May 2005 Archives

Brad Setser is visiting Kansas (which, we learn in today's post, is where he grew up) and finds no housing bubble. As a lifelong midwesterner, I can tell you the same thing. I haven't harped on it in this blog, but I have commented on some other blogs, like Calculated Risk. I don't know if there's a lot to be gained by my telling you that there isn't a housing bubble in most of the rural areas of the country. But I am glad that Brad agrees.

Brad does make an observation that I would like to expand upon.

To paraphrase Paul Kasriel's summary of Greenspan, there is no housing bubble in Manhattan KS (where I grew up), but there is one in Manhattan New York (where I now live). That characterization is a bit off. Manhattan KS (a growing university town and regional medical center) is far more frothy than say Stafford or St. John's KS, but it has a grain of truth.

Likewise, Peoria, IL is far more frothy than smaller communities in central Illinois. But I would not say Peoria is a bubble market. As I said in a comment on Calculated Risk, referring to data on this site,

I see that Wichita is near the bottom of the list with only a 2.48% appreciation for 2004.

I visit Wichita now and then. I can tell you there is a new construction boom going on there too. I see this as pretty strong support for my hypothesis that new construction in small/medium midwestern cities is biasing their median price listed in the NAR report.

Peoria comes in with a respectable 5.27%. Since their methodology includes refinancing, I'd go along with that as quite realistic from my experience. I would guess that the "purchase price" for a refi is the appraised value, which is a little higher than the price it might actually command on the market. Excluding refis might shave a percent or two, don't you think?

Definitely not a bubble. Whether 2 to 5% is a boom is your call.

That's 2 to 5% nominal return, subtract a couple points for inflation and it's 0 to 3% in real terms. But real estate sales in the Peoria area are brisk. There is a pretty massive building boom in the bedroom communities, mostly in the $200,000 range. Thus, the sales of those new homes are pushing the median price up. Rural areas are not seeing that kind of boom.

We just aren't seeing the kind of speculative mania that the coasts appear to be seeing. People buying houses in Peoria actually plan to live in them. As long as that is the case, there is less to worry about. "Flipping" of properties, such as is happening in the more bubbly areas, is disturbing to me indeed. The pundits who decry this behavior have a point. (See here for one of my statements on the subject.) A lot of statements about the housing market in the bubble areas sound like statements about the stock market in 2000, or dare I say 1929. But does that imply that a crash is around the corner? No. Houses are different from stocks in some important ways (even though modern financial markets have caused them to behave in some similar ways). I do think, however, that there will come a time (if I knew when I wouldn't tell you anyway) when the market will slow down from this torrid and, by all accounts, unsustainable pace.

What does worry me is that many people, especially in coastal metro areas are leveraged to the hilt on these properties. Interest only loans, ARMs, and so on, could potentially bite some of the last ones in on the bubble. And I worry a little bit that even in small/medium midwestern cities like Peoria, people are buying those cute little $200,000 homes (that would probably sell for $500,000 or more where many of you live) using the same interest only loans and ARMs.

There are reasons to be concerned, even about the midwest, and reasons to be downright worried about the coasts. Ultimately, this situation demonstrates yet again that the U.S. is a large and diverse economy. The mechanisms driving real estate in Miami are very, very different from those at work in Peoria.

From the Peoria JournalStar:

Two men believed to be former soldiers of the Imperial Japanese Army have been found on Mindanao Island in the southern Philippines, the Japanese Embassy in Manila has reported.

The embassy sent three officials to the southern Mindanao city of General Santos on Friday to meet the two men.

It was not immediately known if the two men were aware that the war was over.

Reuters also has the story.

The last known Japanese straggler from the war was found in 1975 in Indonesia.

The timing of this story on Memorial Day weekend just serves to remind us of the shrinking number of WWII veterans, not just here, but everywhere.

I took this picture of the Tomb of the Unknown Soldiers at Arlington National Cemetery a number of years ago. My high school band laid the wreath in the picture.

I haven't been back to the Memorial Day observance in my hometown for many years, but I remember it well--the introduction of the Gold Star mothers, the reading of "In Flanders Fields," marching in the parade with the high school band, the solemnity of it all.

One thing you could count on was Everett Johnson singing "My Buddy" dressed in his WWII Navy uniform. Everett had a wonderful tenor voice, and the song would bring a hush to the auditorium when he began to sing. To me, Memorial Day wasn't complete without him singing that song. When I left for grad school, I didn't get back as often for Memorial Day, but I never forgot Everett's hauntingly beautiful rendition of "My Buddy." I can still hear it in my mind.

Everett passed away in July 2004 at the age of 83.

This Memorial Day, I will remember Everett. I'm sure the town of Pelican Rapids, Minnesota is missing him greatly this weekend.

Since 1952, only one person has provided the voice for Tony the Tiger--Thurl Ravenscroft. Ravenscroft also sung "You're a Mean One, Mr. Grinch" in How the Grinch Stole Christmas. Put that together with numerous Disney characters and you've got a voice that will continue to sing on in DVD collections and in the memories of anyone who grew up on these classics in the last 50 years.

Hear him say his most famous phrase one more time on this NPR clip.

Via Reuters:

"Given the current outlook for the economy, my personal view is that we've not yet reached a neutral policy stance," Guynn said in prepared remarks to the Certified Professional Home Builders in Atlanta. The Fed released a text of his speech in Washington.

...

The Atlanta Fed president added to recent warnings by Fed officials and others about possible regional U.S. housing bubbles. Investors gambling that housing prices will soar indefinitely are likely to be disappointed, he said.

"There are some local markets, especially in coastal Florida, where I've heard stories for more than a year about behavior that's got to be characterized as nothing other than speculation," Guynn said it response to questions after his speech.

"It makes me very uncomfortable," he added. "Some buyers, some builders, some lenders are going to get burned, could very likely get burned, in some of those local markets."

The entire speech is on the Atlanta Fed website.

Click here for the minutes of the May 3 meeting.

Some highlights:

Partly in response to the receipt of weaker-than-expected data for spending and output in the first quarter, the staff marked down somewhat its forecast of economic growth for 2005 and 2006.

...

In their discussion of current conditions and the economic outlook, meeting participants observed that incoming data over the intermeeting period hinted at possible upside risks for inflation and downside risks for economic growth. Earlier increases in energy prices seemed to be an important factor contributing to an uptick in core inflation and a slower pace of economic activity. With energy prices leveling out more recently, however, and the behavior of compensation suggesting a lack of pressure in labor markets, underlying inflation appeared to remain contained. The weakness in spending was widespread and could not be completely dismissed, but it had appeared only very recently and could be a product of the inherent noisiness of high-frequency economic data. On balance, economic fundamentals including low interest rates, robust underlying productivity growth, and strengthened business balance sheets were expected to support economic growth at a pace sufficient to gradually eliminate remaining slack in resource utilization. Although the economic outlook generally seemed favorable, there was also broad recognition of greater uncertainty attending the outlook for both inflation and output growth.

I'll quote these three paragraphs in full to avoid any chance of taking them out of context.

In the Committee's discussion of monetary policy for the intermeeting period, all members favored raising the target federal funds rate 25 basis points to 3 percent at this meeting. Although downside risks to sustainable growth had become more evident, most members regarded the recent slower growth of economic activity as likely to be transitory. In this regard, the ability of the U.S. economy to withstand significant shocks over recent years buttressed the view that policymakers should not overreact to a comparatively small number of disappointing indicators, especially when economic fundamentals appeared to remain quite supportive of continued solid expansion. To be sure, the Committee had raised its federal funds rate target appreciably over the past year, and, in the view of a few members, a larger-than-expected moderation of aggregate demand in response to this cumulative policy action could not be ruled out. However, all members regarded the stance of policy as accommodative and judged that the current level of short-term rates remained too low to be consistent with sustainable growth and stable prices in the long run. Against the backdrop of the recent uptick in core inflation and in some measures of inflation expectations, members agreed that they should continue along the course of removing policy accommodation at a measured pace conditional on the outlook for inflation and economic growth.

