Every day, I wake up expecting that things can’t get any stranger; every evening, I’m surprised to find out I was wrong. This week saw Saudi Arabia initiating a (virtual) war with Qatar (and oil prices trading at $46 / bbl), former Director of the FBI Comey stating under oath that he was worried the sitting President of the US was a liar, and Britain’s Conservative Party forced into a flimsy coalition government with the political wing of a group of former terrorists. I’m going to need daily chiropractic visits from all the head shaking I’m doing!
Here is a curated list of important stories outside the main headlines that caught our attention this week.
Marvin Goodfriend would be good for the Fed (Financial Times Opinion). My consistent joke is that anything relating to Federal Reserve interest rate policy is above my pay grade. Last year, I analyzed how Fed tightening affects medium-term (two-year) equity returns and concluded that there is no causal relationship whatever. In other words, if the Fed tightens, it doesn’t matter to equity owners; if the Fed loosens, it doesn’t matter to them either.
While I try to stay sanguine about policy changes, it is nice to have an understanding about the people making decisions at the highest levels. In my opinion, Allen Greenspan’s decisions as Chairman of the Federal Reserve very nearly qualify as malpractice, for instance, due to his unwillingness to fulfill his duty to regulate big banks in the lead-up to the debt crisis.
Over the weekend, it was announced that Marvin Goodfriend, an Economics professor from Carnegie-Mellon University, had his name floated as a possible Fed Governor. From this opinion piece and the linked video at the end of the article, it seems like Goodfriend is a sensible candidate and would add a fresh, if perhaps slightly disruptive, perspective to FOMC meetings. While he is now advocating a much more hawkish policy than the one being pursued by FOMC Chairwoman Janet Yellen, in the past, he has also argued for aggressive use of negative rates. The opinion writer is supportive of Goodfriend’s candidacy, but for a divergent opinion, scroll through the reader comments.
Trump’s America Is Facing a $13 Trillion Consumer Debt Hangover(Bloomberg). Fascinating look at the expansion of consumer debt during the post-Crisis period. I was particularly struck by the second graph, showing that two categories of debt have expanded particularly quickly: student debt and auto debt (see also the article in last week’s Reading List regarding auto debt from the Financial Times). The article makes the point that right now, the greater debt appears serviceable, but if the Federal Reserve raises medium-term rates as it has promised to do, servicing floating rate debt will become a greater burden.
Bill Gross Says Market Risk Is Highest Since Pre-2008 Crisis (Bloomberg). While his career over the past few years has been a bit rocky, I have a lot of respect for Bill Gross’s views on the market. This is a short clip of an interview with Gross at a Bloomberg investing conference. My favorite quote: “Instead of buying low and selling high, you’re buying high and crossing your fingers.” He makes a good point during the interview. Namely, bonds, which are (normally) constrained by the zero bound, are much easier to identify as having little upside potential (bond prices rise as yields fall closer to zero), however, stocks have no similar hard ceiling, so it’s harder to tell when they have run out of room. Gross thinks that the stock market has only been in more precipitous of a position once in his long career and that was Pre-Lehman.
‘Big Sugar’ holds out as US and Mexico near trade deal (Financial Times). This is a follow-up to the article we posted last week regarding US-Mexico sugar negotiations. Long story short, Commerce Secretary Ross had to extend the deadline by one day to get the deal done, but it did get done. The tenor of the negotiations is worrisome for several reasons, however. First, “Big Sugar” does not back the agreement because it is not favorable enough to their refiners in their opinion. The agreement is only one in principle, so will have to be agreed in its written form over the next weeks and months. This suggests that a relatively minor negotiation might interfere with the much more crucial NAFTA renegotiations, which have been scheduled to start as early as August of this year. Second, the outcome displays the outsized effects of a single corporate group’s lobbying efforts on an international negotiation. Big Sugar is not happy because they didn’t get everything they wanted, but industrial sugar buyers are not happy because Big Sugar got enough of what it wanted to create a real economic burden on them! In fact, a buyer’s group says that the agreement is tantamount to an “annual $1 billion tax on US consumers.” Third, the structure of the negotiations suggests that the NAFTA renegotiation will likely be difficult, prolonged, and viewed as zero-sum by the US, at least. Mexican producers essentially conceded on each of their points because they realized the larger battle – NAFTA – was yet to be joined. Ross was pressured to “win” this negotiation. He has “won.” Mexican negotiators understand Ross’s style and political / industrial pressures he is under. Expect for a slog when it comes to NAFTA.
Brownback Tax Cuts Set Off a Revolt by Kansas Republicans (NY Times). As a finance guy, the one thing I hate above all else is the dogged pursuit of dogma in the face of contrary empirical evidence. Since the followers of a drug-addled writer of sophomoric fantasy stories became influential in government and pushed through the dogma of “Supply-Side” Economic policies, various administrations have attempted to bring that dogma to life. These attempts have provided enough evidence to conclusively say that supply-side policy does not boost economic growth.
Still the dogma persists. Six years ago, Kansas governor Sam Brownback pushed through what had been the most complete and thorough budget based on this dogma. In Brownback’s plan, entrepreneurs engaged in innovation would pay a tax rate of zero to enable a wave of innovation to sweep across the plains. For salaried workers, taxes would be reduced so that earners would not have a “disincentive” to work hard. This would in turn lead to burgeoning non-farm employment. Government budgets would be slashed to cut down on waste (If this sounds familiar, it is in large measure, what Trump’s tax and budget proposals turn out to be).
Brownback termed this policy a real-life experiment. The results of the experiment are in. The zero-tax policy for pass-through entities to spur entrepreneurship succeeded in encouraging people to reclassify the activities they were already doing in order to receive the incentive but not to actually create value or jobs. Low taxes did not draw salaried workers into Kansas in droves – in fact, its employment lagged neighboring Nebraska, a state that did not participate in the experiment. The state was able to cut “waste” in areas like road construction and repair and programs to boost reading levels among underprivileged children but not enough to balance the budget. The governor blamed the shortfall on wasteful educational spending rather than on reduced revenues even as elementary school reading levels in Kansas fell from 13th in the nation to 30th.
This week, all those chickens came home to roost. Brownback had vetoed a bill that would increase taxes, but his legislature gathered enough votes to override that veto. Can we finally call this experiment done and bury this ridiculous dogma?