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Wednesday, December 25, 2002

The Worst of 2002

Every call you make, every song you take...........we'll be watching you. I've already blogged the NYT story on Big Brother's new tools together with my own opinions on the topic (Here) but today the party is growing.Google News is currently flagging 13 items in the 'and related' category. It's is relatively unusual to find specialist journalists so uniformly in agreement about something, so without further comment I reproduce extracts from a representative selection. Come on John, let's get close up and personal, I think I need to be surveilled.

What was the worst technology product of the year? There are so many deserving choices, mostly related to clumsy efforts by media companies and their lawyers to restrict the public's enjoyment of digital movies and music. But in terms of potential impact on our lives, the Worst of 2002 award goes to TIA, the Total Information Awareness program, spawned by the Defense Advanced Research Projects Agency (DARPA) Information Awareness Office. TIA is exploring the feasibility of developing a national surveillance system intended to identify potential terrorists and criminals through "data mining" of the public and private electronic records of every citizen.

Every telephone call you make, every credit card transaction, all your e-mail and instant messages, all your medical records, your magazine subscriptions, your police record, driver's license records, gun purchases, travel records, banking records--all would be fed into a hopper and sifted by the TIA spy software. Another facet of the DARPA project calls for the study of a nationwide biometric "Human ID at a Distance" program that could track and identify individuals not just in the electronic world but also in the physical world by using facial recognition and other technologies now in development.
Source: Fortune

First it was Echelon, the super-secret global eavesdropping program run by the U.S. National Security Agency (NSA), and then Carnivore, the super-secret Internet-snooping program run by the U.S. Federal Bureau of Investigation. Now we have a new piece of privacy busting to contend with in the form of the Total Information Awareness program, or TIA. Based on the limited information released to date, the goal of the TIA program is to compile and search through thousands of public and private data sources, located in this country and possibly elsewhere. These data sources include commercial databases, such as ones used to record your purchases at places such as bookstores, video shops, grocery stores and Internet malls.

The TIA program would also trawl through the endless public data sources including driving records, tax filings, visa and passport use, calls for police assistance and more. TIA would have access to records listing all your phone calls, all e-mails sent and received (including the content), and all Web sites you have visited. Companies are also collecting boatloads of information about where you go as well. Sporting venues, airports, not to mention small and large shops, are all recording your whereabouts on video. Police departments have even started using advanced software to analyze some of this video to determine who appears in the picture. The "Fast Pass" electronic devices installed on vehicles and used to gain access to toll bridges and highways are currently monitored and recorded in urban locations far away from these structures (to analyze traffic patterns). And don't forget that the new generation of mobile phones all transmit location information that is stored in yet another database.

That is an awful lot of information about any one particular person. What does the government intend to do with all this information? The Electronic Frontier Foundation (www.eff.org) quotes U.S. Undersecretary of Defense Pete Aldridge as having publicly stated that the TIA program will involve "discovery of connections between transactions--such as passports; visas; work permits; driver's license; credit card; airline tickets; rental cars; gun purchases; chemical purchases--and events--such as arrest or suspicious activities and so forth." The single page Web site describing the TIA program (www.darpa.mil/iao/TIASystems.htm) expands on this description somewhat by saying that, among other things, the system will focus on developing "novel methods for populating the database from existing sources, create innovative new sources, and invent new algorithms for mining, combining, and refining information for subsequent inclusion into the database; and, [create] revolutionary new models, algorithms, methods, tools, and techniques for analyzing and correlating information in the database to derive actionable intelligence."
Source: Daily Yomiuri (Japan)

Growing controversy around the US Defense Department's shadowy Total Information Awareness project may be the cause of the steady decrease in the project's virtual presence Call it the incredibly shrinking government Web site. As controversy grows over the Defense Department's shadowy Total Information Awareness (TIA) project, the project's virtual presence is steadily decreasing. First, biographical information about the TIA project leaders, including retired Admiral John Poindexter, disappeared from the Defense Department's site last month. A mirror that one activist created from Google's cache shows the deleted information included four resumes listing past work experience but no addresses or contact information.

Then, sometime in the last week, the TIA site shrank still more and some links ceased to work. The logo for the TIA project -- a Masonic pyramid eyeballing the globe -- vanished, a highly unusual step for a government agency. So did the TIA's Latin "scientia est potentia" slogan, which means "knowledge is power". A spokeswoman for the Information Awareness Office, which runs the TIA project at the Defense Advanced Research Projects Agency (DARPA), said she had no details on the deletions. The disappearing documents come as the TIA has become a lighting rod for criticism and as online activists have been turning the tables on Poindexter by reposting his personal information and home telephone number as widely as possible. The process started with a column in SF Weekly, a San Francisco alternative newspaper, by Matt Smith. He reported Poindexter's home address and telephone number and recounted a brief telephone conversation he had with Poindexter's wife, Linda. Then John Gilmore, the co-founder of the Electronic Frontier Foundation, replied with a widely read essay that urged a broader effort to surveil Poindexter. "Even if some of the information that people end up revealing or using about such targeted scumbags is incorrect, such a public demonstration would highlight the damaging effects that incorrect database information can have on innocent peoples' lives, when used to target them for harassment without due process of law," Gilmore wrote.
Source: ZDNET

Getting to know John, getting to know all about John. As a form of protest, people are working to provide "Total Information Awareness" of John Poindexter. With the potential of all this personal information about the public being in John Poindexter's hands, some people have decided to protest by putting Poindexter's personal information in the hands of the public. By some accounts, it started with an article in SF Weekly and has since spread across the internet and been covered by numerous media sources including the Associated Press, Wired and The Mercury News.

So far quite a bit of personal information about Poindexter has been gathered. (I'm going to resist the urge to post or link to it here, a simple search on Google should turn it up if you are that interested). John's phone number, social security number, home address, relative's names, neighbor's names and shopping habits are just a few of the items now available online for your inspection. Not enough? How about satellite pictures of his home and office? Maps of how to get there? Tax records?

The protest is continuing and more information will surely be discovered and posted by those who want to show John what it feels like when your personal information isn't personal anymore. Aside from making Poindexter uncomfortable, the protest and its coverage in the media has kept the spotlight on the TIA and the privacy concerns it brings. The glare of that spotlight may be having an effect. The TIA's website seems to be shrinking. Along with the creepy Orwellian logo, the biographical information about the project's leaders, including Poindexter, has been removed.
Source: Morons.org

Activists target Pentagon internet information head. Internet activists have a message for John Poindexter, the head of a controversial Pentagon research project to find terrorists by searching the everyday transactions of Americans: Threaten to invade our privacy, we'll invade yours. They've plastered Poindexter's email address and home phone number on dozens of web sites, forcing him to block all incoming calls. They've posted satellite images of his suburban Washington house and maps showing how to get there. And they've created online forms to collect even more personal data on him.

"If you are a store clerk, study the photos above. Learn this face. If you are a shipping clerk, study this name," reads a site titled The John Poindexter Awareness Office, a play on Poindexter's Information Awareness Office at the Pentagon. "When and if you see Mr Poindexter purchase something, travel somewhere or do, well, anything - send us a tip describing your observations. We will display the information received right here on this Web site." It's all an attempt to turn the tables on Poindexter, who is trying to create a vast database of information, from credit card purchases to medical files, and develop software to search it for signs of terrorist activity. The project, called Total Information Awareness, has outraged civil libertarians since it became widely known in November - and spurred some people to do a little database surfing of their own.
Source: NZOOM (New Zealand)

Many are concerned about the government because of their new spyware, the Big Brother affect. Oddly enough, I'm not concerned because I think the government might be "reading my mail".

There's an old saying that goes something like the master swordsman doesn't fear another master, he fears the amateur.

I feel the same way about Big Brother. I don't consider them to be a threat about what they might intentionally find out about me or my friends/family. I fear what they might "think" they found in a fit of total incompetence................

Amen to that. I heard the swordsman comment phrased a little less elegantly: "Evil has to sleep at night. Stupidity is 24/7." At least Big Brother as depicted in Orwell's 1984 was competent - it was staffed by dedicated bellyfeeling Party members who were capable of doing a pretty good job of hunting down and exterminating those who presented a threat to the Party, while leaving the proles alone. A Big Brother staffed by the cluel^H^H^H^H^H fucknoz^H^H^H^H^H^H^H twit^H^H^H^H individuals presently working at INS, or even your local DMV, scares me far more than the one in 1984. But compared to either of those alternatives, I'll take a Big Brother staffed by NSA and CIA any day. Heck, I'll even give the FBI a shot at joining in and redeem itself.

