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Saturday, June 28, 2003

US Recovery, Perhaps the Only Thing Left is Hope

Eddie doesn't seem to be getting much rest in Singapore these days. Now he's taking time out to examine the US recovery situation and the role of tech investment.

THERE'S a lot to hope for, it seems.

The Iraq war is over and the Sars virus subsided quicker than expected. There's relief all round. As United States Federal Reserve chairman Alan Greenspan testified before the US Congress last month, 'expectation for a pick-up in economic activity is not unreasonable'. And the maestro isn't just twiddling his thumbs while waiting for the forecast to unfold. In the past month, Mr Greenspan has engineered a startling drop in US long-term interest rates and a surprisingly large narrowing in the spread between all grades of corporate and government treasury bonds. What is remarkable is that he achieved this loosening of credit conditions before using his main tool, the federal funds rate.

Nobel Prize-winning economist Robert Solow was right when he reasoned in a Los Angeles Times article two weeks ago that, 'one of the good things' left is the US Federal Reserve's flexibility and 'its willingness to think outside conventions'. We are clearly in a unique situation.

The vexing question is: Why hasn't the large cut in interest rates boosted demand as it did in the past?

But first, it is necessary to correct an inaccurate impression. What seems to have been overlooked is that this long-awaited recovery in US investment has actually half arrived. Investment in technology is up, although the rest of manufacturing is still struggling. During the recent three quarters, US investments in computers and peripherals grew at an average rate of 26 per cent. The rate of investment in the first quarter of this year was 24 per cent higher than its previous all-time high reached during the peak of the Internet boom in the late 1990s.

The reason why the technology revival hasn't felt like a recovery in the US is that technology deflation remains vicious. While computers and peripherals are still being bought at a furious pace, they aren't worth as much, and what counts for the bottom line is the value of the investments. Unfortunately, average growth in monetary terms was just 9 per cent during the past three quarters. In fact, weak prices mean the value of investment in computers and peripherals is still some 20 per cent below the peak reached amid the Internet boom three years ago.

But Asia fared better, benefiting from the relocation of production and the outsourcing trend. Singapore's exports of electronics goods rose by almost 9 per cent in the recent three quarters, a decent turnaround after contracting 21 per cent in 2001. Exports of integrated circuits, in particular, jumped 30 per cent. Other Asian economies did better. Thai exports of high-tech goods have been growing an average 19.2 per cent since the middle of last year, while China's computer exports soared 54 per cent last year.

Mr Terence Tan, regional technology analyst with DBS Vickers Securities, says that while there were still some weak sectors in technology, like telecommunications, many Singapore technology companies actually made record profits last year. Unisteel Technology, which supports the disk-drive industry, enjoyed a 62 per cent rise in profits last year on the back of a doubling of revenues. Mr Tan says such companies did well because 'while downward pricing pressures are always present for technology products, this was more than made up by a surge in volume production'. The end demand for disk drives was 'exceptionally strong'.

But he's less optimistic about the outlook, saying: 'It will be hard to sustain already high growth rates.' In other words, this is probably about as good as it gets. Sure, investments in technology are likely to dip in the second quarter of this year and will be made up with a revival in the third quarter. But is it reasonable to expect a significant acceleration? Some of the weak sectors could see a pick-up in growth, but others will find it hard to replicate already robust growth.

So what is Asia waiting for in the second half of the year? Consider the implications of the diverging trends in technology investments. If the US is installing a lot more computing power, that suggests that businesses are still finding value investing in information technology. Quite likely, the rapid growth in productivity the US is enjoying will continue. But this doesn't guarantee that we will see a surge in growth soon. Instead it could suggest that downward price pressures will persist as productive capacity continues to outpace demand. Profitability for Asian manufacturers could come under pressure. The pie just isn't growing very quickly.

After 16 years of massive computer proliferation in workplaces, computer and peripheral manufacturers attract no larger a share of US gross domestic product (GDP) in spending than they did back in the days when singer Rick Astley topped the pop music charts and Ronald Reagan was US president - about 7 per cent of GDP. This trend isn't about to change and could get worse. In a survey of more than 600 chief information officers (CIOs) worldwide earlier this year, Mr Richard Hunter, a research fellow at technology research firm Gartner Inc, reported that, 'CIOs, after years of being asked to do more with more, are being asked in a serious way to do more with less'. The CIOs' top priority is to cut costs, says the survey.

It is going to take something pretty special in the second half of this year if the world is to get what it is waiting for. Perhaps it's better just to hope.
Source: Straits Times Author: Eddie Lee

Friday, June 27, 2003

Counting the Base Points Down

I've been so obsessed with the problems of monetary policy in the time of Great Depressions, that I'd completely forgotten it was Friday and time to check out what Roach has got to tell us going into this weekend. Well I find Brad has actually beaten me to it!! So I'm left with the leftovers, the part that reaches where others fear to tread, Stephen in naustalgic mood:

It was a very different era. In June 1958, the number one song in America was “Who’s Sorry Now” by Connie Francis. That same month the federal funds rate averaged 93 basis points. Fast forward 45 years and the Federal Reserve has taken its policy rate to a new post-Connie Francis low. By pushing the federal funds rate down to the long-forgotten 1% threshold, the Fed has rewritten the script of modern-day monetary policy. The fight against inflation is over. The battle against deflation has been joined................

In its inflation fighting days, financial markets learned never to doubt the Fed. In its deflation-fighting role, markets are giving the Fed the same benefit of the doubt. My biggest fear is that the Fed’s skill-set is asymmetrical -- that the central bank is much better in fighting inflation than deflation. If I’m right, that could spell a tough reality check for the US economy and for ever-optimistic financial markets. By the way, Connie Francis also recorded another song in 1958 that didn’t quite make it to the top of the charts. The title: “I’m Beginning to See the Light.” And I am told by one of the hippest members of our team that next week’s number one album on the Billboard charts is likely to be “After the Storm” by Monica -- whoever she is. What a world!
Source: Morgan Stanley Global Economic Forum

Now For Something Completely Different

So, to lighten things up a bit after an ever-so heavy-post, I thought I'd take you all back to my heady days at the LSE and model-building in the age of the Beatles. This is the title of a festchrift essay by Meghnad Desai for SGB Henry. Now I'm sure neither of these would in any way remember me, but SGB Henry did have the misfortune to be my tutor (I say misfortune, since I am sure that he like many others along the variaries of my life path must have despaired of me ever coming to anything) and I did spend more hours than I should have drinking my miniscule grant away in the company of Meghnad in the Three Tuns Bar. This post was provoked by what might best be termed a small world phenomenon, since Brad has an extremely worthy piece on the truly worthy and decent Meghnad, and since, when rummaging around the internet for something on Christopher Dow, I came across what follows. Of course neither Meghnad nor Henry can in any way be held responsible for what later became of me. On another occassion I will tell more of how I once, quite literally, found myself sitting at the feet of Lionel Robbins, and in my rather less than presentable role in the 'affair of the gates'.

When I first met Brian Henry, he was called Jim. This was on the simple grounds that many of his contemporaries at the LSE were also called Jim, so why not he? Sadly, as time goes by, the number of us who call him by this name is rapidly diminishing, so to ease confusion in the rest of this piece, he is Brian. I got to know him in the first week of my joining the LSE in September 1965. He was new then, like me, and we had no induction at the LSE in those days. So we took to going to the Robinson Room on the third floor of the LSE old building to eat. He told me he was not interested in economics but in painting. I was, in those days, something of an econometric modelling nerd. Fresh from the USA, having worked with Lawrence Klein on the World Tin Economy and then modelling the California Dairy industry at Berkeley, I was determined to get into macro modelling. That I thought was real economics after years of commodity modelling. At this point, Brian was a theorist and not interested in econometrics, but that was to change. By about the third day, Bill Phillips, he of the Curve, found out to his shock that no one had taken us to the Senior dining room. He took us and then we went there all the time. The food was a bit more expensive, an omelette freshly made was 4 shillings (20p.); only Professors—Alan Day, for instance, who had an omelette everyday—could afford that. We were on £1400 (p.a.) plus £60 London Allowance. Of course, the real activity at the LSE was every evening after office hours, i.e. 17:30 in the Three Tuns Bar. Someone should write the social history of research some day. In the Three Tuns Bar were gathered every evening all the younger Lecturers, the graduate students and even some senior faculty—Bernard Corry, Harry Johnson when he was in town. There used to be a lot of shop talk, research topics were discussed and in the blinding light of the next morning some research
topics were even pursued, I must have gone on about Stop Go and how one could model it.

