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Saturday, March 01, 2003

The Way of All Flesh

Now its Red Herring's turn to rest in peace. Close family and friends invited, but I'm not sure where you send the flowers. Of course, without all that too easy money most of these outfits wouldn't have existed in the first place. How long before blogging becomes the whipping girl for all this? After all, from all the noise knocking around these days, I'm sure traditional journalism must be begining to feel the heat. When they begin to cry foul, that's when you know its reaching them. On the plus side, at least we've identified one more business model that definately doesn't work, and thinking of accumulated experience, since life is all about learning and experience, it's probably no bad thing to get lose your shirt once or twice along life's way. Oh well, one good thought, since blogging doesn't seem to be about money, there won't be a tap to get turned off.

Red Herring, the magazine that was considered a must-read among the technology elite, has closed, the latest victim of tough economic times. The magazine's publisher, RHC Media, reached the decision after unsuccessfully trying to sell Red Herring, the chief executive of RHC Media, Chris Dobbrow, said today. Red Herring's March issue, which was delivered to subscribers two weeks ago, was the final issue. The magazine had a circulation of about 275,000. RHC, which was formed last year after the venture capital firm Broadview Capital bought the magazine, plans to liquidate its assets, which include the Red Herring Web site, within the next few weeks, according to Mr. Dobbrow.At its closing, Red Herring had a staff of 31 workers.. In its heyday during 2000, Red Herring and its affiliates employed more than 300 workers. Founded in 1993, Red Herring focused on the venture capital community.
Source: New York Times

Smoking Them Out

Here's some good news for a change. International cooperation to try to stamp out a real mass killer. And for once Geramny and the US are on the same side, even if it appears to be the wrong one. I'm all for constitutional guarantees of freedom of speech, but there doesn't seem to be any US problem in banning the promotion of products associated with the narco-traffic or prostitution trade, nor any German one with todays admirer's of yesterday's Nazis. Still, progress is progress, and should be welcomed. Tying up first world addiction is just one part of the problem, the great saving will come if we can put a break on the spread to the developing world.....

In a global bid to quit a habit that kills almost five million people a year, nearly 170 countries backed on Saturday a tough pact against smoking, including advertising bans and pledges to boost tobacco taxes. The Framework Convention on Tobacco Control, the world's first international treaty on health, was concluded after a marathon 18-hour final session at the end of two weeks of hard bargaining by World Health Organisation (WHO) member states. However, the United States and Germany, two of 171 countries attending the talks, said they could not accept parts of the deal, although they cannot stop it being endorsed by WHO's annual assembly in May.The pact seeks to tackle the "devastating" consequences of tobacco use and exposure to smoke with measures ranging from a halt to advertising and sponsorship within five years to a crackdown on smuggling and a ban on cigarette sales to minors."The spread of the tobacco epidemic is a global problem with serious consequences for public health that calls for...an effective, appropriate and comprehensive international response," the treaty declared.Many of the pact's policies are already applied in rich countries, but for much of the developing world, where deaths from tobacco-related disease are set to surge, it marks the first attempt to fight what WHO says is already the biggest cause of premature death.
Source: Reuters News

The Durably Deflationary World

Now Morgan Stanley's Eric Chaney argues the point: Europe is risking a very close call with generalised deflation. Top of the 'at risk' list: Germany. Gee, their boss, Stephen Roach, is really getting through to them.

From 1973 to the late-1990s, a popular macro game between industrialised economies was to export inflationist pressures. The strong-dollar policy in the Reagan period and also during the Rubin one, and the strong Deutsche Mark policy in the boom years that accompanied the German unification were textbook examples of this not really zero-sum game. Nowadays, in a durably deflationary world, the game is different. Its name is "exporting deflation" and I am afraid that Europe could be on the wrong side, this time. The analytical case is three-folded. First, the euro is already non-competitive, on a unit labour cost basis. This is particularly flagrant for Germany. Second, three years of sub-par growth have widened and continue to widen considerably the output gap. Third, the euro might rise even higher, if the US economy does not recover convincingly and oil prices stay high.

In other terms, even at 95 cents, the euro was slightly overvalued, from a pure productivity-adjusted costs standpoint. Euroland manufacturers could have lived with that. For a region where restructuring is a compelling necessity, a 10% over-valuation of the currency is not that bad, in our view. But at today's rate, 107, Euroland relative labour costs (ULCs) stand at 123. A 20% to 25% over-evaluation of the currency is clearly excessive for a sector already in recession. Put simply, it is deflationary for Europe. Note that, for Germany alone, things are much worse: on the same estimates, German ULCs are now 38% higher than US ones.

As the decline of the US dollar carries on — the US currency is only half-way on its way down, according to my colleague Stephen Jen — the situation will get even worse if the euro is the only counterpart to bear the burden of the rebalancing of the US economy. Well, it seems that this is the case, since most Asian currencies are practically linked to the USD. Using the weights used by the Fed for its own currency basket, it appears that a 10% effective depreciation of the USD would require a 50% rise of the EUR/USD rate. If only half of this is behind us, there is more pain coming for Europe. In addition, it seems that the well-established correlation between oil prices and the USD exchange rate is now inverted and that, practically, the euro has now taken the status of "petro-currency." Just imagine what would happen if crude oil prices stayed around $40 for some time. As the US and Asia export their own internal deflation risks, Europe seems to be the main recipient of this poisoned calice. Has Europe the means to absorb deflation? The answer is clearly negative, given the still very high rigidities most regional labour markets suffer from.
Source: Morgan Stanley Global Economic Forum

Friday, February 28, 2003

Quote of the Week

Kendall Grant Clark identifies a problem, and comes up with a novel solution: pragmatism. Given the Microsoft reality, is the best hope for getting XML as document up and running really the next major release of Office: my, my , my.

If St.Laurent is right, we may be facing a kind of XML variant of C.P Snow's famous (or infamous, if you prefer F.R. Leavis's demolition of Snow's claims) "two cultures" idea: XML developers do not understand what it means to not be a developer, to think about content creation and the like in ways which are unaware of hard technical issues; and, on the other side, non-developers do not understand the hard technical issues involved in creating tools and technical infrastructures within which everyone can be productive. Of course, it may also be the case that the usability people -- as they are wont to complain -- haven't been attended to carefully enough. They tend to be the cog in the machine that is supposed to help the developers understand and build precisely what the non-developers want and need. In other words, there may not be two cultures but merely two different groups, each with its own needs, goals, and interests, which have not yet found enough common, practical ground upon which to reach a mutually beneficial arrangement. Maybe we need to take a more cold-minded, materialist point of view?

Maybe we need to take a more cold-minded, materialist point of view? Norm Walsh, perhaps inadvertently, suggested just such a perspective when he commented that "the tool/development focus is...intensely focused on applications that involve slurping content out of databases, coding it up in messages, firing it across the web, and then slamming it back into databases" -- to, one supposes, the detriment of human-focused tool development. "But, hey," Walsh hastened to add, "everyone has to make a living". Insofar as Walsh's implication is correct, that there simply is more money to be made building tools for the "data" side of XML than for the "documents" side, it seems reasonable to assume that human-centered tools, which are intended to ease the creation of XML content by humans, are going to lag behind the data tools.

This economic perspective also implies a rather unsettling fact -- unsettling if you are, like me, a long time critic of Microsoft. It implies that the XML facilities in the next major release of Office are the very best, realistic hope for the future of the documents side of XML, at least in terms of mass market success. No other entity in the industry (in any industry, for that matter) is as able to swing mass numbers of computers users toward or away from specific technological solutions. That Microsoft has gained such an ability by virtue of its position as an adjudicated monopolist is in some very real sense beside the point. If you keep a flame burning for the XML-as-document position, outside of Microsoft and a few other notables like Topologi, it is and will likely remain slim pickings for some time.
Source: XML.Com

The Language of Health

My regular readers will know I have one strongly held belief: immigration is god's greatest gift to mankind. The economic benefits are just enormous, and all western societies went full speed ahead forward during the ninetees on the backs of other peoples children, human capital produced in far away lands by unknown and anonymous parents. But with all this wealth comes responsibility. This article from the Chicago Sun Times highlights just one area where these responsibilities are not being faced up to: the health needs of our new fellow citizens. Actually, a moment or two of thought about network theory, globalisation and health should lead us to see that this is in our own interests too. Absue of antibiotics on a massive scale, and an ever smaller 'small world', means that we have ever more virulent variants going round the circuits ever more rapidly. If we don't look to fix this we'll live to regret it: or maybe not.

