Tuesday, November 23, 2010

Rebecca's taking an indefinite break from blogging

I started a new job in August 2010. It's a challenging, exciting, and thoroughly satisfying position, however, I am left with little to no time for my family. I have made the decision to cease commentary on News N Economics at this time.

I see this as an indefinite pause. Perhaps, though, at one point I may be able to dedicate time to my career and blogging simultaneously once again.

Thank you all for reading and providing feedback. It is the dedicated readership that keeps a blogger going.

Best regards, Rebecca

Monday, November 15, 2010

Japanese Q3 2010 GDP growth hit it out of the ballpark but set to fall flat next quarter

The Japanese economy grew 3.9% at a seasonally-adjusted annualized rate in Q3 2010 and over 2X the pace in Q2 2010 (data here). According to Bloomberg, the headwinds to Q4 growth are household consumption and the yen:
Consumption, accounting for about 60 percent of GDP, led the gain as households stepped up purchases of fuel-efficient cars ahead of the expiration of a subsidy program and as smokers stocked up before an Oct. 1 tobacco-tax rise. The yen’s climb to a 15-year high will probably damp growth this quarter as companies from Sharp Corp. to Nikon Corp. cut profit forecasts.
To be sure, the surge in real GDP growth is unlikely sustainable; but it's not because of the yen's strength, per se. True, consumption growth is more likely to print on the lefthand, rather than the righthand, side of the 0-Axis. However, the yen on a trade-weighted basis and in real terms hovers at its historical average; hence, the currency poses less of a risk to growth.

The chart illustrates the contributions to non-annualized quarterly growth (not annualized, GDP grew near 1% in Q3) from each of the GDP components: private consumption (C), investment (I), inventory build (Inv), government consumption (G), and net exports (NX).

The Q3 pace of growth is almost certainly not sustainable and has a decent chance of turning negative in Q4 2010 for the following reasons. (See charts below text for illustration)

* The biggest contribution to Q3 growth came from consumer spending, +0.66%. Investment contributed positively, 0.11%, but has been trending downward. Key data points are inauspicious for consumer spending: the unemployment rate hovers stickily around 5% and October auto sales saw a 27% annual decline, as green auto subsidies expired.

* Although the JPY/USD has appreciated 14% since the middle of 2010, the real effective exchange rate, the economic driver of a country's trade balance, has been stable over the same period (see final chart below) and in line with its longer-term average. So while I don't expect net exports to turn negative, per se, any additional impetus to growth is unlikely to come from trade.

* Therefore, the key to growth is final domestic demand, and more specifically consumer spending. That's a stretch.





Rebecca Wilder

Friday, November 12, 2010

Ireland: the battle against "markets"

Is it the sheer size of its contingent liabilities that is driving Irish spreads? Finance Minister Brian Lenihan thinks so via the Irish Independent:
"There is no doubt in my mind that while the announcement on the banking sector in September was not disbelieved by the markets, it wasn't fully believed either because there is a wait and see policy of seeing whether it is an accurate account of exposures in the banking system," the minister said.
Or is it German Chancellor Angela Merkel's recent rhetoric? According to the Irish Times, since her most recent statement on private haircuts, "All stakeholders must participate in the gains and losses of any particular situation", officials are readying the EFSF for possible tapping by the Irish government:
The Irish Times has established, however, that informal contacts are under way between Brussels, Berlin and other capitals to assess their readiness to activate the €750 billion rescue fund in the event of an application from Dublin.
The EU quashes this rumor.

Or is it that "markets" just don't buy the Irish fiscal austerity reduces the Irish budget deficit story? According to the Irish Independent, this is the opinion of Nobel laureate Joseph Stiglitz (mine, too, by the way):
“The austerity measures are weakening the economy, their approach to bank
resolution is disappointing,” Stiglitz, a Columbia University economics professor, said in an interview in Hong Kong today. “The prospect of success is very, very bleak” for the government’s plan to resolve the problem, he said.
What's driving spreads? (They've come off a bit today, but they're still just under 600 basis points over German bunds (as of 6am this morning).) Furthermore, the EU came out with a statement that reiterates the exclusion of outstanding debt on any new restructuring mechanisms:
..does not apply to any outstanding debt and any programme under current instruments. Any new mechanism would only come into effect after mid-2013 with no impact whatsoever on the current arrangements.
The answer is, it's probably a mix of the three above. Markets are starting to price in an insolvent government balance sheet, which will ultimately lead to default - some call Ireland's sovereign balance sheet insolvent but still liquid .

I side with Stiglitz, that ultimately its deficit reduction plan will reveal the axiom that is the three-sector financial balance: if you don't have a surge of external income, then the private sector and the public sector cannot simultaneously increase saving.

Exhibit A. The year of austerity - and even harsher and more front loaded austerity is on the way - has proven to squash growth prospects for the Irish economy compared to the average, which is the Euro area.

The chart illustratest the index of quarterly GDP, as reported by Eurostat. The Euro area data is current through Q3 2010 (only on a "flash" basis), while the Irish GDP figures are available through Q2 2010. These numbers are not annualized; but as of Q2 the Irish economy is running 11% below its Q1 2008 level of GDP, while in Q3 the Euro area as a whole is producing just 2.7% short of its Q1 2008 level.

But the Irish government is sticking to its plan. Recently the Central Bank of Ireland published its quarterly report, where it simultaneously downgraded the growth forecast AND announced that further action will be taken to bring the government deficit to 3% of GDP by 2014. Since then, the government announced deficit cuts that exceeded those originally planned by a factor of two. Seems fishy to me.

Rebecca Wilder

Tuesday, November 9, 2010

Eurozone rebalancing depends on German inflation

The Federal Statistics Office reported that German consumer prices increased 0.2% on a seasonally-adjusted basis in October, translating into a 1.3% annual gain on a harmonized basis. German prices are very sticky, since the domestic economy doesn’t see the boom and bust cyclical behavior like that in other developed economies. However, inflation may headed north, especially if the trend in industrial prices (PPI), a +3.8% annual clip, is any leading indicator. (Click on chart to enlarge.)

