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Friday, May 16, 2003

US Prices Going Down the Slippery Slope

The deflation 'scare' operates on two levels. One is the level of intellectual argument, the other the day to day data. Today's news, in this second sense, is definitely 'deflationary'.

Consumer prices excluding energy and food eked ahead at the slowest year-over-year pace in 37 years in April, while the once robust housing market cooled during the month, according to government data that fanned fears of the danger of deflation. The core Consumer Price Index rose at just a 1.5 percent pace for the 12 months ended in April, its slowest clip since March 1966, the Labor Department said on Friday. For the month, the core Consumer Price Index (CPI) was flat for a second straight month -- the first time that has happened since 1982. The overall CPI fell 0.3 percent in April, but like the big drop in wholesale prices reported a day earlier it was driven down by a big drop in oil prices since the start of the Iraq war eased worries of supply disruptions.

The figures raised the prospect of a further slowing in core consumer prices that has investors fearing that deflation, or an extensive decline in prices across the economy, could ensnare the U.S. like it has Japan.Last week the Federal Reserve said in its policy statement it was worried about a substantial decline in inflation, words that stoked worries of deflation and expectations the central bank could respond next month with another reduction in official interest rates. The federal funds rate already stands at four-decade low of 1.25 percent. "The CPI number shows that the economy is still clearly in an environment of broad disinflation. Whether this will be enough to move the Fed to cut rates is still a huge question mark," said Laura Rhame, senior economist at Brown Brothers Harriman in New York.

"This disinflation factor is adding a whole new level of uncertainty in the U.S. economic outlook," she said. Since the Fed's statement, an array of figures have shown the economy struggling with at best meager growth that has done little to absorb the excess production capacity that tends to drive down the pace of inflation until growth picks up robustly. The Fed said on Thursday capacity utilization at factories, utilities and mines fell to a 20-year low of 74.4 percent in April -- raising the specter of yet more declines in the pace of inflation until strong economic activity returns, analysts said.

The price declines spread almost across the board. Housing prices dipped 0.1 percent, the weakest reading since October 2001 in the immediate aftermath of the Sept. 11 attacks. Apparel costs slid 0.6 percent and are down 3.8 percent from a year ago. New vehicle prices fell 0.4 percent after a 0.2 percent rise in March. Even the once roaring housing market cooled in April as housing starts fell a surprisingly hefty 6.8 percent, largely due to a decrease in groundbreaking for new multifamily homes, the Commerce Department said. But the housing news wasn't entirely bad. Permits, an indicator of builder confidence in future sales, rose 1.2 percent on the month. A third government report showed real average weekly earnings fell 0.3 percent in April after a 0.1 percent gain in March, the Labor Department said. On a year-over-year basis, earnings rose at just a 0.2 percent rate.
Source: Reuters News

Blowing Sunshine

I'm posting some feedback I've received from Kevin. He is obviously right that the US has no declared dollar policy in the conventional sense of the term. But let me suggest this: market participants act on expectations, so part of the 'guess' is what will be the reaction and response of the US Treasury. The US has just won a war, and many people speak of a global hegemon. Now, does anyone doubt that the US could defend the dollar level it wanted, if it wanted. So not having an explicit fx policy is in itself a policy. At the moment I don't buy the dollar correction argument based on the external deficit argument. I don't buy this because of the absence of alternative growth engines argument. Investors may be disenchanted with the US, but realistically, where else do they go? So if they are testing the dollar downwards it is because it senses that the administration will not react against.

Now the BoJ does 'spend' lots of money, but what does this spending involve, selling yen and buying dollars, if the yen long term goes weak, this 'spending' could look like an investment. Now the sterilisation argument is another country: because what is being proposed by Bernanke and others (with due allowance made for the requisite denial of intention) may well be an implicit fx 'policy:

The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt.I need to tread carefully here. Because the economy is a complex and interconnected system, Fed purchases of the liabilities of foreign governments have the potential to affect a number of financial markets, including the market for foreign exchange. In the United States, the Department of the Treasury, not the Federal Reserve, is the lead agency for making international economic policy, including policy toward the dollar; and the Secretary of the Treasury has expressed the view that the determination of the value of the U.S. dollar should be left to free market forces. Moreover, since the United States is a large, relatively closed economy, manipulating the exchange value of the dollar would not be a particularly desirable way to fight domestic deflation, particularly given the range of other options available. Thus, I want to be absolutely clear that I am today neither forecasting nor recommending any attempt by U.S. policymakers to target the international value of the dollar.

Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934.17 The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.

The sterilisation argument is also highly contested. Bernanke and other criticise the BOJ interventions precisely because they are sterilised. Among the proposals for 'unconventional' measures is one that would make such interventions unsterilised. Bottom line, I think the foolproof path isn't 'foolproof' because of the generalised deflation argument and not because, analytically and in principle, you can't separate fx from monetary policy. Obviously, in the final analysis all policies are one, but the nuances may be important. Now Kevin:

I don't really get this notion of an fx policy separate from monetary policy. The press and analysts like Medley have a stake in going on about fx policy it gives them something to talk about, thus a way to make money from readers and clients. That doesn't mean any of it is true. ("If understanding fx policy were easy, anybody could do it.") Of course, Japan has an fx policy. The BoJ spends great gobs of yen in service of that policy. As far as I can tell, though, Japan still sterilizes its fx interventions and the last time I cracked open an economics text on the subject of sterilized intervention well, you know. The US does not intervene nearly as much, not at all under Bush II. This lack of support for the dollar is part of the "dollar policy" story if the US Treasury won't back up strong dollar talk with cash, then the Treasury must really support - or "be happy with" as it is often reported a softer dollar. That isn't a policy, other than in the negative sense that the Treasury has a determined policy of doing nothing to disturb market pricing of the dollar. Similarly, Snow's (and O'Neill's before him) taking Japan to task over fx intervention is really a demand that Japan not have an fx policy.

Let me offer an alternative explanation for US officials' behavior regarding the dollar. Lately, there have been several mentions from US officials of the benefits to exports from a weaker currency. That has been taken, mistakenly, I think, as support for a weaker dollar. It is no more than an acknowledgement of the facts. Why bring it up? Doesn't mentioning it at all suggest policy makers are taking an interest? Well, of course they take an interest, but often the choice to raise the issue lies with a reporter, not the public official. A reasonable rule of thumb for elected officials and their representatives is when confronted, blow sunshine. The US supports a strong dollar. Then isn't a weak dollar a policy failure? Why, no! It supports exports! (No bad news, no policy failures thank you. Not on my watch.) Nobody ever won an election based on their fx policy.

Pegging is still practiced, but not by the US, Europe or Japan (though Japan sometimes seems to have a target band, not so different from a peg). Doesn't pegging a foreign exchange rate simply make monetary policy the slave of fx rates, instead of the other way around? To a lesser extend, doesn't having an fx policy imply that, to some extent, you are pursuing multiple goals with a single monetary policy instrument (again, reference to the textbook suggests* well, you know.) The "foolproof
path" seems (oh, I'm gonna hate myself) a bit of a fantasy, pretending there are two policy instruments when there is only one.

In sum: What mechanism for pursuing fx policy, other than monetary policy, is there? What real evidence is there that the US is pursuing any particular fx
policy, rather than (as O'Neill and now Snow have both said) that the US is pursuing policies which are likely to foster growth and attract investment, which will incidentally support a strong dollar? How can a "foolproof path" that involves currency manipulation work, when deflation risks are general, rather than limited to a single economy? How can it do more than monetary policy, when there is only one instrument?

Japan's Deflation Gathering Speed

David Pilling from Tokyo, on how the rate of deflation in Japan is accelerating. Not good news.And just as I was getting used to talking about the 'slow burn' deflation.The rise in the yen isn't going to help any, either.

Japanese deflation gathered pace in the first quarter with year-on-year prices falling 3.5 per cent - their fastest drop on record. The fall may fuel fears that Japan, which has managed to co-exist with relatively mild deflation since the mid-1990s, could be sliding into a deflationary spiral. Japanese prices - as measured by the gross domestic product deflator, considered a more accurate measure than the consumer price index - have been falling more or less continuously since 1995. Annual price falls have averaged between 1 and 2 per cent for most of that time. Friday's figures showed deflation accelerating in fiscal 2002, a year in which Japan was growing out of recession, to minus 2.2 per cent, a record for a full year.

The figures were released along with GDP data showing that growth in the first quarter fell to almost zero, leading some economists to conclude that the economy was on the brink of yet another recession. Nominal growth fell 0.6 per cent in the March quarter, or minus 2.5 per cent on an annualised basis. Paul Sheard, economist at Lehman Brothers, said: "If you look at the chart it looks horrible. It looks as though deflation is going through the floor." However, the headline figure exaggerated the picture, he said, because the GDP deflator in the first quarter of 2002, when Japan began to pull out of recession, was positive. "It's something of a statistical fluke, though deflation is deflation and it is not a good sign."Shuji Shirota, economist at Dresdner Kleinwort Wasserstein, said "unprecedented deflationary pressure" had been stoked by a big cut in the winter bonuses of government employees, as well as by a fall in the price of PCs and other electrical machinery.

