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Saturday, May 31, 2003

In the Wake of Sars

The worst of the health problem may be over, but the economic consequences linger on. It will be interesting to see whether Chinese growth 'makes up' in the last two quarters for what it lost in the first two. Also note the bit about good export prospects to Europe riding the high euro.

While SARS infections have ebbed across East Asia, the economic consequences will continue to be felt for months to come, according to business executives and economists. Tourism is proving very slow to recover across the region. Retail sales have only begun to rebound, leaving stores reluctant to order more from factories because they are still stuck with huge inventories of goods that went unsold at the height of fears over SARS. The effects of the continued sluggishness are being felt well beyond Hong Kong. Electronics manufacturers complain that the development of new consumer products has been badly delayed because engineers were barred from traveling among the United States, Taiwan and China after the SARS outbreak. That means stores around the world will have fewer innovative computer printers, scanners and wireless network devices on the shelves this Christmas, said Frank Huang, the chairman of the Taipei Computer Association. "There will be, because of SARS, a reduced number of products on the market, that is sure," during the crucial Christmas selling season, said Mr. Huang, who is also the chairman of Power Chip, one of Taiwan's largest manufacturers of computer chips.

Yet some encouraging signs remain for Asian economies. Exports are still strong, especially from China and especially to Europe, as the rising euro has improved the competitiveness of Asian goods. Most Asian currencies are formally or informally pegged to the sinking American dollar, making Asian products less expensive in Asian markets. And the number of new cases of SARS is down sharply from the levels of two months ago. China and Taiwan each reported seven new cases of SARS today, while Hong Kong had four new cases. The strong divergence between slow domestic demand and brisk exports has made it especially difficult for economists to gauge economic output. Sometimes misleading statistics from image-conscious governments have made matters worse. China's government-controlled media, for example, recently said that economic output in China was 8.9 percent higher in April than a year earlier. But investment bank economists say that this figure just shows that the Chinese economy expanded quite fast in the third and fourth quarters of last year and the first quarter of this year. Comparing economic output in the second quarter of this year with output in the first quarter, estimates range from Morgan Stanley's prediction of zero growth to J. P. Morgan's assessment of minus 2 percent. Most economists expect growth in China to resume in the third quarter, but not until the fourth quarter is the Chinese economy expected to resume the 7 to 10 percent growth that it enjoyed until this spring.

Hong Kong's government today cut in half its estimate of economic growth this year, to 1.5 percent, with much of that growth having occurred in January, February and early March, before the SARS outbreak crippled demand. The International Monetary Fund was somewhat more optimistic today, predicting that the economy here would grow by 2.2 percent this year. "The economy was actually doing very well until we hit SARS," said Antony Leung, Hong Kong's financial secretary. Even before SARS, however, Hong Kong was suffering from severe deflation, and Mr. Leung predicted today that because of SARS, the general price level here will drop 2.5 percent this year, instead of the 1.5 percent previously forecast by the government. Economies have also suffered in other countries with large SARS outbreaks, according to assessments released this week. The Council of Economic Planning and Development in Taiwan reported steep declines in many industries this week, while Morgan Stanley warned that Singapore appeared to be headed into another recession.

Andy Xie, a Morgan Stanley economist, said that companies ranging from sausage makers to paper manufacturers had been complaining to him that stores in China had stopped ordering because of bulging inventories of unsold goods. At Lee Fung China Ware, a large store in downtown Hong Kong selling porcelain vases and bone china plates in many hues, sales are deeply depressed, said Lily Wong, a sales representative. Foreign tourists used to account for a third of sales, yet not one has come to the store since March. Sales to local residents leaped on May 23 in the euphoria that erupted when the World Health Organization lifted its advisory against travel here, Ms. Wong said. But these transactions plunged again a day later and remain 40 percent below their pre-SARS levels. The store has told its supplier, a factory in southern China, to halt shipments. Multinationals' long-term enthusiasm for investing in China, from building factories to setting up new sales networks, appears to have survived the SARS outbreak this spring. But company officials warn of delays in negotiating deals and performing due-diligence inspections in China. A few businesses are still entering the market. Heller Ehrman White & McAuliffe, a San Francisco-based law firm with 660 lawyers, has just hired 19 lawyers from a law firm here to expand its Hong Kong practice.Paul Laudicina, a vice president of A. T. Kearney, a consulting firm, said that initial results from the firm's annual survey of multinational corporations did not suggest any long-term flagging in foreign investment. "I don't detect yet any wholesale change in investor orientation toward China and the region," he said.
Source: New York Times

Someone Rats on the Rats

It's hard reading the newspapers this morning, but words escape me on this one:

A British soldier was arrested today after he left a roll of film at a photo store that appeared to show an Iraqi prisoner being tortured, the Defense Ministry said today. The film depicted a bound and gagged Iraqi inside a net that was suspended from a forklift, according to The Sun, which first reported the story this morning. The Sun also reported that the roll included pictures of soldiers performing sex acts near Iraqi prisoners. Howard Rhoades, a spokesman for the Defense Ministry, said a soldier had been arrested and was being questioned by the military police in connection with the photographs, which had been left at a shop in Staffordshire in central England. He has not been identified, but The Sun reported that he belonged to the Royal Regiment of Fusiliers, which fought in southern Iraq and is part of the Seventh Armored Brigade, known as the Desert Rats. The story came to light after a lab technician who was developing the film alerted the local police. The police arrested the soldier at his home in Tamworth, Staffordshire. If the allegations prove true, the soldier, and perhaps others at the scene in Iraq, would be in violation of the Geneva Conventions, which require that prisoners of war must be treated humanely.

This is not the first allegation of mistreatment leveled against a British soldier. Lt. Col. Tim Collins, the commander of the First Battalion of the Royal Irish Regiment, who once urged his troops in a rousing speech to be compassionate towards enemy captives, is facing accusations of having abused Iraqi soldiers and civilians. Colonel Collins, who is known as Nails to his troops because of his steely demeanor, is accused of punching, pistol-whipping, kicking and threatening Iraqi prisoners of war to force information from them. He is also accused of firing his pistol near the feet of civilians. British forces were widely viewed as patient and calm on the battlefield and during the war's chaotic aftermath in places like Basra.The American military also faces accusations of cruelty to prisoners. About two dozen detainees have taken their complaints to Amnesty International, the London-based human rights group, alleging that American and British soldiers hit and beat prisoners, and in one case used electric shocks.
Source: New York Times

Friday, May 30, 2003

Another Mixed US Bag of Data

Something for everyone: consumption and incomes flat, consumer sentiment up, and some energy in manufacturing. But don't miss the core inflation down at 1.3%, the lowest level since the mid sixtees. Still that one step forward, two steps back feel about things.

Consumer spending faltered while incomes were flat in April, government figures showed on Friday, raising worries that Americans may be hunkering down and hurting the economy's most crucial source of growth.
But other reports provided hope the economy may be pulling out of its current "soft patch," as the Federal Reserve (news - web sites) has described it. Consumer sentiment bounced to its highest level in nearly a year in May, while a closely watched gauge of Chicago-area manufacturing showed growth in May for the first time in three months. That upbeat news gave stocks a boost heading into the weekend, with the Dow Jones industrial average rising 1.7 percent while the benchmark 10-year Treasury yield, which moves opposite to price, rose to 3.41 percent. With analysts focusing on the threat of a further decline in already low inflation due to the economy's sluggishness, Friday's data also showed the central bank's favored gauge of core inflation eased in April to just a 1.3 percent annual rate -- its slowest clip since the mid-1960s, excluding a few errant months. Some economists said the slowdown in inflation, something the Fed has said it is watching closely, increased the odds central bankers will respond by cutting interest rates in late June in its aggressive effort get the economy recharged. That would be its 13th cut since January 2001.
Source: Financial Times

Shooting Blanks in the Air

So the Bank of Japan has been caught in the act: intervening to no effect. Of course so long as the US authorities continue to be 'comfortable' with the fall, there is really little that the central banks can do. Mind you, these dollar denominated assets could be a real investment for the future. I mean printing yen and getting a peice of the US action, that has to be one of the best business deal on offer right now.

The Bank of Japan this week set two apparent records relating to the currency markets, but the impact on its main aim - to weaken the yen - appeared to leave currency strategists and investors less than impressed. On Thursday, weekly custody data released by the US Federal Reserve - seen as a proxy for overseas central bank holdings - showed a sharp increase in US Treasuries owned by overseas institutions to a record monthly total of $35.4bn. For holdings to have risen that much, strategists believe one or more central banks must have been actively intervening. Bank of Japan data released on Friday appeared to confirm suspicions that almost all of the Treasury buying came from Tokyo. The BoJ's figures implied a record Y3,983bn ($33.4bn) was spent by the bank in May to stem the yen's appreciation - a bigger sum than many in the market had estimated.

Some said the BoJ's spending underlined its commitment to stemming the yen's appreciation against the weaker dollar and would serve as a warning to any investor preparing to short the dollar against the yen. Most, however, noted the limited impact of the bank's action. "What this shows is how significant the pressure on the dollar is - spending $30bn plus only moved the yen less than 4 per cent," said Mitul Kotecha, head of FX strategy at Credit Agricole Indosuez. The dollar fell to a two-year low of Y115.1 on May 19 and by the end of this week, had climbed to a month-high of over Y119.
Source: Financial Times

Japanese Unemployment on the Rise

More depressing numbers from Japan, as the currency screw tightens it's hard to imagine anything different.

The number of unemployed in Japan remained just below an all-time high and goods prices fell for a 43rd consecutive month in April, reinforcing the impression that Japan's economy may be drifting back toward recession. Unemployed stayed at 5.4 per cent for a second consecutive month, just below the high of 5.5 per cent it hit in December and January. The number of unemployed increased 100,000 to 3.9m while the number of people in work fell 270,000.

