In a funny line uttered at the Republican National Convention California Governor Arnold Schwarzenegger accused pessimists of being economic girlie men.
To those critics who are so pessimistic about our economy, I say: Don’t be economic girlie men! The U.S. economy remains the envy of the world. We have the highest economic growth of any of the world’s major industrialized nations.
Of course we have a much lower economic growth rate than China. But the Chinese are playing catch-up and that is easier to do than it is to develop new technology that raises maximum possible productivity even higher.
Morgan Stanley chief economist Stephen Roach defends the pessimistic views of the "economic girlie men".
By depicting those of us who worry about the state of the US economy as “economic girlie-men,” the Governor offered new meaning to the debate that is currently raging in financial markets. Far be it for me to take this characterization personally. But in the interest of fair play, it deserves a response.
Forget about politics -- at least for the moment -- and consider the facts: This economic recovery, by most conventional measures, has been amazingly lousy. Annualized growth in real GDP has averaged 3.4% over the first ten quarters of this upturn, far below the 5% norm of the previous six business cycles. Nonfarm payroll employment is up only 0.1%, on average, over the past ten quarters -- hugely deficient when compared with the 2.7% record of the past six recoveries. Real wage and salary disbursements -- the essence of the economy’s organic, or internal, income-generating capacity -- is up at only a 0.8% average annual rate over the past ten quarters versus the 3.9% norm of the previous six upturns. The federal government budget is out of control, having swung from surplus to deficit by six percentage points of GDP from 2000 to 2003. This was key in pushing the net national saving rate down to its all time low of 0.4% of GNP in early 2003. Lacking in domestic saving, the US has had to import foreign saving in order to keep the economy growing; that has given rise to a record current account deficit of 5.1% of GDP. All this speaks of a vulnerable and exceedingly low-quality recovery in the US. If that makes me an economic girlie boy, so be it.
Roach makes a convincing argument that the US economy has structural problems (e.g. a large trade deficit, a low domestic savings rate, and unfunded retirement liabilities) of long standing that are not the cause of any one politician's or party's policies. He thinks the blame game in Washington DC prevents the underlying problems from being rationally discussed and addressed.
I am concerned that low interest rates have been used to entice the American consumer to clean up a recession borne by an irresponsible corporate spending binge by going on one of his own. I'm afraid that the $200 billion-plus that Americans have cashed out of their houses has been spent, and the next drop in interest rates won't be concomitant with a rise in prices; rather, it will be because of a full-fledged financial emergency
Washington Post columnist Robert Samuelson cites Brookings Institution economist Charles Schultze to argue that the biggest reason for slow jobs growth during the economic recovery is higher than typical productivity growth.
From late 1995 to late 2000, productivity (output per hour worked) grew 2.6 percent annually. During the next three years, annual growth averaged 4.1 percent. If it had stayed at the lower level, there'd be 2 million more jobs, Schultze estimates. Unemployment would be about 5 percent.
Rapid productivity growth would be a better cause of high unemployment than other possible causes. Though if that is a major cause it brings with it the possibility that the economy is going to become so productive that an growing fraction of the population will beome permanently unemployed.
Another less frequently mentioned cause of the current unemployment rate is immigration. Count on leading figures in both political parties to avoid mentioning that in the election debates.
The economy is not in George W. Bush's favor for reelection. But he's not running on its economic record. He is running on attacks on Kerry's character and ability. Plus, he's wrapping the war in Iraq together with the war against terrorists to argue that the Iraq war was necessary in spite of the aftermath. His argument doesn't sound reasonable to me.
But I'm guessing at this point that Bush's argument is going to convince a majority of voters. One reason for this is that John Kerry is a weak candidate. Bush only has to seem better than Kerry to a lot of voters who do not understand the fallacies at the base of in Bush's foreign policy. Kerry is not going to try to argue against those fallacies (e.g. the supposedly universal desire for liberal democracy) because some of those fallacies are part of liberal mythology as well.
The August 19, 2004 oil price peak of $48.70 per barrel may be cheap compared to even higher prices which may be in store.
No market goes up forever. But Philip Verleger, a respected energy economist, warns that over the next several years, the price pressure will probably get worse. "Prices may rise to $50 per barrel, or $60 per barrel, or even $70 per barrel," he writes in a recent report to clients. "They will likely remain there until growth in petroleum demand slows down enough to match available refining, logistical and productive capacity."
Note that in inflation-adjusted terms during the Iranian hostage crisis the price of oil hit $75 per barrel in 2004 dollars.
High Frequency Economics says that every $10 increase in the price of a barrel of oil lowers its GDP growth expectations by six tenths of a percentage point. All of which feeds back into increased nervousness on Wall Street--and perhaps at 1600 Pennsylvania Avenue.
Not all economists agree on how much smaller the GDP will be for each additional $10 per barrel increase in oil prices. David Wyss, chief economist for Standard & Poor's, sees the economic threat to the economy from high oil prices as being exaggerated by others.
Every $10-per-barrel hike in oil prices reduces economic growth for the next year by about 0.25% to 0.35%, largely by reducing real consumer disposable income. At S&P, we have lowered our consumer disposable income forecast for 2005 to 3.6% from the 3.9% we projected last month, largely because of costlier oil.
Even if oil rose to $75, it wouldn't cause a recession. It would merely lower growth, to 2.4%, from the 3.6% expected in our baseline projection.
"The oil price is firmly in the danger zone," Stephen Roach, chief economist at Morgan Stanley in New York, wrote in a note to clients. Should prices reach $50 and stay there for several months, this would be "in the ballpark with full-blown oil shocks of the past" that have caused recessions, he said.
Roach doesn't see this economic recovery as being particularly strong and in his writings he repeatedly points to jobs figures, consumer debt, the trade deficit, and the federal deficit as factors that weigh against a robust recovery. So part of his pessimism on the potential effects of higher oil prices may be a consequence of his view of the weakness of the current economic recovery.
China is now the world's second-largest oil consumer, and its imports are up 40 percent year-on-year to the end of July, according to recent data.
Before the latest round of violence in Najaf, Iraq had been exporting roughly 1.7 million barrels of oil per day, although volumes have fallen recently to about 900,000 barrels per day, according to a source within the Organization of Petroleum Exporting Countries who spoke on condition of anonymity.
One of the arguments for the war in Iraq was that it would allow Iraqi oil field production to be scaled up tremendously. Well, even before the latest intensification of fighting in Iraq the Iraqi oil fields were still poducing less than they were in Saddam Hussein's final days. The political stability needed to enable substantial investment in Iraqi oil fields remains a distant prospect.
Energy ecnomist Philip Verleger mentioned above has an article on his web site making his argument that current US energy policy undermines US attempts to stop terrorists. (PDF format)
However, the United States and other countries have taken a different approach to the problem. In lieu of adopting energy policies that support the war on terrorism, they have fallen back on other plans that have been tried before and failed. One of these programs involves attacking terrorist financing. This approach echoes the unsuccessful attempt to cut off funding for Colombian drug lords, where international cash flows were scrutinized, bank deposits seized, and organizations closed down. This kind of effort disrupts but clearly does not stop the flow of funds. In the end, Americans, Europeans, and Asians are as vulnerable as ever to attack.
Meanwhile, the energy policy pursued by the United States has contributed to an increase in world oil prices, likely boosting the cash flow to the terrorists. A policy of aggressive ly acquiring crude for the Strategic Petroleum Reserve, directed by the Department of Energy, has raised oil prices by between $3 and $6 per barrel, thus augmenting Saudi Arabia’s income. At the same time, policies that provide tax subsid ies to anyone who buys an SUV weighing more than 6,000 pounds have contributed to the 1.8 percent per annum increase in gasoline consumption. Lastly, in considering the energy bill now awaiting final passage, Congress has refused to adopt any measures that would encourage greater fuel economy in automobiles or SUVs. This situation sends a very clear message to the world : US Energy Policy Supports Terrorists and Opposes the War on Terrorism.
Verleger makes arguments very similar to arguments I've made here repeatedly. For my own arguments on energy policy and terrorism see my previous posts Saudi Arabia, Terrorism, Democracy Promotion, And Energy Policy, China Energy Consumption Growth Complicates Anti-Terrorist Efforts, Energy Policy, Islamic Terrorism, And Grand Strategy, and Luft And Korin On China's Rising Demand For Oil And Saudi Arabia.
The National Association of Business Economists (NABE) Economic Policy Survey polled 172 members to rank their views on the most important issues for the US President to address in the next presidential term. The business economists see terrorism as the biggest short term threat to the economy.
Terrorism remains the biggest short-term problem facing the U.S. economy this year, according to 40% of respondents, up from 19% in March. The deficit was chosen by 23% of respondents.
We separated long-term from short-term concerns for this survey. In the longer run, the rising elderly population and related health care costs are the primary problems. The rising elderly population and the concomitant rise in the dependency ratio were the prime long-term worries for 23% of panelists (down from 27%), while 22% focused on health care costs (up from 19%). The federal deficit was chosen by 17% (down from 24%) as a significant long-term problem.
The Bush Administration has failed in their handling of the terrorist threat in an important way: weak border control policy. Far better border control policies must be part of a complete response aimed at reducing the threat to terrorism. If policies make it harder for terrorists to enter the country on visas then the terrorists will just come over land borders from Mexico and Canada illegally or jump off of ships in ports. The border with Mexico is the biggest threat on this score. But Bush's pandering for Hispanic votes prevents him from closing the border. A barrier on the US-Mexico border is affordable and would pay for itself every year just for reduced costs for health care provided by US taxpayers.
Another way of looking at the concerns of the economists is a look at how they think the next US President should spend his time.
The new president should concentrate one-quarter of his time on terrorism. We asked what percentage of his time and energy should be spent on different issues. The panel recommended that 25% of his time be spent on the Middle East and terrorism. He should spend 17% on reducing the deficit, 16% on health-care reform, and 14% on social security reform. Energy policy should account for 11% of his attention, trade 8%, and education 6%. No other problem should account for more than 1% of his time.
I would reduce the amount of time allocated to reducing the immediate deficit and on social security reform to shift more attention to old age health care. The unfunded liabilities for Medicare are in the range of tens of trillions of dollars. In particular, I would look at formulating policies to achieve the following goals:
Science policy could play a much more productive role in reducing unfunded future liabilities. Better science policy and higher research funding would also increase our life expectancies and allow us to enjoy better health for longer periods of time. So it is an especially appealing tool to use in tackling the financial problems posed by an aging population.
In a stunningly weak performance, the American economy effectively ceased creating jobs last month, the government reported Friday, saying just 32,000 positions were added in July.
Put that in perspective. Imagine that the economy added 12 times that number of jobs in a year. That would be 384,000 jobs. With the econoy employing about 139 million workers that number would lower the unemployment rate by less than three tenths of a percentage point if that growth rate in employment was sustained for a whole year.
Mr Bush's treasury secretary, John Snow, reflected the administration's disappointment that the gain in jobs last month had failed to match Wall Street's 228,000 forecast.
Using the payroll survey measure there are still fewer people working now than at the beginning of Bush's term of office.
Payroll jobs remain 1.5 million short of where last winter the White House said they would be by now. To avoid being the first president since Herbert Hoover to preside over a net job loss, Bush must hope for 372,000 new jobs a month in August, September and October.
Analysts with the Economic Policy Institute, a liberal Washington think tank, said that the economy has lost 1.1million jobs since Bush took office in January 2001 and that job growth has not kept pace with the 150,000 new jobs that are needed each month to keep up with growth in the workforce population.
Note, however, that the payroll survey is only one of two major methods used to measure employment. The household survey provides a separate independent way to measure employment and the household survey is also the source of the unemployment rate.
The unemployment rate, based on the household survey paints a rosier picture of declining unemployment rates.
The unemployment rate, however, dipped to 5.5 per cent last month, from 5.6 per cent in June. The new rate was the lowest since October 2001.
The household survey paints a rosier picture.
The Labor Department said its survey of households — which includes agriculture workers and the self-employed — again showed a picture vastly different from the employers' payroll survey, with a whopping 629,000 jobs being added in July, to 139.7 million.
From the standpoint of the Presidential election what is very important is who is getting the new jobs. Are the new jobs going to voters or non-voters? Here the news looks worse for Bush's reelection prospects. See my previous posts Black Male Labor Market Participation Declines In Face Of Immigrant Influx, Non-Citizens And Illegals Getting Over A Quarter Of New Jobs, and Foreign Employment Rises In US As Native Employment Declines.
For reasons that make no sense to me Tyler Cowen thinks China's demand for oil is not a net cost to the United States. (correct me if I'm wrong in my interpretation Tyler)
Lately we've been hearing a lot about competition from Chinese manufacturing and Indian call centers. But a different kind of competition — the scramble for oil and other resources — poses a much bigger threat to our prosperity.
I am surprised to see Krugman so qualifying his former belief in the virtues of free trade. Keep in mind that the core theory of international theory is a barter theory. "The Chinese buying oil" and "the Chinese selling bicycles" are just two sides of the same coin. If you don't think one can harm the U.S., you shouldn't, in general, think the other will harm the U.S. either. (Of course if your vision of free trade is we get the bicycles but give up nothing in return, we are worse off relative to that state of affairs!)
Here is another way to think of the logic. If the Chinese are bidding up the price of oil, they have found good uses for that resource. If they have a comparative advantage in buying oil, that benefits the rest of the world. Comparative advantage in production also will mean comparative advantage in buying certain inputs. The U.S. still has access to its previous production possibilities frontier. It must now decide whether it would rather spend its money on oil, or on something else, perhaps the outputs of the Chinese.
Tyler is surprised by Paul Krugman? Well, I'm surprised by Tyler. Or wait, no, I take that back. This is the sort of argument I expect Tyler to make. I also disagree with it.
Okay, what is wrong with Tyler's argument? The higher price for oil reduces the amount of oil the US will buy. The oil that the US will buy will cost more. The rising Chinese demand for oil makes us worse off. The Saudis and other oil producing nations will get more money for producing the same stuff and therefore can buy more stuff with the same amount of oil sold. The Saudis will not need to work harder or more efficiently. They didn't even have to do anything to get the oil in the first place. They just got lucky to have oil under their deserts. They didn't even have to develop the technology to extract, process, and ship it. Yet they make the bulk of the money from its sale.
Rising demand for natural resources as a result of the industrialization of more of the world is going to shift more wealth from manufacturers to the possessors of natural resources. The United States will have to lower the prices at which it sells goods in order to generate more sales to get the revenue to pay for the higher price for oil imports. It is hard to see how this is a gain for the USA. The same holds for other existing big buyers of natural resources. They will pay more for inputs and at the same time will have to sell a larger fraction of their outputs abroad to earn the revenue to pay for the inputs.
Tyler mentions the environmental cost to the US and other countries from the increased energy consumption of China. Yes, Chinese air pollution does cross the Pacific to reach the United States.
Based on air quality measurements at Cheeka Peak at the westernmost tip of Washington state and later airplane-based measurements, Jaffe's research group has shown that a steady trickle of air pollution comes across the Pacific from Asia -- at least in the spring -- punctuated by a surge of pollutants once or twice a month.
These surges are presumably due to the wholesale movement of air from Asian urban areas across the Pacific. This prevents the pollutants from being diluted by mixing with cleaner air. During these surges, the air entering the West Coast can have pollution concentrations as high as 75 percent of federal air quality standards, Jaffe said.
