Fed Speak

Rich McIver passed on this handy post to explain what the Fed says and what the Fed means. We recently published "When the Fed says X, they really mean Y (A Handy Translation Book) " ( http://www.currencytrading.net/2007/when-the-fed-says-x-they-really-mean-y-a-handy-translation-book/). I figured I'd bring it to your attention in case you think your readers would find it useful.

Thought of The Day

"March 4, 2007—The US Postal Service is planning another rise in the price of a first-class stamp, perhaps from 39 to 41 or 42 cents. At each past price increase they issued a special letter stamp usable at the new price (since they don’t know how much the new price will be until shortly before it goes into effect). This time they are proposing something new: A “forever stamp”—a generic first-class stamp which will always be good and will be sold at the current price of a first-class stamp. So if I buy the forever stamp when the price is 42 cents, say in 2009, I’ll be able to use it in 2019 when first-class postage costs, for example, 63 cents. So why not stock up on first-class stamps now—buy a lifetime supply—and save money later on? If I buy 1000 42-cent forever stamps in 2009, it will save on postage in 2019; but I could put the $420 in a bank 2009 and let it grow for 10 years. The present value of $630 in 2019 is less than $420 in 2009 if the interest rate is above 4 percent. Only if I expect interest rates to be really low for the next 10 years should I stock up on forever stamps." Dr. Hamermesh is a world renown economist who is often quoted in the Wall Street Journal. Please use the link below to see all of his thoughts.

http://www.eco.utexas.edu/faculty/Hamermesh/EconThought.htm

Waiting at Elder-Beerman

Today I bought some clothes at an upscale retailer in Muscatine. The woman ahead of me was paying for her purchases with cash. She was digging through her purse for a penny to get the exact change. I took her 5 minutes to search for a penny. I figured that if she was a minimum wage earner her time must be worth 10 cents a minute. So she spent 50 cents to get the exact change. I suspect she thinks she's a thrifty shopper. It's been my experience that most women always dig for the exact change even though a long line forms behind them. Why do women dig for the exact change when it would be faster to write a check, use a debit card, or receive change back?

I don't have an answer. But I'd like to make a laundry list. (1) Women pay more to have their blouses dry cleaned then men. Is it possible that women are just different? (2) Women make less than men and their time preference heavily discounts the future. (3) Women have a lower marginal cost of time so they consume more of it. (4) The expected value of the benefits are aysmetrical to the actual benefits.

I welcome more suggestions.

Economy in Cartoons

The cartoon by Trever shows that in order to get the economy flying again, it had to cut some of its weight and inadvertantly killed the dollar.

Greg Mankiw's Blog: A Jump in Expected Inflation

Greg Mankiw's Blog: A Jump in Expected Inflation

Capital Flight

When the Fed lowered the Fed Funds Rate recently, economists predicted a depreciation of the dollar. Why? As interest rates in the United States lower, foreign assets like bonds in Germany become more attractive to US investors. The investors will demand Euros and supply USDollars causing the dollar to depreciate as more and more dollars are supplied.

Oliver Blanchard in his Macroeconomics textbook that is used at MIT illustrates the situation. Suppose the interest rate in the US is 10% and the interest rate in the UK is 8% and the dollar is expected to depreciate by 3%. Investors will be better off to buy the UK assets since the Pound will buy more. In other words the return from holding UK bonds is 11% which is 1% greater than holding a US bond. Rational investors will seek the highest returns assuming every thing else is equal.

In a brilliant post by N. Gregory Mankiw, Havard, a reader plotted the expected rate of inflation after the Fed lowered interest rates. The expected rate of inflation, or better said, future expectations of inflation, increased by .05%. This indicates that foreign goods will be cheaper than domestic including foreign assets. Since I'm new at this, the link to Gregory's post is in the post above.

Gas Prices

For the best article ever on why gas prices reflect future expectations go to this link: http://www.stlouisfed.org/publications/re/2007/c/pages/gas-prices.html The graph shows how the spot price conveys information and prices adjust almost instantaneously.