Economists were divided on the state of the labour market. Takuji Aida, fixed income analyst at Merrill Lynch, said that while the labour market remained tough there were no signs of sharp growth in unemployment, as restructuring seemed to have run its course and corporate earnings were increasing. However, Seiji Adachi, economist at Credit Suisse First Boston, said that employment conditions were deteriorating as more women were entering the market to look for work to supplement their husbands' falling incomes.

The lack of positive news strengthened the argument that Japan's economy may be heading from minimal growth back into recession. GDP figures released earlier this month showed Japan's economy did not grow at all in the three months to March. This followed a gradual slowing of growth in the previous three quarters, and led many economists to say that if exports continue to soften the economy could shrink this quarter. The figures also demonstrated that companies are giving themselves more flexibility in recruitment to cut costs. The number of full-time jobs sank for the 21st consecutive month while part-time jobs, which companies use to adjust staff numbers to meet demand, increased for the 16th month in row. The ratio of jobs to applicants remained unchanged from the previous month, with 60 jobs available for every 100 job-seekers.

Separate data released on Friday showed Japan's consumer price index down 0.4 per cent in April from a year earlier, the 43rd straight month of decline. It was the smallest fall in two and a half years but this was due to a government-mandated increase in the prices of some medical services. If medical prices had remained unchanged, prices would have been down 0.6 per cent, the same as in March, economists said. The consumer price index is one of two closely-watched measures of deflation. The second, included in Japan's GDP figures, is released quarterly, and for the three months to March showed the largest drop ever, a fall of 3.5 per cent. A government report released on Friday spelt out how deflation is hurting Japanese people by putting downward pressure on household income, increasing redundancies and ramping-up the burden of mortgage loan repayments for borrowers. Young people in particular are suffering, the report said, as they are unable to attain financial independence in the current environment, or make plans for the future.
Source: Financial TimesLINK

Singapore: Third Year of Recession?

Morgan Stanley's Daniel Lian with some news about downward growth revisions in Singapore:

Recession is looming in Singapore, in our view. Real GDP grew 1.6% YoY in 1Q03, and the economy appears to be decelerating significantly in 2Q03 as domestic demand is hit hard by SARS and as services exports, chiefly tourist receipts, are impacted negatively by SARS. Tourist arrivals dropped about 70% for the period April to May 19. Based on the correlation between tourist arrivals and consumer confidence and retail sales, we think it is reasonable to assume a double-digit decline in retail sales over the same period.

The deceleration has also spread to the goods sector. Both manufacturing and merchandise export sectors have lost momentum in April and May — a phenomenon that we also observe elsewhere in Asia. Latest figures suggest that manufacturing production fell 5% YoY in April, and there appear to have been disruptions to the supply chain. The negative impact on the goods sector does not bode well for an economy that is already hard hit by the weakness of its services sector.

We believe both goods and services will contract to the tune of 3% or more in 2Q03. Therefore, despite our recovery scenario for 2H03, we expect GDP growth to weaken to a mere 1% in 2003. Singapore has probably entered its third year of recession, with a significant rise in unemployment, relative stagnancy in labor and income, and a significant loss in household confidence dealing blows to domestic demand.
Source: Morgan Stanley Global Economic Forum

US Economy: Mind the Output Gap

Brad also draws our attention to this piece from the Wall Street Journal on the continuing problems of the US 'jobless recovery':

Payrolls in the electronics sector, and for producers of industrial equipment, have declined for 28 straight months. In communications, payrolls have fallen for 24 months. In the securities and airline industries, they have fallen in 16 of the past 24 months.

In some ways, this is the downside of a productivity boom that created much optimism about the economy during the 1990s. Productivity growth means that companies are squeezing more output from existing workers. Over the long run, most economists agree productivity growth is good for workers, because it tends to lead to higher wages. But in the short run, it is creating a problem. Worker productivity has been growing faster than the overall economy. That has allowed corporate executives to meet small increases in demand while still eliminating jobs.

"You end up with a jobless recovery," says Jared Bernstein, a labor economist with the Economic Policy Institute, a left-leaning think tank in Washington. "It is indistinguishable from recession for many working families."

A common definition for a recession is two consecutive quarters of contracting gross domestic product. The nation's GDP -- the broadest measure of economic output -- has expanded at an average annual rate of 2.7% since the fourth quarter of 2001. During the same period, the productivity of the nation's work force -- which is defined as its output per hour of work -- has expanded at a much faster rate of 4.2%. While worker productivity often increases in the early stages of a recovery, this time the mismatch between productivity and overall economic growth is unprecedented.

At the beginning of eight recoveries between 1948 and 1982, GDP grew faster than productivity. In those cases, companies had to add workers to meet demand for their goods and services. During the recovery of 1991, productivity grew slightly faster than output in the early stages, but the difference wasn't as stark as it is now.

"If you want people to have jobs, your demand-side growth has to be much stronger," says Harry Holzer, a labor economist at Georgetown University. The nation would need a 3.5% growth rate in GDP for the unemployment rate not to get worse, he says, but "3.5% is looking optimistic for this year. This might be quite a protracted downturn."
Source: Wall Street Journal

This continuing job market weakness is also reflected in yesterday's employment numbers:

New U.S. jobless claims fell last week but the number of people continuing to draw unemployment benefits rose to the highest level in about 18 months, signaling persistent difficulties in the job market, a government report showed on Thursday. Initial claims for state unemployment insurance benefits, an early reading on the resilience of the job market, fell to 424,000 in the week ended May 24 from a revised 433,000 in the prior week, the Labor Department said. Analysts were expecting 419,000 first-time claims in the latest week, compared with the 428,000 originally reported in the prior week.

The Memorial Day holiday on Monday, May 26, gave states one less day to report their numbers. The Labor Department said the decline in new jobless claims included estimated figures from several states, but there was no way to tell if this had any impact on the data. The decline in new claims nudged the four-week moving average down to 427,000 from 434,250 in the prior week. The average has remained above the key 400,000 mark for 13 weeks. Economists see the 400,000 mark as signaling a lackluster job market. "The claims numbers remained above the 400,000 level, which a lot of people watch," said Gary Thayer, chief U.S. economist for A.G. Edwards. "There's been no significant improvement over the last month. Claims are still elevated and it shows that the labor market is still soft," he said. More data on the labor market are due on June 6, when the government releases the monthly employment report for May, a broad look at labor market conditions throughout the economy.

Analysts are expecting the unemployment rate to be 6.1 percent, up from 6 percent in the April report. The May report is expected to show a loss of 26,000 jobs, compared with a loss of 48,000 jobs in April. For the first three months of the year, more than half a million jobs have been lost. Despite the drop in new jobless claims in the latest week, the still-high number showed that people continue to face a tough time getting back on payrolls. The number of people already receiving jobless benefits who remained on state rolls rose by 83,000 to 3.76 million in the week ended May 17, the latest week for which figures are available. The total was the highest since 3.8 million in the Nov. 17, 2001, week. Tennessee reported the highest number of new claims for the May 17 week, with 3,021 additional layoffs reported in industrial machinery, trade, service and fabricated metals industries, the department said.
Source: Yahoo News

Structural Reform US Style

Well it looks like Paul Krugman as relayed by Brad Delong has it just about right: the Bush administration is well aware of the fiscal situation of the US government long term. And Ari Fleischer yesterday was drawing the conclusions that Paul suggested he would: that the US social security and health benefits systems need to be reformed. (Fleischer is of course leaving soon, just in case this catches too much flack). I think I need to say two things. Firstly these are 75 year projections, and while I imagine that someone somewhere needs to conduct these, if only to have some sort of benchmark to work from, I don't thing we should place a great deal of importance on any kind of detail. Things are getting faster, faster. Strategic lack of visibility and fundamental uncertainty abound, and it's hard enough seeing ahead to 2005, while 2010 is a very, very long way away, in the sense that a great many things can change. In particular we need to know what kind of growth (or shrinkage) the EU and Japan can achieve in what remains of the decade. There are too many non-linear processes at work to see anything clearly.

Secondly, whatever the wrongs of the Bush tax cut, these mid-term demographic problems are going to be there. If the 'soft patch' continues indefinitely the US Federal Government is going to have difficulty fulfilling its obligations whatever the political flavour of the President. A bullet is going to have to be bitten. And it may be better to explain this sooner rather than later to the American public. In this sense there is a danger in both the 'if we get the cut we need we'll have the growth we need' argument, and in the 'it's all the fault of the Bush tax cut' one. The real problem gets lost in the in-fighting. One day or another the American public is going to wake up to find that structural reform is not only a European or a Japanese problem.

The White House said on Thursday it agreed with the conclusions of a study prepared by former Treasury officials that argued the US faced a future of chronic deficits worth at least $44,200bn."We agree with their thoughts," Ari Fleischer, White House spokesman, told a press briefing. But the report underlined the need for big changes to benefits, rather than tax increases, he said. "There is no question that Social Security and Medicare are going to present [future] generations with a crushing debt burden unless policymakers work seriously to reform those programmes."

The study, reported in the Financial Times on Thursday, attempted to estimate the gap between all future federal revenues and expenses. It concluded that large, "immediate and permanent" tax rises, spending cuts or some mix of the two would be unavoidable without big changes to federal retirement and healthcare programmes that threaten to overwhelm the Treasury as the "baby boom" generation retires.The deficit study was commissioned in 2002 by Paul O'Neill, then Treasury secretary, and co-authored by then deputy assistant Treasury secretary Kent Smetters and then consultant Jagadeesh Gokhale. A decision was made after Mr O'Neill's resignation not to include it in the annual Budget report for 2004.

