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Saturday, May 10, 2003

What We Should Not Do

What makes economists different:

In every stage of civilization, in which the power of money has been prominent, poets in verse and prose have delighted to depict a past truly "Golden Age", before the pressures of mere material gold had been felt. Their idyllic pictures have been beautiful and have stimulated noble imaginations and resolves; but they have had very little historical truth. Small communities with simple wants for which the bounty of nature has made abundant provisions, have indeed sometimes been nearly free from care about their material needs, and have not been tempted to sordid ambitions. But whenever we can penetrate to the inner life of a crowded population under primitive conditions in our own time, we find more want, more narrowness, and more hardness than was manifest at a distance: and we never find a more widely diffused comfort alloyed by less suffering than exists in the western world today. We ought not therefore to brand the forces which have made modern civilization by a name which suggests evil.
Alfred Marshall Principles of Economics

More Accidents Waiting to Happen

This time the reference is to the European economy, to the foolhardy flirting with the deflation danger, and to the deadweight anchor role being played by Germany. And who is making the reference, why Stephen Roach, who else?

The European economy is an accident waiting to happen. Lacking in domestic demand, a sharply rising euro is crimping the continent’s main source of growth -- external demand. In my view, the combination of misguided policies, lagging structural reforms, and acute pressure on Germany leaves Europe both exposed and unprepared to cope with most shocks -- let alone the currency shock that is now unfolding. Europe needs to get its act together sooner rather than later. Steeped in denial, the risk is it won’t............

With most of Asia in deflation and US monetary authorities now sounding the alert, it’s hard to fathom the possibility that a structurally impaired Europe might be spared from this increasingly global phenomenon. If anything, the sharp appreciation of the euro makes the case for Euroland deflation all the more compelling. Yet the ECB’s stunning intransigence at its May 8 policy meeting takes the concept of denial to an entirely different level. I believe European policy makers are taking unnecessary risk when they can least afford to do so -- precisely the opposite of what is required to fight deflation. The strictures of EMU are being placed ahead of increasingly worrisome economic perils. Something has to give -- either the economy or an increasingly antiquated policy framework. I vote for the latter. Rules-based policy constraints don’t fly in an increasingly deflationary world -- especially if those rules are set with an eye toward fighting the old battle of inflation............

Obviously, it wouldn’t take much to push Germany through the deflationary threshold. That push may now be at hand. With the German economy probably contracting in the current quarter and the unemployment rate extraordinarily high (10.7%) and rising, there is every reason to expect further disinflation in this extremely low-inflation economy in the months ahead. A whiff of German deflation could be complicated all the more by the nation’s increasingly fragile financial system -- banks and insurance companies, alike. The Japan comparison is no longer a stretch for Germany. And if that’s the case, you have to wonder if the rest of Euroland has the capacity to avoid a similar outcome. As I see it, the German experience has revealed a critical and potentially fatal flaw of EMU: Without true economic convergence, it may well be that the big economies in this heterogeneous union have to be treated as special risks. If and when they are judged to be in a state of acute distress, pan-regional policies may need to be tailor-made for the weak link in the chain. The mounting perils of Germany are now screaming out for just such a remedy. Euroland’s once proud growth engine has been transformed into the deadweight of an anchor.
Source: Morgan Stanley Global Economic Forum

Commoditisation and Overshoot

Brad Delong, an economics professor at the University of California at Berkeley, puts it somewhat more succinctly: "I am optimistic about technology, but not about profits."
Source: The Economist

The Economist has an interesting survey on the IT industry. Interesting, however, is not always the same as analytically sound. This piece cited below on Google and commoditisation, for example. It is fascinating to read about what you can do on the cheap when you really try, and to see how those who really understand something about IT can extract much more value from it than end users who don't. But it also took me back to a point Joerg made in a piece I posted earlier in the week relating to NASA buying Intel chips on E Bay. The point was to illustrate the fact that the introduction of building block type products follows a non-linear path. The process needs to pass a given threshold and then it takes off. The phenomenon of technological 'overshoot' needs to be understood in this context: today's surplus-to-requirements extravagance may become rapidly converted into the foundation stone of tomorrows growth transition (that I take it is the point made being made at the end of the extract about Tetris). Innovation, in this context, forms part of an overlapping nesting system , which can branch-off in almost any direction without prior warning. This is what makes for the underlying strategic uncertainty which characterises the industry, and what makes it way, way too soon to start talking about maturation in this particular technological revolution where even the expression General Purpose Technology seems to fall well short of the mark. Remember the early Marxists already described late 19th century capitalism as in 'decadent' decline.

..........many IT firms would not be too unhappy if Google were to disappear. They certainly dislike the company's message to the world: you do not need the latest and greatest in technology to offer outstanding services. In the words of Marc Andreessen of Netscape fame, now chief executive of Opsware, a software start-up: “Except applications and services, everything and anything in computing will soon become a commodity.”.............

When the two Stanford drop-outs who founded Google, Sergey Brin and Larry Page, launched the company in 1998, they went to Fry's, an electronics outlet where the Valley's hardcore computer hobbyists have always bought their gear. Even today, some of the data centres' servers appear to be the work of tinkerers: circuit boards are sagging under the weight of processors and hard disks, and components are attached by Velcro straps. One reason for the unusual design is that parts can be easily swapped when they break. But it also allows Google's servers to be made more powerful without having to be replaced completely............

Because Google has always used commodity hardware and software, it is not easy to calculate how much money it has saved. But other firms that have recently switched from proprietary gear say they have significantly reduced their IT bill. Amazon.com, the leading online shopping mall, for instance, managed to cut its quarterly technology spending by almost $20m. The most interesting feature of Google's data centre, however, is that its servers are not powered by high-end chips, and probably will not have Itanium, Intel's most powerful processor, inside for some time yet. This sets Google apart among hot Silicon Valley start-ups, whose business plans are mostly based on taking full advantage of the exponential increase in computing power and similar growth in demand for technology.

......other “laws” of the semiconductor sector are becoming more important, and likely to change its underlying economics. One is the fact that the cost of shrinking transistors also follows an exponential upward curve. This was no problem as long as the IT industry gobbled up new chips, thus helping to spread the cost, says Nick Tredennick, editor of the Gilder Technology Report, a newsletter. But now, argues Mr Tredennick, much of the demand can be satisfied with “value transistors” that offer adequate performance for an application at the lowest possible cost, in the same way as Google's. “The industry has been focused on Moore's law because the transistor wasn't good enough,” he says. “In the future, what engineers do with transistors will be more important than how small they are.”

This is nothing new, counters Paul Otellini, Intel's president. As chips become good enough for certain applications, new applications pop up that demand more and more computing power, he says: once Google starts offering video searches, for instance, it will have to go for bigger machines. But in recent years, Intel itself has shifted its emphasis somewhat from making ever more powerful chips to adding new features, in effect turning its processors into platforms. It recently launched Centrino, a group of chips that includes wireless technology. The Centrino chips are also trying to deal with another, lesser-known, limiting factor in chipmaking: the smaller the processors become, the more power-hungry and the hotter they get (see chart 4). This is because of a phenomenon called leakage, in which current escapes from the circuitry. The resulting heat may be a mere inconvenience for users of high-end laptops, who risk burning their hands or thighs, but it is a serious drawback for untethered devices, where it shortens battery life—and increasingly for data centres as well, as Google again shows.

The firm's servers are densely packed to save space and to allow them to communicate rapidly. The latest design is an eight-foot rack stuffed with 80 machines, four on each level. To keep this computing powerhouse from overheating, it is topped by a ventilation unit which sucks air through a shaft in its centre. In a way, Google is doing to servers what Intel has done to transistors: packing them ever more densely. It is not the machines' innards that count, but how they are put together. Google has thus created a new computing platform, a feat that others are now replicating in a more generalised form. Geoffrey Moore (no relation), chairman of the Chasm Group, a consultancy, and a partner at Mohr, Davidow Ventures, a Silicon Valley venture-capital firm, explains it this way: computing is like a game of Tetris, the computer-game classic; once all the pieces have fallen into place and all the hard problems are solved, a new playing field emerges for others to build on.
Source: The Economist

And a final thought:

A measure of this increasing complexity is the rapid growth in the IT services industry. According to some estimates, within a decade 200m IT workers will be needed to support a billion people and businesses connected via the internet. Managing a storage system already costs five times as much as buying the system itself, whereas less than 20 years ago the cost of managing the system amounted to only a third of the total...........

Once thing is clear: once all the technical challenges of grid computing have been overcome, hardware will have become a true commodity. Machines, storage devices and networks will lose their identity and feed into pools of resources that can be tapped as needed. This liquefaction of hardware, in turn, will allow computing to become a utility, and software a service delivered online.

And the 24 billion dollar question is: where will these 200m IT jobs (if that is what there are) and all that grid-computing hardware be located?

Money For Nothin.......and Your Gifts For Free?

