Gross Domestic Problems

John Mauldin
Fictitious Wall Street villain Gordon Gekko famously declared, “Greed is good.” I think actual Wall Street titans would mostly disagree. They would change one word. Instead of “greed,” they would say, “Growth is good.” That is Wall Street’s real mantra. Growth is the magic elixir we all need.

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The question, if we define growth as good, is how do we measure it? Presently we use gross domestic product, or GDP. But GDP is showing its age in the 21st century.
The measure was actually invented in the late 1930s when President Roosevelt needed some way to prove that his policies were working. And at 85 years old, the old formula may be nearing time for retirement.
The only way for Roosevelt to show that his policies were working was to put government spending inside the GDP number. There was vicious fighting among economists over whether he should be allowed to do so. Many economists even argued that military spending should not be included in GDP because it didn’t produce anything. And it’s true that overreliance on GDP has often sent policymakers and business owners in wrong directions. We need a better yardstick.
First, we must next decide what, specifically, a newly formulated GDP should measure and how – and that’s a thornier question than you might think. Today we’ll wrestle with that question and with some of the implications of changing how we measure growth.
These are exactly the types of pressing questions we will be attempting to answer at my upcoming Strategic Investment Conference. By “we,” I mean the hand-selected, A-list cast of economic, investment, and geopolitical powerhouses who will speak, and the audience that will respond to them. And for SIC 2018 we really do have an all-star group, including “bond king” Jeffrey Gundlach, hedge fund titan John Burbank, renowned historian Niall Ferguson, and some 20 more brilliant minds. At SIC you will get their latest and best thinking. Better yet, SIC is small enough that you can usually find the speakers in the hallway or after hours and interact with them.
In addition, there are a couple of hundred “core” SIC attendees who come every year. They represent a remarkable range of talent, experience, and wisdom. Some of them really ought to be on the stage. Instead, they’ll be sitting with you, and you’ll find them friendly and ready to swap ideas. We’ve seen countless business relationships form at SIC, and many more will happen this year. I hope you’ll join us, March 6–9, in San Diego.
Now, let’s see how we can fix the GDP problem, starting with where we are right now.
The Plow Horse Speeds Up

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Brian Wesbury, chief economist at First Trust Advisors, has been calling our present recovery phase a “plow horse economy” for several years. It’s not fast or impressive, but it’s not stopping, either. He’s been mostly right, too.
Last week Brian said that the horse is now breaking free.
We’ve called the slow, plodding economic recovery from mid-2009 through early 2017 a Plow Horse. It wasn’t a thoroughbred, but it wasn’t going to keel over and die either. Growth trudged along at a sluggish – but steady – 2.1% average annual rate.
Thanks to improved policy out of Washington, the Plow Horse has picked up its gait. Under new management, real GDP grew at a 3.1% annualized rate in the second quarter of 2017 and 3.2% in the third quarter. There were two straight quarters of 3%+ growth in 2013 and 2014, but then growth petered out. Now, it looks like Q4 clocked in at a 3.3% annual rate, which would make it the first time we’ve had three straight quarters of 3%+ growth since 2004-5.
That was Monday. On Friday the Commerce Department released its first 4Q GDP estimate at 2.6%. The estimate will likely change, but for now it looks like Brian was a tad bit optimistic about Q4. But you should read his outlook anyway, because he breaks his estimate down to the components of GDP to show how he arrived at 3.3%.
The GDP formula is C + G + I + NX, where
C = Consumer spending
G = Government spending
I = Private investment
NX = Net exports.
Net exports is exports minus imports, so it’s a negative number for a country like the US that runs a trade deficit.
To get GDP, you just estimate the change in each component, weight it by the appropriate amount, and add the components together.
That’s easy enough, but the calculation ignores whether those are the right components and how to define them. The result is a lot of potential distortion. For example, very little happens to GDP if you do your own housekeeping. You consume some cleaning products, but your labor doesn’t count, no matter how long you scrub.
But the labor does count toward GDP if you hire someone and pay that person to do the exact same work while you take a nap. The hired labor “produced” something of value, and you did not.
To an economist, a barrel of oil selling for $100 has the exact same effect on GDP as two barrels of oil selling at $50. Silly, but that’s the way the accounting works.
Libraries and Typewriters
Looking deeper, we realize that GDP is a historical artifact from an industrial economy that doesn’t really exist anymore, at least in the US. GDP worked well in the post-World War II era when the US economy thrived by making material goods: trucks, cars, machinery, appliances, airplanes, houses, and skyscrapers, etc. Output is easy to measure for such goods, as are the kinds of inputs required to produce them, mainly large factories and raw materials.
Today’s economy isn’t like that. Technically, manufacturing is still 35% of GDP, but fewer than 9% of US workers are actually involved in that manufacturing. We are producing more stuff than ever, but we are doing it with far fewer people. And now we produce huge quantities of largely intangible goods: computer software, movies, music, and so on. Those products are easy to copy and hard to track. The productive capacity often exists inside some smart human’s brain. How do you measure that?
Think also of how much more productive technology has made us. That’s hard to measure, too. Imagine it’s 1975 and you want to know what GDP growth was in 1972. Unless you happen to be an economist who keeps such figures handy, you get in your car and drive to the library. You consult a card catalog, note the Dewey Decimal classifications of a number of promising volumes, then set off to search the shelves for them. When you chance on something, you thumb back and forth through it to find the statistic you want. Then you head back home and resume typing your research paper on a typewriter – perhaps you even have an IBM Selectric!
To get that number now, of course, you whip out your smartphone, type  “us gdp 1972” into a search window and voila! I just did this, and it literally took me less than five seconds.