Hispanics who speak little or no English are coping with a health care system that frequently fails to communicate with them in Spanish, a survey released Thursday concluded.The language barrier is having a devastating effect on those Hispanics--mostly newly arrived immigrants--by discouraging them from seeking medical care, said the survey's authors.

Only 1 percent reported getting assistance from a trained medical interpreter. Most relied on family and friends, the survey found.

The survey also found that almost one in three Hispanics who do not speak English well reported their health was fair or poor, twice the rate of whites, blacks and English-speaking Hispanics. And 33 percent rely on community or public clinics for their health care, compared with 12 percent of English-speaking Hispanics, 10 percent of blacks and 7 percent of whites.Almost 6 million Hispanics between the ages of 18 and 64 reported speaking English ''not well'' or ''not at all,'' according to the latest Census Bureau estimates. ''Hispanics are more likely than any other group in the U.S. to be uninsured and to have difficulty obtaining access to health care--and this problem is made worse by language barriers,'' said Karen Davis, president of the Commonwealth Fund, which conducted the survey.
Source: Chicago Sun Times

Meanwhile Back at the Coal Face

Whatever the merits or otherwise of new appointments, whether in the US or Japan, a reality check reveals one thing: things ain't gettin better, and fast.

The pernicious deflation that has plagued the Japanese economy showed no signs of alleviating in January while unemployment hit a postwar high, underlining the challenges facing Toshihiko Fukui, the newly-appointed Bank of Japan governor. Japan's jobless rate rose to 5.5 per cent in January while the core consumer price index tumbled 0.8 per cent from a year ago, its fortieth straight month of decline. Economists said deflation was likely to get worse before it got better, a result of the strengthening yen and "anaemic monetary stimulus". The yen recently rose to a six-month high against the dollar at Y117.Chris Walker, economist at Credit Suisse First Boston in Tokyo, said: "For the next few months, the most likely direction for CPI inflation is down, towards the record rate of minus 1 per cent, year-on-year.
Source: Financial Times

A Spot of the Right Stuff at the BoJ?

Mein Gott, I can't believe it. Richard Katz, a Japan commentator I don't always agree with but who I do respect, has come out and said the unsayable, Toshihiko Fukui is the right man in the right job. (In fairness many pragmatic commentators inside Japan had been coming round to this view, this and the view that the important thing is not just the head man, but the team). The reason Katz thinks this is that he isn't convinced of the monetary policy can do it alone story (lets call this the helicopter money - actually, I even found one Japanese economist imaging this - dropping money from helicopters to provoke inflation - was actually being proposed: still its a nice idea, it would make what is already a lottery into an even bigger one, somehow this puts me in mind of an old Borges story about Babylon......). Katz's reasoning here is faultless as far as I am concerned. With all due defference to heavyweights like Paul Krugman and Ben Bernanke fuelling a 4% inflation rate isn't a problem, it's keeping it there that is the problem, and maintaining the credibility that it's going to stay there, remember yield curves are now flattening out up to the 30 year mark. There's more to the Japan problem than simply its liquidity trap. Until Japan begins to address its structural problems there will be no lasting cure for the deflation.

My principal difference with Katz: in position number one on the structural reform list I put structural reform of the population, ie opening big-and-wide the immigration tap, without this I feel fiscal policy will be less than useless, in particular with the dead weight of the debt looming just round the corner. One other difference between me and Katz: I'm certainly not prepared to stick my neck out for Fukui-san, nor for Takenaka-san, nor for Koizumi-san. The de facto powers who exert such influence on the day-to-day conduct of economic affairs are far too important to be discounted so easily. Still, in the right circumstances Fukui may prove to be more of a runner than was previously expected. Or are we all just clutching at starws here? One curious detail about the saga is the growing mention of one lesser member of the Bush economic team: John Taylor - he of Taylor rule fame - at the international affairs section of the US Treasury.

It is hard to see how Japan's economy can reform and recover unless reformers are put in charge of vital policymaking institutions. That is why the appointment of Toshihiko Fukui as governor of the Bank of Japan is a positive step. His view is straightforward: deflation cannot be stemmed through monetary easing alone, which makes structural reforms more important than ever.

Even some of those who want the bank to inject "unconventional stimulus" acknowledge it cannot revive the economy by itself. Heizo Takenaka, minister for economic policy and financial services, has made it clear that monetary easing will not suffice without the disposal of bad debts. So has John Taylor, undersecretary for international affairs at the US Treasury. Mr Fukui will bring more to the table than the reformist philosophy he shares with Masaru Hayami, his predecessor. Even critics acknowledge his political acumen, flexibility and a dense network of supporters in politics and business. These assets could make him more effective than Mr Hayami in building consensus for action on bad debts supported by monetary easing. The main alternative is the futile hope that massive money-printing, like government spending on "bridges to nowhere" in the past, can substitute for real reform. Critics claim that the BoJ could create 3-4 per cent inflation at will and that this inflation would, in turn, revive private demand. Some advocates of inflation targeting even suggest that the bank buy up assets used as collateral for bank loans, from equities to office buildings. While many economists sincerely believe such measures would help, it is the opponents of reform who are the most fervent advocates. They hope that raising the price of stocks and property can make bad loans good without restructuring "zombie" borrowers - companies that are essentially bankrupt. The more Japan's leaders grasp at monetary straws, the less likely they are to undertake true reform.

Japan's deflation is not the cause of weak demand but a symptom. Prices are falling because the economy is operating at 4-5 per cent below capacity. The bank cannot create steady, manageable inflation just by printing more money. It has tried. It has increased the monetary base by almost 40 per cent since March 2001. Interest rates have responded - the yield on a 10-year government bond is now at a record low of less than 0.8 per cent. But little else has improved. The rest of the broad money supply has barely changed. Meanwhile, bank loans, prices and nominal gross domestic product have all kept falling. Certainly, the Bank of Japan can boost the price of any asset it buys. If it offered to print unlimited money to buy buildings at double their current price, building prices would immediately double. Developers would construct buildings just to sell them at high prices to the bank. However, when it stopped buying, prices would fall back. Such a move would re-create the late-1980s boom and bust on a grander scale.To his credit Mr Hayami blocked such schemes - and so will Mr Fukui. But beyond rejecting false cures, the bank has to stress what it and the government can do. If deflation is a product of weak demand, the solution is to boost demand directly. The surest initial step is a permanent consumer tax cut in the order of a few per cent of GDP financed by the bank. That would put money into people's pockets without raising interest rates.
Source: Financial Times

The Dog Ate My Textbook

So for once the rumourology got it right. Hot on the heals of the departure of Glenn Hubbard comes news of the entry stage left of Greg Mankiw. This is an interesting decision whose significance will need time to evaluate. Greg is clearly a first class economist, and his views aren't those that you usually associate with the present Bush administration. The FT has one plausible explanation, George W doesn't seem to be too hot at following complex arguments, so Greg's facility in keeping things simple may well be a strong point. At the same time I cannot help feeling that this is another case where you need to apply what is proving to be an important key to undestanding the White House these days: look at what they do, not what they say. Following this thought up: in the recent speculation about the future of Alan Greenspan, where is the fact and where is the game playing, seeing is not always believing. Could it be that someone up there really is having second thoughts about the folly of balooning deficits, and is looking for a let-off. With Greenspan, Bernanke, Rogoff, and now Mankiw all effectively playing for the other team its hard to read this decision any other way. We just have to hope that this professor isn't planning an early re-edition of the textbook. Still, if there's any life left in the adage that by their friends shall you know them, then somehow I doubt it. Oh, I can't resist this: but what happens if the dog gets to eat the textbook?

