Tuesday, November 30, 2004
Meanwhile ECB president Jean Claude Trichet meticulously failed to mention the possibility of central bank intervention in closely watched comments to the European Parliament's economic and monetary committee, restricting himself to repeating that currency movements like the ones we are seeing now are 'not welcome'. So we seem set to continue on towards the $1.35 level. What happens then we'll see if and when we get there. As they say somewhere: "this ain't done till it's done
Wednesday, October 13, 2004
Well, one of the main consequences of the introduction of the euro has been the dramatic reduction in what are known as the 'interest rate spreads' on sovereign debt.
Again, what does this mean? Well the word 'spread' in this context, refers to the difference in long term interest rates charged between the stronger and the weaker economies. This difference for - say - Italy and Spain (using the 10-year German Bund as a reference rate) moved from over 6% in 1992 to less than 0.4% in early 1998. Since the late 90's differences in rates across countries have varied slightly, but basically remained negligible. This is what the common currency does. The stronger economies underwrite interest rates in the weaker ones.
However, given the demise of the stability pact, the question Guzzo is really asking is whether this honeymoon can last. It could be that if national debt in the different member countries is allowed to continue to go its own way, these risks spreads could once more increase.
Up to now the only vague indication of such a possibility is the fact that on July 7, Standard & Poor?s lowered its long-term sovereign credit ratings on Italy to ?AA-? from ?AA? - while the the spread between 10-year BTPs and other Euro area government bonds widened only fractionally - and that on September 13, following major upward revisions to Greece?s deficit and debt measures, the same rating agency revised its outlook on the country from stable to negative (while re-affirming the long-term rating at ?A+?). Again market reaction was muted.
The big question is just how long this will last. Another one of those pesky 'things to watch'.
Friday, September 10, 2004
These two situations appear, on the surface, to be somewhat similar, but in reality it may be more interesting to consider how they differ.
The problems of the US Federal deficit and its potential implications are by now relatively well known:
Congressional forecasts published on Tuesday suggest that President George W. Bush is on track to miss his pledge to halve the ballooning US budget deficit within five years.The EU 'dilemna' is also hardly 'breaking news':
According to the non-partisan Congressional Budget Office, the deficit will fall from this year's 3.6 per cent of national income - a record $422bn - to 2.1 per cent of GDP in five years' time. The CBO's estimate of the cumulative deficit in the decade to 2014 will be $2,294bn.
This five-year outlook assumes no real rises in discretionary spending over the next decade and could be far worse if the president's tax cuts of 2001 and 2003 are extended, as Mr Bush has pledged to do.
Failure to reduce the deficit could lead to higher interest rates in the long term and a decline in the dollar, some economists warn.
Source: Financial Times
THE European Union?s stability pact ............died an early, political death, when in November of last year the euro area?s finance ministers refused to punish their French and German colleagues for repeatedly running budget deficits in excess of 3% of GDP. On Friday September 3rd Romano Prodi, outgoing president of the commission, and Joaqu?n Almunia, the EU?s commissioner for monetary affairs, announced their proposals for a reformed pact that will be economically literate and politically feasible, albeit legally feeble.Really I don't want to enter too much today into the politics of the US deficit situation. I imagine that is going to get plenty of 'airing' over the next couple of months as the presidential election looms. What I want to draw attention to are the underlying differences between these two situations in terms of the demographic and growth backdrop.
The commission used to argue, with some justification, that the 3% deficit ceiling gave governments plenty of room to spend their way out of recessions, provided they also saved their way through upswings. Unfortunately, that was not the way the pact worked in practice. Germany, for example, was asked to do too little during its last economic boom (four long years ago), and it is now being asked to do too much in the midst of economic stagnation.
Source: The Economist
The Washington based Population Reference Bureau hit the headlines in mid August with a report on the global population outlook (PDF) (which despite the coverage really added nothing new to information and data already readily available at the UN population division). Apart from the obvious fact of a projected dramatic global population increase over the next 50 years from 6,000 to 9,000 million (which will clearly have an important influence on the relative pricing of raw material resources like oil), the report drew our attention to the changing distribution of this population, in particular, for our present concerns, to the differences between the US and the other OECD countries.
