Wednesday, February 05, 2014 - Another Perfect Day

Another Perfect Day

by Sinclair Noe

DOW – 5 = 15,440
SPX – 3 = 1751
NAS – 19 = 4011
10 YR YLD + .04 = 2.67%
OIL + .11 = 97.30
GOLD + 3.20 = 1258.60
SILV + .39 = 20.00

Yesterday on the Review we talked about the Congressional Budget office report. For a while this morning, the Internet was hopping with job-killing hype, when in fact the truth was vastly different. Obamacare’s impact, the CBO concluded, would lessen the supply of labor by encouraging certain folks not to work: “The estimated reduction stems almost entirely from a net decline in the amount of labor that workers choose to supply, rather than from a net drop in businesses’ demand for labor, so it will appear almost entirely as a reduction in labor force participation and in hours worked. . . .”

That’s different than what most of the media was saying today. And then a funny thing happened; some reporters actually read the report, and the headlines changed just a little:

 Wall Street Journal earlier: Health-Care Law Expected to Take Greater Toll on Workforce

Wall Street Journal now: Health Law Seen Leading to Some Loss of Labor

Talk Radio News Service earlier: Obamacare Will Cost 2.5 Million Jobs: Report

Talk Radio News Service now: 2.5 Million Will Exit Work Force Because Of Obamacare

National Review earlier: The CBO Just Nuked Obamacare

National Review now: The CBO Just Nuked Obamacare

The CBO never, ever reported that Obamacare would somehow or other kill more than 2 million jobs. The CBO’s estimate is mostly the result of an analysis of the impact of the law on the supply of labor. That means how many people choose to participate in the work force. Some people might decide to work part-time, not full time, in order to keep getting health-care subsidies. Thus, they are reducing their supply of labor to the market. Other people near retirement age might decide they no longer need to hold onto their job just because it provides health insurance, and they also leave the work force. Still other people might leave the job they have now and start their own business.

The fastest growing demographic segment of the population currently starting new businesses is people age 65 and older. Why? Two reasons: one, nobody will hire them so they create their own work; two, they qualify for Medicare and so they aren’t locked into an existing job for health care coverage. They didn’t just develop an entrepreneurial urge overnight.

Under questioning today before the House Budget Committee, CBO director Douglas Elmendorf confirmed that in reality, his report suggests Obamacare will reduce unemployment: The CBO report found that Obamacare, through subsidizing health coverage, would reduce the amount of hours workers choose to work, to the equivalent of 2.5 million full-time workers over 10 years. This was widely spun by as a loss of 2.5 million jobs. Actually it lowers the participation rate and the unemployment rate.

Obamacare’s impact will be on labor demand, rather than supply. On page 124, the CBO report estimates that the ACA will “boost overall demand for goods and services over the next few years because the people who will benefit from the expansion of Medicaid and from access to the exchange subsidies are predominantly in lower-income households and thus are likely to spend a considerable fraction of their additional resources on goods and services.” This, the report says, “will in turn boost demand for labor over the next few years.”

Elmendorf testified that when you boost demand for labor in this kind of economy, you actually reduce the unemployment rate, because those people who are looking for work can find more work, and this would actually reduce unemployment. Later in his testimony, Elmendorf confirmed that the subsidies from Obamacare would reduce the incentive to work, and that this could reduce economic growth.

The CBO report raises a bunch of interesting questions and we’re not really certain of all the outcomes. If, as CBO predicts, the decline in work is driven almost entirely by a decline in labor supply, the upshot might actually be higher wages. Workers will choose to work fewer hours; since firms won't be any less interested in hiring, they'll have to pay more per hour to get those workers in the door. The positive wage effect should be concentrated among low-skill workers, who will face the greatest discouragement to work from Obamacare, and therefore will be able to command the greatest wage increases in order to keep working.

The CBO has been busy, and there are some interesting numbers they’ve run. For example, the CBO is projecting that the federal government will take in $16 billion from health plans that are essentially making a profit on the exchange, and will redistribute $8 billion to other insurers running a loss. That means $8 billion in net savings for the federal government. So any legislation that seeks to repeal the Obamacare bailout will need to be scored as increasing the deficit, and need to presumably include $8 billion in payouts to offset revenue loss.