Gregory Mankiw, the man nominated by President George W.Bush to become the next chairman of the White House Council of Economic Advisers, is a highly regarded Harvard economics professor considered one of the nation's foremost experts on deficits, interest rates, monetary policy, inflation and economic growth. But what much of the world might want to know about him could be boiled down to his famous textbook and his dearly departed dog.

The textbook, Macroeconomics, is a bestseller - something almost unprecedented among academics, especially economic professors. Mr Mankiw received a $1.7m (€1.6m, £1.1m) advance in 1997 for its predecessor, Principles of Economics. The appeal of those books is their brevity and clarity: the ease with which Mr Mankiw describes economic principles, theories and models so often viewed as obtuse, counter-intuitive and complicated.........Mr Mankiw's skill in boiling down economics could prove a virtue in the Oval Office - Mr Bush is famous for his preference for brevity and conciseness.

Mr Mankiw has repeatedly asserted in his textbooks, academic papers and other writings that deficits reduce national savings and raise interest rates, crowding out investment and reducing future income.As part of its aggressive campaign to sell its economic plan, the White House has given priority to marginalising the point. But Democrats were already leaping on this history as the news broke of Mr Mankiw's nomination. But Mr Mankiw also has the credentials of a strong, market-oriented economist who has argued that the widening trade deficit is not an immediate concern as long as the US remains a relatively attractive place to invest. Mr Mankiw's other notable feature is his recently departed dog, Keynes - still described on the professor's website as his "best friend". The original Keynes, of course, was a strong believer in the usefulness of government-led economic stimulus.
Source: Financial Times

Back Slapping All Round

Obviously it takes one economics 'expert' to recognise another. Japan's economics minister Heizo Takenaka is reported as saying that: "Mr. Hubbard is an economic expert with considerable insight and he has made deep analyses of economic problems in the U.S. and the world." Meantime Japan has just clocked-in its 41st consecutive month of price deflation. I think I will remember Glenn Hunbbard for two things: as the man who couldn't see deflation coming , and as the man who rewrote his textbook to meet the needs of short term political expediency. I'm sure he will be sorely missed.

Thursday, February 27, 2003

Germany is in Recession

Yesterdays figures leave little room for doubt. Germany entered recession during the last quarter 2002 - growth for the quarter was fractionally below zero, with the possibility of downward revision. Part of the reason the downside wasn't stronger was an inventory buildup in anticipation of a possible Iraq war. Y on Y inflation came in at 0.9%, so only fractionally out of deflationary territory now. Bad news all round. The only remaining questions are how deep, and how long. After months of pontificating, I fear they are now, finally, catching the Japanese illness.

While overall GDP growth was a notch above market expectations, at a reading of -0.0%Q, GDP went into negative territory at the end of last year. Final domestic demand slowed down slightly in Q4, coming almost to a standstill as consumer spending stagnated and government spending even contracted. At the same time investment spending, both capex and construction, surprisingly recovered during the quarter. Next to the upside surprise in investment spending, the main upside surprise amongst the components came from the volatile inventory component, which boosted overall GDP growth by 0.4 percent. Meanwhile net trade weighed heavily on growth, shaving half a point off overall GDP growth as export growth virtually came to a standstill and imports rose markedly.

The GDP deflator slowed down again in Q4, rising 0.1%Q after a 0.3%Q increase in Q3. This takes the annual rate down from 2.0%Y to 0.9%Y. Unit labour costs rose at a steady rate of 0.3%Q during the final quarter of last year. Gross operating margins thus narrowed in Q4, after having remained stable previously. Meanwhile the gross operating surplus fell 0.4%Q in Q4, after an impressive rise of 1.2%Q in Q3 and a massive 7.0%Q rebound in Q2. The decline in the German gross operating surplus suggests that corporate profits have likely weakened in Euroland over the winter as the economy slowed down markedly.

For the year as a whole this would leave us with our new downwardly revised a full-year growth rate of 0.0% -- it could be a 'black zero', could be a red one -- which would mark a further slowdown from the meager 0.2% recorded last year. Only in the second half of this year, do we expect a noticeable pickup in economic activity in Germany on the back of abating geopolitical uncertainties, falling oil prices and aggressive ECB rate cuts.
Source: Morgan Stanley Global Economic Forum

More on the China Technology Front

Lest anyone accuse me of being anti-Chinese (which , of course, I'm not) after my last post about intellectual property protection there, I hasten to add this piece from Fortune, making the opposite point, a company respecting IPP, but reinforcing the importantant point, China is going for the global technology market. If the day when China will be one of the major players (if not THE major player) seems far away just try thinking about networking economies and learning by doing advantages, topics Europe, in particular, seems to have forgotten about long ago.

A prominent item in last Saturday's New York Times resonated with me. The story said that Legend Group, one of China's largest tech companies and the leading PC vendor in Asia, now sets its sights on the world market-aiming for 30% of sales outside China by 2006, up from a tiny percentage now.

The news put me in mind of one of my most memorable business trips: five days in China with Intel Chairman Andy Grove back in 1998. The Intel boss was a hero in tech-mad China, not least because he had been Time magazine's 1997 man of the year. One of the primary reasons for Grove's visit was to attend the celebration of the production of Legend's one-millionth PC. I tagged along for the spectacle-loaded with both cheesy entertainment and passionate testimonials about the importance of technology to China's future. It left me with a deep respect for this company's commitment to winning.

The year before my visit, Legend had surpassed IBM to become the largest PC vendor in China. Today, almost five years later, Legend sells almost a million PCs every quarter. It dominates the Chinese PC landscape with a 27% market share. And China is the market to dominate these days. It is the world's fastest-growing large PC market, with sales rising 20% annually. That compares to an essentially flat market in the U.S. and Europe. This year China will surpass Japan to become the world's second largest PC market.

On the strength of its sales in China alone, Legend is the largest PC vendor in all of Asia, with 11.4%, says Gartner Dataquest. Expect that number to grow with the new focus on non-Chinese markets. Legend is already competing fiercely in Hong Kong. But the opportunities are great elsewhere in the region as well. The PC market grew 40% last year in Thailand, and 20% in Vietnam.

Legend isn't only a PC company. It also sells a million cellphones a year, and is making a major push into PDAs. It sells a PocketPC device, and plans shortly to start selling one based on the Palm OS as well. And services are the company's big new focus, just as they are for its giant overseas rivals like IBM and HP.

It remains to be seen, however, if the company has the managerial depth to match IBM and HP and become a major market force outside Asia. On my visit five years ago I was underwhelmed by the executives I met. Still, Legend is not to be dismissed as a global competitor. It has always positioned itself as a quality brand. Unlike Huawei, the Chinese network-equipment company that Cisco accuses of stealing its intellectual property, Legend has generally played by the rules since its founding by the Chinese government Academy of Sciences in 1984. It buys top-of-the-line chips from Intel (thus Grove's visit) and actually pays Microsoft for Windows, unlike many PC-makers in China.
Source: Fortune

China and New Technologies

I have no idea at all whether the issue between Lucent tecnologies and a number of Chinese citizens has any foundation or not, but for those who have an image of China as a low-end manufacturing supplier, this case and the recent issue between Cisco and its chief Chinese competitor Huawei should give plenty of food for thought. Chinese companies want in on global technology, and however much the intellectual property protection situation may have improved, this still isn't Europe or the US.

