Irving Fisher on Debt Deflation

Deflation and the value of the dollar are two of the topics on the US economy agenda, so I am grateful to Lloyd at Macro Mouse for sending me two links. One an interview with Richard Duncan on the dollar, the other a student essay which really does present an extremely well-argued presentation of Irving Fisher's theory of Debt Deflation.

Irving Fisher developed The Debt-Deflation Theory in 1933 in order to explain the economic mechanism that can lead to a Great Depression such as the one experienced by the US economy from 1929 to 1933. The main point of the theory is that over indebtedness acts in conjunction with deflation to produce a contracting economy causing bankruptcies, rising unemployment and falling profits. Over the last 20 years, one of the US economic policy makers’ goals has been to lower the rate of inflation. However a recent downward trend in the already low inflation, together with an impressive growth in debt, has brought to light Fisher’s theory and triggered fears of a debt-deflation induced depression.

The Debt-Deflation Theory of Great Depressions is an explanation by Fisher of the apparent boom bust pattern prevailing in the economy. He divides the theory into four sections. In the first section, “Cycle Theory in general”, Fisher defines different types of economic cycles and their possible causes. In the second section, “The Roles of Debt and Deflation”, he provides a theory of how excess debt and the consequent deflation play a major role in the boom bust cycle. The third section provides an overview of the Great Depression in light of his new theory and introduces the concept of inflation as a cure to depression and deflation. The last section explores the possible “Debt Starters” that initially triggers a boom economy.

In the first section on cycle theory, Fisher dismisses the idea of the business cycle being a single, simple, self-generating cycle as a myth. In its place he introduces the notion that there are many interacting cycles within the economy also interacting with non-cyclical forces such as growth and haphazard tendencies. He divides cyclical tendencies into two types, forced cycles and free cycles. Forced cycles are imposed onto the economy by outside forces, such as the yearly season cycle, day-night cycle, and monthly and weekly cycles imposed by religion and custom. The free cycle is self-generating and is commonly thought of when referring to the business cycle.
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Prodi on Mutual Trust

Answering my own question over at Fisful of Euros, I don't think Prodi should resign, but I do think someone should accept responsibility. Prodi yesterday he saw "no reason" for members of the EU executive to resign over the "evil" Eurostat scandal, a scandal saw millions of euros of public disappear into secret slush funds. Faced of mounting calls from some backbench members of the European parliament for heads to roll over the affair, he insisted: "I have not made progress in my political career by walking on the bodies of others." Which is another way of not apportioning responsibility by accepting all of it. Like this our institutions will not progress. AG Leader over at Leaderblog has an interesting take on the situation:

the boil will be lanced and the evil rooted out

And there is another question I ask myself. Can one base a Commissioner's relationship with his Director-General on anything but mutual trust? That is what Mr Solbes did. To do otherwise would imply the power to conduct unofficial inquiries, and no one here would want that.
From Prodi's Speech

I wonder how much scoffing there was around the Parliament when he said this. It's a key issue however, because even though trusting trust is a difficult matter, Prodi is effectively noting that institutions cannot function without it. The Economist has also suggested that the Eurostat scandal grew out of the rigidity of EC procedures, i.e., a lack of trust created this 'off the books' attempt at greater autonomy. Unfortunately talking about trust when the confidence has obviously been misplaced may end up giving it a bad name.
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While Abiola understandably wades in from his point of view:

There are two things worth noting here, the first being the shameful reluctance of EU bureaucrats to accept blame, or even to allow their colleagues to take the blame, for any wrongdoing that is discovered during their watch. It would be bad enough if Prodi were trying to simply pass the buck to an underling or a predecessor, but here he is, insisting that even Pedro Solbes should be let off the hook! The second thing that stands out is the manner in which Eurocrats never pass up an opportunity to plead for yet more powers, even when the issue at hand is the abuse of the powers they already have at their disposal. Always the solution to every difficulty is the same - "we lack sufficient authority!" One would be tempted to admire them for the insolence with which they reach out for ever greater authority, were one not enraged by the contempt for the listener's intellect betrayed by such transparently self-serving requests.
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Finally a piece from the EU observer which appears in Abiola's own post, and which as he says, ain't half bad:

Eurostat is not an exception. Eurostat is an example; indeed a very small example of what is going on for many years inside the European Commission, especially in all 'spending DGs', with large amounts of money to spread around. Insiders know it. 'Wisemen' (such as the 'Wisemen Committee" set up after Santer's Commission resignation) know it. People closely working with the Commission know it. Brussels-based journalists know it. Citizens in Europe feel it. The situation essentially has nothing to do with the Commissioners, nor with the idea of a vastly corrupted EU bureaucracy (most EU civil servants are honest). But it has everything to do with the lack of only two controls - political control and judicial - which can prevent an administration, and more precisely its top hierarchy, of becoming, either entirely or partially, a bureaucracy with all its hanging processes of cronyism, corruption and privileges. No political control and no judicial control naturally lead to illegality. Whether we like it or not, it is a fact that the European Commission is lacking both of them:
Source EU Observer
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It's a Dog's World

I guess by now everyone's seen the 'dog didn't eat my homework since I'm partly the dog in question' story. Well Abiola has been reading around and has a rather different take on this:

The New York Times is a great source of general news, but when it comes to science reporting, I usually find its' coverage rather lacking. In consequence, on hearing about the announcement of a draft sequence of the dog genome, I thought it best to turn elsewhere .

There are two things I feel a need to point out about this announcement. The first is that what is being announced is really only 1.5x shotgun coverage of the canine genome, which is really very little. By way of comparison, the fugu genome has been covered to a depth of 5.7x, the mouse genome achieved 7x coverage in 2002, and the finished version of the human genome achieved 8-10x coverage for each chromosome.

The minimum level of shotgun coverage usually required to call a sequence "draft quality" has been at least 3x; given that not even this much has been achieved, why the rush by The Institute for Genomic Research to publish? By their own admission, the assembled sequence so far consists of a massive 2 million fragments covering barely 80% of the canine genome, and it's safe to bet that a substantial proportion of that will be contaminated by bacterial sequences arising from the BACs* used in sequencing. Let's just say that this looks more like another Venter-inspired publicity stunt** than a truly headline-worthy milestone. I expect that once again, the really newsworthy developments will come from a non-profit organization - this time, from the Whitehead Institute, which has already completed a draft sequence of the chimpanzee genome with 4x coverage.

*Bacterial Artificial Chromosomes.
**Something similar occurred with the supposed "race" between Venter and the Human Genome Consortium to create a draft of the Human Genome; it transpired that, far from utilizing some miraculous shortcut unavailable to plodding public researchers, Venter's team was only able to assemble it's shotgun-produced sequences by leaning heavily on the detailed maps so slowly and carefully laid out by the HGC.
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You Gotta Blog: You're Fired

Chi-Chu Tschang is a Chinese American in Beijing. He just got fired by Bloomberg. His apparent 'crime', he has a blog.

I got fired from Bloomberg today because of this web site. I'll post more about it later but I need to start networking like mad now and find a job. If anybody knows of any job openings, email me.

Spent most of this weekend updating my resume, preparing clips and meeting with friends in the journalism business. (Just realized that I got the dates of employment in the old version of my resume I sent to Bloomberg. Oops.) One of the Reuters reporters mentioned that he also had a blog but the company asked him to take it down. I'm starting to wonder how many other journalists around the world have had to take down their blogs because their employers are scared of litigation or authoritarian governments. At least Reuters didn't fire the guy.

Tschang mentions the case of another reuters journalist, which makes you want to ask: just how much of this is going on? Now I've seen blogs criticised for many things, but I never thought we be seen as a real menace by the press. Well I take that back, I didn't think this was going to happen just yet. As I keep repeating, blogging is good practice. So one day some of the bloggers are going to get to be better than the 'professionals'. So Blumberg was either being extremely mean, or extremely perceptive. I just can't work out which.

The Economist and Japan's 'Dysflation'

I've been pretty quiet on Japan recently. This is because I think we need to wait and see what kind of reality there is behind the optimistic projections - and share prices - that we have been seeing recently. I don't think the problem, has gone away by any means. At best we are on the upswing of what remains of the business cycle in Japan. The economist is not too convinced either, and has coined the expression 'dysflation' for the Japanese condition. What I still think is unfortunate is that virtually no-one is prepared to even countenance the idea that Japan's demographic problems (and it's resistance to immigration) could have any part in the explanation. The idea isn't even examined in order to discard it. It seems to be a blind spot pure and simple.

So what exactly ails Japan? Clearly not just the usual sort of business downturn, which can be cured, though painfully, with lay-offs and closures and sometimes with a government shot in the arm. Nor can its chronic weakness be attributed solely to a burst bubble and falling asset prices, though that is clearly part of the problem. Many other countries have been similarly stricken, and have managed to recover. In Japan, the misery has lasted for almost 14 years.

The Economist would like to suggest its own label for Japan's illness. It is “dysflation”: a form of deflation in which dysfunctional economic-policy institutions counteract what would otherwise be good medicine for falling prices. The policies, especially with regard to banks, combine in ways that do more harm than good. More important, policymakers themselves are more inclined to avoid problems than address them; would rather win bureaucratic feuds than co-operate; and base most of their decisions on emotion (such as fear of shame) rather than reason.

