Wednesday, January 04, 2017 ... Deutsch/Español/Related posts from blogosphere

Summers vs Trump on the economy

You know, I've met Larry Summers several times, talked to him during the dinners in the Society of Fellows that he was formally heading, and had to admire him for his seemingly penetrating, hard-science-like thinking and relatively honest attitudes towards the feminists and similar junk, attitudes that gradually turned into a frustrating surrender.

(I remember a party for new junior faculty in his house in late 2004 or early 2005, days before he gave the famous speech about women in science. On that party, I started to apologize to him for some anti-feminist blog post that created some havoc and complaints that had already gotten to his mailbox – but I have already forgotten who the complainer was etc. But of course, I did expect he would say that I had no reason to apologize and he did it. Soon afterwards, he carefully said similar things as those in my blog post and had to pay his beloved job of the Harvard president for that a year later, after some 14 months of annoying battles with the SJW whiners.)

I still think he's sort of very smart and independently thinking but so many Summers' pronouncements in the recent decade make me feel like an idiot because I was considering Larry a relative conservative icon at Harvard, if I exaggerate just a little bit. It just seems crazy to me now. The political atmosphere at Harvard had to be insane – and probably is even worse now – when the likes of Summers could have been viewed as oases of relative conservatism by people like me.

Yesterday, he spoke for some 9 minutes at Bloomberg. See reports in Business Insider, Bloomberg video only, AFR Financial Review, and echoes elsewhere.

Summers criticized the markets and investors for failing to switch to an absolute hysteria. He has also denounced a paper by Wilbur Ross, a billionaire and soon-to-be Secretary of Commerce, and economist Peter Navarro as a paper that is "beyond voodoo economics". This paper is an economics counterpart of creationism and makes climate skeptics look like responsible scientists. Well, the latter is surely OK – we are responsible scientists.

I would agree with Summers – and disagree with Trump – if he discussed the counterproductive impact of protectionism and praised the free trade in isolation and calmly. However, that's not what the bulk of Summers' monologue looks like.

OK, let's begin. Summers said that the investors are "too sanguine" and don't realize the immense risks of the Trump presidency whose start will represent the bumpiest transition of power in the U.S. in the last 75 years or so.

I wonder whether Summers has shorted the stocks after Trump won the elections. ;-)

Dow has gone from some 18,200 before the elections to 19,900 these days, an increase by some 9 percent. The numbers look cool but a change by 9 percent in 2 months isn't a huge anomaly. It sometimes occurs and not so infrequently.

People very close to Summers and maybe Summers himself were betting much of their credibility as political pundits on the statement that Trump had no chance to become a president because he was not even remotely qualified, crazy, extremist, racist, add whatever adjectives you want. Maybe you have failed to notice, Larry, but you have lost this bet and people close to you have lost most of their credibility as political commentators. Maybe if you haven't lost your contact with reality, you could acknowledge this obvious fact by adjusting your humility about politics upwards.

But that was not the only prediction at which most of the Democrats have failed miserably. Another prediction was that a Trump victory would lead to a collapse of the stock market from which the stock market wouldn't recover for a long time, perhaps never. I can find this quote written by Paul Krugman, a former co-author of Summers' papers, and Summers' comments yesterday basically suggest the same thing. Investors should have been hysterical.

Well, for some reasons, they haven't been, at least so far. I did "softly expect" some hysteria after the Trump victory, too. But I wasn't certain and I felt almost certain that this hysteria isn't fundamentally justifiable.

A simple precedent to think that the markets would collapse after the Trump victory was Brexit. The markets did collapse. But one should also notice that while the British pound decreased in the long run, the stocks only dropped for two business days or so. I speculated that the impact of a Trump victory on stocks would be similarly temporary. And in fact, because everyone knows that it's temporary, it's stupid to sell on those days at all. So a part of me expected the markets to learn something from the Brexit experience. There was no reason for a hysteria and the stocks would recover. So most of the people who could sell stocks after a "similar event" already avoided this mistaken step – the stocks would go up again in two days or so – which is why the drop itself was shorter, shallower, or didn't happen at all. This part of me was right.

If the stocks began to collapse tomorrow, it would no longer be a reaction to the result of the presidential election, of course. Do they have a fundamental reason to drop? I don't think so. On the contrary.