My feeling is that we are approaching what the more pretentious among us like to call a 'defining moment' in the life of the internet. I suppose it's the moment when everyone wakes up and realises that it's here to stay. Obviously this reality has always been obvious, but it is surprising how many people have been in denial about it. What we are seeing more and more of these days, are positive assessments of businesses who survived the creative destruction gale which followed the NASDAQ crash. This first started going through my head when my European conscience and alter ego Frans came back at me about Google, Yahoo and Amazon. Now I think that Frans is a really nice guy, but he's missing something important here. And like Frans, millions of others. The internet bubble was always going to burst, too much easy money is never good for anything, but after, when the dust settled, surely it was also always clear that what was left would represent the future. Little by little this is begining to dawn on people. The landscape has changed, and will continue to change. All those 'household names' which were politely congratulated for their realistic prudence in reigning-in their on-line-selves (and thus found temporary shelter from the storm: come on in, she told me........) will now have to address their future as the 'outsiders' they have become (this is already all-too-obvious in the case of Time Warner, and, mein gott, Bertellsman even went 'off-ine').

At the start of all this people would laugh at expressions like 'the death of distance' or 'the weightless economy', today they are not so sure. Clearly distance is not dead, but the dimesions of global 'space' (measured say by the number of clicks which separate us one from the other) are clearly on the down-and-down, whilst the weight of each dollar of GNP (real prices) is getting less-and-less. The much vaunted rise of global services is only one very evident indicator of this. Meanwhile the e-commerce and e-communication companies who have survived look stronger and better every day. I cited a piece from the Economist on the Yahoo's and E Bay's of this world earlier in the week, today a piece in Business 2.0 has caught my eye. Restaurant.com have reinvented a one-to-many version of the prisoners dilemna, and are turning it into a gold mine:

Two years ago, Scott Lutwak, the CEO of Restaurant.com, took his family to Puerto Vallarta, Mexico -- on a trip that felt less like a vacation than a last hurrah. As he lay on the beach, he forced himself to face reality about the floundering company he had co-founded in 1999 with $7.4 million from angel investors. "I was thinking, 'OK, let's take a deep breath, come back, and shut this baby down.'"

Before Lutwak could pull the plug, though, he learned of another failing dotcom, CitySpree, which sold gift certificates. Lutwak and his team realized that if they delivered the certificates by e-mail and stuck to restaurants, they could run more efficiently than CitySpree -- and even, gasp, make money. After going back to investors, Restaurant.com bought CitySpree at a bankruptcy auction for less than $500,000 and refocused on selling gift certificates. Now, instead of being just another nondescript dining portal, it would have its own identity as the gift certificate power seller. Lutwak then brought his clients this proposal: Let us sell your certificates from our site on eBay (EBAY). Unlike placing certificates in newspaper inserts, this campaign won't take any cash from your pocket -- we will simply keep the proceeds from selling the certificates. (A $50-off certificate at New York City's Manhattan Grille, for example, recently auctioned for $16.) Everyone, in short, sees value: Diners eat cheap; restaurants get traffic with no out-of-pocket for marketing; and Restaurant.com gets paid by customers who know exactly what they're getting -- namely, $25 or $50 off a meal -- rather than by cash-strapped restaurateurs who continually need proof of return on investment.

Lutwak and his team relaunched in July 2001, and the concept took off. Revenues doubled in the first five months. Today the company sells about 75,000 gift certificates a month at an average of about $9 each. Lutwak says the company brought in $5 million in revenues last year, is growing 12 percent each quarter, and has been profitable since the third quarter of 2002. Driving traffic with discount coupons is not, admittedly, an Internet-age breakthrough. But Restaurant.com clearly couldn't survive without the Net. By claiming a spot on eBay, the Web's largest virtual mall, Lutwak gets an audience of millions of online shoppers. By e-mailing coupons to customers, it saved the single largest cost of most conventional coupon marketers -- postage and printing. It's a model well suited for these hard times. "Restaurants have to be more aggressive to get people in the door," Lutwak says. "The big expense-account days are over. And price-conscious consumers are saying, 'I'm going where I can get a deal.'" Now they know where that is.
Source: Business 2.0

Or again, there is the case of Harris Interactive:

In 1997, if you'd polled pollsters on Harris Interactive's (HPOL) decision to bet its future on Internet surveys, you'd have found opinions ranging from highly dubious to frankly incredulous. After all, measures of public opinion depend on data that accurately reflects the general population, and Internet users aren't like everyone else. "We got called charlatans and frauds," says Gordon Black, founder and CEO of the company best known for its 40-year-old weekly Harris Poll. Then he adds: "The criticism stopped immediately after the election."

The 2000 presidential election, notable for how it confounded other poll takers, was a watershed for Harris Interactive. The company correctly predicted the vote in 36 of the 38 closely contested states. Even more remarkable, Harris was the only one to predict that the race between Gore and Bush would end in a statistical dead heat. The company's main reason for switching from the traditional telephone poll was that Net surveys are 15 to 20 percent cheaper to administer. The unexpected bonus is that they're also arguably more accurate. "People just don't tolerate phone calls anymore," Black explains. Because people have to opt twice to join Harris's database of willing Internet respondents -- first clicking an ad and then confirming by e-mail -- response rates tend to be higher than with phone polls generated by random dialing. In addition, Internet surveys are free of the biases caused by subtleties in the way telephone interviewers ask questions or prompt for responses.

But what of the biases in the sample of Internet users, who tend to be better educated and more affluent than the general population? Consumer researchers have long relied on weighting systems to correct skewed samples, but most of them believed that data collected online was simply too slanted. In 1997 a Ph.D. at Harris proposed a solution: The company could build on formulas used to make samples of high school students representative of all teenagers. At the time, the split between dropouts and students mirrored the ratio of Internet users to nonusers. Then, by simultaneously conducting hundreds of surveys via phone and Web, Harris refined the algorithm for correcting the Web's obvious biases. It also fixed some not-so-obvious ones, like Net users' tendency to be more participatory than most citizens -- more likely to vote, go to the movies, and so on. Internet surveys now account for 47 percent of Harris's $120 million business, and their efficiency helped profits double from the third quarter to the fourth, while its average competitor grew in the single digits. "Online research is one of the industry's hot areas," says Bob Lederer, editor and publisher at industry group RFL Communications. "It's costly, but Harris has a head start. Everyone else is playing catch-up."
Source: Business 2.0

I'm Sure They Have the Tools..........

John Snow let's us in on more of his 'thinking'. We already know he is maintaining the 'strong dollar policy', now he tells us there is 'no risk' of deflation in the US. I guess this is what he is paid to say, but I do wish they could find a more honest and open way of conducting policy.

Treasury Secretary John W. Snow said today that he saw no significant threat of deflation in the United States, three days after the Federal Reserve warned of a possible fall in inflation. "I don't think the U.S. has any risk of being in any significant deflationary period," Mr. Snow told reporters. Any comparison with Japan, where prices have not risen since 1998, "would be inappropriate," he said. Fed officials, including Alan Greenspan, have said that deflation is a remote possibility. Mr. Snow later told business leaders in Memphis that deflation was a "monetary phenomenon" and thus something for the Fed to address. "We have very competent leaders at the Federal Reserve, and I'm sure they have the tools to deal with it," he said.
Source: New York Times

Friday, May 09, 2003

More Bad News From Germany

Well just to round off the week late Friday afternoon, another ominous piece of data from the German front:

Concern over the fragile health of the German economy, the largest in the eurozone, mounted on Friday after industrial output fell faster than expected, casting further doubt on official growth forecasts.Industrial production fell by 1.1 per cent month-on-month in March after a meagre rise of 0.2 per cent in February, the economics ministry said. The steep fall followed a sharp drop in orders for March. Economists said the decline confirmed their view that GDP growth in the first quarter was just 0.2 per cent. The economy ground to a halt in the final quarter of 2002 and is expected to weaken in the second quarter of this year. The German government, which has forecast gross domestic product growth for this year of 0.75 per cent, will release first quarter GDP figures next week. Most economists believe the GDP forecast will prove too optimistic.
Source: Financial Times

Does This Man Never Sleep

Going back to my last post, I was actually passing through Eamonn's Page looking for a point he made about my blogs. Looking through the list of blogs in my blogroll collumn, he can't help asking the question: "Does he ever sleep? And here am I thinking that running one blog and posting every day without fail was some kind of achievement. Ah, well." I think this would be a good opportunity to clarify one small detail here. The various blogs I maintain have very different functions. Bonobo Land is my real, live, on-line Weblong (that's it: the real thing). The various other items you will find in the list (Deflation Update, Euro Watch etc) are really only a convenient on-line filing system. Useful for me to keep my material classified by topic in those areas of on-going research, and also useful for you the users, to find material on any given topic (since the majority of readers arrive at these blogs via Google and other searches, it also offers me a birds eye view of how interest is shifting between one topic and another: if it's of any value I would say that interest in China is soaring these days, whilst interest in the euro seems to be plumming the depths).

My Website is another matter. This is where I try to build up a collection of material which may have long term interest. This is a long, slow, hard process, and I am only just getting started. To steal an idea from Eric Raymond I would say that my Website is my Cathedral (long, slow, painstaking stuff, etched in stone), while the weblog is the buzz: the buzz of the net, and the buzz that's going through my head when I wake up in the morning. This is also an ongoing research programme, I am sure that as I go I will change my idea of what I am doing and why I am doing it. So everything has its role, and every role is different. However, and as a warning of the dangers involved in building Cathedrals, it should be noted that the Catalan painter and artist Santiago Rusiñol once asked Gaudi about just how long it would take him to complete the Sagrada Familia. Gaudi prevaricated, and declared himself to be unsure citing the example of the great medieval cathedrals which needed around 200 -300 years apiece, to which Rusiñol replied: 'But are you sure Christianity will still exist 300 years from now'. A good question, and a difficult one, from which one might at least deduce that building cathedrals is a difficult business in an epoch when things keep getting faster faster.

