Manna from Heaven: the Harvard Stimulus Debate

Last week there was a fiscal stimulus debate between titans John Taylor and Larry Summers, at Harvard. Taylor wrote his opening remarks on his blog, which I recommend without further comment.  Summers was quoted in the Harvard Crimson:

Summers also said that in studies comparing states that received varying amounts of stimulus money, those that received more money experienced higher levels of job growth.

This makes no sense as an argument for overall fiscal stimulus. 

The fact is certainly possible. A good example of such studies is by Emi Nakamura and John Steinsson, summarized in their VoxEu blog post. Output rises in states that get more military spending:

...when aggregate military spending in the US rises by 1% of GDP, military spending in California on average rises by about 3% of California GDP, while military spending in Illinois rises by only about 0.5% of Illinois GDP. ...we can use regional variation associated with these buildups to estimate the effect of a relative increase in spending on relative output. Our conclusion is that when relative spending in a state increases by 1% of GDP, relative state GDP rises by 1.5%. 

But they're upfront about the limits of this result: 

Are multipliers of 1.5 too large to be true? ... some care is required in interpreting these empirical results. ... in our setting, the region getting the spending is not paying for it. (My emphasis) 

And that's the problem.

Sure. Suppose the government pays contractors to build a military base, or to dig a  ditch from Fresno to Bakersfield (high speed rail.) Is anyone surprised that GDP goes up in those areas? The contract itself is a government purchase, and adds to GDP, whether or not the project is of any use at all. When a donut shop relocates from LA, and people spend their salaries on donuts, that counts for more multiplier.

But where did the money come from? Showing that the government can move output around does not show that it can increase output overall. To build the base or rail line, the government had to tax or borrow the money.  Cross-sectional studies do not measure the loss of demand in (say) Chicago from the money that got spent in Bakersfield.  Actually, the studies can count the loss for stimulus: Every dollar that Chicago's GDP goes down from the extra taxes or borrowing means that the relative output in Bakersfield goes up.

Amazingly, our government has seemed unable to accomplish much of this manna-from-heaven local stimulus in the recent recession.  (Steinsson and Nakamura's study was on military expenditure in general, the potential for such "stimulus," not how much of it actually happened in this recession.)  John Taylor shows that the actual stimulus didn't even get spent, and when it did, didn't create many jobs. The Wall Street Journal had a nice article a few weeks ago, showing in detail how a $10 billion in stimulus money for wind farms produced few jobs. Even taking administration numbers at face value, we spent hundreds of thousands of dollars for each $50,000/year job "saved."

Larry may be citing studies of the recent recession that disagree.  But I think it is a mistake to get too deep in this argument: As  a matter of economics, the government should be able to move output around, making one area worse off and another better off. The delicious irony that it was unable to do much of that in this case shouldn't blind us to the fallacy of composition:

Stimulus has to be paid for. In evaluating stimulus for the whole economy, you have to count the loss of demand from the paying-for-it side equally with the raise in demand or employment from the spending-it side.

(If you like to cite New-Keynesian models, beware they are "Ricardian" so you can't even rely on the magic of borrowed money -- you have to defend the idea that taxing Chicago to dig a ditch in Bakersfield raises output on both places by one and a half times the tax. Not impossible (Jon and Emi try), but not as easy as it seems either.)

Summers was also quoted: 

“Use your common sense,” Summers said. “Do you really believe if we had done nothing in response to the crisis in 2008, it would have been a good idea?”

That's too easy. Medieval doctors said, "the patient is dying, we must do something" before each  bleeding.

I know it's  unfair to criticize quotations in a college newspaper, so take these as comments on the (very common) ideas rather than anything personal about Summers or exact about the views he presented at the debate. I presume Larry said something a lot deeper.

The debate will be repeated at Stanford, and I hope we get a transcript or a video of this important event. This could be the Scopes Trial or Huxley–Wilberforce debate for fiscal Stimulus.