It helps to keep all these aspects of dysflation in mind when assessing Japan's problems. Consider, for example, the Bank of Japan. Ordinarily, the best response to deflation—that is, falling prices throughout the economy, and not merely for a few products such as Chinese manufactures—would be lower interest rates and feverish printing of money. Japan has had zero interest rates since 1999, however, and has been boosting the money supply at a rapid clip since early 2001—and prices have continued to fall. According to the most respectable measure, the GDP deflator, they have fallen 7.6% since 1997, and are still dropping fast. Eventually, all the money that the Bank has been printing will be sucked through the financial system and expelled into the economy in the form of higher prices and rising nominal interest rates. But it is taking a perplexingly long time to happen.

The Bank's explanation is that Japan's deflation is a very rare strain indeed. It points to the large quantity of non-performing loans that have piled up in the banking system. Never in the history of human endeavour have so many owed so much for so long. And as the Bank's officials like to point out, new bad loans, at least until recently, continued to accumulate faster than the banks were writing off old ones, and the Financial Services Agency (FSA), which regulates banks, has done nothing to stop this. Banks are lending mainly to their worst borrowers; and with the credit channel not operating properly, the usual monetary-transmission mechanism cannot work either.

There is probably some truth in this argument. What it ignores, however, is the overarching role that expectations—of firms, workers, consumers and investors—play in transmitting the central bank's policies into rising or falling prices, and the need for the central bank to manage those forecasts. The Bank has not only failed utterly in this role, but has refused to take responsibility for trying.

Under the previous governor, Masaru Hayami, whose term began in 1998, every constructive policy that the Bank undertook was undermined by a statement that the Bank did not really expect its policy to get prices rising again, at least not quickly. This had a sort of reverse placebo effect. Even as the central bank was administering potent medicine, Mr Hayami said that it was only doling out sugar cubes. A new governor, Toshihiko Fukui, took over in March, and has been an improvement. Conceivably he will do a better job than Mr Hayami of convincing people that all that loose money will not be vacuumed up again at some point by the Bank. But even Mr Fukui has shown traces of his predecessor's dysfunctional approach.
Source: The Economist
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A grand Old Man is Gone

Franco Modigliani, he of the Modigliani-Miller Theorem, and the life cycle savings model is gone. He died yesterday. Even to the end of his life he remained active in defence of the ideas which he felt to be important. Even as recently as last Tuesday he was to be found alongside Samuelson and Solow denouncing Berlusconi's version of the Mussolini era. We will miss him:

Franco Modigliani, who received the Nobel Memorial Prize in Economic Science in 1985 for his pathbreaking explanations of how people save and the role of debt in determining the value of corporations, died yesterday at his home in Cambridge, Mass. He was 85.

He died in his sleep, the family said. The evening before, he and his wife, Serena, had attended a dinner in honor of a fellow economist, John Kenneth Galbraith, and Mr. Galbraith's wife. Mr. Modigliani had taught at the Massachusetts Institute of Technology for 28 years, until he retired in 1988, but continued to teach at least one course each spring. Mr. Modigliani, who was Jewish, often recounted his experiences with fascism in his native Italy. As a young man just out of law school — active in the antifascist movement — he fled to France and then the United States after Mussolini promulgated racial laws in 1938. His enduring hatred of the Mussolini government flared up one last time this week. In a letter to The New York Times published on Tuesday, he protested the decision of the Anti-Defamation League to present Prime Minister Silvio Berlusconi of Italy with its Distinguished Service Award. Mr. Berlusconi had been quoted as saying that Mussolini did not murder anyone; he only sent them into long exiles. Mussolini in fact "was responsible for the deaths of many political opponents, partisans and Jews," Mr. Modigliani wrote in the letter, which was co-signed by two other Nobel laureates, Paul A. Samuelson and Robert M. Solow, also of M.I.T.

His various early teaching jobs brought him to the Carnegie Institute of Technology in Pittsburgh in the 1950's. There he developed the life-cycle hypothesis, his best-known work. Economists had thought that only the rich saved, or people saved only when their incomes rose. Mr. Modigliani, who persisted in testing theories against experience, doubted this. Talking it through with Richard Brumberg, then a graduate student, he came up with the insight that everyone saves and accumulates wealth through the early decades of their lives and then spends the accumulated wealth in old age.

Across a nation, savings rise as an economy and a work force grow and productivity rises, Mr. Modigliani concluded. After World War II, that was the experience of the United States, then Japan and now China. In life-cycle theory, the accumulated American savings should be spent soon by the baby boomers now approaching old age. "Modigliani's theory was a powerful searchlight on what was happening," Professor Samuelson said. "It is the best explanation of what has actually been happening in the great swing of American life since the 1950's." Holding this view, Mr. Modigliani criticized what he considered the dissipation of built-up national savings as a result of the Bush administration's tax cuts and the rising deficit. In a similar vein, he has opposed the various Social Security privatization plans and had planned to reiterate his views in a meeting with two congressmen this week, his family said. As it now stands, Social Security gives poor people a greater return relative to their contributions than higher-income Americans, Mr. Modigliani argued.

The Nobel he received in 1985 also honored him for his insights into corporate financing. Working with Merton H. Miller, who won a Nobel in 1990 for his contribution, Mr. Modigliani demonstrated that leveraging a company through a lot of debt did not in itself affect a corporation's value. Until Mr. Modigliani and Mr. Miller came along, much attention had been devoted to determining just the right mix of debt and equity. But the payoff from expansion through debt, for example, is offset by the risk that the company might not be able to repay the debt. What investors focus on, in fact, is profitability, and they offset the risk of purchasing stock in a leveraged company by holding safer investments in their portfolios. Mr. Modigliani thought of himself as a Keynesian who nevertheless melded Keynesian theory with classical economic concepts. He believed, as the classicists do, that economies reach an equilibrium. The demand and supply of labor, for example, balance each other — but not always at the high level of employment that classical economic theory postulates. Mixing in Keynesian stimulus — that is, a combination of public spending and central bank manipulation of interest rates — he played a big role in developing a forecasting model still used by the Federal Reserve and by private forecasters.
Source: New York Times
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The Future of Iraq's Oil Revenues

This proposal has been going the rounds for a few weeks now. At first glance it looks interesting. Without resolving the problem of the oil revenues it is hard to see how you can have a stable democracy in Iraq. This seems to offer a way forward, but there must be counter-arguments. I think it would be good to see some debate on this idea.

The debate about restructuring Iraq's economy has begun in earnest. Paul Bremer's proposed policies represent a free-market dream to some, a corporate takeover nightmare to others. The truth is that because they ignore Iraq's oil, they are a pure irrelevance. Even at the peak of Iraqi wealth in the late 1970s, oil represented half of Iraq's economic output. After three wars and a decade of sanctions, oil is all Iraq has left. That will not change quickly.

Given the mounting death toll in the streets of Iraq, it would be a brave investor indeed who attempted serious commercial operations outside the oil sector. The occupying forces have not begun to establish the security necessary to run a typical business. Even if the security situation is resolved tomorrow, Iraq lacks the infrastructure, legal system and financial depth to sustain a modern economy. Oil is another matter. In many parts of the world, oil production takes place despite war, dictatorship or the most stunted of commercial sectors. This is no coincidence, for war, dictatorship and slow growth have often been associated with oil wealth. Oil will not help Iraq unless the authorities take steps now to avoid the same fate.

As the Iraqi governing council drafts the country's new constitution, it should give all adult Iraqis an inalienable right to a proportionate share of public oil revenues. Direct transfers of oil money are rarely seen, although Alaska is a notable exception. But Iraq is an ideal candidate for the policy, variants of which have been proposed by Michael Prowse in the FT on April 21 and, for Nigeria, by economists Xavier Sala-i-Martin and Arvind Subramanian. To see why this bold step is needed, we have to understand what will happen if it is not taken. When Iraq begins to export large quantities of oil, the real exchange rate will appreciate, making it tough to export anything else. The main burden will fall on agriculture, and people will go hungry unless food is imported and distributed fairly. Manufacturing will also suffer, and with it the main chance for Iraqis to develop commercial and technical experience. The authorities will no doubt talk about diversifying the economy but few oil-rich states have managed this trick.

Because the oil price is volatile, government revenues will also be volatile, making the economy unstable and difficult for entrepreneurs to operate in. The government will probably spend the money on a large bureaucracy whose members cannot safely be sacked, or "invest" it in crazy projects that will never be completed. In oil-rich Nigeria, for example, the Ajaokuta steel complex was started in the 1970s but has never produced any steel. This is a miserable picture but a fair one, because the fastest-developing countries are almost all poor in resources. In fact, it is probably too benign a view. As well as stunting economies, oil eats away at political systems. Iraq itself provides an obvious example. Saddam Hussein could never have held on to power without control over oil revenues. Other resource-rich states could hardly do worse but still tend to suffer corruption, underdevelopment and even civil war.

Remedies are available for the economic problems but they are useless without a competent and benevolent government. That is why fundamental reform is necessary, to nip the problem in the bud. Direct transfers of all oil revenue to citizens would solve a number of problems. Individual citizens are likely to spend their own money more wisely than weak governments would - it is hard to imagine their clubbing together to build an Iraqi version of the Ajaokuta steel mills, for instance. Individuals are also less likely to raid the cookie jar when times are good: most people understand the value of savings.

