4. Debt limit in the US - what is going on?

In the US, legislation limits the amount federal government borrows. The limit was suspended 2 years ago. 

The rest is (quite) a bit crazy, so read it carefully.

The debt limit was reached Aug 1, 2021. To pay US federal obligations, the Treasury department (i.e. Ministry of Finance) has been using "extraordinary measures" - equivalent to looking for spare change among your couch cushions. Some time around mid October these measures will no longer be sufficient. one of three things will happen:

1. The Congress will increase or suspend the limit.

2. US will default on its debt (i.e. some US government bonds or their interest will not be paid). Before this happens, markets will wobble; if it lasts any length of time, it will be a disaster for the world economy.

3. An interesting option is for the Federal Reserve to enable funding of government operations by buying US debt in the open market and ignoring lack of repayments.

So what is it all about? Politics. Republicans are hoping that problems will worsen the fortune of Democrats. They argue that they do not want allow Democrats to increase spending in the future.

Does  the explanation make any sense? Not at all. They talk about future spending; the debt is the result of a past spending. It has been best explained in the letter of the Treasury Secretary to the congress (Debt-Limit-Letter-to-Congress-20210723-Pelosi.pdf (treasury.gov)):

" Since 1960, Congress has acted 78 separate times to permanently raise, temporarily extend, or revise the definition of the debt limit – 49 times under Republican presidents and 29 times under Democratic presidents."

Can we predict what will happen? my bet is 1 above, but who knows.

In Canada, we do not have such problems, or nonsensical politics.

Note that the thrid option is interesting. The FED can legally do it if pushed against the wall (it would help stabilize the US economy). But they would hate to do it because this would mean financing government debt. Also, they think even talk about it is dangerous because it encourages politicians to be intransigent. 

3. Ever (not so) Grande

 The second largest property developer in China (Evergrande) may go bankrupt.

I am not a specialist in Chinese markets in general and property developers in particular, nor do I know how the communist party makes decisions. My best bet is that, if trouble gets serious, the Chinese government will take over the company, put founders and managers in jail for mismanagement, and put in enough money to paper over the problem. The Chinese economy (in nominal terms) in 2020 was about the same size as the US economy in 2008, and Evergrande liabilities are less than half Lehman liabilities.

Nonetheless,  some people compare the problem to Lehman in 2018 ("Evergrande teeters on the edge of collapse. Will China step in to avoid a ‘Lehman moment’? Globe and Mail Sep 21):

"While an Evergrande collapse would cause immediate misery among Chinese homeowners and workers, the fear is that, as losses ripple out to the company’s lenders and bondholders, China’s entire real estate market could stumble – similar to how the collapse of Lehman Brothers sparked the slide of the U.S. housing market in 2008, sending the American economy into recession."

Correct? Not at all.

So we already established that the comparison is an exaggeration. The sentence in bold above (my choice) is misleading. US housing market started "sliding" before Lehman went bankrupt, and the US economy has been in a recession since December 2007.

2. Give people free money; would they avoid work?

Actually, it is the other way  round: take away the free money; will people find work instead?

Here is the issue. In the US, unemployed people were getting up to $300 a week in addition to the regular unemployment benefits. Half of the states eliminated the support over the summer, while the other kept it.

Question: if you give people extra money when they are unemployed, will they dissuade them from working? Or, alternatively, would withdrawing the benefits induce people to get a job?

No brainer, right? This is what conservative policymakers in the US argued. If you give people money when they are unemployed, they will stay unemployed. Take away the money, and they will be forced to find jobs.

Reality: here is a citation from the Wal Street Journal ( States That Cut Unemployment Benefits Saw Limited Impact on Job Growth; WSJ Sep 1, 2021):

"States that ended enhanced federal unemployment benefits early have so far seen about the same job growth as states that continued offering the pandemic-related extra aid, according to a Wall Street Journal analysis and economists.

Several rounds of federal pandemic aid boosted the amount of unemployment payments, most recently by $300 a week, and extended them for as long as 18 months. The extra benefits are set to expire nationwide next week. But 25 states ended the financial enhancement over the summer, and most of them also moved to end other pandemic-specific unemployment programs such as benefits for gig and self-employed workers.

Nonfarm payrolls rose 1.33% in July from April in the 25 states that ended the benefits and 1.37% in the other 25 states and the District of Columbia, the Journal analysis of Labor Department data showed."

Maybe the average person is not a lazy bum, and they would like to find a job regardless of the amount of money they get when unemployed.

