The Capital Letter: Week of October 5

Call me crazy, but I’m not convinced that the latest round of talks on a new stimulus package are going as well as they might be.

a traffic light on a city street at night

© James Lawler Duggan/Reuters


President Donald Trump and House Speaker Nancy Pelosi questioned each other’s mental faculties, showcasing increasing partisan tensions as Election Day looms.

“The president is, shall we say, in an altered state right now, so I don’t know how to answer for his behavior.,” Pelosi said in an interview on Bloomberg Television Thursday.

The Democratic leader also called Trump’s changing positions this week on whether to let his administration conduct talks on fiscal stimulus “strange.” Trump pulled his team from negotiations Tuesday, prompting Pelosi to suggest to colleagues that day that Trump’s thinking might have been affected by the steroids he’s taken to battle his Covid-19, Bloomberg has reported.

“The disassociation from reality would be funny if it weren’t so deadly,” Pelosi said.

For his part, Trump tweeted Thursday that “Crazy Nancy is the one who should be under observation.” He also retweeted posts discussing a “coup.”

As I write (11:24 a.m.) the Democrats and the Republicans are talking, and the S&P was up on hopes of something, but Mitch McConnell, I suspect, was on sounder ground when he said that a coronavirus stimulus package was “unlikely in the next three weeks.”


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And I don’t think that Ted Cruz was that far off the mark when he said that Republicans could see “a bloodbath of Watergate proportions” if voters were “angry and broke” when casting their ballots this year. CNBC reported that Cruz “blamed Rep. Nancy Pelosi and Sen. Chuck Schumer for holding up a deal to provide a new round stimulus and direct payment checks to Americans during the coronavirus pandemic”, but went on to add that “it was President Trump who abruptly called off talks earlier this week”. That’s not wrong, of course (and I have to say that I have been puzzled by Trump’s strategery (to use an old phrase), during this latest leg of the saga. That said, there is plenty of blame to spread around for the failure to have reached a deal by now.

The state of play is what it is, and my guess is that the absence of a deal will indeed contribute to a grim night for the GOP on November 3rd (Disclosure: When it comes to political predictions my record is . . . patchy), and we should start preparing for a Biden presidency or, should I say, Harris regency. It has been suggested that one reason for the market’s strength has been that there will be a clear win for Biden on the 3rd, removing the prospect of chaos in the days and weeks after election night. Investors (or some of them, anyway), may fear the prospect of a Biden win, but they may fear uncertainty more.

Meanwhile back in the here and now, the economic recovery continues to show signs that it’s slowing, and comments this week from Fed chairman Jerome Powell were not, under the circumstances, surprising.


Federal Reserve Chairman Jerome Powell called Tuesday for continued aggressive fiscal and monetary stimulus for an economic recovery that he said still has “a long way to go.”

Noting progress made in job creation, goods consumption and business formation, among other areas, Powell said that now would be the wrong time for policymakers to take their foot off the gas.

Doing so, he said, could “lead to a weak recovery, creating unnecessary hardship for households and businesses” and thwart a rebound that thus far has progressed more quickly than expected.

“By contrast, the risks of overdoing it seem, for now, to be smaller,” Powell added in remarks to the National Association for Business Economics. “Even if policy actions ultimately prove to be greater than needed, they will not go to waste. The recovery will be stronger and move faster if monetary policy and fiscal policy continue to work side by side to provide support to the economy until it is clearly out of the woods.”

While the CNBC report did note that the economy has made considerable progress since the shock in the spring, it highlighted Powell’s fear about the consequences of losing momentum now.

Powell cautioned that backing off now with fiscal and monetary help runs the risk of losing momentum and bringing about an added downturn that would look not like the government-induced one that began in February, but rather a more traditional downturn that would be harder to recover from and worsen the U.S. wealth gap. That would be one where “weakness feeds on weakness,” he said.

“The recovery will be stronger and move faster if monetary policy and fiscal policy continue to work side by side to provide support to the economy until it is clearly out of the woods,” Powell added.

Will the Fed step up in the absence of movement in Washington? I have my doubts, at least for now.

More cheerfully, Bloomberg notes:

The U.S.’s economic scarring from the pandemic is much less severe than initially feared, Goldman Sachs Group Inc.’s economics team said in a note that offered an upbeat take on America’s situation.

Commercial bankruptcy filings are below the pre-pandemic level, business closures have proved temporary and unemployment has fallen sharply, which bode well for medium-term recovery prospects, economists said in the note. A vaccine, combined with further fiscal support next year, is expected to limit long-term damage and keep the economy on track for a recovery that could “much more rapid than usual,” they said.