A story from Davos, and how Grumpy got his name

I was reading Nick Paumgarten's New Yorker article about Davos in the bathtub this morning, and ran into this gem:

The Belvedere [hotel], ... is the annual meeting’s hub after dark. Often, there are a half-dozen parties going on at once. To get into it,...you must pass through airport-like security ... The line, on this night, was long enough that a Nobel laureate in economics, who, moments earlier at the Hotel National, had been holding forth on unfairness, deemed it worth cutting. 

It would be easy enough to figure out who it was, but I like the story better as it is, a reflection on the Davos attitude, not a snarky comment on one individual. (If you know, please don't run it by outing him in the comments.) 
 
A while back, on a lovely spring night, I was walking home with my family after dinner out. We observed one of Hyde Park's Great Liberal Minds, walking his ill-trained dog. He watched his dog deliver a a large steaming poop, and walked off, leaving the poop behind.

I opined, "well, there goes the Great Liberal; I suppose he thinks there is a Federal Department of Picking up your Dog Poop."

The kids laughed and dubbed me "Grumpy Economist" on the spot.

Update: I removed a few comments. I really do not want this to be personal.  

Shake, Shake, Rattle, Rattle But No Roll.

That was the story for the week. I think there are hardly any bears left in town. And I forgot how long the major indices have been going up without even a 1% correction. But the fuel tank is empty and the rocket has been going up on vapors as you can see.

Today McClellan publication has sent out their chart in focus with the following commentary.

The McClellan Oscillator went below zero back on Feb. 14, and has remained negative ever since.  But that has not stopped the major averages from moving up to new multi-year highs. 

Having the Oscillator drop below zero can sometimes be seen as a "sell signal", but it depends on what else is happening in the market.  It is certainly not a positive factor to have higher price highs appear while the Oscillator refuses to confirm that strength. 

Seeing the price indices make higher highs with the McClellan Oscillator down below zero says that the former pace of the price advance is not being sustained.  It is like a Mercury rocket which has run out of fuel but is still rising, and the slowing pace of the rise is a precursor to splashing back down in the ocean.

The problem is all divergences take time to work out and as of now price action says that the trend is up. The market action of Friday was that of confusion. While it did not make a new high, it did not take out the old low or make a new low as well.  Some of the indices like Russell 2000 and DOW-Transport have turned south and are in the sell zone. The divergence between SPX and Transport is worth taking note;

(Hat tip: dynamic hedge)

Let us see if we can find any other clues. On Friday the 10 yr treasury interest fell by almost 50 BP and TLT rose almost 1%. By itself that is not a big deal but if we look at the position of the commercials on JPY, it may be saying something. The commercials were net short in JPY two weeks back and both JPY and US treasury yields were falling.

Now they have turned net positive on JPY and yields have started to rise.  When JPY rises, bond price also rises.

When bond price rises, equities fall (normally) as you can see from the last 5 years comparison.

It is not a done deal yet and we have to wait for the confirmation .

Michael Stastny is a Maths Professor in Spain.( I think now he is in Vienna) Sometimes back in 2010 he had an inspiration and he converted SPX in Euro and compared it with Nikkei. The result was stunning.

So, the upswing that we are seeing now is not totally unexpected and we can expect to get more in the year 2012. The next three years will be the end of the print and inflate economy.  That ties neatly with all other technical and fundamental indicators that I am following and developing. When you have a road map it becomes easier to navigate.  

In the mean time, the trend table has not changed much and gold continues to be on sell signal. I am expecting a bottom in GLD in the price range of  $156-158.

Thank you for reading http://bbfinance.blogspot.com/ . Please forward / retweet the post to your friends and join me in Twitter. (@BBFinanceblog). As always, I welcome your comments and suggestions. Hope you are enjoying your weekend with your loved ones.

Weekend Reading.

