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Wednesday, January 14, 2004

Europe's Latest Population Data

No really remakable news, the general tendency seems to continue to be in this recent report from Eurostat. Of course the highlights are the alarming deterioration in the Accession Countries, and the fact that Spain now accounts for 23% of European immigration and Italy - despite Bossi - for 21%.

According to the first demographic estimates for 2003, published1 today by Eurostat, the Statistical Office of the European Communities, the EU had a population of 380.8 million on 1 January 20042. The population of the euro zone3 is estimated at 306.9 million, and that of the 10 Acceding Countries4 at 74.1 million.

In the EU the population grew by 3.4 per 1000 inhabitants in 2003, due to natural population growth and net migration of +0.8‰ and +2.6‰ respectively. On the other hand, and despite net migration (+0.4‰), the population fell by 0.8‰ in the Acceding Countries, due to a negative natural growth of 1.2‰.

The natural population growth in the EU (live births minus deaths) is expected to decrease from +309 000 in 2002 to +294 000 in 2003, and net migration should be also down, from +1 260 000 in 2002 to +983 000 in 2003. In total, the EU population is estimated to have increased by 1 276 000 in 2003. This is in line with the past few years, but still modest compared with growth in the 1950s and 1960s.

Births and deaths up in the EU, but natural increase down

Live births in the EU are likely to have been 4.03 million, about 1.1% higher than the post-war low observed in 2002. The highest birth rates were recorded in Ireland (15.5 live births per 1000 inhabitants), France (12.7‰), the Netherlands (12.6‰) and Denmark (12.0‰). Germany (8.6‰), Greece (9.3‰), Italy (9.4‰) and Austria (9.5‰) registered the lowest rates. In the Acceding Countries, the highest birth rate was found in Cyprus (11.1‰, the only rate above the EU average of 10.6‰), and the lowest in Slovenia (8.6‰).

Net migration is responsible for over three quarters of the population increase

For 2003 it is expected that the effects of population ageing might start to outweigh the decrease in mortality rates in the EU, with 3.74 million deaths, about 64 000 more than in 2002. The highest mortality rates in 2003 were registered in Denmark (10.7 deaths per 1000 inhabitants), Germany and Sweden (both 10.4‰). Ireland (7.3‰), with its relatively young population, is the Member State with the lowest rate, followed by Luxembourg (8.5‰). In the Acceding Countries, the highest death rate was found in Latvia (14.1‰), and the lowest in Cyprus (7.8‰).

Consequently, the highest natural growth of the population was in Ireland (+8.3 per 1000 inhabitants), well ahead of the Netherlands (+3.8‰) and France (+3.5‰). Three Member States recorded a negative natural growth: Germany (-1.8‰), Italy (-0.8‰) and Greece (-0.1‰). In the Acceding Countries, there was a natural increase only in Cyprus (+3.3‰) and Malta (+1.8‰). The largest decreases were observed in Latvia (-5.2‰) and Hungary (-3.9‰). In Slovakia there was no change due to natural growth.

In 2003, more than three quarters of the increase in the EU's population came from cross-border migration. Spain accounted for 23% of all the net migration to Member States, Italy 21%, Germany 16% and the United Kingdom 10%.

In relative terms, the largest net migratory flows were to Ireland, Portugal and Spain, with +7.0 per 1000 inhabitants, +6.1‰ and +5.5‰ respectively. The Netherlands (+0.2‰) and France (+1.0‰) had the lowest migration rates. Without net inward migration, Germany, Italy and Greece would have seen a decline in their populations.

In 2003, four Acceding Countries recorded more emigration than immigration, in particular Lithuania (-1.4‰), whilst the highest net migration rates were observed in Cyprus (+14.1‰) and Malta (+3.9‰).

EU population growth in 2003: between +0.1‰ in Germany and +15.3‰ in Ireland

In summary, whereas the populations of all the Member States increased in 2003, the changes were notably different. The largest increases were in Ireland (+15.3‰), Spain (+7.2‰) and Portugal (+6.9‰), and the smallest in Germany (+0.1‰), Denmark and Greece (+2.6‰ each).

Half of the 10 Acceding Countries, in particular Latvia (-5.6‰) and Lithuania (-4.5‰), had declining populations in 2003, whilst the biggest rises were in Cyprus (+17.4‰) and Malta (+5.7‰).

Now It's Columbia's Turn

I wouldn't profess to be any kind of expert on the Columbian economy, nor even to know a great deal about it, but I couldn't help noticing this news in Bloomberg today:

Colombia sold $500 million of dollar- denominated bonds due in 2024, the fifth Latin American government this month to take advantage of tumbling debt yields to borrow overseas.

The government sold the 8.125 percent bond due May 2024 at 95.154 cents on the dollar to yield 3.69 percentage points over comparable U.S. Treasuries. The sale was co-managed by Citigroup Inc. and Merrill Lynch & Co.

Colombia's sale comes after $3.75 billion of bond sales since January 1 by Brazil, Venezuela, Mexico and Costa Rica, among other developing countries. The yield on Colombia's bond due in 2020 dropped to 8.45 percent before the sale from about 10.85 percent a year ago, according to J.P. Morgan Chase & Co., as demand rose for emerging-market debt with U.S. interest rates near four-decade lows.

This news comes on the back of an IMF favourable review of the satndby arrangement on Monday, in which context Anne Kreuger says the following:

"Economic policies for 2004 aim to support a further pick up in economic growth and a continued decline in inflation. The government and congress have put in place revenue and expenditure measures designed to lower the overall public sector deficit to two and one half percent of GDP in 2004. Moreover, the authorities intend to announce a further strengthening of the primary surplus for 2005, with a view to achieving a significant reduction in public debt as a share of GDP by 2010. Monetary policy will continue to be conducted in the context of the inflation targeting framework, together with a flexible exchange rate.

"Colombia's economic reform program and the government's firm intention to maintain the pace of structural reform have helped reduce the risks to the economic outlook. Firm implementation of the program will, nevertheless, remain necessary to lay the basis for sustained growth and improved equity. In particular, the adoption of the revised budget code, the rationalization of Colombia's system of fiscal decentralization and further strengthening of the pension system will be critical to moderate the growth of public expenditure and preserve fiscal sustainability. In addition, steps to broaden the revenue base and simplify many of the existing taxes would contribute to achieving a durable strengthening of public revenues."

Now China Joins The Game

Can anybody seriously be surprised by this after the lamentable performance of the Bush administration in this area.

Mainland Chinese steel companies received a boost on Wednesday after China imposed anti-dumping tariffs on imports of cold-rolled steel from Russia, South Korea, Ukraine, Kazakhstan and Taiwan.

The Commerce Ministry said the tariffs - ranging between 3 per cent and 55 per cent - would become effective immediately. "Dumping of such products does exist, and has caused substantial damage" to China’s domestic steel producers, the ministry said.

The tariffs, which would vary for each foreign steel producer China deemed was selling cold-rolled steel at below-market prices, would last for five years retroactive to September 23 of last year. The decision to impose the tariffs was originally made on that date, but was not enacted because of what the ministry only explained as “a special situation.” China will begin levying the tariffs on Wednesday.

Class A shares of Baoshan Iron and Steel, China’s top steelmaker, rose 0.26 percent to Rmb7.79, outperforming the benchmark Shanghai composite index, which dropped 0.94 per cent to 1,597.48 by midday on Wednesday. Shares of Angang New Steel, whose shares trade in Hong Kong jumped 5.77 per cent to HK$4.125.

Government reaction from China’s Asian trading partners was muted. South Korea was unfazed by China's decision because the move exempted Posco, Korea's top steelmaker. Posco was excluded from the tariffs because the price at which it exported cold-rolled steel was not more expensive than how much it sold the steel domestically. Three South Korean steelmakers - Union Steel Manufacturing, Hyundai Hysco and Dongbu Steel - would be subjected to the tariffs.

In Taiwan, government officials said the tariffs would not have a substantial impact on the country’s steelmakers since the majority of their exports to China were re-exported and exempt from the tax. Imports from China Steel, the country’s largest steelmaker, will be subject to a 24 per cent tariff, while its subsidiary Yieh Loong Enterprise will be taxed at 8 per cent. Tariffs for Kao Hsiung Chang Iron and Steel Corp, the largest exporter of cold-rolled steel to China, will be 14 per cent.
Source: Financial Times

All At Sea And Bereft Of Strategy

That's the painful and delicate situation that the French and German governments find themselves in right now. Simply sending a 'strong signal' about the need for stability is about tantamount to (and probably worse than) doing nothing. Whilst an 'optimistic' and relaxed Alan Grenspan gave a polished performance in Berlin (he is of course the greatest man of the theatre of them all) the atmosphere here in Europe is begining to border on panic. While Greenspan waxed about how"There is, for the moment, little evidence of stress in funding U.S. current account deficits," and how the widening to record levels of the ratio of current account deficit to gross domestic product had been, "with the exception of the dollar's exchange rate, seemingly uneventful", US Treasury securities price rose, sinking yields to three-month lows , offering the promise of continuing low mortgage rates and thus continued support for the US housing market. Now, as I am indicating, everything in the US garden is far from Rosy, but at least they have a strategy which bears some relation to the underlying reality, and they are determined to enforce it.

Over here in Europe the reaction to the rise is belated, there is little understanding of the what the game is about, and there is a complete absence of adequate policy. Asking the US to accept deflation so Germany can avoid it simply doesn't seem credible in my book. Where all this will end I do not know. But the endgame doesn't look too pleasant.