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Or consider travel. Remember the spiral-bound map books that covered major cities?
In Dallas the company that made them was called Mapsco. If your job involved going to unfamiliar places, you had to have one, and they were expensive. And you had to buy a new one at least every few years. Now your phone can get you anywhere you want to go, not just in your hometown but the world over.
We could list thousands of little tasks that used to take hours but now require only seconds. Add up all that time saved, then scale it over hundreds of millions of workers. The impact on productivity is mind-boggling. Does it show up in GDP? Not really. It may even reduce GDP, since we no longer consume as much fuel, printing, and library space, etc. I grew up in the printing business, and I would often print prospectuses. They were incredibly expensive and time-consuming to produce.
Today a prospectus is a PDF file. Going back to the old ways might improve the economic numbers, but would it help the economy? No way. Yet we measure economic growth as if it would. That’s a problem.
Our antiquated methods matter to employment, too. I saw in a recent Wall Street Journal report the reduction in labor needed to operate a power plant as we move from nuclear or coal to natural gas or wind or solar. One company that is shutting down its coal plant and laying off 430 workers will be opening a solar plant in West Texas that will be one of the largest solar facilities in the country, operated by two workers, who may actually be part-time. Put that in your future-of-work pipe and smoke it.
Coal power accounted for 39% of US electricity production in 2014, 33% in 2015, and 30.4% in 2016. There are 1308 coal-powered plants in the US. Assume 125 workers per plant. That’s 163,500 workers. Now cut that number by at least 80% if the plants all shift to natural gas, which they will over time. That’s a loss of 130,800 workers.
And that’s assuming that they all go to natural gas and don’t go to wind or solar. This is going to happen in the next 10 to 15 years. My math could be off here or there, but not by an order of magnitude.
We are now producing vastly more energy with far fewer workers than we did in GDP’s heyday. That’s a labor problem for sure, but it’s also a growth measurement problem. We desperately need a better method.

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Better Mousetraps
I could go on at length about the problems with GDP, but I’ve done that before. Read “GDP: A Brief But Affectionate History” and “Weapons of Economic Misdirection” for the gory details.
A key question: Is GDP completely outmoded, or does it just miss some things? If the latter, then maybe it just needs some tweaking instead of total replacement. The wickedly brilliant Diane Coyle, a University of Manchester economist, has been working on this issue for years. She proposed in a recent paper with Benjamin Mitra-Kahn a series of incremental changes that should help: better measurement of intangible goods, an adjustment based on income distribution, and some other relatively simple changes.
Distribution effects are a problem whenever we look at GDP per capita, as we commonly do when we compare nations. Almost everywhere, income is far more concentrated at the top than it used to be, but the effect varies a lot depending on where you are. It is entirely possible, indeed it is likely in some places, for per capita GDP to rise sharply while most of the population sees no change in its living standards or economic health. An adjustment to compensate for this inequity is an excellent idea.
That point brings up a thornier problem, though. In whatever way we measure it, is “growth” the right thing to watch? Does it really tell us what we think it does? We look at GDP growth and assume a country that has it is prospering. We think everyone who lives there must be thrilled. Often, they have little reason to be.
The assumption works in the other direction, too. If GDP is flat or falling, we see a recession and react accordingly. That is particularly the case with political leaders and central bankers, who then introduce policies to solve the perceived problem. These policies can be damaging if the problem is less serious than central bankers think it is. This may be happening in the US right now.
We’re asking GDP to do something it can’t. What we want is a benchmark of economic progress. Are a country and its people generally better off economically than they were last year or five years ago? If so, by how much? Then we can start to know which policies might help and which might hinder progress. Business owners would be able to make better decisions, and ultimately everyone should feel the benefits.
The problem is, measuring concepts like income inequality may differently skew the witches’ brew that is GDP. The only part of the economy that is really subject to serious increases in productivity is manufacturing; and, as noted above, manufacturing involves less than 9% of the workforce. It is hard to get increased productivity out of service workers. Now, you can use technology to replace them, but that hardly improves their situation, even if it does increase the production of gross domestic stuff per dollar spent.
People have proposed such measures. In 2013 the Skoll World Forum launched the Social Progress Index, defined as “the capacity of a society to meet the basic human needs of its citizens, establish the building blocks that allow citizens and communities to enhance and sustain the quality of their lives, and create the conditions for all individuals to reach their full potential.”

Some of those indicators could be hard to pin down. I don’t see how you put a number on “religious tolerance,” or “tolerance for homosexuals,” for instance. But the creators of the index are on the right track in that they are attempting to measure well-being. I am not certain how widely accepted such a measure would be, but it’s a start.
Another effort appeared in a 2010 book by economists Joseph Stiglitz, Amartya Sen, and Jean-Paul Fitoussi, called Mismeasuring Our Lives: Why GDP Doesn’t Add Up. Their suggestion is to continue using GDP but add other data points to clarify it. They would use things like life expectancy, debt levels, educational achievement, and other social progress metrics.
The World Economic Forum, which had its annual shindig in Davos last week, took another stab at this problem with its “Inclusive Development Index.” It too supplements GDP with other progress indicators.

The WEF paper says GDP is fine as a top-level measure, but growth is a means to an end, namely better living standards. Only by looking at those living standards can we know if GDP growth is accomplishing what it should.
By WEF standards, the “most inclusive” advanced economies are mostly European.
The US and Canada are not in the top 10. The most inclusive emerging economies list is more interesting. Azerbaijan? Really?