The issue of deflation has split the government, with officials disputing its causes and disagreeing over its effects. Heizo Takenaka, economy and financial services minister, on Friday said falling prices posed a threat. "Deflation remains severe. While pursuing structural reform we must also press on with efforts to end deflation." This week, Eisuke Sakakibara, former vice-finance minister, said Japan could live with mild deflation so long as it prevented the economy tipping into a destructive spiral of falling prices. He said deflation was the structural result of global productivity gains and would likely spread from Japan to the US and Europe. Mr Takenaka drew some comfort from the fact that real growth for fiscal 2002 was 1.6 per cent, above the 0.9 per cent the government had predicted. Much of that was based on exports, which have begun to slow, and on surprisingly robust consumer spending. In the first quarter of this year, consumer spending, which accounts for 60 per cent of GDP, rose 0.3 per cent quarter on quarter. Mr Sheard said real growth of about 1 per cent a year over the past decade was welcome, but he pointed out that the economy was shrinking in nominal terms. Nominal GDP for fiscal 2002 fell to ¥499,000bn, the first time it has dipped below ¥500,000bn in eight years.
Source: Financial Times

SARS and the Chinese Blogsphere

The SARS problem in China is an area where blogging could, in principle, be extremely useful. I was therefore surprised to come across John Pasden's site and find this 'open letter' to the US media to which he, unfortunately received surprisingly few replies. I also discovered the interesting looking T-Salon and China weblog :

To Whom It May Concern:

I am a 25-year-old American citizen living in Hangzhou, China teaching English. I love China, and I love my life here. I find it very distressing, then, to see an abundance of hysteria- and hype-driven news stories on SARS. What I don't understand is why the American media has not gone to one of the most authentic sources out there today - blogs. Yes, blogs (weblogs). There are many, many English-speaking foreigners living through the SARS crisis. What's more, they are conscientiously WRITING ABOUT IT, and have been since day one. I sincerely hope that you consider adding this angle of the SARS story to your news reports.
Source: Sinosplice

Singapore: After the Sacrifices........Surely There Must Be some Payback Now?

And just to prove that this isn't a 'Europeans only' party, I've got Eddie from Singapore on the line. He says he can't hold, so I'll pass him straight through to you:

Regarding your point on "secondly on the level of expectations, as young people begin to feel that they may not be that much richer than their parents (if richer at all!!) then they won't be so prepared to indebt themselves long term. Among other things this must affect property values."

You are absolutely right! I personally know of 2 friends in their late-twenties, just got married, and aren’t prepared to indebt themselves (by way of mortgage loans) as much as I did when I was their age. The mentality is different now. When I started work, it was rising wages and property prices. You buy on dips. I don’t think this change of mentality among the young is that widespread yet ... perhaps among some professionals now, but its growing and surelywill continue to do so if the poor state of the economy continues.

An open policy towards foreign labour and immigration is absolutely necessary. You’ve mentioned this before. And Singapore has such a policy. Non-residents probably account for a fifth or more of the people working here now. Number of foreign students have grown rapidly over the years. But the influx is slowing (reversing?) given the recession. Rentals are down sharply with fewer expats. Foreign students are returning home since unable to find job here. Chicken and egg.

How do you now attract immigration without growth? That’s why I also sympathize with the Krugman solution. What alternatives are there .. to stop the vicious circle? Because the longer you leave it alone, the harder it is to pull yourself out of the hole. Listening to Adam Smith here can be dangerous. But Adam’s the rage in Asia. Stephen Roach is quite well quoted here, but I read Andy Xie's stuff mainly through your site. Excess money surely contributed to the crash in Asia. He’s right about too much money going into property. But that was in the past. It was crazy then. I remember a local property tycoon coming out to say that Spore was only a small island (with limited space) at the peak of the boom. And people rushed out and queued days ahead of new property launches.

But too much money now? Money is cheap certainly, but how is it too much? More people are running down their savings. More people are trying to maintain their savings as wages fall. You have too much money if there’s abundant frivolous behaviour. I don’t see that. Banks have excess money. yes. Loan-deposit ratios are ridiciously low. But that's because there are no business opportunities. no loans growth. so some of that money flows back into financial markets. but not much now. retail trading in the equity market is very low. It’s a Keynesian problem I think. The liquidity trap, and pushing on a string. My sense is that the precautionary motive for holding money is high and rising in Asia. I’m attaching an article I wrote, urging the govt to spend more to create jobs. May be a stop-gap measure, but what else is there? This country has consistently ran huge budget surpluses in the past and although the cumulative surplus is not published on a regular basis, my guess is we have a credit position in the region of at least US$100bn (over 100% of GDP).. Think Spore as the reverse of Japan. Surely some payback to the people now?

It isn't Just Germany

Latest figures for the eurozone economies indicate that it isn't just Germany that is in trouble, Holland had a bad first quater, and as predicted by bthe Chief Economist here at Bonobo Land, Italy is sinking into the mud:

The eurozone economy teetered on the brink of recession in the first three months of the year, according to figures released on Thursday that will intensify pressure on the European Central Bank to cut interest rates. Output in the 12-member zone was stagnant in the first quarter on the previous three months, with year-on-year growth of 0.8 per cent. Germany, the eurozone's largest economy, lapsed back into recession, with a contraction of 0.2 per cent in the first three months of the year compared with a decline of 0.03 per cent in the previous quarter. Economists said the figures painted a gloomy picture of the eurozone economy and created a com- pelling case for further interest rate cuts. With the global economy still fragile, disappointment has been mounting at the eurozone's failure to play its part in reviving growth.

The Netherlands, whose economy is closely linked with Germany's, contracted by 0.3 per cent - its second consecutive quarter of negative growth. Italy's economy, the eurozone's third largest, shrank at a quarter-on-quarter rate of 0.1 per cent in the first quarter of this year. It was Italy's weakest performance since the fourth quarter of 2001. The government recently cut its growth forecast for 2003 to 1.1 per cent from 2.3 per cent. Silvio Berlusconi, prime minister, said last weekend it was doubtful if Italy would achieve even 1 per cent growth. Together with Germany, Italy has been the eurozone's slowest-growing economy since the euro's launch in 1999. Italian growth last year was 0.4 per cent, the worst result since 1993.
Source: Financial Times

This Should Have Been Expected

Well, with the 'dropped dollar' running full steam ahead over in Washington, this is hardly shocking news:

Japan's economy stood still in the three months to March, after four quarters of expansion, as a slowdown in exports sapped growth momentum and left the economy heading back toward recession. Economists blamed the slowdown on a fall in exports to the US, and a pre-Sars drop in shipments to Asia. With Japanese companies struggling to increase revenues in the deflationary domestic market, many say only exports can drive an economic recovery. Gross domestic product in the first quarter of the calender year was flat, having grown 0.5 per cent between October and December, 0.8 per cent in the quarter before that and 1.4 per cent between April and June. Heizo Takenaka, economics minister, said the GDP data showed that in addition to structural reform more effort was needed to fight deflation.One measure of deflation, the GDP deflator - also released Friday - plunged 3.5 per cent in the three months to March, the biggest drop ever. The figure suggested deflation is more severe than indicated by Japan's consumer price index.
Source: Financial Times

Fathoming the Unfathomable

In trying to 'best guess' just what Duisenberg's problem is, the Economist may inadvertently have picked up on an important clue:

In a little-noticed remark at the end of the press conference called to discuss the policy changes, the ECB's president, Wim Duisenberg, put his foot in his mouth once again. In a comment that seemed to come from the heart, he said: "In the 16 years that I was the governor of the central bank of the Netherlands, there were two years in which we had deflation of ½%. I publicly declared then that I lived in a central banker’s paradise."

That is not a view shared by most economists, who believe that deflation would mark a dangerous new twist in Germany’s declining economic fortunes. Mr Duisenberg’s comments will have brought no comfort to the chancellery in Berlin.
Source: The Economist

(N)either the Fiscal Side (N)or the Monetary Side Sould Be Effective.

I grew up on Xmas re-runs of a film called 'the longest day', I have a feeling that as this year's solstice approaches this title may ring through my head on more than one occassion. This week has been a worrying one for Brad . It started on Wednesday after a hard day at the chalk-face struggling with thinking about liquidity traps . As he reflects

Paul Krugman has just made me much more pessimistic about the likely success of "unconventional monetary policy" measures to fight deflation and liquidity traps. It's not that I hadn't heard the argument before--this is the third time I've read Paul's stuff on liquidity traps, after all. But when you are teaching something, you focus on it in a way that you almost never do otherwise...

Then yesterday he started reading the economist and noted:

Economists vary in their beliefs about what needs to be done to fight deflation: large devaluations followed by pegged exchange rates, inflation targeting, or the two-handed approach of large government deficits financed by printing money: either the fiscal side or the monetary side should be effective (even if we are not sure which).