Will German policymakers see the inflation for what it is? It’s a shift in relative prices to drive real German appreciation in order to rebalance current accounts across the region amid a fixed currency regime.

The Eurozone region is now characterized by current account imbalances, imbalances that are now being addressed through fiscal austerity measures. According to the IMF October 2010 World Economic Outlook, Germany will run the second largest current account surplus in the Eurozone as a percentage of GDP this year (second to Luxembourg), 6.1%, while Greece and Portugal will run the largest deficits, -10.8% and -10%, respectively. Among the bigger economies, Spain’s 2010 current account deficit sticks out at -5.2% of GDP. In fact, just 6 of the 16 Eurozone economies are expected to run current account surpluses in 2010.

If these fiscal austerity measures are to succeed in Europe, the hardest hit economies – Spain, Portugal, Ireland, Greece – must generate income externally via export growth. In order to gain export growth, competitiveness must be drawn upon in one of three ways (or a combination): (1) the nominal exchange rate depreciates in the debtor countries (CA deficit countries); (2) final goods prices fall in the debtor countries relative to the creditor countries; or (3) unit labor costs fall in the debtor countries relative to the creditor countries. Any combination of the three will shift the real exchange rate in favor of the debtor countries and drive export growth.

Since (1), depreciation of the nominal exchange rate, is clearly not an option in the single-currency Eurozone, it’s up to (2) and (3). I’ve talked about wage-cutting; and most of the fiscal austerity packages include some degree of public sector wage cuts, so I won't address that here. And point (2) has been addressed mostly via fiscal austerity dragging price pressures domestically, and leading to increased competitiveness. But point (2) can be seen from another light...

...it's all about relative prices, and inflation in Germany realtive to the debtor countries can establish competitiveness in debtor countries.

German inflation is important for two reasons.

First, it's all about relative prices (point 2 above), so competitiveness in Spain, for example, could similarly be generated if German inflation rises relative to that in Spain, holding Spanish inflation constant – even more so if Spain’s inflation rate is falling . In fact, a rather stark increase in German inflation is likely needed to generate a rebalancing effect when nominal depreciation is out of the question (as is the case for the Eurozone).

On to the second reason why German inflation is important: the ECB average inflation target.

The table to the left illustrates the compounded annual rate of inflation (CAGR) for each of the current member Eurozone economies since 2000. Germany has, on average, seen prices rise at a 1.7% annual rate, while Spain has seen prices rise at a 2.9% annual rate.

Amid fiscal austerity, German inflation is needed is to keep the ECB’s target average inflation rate– the average inflation rate is the weighted HICP across all of the Eurozone economies – around 2% while the much of the Eurozone experiences disinflation (or deflation).

Spanning 2000-2009, the Spanish economy contributed roughly 0.4% to the Euro area's average 2.1% annual inflation (based on the HICP country weight, which is 12.6% - see the Eurostat publication for links to the data). Greece contributed roughly 0.1%, on average, to overall inflation. Going forward, there will be a lot of inflation slack to be picked up as these economies contract further.

It’s gotta be Germany!

But will German policymakers and its massive export sector tolerate higher average annual inflation? Let’s say at roughly 3%, and for some time? I’m skeptical – so the outlook for the Eurozone, in my view, has just worsened.

Rebecca Wilder

By the way, I just told my German husband, Herr Wilder, about this article. You know what his response was? "Oh...Germans don't like inflation." Enough said.

Monday, November 8, 2010

German industrial production fell in September

Today German industrial production surprised to the downside in September, falling 0.8% over the month on a seasonally-adjusted basis. The contraction brought the annual pace of growth to 7.9% over the year, down from a 10.7% clip in August.

It looks like my data mining is proving to be rather useful. The ratio of the Ifo expectations/current index, which tends to lead German IP growth by about 6 months, turned down in February 2010 - now so has the pace of annual industrial production growth. The implication is that the Q4 2010 rate of domestic activity is likely to be quite weak.
The chart illustrates the 6-month lead of the trend in Ifo expectations index minus the trend in Ifo current index and the annual growth rate of industrial production.

By my count (you'll have to trust me here), German data has surprised 9 times to the upside and 10 times to the downside this month (October through current). We'll see; but the scales are tipping to the downside.

Rebecca Wilder

Friday, November 5, 2010

According to bond markets, Ireland is not yet Greece

A few articles regarding the bond crisis in Ireland:

The Irish Mess (IV)
ECB buying of Irish bonds 'vital' support
The world backs away from Ireland, Spain, Portugal
In keeping with Halloween, here's a scary one
EU leaders trigger another bond market crisis
Ireland fifth best place to live (a separate issue, of course)

Yves Smith's article (first link) is good, providing a network of associated links including one to Ambrose Evans-Pritchard. He states the following:

Yes, Ireland is fully-funded until April – and has another €12bn in pension reserves that could be tapped in extremis – but that is less reassuring than it looks. The spreads over German Bunds are mimicking the action seen in Greece in the final hours before the dam broke.
Ambrose Evans-Pritchard's article is well worth a read; but I'd like to talk about bond markets for just a bit. Yes, the probability of Irish default is increasingly being priced into bond markets; however, Irish bond market conditions have not yet reached those of Greece in May 2010 (the bailout announcement), nor are they really close...yet.

The Irish yield curve (proxied by the 10-year government bond yield minus the 3-year government bond yield, now the 3-10) is still positively sloped. (I choose the 3-10 because of the ESFS that is in place through 2013.)

This is important. See, when there is a binary outcome being priced into a sovereign bond market, default or no default, investors go straight to the long end of the term structure, and the yield curve inverts (negative slope). In a default situation, the longer end of the curve offers a higher expected return where the potential yield compression is much larger. That's what happened in Greece in May 2010, as the 10-yr bond yield reached 12.4% on May 7.