China will surpass the United States in annual emissions of CO2 within a decade and, in a few decades, in total cumulative emissions of CO2 since the beginning of the Industrial Revolution.
Between 1990 and 2000, annual releases of sulfur dioxide into the atmosphere in the United States dropped from about 20 million tons to 13 million tons, but in China they have climbed to about 45 million tons.
But pollution is not the biggest cost to the rest of the world coming from increased Chinese oil purchases and increased Chinese coal burning. Nor is the biggest cost the higher price the US has to pay for oil (though, contra Tyler, that really is a net loss for the United States). The biggest cost for the United States from Chinese economic growth is in the realm of national security. The rising demand for oil from China and other industrializing countries is going to make the Middle East even more problematic.
To the extent that China becomes a military rival they will of course also cost us a lot more in increased military spending. How that plays out remains to be seen. But we certainly are faced with both higher energy prices and a more intractable Middle East as a result of China's economic growth.
Update As Nobel Laureate Richard Smalley argues, the US government ought to spend an additional $10 billion per year on energy research. Energy research is a much cheaper way to avoid with the potential costs (assuming there really are net costs) of climate warming too.
The Punjab government says it stopped traders in 18 out of 34 districts from selling wheat in a bid to prevent hoarding and ensure prices were not inflated, but the move has angered officials of Balochistan, the North West Frontier Province (NWFP) and Sindh. The government imposed a similar ban last year but lifted it after protests from the other provinces. Punjab Food Secretary Shahid Hassan Raja explains, "The other provinces should support Punjab's decision because it is in their best interests. Otherwise, they will have to buy wheat for US $206.9 to US $241 per metric ton, but now the Punjab government will be able to provide them wheat for around $151 per metric ton."
A recent decision by Pakistan's central government to prevent the import of Australian wheat may have been motivated by a desire to make profits from the resulting price run-up.
KARACHI: The rejection of 15 lakh tonnes of Australian wheat by the Ministry of Food, Agriculture and Livestock (MINFAL) — a decision that skyrocketed the flour prices in Sindh to Rs 20 per kg and earned at least Rs three billion profit to wheat black marketers in late February — is now shaping into a major scandal for the Jamali government, according to interviews with related officials, informed sources and documents available with this correspondent.
PESHAWAR, May 1: The Jamiat Ulema-i-Islam (F) has held Punjab responsible for wheat crisis in the country and asked the Centre to meet the NWFP flour requirement on propriety basis.
NWFP also grows wheat but its total produce can hardly meet even 25 percent of its requirement. It is therefore showing signs of extreme nervousness over Punjab’s policy of not allowing its wheat to be exported out of the province. One NWFP minister is so angry at this that he has threatened to stop the supply of hydel power to the Punjab if the latter does not lift the ban. Out of a total of 260 flourmills in the NWFP, 100 have closed down because of insufficient inflows of wheat. The NWFP government has tried to assure Punjab that it will not allow the smuggling or hoarding of wheat if Punjab allows it to buy wheat. Balochistan, too, is up in arms. Nawab Akbar Bugti has also threatened to cut off gas supply to the Punjab if it persists in its refusal to supply wheat to Balochistan.
Note that the Punjab government is afraid that if it allows unrestricted selling of wheat to NWFP then at least some of that wheat will be exported to Afghanistan. Of course if that happened it would generate more money for Pakistani farmers giving them an incentive to invest to increase production. Well, can't have that. At the same time the federal government is trying to block import of foreign wheat. In the minds of central planners both imports and exports can be bad at the same time.
Some commentators in Pakistan claim that the central goverment needs to tame those pesky market forces.
Analysts say that a harvest of 20 million tonnes is sufficient for the country’s requirement provided the government can plug smuggling through porous borders with Afghanistan and central Asia. It is also required to evolve a strategy aimed at countering the moves of ‘market forces’ in an effective and meaningful way.
How many other countries mess up their agricultural markets in this fashion so routinely and so drastically? It sounds like the farmers of Pakistan can grow enough wheat to satisfy their markets. But the government intervention surely must be holding back the modernization of Pakistani agriculture. The uncertainty and price fiddling caused by government intervention has to serve as a disincentive for investment in agricultural modernization.
The United States has an assortment of agricultural barriers that seem pretty mild by comparison. For instance,milk products regional markets are structured around subsidies. But it is my understanding that shortages in one region can be met by shipments from another region. There are not barriers to trade so much as barriers to production and subsidies for production. Ditto for the US and peanut growers.
When very left-leaning Bernie Sanders and the most consistently libertarian Republican in the House of Representatives Ron Paul co-sponsor legislation havng to do with exporting of jobs abroad we are not in Kansas any more Toto.
About 50 U.S. House members plan to introduce a bill Wednesday that would deny U.S. companies federal financing and loan guarantees if they shift U.S. jobs overseas.
The proposed Defending American Jobs Act was written by Rep. Bernard Sanders, Independent of Vermont, and will be co-sponsored by about 50 other representatives, including Republicans Ron Paul of Texas and Virgil Goode of Virginia.
Likely Ron Paul saw this as an opportunity to reduce government loan hand-outs and he'd probably be as equally willing to vote for a bill that denied government loans to companies on for any other reason that presented itself as a politically viable reason to restrict some government hand-out. Paul supports free trade so much that he favors the reimportation of price-controlled drugs from Canada (though Sanders may support this as well for different reasons). By contrast, Sanders links to an article on the decline in popular support for free trade.
The Treasurer of the federal government of Australia, Peter Costello, is proposing to encourage Australians to work more years in order to avoid large tax increases to pay for a larger elderly population.
The Australian Treasurer, Peter Costello, will warn today that Australia faces higher taxes, deep Government spending cuts or massive budget deficits unless more mothers and older people stay in the workforce.
Mr Costello will use a speech in Sydney to unveil far-reaching measures to tackle the challenges of Australia's ageing population.
The reforms include changes to make the superannuation system more flexible and encouraging older workers to extend their working lives.
Among Costello's proposals is one to to allow more flexible access to the Australian tax-free savings accounts in order to discourage complete retirement in order to get access to it.
Federal Treasurer Peter Costello today unveiled plans to keep older people in the workforce longer and encourage retirees to take their superannuation savings as a pension rather than as a lump sum.
The Government wanted to cut the eligibility test back so anyone who could work at least 15 hours a week would no longer qualify but the Senate blocked the move.
Yesterday, Mr Howard described the discussion paper's subject as among the most critical facing Australia.
He said Australians should be encouraged to stay in the workforce instead of assuming they had to retire at a certain time of life.
Additional work rules apply to people aged 65 and over. The work test is consistent with superannuation’s intended role as a retirement income vehicle. The rules apply to when a person can make superannuation contributions and when a superannuation fund must pay out benefits. People aged 65 to 74 must work at least 10 hours in each week to be eligible to make contributions; a superannuation fund must also pay out a member’s benefits if they fail this test.
Work opportunities for people over 65 are likely to increase as the population ages. However, the current weekly work test is too stringent and does not accommodate more flexible working arrangements, such as seasonal and irregular part-time work. It also imposes an administrative burden on individuals and superannuation funds.
From 1 July 2004 the Government will change the contribution and cashing rules for people aged 65 to 74 to an annual work test so these rules are consistent with current and future work trends. The Government will consult with the industry and community on an appropriate work test.
One doesn't have to understand the details of Australian retirement tax laws to see the thrust of what Costello is trying to do. He wants people to have more incentives to keep working and paying taxes in order to delay the date when retirees become net burdens to the government. He also wants to reduce the size of the burden by allowing retirees to more advantageously to work in a partially retired status and to switch back and forth between being completely retired and working.
Costello is also proposing changes in the rules for eligibility for complete disability so that some who are currently categorized as totally disabled will instead for part time and provide for some of their support.
Keeping taxes at low levels is not only a personal imperative but a national economic imperative as well. Citizens rightly demand that taxes be restrained so that their own financial freedom and prosperity can be improved.
But it is also vital for the economy that taxes are kept as low as possible. High personal taxes stifle incentive and enterprise and high corporate taxes will drive businesses offshore.
We need a tax system that will raise the required revenue to pay for our national defence, our health, our education, our aged.
The United States faces the same problem. The United States also needs to change tax laws, labor laws, and the rules of eligibility for entitlements programs to encourage people to spend more time in the workforce. Currently American politicians are ignoring the problem. By contrast, Australia's top leaders are discussing the problem publically and making substantial proposals to address it.
"It's a problem for the U.S. budget," said John Shoven, director of the Stanford Institute for Economic Policy Research. "Economists of all political stripes are worried about this." To Greenspan, the response is inescapable. "We will eventually have no choice but to make significant structural adjustments in the major retirement programs," he said in a statement delivered before the House Budget Committee. He urged several actions to reduce payouts, including raising the age of eligibility for full benefits, now scheduled to rise to 67.
"We have been making commitments without focusing on our capability of meeting them," Greenspan said. "And I think it is terribly important to make certain that we communicate to the people who are about to retire what it is they are going to have to live with. And if we promise more than we can actually physically deliver, I think it will be a major blot on our whole fiscal process." Greenspan did not buy into Democratic plans to repeal some of Bush's tax cuts. Instead, he urged reducing the deficit mainly through spending cuts.
Read the links and you will see that John Kerry, John Edwards, and other Democrats reacted far more harshly to the proposal than the Republicans did.
Dana Milbank of the Washington Post examines why the Bush Admnistration has repeatedly overestimated both jobs growth and government tax collection revenue.
Figures released by the White House show that its overestimate of job creation in 2003 was the largest forecast error made in at least 15 years, and its 2002 underestimate of the deficit was the largest in at least 21 years. But the statistics show that forecast errors began to increase considerably around 1997, under the Clinton administration. By contrast, the Bush administration's GDP forecasts have been relatively accurate, indicating job growth and tax receipts have shed their historical correlation to GDP growth.
If the economists she is quoting are correct then many people and/or companies are finding new ways to shelter their income from the tax man. I haven't seen this written about anywhere. Does anyone have any idea how and why this is happening? Are more people self-employed and hence in a position to write off more expenses against taxes? Or is a larger fraction of all stock and other assets being held in tax free retirement accounts and hence out of the reach of the tax man?
If anyone can find some relevant links please post them in the comments.
Robert Samuelson points out that 70% of the projected fiscal 2004 budget deficit is not due to Bush's tax cut of 2001.
Democrats commit the same sin. They're gleefully denouncing Bush's tax cuts for the super-rich as creating reckless deficits. This is not exactly true. For fiscal 2004, the Congressional Budget Office has estimated the causes of the swing from a once-predicted surplus to today's deficit as follows: 40 percent, a weaker economy and "technical re-estimates" of spending and taxes; 30 percent, higher spending (mostly for defense and homeland security); and 30 percent, tax cuts. Even without tax cuts -- which also benefit the middle class -- there'd be big deficits.
Samuelson argues that both parties are failing to deal with the long term financial problem that the US government faces. The biggest cause of the financial problem is the growth of the entitlements programs for old age.
In a Business Week article Christopher Farrell say the long-term gap between obligations and tax revenue is in the tens of trillions of dollars.
Taking into account the funds that need to be spent on this demographic time bomb lifts the long-term fiscal gap to $44 trillion. That's the "optimistic" calculation made by sober economists and green-eyeshade budget experts drawn from the U.S. Treasury, the Federal Reserve, the Office of Management & Budget, and the Congressional Budget Office during the tenure of former Treasury Secretary Paul O'Neill.
The leaders of the study, Jagadeesh Gokhale and Kent Smetters, estimate that restoring fiscal sanity requires either hiking federal income tax collections by 69% or raising payroll taxes by 95%. Don't want to raise taxes? Well, Social Security and Medicare benefits could be slashed by 56%. Another alternative is to cut federal discretionary spending by more than 100% (although that's impossible).
I am skeptical of Farrell's claim that the Bush Administration's restrictions on education spending are going to make matters worse. The whole education industry is incredibly inefficient. It cries out for automation and great reforms to accelerate the rate of education. In fact, one of my favorite policy suggestions to help deal with the declining ratio of net taxpaying workers to retirees and other recipients of government benefits is to acclerate education of the young to put them into the labor market at earlier ages. People who go to college and graduate school and do not enter the labor market until their mid to late 20s are a source of costs rather than sources of tax revenue and production. If children went to school all year around and went to college sooner they'd get into the labor market sooner and become net assets to the economy sooner. This would lower the cost of raising children while simultaneously increasing tax revenues and the proportion of the population that is working.
The number of Medicare beneficiaries is going to grow even as the cost in benefits paid per beneficiary grows due to the prescription drug bill and to the general increase in available treaments as a result of advances in medical science.
The CBO projected last summer that the growth in the number of Medicare beneficiaries will rise from about 1 1/2 percent a year between 2005 and 2008. Between 2009 and 2013 that growth doubles to 3 percent. In the years thereafter we see the steady retirement of the baby boom generation.
In his written testimony, he noted that increased demand for Medicare, Medicaid and Social Security will rise significantly as a percentage of GDP. Social Security and Medicare cost $745 billion in 2003, about one-third of government spending and 6.9 percent of GDP.
By 2014, Social Security and Medicare spending is expected to rise to $1.5 trillion, or 42 percent of federal spending and 8.4 percent of GDP. The CBO estimates that this number could rise to more than 14 percent of GDP by 2030.
A Winter 2003 paper from the National Bureau of Economic Research (NBER) examines the effects of existing retirement programs in incentivizing late middle aged people into retiring early in a publication entitled Social Security and Retirement Around the World.
The United States and many other developed countries around the world face looming financial crises in their social security programs. For example, member countries in the Organization for Economic Cooperation and Development are projected to experience a roughly 50% increase in the share of GDP devoted to old age pension expenditures over the next fifty years, from 7.4% of GDP to 10.8% of GDP. (1) The aging of the population is widely recognized as one important cause of these financial crises - most countries' programs are financed on a "pay as you go" basis, and a rising fraction of the population will be retired and collecting benefits as the population ages, causing program expenditures to swell. Less attention has been paid, however, to the fact that the provisions of social security programs often penalize work beyond the first age of benefit eligibility. If workers are induced to retire earlier as a result of these incentives, this will magnify the financial burden caused by population aging.
We need changes in public policy to give people greater incentives to work more years into their early old age. The longer people work the longer they will pay taxes and the less they will receive in benefits from all the other taxpayers. At the same time, the point of entry into the labor force needs to happen sooner in life so that people become taxpayers sooner. But neither political party wants to be the first to tell the public news they are going to be unhappy to hear. Do not expect leadership on this issue to come from elected officials.
Update: In a December 2002 Tech Central Station article Arnold Kling focuses in on the expected growth in Medicare spending and the need to gradually raise the age for Medicare eligibility.
As large as Social Security looms when the Baby Boom retires, it will be smaller as a proportion of GDP than Medicare. An analysis for the Concord Coalition reports that starting from a current ratio of 2.2 percent of GDP and making some conservative assumptions "just the increase in Medicare spending over the next forty years - 4.5 percent of GDP - would be greater than everything we spend today on Social Security."
Arnold is correct. People are going to have to continue under private medical insurance and stay in the workforce longer or the United States is going to become like Europe with long term slow growth rates. The US is in danger of entering a period of economic stagnation if old age spending is allowed to grow to the point where taxes to fund it choke off economic growth.
In a BusinessWeek article Paul Magnusson reports that while partially protected by tariffs from foreign competition the US steel industry moved vigorously to merge and restructure in order to cut costs.
