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How the World Is Messing With Investors and the Fed

Policy makers and investors might need to get new playbooks

By Justin Lahart

Central banking

After the hold, be bold

It will take more than patience to free rich economies from the zero-interest-rate world
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SOMETIMES doing nothing really is better than doing something. On September 17th the Federal Reserve made the right decision to leave its benchmark interest rate, unchanged since 2008, near zero. With inflation sitting well below the Fed’s 2% target and doubts about China’s economy prevalent, a rise would have been an unnecessary risk.

Yet Janet Yellen, chair of the Fed, will face a similarly tough choice in October—and possibly for many months thereafter. And whenever “lift-off” occurs, financial markets expect rates to stay historically low for years to come. The era of unconventional monetary conditions shows no sign of ending. If the rich world’s central banks are to get back to the normality they crave, their standard toolkit may not suffice. It is time to think more boldly, especially about the idea of inflation targeting.

That is because the usual relationship between inflation and unemployment appears to have broken down. In the short run, economists think these two variables ought to move in opposite directions. High joblessness should weigh on prices; low unemployment ought to push inflation up, by raising wages.

Unfortunately, in many rich countries this standard inflation thermostat is on the blink. In 2008 economic growth collapsed and unemployment soared, but inflation only gradually sank below target. Now, by contrast, unemployment has fallen to remarkably low levels, but inflation remains anaemic. This has wrong-footed central banks. Assuming that rising prices would follow hard on the heels of a jobs boom, both the Fed and the Bank of England ended stimulative bond-buying programmes and prepped markets for looming rate rises. Their recoveries have instead proved nearly inflation-free. Worse, with interest rates close to 0%, central bankers have less room to respond if they misread inflation risks and tighten too soon.

Given this double bind, it makes sense to look beyond inflation—and to consider targeting nominal GDP (NGDP) instead.

Nominal but substantive

 

A target for nominal GDP (or the sum of all money earned in an economy each year, before accounting for inflation) is less radical than it sounds. It was a plausible alternative when inflation targets became common in the 1990s. A target for NGDP growth (ie, growth in cash income) copes better with cheap imports, which boost growth, but depress prices, pulling today’s central banks in two directions at once. Nominal income is also more important to debtors’ economic health than either inflation or growth, because debts are fixed in cash terms.

Critics fret that NGDP is hard to measure, subject to revision, and mind-bogglingly unfamiliar to the public. Yet if NGDP sounds off-putting, growth in income does not. And although inflation can be measured easily enough, central banks now rely nearly as much on estimates of labour-market “slack”, an impossibly hazy number.

Most important, an NGDP target would free central banks from the confusion caused by the broken inflation gauge. To set policy today central banks must work out how they think inflation will respond to falling unemployment, and markets must guess at their thinking. An NGDP target would not require the distinction between forecasts for growth (and hence employment) and forecasts for inflation.

What might an NGDP target mean in practice? Most economies have fallen well short of their pre-recession trend in nominal-income growth. Before the financial crisis, nominal GDP growth of 5% was considered normal in America. Yet the economy is 16% below the income threshold it would have reached had it grown at that pace since 2006. In Britain, too, NGDP is 15% short of where it could have been. The euro zone and Japan are even worse. Such shortfalls are too great to make up quickly; doing so would imply dangerously high inflation rates. Yet even relative to recent trends, rich economies are coming up short; American NGDP is 5% below what you might have anticipated in 2010. Faster NGDP growth could come from better productivity, more hiring or faster inflation; all of which rich economies could use a bit more of.

Setting a different target does not mean central banks will automatically reach it. And their unconventional toolkit looks depleted. Quantitative easing, which is still in use in Europe and Japan, is falling out of favour because of worries about asset prices. Interest rates cannot be cut far below zero without radical changes in the nature of money (the Bank of England’s chief economist recently suggested eliminating cash). But getting the target right is an important start. Patiently waiting for inflation to turn up is no longer good enough.

France signals EU treaty change to avert Brexit, warns on euro survival

'We mustn’t close the door to the British if what they are demanding from other member states is acceptable,' said French economic tsar Emmanuel Macron

By Ambrose Evans-Pritchard

Mr Macron said it is not beyond the wit of man to craft a “win-win deal” that addresses Britain’s worries about the status of the non-euro members, increasingly untenable as the core countries press ahead with ever closer integration.