In discussing the statement to be released after the meeting, members agreed that it was appropriate to acknowledge that rising energy prices seemed to have spurred an increase in core measures of inflation by dropping the reference from the March statement indicating that "The rise in energy prices, however, has not notably fed through to core consumer prices." They likewise all agreed that mention should be made that, on balance, longer-term inflation expectations remained well contained. Regarding the risks to sustainable growth and price stability, some members noted that the risk assessment conditioned on "appropriate policy" no longer seemed to convey useful information regarding the Committee's economic and policy outlook. Although some members noted that a case could be made that the risks to inflation were now somewhat skewed to the upside and those to sustainable economic growth perhaps to the downside, the most likely outcome remained one of stable prices and sustainable growth, and the Committee agreed that it should retain a balanced assessment of risks conditional on appropriate policy.

For many, heightened economic uncertainty in the current environment implied greater uncertainty about the range of possible policy outcomes and placed a premium on flexibility in setting policy at upcoming meetings. Some members commented that this greater uncertainty called for eliminating or paring back forward-looking language from the statement--if not at this meeting, then fairly soon. In the event, most members viewed the forward-looking language in the statement--including the characterization of the stance of policy as accommodative as well as the judgment that policy accommodation could be removed at a pace that is "likely to be measured"--as a reasonable characterization of the policy stance and its likely evolution over time. Moreover, a number remarked that the language in its current form was clearly conditioned on economic developments and therefore would not stand in the way of either a pause or a step-up in policy firming depending on events. In the end, all members agreed to retain the forward-looking language.

This is actually quite interesting and informative. First of all, it should put to rest any misinterpretation of "measured pace." It represents the "likely evolution" and "would not stand in the way of either a pause or a step-up in policy firming depending on events."

Then there is the statement that, "some members noted that the risk assessment conditioned on 'appropriate policy' no longer seemed to convey useful information regarding the Committee's economic and policy outlook." There seems to be some increased support for including language that is a bit more frank about the risks to price stability and sustainable growth. Perhaps the next press release will be more blunt. Perhaps this is the line that the committee really wanted us to read (to prepare the way for more direct language in the future). We'll see in a few weeks.

Other than that, there is little in these minutes that we didn't know already. Nontheless, Wall Street wasn't thrilled (Reuters):

The minutes of the Federal Open Market Committee's May meeting showed the Fed's policy makers believed there was "a discernible upcreep" in inflation, wording that was taken as a sign the Fed would continue its campaign of raising interest rates at a "measured" pace of 25 basis points at a time.

Now, don't tell me that Wall Street learned anything it didn't know already about the "measured pace" business. We've been over that before. Whether Wall Street was more distressed by the possibility of inflation showing a "discernible upcreep" or the markdown of the growth forecast is a question I won't try to answer. But then, 20 points on the DJIA isn't exactly a big drop either.

The 10 year bond gained 7/32 which tells us that the bond market didn't find the inflation news too distressing. On other words, the minutes did nothing to solve Greenspan's "conundrum."

All in all, not much is changed.

UPDATE: The New York Times has this to say:

Participants in the Fed meeting were confronted with a barrage of statistics that suggested slowing growth, but the participants indicated that they felt that any slowdown would be transitory and that they should "should not overreact to a comparatively small number of disappointing indicators."

In hindsight, the decision turns out to have been prescient. In the weeks since the meeting, new data has indicated that job creation, consumer spending and exports have been stronger than originally thought.

Indeed, Wall Street economists have been raising their estimates of growth for the first half of the year. On Thursday, the Commerce Department is expected to revise its estimate of growth in the first three months to 3.5 percent or higher, from 3.1 percent.

UPDATE #2: Mark Thoma comments on the minutes.

UPDATE #3: Macroblog has more.

John Tierney thinks so.

Ok. This might have seemed like a good idea when he thought of it, but you cannot do justice to this in 700 words. Trying to do it in such a short space is just not right.

Smith knew that some people professed love for all humanity, but he realized that a man's love for "the members of his own family" is "more precise and determinate, than it can be with the greater part of other people." Hence his famous warning not to rely on the kindness of strangers outside your family: if you want bread, it's better to count on the baker's self-interest rather than his generosity.

Theory of Moral Sentiments vs. Wealth of Nations. Also called the "Adam Smith Problem" (or as I prefer, the "so-called Adam Smith Problem" since it's really not a problem). Got it. Familiar with the concept.

Tierney uses the first half of his column to compare this to the Jedi's use of the Force for good vs. Anakin Skywalker turning to the dark side. (Must...resist...puns...about...an invisible hand.)

Nonsense. I don't think Adam Smith regarded this as a good vs. evil issue. The "Adam Smith Problem" is not a problem. Tierney's only real cinematic example to support his claim is that Anakin recognizes the limits of altruism. Well, it's a big step from that to... well, you know how the story goes.

Then, in a return to reality, Tierney mentions a paper by Daniel Klein, which I think I might like to read. It's called "The People’s Romance: Why People Love Government (as much as they do)." Sounds interesting. I think this paper probably has a lot more to do with TMS and WN than Star Wars does. Tierney was just straining for an analogy to pitch this idea in his column. Sometimes you find an analogy that works, sometimes you don't. The Darth Vader/Adam Smith thing didn't do it for me.

Luke Skywalker would be a better candidate for an Adam Smith character. (Ok, ok... I'm not saying the analogy works that well for any character, just that Luke represents Adam Smith better than Vader does.)

UPDATE: Brad DeLong and Matthew Ygesias agree. Brad says:

...first, because praise of the ethics of Darth Vader is simply bizarre, and, second, because it is a clear misreading of Adam Smith

That pretty much says it all.

Weird. Really weird.

With a tip of the hat to Mark Thoma (Economist's View), I direct you to today's speech by Donald Kohn.

The speech confirms what I've thought for a while. Donald Kohn's perspective makes his speeches very much worth reading. He was secretary of the FOMC for 15 years before becoming a governor (as well as Director of the Division of Monetary Affairs for nearly all of that time). In a sense, he served the equivalent of a full term of a governor as a non-voting staff member. He is in a unique position to speak on these issues because he's seen it from both sides (staff and governor). That makes for a good speech on inflation expectations and inflation forecasting.

This link (found via Marginal Revolution) should keep you busy for a while.

Answers and explanations are here, but really do try it before you look at the answers.

That reminded me of something that I saw a long time ago. It was a really funny piece called The Mother of All Final Exams. I Googled the phrase and found it on, of all things, the archive of an e-mail discussion list devoted to teaching economics.

You want the answers? Don't look at me!

This special series on class in America by the New York Times is excellent.

Excerpt from one story:

Far more than people who remain in the social class they are born to, surrounded by others of the same background, Ms. Justice is sensitive to the cultural significance of the cars people drive, the food they serve at parties, where they go on vacation - all the little clues that indicate social status. By every conventional measure, Ms. Justice is now solidly middle class, but she is still trying to learn how to feel middle class. Almost every time she expresses an idea, or explains herself, she checks whether she is being understood, asking, "Does that make sense?"

"I think class is everything, I really do," she said recently. "When you're poor and from a low socioeconomic group, you don't have a lot of choices in life. To me, being from an upper class is all about confidence. It's knowing you have choices, knowing you set the standards, knowing you have connections."

Intrigued? Read the whole thing.

The speech was about energy, but the questions generated the media interest. I linked to this same Reuters story in my previous post, but it deserves additional comment.

