Sunday, October 19, 2014

My Response to Pettis Latest Blog - Pettis is a "Must Read" - War on the Horizen - US complicit in EZ crisis

I wrote this in Michael Pettis comment section in response to his brilliant posting today:

http://blog.mpettis.com/2014/10/how-to-link-australian-iron-with-marine-le-pen/

"How to link Australian iron to Marine le Pen"

My comment:

As usual brilliant,  and you are frighteningly alone showing your academic courage.  But I have some thoughts which I hope are additive.

It should be understood that it is not just that  there is a curious  Dornbush  "suddenness"  that resolves imbalances, but if those imbalances were built as policy, especially policy that at its heart is meant to provide societal control, increase government power or repair a perceived deficiency in power or alleviate a risk to power (Tienanmen) , or to counter a foreign security risk, the imbalances created by policy can only be resolved by "un-policy".  In other words via catastrophe and jumps which will be weeks in the process versus the decades that the policy required to build those imbalances.  Since imbalances created are the results of policy, it means by definition they have the current group in power committed "all in" on those imbalances.  China may actually be able to remedy the imbalances by a change in policy based on Confucius ideals of the greater good -but that has never been accomplished in history be it the Athenian mercantilism   to Roman wheat trade with Egypt to American housing market.  So the odds as defined by history is that China will experience a very severe cataclysm ,right up there with a Yihetuan or Taiping event. I hope not, as that would result in war.

That is what is unsaid - maybe it has to be unsaid -  that such imbalances are not just severe economic conundrums lacking sensible policy - but are always the cause of all war.  These imbalances, therefore,  are the most important foreign policy and security issue for the USA and all world governments.  If they are successfully deflected from the international lines of transmission - for example the USA "ate"  the first phase of the China imbalance resolution via the solvency event of 2008 - they will always cause at best intense internal insurrection or a civil war and at worst global war.  Very serious stuff indeed.

These imbalances are intolerable for this globalized world.

Your ideas on Saravelos "Euroglut" are thoughtful.  And Saravelos is thoughtful to approach Europe on an international identity perspective like the good Minskian I am sure he must be.  But that glut does not exist in truth.  The real imbalance is not that that Germany and a few Nord fellow travelers have excess savings and low demand, but that all of those savings are matched and then some by the deficit in the PIIGS.  The T2 accounting has become ubiquitous such that it no longer terrifies or even really acknowledged . And the Nord EZ feel they have successfully forced the PIIGS into a long term acquiescence of the policy that built the T2 imbalances, and they will remedy those imbalances via labor.  Thus the 50% youth unemployment in Greece today, near matched in Spain and Portugal.  And with Italy starting to follow.  This remedy though is a fiction, a Potemkin policy which is providing the illusion that the Nord have the ability to consider  exporting their excess savings and deflation to the USA.  What will happen is all those savings will be marked down so the entire EZ will net to levels the T2 net would now indicate (and then of course the "shadow" netting added as well) so that all that Euroglut goes "poof".  Of course the last time Europe had this process WW II occurred, and it is  telling that you went to Keynes "Consequences of the Peace".  The only constructive answer that can work for Europe is that the T2 and other shadow imbalances are netted across Europe via transfer payments both spot and forward via trans-Europe unemployment insurance like payments and social security and health coverage.  There is the small issue of a constitutional apparatus being built to administer this.  So I do not think the "Euroglut" is of any risk to the USA.

What I do know is that the highest levels foreign  policy formulation in the USA from the beginning of the Euro crisis were well aware of all I say above and anticipated the current status.  I heard such discussion first hand.  The USA policy formulated for the EZ crisis from 2011 on was to give Germany  a "green light" to force PIIGS to use labor to maintain and work to remedy the EZ imbalances.  That very capable US analysis calculated thresh hold levels of unemployment in the PIIGS that they feel could be maintained before insurrection and the return of fascism.  That Fed Reserve support of the regional central banks along with one off ad hoc measures like the IMF "troika" would also assist  in  maintaining  German hegemony of Europe.  France would be bought off by calling this a Gaullist European solution.  This was sought by the USA policy authors because of the obvious logic that the only possible competitor to United States hard power would be a  Monnet Plan "United States of Europe".  So the USA is supporting the German hegemony at the terrible cost of strapping the PIIGS, thereby keeping Europe in one vast chronic "frozen" economic crisis.  The USA has no interest in seeing a land and naval force develop that would equal the US military.  And a United States of Europe would have a land and sea force the complete equal to the United States.

Lastly you are wrong (said with respect),  There is one economist who clearly anticipated both the USSR demise as well as the Japanese crash.  Whats more she correctly predicted the "lost decade(s)" of Japan that followed the 89 crash.  I am not certain that  she was aware of this (but I would imagine this autodidact economist must have read Minsk), but she used a very clean application of Minskian like identities to global imbalances to reach insight.  Whats more she freed herself from the national account data and considered the world as populated by large city-state economic regions and where the imbalances reside.   For example she would focus on imbalances between Honshu and Tokyo and much as Japan to the United States.  That person was of course the great Jane Jacobs.  Just as you went back to "Consequences", a read now of "City and the Wealth of Nations" is a good use of time.

Saturday, October 18, 2014

Common Sense Shows the Household Survey is in Error, Under-reporting Employment by 1 Million (5 1/8%)

If UER-6 and household survey unemployment rate (now at 5.9%) showed  labor slack, a parallel status would be found in the insured unemployment data. Or the the ratio of insured labor force to total labor force would have changed significantly, dropping in similar fashion as the labor force participation rate.

