The Capital Letter

The Capital Letter: Week of August 17

A child runs across East Capitol Street, a normally busy street outside of the Capitol building, as the coronavirus outbreak continues in Washington, D.C., April 6, 2020. (Leah Millis/Reuters)

Another week has passed in our strange sort of stasis, with no real movement on another stimulus package. Nevertheless, the economic data are providing ever more insistent reminders why another round is going to be needed, and sooner rather than later.

Initial jobless claims for the week ended August 15 came in at 1.106 million, compared with expectations of some 920,000. New claims for Pandemic Unemployment Assistance, the program available to gig and self-employed workers, also went up, from 488,000 to 543,000.  Adding to the gloom, the number of people on Pandemic Emergency Unemployment Compensation (PEUC) remains over a million and continues to increase. As Dion Rabouin of Axios Markets explains, “the PEUC is a CARES Act program for unemployed Americans who have exhausted the 26 weeks of unemployment benefits they get from their state. It has grown from 27,000 people on April 11 to 1.3 million as of Aug. 1: it’s likely made up of people who lost their jobs before the wave of business closures that hit the U.S. in mid-March.”

Meanwhile the stock market moves forward. Even allowing for the fact that markets typically anticipate a recovery, what we are now seeing is clearly a product of ultra-low interest rates and, well, the pressure of cash.

Bloomberg:

“There’s this massive disconnect between fundamentals and markets,” said Brian Payne, investment officer at the Teachers’ Retirement System of Illinois. “There’s just too much capital chasing investments, the Fed is flooding markets and that leverage isn’t going to the real economy.”

Meanwhile, over on the housing market . . .

CNBC:

The supply of existing homes plummeted 21.1% annually, with just 1.5 million homes for sale at the end of July. This represents a 3.1-month supply at the current sales pace, down from a 4.2-month supply a year earlier. It’s the lowest July supply in the history of the inventory survey, which has been tracking single-family supply data since 1982.

“The new listings are running a little higher than one year ago but all those new listings are being grabbed by the buyers and taken off the market,” said Lawrence Yun, chief economist for the Realtors.

That shortage drove the median price of a home sold in July up 8.5% annually to $304,100. This is a record high nominal price but also the highest price when adjusted for inflation. When adjusted, it is 3.4% higher than the bubble high set in 2006, when mortgage lending was loose and borrowers could buy a home with no down payment and little to no financial documentation.

Some of us are old enough to remember stagflation.

Meanwhile on Capital Matters, Iain Murray, who I think is old enough to remember stagflation, took aim at aluminum tariffs:

Now, why do tariffs cause price increases? Partly because of the additional cost of tariffs and partly because those tariffs reduce supply. So, when the beer industry needs more aluminum and the supply is reduced, there’s going to be a bidding war for aluminum cans. This pits the beer industry in even more direct competition with the soda industry for a resource that is now scarcer than normal.

As we know, beer is more expensive than soda, reflecting the higher value we place on it. The resources will follow the higher-valued use. So, ultimately, there will be fewer aluminum cans available to soda manufacturers. . . .

Every Fresca, Cheerwine, and Mello Yello drinker who asks why their favorite sodas aren’t on the shelves could be one more convert to the free-trade cause.

No, I hadn’t heard of Cheerwine.

California seems set to continue introducing new measures that will do more damage to the once-Golden State. I took a look at a proposal for a Californian wealth tax, a bad enough idea as it is, but made worse by the way that its proponents would apply it to those who left the state, and would continue to do so for years.

Mind, you, California’s legislators are right to be worried about capital flight, as Brad Polumbo highlighted in his broader survey of the higher taxes likely headed California’s way:

“Individuals respond to taxes by changing their behavior,” the Tax Foundation’s Kristina Zvinys  explains. “Hence, when there are tax differences between [areas], some might respond by moving to a lower-tax area. For higher-income individuals, the benefits of moving as a result of higher taxes are greater because they have more income or wealth at stake.”

Put another way, the higher-tax region faces the risk of capital flight. Capital flight occurs when assets move from one region to another in response to economic changes, usually resulting in harsh economic consequences for the departed area, but the loss, of course is greater than that. When people move, it’s not only their assets that go with them, it’s also their income and their earning capacity. This means that revenue from new taxes on the wealthy often falls short of projections;  and sometimes ends up decreasing revenue.

We don’t have to guess that another tax hike on the wealthy would have this effect. There’s ample empirical evidence showing this trend already in action in California.

In 2012, Californians voted to increase the state income tax for top earners by 3 percent. A recent academic paper researching this tax hike’s impact found that it prompted a greater number of higher earners to leave the state, and that “eroded 45.2 percent of state windfall tax revenues within the first year and 60.9 percent within two years.”

And Sean Higgins reported on California’s war on the rideshare companies:

Uber and other ride-sharing companies insist that’s the case. They note that the majority of their drivers drive for them only ten or fewer hours a week. Only about 17 percent are full-time, according to a National Bureau of Economic Research working paper. Most drivers specifically want the flexibility to work when and for as many hours as they want. The companies realize that that is the way they attract the drivers they need. Tellingly, Uber has been working with its main competitor, Lyft, to preserve this business model against California’s challenge.

