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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).
Andreessen on the Future of IT Commoditisation

Netscape founder Marc Andreessen looks at the future of IT, and sees ousourcing big-time. Well he would wouldn't he, his company Opsware (formerely Loudcloud) has selling IT services at its core. But still his argument makes a lot of sense. (My thanks to Brad de Long for putting me on to this one).

Andreessen thinks the reason we're seeing such dramatic across-the-board commoditization now is because of what he calls a "maniac" focus on cost-cutting among customers. "In 1995," he explains, "the reference architecture at companies was Sun/Oracle/EMC/Cisco, or their comparable competitors. That was still true in 2000 when the bubble ended, because people could still afford it. Now they can't."

Now customers are finally taking advantage of the commoditization that had been creeping along largely unnoticed during the boom. All this has created what Andreessen believes to be a one-time "systemic decline" in the cost of tech infrastructure. But of course it costs a heck of a lot more to operate all this stuff than to acquire it. Andreessen says it costs 6 to 8 times more over time. That's why IT staff constitutes, on average, something like 40% of the overall corporate IT budget. Getting rid of all those expensive people is a top corporate priority, because it would be the best way to cut costs.

Meanwhile, customers have been putting an essential task on hold--installing new applications. It's because there's not enough money, and because CIOs feel burned. Says Andreessen: "Most of the software ideas of the late '90s which people tried and failed on--customer relationship management, marketing analytics, supply chain management, B2B procurement--those ideas all made sense and had good business justifications. But the tech wasn't quite there. Many customers who bought early feel bitter. But at some point those things will hit the mainstream and work."
Source: Fortune

Friday, November 29, 2002

Study Links Rise in Sporadic CJD to BSE

The eating of BSE-infected meat might cause classical CJD in people, as well as variant CJD, a new study using mice suggests. Classical CJD, also called sporadic CJD (sCJD), is generally believed to develop spontaneously and existed before the BSE epidemic in British cattle, while variant CJD (vCJD) is thought to be the human form of mad cow disease. There has been a recent rise in cases of sCJD, in the UK in particular, but it had been thought this was due to better surveillance and diagnosis. The surprising new finding appears to add weight to suggestions that the rise is in fact linked to the BSE epidemic.

The new work involved injecting the BSE infectious agent - a misfolded prion protein - into the brains of mice. The mice had been genetically modified to act as human models of infection and to be susceptible to CJD.

As expected, some of these mice developed symptoms and a molecular subtype of prion protein misfolding associated with vCJD. But others developed a sub-type associated with the most common of three strains of sCJD previously identified in people. "This finding has important potential implications," the team led by John Collinge at the MRC Prion Unit in London, UK, writes in the EMBO Journal. "It raises the possibility that some humans infected with BSE prions may develop a clinical disease indistinguishable from classical CJD."Models predicting the future extent of the human epidemic associated with eating BSE-infected meat are based on the observation of vCJD in the population. But if BSE prions can also cause sCJD, these models will underestimate the ultimate human death toll. To date, 117 people have died in the UK from vCJD.
Source: New Scientist

Variant Creutzfeldt–Jakob disease (vCJD) has been recognized to date only in individuals homozygous for methionine at PRNP codon 129. Here we show that transgenic mice expressing human PrP methionine 129, inoculated with either bovine spongiform encephalopathy (BSE) or variant CJD prions, may develop the neuropathological and molecular phenotype of vCJD, consistent with these diseases being caused by the same prion strain. Surprisingly, however, BSE transmission to these transgenic mice, in addition to producing a vCJD-like phenotype, can also result in a distinct molecular phenotype that is indistinguishable from that of sporadic CJD with PrPSc type 2. These data suggest that more than one BSE-derived prion strain might infect humans; it is therefore possible that some patients with a phenotype consistent with sporadic CJD may have a disease arising from BSE exposure.
Source: European Molecular Biology Journal

Japanese Unemployment Continues to Rise

Japan's industrial production fell last month and families cut their spending after unemployment rose to a record high, adding strength to the growing view that Japan's economic recovery may be running out of steam. Of course much of the future for unemployment now depends on what really happens in the wake of the NPL debate.

Production unexpectedly fell 0.3 per cent in October from the previous month, the Ministry of Economy, Trade and Industry (Meti) said on Friday. With the second second consecutive monthly decline, Meti changed its outlook for the index from a "gradual upward trend" to "flat". The data suggested that industrial production, which has been driven by exports, and the economic recovery , probably peaked between July and September, boding ill for Japan's already high unemployment rate.

Unemployment in September revisited Japan's post-war high of 5.5 per cent, matching a record high set last December, according to government data on Friday. Although the ratio of job offers to applicants rose slightly to 0.56 - meaning there were 56 offers for every 100 jobseekers - the data showed the labour market remains weak. "With the expected faster disposal of NPLs, corporate bankruptcy and involuntary job losses will likely increase," said Takehiro Sato, economist at Morgan Stanley. "Our calculation suggests a ¥29,100bn increase in final NPL disposal would lead to 700,000 more job losses and a 6.5 per cent unemployment rate."
Source: Financial Times

Sweden To Hold Euro Referendum

In what is going to be the first real popular test for the Euro, Sweden has announced plans to hold a referendum on whether to adopt the single European currency on September 14, 2003, Swedish Prime Minister Goeran Persson said on Friday following a meeting of political party leaders. Of course, there's a lot of water to go under the bridge between now and September 2003.

"We have agreed to hold a referendum on the second Sunday in September," Persson said, urging the country's political parties to cooperate across party lines to ensure a "yes" vote. Sweden is a member of the European Union but has joined Denmark and Britain in opting -- so far -- to stay out of the euro zone. Persson said he was optimistic about securing a "yes" vote but acknowledged that the Swedish public was deeply split over the issue. "I believe it will be a yes, but it is far from certain," he said. "We are all a little divided on this issue. That is why we are holding a referendum." Most opinion polls over the past year have indicated Swedes would back swapping their currency, the krona, for the euro, although recent surveys point to more resistance. A Gallup poll published Friday showed 40 percent of Swedes would say "yes" if a referendum were held today, 34 percent would say "no" and 25 percent were undecided. The poll showed however that the "yes" camp's lead had shrunk from 20 percentage points in July to just six points in November.
Source: EU Business

Europe's Trifecta

Three complex and closely related issues are moving rapidly toward important showdowns at the Dec. 12 European Union summit in Copenhagen. The outcome of this summit could have an important effect on any future conflict with Iraq, could influence decisively the EU's long-term relations with Turkey's 70 million Muslims, and could have a major impact on the EU's relations with with rest of the world. After years of discussion and negotiation, the issue of Turkey and Cyprus is finally on the agenda for definitive resolution. It is unclear whether the EU will grasp the need to act.

At stake are three things: Cyprus's application for EU membership, Turkey's desire to start talks on its own EU membership, and the long-stalled talks on the future of the divided island of Cyprus itself.

The first issue seems all but formally settled: At Copenhagen, Cyprus will be invited to join the EU, along with nine other countries, effective in 2004. This is the correct outcome to a battle in which the Greek Cypriot government was supported initially only by the United States and Greece.

The most consequential part of this historic European moment is Turkey's application to join the European Union. The newly elected government in Turkey is controlled by an Islamic party, and this has set off alarm bells among both moderate Turks and in Europe. But since the election, Recep Tayyip Erdogan, the Islamic leader who stunned Europe with his victory, has skillfully lowered fears about his party's intentions, especially with a tour of European capitals to plead his country's EU case. He has even suggested a more forthcoming policy toward Cyprus. Enter, seemingly out of nowhere, former French president Valery Giscard d'Estaing. Three weeks ago Giscard used his new platform as chairman of a major EU commission drafting a European constitution to declare, in a blistering interview in Le Monde, that Turkey was "not a European nation" and its entry into the EU would be "the end of the European Union." It was well understood that what Giscard meant was that the EU was a Christian club whose values and culture would be threatened by the admission of Muslim Turkey. Merci, M. Giscard. By saying in public what many European have long said in private, Giscard inadvertently did the Turks an enormous favor. Since his comments, almost every other public figure in Europe has been scrambling to disagree with Giscard, and to deny that anyone in Europe could possibly harbor racist feelings toward Turks or other Muslims. Yet the furious Turkish reaction to Giscard's comment only served to underscore Europe's dilemma: Keep Turkey out and risk the eventual creation of a radical or fundamentalist regime at the very gates of the European Union.

