Potpourri, But Mostly Economic Tidbits

Potpourri, But Mostly Economic Tidbits

1. Smart Witnesses: A Sad Sign of the Times
The Sunday Times, in a page one article entitled "An Evangelical Article of Faith: Bad Times Draw Bigger Crowds," had this interesting paragraph:

"The Jehovah’s Witnesses, who moved much of their door-to-door evangelizing to the night
shift 10 years ago because so few people were home during the day, returned to daylight witnessing this year. "People are out of work, and they are answering the door," said a spokesman, J.R.Brown."

To me, should the Jehovah’s Witnesses lose their faith, they could get jobs as economists, as they
know how to marginally readjust their resources as costs and benefits change.

2. B’s & M’s

A friend wrote and asked me how one (Bernard Madoff, to be specific) could create a Ponzi scheme involving as much as $50 million. Oops. He made a mistake. $50 million is actually no problem, just con a few hundred rich friends and voila! But the reality, $50 billion, does seem a bit difficult, even for your most adept Ponzi-er. How did he do it?

3. Negative interest rates soon?

Yesterday, the Fed lowered its target rate to a range between zero and 1/4 of 1%. It’s the first time I’ve ever seen a range, but that is hardly the main point. Zero–that’s the point. Now this is a target, so I’ll do some Econ 101: The Federal Reserve requires banks to keep a small fraction of their deposits as reserves at the Fed–about 10%. Now sometimes, expected deposits don’t come in (to be put in reserves) and the bank is short. At the same time, another bank decided not to make a loan, so it has an excess of reserves. The first bank (short of the required reserves) borrows from the 2nd bank, which has an excess. And what is the interest rate on this loan, which is usually over-night? Well, as parrots are trained to say: supply and demand. Or in other words, it depends on how many banks are short (and by what amounts) and how many have excessive reserves.

If the Fed wants to lower rates, it buys Treasury bills that are out there in the market and the recipients of the Fed’s check deposit it into a bank. And thus increased reserves result. By the logic of S & D, the interest rate on borrowed reserves falls (banks borrowing reserves from other banks), since there are more banks with excess reserves who are willing to loan them overnight (to other banks or at least to other banks that look healthy). The Fed typically has a target and if, say the target is 2%, and the actual loaning rates are 2 1/4 %, the Fed buys more T-bills. If the rate is 1.85 %, then the Fed sells T-bills. It tries to achieve the target by either buying or selling T-bills.

The target is now zero (or 1/4 of 1 %). In the past, this rate nudged other rates, which firms and individuals could relate to, such as the prime rate, a rate banks base all their rates on, and the prime would drop ½ % when the Fed dropped its target ½ %. And many credit cards have rates pegged to the prime.

But perhaps even more important, the Fed, feeling that its open market operations are all but useless, is now considering buying long term Treasury bonds, in the hope that reduced rates in the long term markets will bring other long term rates down and that, in turn, will induce potential borrowers to borrow. And stocks reacted positively today (Tuesday) in response)--the Dow was up 4.2%--but stocks always react to news of this sort, even if nothing of substance occurs later on (and I think, in general, the stock market over-reacts whenever positive news hits the headlines). It doesn’t at all mean prosperity is around the corner, as Hoover used to say.

To me, the Fed looks increasingly desperate. Normal monetary policy is simply not working. Zero is a record, but not one we should be in the streets cheering. It’s an indication that times are getting ever more desperate. The odds are that the economy will hit double-digit unemployment during the next year (although Monday’s Times has an article that predicts only 9%) and that recovery will be slow in coming and possibly (even probably) only partial. That is, increasingly it looks like we may be saddled with a weak economy for many, many years.

4. "In the long run we are all dead."

Most persons, by now, know this was stated by John Maynard Keynes. Actually, he wrote it in "A Tract on Monetary Reform" in 1923, long before the Great Depression, during which he authored "The General Theory of Employment, Interest and Money," the classic that made Keynes the greatest economist of the 20th century (and whose approach to hard times is as pertinent today as it was in the 1930's). He was expressing his distaste at economists who would argue, during a time of stress or economic malfunctioning, that in time everything would settle back to normality.

But I bring up the long run to write about the future and the past (what some might refer to as the long run). I have two related but different situations in mind. The first relates to what investment advisers currently suggest. I met an intelligent adviser at a family party recently and he suggested diversification is the answer and one’s portfolio should stocks, primarily, and then bonds and possibly other alternatives–like real estate, CD’s, etc. He like others knows that the present is not exactly like the past, but nonetheless will use figures from the past indicating that over a long period of time stocks have outperformed bonds. The implication, also, is that as you get closer to retirement you might reduce your holdings of stocks, which are more speculative in the short run, and increase your holdings of bonds, which, typically, are not (unless there is an upsurge of inflation, as we had in the 1970's).

But what if the future is significantly different from the past? How does one know it will not be? What, in any event, does significantly mean? So let me bring in the other situation, the overall workings of the economy. Suppose that the future is what some in the 1930's thought of as "secular stagnation?" Secular, has noting to do with religion, or its lack thereof, but means "long run." (My somewhat old Random House dictionary offers, as definition 6 of secular, "going on from age to age; continuing through long ages.")

In the 1930's, deep in the Great Depression, the phrase arose and a conservative economist from Harvard, Alvin Hansen, converted to liberal Keynesianism and gave the 1938 address, as President of the American Economic Association, on just this topic–secular stagnation (and why it existed). Now we all know that after the war, this view of things melted away as there was prosperity and not stagnation. But it’s time to reconsider.