Mr Fleischer denied allegations made by Laurence Kotlikoff, a Boston University economics professor, that the deficit study's figures were deliberately suppressed. "That is absolutely not true," he said.He noted the 2004 Budget included a discussion of 75-year projections of Social Security and Medicare actuarial deficits but many economists consider these measures incomplete and less accurate since they count future tax contributions without accounting for new benefits "earned", or expected, as a result of those contributions. They do not include costs that extend beyond the 75-year horizon.The Bush administration has repeatedly pushed for reforms to benefit entitlement programmes but has so far been largely stymied. Much of its focus has been diverted in recent months towards efforts to bolster the struggling economy, including the $350bn tax cut package signed into law this week.
Source: Financial Times

Thursday, May 29, 2003

From a Baffled Admirer of Stephen Roach

Dave writes to me, describing himself as a baffled admirer of Stephen Roach, with the following conundrum:

I've been reading Roach on the problem of US-centric growth for several years now, and have been largely in agreement with his analysis. One telling statistic he is fond of citing, and which I too have frequently used, is that the US has accounted for more than 60% of world GDP growth in the period 1995 - 2002, roughly twice its share of would output. Yesterday I was challenged to duplicate this result, which I tried to do using IMF data for real GDP growth. To my surprise, the result turned out to be not 60%, but 31.4%, versus an output share of 26.4% in 1995. When I tried calculating the number using current US$ data, out came the 60%+ figure, against a 1995 share of 25.7%, rising to 32% by 2001. What possible justification could there be for using current-price data in this calculation? As far as I can tell, the 60% result reflects dollar appreciation and very little else - the IMF shows a 35% rise in the real effective exchange rate over these seven years.

I don't think this undermines all of Steven Roach's argument - obviously, much of Asia is dangerously dependent on the US trade imbalance. But the heart of the problem seems to me to be an unsustainable US current account deficit, rather than the caricature of a world hooked on US growth.Am I missing something?

No dave, I don't think you are misisng anything. I think the two sets of data are for different purposes. The IMF numbers are to make a comparison in 'real' terms across economies. I imagine the numbers you used from the IMF were based on PPP or Purchasing Power Parity calculations. The answer here is probably: it depends what you want to use the calculations for.

If you want to use the numbers to make calculations about comparative living standards, then the PPP version is much nearer the reality. That is, if you want to say something about whether you live better in Chicago or Frankfurt on salary x, the PPP numbers are the ones for you. On the other hand, if you want to make a calculation about the impact on global growth of a 30% reduction in the US growth rate, then you need the current price data, since this is the data which reflects the real impact. In this sense I think Roach is entirely justified.

Of course behind all this is a bigger can of worms. There is no economics version of the 'rosetta stone'. There is no magic number you can pull out of a box to settle an argument. In the first place: all our economic data are social constructs, much as it would hurt most economists to have to say this out loud. The whole idea of a GDP deflator and a CPI involves the application of a consensually derived set of criteria. In the case of the eurozone HICP, there is not even a compatability of methodology so you may as well take your old phone number and divide it by 2 for all its worth. What gives the HICP, or the PPP numbers value is that we agree to work around them.

In this sense, the use of the terms 'nominal' and 'real', which really come from a medieval scholastic debate about essences, is a bit misplaced. In fact what is real is the current price data which Roach uses, since this is what the economy as an abstract complex system works with. If you want to be anthropomorphic, you could think of an economy as a man in John Searle's Chinese Room, receiving lots and lots of symbols which are essentially meaningless (current prices) and then operating a transformation procedure according to a set of rules.

Bottom line. I think Roach is justified, even if I don't agree with him about the US current account deficit giving the US first priority for devaluation.

Why can’t the world economy simply stay its present course? That’s at the top of my most-frequently-asked-questions list. The main reason is that the current arrangement is unstable. Since 1995, America has accounted for about 60% of the cumulative growth in world GDP -- essentially double its share in the global economy. This powerful US growth impetus has been driven by a spectacular drawdown in national saving. America’s net national saving rate -- the combined savings of households, businesses and the government sector (net of depreciation) -- fell from about 5% of GDP in the mid-1990s to just 1.3% in the second half of 2002. Lacking in domestic saving, the United States has no choice other than to import increased flows of foreign saving -- running ever-widening current account deficits in order to attract that capital. As a result, the world’s dependence on dollar-denominated assets is now at extremes. Currently, about 75% of the world’s total foreign exchange reserves are held in the form of dollar-denominated assets -- more than twice America’s 32% share of world GDP (at market exchange rates). At the same time, foreign investors hold about 45% of the outstanding volume of US Treasury indebtedness, 35% of US corporate debt, and 12% of US equities. All of these ratios are at or near record highs. Never before has the world put more stock in America -- both as an engine of growth and as a store of financial value.............

If the resistance to structural change isn’t disconcerting enough, there’s another set of forces coming into play that is also at odds with global rebalancing -- competitive currency devaluation. The intent is simple -- to counteract a fundamental realignment of foreign exchange rates that may weaken external support to economic growth and thereby force structural change. The Japanese are leading the way in this regard through increasingly heavy intervention in foreign exchange markets; official data, plus our guesstimates, suggest they have intervened to the tune of at least $50 billion in the first five months of 2003 in an effort to limit the appreciation of the yen. While Europe has yet to play its cards on the currency front, an ever-strengthening euro may well elicit a similar response at some point in the not-so-distant future. The lessons of history are painfully clear in one respect: Weak economies always feel that they are deserving of weak currencies. The problem, of course, is that this is a zero-sum game -- currencies are relative prices and not all of them can weaken. The economics I practice tells me that the nation with the current account deficit is the one deserving of the weaker currency. The last time I checked, that was America -- and the dollar. In the end, competitive currency devaluations are doomed to failure. They don’t work and they tempt nations to resort to other more draconian measures to buffer the pain -- such as trade frictions and protectionism. That’s the very last thing an unbalanced world needs.
Source: Morgan Stanley Global Economic Forum

Devaluation advocates in Washington must think hard

Amidst all the folly, in a piece I neglected to post, Andy Xie, as usual, is talking some sound sense. Obviously the US deflation argument is controversial, and I am not advocating it. The problem is that the simple 'the liquidity trap's the problem' argument fails to convince (I'm sorry Paul). It fails to convince because it has no real argument to explain why we are (globally) falling into the trap, and why now. It also fails to convince because putting up an inflation target, and complying with it doesn't tell us what we need to do two or three years from now. It doesn't tell us because it is a-historic. It is Darwin in abstract state space, and this is a mistake. We need to deal with the concrete specificities of the time we have been allotted (even if my use of language here is rather ugly). So maybe there is no way out of deflation, maybe the global economy just made a 'phase transition' and maybe we need to think again, and get more to the heart of the matter. I don't know, I am thinking aloud. But isn't that what blogging is all about. Mein Gott, mein angst!! Meanwhile note the point that the structure of global trade, and the fact of the US dollar as the reserve currency (very path dependent this) means, as Andy says, that the combination enables the US to determine global prices. That for all the dropping of the dollar, the price of a PC, or the price of a pair of shoes, doesn't change much. Forget the textbooks for a moment, go out and take a look at what is happening. Remember, theory is grey, but life is green!

The US dollar adjustment against the euro is about income share rather than current-account balances, in my view. Euro weakness allowed the euro zone to gain export competitiveness. The US and the euro zone had similar export performance prior to 1997. The euro zone’s exports have risen by 17% since 1997, compared with stagnation for exports from Japan and the US. Pushing the euro back to its 1997 level eliminates the euro zone’s competitiveness. The euro has already appreciated beyond this level.

Lifting the euro well above its 1997 level may backfire. The euro zone’s demand may weaken to such an extent that other regions would not benefit from the euro’s strength. The US must put a stop to the current round of competitive devaluation soon. Competitive devaluation is likely to boost the US economy for perhaps 12 months. It will then have to face deflationary pressure again. Mild deflation is the right solution for the US, in my view. The stock market bubble drove the US consumer to over-consume in 1999 and 2000. Some deflation would flush out this excess. It would also trigger debt reduction -- the counterpart of over-consumption in the balance sheet.

If the US insists on reflating the economy, consumption will continue to rise. Even if a stronger euro boosts US exports to Europe temporarily, we do not think this would be sustainable. When price competition becomes the main demand factor, production usually shifts to China.

A strong yen, for example, boosted US exports to Japan by 12% in 1994 and 20% in 1995. However, US exports to Japan have declined by 20% since 1995. The income-starved Japanese went searching for better deals -- their search always ends up in China.

I think that we are seeing a replay of the Japan story. Everyone is enjoying the euro party at the moment. The euro zone is likely to import more from everywhere in the near future. This will put pressure on European companies, and they will likely do what Japanese companies did under the same circumstances – move production to China. The US is trying to grow out of its problem, i.e., exporting more to pay for its excessive consumption. With a shrinking export base and a huge trade deficit, this strategy is likely to fail. Even if the dollar’s recent depreciation is magnified by 200%, the US still could not export out of its problem, in my view.

While the US tries to reflate out of its problem, the dollar’s integrity -- the foundation of the global economy -- is not yet under threat. The US dollar isn’t just another medium of exchange. It is a vehicle for wealth storage for those who try to accumulate wealth in societies that don’t respect property rights. Without US dollar wealth as a safe-haven asset, the global economy would collapse, in my view.

Federal Reserve Board Chairman Alan Greenspan commented that the paper money system resembles the gold standard, because central banks have done their job too well. This is precisely the point. The US is the largest and most open market in the world. East Asia has surplus labor and capital. The combination allows the US market to determine tradable prices. When the euro rises by 20%, the US dollar value of a PC or a pair of shoes remains the same.

The US dollar’s predictable purchasing power is the reason that East Asians are accumulating the currency (see our report, Green Fetters, dated August 28, 2001). The US dollar is today’s gold standard. Globalization functions on the US dollar’s predictable purchasing power. All other currencies can sustain appreciation against the US dollar only if their underlying economies gain competitiveness against East Asia. This is virtually impossible, in my view.

American policy makers are talking about reflation. Unfortunately, this will not work unless US dollar prices rise significantly. As China is adding capacity rapidly in a world that already has excess capacity, reflation is an impossible task, unless the US destroys the US dollar’s integrity.