Things, however are not so simple. Firstly, the problem with large devaluations, as we're seeing with the dollar now, is that one man's meat is another's poison. Solving the US problem by sending Germany to a dark and horrible place is no solution, and this needs to be said clearly. In this sense this weekend's G7 finance meeting is critically important. It's here that the whole Bush strategic vision needs to be reversed, in a global world there is no go-it-alone solution available. But here also is the danger: my fear is that the very shock which Stephen Roach so fears could come from a realisation that money has no safe haven, that a frantic chase from dollar to euro to yen and back again serves no known purpose. In a world swimming in money, this could be very grave indeed. Inflation targeting: this is all about 'expectations', and convincing people you can do it, I mean, I'm not convinced and I fear there may be others. Looking at Japan, what we may well be in is a 'credibility trap'. On the deficit, this is back to Gauti Eggerston, and 'commiting to being irresponsible'. Isn't that just what the Bush set are doing. Is this convincing people? Not if I read Brad's column aright it isn't. Pumping up the deficit as Japan and Europe already know, and the US is discovering, only pushes you closer up against the hard rock of the underlying demographic reality. Bottom line: things are more complicated than 'most economists' tends to assume, and for starters we need to take a view which looks well beyond short run business cycle dynamics.

Thursday, May 15, 2003

Just How Much Do They Understand?

Reading these quotes from the ECB monthly bulletin, you really have to ask the question: how much idea do they have of what is really happening. Tunnel vision, would be another explanation. Obviously grwoth could improve later this year, and miracles could happen in 2004. But rather than exercising your imagination over what might happen in the best of all possible cases, maybe you should be dealing with the downside risks showing up on the radar right now, and these flash 'deflation alert'. Brad would be banging his head against the wall!

The European Central Bank said on Thursday that eurozone inflation risks were limited and that the economy would pick up later this year and accelerate in 2004.However, the statements - contained in the ECB's monthly bulletin - coincided with several eurozone countries reporting weaker-than-expected growth on the same day. Following its decision last week to hold interest rates steady at 2.5 per cent, the ECB said that its monetary policy stance remained consistent with price stability."Looking ahead, a gradual strengthening of real GDP growth is expected to start later in 2003 and to gather more pace in the course of next year," the ECB's report said. "Factors supporting this outlook are and expected recovery of global demand and the prospect of falling consumer price inflation benefiting real disposable income growth, and the low level of interest rates."

There were still downside risks to that assessment, the ECB said. Those included macroeconomic imbalances outside the euro area as well as concerns about the impact of the Sars virus. However, Germany, Italy and the Netherlands all reported on Thursday that their output had contracted in the first quarter of this year.Germany, Europe's biggest economy, shrank by 0.2 per cent during that period, raising the prospect that it will slip into recession this year. That news is likely to increase pressure on the ECB to cut eurozone interest rates when it meets next month.The ECB said that lower oil prices, an environment of moderate economic growth, and the effects of the significantly higher exchange rate of the euro would all contribute to reducing inflationary pressure beyond the short term. "Since the end of the military conflict in Iraq, the exchange rate of the euro has resumed an upward trend that started in early 2002. As a consequence, the nominal effective exchange rate of the euro is now close to the average level of early 1999," the ECB said.
Source: Financial Times

US Retail Sales, Prices and Consumer Confidence Worries

Uff!!! There is a raft of disagreeable looking data coming through today:

US retail sales slid and import prices dropped at the sharpest rate on record last month, fuelling more talk of deflation and offering further evidence of the continued weakness of the US economy. Treasury bond yields sank to 40-year lows, stock prices eased and the dollar weakened slightly in reaction to the data. Futures markets priced in stronger odds of more Federal Reserve interest rate cuts. The fall in sales was accompanied by consumer confidence data suggesting that 73 per cent of Americans consider the economy's condition to be "negative," and the results of a poll in which most respondents said they lacked confidence in President George W. Bush's handling of the economy. Some economists said the data showed that the rebound many had hoped for after the Iraq war had failed to materialise.The Commerce Department said sales dipped 0.1 per cent in April, against economists' predictions of a 0.4 per cent gain. Excluding car sales, sales fell 0.9 per cent.The figures continued an erratic pattern - sales dropped 1.4 per cent in February, but jumped 2.3 per cent in March. Separately, the Labor Department reported a 2.7 per cent plunge in import prices - the biggest fall in a decade. The drop in both sales and import prices reflected, in part, a steep slide in prices for oil and gasoline, but in both cases, the declines were broad-based and much bigger than economists had expected. "This report will be disappointing to [Federal Reserve Chairman] Alan Greenspan, who has led the chorus for a likely pickup," said Peter Kretzmer, an economist at Bank of America Securities.
Source: Financial Times

German Economy Shrank First Quarter

The FT tentatively points out that this might suggest a recession in Germany, my feeling is that it indicates the recession is pretty much guaranteed (but then I think it already was, months of ECB ineptitude, and a complete absence of creative policy alternatives have made this pretty much a dead cert). The only real question is how long and how deep?

The German economy, Europe's biggest, shrank in the first quarter, Hans Eichel (pictured), Germany's finance minister, said on Wednesday night, raising prospects of a recession at the heart of the eurozone. Speaking in Hanover ahead of Thursday's publication of official growth figures, Mr Eichel said that "contrary to Bundesbank and government expectations" the federal statistics office would show that "in the first quarter we did not have slight growth, but a small minus". His comments raise the prospect that Germany will slip into recession - as defined by two successive quarters of contraction - this year.They also undermine Mr Eichel's own previous growth forecasts, which had already been revised downwards. The government forecasts growth this year of 0.75 per cent. Private sector economists had been forecasting growth of at least 0.1 per cent for the first quarter. Thursday also sees the publication of semi-official annual tax revenue assessments - which it is feared will reveal another hole in government finances. The news will increase pressure on the European Central Bank to cut eurozone interest rates when it meets next month. Mr Eichel has recently delivered a series of gloomy pronouncements on the state of the Germany's economy and its public finances. In recent days he has said the government would this year exceed the 3 per cent budget deficit limit for eurozone members and be unable to balance the budget by 2006.
Source: Financial Times

More On Expectations

Obviously there is a kind of 'double bind' dimension to Fed policy making at the moment. Richard Berner was rightly congratulating them last week for 'bringing us in on the conversation', the trouble is once we're 'in' we may feel we want to draw our own conclusions. Judging by movement in Treasury bonds, some people are already drawing the
conclusion that deflation is here to stay. This was not what the Fed had in mind.

The yield on 10-year U.S. Treasuries was testing a record 45-year low in Asian trade on Thursday, supported by poor U.S. data and expectations that the Fed will keep interest rates low.Treasuries have rallied sharply since the Fed warned last week that the economy was in danger of a further decline in inflation or even deflation -- when prices across the economy fall. On Wednesday, helped by poor U.S. retail sales data for April, the yield on the 10-year bond fell to its lowest since 1958. Retail sales excluding autos showed an unexpected fall of 0.9 percent, the biggest since just after the September 11 attacks. "I think this trend will continue for a while," said Akihiro Nishida, senior economist at Mitsubishi Securities. "Economic data has been weak and the Fed's warning is having a great impact on the market." As of 0219 GMT, the benchmark 10-year Treasury note US10YT=RR was at 100-29/32, yielding 3.51 percent, compared with late New York's 100-27/32 yielding 3.52 percent. It hit a 45-year low of 3.51 percent in New York trade. Thirty-year bonds US30YT=RR , though no longer issued by the Treasury and thus prone to exaggerated swings, were at 113-19/32 yielding 4.51 percent, flat from late U.S. levels. During U.S. trade the long bond hit 4.50 percent, the lowest since the securities were first issued in the early 1970s.
Source: Reuters News

Wednesday, May 14, 2003

On the Importance of Weak Links

So what's going on today over at Farrell Land ? Well Henry has an interesting post about the 'Survivor' and network theory. This all goes back I think to the undervalued Mark Granovetter , and a key idea, the importance of 'weak' ties. Now the unstoppable Ben Hammersley has just written a piece on the mysteries of Blogging, but I don't know if he caught up with this one: when you're blogging it's the weak links that matter. Brad links to me, I link to Brad , but this, while it's interesting for discourse and dialogue, isn't really interesting for growth and complexity, because we're both talking to the same people. The more intersting links are the 'out of specialism' ones: maybe this is why I go to Henry and Maria. (I certainly do do plenty of zigginga nd zagging with them). No that isn't true, I'm interested in what they have to say. (Same with frans , same with Eamonn etc.........). Ambiguity and open-endedness is also important as part of a strategy, the objective only emerges are the process moves forward. I remember years ago in some old library stack finding a book by Karl Jaspers entitled 'the idea of the university'. Roughly paraphrasing, one line jumped out of the text at me: 'he travels farthest who knows not where he is going'. That's the one for me I thought. Incidentally Granovetter is currently working on a book entitled the social construction of economic institutions, which implies to me that Henry may in fact be wrong, there may well be a way to harmonise the economic and the sociological perspectives. Don't worry, I'm working on it!

