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Saturday, November 02, 2002


Whilst parents all across Europe are still struggling to convince their children that learning English could be good for them, and whilst the EU politicians still wrangle about ways to find a common language for Europeans, one group of black parents in New York could be pointing the way to the future:

Paul and Denise Gamble have never been to China, and they were never particularly interested in its language or culture. Yet their two school-age children attend Shuang Wen Academy, a public school on the Lower East Side where much of the day is spent learning Mandarin. Their children are part of an unexpected phenomenon at the four-year-old school: while most are children of Chinese immigrants, almost 10 percent of the students are black, and many of them come from the outer reaches of the city, enduring long trips for the chance to attend a school that has developed a reputation for excellence.

Shuang Wen is one of more than 150 small public schools established in the late 1990's as an alternative to larger, impersonal public schools. The school, whose name means dual language in Chinese, has many teachers who believe in dual-language education, and its goal is to teach students Mandarin and Chinese culture. Although only two of the school's first class of 45 students were not of Chinese descent, Shuang Wen gradually gained a reputation among some of the city's black middle-class parents for being nurturing yet rigorous. In last spring's citywide third-grade math and English tests, Shuang Wen ranked third in math and 23rd in English among the city's almost 1,000 elementary schools. Now, before the start of every school year, more and more black parents arrive at the office of the principal, Ling-Ling Chou, seeking admission for their children to the prekindergarten class — which is based on interviews with prospective students and their parents. They are undeterred by the fact that their children will be among the few non-Asians in the school, or that Mandarin is famously difficult to master. Chinese instruction runs from 3 to 5:30 p.m. daily. All subjects, however, are taught in both languages.
Like many of the black parents of Shuang Wen students, Ms. Gamble, Ms. Fouché-Channer and Ms. Smith are from the West Indies, and that is not a coincidence, they said. "Shuang Wen reminded us of the kind of schools we know from home," said Ms. Fouché-Channer, explaining that schools in Trinidad, Jamaica and the Dominican Republic are often strict and orderly, like Shuang Wen is. The Chinese parents are generally enthusiastic about the school's ethnic mix. "The black kids are really nice, and they showed my kids the way when they were new at the school," Christine Chuah, who has two children at Shuang Wen, said in Chinese. "They are seriously interested in learning Chinese, and we like that." The teachers, mostly Chinese-Americans or recent immigrants from Taiwan and China, have embraced the non-Asian children as well, offering them extra help with Mandarin.
Source: New York Times


Forbes has this cuttingly ironic piece from Dan Ackman (might as well have been from Dan Ackroyd). So this is how we're goin to clear things up:

Dan Ackman, 11.01.02, 8:54 AM ET

NEW YORK - The news that U.S. Securities and Exchange Commission Chairman Harvey Pitt has been forced into an investigation of himself is the stuff that inspires poets. In fact, it already has.

Walt Whitman must have had Pitt in mind when he wrote "Song of Myself."

"Listener up there! what have you to confide to me?
Look in my face while I snuff the sidle of evening,
(Talk honestly, no one else hears you, and I stay only a minute longer.)"

Calls for Pitt's resignation--extant even before the latest revelations--are mounting. Pitt says he is going nowhere. Again, Whitman asks the pertinent question: "Who wishes to walk with me?" Webster, for one, seems willing. At least he says his fate is for others to decide.

As of this moment it is not precisely clear who told whom what. But there is a larger question: What was Judge Webster--as he is still known--doing on the board of U.S. Technologies?

