The question was asked if it made sense for Treasury to permit bids and awards at negative interest rates in marketable Treasury bill auctions. DAS Rutherford noted that there were operational issues associated with such a rule change, but that the hurdles were not insurmountable. It was the unanimous view of the committee that Treasury should modify auction regulations to permit negative rate bidding and awards in Treasury bill auctions as soon as feasible. Rutherford noted that any decision on this policy change would likely be made at the May refunding.

Fun times.

It’s an incredible result; stunning, really. I just wish it didn’t make me so depressed.

I salute the innovation and cheer on the profits. That is capitalism at its finest and we need more of it.

It’s that f***king mountain of cash (now up to $100 billion) that concerns me, because it’s symptomatic of what is holding America (and Britain) in the economic doldrums.

The return Apple will be getting on that cash will be miniscule, if it’s positive at all, and conceivably negative.  Standing next to that, their return on assets excluding cash is phenomenal.

Why aren’t they doing something with the cash? Are they not able to expand profits still further by expanding quantities sold, even in new markets? Are there no new internal projects to fund? No competitors to buy out? Why not return it to shareholders via dividends or share buybacks?

Logically, a company holds cash for some combination of three reasons: (a) they use it to manage cash flow; (b) they can imagine buying an outside asset (a competitor or some other company that might complement them) in the near future and they want to be able to move quickly (and there’s no M&A deal that’s agreed upon faster than an all cash deal); or (c) they want to demonstrate a degree of security to offset any market perceived risk with their debt.

Apple long ago surpassed all of these benefits.  The net marginal value of Apple holding an extra dollar of cash is negative because it returns nothing and incurs a lost opportunity cost.  So why aren’t their shareholders screaming at them for wasting the opportunity?

The answer, so far as I can see, is because a significant majority of AAPL’s shareholders are idiots with a short-term focus. They have no goddamn clue where else the money should be and they’re just happy to see such a bright spot in their portfolio.  Alternatively, maybe the shareholders aren’t complete idiots — Apple’s P/E ratio has been falling for a while now – but the fundamental point is that they have a mountain of cash that they’re not using.

In 2005 that wouldn’t have been as much of a problem because the shadow banking system was in full swing, doing the risk/liquidity/maturity transformation thing that the financial industry is meant to do and so getting that money out to the rest of the economy.[*] Now, the transformation channel is broken, or at least greatly impaired, and so nobody makes any use of Apple’s billions. They just sit there, useless as f***, while profitable SMEs can’t raise funds to expand and 15% of all Americans are on food stamps.

Don’t believe me?  Here’s a graph from the Bank of England showing year-over-year changes in lending to small- and medium-sized enterprises in the UK.  I can’t be bothered looking for the equivalent data for the USA, but you can rest assured it looks similar.  The report it’s from can be found here (it was published only a few days ago).  The Economist’s Free Exchange has some commentary on it here (summary:  we’re still in trouble).

So what is happening to all that money?  Well, Apple can’t exactly stick it in a bank account, so they repo it, which is a fancy way of saying that they lend it to a bank (or somebody else in the financial industry) and temporarily take some high quality asset like a US government bond to hold as collateral.  They repo it because that’s all they can do now — there are no AAA-rated, actually safe, CDO tranches being created by the shadow banking system any more, they’re too big to make use the FDIC’s guarantee (that’s an excellent paper, btw … highly recommended) and so repo is all they have left.

But the financial industry is stuck in a disgusting mess like some kid’s hair with chewing gum rubbed through it. They’re all just as scared as the next guy (especially of the Euro problems) and so they’re parking it in their own accounts at the Fed and the BoE.  As a result, “excess” reserves remain at astronomical levels and the real economy makes no use of Apple’s billions.

That’s a tragedy.

[*] Yes, the shadow banking industry screwed up. They got caught up in real estate fever and sent (relatively) too much money towards property and too little towards more sustainable investments. They structured things in too opaque a manner, failed to have public price discovery and operated under distorted incentives. But they operated. Otherwise useless cash was transformed into real investment and real jobs. Unless that comes back, America and the UK will stay in their slow, painful household deleveraging cycle for another frickin’ decade.

