Yes, boys and girls, it’s time to play “Why Did the Market Fall?” This is when you get to blame who or whatever you like for the big plunge in the market that began last Friday (now largely reversed).
I want to blame the partial unwinding of the Affordable Care Act, which is likely to leave millions more uninsured and tens of millions paying more for their health care. I have a friend who wants to blame her uncle’s bad breath. Then there is Andrew Sorkin at the NYT who tells us that investors fear that Donald Trump’s tax cuts will succeed all too well, causing a boom which will generate inflation.
So the Sorkin story is that we get a big uptick in demand from the tax cuts, which will push the economy above its potential level of output creating a good old-fashioned wage-price spiral. That will mean higher interest rates and therefore lower stock prices.
If we want to test this one we can look at measures of investors’ expectations of inflation. On January 31, just before the plunge, the yield on 10-year Treasury bonds was 2.72 percent. The yield on an inflation-indexed 10-year bond was 0.61 percent, implying a gap of 2.11 percentage points. On Friday, the day of the first big plunge, the yield on the 10-year Treasury bond rose to 2.84 percent, while the yield on the inflation-indexed bond rose to 0.7 percent, giving a gap of 2.14 percentage points.
That’s 0.03 percentage points more than before the crash. Do we really want to say that an increase in the expected rate of inflation of 0.03 percentage points will sink the market? Of course, the gap was back down to 2.10 percentage points at the end of the day on Monday, so it’s not clear what happened to investors’ fears that the Trump tax cuts would spur inflation.
Okay, we get that Sorkin is apparently very fearful of inflation and presumably thinks the Fed has to be very vigilant on the inflation watch. He doesn’t even care if he lacks the evidence to make his case.
(It is worth noting that if the Trump tax cuts “work” it is supposed to be by spurring a flood of new investment. That should increase productivity growth, which would relieve inflationary pressures. So if Sorkin has a vision of Trump’s tax cuts causing inflation, he seems them “working” in a different way than has been advertised.)
Yes, boys and girls, it’s time to play “Why Did the Market Fall?” This is when you get to blame who or whatever you like for the big plunge in the market that began last Friday (now largely reversed).
I want to blame the partial unwinding of the Affordable Care Act, which is likely to leave millions more uninsured and tens of millions paying more for their health care. I have a friend who wants to blame her uncle’s bad breath. Then there is Andrew Sorkin at the NYT who tells us that investors fear that Donald Trump’s tax cuts will succeed all too well, causing a boom which will generate inflation.
So the Sorkin story is that we get a big uptick in demand from the tax cuts, which will push the economy above its potential level of output creating a good old-fashioned wage-price spiral. That will mean higher interest rates and therefore lower stock prices.
If we want to test this one we can look at measures of investors’ expectations of inflation. On January 31, just before the plunge, the yield on 10-year Treasury bonds was 2.72 percent. The yield on an inflation-indexed 10-year bond was 0.61 percent, implying a gap of 2.11 percentage points. On Friday, the day of the first big plunge, the yield on the 10-year Treasury bond rose to 2.84 percent, while the yield on the inflation-indexed bond rose to 0.7 percent, giving a gap of 2.14 percentage points.
That’s 0.03 percentage points more than before the crash. Do we really want to say that an increase in the expected rate of inflation of 0.03 percentage points will sink the market? Of course, the gap was back down to 2.10 percentage points at the end of the day on Monday, so it’s not clear what happened to investors’ fears that the Trump tax cuts would spur inflation.
Okay, we get that Sorkin is apparently very fearful of inflation and presumably thinks the Fed has to be very vigilant on the inflation watch. He doesn’t even care if he lacks the evidence to make his case.
(It is worth noting that if the Trump tax cuts “work” it is supposed to be by spurring a flood of new investment. That should increase productivity growth, which would relieve inflationary pressures. So if Sorkin has a vision of Trump’s tax cuts causing inflation, he seems them “working” in a different way than has been advertised.)
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My modest additions to five paragraphs of the NYT article on the budget deal:
“The deal would raise the spending caps by about $300 billion over two years (3.5 percent of projected spending), according to a congressional aide. The limit on military spending would be increased by $80 billion in the current fiscal year (2.0 percent of spending) and $85 billion in the next year (1.9 percent of spending), which begins Oct. 1, the aide said. The limit on nondefense spending would increase by $63 billion this year (1.5 percent of spending) and $68 billion next year (1.6 percent of spending).