Lithuania leads the list, and from what I’ve heard, it probably deserves to do so. (We have employees in Lithuania, and they are excellent and productive workers, as are our Eastern European staff. We are truly a worldwide virtual company.) The other countries on the list look like a strange mix at first but make more sense after some thought. Several live in the shadow of much larger neighbors, so maybe they are more willing to innovate. This list would be a good starting point if you have money to deploy in emerging markets.
That’s a good thought: Countries that are growing in a fair, sustainable way should attract investment. Often they don’t, because investors want quick profits. Look at the move by corporations to increase the number of temporary workers and contract workers so that they are not so much paying for employees as paying money for actual production, without having to cover a lot of the extra benefits that normally go along with traditional employment.
This is a particular complaint that I hear from the friends of my kids, especially the Millennials. They need to hold two part-time jobs in order to make ends meet, and generally those are not jobs that pay a great deal. The gig economy is not all that it’s cracked up to be. The drive by senior management to create short-term profits and to see employees as liabilities rather than as partners in the business process will create a great backlash in coming years.
I’m going to stop here because the next section of the letter would be at least as long as this letter is so far. But let me tease you for next week. I think I’m getting ready to start talking about the probability of a recession before the 2020 election cycle. I see structural problems, monetary policy errors, and a tax cut that is not going to produce the results that the Reagan tax cuts did. M2 money is not even growing at 2%. The savings rate is the lowest it has been for 70 years except for one quarter in 2005; and even though consumer spending was strong last quarter, it came from much-reduced savings and borrowing, much of it on credit cards as a result of the two hurricanes and other disasters and longer-term challenges.
So while on the surface 4.4% nominal GDP growth and 2.6% real growth look pretty good, when you really begin to inspect the engine of growth, you find less under the hood. The velocity of money keeps falling. Our demographics mean that we are not adding workers, and the latest immigration proposal would reduce the number of immigrants and potential workers. And while I am all for allowing the so-called Dreamers to be allowed to stay in this country – the only home country they have known – we do need to be a lot more strategic about allowing potential workers into this country.
After all, GDP is simply the number of workers times productivity. With the number of workers tailing off and with productivity as weak as it has been, the sugar high that the economy has been on is going to wear off. Let me hasten to say, I don’t think nearly enough credit has been given to Trump for changes in the regulatory environment. It’s not merely the reduced number of regulations, it’s the attitude of the regulators that I keep hearing businessmen talk about. Given that I am in highly regulated businesses, I hope to enjoy that new environment sooner rather than later.
Sonoma and San Diego
I will be in Sonoma with my friends at Peak Capital in late February, and then of course I’ll head to San Diego for my conference. I’ll arrive a few days early and maybe stay an extra day just to relax from the adrenaline rush.
My travel seems to have slowed down somewhat, as more people have been coming in my direction lately, keeping me from having to get on the road. And that is a good thing.
Being in and out of the cold in Boston last week – even though I was dressed for the weather – must have weakened my immune system, and then I sat in the plane across the aisle from somebody who was coughing his lungs out. But whatever the reason, I have had a serious head cold that is finally starting to get somewhat better. Last night was the first decent night’s sleep I’ve had. But I shouldn’t complain, as I rarely get sick. And at least I haven’t had a run-in yet with this season’s flu, which I am told is really devastating.
I’m spending a great deal of time on the phone, talking with speakers who will join us at the Strategic Investment Conference, going over details and getting a heads-up on where they are going with their presentations. I am actually shuffling the speaking order around in order to make things flow better. Planning this conference is my personal art form, and from the response I get, it seems I do a reasonably good job. But it helps to have an incredible team.
Shannon Staton is the primary reason it all comes together. We are looking to add one or two more speakers and panel members that I think would be strategic, but with the conference just six weeks away, we are really having to lock things in.
Let me wish you a great week, and I think I will make myself some nighttime TheraFlu, which seems to help, and then began to wind down for the weekend.
Your worried about Federal Reserve monetary policy errors analyst,

John Mauldin

Playing ketchup to the dollar

Value matters again in currency markets

Whether a currency is cheap or dear is not always a good guide to its fortunes. It is now

IN DECEMBER a new dollar bill came into circulation adorned with the signature of Steve Mnuchin. Instead of his usual scrawl, the treasury secretary opted to print his name. If he hoped that his best handwriting would give the greenback a fillip, he may well be disappointed.

The dollar reached a peak against a basket of other currencies a year ago and has not threatened to regain it. Gurus of the foreign-exchange markets agree that 2018 is likely to be another year of modest decline. That is because of three sources of downward pressure.

The first relates to the world economy. The dollar’s descent is not so much a judgment on America’s fitness as a sign of the burgeoning health of other places. So long as America was one of the only places that could be relied upon for economic growth, there was a powerful logic to the dollar’s strength. A broad-based global upswing—evident in everything from booming stockmarkets to a surging oil price—means that investors are now rushing into currencies other than the dollar. That effect is proving stronger than the expectation that American firms will repatriate more profits thanks to the recent tax cut. And it seems likely to continue.

The second source of downward pressure reflects a change in policymakers’ attitudes. Until quite recently, no country seemed keen on a strong exchange rate. A cheap currency was prized. Curbing imports and boosting exports was a way to grab a bigger share of scarce world demand. In 2010 Brazil’s finance minister said that a “currency war” had broken out, with countries vying to weaken their exchange rates using weapons such as quantitative easing (printing money to buy bonds) or capital controls. Rich-world central banks feared that even a hint of tighter monetary policy might cause their currencies to surge against their peers, to their economy’s detriment. But now that global growth is buoyant, few countries seem to mind much if their currency rises. Interest rates have been raised, not only in America but also in Canada and Britain. The European Central Bank (ECB) has reduced its bond-buying programme, as has Japan’s central bank.

An era of currency peace

As extraordinary monetary policy is slowly withdrawn, the fundamentals matter more. This is the third force pushing down the dollar: its price against other major currencies. Benchmarks such as The Economist’s Big Mac index, based on the idea that goods and services (in this case a burger) should cost the same the world over, are useful guides to how far currency values are out of whack. According to the latest version of the index, only a handful of rich countries have dearer currencies than America’s (see article). That is a big change from a decade ago. On the same benchmark in 2008, only two rich countries had a cheaper currency than the greenback.

Some currencies have already jumped against the dollar. In a matter of weeks last summer the euro moved from $1.11 to $1.20, in response to a hint from the ECB’s boss, Mario Draghi, that the tailing off of its bond-buying would begin soon. Other currencies are more likely to strengthen than in past years. It is easy to imagine the yen snapping back towards its fair value in the way the euro did last year. There are still cheap currencies in countries with close ties to the euro area’s thriving economy, such as Poland and the Czech Republic. With the exception of Brazil’s real, emerging-market currencies in general are still very undervalued. Expect them to strengthen further.

In the short term, a consensus on a currency’s fall can be a prelude to it going the other way.

But for 2018 as a whole, further strength in the greenback seems unlikely, no matter whose autograph is on the bills.

The Right Question About Inequality and Growth

Jason Furman

A teacher observes his students

CAMBRIDGE – The belief that inequality hurts economic growth is gaining currency among policymakers. Some argue forcefully that high levels of inequality can make sustained growth impossible, and may even contribute to recessions. This view stands in stark contrast to the traditional view that there is a tradeoff between equality and growth, and that greater inequality is a price that must be paid for higher output.

Lost in the discussion, however, is whether any of this is actually germane to economic policymaking. I don’t believe it is. Whether inequality is good or bad for growth should and will continue to concern social scientists. But those guiding an economy should focus on assessing outcomes and modes of distribution rather than on a puzzle that will never fully be solved.

Three developments make this refocusing necessary. For starters, while recent studies have concluded that higher levels of inequality produce lower long-term growth, other data have challenged this assumption, making definitive claims that are impossible to support, partly because different sources and types of inequality likely have different impacts on growth.

Second, most research focuses on the impact of inequality on growth, rather than on how specific policies affect growth. The former is of interest to social scientists and historians, but it is the latter that is relevant for policymakers.

And, finally, politicians generally defend their policies in terms of how they affect the middle class or the poor, not the arithmetic average of incomes across an economy – which gives equal weight to a $1 increase in the income of a poor person and that of a billionaire. So, even if reducing inequality was bad for overall growth, it might still be good for social welfare in the relevant sense, if it made many households in the middle better off.