Short of spending trillions to achieve the 1984 total security state, the way you achieve the optimum balance between freedom and security is that you have your police force be just a little bit stupid, and just a little bit slow. We got hit on 9/11 because we went for very slow and very stupid. Bureaucratic stonewalling (no information sharing between FBI, CIA, and NSA) was part of it, as were politically-motivated fuckups like diverting FBI resources away from the Islamokazi whackjob terrorist threat to investigate the domestic militia whackjob terrorist threat. As for stupidity, it doesn't get much dumber than giving visa confirmations to the 9/11 hijackers six months after all hell broke loose - only the INS could pull something like that. And only in the INS could Ashcroft himself not fire those responsible. IMNSHO, the proposed Big Brother composed of our intelligence agencies (NSA, CIA, post-9/11 FBI design goal) has the potential to achieve the right degree of stupidity and slowness for the job -- and I don't mean that as an insult. Any stupider and slower (pre-9/11 FBI, current INS), and we'd have another 9/11. Any smarter and faster (Stasi, KGB, Gestapo), and it'd be 1984.
Source: Slashdot.org

Tuesday, December 24, 2002

Protesting is Good for You

It's official. Something I always new in my bones, that getting things out in the open, doing something, is much better than bottling things up inside. Now, in a new study, psychologists at the University of Sussex found that people who get involved in campaigns, strikes and political demonstrations experience an improvement in psychological well-being that can help them overcome stress, pain, anxiety and depression. I am not one for participating in protest movements myself, but perhaps the important thing is that in your work, in your family life or wherever, you actually feel you have some measure of control, of influence, that you matter. Be that as it may I will always remember the scene in Eastwood's 'Black Hunter, White Heart' where the Houston/Eastwood character takes a severe beating from a younger, fitter white African racist: 'sometimes' says Eastwood, 'you just wouldn't feel right inside if you didn't do something'. Perhaps recent science would tell us that this is something to do with reducing cortisol and raising serotinin and HDL cholesterol but its nice to know sometimes that the things you feel to be good actually are. Could this be just one more plus for low-cost, preventive, alternative medicine.

"The take-home message from this research therefore might be that people should get more involved in campaigns, struggles and social movements, not only in the wider interest of social change but also for their own personal good."

The results emerged from in-depth interviews with nearly 40 activists from a variety of backgrounds. Between them, they had more than 160 experiences of collective action involving groups of demonstrators protesting against a range of issues. These included fox-hunting, environmental damage and industrial matters. Volunteers were asked to describe what it was about taking part in such collective action that made them feel so good. "Many published activist accounts refer to feelings of encouragement and confidence emerging from experiences of collective action," said Drury. "But it is not always clear how and why such empowerment occurs, so we aimed to explain what factors within a collective action event contribute to such feelings."
Source: Yahoo News

On the Dark Side of the Net

Recent efforts by the Pentagon and other US security agencies to put in place a system known as total information surveillance has brought to light one interesting detail: most of the technology needed to make this 'dream' a reality is already in place, and it is in place because we 'the people' have willingly embraced the technical prerequisites which lay the basis for such an all inclusive surveillance system. In other words we have, informationally speaking, dug our own graves. Thirty years ago you needed a whole army of spies and cloak-and-dagger security officers to keep track on what were relatively small groups of disaffected citizens. Today, using the same technology that makes possible Amazon-style peer referenced recommendations, it is a pretty simple task to discover who is interested in what.

My own feeling is the question of whether this is sinister or not depends on how we react to this new reality. Blackmail, for example, can never have been easier as you track all those 'unusual' sites that a wife/husband or boss might be interested in. Alternately, our openness about what we really find acceptable can change, and thus there is nothing to blackmail about. Fifty years ago one of the most gifted mathematical minds of the twentieth century - Alan Turing - was driven to suicide by the criminalisation of his homosexuality. Today an adolescent in the US can take his school director to court to assert his right to take his gay partner to the annual prom dance. Or again, the Nazi bureaucratic machine collected one of the most systematic archives of detailed information of the pre-computer era. But when it came down to the massacreing of millions of innocent people all this information played no important role whatsoever, recourse to an item on a dingy card file was no protection from or source of incrimination. The Nazis with their crude and brutal objective had no use for such a honed down apparatus, they needed a much blunter instrument. Result: these archives have only served as an incredible source of detailed information for those historians who would try and understand how the Nazi society actually functioned.

One final point. The danger of seeing all this sophistocated gadgetry as a protection against terrorism is that you commit an error of principle. It's like trying to play chess under the assumption that you opponent has a null strategy. Obviously the technology balance between government and terrorism is not a symmetric one. Terrorists work in the shadows, this means that they are far more likely to adopt strategies which are relatively low-tech, and when they do resort to more high-tech activities to do so in a way which makes their activity hard to locate in the mass of oterwise innocuous fata collected. At the same time, our societies, based as they are on an enormous digital divide will continue to include huge masses of social space where face to face contact is the primary one, and about which hardly a minimal information trace will ever exist. Here lies the main trap and the main danger for the system of total information surveillance.

Because of the inroads the Internet and other digital network technologies have made into everyday life over the last decade, it is increasingly possible to amass Big Brother-like surveillance powers through Little Brother means. The basic components include everyday digital technologies like e-mail, online shopping and travel booking, A.T.M. systems, cellphone networks, electronic toll-collection systems and credit-card payment terminals. In essence, the Pentagon's main job would be to spin strands of software technology that would weave these sources of data into a vast electronic dragnet. Technologists say the types of computerized data sifting and pattern matching that might flag suspicious activities to government agencies and coordinate their surveillance are not much different from programs already in use by private companies. Such programs spot unusual credit card activity, for example, or let people at multiple locations collaborate on a project.

The civilian population, in other words, has willingly embraced the technical prerequisites for a national surveillance system that Pentagon planners are calling Total Information Awareness. The development has a certain historical resonance because it was the Pentagon's research agency that in the 1960's financed the technology that led directly to the modern Internet. Now the same agency — the Defense Advanced Research Projects Agency, or Darpa — is relying on commercial technology that has evolved from the network it pioneered.The first generation of the Internet — called the Arpanet — consisted of electronic mail and file transfer software that connected people to people. The second generation connected people to databases and other information via the World Wide Web. Now a new generation of software connects computers directly to computers. And that is the key to the Total Information Awareness project, which is overseen by John M. Poindexter, the former national security adviser under President Ronald Reagan. Dr. Poindexter was convicted in 1990 of a felony for his role in the Iran-contra affair, but that conviction was overturned by a federal appeals court because he had been granted immunity for his testimony before Congress about the case.
Source: New York Times

Delhi to Get its First Metro

Maybe this doesn't sound like any big deal, but I think it's an important and interesting sign of the times, and of how things are changing. The metro programme will be built in stages, and today prime minister Atal Behari Vajpayee will open an initial 8.3km stretch of track connecting east Delhi with the north of the city. The entire first phase of 62km should be finished by next spring, and the complete 250km network will be completed by 2010.The state-of-the-art rail system will cost a total of £1.4bn to build and aims to revolutionise transport infrastructure for Delhi's 14m-plus people. The project has been in the pipeline since the 1970s, but building only began in 1998 under the control of the Delhi Metro Rail Corporation, which has overseen consulting and construction work by private contractors including companies from Europe, the US and Japan, while loan financing has been obtained from, guess where, Japanese banks.

A couple of observations seem in order here. Firstly if I am right, and the growth curve for the Indian economy just goes up-and-up, then this type of project with a relatively low initial cost due to India's low current price level, can yield pretty good long-run returns as living standards rise and the value of India's currency and capital stock goes up accordingly. Secondly, the productivity implications are mind boggling. Apparently crossing Delhi now takes anything from an hour upwards, while jumping the metro will involve only a 15 minute ride. Secondly all those rickshaw drivers being freed to work in more productive and less onerous activities would also work wonders for productivity. The key problem is one of job creation, and the transition from being a misery-wage to a low-wage economy. For it is the 'misery' wage situation which perpetuates all those otherwise menial and demeaning activities as performed by the multitute of pan, cigarette and milk 'wallas'. To make this transition what India needs is a steady flow of outside investment, and that, by the look of things, is what they are about to receive.

India's capital is in gridlock. Three-wheeler rickshaws, smoke-belching buses, herds of cows, leper carts and 4m cars have brought Delhi's roads near to standstill.Today, all that could begin to change when prime minister Atal Behari Vajpayee gives Delhi's commuters a long overdue present: its first metro. "It's a 50-50 split on cost between the state and the central governments, with Japanese loans to finance some building," said Delhi's chief minister Sheila Dikshit from her office overlooking the Delhi skyline. "The metro will have a terrific impact on alleviating congestion."

Metro tickets will cost between four and seven rupees (5p and 9p), making it affordable to many commuters. The network hopes to have 2.2m passengers a day by 2005. Passengers will be able to start boarding the first stretch from this month after the premier's inauguration. Ms Dikshit and the metro officials insist the network will not be hit by Delhi's chronic power shortages. "We'll have a dedicated power supply for the metro," she said. As well as taking power from five sources, the metro will have its own electricity generator.Publicity campaigns have been launched to teach Delhites how to cope with the new technology for services such as ticketing. A recent Delhi transport trade fair had a model ofthe metro coach alongside short films showing the Indian public how to usethe network and adopt the proper metro etiquette. Attempts to sit on the roof of the train will be discouraged, with offenders facing the threat of a jail sentence. The traditional Indian pastime of chewing and spitting red betulnut juice at the nearest available surface will also be strictly prohibited on the shiny new network.
Source: Financial Times

Monday, December 23, 2002

Paid Content in the Internet?

As one year draws to a close, and we all start to ask ourselves what the next one may have in store for us, the big temptation is to look around and start speculating. And that, of course, is just what the Economist does this week. Topic of the day: the future of internet content.

