Jackson Hole Showdown

Jackson Hole Summit
Federal Reserve Chairwoman Janet Yellen and European Central Bank President Mario Draghi at the Economic Policy Meeting, Jackson Hole, WY, USA. Photo by John Locher, AP

This editorial from the New York Times takes the side of Federal Reserve Chairwoman Janet Yellen against the “inflation hawks” in the aftermath of the Jackson Hole annual meeting of central bankers.  The NYT’s editors challenge the wisdom of raising interest rates citing the Federal Reserves own prediction of a 2.3% rate of economic growth in the US for 2014. I call it a “showdown” because Yellen had to prevail against such as Dr. David Kelly, Managing Director, and Chief Global Strategist for JP Morgan Chase who in this: JPMorganChase3Q14 market update argues for increasing interest rates for fear of inflation and higher wages.

Another source of support for Yellen’s position comes from Dean Baker at the Center for Economic and Policy Research (CEPR) in his weekly “Beat the Press” blog; my original source for the Times’ editorial. Baker’s post is decidedly in the camp of lowered unemployment and higher growth. Unlike the inflation hawks he remembers a similar instance. In 1997 there was clamor among economists for increasing interest rates to head off inflation. Federal Reserve Board member Janet Yellen was among those. Perhaps she remembers that the Chairman, Alan Greenspan ignored these cries, kept the rates low and saw unemployment fall to 5% in 1998 and to 4% by the year 2000. Yellen might also recall that the growing economy led to Federal budget surpluses for the last three years of the Clinton presidency. I might also add that contrary to Kelly’s claim that higher employment leads to lower stock prices due to lowered earnings per share (corporate profits); 1990-2000 was the biggest and longest running bull market in history; especially in each of the last three years which saw gains of more 25%.

Baker’s column goes further to cite a study by one of his colleagues that indicates that for every 1% drop in unemployment there is a nearly 10% increase in wages for the lowest quintile of wage earners. For a worker earning $20,000 a year this means another $2000 in earnings; a significant sum. This is the “tight labor market” effect that has Dr. Kelly of JP Morgan so worried.

It is astounding that rarely is the connection made between higher wages and increased consumer demand. Higher wages are almost consistently cited by such “global strategists” as Dr. Kelly to be inflationary. However, it takes a significant increase in consumer demand over a significant period to cause price increases, especially in an environment where productive capacity is still under-utilized by almost 20% as is the case in the USA today. The reason for this is that if corporations can produce more goods or provide more services without the need to expand plant and equipment, costs per unit do not increase significantly. Since almost 90% of our economy is driven by consumer demand, let’s hope that Yellen, our first Fed chairwoman can hold her ground, keep rates low and allow this tepid recovery to grow into a strong economy with more and better jobs and a higher standard of living first and foremost for those on the lower rungs of our society. All of us will be ahead.




A New Era of Fiduciary Capitalism?

capitalismAn Encouraging View

John Rogers, CFA, President and Chief Executive Officer of the Chartered Financial Analyst Institute weighed in at the Society’s Journal in June with a guest editorial about the state of finance as an industry in today’s economy. Rogers observed that the proportion of GDP attributable to this industry has almost doubled since 1980 and wants to know what the benefit was to the larger society.

He describes the history of interest rate suppression and its effect on the financialization of the economy. The rapid growth of this industry absorbed tens of thousands of bright young people at its height. He laments that the sole objective of this engorged industry was “rent seeking”; the search for greater “alpha” or the margin between principal and current value. Rogers observes that with the advent of institutional investors who control enormous market share, the relentless drive for alpha to the exclusion of all other considerations might be ending.

He asserts that these institutions understand that their role as perpetual entities have, at the core, a fiduciary obligation to their beneficiaries that extends beyond the lives of those who are currently recipients. Because they have this realization, they must take a strategic orientation to the companies in whom they invest. Rogers observes that they are concerned with governance in those corporations because the way a corporation is governed has a tremendous impact upon its future viability. This creates a phenomenon he calls “patient capitalism”. Such a pervading atmosphere in the financial markets would change the objective of capital investment from the search for greater alpha today towards a questioning how the long term interests of the shareholder (for the institutional investors this means the interests of their beneficiaries for generations to come) are being met by this corporation, its products and/or services. Rogers observes that more and more frequently, large institutions are investing directly between each other on private trading platforms, bypassing the exchanges,  their high speed trading programs and excessive fees.

Rogers does not express it directly but in governance, executive compensation is a massive proportion of total costs and easily reduced as a cost of doing business. He does not explicitly address future costs that have enormous social impacts such as developing alternative energy resources and reducing fossil fuel consumption to fight global climate change, but when the outlook is strategic, the beneficiaries numerous and intergenerational these considerations must be included. The aggregate of 1,000 of the largest (fiduciary) institutions accountst for more than half of the world’s capital. This gives them tremendous clout in the global markets. They can bring about enormous social benefit if they were to demand and assert their fiduciary orientation on global corporations.

