The War on Drugs – An Economist’s perspective

The are few policies as damaging as the global War on Drugs.

Most economists – including myself – thinks that the War on Drugs is doing a lot of damage and very little good.

In fact it seems like the only people benefiting from this war are the criminals selling  and producing the drugs. It is time to end this war. It is extremely costly in terms of loses of human life, it has caused a massive increase in crime around the world and even to the social and economic collapse of certain nations.

The War on Drugs even helps fund terrorists around the world and the cost of enforcing draconian drug laws put a serious burden on tax payers around the world.

On February 7 I gave a speech on this topic at a conference in the Danish Parliament organized by the Danish NGO “Gadejuristen” (The Street Lawyers).

You can watch the presentation here. The presentation is in Danish, but given the opportunity I will be happy to do the same presentation anywhere in the world. Just contact my agent (roz@specialistspeakers.com) or write me directly (lc@mamoadvisory.com) then I am sure we can arrange something.

 

 

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Bernie Sanders, Denmark and me

Bernie Sanders has often praised Denmark and now CNN has visited Denmark to have a look at the country.

CNN’s Chris Moody interviewed me about my views of Denmark as Sanders’ dream society. See here.

Obviously there is a lot say about this topic and recently I wrote up some of my views on this on a Facebook update:

Bernie Sanders won in New Hampshire. Bernie loves Denmark – so do I for very natural reasons.

But when US citizens vote for Bernie they should know that Denmark is NOT an economic miracle. Rather the Danish economy has significantly UNDERPERFORMED the US economy since the early 1970s.

The graph below shows GDP/capita in Denmark as a share of GDP.

In the 1950 and 1960 Denmark was catching up to US living standards.

In this period it should be noted that the Danish economy more looked like what Ron Paul would like to see than what Bernie Sanders would like to see. Health care was to a large extent privatized, there were no government mandated minimum wages and the welfare system was quite limited and not very generous.

In fact until the mid-1960s the public sector in Denmark was SMALLER than the public sector in the US as share of GDP.

It was really not before the second half of the 1960s and the early 1970s that the public sector started to grow strongly in Denmark and the welfare system became very generous.

This coincided with Denmark starting to loose ground relative to the US.

So yes, there are great things to say about Denmark and the US could learn a lot from our continued commitment to free trade, to fairly unregulated product and labour markets and a lower corporate tax than the US, but that is just not what Bernie Sanders wants. He wants higher taxes and a larger public sector. Exactly the things that caused Denmark to “de-converge” from the US over the past 35-40 years.

 US Denmark GDP per capita

 

I am presently putting together a presentation on this topic – with the title “Bernie and Denmark – the view of a skeptical Danish economist”. If you want to book me for a presentation on this or related topics please contact my agent Roz Hanna (roz@specialistspeakers.com) or contact me directly (lacsen@gmail.com)

 

The real problem is a nominal problem – also in 2016

In 2009 Scott Sumner wrote an article – The Real Problem was Nominal – in which he explained – was later became known as the Market Monetarist explanation for the causes of Great Recession.

The Market Monetarist explanation for the Great Recession is that the Federal Reserve (and other central banks around the world) allowed monetary conditions to become far too tight in 2008 and that the crisis was not caused by a banking crisis, but rather that the banking crisis was a consequence of the extreme tightening of monetary conditions during particularly the summer of 2008.

Hence, the Fed and other central banks gravely misdiagnosed the problem and as a consequence applied the wrong medicine for the problem. Furthermore, by focusing on nominal interest rates central bankers were led to believe that monetary conditions were very easy, while they in fact monetary policy became extremely tight during the second half of 2008.

This explanation for the crisis is not yet commonly accepted but more and more economists now acknowledge that particularly the Federal Reserve failed greatly in 2008 as it failed to response appropriately to the spike in dollar demand.

Unfortunately, I fear that the Federal Reserve today are in the midst of repeating the mistakes of 2008. Hence, the Fed continues to argue that monetary conditions are very accommodative, while in fact monetary policy has become increasingly tight over the past two years and particularly in recent months we have seen a significantly tightening of US (and global) monetary conditions.

To illustrate this lets, look at six indicators Scott highlighted in his 2009 article to show that US monetary conditions became insanely tightening in 2008:

  1. Real interest rates soared much higher.
  2. Inflation expectations fell sharply, and by October were negative.
  3. Stock markets crashed.
  4. Commodity prices fell precipitously
  5. Beginning in August, industrial production plunged.
  6. The dollar soared in value against the euro.