US prosecutors are preparing to interview 12 Chinese citizens in an international industrial espionage case after Beijing agreed for the first time to let US law enforcement authorities question witnesses in China. The case involves three Chinese citizens charged with stealing trade secrets from Lucent Technologies, the US telecommunications equipment maker. Scott Christie, the assistant US attorney prosecuting the case in New Jersey, said 11 of the 12 Chinese people due to be questioned next month were employees of Datang, the Chinese company alleged to have received the stolen trade secrets. US officials are not claiming that Datang officials were involved with the conspiracy. The two-year-old case centres on two former Lucent scientists accused of conspiring to steal computer technology with the intention of marketing it in China. A third defendant is accused of helping to set up ComTriad, a US company through which stolen trade secrets were passed to Datang. The technology, which transmits voice and data signals over the internet or private networks, has been discontinued by Lucent.
Source: Financial Times

Germany: This One Looks Scary

Under the heading 'Germany's Stagnation is Beyond its Control', two JP Morgan economists argue the case today, Germany's short-term difficulties are not about the need for mid-term structural reform, they are about the absence of control over fiscal and monetary policy. And where does this loss of control come from, why from the participation in a common currency better known as the euro. Well, as regular readers to Bonobo Land will already know, I wholeheartedly agree. One minor caveat: it is unfair to blame all the loss of control over fiscal policy to the euro and the stability pact. Control was effectively lost by earlier German governments (Kohl??) who failed to see the demographic time bomb, the large unsecured liabilities of the German welfare system, and the impact of IT and the internet on the way we workand play. It is the failure to change tack and reform and change mentality earlier - especially in the area of welfare funding reforms, working and contractual practices, attitudes to individual risk-taking, and above all national identity and immigration - which has now left Germany a hostage to fortune on the fiscal deficit problem. Also note the suggestion that monetary conditions are far too loose for Spain and Italy, that in the case of Spain applying a Taylor rule would produce an interest rate nearer to 7%, remember the Spanish housing bubble, and watch out for the crash.

Structural rigidities are widely blamed for Germany's economic stagnation. But although it suffers from a number of structural problems, notably in the labour market, these do not explain the contraction that started in the fourth quarter of last year. Market rigidities explain why Germany has a very low potential growth rate: the latest Organisation for Economic co-operation and Development estimate is 1.5 per cent. But recessions come about owing to a lack of demand. To understand what is going on in Germany, look at the traditional drivers of the business cycle: monetary and fiscal policy and the exchange rate. All these are helping to depress German demand relative to that of its neighbours: monetary policy is tighter in Germany than elsewhere; fiscal policy has tightened, while it has remained neutral in France and Italy and has eased slightly in Spain; and, given its greater trading links to the rest of the world, the higher exchange rate is hurting Germany more than its large neighbours.

Although a common interest rate applies to the whole of the eurozone, this does not mean that the monetary stance in each country is the same. The best way to compare monetary stances is to look at Taylor rules. These were originally developed by John Taylor - now undersecretary for international affairs at the US Treasury - to indicate how a central bank should set policy rates given the extent to which actual inflation has diverged from the central bank's target, and the degree of spare capacity in the economy. Applied to individual countries in the eurozone, Taylor rules show what level of policy rates would be appropriate if each country still had an independent central bank looking at growth, spare capacity and inflation.

There are three clear messages. First, before 1999, monetary policy in Germany (and for the region as a whole) was set on the basis of macroeconomic conditions in Germany. The gap between policy rates set by the Bundesbank and those implied by the German Taylor rule was very small. For France, Italy and Spain, interest rates were higher than their respective macroeconomic conditions required, in order to keep exchange rates stable. Second, since the launch of the single currency, the monetary stance set by the European Central Bank has been too tight for Germany but too loose in Italy and Spain. The gap between ECB rates and the Taylor rule for France has been very small. And third, the divergence in monetary stances has increased. Since 1999, the ECB's policy rate has on average been almost 1 percentage point too high for Germany. But by the fourth quarter of last year, the ECB's policy rate was almost 2 percentage points too high.The implications are dramatic. If the Bundesbank were setting rates purely on the basis of conditions in Germany - as it did before 1999 - they would be close to 1 per cent, rather than the ECB's current 2.75 per cent. Similarly, the Bank of Spain would have raised rates close to 7 per cent. Inappropriate monetary stances are pushing growth rates apart. Meanwhile, in response to pressure to comply with the stability pact, German fiscal policy is tightening this year by 0.5-1 per cent of gross domestic product. The degree will depend in part on the centre-right opposition that has strengthened its control of the upper house. But whatever the outcome of the political negotiations, Germany's fiscal position is tightening after a modest easing of 0.5 per cent of GDP last year, while elsewhere in the eurozone policy is closer to neutral.

Last, of all the big eurozone economies, Germany is the most sensitive to the exchange rate. Although global trade growth will eventually return to a healthy pace, the trade-weighted euro is now 20 per cent higher than its trough in October 2000. This currency appreciation will further widen the growth gap between Germany and the other large economies in the region. Since German weakness is a result of negative shocks to demand rather than greater structural rigidities, only an improvement in demand will get the economy going again in the near term. Here lies Germany's predicament: there is no silver bullet. Even though the ECB is expected to cut rates in the coming weeks, they will still be too high for Germany. And the pressure on fiscal policy will remain intense: with its budget deficit stuck above the 3 per cent ceiling, Germany may be forced by the EU to go further in cutting spending and raising taxes.The only ray of hope is the possibility of a powerful upswing in global growth that is not offset by further appreciation of the euro. This seems unlikely. The outlook for Germany is grim indeed.
Source: Financial Times

Wednesday, February 26, 2003

Deflation in China Continues

Arguing that, in the case of deflation in China, its not over till its over, Andy Xie explains that massive surplus labour and capital supplies in China mean that deflation can be expected to continue, with the global PPI being driven from China. I agree with him.

China’s CPI possibly rose in January from a year ago. This would be the first positive year-on-year change since the fall of 2001. Some may interpret this as a sign that deflation is ending in China. This would be a mistake, in our view. China’s CPI is a lagging indicator to export performance. The CPI stayed positive for six quarters in the last export recovery. A rise in the CPI reflects higher commodity prices during a trade upturn. China’s CPI functions as the producer price index for the global economy.China’s economic development is a deflationary process. This is the nature of industrialization of a large economy with surplus labor and capital. The United States also experienced deflationary industrialization, as immigration created a horizontal labor supply curve, and high domestic savings and capital inflow led to ample supply of capital. Rapid productivity growth in a large economy with no constraints on labor and capital supply is passed on to consumers in lower prices.

Raw material cost is the most important and, probably, the only meaningful, parameter for China’s inflation since the mid-1990s. Labor and capital supplies have exceeded demand and their prices do not respond to demand. Raw material cost has become the only independent variable in inflation. It is a race between productivity and raw material cost. When demand rises fast enough, material cost will rise faster than productivity and, thus, trigger an increase in the finished product price. The purchasing price index for raw materials was up 1.3% in December 2002 from a year ago compared with a 4.8% decline in January 2002. The rise in raw material prices in China in December was much less than in the international market. The CRB index was up 26.4% in December 2002 from a year ago. The raw material component of the US Purchasing Price Index was also up 26% during the same period.China’s raw material price has fluctuated by one third as much as the international market price. This may partly be due to the index composition. However, China’s data may have understated the fluctuation. Recent anecdotal evidence points to a quite dramatic rise in raw material prices. Chinese statistics have a tendency to smooth trends. China’s raw material prices tend to lag international prices. This may be a statistics collection issue rather than any substantial disconnect between China’s and the international market.If the past pattern prevails, China’s raw material price index is likely to accelerate to an 8% increase six months from now. This is similar to the peak in 2000. It should be interpreted as statistics catching up with reality. The CPI should be able to stay in positive territory for four quarters.
Source: Morgan Stanley Global Economic Forum

Mexico: Watch Out For the China Factor

An extremely interesting post on Mexico from Morgan Stanleys Gregg Newman (the man who got it right on Argentina, when most of the other commentators - including Paul Krugman - were either navel-gazing to avoid imagining the inevitable or trying not to make things worse for Cavallo. See for example. Looking For Tipping Points 6 July, 2001, Tipping Has Begun December 3, 2001, Accelerating the Tipping Points December 17, 2001). (See yesterdays China post for some of the significance of the Mexico/China comparison). On China the short term winners will be the suppliers, and the losers will be the competitors. On Mexico, note the consumer strength, this you would expect from the changing demographics, and note the point that its all in the balance, depending on the upward momentum of the US economy.

Given China’s rapid emergence as the low-cost manufacturer of choice, it may seem risky to ignore recent developments. Just this past week, China gained further ground in Mexico’s principle export market, the US. Based on US trade data released in late February, China displaced Japan as the third-largest exporter to the US and is gaining ground on Mexico as well. Indeed, we expect there to be much ado later this year when China’s exports to the US exceed those of Mexico. We are expecting China to take over the number-two spot from Mexico in the third quarter just before Mexico’s new congress convenes.