Brian decided sometime soon after our first meeting to move from concentrating on theory alone..Partly, this was because theory at the LSE had become moribund...........

Sometime during our labours in early 1969, the LSE had a student uprising concerning the ‘gates’. I was involved as a sympathetic staff member. The LSE shut down, but somehow or other we got our paper done in time for the conference.
Model building in the age of the Beatles: Meghnad Desai

Keeping the Clients Valuables Locked in the Strongroom

So Brad has picked up the gauntlet on monetary policy in the Great Depression. As I read him he seems to concede that the argument maybe at least half right, but he still appears to pin his hopes on pumping in enough high powered money to save the day. I would like to make a couple of points at this stage. Firstly that I am deeply indebted for my arguments here to Christopher Dow and his magnum opus on Major Recessions and to my dear brother, the erstwhile anarchist banker. Indeed Dow and Iain Saville seem to have done a good job of keeping the limitations of the Friedman view well in sight even at the height of the monetary mania. As Dow indicates there may well be a good UK post-Keynes tradition of arguing the endogeneity of money, which while it has always been heterodox (we Brits are congenitally heterodox), does at least pass through such distinguished names as John Hicks and Nicholas Kaldor. So not everyone has always been so 'naieve'.

Now going back for a moment to Brad's (and numerous others, many of them currently housed down at the Federal Reserve) faith in the power of high-powered money, it seems to me that one of the issues is how to identify the extent of the problem in advance. It is one of the tenets of the famous Ahearne et al paper that the Japanese reacted by doing too-little too-late. This is fine with the benefit of hindsight, but how do you know in advance? Although we are now well versed in the omnipresence of assymettries - assymetrical shocks, assymetrical risk, assymetrical falsification etc - some symmetries do in fact exist, both in argument and nature. One of these, I would argue, can be found in the boom-crash cycle, and while after recent experience everyone is well clued-up on the difficulties of identifying a bubble in order to 'burst' it, we seem less well tuned into the difficulties of identifying when a downturn might turn into a long and sustained recession. And this is one of the problems I can see in Brad's argument, since, even accepting that flooding the market with money at a key juncture might have some effect (depending on why we were getting the deflation in the first place), identifying when to open the flood gates would seem to be much more difficult. Finally, to back up the difficulty of having so much confidence in monetary instruments with a bit of research, why not try looking at the following paper from Ritschl and Woitek? As their abstract states:

This paper recasts Temin's (1976) question of whether monetary forces caused the Great Depression in a modern time series framework. We adopt a Bayesian estimation and forecasting algorithm to evaluate the effects of monetary policy against nonmonetary alternatives, allowing for time-varying parameters and coefficient updating. We find that the predictive power of monetary policy is very small for the early phase of the depression and breaks down almost entirely after 1931. During the propagation phase of 1930-31, monetary policy is able to forecast correctly at short time horizons but invariably predicts recovery at longer horizons. Confirming Temin (1976), we find that nonmonetary leading indicators, particularly on residential construction and equipment investment, have impressive predictive power. Already in September 1929, they forecast about two thirds of downturn correctly. Our time varying framework also permits us to examine the stability of the dynamic parameter structure of our estimates. We find that the monetary impulse responses exhibit remarkable structural instability and react clearly to changes in the monetary regime that occurred during the depression. We find this phenomenon to be discomforting in the light of the Lucas (1976) critique, as it suggests that the money/income relationship may itself have been endogenous to policy and was not in the set of deep parameters of the U.S. economy. Given the instability and poor predictive power of monetary instruments and the strong showing of leading indicators on real activity, we remainskeptical with regard to a monetary interpretation of the Great Depression in the US.
Did Monetary Forces Cause the Great Depression? A Bayesian VAR Analysis for the U.S. Economy
Albrecht Ritschl and Ulrich Woitek

Now while Brad is busy awaiting the arrival of his troops from the Cardinal, I thought I would also seek a second opinion from my UK back-up, my brother:

My first recollection was of old Mr. Barclay in Lombard Street who in the 1970s was at least 142 years old and still working. He used to start off interviews with any managers who have had bad debts with the question “Why have you lost my money?” In his 128 years of banking old Mr Barclay, bless him, had never had a bad debt!

Why do I use this anecdote? Because I suspect banking has changed since the time of the Depression. This may be important in looking at Mr. De Long’s dichotomy. One way of seeing the difference is as follows.

Targeting outstanding loans may mean that you are emphasising the profitability element of the bank.

Targeting Deposit/Reserves may mean you are looking at the Banks ability to bear losses or to raise more deposits.

The shareholder and the Chief Executive with a profit share scheme are perhaps more interested in A and the Central Bank Control regime in B. Both of course are interested as well in quality of Assets and Maturity Ladder of Deposits. And both are interested in return on Capital. It depends however on the weighting you give to each.

Now my own view is that in old Mr. Barclay’s day we did not have Management by Objectives etc. and all that. And Bankers also used to remember that loans were not only to perform but were also meant to be repaid or at least repayable. Bad Debts, and this may, pace Weber, also have been a moral thing at the time, were to be avoided toute court. Now, today, by contrast, Bad Debts are relegated to an affordable expense and one is playing the percentages. And I would also guess in Mr. Barclays time that one was not operating with such a spread of % spread on loan return as has been the case since the growth of consumer indebtedness from the 1960s onwards. In effect the high interest rates in the consumer market and the interest differential that has grown up between cost of deposits and interest rates in this market is like an insurance premium against Bad Debts (Notwithstanding the other insurance cover products and direct off loading to the insurance sector by means of Securitisation which has taken place, (and for which I was considered a heretic by the Banks chairman when I suggested this would happen in the 1980s!). One further thought in this vein is that when interest rates are low the profitability of interest returns increase since margins become a greater proportion of the total payable by the borrower. Finally there is a split between consumer and corporate lending and this makes a Banker vulnerable to Asset mix. By this I mean if his margin to a AAA Company is 5/16% and his margin to a personal Borrower is 7% then he has to lend a lot more to the corporate borrower than to the Personal Borrower to make up a Bad Debt of £10000. This difference also leads to a spread of risk problem where a Bad Debt in the Corporate Sector leads to much greater loss and thus sometimes the risk /return ratio will affect decision making. This also applies to different Sectors across the board (Classification of Advances Stuff).

Why do I say all this, all of which you know anyway?

What are you doing to the quality of your assets by injecting money into the system. Such effects take time, and by what standard can you estimate this time factor, especially in today’s possible deflationary climate. What are the prior examples? The debate regarding the Fed in the Great Depression shows the lack of example.

Is it going to be throwing good money after bad? My thoughts are than in the Great Depression the mind set had already taken shape (remember the story our father told about his bank going bust in Arkansas and also I think Picasso did not trust his money to banks.) The view was to avoid Bad Debts at all costs. And at that time the Banks were not so subject to the need to perform as regards profit targets then as they are now. (A nice gentleman’s club!) Thus the Banks in the Great Depression saw Bad Debts in 1929 as being directly related to the Stock Market prices and tried to support these by direct purchase rather than by trying to avoid deflation by increased lending. Even if the Fed had injected money I guess the Banks would still have tried to increase the quality of their book in terms of what they believed to be the case rather than what the Fed may have tried to convince them would be the case. (Personally I always went for safety, being prepared to lose business rather than take the risk and the premium. Thus like old Mr. Barclay I did not have Bad Debts. But I was able to sleep at night!).

Such a support operation was the 1970s lifeboat which - thanks to Mr. Cork the Liquidator par excellence - meant that the catastrophe of the Property Boom was manageable rather than disastrous. However, the cost to the Banks was enormous and with the emphasis now being on profit I suspect that the Banks will never willingly enter into such a support operation. When the going gets really tough though the Banks start to look to their Sector Exposure and just bring the shutters down, as we did in the late 1980s when the property sector started overheating. It does not matter who you are, the answer is NO!

What I am saying is that I actually think we may be in a worse situation than in the Great Depression for the following reason. Once the mind set takes hold the Banks will go to improve quality and margins (to cover perceived risk) and sector spread. The situation is NOW, not some hypothetical what if . And if things really get bad with the pressure on profitability more than on social responsibility as it was in the 1970s then any Bank-wide support operation will be much harder to sell.