The two yield curves look "similar"; but Greece's yield curve turned negative, or near -500 basis points (bps) inverted - a basis point is the % * 100 - preceding the bailout. At the time, Irish spreads (chart above) dropped to 120 bps; but now the yield curve is even steeper, 170 bps as of 6am this morning.

The 3-yr Irish spread over German bunds is certainly coming under pressure, 492 bps (as of 6am today). But the front-end sell-off is nothing compared to that in Greece: spanning the period April 1 to May 1, 2010 (i.e. excluding the surge to 1700 bps), the 3-yr Greek spread over German bunds averaged 711 bps.

Further, the Irish debt profile is longer, on average, than that in Greece. The weighted average maturity on existing Irish debt is 6.1 years (starting in 2011), where that in Greece is a shorter 4.5 years.

The chart above illustrates the share of Irish and Greek debt by maturity date. 36% of Ireland's sovereign debt expires through 2015, just half the share of Greek sovereign debt maturing by the same year, 70%. Note, too, that according to Bloomberg, Greece has 3 times the debt outstanding of Ireland - a completely different game (for now).

Irish bonds are certainly under pressure. But Ireland being funded until the middle of next year is important, making the timing of its return to market critical.

In my view, though, the quintissential issue is the government's ability to finance its debt via domestic growth. Here's a great paragraph from an op-ed in the Irish Independent last week:
While interest rates charged to Ireland have been rising sharply, many large countries can borrow at very low rates, as little as three per cent. Many economists have been arguing recently that these countries should consider a further fiscal stimulus package. Instead most of them are committed to deficit reduction. This debate is one that we cannot join, unfortunately. These countries have a choice since it appears that they could borrow more if they chose to do so.

We cannot do that, nor can we devalue our exchange rate, since we do not have one. It is perfectly reasonable to ask how we got into this mess, to allocate blame and to demand retribution. But no amount of ranting can expand the limited range of choices available to the Government.

Ireland needs revenues to finance their debt. We'll see if the persistent fiscal austerity leads to growth - I'm totally skeptical.

Rebecca Wilder

This article is crossposted with Angry Bear blog.

Tuesday, November 2, 2010

G4 GDP, reaction ECB

It's complicated. The ECB is currently juggling two objectives: perpetually assuaging bond investors in the face of a shaky financial system, and managing policy for an economy with a single currency and sovereign government issuers.

But is it really so complicated?

The chart above illustrates the peak (deemed 2008 Q1 here) to trough and recovery of GDP across the G4 (Eurozone, UK, US, and Japan). None of the G4 have returned to 2008 Q1 levels of production (pre-2008). Ironically, as the US Fed readies itself for QE2, the American economy has returned the farthest back up the "production path".

The German recession was deeper, but the rebound has been quick. Annual GDP growth in Q2 2010 was well above potential, 3.7% over the year, and the labor market continues to see gains. But German growth has not been sufficient-enough to bring neither its nor the Eurozone's level of GDP back to pre-2008 levels (as of Q2 2010).

To be sure, 2H 2010 GDP remains to be factored into the recovery in Germany and the Eurozone. Perhaps when all is said and done, Germany will recover smartly in 2H 2010 to generate the final 2.7% bump in GDP to return to pre-2008 levels before the 2011 fiscal austerity measures start to crimp export income. Thus, is the ECB holding pattern correct?

That remains to be seen. If the ECB continues to set policy as it has done so in the past, however, it'll take an economic slap in the face before the ECB reacts to real economic growth and eases further.


The chart illustrates the refi rate (ECB policy rate) at a 2-quarter lead to the annual pace of GDP growth. The relationship is strong and positive, with a correlation is 82%.

The relationship suggests that the ECB's reaction function actually follows economic growth trajectories, but at a two-quarter lag (roughly). For example, the ECB was raising rates into the third quarter of 2008 only to see GDP fall 2.1% at an annual clip in the fourth. It dropped the refi rate by 1.75% in Q4 2010.

The ECB targets inflation, not GDP growth; but the reaction function is roughly 2-quarters lagged to the disinflationary pressures that stem from recession (from my simple exercise, of course). In conclusion, if the ECB is going to react to GDP-induced disinflation signals (i.e., negative growth), then it could get a lot worse in the Eurozone before policy eases further: 1H 2011 is my bet.

Rebecca Wilder

Monday, November 1, 2010

Comparing the Fed, the ECB, and the BoE before policies diverge

This commentary is crossposted with Angry Bear blog.


This week is G4 central bank week. The Federal Reserve Bank (Fed) announces its policy decision on November 3; the European Central Bank (ECB) and the Bank of England (BoE) will make policy announcements on November 4; and the Bank of Japan pushed forward its November 15-16 meeting to be held now on November 4-5.

At this juncture, G4 ex Japan monetary policy is likely to diverge sharply: the Fed is expected to announce an extension of its asset purchase program, while the ECB and BoE are not expected to increase theirs. In fact, the policy wedge between the three central banks is already wide. Despite the ECB's enacting its covered bond purchase program, the amount is small, roughly 1.4% of Eurozone GDP (see chart below), and the central bank is sterilizing the flow - sterilizing the operation means that the ECB performs equal and opposite monetary operations to reduce bank reserves by the amount of the bond purchase program.


The chart above illustrates the size of the bond purchase programs (assets sitting on the central bank balance sheet) as a share of 2010 GDP (IMF forecast). Ostensibly, and from a bank-lending point of view, Eurozone financial conditions appear to be "healthier" than those in the UK or US.

The chart above illustrates total bank lending in the Eurozone, UK, and the US; but this may change as austerity measures in some European countries infect the stronger economies via a tightly integrated trade relationship.

Policy is already much tighter in the ECB compared to its US and UK counterparts. This discrepancy is expected to diverge, as the Fed moves into QE2 mode this week.

