One Recession Away

Well the weekend's finally come round again, and with it another Friday post from Stephen Roach. This week it's deflation he's worried about, and in his view the US is just one recession away from deflation. As he argues, many see the recent spike in producer prices as evidence of a receding deflation danger - others (such as yours truly), however, argue that it provides what threatens to be only a temporary respite, and one which at the same time complicates the picture for Greenspan by putting pressure on him to think about raising rates. Far from offering us any hope of an 'all clear', Roach is surely right to argue that the US, absent any other major engine for global growth, is still trapped in the relegation zone, in danger of being sucked down by the backdraft emanating from Japan, and now, as looks increasingly probable, from Germany. We also need to watch and wait to see what will happen in the UK when the housing bubble finally burns itself out. And if the 'geopolicital uncertainty' produced by the threat or reality of an Iraq war should push us all back into recession, then clearly that could be all that is needed to heave us over the edge. So far from stand easy, it seems more like a case of get ready to man the pumps.

And if I seem even more decided in this than Stephen Roach, the reason is to be found in one detail where I take my difference from him. Stephen's deflation case rests on three premises: post bubble excess global supply, globalised supply networks, and forces associated with the business cycle. On the first two of these we would I am sure, and theoretical niceties apart, be in fairly broad agreement - in place of simply excess supply I would probably develop a story based more on a Moore's Law type process of falling prices in several key technology areas, and in place of global supply chains I would spell out more directly China and India, but let's be reasonable, we're on the same wavelength. It's the third point that bothers me. To introduce the business cycle at this stage as an explanatory variable seems to me to duck the question. Again, leaving to one side all the tricky problems about business cycle analysis, the point it seems to me is that it is precisely the form that the present cycle, or stage of the cycle, is taking that needs to be explained. In fairness Stephen has his get-out: it's the oil shock. And this is fair game, since the portrait he paints concerning the dangers for an already weakened global economy of a sutained rise in oil prices are real enough. The point is why is global demand so weak. Why is it that this recovery, coming as it does after one of the most sustained periods of growth in the history of the world economy, and with all its attendant productivity miracles, is so damned weak, why the dickens is this 'soft patch' we've hit proving to be so difficult to shake off.

Well to understand this I think you have to understand the specific weight in the global economy of a limited number of high income countries, call it G6 or G23, the difference isn't especially important. The fact of the matter is that a relatively small proportion of the world's population is responsible for a relatively high part of it's wealth creation and it's wealth consumption (something which in itself is potentially unstable in any even). Now this population is rapidly becoming old, and this is happening at a time of accelerating technological change which is in itself devaluing the net worth of all that accumulated and aging experience. Hence, ever so subtly patterns of consumption are changing. Look at clothing. It's a world phenomenon, people are looking for cheaper, more buy-and-throw-away apparel. Cultural transition or aging process, you tell me. Then look at Japan, and look at the retail industry which seems to be more and more dominated by cheap outlets selling cheap Chinese imports. The future belongs to Wal-Mart. And now tell me again that the subtle downward shift we're seeing in consumption habits, the one that's causing all the fuss about the output gap, tell me it's got nothing to do with the changing age composition of our populations.

The case for deflation rests on three key premises: First is the post-bubble legacy of excess supply -- especially the overhang of redundant IT capacity that was put in place in the United States and Asia in the latter half of the 1990s. While America’s IT correction was fast and furious over the 2001-02 interval, the rest of the world has not been as quick to follow. Europe’s telecom carnage is an obvious exception but non-Japan Asia’s ongoing appetite for new IT capacity -- especially China -- has been an important offset. Against the backdrop of a post-bubble compression of aggregate demand, the world remains awash in excess supply. That’s a classic deflationary condition.

Globalization is a second force behind the deflation story. Courtesy of accelerating growth in world trade, the globalization of supply chains changes the balance between aggregate supply and demand. That is not only the case in tradable goods -- the so-called China factor comes to mind -- but is also evident in the “non-tradable” services sector. With service sector deregulation now a global phenomenon, surging cross-border M&A activity creating huge multi-national service behemoths that span the globe, and the Internet spawning the advent of IT-enabled service exports from countries such as India, service-sector supply curves have gone from being national to global. That magnifies the overhang of aggregate supply -- yet another reason for global pricing to adjust downward.