2011q2 was the first time since 2004q4 that U.S. Household debt was less than 100% of Disposable Personal Income (click on the image for a less squished version):

2005q1 and 2011q1 were both at 100% exactly, or close enough.

In the period 1999q2 to 2006q3, distressed household debt averaged 4.35% and was never higher than 5.06%. Distressed household debt was at 9.86% in 2011q2, having peaked at 11.98% in 2009q4.  As the Fed’s credit conditions report highlights, that was the 6th straight quarter of improvement.  However, the quarter-to-quarter falls have been quite low:  0.04 percentage points (2009q4 to 2010q1), 0.58 p.p., 0.26 p.p., 0.31 p.p., 0.31 p.p. and 0.62 p.p. (2011q1 to 2011q2).  If we assume a continuing fall of 0.4 percentage points per quarter, it’ll take another 14 quarters – that’s 2014q4 – to return to the pre-crisis average.

Of course, a resumption of growth in consumption is not contingent on that happening (maybe we’ll see a jump in incomes for some reason – I’m looking at you, policy makers), but it’s still pretty depressing.

Crucially, too, everything here only looks at aggregate, or average, numbers and if you think the balance-sheet recession story carries any weight at all, you should be very, very interested in the distributional effects.

I’m disappointed, but not surprised, at the split between cuts to “discretionary” and “mandatory” spending. I choose to hope that at their big, joint summit on the deficit it’ll mostly be entitlement reform, as Americans like to call it, and tax reform.

I’m also disappointed, but again not surprised, that the cuts are not distributed in such a way as to make them stimulative (or at least not contractionary) in the immediate term. On the other hand, as in Britain, there’s a reasonable political economy argument to be made that fiscal retrenchment, conditional on deciding that it needs to happen, must be front-loaded to minimise the PDV of political pain.

I do in principle like the grim-trigger approach to the bipartisan negotiations on phase two of the whole thing, US politics being what they are. I’m dissapointed that increased taxes aren’t in the trigger, but appreciate why they’re not. I’m not at all sure that the gutting of defense spending in the trigger is as asymmetrically bad for the GOP as the Democrats would have liked.

I very much hope that votes in the joint summit to determine phase two cuts are kept sealed (for, say, at least a presidential term).

At present, in order to meet sudden surges in demand, power companies have to bring additional generators online at a moment’s notice, a procedure that is both expensive and inefficient. If there were enough electric vehicles around, though, a fair number would be bound to be plugged in and recharging at any given time. Why not rig this idle fleet so that, when demand for electricity spikes, they stop drawing current from the grid and instead start pumping it back?

Apparently it’s all called vehicle-to-grid (V2G).  That (wikipedia) link has some great extra detail over the Economist piece.  If you want more again, here is the research site of the University of Delaware on it.  If you want more again (again), I’ve included links to the UK study by Ricardo and National Grid referenced in the Economist piece below.

After reading about the idea of V2G, a friend of mine asked a perfectly sensible question:

If having batteries connected up to the grid is a good thing for coping with spikes in demand, then why wouldn’t the power companies have dedicated batteries installed for this purpose?

I presume that power companies don’t install massive battery packs to obviate demand spikes because the cost of doing so exceeds the cost they currently incur to deal with them: having X% of their gross capacity sitting idle for most of the time.

In particular, the energy density of batteries isn’t great, and batteries do have a fairly low limit on the number of charge-discharge cycles they can go through.

Interestingly, another part of the cost associated with battery packs will be in the form of risk and uncertainty [*], which are exemplified by precisely this idea.  If a power company were to purchase and install massive battery packs at the site of the generator only to see a tipping-point-style adoption of electric vehicles that, when plugged in, serve as batteries for hire situated at the site of consumption (i.e. can offer up power without transmission loss), they would have to book a huge loss against the batteries they just installed.