Rebecca Wilder

Friday, October 29, 2010

Eurozone unemployment rate up in September

Today Eurostat released the September unemployment rate figures for the European Union and the Eurozone. From the release:
The euro area1 (EA16) seasonally-adjusted2 unemployment rate3 was 10.1% in September 2010, compared with [downward revised] 10.0% in August4. It was 9.8% in September 2009. The EU27 unemployment rate was 9.6% in September 2010, unchanged compared with August4. It was 9.3% in September 2009.
The Eurozone unemployment rate has been above the EU (27) unemployment rate by an average 0.45% since the outset of 2007.

Across the Eurozone 16 countries, just 5 have seen their unemployment rates fall since October 2009 (I use the teilm020 table at Eurostat, which limits the time series to this time frame). Note that the unemployment rate in Italy rose over the month (8.1% to 8.3%), so unemployment rate is now unchanged since last year.

In the third quarter (the 3-month average ending in September 2010), the unemployment rate fell across 57% of the sample listed below (a highlight of the EU (27) countries plus Japan and the US). This is good, but the improvement is sluggish.

Rebecca Wilder

Wednesday, October 27, 2010

Unemployment rates in Europe: improving ever so slightly

Based on internet searches that lead to my website, there's quite a bit of interest regarding unemployment across Europe. Usually, they are led to this post, which is quite dated.

Going forward, I plan to update the European employment trends as they are released on the Eurostat website. Generally this data is about one month lagged from the national statistics offices, since Eurostat harmonises the employment data for seasonalities and adheres to the International Labour Organisation (ILO) recommended definition . The current release is for August 2010; September will be released in two days.

The first notable shift is that the 3-month moving average ending in August of the unemployment rate (the average across three months) fell compared to that ending in May (a sort of proxy of quarters) across 52% of the sample illustrated in the chart below (many EU economies plus Japan and the US). The average percentage drop (not drop in percentage points) was fairly small, though, -3.5% over the two periods (i.e., the green dot hovers around the outside end of the blue bar). For the September release, we will see the quarterly shift in Q3.

In the Eurozone, the Eurozone 16 that is, the shift in the unemployment rate over the last year is down for just 5 economies: Finland, Italy, Germany, Malta, and Austria.

(Note: some of you may wonder why I compare October 2009 to August 2010. Well, that's the way that it is listed in table teilm020 at the Eurostat website. One can get a longer time series, but this is the table I will use going forward.)

So there you have it. The harmonised unemployment rates are generally screaming "weak" in Europe. Going forward, fiscal austerity is expected to directly pressure unemployment rates across those countries that are tightening. Also, a persistent strengthening of the currency (has yet to be determined) may play a role in key exporting industries, like Germany, where exporters hire large pools of labor.

Rebecca Wilder

Update: Click here for the September 2010 report.

Tuesday, October 26, 2010

A little perspective on the impact that a weaker USD will have on overall economic activity

The Japanese yen, the Eurozone euro, and the British pound have appreciated 16%, 14%, and 9%, against the USD, respectively, since their 2010 lows. Some say that the "US wins" since the Fed's quantitative easing (QE2) will drive export growth via a weaker dollar. (Note that the Fed has not actually announced QE2, this is all just speculation.)

I'm not suggesting that the stated Fed policy will be to drive down the dollar. What I do know, however, is that the United States production model is not structurally positioned to enjoy the economic panacea that is a persistent debasement of the dollar, neither in the near- nor medium- term.



The bottom chart illustrates the export share in overall economic GDP, as forecasted by the European Commission (you can download this data at the Eurostat website). Notice that the US share of exports, expected to be just 12.3% in 2010, is minuscule compared to the export markets in Europe. So what I gather from a chart like this is that the weak dollar will hurt Europe much more than it will "help" the United States.

We need domestic policy to support full employment and the expansion of our export sector that will eventually arise. See Marshall Auerback's post this week at Credit Writedowns for a discussion on austerity, currency wars, and exchange rates.

Rebecca Wilder

Saturday, October 23, 2010

A proxy for nominal aggregate demand and payroll growth: Treasury receipts are recovering...

I present an update on aggregate demand using the highest frequency of economic data available, US Treasury tax receipts. Tax receipts serve as a proxy for nominal aggregate demand via a nominal indicator of private payroll growth.

US daily Treasury tax receipts are improving. (This chart has been modified since its original posting to enable reader to click to enlarge).

The chart illustrates the federal deposits of income and employment taxes that are recorded on a daily basis and presented here as the annual pace of the 30-day rolling sum. The red line illustrates the average annual growth rate spanning the period 2005-current.

Since roughly April of 2010, the annual pace of income and employment tax receipts has been above the average, 2.8%. In the third quarter, the annual pace of income and employment tax receipts remained around 4%, consistent with the second quarter pace. Hours and employment are improving, supporting wage gains and higher tax receipts. But more importantly, the pace of tax receipt growth has not faltered, demonstrating ongoing recovery in the labor market and consumer demand.

But it's not enough. The gains in tax receipts are likely a function of firms adding back hours instead of pumping up the work force. (see my previous post with links on the "hourless recovery").

The chart above illustrates the cyclical loss from recession and gains during the recovery of private net-jobs (payroll) and aggregate weekly hours (you can see the summary data from the September payroll report here).

Both series found a trough in the third quarter of 2009, which is consistent with the bottom in tax receipt growth (chart above). However, the hours index has recovered quicker than has its payroll counterpart (of course it fell farther, too). To date, both private hours and payroll are 7% short of their values at the peak of the economic cycle.

Receipts are growing, but not vigorously enough to indicate any shift in the current trajectory of payroll growth. Therefore, nominal aggregate demand remains weak. Furthermore, the still-nascent household deleveraging cycle is very likely moving at snail-speed (see this article for a discussion of the link between consumption growth, income growth, and deleveraging for today's commentary).