This brings us back to our starting point. If all goes perfectly, Cyprus will be invited into the EU at Copenhagen, Turkey will be given a starting date for its negotiations, and the two parts of Cyprus will start serious talks on the basis of the U.N. plan. That would be a real trifecta -- a tall order for just three weeks. It is unlikely to happen unless Europe's leading nations make a bold leap past the kind of not-so-secret fears so openly uttered by Valery Giscard d'Estaing.
Source: Washington Post

Now the Washington Post Joins the Club: Deflation Fretting

Two articles in this weeks Washington Post illustrate how Bernanke's deflation 'wake up call' is going the rounds. In support of a generally upbeat analysis which tends to 'reassure' more than forewarn there seem to be four key arguments.

Firstly there is the clean bill of health of the US economy. In this Bernanke agrees with Greenspan that, at present, the U.S. economy is too resilient and too stable for some type of shock to generate a deflation. This is an assertion whose truth or otherwise we are about to witness. Of course the same argument was being used only a coulple of years ago to suggest that growth this decade would be higher than normal due to the large productivity improvements which were flowing from the new technologies. So while it may be true that the the US economy is financially and economically resilient, we could be entitled to entertain doubts. Stephen Roach's structural imbalances arguments would suggest otherwise. The cases of Enron, and WorldCom which are cited to reassure, could also be interpreted otherwise. Only if and when the housing boom ends will we know just how financially resilient the US banking system is.

A second line of argument from Bernanke runs as follows: "Under a paper-money system, a determined government can always generate higher spending and hence positive inflation". Unfortunately this is far from a universal truth, as Japan is finding out to her cost. One of the more preoccupying myths about Japan is that they have not been trying, believe me , they have.

Another of the disturbing myths is put forward by Alan Meltzer.In a new book, "A History of the Federal Reserve, 1914-1951," Meltzer of Carnegie Mellon University
suggests that the 1930's deflation and the resulting Depression were primarily the result of a mistaken Fed policy that allowed the money supply to decline sharply. Following this line Meltzer last week told an audience at the American Enterprise Institute that he was confident the Fed, using different tools, could deal with any deflationary threat. This US centric account of the Depression is far from complete. Sure the monetary policy purued by the Fed in the 1930's was open to question, in fact any human action, with hindsight, is open to question. The problem is to be right, on the right question, and at the right time. Is, for example, the monetary policy of the ECB now the right one for the right problem. Whatsmore, what if there is (as I suspect, and others argue coherently, more to the Depression than US monetary policy) then the defence is flawed. No one would dream of playing chess like this.

Finally there is the Japan argument. For Bernanke the inability of the Japanese government to deal with its deflation using monetary policy tools is not that the tools are inadequate but that the country faces multiple problems, including a huge overhang of bad loans on the books of its banks. "The failure to end deflation in Japan does not necessarily reflect any technical infeasibility of achieving that goal," he said. "Rather, it is a byproduct of a long-standing political debate about how best to address Japan's overall economic problems." Actions to deal with those problems, however, "will likely impose large costs on many, for example, in the form of unemployment or bankruptcy," So really, Japans failure is rooted in the incapacities of its political system. Sure, a worse system for putting out this fire would be hard to imagine. But still I beg to differ. The problems run deeper and are more intractable. The 'infamous' Fed paper also has its part to play here. Useful as this paper is for alerting to the danger and the need to act, and much as its contents need to be thoroughly assimilated here in Europe, ther is a danger that the paper can have precisely the opposite effect to that which it's authors intended. It could be used as saying, if only the Japanese had acted early and vigorously, as we of course have, then they wouldn't be in the mess they are now. I beg to differ. We need to dig deeper.

Federal Reserve Chairman Alan Greenspan recently assured Congress that "we are not close to a deflationary cliff," and that should the United States ever get near such a dangerous place, the central bank has the tools necessary to flood the country with money and get prices up and the economy moving again. In a speech last week to the National Economists Club, Fed Governor Ben S. Bernanke, an expert on monetary policy, acknowledged that some people have expressed concern that the nation could face a deflation -- a general decline in prices -- a perilous, debilitating circumstance in which borrowers have to repay their debts in dollars worth more than those they borrowed.

Bernanke said in his speech that the current concern about deflation "is not purely hypothetical" because it "is brought home to us whenever we read newspaper reports about Japan, where what seems to be a relatively moderate deflation -- a decline in consumer prices of about 1 percent a year -- has been associated with years of painfully slow growth, rising joblessness, and apparently intractable financial problems in the banking and corporate sectors."

Overnight interest rates in Japan have been pegged at zero by the Bank of Japan, that nation's central bank. But with deflation, when the nominal rate is zero, the inflation-adjusted rate, which is more important in terms of influencing economic decisions, is actually about 1 percent. In contrast, the U.S. financial system is in good shape, with financial institutions holding enough capital that they can absorb even very large losses, such as those associated with the bankruptcies of Enron, WorldCom and some other large companies, without severe damage to their balance sheets.
Source: Washington Post

After half a century of trying to prevent prices from rising too fast, economic policymakers have a new concern: Prices aren't rising fast enough. Government statistics show that average prices for products have declined in the past year, including those of cars, clothing, computers, furniture, gasoline and heating oil. So, too, have the prices for services such as telephones, hotel rooms and airplane tickets, even as costs for other services such as health care, housing, education and cable television continued to rise. The broadest measure of prices in the economy shows they rose less than 1 percent during the 12 months that ended in September, the smallest increase in 50 years.
Until now, the slowdown in overall inflation has been a boon to the American economy, giving consumers more for their money and allowing living standards to continue to rise even during a period of slow economic growth. But economists warn that if disinflation turns into deflation -- a broad and sustained decline in prices -- it would create a dangerous dynamic that could drag the economy into a nasty recession from which it could be difficult to escape. "If you had asked me a year ago, I would have said it was ridiculous to worry about deflation," said Alan S. Blinder, a Princeton University economist and former vice chairman of the Federal Reserve. "But the prospect of deflation is now sufficiently probable -- I'd say 15 to 20 percent -- that it's now worth talking about."

Deflation, like cholesterol, comes in good and bad varieties. The good kind, such as many of the price declines over the past few years, happens when companies find ways to produce goods and services more cheaply, usually by making use of new technology or new ways of doing business. In varying degrees, these productivity gains are passed on to consumers as lower prices, to workers as higher wages and to shareholders as higher profits. That makes almost everyone better off. By contrast, the bad kind of deflation occurs because there are too few customers chasing too many goods and services, resulting in repeated rounds of competitive price cutting that leads to layoffs, falling wages, and a decline in business investment and consumer spending.
Source: Washington Post

Thursday, November 28, 2002

Computer-Mobile Fushion?

This is the question posed by the Economist in two thought provoking articles. Converge is the word that comes to mind when looking at the attempt of the computer industry to cram PCs into pocket-sized devices. The latest phones announced by Nokia, the world's largest handset maker, include a model with a folding keyboard aimed at business users, as well as a colourful phone that plays computer games. Digital cameras, already a popular feature of mobile phones in Japan, are starting to appear across the planet. Colour screens are spreading fast. To top it all the latest phones have as much computing power as a desktop computer did ten years ago.

“A COMPUTER on every desk and in every home.” This was Microsoft's mission statement for many years, and it once sounded visionary and daring. But today it seems lacking in ambition. What about a computer in every pocket? Sure enough, Microsoft has recently amended its statement: its goal is now to “empower people through great software, anytime, any place on any device”. Being chained to your desktop is out: mobility is in. The titan of the computer industry has set its sights on an entirely new market. It is not alone. This week Dell, the world's largest PC maker, launched its first handheld computers, which run Microsoft's Pocket PC software. HP and Palm, which also make handheld computers, have just unveiled new models, with far more emphasis on wireless networking and telephony. And in an even more portentous move, the SPV, the first device to run Microsoft's special version of Windows for mobile phones, has just been launched in Europe by Orange, a mobile operator.