A possible explanation: child-care responsibilities and general concerns about safety and health with the pandemic still continuing.”

1. Sep 15, 2021 Inflation: is the high inflation temporary or will it become entrenched?

 Yesterday, the US Labor Department announced that inflation in the US (August 2020 to August 2021) was 5.3%.

Excluding the last few months, this is the highest in many years, and way above the target of 2%.

There are several explanations for the high inflation;

1. Shortages (of everything from microchips to olives - check this: Ford to Idle or Curb Output at More Plants Because of Chip Shortage, WSJ June 30 )

2. High freight prices

3. Shortages of workers, which lead to high wage increases

The question that economists (and politicians) are asking is whether the high inflation will stay, or whether this is a temporary blip, caused by the above factors which are, generally, temporary.

Economists surveyed by the WSJ predict inflation to fall to 2.5% in 2022 and 2.43% in 2023.

We will talk about more in the course. 

Two useful pieces of info for the course;

Measures of inflation

Apart from the regular inflation measure (5.3% in August), often refereed to, incorrectly, as CPI (inflation is a percentage change in CPI), there is Core inflation, which excludes the most volatile elements (food, energy) (4.1%) and trimmed mean CPI, which excludes the items that changed the most during the period (increased the most of fell the most): (3.2%)

Real versus nominal variables

Wage increases for the 25% lowest earning workers were 4.8% in August, the fastest increase since 2002. Good? No. This is the nominal wage: the number of dollars people get.

The real wage (i.e. how much the wage buys), which is the one that matters, has been falling.

(see WSJ, Sep 14, What’s Your Raise Really Worth? Inflation Has Something to Say About It. For the lowest-paid Americans, real wages—adjusted for rising prices—fell 0.5% in August from a year earlier).

****************EC 250ab blog is back ****************

In the past I was writing a blog for EC250 students where I would post a link to a recent interesting article that would be useful in understanding economics (in that order).

I skipped this last year, given the pandemic disruption, but it would be useful to restart the practice.

So I will post things from time to time; mostly my comments on current events. Hopefully, it will be helpful.

Sep 15 is a good time to start the blog. Notable things that happened on that date:

• 13 years ago, the Great Recession started, with the collapse of Lehman Brothers
• 5782 years ago everything started, according to the Jewish calendar

2019-28 The cost of storing cash

Earlier in the course we discuss the cost of storing cash. This article from the Guardian provides an estimate. It is about safety boxes for billionaires.

"The cheapest safety deposit box, which is just 5cm high, 16cm wide and 49cm deep, costs £600-a-year-to rent. That compares to £465 for a box twice the size in Harrods, and £240 in Metro Bank – the UK’s largest supplier of safety deposit boxes with 150,000 boxes across 70 branches."

You probably do not qualify so I am going to use the info on Metro Bank. 

1. A box twice the size of a box for billionaires would be 10cm by 16 cm by 50cm = 8000 cubic cm. It costs 240 pounds a year, or about USD 300
2.  So it would hold 8litres = 8kg of water
3.  Assume, generously, that paper money is four times lighter than water (nowadays banknotes are not flat). That means the box would hold 2 kg of banknotes
4.  A USD100 note weighs 1 gram. So this would be 2000 such notes, or $200 000

So the yearly cost of holding cash in a Metro Bank safety deposit box is $300/$200 000, or 0.15%

This limits how negative interest rates can become.

If you do qualify, here is the website:  https://www.internationalvaults.com/

It will cost you five times as much but they will pick you up in a Rolls Royce. And bigger boxes probably have lower prices per unit of volume.

2019-27 Another risk to watch

This Bloomberg article discussess the worries of central bankers about one important consequence of low interest policies: risky behaviour by investors (investors here are understood, as in common language,  as people who buy stocks and bonds. Recall that, in economics, this is not considered investment: it is just a change in ownership.  We define investors as people who build new factories, machines, office buildings etc).
What is the issue: with low interest rates around the world, people are searching for return, and put insufficient weight on risk. Here are a few quotes from the aticle:
"A prolonged period of low rates could also “spur reach-for-yield behavior, thereby increasing the vulnerability of the financial sector to subsequent shocks,” .
The ECB -- whose own benchmark rate is below zero -- highlighted threats to investment funds, insurers and in some real-estate markets. It also had a warning that mispriced assets could face corrections in future.
At Germany’s Bundesbank, which has long warned of the dangers of too-loose policy, Vice President Claudia Buch says there’s an “underestimation of credit risk.”"