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Friday, May 27, 2005

Volatility in US Consumption

A nice graphic showing the current volatility in US consumption. (Courtesy of Reuters)

Disinflation Anyone?

"Stripping out volatile food and energy costs, prices rose just 0.1 percent, the smallest increase since December and a slowdown from a 0.3 percent March advance. Over the 12 months through April, prices were up 1.6 percent, a touch less than in the 12 months ended in March."

So core US consumer price infltion is running at an annual rate of 1.2%. Inflation scare, what inflation scare?

Andy's Back On Form

Andy, Andy who? Andy Xie, silly:

"The market and media are spinning a new story on China’s currency: the US is ordering China to revalue by more than 10% or face protectionism. Do not hold your breath. China will not buckle. China does not possess the conditions for a strong currency and will not succumb to foreign pressure and take a decision that may cause economic chaos at home.

The noises of protectionism can be deafening these days. The bottom line for protectionism is that the labor in high-cost economies cannot adjust as quickly as capital to seek out lower-cost production locations. This asymmetry may justify temporary and selective trade protection to address the mobility difference between capital and labor. As global companies extend their reach and increase the speed of capital mobility, the cases of targeted protection would increase. However, this would only affect the growth rate of global trade. Such protectionist measures do not imply that the trend of globalization is reversing.

Some argue that the labor backlash in the rich economies may stop or even reverse the trend of globalization. This sort of virulent protectionism did happen in the 1930s. I strongly disagree that the world could head down this path again. Today’s world is dramatically different from that in the 1930s when globalization suffered a severe setback. Modern communications and transportation technologies have dramatically shrunk the world. The interactions in the world community are rising rapidly. Politicians will not be able to stop the trend.

Of course, try telling this to French voters on Monday.

Show Your Strength, Not Your Weakness

Well I think this coming climb down was always obvious:

"Even as it publicly pressures China to let its currency rise in value, the Bush administration has quietly softened one of its key demands.

In a calculated shift in tactics, administration officials have stopped demanding that China let it currency, the yuan, float freely against other major currencies. Instead, American officials are telling Chinese leaders that they can keep their policy of a fixed exchange rate if they increase the value of the yuan by 10 to 15 percent.

The policy switch reflects a growing realization that Chinese leaders were simply not going to let their currency soar, which would make their exports more expensive and could disrupt China's troubled banking system.

But the switch also highlights the administration's limited leverage over China

Maybe they should learn a trick or two from Blair, and try actually getting 'inside the tent'. So if they are demanding 10 - 15%, that means they may get, what, 5 - 10%?

Thursday, May 26, 2005

Where There's Life There's Hope

Interesting new working paper out from the NBER this week:

Age And Great Invention: Benjamin F Jones

Here's the abstract:

Great achievements in knowledge are produced by older innovators today than they were a century ago. Using data on Nobel Prize winners and great inventors, I find that the age at which noted innovations are produced has increased by approximately 6 years over the 20th Century. This trend is consistent with a shift in the life-cycle productivity of great minds. It is also consistent with an aging workforce. The paper employs a semi-parametric maximum likelihood model to (1) test between these competing explanations and (2) locate any specific shifts in life-cycle productivity. The productivity explanation receives considerable support. I find that innovators are much less productive at younger ages, beginning to produce major ideas 8 years later at the end of the 20th Century than they did at the beginning. Furthermore, the later start to the career is not compensated for by increasing productivity beyond early middle age. I show that these distinct shifts for knowledge-based careers are consistent with a knowledge-based theory, where the accumulation of knowledge across generations leads innovators to seek more education over time. More generally, the results show that individual innovators are productive over a narrowing span of their life cycle, a trend that reduces -- other things equal -- the aggregate output of innovators. This drop in productivity is particularly acute if innovators' raw ability is greatest when young.

Obviously there is hope for some of us yet :).