Direct transfer would undercut the politics of patronage, because Iraqis would have an automatic right to oil money, defensible in the courts. Possibilities for corruption would not go away, but they would be limited. To raise revenue, the Iraqi government would have to behave the way serious governments do, setting up an efficient system to tax its citizens. Broad taxation is more likely to lead to better governance, because it requires an accountable relationship between government and people. Giving Iraq's oil directly to its citizens is a radical suggestion, but Iraq is starting from scratch anyway. The wretched experience of resource-rich states across the world suggests that it is time to give radicalism a try.
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Putting Mumbai on the Map

Reuben over at Zoo Station clearly likes Mumbai, but he has trouble sorting out just what it is the city has to do to put itself back on track, apart from investion 10 billion dollars that is.

Bombay is a city I spent a few wonderful years in. Though I did get tired of the city, I continue to be very fond of it, especially when I visit for a few days at a time. So, I used to wonder why the city was allowing the attrition of businesses, especially to the booming southern cities. In fact, a report I once read predicted that the GDP of Bangalore would overtake Bombay by about 2008, though Bangalore has only one-third the population. Jayshree Bajoria reports the results of a new McKinsey study, according to which Bombay needs investments worth at least $10 billion over 10 years to be competetive with other commercial hubs like Shanghai, Dubai and Singapore.

The report strikes an optimistic note by suggesting that Bombay could actually raise that money quite easily, especially if it grew at 8-10% per year. The government has clearly taken note of the report and has announced that it would contribute $1.3 billion to the Mumbai Infrastructure Fund. Amen.
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This Seems Nearer the Mark

At last a report on the US economy which seems nearer to my own impression. Of course, just because I agree with it doesn't make it right.

The U.S. economy faces at least another year of tepid growth despite a growing number of predictions that a stronger recovery is around the corner, according to a forecast released on Wednesday. The widely watched survey issued by the Anderson School at the University of California, Los Angeles said neither consumers nor businesses have the buying or investment power to drive the solid growth seen in typical economic recoveries. While a recent spate of better-than-expected economic data has pushed growth forecasts to 4 percent or more for the second half of the year, the Anderson Forecast pegs growth at a modest 2.5 percent on average through the middle of 2004. That forecast is far less optimistic than the emerging consensus. A panel of 35 economists at the National Association for Business Economics earlier this month raised its forecast for U.S. growth this year, citing tax cuts and very low interest rates. "There is nothing to make you think we will have this spurt of growth," said the report's author, UCLA economist Ed Leamer. "I just don't see it." Leamer said even though business investment is creeping back, consumers -- who have taken advantage of low interest rates to keep spending -- do not have much room left now to help spark stronger growth.


Increased debt and higher debt servicing because of rising long-term interest rates are also likely to further drag down consumer spending, the report said. "We need an improvement of the consumer balance sheets and that takes time," Leamer said. "We are sort of stuck like we were in the early '90s with no significant driver pulling the economy forward." Defense spending, which soared due to the war in Iraq (news - web sites) and helped boost growth to 3.1 percent in the second quarter, will not add much to gross domestic product in the second half of the year, he said. And tight budgets will keep a lid on spending at the state and local level and be a drag on the economy, Leamer said. "State and local is going to contribute negatively where normally it contributes about 0.4 percent to GDP growth," Leamer said.


Leamer said the labor market will remain poor with the unemployment rate rising to 6.4 percent in 2004 from 6.1 percent in 2003. The jobless level was expected to remain above 6 percent through 2005. "This labor market is much worse than it has ever been in terms of post-recession outcome," Leamer said. "The job market is extremely unhealthy." Leamer said the economy will not get much more of a boost from a red-hot housing market because elevated mortgage rates will slow home buying by the end of this year. The UCLA forecast pegged housing starts to rise slightly to 1.78 million in the third quarter before dropping to 1.56 million in the fourth quarter and 1.5 million in the first quarter of 2004. The survey also forecast core inflation -- measured as the consumer price index (news - web sites) minus food and fuel prices -- remaining tame at 2.1 percent in the third quarter followed by 1.5 percent at the end of the year.
Source: Yahoo News
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Argentina: Just When You Thought it Was All Over............

They aren't happy on Wall Street. Obviously everyone is posturing here, but I don't see what else they realistically expected.

Wall Street reacted with disappointment to Argentina's request that private creditors write off 75 percent of its 94.3 billion dollars' debt. request, analysts said. US holders of Argentine bonds rejected the move, although they did show willingness to negotiate, hoping the crisis-stricken South American country would show some flexibility. "The reaction in Wall Street has been very negative," said Carl Ross, an analyst with Bear Sterns. The market was "surprised" by "the amount of the haircut that Argentina is looking for -- 75 percent," said Ross. "I think a lot of people felt maybe 50 to 60 percent would be more in line with the historical experience." Ross noted that Argentina's initial bargaining position -- "not paying the past due interest" worth 14 billion dollars since Argentina's December 2001 default -- "is truly a departure from previous norms." Personally, however, he said he was not very surprised. "When you analyze the numbers in Argentina what you find is that they cannot pay much more than the debt service implied in the 75 percent debt reduction," Ross added.
Source: Yahoo News
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EU Commissioners Under Fire

Couldn't resist posting on this one at Fistful , comments welcome:

Romano Prodi, European Commission president, will on Thursday attempt to fight off calls for resignations over the Eurostat affair amid new evidence that financial irregularities continued long after he took office in 2000.


Three reports into the financial scandal released on Wednesday night reveal a saga of fake contracts, secret slush funds and huge waste which went unchecked in the Commission for many years. They tell how millions of euros disappeared into the secret accounts, ostensibly to fund additional statistical research. Large sums simply vanished while some money was used to fund staff perks. Mr Prodi will on Thursday face a grilling by members of the European parliament, many of whom believe he and his team failed to get a grip on the situation soon enough. Members of the 20-strong Commission claim the first they knew about the extent of the problems at the EU statistics arm was in May this year when they read about it in newspapers, including the Financial Times.
Source: Financial Times

Sustaining the Unsustainable

The question of the reality and sustainability of China's growth continues to be an ever present topic of debate, this piece from James Kynge is revealing, and seems to stick to the 'fair and balanced'.

THE name Wuhu means reed lake. And until the mid-1990s, it seemed an apt description for an urban backwater on the Yangtze River, distinguished by little except a crumbling, mildewed cathedral built long ago by the British. But over the past five years, largely unnoticed, Wuhu - the second city in Anhui, a poor central province - has been seized by the type of transformation that is driving China's economic expansion. The process is not pretty. Youthful labour is consumed amid a clash of steel; jobless girls are forced into prostitution; the intellectual property of foreigners is stolen; and the gulf between rich and poor grows wider. But the combination of energy, suffering and guile has brought results.

Wuhu is now served by four expressways, a bridge over the Yangtze and a busy port, all built or expanded since 1998. About 250 million people - equal almost to the population of the United States - can be reached within 10 hours, says Mr Chen Xiaosu, Wuhu's Deputy Mayor. Its new-found accessibility has sired an investment boom. Makers of car parts from the US and Europe have set up shop. Midea, the world's biggest maker of air-conditioners, recently moved a factory to Wuhu from near Hong Kong because of lower labour costs. Mr Yoshii Jiro, the local boss of Hitachi, another recent arrival, says Wuhu provides the lowest costs anywhere for the Japanese multinational.
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India and the BJP

Two posts from Brad here and here on the subject of India and Cancun. In the middle my 'partner in crime' Kaushik . What can I say, I didn't agree with Brad version 1, and in Version 2 he is the perfect gentleman. Non of us are supporters or admirers of BJP, but what we need is a bit of perspective. Along the way, having stuck my neck a bit in the noose, I did seek some independent opinion. First from Indian muslim and blogger ubaid who answered me as follows:

The BJP's time in office has been a mixed bag, they seem to be serious about the economy but they also seem to be haunted by the spirit of hindu nationalism that is still alive and kicking in the party. The Godhra massacre bears ominous testimony to the BJP's willingness to appease its extremist sections. My concern in recent months has been the spate of
bombings in Mumbai, my home town, the memories of the serial bomb blasts in 1993 may be ten years old but they are not forgotten. If Islamic extremist groups get bolder it can only result in heightened tensions and an unstable business environment. Hopefully the law enforcement agencies will nip this problem in the bud.

To which everyone can have there own opinion, but what Ubaid says is clearly pragmatic and non-dramatic. And then Vivek, one of the participants in the debate at Brad's place, who wrote to me as follows:

Hindu-Muslim relations in India, as you can probably guess, are an extremely knotty subject. Actually I try and never refer to the problem as such. For it implies the existence of two distinct and homogenous groups--quite far from the reality for most Indians. I also avoid this characterization to avoid playing into the hands of BJP ideologues who love to see it this way. A united Hindu community dealing with a monolithic 'other' ignoring differences in castes, language, region, culture.

However, you are right Brad flew off the handle the other day. The rise of the BJP is actually a much more complex phenomenon than just Hindu's hating Muslims. I would argue that it is more social and economic than religious. For most part, the BJP is very much the sort of petty bourgeois party like the Republicans. But with a Nixonian twist. It has very successfully exploited the resentment (envy?) that many urban Indians feel towards the deracinated "South Delhi, South Bombay" elite. Nixon did something similar, and from what I gather Likud does it in Israel to beat Labor. In rural India the BJP has benifited from caste polarization that occured in the late 80's. Upper caste rural voters in states in north/west India, under increasing pressure from assertive and organized lower castes, vote for the BJP.