This is my worry. Conventional reflationary policies would only prolong the large trade deficit in the United States. US external liabilities could increase by a further US$1 trillion in two years. Would the US accept the deflation solution in 2005, when the current bout of stimulus may lose its potency, to preserve global stability, or would the US be tempted to destroy US dollar integrity to renege on its external liabilities, which may have reached US$4.5 trillion by that time?

American policy makers should understand that, if the US dollar collapses, the US would likely cease to be the superpower. At the moment, in my view, Americans can enjoy their living standard and still spare so much for defense because of low labor costs in East Asia. If this were no longer the case, Americans would have to do everything themselves and might not be able to put together the war machine that they possess today. Devaluation advocates in Washington must think hard, I believe.
Source: Morgan Stanley Global Economic Forum

On the Problems of E-Mail Content Filtering

Well I always knew there were some bad guys in high places over there in Bulgaria, and I new that e-mails were being filtered. What I never expected was to find myself in the middle of an 'issue', well not so quickly, and not for such an innocent piece of research. No prizes for guessing what the offending material was (it couldn't be to do with the money-transfer networks, now could it?). Anyway I'm posting my 'advice' from Margarita together with the full text of the 'offending' mail: please link to it all you like, since the more stink the better.

Dear Edward,
My provider had sent to me this message, related to your last e-mail
for me:

Recipient, Content filter has detected a sensitive e-mail.

Now here's my mail:

OK here's some news.

I met with some of my colleagues at the university today, and they were very interested in what I explained about your work. In principle they would like you to participate in the project team.

I have also found a researcher (anthropologist) in the Unviersity of Valencia, and we will probably ask him too. (this one was very funny, since I was in the town hall in Enguera interviewing the woman responsible for registering the immigrants and she said: yes I prepared the data for people at UV. And I said, oh you wouldn't mind giving me a photocopy of their letter, now would you. My life is full of these ridiculous accidents. Also funny is the fact that they, anthropologists have only been gathering quantitative data, while we have incorporated an ethnographic element. Nonetheless their data will be interesting, since my feeling is that your Bulgarian immigrants are fanning out across the province. Enguera is like a jug of water which is continually overflowing).

This means, that the project is going forward. Now at the moment we have no money, but then at the moment the proposal is likely to be a low cost one. Whatever happens I will start something at the end of June. We can start with a limited version and expand as and when we get the funding. I want to talk about the content of the project, but I will save that for another mail. More, and shorter mails, may be a better policy.

On Western Union, obviously the money is important, I'd already picked that up. But here in Spain there are 'other' networks, I'm not sure how they work, and it may be something to investigate. Here we have 'locutorios' which are call-centres where people can video-conference with their families. Barcelona is now full of locutorios, and they are used to send money. In fact they tend to be a 'meeting place' for members of the new groups - a new 'holy' place? Now for the interesting part. I also interviewed people in the Agencia de Desarrollo Local, (Local development Agency, they really spend most of the time promoting rural tourism, and are responsible for all the internet material: if you want to see nice pictures try googling Caroig, which is the big moutain with evidence of megalithic settlements) and they explained that the Bulgarians were taking a leading role in introducing new technologies, with three businesses being set up in Enguera, and one of them, guess what, an internet cafe, locutorio! Well, more on this when I know more.

But you could imagine that they are sending home around one third of their income. The IMF keeps numbers on this somewhere. This is becoming an issue in Spain since we now have large numbers of migrants all sending money home, and this means they effectively count as an import!! The bad news for Bulgaria is that the evidence I've seen from the US suggests that these quantities reduce considerably with the passage of time, tending towards zero after about 7 years. This is all to do with the transitional identity.

On the question of temporary or permanent, I can see one picture from your material, the coming and going, but there is another one, one part of the migrants are settling down, some are even buying houses. Looking into this aspect will be important. I will have more to say soon on this. Also you mention that Bulgarians appear under others in US and EU stats, and hence the numbers are not important, but looking at your recent population numbers I have the impression that the number is growing. This phenomenon may be a result of the fact that the EU and US numbers are aggregates, and at this level Bulgarians are less important, but my impression is that in Greece, Portugal and Spain they may be important.

Well, that's it for now, some more tommorrow.

Best wishes,


Of Water Pistols and a Rhinoceros

Some sound sense from another FT writer on the currency situation. Perhaps the most heartening comment is this one:"But every time in the past couple of decades that there has been a genuinely co-ordinated attempt to shift the currency markets, it has worked." This was my feeling, but its nice to see the picture confirmed from the people who have all the data at their fingertips. What is needed is a decision, and a determination to make it stick. And the real problem lies here (and not in the supposed will of the markets). We are far, far away from consensus. Indeed what consensus there is probably leans towards the idea that punishing Germany and Japan will be long-term beneficial. As the FT writer notes "As of now, the prospect of building such a consensus to arrest the euro's rise seems remote." Of course, he also makes a distinction between a 'fundamentals' driven correction and the turning point". I base my argument on the idea that this whole correction is perceptions rather than fundamentals driven - this is especially true in the context of the 'reserve currency' ingredient. There is a perceived 'overvaluation' of the dollar, so there is a correction. This perception is based on the supplementary evidence of the trade deficit. But the trade deficit is the result of a structural problem US-Asia, and by-and-large this will not be affected by the dollar fall, since many of the key players are falling with the dollar. To swallow the fundamentals driven story I would have top be convinced that the whole 'new economy' story of the late ninetees was a sham. That there was a bubble: period.

The problem is, I am not convinced. Sure, there was a bubble in IT investment. Sure the 'new economy' idea was exaggerated. Underlying this there was a massive re-organisation in the US corporate mentality. There was a change of dynamic. Powerful software which enabled flexible and decentralised organisational structures came on the scene. There was the 'death of distance' and the 'weightless economy'. All of this was real. Amazon, Yahoo and Google were born, Wal-Mart came of age (forget WebVan that was always a diversion - or at least it was too much, too soon). Then we have the internat, and the 'externality' of the English language. The productivity benefits of the ICT revolution reached longest and furthest in the US and other English speaking countries. Sure the other players are now getting some of the benefits. But this process isn't slowing down, it's accelerating. So the gap remains, or is increasing. The US economy is 'weak' precisely because productivity is rising fast, while consumption is much more laggard, due, in part to the weakness of cap-ex in a global oversupply context.

In fact growth and productivity improvements in both Germany and Japan are slower and lower than in the US. The deflation danger is either already present or greater. And the resolve and vision of those responsible for policy making is weaker and more confused. So what exactly are the fundamentals we are talking about here? Of course, Stephen Roach (and to a lesser extent Paul Krugman) has it easier here: he never did believe in the 'new economy', so there is nothing special to justify the US dollar premium. He also doesn't understand just what the probem is going to be trying to 'kick-start' Germany and Japan. I'm sure they will receive the kick, it's the start bit that may be a problem. Meantime, to give an idea of where I think the fundamentals are, I reckon that if we want to see any turn round in the growth situation, we would need to be looking at a yen at around 140-150 to the dollar, and a euro in the 0.90 - 0.95 region. But to make this stick we'd need to recognise that ageing is a problem, that international labour migration forms a key to easing the situation, that the biggest structural imbalance is the North-South one, and that co-operation rather than fueding is a better platform to work from. I seem to be talking about another planet. Oh, never mind.

Intervention in thecurrency markets is notoriously pointless - like shooting a water pistol at a rhinoceros, according to one description. But as the euro surges past successive landmarks, policymakers are beginning to worry about how they might be able to bring it down: and the water pistol is all they have. The good news is that it is not quite as useless as is sometimes supposed. The overwhelming weight of evidence is that in currency markets where turnover is in the region of $1,000bn a day, policymakers cannot spend a few billion to shift exchange rates at will. But every time in the past couple of decades that there has been a genuinely co-ordinated attempt to shift the currency markets, it has worked. "When you look at the tops and bottoms of exchange rates, they are marked by policy changes," says Avinash Persaud, global head of research at State Street. "Economic fundamentals can determine the trend in a currency, but policy determines the turning points." The concerted intervention instigated by the European Central Bank to support the euro in September 2000 was widely derided: after a brief recovery the euro slipped from a little over $0.85 before the intervention to an all-time low of a little over $0.82 the following month.

But with the benefit of hindsight, European policymakers think, it was a success, because it established a floor below which the euro would not sink. Similarly, the previous trough in the dollar, in which it fell below the equivalent of $1.40 to the euro, prompted the Group of Seven developed countries to call for an "orderly reversal". The US and other countries had been intervening to support the dollar for a year with little success, the effort undermined by international bickering. The G7 communiqué initially seemed equally ineffectual, but it later became clear that the dollar had turned the corner. Such statements and intervention can work by conveying information about policymakers' intentions: the September 2000 intervention, for example, gave advance warning that the ECB was going to take a tough line on inflation, and was reinforced by a rate rise from the ECB the following month.But policy can also simply provide the markets with an anchor for their opinions.

People tend to think the right value for anything is what it is at the moment, plus or minus a little. If the ECB and the US Treasury can manage to agree that the dollar needs to rise, for example, they will send a very strong signal to the markets that it will not keep falling indefinitely. As of now, the prospect of building such a consensus to arrest the euro's rise seems remote. John Snow, the US Treasury secretary, has several times reiterated his view that "interventions [should be] kept to a minimum". While the rising euro is setting off alarm bells in Europe, it is seen as an unalloyed boon in the US. However, the fall in the dollar in 1987 was one of the triggers for that year's crash in bond and equity prices. If the dollar's decline accelerates, the US may decide it needs to reach for the water pistol after all.
Source: Financial Times

Wednesday, May 28, 2003

Otmar Excells Himself Again

There's no need to charicature Otmar Issing, the ECB's Chief Economist is fully capabable of doing that all by himself. Obvioulsy he doesn't have the first idea what the deflation proble is all about, I sometimes wonder if he has any sort of idea of what an economy is! It's kinda scary to think that someone who is so out of touch (eg his argument that what is happening to German prices doesn't matter, since we have the European average to console us. At best this is crass, at worst.......) has got his hand any nearer the Frankfurt tiller, but the looking at Duisenberg he may feel quite at home.