The fact is, economic policies in the real world are nuanced and site-specific, making the search for a single answer to the question of how – and how much – inequality affects growth a Sisyphean task. Rather than concerning themselves with how to balance growth and inequality, policymakers would do better to focus on how policies impact average incomes and other welfare indicators.

Win-win policies – defined as distribution mechanisms that produce growth and reduce inequality simultaneously – are the easiest to evaluate, and the most advantageous to adopt. Education is a classic example. Reforms that cost little or no money, such as improving the quality of primary and secondary education, have been shown to encourage growth while ameliorating inequality. Even reforms that cost more – like expanding preschool education in the United States – generate economic benefits that far exceed the tax losses associated with funding them.

These types of approaches – what I call “all good things go together” policies – could be applied to other sectors of the economy that are being squeezed by imperfect competition. More vigorous antitrust policies, or increased consumer ownership of data, could strengthen competition and, in the process, boost efficiency and improve income distribution.

Any policy that promotes growth or lowers inequality without negatively affecting the other variable can also be classified as a win-win. A revenue-neutral reform of business taxes, for example, could raise the level of output with no meaningful impact on the distribution of income.

It is far more difficult to evaluate policies that involve a tradeoff between growth and inequality. For the sake of illustration, consider the effects of a hypothetical 10% reduction in labor taxes paid for by a lump-sum tax modeled using a neo-classical Ramsey growth model – a scenario that I detailed in a recent paper for the Olivier Blanchard and Lawrence Summers series on Rethinking Macroeconomics. This plan is good for growth, with average output increasing by 1%. But to understand how this policy would actually play out for taxpayers, I applied the scenario to the real distribution of US household incomes in 2010.

Nearly all households in the model experienced an increase in pre-tax income. But taxes increased for two-thirds of households. For middle-income households, the increased taxation was offset by earnings, but leisure also fell. As a result, the tax change left around 60% of households worse off, even as average household income grew, driven by gains at the top.

This analysis does not answer the question of whether this illustrative tax policy is a good idea. But most policymakers would likely object if they understood that growth would be achieved by higher taxes on two-thirds of households, leaving the median household working harder to earn the same after-tax income.

Social scientists should continue to ask whether inequality is good or bad for economic growth. More research is needed on the variables that affect growth, such as median income. Economists should also pay less attention to inequality in the aggregate, and more on the specific policies that might increase or reduce inequality.

But policymakers have different priorities than economists do. Rather than rethinking macroeconomics, policymakers must consider whether specific goals for social welfare and distribution can be achieved through win-win measures or through policies that make worthwhile tradeoffs. The answer may be to obsess less over aggregate data, and to focus more on how policy decisions impact real people.

Jason Furman, Professor of the Practice of Economic Policy at the Harvard Kennedy School and Senior Fellow at the Peterson Institute for International Economics, was Chairman of President Barack Obama’s Council of Economic Advisers from 2013-2017.

Russia and the Limits of Power

By George Friedman

The government of Belarus has announced that it will not permit more than two foreign military bases on its territory. There are now two Russian military bases in Belarus, and it is unlikely that any other country has suggested placing bases there. It is therefore reasonable to assume that the Russians have asked Belarus for additional facilities and that the Belarusians have turned them down.

The reason for Russia’s interest in Belarus is obvious. The Baltics are part of NATO, Ukraine has a pro-Western government, and Belarus is the last piece of the Russian buffer zone that is not overtly anti-Russian. If Belarus were to shift its stance and turn against Russia, the entire buffer zone would be gone and with it the strategic depth Russia has depended on. Obviously, more bases would strengthen Russia’s position in Belarus.

The ability to base larger, more significant forces in Belarus would also give Russia offensive capabilities. Ukraine’s northern frontier would be vulnerable, and the ability of Russia to project forces westward would also increase. The Russians are unlikely to launch an offensive, since war is always risky: The outcome is unknown and the cost of defeat could be destabilizing for Russia. But the ability to do so would put pressure on the region. Belarus’ rebuff to the idea of more bases shows that Russia is reaching the limits of its power, or in other words, encountering the turbulence that comes with expanding power, precisely because it has few options.

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The Russians have been trying to increase the perception of their power since the West turned on them following the Ukraine crisis of 2014. To a great extent, Russia has convinced other countries that it is a rising power. But being a rising power always brings resistance from those who fear its rise. It also forces Russia to be concerned with events that are in its putative area of interest, forcing it to diffuse its attention and its power. That there is a desire to convince other countries that Russia is a rising power is indicative of the limits of its power.

Entanglements in the Región

Russia has been examining possibilities in the Balkans, and in particular has drawn close to the Serbians, who are unhappy with the rise of Albanian power in Kosovo in particular and the region in general. The initial decision by Macedonia to recognize Albanian as an official language was made in order to manage its internal realities and also to placate Albania. The introduction of the second language was backed by Macedonian Prime Minister Zoran Zaev, who gained power with the support of Albanian partners. He wants to maintain this support to include Albanians in the solution of the Macedonian question and to accelerate Macedonia’s accession to the European Union and NATO.

Though Macedonian President Gjorge Ivanov vetoed the measure a week later, the general trend of supporting Albania remains. Normally this issue would not interest the Russians. However, Serbia is extremely alarmed by it, and therefore the Russians were compelled to take a stand, condemning Macedonia’s decision. Russia’s attempt to present itself as a major power led to its involvement with Serbia, thus entangling it with Serbian interests.

A similar situation exists in Turkey. The Russians intervened in Syria to preserve the regime of President Bashar Assad. This was not of overwhelming strategic importance to them, but it appeared to be a low-risk path to demonstrating their power. The evolution of events in Syria has led the Turks to the verge of intervening against the Kurds. Russia wants good relationships with Turkey, in spite of Turkey’s hostility to the Assad regime, but it does not have a major stake in the future of the Kurds (except that Turkish hostility toward the United States’ attempt to defend the Kurds must delight the Russians). The Syrian government has threatened to intercept Turkish aircraft over Syria, which complicates Turkey’s strategy to deal with the Kurds, prompting Turkey’s head of intelligence to fly to Moscow to talk to the Russians about the matter. This puts the Russians in a difficult position, since the Turks will hold them responsible.

All of these matters – Belarusian military bases, language laws in Macedonia and Syrian airspace – were not important to Russia before 2014. Now the Russians must feel like the Americans always do, trying to solve a problem that is not really their concern to protect a foreign policy interest that is real, but three or four links down the line. Russian power is perhaps better managed at the moment than American power, but it is not nearly as deep. And Russia has entangled itself in affairs over which it has little power, or which lead to an untenable situation. The risks of foreign entanglement increase the less fundamental power a nation has. Russia, like the United States, is experiencing the limits of that power, a limit that is more daunting precisely because of the Russians’ need to demonstrate that they have more power than they actually have.