A typical BJP supporter would be urban, middle-class, meritocratic, genuinely religous, right on national security, socially conservative, very uncomfortable with cosmopolitan-irrelgious-western (European) liberalism. No different from conservatives elsewhere. And not neccessarily Nazi.

The problem, however, comes from the other social/ political groups which claim kinship to the BJP--in particular the Shiv Sena, the VHP and the Bajrang Dal. Their ranks are filled up under-employed urban youth--the sort of lumpen element that made the trip to Ayodhaya in 1992 to break the mosque. It is they who I fear most.

I'm afraid, I don't quite agree with Ubaid about the BJP being serious on the economy. Despite extravagant promises before they came to power their economic performace has been no better than previous governments. Besides, the BJP has never distinguished itself with clear, coherent thinking on any matter--the economy is no different. It seems to be some unseemly mix of Buchhan style protectionism and Cheneyesque corporatist. I would very much question their commitment to genuinely free markets and free trade. But to give the devil its due, their performance hasn't been terrible.

Again pragmatic. So now, let's get a little perspective on this, and take things calmly.

R.I.P. Chat

No special comment on this, other than to note: look how fast things move. It wasn't long ago that we were in the 'pre-chat' era.

Microsoft announced this morning that it will shut down its free MSN chat rooms in Europe, Asia, and Latin America and limit the service in the United States, Canada, Japan, and Brazil in order to reduce criminal exploitation of children, pornographic spam, and other inappropriate uses. The changes will take effect October 14, according to Microsoft, and affect all of the countries in which MSN is available. Executives from the company noted that chat rooms were increasingly filled with inappropriate content for children in recent months as most legitimate users are moving from chat rooms to instant messaging (IM) for online chat.



"We recognize that [this inappropriate conduct and content] is a common industrywide problem," says MSN's Lisa Gurry. "We've taken a look at our service and how can we make efforts to step up our efforts to provide a safe environment ... The change is intended to help protect MSN users from unsolicited information such as spam and to better protect children from inappropriate communication online." The company's decision to change its chat strategy comes in the wake of a sharp increase in high profile cases worldwide where children and other people have been lured to physically meet with sexual offenders and other miscreants after chatting online.

In the US, Canada, Japan, and Brazil, MSN's chat rooms will stay open, but users will have to participate in at least one paid service at MSN, ensuring that Microsoft has their credit card number and other personal information on file in the event of abuse. Microsoft currently provides local MSN content in 33 countries and in 17 languages, and the company says that over 200 million people use the service worldwide; over 1.2 million people access the MSN chat rooms.
Source: Wininfo
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Currency: Going up anyone........Not Just Yet, After You Please.

Now the Economist is joining the curency debate. The G7 message was meant for China, but got lost in the post, and has ended up being delivered to Japan:

Why does Japan want a cheap yen? A history of mercantilism may be part of it. A cheap yen is one way to capture lucrative export markets. But Japan also hopes that selling yen and buying dollars will release it from its “liquidity trap”. Japan cannot stimulate its economy by cutting interest rates, because interest rates are already zero. It therefore has to find an alternative way to reflate the economy. Debasing the currency is one. Every time the Bank of Japan buys dollars, it creates yen to pay for them. Eventually, it is hoped, the supply of yen will outstrip demand. Depreciation is one result—lowering the value of the yen in terms of dollars; inflation is another—lowering the value of the yen in terms of Japanese goods. The last time America was caught in a liquidity trap it did exactly the same thing. President Franklin Roosevelt devalued the dollar by almost 60% in 1934 to help America recover from the Depression.

The yen could never fall quite that far. Nonetheless, the Bank of Japan’s efforts seem to have gained some traction in recent months. Output grew by 3.9% in the second quarter, outstripping even the United States. In the past two months, J.P. Morgan has raised its growth forecast for 2004 from around 1% to as high as 2.6%. Other banks are not far behind. Given this turnaround in Japan’s prospects, relative to those of the United States, it is perhaps no surprise that the yen is strengthening against the dollar.

But Japan’s recovery might be quite fragile. Much of the economy’s dramatic second-quarter growth was driven by strong capital spending, which increased by over 20%. Some of that strength is probably a statistical artifact: the volume of investment looks big because the price of capital goods has fallen so far. The investment boom is, in any case, unlikely to continue if share prices carry on down. The jittery reaction of Nikkei investors to the G7 communiqué suggests that a strong yen was not part of their scenario for a strong Japan.

America, it seems, wants a cheaper dollar; the Europeans don’t want a stronger euro. But no one wants to jeopardise Japan’s nascent recovery. Over time, stronger demand in Japan will translate into a stronger yen, not to mention a stronger world economy. But in the meantime, the Bank of Japan needs to continue its aggressive monetary easing, and the exchange rate is one important channel for this. In his past statements, Mr Snow seemed to understand Japan’s predicament: he gave it a sympathetic hearing, reserving his most trenchant comments for China. Perhaps, then, the G7 communiqué was bound for Beijing, but misdirected to Tokyo. Unfortunately, the markets seem to think the message was intended for Japan, and what the markets think matters, even when they are wrong.

The major foreign-exchange markets are deep and liquid. Central banks wade into them from time to time, but they rarely succeed in turning the tide. In fact, the scholarly consensus is that while central banks can reinforce market trends, they cannot reverse them. Until last week, the Bank of Japan succeeded in keeping the yen above its “line in the sand” of 115 to the dollar. That line is now gone. The Bank hopes the yen will trade at 110 or more to the dollar in the future. That line might soon be swept away as well.
Source: The Economist
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More Trouble for Alstom

I wonder what they'll make of this in Brussles?

Debt-stricken French engineering group Alstom received a sharp reminder yesterday that its fight for survival is just beginning when it emerged that the manufacturer of London Underground trains is facing a class action lawsuit in the United States. The news - which came one day after a controversial €3.2bn (£2.2bn) rescue plan for Alstom was agreed - appeared to unsettle investors, who began to fret about the company's long term viability, sending its shares plunging 14% on the Paris stock exchange at one stage. The complaint is similar to that levelled at Enron in the US last year and alleges that Alstom deliberately deceived investors by overestimating its results and understating its net debts at various times between November 1998 and June 2003. The plaintiffs are unnamed minority shareholders who claim that Alstom artificially propped up its share price in the process. They are seeking an undisclosed amount to compensate them for subsequent losses. The fact that US lawyer Bill Lerach, the scourge of corporate America and the man who lodged the Enron complaint, is said to be handling the case will make Alstom executives all the more nervous. According to the French magazine, L'Expansion, the case has already been filed in New York and targets Alstom itself as well as the present and former chief executives, Patrick Kron and Pierre Bilger.
Source: The Guardian
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Posting On Fistful

As I said yesterday, I am now going to be doing some regular posting on Fistful of Euros . My first post is up, about the public holiday we're having today in Barcelona.

Where is Europe Headed?

Tomorrow I'm going to post for the first time on Fistful. Today David Weman has a thoughtful post on the future of the European project:

There has been a lot of talk lately [back in May at least] about what the long-term consequences of enlargement will be, and also about the rift that the Iraq war has caused in Europe. Some people, especially Americans have been saying there's a risk of crisis, and that the Union will become divided and dysfunctional. There's one in my estimate strong indication that they're wrong: Look at the Convention. Divisions have not at all been on the lines of "old" or "new" Europeans, but between small and big states and between intergovernmentalists and supranationalists. The actors have taken positions out of what they think is right, and what they perceive is in their interest. And that's how things will continue to be.............

By the evidence of the Convention, plus my general knowledge of the Candidate countries, I don’t see enlargement seriously working against these trends, though if the constitution will be a drastic step, it may cause a temporary breathing pause. I don't see anything else seriously slowing the process either in the foreseeable future. (Granted, in these matters, that's hardly longer than a decade as I see it.) That begs the question when will it stop? I don't think this gradualist, often not noticed by the public, process can't possibly continue to the point where suddenly we find ourselves citizens of a federal state. At some point something's gots to give. When and how that will happen, I have no idea. Everything about the EU's development is so gloriously uncertain and unprecedented, which is why it's so fascinating.
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Le Pot au Vin

French-speaking blogger François Swissroll Brutsch has an interesting piece about independence and integrity of the French Commissioner Michel Barnier. According to Le Monde Barnier attemmpted to intervene in a case in the High Court in Luxemberg by forewarning Raffarin, who duly travelled to Brussels to 'ward off' the problem. This behaviour, as François notes, violates the priniciple of neutrality and independence. François, but not Le Monde, demands the resignation. The article is in French, but I think you got the message.

"Lors [d'une] réunion de juillet, la Commission s'apprêtait à demander à la cour de justice de Luxembourg d'imposer à la France une astreinte de plusieurs centaines de milliers d'euros par jour pour non respect des règles environnementales, en particulier la "Directive oiseau" de 1979 et les lois "Natura 2000" dans le marais poitevin. La veille de la décision, le commissaire Français Michel Barnier, dépourvu d'arguments pour défendre Paris, prévient M. Raffarin du sort qui l'attend. Le premier ministre téléphone à M. Prodi et lui propose de venir s'expliquer devant la Commission."