The pace of China’s export growth is significant: exports to the US in 2002 reached $125 billion, nearly double the $62 billion of 1997. Mexico’s exports to the US, after growing at a clip of nearly 18% during the late 1990s, have slowed in the past three years. Exports to the US in 2002 ($135 billion) were largely unchanged from those in 2000. Meanwhile, total Mexican exports in 2002 ($161 billion) were actually off slightly from 2000 ($166 billion).

Our advice not to worry about China is not meant to belittle the serious challenge that it represents to Mexico in the coming years. Indeed, in discussions with a whole host of manufacturers, we have seen examples of production having been lost in Mexico to China. There is little doubt that Mexico’s export performance in 2002 was in part hampered by China’s gains. The long-term threat of China has arrived. But where we would advise caution is in underestimating the cyclical component which has also worked against Mexico. The bulk of Mexico’s export performance and economic weakness appears to be directly tied to the weakness in US activity. Indeed, during the past three years, Mexico’s export sector appears to be more synchronized than ever with the US business cycle. Steve Roach is fond of reminding us that globalization has led to a more US-centric world economy; nowhere is that clearer than in the direct links between the US and Mexican real economies. When the US recovery returns, we expect to see the kind of pickup in Mexican exports and manufacturing output that we witnessed in early 2002. We believe China’s threat to Mexico’s growth prospects is real, but we believe this secular trend is likely to be overwhelmed with the cyclical upturn in US activity. And with Mexican consumers in better shape coming out of a downturn than at any point during the past 30 years – the first downturn in which purchasing power was not devastated – the export-led recovery should find domestic legs
Source: Morgan Stanley Global Economic Forum

Taiwans Deflation Continues

While the world continues to pore over the tealeaves and debate the future of the German economy, most commentators continue to treat deflation as a purely Japanese phenomenon. Deflation also exists in other Asain economies, notably China, and........Taiwan. (NB Also, and with reference to yesterdays Joanthan Anderson post, don't miss the China factor here).

Taiwan’s economy grew by 4.2% YoY in real terms in 4Q02, above our and market expectations of around 3.6% but a slowdown from 4.8% in 3Q02. Full-year 2002 growth came to 3.5%, versus our forecast of 3.3%. A closer look at the numbers reveals that Taiwan is becoming ever more dependent on exports as its engine of growth, while a weak currency policy remains crucial in guarding against deflation and the loss in nominal income amid structurally weak domestic demand. Nominal GDP expanded only 2.4% in 2002 to NT$9.73 trillion, implying a negative YoY change in the GDP deflator of 1.1%, which reflected deflationary pressure and the loss in terms of trade. The situation worsened in the last quarter, when the GDP deflator fell 1.9% YoY. In US dollar terms, nominal GDP remained stagnant at US$281.6 billion (+0.1%) in 2002, still 9% below that in 2000. Currency weakness remains crucial for Taiwan to maintain its size in the global economy.

Taiwan is undergoing immense structural change (“Positioning HK and Taiwan Against the China Shock”, January 27, 2003). Its economic development over the medium term is likely to be shaped by further integration with the increasingly open economy of Mainland China. We estimate that cross-strait trade (whether re-exported or transshipped through Hong Kong) totaled US$43.6 billion in 2002, growing at 35.4% (“Understanding Cross-Strait Trade”, February 13, 2003). This represented 18% of Taiwan’s total merchandise trade, compared with 10% in 1994. As the manufacturing operations become even more integrated, we believe that the strong trend in cross-strait shipments will persist. China absorbed 28% of Taiwan’s exports in 2002, replacing the US (20% of total) as the top market. Nevertheless, the surge in intraregional trade masks the structural pressure on Taiwan from a hollowing-out effect. While refined specialization in manufacturing processes amid China’s development boosts exports of upstream IT components and machinery to the China-based Taiwan factories, we should keep in mind that Taiwan remains under threat of its role as a manufacturing producer in the global economy shrinking over the medium term.
Source: Morgan Stanley Global Economic Forum

US Consumer Confidence Takes a Tumble

Everyone says its the Iraq jitters. I hope they are right. 2002, may I remind you, was the year of the heroic American consumer. The year the loyal US citizen reached for their wallet, or rather credit card, to try to spend the global economy out of trouble. But it was always recognised that this could only be a temporary stopgap, and that the only key to long term recovery lay in burning off the capacity excesses of the late ninetees, and getting investment to take over part of the heavy lifting. Well the recovery in capex is still pretty feeble, and it seems the consumers - or rather their credit cards - are getting worn down. Added to this is the continuing boom in US housing. Clearly when real interest rates on housing purchases are dropping ever lower, and other forms of saving are either downright risky (equities, pension plans) or offer a low return, housing assets have probably converted themselves into the principal form of saving for an aging american populace, if and only if, as they say, property prices sustain the rise. Because, if to the contrary, there's going to be a 'correction' at some point in the property market...........well let's not think about that right now. As they keep saying, it's probably just the Iraq jitters.

Consumer confidence plunged in February to its lowest level in nearly 10 years, dragged down by the prospect of war with Iraq. The Consumer Confidence Index fell almost 15 points to 64.0 — its lowest reading since October 1993 — from 78.8 in January, the Conference Board (news - web sites) reported Tuesday. Analysts were predicting a reading of 77.0. "On all fronts, it's jitters about the upcoming war with Iraq," said Josh Feinman, chief economist for Deutsche Asset Management in New York. The Dow Jones industrials fell as much as 138 points to a fresh four-year low before staging a late-day rally on bargain hunting. The Dow rose 51.26 points to close at 7,909.50, while the Nasdaq composite index gained 6.6 points at 1,328.98. Economists closely track consumer confidence because consumer spending accounts for two-thirds of U.S. economic activity. "The gloom is deepening," said economist Oscar Gonzalez of John Hancock Financial Services in Boston. "A stagnant job market, rising oil prices, slumping stock prices and the threat of war with Iraq, all of these seem to be pressing down heavily on consumers." Still, Americans continued their home-buying frenzy last month as the housing market remained one of the few bright spots in the economy. Sales of previously owned homes surged in January to their best month ever, at a seasonally adjusted annual rate of 6.09 million, the National Association of Realtors said Tuesday. That represented a strong 3 percent increase from December and defied analysts' expectations that home sales would dip slightly to a rate of 5.80 million. "It's mortgage rates," said David Lereah, the association's chief economist. He said low mortgage rates continue to be "the fuel for the housing engine." The average, fixed-rate 30-year mortgage dropped to 5.92 percent in January — the lowest level since the early 1960s. The average in December was 6.05 percent.
Source: Yahoo News

E Commerce Continues its Rise

Well, while everything else is experiencing a soft patch, one area sure is growing, still:

Retail sales over the Internet grew by 28.2 percent in the fourth quarter of 2002 compared to the same quarter a year earlier, rising to $14.33 billion, the US Commerce Department said on Monday . The gain was the smallest year-over-year increase since the second quarter's 24.5 percent gain, Commerce said in its quarterly report on sales of goods and services over the Internet or other electronic networks or by e-mail. Payment does not have to be made online for the transaction to be counted. Unlike most economic indicators released by Commerce, the data are not adjusted for seasonal or holiday-related variations, a limitation that sharply restricts their usefulness to analysts. Commerce began separately tracking e-commerce sales in late 1999. In comparison with the third quarter, sales grew by 29.3 percent in the last three months of 2002. Overall retail sales grew by a slower 5.1 percent compared to the third quarter. That brought e-commerce sales as a percentage of overall sales to their highest level since Commerce began its tracking, a minuscule 1.6 percent of total retail purchases.
Source: Yahoo News