Of course this one has been around since the early days of dial-up, but it has reached new highs in the aftermath of the advertising slump. Since the big dot-com bust it seems to me that there has been relatively little serious analysis of where things stand, and where they are likely to go. The most rational assumption would seem to be that while initial expectations were horrendously exaggerated, current pessimism is simply the reverse side of the same coin. If we have an economic system that is prone to give itself over to crazy speculation from time to time, and if the aftermath to the crazy speculation is a credit drag which produces either low growth or outright slump, then the blame is hard to lay at the door of the internet itself. The internet was merely a vehicle for something else. And now that the dust is settling we can see more reasonably were the real trend line is. Thanksgiving weekend, for example, Amazon posted a year-on-year 60%+ growth in sales, not bad in a low growth environment. And as for broadband access, well only 15 million US households have it, but it is spreading at a rate of 50% per annum, so do the math and you'll see that before long that number is going to be a lot bigger. The advertising slump cannot be expected to last forever, and as more broadband users spend less time playing at coach potatoe, then the advertisers will have to follow the eyeballs. Paid content? Well there is space for it, and it will undoubtedly grow. But there is an important rider, it will have to justify itself. (Blogger pro is, for example, something which it goes without saying is worth paying for).

From the individual perspective there is virtually infinite content available, so any paid content will have to justify itself according to a quite strong test. I remember when Brad de Long sent out a cheer on behalf of all of us when the encyclopaedia Britannica went free on-line. Well I have a confesion to make, it's been longer than I can remember since I last consulted the BE. This is because the internet itself is an encyclopaedia, the biggest that has ever been built. (And if the internet is an encyclopaedia then Google has to be the index page). So selling knowledge-based content is going to be hard.

Over here in Europe I have noticed that some newspapers - El Pais in Spain, Franfurter Allgemein in Germany for example - are now trying to charge for access to the majority of articles. This policy seems doomed right now. Faced with phenomena like Google News and the plethora of compare-and-contrast information that is so readily available it is hard to see who is going to pay for the same information as is on offer free elswhere, and if it's opinion you're after, well you need look no farther than the web log world. What seems to be happening is that too many of these decisions are being taken by people with too little knowledge and understanding of what is actually happening in the internet. And there is an additional danger, the habitual use of the internet in non English-speaking countries is already below that in the English-speaking world, and the evidence seems to suggest that in the non English-speaking world the policies of restrictive access are only likely to get worse. Put another way, if this continues instead of seeing the benefits of positive feedback many of these commercial initiiatives are only like to generate a lot of the negative variety.

The internet then is not the South Sea bubble, and it is not a bunch of Dutch tulips. It is real, it is here and it is growing. Which brings us back to the first problem. How to make money out of it?

This being the Internet, things are now poised to change again, with the spread of high-speed, always-on, broadband connections. Broadband boosts all business models, as users “do more of everything”, according to eMarketer. It may even revive growth in online advertising sales. “Rich media” adverts, which contain fancy graphics and sound, tend to be more interesting to consumers than plain banner advertising. More importantly, broadband may capture more broadcast-television ad revenues than dial-up modems have done, says Jeffrey Cole of the University of California in Los Angeles. People seem to like nipping away from the television set to use their always-on broadband connections during commercial breaks, says Mr Cole. Advertisers may cotton on and start exploring ways of advertising to this fast-growing lost audience again.

None of this is likely to mean that Internet firms will deliver on the absurd claims of the late 1990s. But it does suggest that there are profits to be made by selling consumers content and services—as well as physical goods—online. A year ago, even this modest claim would have sounded as implausible as a visit down the chimney from Santa Claus.
Source: The Economist

Sunday, December 22, 2002

Housing. Bubble, What Bubble?

The United Kingdom is a country which has often been blessed in terms of its human resources. The most recent example is that of Mervyn King who has recently been appointed to the post of Governor at the Bank of England. A comparison with the work of a roughly equivalent intellect – Otmar Issing say – at the ECB would show that there was, as the Spanish say, ‘ni color’. Meanwhile the Washington Post today makes a comparison with the Fed’s own Alan Greenspan, a comparison from which our dear Mervyn emerges almost smelling of roses.The issue in question is whether to treat the current escalation in house prices as a bubble, and whether, if the former proposition is well founded, it should be well-and-truly pricked. King’s observations come from a recent speech delivered at the LSE (and which can be found here).

Among the more interesting of the points which King makes about the current UK bubble (in the US the question may be more debateable, but in the UK there is a bubble!), relates to the relative expected evolution of capital values and the debt repayment schedule. In his speech King identifies two regimes: a high-interest, high-inflation regime, and a low-interest, low inflation one. These two regimes have very different underlying structural properties in terms of capital values and debt repayments. In the case of the high interest regime, the initial cost is high, but the burden progressively reduces as inflation eats into the capital value and nominal salaries are adjusted upwards. In the second regime however the entry cost may seem relatively low while the burden of repaying the debt changes little (or even rises in the case of deflation).

Now behavioural economics has been in the news recently with the Kahneman (alias Tversky) Nobel. One of the strong arguments in favour of this way of analysing economic decision taking is its emphasis on the use of ready-made rule-of-thumb criteria for decision taking (this has come into popular parlance through the notion of common sense). This notion of the rule-of-thumb is derived essentially from the work of evolutionary psychologists like Cosmides and Tooby (as popularised by MIT’s Stephen Pinker in books like ‘How the Brain Works’ and ‘Blank Slate’) The point about these rules is that they normally work (and this is why we have a positive appreciation of common sense) since they have been positively selected through an evolutionary process. Now logically normally doesn’t mean always. There are cases where such rules may break down, and I have a feeling King has just identified one such case.

The simple rule of thumb for the future is that this year is going to look something like last year, or, the next five years should look like the last five years (actually stochastically speaking the first statement seems sounder, while from the rule of thumb perspective the second SEEMS sounder) and this is where the mismatch may arise. Central bankers tend to see it differently. They tend to assume that the next twenty years will not resemble the last twenty in the area of inflation because they will be applying a policy of inflation targeting or something like it. Good economists may also have well founded intuitions that the next twenty will be different from the last. But the young person trying to decide on a flat or house may not have recourse to such ideas. This is where the rule of thumb sends things badly awry. For what is more reasonable than to think that with interest rates coming down, and the same monthly payment getting apparently more capital action, to target constant monthly payments rather than square metres. Of course this doesn’t get the extra capital action sought after since the housing stock cannot be expanded rapidly in the way the flow of mortgage funds can (‘sticky’ I think is the word here), and the value of the existing stock adjusts upwards accordingly.

The real problem arises since initial repayments under the inflationary regime tend to consume a rather large part of the current income stream, but this is accepted since with time the proportion of current income consumed reduces. However, as has been observed above, in a disinflationary or outright deflationary environment this doesn’t happen and the proportion remains relatively constant (or even grows if in a given moment interest rates have to rise). This has knock-on effects for other areas of consumption as the money to fund it does not become available. Bottom line: a complete mess. Solution, the normal one as advocated by Keynes, stoke-up a bit of inflation to sweat off some of the debt. But the world of Keynes was then, and this is now. In front of Keynes were years of young generations progressively entering the labour market. The problem was how to create enough employment for an ever expanding working population, our problem is how to persuade more working age women to go to work and to persuade men of 58 not to retire early. We are facing generations to come in declining numbers.

The political dynamics of this are rather complicated. The much longed for inflation would, as we know, devalue both debt and savings. But with ageing populations the losers can outnumber the winners. One further lag should now become of interest to economists, that between immigrant arriving and immigrant voting. Roughly ten years is my back-of-the-envelope guess. This is relevant since immigrants tend to have neither debts nor assets, live on a stream of income basis, and are likely to be inflation/deflation neutral. Without the immigrant vote the ageing savers can dominate the electoral process. I still cannot really claim to understand the subtleties which like behind the dynamics of the Japanese political system, but could the age structure of their population just possibly have something to do with their reluctance to adopt inflation boosting strategies to fight deflation?

A New Bubble
Even as the debate over the stock market bubble continues, another is just beginning, this one over house prices. Nationally, house prices were growing at the annual rate of about 8 percent through much of 2001, while in some metropolitan areas, such as Washington, the average annual percentage increases were as high as the mid-teens. Such increases were two and three times those in household income, leading some analysts to argue that investors who had once poured their savings into the stock market had now decided they could get better, or at least more secure, returns by investing in new and bigger homes. Lending support to that notion were the Fed's own figures on household wealth, which show an acceleration in the growth of mortgage debt beginning in 2001. By the end of 2001, mortgage debt burden as a percentage of disposable household income had reached its highest level in more than 20 years.

A number of critics, including Ed Yardeni, an economist and chief investment strategist at Prudential Securities, blame the Fed for helping to create and fuel what they characterize as a housing bubble. Keeping interest rates at their lowest level in decades, they argue, had the effect of pushing house prices even higher while encouraging households to allow their debt to grow faster than their incomes or their wealth. But Fed officials have repeatedly declared that there is no housing bubble worthy of the name. "We've looked at the bubble question and concluded it's most unlikely," Greenspan testified at a congressional hearing in July, noting that the housing market by that time had already begun to cool. "We see no evidence of it." Indeed, rather than expressing concern about the increase in mortgage debt levels, Greenspan and his colleagues have applauded the boom in mortgage refinancings that allowed millions of homeowners to "cash out" on some of the equity value of their homes. Consumers have used much of that money to continue spending on new cars, furniture and other goods right through the recession, Fed officials argue, helping to smooth out the business cycle and make it one of the mildest in memory.