Bernanke on the Renminbi (again)

The FT has an article on Bernanke (rather than the renminbi) today. It is headlined : Rise in renminbi 'would not harm US'. That, you would think would be obvious, and hardly worth a headline. It isn't really the renminbi that Mr Bernanke is talking about, but the US Treasury debt.

"“I do believe that US financial markets and world financial markets are sufficiently deep and liquid and there's sufficient private interest in US securities, that moderate adjustment in these reserve positions are not a risk to US interest rates or the economy,” Mr Bernanke said, referring to the possibility that Asian governments would stop buying US assets."

So the real questions are:

* will any 'flexibilising' of the renminbi have a major impact on the US trade deficit: my answer is an unequivocal no.

* will China stop buying US treasuries any time soon: this is often phrased "is the dollar about to crash", and again my answer is an unequivocal no.

The latter is the more interesting question, and my internal jury is still out on this to some extent. But about one thing I am sure, with euro entering a phase of enduring weakness, and with no other reserve currency on the horizon, the dangers of any 'dollar denominated assett' flight in the near future are remote at least.

Of course, if one day China gets big enough to 'tu a tu' with the US, then obviously things become very different, but this day is still some way off.

Wednesday, May 25, 2005

Something's In The Offing

reading the economics headlines in the press today, it isn't hard to seeing that some parts of the global system are creaking at the seams. Latest items on this front are the results of todays Ifo survey in Germany and the drop in Italy's Isae institute confidence index. This Isae reading is the lowest in three and a half years.

The Ifo Business Climate index for German industry and trade declined in May, after already having fallen three times in succession in the preceding months. The surveyed firms again reported less favourable business expectations for the coming six months. Appraisals of the current situation have stabilised, however. Inflation pressure has further declined. An improvement in the economic situation in the next months is not to be expected.

The Rome-based Isae institute's confidence index today fell to 84.2, the lowest since November 2001, from a revised 84.8 in April, matching the median forecast of 21 economists surveyed by Bloomberg. For the report, Isae interviewed 4,100 manufacturers between May 1 and May 18.

Japan Export Volume Down

The volume of Japanese exports fell year on year in April, reinforcing fears that the country’s reliance on global demand to bolster its economy may have come to an end.

"Wednesday’s figure from the Ministry of Finance showed a 1.5 per cent year-on-year fall in exports, following a slight decline in the first quarter of the year. A March rise in export volumes by 1.1 per cent on the year had failed to make up for a 3.1 per cent fall in January and a 4.2 per cent fall in February.

Trade surplus narrowed 10.4 per cent in April from a year ago.

The news would mean that further recovery is increasingly dependent on whether domestic consumers start spending at a faster pace at a time when the underlying drivers of consumer confidence are decidedly mixed.

Well given Japan's demographics, I considered this latter possibility - ie a consumer rebound - to be extraordinarily remote. A one off quarterly boost is not of course excluded, but sustained, secular growth in consumer activity in Japan (as in Germany, as in Italy) is OFF the agenda.

This Lady Is Not For Turning

Well, as might have been imagined, the Chinese administration are giving the US senate a very politite 'no'. Politics, as I understood it was the art of the achieveable. Making demands on others that they aren't going to comply with may only expose your own vulnerability. With Iraq already giving a major dent in global confidence that the US can deliver on what it promises, I can't help feeling we could have lived without this latest embarassing incident. Elitist as it sounds I have the feeling that it is far more productive to address these problems patiently behind the closed door meeting of the G7.

China rejected on Tuesday a detailed prescription from Washington for a quick move to a more flexible exchange rate system, beginning with a 10 per cent revaluation of the renminbi.

A foreign ministry spokesman, in response to questions about a Financial Times report that the US Treasury had made a revaluation demand via unofficial envoys, said many US visitors had come to China recently carrying “such messages” about revaluation.

But he repeated Beijing's view that it would not bow to foreign pressure on the issue.

“China will not do this when internal conditions are not ripe, no matter how great the external pressure is,” said the spokesman, Kong Quan.

