The government shutdown

1. FAQ about the impact on federal workers, on the Washington Post.

2. 66 questions and answers about the shutdown, by USA Today.

3. Martin Wolf is appalled by how and why the shutdown is happening. He writes about the possible default too.

Added on Oct. 2, at 11.51am:

4. For good measure, here are the thoughts of Chris Edwards at the Cato Institute about the shutdown.

Iran; the price of rice; U.S. employment report

1. Sanctions on Iran; 2. The price of rice; 3. U.S. employment report.

1. The new round of U.S. sanctions on Iran, by Al-Jazeera.

Also, this just reminded me of the upcoming presidential elections. BBC reports that all eight of the candidates are hardline conservatives, and that the progressive candidates were banned from running.

2. How Vietnam and Thailand try to stabilize the price of rice. According to data from the World Bank, in April the price of Thai A.1 rice was down 9.1% from last year, and the price of Vietnamese 5% rice was down 10.7%.

3. U.S. employment report.

The good: 
1. The change in nonfarm payrolls was decent (175k), even good in this post-2007 era.
2. Local and state government payrolls keep going up, albeit slowly, a sign that the fiscal consolidation at the local and state level is probably over.
3. Payrolls in the temporary help services industry ("temps") went up again, and the one-month diffusion of payrolls by industry was almost 60%.
4. The labor under-utilization rate (U6) went down, even though the unemployment rate went up, a sign that discouraged workers and people working part-time for lack of a better option dwindled in number.

The bad:
1. Nonfarm payrolls for March and April were revised down by a net -12k.
2. Manufacturing payrolls have been declining for three months in a row. It is not clear whether this is a broad cyclical signal, or merely a sector story.
3. Federal government payrolls went down (although this was expected, given the fiscal consolidation under way).
4. The employment-population ratio is stagnant. It's been stuck at 58.5-58.6 since November 2012.
5. The six-month diffusion of nonfarm payrolls by industry declined in both April and May.

The increase in the unemployment rate has both good and bad elements. On one hand, the labor force participation (LFP) rate went up, which might mean that more people are looking for jobs. But an increase in the LFP pushes up the unemployment rate, ceteris paribus. On the other hand, the employment-population ratio (EPR) stayed level, which means that employment grew just as much as the population did. An increase in the EPR would have brought down the unemployment rate, ceteris paribus.

Overall:
A fairly positive report, indicating that employment keeps growing, albeit slowly, and that the slack in the job market is shrinking, slowly. However, the markets will probably zero in to the slight increase in the unemployment rate and hope for a delay of the Fed's tapering of QE. Clutching at straws, if you ask me.

I will leave you with this chart.

It shows what part of the change in the unemployment rate is attributable to the change in the LFP and which part is attributable to the change in the EPR. The sum of the two add up to the change in the unemployment rate. So, for instance, in May the unemployment rate went up by 0.04% (even though in the BLS report the reported rounded number is 0.1%). The increase in the LFP made the unemployment rate go up by 0.18%, whereas a slight increase in the EPR brought the unemployment rate down by 0.13%. The last column in the chart shows that over the last 12 months unemployment has gone down by 0.63%: 0.1% is attributable to an increase of EPR, and 0.53% is due to a decrease of the LFP.

20130603 Links

1. China's exchange rate; 2. Nigeria's banking system; 3. The Fed indirectly caused low interest rates.

1. Is the renminbi overvalued? Charles Dumas at the FT thinks so.

Overvaluation became a serious problem in 2011. Producer price inflation (PPI) of 7 per cent then matched unit labour costs (in yuan), but crumpled into 2-3 per cent producer price deflation over the past couple of years. April’s 2.6 per cent deflation has intensified from 1.6 per cent in February. Chinese businesses have to slash prices to keep a grip on their export markets. But unit labour costs are still rising at a 5 per cent rate, squeezing profit margins, and are up 20 per cent relative to the export competition since 2011.  