As Navarro and Ross argued elsewhere, many of Trump's planned economic policies are unquestionably pro-business, pro-growth, pro-employment policies. He wants to cut taxes, reduce regulations, remove restrictions on energy developments, and – more controversially – eliminate trade deficits.

If Trump really managed to reduce the corporate taxes from 36.5% now to 15% as promised, calculate and discuss the effect of this policy on stock prices, Larry. ;-) You know, what's left after the taxation increases from 63.5% to 85%, the ratio 85/63.5 = 1.34, so you could reasonably expect that this policy could increase the profit for the investors by 34%. Because the stocks' valuation reflects some expected profits for a number of coming years, the prices of the stocks could increase by a similar percentage, couldn't they? And the justifiable increase could be even higher because lower taxation likely increases the GDP (and profit) growth rate so the accumulated profits in the coming 10 years may be even higher than that.

Now, when the government removes some regulations, do you think that the companies are happier or not? Should the stocks go up or down? Do you think that the companies and factories from the not-so-regulated West were more valuable or less valuable than the companies from the overregulated Soviet bloc? ;-) What about the re-legalization of the cheapest forms of energy? Especially when we talk about businesses that consume a lot of energy, do you think that they will be able to do more work or less work (and higher profits or lower profits) when the energy prices go down?

People should give their answers to these questions but I mostly meant them to be rhetorical questions. Everyone who fails to understand why these standard pro-business plans – tax cuts, deregulation, cheap energy etc. – are good for the economic growth is a nutcase. I don't want to discuss these things in detail because I don't really believe that Summers is a nutcase of this magnitude, although he implicitly tries to suggest that he is one. Summers implicitly dismisses deregulation and lower taxes as a boost for the economy as "creationism". I believe he can't possibly mean so.

(The very fact that Wilbur Ross' net worth is some $3 billion indicates that he can't be such a complete crackpot concerning money, can he? Billionaires are basically "applied or experimental economists" in some sense. I am ready to equally flatter our otherwise annoying billionaire finance minister Andrej Babiš who not only has the same $3 billion in net worth but who also boasted [yesterday] the first Czech budget surplus, $2.4 billion, since 1995. It's not really "mainly his achievement" and many aspects of his work as the minister are suboptimal for various reasons. But other people could have screwed the budget much more than that but he didn't. I still think that he's a net negative for the country and a big threat for the freedom and democracy but it would be insane to describe his relatively responsible, uninspiring everyday work with finances as "creationism". It's similar to Wilbur Ross' attitudes to finances. By these words, Summers is just imposing some aggressive group think. Sorry, Larry, I don't think that you have the economic credentials to place yourself so much above e.g. Wilbur Ross. Ross and Navarro may write things that are very different from the kind of stuff that you may like to repeat on parties with Paul Krugman and similar "monster minds" but that surely isn't enough to prove that Navarro and Ross are wrong, is it?)

The only class of policies whose impact on the value of the stocks – and, loosely equivalently, the expectations about the GDP growth – could have an uncertain sign are Trump's policies related to protectionism, trade barriers, methods to suppress the imports into the U.S., ways to bully companies to invest on the American soil, and so on. Those things could also be negative indirectly because the artificial improvement of the trade balance of the U.S. (by the barriers and tariffs) could push the U.S. dollar to be even stronger than it is today.

I think that trade wars and barriers would ultimately be bad news for the whole world although some countries – well, especially those whose economies are powered by exports – could be hurt more than others. But should some catastrophes be automatically expected? And can we be sure that the dollar will be 20% stronger if Trump tries to do what he promised, and so on?

I don't think so. (If it were sure that the dollar is gonna be 20% stronger in a year, it would surely be stupid for everyone not to buy it already now.)

Trump wants to work for America and bring advantages to his motherland – perhaps even if the motherland doesn't quite deserve those advantages. He may have been "tough" in his own business, too. But we shouldn't overlook one aspect of his "America first" policies. He believes – and so do many voters – that America is currently being "robbed" by others who are abusing the asymmetric relationships. In particular, Trump and some of his key people believe that China is abusing the economic relationships and these relationships have to be rebalanced. The outcome of this rebalancing will be "better for the Americans", the Trump belief system says.

Is that true or possible? It might be. It partly depends on the definition of "the Americans". What do I mean?