California legislators say that’s simply a dodge to get around having to pay the full benefits for overtime, health insurance, unemployment, and other legal obligations, since those rules don’t apply to contract work. The state’s lawmakers have attempted to force these companies to provide those benefits by passing the AB5 law, which strictly limits the type and amount of contract work that can be done. The law has proven to be a major headache for freelance workers, limiting the ability of people such as translators, photographers, musicians, and yoga instructors, among others, to earn a living. California has nevertheless stuck to its guns, arguing that the law is important as a way to protect those workers. . . .

Ironically, we already have an existing model for ridesharing favored by California lawmakers: It’s called the “taxicab system.” The principal reason that ridesharing companies such as Uber and Lyft took off in the first place is well-known to anyone who has tried to hail a taxi in the rain, in a difficult neighborhood, and with an expectation of respect and cleanliness. Taxis didn’t respond very well to the needs of consumers.”

Not to pile on, but as problems with its power supplies are becoming all too evident, California’s sneak preview of (a part of) the Green New Deal does not appear to be working out too well.

More on that, doubtless, to come, but in the meantime we turned to another front in the debate over the environment by featuring Benjamin Zycher on the Trump administration’s reform of its predecessors’ methane rules:

Let the hysteria begin. The Trump administration has finalized a reform of the federal rules on emissions of methane, the major component of natural gas, from oil and gas production. The existing rules were implemented by the Obama administration in 2016, justified largely as a means of addressing anthropogenic climate change. That justification is deeply dubious, but any relaxation of such regulations is unacceptable to an environmental Left ideologically opposed to fossil fuels. And so an inexorable avalanche of criticism and litigation from the usual suspects is upon us, all of which will ignore several central truths.

Follow the link to get to those (inconvenient)  truths . . .

Capital Matters doesn’t confine itself to these shores, and this week we went very afield — almost (but not quite) to Antarctica — with Steve Hanke’s proposal for the Falkland Islands:

How should the conflicting claims over sovereignty and property rights be settled? Years ago, after the U.K–Argentina dust-up, Sir Alan Walters — Mrs. Thatcher’s economic guru — and I developed a transparent market solution that bestowed voting rights upon the settlers of the Falkland Islands. This plan was delivered to Mrs. Thatcher by Sir Alan. We advocated a binding referendum in which qualified Falklanders would vote on whether to uphold the status quo (British rule) or to agree to an Argentine take-over. If the required super-majority of Falklanders (say, 80 percent) voted in favor of Argentine rule, the United Kingdom would peacefully transfer administration of the islands to the Argentine government. It’s time for our proposal to be resurrected.

Unlike the 2013 referendum, when Falklanders voted 1,513 to 3 in favor of remaining a U.K. overseas territory, the Walters-Hanke referendum would require compensation from Argentina to the Falklanders — who are English speakers and British by custom, institutions, and loyalties — should they choose to transfer sovereignty over their lands and resources to Argentina. The referendum would be designed so that Argentina would offer a cash incentive if the islanders voted in favor of Argentina’s rule. Prior to the referendum, Argentina would deposit an amount (say, $20,000,000) in escrow in Swiss accounts for every person who can prove their Falkland Islands citizenship.

I returned to more familiar territory with a closer look at the EU’s new rescue plan for those of its member states most severely affected by COVID-19 (at least that’s the theory). Some eurofundamentalists were disappointed that the outcome did not represent a “Hamilton moment,” but I am not so sure. The deal may not have represented one shining moment, but it can certainly be seen as another episode in EuroHamilton: The Serial, and not an insignificant one either.

Whether or not those who signed up for the NGEU were ready to admit to its Hamiltonian characteristics, markets appeared to be impressed. Measures taken by the ECB were already holding down Italy’s borrowing costs, but the yield spread between Italian and German ten-year government bonds narrowed further after Brussels. The euro strengthened against the dollar, although other factors — including political uncertainty in the U.S. and a fresh surge in the coronavirus there — played a part in that. What’s more, if any investors had earlier been seriously worried about a break-up of the euro, they cannot have been paying attention to the lesson of the last decade or so. While it has long been obvious that a one-size-fits-all currency union has been a catastrophe for some of its members, it has also been evident that there is almost no limit to what will be done to keep it alive — if only for fear of the alternative.

That means that when the next crisis comes as, inevitably (thanks to the euro zone’s in-built failings), it will, its leaders will turn either (as Leino suggests) to the NGEU, or to something like it, to rescue the country or countries that have gotten into fresh difficulty, countries that will not be in the frugal zone. Those additional debts will have to be repaid, and Brussels will be given yet more power to tax. Thus, the fiscal union, which will also be a transfer union, whether acknowledged or not, will continue its slow birth. There will be no turning back.