On the Welsh Character

Well I just dropped in on another Celt, Eamonn Fitzgerald , trying to follow-up an earlier point, and what did I find: Evelyn Waugh's view of the Welsh Character.

"The Welsh character is an interesting study," said Dr Fagan. "I have often considered writing a little monograph on the subject, but I was afraid it might make me unpopular in the village. The ignorant speak of them as Celts, which is of course wholly erroneous. They are of pure Iberian stock-the aboriginal inhabitants of Europe who survive only in Portugal and the Basque district. Celts readily intermarry with their neighbors and absorb them. From the earliest times the Welsh have been looked upon as an unclean people. It is thus that they have preserved their racial integrity. Their sons and daughters rarely mate with humankind except their own blood relations. In Wales there was no need for legislation to prevent the conquering people intermarrying with the conquered ..."
Source: Eamonn Fitzgerald's Rainy Day

On the Use and Abuse of English

Brad has picked up on my earlier post about the extent of 'externalities' associated with having or being an English language speaking community. Now maybe it's worth clarifying a few points here. My argument is that in the information age the principal systems of information transfer involve either a scientific language (like mathematics) or a natural one (like English). Many people in the world have to invest significant quantities of time and money in acquiring the requisite language skills, others are born with them as part of their immediate environment, this latter situation has to offer a distinct evolutionary advantage. The painful consequences which can accompany this reality may have been brought home earlier this week to those of my readers who tried to follow my link to Frans in Holland. There they will have found that Frans informs us that he has only one page in English since, among other things, he wishes to encourage the use of the Dutch language. This extremely laudable aim is, at the same time, an extreme limitation. A limitation which I imagine places Dutch bloggers at a considerable disadvantage.

But recognising this is not the same as arguing that we should not all respect each others languages and cultures: far from it. I was born in the UK, in Liverpool, in a home where my mother and all her relatives habitually conversed in Welsh. In fact all my grandparents (in an epoch now buried deep in the mists of historic time) were Welsh immigrants who had settled in a Liverpool which then was (to quote the Dubliners) the second capital of Ireland, and which was, like the Emerald Isle itself, bitterly divided by internicine religious sqabbles. I went diligently every Sunday to Chapel to learn my ancestral language, and I have never regretted the fact. Diversity is not backwardness. In a Europe of vested nation state interests we Celts form a virtually stateless continental minority, under-represented and little appreciated, but we are at the same time a constant source of creativity and imagination. That is to say difference is also valuable. Today I live in Spain, and in my home we speak both Spanish and Catalan. What I fail to appreciate is the kind of 'difference culturelle' represented by the nationalism of the major European states. As I tend to say on my (numerous) visits to France: I am sorry, I have the inconvenience of speaking one language which you probably consider too big (English) and another one which you certainly consider too small (Catalan). The irony is that since, all too often, they speak neither, I have to explain this in French. Let's forget the hypocracy shall we, and get on with building a better, more prosperous world.

The Rise and Rise of Japanese Bonds

With the yen rising, and the deflation outlook predicatbly worsening, investors are digging in for the winter and buying bonds. The consequence: the yield curve is now just about horizontal as far as the eye can see, and the thirty year return is now below !% for the first time in history. Thos who would shift 'expectations' seem to have a lot of heavy lifting in front of them.

Japan's 30-year bonds rose, driving yields below 1 percent for the first time, on expectations among investors that yen gains will fuel deflation. Yields on five-year notes, 10- and 20-year bonds all fell to records on concern the yen's 2.1 percent gain against the dollar in the past month will slow exports and growth. ``I'm more bullish on bonds than I was a month ago,'' said Yoshiaki Murakawa, who manages the equivalent of $2.56 billion at SG Yamaichi Asset Management Co. ``The strengthening in the yen is good for bonds.'' ................The yen rose as high as 116.01 against the dollar yesterday, its strongest since July 24. A stronger yen pushes down import prices, adding to deflation and the value of bonds' fixed payments. It traded at 117.29 compared with 117.10 in late New York trading yesterday. The Bank of Japan on April 30 said it expects between 0.4 percent and 0.5 percent deflation in the fiscal year started April 1. Prices for consumer goods excluding fresh food haven't risen since April 1998...............

``Deflation will continue and investors will keep buying bonds,'' said Toshifumi Sugimoto, a general manager of investment trust marketing at Meiji Dresdner Asset Management Co., which manages the equivalent of $256 million in trust funds.Debt in the world's largest government bond market also gained after the government said yesterday its index of leading indicators fell below 50 percent for the first time since October, signaling an economic contraction may follow in three to six months. Japan has the largest government bond market in the world with 527 trillion yen in marketable securities, or $4.5 trillion, outstanding at the end of September, compared with the U.S. government's $3.1 trillion. The index, which measures job offers, consumer confidence and other signs of future activity, fell to 20 percent in March from 54.5 percent in February, the Cabinet Office said. ``It doesn't look like the economy is going to get better in the near future,'' said SG Yamaichi's Murakawa. ``There isn't anything on the horizon to push up bond yields.'' Michael Jansen, a market strategist at National Australia Bank, said in an interview on Bloomberg Television that 10-year yields may fall as low as 0.4 percent.
Source: Bloomberg

On the So-Called Sars Paradox

Here's a really good example of a really bad argument. SARS, apparently, is good for you, economically speaking. Why? Because if SARS means that the supply lines to China are cut, then this will be inflationary as supply fails to live up to the needs of demand. You see, every cloud has a silver lining.

Or does it? Let's think about this for a moment. On this argument the Iraq war, and the rise in petrol prices, was a plus. But it wasn't was it. I mean if the problem was to create inflation however, well we could all pick up spanners, go out and unbolt some of those precious petro-ducts, and bingo, the true technical solution......... Now why wouldn't this work. It wouldn't work because productivity isn't a bad thing, it's a good thing. The problem is not too much productivity, but too little growth. The fix we need involves unblocking the the structural imbalances which are a brake on growth - and in my book the main one of these is having a global population which is too old in the developed countries and too young in the developing ones. Cutting off supplies won't help here. In any event this would only be even more deflationary inside China, and hence even more deflationary for the rest of the planet once the supply resumes.

There is a second bad link in this argument, and that is the idea that it is the growth in China itself which is producing the problem. The extraordinary growth which is taking place in China is a product of US overcapacity and lack of pricing leverage, not the cause of it. Here Stephen Roach is undoubtedly right. China is growing because global corporations are franically looking for ways to cut costs in order to maintain momentum. Without China thinks would only be even worse. If you're climibing Everest and feeling scared, it's best not to look down. The only way forward is up............

Call it the SARS paradox: while the killer disease is set to depress prices across Asia, it could have the opposite effect globally and so help allay growing fears of deflation in the United States and Europe. Anecdotal evidence suggests the spread of SARS has so far had little impact on the Asian factories that form the critical links in global supply chains. But as long as the outbreak goes unchecked in China, the point of final assembly for a plethora of manufactured goods, economists see a risk of output disruptions that would push up prices worldwide of everything from toys to televisions. "If you really do have low-cost China no longer being a major supplier, even for a temporary period, that may actually have a positive ripple effect on inflation in the rest of the world," said William Lee, the International Monetary Fund's representative in Hong Kong.Apart from Motorola Inc's closure of its main office in Beijing, the impact of Severe Acute Respiratory Syndrome on multinational corporations has been conspicuous by its absence.

Economists worry, though, that exports will start tailing off if foreign engineers are unable to travel to China to rejig production lines. A failure to prevent SARS spreading to the Chinese countryside is another fear. "Disruption to China-based factories could cripple some Western companies and trigger surging prices for certain products, particularly PCs and related IT equipment," Richard Martin, managing director of International Market Assessment Asia, said in a report. Such an effect, though not the cause, would probably be welcomed in industrial countries worried about following Japan into a deflationary spiral. China's role as price-setter for a growing array of goods in a world glutted with supply is sure to be on the agenda when Chinese President Hu Jintao attends a forum on development issues with the Group of Eight leading nations in France next month. SARS was not detected until mid-March, so it is too early to deliver a verdict on the disease's economic impact on Asia.Beyond decimated sectors such as tourism and restaurants, though, data paint a picture of resilience. Singapore's purchasing managers' index, for instance, edged up in April even though it remained below the no-growth threshold.

Still, economists remain cautious. "The signal we got from the Singapore PMI, though encouraging, is simply not enough to relieve the global anxiety over the potential for the production chain to be disrupted," said David Fernandez of JP Morgan Chase. Whereas a supply-side SARS shock remains only a possibility, the impact on Asian demand and thus on inflation is all too real. Deutsche Bank expects consumer prices in China to rise 0.6 percent in 2003 assuming SARS is contained in three months. But an outbreak lasting nine months would result in deflation of 0.4 percent. Prior to SARS, Citigroup economist Joe Lo expected prices in Hong Kong to fall 1.5 percent this year. His forecast now is two percent. Although the tumbling U.S. dollar should push up prices because of Hong Kong's peg to the U.S. currency, Lo said demand is so weak that retailers cannot pass on higher costs. "The SARS shock will extend and deepen Hong Kong's deflation trend," Lo said.
Source: Forbes

Complicated Brain Gymnastics

Seeing the damage that was clearly being done, another of the savants, Otmar Issing, has emerged from the closet to clarify: the key phrase 'close to - but below - 2% should give a 'sufficient margin to guard' against the deflation risk. Of course, the fact that this 2% is an aggregate (of somewhat dubious propriety), and that some countries (Germany, Italy...) are already significantly below that magic number and falling, this detail does not seem to merit too much attention.

