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Friday, April 04, 2003

US 'Participation' Rates Fall

An interesting point from Morgan Stanley's Dick Berner: US labour force participation rates are falling. Aside from the explanations he offers two additional points occur to me. Firstly the drop in 'teen' particiaption is consistent with an enhanced value placed on education and training among young people in the context of the rising 'human capital' values of the information age. Secondly, in an aging society, there may be more pressure on middle aged women to stay home to care for an elderly relative. Downward wage pressure and rising care costs would only enhance this tendency.

A significant drop in labor force participation has restrained the rise in the jobless rate. Over the past year, the overall participation rate-the ratio of the labor force, or the number of people employed plus those looking for a job relative to the civilian population, declined by 40 basis points. Had the participation rate stayed at February 2002 levels, that the unemployment rate could be as high as 6.4%.

That reduction in labor supply may seem normal; after all, in a tough labor market, "discouraged workers" may well stop looking for a job and go back to school or raise a family. But the participation rate actually rose slightly in the first year of the 1991-92 recovery, and the unemployment rate rose by 0.7 percentage points. The recent decline in labor supply has been most pronounced among teenagers and adult men between the ages of 25 and 54, with their participation rates dropping by 200 and 80 basis points, respectively, over the past year. Teen job seeking has been dropping for a quarter century, as extracurricular activities and summer school have taken the place of entry-level jobs (see "Will the Real Job Tally Please Stand Up?" Global Economic Forum, October 29, 2002). But both teens and prime-age adult men who have had trouble finding jobs may well be dropping out of the pool of available labor.
Source: Morgan Stanley Global Economic Forum

Global Double Dip?

Yes, its Friday again, and Stephen Roach is here to cheer us up for the weekend. And as can be seen he's got his flag up and is calling: even if, as he admits its, his call is a close one (no pun intended). Maybe I should take heart and make mine: it's time we started to rewrite this business cycle plus shocks story. As with every great epic the main characters aren't always who they appear to be at the start. My favourite image from classical literature has always been that of the return of Odysseus to Ithaca, arriving dressed as a beggar to receive only scorn and contempt, before finally revealing himself to see-off definitively Penelope's suitors. Don't worry if you haven't caught onto what I'm getting at. Hamlet will soon be on stage for all to see, and the mystery variable will be revealed. Otherwise forgive my indulgence, it was the talk of war, pestilence (sorry uncertainty) and disease that put me in mind of classical Greece.

War, uncertainty, and disease are a tough combination for any economy. But for an unbalanced and vulnerable world, this confluence of shocks hurts all the more. For the industrial world as a whole, an economic contraction now appears to be under way. Moreover, we are adjusting downward our baseline estimate of overall world GDP growth for 2003 to 2.4% -- an outcome that would take the world economy through its official recession threshold of 2.5%. A global double dip may now be at hand.

The major economies of the developed world appear to have contracted in February and March. Not only is that true of industrial activity in the United States, Europe, and Japan, but most major barometers of service sector activity in these same countries are now flashing similar signs of weakness. Moreover, around the world, labor markets are softening, higher energy prices are sapping consumer purchasing power, and capital spending projects are being put on hold. And now Asia has been hit hard by the outbreak of a virulent new disease -- severe acute respiratory syndrome (SARS) -- that has brought tourism, travel, and entertainment to a virtual standstill in this once-resilient region. Yes, there is always a good deal of statistical noise in extracting meaningful information from month-to-month changes in any economy. In this instance, however, the data fit all too neatly with the script of a world in shock.

Nor should this dip be viewed as just a two-month statistical fluke that will end the moment that Baghdad falls. Our baseline forecast currently points to a world economy that is likely to record “zero” to slightly negative real GDP growth in the second quarter of 2003. For the current period, we are projecting outright contractions in Europe and Japan that could more than offset fractional growth in the US and elsewhere in the world. Moreover, with SARS-related disruptions hitting Asia exceedingly hard at the moment, the risks to our second-quarter estimate are decidedly on the downside. As the flow data comes in, we will, of course, adjust these estimates accordingly. As it stands today, however, our forecast of record paints a picture of a world economy that is likely to be exceedingly weak in the first half of 2003. Whether that weakness ultimately takes the form of stagnation or cumulative contraction is still an open question. But the bottom line is that we are debating degrees of weakness -- not strength -- for an already vulnerable global economy.
Source: Morgan Stanley Global Economic Forum

Since I've set off on this, I'll let Thucydides have the last word:

Such was the funeral that took place during this winter, with which the first year of the war came to an end. In the first days of summer the Lacedaemonians and their allies, with two-thirds of their forces as before, invaded Attica, under the command of Archidamus, son of Zeuxidamus, king of Lacedaemon, and sat down and laid waste the country. Not many days after their arrival in Attica the plague first began to show itself among the Athenians. It was said that it had broken out in many places previously in the neighborhood of Lemnos and elsewhere; but a pestilence of such extent and mortality was nowhere remembered.Neither were the physicians at first of any service, ignorant as they were of the proper way to treat it, but they died themselves the most thickly, as they visited the sick most often; nor did any human art succeed any better. Supplications in the temples, divinations, and so forth were found equally futile, till the overwhelming nature of the disaster at last put a stop to them altogether.

Nor was this the only form of lawless extravagance which owed its origin to the plague. Men now coolly ventured on what they had formerly done in a corner, and not just as they pleased, seeing the rapid transitions produced by persons in prosperity suddenly dying and those who before had nothing succeeding to their property. So they resolved to spend quickly and enjoy themselves, regarding their lives and riches as alike things of a day. Perseverance in what men called honor was popular with none, it was so uncertain whether they would be spared to attain the object; but it was settled that present enjoyment, and all that contributed to it, was both honorable and useful. Fear of gods or law of man there was none to restrain them. As for the first, they judged it to be just the same whether they worshipped them or not, as they saw all alike perishing; and for the last, no one expected to live to be brought to trial for his offences, but each felt that a far severer sentence had been already passed upon them all and hung ever over their heads, and before this fell it was only reasonable to enjoy life a little.
Source: Thucydides Book 2: The Plague in Athens (excerpted)

As Brad Delong so often notes, we're fortunate today in that we have modern medicine, but it's only useful when we know how to use it.

Inflation: Is What we See What we Get

Morgan Stanley's Eric Chaney raises some interesting questions about whether perceived inflation affects consumer activity, and if it does, how this might help us understand the so-called 'teuro' effect. On the way he makes some depressing comments on the state of mind of the French consumer.

In two months time, French households' morale lost more ground than it did during the 1991 Gulf War. Categorised as assets in the European growth equation since 1997, French consumers are turning into liabilities. If this were only a swing of the growth pendulum across Europe, we would not care. But this is not the case. French are indeed catching up, or should I say catching down, with the European crowd, which already looked miserable. With European companies allocating their cash to debt repayment rather than to capital expenditure, with governments forbidden to press the fiscal pedal by EMU rules, there is no doubt that a downturn in consumer spending would put the region on a recession track. Against the consensus view of slow but positive growth in the second quarter, we have already priced in a GDP contraction, in the euro area at least (0.2%Q in Q2). Then, the question is, could be the correction be more serious -- I am afraid this could be the case -- and, more importantly, how long consumers will stay in the doldrums..................

Macroeconomists are supposed to be cold number crunchers, shielded from the real world by a wall of elasticities and multipliers, and I will play this role later on. However, we must not forget that the real world is made of human beings taking individual decisions. As far as consumers are concerned, decisions are based on their perception of current and future real income, but also on their perception of a wide set of risks, such as their job, their future pension or their wealth, but not only. Because layoffs are accelerating now, there is a risk that wage earners could suspect companies of using geopolitical tensions as a pretext for restructuring and thus raise precautionary savings if the war does not end soon. Unfortunately, quantifying the link between confidence and actual spending is not straightforward. Over the last 15 years, consumer confidence in the euro area and actual real spending show a modest 62% correlation. Nevertheless, a simple regression indicates that a 10-point fall in confidence is typically associated with a 1% cut in real consumer spending, which, other things being equal, implies a 0.5% cut in GDP. From Q3 2002 to date, confidence has dropped by 11 points. At 21, it now stands exactly 10 points below last year’s average. Since we expect consumer spending to grow 0.7% this year, after 0.5% last year, it is clear that even our gloomy forecast might err on the side of optimism if confidence does not improve in the coming months. In any case, second quarter consumer spending is likely to disappoint and I would not exclude an outright contraction in consumption and thus a deeper dip for GDP than the two tenths envisaged so far.