Even steel executives acknowledge that the temporary tariffs helped the industry get back on its feet. Thomas Usher, chairman and CEO of United States Steel (SXX ), says the tariffs stabilized prices, allowed the U.S. industry to consolidate, stopped the flood of bankruptcies and layoffs, and encouraged a wave of productivity-enhancing investment.
More than half of steel-production capacity today is owned by companies that have merged or restructured, Bush Administration figures show. Usher's company can now produce a ton of steel with just two man-hours, down from two-and-a-half before the tariffs were imposed, he says. And the company's stock, at $27.65 as of Dec. 4, is within spitting distance of its 52-week high.
Contrary to the impression you might get from listening to the many critics of Bush Administration steel tariffs, Magnusson points out that the other steel-producing nations are far from highly principled free marketeers when it comes to the steel industry:
There's no free market in steel because most nations -- other than the U.S. -- either massively subsidize or own outright their nation's steel plants, totally distorting the market.
Ron Scherer and Adam Parker of The Christian Science Monitor report that major changes have recently happened on the shop floor of US steel plants.
Yet probably the biggest change is on the shop floor. In an industry that has a history of difficult union-management relations, much of the animosity in the hot and noisy mills is dissipating. For example, here at Sparrows Point, ISG eliminated 200 overseers, reducing seven layers of management to three. "There are less people looking over their shoulders," says Joe Rosel, a United Steelworkers contract coordinator who helped negotiate the new contract.
Now, the workers are basically running the plant, making many of the day-to-day operating decisions. "We were 50 years coming to this point," says Jim Huber, a union trainer.
The workers are quick to point out that they are working harder too: Sometimes one hard hat is doing the work that used to be done by two or more. Some 165 different job descriptions - with all the union ramifications - have been trimmed to five. "It's been hard to get used to in the last six months," says Mr. Huber, "but a lot of growing pains have eased."
So the tariffs did not cause the steel industry to become incredibly complacent.
My own reaction to the steel tariffs brouhaha is that it has been a tempest in a teacup. The United States has such low barriers to imports that it is running a half trillion dollar trade deficit of about 5% of GDP. In the face of this massive deficit assorted economists and free market advocates have found far more time to castigate the Bush Administration for tariffs than they have to discuss what is doing far more harm to the long term health of the US economy: the gradual build-up of huge debts owed to other nations and the loss of sales by US businesses to foreign competitors. Some argue that the deficit is there because the US government is running a large budget deficit and therefore is sucking in foreign money to buy bonds. There are two facts that, at the very least, have to be reconciled with that explanation:
There is an aspect of the focus of economists on things like tariffs where they have a model that predicts that a certain policy is bad and they are sort of like someone in possession of a hammer who wants to knock away at nails. Meanwhile there are all sorts of nuts and bolts that need attending to (e.g. the overvalued dollar and the huge trade deficit) and most economists do not have nearly as much to say about these other very real economic problems.
To his credit in a recent Tech Central Station essay Arnold Kling took a stab at explaining the US trade deficit problem and argues that the US might be able to shrink the trade deficit by shifting taxes from income to consumption.
The best idea from supply-side economics is to use tax policy to encourage work and thrift rather than as a tool to redistribute income. We should change the mix of taxes to favor saving rather than consumption. That would increase private saving.
Why do foreign investors invest so heavily in dollar-denominated assets and bear the risk of a decline in the dollar? Personally, I think it is because they are stupid. But that is not an appropriate answer for an economist to give.
If I were forced to pick an economic theory to explain the dollar bubble, it would be the theory of the safe haven. In a world of political and economic turmoil, America's securities represent a stable store of value. Are you a Saudi worried about the viability of the regime? Buy U.S. securities. Are you a citizen of a former Soviet republic trying to keep the criminals and kleptocrats away from your savings? Buy U.S. securities. Are you a European who is pessimistic about the prospects for the welfare state? You get the idea.
That flow of money to buy US securities, by driving up the value of the dollar, effectively reduces the demand for actual real American products and services. So one way to explain the US trade deficit is that the rest of the world has enough fear about the stability of their own societies that they want too much in the way of US financial assets. Is this argument correct? There are reasons to be skeptical. For instance, private Japanese investors have ceased to be net purchasers of US securities and yet the Japanese government is buying US treasuries in order to prop up the dollar against the Yen in order to increase Japanese exports to the US while simultaneously decreasing US exports to Japan (and probably do to the same for Japanese trade for other countries since, for instance, China's currency is fixed against the dollar).
Suppose Arnold Kling's argument is correct. This means that foreign people in massive numbers make decisions that cause the US market to become highly distorted. Is it wrong for the US government to try to pursue policies that compensate for this distortion? Or are such policies anti-free market and therefore automatically wrong? The latter position strikes me as ideological. Economists who argue that it is wrong for governments to attempt to compensate for the madness of the crowd are clinging to an incorrect model in the face of enormous evidence that humans do not behave like highly rational homo economicus. Attempts to make policy prescriptions based on false assumptions about human nature have got to lead to bad policy choices.
In the real world foreign investors went through a period of irrational exuberance about the US economy and then when that irrational exuberance finally started to wane other governments stepped in to keep the currency market thoroughly distorted. For example, when Japanese investors lost their enthusiasm for US securities the Japanese government stepped in to replace them.
Foreign investors are growing wary. According to Dr. Rob Van de Wijngaert, a strategist at ABN AMRO in Amsterdam, U.S. Treasury numbers show that "apparently there is not a single institutional fund in Japan which is willing to buy U.S. Treasuries and instead the Bank of Japan purchased no less that $150bn this year" According to Van de Wijngaert, the latest numbers show that foreign "demand for U.S. Treasuries, bonds and stocks is plummeting."
For example, the Bank of Japan has already spent 18 trillion yen (S$283 billion) slowing US dollar losses against the yen this year, and the strongest signals on our charts are for further euro, Sterling pound and Australian dollar gains versus the yen.
In descending order Japan, Britain, and China are the three biggest holders of U.S. Treasuries. It would be very interesting to know in each case what percentage of those Treasures are held by central banks and by private entities.
Morgan Stanley chief economist Stephen Roach, casting doubt on recent figures which show large rises in worker productivity, says financial services workers are putting in more hours than are reported.
For example, in financial services, the Labor Department tells us that the average workweek has been unchanged, at 35.5 hours, since 1988. That's patently absurd. Courtesy of a profusion of portable information appliances (laptops, cell phones, personal digital assistants, etc.), along with near ubiquitous connectivity (hard-wired and now increasingly wireless), most information workers can toil around the clock. The official data don't come close to capturing this cultural shift.
As a result, we are woefully underestimating the time actually spent on the job. It follows, therefore, that we are equally guilty of overestimating white-collar productivity. Productivity is not about working longer. It's about getting more value from each unit of work time. The official productivity numbers are, in effect, mistaking work time for leisure time.
His argument correlates with what we see happening around us. Lots of people talk on their cell phones about work-related matters while doing their driving commutes. E-mails about work matters flow at all hours of the day and night. People go on vacation and keep track of business events using cell phones. Faxes flow in to home fax machines. Though these changes do not affect all kinds of work. Still, there are plenty of people who do all their work and work-related communications while at the office. Roach's own position as a chief economist at a major brokerage firm is untypical. Some types of jobs require that by their very nature. In other cases where people interact with computers the employers do not allow access to corporate database access applications from off-premises sites.
How much has your own work bled over into your non-work life as a result of advances in communications and computing technology? How much of that change is voluntary on your part and how much is being pushed on you by your employer, customers or vendors?
By the end of the 1990's boom, this invisible unemployment seemed to have stabilized. With the arrival of this recession, it has exploded. From 1999 to 2003, applications for disability payments rose more than 50 percent and the number of people enrolled has grown by one million. Therefore, if you correctly accounted for all of these people, the peak unemployment rate in this recession would have probably pushed 8 percent.
Unfortunately, underreporting unemployment has served the interests of both political parties. Democrats were able to claim unemployment fell in the 1990's to the lowest level in 40 years, happy to ignore the invisible unemployed. Republicans have eagerly embraced the view that the recession of 2001 was the mildest on record.
Keep in mind, though, that a lot of loafers on disability payments who are not really disabled would be working if they were not able to receive the payments. So while the argument by Austan Goolsbee that disability payments cause an underestimate of official unemployment not all those who are unemployed and on disability are unemployed as a result of worsening economic conditions.
The need for reform is clear. OECD countries spend at least twice as much on disability-related programmes as they spend on unemployment programmes. Disability benefits on average account for more than 10 percent of total social spending. In the Netherlands, Norway and Poland they reach as much as 20 percent of social expenditure.
The Netherlands has a low unemployment rate by European standards. But about one seventh of the Netherlands working age population lives on disability payments.
The absurdly generous disability scheme, the WAO, has nearly 1 million people on its rolls out of a total working-age population of 7 million.
By October more than 800,000 people, or a fifth of the workforce, were on sick leave or had been pensioned off early, according to the National Insurance Board. The cost from January to October was 86.5 billion crowns ($11.45 billion) or 15 percent of spending.
Those rates are the worst in the EU and have doubled in two years, despite the healthy lifestyle of a people who smoke and drink less than other Europeans, do more sport and have the world's third highest standard of living in U.N. rankings.
The populations of the Western democracies are aging. The burden of supporting the swelling ranks of the elderly looks set to grow substantially. The Western countries need to push the able-bodied among their populations out into the workforce to work, produce goods and services, and pay taxes to support those who really can not work.
It has become popular to argue that First World subsidized food dumping harms Third World countries. Is this argument correct? Let me present a contrarian view. I'm not sure I believe it but it is presented for your consideration:
Urban workers (and some of them are self-employed) who can pay less for food can buy more food and that is a real benefit to them. If they have enough money after that they can buy other stuff as well and accumulate capital to start their own businesses. Accumulation of capital in non-farming economic activity is essential for the development of the poorest countries.
Agricultural workers: Some are subsistence farmers who eat everything they grow. Lower import prices do not hurt them if they are not even able to sell surplus food. Others are hurt if the imports drive down the price of local food. But they are only hurt for that portion of the food they grow that they sell.
Imagine responding to this argument by driving up world food prices to some high level. Think that thru. Why not, in the name of helping Third World farmers, triple the price of internationally traded food? What do you think the effect of doing that would be? My guess is that the total amount of hunger and poverty would rise. Third World countries would have to pay more to import food and therefore would have less money (or no money) to spend to import other things. Granted, local production might rise as a result. But the money available even to invest in local agriculture would be less.
Take the other extreme: imagine that the price of food dropped to zero. Well, everyone would have enough to eat and they'd have more time to engage in economic activity that produces other kinds of goods and services.
This focus on the Third World farmers and the prices they get for their crops seems misplaced. The way forward for the Third Worlders is for them to get work that is off the farm. The benefits of lower tariffs for textiles and other low tech manufacturing products are far more certain than the supposed benefits of having developed countries raise the prices of their agricultural exports. Low food prices help some while hurting others. But the ones that are helped are the very ones who are doing the kinds of work that will lift the Third World out of subsistence farming. Lower food prices will probably accelerate their accumulation of capital. If Third Worlders to spend less on food they will have more more money on other things such as, say, a sewing machine or a hand tool or a cart for transportation.
Plus, even low prices for some types of food are beneficial for some forms of agriculture. Consider that cattle and chicken farmers use grains to feed their cattle. Lower the price of corn and their costs go down.
In a nutshell: Human living standards rise because humans find ways to spend less time doing what they used to do so that they can spend more time creating new kinds of goods and services. The fact that so many people in less developed countries spend so much time working on farms is not an argument for protecting the farm economies of the Third World. It is an argument for reducing the need for Third Worlders to work on the farm so that they can spend more time creating other kinds of goods and services. The real problem is not that farmers can not get enough money for their crops. The problem is that people in poor countries have to spend so much time farming and hence do not have enough time to do other work.
Anything that frees the world's poor from having to farm should cause living standards to rise if the local economies allow those people to move into other work. If there is a problem in the Third World with the move off the farm then the problem must come in the form of obstacles to developing other kinds of work activities.
Update: A couple of arguments against the proposition above could be advanced.
First, a rapid collapse in food prices could be too disruptive to a society. Societies are made up of webs of relationships and if too many relationships are disrupted at once then the resulting chaos will unleash wars, crime waves, and other disruptions that cause net harm and destruction.
Another argument is that people in poor countries know how to farm. They don't know how to do other things. But think about that. They may plow fields but they also make their own clothing and implements for working the fields. They do have other skills. They also can be taught other skills by those who are already working in other industries. Plus, a lot of low-tech manufacturing is incredibly low skill work. One big barrier to engaging in other kinds of work is that so much time has to be spent farming. Free people up from having to farm and they will have more time to do other work.
Berkeley, October 29, 2003 – A ferocious new wave of outsourcing of white-collar jobs is sweeping the United States, according to a new study published by University of California, Berkeley, researchers, who say the trend could leave as many as 14 million service jobs in the United States vulnerable.
Study authors Ashok Deo Bardhan and Cynthia Kroll, both researchers at the Fisher Center for Real Estate and Urban Economics housed at UC Berkeley’s Haas School of Business, say that not all of the at-risk jobs are likely to be lost. But, they note, jobs remaining in the United States could be subject to pressures to lower wages, and the jobs that leave may slow the nation’s job growth or generate losses in related activities.
Jobs most vulnerable to the new wave of outsourcing, the researchers say, include medical transcriptions services, stock market research for financial firms, customer service call centers, legal online database research, payroll and other “back office” activities. Altogether, the positions feature vulnerability-producing attributes such as a lack of face-to-face customer service, work processes that enable telecommuting and Internet work, high wage differentials between countries, a high information content, low social networking requirements, and low set-up costs.
Bardhan and Kroll say that the widely quoted Forrester Research (an independent technology research company) report issued in 2002 that 3.3 million jobs would be lost to outsourcing by 2015 already seems conservative. They point to the rate of outsourcing over the past few years to India – 25,000 to 30,000 jobs in June 2003 alone.
Even face-to-face customer service will be affected as companies compare the costs of, say, face-to-face customer contacts versus phone contacts and other electronic ways of interacting with customers.
In the face of all this intensifying competition from abroad the United States should not have an immigration policy to bring in millions of unskilled workers with less than 9th grade educations. We need an immigration policy designed with knowledge worker competition in mind. We could improve our educational system in ways that increase the number of sharp knowledge workers we have as well. See the post Accelerate Education To Increase Tax Revenue, Reduce Costs.
University of Maryland professor Peter Morici, in testimony at an October 30, 2003 hearing of the U.S. House Ways and Means Committee, argues that the large US trade deficit is slowing US economic growth.
Given rapid productivity growth and foreign investments in China, we would expect the dollar value of the Chinese currency to rise with its development progress. However, since 1995 the Chinese government has maintained a policy of pegging the yuan at 8.3 per dollar.
Since 1995, the U.S. trade deficit with China has grown from $38 billion to $140 billion, and the overall U.S. current account deficit has grown from $105 billion to $555 billion. In contrast, when China was granted most-favored-nation status by the Congress in 1980, the U.S. bilateral trade and global current accounts were in surplus at $2.8 billion and $2.3 billion, respectively.
Consequently, reduced sales and layoffs in U.S. import-competing industries caused by Chinese competition have not been matched by increased sales and new jobs in U.S. export industries at the scale a market driven outcome would require. The free trade benefits of higher income and consumption to the U.S. economy have been frustrated by currency market intervention.