One thing I want to say is that the China-U.S. business relationships are obviously asymmetric and China is still providing "mostly" the cheap labor and its factories. There is a weird division of labor here. In China (well, in this case Republic of China i.e. Taiwan), Foxconn produces all the physical iPhones. The product is completed by Tim Cook inviting a few gay artists to a party and collecting an overwhelming majority of the price of the iPhone as his profit.

In this particular relationship, is China robbing America? Needless to say, most of us will say that it's silly. It's obviously better to be in the place of the American workers and CEOs who are getting much higher salaries than the Chinese workers etc. It's more comfortable to live in a country with higher nominal salaries, when converted to the same currency by current exchange rates. It seems better to enjoy your life without the need to work too much or too hard. In this sense, it's also good for a nation to have a strong currency, and so on. These people may live without working too much – at least, they don't need to use their muscles too much. There are not too many reasons to be jealous towards the Chinese workers.

I mostly do adopt this attitude. "Obviously", it is better to live in the wealthier countries that contribute mainly a party in California to the iPhone as a product.

But this "obvious" conclusion isn't as obvious as it may seem. Look at it from the viewpoint of the 4.5% U.S. citizens who are unemployed now, from the viewpoint of those who would like to do similar work as workers as the folks in Foxconn are doing in Taiwan, or from the viewpoint of the workers who are doing this work in America but are worried that they will lose their job soon. Many of these people could actually be jealous about the conditions in Asia – in the countries of assembly lines and cheap labor.

Many of these people belong to the most typical group of Trump's voters. They want the new plants – including not the most hi-tech assembly lines – to be built on the U.S. soil. Are these wishes realistic?

The importance of workers is changing as a function of time. Manual work is generally getting less important and needed as robots replace human workers. But let's divide the changes into two groups or two terms:

  • The changes of the types that occur or are relevant globally
  • Transfers of industrial activity from one country to another
Can Trump stop or reverse these two trends that hurt or threaten his working-class voters? Should he? Will he?

Well, in the case of the first trend, it's basically the question whether Trump may, should, or will declare the war on robots etc. He could. But he shouldn't and I think he won't. The robots are spreading spontaneously. To reduce their propagation means to impose a brutal regulation that would hurt the economy rather quickly. Lots of people, including the workers, would probably understand rather quickly that the war on robots is hurting their future well-being.

So let's eliminate this possibility. The need for manual work and unsophisticated workers will keep on decreasing – in other words, the demand for some special skills and knowledge of the employees will keep on increasing – and Trump won't really change that.

This leaves us with the second trend which is being addressed by the protectionist policies. Trump plans to force companies (e.g. Ford and General Motors in recent days) to build new plants on the U.S. soil, and so on. Is that doable? Is that right? Is it dangerous? Will it lead to a much stronger U.S. dollar?

Again, I think that protectionism is generally counterproductive. But the plan to force the U.S. companies to invest in America is doable and to some extent sensible. Why? I have the Foxconn-Apple example in mind. The division of labor is too brutal. It would make sense to build similar Foxconn-like plants on the U.S. soil. I am sure that you find many Americans who can do this kind of work and who would be willing to do it. (A question is, of course, whether the Americans would be willing to do any of these things for the Chinese salary. I will get to that.)

U.S. companies are building plants abroad – or using the services of existing plants in Asia etc. – because those are cheaper. This is a basic economic fact that you can't easily change. Trump can make the exports – including the exports of components and "almost final products" – more expensive by imposing tariffs etc. While I think that this is basically a wrong path, I don't think that it's automatically catastrophic.

One reason is that similar tariffs and hurdles push the companies to behave "reasonably" and even "environment-friendly" in some way, i.e. to reduce the transfer of products and components over big distances. You could argue that tariffs have a similar logic and impact as some carbon tax on transportation fuels – although the numbers aren't quite proportional to each other.

To some extent, it's surely possible for Trump to increase the number of plants built and investments made in the U.S. Summers dismisses this possibility by these words – arguably the most technical part of his monologue at Bloomberg:
"The vast majority of the companies who have large overseas cash also have substantial amounts of domestic cash," Summers said. "The reality is that cash that's brought home will be used to pay dividends, to pay back shareholders, to buy back shares, to engage in mergers and acquisitions, to rearrange the financial chessboard, not to invest in large amounts of new capital. It is a chimera to suppose that there will be large increases in capital investment as a consequence of that repatriation."
Well, Summers dismisses the "repatriation of cash" idea. If the companies are forced to transfer their cash from foreign countries to the U.S., they will use it differently than by building new plants that could be loss-generating due to the rather expensive labor in the U.S.