European Central Bank Chief Economist Otmar Issing said on Wednesday concerns about deflation are excessive, even in Germany. While Germany could see a period of declining prices, that would not translate into deflation. "From those events we are miles away," Issing said at a university symposium. Asked if there is a hysteria over deflation, Issing said: "Currently, this is like a Pavlovian reflect.""Nobody can rule out that we will see negative inflation rates in Germany in the coming two years, but that has nothing to do with deflation," he said.The International Monetary Fund has warned that Germany faces a risk of declining prices that threatens economic activity. ECB officials have disagreed that it is a problem for the euro zone if its largest member, Germany, faces a short period when prices are declining. Issing said the reason why declining prices in Germany is not a deflationary threat for the ECB is because the central bank looks at the whole euro zone, and inflation differences will equal out. Some nations, such as Ireland and Spain, have high inflation rates way above 3 percent.
Source: Forbes

China: Continuing Problems from Sars

Economic news from China on the SARS front continues to look a bit grimmer than I expected. Let's see how it works out over the year.

Instead of the usual delivery trucks, an ambulance pulled up to a Matsushita factory in Beijing's dusty north and unloaded seven white-coated medics. Their job: to check the quarantine. Two Matsushita factories in Beijing shut down last week, idling nearly 6,000 workers, after Chinese employees fell ill with SARS -- the second time the Japanese electronics maker was forced to suspend production. Ricoh Electronic Technology, the Japanese office equipment maker, also had to close a Beijing factory temporarily this month after an employee came down with SARS. U.S. mobile phone maker Motorola briefly closed its Beijing offices after a case was found there. Such closures highlight the outbreak's mounting impact on export industries that drive China's economy.

Even as reports of new cases decline, the potential for longer-term damage is rising as businesspeople avoid China and precautions within the country interfere with work and deliveries. "The production system is seriously affected. Goods, materials and supplies are not being delivered," says Chen Xingdong, chief economist in Beijing for BNP Paribas Peregrine Securities Ltd. "These problems will surface more in June, July or even August," Chen said. China's leaders have told officials to do their best to minimize the disease's economic damage among Chinese companies and are promising subsidies for the hardest-hit industries. And any fall in Chinese economic output will come from a level of growth that would be the envy of other major economies. Before severe acute respiratory syndrome spread in earnest, China's economy grew by 9.9 percent in the first three months of this year -- its fastest quarterly growth in seven years. Industrial output rose 14.9 percent in April, according to the government. Retail sales were up 7.7 percent, even though many families in Beijing and other cities are avoiding shops and other public places.

But more economic pain is likely even after the outbreak passes. Foreign companies, heeding advisories not to travel to the mainland, are putting off launching new products, opening new factories or starting new joint ventures. A survey of 29 major multinational companies by Deutsche Bank found that 88 percent expected delays in business travel to affect investment plans. In Japan, a major investor in China, a survey of 2,015 companies by the Japan External Trade Organization found that 70 percent said SARS was affecting operations. Three-quarters said business negotiations stalled, while one-third said they suspended production because of limits on travel by their staff, according to the agency.

Work stopped last week at Beijing Matsushita Color CRT Co., which employs 5,200 people producing television picture tubes, and Beijing Matsushita Lighting Co., which employs 400. The two facilities had five SARS cases and four suspected cases, with 28 more employees reporting fevers. The medical workers who were dropped off outside the factory tied on white surgical masks as they walked to factory dormitories where several dozen employees who had close contact with people who had SARS are quarantined. The balconies of the high-rise buildings were hung with bedding put out to be aired. A Matsushita spokesman in Tokyo, Kunio Ishikawa, said he expected the factories to be closed for at least 10 days -- the incubation period for the flu-like disease. ASIMCO, an American company with joint ventures in China's beer and auto parts industries, is hindered by SARS at every turn -- even though it hasn't seen any outbreak among its employees -- said Henry Huang, its manager of public and government affairs.

"Delivery people sometimes cannot send goods to certain areas," says Huang. "Some markets for components are half-closed, some totally closed. It's affected some deliveries and some sales, but it's not like a fatal problem." Chinese airlines have been hardest hit, with passenger traffic reportedly down more than 80 percent this month. Also hurting are China's textile producers, whose sales depend on visits by foreign buyers. After a 25 percent jump in the first three months of the year, sales for the rest of the year aren't expected to rise at all, the China Textile Industry Association said. "Exports this month have been hit badly," said Gao Yong, the association's deputy director. Japanese automaker Honda Motor Co. says that after sending 100 Japanese engineers home as a precaution it may delay production of a subcompact car in China planned for summer. In the eastern province of Shandong, an area with few SARS cases, a survey estimated the outbreak would cost at least $3.6 billion in lost industrial output, according to Chen of BNP Paribas. "If it's translated into the whole country, it will really add up," Chen said.
Source: Newsday

One Minute You're Up, the Next You're Down

Here's another example of the see-saw type swings which characterise news on the US economy front these days.

Orders for U.S. durable goods slid in April, the government said on Wednesday showing another sign of the manufacturing sector's slump, while two other reports showed sluggish retail sales in early May. The Commerce Department said orders for durable goods -- items meant to last three or more years -- fell an unexpectedly large 2.4 percent in April. With Wall Street analysts having anticipated a smaller 1.0 percent drop, the report underlined the sluggish state of U.S. manufacturing. As the overall economy has been stuck in low gear, the factory sector has been the hardest hit, shedding jobs and plagued with excess capacity. "This is a disappointing report, with weakness in all of the key categories," said Anthony Karydakis, senior financial economist with Banc One Capital Markets. Financial markets took the reports in stride, though. The Dow Jones industrial average was up more 40 points in mid-morning trading, while the Nasdaq composite was up more than seven points.
Source: Yahoo News

Coming Down to Earth

This is an interesting one. Terra Lycos has to be one of the big disaster stories of the European internet boom. Launched at the height of the buying craze, it was born of a merger with Telefonica's Terra and internet search engine Lycos, in an attempt by the Spanish monopoly to gain global reach. Ill conceived from the outset, and only managing to continually lose money, this adventure has effectively been paid for by all Spain's 'emprisoned' fix line customers. When I complain about the pathetic behaviour of some of the European 'multi-nationals' this is exactly the kind of thing I have in mind. Of course there's no question of any accountability, anywhere. I don't think there'll be too many mourners at the funeral.

Telefónica, the Spanish telecoms group, said on Wednesday it will launch a cash bid for the remaining shares of Terra Lycos, its internet business, costing as much as €1.7bn if acceptances are won from all the target shareholders. The move had been a long-running rumour - consistently denied by Telefónica - as analysts questioned the logic of the parent group competing for business against its own internet unit. Telefónica said its earnings before interest, taxes, depreciation and amortisation would improve by €269m in the 2003 to 2006 period after absorbing Terra Lycos.The offer is at €5.25 a share, valuing the company at €3.26bn, less than half the €13 price during its initial public offer in November 1999, and conditional on receiving 75 per cent of its shares.Telefónica, which owns 36.5 per cent of the company, said the operation values Terra Lycos at 15 per cent above its average share price over the past six months and 51 per cent above its business value. The internet business has cash reserves of €1.73bn, equivalent to €3.09 a share.

Terra Lycos shares were suspended from trading before the announcement, after rising 5.5 per cent to €4.77 in early deals.The company has yet to report a profit, as the on-line advertising market and competition from Telefónica to deliver high-speed internet access prevented its business plan from taking off.The business model was thrown into jeopardy after Bertelsmann, the German media group, backed out of a $1bn online advertising deal with Terra Lycos reached at the height of the internet boom in 2000. Its $12.5bn merger with Lycos the same year also created problems, including the resignation of the management team at the Boston-based internet company. Telefónica wrote off €1.3bn relating to that acquisition earlier this year.
Source: Financial Times

Transition To What?

I am still girding myself up to do something about the Bulgarian crisis. I say crisis advisedly, and with qualifications. It is not yet a full blown economic crisis. But it is a human tragedy of tremendous proportions. And even more tremendous for being unspoken. I discovered the full implications of this situation from visiting my wife's village. From this post Margarita got in touch, and now I know a lot more. This weekend I will put up a Bulgaria page on my website, meanwhile Margarita explains it all so much better than I could:

In a recent press conference a government official released the ‘little’ news that for the first time in our history the amount of money sent by emigrants is bigger than the amount of foreign investments. And he muttered some data. Then he smiled to the journalists and continued his interview on other subjects. Do you think this became a talking point in Bulgarian society? After all, isn't this only to be expected from a civil society in a country in transition which produces a huge emigrant flow (about 1 million emigrants since 1990. Total population 7 mill. – census 2000).

I am sorry, this was not a ‘breaking’ or at least – an important – piece news. A gang war, corruption at all levels of the administration, the postponed privatization of the Bulgarian Telecommunication Company and of Tobacco Holding, gossip related with any new political personality now that new elections are on the horizon (in the autumn) – these all seem to be much more important at the moment.

Why do I mentioned this “usless” information? In the first place, probably because nobody from my family, nor any of my close relatives has emigrated. This means, I belong to that small number of households in Bugaria who do not count for their annual income on any financial support from abroad. Secondly – I am researching emigrant flows from an ethnological perspective and thirdly - I am really concerned about the future of Bulgaria.

Don’t get me wrong. I am not someone who is against globalization or against the free movement of persons, knowledge, tehnology and of money. I do like to travel and Thank the lord I am travelling a lot.

My point today is whether the outcomes of emigration (both - permanent and temporary labor emmigration) are something which will be important for the future development of the local economy? What will our emigrants bring from abroad?