But data  clearly shows that the ratio of insured labor force to total labor force has been unusually steady, ever since the large influx of women entered the work force in the 1970s onward.  The ratio of insured labor force to labor force does drop similar to  the labor force participation rate drop,  during the 2008 to 2009 business slowdown, but has corrected swiftly while the labor force participation rate has stayed unchanged.


The ratio of insured labor force to labor force has returned to levels experienced throughout the decade prior to the solvency event of 08.

The weekly initial claims and continuing claims data is accurate and timely. It is not a derived level or rate from a sample as it is comprehensive.  But for the ARIMA seasonal adjustments, the insured claims is consistent and accurate and factual.  It is what it is.  The BLS and CES uses the state data to calibrate and revise the household survey which by definition is  a sample, and the establishment business survey that derives payroll.  The household and establishment data can only be accurately portrayed with little margin of error every 10 years with the census - but even then that window of accuracy comes as hindsight after the census data is ordered and cleaned.  So BLS and CES depend on the above stable ratio to calibrate and revise the household and establishment data using the timely and comprehensive claims data.  At least they have done so for the 40 years prior to 2008. But in this solvency event with both the slowdown and then the recovery,  BLS and CES have not applied the claims data with the same rigor they have in the past.   If they had done so, using the 80% to 85% insured to total labor force ratio, the unemployment rate would have experienced much higher rates at the economic  nadir and then much lower rates as we recovered.  It is obvious that given the insured labor force to labor force ratio relative stability, the household data is now in error and will have upward revision of approximately 1 million employed.

That would change the current 5.9% unemployment rate to 5.1% unemployment rate raising the labor force participation rate accordingly and eliminating the unusual spread between UER-6 and UER-3.

Here I take the weekly complete census of insured unemployment rate and divide continuing claims by that rate to end with a derived household unemployment rate using insured unemployment and the stability of the ratio of the subset insured labor force to labor force.


 The last data point for both - August 2014 - is provided. The growing error in the household data by calibrating to the weekly claims census is obvious.  It also shows the error is approximately .8 % in the unemployment rate or approximately  1 million employed.

The magnitude of this error  is shown in the Beveridge Curve for insured unemployment and for household unemployment.


This shows the insured data coordinates to other impressions of the recovery like retail sales, consumer lending, durable goods and especially autos; while the household unemployment data is out of synch with other economic data, including  the JOBS data.

Detailed and complex contortions explaining why the household survey is accurate are more and more frequent, but none of these discussions even bother to explain the census based claims data - since it cannot be done -  it is simply dismissed or there is some sort of bizarro world parallel universe explanations that  claims data only reflects the rate of layoffs. That of course makes no sense when one considers the continuing claims data which drops only as employment picks up.

So the insured data Beveridge Curve is the accurate and complete depiction of the nations employment status.

The   reality is the employment levels are showing a near record if not record robust strength that can only occur with a consistent 4% real GDP. The unemployment rate when it is finally revised to the correct level will show that the current unemployment rate is about 5 1/8%.

This means that the FOMC is in the midst of one of the most significant policy errors in the history of the Federal Reserve since 1913.  That the whole premise of "forward guidance" is in error as the inflation rate is not related to the output gap, and then the output gap now being used is in error as right now there is no labor slack left and,  unless a new internet like technology flows into the economy as it did in the 1990s, heightening productivity, significant inflation given all the capacity being used will certainly occur.

But why is there no inflation now given a correct read of an extremely tight labor market? Where are the wage pressures that theory says should exist now.

That is easily explained pragmatically with obvious cause.  The 2008 solvency event hitting the "consumer of last resort" USA market made the USA specific event a global event.  That has created the illusion there is this Rogoff Reinhart "global economy" when there is not.  There is the massive hegemon USA economy and then the rest.



As the other sovereign economic units respond to the USA solvency crisis, almost all have resorted to a mercantalistic currency  policy.  Abenomics, China and now Germany via the Euro reversed the trade weighted decline of the dollar to a consistent 2 1/2% per annum enriching  of the dollar on a trade weighted basis. One can see when the dollar has a period of unchanged values then CPI then surges,  as we saw in the the 2nd Q 2014.  The lack of inflation is solely  dollar level caused and explains about 130% of the inflation that would have occurred now given the lack of capacity in the US economy.  If the FOMC persists in this gross misread of the current status - and perhaps Fischer does realize that as shown by his recent focus on exchange rates - and seeing that the dollar level has always been an administered rate, established by the US hegemon after considering security needs first then domestic needs second, the dollar will cheapen as it usually does, suddenly,  after some keystone forum as the USA asserts their power.  Then a calm to cheapening dollar will expose  the reality of the tight labor market  and little capacity of the US economy.  A large surge in inflation will occur to levels that may approach 6%. That is if the Fed carries on with ZIRP.

The BLS,  and the CES  - who does the heavy lifting and revisions for the BLS - very clearly go over the source of error in the household data and how it is repaired/revised by claims data:

"On an annual basis, the establishment survey incorporates a benchmark revision that re-anchors estimates to nearly complete employment counts available from unemployment insurance tax records. The benchmark helps to control for sampling and modeling errors in the estimates."

And the margin of error for the household data can be substantial:

"...the threshold for a statistically significant change in the household survey is about 400,000..."

(Both quotes from  http://www.bls.gov/news.release/empsit.faq.htm

Given the solvency event was a once in century trend event that experienced a dramtic sudden reversal, it is easy to see that a cumulative  error of three or four months has occurred of about 1 million employed.