Click to enlarge the graph or go to the St. Louis Fed website.

Dead Weight Loss From Breast Feeding

Click on the link to read one of the the smartest posts I've seen. The link is: http://fatvegan.com/2007/09/18/the-deadweight-loss-from-breastfeeding/#comment-3319

Dollar Slide

As the baseball season reaches its final innings, the dollar is sliding on a rate cut from the Fed. As interest rates in the United States falls, why does the dollar fall too?

The econ 101 answer is that investors compare interest rates between countries and will invest where they will earn the most return for their investment. If US financial assets have a smaller return then foreign then investors will invest in Japanese or European assets. In order to buy a foreign assets, US investors will have to demand a foreign currency and supply dollars. As with anything in which the supply increases, the price of the dollar will depreciate. This makes buying French wine and European vacations more expensive.

Does the model predict? Oliver Blanchard, MIT, explains in his book that opportunities for arbitrage will indeed cause capital to fly to foreign countries. Perhaps some of the depreciation is offset by cheaper exports from the United States, but the effect is a depreciation of the USD.

Paul Krugman, NY Times, commented on a recent blog that the dollar might have met the Wiley E. Coyete moment where it will suddenly drop off the cliff.

I just scanned the Economist for interest rates between countries and found them almost equal except in Japan. This suggests that opportunities for arbitrage will be eliminated by transaction costs and currency changes and the flight of US capital minimal.

Gasoline Inputs Increase

BigCharts.com shows that the price of light sweet crude oil is rising. If the econ 101 model is correct, we should expect to see an increase in the price of gasoline. USA Today predicts that for every $1 increase in oil, the price of gas at the pump will increase by about 2 cents. Overnight prices increases average .5 or a half cent according to USA Today. Econ 101 predicts that suppliers will expect high prices in the future and restrict output today so they can offer their cache at higher prices tomorrow.

Critics of Big Oil say things like it's football season so people will be driving more and the oil companies are pumping up the price of gas to make more money. I disagree with statements like this since prices seem to be reacting to simple fundamentals. If I am incorrect, then when prices paid for retail gas go up, we should see an influx of gas that was saved from expectations and the price to drop. Let's wait and see.

Blog Sense

On a USA Today post earlier today, a blogger gensmahaut wrote, "Saying that poor unskilled Americans don't want to do the work mexicans do is like saying American programmers and engineers don't want to do the work Indians do. It's complete and utter nonsense. People are ready to do any kind of work in America, at a living wage. Americans are extremely hard working people, I've found in my travels around the world. Take a look at the state of Mexico and you'll see they're by no means any harder working than Americans. Pay a decent wage and Americans will work in agriculture, service sector, just like they have in this country for centuries. There has been no magical disappearance of the work ethic of America's underdogs, on the backs of whom this country rose to great wealth." I call the purple highlighted text a brain spark since it made me wonder, is this a case of the economy working at it's comparative advantage?

In other words, Mexicans and Indians can work at a lower opportunity cost than US workers and the wages reflect the differences. If the wage increases for occupations that foreign labor is employed, then the higher wage will attract domestic workers and foreign labor will be displaced. The market will clear at a higher wage rate.

Smoke Signals

She was sitting at her table at Applebee’s laughing with her girlfriends. They were eating chocolate cheesecake for desert. The high school teenager thought about walking over to her and saying something like, “Your legs must be tired because you've been running through my mind all night.” His line intended to be witty and smart to show her how cool he is especially in front of her friends.

When she lights up a Marlboro Menthol 100, he changes his mind. He doesn’t want to date a smoker. What does smoking signal about the smoker? What does the pickup lines say about the teenager? In this op-ed I discuss what some experts think that smoking signals about the smoker.