The crypto sun sets in the East

The threat of tough regulation in Asia sends crypto-currencies into a tailspin

China has taken a harsh line, as South Korea contemplates banning bitcoin exchanges

IT HAS been another week of vertiginous swings in the prices of bitcoin and other crypto-currencies. This time, the moves have mostly been downwards, with some days seeing falls of over 20%. Views on this were as divided as they were during the giddy climb: did it mark the definitive bursting of a bubble as rapidly inflated as any in history (see chart)?

Asia provides both an explanation of this week’s sell-off and a glimpse of crypto-currencies’ future. The threat of a ban in bitcoin-trading in South Korea was the proximate cause of the plunge. As to the future, the question is which Asia? At one end of the spectrum is Japan, which has embraced crypto-currencies. At the other is China, which has all but banished them. South Korea has been in the middle.

These countries have outsized roles in the crypto universe. China’s exchanges hosted more than nine-tenths of global bitcoin-trading until the government closed them last year. Japan now has the biggest share of virtual-currency markets. South Korea makes up less than 2% of global GDP but nearly a tenth of bitcoin-trading.

North Asia has been fertile ground for crypto-currencies for several reasons. Partly it is the high-tech pedigree. A prevalence of smartphones, fast internet and computer-science graduates makes people receptive to the newfangled. The rigidity of conventional finance has helped.

Capital controls boost the appeal of crypto-currencies in China and South Korea, and in Japan they are a beguiling alternative to low-yielding mainstream investments. A zest for gambling has surely lured some to a market that is driven by speculation.

But the region’s regulators are going in different directions. China, alarmed at the way crypto-currencies can evade government oversight, has taken the harshest line. Last year it banned domestic exchanges; in recent days it has taken aim at websites flouting this ban. Officials have also called on local authorities to choke off the power supply to bitcoin miners, computer networks that create new coins through massively energy-intensive calculations. China’s miners, still dominant in the global industry, are shifting to other countries.

The Chinese government admires the technology that underpins virtual currencies and wants to reap the benefits. It is prodding its big financial firms to experiment with blockchain, a system of distributed ledgers popularised by bitcoin. But officials believe they can do this without having to tolerate the currencies themselves. As Pan Gongsheng, deputy governor of the central bank, quipped last year, quoting a French economist: “The only thing to do is to sit by the riverbank and wait for bitcoin’s corpse to float past.”

Japan, by contrast, has given crypto-currencies room to run. Its regulators know the dangers. One of the biggest scandals in bitcoin’s short history was the collapse of Mt. Gox, a Japan-based exchange, in 2014. And officials have not minced their words, with Haruhiko Kuroda, governor of the Bank of Japan, warning that the bitcoin rally in late 2017 was “abnormal”.

But rather than throttle virtual currencies and the innovations they might spawn, the government has let them develop, within parameters. Last March it passed the “virtual-currency act”, declaring that they are assets and can be used for payments. The financial-services authority has granted licences to 11 exchanges, to reduce the risk of fraud. Zennon Kapron, a Shanghai-based analyst of digital currencies, says that some of China’s leading crypto-coders are now moving to Japan.

South Korea was initially hands-off in its regulations. But alarm has mounted about the speculative fervour. So intense is the demand that South Koreans pay a “kimchi premium” of roughly 40% for their bitcoins (not easily arbitraged away because of capital controls). On January 11th the justice minister said crypto-currency exchanges would be banned. Their devotees responded with a petition urging leniency, which swiftly collected more than 200,000 signatures.

Faced with this backlash, the government appeared to soften its stance, saying a ban was just one idea. Other incoming measures are less potent: investors will have to pay taxes on capital gains and register trading accounts under their real names. But just as crypto-markets had recovered their poise, South Korea’s finance minister said this week that the ban was still very much on the table, calling it a “live option”. The collapse resumed.

Virtual currencies have bounced back from past sell-offs, but this has been a big one. At one point bitcoin was down about 50% from its highs in December. Believers in virtual currencies say that one of their selling points is freedom from government meddling. In Asia, the cutting edge of the crypto-world, it is governments that are making—and breaking—their fortunes.

America First and the Decapitation of King Dollar

Doug Nolan

The U.S. ran a $71.6 billion Goods Trade Deficit in December, the largest goods deficit since July 2008’s $76.88 billion. The U.S. likely accumulated a near $550 billion Current Account Deficit in 2017, also near the biggest since before the crisis. Going all the way back to 1982, the U.S. has posted only two quarterly surpluses (Q1, Q2 1991) in the Current Account. Since 1990, the U.S has run cumulative Current Account Deficits of $10.177 TN. From the Fed’s Z.1 report, Rest of World holdings of U.S. financial asset began the nineties at $1.738 TN; closed out 2008 at $13.699 TN; and ended Q3 2017 at $26.347 TN. It’s gone rather parabolic – with a curiously similar trajectory to equities markets.

For better than three decades, the U.S. has been in an enviable position of trading new financial claims for foreign manufactured goods. The U.S. has literally flooded the world with dollar balances. In the process, the U.S. exported Credit Bubble Dynamics (including financial innovation and central bank doctrine) to the world. When the central bank to the world’s reserve currency actively inflates, the entire world is welcome to inflate. The resulting global monetary disorder ensured a world of fundamentally vulnerable currencies.

Despite unrelenting Current Account Deficits, there have been two distinct “king dollar” episodes. There was the “king dollar” period of the late-nineties, fueled by global financial instability, a U.S. edge in technology and, importantly, the Greenspan Fed’s competitive advantage in sustaining U.S. securities markets inflation. More recently, a resurgent “king dollar” was winning by default in 2013-2016, as the ECB, BOJ and others implemented massive “whatever it takes” QE and rate programs. Moreover, the shale revolution and a dramatic reduction in oil imports was to improve the U.S. trade position. Oil imports did shrink dramatically, but this was easily offset by American consumers’ insatiable appetite for imported goods.

It’s an intriguing case of parallel analytical universes. There’s the bullish – U.S. as the world’s invincible superpower – view. America is blessed with superior systems – economic, governmental, market and technological. The world’s best and brightest still yearn to come to the land of opportunity. And with a few notable exceptions, this view has received almost constant affirmation from booming equities, debt securities and asset markets. Robust bond markets, in particular, ensured insatiable international demand for dollars. Surely, concern for U.S. Trade and Current Account Deficits is archaic, at best.