“When employment declined by 25 million in little more than a month, the labor market appeared at risk of again experiencing the deep distress seen after the financial crisis,” the economists including David Mericle said in the note. “Just five months later, the number of newly unemployed workers since the virus shock has indeed declined dramatically, and about half still report that they are on temporary lay-off.”

Despite a recent increase in long-term unemployment, the rapid recovery of labor demand and faster pace of labor reallocation should help most workers avoid long unemployment spells seen in prior recessions, the note said.

The decline in the labor-force participation rate since February largely reflects virus-related obstacles to taking part that should disappear with a vaccine, such as fear of getting sick or a need to take care of children while schools are closed, they said.

We’ll see. I would just observe that economics and politics do not operate in different worlds. The economic impact of the pandemic and the lockdowns (phenomena that, to a degree, should be looked at separately) have already had political consequences. I have no doubt that they have contributed to no small part of the social unrest that we have seen in recent months.

And those political consequences are, clearly, by no means played out. As to what that might mean for the economy, we’ll have to see, but I read this news item (also from Bloomberg) with interest — and foreboding:

Democrat Joe Biden is considering creating a special White House office led by a climate “czar” to coordinate efforts to fight global warming if he is elected president, according to people familiar with the deliberations.

Among the candidates being discussed to head the operation are former Secretary of State John Kerry . . .

Well, I’ll stop there.

Opening up for Capital Matters on Monday, Mike Watson checked out electric cars:

Electric vehicles are not only an important issue in a critical sector of the American economy; they are also a microcosm of the challenges American manufacturing faces. For now, many new technologies — particularly green ones — are not noticeably better products either for consumers or the environment, but they generate fewer jobs and will deplete the ranks of skilled industrial workers. Meanwhile, maintaining any technological advantages we accrue is challenging amid rampant cyber espionage and government-sanctioned theft.

Some see electric vehicles as the commanding heights of transportation, but are we sure that this is the hill to die on?

Christos Makridis described how regulation kills middle-class jobs:

Using data spanning every occupation over time, we show that a 10 percent rise in regulatory restrictions is associated with a 5.3 percent rise in STEM employment. Increases in regulatory restrictions are also associated with declines in lower- and middle-skilled jobs. That’s important, given that non-STEM jobs have historically served an important role for the middle class, creating opportunities for upward mobility and family stability. This marks one of the important unintended consequences of greater regulation.

Unlike prior studies that have sought to quantify the effects of regulation, our analysis uniquely isolates the responsiveness of STEM employment, relative to its non-STEM counterparts, to changes in regulation within the same sub-sector over time. This helps avoid concerns about spurious factors like overall changes in technology or a growing demand for the digital workforce.

What explains the link between regulation and STEM employment? Not surprisingly, we show that increases in regulation are associated with greater compliance costs. In this sense, the data suggest that firms, especially in financial services, hire STEM workers at least in part to automate more of their organizational activities, which reduces the scope for human error and raises the overall value of the business. In fact, according to some estimates, the market for regulatory technology (or “RegTech”) is expected to grow from $4.3 billion in 2018 to $12.3 billion by 2023.

In sum, the surge in regulation accelerated the shift toward STEM employment in financial services, adversely impacting many lower- and middle-skilled workers who traditionally relied on these jobs.

These results highlight the importance of thinking through the unintended consequences of regulations before enacting them. Indeed, even if your priority is to mitigate inequality, these results show that the rise in regulation adversely affected the very individuals that it aimed to help. On the other hand, regulatory reform that focuses on removing unnecessary costs works in the other direction: It leads to increases in economic growth and wages across the distribution.

In the latest edition of his Inflation Dashboard (a regular feature on Capital Matters), Steve Hanke explained how to define hyperinflation, an over-used and much abused word:

So, just what is the definition of the oft-misused word “hyperinflation?” The convention adopted in the academic literature is to classify an inflation as hyperinflation if the monthly inflation rate exceeds 50 percent. This definition was adopted in 1956, after Phillip Cagan published his seminal analysis of hyperinflation, which appeared in a book edited by Milton Friedman, Studies in the Quantity Theory of Money.

Since I use high-frequency data and Purchasing Power Parity theory to measure inflation each day in countries with significant price increases, I have been able to refine Cagan’s 50 percent per month hyperinflation threshold. With improved measurement techniques, I now define a hyperinflation as an inflation with a rate exceeding 50 percent per month for at least 30 consecutive days.

