Here’s my first curation for 2019 and there were some surprisingly good pieces produced over the past month. We have Paul Krugman, Ken Rogoff and Larry summers wade into policy waters – they disagree on the use of fiscal stimuli, taxing the rich and negative rates. There were a swathe of articles on the euro’s 20thbirthday – all agree the construct is imperfect but they vary in their pessimism on its future. There are some great data and charts; notably Chinese growth data back to the 10th century and which countries the US media has obsessed about over the past 100 hundred years. On markets, there is an intriguing paper on good vs bad FX carry trades, a great set of charts on market performance/valuations and a piece on why US long-dated swap spreads are negative. Enjoy!
The Economics of Soaking the Rich What does Alexandria Ocasio-Cortez know about tax policy? A lot says Paul Krugman. He writes “What we see is that America used to have very high tax rates on the rich — higher even than those AOC is proposing — and did just fine ” . Also read rebuttal from John Cochrane here
Central Bankers’ Fiscal Constraints Ken Rogoff argues that “with policy interest rates near zero in most advanced economies (and just above 2% even in the fast-growing US), there is little room for monetary policy to maneuver in a recession without considerable creativity. But those who think fiscal policy alone will save the day are stupefyingly naive. It is high time to sharpen the instruments in central banks’ toolkit. Over-reliance on countercyclical fiscal policy will not work any better in this century than in it did in the last.”. Worth reading with Paul Krugman’s opposing view: Who’s Afraid of the Budget Deficit?
When Alan Greenspan Worried about Overly Large Budget Surpluses Fun read, I wonder if our forecasts of large deficits may similarly be overdone.
Intergenerational mobility in the US: One size doesn’t fit all The authors examines the influence of parents’ income on the income of their children in the US for the period 1980-2010. Parental income has a greater influence, implying lower levels of mobility, for families with the highest and lowest levels of income. They find that between one fifth and half of intergenerational income transmission can be explained by the level of education that parents can provide to their children. They also find that one tenth of the ‘inheritance’ of parental income is attributed to the race of the individual.
Piketty’s World Inequality Review: A Critical Analysis “Thomas Piketty and his colleagues have insisted that tax records are better for measuring inequality than income surveys. They’re wrong.”
Think You’re Middle Class? Check This Chart to Find Out You probably think you are, according to new research from the Pew Research Center, but that doesn’t necessarily mean you’re right. It turns out household size is a major determiner of status in the lower, middle and upper classes (see chart above).
The Euro Turns 20 “In 1999, conventional wisdom held that Germany would incur the biggest losses from the euro’s introduction. Beyond the risk that the ECB would not be as tough on inflation as the Bundesbank had been, the Deutsche Mark was overvalued, with Germany running a current-account deficit. Fixing the exchange rate at that level, it was believed, would pose a severe challenge to the competitiveness of German industry.” And “In fact, the eurozone’s economic performance has not been as bad as the seemingly endless stream of bleak headlines implies. Per capita GDP growth has slowed over the last 20 years, but not more so than in the US or other developed economies.”
The so-called euro stability spawned banking system that caused havocPolemical article against EU and specifically how lax banking standards resulted in a “European banking glut” which helped contributed to the 2008 financial crisis.
The euro at 20: An enduring success but a fundamental failure Barry Eichengreen writes: “In the absence of the political solidarity required for such transfers, the crisis countries were forced to double down on spending cuts. For them, the eurozone was transformed into an engine of deflation and depression… Yet the euro is still with us. It has survived for fully 20 years. It survived the mother of all stress tests, the global financial crisis…. So the euro will stumble forward. No one will be happy with its operation. Equally, no one will leave. Progress will be minimal, since there is no appetite for the political union needed to support fundamental reforms. As a result, the euro remains vulnerable to another crisis. “
The gains from economic integration: The EU has still a long way to goThe column uses data on trade frictions to estimate the long-run impact of trade frictions on GDP if countries in Europe were to be more or less integrated. Negative between-country impacts, such as from Brexit or an EU collapse, imply a GDP reduction of between 1-3%. The potential trade benefits of a ‘United States of Europe’, on the other hand, may be an order of magnitude greater for its members.
Questioning the claim of German ‘employment miracle’ “Germany has experienced the twin phenomenon of a rapidly growing segment of the “working poor” and development of a massive low-wage sector.”
Macroeconomic Consequences of Tariffs IMF paper looks at 151 countries over 1963‐2014. They find that tariff increases lead, in the medium term, to economically and statistically significant declines in domestic output and productivity. Tariff increases also result in more unemployment, higher inequality, and real exchange rate appreciation, but only small effects on the trade balance. The effects on output and productivity tend to be magnified when tariffs rise during expansions, for advanced economies, and when tariffs go up, not down.