Now clearly, you have to behave strategically to prosper in the game. But what does "strategically" mean? Game theorists and sociologists have very different answers to that question. A game theorist would assume that everyone would have a clear map in their head of the different kinds of players that she might encounter, the different kinds of strategies that she could use (perhaps dependent on which kinds of player she is dealing with), and the different kinds of outcomes that will likely result from different kinds of actions. There's room for some uncertainty in the game (random acts of "nature" can intervene here and there), but everyone knows that if they are at point x in the game, their interest is best served by strategy y (I'm simplifying a little here for the purpose of popularization). Here, it's a matter of playing within a fixed structure (the parameters of the game), which you completely understand, and where your interest is dictated at any particular moment by the specific point of that structure you're at.

Sociologists tend to take a different approach to social structures. By and large, they're interested in networks rather than games. Network theory suggests that a player's power and influence depends on her position within the network of social interactions that she finds herself in. Again, simplifying wildly, some actors can be at the centre of a spiderweb of relations; everyone comes to them in order to get things done. Others may be gatekeepers or intermediaries between two groups of people who don't otherwise have much contact with each other; these actors too can be quite important. Here, strategy is all about positioning yourself well within the network, and then manipulating information and resource flows in order to maintain or improve your position. It's much more open-ended than game theory - the universe of possibilities isn't fixed at the outset, but changes over time, and can be affected by the conscious action of the players.

Which of these conceptions of strategy best fits Survivor? I think that the answer is obvious to anyone who watched the series. It's the second, sociological conception. Pretty well everyone who saw this series of Survivor would agree that Rob was the smartest and canniest player. He didn't win; but this was in large part because he was quite unlucky at the end (Jenna, who did win, survived by a fluke). Both of the two finalists agreed that he should have been there instead of them.

How did Rob play? Not by having a rote set of strategies at the beginning of the game. Instead, as he explained it, he was always at pains to keep his options open; he maintained friendly relations with as large a group as possible (and was rather good at convincing others that he had their best interests at heart, even when he didn't). He then chopped and changed his strategy as circumstances demanded. When he needed to zig, he zigged, and when he needed to zag, he zagged. He didn't seek to lead alliances, but instead made himself into the pivotal player, who could move from one alliance to the next, and thus swing the vote in one direction or another. By so doing, he shaped the strategic context which everyone else had to play in.

Compare his behavior with that of Cosimo de Medici in early Renaissance Florence, as depicted in John Padgett and Christopher Ansell's classic piece, "Robust Action and the Rise of the Medici." Padgett and Ansell are sociologists, who want to argue against rational choice notions of strategic behavior, by offering their own notion of "robust action." Robust action is all about trying to maintain your own flexibility and freedom of choice over as wide a range of options as possible, while narrowing the options of everyone else. It implies that there aren't any fixed interests - all interests are positional and actors are less interested in pursuing specific goals at any point in time, than in maintaining discretionary options against the day when they do have a definite end to pursue. Thus Cosimo positioned himself at the center of a web of influence, without ever wanting fully to commit to anything or anyone...........

Don't get frozen into a group with a specific agenda; instead, try to be a key player (or potential key player) for every possible group. You're more powerful (in the sense of maintaining options and contacts) as a swing vote than as tribal chief. Keep your end-goals and specific strategies mysterious - try to be all things to all men and women. Maintain flexibility at all costs. And then go for broke when the opportunity arises.

I reckon that two important lessons flow from this. First, that sociological approaches to the understanding of human behavior capture certain things that economic approaches can't. They're much better at dealing with fluid situations, where the future is unknowable, and people want to keep as many options open as possible for dealing with unanticipated problems. And many other things besides, I'm sure. Second, that an academic with time on his hands during the summer break is a dangerous thing indeed.
Source: Gallowglass

The Liquidity Trap: A Sticky Problem

Brad has a number of posts this week on the liquidity trap problem (and here and here . Two points occur to me: firstly, is it more than a merely semantic point whether we are 'fast approaching' or "already caught in the orbit" of one; and secondly whether (as Joerg asks me) the name is not a misnomer, wouldn't 'viscosity trap' be a better description? Meantime, John Irons recent post is as good a start for the 'unintitiated' (we still await the 'guide for the perplexed') as any you will find:

The recent FOMC statement by the Federal Reserve (Fed) included the line that "... the probability of an unwelcome substantial fall in inflation, though minor, exceeds that of a pickup in inflation from its already low level" (emphasis added.) It occurred to me that this statement might be a little confusing - isn't inflation supposed to be bad? Why would a fall in inflation be "unwelcome"? The answer has to do with what economists call a "liquidity trap." (Note: the full analysis of a liquidity trap is considerably more complicated than below, but this should convey the basic idea.)

The basic argument is that the interest elasticity of money demand increases, and monetary policy becomes less effective, when the nominal interest rate approaches zero. Ok, here's the English version...........
Source: ArgMax

Direct From the Singapore Front

News from the other Eddie the one in Singapore . He, like me he isn't convinced by the 'official-speak':

I read people like you because I'm concerned about the situation in Singapore. We are the third oldest Asian country. Our recession has stretched for 3 years. Our govt talks about structural reforms, which essentially consists of FTAs, liberalisation and the like, as solutions to the recession. I dont think they've diagnosed the problem correctly. We're talking about one of the free-est trading nation in the world already. What impact will these policies have? Unemployment is rising, yet the civil service thinks its a good idea to force early retirement. There is a greater sense of insecurity and uncertainty. The optimists say it'll foster the entrepreneur spirit. I'm not so sure. There are lots of mortagages to be paid.

The Global Medley

This piece from Forbes about the latest Global Medley report seems to confirm what I've been saying for longer than I care to remember: that it is the US Treasury (and not the ECB) who is really 'comfortable' with the changing currency parities. Reading about this report has reminded me of an earlier Fed Watch to be found on Brad's site. Which occasions two observations. Firstly they seem to be very well 'informed', and secondly it was actually in his comments on their 'deflation alert' that Paul Krugman warned of deflation expectations setting in for the long haul. Both Paul and Brad seem to have all they're confidence focused on the Fed. Paul says 'push this button', I say, by all means push, but let's not be too surprised if the result isn't the one we expect.

Officials at the U.S. Treasury Department are happy to see the dollar's gradual decline, but hope to keep markets guessing about its policy so as to prevent a disruptive plunge, macro-political advisory group Medley Global Advisors said. The Medley report, seen by market sources on Tuesday, said U.S. officials plan to counter any complaints at a G7 meeting this weekend with calls for Europe to cut interest rates and for Japan to undertake structural reform. "This is the U.S. retort at the G7 meeting. If the Europeans complain about the weak dollar, all the Treasury has to do is tell them to cut interest rates," said a trader at a large European bank in New York who had seen the report.

The Treasury believes that if Europe wants to stop the euro's export-choking appreciation against the dollar, a deep cut in euro zone interest rates will go a long way toward accomplishing that goal, the report said.The dollar sank to four-year lows against the euro on Monday after Treasury Secretary John Snow said a falling dollar helps exports, comments widely viewed as acceptance of a weaker currency.European and Japanese officials are not worried about current exchange rate levels but fear the U.S. administration's new tone has made it difficult to convince markets the U.S. favors anything but a gradually weakening currency, the report said.The dollar recovered a little on Tuesday after Snow said a sound currency is key to a sound economy. But Snow also said this week that currencies should reflect economic forces and not be held artificially high or low by intervention.

Market players say Japan has secretly intervened in markets lately in an effort to counter the dollar's fall, which hurts its exports, a key source of economic growth for an economy struggling with deflation and a decade-long slump.On Tuesday, traders said monetary authorities bought dollars for yen during the Asian and London trading sessions. But the Bank of Japan and the Ministry of Finance refused to confirm such transactions.In data released last week, Japan said it spent 2.38 trillion yen ($20.44 billion) on currency intervention during the first quarter. Even European officials are starting to worry about the dollar's impact on the competitiveness of European exports as its economy also suffers. The dollar is down 9 percent against the euro this year and it has shed about 20 percent in the past 12 months.
Source: Forbes

Currencies and Deflation: The Debate Continues

If things continue like this, my guess is that both the intenational currency markets, and the international equity markets are going to get extremely nervous. Having a rising euro which pushes Germany (and Italy!!) into deflation just doesn't make sense as a long term strategy. Nor is a rising yen going to help an already deflation-bound Japan. The US won the war in Iraq, and now has the 'clout' to impose its will. But what purpose does it serve saving the US scalp by sinking the rest. Contrary to what some say, there is no 'foolproof path' available here. Where does the money go? This is the problem, and this in its way could be the 'shock' that Stephen Roach most fears, the realisation that there may be nowhere to hide, no safe-haven left. After all it can't all go to China. If my memory serves me right, it was in the fear economy that Krugman argued that the biggest problem of all was not the deflation itself, but the shift in expectations towards a horizon of self-perpetuating deflation. One anecdotal detail, visits to my deflation blog have grown by a multiple of ten over the last week, my feeling is that our expectations may be shifting, right now as I am writing this. Whoever 'Mr Yen' is, he's not entirely on the wrong path, deflation is not a monetary phenomenon, it all depends, however, on what you mean by 'structural'.

