This is the question that will be asked by readers of his column complaining that no one is listening to Morgan Stanley director Erskine Bowles and former Senator Alan Simpson. Milbank complains that Obama is only willing to cut Medicare by the $400 billion amount advocated in Bowles-Simpson’s initial plan. (Milbank mistakenly calls this the commission’s plan. The commission did not issue a plan since no plan received the necessary majority vote.) Milbank attacks Obama on these points:
“But that proposal was made in 2010, and the nation’s finances have since deteriorated.”
If Milbank had access to budget documents he would know that the nation’s finances have deteriorated because the economy has performed worse than the Congressional Budget Office had expected. In 2010, it expected that unemployment rate would average just 6.5 percent for the years 2012-2014 (Table 2-3). The country did not have a lavish spending spree or tax cutting orgy, it ran larger deficits because the economy has been weaker and needed and needs more support.
Milbank condemns the failure of Obama to support more budget cuts, and specifically more cuts in Medicare, in the face of economic weakness as being unserious. (He also condemns Republicans for being unwilling to raise taxes. Milbank’s attachment to Medicare cuts is striking since CBO’s projections for Medicare costs have actually fallen by more than the cuts originally advocated by Bowles and Simpson.
Anyhow, for Milbank it is clear that the goal is to inflict pain on ordinary people, throwing them out of work and taking away Medicare and Social Security. In the Washington Post this is the criterion for being serious.
This is the question that will be asked by readers of his column complaining that no one is listening to Morgan Stanley director Erskine Bowles and former Senator Alan Simpson. Milbank complains that Obama is only willing to cut Medicare by the $400 billion amount advocated in Bowles-Simpson’s initial plan. (Milbank mistakenly calls this the commission’s plan. The commission did not issue a plan since no plan received the necessary majority vote.) Milbank attacks Obama on these points:
“But that proposal was made in 2010, and the nation’s finances have since deteriorated.”
If Milbank had access to budget documents he would know that the nation’s finances have deteriorated because the economy has performed worse than the Congressional Budget Office had expected. In 2010, it expected that unemployment rate would average just 6.5 percent for the years 2012-2014 (Table 2-3). The country did not have a lavish spending spree or tax cutting orgy, it ran larger deficits because the economy has been weaker and needed and needs more support.
Milbank condemns the failure of Obama to support more budget cuts, and specifically more cuts in Medicare, in the face of economic weakness as being unserious. (He also condemns Republicans for being unwilling to raise taxes. Milbank’s attachment to Medicare cuts is striking since CBO’s projections for Medicare costs have actually fallen by more than the cuts originally advocated by Bowles and Simpson.
Anyhow, for Milbank it is clear that the goal is to inflict pain on ordinary people, throwing them out of work and taking away Medicare and Social Security. In the Washington Post this is the criterion for being serious.
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Most economists have names, but the NYT managed to find some without names to give critical comments on the stimulus plans of Japan’s prime minister, Shinzo Abe. An article on Mr. Abe’s plans told readers:
“Economists say Mr. Abe’s policies so far contain few of the deeper-reaching structural reforms that they say are needed to produce sustainable growth by encouraging competition in Japan’s sclerotic economy. They say the most symbolic step would be joining a Pacific-wide free trade pact that would force Japan to open sheltered domestic markets, like farm products.”
It would be interesting to know which economists have this view, because some economists, like Paul Krugman, have argued that the main obstacle to Japan’s growth is a lack of demand. They have advocated exactly the sort of expansionary fiscal and monetary policy that Abe is now advocating.
It is also worth noting that the Pacific trade agreement mentioned in this piece cannot properly be described as a “free-trade” agreement. Most of its provisions have nothing to do with trade and some involve increased protectionism, like stronger patent and copyright protections.