This is the core Market Monetarist story. We believe that markets are the best indicators of the “tightness” of monetary conditions. If for example market-inflation expectations drop, the dollar strengthens and commodity prices fall at the same time then it is a very strong indication that money demand growth exceeds money supply growth and hence that US monetary conditions are getting tighter.

This also means that monetary policy works with long and variable leads (rather than lags) – the policy changes starts to impact the economy once the they are announced rather when they are “implemented”.

So lets look at what these indicators have been telling us recently.

First lets look at real interest rates – here we look at real 5-year US bonds (nominal bond yields minus 5-year TIPS breakeven inflation expectations).

 

Real 5 year bond yield

Looking at real bond yields we get an clear indication that monetary conditions have been tightening since May 2013 when then Fed Chairman Ben Bernanke announce the Fed would “taper” it monthly asset purchases and gradually scale back quantitative easing.

Hence, it is also clear that the Fed didn’t initiate the rate hiking cycle in December 2015 as we are normally told, but rather in May 2013 if we focus on real rather than nominal interest rates as every textbook would tell would be the thing to do.

I am not arguing here that it was a wrong decision to start tapering in 2013, but rather that we need to get the facts right – the Fed has been tightening monetary conditions for more than two year – at least if we focus on real interest rates.

The same picture clearly emerges if we just look at the bond market’s inflation expectations. This is 5-year breakeven inflation expectations:

5y BE inflation expectations

As the graph shows Ben Bernanke’s Fed had essentially managed to anchor inflation expectations around 2% before tapering was initiated. However, that has dramatically changed since then and inflation expectations has consistently been drifting downwards for more than two year with out the Fed taking any corrective actions to halt the decline in inflation expectations – effectively telling the markets (and everybody else) that the Fed really isn’t that concerned about hitting its 2% inflation target.

That message has further been strengthened after Janet Yellen took over as Fed chair in February 2014. Yellen has again and again told the markets that she really don’t trust market expectations and that inflation would soon rise. She, however, has been badly wrong and 5-year breakeven inflation expectations have now dropped to 1%.

This is the story seen from the stock market:

SP500

If we look at the stock market the story is slightly different than when we look real bond yields and inflation expectations. Hence, S&P500 continued to inch gradually up essentially until a year ago when stock prices started to flatline and after Yellen in October pre-announced the December rate hike stocks have essentially fallen of a cliff.

A way to interpret the stock market action is that even though monetary conditions were becoming tighter after May 2013 monetary continues weren’t getting excessively tight before sometime during 2015.

This was essentially also the story that I was telling in 2014 and early 2015 – most indications were that nominal GDP was growing along the post-2009 4% path, which I at that time considered to be Fed’s de facto monetary policy target. See for example this post from March 2015 where I agued that monetary policy more or less was on track.

At that time there was no real signs that the post-2009 recovery in the stock market was about to come to an end. However, that changed shortly thereafter and I personally became quite worried about what I considered to be an overly hawkish Fed in August last year. A concern I voiced in a number of blog posts in August. See for example here and here.

I was particularly concerned that Yellen apparently ignored both what the markets and nominal indicators (M, V, P, NGDP) were telling us about monetary conditions.

Hence, in August it was becoming clear that nominal GDP was falling below its post-2009 4% path and that inflation and inflation expectations consistently were undershooting the Fed’s 2% inflation target and despite of that Yellen continued to argue that we would get a rate hike in September.

The Fed then postponed that rate hike after the first round of market jitters and the stock market sell-off in the late Summer of 2015, however, it was clear that the Fed desperately wanted to “normalize” interest rates (whatever that is!) and the Fed then in October pre-announce the December hike. Ever since then financial market distress has increased.

Returning to the market indicators – we also got a clear message from the commodity markets. This is the oil price:

oil price brent

Here the story is the same as from the stock market – it might be that the Fed initiated tightening in May 2013, but did it was not before the Summer of 2014  that oil prices started to drop.

There are many theories (and conspiracy theories) about why the oil price have dropped and it often argued that the drop in oil prices is driven by the supply side – more oil being put on the market by the Saudis.