Greenspan acknowledged that China needs to amend its exchange-rate policies for its own good. In order to maintain the peg without sparking inflation, China must "sterilize" the large amount of reserves it amasses in the process of buying U.S. dollars and issuing yuan-denominated debt.

"The trouble with the sterilization issue is that they're only able to sterilize about half of what they are accumulating," Greenspan said, which has the effect of leaving its financial system awash in cash that can fuel inflation.

Precisely. All that extra cash does make their shaky banking situation seem a little less precarious. Taking away that extra cash would really shake things up and has always been a reason that China has been reluctant to float the yuan. Once inflation begins to pose a greater risk, they will move... perhaps reluctantly. It's not a trouble-free proposition for them. If it was, they would have done it already.

Next question:

"We don't perceive that there is a national bubble but it's hard not to see ... that there are a lot of local bubbles," he said.

The Fed's policy in sharply cutting U.S. interest rates from 2001 to 2004 to 46-year lows -- before initiating a round of rate rises in June last year that continues -- was criticized by some analysts as having sown the seeds for a potential nation-wide bubble as house prices soared.

Since last June, the Fed has lifted its trend-setting federal funds rate from 1 percent to a current 3 percent in search of a hard-to-define "neutral" rate that neither fosters inflation nor crimps expansion.

Greenspan dodged a question about where the neutral rate is, calling it an "amorphous" concept. "Essentially you get down to the point that we will not know it until we're actually there. Maybe we'll miss it -- it's conceivable."

I agree that there are a lot of local bubbles, but I wouldn't call the Peoria market a bubble. As for the "amorphous" neutral rate, that's not a question I'd want to answer if I were him. I don't think I would say that it's coneivable that we'll miss it though. Some things are better left unsaid. (It's not like we don't all have those thoughts in the middle of the night, right?)

UPDATE: Calculated Risk has more quotes via Bloomberg. Lest anyone think I'm being Pollyannaish about the housing situation (which I would call a bubble in many areas of the country), I remind you of this post. So when CR quotes Greenspan:

"... only those who have purchased very recently, purchased just before prices actually literally go down, are going to have problems."

and a commenter on that blog says:

Would very recently be before or after he recommended prospective buyers to use ARMs?

I have to nod in approval. The ARM comment by Greenspan was a mistake.

The Prudent Investor has more as well.

Krugman says (NY Times):

But the negative effects of a change in Chinese currency policy will probably be immediate, while the positive effects may take years to materialize. And as far as I can tell, nobody in a position of power is thinking about how we'll deal with the consequences if China actually gives in to U.S. demands, and lets the yuan rise.

I've been saying that China will not revalue until it is the right thing for them to do for their domestic economy. I've never considered the yuan issue a critical policy matter for us (in the sense that a floating yuan would make life a lot better for us). Of course, anything that arouses so much passion in Congress is bound to get my (and your) attention. Everytime I ponder the yuan, I usually end up thinking about the fact that this is a much more important issue for the Chinese than it is for us and that we can't do much about it anyway. Inasmuch as we are one of China's major customers, they probably will not ignore any negative effects that it may have on us. Still, I'm inclined to agree with Krugman on this one. All of the blustering the U.S. has been doing has been puzzling me. Until recently it has just been a buzz in the background, but it's getting louder. Loud enough, in fact, that Greenspan is stepping into the ring. Greenspan says that revaluation will not matter that much for our trade deficit.

Yet Secretary Snow just appointed a special envoy to address the Chinese currency issue. And then you have this story that is just plain disturbing:

Snow said the dark mood on Capitol Hill represented "a dangerous situation" and he hoped China recognized and understood that was the case.

If you could see me now, you'd see that I'm just sitting here shaking my head.

UPDATE: The New York Times editorial page weighs in with similar sentiments.

Greenspan called it a "conundrum" back in February. That sure showed the markets. Apparently the Greenspan effect has worn off. From the NY Times:

The yield on the benchmark 10-year Treasury note went below 4.10 percent yesterday for the first time since February, a move that could confound the Federal Reserve's effort to slow economic growth. At the same time, however, the rally in Treasuries appears to reflect a decline in inflationary fears.

I half expect Rod Serling to step out from behind a tree any minute.

The rest of the article tried to explain it. Here's a part of it.

William H. Gross, the manager of the world's biggest bond mutual fund - the Pimco Total Return fund - signaled Tuesday that he was moving in this direction when he said that he thought the 10-year yield would be in a range of 3 percent to 4.5 percent over the next three to five years.

Mr. Gross, in his investment outlook published Tuesday, said that the recycling of billions of dollars from Asia - mostly from China's central bank - into the Treasury market would also help keep Treasury rates low.

This is because China, even if it revalues its currency, the yuan, later this year, will still have to buy dollars and sell yuan to prevent the yuan from becoming less competitive globally too quickly. And those dollars will be used to buy Treasuries, keeping rates lower by about a percentage point than they otherwise would be, according to Mr. Gross.

Lundy Wright, who runs the Treasury desk at Nomura Securities International, said the rally in the Treasury market, was, in part, a flight to quality because of the turmoil in the corporate bond market. He said that money managers were reducing their bets until the smoke cleared. What is not contestable is that the bond market continues to be volatile as investors shift sentiment on a dime in a global economic environment where uncertainty seems to be one of the few constants. This means yesterday's move could reverse quickly.

For related reading, I direct you to Brad Setser's post from May 11.

The bond market, right now, is not for the timid.

Ok, so this caught my eye today: (Reuters)

WASHINGTON (Reuters) - The Bush administration is considering whether to ask Federal Reserve Chairman Alan Greenspan to stay in office a few months past the end of his Fed board term, which expires on Jan. 31, The Washington Post reported on Wednesday.

The newspaper said the delay would give the White House more time to conduct the search for a successor, which could include corporate leaders.

A quick check of 12 USC 242 reveals:

...Upon the expiration of their terms of office, members of the Board shall continue to serve until their successors are appointed and have qualified. Any person appointed as a member of the Board after August 23, 1935, shall not be eligible for reappointment as such member after he shall have served a full term of fourteen years.

So it is possible that he could stay on if Bush has not appointed a replacement by the end of January (of if the appointee has not been confirmed by that time). I also suppose that he could announce his intention to resign on Jan. 31 even if a replacement hasn't been found. Wouldn't that be an interesting prospect?

Anyway, I am not foolish enough to make book on whether Bush will appoint someone and whether that person will be confirmed by Jan. 31. (Are you watching C-Span2 today?) But if the President is listening, I have a little advice. Appoint a replacement sooner rather than later and make sure he or she can be confirmed without threat of a filibuster. The markets will thank you. Don't play games with Fed chair appointments. Especially on a day like today, this sort of news gives me an uncomfortable feeling.

Greenspan himself recently took the opportunity of a commencement speech to point out that his time at the Fed is coming to an end.

Dean Harker, members of the faculty, Wharton alumni, friends and families and, especially, members of the 2005 graduating class. I have more in common with you graduates than people might think. After all, before long, after my term at the Federal Reserve comes to an end, I too will be looking for a job.

The entire speech to the graduating class at Wharton can be found here.

UPDATE: Mark Thoma turns the mic over to Tim Duy for today's Fed watching post. Looks like he basically agrees with me:

More generally, what does the difficulty of finding names say about the importance of Greenspan? I don’t want to believe that only he can do this job. If the Administration delays his retirement, it suggests that this is true, casting a pall over Greenspan’s eventual successor and diminishing their credibility. Is this how we want to start off the tenure of fresh blood in the Chairman’s seat? I don’t think so. Maybe the blogging community should turn a fresh eye to the question of possible names to replace Greenspan….

Can we all say it together? Appoint a successor sooner rather than later and don't play games with this position.

UPDATE AGAIN: Edward Gramlich announced his intention to resign his post at the Board at the end of August.

