Strong Views Lightly Held

I wrote most of this before Biden dropped out.  Revised lightly.  Biden’s decision clears the table, shuffles the cards, and deals out new hands.  But it really doesn’t change the race.  It was and still is about Trump and turnout.

TLDR:  Election are decided by the actual voters –  who shows up and who stays home.  We are likely heading into a low enthusiasm, low turnout election skewed by state abortion ballot initiatives.  Low turnout means most actual votes come from “likely voters.”  The one certainty is how swing state abortion rights initiatives will skew turnout in favor of Democrats.  They could prove more decisive in this election than the personalities involved…That math tilts in favor a Democratic president.  The lower voter’s enthusiasm, the more the math leans against Trump. That is just what the polling data tell us – follow this link if you disagree.

“For the first time in 2024, polls are showing that the likeliest voters are Democrats, while the ones who are less likely to vote are Republicans…. The information all points to a new reality: The fewer people vote, the more likely Democrats are to win.”

My day job is to look for places where a lazy consensus isn’t supported by facts.  That’s all I am doing here.  Per the data above, the facts have changed, but people haven’t updated their assumptions.  That creates potential for a surprise.

My quick take post-Biden?   Outside of his immediate family, no-one really voted “for” Joe Biden.  The same applies in 2024.  The race remains a contest between Trump and “Any Competent Adult” (a great bumper sticker I saw last cycle).

• If low turnout wins, a bland Democrat would fare better than a polarizing one.
• Kamala is polarizing.  That is bad.  Although maybe she sucks even more enthusiasm out of the race?  It would be is a strange path to victory, but a win is a win (if not a mandate…).

We won’t have a clean answer until the “likely voters” convert to actual votes.  We know likely voters skew Democratic.  We also know abortion-rights initiatives will skew it Democratic.  We also know a lot of people aren’t looking at this race from the bottom up…

1. Abortion is on the ballot in a lot of swing states.  That will REALLY skew turnout.  Boosting it for (Democratic skewing) women in general and college educated women in particular.  DEPRESSING turnout among Republican-leaning women – especially college educated women in (swing) suburban districts.  They will also boost turnout by motivated anti-abortion voters, but they are already counted in that 30% MAGA “likely voter” segment.  So their participation doesn’t change the equation…
2. The Trump show is getting old and tired in its 3rd season.  The aging star isn’t as fresh or fun…  If you could see past the Biden dumpster fire, Trump’s debate & convention speech came across more like an aging Vegas comedian re-hashing old routines in some off-Strip casino to a static fan base that already knows the punch lines.
3. Trump’s vote totals are also capped.  Pretty much everyone has already made up their minds about Donald Trump.  So who can he persuade to change their minds?  Low-turnout. low-information voters…
4. Enthusiasm is super low.  Democrats are depressed.  A huge, silent, college educated segment of the Republican voter base is equally depressed.  Neither group really likes the choices both parties are shoving down our throats.  No matter who replaces Biden, that sentiment likely remains.
5. Hardcore MAGA Trumpers (about 30%-35% of active voters?) are energized, but their enthusiasm is partly self-canceling.  They will drive up turnout by people in the “very likely voter” segment.

None of the above is necessarily decisive.  But it tells us to beware headline poll numbers.  If anything, Trump-friendly poll headlines HURT Trump’s  chances.  Look at what happened to Hillary in 2016.  Her polling lead motivated the haters and de-motivated her less-committed supporters  A lot of people woke up Wednesday morning deeply regretting their no-shows the day before…

Adam Tooze piece here inspired me to do a little blogging. 

See chart below.  All that Chinese industrial lending = goods deflation.  China is (still) trying to export its way to prosperity.

This will be a persistent deflationary force until China either gives up or blows up…

Various people (Micheal Pettis especially) pointing out very few countries are able/willing to accept a permanent trade surplus.  But that is what China is (still) trying to run with.  That will hit developing countries and, likely, the US “consumer of last resort.”

A lot of that Chinese industrial lending is going to end up coming our way one shipping container at a time.  Why?  China’s consumers don’t claim a large enough share of national income to consume it.   So the US will continue to run a “permanent” trade and budget deficit.  Just how the math must work.

The Chinese alternative – driving up domestic consumption to absorb that production – would involve an internal income redistribution.  They are unwilling to take on.  That is why Pettis’ book is called “Trade Wars are Class Wars.”  China has a Class conflict that is driving its Trade policy.  Until either the upper classes accept the need to re-distribute income or some other factor forces the issue.