The detailed analysis for the day and for the week will be posted tomorrow. In the mean time, here are some interesting news from around the world;
Juncker Piles on the Pressure: Merkel Stuck in the Euro Firewall Trap - SPIEGEL ONLINE - News - International
Bundesbank at odds with ECB over loans - FT.com
European Central Bank's cheap money has just turned toxic banks into zombie banks - Telegraph
Juncker wants EU commissioner devoted to Greece | Athens News
ECB puts Greek banks on emergency aid after downgrade | Athens News
Euro zone puts Greece's efforts under microscope | Reuters
5 Hurdles that Could Make Greece Bankrupt | Forex Crunch
Greek Official Warns Debt Holdouts - NYTimes.com
Spain defies Brussels on deficit target | Reuters
www.openeurope.org.uk/Content/Documents/Pdfs/Greece_Bad_Deal.pdf

Have a great weekend folks.

Return of Volatility?

It was a volatile last hour in SPX without any clear direction.  How would you conclude today’s market action? Was it a retest of yesterday’s high? Do we have a confirmed top yet? One thing for sure, a strong market trend like this one does not die quickly. While SPX closed above 1370, DOW was below that psychological 13000 and Nasdaq below 3000. Today SPX was helped by the banks. Both GS and JPM broke to new highs.

Where we are in terms of sentiment? Per Reuters professional assets managers have the highest equity long exposure in 14 months and retail participation in equity mutual funds are also net positive. Is there anyone left in the game?

Our good friend Cobra was right in his last night’s assessment that yesterday we had a bearish engulfing candle in SPX which results in green close next day. I was doubtful. This is his chart from yesterday.

It is quite a big chart. To know more about bearish engulfing candle pattern, please read here: http://thepatternsite.com/BearEngulfing.html .  So from yesterday’s action, we have a two reversal patterns and a possible test of the high. And Fridays have been the most bearish day off late. Will we see the turn tomorrow? It is going to be a very crucial day.  We still do not have a 1% correction day and we are 60 days in the year!

The weekly BPSPX showed 1^st tiny red bar:

Again, it is just a sign that the momentum is stopping. Not an invitation to short.

Apple showed the 1^st intra-day red in 2012. Yesterday when the market was selling off, Apple was going higher. It seems they are selling it in strength. Because the strength of both SPX and Nasdaq is based on Apple, when Apple sells off, you will find the door too small for all to exit. Here is some interesting tit-bit from Sentimentrader.com. Let us call it $500 Billion dollar club. There are only six companies so far in this club.

It sure is going to be interesting.

It has been a strong up- trending market so far in 2012. More so, it is a Presidential election year and stakes are high. Central Banks all over the world is flooding the market with cheap liquidity, otherwise they will go bust. Most likely it is the beginning of the end game. In this stage we will find a blow-off top for the stock markets. But before that we will have to go through some panic which will justify more free money by Bernanke. He cannot dole out money if SPX is near 1400.

Because of so much money printing, gold is going to benefit along with equities. I think by year end we will see gold price in the range of $ 2000-$2200/ounce. Question is when is a good time to get in.

Today’s reminder of market manipulation came from oil complex. 1^st the news of Saudi oil pipeline explosion pushed oil above $ 110 and then the denial after the market close. Someone wanted to offload the position. Good show!

In the mean time, not much change in the trend table.

In future I will be trading based on trend table. We have seen that even the best of signals fail in a strong trending market.

And here is some interesting news from around the world:

Why the ‘risk-on’ rally will not last - FT.com

Rental Business Picks Up - NYTimes.com

Why Conventional Commodity Indexes Will Likely Disappoint

Capital Flight: Southern European Money Migrating North to Safety - SPIEGEL ONLINE - News - International

German court: parliament panel can't decide bailouts | Athens News

Averting the Next Greece: Portugal Needs More Money To Stay Afloat - SPIEGEL ONLINE - News - International

Thank you for reading http://bbfinance.blogspot.com/ . Please forward / retweet the post to your friends and join me in Twitter. (@BBFinanceblog). As always, I welcome your comments and suggestions.