Since consumers were more sensitive to perceived inflation than to actual inflation when euro banknotes and coins arrived, they must have saved more than they would have done otherwise. Here are the maths. Using the high correlation between real spending and inflation, we have estimated that a one-percentage-point rise in the inflation rate typically cuts spending growth by 0.9 p.p. (since this coefficient is statistically not different from unity, it will be rounded to one in the following section). In fact, during the sampling period (1992-2002), consumers behaved as if their future income would not discount inflation changes and thus considered that gains or losses in current real income due inflation or disinflation were permanent. Until mid 2001, the link between real spending on the one hand and actual or perceived inflation on the other was the same, as consumers proved to have a very accurate perception of inflation. Then, price tags were switched from good old lire, D-marks or francs to strange euro numbers. Consumers quickly understood that something was wrong, especially in January-February 2002, when euro banknotes appeared. On our estimate, the "Teuro", as the new currency was dubbed in Germany, resulted in a 0.5-1% price increase (see "From Stag-flation to Stag-disinflation", December 5, 2002). On Eurostat estimates, it was only 0.3%. However, for Euroland consumers, the perceived rise of inflation was much larger. Using the excellent econometric relationship between actual and perceived inflation between 1992 and 2001, we reckon that, since the introduction of the euro, perceived inflation has averaged 4.6%, whereas actual inflation has been only 2.2%. This 2.3 p.p. gap between reality and perception is massive, in a low inflation world. However, for once, I see a positive aspect in this otherwise very negative story. Consumers must have continued to take their spending decisions based on their perception of inflation, not on actual inflation -- they do not believe in official numbers. Since they feel that inflation is 2.3 p.p. higher than it is in reality, they have refrained from spending by the same amount, given the unitary elasticity of consumption.

I am not talking about small numbers. The euro area generated €7,200 billion of value in 2002 GDP accounts, 58% of which went to consumer spending. Our calculations suggest that the optical inflation illusion generated by the euro resulted in an exceptional and temporary rise of Eurolanders' savings worth €95 billion (2.3%*58%*7,200). On our estimates, the personal saving rate increased from 14.7% of disposable income in 2001 to 15.5% in early 2003. This was at odds with traditional macro relationships. In the context of real disposable income slowing down, the natural shock absorber that is the savings rate should have decreased, not increased. Our analysis of the Teuro effect provides a credible explanation for this surprising event. Looking forward, consumers' misperception of inflation will not last forever, and the savings rate will come back to its "normal" level, freeing up at least two points of income. As always, this wealth now hidden in savings accounts will go to discretionary spending, mainly to big-ticket items such as cars and home equipment goods.
Source: Morgan Stanley Global Economic Forum

US Services Take a Hit

Now it's the US services sector, which accounts for around 70% of the whole economy, which looks like it just had a nasty knock.

The vast U.S. service sector unexpectedly shrank in March for the first time since January last year, a report said on Thursday, in the latest sign the economy was already faltering as the war in Iraq was launched. The pull-back in services, coupled with data this week showing contraction in manufacturing, a hefty drop in factory orders and a big jump in jobless claims, have revealed a grim picture of the economy's health as U.S.- led forces approach Baghdad. The Institute for Supply Management said its index of non-manufacturing activity fell to 47.9 - the lowest reading since October 2001, just after the Sept. 11 attacks on the U.S. - from 53.9 in February.

Economists took a cautious view of the data and said the Federal Reserve would likely wait to see how long the war drags on before taking any action on official interest rates, despite the array of weak economic figures.So far the Fed has expressed optimism growth will take off once the war uncertainty fades."I think the Fed will withhold judgment because it's impossible to ascertain to what extent the uncertainty right before the war was leading to paralysis," said Jade Zelnik, chief economist at RBS Greenwich Capital."But if they become convinced the war will be drawn out, they will not be able to ignore such weak statistics forever," she said. Financial markets again overlooked the weak data and focused on developments in Iraq. Stocks and bonds were mostly flat on the session. Survey respondents said the war was having a negative impact on their businesses. But beyond the war, some said low interest rates were still not helping to spur capital investment, one of the key missing ingredients preventing a full-fledged recovery. The ISM services reading was much worse than the 52.3 reading forecast by economists. Any figure below 50 signals contraction in the sector which includes everything from entertainment to tourism and banking. The survey's components also showed deterioration across the board. New orders, a key source of future growth, fell to 47.7 from 53.0 in February. Businesses stepped up layoffs, with the employment index falling to 47.9 from 49.0 last month. A surge in energy prices tied to the Iraq conflict and oil supply disruptions around the world has also eroded both consumer and business sentiment.The prices paid index, rising to 62.0 from 60.9 the prior month, showed high energy costs are still sapping profit margins, meaning business managers will remain reluctant to make investments or hire workers. Earlier this week ISM's gauge of manufacturing activity revealed a sharp slowdown, with growth in the sector contracting in March for the first time in five months.
Source: Reuters

The Jobless 'Recovery' Continues

The bleak US employment outlook continues with 445,000 first time claims this week. With consumer confidence so low, manufacturing output taking a hit, and little forward looking capital investment I think it's time we started doing the math.

The number of new U.S. jobless claims last week jumped to its highest in nearly a year, the government said on Thursday, offering little hope for a turnaround in the grim labor market picture. First-time claims for state unemployment insurance benefits spiked 38,000 to 445,000 in the March 29 week, the largest one-week rise since an 86,000 jump in the Dec 7 2002 week, the Labor Department said. The rise was due in small part to a massive snowstorm in Colorado the third week of March.The number of new claims were at their highest since measuring 452,000 in the April 13, 2002 week and well above Wall Street economists' forecast for 410,000. "It's clear that there's a deterioration going on," said Robert Brusca, chief economist at Native America Securities in New York. "It's a large move; we have a clear weakness in the economy." The total number of unemployed workers staying on jobless aid rose to 3.61 million during the week ended March 22 -- the latest week for which figures are available - from 3.5 million the prior week. U.S. Treasury bonds, which had been focusing on developments on the war in Iraq, tried to pare their losses on the sharp rise in jobless data. However, news that U.S.-led forces in Iraq were pushing close to the capital Baghdad held back Treasury bonds in morning trade. The latest jobless claims figures suggest that the level of unemployment in the economy, which stood at 5.8 percent for February, could go even higher.
Source: Reuters

Thursday, April 03, 2003

More Euro Gloom

This time from Eric Chaney and Anna Grimaldi:

Updated with fresh data coming from March polls, our survey-based model -- call it the MP model -- is unequivocally negative. It says that manufacturing posted an initial contraction in Q1 (-0.9%Q) and, mind the steps, is likely to post another one in Q2 (-0.5%Q). This might well be true and, as a matter of fact, our general rule is to trust the MP model rather than hard data, as long as only the first month of the quarter is available. However, we take the MP model Q1 estimate with a grain of salt, because manufacturing production actually jumped 1.1% in January. Although susceptible to revisions, this strong entry point implies that, in order to validate our model's prediction, production would have to drop by 1.5% in February. Although not impossible, we think that such an outcome is at odds with the quasi-stability of opinion on current output in the February surveys. At this stage, we think that a fair compromise is to assume that actual manufacturing GDP growth in the first quarter dipped into negative territory, but by less than indicated by our MP model -- say a 0.5% contraction. Note that the important point here is that, even with this discretionary amendment, manufacturing production is contracting for two quarters in a row, unless business conditions change radically in the coming weeks.

A manufacturing recession does not necessarily imply an overall recession. When the Asian crisis hit Europe, manufacturing contraction lost 0.5%, in Q4 1998; this did not prevent GDP growth from growing a solid 0.3% rate. Our early GDP indicator, which is based not only on surveys but also on interest rates and US cyclical indicators, is nevertheless highly sensitive to manufacturing production, which it takes from the MP model itself. Then, if fed the raw results of the latter, our GDP model would print 0.0% in the first quarter, followed by 0.1% in the second. Alternatively, fed with our compromise manufacturing production estimate, it would say 0.1% in the first quarter and 0.0% in the second. Given the very relative precision of econometric models, these differences are totally insignificant. If there is one message to take away from quantitative tools, it is that euro-area GDP growth came to a standstill in January and did not show any sign of taking off since then. Of course, zero growth implies higher unemployment and higher government deficits, but that is another story.