John Rogers, in conclusion hopes for the supplanting of 30 years of finance capitalism with a new era of fiduciary capitalism and warns the financial sector that if it causes another meltdown then it should expect more regulation even to the point of making them into public utilities. He decries the era of stratospheric managerial bonuses and is fervently wistful and optimistic for “…efficiently and cleanly connecting capital with ideas, long term investing for the good of society, and delivering on promises to future generations”. We should insist upon, be on the lookout for and prepared to spotlight the coming fiduciary capitalism.






Krugman on inflation, deflation and economic growth

03-28-09_1041Oligarchy and monetary policy

Krugman finds evidence of hoarding in the latest report from the International Monetary Fund. The concentration of income causes cash to lose circulation; thereby facilitating economic stagnation. Generally accepted economic principles maintain that robust economies are those with large amounts of cash in circulation. It is my understanding that cash in circulation can even be measured in terms of it’s velocity. Krugman believes that an “oligarchy”;  just .1% (0ne tenth of once percent) of the population has the most to lose with increasing inflation since the value of hoarded cash erodes with it. Rising inflation is also a stimulus for spending since today’s dollar will buy less tomorrow. Other economists such as Dean Baker and Mark Weisbrot at the Center for Economic Policy Research (cepr.net) are unequivocal on this topic and Weisbrot has observed that rapidly growing economies such as Brazil experience inflation at high single digits without ill effects. Krugman rightly asserts a social injustice element as he observes that monetary policy that places low inflation uppermost causes persistent high unemployment. He counterpoises the interests of the rich against the interests of millions of unemployed and finds that the needs of the masses trump the desires of a tiny few. Politically, however, advocating higher inflation can be a difficult sell in middle America. Workers, especially retired workers on fixed income are easily alarmed at the suggestion of eroding purchasing power and historically are not altruistic enough to endure it for the sake of the jobless.

Raising the Minimum

I found this story http://t.money.msn.com/now/californias-minimum-wage-hike-may-be-a-harbinger on the MSN newsfeed today. I was impressed at first by the boldness of the move but after seeing the details, namely that the increase would be incremental I am now underwhelmed. Although the increase would take almost 2 years to reach the $10/hr. target, the California Chamber of Commerce was howling nonetheless.

Increasing the minimum wage would be a relatively painless way to shift the economic gears into, well, 2nd gear from where we are today. The reason it would significantly improve our economy is that at present there are too few dollars chasing too many goods. Recently, it was reported that the income gap between the richest and working class Americans is the highest it has been since the robber-baron days of 1928. So much of the Gross Domestic Product (GDP) is “earned” by the richest Americans that the “consumers” are left with little to demand goods. It is impossible for those with annual incomes exceeding $350,000 to make significant demands on production. In other words, if you’re rich enough you already have everything you could want so you just can’t spend a whole lot more. Although finished goods are by historical standards cheaper than ever before, there is still not enough demand to raise the capacity utilization above 70% http://www.census.gov/manufacturing/capacity/index.html. This means that in the aggregate, U.S. manufacturers, regardless of the amount of investment capital that is thrown at them, cannot expand their factories and hire more people because they can already produce 30% more product with the people, plant and equipment they have.

Wages and profits are a “zero sum game”. That is, for every dollar added to wages, a dollar is lost to profits, generally speaking. Floyd Norris reports this phenomenon in the New York Times http://www.nytimes.com/2013/08/10/business/economy/us-companies-thrive-as-workers-fall-behind.html when he points out that wages and salaries as a proportion of the GDP are at their lowest level (42.6%) since 1929 while corporate profits, at 9.7% of GDP are at a historical high (the “flip side” of the equation). It must also be noted that there are some very high wage earners out there so statistically speaking there is a tremendous amount of low wages to pull the average down. President Harry Truman nearly DOUBLED the minimum wage in 1949 http://t.money.msn.com/now/c_article.aspx?cp-documentid=252398349  setting it at $.75 from $.40 per hour. None of the calamity predicted by the US Chamber of Commerce came to pass; in fact the 1950s are generally regarded as a period of unparalleled prosperity in US history.

“What about the inflationary impact of all those high wages”, a banker might ask. There would certainly be some inflationary impact to such a dramatic increase as Truman made. However, although the Labor Dept. reported that nearly 1.3 million workers were immediately effected by the Truman wage increase, the 1950s are not known to be significant inflation-wise. Since there is so much excess productive capacity already, a whole lot more goods could be produced without significant cost. Also, since US profits are at a historically high level, business could easily absorb the increase in wages and at the same time enjoy a tidal wave of demand.

This seems to be a perplexing situation. It’s pretty clear that it could be a win-win-win situation. Higher wages would spell increased standard of living for millions of people, higher sales would spell increased profits (with a smaller profit MARGIN, however) for business, and higher sales and purchases would spell dramatically increased revenues for Federal, State, and Local governments. It doesn’t happen because unfortunately the balance of political power in the USA has tipped too far in favor of large corporations. Without a check on their power, they cannot be brought to do what is in their best interest in the long run.