International tension over exchange rates, accompanied by news of a widening US trade deficit, compounded the uncertainty in currency markets on Tuesday. John Snow, US Treasury secretary, warned that actively managing currencies was no route to prosperity and that Europe and Japan should not blame the falling dollar for their economic troubles. The dollar fluctuated heavily in the wake of his comments, ending New York trading higher despite the release of figures showing the monthly US trade deficit widening sharply in March to its second highest recorded level. In an interview with Reuters conducted last week but released on Tuesday, Mr Snow said: "As I have said on various occasions, devaluation strategies are not well calculated to breed long-run domestic prosperity." Although his comments largely reflected US policy, they came at a time when Japanese and some European policymakers have been signalling rising concern about the fall in the dollar.

Mr Snow's comments came as the US Commerce Department said the monthly deficit in goods and services rose by 7.7 per cent in March, the biggest increase this year, to $43.46bn, well above most economists' expectations. The figures could mean that US economic growth was even slower than reported in the first quarter. Much of the import surge reflected the oil price rise that preceded the war in Iraq and the dollar's fall over the past year. But a sharp increase in oil volume also played a significant role, and the rise in imports was broad-based. Eisuke Sakakibara, the former Japanese vice-finance minister known as "Mr Yen", warned yesterday that attempts at competitive devaluation by any of the three large currency areas could be dangerous. Mr Sakakibara, now a professor at Keio University, said Japan was the forerunner in a global shift from an era of structural inflation to one of structural deflation. "Even if we do not yet have [global] deflation, you have to concede that we have disinflation," he said, attributing falling prices to rapid productivity gains in manufacturing, particularly in China. "Deflation is a structural, not a monetary phenomenon."
Source: Financial Times

The Decline of East and West

Maynard is in truculent mood today. he's picked-up on my Economist quote about Google, and he doesn't like what he sees.

You quote The Economist as saying: "When the two Stanford drop-outs who founded Google, Sergey Brin and Larry Page.......". Going to Sergey's home page, home page , likewise for Larry Page .......

It seems to me that the statements is both factually false (they both appear to be on leave-of-absence from Stanford, not drop-outs) and more importantly misleading; in that drop-out carries implications of someone who went to college for a year, spent a lot of time drinking and chasing girls and left after being unable to pass the exams. I comment on this because I think this is one more sign that the West is simply doomed. Society, and publications like The Economist pay lip-service to the idea that education is important, but when push comes to shove they're more interested in promoting ideas like randomness, luck and "sticking it to the man by following my own unorthodox path"; which is why at every opportunity they want to tell you that Bill Gates and Steve Jobs are college dropouts. When something doesn't fit into the mold (Sergey and Larry, or the fact that Bill didn't exactly work his way up from the gutter but was born into the US corporate elite, and got the IBM contract that kick-started MS through his mother talking to the head of IBM [they were both on the board of the United Way]), well heck, let's omit or distort the inconvenient facts.

Well, Bill's mother and the fact that the unfortunate Gary Kildall was out flying a plane. Maynard amd I are having a discussion about ergodic and non-ergodic processes right now, whatever the subtlties of this topic the subsequent trajectories here certainly seem to have been path-dependent ones all right! The sentimental among us may like to pay a visit here . Meantime whilst Maynard laments the plight of the West, things East don't exactly fill me with joy either. Take the fact that the livelihood of millions in Japan seems to be hanging on the thread of Sony's new hand-held gaming rival for Nintendo:

Sony's plans to launch a hand-held gaming device to take-on Nintendo helped pull Tokyo shares into positive territory on Wednesday morning. The Nikkei 225 average closed up 0.4 per cent at 8,218.69 by midday, while the Topix index gained 0.3 per cent to 832.03. Sony, the electronics and media giant, managed to put its results shock behind it by announcing overnight it would launch a hand-held PlayStation gaming device to compete with Nintendo's Gameboy. Sony shares were up 3.1 per cent at Y3,010 but Nintendo stock moved in the opposite direction on the competition threat, tumbling 9.9 per cent to Y8,690.
Source: Financial Times

Tuesday, May 13, 2003

Not a Total Eclipse of the Heart

I'm back with Frans again. Somehow I get the feeling he may never leave me. The topic of the day is my post on the uses and abuses of English. The real problem arises for bloggers whose first language isn't English. I think this has to be a real dilemna. Frans writes to me:

In relation to your posts on language I must admit that my “Sorry-page” (for not writing in English) was one of the first I wrote for my website: more than a year before I discovered the phenomenon of web logs altogether and written while I had some hope that maybe later I could maintain a website in both English and Dutch. The last few months I have been searching for Dutch blogs on economy and/or politics of sufficient quality. In vain. So I was thinking already of switching to English for my site. Partly thanks to your site I discovered the “realm” of English blogs of quality. Your posts make me give more serious consideration to the idea of switching. I might lose some of the already small number of visitors and now wonder if I should worry about losing readers who would be deterred by my (inevitably simple) English.This question refers to a dilemma that is closely related to a second core element of my thinking and (intended) writings; on the decline of political parties, dominance (-still-!) of ideologies in politics, democracy, television and populism. My way out of this dilemma is a proposal for more independent politicians (emphasis on more or independent) and indirect elections.

What Frans is explaining here is the increasing returns, power-law structure problem. If he switches to English he'll lose the small number of Dutch visitors, and gain some English ones. But the big loser will be dutch web-logging, since there will be one less voice there, Henry would probably call this a classic polya-urn process, one less red ball. I don't know what to tell him. I have to let you all in on a little secret, I would really like to maintain a Catalan weblog, but where would I find the time (does this man never sleep!). My, pragmatic, solution is to hope one day that I can persuade a friend to start one and let me post. (I suppose that's really what I will suggest to Frans, that he keeps the Dutch one going, one day there will be more readers in Holland(!!!), and send me over some 'un-smooth' material to post for him).

But why do I call Frans my European-conscience alter-ego? Because, as must be obvious, I have taken a strong stand in favour of some things we Europeans can learn from our US neighbours across the Atlantic. In particular I like the attitude to change, to IT, to the small guy or gal getting a chance, to the 'free' dimension of the internet (oh, I know this is under threat, but we aren't there yet, by any means), to openness of information, to the Fed over the ECB, to Amazon over Bertellsman, to Yahoo over Terra Lycos etc etc etc. In particular, I think we Europeans are far too ensconced in our 'nationalities' and not sufficiently open to the problem of adapting our identities. This issue becomes especially sharp in the area of immigration, and in this sense the American identity - with its appreciation of the strength of diversity - must be far better adapted to the realities of the modern global world: in particular the global world in which some societies are ageing rapidly while others have a superabundance of children. We need to read our Axelrod, and understand the strategic benefits of cooperation and sharing.

I think it is no accident that Paul Krugman spends most of his time criticising contemporary American society and lauding the benefits of being Mario Monte, or being French, while I rail against the ECB and the French, and laud the land of Jefferson. It is a question of perspective. It is always easier to defend home and criticise abroad, so those who seek the more rugged paths criticise home and defend abroad. This is where I need people like Frans, to remind me of who I am, and to remind me that we can, all of us, stretch an argument too far.

One last point about Frans. His remarks about ideology. Here I am in 100% with him. Blogging is about diversity. Truths in blogging are not one but many. This is our selection advantage. This is why, among other reasons, I have a soft spot for the Farrell's of this world, not because I agree with them (in some ways we couldn't be farther apart) but because the Blogosphere is richer for their presence.

A Lament For the ECB

Paul de Grauwe, Belgian nomination for an up and coming place on the board of the ECB stakes his claim. His point, last weeks ECB announcement of a new monetary policy strategy, far from clarifying things, has only produced confusion. Among other details, it's also nice to note that I'm not the only person who can't fathom the depths of Otmar Issing.

The European Central Bank has a new monetary policy strategy. Or does it? After months of research and deliberations within its governing council, the ECB last week announced a new strategy, only to deny that it constituted a change at all. How are we to make sense of this brain-teaser? The first change is clear enough. The ECB is downgrading the importance of the money supply (M3) in its monetary policy strategy - and rightly so. It did not make sense any more to pretend that the money supply was the most important variable to watch. This signal was so easily distorted by "background noise" that it was rarely a reliable indicator of future inflation. On the contrary, it often gave the wrong signal, as after September 11 2001 when investors fled into short-term assets, thereby massively increasing the money supply. Luckily, ECB policy makers had enough sense to recognise that the build-up of M3 did not signal inflation but its opposite - a risk of deflation. So the Bank did what had to be done: to disregard the money numbers. Since then, the ECB has been forced to do the same all too often. Inevitably it concluded that it was better to stop pretending that the money supply was important while everybody else could see that the measure played almost no role in the setting of interest rates.