The threat of deflation in Europe prompted the European Central Bank on Thursday to soften its inflation objective and redefine its monetary policy strategy. In a move that economists said raised the likelihood of lower interest rates in the future, the ECB said it would aim in future for an inflation rate of "close to - but below - 2 per cent".Its previous formal objective had been simply to keep inflation at 2 per cent or less...............

The ECB took no action on interest rates as a result of its new strategy, leaving its main rate unchanged at 2.5 per cent. The decision to leave rates on hold was widely expected, but the steep rise in the euro to a four year high against the dollar had fuelled hopes that the downward pressure on inflation might encourage the ECB to cut rates. Ken Wattret of BNP Paribas said: "I think the ECB view is that deflation may be a problem, but not in the euro area. I get the impression that the ECB has not really taken in the implications of the rise in the euro." The euro hit a four-year high of $1.1506 on Thursday, up 1.25 per cent from Wednesday's New York close, before falling back in late trading.

Mr Issing said the changes to the ECB's strategy would not lead to a change in policy, insisting that past rate decisions would not have been any different if the clarification had been in place earlier. Nevertheless, economists said the change represented a significant shift for the longer term and could lead to a bias in favour of lower rates. David Walton of Goldman Sachs said the review would bring the ECB's declared strategy into line with its interest rate decisions. "I think they should be commended because they've used this as an opportunity to formalise in words what they've been doing in practice," he said. "They will be aiming at inflation of close to 2 per cent, but you can't keep inflation precisely at that level."
Source: Financial Times

Euro Rise: Not Significant,...........But a Problem For Business?

This is Pedro Solbes' appreciation of the situation as the common currency seems to continue its upward climb without restraint. As I indicated yesterday, probably the main legacy of the war is that no-one would believe the ECB had the capacity to stop the dollar's fall if that fall were being pushed by a deflation consciouss US government. So maybe the best policy they can see is put up and shut up. The question is one of credibility, and right now Brussels and Frankfurt have very little indeed. Even so, what is a problem for business today will reach the rest of us tomorrow. It's the complete bankruptcy of the thing that gets to me. While everyone is busy congratulating the Fed on seeing the danger coming, on 'letting us in on the conversation', on preparing the 'unconventional tools', the ECB is still in denial: we are still talking about a further reduction in inflation being beneficial and liable to promote growth. It seems that the time the ECB spokesmen don't use excelling themselves Byzantime obscurantism, they seem to idle away testing the limits of absolute folly.

I am not, in principle, convinced as to the workability of the euro. But if I was, then I would be looking to see a serious effort made to make it work. This would involve a real call to arms from the Central Bank and the Commission. It would involve an open recognition that the flagship, the titanic of the fleet, was in danger, and that its was hands-on-the-pumps time all round. This is the time to show that level of mutual solidarity that is considered so necessary to make the euro work. The smaller, peripheral economies need to be prepared for sacrifices (or did they think it was all about drawing down money from the structural funds?). Maybe near zero interest rates would provoke dangerous inflation in Spain, Greece and Portugal, but if Germany sinks into the deflation mire, and the 'unconventional tools' come out, the damage is going to be far, far worse. Or are we not prepared to think about the unthinkable?

The euro hit a record high against the yen in Asian trade on Friday as its appeal as a yield earner, after the ECB kept eurozone interest rates on hold, gathered momentum. The single currency rose as high as Y135.26 against the yen, after closing at Y133.57 over night in New York.In early European trade the single currency was at Y134.83. Against the dollar the single currency hit a new four-year high of $1.1537 before falling back to stand at $1.1505 after closing at $1.1451 in New York on Thursday. Gains for the euro were, in part, fuelled by comments after the European Central Bank's rate decision by governor Wim Duisenberg. Mr Duisenberg said that the ECB was not alarmed and that current levels were not excessive.Pedro Solbes, the EU's monetary affairs commissioner, echoed Mr Duisenberg's comments overnight, saying that the level of the euro was not significant. He voiced concerns however, that the currency's rapid rise was a problem for businesses.
Source: Financial Times

Thursday, May 08, 2003

The Man with Feet of Clay Does it Again

This could be one for the record books, 45 minutes after Duisenberg described himself as 'comfortable' with the euro's recent rise the currency broke the $1.11 level and shot up to $1.14, to be closely followed by next months German unemployment figure if things continue this way. Won't he ever learn that if you've got nothing useful to say it's better to keep your mouth wide shut.

The euro jumped to new highs against the dollar on Thursday after Wim Duisenberg, head of the European Central Bank, signalled his ease with the currency's recent strong rally. Earlier, the bank decided to hold interest rates steady.At a press conference following the bank's policy meeting, Mr Duisenberg said the euro was now trading around its historical average and that its current levels were therefore not excessive.The single currency leapt to a high of $1.1486 against the dollar, breaking decisively through its previous high of $1.1437, as Mr Duisenberg made the comments. The euro was at $1.136 ahead of the decision.Mr Duisenberg struck a relatively hawkish note at the conference giving further support to the euro. The bank head said current monetary policy was conducive to stability in the medium term and that the ending of war had removed many of the downside risks to the economy. Economists had expected a more dovish speech to prepare the market for a rate cut at the ECB's next meeting in June.
Source: Financial Times

Nero Fiddles...................

The European Central Bank and the Bank of England kept interest rates unchanged as policy makers wait for signs that rate cuts this year are sufficient to spur an economic recovery. The ECB left its benchmark rate at a 3 1/2 year low of 2.5 percent. The U.K. central bank kept its rate at 3.75 percent, the lowest since 1955. Most economists surveyed by Bloomberg News expect lower rates next month. Lucas Papademos, the ECB's vice president, is among officials to predict growth in the dozen euro nations will rebound in the second half. In Britain, the pound's 8 percent slide against the euro this year may help manufacturers struggling to recover from the worst slump in a decade, by making exports less expensive. ``Rate cuts have been postponed, but only postponed'' said Holger Schmieding, an economist at Bank of America in London and former adviser to the International Monetary Fund. ``For the Bank of England the currency move means there's little harm in waiting. The ECB has missed an opportunity'' to cut rates. Stocks extended their decline. The Dow Jones Stoxx 50 Index fell 1.7 percent to 2298.5 at 1:51 p.m. in Frankfurt. The yield on the 3 percent German government note dropped 2 basis points to 2.25 percent. A basis point is 0.01 percent.
Source: Bloomberg

............................While Rome Burns

Germany was facing the threat of another recession on Wednesday after manufacturing orders fell sharply and unemployment climbed for the 13th successive month. The steep 3.9 per cent month-on-month drop in orders for March, far more than the most pessimistic forecasts, and the jump in unemployment to its highest April level since unification put paid to lingering hopes of an upturn. The numbers even fuelled concern that the fragile German economy, the largest in the eurozone and the third-largest in the world, could slide into recession for the second time in as many years. Germany saw a shallow recession, technically two successive quarters of contraction, at the end of 2001. Economists said the figures were "catastrophic" and would exert more pressure on the European Central Bank to cut interest rates when it meets in Frankfurt today. Bank officials have so far played down market hopes of a cut in its primary interest rate.

But Europe's economy was "on its back. . . there has been no Baghdad bounce. . . no postwar rebound," said Ken Wattret of BNP Paribas. "The ECB seems to be biding its time - but you should never say never in an environment like this." Economists said the weakness of the eurozone and the relentless rise of the euro argued for a cut. The ECB last cut rates in March by a quarter-point to 2.5 per cent. The fall in orders, an important but volatile indicator of future economic developments, was led by a 5.6 per cent drop in domestic demand, the second-biggest decline since the data series began in January 1991.Foreign orders fell 2 per cent after falling 4.2 per cent in February, raising fears that the surging euro is curbing export growth. Jacques Cailloux of Barclays Capital said Europe's largest economy was "now flirting" with renewed contraction. "Falling domestic and external demand is a lethal combination for the economy." Many analysts expect the German economy to contract in the second quarter after marginal growth in the first.

Last week the Berlin government cut its gross domestic product growth forecast for 2003 to 0.75 per cent from 1 per cent. But most market economists think even that is over-optimistic.The bleak outlook was reinforced by a 44,000 rise in seasonally-adjusted unemployment to 4.46m, roughly 10.7 per cent of the workforce and a sharp rise in insolvencies for January. Some economists fear unadjusted unemployment could reach 5m by the winter. Government officials said the latest jobless figures highlighted the urgency of reforms needed to cut crippling non-wage labour costs and improve German competitiveness. But Chancellor Gerhard Schröder's plans to cut unemployment benefit and loosen job protection face stiff opposition from leftwingers in his Social Democratic party and the trade unions.The federal statistical office said insolvencies soared by 42 per cent year-on-year in January to 8,158. Company insolvencies rose by 19.2 per cent.
Source: Financial Times

No Comment

The Fed: Letting us in On the Conversation

I'll let Morgan Stanley's Dick Berner initiated the non-initiated into the deeper mysteries of FOMC decision interpretation. As he says the Fed has improved enormously over the years: would that the monthly 'dialogue for the deaf' that seems to pass for policy explanation over in Frankfurt were to do the same.