Drawing Up The Battle Lines At The ECB

A right royal row is brewing at the ECB: basically the old guard theorists of the 'one size fits all' monetary policy are being challenged by the more pragmatic observers of day to day realities. For the moments it is the politicians who are making the running (but there are plenty of competent economists in Germany and Italy who are ready to back them up):

"Wolfgang Clement, Germany's economics and labour minister, supported the OECD's conclusions about Europe, joining Italian ministers in urging the ECB to loosen monetary policy."

At the other end there is eg Erkki Liikanen:

"In an interview in today's Financial Times, Erkki Liikanen, governor of the Bank of Finland and a member of the ECB's governing council, reiterated the ECB's view that the next move in European rates would be up."

Or then there is the theorist of the old guard over at the ECB Otmar Issing:

"European Central Bank chief economist Otmar Issing said euro zone growth differentials have to be addressed by national economic policies rather than by the ECB's interest rate policy."

In fact Issing is really digging in. He provocatively gave this One Size Fits All speeach on 20 May.

"Let me conclude with a citation. On the eve of the changeover, I wrote a commentary on diversity and monetary policy in the euro area. To the question whether a single one-size monetary policy could fit all parties involved – be they national entities, social partners or economic actors – my answer was: “One size must fit all”. The political decision on the creation of EMU had resolved all discussions on whether monetary union should precede or follow political unity and the fulfilment of the criteria for an optimum currency area. Today, in light of the evidence gathered so far in the euro area, I am more confident in saying: “One size does fit all!”"

Obviously you have to ask whether Issing in now losing his grip on reality. Clearly he has a lot personally at stake in the euro process, but obviously, as we can see from political life, inability to reform and address real life issues normally leads to even bigger changes later. My feeling is that it will not be long before heads will roll at the ECB.

As the FT notes:

"The ECB has insisted that a rate cut would be harmful and was not supported by sensible economists. Jean-Claude Trichet, the ECB president, told the European Parliament on Monday: “The last time we met, we were absolutely convinced that we would not improve the situation [with a rate cut] but that we would hamper Europe if we would go in the direction that is suggested by some.”

But now that the OECD, a bastion of orthodox economic thought, has flatly contradicted the ECB's position, Mr Trichet will find it more difficult in future to reject out of hand a discussion of lower rates.

I don't know if I count as a sensible economist or not, but this situation has long been clear to me. Personally I welcome the prospect of a new broom sweeps clean over in Frankfurt. This problem has been obvious for a long time, and it is better to address it sooner rather than later.

BoJ Minutes

Following up on my post about the possibility of moves towards ending quantitive easing in Japan, the BoJ has now published its minutes. The vote was in fact 8-1 against, with Fukuma being the only one in favour. Of course there was some nebulous commitment to ending the easing at some appropriate time in the future. Ok, I guess, what else is new?

"The Bank of Japan Policy Board's Toshikatsu Fukuma was the sole member who voted against maintaining the central bank's funds target at a policy meeting on April 5-6, minutes showed on Wednesday. Fukuma proposed lowering the current account deposits target to 27-32 trillion yen ($251-297 billion), which was rejected by a vote of 8-1. The board decided to keep the target at 30-35 trillion yen.

But the minutes said two members said cutting the target in future could be considered, and one member said the board should not rule out a future review of conditions for ending the "quantitative easing" policy.

At the latest monetary policy meeting, which ended last Friday, the BOJ tweaked its super-easy stance, saying the funds could temporarily fall below the target range if demand was weak. ($1=107.58 yen)

Mind you according to MS's Takehiro Sato, the real underlying isssue isn't that they believe there will be an early an orderly return to inflation, but that maintaining these levels of liquidity (which he estimates to be five times the quantity needed simply to underpin a zero rate) is presenting tecnical difficulties: the thing is there is proportionately very little demand for loans, and this makes bulking up the monetary mass difficult.