To illustrate their point the PRB drew attention to two countries with starkly different population projections: Nigeria and Japan. They point out that, today, the two countries have similar populations: 137 million for Nigeria and 128 million for Japan. But by 2050, Nigeria's population is expected to reach 307 million, while Japan's population is projected to decline by 22 percent to 100 million, ie Nigeria will be three times the size of Japan.
The really significant difference, however, are to be found elsewhere. For when it comes to population trends, the United States is in an enviable position relative to its industrialized peers. While Japan and most EU countries have a fertility rate that is well below replacement, the United States still enjoys a steady and sustainable fertility rate of around two births per female. In addition, they note the United States benefits from a regular infusion of working-age people thanks to the 1.3 million immigrants who arrive in the country each year. Against this backdrop U.S. population is expected to swell to more than 400 million by 2050.
So this is the first point: the US, like Europe, is an ageing society, but the population momentum is still much higher. This means that the economic problems faced differ significantly in each case. I have posted at lengh recently about the soft labour market in the US and its attendant problems, but one point needs to be made clearly: the labour market is in part 'soft' since the US demographics are such that it needs to create around 175,000 new jobs every month just to tread water. This is not the European case.
I have been arguing that in fact the US case is far nearer to the UK situation which Keynes struggled to address in the 1920's: growing working age population and declining global importance economically (in this case due to the rise of new powers like China and India, in the earlier UK case due to the arrival of the US itself). Given this it is pretty reasonable to argue that more traditional Keynesian remedies are more relevant to the US, and amongst these policy remedies is of course the fiscal deficit. The EU situation is quite different: we simply don't have this luxury, we are in a more 'backs to the wall' battle.
(Interlude: news in today about the Japanese economy which reveals a significant slowdown in second quater growth indicates what may happen when government expenditure needs to be cut 'at a forced march'. Equally revealing in a European context is the Swiss case (another of the significantly ageing European societies) where again the typical symptom of a domestic demand which stubbornly refuses to revive has seen interest rates near to a Japanese style zero rate policy (ZIRP) for some time now: I don't think it will be going up too far any time soon)).
Now I am not saying that the US deficit, and the manner of inflating it (the Bush tax cut) are not important issues, I am simply saying that this pales virtually into insignificance when compared with the European case. The US has much more room for manoeuvre, that's all.
Reinforcing this is the relative growth situation. UK chancellor of the exchequer Gordon Brown in an interview in the FT today (subscription only unfortunately, although a summary can be found here) gets right to the heart of the matter.
?It is the weakness of European Union growth that lies at the root of imbalances?
What does he have in mind here, well the fact that the Europe economies collectively have grown at a rate of 3 per cent in only one year in the past 10, while the US grew at more than 3 per cent on average over the decade, might do for starters. Clearly the EU economies, and the eurozone in particular, have a 'growth deficiency problem'. And it is this which again makes all the difference with the deficits. For if Europe doesn't get growth, then meeting even the minimum deficit reduction criteria is going to be near impossible.
So what are the proposals?
Basically the new Commission proposals to 'flexibilize' the pact are twofold. In the first place they would oblige countries to tighten fiscal policy in good times, but allow them more leeway to loosen it in bad times. And in the second place the commission wants to shift its focus from the size of a country?s deficit to the sustainability of its debts. In other words towards the proportion of a country's GDP the accumulated (not the annual) deficit represents. Put simply, this would move the key 'sinners' from being France, Germany and the Netherlands - who have the highest deficit forecasts for this year - to Italy, Greece and Belgium all of whom have accumulated debts on or around the 100% of GDP mark.