After years of research with the help of many assistants, I have documented, with primary data, 62 episodes of hyperinflation that are listed on the “Hanke-Krus World Hyperinflation Table,” with Lebanon being the most recent entry on the Hyperinflation Table.

Hungary holds down the top spot. Its peak hyperinflation occurred in July 1946, when prices were doubling every 15 hours. Zimbabwe’s November 2008 hyperinflation peak is second highest, but way behind Hungary’s. Indeed, at their peaks, the daily inflation rates were 207 percent in Hungary and 98 percent in Zimbabwe. Right behind Zimbabwe is Yugoslavia, which reached a peak inflation rate in January 1994, when the daily inflation rate hit 64.6 percent. Yugoslavia’s monthly inflation rate at that peak was a stunning 313 million percent per month.

As someone didn’t exactly say, “a million here, a million there, and pretty soon you’re talking unreal money.” Contrary to popular opinion, Weimar Germany is not the all-time hyperinflation champ. It comes in at number five.

On Wednesday, Daniel Tenreiro looked at why the stimulus talks collapsed and focused on what he described as the “main sticking point”: federal assistance to states and cities:

Pelosi’s bill provides $500 billion in state and local funding and an additional $225 billion to public-school systems — more than double what Republicans are willing to agree to. And as with previous rounds of negotiations, Democrats have attempted to avail themselves of the recession to eliminate the cap on state and local tax deductions included in the 2017 Tax Cuts and Jobs Act. . . .

The cultural and political power of major metropolitan centers stems from their unique combination of economic dynamism and progressive governance. In San Francisco, for instance, byzantine zoning restrictions mean that tech investors can live in hermetically sealed, perfectly manicured neighborhoods and be guaranteed that their homes will appreciate in value. This unstable equilibrium, propped up by expensive city services and high-paying municipal jobs, is made possible by federal largesse. It is the relationship between Congress and blue-state legislatures that creates cities like San Francisco, simultaneous powerhouses and basket cases with sufficient political clout to foist their will on the rest of the country.

The Democratic Party is banking on consolidating its strongholds in cities and the suburbs. Chuck Schumer explained the strategy in 2016: “For every blue-collar Democrat we lose in western Pennsylvania, we will pick up two moderate Republicans in the suburbs.” The unraveling of these metropolitan strongholds — which seems already to have begun — could be an existential threat to the Democratic Party as we know it. If high earners are forced to pay up for the policies they support, they may rethink their political preferences — or else relocate altogether.

As New York governor Andrew Cuomo put it, the “SALT [cap] encourages high-income New Yorkers to move to other states.” That’s why reinstating state and local tax advantages is so high on the list of Democratic priorities. During an earlier round of stimulus negotiations, Chuck Schumer pledged, “If I become majority leader, one of the first things I will do is we will eliminate [the SALT deduction cap] forever. . . . It will be dead, gone and buried.”

Kevin Williamson has never agreed with the president’s focus on the trade deficit, but:

The so-called trade deficit has always been the wrong thing to worry about and the wrong metric of success or failure, but it is the one Trump chose for himself, and, in that respect, he must be counted as a failure. . . .

The trade deficit is not a deficit in any meaningful sense of the word; unlike the federal budget deficit, it does not contribute to a mounting debt that Americans individually or collectively owe to somebody. If a lawyer buys a $5 loaf of bread from your grocer, and the grocer does no business at all with the lawyer, then he has a $5 trade deficit with the grocer — but he doesn’t owe them $5, because the transaction already has been completed. He does not end up $5 in debt, because his income is a heck of a lot more than $5.

Trade deficits are capital inflows. As David Kreutzer puts it in his very forthrightly titled “The Uselessness of Trade Deficits in Calculating Economic Vitality”:

“International trade is always balanced. Trade deficits are imbalances in only a single part of the total balance of international payments. Any trade deficit is offset by surpluses in other parts of the balance of payments. These offsetting surpluses in the financial account provide an economic stimulus at least as important as that from exports of goods and services. A trade deficit means that the home country receives goods and services with a greater total value than the value of the home country’s exports. However, this trade deficit is matched by an identically sized surplus in inflow of foreign investment into the home country. . . . Trade deficits are not a measure of lost income or jobs; trade surpluses are not necessarily good things nor signs that a nation is “winning” a competition.”