Gramlich, Bernanke, Greenspan. Lots of big shoes to fill.

Nothing really new or unexpected. The week ended as it began, but there was a bit of movement during the week in the predictions for October. David points out that the probability of a pause in the rate hikes took an upward turn early in the week. It looks like that was due to a dive in the probability of being at 3.75% (3 more quarter point increases) in October. The probabilities of all the other outcomes went up--a pause (3.25% or 3.5%) or a more aggressive stance (4.0%). Not sure I can explain that either. I can understand the suddent jump in the probability of 4.0% jumping with the employment report. Could it be just a result of thin trading that far out into the future and a sudden lack of interest in 3.75% that pushed everything else up? Who knows. It only lasted a couple days anyway.

Thank you, David, for the updates.

Apologies for the long quote, but it's a 9 page feature article. Read the whole thing. (NY Times)

Britney Schmidt was hunched over a spectroscope in a small physics lab, peering into the eyepiece and scribbling numbers in a notebook. No one is more surprised to be there than she is. She arrived on campus in fall 2000 with a clear plan: because she loved creative writing and horseback riding and was active in the Future Farmers of America, she would study English and agriculture. Now she is a fifth-year senior majoring in physics (3.5 G.P.A.) and heading for graduate school in planetary science. "I owe it all to my educational identity crisis," Ms. Schmidt, 22, says with a laugh. "I always knew exactly what I wanted to do. I was independent, I was going to go get it, and I was just going to do amazing things."

College was a disappointment. Professors gave her the impression they would rather be someplace else. Their attitude was, " 'O.K., well, I've got to teach, but I really am interested in research, or I'm really interested in what I'm doing after class,' " she says. "They'd come for an hour and give their lectures and leave. There's not that ownership that you feel in high school. There, I knew all the teachers and all the students. And then I got here and was one of 37,000 people on campus, and really not an important one. I didn't know where I fit in the picture."

All of a sudden, she recalls, "I was just like: 'I have no idea who I am. I don't know what I'm going to do. I don't know what I want to do.' I was getting A's in all my classes, but I wasn't being challenged, and I wasn't thinking about new things." She decided that she needed to start over somewhere else, but meanwhile, she enrolled in a semester's worth of general-education requirements - "sampling," as she puts it. Students must take 11 courses in different areas: math, composition, a second language, natural science, humanities, art, non-Western studies, traditions and cultures and individuals and society.

A natural-science class caught her imagination and she began staying after class, talking with the teaching assistants. She had never met a scientist before. "I began to feel like I really belonged," she says. "I would ask the T.A.'s what they were researching, and why. I asked all these questions I'd always thought about but never had the opportunity to ask." As the semester progressed, she felt comfortable enough to approach the professor, Robert Brown.

Professor Brown remembers Ms. Schmidt as "just a face in the crowd" of 160 students until she showed her passion, and then he invited her to get involved in lab work. "Students like Britney who have that extra motivation usually take leadership roles," says Professor Brown, who gave up an appointment at NASA's Jet Propulsion Laboratory to combine teaching with research. "I like to challenge them, to make sure they use their gifts." Ms. Schmidt recalls the day he challenged her. "One day, Dr. Brown sat me down and said: 'Look, you're independent enough to come in and ask questions. In my experience, that level of independence is someone who does really well in science. You should really think about giving it a go.' "

...

Ms. Schmidt has been accepted at the University of California, Los Angeles, in planetary physics and at the University of Chicago in cosmo-chemistry but has not decided which graduate school to attend.

She offers this advice to incoming freshmen: "Get out of your comfort zone. You learn so much more when you have to change what you're doing, than if you just came in and said, 'Well, this is me and I'm always going to be like this and I'm always going to study this.' If you think that way, then you never stop to question whether that's what really you're supposed to do. Relax. You haven't lived 20 percent of your life. What's the rush?"

I've known students like Britney. Most of them are in grad school. I wish there were more like them.

Students, if I could give you just one piece of advice it would be: be like Britney.

Becker:

So my conclusion is that the estate tax should go, or at least have greater reduced rates, since this tax has little effect on inequality in a knowledge economy, encourages costly avoidance behavior to take advantage of various tax loopholes, raises only a modest amount of government revenue, and reduces incentives to form family businesses and other entrepreneurial activity. Estate taxes do not even tax the right base if the aim is to reduce the effect of inheritances on inequality in the personal distribution of income and wealth. The energy and political capital spent on supporting high estate taxes is better spent on trying to raise opportunities to children from poor families by improving their education, training, and health.

Posner:

I agree with Becker that inheritance taxes are preferable to estate taxes and that consumption taxes are preferable to income taxes. However, I do not share his strong opposition to the federal estate tax.

Worth reading.

As a purist and someone who studied Latin, I object a little bit to calling these study spaces "libraries" if they don't have books (libri). But I agree that digital information should be embraced by college students. I encourage it in my students.

College Libraries Set Aside Books in a Digital Age (NY Times)

The trend is being driven, academicians and librarians say, by the dwindling need for undergraduate libraries, many of which were built when leading research libraries were reserved for graduate students and faculty. But those distinctions have largely crumbled, with research libraries throwing open their stacks, leaving undergraduate libraries as increasingly puny adjuncts with duplicate collections and shelves of light reading.

True. There is no need for separate graduate and undergraduate libraries.

"There's a real transition going on," said Sarah Thomas, past president of the Association of Research Libraries and the librarian at the Cornell University Library in Ithaca, N.Y. "This is not to say you don't have paper or books. Of course, they're sacred. But more and more we're delivering material to the user as opposed to the user coming into the library to get it."

I'm in favor of it. E-books on tablet PCs might be the next revolution in the college classroom. And of course if more journal collections can be put on-line and made available at minimal expense, scholars everywhere will rejoice.

Still, don't get rid of the libraries (the ones with books) just yet. I need a place to walk to just to pull a random book off the shelf for enjoyment and enlightenment. So far, the internet does not replicate that fully (especially the walk).

Most of you probably have heard most of what is in this article before if you've been following the debate. But in case you haven't...

Beware the Easy Fix for Social Security (NY Times)

I spent most of the day dealing with other things, so I will simply note some of the excellent discussion of the trade numbers at the usual blogs with a brief comment at the end.

Macroblog sees the silver lining and calls our attention to a Chicago Fed Letter on the sustainability of the trade deficit by Michael Kouparitsas. Brad Setser is more optimistic than he was last month in the post on his blog, but he lays out a critique of the Kouparitsas article in the comments of macroblog. Kash at Angry Bear has two posts. In the first, he concludes:

Thinking about it this way reminds us that the US's voracious appetite for imports is not the result of low labor costs in China, but rather the result of a fundamental imbalance in which the US consumes more than it produces of virtually all types of goods. In many of the countries with which the US runs a trade deficit labor costs are actually higher than in the US, but since those countries don't consume everything they produce the US imports from them. The cause of the trade deficit is therefore clear: it is simply the direct result of the US's lack of saving.

PGL offers critique of the Kouparitsas paper in a separate post. Calculated Risk has the charts. The Prudent Investor is not impressed by the supposed good news.

My two cents:

I don't put a lot of emphasis on big swings in monthly data for some of the more volatile statistics, like the trade deficit. Yet, if you want to contribute to the discussion, you have to find a way to tell a tale about the numbers as they are presented. So the question is how today's news affects my expectations going forward.

Last month's trade figures really worried me. I mean when Brad Setser starts throwing around numbers like $900 billion, it makes you wonder. And do I need to remind you that it was about a month ago that we started going back and forth on the whole "soft landing" or "hard landing" business? But amid my worry, part of me wondered if last month's numbers were an aberration.

