Geo-Graphics

Bloomberg and other media outlets have been highlighting the apparent significant recent fall in China’s foreign exchange reserves, suggesting that the development had important implications. In a recent blog post, former Fed Chair Ben Bernanke argued that a “global excess of desired saving over desired investment, emanating in large part from China and other Asian emerging economies and oil producers like Saudi Arabia, was a major reason for low global interest rates.” If this is so, then Chinese reserve sales can be expected to push up global rates.  But is China actually selling reserves? The actual currency composition of China’s reserves is unknown – so no hard measurement of sales can be made.  However, if we assume that the composition is approximately the same as that of other EMs – about 65% dollars, 20% euros, and 15% others – we can estimate it. As shown in the graphic above, once we strip out currency fluctuation effects – that is, the steep recent rise in the dollar - Chinese FX reserves actually increased mildly, rather than decreased, between last June and December.  Thus Bloomberg’s assertion that China had “cut its stockpile” of reserves appears erroneous. So to the extent that Bernanke’s global savings glut thesis is accurate, China continues to exert downward pressure on global interest rates.   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”

How will the Fed raise rates once it starts?  Gradually, in small steps?  Faster, with larger steps? In 2012, before becoming Fed chair, Janet Yellen argued for a later first rate-hike than would be suggested by a traditional “Taylor Rule” approach, followed by more aggressive catch-up rate hikes.  Now, however, she is suggesting that those rate hikes will be gradual and measured after all.  Almost certainly she is wary of a repeat of 1994, when the Fed began raising rates and bond markets took a pounding. New York Fed president Bill Dudley said that the pace of tightening would depend on “financial conditions” in the market once the Fed achieves lift-off.  He pointed to the spring/summer 2013 “taper tantrum” as a reason to go slow.  But he then warned of the risks of repeating the 2004 experience, when the gradual, measured, salami-slice tightening left “financial conditions . . . quite loose,” suggesting that policy should perhaps “have been tightened more aggressively.” These comments suggest that the Fed might be more aggressive this time if longer-term interest rates, like the 10-year Treasury rate, don’t rise with short rates. The graphic above shows how the 10-year rate evolved after the 1994 and 2004 tightenings.  The Fed, at least as suggested by Dudley’s comments, doesn’t seem to want to repeat either of these episodes.  It wants financial conditions to tighten, but not too much. What accounts for the different market reactions in the 1994 and 2004 episodes? One possibility is the very different way the Fed handled communications.  In 1994, there was no real “forward guidance.” In testimony before the Joint Economic Committee on January 31, 1994, four days before the Fed’s first rate hike, Fed Chairman Alan Greenspan indicated only that “At some point, absent an unexpected and prolonged weakening of economic activity, we will need to move [rates] to a more neutral stance.”  In 2004, in contrast, the Fed’s guidance was almost identical to 2014/15: first it said that accommodation would remain for a “considerable period,” then it said it would be “patient” in removing it, and then said rates would go up at a “measured” pace. Going forward, this suggests, all else being equal, that a repeat of the 2004 market reaction is more likely than a repeat of 1994. To the extent, however, that Dudley’s concerns about 2004 apply to the coming Fed tightening, we can expect the Fed to do something about it.  What disturbs us is that Dudley, repeating a Fed pledge from 2011 and 2014, has ruled out using the most obvious tool for affecting long rates.  This is to sell longer-term Treasury securities from its balance sheet, which would put upward pressure on their yields and, almost certainly, the yield on longer-maturity private credit.  The Fed holds a whopping $1.3 trillion in Treasuries with remaining maturity of 5 years or longer on its balance sheet, as the bottom figure above shows. Dudley says the Fed will instead simply push harder on very short-term rates, through the interest rate paid on excess reserves (IOER) and the overnight reverse repurchase (ON-RRP) facility.  “Macroprudential measures,” which he said should have been considered in 2004, might also be tried. But the first, indirect, approach makes little sense if the Fed wants to affect longer rates directly.  And the second is just a fancy way of saying “do something non-monetary, something we can’t specify.” Neither inspires confidence that the Fed will actually succeed in tightening financial conditions, if this is what it needs to do. Why did the Fed, then, and Dudley personally, rule out selling assets from the balance sheet?  Because they fear 1994 even more than they fear 2004.  But here the Fed is once again paralyzing itself with clumsy forward guidance. Dudley himself has acknowledged that the Fed does not know how the market will react to Fed tightening, and that it should, in fact, itself react to actual market conditions at the time.  We agree.  But this means that asset sales should be on the table for the eventuality that financial conditions become too loose; the Fed should not be trying to thread the needle between 1994 and 2004 using inappropriate or dubious implements.   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”

On February 19, Walmart announced that it was raising its minimum starting wage to $9 an hour.  Since Walmart is famous for its ruthless cost management, this appeared to be a significant sign of a tightening labor market. New York Times columnist and Nobel economist Paul Krugman certainly thought it was significant: “there will be spillovers,” he wrote. “Walmart is so big that its action will probably lead to raises for millions of workers employed by other companies.” But he rejected the idea that it said anything about the state of the labor market.  Walmart, he said, was raising wages in spite of wage pressures that were insufficient to justify it. So why are they doing it? “Walmart’s move tells us,” he writes elliptically, “that low wages are a political choice, and we can and should choose differently.” Many paragraphs later he states that “Walmart is under political pressure.” The implication is that the company has bowed to it. Curiously, Krugman offers no evidence against economics as an explanation, and no evidence in favor of politics.  Yet his policy conclusions are sweeping: the government “engineering a significant pay raise for tens of millions of workers,” through “substantial” increases in minimum wages and increased collective bargaining rights, is “much easier than conventional wisdom suggests.” We prefer to look at the data. Retail-sector wages have risen significantly over the past year, and, as today’s Geo-Graphic shows, far faster than wages in the private sector as a whole: 2.8% vs. 1.6%. In short, Walmart is just being Walmart: making a rational decision to attract and retain workers in a tightening retail labor market through greater compensation.  Period. Neil Irwin: As Walmart Gives Raises, Other Employers May Have to Go Above Minimum Wage The Atlantic: Why Walmart Raise Its Wages Walmart: Fact Check: The New York Times: “The Corporate Daddy” Wall Street Journal: Wal-Mart Looks to Bump All Workers’ Pay Above the Minimum Wage   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”