Two decades ago, Fed watchers were like members of the Army Signal Corps, furiously trying to break the code of the Open Market Desk. Today, the Fed lets us in on the conversation, as the Fed's numerous advisory panels attest. Those small groups may be more privileged than others are, but the Fed has its own version of Reg FD. Officials regularly and freely communicate their views about the economy and policy, so all market participants can weigh the risks surrounding policy choices on an ongoing basis. Announcing policy changes, the rationale for them, and how members voted immediately following each meeting has helped all market participants understand policy intent. Now that the Fed has clarified its intent and game plan, policy has a better chance of success.

The new Fed statement vastly improves on the old model in three ways. First, it separately identifies two medium-term “balances of risks,” one for growth and one for inflation. The old statement implied that there was a longer-term trade-off between them, but neither the Fed nor most economists think that such a long-term trade-off exists. So most market participants interpreted the statement as a gauge of the FOMC's short-term policy bias. In a world dominated by demand shocks, this statement was adequate, because the trade-off seemed to work. But it was inadequate for a world in which supply shocks -- like a surge in productivity or a post-bubble reduction in inflation expectations -- are at work. Separating the medium-term risks for growth and inflation clearly identifies the benchmarks for policy action, but does not commit to any near-term change in policy.

The second improvement involves a step toward reinstating a policy bias. The Fed had been trying to get away from stating that bias because it legitimately did not want to commit to a future policy action. Hence the “balance of risks” was born. But the FOMC understandably was ambivalent about whether the statement should appraise risks for the economy or be an announcement about policy bias. That's because it really wanted to convey -- and should convey -- some of both. However, trying to convey two messages with one statement in November of last year exposed the weakness in the formula. The FOMC shifted to a neutral risk assessment when economic weakness and lower inflation were the dominant risks. Officials were concerned that financial markets would overreact and wanted to tell market participants that the change was a one-off insurance move.

Officials haven't quite fixed this flaw. The latest statement says that, "taken together, the balance of risks to achieving [the FOMC's] goals is weighted toward weakness over the foreseeable future." Every headline and most analysts saw this as a bias toward ease, with a weak economy the trigger for action. That blurred slightly the Fed's masterful separation of growth and inflation risks. In my view, the Fed should eliminate this blurring; officials should be willing to say whether policy is north or south of equilibrium. The recent statement could have said, "Taken together, the balance of risks prompted the Committee to adopt a directive that was biased toward a possible easing of policy going forward." And officials could have made it clear that, as they stated on October 5, 1999, the "directive might not be a commitment to near-term action." To clarify policy intent, I think the Fed should speed up the release of the minutes of the FOMC meeting, to the end of the second week after the meeting. If it does so, it can leave most of the nuances for that document.

The third and most important improvement in the statement is that in an era of price stability, it marks an important step toward targeting inflation. Fed Governor Bernanke recently spelled out the benefits and costs of such a move (see his "A Perspective on Inflation Targeting, March 25, 2003). I agree with Bernanke that such a step, with or without a numeric inflation target, clarifies the Fed's policy framework, so that officials have clear guidelines for action. I also agree that it makes policy goals easier to get across to the public at large, which increases the odds the Fed will achieve them.
Source: Morgan Stanley Global Economic Forum

'Tradeable' Non-Tradeable Services

In yesterday's post Stephen Roach was once more eulogising about the growth (and deflationary) potential of services outsourcing. He now has a two part story: manufacturing in China and services in India (and Ireland??? - what no-one has quantified yet in all this is the language-based externality attached to being a country with a large English-speaking community. By the way what about South Africa in this context?). I think there is a third part of the picture he is missing. Services now constitute around 70% of the US economy. One part of this is inherently immobile, the labour intensive, people oriented services component: social services, elderly care, health system, cleaning services, security guards etc. But don't worry, labour market globalisation has a solution: immigration, legal or otherwise. Now what was it we were saying about the modern industrial economy being global deflation resistent due to the high proportion of non-tradeables...............?

Globalization is a third leg to the deflation stool. In its early stages, globalization is mainly about new increments to global supply. Courtesy of trade liberalization, rapid dissemination of new technologies, and market-driven structural reforms, low-cost, high-quality production platforms are expanding rapidly in nations like China. As trade barriers come down, worldwide prices of tradable goods converge on the lowest common denominator -- an inherently deflationary transition.

The big surprise is that a similar phenomenon is now playing out in “non-tradable” services. Deregulation of once sheltered services industries is now global in scope, transforming administered pricing into market-driven pricing for this vast segment of economic activity. Moreover, courtesy of a surge of cross-border M&A activity, huge multinational service providers now span the globe; as a result, service enterprises are operating more and more with global rather than local supply curves. Finally, there’s the impact of the Internet. With the click of a mouse, increasingly high-value-added services can be extracted from white-collar outsourcing platforms in India, China, and even Ireland. Once shielded from global forces, service sector pricing is now feeling competitive pressures quite comparable to those shaping the tradable goods sector.
Source: Morgan Stanley Global Economic Forum

Our Little Pot of Gold

Looking at the curve on my blog statistics recently it's obvious why five or six years ago people started to take internet-based growth potential extremely seriously. Then came the crash, and everything went quiet, and now slowly, little by little, things have started to pick up again. One day soon some people are going to turn round and notice: the universe has changed. The Economist, for once, is getting things right.

THREE years after the dotcom delirium reached its peak, investors are once again taking an interest in online businesses. This week’s purchase of LendingTree, an online mortgage and loans exchange, by Barry Diller, one of America’s best-known media moguls, is just the latest in a string of acquisitions marking his shift from Hollywood to Silicon Valley. At around $720m, the price paid for LendingTree—in shares of Mr Diller’s USA Interactive (USAi)—represents a premium of more than 40% over the current share price. More broadly, investors are starting to sit up and take notice as the revenues of a select group of online survivors soar and the e-business they do becomes part of the mainstream.

The carnage surrounding the dotcom bust has been so bloody that at times it has seemed like the sector was done for good. High-profile internet companies like Webvan went bust, bringing down with them other internet stars. As investors woke up with a thumping hangover, it suddenly dawned on them that the web would not, after all, change everything: customers saw it as a useful distribution channel but that would not necessarily translate into lots more sales for e-savvy companies. For many firms, the internet meant spending a lot of money on setting up new operations while waiting for a revenue boost that might never materialise. But it is now clear that the web gives a compelling advantage to some types of business, hence the continuing rise of firms such as eBay, Yahoo! and Amazon. Mr Diller is trying to assemble an internet marketplace that can rival these surviving giants............

Mr Diller has hinted that he may sell the poorly performing Home Shopping Network, a television channel, as part of an attempt to raise USAi’s valuation closer to the levels enjoyed by Amazon, Yahoo! and eBay. All three internet survivors have been among the best stockmarket performers over the past year (see chart). Shares in Amazon, which started life as an online bookseller, and which has expanded into videos, DVDs and the like, have risen fivefold from their 2001 low point; eBay has gained 40% this year, and Yahoo! has jumped by a half.

All three have turned in financial performances that have pleased Wall Street, even if profitability still lags robust revenue growth. Last month, Yahoo! announced a 47% rise in first-quarter revenue, and net profit of $46.7m. It is now forecasting that revenue for the year will be above $1.22 billion, higher than previously expected. Many analysts think Yahoo! has Terry Semel, its newish chief executive, to thank for this revival. Mr Semel has changed the site to make it more attractive to advertisers, while adding new job listings and other fee-based services. Following the collapse of online-advertising rates and volumes, internet businesses have been struggling to find a way of making users pay for online services. Even Yahoo! can still only manage to get about 1% of its 200m-plus customers to pay for such services.

Amazon is still losing money, albeit less than before: its loss for the first quarter of this year was $10m, down from $23m for the same period last year. Revenue was up by 28%, to $1.08 billion. The Seattle-based retailer has built sales on the back of discounts and promotions, most notably a free-shipping offer that applies to sales above $25. But this is a costly promotion: altogether, distribution currently costs Amazon $27m more each quarter than it receives in shipping fees from customers.

EBay, the world’s leading online auctioneer, has a business model that unequivocally works better on the internet. Thanks to a host of clever search features, it can match up sellers and collectors of even the most esoteric items. And because of its smart cost and revenue structure—it charges a modest commission on each transaction and does not store goods itself—eBay has been one of the most consistently profitable e-commerce businesses. In the first quarter, its net income more than doubled, to $104.2m, on revenues of $476m. This was partly due to eBay’s acquisition of PayPal, a payments business, last year, though even with the effects of that deal stripped out, underlying sales were up by 56% over the previous year. One of eBay’s greatest strengths, however, is also one of the biggest risks it faces. Its business, like any marketplace, is a natural monopoly, and so once it is established, it is pretty hard for a newcomer to challenge it. This has already aroused the interest of America’s Department of Justice. Its trustbusters took no action after an investigation a couple of years ago, but some think they will be tempted to take another look as eBay expands.