Adding to this problem is the sudden, related, swing into high real interest rates. In mid-2011, the one-year lending rate from state-owned banks was 6.6 per cent, which combined with 7 per cent PPI to give a slightly negative real rate. But a flight of depositors from China’s banks has kept nominal interest rates high. The nominal interest rate is only down to 6 per cent now, but combined with PPI deflation, the real interest rate is close to 9 per cent. Such high real interest rates combined with squeezed profit margins have pushed China into a prolonged “investment-led” slowdown. 

China’s extravagant post-crisis recovery splurge, with capital spending raised to 48 per cent of GDP, much of it debt-financed, has left it with high prices for real estate and industrial commodities. These assets with low-to-negative yield are also the most sensitive to interest and exchange rate changes. Whether or not Chinese real estate is in a bubble, high nominal and real interest rates make these asset prices vulnerable. 

Premier Li Keqiang spoke recently of plans to remove controls on capital outflows. Any such action could release a wave of savings seeking real foreign assets. This would devalue the yuan and cushion the rebalancing of the economy away from excessive capital spending. But it would also drain away bank deposits, threatening a major domestic asset sell-off as well as bank insolvency. 

[Emphasis added.]

I am most worried about a spiral of: flight of savings away from Chinese banks, rising interest rates, a property crash, and household and bank insolvencies.

2. Nigeria's banking system has recovered. To me, not following the Nigerian economy closely, it was news that the country suffered a banking crisis in 2009. In any case, the IMF has published a report that says that banks have recovered just fine, although (of course), substantial risks remain. Selected paragraphs from the executive summary:

1. The Nigerian economy has experienced domestic and external shocks in recent years, which resulted in the 2009 banking crisis. However, the economy has continued to grow rapidly, achieving over 7 percent growth each year since 2009. The performance of financial institutions has begun to improve, though some of the emergency anti-crisis measures continue to be in place. The success in maintaining financial stability after the crisis, and in the face of major external threats, reflects the decisive and broad-based policy response by the government and the Central Bank of Nigeria (CBN).  

2. Following the crisis, the authorities took a comprehensive set of remedial measures. Substantial liquidity was injected; a blanket guarantee for depositors, as well as for interbank and foreign credit lines of banks, was provided; the Asset Management Company of Nigeria (AMCON) was established to purchase banks’ nonperforming loans (NPLs) in exchange for zero coupon bonds and inject funds to bring capital to zero; regulations and supervision were strengthened and corporate governance enhanced; and the universal banking model was abandoned and banks instructed to establish holding companies or divest their nonbank activities.  

3. As a result, Nigeria avoided economic collapse and economic growth resumed. The challenge now is to build on these achievements, so that vulnerabilities can be mitigated and growth placed on a sustainable and enduring path. 

(...) 

5. The financial system continues to suffer from weak governance, including some non-transparent ownership structures, deficiencies in financial reporting, and endemic perceptions of corruption. These weaknesses were highlighted by failures and severe undercapitalization of several banks, contributing to banking sector consolidation from 89 banks in 2005 to 20 in 2012. The federal government’s fight against corruption has resulted in an improvement in perception of the extent of corruption as indicated, for instance, by Transparency International in 2011. However, corruption continues to be a significant problem, including in the court system and other public authorities.  

6. Despite significant progress in recent years, the regulatory and supervisory framework has gaps and weaknesses: (i) Nigerian financial institutions operate under a framework of laws, regulations, circulars, and guidelines that are not all well-understood, and do not seem to provide a coherent overall framework; (ii) further enhancements are still needed in bank supervision and resolution, particularly with regards to at least one weak bank, and to cross-border supervisory practices; and (iii) the extensive agenda ahead for supervisors and regulators will pose serious capacity challenges.  

7. The development and regulation of non-bank financial institutions require further reforms. The insurance sector needs better enforcement of compulsory insurance; improvements in product disclosure standards; and resolution of small unprofitable companies. The 2004 pension sector reform was helpful, but coverage remains low. Legacy funds’ assets are yet to be transferred to Pension Fund Administrators. Although the Nigerian Securities and Exchange Commission (SEC) has made progress, more reforms are needed to further enhance oversight of the capital markets. The SEC has been without a Board since June 2012, jeopardizing its proper governance and functioning.  