The US current unemplyment rate is now about 5 1/8%.  It is very difficult to refute the above logic.  I cannot.





Wednesday, October 8, 2014

Ebola is an unsuccessful disease - why is it creating such impact?

Ebola is a lousy and ineffective virus, as a virus goes – at least in the human sphere.  The epidemiology math  “p” factor in morbidity and virulence  is lousy and requires massive mutation to ever make the big time in becoming a world class killer, like HIV or ubiquitous malaria. 




Retching blood in great agony, or crying tears of blood is great drama, far more terrifying than night chills of malaria or the sarcoma of AIDS, and makes great press.  And like any body fluid spreading disease with high levels  of morbidity – and with all  the blood and gore – it’s  first hit is noted and effective, to say the least.  But the fact it does kill in such a gruesome high profile way with lots of  fluids slopping around, makes it more a terrible and deadly test of basic infrastructure and public health policy than as a effective killer disease.  Most locales have no problem dealing with Ebola, it is a minor though dramtic.  Obviously many African locales are failing utterly.

But Ebola is not a major health risk for the world.

The current press and media are either deliberately doing great harm so as to sell ad space, or they are maliciously  enjoying this gruesome tale, or they are very poor journalists and have made no effort to define the story and get the facts. The press coverage on Ebola is close to or is criminal.

Epidemiology, the science backing the spread of a disease or condition, is  well understood and specific.  The Atlanta based CDC has released a model for Ebola at stacks.cdc.gov/view/cdc/24900 where one can download a easily used Excel spread sheet. 



  Inputs for the population of the area of concern; the ground zero beginning carriers numbers;  the infectious time for the carriers;  hospital, home quarantine and wanderers commitment rates;  how infectious or effective in transmission the disease is while in the hospital, home quarantine, or wandering around – all these variables can be entered to find out how many Ebola cases will occur.  Then a 40% mortality rate can be applied to calculate the deaths Ebola can cause.
I used a very high number of 20 Ebola carriers make it to the USA and go to 20 different cities, not knowing they have Ebola at first. But as soon as they are thought to be at risk I have 95% hospitalized, 3% under home quarantine, and 2% loose in the population.  The 20 different locales means this happens to a population of 200,000,000 (20 times cities of 10MM – obviously a very dramatic number), and the transmission rate of the disease I use .001% in the hospital,  5% while in home quarantine and those wandering around having a 30% infection rate.


The numbers – and keep in mind this is well understood science with little if no debate in this outcome – well a 5% confidence band which is what I instructed the CDC model to solve to – comes out with a Ebola, as far as the US is concerned, a non-event. No Brad Pitt World War Z.


Since this is material is easily found and can be vetted by those more experienced than I quickly, and since the CDC has made this available in a very easy form to understand and do “what ifs”, some disturbing conclusions emerge.

  1. Why isn’t the CDC and the US public health authorities making this well known?  One can conclude that they are spinning Ebola, again from the US perspective, into a monster story into realms of fiction – why? Why aren’t the US public health guys doing their job at a a most critical time of public concern?  Why are they allowing this panic to emerge?
  2.  If I am wrong and the public health authorities are making this available to the press – this CDC spread sheet was easily found – why is the press deliberately ignoring the facts and spinning this into a Hollywood horror sci-fi horror movie?  If the press is aware I can only see this as one of the most callous if not criminal acts of the press that I can remember.
  3.  Or is the press  simply stupid and have been swamped by Twittter and have been reduced to a most ineffective and unprofessional status?  If they are bungling to the point of malfeasance the Ebola story – what other stories are they also “blowing”?  is this Ebola hack coverage defining?
  4. This presents a very grim picture of how terrible lifestyle , infrastructure and public policy is for those stricken African countries.   If the most basic hygiene were applied or the most basic hygiene applied at mortuary or tending to the dead, or just if everyone would wash hands – Ebola would be as it should be, a bizarre one off event striking like lightening some very unlucky folks. 
Ebola is piker of a disease, even in Africa it is at best semi-pro.

What is killing Africans is not Ebola, but that  a very easily contained disease like Ebola can kill so many.  It is the basic African lifestyle and infrastructure that is the disease.  Case in point is that Nigeria, not high on many folk’s list of successful countries, has dealt with Ebola successfully.  That is a frighteningly damning for those countries not dealing with Ebola successfully.  They must be hell on earth.  At the very least all countries need to be brought up to the relative “rich” levels of Nigeria in terms of public health – at the very least.

Monday, September 1, 2014

US Treasury 10 Year - NO "Conundrum"

Basically seeking a place to hang the following slides, both of 5 year UST Yield versus the sell 5 year UST and buy 30 year UST curve trade. But will provide a short discussion

I decided to do a scatter on this after reading the great analysis Jim Hamilton did on the US Treasury 10 year rally and how this was a "conundrum".  While very comfortable with his analysis of risk premium and GDP expectations - at first I was all set to agree - I decided to pull the data. I conclude there is no conundrum but a rare powerful technical move of the curve in anticipation of a sudden Fed Funds hike,  a hike that given the pressure building will certainly be well before year end 2014.  To my read it is akin to how the bay will empty of sea water prior to the arrival of the tsunami.

http://econbrowser.com/archives/2014/08/bond-market-conundrum-redux


Over the long run the 5:30 curve is an equivalency to the 5 year UST yield with usually a vol ratio (5 year UST YV/32) making a .4 outright 5 y UST to every 1 5y amount in the 5:30.

