Man Bites Dog by Bob Brusca

With all the Trumpian hullabaloo over trade, I want to share with readers a balanced, well-reasoned analysis of US trade issues penned by my good friend Bob Brusca, Chief Economist of FAO Economics. Bob makes it clear that while there are pros and cons to the US’s longtime propensity to run trade deficits, there is one overriding danger in doing so, and there are consequences that are affecting our economy today and will affect it even more seriously in the future.

David R. Kotok
Chairman and Chief Investment Officer
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Man Bites Dog; Dog Gets Tetanus Shot
by Bob Brusca
(Or how our fellow G-7 members learned to whine about trade)

All six of our fellow G-7 members are now complaining about the US and the ‘National Security’ tariffs being imposed by the Trump Administration. I will admit that I do not like this specific strategy. But on the issue of trade confrontation the US’s becoming more aggressive is long overdue. These countries among others have long taken advantage of the US and are provided in general much better access to the US market than US firms are provided access to their markets. In the case of Canada, trade is governed by the NAFTA agreement, for better or worse.

Los Seis Caballeros: The US is an unfair trader?

First let’s look at the complainants: In this corner stands the group consisting of Canada, Germany, France, Italy, the UK and Japan. The US stands alone.

Man Bites Dog Dog Gets Tetanus Shot 01

These countries (summed) have tended to run $200 billion worth of surpluses (US deficits) annually over the past decade on their bilateral accounts with the US (ten-year average is $196.5b, made smaller by the US import contraction in the Great Recession).

Why does this matter?

International economists (full disclosure: I am one) will tell you that having a bilateral deficit does not matter. They will go on to say that whether a country has a surplus or a deficit does not matter. This latter point is ‘evolutional.’ Old economics texts refer to running a current account deficit as ‘living beyond your means.’ That is hardly a statement of ‘neutrality.’ But the real point is this: WHY are so many countries running a surplus vs. the US and why are US deficits so intractable? In the case of the US, where GDP is 70% made of consumption, it is to take advantage of cheap consumer goods made abroad, NOT to invest. As a result the US more easily can finance its fiscal deficits and keep interest rates low. It can carry a higher debt load, and citizens benefit from cheaper goods today as future generations are saddled with the debt whose accumulation permits this state of affairs. Milton Friedman is reported to have said, if someone is willing to sell to you below cost you should buy as much of it as you can. Well, we have been doing that; and living for the short run has consequences. There is still a question of damage and distortion. The damage and distortion include the fact that in this instance there is intergenerational unfairness. We do the excessive consuming while future generations do the excessive paying.

The real point is that our deficits do matter and are bad because they represent consumption not investment. If the US were investing for its future these capital inflows that finance the deficit would finance themselves. But when we only use them to pay off and sustain high fiscal debt or corporate debt and to fuel consumption, then the deficits are bad.

Deficits being good or bad should not be a function of the currency regime. Under the gold standard countries WOULD NOT run deficits because they would have to pay for them in gold. Now that we only pay with fiat money IOUs, economists are no longer so concerned about whether it’s a deficit or a surplus on current account – but that is wrong. The gold standard was too restrictive, but that does not make the anything-goes floating currency regime right regardless of the outcome. Countries still need to mind their balance of payments and to run deficits for the right reason… and duration.

It should be lost on no one that the most fiscally sound countries do not run strings of current account deficits. They run surpluses.

Under a fluctuating exchange rate system, exchange rates are supposed to move to put current accounts back in equilibrium – has this happened?

The Kvetching Six

Man Bites Dog Dog Gets Tetanus Shot 02

We do not even have to look at exchange rates to answer this question. Only the UK metrics are close to a balanced position with surpluses sometimes and deficits other times. Everyone else runs only surpluses (US deficits) all the time on their bilateral accounts.

My position on this [issue] is that this is proof that WTO has got it wrong and these countries are foreign exchange manipulators that do not allow their currencies to RISE (undercutting their competitiveness and increasing their purchasing power). As a result they stay too competitive. The US remains uncompetitive. And US demand serves to stimulate growth in these countries. And, yes, the US gets more and cheaper goods as a result. It also gets higher unemployment (or less labor force participation), lower wages, lower inflation, lower interest rates, and is encouraged to carry more debt financed by foreign capital inflows (the counterpart of current account surpluses).

Of course, I do not even have on this chart some of the Asian countries that maintain an economic agenda of export-led growth.

Under FREE TRADE each country is supposed to produce according to its comparative advantage. But the US is producing less; Asia is producing more; and the US is consuming more as the structural US current account gap leaches US income off and stimulates growth overseas while taking away from growth in the US. US spending stimulates growth abroad as US citizens buy imports (foreigners’ exports) and their exporters thrive on these payments. This is NOT FREE TRADE.

It is also true that the US has fewer commercial policy (tariffs quotas and other restrictions) impediments for foreign goods, making the US an easy export target compared to other countries where US goods DO NOT face the same level playing field.

Trump’s ‘National Security’ tariffs do not remedy any of this, but they do put the rest of the world on notice that the US is finally going to stick up for its firms and that US commercial policy may be used even when the problem is not a specific foreign commercial policy.

You see, it is impossible to force a nation to appreciate its currency. But if it keeps its currency too low and keeps an unfair advantage from that, what recourse is there? Foreigners blame the US. We consume too much and save too little. But it’s the natural thing to do when faced with the choices they give us. Foreigners buy a lot of US-based financial investments, which keeps their own currencies weak. Capital flows into the dollar strengthen the dollar and weaken the currency they come from. In this way foreign holdings of US Treasury securities in particular (allegedly made to beef up needed foreign exchange reserves) are instruments of long-term currency manipulation.

Man Bites Dog Dog Gets Tetanus Shot 03

Looking at the G7 (putting the US back into this group), the chart above shows current account positions as a percentage of GDP by country. From early 1996 through 2008 the US ran the largest deficits relative to GDP. Since then Canada and the UK have surpassed the US. France has run deficits from 2008 (no data before then). Italy is back to running surpluses; so is Japan in the wake of its natural disasters, when it unexpectedly needed to import oil when it had to shut down its nuclear reactors. Germany has a surplus at 8% of GDP and may still be growing it larger.

So how is the US a trade pariah with this record?

The specifics of the Trump action are poorly chosen. The national security ruse is thin gruel, but it is legal and accessible. The US has much stronger grounds to pressure even our closest allies to shape up and be fair.

To be really fair we can step up and shoulder our share of the blame. US economists for years were in denial about the damage that global unfair trade was doing to the economy. They called it ‘fair trade’ or said it was close enough to it. Well, it is not close enough to it. The US balance of payments currently is being repaired by oil and fracking. We should not let the illusion of a smaller trade and current account deficit, because of our selling our natural resources, mask the fact that US firms are not as competitive as they need to be AT THESE EXCHANGE RATES.