The same is true tonight. I wonder if today's numbers were an aberration. I'm inclined to think it's one or the other, and we won't know for another few months. So today's numbers increase the width of my confidence interval if I was to forecast the trade deficit, but that's about all. There's not much more you can say about headline numbers as bad as last month and as good (or, not as bad) as this month.

Looking behind the headlines, I don't think we've turned a corner yet (or if we have, it will take a couple months before we really know it). The issue is, as Kash points out, a lack of savings. Falling oil prices are great, but it's not enough. I don't see a lot of compelling reasons for the trade deficit to shrink much in the near term. What you think about the longer term depends on a lot of other things (hard/soft landings). I'm willing to wait another month before revising my expectations very much.

Oh, and in the blog-find of the day, macroblog links to Economics Unbound by Michael Mandel of BusinessWeek.

First, I don't know if "Jane Galt" read my post on Social Security as insurance, but she comes to a similar conclusion.

What's the best solution, then? I'd say we're converging on it: a system of minimal government insurance for those who have been unlucky, in life or investments, combined with a regulated forced savings plan to make sure that those who aren't unlucky aren't tempted to free-ride on society, and incentives to employers to encourage additional savings among employees. This won't make anyone ideologically happy. But it seems like the least intrusive, most fair, most economically sound possibility.

Your ideological happiness (or lack thereof), I'd say, rides on how minimal the insurance. Hence, Mark Thoma writes in a comment to my post:

I agree entirely and have noted before that the question of whether a person views the current system as just insurance or insurance plus savings depends upon their (normative) view of the level of support that ought to be insured, the minimum acceptable level of societal support. Much of the argument you hear is needless because it is really an argument over this difference and there is no right answer.

Yup.

So now, Winterspeak asks (also in my comments section):

So what risk are we left with -- the risk that the retiree has not saved enough before he retired? I don't see how this is a risk. The retiree 1) chose when to retire and 2) saved throughout his life. This is not a risk, this is a bad choice.

Not to mention the bad choice of leaving all your retirement in the stock market too long.

I am supportive of (and understand) forced savings so ppl don't make the bad choice I've detailed above. But I cannot see the insurance aspect so social security. I don't understand why insurance against unexpected poverty should be limited to old people.

One crucial reason for a different sort of program to insure against old age poverty is that most of us are of a sensibility that makes us uncomfortable making senior citizens work to pull themselves out of poverty. For younger people, we have unemployment insurance and TANF, both of which have limits which induce young people to get back into the workforce. I think there is good reason for something different for those over a pre-defined, socially acceptable age.

As for the distinction between risk and a bad choice, I'd offer the following. Too much risk is sometimes the result of a "bad choice." In a free society, some people will make what I would consider to be bad choices and take on too much risk. Some will lose. Yet, I am uncomfortable watching them be reduced to poverty (when they have less of an opportunity to pull themselves out). So I like the idea of a safety net. But I also understand moral hazard, so I know that a safety net that is too generous will just encourage folks to make bad choices (take on too much risk, let it ride on the stock market too long, etc.).

Hence, the problem simply boils down to how generous we want that safety net to be. That is an appropriate question for society to consider through the political system. (And a question on which economists can and should offer sound theory and evidence.) Or, as Mark says (in a comment to my post),

You can argue anywhere from an absolute bare subsistence level to a fairly generous level of support, but there is no correct answer as to what is fair that we will all agree upon other than that a floor exists. And I suspect there are a few who would even argue against a minimal level of support.

And while we're at it, let's consider another source of risk that could bite a lot of people in the next few decades--the demise of the corporate pension system. I would be remiss if I didn't mention this:

Unions Threaten to Strike After Pension Default at United

This is the tip of the iceberg. There is also the more subtle pension shaving due to reductions in health benefits for retirees in a number of companies. Did the workers in these situations make a bad decision? The fact is, corporations may no longer be the appropriate vehicle for bearing this sort of risk.

Back to "Jane":

The defined benefit corporate pension plan has been, for a long time, the holy grail of liberals. It was lavish and safe. It is also dying. Not that it was ever that prevalent in the first place, mind you; liberals who lionize the Golden Days of the fifties and sixties seem to believe that everyone worked for either IBM or GM, when in fact most jobs, just like today, were with small businesses.

But the corporate pension was certainly *more* prevalent. Unfortunately, time has revealed its cracks; companies aren't very good vehicles for managing this sort of risk. Time is the biggest one; pensions require companies to plan over time horizons that span 30 or 40 years. That was fine in the cozy, protected, and highly regulated environment of the 50s and 60s, but when the market changed, the pension promises couldn't. This is what (among other things) is dragging down the major airlines; I expect that within the next decade we will also see Ford and GM default on their pension promises.

She goes on to say that there are problems with having the government provide this insurance as well (which I take it is why she argues for "minimal" government insurance). All of this leading up to her conclusion I quoted at the top of this post.

If we could get broad agreement on a coherent system that provides incentives for saving, together with an open and honest debate about the appropriate level of social insurance, that would be ideal.

From Yahoo News: Report: More Competition Leads To Better Prices

My first reaction: This is news? But the article does not totally focus on the wonders of competitive markets, but also on the evils (cue scary sound effects here) of those stores that happen to be located in areas where there are fewer stores around them to compete on the basis of price.

If a big-box retailer is the only store for miles, you may be paying higher prices for items.

5 On Your Side Consumer Specialist Angie Lau reported the more stores vie for business, the more they will compete with each other to get it. Consumers end up coming out on top as the winners.

...

One day, she found that Tide liquid detergent was $7.44 in Parma, but $5.67 in Brooklyn. It's about a 25-percent difference.

...

Some shoppers could not believe that there were differences based on the location of the stores.

To quote the inimitable Wallace Shawn in The Princess Bride, "Inconceivable!"

Moe Dunch, who shops at the Wal-Mart in Cleveland Heights, was one of those shoppers.

Angie: "Do you think it's fair that they don't offer the same bargain price for every store?

Dunch: "If they offer the same bargain price for the store... they should offer it for every store."

NewsChannel5 contacted Wal-Mart's corporate headquarters.

A spokesman said, "All of our merchandise starts out with the same basic price. However, our store managers do have the prerogative to lower prices to meet or beat the competition in their neighborhood."

Target also confirmed the practice of competitive pricing. The store also provided a statement.

It read: "Prices can be impacted by prices at nearby retailers. That's why prices may vary from Target store to Target store."

Competitive pricing doesn't make Jessica Kennan, 19, feel good. She's paying her way through college and needs every dime.

Lau said the valuable lesson is the more stores around a big-box retailer, the lower prices will be.

It's a quiet strategy that retailers don't advertise, Lau said.

(Sarcasm on)And thanks to this reporter, the secret is out.(Sarcasm off)

Nevertheless, busy mothers, like [Anissa] Lopinski chooses between saving time over money.

(Sarcasm on)Imagine! Choosing to save time over money! You mean all those opportunity cost examples I use in my principles of micro course really describe human behavior? Wow!(Sarcasm off)

"It's close to home, and I don't want to be traveling all over city looking for the best buy," she said.

Economists call this "search," as in: Her "search costs" are high, so she shops at the store close to home.

Lau said retailers are banking on more consumers like Lopinski.

Write your own conclusion.

Hat tip: Division of Labour

PGL at Angry Bear recently commented on the lack of a rebound in the employment to population ratio (henceforth in this post: e/p) during the current recovery.

Fortunately, we saw some improvement in the labor market this month, which showed up in higher EP and LF ratios. I’m on record for praying for a return to the days of having employment being 64% of the adult population. Let’s suppose some forecaster tells us his macroeconomic model predicts a 4.5% unemployment rate by the end of 2006. I’m sure some Administration apologists will go giddy with glee, but I’m going to look at the details as to what the forecaster is saying about the labor force participation rate. If the forecast is for LF = 67% so EP = 64%, I’ll join in the glee. But if the forecast is for LF = 66% so EP = 63%, I’ll continue to argue we should hold to higher standards before we declare full employment.