I know where Summers is coming from. Paradoxically, it's a very similar argument to one that I have often raised against the quantitative easing. I was always saying that e.g. assets purchases don't really push the people to spend their savings because the people have their own, pretty much internal and psychological, reasons to decide how much they want to spend and how much they want to save. So when asset purchases programs are making cash less valuable and bonds more expensive, the people just move their savings from one asset class to another, some of the people lose because of the QE programs, and others gain. But the aggregate is basically the same and the asset purchases don't matter much.

This was largely true because the huge asset purchase programs by the Federal Reserve, ECB, and other banks haven't made much impact. It was unavoidable that inflation expectations and inflation would start to rise at some moment again. But one could argue that by his victory, Trump has achieved what all the central banks with their trillions of dollars couldn't achieve for years: He kickstarted the inflation expectations and probably the inflation itself. Globally. Again, many of us start to worry that the inflation is going to accelerate too quickly – that is the more usual kind of worries in any economy with fiat money. All the worries about "irrational" phenomena such as the negative interest rates and how the could have arrived at all are already evaporating now. They're really not possible in the long run. The return of inflation was inevitable.

So far, Trump hasn't really changed anything because he's not the U.S. president yet but his victory has sent a new message to everyone. We're not stuck. Things will change. New cash may circulate somewhere. Summers says that this transition will be the most discontinuous one in 75 years but what he doesn't realize is that this move may have very good consequences. One of them was that Trump has easily averted any threat of deflation, something that economists including Summers were presenting as a holy grail that they just fucking couldn't reach for many years, despite the unlimited amounts of printed money. Without doing a thing, Trump could do it easily. It's not impossible that Trump will similarly easily kill "secular stagnation" and other bogeymen that Summers and others have spent tens of hours by talking about without positive effects.

When someone like Trump is bringing a real change in the context of an economy where money can be printed, it's reasonable to expect inflation. His plans don't really add up so far and that's actually one reason to expect that inflation will kick in. He wants to revive arms races and increase the spending on defense (and offense, I suppose). On the other hand, he wants to withdraw the U.S. troops from much of the world (e.g. the Middle East) and reduce the tension with Russia which could indicate that the U.S. will need less military spending. He wants to increase investments and lower taxes and the sides of the budget don't really match.

Well, many people surely expect that Trump will actually run huge deficits again – that he won't be a true fiscal conservative. Just to be sure, Reagan ran big deficits, too. Under Reagan, the U.S. debt almost tripled. Similar things could happen under Trump as well. Those real possibilities are surely a reason to expect higher inflation (from all the new money supply that Trump increases by his projects), higher interest rates by which the Feds will fight the inflation, and so on. We're not stuck anymore.

But I want to get back to Summers' "no-go theorem". He said that the companies would pay the repatriated cash as dividends etc. Maybe. If they were allowed to do so. I can imagine that Trump wants to micro-manage all these transfers in much more detail. He may simply make the companies pay for not repatriating the cash as well as for paying the repatriated cash as dividends. Those policies would distort the markets in some way but Trump wouldn't be the first politician who is distorting the market in some way.

So even though many of us would say that it's not natural, it's possible. I guess that he will try to do such changes.

Will these policies lead to a much stronger dollar? I am not so sure. The justification for the "Yes" answer is that the U.S. trade balance will significantly improve because he will encourage the U.S. production and exports and discourage the imports to the U.S. Because the exchange rates are basically trying to adjust themselves to make trade balanced (or, in the case of the U.S, make the trade deficit equal to some percentage of the U.S. GDP which America may afford due to the dollar's reserve currency status – because the printed banknotes and treasuries may be partly interpreted as American products bought overseas and when they're added as exports, the balance is restored), the artificial reduction of imports will make the dollar stronger.

But this idea is probably naive. One fact that it overlooks is that protectionism usually gets a response from the other side. If one starts to protect the U.S. workers against imports etc., other countries probably start to do the same thing – perhaps selectively against the U.S. So at the end, the amount of "trade hostilities" may be expected to be symmetric. That also means that there's no expected effect on the U.S. dollar at the end.