Rebecca Wilder

Wednesday, October 20, 2010

China's competitive devaluation

This commentary is crossposted with Angry Bear blog.

China took the world by surprise on Tuesday by raising bank lending and deposit rates for the first time since 2007. The story is, that restrictive monetary policy (i.e., raising rates) is needed to curb excessive lending, with an eye on mitigating inflation pressures. See this Bloomberg article to the point.

While restrictive monetary policy is needed, raising rates is not the only tool available to policy makers: China could allow their currency (CNY) to appreciate. With support from the fiscal sector, a broad CNY appreciation would improve prospects for global growth ex China via import demand. Instead, the higher domestic rates may crimp domestic demand, perhaps reducing inflation, but contemporaneously lowering import demand.

In my view, China's move yesterday should be viewed as competitive devaluation: reducing domestic prices in order to capture a competive edge. The currency war, as so-called by Brazil’s finance minister, Guido Mantega, is afoot; and China just confirmed its participation.

Textbook economics says that a central bank cannot have it all: independent monetary policy, a fixed exchange rate, and open financial markets (the impossible trinity). China has a fixed exchange rate (currently, it's effectively pegged to the USD, see chart below) with tightly monitored capital markets. This means that the Chinese economy effectively matches the "easy monetary conditions" of its counterpart, the US. Monetary policy in China is too loose.

Going forward, further accommodative monetary policy in the US will likewise loosen policy further in China; inflation pressures will be even more robust. But, large-scale asset purchases on the part of the Fed will likewise weaken the USD, which is positive for US exports and negative for US import demand.

All in all, policy makers in China are looking at the USD move with tunnel vision. If the CNY maintians its current trajectory (effectively flat), then any shift in relative prices based on the recent (or future) rate hikes will reduce the CNY real exchange rate (all else equal, of course) - that's competitive domestic devaluation.

The table has already been set.

Chinese policy makers have slowed the nominal appreciation. Think about what could be if the CNY had maintained its 2005-2008 trajectory, where the CNY appreciated against the USD nearly 20%. Using the compounded annual growth rate (CAGR) over the same period, where the CNY gained 0.5% on a monthly basis against the USD, the month-end September CNY would be valued 11% higher against the USD than it is now.


They slowed real appreciation, too. The real appreciation of the CNY against its trading partners – the real exchange rate accounts for both nominal appreciation and price differentials across countries – slowed from an average 0.4% monthly gain spanning the period 2005-2008, as measured by the CAGR, to just 0.05% since then. (I use the JPMorgan real exchange rate index, but the BIS makes similar data available free of charge.)

The Chinese authorities are fully aware of the economic value of external demand (exports). The media will say that China’s trying to “cool” domestic inflation by raising domestic bank rates; but that’s not the full story. In my view, what they’re really trying to do is to “cool” domestic inflation in order to shift relative prices and depreciate the real exchange rate, all to gain a competitive advantage in global goods markets.

Rebecca Wilder

Monday, October 18, 2010

More on how the NY Times is wrong about the Japanese economy

The NY Times writes Japan Goes From Dynamic to Disheartened. As highlighted by Dean Baker, this article grossly misrepresents the dynamics of the Japanese economy. I likewise read this article with some dismay, wondering was there any actual research done in preparation for this commentary?

First, the reporter draws conclusions on the aggregate economy through anecdotal accounts of Japanese businesses and households. Here's one example:

But his living standards slowly crumbled along with Japan’s overall economy. First, he was forced to reduce trips abroad and then eliminate them. Then he traded the Mercedes for a cheaper domestic model. Last year, he sold his condo — for a third of what he paid for it, and for less than what he still owed on the mortgage he took out 17 years ago.

As highlighted by Dean Baker, the Japanese standard of living, measured by real per-capita income listed in the IMF World Economic Outlook database, has grown markedly over the last two decades. Spanning the years 1990 to 2010 (f), Japanese real average income grew 17%, while that in the US grew 33%. The growth differential across the two countries is admitteldy large; but Japan's standard of living has not crumbled, rather grown.

The article is overly pessimistic about the effects of Japanese deflation on the standard of living. Spanning the years 1999 - 2010 (f), the period for which the Japanese economy experienced persistent annual deflation, real per-capita income in Japan grew neck and neck with that of the US: 9.7% in Japan, versus 10.4% in the US.

Even worse, the article barely touches (misses actually) on the fundamental economic problem in Japan: the shrinking labor force. Spanning 1999 - 2010 (f), real GDP in Japan grew at less than 1/2 the pace of that in the US, 10% in Japan versus 23% in the US. Deflation? I think not; it's a secular decline in employment.

The chart illustrates a measure of productivity, as real GDP normalized by the level of employment (also from the IMF World Economic Outlook database). During the period 1999 - 2010 (f), productivity growth in Japan's been roughly in line with that of the US, 14% and 17%, respectively.

Finally, in my view this is the most egregious NY Times error:
But the bubbles popped in the late 1980s and early 1990s, and Japan fell into a slow but relentless decline that neither enormous budget deficits nor a flood of easy money has reversed.
It wasn't that government deficits were not able to slow the decline - fiscal policy mistakes caused some of the decline.

Richard Koo, author of Balance Sheet Recession: Japan's Struggle with Uncharted Economics and its Global Implications and Chief Economist of Nomura Research Institute, who was interviewed for the NY Times article must be quite irked by the NY Times account of Japanese fiscal policy. Here's a presentation that Koo gave in 2008, where the title of slide 9 says it all: "Exhibit 9. Premature Fiscal Reforms in 1997 and 2001 Weakened Economy, Reduced Tax Revenue and Increased Deficit".

The government raised taxes in 1997 to see growth deline from 1.6% that year to -2% a year later.



Be careful what you read. Rebecca Wilder

Thursday, October 14, 2010

Who's bringing home the dough?