And if the Fed or the BoE tries to inject money into the system it will not result in new investment or a real rise in spending. The Banks will just try to take the opportunity to offload more risk by way of securitisation against fixed rates at a time of deflation resulting in more of such as the bond bubble.

As I have said to you before the way of trying to manage the impossible situation (if at all) is by trying to look more closely at the Asset side of the Banks Balance sheets, say making certain types of Lending Reserve Assets, and penalising others. This relates control to profitability rather than to Reserves/ Deposit risk which is more in line with the present climate. The A side rather than the B side. In this respect today is different from the days of the Great Depression. But at base, when Bad Debts start to rise the Banks don’t look to the Fed or the Bank of England forecasts of trying to increase liquidity and to avoid deflation. The Banks scramble to secure what they have at present. (And I was always accused of having my customers testicles in jars in the strong room in this connection!)

Once the mind set takes hold the velocity of money slows considerably, and I do not feel any amount of injecting money will alter this. It has to run its course, like a huge ship. As does getting used to permanently lower returns on Capital employed. We have some way to go at present. The last two years have been ones where people have been able to hide behind spectacular bad news, Enron, SARS etc. This has been an excuse for other firms. But now they will not have such an excuse for their lower profitability and the gloom may well deepen. A sort of psychological double dip.

Doldrums Japan

Japan continues its weary path. Nothing especially new or surprising here, but clearly with the number 2 and the number 3 economies heading stubbornly downwards, you have to give some though to what might be the implications for the number 1 economy. Also there's more for Joerg's list here: the rising youth unemployment as the big firms flexibilise and re-structure.

Economic data released on Friday showed that the Japanese economy remains locked in a low to no-growth pattern, with unemployment hovering near post-war highs and consumer spending continuing to fall amid a decline in wages. The April core consumer price index (CPI), a key gauge of deflation in Japan, remained unchanged at negative 0.4 per cent, year-on-year. Economists said deflationary pressures were likely to worsen amid the current trend of declining wages.

"Going forward, we see little possibility of a sustained rise in consumption and upward push on prices amid the downward trend in wages," said Mamoru Yamazaki, chief economist at Barclays Capital in Tokyo. "To the contrary, we expect retailers to continue lowering prices as they see consumers pinching pennies." Against this backdrop, May consumer spending fell 1.8 per cent, year-on-year, as households pared expenditures amid salary reductions and continuing high unemployment rates. The May unemployment rate remained unchanged at 5.4 per cent, just shy of a post-war high of 5.5 per cent last reached in January. The percentage of 15-24 year-olds who were unemployed reached 11.1 per cent, a rise of 30,000 from a year ago, almost double the unemployment rate of any other age bracket.

The increasing number of youths out of work reflects the increasingly stringent hiring practises of firms, which are cutting back on taking on new graduates amid cost-cutting and restructuring measures. It also reflects a social shift, as high school and college graduates increasingly shun the Japanese tradition of lifetime employment at a single company in favour of part-time jobs or pursuing creative interests.The one bright spot amid the dreary data were May industrial production figures, which showed output growth of 2.5 per cent, month-on-month, about 1 percentage point better than market expectations. Economists pointed out that over the past six to nine months, Japanese industrial production has been stable, whereas US output has been weakening.
Source: Financial Times

Would You Let Your Children Go Cleaning?

Joerg of course doesn't miss a trick, or waste a moment, so he's back with a bag of comments that I'll let trickle through. First, some stuff on Germany which relates to the last two posts. To my throwaway question "How many of my readers have the ambition for their children to work in construction, or in domestic cleaning?" he rejoins the following:

You say:

"But isn't this in part what our labour market, flexibility, reforms are supposed to be all about. Reducing costs to foment economic expansion. This is the good kind of dis-inflation. This is supply stimulus... It also adds to the demand side stimulus, since immigrants are predominantly young and liable to borrow against their futures (normally they
borrow even to arrive)..."

There is a difference between the flexibility argument and the timespan-of-payments-to-the-pension-fund argument. The flexibility argument is nonsense. (E.g., 97% of all medical assistants to doctors in Munich are from Eastern Germany: I guess that shows how "inflexible" we all are.) Also, in the balance you either have an effect on the supply- or the
demand-side. The supply-side effect is the predominant one. Its result is quite simply contraction on the demand side of the domestic economy - due to worker displacement. Free trade works toward the same end, but if you fast-forward its effects - and do not give an economy the breathing-room to adjust that the slower timescale of globalisation allows for -
by introducing "proxy globalisation" before trade globalisation arrives at its peak level, you are heading towards the severest trouble imaginable............................

Remember my example concerning medical assistants in Munich? Only 3% of them do not come from Eastern Germany. Being a medical assistant to a doctor is certainly more desirable than doing domestic cleaning - yet just about any teen in Munich that has barely learned to read and write seems to look down upon that kind of job. I remember reading a story in the "Economist" - in the late eighties, I believe - about a married American housewife who wanted to earn some cash of her own. So she started out doing domestic cleaning. She did it thoroughly, was recommended by her customers, soon ran a company, wrote a training manual on how not to break the Chinese vase, expanded madly, got a sportscar and a divorce and ended up owning one of the largest businesses of this type in the U.S. - no doubt having become a millionaire some time along the way... The world as will and idea of middle-class moms and dads just does not seem to be a promising point of departure for economic reasoning.

Going back to my last post, I do think that timing and velocity are important here. These are precisely the kind of structural points which seem to get lost somewhere in a lot of the more formal treatments. I think Joerg's argument above, when taken with his point about the 'labour buffer' as the modern gold standard yesterday, need serious consideration. What he is saying I think is that if we drive the supply side expansion too fast, and imagine that the demand side will inevitably follow (yes, but when?? and are there not cultural factors at work, think SE Asia) we will run into problems (as in fact we are).

Good, I like it. My 'immigration as temporary solution' idea was only a beta 1.0 release, we may be working towards a beta1.1, but it still needs more work.

On the US woman who got rich, this does remind me of something I saw in the 70's. When I was doing my doctoral studies, I did some teaching work on the side to supplement my income (probably to feed my voracious appetite for books, and days in the country). I found some work teaching English to Chilean refugees (incidentally I see some comparisons here with the Bulgarians I am meeting, very different from the traditional 'immigrant'). Now the majority were displaced professionals, academics, teachers etc, and they found the stress provoked by the drop in social status unbearable. However there were one or two who didn't fit the picture at all, including one woman who seemed to have no political opinions whatsoever. So while everyone else was sitting round feeling sorry for themselves and feeling 'unsupportable' naustalgia for La Patria, what did she do, she got a job doing industrial cleaning. I met her one year later, she was well dressed, had a nice car, and was to all appearances living well. The reason, she had set up her own cleaning agency (certainly using immigrants, probably employing other 'more intellectual' chileans) and was making money. I have no idea where she is now, but I imagine she too is probably extremely rich. I think part of the lesson is knowing how to value, and take advantage of, networks of information.

And of course, don't miss this. I'm in the local locutorio, full of immigrants, and the boss is an Armenian immigrant. Yesterday, in the Yuppie version, the owner is a UK based company. I don't think I've seen any Spanish entrepreneur, big or small, making a success out of this.

PPS. In the centre of Barcelona there's a district which has been one of the traditional centres of wholesale textile distribution for Spain (think Steve Johnson's 'Emergence' here). Now guess who runs this whole area these days? Chinese immigrants, who mainly arrived illegally in the early 90's to work long hours for little money in those notorious Chinese restaurants. Work and entrepreneurship is all about culture and attitudes.

Things in Germany are Hotting Up

Two pieces from the FT today give a clear indication that we could have a long hot summer, followed by an even longer cold winter opening up in front of us. First the growing crisis in Germany's life assurance industry:

Germany's financial regulator on Thursday night sent a life assurer into insolvency for the first time in more than 50 years, after losing patience with Mannheimer Lebensversicherung. The assets and liabilities of the life assurance unit of Mannheimer, which is a prominent medium-sized insurer, will be transferred into Protektor, a pan-industry safety net that was set up last year to safeguard policyholders' investments. The move opens up the prospect of other failures among life assurers and is likely to shake up Germany's fragmented insurance sector, concentrating new business among the market leaders, such as Allianz and Munich Re. Analysts said that the move - which followed months of rescue efforts by the company and the GDV, the insurance industry association - was also a black day for chancellor Gerhard Schr?der and his plans to persuade Germans to invest for their own retirement, rather than relying on the state. Wolfgang Rief, credit analyst at Standard & Poor's, said: "For the integrity of the life insurance industry as a whole, nothing is worse than a negative image." Mannheimer's fate was effectively sealed on Wednesday, when the GDV failed to win the 90 per cent approval necessary from its members to launch a Euro370m ($428m) capital raising to which they would subscribe.