Nonetheless, our quantitative tools do not yet indicate that GDP is going to contract in the second quarter, as indicated in our economic forecasts. One of the assumptions we used to build our full-fledged GDP forecast (see "Recession Alert", February 24, 2003, by the European economic team), namely that crude oil prices would shoot up to $40/bbl in March, did not materialise. Instead, oil quotes declined enough to bring the 30-day average to the vicinity of $30. For this reason alone, we could find a justification for a forecast change on the upside, for the first time since 2000. However, we are not yet ready to take this step. Gloomy we are, and gloomy we are likely to stay for a while, even though market conditions are slightly better than they were three weeks ago. Put simply, the volatility caused by inconsistently reliable news from the front in Iraq makes us very cautious about the markets' judgement.
Source: Morgan Stanley Global Economic Forum

There's a Breathless Hush in the Close To-night

I'm afraid Stevie boy's reduced this immortal line to: there's an eerie sense of calm in the global economy. But still poetry probably isn't his strong point, and I don't suppose he was brought up on the likes of Henry Newbolt. I'm also pretty sure he wasn't thinking of the bit about the sand of the desert being sodden red. More to the point 'the Gatling's jammed and the Colonel dead' - of course I'm talking about the Fed's last stand and there's no hidden metaphor with Iraq either intended or to be looked for. So come on everybody: 'Play up! play up! and play the game!' coz last one out of the showers and into the bar is a sucker.

There’s an eerie sense of calm in the global economy. Growth in the industrial world came to a near standstill in late 2002 and has shown little signs of life since. This has led to a peaking in the global trade cycle, putting new pressure on most trade-dependent economies in the developing world -- with the notable and important exception of China. Then came the shock. The world is still in the process of absorbing the impacts of war and the uncertainty of the peace that follows. While the global economy has hardly collapsed, I am reminded of how calm it always seems in the eye of the storm. I continue to fear that this storm is far from over. I worry much more about the downside of another recession than I do about the upside of a victory recovery.
Source: Stephen Roach, Morgan Stanley Global Economic Forum

'D' Day Preparations Down at the Fed

So just in case 'it isn't just the war, stupid', the Fed does seem to be moving ahead vigourously with battle plan 'B'. (I sure hope George Bush finds the time in his crowded agenda to let himself be briefed on this one). Obviously all the talk of war has put everyone in a macho mood. After Krugman's allusions to the 'Baghdad is for boys, the real men want to go to Teheran' doctrine, this week we have the Fed's McTeer say that 'it would be kind of fun to fight deflation'. He must have a pretty boring life if he thinks this is going to be fun! Mind you, after reading that George Bush has nothing better to do with his Saturday afternoons than nibble pretzel on the sofa while watching football nothing really surprises me any more. (Presumeably this is the couch potatoe minus the six-pack, which must make it even more boring).

More to the point is McTeer's 'as long as you're pumping out money at a faster rate than the demand for money is rising you're going to stimulate spending', since its the 'as long as' bit that's important: the Japanese have been finding that the demand for money is quite capable of running neck-and-neck with its rising supply as the store of value component takes over the heavy lifting from the means of exchange one, in a world where the value of everything else is falling against money, and the speed of circulation is slowing down. (Come to think of it: maybe this is the real force of the critique that economic theory is still too dominated by the world of Newtonian mechanics, maybe to many people have never got their heads round the implications of special relativity theory. The salient point here, I think, is that you can run round and round very fast indeed, and still come back to a place where things have barely moved. Still since all the 'real men in Teheran' BS has gone to my head, I have to confess that I find the Wolfram vision of a set of space-time coordinates floating on a platform of information much more sexy).

Getting back to reality: I think the point about the anti-deflation package looking good on paper since it is not yet tested is an important one. My preoccupation is that, like many others things which look good on paper (and of course operation 'air head' immediately comes to mind) the reality may turn out to be more complex. Remember theory is grey, but life is green. Also worthy of comment is the 'good' deflation 'bad' deflation dichotomy. Virtuous deflation does exist: in some sense we can see an example of it now in China. Prices in some sectors fall in such a way as to produce a general economic expansion. History (in the nineteenth century) or contemporary reality (in China) does also tend to indicate that this virtuous deflation has its own attendant convulsions, as those thrown out of work in the backblast of creative destruction know to their cost. In a sense the 90's was a period of positive sectorial deflation in the US. A dramatic fall in prices in a number of sectors produced a historic expansion 'lifting all boats'. But if the fall in prices, due to the relevant cross-elasticities, fails to provoke real revenue growth in the affected sectors (think post March 2000) then the result can be slowdown and growing output gap.

So then you have to look at what's happening in the rest of the economy. This is what determines in the final analysis if 'good' deflation turns bad. Now conjuncturally we face two other negative headwinds. Firstly China. Of course, in other times, China would be producing the kind of 'healthy' deflationary tonic we all hope for. Falling prices in manufactured products stimulating a general market expansion, and growth all round. But this is not what is happening. China - entering sixth place - is giving the global economy what little push it has, but that is not sufficient to achieve lift-off. It is being more than compensated for by what appears more and more like an irreversible, 'historic', decline in the number two and number three slots: Japan and Germany. So we have what Stephen Roach (see my post yesterday) comes near to calling (and I will call) a negative feedback dynamic. As pricing pressure in the slows down the activity of the large global corporations in the developed economies, this ironically only increases the pressure to outsource in China. Ergo: not only may China be insulated from the growing global slowdown (SARS is another question), it may actually be a positive beneficiary of it.

Secondly, there is the demography. If Japan and Germany are moving backwards, there must be a reason. Simplistic calls for structural reform entirely miss the point. The reason is negative demographics. This argument is explained in interminable detail here>, and here and here. Since this phenomenon, in greater or lesser measure, is about to hit all the developed economies, then the plight of these two may give us some measure of what is to come. All in all then, whilst I think the deflation preparations of the Fed are admirable (in the sense that they are at least trying to do something, and doubly admirable in the light of the complete absence of preparations here in Europe), I think we still have a long way to go before we really start to get the measure of this one.

Most Federal Reserve officials think the U.S. economy will revive once war doubts lift but with corporate pricing power hamstrung, they are still bracing to avert a threat they hope never arises -- deflation.While Fed policymakers have expressed confidence the United States won't suffer Japanese-style deflation, in which falling consumer prices drag the economy lower, part of that faith reflects a willingness to act aggressively if needed."We don't want to get into a position where we get extra headwinds in an environment where we're fighting some other headwinds and that underscores the importance of being ... aggressive and willing to act preemptively." explained Vincent Reinhart, a top adviser to Fed Chairman Alan Greenspan.

The U.S. economy hit a brick wall of war worries and bad weather in February, fueling concerns among some analysts that the stop-and-go recovery was in danger of stopping altogether. Early readings on March appear little better. For its part, the Fed has blamed much of the weakness on disquiet about the U.S.-led war against Iraq and its potential economic impact, saying growth was poised to pick up once war-related worries ease. Officials at the central bank are hopeful that the 12 U.S. interest rate cuts since early 2001 will be ample to stimulate faster expansion. But markets are not so sure. "The Fed thinks they're done but the economic news is not really cooperating," said Bill Dudley, chief economist at Goldman Sachs. "The most likely thing is the Fed's on hold for the time being and we wait to see how the data, the war and the markets behave," he added.

While rising oil costs have pushed overall inflation up the past year, so-called core inflation, which strips out food and energy costs, has been slowing -- the Fed's favorite measure was up only 1.4 percent in the 12 months through February. With core inflation low and the economy weak, some analysts see a risk the United States could end up like Japan, which has been in and out of recession since equity and real estate bubbles popped more than a decade ago. With the benchmark overnight lending rate now at a 41-year low of 1.25 percent, the Fed has had to face the unsettling prospect that short-term interest rates alone might prove an insufficient tool if the economy weakened sharply.Many analysts believe the central bank would be loath to cut rates to zero because that could cause problems in money markets, which count on a positive rate of return to function."That's an issue that's getting a lot of attention these days and we'd have to make that kind of judgment in the context of everything that might be happening," Richmond Fed President Alfred Broaddus told reporters this week, while stressing he did not see deflation as a near-term threat.

Like Broaddus, Reinhart made clear the Fed was conducting due diligence for a prospect he called "quite remote." "You've seen the chairman testify (before Congress). A van pulls up and empties out with staff and they're all carrying briefing books. In an institution like that, what do you think we're doing?" Reinhart quipped when asked if the Fed had been giving more thought lately to how it might battle deflation. Speaking at an economic conference last week, Reinhart laid out a number of tools other than short-term rates that could be used to fight deflation, from pumping money into the banking system to lowering long-term rates by buying U.S. Treasuries. Officials express confidence such measures, while unusual, would prove effective, even while they admit a lack of experience makes it hard to gauge the likely impact. "As long as you're pumping out money at a faster rate then demand for money is rising you're going to stimulate spending," Dallas Fed President Robert McTeer said in mid-February. "I think it would be kind of fun to fight deflation, actually."