Technological innovation and adoption is disruptive and frequently cumulative, meaning that any market power created by it is likely to be short-lived, which in turn creates a short-run focus for companies that work in that space.  For an infrastructure supplier more used to thinking about projects in terms of decades, that creates a strong status quo bias:  by not acting now, they retain the option to act tomorrow once the new technologies settle down.

Anyway, I’m a huge fan of this idea.  For a start, I’ve long been a huge fan of massively distributed power generation.  Every household having an ability to sell juice back to the grid is just one example of this, but I think it should be something we could aim to scale both up and down.  Imagine a world where anything with a battery could be used to transport and sell power back to the grid.  My pie-in-the-sky dream is that I could partially pay for a coffee at my local cafe by letting them use some of my mobile phone’s juice for 0.00001% of their power needs for the day.

More realistically, the other big benefit of this sort of thing is that because the grid becomes better able to cope with demand spikes without being supplied by the uber generators, the benefit to the power company of maintaining that surplus capacity starts to fall.  As a result, the balance would swing further towards renewable energy being economically (and not just environmentally) appealing.

At a first guess, I suspect that this also means that it is against the interests of existing power station owners for this sort of thing to come about, which ends up as another argument in favour of making sure that power generators and power distributors are separate companies.  The distributor has a strong economic incentive to have a mobile supply that, on average, moves to where the demand is located (or better yet, moves to where the demand is going to be); the monolithic generator does not.

Back in December 2007 (i.e. when the financial crisis had started but not reached it’s Oh-God-We’re-All-Going-To-Die phase), Doctors Willett Kempton and Nathaniel Pearre reckoned a V2G car could produce an income of $4,000 a year for the owner (including an annual fee paid to them by the grid, about which I am highly sceptical).  The Economist quite rightly points out that V2G, like so many things in life, would experience decreasing marginal value, but apparently it wouldn’t fall so far as to make it meaningless:

Of course, as the supply of electric vehicles increases, the value of each to the power company will fall. But even when such vehicles are commonplace, V2G should still be worthwhile from the car-owner’s point of view, according to a study carried out in Britain by Ricardo, an engineering firm, and National Grid, an electricity distributor. The report suggests that owners of electric vehicles in Britain could count on it to be worth as much as £600 ($970) a year in 2020, when an electric fleet 2m strong could provide 6% of the country’s grid-balancing capacity.

If you’re interested in the study by Ricardo and National Grid, the press release is here.  That page also has a link to the actual report, but they want you to give them personal information before you get it.  Thankfully, the magic of Google allows me to offer up a direct link to a PDF of the report.

The ever-sensible Economist also raises the upfront cost of capital installation by the distributor as something to keep in mind:

There is, it must be admitted, the issue of the additional cost of the equipment to manage all this electrical too-ing and fro-ing, not least the installation of charging points that can support current flows in both directions. But if the decision to make such points bi-directional were made now, when little of the infrastructure needed to sustain a fleet of electric vehicles has yet been built, the additional cost would not be great.

I can’t remember a damn thing from the “Electrical Engineering” part of my undergraduate degree [**], but despite the report from National Grid, I’m fairly sure that there would still be significant technical challenges (by which I mean real engineering problems) to overcome before rolling out a power grid with multitudes of mobile micro-suppliers, not to mention the logistical difficulties of tying your house, your car and your mobile phone battery to the same account and keeping track of how much they each give or take from any location, anywhere.

If I were a government wanting to directly subsidise targeted research to combat climate change I’d be calling in the deans of Electrical Engineering departments and heads of power distribution companies for a coffee and a chat.  I’d casually mention some numbers that would make make them salivate a little and then I’d talk about open access and the extent to which patents are ideal in stimulating innovation. [***]

[*] By which I mean known unknowns and unknown unknowns respectively.

[**] Heck, I can’t remember a damn thing from the “Electronic Engineering” or the “Computing Engineering” parts, either.

[***] But that’s a topic for another post.

Here’s the almost-anonymous W.W., writing at The Economist:

This left her in the odd and almost certainly untenable position of advocating a minimal state financed voluntarily. In her essay “Government Financing in a Free Society“, Rand wrote:

“In a fully free society, taxation—or, to be exact, payment for governmental services—would be voluntary. Since the proper services of a government—the police, the armed forces, the law courts—are demonstrably needed by individual citizens and affect their interests directly, the citizens would (and should) be willing to pay for such services, as they pay for insurance.”