The piece also referred to “Japan’s already stifling national debt.” It’s not clear how it has determined that Japan’s debt is “stifling.” The interest burden of Japan’s debt is roughly 1.0 percent of GDP, roughly two-thirds the current size of the U.S. interest burden and one-third of the burden the U.S. government faced in the early 1990s. The interest rate on long-term Japanese debt is just 1.0 percent. And, it is facing deflation, not inflation.
If the debt is stifling Japan’s economy, it is not showing up in the data. If the economists cited in this article had names perhaps people could try to figure out what they meant.
Most economists have names, but the NYT managed to find some without names to give critical comments on the stimulus plans of Japan’s prime minister, Shinzo Abe. An article on Mr. Abe’s plans told readers:
“Economists say Mr. Abe’s policies so far contain few of the deeper-reaching structural reforms that they say are needed to produce sustainable growth by encouraging competition in Japan’s sclerotic economy. They say the most symbolic step would be joining a Pacific-wide free trade pact that would force Japan to open sheltered domestic markets, like farm products.”
It would be interesting to know which economists have this view, because some economists, like Paul Krugman, have argued that the main obstacle to Japan’s growth is a lack of demand. They have advocated exactly the sort of expansionary fiscal and monetary policy that Abe is now advocating.
It is also worth noting that the Pacific trade agreement mentioned in this piece cannot properly be described as a “free-trade” agreement. Most of its provisions have nothing to do with trade and some involve increased protectionism, like stronger patent and copyright protections.
The piece also referred to “Japan’s already stifling national debt.” It’s not clear how it has determined that Japan’s debt is “stifling.” The interest burden of Japan’s debt is roughly 1.0 percent of GDP, roughly two-thirds the current size of the U.S. interest burden and one-third of the burden the U.S. government faced in the early 1990s. The interest rate on long-term Japanese debt is just 1.0 percent. And, it is facing deflation, not inflation.
If the debt is stifling Japan’s economy, it is not showing up in the data. If the economists cited in this article had names perhaps people could try to figure out what they meant.
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That’s what he told us in his column today, because he sure didn’t make much of an argument. Lane cites several recent papers showing that the minimum wage has no negative effect on employment (including my colleague, John Schmitt’s paper). He then notes that these studies could be right, but he also refers to research by David Neumark of the University of California at Irvine and William Wascher of the Federal Reserve that shows the last minimum wage hike (from $5.15 an hour in 2007 to $7.25 in 2009) lowered employment of young people by 300,000.
He then warns that if their research is right, and we push the minimum wage too high, then we could be hurting the people we are trying to help. He also points out that even if the research showing no employment effect is right, then we would still be hurting other workers by pushing up prices or wage compression. He then proposes spending more money on the earned-income tax credit (EITC) as an alternative to a higher minimum wage.
Okay, let’s have some fun here. Lane’s bad story is that 300,000 fewer workers would be employed. That sounds really awful, after all these are the people we are trying to help. But let’s think about this one for a moment. The jobs we are talking about tend to be high turnover jobs that workers only hold for relatively short periods of time. The research that Lane is depending on shows that at any point in time 300,000 fewer workers will be employed as a result of a minimum wage hike of more than 40 percent. In effect, this means that workers will on average have to spend more time between jobs looking for work.
More than 3 million workers were in the affected wage band between the old and new minimum wage. If we assume that on average they worked 10 percent less (the 300,000 job loss) and that their average hourly wage gain was 20 percent (half of the wage increase) then on average these workers will net roughly 8 percent more in pay each year (120 percent * 90 percent), while working 10 percent fewer hours. Pretty awful story, huh? And that’s based on the research that finds a negative effect on employment.
As far as the rest Lane’s story, yes, the higher pay for minimum wage workers comes mostly out of other workers’ pockets. (Some comes from profits and some comes from increased productivity.) This is true of everyone’s pay. If protectionists did not dominate national policy we could import more doctors and bring our doctors’ pay in line with pay in other wealthy countries and save other workers close to $100 billion a year in health care costs. But the money that goes out of workers’ pockets to support the excess pay of doctors, Wall Street bankers or CEOs doesn’t concern Lane, only the money that goes to pay custodians, retail clerks, and dishwashers.