By contrast, Mervyn King, the new governor of the Bank of England, used a speech last month to warn that the British economy had become overly reliant on consumer spending propped up by increases in housing values that reached nearly 30 percent in the past year. "Even the optimistic Mr. Micawber would realize that this cannot continue indefinitely," King said, referring to Charles Dickens's character in "David Copperfield." But King went on to acknowledge that he wasn't sure whether the central bank should try to prick the bubble before it burst, or give it a chance to deflate on its own.
Source: Washington Post

Saturday, December 21, 2002

Unscrupulous Hucksterism

Commenting on the recent golbal settlement between Wall Street regulators and analysts, the New york Times, in an editorial, muses the adequacy of the agreed punishment to the acknowledged crime. Irrespective of your verdict on this one, it's impossible not to be struck by their conclusion that prosecutor Spitzer's determined efforts have at least served an educational purpose since "investors are now on notice that unscrupulous hucksterism is a part of any frenetic bull market". Unfortunately this, I fear, is to miss the point. During any bear market the "unscrupulous hucksterism" of the bull market is all too apparent, but it's during the bull market itself that it's hard to see. Any bull market bubble will have its attendent "irrational exuberance", that's what defines it as a bubble. The analysts were, after all, only telling the people what they wanted to hear, and if they had offered a different message it probably wouldn't have been heeded. Bottom line: any agreed regulations will work perfectly during the bear, but will be surprisingly ineffective next time we go up. Anyone who doesn't believe this should try asking house buyers in the UK, or here in Spain, what they think of the research reports which say property is currently greatly overvalued and warn that a correction is in the pipeline.

The cleanup crew showed up at the New York Stock Exchange yesterday to tackle the debris left over from Wall Street's dot-com binge — the tainted research, the rigged initial public offerings and all the rest of it. Marshaled by Eliot Spitzer, New York State's attorney general, a raft of regulators announced a global settlement with 10 major Wall Street firms that stand accused of duping investors. The firms will pay close to $1 billion in fines, and have agreed to alter their behavior.

The settlement should prove beneficial to investors. The firms agreed to insulate their research analysts from their investment-banking operations. No longer will analysts be permitted to help land underwriting deals, or to have their compensation tied to these efforts. Greater disclosure will be required of analysts' past performance, and firms will pay hundreds of millions of dollars, beyond their fines, to subsidize independent, third-party research that will be shared with their retail clients. Firms are also barred now from allocating I.P.O. shares to executives of client companies.

Critics who feel such sums are paltry compared with the billions that banks made peddling overvalued stocks can take comfort in the fact that a record of findings to be released next month as part of the settlement could prove valuable to the dozens of class-action lawsuits the banks still face.
Source: New York Times

Thursday, December 19, 2002

German Doldrums

Two pieces of news from Germany this morning which may be more related than they appear at first sight. The first is the decision of the country's highest court to strike down the new landmark immigration law after procedural objections by the opposition.The ruling by the federal constitutional court means the law, simplifying and modernising Germany's complex immigration rules to allow greater access for well qualified candidates from outside the European Union, will not come into effect on January 1 as planned. The second is the fact that German business confidence deteriorated for the seventh month running in December (although it did show signs it might start to pick up again soon). The Ifo economic institute on Wednesday said that its business climate index fell to 87.1 this month from 87.3 in November. Now while these two items are clearly not related in the sense that there is any evident causal mechanism which links them, German business men and women do have good reason to lack confidence in a population which is now in natural decline (ie live births are now less than deaths) and which repeatedly demonstrates its inability to open itself to the world:

The constitutional court upheld the argument of six opposition-governed states that last March's controversial Bundesrat immigration vote was invalid. The case stemmed from differences between the government and opposition regarding the treatment of the decisive vote cast by Brandenburg, a state run by a "grand coalition" of the CDU and the Social Democratic party (SPD).The ruling came against a background of wage strikes by public-sector workers and followed the government's embarrassing need this week to offer the CDU extensive concessions to ensure support for its ambitious job placement and labour market reforms
Mr Schröder's difficulties were further underlined on Wednesday with the latest Ifo index of business confidence, showing its seventh consecutive monthly fall. Separately, a new opinion poll revealed that Mr Schröder's SPD was trailing the opposition by 21 percentage points.
Source: Financial TimesLINK

Wednesday, December 18, 2002

A Future Without McDonalds, The Food Your Father Ate

In yet another illustration of the fact that everything that lives was born to die, McDonalds turned-in its first loss in history yesterday. McDonald's Corp. informed the world of its first-ever quarterly loss after a package of cutting jobs and closing outlets failed to bring the numbers back into line, while sales at the world's largest restaurant deteriorated in the saturated U.S. fast-food market. The hamburger maker's shares fell 8 percent to close at $15.99 on the New York Stock Exchange, down $1.39. In fact yesterday the stock was the most actively traded issue on the NYSE, touching at one stage $15.59, its lowest level in nearly eight years. The background to all this is a change in the U.S. fast-food market which has become increasingly competitive as McDonald's hamburger rivals Burger King Corp. and Wendy's International struggle to maintain market share while consumer tastes change and other fast-food options - such as sandwich chain Panera Bread - emerge. All this goes to show that in a world of dynamic competition, nothing lasts forever. With other big name outfits like Disney also hit this year, it is clear that something of a cultural sea change is taking place. How long should we give Levi's and Coca Cola?

McDonald's, based in Oak Brook, Illinois, has been testing other concepts, including pizza and Mexican-food chains, while Wendy's has relied on its Canadian doughnut chain to help drive growth. Yum has been pushing aggressively into overseas markets such as China. So far in the fourth quarter, McDonald's sales at stores open at least 13 months are down 1.6 percent before the effects of foreign exchange, the company said in an updated earnings outlook. Same-store sales in the United States, McDonald's largest market, fell 1.3 percent in October and November and 1.5 percent through the first 11 months of the year, a sign that the company's new discounting strategy is not meeting expectations, analysts said. "It's clear that the discounting program is not working," said Bear Stearns analyst Joe Buckley, referring to the "Dollar Menu" McDonald's recently launched to drive up sales. "To improve service is very important for them, I think that's kind of the short-term key." Incoming CEO Jim Cantalupo, former vice chairman and president, is in the process of "aggressively reviewing" all aspects of the restaurant company's operations with an eye on improving financial performance.
Source: Reuters News

Tuesday, December 17, 2002

Some Thoughts on Stephen Roach and Paul Krugman

While it's 'full marks' to both Krugman and Roach for having focused all our attention on the complex problems attendant on the collapse of the internet boom and the bursting of the stock market bubble, I still can't convince myself that the analysis isn't missing something. Both of them have, correctly in my view, stressed heavily the point that bubble-unwinding takes us into territory which is outside the pattern of the 'normal' business cycle as we have come to know it since the 1970's. In particular this is a result of the negative credit dynamics which follow the unwinding, a dynamic process which makes investment much more expensive for the corporate sector and hence, as a consequence, growth much slower. It is this 'sluggish' growth which brings the danger of deflation nearer as rapid productivity improvement puts downward pressure on prices. Hence our economies as they say 'are subject to downside risks'.

The latest piece of evidence Roach cites to back his thesis are the just-released minutes of the early-November Federal Open Markets Committee meeting. For him there is little question about what the Fed is really up to: they are preparing the fire brigade ready for action. In the Fed's own words : "…a faltering economic performance would increase the odds of a cumulatively weakening economy and possibly even attendant deflation. An effort to offset such a development, should it appear to be materializing, would present difficult policy implementation problems."

However I cannot help feeling that there is something missing in this story. As I have said before, it is rather like staging Hamlet without the Prince. In the present case offering a projection of our current problems and future prospects absent the principal actor: the demographic transition.

I’ve been bearish for so long, they’ve removed the "plus key" from my laptop. I am still of the view that the risks to this US-centric global economy remain decidedly on the downside of consensus expectations. I also believe that there’s more to come on the deflation watch. But this once heretical view has now caught the attention of policy makers around the world. They have jumped on the anti-deflation bandwagon as never before.

America’s Federal Reserve has led the way. The Fed has clearly gotten religion on the deflation watch. The first inklings of this conversion were evident in the form of a seemingly obscure staff research paper published by the Federal Reserve Board last June (see A. Ahearne, et. al., "Preventing Deflation: Lessons from Japan’s Experience in the 1990s," International Finance Discussion Papers, No. 729, June 2002).

