Tuesday, June 29, 2010

Yield curves in Japan and the US: similar but not the same

Andy Harless presents the case for a double dip (second recession) - I would re-order #1 and #2 on that list - and that for a sustained recovery. #6 of Andy's case for a sustained recovery (he calls it Case Against a Second Dip) caught my attention, pointing me to an earlier Paul Krugman article about positively-sloped yield curves in a zero-bound policy environment.

In a related article, Krugman argues that a current policy of near-zero short-term rates precludes the lowering further of future short-term rates. Therefore, the steep yield curve reiterates that rates have nowhere to go but up rather than that the economy is expected to improve.

Reasonable; but it was Krugman's comparison to policy during Japan's lost decade that got the mental wheels rolling:
Indeed, if we look at Japan we find that the yield curve was positively sloped all the way through the lost decade. In 1999-2000, with the zero interest rate policy in effect, long rates averaged about 1.75 percent, not too far below current rates in the United States.
In my view, current Fed policy is generally more credible than policy undertaken by the Bank of Japan in the early 2000's. The fed funds target has been near-zero since December 2008; and the new reserve base (liquidity) peaked quickly since the onset of QE and has since remained in the banking system.

Therefore, it would stand to reason that as long as policy remains consistent and big (the latter on the fiscal side is the problem right now), the US yield curve can, in my view, be interpreted as an auspicious sign - all else equal, as they say - as compared to the positively-sloped one in Japan.

Monetary policy in Japan: 1998 - 2006

The Bank of Japan has a solid history of rescinding their own policy efforts. They did it earlier this year; but more importantly their policy announcements spanning the years 1999 to 2006 have on occasion been rather deceiving. Notice that the 2-10 yield curve never became inverted.

The shortened version of the timeline (illustrated in the chart above):
  • From Bernanke, Reinhart, and Sack (2004): "In April 1999, describing the stance of monetary policy as “super super expansionary,” then-Governor Hayami announced that the BOJ would keep the policy rate at zero “until deflationary concerns are dispelled,” with the latter phrase clearly indicating that the policy commitment was conditional."
  • In August 2000, The BoJ raises the overnight call rate to 0.25%, up from near-zero.
  • In February 2001 the BoJ lowers the overnight call rate to 0.15%.
  • In March 2001, the BoJ announces its quantitative easing strategy, initially targeting current account balances (essentially reserves) at 5 trillion yen and lowered the overnight call rate target to near-zero.
  • Until 2004, the BoJ raises the current account reserve target several times until it peaks at 30-35 trillion yen.
  • In March 2006, the BoJ exits QE.
I concur with Paul Krugman, that the deflation threat is very very real. I do not think that it is completely fair to compare the current US yield curve to that to early 2000's Japan.

To be sure, the likelihood of rates rising is the only possibility built into the US yield curve right now (no possibility of lower rates); but since the Fed is relatively more credible and consistent, the probability of rates rising is much higher compared to that in early 2000's Japan.

And the current US curve is steep! The chart below compares the dynamics of the 2-10 yield curve in Japan from its low in 1998 through 2006 to that in the US from its low in 2007 through June 24, 2010.

Rebecca Wilder

Reference for paper in final chart: Luc Laeven and Fabian Valencia (2008), Systemic Banking Crises: A New Database, IMF Working Paper WP/08/224.

Saturday, June 26, 2010

Another blow to the US labor force

The Senate voted down the American Workers, State, and Business Relief Act of 2010, 57 to 41 (see an earlier version of the CBO's estimate here for a breakdown of the Bill). The emergency extensions to weekly unemployment benefits will now expire, leaving many without government support as the labor market improves at snail speed.

Those who support the Bill claim that benefits prop up consumer spending. It is true, that unemployment benefits payments are more likely to be spent rather than saved. However, the latest version of the Bill allocated about $35 billion to benefits, just 0.34% of consumer spending in Q1 2010. Consequently, the direct impact on consumer spending of extending the benefits would have been small. (The provisions of the Bill in full would have quickened the recovery, according to David Resler at Nomura.)

