Trump wins election, not that it matters

For someone who despises politicians as much as I do it’s really hard to avoid political news lately. But there is a nexus between the presidential election and economics: most voters think the president controls the economy. The evidence for that is the fact that economic models predicting the winners of presidential elections are the best forecasters, far superior to the myriad of polls, except the exit polls, and vastly superior to the legions of political pundits in the media. On the superiority of simple regression models over that of experts for forecasting anything, even the price of wine, read Super Crunchers.

One economic model predicting presidential elections using just GDP growth shows that the economy must grow at an annual rate of 2.5% in the second quarter of the election year in order for the incumbent party to win. Based on the latest release showing Q2 growth at an annual rate of 1.2%, Trump has virtually won.

The model created by Ray Fair at Yale University agrees, according to a story on NPR: "It's based on economic growth per capita in the four years before the election. According to Fair, because of the sluggish growth in this recovery, his model now predicts the Republican candidate will win. Fair's model has picked the winner in all but two elections since 1916."

What the market has in common with Trump

Watching this market is like watching Trump’s candidacy. Everyone is waiting for both to crash and burn but they keep climbing to greater heights. Even Fox News appears to oppose Trump without much effect just as the stock market sets new records in the midst of gloomy economic news all around.

The market has set new records even as profits are expected to have fallen for the fourth consecutive quarter. Earnings season is upon us and we will soon understand how bad the damage in the second quarter was. Thomson Reuters has predicted that profits in Q2 will be down about 5% from the same quarter last year. Revenue will have fallen 0.8%. It blames oil prices, low interest rates, and a saturated cell phone market.

How long can low rates last?

The charging of interest on loans is one of the most hated and worst understood concepts in human history. Aristotle claimed that money cannot beget money because it is dead, so charging interest on loans is immoral. Moses’ law forbid Israelis to charge interest on loans to the poor, but the Church interpreted that prohibition according to Aristotle’s economics and made charging interest on loans one of the worst sins that Christians can commit. Aristotle’s writings had almost equal weight with the Bible in many matters until Copernicus and Galileo trashed his astronomy.

But kings, nobility and popes needed to borrow money occasionally in order to keep up their conspicuous consumption, so Jews were allowed to commit the sin of usury. That gave Christians an excuse to persecute them regularly.

The church didn’t reform its economics until the 17th century when theologians from the University of Salamanca abandoned Aristotle for common sense. A letter from John Calvin to a friend on the topic may have helped. Calvin wrote that interest on loans was no different from charging rent on land, which everyone could understand.

Recently, an investing newsletter increased the confusion over interest rates for its readers. It claimed that interest rates have fallen naturally from roughly 50% in 5000 BC. “Fast-forward a bit and we see the Greeks expanded the credit system. In 600 B.C., they paid rates of around 16% in a quickly modernizing monetary system. By 100 B.C., though, a typical loan came with a rate of just 8%. And then things got interesting...”

The Damage that NIRP does

Bloomberg carried a story a few weeks ago on Denmark, which has been “blessed” with a negative interest rate policy (NIRP) longer than any other developed nation. The authors asserted that the horror stories about low interest rates with which economists have typically frightened us for decades haven’t come true in the Scandinavian country, so economics must be wrong.

Of course, the Bloomberg journalists have forgotten the primary caveat of economic reasoning – ceteris paribus, or all other things being equal. The horror of money printing, such as the disaster that nearly destroyed Germany in the early 1920s, caused hyperinflation and a plummeting exchange rate. Those haven’t afflicted Denmark, or any other major country, yet, because everything hasn’t remained ceteris or paribus.

When every nation reduces rates in concert, it has no impact on exchange rates. And it may not cause much inflation. The idea that it must cause price inflation or economics is wrong comes from a blockheaded view of the quantity theory of money. Again, ceteris paribus applies. Printing money (or technically credit expansion via low interest rates) will cause price inflation if nothing else in the economy changes. But money printing doesn’t work mechanically. Japan should know. The Bank of Japan has desperately tried to create inflation through money printing for the past 30 years.