The deal will cause federal budget deficits to grow even larger, on top of the effects of the sweeping tax overhaul that lawmakers approved in December. But because the agreement gives both parties what they wanted most, the deficit impact appears to be of little concern. Defense Secretary Jim Mattis, White House Press Secretary Sarah Huckabee Sanders and Speaker Paul D. Ryan all quickly embraced it.
From the increase in domestic spending, Mr. Schumer said the deal includes $20 billion for infrastructure (0.2 percent of spending [all calculations assume a two-year figure]), $6 billion for the opioid crisis and mental health (0.07 percent of spending), $5.8 billion for child care (0.07 percent of spending) and $4 billion for Veterans Affairs hospitals and clinics (0.05 percent of spending). It also includes disaster relief for areas hit by last year’s hurricanes and wildfires.
The deal also includes $4.9 billion — two years of full federal funding — for Medicaid in Puerto Rico and the United States Virgin Islands (0.06 percent of spending), helping to avoid a looming Medicaid shortfall. There is additional money to repair infrastructure, hospital and community health centers severely damaged by Hurricanes Irma and Maria.
The relief aid also includes $28 billion in community development block grants (0.33 percent of spending), including $11 billion for Puerto Rico (0.13 percent of spending), with $2 billion of that going to repair the power grid (0.02 percent of spending). About 30 percent of Puerto Ricans — more than 400,000 customers — still don’t have electricity more than four months after Hurricane Maria. Puerto Rico requested $94.4 billion in aid after the storm.”
My modest additions to five paragraphs of the NYT article on the budget deal:
“The deal would raise the spending caps by about $300 billion over two years (3.5 percent of projected spending), according to a congressional aide. The limit on military spending would be increased by $80 billion in the current fiscal year (2.0 percent of spending) and $85 billion in the next year (1.9 percent of spending), which begins Oct. 1, the aide said. The limit on nondefense spending would increase by $63 billion this year (1.5 percent of spending) and $68 billion next year (1.6 percent of spending).
The deal will cause federal budget deficits to grow even larger, on top of the effects of the sweeping tax overhaul that lawmakers approved in December. But because the agreement gives both parties what they wanted most, the deficit impact appears to be of little concern. Defense Secretary Jim Mattis, White House Press Secretary Sarah Huckabee Sanders and Speaker Paul D. Ryan all quickly embraced it.
From the increase in domestic spending, Mr. Schumer said the deal includes $20 billion for infrastructure (0.2 percent of spending [all calculations assume a two-year figure]), $6 billion for the opioid crisis and mental health (0.07 percent of spending), $5.8 billion for child care (0.07 percent of spending) and $4 billion for Veterans Affairs hospitals and clinics (0.05 percent of spending). It also includes disaster relief for areas hit by last year’s hurricanes and wildfires.
The deal also includes $4.9 billion — two years of full federal funding — for Medicaid in Puerto Rico and the United States Virgin Islands (0.06 percent of spending), helping to avoid a looming Medicaid shortfall. There is additional money to repair infrastructure, hospital and community health centers severely damaged by Hurricanes Irma and Maria.
The relief aid also includes $28 billion in community development block grants (0.33 percent of spending), including $11 billion for Puerto Rico (0.13 percent of spending), with $2 billion of that going to repair the power grid (0.02 percent of spending). About 30 percent of Puerto Ricans — more than 400,000 customers — still don’t have electricity more than four months after Hurricane Maria. Puerto Rico requested $94.4 billion in aid after the storm.”
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Before anyone starts jumping off buildings, let me give you a few items to think about.
1) The stock market is not the economy. It moves in mysterious ways that often have little or nothing to do with the economy. In October of 1987, it plunged more than 20 percent in a single day. GDP grew 4.2 percent in 1988 and 3.7 percent in 1989. The market did recover much of its value over this period, but we don’t know whether or not it will recover the ground lost in the last week either.
2) The market has gone through an enormous run-up over the last nine years. The current level is more than 230 percent above its 2009 lows. That translates into an average nominal return of more than 14.0 percent annually, before taking into account dividends.