France is co-ordinating efforts with Germany to ensure that next month's meeting of Group of Seven finance ministers sends a strong signal on the need for stability in the currency markets.

My feeling is that we won't see any big change in exchange rates now ahead of the G/, but that next week, possibly after an initial hesitation, we will see the dollar decline continue it's course.

But both countries are facing an uphill task in persuading the US administration of the need for G7 action to correct the steep decline in the dollar against the euro.

European officials said the two sides were holding increasingly antagonistic views. European governments and central bankers are increasingly concerned about the problem while US officials insisted there were no grounds to act.

The growing rift was highlighted on Tuesday when Alan Greenspan, chairman of the US Federal Reserve, played down the dollar's weakness and repeated his view that he saw no problem in funding US deficits.

His comments came just a day after Jean-Claude Trichet, the European Central Bank president, signalled his disquiet at the euro's rise against the dollar, insisting it had been "brutal" and a sign of "excessive volatility".

Speaking in Berlin, Mr Greenspan said he saw "little evidence of stress funding US current account deficits". He said the dollar had fallen broadly against other currencies.

He conceded that the dollar's steep decline had put eurozone exporters under pressure but noted it was not fuelling inflation, which remained "quiescent", or endangering the global recovery.

His comments drew heavily on speeches he made two months ago when he stressed the dollar's decline had created no "measurable disruption" and warned it was vital to thwart creeping protectionism.

Gerhard Schröder, the German chancellor, is understood to have expressed unease about the "abrupt exchange rate movements" during a meeting with Mr Greenspan. "He is not watching this without concern," said an official.

In Paris, Francis Mer, the French finance minister, told the national assembly that France would try at the G7 meeting - to be held in Boca Raton, Florida, on February 6 - "to send the correct signals to the markets . . . it is not the euro which is strong but the dollar that is too weak."

Over the past year the euro has risen more than 20 per cent against the dollar. European policymakers fear that the relentless rise of the euro could put the eurozone's fledgling export-led upturn at risk.

But European officials said initial work on a G7 draft had shown the US was concerned about any language that could cause the dollar to rise again.
Source: Financial Times

Tuesday, January 13, 2004

Latin America's Greatest Game

It's not soccer, it's debt negotiations. And Argentina is playing the mother of all matches.

The situation, as it stands, is simple: Argentina owes above a hundred billion dollars to foreign private creditors, and it's offering to pay about 25% of it. Creditors refuse the offer, and there are we, in a stand-off of sorts. But a number of factors complicate this simple picture.

Given his nigh-hegemonic political power, the Argentine position is actually President Kirchner's. Lacking (at least so far) a peronal power structure, he needs internal support and cash (to pay for the social programs) in the short term, and a growing economy in the middle term. Thus, it makes sense for him to keep the IMF/World Bank obligations and offer a very small sum to private creditors: it maximizes surplus resources and internal support (the debt is a very politically charged issue in Argentina) while keeping open the doors for future loans that will finance Argentina's growth beyond the next year. Don't let the rhetoric fool you: it's a rational position, as far as it goes.

Creditors, of course, want as much of their money as they can get. Their actions are based on how much they expect the Argentine government will ultimately be willing or forced to pay. So far, they seem to think that it's going to be around 65% of the debt, although probably via (unprecedented in scope?) judicial procedures that the Argentine government is trying to pre-empt by denying the representative nature of currently engaging groups.

The critical questions shaping the future of the Argentine debt issue are then:

Q1: Could/Will judicial actions asssure payment above the
government's offer? If so, creditors are going to get what
they want, and Kirchner's is going to be in deep political

Q2: Could/Will the Argentine offer be used as a precedent
in other cases? If so, and judicial measures fail, creditors
are never going to accept the 25% offer, as it would
drastically slash the value of the global emergent debt

Q3: Can Kirchner's internally-generated support and
surplus outlast the Argentine bonds and the country's
need for investment? If they begin to depreciate quickly
enough, judicial actions seem ineffective and the offer is
not seen as a too-dangerous precedent, then investors are
going to take the goverment's offer, cutting their losses so
to speak. On the other hand, if the country begins needing
external cash to keep up with demand -for example, if soy
prices drop too much, then external financing will be
unavoidable, and creditors will force better terms.

The answers to these questions will determine, I think, the resolution of this issue, perhaps one of the most critical conflicts going on in the financial world today.

French Industrial Production Disappoints

There is little sign of recovery in the latest data from France:

Industrial production in France, Europe's third-largest economy, unexpectedly declined in November, snapping two months of gains as makers of consumer goods and cars reduced output.

Production fell 0.4 percent from October, when there was a revised 0.8 percent gain, the Paris-based statistics office said. Economists had expected a 0.1 percent increase, according to the median of 23 forecasts in a Bloomberg News survey.

The drop in French production contrasts with a 1.3 percent increase in Germany, Europe's biggest economy, in the same month and suggests growth in France may have slowed in the fourth quarter. Both exports and imports declined in November, the customs department said today. The drop in imports indicates that demand within France may be faltering.

``Consumer spending hasn't shown any signs of taking off, investment hadn't picked up at the end of 2003, and while exports are being helped by global economic growth, the euro is holding them back,'' said Ernest-Antoine Seilliere, president of Medef, a Paris-based employers' federation representing more than 700,000 companies.

Both France and Germany are recovering from a first-half slump as global growth accelerates. France's economy will probably grow 1.7 percent this year after 0.2 percent expansion in 2003, Medef predicts. Germany's government forecasts growth of between 1.5 and 2 percent this year after a third year of stagnation in 2003............

In France and Germany, there are few signs of a recovery in consumer demand at a time when the euro's appreciation against the dollar threatens to slow export growth. Consumer spending accounts for more than half France's gross domestic product and declined the most in seven years in November.
Source: Bloomberg

In Good Company

Alerted by Michael in the comments column, I went over and checked out Steven Roach. It appears we are singing from the same hymn book on this: even down to the twin forces behind the productivity surge - outsourcing, and IT enebled connectivity - and the idea that there is a "powerful leakage in the system". And while the leakage continues, of course, Europe continues to be pushed at the sharp end. Bravo, nice to see someone really 'gets it'. Now what is needed is some serious thinking about the global policy implications of all this.

The Great American Job Machine has long powered the US business cycle. It drives the income growth that fuels personal consumption. That internally generated fuel is all but absent in the current upturn. The US economy is mired in a jobless recovery the likes of which it has never seen. This has profound implications for the economic outlook, the political climate, trade policies, and the global business cycle.

Contrary to popular spin, the US labor market is not on the mend. In the final five months of 2003, a total of only 278,000 new jobs were added by nonfarm businesses — a gain that is easily matched in a single month of a typical hiring-led recovery. Moreover, literally all of the job growth that has occurred over this period has been concentrated in three industry segments — temporary staffing, education, and healthcare — which collectively added 286,000 positions in the final five months of last year. The “animal spirits” of a broad-based hiring-led revival by US businesses are all but absent. Jobs may be rising in America’s low-cost contingent workforce (temps) and in high-cost-areas that are shielded from international competition (health and education), but positions continue to be eliminated in manufacturing, retail trade, and financial and information services.

The modern-day US economy has never been through anything like this. Fully 25 months into this so-called economic recovery, private-sector jobs are still about 1% below levels prevailing at the official trough of the last recession in November 2001; at this juncture in the typical recovery, jobs are normally up about 6%. Had Corporate America held to the hiring trajectory of the typical cycle, fully 7.7 million more American workers would be employed today. Moreover, the current hiring shortfall far outstrips that which was evident in America’s only other jobless recovery — the upturn following the recession of 1990–91. In that instance, it took about 12 months for the job machine to kick back into gear. By our calculations, the current job profile in the private economy is now 2.4 million workers below the trajectory of the jobless recovery a decade ago..............

The global labor arbitrage remains at the top of my list of possible explanations.... It depicts the interplay of two brand-new forces — offshore outsourcing in goods and services together with the advent of Internet-driven connectivity. Such IT-enabled outsourcing has taken on new urgency in today’s no-pricing-leverage climate of excess global capacity. The unrelenting push for cost control leaves return-driven US businesses with no choice other than to push the envelope on productivity solutions. The result may well be a new relationship between US aggregate demand and employment

The “imported productivity” provided by offshoring has become especially evident in IT-enabled services — where the knowledge-based output of a remote low-wage white-collar workforce now has real-time, e-based connectivity to production platforms in the developed world. One of the clearest examples of this is a significant shortfall of job creation in America’s IT and information services industry. In the upturn of the early 1990s, employment in this industry had increased nearly 4% by the 25th month of that recovery; by contrast, in the current cycle, such jobs are down over 1% — even though the US economy is far more IT-intensive today than it was back then. At the same time, knowledge professionals’ headcount in India’s IT sector has risen from 50,000 in 1990–91 to an estimated 625,000 workers in 2002–03.

I don’t think these trends are a coincidence. More likely than not, they are the flip sides of the same coin — a shift of comparable-quality labor input from the high-wage US services sector to the low-wage Indian services sector. And, of course, this trend is only the tip of a much bigger iceberg, as offshoring now spreads up the value chain to include professions such as engineering, design, and accounting, as well as lawyers, actuaries, doctors, and financial analysts. Long dubbed the “nontradables” sector, the IT-enabled globalization of services is now in the process of transforming this vast sector into yet another tradable segment of the US economy — posing a formidable challenge to the once unstoppable Great American Job Machine.

