Tim Duy's Fed Watch

On Krugman And The Working Class

Paul Krugman on the election:

The only way to make sense of what happened is to see the vote as an expression of, well, identity politics — some combination of white resentment at what voters see as favoritism toward nonwhites (even though it isn’t) and anger on the part of the less educated at liberal elites whom they imagine look down on them.

To be honest, I don’t fully understand this resentment.

To not understand this resentment is to pretend this never happened:

“You know, to just be grossly generalistic, you could put half of Trump’s supporters into what I call the basket of deplorables. Right?” she said to applause and laughter. “The racist, sexist, homophobic, xenophobic, Islamaphobic — you name it. And unfortunately there are people like that. And he has lifted them up.”

Clinton effectively wrote off nearly half the country at that point. Where was the liberal outrage at this gross generalization? Nowhere – because Clinton’s supporters believed this to be largely true. The white working class had already been written off. Hence the applause and laughter.

In hindsight, I wonder if the election was probably over right then and there.

Krugman continues:

In particular, I don’t know why imagined liberal disdain inspires so much more anger than the very real disdain of conservatives who see the poverty of places like eastern Kentucky as a sign of the personal and moral inadequacy of their residents.

But they do know the disdain of conservatives. Clinton followed right along the path of former Presidential candidate Mitt Romney:

It was the characterization of “half of Trump’s supporters” on Friday that struck some Republicans as similar to the damning “47 percent” remark made by their own nominee, Mitt Romney, in his 2012 campaign against President Obama. At a private fund-raiser Mr. Romney, who Democrats had already sought to portray as a cold corporate titan, said 47 percent of voters were “dependent upon government, who believe that they are victims” and who “pay no income tax.”

There was, of course, liberal outrage at Romney.

Krugman forgets that Trump was not the choice of mainstream Republicans. Trump’s base overthrew the mainstream – they felt the disdain of mainstream Republicans just as they felt the disdain of the Democrats, and returned the favor.

I doubt very much that these voters are looking for the left’s paternalistic attitude:

One thing is clear, however: Democrats have to figure out why the white working class just voted overwhelmingly against its own economic interests, not pretend that a bit more populism would solve the problem.

That Krugman can wonder at the source of the disdain felt toward the liberal elite while lecturing Trump’s voters on their own self-interest is really quite remarkable.

I don’t know that the white working class voted against their economic interest. I don’t pretend that I can define their preferences with such accuracy. Maybe they did. But the working class may reasonably believe that neither party offers them an economic solution. The Republicans are the party of the rich; the Democrats are the party of the rich and poor. Those in between have no place.

That sense of hopelessness would be justifiably acute in rural areas. Economic development is hard work in the best of circumstances; across the sparsely populated vastness of rural America, it is virtually impossible. The victories are – and will continue to be – few and far between.

The tough reality of economic development is that it will always be easier to move people to jobs than the jobs to people. Which is akin to telling many, many voters the only way possible way they can live an even modest lifestyle is to abandon their roots for the uniformity of urban life. They must sacrifice their identities to survive. You will be assimilated. Resistance is futile. Follow the Brooklyn hipsters to the Promised Land.

This is a bitter pill for many to swallow. To just sit back and accept the collapse of your communities. And I suspect the white working class resents being told to swallow that pill when the Democrats eagerly celebrate the identities of everyone else.

And it is an especially difficult pill given that the decline was forced upon the white working class; it was not a choice of their own making. The tsunami of globalization washed over them with nary a concern on the part of the political class. To be sure, in many ways it was inevitable, just as was the march of technology that had been eating away at manufacturing jobs for decades. But the damage was intensified by trade deals that lacked sufficient redistributive policies. And to add insult to injury, the speed of decline was hastened further by the refusal of the US Treasury to express concern about currency manipulation twenty years ago. Then came the housing crash and the ensuing humiliation of the foreclosure crisis.

The subsequent impact on the white working class – the poverty, the opioid epidemic, the rising death rates – are well documented. An environment that serves as fertile breeding ground for resentment, hatred and racism, a desire to strike back at someone, anyone, simply to feel some control, to be recognized. Hence Trump.

Is there a way forward for Democrats? One strategy is to do nothing and hope that the fast growing Sunbelt shifts the electoral map in their favor. Not entirely unreasonable. Maybe even the white working class turns on Trump when it becomes evident that he has no better plan for the white working class than anyone else (then again maybe he skates by with a few small but high profile wins). But who do they turn to next?

And how long will a "hold the course" strategy take? One more election cycle? Or ten? How much damage to our institutions will occur as a result? Can the Democrats afford the time? Or should they find a new standard bearer that can win the Sunbelt states and bridge the divide with the white working class? I tend to think the latter strategy has the higher likelihood of success. But to pursue such a strategy, the liberal elite might find it necessary to learn some humility. Lecturing the white working class on their own self-interest hasn’t worked in the past, and I don’t see how it will work in the future. 