Far from being a sign of economic trouble, U.S. trade deficits tend to grow a little bit when the economy is doing especially well, because a booming economy means that Americans have more money to spend, and they spend some of that money on Japanese electronics and German cars. The fact that our trade deficit is growing right now does not tell us very much about the overall economic health of the country, but it is another piece of evidence that the economy is, in fact, doing a little bit better than many economists had expected. The fact that Americans are spending on imports is probably a good sign, and the opposite would be a concerning development.

Of course, Trump doesn’t have the good sense to make that point, and Larry Kudlow, alas, is not the president of the United States. So Trump must be judged on his own terms — building the wall, shrinking the trade deficit — and found wanting.

I returned (yet again) to the subject of world’s worst currency union and discovered that Spain may be overtaking Italy as the euro zone’s weakest link. The economy may shrink by over 12.5 percent this year and the debt/GDP ratio may reach 115 percent by year-end.


[A]s with Italy, Spain’s underlying problem is that it is trapped in a currency union in which, quite obviously, it does not belong. To repeat myself repeating myself (this time from May):

“Splitting the euro into ‘northern’ and ‘southern’ units has long been the least bad way to fix the mess created by the belief that a ‘one size fits all’ currency would work for such a wildly disparate group of economies.”

But, sadly and madly, the necessary support for that idea is simply not there.

The always-astute Cameron Hilditch wrote a thoughtful piece on what Pope Francis gets right, something that I would have thought would have made for a very brief article indeed, but, no, it’s well worth reading in full. Cameron’s conclusion:

If we really want to make headway in limiting the scope of government, we’ll have to find a way of rebuilding voluntarily the dense, local habits and institutions of association that alone concretely check the power of the state. Capitalism, as Tocqueville foresaw and the Chinese Communist Party has proved, offers hardly any effective resistance to the growth of government in and of itself. If the agents of the state are wise enough to resist the temptations of full-tilt socialist oppression and the concomitant national suicide it involves, they can usually utilize the market in order to generate profits to confiscate and spend on state enterprises. Once again, China is scarily instructive in this regard. As the pope himself wrote elsewhere, “an innate tension exists between globalization and localization. We need to pay attention to the global so as to avoid narrowness and banality. Yet we also need to look to the local, which keeps our feet on the ground. Together, the two prevent us from falling into one of two extremes.”

I write all this as an unabashed enthusiast for free markets. The problems that they cause are infinitely preferable to the ones they solve, like starvation, disease, and serfdom. As an anti-utopian, however, I’m convinced that every arrangement or system devised by the mind of man on this mortal coil is bound to throw up its own intractable problems. In the midst of all the many shortcomings of his latest encyclical, Francis has put his finger on a problem endemic to capitalism: one that those who care about limiting government need to be aware of. The ability of free markets to generate phenomenal material wealth and standards of living will not prevent us from throwing it all away in the long run. As Tocqueville himself wrote, “the ten or fifteen years which preceded the French Revolution were, all over Europe, years of great prosperity.” Those who orchestrated the Revolution and the subsequent terror were not the oppressed benighted underclass but “wealthy people, surrounded by literary society in their drawing rooms, passing their time in endless philosophical discussions which affected, excited, and inflamed them until they shed torrents of imaginary tears most of the time.”

The greatest threat to free markets and to freedom more generally comes from bored, disillusioned, middle-class people of middling intellect: ’Twas ever thus. Capitalism makes tremendous promises to people about their physical well-being — and keeps all of them. But once these same people have grown accustomed to physical comforts, they always try to extract metaphysical promises from free markets as well. Finding that these are not promises that dollars and cents can keep, this alienated class then proceeds to vandalize each and every engine of prosperity in the economy, destroying lives and livelihoods unnumbered in the process. So it went in 1789, and so it will go in the future if we delude ourselves into thinking that markets alone can consummate the most fundamental human desires.

This is the inevitable endpoint of capitalism unconstrained. Without the ascendency of authority, tradition, home, hearth, and altar in civil society, this great economic run the human race is on simply cannot last. Francis deserves credit for pointing this out, hapless though he may be when it comes to the finer points of economic theory. If markets are allowed to metastasize to the point where they cease to sell materials and start to sell materialism, we should not be surprised to find image-bearers of God, hungry by nature for transcendence and communion, ready to burn it all to the ground in a desperate attempt to drag Heaven down to Earth with the guillotine’s blade.