France Confirms 2002 Deficit

Yesterdays confirmation that the French budget deficit exceeded the 3% limit in 2002 and will continue to exceed it in 2003, coupled with the refusal of the French government to take any specific measures to reign back the deficit can only make the controversy surrounding the growth and stability pact grow worse. Clearly one of the essential conditions for a coherent monetary policy from the ECB is a common commitment to adhere to agreed principals. For the euro to have any mid-term possibility of survival as a common currency, it is clearly necessary to find a way to steer the twelve separate economies to a position where they act, in principle, with one voice. I personally doubt this is possible (which means, I suppose, that I doubt that the euro can survive in its present form). Certainly the response of each of the national governments to the arrival of a more difficult economic climate does little to convince that this is going to happen. And to all my American friends who are so pronounced about criticising the Bush deficit at home, but seem somehow to imagine an alternative, more growth oriented policy, is readily available here in Europe where the underlying 'fundamentals' are even worse, I would add that what's sauce for the goose is also sauce for the gander, and that growth based simply on trying to borrow your way out of trouble isn't real growth at all, it's growth now at the price of bigger problems later. This, as is often noted in the Bush case, is fine by politicians who are around now, but who won't be around later to pick up the pieces. Of course 'all good men and true' (not to mention the good women) agree that you shouldn't apply dogma rigidly, and that hard times need flexible attitudes. But hard times sometimes also need hard decisions, simply borrowing money to put offf taking decisions is no answer. Borrowing money to facilitate the changes you need to make to be able to repay later would be another question. But take a hard look at what is actually on the table. Europe, like Japan, is postponing change rather than confronting demographic realities. "When growth is uncertain you do not lower spending more than necessary." Raffarin informs us. That is true enough, but when exactly is growth going to become more 'certain', this is the tricky bit.

France on Tuesday launched the most serious challenge yet to the EU's economic rules by ruling out austerity measures to plug its growing budget deficit. The French government admitted for the first time that its deficit for 2002 was likely to top the EU stability and growth pact limit of 3 per cent of gross domestic product. Jean-Pierre Raffarin, prime minister, told business leaders that it was "probable France's budget deficit exceeded 3 per cent as early as 2002". He also indicated that the deficit could remain above 3 per cent this year. However, Mr Raffarin - who heads a right-wing government haunted by memories of an unexpected defeat in 1997 after a failure to honour election promises - said there would be no austerity measures. The government last year promised to reduce taxes by 30 per cent over five years. "I won't conduct a policy of austerity," he said. "When growth is uncertain you do not lower spending more than necessary. That would depress the economic climate even further." The French response to its likely breach of the stringent economic rules underpinning the euro will test the credibility of EU economic policy. A defiant stance by France, which has recently clashed with other EU members on other issues such as Iraq and Zimbabwe, would make it easier for other countries to disregard the pact. The Commission said it would "have no choice" but to take action against the French government if the pact's breach was confirmed when final figures were submitted at the end of this week.
Source: Financial Times

Changing Patterns in IT Outsourcing

This decision by Ford looks interesting, and significant in its implications if the trend continues.

Ford Motor Company said on Tuesday said it would cut its information technology budget by 20 per cent, or $300m, in a further sign of the company's efforts to accelerate its sweeping restructuring. The move is part of a shift away from contract workers and echoes a broader swing in the balance of power in the IT employment market. At the height of the technology boom, with workers in short supply, IT experts were able to dictate the terms of higher-paying contract work rather than accept positions as salaried employees. Power has since shifted back to employers. To attack their overall staff costs, many big companies have opted to outsource large parts of their technology operations completely, shifting staff en masse to companies like IBM and EDS. Such exercises are normally estimated to produce savings of around 15 per cent. Visteon, Ford's largest parts supplier, last week announced a 10-year agreement in which Visteon will pay IBM $2bn over 10 years to handle its IT requirements. Ford said that as a result of its move, some of its current 2,800 contract IT jobs would be cut. Some of the workers are employed by IBM and Compuware, a large Michigan based IT company.
Source: Financial Times

Tuesday, February 25, 2003

Driving Without a Map

In this age of GPS and other electronic orientation systems, I keep having the slightly giddy feeling reading the economist that I'm a passenger in a car travelling at breakneck speed across unfamiliar terrain, but that the driver has no idea where he (or she) is going. Letting the comment from Yamaguchi pass without even a nod in the other direction. Isn't that the faux pas of the century. What we have are a shopping list of problems, but where, oh where, are our critical faculties.

One of the outgoing deputy governors of the central bank, Yutaka Yamaguchi, said in London last week that the worst of Japan’s deflation might be over. If Mr Yamaguchi’s assessment proves correct, Mr Fukui would have one less headache in the medium term. In the short term, though, it will not silence the critics who believe that more aggressive measures, using monetary and fiscal policy, are needed to tackle Japan’s problems.

Japan’s performance continues to be the weakest in the G7. But it is not the only country in a bad way, nor are its leaders alone in being confused about the appropriate policy response. Germany, in particular, is displaying the same lack of urgency in confronting its economic slowdown as Japanese policymakers have persistently shown. Europe’s largest economy is now once again teetering on the brink of recession. Its government has, as yet, signalled only weak commitment to much-needed structural reforms. And Germany, like France, is embroiled in a bitter dispute about fiscal policy. Both countries are in breach of the euro-area’s fiscal rules, or about to be. The European Central Bank (ECB) has, in the past, shown little enthusiasm for cutting interest rates to stimulate growth while the rules are being flouted.
Source: The Economist

Euroland: All Numbers Down

All numbers down: this in the opinion of the Morgan Stanley European Team is the likely impact of a war in Iraq, all numbers excepting, of course unemployment, but including a 1 per cent cut in base rates, and eurozone wide economic growth at its lowest level since the recession of 1993.And, in my book, watch out for those downside risks

Two months ago, we cut our EU GDP forecast for 2003 from 1.6% to 1.2%, on the basis of disappointing business surveys and rising uncertainties, both geopolitical and related to unclear economic policy options in the euro zone. Our forecasts were still based on relatively soft oil price assumptions, $24.8 for Brent on average in 2003, and a moderate rise of the euro, from $ 0.95 in 2002 to parity in 2003. Both assumptions now clearly look too low. Our currency team is currently expecting the euro to average $1.08 this year, and our new baseline scenario for oil prices assumes that the barrel of crude Brent should average $28.8 this year, 16% higher than previously assumed. By itself, this increase in oil prices is likely to cost 0.15 p.p. to European GDP growth, the same factor holding for both EMU and non-EMU countries.

In the end, and pricing in a positive effect from additional monetary easing (see below), we estimate the full cost of a war in Iraq at 0.7% of GDP, spread over 2003 and 2004, two-thirds of this impact being concentrated in 2003. Practically, we cut our GDP growth forecast for 2003 from 1.2% to 0.8%, and our forecast for 2004 from 2.6% to 2.3%. For the euro zone only, things are even worse: we now expect GDP growth to reach only 0.6% this year. If our prognosis were correct, this would be the worst year for continental Europe since the infamous 1993 recession.

With a war and even higher oil prices having become our central case, hitting confidence and economic growth further, we now look for a total of 100 bp of rate cuts from the ECB during the first half of this year, taking the refi rate to an unprecedented low of 1.75%. Forecasting the timing and the size of the cuts is trickier than ever, given that the fluid geopolitical situation is likely to loom large in the ECB Council's decision-making process. Assuming a war starts during March, the two most likely rate cut scenarios are as follows. First, the ECB may already be ready to cut rates at the March 6 meeting, even if a war hasn't started yet, justifying the cut with the euro's appreciation, the adverse impact of the prevailing uncertainty on confidence and economic activity, and the likely easing of inflation pressures later this year. In fact, comments by ECB President Duisenberg at the G-7 press conference this past weekend suggest that the Bank no longer believes in a meaningful economic recovery this year and has reduced its sighting shot for inflation further. Following these comments, a rat cut in March would no longer come as a surprise for markets. And if it happens, we continue to think it is more likely to be a 50 bp rather than a 25 bp cut, in order to make an impact on confidence. A second move would then follow soon after the start of a war.
Source: Morgan Stanley Global Economic Forum

China, the Worlds Manufacturing Hub?