Right now, total e/p is at 62.6%. It was around 64% before the recession (hence PGL's comment) and bottomed out around 62%. But let's go behind the total number and break it down as the BLS does. (All data is available on the BLS site.)

My series starts before the 1990-91 recession for some additional historical perspective. Some things should pop out at you. The decline in e/p for males 20 and over was similar in both cycles. In the '90s the ratio never quite made it back to its level before the 1990-91 recession. Hence, the trough was a little lower. The recovery does not seem altogether much worse than after the last recession, though it is a little early. The ratio didn't make it back up to 73% until nearly 1995 after the last recession. Demographics will start working against us on this series very soon as well if some baby boomers start to retire early. Whether the e/p ratio can attain the level at its last peak is a serious question, just as valid today as in 1995. Like PGL, I would like e/p to get back to something more akin to full employment, but I also think there should be research into what that level is for the demographics.

For women age 20 and over, the picture is not quite as bright, and it is a very different picture indeed. The e/p ratio fell only slightly in the last 1990-91 recession and then quickly returned to its former pace as women continued to enter the workforce during the '90s at a rapid pace. After falling nearly 2% in this recession, it has stabilized at just over 57%. For reference, this is about the level of early 1997. The speed with which the ratio will return to its previous level depends on what kind of continued gains in e/p women would be expected to see in a full employment economy and the elasticity of labor supply. Those, too, are interesting questions that could be pursued.

And so we come to the real story behind the story. Both sexes ages 16 to 19. Their e/p ratio practically fell off the chart in this recession and has not started to recover at all. The reasons for this are many, but the CBO (who I do not categorize as apologists for the administration) seems to have found one factor. Men and women ages 16 to 19 as well as those 20 to 24 are more likely to stay in school than even just a few years ago--enough to make a difference. This fact does not explain everything. Employment rates are lower even among non-students. This could be due to increased competition from unskilled immigrants, among other things, according to the CBO. The entire report, published in November of last year, is worth reading--too much to summarize effectively in a single post. But the comments are open to anyone who wants to read the report and talk about it.

While you're at the CBO, check out these titles which are apropos to the topic at hand.

Disability and Retirement: The Early Exit of Baby Boomers from the Labor Force

CBO Projections of the Labor Force

UPDATE: PGL responds at Angry Bear an in the comments to this post. A commenter at Angry Bear remarks that job prospects drive schooling. Hence, the increase in enrollment is not something to celebrate. True, there is a cyclical component that I think can be seen quite clearly in the more dramatic response in e/p in both of the last two recessions. As with the males over 20, the cyclical declines in the series are very similar in the two recessions. But what explains the fact that teenage e/p failed to reach its pre 1990 peak during the late 1990s? School enrollment seems a good place to start.

Another commenter here claims that minimum wage increases also contribute to what we are seeing here. It's hard to separate the effect of the recession and the coincident increase in the minimum wage in the early 1990s. However, the minimum wage increase in 1996 and 1997 where the chart does show a little weakness. There were two separate increases in the minimum wage, and the timing works well for one but not the other in the chart. Thus, I'm hesitant to pin an inordinate amount of significance to it, but I'm willing to accept it as a possibility, especially for late 1996 and early 1997 where it probably did have some effect on keeping teenage e/p from rising more rapidly.

The fact that students may stay in school longer when job prospects are poor does not invalidate my point that the e/p ratio may decline over time due to a combination of a long run trend towards more schooling and the demographics of an aging population.

UPDATE PART TWO: Bob Herbert laments "The Young and the Jobless."

According to Hal Varian (NY Times):

TAX systems are like septic tanks: they need to be cleaned out every 10 years or so.

And also:

Some might want to see marginal tax rates increase with income; some might like to see them stay relatively flat. But, as the authors point out, there is no coherent theory that advocates the "crazy quilt of blips" implied by the current rate structure.

Read the whole thing.

It was a beautiful day in Peoria on Saturday--warm, sunny...perfect. So we decided to jump in the car and drive up to Chicago just for the fun of it. Of course, Dad (that would be me) forgot to check the weather for the lakefront. It was chilly, but great fun nonetheless.

In the photo, you can see the low clouds rolling in off Lake Michigan and enveloping the skyline. We took this picture from the Ferris Wheel at Navy Pier. Fortunately, there is as much to do inside Navy Pier as there is outside. Turned out to be a great day even with the clouds.

It's true. If it wasn't so maddening, it would be funny. But there's nothing funny about the inequalities present in public schools today.

Attorneys representing students from the Shawnee Mission district say the story "Harrison Bergeron" shows that a world of forced equality would be a nightmare, so unequal funding of public schools is OK.

Their legal brief says capping local taxes on schools was unconstitutional, and they cited the 1961 story, which depicts a future society where everyone is made equal by forcing impediments on anyone who is better.

"Nobody was smarter than anybody else," the attorneys quoted Vonnegut as writing. "Nobody was better looking than anybody else.

But in a telephone interview Wednesday, Vonnegut told the Journal-World that the students' attorneys may have misinterpreted his story.

Ya think?

"It's about intelligence and talent, and wealth is not a demonstration of either one," said Vonnegut, 82, of New York. He said he wouldn't want schoolchildren deprived of a quality education because they were poor.

"Kansas is apparently handicapping schoolchildren, no matter how gifted and talented, with lousy educations if their parents are poor," he said.

...

The court has ruled that the $2.7 billion in school funding is inadequate and distributed unfairly. The Legislature has approved a $142 million increase and allowed local districts to raise property taxes nearly $500 million more.

Critics say the increase is not enough and the local property tax options will widen the disparity between wealthy and poor districts. The court will hear oral arguments on the new legislation Wednesday.

Attorneys representing 40 students from the Shawnee Mission school district in Johnson County filed a brief supporting the Legislature's new law, and went further, saying there should be no limit on how much local districts could raise in taxes for local schools.

Any attempt to cap local taxes for schools is unconstitutional, they argue, "because it impermissibly infringes on individual liberty and related fundamental rights and usurps local school board authority to supplement public education over and above the suitable level."

OK. In principle I don't see anything wrong with their argument that local districts should be able to raise as much as they want. This isn't the problem. The problem is when the wealthy districts use their power in the state legislature to diminish the state funding to extremely low levels. Implicitly saying to the less wealthy areas, "Don't count on the state, raise the money with local taxes. Look at us! We're doing it!"

Alan Rupe, an attorney representing plaintiff school districts on the opposing side, said the Shawnee Mission brief was "well-written" but that he disagreed that local districts should be allowed to raise as much as they want.

The opposing attorney understands this point.

"I would classify this as the Johnson County viewpoint of the world," Rupe said. "This kind of viewpoint exists when there is not adequate funding for all schools," he said.

Rupe said that he didn't oppose the use of some local taxes for schools, but that under the current system local taxes were used for essentials in schools and that was not fair to poor districts that couldn't raise much in local taxes.

"We don't want to cut off any mountain tops. We want to raise the valleys so kids in poor areas come up to the mountain tops," he said.

We don't want to cut off the mountain tops. We want to raise the valleys. Beautiful. But the political cards are stacked against it.

I don't mean to suggest that there's an easy answer. There is not. But I think it's pretty extreme to quote Vonnegut's science fiction where...

In the story, smart people have to wear radios that emit distracting noises, pretty people must wear hideous masks, and athletic people are weighed down with bags of birdshot.

Comparing this to subsidizing public education missing the mark.

Readers are free to draw analogies between this story and my Social Security as insurance post.

Oh, and a shout out to my friend Alan Bjerga who writes for Knight-Ridder's Kansas newspapers (and with whom I had a spirited discussion of Thomas Frank's What's the Matter With Kansas last summer.

