Macro Roundup

Daniel Kruger, "Negative Yields Mount Along With Europe’s Problems,"Wall Street Journal, February 18, 2019, https://www.wsj.com/articles/negative-yields-mount-along-with-europes-problems-11550491201

Negative Yields Mount Along With Europe’s Problems

Negative-yielding government bonds outstanding through mid-January have risen 21% since October, reversing a steady decline that took place over the course of 2017 and much of last year, according to data from Bank of America Merrill Lynch. While the stock of negative-yielding debt still remains below its 2016 high, the proliferation of these bonds—which guarantee that a purchaser at issuance will receive less in repayment and periodic interest than they paid—underscores the uncertainty over the growth prospects in much of the developed world.

“Europe is an absolute quagmire,” said Matt Freund, co-chief investment officer at Calamos Investments. “There are significant headwinds that we’ve been talking about for a long time—now they’re showing up in the numbers.”

Investors are buying five-year German debt, sending yields down to about -0.4% from 0.03% in April, while in many cases avoiding similar-maturity Italian securities, which yield about 1.8%, versus roughly 0.6% during the same period.

Negative-yield debt hit a peak of roughly $13 trillion in 2016, according to Bank of America. Until recently it had been declining as the eurozone economy accelerated amid growing exports. The amount of negative-yielding bonds in the region first began growing substantially in 2014.

The ECB is examining reviving a program of lending to banks that analysts say could give a small boost to the economy without suggesting a turn away from the goal of normalizing policy. ECB President Mario Draghi’s term expires in October, leaving officials handcuffed by his departure, said Laura Sarlo, a sovereign-debt analyst at Loomis Sayles & Co.

At the same time, tensions are rising within Germany and France as populist movements have undermined the power of governing coalitions. That same populism has also set countries against each other, as Italy has sought EU permission to increase government spending to stimulate growth while Germany and France have tried to block that move.

The European Central Bank is examining reviving a program of lending to banks that analysts say could give a small boost to the eurozone.

“Europe cannot figure it out,” said Simona Mocuta, an economist at State Street Global Advisors. By deciding to restrict growth measures to central bank rate cuts, “you have this effect on rates, but it’s not giving you the real-economy response.“

The ECB first lowered its deposit facility rate below zero in June 2014, and has lowered it three times since, most recently to -0.4% in March 2016. The policy was intended to dissuade businesses and consumers from keeping money idle in the bank, and instead encourage more consumption and investment.

Many investors buy the debt simply because they have to. Insurance companies need bonds to ensure they can align maturing assets with expected liabilities. Many mutual funds buy the debt because they follow an index that includes the securities. Holding bonds with negative yields can also be a more palatable option for institutional investors who face a surcharge of 0.1% on cash for simply keeping deposits in a bank.

While investors who buy at current prices stand to lose money if they hold negative-yield bonds to maturity, they can be traded profitably, said John Taylor, a London-based bond manager at AllianceBernstein who has purchased five-year sovereign debt from Austria and Finland with negative yields.

Low returns on bond portfolios send investors a message that their retirement savings aren’t growing enough to meet their needs, causing them to save more and spend less, Mr. Taylor said. That is important because it suggests the policy isn’t working as intended and could lead to a deeper slowdown. The longer negative rates are in place, “the more it changes people’s behaviors,” he said.

".... Nima Arkani-Hamed and Jaroslav Trnka discovered a reformulation of scattering amplitudes that makes reference to neither space nor time. They found that the amplitudes of certain particle collisions are encoded in the volume of a jewel-like geometric object, which they dubbed the amplituhedron. Ever since, they and dozens of other researchers have been exploring this new geometric formulation of particle-scattering amplitudes, hoping that it will lead away from our everyday, space-time-bound conception to some grander explanatory structure.Whether these researchers are on the right track or not, the web of explanations of reality exists. Perhaps the most striking thing about those explanations is that, even as each draws only a partial picture of reality, they are mathematically perfect. Take general relativity. Physicists know that Einstein’s theory is incomplete. Yet it is a spectacular artifice, with a spare, taut mathematical structure. Fiddle with the equations even a little and you lose all of its beauty and simplicity. It turns out that, if you want to discover a deeper way of explaining the universe, you can’t take the equations of the existing description and subtly deform them. Instead, you must make a jump to a totally different, equally perfect mathematical structure. What’s the point, theorists wonder, of the perfection found at every level, if it’s bound to be superseded?It seems inconceivable that this intricate web of perfect mathematical descriptions is random or happenstance. This mystery must have an explanation. But what might such an explanation look like? One common conception of physics is that its laws are like a machine that humans are building in order to predict what will happen in the future. The “theory of everything” is like the ultimate prediction machine—a single equation from which everything follows. But this outlook ignores the existence of the many different machines, built in all manner of ingenious ways, that give us equivalent predictions. To Arkani-Hamed, the multifariousness of the laws suggests a different conception of what physics is all about. We’re not building a machine that calculates answers, he says; instead, we’re discovering questions. Nature’s shape-shifting laws seem to be the answer to an unknown mathematical question. This is why Arkani-Hamed and his colleagues find their studies of the amplituhedron so promising. Calculating the volume of the amplituhedron is a question in geometry—one that mathematicians might have pondered, had they discovered the object first. Somehow, the answer to the question of the amplituhedron’s volume describes the behavior of particles—and that answer, in turn, can be rewritten in terms of space and time. Arkani-Hamed now sees the ultimate goal of physics as figuring out the mathematical question from which all the answers flow. “The ascension to the tenth level of intellectual heaven,” he told me, “would be if we find the question to which the universe is the answer, and the nature of that question in and of itself explains why it was possible to describe it in so many different ways.” It’s as though physics has been turned inside out. It now appears that the answers already surround us. It’s the question we don’t know."...