Previous attempts to secure a rights issue had been blocked by the company's shareholders, which include Munich Re. Analysts estimated that Mannheimer's failure would trigger a write-down of at least €25m for Munich Re, which had a 10 per cent stake in the group. Under the Protektor scheme - which has until now remained dormant - the customers of Mannheimer will continue to receive a statutory minimum return on their investments. Industry insiders said that the decision by BaFin, the regulator, to call a halt to rescue attempts followed the failure of last-ditch negotiations yesterday between Bernd Michaels, GDV chairman, and BaFin bosses. One person who is close to the regulator said: "We have been in talks for a long time. Finally, we lost patience." Analysts said that the stance was another show of force from a tough new-look regulator that has previously been saddled with a soft reputation. "Jochen Sanio [the head of BaFin] is definitely flexing his muscles," said one observer. In less than a week, BaFin has produced a damning report on the failure of risk controls at WestLB's principal finance unit as well as triggering Mannheimer's demise.
Source: Financial Times

And now the growing argument over the lack of sympathetic ears:

The European Central Bank president told Germany on Thursday to live up to its fiscal promises and cut borrowing to boost investor confidence.Wim Duisenberg said the 2004 budget plan drawn up by Hans Eichel, finance minister, was a "cause for concern" because it would make government debts rise when they should fall. His rebuke came after Mr Eichel revealed plans that will require a steep rise in net new borrowing to €23.8bn, and are expected to lead to Germany breaching European Union budget rules for a second year.Germany's budget deficit in 2002 exceeded the 3 per cent of gross domestic product limit set by the stability and growth pact and is expected to do so again this year and next. The finances of the eurozone's biggest economy are expected to deteriorate further if Berlin brings forward €18bn of tax cuts next year.

Mr Eichel deflected questions about cuts until this weekend's rare conclave of ministers and coalition party leaders. Reacting to the plans, Pedro Solbes, the EU's monetary affairs commissioner, said Berlin could not count on the commission's support if fiscal rules were breached. But amid fears Germany's stagnating economy, already in technical recession after two quarters of contraction, could sink into a deflationary spiral, Berlin has little option but to ease budgetary reins to stimulate growth. Robert Prior of HSBC said: "It is the only weapon it has left . . . it cannot cut interest rates and it cannot devalue." But Mr Duisenberg said Germany needed "to do everything to generate confidence" to overcome its economic weakness. For that to happen, the government must stick to agreements.
Source: Financial Times

The terrible incomprehension of Germany's problems revealed in the above is really staggering. I have a horrible feeling we are watching history in the making here. A great tragedy is about to come upon us, and we all seem powerless to stop it. To be sure there is no easy solution, but as Eddie indicated yesterday, sometimes in economics timing is everything, and this is not the time to pin down a German economy already hamstrung by euro commitments. (Come to think of it, why not ask some of the others to 'cough-up' for a change and send 'extra structural funds' back to Germany!!!). The only end-game here will be to instill the fear of god in an already highly risk-averse German population, and no good can come from that. It would almost seem comic to talk of a 'confidence' element here. What we need to do is avoid upping-the-ante on the 'panic' register. Because panic is what we may have to face if, after all the soothing talk that there is nothing to worry about, the combined 'best efforts' of Brussels, Frankfurt and Berlin fail to ease the Titanic back onto its course (or if you prefer trend growth path, although I hesitate to use that term since I fear that that is precisely what the German economy may already be on). It's the potential sense of impotency that worries me, and the associated rage which may then follow.

Thursday, June 26, 2003

On Some Minor, Secondary, Non-mainstream Disputes Which May Turn Out to be Important

There's been quite a party going on this week with Brad , dsquared and even Krugman all getting in on the act. The topic, the 'naievity' of Milton Friedman. Now by hazard of circumstance yours truly also has a part in this little saga since I, as an inveterate Roach reader, stumbled upon his reference to the FT interview which has provoked all the fuss, and immediately posted. Such is the pathway to fame and fortune.

However, I wouldn't like to miss the thrash completely, so since I have nothing especial to add to the debate about his personality (frankly my dear I have no idea, although the times I did see him on TV, he did seem incredibly basic and dogmatic), I will try and hijack things off along the lines of his other major 'contribution' to economic debate, his study of the Great Depression. In fairness Brad has set the scene:

And the fight over whether the Federal Reserve caused the Great Depression? Purely a dispute over definitions. Did the Federal Reserve walk into the middle of a well-functioning market economy and wreck it? No. Should the Federal Reserve have taken the decline in the money stock as a signal that there was a real problem and that it needed to shovel liquidity into the banking system as fast as possible? Yes. Did the Federal Reserve do so? No...............

The way I put the bottom line is that the Federal Reserve did not cause the Great Depression, but that it bears responsibility for the Great Depression because it allowed the money stock to decline and so did not block the vicious cycle of deflation at the beginning. But the serious mainstream disputes** over the "cause" of the Great Depression are semantic and definitional only................

**Serious mainstream disputes: there are (a few) people who believe that the Great Depression was caused by the fact that the Federal Reserve did not deflate the American price level back to its pre-WWI level in the 1920s, or who blame the Great Depression on the Smoot-Hawley Tariff or the New Deal. The tariff certainly didn't help, but it was a minor factor. Some elements of the New Deal retarded recovery (and others accelerated recovery), but the Great Contraction was completely over when Roosevelt's 100 Days began.
Source: Semi Daily Journal

The matter in question is Friedman and Schwartz's Monetary History (1963). Chapter 7 of this book is entitled 'The Great Contraction', but in fact it is not clear to which 'contraction' we are referring at times, to the monetary or to the output contraction. The impression is that the two are inextrically intertwined, but the innocent mind might draw the conclusion that this impression is in fact never justified with anything amounting to precision. The point being, there could well be plenty of debate as to whether the monetary contraction was the cause or the effect of the real contraction.

What seems preoccupying in the F&S view is that they never seem to actively consider the possibility that banks may have been held back by factors other than their reserve position. This appears to be because they take virtually no account of the assett side of the bank's balance sheets. Indeed it seems to be the case that their conceptual framework leaves little place for a consideration of the role of the banks as financial intermediaries between two types of client: depositors and borrowers. Nor do they seem to put great store by the fact that the banks as intermediaries operate in a world of uncertainty, that banks assessment of their clients' creditworthiness varies, and that in the short trem their lending determines the size of the money stock. (And how do I know all this: because my brother used to be a banker, and he has spent years perforating my eardrums with this and other relevant information as to the realities of money stock fluctuations).

Now why is any of this of any real importance today, and why is the problem more than merely a semantic one: because right now, in Japan, there is a problem, and many economists once more failing to listen to what the bankers are telling them, imagine that there is a simple monetarist solution to the problem: dramatically expand the money stock. And why may the problem assume even more importance: because right now in Germany and the United States deflationary pressures may well be raising their ugly head, and because, once more the simple monetarist solutions are going the rounds without giving sufficient consideration to the question as to in which direction the causal chain may in fact be operating.

Another (non-trivial, and definitely non-semantic,) problem which to avoid argument I will relegate to the level of secondary non-mainstream dispute, would be to open an examination of what impact the US decision to effectively close the doors to mass immigration in 1922 might have had on the extent and duration on the depression. Or, for that matter, to look a little harder (going back to another Friedman core theme) what impact the demographic profile of the OECD population had on theintensity and duration of the 1970's inflation.

Various Details About the European Reform Process

Frans writes that he has been noticing the funnier side of linguistic discourse in a cosmopolitan society. He also draws out some comparison with my internet connection problems.

Visited a first meeting of a Dutch think-tank in the making risq. An inspiring meeting with 20 educated people most of them much younger than me. So much knowledge and commitment to be combined! There was some language-question. Two people did not speak Dutch very well, so the meeting was in English completely. When I got back to Utrecht an Italian man came to me at the bus station and asked me in very poor Dutch if he waited at the right platform. I answered in English but he did not got me very well. Some young girls from Moroccan background helped him out: in Dutch !