The company has its roots in hiring prisoners to assemble electronics and manufacture furniture. But in the late 1990s, it discovered the Internet and became that most dubious of all enterprises: an Internet incubator. The company's description of itself reads like a satire of the genre: "The transformation of U.S. Technologies was initiated with the acquisition of E2Enet, an incubator for early-stage Internet-related companies. Founded in 1998, E2Enet had been funded principally by an individual investor and Northwood Ventures...E2Enet sought out promising early-stage ventures directed toward e-commerce in the business-to-business (B2B) and business-to-consumer (B2C) areas." Webster was not alone in this mess. Former Senator George Mitchell was a director. So was Beth Dozoretz, former finance chair of the Democratic National Committee. Dozoretz is the wife of Ron Dozoretz, chairman of FHC Health Systems, and she has been in the news before as one of the people who lobbied President Bill Clinton to pardon Marc Rich. Jonathan Ledecky, a prominent Washington, D.C. businessman and former owner of the Washington Capitals hockey team, was also on board.
Source: Forbes


So the judge has finally made her call, and Microsoft get to stay together. Good for Microsoft, and bad for the competition, this seems to be the 'thinking persons' response. And for the rest of us? Especially those who are neither insiders nor complete info-freaks. This I think this one is very diffficult to call. I am an MS user, but I never bought anything from them directly in my life. The windows o/s comes with the computers I buy, and everything else follows from that. The other important part to my life, the browser, well I'm indifferent: Mozilla, Netscape, Internet Explorer, it's all the same to me. Perhaps I should use Mozilla, since I guess I think they're good folks, and I'm sure glad they exist.

And this, I think, is the point here (apart from the obvious one, that when you let Federal Court judges pontificate on internet browsers, you get what you ask for). There is virtually no possibility of a commercial rival for Microsoft appearing on the PC market, Microsoft could always outdo them in both quality and price. Following theories of dynamic competition under increasing returns, the only normal option here would be competition over platforms, by which I mean a rival, being blocked in the PC market could, in the manner of Palm, develop a rival platform to displace the MS based incumbent. The threat of this, is what, at the end of the day, and with more guarantee of impact than any court ruling, will force Microsoft to move.

But there is, of course, a non-commercial alternative. Call it Linux, or call it open-source, the alternative to Microsoft is there and it's presence is felt. Talk Instant Messengers, talk Movie Players, Microsoft is not a normal monopoly. Linux, we will remember is free. For a price-competitive international PC market long-term this can make it an attractive proposition. Linux can also count on the presence of hundreds of thousands of 'collaborators', all giving their time free, in the development of cutting edge uses and products. So Microsoft cannot just go to sleep and collect rents. In fact it could be argued that the leverage of open-source on Microsoft is the dynamic really driving innovation in the user-oriented apllications world. Microsoft only 'owns' Media Player under a very strange meaning of this word. For they are not free to decide what goes in the package as many critics fear. Since all of this is user driven, and the leading edge users have overwhelmingly entered a use-and-share culture, the truth is that Microsoft has become a virtual prisoner of the 'hackers', as the world of Hollywood knows only too well. If Media Player isn't compatible with the appropriate hack driven codec, then it simply won't survive, and if it doesn't survive, then ultimately Windows is finished, since its power lies in its compatability, and we're not talking about the latest version of office suite here. Those who have upgraded to XP know only too well, the main advantages (over say Windows 2000) lie almost exclusively in the content-management/leisure uses, and for the PC industry selling more 'souped up' units depends on creating more 'souped up' uses. In one of those strange and wonderful twists in historical logic, Microsoft has now become the main shield protecting P2P from the movie and record industry.

The day they stop doing this, that day their 'monopoly' breaks. Where exactly on the curve the tipping point between Windows and Linux lies, which small change will finally tip the scales from one to the other (or to a third, as yet unimagined, rival contendor), no judge can say. But one thing is sure, the day the new PCs ship out in bulk with another o/s, that day I'll be changing camps.

In conclusion then, Microsoft are in a sort of 'prisoners' dilemna. Or perhaps, following Hegel, this is just another instance of the master-servant dilemna. The master needs the 'look' and the respect of the servant much more than the servant 'needs' the master. In his book Beyond Belief, VS Naipaul, tells us of a wall slogan he saw outside Teheran's main prison. Written by the inmates, it reminded the guards, that they, having served their sentence, would leave. Those who would never leave - the jailers - these in fact are the true 'prisoners'.
Of course, Judge Kollar-Kotelly understood nothing of this.