If this is the next stage in the evolution of computing, one obvious question arises: which firm will dominate it, as IBM dominated the mainframe age, and Microsoft the PC era? The answer is that there is unlikely to be a single winner this time around. IBM ruled in mainframes because it owned the dominant hardware and software standards. In the PC era, hardware became an open standard (in the form of the IBM-compatible PC), and Microsoft held sway by virtue of its ownership of Windows, the dominant software standard. But the direction of both computing and communications, on the Internet and in mobile telecoms, is towards open standards: communication devices are less useful if they cannot all talk to each other. Makers of pocket communicators, smartphones and whatever else emerges will thus have to compete on design and branding, logistics, and their ability to innovate around such open standards.
Source: The Economist

So, the once-separate worlds of computing and mobile telephony are now colliding, and the giants of each industry—Microsoft and Nokia, respectively—are squaring up for a fight for pre-eminence. Both camps are betting that some kind of pocket communicator, or “smartphone”, will be the next big thing after the PC, which has dominated the technology industry ever since it overthrew the mainframe 20 years ago. Admittedly, the two camps have different ideas about how such devices should be built. The computer industry believes in squeezing a general-purpose computer into a small casing; the mobile-phone industry takes a more gentle, gradualist approach of adding new features as consumers get used to existing ones. But are they right about the future of computing in the first place?

IT MAY look like a mobile telephone, but the Orange SPV, launched last month, is much more than that. With its colour screen, garish icons and musical ringtones, it resembles other handsets on the market. But it has one far more significant feature: the software inside, indicated by a familiar-looking four-coloured logo on its screen. For the SPV is the first “Windows-powered smartphone”—in other words, it runs software from Microsoft. It is the software giant's attempt to stake its claim in the new market created by the convergence of mobile phones and computers. It is no less than a declaration of war.

The market for smartphones is still small. But it is growing fast, as new features are added to handsets, making them ever smarter. Of the 400m mobile phones that will be sold this year, around 16m will have built-in cameras. Nokia, the world's largest handset maker, expects to sell 50m-100m colour-screen handsets next year. A new report from Analysys, an industry consultancy, predicts that by 2007 nearly 300m Europeans will be carrying handsets with colour screens, cameras, music players, support for downloadable games, and other features that are now available only in the most advanced models. Such features are already common in Japan and South Korea, and they are starting to appear in Europe and America. These advanced handsets are, in effect, pocket computers—but they have emerged from the consumer-electronics industry rather than the world of computing.

In Europe, more people now send and receive short-text messages on their phones than use the Internet, according to figures from Gartner, another consultancy. This year, users of mobile phones around the world passed the 1 billion mark. The number of mobile phones is now greater than the number of fixed-line ones. PC sales, meanwhile, have stagnated, and innovation has slowed: today's PCs are really just like those of a year ago, or two years ago, only faster. Sales of handheld computers, or personal digital assistants (PDAs), at around 10m a year, are dwarfed by sales of mobile phones. It looks increasingly as though the “personal computer” was a misnomer. The truly personal digital device today is the phone.

That does not mean that PCs will vanish. Just as mainframes continue to hum in companies' back offices 20 years after the emergence of the PC, so too PCs will continue to have an important role. But their appeal is far from universal; no matter how cheap they become, there are limits to the number of people who want to buy one. Microsoft's once-visionary mission statement—“a computer on every desk and in every home”—now seems dated. Instead, the company talks of “empowering people through great software, any time, any place and on any device”. This is an acknowledgment, concedes Ed Suwanjindar of Microsoft's mobility division, that the PC is no longer king, and that “mobile devices are totally critical to the new extended vision for the company.”

The first obstacle thrown into Microsoft's path by the handset makers was their refusal to license its software—a complete reversal of what happened in the computer industry. There, PC makers queued up to license Windows. The largest mobile-phone makers, on the other hand, established a software consortium called Symbian to produce smartphone software of their own. Their aim was to achieve the benefits of Windows (a single, common software standard) without what they regard as its chief drawback: that the predatory Microsoft owns it. “We want to fend off Microsoft—we don't want to go the way of the PC business,” says a spokesman at one handset maker. Several Symbian-powered handsets have already come to market. The latest is the Nokia 7650, with a built-in camera and colour screen. It was launched in the summer and sales are expected to exceed 2m by the end of the year. More Symbian handsets will appear over the next few months. Besides Nokia, Symbian's backers include Motorola, the world's second-largest handset maker, Siemens, the number two in Europe, SonyEricsson, Panasonic and Samsung. Between them, Symbian licensees account for almost 80% of all handsets sold.

Yet, for all their similarities, Microsoft and Nokia differ in one crucial respect. Microsoft's dominance stems from its closely guarded ownership of Windows. But the mobile-phone industry, in which Nokia is top dog, is based on open standards. The use of common standards that are not owned by any particular vendor has benefits. For example, it enables handsets based on the GSM standard to be used in most parts of the world. But it also has drawbacks: Europe's proposed standard for 3G does not work yet. Nokia has achieved its dominance not through ownership of proprietary technology, but from its ability to innovate around open standards, from its strong brand, and from its impressive logistics. In other words, in several respects it is not like Microsoft at all.Nokia's attitude to Microsoft is revealing. “We are not in competition, but approach convergence from different sides,” says Mr Alahuhta, choosing his words carefully. He is right: Microsoft is so insignificant in the mobile-phone market that it is not a competitor—at least, not yet. But as their industries collide, the firms are sure to become opponents in what promises to be a long and bitter fight.
Source: The Economist

Free Trade and the Doha Round

Two articles raise to-the-point questions about the current state of 'free-trade' thinking. The first, in this weeks Economist, congratulates the Bush administration for proposing the elimination of global tariffs on industrial and consumer goods by 2015 in an attempt to revive the stalled Doha round of world trade talks. However, what it gives with one hand it takes back with the other. As it notes caustically "agriculture is the single most important issue in the Doha talks—without a deal which involves the rich countries cutting back sharply the subsidies they pay to farmers, developing countries will not sign up to any overall agreement. America’s proposal to abolish export subsidies came after the farm bill was signed and drew attention to the gap between what America says and what it actually does"

AMERICAN presidents like to think big, and George Bush is no exception. Mr Bush has now given his backing to a new proposal which would mean the abolition of all tariffs on industrial and consumer goods by 2015. And by all tariffs Mr Bush means all—not just in America, but around the world. The aim is to inject new life into the Doha round of world trade negotiations. The World Trade Organisation’s (WTO) director-general, Supachai Panitchpakdi, said on November 25th that slow progress was putting the talks at risk.

Yet the boldness of the latest proposal, which follows an equally ambitious American plan to eliminate agricultural export subsidies, is enough to make many of America’s closest industrial partners pale. The European Commission's initial reaction was cautious and even Mr Supachai has said the plan would not be at the top of his agenda. America is not proposing unilateral reductions, after all—the commitment to reduce and then abolish tariffs involves all 144 WTO members. And developing countries, whose tariffs tend to be much higher than those of rich countries, and which would therefore have to make much bigger tariff reductions, are more likely to see America’s plan as brazen hypocrisy on Mr Bush’s part.The plan’s simplicity certainly helps America in its effort to recapture the moral high ground on trade. By 2010, there would be no tariffs above 8% on a wide range of goods, and the tariffs would disappear altogether by 2015. Tariffs currently below 5% would go by 2010. In some industrial sectors, including chemicals, paper and construction equipment, tariffs would go even more rapidly.
Source: The Economist

Meantime Brad de Long draws our attention to the growing disenchantment with China in some American policy circles. as he warns us: "Here is another thing that makes me want to bang my head against the wall":

Surging China imports devastate U.S. industries: Trade deficits usually shrink during an economic downturn, but China's unfair trade practices have caused the U.S.-China deficit to soar despite the U.S. recession of the past two years. Between 1989 and 2001, though U.S. exports to China more than tripled, imports from China increased eightfold, causing a whopping twelvefold surge in the U.S-China trade deficit. So far this year (through September, the latest month for which data are available), the deficit has continued to grow and is projected to reach $100 billion, an all-time record.