This is faintly ridiculous. From one side, the libertarian anarchist will agree that people are willing to pay for these services, but that a government monopoly in their provision will lead only to inefficiency and abuse. From the other side, the liberal statist will defend the government provision of the public goods Rand mentions, but will quite rightly argue that Rand seems not to grasp perhaps the main reason government coercion is needed, especially if one believes, as Rand does, that individuals ought to act in their rational self-interest.

The idea of private goods vs. public goods, I think, is something that Rand would have recognised, if not in the formally defined sense we use today, but I do not think that Rand really knew much about externalities and the ability of carefully-targeted government taxation to improve the allocative efficiency of otherwise free markets.  I think it’s fair to say that she would probably have outright denied the possibility of anything like multiple equilibria and the subsequent possibility of poverty traps.  Furthermore, while she clearly knew about and despised free riders (the moochers  in “Atlas Shrugged“), the idea of their being a problem in her view of voluntarily-financed government apparently never occurred to her.

However, this does give me an excuse to plump for two small ideas of mine:

First, I consider the charitable (i.e. not-for-profit) sector as falling under the same umbrella as the government when I consider how the economy of a country is conceptually divided.  In their expenditure of money, they are essentially the same:  the provision of “public good” services to the country at large, typically under a rubric of helping the most disadvantaged people in society.  It is largely only in they way they raise revenue that they differ.  Rand would simply have preferred that a (far, far) greater fraction of public services be provided through charities.  I suspect, to a fair degree, that the Big Society [official site] push by the Tories in the UK is about a shift in this direction and that, as a corollary, that Mr. Cameron would agree with my characterisation.

Philanthropy UK gives the following figures for the size of the charitable sectors in the UK, USA, Germany and The Netherlands in 2006:

Source: CAF Charity Trends, Giving USA, Then & Spengler (2005 data), Geven in Nederland (2005 data)

Combining this with the total tax revenue as a share of GDP for that same year (2006), we get:

Source: OECD for the tax data, Philanthropy UK for the giving data

Which achieves nothing other than to go some small way towards showing that there’s not quite as much variation in “public” spending across countries as we might think.  I’d be interested to see a breakdown of what services are offered by charities across countries (and what share of expenditure they represent).

Second, I occasionally toy with the idea of people being able to allocate some (not all!) of their tax to specific government spending areas.  Think of it being an optional extra page of questions on your tax return.  Sure, money being the fungible thing that it is, the government would be able to shift the remaining funds around and keep spending in the proportions that they wanted to, but it would introduce a great deal more democratic transparency into the process.  I wonder what Ms. Rand (or other modern day libertarians) would make of the idea …

Anyway … let me finish by quoting Will Wilkinson again, in his quoting of Lincoln:

As Abraham Lincoln said so well,

“The legitimate object of government, is to do for a community of people, whatever they need to have done, but can not do, at all, or can not, so well do, for themselves—in their separate, and individual capacities.”

Citizens reasonably resent a government that milks them to feed programmes that fail Lincoln’s test. The inevitable problem in a democracy is that we disagree about which programmes those are. Some economists are fond of saying that “economics is not a morality play”, but like it or not, our attitudes toward taxation are inevitably laden with moral assumptions. It doesn’t help to ignore or casually dismiss them. It seems to me the quality and utility of our public discourse might improve were we to do a better job of making these assumptions explicit.

That last point — of making the moral assumptions of fiscal proposals explicit — would be great, but it is probably (and sadly) a pipe dream.