Officials in Washington repeatedly stress that the United States is not like Japan, where banking system woes have complicated efforts to spur growth. In Japan, falling prices have raised the burden of debt, adding to bad loans at banks and thus hampering new lending, which weighs on the economy and fuels more price declines. Fed researchers say that if a deflation threat arose in the United States, the key to avoiding a Japan-type spiral would be to act quickly while the now-healthy banking system could still transmit the benefits of an easier monetary policy.Even if prices were to fall, all deflation is not created equal. In December, one Fed official said deflation might not be so dire if it occurred when productivity -- or worker output per hour -- were rising rapidly, as it currently is in the United States. Since rising productivity cuts the cost of output, profits would be buffered even with falling prices.

Steven Kamin, a researcher at the Fed's Washington-based Board of Governors, said last week there was some merit to distinguishing between productivity-related "good deflation" and "bad deflation" caused by a collapse in demand. Still, he warned the economy could easily tip from good deflation to bad if hit by a negative shock. "The good part of good deflation is the productivity growth, it's not the deflation itself," Kamin said.
Source: Reuters News

Wednesday, April 02, 2003

Petro Dollars or Petro Euros?

I have a mail from Maynard this morning asking me about seignorage on the dollar, and the importance of a dollar-euro switch. He also informs me that: "internet conspiracy theorists....claim that operation Iraqi Conquest is based on a fear of oil sellers switching to selling in euros rather than dollars". I have a number of comments. Firstly this area is a good deal outside my competence. On currency questions I normally limit myself to listening to what those who know more say, and citing those comments I feel are intelligent and to the point. In this sense I feel you cannot do better than Morgan Stanley's own Stephen L Jen. On the other hand, whilst I am sure conspiracies abound everywhere, I am equally convinced that few of them ever succeed in obtaining the results intended. Since the future is not ours to see, I find the whole idea absurd. Imagining, just for the moment, that the euro were a conspiracy, then it surely seems like one that is destined to fail. Or take the late 90's 'new economy boom': there seems plenty of evidence that consultants contrived to sell products they themselves didn't believe in. But I can hardly believe they intended to produce the market crash which was, in fact, the end product of their best endeavours.

In this sense I am deeply manichean: if there were to be a god, we would undoubtedly be a totally unexpected outcome of his or her endeavours. So following Occam and Einstein on the simplicity front: I am sure there may be conspiracies, but theoretically speaking their existence or otherwise is an entirely extra-to-requirements assumption. We have enough to think about by considering the repercusions of the activities of well intended men and women. Those in doubt should read Borges, and if you're still not convinced try his Argentinian colleague Roberto Arlt.

Now on the substance. Stephen Jen among others reminds us time and again that the Asian dollars are in fact more important than the petro ones - he estimates by a factor of ten to one. Secondly, bringing down the price of oil by bringing Iraqui oil on-line after the war would probably reduce the importance of the petro dollars even more. Thirdly, it seems to be a US Treasury mid-term objective to bring down the value of the dollar (among other reasons because of fears about deflation, but also to correct the current account deficit). None of this would seem to suggest that US strategic thinking is motivated by dollar seignorage arguments. Additionally the greatest threat on this front may well come from global central bank currency reserve holdings. Here is what Jen recently had to say on the issue

In light of the geopolitical developments in recent months, it is possible that one of the factors weakening the USD may have been a growing share of petrodollars being re-invested in non-USD assets. In this note, we revisit this issue, and conclude that re-direction of petrodollars is likely to have had a positive effect on EUR/USD, reflecting more the rising concerns about the USD and the nature of the geopolitical tensions, rather than the higher oil prices per se. However, this is not likely to have been a ‘dominant’ factor behind the descent in the USD in recent months but, more likely, only a modest USD-negative.

Tracking the petrodollars to help us think about the evolution of the G3 currencies is not new. In fact, we first analysed this issue back in October 1999, in ‘Tracking the Petrodollars’. While how petrodollars are re-invested is very important for the USD, the absence of data on these flows has always posed the most serious obstacle to us in reaching unambiguous conclusions. At the same time, the paucity of data has also fuelled many ‘conspiracy theories’ about how petrodollars may be redirected away from USD assets. In the various pieces of analysis we have conducted since then, and including this piece, we have only been able to draw tentative conclusions that are conditional on specific assumptions. Having said this, there are several aspects of the flow of petrodollars that are worth remarking on.

There is the argument that, in fear of funds being confiscated or frozen by the US, petrodollar owners have shied away from USD-assets, and that this has been a major factor driving the USD lower. We don’t find this argument convincing. First, there is a difference between investing through US-based funds and investing in US Dollar-assets. These investments in question could be shifted to off-shore accounts and still be invested in USD-assets. Further, suspicious investments would not be ‘off the hook’ just because they are not in USD-assets. Second, this argument presumes that most of the petrodollar investments are ‘suspicious’ in nature, and that the US is feared to indiscriminately freeze funds. Both of these presumptions are not reasonable, in our view.

There is no mystery to the 12% decline in the Fed’s major USD index since the beginning of 2002. Not only was the USD very over-valued, but the cyclical fundamentals of the global economy permitted the USD to correct in three mini-phases (‘USD Twin Deficits — USD No Longer Lord of the Currencies’ Stephen L Jen, 16 Jan 2003). We believe there are compelling ‘conventional’ justifications for the USD to correct. Even petrodollar owners themselves may have limited their holdings of USDs and increased their exposure to the EUR, not for fear of being investigated by the US intelligence services, but simply because they think the USD is overvalued. In other words, there could be nothing special or mysterious about petrodollars. This is not to say that such a re-direction away from USD-assets did not take place, but a redirection due to petrodollars was most likely of secondary importance, being only part of the general USD selling seen over the period.

Whatever the true story on petrodollars, they are not large enough to significantly move markets alone, in our view. Petrodollar receipts are large, but not that large. OPEC oil export revenues are estimated by the EIA (US Energy Information Administration) at US$179.6 billion for 2002. This amount is dwarfed by the total export receipts of the Asian countries (around US$1.6 trillion in 2001), and which are also predominantly denominated in USDs. Even though the sharp oil price increase could push total OPEC-10 export revenues above US$300 billion this year, a change in the re-investment pattern of Asian exporters is, on this basis, potentially much more important than that of the petrodollar owners. The Asian exporters and central banks divesting from USD-assets alone would be powerful enough to drive the USD weaker.

This is the ‘flow’ aspect of the discussion. There is also a ‘stock’ aspect we need to consider. Most Asian economies have been capital-surplus economies (indicated by running a current account surplus) in recent years, as have most of the OPEC-10 (according to OPEC estimates). Looking at cumulative current account (C/A) balances can give an indication of an economy’s cumulative gross foreign assets (a ‘stock’ concept). Cumulative C/A balances for the OPEC-10 over the period 1981-2001 are US$110.5 billion, while those of the Asian economies sum to US$1.9 trillion. Hence, this suggests that gross foreign assets held by Asian economies are likely far larger than those of the OPEC-10. The point here is that the Asian exporters and central banks deciding to raise the weighting of the EUR at the expense of the USD, because of the structural negative trend in the USD, would be a powerful enough USD-negative to dominate the decision by petrodollar owners over whether to do the same.
Source: Morgan Stanley Global Economic Forum

Which brings us to Europen government strategy. It is I suspect a widely held belief here in Europe that a significant part of contemporary American prosperity is based on the fact that the rest of the world is prepared to subsidise US consumption by holding dollar denominated assets. This, like most theories, is partly true. But only partly, and begs the real question as to why many in the world, including many Europeans, have been prepared to hold dollar denominatd assets. The reasons for this may be many and complex, and this is not the time to go into them in any depth, but suffice it to say that the performance of many of the leading US corporations, in comparison with the rather lacklustre showing of their European equivalents, in particular in the so-called 'new economy' sector (where, for example, are the European Amazons, Googles and Yahoos?) may offer some part of the explanation. The cart is again being put before the horse, and the relations of cause and effect reversed. America is not wealthy because it is powerful, but powerful because it is wealthy, and rich because of it's wealth creating capacity.