However that vol ratio is now flipped and is 1.4:1 outright to 5:30.

To me this is indicative of significant if not massive pressure on the curve to realign so as to be priced for a regime shift - since the 5 year is still anchored in ZIRP, it means the longer maturities rally harshly to flatten the curve.  Then after the Fed hikes, the curve will continue to flatten but the relationship of 5 y UST now normalized to the curve.

The surge in vol of the 5:30 relative to outright 5 y UST indicates to me a regime jump is about to occur, certainly well before year end.  That regime shift would be a surprise rate hike that will lead to a 2 1/2% to 3% 5 year UST imminently.

Note that the small formation under the 8/30/2014  is the worst of the crisis, when it seemed calamity was to occur, from December 08 to January 2009. It is unlikely we reach such a stressed position  so I suspect the 5 year (and UST yield in general) jumps suddenly to the prior regime.  That is marked by the yellow arrow.

Those who have done well in the flattener to date should swap that position for puts on the 5 y UST.




For open 9/8/2014 followup:

The 5 year UST vs the UST 30s to 5s did move from the above 9/2/2014 opening.  The 30s5s backed 6 basis points and 5 year UST backed 19 basis points, for a total net P/L impact, if you did the above swap, of 25 basis points or $8900 per million 5 year UST par amount.  So far so good.  I think there is a boundary at the data point of 8/29/2014 close.







Sunday, August 24, 2014

Federal Reserve "Dual Mandate" of Full Employment and Price Stability is Likely Unconstitutional and Radically New

 “Justice? - you get justice in the next world, in this world, you have the law.”
                                                                                                William Gaddis  JR

To most the following clearly outlines a "dual mandate", a long running permanent foundation stone of the powers mandated to the Federal Reserve by Congress, an ubiquitous feature of monetary policy:

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.

 November 2010 FOMC Statement.

From then on it was posted in one way or another in every FOMC Statement:

“Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators and inflation moving toward levels the Committee judges consistent with its dual mandate.

 July 30, 2014 FOMC Statement.

But the current use of "dual mandate" is not a legacy constitutional keystone empowering the Fed but is a radically new interpretation of the Federal Reserve Act perhaps now cynically used by Yellen and company.  The  current use of "dual mandate" is unconstitutional and is at odds with the academic literature on monetary economics and  a "ruse" so as to allow the Fed to make economic policy that they are excluded from doing so - thus its unconstitutionality.   

The “dual mandate” used in the Statement, the  official lawful communique by the Federal Reserve,  a radical ambitious (mis)interpretation of the law so as to justify the current focus of the Board of Governors, as led by the Chair, have on employment.  

This citing of “dual mandate” with "maximum  employment" as used is necessary to  justify the current Odyssean Fed and the principles of “forward guidance”.  It empowers the Fed to subjectively and secretively define what is  “maximum employment” – now a slippery qualitative and complex mixture of 19 distinct measurements of employment characteristics, the LMCI,  and a radical de-emphasis on the unemployment rate (UER-3), especially as the rate falls to levels that mocks the Fed.

The Fed's has justified their power rests on the “dual mandate”,  as defined by the Fed and by the  Board of Governors, specifically the Chair, deploying a English/Alvarez/Bernanke invention of the centrality of employment as the mainstay  of "communicative" policy.  But this use of the dual mandate is not a consensus of  Federal Reserve staff, nor with the staff at the Board of Governors.   
There is deep concern within the Fed  that the emphasis on employment, now qualified by the economic intuition of Yellon,  is an incorrect interpretation of the law and is either a theoretical non sequitur or a deliberate academic falsehood, a ruse.

Empowerment for current Fed forward guidance monetary policy rests upon the constitutionality of the “dual mandate”, provided it does not cause undue inflation, on a subjective constantly changing definition of  “full employment”.

This stress on employment is not reconciled with the Federal Reserve Act original intent nor by the amendment of 1977 and 1978.  The 1946 Employment Act does grant the President, or rather charges the President to table policy to Congress to provide “maximum employment”, and the 1978 Act does request the Fed to coordinate with that Executive defined policy.  But it is clear if the President does not table such policy and Congress does not insist upon the Executive to do so, the Fed is not to intercede or fill in the vacuum with monetary policy aimed at changing employment status.

If the “dual mandate” now offered at the end of a paragraph sites a mandate the Fed does not have granted by Congress, wording   starting with  “Consistent with its statutory mandate”, is a legal ploy by the Fed to end that paragraph with seemingly a repeat of the “statutory” with “dual mandate” but now, unlike the language of the statue it states “maximum employment”.

Thereby the Fed “switching” the statutory mandate of conducting monetary policy  "commensurate with potential production” with “maximum employment” is to switch a forward view of not impeding potential production being reached, and thereby the resulting in perhaps the sweet spot of “maximum employment”,  with the Fed current  "exteaordinary" proactive current policy that has “maximum employment” as the only economic objective. This is not the law.

Since this cannot have gone unnoticed by the Board of Governors, I am certain that there has been discussion at the highest levels with the involvement of Alvarez etc, so  the use of "dual mandate" is a deliberate redefinition of the law by the Fed – and is therefore unconstitutional.  

The ability to show there can be a reasonable argument in that “dual mandate” is an incorrect read of the law, that the debate can even be had by thoughtful people both in the Fed and outside, should cause great concern.  