This is also why I am skeptical the global neutral interest rate R* has suddenly moved up.  China’s surplus policies create excess supply and constrained demand on a global basis. That should(?) suppress interest rates, as we saw pre-Covid

That equation eventually gets solved.  Hopefully the damage is mostly contained within China’s mostly-closed financial system.  We’ll see?  At least we’ll get a lot of cheap EVs and fridges out of the trade.

The other country highlighted in Pettis book is Germany.  Their export-led model seems to have finally hit the end of its run.  Not sure how to slot that into the above…

https://substackcdn.com/image/fetch/f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F57e83a72-b5a8-421a-9824-f9347a99b87a_2468x1440.png

None of the below is a prediction.  It is simply a speculation.  I’m not foolish enough to “predict” the EU would do the right and courageous thing.  But they could always surprise us…

There hasn’t been much to say about Ukraine.  They did not get lucky in the summer counter-offensive.  So we’re looking at another year of war.

Putin and Russia have still lost.  That has been obvious since about 5 days into he war.  No amount of goal-post moving will hide that Russia is weaker and less powerful today.  Nor does he have a clear exit strategy.

Ukraine “wins” decisively if they push the border back to their pre-war boundaries.

• They have definitely joined “Europe” and avoided the vassal-state status Putin intended to impose.  I’m assuming the Ukrainian people will not forgive or forget.
• They would be solidly better off.  It isn’t a huge loss if Luhansk and Donetsk – economic basket cases – remain Russia’s problem (for the time being).
• Crimea remains an open question and the most obvious source of future tension.    But Crimea itself might decide that life is better in a prosperous “European” state somewhere down the line.

Even today, you could plausibly argue they are in a better position than before the war.  Giving up some territory to join Europe might still be worth it.  But that’s a narrow and bitter win at best.

So the outlook boils down to

1. Can Ukraine take back that occupied chunk north of Crimea, West of Donetsk, and East of the Dnipro?  The past 6 months show that won’t be easy.  But it is still very possible.  They just need a little luck and a lot of artillery shells.
2. Will “the West” give them the money and materiel to stay in the war?  There are growing questions about the US commitment.  There is surprisingly little consideration given to the European commitment…

Will Europe step up if the US Steps Back?  Existential Threats Can Focus The Mind…

The “Ukraine support” debate usually focuses on Washington.  People assume that Europe lacks the will, cohesiveness, or funding to sustain Ukraine on its own.  Putin is on that side of the wager.  Based on the EU’s track record, that’s a good bet to make.  But it is POSSIBLE (if not probable) that Europe could surprise us all.  It is at least worth thinking about.

Lets say I could magically insert a moral and political backbone into Europe.  If the will were there, could Europe sustain Ukraine on its own?  Probably yes…

• Ukraine needs a lot of money, but Europe is a pretty rich place.
• Ukraine needs a lot of material support, but it is the sort of stuff the EU already produces.  Artillery shells, vehicles, drones, and missiles.  There is a “European” substitute or supply chain for pretty much all the US military systems Ukraine is using.  Moreover, Europe can also buy in gear from the US (or South Korea).

We have seen some encouraging signs.  Finland is sending more shells.  Germany is shipping in more arms.  The UK and France handed over Storm Shadow class missiles that have proven highly effective.  The Europeans have supplied a lot of anti-air capability.

So the money is (probably) there.  The means are definitely there.  The problem is, as always, political will. Could Ukraine prove a catalyst for the EU?

Perhaps and JUST perhaps, the Europeans might come to realize that letting Ukraine fall will just invite deeper Russian encroachment and destabilization.  Putin has unmasked himself.  Even the most greedy burgher is going to find it hard to pretend otherwise.

Maybe the core European countries act in their own collective self-interest?  Ramping up production and digging deep in their pockets to give Ukraine the tools it needs to actually win?  Better to draw the European boundary with the rapacious Russian klepto-state at a reasonably prosperous, now rabidly anti-Russian, pro-European Ukraine.  Much better than drawing that line along the Russia-friendly Hungarian/Moldovan border.

Note also that the “Europe” that emerged from such a decision is likely to be a more cohesive, competent, unified place.  In some possible future, Ukraine’s entry into the EU might also mark the real birth of the EU itself as more unified entity.  The dream of European integration has always been pursued by lurching from crisis to crisis.  This challenge might mark another major lurch forward.