...Corporations. Since earnings season is now well underway, I decided to look at the breakdown of aggregate domestic income (gross domestic income). Corporate profits are up 44.7% since the outset of the US recovery, while wages and salary accruals are up just 0.9%.

The chart above illustrates the peak-trough losses (total loss), trough-Q2 2010 gains (total gain), and peak-Q2 (relative to peak) deviations of nominal gross domestic income, disaggregated by income type.



First up, wages and salaries (employer contributions for employee pension and insurance funds and of employer contributions for government social insurance) and private enterprises net of corporate profit incomes grew in sum spanning the recession (private enterprises net of corporate profits includes proprietor's income, which did fall). Furthermore, the drop in wage and salary accruals, -3.6%, was small compared to the drop in corporate profits, -18.1%.



Second, the corporate profit gains during the recovery massively outweigh the wage and salary gains over the same period, 44.7% versus 0.9%. Corporate profits are now 18.5% above the peak in 2007 IV, while wages and salaries hover 2.8% below.



The problem here is, that the deleveraging cycle is heavily weighted on the household sector (the workers at the corporations) - if corporate profit gains do not translate into hiring and wage gains, or even to further capital spending, economic growth will suffer going forward.



Better put, at the very minimum, the recent surge in corporate profits is not sustainable if firms do not distribute the gains to the real economy. Also, meager wage gains does make healthy deleveraging difficult for household sector. Therefore, the recent surge in gross domestic income (hence, it's spending counterpart, GDP) is not sustainable if corporate profits are not recycled.



Rebecca Wilder

Monday, October 11, 2010

Who's saving where? An application of the 3 Sector Financial Balances Map

This commentary is crossposted with Angry Bear Blog.

Dean Baker finds gaping holes in deficit hawk rhetoric using the simple accounting identity that national saving must equal the current account (S-I = CA). If the domestic private-sector's desire to save is positive, then the only way for the public sector (i.e., government) to net save is for the economy as a whole to run a sizable current account surplus.

Singapore does just that. Spanning the years 2004-2009, the average current account surplus was near 21% of GDP, which enabled the government to run surpluses near 5% of GDP and the private sector to save 16% of GDP. Singapore is a net-saver in all sectors of the economy: private, public, and international. However, it's Singapore's huge current account surplus that allows the domestic sector to net save, and not all financial balances are created equally.

Let's use a slightly different version of Rob Parenteau's 3 Sector Financial Balances Map to illustrate that not all financial balances are created equally.

The chart illustrates the combination of private and public surpluses (or deficits) that prevail at each of three "zones" of the Balanced Current Account Line (BCAL). The BCAL zones are: CA > 0 to the right of the red line, CA < 0 to the left of the red line, and CA = 0 on the red line. The World Economic Report database, October 2010, is used to construct the average 3-Sector Financial Balances Map for the IMF's Advanced Economies spanning the years 2004-2009. (Note: Singapore, Norway, and Iceland are not illustrated because their respective sector financial balance points lie outside the normal range and distort the map.)

The public-sector financial balance (PubS) for each economy is the IMF's measure of general government net lending as a percentage of GDP. The domestic private-sector financial balance (PrivS) is the residual of the current account as a percentage of GDP less PubS such that the following identity holds:

PrivS + PubS = Current Account
(please see Rob's post for further detail on the sectoral balances approach)

In the chart, the four quadrants of public-sector and private-sector financial balances that account for the CBAL zones across the Advanced Economies are:

I. PubS > 0 (public-sector surplus) and PrivS < 0 (domestic private-sector, households and firms, deficit)
II. PubS < 0 and PrivS < 0
III. PubS > 0 and PrivS > 0
IV. PubS < 0 and PrivS > 0

The quintessential savers are listed in quadrant III and to the right of the BCAL: Sweden, Hong Kong, Luxembourg, and Singapore (not shown). The classic debtors are listed in quadrant II and to the left of the BCAL: Ireland, Spain, Portugal, Greece, and a couple of other Eurozone economies that are not labeled (Cyprus, Malta, and Slovak Republic). Finally, quadrants I and IV list economies that have positive saving in one of the domestic accounts: public (I) or private (IV).

The point is pretty clear: in order for the government to net-save, PubS > 0, either the private sector must dissave and/or the current account must be in surplus. It's that simple.

Notice that the financial balances of Spain, Portugal, Ireland, and Greece are in quadrant II and to the left of the CABL. These are averages, and the fiscal deficit worsened markedly in 2009 and 2010 as the private sector incentive to save surged. Currently, though, the fiscal adjustment requirements are huge (deep into quadrant II). For example, Spanish policymakers announced a deficit reduction path to take the PubS < 0 from 11.2% of GDP in 2009 to 9.3% in 2010, with a colossal further reduction of 4.9 percentage points to 4.4% of GDP in 2012.

Given that Spain, for example, is starting from a point of hefty private-sector deficits over the last five years, on average, the sole hope for a successful policy tightening lies with external demand growth (the current account). Spain needs massive export income in order to finance such reductions in the government deficits.

So who will succeed in reducing their public fiscal deficits? Pretty much any country with private surpluses has a fighting chance: Germany, France, the Netherlands, Belgium, the UK, and the US even (on the corporate side). The problem is, that policy makers can't just tell the private sector to start dissaving. Well, it can, but incentives may be needed.

All else equal, recent FOMC announcements furthered a dollar sell-off, and along with recent disinflation the economy has a fighting chance if policy does move toward austerity. But as Dean Baker suggests, more currency re-valuation is needed.

Rebecca Wilder

Thursday, October 7, 2010

German industrial production: Hot or Not?

Hot now, maybe not in six months.

In Germany, industrial production increased 1.7% in August, or 10.7% over the year. The monthly surge beat expectations 3-times over (0.5% on Bloomberg).