Morici claims the US economy would be much larger today if the US was not running such a large trade deficit for so many years.
Chronic trade deficits with China, Japan and other countries, which emerged in the 1980s, have reduced U.S. productivity growth and the trend rate of GDP growth by lowering U.S. value added per employee and investments in R&D.
In a nutshell, increased trade with China and other Asian economies should shift U.S. employment from import-competing to export industries. Since the latter create more value added per employee and undertake more R&D, this process would be expected to immediately raise U.S incomes and consumption and boost long-term productivity and GDP growth.
Instead, growing trade deficits with China and other Asian economies have shifted U.S. employment from import-competing and export industries to nontradeable service producing activities. The import-competing and export industries create about 150 percent more value added per employee, and spend more than three times as much R&D per dollar of value added, than the private business sector as a whole.
By reducing investments in R&D, an econometric model constructed for the Economic Strategy Institute indicates the overvalued dollar and resulting trade deficits are reducing U.S. economic growth by at least one percentage point a year—or about 20 percent of potential GDP growth.  China accounts for almost half of this lost growth.
Importantly, this one percentage point of growth has not been lost for just one year. The trade deficit has been taxing growth for most of the last two decades, and the cumulative consequences are enormous. Had foreign currency-market intervention and large trade deficits not robbed this growth, U.S. GDP would likely be at least 10 percent greater, and perhaps 20 percent greater, than it is today. GDP and tax revenues would be higher, and the Congress would not be facing large federal deficits. We would not be enduring a crisis in manufacturing and a jobless recovery, and the Congress would not be facing the difficult task of trimming Medicare benefits.
This makes a certain amount of intuitive sense. US companies faced by lower cost competitors are not going to invest in research, development, and capital spending in the United States if they have no chance of competing against such lower cost producers. Also, a deficit represents large amounts of sales not made to companies in the US. Those companies that lost sales to foreign competitors did not pay US salaries and taxes to produce goods and services domestically. Those companies had less revenue to use to develop new products and improvements in manufacturing processes.
Free trade advocates would argue that lower cost imports force domestic producers to innovate. But if the imported products were incredibly successful in making domestic companies more efficient then the importers would not continue to be so successful selling in the United States. Yet, as evidenced by the huge trade deficit, the foreign makers are very successful. Plus, trade conducted with a fixed currency peg is does not constitute free trade anyway. It is trade which is being manipulated by the country maintaining the currency peg.
Clyde Prestowitz, president of the Economic Strategy Institute mentioned above, sees the exchange rates as less important than other factors in explaining the US trade deficit.
As long as the United States runs federal budget deficits and has low domestic savings rates, it will have a current account deficit and will be dependent on capital inflow from abroad, mostly from China and Japan. And that's not to mention the fact that we also want those countries to help us with North Korea and Iraq. Which is why no American treasury secretary or president is going to mean it when he talks about getting tough with either China or Japan.
But the problem with this argument is that the US still had high and rising trade deficits during the later Clinton Administration years when the US federal government was running a large budget surplus. Therefore the argument that a budget deficit causes a trade deficit doesn't seem to work.
In spite of his views about the cause of the US trade deficit Prestowitz still sees a very big reason to make China drop the Renminbi-Dollar currency peg: Latin American economies.
CLYDE PRESTOWITZ: Cheap labor has made China a trade powerhouse. Combine that with an undervalued yaun, kept down by pegging China's currency to the dollar, and you have a magnet for factories that produce everything from toys and tech to textiles. That's been great for China, but it's often been a great cost to other countries struggling to develop. Look at Mexico. Every day now factories that once lined the corridor just south of our border are closing up shop and moving. You guessed it: Off to China.
He is exactly right about this. The US would face less of a problem with illegal alien immigrants if jobs were not getting shipped wholesale from Mexico to China. Those illegal aliens who come to the US looking for pay little in US taxes while generating large costs for citizen taxpayers of the United States.
But to get back to the original issue, the US trade deficit: A long sustained US trade current account deficit has negative effects on the long term health of the US economy. Debts to foreigners have to be paid off some day. When US companies lose sales to foreign companies the domestic companies do not pay American citizens to build capital plant, to make consumer products, or to do design and we are worse off in the long run.
Businessweek sees the pressures building on China to devalue its currency.
The G7's Dubai declaration echoed the group's Plaza Accord of Sept. 22, 1985. That agreement also sought to bring the greenback down from its then-lofty heights. And it succeeded beyond the group's wildest expectations, as the dollar lost more than a third of its value vs. major currencies. Dubai suggests that history may be about to repeat itself, albeit to a more muted extent.
George W. Bush wants to get reelected. The job market continues to be weak while China's trade deficit with the United States continues at record highs.
Jasper Becker also sees devaluation of the Renminbi as inevitable because China can't keep buying up US government debt in order to prop up the exchange rate with the US dollar.
In June China had foreign currency reserves of $365bn. In order to keep the renminbi stable at about 8.28 to the dollar, China's central bank has to keep buying up surplus dollars and reinvesting them abroad. In practice this means buying US Treasury bonds. China's holdings of US Treasury bonds rose to a record $122.5bn last month, far more than any other country apart from Japan. Together Japan and China hold 41.9 per cent of the $1.35 trillion debt the US government owes the world.
Of course, a decline in the demand for US government debt combined with a decline in the value of the US dollar could unleash higher prices and higher interest rates in the face of an already weak labor market.
U.S. investors are worried that too rapid a decline in the dollar would kick up interest rates and could spell a sudden end to the recovery
A US dollar decline would boost the demand for US exports and at the same time it will reduce foreign competition for domestically produced goods and services. But that effect takes a while to play out.
The problem with the US economy at this point is that while while layoffs have declined hiring has not picked up.
The new numbers portray an economy stuck in neutral, with workers no longer losing their jobs at the rapid pace of 2001 but with relatively few new job opportunities popping up. In the last three months of 2002, 7.8 million jobs were eliminated, while 7.7 million were created, according to company records studied by the bureau.
My own suspicion is that US corporations are net hirers abroad but not in the US labor market.
Health insurance premiums for American employees rose 13.9 percent during the past year, the biggest annual jump since 1990, according to a survey of employers released today in Washington.
As employers cut medical benefits in response to cost increases people are more worried about becoming uninsured than being attacked by terrorists.
The poll found that 33 percent of the insured worry that their income might not keep up with health premiums, while just 8 percent said they fear being a victim of a terror attack.
Dick Morris explains George W. Bush's declining approval rating in polls as a result of a declining concern about terrorism along with a rising concern about other issues.
Why is Bush falling so badly? The superficial reasons are the Iraq casualties, the failure to find WMDs and the continuing inability to round up Saddam Hussein and Osama bin Laden. But the real reason is that terror is receding as an issue, largely due to Bush's success.
While the terrorist issue is receding people are continuing to feel bad for economic reasons. Discouraged workers are abandoning the job search and causing a lower reported unemployment rate.
Nonfarm business payrolls declined by 93,000 last month, raising the total of job losses since the start of the year to 431,000. The job cuts were the deepest in five months. Still, the unemployment rate fell a tenth of a percentage point to 6.1% as more discouraged workers dropped out of the labor force.
Probably the biggest threat to George W. Bush's reelection is the so-far jobless economic recovery caused in part by rapidly rising productivity.
Production is rising even faster this quarter than last, according to many forecasters, while yesterday's report showed that the number of hours worked nationally fell at a faster rate in July and August than it did in the April-June period. That combination points to another huge gain in productivity, several analysts said.
Whether personal economic assessments will remain as important as they are now come the date of the November 2004 vote is hard to say. A big terrorist attack could shift people's thinking away from economics even as a large attack would have enormous costs. But at this point Bush really needs an economic recovery that starts generating jobs.
If Bush wasn't so intent upon his foolish and futile pursuit of the Hispanic vote he could strengthen his support among lower class blacks and whites by reducing the competition they face in the labor market from illegal immigrants. If he announced support for a massive fence to keep out illegals and initiated mass deportations of illegal aliens this would decrease the amount of competition that low income Americans face in the labor market. Doing that alone would probably get him reelected. The Steve Sailer strategy for California could work nationally.
Morgan Stanley chief economist Stephen Roach argues it is not the fault of China that it is running a huge trade surplus.
This argument makes no sense. Roach correctly argues that it is foreign investment in China that is responsible for most of the factories that make the surging amounts of goods being exported from China. He thinks that just because foreign rather than domestic investors are responsible for China's surging exports that the Chinese government should not have to respond to demands for a revaluation of the Chinese Renminbi (RMB). But the nationalities of the owners of the capital invested in China are largely irrelevant to whether China should float its currency. Is he going to argue that it is wrong for foreign investors to invest in China since the result is large trade imbalances? I think not. The real issue here is whether changes in currency valuations should be used to balance trade. Well, why shouldn't this mechanism be allowed to work?
A second argument in support of China’s currency peg is the nature of the nation’s competitive prowess. Contrary to widespread perception, China does not compete on the basis of an undervalued currency. It competes mainly in terms of labor costs, technology, quality control, infrastructure, the improved human capital of its work force, and a passion for and commitment to reform. I honestly believe that if China were to revalue the RMB upward by 10% -- a change I do not expect nor advise -- its exports would suffer minimal loss of market share.
He notes, correctly, that the peg of the RMB to the US dollar (USD) is causing the RMB to decline in value along with the USD. But this is contributing to the huge surge in exports from China. Why should one currency, in this case the RMB, be pegged? He blames foreign companies for shifting production to China. But take some other country, fix its currency to the dollar at a rate that makes exports from that country very cheap, and foriegn investors who are assured that the currency peg will be maintained will invest in factories to export from that country.
The only other way to fix trade imbalances is to impose trade barriers. Surely Roach is not advocating that option. Therefore he's essentially arguing for a continuation of large scale trade imbalances that he has argued in other essays are unsustainable.
Morgan Stanley chief economist Stephen Roach sees continued decline in the US net national savings rate. (my emphasis added)
This is a story of arithmetic. The accounting identity is often the most powerful of economic constraints. Such a framework is not subject to theoretical interpretations -- the identities simply have to add up, year in and year out. For any nation, saving must always equal investment. Unfortunately, America’s national saving rate is plunging into the danger zone. In the first quarter of 2003, gross national saving -- households, businesses, and government units, combined -- fell to 14.0% of gross national product; that’s down 1.5 percentage points from the year-earlier rate and fully 4.8 percentage points below the post-1960 norm of 18.8%. But that’s only the tip of the iceberg.
The problem is that most of America’s national saving now shows up in the form of depreciation -- funds that are earmarked for the replacement of worn-out physical assets. In the first quarter of 2003, such depreciation accounted for fully 94% of total saving. That means that the net national saving rate -- that portion of national saving that is available to fund the actual expansion of productive capacity -- fell to a record low of 0.7% of gross national product in the first period of this year. That’s off sharply from the year-earlier reading of 2.3% and is well short of the nearly 5% average of the 1990s and the 11% norm of the 1960s. There are few macro gauges that tell us more about an economy’s internally generated growth capacity. Sadly, America has all but depleted its reservoir of net saving -- the sustenance of longer-term economic growth.
The savings rate is only part of the structural problem in the US economy. Think intuitively about what it means for the US to be running a 5% trade deficit. We are consuming 5% more than we are making. Now, there may be services trade that is hidden that makes that deficit smaller than it seems. But it is not sustainable. American living standards will effectively have to fall (or grow more slowly for a while) in order to bring that back into balance.
Roach thinks that the US net national savings rate may shrink to zero or even go negative while the trade deficit simultaneously widens. Roach expects further declines in the trade-weighted value of the dollar by as much as an additional 30%. Only a decline in the dollar can reduce US demand for imported goods and increase world demand for US goods enough to bring US trade back into balance with the world. That would have an inflationary effect on prices in the US and deflationary effects on much of the rest of the world.
More than 30 British farmers have signed up for leases on Russian land in a move to tap the potential of Russian agriculture and escape the doldrums of British farming.
Recent agricultural reforms and an improving outlook for Russian farming have encouraged certain British farmers to consider the potential of investing in Russian agriculture.
Over half of Russia's arable land is idle and the country has to import basic foodstuffs. The British farmers will find a large domestic Russian market for the crops they grow in Russia.
British farmers entangled in the European Union's red tape are aiming to break free by moving to Russia to cultivate land being offered to foreigners in a fertile region.
Almost a million acres of prime arable land are lying idle in the Penza region, 400 miles south-east of Moscow, because local farmers cannot raise sufficient money to buy the machinery, fertiliser and seeds needed to work it.
The ability of foreign farmers to enter into lease agreements to farm Russian land was made possible by a land reform law change passed in June 2002.
After six hours of half-hearted debate, the State Duma approved a bill in the crucial second reading allowing Russians to buy and sell farmland and restricting foreigners to 49-year leases. Liberals slammed the limitation on foreigners. The only protest from the Communists, who oppose the sale of farmland altogether, came from a crowd of about 200 people rallying outside the Duma building. Most lawmakers appeared to be more interested in following two World Cup soccer games that were being played, and the Duma hall was all but empty during the debate.
There are nearly 1,000 people per square mile in the Netherlands. In Iowa there are 50. Dutch dairy farmers -- also burdened by strict government regulations on land use -- are looking for alternatives, and Iowa's Butler, Mitchell, and Poweshiek counties are looking to take advantage. Along with two advocacy groups, Iowa Extension and the Dutch National Extension, the counties are trying to facilitate a wave of agricultural emigration under the Iowa New Farm Family Project.
The Dutch National Extension Service estimates around 7,000 farmers will resettle in the US over the next decade. Iowa wants and needs many of them. Butler County, for example, had 176 farms with dairy operations in 1982. Fifteen years later that number was down to 44.
The net result will be to pump some $210 billion in purchasing power into the economy over the next sixteen months—a non-trivial 1.4 percent of GDP. The neo-Keynesians in the White House—yes, such there be—believe that it is necessary to stimulate demand in order to sop up the excess capacity that is deterring new investment in several key industries. Moreover, everyone is underestimating the size of the tax cut. Congress halved the president’s request, and approved $350 billion in tax relief over the next ten years. But Congress managed to keep the figure so low by assuming that taxes will be allowed to return to their prior, higher levels on January 1, 2005. That, say the politicians who have experience with such things, is highly unlikely: congressmen are not about to campaign in November of 2003 on promises to raise taxes shortly after taking office. So the reductions won’t expire, and total tax relief is likely to approach the figure the president originally requested.
The debate over the size of the package -- $350 billion versus $550 billion versus $726 billion -- is essentially meaningless. These amounts represent the total impact over the 2003-2013 period and can be greatly affected by altering the phase-out dates. Under the theory that it is much harder to raise taxes than it is to cut them, there is a strong likelihood that most of the changes contained in this bill will be made permanent at some point. Indeed, there are dozens of provisions of the tax code that are slated to expire every single year and routinely wind up being renewed. So, even though it is being advertised as "only" a $350 billion tax bill, the enactment of this legislation appears to be a major victory for the White House.
Is this tax cut big enough to make a difference to the US and world economies? The problem is that US can no longer serve as the demand source for economic growth. American consumers are saving too little. They have too much consumer debt. The US trade deficit can not continue to grow and the fall in the dollar is finally beginning to reflect that.
Morgan Stanley chief economist Stephen Roach runs thru some of the numbers that demonstrate why the US must go thru a wrenching economic readjustment.