Et, fin août, Raffarin rencontre discrètement, à Bruxelles, Prodi et la commissaire chargée de l'environnement, Margot Wallström.

Cela est raconté en passant dans une intéressante page du Monde du 20 septembre sur les relations difficiles entre la France et l'UE.

Peut-être bien que dans l'affaire Alstom les arguments de politique industrielle doivent finalement permettre d'éviter le dépôt de bilan. Mais Prodi devrait révoquer Michel Barnier. Pour signifier clairement que la règle de l'indépendance des membres de la Commission, en particulier vis-à-vis de leur pays d'origine, doit être respectée.
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Chinese Banking Reform Moves Forward, Slowly

There is some evidence that the process of sorting out the Chinese non-performing loan problem is moving forward: slowly. Six billion out of a possible total of anywhere up to 750 billion dollars doesn't seem like a revolution. Still it is a start.

Chinese financial institutions plan to put up for sale about $6bn in non-performing assets over the next few months, marking the biggest push since 1999 to clean up the bad debts of the country's huge but insolvent big four state banks, Chinese officials and financial industry executives said. The new level of activism in China's most pressing economic reform signals an increased willingness from the government of Wen Jiabao, the premier, to experiment with new and different forms of asset disposal. It also suggests a potential bonanza for foreign and domestic investment banks. The big four banks, which between them have problem loans estimated at between $375bn and $750bn, are in a race to clean up their balance sheets and win official approval for a stock market listing.

The two front-runners to be listed are the China Construction Bank and the Bank of China, followed by the Industrial and Commercial Bank of China and, in a distant fourth place, the Agricultural Bank. The first move is expected to be an auction by Huarong, the biggest of four asset management companies set up in 1999 to dispose of about Rmb1,400bn in non-performing loans transferred from the big four banks. The auction, expected to take place this year, would be for NPLs with a face value of about $2.2bn, executives said. Yang Kaisheng, Huarong's president, started a roadshow to promote the NPLs to financial institutions in the US and Japan over the weekend. If it materialises, the auction would be only the second to be held since 1999, when a consortium led by Morgan Stanley bought NPLs with a face value of Rmb10.8bn and a Goldman Sachs consortium bought assets with a face value of Rmb1.97bn.

The increased size of Huarong's second auction indicates Mr Yang's confidence that foreign banks have been able to profitably dispose of the NPLs they bought. Mr Yang is also hoping for higher returns than in the first auction, when NPLs were sold for 8-9 per cent of their face value, Huarong executives said. Later, the Wuhan branch of Huarong plans to package about $500m in bad assets for sale, Chinese officials said. This represents a new method of disposal - previously only the head offices of the asset management companies were allowed to court foreign clients. Wuhan is an industrial city in central China.

Another new form of asset disposal is planned by the Bank of China in Hong Kong, which hopes to offer to the market assets with a face value of about $1.2bn, executives said. Because Chinese banks are not allowed to sell NPLs directly, the Bank of China assets are being packaged and held by a Cayman Islands entity, said the executives, who declined to be identified. It was not clear if the Bank of China (Hong Kong) plans have received approval from Beijing. A spokesman at the People's Bank of China, the central bank, said he had not heard of the scheme.China's largest bank, the Industrial and Commercial Bank of China, is also trying to package about $2bn to $2.5bn in non-performing assets for sale in the more distant future. The timetable for this sale was not clear.
Source: Financial Times
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India's Cities Evolve

Rajesh Jain muses on how the modernising of India's infrastructure is changing his life:

I was born in Pune, and spent the first few years of my life there. I have regularly visited the city (192 kilometres from Mumbai), though in the past few years, the visits have been few and far between. Most of my journeys have been by train. I find train travel (like air travel) gives me the freedom to think - as long as I am travelling alone! Recently, I took a taxi (a “Cool Cab”) back to Mumbai, riding along a sparsely trafficed Expressway. On the way, I couldn’t help thinking how improving infrastructure is changing the dynamics of life and business between the two cities.

The first thing the expressway has been is made travel time between the two cities flexible and predictable. This is very important. One can reasonably easily predict that it will take about three hours to travel between the two cities at any point of time – either via car, taxi or bus. Even the train journey time has been reduced – the Shatabdi now takes under 3 hours to cover the distance. This is bringing the two cities closer, with the result that Pune is enjoying a mini-boom of sorts.

Software companies are expanding or setting up shop, many people are returning from abroad to live there (quality of life being better than Mumbai – something I don’t necessarily agree to!), real estate projects are sprouting up everywhere, the outer boundaries of the city are widening, and the service industry is growing rapidly in the form of malls, multiplexes and restaurants. Pune also has a historically strong education base like Bangalore, and this is likely to serve it well in the years to come.

What is fascinating to see is how cities evolve. A decade ago when I returned back to India, it was hard to imagine how places will change. Now, all around, symbols of the change and optimism abound. The Mumbai-Pune expressway may just be hundred kilometres of concrete, but for a generation, it is a symbol of the New India.

For long, India has lacked the appropriate infrastructure to ensure that simple things get down quickly. This is now being built – slowly. But I hope, we can do things right. A point Atanu Dey makes often is the need for standardisation. Take an example. Finding places given an address is so difficult. If we had clearly marked numbers on the road for the plots, it would be so much easier. More often than not, we give directions saying it is near this place or opposite that place. As we do the new things that need to get done, let us make sure we also do them right. Let a few think and set the standards, so others can follow.
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Steeling Jobs

This piece from the Washington post puts an interesting light on the 'new protectionism' US style. The tarriffs help, logically, the steel industry, but the general impact on the economy is negative. In a politically driven economy it all depends on where the votes are I suppose. But please don't let them give me all that cant about believing in free markets, this preaching, it seems, is only for the ears of others.

The steep tariffs that President Bush imposed on imported steel 18 months ago have helped the beleaguered U.S. steel industry regain its footing, but likely have had a modestly negative impact on the overall economy and the woeful U.S. job market, the U.S. International Trade Commission has concluded.

The eagerly anticipated progress report -- completed Friday night, halfway through the tariffs' three-year duration -- will give both steel producers and steel-consuming industries such as automakers and tool companies ammunition for the fierce lobbying battle already underway in Washington over the tariffs' future.

Although the president is not required to make any changes to the tariffs, the World Trade Organization is expected in November to allow the European Union to impose billions of dollars in retaliatory import quotas on U.S. goods. The Bush administration's economic team, which was divided on the tariffs last year, is now united in its call to lift them by then. And some Bush political advisers fear the tariffs may have backfired politically, by costing the president more support in steel-using states such as Michigan and Tennessee than the support he gained in steel-making states such as Pennsylvania and West Virginia.

The reports, totaling three volumes and 890 pages, concluded that the tariffs had cost the U.S. economy about $30.4 million a year, or 0.0003 percent of total output. Steel-using industries did face steeply higher prices at first, but those have declined. Steel-consuming industries have seen their earnings trimmed by $601 million, or 0.01 percent, the reports conclude, while steel producers, mining companies and other beneficiaries saw earnings rise by $67.4 million, or 0.04 percent.
Source: Washington Post
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Will The Dollar Continue its Decline?

After all the fire and fury in the currency markets yesterday, things are much calmer today. I have the impression that everyone is convinced that the dollar needs to come down substantially, but that nobody believes it is actually going to happen. Chinese reticence, Japanese dithering, and euroland alarm are amongst the various reasons one could think of. For the dollar really to come down, everyone has to believe that it is going to happen, and accept it. I'm not sure we're there yet, and when we do get there I'm not sure the consequences will be as benign as many imagine.

Many investors remain wary that the Bank of Japan could restart yen-weakening currency market interventions that would boost the dollar. "We think the BoJ will definitely be back. If they need to intervene, they need to do it this week," said Robert Sinche, global head of currency strategy at Citibank in New York. "People are very hesitant to be long dollars ever since the G7. After such a break (below) key levels on dollar/yen, the only way we could get back to dollar-buying mode would be some BoJ activity somewhere near the 110 yen area," said David Leaver, senior trader with Gain Capital in Warren, New Jersey. Markets seem to view the U.S. endorsement of the G7 statement as an apparent abandonment of the U.S. strong dollar policy, many analysts said. Japan is concerned that a rapid rise in the yen could jeopardize the country's tentative export-led recovery and has spent roughly nine trillion yen ($70 billion) in yen-weakening currency intervention already this year. Comments from Japan's top financial diplomat, Zembei Mizoguchi, that the yen's rise was too rapid did inject some wariness into the market.Mizoguchi, attending IMF meetings in Dubai, said the yen's recent surge had been partly due to speculative buying and Japan would act as needed to stem disruptive exchange rate moves. Some analysts characterized Mizoguchi's talk as "verbal intervention" that has had only limited impact. "The verbal intervention is part of what brought (the dollar) back up above 111 (yen)," said Greg Anderson, senior foreign exchange strategist at ABN Amro in Chicago. "Until the Japanese actually intervene, dollar/yen is going to continue to see the downside."
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Meanwhile over at Morgan Stanley, Andy Xie doesn't seem too convinced:

The G-7 communiqué over the weekend was not another Plaza Accord. In my view, it was more the outcome of a group of the world’s wealthiest nations trying to beat down a large, fast-growing but still poor China without China being present. A new world order is only likely to work with China’s consent.