So what worries me most about the euro in this context is that its very existence may be based on an illusion, the illusion that runs along the lines of an 'if only we too could only get some of the additional seignorage action'. It is a moot point today whether the rise in the euro will encourage central banks worldwide to rebalance their currency holdings by accepting more euros. It is another moot point whether short term tendencies (like the fall of the dollar) will be reversed mid -term if the European economies cannot hold the weights to do the heavy lifting. It is a complete unfathomable whether any of the euro zone governments may or may not have been influenced, either individually or collectively, in their Iraq war allignments by the prospects of more favourable euro receptions in the third world. And it is the mootest point of all whether the rise in the euro/dollar rate that any such pro-euro sentiment might provoke would be beneficial or downright harmful mid-term for the European economies. Finally, and without prejudice to any of the above, it is extremely doubtful whether 'conspiracies' which have no idea if the end result of their intended actions would be beneficial or harmful for the 'conspirators' really deserve the name of conspiracy at all. Confederacy of Dunces sounds more like it.

One Recession or Two

Brad de Long's worried about the NBER Business Cycle Dating Committee:

The latest NBER business-cycle memo. I think it's time to wander down the hall and ask David and Christie Romer whether the inability of the Committee to decide now--fifteen months after what I see as the recession trough--whether we are in an expansion or not is not sufficient reason to rethink the whole business-cycle methodology that Wesley Clair Mitchell set up for the NBER.
Source: Semi Daily Journal

My feeling is that Brad is being over-precipitate here. I'm afraid I'm inclined to agree with the dating committee. In one sense classifying activity is simply a taxonomic problem, and there is always more than one way to peel the onion. But given the level of uncertainty surrounding current conditions - I would use the term fundamental, or strategic, uncertainty - I think it's wise to be prudent. The question really is whether this is a continuation of what's been happening already, or if it is something new. The latter would need to be the case to make it worthwhile separating it out analytically.

Now if the recent stalling of the housing market is an indicator that the real economy is about to feel the consequences of the earlier 'correction' in the equity markets, then analytical convenience and simplicity (think Occam) suggests it might be better to group the two together.Of course, like the Catalan oath if not, then not........

Playing safe I think wait and see may be the better option. If my memory serves me well we do talk about 'the Great Depression' as one event, even if what started in 29 only really became fully apparent in its consequences in 31. I'm not saying it's that bad, but it sure ain't good.

According to the most recent data, the U.S. economy continues to experience growth in output and income without growth in employment. Employment, which grew in January after several months' downturn, declined substantially in February. Because employment is still at a low level, it remains our conclusion that additional time is needed to interpret the movements of the economy last year and this year. The NBER's Business Cycle Dating Committee will determine the date of a trough in activity when it concludes that a hypothetical subsequent downturn would be a separate recession, not a continuation of the past one. The trough date will mark the end of the recession. The committee will not issue any judgment about whether the economy has reached a trough until it makes its formal decision on this point. The committee waits for many months after an apparent trough to make its decision, because of data revisions and the possibility that the contraction would resume. For example, the committee waited until December 1992 to announce that a trough had occurred in March 1991.

In November 2001, the committee determined that a peak in business activity occurred in the U.S. economy in March 2001. A peak marks the end of an expansion and the beginning of a recession. The determination of a peak date in March is thus a determination that the expansion that began in March 1991 ended in March 2001 and a recession began in March. The expansion lasted exactly 10 years and was the longest in the NBER's chronology.

A recession is a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades.

Because a recession influences the economy broadly and is not confined to one sector, the committee emphasizes economy-wide measures of economic activity. The traditional role of the committee is to maintain a monthly chronology, so the committee refers almost exclusively to monthly indicators. The committee gives relatively little weight to real GDP because it is only measured quarterly...
Source: NBER Business Cycle Dating Committee

China: Push or Pull?

Stephen Roach asks whether China is too dependent on exports, or are we witness the rapid growth of an economy which is, for the present, cyclically resistant due to the outsourcing dynamic. Roach suggests that 'deteriorating external demand conditions shouldn't make much of a difference to multinationals who are moving aggressively to integrate their new Chinese-based operations into global production platforms'. In fact the situation may be even stronger than that as deteriorating conditions push multinationals down the China outsourcing road in the search to cut costs in a high pressure market. His concusion is that far from being on the point of an internally driven consumption ramp, China is supply side driven, as it uses external trade to facilitate strategic purchases in machinery and equipment. Somewhere where japan was in the 60's and 70's. Since things move quicker, quicker today, by my calculations the end-game should come on-line in about a decade.

First of all, the numbers: I am on record as stating that fully 74% of China’s GDP growth in 2002 is traceable to the growth in exports. Based on more recent data, this figure has actually been revised up to 77%. The data come from China’s own national income and product accounts. In 2002, the level of exports accounted for “just” 26% of Chinese GDP. But exports increased from $266.1 billion in 2001 to $325.6 billion in 2002. That amounts to a $59.5 billion increase -- a 22.4% surge that accounts for fully 77.2% of China’s $77.1 billion increase in nominal GDP in 2002. At the margin, there can be no mistaking China’s export-led growth dynamic.

The critique comes from those who claim that I am only looking at half the story. Trade flows, after all, are a two-way street -- and imports should also be taken into consideration. Chinese import growth certainly did accelerate last year, surging by 21.2% in 2002 following an 8.2% rise in 2001. Nor was this a one-off development. Over the past five years, Chinese imports have effectively doubled. Imports, of course, are a reflection of China’s “demand pull” on its trading partners. China actually ran outright trade deficits with Korea, Japan, and its ASEAN neighbors -- giving rise to the view that China has now become the growth engine of Asia. At a minimum, goes the argument, this solid growth in Chinese imports seems to dispel the notion that China is an externally driven economy.

Not so fast, in my view. First of all, Chinese exports still exceeded imports (the “trade balance”) by some $30.4 billion in 2002. This trade surplus was fully 35% wider than the $22.5 billion surplus prevailing in 2001. While the external impetus as measured from the positive trade balance was a good deal smaller than that measured by the export side alone, that does not alter the basic thrust of an externally led impetus to Chinese economic growth. The more critical point bears on the mix of Chinese imports. According to our China expert, Andy Xie, purchases of foreign-made equipment have accounted for fully 55% of the growth in total Chinese imports since 1997; chemicals make up another 20% of the total growth in imports over the past five years, whereas purchases of foreign-produced fuels and related products account for another 13%. That means fully 88% of the cumulative growth in Chinese imports over the 1997-2002 interval can be tied either to capital formation or to the fuel or feedstocks of the industrial supply chain. That’s why I have concluded that there’s far more to China’s spectacular success than a self-contained domestic demand story.

Yes, import growth doesn’t occur without domestic demand. And many believe that China’s strong growth in imports validates the notion that the Chinese economy now rests on an increasingly solid base of domestic demand. That may be technically correct. But it’s a domestic demand that, in my view, is largely focused on the supply side of the Chinese growth equation -- namely the ramp-up in new capacity and infrastructure, in conjunction with the vigor of industrial production from existing capacity. China’s import story also goes hand in hand with the dramatic emergence of an externally focused outsourcing production platform that is an obvious and important by-product of a massive surge of foreign direct investment (FDI). In 2002, FDI into China surged to a record $52.7 billion, making the Chinese economy the world’s leading recipient of such flows. Moreover, this trend is continuing unabated: In the first two months of 2003, FDI hit $11 billion, running well above last year’s record clip. In my view, China’s FDI surge and its supply-oriented growth of imports go hand in hand -- both critical ingredients in the establishment of the world’s newest manufacturing platform.

Consequently, as I see it, China’s demand story today is much more about capital formation than private consumption. In the context of such a supply-driven growth dynamic, the Chinese consumer is the understandable laggard. Indeed, Chinese retail sales rose “only” 9.2% in the year-ending December 2002, about one percentage point short of the government’s official growth target. This shortfall should not be surprising. As long as reforms in state-owned enterprises continue to result in the elimination of some 6-8 million jobs per year, the Chinese consumer will remain understandably hesitant. That will change at some point in time, as the reforms run their course and as the income generation of externally directed production provides support for private purchasing power. But that day is not yet at hand. Sure, there are some signs that Chinese consumers are beginning to stir -- witness last year’s 30% surge in vehicle sales and an emerging retail culture in vibrant coastal areas such as Shenzhen and Shanghai. But those trends remain the exception, not the rule, in my view.

