Layman’s Terms: What Is the S&P Downgrade?

Well, I was going to rattle off my thoughts on the S&P downgrade like everybody else but first I thought I’d make a post explaining what that even means to help give some context for anyone who doesn’t follow world financial news or even national financial news all the time.

So, basically, there are three organizations known as the Big 3 credit ratings agencies – Standard & Poor’s (S&P), Moody’s, and Fitch. There are investors all over the world, from rich billionaires to folks managing the retirement portfolios of middle-class Americans, and they like to make more money by loaning the money they have to various groups of people, from governments to homebuyers, who pay it back with interest. Except sometimes, of course, people can’t pay the money back when it’s due – maybe a country got into too much debt and is about to collapse, or maybe a million people bought homes they couldn’t afford and then lost their jobs and then stopped making house payments and now the group that originally loaned the money to the homebuyers from the investors can’t pay the investors back. That’s oversimplified, of course, but the main point is that when you loan money there’s a good chance you’ll get more money back but always a small chance you won’t get any of it back. In general, the more investors are wary of a certain borrower, the higher the interest rate they will require to loan them money. If the interest rate for, say, bonds issued by a certain country is low enough that there aren’t enough investors willing to get in on it, then the rate goes up until enough investors get attracted by it so the country can borrow as much money as they need for that time period, and that’s partly why interest rates all over the world go up and down all the time.

This is all well and good, but it gets rather complicated. for your average portfolio manager (let’s name him Max). If Jane Smith has $25 coming out of her check every two weeks to save for her retirement, Max tries to decide where best to invest the money. But there are thousands of places where he could put that money, from stock markets to government bonds all over the world, and he doesn’t have time to keep up with the ever-changing details of every country’s financial situation – right now the 5% interest rate on Italy bonds is a way better return than every stock market in the world, but the reason it’s so high is there are increasing fears that the government there might default – so Max probably doesn’t want to put Jane’s money there. But that’s just one example, and Max doesn’t have time to keep up with the ever-changing risks associated with the thousands of available options. So how does he decide where to put Jane’s money?

Continue reading Layman’s Terms: What Is the S&P Downgrade?

What’s Wrong With Mandated Paid Vacation?

I’ve been reading The Price of Everything by Eduardo Porter, which was recommended to me by, of all things, a copy of Relevant Magazine I got from Cornerstone Festival, and it’s got a lot of interesting information in it. Some of it has to do with how money relates to happiness. We know in general that money can’t buy happiness, but Porter looks at decades’ worth of surveys done across dozens of countries that attempt to measure satisfaction, well-being, and happiness. He concludes that generally people in richer countries are happier than people in poorer countries, but that the happiness gains from income gains seem to level off once you hit a rich enough point, partially because things like time start to matter more than money:

Time is relatively more valuable to the rich, who already have money, than for the poor who don’t… The value of our time also rises with age. That’s because wages increase as we proceed on our careers, gain expertise, and acquire seniority. The number of hours in the day, by contrast, does not. (p. 34)

Porter claims that according to surveys, life satisfaction actually fell in the United States in recent years even though it has increased in most other countries. He says that while Americans are on average more than one-third richer than French or Germans, we report about the same level of happiness, and he has a pretty good theory, related to the value of time, as to why this is the case:

No other workers in the industrial world work as much as Americans. Every country in the OECD except the United States mandates a combination of paid leave and paid public holidays… While the time devoted to work has declined in most industrial countries, in the United States it has remained flat over the past thirty years…

This work has produced a lot of growth… Yet perhaps what went wrong is that all the happiness gained by Americans from the extra income was consumed by the unhappiness of having to work seventy-six more hours a year to get it. Compare this with the situation in France. The French economy has grown a little more slowly. But the French worked 260 fewer hours in 1997 than in 1975… The trade-off changes as we become richer. The value of our scarce free time increases, while the things money can buy become less important the more we have. (p. 75-76)

Well, that’s pretty interesting, isn’t it? The libertarian in me thinks there’s already way too many government requirements for businesses, and the proper response to a desire for mandated paid vacation would be to write it off without a thought. Just because all the other countries do it… yeah, that’s what they said about health care too. The more you require things out of companies, the more they just make up for it by paying employees less or charging more for products; nothing is free and everything has a cost; extra regulations just slow down the economy and make it harder for us to make progress.