I wonder what he thinks about this.

A couple days ago I said,

And what, you ask, do I think the real debate is (or should be)?

I'll have some thoughts on that later. It's probably not what you think I'm going to say.

Social Security benefits are progressive--benefitting lower income workers with higher replacement rates. The system is widely touted as Insurance against poverty in Old Age or in the case where a spouse or dependents Survive the main breadwinner. OASI=Old Age and Survivor's Insurance.

However, benefits are at least marginally tied to your lifetime wage profile--like a defined contribution plan or a forced savings program. So what is it? Insurance or forced savings? Brad DeLong and Mark Thoma emphasize the insurance aspect. Actually, they take particular objection to those who call it welfare. Most assuredly, Social Security is not welfare, so we've got no argument there. Angry Bear comes closer to a direct comparison of the insurance vs. savings question. He says,

...all of the privatization plans I've seen discussed would replace Social Security with a defined contribution style system in which the more a person makes, and the luckier that person is, the more that person will have at retirement, and vice-versa. The insurance function of pooling and attenuating risk is totally removed; or, more accurately, reversed.

So I think it is useful to think of a Social Security program like ours as having an insurance component to prevent poverty and indexed benefits as a political appeasement to those who are less likely to need the insurance.

Where do you draw that line? What is the appropriate level of insurance? Can you have private accounts (add-on or carve-out) and maintain the insurance aspect? How do we get from where we are to where we want to be?

This is the discussion that we aren't having, but should have. It doesn't matter where you stand on trust funds or private accounts to discuss the appropriate level of social insurance. If we could get a handle on that question, then we could make progress on the rest of it. The consequences of this question run deep. If you believe that the insurance portion of the system should be enhanced above what it is now, then private accounts are a non-starter. If you want to allow people to self-insure more than they do now, then you would likely think that private accounts are a vehicle for them to choose their level of risk. This is a normative question. This is a matter of your view on how much risk is acceptable in a person's lifetime consumption profile, how replacement rates should vary with lifetime income, etc.

Trust funds are a distraction when you look at the problem this way. All these posts about the trust fund are arguing over minutia--how real are the assets, how shortsighted the credit market is for not recognizing that the trust fund has been raided, and so on. The bonds are real. The promise to pay benefits will be kept (subject to modifications by Congress, but the modifications are not likely to be severe). The trust fund is being used by both sides as a rhetorical device to advance their point of view by quibbling over the value of a bond. These matters, while interesting, are nothing compared to a frank discussion of the role of Social Security as insurance and the appropriateness of having the government run a pension program whether it's with private accounts or not. This discussion would not take place in a vacuum, but would necessarily take place in the context of the overall tax and spending environment at the macro (government finance) and micro (overall tax progressivity and the effect on households) levels.

Debating the progressive price indexing of the Pozen plan is a start. Brad DeLong's piece in Slate is a good opening salvo. In it, he implicitly acknowledges the political reasons for less draconian cuts.

Pozen's proposal caps the maximum Social Security retirement benefit at roughly $22,500 dollars a year (adjusted for inflation). Bush's private-accounts plan—which would allow people to contribute 4 percent of their wages—makes retirees repay the taxes they diverted into private accounts out of their standard Social Security benefit. Medicare premiums are already deducted from your Social Security check. Deduct the claw-back for the private-accounts diversion as well, and by late in this century the odds are that—at least for the upper middle class—the standard Social Security check would be zero. Social Security would no longer be a universal program: It would be a program in which the half of America that is richer and more powerful and more likely to vote sees large chunks of its money going in and nothing coming out. (emphasis mine)

Appeasement for those less likely to need insurance might be a political necessity to keep the program viable. This has always been a standard argument against means testing.

I say again, this is the right discussion to have.

I, for one, would approach such a discussion with an open mind.

Via Reuters:

The Treasury said it was considering semiannual auctions of a 30-year nominal security beginning February 2006. It announced suspension of the 30-year bond in October 2001, with the last auction having taken place in August that year.

Not that surprising, really. Everyone who has refinanced their house in the last few years knows that locking in a low interest rate for 30 years is a good thing.

They'll make an announcement August 3. I think it will be affirmative. They wouldn't admit they were considering it unless it was actually going to happen.

UPDATE: Brad Setser has more, including this very sensible conclusion:

But even as the Treasury is (rightly) reconsidering the risks that arise from the combination of a rising debt stock and a shorter-maturity on that debt stock, demand from central banks for Treasuries may be shrinking somewhat, albeit from an extremely high level. Central banks right now are all talking about diversifying the composition of their dollar reserves, and put less of their still growing reserves into the Treasury market.

That supports the case for resuming issuance of the thirty-year bond. It might bring new demand into the Treasury market even as central bank demand fades. Since central banks generally prefer shorter maturities, a shift in the Treasury's issuance pattern would help to match the bonds the Treasury issues with the bonds the market most wants.

But it is at least possible that the Treasury could end up increasing the supply of long-term debt in market just as demand for those Treasuries starts to fade a bit. Who knows, that might even put pressure on rates and some hedge fund might get caught with too large a leveraged bet … (Note the complaining at the end of this New York Times article). Is it likely a surge in long-term Treasury issuance will change the dynamics of the market? My guess: No, not on its own. But it might interact with something else in the market in an unpredictable way.

My bottom line: the Treasury should have started issuing more long-term debt – be it ten year notes or longer term bonds -- back in 2003, even if there was a cost advantage to issuing more short-term debt at the time. The Treasury does need to take steps to reduce its own refinancing risk. But it is at least possible that it may not be able to do so in 2006 without putting more pressure on the market than it expects ...

The comments on his post are interesting too.

From the NY Times: "Fed Raises Rates but Bobbles Delivery"

The unexpected amending of the Fed's statement just before 4 p.m. caught the bond market by surprise and cost traders some money. As for stocks, the announcement was so close to the end of the session that its impact was muted. But stocks rose in the last few minutes of trading.

I was right about the time. It's pretty apparent in the intra-day charts.

"I can't remember anything like this," said Louis Crandall, chief economist at Wrightson ICAP. He said one reason the market was caught off balance was that the original statement was the kind of negative news many bond traders had prepared for.

Yes, and prepared quite well. (Hence, the title of the post I wanted to make--"Bond market keeps its head."

The head trader on the Treasury desk at a major bank, who spoke on the condition he not be identified, said, "I can tell you it cost us some money."

When the original statement was released at 2:15 p.m., the price of the Treasury's 10-year note fell immediately but modestly. The yield, which moves in the opposite direction, rose to 4.21 percent from 4.19 percent.

Yes, "modestly" is a good word to describe it. But then...

After the announcement of the restoration, the yield fell quickly to 4.15 percent and the price jumped. In late trading, the yield was at 4.16 percent.

"I think people took positions on a set of facts that they thought to be correct and then they changed," the trader said. For a few minutes, he said, it was hard to buy Treasury securities to cover losing positions, and traders who were short in their holdings had to buy back Treasuries quickly to avoid losses.

I wonder if the volatility will carry over into tomorrow or if traders were able to re-establish their positions. Sound like it was a pretty crazy few minutes in the bond pit. Not what the Fed wants. Not at all.

Now, if that sentence had just been in there in the first place, would there have just been a modest move upward? I tend to think so. Perhaps that's where we'll end up tomorrow (absent any new information pushing us in another direction), maybe 4.17% or 4.18%, which is just barely changed from where we started.

What a day.

UPDATE: Dave Altig does his usual yeoman's work in summarizing the blogs. Check out the links. Some are harsh. Can't say I blame them. I realize we all make mistakes, and I know I've made my share. But when the stakes are this high, you really need to proofread the document to make sure it says exactly what you want it to say. I don't think it will cost them many confidence points, and I sure hope it doesn't. But still...