But the latest twist can be found in the business cycle, the third piece to the deflation puzzle. Recessions are, by definition, deflationary events. Since the world economy entered its last recession in 2001 at a very low inflation rate -- a 1.3% increase in the advanced world GDP deflator in 2000, according to the IMF -- a close brush with outright deflation can hardly be judged a shock. In the parlance of macro, this recession opened up a positive “output gap” as a deficiency in aggregate demand and, in the context of excessive aggregate supply, virtually destroyed any semblance of pricing leverage for most global businesses. Normally, cyclical recoveries promptly close the gap between supply and demand, thereby restoring pricing leverage. That has not been the case in the decidedly subpar recovery that has occurred in the aftermath of the 2001 global recession. By our estimates, a 2.6% increase in world GDP in 2002 -- versus a longer-term trend of 3.6% -- actually led to a further widening of the global output gap and a concomitant increase in deflationary pressures. Against this backdrop, it would now take a fairly vigorous recovery in the global economy -- several years of world GDP increasing in excess of 4% -- to tilt the business cycle away from deflation.

Yet precisely the opposite now seems to be in the cards. Courtesy of a full-blown oil shock, the world is now flirting with yet another recession. Crude oil prices (as measured on a West Texas Intermediate basis) are now around $37 per barrel. Not only does that represent an 87% increase from levels prevailing at the start of 2002 (an average of $19.69 in January 2002), but today’s prices ($36.79 as of the close on 20 February) are nearly identical with the highs hit on 20 September 2000 ($37.20) that played a key role in triggering the recession of 2001. Unfortunately, oil shocks and recessions go hand in hand. That was not just the case in 2001 but also the outcome in the aftermath of the first OPEC shock of late 1973, as well as the result of the spike associated with the Iranian Revolution in 1979. And, of course, the same was the case following the sharp run-up in oil prices leading up to the Gulf War. In other words, show me an oil shock and I’ll show you a recession. It’s hard to believe that the current oil shock will be the one exception.

Another recession at this juncture could well reinforce the cyclical piece of the case for global deflation. Our global forecast is currently “under review” as we assess the twin impacts of looming war and higher oil prices. Our baseline scenario for 2003 world GDP growth currently stands at 2.9%. While I do not want to prejudge the outcome of our deliberations, I would place the ultimate downside somewhere in the 2.0% to 2.5% range. With global recession widely viewed as anything below the 2.5% world GDP growth threshold, there can be no mistaking the potential consequences of this oil shock -- a second worldwide downturn in two years. But the key insofar as the macro-analytics of deflation are concerned is the implications for the global output gap -- the discrepancy between aggregate supply and demand. When judged against the world economy’s 3.6% long-term trend line -- a good proxy for potential growth, or global supply -- a sharp downward revision to our 2003 baseline forecast has critical implications for the global output gap. Taking the midpoint of the 2.0% to 2.5% world GDP growth range noted above as an illustration, that would represent a 1.4-percentage-point shortfall from trend. Such a further widening of the global output gap would come on the heels of a 2.4 percentage point shortfall that opened up over the 2001-02 interval. That would bring the cumulative shortfall from trend to nearly four percentage points since 2000 -- large by any standards of the past.

Therein lies the risk. In my view, it was the widening of the global output gap in 2001-02 for a low-inflation world economy that led to the subsequent lack of pricing leverage and the close brush with deflation. And now -- courtesy of another oil shock -- that global output gap is set for a sharp further widening. As I see it, that can only intensify the lack of pricing leverage, taking the world all the closer to the brink of outright deflation. In other words, the current oil shock should not be interpreted as an inflationary event along the lines of the outcomes of the 1970s. It is, by contrast, very much a deflationary shock. Prior to this oil shock, I would have depicted the world economy as being only one recession away from deflation. To the extent that recession may now be in the offing, the case for deflation actually looks more compelling than ever.
Source: Morgan Stanley Global Economic Forum
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This Years ET Conference

I have just noticed that O'Reilly have posted the programme for this years Emerging Technology Conference. Clay Shirky's session, entitled A Group is its Own Worst Enemy, looks interesting enough, both in terms of it's on-line and off-line implications. Any self-confessed neurotics willing to stand up?:

The psychologist Wilfred Bion practiced group therapy with neurotics, and during this work, he came to see that groups are far more often thwarted in their goals from internal difficulties than external ones, because of a tension between the members’ individual goals and their emotional commitment to group membership. This tension creates patterns in groups that cannot be accounted for by any theory of individual behavior. Bion saw this tension as unavoidable, saying that we are, as a species, "hopelessly committed to both" individual goals and to group membership.