The second change is far less clear-cut. The ECB has now defined a new inflation target. Or so it seems. When the ECB started operating in 1998 it defined price stability as a rate of inflation of at most 2 per cent over the medium term. This definition has come under increasing criticism for giving the ECB an incentive to push inflation below 2 per cent, thereby increasing the risk of deflation, especially in those countries where inflation was already significantly lower than the 2 per cent eurozone average. One could have expected the ECB to do last week what common sense dictates: announce a point target of, say, 2 per cent and allow for some leeway above and below that target. Surprisingly, it was not so sensible. In last week's communiqué the ECB first confirmed that the old definition of price stability still held - that inflation should not exceed 2 per cent over the medium term - and then added that "in the pursuit of price stability it will aim to maintain inflation rates close to 2 per cent over the medium term".

How should we interpret these seemingly contradictory statements? The last sentence could mean that the ECB has shifted to a mid-point target of 2 per cent for the rate of inflation. Many analysts have come to that conclusion. However, this interpretation would contradict the ECB's reaffirmation that nothing has changed with its definition of price stability.What an anticlimax. Instead of creating clarity, the ECB has managed to create confusion about its true intentions. There can be no doubt that this is the result of strong disagreements within the governing council - the rate-setting body comprising the 12 national central bank governors plus six permanent ECB members.

The markets demand clarity and transparency. There is now less clarity about the objectives of the ECB than before last week's announcement. So the governing council will have to start again and come up with a new strategy that satisfies the markets' demands.This new strategy should consist of the following elements. First and foremost, the ECB should switch to a more explicit inflation targeting procedure that is now increasingly adopted as best practice in central banking. This consists in defining a point target for inflation with a symmetric range around it. It further requires the central bank to announce its inflation forecast, regular information that helps the market to understand the policy actions of the central bank, thereby promoting transparency.

Second, the ECB's mandate consists not only in maintaining price stability but also in pursuing other objectives - financial stability, stabilisation of the business cycle - as long as these objectives do not interfere with price stability. Up to now the ECB has been mostly silent about this second "pillar" of its mandate. It is time for the Bank to spell out what it intends to do to meet it, or to explain why it continues to ignore it. Immediately after last week's announcement, Otmar Issing, the ECB's chief economist, declared that there was nothing new in the new monetary policy strategy. This is quite unfortunate. The new strategy creates confusion and will maintain the ECB in a defensive position. The only way for the ECB to get out of this uncomfortable position is to come up with a better strategy than the one presented last week.
Source: Financial Times

On the Supposed Advantages of 'Being Close To Death'

One of the people who doesn't buy the euro rise bravado is Morgan Stanley's Eric Chaney. He's been doing some number crunching and comes to the conclusion that the with the euro valued at $1.15, the german economy is nothing less than 45% over it's neutral par with the US. He also considers the advantages of the 'being near to death' argument (ie when you have the gun pointing straight at you you have to do something). He, like me, is not convinced that this situation is necessarily any more conducive to reform. If anything, he feels that the real 'collateral damage' would probably be the growth and stability pact. Good riddance some might say. I beg to differ.

Models assume that economies react linearly to changes in macro inputs. The real world is different, I think, especially for reactions to exchange rate gyrations. I believe for instance that, when a currency is largely undervalued -- this was the case for the euro in 2000 -- an appreciation can be positive for growth, because positive wealth effects would largely overcome negative profitability effects. In the real world, producers know when a currency is far out of reasonable bounds and, in the case of an undervaluation, they know that super-profits cannot last forever. At the other end of the spectrum, if the initial conditions of a currency rise are already over-stretched, then the negative impact on the real economy is likely to be worse than model multipliers suggest, because of self-reinforcing effects on corporate spending, especially if deflation appears.

Models suggest that a 10% rise of the euro would cut inflation by 0.5% to 2%, most of the divergences coming from differently specified wage-price loops. Let’s assume that inflation would be cut by only 1.2%, after four quarters. Since our inflation forecast for 2004 is 1.5%, only 0.3% would be left. Whatever the uncertainties regarding the inflation measurement bias, often assumed to be around 0.8%, there is no doubt in my view that, without monetary reaction, Euroland would enter into deflation territory. Note that if inflation drops below 1% next year, it is most likely to print in red ink in Germany. Also, for highly indebted companies, the vicious circle of real debt increased by deflation would start, with straightforward consequences for banks: non-performing loans would rise faster than write-offs. I guess readers already have a feeling of déja vu and may stop here.

On more structural ground, is it possible that a sustained over-valuation of the euro would prove a “blessing in disguise” and act as a catalyst for structural reforms? According to my colleague Robert Feldman, the Japanese experience suggests that the answer might be yes, but also that a very large misalignment is needed to get there. Being “close to death,” to borrow from PM Koizumi’s own words is a necessary condition to gain the support of public opinion for reforms, in Feldman’s view. According to my colleagues Joachim Fels and Elga Bartsch, reforms in Germany would be accelerated by another year of zero or even negative growth and, in that case, other euro area countries will have to follow. Another school of thought, more popular in Washington than in Frankfurt or Brussels, considers that a super-strong euro would force European politicians to embrace the reflationary policies they have been reluctant to implement so far. No doubt in my view this will be debated at the next G-7 summit in Deauville. Practically, the reflationist camp thinks that the Stability Pact should be scrapped, so that the job of kick-starting the global economy by fiscal means would be more evenly shared between the United States and Europe. This camp also thinks that a super-strong euro will force the ECB to team up with the Fed in a kind of global fight against deflation.

I am not convinced by either camp and I am afraid that on these highly political grounds, there are more opinions than evidence. However, I would concede that the Stability Pact could be one of the collateral damages of a super-strong euro. If, instead of a mild recovery, Euroland is to fall into recession, I do not see how the governments of the three largest countries could cut their deficits below 3% of GDP next year. The rule of thumb is simple: a 1% loss in real GDP growth implies a rise of 0.5% of GDP for budget deficits. In the cases of France and Germany, which are likely to start from 3.5% of GDP this year, abiding with the Pact would imply a discretionary tightening amounting to 1% of GDP, which, I think, is not politically feasible. The same would hold for Italy, which, so far, has managed to conceal the deterioration of its public finances, in my opinion, by selling state assets.

Ditching the Stability Pact would not be in the interest of Europe, where big governments have accumulated huge debts and where baby boomers will start to retire in the coming years. Writing off the Pact would be an incentive for governments to endorse “muddling through” strategies and postpone reforms even more, because it would open the door to higher public spending.

Halting the rise of the euro has become an urgent necessity, I believe. The European Central Bank missed an opportunity to send a first signal last Thursday. But even a bold action on interest rates might not be sufficient to stabilise currency markets. Interventions, if they are backed by a strong commitment to respect the Stability Pact and meaningful decisions on structural reforms (pensions and/or labour markets), should be considered as well.
Source: Morgan Stanley Global Economic Forum

Everything For the Best

The EU finance ministers have gotten together and convinced themselves, probably in the absence of their ability to convince anyone else, that the rise in the euro is a good thing. It is called folly, isn't it? And it is a scandal.

Finance ministers from Europe's single currency area on Monday night insisted that a strong euro was good for the EU and for the global economy. The statement came after the euro climbed within sight of its January 1999 launch rate of $1.1750, sparking renewed concern about the eurozone's competitiveness. The single currency briefly touched four-year highs above $1.16, fuelled by comments from John Snow, US Treasury secretary, that the dollar's decline was helping US exporters.But the 12 eurozone finance ministers, meeting in Brussels, said the rise in the euro helped to control inflation in the EU and forced exporters to become more competitive. Nikos Christodoulakis, the Greek chairman of Monday night's eurogroup meeting, said: "Strength is very useful because it reflects the economic fundamentals which pertain in the European economy."Pedro Solbes, EU monetary affairs commissioner, said volatility was a problem, but added: "On balance, a strong euro is in the interests of the euro area and the global economy."
Source: Financial Times

Snow, Turkey and the IMF

The interesting thing about these comments is not that Snow is making them. The interesting thing would be to know why he feels the need to make them.

U.S. Treasury Secretary John Snow said it is crucial Turkey stick closely to the economic plan it reached with the International Monetary Fund. "It is absolutely essential from our point of view that Turkey adhere to the commitments they've made," Snow told Reuters in an interview conducted on Friday but embargoed until Tuesday by Treasury. "We've expressed that to the Turkish government."Turkey has a $16 billion loan deal with the IMF. The fund paid a $700 million loan tranche last month after a review long held up by delays on economic reform. With a May review looming, Ankara is already lagging in some areas. Snow said recently Turkey's adherence to its IMF program would be a condition of the $1 billion approved for Turkey in President George W. Bush's budget for the Iraq war. The money can be converted into $8.5 billion in direct loans or loan guarantees. But Snow on Friday said it is not yet decided how the funds will be distributed to Turkey.
Source: Forbes

Monday, May 12, 2003

When There is No Significant Capacity Outside China

I'm posting this snippet from Andy Xie seperately, even though it comes from the last post the point is significant enough to stand on its own.