The opposing view holds that the U.S. financial situation is unsound and untenable. A deindustrialized “services” and finance-based economy is dependent upon unending Credit expansion, with the vast majority of new Credit non-productive in nature. The U.S. boom is again financed by unsound leveraging, this time generated chiefly by global central banks and foreign-sourced speculative finance. The perpetual outflow of U.S. currency balances internationally ensures at some point a crisis of confidence in the dollar. What’s more, extreme monetary inflation by the other major central banks since 2012 only increases the likelihood of a more systemic crisis of confidence throughout global markets and currencies. The resulting unprecedented looseness in global monetary conditions over recent years has promoted a degree and scope of excess sufficient for a deep and prolonged global crisis.

It’s been my long-hold expectation that the world at some point would discipline U.S. profligacy. The world instead followed in our footsteps. Global central banks accommodated unfettered finance, adopted inflationism and, without protest, recycled trade surpluses right back into U.S. financial markets.

There was Greenspan’s “conundrum” and Bernanke’s “global savings glut.” The reality is that U.S. trade deficits have been at the heart of a runaway expansion of market-based finance around the world. This dysfunctional and precarious financial backdrop was interrupted temporarily in 2008. Zero/negative rates along with $14 TN (and counting) of central bank liquidity fueled a much more systemic Bubble of unprecedented dimensions. Importantly, central bankers came together to support a common goal: reflation of markets and economies. Concerted policymaking – from Washington to Ottawa, London, Frankfurt, Zurich, Tokyo, Sydney, Beijing and beyond – has been fundamental to the synchronized global surge in risk-taking, over-liquefied market Bubbles and economic recovery.

January 24 – New York Times (Jack Ewing): “Mario Draghi… directed unusually sharp criticism at Steven Mnuchin, the United States Treasury secretary…, effectively accusing Mr. Mnuchin of violating agreements among nations against starting currency wars. Mr. Draghi… said he objected to ‘the use of language in discussing exchange rate developments that doesn’t reflect the terms of reference that have been agreed.’ He then quoted from an agreement reached in Washington in October under which countries promised to ‘refrain from competitive devaluations.’ …Mr. Draghi portrayed Mr. Mnuchin’s comments as part of a broader deterioration in international etiquette. At a meeting of the central bank’s Governing Council that preceded the news conference, Mr. Draghi said, ‘Several members expressed concern and this concern was broader than simply the exchange rate. It was about the overall status of international relations right now.’”

January 25 – Reuters (Doina Chiacu): “U.S. President Donald Trump said on Thursday he ultimately wants the dollar to be strong, contradicting comments made by Treasury Secretary Steven Mnuchin one day earlier. ‘The dollar is going to get stronger and stronger and ultimately I want to see a strong dollar,’ Trump said…, adding that Mnuchin’s comments had been misinterpreted.”

January 25 – CNBC (Sam Meredith): “Treasury Secretary Steven Mnuchin said Thursday he spends little time thinking about dollar weakness over the short term, walking back his comments that sent the U.S. currency reeling amid fears of a trade war. Speaking during a CNBC-moderated panel at the World Economic Forum in Davos, Mnuchin said dollar weakness in the short term was ‘not a concern of mine,’ before adding: ‘In the longer term, we fundamentally believe in the strength of the dollar.’”

After the dramatic cut in corporate tax rates and myriad measures seen as benefiting the wealthy, some argue that Trump populism is a ruse. But now we see a 2018 push on tariffs, aggressive trade negotiation, U.S. capital investment and higher wages meant to rebuild our manufacturing base to the benefit of the American worker. Rather than the rich continuing to build wealth at the expense of the lowly worker, they can now grow wealth together. Is such a radical change even possible? Where are the losers?

January 24 – CNBC (Matt Clinch): “Treasury Secretary Steven Mnuchin said the U.S. is open for business and welcomed a weaker dollar, saying that it would benefit the country. Speaking at a press conference at the World Economic Forum…, he made a bid for investment into the U.S., saying the government was committed to growth of 3% or higher. ‘Obviously a weaker dollar is good for us as it relates to trade and opportunities,’ Mnuchin told reporters…, adding that the currency's short term value is ‘not a concern of ours at all.’ ‘Longer term, the strength of the dollar is a reflection of the strength of the U.S. economy and the fact that it is and will continue to be the primary currency in terms of the reserve currency,’ he said.”

Surprisingly candid comments from our Treasury Secretary. And as much as he, the President and other administration officials work to “walk back” Wednesday’s comment, “obviously a weaker dollar is good for us” confirms what many had suspected. “America First” has a “beggar-thy-neighbor” currency devaluation component. A revitalized U.S. manufacturing sector will come at the expense of our trade partners and the holders of our debt.

I’ve posited in past CBBs that it would have been easier to implement the Trump agenda in a crisis backdrop. This requires revision: it would have been less risky to implement… Huge tax cuts at this late stage in the Bubble come with unexpected consequences, including those associated with stoking acutely speculative risk markets. There are major risks in feeding an investment boom now, following years of extraordinarily loose financial conditions and today’s 4.1% unemployment rate. It’s reckless running huge fiscal deficits at this late stage of a boom cycle – with federal debt having already inflated from $6.074 TN to $16.463 TN in less than ten years. And, this week, openly lauding the benefits of a weaker dollar with foreign holdings of U.S. debt securities at $11.370 TN (up 57% since the crisis!).

Mario Draghi’s rebuke was as swift as it was stern. The ECB’s Maestro well-appreciates that Mnuchin and the Trump folks are playing with fire. Global central bankers in concert have cultivated the perception that everything is well under control. No need to fret market liquidity, at least not in equities and bond markets. Currencies, well, that’s a whole different animal.

There are few matters that keep central bankers awake at night like the prospect of dislocation in the currency markets. These are massive markets, generally well-behaved but not easily controlled when they’re not. Disorderly selling of the dollar – with all the leveraged currency trades and unfathomable derivative exposures that have accumulated for decades and mushroomed since the crisis - now that’s lush habitat for the proverbial black swan.

The Dow gained another 545 points this week, bring 2018 gains (17 sessions) to 1,897 points. The S&P500 jumped 2.2%, as the dollar index declined 1.7%. Clearly, U.S. and global risk markets are fine with dollar devaluation. Heck, they’re delighted with the notion of concerted global currency devaluation. The sickly dollar will only pressure the ECB, BOJ and others to stay looser for even longer. What country these days feels comfortable with a strong currency? What could go wrong?