When America Was Great

ht @TimAeppel

Rent or Buy?

Rent or buy? Often I am asked this question, and I find I lack a satisfactory answer. I realize that people who ask me this question are typically in transitional phases in their lives – moving from young adulthood to real adulthood. The answer is perhaps more obvious on either side of that inflection point, less so in the middle of it.

From my experience, these are the pros and the cons:

Pros.

• You earn the untaxed imputed rent (you pay yourself rent) and receive a tax deduction on your mortgage interest. Double subsidy.
• Assuming a fixed rate mortgage, you no longer face the prospects of future rent hikes.
• Owner-occupied housing provides you both the service of shelter and an investment asset.
• It is a leveraged asset, which improves returns in a rising market.
• Mortgage rates are historically low. That won’t last if policymakers do their jobs.
• Housing is a hedge against inflation.
• You receive psychological benefits.

Cons.

• It doesn’t provide cash flow. Instead, it requires cash flow. Mortgage payments, property taxes, insurance, repairs, etc.
• Most buyers do not recognize/plan for depreciation costs. I have heard that you should expect annual depreciation of 2% of the cost of your home. This seems consistent with my experience.
• Maintenance and upkeep are time consuming, particularly for single-family housing. Anyone want to come over and rake leaves with me this weekend?
• Depending on the market, it can be an illiquid asset. This can be a problem if you plan/need to move. This is especially the case if you buy in a region that is struggling economically.
• It is a leveraged asset, which is brutal in a falling market.

I am guessing that commenters will add additional pros and cons.

My standard advice is that property should be a part of your portfolio, but not your entire portfolio. If buying a home leaves you cash poor or unable to save in your firm’s retirement plan, it probably isn’t a good option for you. If you plan to move soon, it probably isn’t a good option. If you are too busy with your career to deal with upkeep, it probably isn’t a good option. Recognize the risk that comes with the reward. If you aren’t ready to accept the risk, it probably isn’t a good option.

I don’t think you should let the recent housing bust play too heavily in your decision. I tend to think that was a fairly unique event. If you are waiting for another housing bust on a similar order of magnitude before you buy, you might be waiting forever.

I have heard the advice that you should buy the most expensive house you can because the burden will fall as your earnings rise. Bad advice, in my opinion. Following this advice will leave you cash poor and unable to meet other financial goals or prepare for a life change or emergency. My advice is to leave substantial margin for error. And buy for the neighborhood, not the house.

My experience as a homeowner has been generally positive, but I would say that my circumstances are somewhat unique. Partly through accident, and then later through design when we recognized the benefits, Mrs. FedWatch and I have always purchased housing that we could afford on just one of our incomes. As a result, we have had to make some housing sacrifices. Not really me so much, mostly for her. She complained the last house was “killing her soul.” That doesn't sound pleasant. And the current house needs some work. But on the upside, however, when Mrs. FedWatch wanted to take time off work, we did not face a financial hardship.

Good luck with whatever decision you make.

December Still A Go

Some back of the envelope calculations: The Fed's long-run real GDP growth estimate - the rate of potential GDP growth - is 1.8%. According to Federal Reserve Vice Chair Stan Fischer last week:

If labor force participation was to remain flat, job gains in the range of 125,000 to 175,000 would likely be needed to prevent unemployment from creeping up. However, if labor force participation was to decline, as might be expected given demographic trends, the neutral rate of payroll gains would be lower. If we assumed a downward trend in participation of about 0.3 percentage point per year, in line with estimates of the likely drag from demographics, job gains in the range of 65,000 to 115,000 would likely be sufficient to maintain full employment. 

Labor force growth of 0.3%. Together, these two points imply a productivity estimate of 1.5%. The Fed's inflation target is 2%. The 2% inflation target plus 1.5% productivity growth suggests that the Fed anticipates wage growth of 3.5% when the economy settles into full employment.

Roughly; these are just back-of-the envelope calculations. Notice though that the 3-month moving average for average wage growth ticked up to 3.3% last month:

To be sure, 12-month wage growth still lags at 2.8%, but you can see where that trend is headed. Just like inflation, headed higher. 

Under these conditions, it is reasonable to believe the economy is very close to full employment. Of course, some slack may still lurk in the background. Perhaps it exists in the underemployment estimates:

 

Or perhaps labor force participation will feel more cyclical pull before demographics begin to dominate again. But that would be a short-term impact. Longer run, the aging population will take its toll on the labor force. Anyway you slice it, the Fed's comfort level with their estimate of full employment must be on the rise:

Indeed, given the current pace of job growth, the Fed anticipates the economy is positioned to soon reach their mandates. Perhaps even more so. Fischer from last week:

...the more interesting and important questions relate to the next few years rather than the next few months. They relate in large part to the secular stagnation arguments that were laid out yesterday in Larry Summers' Mundell-Fleming lecture--in particular the behavior of the rate of productivity growth. The statement that the problem we face is largely one of demand--and we do face that problem--seems to imply either that productivity growth is called forth by aggregate demand, or a Say's Law of productivity growth, namely that productivity growth produces its own demand.  