When the federal government and 20 states filed their sweeping antitrust suit against Microsoft in May 1998, the company dominated the personal computer business and was aggressively moving into the markets for software for hand-held computers, cellphones, television set-top boxes and data-serving computers. More than four years later, little has changed. And there is little in yesterday's ruling on sanctions in the case by Judge Colleen Kollar-Kotelly of Federal District Court in Washington that will slow down the big software maker.

By endorsing most of the Bush administration's settlement with Microsoft, reached last year, the judge adopted a fairly narrow view of the case and showed a reluctance to meddle in Microsoft's business practices and product designs. She rejected calls by nine dissenting states seeking tougher measures, like requiring Microsoft to offer a stripped-down version of its Windows operating system or to publish freely the programming code for its Internet browser. In doing so, Judge Kollar-Kotelly chided the plaintiff states, writing that some of the proposed remedies appeared to be intended "simply for the sake of changing the status quo." In a passage that echoed Microsoft's complaint that its legal problems were the work of its rivals, she wrote: "Certain of Microsoft's competitors appear to be those who most desire these provisions."
Source: New York Times

Tuesday, October 29, 2002


Having come out two weeks ago dramatising the possible consequences of a 'hard landing' in Japan in a way which may have been a little OTT for the taste of some people, it is heartening to see that one of the leading Japan 'experts' comes to similar conclusions, in a much more reserved way, of course.

By Akio Mikuni and R. Taggart Murphy
An upheaval in Japanese finance, bringing with it a complete restructuring, is not impossible. But such a restructuring would produce shocks that would reverberate around the world. Japan as a nation holds nearly $3 trillion in dollar-denominated assets, many of them ultimately supported by the very deposits that would be withdrawn in a wholesale reorganization of Japanese banking. Those dollars have played an indispensable role in permitting the United States to swell its trade deficits far beyond the levels of most nations.

That so many foreigners are willing to keep their earnings from trade inside the United States banking system — what "holding dollars" literally means — helps the United States tolerate its deficits. But this situation is precisely what restructuring in Japan threatens. If banks were forced to call in loans to pay off depositors, and if those loans financed their customers' dollar holdings, Japanese companies would be forced to sell their dollars for yen. Real money and purchasing power would then leave the United States as the conversion weakened the dollar, forcing a rise in interest rates and import prices and further raising the risk of recession. That is what usually happens to countries that run excessive trade deficits — foreigners lose confidence in these countries' currencies, interest rates rise, the economy goes into recession and, as people can't afford to buy so many imports, the trade deficit begins to close. The United States has escaped this fate largely because of the very problems with Japanese finance that Mr. Takenaka promises to attack. Washington ought to be careful what it wishes for.
Source: New York Times


The deep and profound changes that are taking place in China right now, are perhaps best summed up by this timely piece in the FT:

The power behind China's emergence as the workshop of the world resides within people like Liu Hongmei, a 19-year-old with ruddy cheeks and a floral headscarf who recently stepped off a bus in the booming southern city of Zhuhai.

She has come from an impoverished village in the central province of Hunan, motivated by her parents' entreaties to earn enough to pay for her brother's schooling and by her own insight that her marriage prospects would improve if she managed to save something."If you want to marry a man with money, you have to have money yourself," she says. "The dragon accompanies a dragon, the phoenix a phoenix and the son of a poor rat will forever dig holes."
Source: Financial Times


This piece from the NYT implicitly raises a lot of interesting problems about the future of companies like AOL Time Warner. On the bandwidth side, no one seems very clear on which tubes will carry the flow. ADSL seems like a temporary 'fix' to take advantage of an existing infrastructure. But the future: CDMA, Bluetooth, WiFi, Sattelite. Who knows? Your guess, at this stage, is as good as mine, or that of the AOL executives. But then you and I don't have to put up the money.