There can be no mistaking the important implications of this jobless recovery. Lacking in job creation as never before, it follows that there is equally profound shortfall of wage income generation. Normally, at this juncture in a US business cycle expansion, private wage and salary disbursements — fully 45% of total personal income and easily the largest component of household purchasing power — are up by 8% (in real terms). Yet 24 months into the current expansion, this key slice of income is actually down nearly 1% — the functional equivalent of about a $350 billion shortfall in real consumer purchasing power............

Unfortunately, the theory behind such a cyclical dynamic just isn’t working. Starved of job creation and wage income generation, consumers need supplemental sources of growth. To date, America’s monetary and fiscal authorities have been more than happy to comply. The Fed has provided the interest-rate support to asset markets that drives the wealth effects underpinning consumer demand. Washington’s penchant for deficit spending has also provided an extraordinary boon to household purchasing power. Yet there’s little opportunity for removing these life-support measures. To the contrary, until the economy kicks in on its own, the monetary and fiscal authorities could well be called upon to keep upping the ante. Therein lies the conundrum: With the Fed’s policy rate now near zero and America’s budget deficit at a record, the authorities are all but running out of options.

In the end, America’s protracted shortfall of jobs and internally generated income has created a new and powerful leakage in the system — a leakage that ultimately renders traditional multiplier effects all but inoperative. Not only does that draw into serious question the case for a cumulative and self-sustaining recovery in the US economy, but it could well elicit dangerous policy responses from Washington. Jobless recoveries unmask the false foundations of a cyclical upturn. That’s precisely the risk financial markets are missing.
Source: Morgan Stanley Global Economic Forum

Turkey On The Ramp?

If my demography thesis can really hold water, we should be able to look to trends beyond China and India for additional confirmation. I have already been playing around with Turkey and Brasil as potential beneficiaries of the transition for some time now (and I have been meticulously nay-saying Russia, and the transition economies generally, for similar, but of course diametrically opposite reasons). Now it is heartening that Morgan Stanley's Serhan Cevik seems to be among the converted, at least as far as Turkey goes. Incidentally note his estimate of the 30 - 50% gain in productivity necessary to move workers from the informal to the formal economy, this is coming up in a later post.

The Turkish economy will continue to grow at an above-trend speed, we believe. Turkey’s gross domestic product increased by 5.4% year on year in the first three quarters of last year, after rising by 7.8% in 2002. With far-reaching economic and institutional reforms unlocking the country’s full potential, we are witnessing a paradigm shift in progress, and expect the economy to grow at an above-trend pace in the foreseeable future (see Everything’s Gonna Be All Right, December 12, 2003). Of course, Turkey is still in the early stages of economic and financial convergence, but the latest data show that structural changes in the economy and political consolidation have started to yield promising results. In our opinion, the remarkable growth performance is no longer a story of cyclical recovery, but driven by productivity gains and a significant compression of real interest rates.

A discernible improvement in the rate of productivity growth has been an important factor in the strength and duration of the current economic expansion. Labour productivity in the manufacturing sector rose by 8.0% in the third quarter of 2003, up from an average of 3.9% in the first half. On a seasonally adjusted basis, the underlying growth of labour productivity increased to an annualised rate of 13.5% in the third quarter, from 9.4% in the first half of 2003. Although Turkey’s private sector has the lead in improving productivity, restructuring measures have also increased labour productivity in the public sector by 23.4% in the last two and a half years. As a result, the rate of overall productivity growth accelerated from less than 4% per annum in the 1990s to 8.4% in the aftermath of the 2001 crisis............

Notwithstanding the economy’s modern segments that display exciting productivity growth, traditional segments remain inefficient and continue to drag down overall productivity growth. The country’s large informal economy is a big obstacle for upgrading production technologies, in our view. Since modern production processes require a larger scale, firms that adopt such technologies cannot maintain the low visibility and mobility that allow them to avoid the taxes and other obligations of the formal economy. Therefore, the state’s failure to enforce the tax and regulatory system in a uniform way imposes a very high tax burden on efforts to improve productivity, since moving a worker from the informal to the formal sector requires a productivity gain of 30-50% just to cover the tax wedge. Macroeconomic reforms may have breathed a new life into the country’s development prospects, but speeding its transition into the ranks of developed nations requires (1) microeconomic reforms that would dismantle the rent-based political economy and (2) investments in education and knowledge that would increase value-added.

And if you think deflationary labour market pressures are only a Chinese phenomenon - take a look at this from his post last week:

Labour’s share of national income might be a better measure of the ‘demand’ gap. In our opinion, the share of labour in national income is an important variable in explaining inflation variation in Turkey. With declining real wages and employment, the labour share of GDP declined from 30.7% in 1999 to 26.7% in 2002 and, on our estimates, to 25.6% last year. Meanwhile, the 30.4% rise in labour productivity led to an unprecedented 37% reduction in unit labour costs. Of course, productivity gains take a while to feed through to higher growth of labour compensation. In fact, productivity gains are not raising demand as much as might have been expected and may even have been delaying the recovery of investment by enabling firms to increase output without expanding capacity. As a result, declining employment and labour income have created a ‘demand’ gap and effectively accelerated the pace of disinflation despite rapid economic growth in the last two years............

The death of inflation would mark a historic turning point. Turkey has suffered from high and variable inflation rates for over three decades, and thus achieving a single-digit inflation rate would signal the arrival of economic stability. Of course, the end of the road is still far away, and achieving price stability in a country with structural infirmities and a long history of macroeconomic instability requires policy consistency. Nonetheless, macroeconomic developments have shown that the country has an exciting long-run capacity for economic growth, and a benign global outlook should help to maintain an above-trend job-creating expansion and disinflation in the direction of the year-end inflation target. However, to sustain the growth and disinflation performance of the last two years, the authorities must keep implementing economic and institutional reforms.

Sustainable Deficits?

The Economist has a piece again this week on the US Federal Deficit situation. Two questions stand out. Firstly if all this is so clear in the US case, why is no-one (apart from Edward Hugh that is) yet talking about possibility of third world style financial crises? All the problems of fiscal deficits looming ever larger in the future are there for all too see, as are the fiscal liabilities of health and pensions (indeed our problems are potentially much worse). So what is it, why can't we see?

Secondly, just how viable are the case of the "others are thinking more seriously about the choices" safety line. One of these alternatives is a serious hike in taxes, well just how realistic is this alternative in a globalised world were jobs can re-locate at the click of a mouse. I do not doubt the US has some room to raise taxes, but by how much. We are already talking of those "weaknesses in the US labour market", just how much weaker will that become if the cost of each job suddenly takes a jump upwards? It would at least be nice to see some studies on this. As with the rising participation possibility (and my obesity post yesterday) all of this makes for very interesting conjecture, but where exactly is the evidence?

Between 1998 and 2001, America's federal government ran a surplus on its accounts. The prospect now is of years, even decades, of deficits. Is that scary?.........

A new and frank report by the Congressional Budget Office (CBO) shows that rising health-care costs and an ageing population mean that federal ?entitlement? programmes?notably for Medicare, Medicaid and Social Security (pensions)?will claim a much higher share of the country's economic output over the coming decades. Currently, Social Security funds run a surplus that helps to finance other parts of government. But by 2015 surplus will swing to deficit, and by 2030, on current policy, the cost of Social Security will have risen from 4.2% of GDP to 5.9%.

Spending on pensions pales in comparison with health care. The range of estimates is necessarily vague, since they involve assumptions about the future rate at which health-care costs will grow faster than per-head GDP each year: since 1970, the ?excess-cost growth? for retired people on Medicare has been around 3%. The CBO calculates that, if future excess-cost growth of both Medicare and Medicaid was only 2.5%, then federal spending on these programmes would jump from 3.9% of GDP in 2003 to 21% in 2050.

It is clear that holding back the growth in non-entitlement (or ?discretionary?) programmes, such as defence and transport, will not be enough to ensure a sustainable budget in the long run. Unless entitlement programmes are cut too, or taxes raised to unprecedented levels, or both, the country is on a financially unsustainable path over the next half-century. ?An ever-growing burden of federal debt held by the public?, the CBO concludes, ?would have a corrosive and potentially contractionary effect on the economy.?

Fortunately, others are thinking more seriously about the choices that need to be made to secure long-term deficit reduction. In ?Restoring Fiscal Sanity?, a report to be published on January 13th by the Brookings Institution, edited by Isabel Sawhill and Alice Rivlin, once Mr Clinton's budget director, three options are offered.

The ?smaller government? path emphasises cuts in ?corporate welfare? (subsidised insurance, loans, etc), the devolution of responsibilities to the states, savings from that old chestnut of ?waste, fraud and abuse?, and deep cuts in entitlements. The ?larger government? path emphasises tax increases as the main route to sustainability. The ?better government? path argues, in Clintonian style, that the government can be more effective without absorbing a larger share of GDP. The problem with this path, as the authors admit, is the difficulty of measuring the effectiveness of various government programmes, and of dealing with resistance to cutting them.

Given such resistance, it is more likely that higher taxes will play the largest part in plugging the deficit. The question, then, is whether the process of plugging begins sooner or later. Either way, Americans will soon have to accept that federal spending is rising to a permanently higher level, one closer to European levels of government spending. Perhaps they can soften the shock by taking their holidays in Paris.