Natalie Wolchover, "A Different Kind of Theory of Everything,"New Yorker, February 19, 2019, https://www.newyorker.com/science/elements/a-different-kind-of-theory-of-everything

"... Long-term nominal interest rates in the US have fallen since 2001 even as federal deficits and debt have risen, in particular since the Great Recession. This has led some to question the pre-crisis conventional economic wisdom about a link between deficits and interest rates. In this blog post, I update the empirical analysis of Warnock & Warnock (2009) to show that deficits and debt, both actual and expected, still have positive and statistically-significant impacts on interest rates at the margin. A one percentage point increase in the ongoing cyclically-adjusted federal deficit raises the 10-year Treasury yield by 18 basis points, and the ACM 10-year term premium by 20 basis points. Yet other factors with downward effects on yields such as growth and productivity, monetary policy, demography, and foreign demand for US Treasuries have ultimately dominated this upward fiscal effect since 2001.....In simple terms of simple rule-of-thumb tradeoffs, the evidence suggests pre-crisis consensus was largely correct: an increase in structural budget deficits puts upward pressure on interest rates, all else equal.....However, all else may not always be equal, particularly in periods where there is high foreign demand for US debt and/or high demand for safe assets in general. Over the last 20 years, this has helped blunt the effects of deficits on interest rates. By the same token, if foreign / safe asset demand dynamics subsided in the future, then structural deficits could shift to having a larger net upward effect than they have in recent years.....These deficit effects appear to have fallen substantially over the last two decades, but are still positive and statistically significant..... The upward interest rate effect from structural deficits and the countervailing downward effect from foreign purchases both appear to flow materially through term/risk premia at least as measured by the ACM model, though given that the ACM model is not the final word on term structure decompositions this is not dispositive. Still, this finding makes it more likely that the interest rate impacts of higher deficits reflect more than just policy choices by the Federal Reserve......Other structural and cyclical factors can depress interest rates as well. In the US context, these factors have more than offset the influence of higher deficits over the last 20 years. Some examples include the aging of the population and slower productivity growth.....Policymakers may exploit the interest rate room carved out by these countervailing factors by running higher deficits, particularly as a means of financing policies designed to combat such factors as e.g. secular stagnation......Because these structural factors are unlikely to reverse themselves suddenly, and because US interest rates are already relatively low given the state of the business cycle, deficits and debt should not be a near-term worry, nor should they impede counter-cyclical policy when the economy is far from full capacity..... However, deficit-financing still poses a tradeoff in the form of upward interest rate pressure. This has implications for investment, productivity, wages, and consumption in the long-term that policymakers ought to weigh against the specifics of the policy being financed.... These are distinct questions from many other recent fiscal policy debates; for example, whether there are states of the economy, such as when r < g (interest rates are lower than the rate of economic growth), when debt-financing certain policies is more likely to be welfare-enhancing. Note though that my analysis implies that deficits and debt can be endogenous to the determination of r over the medium- to long-run. In other words, the more that policymakers exploit an r < g state and deficit-finance changes in fiscal policy, the less likely it will be that the r < g state persists over the medium- to long-term...."

Ernie Tedeschi, Deficits are Raising Interest Rates. But Other Factors are Lowering Them.,"Medium, February 19, 2019, https://medium.com/@ernietedeschi/deficits-are-raising-interest-rates-but-other-factors-are-lowering-them-6d1e68776b7a

Another FYI article.