Even though China is battling by SARS at this time, the most sustainable investment ideas appear to be related to its rise in the global economy. China is effectively re-pricing the investment cost for more and more industries. I believe book value in China is perhaps safer than anywhere else.The reluctance to write off book value outside China is the reason that China’s export sector can sustain its profitability, in my view. As prices are artificially supported by higher depreciation costs, China’s exports enjoy high growth and profitability at the same time. This process ends for an industry when there is no significant capacity outside China.
Source: Morgan Stanley Global Economic Forum

Money To Burn

Too much money, that's Andy Xie's explanation of where we are. I suspect he may be right, understanding why there may be too much money is another matter altogether.

You are holding cash and the interest rate is zero. The bank in which you keep your money pays dividends equal to 5% of the stock value. Then your friendly private banker calls you up and confidently explains that you would be better off if you owned the bank’s stock than if you continued to deposit your cash with the bank. Aha, you saw through this one! The bank’s stock price could fall but your deposits are protected, first, by the bank’s capital, i.e., shareholders, and, second, if the stock price falls to zero, by the government that regulates the bank.

We saw the same situation in the Tokyo property market. The rental yield rose above the mortgage interest rate in the 1990s. For some reason, the property value always seems to drop a bit more than the pickup in the yield for owning the property. This also happened in the Hong Kong property market. The property market was more sophisticated in Hong Kong than in Tokyo and had the affordability index to show why property was worth buying. Waves and waves of bottom-fishers braved the market. They now have no cash. However, they are proud owners of high-yield assets but at much-reduced capital values.

Asset markets have been cash guzzlers in East Asia for years. The cash goes to maintaining growth in value-subtracting GDP. Hong Kong property provides the best illustration of this point, in my view. Buyers effectively subsidize an industry that faces declining prices. Their past savings subsidize the property industry, which in turn keeps up GDP. Without the massive destruction of savings, the Hong Kong economy would have shown a much greater decline.

The stock market is a less obvious example. It can attract money through volatility. Even though most markets in Asia have been merely fluctuating for the past ten years, they have raised money to fund one industry after another. Investors have poured money into a series of growth industries. However, the high profitability of a growth industry generally proves to be ephemeral, I believe. As capacity expands, most ex-growth industries are plagued by excess capacity and low profitability.Too much money is at the root of the problem. It causes speculative spasms in asset markets and excessive capacity formation in production. The two conspire to generate high GDP growth and value destruction. Economic growth generates high profitability in an industry, only to be destroyed by easy capital for capacity formation.

The Asian experience is spreading. The world has too much money, I believe. Money with zero maturity (MZM) has grown at 12% a year in the US since the NASDAQ peaked in March 2000, 62% faster than the average for the preceding ten years. Much of the surplus liquidity in the global monetary system will be destroyed, in my view, either through (1) deflation bubbles or (2) stagflation. The world currently seems to be on the first path. The world’s asset markets are behaving increasingly like their Asian counterparts. Stock markets experience periodic speculative spikes up with little change in fundamentals. People give more and more of their savings to governments to spend. Rising fiscal deficits coincide with falling interest rates.

The relationship between markets and the economy has fundamentally changed in the current environment. Falling interest rates provide the justification for pouring more savings into low-profit activities, which keeps up GDP. Giving money to the government to spend is the ultimate expression of supporting low value-adding GDP. In a normal environment, rising profitability attracts more capital.
Source: Morgan Stanley Global Economic Forum

War, What War?

Strange piece from the Farrell Family . I mistakenly imagined that it was from Henry since my eyes are now weak and I have difficulty seeing in the dark : sorry Maria. They paint a very disturbing picture of what is happening right now here in Spain. I only have one problem: it doesn't fit with the reality I see around me which is one of the PP supporters on the defensive on all fronts. Of course, this will become a bit clearer after the elections on May 25. Just in case in my 'non-political' cocoon I was missing something, I asked a friend of mine who is a long standing neighbourhood activist round here, and would surely be one of the first to be arraigned before any nascent 'military tribunal'. He was very surprised to hear of the report, but did pass the wry if interesting observation that, since Aznar is in fact denying at full volume that Spain has been participating in any recent military conflicts, it would be hard to incarcerate anyone for opposing one. Spain, after all, is not Poland. Of course, I'm posting this just in case there is any danger.

The latest developments are domestic rather than international, but they're even more sinister. Yet again, it's Statewatch which has the story. They report on a draft change to the Spanish military criminal code, which proposes that participation in public acts opposing military intervention, in a situation of armed conflict, could lead to prison sentences of between one and six years for the people involved, if they're convicted of "defeatism."

Even more frightening; "Civilians could find themselves before military courts." For a country which emerged from a fascist dictatorship in recent memory, this is scary - and all too familiar - stuff. Of course, it's not only the Spanish who are opportunistically trying to lump legitimate protest in with terrorism and serious crime. The EU Justice and Home Affairs Council's proposed definition of terrorism last year was broad enough to include anti-globalisation protests. Very few people think that this was due to sloppy drafting. The right wing rump of the Spanish government isn't just showing its teeth; it's looking to use them. Already, El Mundo reports that there are serious threats to use existing legislation to prosecute the people behind No a la Guerra.
Source: Gallowglass

The 'Eve' of Destruction

For those who are not old enough to remember the reference here is not to Barry McGuire, but to what might be happening right now in N Korea. Joerg is worried and has been writing to nuclear physicists. He's mailed me about it: I guess he wants me to post:

I had an email exchange with Dr. James Gordon Prather, a nuclear physicist who was deputy assistant secretary for science and technology in the department of the army in the Reagan years.Let me just pass it along to you. I wrote:"What can the U.S. do with respect to North Korea? ... You indicate
that the location of part of the facilities is not even known. The implication would seem to be that Woolsey´s statement to David Corn is correct: talking to "take out North Korea´s nuke capability" is tantamount to talking full-scale war ... William F. Buckley writes: "What is breath-catching is that we may indeed be orienting our policies not to removing the North Korean bomb, but to neutralizing it." I guess that amounts to relying on a missile defense shield - just like Japanese politicians have recently started discussing.

Such a shield would provide a defense against direct military attack - it does not even begin to guard against the prospect of North Korea dealing in plutonium, nukes or blueprints. Essentially Buckley entertains the idea that nuclear non-proliferation can be replaced by nuclear containment. If there is no chance for rollback, then Bush´s rhetoric needs to be read backwards: every nation that is not a declared enemy of the United States will have to be enlisted to partake in the containment effort. Buckley concludes by proclaiming: "Those are fresh charters for the world of 2003." Well, yes: the charters from 2001/2002 would seem to be obsolete already - no pre-emptive strikes against nuclear powers, no credibility for Bush´s grand strategy statement. Such an almost instant loss of relevance is certainly a first in the history of presidential
American foreign policy doctrine."

Dr. Prather´s reply:

"The CIA doesn't know where the Pakistani-origin DPRK uranium-enrichment facilities are. I suspect they are the ones recently identified by the IAEA that are in Iran ... There is no real difference between a uranium-enrichment facility for producing light-water reactor fuel and a facility for producing HEU for nukes. France, Germany and Russia have somehow got to put the IAEA-NSG regime -- which the US-UK have practically destroyed by invading Iraq -- back together again. The only course for the US at the moment seems to be to sign a non-aggression pact with DPRK [guaranteed by Russia-PRC], or go to war."

More On the German Deficit

The political crisis in Germany continues unabated. As I look from my window what strikes me as curious about the panorama (strikes in France, damaging admissions in Germany) is that in a normal world this would all be extremely euro-negative. But the euro continues its rise. Of course the 'diplomats' down at the Commision are leaving no stone unturned in the effort to tell us that two plus two does in fact equal five, and that the stability pact is not being breached. All of this should give a measure of how far from normality things have gotten, and give all of us a lot of cause for thought.

The German government, battling to cut spending and avoid recession, on Sunday dropped its pledge to balance its budget by 2006, adding strain to the eurozone stability pact. Chancellor Gerhard Schröder and Hans Eichel, the finance minister, conceded defeat in two separate interviews, saying Germany's depressed economic growth made the goal, formulated three years ago, unattainable. Mr Schröder told the Berlin newspaper Tagespiegel: "A balanced 2006 budget would require growth rates that I cannot expect and if achieving this meant cutting spending as much as revenues are falling, or giving up the 2005 tax reform, I would not be ready for it." Mr Eichel admitted for the first time that the deficit would be above the stability pact's ceiling of 3 per cent of gross domestic product this year. The ministry later said it would fall below the limit next year, but denied reports that Mr Eichel had threatened to resign if fellow ministers failed to agree to drastic spending cuts in 2004. The twin admissions could further dent confidence in the stability pact, initially designed to keep fiscal profligacy in check within the eurozone, after France admitted it would rack up two consecutive deficits in excess of 3 per cent of GDP. But a European Commission official said Germany's decision to drop the 2006 target did not mean it would necessarily breach its commitments under the pact, which is concerned with the underlying budget balance, rather than its nominal level. "What is crucial is that they continue the plan to improve the structural deficit," he said. "It is also very important that they don't have a deficit of more then 3 per cent in 2004."