The U.S.-China trade relationship is of growing importance to overall U.S. trade. Exports to China grew from 1.6 percent of total exports in 1989 to 2.6 percent in 2001. Imports from China now comprise 9 percent of all U.S. imports, up from 2.5 percent in 1989. China alone now accounts for more than one-fifth of the total U.S. trade deficit.

Contrary to promises by business and government leaders that increased trade would benefit workers on both sides of the Pacific, the opposite is actually occurring. China's export industries are associated with gross violations of human rights, including forced labor, and even while China's economy is growing and becoming more productive, minimum wages are stagnant or decreasing in major manufacturing centers. Meanwhile, in the U.S., growing trade deficits are resulting in closed factories and lost jobs in every industry and state. Between 1992 and 1999, growing U.S. trade deficits with China eliminated more than 683,000 jobs in the U.S. economy; EPI economists forecast the loss of an additional 872,000 U.S. jobs due to surging trade deficits with China by 2010.
Source: Economic Policy Institute

As Brad asks, do they really want to claim that all of the $100 billion paid by Americans to buy Chinese-manufactured goods goes straight into the pockets of the plutocrats of the Chinese Communist Party, and that none of it leaks out and raises urban Chinese median standards of living? And do they really want to claim that U.S. workers real earnings aren't boosted by their ability to benefit from China's comparative advantage in light manufacturing--that their families aren't better off because of their increased ability to buy Chinese-made goods whenever they decide that such goods give more value for money? Of course what about China's apparent growing comparative advantage in high-tech and engineering design? This problem is only just begining. I cannot help feeling that growing protectionism will, in the last analysis be what poses the biggest threat to growing global living standards.

Wednesday, November 27, 2002

Solbes Presents the Commission Pact Reform Proposals

Pedro Solbes, EU commissioner for economic and monetary affairs, on Wednesday set out the Commission's proposals to reform the operations on the EU's stability and growth pact, which commits member states to limit their budget deficits. As I indicated earlier in the week, it is hard to see how these proposals, which are likely to benefit mainly non-Euro zone members can be well received by the hard-pressed debit-ridden countries (Greece, Italy and Germany in particular). A careful reading of the text could see it as an unambiguous tightening of the pact, especially the part which refers to the requirement for " a careful examination to be made by the Commission of outstanding public debt, contingent liabilities (such as implicit pension obligations) and other costs associated with ageing populations." It remains to be seen how EU finance ministers will interpret and react to the text. The Communication presents five proposals to improve the interpretation of the Pact in order to ensure a more rigorous adherence to the goal of sound and sustainable public finances:

Due account should be taken of the economic cycle when establishing budgetary objectives at EU level and when carrying out the surveillance of Member States budgetary positions. The 'close to balance or in surplus' requirement of the SGP would be defined in underlying terms. This isolates out the impact of the economic cycle on budgetary positions. As such, it provides a better picture of the true state of public finances in a country, and enables the Commission to carry out a better assessment of compliance with budgetary commitments given in the Stability and Convergence programmes.

Clear transitional arrangements should be established for countries with underlying deficits exceeding the "close to balance or in surplus' requirement. They would be required to achieve an annual improvement in the underlying budget position of 0.5% of GDP each year until the 'close-to-balance or surplus' requirement of the SGP has been reached. This rate of improvement in the underlying budget position should be higher in countries with high deficits or debt. Also, a more ambitious annual improvement in underlying budget positions should be envisaged if growth conditions are favourable. This proposal recognises that account must be taken of economic conditions when setting the pace of budgetary consolidation, but that the deadline for reaching the goal of the Pact cannot be postponed indefinitely.

A pro-cyclical loosening of the budget in good times should be viewed as a violation of budgetary requirements at EU level, and should lead to an appropriate and timely response through the use of instruments provided in the Treaty. Countries must avoid a pro-cyclical loosening of budget policies in good times as the automatic stabilisers provide enough cushion over the economic cycle.

Budgetary policies should contribute to growth and employment. The 'close to balance or in surplus' requirement should be combined with the right incentives to help ensure the implementation of the Lisbon strategy. A small temporary deterioration in the underlying budget position of a member state could be envisaged, if it derives from the introduction of a large structural reform, like for example a tax reform or a long term public investment programme whether in physical infrastructure or in human capital. However, this should only be envisaged if the Member State concerned fulfils strict starting budgetary conditions: substantial progress towards the 'close to balance or in surplus' requirement and general government debt below the 60% of GDP reference value. Moreover, the Commission must verify that there is a clear and realistic deadline for returning to a position of "close to balance or in surplus", and that an adequate safety margin is provided at all times to prevent nominal deficits from breaching the 3% of GDP reference value. To reflect differences in the sustainability of public finances across Member States, a small deviation from the 'close to balance or in surplus' requirement of a longer-term nature could be envisaged for Member States where debt levels are well below the 60% of GDP reference value, and when public finances are on a sustainable footing. This will require a careful examination to be made by the Commission of outstanding public debt, contingent liabilities (such as implicit pension obligations) and other costs associated with ageing populations.

The sustainability of public finances should become a core policy objective at EU level with greater weight being attached to government debt ratios in the budgetary surveillance process. Countries with high debt levels well above the 60% of GDP reference value would be required to set down ambitious long-term debt reduction strategies in their stability and convergence programmes. Failure to achieve a "satisfactory pace" of debt reduction towards the 60% of GDP reference value should result in the activation of the debt criterion of the excessive deficit procedure.
Source: European Commission for Economic and Financial Affairs


Immigration to the US has not reduced as a result of the September 11 attacks and the economic slowdown, according to a report released yesterday. The Centre for Immigration Studies, an essentially anti-immigrant group that wants less immigration to the US, said more than 3.3m legal and illegal immigrants entered the country between January 2000 and March 2002. Using data collected last spring by the census bureau, it found that 33.1m legal and illegal immigrants live in the US, an increase of 2m since the last census in 2000.The CIS defines immigrants as people who are foreign-born but does not include those born overseas to US parents.

Immigrants make up 11.5 per cent of the population and are the main drivers of US population growth, according to the report. (What the report doesn't note of course is that this means they are the principal source of potential new labour market entrants, and hence a potentially important driver of US economic growth). The report suggests that the immigrant population has reached "historically unprecedented" levels and stands at more than twice the figure of 13.5m attained during the last great wave of immigration, in 1910. California has the highest percentage of immigrants, with West Virgninia the lowest. Mexicans are the biggest group, making up almost three-tenths of the immigrant population, with those from China, Taiwan and Hong Kong the next largest group, at 4.5 per cent of the immigrant population.

Among other report findings of note are the fact that the arrival of 1.5 million immigrants each year, coupled with 750,000 births to immigrant women annually, means that immigration policy is adding over two million people to the U.S. population each year, accounting for at least two-thirds of U.S. population growth. At the same time, although immigration has a very large effect on the overall size of the U.S. population, it has a much more modest effect on the age structure in the United States. The nearly 16 million immigrants who arrived in the United States since 1990 have lowered the average age in the United States by only four months. Further, immigration accounts for virtually all of the national increase in public school enrollment over the last two decades. In 2002, there were 9.7 million school-age children from immigrant families in the United States. Whatever the intentions of this body, the report contains some interesting and revealing information.

An analysis by the Center for Immigration Studies of the Current Population Survey (CPS) collected in March of this year by the Census Bureau indicates that 33.1 million immigrants (legal and illegal) live in the United States, an increase of two million just since the last Census. The March CPS includes an extra-large sample of minorities and is considered one of the best sources for information on persons born outside of the United States — referred to as foreign-born by the Census Bureau.1 For the purposes of this report, foreign-born and immigrant are used synonymously.2 The questions asked in the CPS are much more extensive than those in the decennial census, and therefore it can be used to provide a detailed picture of the nation’s population, including information about welfare use, health insurance coverage, poverty rates, entrepreneurship, and many other characteristics. The purpose of this Backgrounder is to examine immigration’s impact on the United States so as to better inform the debate over what kind of immigration policy should be adopted in the future.
Source: Centre for Immigration Studies

Tuesday, November 26, 2002

Ben Bernanke Muses on Deflation: Just Hypothetical Of Course

In his recent speech 'Making Sure "It" Doesn't Happen Here', Ben Bernanke, governor of the Federal Reserve Bank and distinguished academic and economic historian of the thirtees depression asks the question: it won't happen, but what if it did? Bernanke points to the considerable powers of the Fed has in shaping monetary policy, and in creating money and inflationary expectations. In particular, and perhaps most controversially, he reflects on the possibility of direct intervention to reduce the value of the American currency. This all assumes that other economies are in a position to bear the load. It is here I think, that I perceive the greatest weakness in the landscape described by Bernanke. For it is difficult to imagine that the main burden of a weaker dollar policy will be borne by Japan, and it is way-to-soon to imagine the responsibility can be shouldered by China. So this leaves us with Europe (assuming that Germany hasn't already entered the deflation trail, and that the ECB isn't already trying to out-Bernanke Bernanke). The consequence initially of a dollar drop would be to shoot the Euro into the air, from which elevated height it could only do one thing: fall. Perhaps the greatest weakness in the Fed's anti-deflation drill at this stage is the assumption that Japan and Europe aren't growing because their central banks aren't doing enough. What if this whole perspective is wrong. What if this growth potential just isn't there, and what if the problem is altogether more serious? Perhaps we should dig a little deeper before congratulating ourselves that we have it cracked.