I have long felt that the Fed was laying the groundwork at the time for an anti-deflationary assault in the United States (see my 15 July 2002 dispatch, "Asymmetrical Risks" in the Global Economic Forum). And that’s exactly what has happened. The Fed threw down the gauntlet, with its larger than expected 50-basis-point monetary easing on 6 November. The ink was barely dry on the policy statement of that action, when Chairman Alan Greenspan went public on the deflation debate in front of the US Congress. That was followed by a seminal speech by newly installed Governor Ben Bernanke, which dispelled any lingering doubts over the Fed’s concerns over deflation (see his 21 November remarks before the National Economists Club, "Deflation: Make Sure ‘It’ Doesn’t Happen Here").
Source: Morgan Stanley Golbal Economic Forum

The problem is that as we empty all our conventional armoury of ammunition - interest rates steadily draw nearer to zero, and fiscal policy looks increasingly problematic as outstanding obligations to ageing populations make debt-related spending a non-starter for any protracted period - the only remedy which seems to be left is exchange rate policy (unless your're in the Euro zone that is, because there even that is a non-starter). But even a mathematical non-genius can see that if we all try to come down at once it won't work. And, hey, doesn't this smell awfully like those 1930's style competitive devaluations which seemed to do so much harm, and which all the post 1945 financial and monetary architecture was supposed to stop. Well guess what, we're back in the land of Keynes, a land where looming indebtedness seems to be about to throw an enormous brake switch on our collective growth capacity, and we haven't even realised it's happening, yet. Well Keynes was always unorthodox, so I've got one 'New Keynesian' proposal which might help start the ball rolling. How about an international 'Bretton Woods' style conference on population and international migration?
Japan About to Try to Lower the Yen

Signals coming out of Japan, difficult as they are to read at times, seem to indicate that a change in exchange rate policy may be imminent. On Mondayprime minister Junichiro Koizumi added his voice to a growing body of evidence that his government, which regards the yen's rise as reflecting external weaknesses rather than any significant improvement in its own economy, would welcome a currency depreciation. He said the new governor of the Bank of Japan should support an aggressive anti-deflation policy. Mr Koizumi must choose a new BoJ governor by March. Since Japan has all but exhausted the possibilities of fiscal and monetary policy a substantial depreciation of the yen remains one of the few policy options open to the government.

A senior official warned on Monday that Japan would take decisive action against rapid fluctuations of the yen, reflecting growing concern that economic recovery is being stifled by a strengthening of the currency. The signal from Toshiro Muto, vice-finance minister, of possible intervention came on the same day that the Nikkei average notched up its longest losing streak in 11 years, with yen-sensitive exporters particularly heavy casualties. On Friday, the yen rose to a one-month high against the dollar at ¥120.3, and was hovering around ¥120.6 on Monday, prompting investors to unload shares of Japan's biggest exporters, including Sony and Canon. The Nikkei average lost 0.8 per cent to 8,450.94, its first nine-day losing streak since September 1991.
Source: Financial Times

Monday, December 16, 2002

Europe Groping for an Identity?

Last week's EU enlargement agreement has been hailed as historic by some, and as a lost opportunity by others. Whatever decision is finally passed by history one thing seems sure, this is an important turning point. Among other changes, the Euro zone countries will now be a minority within the EU. In redrawing the map of Europe, the 15 men whose countries represent one of the world's most important and exclusive clubs tore down one border only to build another. The summit formally invited 10 new members, most with dysfunctional economies, to join the European Union by 2004, thereby expanding eastward into territories whose future economic and political development is far from clear. At the same time they rejected Turkey's demand that its candidacy be given more urgency, erecting a wall that is sure to be seen by the mostly Muslim country of 67 million people — and by the rest of the Muslim world — as a division between the Christian West and the Islamic East. The Europeans rejected a plea from Turkey to set a date for starting talks on its eventual admission. The response from within Turkey itself was predictable. The front page of one Turkish newspaper - Hurriyet - was illustrated with da Vinci's "Last Supper". Below figured the question, "Will the E.U., like Christ's last supper, be purely for Christians or will there be a Muslim at the table?"

My feeling on these decisions is that on the one hand the enlargement programme is far more problematic than is normally recognised, while on the other a great opportunity has been missed. But the Europeans are getting old, and old is not normally synonymous with bold. The newly admitted countries are not a re-run of the Spain, Portugal, Greece expansion of an earlier era. The new countries do not have the demographic 'gift' that lay before the mediterranean countries at the time of their entry. They are mainly economies which have barely survived the transition shock from the old centrally-planned type. They are ageing societies whose birth rates have long been among Europe's lowest, where women - of all ages - have long since been out of the home working. If they do not face the negative debt dynamics of the other EU countries, then this is only because they have assumed only minimal responsibility for the welfare of their aged, and thus the anticipated costs of ageing are lower. But this is not exactly good news. It means, among other things, that we are extremely unlikely to see an expansion of internal consumption 'mediterranean-style', but rather an increase in decrepitude, misery and dispair.

Turkey's stuation could not be more different. Turkey is going through a 'demographic transition' and birth rates are steadily falling towards that magic number: 2.1 live births per woman of childbearing age. But they have not got there yet, and Turkey's young population - nearly 30% of the 70 million population are under 15, compared to an average of only 15 % in the new entrants - could give EU consumption growth a much needed boost. But while the economic arguments for an early accession date for Turkey are compelling, the political and cultural ones should be decisive. Turkey has a human rights problem, sure. But there is an internal battle inside Turkey over this, and bringing the Turks into dialogue with the Union would give important aid to the pro-democratic, pro-human rights forces that exist there. In addition, moving Turkey's dossier forward would give the world another, and even more imporant, message about Europe's cultural identity. It would give a message about diversity and openness, a message of hope for that enormous majority among the islamic populations of the world who have no more sympathy for the Bin Laden's of this world than we do.

European politicians wave away talk of a clash of religions or of blocking Turkey to control immigration and insist that their decision was based on standards of democracy and human rights, and on controlling immigration and terrorism. With the decisions here, the European Union has given itself the thankless task of defining Europe, a task that has baffled scholars and politicians for centuries. "Geographical Europe," wrote Norman Davies in "Europe: A History," "has always had to compete with notions of Europe as a cultural community, and in the absence of common political structures, European civilization could only be determined by cultural criteria." Jean Monnet, the visionary advocate not just of economic union but of an eventual United States of Europe, took the extreme position in the immediate years after World War II, writing, "Europe has never existed; one has genuinely to create Europe." His way of doing so was to bring together that part of geographical Europe that was democratic into a common unit by knitting its economies together. The aim was that politics would follow. Now, the European Union is embarked on the task of adapting that vision to a very different political landscape. Even as it struggles to create political, economic, social and even military institutions to serve its current members, it has been challenged by events to enlarge itself — and is faced with the question of what other societies might fit in.
Source: New York Times

Friday, December 13, 2002

German Debt to Lose AAA Status?

It seems Germany's status as the benchmark in the eurozone debt market is under threat because of growing concerns about their ability to hold on to their triple A credit ratings. Arguably investors are already begining to price in the risk of a German downgrade as the fiscal position continues to worsen. Standard & Poor's this week affirmed Germany's triple A rating with a stable outlook, but pointed to growing debt and fiscal deterioration as an indication that Germany "has begun to fall behind its triple A rated peers in terms of fiscal and economic indicators". Because of its benchmark status - the result of Germany's historically strong finances - Berlin has been able to borrow more cheaply than other eurozone governments, this position could now be in the process of changing, making the debt more costly to maintain and thus in principle increasing the deficit.

David Riley, head of sovereign ratings at Fitch, said: "Germany's triple A rating can no longer be taken for granted." Fitch plans to review Germany's rating in the first quarter of next year. "We are going to Germany because we are concerned about the structural issues and I would not rule out a negative action," Mr Riley said. Moody's is also planning to visit the country next year but it said that its main concerns focused on long-term structural issues, such as the state pension system, rather than on the shorter-term fiscal position. A downgrade or even a change of outlook on Germany by any of the three large rating agencies could affect its benchmark status. While German 10-year yields are still the eurozone's lowest, some analysts now expect France, its closest rival since the euro came in, to achieve benchmark status next year in terms of the price of its debt.
Source: Financial Times

Meantime Italy, with a current debt GDP ration of around 109.8%, plans to use a piece of 'coupon-clipping' to reduce the outstanding stock of debt to around 108.5% by swapping €39 billion of 1% government bonds held by the Bank of Italy in its own portfolio with comparable issues carrying higher coupons (say in the 4-5% range). Since an increase in the coupon would reduce the nominal value of the debt this move would help the debt/GDP ratio, the stream of future budget deficits, in contrast, would go up by around one-tenth of a percentage point a year in paying the higher interest. The real problem, however, is that a country with a stock of debt larger than its GDP keeps living beyond its means and borrowing from the future, and no amount of financial jiggery-pockery is going to change that reality.

Thursday, December 12, 2002

World Bank Warns on Risk of Latin American Detachment

In a report published 11 December (Global Economic Prospects and the Developing Countries: 2003) the World Bank suggests something which most thinking people have already discerned: that economic growth 2003 will be a sluggish affair. They also the opportunity to highlight the growing risk that Latin American economies generally can become detached from the pack in an environment of hightened investment risk and stronger than par economic growth in Asia.

They argue that after exceptionally slow growth in 2001 and 2002, global GDP is now expected to rise by 2.5 percent in 2003, higher than the previous two years but still well below the 3.9 percent expansion recorded in 2000 and significantly below long-term potential growth rates. The report warns that the global rebound might quickly lose momentum and suggest there is a significant risk that the world could slip back into recession. According to their latest forecasts, high-income countries are expected to grow at about 2.1 percent in 2003. On average developing countries will grow considerably faster, at 3.9 percent. But the average masks wide regional differences, with East Asia leading the pack at 6.1 percent, followed by South Asia at 5.4 percent. Other regions are expected to grow less than 4 percent, with Latin America managing a mere 1.8 percent. Outside of Asia and Eastern Europe, growth rates in most developing countries are too low to generate a marked reduction in poverty.