French economy minister, Emmanuel Macron  Photo: Bloomberg Finance

The comments came a day after French president Francois Hollande met David Cameron for a brain-storming session at Chequers. There appears to be a coordinated move by Paris to defuse an unnecessary clash with Britain.

Mr Macron said changes to the UK’s membership terms could be lumped together with euro reform in a broader EU accord, giving Mr Cameron the coveted imprimatur of full treaty change.

“The first step is for the British government to clarify its requirements. The question is: ‘What exactly do you want?’” he said.

France seems determined to keep Britain in the EU, not least because the two countries are working tightly together in foreign policy and defence. Nobody wants an avoidable fight with the UK when eastern Europe is rebelling over migrants and the EU itself faces an existential crisis.

Yet there are limits to French appeasement. “An a la carte Europe is not feasible. It would progressively kill the European idea,” he said.

Mr Macron had even tougher words for Germany, warning that the eurozone will disintegrate in a storm of populist revolt unless Berlin drops its vehement opposition to fiscal union and large transfers to the poorer regions.

The former Rothschild banker said the currency bloc is fundamentally unworkable without a joint budget to back it up and will leave debt-stricken countries on the periphery in permanent trouble.

“If we don’t move forward, we are deciding the dismantling of the eurozone. We have to choose: is it a fixed exchange system or a monetary union?” he said.

He called the struggle over the euro a new Thirty Years war in Europe between Calvinists and Catholics. "The Calvinists want to make others pay until the end of their life. They want reforms or no contributions toward any solidarity. On the other side are the Catholics, largely on the periphery,” he said.

"At every eurozone summit, at every Eurogroup, we have this same dilemma between member states. We have to exit this religious war," he said.

Mr Macron has repeatedly argued that Germany's one-sided approach to the aftermath of the euro crisis is what has pushed the region into a deflationary vortex. Vulnerable countries are being forced to go through harsh reforms and budget cuts with little economic solidarity in return.

It is a gift to “demagogues”, able to capitalize on seething resentment against Brussels - a clear allusion to the Front National’s Marine Le Pen, currently leading French opinion polls at 29pc with vows to restore the French franc.

Mr Macron said the design flaws of EMU have led to a situation where the eurozone’s inner core is sucking the lifeblood out of the rest of the currency zone. “The periphery will never converge without fiscal transfers,” he said.

He called for an EMU treasury and investment arm with powers to raise taxes in order to cope with asymmetric shocks hitting any one area, perhaps through the tithing of VAT payments.

Unemployment costs should be “mutualised” through some sort of joint insurance scheme. The whole structure could be built on the current bail-out fund (ESM), under the executive control of an EU super-commissioner, answering to a eurozone parliament.

Such plans are anathema to Germany, where all major parties are opposed to any form of “transfer union”. They know from hard experience how much it has cost over the last quarter century to bail out the old East Germany within a currency union.

German experts say the cost of propping up half of Europe in this fashion would be greater than the reparations burden imposed on Germany at the Versailles Treaty in 1919. Such a move would destroy popular consent for the euro project.

Otmar Issing, the European Central Bank’s first chief economist and an iconic figure in Germany, warned earlier this month that any move towards an EMU treasury and budget would require a constitutional amendment in Germany backed by a two-thirds majority in both houses of parliament. "The chances of political union are close to zero," he said

He said it would be "dangerous" to transfer control over tax and spending to the EU federal level before full political union has been established on democratic foundations. Attempts to slip through such changes by the back door would be fatal.

Diplomats say the strategic trade-off is for France to give up some degree of sovereignty while Germany accepts some degree of fiscal burden-sharing, but a deal looks remote.

Mr Macron is currently launching a blitz of "Thatcherite" reforms in France, much to fury of the Left-wing of his own Socialist Party. His "Macron Law" is an assault on red tape and vested interests, applauded and reviled in equal measure as the first step in a root-and-branch reform of France’s archaic welfare model.

There have been attempts before to bring France kicking and screaming into the 21st century but this time the forces of the status quo are on the back foot. They cannot mobilize protests.