Why is this such an important issue? Two reasons come to mind. First, if Chinese export demand were to falter, the economy would be in serious trouble. In an increasingly weak global climate that seems like a perfectly legitimate risk to worry about. But fear not -- China’s export comparisons actually accelerated sharply further to a 33% y-o-y comparison in the first two months of 2003. At work could well be the rapid growth of a cyclically resistant outsourcing dynamic. Deteriorating external demand conditions shouldn’t make much of a difference to multinationals who are moving aggressively to integrate their new Chinese-based operations into global production platforms. Second, China’s externally led growth dynamic is important because it has an increasingly powerful impact on the rest of the world. Last year, China accounted for only about 5% of the world’s total manufactured exports but fully 29% of the growth in such trade. That means China’s external impact on the rest of the world -- whether it’s driven by exports of Chinese companies or outsourcing of foreign multi-nationals -- is undoubtedly several multiples of its share in the global economy. This has an important bearing on a host of critical global macro issues -- especially, currency considerations, the deflation debate, and the battle for market share in a soft global climate. China’s global impact can no longer be denied.
Source: Morgan Stanley Global Economic Forum

There's More Than One Kind of Protectionism

I have made no secret of my feeling that growing economic pressure on an ageing Europe is not likely to produce the mood for imaginative radical structural reform that many anticipate. I think that commentators in general, and Stephen Roach in particular, are way too optimistic here. I also think that as the outcome is an unknown, since we haven't been here before, and that at best a wait-and-see approach is called for. Today some additional news from Brussels which suggests that protection may be as likely as reform. (In fact Japan has already shown us this, but the, of course, Japan is 'different').

Public services such as electricity, post and telecommunications could be given greater protection against competition and state aid rules under plans being considered by European regulators. The European Commission is studying proposals that could prevent antitrust and single market regulators from acting against companies involved in "services of general interest". Brussels authorities are also considering whether to launch new regulations to clarify the role of public services such as railways, energy, telecoms and health. The plans are at an early stage but could attract criticism that European governments are seeking to protect state-owned enterprises such as Electricité de France and Deutsche Post. Both companies have been attacked by the Commission for using government protection and subsidies to harm rivals in the private sector. An early draft of a consultative document, due to be finalised by the summer, says the Commission could present an EU-wide law on public services.

The text, seen by the Financial Times, says the law could specify "the conditions under which the provision of services of general interest is exempted from . . . the internal market and competition rules". The EU's founding treaty states that services of general interest are exempt from competition and internal market rules but fails to specify what these services are. In practice, the onus is on governments and companies to convince regulators their activities are not anti-competitive. Critics of the Commission's proposals fear that a new law would widen the scope for exemptions and make it easier for companies to escape punishment from Brussels. Such a law has been championed by the French government, which made it a condition for the partial opening of its electricity market - currently dominated by EdF - at last year's Barcelona summit.The French government and other supporters of the law argue that without protection from regulators, companies would not have the incentives to provide vital services such as post and healthcare to remote or poorer regions.
Source: Financial Times

Top Financiers Urge Action

In an implicit recognition that the global economic weakening goes beyond the potential impact of the Iraq war, the Institute of International Finance urges finance ministers to take co-ordinated action to reduce the pressure at next week's IMF meeting. Of course urging coordinated action is one thing, achieving consensus in this charged atmosphere may be another. The IIF is right though, the situation in March deteriorated significantly, and if this line continues Stephen Roach will get his double dip, the only real debate will be whether this counts as a continuation of the previous recession or a new one!!

The world's top economic policymakers should promise now to take swift and concerted action - such as cutting interest rates - if the global economy weakens further, the leading association of financial institutions said on Tuesday. The warning from the Institute of International Finance, a private sector body representing banks, fund managers and finance houses, came as a run of poor figures showed weakening confidence across the world's large economies in the period before the war with Iraq.The IIF, issuing its advice to ministers before next week's meetings of the International Monetary Fund, said the economic fragility went beyond the transitory effect of the war.

"It would be unfortunate if ministers came to Washington believing that an early end to the war would remove the need for action," said Charles Dallara, the IIF's managing director.The Group of Seven rich countries has shied away from promising a collective plan to cope with economic weakness, saying each central bank and finance ministry should concentrate on its own economy. But the IIF said challenging times called for extraordinary measures."There is value sometimes in the demonstration effect of co-operative and co-ordinated action," Mr Dallara said. The G7 should announce a bias towards monetary easing underpinned by a joint commitment to act if necessary and to flexible short-term management of fiscal policy, he said.Global financial markets appeared slightly stronger on Tuesday, with most stock markets and long-term interest rates pulling back a little from recent falls. But surveys from the US, the eurozone and the UK confirmed that business and consumer confidence had been badly dented in the run-up to the war.The widely watched Institute of Supply Management survey suggested that US manufacturing stalled in March, when its activity index fell to its lowest since the aftermath of the September 2001 terrorist attacks. The slide to 46.2 in March from 50.5 in February was sharper than most economists had expected.The Reuters/NTC purchasing managers' survey for eurozone manufacturers showed the index sliding by a higher-than- expected 1.7 points to 48.4. In France, the Insee survey of household confidence in March showed consumers at their gloomiest since 1996, when the country was disrupted by public sector strikes. In the UK, the regular Reuters purchasing managers' survey suggested the sector was beginning to contract again.
Source: Financial Times

Tuesday, April 01, 2003

UK Retail Sales Drop Sharply in March

This result frm a CBI survey is right in line with other data coming in from the UK, including the 'cooling' in the housing market.

UK retail sales fell at their highest annual rate in more than a decade in March, as consumer confidence was damaged by fears of war in Iraq, according to a CBI survey released on Tuesday. The group's distributive trades survey found 28 per cent of companies said business was up on March last year, while 41 per cent said it was down - a balance of -13. That is the worst result registered since the UK economy was emerging from recession in 1992, and the first significant fall since the start of 1999. The survey was carried out just before the start of military action in Iraq. The CBI said demand weakened across all retail sectors except hardware, china and DIY materials, where sales growth increased. Overall, sales were "well below" average for the time of year, and the outlook remained "downbeat". "These results confirm our fears that consumer confidence has been affected by uncertainties surrounding the war in Iraq, the impending tax rises and worries about the housing market," said Ian McCafferty, the CBI's chief economic adviser. The survey also comes hard on the heels of official figures which revealed that retail sales growth in February slowed to its weakest rate in more than three years, raising fears that the economy could be set for a period of below-average growth and higher inflation. Analysts said that the survey, combined with Tuesday's gloomy manufacturing PMI data, recent evidence of a cooling housing market and eroded consumer confidence linked to the war in Iraq, would likely increase pressure on the Bank of England to cut interest rates further.
Source: Financial Times

Kinnock Predicts No UK Euro Vote Before 2005

My own feeling is that I'd be surprised if the euro passes the five tests, but I'm always willing to be proved wrong. If it does, then I think the arguments used to justify the result will be interesting. Only to be expected really as an opinion since I'm not sure how much economics ol' Neil really understands, and the argument could be read as a diplomatic postponment. Still if there is not going to be a referendum before 2005, and with the problems associated with EMU getting clearer every day, I'd be extraordinarly surprised if there was a yes vote. Still the future could bring two or more surprises, the past already has. But I'm still sticking to my view: Britain won't join the euro, period.

Britain could delay holding a referendum on joining the euro until late 2005 or even 2006, according to Neil Kinnock, vice-president of the European Commission. Mr Kinnock, who has close links to Tony Blair, believes the British prime minister will still try to hold the vote in the lifetime of this parliament. But he says the "five tests" on British euro membership, due to be completed by June, will conclude that more time is needed to gauge convergence between sterling and the single currency. "I think the answer to the tests will be Yes, but when certain things have been accomplished," he said in a Financial Times interview. "I think the assessment will be positive. But what we won't have in June is Yes, and here's the date for a referendum."

Mr Kinnock rejects any suggestion that Mr Blair had contemplated holding a "khaki referendum", if a swift and successful war in Iraq had brought him a boost in popularity. "That demonstrates a complete misunderstanding of the psyche and politics of Tony Blair," he said.Instead Mr Kinnock believes that a referendum in late 2005 or early 2006 - within months of the June 2006 deadline for a general election - is the most likely scenario."It would give you just a bit of extra time to focus public opinion on the facts," he said. Mr Kinnock, the former leader of the British Labour party, retains close ties to Mr Blair, as well as to Gordon Brown, the finance minister. Many of Mr Kinnock's former lieutenants hold senior positions in Downing Street and in the government. But the EU administration commissioner says Mr Blair has not done enough to prepare British public opinion for a euro referendum. "Not enough opportunities have been taken to provide dispassionate and objective information," he said.
Source: Financial Times

From the Mouthes of Babes and Children

As has probably been noticed: I am NOT a war blogger. This is not because I don't have any opinions, but because I feel just as confused as most other people probably are, and I prefer to keep to topics that I can convince myself I know something about. However a mail I received from my son in the UK today has prompted the following from the 'out of the mouths of babes and children department'. My son, who is a medic currently studying administration of health systems is puzzled. He thinks he understands all of the arguments, but can't convince himself that either individually or collectively they explain why there is a war. Today he sent me the following which he found in his course study notes:

"too many facts can be undesirable in a vision. For example, consider the visions of Reagan and Clinton. Reagan called for military strength in the form of first-strike capabilities and the capability to prevent a first strike by others to "keep America great", paid for by 'getting government off the backs of people'.