Does dollar weakness and attendant securities market froth pressure the Fed to pick up the pace of rate increases? Heaven forbid, might they actually come to the realization that they need to actually tighten monetary conditions. Beyond stock market Bubbles, the weakening dollar bolsters the case for an uptick in inflationary pressures. WTI crude is up a quick 9.5% y-t-d to $66.14. The GSCI commodities index has gained 4.7% in the first four weeks of the year. Heightened dollar vulnerability might also engender a consensus view within the global central bank community supportive of tighter U.S. monetary policy.

“Beggar-thy-neighbor” – not desperate depression-era measures, but amid economic/financial boom and record stock prices. Uncharted territory. Trapped in concerted reflationary monetary policymaking, global central bankers may be tempted to disregard ramifications of “America First.” This will unlikely be the case with foreign governments. And when do anxious governments begin to pressure their central banks against accommodating Team Trump ambitions? Beijing has already reminded the world of their prerogative to liquidate China’s Treasury hoard. Global markets remain confident that central banks have no option other than recycling dollars back into U.S. securities markets. Perhaps this is too complacent.

Crisis-period QE and zero rates evolved over years into “whatever it takes” open-ended QE, negative rates and egregious market manipulation. Global central bankers took control – and today have things fully under control. This market perception has been instrumental in the historic collapse in market volatility. Resulting readily available cheap market risk protection has incentivized historic risk-taking and today’s speculative melt-up market dynamic.

Historians may look back at Team Trump’s jaunt to chilly Davos as a pivotal juncture in global finance. Was it naivety, gall or a combination – or just typical of today’s overabundance of complacency? The U.S. Treasury Secretary - facing enormous fiscal deficits, rising rates, $16.5 TN of federal debt, a nervous bond market and suspicious foreign officials - openly advocating a weaker dollar.

There are certainly plenty of dollars in the world available to sell or hedge. What is the likelihood of dollar selling turning disorderly? One might look at several years of incredible ECB and BOJ “whatever it takes” liquidity creation and rate suppression (and interest-rate differentials you could drive a truck through) and ponder Friday’s closing prices of 1.24 for the euro and 108.58 for the dollar/yen. Those are two flashing warning signs of dollar vulnerability.

In all the euphoria, markets can be excused for presuming dollar weakness ensures a further delay in global rate normalization. Yet things turn quite interesting the day unruly currency markets begin indicating disorderly trading. The almighty central bankers might have little to offer. What if they intervene to no avail? This could prove the juncture when markets begin questioning the Indomitable Central Banks in Control thesis. The price of market “insurance” would begin to creep (or, not unlikely, spike) higher, and the availability of cheap risk protection would wane (possibly abruptly). In such a development, I would expect the more sophisticated market operators to begin (aggressively) pulling back on risk and leverage. Such a dynamic, especially after such a spectacular melt-up, would mark an important inflection point for market liquidity.

Ten-year Treasury yields were little changed on the week at 2.66%. Yet two-year yields rose five bps to 2.12% and five-year yields rose two bps to 2.47%. Global yields are on the move. German 10-year yields jumped six bps to a 13-month high 0.63%, and French yields gained seven bps to 0.91%. UK yields jumped 11 bps to 1.44%.

The dollar’s worst start to a year since 1987. Wildly speculative stock markets, rising bond yields, Fed rate hikes, dollar weakness and acrimony, and general currency market instability. Today’s backdrop recalls 1987, though with some important differences. The world has so much more debt these days. Global equities markets are so much bigger and interconnected – derivatives markets incredibly so. Did China even have a stock market in ’87?

Today’s central bank balance sheets would be unimaginable back in 1987. Markets certainly had much less faith in central bank liquidity backstops. 1987 had this exciting new financial product, “portfolio insurance.” 2017 has the continuation of this enchanting New Age notion that central banks insure all portfolios. The Great Irony of Contemporary Finance: years of extreme central bank inflationary measures ensured that global finance outgrew the capacity of central bank liquidity backstops.

January 25 – Wall Street Journal (Richard Barely): “Only a select few people can move foreign-exchange markets with a handful of words. U.S. Treasury Secretary Steven Mnuchin and European Central Bank President Mario Draghi are two of them. Thursday they clashed, and the ECB clearly has a fight on its hands. The euro had already been rising against the dollar before Mr. Mnuchin’s comments in Davos Wednesday, that a weak dollar was helpful for trade, sent it even higher. Mr. Mnuchin’s apparent attempt Thursday to play down that comment didn’t reverse the trend. Mr. Draghi’s first-round defense proved insufficient.”

January 21 – Bloomberg: “China’s bad-loan data, which analysts and investors have long regarded to be understated, was thrown into question again after the banking regulator uncovered faked reporting at a local lender. Shanghai Pudong Development Bank Co., the nation’s ninth-largest lender, illegally lent 77.5 billion yuan ($12bn) over many years to 1,493 shell companies to take over bad loans at its Chengdu branch, the China Banking Regulatory Commission said… The branch, which had reported zero bad loans, inflated its earnings and faked other operational data to improve performance and evade compliance, the CBRC found.”

January 21 – Bloomberg: “For years, a branch of a mid-sized Chinese bank outshone rivals by reporting zero bad loans at a time others were struggling with rising soured debt. Financial indicators at Shanghai Pudong Development Bank Co..’s branch in the western Chengdu city were healthy, officials raised no red flags, and Fitch Ratings upgraded the parent last July citing tighter support and supervision by local authorities. Unknown to most, however, regulators had been probing the lender for a fraud that may reverberate across China’s financial industry. ‘It is not just about Pudong Bank,’ analysts at Guangfa Securities Co., led by Ni Jun, wrote… ‘The underlying issue is that the market may conduct a systemic review and re-rating on the bad loan ratios of those highly-leveraged Chinese banks that had gone through a round of balance-sheet expansion.’”


The hedge-fund delusion that grips pension-fund managers

Most hedge-fund managers are not good enough, on average, to offset their high fees

HEDGE-FUND managers may be feeling quietly smug about their performance in 2017. They returned 6.5% on average, according to Hedge Fund Research, a data provider, their best year since 2013.

But those returns do not really suggest that they are masters of the investing universe. The S&P 500 index, America’s main equity benchmark, returned 21.8%, including dividends, last year. More tellingly, a portfolio split 60-40 between the S&P 500 and a mixture of government and corporate bonds (an oft-used benchmark for institutional portfolios) would have returned 14.8%. Last year was the fifth in a row when hedge funds underperformed the 60/40 split (see chart).