There is no foolproof way to get other countries to revalue their currencies. Forcing current-account-surplus countries to make changes is nearly impossible. But Trump’s actual use of commercial policy to go after imbalances caused by other issues may have merit. Trade needs to be fair. Americans have enough ‘stuff.’ We don’t need more cheap stuff; we need jobs. And while there are gobs and gobs of jobs, there are not enough good ones. A weaker dollar would help that. But of course one aspect of Trump’s policy is that the dollar has actually been rising. And this is in part because the Federal Reserve has a program of steadily raising rates.

I hope this discussion puts the trade issues in perspective. One big problem is that no one really can observe and identify an equilibrium exchange rate. Also that an exchange rate is necessarily a bilateral thing – it takes two to tango. And it is often hard to get agreement on what it should be. But over long periods of time we can look back and see what misaligned currency rates have done. The trail of US current account deficits is such a thing. Viewing it as a problem unfortunately gets us caught up in a crossfire in which some push for a strong dollar for political or geopolitical reasons or just for what they think are patriotic issues. And if you are the greatest, best, most productive economy on earth, you will have the strongest currency, and it would not kill you. But if you are no longer that dominant economically and if you still push for such a strong dollar, bad results will follow… as we have seen. So the US situation has been the result of US misunderstandings about the facts regarding its international competitiveness and foreign opportunism. But US deficits are leaching wealth from the US. We are living off of our ‘former greatness.’ Our labor market lacks skills. The dollar can’t be the strongest currency in the world unless our capital is the newest and the best, operated by the brightest. And now the only way we get there is with H1B visas. That is not the answer.

We have many needs as a country. And you can’t start by boasting. You can trash talk before the game, but if you don’t bring it during the game, in the end you will be embarrassed. That is what is happening to the US in the wake of all this strong-dollar talk. We should aspire to a strong dollar someday. But not today. You can’t impose that on an economy that is not ready for it without some very adverse results.

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On day 1 our econometrics professor warned us to be careful with correlation: A strong correlation doesn’t necessarily mean causality. This is the case with the VIX. It’s closely related to the S&P 500 with a negative correlation, but the relationship may not be causal. I will never forget the example our professor gave us: The number of people who have drowned by falling into a swimming pool, it turns out, is highly correlated with the number of movies Nicolas Cage has filmed. Unlike school vending machines that can be causally linked to childhood obesity, Nicolas Cage didn’t need a scientific study to prove his innocence.

However, investors sometimes mistakenly assume causality between seemingly related events. If a rise in VIX is accompanied by some down days in the stock market, did the VIX cause stocks to fall? To answer this question, we need to know how the VIX is calculated. The VIX uses factors from the options market, one of which is the observed forward index price calculated by out-of-money options in the short term. But this correlation calls for caution about endogeneity: The VIX is derived from traders’ perceptions about the future, but actual futures prices also affect traders’ perceptions. How can we be sure that the VIX causes stock price to change? If anything, VIX is more likely the effect than the cause in this relationship. Analogously, the more firemen are sent to a fire (effect), the bigger the fire is (cause). From the perspective of future perceptions, VIX appears more likely to correspond to the firemen who respond to the fire in numbers according to its size than to the fire itself.

What is causation as opposed to correlation, then?  Here’s an example of causation: Consuming alcohol can cause a hangover the next morning. Unfortunately, causality is not as easy to identify in finance as it is in the case of having too much to drink. Oftentimes, what appears to be causation turns out to be just correlation. But why is causation so important for investors? The reason is simple: If a variable can cause stock prices to change, then it is a predictor. Who wouldn’t like to know tomorrow’s stock prices? If we have causation, we have a way to anticipate what’s coming. Why is it so difficult to identify a causal relationship? It is not because there is a limited supply of crystal balls; instead, the stock market is too complex. The stock market is sensitive to all information pertaining to the future. Therefore, it’s not just one variable but many that affect the stock market. Those variables can be as simple as some new product or quarterly earnings, or more intricate ones such as a tax bill or an interest rate change.

At this point we seem to be mired in a paradox: If there are so many factors that can cause stock prices to change, why is it so difficult to identify one? The answer once again falls upon the complexity of the market. Investors and financial engineers have studied the stock market extensively. Although there have been many models, such as the Fama-French three-factor model, created to attempt to explain stock prices, unfortunately, no model yet invented captures the complex interactions of the stock market. This limitation makes it extremely difficult to test any variable against the so-called benchmark. Currently, one of the most-used ways to mitigate this problem is to test one variable at a time against a bundle of existing factors. Nevertheless, our modern research methodologies still only allow us to conclude with a probability rather than certainty. To complicate matters further, the stock market is dynamic. This challenges any model used to predict the stock market. In other words, a factor may have a causal relationship with the stock market at a certain time but not at all times. The explanation is straightforward. If a factor were known to cause stock prices to change, then investors would use that factor repeatedly. By Goodhart’s Law, that factor would not be rendered ineffective over time.

Finally, the key difference between causation and correlation is simple. Causation means A happens before B, while correlation suggests A and B both happen at the same time. Let’s use the figure below, for instance. By rule of thumb, household income is likely to lead personal expenditures, which may explain why there is a slowdown in income preceding each decrease in expenditures.

Personal Consumption Expenditures and Median Household Income in the United States. Source: St. Louis Fed. 
Leo Chen, Ph.D.
Portfolio Manager & Quantitative Strategist
Email | Bio

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France Notebook

We are back in Southern France, in the town of Bonnieux, perched on a hilltop in the Luberon region of Provence, far from the hustle of Paris. The country has recently endured a record number of thunderstorms, which have caused some serious flooding, and continues to experience a series of rail and airline strikes. However, France’s economic performance continues to be robust despite some recent moderation, and French equities have been outperforming most other advanced-economy equity markets except that of the US. The iShares MSCI France ETF, EMQ, is up 3.9% year to date as of June 6 and 10.15% over the past 12 months. In comparison, the iShares MSCI EAFE (all advanced counties ex North America), EFA, is up just 0.6% year to date and 6.11% over the past 12 months.

France has the advantage of a strong and stable government, in marked contrast to the political turmoil to the south in Italy and Spain, the Brexit-related uncertainties across the Channel in the UK, and the disturbing antidemocratic developments to the east in Hungary and Poland. Fortunately, France’s neighbors in the northern tier, most importantly Germany, are also stable politically, with healthy economies.