People were eased into the cost of vague military programmes by the promise of cuts in government spending. In contrast, Clinton articulated health care reform as 'universal coverage'. This added level of specificity allowed the critics to make estimates of cost, feasibility, and what they stood to gain or lose, prompting a debate about the merits of the vision before its details could be sorted out. Reagans vision was vague in details, which kept critics at bay as these details were worked out. These examples suggest that visions with too much detail will be prematurely evaluated, which is apt to lead to failure."

You know, I think he may be right. But as he also points out, recognising this still doesn't tell you whether the war is right or wrong. It's just informative about the political process and what decision strategies may be deployed.

Monday, March 31, 2003

My New China Page

China, in Steven Roach's words, is just 'mind blowing'. It is for one thing enormous. This means that however low the level of current per capita income actually is, any change in China has direct global impact. Add to that the export oriented dimension of Chinese growth and controversy is guaranteed.

Then there is the way in which China is growing. China has an immense pool of untapped labour which can be introduced systematically into strategically situated centres of investment lead growth: the Yangtse and Yellow River deltas to be precise. At present China is exporting middle of the market consumer goods, but don't be mislead, china has nascent computer software, hardware and tececommunications industries. It plans to try a manned space flight later this year to demonstrate the reach of this ambition.

All of this growth is not without pain. Internally wages and prices in China itself are experiencing deflation as giant state enterprises throw formerly secure workers out on the streets to fend for themselves. Thus the industrial revolution in China is at the same time a huge social revolution, with, in turn, its winners and losers.

Lastly there is the old China. Not the one which is disappearing, but the one which is now being born, the one which is the inevitable and predictable result of all those years of single child families. So if industrial China now draws the benefits of its enormous supernumery population, this 'window of opportunity' will be quite short lived. By 2020 China will have the largest accumulation of old, and very old people on earth, with more than 22% of the population over 65.

So what we have is a country of extremes, extremes of opportunity, coupled with extremes of instability. It's very size guarantees that it is bound to make it's presence felt. So look out, it looks like it's going to be a bumpy ride!

Japanese Saving Moves Towards Negative Territory

I'm really not sure what importance to put on this, but it does seem in line with the idea that demographics, and the life cycle model, have something to say about what is happening in Japan. It seems to fit my picture nicely, which is why I'm cautious. There isn't going to be anything to cheer about here.

Despite a worsening income environment for employees, personal consumption has held up pretty well. Nominal employee compensation in calendar 2002 shrank by 2.4%, but nominal consumption was flat or up 1.5% in real terms. This has resulted in a notable decline in the rate of household savings. The household savings rate fell from the 14% range at the start of the 1990s to around 10% in the late 90s, and to 6.9% in 2001. Figures for 2002 are not yet available, but judging by the relevant data, we estimate that it slipped still further to about 4.3%. The savings rate based on sequential quarterly data (the 4-quarter moving average) has dropped even more startlingly. After dipping below 10% at the start of 1996, declines accelerated from 2001 to 4.7% in January-March 2002, the most recent period that can be calculated. Our estimate is that this figure was down to about 2.5% for October-December 2002, and that a negative savings rate is a possibility soon. This could happen within a few quarters, under our assumptions of an ongoing decline in disposable income and flat consumption.

Normally, the savings rate tends to rise during an economic recession, due to the tendency to suppress consumption amid rising uncertainty. Further, deflation is known to stimulate demand for bank notes and cause expenses to be put off. The classic business cycle theory suggests that the savings rate should now be rising. This makes the actual declining trend all the more alarming. We attribute this decline to (1) growth in the generation that is tapping into assets, a result of the aging of society and the increase in unemployment among older workers (the life cycle hypothesis); (2) reduced incentives to save and a growing preference for durables, due to extremely low interest rates; and (3) due to the difficulty in reining in spending after becoming accustomed to a certain level, spending is cut back, but not by enough to offset the decline in income (the habit-formation hypothesis).

Regarding (1) above, we assume the following age/life-cycle influenced consumption/saving pattern is in effect: consumers borrow when they are young and their incomes are low, save in preparation for old age in mid-life, and live off what they saved in their retirement years. The increase in unemployed older workers has played a substantial role in the decline in the savings rate in recent years. The savings rate for unemployed older workers stands at -26.0%, making it clear that savings are being drawn upon. On top of this, the decline in the savings rate resulting from the increase in unemployed older workers, in addition to being grounded in a long-term trend caused by the aging of the population, has been further exacerbated by earlier retirement age, early retirement programs and the dismissal of older workers. The percentage of households headed by unemployed aged 60 and over is conspicuously trending upward, having increased from around 12% in the early 1990s, to 19.1% in 2000 to 21.0% in 2001 and to 22.0% in 2002. Japan's population is expected to reach a peak in 2006 and then began to decline, but the fact that savings have begun to decline ahead of the population suggests greater urgency.

Regarding (2), the view that extremely low interest rates have destroyed the incentive to save is further supported by recent consumption patterns, which show that the consumption of durable goods has remained relatively strong. One incentive for holding financial assets is the function they provide as a store of value and wealth, but it is conceivable that low interest rates have diluted this "store of value" function of financial assets and thereby increased the preference for real assets. This increased preference for durables, which also function fairly well as a store of value, as opposed to regular consumer goods, could be considered further corroboration of this hypothesis. It is interesting to note that this massive shift of funds in 2002, which was sparked by both implementation of a deposit insurance cap and disappointment in investment trusts with net asset values below initial investment amounts, coincided with the period in which the consumption of durable goods was robust.
Source: Osamu Tanaka, Morgan Stanley Global Economic Forum

Japanese Intevene Heavily to keep Yen from Rising

The Bank of Japan intervened heavily in March, spending the double of what it spent in February. The only remaining question: just what would have been the yen/dollar rate without this intervention?

The Bank of Japan stepped up its efforts to prevent the yen strengthening in March, according to official data that confirmed traders' suspicions that the authorities had covertly intervened in the market for a third successive month. The BoJ said on Monday it spent a total of Y1,131bn ($9.5bn) in March through its foreign exchange account, which generally indicates foreign exchange intervention. In January and February, the bank spent Y678bn and Y513bn respectively.But strategists noted the money spent, believed to be mostly buying dollars for yen, had had little impact on the yen's exchange rate this year. The dollar ended 2002 around Y118.6 against the yen - almost exactly the level at which it was trading when the BoJ released its data on Monday.
Source: Financial Times

Japanese Industrial Production Falls in February

Japan's industrial production fell 1.7 percent in February from a month earlier on a seasonally adjusted basis, preliminary data from the Ministry of Economy, Trade and Industry (METI) showed on Monday. That was worse than a median forecast of a 0.9 percent fall in a Reuters survey of 19 economists conducted last week. METI forecast manufacturers' output -- a key component and close proxy of industrial production -- would rise 2.8 percent in March and rise 0.2 percent for April The ministry kept its assessment of industrial output unchanged from last month, saying it remains on a weak trend.
Source: Forbes Reuters

Nikkei Closes Year Below 8,000

It's not clear what consequences this will have, but it is certainly not good news.

Tokyo share prices fell below the 8,000 yen mark on Monday to close fiscal 2002's trading amid fears that the U.S. led war against Iraq will be prolonged.The sharp decline will certainly hurt the business results of many companies and commercial banks over the current business year, corporate executives fear. Firms are now legally required to report their assets' market prices, instead of face values, in their account books.The Nikkei Average of 225 selected issues on the Tokyo Stock Exchange (TSE) closed at 7,972.71 yen, down 307.45 yen from last Friday's closing index. This is the lowest closing price at the end of a fiscal year since March 1982. TOPIX, a broader index of share prices on the TSE First Section, also fell 29.92 points to 788.00 from last Friday's figure.
Source: Mainichi Shinbun

Eurozone Economic Confidence Hits Low

Eurozone Economic Confidence is at a six year low. Hardly surprising, and consistent with the outlook that the coming months are going to offer a bumpy ride.