But eBay and the other dotcom survivors still have some way to go before they reach the sort of valuations they enjoyed during the first internet boom: they are currently trading at levels far below their peaks. However, they are also all trading at levels well above the rest of the market. EBay, Yahoo! and Amazon shares are priced at between 67 and 80 times earnings, compared with a current stockmarket average in the twenties and a post-war average of around 15. Have investors finally found the internet’s real pot of gold? Perhaps, but they would do well to remember what happened after the railway fever of the 19th century: the industry had to endure three busts before investors made any serious money.
Source: The Economist

Beware the Bogeyman Cometh

Nothing especially outstanding about this piece: except that it's being written that is. The Yahoo economists are up to the mark again!! (This is only meant as a scarcely veiled hint to those at the Economist to get their act together, and to those taking the decisions at the ECB to start reading Yahoo News - of course, I forgot, we Europeans tend to laff at Yahoo for their 'failed business model, and 'inability to make money', ha, ha ,ha). But don't miss the Ari Fleischer comment: the WH is 'studying Federal Reserve thinking'. Now you can read into this what you want, but since they're also saying the strong dollar policy is still in place, you have to imagine that they may be playing some of their cards extremely close to their chest (remember my responsible 'irresponsibility' argument, if you watch carefully you'll see the bit where they switch horses under the cowboy).

The fear of falling prices -- the boogeyman that has crippled Japan since the early 1990s -- has come to haunt the U.S. Federal Reserve. After months of worry about sluggish growth and mounting job losses, the uncertainty of war and tepid business spending, the central bankers who steer the nation's monetary policy admitted concern about deflation. The Fed signaled after its policysetting meeting on Tuesday in a brief but unusually complex statement that it stood ready to cut interest rates, if needed, to prevent an "unwelcome substantial fall in inflation." It was the second such warning, but the first to appear in an FOMC statement. Fed Chairman Alan Greenspan last week flagged the problem of slowing price rises when he testified before the House Financial Services Committee.

Few analysts believe the risk of falling prices in America is anywhere near that facing Japan, which has struggled for a decade with the self-reinforcing horror. The Fed on Tuesday said low interest rates, falling oil prices, strong consumer confidence and strengthened debt and equity markets should foster improved growth "over time." However, analysts cheered the Fed's shift in focus to -- and saber rattling against -- falling prices. They said these warnings were not designed to frighten American investors but to reassure them the Fed is on the case and interest rates will stay low, allowing investors the lowest possible borrowing costs for long enough to get the recovery rolling properly. "They're just saying that inflation is too low now, rather than too high," said Goldman Sachs chief economist Bill Dudley. "And that means we want growth, and we want growth to be strong enough to push inflation up and we're not tightening monetary policy for quite a long time."

The White House on Wednesday joined the chorus of concern, saying it, too, would be watching prices. "Administration officials are studying the Federal Reserve thinking on this matter," White House spokesman Ari Fleischer said. "This is one of many areas in the economy that get reviewed on a regular basis." According to the Fed's preferred measure of price rises, inflation rose at an annual rate of just 0.9 percent in the first three months of 2003, a sharp slowdown from the 1.5 percent increase in the fourth quarter of last year. Prices have not increased so anemically since the third quarter of 2001, when the attacks of Sept. 11 brought economic activity to a near standstill. While lower prices may please shoppers, slowing price increases, or disinflation, can quickly turn to deflation -- when falling prices drive manufacturers to bankruptcy.

For the last year, factory owners and retailers have seen the prices they can charge for goods like clothing and cars sink steadily, while the cost of making them continues to rise. With their profits under increasing pressure, businesses have laid off workers and curbed investment in plants and equipment -- the very sort of business spending central bankers have been hoping will boost overall economic growth. "It's a vicious circle," said Sal Guatieri, senior economist at Bank of Montreal/Harris Bank. "People keep deferring their spending, which contributes to further economic weakness and further downward pressure on prices, and price expectations continue to fall. And when you believe that prices will continue to fall, you defer spending."
Source: Yahoo News

Nikkei Drifts Lower as Yen Rises

The Japanese markets are drawing the logical conclusion from the weaker dollar: less exports, less profitability, weaker 'recovery' etc.

Tokyo stocks were lower in midday trade on Thursday as the shares of the country's largest exporters tumbled, after the dollar fell to a 10-month low against the yen overnight. The benchmark Nikkei 225 average was 0.7 per cent lower at 8,055.13, while the broader Topix index was down 0.5 per cent to 818.58. The dollar fell to a low of Y116 against the yen in the aftermath of the US Federal Reserve's signal about the risks of deflation. The White House reiterated that its "strong dollar" policy was unchanged but economists said market sentiment towards the currency remained weak. The dollar recovered a little ground in morning Asian trade to Y116.5 from its Y116 low, but shares of Japan's leading exporters - many of which derive the bulk of their revenues from overseas markets - were broadly lower. Sony lost 2.5 per cent to Y2,890 and Canon was down 2.7 per cent to Y4,780. Shares of Toyota, which is set to announce its annual results after the market close, were off 1.3 per cent to Y2,745. Honda was 1.7 per cent lower at Y4,040 and Nissan was 0.6 per cent lower at Y320.
Source: Financial Times

Yen-Dollar: Japan Loses No-contest Test of Strength

Just a snippet from Reuters about yesterday's yen-dollar no-contest to illustrate what I have been saying in earlier posts.

The dollar hit a 10-month low versus the yen on Wednesday in a rapid sell-off that tested Japan's resolve to protect its vital export sector by keeping its currency weak against the greenback and the euro. "I think the fear of intervention is keeping the dollar above 116 yen at this point," said Larry Brickman, currency strategist at Bank of America in New York.In January and February, Japan's central bank intervened by selling yen for dollars, catching many investors off guard. On Wednesday traders said they could not detect intervention by Japanese authorities to stop the sharp dollar decline, which makes Japan's exports less competitive on the world market. "We do think intervention risks are significant given the pace of the dollar/yen fall," said Rebecca Patterson, global currency strategist at JP Morgan in New York. She said the lack of comments from Japanese policymakers on the yen's strength has emboldened shorter-term investors to sell the dollar. At the same time comments this week from U.S. officials supporting a strong dollar policy did little to slow the dollar sell-off, and some analysts were calling them hollow. The dollar fell as low as 116.10 yen on Wednesday before trimming its losses to trade at 116.41 yen, a loss of 0.85 percent from Tuesday's New York close. The euro was also affected by the silence surrounding the yen's strength, falling 1.66 percent against the Japanese currency to trade at 132.20 yen .
Source: Reuters News

Is There a Way Out?

War, uncertainty, and disease are a tough combination for any economy. But for a stalling and vulnerable global economy, this confluence of shocks hurts even more. The result could well be a weak recovery or the world's second synchronous recession in three years. This could be a critical tipping point for a low-inflation world that is already on the brink of outright deflation. Is there a way out?

Such is the question that Stephen Roach asks us today. The problem is now on the table for all to see. The global economy is not growing fast enough to keep pace with all that increased capacity. This means only one thing: deflation. So what is the remedy. For Stephen this is clear enough, forced by the pressures of a high currency the 'ancien regimes' of the planet will reform. As I keep indicating, this is unlikely (see last post below). Is there a way out: there has to be. Can we see it clearly yet: I'm sorry my answer has to be no. I think we are all going to have to live through a period of more or less complicated re-adjustment. I would say that this is my most important difference of opinion with Krugman and Roach (Brad has really still to pronounce!!). Paul says 'push this button', I say maybe, but if that's all you do you won't fix it. These are uncertain times, and the uncertainty isn't only in the forecasting, we have strategic uncertainty in a more profound sense. Remember we haven't been here before, history and theory can only take us so far. As I keep saying, I personally refuse to speculate much farther forward than 2005, the degree of uncertainty is just too big. Is this a weakness: I don't think so. As someone once said, the first step for getting from here to where we want to be is coming clean on what we don't know. After all if I was claiming to tell you everything that was going to happen, now life would be boring, wouldn't it.

Finally Roach allows his mind to wander over what might happen if the 'cure-all cure' doesn't work. Fissures in the globalisation process. Here he may have more of a point, but I'm not totally convinced, perhaps the degree of global 'connectivity' has already gone one link to far this time. After all, what would happen to the first one out?

A weaker dollar could save the world from deflation. For the United States, a shift in the “currency translation” effect would transform imported deflation into imported inflation. For Japan and Europe, stronger currencies would initially be painful. The appreciation of the yen and the euro would undermine external demand, the only source of sustainable growth in these economies in recent years. That would leave Japan and Europe with no choice other than finally to bite the bullet on reforms in order to stimulate domestic demand. The gain would be worth the pain. It would eventually result in a more balanced mix of global growth -- less domestic consumption from a saving-short US economy and more domestic demand from the saving-surplus economies of Japan and Europe.