However, if that was indeed the case one should have expected global stock markets to have rallied and we should have seen a pick up in growth. That, however, has certainly no been the case, which makes me think that the drop in oil prices mostly is about global monetary conditions becoming increasing and excessively tight. This is the combined effect of both the Fed and the PBoC tightening monetary conditions at the same time.

So that is yet another market indicator that strongly suggests that US monetary conditions have become increasingly tight – too tight – for some time.

The final market indicator to look at is the dollar.

dollar rally

Once again the story is the same – there is some effect of the ending of quantitative easing and the dollar trended moderately stronger indicating a gradual, but not dramatic, tightening of monetary conditions.

However, shortly after Janet Yellen became Fed chair in February 2014 the dollar started to appreciate strongly and that has been going on for two years more or less uninterrupted.

All market indicators are tell us that monetary policy has become excessively tight

Hence, looking at real bond yields, inflation expectations, the stock market, commodity prices and the dollar the message is uniform – monetary conditions have gradually become tighter over the past 2-3 years.

Initially the tightening of monetary conditions were likely not excessive, but the signs are now very clear that since August-October 2015 the Federal Reserve got way away ahead of the curve and it is now very clear that the markets are telling us that monetary conditions in the US are become far too tight and it is only a matter of time before this will be very visible in the macroeconomic data.

In fact it is already visible. Just take a look at the final indicator that Scott highlighted in his 2009-article – industrial production.

Industrial Production US

Again the picture is very clear – the post-2009 recovery in the US manufacturing sector was doing fine until mid-2014 whereafter we have seen a clear downward trend in industrial production.

It is hard not to conclude that this is a direct consequence of the tightening of US monetary conditions over the last couple of years.

The question is of course whether this will turn into an economy-wide recession or not, but if we compare the recent developments with the situation in 2007-9 then we certainly should be worried.

Misdiagnosing the crisis once again

In this 2009-article Scott Sumner argued that a key contributing factor the mistakes of the Fed in 2009 was the that Fed simply misdiagnosed the crisis. Hence, while Scott clearly showed that the crisis was caused by an excessive tightening of monetary conditions, which in turn led to a banking crisis the Fed on the other was convinced that the banking crisis was the cause rather than the consequence of the crisis.

Furthermore, all through 2008 the Fed continued to argued that monetary conditions were highly accommodative, while in fact if you where tracking market indicators then it was clear that monetary policy had become insanely tight.

I fear that the Fed today is making the same mistake once again. The Fed is convinced that monetary policy is very easing (nominal interest rates are very low), but the fact is that market indicators – as I have shown above – clearly are telling us that US monetary policy not only has become gradually tighter since the announcement of tapering in May 2013, but also that monetary policy has become excessive tight since the Autumn of 2015 and that Janet Yellen and her colleagues in the FOMC has been overly focused on labour market conditions and have completely ignored market and money indicators and as a consequence the US manufacturing sector is already in recession and it increasingly seems like that we soon will see an outright recession in the US economy and if the Fed continues to ignore that message from the markets then we might risk this turning into a banking crisis once again.

And without commenting too much on the state of Deutsche Bank it is obvious that commentators and central bankers alike once again are becoming overly focused on the banking sector rather than on focusing on monetary conditions and most alarmingly all the major central banks of the world presently seem to be ruling out stepping up quantitative easing and instead continue to focus on short-term nominal interest rates.

Or as Scott wrote in his brilliant 2009-article:

Central bankers misdiagnosed the problem, they were not able to come up with an effective policy response. It was as if a doctor prescribed medicine for a common cold to someone whose illness had progressed to pneumonia. And because economists were confused by the nature of the problem, it appeared as if modern macro offered no solutions. Thus policymakers turned in desperation to old-fashioned Keynesian fiscal stimulus, an idea that had been almost totally discredited by the 1980s.

I so hope that the Fed has learned a lesson from 2008, but I fear the worst.

PS if you wonder what I think the Fed should do then you should read this recent blog post of mine.

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

Talking to Ambrose about the overvalued dollar

The Telegraph’s  has an excellent article on the sharp sell-off in the dollar this week. Ambrose quotes me in the article:

Lars Christensen, from Markets and Money Advisory, said the Fed made a grave policy error last year – long before its first rate rise in December – by talking tough and pushing up the dollar.

“They have been looking at notoriously lagging indicators like jobs and downplaying the forward market indicators, like equities and the yield curve. This is a repeat of what they did in 2008. The US is very likely heading into a recession, and the data may start to show this soon,” he said.