“The difference today is that we don’t have people out on the streets. People are perfectly aware of the situation we are in,” he said.

Asked about Volkswagen’s manipulation of emissions data, Mr Macron said it was outrageous conduct but so far appears confined to VW, and does not in itself change the strategic debate in Europe about clean diesel.

As for the instant market contagion to other car makers on European bourses, his answer was a wave of Gallic contempt. “It’s ridiculous,” he said.

Buttonwood

Greys’ elegy

Demographic change will have big economic impacts
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THE population of the developed world is ageing. Everyone knows that it is happening but no one is sure what it will mean. A new paper from Morgan Stanley, part-written by Charles Goodhart, a former member of the Bank of England’s rate-setting committee, along with Manoj Pradhan and Pratyancha Pardeshi, suggests there may be dramatic economic impacts.

In particular, the paper suggests that the greying population may reverse three long-term trends: a decline in real (inflation-adjusted) interest rates, a squeeze on real wages and widening inequality. That is because those trends were driven by previous demographic shifts; first, the entry of the baby boomers into the workforce after 1970 and second, the more than doubling of the globally integrated workforce as China and eastern Europe joined the capitalist system.

This rise in the labour force produced downward pressure on real wages. It also led to slower improvements in productivity, particularly in Europe. As Mr Goodhart writes, “As labour cheapens, managers spend less effort and invest less capital in order to raise productivity.”

The falling cost of labour also produced downward pressure on the prices of manufactured goods, especially as companies relocated to Asia and eastern Europe. This created deflationary pressures, allowing central banks to ease monetary policy. China’s relatively closed financial system and lack of a social safety net created a savings glut that added to the downward pressure on real interest rates. In turn, lower real rates pushed up asset prices which, along with the pressure on wages, added to inequality since financial assets tend to be owned by the better-off.

But population growth in the rich world, which was 1% a year in the 1950s, has fallen to 0.5% and should drop to zero by 2040. Some countries will see declining populations before then.

Crucially, the share of the population formed by those of working age is already starting to fall.

Indeed, Mr Goodhart reckons that the ageing population will create additional demand for labour, as illnesses such as dementia will require more care workers. This will start to push real wages higher, raising labour’s share of national income and reducing inequality.

Real interest rates balance the desired level of savings with the desired level of investment. The elderly save less and spend more of their income than the middle-aged, as a natural part of the life cycle. But even the middle-aged will not save enough, Mr Goodhart says, either because they underestimate the amount they will need for a comfortable retirement or because they expect to depend on the state.

If that analysis shows that savings are bound to fall, what about investment? In a slow-growing economy, there will be fewer profitable investment opportunities. But Mr Goodhart argues that investment will not fall as fast as savings and thus real rates will rise.

What is his rationale? Most investment by households is in the form of housing. The old are usually reluctant to move out of the homes they bought when middle-aged, even though their children have moved out. This will make it more difficult for families to find the space they need; that means residential investment will not fall significantly. As for investment by firms, rising wages will encourage companies to substitute capital for labour. Corporate investment could rise.

The thesis is vulnerable to other changes in the economy. The labour force could be boosted by greater participation by women and the elderly, or by immigration—although Mr Goodhart does not think these factors will be sufficient to compensate for the effect of ageing. The less educated, for example, find it harder to stay in the workforce beyond 65.

This last point also raises the question of whether inequality will fall as he predicts.

Demography has not been the only factor behind widening inequality: many economists point to “skill-biased” technological change as a driving force. Low-skilled workers who can be replaced by computers or robots will be more vulnerable in a world of rising real wages; the computer-literate will still command premium salaries.

The people who would most like Mr Goodhart to be right are probably mainstream politicians.

The sluggish performance of real wages in advanced economies, along with the signs of rising inequality, have caused them to lose votes to parties on their left and right. If these trends go into reverse, voters might be a bit more content. But the change might not occur fast enough to save some political careers.

Open Letter to John Mauldin

By: Bob Hoye

Who Caused the Refugee Crisis?

Christopher R. Hill. 

DENVER – The scenes of desperate refugees making their way through a gauntlet of impediments – including hastily unfurled barbed-wire fences, ill-tempered border guards, and angry residents – have been horrific, reminiscent of Europe’s darkest decades. They are a stark reminder that Europe can never be “whole, free, and at peace” if its neighbors in the Middle East are not. Nonetheless, the widespread condemnation of European countries that have refused to accept refugees is not entirely fair.