But the best part is the idea that the EITC is somehow free. In fact we need government revenue to pay the EITC, which requires taxes. Taxes will also come out of workers’ pockets and also have a distorting effect on the economy. In addition, there are also costs associated with administering the EITC. While it does not have nearly the level of fraud claimed by its critics, clearly some portion of the money is paid out improperly. And, low-wage workers often have difficulty dealing with tax returns. Many throw hundreds of dollars in the garbage paying tax preparation services in order to claim their EITC.
In short, Lane doesn’t really have much of a case against a higher minimum wage even if we accept his bad story about job loss. And, he seems to have imagined that there is an alternative costless way to get more money to low-paid workers.
There is one final point worth noting in the context of proposals to increase the minimum wage. From its inception in 1938 to 1969, the minimum wage rose in step with economy-wide productivity growth. If we had continued this policy over the last four decades the minimum wage would be $16.50 an hour. Even if the minimum wage is raised to 9.00 an hour, minimum wage workers would get none of the benefits of economic growth over the last four decades.
Addendum:
Charles Lane wrote to tell me that I had misrepresented the Neumark estimate of the employment impact of the last minimum wage hike. Neumark was only referring to the impact of the last phase of the increase (which was phased in over three years) from 6.55 to 7.25, a rise of 10.7 percent, not the increase from 5.15 that I had referred to in my initial note.
I should have looked at his reference in the column. I’ll admit that I have not taken Neumark’s work on the minimum wage seriously since he uncritically took data from the fast food industry lobby to try to argue the case that the minimum wage caused unemployment. It turned out that the industry had cooked the data. When Neumark used data that was independently collected he found the same result as everyone else, the minimum wage did not increase unemployment.
But, even if we take Neumark’s numbers at face value, we still don’t get much of a horror story. A rise of 10.7 percent means that the average gain would be around 8.9 percent. (To see the logic, imagine that hourly earnings were originally distributed evenly between the prior minimum wage of $5.15 an hour and the new minimum wage of $7.25 an hour. After two rounds of minimum wage hikes, two thirds of the workers are now sitting at $6.55 an hour or close to it. The remaining third are evenly distributed across the remaining band. This would mean that two-thirds of the affected workers would recieve the full 10.7 percent increase, while the remaining third would see an average hike of 5.4 percent. This gives an average increase of 8.9 percent.)
Neumark’s estimate would then imply workers are on average putting in 10 percent fewer hours and taking home 2 percent less money. This is based on the assessment of an economist who has devoted a career to trashing the minimum wage. Can’t say that sounds like a horror story.
That’s what he told us in his column today, because he sure didn’t make much of an argument. Lane cites several recent papers showing that the minimum wage has no negative effect on employment (including my colleague, John Schmitt’s paper). He then notes that these studies could be right, but he also refers to research by David Neumark of the University of California at Irvine and William Wascher of the Federal Reserve that shows the last minimum wage hike (from $5.15 an hour in 2007 to $7.25 in 2009) lowered employment of young people by 300,000.
He then warns that if their research is right, and we push the minimum wage too high, then we could be hurting the people we are trying to help. He also points out that even if the research showing no employment effect is right, then we would still be hurting other workers by pushing up prices or wage compression. He then proposes spending more money on the earned-income tax credit (EITC) as an alternative to a higher minimum wage.
Okay, let’s have some fun here. Lane’s bad story is that 300,000 fewer workers would be employed. That sounds really awful, after all these are the people we are trying to help. But let’s think about this one for a moment. The jobs we are talking about tend to be high turnover jobs that workers only hold for relatively short periods of time. The research that Lane is depending on shows that at any point in time 300,000 fewer workers will be employed as a result of a minimum wage hike of more than 40 percent. In effect, this means that workers will on average have to spend more time between jobs looking for work.