According to MarketWatch:

After two rather disappointing months in the German industry, concerns about
fading external demand and the sustainability of the German recovery surfaced.
Today's numbers should hush these concerns. Not only once, but for a longer
period. Looking ahead, all available evidence points to a further strengthening
of the German industry," said Carsten Brzeski, senior economist at ING in Belgium.
To be sure, this report is consistent with a slew of recent German statistics beating expectations: the unemployment rate dropped to a near 20-year low; consumer confidence continues its fearless ascent; annual inflation is on an upward trend (as opposed to a downward one); and factory orders are increasing at an average 2% monthly rate, far above the pre-recessionary average (0.5%).

In contrast, the Ifo business climate survey, which breaks down expected and current conditions, portends a precipitous decline in annual industrial production activity in the next six months (see chart below).

The chart illustrates the 6-month lead of the trend in Ifo expectations index minus the trend in Ifo current index and the annual growth rate of industrial production. The series are highly correlated, and the expectations/current Ifo peaked in February and fell precipitously thereafter. This suggests that the pace of German industrial production should slow markedly in coming months, and possibly turn negative.

This is just one indicator, and may be a truly spectacular bit of data mining on my part. However, as external demand slows, the German economy, with its 46% of GDP export share, is openly exposed to its drag.
Rebecca Wilder

Monday, October 4, 2010

Retraining workers won't work

Update: one of our readers caught a mistake in the chart. I indexed the data to December 2008, or one year after the recession actually started in December 2007. The statistics that changed are formatted in bold, and the chart in the article has been updated. The analysis doesn't change at all, but the number of jobs lost during the recession is higher than those indicated in the original article.

From the NY Times, White House Plans Job Training Partnership (bold by me):

As part of efforts to address record-high levels of long-term unemployment, President Obama plans to announce a new national public-private partnership on Monday to help retrain workers for jobs that are in demand.

The national program is a response to frustrations from both workers and employers who complain that public retraining programs frequently do not provide students with employable skills. This new initiative is intended to help better align community college curriculums with the demands of local companies.

“The goal is to encourage community colleges and other training providers to work in close partnership with employers, to design a curriculum where they want to hire the people coming out of these programs right away,” said Austan Goolsbee, chairman of the President’s Council of Economic Advisers.
The White House has coined this program Skills for America's Future. The complication is, that lack of skills is not the problem for the 66% of the labor force aged 25 years and over without a bachelor's degree. The problem is the lack of jobs.


The chart illustrates the dynamics of employment by level of education through August 2010, as measured by the Bureau of Labor Statistics. Note that the data are indexed to the onset of the recession, December 2007, where 100 implies that employment is now at its pre-recession level.

The only category to recover employment in full is that requiring a Bachelor's degree or higher. Furthermore, no material change in employment for BA's (or higher) has occurred since about a year ago, as indexed employment hovers around 100. No new jobs.

The levels of employment for those workers with the lowest levels of educational attainment, 1. and 2., are 10.2% and 6.6% below pre-recession levels, respectively. That is over 3.5 million jobs.

The White House program is targeted at community college students, or education category 3., some college or associate degree in the chart above. Employment for workers with a community college degree sits over 3.2% below pre-recession levels, or 1.1 million jobs. Retraining workers will not raise the employment level further.

The government needs to "add jobs", not "retrain workers", and stimulate domestic aggregate demand.

Rebecca Wilder

Thursday, September 30, 2010

The money quandary

The Federal Reserve, the Bank of England, and the Bank of Japan are considering further quantitative easing. It's an explicit statement, as with the Federal Reserve and the Bank of England, or implied by the fact that the foreign exchange intervention will eventually be sterilized if the policy rule is not changed, as with the Bank of Japan. Why more easing?

In response to this question, BCA Research (article not available) presented a version of the quantity theory of money. They looked at the simple linear relationship between the average rate of money supply growth (M2) and nominal GDP growth (P*Y).

The chart is a reproduction of that in the BCA paper, but with a sample back to 1959 (they went back to the 1920's when M2 was not measured). The relationship illustrates the 5-yr compounded annual growth rate of money (M2) against that of nominal GDP, and has an R2 equal to 50% - okay, but not perfect.

Nevertheless, the implication is pretty simple: the current annual growth rate of M2, 2.8% in August 2010, corresponds to an average annual income growth just shy of 4%. Sitting beneath a behemoth pile of debt relative to income, 4% nominal GDP growth is unlikely provide sufficient nominal gains for households to deleverage quickly or "safely".

However, notice the 2000-2005 and 2005-2009 points, where the relationship between M2 and nominal GDP growth deviated away from the average "quantity theory" relationship. Would a broader measure of money account for the weak(ish) relationship in the chart above? Yes, partially. (Note: the relationship almost fully breaks down at an annual frequency.)

These days it's all about credit. I'm sitting in Cosi right now - bought a sandwich and charged the bill on my credit card. Actually, I prefer to use cards. But M2 doesn't account for this transaction as money if the balance is never paid in full. M2 is essentially currency, checking deposits, saving and small-denomination time deposits, and readily available retail money-market funds (see Federal Reserve release).

One can argue about the merits of including credit cards balances as "money", per se. However, the sharp reversal of revolving consumer credit, and likely through default (see the still growing chargeoff rates for credit card loans), would never be captured in M2. The hangover from the last decade of households using their homes as ATM's (i.e., home equity withdrawal) and running up credit card balances to serve as a medium of exchange is dragging nominal income growth via a sharp drop in aggregate demand.

The Federal Reserve discontinued its release of M3 in 2006, which among other things included bank repurchase agreements (repos). Including M3, rather than M2, in the estimation improves the the R2 over 30 percentage points (to 81%).


This is a very small sample, and removing the latest data point from the original estimation improves the R2 slightly to 64%; but clearly there's something going on here. I think that it's fair to say that we may be disappointed by the M2 implied average nominal GDP growth rate over the next 5 years (4%).