That is not an issue that can be answered purely by theorizing. Rather, it will be answered by the behavior of output and inflation as we approach and perhaps to some extent exceed our employment and inflation targets.

The Fed faces a familiar dilemma in December. Act preemptively, or hold still waiting for labor force and productivity growth to comes along? Most likely the Fed will take the opportunity in December to act preemptively and reiterate that doing so allows for them to retain their "move gradually" plan.

Does the election throw a wrench in their plans? Financial markets were buoyed by the prospect of a Republican dominated government, sending stocks higher and bonds lower. Would the bond sell off induce the Fed to take a pass in December, on the theory that higher interest rates imply tighter financial conditions? In this case, I think not. The steepening of the yield curve:

likely reflects the prospect of a reflationary policy mix. Note also that market-based inflation expectations tell the same story:

The Fed finally has the chance to chase the yield curve higher; I think they take it.

The situation differs from the steepening of the infamous "taper tantrum." Then the sell-off on the long end reflected a perceived change in the path of monetary policy, a perception the Fed did not share. Hence they needed to act in such a way to communicate their true intentions. In this case, the market is digesting new developments and raising estimates of the medium-run economic outlook and the likely monetary policy path. 

Note that the Fed sees the prospect of fiscal stimulus as well. Fischer again, via Reuters:

"On more expansionary fiscal policy, I think many members of the open market committee and of the Federal Reserve Board have commented it would be useful to have a more expansionary fiscal policy," Fischer said.

It is not exactly a secret that the Fed would like a more expansionary fiscal policy to take on more of the macroeconomic policy burden. The Fed believes that a more expansionary fiscal policy would provide them greater room to "normalize" interest rates. Hence they will be closely watching the evolving fiscal agenda. It is too early for them to update their economic projections dramatically, but with regards to the December rate decision, the prospect of substantial fiscal stimulus must count as an upside risk for growth and inflation.

Given that the economy is already near the Fed's estimates of full employment, the risk of fiscal stimulus should imply a risk of a higher rate path in 2017 and beyond. Assuming no change in productivity or labor force growth, it is reasonable to anticipate that the Fed would consider a full monetary offset to any fiscal stimulus; the alternative from their perspective would be substantially higher inflation. President-elect Donald Trump might not take too kindly to such an agenda, thinking that it would undermine his efforts to
"make America great" again. The risk is that he would attempt to further politicize the Fed, nominating friendly governors willing to minimize the monetary offset. Beware of higher inflation in such an environment.

Bottom Line:  With the economy hovering near full employment, the Fed will want to press forward with a December rate hike. Market odds of 85% are reasonable. Watch for signs the Fed will feel they have little choice but to offset fiscal stimulus if they want to preserve their inflation target. This is particularly the case for any large stimulus; Republican administrations have historically been pro-deficit spending. The stage is set for a contentious relationship with the next Administration. Watch for increasing politicization of the Federal Reserve. 

Fed Remains On The Sidelines

As expected, the Federal Reserve left policy unchanged this month. The statement itself was largely unchanged as well. The near term inflation outlook improved, going from this is in September:

Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further.

To this in November:

Inflation is expected to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further.

With the year-over-year impacts of oil prices falling out of the data, headline inflation will track back upwards. Not a big surprise. With regards to the timing of the next move, the Fed went from this in September:

The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives. 

To this now:

The Committee judges that the case for an increase in the federal funds rate has continued to strengthen but decided, for the time being, to wait for some further evidence of continued progress toward its objectives. 

See what they did there? Conditions are moving in the right direction, but the Fed still waits for some "further" evidence. Continuation of recent trends is likely sufficient to be that "further" evidence needed to justify a rate hike in December. 

What would derail a December rate hike?  Greg Ip at the Wall Street Journal speculates that a Trump win in next week's election would do the trick:

...a Trump victory would probably cast enough of a pall over the outlook to give the Fed reason to delay its next rate increase into next year. Ironically,  Mr. Trump may discover that he, not Mr. Obama, is the reason the Fed hasn’t tightened.

Agreed, although this doesn't seem likely at this juncture. More likely to stay the Fed's hands would be a slowdown in hiring to something closer to 100k a month. That would probably end the downward pressure on the unemployment rate and raise questions about the Fed's basic forecast that the unemployment rate will continue to decline in the absence of additional rate hikes. We get two employment reports before the December meeting; for the Fed to stay on the sidelines yet again, we probably need to see both reports come in weak. The first one - for October - comes Friday morning. ADP estimates that private payrolls will be up 147k - not surging, but still easily sufficient for the Fed to justify a rate hike. If this comes to pass, we would probably need a deluge of soft numbers to keep the Fed on hold again. 

Bottom Line: Fed is looking past the election to the December meeting for its second move in this rate hike cycle. Probably need some unlikely softer numbers to hold them back again.