More than 3 million workers were in the affected wage band between the old and new minimum wage. If we assume that on average they worked 10 percent less (the 300,000 job loss) and that their average hourly wage gain was 20 percent (half of the wage increase) then on average these workers will net roughly 8 percent more in pay each year (120 percent * 90 percent), while working 10 percent fewer hours. Pretty awful story, huh? And that’s based on the research that finds a negative effect on employment.
As far as the rest Lane’s story, yes, the higher pay for minimum wage workers comes mostly out of other workers’ pockets. (Some comes from profits and some comes from increased productivity.) This is true of everyone’s pay. If protectionists did not dominate national policy we could import more doctors and bring our doctors’ pay in line with pay in other wealthy countries and save other workers close to $100 billion a year in health care costs. But the money that goes out of workers’ pockets to support the excess pay of doctors, Wall Street bankers or CEOs doesn’t concern Lane, only the money that goes to pay custodians, retail clerks, and dishwashers.
But the best part is the idea that the EITC is somehow free. In fact we need government revenue to pay the EITC, which requires taxes. Taxes will also come out of workers’ pockets and also have a distorting effect on the economy. In addition, there are also costs associated with administering the EITC. While it does not have nearly the level of fraud claimed by its critics, clearly some portion of the money is paid out improperly. And, low-wage workers often have difficulty dealing with tax returns. Many throw hundreds of dollars in the garbage paying tax preparation services in order to claim their EITC.
In short, Lane doesn’t really have much of a case against a higher minimum wage even if we accept his bad story about job loss. And, he seems to have imagined that there is an alternative costless way to get more money to low-paid workers.
There is one final point worth noting in the context of proposals to increase the minimum wage. From its inception in 1938 to 1969, the minimum wage rose in step with economy-wide productivity growth. If we had continued this policy over the last four decades the minimum wage would be $16.50 an hour. Even if the minimum wage is raised to 9.00 an hour, minimum wage workers would get none of the benefits of economic growth over the last four decades.
Addendum:
Charles Lane wrote to tell me that I had misrepresented the Neumark estimate of the employment impact of the last minimum wage hike. Neumark was only referring to the impact of the last phase of the increase (which was phased in over three years) from 6.55 to 7.25, a rise of 10.7 percent, not the increase from 5.15 that I had referred to in my initial note.
I should have looked at his reference in the column. I’ll admit that I have not taken Neumark’s work on the minimum wage seriously since he uncritically took data from the fast food industry lobby to try to argue the case that the minimum wage caused unemployment. It turned out that the industry had cooked the data. When Neumark used data that was independently collected he found the same result as everyone else, the minimum wage did not increase unemployment.
But, even if we take Neumark’s numbers at face value, we still don’t get much of a horror story. A rise of 10.7 percent means that the average gain would be around 8.9 percent. (To see the logic, imagine that hourly earnings were originally distributed evenly between the prior minimum wage of $5.15 an hour and the new minimum wage of $7.25 an hour. After two rounds of minimum wage hikes, two thirds of the workers are now sitting at $6.55 an hour or close to it. The remaining third are evenly distributed across the remaining band. This would mean that two-thirds of the affected workers would recieve the full 10.7 percent increase, while the remaining third would see an average hike of 5.4 percent. This gives an average increase of 8.9 percent.)
Neumark’s estimate would then imply workers are on average putting in 10 percent fewer hours and taking home 2 percent less money. This is based on the assessment of an economist who has devoted a career to trashing the minimum wage. Can’t say that sounds like a horror story.
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This one is well-deserved. The Post got the George W. Polk award for Medical Reporting for the series “Biased Research, Big Profits” by Peter Whoriskey. It was a well-researched and reported series. I take back 17 of the bad things I’ve said about the WAPO. I’m not commenting on how many that leaves.