Back home, Jon Hartley checked out new rules which would permit savers to use their 401(k)s to invest in private equity:

While 401(k) plans have always been able to invest in publicly traded private-equity stocks such as KKR, Apollo, and Blackstone, these stocks do not allow for granular, fund-level selection. Now 401(k) firms can invest in mutual funds that pick private-equity funds they think will outperform going forward. . . .

Private-equity funds can improve diversification in a portfolio since they are not perfectly correlated with any other asset class. When this happens, investors can reduce the volatility of their portfolio by allocating some money to each asset class.

Most important, the individuals who will be able to access these types of investment benefits are not the top one percent.

Unavoidably, alas, COVID-19 made its appearance in the Capital Matters week. Allison Schrager and Jessica Hullman called for better communication of the risks associated with the disease:

It’s not realistic to leave it to the government to manage all our risks. Government has a responsibility to regulate or ban the riskiest activities, but it can’t eliminate all COVID-19 risk. America is too large, diverse, and interconnected. We also can’t all stay at home until there’s a vaccine, unless we want to ignore the heavy emotional toll of social isolation and the inevitable destruction of our economy. Instead, we must rely on our fellow citizens to make smart risk decisions. Some will make reckless choices and others will be overly cautious, no matter how much information they are given. But we can at the very least reduce some of COVID-19’s spread if those who want to act responsibly are given the tools to do so. For that to happen, they need better information.

Kevin Hassett (who has kin in the game) argued against college freshmen postponing taking up their places and going on a “gap” year instead:

One of the hottest topics among high-school seniors (and the parents thereof) is whether this is a good time to take a “gap” year and delay freshman year until 2021. The motivation to skip next year is clear. Freshman year is a momentous time for everyone who attends college, and a joyful time of exploration. The idea of having freshman year sucked away from you by “remote learning” and social-distancing guidelines that ban keg parties, sports, and club meetings must be devastating. But economics being the dismal science, it should not surprise that an analysis of the economics of a gap year suggests that rising freshman should bite the bullet and attend.

The first consideration is “opportunity cost,” which enters the equation through two main effects. The opportunity cost of attending includes not doing whatever you might do during a gap year. The opportunity cost of attending freshman classes this year includes not attending them next year. But the gap year, which in the past might have involved travel or public service, will be far less enjoyable than a normal gap year. Instead of remote learning, you will be remote gapping, and probably doing that around your parents. And remote learning in college is going to be far different than it was in high school. In college, many freshman classes are in giant lecture halls that hold hundreds of students. Watching such a lecture on a computer is not much different from attending the class.

Some universities are going to hold smaller classes in large rooms, and big lectures remotely. Students who hate remote learning can load up on small classes, students who want to get the introductory classes out of the way can remote-learn the giant lectures. Either way, the opportunity cost of not taking freshman classes next year seems very small relative to the alternative.

As for social life, it will improve dramatically once COVID-19 is under control, and it will be difficult until then. That is true whether or not you attend college, and imagine the joy that will sweep through campus once everyone has received a vaccine. Would you rather be on campus when that happens, or at home with your parents?

And:

Kids who tough it out and go this year will enter the job market (or the graduate-school admissions game) with an enormous numbers advantage. Jobs and admission will be less competitive than ever.

Kevin also had “five questions for” (the second of what will be a continuing series) Ed Conard. The answers were encouraging without ever being complacent.

An extract:

We shouldn’t take America’s success for granted. Liberalism has greatly diminished the vibrancy of Europe’s economy and slowed the growth of its middle-class incomes relative to America. The cost of liberalism is hidden by ignoring the enormous difference between America and Europe.

Despite claims that inequality is rising, after accounting for government benefits, taxes, and investment, the amount consumed by the rich (the 90th percentile) — the most relevant measure of inequality by far — has barely increased relative to the poor (the 10th percentile) since the 1960s. Most studies of wealth inequality ignore the value of Social Security and Medicare, which substantially increase the consumption of retirees. Including the value of this consumption, in effect, triples the wealth of the bottom 80 percent from 15 percent of the wealth to 45 percent.

Nor has America’s middle class been hollowed out. Although the Pew Research Center claims America’s middle class has declined from 61 percent of the population in the 1970s to 50 percent today, seven percentage points of the eleven-point decline came from families whose income moved upward. And Hispanic immigrants account for three of the four points of the decline. So native-born Americans have enjoyed a seven-point upward shift in income offset by a single point of decline. A recent Brookings study finds the share of working- and middle-class families falling from about 80 percent of families in the late 1960s to 50 percent today, with the entire loss coming from families with rising incomes.

Finally, Daniel Tenreiro and I produced the Capital Note (our “daily” — well, Monday-Thursday anyway). Topics covered included some signs of hope in Japan, lockdowns and lumber, “socially responsible’ investing and China, the adventures of an oil price ETF, a renaissance in “macro” hedge funds, and “Black Wednesday”, the day the pound collapsed. In fact that turned out to be a good thing, but that’s a story for another day.

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