According to John Williams' Shadow Statistics website, M3 is still contracting at (roughly because I don't subscribe to the data) 4% over the year. The relationship in the second chart implies that nominal GDP will fall, on average, about 4.5% per year. Japan's nominal GDP never contracted more than 2.08% annually during its lost decade, but the implication is that "things" may not be as rosy as the M2 measure of money suggests.

Rebecca Wilder

Sunday, September 19, 2010

Evaluating the "excess" in the US corporate financial balance

In a NY Times op-ed, Rob Parenteau and Yves Smith reminded us that the private sector financial balance is a function of the household financial balance and the corporate financial balance. They concluded the following regarding excess corporate saving:
So instead of pursuing budget retrenchment, policymakers need to create incentives for corporations to reinvest their profits in business operations.
In my view, it's not that simple (not that passing this type policy would be easy at all). As I illustrate below, firms, like households, are in a deleveraging cycle, where corporate excess saving is likely to persist for some time. (Note: US total corporate financial balance, excess saving if the balance is positive, is roughly undistributed profits minus gross corporate domestic investment)

In their NY Times article, Rob and Yves cite a 2005 JP Morgan study, "Corporates are driving the global saving glut". In that study, JP Morgan argues that the global saving glut has been driven largely by G6 excess corporate saving, and to a lesser extent emerging economies. In the US, positive corporate excess saving persisted through the latest print, 2010 Q2.

The illustration above plots the total corporate financial balance as a percentage of GDP. I calculate the Total Corporate Financial Balance (TCFB) as in the JP Morgan study, which is the residual of the national accounting identity of the Current Account Balance minus the Household Financial Balance minus the Government Financial Balance. According to this measure, the TCFB was roughly +3% in 2010 Q2, or about +1% above the 2008-2010Q2 average (2.1%).

About the same time as JP Morgan published their research, the IMF and the OECD were wondering why global TCFBs were rising. Several factors are attributed the upward trend in the first half of the 2000's, including (this is not a complete list of factors):
  • Repurchase of stock shares relative to dividend payouts
  • The falling relative price of capital goods dragging nominal investment spending as a share of GDP (see Table 3.2 of the OECD publication)
  • The overhang of leverage build in the 1990's
  • Rising profits via falling taxes and low interest payments (especially in other OECD economies)
Although firms likely worked out much of the debt overhang from the 1990's, the debt accumulation spanning the second half of the 2000's was precipitous.

It's very unlikely that the excess corporate saving will fall anytime soon, as non-financial business leverage is high just as household leverage is high. Total non-financial business debt peaked in 2009 Q1 at 79.5% of GDP and is now trending downward, hitting 74.9% in 2010 Q2.

If history is any guide, then the "excessive" borrowing spanning 2005-2008 will take some time to repair. Spanning 2002 to 2004, the non-financial business sector dropped leverage 2.5% to 64%. If this 2-year period of de-leveraging indicates an "equilibrium" level of leverage, then non-financial businesses are likely to run consecutive financial surpluses (excess saving) in order to reduce debt levels by another 11 percentage points of GDP for a decade more.

If firms run excess saving balances, then they're not investing in future profitability via capital expenditures nor increasing marginal costs, like wages and hiring, relative to profit growth. So while it is true that some fiscal policy should be targeted directly at investment incentives (Rob Parenteau and Yves Smith article), these measures may prove less effective since the non-financial business sector's desire to "save" and repair balance sheets is high.

I leave you with one final chart to inspire more discussion: a breakdown of the total corporate financial balance into its two parts, financial-business and non-financial business.

The financial balances in illustration 2 are computed directly from the Flow of Funds Accounts, Table F.8, rather than taking the residual as calculated in illustration 1. Thus, the total corporate financial balance will not match that in illustration 1.

The point is simple: the small drop in excess saving in total corporate financial balance in illustration 1 is stemming from the financial side. The non-financial corporate sector continues to raise excess saving by investing retained earnings into liquid financial assets relative to capital investment.

Fiscal policy should be targeted at the high desired saving by the corporate and household sectors alike. The idea is to pull forward the deleveraging process by "helping" households and firms lower debt burden via direct liquidity transfers (lower taxes or subsidies, for example). Only then will healthy private-sector growth resume.

Rebecca Wilder

Wednesday, September 15, 2010

Harmonised unemployment rates: a tad scary

Across the OECD, the unemployment rate was unchanged at 8.5% in July 2010.

The chart illustrates the harmonised unemployment rates for 28 economies in July spanning 2008-2010 (based on data availability, the comparison month is June for Chile, Netherlands, Norway, and Turkey, and May for the UK). The countries are ranked by the percentage change in the unemployment rate from 2008 to 2010, where Denmark is the highest, 115% increase, and Germany is the lowest, -4.2%.

The story in this chart is obvious: the slack in global economic activity remains extreme in much of the developed world. More growth it needed; but apparently, we're not going to get it.

The OECD released its index of composite leading indicators (CLI, where you can view the components of the index for each country here) for July. The pace of economic expansion is waning. (Click on chart to enlarge.)



From the release:
The CLI for the OECD area decreased by 0.1 point in July 2010. In Canada, France, Italy, the United Kingdom, China and India there are stronger signals of a slower pace of economic growth in coming months than was anticipated in last month’s release. Stronger signals that the expansion may lose momentum have emerged in Japan, the United States and Brazil. Tentative signals have also emerged that the expansion phases of Germany and Russia may soon peak.
According to the composite CLI, the OECD hit a cyclical trough in May 2009 (14 months before the July release). Since then, the unemployment rate has risen in 20 of the 28 listed economies.

The robust global restocking of inventories fueled world export income; but that cycle is now over (see the chart on page 8 of the OECD's interim forecast). Furthermore, expansionary policy, which underpinned domestic demand around the world, is tightening.

Policy will turn expansionary again in several of these economies. The faltering sum of income will drag global growth further until stabilizing policy kicks in.

Rebecca Wilder