(...) 

9. Access to finance is an important constraint to Nigeria’s development. There is negligible intermediation to small and medium-sized enterprises (SMEs) by the formal financial sector. While the microfinance sector has undergone significant changes, it remains characterized by numerous small, financially weak and ineffective institutions. 

3. Bringing perspective to QE. David Beckworth points out that the Fed, yes, bought a lot of government debt in 2010-11, but they also allowed their share of Treasury debt balances to drop in 2008-09. In his view, the Fed is indirectly responsible for the ultra-low interest rates. If I understand him correctly, the Fed did not respond adequately to the spike in demand for money balances in 2008-09, and that that failure is behind the low interest rates.

David asks "Why are interest rates so low?"

The most obvious answer is that the monetary policy of the Federal Reserve is keeping them low. Many observers point to the Fed’s large-scale asset-purchase programs as the reason for the low interest rates. Others point to the Fed’s forward guidance on interest rates that says the target federal-funds rate will remain in the exceptionally low 0–0.25 percent range for some time. These observations have led some to conclude that the Fed is not only creating a drag on the economy with its low-interest-rate policies, but is also making it easier for Congress and the president to avoid tough budget choices and enabling large government deficits by reducing the Treasury Department’s financing costs. 

This understanding, however, runs up against three inconvenient facts. First, the Fed has not been dominating the Treasury market. At the end of 2012, the Fed held only 15 percent of all marketable Treasury securities, roughly the same share it has held over the past decade. This means that the largest-ever run-up of public debt was financed mostly by individual investors, their financial intermediaries, and foreigners. Second, the Fed’s forward guidance on interest rates is itself shaped by the Fed’s forecast of the economy. The Fed, then, is not independently shaping the future path of interest rates, but is responding to what it thinks will happen to the economy in the future. Finally, long-term interest rates on safe government debt across the world have fallen: Very similar sustained declines in government-bond yields have occurred over the past four years in the United States, the United Kingdom, Germany, and Japan, as the graph below shows. It is far easier to explain these declines as a function of a weak global economy than to attribute them to an overactive, all-powerful Fed.

David moves on to say that

The proximate reason, then, for the low-interest-rate environment is that the ongoing weak economy has stirred investors’ appetite for safe and liquid assets. Households, for example, continue to hold an inordinately high share of money-like assets, including Treasuries, in their portfolio of assets.
Households’ high share of safe assets should not be surprising given the spate of bad economic developments over the past five years: the Great Recession, the euro-zone crisis, concerns about a China slowdown, the debt-ceiling dispute of 2011, and the more recent fiscal-cliff talks. The immediate effect of these developments was to create uncertainty about future economic growth and raise the demand for money-like assets. This elevated broad money demand not only has kept interest rates low, but also has prevented a robust recovery from taking hold.
While this absolves the Fed of direct responsibility for the low-interest-rate environment, it does not absolve it for its indirect influence. Through its control of the monetary base, the Fed can shape expectations of the future path of current-dollar or nominal spending. Thus, for every spike in broad money demand, the Fed could have responded in a systematic manner to prevent the spike from depressing both spending and interest rates. In other words, the Fed could have adopted a monetary-policy rule that would have committed it to maintaining stable growth of total-dollar spending no matter what happened to money demand. A promise from the Fed to do “whatever it takes” to maintain stable nominal-spending growth would have done much by itself to prevent the money-demand spikes from emerging at all. Why hold a greater number of safe, liquid assets if you believe the Fed will keep the dollar value of the economy stable?

Simplifying, the two opposing views implicit in David's discussion are: 1. The Fed bough a lot of Treasury debt, thus keeping their prices high and yields low; 2. There was an independent rise in the demand for money, motivated by expectations of slow growth and by increased risk, and the Fed failed to counter expectations of depressed nominal spending.

