in Europe where the big tech companies are seen as foreign and less likely to be coddled by politicians.
3. The US regulatory response to crisis may have created more inequality as an unintended consequence
Here’s the last thread on macro getting it wrong via Bloomberg:
A few years ago, one of Karen Petrou’s banking clients gave her an unusual assignment: It wanted her to write a paper laying out “the unintended consequences of the post-financial-crisis capital framework.” Petrou is the co-founder of Federal Financial Analytics Inc., a financial services consulting firm in Washington that focuses on public policy and regulatory issues. She is also, as the American Banker once described her, “the sharpest mind analyzing banking policy today — maybe ever.” Whenever I’m writing about banking issues, she’s the first person I call.
Writing that paper caused Petrou to ask a question she’d never really considered before: Did the bank regulations enacted after the 2008 crisis — along with the Federal Reserve’s post-crisis monetary policy — exacerbate income inequality? Her answer, which she laid out in a series of blog posts, as well as a lecture at the New York Federal Reserve in March, was yes. “Post-crisis monetary and regulatory policy had an unintended but nonetheless dramatic impact on the income and wealth divides,” she wrote recently.
Why this matters: the anecdotes are really good. Petrou talks about capital requirements making middle class banking products unprofitable, pushing banks increasingly into wealth management products which are still very profitable. She also talks about mortgage regulations making it less profitable for banks to make loans to middle class people without Fannie Mae and Freddie Mac there to repackage them to free up capital on bank balance sheets. So banks are increasingly concentrating on jumbo loans to wealthy clients, where the margins are higher.
4. Turkey retaliates with tariffs of their own
In other news, Turkey has decided to draw up a list of US products to apply tariffs to. The list below is in Turkish, but I am told the items to note are the ones with 140 and 120 next to them. The 140% tariff is on US-made alcoholic beverages. And the 120% tariff is on US cars. There are European substitutes for both. Notably absent from this list is electronics, and I’m guessing that’s because there are no substitutes for iPhones and the like.
Why this matters: It’s the escalation that counts, of course. It tells you that Turkey is going to continue on a confrontational path with the US. It’s interesting to note that the US actually has a trade surplus with Turkey of over $300 million. It’s not a big trade flow. But Turkey is one place where the US exports more. Much of that is cotton and other agricultural products. These will also come under tariffs.
5. Yuan falls to a 15-month low
The yuan weakened to a 15-month low on Wednesday and flirted with a key support level not seen since 2008 as the dollar extended gains and a raft of data pointed to further slowing in China’s economy. The yuan slipped through 6.9 to the dollar with no signs of intervention, reinforcing views that a test of the critical 7 mark is not far off. Traders are watching that level to see if China draws a “line in the sand” under the yuan’s recent sharp losses, or allows it to weaken further as U.S. trade tensions rise. The yuan has not breached 7 since the global financial crisis.
Why this matters: As the CNBC article highlights, 7 yuan per US dollar is sort of a mental mark. If the yuan were to fall below this number, a lot of people would sit up and notice. And as the yuan falls, we should certainly expect the other Asian currencies to depreciate as well.
What people are looking for now is whether China will let market forces dictate the Chinese currency movement lower without intervention. If they do so, it would be seen as a sign of using their currency to amplify the trade war with the US.
6. China’s need for soybeans
From Breakingviews:
China may need to start purchasing U.S. soybeans in the coming weeks as other countries cannot produce enough to meet its demand, analysts at Oil World said on Aug. 7.
Soybeans were the biggest U.S. agricultural export to China in 2017.
Why this matters: The soybean situation highlights how little leverage China has on the trade front. They really don’t have a lot that they can use as a weapon on that score. That’s why people are looking at the currency side of things as the new battlefront. None of this is to say the Chinese will roll over. But trade flows are not where they can inflict the most damage in an economic war with the US.
7. Tesla funding not secure
I think it’s pretty obvious that the Elon Musk tweet about funding being secure for taking the company private was highly misleading. The more journalists dig into the matter, the more it is apparent that Musk had not lined up financing. Tesla mentioned the Saudis specifically in a blog post I highlighted yesterday. Here’s what the Wall Street Journal is saying about that today:
The common perception is that Saudi Arabia’s oil wealth gives the fund unlimited resources, but in reality the kingdom’s finances are tight, advisers and government officials say…
The vehicle at the center of the effort is the sovereign-wealth fund, known as the Public Investment Fund, or PIF. It has committed $65 billion to two enormous outside funds—up to $20 billion for a planned infrastructure investment vehicle managed by Blackstone Group LP and $45 billion for a technology fund led by SoftBank Group. It has also written a total of more than $4 billion of checks to Silicon Valley startups including Uber Technologies Inc., Magic Leap Inc. and Noon.com.
PIF is also on the hook to contribute an unknown sum to Neom, the $500 billion futuristic megacity to be constructed in northwest Saudi Arabia abutting the Red Sea.
Why this matters: Tesla has huge backers like the Saudis and Silver Lake, the technology-focused PE firm. They have a lot of money riding on the company. So in a pinch, Tesla will be able to depend on them. That represents a safety net of sorts for the company as it goes through this difficult period.
But it’s not yet clear what the Tesla board or the SEC will do about this affair. But its also unclear whether Tesla can or will go private. This is a huge distraction though. The focus has to be in reducing cash burn and ramping up production.