And the ISP architecture, many clients/one server, or P2P. Again it's up for graps.Then we have "the 30-second ad-skip button." Call this the death of the economic model of TV as we know it. Maybe the anaysts had it wrong from the start, maybe it wasn't the internet that was looking for an economic model, but TV that was looking for a survival strategy in the age of internet. So maybe TV needs to embrace the internet-Google-model, providing something really good free in order to indirectly (and inobtrusively) promote something else. Maybe this way the quality could get to improve a bit too!

Bottom line, will all that AOL Time Warner cable only live to become the modern equivalent of the canal boom.

Under fierce competition from satellite services, the Time Warner cable division is racing to sell new features that give viewers more control over what and when they watch. Its new digital services can let subscribers order any of an array of films and network programs whenever they want and even turn set-top boxes into personal digital video recorders that make it easy for viewers to fast-forward through commercials. But as Time Warner Cable promotes the services — especially the one that can skip commercials — its plans are colliding with the interests of networks and studios, which own the rights to the most popular shows. Both live off programming schedules and advertising sales. At many, including AOL Time Warner's own Turner Broadcasting and Warner Brothers divisions, executives consider the idea of skipping the commercials to be a threat.

The negotiations among divisions of AOL Time Warner are part of the early rounds of a broader contest over television that is unfolding as satellite and cable companies haggle with networks and studios. The satellite and cable companies say they are giving viewers what they want, but networks and studios sometimes feel they are being robbed. AOL Time Warner is moving faster than any other cable company. As one of the largest companies on all sides of the business — in cable systems, television production and operating networks — it is situated to reconcile the competing interests. How it fares at selling the digital services could influence the shape of the industry. The company has already shown it can use its power to change Hollywood, when Warner single-handedly brought down prices to jump start sales of DVD's. The strong feelings at AOL Time Warner's networks and studios have already influenced the company's progress. Six months ago, company executives said Time Warner Cable's chief executive, Glenn A. Britt, discussed the feasibility of a 30-second fast-forward button as part of its video-recorder services. But executives from Warner television studios and Turner Broadcasting argued against it, some calling it "the 30-second ad-skip button." Mr. Britt decided to drop it, people in the meetings said.
Source: New York Times

Monday, October 28, 2002


Now it's Samsung's turn to try consolidate its position in the LCD market with the opening of a factory in China. The Korean electronics giant has begun work on a 100,000 sq meter TFT-LCD factor in Suzhou in Jiangsu province, China, which will produce around 160,000 modules a month, when it opens in the second half of next year.

Expanding its presence in China, South Korea's Samsung Electronics on Friday broke ground on a new flat-panel display module assembly plant in the Chinese city of Suzhou, and beefed up its existing chip-assembly operations in the same location. Samsung's Device Solution Network business unit is also pursuing plans to establish an R&D center in China next year. The company also outlined plans to establish a system that will integrate production with R&D and sales in that nation. Samsung intends to use this expansion as a springboard for achieving $4.2 billion in sales within China by 2006. Its sales target for China this year is $830 million, up 87% from 2001.

"China is the most attractive market for the IT industry in terms of growth potential for the 21st century," said Yoon-Woo Lee, president and CEO of Samsung's Electronics Device Solution Network unit, in a statement. "We intend to continue bolstering the competitiveness of our semiconductor and TFT-LCD businesses and expand our China-based production, sales and R&D operations," he said.
Source: CMPnet Asia


According to the Financial Times, Heizo Takenaka, Japan's economics and financial services minister, continued a frantic round of diplomacy on Monday as he sought to secure the backing of bankers and politicians for his plan to revive the financial sector ahead of its possible release later this week. I'm on tenterhooks.

The newly-appointed banking tsar held his third emergency meeting with the leaders of Japan's seven largest banks in an attempt to placate them, although it is understood the meeting - like the two previous gatherings - did not go well. Mr Takenaka on Monday also sought to appease members of the three party coalition government who forced him to abort publication of his plan last week and have since been openly criticising both him and his proposals. Adding to the air of uncertainty is speculation over the outcome of the next monthly meeting of the nine-member policy board of the Bank of Japan, which begins on Wednesday.