If in fact the argument prevails that the wording “dual mandate” is an incorrect read, perhaps to serve a political agenda by certain ascendant groups in Congress, will be devastating for the Fed and likely ends with Yellen’s dismissal. 

That will  take place if,  though well-meaning in terms of public service, the “dual mandate” does not work and then it will be easily shown it is a  legal ruse justifying a radical progression of the Fed to write macroeconomic policy for which they do not have the mandate or the constitutional power or power to do so.

What further compounds this problem and heightens risk is that the replacement of Federal Reserve Act "production" with many facets, with just  employment is an unproven and keenly debated thesis which involves the Phillips Curve, wage stickiness and many other confusing and unknowable economics.  

Employment has been massively disturbed by a once per century economic event, a solvency event, and it is not even known why unemployment rose as it did and why it is dropping in the fashion it is now. The various ways of describing unemployment are also not calibrating with  “demand side” of qualified labor showing an extremely strong if not on the edge of a bubble economy while unqualified workers and many of the supply side metrics of labor show perhaps a lack luster economy.

This is not the time for the Fed Board of Governors and FOMC  to rewrite law with unproven radical theories of how monetary tools connect tonreak world outcomes.

Yet the public and strangely almost all those in the financial industry are uncritically accepting of the Fed’s radical rewrite of law.  Most have the adamant view that “dual mandate” is written on bedrock and are derisive or dismissive when someone points this out. That they "know" the dual mandate was the intent of Congress and it has always been with us, at least since 1977.

The reality is that before the November 2010 Statement, the dual mandate of employment and inflation  was an abstract or descriptor of what the Fed did, a shorthand even, and was never considered  the statutory mandate.  “Dual mandate” was economic slang,  describing  what the Fed would monitor and consider but not the  statutory mandated objective. It was the “effect” and not the “cause”.  The original clause was a different “dual” – that of inflation and low long term interest rates. The title sentence of the Federal Reserve Act to this date does not even mention employment but states:

“An Act To provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes.

The Federal Reserve is not to write economic policy but first and foremost provide a Bagehot/Kindleberger central authority that provides lender of last resort services and maintains liquidity through the acquisition of assets from the private sector.  This is the most inspired public policy since Hamilton created the US Treasury and national fungible debt. And of course it is why the USA did not enter into depression in 2008.  But once that courageous and wonderful duty was implemented for the nation, the Fed – likely for a myriad of reasons – decided they must focus solely on “for other purposes” as they interpreted in the fly.

The first Congressional act that dealt specifically with employment, in 1946, did not even mention the Federal Reserve but  the President.  There was great concern that after the massive Keynesian stimulus of WWII remedied the crazy tightness of FDR working in coordination with the Federal Reserve tightening, the new President Truman with his reputation of being a “Blue Dog” and fiscally tight, was charged by Congress to deal first and foremost with employment.  It was thought that returning soldiers  returning to a peace time footing would throw the economy into depression, once again.  Therefore it is in error to cite the 1946 act as having anything to do with the Federal Reserve “dual mandate”.  This is the popular view error was  summed in a Washington Post letter to refute George Will taking similar lines to what I am stating  here.  Since the writer is Ken McLean who was a staffer in the writing of the 1977 and 1978 amendments to the Federal Reserve Act, it is thought to have authority and set the record straight.  McLean writes:

“The 1977 legislation referred to by Mr. Will was the Federal Reserve Reform Act, which among other things called upon the Fed to conduct monetary policy so as to "promote effectively the goals of maximum employment, stable prices and moderate long term interest rates." These goals are substantially equivalent to the long-standing goals contained in the 1946 Full Employment Act. The goals of the 1977 act were further affirmed in the Humphrey-Hawkins Act the following year.”  (WP November 25 2010)

This is either at best in error, or worst disingenuous as nothing that transpired or said by Congress, even to date, supports his statement.  To cite the 1946 act is either an old man with a fogged mind or simply bunk.  The 1946 act has nothing to do with the Federal Reserve Act and the  the Federal Reserve amendment of 1977 citing of the 1946 act in 1978 clearly has employment as the effect that increased production would bring about, among other economic variables.  McLean also takes the wording of maximum employment out of context, not mentioning the preceding language.

The key and entire language is in Title 12 Chapter 3 Section 225 (a) which was changed with the 1977 amendment,  a change that was 64 years in the making, with the  addition of the term “maximum employment”:

The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”

It is important to note where employment appears in regards to or dependent on what.  The statutory mandate is to “increase production”.  “Maximum employment” is the intended  results of “increase production” and explains why Congress is instructing the Fed to increase production. To have the Fed to assist or allow administrations policy for the country to reach potential production is the entire mandate, and it is assumed that maximum employment will be the end results, which by production growth  the Fed "promotes" for the long run.

The following year Humphrey-Hawkins Act elaborated further on this intent and “finding of Congress”  and clearly shows the non policy making role of the Fed  by adding a reporting section 225 (b), which by listing what Congress wants reporting on shows the placement of employment in this intent:

(b) Congressional Report. The Board shall, concurrent with each semi-annual hearing required by this section, submit a written report to the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Banking and Financial Services of the House of Representatives, containing a discussion of the conduct of monetary policy and economic developments and prospects for the future, taking into account past and prospective developments in employment, unemployment, production, ,investment, real income, productivity, exchange rates, international trade and payments, and prices.’

Clearly employment is only one of the several factors of “the long run potential to increase production”.  There are many variables, employment being only one of the variables.