 

Refugees are a natural consequence of war; indeed, there has seldom been a war without civilians trying to flee from its carnage. But what causes the wars? In some cases, demands for regime change.

 

After all, the regimes being overthrown are often brutal, and unlikely to back down without a fight.

 

Nowhere has this inexorable sequence been more evident than in Syria. President Bashar al-Assad, with his narrow Alawite base, has overseen a brutal dictatorship for years – one that has never given an inch to those demanding democratic reform, nor made any room in the country’s polity for those motivated by a less sectarian conception of government.

 

In fact, Assad’s regime is a continuation of that instituted by his father and predecessor, Hafez al-Assad, when he took over the presidency in 1971. The elder Assad’s approach was, if anything, more brutal than his son’s, as the survivors of his 1982 siege of the town of Hama, aimed at quelling an uprising by Syria’s Muslim Brotherhood, can attest.

 

Hafez al-Assad’s effort to subdue Islamist resistance with iron-fisted authoritarianism held for decades. His secular Ba’athist ideology sought to blur the distinctions among the various Syrian communities, especially between Sunnis and his own Alawite tribe, which follows a version of Shiism.

 

But in 2003, when a United States-led coalition overthrew another Ba’athist dictator, Iraq’s Saddam Hussein, the 1,300-year-old Sunni-Shia divide – which had been largely hidden, or even in remission, for many of those centuries – gained renewed and lethal salience. Iraq’s Sunni minority, which had long dominated Saddam’s government, lost power to the majority Shia, whose own brand of narrow sectarian rule has fueled violent resistance to the central government. Since dismantling Saddam’s version of Ba’athism, which many viewed as a cover for Sunni-minority rule, Iraq’s Shia leaders have done little to soften the blow – an approach that has not gone unnoticed elsewhere in the region.

 

In the Middle East, there is always plenty of blame to go around, and those who blame the US for renewing sectarianism in the region fail to recognize its antecedents and its cyclical nature.

 

Still, the US did play a major role in the Syrian drama. In July 2011, the US and France sent their ambassadors to Hama, the site of so much bloodshed and enmity toward Syria’s government, in order to urge the “opposition” there – that is, a then-peaceful Muslim Brotherhood – to unite against the regime.

 

Following that visit – the culmination of an effort to bring about regime change in Syria – any prospect of dialogue or negotiation with Assad (whose family, for better or worse, had controlled Syria for decades) was destroyed. Neither ambassador ever had a consequential meeting in Damascus again.
 

American and French leaders had mistaken the war clouds that gathered in Syria after the Arab Spring as early signs that, at long last, the country was ready for democracy. Rallying the opposition and overthrowing the government, it was thought, would be enough to transform the country’s entire system of – and, indeed, approach to – governance.

 

The Prussian military theorist Carl von Clausewitz once called war a serious means to a serious end. The same is true of a policy of regime change, as evidenced by the ruinous state of Syria today and the millions of people seeking refuge in Jordan, Lebanon, Turkey, and Western Europe.

 

To be sure, the Assad regime bears most of the blame for Syria’s current situation. But, in the absence of any meaningful political process, it would appear that external demands for regime change back in 2011 – which amounted to a choice between Assad and extremist Sunni terrorist organizations – were not entirely thought through, to say the least. With more consideration, those contemplating regime change would have noted that Assad and his cronies provided no indication whatsoever that they would heed the call and leave.

 

As Syrian refugees in their hundreds of thousands risk everything for a chance at safety, those who advocated for regime change four years ago should reflect seriously on their choice.

 

Instead of joining the chorus of criticism against countries like Hungary and Serbia – which are beset with internal problems and played no part in inciting the war – they should take more responsibility for helping the refugees. And they should start to encourage the establishment of inclusive political structures that can help end Syria’s hideous civil war.

 

Read more at https://www.project-syndicate.org/commentary/who-caused-the-refugee-crisis-by-christopher-r-hill-2015-09#qUOEheupssIgRH6S.99

Contributing Op-Ed Writer

A Francis Effect for a Broken System

Timothy Egan
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