This one is well-deserved. The Post got the George W. Polk award for Medical Reporting for the series “Biased Research, Big Profits” by Peter Whoriskey. It was a well-researched and reported series. I take back 17 of the bad things I’ve said about the WAPO. I’m not commenting on how many that leaves.
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It is really easy and apparently fun for some people to use scary numbers about health care costs. The trick is to take numbers over a long period of time that are not adjusted for inflation or income growth. Of course no normal person has any idea what their income will look like in nominal dollars 50-60 years out, so you can scare people to death with this sort of stupid trick.
That is what David Goldhill, the chief executive of GSN, did in an op-ed in the NYT. He told readers about a newly hired 23 year-old at his company who is earning $35,000 a year:
“I have estimated that our 23-year-old employee will bear at least $1.8 million in health care costs over her lifetime.”
Do any NYT readers have any idea what this $1.8 million figure means either in today’s dollars or as a share of this worker’s lifetime income? The answer is almost certainly no. It is unlikely that even 1 percent of NYT readers (I know they are highly educated) has any clue what $1.8 million means over this worker’s lifetime.
The question then is why did the NYT let Goldhill use the number? He surely could have used a standard discount rate and converted it into 2013 dollars. Alternatively he could have expressed the number as a share of the worker’s lifetime income. The NYT was incredibly irresponsible to let Goldhill just include this $1.8 million number with no context.
It is probably also worth noting that this recipe for curing health care costs would be quickly dismissed by anyone familiar with current expenses. He wants to restrict insurance to catastrophic care (will he arrest people for providing normal insurance?), but he seems to have missed the fact that the overwhelming majority of health care costs fall into this category. His plan may deter people from getting necessary check-ups and preventive care, but would have little impact on the costs that are driving up the country’s health care bill.
He apparently is also unfamiliar with the experience with health care costs in other countries, which pay an average of less than half as much per person as the United States, while getting comparable health outcomes. The U.S. would be looking at large budget surpluses rather than deficits if per person health care costs were comparable to those in other countries.
It is really easy and apparently fun for some people to use scary numbers about health care costs. The trick is to take numbers over a long period of time that are not adjusted for inflation or income growth. Of course no normal person has any idea what their income will look like in nominal dollars 50-60 years out, so you can scare people to death with this sort of stupid trick.
That is what David Goldhill, the chief executive of GSN, did in an op-ed in the NYT. He told readers about a newly hired 23 year-old at his company who is earning $35,000 a year:
“I have estimated that our 23-year-old employee will bear at least $1.8 million in health care costs over her lifetime.”
Do any NYT readers have any idea what this $1.8 million figure means either in today’s dollars or as a share of this worker’s lifetime income? The answer is almost certainly no. It is unlikely that even 1 percent of NYT readers (I know they are highly educated) has any clue what $1.8 million means over this worker’s lifetime.
The question then is why did the NYT let Goldhill use the number? He surely could have used a standard discount rate and converted it into 2013 dollars. Alternatively he could have expressed the number as a share of the worker’s lifetime income. The NYT was incredibly irresponsible to let Goldhill just include this $1.8 million number with no context.
It is probably also worth noting that this recipe for curing health care costs would be quickly dismissed by anyone familiar with current expenses. He wants to restrict insurance to catastrophic care (will he arrest people for providing normal insurance?), but he seems to have missed the fact that the overwhelming majority of health care costs fall into this category. His plan may deter people from getting necessary check-ups and preventive care, but would have little impact on the costs that are driving up the country’s health care bill.
He apparently is also unfamiliar with the experience with health care costs in other countries, which pay an average of less than half as much per person as the United States, while getting comparable health outcomes. The U.S. would be looking at large budget surpluses rather than deficits if per person health care costs were comparable to those in other countries.
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The Post had a very nice lead front page story, too bad its editors probably won’t see it.
The Post had a very nice lead front page story, too bad its editors probably won’t see it.