America’s net national saving rate -- the combined savings of households, businesses and the government sector (net of depreciation) -- fell from about 5% of GDP in the mid-1990s to just 1.3% in the second half of 2002. Lacking in domestic saving, the United States has no choice other than to import increased flows of foreign saving -- running ever-widening current account deficits in order to attract that capital. As a result, the world’s dependence on dollar-denominated assets is now at extremes. Currently, about 75% of the world’s total foreign exchange reserves are held in the form of dollar-denominated assets -- more than twice America’s 32% share of world GDP (at market exchange rates). At the same time, foreign investors hold about 45% of the outstanding volume of US Treasury indebtedness, 35% of US corporate debt, and 12% of US equities. All of these ratios are at or near record highs. Never before has the world put more stock in America -- both as an engine of growth and as a store of financial value.
The problem is that the math gets exceedingly tenuous if it is projected into the future. And yet the die is now cast for additional widening of an already massive US current account deficit (a record 5.2% of GDP in 4Q02), suggesting that all of these ratios will have to rise sharply further on the years ahead.
The rise in the Euro and drop in the dollar is effectively exporting US deflation to Europe. The problem is that Germany is already experiencing deflation and this will only make deflation a worse problem in Europe. Yet the US dollar really does have to fall to decrease US demand for imports and to increase world demand for US exports.
The decline in the US dollar against the Euro is limited in terms of how much it can cause a necessary rebalancing of the world economy. One reason for that is that the important growing US-China trade is conducted at a fixed exchange rate.
China has kept the yuan (its official name is the renminbi) fixed at about 8.3 yuan to the dollar since the mid-1990s. For any other big exporter, keeping this peg would be a near-impossible task. Last year, China sold $125 billion in goods directly to the United States, according to the Commerce Department, a big shift up from 2000, when China's U.S. exports came to just $82 billion. Meanwhile, the United States exported just $22 billion in goods to China in 2002.
This has a perverse effect. As the US dollar falls the currency of a very large ($6 trillion dollars per year at current exchange rates) economy that is running large trade surpluses experiences a fall in its currency as well. Does this cause a net improvement in trade balances by shifting demand and supply between America and the rest of the world in a more sustainable direction? Or does it cause greater harm by increasing demand for Chinese goods by lowering their costs?
The stakes in the needed big global economic rebalancing are quite high. Stephen Roach outlines a scenario in which the currently sound US financial system could become unsound if deflationary pressures become too great in the United States.
By contrast, US banks are in good shape at the moment, having gone through a serious shakeout in the early 1990s. But America has record debt loads, especially the household sector, where debt-to-GDP currently stands at a record 80% -- fully 15 percentage points above the ratio prevailing in the recession of the 1990s. The US also has flexible labor markets and a relatively flexible wage-setting mechanism. Should deflationary risks get to the point where Corporate America needs to slash labor costs more aggressively -- both headcount and compensation -- that would severely impair the household sector’s debt-servicing capacity. The result would be a sharp increase in nonperforming loans and a concomitant outbreak of distress in the American banking system.
US consumer debt and the US balance of payments deficit are just two reasons why I do not foresee robust US economic growth. Another problem is that, as John Maudlin points out, the asset bubble of the 1990s has left the US economy with a capital surplus and excess unused productive capacity.
The last problem to look at is the business spending excesses of the 90's. We simply created too much capacity throughout the world to manufacture every conceivable product. Capacity utilization is one of my favorite bellwether statistics. As of May, 2003, US manufacturing was using less than 75% of its capacity. Economists tell us that capacity utilization must be in excess of 80% for significant new business investment to occur. This can happen in two ways: demand can pick up OR companies can go bankrupt thereby reducing capacity.
An asset bubble that causes excess capital spending causes the worst kind of adjustment when the bubble finally pops. A recession caused by a need to put an end to consumer price inflation is nowhere near as difficult to get thru. The great historical economic downturns (e.g. the 1920s Depression) have been caused by capital asset bubbles because the resulting surplus of capital goods takes many years to dissipate.
The competition from China for the production of cheaper consumer goods is an additional source of deflationary pressure contributing to lower capacity utilization in the United States. But the telecommunications and information technology revolution is adding a new form of global competition: competition for services. Many forms of phone-provided services such as technical support for software, order-taking, and reservations scheduling services are being outsourced to India, the Philippines, and other countries. Also, even higher paying jobs such as computer programming are being outsourced to India.
US policy makers are trying monetary expansion and fiscal stimulus to try to get the economy growing briskly. But they are fighting against too many external factors as well as excess consumer debt and the lingering excess capacity caused by the 1990s asset bubble. It is quite possible that the deflation now occuring in Japan, Germany, and other countries will spread to the United States. Even if it doesn't the US economy has too many problems that still need to be worked out before rapid economic growth can resume.
The Hong Kong Retail Management Association reports Hong Kong retail sales have dropped in half due to SARS.
Retail sales in Hong Kong have fallen by 50% since the outbreak of the deadly pneumonia-type Sars virus, a retail group has said.
"Sars is a growing threat to Asia and possibly the globe," Citigroup said in a research report, estimating that even if it ended soon, it could have a negative impact of more than 1 per cent on Hong Kong and Singapore's gross domestic product growth
Singapore and Hong Kong, the two cities that have been hardest hit. Hotels in the former British Crown colony have seen occupancy levels drop to below 20 percent.
According to IT researcher the Aberdeen Group, Motorola Inc. has temporarily closed a cell phone manufacturing facility in Singapore after authorities quarantined 305 workers due to SARS exposure;
Cell phones are end-user products. There are many alternative suppliers. Loss of one manufacturing plant is going to have a fairly small impact. What would have a much greater impact would be shutdown of a plant that makes key components that are made by few other plants.
"The SARS situation is causing greater concern for us right now than the war is," says Irwin M. Jacobs, CEO of phone-technology giant Qualcomm Inc. (QCOM ) "It has the potential to seriously disrupt business."
Russell Craig, co-author of a report by the Aberdeen Group on the threat that SARS poses to electronics manufacturing, emphasizes the threat that SARS poses to the key component makers in the electronics supply chain.
“As an example, the PRC is a major source of AC-to-DC power supplies -- those little black cubes that clutter your power strip. You can assemble a laptop elsewhere, but you cannot sell it without a power supply. Thus SARS threatens the supply of key component building blocks, not just the assembly plants.”
Another big impact of the reduced amount of travel due to SARS will be decreased numbers of business deals, decreased rate of progress for engineering meetings to customize parts for customers, reduced amounts of on-site tech support, and other reductions of face-to-face meetings that enable commerce to happen.
Given time, the ripple effects of manufacturing disruptions, travel bans and transportation delays, would affect the entire supply chain of the industry. Due to its low manufacturing costs, China has been a key producer of electrical components in recent years.
Distrust of the Chinese government is causing people to react to their worst case fears on the spread of SARS.
Until Wednesday, Shanghai had consistently denied harbouring any SARS cases. Though the city government announced on Friday it has discovered just one SARS case so far, many city residents say they find that hard to believe because of the thriving commercial metropolis' close business links with Hong Kong and Taiwan.
Businesses are going to avoid sending personnel to China for longer than they avoid sending people to Singapore and other areas infected with SARS because the Chinese government can not be trusted to tell the truth about SARS. After supposedly admitting to all known SARS cases the latest report from China which reports a total of 53 deaths sounds like it includes older known cases that were previously not revealed.
State television reported one SARS death each in the provinces of Shanxi in the north, Sichuan in the west and Hunan in central China the first reported fatalities in those areas and an indication the disease was more widespread than previously acknowledged.
In at atmosphere of distrust about what are the real facts about SARS business decision-makers are going to tend toward assuming the worst. If China is unable to stop the spread of SARS then the rate of new foreign direct investment will begin to decline. That will slow China's economic growth rate.
A lot is riding on the ability of public health authorities to stop the spread of SARS. For the latest thinking on the scientific and medical efforts to stop SARS see my FuturePundit post entitled "Scientists Say SARS Spread May Be Inevitable"
Morgan Stanley chief economist Stephen Roach sees no growth in the world economy in the second quarter of 2003. He says the economies of the developing world appear to have contracted in February and March. Overall for the year his group sees 2.4% growth for the entire world. But since the world average is boosted by some faster growing East Asian economies the industrialized Western economies will see a more anemic growth rate. Roach says that the potential for the further spread of SARS and other risk factors make further forecast revisions most likely to be toward the downside.
Nor should this dip be viewed as just a two-month statistical fluke that will end the moment that Baghdad falls. Our baseline forecast currently points to a world economy that is likely to record “zero” to slightly negative real GDP growth in the second quarter of 2003. For the current period, we are projecting outright contractions in Europe and Japan that could more than offset fractional growth in the US and elsewhere in the world. Moreover, with SARS-related disruptions hitting Asia exceedingly hard at the moment, the risks to our second-quarter estimate are decidedly on the downside
If the SARS outbreak is not controlled the economic impact of SARS could quickly become much larger as business and tourist travellers start avoiding an even longer list of destinations and people who live in affected areas avoid going out, spending money, and working in crowded offices. If SARS is spreading in the poorest parts of China or makes it into Bangladesh or India or some other country will primitive health care infrastructure then the containment of SARS becomes much less likely. Then the economic impact of the disease will increase enormously.
0525 GMT [Dow Jones] Another sign of how SARS taking toll on travel in Asia with Sydney Airport chief saying traffic yesterday was down 23% on-year; but adds it's too soon to say what impact SARS will have on Australia's largest airport, and analysts say fall was expected after Qantas' recent profit warning.
The Business Travel Coalition survey of large employers found 27 percent banned travel to some Asian destinations.
The group contacted about 1,800 corporations and other large employers Tuesday. Of the 180 who responded, 27 percent said they had banned trips to some Asian countries because of SARS. An additional 8 percent were considering similar prohibitions. Those banning travel had restricted visits to Hong Kong, and most also had limited trips to China, Singapore and Vietnam.
The Toronto Canada SARS outbreak has raised enough concern that some governments are advising against travel to Toronto
The situation in Canada is judged so serious that authorities in Ireland, Australia and Spain have issued a travel warning recommending that their citizens avoid travel to Toronto, the epicenter of the Canadian outbreak.
Remember, a reduction in business travel doesn't just reduce revenue to the travel industry. It also reduces the rate at which sales deals and investment deals are made. It slows the rate at which engineers get together to hash out problems between large customers and their suppliers. Travel bans prevent service and support people from coming to fix a problem on a factory floor at a remote location.The world economy is very dependent on labor mobility. The reduction in business travel will reduce economic activity in ways that are less visible than revenue drops for the airline industry.
In another sign of worsening economic conditions the OECD has recorded a drop in its early warning indicator.
The Organisation for Economic Cooperation and Development said its early warning indicator for the OECD area fell by 0.5 points in February to 120.4 from a revised 120.9 in January. It was the first fall in the index for four months.
The problem for the world's economy is that SARS comes on top of so many other economic problems.
It's unclear how much of the blame for this can be attributed to Iraq. The continued after effects of 11 September, the end of the investment bubble, and the subsequent 50 per cent collapse in equity values are equally potent factors. To these must now be added a fifth, Sars, which has already prompted a collapse in international air travel and the cancellation of conferences and events across the world.
Imagine the SARS spending reduction effect as reported in Hong Kong if the fear of catching SARS was spread over a larger area than Hong Kong.
Holders of Hang Seng Bank credit cards spent 10-20 percent less in the last two weeks of March compared to earlier in the month, Hong Kong's third largest bank told Reuters.
As a result of the reactions to the atypical pneumonia called Severe Acute Respiratory Syndrome Stephen Roach predicts a world recession for 2003
Morgan Stanley's chief economist in the United States, Stephen Roach, will formally advise clients Friday that he's forecasting a world recession in 2003.
Roach's Monday March 31, 2003 economic commentary foreshadows his turn toward a more pessimistic view of the world economy for 2003.
The SARS shock, in conjunction with war- and trade-cycle-related uncertainties, could deal a severe blow to the Asian and global economy. Our current baseline forecast calls for GDP growth of 5.0% in Asia ex Japan in 2003 -- easily qualifying this region as the fastest-growing segment of the global economy. And yet now downside risks are building rapidly in this region of the world as well. Against the backdrop of a growth starved industrial world, Asia ex Japan accounts for nearly one-half of the 2.5% increase we are currently estimating for world GDP in 2003. Asia, in effect, had become the world’s growth backstop of last resort. Therein lies yet another serious risk.
Andy Xie of Morgan Stanley Hong Kong sees a growing economic impact from SARS. (bold emphases added)
The economic impact of this epidemic is already significant and still mounting. The virtual cessation of tourism and the contraction of service consumption may push a number of economies into recession. Hong Kong, Singapore and Taiwan may well be sliding towards recession. Malaysia and Thailand are at risk also. I experienced the effect firsthand on my return flight from London to Hong Kong last weekend. There were three passengers in my cabin -- a 10% occupancy rate at best. Hong Kong’s restaurants are mostly empty. It is difficult to enjoy a meal with masked waiters tiptoeing around in silence. If you want to frighten people in Hong Kong, just sneeze. Exports are peaking. Real capex is only taking place in China. Tourism and consumption have been the only factors keeping East Asian economies out of recession. Now SARS is knocking the wind out of both. In particular, Chinese tourism is likely to decrease dramatically. The number of tourists from China increased by 4.5 million to 16.6 million last year. With most going to Asian destinations, this was the primary channel for China’s FDI and export successes to spill over into other Asian economies.
A reduction in business travel, and even of business meetings between people who are within the same geographic proximity, will reduce the rate of decision-making for capital investment decisions and the rate of business deal-making. Fear of SARS could become a far greater source of uncertainty than war.
In light of the economic impacts of SARS it is of interest to see how SARS might affect China. Contrary to conventional wisdom Stephen Roach does not see a big shift in China's economy toward satisfying domestic demand. If he is correct then the Chinese economy's dependence on the export market for growth will make it quite vulnerable to a world recession.
According to our China expert, Andy Xie, purchases of foreign-made equipment have accounted for fully 55% of the growth in total Chinese imports since 1997; chemicals make up another 20% of the total growth in imports over the past five years, whereas purchases of foreign-produced fuels and related products account for another 13%. That means fully 88% of the cumulative growth in Chinese imports over the 1997-2002 interval can be tied either to capital formation or to the fuel or feedstocks of the industrial supply chain. That’s why I have concluded that there’s far more to China’s spectacular success than a self-contained domestic demand story.
The rate of new foreign direct investment in China could slow as a result of a combination of decreased business travel and slackening world demand. Therefore China's economic growth could slow or stop along with the larger world economy.
If you want to track SARS from more of a public health and science perspective then read my Natural Dangers archive on the FuturePundit blog. The post WHO Advises Against Hong Kong, Guangdong Travel illustrates how SARS can very rapidly cause a large economic impact.
Cars, furniture, clothing, appliances, televisons, audio equipment, software, and toys are among the goods whose prices are falling:
Prices for 40 percent of all the goods and services in the Labor Department's consumer price index (CPI) showed year-over-year declines in September, the latest data available, according to a research note by Merrill Lynch's chief Canadian economist David Rosenberg.
Health care, education, and auto insurance are rising. I suspect that its not a coincidence that the first two have heavy government involvement.
China's benchmark consumer price index fell 0.8 per cent in October from a year earlier and dropped the same amount in the first 10 months, the State Statistical Bureau said yesterday.
That was a slight moderation from the 0.7 per cent dip in September from a year earlier, and on par with a 0.8 per cent fall in the first nine months.