Final thought: "one closer to European levels of government spending". But isn't that precisely what is supposed to be having to come down. Doesn't anyone understand anything here, or does it suffice that we simply have a good laugh at each others expense across the watery divide? All of this seems to forget one big and important thing: the rest of the world exists, and it isn't standing still.

China Growth: The Directors Cut

OK, for those of you who know what do do with it, China growth 2003 the 'directors cut' is here. China's economy officially grew 8.5% in 2003. Gross domestic product had its biggest annual gain since 1997: the world's sixth-largest economy managed a mere 8% in 2002. Xie Xuren, commissioner of the State Administration of Taxation, also informed a press conference in Beijing that fixed-asset investment which constitutes about a third of China's economy grew by 35%, and industrial production by 17%.

Now these numbers may be far from accuracte, however there is one interesting question to ask the growth sceptics: if the numbers are so inaccurate, is there any method to the madness? That is, is the error bias systematic? Or is it all just random? Because if the bias is sytstematic we should be able to do some triangulation and get some idea whether we're going north or south. I buy this latter argument, and so while I couldn't put my hand on my heart and say that 8.5% is the truth, the whole truth and nothing but the truth, I would be prepared to wager that growth last year was more than 2002, and that growth 2004 will probably be more than growth 2003. But that's just me.

Booming investment and production are helping China grow fastest among the 10 biggest economies. They're also raising concern about gluts forming that may force companies to discount. Standard & Poor's last month said markets including autos, consumer goods and property are at risk of oversupply

``With economic growth at the pace it has been the last two to three years, there is a certain nervousness whether the economy is overheating,'' said Ian Strickland, managing director of B&Q China, a home-improvement retailer with 15 stores in China. The company, a unit of London-based Kingfisher Plc, has invested $300 million in China in the past four years.

Peugeot and Chinese partner Dongfeng Motor Corp. said last week they plan to spend 600 million euros ($766 million) on plant and machinery to double their venture's production capacity to 300,000 vehicles by the second half of 2006. The partners plan to introduce their first Peugeot model, based on the French automaker's 307 compact car, this quarter.

Peugeot, Volkswagen AG and other overseas automakers have poured an estimated $20 billion into China, which is forecast to overtake Germany as the world's biggest automaker after the U.S. and Japan in the next two years. Production of cars, trucks and other vehicles will increase by a third to 6 million units by 2005, China's Association of Automobile Manufacturers predicts.

``Massive production capacity has created some worries,'' Standard & Poor's credit analyst Maria Bissinger said last week in Frankfurt. ``Profitability will drop over the next five to eight years on pressure from competition.''

At the same time as prices of cars, fridges and computers are falling, manufacturers' costs are rising as demand for raw materials increases. The cost of iron ore jumped 36 percent in November and prices of steel construction wire rose 24 percent, the statistics bureau said last month. Autos were 4.6 percent cheaper and home-appliance costs fell 2.3 percent.

The state has already tightened rules governing lending to property developers and aluminum makers to curb investment, and in September raised banks' reserve requirements to help damp loan growth. M2, the broadest measure of China's money supply, grew faster than the central bank's 18 percent targeted rate every month this year.
Source: Bloomberg

Monday, January 12, 2004

Free Money From the Fed

OK here's the Andie Xie argument. I don't go along with all of it, but it is interesting:

Why can East Asian countries not appreciate their currencies against the dollar to contain the bubble? The reason is that US consumers determine Asian currency values. The region?s development model involves wedding the OEM or outsourcing model to its surplus labor. This model has no pricing power until the surplus labor has been exhausted ? a distant prospect considering China?s huge pool of surplus labor. If Asian governments allow their currencies to appreciate with the Fed policy cycles, their productive sectors would suffer huge swings in profitability, causing the cost of capital to be too high for rapid economic development.

East Asia is usually in good shape when either the US economy is doing well or the dollar is weak. When both happen at the same time, the region ends up in a serious frenzy. This was the case in 1993 following the yen?s 20% appreciation against the dollar during 1991?93; the Hang Seng Index doubled during that year but had to struggle in 1994.

While the fundamental relationship between the US demand side and the Asian supply side has not changed, the distribution of the Asian supply side has changed. Since the OEM model is based on cheap labor, the economy with the cheapest labor determines where benefits from US demand go. China is the only direct beneficiary of the US demand stimulus and the cheap dollar, as its vast pool of cheap labor quickly sucks in the supply side from the surrounding economies and then some.

China?s economy is, therefore, the most leveraged to the Fed policy, more than the US economy itself. Other Asian economies benefit from Fed policy by exporting to China, mostly capital goods to expand its supply side. The combination of capacity expansion and rising exports creates a super-buoyant Chinese economy. Deflation disappears for the time being. This is why bad companies become profitable at times like this. As investors extrapolate the current profitability into the future, stock prices shoot up. But the current profitability is just a cycle-peak phenomenon, in my view. When either the US economy weakens or the dollar strengthens, I believe stocks will return to where they came from.
Source: Morgan Stanley Global Economic Forum

Euro Reaches New High During The Day

There is nothing really especially important in this, since it is set to continue dayu after day at the moment. It is interesting however to watch M. Trichet trying to find a way to position himself. Today he said that "brutal moves'' in the currency are unwelcome. Now the market is trying to decide how to define the word brutal:

The euro fell from a record high against the dollar in New York after European Central Bank President Jean-Claude Trichet said ``brutal moves'' in the 12- nation currency are unwelcome.

Traders drove the euro almost half a cent lower in five minutes after Trichet said ``we're certainly not indifferent'' to the euro's 22 percent rally in the past year. He spoke following a meeting of central bankers in Basel, Switzerland, after the euro touched an all-time high of $1.2899 earlier today.

``The ECB is finally expressing some concern about the appreciation of the euro,'' said David Durrant, chief currency strategist in New York at Bank Julius Baer & Co., with about $87 billion in assets, in a televised interview with Bloomberg News. The remarks may be ``a catalyst that creates the pause'' in the euro's rally, Durrant said.

Europe's common currency sank to $1.28 at 10:14 a.m. in New York, from 1.2818 late Friday, according to EBS prices. It dropped to 136.48 yen from 136.90 on Friday, when it reached the strongest since July. The euro has set record highs against the dollar on 11 of the past 18 trading days.

Trichet on Thursday said rising demand for European exports was tempering the impact of the strengthening euro. Those remarks ignited a rally in the currency as traders interpreted them to mean the central bank wasn't about to halt the advance.

"There's much more candor in his comments'' today, said Richard Franulovich, a currency strategist in New York at Westpac Banking Corp. The ECB can "slow the trend, but they can't stop it.'' He predicts the euro will climb to $1.35 in six months.
Source: Bloomberg

China's Global Impact

Every day in the postbox I get questions about this and questions about that in connection with China's economy and its prospects, and guess what the first thing I need to make clear is: that the biggest problem in assessing China is that no-one really knows. I do my best, but this is what has to be stated clearly, and up front. And anyone who says they do know is a charlatan. You see we are out of the realm where text book economics - with it's all its emphasis on comparative statics (taking two or there variables and examining how they interact locally) - can be of much help. What we need is some complex comparative dynamics, but all the mathematical models we have to date lack capacity to adequately capture this, so we are back to good old human brain power, and trying to perform those lovely pattern-recognition heuristic exercises that we may in fact be better at than we like to recognise.

This in my view is why Stephen Roach finds himself having so much to say on China, not because he is a good theoretical physicist who has moved over to see what he can do with economics, but precisely because he isn't. He is an economist from the old school, not a lot of theoretical luggage, but an intuitive capacity to keep more than three balls in the air at a time and to do some 'now what if' reasoning exercises on the fly. The fact that he works for a company called Morgan Stanley is decidedly besides the point here, IMHO.

If you want to know the kind of approach to science that I am advocating, you could do worse than pick up a copy of How Nature Works by the Danish physicist Per Bak: low tech, low budget physics with powerful results. Now what I am advocating for economics is more low tech, low cost thinking, putting human brainpower back were once there were only equations and computer models. Oh yes, and spending money on qualitative research to try and get a better understanding of how people actually relate to economic phenomena. I guess what you have here is something like a programmatic statement.

So now for the hard nut: China. Now you are probably aware that I place a great deal of emphasis on demography. I argue not that economics is 100% demography, but simply that it forms a far higher percent of the explanation than people like to think. If we had been able through policy to aid the third world better in reducing the demographic explosion, my guess is that we would have seen economic growth taking off much more rapidly all over the place.

Equally if we were now better able to handle the problems of diversity, identity etc, and manage better the global migrant flows, we would be able to do much more to steer the ageing OECD economies.

Now China, IMHO, is going to have a very rapid, exceptionally rapid, zoom upwards, but if you look at the population structure, this can equally rapidly come screeching to a dead stop at some point, as the structural imbalances lock-in. All this, of course, is still some years out in front of us.

The dominant factor right now will most likely be one long expansionary wave. (Incidentally I don't know how many of you have ever heard about wave theory in economic development, a lot of this material is frankly cranky, but just off the top of my head now, there must be some relatively simple way of squaring identified wave phenomena with demography, and demographic cycles. Nobel economist Samuel Kuznets did this for immigration flows and the US business cycle in the first half of the 20th century in some now long forgotten work, and my feeling is that one of the big unsung stories of current US growth is that the Kuznets cycle has reared its head again).