To answer this I’ll pose two more questions: The first question is what will that money be spent on? As everywhere in the so called “Third world” the money sent home by migrants is used to deal with the immediate needs of relatives. If a migrant is sending money to his retired parents he is aware that he helps them to survive. An average pension is about 50 Euro per month. Just to have an idea – central heating in Sofiya for a two bedroom flat is about 100 Euro per month, and there are 6 months in our country cold enough to use it. My recent research has shown that most of short and long-term labor migrants use their savings to improve a little (or just to maintain) their standard of life here. No wonder. The amount of savings is not impressive or not big enough to start their own business: in addition the legislation for last 13 years (since the collapse of the centrally regulated economy) is working against small and middle businesis. Keep in the mind the lack of entrepreneurship which results froma long-lasting (50 years) centralized economy too. So, the migrant’s money will be spent on modernising a home, new furniture, new clothes, medical attention (we suffer from the transition in the health care too) or probably on such a social events as the wedding of a son or daughter, or the sending of a mature son off to the Army (those are such money consuming rituals!) and so on. After spending savings on this, men or women will take a bus and start labor migration again.

When the first labor emigrants from Europe and from the USA came back home in early 20-s of XX century they brought back some new technologies. One example was the so called “American vineyard”. New knowledge, new ways of organizing work, new ideas for how to improve the Bulgarian economy, all these arrived as a result of their new experiences. Here comes the second question: What kind of professional experience do our labor migrants have today? Only a small part of them are highly skilled professionals working with contracts abroad as white collar employees. Most labor migrants are undocumented people, working in the submerged economy at levels way below their professional level here, without language skills… No need to continue – this picture is well known all over the world. So, what will they bring home in terms of new skills, new technologies? The answer is obvious. Now returning to the previous question: “Why introduce the new expensive machinery which I’ve seen in Greece? Here I own only small pieces of unfertile land, you know, you can grow only tobacco on it. There is no stable tobacco market in Bulgaria as there is in Greece. The EU supports their agriculture. I think for now it is better to work there”, said Ibrahim (35 years old, Bulgarian Muslim, electrician by training).

The picture I have drawn here is dark. And there is no official data to prove my answers on both questions. Most immigrants prefer to have their money in cash. Nobody can say for sure how much there is. I can testify that this money won’t be invested in the improvement of the Bulgarian economy. In Satovcha Municipality, where my research was done, for last 10 years there has not been a single new business established with emigrant money. There are regular bus lines to every EU country. After three months temporary work, labor emigrants are coming home and thinking where to go next time. And I repeat – all of this is neither newsworthy, nor an important issue for Bulgarian politicians.

Is it All Over Before it's Over?

My feeling is it isn't. But that's to bet against the mood on Wall Street at the moment, where there definitely seems to be a feeling that the worst is now behind us, and that normal business cycle upward-traction will gradually start to lock-in. I think they may be wrong in this sentiment even as far as the US is concerned. My reasoning is that we need to look out more towards what is happening globally. Firstly I doubt the currency 'correction' will be positive for global growth. Japan and Germany are going to feel the pain. That, I suggest, is the intention. The German discomfort will be a drag on the eurozone economies generally. Meantime China should go full speed ahead on outsourcing. I haven't found a published source on this yet, but I did hear a radio report that a recent business survey in Germany found that 25% of German manufacturing enterprises responded that they were actively considering relocating some, or all, of their production out of Germany following the euro rise.

Taking T-Salon's point that China's growth is export driven rather than internal consumption driven, this is not going to pull global growth forward enormously. So we face a US economing, firing on only three cylinders, with a relatively weak job market, trying hard to pull the entire global train, and looking for export markets. Not exactly a boom around the corner scenario in my book. If we add to this the fact that the demographic (ageing) factor should be gradually locking-in, then this uphill climb will only be notably more so. So my prognoisis, for what its worth, is the tonic of 'one step forward two steps back' will continue, with the 'recovery' forever seeming out there, but 'just around the corner'. I may be right, or I may be wrong. I think we are getting near to the moment when all theories will be tested. George Bush has his road map, and I have mine.

US investors applauded the release of positive reports on consumer confidence and the housing sector and sent Wall Street broadly higher by the close. "The consumer confidence number suggests the consumer is anticipating a strong economic rebound later in the year," said Peter Cardillo, president of Global Partners Securities. "The fact we escaped a terrorist attack over the weekend is adding to the rally." The Dow Jones Industrial Average surged 179.97 by the close to 8,781.35, rebounding from steep losses at the opening bell, after the Conference Board reported that its May consumer confidence index was at 83.8, up from the previous month.The broader S&P 500 added 18.26 to 951.48, while the tech-heavy Nasdaq climbed 46.60 or 3.1 per cent to 1,556.69, led by a rally in semiconductor stocks."The market is also interpreting the falling dollar as a short-term positive," Mr Cardillo added. He said the weakening US currency was good for US stocks because it helped exporters exert more pricing power in overseas markets. "This market does seem to want to move higher and it suggests the stock market is discounting better economic times ahead".Positive home sales figures spurred a small flurry of interest in home building stocks."Sentiment in the marketplace, coupled with lower rates, is causing people to put money into home stocks," said Mike O'Hare, head of listed trading at Lehman Brothers.
Source: Financial Times

To Join or Not to Join: That is the Question

It's decision time for the UK on those famous tests, and the political row is already brewing. Meanwhile a timely piece from Morgan Stanley GF summarising the five points and what are likely to be the main areas of contention. As they indicate real convergence has not been achieved, although it is not clear that this is due to divergence in policy. My feeling is that we need to wait a little yet to see what are the full effects of the 'one size fits all' constraint.

In his statement in October 1997, UK Chancellor Gordon Brown stated that the UK would only join EMU if the economic case for it is "clear and unambiguous". There are five economic tests to define if such a case can be made:

1. Sustainable convergence between Britain and the economies of the single currency.
2. Whether there is sufficient flexibility to cope with economic change.
3. The effect on investment.
4. The impact on the financial services industry.
5. Whether it is good for employment.

Interestingly, while the five convergence criteria set by the Maastricht Treaty only looked at nominal convergence, the UK tests also focus on real convergence. Considering both dimensions seems to us a sensible approach, as nominal convergence does not in itself (as Euroland has shown) guarantee real convergence. On the other hand, the Maastricht criteria were 'cleaner', assessing the actual situation in each economy before joining the single currency. In contrast, the latter three of the UK's tests try to evaluate the potential impact of EMU on the UK. This approach opens itself to criticism via the well-known ‘Lucas' critique’. Indeed, in his critique, Nobel prize winner Robert Lucas effectively warned against such tests, arguing that macroeconometric models being used to assess economic relationships are likely to be invalidated by structural changes (such as the UK joining EMU) and thus cannot be used to test the effect of these structural changes (such as the impact on UK investment of joining EMU).

We concentrate here on the first test, convergence. Our view is that a case for sustainable convergence of the UK economy with Euroland cannot be made at this stage. Nominal variables seem to have converged somewhat, but real variables have not. The measures used are explained in detail in the full report. In short, the nominal variables are inflation and long- and short-term interest rates, while the real variables are unemployment and domestic demand growth. Both the inflation and interest rate differentials diminished in the last decade. (Note, though, that the convergence in inflation itself explains part of the convergence in nominal interest rates.) On the other hand, standardised unemployment rates decoupled and domestic demand growth in the UK has consistently outperformed growth in Euroland since 1993, by an average of 1.6 pp per year.
Source: Morgan Stanley Global Economic Forum

Tuesday, May 27, 2003

How is Bombay Quaint?

Short piece from Yahoo India on the telephone situation there:

India, expected to be one of the world's fastest growing phone markets this decade, had five phones per 100 people at the end of March 2003, up from 3.64 two years ago, the government said in a statement on Friday. It said overall teledensity was 15.16 in urban centres on March 31, 2003 compared with 10.37 two years ago but was only 1.49 in rural areas compared with 0.9 phones two years ago. More than 60 percent of India's billion plus population lives in rural areas. Teledensity was highest in the national capital, Delhi, which had 26.85 phones per 100 people, and lowest in the central state of Chhattisgarh at 5.55. India has liberalised its telecoms industry over the past decade in a bid to boost investment and is aiming for a teledensity of seven by 2005 and 15 by 2010.
Source: Yahoo India

And a more personalised insight from Ubaid, our man on the streets of Bombay.

I guess I'm in a position of advantage, if not envy, having had the opportunity to observe the world's largest and richest democracies first hand. The social and economic fabric here is rich, varied and very complex. On one hand there is the ever rising curse of pop music and insufferable soaps on television, on the other there are shanties lining the railway tracks, the stark reality of urban poverty. Not withstanding my lack of qualifications as an economist, as a mere observer one thing can be said, the difference between the rich and urban poor is not as great here as seems to be the case in america. the sheer number of people, however, in the middle class and the economically disadvantaged bracket is huge. i find it difficult to accept projections of india becoming a super power in the next twenty years. we have over a billion people and rising, filtering economic well being to even a simple majority of this population is no mean task. the information technology revolution has definitely helped keep the wheels churning, accelerated the juggernaut even, but we are still quite some way off from being really well off as a nation. china seems to be running away with pie but it is a communist country and i'm not sure how well or evenly the wealth is distributed there.

I haven't read the death of vishnu but have read about it and yeah from what i hear, suri does a commendable job of portraying the ethos of the city. it is just that there are so many colors here, people have and amazingly wide array of perspectives. how's bombay quaint? well an example, the absolute disregard for traffic rules, people cross roads as and when they wish, there is a continuous cacophony of screeching brakes and shrieking horns, but pedestrians keep crossing the road as if they were strolling in the park. the pollution borders on being criminal and corruption, though people rant and rave about it all the time, is almost cultural.I recently read a report saying the telephone density in india is around 5 per cent with the metros beingfar better off than the rural areas. Cell phones are cheap and air time is cheaper. Everyone, no matter what attire, seems to sport one. I mention the attire because when cell phones were first launched, they were as much a fashion accessory as a communicatins tool. Nowadays every working professional seems to have one as does a large percentage of the college going crowd. Two uncharacteristically violent incidents have taken place in the past week, both related to stress at work. In the first one a 'jawan' (soldier) of the Central Industrial Security Force shot and killed a superior before taking five women and a man, all of them his colleagues, hostage at the Chhatrapati Shivaji International Airport. The situation was diffused after some six hours of drama when his parents talked him into surrendering. As a bizarre sequel to this incident a cop shot and killed his wife and son before taking his own life on Sunday, a day after the occurence at the airport.