Reading about your experience with providers it looks like there is some pattern in it. I started with a respected but little bit old-fashioned provider. Then I went over to aggressive seller Wanadoo (cable) and met with bad service and arrogance and turned back to the first one quickly. Now that I want to switch to ADSL-connection I arrive at xs4all: cheap (because of?) little advertisement and with an approach that has some similarity with open-source-software.
(btw: I plan to move to pmachine as blogtool; looks a bit simpler than movable type but with many nice features all the same).

On the connectivity side, I am still stuck in a locutorio, but this time it's a bit more yuppie, just next to the cafe Zurich at the top of Las Ramblas. It's full of various categories of globetrotters, and the music is OK. It drives me onward. It's pricier than my local one, and not as cosy. This morning I was blogging from the university, but after 9.00 the connection really is sl............ow. It's cheaper in time/money to go outside and pay. This should give some idea of how the info-revolution is panning out down here. I'm sorry to say it, but outside the adolescents I have the distinct feeling that the Spanish really don't like internet. Plus everyone seems to have an inordinate amount of difficulty with their computers which always seem to be crashing, which of course is the computer, and not the user's, fault, now isn't it? Plus the quantity of free info available really seems to be zilsch. Even the national newspapers like El Pais are taking to charging for everything beyond the front page. One of my wittier students did remark that I probably had as many daily visits across my pages as El Pais does these days.

The 'we can charge, but reserve the right not to provide a service' bit certainly does seem to typify the way the pressure in the high-tech sector doesn't seem to be leading to any kind of reasonable reform in any meaningful sense of the word. What we have is a retrenchment of the existing monopolies (Telefonica just took back its former star 'Terra Networks' to try to survive nestling in its mothers arms and for a price way below the initial launch price. All the bills run up in the 'buy now' craze are being paid off by increasing the fix line charges over which Telefonica has a monopoly). And now there seems to be a crisis in the ADSL sector, Jazztel seem to be having their own problems, and my provider France Telecom subsidiary Wanadoo have had all their Barcelona ADSL clients cut off for two weeks now. No explanation and no end in sight. We were transferred by Retevision to Wanadoo, presumably because it's hard to make money from this here, then shortly after the transfer we were cut off. I smell Telefonica!!!

The point really is: how is it possible to be optimistic about a 'reformed' Europe if even telecom liberalisation is folding back on itself, with customer treatment being at the lowest of lows since the old Franco years? It isn't only the Bulgarians who feel that there is something missing in the idea of the 'rule of law' in this country.

Mind you the French government seem to be being forced to back away from Bull. I wonder what Frans thinks about this?

Shares in Bull tumbled 20 per cent after it said on Thursday that the French government would no longer be stakeholder or provide guarantees once the computer services group completes its financial restructuring. Speaking at Bull's annual general meeting, Pierre Bonelli, chief executive of Bull, warned shareholders and bondholders in the troubled computer group they would have to make "heavy sacrifices" as part of its plan to repay a E450m loan from the French government.

Brussels is set to launch legal action over the loan unless Bull repays the money in the next few weeks. The company has promised to complete refinancing by the end of September, after missing a June 17 deadline, but the European Commission’s patience is wearing thin. Mr Bonnelli said: "Someone asked me about the recent rise in the shares and bond prices - but that is pure speculation and nothing to do with the true situation of this company. I wanted to calm the situation down and bring it back to reality." Shares in Bull, which more than doubled in the last month, fell more than 20 per cent to 0.91 on Thursday afternoon, valuing its equity at about E150m.

Once a flagship of the French computer industry, the group has seen its workforce shrink from 46,000 in 1988 to about 8,000 at the end of 2002. The company is believed to have received some E7bn in bail-outs from Paris since the 1960s. Nevertheless, Bull reported a return to operating profitability in the first half and says its restructuring plan is progressing well. "Once we pay back this loan we need no more help from the state," said Mr Bonnelli. "We will be profitable and generating positive cash flow."
Source: Financial Times

Learning to Speak Like a Fed

Morgan Stanley's David Greenlaw talks us through the intricacies of 'fedspeak'. I think what he's saying is that the idea of sending a clear signal to the markets still needs working on. Meantime it's a hell of a lot better than Duisenberg and co.

Here is the comparison of the risk assessment portion of the May and June statements:

June 25 Statement

"The Committee perceives that the upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal. In contrast, the probability, though minor, of an unwelcome substantial fall in inflation exceeds that of a pickup in inflation from its already low level. On balance, the Committee believes that the latter concern is likely to predominate for the foreseeable future."

May 6 Statement

"The Committee perceives that over the next few quarters the upside and downside risks to the attainment of sustainable growth are roughly equal. In contrast, over the same period, the probability of an unwelcome substantial fall in inflation, though minor, exceeds that of a pickup in inflation from its already low level. The Committee believes that, taken together, the balance of risks to achieving its goals is weighted toward weakness over the foreseeable future."

As you can see, the wording is virtually identical except that the reference to "weakness" in May is replaced by an indication that deflation risk is likely to "predominate" for the foreseeable future. This might be interpreted as a signal that monetary policy is likely to remain easy for an extended period of time -- but it is couched in Fedspeak and the message seems no more or less clear cut than in May. So, the latest risk assessment is probably best described as tilted toward deflation concerns (though the Fed is still careful to not use that term) -- as opposed to the previous tilt toward weakness.

Clearly, the risk assessment language remains a work in progress. Following the May meeting, some analysts (including ourselves) had expressed dissatisfaction with the "weakness" label. If the economic risks are described as balanced (as in the first sentence of the paragraph), then what does weakness refer to: weakness in inflation? weakness in monetary policy? The wording was certainly confusing. So, the Fed tweaked the format once again. However, in our view, the new wording hardly represents a notable improvement. It would be much clearer -- and allow the Fed to send a more powerful signal -- if they simply added an indication of their policy leaning to the assessment of the dual growth and inflation/deflation risks.
Source: Morgan Stanley Global Economic Forum

Labour Surplus as the 'Buffer Stock'

Well I'm having a nice day, for once Joerg is happy with something. He liked Eddie's piece yesterday, so did I.

Good points from Eddie.

Did you catch the Economist´s latest recommendations for India? You guessed it: part of the package they propose is labour reform.

I just read an interesting piece of local news. The metal workers´ union organized a strike against Panasonic. Panasonic wants to keep up production. How do they go about it? They fly in workers from Japan. Germany seems to be tilting towards labour reform as the preferred strategy of dealing with the problems lying ahead. There are many proposals
being forwarded by industry associations that center around lengthening the workweek. While these meet with opposition from the unions, my perception is that the unions are rapidly losing influence.

Yesterday I listened to talk radio while driving. One doctor phoned in to say every German should donate eight hours per week to get the export machine moving again. Polls suggest that 45% of the population support reverting to longer work-hours. Industrialists claim Germans are not competitive with Americans because they work 20% less than Americans do. This argument is gaining traction.

Under the gold standard, the price of gold was the "fix" that all other economic variables were subjected to, i.e., gold served as a buffer stock commodity that dictated the direction of the real economy. While in principle other commodities could serve the same function, there doesn´t seem to be any advantage in returning to either a gold standard or
some other form of commodity standard. We could, however, come to the realization that labour should serve as the buffer stock. I am not sure we will ever arrive at a "knowledge economy" without promoting labour to this privileged status. Currently, however, many countries in the world operate on the principle of considering their export surplus as such a buffer stock. That surplus is the variable that they try to fix - to change into a constant -, i.e., they conduct monetary and fiscal policy such that the buffer stock remains reproducible (under a gold standard the operative term would have been "credible"). The tail - the export segment of the economy - gets to wag the dog.

Meanwhile, the deflation dominoes start falling: CPI data from Mexico, Chile and Argentina show prices are decreasing. In Israel, the cost of living dropped at a 5% rate in the last 3 months. If deflation arrives in the U.S., it is going to bury the debtors there.

I guess the part Joerg is referring to in the Economist is the following:

Policy changes could do much to help India catch up: cutting import duties; simplifying and cutting indirect taxes; reducing the list of industries “reserved” for small companies; easing labour laws to make hiring and firing and the use of contract workers easier. Indeed some of these reforms are already, slowly, under way, or at least under consideration.
Source: The Economist

Should the Fed Have Gone Further?

The Economist asks the question that is on everybody's minds, and seems to come to the conclusion that, like the rest of us, on balance they're not sure. Its finger crossing time, but with plenty of downside risk.