But what if we’ve already made enough progress that an extra week or two of free time would make us happier than the extra economic progress from the work? That’s a tantalizing thought. (For perspective, note that it’s estimated that about 75% of American workers already receive some paid vacation, although most of them probably do not get the several weeks offered in some European countries.) I’ve already seen time become more valuable to me as I grow up, and I’m only 22. Even the poor in the modern United States are fairly well-off, as this information from the Heritage Foundation suggests:

heritage-foundation-poor-households-amenitiesWe already have plenty of stuff. Even if a mandate for paid vacation slowed economic progress in the United States, maybe we would all be happier. Of course, there are other arguments that we don’t want more vacation in the United States. CNN says, “Only 57% of U.S. workers use up all of the days they’re entitled to, compared with 89% of workers in France, a recent Reuters/Ipsos poll found… Working more makes Americans happier than Europeans, according to a study published recently in the Journal of Happiness Studies.” We get fewer vacation days, but we don’t even use them all – a bunch of us sure aren’t acting like more time off would make us happier.

Continue reading What’s Wrong With Mandated Paid Vacation?

End Aid To China. We Send Aid to China?!

They say that raw fraud and waste and inefficiency doesn’t make up a very large part of the budget. They say that all the easy low-hanging fruit has already been picked in the last couple years, and the only stuff left to cut requires hard decisions and painful sacrifices. But I sure keep getting surprised by stories of members of Congress trying to cut spending that I didn’t even know was happening. Here’s the latest:

WASHINGTON — A bipartisan group of senators is calling for an end to tens of millions of annual U.S. development aid to China, saying there are more needy countries than the world’s second-largest economy, which has trillions in foreign reserves.

The eight Democrats and four Republicans made their appeal Thursday to a Senate appropriations committee that must approve foreign aid funding for the fiscal year starting in October.

They urge an end to all development aid for China other than for Tibetans and for promoting human rights.

They say since 2001, the U.S. has provided more than $275 million in direct assistance to China, such as for expanding Internet access and improving public transportation.

If we’re still sending million of dollars to China to help them build roads or whatever – something we arguably shouldn’t have been doing in the first place – then I have to believe there’s still billions of dollars of easy cuts out there to horribly inefficient and unnecessary spending. (Also note that this one started when Bush was president.)

The irony with this one is that you could say the money we gave China probably came from China anyway. But the difference between this and China funding their own infrastructure is that we still have to pay the $275 million back.

The Narrative Fallacy and the Debt Ceiling

In Nassim Nicholas Taleb’s interesting book The Black Swan, he talks about the “narrative fallacy,” wherein we like to confidently prescribe reasons for random events. This happens all the time in financial news. Last Thursday the stock market dropped, and the headlines said, “Buyers exit market before House debt plan vote.” The article said:

U.S. stocks faded in the afternoon on Thursday to end mostly lower, with investors skeptical a key vote by Congress would lead to a deal to avoid a U.S. default. The S&P 500 fell for a fourth straight day as buyers kept to the sidelines while lawmakers tried to hash out an agreement on the deficit.

The next day, Friday, the stock market dropped again, bringing the Dow Jones loss over the last six days to 581 points. And what did the news say? Wall St ends worst week in a year on debt stalemate. Or, Markets on edge as debt limit debate drags on:

The Dow Jones industrial average fell nearly 100 points, its sixth straight decline, as the U.S. edged closer to a Tuesday deadline to raise the country’s borrowing limit or risk the prospect of a debt default.

Wow. We didn’t know if Congress was gonna pass a bill to extend the debt ceiling by August 2 (even though that date was part of even more atrocious reporting), and apparently investors were worried. That was repeatedly given as the reason for the stock market going down all last week. Then Sunday night they hammered out a deal, the House passed it on Monday, the Senate passed it on Tuesday, and it got signed into law. So what happened on Tuesday, August 2?

Stocks now down for year as economic concerns grow:

The stock market fell sharply Tuesday because investors have grown increasingly worried about the economy.

Aww! So much for the buyers coming off the sidelines because the debt ceiling got raised. Now it’s just the economy! But does anybody have any doubt what the headlines would have said if the Dow had dropped 265 points today and we hadn’t passed the debt ceiling bill?

If The Debt Ceiling Is Raised, What Changes?

The entire debt ceiling debate boils down to two possibilities – either the United States government will begin to borrow more than $14.3 trillion dollars, or it won’t.

The August 2 date is irrelevant. Despite the atrocious news reporting that continues to insist that there will be at least a partial default on that date (the cable news stations even have countdown timers!), there have been plenty of reports suggesting that the government has received more tax revenues than they expected they would when they announced that date a few months ago, and they should be able to pay the August 2 bills and maybe even a few days more. But even if the government runs completely out of money on some date in August before they figure out a way to borrow more, I really don’t expect it to stay that way forever.