The central bank played a key role creating the current proposals to reform the banks after its decision to purchase stocks directly from banks led to the sacking of Hakuo Yanagisawa, the former financial services minister.With opposition mounting to the more controversial aspects of Mr Takenaka's proposals, there are strong signs the harder edges of the package are in the process of being worn away and replaced with compromise solutions. While the content of the plan is changing regularly, it is understood Mr Takenaka has agreed to delay a more strict treatment of deferred tax assets by the banks by at least a year and possibly until 2004.
Source: Financial Times


Some interesting behind-the-scenes political analysis fro Time of Asia:

Japan's Prime Minister Junichiro Koizumi is used to making other politicians unhappy. But even he seemed shaken when his longtime supporter Mikio Aoki took the floor of the Diet last Tuesday and added his voice to the growing dissension over the Prime Minister's latest round of banking reform proposals. In a withering attack, he accused Koizumi's new finance chief Heizo Takenaka of being a loose cannon, an unelected and unaccountable radical operating outside the system. And he finished with a direct salvo against the man he used to defend, telling Koizumi, "What is lacking most is leadership in coping with economic issues." When the barrage was over, the Prime Minister smiled wanly and thanked Aoki for his "encouragement."

On Tuesday morning, Liberal Democratic Party (LDP) heavyweights Mitsuo Horiuchi, Taro Aso and Taku Yamasaki vowed to intervene. While Koizumi briefed the emperor at the Imperial Palace that evening, the three leaders and other LDP bosses confronted Takenaka behind closed doors in the Diet building. Takenaka left the meeting looking visibly pale. "This was poor leadership from Koizumi," says Mamoru Yamazaki, chief economist at Barclays Capital Management. "Takenaka was accused by the leading politicians of the Diet, and the Prime Minister wasn't protecting him." That evening, Takenaka said the publication of his plan was postponed till the end of October, though he later insisted that he wouldn't temper his proposals.

Koizumi's opponents are worried about a host of factors, including what they deem a "Takenaka Recession." Under the finance chief's plan, the easy pipeline of money from complacent banks to profitless companies would be cut off, giving these companies no choice but to shut down and throw their workers out on the street. "Companies are going to go under and Japan offers no support for the unemployed," frets Minoru Morita, a prominent political analyst. Already, LDP politicians and Tokyo bankers are circulating a list of 51 companies presumed likely to meet with peril under the plan—including retailer Mitsukoshi, video gamemaker Sega and trading outfit Nissho Iwai, plus a slew of construction, heavy machinery and real estate companies. Goldman Sachs estimates that if all 51 companies on the list were to close, Japan's unemployment rate would jump from 5.4% to 6.1%. And that tally doesn't include thousands of small and medium-sized businesses also likely to go belly-up. Indeed, bleaker estimates suggest that unemployment could spike to 10%. In Japan, that grim prospect is less palatable than trillions of yen in bad debt—not just to politicians but to the majority of Japanese citizens who vote for them.
Source: Time Asia Magazine


This is a strange item for me to blog, as I don't especially like rap, and I don't claim to know too much about the contemporary music scene of young Americans. Reading the piece I have the impression that Emminem drives on a mixture of populism and raw energy, and what's wrong with that as they say. No, my interest isn't musical, I can't help noticing and thinking about how the heavy migration into the US dince the early eighties is having an impact on the entertainment industry production targeting.

The Bronx River Houses are hallowed ground in the hip-hop world, one of the neighborhoods where young African-Americans and Hispanics helped create a new art form in the 1970's. The housing project in the South Bronx takes its heritage seriously. From there emerged a founder of hip-hop, Afrika Bambaataa, and the loose-knit group of D.J.'s, dancers, graffiti artists and rappers called Zulu Nation.Three decades later, the No. 1 selling rapper in the country is a 30-year-old white man, Eminem, born Marshall Bruce Mathers III. Only three years ago, he was derided as "the Elvis of hip-hop," or a raw version of the 1980's flattopped performer Vanilla Ice (no comparison could be worse on these streets). But these days at "the Bricks," as the Bronx River Houses are called, there is no resentment, there are no complaints about Eminem's racial identity.