So should the Fed have gone further, or will the latest rate cut do the trick? Answering that question is difficult, partly because there is some doubt about the Fed’s main objective in making the reduction. Before the announcement, which came at the end of the Fed’s regularly scheduled meeting, deflation was the word on everybody’s lips. A series of comments from the Fed chairman, Alan Greenspan, and some of his colleagues, had made it clear that the Fed is concerned about the risk of prices falling in the American economy. Economists and financial-market players expected that the Fed would justify any cut as a pre-emptive strike—what Mr Greenspan recently called a “firebreak”.According to its statement, the Fed remains concerned about deflation. It repeated the view expressed after previous recent meetings: that though the risk of a further fall in inflation is small, it is greater than the risk of a resurgence of inflationary pressures. That clearly implies the scope for further reductions in interest rates—and the Fed has taken advantage of that room for manoeuvre. Since inflation is likely to remain subdued for some time, the Fed’s continued emphasis on deflationary risks also implies that low—and possibly even lower—interest rates are likely to be a feature of the American economy for some time.

But the statement implied that concern about deflation was not the principal motive for the latest interest-rate cut. Instead, the main justification offered was the need for a more accommodative monetary policy to give a further stimulus to the economy. On balance, Mr Greenspan and his colleagues seem a little more upbeat about America’s economic prospects now than they did after their last meeting, in May. They noted some of the improvements signalled by recent economic data. But the Fed statement went on to note that the economy has yet to show signs of sustainable growth. Loosening monetary policy still further will, the Fed hopes, give further support to the recovery it believes is under way.

Of course, concerns about deflation and slow growth are closely interlinked. If the American economy were to slide into deflation, with prices actually falling, hopes for a sustained economic recovery would be dashed. Once prices start to fall, consumers and businesses postpone all but the most essential purchases. What is the point of buying something now if it will be cheaper in a few months’ time? It is easy to see how quickly the economy could slide back towards recession. Japan, in or close to recession for much of the past decade, is now experiencing its fourth consecutive year of falling prices. The economy is moribund.

Buoyant growth is one of the best defences against deflation. Persistent economic underperformance is a breeding ground for the economic phenomenon that last plagued industrial countries on a widespread basis in the 1930s. And that is why the Fed remains anxious about the American economy’s failure to gain momentum now. Since the recovery began, at the start of last year, there have been several false dawns. After 18 months or so, the economic signals continue to be mixed. The stockmarkets have become more optimistic lately—though they lost some ground after the Fed’s latest announcement. But business investment has yet to pick up in the way Mr Greenspan has consistently argued is essential for sustained recovery. And unemployment, at 6.1%, is currently at its highest level for nine years.
Source: The Economist

The Wish

Just got this down the wires from Margy. I'm not entirely convinced of the propriety of it, but since nothing truly human is alien here at bonobo land, here goes:

A man, deep in thought, was walking down a California beach. All of a sudden, he stopped and said aloud "Lord grant me one wish." Suddenly, the sky clouded above his head and he heard a loud booming voice say " Because you have TRIED to be faithful to me in all ways, I will grant you one wish."

The man said, "Lord build me a bridge to Hawaii so I can drive over anytime I want." The Lord said, "Your request is very materialistic. Think of the enormous challenges for that kind of undertaking. The supports required to reach the bottom of the Pacific Ocean, the concrete andsteel it would take. I
can do it, but it is hard for me to justify your desire for worldly things. Take a little more time and think of another wish, a wish you think would honor and glorify me."

The man thought about it for a long time. Finally, he said, " Lord, I wish that I could understand women. I want to know how they feel inside, what they are thinking when they give me the silent treatment, why they cry, what they mean when they say nothing, and howcan I make a woman truly happy."

The Lord replied, " You want four lanes or eightlanes on that bridge?

Europe's Agricultural Reform

One year after starting the talks there is an agreement of sorts. Despite the fanfare that this is the biggest reform for 40 years, there do seem to have been a lot of compomises. So whether it turns out to be as radical as is being suggested truly remains to be seen. Decoupling can be as much a formula to save subsidies as it is a piece of radical surgery. The true test will come in Mexico in September

After almost a year of tense negotiations, the European Union on Thursday agreed a radical overhaul of its €43bn farm subsidy regime. The breakthrough is likely to lead to the most dramatic transformation of farm aid in Europe since the foundation of the common agricultural policy 40 years ago.

The final agreement represents a heavily diluted version of the original reform package, though Franz Fischler, EU farm commissioner, managed to rescue the central plank of his proposals - a plan to break the link between subsidies and production, also known as "decoupling".

Decoupling should in theory allow farmers to tailor output to demand, reduce incentives for overproduction and thus minimise the need to dump EU farm surpluses onto the world market. Decoupled farm subsidies are also deemed non-trade distorting under World Trade Organisation rules, which means they are not subject to the cuts widely expected to result from the current Doha world trade round.

However, bowing to incessant pressure from France and other countries, the final agreement will allow member states to keep a share of farm payments linked to production. Early European Commission calculations put the figure at about 30 per cent of overall direct subsidies to farmers.

But the biggest setback for Mr Fischler's reform proposals came as France and its allies blocked a plan to cut the prices at which the EU guarantees to buy cereals. Mr Fischler had hoped to bring EU prices closer into line with those on the world market, another thorn in the eye of Europe's trading partners.
Source: Financial Times

Wednesday, June 25, 2003

So the Waiting is Finally Over

So the Fed has finally opted for a quarter point cut. Whether this counts as the kind of aggressive stance advocated the widely quoted Ahearne et al only history will tell us. My own feeling is that it probably wouldn't make a lot of difference, but that a half point cut might have indicated more determination. Yet even while the waiting on the decision is now over, the real wait is only just begining, the one which is to see whether the big ship is about to turn itslf round, or whether the slow downward descent will continue inexorably.

The Federal Reserve on Wednesday cut U.S. interest rates a quarter percentage point to 1958 lows and suggested it stood ready to take more action if the risk of falling prices worsened. The central bank's rate-setting Federal Open Market Committee trimmed the bellwether federal funds rate for overnight loans between banks to 1 percent, the 13th rate reduction since early 2001 in a campaign aimed at nursing the economy through a recession and back to vigorous health.

All but one member of the committee voted for the cut with San Francisco Federal Reserve President Robert Parry pushing for a more aggressive half-point reduction. "Recent signs point to a firming in spending, markedly improved financial conditions and labor and product markets that are stabilizing," the FOMC said in its post-meeting statement. "The economy, nonetheless, has yet to exhibit sustainable growth. With inflationary expectations subdued, the committee judged that a slightly more expansive monetary policy would add further support for an economy which it expects to improve over time," it added. Markets gyrated following the decision with blue-chip stocks falling and Treasury bonds turning lower but the dollar rising. Many in financial markets had been hoping for a larger reduction.

As in its statement following its meeting on May 6, the Fed was sanguine about prospects for future growth even as it voiced concern about the risk of deflation or falling prices. "On balance, the committee believes that the latter concern is likely to predominate for the foreseeable future." Recent data have shown the economy is still crawling back from a relatively mild recession in 2001, a sluggish pace that has pushed the unemployment rate to above 6 percent from under 4 percent late in 2000. Gross domestic product has expanded at around a 2 percent annual rate, well under the 3-to-3.5 percent pace seen as the U.S. economy's long-term potential for growth. The single bright spot -- largely stemming from low interest rates -- has been housing. Other key sectors like manufacturing have been in the doldrums.
Source Yahoo News

On the Non-Adviseability of Wage Reform

Some weeks ago, when I first read one of Eddie Lee's articles in the Straits Times, I let slip the comment that I knew nothing about this guy's views on civilisation and its problems, but that he sure did seem to have understood something about Japan's deflation problem. Now rewinding back several week to the world of today (Harold Wilson once said a week was a long time in politics, well several weeks in the internet can be more like a lifetime), I think I can safely say I have learnt a lot about what Eddie's views on civilisation and it's problems are, and the more I get to learn about them the more I like them. This time he's having a go at the latest set of proposals to restore the Singapore economy to it's former path of glory, they are known as wage-flexibility. BTW, it is worth bearing in mind that Singapore's currency, like the euro, is rising. There is an alternative.

Do we really need additional wage reforms now? NTUC deputy secretary-general Matthias Yao says many companies are lukewarm to the idea of wage reform because "(Some) say their systems are already flexible enough." Indeed, there are few impediments in our labour market. There is no minimum wage law, unions account for only 15 percent of the work force, and many firms have already built an annual variable component into their wage system.

