A unifying theory of the economy

Pension Geeks shall inherit the earth

Photo by Hans Isaacson on Unsplash

Hello,

Welcome to Known Unknowns, a newsletter about economic events with as much staying power as a fight on Twitter and some things that matter.

Economic news that matters and news that does not.

So much is going on that we won’t remember in a few months. First, there is a risk that the government will run out of money in a few weeks if we don’t raise the debt ceiling. I mostly refuse to engage with this news cycle because a deal seems to be made, but we must endure lots of scare pieces about default and even more tedious articles about the trillion-dollar coin. And then it all works out anyway. But I think the debt ceiling is kind of a good thing because it forces us, in a dysfunctional way, to have a conversation about what the size of government should be. Biden has put out his budget, and the Republicans have put out theirs. They are both ridiculous in parts, but there is some vision, and we can see where they stand on the size of government question. In theory, this would not happen under the threat of default, but the same dysfunction that causes this drama is the same reason why we don’t have this discussion at all—or only if we count, “What is the right size government? OK, let’s double that!” which we normally do.

Unemployment is at 3.4%; inflation is at least 200 bps bigger than it should be. Seems like a no-brainer that the Fed should be tightening. But small and regional banks are in trouble. Now the very same people who worried about market concentration are questioning why small banks exist. I don’t have a view. Many people are asking me if the Fed should have raised rates and if this financial instability is their fault. Yes. But they had to raise rates this fast because they waited too long to begin with. And it did not help that they assured us market rates would not rise too much or for very long while they were dithering. I am not so sure about this forward guidance anymore. And I can’t totally blame the small banks when they got so many confusing messages.

In the grand scheme of things, a 25-bps rate increase does not matter. Neither does debt ceiling theatrics. However, there was also a piece of economic news that will have long-term and important consequences. Apparently, there is a new “Washington Consensus,” but instead of freer trade and market-based solutions, the new regime is about controlling markets with industrial policy, reshoring, or sometimes friend shoring. About ten years ago, at the Council on Foreign Relations, I heard people with senior positions in the state department explain the new frontier of economic statecraft, which is using economic policy to further diplomatic and strategic aims. Most people in the audience oohed and aahed about this new powerful tool. But as they spoke, I was struck by how little they understood economics and what drives prosperity.

Shame on me because they are now in charge, and their worldview is the “Washington Consensus.” The hope is that clever policymaking can control everything: geopolitical risks, trade, the pace of growth, and have no setbacks or market mistakes. In other words: lower growth. Because, just like with financial markets, there is no free lunch. Higher returns come with more risk, and growth means you can’t manage the economy. If you de-risk the economy, there is less growth and innovation. And that’s a choice we are making.

Maybe we’ll get lucky. AI and AGI may bring big increases in productivity despite our efforts to rein them in. Tech innovators are asking the government to help because they are wary of the profit motive guiding them. They think the scope for human annihilation is too great. Maybe. Regulation is probably necessary at some point; I don’t know the technology as well as they do. But if the government can’t make a semiconductor efficiently, how will it guide the progress of AI?

The unifying theory of everything

I am as much of a YIMBY as anyone. But is it just me, or is the reflexive “if we just build more housing, 98% of America’s problems will go away” thing getting a little annoying? Also, as much as I think we should build more, even good policies can go too far.

But I should not talk. While hardcore YIMBYs think changing zoning restrictions is the root of what’s wrong with everything, I, too, can point to a single thing that is ruining the US economy —public pension accounting standards. It really is what’s wrong with everything.

There are two new books that spawned some compelling and widely read articles that argue private equity (PE) is ruining America. And it does make a good villain, rich people in fancy suits coming in and selling off parts of a company and firing people. But the concept of private equity is actually not terrible. Some companies need someone else to make them more productive and viable in a changing economy. And traditionally, private equity firms were pretty good at that.

I wrote for Bloomberg this week that this has changed in the last decade. PE backing was associated with more job loss and less productivity. What changed? Very underfunded public pension plans plowed lots and lots of money into PE funds, often not very good funds. They had every incentive to do so. Their accounting standards suggest they discount their liabilities using their expected rate of return. So, if they invest in something opaque and illiquid, they can claim whatever return they want, and—BAM! Funding problem solved. Throw in low interest rates, and PE was even more attractive to desperate capital.

They need better standards. Pension funds should discount their liabilities using market interest rates. The whole idea of using your expected rate of return makes no sense. It is the kind of nonsense you get when you let actuaries or state department officials make economic decisions. The high-rate environment is a good time to impose better standards. And then PE investment will be better, the economy will be more efficient, and there will be more jobs.

That’s all we need to do.

Twitter Blues

I have complicated feelings about Twitter. I get so much useful information from it about news, the latest economic research, and lots of silly stuff too. But I also blame it for my constant state of low-grade rage that so many people are racist or just bad at economics. So even though I lost my Blue Checkmark, I have no plans to pay for one right now.

I have no ill will toward Elon. And considering how much time I spend on Twitter and how useful it is for my work, I can justify the cost. The problem is just that I don’t want to pay for something that used to be free.

We all have weirdness around free stuff, and making something no longer free is a hard pill to swallow. Apparently, people in Spain who can’t share Netflix passwords anymore are quitting in droves, same thing.

It poses a big problem for the tech industry. They bet on offering free services to get many people to use their product because owning the network was critical to success. But now, with rising rates and an iffy economy, they have to pivot to charging people money. And it is not clear they can pull it off unless they offer a new value proposition.

In the meantime, the freakout over people losing and gaining status in real-time is something to behold. No matter how much technology we have, people are still petty and tribal.

In other news

I spoke to Richard Shinder about everything that’s going wrong with the economy—except for pension discount rates.

Until next time, Pension Geeks!

Allison