The report argues that factors suppressing global growth in the near term include waning consumer confidence, high debt levels in the face of a weak equity market, and the fallout from corporate financial scandals in the U.S., continuing investor worries over imbalances in the Japanese banking system, and over-investment in telecommunications and other high technology in Europe, as well as concerns about debt problems in Latin America.

At the same time, the region remains more vulnerable than many other developing regions. First, a high debt overhang from the 1980s remains a problem to finance in many countries. In the 1990s, some countries continued to rely on significant debt financing, particularly in the public sector. Public debtto- GDP ratios rose in some countries and the maturity of that debt shortened in duration, increasing their vulnerability to shifts in investor sentiment as they question debt sustainability. LAC countries may have to learn to live with less debt in the future, adjusting public expenditures as required. Countries need to create fiscal space during good times (boom years) to be able to conduct countercyclical policies in future downswings in economic activity. Second, many countries, especially the low-income coffee producers, also need to further diversify their export base to reduce vulnerability to large swings in commodityprices. Finally, the region still lags in financial deepening (which could help raise national saving rates), infrastructure, and quality of institutions—areas that need to be improved before the region can attain high sustainable growth rates.
Source: World Bank

Wednesday, December 11, 2002

Portuguese Workers Are Not Happy

Portugal was brought to a virtual standstill by a general strike yesterday as unions challenged reforms introduced by the centre-right government in its effort to cope with the eurozone's spending and borrowing rules and the impact of European Union enlargement. The 24-hour stoppage, Portugal's first general strike in a decade, mainly involved public sector workers who say they are bearing the brunt of the austerity measures which are designed to bring the budget deficit back within the limit set under the eurozone's growth and stability pact. Whatever the complexity of the problems lying behind Japan's deflation problem, it is not too hard to look into the proverbial crystal ball and see how the future is likely to pan-out for some Euro-zone members. Faced with an inflation dynamic which makes them increasingly less competitive they are finding growth hard. At the same time an ageing population and escalating future pension liabilities mean they have a debt trap - they cannot try to stimulate growth by getting into debt because the future growth expectations, which would enable them to pay-off the debt, just are not there. Hence deflation is an ever present danger.

"Portugal is in danger of losing an important dimension of social solidarity and stability if the government goes ahead with these reforms," said Manuel Carvalho da Silva, general-secretary of the CGTP-Intersindical trade union federation, which called the strike. But António Bagao Félix, labour and social security minister, said the reforms were vital if Portugal was to compete successfully for export contracts and inward investment with the east European countries due to join the EU in 2004. The strike, which disrupted hospitals, schools and courts and brought public transport to a standstill, was mainly targeted at government proposals to replace about 80 labour laws with a single new code designed to increase efficiency.
Source: Financial Times

EU Expansion Agreement Proving Difficult

With a summit aimed at admitting 10 more countries to the European Union only two days away, the candidate governments are still bargaining hard for better financial terms of membership, and the member governments are still trying to decide how much to offer. According to the experts, with so much unresolved, the summit that opens Thursday in Copenhagen could well extend beyond its scheduled two days. In fact European officials are saying that the most difficult issues will not be resolved until government leaders sit down behind closed doors for last-minute deal-making. Of course, the main sticking point in the negotiations between the 15 EU countries and the candidates is money. The countries joining the union will get direct cash payments in the form of development aid and support for farmers, far beyond the amounts they will have to pay into the EU. But they are joining at a time of economic constraints in Europe generally. In return for the aid the new countries would have to accept a series of strict agricultural production quotas. Poland, which has more farmers than Germany and France combined, has been particularly vocal in crticising the proposed terms, pressing for more farm aid and higher production quotas in areas such as milk. The nub of this problem is that all this comes at a time when the leading EU countries are experiencing far more economic difficulties than were expected at the time of proposing entry. Germany in particular is having to propose a very difficult package to its own citizens this winter to maintain its commitment to the stability pact, while having higher than desireable interest rates due to Euro membership. This means that it is in no position to be especially generous. Hence we have an 'expectations gap', the new, poorer, countries being in a worse position that the existing members imagine, while the existing members are unable to meet the generosity expectations of the newcomers. All-in-all it is difficult to see how this can work well long-term.

"This has to be in the hands of the heads of state and government," said Romano Prodi, president of the European Commission, the EU's appointed executive body. "The decision is too important a decision to be taken beforehand." He added, "Miracles are always possible." Prodi said he did not expect the haggling to derail plans to formally issue membership invitations to the 10 countries -- Poland, Hungary, the Czech Republic, Slovakia, Slovenia, Malta, Cyprus, Latvia, Lithuania and Estonia. "The deep sentiment of all the heads of state and government -- I repeat, all -- is in favor of enlargement," Prodi said. "The enlargement is seen as an historic goal. It is not a decision of 'if,' it is a decision of 'how.' "
Source: Washington Post

Tuesday, December 10, 2002


The U.S. unemployment rate shot up to 6 percent in November as employers reduced their payrolls by the largest amount since February, the US government said on Friday in a weak jobs report that offered little short term optimism for the economy. The jobless rate hit its highest level since April, jumping three-tenths of a percentage point from October's 5.7 percent, according to the Labor Department. Many US labour market watchers had been expecting a more modest rise to about 5.8 percent. At the same time, the number of workers on U.S. payrolls outside the farm sector fell by 40,000 last month, a worrisome showing compared to a consensus expected gain of 38,000. The hard-hit manufacturing sector shed 45,000 jobs last month. Furthermore, in a worrying indication that businesses are remaining cautious in the run up to the Christmas holiday shopping season, retail jobs sank 39,000. All this, when placed alongside the rapidly rising US productivity number gives some cause for concern that a deflationary environment may be slowly but surely arriving.

The monthly decline in the nation's job market was the biggest in nine months. Highlighting the slide was a further reduction in manufacturing payrolls, which contracted by 45,000 jobs in November. It was the 28th consecutive drop in monthly employment at the nation's factories.

While manufacturing only represents about 20 percent of the nation's output, analysts said the economy would be hard-pressed to return to a sustained growth path until factory output and employment start to rebound.

The manufacturing numbers, which included a third successive decline in aggregate hours worked, strongly suggest that industrial production fell again in November. The Federal Reserve is scheduled to release industrial production statistics on Dec. 17. In advance of the jobs report, economists had been forecasting a modest 35,000 to 40,000 increase in nonfarm payrolls. Part of the optimism was based on a string of declines in new weekly claims for unemployment benefits. But the hopeful feeling was inaccurately based, some analysts said."This will cause people to remember that claims tell you how many people are getting laid off," said David Resler, chief economist at Nomura Securities International. "They tell you nothing about how many people are being hired."

On a brighter note, employment in the service sector rose. Health-related companies made up more than half the November increase, with notable gains in hospitals and nursing homes. But employment at temporary-help agencies fell for the second month, after several months of steady gains. Such employment is closely watched by economists because companies often seek temporary help as their businesses start growing again, instead of taking on full-time workers. Other big industries showed little change in November, including construction and government, which had a large gain in October. Economists said the rise in the unemployment rate would undoubtedly be a topic of discussion when Federal Reserve policy-makers meet on Tuesday. But the Fed, which last month announced a sharp cut of half a percentage point in short-term interest rates, is very unlikely to approve another rate cut anytime soon, the economists said. "They made a strong statement last month, and will sit back and watch for a while," said Ward McCarthy, a managing director at Stone & McCarthy, an economic research firm in Princeton, N.J. "But they have to be disappointed with these numbers." The rise in the unemployment rate is almost certain to stoke talk about the need for further stimulus, probably in the form of tax cuts, analysts said. "There is a very high chance of some sort of new fiscal package," Mr. Harris at Lehman Brothers said.
Source: New York Times

Friday, December 06, 2002

Is the ECB Rate Drop a Good Decision? It Depends Where You live

As I have been flagging in this column for some weeks now, interest rate policy for the Euro zone is a mess. The most obvious way of indicating this is to say the Duisenberg has no good decision strategy available. Not because he is a good, or bad, banker, but because undecideability is structurally in-built into the problem. The decision is rather whose interests do you favour, the low-inflation or the high-inflation countries. Even if this decision could be seen as mildly helpful from a German, or French point of view, from 'down South' in Portugal, Greece and Spain it looks decidedly risky. For Germany it seems to be a question of far too little, far too late, well behind the curve as they say. Of course, one day the inflation down South will stop. It has to, since they now have no independent currency to devalue in order to recover competitiveness, and, of course, unlike the US they do not have a central bank of their own to start the printing presses rolling. So one day the inflation will turn into deflation as their economies cease to be able to oxygenate and they start to suffer an absence-of-liquidity induced asphyxiation. Meantime we are in a kind of time-void between a decision whose chronicle was already foretold two to three weeks ago (thus there is no real market-shock as it is already priced-in), but whose consequences won't be noticed in any significant sense for six to nine months at least. Bottom line: whatever the long hard winter was which lay in front of Germany as of last Wednesday, well, it still does.

On another front, back in the UK, the consequences for Euro membership of the current interest rate divergence are starting to sink in:

After walking side by side for a while, the European Central Bank and the Bank of England have come to a parting of the ways. It may now be a long time before their paths bring them so close to each other again.In recent years, the gap between the main interest rates of the Bank of England and the ECB has been falling steadily. Last year it closed to just three quarters of a percentage point.Thursday's decisions by the two banks, however, suggested that the impression of convergence between Britain and the eurozone has been illusory......

