Embargoed until 5 PM CST, December 23, 2015
The 2015 Festivus Airing of Grievances
Well, it’s that time of the year again for the airing of grievances. And, although I don’t have a lot of problems with you people this year, rest assured, I have a few. The first one has to do with the continued misconception that the purpose and measure of effectiveness of central bank quantitative easing (QE) is related to a decline in bond yields. If falling bond yields are an indicator of an easing monetary policy, then how would one explain the contractions in industrial production almost month after month from October 1929 through June 1931 in the face of declining bond yields (see Chart 1)?
Let’s fast forward to recent years when the Fed was engaged in three separate rounds of QE. As shown in Chart 2, generally, as the Fed stepped up its purchases of securities in the open market, bond yields tended to move higher. Conversely, as the Fed backed off its securities purchases, bond yields tended to move lower. So according to conventional wisdom (?), the Fed’s QE was a failure because the level of bond yields was positively correlated with the amounts of securities purchased rather than negatively correlated, as the cognoscenti hypothesized.
Okay, when the Fed stepped up its securities purchases, the level of bond yields tended to rise. Does this imply that QE was a failed policy with regard to its ultimate purpose – to stimulate the growth in domestic aggregate demand? On the contrary, QE was successful in stimulating nominal aggregate demand (and real aggregate demand, too). QE provided thin-air credit to the economy, augmenting that provided by private depository institutions. (Alright, you may drink from your Festivus wassail cup now that I have mentioned thin-air credit.) Let’s compare the relationship between year-over-year growth in nominal gross domestic purchases with the year-over-year growth in thin-air credit provided by private depository institutions and then thin-air credit growth augmented by Fed securities purchases. These relationships along with correlation coefficients are shown in Charts 3 and 4.
When Fed securities purchases are excluded, the correlation between growth in private depository institution thin-air credit, advanced one quarter, and growth in nominal domestic aggregate demand is 0.25. When Fed securities purchases are added to private depository institution thin-air credit, the correlation between growth in this Fed-augmented thin-air credit, advanced one quarter, and growth in nominal domestic aggregate demand more than doubles to 0.55. So, if the goal of a monetary policy is to push bond yields lower, it would seem that the Fed should sell large quantities of securities. Notice that on December 17 and December 18, 2015, when the Fed began implementing its policy interest rate increase by draining reserves (thin-air credit), Treasury bond yields fell. If the goal of a monetary policy is to stimulate nominal domestic aggregate demand, then it would seem that the Fed should purchase large quantities of securities.
Another problem I have with you people (i.e., mainstream economists) is your proclivity to strip out telling elements of an economic report. What I have in mind here is the monthly retail sales report. First, you strip out new car and truck sales because the Commerce Department uses a separate unit sales report when it calculates the contribution of car and truck sales to personal consumption expenditures. Fair enough. Then why don’t you add back into nominal retail sales excluding autos your estimate of motor vehicle sales from the unit sales report that had been released previously? I mean if I am interested in the behavior of total household spending on goods, leaving out spending on motor vehicles provides only a partial picture. By the way, the correlation between month-to-month percent changes in nominal retail sales of new cars and trucks and unit sales of new cars and trucks is pretty high, at 0.90, as shown in Chart 5.
And then there is the convention to exclude from retail sales those for building materials and garden equipment. The rationale is that this category gets captured in the residential investment (housing) component of GDP. Alright. But expenditures on building materials are part of total spending in the economy. If you are stripping these expenditures out of retail sales, please tell me by how much they raise or lower your residential investment estimate. Enquiring minds want to know (as in National Enquirer, you twit who scolded me for not spelling it “inquiring”).
But what really steams me is the exclusion of gasoline sales from retail sales. Yes, gasoline sales are volatile month-to-month because of volatile gasoline prices. The short-run demand for the physical volume of gasoline is relatively insensitive to variations in its price. I need X gallons of gasoline to get to and from work each week. So, a 10 cents or 20 cents change in the price of a gallon of gasoline in a month is not going to change that much the number of gallons I purchase that month.
But, assume that the price of gasoline is trending lower over a number of months. All else the same, would I not use the income previously spent on gasoline purchases to increase my purchases of more discretionary items? Alternatively, observing a more persistent decline in gasoline prices, I might increase my discretionary driving, which would entail an increase in the volume of gasoline I purchase. Either way, on a longer-term basis, growth in my nominal retail expenditures should not be negatively affected by lower trending gasoline prices. I use the “savings” from lower gasoline prices to step up my nominal and real spending on more discretionary items. But if gasoline sales are stripped out of total retail sales, this information is lost.
Let’s see what has happened in the past 12 months to gasoline prices, total retail sales and retail sales excluding gasoline sales. The year-over-year percent changes in each of these series are shown in Chart 6.
In the 12 months ended November 2015, the price of a gallon of unleaded regular gasoline has fallen 36.3%. In this same period, total nominal retail sales have increased 1.4%. This compares with an increase of 4.9% in the 12 months ended November 2014. So, growth in total nominal retail sales has slowed sharply in 2015 vs. 2014. With their “savings” from lower gasoline prices, why didn’t households increase their spending on discretionary items? Even if nominal gasoline sales are excluded from nominal retail sales, there still has been slowdown in the growth household spending on goods. In the 12 months ended November 2015, retail sales excluding gasoline sales increased by 3.7%, down from the 5.9% increase in the 12 months ended November 2014.
What’s been going on here? One thing that has been going on is that households have been using some of their gasoline “savings” to build up their liquidity in the form of currency and deposits at banks and other depository institutions. This is implied in Chart 7. In the four quarters ended Q3:2015, household acquisitions of currency and deposits relative to their after-tax income averaged 4.6% vs. 3.9% in the four quarters ended Q3:2014. In economics jargon, this means that the velocity of money has fallen. Falling money velocity implies slower growth in nominal spending.
An explanation of how a decline in the velocity of money results in weaker nominal spending will have to wait for another time. Right now, it’s time to gather around your Festivus poles, preferably made of aluminum because of its high strength-to-weight ratio, and join me in singing the Festivus Carol.
A Festivus Carol
(Lyrics by Katy Kasriel to the melody of O’ Tannenbaum)
O’ Festivus, O’ Festivus,
This one’s for all the rest of us.
The worst of us, the best of us,
The shabby and well-dressed of us.
We gather ‘round the ‘luminum pole,
Air grievances that bare the soul.
No slights too small to be expressed,
It’s good to get things off our chests.
It’s time now for the wrestling tests,
Feel free to pin both kin and guests,
Festivus, O’ Festivus,
The holiday for the rest of us.
Paul L. Kasriel
Econtrarian, LLC, Founder and Head of Values (BBC “W1A”)
Senior Economic and Investment Advisor
Legacy Private Trust Co. of Neenah, WI