He even speculates that they might be lead to step up the Rimban operations (where the BoJ buys JGB's). Now since the JGB's could themselves become paper issue of questionable value at some stage, (Japan's accumulated deficit remember, climbs and climbs regardless) you have to really worry about long term balance sheet issues at the BoJ.

Tuesday, May 24, 2005

Lies, Damn Lies, And Italian Government Statistics.

There is no secret about the fact that Italy may well be in line for an excess deficit process under the terms of the eurozone bility and growth pact. What is less well known is the difficulties under which the EU's statistical office has to labour, just to get accurate numbers.Eurostat has just published it's latest report on deficit number revisions that it has extracted from the Italian government. But there is still a lot of haggling in the pipeline, as can be seen from the extract reproduced below. The language is very formal, but between the lines it isn't hard to see the frustration with the kind of data they've been getting.

"It is recalled that Eurostat was not in a position to validate the figures for Italy in the context of the March 2005 EDP notification. Apart from the three issues mentioned above, this was mainly due to the recording of transactions with the EU budget, to inconsistencies between data on cash and accrual bases and to statistical discrepancies in government accounts. It is expected that Eurostat will shortly receive from the Italian authorities the information requested on these issues and will then be able to clarify these issues in co-operation with ISTAT. Depending on the outcome of the examination, this could lead to a further upward revision in the government deficit for the period between 2001 and 2004."

Renminbi Blues

Dave at Macroblog has a link to an FT article which reports that the US are effectively trying to give the Chinese authorities six months to make a renminbi float. As the FT notes, and Dave concurs, this is a rather foolish thing to do. One thing must be clear in all this argument, the Chinese authorities will not publicly let themselves be seen to be pushed around.

But then, even if the pressure were to work, would it have the desired impact?

Brad Setser has a post on this very subject, outlining five (at least) myths about the renminbi float. Four of the 'myths' are just that: myths, as Brad shows. But the fifth one - namely that: Chinese wages are so far below US wages (and for that matter wages in other industrial countries, and many emerging economies) that a change in the renminbi won't have any impact - seems to me to be probably valid. And of course this is the key point on which the whole debate turns.

Now there is a semantic detail here - the won't have *any* impact bit - clearly everything has some impact or other. So lets rephrase the point: won't have the impact that the renminbi float advocates suggest - this I think isn't a myth, but rather an extreme liklehood.

I quote myself from the comments:

I don't think Brad, many of us would disagree that China should revalue (or rather 'flexibilise'). The issue is when, in what way, and above all what the consequences would be.

Whatever the rest of the world wants I wouldn't be too optimistic that the Chinese administration are going to be pushed anywhere very quickly.

There are lots of points, but this seems to be the key one:

"Myth. Goldman Sachs estimates that a 1% rise in the renminbi's real value (which can come either if Chinese inflation is 1% higher than inflation in the rest of the world, or is China's currency rises by 1% and inflation is unchanged) leads to a 1% reduction in China's export growth rate."

I think one would need to see the methodology applied by Goldman Sachs (you wouldn't have the link would you?). I mean intuitively I find this hard to accept.

You youself yesterday were citing Greenspan about how German exporters have swallowed a 40% plus rise in the currency and still go from strength to strength.

If Goldman Sachs say one thing, Morgan Stanley - in the shape of Andy Xie - say another. I tend to trust Andy's intuitions on China, and they fit with mine. But it shouldn't come down to this: we should have some way of trying to validate our intuitions.

My reasoning would be, following Xie, that the differentials between prices of origin in China and end prices in Europe and the US are so huge that there is bags and bags of room for absorption along the line. So I don't think that Chinese exports are likely to reveal the kind of currency sensitivities which you suggest.

Of course there are more arguments. Firstly one could look at the excess fixed capital formation that is taking place in China. A chunk of this is going to end up in products which arrive at end users. This xcess capacity will exert deflationary pressures on prices ex works in China, and these could easily compensate for any upward movement in currency.