Still, if the National Wage Council (NWC) gets its wish, up to 30 percent of wages will be considered variable. And a third of that can vary on a monthly basis. Now, in principle this sounds like a good idea. Increase wage flexibility so that companies can respond faster to economic conditions in order to save jobs. But things may not be so simple. The question is, how many jobs will the wage reform actually save if the measures only end up increasing Singaporeans' apprehension of the future? In the current climate, the wage reform means even greater uncertainty. The result is that Singaporeans are likely to markdown up to 30 percent of their wages when planning ahead. Lets face it, we are not even sure what's going to happen next year. So it is only prudent to base plans on what you are guaranteed to receive. And that will be just 70 percent of what you thought you were assured previously.

The economic impact will be similar to a reduction in income. Households will reduce their expenditure in order to ensure there's sufficient amount for their fixed commitments. Singaporeans are already struggling to come to grasp with the current environment. Personal savings rate have declined steadily since 1997. Part of the reason appears to be an attempt to restore living standards post Asian crisis. But what's disturbing is that the decline in the savings rate failed to reverse even as the economy slipped back into another recession. Typically, you'd expect savings to rise during an economic downturn. People suppress consumption amidst rising uncertainty.

Yet Singapore's savings rate, based on earned income, fell from over 7 percent in 1997 to under 4 percent in 2000, and is just under 3 percent in 2002. It's likely we will see a further cut back in spending in order to restore the savings rate. If you think that's tough, I shudder to think of the alternative. If the savings rate doesn't reverse, it would suggest that the majority of Singaporeans are finding it hard to sustain a decent standard of living today, rather than have the luxury of thinking of tomorrow. They could find themselves tapping into their assets much earlier than expected in order to stay afloat.

And here's where more problems lie. For many years, Singaporeans have invested in property as part of their retirement plans. The upgrading fiasco at Marine Terrace reminds us of the sorry state of the local property market. One of the failed contractors, Sum Keong Construction was actually named Singapore's 50 best enterprises in 2001. But public housing construction almost came to a standstill last year compared with about 30,000 HDB flats built during the peak. There's hardly a queue if you apply for a new HDB flat these days.

It's seven years since the peak of the property boom. The problem now really isn't so much that we built too many flats in the past; it's anxiety about the future. Property prices are still languishing between 30 to 40 percent below their peak reached in 1996. One way to gauge the outlook for property prices is to check how property stocks are faring in the Singapore Exchange. According to property analyst Tan Cheng Teng from G.K. Goh Research, "investors are valuing property companies' assets, which include their residential land banks, at 20 to 30 percent below prices in the physical market." In fact, Ms Tan says that this discount has been the norm "for the past few years."

Retirement funds sunk in property now looks like lost savings. This comes at a time when returns on other investments are at an all-time low. You can't get an interest rate of more than 1 percent on fixed deposits. A ten-year government bond now yields under 2 percent. And stocks? More Singaporeans have been burnt investing in them than they care to remember. In other words, there is a sharp devaluation of retirement savings, that is now being compounded by a lost in income. And it's a fallacy to say that the wage reform is required to attract foreign investments. Foreign investments have been doing well. There's no noticeable slowdown in recent years. But Singapore attracts capital-intensive projects and these don't create a lot of jobs.

To get a sense of how rapidly the economy is losing employment growth with the type of investments it is attracting, just look at official statistics. In 2000, total investments committed were worth $9.2bn and was estimated to have created 20,700 jobs. Last year, $9bn worth of investments translated to 14,000 jobs. In just 2 years, there was a drop of 32% in job creation for the same amount of money invested. But higher productivity means that Singapore's export sector can still manage even carried to the extreme, it may inadvertently release further downward price pressures at a
time when global deflationary forces are already on the rise. Economic policy, as Charles Kindleberger once pointed out, is all about timing. And this is not the time to use a deflationary tool.

More On the Generation Gap

My son continues his intellectual voyage which will lead him I know not where. I hope one day he will get back to studying medicine.

I have recently been reading a bit of nietzsche which i must confess is very interesting. Its interesting how you will spend a bit of time discussing something with friends (in this case me and my mates were having an argument about morality) and then by coincidence i read a bit of this introduction to nietzsche and find exactly what i was arguing written down in front of me!... so the debate will certainly start to liven up tomorrow. I've only covered the basics so far (democracy, the herd and anti-darwinism, but i read on in anticipation. Perhaps i should consult one of his proper texts?)

Foreign Direct Investment Taking a Knock

The Economist summarises a new OECD report which shows inward flowing FDI to OECD countries could fall a further 25% to 30% this year, after falling continuously since 2000. Whatever your opinions on mergers and acquisitions activity this is surely not a sign of a growth-prone global environment.

The days when companies boldly scooped up competitors abroad, especially in now-distressed sectors like technology or telecommunications, are long over. Big mergers have now slowed to a trickle, with cross-border M&A activity reaching its lowest level this spring since the mid-1990s, according to Dealogic, a research firm. M&A bankers (those, that is, who haven’t already been laid off) have been left twiddling their thumbs.

The magnitude of the M&A drop shows up in a foreign-investment report released last week by the Organisation for Economic Co-operation and Development (OECD). Inflows of foreign direct investment (FDI) to the OECD’s 30 member countries fell by more than 20% last year. Merger activity comprises the largest chunk of FDI in rich countries (the other big bit consists of companies adding factories in foreign countries), and it fell sharply. The OECD says that in 2002 and early 2003, just eight cross-border M&A deals had values above $5 billion. At the height of the bubble, by contrast, corporate takeovers of that size were being announced almost daily.

Underlying the slump in merger activity, and FDI at large, is global uncertainty. Investing abroad means taking on the receiving country’s risk. Fears of terrorism and war, combined with weak economies in most rich countries, make such risks greater and harder to bear. Talk of deflation in America (and in Germany, where consumer prices have recently fallen) has also scared foreigners, as have corporate scandals. Chief executives are also finding it harder to persuade their shareholders and other sources of finance that mergers and takeovers make sense. In the current tough climate, most investors would prefer to see managers focus on improving the businesses they already run.

The M&A volatility has probably been felt most keenly in America and Britain, both traditional investment hot-spots. FDI inflows declined sharply last year in America (down by 77%) and Britain (down by 60%). Foreign investment in both countries is a mere shadow of what it was at the peak three years ago—in America, FDI inflows last year were a mere tenth of the amount received in 2000; in Britain, about a fifth.
Source: The Economist

What is a Recession?

Brad continues to be frustrated by the indecisiveness of the NBER Business Cycle Dating Committee. He thinks their problem is more deciding what a recession is , than pronouncing on this one. He may be right, and I agree with his diagnosis that what we have is "slow growth in demand and output accompanied by rapid underlying productivity growth and so declining employment". What I am not so sure about is where all this will lead us, and so I sympathise with the members of the NBER panel who obviously would like to avoid the embarassment of having to declare one recession officially over, only in order to announce that another one has commenced. But maybe it won't be that way, so maybe it's better to wait and see a bit more first. After all, one thing is a quiet and civilised debate among economists and another are the media and political pressures which will follow any 'official' announcement, and even more the ridicule which would then fall upon the economics profession should that call turn out to be premature, or only the harbinger of another recession. All-in-all, not an easy decision. For those who are still persplexed, here is some of the explanation:

Q: Suppose that the economy turns down this year, contrary to current forecasts. How will the NBER decide about turning points?

A:The first step would be to determine if economic activity in the period from March 2001 through early 2003 ever surpassed its peak in March 2001. If economic activity had never surpassed its previous peak, the new period of weakness would be a continuation of the recession that began in March 2001. If economic activity had surpassed its previous peak, we would need to determine whether the new period of weakness amounted to a recession. In this determination, we would refer to our standard criteria of depth, duration, and dispersion. The definition of a recession is stated in the third paragraph of this memo.

Q:The financial press often states the definition of a recession as two consecutive quarters of decline in real GDP. How does that relate to the NBER's recession dating procedure?

A: Most of the recessions identified by our procedures do consist of two or more quarters of declining real GDP, but not all of them. According to current data for 2001, the present recession falls into the general pattern, with three consecutive quarters of decline. Our procedure differs from the two-quarter rule in a number of ways. First, we consider the depth as well as the duration of the decline in economic activity. Recall that our definition includes the phrase, "a significant decline in activity." Second, we use a broader array of indicators than just real GDP. One reason for this is that the GDP data are subject to considerable revision. Third, we use monthly indicators to arrive at a monthly chronology.