"8 Mile," starring Eminem, is released on Nov. 8. The film, loosely based on Eminem's life, is the latest test of the rapper's crossover appeal. The film's title refers to the rough-and-tumble neighborhood that is Detroit's racial and economic divide. While it is well known among music industry executives that hip-hop consumers are more than 75 percent nonblack (Eminem's core audience is suburban white teenagers), Universal Pictures will need to reach into minority audiences to make "8 Mile" a hit.Hip-hop artists are a proven box-office draw. "Barbershop," an urban comedy starring Ice Cube, grossed an estimated $69.5 million by Saturday since its release on Sept. 13. "Brown Sugar," a hip-hop love story starring Taye Diggs, grossed $22.4 million since its release on Oct. 11. Last year, "Exit Wounds," starring DMX, grossed $52 million. The main artists in these movies have been black. But no one expects Eminem's race will keep blacks and Hispanics from going to the box office.
Source: New York Times

Sunday, October 27, 2002


Stephen Roach has interviewed Franco Modigliani.

There are always great imponderables in the macro outlook. But today the questions seem to loom larger than ever. At the top of my list are two burning issues -- the prognosis for the American consumer and the risk of a US deflation. Nobel laureate Franco Modigliani has long been noted for his path-breaking work on these very issues. He was in town in couple of weeks ago, and we had the chance to sit down for a most engaging discussion. An edited version of our conversation follows.
Source: Morgan Stanley Global Economic Forum

Below are my comments on the interview.

"I must confess to being surprised about the resilience of consumption after the stock market bubble popped."

Well I think actually people like Stephen Roach and Paul Krugman have been telling a reasonably plausible version of things here. The so-called wealth effect, however, is much more likely to show itself, in my view, not in the direct impact of the stock market ride down, but on the preparedness-to-accept-indebtedness effect based on the value of the whole asset basket, and here it seems property is paramount.

"I have my doubts. I am suspicious of those studies that find the wealth effect is larger from real estate than equities. Theory tells me it should actually be the opposite. That’s because the house in part, produces a consumer good -- housing services, which we consume. When the value of the house I inhabit goes up, its implied rental value increases. But that does not significantly improve my spending power, because my imputed rent has gone up as much. Any wealth effect on individually-owned property must net out the consumption of the service we derive from living in our homes."

Well, yes and no. In a time of high asset price volatility housing is perceived as the savings harbour of last resort. especially when people are conditioned to expect inflation. In addition the rents argument doesn't seem to me to be of the best, since - following one reading of the life-cycle hypothesis - people tend to trade down as they get older. Again it doesn't fit with the situation here in Spain were many members of the middle class now have two, or even three properties as a form of saving.

In addition I think he is looking at it too theoretically, from the point of view of drawing up the pertinent equations, assigning shadow vales, opportunity costs, etc.

But the individual/consumer isn't looking it in this way at all (remember Kahneman/Tversky just got a Nobel). The consumer/individual is simply looking to find a 'rule of thumb' solution to the savers problem: where to park money in a time of low interest rates (never mind that in part this is money illusion), and equity market collapse. The 'rule of thumb' answer is property. Especially with the built-in inflation expectations that easy money and growing deficits must produce. The 'safe harbour' appears to be property. But I say 'safe' advisedly, because it isn't safe at all.

Of course when I’m talking about the saver’s problem, I’m only talking about roughly 49% of the consuming population, since the bottom 50% do virtually no saving. While you need to strip out the top 1% (following Krugman) since they probably give freak readings and simply distort the picture.

‘Neither a Lender nor a Borrower be’
(Old English Ditty)

All this has finally allowed me to make some sense of that optimal control stuff we economists are forced to learn, since I can now see that in a situation of volatile inflation/deflation switchovers, and financial crashes the optimal saddle-path trajectory for the consumer/worker is to operate a continuous stream of expenditure-stream of earnings adjustment in order to pass smoothly through the middle, nicely avoiding all those savers/debtors problems.