Enough said.  Europe usually disappoints.  Especially when it comes to defense matters.  They likely will do so again.  But it is just possible they act intelligently in their own self-interest (and also do the right thing).

In all the commentary around what the Fed will or won’t do, no-one wants to mention that elephant over there in the corner.

Does Fed Chair Powell want another 4 years of Donald Trump?  Or is he on Team “we’ll stomach another 4 years of Biden?” Either on principle (risk of an authoritarian takeover) or on self- interest “we have to break the Trump fever if we’re ever going to take “our” Republican Party back from the wackos…?”

If you think…

1. …Powell wants Trump = no rate cuts.  That risks a recession.  Underlying inflation has already trended down to 2.6% by this solid NYFed data series.  Keeping rates at 5% gets more restrictive as inflation recedes.
2. …Powell sees Biden as the lesser of two evils = rate cuts as soon as he can plausibly can.

If Powell wants to cut, he HAS to do it relatively early in 2024.  A rate cut close to the election would look like an obvious intervention.

My guess is Powell is an institutionalist first and a partisan second.  No fan of Biden, but more afraid of another 4 years of chaos and norm-breaking.  If that’s the case, the Fed will be looking for an excuse to cut rates early in 2024.  Comments by the normally hawkish Waller hint at what that excuse might be –

If inflation continues to cool “for several more months — I don’t know how long that might be — three months, four months, five months — that we feel confident that inflation is really down and on its way, you could then start lowering the policy rate just because inflation is lower,” Waller said in remarks at the American Enterprise Institute, a Washington, D.C.-based think tank. “It has nothing to do with trying to save the economy or recession.”

Lots of other factors involved.  But worth thinking through.

I’ve been buried in thinking about AI etc.., but coming up for air a bit.  Have a Ukraine piece to get out too.

So we have strong GDP growth, rising real rates, and falling inflation.  What is the SIMPLEST explanation for that?

High real rates = “strong expected demand for financing” = “strong expected economic growth (driving demand for capital, labor, etc…).”  I’m not quite sure I believe this myself, but that is the Occams Razor answer.

GDP and Inflation

The Atlanta Fed’s “GDPNow” forecast for the quarter ended September 30 is still at 5.4%.  The “Blue Chip” consensus forecasts are at 3.4% and have been rising towards the (eerily stable) Atlanta Fed’s forecast.  This far into October, the Atlanta Fed is usually pretty on track…

The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2023 is 5.4 percent on October 18, unchanged from October 17 after rounding.

This comes as the 10 year bond’s interest rate is zooming up to 5%.  Thats reflect higher Real rates, not higher inflation.   Inflation expectations are fading and actual inflation is trending down to the 2%-3% range the Fed was targeting pre-COVID (ignoring of the lagging “shelter” series with accounts for 40% of CPI).

But What About the Deficit!!! [clutching pearls and fanning self furiously]

What about the counter argument?  “THE FEDERAL DEFICIT IS DRIVING UP RATES!!!!!!!  WE MUST CUT SPENDING!!!

The economics suggest otherwise.  If federal borrowing were truly expected crowding out private sector borrowing, that would drive real rate DOWN and expected inflation UP.

• …expectations for future real economic growth would fall AND…
• …expectations for future inflation would go UP (as deficit spending by a reserve currency issuer will show up via inflation not a debt default…)

Federal borrowing is part of the picture, but the moving part in the rates equation is more likely to be expectations for private sector borrowing.  Strong private sector demand for capital would push up real rates with minimal effect on inflation expectations. 

We have real rates going up and expected inflation going down = private sector demand. 

If your macro diet is currently filled with doom-laden warnings about the deficit, you are consuming politics not economics.

This logic above is a great quality test for the rigor, motives and honesty of your favored economic commentator(s).  Are they working from the facts?  Or are they pushing an agenda?

The deficit narrative is mostly politics dressed up to sound like economics.  Very few people selling the “deficit” story are actually serious about the deficit.

• the real (political) agenda here is “lets cut spending!“
• “spending cuts” is also a fantasy.  It is a political fig-leaf over the real agenda
• “I want more tax cuts => further increasing the deficit.“

Everyone is entitled to their personal agenda and politics.  But lets not pretend there is serious economics behind it.  Moreover, you should never invest based on your politics.  Its like betting on your favorite sports team vs “the team that is actually going to win this game.”