French President Emmanuel Macron is no longer in the “honeymoon” period that followed his election. He continues to press ahead, nevertheless, with his reform agenda, believing he has a strong mandate to do so. The reforms, for the most part, are directed at improving the performance of the economy and are welcomed by business and financial markets. The opposition on the Left continues to resist the reforms but to little apparent effect.

Macron continues to push his ambitious proposals for reform of the Eurozone’s institutions. He and Germany’s Merkel are now in effect the two leaders of the Eurozone, and they are expected to set the reform agenda. Merkel appears to go along at least part of the way with Macron’s wide-ranging proposals. Both support the creation of a European Monetary Fund (EMF); but while Merkel sees the institution’s main role as strengthening budgetary discipline, Macron sees the EMF as a tool for fighting future financial crises. A clearer idea on this and other issues should come out of this month’s EU summit.

The issue of refugees and migrants continues to be very challenging for all of Europe. The emergence of a populist government in Italy was driven in large part by this issue, as are the political developments in Hungary and Poland noted above.  In France the whole country was moved by the courageous act of a 22-year-old migrant from Mali, M. Gassama, who had no papers. He came across a scene where bystanders were looking up at a young child dangling from a fourth-story balcony. Without hesitation he climbed up the four stories, leaping from one balcony to the next, and rescued the child. The country was thrilled, President Macron met the young man and offered him French citizenship, and the Paris Fire Brigade offered him a job. The event brought attention to the uncertain futures of the many migrants without papers who also have made long and dangerous journeys to France. The new populist government in Italy is likely to make it even more difficult for the European Union to reach agreement in this area.

French newspapers these days are full of the international tennis tournament underway at Roland-Garros and the upcoming World Cup soccer matches, with France’s first match on June 16th versus Australia. But even more attention is being given to the anticipated confrontation between President Trump and the heads of state of the other six countries that make up the G7, who are gathering for a summit in Quebec June 8th and 9th. Both Macron and German Chancellor Merkel have indicated in advance their reluctance to agree to issue the traditional joint G7 statement at the end of the meeting without the leaders finding common ground on tariffs, Iran (the Europeans demand to be exempt from any new US sanctions), and the Paris climate accord. That outcome seems pretty unlikely.

All of the other G7 members, America’s closest economic and military partners, are infuriated by Trump’s decision to pursue protectionist measures against them. At last week’s G7 finance ministers meeting, Canada’s finance minister, Bill Moreau, said, “Unfortunately, the actions of the United States this week risk undermining the very values that traditionally have bound us together.” Canadian Prime Minister Justin Trudeau summed up the views of United States allies, stating, “The idea that we are somehow a national security threat to the United States is quite frankly insulting and unacceptable.” “Deeply deplorable” was Japan’s Finance Minister Taro Aso’s assessment of America’s actions.

The French clearly share this strongly negative reaction. The French finance minister, Bruno Le Marie, referring to “the G6 plus 1,” said, “We cannot understand the American decision on steel and aluminum.” He explained that European steel companies face the same problem as American steel companies do, excess steel production capacity in China, and therefore the American action is clearly misdirected. President Macron’s formerly positive relationship with Trump has deteriorated sharply. It appears that the trade action was the last straw, and Macron will state his views strongly at the summit. In this he will have support from across the political spectrum in France and from Germany’s Merkel, although she will likely make her points in a more measured way. Trump may well seek to cut separate deals with individual European members, dealing with them on his preferred one-on-one basis. But that approach will not work with the European Union, which negotiates trade matters on an EU basis.

Until this morning (June 8th), global markets have been discounting the likelihood of a serious trade war breaking out, but the risks of this happening appear to be increasing. As this note goes to press, an outspoken Twitter war has broken out between Trump, Macron and Trudeau, with Trump now complaining about agricultural tariffs and “non-monetary barriers” and indicating he will leave the G7 Summit before the discussion on the climate and environment. This does not bode well for this heads-of-state gathering.

Bill Witherell, Ph.D.
Chief Global Economist & Portfolio Manager
Email | Bio

Sources: Financial Times, Le Figaro, Le Monde, New York Times, Bloomberg,

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Predictions: a follow up

In our recent commentary “Predictions,” we quoted Daniel Kahneman and the story of the cost overruns and prolonged construction period associated with the Scottish Parliament Building. The project’s troubles didn’t end when the ribbon was cut. Brian Barnier, who is a voracious reader, sent me the article linked below, detailing the urgent repairs necessitated by the Parliament Building’s faulty construction and design: I’m a little older than Brian, but I’m fully simpatico with his appetite for confirmed information.

I share the article with readers as a follow-up to my piece on predictions ( It’s a three-minute read. Here is an excerpt:

“PARLIAMENT chiefs could be hit with their biggest ever repair bill after potentially lethal faults were found on the roof of the £414million building. Emergency site visits were arranged on Friday after contractors refused to carry out maintenance work on the roof, claiming it is dangerous for them and the public. Meanwhile, our astonishing pictures show a loosened 100lb granite block on the side of the Holyrood building being held in place by makeshift wooden wedges just yards above the Royal Mile.”

We have here another chapter in government incompetence and the mess it can create.

Some readers chastised me for slamming Democrats, since all the sponsors and other proponents of the legislative proposal in the US Senate for “work at taxpayers’ expense for anyone who wants it” are Democrats, like Senator Booker, or independents, like Senator Sanders, who caucus with Democrats. Other readers asked why I didn’t focus on artificial intelligence (AI) as a risk that would eliminate many jobs with machine learning.

Supporters offered that there were lots of “buggy whip jobs” that disappeared when automobiles took over the roads and that agricultural jobs were winnowed by tractors and other farm machinery.   History says AI will increase productivity and plant the seeds for an entire generation of jobs that are presently unknown. History also says education and training are the keys to that success.

My point is that government intervention in a market-based clearing system has a bad history. Kahneman has demonstrated that in his book. And most economists and financial folks would agree that government intervention often causes more problems than it fixes. I used energy subsidies as an example.  But there are many examples of subsidy like sugar which is killing people alongside corn syrup.

My friend Chris Whalen points to the causes and effects of banking system failures. His recent piece referenced Ed Kane’s seminal work on “zombie banks” in Europe. Google Ed Kane if you don’t know him and his efforts as a professor of banking and finance.

The key point is that a political economy needs constant surveillance and scrutiny. Government has an inherent bias, and that bias must be tempered by those who are willing step forward to offer well-researched views. In the social media world of today there is a lot of confusion about what constitutes a researched view vs. an unsubstantiated assertion or opinion. To paraphrase a known media social-ist: beware of fake research.