"...You don’t want a punitive tax on income or wealth; you want a punitive tax on very high consumption—say beyond $50,000,000/year. Gates and Buffett would still be able to use their income for charity and investment purposes, with no almost deterrent effect from high taxes. They’d only be punished for an excessively lavish lifestyle. Now admittedly there might be a few billionaires that would be deterred by a high consumption tax, say Larry Ellison. But even there, the deterrent effect would be less than you might think. That’s because a lot of the high-end consumption is positional goods.... The high tax rates would not just apply to Larry Ellison, but to all the superrich. Thus if Larry had to scale back from a 500-foot yacht to a 400-footer, his closest rival would scale back from a 400-footer to a 320-footer. The relative ranking of consumption would be roughly unchanged. Ditto for real estate, where the exact same people would still live on the ocean in Malibu, but the price of land would fall to reflect the lower consumption of the superrich. Ditto for fine art. Larry Ellison can enjoy parties on a 400-foot yacht surrounded by young Ukrainian beauties just as much as he can enjoy parties on a 500-foot yacht, as long as his closest rivals only have 320-foot yachts. That’s how human brains work, and that’s why even a 70% or 80% tax on consumption doesn’t really deter work effort from the superrich, or at least not as much as conservatives fear...."
Scott Sumner, "Tax luxury, not wealth or income,"The Money Illusion, February 16, 2019, https://www.themoneyillusion.com/tax-luxury-not-wealth-or-income/

The Money Illusion: Tax luxury, not wealth or income

I favor very high marginal tax rates on the super rich, say 70% to 80%. But I am also opposed to all income taxes and all wealth taxes. Why?

Let’s start with the conservative argument that taxes on the super rich will deter work, saving, and investment, by reducing the incentive to build more wealth. Is it true? The answer will depend on the type of tax.

If you look at the behavior of superrich people like Bill Gates and Warren Buffett, they tend to spend only a few extra pennies on consumption, for each extra dollar they earn. Thus it does not seem like extra consumption is an important motivation for the superrich, beyond a certain point. So perhaps high taxes are not a disincentive.

Ah, but you might argue that they have other motivations. They like to be big time philanthropists, or they like to build their business empire up to greater and greater heights. That’s their real motivation, and a punitive tax rate would therefore discourage them from putting in the extra effort that we want to get from talented people. I agree.

But that proves my point! You don’t want a punitive tax on income or wealth; you want a punitive tax on very high consumption—say beyond $50,000,000/year. Gates and Buffett would still be able to use their income for charity and investment purposes, with no almost deterrent effect from high taxes. They’d only be punished for an excessively lavish lifestyle.

Now admittedly there might be a few billionaires that would be deterred by a high consumption tax, say Larry Ellison. But even there, the deterrent effect would be less than you might think. That’s because a lot of the high-end consumption is positional goods.

Let’s suppose that currently the biggest yacht is a 400-foot monster, and Larry Ellison wants a 500-foot one—to impress his friends. Also suppose that a steep consumption tax prevents Larry from getting this mega-yacht. You might argue that this reduces his utility, and would discourage his effort to make Oracle the best company it can be.

But here’s what you are missing. The high tax rates would not just apply to Larry Ellison, but to all the superrich. Thus if Larry had to scale back from a 500-foot yacht to a 400-footer, his closest rival would scale back from a 400-footer to a 320-footer. The relative ranking of consumption would be roughly unchanged. Ditto for real estate, where the exact same people would still live on the ocean in Malibu, but the price of land would fall to reflect the lower consumption of the superrich. Ditto for fine art.

Larry Ellison can enjoy parties on a 400-foot yacht surrounded by young Ukrainian beauties just as much as he can enjoy parties on a 500-foot yacht, as long as his closest rivals only have 320-foot yachts. That’s how human brains work, and that’s why even a 70% or 80% tax on consumption doesn’t really deter work effort from the superrich, or at least not as much as conservatives fear.

I’m not sure the best way to implement a progressive consumption tax. One could imagine two systems, one for employees of companies and one for the self-employed. Company employees would simply pay a progressive payroll (FICA) type tax. Very simple—no forms to fill out, even for LeBron James. A wage tax is identical to a consumption tax, in the long run.

The self-employed would pay an income tax with unlimited 401k privileges (which is effectively a consumption tax). So they’d only be taxed when they consumed their income. Income from any shares you own in your own company would be viewed the same as income earned by the self-employed—i.e. “wage income”.

The heirs of the rich would receive their inheritance in 401k-type accounts, and they’d pay taxes as they pulled the money out of those accounts to consume it.

There’s a difficult issue in determining how to tax existing stocks of wealth, at the point the new system goes into place. Perhaps a compromise where existing stocks of wealth above a certain threshold are put into a 401k-type structure, but taxed at a lower rate—in recognition of the fact that a part of the wealth has already been taxed.