My favourite after-dinner trick of late is to pull-out a nice clean 20 Euro note over coffee, grab a saltcellar, sugar bowl, a saucer, etc, and then ask my wide-eyed audience, if the saltcellar was a flat, the sugar bowl a basket of equities, the saucer some bars of gold, and the 20 Euros the equivalent in cash to the dollar value of each one of the other three (which all have the same) then which would they buy with the dollars I offer to give them to play the game (this thought experiment takes place in Barcelona). The answer - without exception - is the flat. Regardless of whether the person in question needs somewhere to live or not. Wrong I say, take the money, at the moment it's the best investment available for the individual saver given the high risk element attached to all the others and the imminent arrival of deflation when the value of money will rise.

"Sadly, the large cohort of aging baby boomers is not adequately prepared for old age."

You bet, we are also not prepared for the fact that there are not enough young people coming up behind to maintain growth and living standards. The so-called 'demography' effect. More on this another day, but it's smack in line with the deflation hypothesis.

"Are you saying that creditors gain because deflation effectively expands their purchasing power?"

This is true, as Modigliani notes, only if the deflation doesn't get serious. But if we get the collapse of financial institutions then the creditors obviously lose since the debtors can't pay. But of course he's right about the initial positive effect for savers, and that must be why all those old people in Japan don't vote for the 'inflation driven' solution to deflation.

"it probably would be offset by a devaluation of the dollar"

This is really Svennson's 'foolproof path' argument. The problem is how the dollar can come down when there's no-one to go up. Or, on the 'foolproof path' more generally, it simply isn't foolproof if all the 'fools' try to go down at the same time, ie if the deflation is global.


"The answer to that question depends on the causes of the supposed deflation, a subject on which you have not dwelt extensively. I can think of two major causes: The most obvious would be a deep cyclical decline, but this version is most unlikely because of the availability of well known stabilization policies, and because in this century, as a result of wage rigidity, no contraction has ever produced deflation in developed countries, since the Great Depression. The other possibility is dogged foreign competition from countries like China. This type of deflation, within limits, would be good for the consumers and would compensate for any resulting downward pressure on nominal wages.

If it’s just a temporary blip down in the price level, it wouldn’t worry me....The answer to that question depends on the causes of the supposed deflation....Historically the floor for increases in wages is defined by productivity. So as long as productivity growth is maintained, nominal wages are unlikely to fall."

Here is the problem, if deflation isn't just a temporary blip, then the theory side of why not needs a lot of building up. I have a strong feeling that it won't be just a blip, but the explanation is going to need time. On a more contingent point, Modigliani doesn't seem to consider the output gap mechanism seriously, clearly once prices drop below zero-increases, if the gap continues then the problem only exacerbates, there is no blip. Secondly, the rigid wages argument (like the low productivity services) argument is a strange one in the context of deflation since many argue that in the 1930's wage-rigidities were not an advantage, but in fact helped to prolong the problems, which could be equally true today for the margin-pressured corporate sector. Alternately, in the epoch of outsourcing and short term contracts, perhaps wages are not as 'sticky' as they were. A big chunk of 'greying' America is about to retire, what's the betting that the wages of their replacements won't turn out to be so sticky.

I think what I'm saying is here is that the good and grand old man is just that, and unfortunately a little out of his times.

Without specifically referring to Romano Prodi as 'stupid' the ECB issued a press release last Friday which might as well have done so:

The principle of budgetary discipline enshrined in the Treaty and the Stability and Growth Pact are indispensable for Economic and Monetary Union (EMU)
EMU, with a single monetary policy and 12 governments responsible for budgetary policies, needs a fiscal institutional framework. The framework must be simple and enforceable and ensure that fiscal policies in Member States are sound and sustainable. Such a framework of fiscal policies fosters sustainable growth and employment, is conducive to economic stability and is a necessary complement of a monetary policy geared to price stability.........