This second point has a certain logic, since it is difficult to see how these states can sustain their finances if there is not a drastic reduction in the accumulated deficit (which means annual budget surpluses, not deficits!). Regular readers will already know that I have long seen the Italian economy as the real 'sick man of Europe', and as such I can only welcome this emphasis. In fact I see the Italian case as the litmus test for the whole problem. (Indeed I am happy to let my demographic 'thesis' stand or fall on the Italian 'bridge'. Remember Italy is far from being Japan in economic terms. I am not a betting man, but I have no doubt that I would be backing a 'winner' here). But this being said, I am far from being convinced that the new proposal will be sufficient to alter dramatically even the Italian situation.
Going back to the first point - the good times bad times distinction - the problem is that this really begs the question: how do you decide where in the cycle you are, and, indeed, what kind of cycle you are on? In theory, and according to the 'luminaries' aren't we now in full recovery mode? This being the case, oughtn't countries like Germany and France now to be running not deficits but surpluses to get ready for the downswing to come? It is hard in this context to see what all these fine words mean.
So as I said, we are 'backs to the wall'. In this context, and in order not to be simply called a 'defeatist', I will cite the words of the paraplegic Catalan poet Miquel Marti i Pol:
Treure el pit
Tot es possible
Tot esta per fer
which liberally translated reads:
Out with the sword
Out with your chest
Everything is possible
Everything is still to do
If this doesn't seem much like a policy then I will leave you with the thoughts of one European politician of an earlier generation, in his blood, toil, tears and sweat speech:
"You ask, what is our policy? I say it is to wage war by land, sea, and air. War with all our might and with all the strength God has given us, and to wage war against a monstrous tyranny never surpassed in the dark and lamentable catalogue of human crime. That is our policy."
Of course I am not thinking here of the kind of war one GWB would have in mind. I am thinking of a war on poverty, injustice, desperation, fatalism. A war which could avoid seeing the majority of the EU elderly population sinking into poverty and depression in the face of problems which seem insurmountable. A war to instill optimism and drive into a generation of young people who - faced with the mounting costs of intergenerational transfers - may sometimes see little alternative to leaving what may seem increasingly like a sinking ship. A war to save the ideals which we all as Europeans can be justifiably proud of. As a child I coudn't stand Churchill for the class bias and priviledge which he seemed to represent. Now I find politicians of his calibre, and economists of the stature and commitment of Keynes, sorely wanting. How one's perspective on things changes with age!
Friday, March 05, 2004
So what happens next? Well as I have been saying, how this ends is difficult to see. We are still trying to get to grips with the causes.
Of course two groups of people have it fairly easy. Firstly those who argue that this is all down to George Bush, and then, on the other hand, those who would want to say that the Indians are the culprits.
As always, both these arguments do contain a grain of truth. It's clear that GWB has not excelled in terms of his economic stewardship, and it's clear jobs are going to India. However I think pretty quickly both these simple solutions run out of steam given the depth of what is taking place. Some argue that Bushes stimulus could have been better directed: possibly, but there was still plenty of kick going into the US economy in the second half of 2003. And those famous tax cuts are still out there in the future, so while they may well be colouring the debate about the future of social security, they are hardly the key operative factor right now. Likewise high-end service jobs. In the future this is going to be important, but it is hard to see that this is having a major impact on the global economy in the here and now. So my argument is that something much bigger is happening, something which makes normal debates about economic management seem somehow totally inadequate.
My starting point is that, in terms of the global economy, we are seeing a profound transformation on three fronts: demography, technology, and development.
The OECD economies are ageing (and I'll leave this one here for today), we are living through a profound technological revolution, and thirdly the relative state of development of some of the worlds key economies is changing, and fast. On occasion I have called this globalisation phase 2.
What I really want to focus on in this post is one of the fundamental characteristics of this transformation: its deflationary implications. A year or so ago, it was much more fashionable to talk about deflation than it is now. Recently things have gone pretty quiet. Nonetheless the IMF (under Ken Rogoff as chief economist) did see fit to publish a background paper (warning PDF, and fairly technical, the Economist had a couple of easier articles here, and here). So let's go and take a reality check, why not: on deflation. Or rather disinflation, since this is the name the current global condition is popularly known by. In order to do that we could go on a quick inter-continental whistlestop tour.