It is unusual for the Fed to tighten at a time when the manufacturing index is below the boom-bust line of 50 and nominal GDP growth is trending down, falling to 2.9pc from 4.8pc in late 2014.

Mr Christensen said the Fed’s policy had unwisely compounded the crisis for the whole “dollar bloc”, including China, Hong Kong, the Gulf region and a string of states with dollar ties.

I might be overstating the risk for a US recession and it might be slightly premature to call the recession, but if I would take a bet on this I would certainly be positioning myself for a US recession in 2016.

In terms of the US dollar I am actually a bit split. I think it is quite clear that the dollar is overvalued in real terms against most currencies in the world. However, that does not mean that the dollar should weaken right now.

That to a very large extent dependents on when the Federal Reserve will realize that it has made a policy mistake. My bet on that is that the Yellen’s Fed will remain stubborn for a bit longer and as a consequence keep monetary conditions too tight and postpone monetary easing for some time.

However, the fact that the Fed now certainly has tightened monetary conditions too much and as a consequence might send the US economy into recession in the coming quarters soon or later will cause the Fed to dramatically change course (or at least I hope so!)

Therefore, I think it is a good bet to say that the dollar will be significantly weaken in 12 months than today.

PS I have no clue how the US labour market numbers will come out today and fundamentally I think the labour market data is a pretty worthless indicator of what is going on in the US economy, but since Janet Yellen is obsessing about the US labour market then I guess that I will have to have a look at the data later today…

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

 

‘Googlenomics’ predicts sharp rise in US unemployment

It is no secret that I am quite fascinated by the the idea that social media data might be very useful as early/leading indicators of macroeconomic variables. Said in another way I think that social media activity can be seen as a form of prediction markets.

So recently I have been tracking what Google Trends is saying about the development in searches for different terms that might give an indication about whether we are heading for a recession in the US economy.

Lets start with the world ‘recession’.

Recession Google Trend

The picture is not dramatic and the Google searches for ‘Recession’ clearly is much lower than at the onset of the Great Recession in 2007-8. That said, there has recently been a relatively clear pick up in the ‘recession indicator’ that could indicate that ‘Google searchers’ are increasingly beginning to worry about the US economy entering a recession.

How about the labour market? This is Google searches for ‘Unemployment’.

Unemployment Google trends

This is much more alarming – there has been a very steep rise in Google searches for ‘Unemployment’. In fact the rise is more steep than it was in 2008. This certainly is an indication of a very sharp deterioration of US labour market conditions right now.

The question then is whether Google searches have any prediction power and here the evidence is quite clear that, that is indeed the case. At least that is the conclusion in a recent paper – The Predictive Power of Google Searches in Forecasting Unemployment – by Francesco D’Amuri and Juri Marcucci.

The evidence is in – the Fed should re-start QE rather than hike rates

Janet Yellen’s Federal Reserve have been extremely eager to say that inflation would soon rise due to the continued decline in unemployment and has essentially ignored all monetary and market indicators, which for a long time have indicated that monetary conditions should not be tightened as fast as the Fed has signaled.

That in my view is the main reason why US economic activity now is slowing significantly in and paradoxically that will now very likely push up unemployment. In fact if we trust the signals from Google searches then we are in for a significant deterioration in labour market conditions in the US very soon.

So while the Yellen-Fed seems to ignore monetary indicators at least the fact that unemployment might soon shoot up again should tell the Fed that it is time to dramatically change course.

In fact it now seems more likely that we will have a new round of Quantitative Easing in the next couple of quarters rather than more rate hikes. Or at least that is what the Fed should do to avoid another recession.

PS have a look at a couple of other Google searches as well: ‘jobs’, ‘loan+default’, ‘economic crisis’, ‘bear market’

PPS I seriously thought that Janet Yellen was well-aware of the dangers of repeating the mistakes of 1937. Apparently I was wrong.

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

Ted Cruz – Market Monetarist?

Some have recently suggested that Ted Cruz has been inspired by Market Monetarist thinking. I have no clue about that, but at least it seems like Cruz understands now that the Great Recession – as the Great Depression – was caused by too tight monetary policy.

Listening to this recent question to Janet Yellen from Senator Cruz could make you think that has moved away from his former goldbug thinking. That would certainly be good news.

Watch Ted Cruz question Yellen here.

PS No I am not endorsing any US presidential candidate.

Update: A friend sent me this one.

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