Now, one long expansionary wave doesn't mean no ups-and-downs. And it is here that the problems may well come, and not simply for China. So let's step back and think about it.

You see China isn't only important for its internal growth it is important for its impact globally: agriculture, industry , raw materials etc. It is an important source of both demand and supply. And China is increasingly becoming a price setter, not a price taker. (The only real exception would be the knowledge economy, where it seems likely that India is going to become the price setter). Here again competitive-markets theory seems to be called and found wanting - we shouldn't have price setters: and the nation state is perhaps the most important source of market distortion there is.

Now this is a big turnaround from twenty, even ten years ago. In those days the OECD were really the price setters, using not intellectual property rights, but tacit knowledge, available capital and educated workforces to leverage world markets. But the really the big news of the 21st century is that this no longer works like this. An analysis of the recent globalisation process still remains to be done, but when it is I will suspect that we find a first and a second wave.

During the first wave globalisation was undoubtedly more advantageous to the OECD world than it was to the third world as a whole. Nearly everyone it seems (with the exception of what are called the LDCs) benefited to some extent, but you needed some pretty cute statisticians (like Xavier Sala i Martin) to be able to find the difference.

The second wave is very different: a whole squadron of newly developing countries - and not simply 4 Asian tigers - are arriving on the global stage: China and India are obvious, but who knows what comes behind Brazil, Turkey, Indonesia?

In part this is demographic. More and more countries are jumping through the window of opportunity. But in part it is also to do with the shift between an industrial and an information/knowledge-based society. Put simply in this latter human capital is much more important than fixed capital. What you need is a computer, a fast internet connection, and an educated person. And it is here that the comparative advantage, that well worn Ricardian notion, has shifted: the third world is rich in people, is even richer in young ones, and the education costs are cheaper here. What'smore the ICT revolution means that most of the world's richest markets are only one mouseclick away. How can anyone seriously imagine that the game hasn't changed?

Now let's look at China impacts. China's take-off has been so big that the rest of the world has been gradually sucked in. In Latin America this is obvious: Marcelo and I (here and here) have been posting about the Soya in Argentian and Brazil, and the copper in Chile. The impact on Argentina has been such that they have been effectively able to meet their internal social obligations, start the growth process again, and thumb their noses and the international debt community. It should not escape the notice of the collective consciousness that it is China not the IMF which is effectively giving the lifeline to the victim of the most important financial disaster of recent years.

If we look at the rest of Asia we find the same picture: Eddie Lee and Stephen Frost have been posting about this. As regards the United States Andy Xie has been flagging the fact that China is the main beneficiary of Fed easing, whilst the whole outsourcing debate and the alleged Walmartisation of the labour market shows another side of the impact. Meantime the other Walmartisation dimension means that the American working classes are living well and cheaply, with all the produce they are buying from China.

So this is why I think all these comments about the China growth numbers being false are completely beside the point. Sure we have no idea what the real growth rate in China is, and an overall growth rate may be entirely irrelevant: what matters is the rate of growth in tradeables, and that, as everyone can see, is enormous. This is why there is the impact.

Is this sustainable? As I say we are on a long wave, the water-table just tipped towards Asia, and the part that isn't going to India is draining off into China. So I feel there is more slack out there than people imagine. I mean most models of the global economy are based on something called 'trend growth' and whether you are above or below the line. But it is a charecteristic of the kind of fundamental uncertainty we have currently that you have no idea what trend growth is, either in the OECD, or in India and China. So we have no criteria by which to measure something like 'overheating' for China, or say 'sub-par' in the cases of Germany and Japan. Everything is up for grabs: and it would be a brave person or a very foolish one who would rush in and pronounce under these conditions. Sure there will be bottlenecks, local bubbles etc, but how generalised will these become. Those predicting disaster may be in for some rude surprises.

What is clear is that in this long wave expansion there will be normal business cycle fluctuations, even if we can't see their reach and extent. China will go now slower, now more quickly, but the impact of this I am suggesting will more probably be outside China. It is here that we should expect the real problems and the real surprises. The China impact can only be handled globally.

The Price of Obesity

OK this story is interesting and I'll try and get round to a bit more later: meantime I just posted this over at Fistful:

Economist for Dean Lerxst gets hold of something really interesting in a post yesterday ( which Calpundit also picks up on). He draws our attention to the fact that some US economists have recently been arguing that there has been a significant rise in individuals claiming disability benefits and this has taken a large number of workers out of the labor force, thus - at a stroke - reducing the "official unemployment rate". The research by Mark Duggan and David Autor is discussed in a NYT op ed by University of Chicago Professor Austan Goolsbee.

Lerxst also highlights the significant role obesity may play in this. He cites an article in Friday's Wall Street Journal describing a new study by RAND Health economists showing that obesity may actually be the "primary" explanation for the rise in the disability rolls. According to Dana P. Goldman, director of health economics at Rand and the principal investigator on the study cited in the WSJ there is "evidence to support (the idea) that obesity may be a primary reason."

| Continue reading...
Now all of this is extraordinarily interesting. Not least for us Europeans, since anyone over here in Europe knows that this kind of thing has been an issue for years in our employment numbers. The Netherlands, which allegedly had a 2% official rate, but notoriously had a real rate of anything from 5% upwards depending on how you interpret the stats, had very substantial numbers of people on disability allowances.

This phenomenon is obviously partly demographic: as your workforce gets older more people are liable to become disabled, and as Lerxst points out with medical advances more people survive who may not have perfect health. But it can also be encouraged by employers who want to practice 'age churn' and political administrations who want to 'mask' existing unemployment. It is in this context that I don't see the practical viability of all these policy pronouncements about easying the demographic impact by encouraging higher participation rates among older workers: their existing employers don't want them, and they don't want to do the low paid jobs (see Japan here) that they are offered.

Incidentally, as a European, I'd like to personally protest about all the mud that is thrown at us about our welfare states. Unfortunately most of our welfare states are going to disappear in their present form because our demography makes them unsustainable, not because they weren't nice things to have in their day. Now it turns out that US job numbers have been being massaged all through the 90's...now come on, let's not try and have our cake and eat it. A little less hypocrisy please!

The reality is that we didn't have a mild recession. Jobs-wise, we had a deep one.
The government reported that annual unemployment during this recession peaked at only around 6 percent, compared with more than 7 percent in 1992 and more than 9 percent in 1982. But the unemployment rate has been low only because government programs, especially Social Security disability, have effectively been buying people off the unemployment rolls and reclassifying them as "not in the labor force."

In other words, the government has cooked the books. It has been a more subtle manipulation than the one during the Reagan administration, when people serving in the military were reclassified from "not in the labor force" to "employed" in order to reduce the unemployment rate. Nonetheless, the impact has been the same.

Research by the economists David Autor at the Massachusetts Institute of Technology and Mark Duggan at the University of Maryland shows that once Congress began loosening the standards to qualify for disability payments in the late 1980's and early 1990's, people who would normally be counted as unemployed started moving in record numbers into the disability system — a kind of invisible unemployment. Almost all of the increase came from hard-to-verify disabilities like back pain and mental disorders. As the rolls swelled, the meaning of the official unemployment rate changed as millions of people were left out.

By the end of the 1990's boom, this invisible unemployment seemed to have stabilized. With the arrival of this recession, it has exploded. From 1999 to 2003, applications for disability payments rose more than 50 percent and the number of people enrolled has grown by one million. Therefore, if you correctly accounted for all of these people, the peak unemployment rate in this recession would have probably pushed 8 percent.

The point is not whether every person on disability deserves payments. The point is that in previous recessions these people would have been called unemployed. They would have filed for unemployment insurance. They would have shown up in the statistics. They would have helped create a more accurate picture of national unemployment, a crucial barometer we use to measure the performance of the economy, the likelihood of inflation and the state of the job market.

Friday, January 09, 2004

Wow, This is Surprising

Now the cynics will say this US Labour Department report it isn't surprising at all, and ask me what the hell I am talking about, well I'll tell you, I had actually expected the momentum to continue for another couple of months before tapering off. This is relatively dramatic after the powering ahead of recent months. And of course, now the interest rate is really pinned down near ground level as far ahead as the eye can see. Looks like another bruising week ahead for the euro.

American employers barely took on any new workers in December, a disappointing government report on Friday showed, indicating the economic recovery has yet to translate into sustained jobs growth.
The unemployment rate fell to 5.7 percent, the lowest level in over a year and down from 5.9 percent in November. But this was largely due to people leaving the workforce, according to the Labor Department's report.

The number of workers on U.S. payrolls outside the farm sector in December increased by just 1,000, after a downwardly revised rise of 43,000 in November. It was the fifth consecutive monthly rise but was far worse than economist expectations of a rise of 130,000. The poor report will likely be a headache for President Bush (news - web sites) as he seeks re-election in November with the economy -- specifically job creation -- expected to be a key issue in the run-up to the vote. "This is a very disappointing jobs report," said John Person, head financial analyst, Infinity Brokerage Services, Chicago. "One component to prove that the economy is on a solid path to recovery is an increase in jobs." The dollar fell and U.S. Treasury bond prices rose after the report. The data will likely reinforce expectations that the U.S. Federal Reserve (news - web sites) will keep interest rates on hold at 45-year lows at its next policy meeting on Jan. 27-28, and for some time after that.