Those who oppose the Bill claim that extending the benefits only increases the duration of unemployment - in May 2010 median duration was 23.2 weeks, its highest level since 1967. This is a weak argument when 7.4 million jobs, near 6% of the current payroll, have been lost since the onset of the recession (this is a cumulative number, which includes the gains since January 2010). The bulk of the unemployed would likely jump at an opportunity to work rather than live on benefits.

One way or another the government will plug the hole that is private spending. And the government will find this out the easy way (expansionary fiscal policy) or the hard way (perpetual deficits that result from weak private-sector tax revenue). Apparently it's going to be the hard way.

At 9.7% unemployment, isn't it obvious that Congress is not "spending" enough?

The chart illustrates the Nairu-implied level of unemployment (NAIRU, or the nonaccelerating inflation rate of unemployment) versus the measured rate of unemployment. The concept of NAIRU is limiting in that it inherently binds fiscal policy and is a theoretical notion at best; but it does present a baseline for comparison. The Nairu-implied level of unemployment is simply the CBO's estimate of NAIRU multiplied by the current labor force. Let's call points when the current level of unemployment is above the NAIRU-implied level as cyclical surplus of workers.

According to this measure of worker surplus, the state of the labor market is obvious: depressed. The NAIRU-implied level of unemployment is half of that currently measured by the BLS with a record wedge between the two. Furthermore, the cyclical surplus of workers in '82-'83 - the last time the unemployment rate peaked above 10% - was relatively mild compared to current conditions.

By failing to pass this Bill, the Senate reiterated its unwillingness to support the US labor market. Of course benefits are not the answer - we need a comprehensive jobs Bill to mitigate the consequences of such a depressed labor market. (There was a good article on the longer term unemployment problem at the Curious Capitalist some months back.)

Rebecca Wilder

Wednesday, June 23, 2010

GIIPS labour costs not moving in the "competitive" direction

The GIIPS (Greece, Italy, Ireland, Portugal, and Spain) hope: exports. Fiscal austerity crimps the saving of the private sector. And provided the governments make good their plans to put on the fiscal straight-jacket, there’s no other impetus for growth except foreign demand. Financial crises are often accompanied by currency crises, i.e., Sweden 1991, which drives export growth if there is sufficient external demand. For Sweden, there was.

For the GIIPS, there is not. But worse yet, there's not a possibility of a currency crisis deep enough to drive sufficient external demand growth in Greece, Italy, Ireland, Portugal, and Spain. Therefore, it’s generally understood that the GIIPS will get the economic boost if internal competitiveness is restored. Put another way, in lieu of a domestic impetus to economic growth, "internal devaluation” (Marshall Auerback calls it “infernal devaluation”), i.e, dropping hourly labor costs and final goods prices through productivity gains and reform, is the only economic means to attract a sufficient boost of external income to grow the economy.

Well, internal labour cost devaluation has yet to materialize in the GIIPS or the Eurozone as a whole. According to last week’s Eurostat release of Q1 2010 quarterly labour costs for the European Union, labour costs are still very much rising:
The two main components of labour costs are wages & salaries and non-wage costs. In the euro area, wages & salaries per hour worked grew by 2.0% in the year up to the first quarter of 2010, and the non-wage component by 2.1%, compared with 1.6% and 2.0% respectively for the fourth quarter of 2009. In the EU27, hourly wages & salaries rose by 2.3% and the non-wage component by 1.9% in the year up to the first quarter of 2010, compared with 1.9% and 2.5% respectively for the previous quarter.
There is a lag associated with labor cost growth, especially in Europe. But over the last two years, the Eurozone 16 saw labour costs rise a cumulative 5.3%, which is on par with the previous two-year horizon, 5.7%; labour cost growth isn't even slowing.
(this chart was updated at 4:00pm on June 23)

The chart illustrates the two-year cumulative labour cost gains across the Eurozone 16 (seasonally and working-day adjusted) alongside the annual gains over the last year (working-day adjusted only). Note: country-level data for Ireland, Finland are not available. Furthermore, country-level data through Q1 2010 are not available for Belgium, Italy, and Greece, so Q4 2009 is used instead.