The Impact of Import Tariffs on U.S. Domestic Prices NY Fed finds “ that the higher import tariffs had immediate impacts on U.S. domestic prices. Our results suggest that the aggregate consumer price index (CPI) is 0.3 percent higher than it would have been without the tariffs. “
How Much Do We Spend on Imports? From San Fran Fed: “When you buy a $100 pair of Nike sneakers made in Asia, only $25 of its cost goes to the Asian factory that assembles the shoes (Kish 2014). Of the remaining $75, $3.50 is spent on shipping from Asia to the United States, and $21.50 goes to Nike to cover its design, marketing, profits, and other expenses. The remaining $50 goes to the U.S. retailer that pays for the transportation of the sneakers inside the United States, worker wages in its U.S. warehouses and retail outlets, rental cost of retail space, insurance, and so on. Thus, half the cost of a pair of sneakers made abroad pays for workers and capital expenditures in the United States, not even counting the part that goes to Nike.”
FX, RATES and COMMODITIES
Good Carry, Bad Carry Intriguing paper on FX carry trades that derives ”good” and ”bad” carry trades constructed from G-10 currencies. The good trades exhibit higher Sharpe ratios and sometimes positive return skewness, in contrast to the bad trades that have both substantially lower Sharpe ratios and highly negative return skewness. On their back-test, they surprisingly find that AUD and JPY typically do not feature as a “good” carry trade. Dropping them noticeably improves basket returns.
From Commodity to Fiat and Now to Crypto: What Does History Tell Us?Barry Eichengreen looks into whether crypto currencies can replace paper money. He finds that the information sensitivity of those units, evident in the fact that they trade at varying prices, suggests that they do not yet provide the core functions of money. So-called stable coins are intended to bridge this gap, but whether they can be successfully scaled up and maintain their stability is doubtful. The one unit that can clearly meet these challenges is central bank digital currency.
Wharton paper that tries to model negative long-dated swap spreads seen in the US since October 2008. In theory, the spread should be positive, otherwise there is an arbitrage opportunity. The author finds that by introducing frictions for holding cash bonds the scope for arbitrage is limited. Analytically this can explain the negative swap spreads.
How oil traders make big bucks by using satellite surveillance A flurry of Cubesat launches is already changing economic forecasting. In the near future, it could have an even more profound impact
Technological progress may be changing what we learn and how we tradeTechnological change is making it possible to process more and more information. This column looks at the implications of this for trading strategies. It finds that growth in the amount of data investors can process is a logical and predictable cause of a shift from fundamentals-based to order flow-based strategies.
2018: The Year in Charts Very comprehensive set of charts on asset class performance over 2018. Worth a look.
The Creation and Evolution of Entrepreneurial Public Markets The paper looks at the evolution of new stock exchanges around the world geared towards entrepreneurial companies, known as second-tier exchanges (eg NASDAQ, AIM, ChiNext). They find the proliferation of these new stock exchanges that were created in a large number of countries, attracted a significant volume of global IPOs, were introduced fairly cyclically, and had lower listing requirements when compared to first-tier stock exchanges. They find no evidence that new second-tier exchanges diverted the existing flow of IPOs from established stock exchanges. Shareholder protection strongly predicted exchange success.
METHODOLOGY and DATA
Can We Minimize Econogenic Outcomes? George DeMartino, has coined the term “econogenic”, as “harm done by economists,” and it is inspired by “iatrogenic,” referring to harm done by physicians. The medical profession is 50 years ahead of the economics profession on dealing with harm they do. For physicians, the patients’ rights movement that took off in the 1960s and has gained substantial legal support, with patients now having say on how they are treated by physicians rather than living in a world where the physician was always right. Perhaps, something similar is needed for those suffering from economists “remedies”
Top Ten Ways to Sound Like an Economist Whatever the question, always answer, “There’s no such thing as a free lunch.” and more!
Using the Front-Door Criterion to Estimate Causal Effects in a Regression Context. More for stats-oriented readers. Many are familiar with the usual methods used by economists to identify causal relations (e.g., randomized controlled trials, instrumental variables, difference-in-differences, etc.) But one lesser known method is Pearl’s (2000) front-door criterion,.