Japan is now in its 4th year of declining prices:
Japan's economy and banking minister said Wednesday that deflation has worsened more severely than the government had expected, hampering the disposal of nonperforming loans.
"Because of deflation, more nonperforming loans have been generated and that has accelerated deflation," Heizo Takenaka said in a Lower House committee session. "That's why we need to speed up the bad-loan disposal process," he said.
Jesper Koll, chief economist at Merrill Lynch Japan Securities Co., sees considerable risk for deflation in the US:
Deflationary realities are all over the U.S. economy. By mid-2002, goods prices for consumers were falling at an unprecedented rate of almost 2 percent. Service prices were still rising, but this is mostly due to the imputed rent calculations as well as high measurement error for services.
For example, the true cost of services offered is falling much faster than measured because service providers are offering extended "free" service periods. The only true price that did not fall is the oil price, but oil is a "Terror War Premium," not the start of a new secular inflation trend.
But Alan Reynolds does not see a risk of deflation in the US:
It would be difficult to retell that story about the U.S. today. The fed funds rate is 13/4 percent and producer prices were essentially flat over the past year, if you leave out food and energy. Subtract almost any other measure of inflation from the fed funds rate, and it is hard to argue that real, inflation-adjusted interest rates are much too high. The Economist's index of commodity prices is up 21.2 percent over the past year, gold is up 13.4 percent, and oil is up 28.9 percent. That makes it quite challenging to argue that falling commodity prices are signaling a broader price decline ahead. The same journal's measure of the dollar exchange rate has dropped from 119.6 percent to 115.1 over the past year, making it equally tricky to argue that the dollar is rising too fast. The producer price index fell in September. But if you leave out food, the index rose from 136.3 in January to 139.3 in September.
Morgan Stanley economist Stephen Roach thinks the US Federal Reserve's latest move and pronouncements indicate that the Fed is now treating deflation as a serious threat. By contrast, he finds much to fault in the ECB's recent failure to lower rates.
The problem with the ECB’s approach is that it is completely out of step with the perils of deflation. While we forecasters live and die on the basis of our predictions, the policy maker cannot afford to bet on any one point estimate of the future. Like investing, policy setting is a business of probabilities. The ECB, like any central bank, must frame its actions in such a probabilistic context. Here’s, again, where the Fed anti-deflation script described above comes into play. According to this recipe, when the risks of deflation become significant -- say in excess of 25% -- the authorities must then treat such an outcome as their central case.
With 54% of the world already in the deflation zone and with Euroland’s fundamentals flashing a similar warning sign, I would argue that the ECB must now embrace the same risks that the Fed has adopted. In this climate, it can no longer afford the luxury of betting on the avoidance of deflation.
By contrast, Richard Berner and David Greenlaw, also of Morgan Stanley, think the threat of deflation is not receding, at least in the US:
But even if growth improves, the great deflation debate is still heated. "Core" producer prices declined in October from a year ago for the first time in the 26-year history of the data, and GDP price inflation has sunk to 40-year lows of 0.8%. We repeat our view: While deflation risks have risen, deflation enthusiasts err by looking at year-over-year headline inflation data (see "The Deflation Debate: Are Services the Next Leg?" Global Economic Forum, October 18, 2002). More recent inflation data, especially those purged of the decline in energy prices from a year ago, evince stable inflation. For example, the price index for gross domestic purchases excluding food and energy has been roughly stable for the past two years at 1 1/2%. Likewise, inflation expectations and forward-looking cyclical inflation indicators point to inflation stability. Nonetheless, global economic slack and a still-strong dollar will likely keep inflation hovering near 40-year lows.
As further proof, perhaps the strongest indication that deflation risks are mostly in the past comes from large-capitalization companies: Despite the mantra of no pricing power, Corporate America is racking up modest gains in revenue and much bigger increases in earnings. For example, with 86% of S&P companies reporting for the third quarter, earnings rose by 12.3% from a year ago on the back of a 3 1/2% rise in revenues. To be sure, earnings and revenues are below their previous peaks. And this rebound follows the biggest earnings bust in 50 years -- and the only decline in top-line revenues in the history of the data. But the results strongly suggest that operating leverage is now working to the upside, and that the benefits of financial deleveraging are beginning to help corporate cash flow.
For details of their comparison of Germany, the US and Japan see the chart "Testing for Nipponitis" on this page.
Our analysis suggests that Germany has more symptoms of the Japanese disease than America. America's bigger bubble infected its economy more severely; but its more flexible markets and institutions should now help it to adjust. For now, both countries remain in danger.
Policymakers dismiss the risk of deflation—just as in 1990 it would have seemed far-fetched to predict that Japan would enter a deflationary slump that would last for more than a decade. Yet as Marx reminds us: history repeats itself first as tragedy, then as farce.
The US scores highest on "Size of asset-price bubble", "Coporate overinvestement", and "Large private-sector debts" with a moderate score for "Risk of deflation". Whereas while Germany only scores highest on "Large private-sector debts" and "Shrinking/ageing population" it also has a longer list of moderate scores for "Size of asset-price bubble", "Risk of deflation", "Weak banking system", "Severe structural rigidities", and "Political/social paralysis".
Update: Also, see this article that argues Germany's problems are not as serious as Japan's.
'We're a long way from that sort of psychology in Germany,' said Mr David Walton, the chief European economist at Goldman, Sachs.
He noted that the benchmark short-term interest rate in the 12 nations using the euro currency stands at 3.25 per cent, leaving the European Central Bank some flexibility to lower rates, an option the Bank of Japan has exhausted.
Japanese banks are also a world apart from those in Germany.
Update II: This article lays out the opposing views about whether the US Federal Reserve still has additional unused power to stimulate the economy:
On the other side of the argument are economists such as Russell Sheldon of BMO Nesbitt Burns, who wrote a report for clients recently entitled "The Myth of Fed Impotence," in which he said "readers are about to be deluged with stories about Fed impotence, suggesting the final rate cuts won't matter." According to Mr. Sheldon, such stories "are perfectly normal for the end stage of any Fed easing process and can safely be ignored," because the benchmark Fed rate "is not as low as you think."
The BMO economist says while the Fed funds rate may be at a 40-year low, it isn't that low on a historical basis if you use the Federal Reserve's preferred inflation benchmark, which Mr. Sheldon describes as "smoothed core PCE." Using this measure, the Fed moved rates as low as negative 1 per cent in real terms after the 1990 recession, and has done so in previous downturns as well. On that scale, U.S. interest rates are still well above zero, and therefore there is still room for more cuts ahead.
The problem with the more complacent viewpoint is that if inflation drops then without the Fed even changing interest rates the real cost of money will rise. If inflation drops to zero then the Fed will no longer even be able to make real interest rates go negative.
You all may recall the big deal that EU mandarins made over George W. Bush's steel tariffs. Well, next time you hear a European complaint about American tariffs ask them about the size of their farm subsidies and farm goods import barriers:
Meeting in the city's swanky Conrad Hotel, the two leaders struck a deal that freezes EU's farm spending at a shade under $50 billion a year for the next decade (good news for the Germans who are the union's principal paymasters) in return for a commitment to continue subsidizing European farmers (good news for the French who receive more agricultural handouts than any other EU country.)
My interpretation of the BBC article excerpted below is that the US is spending about 35% of what the EU is spending on farm subsidies:
An international outcry has greeted the decision by the US senate to pass a subsidy bill offering US farmers $173.5bn (£118.7bn) over ten years.
Here's a slightly more detailed breakdown for how much the passed bill authorized:
The farm bill authorises US$ 173.5 billion in subsidies for a ten-year period, $73 billion for 2002-2007 alone, and increase of 70 percent over the previous level. Existing subsidies are increased for soya bean, wheat and corn. New subsidies are introduced for peanuts, lentils, chickpeas and dairy farms. Previously abandoned subsidies for honey, wool and mohair have been restored.
Using a different measure of support the web site of what appears to be the US Ambassador to France comes up with much higher figures for the US and EU in farm subsidies in 1999 and I suspect these figures are no higher than the current figures:
Those following agriculture issues and the important discussions on agriculture taking place in the world trade organization and the OECD are aware that american government assistance to its farmers remains less than one-half that provided by the EU. The most respected indicator of support to the agriculture sector, the OECD's producer support estimates (pses), provides the following comparisons in its just-released report: in 1999 the EU provided $114.5 billion in producer support which was the equivalent of 49 percent of gross farm revenue. The comparable figure for the U.S. was $54 billion in producer support or 24 percent of gross farm revenue.
The $311 billion per year figure is an astounding amount of money:
The U.S. is not alone in coddling farmers and food processors. Rich countries spend more than $311 billion a year in ag subsidies, twice the amount of total farm exports from developing nations, according to a study by the Paris-based Organization for Economic Cooperation & Development. U.S. farmers, on average, receive a fifth of their income from Washington. European and Japanese farm sectors are even more pampered. Their subsidies run to 31% and 59% of farm income, respectively. That results in overproduction, which artificially cuts prices around the globe.
EU food prices are 44 percent higher than they would be without the Common Agricultural Policy, while US food prices are 11 percent higher because of US farm subsidies.
In the EU-15 countries, about 17 percent of consumer spending is for food; in the 10 new countries, the average is 35 percent. The price of butter, for example, is about 2.5 times higher in the EU than in New Zealand, which has eliminated most farm subsidies.
Will the Japanese government ever do something about its economy?
The government of Junichiro Koizumi, Japan's prime minister, on Wednesday night backed away from imminent action to clean up the financial system after pressure to water down proposals from bankers and from the ruling Liberal Democratic party.
In an interview with Morgan Stanley economist Stephen Roach the economics Nobel Prize winner Franco Modigliani discusses consumer debt, deflation, life-cycle theory, and his expectations that consumers will have to reduce their spending levels:
A negative wealth effect tells me it can’t go on forever. And that’s when I revert to the life-cycle theory. Sadly, the large cohort of aging baby boomers is not adequately prepared for old age. The personal saving rate is too low. It has been depleted by individuals betting on asset markets. Life-cycle theory suggests that the saving rate should have gone up by now. Obviously, it hasn’t -- at least, not yet. While that puzzles me, it doesn’t dissuade me from the basic view that the balance between consumption and saving will have to adjust. It’s just a matter of when. That leads me to conclude that that the American consumer is the most dangerous portion of the picture.
Morgan Stanley economist Stanley Roach compares the US and Japanese bubbles in an excellent analysis that is worth clicking thru to read in full:
That’s not to say there aren’t some important similarities between the US and Japan that bear careful noting. Two, in particular, come to mind -- the asset bubbles and the impact of those bubbles on the real economy. On the first count, I hear repeatedly that Japan’s bubble was much bigger than America’s. After all, it wasn’t just the Nikkei; it was also an outsize property bubble. It was the interplay between these two asset bubbles that wreaked such havoc on Japan in the late 1980s and early 1990s. The truly astonishing thing is that America can’t look in the mirror and see precisely the same pattern. The Nikkei reached its peak of 38,915 on December 29, 1989. Over the ensuing 21 months it would go on to lose 38.5% of its value while Japanese land prices, as measured by the Japanese Real Estate Institute, would continue to rise by approximately 15% before peaking in September 1991. Fast forward to America. Between December 31, 1999 and September 30, 2002, the S&P 500 lost 45% of its value -- actually worse than the initial decline in Japan. Over the same 33-month period, nationwide US home prices as measured by the Fannie Mae (OFHEO) index rose around 15%. If that’s not Japanese-like, I don’t what is. Property bubbles typically outlast those in the stock market. It was true of Japan in the early 1990s and it appears to be true of America today.
The Fed is still in denial about the threat of inflation. See, for instance, this article where Federal Reserve Vice Chairman Roger Ferguson rates the risk of deflation as fairly low. Also, Glenn Hubbard, chairman of the President's Council of Economic Advisors, thinks the chance of deflation is "really remote".
Morgan Stanley economist Stephen Roach basically recaps his previous statements about the real estate bubble and the unsustainable levels of consumer spending and imports:
Speaking at the Morgan Stanley Asia-Pacific Summit in Singapore, Stephen Roach said, "America is in trouble. We are in the midst of a post-bubble business cycle. Many of the imbalances built during the last bubble are still with us."
Roach says Bush will feel pressure to use devaluation of the dollar as a tool to reduce deflationary pressures. A US current accounts deficit which is headed for 6 percent is just not sustainable:
The dollar could fall more than 15-20 percent in the next two years against the euro and the yen, Morgan Stanley's chief economist Stephen Roach said on Tuesday.
Will the Chinese be able to maintain their peg of the dollar against the renminbi? If the dollar drops and the renminbi remains pegged to it then the renminbi effectively drops with it. If the head of the Bank of Canada gets his way the US dollar will drop against the Canadian dollar. That would affect a large chunk of US imports.
Check out the table at the bottom of this National Post article by William Watson for tax levels of the OECD nations in the years 1965 and 2000:
Canada's tax ratio is currently 35.8% of GDP, just a little under the OECD average (38.8%). In terms of rankings, we've actually fallen a bit, to 14th. The United States is second last, eight spots behind us, with only Japan behind it. Ten countries are above 40%, and five (Sweden, Denmark, Finland, Belgium and France) are above 45%.
Corporations are issuing less debt and are focused on cost cutting in response to deflationary pressures:
Prices on consumer commodities excluding food and energy fell by 1.3 percent year over year in July, the biggest drop since the Labor Department began keeping those records in 1958, Lonski said. Consumer commodities are traded goods that compete with imports and are separate from the more widely watched core consumer price index, a gauge of prices paid by U.S. consumers.
Nathan Lewis, an economist at Polyconomics, has written an article in the Financial Times of London arguing that the root problem in the Japanese economy is deflation:
There is no solution to the bad-debt problem without a solution to Japan's basic economic problems: monetary deflation, economic contraction and falling asset values. Monetary deflation is caused wholly by the Bank of Japan, which has allowed the yen to rise steadily in value since 1985. The bank should increase the monetary base with the stated goal of lowering the yen's value to a point where it is neither deflationary nor inflationary. A 10 per cent fall in the yen's value would be an appropriate start. If the BoJ depressed the yen excessively, it would create inflation, which could be avoided by contracting the money supply. In spite of arguments to the contrary, the BoJ has complete control over the money supply and, by extension, the value of the yen.
This argument makes sense for a reason previously discussed here: Even the foreign banks in Japan that are not encumbered by debt are decreasing their lending in Japan. If the problem was the inability of financially strapped banks to provide more credit then one would expect the foreign banks to expand their operations to fill in part of the void. Instead, the deflation causes more and more companies to get into financial trouble and no matter how many bad debts the banks clear from their books other existing debts turn bad as more companies can't handle falling prices.
Glenn Reynolds has linked to a story in The Economist reporting on an IBM study on high and low trust societies and internet adoption:
The degree of trust in a society, as measured by the percentage of respondents who answered “yes” to the first part of the question above, explains almost two-thirds of national differences in the percentage of households that have Internet access. Even when controlled for other variables, such as the number of computers, trust remains an important factor.