As Steve Benen points out, it definitely isn’t (or isn’t just) a function of Democratic legislators’ lack of determination. It’s partly a function of the fact that, as recentNBC/Wall Street Journal, Pew, and Gallup polls show, Democratic voters want their leaders to compromise, while Republican voters don’t. Jonathan Chait argues that what we have here is a structural issue that forces Democratic politicians to be wimpy:

Most people have the default assumption that the two parties are essentially mirror images of each other. But there are a lot of asymmetries between the Democratic and Republican parties that result in non-parallel behavior. The Republicans have a fairly unified economic base consisting of business and high-income individuals, whereas Democrats balance between business, labor, and environmental groups. The Republican Party reflects the ideology of movement conservatism, while the Democratic Party is a balance between progressives and moderates.

The upshot is that the Democratic Party is far more dependent upon the votes of moderates, who think of themselves in non-ideological terms and want their leaders to compromise and act pragmatically. The reason you see greater levels of partisan discipline and simple will to power in the GOP is that it has a coherent voting base willing to supportaggressive, partisan behavior and Democrats don’t. This isn’t to say Democrats are always wimps, but wimpiness is much more of a default setting for Democrats.

The article then goes on to discuss the psychological origins of ideological allegiance.  The upshot is that certain people have certain preferences and the political parties are representations of those groups of people.  There’s an implied assumption that all of this is exogenous to the system at large; that there’s nothing you can do about it, you just need to take it as given in your deliberations.

For anybody interested in this stuff, I strongly encourage you read Steve Waldman’s opposing view:  ”Endogenize Ideology“. Here is his basic point, from quotes arranged in a different order to that in which he provides them:

Many [people] treat ideology or “political constraints” as given, and perform the exercise that economists perform reflexively, starting with their first grad school exam: constrained optimization. Constrained optimization is a mechanical procedure. The outcome is fully determined by the objective function and the constraints.

However …

That’s the wrong approach, I think. Rather than treating ideology as fixed and given, we should treat it as dynamic, as a consequence rather than a constraint of policy choices.

Ultimately, he argues, in a world of hard-nosed ideologues versus constraint-respecting policy wonks …

Rather than two optimizers, one of which has strictly less information than the other, in the real world we’ve seen two satisficers, one of which has adopted the strategy of optimizing subject to fixed constraints and the other of which has neglected pursuit of optimal present policy in favor of action intended to reshape the constraint set. A priori, we would not be able state with certainty which of the satisficers would outperform the other. If the constraint set were, in fact, strongly resistant to change Team Obama’s strategy would dominate. But if the constraint set is malleable (and constraints frequently bind), then Team Bush outperforms.

Just to really kick it home, he pulls out this quote from Karl Rove:

[Probably Karl Rove, talking to Ron Suskind] said that guys like me were ”in what we call the reality-based community,” which he defined as people who ”believe that solutions emerge from your judicious study of discernible reality.” I nodded and murmured something about enlightenment principles and empiricism. He cut me off. ”That’s not the way the world really works anymore,” he continued. ”We’re an empire now, and when we act, we create our own reality. And while you’re studying that reality — judiciously, as you will — we’ll act again, creating other new realities, which you can study too, and that’s how things will sort out. We’re history’s actors . . . and you, all of you, will be left to just study what we do.”

Put me down as somebody who does not believe that the seasonal factor in the unemployment rate is twice as big today as it was four short years ago, or was half as big four short years ago as it was in the early 1990s…

Not that I am complaining about the BLS, you understand. If I could do better, they would already have done better. Nevertheless this is a source of nervousness…

My first thoughts:

At a first glance, the size of the seasonal adjustment factor looks like it is countercyclical to the business cycle, which immediately raises the question: Why would seasonality-based volatility in unemployment increase during a recession?

Could it just be that seasonal employment is less susceptible to business cycle movements than regular employment, so that during a recession the (relatively constant) seasonal movements look larger relative to the smaller total employment number?

• Liquidity is not uniform over the duration-instantaneous-default-risk space.   Liquidity is not even monotonic over the duration-instantaneous-default-risk space.

• There is still a trade-off for the Fed in wanting lower interest rates for long-duration, medium-to-high-risk borrowers to spur the economy and wanting a steep yield surface to help banks with weak balance sheets improve their standing.

• I would have preferred that the interest paid on excess reserves (IOR) be lowered.

