Tag Archives: economics

Overcomplexifying

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That’s what the Federal Reserve is doing.

Many Federal Reserve officials entered 2015 thinking they likely would start raising short-term interest rates by midyear. That idea got put on ice after a winter economic slowdown, partly attributed to the dollar’s rapid rise in previous months.

And

Fed officials say they won’t act until they see more labor-market improvement and are confident that inflation will rise toward their 2% goal.

Wrong.

The Fed’s mission, by statute, is to manage inflation and work toward full employment. It also has a requirement to maintain moderate interest rates, the subject here, but that’s largely subsumed in managing inflation. Inflation, for the last several years, has been held artificially low by the Fed’s holding interest rates artificially low and by this historically slow recovery and slow-growth economy in which we’ve been mired since the Panic of 2008.

The artificially low interest rates are not “moderate” by any stretch: they’re much too low and for entirely the wrong reason. Normal interest rates are in the 5%-7% range, and they’re not there because of Fed diktat, not because—properly—of market forces.

The inflation rate extant these last few years have been below the Fed’s target rate, and the most effective tool the Fed has is its interest rate management. Hence, interest rates must rise, in order to facilitate the inflation rate rising to the Fed’s preferred range (which isn’t a hard 2%, it’s a range from 2% to around 3-3.5%).

There are additional reasons rates need to rise. Borrowers are reluctant to borrow, for all the low rates, because the economy remains sluggish: there are too few buyers, whether consumers or other companies, because there’s too much uncertainty in the economy’s future. A robust, growing economy will take care of that. That requires the government generally get out of the way of the economy, and it requires the Fed to get out of the way of the market and, among other things, interest rates.

The other reason is that too many folks are dependent on fixed income instruments for their own income. These last six years of suppressed interest rates have depressed those folks’ income.

A strong dollar has nothing to do with any of this. The dollar is strong for two reasons: one is that we pay interest rates, low as they are, are higher for dollar denominated debt instruments than for other currencies. The other is that, sluggish as our economy is, it’s still doing better than much of the rest of the world. Neither of those are going to change anytime soon, but notice the key factor in both of those: the dollar’s strength is a reaction to those factors, not a driver. The dollar is strong in response to interest rates, a strong dollar is not driving rates.

The Fed needs to let rates rise and ignore the dollar. Full stop.

With moderate interest rates and inflation under control, the economy will have a chance to grow. From that, employment will improve, and not just the headline number; the labor participation rate will improve, too. The dollar will take care of itself.

Oil and Pricing

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From a recent Wall Street Journal article:

“If OPEC or Saudi Arabia or anyone else wants to call” the US to curtail production, “there is no one to call,” said Amos Hochstein, coordinator for international energy affairs at the US State Department, in May. “You will have to call 4,000 companies operating in the United States as producers. For the first time, there is an element of real free market.”

Indeed. It’s about time, too. Now all we have to do is get rid of the export limits.

Symptoms

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The headline for Greg Ip’s piece in The Wall Street Journal pretty much says it all:

In a Slow Economy, Negative Quarters Shouldn’t Surprise

No, they shouldn’t. But their frequent occurrence without the economy formally falling into recession is dispositively symptomatic of a slow economy. When economic progress is running at a sound 3.5% GDP growth year-on-year, a one quarter slowing of growth rate by, say, 1.5 per centage points—a common enough occurrence in an economy—would drop GDP’s year-on-year number to 2%. On the other hand, when economic progress is bumping along at that anemic 2% for its longer term, a 1.5 point drop takes growth to near zero. In the workaday volatile world of economics, a quarter’s slowing by 2 or 2.5 points—less common, but far from unheard of—moves the year-on-year number to outright shrinkage from merely slowed growth.

As this year’s first quarter GDP “growth”—a negative 0.7%–illustrates, coming as it does on a string of 1st quarter negative numbers and coupled with lots of quarters of less than 2% growth, here we are six years after the Panic of 2008 in a still slow economy.

Business Investing

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US businesses, feeling heat from activist investors, are slashing long-term spending and returning billions of dollars to shareholders, a fundamental shift in the way they are deploying capital.

Data show a broad array of companies have been plowing more cash into dividends and stock buybacks, while spending less on investments such as new factories and research and development.
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As the trend picks up steam, so too has debate about whether activist investors—who take sizable stakes in companies, then agitate for changes they think will boost share prices—have caused companies to tilt too far toward short-term rewards.

Vipal Monga, David Benoit, and Theo Francis in their Wall Street Journal article at the link lay the bulk of this reallocation of business funds to activist investors demanding a prompt return on their, and other investors’, return. In truth, there’s a lot to this.

There’s another factor though, that plays at least as important a role: government regulation. Regulation compliance cost the US $1.86 trillion in 2013—11% of our GDP. That’s the general case; there also are regulations surrounding increasing—even improving existing—physical plant. The EPA’s new water “protection” rule, for instance, gives the EPA—the EPA!—a say in whether, and under what conditions, a new factory can be built.

And taxes. Despite lots of Congressional chit-chat, there remains on the books, for instance, the medical device tax of Obamacare, a tax that takes money off the top line revenue—revenue coming into a company before the first dime is spent on company-related things. A tax that’s already caused companies to cancel expansion plans or to move them overseas.

Regardless of the cause, though, whether activist, regulation, to taxes, this misallocation of funds can only have a negative effect in the mid- to long run, even though it’s a short-term good for investors like me. This sort of thing is bad for business’ competitiveness and bad in the aggregate for American global competitiveness and technological leadership.

Should our government do anything about this? Of course not, at least not directly. It is bad business to allocate all those funds to buybacks and dividends at the expense of expansion, upgrade, and innovation, but the real economy, the private economy where actual citizens and market participants live and work, will do a fine job of handling this. There’s no need for government to “get impatient” and step in, because the time lags between the stock market and the actual economy are so variable and unpredictable. Which lags make it positively counterproductive for government to interfere.

It would be good, though, if our government moved to reduce the cost of regulation. A good first step would be simply to rescind a random 10% of existing regulations, and then begin serious rescission from there. After that, the real economy will deal with the activists.

Funny Thing

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…about competition and private cost control.

The Saudis and their OPEC colleagues, at the start of the shale and fracking revolution last year, made an overt decision to keep their own production up, which would allow prices to drop (much of OPEC—especially Saudi Arabia—had lots of cash reserves with which to handle the drop), which would kill American deep drilling and put those competitors out of business, restoring price control to OPEC.

However.

The US shale industry is by necessity becoming more efficient than ever. Low oil prices have become an opportunity. The Saudis have lit a fire under producers to trim the fat, deploy new productivity-boosting technologies and zero in on the most productive geology.

And

Just a year ago, popular opinion seemed to be that shale oil production was generally unprofitable if oil prices fell below $80 per barrel.

And

Statoil, for example, reported that just in a few months it cut its drilling time for new wells in Texas’ Eagle Ford formation from 21 days to 17. That kind of efficiency gain has helped “petropreneurs” reduce the cost of drilling wells from $4.5 million to $3.5 million.

Other companies are experimenting with new fracking fluids and different types of sand to create better shale-rock fractures. Some are effectively incorporating Big Data to better understand the sweet spots of geologic formations and optimal well-spacing to increase productivity.

The result is a rapid decline in the break-even price across shale plays. Already, analysts believe it is now $60 per barrel and before long will fall to $50.

Oops.