Seeing this, Bion came to conclude that the need for group structure is largely for self-protection. We use a range of organized behavior--traditions, customs, laws--that are designed to protect the group from itself, and from predation by individual members. This scenario has played out many times on the Internet in the form of constitutional crises, where an online community confronts the impossibility of having a functioning group without some structure that shapes the behavior of individual members. From LambdaMOO's fights about the political role of wizards through today’s karma and moderation systems on sites like slashdot and kuro5hin, many communities have passed through crises of self-governance, and emerged with a structure that is nothing less than political theory instantiated in code.

In this talk, Shirky presents several patterns of constitutional crisis in online communities, and draws general lessons about designing social software that allows for a degree of self-governance by the users.
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A Raft of Tricky Looking Data

Seeing through the fog, and trying to decide which way the US economy might be heading is proving to be fairly difficult these days. Yesterday's latest batch of figures do nothing to help make matters any clearer. Deficit up, unemployment up, producer price index up, there's little to cheer the faint hearted here. Obviously it's that 'soft patch'. The only interesting sideline is that the spike in producer prices probably pushes deflation back into the distance a bit, a knock-on effect of rising energy and a falling dollar. But don't cheer just yet: in particular remember that the Fed rate is only 1.25 and with inflation creeping up just a little the US could soon be in negative real rate territory, another headache for Greenspan, since negative rates could easily spark house prices and provoke a bubble in property. Yet raising rates would put a brake on recovery. Back to the zone between the rock and the hard place. Nothing in this life ever gets to be easy.

The US trade deficit soared to a new record last year, while wholesale prices surged in January at their fastest pace in more than a decade. The US Commerce Department said the monthly trade deficit rose 10.6 percent in December to a record $44.2bn, as imports continued to grow and exports slumped. The December reading put the annual deficit for 2002 at a record $435bn - a 21 per cent increase over the 2001 level. The widening deficit reflects, in part, the US economy's continuing outperformance of major trading partners, but some economists fear it also represents a big and growing risk to the stability of the US dollar and US interest rates. Separately, the US Labor Department said prices at the wholesale level surged last month. The department said its producer price index jumped 1.6 per cent in January - the biggest increase since January 1990 - after dipping 0.1 per cent in December. The increase was led by rising energy costs, but even after excluding food and energy, the producer price index rose 0.9 per cent, the biggest such since December 1998 and the second biggest in 14 years. The department also said demand for new US jobless benefits last week rose to its highest level this year, and above the 400,000 level generally associated with recession. First-time unemployment insurance claims rose to 402,000 in the week to February 15 - thehighest level since December - from 381,000 the previous week. However, the four-week moving average, a smoother guage of the trend, remained below 400,000, though it rose slightly to 389,000. In another report, the Conference Board said its index of leading economic indicators, a gauge of future growth, was flat last month, its weakest reading since last September.
Source: Financial Times
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Looking Forward to the G7




The G7 finance ministers have a meeting scheduled for Paris on Friday. Among discussion items will be the geopolitical uncertainty surrounding a possible Iraq war, the continuing high price of petrol, and.........the desireability of a revaluation of the yuan. Or at least so we are informed by recent reports from Japan, since the rumourology has it that Janapese Finance Minister Masajuro Shiokawa will use the meeting to argue the case for exerting pressure. Personally I think its way to soon to start thinking about this. Chinese growth is currently one of the few bright spots on the global horizon, and the chinese economy - with all the internal strains being produced by the reform process - is in no position to do the heavy lifting on behalf of the rest of us, yet. I'm happy to be in the company of Morgan Stanley's Stephen Roach and Andy Xie on this one. Unfortunately in my book this is simply another example of what hypocrites we are. In the 90's, when things still went well (you do remember those days, don't you?) we lectured the world on the need for reform and the benefits of following the western model, and now that we are finding the going a bit tougher what do we do: start asking for help from one of the countries that actually took our advice seriously. I didn't notice us exactly reaching out a helping hand to China when it really needed one. If Japan, the EU and the US have significant economic problems, perhaps it would be better to start by examining what is happening at home before reaching out to find scapegoats abroad.

Finance Minister Masajuro Shiokawa is expected to urge finance ministers and central bank governors of the Group of Seven industrialized countries to press China to revaluate the yuan, government sources said Friday. At a two-day G-7 meeting, scheduled to open in Paris on Friday, Shiokawa will argue that China's "export of deflation" is one of the factors behind global deflation, and he will insist that China's cheap exports are negatively influencing the world economy, the sources said. The current exchange rate of the Chinese yuan, which is effectively pegged to the U.S. dollar, is seen as being unnaturally low for the country's fast-growing economy.