The United States is clearly in some kind of secular decline, possibly un-reversible. Our manufacturing is down enormously from what it was, as a percentage of our GDP. Our trade balance is just awful. And we only seem to survive by bubbles that inevitably burst. What is to propel us in the future? I know there are optimists who believe our science and superior level of education will enable us to lead the way in developing an appropriate green technology, but while I think this is possible, I doubt very much it will happen. I’ll believe it when we are able to pass what is absolutely necessary if we are to successfully switch to electric cars–a whopping gasoline tax of, say, $4 a gallon, with further increases to come. No way, Jose.

If we do bounce back some from the disaster we are now in but then limp along, aided by huge levels of Federal government spending, that simply continue, and are not temporary, we will in effect be in what was known 70 years ago as secular stagnation. If this is the case, then it would seem to me stocks will not be surging ever upward, but worse--interest rates will be high and partly because of this, the economy will stagnate even more. Interest rates will be high, since we are printing money by the trillions to try to jump-start the economy, and then keep it moving upward, and at some point the dollar must weaken and inflation will appear. Who of our creditors wants to hold a currency that is being massively printed into worthlessness (or perhaps less emotionally into less and less worth). To deal with the declining dollar, and the inflation it will create–all foreign goods will cost more–interest rates have to be high.

This means that over the next generation, it is likely that bonds will outperform stocks, although there is a matter of timing to be dealt with. That is, after the dollar starts weakening, and bond rates rise, then, and only then, will one’s investment in bonds outstrip one’s investment in stocks, if I am correct. The decline of the dollar may actually have begun (or begun again). After seeking safety in the dollar, the dollar strengthened this summer against the Euro, but it has been weakening recently, against the Euro, and has weakened enormously against the Japanese yen. Is it not possible then that over the next two or three decades bonds might be a better investment than stocks? If the future is like the past, of course not. But if it isn’t?

What all this also suggests is that "full employment" is going to be higher than what it has been. At one point, earlier in the post-war period, full employment was perhaps defined as 3 %, rarely achieved, or 4%, last achieved in the late 1990's. During the mid-nineties, Greenspan refused to raise rates, when the existing theoretical apparatus suggested that full employment was about 6 % (or a tad more), meaning that levels of unemployment below this 6 % would lead to increases in the rate of inflation. But Greenspan rightfully decided this statistical measure, based on the past, was inappropriate. He didn’t raise rates to prevent inflation, because he thought there was no inflation to worry about. (We leave off the question of whether he should have raised rates to slow down the dot-com bubble or at least raised margin requirements to 100% or repeat periodically his fear of "irrational exuberance.")

But given what the Fed will have to do to stop inflation, it is possible that full employment will be higher than it was thought to be in the nineties. That is, the Fed will believe it has to keep rates at a level that will lead to 7 or 8 % unemployment or we will have increasing inflation. This means, to me, we will be living in world of secular stagnation, in spades.

Let’s modify Keynes: "In the long run, almost all of us will be deadly poor."

5. TIAA Real Estate Fund and Empty Stores

Although only persons who have holdings in TIAA-CREF, the enormous college retirement fund, have a financial interest in its real estate fund, there is, I think, an intellectual interest in what is happening. Plus there is discussion of real estate in general.

Ignore that I had over 90% of my retirement funds in the TIAA Real Estate Fund, violating the conventionally held view, by maybe 99.5% of economists and financial advisers, and ignore that I did very well and even partially convinced a very smart economist that because of its lack of volatility, my arguments for holding this fund might, in the last analysis, be sound. [For about the first three months of the year, the fund was up about 1%; then, for the next three months it declined so that it was only up by about one half of one percent–that’s when I got out. Now it is down 9 ½ % for the year, far less than the CREF stock funds, but obviously not doing well.

The TIAA Real Estate Fund is unique. You give them money and when they have enough, they invest it by buying commercial buildings, or shopping malls or storage facilities, etc., without a mortgage. (I’m oversimplifying: they keep some funds as a cash reserve and a small percentage in gated communities and a few buildings had mortgages.) Unlike REITs (real estate investment trusts), which you buy into by buying stocks that others sell, the Real Estate Fund was not sold in a market.

I once looked over its day-to-day listings since it was formed in the late nineties. Usually, it had gains of .06 in a fund worth, say 200, so that your holdings increased to 200.06. On very, very big days, it increased by .75. Or perhaps it lost .5. This happened maybe two or three times a year.

Well things have changed! On Friday, in one day, it dropped 5.0, from 287.91 to 282.91, almost 2%. It could be compared to the Dow dropping 23% in one day, in 1987. Though I find this amazing, I was asked by someone I got to put more money into the Real Estate Fund a few years ago and then told him to get out, when I did, "since the real estate fund was the last to go down, will the Real Estate Fund be the first to revive or the last?"

Here was my answer: "I think the real estate fund (of TIAA) is a lagging indicator. That is, it started down after the economy started down because it was only over time that its leases fell due and its customers, those in reasonably good health, could either ask for lower rents or move to smaller and cheaper quarters. By the same token, I think it will go up after the economy starts going up, if it ever does."

An acquaintance of mine has a very pessimistic of things and believes we are not far from seeing stores being boarded up and tent cities. I’m not sure. But another friend tells me that there are a lot of stores on Broadway near 96th Street that are empty. On my own corner, there is a site that used to be a restaurant, and one that was usually close to being full, that closed about two years ago and remains un-rented. What I think happened is that the landlord asked for a huge increase in rent that the restaurant couldn’t pay (maybe double the rent) and then after fixing up the place some, put the site up for rent. And it simply hasn’t rented. Whether the landlord is going to get more realistic I have no way of knowing.

I think this slump is going to take an enormous toll on owners of business property just as it has on people who own residential property.

We’ll know, for sure, we’re in a real depression when there are increasing numbers of homeless sleeping in doorways and others are selling in the streets the 21st century equivalent of apples (or maybe apples are what will still be sold).