"The ECB's next move is more likely to be down than up, while the Bank of England's next move is more likely to be up than down," said Robert Barrie of Credit Suisse First Boston. "Inflation is below target in the UK, but potentially going above it, while it is above target in the eurozone but probably going below it." Although both investment and exports have been weaker in Britain than in the eurozone, consumer demand is very much stronger. According to the Organisation for Economic Co-operation and Development, consumption is expected to have risen by 3.6 per cent in Britain this year, supported by a boom in house prices and household borrowing, compared with a mere 0.6 per cent in the eurozone.

The first four years of monetary union have shown that convergence inside it is a slow process. The dispersion of core inflation rates in the eurozone is actually greater now than it was at the euro's birth at the beginning of 1999.For some countries such as Spain and Portugal, real interest rates allowing for inflation are negative. Hence this week's complaint from Rodrigo Rato, Spain's finance minister, that "an interest rate cut is not so great from the inflation point of view". But for Germany, where inflation is low, real rates are still positive although the economy is close to a standstill. "Monetary policy is extremely expansionary in Spain, and extremely restrictive in Germany. It is amplifying the differences between unemployment and growth rates across the eurozone," said Patrick Artus of CDC Ixis in Paris. "If you have a single monetary policy with no significant migration or fiscal transfers, you're in trouble." Whatever the benefits of joining the euro for trade and investment, the risks involved in submitting to the eurozone's single interest rate will make the British government think very hard indeed before joining.
Source: Financial Times

Tuesday, December 03, 2002

Is Japan Trying?

This question at first sight may strike one as strange, but it appears to be one which is worth asking since US economists have been lining up one after another recently to suggest just that. One way or another, it seems, the Japanese are simply not trying to find a way of getting out of their dreadful economic mess. Of course this assumes we have a diagnosis which is adequate to the problem, that there is a convenient solution to hand, and that the principle problem is one of having the will. It was Stephen Cecchetti who got the ball rolling in this latest bout of 'Japan fretting' with the following in his Financial Times article on deflation:

"What about the zero nominal interest-rate floor, the point at which central banks supposedly become impotent? Listening to officials from the Bank of Japan, you would think that once they set their interest rate target to zero, there was nothing else they could do about stagnant growth and falling prices. Again, I do not believe it."(see my article here)

Then Ben Bernanke added his tuppence-worth:

"The claim that deflation can be ended by sufficiently strong action has no doubt led you to wonder, if that is the case, why has Japan not ended its deflation?.......Japan's deflation problem is real and serious; but, in my view, political constraints, rather than a lack of policy instruments, explain why its deflation has persisted for as long as it has. Thus, I do not view the Japanese experience as evidence against the general conclusion that U.S. policymakers have the tools they need to prevent, and, if necessary, to cure a deflationary recession in the United States."

In fairness Bernanke does not suggest that the Japanese have failed to use monetary easing. But his analysis of what the Fed might do almost all revolves around the use of monetary and exchange rate policy to produce inflationary expectations, thus the claim that all will be well in the US 'since the US has the tools it needs' might be thought to ring somewhat hollow. If the problem in Japan revolves around political constraints, constraints like an unwillingness to bear the weight of the impact of structural reform, then perhaps he might have done better to address the reasons these political constraints will not be operative in the US. Absent this, the assurance that the US will be different seems to imply that there is a mix of monetary and economic policy (short of collapsing their economy completely by closing half of it down) which the Japanese are NOT using. This however seems doubtful.

On the fiscal front what Bernanke terms 'the heavy overhang of government debt' is cited as making ''Japanese policymakers more reluctant to use aggressive fiscal policies". Now this public debt overhang is a product of Japan's ageing population, so are we really to believe that the US might not face similar dilemnas as we get further up this decade? Further, as Paul Krugman has suggested, Japan has not been exactly backward in coming forward with fiscal policy:

"What about the second line of defense, fiscal policy? Japan has tried that, and it has worked -- sort of. Let me explain. .....If you have visited Japan recently you know that it does not look like a country in the midst of a depression. There are strong similarities between Japan in the 1990's and the United States in the 1930's, but there is also a big difference. America descended rapidly into depression. Japan's crisis has unfolded far more gradually........

The other reason that Japan does not look like a country in the midst of a depression is that the government has found a concrete solution to the problem of mass unemployment. By ''concrete,'' I don't mean serious, hardheaded, substantial. I mean concrete, as in roads, dams and bridges. Think of it as the W.P.A. on steroids. Over the past decade Japan has used enormous public works projects as a way to create jobs and pump money into the economy. The statistics are awesome. In 1996 Japan's public works spending, as a share of G.D.P., was more than four times that of the United States. Japan poured as much concrete as we did, though it has a little less than half our population and 4 percent of our land area. One Japanese worker in 10 was employed in the construction industry, far more than in other advanced countries.

Now for the bad news: deficit spending has slowed the Japanese economy's slide, but it has not reversed it. That is, the public works programs provide only temporary, symptomatic economic relief. The favorable effects last only as long as the spending itself. They don't seem to lay the basis for a permanent turnaround.
The Fear Economy

Well, you might think that the case was far from clear. So why don't the Japanese complain at all this unfair coverage of their economic and financial policy. Well, that's just what two of their politicians do in yesterday's Financial Times. Of course their solution is not particularly unconventional: stop China. Since attack is always the best form of defence, they begin with a scarcely value sideswipe at the ECB:

Monetary policymakers around the world are still fighting the old enemy of inflation, not the new foe of deflation. There is an urgent need to switch to global reflation in order to avoid a deflationary spiral. In order to cope with economic stagnation, there has been aggressive fiscal expansion since the early 1990s. Several years after the collapse of the bubble, the Bank of Japan belatedly shifted to easy monetary policy. Then it gradually guided the short-term money market rate below the discount rate, but without much success in stopping price deflation, let alone reviving economic activity.

Last year, with the short-term rate virtually at zero, the BoJ abandoned the use of interest rates and shifted to a quantitative easing policy by targeting the current account balances of commercial banks held at the bank. Despite the injection of liquidity into the markets, the BoJ has not stopped price deflation. Its ability to conduct an effective monetary policy has also been hampered by a dysfunctional financial sector. Commercial banks, saddled with large non-performing loans and inadequate capital positions, have been unable or unwilling to extend loans even though they have abundant liquidity.The Japanese experience demonstrates that traditional monetary policy can lose potency in a deflationary environment. Since the nominal rate cannot fall below zero, a central bank can lower real interest rates and so provide monetary stimulus only by drastically changing price expectations.
Source: Financial Times

This attempt to shift the blame for deflation towards China has recently drawn fire from Stephen Roach. In a post on December 13 entitled 'Stop Bashing China' he takes time out to make special comment on this argument from Kuroda:

The Japanese have recently taken their China complaint to a different level, using it as a scapegoat for their deflationary conundrum. That was the unmistakable message from Haruhiko Kuroda, the Japanese MOF vice minister for international affairs, in a recent opinion piece in the Financial Times (see "Time for a Switch to Global Reflation," published on 1 December 2002). Kuroda-san pointed the finger at Japan’s Asian neighbors in general – and China, in particular -- as a major source of deflation. Yet inasmuch as Chinese imports account for less that 2% of Japanese GDP, it’s hard to be too aggressive and blame China for sparking Japan’s own self-created deflation.
Source: Morgan Stanley Global Economic Forum

One Japanese observer who has some experience of watching how monetary policy evolves as interest rates approximate to zero (ZIRP) is Morgan Stanley's Takehiro Sato. In a post in early November in the Morgan Stanley Global Economic Forum he made the following observation in connection with Greenspan's recent 50bp reduction in the Federal Funds Rate.

The Japanese economy can be viewed as the front runner in a global deflation race with no apparent end. The central banks of other industrialized economies will gradually come to understand the BoJ’s struggle, having completely exhausted traditional policy measures. Central banks fought inflation through the mid-1990s, but the battleground has changed to the uncharted territory of deflation. In some respects, it is positive that overseas policy authorities and academics will begin coming to terms with the tough challenges of fighting deflation in a ZIRP environment, which is something that only Japan has experienced until now. The BoJ should benefit from overseas financial authorities giving serious consideration to the implications of a "purposeless" policy of quantitative easing (basically a zero interest rate with a ¥15-20 trillion reserve floor) should the FRB and ECB move into the ZIRP realm. The unfavorable scenario for the BoJ would be foreign central banks having unexpected success with quantitative easing and such easing ironically spurring a recovery for the global economy. In this case, the BoJ is likely to face criticism for being slow on the draw with policy action.