So, is deflation a threat to the economic health of the United States? Not to leave you in suspense, I believe that the chance of significant deflation in the United States in the foreseeable future is extremely small, for two principal reasons. The first is the resilience and structural stability of the U.S. economy itself.....The second bulwark against deflation in the United States, and the one that will be the focus of my remarks today, is the Federal Reserve System itself. The Congress has given the Fed the responsibility of preserving price stability (among other objectives), which most definitely implies avoiding deflation as well as inflation. I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States and, moreover, that the U.S. central bank, in cooperation with other parts of the government as needed, has sufficient policy instruments to ensure that any deflation that might occur would be both mild and brief.

The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand--a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers. Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending--namely, recession, rising unemployment, and financial stress.

Deflation great enough to bring the nominal interest rate close to zero poses special problems for the economy and for policy. First, when the nominal interest rate has been reduced to zero, the real interest rate paid by borrowers equals the expected rate of deflation, however large that may be.To take what might seem like an extreme example (though in fact it occurred in the United States in the early 1930s), suppose that deflation is proceeding at a clip of 10 percent per year. Then someone who borrows for a year at a nominal interest rate of zero actually faces a 10 percent real cost of funds, as the loan must be repaid in dollars whose purchasing power is 10 percent greater than that of the dollars borrowed originally. In a period of sufficiently severe deflation, the real cost of borrowing becomes prohibitive. Capital investment, purchases of new homes, and other types of spending decline accordingly, worsening the economic downturn.

Because central banks conventionally conduct monetary policy by manipulating the short-term nominal interest rate, some observers have concluded that when that key rate stands at or near zero, the central bank has "run out of ammunition"--that is, it no longer has the power to expand aggregate demand and hence economic activity. It is true that once the policy rate has been driven down to zero, a central bank can no longer use its traditional means of stimulating aggregate demand and thus will be operating in less familiar territory. The central bank's inability to use its traditional methods may complicate the policymaking process and introduce uncertainty in the size and timing of the economy's response to policy actions. Hence I agree that the situation is one to be avoided if possible.

However, a principal message of my talk today is that a central bank whose accustomed policy rate has been forced down to zero has most definitely not run out of ammunition. As I will discuss, a central bank, either alone or in cooperation with other parts of the government, retains considerable power to expand aggregate demand and economic activity even when its accustomed policy rate is at zero. In the remainder of my talk, I will first discuss measures for preventing deflation--the preferable option if feasible. I will then turn to policy measures that the Fed and other government authorities can take if prevention efforts fail and deflation appears to be gaining a foothold in the economy.

First, the Fed should try to preserve a buffer zone for the inflation rate, that is, during normal times it should not try to push inflation down all the way to zero.6 Most central banks seem to understand the need for a buffer zone. For example, central banks with explicit inflation targets almost invariably set their target for inflation above zero, generally between 1 and 3 percent per year. Maintaining an inflation buffer zone reduces the risk that a large, unanticipated drop in aggregate demand will drive the economy far enough into deflationary territory to lower the nominal interest rate to zero. Of course, this benefit of having a buffer zone for inflation must be weighed against the costs associated with allowing a higher inflation rate in normal times.

Second, the Fed should take most seriously--as of course it does--its responsibility to ensure financial stability in the economy. Irving Fisher (1933) was perhaps the first economist to emphasize the potential connections between violent financial crises, which lead to "fire sales" of assets and falling asset prices, with general declines in aggregate demand and the price level. A healthy, well capitalized banking system and smoothly functioning capital markets are an important line of defense against deflationary shocks. The Fed should and does use its regulatory and supervisory powers to ensure that the financial system will remain resilient if financial conditions change rapidly. And at times of extreme threat to financial stability, the Federal Reserve stands ready to use the discount window and other tools to protect the financial system, as it did during the 1987 stock market crash and the September 11, 2001, terrorist attacks.

Third, as suggested by a number of studies, when inflation is already low and the fundamentals of the economy suddenly deteriorate, the central bank should act more preemptively and more aggressively than usual in cutting rates (Orphanides and Wieland, 2000; Reifschneider and Williams, 2000; Ahearne et al., 2002). By moving decisively and early, the Fed may be able to prevent the economy from slipping into deflation, with the special problems that entails.

As I have indicated, I believe that the combination of strong economic fundamentals and policymakers that are attentive to downside as well as upside risks to inflation make significant deflation in the United States in the foreseeable future quite unlikely............

As I have mentioned, some observers have concluded that when the central bank's policy rate falls to zero--its practical minimum--monetary policy loses its ability to further stimulate aggregate demand and the economy. At a broad conceptual level, and in my view in practice as well, this conclusion is clearly mistaken. Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero.

The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Of course, the U.S. government is not going to print money and distribute it willy-nilly (although as we will see later, there are practical policies that approximate this behavior). Normally, money is injected into the economy through asset purchases by the Federal Reserve. To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys. Alternatively, the Fed could find other ways of injecting money into the system--for example, by making low-interest-rate loans to banks or cooperating with the fiscal authorities.

The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt. I need to tread carefully here. Because the economy is a complex and interconnected system, Fed purchases of the liabilities of foreign governments have the potential to affect a number of financial markets, including the market for foreign exchange. In the United States, the Department of the Treasury, not the Federal Reserve, is the lead agency for making international economic policy, including policy toward the dollar; and the Secretary of the Treasury has expressed the view that the determination of the value of the U.S. dollar should be left to free market forces. Moreover, since the United States is a large, relatively closed economy, manipulating the exchange value of the dollar would not be a particularly desirable way to fight domestic deflation, particularly given the range of other options available. Thus, I want to be absolutely clear that I am today neither forecasting nor recommending any attempt by U.S. policymakers to target the international value of the dollar.

Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934. The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.
Source: Federal Reserve

Meanwhile Stephen Roach informs us that this speech together with the recent 50 bp monetary easing means that the Fed finally gets it. The "it" in this case is deflation. Bernanke's speech, he says leaves little doubt in his mind that the Fed has gone into a full-blown anti-deflation drill.

It would be rare, indeed, for the monetary authority to warn explicitly of the imminent perils of deflation. And so, as key Fed officials have now gone on the offensive against deflation in recent days -- namely Chairman Alan Greenspan and Governor Ben Bernanke -- they have done so under the guise of the "low probability what-if." The likelihood of deflation is still characterized as "remote" or as "extremely small." But once those predictable caveats are dispensed with, it’s on with the battle.

The Fed’s focus in countering deflation is mainly on a broad array of so-called nontraditional instruments. This is of obvious importance given the limits that are now looming for its traditional instrument -- the federal funds rate. The Fed, of course, has taken the overnight lending rate down an astonishing 525 bp since early 2001, with only 125 bp to go before it hits the dreaded zero nominal interest rate boundary. Yet both Chairman Greenspan and Governor Bernanke have gone out of their way to stress that the Fed is far from out of ammunition once the funds rate hits zero. After all, the central bank has virtually unlimited capacity to purchase Treasuries or the so-called agency debt of organizations such as Ginnie Mae. Or the Fed could subsidize bank lending, directly spurring the private credit cycle. Or the Fed could monetize any number of fiscal schemes to stimulate the economy. Governor Bernanke makes the point that since under a paper-money system there is really no limit to such extraordinary efforts at liquidity creation, "a determined government can always generate higher spending and hence positive inflation." What he doesn’t state, however, is how difficult it may be to achieve such an outcome for a saving-short, overly indebted US economy. Yes, money must go somewhere, but initially it might be channeled into balance sheet repair, paying down debt, or a restoration of saving before it ends up in the real economy or the price structure. There are no guarantees of instant policy traction near a zero rate of inflation.