Shiokawa is expected to point out that restrictions on capital transactions by the Chinese government has led to an expansion of the country's trade surplus, and he will ask G-7 finance ministers and central bank governors to consider calling for the revaluation of the yuan, the sources said. It will be highly unusual for a G-7 member to request discussions on the capital liberalization of a nonmember country like China at a G-7 meeting. Shiokawa is expected to call on China to adopt a policy that pays closer attention to its influence on the world economy, sources said. The finance minister will also request that China relax its regulations on capital transactions as yuan-based fund-raising by foreign banks is restricted in China.

Deflation is eroding not only the economies of Japan, China and Hong Kong but also the world economy, with inflation rates in the United States and Germany slowing down. Conversely, China is accelerating its export drive, which is also affecting the economies of many countries. The U.S. trade deficit with China in 2002, which was announced Thursday, was a record high 103.1 billion dollars. The U.S. economy, which has served as an engine of global growth, slowed sharply in the fourth quarter of 2002 on the back of sluggish personal consumption, expanding a mere 0.7 percent, compared with a 4 percent increase in the third quarter. According to a preliminary report on Japan's trade in 2002 released by the Finance Ministry in January, imports from China rose 9.9 percent from a year earlier, surpassing those from the United States for the first time since World War II. Observers have pointed out that the continued influx of Chinese products, whose low prices reflect the country's cheap labor and manufacturing costs, may intensify the deflation problem. However, as the United States is expected to pay closer attention to China because of the mounting tension in Iraq, the government plans to fine-tune its announcement before the G-7 meeting.
Source: Daily Yomiuri
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News Monster Causes a Stir


Ben Hammersley notes that his comments section on NewsMonster is worth checking out. I've been using it for a couple of days now, and it meets my needs just fine. Still, I suppose I'm not a particularly demanding user, nor am I a purist, so perhaps I'm not among the best placed to recommend to others. I'm sure the debate about the robot exclusion standard is important, but it's a bit beyond me. On the other hand, not having an automatic update does seem to be a substantial drawback, I don't know if they've got a fix for this in the pipeline. One of the posts made, what was for me a particularly telling point about those who don't enjoy the luxury of a broad band connection (or only have one at work where they don't have time (?) to take advantage of it). I acquired a pocket PC with the intention of chewing up lost travel time with news updates, and then I found blogging. Now I use my 'prime time' travel to plough through some of the highly appealing books that are piling up on my 'to read' shelf. Who the hell ever said the old was incompatible with the new, the trick is to find the way to put them together.

I haven't tried NewsMonster yet, but based on the discussion, it appears that the functionality that it most closely resembles is the "Offline Web Pages" feature of Internet Explorer for Windows. It also would appear that most people contributing to this discussion have not used this feature before, and therefore don't appreciate just how valuable it is. If you haven't used it, here's a quick overview:

Offline Web Pages drives Internet Explorer just as if a live user were driving it. It stores complete web pages and all linked images and other content elements in IE's regular cache. It's completely user configurable: it can store complete sites or just single pages depending on the URL; it can recursively dive down up to 3 (I think) levels deep; it can follow links to "outside" sites or stay within the domain specified by the initial URL; it can run on a schedule, on system events like startup or shutdown, or on demand; it can traverse and cache a single site, or a whole list of sites.From the user's perspective, you just run IE, put it into offline mode, then browse the site(s) as you would normally. There's no difference between that and browsing the site online, except that the offline experience is blazingly fast, much faster than browsing online even over DSL or other broadband. The way I used to use this feature was as follows: I have a half-hour train ride to and from work every day. I had my laptop set to download a list of sites every weekday morning at 5 a.m. and again in the afternoon at 4 p.m. The sites included CNET, NYT-Tech, Wired, GMSV and a few others. I could then read the news on the train using my laptop with IE in offline mode. This was a tremendous time-saver for me. I've since switched to using a Pocket PC for the train ride, but I still use Offline Web Pages for a few sites that I look at in the evenings at home. Remember that the vast majority of web users still are stuck with 56K dialup, and will be for years to come. Using Offine Web Pages vastly improves the experience of browsing the web in that environment, as well as extending the availability of the web into situations where it isn't currently accessable. Are Offline Web Pages inefficient from a server perspective? Certainly. Nevertheless, the feature is invaluable under certain circumstances.
Source: Ben Hammersley.Com
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Lessig Makes the Case on Software Patents