Yes, I thought it was a little odd that the statement that came out at 2:15 EDT lacked a sentence about long term inflation being contained. I thought maybe they were trying to sound like they were playing to both sides. There was a mention of the slowing economy but also a tacit acknowledgement of creeping inflation. This was followed by a conditional outlook. A whiff of stagflation? It was a question worth pondering. I started to see headlines on the 'net that stocks were falling on the news. Bonds appeared to hold steady. I began composing a post in my head that I would call "Bond market keeps its head."

And then, this. In the first ever "oops!" of this kind, the FOMC corrects itself saying it left out the sentence about long-term inflation being well contained.

I don't know exactly when the announcement of the corrected press release came in (anyone?), but I looked at the intra-day 10 year yield and I'm guessing it was close to 4pm EDT. As of now, the bond is up 6 ticks and the yield is at 4.16%. I'm thinking it might still give a little of that back--it was up 8/32 for a while. Interesting little episode, but I don't think there's much to make of it other than illustrating to our students just how tightly wound the bond market is right now.

The press release wasn't bad to begin with, and adding back that sentence (which has been there before) makes it marginally better. I'm definitely not as bewildered by the bond market as I was in March. The 10 year might be a little overvalued for my blood, but at least they didn't react the way they did last time. For the most part, the market did keep it's head today in a collective sense.

And I think that this statement keeps the door open to a faster or slower pace of monetary adjustment as needed. If you've been watching the intermeeting data, nothing in this statement should surprise you. The acknowledgement of the "soft patch" comes here:

Recent data suggest that the solid pace of spending growth has slowed somewhat, partly in response to the earlier increases in energy prices. Labor market conditions, however, apparently continue to improve gradually.

Special note to my intermediate macro students: This language is pretty close to what we discussed this morning.

Oh, I should mention that today is the last day of classes at Bradley University before finals start. As I have done for the last couple years, I led my intermediate macro class in a simulated FOMC meeting on the last day of class that coincides with an actual meeting day. When it also happens to be a the last day of class, it's a great way to end the semester.

They did a fantastic job.

Note to macro professors: For a good description of an FOMC simulation, see this paper by Scott Simkins. If you actually try to do the simulation it would be worth reading A Term at the Fed by Laurence Meyer for a detailed description of what goes on in a meeting.

And so now all eyes turn toward Friday and the April employment report.

A 25 basis point increase in the funds rate is all but a certainty. The question is what will happen next. Consider this from the Wall St. Journal (subscription)

About a month ago traders were talking about how, with the U.S. economy strong and inflation picking up, the Fed might raise the rate used by banks on overnight loans by half a point by the time the summer was up. Now that it has become clear that the economy began rowing against the tide in March, the talk is how the Fed might skip raising rates at one of its meetings to assure itself that nothing has gone seriously amiss.

The article finishes with a mention of the yield curve, which is flattening. Speculation is increasing that a pause in the rate hikes is coming. (See macroblog's weekly installment on the fed funds futures.)

It's no secret that everyone will be parsing the press release for words indicating that a pause is around the corner. I'm thinking that we will see a press release that looks a lot like the last one. The biggest thing that the FOMC could realistically do tomorrow is to change the risk assessment. I don't think they will, but that would open the door for a pause.

One thing they should not do, however, is allow inflation expectations to creep up--even if that means continuing the rate increases at a... (*cough*)... "measured"... pace.

Buffet loses millions, but his pockets are deep.

Chris Dillow (Stumbling and Mumbling) makes a couple of good points.

Indeed, even common sense is little use. It tells us that currencies with high interest rates should depreciate relative to those with lower interest rates. As often as not, they don’t. That’s the forward premium puzzle.

For money-making purposes, then, economists don’t know much about exchange rates.

Is this a failure of the economics profession? No, It’s a success. People pay many economists good money for exchange rate forecasts. How many other professionals can get such good money for so little?

Instead, this is just another vindication of Blinder’s law: economists have most influence where they know least and disagree most, and least influence where they know most and disagree least.

Yep.

Let's look at what the President said in his news conference.

We're saying, you ought to have the right to set up a personal saving account so you can earn a better rate of return on your own money than the government can.

And it's that difference between the rate of return, between what the government gets on your money and what a conservative mix of bonds and stocks can get on your money that will make an enormous difference, and a person being able to build his or her own nest egg that the government cannot spend.

Now, it's very important for our fellow citizens to understand there is not a bank account here in Washington, D.C., where we take your payroll taxes and hold it for you and then give it back to you when you retire. Our system here is called pay-as-you-go. You pay into the system through your payroll taxes, and the government spends it. It spends the money on the current retirees, and with the money left over, it funds other government programs. And all that's left behind is file cabinets full of IOUs. (emphasis mine)

What's wrong with the italicized part? If you said that what the government "gets" on your money is irrelevant, you're a winner. Why did he say it this way? No clue. Rhetorical flourish maybe. Maybe he thinks it sounds good to put the idea in people's minds that individuals can do better than the government. Sounds nice, but it's both irrelevant and technically wrong.

Hence PGL at Angry Bear writes:

So if I own a Treasury bond, that is a real asset but it is not a real asset when a Trust Fund owns a Treasury bond. And suppose I recently purchased a bond paying a 4.8% nominal return. Bush is saying this is somehow a better return than the Trust Fund gets – even though its bond also pays a nominal return equal to 4.8%.

Good catch, my friend. That is what Bush appears to be saying. And you're also correct to point out that it can't possibly be right.

But it's also irrelevant. Why? You could set the nominal interest on those non-traded bonds to be anything you want. It has no impact on the benefits that retired people will receive (a point I made here). The interest on the bonds does not figure into the benefit formula for an individual. Higher interest on the bonds would just mean that the general fund has to pony up more cash when the bonds come due--restoring "solvency" at the stroke of a pen by making it explicitly a general fund problem. It's irrelevant to the discussion of private accounts!

To the individual, it matters not "what the government gets" but "what the government gives" (the benefit formula).

So, PGL calls out Don Luskin for saying

Younger workers should have the option of putting a portion of their payroll taxes into a voluntary personal account which will allow them to build a nest egg that belongs to them. This money will give workers an opportunity to receive a higher rate of return than the current Social Security System can provide. (emphasis mine)

But to be fair, this is really just a paraphrase of the Moynihan-Parson's Commission (2001, p.38).

The river of lousy rhetoric runs deep indeed. Let's get it right. The pro-privatization side is doing a terrible job of explaining itself and it plays right into the hands of the opposition. It's a shame, because this just bogs down the real debate.

And what, you ask, do I think the real debate is (or should be)?

I'll have some thoughts on that later. It's probably not what you think I'm going to say.

Thousands.

After this week, Dr. Joan Buckley can put down the red pen and enjoy the other things she loves to do. She's retiring from Concordia College.

50 years is a long time in this business, and she spent all but one year at Concordia where she taught thousands of students. Many of them were your basic freshman English composition/literature students. One of them was me.

Dr. Buckley (even today I don't think I could call her Joan) was a legend in her own time at Concordia. She was "old school" in the way that many of the greatest professors are old school. She was very demanding, but high expectations can inspire students to great things. I worked harder on my final term paper for her class than I worked on anything else in my freshman year.

I still have that paper, "The Nature and Treatment of Grace in the Literature of Flannery O'Connor."

I became a fan of Flannery O'Connor's short stories because of Dr. Buckley. I also read Nathaniel Hawthorne for the first time in her class and loved it.

When the end of the semester came, I gave her a good evaluation. But alas, how does an end of semester evaluation measure the enjoyment that a person gets from reading great literature with a critical eye years later?

Thank you, Dr. Buckley. May you enjoy a long, happy, and healthy retirement.