Furthermore the 1978 Act has a preamble a “finding” of Congress which shows the limits and the expectations of how the Fed was to act in this system and with whom:

and by improved coordination among the President, the Congress, and the Board of Governors of the Federal Reserve System.

It is obvious that the mandate the Fed received from Congress was to implement policy that contained or prevented inflation in the context that would increase production.  The Fed was to then report on how the monetary policy impacted the variables that describe the whole spectrum of production.

There never was a dual mandate of “maximum employment" and inflation granted to the Fed by Congress.  It is clear “maximum employment” is the desired results but not the mandated objective.

The history of the Fed after the 1978 and a consideration of the “dual mandate” use since then, also shows that Congress has never granted the Fed the employment and inflation dual mandate.  Almost immediately after the 1978 Humphrey Hawkins Amendment, Volcker simply tossed onto the academic rubbish heap Miller’s use of the amendment – and Miller did not focus on employment but concentrated on economic growth via an easy Fed such that it would result in greater employment.  The results were the agony of stagflation, which in theory was never to occur, so the 1978 act suffered immediate discrediting and seemingly proof that the linkage of inflation and production was not understood.  So the entire academic basis for the 1978 was tossed out the window – and to many that is still its status. Volcker commented:

“… I don’t think that we have the choice in current circumstances — the old tradeoff analysis — of buying full employment with a little more inflation.
We found out that doesn’t work, and we are in an economic situation in which we can’t achieve either of those objectives immediately. We have to work toward both of them; we have to deal with inflation. And the Federal Reserve has particular responsibilities in that connection. “

From then until the mid 1990s, the Fed “dual mandate” was rarely mentioned as the Phillips Curve and the ability of the Fed to control the employment inflation tradeoff was a risible concept.  In fact employment was dropped from consideration and it was accepted in the sense Congress always had placed it, as a subset of production with production analysis framed in terms of realized and potential.  The rules appear where societal goals of full employment are not considered to be within the ability of the Fed to seek.  That is why all monetary policy “rules”  (ironically Yellen implicitly acknowledges this with her modified Taylor Rule, her “balanced rule” not having employment as an explaining factor) either have only inflation or inflation and some metric  qualifying production – usually an output gap value -   as the entire useful set of factors that the Fed can effect.  Since there is no academic literature, at least that I can find, that applies an employment variable into a “rule”, it shows that no one at the Fed thinks they can directly impact employment.  This is another indication that not only is “maximum employment” cited as the mandate an unconstitutional legal ruse, the use of employment in the dual mandate  is a communicative effort, or more correctly described as propaganda.  Bernanke admits as much, how the fed cannot impact employment but is in the domain of economic policy not monetary policy  in one of his last speech on November 19 2013:

“….the Federal Reserve could not adopt a numerical inflation target as its exclusive goal. Nor would it have been appropriate for the FOMC simply to provide a fixed objective for some measure of employment or unemployment, in parallel with an inflation objective. In contrast to inflation, which is determined by monetary policy in the longer run, the maximum level of employment that can be sustained over the longer run is determined primarily by nonmonetary factors, such as demographics, the mix of workforce skills, labor market institutions, and advances in technology. Moreover, as these factors evolve, the maximum employment level may change over time. Consequently, it is beyond the power of the central bank to set a longer-run target for employment that is immutable or independent of the underlying structure of the economy.”

This is amazing, to me as Bernanke is almost winking and rubbing his nose and admitting that the use of employment by the Fed is solely to fool the folks into having the expectations the Fed seeks – ergo “forward guidance”.

The problem now seems to be that some in the Board of Governors group, including Yellen have come  to believe that  the mandate is full employment, one of a duo,  and the Fed can bring about a qualified full employment status.  Or she is a most audacious liar and is cynically leaning into the Bernanke “communicative” purpose of the ruse – no harm no foul all for a good cause – to simply expand and maintain the newly found power of the Federal Reserve delivered to them by the crisis.

The use of employment in the dual mandate also didn’t appear until mid 1990s, and when hawks attacked   Greenspan who bravely made a call on productivity that allowed him to stay in relative ease throughout the 1990s, producing the “Great Moderation” and providing the strong capital market setting that allowed for the rise in productivity in the first place, the dual mandate was thrown in his face to justify the Greenspan policies. It seems the Princeton colleague to Bernanke, Alan Blinder was the first to use this approach, defending Greenspan from the hawks when he wasnt trying to oust Greenspan and replace him with Alan Blinder:  

“As usual, let me defend the status quo. We have a dual objective in the Federal Reserve Act now. I think it works very well. I think the case that it is broken and needs fixing is very thin. … There is no existing evidence — and I can’t say this too strongly — that having such targets leads to a superior trade-off. None at all. It is not one of those cases in which the evidence is equivocal. There is nothing that can be cited “  FOMC Minutes Jan 31 1995  Blinder

Then, perhaps with Blinder exiled from the Fed and the dotcom bust, employment in the dual mandate disappears from academic and Fed lexicon until the 2008 solvency event.

And even then the Fed was slow to discover that their main purpose in life was to honor the “dual mandate”, not even mentioning employment and mandate in the same sentence until the September 2010 FOMC.  I find this very strange as it certainly does not sync with those who think “of course” the Fed’s powers rest upon the long established core empowerment of the dual mandate – it is law!

“Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the long run, with its mandate to promote maximum employment and price stability” September 2010 FOMC Statement"

But even as late as 2010 the Fed was yet to discover their constitutional bedrock of empowerment, the obvious long standing dual mandate of “maximum employment” and inflation.  But by September, as they started to get some heat over the startling swelling of the Fed’s  balance sheet via QE I and then the start of QE II, they had obviously switched the statutory mandate to support increased production with “maximum employment”.  By the November 2010 FOMC, finished form had been “discovered” and the shibboleth of dual mandate had been created with the Fed freely rewriting the Federal Reserve Act, despite the fact that they believed that the Fed could not directly affect employment, that employment was a nice results but since Miller no one at the Fed thought it had much to do, if anything, with monetary policy. Still the November 2010 Statement was the first statement of the dual mandate claim that has been in every statement since:

“Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.” November 2010 FOMC Statement

The belief in a “natural rate”, a Fisher rate, is the keystone to FOMC monetary theory.  The level of what the natural rate is is the subject of great debate, but almost all policy makers and analysts in the Fed system believe in the Friedman-Phelps natural rate thesis that the natural rate cannot have any impact on the level of employment.  
 
So based on the record, a read of the relevant law and the amendments, the academic use of “dual mandate” both inside and outside the Fed since the 1978 amendment, the widespread belief in Freidman-Phelps, and how the “dual mandate” slipped into the FOMC Statement and when it did so (late as November 2010) – the Fed, in truth,  do not believe they have a Congressional mandated objective to reach “maximum employment” and the use of the concept of “dual mandate” is for “communicative” purposes or to justify the  greatly expanded power base.   

In short, the formal use of “dual mandate” with maximum or full employment as one of the main objectives of the Fed, is clearly unconstitutional and a “ruse”.   Since Miller every FOMC was loath to express their objective or mandate in terms of unemployment or employment as it was felt that it could not be changed via monetary policy and was not the mandated task assigned to the Fed by Congressional law.

All that radically – and  in a very risky unconstitutional way – changed on November 3, 2010.

Those who think the dual mandate is a given, always a keystone to Fed policy and clearly the assigned duty of the Fed by Congress simply have not read the history of the Fed, considered the law in even a casual manner, and are naive.

Wednesday, July 9, 2014

The "Dots Explained

Much has been made of the “dots”, the pretty smattering of the FOMC voting members depicting their Fed Fund expectations to 2016 and then for the “Long Run” thereafter.  The tabling of these expectations are potent as they show the FOMC voters true thoughts no matter the verbiage of the Minutes or the Statement prior.  A voting FOMC member can now dissent  anonymously without casting a dissenting vote, providing subtle and yet more powerful contrary views.  Finally, in the “Long Run” Fed Funds expectations,  the Keynesian steeped FOMC members – no matter if a classic Taylor like view or a New Keynesian  “forward guidance”  believer – all agree Fed Funds converge to NGDP.  So much can be expressed in the ‘Dots” without knocking heads against Chairman Yellen directly, or entering into a weary argument, once again, with the likes of President Kocherlakota or Secretary English.  The “true believers” are onto this form of sneaky dissension and have even started a move to ban the “Dots” forcing  dissenters into a publically noticed “no” vote.   But for now we still have the ‘Dots”. It is obvious the "1%" expectation FOMC voter does not believe in a single word of both the Minutes and the prior Statement. 

The “Dots” as almost all wrestle with to date are here:


Very pretty  indeed, and then most cut and paste several of these FOMC charts on top of each other, holding them up to a bright light, to get an idea how they change.

A better way to consider the “Dots” is via the famous statistician John Tukey's “box plot”, with each column above represented by a “box and whisker”.  The line bisecting the box (sometimes it doesn't bisect if the expectations are extremely skewed) is the median value, the top and bottom of the box is the 75th and 25th quartile boundary and the dotted line goes out to the 100%  but for extreme trimmed outliers which are shown well above or below the box.  Those are our “secret dissenters”.  A  set of boxplots are plotted for the Dec 2013, Mar 2014 and the June 2014 FOMC package attached to the minutes.  And here it is:


A lot easier to track the “secret dissenters” and the range of the calls and the median of those calls which most see as the “Fed Funds “ path as if it is written on a tablet from the mountain.  There is obviously much turmoil at the FOMC hiding behind the tepid minutes written by the “true believer” Secretary Bill English to suit the Chair’s supposedly all-encompassing view.  To my read it looks like the FOMC consensus is now a facade of sorts and there are some serious mischief makers armed with their large credible staffers back at the regional FRB office tower.  Then there are some technical issues of note – first extreme disconnect for the majority of the FOMC who feel a very large 1% rise in the Fed Funds will be required – hopefully not all on the last day of 2015 as the Chairman suggests. Then the majority believe another wrenching very large 1.5% add on to Fed Funds are required in 2016.  Given the size of these expectations of the FOMC majority, and taking into account past FOMC tightening, most of this 2.5% raise will happen swiftly, likely within 6 months or even shorter.  The next interesting point is that the Long Run consensus is very tight around 3 ¾%, but that has dropped from 4% recently.  This shows the entire FOMC is a believer in the “New Normal” of Bill Gross, just not as much a drop that he anticipates from the “Normal” long run NGDP.  And a significant change in this belief to even a more pessimistic view occurred in the three months between March 2014 and June 2014.  Why?  Yet at the same time the expectations for growth or return to trend growth accelerated from the March FOMC meeting to the June, as shown by increases by the majority of FOMC voting members for 2015 and 2016.   No wonder the  curve flattened so much in 1st Q to 2nd Q 2014.  The dispersion  increased in the June meeting for both 2015 and 2016, suggesting greatly increased volatility is implicitly expected by the FOMC voting members.  VIX shorts  should take note.