I went digging back through the IBM site (with some help from Google) and found what appears to be the original paper, Authored by Claudia Keser, Jonathan Leland, and Jason Shachat of IBM Thomas J. Watson Research Center and Hai Huang of Duke University, it examines whether trust increases the speed of internet adoption and therefore whether the internet increases even further the opportunity costs of having a low cost society. The short answer is Yes:
Almost all transactions involve some opportunities for misrepresentation, non-compliance, or outright fraud. Detailed contracts, extensive monitoring of performance, and litigation are means of discouraging such behaviors, but they are all costly to implement. Mutual trust is an efficient substitute for these enforcement mechanisms, and empirically it appears to serve this purpose. Knack and Keefer (1997), for example, found that a very simple measure of how trusting inhabitants of different countries are is a significant explanatory variable in regressions of average annual growth rates in per capita income from 1980 to 1992. Moreover, the impact is large – a 10% increase in the measure of trust translates into a .8% increase in economic growth – a sizable increment given world average growth rates of 1% to 3% in the latter half of the 20th century.
Taken together these observations have a potentially troubling implication for low trust countries, the majority of which tend to be of low and middle income; namely, that in the coming years they will take a double-hit in terms of economic growth – penalized for low trust first in terms of higher transactions costs and then again through lower adoption of growth enhancing technology. Knack and Keefer’s (1998) findings suggest the first hit will surely come to pass. Whether the second does as well depends upon whether trust impacts Internet adoption. Our first objective in this paper is to test whether the proposition that trust is an important determinant of Internet adoption is, in fact, true. To presage our findings, it is.
My Canadian friend Dave Ings has alerted me to a couple of Globe And Mail articles about the reasons the Canadian economy is lagging the American one. The first is by Anne Golden, president and chief executive officer of the Conference Board of Canada.
This per capita income gap between our country and the United States -- due largely to our lower productivity -- is on its way to doubling within this decade. And this means not only that individual Canadian incomes will suffer in comparison to American incomes -- but also that our ability to finance existing programs and launch new ones will suffer, too. Expanding public education and health care, addressing the pressing infrastructure needs in our cities, reversing environmental deterioration, or adding national elder care or day care or pharmacare are simply beyond our current financial capacity without significant increases in income per capita.
Note the emphasis here on government spending. If the economy doesn't grow the government can't get a bigger slice to spend. While this is certainly true it demonstrates the sort of emphasis on government as purveyor of so many goods and services and guarantees that caused the Canadian economy to lag in the first place. Later in the article Ms. Golden states something that has now become a widely accepted myth:
We will face labour shortages, especially for skilled workers. At present, about 94 per cent of all jobs in Canada require at least a high-school diploma.
Wrong. Can a high school drop-out drive a truck? Sure. Dig ditches, put roofs on houses, sewer work, or paint houses? Yes, of course. In construction, structure repair, and delivery work there is already more than 6% of an industrial economy's jobs. Then throw in low tech service work: washing dishes or working as a cook or waiting tables in a restaurant, delivering pizza, janitorial work, trash collection, and assorted other ways to clean up and wait on people. At that point we are well beyond the 6% figure for non-high school diploma work.
Why do experts associated with big bureaucracies trot out such inflated figures for the demands that economies have for training for credentials? Simple answer: credential requirements inflation. Bureaucratic organizations that do not want to make personal judgemets about individuals choose instead to up the credentials requirements for many kinds of jobs. This makes it easier to choose people. At the same time those who have credentials who support the rise in credential requirements do so in order to increase the market's demand for themselves and to make their own jobs more secure. Plus, the people who do the training and teaching for credentials (eg see any university's faculty for examples) like the fact that credentials requirements also increase the demand for them as trainers. Plus, there are plenty of occupations which are not in government where governments have created unnecessary credential requirements (eg for cutting hair) partly because they imagine that they are protecting the public and partly in response to organized pressures to restrict supply in order to drive up wages.
The next Globe And Mail article up for consideration by Jeffrey Simpson hits closer to the mark:
A complete consensus obviously did not emerge, but no one bettered the alternative to productivity improvement offered by CAE president Derek Burney: Canada as "North America's cottage country, a place whose physical beauty masks a slowly declining standard of living and quality of life among the locals."
The raw facts, as outlined by Andrew Sharpe of the Centre for the Study of Living Standards? Canada's per capita GDP is 84.7 per cent of the U.S. level. Personal income is 78.6 per cent. Personal disposable income (that is, after taxes) is 70.4 per cent. All of these gaps widened from 1980 until the last year or so.
What is curious here is that not only is a larger percentage of Canadian personal income paid in taxes but for some reason (anyone know why?) a smaller percentage of Canadian per capita GDP is paid out as personal income. But taxes are only part of the story. Canadian rules for hiring and firing and unemployment and welfare benefits make for a less efficient market for labor. So regulatory and welfare systems account for part of Canada's lag.
Dave, being an optimistic sort of guy, sees these articles as promising signs that the issue of productivity has finally arrived on the Canadian political scene as a serious issue. Canadian blogger Colby Cosh tells me in private email that he doesn't share this optimism:
I'm not optimistic that economic productivity is going to suddenly become an issue here after 20, 25 years. What's the reason for hope? If voters east of the Lakehead cared about the economy they'd already have sent Canadian Alliance MPs to Ottawa. If your friend feels optimistic, great. But a lot of us felt optimistic before the 2000 election, before the 1997 election, and before the 1993 election...
Another Canadian friend of mine Bob Badour thinks Canadians are too complacent about the conditions of their lives and he is similarly not optimistic.
Aside: Note in the Jeffrey Simpson article the use of EI as an acronym. That's Employment Insurance which is roughly equivalent to American unemployment insurance. Dave Ings tells me that Orwellian renaming resulted in its change from UI (Unemployment Insurance) to EI (Employment Insurance). Of course, by the original logic of calling it UI it makes more sense to say Death Insurance than Life Insurance. This also reminds me of the use of the term Death Tax as a term with more negative connotations to describe Inheritance Tax. There is also the highly visible fight over the pro-abortion/pro-choice vs anti-abortion/pro-life factions where terminology games are played in Orwellian fashion.
In response to a previous post I made on the subject of Canadian living standards versus the USA the Canadian blogger Colby Cosh has chipped in with his thoughts. This is obviously a subject he has thought a lot about and he has a previous article from August 2002 which is a pretty vigorous rant on the subject. That article links to an excellent graph that provides a good summary at a glance of how Canada's per capita income is doing versus America's. The short answer: the USA-Canada living standard gap is not closing and may even continue to widen. Well bummer Canadian dudes.
Colby comes across as fairly pessimistic (and not a little bit frustrated) about the prospects of Canada's political and opinion-making elites becoming willing to admit to the causes of this poor economic performance let alone deciding to make the necessary policy changes (ie the standard reductions in regulatory, economic engineering, social engineering, and tax burdens that all good capitalists advocate). Well, since I'm not a Clintonite I'm not going to say "I feel your pain". But I sympathize with your plight. Canada's economy ought to be able to grow more rapidly and Canada's living standard ought to be able to rise to a level that is closer to that of the USA. But a lot of watered down socialism is holding it back. The root of this problem exists in the minds of a Canadian populace to whom Al Gore would seem like a right-wing candidate. The solution has to begin with better publicity about the causes of the differences and the extent of the differences. Canadian bloggers need to rise to the challenge and publish a continuous stream of links to relevant information with cutting commentary.
The Economist joins the chorus of concern over the risk of inflation:
As measured by the GDP deflator, the best economy-wide gauge, America's inflation rate has fallen to 1.1%, its lowest for 40 years. Its consumer-price index has risen by 1.8% over the past 12 months, but prices have fallen in half of its 16 main product categories—the biggest proportion since the current series started.
Note that this article cites Stephen Roach of Morgan Stanley on the declining rate of inflation in services. My guess is that The Economist writer is referring to the Stephen Roach article I link to here.
This is no normal business cycle, but the bursting of the biggest bubble in America's history. Never before have shares become so overvalued (see chart 1). Never before have so many people owned shares. And never before has every part of the economy invested (indeed, overinvested) in a new technology with such gusto. All this makes it likely that the hangover from the binge will last longer and be more widespread than is generally expected.
Can the economy recover from such a large capital overspending and asset price bubble with just a mild to moderate recession? Seems to me that consumers need to enter an extended period of spending less. They can't drive their debt up to higher levels. When they fully internalize the prospects for slower stock market rises and the consequent need to save more for retirement they are going to want to spend less, save more, and reduce debt. Just as the consumer debt run-up helped fuel the boom the consumer debt run down will lengthen the bust.
Yes, stock market prices have fallen far. But when we look at prices in terms of yields and price/earnings ration then no, they haven't fallen all that far as compared to previous historic lows:
And valuations were much more depressed at the bottom of the 1974 market than they are today. Back then, the Dow yielded 6.1 per cent and traded on a price-earnings ratio of 6.2; now the Dow yields just 2.4 per cent and the S&P 500 trades on an historic p/e of 31, according to Datastream.
This strikes me as an indication of just how loony the prices were at their peak.
This article in the Far Eastern Economic Review gives the impression that China's huge pool of untapped cheap labor will allow exports to just keep rising:
Inside the squat white-panelled factories of Chint Group, women in blue smocks fasten wires to plastic switches moving along an assembly line. Their work is fast and cheap, with each employee earning just $150 a month on average. Last year the company's exports rose 28% to $35.8 million. Chint executives hope to maintain this export clip by targeting new markets, such as the U.S. and Europe.
Beijing gave Chint and others a boost recently by allowing them to bypass state-designated middlemen, driving down their export costs. Another WTO bonus is falling import tariffs, which mean these companies can now buy foreign manufacturing equipment at much reduced prices, making the final product they export even cheaper. These simple changes have had a profound impact: private Chinese companies raised exports by nearly 50% in the first half of this year.
Morgan Stanley chief economist Stephen Roach believes services are now vulnerable to deflationary pressures:
Although deflationary pressures are building in a US-centric global economy, there is still a sense that the aggregate price level will stop short of outright contraction. Central to that belief is the long-standing dichotomy between goods and services. Unlike the tradable-goods sector, which is increasingly exposed to the tough competitive pressures of cross-border trade, the so-called non-tradable services sector has long been shielded from such pressures. That was then. The globalization of services changes all that, and points to the possibility of a new leg of deflation in the United States and the world at large.
They have a Bribe Payers Index which measures the willingness of business representatives from various countries to pay bribes in less developed countries. Read the summary with a link to the full report. The 2002 summary has 15 countries ranked from best (Australia) to worst (Russia).
To measure domestic corruption within countries Transparency International has developed a Corruption Perceptions Index. A perfect 10 indicates enormous purity and virtue. A fallen 0 indicates you've sold your soul to the devil. You can read the 2002 summary with 102 countries ranked in a table here. Finland (9.7) has the least amount of corruption by their measure. It is followed by Denmark (9.5), New Zealand (9.5), Iceland (9.4), Singapore (9.3), and Sweden (9.3). Down at the bottom we find Indonesia (1.9), Kenya (1.9), Angola (1.7), Madagascar (1.7), Paraguay (1.7), Nigeria (1.6), and Bangladesh (1.2) is the worst.
Other countries of interest include UK (8.7), USA (7.7), Germany (7.3), Israel (7.3), Japan (7.1), France (6.3), Taiwan (5.6), Italy (5.2), Brazil (4.0), Turkey (4.0), China (3.5), and Russia (2.7). Looking at this chart it becomes clear that one problem the EU faces is that its expansion south and east is causing it to take in new members that are more corrupt than the EU average. It already appears from this table that the EU as a whole must have a lower index score than the USA. So corruption is a serious EU problem.
A Canadian friend (not sure if he wants to be mentioned by name) sent me a link about relative Canadian and US economic performance. I am curious to know whether Canada's economy is showing any signs of starting to close the gap in per capita GDP and productivity versus the US. One would expect NAFTA to allow Canada to achieve higher economies of scale and lower costs. This article paints a bleak picture:
In the financial services industry, for example, Mr. Nixon said the regulatory cost of $1,000 of service output is $10.83 in Canada, which is 154% more than in Britain and 58% more than in Australia. "From environmental approvals to securities regulation, Canadian business is subject to costly and lengthy regulatory processes that are seriously undermining our competitiveness," he said.
One cause of Canada's trailing economy is too many financial regulators:
Canada's securities industry is governed by a patchwork of 13 provincial and territorial securities commissions, all jealously guarding their turf. Because of that, it may be impossible to get agreement on a single regulator for the industry. Instead, Ottawa will settle for an agreement among the commissions to make their rules and regulations equal and to cut down on red tape.
The Western Canadians are not keen on major changes:
The federal government's plan to stick its big fat nose into securities and stock market regulation -- a provincial matter -- could be as damaging to western Canadian business interests as the Liberals' efforts to make us conform to the fatally flawed Kyoto climate change protocol.
Can Canadians use discount online brokers?
Canadian industry sees worsening Canadian federal government economic and regulatory policies:
More companies see a worsening in Canada's federal policy environment than improvements in public policy. Top areas of concern include user fees (46%), environmental regulations (39%), customs regulations (37%), a lack of sensitivity to business interests (30%), health and safety regulations (29%), overall fiscal management (29%) and payroll taxes (28%). There is slightly more confidence in the provincial policy environment, especially with respect to tax reform, but there, too, many more companies see policy conditions worsening than improving. Frequently cited concerns are in areas such as user fees, where 43% expect conditions to worsen, labour regulations (36%), environmental regulations (35%), health and safety regulations (32%) and overall fiscal management (25%), transportation and infrastructure (24%) and sensitivity to business interests (23%).
The event that prompted the first story in this post is the TD Forum on Canada's Standard of Living which happened today in Ottawa. I can't find any conference documents on the web for it (not saying they aren't there somewhere; just can't find them if they are) but here's another National Post article which lists various recommendations made at this conference:
"Several authors noted the current employment insurance system does much to perpetuate reliance on low-skilled, seasonal work, while acting as an employment tax on more dynamic sectors of the economy," it states.
Robin Neill, an economics professor at the University of Prince Edward Island, said regional development policies -- such as the $700-million Atlantic Innovation Fund -- encourage firms to devote energy to creating programs that qualify for government money rather than profitable ideas.
UPDATE: You can find the full text for each of the presentations at the TD Forum on Canada's Standard of Living here.
Try this inflation calculator.
Commerzbank effectively can no longer borrow on the public market:
Details of Merrill's e-mail quickly filtered into the London and Frankfurt markets and Commerzbank's share price fell 6 per cent to €6.02. Credit default swaps on the bank traded above 200 basis points - a level that prices the German bank out of the market.
Guido Versondert, credit analyst at Barclays Capital, said: "Everyone is so on edge that they're prepared to believe the worst and . . . this is affecting equity and credit markets."
Commerzbank also can't forecast its earnings:
Last week, Klaus-Peter Müller, Commerzbank's chief executive, said he could no longer give a forecast for full-year profit, earlier at €700m-€800m ($688m-$785m), and said he expected 2002 risk provisions of about €1.3bn, up from €1.1bn earlier.
More talk of parallels with the 1930s:
'There are strong parallels to the Thirties after an unsustainable "new era" boom,' says Avinash Persaud managing director for economics and research at State Street Bank. 'Then, the stock market decline was not just steep, it was long, taking three years to reach the bottom.'
'Commerzbank being affected is a sign of the severity. But in today's crisis risks have been offloaded from the banks to the markets and ultimately our pensioners, which makes the problem more difficult to deal with,' he says.
German insurers may be in trouble too:
Germany’s Federal Financial Supervisory Agency has also said that it is monitoring the health of the country’s insurers: it fears that many of them will be nursing massive unrealised losses.