The main commitment of Member States under the Stability and Growth Pact is that the fiscal policies should result in medium-term budgetary positions which are "close to balance or in surplus". This, in conjunction with the Maastricht Treaty obligation to avoid excessive deficits and to apply appropriate implementation procedures, secures the sustainability of public finances and provides scope for dealing with the expected fiscal challenges caused by population ageing. Moreover, and contrary to the claims of its critics, the Stability and Growth Pact also provides sufficient flexibility after "close to balance or in surplus" positions have been reached, as automatic stabilisers can then operate fully. Problems have arisen not because the rules are inflexible, but as a result of some countries' unwillingness to honour their commitment to respect the rules. The results of fiscal policy in several countries are very disappointing. In this context it is important to recall that the main reason why countries are in budgetary difficulties at present is because they have not used the situation of higher growth to substantially improve their fiscal position.
Source: ECB Press Release

In saying "contrary to the claims of its critics, the Stability and Growth Pact also provides sufficient flexibility", the ECB doesn't directly mention Prodi, but they might as well have done so. This means the two leading institutions of the Euro zone have effectively gone to war with each other. As Morgan Stanley's Eric Chaney has it:

The debate on fiscal policy in EMU-land has suddenly jumped several degrees on the Richter scale. A lapidary communiqué from the European Central Bank created a sensation on trading floors and government circles. In short, the ECB entered the fray with a strict interpretation of the Stability and Growth Pact (SGP) that leaves little ambiguity on its intention: the ECB is throwing its full weight toward avoid a watering down of the EMU code of good conduct.

The explanation given in yesterday's communiqué will sound rhetorical and hollow to most readers: "By ensuring sustainable public finances and by providing enough flexibility for the full operation of automatic stabilisers in periods of economic weakness as well as strength, the SGP also has a favourable effect on macroeconomic stability. This facilitates achieving price stability and fosters confidence in the euro area's economic prospects." Reading between the lines, I understand that fiscal stability is crucial for the ECB because its opposite might eventually imply its own extinction. In plain English, fiscal instability -- read spiraling government debt -- might lead to a serious political crisis and, in the end, a break-up of the EMU. Hence, it makes sense that central bankers do their best to secure a strong initial bargaining position.
Source: Morgan Stanley Global Economic Forum

The situation of having the two leading institutions of the Euro zone at loggerheads is a new development for financial architecture theory to chew on, it is also, for a Spanish resident like me, rather preoccupying.

Paul Krugman has recently raised the question of using backward induction points (which I don't claim to fully understand) as a means of analysing current strategy options for key players. Well, one possible scenario could look like this:

Firstly, think about the impact of this rather chaotic situation on an already Euro-skeptic British public. The balance of pro's and con's of the Euro just took a dramatic hit in favour of the latter. (Many commentators try to be positive by emphasising the teething troubles line, but others may be surprised that so-many problems are arising so-quickly). Then look at the impact of the entry of ten new members into the EU, and the consequent impact on agricultural policy and structural fund distribution. The first idea which comes to mind is that these new members will not be entering the Euro any time soon. The problems of coordinating the existing members are just too big. So we've got a two tier Europe, a customs union and a core currency union block (I suspect that this was always Margaret Thatcher's spanner-in-the-works strategy). Then think about the budgetary impact of the new entrants, Spain, Portugal and Greece will all be net losers, less aid/more contributions and more competition from low-wage, currency flexible customs union states. Add to this the inflationary tendencies of the latter three, and the fact that if they were not in the Euro and the UK was, then interest rates could come down and help Germany with its difficult situation since the average inflation would then be well below the 2% target (nice thought that the UK being able for once to help Germany).

Bottom line: medium term the three above mentioned countries (suffering from a mixed metaphor of 'cost push'/'demand pull') could well as we say in Spanish 'salir disparados' from the Euro group. Oh, what a mess, and why didn't anyone think of this sooner! Of course this is just one scenario. But it is a real possibility, and if the financial community finally get round to projecting forwards and then calculating backwards to factor it in, then the chances of it happening shoot up significantly.