Lest I be misunderstood, the critics who assumed that I am opposed to immigration are dead wrong. We have 6.5 million unfilled job openings in America right now. Many would come to the US and fill those jobs, bringing with them skills we need and do not have. They are discouraged from doing so by the Trump Administration. That policy of discouragement is awful for our country.

Last night I had dinner with a young person who wants to be an American. He drives a car legally, with a license. He works. He saves. He reads. His English is perfect. He is a taxpayer. He is living on the edge since he falls under the DACA program. He does not want to go back to his country of origin. He has a good reason. There is great personal danger there.

My fishing guide in Miami originates from Cuba. He obtained asylum after a multi-year ordeal to get a foot on American soil. He is now a citizen. He has a family. He works. He votes. He served in the American armed forces. Obama failed by eliminating Cuba asylum. Trump fails by not restoring and expanding it. Venezuela?  I’m biased. One of my ancestors walked 1000 miles to escape a czar and take a steerage passage to Ellis Island.

There are millions of such stories. America can thrive and grow with immigrants and more of them.  America can shrink and age without them.

Meanwhile our universities are shutting down courses because of a fall-off in foreign students. Higher education is a great American export. The US is squandering a competitive advantage. And the buyer comes here to make the purchase and pays cash. We don’t have to ship a higher education anywhere. But when we make it more difficult for prospective international students to get here, they go elsewhere to study. Consequently, US universities don’t have the money for this course or that one, so the course gets cancelled. This is now a national phenomenon. Don’t take my word for it; go ask the dean or admissions officer at the college you know well.

Many readers said my earlier piece on jobs wasn’t a rant at all, but a thoughtful discussion. Thank you for the encouragement. Here is a non-rant to add to your day.


“It’s tough to make predictions, especially about the future.” Yogi Berra made this quote famous, though its origins are disputed.

On May 31, we published a note entitled “Jobs for Everyone”(see Many readers replied, and the views were diverse, as you might expect. We thank all those who sent a comment.

Eddie Dawes wrote this reply:

“Your excellent analysis does not address the POTENTIAL very large loss of human jobs due to the automation of jobs due to technology. McKinsey et al have bleak predictions about the future of the human worker. We need to reconcile the current real-world analysis you present with the automation story before the USA can possibly figure out a somewhat optimal way forward. I think the Bernie Sander’s government-supported jobs approach believes the automation story of the future as opposed to the current real-world job statistics that you show. Really enjoy your emails. [Signed] One Confused Retired Engineer. Eddie Dawes”

Thank you, Eddie. You raise a key point.

Do we make a policy now that commits to a path toward a long-term, multi-billion-dollar subsidy of millions of folks at taxpayer expense, based on a forecast? We’ve seen the McKinsey study and others like it. And we know that many strategic policy shifts are made based on opinions and analysis of the future. So your question goes to the heart of “acting based on a forecast.” We would suggest that history is not kind to those who do so.

History tells us that basing policy on forecasts made by political claques with extreme economic views is a particularly misguided and dangerous thing to do. Here are a few examples.

Remember the concern about “peak oil,” the theory of global oil depletion that was first put forward by the Shell Oil research geologist M. King Hubbert in the 1970s? Remember how doomsayers on both the left and the right seized on the theory and influenced policy, so that taxpayer-financed subsidies poured into the energy sector (and are still being poured into energy, since we rarely repeal anything in this nation of ours)?

Remember the 1999 prediction of Dow 36,000 by Jim Glassman and Kevin Hassett. (See Glassman issued a mea culpa and explained why they were wrong in this 2011 piece in the WSJ: But by 2013 Glassman was back, in a Bloomberg piece, making the case that Dow 36,000 “is now clearly in reach.” (See Today, Hassett sits in the White House as chief economic adviser to President Trump, while Glassman runs his own consultancy and thinks Trump is taking a big risk linking the bull market to his presidency. “Politically, I just think it’s a gigantic mistake. It doesn’t go straight up” (as published in the Financial Times in “Why Donald Trump needs to read Dow 26,000).

I could go on and on but will end with the following few amusing quotes from history. “When the U.S. government stops wasting our resources by trying to maintain the price of gold, its price will sink… to $6 an ounce rather than the current $35 an ounce.” – Henry Reuss, chairman of the Joint Economic Committee of Congress, November 25, 1967. Note that in 1971 the US stopped buying gold. You may check today’s price for reference.

“In our opinion the data available today do not justify the conclusions that the increase in the frequency of cancer of the lung is the result of cigarette smoking.” – Dr. R. H. Rigdon, director of the Laboratory of Experimental Pathology at the University of Texas, April 14, 1954. And this: “There is growing evidence that smoking has pharmacological… effects that are of real value to smokers.” – Joseph F. Cullman III, president of Philip Morris, Inc., Annual Report to Stockholders, 1962.

One more. And we offer this one in light of the present global negotiations about nuclear weapons, which are key to China-US-Korea policy as well as to US-Iran-Europe-Middle East developments.

Franklin D. Roosevelt, a former assistant secretary of the Navy before he was elected president, said in 1922, “It is highly unlikely that an airplane, or fleet of them, could ever sink a fleet of Navy vessels under battle conditions.” In the Army-Navy Football game program on November 29, 1941, the caption to the photograph of the battleship U.S.S. Arizona read, “It is significant that despite the claims of air enthusiasts, no battleship has yet been sunk by bombs.” Eight days after that football game, the Arizona suffered a direct hit by bombs when the Japanese Air Force attacked Pearl Harbor and sank the battleship, with 1102 casualties.

Nobel Laureate Daniel Kahneman discusses the “planning fallacy” in his seminal work entitled, Thinking Fast and Slow ( His examples of biases and optimistic leanings and emotional delusions are abundant. He stresses how good luck is often viewed as skill and how that assumption leads to error.

Since the focus of Eddie Dawes’ email is the McKinsey forecast study and its use to defend the taxpayer-funded “jobs for everyone” proposal, I want to end this note with an example of government offered by Kahneman in his book. As he notes, “The list of horror stories is endless.”

Here is just one of them:

“In July 1997, the proposed new Scottish Parliament building in Edinburgh was estimated to cost up to 40 million pounds. By June 1999, the budget for the building was 109 million. In April, legislators imposed a 195 million ‘cap on costs’. By November 2001, they demanded an estimate of ‘final cost’, which was set at 241 million. That estimated final cost rose twice in 2002, ending the year at 294.6 million. It rose three times more in 2003, ending the year at 375.8 million by June. The building was finally completed in 2004 at an ultimate cost of roughly 431 million pounds.”