• By keeping IOR above the overnight rate, the Fed is sterilising their own QE (the newly-injected cash will stay parked in reserve accounts) and the sole remaining effect, as pointed out by Brad DeLong, is through a “correction” for any premiums demanded for duration risk.

• Nevertheless, packaging the new QE as a collection of monthly purchases grants the Fed future policy flexibility, as they can always declare that it will be cut off after only X months or will be extended to Y months.

• It seems fairly clear to me that the announcement was by-and-large expected and so “priced in” (e.g. James Hamilton), but there was still something of a surprise (it was somewhat greater easing than was expected) (e.g. Scott Sumner).

• Menzie Chinn thinks there is a bit of a puzzle in that while bond markets had almost entirely priced it in, fx-rate markets (particularly USD-EUR) seemed to move a lot.  I’m not entirely sure that I buy his argument, as I’m not entirely sure why we should expect the size of the response to a monetary surprise to be the same in each market.

We live in a strange world – the 10 year US Treasury is trading with a 2.63 percent yield.  The market is presuming that there will not be much inflation in those ten years.  However if there is deflation (as per Japan) then the 10 year will wind up being a very good investment (see my blog post on Japanese bond yields from the perspective of a Japanese household).

At the same time gold is appreciating very sharply – from $950 per oz to $1250 in the past year – and from $800 two years ago or $450 five years ago.  On the face of it the gold price is predicting inflation.

Try as I may – I can’t see any reason why both those prices are correct.  I have long held the view that prices are mostly sort-of-rational … [s]o either there is a theoretical way in which both these prices can be correct or even my weak version of the efficient market hypothesis is spectacularly wrong.

and then asks

My first question thus is can anyone tell me why these prices could possibly be consistent?  Is there a rational reason why the bond market is pricing low inflation and the gold market seemingly pricing high inflation?  Does anybody have the ingenious world view in which both these prices are correct?

Since Blogger rejected my comment over at John’s site as being too long, I may as well reproduce it here. I don’t know about “correct” and I’m no finance guy, so my first point is that  I have no freakin’ clue.  Nevertheless, here are five, somewhat contradictory ideas, three of which might fit in a weak EMH world …

Idea #1) Yes, yes, your whole post was predicated on some weak version of the EMH. However … Treasuries, despite what the arch-conservatives are saying, are unlikely to be in a bubble (see idea #4 below).  It might (and only might!) even be impossible for them to be in a bubble.  On the other hand, gold can experience a bubble (to the extent that you concede that bubbles can exist at all).  Just because it can doesn’t mean that it currently is in one, but if it is and treasuries are not, that would partially resolve your dilemma.

Idea #2) Gold, as a commodity, is a affected by global phenomena, whereas US treasuries, while obviously still influenced by global pressures, are more sensitive to the US economy than is gold.  This statement will become more true over time as the US economy shrinks as a share of global GDP.  Therefore, perhaps you should deduce that markets are predicting low inflation or deflation for America, but quite high inflation for the world as a whole.

Idea #3) Gold, as a commodity, partially co-moves with other commodities, many of which are seeing price increases because of real, observable events in their markets (Chinese construction, Russian drought, etc).  Perhaps it is being dragged up by those (this augments idea #2).

Idea #4) In the broad market for USD-denominated investment-grade bonds, there has, I believe, been a net contraction in supply despite the surge in US government borrowing.  This is the private-sector balance-sheet correction.  One might argue, from something of a monetarist point of view, that (disin|de)flation is occurring in the US precisely because the US government is not expanding its borrowing fast enough to replace the private-sector contraction.  I mentioned this briefly the other day.

Idea #5) Another non-EMH idea, I’m afraid:  Both the USD and gold enjoy safe-haven status.  An increase in generalised fear (Knightian uncertainty, unknown unknowns, etc) will shift out the demand for both at all price levels.  To the extent that such a dynamic exists, I suspect that it ebbs away only slowly and, while elevated, is susceptible to rapid increases in response to events that would, in normal times, not affect people so much.

Update 11 Oct 2010:

John Hamilton on essentially the same topic.