The United States, Japan and some European countries are focusing on exchange rates to explain their own economic problems. This is confusing the symptom with the cause. The global imbalance is due to differences in savings rates. Savings imbalance and competitiveness are two distinct issues. The situation today is different from that in the 1980s.

Intervention in currency markets is a necessary part of the adjustment process. Mature economies in Asia still have high savings rates but cannot invest as much as previously, as they have lost competitiveness to China. Without intervention in the currency markets, the savings surpluses will cause excessively strong currencies and serious deflation.

Currency intervention allows these economies to adjust their savings rates in an environment without massive deflation. This is ultimately good for global economic stability. As these economies decrease their investment, their savings rates decline with lower capital income............Several mature economies in Asia cannot invest as much as previously as they have lost competitiveness to China. However, their savings rates, determined by demographics and existing capital structures, cannot suddenly decline to reflect the new reality. These economies, therefore, experience capital surpluses...........Waning investment and slow economic growth are lowering savings rates in mature Asian economies. The gross national savings rate in Japan has decreased by 3.9 percentage points, in Korea by 5.6 and in Taiwan by 2.7 in the past three years from 1990s levels. Their savings surpluses are still large because their investment-to-GDP ratios continue to decline. Before the end of the decade, Asia’s savings surpluses should have largely disappeared, in my view. By that time, global rebalancing could have been achieved through slow growth and some deflation among Asia’s mature economies.
Source: Morgan Stanley Global Economic Forum
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I can't believe it. Someone actually mentioned demographics!

Drawing Conclusions From the Swedish Vote

The more one looks into it, the more difficult it is to read last weeks Swedish vote as a vote about the euro. In too many people eyes the euro and the EU seem to be one and the same thing. It may well be that many Swedes were voting about their perception of large state 'arrogance' rather then the economic issues in hand. This has unfortunate consequences, since when the euro goes well, the EU seems to go well, but, and here lies the danger, if the euro does not go well, the focus of resentment could become the EU itself, and that would be a tragedy.

Whether Sweden has made the right decision is debatable. From an economic point of view, there are things to be said on both sides. In some ways, Sweden is the ideal euro candidate: a small, open and internationally competitive economy, with more than most to gain from exchange-rate stability across Europe. On the other hand, the euro area is performing badly, partly because its economic-policy rules have been poorly designed, whereas Sweden is doing well. A vote to wait and see, if that is what it was, makes sense. Sweden can adopt the euro later, if it seems to be losing inward investment, or if the policy rules are mended, or if the euro area's performance inspires. In this, no is not for ever. Yes is—or that is the idea, anyway.

In fact, however, Sweden appears not to have been voting to wait and see. Arguably, the country was not even voting about the euro, as such (see article). So far as one can tell, the vote reflects a verdict on the economics of the single currency less than it expresses deeper suspicions about what the European project implies for Sweden's sovereignty and for the future of its democracy. This matters for Europe as a whole, not just Sweden, because people in many other countries have similar doubts—and because many of them, just like the Swedes, will shortly get a chance to say so.

Next month the European Union embarks on an inter-governmental conference (IGC) whose task is to finalise the proposed new European constitution.............The point is that the new constitution, once it emerges from the IGC, will need to be ratified by every government in the Union. In several countries, it is already understood that ratification will be subject to referendum. Pressure for a referendum is mounting elsewhere too—notably in Britain, whose government has pledged to deny a vote to its citizens, despite the fact that more than 80% of voters say they want one.
Source: The Economist

French Consumption Wilts in the Heat

I think it would be premature to draw any conclusions from this, since it was clearly very hot (I can still remember, phew), and this will have affected shopping. But still it is one more indicator.

This summer's heatwave has taken its toll on consumer spending in France, which suffered its sharpest drop in more than six years in August, raising the spectre of recession in the eurozone's second-largest economy. While the heatwave has already dented the popularity of prime minister Jean-Pierre Raffarin, after thousands of people perished in the sweltering heat, the resulting drop in consumer spending may also undermine his room for manoeuvre on the economy.The Insee national statistics institute said France's consumer spending on manufactured products fell 2.7 per cent in August, against a rise of 1.1 per cent the previous month. The decline was accentuated by an 8.9 per cent fall in consumer spending on clothes and leather goods in August, as the French stayed away from high-street stores and put off buying sweaters, coats and boots ready for winter.
Source: Financial Times
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Global Turning Point?

Following the G7 decision in Dubai, the financial markets are more than a little nervous . Stephen Roach, in contrast, is so ebullient you would almost say he was apocalyptic:

An unbalanced global economy has finally come to its senses. At the just-concluded G-7 meetings in Dubai, the world’s major industrial economies have endorsed the basic premise of global rebalancing -- a long overdue adjustment in the dollar. This could well have profound and lasting implications for the world economy. It is an unequivocally positive development, in my view............

For the US, Dubai was also a watershed event. The motivation is not hard to fathom. At work is an increasingly powerful interplay between economics and domestic politics, as America’s jobless recovery appears on a collision course with the Bush Administration’s re-election hopes. With America’s fiscal and monetary levers already fully engaged, the currency option takes on new and critical importance as the only means left to provide macro stimulus to a beleaguered US labor market. It remains to be seen as to whether such tactics will work -- especially with IT-enabled outsourcing creating a new and lasting global labor-cost arbitrage that biases US employment growth to the downside. But the Bush administration has evidently concluded that a currency adjustment needs to be added to America’s reflationary policy arsenal. In doing so, US politicians should benefit by having fundamental economics on their side, as America’s massive current account deficit screams out for a weaker dollar.

History tells us that the US dollar has only just begun its downward descent. On a broad trade-weighted basis, the dollar (in real terms) has fallen about 8% from its early 2001 highs. In a full-blown current account adjustment, a drop of around three times that magnitude can be expected -- not all that different than the 30% real deprecation of the dollar that occurred in the late 1980s when the current-account disequilibrium was far less acute. In the end, a lopsided world has no choice other than to accede to a weaker dollar. The G-7’s Dubai communiqué now puts the major economies of the world on the same page with respect to the global rebalancing that such a currency realignment can trigger. The road ahead will be long and arduous -- and not without risk, especially in oft-volatile currency markets. But the economics I practice suggest it is the only way out for such an unbalanced world. As someone with a long-standing gloomy bias on global prospects, I am now encouraged for the first time in four years.
Source: Morgan Stanley Global Economic Forum
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I've only one big question in the face of this, where does the growth come from? This is the problem. If there is a BIG dollar 'correction', then US consumption will be affected, the US consumer will be able to buy less. Remember Andy Xie's calculations to the effect that each dollar ex-China, becomes 6 or 7 dollars for the US consumer. To dent those imports the change in the yuan has to be fairly big since there are a lot of US china-based margins to trim - and of course there's no sign of any change at all at the moment, in fact there are a lot lot of arguments inside China that the Chinese financial system wouldn't stand a revaluation of the necessary order. Of course all of this could be seen as a tremendous gamble, a gamble to force the Chinese to conform, to 'be reasonable'. But if they don't it could be a gamble with a double backfire, in Europe and Japan.

Because if the Chinese prove either unwilling or unable to respond, make no mistake it will be the EU and Japan who get to do the 'heavy lifting'. And it's this other part, the rest of the world thing I don't see, at least not in the OECD. For Stephen Roach the optimism is easy, the problem is lack of structural reform, and what we will now get are structural reforms. Fine, he's happy. But I worry. I worry because nobody even seems to be thinking about the other part of the problem, the ageing part. The US is outside this a bit, since the demography is much better, but even so, look at the problems the 'baby boom' is about to cause for federal finances.

Obviously if the structural components of the US economy were sound, then the loss of jobs to India wouldn't be a problem. But the fundamental structurals are not sound. So where we go is anybody's guess. Japan is on the upside of the cycle, but will this last? How will Japan cope with a much higher yen? There are a tremendous number of questions. Even the geopolitical dimension is hardly resolved - we're just conveniently forgetting about it. My guess is - ex China, India, Turkey, Brazil - next year's growth forecasts will not be fulfilled.

What I want to say is that all of this is very unstable, and as Roach in his other mood says, one little shock can have big consequences. When we talk of growth this year of 3-4% in the US, just look at the budget deficit you need to get this. It is the rate effect that is important here. The deficit has gone from 2% positive to 4 points negative in a very short time. This is a big stimulus. But next year, they cannot repeat this, they cannot add another 6 points to the deficit, they can only maintain it as it is. So if the growth doesn't arrive, then they have !% to drop on the money side, and very little possible extra stimulus on the fiscal one. Remind anyone of Japan?

One important thing is the corporate debt component. With strong disinflation they cannot get the debts off their necks. So they have to fight about margins, and hence they outsource. The latest numbers on H1B visas speak for themselves on It work in the US, and the bulletin boards are full of disgruntled IT workers. The new jobs at the moment seem to be in construction (housing boom) and health care (ageing). The drop in the dollar could send a river of money out of the US, hit treasuries hard, and cause long term rates to rise. What effect this would have on the 'recovery' is anybodies guess.