Continue reading If The Debt Ceiling Is Raised, What Changes?

Financial Craziness But Treasuries Still Safe Haven

It’s been a crazy week. Ronny and Donny (from my train metaphor) are still fighting each other, and with every passing day and hour it seems increasingly unlikely that Congress will reach an agreement to extend the debt ceiling that limits how much money the government is allowed to borrow. The partisan bickering has been complicated, hypocritical, deceptive, and boring, but the commentariat has been much more exciting.

We’ve been hearing that if the debt ceiling is not raised, the stock market will crash and interest rates will go up – meaning, ironically, that it will cost the government more money to pay off its debt if we don’t let the government borrow more money now. Investors all over the world will lose confidence in the dollar and no one will want to buy our debt anymore. But as the alleged August 2 deadline has drawn near, interest rates on 10-year Treasuries have stayed remarkably low. Many, including myself, have used this as evidence that the world will not end if the ceiling is not raised. We’re biased against government spending, and when alarmists confidently declare that horrible things will happen if we don’t let the government spend more, we look for ways to prove their confidence wrong. The stock market seemed to be doing fine, too. One of the arguments was that the markets expected Congress to work something out, so that’s why they weren’t responding negatively yet.

Well, the stock market has been dropping all week, and today pretty much the entire world’s markets are in red. There is a lot of interesting movement going on – including things that involve some of the short Treasury bills due in August and insurance rates against default and other complex things. Tyler Cowen tweeted, “The excess citing of low T-Bill rates as ‘no reason to worry’ has come back to bite some economists in the bum.” Maybe the alarmists were right. Now that the market does not expect a deal, the market is hurting.

And yet today the 10-year Treasury rates have dropped even further! They were hanging out in the 2.95%-3% range all week and now are down to 2.85%. Financial articles always give reasons for every movement of every financial thing, and they’ve been saying things like, “Stocks fell today on concerns about the debt ceiling impasse. Treasury rates went down on concerns that the impasse would hurt the economy.”

Treasury rates have been really low lately, because even though in a lot of ways the U.S. is in bad shape, we have always had plenty of money to pay the interest on our debt, and we still do, and when countries around the world get into trouble, many investors stop loaning money to them and loan money to the U.S. It’s a safe hedge, and the more people that want it, the lower the interest rates go, but these investors would rather make low interest here than risk higher interest from a different country that might completely collapse and never pay them back. That’s why the 10-year Treasury rates have stayed around 3%, which is already historically low.

So the fact that today the rate has dropped even lower means that while investors may be concerned about the current situation or that some of the bills coming due in August may have trouble getting paid, they are not losing any faith in the ability of the government to pay long-term bills! They still view U.S. Treasuries as a safe haven, not only safer than bonds of other countries but even safer than stocks in the U.S. economy! (At least for now.) In fact, right now it looks like the debt ceiling crisis is lowering our government’s borrowing costs!

So some of the alarmists may have been correct that the markets would react negatively to a lack of a deal. We can no longer say, “Chill out, the stock market’s not even going down!” But I don’t think the alarmists can claim vindication here. We may not be able to cite low T-bills as “no reason to worry” at all, but the alarm was that U.S. borrowing costs would go up because T-bills won’t be low anymore, and that still has not happened. At least not yet.

A Tale of Two Train Conductors

There are a lot of analogies out there about how the American economy is a train headed for a cliff and Congress is arguing about how to stop it from going off the cliff. I think I’ve got a better one.

Once upon a time there was a train. It had two conductors, Ronny and Donny, and every now and then the passengers would change their minds about which one of them should be guiding the train. Now the train was climbing a mountain, because it seemed that this led to (ahem) a higher standard of living then if it remained on the ground. (The farther up they went, the more wood from trees it took to keep the train going, but they just kept going farther up the mountain to get more trees.) Soon the train was very, very far up the mountain. The air was foggy, and they couldn’t tell how much higher the mountain went, but they knew that eventually they would get to the top and that the train tracks ended there, and there the train would crash. So the passengers built a catapult on top of the engine, and had Ronny and Donny launch a big boulder that landed somewhere ahead on the tracks, figuring that they would stop the train when they got to the boulder.

Sooner or later the train approached the big boulder. The passengers told Ronny and Donny that they wanted to keep going up the mountain for now, so they chose one of them to pick up the boulder and launch it farther along the tracks. This continued on for several years, and sometimes the passengers would change their minds about who should be in charge of kicking the boulder along the tracks, too.

One day while Donny was conducting the train and Ronny was in charge of the boulder, the train got close to the boulder again.

“Go move the boulder, Ronny,” Donny said.