Reassuring words from Goldman Sachs Jonathan Anderson on the pros and cons of the China factor. In general I think he's getting it right, China is not running up enormous trade surpluses. There are, however, winnners and losers here. The main group who will undoubtedly suffer from the China factor in the short term are other LDCs in Asia and Latin America (Mexico, Brazil ??) who compete for the same markets and at the same time cannot retrun the favour by supplying China with high end machinery and equipment. But I cannot help asking myself , is he missing something? If the majority of Chinese imports are in high tech products, could this not reflect itself later in enhanced high end design and manufacturing capacity. Is this not a two stage operation, and are we not in the first stage? Sure he covers himself by arguing that for this sitaution to change we would need to see a rapid build-up in capital-intensive sectors with both a high domestic value-added component and a significant export orientation, and that this possibility is remote. I think it may not be so remote: remember Japan in the fifties and sixties, and then Japan in the seventies and eighties. The low end exports of today are to pay for the transition to the high end exports of tomorrow, China is not just another poor thirld world country about to become dependent on large foreign multinationals. There is a strategic plan somewhere, and while Anderson may be right about this decade, I'm not sure he will be about the next one. The principle of acceleration is working. And just at the time when all those western baby boomers will be looking to cash-in their pension cheques.

Is China really taking over as the global manufacturing hub? In the past few months the alarm bells over the country's rapid penetration of industrial markets have grown louder. The main arguments are familiar: first, there is a significant migration of global manufacturing capacity to the mainland; and second, China is rapidly moving into capital-intensive and high-technology industries, threatening to erode the competitiveness of producers in developed countries. Both are based on a misinterpretation of China's astonishing growth.

First, take the question of manufacturing migration. This is not a complicated analytical issue but is nonetheless misunderstood by a surprising number of analysts. For China to be a global manufacturing hub, it has to be a net exporter of manufactured goods. And the best measure of the rate at which industrial capacity is migrating to the mainland is exactly the rate of increase of China's net manufacturing balance with the rest of the world.

Between 1993 and 2002, China's gross industrial output rose from $480bn to $1,300bn. This represents an impressive increase from 2.4 per cent of estimated global industrial production at the beginning of the period to more than 4.7 per cent last year. However, at the same time China's gross purchases of industrial products rose from $490bn to $1,250bn, or 4.6 per cent of world industrial production.

The difference represents China's net manufacturing exports to the rest of the world, which were $50bn in 2002, or a meagre 0.18 per cent of global manufacturing capacity. Moreover, that figure has not been increasing noticeably over time; the net balance reached $45bn in 1997 and has been broadly stable ever since. In other words, the mainland may account for an ever-greater share of the world's industrial output but this is almost completely offset by its growing industrial market. Far from sucking in capacity, China has had virtually no overall effect on manufacturing outside its borders.

The astute reader will argue that in lumping all manufacturing industries into one overall category, the above argument misses the point, which is that China has a much more devastating impact on those markets in which it competes directly. And the reader would be right. This brings us to the second argument, that China is rapidly moving up the manufacturing food chain. When we break down overall manufacturing by industrial category, we find that the mainland records a rapidly growing net surplus in textiles and light consumer goods (roughly $80bn last year) and an expanding deficit in machinery and capital equipment. Despite headline electronics exports of more than $100bn in 2002, the net balance was only $11bn, as China's information technology export sector is still predominantly made up of processing and assembly of imported components for re-export.

The bottom line is that China is becoming a manufacturing hub for the rest of the world in low-end, labour- intensive goods. Contrary to current fears, the rest of the world is becoming a manufacturing hub for China in high-end, capital-intensive goods. This is exactly how international trade should work.

So far, so good. But could all this change tomorrow? Is not China importing capital equipment today so that it can turn round in a few years' time and flood the world with cheap high-end products? Of course, there is no guarantee this will not happen - but the chances are remote. For China to jump multiple rungs on the global value-added chain, we would need to see a rapid build-up in capital-intensive sectors with both a high domestic value-added component and a significant export orientation. There are plenty of industries where one or the other is true but few examples of both.

A final worry is that China's economy could collapse, or at least slow sharply, resulting in a flood of excess manufacturing capacity on to world markets. After all, this is what happened in 1997 and 1998, when a post-bubble decline in domestic demand caused the trade surplus to rocket to nearly 5 per cent of gross domestic product. Again, however, the chances are remote. Goldman Sachs' index of activity in China points to rapid growth over the past two years and, despite objective macroeconomic risks in the future, the outlook is far more stable and manageable than it was six years ago. Chinese manufacturing is a force to be reckoned with but not one to fear.
Source: Financial Times

All Does Not Seem Well With German Banks

This doesn't look too promising. The fact they've gone so far as to come out to deny the plan seems to indicate all is far from well. After all, they are hardly likely to come out publicly and admit the problem. My response, like that of Christine Keeler in an earlier epoch: they would say that, now wouldn't they.

The European Central Bank on Monday sought to allay fears of a banking crisis in Germany amid reports that the government and senior bankers had discussed emergency measures to bail out the financial system. In a hurriedly called press conference to launch an ECB report on banking stability in the European Union, Edgar Meister, who heads the ECB's banking supervision committee, dismissed talk of a Berlin-backed bank rescue plan. Mr Meister, who also sits on the board of the Bundesbank, said he was confident Germany's beleaguered banks could "resolve their specific weaknesses on their own" without needing taxpayers' money.His comments came in the wake of a meeting at which top bankers met Chancellor Gerhard Schröder and discussed setting up a government-backed "bad bank" to take on the bad debts of the big commercial banks.German banks have taken billions of euros in loan loss provisions and seen profitability collapse, as corporate insolvencies have jumped to record levels amid the steep downturn in the eurozone's biggest economy.HVB Group and Commerzbank reported big losses for 2002 and investors fear they may face further heavy losses this year, fuelling concern over the resilience and stability of the German banking system. Mr Meister said he was not aware of any government plan for a bad bank, adding:"I don't think German banks are in a condition that they would need such a plan." He said 2002 had been very difficult for German banks and the outlook for this year was "not good either". But he insisted that neither the stability of the financial system nor bank liquidity were in question.His remarks echoed comments by Hans Eichel, the German finance minister, who said the banking system was not in crisis and denied the government was considering any emergency measures. But speculation over a bail-out plan is likely to be fuelled today by a report from credit analysts at HVB, who say the bad bank idea is "a step in the right direction". German press reports said the proposal was raised at the meeting with Mr Schröder by Deutsche Bank chief Josef Ackermann, although he insisted Deutsche itself would not take part.The HVB analysts said the plan amounted to "an admission that there are very serious challenges facing German banks", but pointed to Sweden's success in using the model to overcome a banking crisis in the early 1990s.
Source: Financial Times

Monday, February 24, 2003

Bank of Japan: the Speculation is Over

Well finally the speculation is over, and Japan has got a new governor for its central bank. Much to the sighs of disappointment across the planet, the newcomer is not an inflation targeter, in fact he is a tried and trusted member of the old guard, so in theory this means more of the same. But since nothing is ever completely predictable, and even less so in Japan, we may still see some surprises. Japan is, after all, mired in deflation, with government debt rising every year and no sign of capacity to repay improving. So, one day or another, something has to give somewhere.

Toshihiko Fukui has been named by Junichiro Koizumi, Japan's prime minister, as his choice to be the new governor of the Bank of Japan, prompting critics to question Mr Koizumi's qualifications as a reformer and Japan's commitment to tackle deflation. Mr Fukui, former deputy governor of the BoJ before resigning amid scandal in 1998 and currently head of the Fujitsu Research Institute, a think-tank, is a career central banker expected to continue the policies of the incumbent governor, Masaru Hayami.

Mr Fukui's nomination indicates strongly that future moves by the BoJ to tackle inflation will not make use of so-called unorthodox measures such as an inflation target or the purchase of overseas assets, but will continue the current policy of injecting liquidity into the banking system.Peter Morgan, economist at HSBC Securities, said: "Mr. Fukui's views on monetary policy are conservative, and in line with the mainstream of the Bank of Japan. This means that there will be no break in the BoJ's monetary stance, and that the adoption of unconventional policy measures is extremely unlikely. Adoption of an inflation target is also unlikely."
Source: Financial Times

Our Brush With Deflation

Thinking more about the Stephen Roach piece I blogged last Friday, I think there are a couple more points I should make clear. Firstly my quibble relates to the deflation story, not its reality. We are certainly running extraordinarily close to a global deflation scenario, despite the fact that, ironically, a short term rise in fuel costs might seem to be leading us in the opposite direction. Secondly, the oil price spike is significant. Of course if the price continues at current levels (or, god forbid, above them), the shock can knock the global economy back into recession. Stephen's argument on this count are cogent and compelling. And the weakest will feel the pain first, again as I tried to flag in last week's post on the Brazil dilemna. I, however, remain unconvinced that, with or without the petrol shock, we are heading anywhere especially attractive economically speaking, and for the reasons I spelt out in the original blog.