As I said yesterday, make your adjustments based upon whatever reality you choose.

Who knows? That’s why I find this economics stuff so much fun. Here’s another example from an article by Edward Hadas, writing about deflation; Christine Lagarde, the IMF Director, says deflation is an “ogre which must be fought decisively.” Lagarde did not explain why she thought deflation was so dangerous. Most likely, she had three commonly-made arguments in mind.

First, deflation might make a tragic debt cycle more likely. The fear is not totally irrational; a generalized price decrease can lead to economic disaster: prices fall, debts go bad, banks collapse, businesses fail, desperate workers take pay cuts and then companies cut prices even more. The downward spiral lasts until something happens – war, anarchy or a new monetary order.

The second purported reason to worry about deflation is the prospect that gently falling prices might reduce consumption. Rational people, economists say, will hold onto a dollar until the eagle grins as they wait for even lower prices. Maybe, but consider the sharp, predictable declines in the price of electronic goods. They have not noticeably hurt sales. Mild deflation might lead a few canny shoppers to delay some purchases, but the prospect of paying 1-2 percent less a year down the road is a pretty weak motivation for restraint.

Finally, Lagarde might be concerned that deflation limits the ability of central bankers to provide helpful stimulus. After all, policy interest rates cannot easily go below zero, as theory would dictate they should when the economy under-performs while prices are falling. In reality, the policy interest rate is rarely powerful and never the only available tool.

Of course, some rate moves can change the economic balance, but the statistical evidence suggests that monetary policy is less important than many other financial and economic forces. The economist Edward Prescott, a Nobel prize winner, even claims that “it is an established scientific fact” that the Federal Reserve’s monetary policy has had “virtually no effect on output and employment.”

That’s probably not quite accurate; the Fed has had an effect, just not a positive effect that extends to Main Street. In any case the authorities have other ways to influence the economy. They can print new money, as the Fed is doing. Alternatively, they can change financial regulations, taxes or government spending. At worst, mild deflation would force central bankers and their political masters to be more creative.

Why are we even talking about deflation? Two reasons; first is the domestic story. The acceleration in US GDP growth seen during the second half of 2013 has given support to FOMC and market expectations of stronger growth in 2014. As currently reported, annualized GDP growth has risen from a sub-par 1.8% in the first half of 2013 to a decidedly above-trend 3.7% for the second half of 2013. If sustained, such a growth pace would not only argue for a rapid end to the tapering process, but also initial steps towards raising interest rates.  The problem is that the acceleration in growth experienced through 2013 has not come about from domestic end demand (on which the US typically depends), but rather the accumulation of inventories and, to a lesser extent, a contribution from net exports.

The impact of inventory accrual was most obvious in Q3 when it contributed 1.7ppts to the 4.1% annualized headline. This was followed by a further 0.4ppt contribution in Q4 as stocks were accumulated at an even faster clip into year end. Periods of rapid inventory accumulation are almost always fleeting, with end demand and supply inevitably brought back into line, one way or another.

The other reason to consider the effects of deflation come from Europe. Eurozone inflation eased to 0.7 percent in January, from 0.8 percent in December. Disinflation, caused by stagnating consumer demand, saps growth and weakens the currency by reducing the appeal of euro-denominated assets; at least that’s the theory. The European Central Bank meets tomorrow and there’s speculation President Mario Draghi will either cut rates to near zero or announce alternative measures such as bond purchases. Or he might just say he’ll do “whatever it takes” but he’ll say it louder.

Yesterday, Microsoft announce they were promoting Satya Nadella, a veteran company insider, as its new CEO. Along with Nadella's new role, Microsoft also announced that co-founder Bill Gates had quit his job as chairman of the board and would serve as Nadella's advisor on technology and product selection issues. Apparently Bill Gates’ first day on the job in his new role as a technology advisor got off to a rough start as Nadella and Gates spent several tense hours behind closed doors trying to install the Windows 8.1 update.