There is always a chance such a currency realignment might backfire. If the non-US world chooses to deflect the pain of a weaker dollar, the risk of competitive currency devaluations might intensify. That would take the world down a very slippery slope of trade frictions and protectionism. The recent outbreak of China bashing in Japan is particularly worrisome in that regard. The Chinas and Indias of the world are not a threat. To the contrary, they enable high-cost producers and service-providers in the developed world to realize efficiencies through outsourcing. They also enable rich nations to expand their purchasing power by buying cheaper, high quality goods and services. There will also come a day when the supply-led impetus of countries like China and India hits a critical mass in boosting income generation and domestic demand -- completing the virtuous circle of global rebalancing.

A dysfunctional global economy is at a critical juncture. An intensification of deflationary risks is a real threat if an imbalanced world stays its present course. As globalization continues to expand the supply side of the world economy, a deficiency of aggregate demand becomes the real enemy. If concrete actions are taken to boost the demand side of the global economy, the deflationary time bomb will be defused. The heavy lifting of structural reforms and global rebalancing is the only way out.
Source: Morgan Stanley Global Economic Forum

Print Any Amount of Money

The following quote from an investment strategist in today's FT may bear thinking about:

"The euro is strengthening because the US seems prepared to print any amount of money to avert deflation whereas the European Central Bank seems unwilling to do anything," said Kit Juckes, chief strategist at Royal Bank of Scotland financial markets. Despite the strength of the euro, the majority of economists expect the European Central Bank to keep rates on hold at today's meeting.

Now the interesting thing is the logic here. People are buying euros because the US "seems prepared to buy any amount of money". So why are they prepared to spend any amount of money, to have a big party, to fight more wars? No, silly, to fight deflation. And is this a good thing to do, I mean the Europeans don't seem worried about it? No, no, it's a good thing to do, it's just that the Europeans don't take the problem seriously enough, they haven't learnt the 'lessons from Japan', they aren't acting agressively, they're busy fighting last years problem, inflation. So if the US avoids deflation, will that be good for the dollar? Oh, yes, definitely yes, the economy will grow, earnings will grow, consumption will grow, there will be more jobs, yes definately a dollar plus this. And the euro, if the ECB's appeasmanet policy with the deflation menace continues, will this be euro positive. Well............

I think the important thing here is to distinguish between the short and the medium term. Short-term people are buying euros, and European bonds, not principally for the interest rate differential, but because of the US policy of lowering the dollar in relation to the euro, and because this policy convinces them that the dollar will have to fall, and this adds to the momentum. At the same time the absence of any evident willingness to resist from Frankfurt and Brussels only encourages this process. But once we look out to the medium term (say 18 months to two years) process can only unwind. It can only unwind since the relative economic strengths of the two regions can only change in the direction of US positive. The only serious 'runner' as an argument against this is Steven Roach's forlorn hope that the pressure will force reform on Europe and Japan. To this I have only to things to say. Firstly, even were this argument a good one, things can only get worse before they get better. The 'remedies' being proposed - solving the bad-loan problem in Japan, and cutting back the social security system in Germany - ar not going to be consumption and investment positive in either case. An secondly, the argument is ill founded. If the underlying problem is a demographic transition, then all the currency pressure in the world won't get to the heart of the matter. For that we need 'unconventional tools' of the institutional kind: like - eg - immigration.

So why will the dollar continue it's rise short term. Now here things get really interesting. Remember all those silly 'conspiracy' theories about the war and petro dollars. Well, that's what they were 'silly'. But if we step back and thing about things a little, the war has had an impact here. The 'battle of the titans' between the central bankers is very much a no-contest one these days. If the US wants the dollar down, the dollar will come down. This is very different from, say, the late 80's. Now why does everyone imagine the US can get its way here (and thus why do the markets act on that supposition)? Well they have just won a war haven't they? Everyone is talking about the monopolar world, the pax Americana, now aren't they? So what self-respecting global super power, in the moment of its 'supreme' power (and just before, incidentally, its rapidly growing young rival, China, enters stage left to confuse the picture) would allow itself to be pushed around on a 'mere detail' like currency policy. So this is all about credibility and enforcement. The current US strength is undeniable, and this is the trump card. Now, what was the war about? I really have no idea: I think only hisory will tell us, and maybe not even then. But the consequences are plain to see. Was this a policy objective. I doubt it, even I don't think they have such a good grasp of the economic realities of things in the White House. Remember, you read it first in Bonobo Land.

The euro on Wednesday rose to its highest level against the pound since the European currency was launched in January 1999, adding to the strains on the Continent's exporters and intensifying pressure on the European Central Bank to cut interest rates. The move - which took the euro to £0.714 - reflected broad strength in Europe's currency, as global investors warmed to the appeal of European bonds. Although the euro eased slightly against the dollar yesterday, it has risen by 4 per cent over the past 2 weeks. Indications on Tuesday that the Federal Reserve may be prepared to ease monetary policy further to stave off the risk of falling prices have further increased investors' appetite for the euro."The euro is strengthening because the US seems prepared to print any amount of money to avert deflation whereas the European Central Bank seems unwilling to do anything," said Kit Juckes, chief strategist at Royal Bank of Scotland financial markets. Despite the strength of the euro, the majority of economists expect the European Central Bank to keep rates on hold at today's meeting.

The ECB has long been criticised for its failure to respond quickly to deteriorating economic growth in the eurozone. But economists said the ECB's inflation fighting zeal now made the euro particularly attractive. "We are back in a world where cross-border bond flows are larger than equity flows," said Avinash Persaud, head of global research at State Street, the Boston-based investment bank. "Two years ago the ECB was being criticised for reluctance to cut rates and now it is being rewarded for the same behaviour." Analysts said that many European companies had been taken by surprise by the speed of the euro's rise and had not yet done enough to insulate themselves from currency strength.The strength of the euro may be given added impetus from European exporters seeking to hedge themselves against a further appreciation of the currency. Since this usually involves buying the euro forward, it should assist the euro's rise. Volkswagen AG said yesterday that its profits had tumbled by more than two-thirds in the first quarter, dented by a weak dollar and spending on new models.
Source: Financial Times

Wednesday, May 07, 2003

On the Non-Linear Path of Building-Block-Type -Products

I am having quite a tussle with Joerg these days, he keeps sending me these long interesting mails and I simply can't keep up with him. This time the topic is Ray Kurzweil and my Deflation Page . Basically I am arguing that it is the whole question of the unit price of information that we need to examine, and how a Moore's Law type process can extend throughout the 'information' economy. My conclusion is basically that there may well be deflationary tendencies at work here, especially if we cannot set the global economy on a significant and sustained high growth trajectory. Joerg begs to differ, but that's what blogging is all about, isn't it. Incidentally, he doesn't know yet (because I haven't explained it to anyone) that I have another argument up my sleeve, and that is the 'gift economy' type characteristics of the internet-driven information revolution (just a hint: think SETI@Home, think file sharing (not just music, but working papers etc) think Linux, think internet archive, think blogging.....).

I am absolutely convinced that you are wrong about the productivity issue. Kurzweil´s graphs and diagrams are one part of the picture. However, they do not translate directly into output data. They demonstrate how much more efficient new building-block-type products become over time - and how this development is non-linear. Assembling and configuring these products - ICs, disks, etc. - to automate production processes necessarily turns out to be a similarly non-linear process. Chinese workers and engineers have 1:20 advantage in terms of attracting investment to China as a low-wage country and securing employment in due course.

Once a company decides to be ready to automate production this comparative advantage evaporates instantly in a completely non-linear fashion. You cannot possibly automate employing last year´s technology. NASA still buys Intel´s earliest chips on Ebay which happen to be part of critical systems - they are missing out on productivity advances because they have no funds and no mandate to redesign the systems in question. The upshot is that - at any given point in time - there are large unrealized gains from technological progress which will be realized as soon as some critical threshold has been surmounted. The point is that these clustered innovations are not implemented as their isolated components are invented - "as time goes by", one might say - but as soon as the profitability threshold of the whole package has been overcome. Automation occurs not when the benefit to be had is larger than your workers´ latest wage increase, but when the benefit outweighs the twentifold advantage the Chinese currently (seem to) command. These technological gains are not prone to evaporate like unrealized investment gains on paper assets
- as long as we can be sure that we do not reverse the process of civilization and technological advancement. (That is a very real "if". Natural processes are not like that. What are the lessons to be drawn from history? What progress was there during the centuries following the fall of Rome? There is such a thing as an inbuilt cultural bias for picking one timeframe over another. Asians are less liable to sort of "daytrade away" the resources at hand. Differences in national savings rates kind of manifest our varying collective attention spans and agenda preferences.)

Japan's Zombie Warehouse

This looks like another non-starter 'jump-start' for Japan's continuing problems. The Industrial Revitalisation Corporation is to spend $84 billion buying up bad loans: this sounds fine, it's the bit about reselling them back to the market at break-even prices that should make you start to wonder. If this was half-way serious it would be buying up the debts to write them off, not to refloat non-proftable companies and send them back in to add to the bloated-capacity problem. Of course here it's more a question of how you see the problem dictating how you read the 'solutions'.

A new public body charged with turning around some of Japan's struggling borrowers plans to buy up loans belonging to as many as 400 companies over the next two years. The Industrial Revitalisation Corporation, which starts business on Thursday, has been licensed to spend up to ¥10,000bn ($84bn, €74.7bn, £52bn), amounting to almost a quarter of the official estimate of ¥43,000bn in bad loans that is swamping the banking sector.Kazuhiko Toyama, the corporation's chief operating officer, said on Tuesday that the IRC plans to break even within five years.The new body is mandated to buy problem loans belonging to salvageable companies, repackage them and sell the loans back to the market. It is capitalised at ¥50bn, but can borrow up to ¥10,000bn.

