Unpersuasive Phelps

Nobel Laureate Edmund Phelps had written for Wall Street Journal on the Federal Reserve monetary policy. He fails to persuade. Clearly, his distaste for the current purveyors of conventional wisdom shows through in the first paragraph itself. He used the word, ‘crowed’ to refer to Bernanke and to Blanchard’ alleged assertion that monetary policy had become a science, in a conference in 2005. Unfortunately, my efforts to locate their assertion did not succeed.

In fact, there is a paper by Olivier Blanchard presented in April 2006 in honour of Ottmar Issing, the Chief Economist of Bundesbank. He is reasonably humble and modest. He does not claim that monetary policy had become a science.

Then, my search yielded a paper by Frederic Mishkin in 2007 for the Federal Reserve Board. That was the heyday of  global euphoria. Even, he does not go as far as to label monetary policymaking as science.

Also, some of the conclusions that he has presented as to the consequences of easy money on firm behaviour – with respect to hiring and wages – do not seem instinctively correct. Also, as to the peaking of the US dollar, against developed currencies, it did peak in 2013-14 (more like 2013) rather than in 2015. Against emerging market currencies, it might have peaked in late-2015 or in early 2016.

Yes, he is right that the weak dollar boosted profits and that he is right that the bottoming of the dollar against other majors had coincided with the peak in profit for S&P 500 companies in 2014. But, hiring has continued.

In other words, the dollar’s end of weak spell and its strong spell in the last year+ has not made a big difference to either output growth or employment although it seems to have made a difference to corporate profits. Both output growth and employment are proceeding at their same gradual place both before and after.

This blog is well known for its deep distaste and aversion to the persistence of unconventional monetary policy (UMP) well past their SELL BY date. But, making a wrong case against it weakens the argument and gives an opportunity for many of its cheerleaders to pounce on it and pronounce all criticism flawed.

Here are interesting statistics that make a devastating case against QE and UMP :

(1) In 2001, the nominal GDP growth was 3.3% and in 2015, it was 3.7%, after three rounds of QE, reinvestment of maturing bonds and years of zero interest rates, etc.

(2) In terms of quarterly data, the nominal GDP growth rate y/y in 4Q2001 was 2.2% and in 2016Q2, it was 2.4%. It seems like a case of too much for too little, when it comes to UMP.

(I saw this comparison between nominal GDP growth in 2001 and 2016 mentioned somewhere. It is not a original exercise on my part. Of course, what happened in 2001 needs no repetition: technology bubble burst; 09/11 happened and the U.S. economy was in recession.)

(3) From the FT on Sept. 9, 2016:

Between 2012 and 2015, US companies acquired $1.7tn of their own stock, according to Goldman Sachs, counteracting sales by pension funds, foreign investors and households.

Indeed, excluding corporate buybacks, net US equity flows would have been negative to the tune of $1.1tn over that period, despite burgeoning inflows into exchange traded funds. In other words, the post-crisis stock market recovery would have looked much shakier without the backstop of companies themselves. [Link]

In other words, corporate buybacks turned a USD1.1trn stock outflow into a USD600bn stock market inflow. Who and what made it possible? Federal Reserve and UMP. Check this out:

A recent Morgan Stanley report estimates US companies’ collective debt at a record 2.4 times their collective earnings as of June.

The debt metric, which doesn’t include banks and other financial companies, has climbed for five straight quarters as corporate profits decline at the same time companies load up on the increasingly cheap borrowings, Morgan Stanley analysts led by Adam Richmond wrote in a note to clients.

“Leverage tends to rise most in a recession — so the fact that it is this high in a ‘healthy economy’ is even more concerning,” the analysts wrote. In other words, they said, “mistakes are both more likely and more costly.” [Link]

(4) The latest monthly Mercet pension funding gap press release shows that in the United States, the funding gap was USD570bn and that it was USD404bn at the end of 2015. This is for the month of August 2016. According to this Bloomberg story, more than 60% of the global pension assets are held in the United States.

(5) Goldman Sachs has released a 106-page slide presentation titled, ‘Where to invest now?’. Page 59 of that presentation has two graphs on P/E ratios of stocks for various nominal and real interest rate bands. The average forward P/E ratio is at its peak for nominal 10-year Treasury rate range of 5% to 6% and for real rate of around 3% to 4%. This makes a lot of sense. A world of zero or negative nominal and real interest rates is a world of low investment returns and deflationary expectations. Financial asset prices should and will eventually reflect that. That financial markets have been in thrall to UMP is a big folly. Empirical evidence is not on the side of investors.


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