To Cry or Not to Cry for Argentina

I'm not sure whether this piece in the Economist is about Argentina or about the IMF. Either way I think they're a bit off target. The big IMF mistake was the $40 billion of Jan 2001, not the additional $8 billion in August. The major problem that comes out of the mess, is the difficulty of maintaining fixed-pegs, and this might be considered to have some implications for the eurozone, which is after all, not a single economy like the US, but a collective fixed-peg added on to a free trade area. However reflections on the disadvantages of fixed pegs for small economies are none too fashionable these days. The other topic is Argentine politics and the 'recovery'. Here I think the Economist is living in the proverbial cloud cuckoo land. The political system is still in deep crisis in Argentina, and while the political system remains in denial, it's difficult to see any kind of sustained economic recovery. If they carry on like this, Argentina could easily become another Cuba ten years down the road: ie out-of-date technology, and no money to buy the new stuff. Think Jarred Diamond, and the difficulties associated with cutting yourself off, especially in an ever more closely networked world.

Mr Kirchner has come to power after a period of unusual tension between Argentina and the IMF. Rarely have negotiations between the IMF and one of its borrowers been so strained and dragged on for so long. The economic crisis at the end of 2001 saw the abandonment of the one-for-one currency peg with the American dollar and the largest government debt default in history. It brought the economy to its knees. It also led to the collapse of the government and, for a time, the political order. A succession of presidents came and went before Eduardo Duhalde took office early in 2002. But he struggled to secure political backing for the reforms demanded by the IMF: there was enormous popular resentment as the economy contracted and unemployment and poverty rates shot up.

The very large devaluation of the peso was painful for those who watched the value of their savings shrink. But it did help kickstart the economy. After a recession that lasted four years, the economy is growing again and some semblance of financial stability is beginning to return. After the Duhalde government threatened to default on the country’s debts to the IMF late last year, a temporary deal was done with the Fund, whereby Argentina was able to roll over its obligations. But as the IMF made clear late last week, there are still outstanding issues to be resolved before a new programme of assistance can be put in place. That will be one of the first tasks for Mr Kirchner and is one reason why he chose to retain Roberto Lavagna, the economy minister in the outgoing Duhalde government.

The crisis in Argentina focused attention yet again on the quality of economic advice that the Fund provides. Within the IMF, the debate still rages about whether it was right to extend Argentina a loan of $8 billion in August 2001, just a few months before the currency peg was abandoned. Some economists, inside and outside the IMF, insist that the loan was tantamount to pouring money down a black hole. By then it was obvious to almost everybody except the government in Buenos Aires that the currency peg would have to go.

But the IMF often gets the blame both for the mistakes of the countries that borrow from it and those of its principal paymasters. America and the other big industrial economies have so many votes that they have a veto on IMF lending programmes, and are often able to dictate the timing and nature of emergency bail-outs. The Bush administration wanted to give Argentina a lifeline in August 2001, and wanted to do it through the Fund.
Source: The Economist

On Dvd Binges in Nanking

Someone, who shall be nameless, informs me he is having a hard time deciding whether to purue a career in economics at grad school or try to work in the cinema. Either way I think he'll do a good job, the qualifications and reasoning are impeccable:

I was an
econ major in undergrad and going to econ grad school is the $64,000 question I've been grappling with over the past year. I'm also really into Chinese cinema, as you can tell. Other than the latest Matrix movie, I don't have the inclination to go out and pay $9 to see a movie just because I've got a stack of 70 DVDs I still have to watch. A weekend trip to Nanjing for a DVD binge (which seems to have a better and cheaper selection of DVDs than Beijing or Shanghai) alone would nearly justify the airplane ticket out there. I was finding just about every possible Hollywood and European classic as well as good Asian stuff and even some good third world stuff (Iranian and Indian) buried in masses of bad American B-movies.

On the Seamy Side of the Street

News is a bit slow at the moment after the holiday weekend. this gives me an opportunity for a little time out on Spain. I noticed this in the Financial Times this morning. Since Brussels virtually never does anything about EU abuses in Spain, this couldn't have any connection with the recent Spanish posture on Iraq, now could it? Oh, how I wish we had an EU which conformed more to some of our earlier ideals. What is it Frans says, idealist but not naieve, realist but not cynical:

European regulators are to probe a €1.5bn ($1.8bn) cash injection by the Spanish government into Izar, Europe's second-largest shipbuilder, because they suspect the aid might be anti-competitive. The investigation, to be announced as early as Tuesday, is set to anger Madrid, which is believed to have argued that the European Commission has no powers over the aid. If the Commission's investigation, likely to last several months, finds the aid is illegal, Izar will have to pay the money back.The issue is politically sensitive in Spain, where state-owned Izar is a major employer. For this reason, the Brussels authorities are believed to have delayed the opening of the investigation until after last weekend's Spanish local elections.The probe could be controversial because the Commission has authorised European Union governments to subsidise struggling shipbuilders as part of a trade battle with South Korea.However, people close to the Izar case said Brussels is concerned the aid, dispensed between 2000 and 2002, gave the company an unfair advantage over EU rivals. They argue that some of the shipyards owned by Izar already received €800m in state aid in 1997 and, under EU rules, should not be granted any more subsidies until at least 2007."One of the key conditions attached to the approval was that the yards would not receive any further aid," the Commission said at the time. But Spain is believed to have told the Commission the new aid would be used to build military vessels - an area over which the Brussels authorities have no powers.The Commission declined to comment on Monday. Sepi, the Spanish government's industrial holding company that is responsible for Izar, said it had not received any formal communication from the Commission.
Source: Financial Times

Monday, May 26, 2003

Tightening the Deflationary Screws

Long term interest rates are dropping across the planet. Japan 10 year bonds are now at 0.555 per cent. Looks like we're settling in for the season:

A leading Japanese business daily warned long-term interest rates were falling to historically low levels in Japan, the United States and Europe, amid fears of a deepening global deflationary trend. The yield on newly issued 10-year government bonds, a benchmark of Japanese long-term interest rates, has fallen about two-thirds in a year, the Nihon Keizai Shimbun said. The rate declined to 0.555 percent on Friday, down from the 1.400 percent return offered a year earlier. The daily noted that the yield on 20-year bonds sank to 0.860 percent and that on 30-year instruments dropped to 0.980 percent. This means that the yields on all key Japanese long-term bonds are now lower than one percent, Nihon Keizai said, adding that long-term interest rates are close to future nominal economic growth rates predicted by investors. Private-sector economists have predicted the Japanese economy will suffer negative growth of minus 1.3 percent in nominal terms in the year to March 2004. Japan's price index for consumer goods, excluding perishables, had steadily fallen from year-earlier levels for the past three and a half years, it said.

The deflationary trend is spilling over into the United States and Europe with China emerging as the world's largest manufacturing base with cheap labour and technological innovation, it quoted an analyst as saying. US and European interest rates were already declining rapidly, with the yield on the 10-year US treasury bond touching 3.28 percent on Friday, the lowest level since 1958. The yield on 10-year German federal government bonds slid to 3.6 percent, the lowest return since January 1999. The US consumer price index dropped 0.3 percent in April from the previous month. The US Federal Reserve Board has pointed to a disinflationary trend in which the pace of price growth declines.

The direct cause of recent drops in Japanese long-term interest rates has been the growing movement of funds from stocks to bonds by banks, life insurance companies and pension fund managers, who predict a fully-fledged economic recovery will not occur for some time, it said. Those investors are expecting deflation to adversely affect stock prices through falling corporate sales and income, and are rushing to shift their funds to bonds to protect themselves against that risk, it said. The concentration of investment in government bonds causes a serious distortion in the overall flow of funds, the daily warned. But even if financial authorities relax their grip on credit, most of the funds made available will make their way into government debt instruments, with lending to corporate borrowers continuing to drop and little money being funneled into stock purchases
Source: Yahoo News

Problems of the Euro-Global-Union

The point behind the last post had already been picked up by David Weman over at Europunditry. Nice to no someone out there is listening.

Henry Farrell blogged two days ago about Israel
becoming an EU member, an idea some Israelipoliticians sometimes like to flout. The Head Heebwrote about this back in December. He explains thepolitical context and discusses the ramifications and the arguments for and against; from the Israeli perspective, where he does a good job, and the
European perspective, where I think both he and Henry misses what it comes down to:

Do you like or dislike the prospect of the European Union turning into the Global Union, maybe even morphing into a future One World Government? Israel does not lie in Europe. If you discard the geographic criteria, and make it all about values or whatever, what legitimate arguments do you have against excluding a future democratic Iran? And then why not Pakistan? And then why not India?

Now, you may say: that's never gonna happen, be serious David. I don't think you should be so certain; it's just too far into the future. But okay, Indian membership is very far off. However, it's quite likely various Arab states, and very possibly Iran will, in the distant but not too distant future, become democracies and then ask for membership. (Sadly, it's not necessarily more distant than an end to the Palestinian issue, that must be resolved before an Israeli membership.) I don't think we will let Israel in unless we'll also accept the possibility of lots of Muslim nations joining. Edward Hugh would approve, but I don't think neither our leaders nor the electorate are prepared to do that, and don't know if they ever will.
Source: Europunditry

Of Lions and Lambs

Interesting post here from Henry although it seems to have originated in Haaretz. The idea is appernetly being floated in Israel that they join the EU. A researcher at Cato has added that this should be together with any new Palestinian state, and Iraq. Henry himself adds on Turkey. While I like some of this in principle, I think we are in danger of making an awful muddle. I think we are going down a bad road if we distance Israel even more from its already distant neighbours. The job is to build bridges, not place more walls. The key to the middle east is in the middle east, however attractive Henry's 'road map' at face value. Turkey is another matter, and Morroco. There are strong demographic, cultural and logistical reasons why these countries could benefit Europe, and Europe benefit from their presence in return. Long term I still suggest India as our best bet for having a part to play in the future.