And what better place to start than Chile:
This is striking, isn't it. A Latin American country with zero inflation and a 1.75% funds rate which is under review for reduction. Of course a big part of this picture is currency-appreciation-driven, and the currency appreciation in turn is driven by China's demand for copper. So Chile's miraculous disinflation is fairly lop sided, but still. It remains a striking situation. Where it an isolated case, then perhaps we could shrug our shoulders and say, well, that's life. So to make some comparison, now lets go a bit nearer home, to my country of birth, the United Kingdom:
Chile's annual inflation rate fell to zero for the first time since 1939 as companies such as General Electric Co. lowered prices following a 22 percent rally in the currency last year that made imports cheaper.
Consumer prices were unchanged in February from January -- after falling the four previous months -- and unchanged from February 2003, the National Statistics Institute said.
``We're passing on our lower costs,'' said Pablo Palavecino, manager of General Electric de Chile SA's appliance line in Santiago. ``Prices are a lot less.'' An imported refrigerator sells for 999,000 pesos ($1,655), down 17 percent from last year, he said.
Investors such as Andres Ergas at BanChile Administradora General de Fondos SA said the central bank will keep its benchmark lending rate at a record low of 1.75 percent at a policy meeting next week in a bid to prevent slowing inflation from turning into deflation. Central bankers have said they're concerned about deflation, which could slow the South American country's expansion by prompting consumers to delay spending on expectations that prices will keep declining.
Ergas said the lack of a pickup in inflation toward the central bank's target of an annual rate of between 2 percent and 4 percent would likely prompt policy makers to cut interest rates again.
Again striking isn't it. The UK CPI hasn't been up to 2% since May 1998, and in fact the annual average is only 1.2%. And the current rate seems to be riding on the back of what I at least am prepared to recognise as a housing driven asset bubble. So if this is the case, the big question is what happens to the CPI the day the bubble bursts, it hasn't exactly got very far to fall. I am sure this fact is exercising Mervyn King's mind a lot these days.
Will CPI inflation ever rise back to 2% or above?
Since December, the Bank of England?s official remit is to target a 2% inflation rate as measured by the harmonised consumer price index (CPI). Conveniently, the Bank forecasts inflation to rise to around the 2% target by its two-year forecast horizon (assuming unchanged interest rates), from 1.4% currently.
Perhaps the strongest reason to expect CPI inflation to rise to 2% is that the Bank of England is now charged with making sure that this happens. After all, the Bank is a highly credible institution that almost exactly attained its former 2.5% objective for RPIX inflation (on average) over the 1997 to 2003 period. And, if everyone believes that the Bank will hit its new target too, cost and price setters should behave accordingly and the target should in fact be met, barring large unforeseen shocks.
However, things may not be that easy. After all, the last time CPI inflation stood at or above 2% was in May 1998; and it has averaged a mere 1.2% over the last five years. Thus, if past inflation performance is any guide to future inflation performance, and even factoring in that the Bank is now charged with aiming for 2% CPI inflation, there would seem to be a considerable risk that the 2% target will NOT be reached.
Source: Morgan Stanley Global Economic Forum
OK, so now why don't we go to China?
Now here I have edited Andy Xie down to what I consider to be the bear essentials of the case. These essentials are:
Who Benefits from Productivity?
One can witness Chinese productivity first hand at the local Wal-Mart store. Yes, the Chinese economy is becoming more productive. I estimate that China?s total factor productivity (TFP) - how much more output with the same inputs - is 3-4% per annum ......... My guesstimate is that Chinese wages are rising at half the rate of labor productivity, which includes the impact of more capital per worker, and is about twice as much as TFP. Why can?t Chinese wages rise at the same pace as labor productivity, which would capture all the TFP to benefit Chinese workers?
The problem is that the competition for jobs in China is fiercer than the competition for goods in the world market. For the Chinese to gain jobs faster than average rates in the world economy, they need to sell their labor cheaply, i.e., passing on the TFP to western consumers in the form of lower prices so that they would buy more Chinese goods, i.e., more Chinese labor. The relative balance would change only when most Chinese are employed. When China reaches the tipping point, either its currency would appreciate, as in Korea and Taiwan in the 1980s, or its inflation would be higher than the global average, as in Hong Kong in 1980s and 1990s..............
