Known Unk


Welcome to Known Unknowns, a newsletter in complete denial that anyone ever seriously considered punitive tariffs or currency manipulation.

What causes a recession?

For the past five years, everyone has been waiting for the big one—another bad recession. Yet, despite unpredictable elections, the return of stock market volatility, a resurgence of populist economics, and a whole lot of uncertainty, the economy keeps chugging along and unemployment is only 3.6%.

It feels like the boom must end eventually, but how and why? The Wall Street Journal digs into the two factors that generally cause a recession: an economic shock or bad Fed policy. It turns out that booms don’t die of old age. An economist at the San Francisco Fed, like an actuary (!), puts the odds of a boom ending at each age and the odds of a recession are the same five years into a boom as they are 10 years in.

So, what will cause the next recession? There several candidates for a shock: a trade war, the messy Brexit or Euro area troubles, an increase in long-term interest rates, a stock market drop worsened by leveraged loans, or something we aren’t paying attention to like Korean pensioners.

Another candidate is a bad Fed policy. A 25- or a 50-basis point rate increase won’t do it. It would need to be a huge and unexpected rate increase. Or maybe it could be a rate cut. If markets believed the Fed had lost its independence, is trying to compensate for a trade war, is enabling more leverage, or is just trying to prop up the stock market. In a low-inflation, low r* world, the channels through which monetary policy works might change and then so will its impact on the economy.

Will annuities ever be popular?

Economists and insurance companies love annuities—but no one else does. It is a small miracle that the SECURE Act passed the House with bi-partisan support and is now expected to pass the Senate. It does many important things to enhance retirement income security, notably by helping savers achieve predictable income rather than encouraging them to save and invest for wealth. 401(k)s were meant (not originally, but this where we are now) to provide income in retirement, not just be a pot of money on day 1 of retirement.

Knowing how much to spend each year and how to invest in retirement are hard, much harder than saving. Most savers aren’t equipped to make these decisions. It does not help that they’ve been conditioned to think in wealth terms their whole lives. The SECURE Act is a step in the right direction. It makes it easier to offer annuities in 401(k) plans and it requires statements to show balances in income terms (how it will be calculated is another story, but we’re on the right track).

The question remains: Will it make a difference? People are reluctant to annuitize their wealth. Low rates aren’t helping because they make annuities so expensive. The media push-back is not helpful either. Unfortunately, many financial journalists hate annuities because they distrust financial institutions and still think the goal is wealth accumulation. Take this line from Barons:

“It made no sense—savers don’t need income; they need growth.”

What then is the purpose of saving!? To be fair, there are some expensive, complex annuities. The current broker model means people are often sold expensive features they don’t need. Ideally, there will be some parameters on the annuities that qualify for the safe-harbor provision.

Another bad statistic

You’ve probably heard that 40% of Americans can’t cover a $400 expense. That’s only kind of true. None of the 40% have the cash, but most of them could cover $400 with a credit card. The share of Americans undone by that $400 is only 12%—not great, but not nearly half the population either.

Now, credit cards aren’t an ideal emergency saving strategy—just think what will happen if populists get their way and impose credit interest rates. But it may reflect a choice to spend or have more illiquid savings because emergency credit access is so easy—albeit expensive.

I think this distinction is important because, to solve the problem, it must be identified first. The problem is not that Americans are so hard up they can’t cobble together $400; but rather that they don’t appreciate risk or the interest on credit cards. These are different problems that require different solutions.

That’s why everyone needs to learn more math

The students at LaGuardia High School (the Fame School) are protesting their tougher academic standards. The principal wants to enforce academic standards in admissions and require more academic college prep classes, but the students want to focus on the arts.

They aren’t the only ones making this argument. You can’t swing a dead cat without hitting someone pushing for more vocational training and complaining that people are too fixated on college. I agree that more vocational schools may be more efficient, but I worry about what it will mean for economic mobility.

There is also that pesky risk issue. The economy requires critical thinking skills in all jobs. Even construction jobs require more technical skills. Critical thinking enables workers to retrain and learn new skills as the economy evolves. Even dancers might need math in the future if they want to protect their jobs.

So even while the chatter is toward earlier tracking, we may need people to specialize later.

In defense of theory

Economists (and really everyone) have become much more data dependent recently. On balance, that’s wonderful as data often tells the real story…sort of. Data tells us stories from the past and we use our own judgement about whether these stories are relevant or not. Data will never speak for itself, and therefore sometimes we get the story wrong.

I reckon that’s why elections forecasting is terrible, why Hollywood makes so many bad movies, and why economic policy often fails to have the impact we expected. When it comes to data, we have a little too much of a good thing. Data means nothing without theory. Theory tells us what data is useful, and what the overall story means. I realize it is imperfect and prone to our human failings, but at least it is clear and transparent.

I am also starting to suspect more data and less theory could be one reason why there have not been many earth-shattering break-throughs in recent economic thought. We are still mulling ideas from the 1970s and 1980s. What do you think?

In other news

Until next time, Pension Geeks!