Persaud's point about the pensioners is an important one. How can people save for long years of retirement when the stock markets are declining so rapidly? Of course lots of corporate and public pension funds are invested at least partially in the stock market. So their unfunded liabilities rise as the stock markets decline. Plus, declining interest rates make the size of the unfunded liabilities larger as well. People can't expect to live longer while at the same time work fewer years than previous generations. The math doesn't add up. The deflationary forces at work in the markets are going to make the retirement funding issue one that can no longer be put off.
The Economist has an article about underfunded corporate pension funds. The problem is particularly acute among German corporations:
Of 47 companies with outstanding bonds examined by Dresdner, only six had pension funds with assets that exceeded liabilities: General Electric of the US; Unilever; Philips; Corus; FKI; and Dow Chemical. Worryingly, the rest all had shortfalls. Those with the worst deficits were German companies, but for good reason: German firms are not required to set aside money to cover their pension-fund liabilities but do have to carry the cost on their balance sheets. For well-heeled firms like Aventis, a pharmaceuticals and agribusiness group, this poses little problem even though in 2001 the company’s pension liability was half as much again as its earnings before interest, tax, depreciation and amortisation. But for others, such as E.On, an international energy and engineering group, any increase in its liabilities may well affect its credit rating and so the interest rate it has to pay when issuing new bonds.
The article goes on to point out that as interest rates continue to drop the bond yields in the pension fund portfolios decline and the size of the unfunded liabilities rises. This is a far more serious problem on the European continent than in either the UK or the US. Europe's declining birth rates, slower, economic growth, and higher unemployment rates all make the pension fund liabilities greater. European countries are going to have to raise their retirement ages and make their labor markets more flexible.
Conference Board survey finds gloomier outlook:
The number of executives who say business conditions are better now than they were six months ago has plunged to 29 percent from 62 percent last quarter, according to a Conference Board survey released yesterday.
The Business Council finds similar sentiment:
The Council's CEO poll found that 94 percent expect the U.S. economy to slow. Sixty-five percent said growth next year would total between 1.5 percent and 3 percent.
Dallas Fed Research Director Harvey Rosenblum believes that just as there is a lag time between monetary expansion and inflation there is a similar lag time between asset price collapses and a wider deflationary pressure. He is concerned that the anecdotal evidence and the predictions of economic models don't match:
Like McTeer on Monday, Rosenblum put heavy emphasis on the value of anecdotal information on the economy's health, particularly since long-accepted economic models are proving an unreliable policy guide.
"When they start telling me things consistently that aren't being told by the economic modelers, I've learned the hard way over the years that I need to pay attention to that,"
The article has some charts that are well worth a look. The chart that shows the percent annual change in aggregate lending tells a gruesome story. But Peter Tasker of Tokyo hedge fund Arcus Investment does not believe bad banks are the cause of the lack of new lending:
Mr Tasker questions the argument-common among analysts in Tokyo - that Japan's economy is suffering because banks are lending to the weakest companies and neglecting young, promising ones. He points to evidence that US and European banks operating in Japan without bad loans are also shrinking their lending base. "I don't really accept that there are high-quality options for lenders out there that are not being funded," he says. "If there was genuine demand for capital, you would have high interest rates, which you simply don't have."
This seems like a compelling argument. The alternative explanation is that a shrinking money supply and the deflation that it causes is making too many businesses unprofitable and hence not worthy to be recipients of loans.
Could the Bank Of Japan reflate the economy? Well, they can't do it by lowering interest rates. But they could more aggressively buy up public debt. They could buy all new debt issues of the Japanese government while simultaneously buying up government debt that is in other hands. The government could cut taxes and have the BoJ buy up all the increased government debt that results from the tax cuts.
Federal Reserve Bank governors appear divided on whether the risk of deflation is substantial. Dallas Fed President McTeer would like to see more growth to pull us away from deflationary dangers:
"I do believe faster real growth is essential and consistent with a policy to combat deflation," McTeer told a conference of the National Association for Business Economics.
The rather less worried William McDonough is part of the majority on the Fed that voted not to cut rates further:
"It is very likely that the U.S. economy will do just fine," New York Federal Reserve Bank President William McDonough said, but if that turns out not to be the case, "We know what to do."
McTeer and Edward Gramlich were the only two Fed Governors who voted to cut rates further in their most recent meeting.
Okay, suppose your country was faced with recession, deflation, and rising unemployment. What would you do? If you are like me it wouldn't occur to you to have the wisdom (that's a joke kids) that the German government has to raise taxes:
Just a month after Schröder promised Germans not to raise taxes, tax hikes are on the table as a way of increasing the government’s income. The plans to raise the cigarette, inheritance and sales tax paid by companies as well as a proposal to re-introduce the property tax eliminated in 1997 have incensed opposition parties and editorialists alike.
The Greens are holding out for more welfare state spending as a great way to use some of those tax revenues. But the Social Democratic Party is proposing the taxes in order to avoid exceeding EU caps on government debt as a percentage of the GDP. So that leads to an obvious logical suggestion that they are certain to think of in due time: raise taxes even higher so that the debt can be reduced and government spending can be increased at the same time. That won't turn the recession into a depression will it?
Now you might be thinking that in the face of falling prices and recession it would instead be time to pursue an expansionary monetary policy. After all, the German central bank has an admirable record of fighting inflation and the markets would not be worried about an expansionary monetary policy in the face of rising unemployment and falling prices. But oh darn, the Germans gave up their ability to control their monetary policy when they joined the Euro.
President Bush might be thinking that the US should retaliate against the German politicians for what they said about him and about America. I say that is not necessary. The Germans seem intent on hurting themselves far more than Bush could and without any help from us.
10 Year Treasuries are at the lowest level they've been since 1958. The effects of the asset price decline will last for years:
These strategists are even making unsavory comparisons between the United States' current troubles and the decade-long stretch of economic stagnation and eventual deflation that followed Japan's own bursting stock market bubble.
"The question is whether the real economy can shake off the impact of the implosion of asset prices. I personally don't think it can," said Richard Gilhooly, senior fixed-income strategist at BNP Paribas.
If real estate prices start to drop then we may actually enter a deflationary recession.
When prices start falling across the board (as has been happening in Japan) people delay consumer and capital spending with the expectation that the same goods can be purchased more cheaply later. The resulting decrease in spending fuels the price decline. The IMF appears to be clueless as usual:
The IMF's World Economic Outlook looks at the impact of recent stock price falls around the world on real economies and concludes that the fall in consumer spending associated with market declines could reduce GDP growth by one percentage point in the US and in Britain, and by one quarter of one per cent in Europe and Japan (where equity markets are less important in the overall financial scheme of things).
Oddly, however, the IMF takes comfort in the fact that 'buoyant housing markets' in the US and Europe are having a compensating effect by boosting consumption. Much of this consumption is financed by leveraging the equity in house price gains and if property markets fall - as many fear they will (hence the popularity of deflation as a dinner-table conversation topic) - then that equity will disappear. Meanwhile, the bank lending based upon house price gains could produce a rash of new non-performing loans (NPLs).
The real estate bubble has actually been fed by the bursting of the stock market bubble as investors have rushed for the supposed safety of real estate ownership:
According to the Milken Institute in Los Angeles, asset bubbles tend to both enhance and cannibalize each other. Profits from surging tradable securities are used to buy property and drive up its values. Borrowing against residential equity fuels overvaluations in fervid stock exchanges. When one bubble bursts, the other initially benefits from an influx of funds withdrawn in panic from the shriveling alternative.
Quantitatively, both in Britain and the U.S., a considerably larger share of the nation's treasure is tied in real estate than in the capital markets. Yet, the infamous wealth effect -- an alleged fluctuation in the will to consume as a result of changing fortunes in the stock exchange -- is equally inconspicuous in the realty markets. It seems that consumption is correlated with lifelong projected earnings rather than with the state of one's savings and investments.
This is not the only counterintuitive finding. Asset inflation -- no matter how vertiginous -- rarely spills into consumer prices. The recent stock market bubbles in Japan and the U.S., for instance, coincided with a protracted period of disinflation.
Central bankers need to come to the realization that asset price inflation can cause as much damage as consumer price inflation.
This article in The Scotsman reviews some of the evidence:
What is spooking world stock markets is not just disappointing results from top blue-chip companies. It is that the world economy may now be staring a deflation recession in the face.
US interest rates are now at a 41 year low:
In any event, it is increasingly apparent that bringing interest rates down to a 41-year low has not sparked the widely trumpeted recovery. Greenspan’s blunt truth to Brown may be that if he is looking for a quick fix, there’s just none on offer.
The Financial Times has an article about the inability of the Japanese to make changes to fix their stagnant deflating economy:
Japan's deflation is deepening:
Nobuyuki Nakahara, until March a BoJ board member of a dissident frame of mind, makes a similar point. He quotes Arnold Toynbee, the British historian, as saying that all societies are better at dealing with external threats than internal ones. Japan is the prime example, he says.
Mr Nakahara compares the country's adept response to the external oil shocks of 1973 and 1979 with today's dithering and obfuscation. "The bubble was made from within so it is very much harder to deal with," he says. "Unless the situation worsens very much, no major policy initiatives will be adopted."
In April to June, Japan's broadest measure of deflation, the gross domestic product price deflator, fell 1.0 percent after a 0.4 percent drop in January to March -- the first deterioration from one quarter to the next since the last three months of 2000.
Reckoning prices will fall even further, many shoppers are delaying big purchases -- a painful reminder for retailers like Ogawa that bargain prices in one of the world's most expensive countries are still no elixir for consumer spending.
Research firm Teikoku Databank, which compiles statistics on bankruptcies, cited a "deflationary depression" as a reason behind 1,814 corporate failures in July -- a 28 percent increase from June and the worst number this year.
Modest proposal for the Japanese government: Cut taxes and have the BOJ buy up most of the sovereign debt.
The Financial Times reports Germany sits on the brink of deflation:
The bursting of the bubble in US equity prices, particularly for technology, media and telecommunications stocks, has led some commentators to draw parallels with the Japanese situation at the end of the 1980s. The US may suffer a decade of lost growth, just as Japan did during the 1990s, they argue. But when looking for a country most likely to be sucked into a deflationary trap, people should focus on Germany, not the US.
The article then goes on to catalog parallels between Germany's and Japan's economies. Meanwhile the Bank Of Japan continues to do too little too late:
But analysts doubted the BOJ would adopt any effective new monetary tools, despite increasing government pressure to do so.
The BOJ has left its monetary policy unchanged since February 28, when it pledged to lift liquidity in the financial system by raising outright purchases of government bonds by a quarter to one trillion yen.
These deflationary elements are now reinforced by the growing gap between the economy’s actual production and its potential. Our current total GDP is 3 percent to 4 percent less than what it would have been had the economy produced up to its potential over the last two years. (The difference adds up to $3,000 per American household.) According to the conventional model, when the economy’s actual production is one percentage point less than its potential, inflation will fall one-quarter percentage point. And using this model, Krugman recently forecast that the U.S. economy could experience actual deflation by 2004; other economists think it could arrive in 2003.
As the previous article points out, consumer debt in the US as a percentage of GDP is at a record high. Consumers can't spend and since business has lots of capital operating at less than full utilization. So there is no incentive for business to increase capital spending.
Stephen King points out that an asset bubble's after effects can cause conventional monetary policy to cease to be capable of maintaining price stability. Once prices start falling then real interest rates can be high even if there nominal interest rates are reduced to zero:
Second, and more importantly, asset prices can play havoc with the ability of a central bank to hit its inflation target over time. There is clearly no one-for-one relationship between asset price inflation and inflation of the price level. So, if in the short-term, inflation of the price level is close to target, it might be reasonable to ignore asset price inflation. Let's say, though, that, later on, the asset price bubble bursts, leaving people with unwanted amounts of debt (which, in a low inflation environment, tend to hang around for a long time). The process of debt consolidation could then lead to significant downward pressure on demand and inflation – so much so, in fact, that deflation becomes a possibility. Under these circumstances, real interest rates are in danger of rising – the opposite effect of that seen in the 1970s.
The Bank Of Japan's announcement last week that it was going to buy stock from banks while probably necessary was probably the minimum they had to do to allow banks to meet capital requirements:
The BOJ's move is meant to clear up the problem of the bank's problem portfolios, which in turn could put banks in a better position to deal with their problem loans. The plan also is meant to allay the fear that falling share prices could put some banks below minimum capital requirements -- which could put them in the same fix as George Bailey before Mr. Potter got foiled.
The Japanese government and BOJ just never seem to be able to bring themselves to take steps that are large enough.
Of course, at least the First World nations can service their sovereign debt. The dramatic increase in sovereign debt defaults is an indicator of financial troubles in Latin America.
Joseph Stiglitz reminds us that the US can't continue to run a huge trade deficit to provide sufficient demand for faltering economies.
The system has behaved perhaps better than might be expected because the US has acted as the deficit-of-last-resort. But for how much longer can the richest country continue to borrow from the rest? How long will the appetite of the rest of the world for American bonds and equities continue?
Last time I saw figures for it the US was running a trade deficit of over 4% of GDP. On top of that American consumers are now carrying a historically record high amount of debt. The US is not going to be able to serve as the demand engine to pull the rest of the world away from a deflationary recession or depression.
Writing this time in the Op-Ed section of The New York Times the Morgan Stanley chief economist Stephen Roach argues that deflation is our greatest economic peril:
America is already on the brink of deflation. Our broadest price gauge, the G.D.P. price index, recorded just a 1 percent annualized increase in the second quarter of 2002. That's the lowest inflation rate in 48 years. Prices of goods and structures — covering nearly half the economy — are already contracting at an annual rate of 0.6 percent. Only in services, where price statistics are notoriously unreliable, are prices still rising.
The hows and whys of America's deflationary perils will long be debated. Two sources seem most likely. First, the bubble-induced boom of business capital spending led to an overhang of new information technologies and other forms of capital equipment in the late 1990's. The result was excess supply, a textbook recipe for lower prices.
Also at work are the unmistakable effects of globalization. The modern-day American economy now has a record exposure to global competition. In the second quarter of 2002, America imported a third as many goods as it produced, well in excess of the 20 percent ratio prevailing at the onset of the last recovery in the early 1990's.
I think this threat is real. It is hard to pop asset price bubbles without a wrenching readjustment. So far we have only popped the equity and venture capital bubble. The real estate bubble is still there. Capital surpluses, combined with a large consumer debt overhang, place the US economy at considerable risk. Japan, the second largest economy in the world, continues to be stuck with a stagnant deflationary economy. The EU area is not doing well. South America's troubles are, if anything, getting worse.
Economist Stephen Roach of Morgan Stanley is concerned about the asset bubble that hasn't popped yet, the real estate bubble:
There’s one key aspect of the above that does represent a change in my thinking -- that America is now in the midst of a property bubble. I haven’t come to that conclusion lightly. Two piece of evidence have pushed me over the edge: First, the sleuths at The Economist report that inflation-adjusted US house prices have "risen more in real terms since 1997 than in any previous five year period since 1945." Second, there’s an excellent study by Dean Baker of the Center for Economic and Policy Research (CEPR) that comes up with a perfectly reasonable way of assessing whether this surge in house prices qualifies as a bubble, or not. The CEPR test hinges on the relationship between housing rents -- the intrinsic returns on the asset -- and market-clearing home prices. Baker finds that inflation-adjusted house prices have risen by about 30% since 1995 -- literally three times the cumulative 10% rise in the real rental index over that same period. In fact, this gap between house-price and rental inflation has never been wider in the post-1975 history of these data. If that’s not a bubble, I don’t know what is.