Thank you to Eddie Dawes for opening up the question about forecasting the future and using the forecast to make a policy decision today. It is indeed likely that automation will continue to have a profound effect on jobs. But we think it would be a big mistake to jump aboard the policy bandwagon of “jobs for all” based on the speculative conclusions of the McKinsey study or similar research. To put it another way, we think it is smarter to rely on careful extrapolations of “current real-world job statistics” than on an “automation story of the future” (to borrow Eddie’s language).

We dedicate this closing quote to readers of Sports Illustrated (swimsuit edition or otherwise).

“I think the world is going to blow up in seven years. The public is entitled to a good time during those seven years.” – Henry Luce, publisher of Time, Life, and Fortune, explaining in 1960 why he would publish so unserious a magazine as Sports Illustrated

Readers please note that the world did not end in 1967. Henry Luce did however die in February, 1968.

Special thanks to Christopher Cerf and Victor Navasky for their work The Experts Speak, The Definitive Compendium of Authoritative Misinformation.


Jobs for Everyone?

In the May 10th edition of the Economist, an article entitled “Make work can’t work” (p. 25 in the print edition) considered the Democratic proposal for a jobs guarantee in United States. It opened as follows:

“In April, America’s unemployment rate fell to 3.9%, its lowest since December 2000. That is not good enough for Democrats eyeing the 2020 presidential race. Senator Bernie Sanders recently promised to introduce a bill guaranteeing every American a taxpayer-financed job, should they want it. His colleague, Senator Cory Booker, has already written a bill that would test such a policy in 15 places with high joblessness. Senators Kamala Harris, Elizabeth Warren and Kirsten Gillibrand, three other potential presidential contenders, are co-sponsors. Ms. Gillibrand will reportedly soon pen her own plan, too.” (See

Meanwhile, Torsten Slok (Deutsche Bank) notes that “The labor market is so tight that people are leaving disability insurance to come back to the labor market.” He notes that “The flow of people outside the labor market finding jobs every month is currently at a post-crisis high, suggesting that there is still a stock of available workers outside the labor market to draw on.”

So on one side we have a proposal for taxpayer-funded “jobs for anyone who wants one,” and on the other side we have evidence that the present recovery is finally attracting folks into the labor force and into jobs. Are Democrats setting themselves up for a defeat with this proposal? Do Republicans know how to frame this debate? And is either side figuring out that the country needs a forward-thinking immigration policy when we have 6.5 million unfilled US jobs that require skills and we don’t encourage folks from around the world to come here and fill them?

When we dig deeper, issues of labor force policy become even murkier. Many wonder whether our Phillips curve-based assumptions and models need to be thrown out. We at Cumberland think the answer is yes. Many of our professional colleagues believe the same, as longtime readers know. But the policy at the central bank and in the Congress doesn’t seem to change. The purpose of this commentary is to try to raise the level of the debate in layman’s terms rather than with mathematical models.

We will offer a list of points to think about.

Greg Ip, writing for the Wall Street Journal, has phrased a key question well with this lead sentence: “Standard models of the economy are built on a simple relationship: When unemployment goes down, inflation eventually goes up. That relationship has looked sickly for years. In Japan, it may be dead – a preview of what central bankers may confront everywhere.”

Here’s a link to an NBER paper (NBER Working Paper No. 24576, Issued in May 2018) on “Working Longer in the US: Trends and Explanations”: ( We suggest serious readers take a look (hat tip Brian Barnier).

Peter Boockvar noted on May 8th that “In March there was a record number of job openings totaling 6.55mm (survey dates back to 2000). That was up from 6.08mm in February and about 400k above the estimate. Areas that most need warm bodies relative to February were construction, transportation (I’m assuming truck drivers), information, professional/business services, education/health and leisure and hospitality. There was also an increase in government jobs available. Unfortunately, the lack of supply has made it very difficult to fill these jobs. Hiring’s fallen by 86k. Because existing employees are feeling more confident about the state of the labor market, the number of quitters rose, with the quit rate at 2.3%, matching the most since April 2001.”

So why are several senators advancing their taxpayer-funded “jobs for anyone who wants one” program. They need to be pressed to answer.

Let’s dig deeper. Here are some statistics courtesy of Jessica Rabe at Datatrek.

• “The number of job openings jumped by 472,000 to a record high of 6.55 million in March 2018 (latest available data), up 16.8% year-over-year. No doubt this shows the tremendous interest that employers have with respect to hiring new workers.

• “The trouble comes when looking at how many people are actually getting hired, which slipped by 1.6% m/m to 5.43 million. It is still up 2.4% y/y, but moving in the wrong direction. It’s not like employers are cutting back on their payrolls either, as the number of layoffs and discharges declined by 6.3% y/y to 1.56 million.

• “Consequently, job openings continue to exceed the number of people starting new jobs, which has been an unusual development over the past few years compared to JOLTS’ full history. For example, from December 2000 (when the data was first collected) to July 2014, there were more hires than job openings during every single month. In fact, the difference between hires and job openings averaged about 1 million during that time frame.”

What about the “gig” economy and the impact on the labor force? Try this link: Here is the lead paragraph, quoting a Bloomberg story:

“Murray Webb had been a lackluster student more interested in sports than schoolwork while attending a small Virginia college. Then he transferred to Kennesaw State University in suburban Atlanta to pursue a master’s degree in applied statistics and landed four job offers upon graduation. Webb, 33, now earns $160,000 a year targeting health-care customers for hospitals and says he is approached weekly by companies and recruiters seeking data scientists. Webb is part of a national employment trend that has data scientists at tech companies such as Airbnb Inc. and Uber Technologies Inc. adding the words “I’m hiring” next to their profiles.”

Here is the Intuit 2020 report – 27 pages of thought-provoking elements that suggest the Bureau of Labor Statistics is missing the counting and that decisions in the expanded labor universe are changing behaviors and the way we should be accounting for those changes. There is a debate about this issue. Our view is that freelance and independent work is booming and not being captured in old models that were created in the manufacturing era. We think this is a big deal.

Torsten Slok (Deutsche Bank, May 25, 2018) takes an opposing view:

“A Fed report this week found that gig work is a very small share of family income. For over 75% of gig workers, these activities account for 10% or less of their family income. This picture is also confirmed when looking at the ride-sharing market. The total number of Uber drivers in the US is 833,000; and translated into full-time full-year jobs, there are about 100,000 Uber drivers. Comparing these numbers with US economy-wide employment of 148mn shows that the gig economy is more myth than reality. Another way to look at it is to think about how small a share of your total income goes to car services. Why is the gig economy getting so much attention? It is probably because many people in Manhattan now use ride-sharing apps and mistakenly think that what they are seeing is representative for the rest of the economy.”