I know men who go to bars to meet women. These men tell me, “Why else would a single woman go to a bar if they weren’t trying to meet a man?” Going to a bar like Jody’s or the Mississippi Brew signals a man’s intent to meet a woman. The problem of going to a bar to meet a mate is that there’s no separating equilibrium. In other words, it doesn’t sort or separate the winners from the losers. It’s easy for the losers to copy. Thus, you might hear a comment at the bar like, “I need to buy a Harley to impress her.” You might see a bright Corvette parked conspicuously by a bar patron to signal the worth of the mate. This is like the male peacock strutting his colorful feathers to impress the female peacock or the male gorilla beating his chest. Therefore, if one smokes to impress women by smoking Marlboros, it’s easy for the wimps to copy and doesn’t signal a rough and tough mate.

Smoking will attract some mates and discourage others. “You’re not my type,” a potential mate might say” when you light up a cigarette. According to Steven Landsburg, The Armchair Economist, “Smoking signals, among other things, a taste for risky behavior (and hence a greater likelihood of, say, skydiving) and a relatively low value on the happiness of one's loved ones.” The Slate columnist continues, “For me, smokingmight be worth the cancer risk. But if I account for the fact that my cancer hurts not only me but also those who love me, I might choose not to smoke.” It might be hard to love someone in sickness and health when one’s mate is dying from lung cancer that was self-inflicted by smoking 30 years.

Recently, on a National Public Radio talk show, All Things Considered, stated that “in California, gays are 70% more likely to smoke than nonsmokers.” Don’t jump to the conclusion that all smokers are gay. What does smoking and being gay convey? Gays typically are childless and childless people are more likely to smoke. Couples with children often worry about second-hand smoke and also pay higher insurance costs so most choose not to light up. Smoking might signal that to potential mates that you do not intend to have children.

Tyler Cowen, author of Discover Your Inner Economist, told me, “Why do people in New York City smoke so much? Social networkers smoke and in Manhattan it’s more important to signal that you are cool.” So in order to fit it and socialize, people smoke to show that are like the social crowd they want to be part of. In other words, if the boss smokes, you’d stand a better chance of promotion if you smoke.

According to Robert H. Frank, a Cornell University professor and author 10 books including The Winner Take All Society, “Consultants hired by the tobacco industry have testified in Congress that the main reason teenagers smoke is that their friends smoke. So many teenagers smoke because they just want to fit in.”

So when our teenager approaches the girls at Applebees, he has a several motivations not to approach the girl for a date. One, she is telling him that she’s prone to taking health risks. Two, she is easily influenced by her friends. Three, she likely not to want to bear children. Maybe a better line would be, “I was going to ask you out, but I don’t date women who run in packs.”

Iowa Employment Data

The Iowa Employment data as reported by WWW. FreeLunch.Com shows an increase in unemployment since Iowa raised the minimum wage rate in April, 2007. FreeLunch is a division of Moody's so I believe the data is reliable.

Gas Prices and NYMEX

For a link to the latest in the oil market, check up USA Today reporter, Barbara Hagenbaugh's latest article in USA by following this link: http://www.usatoday.com/money/industries/energy/2007-09-11-opec-oil-production_N.htm

My comment posted earlier today was: If big oil is a monopoly, then big oil would have the incentive to make as much money as possible. In the econ world, when a company lowers the price for a good like oil and total revenue increases, the good is considered elastic. But the price is INCREASING and total revenue is going up. This must mean that the good is inelastic. No monopoly would set the price on the inelastic portion of their demand curve since it wouldn't maximize profits. Given that the price of gas has gone down as well as up, the oil market must be competitive and simply reacting to supply and demand fundamentals.

Iowa's Minimum Wage and Employment

I have waited a long time for this post. I begin by stating the premise that raising the minimum wage will result in unemployment especially among blacks and teenagers. Econ 101 predicts that the minimum wage is a price floor that results in an excess supply of workers and employers will change the quantity demanded by decreasing the quantity of workers. Great theory but does it hold water in reality?