The US is at a crossroads, and it is in some ways reminiscent of the UK post WW1. Certainly it is very ironic that they win a war, and then face all this. Of course, I'm not trying to say that devaluing the dollar is a bad thing. For the US, despite short-time living-standard impacts, there could be more solid growth later, and as Brad keeps pointing out their debts are in dollars, so the real bill is paid elsewhere. (Of course, whether this is just is another question, being the reserve currency it seems only has advantages, on the way up you get to be able to borrow a lot, and on the way down you get to burn-off much of the debt). The problem is Europe and Japan. They can't afford to allow their currencies to go up so much. So in fact I end up agreeing with Roach, at the heart of the problem are the global imbalances, with the gap between OECD and the rest being at the top of the list. I'm also trying to suggest that this is not a 'theory problem', but a real empirical one that may not be well anticipated in the theories. There may be no easy short-term solution. Look at the choppy markets today. Maybe they are a sign of things to come.

China's Real Munfacturing Revolution

Here's a nice piece for a change from the WSJ, and as they say, it's 'fair and balanced'. The message seems to be that there are scale and 'learning by doing' components to working in China, which is what theory would lead you to expect. Supply chain reliability and local management expertise are things which will only develop with time. This is really the strongest, and the only really uncontroversial globalisation argument. The third world isn't going to 'bootstrap up' if it doesn't have the opportunity to learn. Of course, once they start, then they become potential competitors, and we get to hear another set of arguments.

The argument about plant design is interesting, since having a high labour component is only a temporary option for China: with time wages and living standards will rise. Of course if they also manufacture capital goods there, then this will keep capital cheaper, and if a large part of capital costs are in IT hardware and software, and these come from China and India, then where we are going is anybody's guess. (BTW, thanks to Walter for drawing this article to my attention).

The Real Contest Between America and China
By THOMAS HOUT and JEAN LEBRETON


Shopping at Wal-Mart will give you the wrong idea about where China's threat to U.S. manufacturing lies. Most made-in-China consumer goods on those shelves represent industries which left the U.S. for Mexico and Southeast Asia years ago. Instead the real contest between American and Chinese factories is taking shape over industrial goods, a $2 trillion market of everything from small motors to oscilloscopes to locomotives, where fast-moving U.S. productivity and technology have kept production at home.

The problem is that China's rapidly-growing capability and huge scale are turning these U.S. defenses on their head, creating astonishing cost advantages in moving to China. These can amount to savings of 20-35% with no loss of quality -- opening the doors to moving even high-performance, highly-automated product lines there.

Unlike Japan a generation ago, which reinvented manufacturing through quality and continuous improvement, China is deinventing it by removing capital and reintroducing manual skill and handling on the plant floor. China's far lower cost of not only production workers but plant technicians, accountants and managers allows U.S. companies to rethink everything from how the product and its parts are designed to how they are made and tested.

The result is more craft, less complexity in plant processes, and often a shorter time from design to production -- all at a far lower total cost. Together with the improving quality of materials and reliability of supply chains inside China, this means some American companies are moving whole core product lines there.

But many are not. China is still small fry in the U.S. industrial-goods market. Domestic production accounts for 70% of industrial goods sold, and imports from Japan and Western Europe account for another 20%. Only 10% comes from low-wage economies, and China has less than one-third of this -- or 3% total penetration of the U.S. market, shipping fewer goods than Mexico.

Many American companies find China's cost advantage elusive. Sending buying teams to China from their headquarters in the U.S., armed with drawings and specs in search of lower-cost sources, often doesn't work -- as American auto companies have recently learned. Small engine and low-end farm equipment producers, among others, have looked at taking production lines to China and found uneven quality and unreliable supply lines back to their U.S. customers outweigh the advantage of lower production costs. The higher technical- and inventory-support costs plus all the risks just aren't worth it.

Sourcing in China works best for companies which invest know-how and painfully nurture their China operations over sustained periods, and only a limited number of foreigner manufacturers have done this so far. Our research shows that companies committed to large-scale manufacturing in China think differently in several important ways from competitors without such commitments.

First, committed companies accurately cost the labor and capital costs of their products. Accounting statements may tell a finished-equipment manufacturer that factory payroll is only 10% of its costs, but when the full payroll cost of the purchased components and company overheads are added in, the total labor costs are typically 40% to 60% of the final product cost. And those labor costs are lower across the board in China. Production workers typically cost 5% of their U.S. counterparts, while good engineers and plant managers may cost 35%.

But what about higher U.S. labor productivity? True, American workers in capital-intensive factories can be several times more productive than their Chinese counterparts. That's because U.S. plants have replaced many factory workers with complex flexible-automation and material-handling systems. This has reduced labor costs but raised capital and support systems' costs.

Chinese factories reverse this process by taking capital out of the production process and reintroducing a greater role for labor. Parts are designed to be made, handled and assembled manually. This reduces the total capital required by as much as one-third. So output per worker is lower in Chinese factories, but the combination of lower wages and less capital typically raises the return on capital above U.S. factory levels.

American companies like Kodak or Copeland that develop several factories in China will see more cost savings than a competitor taking its first steps. Several factors working together explain this. These companies develop and improve their local suppliers. Their Chinese engineers learn the quality disciplines. And they become smarter in hiring people and designing incentives. The costs and benefits of manufacturing in China increase with scale and experience there, meaning that the more you grow the easier it is to continue to grow.

Second and counterintuitively, it usually makes more sense to send a distinctive new product line to China than an old, price-pressured one. The payoff from sending the latter to China is low. The many one-time expenses -- product and process redesign, new local suppliers to sort out, and the need to requalify the finished product with U.S. customers -- could wipe out any profit margin. But designing a new product for China makes sense for a company well down its experience curve there.

For instance, Tektronix's new oscilloscope was designed by U.S.-based engineers working virtually with their China-based tooling counterparts. Although some materials and components were imported, the product will have only one set of start-up costs and a lower capital investment to amortize.


Third, companies committed to production in China take a more realistic view of the risks involved. Supply-chain risks are often exaggerated by outsiders. As for country risk, again China's resilience and production security tend to look better to insiders. That was recently demonstrated when the outbreak of severe acute respiratory syndrome earlier this year caused few supply disruptions from China. And Chinese authorities regard foreign-owned plants as valuable assets not to be disturbed.

But some risks are not exaggerated, such as the need to protect intellectual-property rights, which deters many companies from bringing highly proprietary processes to China. Armstrong, the world's leading floor- and ceiling-tile manufacturer, keeps some material formulas and processes in the U.S. AMP, the world's leading connector producer, had no choice but to move to China because of the cost savings involved. So its proprietary inline plating process in China is done in a special secure enclosure with specially licensed employees. U.S. auto companies know their technology is leaking to Chinese joint-venture partners, but in return they get a head start in China's exploding market.

There are limits to what can move to China. Products where customer-driven innovation is frequent and critical will not go. Nor will those where customization and intimate user contact with the factory are required. Some American customers, especially publicly funded organizations, will insist on goods being produced in the U.S. The most persuasive barriers to movement will be customer-related, not technology-related. Production technology is often surprisingly mobile and divisible between locations. Large portions of leading-edge medical diagnostic equipment are being made in China, and jet aircraft engines will follow.

While China today has only 3% of the U.S. industrial goods business, its shipments are growing at 21% annually in a basically flat market. This penetration rate will be governed by the rise of capability of foreign-owned and operated plants in China, not by wage increases or exchange-rate revaluations. The cost differences are too great. In addition, China is becoming the world's largest market for some industrial goods, for example machine tools and power equipment. There are many reasons to make more things in China. As more companies discover this, the impact on American jobs will grow, making it an increasingly potent political issue.

There are limits to what can move to China. Products where customer-driven innovation is frequent and critical will not go. Nor will those where customization and intimate user contact with the factory are required. Some American customers, especially publicly funded organizations, will insist on goods being produced in the U.S. The most persuasive barriers to movement will be customer-related, not technology-related. Production technology is often surprisingly mobile and divisible between locations. Large portions of leading-edge medical diagnostic equipment are being made in China, and jet aircraft engines will follow.

While China today has only 3% of the U.S. industrial goods business, its shipments are growing at 21% annually in a basically flat market. This penetration rate will be governed by the rise of capability of foreign-owned and operated plants in China, not by wage increases or exchange-rate revaluations. The cost differences are too great. In addition, China is becoming the world's largest market for some industrial goods, for example machine tools and power equipment. There are many reasons to make more things in China. As more companies discover this, the impact on American jobs will grow, making it an increasingly potent political issue.
Source: Wall Street Journal
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One Little Noticed Consequence

In all the heat generated over the collapse of the talks at Cancun, one, apparently minor, consequence does not appear to have received the attention it may deserve: the expiry of the so-called 'peace clause'.

Can any of these failures be addressed and the Doha round be revived? Some countries are more optimistic than others. The G21, for instance, left Cancún determined to stick together and fight another day. Brazil, in particular, is convinced that sooner or later rich countries will be forced to reform their outrageous farm policies. One weapon it points to is the expiration of the “peace clause”.