Maybe but maybe not?  This Jobble report offers 45 statistics about the Gig economy:

Let’s segue to what taxpayers are being asked to pay for and focus on who is doing the paying.

We’ve discussed the independent contractors and the rapid growth rates in the gig economy and why folks believe this trend will continue and accelerate. Gig workers who are legally filing their tax returns are being asked to pay for the “jobs for everyone who wants one at taxpayer expense” proposal. There are also 148,424,000 folks (April, 2018 US government sources) who are currently working in the US. They are taxpayers who happen to already hold jobs. They are being asked to pay for this proposal. Note that every statistical cohort and category has more people working today in it today than a year ago.

Philippa Dunne and Doug Henwood note in TLR (May 14, 2018) how low “initial unemployment claims are as a percent to flows into the unemployment” count. They are down from peaks around 100% in 1990, 2000, and 2009 to about 65%, a low point in many decades. They also note that the “ratio of insured to civilian unemployment rates” is the lowest in half a century. Is this the time to have a “taxpayer-funded jobs for anyone who wants one” program?

The shortage of workers is in skills, not in people. That is becoming clearer. In the wake of the financial crisis, there are 10 million more people employed who hold bachelor’s degrees. About 1 million more who hold associate’s degrees have added to the employed headcount. The number who have only a high school diploma or less has declined nearly 5%. We know education pays. But can we find a way to increase workers’ skills? Does the taxpayer-funded “jobs for everyone who wants one program” require an education standard? Will it be enforced? By whom? At what cost?

Also, about 8 million jobs in the service sector are newly added since 2014. Manufacturing and mining are essentially flat. I won’t get into the government sector but will leave that to readers to do on their own since government is at every level in our society.

Most of the new civilian jobs that have been created since the financial crisis are full-time jobs. There have been about 18 million of them. Part-time new jobs have added about 3.5 million. The last time the ratio of employed to unemployed was this high was 20 years ago. And, finally, the employment-to-population ratio for those over age 65 is at an all-time record high of 19%. Note that most of the other 81% are the taxpayers who would be asked to pay for the jobs for the “anyone who wants one” program.

Dear readers, you are taxpayers in most cases. You now know that there were six unemployed workers per job opening in 2009, and now the ratio is only one for one. What you do with regard to the Democratic jobs guarantee initiative I mentioned at the start of this commentary is up to you. But please remember that what we do with opening borders to bring in the much-needed skills we cannot seem to provide domestically is also up to you. This not a Democrat-versus-Republican debate; it is a national policy debate that the country must have. So we constituents must tell both our Democratic and Republican members of Congress that it is time to have that discussion and to take a hard, nonpartisan look at the facts and the nation’s labor needs.

Politicians in Washington and in some states may want to examine Finland’s withdrawal from its guaranteed basic income experiment. See You may recall that Finland launched the experiment three years ago (see Finland is a case study in the failure of exactly what the senators are proposing.

Thank you for taking time to read this rant.

Political Instability in Italy and Spain and Slowing Business Activity Confront European Markets

In the past two weeks investors have come, belatedly, to recognize the negative implications of the election of a populist government in Italy, the first such government in Western Europe. The possibility of a government collapse in Spain as a result of the main opposition party’s call for a vote of no confidence added to investor concerns last week. Leading indicators of Eurozone business activity showed that economic growth in May, while still characterized by HIS Markit as “robust,” had slowed for the fourth month in a row. Bond prices and financial stocks fell sharply, though by no means as much as they did during the Eurozone crisis.

Cumberland Advisors Market Commentary - Cumberland Advisors - Political Instability in Italy and Spain

The Italian election on March 4th resulted in two radical populist parties seeking to form a coalition government. While both are called “populist,” they have conflicting policies, so it isn’t surprising that their efforts to form a government were difficult, and ultimately failed. The Five Star Movement (M5S), which says it transcends the left-right divisions, called for a universal basic income of $920 a month, implying a huge increase in government outlays. The Northern League is a far-right party that has called for a flat tax rate of 15% and xenophobic actions against refugees. It would like to see heavy spending on infrastructure, which is opposed by the environmentalists in M5S. Both parties wish to roll back pension reforms and other reforms that were directed at boosting competitiveness. Both are strongly Eurosceptic and show little inclination to be bound by European Union rules and regulations. Both call for scrapping sanctions against Russia.

Last Monday the two parties decided on a compromise candidate for Prime Minister, Giuseppe Conte, a law professor, who on Wednesday was given a mandate to form a government. They then turned to putting together a cabinet. Their choice for Finance Minister, Paolo Savona, an 81-year-old arch Eurosceptic economist who also is an opponent of austerity programs, encountered strong opposition from investors and most importantly from Italy’s president, Sergio Mattarella.

Italy’s president has the right under Italian law to reject the appointment of a cabinet member and he did block the appointment of Savona Sunday night. Conte then gave up his efforts to form a government. Mattarella asked Carlo Cottarelli, a former IMF economist, to run a technocratic (caretaker) government.  Mr. Cottarelli said he would like to receive parliament’s backing for him to serve through the end of the year followed by a new election in January. That would permit him to propose next year’s budget. However, it looks more likely he will not gather sufficient support, which would imply new elections as early as September.

Monday there was first relief in European governments and in financial markets that a populist government in Italy had been prevented but this reaction soon was overtaken by the fear that the populist parties could emerge strengthened by these events if there is a new election. The drama thus continues.

Before the weekend, Moody’s had already seen enough to place Italy’s credit rating on review for a downgrade. The agency cites a “significant risk of a material weakening” in Italy’s fiscal situation and of a reversal of recent reforms. Note that Italy’s public debt at the end of 2017 was 132% of GDP.

The situation in Spain is less dire. Prime Minister Mariano Rajoy, whose minority government has been hurt by a campaign finance scandal, faces a confidence vote later this week and may have to call snap elections. Also, Catalonia has a new regional government that looks likely to be confrontational in pressing its separatist agenda. Markets do not like uncertainty. However, it is important to note that Spain has made great progress in recent years in strengthening its fiscal position and addressing problems in the banking sector. This progress does not appear to be threatened.

Economic expansion continues in the Eurozone but at a more moderate pace than at the beginning of the year. The increase in the HIS Markit Flash Eurozone Composite Purchasing Manager’ Index (PMI) for May was the weakest in one-and-a-half years. The final PMIs for April showed output growth for Italy at a 15-month low, for Spain at a 4-month low, and for Germany at 19-month low, while for France it was at a 2-month high. Understandably, business optimism in the Eurozone is reported to have weakened. While a number of special factors have affected the data, including extreme weather, the timing of Easter and of holidays in May, and strikes, underlying momentum has clearly slowed.