Effect April 1, 2007, Iowa raised the minimum wage from $5.15 to $6.20. I have graphed the unemployment rate in percent for Muscatine Country. As you can see the unemployment rate actually fell from January, 2007, to July, 2007. In other words, employers hired more workers just as TCU economist, Ravi Batra predicted. Batra simply states that if wages increase, prices will too. So everything stays in balance. (Click on graph to enlarge.)

One has to be careful not to generalize my conclusion to the whole state and commit the falacy of composition. However, the actual number of unemployed decreased in May to 922 from 962 while the number in the number employed increased from 29,057 to 29,084. Were these workers displaced by college students returning to old jobs?

In Econ 101 speak, the demand for labor is given by how much labor can make for the employer and is given by the formula: MRPlabor = $P times MPP, where MRPlabor is the demand for labor, $P is the price of the product, and MPP is the marginal Physical Product or how much labor makes. Say, businesses raise the price of its good because the minimum wage increases. According to this formula, the demand for labor will increase. According to my data obtained at www.economagic.com/ raising the minimum wage did not result in unemployment.

My Trade Deficit

On Sunday's I like to visit my mom who lives in Davenport, Iowa. I like to leave early so I can go to the Borders super bookstore on my way. I usually spend $20 a pop on my visit to Borders. I have a trade deficit with Borders. In other words, I import more goods and services from Borders than I export. By the way, I'm happy with this arrangement since I believe I get more benefit from the trade than the cost. It's the same way with trading countries.

When A US citizen supplies a dollar, it's a debit to our balance of payments. When a Chinese citizen demands a dollar, it's recorded as a credit to our balance of payments. In accounting language, debits must equal credits. So, when a US citizen demands a product for China, she supplies dollars and demands Yuans. This is recorded as a debit. When a Chinese citizen wants to buy stock in an American company like Microsoft, she demands US dollars. This is recorded as a credit. How do accountants get debits and credits to equal?

Say the US imports more from China than she exports. Her exports are recorded as a debit. America has a trade deficit which economists show in shorthand form as NX (Net Exports or E-I). In order to spend more than the US earns, she must borrow. The US sells IOU's in the form of shares of stock, bonds, and government T-bills that pay dividends and interest. When the US sells IOU's, Chinese citizens must demand dollars. Thus, debits equal credits. The Chinese demand is a capital inflow to the US which means that foreigners are investing their dollars in our capital. Economists use the shorthand, "KI" to show foreign direct investment in the US.

Robert H. Frank demonstrates that NX + KI = 0. If NX is negative (-) and KI is positive (+), then the two negate and the balance of payments is zero. Oliver Blanchard writes in his book that most major economies run a trade deficit with the world. Why would developed economies like the US run a trade deficit? Let's say your daughter wants to borrow money to have her nails painted. You might be reluctant to loan her the money especially if she had no productive way to repay. But suppose your daughter wants to go to college. You might have faith in her ability to repay the loan in the long run. So it is with developed economies who run trade deficits. The ability to repay loans is high probably because of the high productive capacity of these economies.

As long as the US is increasing its productive ability, we will run a trade deficit or we run out of assets to sell.

The Trade Deficit

The United States imports more than she exports. When imports are greater than exports, a trade deficit like the one shown on the graph results. How does the United States routinely run a trade deficit?

The econ 101 answer is that foreign investors buy stock, bonds, and government T-bills in the United States to counter balance the out flow of money going to buy imports. So the money going out equals the money coming in to buy our assets. In other words, were selling America.

The United States has a low rate of national savings (NS = Y - C - G). Since the U. S. has a high rate of spending, this infers a low savings rate and a high flow of capital inflows to finance the spending. In theory, the USD should depreciate and foreign goods will become more expensive and the flow would reverse. It is my opinion, that as long as the United States has a stable government that will honor its contracts and maintains relatively high interest rates, the U. S. will continually run a trade deficit.

Are Obesity and the Law Of Demand Related?

The law of demand states that as the price of a good decreases in price, people will consume more of it. In the cartoon to the right, an obsese child is eating a lot of everything (click to enlarge). The couch slopes downward and to the right. Does this prove the law of demand?