Continue reading A Tale of Two Train Conductors

The Struggles of the Long-Term Unemployed

Econ bloggers have been discussing this topic for awhile, but now it’s even making its way into the New York Times (I saw the same article on Yahoo! Finance yesterday). The longer you’ve been out of work, the harder it is to find work, because your skills get rusty and if you’ve been out of work for a year you don’t look as attractive as someone who’s currently using those skills at a job. There are openings out there, but we are hearing about increasing numbers of employers saying they are only interested in workers who currently have jobs, or essentially, “Unemployed need not apply.” Well, now what are you supposed to do, right?

Of course, there are NYTimes readers who view this as discrimination and want a legislative fix. But, like a lot of things, I think this problem is part of a strong enough reality that you can’t just pass a law to make it go away. Employers have enough applicants right now that they can be picky about hiring the best workers, regardless of how much you try to make them consider unemployed workers along with employed workers. (A bit of a straw man here, but what are you gonna do? Some sort of affirmative action that mandates a percentage of new hires have been unemployed for more than X weeks? Just thinking about the bloated regulation required to stop businesses from getting around that law’s intention has my head screaming boondoggle!)

Of course, there are Marginal Revolution readers who don’t view this as a problem at all. Back in February TomHynes remarked, “It doesn’t matter. Hiring an employed person creates a job opening at his former company. Eventually a job goes to an unemployed person. Which is better – five employed people get slightly better jobs and an unemployed person gets a job, or an unemployed person gets a job?” I like this thinking because it’s clever, and because it fits my bias about problems solving themselves without government help. But I’m not convinced that it fully works in reality, either, because if such remarks are true now, they would also be true in a situation where there aren’t millions of long-term unemployed folks. In that situation, there are still enough employed and recently unemployed folks to work the merry-go-round, so when you add the long-term folks to the mix, what stops them from being ignored just like the times when they aren’t there at all? When an employed person creates a job opening at his former company, it may eventually “trickle down” to an unemployed person, but how do we do know that this process is happening fast enough with the long-term unemployed to make a difference? The sheer numbers of the long-term unemployed are nearly proof that it isn’t.

This is one of those complicated issues about which I don’t have a strong, informed opinion. There are two sides to me here.

Continue reading The Struggles of the Long-Term Unemployed

Debtpocalypse & Treasury Forecasts Don’t Add Up

I’m still not sure how concerned to be about this upcoming debtpocalypse or whatever. For one thing, the stock market is supposed to crash, and Treasury interest rates are supposed to rise (and if money’s being pulled out of both investments I’m not sure where it’s going to go… Euro bonds? No way. Commodities? Not with oil dropping every time the global economy coughs. Gold, maybe? Not all of it… I just don’t know.)

But more on those Treasury bond interest rates. We keep hearing that the United States will suffer irreparable damage to its credit, and that not increasing the debt ceiling will lead to the interest on our debt going up by so much that we would actually be increasing the debt! That sounds pretty bad. So why do I keep reading about non-pocalpyse forecasts like this one?

If the U.S. defaults on some obligations after Aug. 2, even if it pays bondholders, S&P forecasts short-term interest rates would rise 0.50 percentage points and long-term interest rates by 1 percentage point.

In the very same article, I read this:

Yields on benchmark 10-year notes rose six basis points, or 0.06 percentage point, to 2.96 per cent July 22 in New York, from 2.91 per cent on July 15, according to Bloomberg Bond Trader prices.

Still, markets through last week hadn’t demonstrated great concern about the potential for a default. Yields on 10-year- notes remained well below the average of 4.06 per cent during the past decade.

Wait. For whatever reason, the interest rate on U.S. debt is over a percentage point lower than it has averaged for the last decade. Apparently a lot of investors still think it’s a safer bet than some other countries’ debt. Or maybe they just have an insane optimism that the U.S. will really increase the debt ceiling, or at least, continue to pay the debt interest. Regardless, the forecasted crisis is that the interest rates will rise a whole percentage point and go back to the long-term average?

I’m just not seeing the catastrophe.

Do Fines Help Regulations Pay For Themselves?

Recently in a comment on a news article, I read someone arguing that the beauty of government regulations is that usually pay for themselves through fines, so it doesn’t make sense to blame regulations in discussions of debt and deficit. This was an interesting point, as I had never really thought before about fines from violated regulations as a source of income for the government. But the more I thought about it, the more I thought that this viewpoint contains an inherent contradiction – even if fines completely offset the cost of implementing and enforcing a regulation.

Continue reading Do Fines Help Regulations Pay For Themselves?