"The good news is that there is absolutely no pressure on the Fed to raise rates any time in the foreseeable future," said Edgar Peters, chief investment officer, Panagora Asset Management Inc. The jobless rate had been forecast to hold steady at 5.9 percent. The Labor Department, though, said there were 433,000 "discouraged" workers in December, who were not looking for work because they believed no jobs were available. Economists had been expecting a more robust rise, encouraged by a reasonable holiday shopping season and a drop in filings for jobless benefits in December. However, the report showed a 38,000 fall in hiring in the retail sector, which the department said was due to general merchandise stores taking on fewer workers than usual.

The troubled manufacturing sector failed to break its job-cutting trend, shedding 26,000 jobs in December, the 41st month of declines. Some economists, pointing to recent data suggesting a turnaround in manufacturing, had predicted factories would finally take on new workers in December. In another bad sign for job seekers, the number of hours worked per week dropped to 33.7 from 33.9 in November. The average work week had been expected to climb to 34.0 hours. Employers often increase the amount of hours worked by existing workers before taking on new hires. One bright spot in the report was hiring in construction, which was up 14,000. The building industry has boomed as low mortgage rates have fueled home buying.

Current Trends Are Unsustainable

Economist for Dean Steve Kyle had a post on the dollar as a reserve currency issue the other day, and I put up a couple of comments. In particular I was infuriated because I discovered inadvertently what I consider to be a scandalously irresponsible piece by Paul Krugman where he simply side-steps the whole question of the structural problem of having a given reserve currency in a continually changing world, and reduces it to a paying in dollars or paying in euros issue Steve subsequently wrote to me, and I am now posting his mail. He seems to have understood the problem, the danger is the hard landing, not the fact of the transition itself. There is a problem of 'money illusion' here: the US is obviously richer than most European economies, but not as much richer as they felt themselves to be. That was an illusion brought on by the exaggeratedly high value of the dollar, and that is the reason why Stephen Roach was constantly going on about the proprtion of global growth being due to the US economy, this was a kind of statistical illusion brought on by the reserve currency status, and if the US was not as rich, then India was not as poor, and the complicated unwinding of this illusion is where the problem is. Incidentally, like everyone else I've been watching US films for years, and it has alwasy puzzled me why, if they were so rich, the US worker didn't appear to be more different from the German one, why, for eample, the characters are forever in these two-bit diners which always seem so seedy, and why when you watch the people working you can't see more evidence of all that extra productivity being generated just in the way they work and the technology they use.

It is indeed a complicated set of issues, and I dont claim to have perfect understanding of what will happen, but that is precisely the problem. To make this clear, a couple of points:

1. I certainly dont agree with Krugman that the only problem is what bills drug dealers have in their pockets. That is small potatoes, though there ARE serious issues of psychology in the long run regarding which is the preferred currency to have in the world - an issue not limited to drug dealers. The issue is what happens on the way to that situation and it is this that makes me nervous.

2. It is this very uncertainty - we dont know what will happen - that is the most reckless part of this economic adventure of ours - that we can even be IMAGINING a global financial crisis brought on by the US is in itself a very scary thing.

3. We know that the current trends are unsustainable - The US government is spending money it doesnt have at the rate of half a trillion a year and climbing as far as the eye can see. We arent even spending the money on investment - it is going to guns, bombs, transfers, and tax breaks to people who, if they are like me, have put all available personal assets into Euro denominated instruments. Our current account more or less mirrors this, since private sector savings are negligible.

My fear (not yet a likelihood, but a visible and positive chance of occurence) is that we will suffer a very hard landing. At the moment foreign central banks seems to be soaking up a large share of what we are emitting. This cannot go on forever though, of course, there is no natural limit to the amount of their own currency these governments (China,
Japan, etc.) can print. Sooner or later, if the supply of dollars keeps growing and there is no reasonable expectation that this flow will cease (on the contrary, it seems to be scheduled to grow indefinitely) even central banks will stop buying dollar assets and the game will be over. What will happen then?

It is somewhat analogous to Triffin's dilemma backin the 50's and 60's - I wrote a paper touching on this a while ago, but the basic problem is more apparent today - How will the transition from a dollar standard (or gold as in Triffin's day) be managed?

You may be right that a deflationary scenario is better and will solve the problem of foreign banks' unwillingness to hold dollar reserves. Certainly they would remain happy if deflation raised the value of those reserves. But the real problem in this scenario is a major depression. And finding our debts to the rest of the world increased in
value while we are going through high interest rates (real rates are bound to be high in any deflationary scenario - perhaps very high) is a recipe for a depression along the lines of some of the adjustments suffered by e.g. Argentina within recent memory. It is one thing for Argentina to do this, but quite another for the US - Were we to lose, e.g. 20% of GDP in a very bad scenario, the consequences for the rest of the world would be pretty awful. (Again, I am not predicting this will happen but the fact that it is within the realm of possibility is not a good thing)

It is certainly the case that reasonable people from all of the important interested parties need to get around a table and figure this out. However, my estimate of the chances for this are much lower than yours. I DONT think that Alan Greenspan is the puppeteer here. Sure, he controls monetary policy, but the Administration cares ONLY about
political advantage. They neither know nor care what will happen beyond the next election. Just look at the caliber of the Treasury secretary now (and the one before) and compare them to Rubin. These guys simply dont
understand international finance. Not even a little bit. There is nobody in the White House who does either. Greg Mankiw certainly is no dummy, but he is out there making statements we all know he doesn't believe, so he is
obviously being a puppet, not a puppeteer.

What I hope is that nothing bad will happen before November and that sanity will return after that point. Even here, though, there is room for doubt. The Republicans (if they win) have demonstrated a complete lack of interest in or understanding of the need for responsible economic management. The Democrats (if they win) might do better but at the moment their posture is one of wanting to spend on DIFFERENT things but not LESS of them. And they will have a very hard time getting a repeal of the tax cuts through Congress, which is very likely to remain Republican (and
perhaps more so).

Well, that is all I have at the moment. - Feel free to post this on your site if you like - Perhaps we could continue the discussion there - I would be interested in hearing what others say. Also, you can look at stuff I have written in the past on my own website

By the way: note the "even central banks will stop buying dollar assets ", this is my endgame to, and if nothing is done before we get there the outcome may well not be pretty.

Incidentally: "a deflationary scenario is better". I'm not really saying this. I'm saying this is what we have. It may be relatively acceptable to those with savings (which is why political change is so slow in Japan, and always imagining that the impact in the equity markets and on the banks isn't too dramatic) but it won't be any fun for the young people who have just accumulated all that debt. There are lots of silly little details I would quibble about here, but in general I think Steve is talking a lot of sense.

Sock It To Me Juan

Probably you may have noticed that from time to tme I refer to Jaun Cole's Blog: Informed Comment. Actually if I want to know what's happening today on the Iraq front it's there that I normally go. I have in immense regard for the blog and the mind behind it. Well it looks like the post xmas atmosphere is leading more people than just me to reflect on where they are going. I could simply put the link, and over you would go, but I'm posting most of it because I agree so much with what he says, in particular the bit about "I dislike the kind of 'consistency' that is based on a black and white view of the world".

I've noticed that others in Blogistan are sometimes puzzled at where exactly I stand on matters. This puzzlement derives in part, I think, from the analytical nature of my enterprise here. I am not a politician. I am not running for office. Good analysis is not black and white. In politics, you are inconsistent if you say you are anti-Bush and then you praise him for something. But in a more dispassionate kind of analysis, it would be foolish to put forward the proposition that W. has done nothing right. Actually I thought many of his initial reactions to 9/11 were well considered, including the Afghanistan War and his determination not to allow Islam per se to be demonized (something he has been criticized for by the Neocons and the Christian Right). Politically, I am probably opposed to 90% of what he has done, including further skewing the tax structure toward the super-rich, gutting political rights with the Patriot Act, etc., etc.. But unlike a politician running against him, I am willing to admit the 10%.

1) I hate Saddam Hussein, the Baath Party, and everything they did to Iraq, including invading Iran, gassing the Kurds, invading Kuwait, and putting tens of thousands of Shiites in mass graves. Because of my friendships with Iraqi Shiites, I lived through the pogroms as they happened, and they got me in the gut. I also have Iranian friends who suffered from the Iran-Iraq War. One puzzled observer said I sounded like a war blogger when I started celebrating the US defeat of the Fedayee Saddam. Probably I did. I hate them. They were the SS of Iraq. Our brave men and women who are out there risking their lives to make sure the fascists can't harm anyone else deserve our praise and support.

2) Because of 1), I declined to come out in opposition to the war. As late as February, 2003, I thought it was still possible that the UN Security Council would authorize the war, which would have made it legitimate in my view. I now think that the terms of the Genocide Convention could have been effectively evoked to justify the war at the UN.

3) When the Bush administration dumped the UNSC and acted unilaterally, it put me in a difficult position. I felt the war lacked legitimacy in international law, thenceforth. Then when Rumsfeld, Wolfowitz and Feith grossly mismanaged the aftermath of the war (I have never, ever, seen such an amateurish, ineffective and frankly screwed up effort in a major foreign policy arena), I grew increasingly disgusted.

4) I think there is a 60% chance that the whole situation in Iraq will go south, and am therefore worried about the consequences.

5) I think the US owes the Iraqis. The US overthrew the Iraqi government and disbanded the Iraqi army, and therefore is responsible for putting the country on a sound footing before just walking away.