But on another level my plea is for another road. For a global vision. The piecemeal approach means we will inevitably create insiders and outsiders, and be at risk of the criticism that we are only using everyone else to solve our own problems. Love it or hate it, the road passes through the UN and Multilateralism.

Moving on to the bigger issue … I don’t see Israel becoming a member of the EU anytime soon. But in the medium term, it actually might not be a bad idea at all. The Sharon government is, for the most part, appalling, and Israel has done, and continues to do, genuinely unconscionable things to the Palestinians. Israel is, however, the closest thing to a real democracy in the region. Its main problem is that it can’t make its mind up as to whether it wants to be a genuinely pluralist democracy, with all the commitments to minority rights etc that this would entail, or not. Membership of the EU might help consolidate this pluralism, as it has in other countries (Spain, Greece, Portugal). Moreover, all EU member states have to be members of the European Convention on Human Rights, which has strong and justiciable rules on the use of torture, collective punishment etc. And there is some evidence that EU membership helped transform the previously intractable conflict in Northern Ireland, by reshaping people’s ideas about what national self determination involved in practice.
Source: Gallowglass

Portrait of the German Economy As a Young Man

OK let's see if I can call this one a bit better than the Ifo economists. What we seem to have is a sort of stop-start shuffle, on the expectations front, kinda 'one step forwards two steps back'. We've had this across the globe for nearly two years now. In the case of Germany we have overtight monetary conditions, fiscal retrension and deflationary tightening on the euro front. Oh yes, and don't forget the 'arthrosis' factor, an ageing and declining population. Bottom line: I just don't see where the growth is going to come from. I think, it's a question of looking in the mirror and seeing what you want to see.

Germany's closely watched Ifo business climate index rebounded more strongly than expected, raising hopes of an upturn in the ailing economy in the second half of the year, but not deflating expectations that the European Central Bank will lower interest rates next week.The index for western Germany rose to 87.6 in May, recovering from an unexpectedly sharp fall to 86.6 in April, and well above expectations for an increase to 86.7. Business expectations for the next three months also improved, to 97.2 from 94.9. Ifo economists said Monday's figures suggested that the risk of recession in the eurozone's largest economy was significantly reduced, and that the chances for a slight pick-up in the second half of the year had improved. Analysts cautioned that, at this stage, the reading represented a correction from the previous month's sharp fall, rather than signalling an imminent turnaround. Germany's economy shrank 0.2 per cent in the first three months of the year, and a raft of recent economic data from the country signal that Germany could face a period of at least for stagnation before a recovery can kick in. The recent strength of the euro, in particular, is liable to represent a problem for the export-driven economy.
Source: Financial Times

More On the Reasons For the Dollars Strength

Stephen Cecchetti in today's Financial Times, supporting John Snow. The thing is I agree with ninety per cent of what he has to say, it's the other ten per cent that causes the problem. Actually Stephen is only saying what Bonobo's 'currency adviser' - Kevin - has been arguing for a couple of weeks. But I still don't buy it all. We all agree with the the 'textbook' version - isn't it called the Krugman triangle - that if you have free capital movements, you can't control both interest rates and the exchange rate. But wait a minute, isn't there another argument that cuts across this related to the 'reserve currency' question. In other words what may be true for Argentina, Malaysia, Norway.....even (or perhaps especially - watch out the euro vote) for the UK, may not be true in quite the same fashion for Japan, the eurozone and the dollar. Now, Japan is a special case, and so will get a special post. Essentially the surpluses and reserves mean that Japan is much more in control of the 'market' evaluation of its currency than many other players. If factors other than monetary policy and 'economic fundamentals' weren't at work, then why would the yen be rising when interest rates are stuck at zero and the 'fundamentals' seem much weaker than in the US.

So, there may be other factors at work than interest rates and 'fundamentals', since in the former case Europe is likely to be reducing soon (and if the dollar-euro switch were only seen as temporary and disturbing, there would be even more argument for G7 'calming' activity), and in the latter, the US is obviously in healthier shape than the eurozone countries. So what is this other factor? My guess is perceptions. The players are being more influenced right now, by their perceptions of what the other players will do than by anything else. This is one of the hidden, 'dark', secrets of economics. We influence each other. How we do it is more obscure, but this doesn't make it any less true. How do you decide which films to see, by the publicity, the reviews, or what your friends do? Obviously in the case of the thinking person the latter two are more important, and your favoured critic may be considered your 'friend' in this sense. This is one topic you won't find well treated in the economics text books. It is, however, the case that the dollar 'correction' we are watching is as much a product of a received view that the dollar was too high and had to come down. Now the wish has become a reality, for the moment. But how will the world live with this. Stephen Roach, who has been active in propagating the 'dollar correction' view would say we lack alternative growth engines. But in their absence how do we sustain the falling dollar argument? By suggesting that Europe will be forced to reform. Open the flood gates of Creative Destruction: well excuse me if I am extremely skeptical that this play will work (in fact having accompanied Stephen for such a long stretch of the road, I now fear the parting of the ways may be approaching: finding your footing as you slowly scale a steep and craggy rock-face is never easy. Best advice: 'don't look down').

My plea is that the road forward here is global, is collaborative, and is institutional. Enough of 'we cannot do otherwise'. In winding up a thought from Maynard:

This is not a very profound insight that I'm making, nonetheless...I wonder if one of the things that will slow down recovery (and perhaps lead to a repeat of the 30's) is the blinkered ideology of the US. The point of your writing is that how people behave depends on expectations of how every one else behaves. Now if you are ideologically committed to the idea that there is, as Ms Thatcher put it, no such thing as society, that the way to run a country like the US is to have 250 million individuals making completely uncoordinated decisions, then there is no way to create this new expectation. If the US govt believes that the only ideologically acceptable way to compel the population to all head in the same direction is through war, then war we shall have.

And now for Stephen Cecchetti:

The criticisms are unfair. Being in charge of exchange rate policy, the Treasury secretary has little choice but to comment on the dollar. But there is not much the Treasury can actually do about currency fluctuations. Mr Snow's and Mr O'Neill's comments are no more responsible for the fall in the dollar than Mr Rubin's were for its earlier rise. So what should Treasury officials be thinking and saying about the dollar? To answer that question, we must look at what does affect exchange rates. Modern economic textbooks agree on one basic principle: a country cannot be open to international capital flows and control both its exchange rate and its interest rate. This as one of the very few immutable laws of economics - one that has been validated repeatedly in many financial crises.

It is fairly simple to grasp why, in a world of capital mobility, policymakers must choose between controlling interest rates and exchange rates. Open financial markets require investors to be indifferent between the purchase of bonds in different countries, so interest rate differentials must equal expected exchange rate changes. If a country's interest rate is relatively high, its exchange rate is likely to appreciate.

Since central banks such as the US Federal Reserve, the European Central Bank and the Bank of England control domestic interest rates, they have implicitly decided to let their exchange rate fluctuate. The implication is that direct exchange rate interventions will be ineffective: decisions to buy or sell currency that leave domestic interest rates unchanged will have no impact on the exchange rate.

To see why this must be so, consider what intervention does to the central bank's balance sheet. In order to control interest rates, policymakers manipulate the size of their liabilities - the level of reserves in the banking system. Foreign exchange intervention that leaves reserves unchanged affects only the asset side of the balance sheet. Intervention by a modern central bank simply exchanges securities denominated in domestic currency for securities denominated in foreign currency.

Most Fed and Treasury officials know this, and act accordingly. Mr Rubin told anyone who would listen that "a strong dollar is in the interest of the US" but rarely intervened to try to influence its level. After his first year in office, he intervened only once - in June 1998 - and that was to try to weaken the dollar. Since then, the US has intervened only once more, again to weaken the dollar. So Mr Rubin's strong dollar policy did not imply any active attempt at raising its value.

Although interest rate changes have a direct impact on exchange rates, Federal Reserve officials always emphasise that the Treasury secretary has formal responsibility for dollar policy and decides when to intervene. He or she has responsibility without power. But unlike Alan Greenspan and his Fed colleagues, the Treasury secretary cannot refuse to answer questions about the dollar. What should Mr Snow say?

Any answer must be clear that exchange rate policy is designed to achieve two long-run goals: first, keeping the dollar as the pre-eminent global currency; and second, maintaining economic policy that ensures high, stable real economic growth and high, steady investment returns. If these objectives are achieved, it will, in Mr Snow's words, make people confident in the dollar. A stable economy will bring a stable dollar, which is what is wanted.

It is essential that Treasury officials are clear that they are going to let financial markets determine the dollar's day-to-day value. They are unable to do anything about currency trends, even over several years, and intervention in currency markets can be an emergency measure only.

So the next time Mr Snow is asked about the dollar policy - which he will be - this is what he should say: "Day-to-day fluctuations in the value of the dollar are determined in financial markets. Our goal is to implement policies that ensure high and stable growth, so that the US economy continues to be the best place in the world to invest and the dollar remains the pre-eminent currency."

If Mr Snow and Mr O'Neill had been saying this for the past two years, would it have made any difference? Would the dollar still have depreciated by 25 per cent against the euro? The answer is probably yes. The dollar's decline is a result of economics, not rhetoric. Mr Snow is clearly right. What the US needs is a fiscal policy that inspires investor confidence. When the country gets it, it will also get a stable dollar.
Source: Financial Times