That ought to be a salutary lesson for those institutions who think that backing hedge funds is the answer to their prayers. Despite the highs recorded by stockmarkets, many employers are struggling to fund their final-salary pension promises. In 2016 the average American public-sector plan was just 68%-funded, according to the Centre for Retirement Research at Boston College. In the private sector, multi-employer pension plans, covering workers in industries like mining and transport, have liabilities of $67.3bn and assets of just $2.2bn. Worse still, the insurance scheme established to back those schemes is on course to run out of money by 2025, according to the Pension Benefit Guaranty Corporation.

It is hard to cut workers’ benefits and painful to increase contributions. Schemes hope to square the circle by earning a high return from their assets; 7.5% is a common target. But bond yields are very low and equities are trading at very high valuations by historical standards. The temptation is to turn to “alternative assets”—a category that includes property, private equity and hedge funds.

The first two offer a genuine alternative. Property generates a stream of rental income and the hope that capital values will keep pace with inflation. Private equity is, in part, a bet that unquoted firms can generate higher returns than listed ones because they have more freedom to invest for the long term.

But what about hedge funds? A lot of funds specialise in equities or corporate bonds—the same assets that institutions own already. In some other categories, such as macro funds or merger arbitrage, returns are entirely dependent on the manager’s skill. Recent years do not suggest that hedge-fund managers display enough skill, on average, to offset their high fees.

Clients may think they will be able to pick the best hedge-fund managers, not the average ones.

But one group of professionals—fund-of-fund managers—tries to do just that. They did manage to pip the average asset-weighted return of hedge funds in 2017, but failed to do so in any of the previous four years. If the experts cannot manage to pick the winners, why should a pension fund or endowment be able to manage the feat?

Another justification for placing money with hedge funds is that they are less likely to lose lots of money in a downturn. That argument was somewhat dented in 2008, when the average hedge fund lost 19%. In any case, pension funds and endowments are investing for the long term; they ought not to be that bothered by short-term volatility.

The Centre for Retirement Research conducted a study* of the effect of investing in alternative-asset categories on state and local-government pension-plan returns in the 2005-15 period. It found that schemes that placed an extra 10% of their portfolio in private equity and property had marginally increased the return on their portfolios (by around a sixth of a percentage point). But investing in commodities or hedge funds had reduced returns, with the latter knocking half a percentage point off the total.

Some investors have seen the light. CalPERS, a public-pension fund in California, announced that it was pulling out of hedge funds in 2014. But Preqin, an information provider, estimated last year that pension funds accounted for 42% of all money flowing into the global hedge-fund industry. North America provided the bulk of the money, with 776 pension schemes investing from that region alone.

Who knows what those schemes are trying to achieve? A few of them may be lucky enough to pick the best performers in the industry. But if they think, in aggregate, that their strategy will reduce their funding deficits, then they are suffering from a delusion.

* “A First Look at Alternative Investments and Public Pensions” by Jean-Pierre Aubry, Anqi Chen and Alicia Munnell, July 2017

Immigration Is Practically a Free Lunch for America

Tax cuts are well and good, but the surest way to spur economic growth is to let in more people.

By Neel Kashkari

As Congress and the Trump administration debate immigration reforms with important legal and social implications, they must not lose sight of an overarching truth: Robust immigration levels are vital to growing the American economy.

Legislators of both parties, policy makers and families all want faster economic growth because it produces more resources to fund national priorities and raise living standards. But growth since the end of the Great Recession has been frustratingly slow, averaging only 2.2% net of inflation, down from 3.6% on average from 1960 to 2000.

Republicans hope the new tax cuts will lead the economy to grow faster. But while stimulus plans can indeed produce growth at least temporarily, they usually do so by increasing the deficit. Can’t policy makers achieve faster growth without further ballooning our national debt? Yes—and increasing immigration levels is the most reliable way to do so.

Long-term economic growth comes from two sources: productivity growth and population growth. Productivity growth means the same number of workers are able to produce more goods and services. Increased productivity comes from better education (equipping workers with better skills) and technology development (giving workers more sophisticated tools). Productivity growth has been very low during this recovery, averaging only 1.1% per year, down from 2.1% from 1960 to 2000.

We can’t predict whether productivity growth is going to return to prior levels on its own. Congress could decide to spend more on education or basic research to boost productivity, but it takes years for such investments to translate into a more productive economy. That doesn’t mean they aren’t worth making, but the payoffs are highly uncertain.

Population growth drives economic growth because a larger population means more workers to produce things and more consumers to buy things. But as is true in most other advanced economies, Americans are having fewer children. The U.S. working-age population has stagnated over the past decade.


Using public policy to increase the nation’s fertility rate is not easy. Congress could try to create economic incentives for families to have more children by offering tax credits and free child care, but both would be expensive and take years to move the needle on population growth. The surest way to increase the working-age population is through immigration.

Immigration has boosted U.S. economic growth throughout history and can continue to do so if the country remains committed to openness and opportunity. Some immigration opponents fear immigrants will compete with native-born Americans for jobs, but the bulk of economic research shows immigration has led to faster overall growth and a higher per capita standard of living.

There is a global competition for talent among countries to lure workers, including highly skilled workers to develop new technologies and lower-skilled workers to support agriculture.
This is a competition America has won resoundingly decade after decade. My parents, who immigrated from India, and my wife, who immigrated from the Philippines, are examples. They came to finish their education but stayed because of America’s welcoming culture and strong job prospects. Given the choice of immigrating here or to virtually any other country, the majority of immigrants would choose the U.S.

Immigrant inflows to the U.S. are relatively low by postwar standards. If Congress and the administration can deliver reforms that boost legal immigration by one million people a year and tailor the policy to prioritize workers who meet the needs of our economy, the Minneapolis Fed estimates growth would increase by at least 0.5 percentage point a year under the most conservative assumptions, with no corresponding increase in the deficit. This would close almost half of the growth gap between our postrecession recovery and the late-20th-century norm. And if some of those immigrants or their children turned out to be the next Steve Jobs or Elon Musk, we might solve our productivity woes, too.

Immigration is as close to a free lunch as there is for America. Our welcoming culture provides us an unfair competitive advantage most countries would love to have. Let’s use that advantage to win the immigration competition and accelerate growth. We’d be crazy not to.

Mr. Kashkari is the president and CEO of the Federal Reserve Bank of Minneapolis and participant in the Federal Open Market Committee.