Business and consumer confidence across the eurozone dipped to a six-year low in March, according to a survey released on Monday. The European Commission's report, mainly carried out before the start of military action in Iraq, showed sentiment fell to 97.8 in March, compared with 98.4 in February. "Such a drop in confidence has not been observed since the events of September 11," the Commission said. Analysts had predicted the index would fall in March, partly for war-related reasons. Business confidence fell to -12 compared with -11 in February, the lowest level since September 2002, while consumer confidence dropped from -19 to a nine-year low of -21. "A further deterioration in the expected developments of the general economic situation and the financial situation of households coupled with an anticipated rise in unemployment are behind the worsening of consumer confidence," the European Commission said. Consumers' expectations about the general economic situation deteriorated in all EU member states with the exception of Ireland and Luxembourg. The news of deteriorating economic sentiment coincided with official figures that suggested eurozone inflation stayed above the European Central Bank's 2 per cent ceiling for the eighth month in a row in March. Eurostat, the EU's statistics arm, said annual inflation was expected to be 2.4 per cent in March according to a flash estimate. That is unchanged from February's figure.
Source: Financial Times

The US Twin Deficits: See How they Grow

Recent news from the Iraq front can only mean that the deficit will be on the up and up. This war-related increase is already being noticed, but as Morgan Stanley's Ted Wiseman reminds us, so to is the demographic push in mandatory spending programs (like Medicare). Meanwhile as the 'soft patch' continues, tax returns go down.

As we head into the key April tax season and the budget conference committee to reconcile the different House and Senate tax and spending plans, the budget gap continues to sharply widen. Even before considering any additional fiscal stimulus, the current fiscal year budget gap already appears to be running well above our $275 billion estimate. As seen in the summary table below, in the trailing twelve months through February, the budget deficit has widened to $284 billion from the FY2002 (ending in September) deficit of $158. Tax receipts continue to fall sharply and spending to grow at a robust pace, led not only by defense but also by hefty growth in mandatory spending programs (in particular Medicare)...........

In the near term, three issues will be important in determining the ultimate FY2003 budget gap and corresponding additional Treasury supply needs -- tax refunds, nonwithheld tax receipts, and debate over additional fiscal stimulus. Of course, the pace of economic recovery will also play a key role, as will developments in Iraq. While the war has caused no clear signs of a significant immediate financing need in the Treasury's daily cash flow statements, President Bush's request for $75 billion in supplemental spending (most of which is earmarked for the current fiscal year) clearly indicates that growth of defense and security spending is likely to remain significantly elevated for some time, so there is little prospect of any relief from the spending side of the ledger.
Source: Morgan Stanley Global Economic Forum

Stephen Roach: the Global Imbalances Mantra Continues

Stephen Roach continues to pound away at his central point: the massive instability of a US centric global economy with the US 'twin deficit'. He argues that two key changes are necessary: a US current account adjustment and 'structural reform' in Europe and Japan. Since neither of these seem likely to occur, the former at least in the short term, and the latter in any way which will impact sufficiently due to long term demographic changes, the famous 'downside risks' are clear to see. Thus Roach's vision of a dysfunctional world remaining stuck looks an all too real possibility. This scenario only seems even more likely in the light of the growing US deficit problems, the fact that 'winning the peace' may turn out to be even more difficult than winning the war (ie a sustained return of confidence doesn't look too realistic), and that the global tensions which have arisen within the G7 itself may prove to have an enduring impact on global economic collaboration.

And so it may well be that a dysfunctional world remains stuck -- unwilling or unable to uncover new sources of growth and, therefore, waiting by default for yet another kick-start from the now dormant US growth engine. But that kick may be a long time in coming. Not only does America need slower domestic demand in order to narrow its current-account deficit, but it also faces the negative wealth effects of a post-bubble hangover. Consequently, a world that waits for another shot of US-centric growth may be in for a rude awakening. In my view, the days of US-centric global growth are numbered. The time has come for the rest of the world to wean itself from the American growth engine and draw on internal sources of domestic demand. A failure to do so unmasks the true flaws of a dysfunctional world -- the inability to generate self-sustaining economic growth. America has carried the world for long enough..............

.......the war in Iraq could well spell trouble for globalization. To the extent that this conflict undermines the supra-national alliances that have long bound the world together, globalization will lack the collectivism of political support that it needs for further success. That possibility, in conjunction with the potential for trade frictions arising from a weaker dollar, a super-competitive Chinese economy, and the outsourcing of white-collar jobs to nations such as India, spells tough times ahead for globalization. Moreover, the war could well push an already weakened world economy into its second recession in three years -- an outcome that would only make matters worse for globalization. In recession, nations look inward to matters of self interest. By contrast, the look outward to collective interest that globalization requires usually comes in good times.

Ironically, the feel-good case for a “victory recovery” that financial markets are craving could also exacerbate the imbalances of a dysfunctional world. That would be especially the case if the US led the way -- not just on the battlefield but also in a restarting of the US-centric global growth dynamic. Under those circumstances, America’s current-account conundrum would only intensify. A resurgence of US domestic demand would boost imports. That would provide yet another excuse for the rest of the world to stay the course of externally-led growth and defer the reforms needed for an unlocking of domestic demand. The last thing a dysfunctional world needs, in my view, is to go back to the well of US-centric growth.

It has become conventional wisdom to believe that the war is the root cause of the perils now afflicting the global economy. I don’t buy that. In my view, an unbalanced, US-centric global economy was in serious trouble long before the war in Iraq commenced. Yes, the seemingly inevitable victory will undoubtedly unleash a sigh of relief on the confidence front. But rest assured it won’t fix what ails a dysfunctional world.
Source: Morgan Stanley Global Economic Forum

US GDP Growth Confirms the Expected

The US economy slowed significantly in the last quarter of 2002, with consumption slowing and the job market weak according to data released this weak by the US Commerce Department. I guess we already knew all of this, but still it's nice to see our 'best guesses' confirmed.

U.S. gross domestic product rose at an annual rate of 1.4 percent in the final three months of last year after rising a robust 4 percent in the third quarter, the Commerce Department said in its final snapshot of fourth-quarter growth. For the year as a whole the economy grew a modest 2.4 percent, not enough to generate new jobs but a good bit better than the 0.3 percent gain in recession-bound 2001. The weak fourth-quarter reading on GDP which measures the value of all goods and services produced within U.S. borders -- was unchanged from a preliminary report released a month ago. Wall Street dismissed it as old news, with traders there fixated on the course of the war in Iraq. A separate report on claims for jobless benefits suggested businesses were reluctant to hire new workers with war clouding the outlook, although it hinted at some easing of labor-market strains and was not as bleak as most economists had expected. In addition, employment weakness pushed an index of national economic activity into negative territory in February and help-wanted ads in major U.S. newspaper inched lower, according to two other reports. "We sort of stand on the edge of recession," Goldman Sachs economist Jan Hatzius said, adding that the economy could tip into a slump quickly if hit by a shock. Hatzius said, however, that a sharp decline in oil prices as the United States launched military action against Iraq lessened chances of a renewed downturn. Consumer spending rose at a 1.7 percent pace in the final three months of last year, a sharp slowdown from the third quarter's 4.2 percent gain that reflected a big drop in auto sales, the Commerce Department said. In addition, exports plunged and imports rose, supplanting some domestic production. It said the widening trade gap shaved 1.59 percentage points from GDP growth.
Source: Yahoo News

Doha Round: No Progress in Sight

Amidst all the other gloomy news, more gloom this morning from the Financial Times on Doha. Apparently their is little hope of progress on agricultural reform before the deadline. Since Europe and the United States are the main players who need to give ground, and since relations between them are not exactly at an all time high, I suppose this is fairly predictable. It does, however, raises a question as to what other 'casualties' we might find moving forward.

The Doha global trade round faces crisis as agricultural trade negotiators are expected to fail to agree reform guidelines on Monday. This threatens paralysis in the broader World Trade Organisation talks. Stuart Harbinson, chairman of the agriculture talks, said on Friday that, with WTO members unwilling to budge from opposing positions, today's deadline for setting negotiating guidelines on agricultural tariff and subsidy cuts would be missed."It is clear that no movement on key issues is possible at this stage," he said. Trade diplomats see little prospect of any early accord as the US-led war in Iraq dominates the global agenda. Launched in late 2001, the Doha round aims at agreement between the WTO's 145 members by January 2005 on issues including cutting industrial tariffs and allowing foreign companies to provide services such as insurance and telecommunications.But an overall accord hinges on a deal to slash subsidies and trade barriers in agriculture, the most heavily protected sector in global trade and the one offering the greatest potential benefits to developing countries."Europe and America should recognise that we are better as partners, not rivals, not at odds with each other but true allies creating both peace and prosperity around the world," he will tell the British Chambers of Commerce conference. "We must strengthen, not weaken our links."
Source: Financial Times