So, my position is that getting rid of Saddam was a good thing; and that US troops deserve credit for the efforts they are making to restore security and root out Baath remnants in Iraq; but at the same time, I believe the war was illegitimate in international law and contravened the UN Charter, and that many of the actions of the US in Iraq contravene the international law of occupation. In the end, I think the war was unwise and not justified by the arguments that Bush put forward. But now that it has been fought I want to hold the administration's feet to the fire about not creating a mess and just walking away from it. (That was tried in Afghanistan by Bush senior and it gave us the Taliban and al-Qaeda).

I was struck, when I spoke at MIT, by how one speaker stood up and made the CIA the fount of all evil. Well, I don't think there is any doubt that the CIA has done some bad things from time to time, from the 1953 Iranian coup to the overthrow of Allende, to the sorts of rogue operations that the Church Commission exposed in the 1970s. But the CIA was acting as an arm of the executive for the most part, so one might as well say that the elected presidents were responsible for a lot of bad things. After September 11, I can't tell you how glad I am we have a CIA, and how much I hope the field officers and analysts get up to speed on Arabic and radical Islamism, and are able to prevent further major acts of terrorism against innocent US citizens.

I'd never get elected to anything, even if I wanted to, because I dislike the kind of "consistency" that is based on a black and white view of the world. I think ethics and reasoned analysis require us to have a complex view of the world, not a simplistic one. And, I think ethics always requires us to balance competing and contradictory values (I agree in this with Isaiah Berlin).

"I now think that the terms of the Genocide Convention". I'm not a sufficient expert to judge, but I'd like to think that he was right on this one.

How to Position Myself?

Obviously I'm making no secret of the fact that I'm trying to decide what I think about the candidates in the coming US presidential elections. I think the issue of who is there in the White House from the end of 2004 onwards is an important question. Possibly one of the most important questions facing all of us. Not simply because the United States is a giant superpower, that has long been true. Rather I think it is important because we are going to be facing a set of relatively unique, and certainly novel problems on the global level, and we all need a US president who is focused on those problems, open to dialogue, and capable of gaining the confidence of the rest of the world. Now more than ever we need a coalition of the willing as we try to get to terms with a whole slew of problems which can really only be confronted on a global level: the nation state has, as it were, seen better days. Now given the global rebalancing which I think is taking place, by the time we get to 2008 I don't think the US will still be quite the exclusive super power it was in the late 1990's. The relation of forces is changing, and this can either be done the easy way, or the hard way. If it is done the hard way we might all have a lot to lose, both in the US itself, and in Europe, in China, in India, in Africa wherever.

Now casting around I've been struck by two candidates Clark and Dean: they are obviously both Democrats for the simple reason that we don't have an alterantive on the Republic side, the candidate will be George Bush, and it is the way that Bush has conducted himself internationally which makes me think we need a new US president in the first place. Probably my intellectual leanings are much more in the direction of the democrats, I mean I've had problems swallowing Nixon, I've had problems swallowing Reagan, and now I've got problems stomaching Bush: Harlod MacMillan and Edward Heath were never like this, to cite two more or less right of centre UK politicians who I have had a deal of respect for. Margaret Thatcher seems much nearer the type, but this is precisely the point: I found her bullying manner thoroughly repugnant, I will never forgive her for sinking the Belgrano, and I didn't notice her anti-terrorism hard line stance bringing any real progress in the North of Ireland.

So I wouldn't object in principle to a moderate, dialogue oriented, non-nationalistic republican US presidential candidate: it's just that there isn't one. I think if Colin Powell were standing a lot of us here in Europe would be right behind him. Indeed in my innocence and naievety I had hoped that Bush might have turned out to be something different. I mean 8 years of having the Democrats in power and it was time for a change. Any democracy needs this type of change, and I think in the end the interests of democracy should override the interests of party. But how wrong I was. Of course back then I hadn't heard the term 'neo-con', and why should I have, it's not really my area of interest. In fact it's my ability to get things so wrong here that leads me to try and stick to economic (and related) commentating: I may still get things wrong, but I've a lot more confidence in the validity of what I am saying. I think I have got something useful to say about economics, when it comes to politics I'm never entirely clear.

Take the Iraq war: those who were reading me back then will have noticed I kept my mouth meticulously shut. That wasn't because I didn't have opinions, but simply because I didn't have sufficient confidence in my opinions to voice them too loudly, and I didn't want what I am saying about demography, about which I am a damn sight more clear, to be tainted with my other more questionable 'opinions'. So it was only after the war that you probably realised I had reluctantly supported it. Only when I started in fact to make my own form of 'self criticism' for having got it wrong, or at least for having committed the error of allowing myself to accept Tony Blair's word at face value.

I mean I accepted that there may well have been non-conventional weapons of mass destruction in Iraq, and if that were the case, then I certainly didn't want to stand by and see one of our major cities simply taken off the map, so I felt we had no real alternative. Now I know that the intelligence was probably faulty (also I feel we were all probably sent up the gum tree by the Mohammed Attah/Prague connection, which it now appears may well have been a 'plant'). One of the factors we should probably all have taken much more into account was the immediate interest of certain key Iraqi exiles in provoking an invasion. Still, these are hard calls, and I am sure as hell glad that it is not my responsibility normally to make them. Which is why we need politicians - of whatever party - that we can respect and have confidence in. Which brings me back of course to the WMD's and how we decided to go into Iraq. If I had been told at the time that this was to take democracy at bayonett point (Napoleonic style) to the Iraquis I would never have agreed (more of this in a leter post).

So this brings me back to where I started: Dean and Clark. I have nothing whatsover against Clark, indeed in some ways having an ex-soldier in the White House might be just what is needed to help relax the atmosphere inside the US. But Dean is making more of an impression on me at the moment. All I new about Dean previously was that he favoured gay marriages (which is definitely a plus - oh yes, this may only appear a minor point in internal US politics, but it isn't at all: I don't see how a President who has any kind of second thoughts on the issue of condoms can hope to lead a campaign against AIDS in Africa, and this topic should be right at the top of the agenda for anyone who wants to consider themself any kind of widely respected world leader), and that he had been consistenly against the Iraq war.

On top of these facts people have tried to pour a whole lot of opinions, normally seeing what they wanted to see, depending on their perspective. Maybe the most damaging thing I've heard said is that he was flirting with protectionism: and maybe he was. But if you think about it for two seconds he really can't go down that road: if he wants a return to multilateralism and he wants to rebuild the bridges with America's real allies and reduce the fear in those like China who are not allies, but may not want to be enemies, then you just can't go down the protectionist road, that should be obvious.

In recent days our image of Dean seems to be changing. What we are seeing is a much more centrist Dean, more of a Jimmy Carter than a George McGoven (in fact I think I first read the comparison with Carter in the Economist months ago, which kinda puts in perspective the silly idea that the Economist is an apologist for the Bush administration). Now I know all this is image construction, but isn't that what politics is all about at the end of the day? I don't know whether the content of this article I am posting below is fair and balanced: I certainly hope it is. I cannot guarantee for you that Dean is the "bipartisan, Cold War, leader-of-the-free-world policy Americans know and remember", but again, I certainly hope so.

Dean and the world: the nonradical candidate

Howard Dean has won the hearts of Democratic liberals by opposing the war in Iraq and by slamming his Washington, D.C., rivals as compromisers. It is a fine strategy for the man from Montpelier, Vt., the smallest state capital in America, but it does not mean what many of his followers seem to think.

Dean is not a peace candidate in the George McGovern mold. In 1972, McGovern's stand against the Vietnam War signaled an attitude about foreign intervention generally. In Dean's case, it does not. He supported the first Gulf War and the interventions in Bosnia, Kosovo and Afghanistan.

In foreign policy, Dean compares himself to Harry Truman, the president who authorized the dropping of atomic bombs on Japan and who sent troops to South Korea without a declaration of war. Those are not the things he cites about Truman, of course, but they are part of the Truman toughness.

Consider, also, Dean's advisers. Advisers are important; in 2000, the foreign policy of George W. Bush could be discerned more from his advisers than from Bush, who (like Dean today) had no experience. Dean recently appointed a group of 14 advisers on foreign policy. One, Clyde Prestowitz, worked for Ronald Reagan, and another, Adm. Stansfield Turner, was CIA director under Jimmy Carter. Four are retired generals. Most of the rest are former civilian officials from the Clinton administration.

Dean's identity as the against-the-Iraq-war candidate energizes the Democratic base. It may even keep Ralph Nader at bay as a third-party candidate. It also pleases Bush, because against a flatly anti-war candidate, Bush wins in the latest polling.

But Dean is not Dennis Kucinich, and the Democrats, as James Traub of The New York Times writes, "are not really a peace party."

The real Dean, judging by his prepared speeches rather than his oral flubs, offers something much more like the bipartisan, Cold War, leader-of-the-free-world policy Americans know and remember.

Whether that is the best policy for the post-9-11 world is another question. But at least let us stop pretending that in foreign policy, Dean is something radical. He is not.