Some believe that appreciating the Chinese currency would effectively deliver a raise to the country?s workers. Would this work? Would western consumers pay more for Chinese goods if China?s currency were to go up? I doubt it. China?s export price is determined by the relative balance between the number of Chinese workers and western consumers. How could manipulating the exchange rate change this reality? If western consumers refused to pay more in the event of a yuan appreciation, wouldn?t the result be to push down wages in China in order for its labor market to reach some sort of equilibrium?
Throughout the industrialization of the West, productivity also mostly benefited consumers; deflation prevailed due to productivity gains. What is occurring in China is not unusual. It is the vast pool of surplus labor that keeps down labor?s pricing power, and also makes consumers who are workers price-sensitive. Thus, productivity gains are competed away by businesses in endless price wars.............
The global economy is experiencing much higher productivity growth rates because information now spreads to developing countries much easier than before, which provides more people in the developing world with the skills to join the global economy. Thus, the global economy behaves like an emerging economy that gains productivity from moving labor from low-productivity rural sectors to high-productivity urban sectors............
Combating inflation is a central goal of modern central banking. But inflation is becoming less of a threat. The US economy has experienced disinflation for two decades. The same trend pushed Japan into deflation.
Source: Andy Xie, Morgan Stanley Global Economic Forum
That we have a global environment which is strongly disinflationary, and heading for deflationary. (He doesn't make this point but I will: interest rates are at near-historic minimum all over the place, and we are now - as Stephen Roach keeps reminding us - in the upswing phase, more price downsize is only to be expected later).
Technological change is driving down prices in some key sectors. Huge reserve armies, and massively increased connectivity are pushing them down in others: the whole global economy is behaving like a single emerging economy.
The situation in China is normal if you look at what happened in the European economies during a comparable period of technological change and industrialisation: the late 19th century.
I think I'll leave it there, but the picture should be plain enough. I don't buy the 'consensus' explanation. There is something more to all this than good housekeeping practices across the central banks. These US employment stats today are only a reminder. Now go have a nice weekend everyone.
Thursday, March 04, 2004
Now before we go any further, I would like to make a retraction. I think it's only a small one, but still the point is worth making. Back after the last G7 meeting I mildly mocked the joint declaration for highlighting currency 'volatility' as the major problem. My point was that I didn't see much volatility in a movement in one direction only. In fact I was wrong. What we are seeing at this moment is 'volatility' as the dollar/euro value constantly readjusts back-and-forth. So even though I would stick my neck out, and go for a continuing upward pressure on the euro, the ups and downs are not without their consequences. This makes business forward planning much more complicated, and obviously is no help to those trying to export.
On the substantive question all eyes need to be on the US labour market. The minor dollar 'rally' this week was based on the expectation of a cut in euro interest rates, and a relatively stronger US labour market which would be pushing Greenspan in the direction of raising rates. Well we've seen that euro rates are staying put, so now we have to watch how the US data evolves over the next few weeks. My guess is that the $1.30 level will be being tested again before too long, but you never know, I may have got it wrong.
Meantime, and for a change, I'm linking to myself: I just got the latest copy of the Sprout, and here is my article for this month:
German Finances: Much Ado About Something
Germany's claim that it has its budget deficit under control and that its economy will quickly return to strong growth has recently been put into question by European Commission member Pedro Solbes. In his last assessment of Germany?s updated stability programme, Solbes welcomed Berlin?s pledge to lower its budget deficit, but stressed that differences remained over the "possible rates of growth?. The Commissioner even went so far as to suggest that the economic forecasts produced by Chancellor Gerhard Schr?der's government are unrealistic, and that in all likelihood Germany will breach the European Union's stability pact for a fourth successive year in 2005.
Behind all this lies a long-running sore of a problem which divides the Commission and the national governments, a problem where Solbes plays the part of ?villain in chief? for his role as defender of the growth and stability pact. Now that this problem has once more resurfaced it may be worth revisiting it roots.