Then there is outsourcing. If China is as so sensitive to currency movements then China will outsource: either into the vast interior of China itself, or, as has already been happening as wages have been slowly ticking up in China, to Cambodia, Vietnam and elsewhere. Of course, the ability to do this depends on the product profile. It depends on the level of skill input required, but my guess is that in many of the cases where China is having export success, part of the supply chain is in fact mobile.

OK, that more or less is why I think this myth isn't such a myth.

Brad's response: The Goldman paper looks at overall chinese exports/ imports, not us-chinese trade. And the basic reasons for the econometrics are pretty easy to see -- China's export growth rate picked up dramatically after the real exchange rate started to fall in 02 (along with the dollar).

And my riposte: Just two points here Brad: Firstly these things are not necessarily symmetrical - you may react differently to an opportunity than you do to a threat, it is easier to hire workers and buy equipment than it is to fire and 'decomission' them. ie once you're in for the fixed costs, the economics of decision taking are different.

Secondly, there is the cause/effect problem. ie was the important point here a cheap renminbi, or a high euro. My feeling is that you need to start from the latter, and its impact on re-structuring in Europe.

Prior to 2002 China outsourcing was very much a US thing, probably driven by the high dollar and the need to sell to Europeans and Japanese (we need some trade theory as well as econometrics here). So post 1995 the US corpration increasingly reaches out globally to extend supply lines, and discovers China. The EU response - as with IT - comes later, and post 2002 there is a major push into Central Europe and China.

So the methodological question is what is driving what here. As I say, given the capacity expansion in China, any obstacles to trade are just going to drive prices down there.

The point maybe is this:

"leads to a 1% reduction in China's export growth rate".

Now is the export growth rate being driven primarily by the value of the currency, or by the increase in fixed investment, which may be rather responding to other factors? All I am really saying is that this problem is a fairly complex one, with a lot of inter-connections, and I still am not convinced that the Goldman Sachs argument gets us very far.

Also, of course, if the myth is that a revaluation 'won't have any impact' then clearly it is a stupid one: some impact there will be (so it's a trick question :) ). The question is: will a renminbi revaluation have the consequences that its most vociferous advocates assume it will? I think this is much more open to doubt.

Anyway, the whole thread is worth a look, so go read :).

OECD Advocate ECB Rate Reduction

At market closure in Europe today the difference in yield between German 10-year bunds and their U.S. equivalents was 73 basis points, more or less a one-month low. Analysts suggest that investors are scaling back expectations the Federal Reserve will keep raising its main rate to counter the threat of inflation as the European Central Bank keeps its rate unchanged - ie most of the weight is being put on the fact that inflation expectations are low. I can think of another reason Alan Greenspan may have to thing more than once about proceeding with rate rises in the US: rates not only may not rise in the eurozone, they may in fact fall, and if they do any appreciable increase in the Atlantic spread could precipitate a rise, not a fall, in the value of the US dollar.

In fact the OECD today recommend that the Federal Reserve should continue to raise U.S. interest rates, while the European Central Bank should ease eurzone monetary policy. These recommendations come in the OECD semi-annual Economic Outlook out today. The OECD's eurozone growth forecasts of 1.2 % for 2005 and 2.0% for 2006 are based on the assumption that the ECB, which has maintained its core refinancing rate at 2.0% since June 2003, will cut rates by half a percentage point in mid-2005.

With domestic demand sluggish, resilience feeble and possible upward pressures on the euro looming ahead, the balance of risks on growth and inflation is clearly tilted to the downside, calling for an early easing of monetary policy”.

And why does the US need to keep raising rates: well todays housing data would be one of the reasons. So what I am saying is that Greenspan is increasingly likely to find himself between the proverbial rock and the hard place. Domestically he needs to keep rates moving up, but in terms of the deficit and the international competitiveness of the US economy, he needs to keep them low.