Update: the other economist for Dean - Lerxst - has an equally interesting piece about Dean the centrist:

One of the things that I haven't quite figured out is why many of the ex-Clintonites and DLC types are so sure that Dean will be easy to tar by Repubs as an out of the mainstream left-winger, when pretty much his whole record shows him to be more mainstream than the rest of the field. As Dean puts it in a front page Wall Street Journal article:

Thursday, January 08, 2004

The Economist and Japan

You know, this has been obvious for some time now. Oh well, better late than never. One small detail, I have no accurate idea how many immigrants per year Japan would have to accept to maintain even it's current growth, the UN estimated tha scale of the problem as follows: This scenario keeps the ratio of the working-age population to the retired-age population at its 1995 level of 4.8. In order to keep this level of potential support ratio, the country would need 553 million immigrants during 1995 through 2050, or an average of 10 million immigrants per year. Under this scenario, the population of Japan is projected to be 818 million in 2050 and 87 per cent of them would be the post-1995 immigrants and their descendants. As nothing even remotely like is likely to happen, unfortunately we can only assume and imagine the worst. On increasing female participation, this is fine, and I am infavour, but do bear in mind that most assessments also assume the Japanese family model being the basis for an old age support system laking some real pillars: but that assumes that the women are staying at home. As this is definitely not a 'new economy' phenomenon, I assume here you can't have your cake and eat it.

JAPAN is entering a crucial lap in its economic race against time. The good news is that, as it makes the turn into 2004, the economy is riding the momentum it built up during a moderate expansion last year. Real GDP grew by an estimated 2.6% in 2003, according to The Economist's latest poll of forecasters, and is expected to rise by another 2% this year. The bad news, however, is that even though the economy has sped up for a bit, Japan's runaway demographic trends still threaten to leave it in the dust.

The population of 127m barely changed in 2003, rising by fewer than 100,000. The number of births continued its steady slide, with only 1.12m babies being born last year. Japan's 1.03m recorded deaths, meanwhile, were its highest number since 1947. Within only a year or two these two trends are expected to cross, and the population will begin to fall. The combination of a shrinking population and an increasingly elderly one will have a growing impact on everything from demand for goods and services, to public finances, to the structure of the workforce. Within five years, for example, Japan's universities expect to have more available university spaces than applicants.

The effects of these trends on the workforce could be especially dramatic. Although the overall population is just beginning to peak, the number of people in their working years (between 15 and 64 years old) has been falling since 1995, when it reached 87m. The National Institute of Population and Social Security Research forecasts that this age group will shrink to 70m in 2030, and to as few as 54m in 2050. Meanwhile, the number of people aged 65 and over is expected to rise from less than one-fifth to one-third of the population. If Japan cannot find some way to slow this trend, or to mitigate it through new sources of labour or faster productivity growth, it will eventually take a heavy toll on the economy.

One way to bolster the workforce would be through immigration, a prospect many Japanese find unsettling. A report published this week by Robert Feldman, Morgan Stanley's chief economist in Tokyo, does not offer them much comfort. Mr Feldman reckons that, on current trends in demography and productivity, Japan will need to import 5m foreign workers over the next decade (not counting their dependants) just to maintain the current anaemic rate of improvement in living standards. “The numbers of required immigrants are so large”, wrote Mr Feldman, “that they recast the entire debate.”

Japan could also increase its workforce in other ways, such as by making it easier for women and the elderly to take productive jobs. Progress on this front, however, seems much too slow when compared with the speed at which the labour force is shrinking.

If labour reforms and productivity do not keep pace with the demographic challenge, one way in which living standards will suffer is through a squeeze on the social-security system: a daunting prospect in the land of the rising debt ratio. The ruling coalition worked out a compromise last month to raise premiums from 13.6% to 18.4% of employees' pay, while cutting benefits from 59% to 50% of average salaries, over the next decade-and-a-half. It is expected to introduce a bill along these lines in February. Even these changes will not be enough to close the pensions gap without faster economic growth, which will become harder to achieve as tax burdens rise. Japan's reformists might want to pick up the pace.

Trichet's First Play

Again this was probably to be expected. Trichet has a reputation for being an inflation fighter, and may not have felt inclined to drop the interest rate, which would have been the only important thing he could have done. They're obviously still banking on a stronger recovery than I can see coming. OTOH, if you effectively can't do anything it may be better to cover your tracks as carefully as possible.

The euro surged more than 1 percent against the dollar and yen after European Central Bank President Jean-Claude Trichet said the euro's 22 percent gain in the past year won't prevent the region's exports from increasing. Trichet's comments led traders to erase bets he would use today's press conference to signal concern about the pace of the euro's advance. Within half an hour of the remarks, the euro had jumped almost two cents from the day's low.

"He's not looking too concerned about the euro -- the market's taking him at his word,'' said Steven Englander, chief foreign exchange strategist in New York at Barclays Capital Inc. With this kind of signal, "you sell dollars,'' he said. Against the dollar, the euro rose to $1.2766 at 1:23 p.m. in New York from $1.2631 late yesterday, according to EBS prices. It rose to a record $1.2812 Tuesday and has climbed to all-time highs on nine of the past 16 trading days. Compared with the yen, the euro had its biggest percentage since November, rising to 135.58 from 134.10.

``Although recent exchange-rate developments are likely to have some dampening effect on exports, export growth should continue to benefit from the dynamic expansion of the world economy,'' Trichet said. He spoke after the ECB's monthly meeting, at which policy makers kept their benchmark interest rate at 2 percent.
Source: Bloomberg

IMF Warns on Dollar

Nothing either especially surprising or especially new in this, except that the IMF has seen fit to say it.

Large and growing U.S. budget and current account deficits raise the risk of an abrupt drop in the value of the dollar, which could hit U.S. and global economic growth, the IMF said on Wednesday. "Although the dollar's adjustment could occur gradually over an extended period, the possible global risk of a disorderly exchange rate adjustment, especially to financial markets, cannot be ignored," the International Monetary Fund warned in a new report on Washington's fiscal stance. "An abrupt weakening of investor sentiment vis-a-vis the dollar could possibly lead to adverse consequences both domestically and abroad," particularly since U.S. debts to the rest of the world are at record highs, the fund said.
Source: Yahoo News

As you can see from the lack of posts it has been a busy day. I will try and dig out the IMF original tomorrow.

Wednesday, January 07, 2004

All the Way Up the Yield Curve

Actually, I just realised there is one small flaw in my Bernanke post of yesterday: the US Federal Reserve dosn't need to buy the government debt, well not yet anyway. The reason why: the foreign central banks are doing it:

Treasuries edged higher on Wednesday on news that the Treasury's five-year note auction, the first major auction of U.S. government debt this year, attracted strong demand, including from foreign central banks.

Indirect bidders, which mainly comprise foreign central banks, picked up 40 percent of the issue, beating last month's 34.6 percent. The sale of $16 billion in new five-year Treasury notes went at a yield of 3.26 percent and drew bids for a hefty 2.50 times the amount on offer, way above the 2.09 average of last year's sales.........

Dealers believe offshore central banks account for much of the indirect bidding as they spend some of the dollars they have been amassing in recent days. The Bank of Japan was thought to have bought an astonishing $28 billion in just the first two days of this week in an attempt to support the yen. Much of this money is thought to end up in Treasuries, an understandable assumption given that foreign central bank holdings of Treasury and agency debt ballooned by $224 billion last year to a record $1.07 trillion, and by $91 billion last quarter alone.

Alan Ruskin, chief economist at 4CAST, noted that is equivalent to financing 79 percent of the Treasury's entire net borrowing needs in the fourth quarter. "No wonder the Treasury market is so resilient to the influx of exceptionally strong data and the scale of supply," Ruskin said. He said central banks like the BOJ were doing the Federal Reserve (news - web sites), and the White House for that matter, a big favor by holding Treasury yields down. "Two hundred billion dollar Treasury purchases from the Fed would have been widely viewed as a massive distortion. But foreign central banks doing exactly the same thing is quietly sanctioned and encouraged by U.S. policy-makers," he added.
Source: Yahoo News

Ok, so this is a twist that really needs a bit more thought. Let's just imagine that all the central banks end up buying each others treasury debt, what is the consequence? Well clearly if they are printing money to do this - obviously if they are not then the thing probably ends up being pretty neutral until someone wants to collect on the debt from one of the indebted governments, they would in this case be only swapping bits of paper - so if they are printing money, then they are collectively undermining the unit value of each of their currencies, ie producing inflation. But then if there is a global deflationary backdraft, that inflation may simply mean that the CPI's simply register zero instead of minus 3 say. So on one front nothing changes.

But of course on another something definitely does. For what the central banks would be doing would be collectively financing each others government debts, that is the money would be channeled to the public, and not the private sector, hence there would be an effective redistribution towards public, and away from private consumption. That is one thing to think about.

Another topic might be the case of a country like China where the purchase of treasuries may only reflect an inward dollar flow, purchasing yuan to speculate on a future revaluation. Then clearly at some stage the yuan will revalue, and the Chinese central bank will simply take a loss on all the non-yuan assets it holds. The Chinese will end up being collectively richer, and everyone else poorer by the extent of the revaluation. But wait a minute, seeing the yuan rising, what if the central banks start buying Chinese government debt, as something more solid, and backed by an appreciating currency (I mean they should be neutral about location these central banks, simply following the law of best price): then clearly to attract finance the other governments will have to raise yields - here is where the problem may lie, and ultimately come. Remember Argentina had both deflation and massive risk premiums. Well, that's it. This was just thinking aloud really. Interesting set of problems though, aren't they? (In fairness I would like to point out that Lloyd was more or less covering this story on his blog about three weeks ago).