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Dylan Matthews has an interesting column discussing former M.I.T. professor Stanley Fischer’s career in the context of the possibility of him replacing Ben Bernanke as Fed chair in the fall. There are a couple of important items that are not mentioned in this discussion.
First, Matthews notes the central role that Fischer played in the I.M.F.’s resolution of the East Asian financial crisis. While this discussion might lead readers to believe the resolution was a success, this crisis actually marked a turning point that led to the major imbalances of the next decade.
Prior to the crisis there were substantial capital flows from rich countries to poor countries, as textbook economics would predict. However as an outcome of the crisis developing countries began to accumulate massive amounts of foreign exchanges reserves, presumably to avoid ever having to be in the same situation as the East Asian countries were placed when they had to deal with the I.M.F. in the crisis.
This led to a huge rise in the value of the dollar and large trade deficits. The gap in demand created by the trade deficit with developing countries was filled in the United States by the housing bubble. The predictable outcome of this situation was the collapse in 2007-09, which is likely to cost the country close to $10 trillion in lost output before the economy fully recovers.
This raises the more general point that Fischer is one of the pillars of the school of thought that central banks should target 2.0 percent inflation and otherwise do nothing. If it is in principle possible for an economic theory to be refuted by evidence, this view of the optimal monetary policy has been decisively discredited.
These items may affect how people would view Stanley Fischer’s qualifications as a candidate for Fed chair.
The piece also gets one other important item wrong. It contrasts the ability of Israel (where Fischer now runs the central bank) as a small country to devalue its currency with the United States, as the holder of the world’s reserve currency.
“If Bernanke halved the value of the dollar relative to, say, the Chinese yuan, that would dramatically increase U.S. exports and probably economic growth, too, but it would also wreak havoc with the global financial system. Every dollar-denominated asset in the world, including all manner of bonds, would plummet in value.”
Actually this is very far from being the case. Most holders of dollar denominated assets are not hugely interested in the value of their assets measured in yuan. (Quick, how many yuan is your 401(k) worth?) While the repercussions of a large fall in the value of the dollar against one or more major currencies are certainly greater than the fall of the Israeli shekel, it is certainly not obvious that a major reduction in its value would have disastrous consequences. In fact, over time it is virtually inevitable.
Dylan Matthews has an interesting column discussing former M.I.T. professor Stanley Fischer’s career in the context of the possibility of him replacing Ben Bernanke as Fed chair in the fall. There are a couple of important items that are not mentioned in this discussion.
First, Matthews notes the central role that Fischer played in the I.M.F.’s resolution of the East Asian financial crisis. While this discussion might lead readers to believe the resolution was a success, this crisis actually marked a turning point that led to the major imbalances of the next decade.
Prior to the crisis there were substantial capital flows from rich countries to poor countries, as textbook economics would predict. However as an outcome of the crisis developing countries began to accumulate massive amounts of foreign exchanges reserves, presumably to avoid ever having to be in the same situation as the East Asian countries were placed when they had to deal with the I.M.F. in the crisis.
This led to a huge rise in the value of the dollar and large trade deficits. The gap in demand created by the trade deficit with developing countries was filled in the United States by the housing bubble. The predictable outcome of this situation was the collapse in 2007-09, which is likely to cost the country close to $10 trillion in lost output before the economy fully recovers.
This raises the more general point that Fischer is one of the pillars of the school of thought that central banks should target 2.0 percent inflation and otherwise do nothing. If it is in principle possible for an economic theory to be refuted by evidence, this view of the optimal monetary policy has been decisively discredited.
These items may affect how people would view Stanley Fischer’s qualifications as a candidate for Fed chair.
The piece also gets one other important item wrong. It contrasts the ability of Israel (where Fischer now runs the central bank) as a small country to devalue its currency with the United States, as the holder of the world’s reserve currency.
“If Bernanke halved the value of the dollar relative to, say, the Chinese yuan, that would dramatically increase U.S. exports and probably economic growth, too, but it would also wreak havoc with the global financial system. Every dollar-denominated asset in the world, including all manner of bonds, would plummet in value.”