Benn Steil and I debate house prices

Last week Benn Steil wrote a very interesting oped on housing. (Originally at Financial News) He unearthed the amazingly large number of young people who bought houses in the boom, and then lost a lot when house prices fell. One quote:

What effect did the housing bust have on them? Household balance sheets among the Facebook generation were the hardest hit: between 2007 and 2009, half of those under the age of 35 lost over 25% of their wealth. A quarter of those under 35 lost over 86% of their wealth. Not surprisingly, they have been badly hit by the foreclosure tsunami; the median head of household in foreclosure being eight years younger than the median not in foreclosure. Younger households typically started off with less wealth than older ones and, following the bust, ended up with much less.

This bodes badly for their future, and the country’s

I wrote back, and the following exchange might be useful for blog readers here.  We don’t come to hard and fast answers, but I think we clarified a lot of channels that do and don't work.

John:
Your oped was very interesting, but I have to disagree with a basic point.  Lower house prices are great news for the majority of young households.
They either don’t own a house or are looking to trade up. Cheap stocks are also great news for them. Even those that lost money in one house will still want to live in houses for a long time, so they can buy a new house for the same low price that they sell their old houses for.  Lower prices are only bad news for old people who want to downsize.

Benn:
For those that did buy – a lot – the data I cite say they’re in bad shape.  For those that didn’t, you surely have a point, with the major caveat that credit standards are much, much tighter now (I’ve been through a mortgage and a refinancing over the past 2 years, and they were hell).  You yourself have commented several times on the great rates that no one seems to have access to.

John:
The ones who bought surely are in bad shape, at least on paper.  A young person who bought stocks on margin leveraged 90% in 2006 would also have lost a lot of money!  But together with a collapse in wealth, there also has been a big decline in the cost of living – houses are cheaper. They don’t need as much wealth as before.

View it another way. They still have the house. If you bought a house in 2006, and you’re still employed, by and large your wages haven’t shrunk. You can have exactly the standard of living you had planned for in 2006, and it doesn’t matter a whit that the resale value of your house has declined. Really, look at it: same wage, same mortgage payment, same prices for stuff. So what if the house price went down?  And even if you want to move - - again, you buy a new house for the same low price you sell your old hose. You can keep the planned standard of living.

OK the ones who are not employed have trouble. Or the ones whose wages are cut. But really, employment is the source of their trouble, not that the value of their house has gone down. 

Benn:
If your net wealth, including home value, was $100,000 in 2006 and $10,000 today, you could still “have exactly the standard of living you had planned for in 2006”?

John:
If you can afford to buy the same basket of goods, you have the same standard of living.

Basically, it’s deflation. The deflation is not yet recorded in statistics because they use the rental equivalent measure of housing costs.  If your net worth goes from $100,000 to $10,000 but there is a 90% deflation you are exactly as before.

As an extreme, suppose technical improvement makes housing free – we figure out how to grow houses from chia pets in a week. The price of existing houses goes to zero. There are winners and losers here too. But obviously as a society we are much better off.

Benn:
If I lose 90% on a stock am I no worse off because the broader index is also down 90%?

John:
You don’t live in stocks…

So,  yes. If you lose 90% on a stock, but the stream of dividends is completely unchanged, then yes, you’re just as well off as before. If before you were planning to live off that stream of dividends, you can still do so. If before you were going to exchange the stock for a different one that gave a similar stream of dividends, you can still do so.

The key difference: Stocks typically fall when there is a big bad shift to the expected stream of dividends. When your house price falls, there is absolutely no effect whatsoever on its value to you as living space.

As with houses, you’re worse off if you were just about to switch from stocks to bonds. And you’re better off if you were young and about to invest in stocks, as now you get to buy the same dividends much cheaper.

(In retrospect I’m being a bit too strong, as usual. The fall in house prices comes with a lot of foreclosures and neighborhoods that are no longer great places to live.  A lot of  the houses are now in the “wrong places,” so genuinely less valuable. But for the argument here, that’s really about foreclosures costs, and the rise and fall of neighborhoods, i.e. collateral damage from house prices, not the direct effect of house price falls per se. Also, if you don't have the cash to pay off a mortgage and take the loss, moving is tough.)

Benn:
Is the ability to borrow against my appreciated home worth nothing, then?

John:
Now I have to give in a bit. Yes, this is a good point, and I ignored your credit point above. 