According to the measure of "labour costs", it appears that “competitiveness” is not improving markedly in any country across the Eurozone, especially in the GIIPS that need it. In contrast, US nonfarm business unit labor costs dropped 4.2% over the last two years.

To be sure, there are other measures of “infernal devaluation”, like final goods prices. But strictly speaking labour costs remain too sticky in the Eurozone to attract external demand sufficient enough to offset the drag that would stem from the announced fiscal tightening across Europe.

Rebecca Wilder

Wednesday, June 16, 2010

The hourless recovery

There was an interesting blog post over at the Macroblog (Atlanta Fed) regarding productivity. John Robertson and Pedro Silos highlight the contributions to GDP growth from various factors, including productivity and employment. One of their findings:
As this chart shows, relatively high labor productivity growth during a recession is not a phenomenon isolated to the 2007–09 and 2001 recessions (for present purposes, the end of the most recent recession is identified with the trough in GDP in the second quarter of 2009). All recessions from WWII through 1970 also featured sizable growth in labor productivity.
The article focuses on the contribution of productivity gains to GDP growth during a recession and the early stages of the recovery. The authors do not comment on, however, a very interesting bit of their story: the “hourless” recovery. Lockhart speaks of this curtly in his speech - the focus of the macroblog article:
Current data on the use of part-time workers suggest that businesses have some scope to increase hours without hiring new full-time employees.
The precipitous drop in hours worked has differentiated this labor downturn from previous cycles (papers here and here). According to the BLS Q1 2010 productivity report, the recovery of the 2007-2009 recession has so far been “hourless”, which is consistent with the previous two cycles.

The chart illustrates the contributions to output growth from hours and productivity for the the first three quarters of recovery spanning the last six recessions. Note: the current recession has not officially been dated as having ended, but June or July 2009 is the "whisper" talk for now. I will simply call Q3 2009 as the onset of the recovery, since GDP grew that quarter.

The "hourless recovery" is underway: a cumulative 3.3% of output has been generated over the last three quarters (using the BLS productivity report) via a 0.9% drop in aggregate hours. I argued last year that adding back hours cannot generate sufficient output growth for sustainable "recovery"; however, productivity growth has been strong enough that the productive hours cycle has not even begun.

It’s likely that the large service sector is the drag that is driving the “hourless” recovery because manufacturing hours are red hot.

(The weekly hours series are indexed to 100 for comparison.

The chart illustrates average weekly hours of production and nonsupervisory workers in manufacturing and private industry payroll. Manufacturing weekly hours, 41.5 hours per week in May 2010, recovered 5% off the low of 39.4 hours in March 2009. Furthermore, May 2010 set a ten year record, breaking past levels not seen since July 2000 (not shown in chart but you can see it here). In contrast, total private weekly hours remain below pre-recession levels, just 1.5% off of the June 2009 low, 33.0 hours.

The BLS breaks down average weekly hours for all workers by industry since 2006. The service sector is the lion's share of the private payroll (~85%). Of the service sector payroll, 68% remains short of pre-recession weekly hours worked: trade, transportation, and utilities, professional and business services, and education and health services.

Adding hours still won’t provide a large growth impetus, as I argued here; however, the service industry has yet to see the burst in hours like in manufacturing. As such, I agree with the overall conclusions of the Robertson and Silos article:
Hence, it will probably take awhile to see how President Lockhart's forecast of continued modest employment growth pans out.
Rebecca Wilder

This article is crossposted with Angry Bear blog

Sunday, June 13, 2010

I understand why Asia's worried about Europe

On the forefront of the Chinese economic releases this week was the trade data, where headlines shouted +48.5% Y/Y export growth in May. This report didn’t go unnoticed in Washington, as renewed obsessions with the Chinese peg against the US dollar fired up again.

But the Chinese release overshadowed the Philippines April trade report, which in my view, illustrates more transparently the slowdown in external demand that is likely underway across the region. In the Philippines merchandise exports increased 27.4% over the year in April, which was half the rate of the Bloomberg consensus and that in March, 42.7% and 43.8%, respectively.