Japan Prepares to Say Farewell to Hayami

Central bankers are a select group. Some like Alan Greenspan, Wim Duisenberg, Eddie George become household names. Others seem more comfortable with obscurity (the is not the same thing as obscurantism which is undoubtedly Duisenbergs best known attribute). Masaru Hayami, who will complete this month his five-year term as governor at the Bank of Japan, would probably have preferred the obscurity, but Japans continuing economic plight, and its significance in the world economic order have meant that this preference was not to be respected. In particular this has been the case since during his watch at the bank Japan has been the first major economy in recent times to face a sustained battle with deflation, and as a consequence the eyes of the economic world have scrutinised every decision looking both for a way out, and for lessons for the rest of us.

Hayami took control of Japans monetary policy levers in March 1998, after his predecessor resigned following a wining-and-dining scandal involving top Bank of Japan officials. Much was expected of him, and, in the event, criticism of him has been widespread, first and foremost for the fact that he appears to have had more fear of provoking inflation than he did of permitting deflation to continue. His most notorious failure: the decision to terminate the zero interest rate policy in August 2000, right after the NASDAQ bubble burst, only to have to re-introduce it and change course yet again in March 2001. As the eyes of the world turn towards the appointment of his successor, and to whether or not he will be an 'inflation targeter', the Daily Yomiuri offers us this assessment of Hayami the central banker:

With extensive experience in both the private sector and the central bank, Hayami was expected to usher in a new era for the nation's financial guardian. But instead, Hayami failed to recognize that his key mission was to overcome deflation as he was haunted by the specter of inflation, which had troubled the nation's early postwar years. The year that preceded Hayami's accession to the governorship was plagued with financial woes for the nation, including the collapse of former giants including Yamaichi Securities Co. and Hokkaido Takushoku Bank. Yet despite the prospect of far-reaching economic fallout from such financial woes, the central bank failed to quickly respond to the unprecedented situation. It was not until September that year that the central bank reduced its benchmark short-term interest rate--the unsecured overnight call rate--to 0.25 percent. However, the effects of the rate change were minimal, and the central bank was subsequently forced to adopt a zero-interest rate policy in February 1999. From the perspective of a traditional central bank, such a move was unusual in that it had effectively given up one of its most powerful monetary policy instruments. Thereafter the Bank of Japan went on a policy zigzag, bringing an end to its zero-interest rate policy in August 2000 despite warnings concerning the nation's worsening deflation, especially after the bursting of the information technology bubble in the United States. However, the central bank's decision to hike rates was strongly criticized, and the bank reinstated its zero-interest rate policy just six months later. In March 2001, financial uncertainty again rocked the economy as companies closed their accounts for the fiscal year-end. In a last-ditch effort to overcome a deflationary downturn, the central bank changed its policy from targeting interest rates to quantitative monetary easing--a policy of raising the balance of current account deposits held by private financial institutions at the central bank.

But when the new policy failed to work, Hayami reportedly responded to growing criticism by indicating to then Prime Minister Yoshiro Mori that he wanted to resign. Central bank officials seem to have an inclination to accept a certain level of recession on the grounds that an economic contraction is an inevitable consequence of speeding up the disposal of banks' nonperforming loans and hastening structural reforms. Some top officials have openly stated that recent price falls are "good" as they allow consumers to buy quality goods cheaply. The central bank officials' lack of recognition of the problem has resulted in their failure to implement timely antideflationary measures. This has caused deflationary pressures to accelerate, a situation for which Hayami must accept responsibility. Nevertheless, in contrast to general discussion on the topic, Hayami and his experts at the central bank may not have been as timid or conservative as one might have been led to believe. Not only have their adoption of a zero-interest rate policy and quantitative easing been bold steps, but other measures such as the purchase of stocks held by banks should be applauded for having gone beyond the traditional bounds of central bank policy, such as open-market operations and lending to banks.

Yet as soon as the economy appears to be on the verge of recovery, the central bank has nipped it in the bud by reimposing a tight-money policy, a habit it seems incapable of shaking off. Market players are well aware that the central bank has no option but to continue its easy-money policy as it has been unable to devise policies to overcome deflation. The central bank's reluctance to act has resulted in the yield on the benchmark 10-year government bond falling to a record low of 0.75 percent at the end of January, indicating that the market expects deflation to continue. The central bank's maneuvering of the overnight call rate formerly acted as an alarm bell for the market. The bank would leak its rate decisions if it judged the economy was overheating, using the announcement effect to fine-tune the economy.

This jawboning of the market by the central bank indicated to market players that the Bank of Japan was keeping a close watch on the nation's financial health. But now, the bank is sending out unfavorable signals that may prolong deflation and its ultra-easy monetary policy for no good reason. If a central bank fails to devise policies to influence the market, its raison d'etre must be called into question. What about purchasing a wider range of assets as the next strategy? If the bank purchased exchange-traded funds or real estate investment trusts, it would boost land and stock prices, helping to improve the banks' balance sheets as they hold large amounts of such assets as collateral. May the new governor be reminded for the last time that deflation is the nation's economic enemy, not inflation or an asset bubble. It is hoped the new central bank chief will be both courageous and flexible in carrying out the policies to overcome such a financial foe.
Source: Daily Yomiuri

Sunday, February 23, 2003

McDonalds Health Problems

Problems only seem to be mounting up for McDonalds these days. On the one hand they've started to lose money and are looking for a change of image. On the other a more 'health aware' society means even more headaches. I've a feeling this one is going to run and run. Regardless of the legal basis for the claims that their products are 'hazardous and detrimental' it is clear that obesity and related problems like diabetes and coronary heart disease are more than likely about to be come one of the topics of the decade. Thinking about this makes me realise that the topic is a lot bigger than McDonalds and obesity and takes me back to a post I made earlier last week - about Kurzweils talk at the Future of Life Conference - and about what he calls the relation between purpose and biology. His points is that our dietary system and needs have evolved over hundreds of thousands of years in conditions vastly different to those which we experience today. In the last two hundred years our societies have made a huge leap forward, and in the last ten another one. It's an old adage that says that what we are is what we eat (both mentally and physically), so clearly we need to take a long hard look at what we are doing here, and use our newly discovered creative intelligence to try and figure out a better way to combine sensory pleasure with biological reality.

Fast food restaurant chain McDonalds is facing renewed legal action in the US over claims that the its food was responsible for health problems among a group of obese American children. The original complaint was thrown out last month, but US district judge Robert Sweet left the door open for further litigation. His ruling pointed out the possibility of a case to prove that additives in fast food meant there were risks in eating it that consumers were not aware of. The original case was brought on behalf of a group of overweight teenagers in the Bronx district of New York.

The new suit alleges that products such as Chicken McNuggets were "hazardous and detrimental" to an extent beyond what was understood by the ordinary consumer. It alleges that McDonalds promoted its Chicken McNuggets, fish and chicken sandwiches, fries and hamburgers as being healthy when researchers, and even the company's own nutritional division in France, warned otherwise. Furthermore, it says that researchers have warned that some of these foods should not be consumed more than once a week or consumers could suffer problems such as obesity, diabetes and heart disease. McDonalds has dismissed the case as "senseless" and "absurd". The National Council of Chain Restaurants (NCCR) has also condemned the new lawsuit as "ridiculous", saying it attacked "common and everyday foods and ingredients" approved by the US Food and Drug Administration, the industry's safety regulator. But the decision to renew the lawsuit is an uncomfortable development for the food industry, which fears it could become the next focus for the fee-hungry legal profession.
Source: BBC News