China, Europe, and the Great Divergence: A Study in Historical National Accounting, 980–1850 Love this! “estimates of GDP per capita are now available for a number of European economies back to the medieval period, including Britain, the Netherlands, Italy, and Spain. The approach has also been extended to Asian economies, including India and Japan. So far, however, China, which has been at the center of the Great Divergence debate, has been absent from this approach. This article adds China to the picture, showing that the Great Divergence began earlier than originally suggested by the California School, but later than implied by older Eurocentric writers.” (see chart on Chinese constant GDP and GDP per capita )
MONETARY POLICY and INFLATION
The Imbalances of the Bretton Woods System 1965 to 1973: U.S. Inflation, The Elephant in the Room Michael Bordo argues that the key deep underlying fundamental for the growing international imbalances leading to the collapse of the Bretton Woods system between 1971 and 1973 was rising U.S. inflation since 1965. What was kept in the background at the Camp David meeting on August 15 1971 when President Richard Nixon closed the U.S. gold window, as well as imposing a ten per cent surcharge on all imports and a ninety day wage price freeze—was that U.S. inflation, driven by macro policies, was the main problem facing the Bretton Woods System, and that for political and doctrinal reasons was not directly addressed. Instead President Nixon blamed the rest of the world rather than focusing on issues with U.S. monetary and fiscal policies
Larry Summers rejects negative interest rates policy as crisis fighting toolNegative central bank rates have not been transmitted to overall deposit rates, and a model suggests that tiptoeing into negative territory in a world with such a disconnect is “at best irrelevant, but could potentially be contractionary due to a negative effect on bank profit”,
Please abolish the Fed’s balance sheet Scott Sumner argues that the Fed balance sheet should be transferred to the Treasury to remove all talk of the Fed possibly going bankrupt. The Treasury would follow Fed instructions, though. But by removing talk of bankruptcy, it would make it easier for the Fed to do very large QE should the need arise.
Seven questions for Janet Yellen on financial stability (and her answers) A bunch of questions on bank regulation. On asset prices, she says that the US “very few macroprudential policy tools in the U.S.” to deal with asset price threats. On corporate debt: “[It[ is now quite high and I think it’s a danger that if there’s something else that causes a downturn, that high levels of corporate leverage could prolong the downturn and lead to lots of bankruptcies in the non-financial corporate sector.”
BUSINESS CYCLE and DEVELOPMENT
What Will Cause the Next US Recession? Three of the last four US recessions stemmed from unforeseen shocks in financial markets. Most likely, the next downturn according to Brad DeLong, will be no different: the revelation of some underlying weakness will trigger a retrenchment of investment, and the government will fail to pursue counter-cyclical fiscal policy. “The particular nature and form of the next financial shock will be unanticipated… there will always be other contingencies that have been missed. For example, the death blow to the global economy in 2008-2009 came not from the collapse of the mid-2000s housing bubble, but from the concentration of ownership of mortgage-backed securities”
Debt Relief and Slow Recovery: A Decade after Lehman The authors look at a representative panel of millions of consumers in the U.S. from 2007 to 2017 and document several facts on the long-term effects of the Great Recession. There were about six million foreclosures in the ten-year period after Lehman’s collapse. Owners of multiple homes accounted for 25% of these foreclosures, while comprising only 13% of the market. Foreclosures displaced homeowners, with most of them moving at least once. Only a quarter of foreclosed households regained homeownership, taking an average four years to do so.
The Monetary and Fiscal History of Brazil, 1960–2016 Useful history from Minneapolis Fed
The deep roots of development Houston University Prof Vollrath summarises the current thinking on development. Good summary
Data mining adds evidence that war is baked into the structure of society A new study of wars over 600 years shows conflict following a universal mathematical law, suggesting that the current period of relative peace could be more fragile than many have thought.
U.S. is nearly as dangerous as Russia, much more than North Korea, Germans say in a new poll 56% view Russia as a threat to Germany, 55% view US as a threat, 27% view N.Korea as threat, 24% view Turkey as a threat, 23% view Saudi Arabia as a threat, and only 16% view China as a threat
This Map Shows Where in the World the U.S. Military Is Combatting Terrorism The infographic reveals for the first time that the U.S. is now operating in 40 percent of the world’s nations
8 Predictions for What the World Will Look Like in 20 Years Fun read. Ranges from “In 2039, the [US] Supreme Court will consist of two people”, “there will be an internet cold war”, and “America will have antebellum (first half of 1800s) politics”
Is populism popular? Has it peaked? A few others are agreeing with one of our grey swans!
The option value of civilization Pretty cool: “ I think discounting is the wrong financial metaphor to use when discussing the moral worth of the present vs. the future. Instead, we should look to option pricing theory.
After 40 years, the US and China are still trapped in their own political bubbles China’s state-controlled media environment has never been conducive to Western values, despite hopes that trade would change China. Meanwhile, in the US political bubble, few understand why Chinese accept one-party rule
Which Countries Have Been Top of Mind in the US Over the Past Century?Great infographic looking at 740,000 headlines from the NY Times since 1900 to determine which country the US was most interested in for each month