At the heart of Solbes? most recent jab at Schroeder lies one stark and self-evident fact: Germany is growing old. Forty years ago, just 17 percent of Germans were aged 60 or older. Today, 23 percent are. Forty years from now, the share will be nearer to 40 percent. At least this will be the case if current estimates turn out to be anywhere near accurate. In fact the truth is that we don?t really know what the exact position will be, but there are grounds ? if we look at likely medical and other advances ? for thinking that life expectancy may well be significantly longer than we are currently calculating for.
Now much has and will be written about this topic, but here I would like to focus on three key components of what is going to be an extremely complex situation: demography, technology, globalisation.
As I have said Germany has an ageing population. This is bound to have an important labour market impact as the potential labour force declines, and its average age rises. So what can be done? Well broadly there are three remedies on the table. Firstly increase immigration to replace the lost workers, and in so doing attempt to redress some of the inevitable damage to the support ratio. This road seems highly unpopular, and is unlikely to be explored in any great depth if recent history is anything to go by. Indeed even culturally proximate groups, like the citizens of the new eastern accession countries seem less than fully welcome judging by recent decisions to have an ever receding transitional period for full freedom of movement.
Secondly you can lengthen the working life, from 65 to 70, and then from 70 to 75. The longer life expectancy scenario seems to make this attractive, but the response from those expected to extend their working lives does not appear to be too encouraging.
Thirdly you can increase participation rates: that is the percentage of those below retirement age who continue working. Yet here, once more there seem to be problems. Society at large may agree that this is an interesting objective, but two factors seem to stand in the way. On the one hand the interests of the individual corporate entity. A personal detail here, my wife works for a German multi-national. And do you know what, right now on her boss?s desk lies a proposal to ?recycle? all those employees with over 25 years service. Recycle here is a euphemism for finding a way for them to go through the door. And who can blame the firm. This is a competitive world, and they need to survive. In an era of accelerating technical change, and ever-shortening product and system cycles, rapid reaction on the fly has more value than accumulated wisdom. This means youth. Those valued work-teams of yesteryear, embodying as they did all that accumulated tacit knowledge don?t seem worth what they were. That, of course, is what the structural reforms are all about: asset devaluation. Changing the valuation placed on acquired capacities, in line with the way technical change ?creatively destroys? their value. Nowadays the boss doesn?t cut the quip in the elevator about his most valued asset not being the building but his workforce. No, today?s boss likes to tell his subordinates that his most valued assets are his high-speed broadband connections to cheap bright young minds in China and India. So make no mistake about it, youth brings comparative advantage, and the locus of that advantage is moving, eastwards: this is where the globalisation part comes in. In this sense the split identity we have between the private and the social seems a hard one to resolve.
There is, of course, another way to increase participation rates, and that is to bring more women into the labour market. This objective seems laudable, but is it realistic in an environment where public welfare provision is likely to be severely curtailed? Absent state-financed care, looking after the elderly inevitably tends to fall on the female member of the family. Is caring for an elderly parent with Alzheimer compatible with a high level of active participation in the labour market: I think not. Here we are trying to say that two plus two makes six, and it doesn?t convince.
Which brings us back to immigration, and to Pedro Solbes. One of the few viable strategies for facilitating increased female participation in an environment of dramatic ageing like the one which Germany has in front of it, is to increase the supply of cheap migrant labour, to globalise the internal labour market. On the other hand, as Solbes would I am sure point out, one of the explicit reasons for ?flexibilising? the stability pact was to promote growth, we have flexibilised, and the growth still isn?t coming. Of course we continue to hear that ?I promise it will, but next year?. I?m with Solbes on this, don?t give me pipe dreams, tell me what we are going to do in the here and now to get to grips with the problem. If we don?t do this we may well end up seeing one of those nasty financial crises which would be our worst nightmare. Isn?t it time we had a frank and open debate on all this? When you are living in denial maybe the first step forward is to recognise that you are.