Q:Could you give an example illustrating this point?

A:On July 31, 2002, the Bureau of Economic Analysis released revised figures for gross domestic product that showed three quarters of negative growth in 2001-quarters 1, 2 and 3-where previously the data had shown only quarter 3 as negative. This revision shows why the committee does not rely on a simple rule of thumb such as two consecutive quarters of negative growth, nor relies on GDP data alone, in making its determinations, but rather looks at a broader array of statistics. In November 2001, the committee determined the date of the peak in activity in March 2001 using its normal indicators. The two-quarter-decline rule of thumb would not have allowed the declaration of the recession until August 2002, let alone a declaration that it had begun early in 2001, as in the statement that the committee made in November 2001. It wasn't until eight months later that revisions in the GDP data showed declining real GDP for the first, second, and third quarters of 2001.

Q. The NBER refers to the recession as having begun in March 2001. Some observers, however, cite April as the start of the recession, reasoning that if the peak ended in March, then the recession began in April.

A: The exact peak occurred sometime in March. For the rest of the days in March, the economy was in recession. So the expansion ended and the recession began in March.

Q: Isn't a recession a period of diminished economic activity?

A: It's more accurate to say that a recession-the way we use the word-is a period of diminishing activity rather than diminished activity. We identify a month when the economy reached a peak of activity and a later month when the economy reached a trough. The time in between is a recession, a period when the economy is contracting. The following period is an expansion. Economic activity is below normal or diminished for some part of the recession and for some part of the following expansion as well. Some call the period of diminished activity a slump.

Q: How does the NBER balance the differing behavior of employment and output?

A: Following the precedents established in many decades of maintaining its business cycle chronology, the NBER considers employment, production, sales, and real income. When special factors-such as unusual productivity growth and favorable shifts in the terms of trade-make income and production-based measures move differently from those based on employment, we balance the two types of evidence.
Source: NBER

Meantime, just to make the point, the latest batch of durable goods data underline the continuing weakness of the US economy, and may well give food for thought for the FOC's rate decision due later today:

Orders for costly U.S. manufactured goods fell in May for the second month in a row, the government said on Wednesday, a sign of economic weakness that comes at a time when Federal Reserve (news - web sites) officials are meeting to discuss interest rates. U.S. durable goods orders sank 0.3 percent last month -- in contrast to the expectations of private economists that they would rise 0.8 percent. The data from the Commerce Department showed April orders plunged 2.4 percent, revised down from an earlier reported 2.3 percent drop.

The report showed broad-based weakness in demand for big-ticket items, with categories such as cars, computers and machinery showing declines. Excluding the volatile transportation sector, orders edged up 0.2 percent, a much weaker showing than the 1 percent gain projected by economists in a Reuters survey. Fed policy-makers were set on Wednesday to continue a two-day meeting on interest rates. Around 2:15 p.m. EDT, the Fed will announce its decision on rates. Analysts widely predict a cut but are split on whether it will be a quarter of a percentage point or a half point.
Source: Yahoo News

Tuesday, June 24, 2003

The German Battle Looms

My feeling is that nothing about the present German crisis is going to be simple, and this news confirms my impression:

Gerhard Schr?der, German chancellor, was on Tuesday heading for a showdown with the European Commission over his plan to boost the German economy by bringing forward tax cuts. Pedro Solbes, EU monetary affairs commissioner, warned Mr Schr?der the proposals could breach Europe's budget rules and urged him to focus on reforming pensions and healthcare. Mr Solbes has been irritated by reports from Berlin that he would endorse the personal tax cuts even if it meant Germany breaking the EU's stability and growth pact for the third successive year in 2004. "The German government should not count on support by the Commission if their budget proposals are not compatible with the fiscal rules," he said. He could recommend heavy fines or other sanctions if Germany's budget deficit exceeds the stability pact's ceiling of 3 per cent of GDP in 2004. The Munich-based Ifo institute on Tuesday highlighted Germany's economic problems when it lowered its 2003 growth forecast for the eurozone's biggest economy from 0.5 per cent to zero. Ifo warned unemployment would rise further, increasing the burden on state finances. It said the jobless rate would average 10.4 per cent this year but rise to 10.8 per cent in 2004, the highest since reunification. As the economic problems crowded in on Mr Schr?der, the European Commission suggested his plan to bring forward unfunded tax cuts was ill-conceived.
Source: Financial Times

On Europe and Its Values

Eamonn has a piece on the Habermas-Derrida proposal which i think I agree with in spirit. Somehow, either because of disconnection, or because of my obsession with Bulgarian immigrants I seem to have missed out on this one. My sympathy is with the idea that we don't need more Europe vs America stuff. On the other hand I think I need to read these pieces in a quieter moment before I go much further:

Rainy Day visitors will need no reminding of where we stand on the call by Jürgen Habermas and Jacques Derrida on 31 May to form a "core Europe" — the founding members of the EU plus Spain — to act as a counterweight to the USA. "Profoundly Atlanticist!" is the Rainy Day motto, which means an outright rejection of the Habermas-Derrida notion. In today's Süddeutsche Zeitung, Paul Kennedy, Director of the International Security Studies at Yale University, adds his considerable weight to the debate and rebuffs the Habermas-Derrida proposal in no uncertain terms.

Titled "Taten statt Worte" ("Deeds instead of words"), Kennedy says that the Habermas-Derrida "core-Europe" initiative is condemned to failure because neither Great Britain nor Spain will play ball, ditto possibly Italy and the Netherlands, and certainly the majority of the middle- and East European states. The latter, incidentally, didn't even earn as much as a mention in the Habermas-Derrida paper of 31 May. So much for their vision of Europe.

To counter those visions that have no basis in reality, Kennedy makes six suggestions for the establishment of a stronger Europe that would have a cohesive identity and would then enjoy respect on the world stage.........
Source: Eamonn's Rainy Day

An Historic Moment?

Well, I'm back from my weekend break, and I'm still stuck in the locutorio, France Telecom subsidiary Wanadoo are still benefiting from their contractual priviledge of charging while not providing service. Well, I lived through petrol rationing in the 56 Suez crisis, so I reckon I can ride this one out too. meanwhile the historic moment in the title is not my anticipated reconnection, but Steven Roach's assessment of the global macro picture. I can't help agreeing with him about the moment, even if I don't buy all the diagnosis and cure.

Far be it for any of us to render historical verdicts on current events. Yet to me it feels as if this is a pivotal moment for macro — one that challenges many of the key principles that have long shaped the modern era. At work is a collision of several mega-forces: Global imbalances have never been more acute. Global deflation has never been a greater risk. And there has been an extraordinary confluence of asset bubbles — from Japan to America. Moreover, the Authorities have never been so lacking in conventional weapons to meet these challenges. There’s an understandable bias to minimize the risks and trust the System to find a way out. The recent rally in global equity markets underscores those biases. But the basic question remains unanswered: Can equilibrium be restored easily in a dysfunctional global economy?........

I guess that’s what troubles me the most — the presumption that there is a quick and relatively painless fix to all that ails the world. I don’t buy that any more than I bought the “market-tested” rhetoric of the New Paradigm in the late 1990s. In my opinion, the world is facing its toughest array of macro problems since the end of World War II. The answers do not lie in the ideology of monetarists and supply-siders. Instead, I continue to believe that resolution will ultimately have to come more in the form of a rebalancing of an unbalanced world. And that can only occur with a realignment of the world’s relative price structure. Inasmuch as the dollar is the world’s most important relative price, the conclusion is fairly straight-forward — the dollar will have to continue to come down until this lopsided world finds a new and sustainable equilibrium. The main problem with this resolution is that it is too painful — that it can’t occur without the heavy lifting of structural reform in places like Europe and Japan. Such reforms challenge deeply entrenched political power structures and social contracts.

Like it or not, we’re in uncharted waters, both in diagnosing the world’s problems as well as in prescribing the remedies. Today’s dysfunctional global economy is replete with massive external imbalances and heightened deflationary risks. Traditional policy options have all but been exhausted. The Authorities are now being forced to improvise. Notwithstanding newfound optimism in world equity markets, there are no guarantees of policy traction in this post-bubble era. I never dreamt that I would live to see such profound challenges to core macro principles.
Source: Morgan Stanley Global Economic Forum