Japan’s experience thus far suggests slim chances for the latter scenario. Once the policy rate drops into the lower 1% range, the game is already over for monetary policy. While monetary policy can be effective in restricting total demand when necessary, it lacks the wherewithal for demand creation. Since the elasticity of real money demand from nominal rate fluctuations rises to an extreme level with a zero interest rate, the short-term money market endlessly absorbs liquidity supplied by the central bank, just like spraying water in a desert. Liquidity never makes it to the real economy. This can also be understood in terms of zero opportunity costs for reserve deposits. There is no pain from holding an infinite amount of reserves ("no pain, no gain"). Additionally, the BoJ has gradually raised its liquidity provision mechanism of Rinban operations (which is equivalent to coupon pass). However, these operations wind up strengthening flattening bias on the yield curve, and actually contribute to deflation expectations through the financial market’s expectation formation dynamic. ZIRP poses the danger of getting caught in a policy trap that cannot be easily escaped.
Source: Morgan Stanley Global Economic Forum

In an intriguing and much negelected book published in 1989 - The Enigma of Japanese Power - Karel van Wolferen asks some highly pertinent questions about our 'western' attitudes to change in Japan:

Countless newspaper articles, magazine features and scholarly assessments have asserted over the past quarter-century that Japan had reached a crossroads. Perhaps no other country is so regularly examined by journalists and scholars for signs of impending change: not just the routine kind of change that may be expected in any society, but something basic, a change in the way people see themselves and consequently a change in the attitude of the entire nation towards the world.

Implicit in most reports on the Japan-at-the-crossroads theme is the idea that Japan must change; the things setting Japan apart from the rest of the world are often seen as anomalous and temporary. In the 1970's it was thought that many employees who went abroad for their corporations were going to 'internationalise' Japan upon their return. Later it became fashionable to think that the 'internationalisation' of the Japanese financial markets and other unstoppable economic developments would force Japan to come to terms with the outside world's expectations .....In 1987 there existed a pervasive notion that the pressure of supposed public demand for change, combined with loss of bureaucratic control over businessmen, was begining to transform the Japanese political economy into one more clearly driven by market forces.

Today, Japan is stuck at the same crossroads as twenty five years ago.......No country should be condemned to waiting at the same uncomfortable spot for so long. What the crossroads story appears to reflect more than anything else are myopic western preconceptions about the possible forms that institutions and the organisation of affairs in non-Western nations can take. The march in the direction that many Western observers thought inevitable is just not going to take place.

Karel van Wolferen wrote this fourteen years ago. Japan is still at the same crossroads, with the same need for and possibility of reforms being paraded around in a Western press that appears to understand little and learn nothing about how Japan works.
UK Housing Prices Near the Top?

Is the rate of increase in UK housing prices nearing its ceiling? The latest monthly figures (November) which put the annual rate at nearly 25%, in a generally low inflation environment, only serve to underline how bubble-like the house price explosion has become. Clearly these numbers bear little relation to any any real appreciation in the underlying value of the assetts concerned, and stand in marked contrast to the recent growth estimates revisions from the UK Treasury.

House prices climbed 2.0 per cent in November from October's 1.4 per cent monthly rise, Nationwide said. The average house price rose more than £2,000 last month to reach £115,761. The surging housing market is expected to act as a brake on interest rates cuts when the Bank of England's monetary policy committee announces its rate decision on Thursday, despite new evidence showing manufacturing stagnated last month. House prices have underpinned Britain's consumer boom and fears of the unsustainable rate of growth have led to concerns about the threat of another housing market crash.

John Butler, UK economist at HSBC, said the housing market remained buoyant at a time when global uncertainties had increased. "That makes the UK vulnerable, a vulnerability that has been encouraged by the Bank of England. We believe house prices and consumer spending will slow next year, but the threat of a crash has increased. However, crashes typically need a trigger," he said. "That trigger would tend to come from a rise in rates or rapidly rising unemployment. The former still seems increasingly unlikely. And the latter is well supported by the public sector. It is true to say that at the moment there seems no mechanism for it to self correct."
Source: Financial Times

Saturday, November 30, 2002

UK Treasury Having Second Thoughts on Euro?

The UK Treasury's growing reservations about the wisdom of fixing exchange rates have been revealed in a little-noticed supporting document published with this week's pre-Budget report. Treasury officials have said that the paper has been prepared for the New Delhi meeting of the Group of 20 rich and poor countries a week ago, and was written with developing countries in mind. Nevertheless it probably provides a good test of the temperature of the water being written in what might be called "Treasury-speak" (stealing yet another Roachian expression).

Officially the assessment of the five economic tests for the decision on the euro, due by next June, has not begun, you would however have to be blind not to see some of what is going on in Brussels and Frankfurt, and not, in good British style to raise the proverbial eyebrow. The language in the paper, 'Macroeconomic Frameworks in the New Global Economy, is the strongest yet heard from the Treasury about the potential risks of joining a monetary union. It warns, for example, that if a country wants to establish "a rigidly fixed regime, for example through monetary union", then "the conditions which must be met to minimise the risk of destabilising shocks are specific and demanding". Among those conditions are that "the economy must be very open, with a high share of trade with the country to which it is pegged, the economy and financial system must already extensively rely on its partner's currency, and the shocks it faces must be similar".Much of the evidence continues to raise doubts over whether Britain would or could meet those "demanding" conditions.

The paper also offers an interesting review of thinking behind current UK monetary and fiscal policy. Interestingly enough Britain has become, it seems, the land of the middle way. Contrasting the Schylla and Charybdis of complete discretion (read Greenspan and the US Fed) with fixed rules (read Duisenberg and the ECB) Britain's system is, we are informed, one of constrained discretion (this means that while you may be able to get your hand into the till, you can only take so much out at a time). The first real hint that not everyone is happy with the way things are going in Euroland comes with the following reservations expressed about the problem with fixed rule regimes:

the relationships on which such rules are based tend to break down in the face of financial deregulation, changing technology and widening consumer choice;

rigid rules do not allow any flexibility to respond to economic shocks, leading to substantial costs of adjustment and, at the extreme, irresistible pressure on the rule itself. If a fixed rule becomes too costly to maintain, it will tend to undermine credibility, rather than support it. For example, a rigid fiscal policy rule which requires offsetting adjustments irrespective of an economy’s cyclical position could exacerbate the cycle and undermine public support for the policy.

Obviously someone is thinking about the problems with the stability pact. These problems are not, however, insuperable in principle. This weeks proposals from Pedro Solbes - which would in fact give the UK (but not France, Germany, Italy and Spain) considerable leeway with defecit management - can be seen as going some way towards calming British anxiety here. In another little aside they also indicate that they are not as blind as Frankfurt seems to be to the real problems of the moment:

Shifting the policy focus towards sustainable long-term goals requires governments to set realistic and appropriate objectives for macroeconomic policy which are clearly defined, and against which performance can be judged. For example, the UK has introduced a clear, single, symmetric inflation target. The symmetry of the target means it is clear that inflationary and deflationary pressures will be resisted equally, and there is no dual targeting of inflation and the short-term exchange rate.

In treasury-speak this means that the deflation watch is on. On the subject of monetary union and other forms of fixed-peg system the document contains the following:

The exchange rate can provide an alternative nominal anchor for monetary policy. Countries have put in place a variety of different exchange rate regimes, ranging from a rigidly fixed regime (e.g. through monetary union or a currency board), to regimes that peg the exchange rate to a greater or lesser degree. At the other extreme, a freely floating rate requires domestic monetary policy to provide the nominal anchor.

A fixed exchange rate does not allow any scope for ‘constrained discretion’ in response to shocks. Since it sets a rigid rule, shocks have to be absorbed elsewhere in the
economy, if stability is to be maintained.

If a country wants to establish a fixed exchange rate as part of a longer term policy framework, the conditions which must be met to minimise the risk of destabilising shocks are specific and demanding: the economy must be very open, with a high share of trade with the country to which it is pegged, the economy and financial system must already extensively rely on its partner’s currency, and the shocks it faces must be similar. It must also be willing to give up monetary independence for its partner’s monetary credibility; this means that its fiscal policy must be flexible and sustainable, and it must have flexible labour and product markets to cope with shocks when the exchange rate can’t adjust. The real credibility of any peg thus does not come from the peg itself, but from putting in place the wider institutional arrangements that support the regime and which facilitate adjustment. Experience suggests that a peg in itself cannot be relied upon to be the driver for the essential, wider-ranging reforms.

Some have argued that in a world of international capital mobility, it is not credible for countries which are open to capital flows to run intermediate forms of exchange rate regime in the long-term. This is because they do not have the institutional backing provided by more rigid regimes, such as currency boards, so lack sufficient credibility and strength to withstand speculative attacks. Thus only the extreme ends of the spectrum, (of freely floating or very rigid regimes such as monetary union or a currency board) are feasible. But even with a very rigid fixed exchange rate regime, such as a currency board, the same conditions apply, i.e. monetary and fiscal policy have to operate in a way consistent with it. A fixed exchange rate regime cannot be expected to solve a country’s economic problems if the appropriate macroeconomic framework is not in place. Argentina’s recent experience demonstrates the difficulties of sustaining a fixed exchange rate regime, even where a currency board is used.

Obviously the force of these comments is directed towards the problems of more fragile economies of the newly developing countries type. It should not however escape our notice that the UK economy has a very different form of 'openness' to that of the main Euro economies, an openness to international finance, and rapid capital movements (remember 1992 and the EMU exit). The UK economy may experience shock whichs differ fundamentally from those to which the other Euro economies are susceptible. It should also be noted that while the weaknesses of the fixed rate regime type are identified (and even Argentina is mentioned) the document is strangely silent on the problems of a free-floating regime (which, of course, are enormous for a developing economy, but seem not to be extreme in the context of the UK's current needs).