Although the your typical investor tends to lean right.  So investing in right-leaning political agendas can work over the short-to-medium term.  As Keynes said, the market can stay wrong for longer than you can stay solvent…

The grinding and creaking of structural metal fatigue just keep getting louder behind the Chinese facade.  This 2021 post (by a respected econ blogger) has aged very well. Worth a read.  Beyond “what he said” I’d add…

1. There is an instinctive appeal in the image of the decisive autocrat.  Especially for people who subscribe to the “hero CEO” narrative of MBA case studies and the business press.  Back in 2021, I remember a lot of “serious businesspeople” were still clinging to their man-crush on China’s CCP and Xi as the facts turned against them.  They really wanted to believe in an “other” more effective and decisive than the weak, woke, befuddled USA.  This piece is a great antidote.
2. More generally, the US right wing really fell for autocracy over the past decade.  Victor Orban, Putin, Xi, and (of course) Trump.  As the contrary evidence piles up, I see/hear a lot of people doubling down on that “strong man” faith.  Everyone likes that clever “when the facts change, I change my mind” quote, but not so many people like to practice it. I wonder what breaks the fever?
3. What is the real China risk at the many companies who do high volume business there – Apple, Tesla, Volkswagen, BASF, Airbus…  Is that intelligently priced in given the tendencies above? 

Here’s the summary quote but worth a skim in full

But other than turning a bureaucratic oligarchy into a personalistic dictatorship, what are Xi’s accomplishments, exactly? In my experience, people tend to assume that Xi is hyper-competent because:

1. There’s a general impression that the Chinese government is hyper-competent, and Xi has made himself synonymous with the Chinese government, and
2. Under Xi’s watch, China has arguably become the world’s most powerful country.

But this doesn’t mean Xi actually deserves his reputation as a one-man engine of Chinese greatness. Much of his apparent success was actually inherited from his predecessors. He has taken absolute control of the apparatus built by people such as Deng Xiaoping, Jiang Zemin, and Hu Jintao, but I think it’s hard to argue that he has added much to that apparatus.

In fact, I think there are multiple signs that Xi has actually weakened the capabilities of the Chinese juggernaut. So far, China’s power and general effectiveness are so great that these signs seem to have gone largely unnoticed, but I think they’re there. The three big ones are: Slowing growth, an international backlash against China, and missteps related to the Covid pandemic.

It’s time to consider the possibility that for all his self-aggrandizement, Xi Jinping is just not that competent of a leader.

https://www.noahpinion.blog/p/what-if-xi-jinping-just-isnt-that

Is this why the stock market refuses to go down? Also why the economy is seemingly so indifferent to the Fed’s rate-raising campaign? It is probably at least part of the puzzle.

Paper is a very quick read – by Economists from Stanford, Northwestern, and Harvard.

conventional wisdom… [argues] the effect of excess savings will dissipate in a few quarters. By contrast, our benchmark scenario suggests that these effects will stick around for roughly 5 years. These numbers are larger if MPCs [Marginal Propensity to Consume] are lower, and are robust to plausible alternative calibrations.

• Rational expectations about the future boom make the response much larger on impact due to current spending out of anticipated income, which turns out to speed up the trickling up process.
• Tight monetary policy, on the other hand, also speeds up trickling up, but it does so by mitigating the effects of excess savings on demand.

In either case, however, the duration of excess savings and output remains more than twice as long as the conventional wisdom suggests.

FYI the paper (and the draft post) is from March – so a little late but…

Click to access tricklingup.pdf

Thoughts on Ukraine.

WTF was going on with Prigozhin and the whole Wagner coup/mutiny/whatever-it-was?  I’ve avoided writing about this because I simply could not figure it out. Nor could anyone else.*

We do know this – Prygozhin suffered a “catastrophic success.”** He never expected to find himself 175 miles from Moscow facing no organized opposition.  He had no plan to proceed because he never expected to be in that position…

That is the best explanation for the weird “never mind, back to regular programming” response from both Putin and Prygozhin.  Whatever the real game was, no-one expected it to come to that combination of pieces on (or signally failing to show up on) the board.  The main (non)-event was the stunning absence of any organized resistance to Wagner.  You get a feeling a whole lot of people-in-power dropped their phones in a toilet and simply disappeared for a few days.