There has been a positive development in Europe worth noting. European Union finance ministers have agreed on a deal that will toughen regulation of European banks and reduce risk in the banking system, a step urged strongly by Germany and its Northern European neighbors. This deal is regarded as a necessary step to further Eurozone reforms. The agreement must be discussed with the European Parliament before it is formally adopted. There are concerns that Italy, which abstained from the agreement, will try to alter the text.

The market reaction to recent European developments has been sharpest in the bond markets. A sell-off of Italian debt resulted in a spread of some 130 basis points in the yield of Italian two-year bonds above their German equivalent during the last two weeks through last Friday. This development was due to both a sharp rise in Italian bond yields and a decline in German yields as the German bond market benefited from a flight to safety. On Monday the fear that Italy’s populist parties would win more votes in a new election caused the yield on Italian 2 year bonds to spike up again to 0.981% and then settle close to 0.9%.

The equity market reaction thus far has been greatest in Italy. The iShares MSCI Italy Capped ETF, EWI, lost 4.28% over the past week and 9.41% over the past 30 days through last Friday. Monday the US markets were closed but the FTSE MIB index for Italian equities fell by 2.1%. The Spanish market fared somewhat better. The iShares MSCI Spain Capped ETF, EWP, posted losses of 3.9% last week and 5.08% over the past thirty days through last Friday.

The overall effect on Eurozone equities had been modest until today, May 29. The iShares MSCI Eurozone ETF, EZU, eased only 1.96% over the past week and just 0.32% over the past 30 days. However, today the turmoil in Italy is disturbing global markets. Dow Jones Stoxx 600 dropped 1.3% with financials down 3%. Italian stocks tumbled another 3% and Spain fell 2.5%. The yield on Italian two-year bonds rose another 140 bp to 2.24%.  The evolving situation, particularly in Italy, requires careful monitoring, because systemic risks in the Eurozone appear to have increased.

Bill Witherell, Ph.D.
Chief Global Economist
Email | Bio

Sources: CNBC, Bloomberg, Financial Times, The Economist

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FOMC Minutes – May 2018

The FOMC minutes are designed to provide a concise summary of the presentations and discussions that take place at FOMC meetings and the context behind the terse press release provided at the end of each meeting. Presumably, this communication device is meant to provide added color and a sense of where policy may be going. But has it? Consider the following:

The Wall Street Journal front-page headline of May 24 states “Fed Signals June Rate Rise,” but the only evidence provided is this quote from the minutes: “It would likely soon be appropriate for the Committee to take another step.” While soon may rhyme with June, the statement in no way justifies the Journal’s headline. The minutes made no mention of a rate hike in June.

Then there was the headline from Marley Jay, Associated Press: “Fed Gives Stocks a Boost…” with this first line of the story: “U.S. stocks turned higher Wednesday after the Federal Reserve indicated it’s not in a hurry to raise interest rates too quickly.” The story went on to conclude that the FOMC would be on a gradual path of raising rates and might even tolerate inflation’s rising above 2% for a brief period. However, there is scant evidence in the minutes for this conclusion. The only mention of the possibility of inflation’s being above 2% was the statement that “Some participants suggested that inflation was likely to moderately overshoot 2 percent for a time.” But the minutes go on to note that “… several participants suggested that the underlying trend in inflation had changed little, noting that some of the recent increase in inflation may have represented transitory price changes in some categories of health care and financial services, or that various measures of underlying inflation, such as the 12-month trimmed mean PCE inflation rate from the Federal Reserve Bank of Dallas, remained relatively stable at levels below 2 percent.” It is important to note here that the words some and several have quantitative meaning when used in the minutes to describe how many FOMC participants are being referenced. Some means 3 or 4 while several means more than half.[1] So only 3 or 4 participants thought that inflation might drift above the target, but this was certainly not the majority view, nor do the minutes provide any indication of the Committee’s willingness to tolerate inflation above its target of 2% should that event occur.

Finally, Deutsche Bank, in its research commentary, continues to expect three more rate hikes in 2018, based upon the assessment that labor markets are tightening more and that there is now a greater likelihood that the FOMC will overshoot its inflation target.[2] However, this view is counter to what the FOMC suggests in its minutes, for several reasons. The quotes above certainly don’t suggest that a majority of the FOMC see significant inflation risks to the upside. Nor does the majority see overshooting as a problem yet. Furthermore, recent increases in healthcare and financial services were viewed as being transitory. The tight labor markets were not seen by “many” as an immediate problem:Many participants commented that overall wage pressures were still moderate or were strong only in industries and occupations experiencing very tight labor supply; several of them noted that recent wage developments provided little evidence of general overheating in the labor market.” So even to those who believe in the Phillips curve, the inflation pressures from labor markets are not viewed by the FOMC as a pressing risk. The word many here is meaningful, since in Fedspeak it suggests that well more than half of the participants held the view.

All of this reading of the tea leaves, often leads to conflicting interpretations of the minutes and suggests that there is still much work to do on the FOMC’s part with respect to its communications policies overall and with the minutes in particular. While there are people, both inside and outside the Fed that are against some of the FOMC’s disclosure policies, such as releasing the dot charts, the bigger problem is that there are multiple constituents for information and not all have the same needs. For example, the current SEP forecasts are not granular enough, in that markets care more about the short term and what the likely policy path for rates looks like quarter by quarter and not simply yearly. Too much guessing is inspired by the present yearly forecasts. The reluctance to provide more granularity is understandable, especially when the projected paths may not be realized and there is the real risk of being wrong?  But more granularity would also serve to better inform expectations and perhaps anchor expectations in a more reasoned way. It is easy to criticize forecasters, but one also needs to consider the Fed’s problem. The Fed is tasked with steering a battleship while looking in the rear view mirror. It is no wonder that the FOMC remains cautious and uses words like patient and data-dependent.

Robert Eisenbeis, PH.D.
Vice Chairman & Chief Monetary Economist
Email | Bio

[1] See Ellen E. Meade, Nicholas A. Burk, and Melanie Josselyn, “The FOMC meeting Minutes: An Assessment of Counting Words and the Diversity of Views,” Fed Notes, Board of Governors of the Federal Reserve System, May 26, 2015.
[2] See Deutsche Bank Research, “US Outlook: Paving the Path to Higher Rates,” May 22, 2018.

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Kim, Trump, Thucydides

Trump’s cancellation of the Kim summit meeting clearly draws lines in the sand. Trump’s position cannot now be reversed for a longer period of time than was contemplated just hours ago. We now have an unpredictable escalation path.

Kim’s behavior in destroying tunnels, underground mountain rail lines, and other parts of his nuclear test site implies that he has lost the use of the facility. We do not know the casualties. The Kim family has practiced deceit for generations (three of them). US policy now realizes that hope is not a strategy.