The issue of patent protection for software continues to go the rounds. This time it's the turn of the European Parliament to take a view. Lessig eloquently makes the case that patent and copyright law in relation to software is a mess, but Europe is the land of regulation (not all of it bad by any means) and conservative traditions in Europe are very different from their American counterparts (with the notable exception of the UK the idea of individual liberty and privacy bears little resemblance to the US one: something which should have been made clear by the attitude of French law to material posted on Yahoo and e-Bay) so I'm not especially optimistic. With many of Europe's major companies having lost more money than they want to think about, and with governments who don't understand the internet having been given the excuse they needed by 11/09 to focus on the 'security' problem, and the control, rather than the 'freeing' of information public policy in Europe seems to be hovering dangerously in the region of an all time low. After a lot of trumpeting about the coming benefits of the 'information age', no-one in Brussels it seems is particularly concerned about the absence of a 'critical mass' of basic material to search in any language other than English (if you don't believe me try surfing the web in eg French, or Spanish, or Italian sometime). Europe, as I said, is the land of public policy and regulation, and own-language content is an issue which is just crying out for subsidies if ever there was one. The French government makes no secret of its preoccupations about the future of the French language, but isn't it time to 'put your money where your mouth is'. The answer, unfortunately, seems to be no, as the main talking point these days seems to be how to find a way to charge for content. I'm sorry Larry, I fear your reasoned plea is destined to fall on deaf ears.

As pressure mounts on the European Parliament to extend patent protection to software, a crisis is developing in US patent law that Europe would do well to consider. The system in America is broken - to the great detriment of software developers generally - and there is no reason to believe the Europeans could do any better.
The claim that the US patent system is in crisis is nothing new. What is new is the identity of those making it.........throughout the administration of President Clinton the Patent Office insisted that the system worked just fine. Patents were being granted for truly novel inventions only, the office said; and innovators had no trouble in identifying who owned what invention. Claims that the system was in crisis were little more than the ravings of Chicken Little. The system would work itself out. It always had.

Yet now the Patent Office is singing a different tune. As its new head, former Republican Congressman James E. Rogan, said in an interview with the L.A. Times on February 7, 2003: "This is an agency in crisis and it's going to get worse. It doesn't do me any good to pretend there's not a problem when there is." The reason is the mess created by the last administration's patent office, especially in the context of business method patents (the type of patent, for example, that gives Amazon an exclusive right to its "one-click" method for selling merchandise online). "Some of [these] were fairly broad," Mr Rogan told L.A. Times reporter David Streitfeld. "We've gone from a 75 per cent acceptance rate to a 75 per cent rejection rate." This early and easy acceptance rate led to an explosion in patent applications and patents granted - and, in turn, in the costs that software developers face. "Developing software is [now] like crossing a minefield," says Richard Stallman, the originator of the free software movement that has developed the GNU/Linux operating system. "With each design decision, you might step on a patent that will blow up your project."

This is the most surprising fact about software patents: they are generally opposed most strongly by the people they are intended to benefit. But such opposition is not difficult for a conservative like Mr Rogan to understand. Patents are a form of regulation. They represent a government decision on who gets a monopoly over what invention. Republicans like to claim that Democrats regulate first and ask questions later. They are therefore more eager to ask the right questions up-front. Yet the questions here have no good answers. Like any form of government regulation, patents make sense only if their benefits outweigh their costs. The public benefit from patents is presumably the inventions that otherwise would not have been made. The costs include the extraordinary burden of knowing just what innovation is and is not subject to a government monopoly. These costs are borne both by innovators seeking a patent and by those just writing code. Both must wade through incomprehensible claims about who owns what inventions to avoid the inevitable hold-up if their code proves successful.

Software developers are quite aware of these costs. Yet economists have found it very hard to reckon any net benefits. And thus conservatives are increasingly sceptical of this form of regulation. No doubt it has produced "a whole cottage industry of shysters," as Mr Rogan admits. It is harder to show that patents have produced any gain that would justify their costs.The issue is not just a problem of implementation. The weakness runs much deeper. It may well be that software development requires some form of government protection. It does not follow, however, that patents are the protection that software needs. Software already receives the protection of copyright and trade secret. (The "code" of software is a kind of writing that copyright protects; and the properly hidden secrets that stand behind software can be protected like any other business secret.) These too have their critics: the term of software copyright is effectively perpetual; and trade secrets tend to hide, not spread, knowledge. But if these forms of protection are inadequate or misinformed, then the solution is to find a form that better fits software. No one really believes that patents are well designed for this type of invention. Yet no government has adequately explored the alternatives.
Source: Financial Times
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