Mr Toyama, 42, who has built a reputation as a corporate doctor, said the IRC would have to overcome fear among banks and borrowers that might dissuade them from signing up. "Some people might be scared that the IRC is some kind of aggressive private-equity-style player and that we aim to push the purchasing price down and to make an arbitrage profit, but that's completely nonsense. "Our goal is to revitalise Japanese industry."

Mr Toyama said he aimed to sign up borrowers from several industrial sectors as quickly as possible to establish early success stories that would encourage others to come forward."This is not a profit-oriented company, it's a public company, so we are okay with zero profit," he said. In some cases the IRC, as well as buying loans, would provide fresh investment to build a company's competitive advantage. Turnaround meant more than simply cutting headcount, especially given Japanese lifetime employment practices, said Mr Toyama. Canon, the printer and camera manufacturer, showed that a successful hybrid could be developed between US and Japanese management practices.

Mr Toyama denied that the IRC would become a warehouse for "zombie" companies, saying it aimed to sell on investments within three years of purchase. He admitted that some turnarounds might fail, leaving the IRC - and ultimately the taxpayer - to foot the bill."There is always a risk in turnarounds. The IRC has been established to take the risk that sometimes private creditors cannot afford." Mr Toyama was a founder of Corporate Directions, one of Japan's few corporate turnaround specialists, and helped salvage a number of well-known companies including Japan Lease and Akiyama Printer. The IRC, which has a staff of about 100, will rely heavily on outsourcing to experts inside and outside Japan.
Source: Financial Times

Deflation is very Difficult to Reverse

The economists over at Yahoo seem, as usual, to have grasped the significance of the situation. The times they are a changin', in every sense.

Despite a recent slew of sluggish data, the economy should pick up as the Iraq war fallout fades, Federal Reserve chairman Alan Greenspan and his fellow policymakers said. But an emerging menace, deflation, loomed. Over the next few quarters, opportunities and risks for sustainable economic growth were "roughly equal," Federal Reserve chairman Alan Greenspan and his colleagues said in a statement. "In contrast, over the same period, the probability of an unwelcome substantial fall in inflation, though minor, exceeds that of a pickup in inflation from its already low level," they said. It was the first time the committee had issued such a clear warning about the downward pressure on prices, although they carefully avoided using the word deflation. Deflation, or falling prices, deals a double blow to economies by pressuring people to postpone buying until prices fall further, and by raising real interest rates. It is also very difficult to reverse.

Because of the deflation spectre, the balance of risks overall was "weighted towards weakness over the foreseeable future", the bank said, in a signal it was ready to cut rates if needed. "Evidently the Federal Reserve believes that the economic rebound wont be strong enough to allay deflation concerns," said Wells Fargo Banks chief economist Sung Won Sohn. "The probability of another cut in the interest rate on June 24 has increased significantly." Greenspan was sweating over the threat of deflation after concluding that Japan had waited too long to act before plunging into a four-year deflationary spiral, Sohn said. "The Federal Reserve is determined not to repeat the same mistake," he said. Soaring energy costs in March led to a 3.0 percent rise in consumer prices compared to the same period a year earlier. But when volatile energy and food prices were excluded, core prices rose just 1.7 percent.
Source: Yahoo News

The Fed's Unprecedented Move

As if to confirm my earlier point about the flagging rate of intelligence down at the Economist, the FT comes in with a hit, which, as is becoming habitual with them, is bang on target. Since both parties tend to cite the opinions of unidentified 'economists' one can only assume that those the FT asks have more idea of what is going on than those consulted by the Economist.

In an unprecedented move, which economists said underlined its concerns about deflation, the Fed split its usual assessment of the overall balance of risks to the economy into separate judgments on growth and inflation. The risks to economic growth - one of the Fed's key objectives - were balanced, the Fed said. But the committee said the risks arising from another fall in inflation meant the overall balance of risks to the economy was on the downside.The statement amplified Fed chairman Alan Greenspan's warning about low inflation last week. Mr Greenspan's favoured measure of inflation, the change in the core price index for personal consumption, recently fell to an annualised rate of just 0.9 per cent and the Fed has been anxious to head off any chance of inflation turning negative. Financial markets read the statement as a clear indication that the Fed was prepared if necessary to lower rates later in the year even if growth picked up. Following yesterday's announcement, the futures market priced in close to a 75 per cent chance of the Fed cutting rates at its next meeting in June, and bond yields also fell.........

On Tuesday, the Fed continued to argue that the US economic recovery should gather pace. "The ebbing of geopolitical tensions has rolled back oil prices, bolstered consumer confidence, and strengthened debt and equity markets," it said. But economists have warned that with the sustainable rate of growth of the US economy now estimated at about 3 to 3.5 per cent, it needs a strong recovery in growth towards its potential to stop inflation falling further.
Source: Financial Times

What the Fed Actually Said

For those with an eye for detail, and for the simply curious, here is the full text of the FOMC declaration:

The Federal Open Market Committee decided to keep its target for the federal funds rate unchanged at 1-1/4 percent.

Recent readings on production and employment, though mostly reflecting decisions made before the conclusion of hostilities, have proven disappointing. However, the ebbing of geopolitical tensions has rolled back oil prices, bolstered consumer confidence, and strengthened debt and equity markets. These developments, along with the accommodative stance of monetary policy and ongoing growth in productivity, should foster an improving economic climate over time.

Although the timing and extent of that improvement remain uncertain, the Committee perceives that over the next few quarters the upside and downside risks to the attainment of sustainable growth are roughly equal. In contrast, over the same period, the probability of an unwelcome substantial fall in inflation, though minor, exceeds that of a pickup in inflation from its already low level. The Committee believes that, taken together, the balance of risks to achieving its goals is weighted toward weakness over the foreseeable future.

Voting for the FOMC monetary policy action were Alan Greenspan, Chairman; William J. McDonough, Vice Chairman; Ben S. Bernanke; Susan S. Bies; J. Alfred Broaddus, Jr.; Roger W. Ferguson, Jr.; Edward M. Gramlich; Jack Guynn; Donald L. Kohn; Michael H. Moskow; Mark W. Olson; and Robert T. Parry.
Source: Federal Reserve Board

Global Fudge

Am I the only one around who has the distinct impression that there is something missing in the Economist's coverage of the global economy these days? Belonging as I do to a generation of economists that was brought up on the staple diet of balance, analysis and fair play that was to be found in its pages, I don't remember the Economist ever having a repution for reluctance to take risks with its judgements. But recently they seem to have succumbed to a severe case of 'sitting-on-the-fence-ism'. The latest case in point: yesterdays reading of the Fed Open Market Committee decision. For the Economist the question apparently seems to revolve around whether or not to 'keep the powder dry' on the next rate cut. The astute observer, however, cannot fail to notice that the underlying weakness and 'the probability of an unwelcome substantial fall in inflation' (which, of course, they say is minor) points offer a different reading. The phase of conventional monetary policy may be reaching its end, what now seems to be on the agenda is an opening of the 'unconventional toolbox'. The first indication of this can be found in the attitude to the 'softer dollar'. There certainly will be more to come. We should take the Fed's determination not to fall into the Japan trap seriously. And they are surely only too aware that another 50bp cut is not going to achieve what a drop of 475bps already hasn't. So more will undoubtedly be to come in the days that lie ahead. What a pity the Economist couldn't bring itself to offer a clearer reading of this novel situation: or have I just been spoilt by the risky calls offered by the likes of Stephen Roach, Paul Krugman and Brad Delong? Risky calls that get to look better with every passing day.

BE WORRIED but don’t panic. That seems to be the message that Alan Greenspan and his colleagues are keen to get across. The chairman of the Federal Reserve, America’s central bank, is clearly anxious about the timing and strength of the long-awaited upturn in the world’s largest economy. But the Fed decided, unanimously, to keep interest rates unchanged when it met on May 6th. Few can have been surprised by that: at 1.25%, rates are at their lowest for more than 40 years, and so close to zero that the Fed wants to hold on to what remaining room for monetary manoeuvre it still has, just in case.

What will have given some observers pause for thought was the Fed’s decision to shift its assessment of the future risks for the economy. It now judges the risk of further economic weakness to be greater than that of an upturn in inflation. This so-called “bias” is closely monitored because of the clues it offers about the likely movement of interest rates in future. Shifting the bias towards weakness does not mean interest-rate cuts are on the way; but it does mean rates are more likely to remain flat—or, in certain circumstances, even to fall—than they are to rise.

..........the logic of the latest statement was impeccable, if tortuous. The balance of risks about the economic outlook, said the statement, was “roughly equal”. But the Fed thinks there is only a small chance of inflation gathering pace. Thus the overall balance of risk is tilted towards further weakness...........At this stage in the economic cycle, such uncertainty should be a thing of the past. The recession ended in 2001 and the American economy has now been growing for several successive quarters. The recession itself was one of the mildest on record. But although America is still expanding faster than most industrial economies, it has lost a good deal of the momentum seen at the beginning of 2002. Which is why Mr Greenspan is having to keep his fingers crossed.
Source: The Economist