As part of the trade round before Doha, the Uruguay round, countries pledged not to file formal WTO complaints over the dumping of farm products as long as each country stuck to its (limited) farm-trade commitments. That peace clause runs out at the end of this year. The ensuing flood of disputes, claim some Brazilians, will at last force the Americans and Europeans to negotiate seriously on farm trade.
Source: The Economist
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Indian agriculture Rajnath Singh seems to follow this interpretation:

Speaking to mediapersons at his office, Singh, however, ruled out any review of the move to phase out quantitative restrictions on imports. Other means were available to the country to curb the import of any item hurting domestic interests, he pointed out. The minister said the peace clause was slated to lapse in December this year and there was little chance of its revival after the collapse of the Cancun negotiations. "This, in a way, will benefit India", he maintained. Elaborating on the provision, he explained that in case any country tried to export its goods to India below domestic prices, it would be possible to impose counter-veiling duty to offset the price advantage. Singh expressed doubts over the true intentions of developed countries such as the US and the European Union (EU) in pushing their trade agenda. "It seems the US did not want any progress at the (Cancun) talks in view of the Presidential elections due in November 2004. It wanted a holiday from reforms to continue with its high farm subsidies till the polls", he said.

Source: Business Standard

My big worry is that, while Singh is probably right that the initial US horizon is the 2004 election, things can change and move so much during the next year that what began as a tactical retreat can turn into a wholesale rejection of the multilateral process. In this sense, let's hope the ending of the truce doesn't turn into the declaration of the war. My feeling, for what it's worth, is that here in Europe while the issue of agricultural dumping is no great deal, the issue of subsidies to the farmers is. The possibility of anyone outside the EU being systematically able to sell to us at competitive prices anytime soon seems just about zero.

What really happened at Cancun?

Since the breadown of talks last week in Mexico, economics commentators around the globe have been all asking themselves the same question: what happened and why. The economist, whilst blaming the EU for not being sufficiently prepared to give ground, and the ONG's for firing unreasonable expectations amongst the poorest countries, seems to have little doubt where the responsibility should be placed for the proximate cause of the breakdown: the problem of cotton subsidies. (BTW: this is I'm sure not interesting to any of you, but while I'm writing this, I'm listening to British playwright Edward Bond being interviewed on the radio. He isn't half giving-it to Bertholt Brecht. Well done! His definition of tragedy: the hands of the blind man must see. What is worth remembering here is that the principal bard who 'composed' the works of Homer was - according to the tradition - blind. What is pre-wired at birth for Bond is a sense of the tragic, a sense of the comic, and an imperative to impose meaning on things. He also says that he feels his characters write his plays more than he does, I sometimes think this about the blog, it is written more by the news, and by the way things evolve, by the random contacts I have across the planet than it is by me. Would that the blind man had been in Cancun!)

While the fight between Europe, America and the G21 received most attention, another alliance of poor countries, most of them from Africa, was also worried about agriculture, but for different reasons. They feared that freeing farm trade would mean losing their special preferences. (Europe's former colonies, for instance, get special access to the EU's markets for their bananas.) They were even more worried about cutting tariffs than India, fretting that imports would ruin their small farmers. And many, particularly a small group of countries in West Africa, worried most of all about cotton.

Prodded and encouraged by non-governmental organisations (NGOs), especially Oxfam, a group of four West African countries - Benin, Burkina Faso, Chad and Mali - managed to get cotton included as an explicit item on the Cancun agenda. Their grievances were simple, and justified. West African cotton farmers are being crushed by rich-country subsidies, particularly the $3 billion-plus a year that America lavishes on its 25,000 cotton farmers, helping to make it the world's biggest exporter, depressing prices and wrecking the global market.

The West African four wanted a speedy end to these subsidies and compensation for the damage that they had caused. Though small fry compared with the overall size of farm subsidies, the cotton issue (like an earlier struggle over poor-country access to cheap drugs) came to be seen as the test of whether the Doha round was indeed focused on the poor.

But the draft text that emerged halfway through the Cancun meeting was a huge disappointment. The promises on cotton were vague, pledging a WTO review of the textiles sector, but with no mention of eliminating subsidies or of compensation. Worse, it suggested that the West African countries should be encouraged to diversify out of cotton altogether.

This hardline stance had American fingerprints all over it. Political realities in Congress (the chairman of the Senate agriculture committee is a close ally of the cotton farmers) made American negotiators fiercely defensive of their outrageous subsidies. For the Africans, the vague text was a big blow. It caused "anger and bitterness" said one delegate. As a result, the poorest countries dug in their heels when it came to the other big controversial area: that of extending trade negotiations into the four new Singapore issues. Along with many other poor countries, the Africans had long been leery about expanding the remit of the trade talks at all.
Source: The Economist
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Now what the Economist seems to be suggesting here is quite important. They are suggesting that the US allowed a draft text to emerge halfway through the meeting in the full knowledge that it would be resisted by the four 'agrieved' west African countries, who would then proceed to become more obstructive on other matters, like the Singapore issues, and thus place any possibility of worthwhile agreement greatly in jeopardy. If the passage of time allows more credence to be placed on this version, it will certainly be worth while asking what has caused the United States to act in this way? Certainly it cannot be the issue of cotton subsidies alone. Possibly the whole problem of another round of trade expansion is just too much for the US to handle in election year. Or again, we might ask ourselves the question: are we witnessing the beginings of a turn in the tide of globalisation itself?

Are Trade Talks Really About Freeing Trade?

Cancun and the Singapore issues: Eddie, our man in Singapore, at it again.

Why Cancun couldn't

By Eddie Lee

AFTER the Cancun trade talks imploded, Singapore's Trade and Industry Minister George Yeo, who was the facilitator for agriculture, lamented that developing countries were the biggest losers 'because many of them would have stood to gain the most from the reform of agriculture'. He felt the talks failed because resentment against the United States and the European Union (EU) resulted in demands being pressed, 'often to unreasonable limits'. EU Trade Commissioner Pascal Lamy said he would not get into 'the blame game', but then implied that the developing world was responsible for the breakdown.

It was, indeed, a lost opportunity for all. You could say the unity among developing nations is providing a new dynamic in the trade talks, while the US offered little leadership. But if both the developed and developing nations wanted an agreement so much, why were they both so stubborn? Free trade in agriculture certainly means a lot to the developing countries, since most of their people live in the rural sector. According to The Guardian, a Malian trade representative came away from the meeting saying, 'This is a great loss to three million farmers in Mali who live on agriculture. Back home, there will be mourning because nothing had been agreed. I do not know how we will explain this to our people.'


THE talks, however, did not collapse over agricultural subsidies, but over the so-called 'Singapore issues'. The latter term was coined after working groups were set up by the 1996 Singapore Ministerial Conference to negotiate rules involving investment and competition policies, trade facilitation and transparency in government procurement. The Europeans and Japanese insisted on negotiating the 'Singapore issues' in exchange for a deal on agricultural subsidies. Of the four 'Singapore issues', the one concerning foreign direct investments (FDI) was particularly contentious. Developed countries wanted restrictions on investments by overseas corporations removed. Developing nations, however, were concerned about nurturing infant industries and sovereignty issues.

Whatever your views on FDI, you have to ask why talks on free trade should also involve an issue like foreign investments. Why should they be related? Was it a show of muscle by developed countries, extracting FDI concessions in return for granting access to their agricultural markets? The US demanded its own quid pro quo when it slapped environmental conditions on Mexico's membership of the North American Free Trade Agreement. It did the same when it demanded curbs on capital controls in FTAs with Chile and Singapore. Sceptics however suggest that the developed countries' demands on FDI were merely a smokescreen to disguise their own intransigence over agriculture.

Anti-globalisation activists, of course, had a field day. They have been arguing for years that the World Trade Organisation (WTO) is merely a cynical exercise in forcing developing countries to accept foreign ownership and control. Cancun was a chance for the developed countries to give something up for the benefit of the developing countries. It would have meant giving a little for a lot - the average European subsidy per cow, for example, matches the US$2 (S$3.5) per day poverty level on which billions of people barely subsist. But that became a side issue. Perhaps they never intended to give anything up. Why else would the EU and Japan have insisted on negotiating the 'Singapore issues' at Cancun, when there has been virtually no progress on these since the 1996 WTO Ministerial Conference in Singapore? There has always been little connection between trade policy and what's good for a country. Trade policy is made in the world of politics where interest groups count. And right now, in the developed world, there are real concerns with jobless recoveries.


THE gains from trade have always been an abstract concept to grasp. They are derived from taking advantage of differences between countries. The larger the differences, the more there is to benefit. So an urban economy can profit from trading with a rural economy by exporting manufactured goods while importing agricultural produce. But trade also brings pain. This comes during the adjustment process. The problem is magnified when unemployment is already high in an economy. Economic theory does not provide a timeframe for the adjustment process and the human costs.

There are deeper concerns among developed countries. When farm jobs were first lost to poorer nations in the past, new manufacturing jobs made up for the loss. When manufacturing jobs were lost, there were services jobs. But what if services jobs are being lost too, as they are now? Hidden underneath the so-called 'Singapore issues' at Cancun was something which in WTO jargon is known as Mode 4 of the General Agreement of Trade in Services. It concerns removing barriers to the supply of services through allowing temporary migrant labour. Developing countries want their people to be allowed into developed countries to work; the latter are more sticky about it.

Many developing countries had expressed their disappointment with the first pre-Cancun draft ministerial text which omitted this issue altogether. Even then, there was only a token acknowledgement of the 'interest of developing countries' in the final draft issued before Cancun. Whether or not migrant labour should be allowed into developed countries will surely be another test of the latter's commitment to the principles of free trade. But I get a feeling that it will continue to be met with indifference. So tell me again, are trade talks really about freeing trade?
Source: Straits Times
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