Actually this is very far from being the case. Most holders of dollar denominated assets are not hugely interested in the value of their assets measured in yuan. (Quick, how many yuan is your 401(k) worth?) While the repercussions of a large fall in the value of the dollar against one or more major currencies are certainly greater than the fall of the Israeli shekel, it is certainly not obvious that a major reduction in its value would have disastrous consequences. In fact, over time it is virtually inevitable.
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He may well be right. His story is that the yield on junk bonds is currently lower than the earnings yield on stock. Irwin tells readers:
“The stock market’s earnings yield is 6.6 percent, which is actually higher than the 6.1 percent that junk bonds are yielding. Buyers of junk bonds are tolerating lots of risk and not even being compensated. That suggests a market that is somehow out of whack. And there’s a quite plausible case that the Federal Reserve’s quantitative easing policies are part of the story. With the Fed buying billions of Treasury bonds and mortgage backed securities, those who would normally buy those assets have to buy something else. But it’s easy to imagine that this doesn’t affect all assets equally. Investors normally inclined to buy bonds may not be willing to move that money into stocks, but will buy junk bonds, even if the prices seem unfavorable.”
The big story here is that last sentence:
“Investors normally inclined to buy bonds may not be willing to move that money into stocks, but will buy junk bonds, even if the prices seem unfavorable.”
Okay, so we have people controlling funds with billions or even tens of billions of dollars who can’t figure out that they should move from junk bonds to stocks even when current prices suggest that the stocks provide a much better risk/return trade-off. Given that almost all of these people were buying into the stock market in the late nineties, when price to earnings ratios crossed 30, and that almost none of them saw the housing bubble in the last decade, Irwin’s observation is entirely plausible.
This does raise the question as to why the people who manage money funds earn many hundreds of thousands of dollars a year and often many million? If a fund manager just holds bonds rather than stocks out of habit then this person clearly has few skills. Rather than paying someone millions of dollars to cost a fund big bucks in virtually guaranteed losses isn’t it possible to find some high school kid who could be paid the minimum wage. After all, if we don’t expect people who manage funds to have any investment skills why are the jobs so highly paid?
He may well be right. His story is that the yield on junk bonds is currently lower than the earnings yield on stock. Irwin tells readers:
“The stock market’s earnings yield is 6.6 percent, which is actually higher than the 6.1 percent that junk bonds are yielding. Buyers of junk bonds are tolerating lots of risk and not even being compensated. That suggests a market that is somehow out of whack. And there’s a quite plausible case that the Federal Reserve’s quantitative easing policies are part of the story. With the Fed buying billions of Treasury bonds and mortgage backed securities, those who would normally buy those assets have to buy something else. But it’s easy to imagine that this doesn’t affect all assets equally. Investors normally inclined to buy bonds may not be willing to move that money into stocks, but will buy junk bonds, even if the prices seem unfavorable.”
The big story here is that last sentence:
“Investors normally inclined to buy bonds may not be willing to move that money into stocks, but will buy junk bonds, even if the prices seem unfavorable.”
Okay, so we have people controlling funds with billions or even tens of billions of dollars who can’t figure out that they should move from junk bonds to stocks even when current prices suggest that the stocks provide a much better risk/return trade-off. Given that almost all of these people were buying into the stock market in the late nineties, when price to earnings ratios crossed 30, and that almost none of them saw the housing bubble in the last decade, Irwin’s observation is entirely plausible.
This does raise the question as to why the people who manage money funds earn many hundreds of thousands of dollars a year and often many million? If a fund manager just holds bonds rather than stocks out of habit then this person clearly has few skills. Rather than paying someone millions of dollars to cost a fund big bucks in virtually guaranteed losses isn’t it possible to find some high school kid who could be paid the minimum wage. After all, if we don’t expect people who manage funds to have any investment skills why are the jobs so highly paid?
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