If your country needs to raise large sums of money (and it shouldn’t-see Singapore), you need multiple tax systems; otherwise there will be too much evasion. These might include VATs, property taxes and carbon taxes. The property tax is a sort of tax on housing consumption, to make up for the fact that VATs don’t include housing. Currently, the superrich in places like New York pay a far lower rate of property tax than average homeowners, whereas they should pay a far higher rate. The fact that even liberal cities like New York are this regressive is an indication of the confused nature of our debate over taxes. Commenter “dtoh” has proposed a VAT where the poor are rebated what a poverty line person would spend on consumption, so that the tax is not regressive.

Read the debate in the blogosphere and you’ll see that people are horribly confused by taxes; they aren’t even debating the right issues. They talk piously about the need to tax capital income, which is the worst possible way to think about taxes. Meanwhile Larry Ellison will continue to enjoy his 500-foot yacht, with the extra 100 feet made of steel and employing labor that could have been used to provide dozens of cars for average people.

Sad!

PS. Some people like the following analogy. On Christmas Eve, people bring presents and put them under the tree. The next morning, people show up and grab presents from under the tree. Should we tax those who put them under the tree, or those who take them away the next morning? Based on how much you produce or how much you consume?

PPS. This post is on the superrich. I’m not sure how to handle the far more numerous ordinary rich-perhaps a 50% MTR on consumption. That sounds bad, but don’t forget the unlimited 401k privileges for the rich self-employed. That sort of tax would actually be less than 50% of one’s income. If they are rich wage earners, you can view the system as unlimited Roth IRA privileges.

PPPS. This post was a bit unfair to Larry Ellison, as he sold his 453-foot yacht to David Geffen and bought a smaller one, which could access more ports. And he has far more sophisticated taste than Trump. But I still maintain that high-end consumption is largely about positional goods.

"...The Great Recession led 1.4 million former workers to apply for SSDI benefits during 2008- 2012. Of these, nearly 1 million (72 percent) would not have applied if the recession had not occurred, while the rest (28 percent) would have applied anyway, but at a later date.By the recession’s peak, the system was receiving 16.5 percent more applications than usual, resulting in substantial processing backlogs. Induced applicants (excluding the accelerated applicants) accounted for 11.6 percent of all applications filed during 2008-2012. More than one-half million of the recession-induced applicants were awarded benefits. Over 400,000 were awards to people who otherwise would not have entered the SSDI program, while the rest were awards to people who would have entered the program anyway in the near future. The induced awardees were more likely to have been allowed on appeal than on initial review—53 percent of the induced new beneficiaries were allowed on appeal (rather than on initial review), compared to 37 percent of all new beneficiaries during 2008-2012. On net, the induced awardees (excluding accelerated awardees) made up 8.9 percent of all new beneficiaries who entered SSDI during 2008-2012.While some people with automatically-qualifying disabilities choose to work rather than claim SSDI benefits, we find little evidence that the recession-induced applicants came from this group. In fact, the induced applicants had less severe impairments and were more likely to have transferable skills. They were either allowed for medical-vocational reasons (33 percent) or denied (58 percent); relatively few were allowed for severe, listing-level impairments (9 percent). The mean allowance rate among induced applicants was 42 percent (accounting for appeals), substantially lower than the average allowance rate of 54 percent for the system as a whole. Perhaps not surprisingly, 58.7 percent of the induced applicants who were awarded benefits had a musculoskeletal or mental impairment, a somewhat higher proportion than in the general population of applicants. Importantly, we find the Great Recession does not account for the decline in the hearinglevel allowance rate that began in 2011, when SSA introduced focused reviews and new training initiatives to improve the quality of judicial decision-making. Our estimates imply that absent the effects of the Great Recession, the hearing-level allowance rate would have had a sharp decline anyway, beginning with the appellate hearings held for applications that were initially filed in 2010, and that would have had hearings in 2011 or later. The impact of the Great Recession is economically significant. In terms of human capital, over 400,000 workers were awarded benefits who would not otherwise have entered the program. Because working above SGA after program entry is rare, this corresponds to a nearpermanent decline in productive capacity. In terms of the fiscal health of the U.S. disability insurance system, both contemporaneous and future SSDI program costs increased significantly. Administrative claims processing costs rose by $2.960 billion dollars during 2008-2012, while SSDI benefit obligations increased by $55.730 billion in present value, or by $97.365 billion when the present value of Medicare benefits is included...."
Nicole Maestas, Kathleen J. Mullen and Alexander Strand "The Effect of Economic Conditions on the Disability Insurance Program: Evidence from the Great Recession," National Bureau of Economic Research, December 2018, https://www.nber.org/papers/w25338