I admit that I have not articulated a full-fledged response to David's views, but here hare a few thoughts:

1. The Fed's balances of Treasury debt do not matter for the determination of interest rates as much as the marginal purchases of treasuries, and the announcement of (possible, not even actual) future purchases.

2. Risk perceptions and risk aversion probably played a big part in the surge of money demand in 2008-09. The Fed did step in to assuage the markets. Although the Fed did fall short of targeting nominal spending, it is not clear to me how NGDP targeting would have been more effective than the policies that the Fed actually followed in regards to mitigating the rise in risk perception and risk aversion.

3. The Fed's policies in 2008-11 did probably suffer from the "pessimism problem," and it was not until 2012 when they got around it by targeting the unemployment rate. And it might have been better if they figured that out sooner. But can the Fed, really, steer the real economy one way or another, by buying more treasuries? Why would it make any difference if the Fed targeted NGDP instead of targeting the unemployment rate? In my opinion, the announcement of an intention to keep interest rates low for a long period of time had an effect on the prices of financial assets, but it made a difference on the real economy mostly by removing some uncertainty and instilling a bit of confidence. Having an objective, well-defined target was important, but the choice of target (NGDP, unemployment, employment creation, output growth, what have you) was secondary.

Here's David's blog post, and here is his recent piece on the National Review.

20130530 Links

1. Expected income growth in the U.S.; 2. Rising rates in Canada?; 3. Property speculation in China.   ***************************************************************************************************************************************************************************************************************************************************

1. Income growth expectations and forecast consumption growth.

A research note at the Chicago Fed. Conclusion:

This article documents the decline in aggregate consumption during and after the Great Recession. It also explores the relationship between the decline in consumption and the decline in consumers’ expectations about their future income. The analysis uses microeconomic data from the Michigan Surveys of Consumers to study expected income growth. These data show that expected income growth declined significantly during the Great Recession for all age, income, and education groups. It is the worst drop ever observed in these data, and it has not yet fully recovered to prerecession levels. Furthermore, we show that expected income growth is a strong predictor of actual future income and consumption growth. For this reason, forecasts of near-term consumption and income growth using these data suggest sluggish income and consumption growth over the next year.

2. Wage gains and higher expected inflation in Canada: The end of the easing cycle?

Yes, consumer price index (CPI) inflation last month ran at an ice-cold 0.4 per cent on a year-over-year basis, the slowest rate since the 2009 recession. Yes, even so-called “core” CPI inflation (a measure that excludes the most volatile components such as food and energy, which is not only a more reliable measure of the underlying inflation trend but is the ultimate guide for Bank of Canada interest rate policy) is a thin 1.1 per cent, dangerously close to the bottom of the bank’s inflation target range of 1 to 3 per cent.

And yes, all of this would typically spur the central bank to action to bring inflation back toward the happy middle of its target range – meaning, typically, rate cuts to lend a hand to a clearly sluggish economy. 

Yet the central bank continues to indicate that its next rate move, whenever that will be, will most assuredly be up, not down. It sees that there are a host of temporary factors that have kept consumer prices down – most recently a dip in fuel prices – that may not last. 

And, perhaps more strikingly, it sees the wage growth 

Statistics Canada reported Wednesday that Canada’s average weekly wages rose 3.1 per cent in March from a year earlier, matching the pace of February. Those numbers are the highest since last fall, and coming back to back, they make a solid case that wage inflation is gaining speed in this country, as economic growth picked up in the first quarter.

3. Property speculation in China.

In the latest effort to cool the property market, local governments were urged to implement a 20 percent personal income tax on capital gains from property sales, if a homeowner sells the property within five years of its purchase and the property is not the only one owned by the seller.

The authorities in major housing markets such as Beijing, Shanghai and Guangdong said in late March that they would implement the policy, which led to a sharp decline in secondhand home sales in those markets.

Although Li said that other local authorities are only expected to carry out the personal income tax policy on a "selective" basis, he pointed out that the country may tax the possession of multiple properties in the second half, if current policies continue to push up housing prices and worsen the market environment.

"The mismatch between supply and demand has been growing for years," Li said.