That non-response undermines the Putin system in ways that cannot be undone.  Showing how deep the rot goes.  But we already knew that after 12 months of Russia losing this war.  Maybe Putin also now understands that?  “Catastrophic Success” is a bad outcome for all parties involved… 

• ** “Catastrophic Success” – I wish I’d come up with that framing myself and I don’t remember who did.
• *Why did the coup discussion fade so fast?  People hate to talk about complicated things where they feel more uncertain than clever and confident…  (like people avoid talking about the magical Fed’s real-world powers and role in the economy… but I digress :-p).

Why are people still avoiding the obvious?  The Russians lost big about 6-12 months ago.  The remaining question is does Ukraine win big or win small?

I’m keep running into people and commentators who just keep re-narrating the conflict and moving the goalposts in order to avoid admitting they were…. wrong.  (Kind’ve like people keep re-narrating the “just follow the Fed – the yield curve is infallible” narrative, but I digress :-p).  In real-world terms, Russia is a massively weaker than 18 months ago.  In terms of global perception, Russia, has kicked itself out of the “great power” league and might well be heading to “failed petro-state” with no stop in the “middling power” game.

• Great Foreign Affairs article here on the Western Analysts failures before the war and (less forgivable) doubling down on their (wrong) analysis since.  Written by a guy who did get it right…  (Kind’ve like many analysts have just doubled down on their prior Fed-centric narratives, but I digress… :-p )

Will Ukraine win big or small?  Napoleon apocryphally wanted generals who were lucky more than he wanted generals who were smart.  In the counteroffensive, Ukraine is so far guilty of “not getting lucky.”

So they are slugging away at artillery pieces and ammo dumps and hoping to break the line somewhere.  That hopefully sparks a localized collapse that hopefully converts into a general collapse.  What we saw around Kharkiv and Lyman/Izium.  Ukraine do seem to be managing steady progress without awful casualties.  They’ve got at least 3-4 months of decent weather to keep plugging away.  So there’s hope. Hope and luck is all you’ll ever get…

• I ran into a good description of Ukraine’s current strategy – Send a small infantry attack.  Look to see what artillery and other fire-support gets activated to repel it.  Rapidly prioritize those locations and blast them before they can move to new cover.  The pinprick infantry attacks are just to flush out the Russian artillery out of cover.  Which is a really grim insight into how non-armchair, non-Hollywood wars actually proceed.  Ugh.

So we wait…

Working on a Ukraine rant, but noting a few “Fed” source pieces here from people more qualified than I am.  They also keep looking in vain for fact-based evidence to support the dominant Fed/markets/inflation/liquidity narrative.

They don’t replace that simple, “one-factor trade” narrative with anything but complexity and nuance.  But that’s kind’ve the point, no?  Maybe this is why faith in the Fed is so resistant to facts?  People like simple stories with no loose ends…

• Paul Krugman goes looking for evidence of the Federal Reserve’s rate changes “bringing down inflation” and comes up with…. not much.  Placebo effect from talking/acting tough?  Yes.  Real measurable impacts in the data?  No.  Note that Krugman has no political angle on this – just noting that the Emperor’s New Clothes are pretty skimpy when you look at the facts…

stories about “recombobulation” — the fading away of pandemic-era distortions — driving disinflation are clearly supported by the data. Claims that Fed tightening drove it are sketchier and much more speculative.

Another claim I’ve been seeing is that inflation would be much worse right now if the Fed hadn’t raised rates. This might well be true, but it’s also something of an evasion — it’s offering a counterfactual rather than answering the question of how we’ve achieved disinflation so far.”

• This guy does a very good job of explaining why Real Interest rate effects are pretty minimal when the marginal borrower is the US Government…  The government doesn’t care about real rates.  So real rates don’t have much impact…
• People love to assume causation and/or correlation from “two lines on a chart” simplifications (most famously relating skirt’s hemlines to stock prices back when that was a thing)…  Worth a read in full – one of the simplest explanations I’ve seen of a complex subject.  Here’s a tidy summary of the fact-based case (bank reserves don’t leak ,much if at all) against the faith-based idea that “liquidity” is a one-factor trade (or even a thing).

A simple linear regression exercise tells us ‘’liquidity’’ is pretty bad at predicting stock market returns: as shown by the R2 data, in the last 15 years US liquidity only explained 3-4% (!) of the variation of SPX returns.

So, yes: both series trended up over time and plotting them on a dual-axis chart looks great but stocks go up over time because earnings grow and not because Central Banks pump ”money” in the ”system”.

Money in this case means bank reserves, and banks can’t and won’t use reserves to buy stocks – the direct relationship and simple narrative suggested by mainstream macro commentators…

…simply doesn’t exist.