In his discussion of nontraditional options to counter deflation, Governor Bernanke also makes note of the potential role of a dollar devaluation. I believe this is the first such public mention of such a measure by a senior US government official. It is also an option that I have long favored as an anti-deflationary measure (see my 26 September 2002 Special Economic Study, All Eyes on the Dollar). Most importantly, a weaker dollar would have the effect of transforming imported deflation into imported inflation. Given the ever-present risk that traditional counter-cyclical initiatives of the monetary and fiscal authorities may be too late to stave off deflation, currency devaluation may well be a perfectly legitimate last-gasp effort. But there is an added benefit: A devaluation of the dollar would likely also force foreign authorities -- especially those in Europe and Japan -- to adopt long-overdue pro-growth policy strategies of their own. An extremely lopsided global economy -- actually more US-centric than ever before -- needs a shift in relative prices in order to correct the extraordinary disparities that have opened up between the current-account deficit nations (mainly the United States) and the surplus countries (especially Europe and Japan). As the world’s most important relative price, a realignment in the dollar hardly seems inappropriate under those circumstances. In Governor Bernanke’s words, "It’s worth noting that there have been times when exchange rate policy has been an effective weapon against deflation." He cites, in particular, the 40% dollar devaluation of 1933-34, which he argues was key in transforming a –10.3% deflation rate in 1932 to +3.4% in 1934. Coming from a Fed governor, this can hardly be dismissed as idle chatter.

The common retort to my call for a dollar devaluation is "against what?" Don’t get me wrong; this is not about a dollar that weakens on its own accord. Even though the fundamentals of a massive US current account deficit beg for a depreciation of the dollar, in the end any currency is a relative price. With problems in Japan and Europe perceived to be far more serious than those in the US are, the dollar is unlikely to weaken by the sheer weight of gravity. The dollar comes down, in my view, only if the US makes a conscious effort to alter the rhetorical aspects of its "strong dollar policy." It still amazes me how important the words of senior public officials are in shaping currency fluctuations. Former US Treasury Secretary Robert Rubin mastered the art of talking up the dollar from its record lows hit in the spring of 1995. Therein lies the key to a weaker dollar. If Secretary O’Neill were to publicly disavow America’s so-called strong dollar policy, and if the Fed were to validate such a rhetorical shift with an unexpected easing of monetary policy, I am convinced that the dollar would fall sharply in a very short period of time. Such an outcome could be expected, in my view, irrespective of fundamental weakness in Japan or Europe.

Despite public disclaimers to the contrary, the Fed has made it abundantly clear that it now views the chances of deflation as high enough so that it must treat such an outcome as its central case. Why else would it have eased so aggressively on 6 November? Why else would its senior representatives now be out front in discussing nontraditional deflationary remedies? And why else would the US central bank dare mention the dollar-devaluation option?
Source: Morgan Stanley Global Economic Forum

Calmfors and Corsetti Join the Hunt

Hot on the trail of EU commissioner Pedro Solbes, two more European economists argue the case for a loosening of the stability pact in today's Financial Times. A loosening which would allow not cyclical but structural deficit fluctuation. This is to encourage the 'good boys' and punish the 'bad' ones. Only one problem, most of the beneficiaries are non-Euro countries, and it's hard to see how the non-beneficiaries are going to arrive at a clean bill of health.

Their proposal is to allow countries with a debt-to-GDP ratio below a given percentage, for example 55 per cent, to run larger deficits than 3 per cent of GDP in recessions. The deficit limit could then be raised in steps as the debt ratio was lowered. Such a "ladder" of deficit ceilings could enhance the incentives for fiscal discipline, as governments would be seen to enjoy the benefit of moving up a rung after reducing their debt. They stress that for reasons of credibility it is important that any changes in the maximum deficit do not accommodate the current budgetary problems of Germany, France and Portugal etc. Their proposed 55 per cent limit would not do this, as these three countries will all have debt ratios close to 60 per cent - and rising - next year.

They also stress that it would be a mistake to change the long-term rules to solve a short-term problem, that there is no "quick fix", as the present situation was caused by insufficient fiscal retrenchment in the earlier boom. The problem is that it was probably presicesly these countries - those with debt to GDP ratios over 55% and rising, and who are now facing recession - that Prodi had in mind when he called the stability pact 'stupid'. I fear it is precisely the 'quick fix' that the politicians are looking for.

The European Union's stability pact has been much derided. To restore some credibility, the European Commission will tomorrow present its reform proposals. Yet preserving the spirit of the pact will require more fundamental changes than a new interpretation.

The basic problem is how to combine long-run fiscal discipline with short-run flexibility. The stability pact is mainly geared towards the first aim: to create a counterweight to the risk of fiscal profligacy. There has always been a fear that the incentives for fiscal responsibility would weaken once monetary union was created. Recent developments confirm these fears. At the same time, there is a case for refining the stability pact to facilitate counter-cyclical stabilisation.

Any modification of the EU fiscal policy framework involves a trade-off. On one hand, reforms must not be seen as giving in to claims from member states with current difficulties, since this would ruin the future credibility of any rules. On the other hand, if the current framework is viewed as too rigid it will lose its legitimacy.

What should be avoided is a relaxation of the budget target over the cycle, given the future strain on government budgets of ageing populations. Reductions in government debt, and thus in interest payments, are one way of mitigating this problem. So this is not the time to loosen budgetary requirements by introducing a "golden rule", according to which governments can borrow for investment.
Source: Financial Times

Business Week Ponders Revaluing the Yuan

Recognising the growing importance of the Chinese economy in the worlds markets, and the vigorous price competitiveness of China's products, Business Week begins to ask itself whether China has some role in explaning the global deflationary environment. But one of the proposed solutions, a revaluation in the Yuan seems of dubious value to BW. As they argue a stronger yuan would make it cheaper for the Chinese to import materials and machinery--which they would then turn into products for export - something Japan once did to good effect. Since the internal Chinese market is not competitive but highly regulated, the Chinese could simply pass on the savings from cheaper import costs in their exported products, making up the difference by charging more internally.

In addition it would take a significant surge in China's currency - something to the order the order of 25% BW speculates - to make much of a difference. But that could spark a financial crisis in China: if a rise in the Yuan were to be followed by a drop in exports then this could wipe out the weakest producers and hammer the banking sector, which is already shouldering some $700 billion in bad loans. all-in-all, not a very clear picture, and not very reassuring for a Ben Bernanke and an Alan Greenspan should they adopt the strategy of going for a significantly weaker dollar.

Four years ago, China figured prominently in the disaster scenarios of some international economists. At the time, South Korea, Thailand, Indonesia, and Russia had all suffered severe currency crashes--and contagion was raging through South America. As a result, China's once-booming export machine sputtered to a near-halt, and its manufacturers were pleading with the government to do something. What would happen if China were to sharply devalue its currency to boost its competitiveness? The result, economists worried, would be another devastating round of devaluations around the world that would exacerbate the global financial crisis. Beijing thought long and hard. In the end, it decided to keep the yuan fixed at 8.28 to the U.S. dollar, to the great relief of the outside world.

These days, Beijing again is coming under pressure to do something about the yuan--still valued at 8.28. But now it faces an entirely different conundrum. Trading partners such as Japan and the U.S. are urging China to let its currency appreciate. Why? Because Chinese factories are flooding the world with cheap goods, everything from televisions and DVD players to bicycles and children's pajamas. At a time when most of the global economy is on its knees, Chinese exports have rocketed by 20% so far this year, while its economy is expanding by nearly 8%. In China itself, overproduction has helped push industrial prices down by 7% over the past five years and retail prices by 10%.