This shows the basis point vol as reflected in the dispersion of the FOMC voters:


The move from 0.78 yield vol to 1.26 for 2016 Fed Fund call in the June FOMC will likely result in about a 2% 2 year vol at some point which will be wrenching and perhaps transmit to a 25% VIX and 2 year SP vol swap.


The voting members of the FOMC “Dots” should be taken in very carefully with a few caveats. The first, though with exceptional knowledge, experience and insight, is that these are human expectations and the wide differences  between the members shows clearly the lack of consensus, despite the unanimous vote.  And those expectations, already diverse,  always change with a “whoosh”.  The second point, on that “whoosh”, is well described by Mike Tyson; “everyone has a plan until they are punched in the face”.  



Or to paraphrase; “Expectations from the FOMC are reliable until they change, suddenly.” 

The “Dots” should also be seen as the tip of an iceberg where each “dot” is backed by a army of researchers and the credentialed, who are without a doubt the best in the world at monetary policy and monetary economics.  Each “dot” represents thousands of hours of research and debate, sometimes intense debate to the point careers are ruined, or then rescued as Kehoe was at the Minneapolis FRB.  So each “dot” is the end results of the very complex political demands of each voter to their home base, and is a melding of their staffers views and their own.  At the very least the voter is required to spend hours upon hours consulting and interacting with the staffers even if the voter's personal view is different.  That is unless you are President Kocherlakota in which case you simply fire the bastards. 

Thursday, April 24, 2014

My take on Piketty - 4/21/2014 BI Interview by Rob Wile

Editor's note: Below is a Q&A with Mac Robertson, an independent portfolio manager and macro strategist who recently Tweeted a critique of Thomas Piketty's new book, "Capitalism in the 21st Century." This Q&A went out to subscribers of our "10 Things You Need To Know Before The Opening Bell" newsletter on Monday morning. Sign up here to get the newsletter and more of these interviews in your inbox every day.

BUSINESS INSIDER: Your main point of criticism was Piketty's data set. What was wrong with it?

MR: National account income data is, by definition, made up of many subaccounts which have various weights waxing and waning. So as particular weights suddenly surge while others decline, the aggregate summation is not reflective of these dynamics. This is especially problematic with household income, both annual income or accumulating net worth. In particular income is a "fat tail" with extreme skew — a Pareto distribution — or is actually a bimodal or multi modal distribution.
This means policy acting upon one part of the distribution will often have little impact on another part. Policy changes for, say, the top decile will have no impact on the lower quartiles.
Or, if top decile, which might actually be a separate distribution, is reduced by tax, the lower quartiles may drop. The connectivity implicit when one discusses inequality does not really exist.
So, to use the aggregate tells you nothing and provides no prescription.

BI: You go on to say he erred in trying to compare nations' outcomes. What did you mean? 

MR: Nation states, as far as macro economics, are really a fiction. The real aggregations are among hegemonic powers which set economic policy for their group or are a constantly morphing alliances of regions that transcend national borders.
And currently there is only one true hegemon which is the USA, but regional hegemons have defining capability if the USA has benign indifference in a certain region. For example Brazil has much clout in South America now. This is always a fact of life now and the usefulness of examining many nations hasn't really been useful since Metternich.
In fact many of the wars in the last 150 years have been caused by one power thinking that there was a balance of power and one could, by strategy, dominate. Germany and Japan made that mistake in the 1940s and China may be doing the same now. What this means is there is little relevancy or usefulness in comparing Italy in the 20th century to the USA, for example.
Some economic histories are useful as they produce a laboratory of unique events, like Weimar inflation or Sweden's solvency crisis of 1990s, but then only in terms or organizing ex ante thesis. The empirical record is useless.

BI: Piketty described a "fantasy world." What are you referring to?

MR: The fantasy world is the same as Rogoff and Reinhart offer: that there is a scientific theorem that can be developed from this analysis of many national accounts. But that assumes there is equivalency between nations and consistency of the subsector input that makes the national accounts. The above two points do a good job in briefly explaining why that is a fantasy.

BI: You said you preferred Henry George's analysis of income distributions. Who was he and what did he say?

MR: Henry George was akin to Keynes and also Locke, that sound economic policy cannot leverage "luck" in being given rare resources from an accident of birth or through lucky stratagems. George called this resource "land," later Keynes would call this capital and land. But the common denominator is one class of folks are "rentiers" who only seek a low risk return on their assets — usually inherited. That income is "rent." Again in George's time that was, for the most part, real rent on land leases.
George proposed that all funding of the public purse would be a tax on rent. Keynes went further and proposed that not only would rentiers be disproportionately taxed, but their " euthanasia" should be sought. George would propose that inequality between rentiers' capital accumulation and income of consumers and entrepreneurs is the only inequality to seek reducing or eliminating. Keynes agrees, so do I.
To not differentiate this income type, speaking to the first point above, invites disaster. Why would you tax a Bill Gates midstride? It would be very destructive. Yet Bill Gates' income explains much of the income inequality. But would taxing late-stage Buffett be good? Perhaps. Certainly to tax third-generation rentiers and forcing the money back into the hands of future Bill Gateses, perhaps by funding universal education to promote future Bill Gateses, is good.

BI: Is there anything Piketty got right?

MR: No, there is very little Piketty got right. And his work lacks integrity with solipsism and "pop" so that I suspect he is a careerist. All the above he would know well.


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