We’re a broad church (so to speak) here at Capital Note, happy to publish a wide range of views, and, as it happens, in Tuesday’s Capital Note, I drew attention to a fine piece from Matt Kilcoyne, the deputy director of London’s Adam Smith Institute, in CapX on what I gently referred to as the pope’s “latest unimpressive foray into economics” and I concluded:

Whether the contradictions contained within the Pope’s ideas are as “strange” as Kilcoyne politely suggests is a matter of debate. When it comes to economics and finance, Francis regularly reveals how deeply he has been influenced by the class-based demagoguery, economic illiteracy and conspiracism that characterized the Peronism of his youth. There’s no mystery there.

More importantly, though, Kilcoyne’s article is a reminder that, beyond simple utilitarianism, there are strong moral cases for the free market, of which he gives us one example.

Not entirely unrelatedly, although the trigger was some comments made by Senator Mike Lee rather than the pope, Ramesh Ponnuru had this to say:

A lot of the value of economic and political freedom is instrumental: They help us achieve other goals, and those other goals should inform how we structure and sometimes limit that freedom. Keeping that instrumentality in mind should help us avoid a distorted understanding or overvaluation of the goods of markets and democracy.

But they’re not just instrumental goods. We value the toaster only for the toast. Economic liberty is valuable in itself, and so is the ability to take part in the making of the laws one must obey. Given the choice between two equally prosperous and peaceful societies, one with voting and markets and one without, the first one would be preferable. (And of course we have good reason for believing that markets and democracy are more likely to achieve these happy results.)

Jessica Melugin was not impressed by what the House Judiciary Committee had to say about big tech:

A new House Judiciary Committee report on competition in the technology industry starts from the premise that everything Amazon, Apple, Facebook, and Google do is unscrupulous, and then works its way backward with anecdotes, distortions of long-accepted business practices, and sometimes unattributed numbers. But the biggest threat the report poses is its recommendation to rewrite U.S. antitrust law and abandon the consumer-welfare standard. A change that abandons the primacy of consumer welfare threatens to harm consumers instead.

A traditional case against these tech giants is hard to prove: Innovation is the norm, costs are falling if not already at zero, and Americans have benefited from these firm’s products — especially during the COVID pandemic. It’s hard to imagine being quarantined at home or trying to keep a business afloat without the services of Amazon’s online shopping, Facebook’s facilitation of communicating curbside pick-up options, Google’s maps for home deliveries, and Apple’s devices to enable it all. Consumer welfare abounds.

That’s due in large part to intense competition. Google has Amazon nipping at its advertising revenue heels. Amazon is watching Walmart, the nation’s largest retailer, roll out a same-day home-delivery service. Apple competes with Google’s Android operating system and Google’s app store, Google Play. Facebook competes with Google and Amazon for online advertising dollars and against other social-media platforms, like Twitter, Google’s YouTube, TikTok (for now), Pinterest, and Snapchat for eyeballs.

Lastly, Charles and Jerry Bowyer made the case for some shareholder activism at Netflix, and, not so coincidentally, the need for a little viewpoint diversity in big tech:

Conservatives, and many liberals, have rightly decried the Cuties marketing as appalling exploitation of children, but aside from the actions of a few red-state senators and attorneys general, little has been offered in the way of meaningful action. We could go on and on about how terrible Netflix’s behavior was, and we would be right to, but that would do little to promote actual change at the company. What does promote change is shareholder activism.

As the owners of a publicly traded company, shareholders are in ultimate control and have a say in the matter. Shareholders can propose resolutions, vote on resolutions, and vote on the board of directors. The managements of woke corporations can argue that moral questions are irrelevant to business operations, but that argument holds no water here. By advertising Cuties in the way that it did, Netflix has incurred substantial legal and regulatory risk, to make no mention of the spike in cancellations. The company now has three sitting senators and four attorneys general breathing down its neck, and for good reason. This issue is directly relevant to the company as a whole, which means it is directly relevant to its shareholders.

Shareholders can demand programs promoting viewpoint diversity at Netflix. Shareholders can demand an internal investigation into why something this appalling was allowed to go public. Any and all of those options should be utilized here. What Netflix did was profoundly immoral, and the mere fact that the poster and description passed through the company and no one stopped and pointed this out exposes serious weakness at the company. It’s a weakness that shareholders have the means, and the responsibility, to fix.

Finally, we produced the Capital Note (our “daily” — well, Monday-Thursday, anyway). Apart from Pope Francis’ curious economic views, and state and local assistance, topics covered included central bankers tackling climate change, a look at New York’s near-bankruptcy in 1975, Illinois’s proposed tax hikes, Treasuries losing their status as a hedge, bullish markets, overbearing banks, hidden muni defaults, the last picture show, whisky galore, investors betting on a strong recovery, ESG everywhere, and Big Tech antitrust.

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