But a growing minority of economists and policymakers are arguing that a deflationary China poses a real threat to the world. "China's prices are becoming global prices," Morgan Stanley economist Stephen S. Roach wrote in a recent report. Chinese prices are already causing imbalances in the developing world. Mexico is seeing the flight of whole industries to the mainland. New manufacturing investment has plunged in most of Southeast Asia. The Japanese are already exploring exporting autos from China. Meanwhile, an influx of cheap Chinese consumer items and foods is raising hackles from Japanese producers. Haruhiko Kuroda, Japan's vice-finance minister for international affairs, warned in mid-November that "China will be exporting price deflation to the other Asian countries" as it produces more sophisticated products.

Kuroda's solution: Revalue the yuan by an unspecified amount. Chinese Finance Minister Xiang Huaicheng says Washington is starting to push similar advice. The idea is to make China's products more expensive, which in turn would curb exports. If only it were that simple. China's competitiveness is so strong that it could easily compensate for a moderate rise in the currency. The supply of $100-a-month Chinese labor is virtually inexhaustible. And $50 billion in annual foreign investment is pouring into China, much of it going to build state-of-the-art factories for U.S., Japanese, and European multinationals. That money is upgrading Chinese industry and boosting productivity by 4% annually, according to the Bank of China.
Source: Business Week

Monday, November 25, 2002

Pedro Solbes Wants to Give Flexibility to the Pact

In a new draft paper containing proposals to reform the stability pact, Pedro Solbes wants to reward those countries with sound finances and low debt, by giving them more flexibility to combat economic downturns. Only problem, the good countries are mostly non-Euro ones. To quote the FT: "Those benefiting most from this new flexibility would be Britain, Ireland, the Netherlands, the Nordic countries and most of the EU's 10 candidate countries - mainly from the communist bloc - which have low debts and small pensions liabilities".

Pedro Solbes, EU monetary affairs commissioner, wants to focus more attention on high debt, arguing Europe is failing to prepare for an impending pensions crisis. He hopes his paper on budgetary co-ordination will restore much-needed credibility to the stability pact, which was designed to underpin the euro by imposing fiscal discipline.Mr Solbes will try to answer the charge that the stability pact lacks flexibility by proposing that countries with "high-quality public finances" - including low deficits and low debt - should be able to borrow to fund investment.

The question of what qualifies as "good" investment, boosting growth and justifying short-term deficits, will be controversial. For instance, the Commission welcomes Britain's expenditure on hospitals and schools, while France says it should be able to spend more on research and development. In Germany labour reform is a priority. The Commission will give its view on each state's budget proposals each year, but the final verdict will lie with EU finance ministers.

Those benefiting most from this new flexibility would be Britain, Ireland, the Netherlands, the Nordic countries and most of the EU's 10 candidate countries - mainly from the communist bloc - which have low debts and small pensions liabilities......Belgium and Greece both have debts of over 100 per cent of GDP - far above the 60 per cent limit set at Maastricht - but Italy is by far the biggest problem: its debt is 110 per cent and rising.
Source: Financial Times

French Bank Auction

You know, reading this piece in the FT I have one nagging feeling, is this for real? Or are we all hopelessly naieve?

Francis Mer, French finance minister, announced over the weekend that BNP, France's biggest bank by market capitalisation, would pay €2.2bn ($2.2bn), or €58 per share, for the government's stake - a price that exceeds the previous record for Lyonnais shares and represents a 49 per cent premium to the closing price on Friday.There were only four bidders in what is believed to be the quickest privatisation auction in French history. The other three - French banks Crédit Agricole and Société Générale and insurer AGF, part of Germany's Allianz - all offered less than E50 per share, according to insiders. Crédit Lyonnais , most of which was privatised three years ago, has three main shareholders - BNP, AGF and Crédit Agricole. Each has about a tenth of the bank. BNP played down speculation that it would bid for Lyonnais soon, but said there were "obvious" possibilities for co-operation. It plans to begin talks with the Lyonnais management.

Faced with Mr Mer's delight at such a high price in the first round of bidding, BNP executives said the bank had tried to win the stake rather than risk another round. "We offered a high price that reflects the special value of the extraordinary opportunity to replace the state as the largest shareholder in Crédit Lyonnais ," Baudouin Prot, BNP managing director, said.
Source: Financial Times

Japan Banks Claim to Tackle Non-Performing Loans

According to the Financial Times there are signs the pressure being put on Japan's banks to deal with their bad loans is starting to bear fruit in the fact that the country's largest lenders used the publication of their first half results to simultaneously announce more aggressive action to tackle the problem. my feeling is it would be better to adopt a wait-and-see approach on this before starting to cheer.

SMBC, Japan's second largest bank, increased its forecast for loan loss provisions for the full year from ¥500bn ($4.1bn) to ¥700bn, while UFJ, the fourth largest lender, said it would transfer ¥1,000bn in bad loans to a new group company. SMBC said net profit for the first half rose 61 per cent to ¥55bn and added it expected to report a ¥30bn profit for the full year. It incurred loan loss charges of ¥266bn for the six months compared to ¥1,540bn for FY2002. It said in the first half it wrote off bad loans worth ¥953bn and that it had bad loans worth ¥5,700bn left on its balance sheet, of which ¥3,000bn were loans to companies considered in danger of bankruptcy or already bankrupt. UFJ said it made a net profit of ¥72bn for the period compared to a loss of ¥67bn for the same period a year ago. It forecast a profit of ¥70bn for the full year and confirmed it would transfer ¥1,000bn in non-performing loans to a new company to be set up next March.

Mizuho, the world's largest bank in terms of assets, said net profits for the half dropped to ¥39bn compared to a loss of ¥264bn previously but said it now expected to make a loss of ¥220bn net loss for the full year. The bank added it had bad loans of ¥4,970bn at the end of September compared to ¥5,000bn at the end of March. It increased its forecast for loan loss charges from ¥600bn to ¥1,040bn. MTFG reported a group net loss for the first half of ¥188bn compared to ¥96bn for the same period last year. It cancelled its interim dividend and said it now expected to make a group net loss of ¥185bn for the full year. MTFG said it had problem loans worth ¥3,6800bn at the end of September compared to ¥4,270bn at the end of March.
Source: Financial Times

Japan: What is The Economist Missing

According to the Economist it WAS just possible to find a nugget of good news about Japan’s economy on November 19th. However rose-tinted glasses, they suggest, were needed to spot it. On a day which saw another round of declines in the share prices of Japan’s biggest bank the Organisation for Economic Co-operation and Development (OECD) changed its mind about the economic outlook. Yutaka Imai, an OECD economist, said the organisation no longer expected Japan’s economy to contract this year. Instead, he said, it was likely to remain flat.

That zero growth is an improvement is a telling indication of Japan’s economic mess. Mr Imai was in Tokyo to talk about the OECD’s newly published survey of Japan. New data since the survey was completed makes the OECD’s economists slightly more optimistic about this year. But this has not altered their broader assessment: that the economy is in serious trouble. The prospect is for virtually no growth till the end of 2004. There is no sign yet of an end to deflation, now in its third year. And the problems created by Japan’s crisis-ridden banking system are in ever more urgent need of attention.

Besides the banking sector, the OECD identifies deflation, fiscal policy and the burgeoning government debt, and the uncompetitive nature of much of the economy as areas in need of urgent remedy. With the downside risks greater than they were, and no sign of an end to deflation, the OECD thinks monetary policy needs to move into uncharted territory. It urges the Bank of Japan to consider a range of new measures to tackle deflation. It also says that inflation-targeting might eventually have a role to play.But the OECD is far more concerned about the large part of the economy that is not export-oriented. Japan has what the organisation describes as a dualistic economy: the domestic, or protected, part of the economy is “remarkably unproductive”, which reflects poor resource allocation underpinned by, above all, poorly enforced competition law and regulation.

Reform is beginning, in some areas at least, to move in the right direction—though the OECD describes much of this as “timid”. So far, the ambitious reform plans of the prime minister, Junichiro Koizumi, have been more noticeable for their absence than their effectiveness. The OECD is not, on the whole, prone to exaggerate gloom. That is why its report on Japan makes such depressing reading.
Source: The Economist

Let's run this last paragraph again. The reform is begining. After ten years we can really believe that things are so simple. And even after ten years they remain 'timid'. Plans are ambitious, but remain notable for their absence of effectiveness. Our learning curve doesn't seem to be very steep at this point.