Remember though that borrowing has to be paid back. So you bought a $100,000 house in 2005 with $10,000 down, and $1,000 per month mortgage.  It goes up to $200,000. Great! Now you can refinance and take an extra $90,000 out of the house and go on that round the world cruise you had been hoping for. (Or start a business, or whatever.)

Whoops.  Except now you have to pay the loan back. You have to pay $2,000 per month on your bigger mortgage. As long as you want to live in the house – or another one of the same size – you didn’t get any more wealth.  “Removing a borrowing constraint” is different from “having more wealth.”

So you are better off, but only if you knew you were going to get a big raise, so that you wanted to borrow a lot of money but the bank wouldn’t let you.   That might be true for a lot of people. On the other hand, we are perhaps becoming skeptical that it is such a great idea for young people to pile on a huge amount of debt, so perhaps not such a social tragedy that they can’t do it as easily any more.

But don’t confuse the size of a possible borrowing / collateral constraint with “wealth.”

That’s part of the transfer question. Those who rented did worse when house prices went up, and do better when house prices go down.  There’s no question that It’s better to be a renter if you know prices are going down and vice versa. Just as it’s better to be out of the stock market when prices are going down.

Benn:
My point is precisely that the young, as a group, are worse off (irrespective of what they thought they knew about where prices were headed).  I think there’s more than a fair debate to be had about the macroeconomic effects of this going forward.  But surely what I’ve found on the demographics must be relevant to the question – so at least worth raising.  No? . . .

John:
Yes indeed!  I think we’ve talked about all sorts of interesting channels by which some groups benefitted, some were made worse off, and we all were made worse off by the end of the housing boom. Less collateral (for better or worse), houses built in the wrong places, half-finished houses, foreclosure externalities, the difficulty of young people starting carrers and so on.

 But let’s also steer clear of the things that aren’t true, like the idea that just because the resale value of your house declines, you are automatically a lot poorer, especially if you are young and going to live in the house for a long time.  


(A special thanks to Benn for graciously agreeing to let me post our exchange.)

Another Economist Off the Rails

Maybe he is being misquoted! In today's NY Times Professor Ronald Kurtz of MIT's Sloan School of Management is described as believing, in his new book, that tax policy is the reason we have an out of control debt situation. If Kurtz believes this, he must have some serious trouble with arithmetic. Taxes are really irrelevant to our long run debt situation -- whether high or low. The entitlements cannot be afforded if we were able to grab 100 percent of everyone's income -- rich and poor.

So what difference does the tax rate make? There are, of course, two debates going on. One is the "fairness" debate which is a bit misleading, since those who advocate "higher taxes on the rich" are well aware that higher tax rates may end up reducing what rich people will show as taxable income and reduce revenues, potentially dramatically reduce revenues. So "fairness" may come at the price of lowered federal revenues. Is that fair?

The other part of the debate is that higher marginal tax rates reduce incentives for business expansion and employment. Those who deny this point to earlier periods when marginal rates were higher. But, no one paid those higher rates of yesteryear. There were far too many loopholes.

When John Kennedy was first sworn in, he asked for a report on all the taxpayers paying the 91 percent rate, which was the highest rate at the time. Guess what? There were a whopping total of seven taxpayers paying that rate. No one willingly pays rates like that. You wouldn't either (neither would Warren Buffett). The rich simply shift assets around so that no income shows up. One of the wealthy taxpayers in 1961, Mrs. Dodge, a General Motors heiress from Grosse Point, didn't even file a tax return. Her assets were all in tax free municipal bonds. So, do you think Mrs. Dodge cared a whit whether rates were 30 %, 70 %, 91 %, or 100 %.

So, what did John Kennedy do? He sent a bill over to Congress to lower the highest marginal tax rate from 91 % to 70%. His purpose? To increase tax revenues. President Kennedy got the point, that seems lost on Professor Kurtz.

Anyway, here we go again. Another economist who thinks that a $ 66 trillion unfunded liability can be dealt with by taxing a hand full of wealthy Americans.