The gains have been even more rapid over the last two years. Even with the recent drop, the market is more than 40 percent above its February 2016 level. Most people would have considered it crazy to predict the market would rise by 40 percent over the next two years back in February 2016. In other words, people who have invested heavily in the stock market have nothing to complain about. If they didn’t understand that it doesn’t always go up then they should keep their money in a savings account or certificates of deposit.
3) This plunge is not in any obvious way linked to higher interest rates. We can say that because interest rates have not risen that much. The yield on 10-year Treasury bonds stands at 2.71 percent. (It fell sharply today as the market was plunging.) That compares to about 2.4 percent a year ago. It’s pretty hard to tell a story that a 0.3 percentage point rise in long-term interest rates will sink the stock market and the economy. The yield had been less than 1.8 percent two years ago.
4) The plunge in markets is worldwide with markets in Europe and Asia also sinking sharply. This undercuts the blame Trump story unless the theory is that Trump is so bad he is going to sink the whole world economy. Also, the markets are still above the levels they were at when Trump took office, so this is really not a good theory for Trump critics to embrace.
In short, calm down. The economy is not going to collapse. If you have less money in your 401(k) than you did last week, just remember: you have far more than you expected to have last year.
Before anyone starts jumping off buildings, let me give you a few items to think about.
1) The stock market is not the economy. It moves in mysterious ways that often have little or nothing to do with the economy. In October of 1987, it plunged more than 20 percent in a single day. GDP grew 4.2 percent in 1988 and 3.7 percent in 1989. The market did recover much of its value over this period, but we don’t know whether or not it will recover the ground lost in the last week either.
2) The market has gone through an enormous run-up over the last nine years. The current level is more than 230 percent above its 2009 lows. That translates into an average nominal return of more than 14.0 percent annually, before taking into account dividends.
The gains have been even more rapid over the last two years. Even with the recent drop, the market is more than 40 percent above its February 2016 level. Most people would have considered it crazy to predict the market would rise by 40 percent over the next two years back in February 2016. In other words, people who have invested heavily in the stock market have nothing to complain about. If they didn’t understand that it doesn’t always go up then they should keep their money in a savings account or certificates of deposit.
3) This plunge is not in any obvious way linked to higher interest rates. We can say that because interest rates have not risen that much. The yield on 10-year Treasury bonds stands at 2.71 percent. (It fell sharply today as the market was plunging.) That compares to about 2.4 percent a year ago. It’s pretty hard to tell a story that a 0.3 percentage point rise in long-term interest rates will sink the stock market and the economy. The yield had been less than 1.8 percent two years ago.
4) The plunge in markets is worldwide with markets in Europe and Asia also sinking sharply. This undercuts the blame Trump story unless the theory is that Trump is so bad he is going to sink the whole world economy. Also, the markets are still above the levels they were at when Trump took office, so this is really not a good theory for Trump critics to embrace.
In short, calm down. The economy is not going to collapse. If you have less money in your 401(k) than you did last week, just remember: you have far more than you expected to have last year.
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The NYT had a very good piece pointing out that the bonuses promised by many corporations following the tax cut are often less consequential than they appear. For example, many companies highlighted their maximum bonus amount. This was often a figure (e.g. $1,000) that went to a full-time worker who had been with the company for twenty years or more. At a company like Walmart, very few of their workers would have been there for twenty years and many are part-time. This means that the typical worker would receive much less than the hyped $1,000 bonus.
However, the most remarkable aspect of the bonus game is the fact that a bonus could be tax deductible in 2017 even if it was not paid until 2018. This inexplicable (on policy grounds) quirk in the tax code gave corporate America an enormous incentive to announce bonuses at the end of last year since bonuses announced in 2017 cost much less money than bonuses or pay increases announced and paid in 2018.
If a company like Walmart or AT&T gave its workers $100 million in bonuses or pay increases in 2018 it would cost the company $79 million in after-tax profits, given the new 21 percent corporate tax rate. However, if the same $100 million bonus was announced before the end of 2017 it would only cost the company $65 million in after-tax profits since it could be deducted in a year when the tax rate was 35 percent. (These calculations assume that the companies actually pay the marginal tax rate.)
This means, in effect, that the government would have been paying these companies $14 million to announce a bonus before the end of the year. Since we all believe that companies respond to incentives, it should not be surprising that many announced bonuses before the end of 2017.