There should be a special discussion about the strength of the responses in asymmetric situations. China doesn't import too much from the U.S. so its protectionism against the imports from the U.S. wouldn't have the same effect as the opposite ones. The Chinese exports to the U.S. are almost 3 times higher than the imports from the U.S. which suggests that China would "lose the trade war".

While the asymmetries are real, I find even these considerations naive, however. First of all, I don't believe that "to be able to export XY" is such a great advantage. Both sides of every business transaction benefit pretty much equally. America really needs some imports from China and other countries. You could divide the imports to the U.S. to "essential products America needs" and "consumer goods" and suppress the latter. But it's extremely hard to divide these things, easy for the process to get corrupted, and there would be tricks to circumvent such barriers, anyway.

At the end, I think that Trump will try some protectionist policies and trade wars and some plants will return or will be built in America but it will be locally obvious that the effects aren't that great, or that the negative reactions make about as many damages as the benefits of the protectionist policies, and the growth of this "miraculous cure" will be stopped. The protectionist barriers may reach some reasonable value. Americans, Europeans, and Asians may be encouraged in 2020 to buy a product (e.g. a smartphone) produced on their own continent by some 20% extra tariffs incorporated into the price of the products from different continents. Those changes won't be cataclysmic and they will act as a "carbon tax for transportation".

It's my feeling that Trump and some of his supporters have naive ideas about the advantages of protectionist policies. But when you build a Foxconn-like plant in the U.S., you really need workers to be getting low salaries (almost) like the Chinese ones for the plant to be competitive. If the workers get much salaries, the products must be more expensive and can't be competitive abroad. Trump can make them artificially competitive in the U.S. by banning imports of the competing products but he can't make them competitive as exports – unless the dollar weakens. Or unless he subsidizes them and threatens the sustainability of the U.S. government debt, which would also weaken dollar.

The effect of policies that don't seem to add up fully can't be fully predicted. But I think that if the Trump administration creates too many barriers and distorts the market and cash flows too much, the U.S. currency, U.S. treasuries, and U.S. stocks will unavoidably lose much of their luster, too. The U.S. dollar may very well weaken because of these policies. America may regain many assembly lines similar to those in China – but it will unavoidably share things like low real salaries with China (or countries in between), too.

A question is whether America wants to go in this direction. As I mentioned, different people may have different answers and the U.S. working class could pretty much like to make America more similar to some countries which produce a lot. Trump represents "especially" those who would prefer their manual labor to be more wanted and valuable but it can't be done without negative side effects.

I am uncertain about consequences of the many steps that Trump may make. But I've mentioned that I see a certain core that is indisputably good for the business and economic growth in the U.S. – and probably not only in the U.S. And then there are policies that I wouldn't endorse but they will only shift the plants, jobs, and currency exchange rates, among other numbers, in various directions. The markets – composed of the economically thinking people – will adapt to the new conditions that Trump may introduce.

It seems unlikely to me that he would continue with policies that would seem clearly devastating in some visible way. What we will get are some new winners and new losers instead, new rebalancing of all the parameters. When it comes to the protectionist and similar changes he wants to make, I think that it will be mostly a zero-sum game. Some people, investors, and companies will benefit, others will lose, and so on. Summers' prediction of a cataclysm seems unwarranted to me. On top of this zero-sum game, I see the clearly positive-sum changes of the policy including tax cuts, deregulation, cheap energy, and better relationships with at least some countries.

When Barack Obama took over 8 years ago, he could have been expected to be very different from George W. Bush but from many (or most) viewpoints, he wasn't. Eight years ago, the world economy was experiencing the downturn which overshadows many things but it was a coincidence that this downturn took place during a transition of power. If you could subtract it from the optics, and maybe even if you don't subtract it, it seems fair to say that the Bush-Obama transition brought almost no earthquakes. The Obama-Trump transition will probably be more visible but I think that if the changes are going to be 5 times more pronounced than 8 years ago, there's no reason for the kind of concerns that Summers has promoted.

It's healthy for a democracy to occasionally undergo changes that are deeper than the relatively cosmetic changes of the Bush-Obama transition. America and the world deserve such a transition, they may get it, but there's no good reason for Summers' alarmism.

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