One of the problems with the Japan debate is that much of the material fails to tackle the problem head-on. For instance the well-publicized Federal Reserve research report "Preventing Deflation: Lessons From Japan's Experience in the 1990s" rather surprisingly manages to miss one of the most important factors driving the Japanese deflation: DEMOGRAPHICS.

So all of this is like Hamlet without the prince. And the OECD report which forms the basis for the Economist article isn't any better. It simply ignores the problem. Non of this analysis then really helps us understand why Japan government debt is growing out of control - after all with deflation even government supplied services should get cheaper, and why raising interest rates at any point is going to be difficult.

Many of the arguments rest on the assumption that eventually Japan will solve the slow growth problem. Well, I wouldn't be too sure, if the problem is a wrong diagnosis how the hell do you expect the medicine to work (although they did just discover that statins may reduce c-reactive protein as well as cholesterol, so there is hope, it's just that this reduces economic policy to a lottery).

At one level Paul Krugman is surely right, if Japan could spark inflation then things would get easier (although not necessarily for all those old people who are net savers), trouble is it seems it can't. Japan lived for fifty years on short term credit being wiped out by a steady inflation in land and property values, but when the labour force numbers hit the ceiling all that came to a fairly unpleasant end. I doubt it can start another assett driven buble, if it can't it isn't for want of trying. But if there's no petrol in the bike tank, then all the kick starting in the world won't help.

Another problem is the assumption that the Japanese are simply living on credit. Were things so simple! If you want to talk about debtor nations then you need to talk about the US, and all those dollars the Japanese have on deposit inside the Federal Reserve System which partly pay for those nice fat trade deficits. The IOU's are going from the US outwards, Japan is a net international creditor. And if one day push comes to shove and the Japanese take their money home, the first impact will be on Wall Street.

Another typical misunderstanding seems to relate to the debt service problem, and when it might begin to look problematic. When should we expect a risk premium on Japanese Government Bonds that really starts to bite. The problem here is that the Japanese govt though the postal bank and savings system effectively buys it's own bonds (or constrains savers institutionally to supply the funds which makes this possible) so they are, at present relatively immune to these downgradings. Japan is not Argentina.

That is the Japanese savings rate isn't just cultural, it's also structural, it's been engineered. Which leads to another misconception. The late-great Rudi Dornbusch was prescient enough to foresee that in the case of Japan "one day there will be a creditors strike, the investors leave for foreign assets (just as with any delinquent emerging market) the currency crashes, the debt crashes....".

But with Japan, as ever, things are not so simple. This creditors strike will not be as easy as it sounds. Cultural factors do have a role, and it is hard to see Japanese citizens abandoning their country anytime soon (again the Japanese are not the Argentinians). So they will attempt to keep paying the debt. As for the currency, there are relatively few Yen in international circulation, the MOF has seen to that as part of an explicit policy, so for the time being Japan has more control over its own currency than any other country. If the Yen does come down it will be because the MOF, or the MOF plus Washington want it that way. Of course one day everything will snap. Put another way all this will continue until it can't.
The Economic Future According to the OECD

The Organisation for Economic Co-operation and Development forsees only a slow and irregular global recovery in its latest economic outlook. According to the Economist, policymakers are finding life difficult in part because they relaxed too much in the 1990s.

As the OECD acknowledges, most economic upturns are uneven in the months directly after recessions have ended. But the latest report points out one unusual feature of the rather weak pick-up in activity this year: the coincident fall in share prices around the world. Equity markets have continued to weaken even as most economists concluded that the worst was over in America and Europe. In America, the drop in share prices since the recovery began at the turn of this year is the first such fall in any of the 18 economic recoveries since 1912. That is more than just another interesting statistic. Falling share prices undermine corporate and individual wealth and could in turn weaken economic activity. Business investment is already weak—the accounting and other corporate scandals in America have done little to help there—and if consumers start to lose heart as well, recovery could stall, and might even go into reverse.

Another unusual feature of the global recovery, which follows the first worldwide downturn for more than a decade, is its apparently divergent nature. The OECD does not think this is a cyclical phenomenon—ie, simply a matter of different regions being at different stages of recovery. It reckons that structural differences explain the different pace of the upturn in different parts of the world—and that, in particular, the potential for future growth in America is considerably greater than in other parts of the world. If this analysis is right, policymakers in Europe and Japan should be worried.
Source: The Economist

Well, five out of ten for the Economist. They've got it half right. These statistics are disturbing, and we should be worried. But they don't offer much in the way of explanation as to why this should be happening. They argue for structural reforms, fair enough, we could do with some. But put the problem another way. In the last quarter of the twentieth century economic growth went on more-or-less OK, without these structural reforms. So why the urgency now. Why is Japan down, and Germany sickly. Here there is silence. The deflation danger. Yes but why deflation, and why now. Here the analysis is thin. I am not convinced we have got anywhere near to the bottom of this one, yet. (No pun intended).

Sunday, November 24, 2002

A New Way of Life

The project launched this week at the Institute for Biological Energy Alternatives in Rockville should cause both scientists and policymakers to stop and think, at least briefly. Directed by genetic entrepreneur J. Craig Venter and Nobel laureate Hamilton O. Smith, scientists will remove all of the genetic material from M. gentilatum, a tiny microbe, and replace it with artificial genetic material made in a laboratory. While scientists have inserted genes into organisms before, they have never tried to insert so many at once. The result will be, in effect, a living thing that is at least partially a human creation. as this editorial from the Washington Post suggests, this raises at least two important questions:

This experiment raises two sets of issues. The first is regulatory. If they succeed in inserting a simple string of genetic code, scientists could eventually insert a more complex string. As a result, they could, for example, create a microbe able to break down carbon dioxide in the atmosphere and thus end the greenhouse effect; that would be good. They could also create a new virus or bacteria that could become a biological weapon; that would be bad. Yet despite the danger of abuse, this kind of research is taking place within what bioethicist Arthur Caplan calls a "regulatory vacuum."........... Mr. Venter and Mr. Smith have said that their "new" organism will be unable to survive outside a petri dish. But no rules prevent other, less responsible scientists from conducting similar experiments in less secure conditions -- and perhaps allowing a "new" bug to escape through a ventilation shaft.

The second set of issues this experiment raises are philosophical: Should human beings try to create new forms of life? Again, while this stage of the experiment does not exactly pose that challenge, the question might arise in a more radical form in a few years. The appearance of Dolly the sheep, the first cloned mammal, led to shock, surprise and a counter-reaction, precisely because the many small experiments that led to her creation had never attracted much notice. If more attention had been drawn to the technological advances along the way, the public might have been better informed and its reaction more reasonable. "
Source: Washington Post

Here's Another Country That Just Doesn't Get It

Today Swiss voters will cast ballots on a measure that, if passed, will give the country one of the most restrictive immigration policies in Europe. The referendum, initiated by the right-wing Swiss People's Party, is an attempt to deny asylum to anybody who arrives in Switzerland from a country considered to be a safe haven. This category applies to all of Switzerland's neighbors, including Italy, which to date has practised the rather hypocritical policy of serving as a transit country. The measure also proposes reducing social benefits for people whose applications are under review, and plans to impose penalties on any airline that brings in passengers without appropriate papers.

Aliki Panayides, vice secretary general of the People's Party, said the party campaigned to get the measure on the ballot because too many people were trying to reach Switzerland for economic rather than political reasons. This is exactly the part they don't get. It is Switzerland, an ageing society, that needs the immigrants, FOR ECONOMIC REASONS.

The referendum, whose outcome pollsters say is too close to call, has been condemned by all other Swiss parties, the government and the United Nations High Commission for Refugees. "If the Swiss vote yes to this initiative," said Ruud Lubbers, the United Nations high commissioner, "the country will have more or less shut its doors to people fleeing persecution, even people who have escaped atrocities, massacres or torture." Despite this criticism, 71 percent of Swiss voters believe their country, which already has Europe's highest concentration of refugees, is attracting too many asylum seekers, according to a poll conducted for Swiss television by the GFS research institute.
Source: New York Times