The NYT had a very good piece pointing out that the bonuses promised by many corporations following the tax cut are often less consequential than they appear. For example, many companies highlighted their maximum bonus amount. This was often a figure (e.g. $1,000) that went to a full-time worker who had been with the company for twenty years or more. At a company like Walmart, very few of their workers would have been there for twenty years and many are part-time. This means that the typical worker would receive much less than the hyped $1,000 bonus.
However, the most remarkable aspect of the bonus game is the fact that a bonus could be tax deductible in 2017 even if it was not paid until 2018. This inexplicable (on policy grounds) quirk in the tax code gave corporate America an enormous incentive to announce bonuses at the end of last year since bonuses announced in 2017 cost much less money than bonuses or pay increases announced and paid in 2018.
If a company like Walmart or AT&T gave its workers $100 million in bonuses or pay increases in 2018 it would cost the company $79 million in after-tax profits, given the new 21 percent corporate tax rate. However, if the same $100 million bonus was announced before the end of 2017 it would only cost the company $65 million in after-tax profits since it could be deducted in a year when the tax rate was 35 percent. (These calculations assume that the companies actually pay the marginal tax rate.)
This means, in effect, that the government would have been paying these companies $14 million to announce a bonus before the end of the year. Since we all believe that companies respond to incentives, it should not be surprising that many announced bonuses before the end of 2017.
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Mick Mulvaney, the acting director of the Consumer Financial Protection Bureau (CFPB), effectively decided to incentivize ripoff schemes by taking away the enforcement powers of the CFPB division that is charged with blocking such schemes. As fans of free markets everywhere know, if it possible to make money by designing deceptive financial products that rip off low- and moderate-income people, profit-maximizing companies will do it.
Mick Mulvaney, the acting director of the Consumer Financial Protection Bureau (CFPB), effectively decided to incentivize ripoff schemes by taking away the enforcement powers of the CFPB division that is charged with blocking such schemes. As fans of free markets everywhere know, if it possible to make money by designing deceptive financial products that rip off low- and moderate-income people, profit-maximizing companies will do it.
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As I have pointed out repeatedly, the Republicans story about how their corporate tax cut will benefit everyone hinges on the idea that it will kick off a huge round of new investment. In their telling, investment is hugely responsive to tax rates. This means their tax cut will spark an investment boom. The higher levels of investment will increase productivity, which will eventually lead to higher wages.
We got our first weak test of this story with the Commerce Department’s release of advanced data on capital goods orders for December. As I pointed out, these are orders, not deliveries, so fast-moving companies should have been able to get some in before the end of the month.
Even though the tax bill was not signed until almost the end of the year, its passage was virtually certain by the middle of the month. Furthermore, the outlines had been known since Labor Day, so unless a corporation’s management was sleeping on the job, they had four months to plan their response.
As it turned the initial release showed a modest 0.1 percent drop in new orders for capital goods. Today the Commerce Department released its full report on manufacturing orders for January, with more complete data. This showed a 0.5 percent drop in orders for non-defense capital goods (0.4 percent, excluding aircraft).
Perhaps we will see a different story in future months, but so far it doesn’t look like corporate America is feeling inspired to undertake an investment just yet.
As I have pointed out repeatedly, the Republicans story about how their corporate tax cut will benefit everyone hinges on the idea that it will kick off a huge round of new investment. In their telling, investment is hugely responsive to tax rates. This means their tax cut will spark an investment boom. The higher levels of investment will increase productivity, which will eventually lead to higher wages.
We got our first weak test of this story with the Commerce Department’s release of advanced data on capital goods orders for December. As I pointed out, these are orders, not deliveries, so fast-moving companies should have been able to get some in before the end of the month.
Even though the tax bill was not signed until almost the end of the year, its passage was virtually certain by the middle of the month. Furthermore, the outlines had been known since Labor Day, so unless a corporation’s management was sleeping on the job, they had four months to plan their response.
As it turned the initial release showed a modest 0.1 percent drop in new orders for capital goods. Today the Commerce Department released its full report on manufacturing orders for January, with more complete data. This showed a 0.5 percent drop in orders for non-defense capital goods (0.4 percent, excluding aircraft).
Perhaps we will see a different story in future months, but so far it doesn’t look like corporate America is feeling inspired to undertake an investment just yet.
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