Euroland: Pension Reform and Strife on the Agenda

Now the euro is about to face rising social protest from within. First it was Germany, now it is France, soon it may be Italy. While I have no difficulty in sympathising with all those who will feel cheated by having paid - the pensions of others - all their working lives only to arrive at retirment age to find that there will not be so much money to pay for them, there is, unfortunately, an air of ineviatability about all this. But inevitability and resignation - as we can see from Argentina - are not the same thing. Hence we can only expect more such protests as time passes, and the 'reforms' gather momentum. What is striking in the French case is the minimalist nature of the proposals, we will now have to wait and see whether the protests will be equally minimalist. By the way, hoping to use the EU as a shield against voters at home, Berlusconi seens to be suggesting he will use the forthcoming Italian EU presidency to promote a 'pensions Maastricht' intended to be binding on member governments. This promises to be interesting.

France's centre-right government faces the first serious challenge to its policies on Tuesday when trades unions hold a national day of strikes and demonstrations against plans to reform the costly state-run pensions system. The protest is expected to see disruptions to public transport and the civil service in what is likely to be little short of a general strike. It is the biggest demonstration so far of union muscle, with all the three main federations burying their differences to press the government to water down its proposed reforms. Jean-Pierre Raffarin, prime minister, has insisted that the government will stick to its plans to end the privileged position of public sector pensions by 2008 and then raise the contribution period for all in phases to 41 years by 2012. Nevertheless the government's nerve will be tested by this union opposition, which is strongest in the public sector.

This is centred round raising the level of public sector contributions to 10 per cent of pay from 7 per cent by 2008 in line with the private sector. The contribution period will also be extended from 37.5 to 40 years over the same timescale.The government is confident the public understands the urgent need to overhaul pensions and that the union mood is different from the mid-90s when damaging strikes led to the shelving of plans to overhaul railway workers' pensions. In a publicity campaign in the form of an open letter to French citizens, Mr Raffarin is reminding the country of the dangers of failing to address the growing cost of pensions. In 1960, he says, four people in work were able to fund one pensioner; by 2000 there were only two people in work to fund each pensioner.But the depressed economic climate and the need to impose tight budgetary constraints to head off sanctions from Brussels for breaching the European Union's stability pact make the reforms harder to sell. Only last week, Mr Raffarin sent out the annual budget guideline letters to individual ministries on the basis that overall public spending in 2004 would not increase in real terms. Even so the budget deficit is likely to remain above the 3 per cent ceiling imposed by the EU.
Source: Financial Times

Italy and Tragic Pantomime

Reflecting my feeling that the moment of truth is -albeit gradually - approaching, I will be posting a little more on Italy, as and when I can find relevant and interesting material. Many eyes, rightly, are focused, on Germany right now. My own feeling is that Italy's problems are, if anthing, worse, and that, given the existence of 'fundamental instability' on the management side (remember the tug of war on 1 January 2002 even to get the euro issued there) we should not be too surprised to see sudden and dramatic changes coming at us over the horizon. For the moment Berlusconi is promising the Italian voters a growth renaissance in 2004, in his case absent the 'massive tax cut' since public finances do not permit even this. The issues raised in this article below are more fundamental, relating as they do to the basic pillars of the democratic system. Looked at from Spain, perhaps the greatest weaknesses of the new style 'mediterranean' democracies appear to be the absence of an independent and non-interest-driven critical press, and the politicisation of the judiciary. As the writer notes this may seem fine when the objective seems emminently 'politically correct' (for example Garzon with Pinochet), but this should not blind us to the dubious virtues of judicial systems in the hands of a tit-for-tat political process.

The pantomime that is Italian politics has become more lively lately, with its leading man, Silvio Berlusconi, putting in a command performance as the persecuted and much misunderstood hero. Attacking the villains (the "red judges" and "communists") with one breath, appealing to his public audience with the next, the showman dazzles with alternate flashes of anger and expressions of innocence. But the farce is rapidly descending into tragedy. Politics in Italy have often been described as theatre; but this time the antics on stage risk spilling over, with serious consequences, into the real world.

The plot is complex. Act one: in the early 1990s, the Italian political class and most established parties collapsed in the face of a judicial onslaught on systemic corruption. Since the late 1940s, all Italian parties had engaged in a complex game of collusion, funding their activities from tangenti, or bribes, from public and private sector companies. The Communists, who comprised the permanent opposition, were not exempt from such practices. In spite of frequent protestations to the contrary, all politicians from that era either actively engaged in, or knew of, these nefarious activities. But if politics was anomalous in Italy, so too was the judicial system. Since the late 1950s, the judiciary has enjoyed great autonomy from the executive; it is self-governed by a constitutionally-mandated Higher Council. Italy is the only democracy in which the same corps of independent career magistrates performs both judicial and prosecuting functions. Powers of investigation and prosecution were strengthened during the anti-terrorist drive of the 1970s and early 1980s and to combat organised crime. By the 1990s, Italian judges could operate like a highly-trained guerrilla force in taking on the might of the corruption-ridden Italian state.

As Mr Berlusconi never fails to point out, in Act two, staged during the past decade, the democratic function of the judges became problematic. While becoming a power in its own right with control over the activities of politicians, after the 1970s the judiciary had also become highly political as its own ideological factions closely mirrored and interacted with party organisations. After 1992, the charisma of particular judges, their elevation to star status by the media and their zeal in prosecuting criminal cases contrasted with the gross inefficiency of the judicial process, especially in civil actions, which makes Italy the most frequent offender in the European Court of Human Rights. While political attacks on the judiciary by the present government have been censured by the United Nations human rights committee, so too has the practice, frequently employed in the tangentopoli prosecutions, of holding offenders for lengthy periods in preventive detention and reliance on the testimony of defendants. Most damaging for the integrity and legitimacy of the judiciary has been inattention to the rights of the accused (a notification of investigation by a prosecutor is often interpreted as a guilty verdict) and the failure to develop a sound rights-based legal culture.

Act three: Mr Berlusconi returns to power and expends much of his energy combating a series of outstanding indictments. He could be found guilty in the cases brought against him. But the inquisitorial tendencies of Italian judicial culture and the undeniable and strong links between the judges' ideological factions and political parties give him plenty of ammunition to rebuff the charges, claiming political persecution. The parlous state of the judicial system and the chronic inefficiency of criminal and civil procedures means that many Italians (at least in the centre and on the right) support and sympathise with him. Italy, it seems, cannot escape its past and move on. The main reason is rampant politicisation. Mr Berlusconi is a politician tainted by involvement in the politicised economy of the pre-1992 republic; justice, in his case, should clearly be seen to be done. But no matter how worthy and dedicated to legal rectitude, the judges pursuing him are also afflicted by the politicised nature of their profession.Since the mid-1990s, plans to reform the judiciary, separating the careers of prosecutors and judges and giving greater jurisdiction to the minister of justice - both measures that would help improve the accountability and legitimacy of the judges - have been defeated by partisan divisions. Similar reforms introduced under Mr Berlusconi are delegitimised by his ongoing entanglement with the law. The system is blocked, and the political class is powerless to respond. The pantomime goes
Source: Financial Times

John Snow Rehearses His Lines

John Snow, he of the 'stong dollar policy' and 'deflation is a monetary phenomenon' fame, is getting his act up and running. "Deficits are not all equal, we need to distinguish here......" and "the best tonic for a weak economy, high unemployment and a slumping stock market is a massive tax cut", no "We're not going to be satisfied unless we have the biggest number we can get" Now, as we go forward on this try to stay calm, and think of Gauti Eggerston .

As the Senate prepares to debate a tax cut proposal considerably less than is being sought by President Bush, Treasury Secretary John W. Snow yesterday dismissed Democratic concerns about mounting deficits and said the administration's plan is just what is needed to fix a "soggy" economy. Snow, making the rounds of the Sunday TV talk shows, told Fox News, "The president wants to create jobs now, and the best way to do that is to reduce taxes now, taxes for households and taxes for small businesses that are the engines of creating jobs." Asked whether the administration would settle for less than the $550 billion package passed by the House, Snow replied, "We're not going to be satisfied unless we have the biggest number we can get that creates the most jobs. That's what we're going for."

Snow argued that the best tonic for a weak economy, high unemployment and a slumping stock market is a massive tax cut. During an appearance on NBC's "Meet the Press," Snow described current conditions this way: "The economy is in a recovery, but it's not a robust recovery. It is a sort of weak -- soggy is a word I sometimes use -- recovery. Growth rates last quarter, 1.6 percent. You know, we should be growing at 3.5 to 4 percent."Pressed to justify administration proposals for the third tax reduction in as many years while the budget has gone from a $281 billion surplus to a $246 billion deficit, Snow replied: "Deficits are not all equal. We need to distinguish here. . . . Today we have underemployment" and a greater need for deficit spending.
Source: Washington Post