Multidimensional issues abound: US–China, US–South Korea, other players in the region. What happens with Japan?

Bottom line is that the “peace breaks out” euphoria is now replaced with a more pragmatic set of facts. The Pentagon study on North Korea’s behavior only adds confirmation to the increasing risk assessment.

The implications for our dealings with Iran are a critical discussion item now. We must believe that Iran is watching the North Korean situation carefully. Remember that Iran is a customer of North Korean missile and other arms sales.

We have a cash reserve in our ETF accounts.

We are watching important lessons from ancient times playing out again. How much has humanity learned?

For Thucydides part 1, see:

For Thucydides part 2, see:

For Thucydides part 3, see:

Brian Barnier Guest Commentary – A Concise, Practical Seminar on Root-Cause Analysis

My friend and fishing buddy Brian Barnier is Director and Head of Analytics for ValueBridge Advisors (US) and Burnt Oak Capital (UK). He focuses on growing companies and investments through an emphasis on the application of technology to process improvement and the understanding of product, market, and economic trends. He has an analytical edge in risk management that comes from being a whiz at systems analysis and advanced data visualization. He is co-founder and editor of the economic and market risk site Fed Dashboard & Fundamentals ( and the author of The Operational Risk Handbook and over 200 professional articles. He teaches a graduate seminar at the Colin Powell School at the City University of New York.

In the guest commentary that follows, Brian gives us a concise, practical seminar on root-cause analysis, a mindset and methodology that I learned from Brian and have found endlessly helpful.

Now, here’s Brian.



Think about using your car navigation app to route around congestion. Have you used a fish finder to locate a great place to drop your line? Or did you repair the air pump for your live bait bucket because bait fish need air to stay alive? Better yet, have you repaired an outboard motor? Have you watched an outboard motor or anything being manufactured? All of these activities are about systems and involve root-cause analysis that was refined during World War II. Yet these tools are rarely used in monetary economics.

By contrast, monetary economics largely runs on a strain of math borrowed from physics before World War II and dedicated to searching for high-level equilibria. Monetary economics, then, relies on abstract calculations rather than on pragmatic investigations into how the mechanics of how an outboard motor actually work, including that filters can get clogged.

When central bankers say “data-dependent,” they mostly refer to aggregate averages, such as all the fish in lakes in Maine rather than the smallmouth bass in West Grand Lake. Or, central bankers might fret that fishermen are not taking enough fish – without realizing that fishermen might be shifting preferences to “catch and release” because having a model mounted on a wall, created from a photograph of a trophy fish, is just fine.

Overlooking systems and root-cause methods (from operations research and related fields) leads central bankers into two mistakes: not drilling down into deeper data and not updating variables in formulas (e.g., potential GDP) to reflect current dynamics.

This flawed methodology has led to missing the magnitude of change in our world, especially in two areas: tech (including management technique and technology) and trade.

The global tech and trade transformation has led to falling costs (goods other than food and energy have been falling in cost since the mid-1990s) and the global rise in financial assets (sparked by regulatory and technology changes in the late 1980s). This sea change resulted in a shift from scarcity to abundance.

Most all the systematic errors in central bank forecasts and actions can be traced back to overlooking this math, data, and change.

Within monetary models, these root causes are widely overlooked:

  • * The long-run aggregate supply curve for goods, especially durables, hasn’t been upward-sloping since the mid-1990s. This means people tend to buy more, not less, when prices fall. And, it means that central bank attempts to increase prices are more likely to cause stagflation than growth in units purchased.
  • * Potential GDP is much higher than assumed because excess capacity in labor hours is much higher than assumed (leisure – work preferences before 2009 are ignored, especially those of the early 1970s, when people worked more). Improvements in equipment (the capabilities of new equipment and the speed of putting it in place: oil fields, data centers), structures (high-density offices and smaller-footprint manufacturing), or a championship fishing lake by 5AM in the summer also augment potential GDP but aren’t sufficiently accounted for.
  • * Economic growth is now less limited by labor hours simply because the labor hours needed to produce results have been falling with improvements in management technique and technology.
  • * Wages won’t necessarily rise when workers become “service humans” providing support to robots, because of the falling cost and increasing capabilities of automation (whether for equity trading or for assembling cars).
  • * Labor productivity is not widely weak, and weak labor productivity isn’t necessarily bad when businesses prioritize improving returns on assets (especially expensive ones) and returns to investors.
  • * Multifactor productivity (MFP) is less and less a measure of “technological progress” now that technology inputs have been explicitly included, especially since a 2008 national accounting change. MFP is a residual of outputs compared to inputs. Practically, its value diminishes the more detached it becomes from business measures of production and returns.
  • * Business fixed investment doesn’t necessarily rise with a lower effective federal funds rate because (1) the effective fed funds rate is a small part of the net present value equation used for investment decisions and (2) the cost of productive capacity (equipment and structures) for a given level of output has been falling.
  • * Natural interest rates are lower than assumed because they are set more by global funds flows than by production levels; and, again, the cost of fixed investment is now less.
  • * It is generally assumed that most of the weighted-average product price change (as reported in price indices and deflators) is due to monetary (money-supply and interest-rate) causes. That assumption might have been reasonable in the 1970s, but it has been less true since 1981. When the root cause of a product price change is technology, management technique, online shopping, or government policy (regulatory, trade, tax, or subsidy), central bank monetary policy tools have had little effect. Central banks need a method to separate monetary causes (that central banks can address) from nonmonetary causes (that they rightly punt to other agencies of government).
  • * A central tendency is assumed in average price indexes or deflators, rather than the dramatic dispersion of price trends. With prices having multiple modes (starting with the simple split of goods and services), targeting “average” inflation makes no sense. Landing at the average location of two airports is a crash.
  • * Looking at growing research on the prices of complex and changing products (from mobile devices to medical treatments), we find it likely that the measured average price level increase is significantly overstated. If so, then real interest rates have long been higher and natural rates have been lower than assumed.

These examples cascade through monetary models and decisions. Just as with the basics of baiting a hook and casting a line, monetary models might benefit from factory-floor-style root-cause analysis and continual improvement. The goal is to catch a great fish, not get injured by an error with a hook.

We thank Brian for sharing this with our readers and wish him “tight lines”. For readers who can make last minute changes, there is a little space left for the June 21-22-23-24 gathering at Leen’s Lodge. Go directly by phone to Scott Weeks, 207-796-2929. August is now full. Labor Day is nearly fully reserved with few spaces remaining.

David R Kotok
Chairman & Chief Investment Officer
Email | Bio

Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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