A negative export growth trend has been established - explicitly in the Philippines and likely going forward in China (see Goldman Sachs report below). And these countries have strong trade ties with Europe - the Eurozone was 15% of 2009 world GDP (PPP value) according to the IMF.

Therefore, recent nominal appreciation of the Philippine peso and Chinese yuan against the euro, and expected real appreciation - Europe's self-imposed economic contraction stemming from harsh fiscal austerity measures will drag prices downward - may very well hamper the economic recovery for key Asian economies via the export channel.

Export growth in the Philippines has been slowing to top trading partners.

The chart illustrates the contribution to overall export growth from the Philippines six largest trading partners - together these countries account for roughly 50% of total exports. The contributions to the Philippines export income growth has been slowing or flat for some time to China, Singapore, and Germany. Slightly more worrisome is the Netherlands contribution having turned negative for two consecutive months.

The Netherlands and Germany account for roughly 13% of total export demand from the Philippines. The euro has depreciated 8% against the Philippine peso since April 2010 (through June 11 and see chart below), and the lagged effects of the nominal depreciation will continue to pass through to exports.

In China, though, a resurgence of export growth among its top trading partners bucks the trend seen in the Philippines.

The chart illustrates the contribution to overall export growth from China's six largest trading partners - again, these countries jointly demand roughly 50% of total Chinese exports. China’s May report was indeed strong: the US added a large +8.3pps to overall Chinese export growth in May, and Hong Kong contributed another robust +6.2pps of growth. In contrast to the Philippines April numbers, The Netherlands contribution to Chinese export growth remained strong, contributing 1.5pps in May.

Chinese exports are quite volatile in the beginning of the year. I suspect that Yu Song and Helen Qiao at Goldman Sachs are right, that export growth will initiate its trend downward starting in June:
“We believe the very strong exports growth in May is likely to be a temporary phenomenon, much like the very weak exports data recorded in March, and expect June data to show a visible normalisation,” said Yu Song and Helen Qiao at Goldman Sachs.
In their Goldman report (no link) Yu Song and Helen Qiao argued that the Chinese numbers remain clouded by the following distortions:
  • "The exports acceleration was likely to be partially induced by a potential cut to the export VAT rebate for some commodity exports: There have been a number of domestic news reports that this might happen soon as a part of the broader policy package to reduce pollution and energy consumption.
  • But it probably also reflected changes in the domestic economy: Our proprietary GS Commodity Price Index (GSPCC) (Bloomberg ticker: ALLX GSCP) suggest that the domestic prices of main commodities have been mostly trending down in May which might have encouraged more exports in this area.
  • Strong export activities might also be impacted by the Lunar New Year effects as many exporters resumed production after taking time off during the holiday season which often last for weeks. [although they say this cannot be validated until a further breakdown becomes available later this month]."
The recent nominal depreciation of the euro against the Chinese yuan and the Philippine peso, 11% and 8%, respectively, since April 1 2010, will pass through to both Chinese and Philippine exports at a lag. And further real depreciation - the nominal exchange rate adjusted for relative prices of goods and services - of the euro against the yuan and the peso is almost certain. Europe’s self-imposed fiscal austerity measures will crimp economic growth and deflation is bound to take over across Europe and relative to Asia.

As such, recent external shocks from Europe will likely show up Chinese and Philippine trade data in coming months. Doesn’t look good for Asia, especially for those economies like the Philippines and China for which exports provide a robust growth impetus.

We’re nowhere NEAR out of the woods yet.

Rebecca Wilder

Thursday, June 10, 2010

European Propaganda

Dan (as in Rdan) sent me a link to this article published at Eurostat, “Impact of the crisis on unemployment has so far been less pronounced in the EU than in the US”. The report states:
The unemployment rate in the EU27 has grown since the first quarter of 2008 as a result of the economic crisis. However, the increase has been smaller than in the US, where the rate has overtaken the EU27 despite having been much lower at the start of the crisis. On a more detailed level, similar patterns in the evolution of unemployment by gender and educational level during the crisis can be observed in the EU27 and the US.
Admittedly, the US unemployment rate has seen a much sharper upward trajectory than that of Europe (see chart below); but that is nothing new. Historically, the US labor market has been more flexible than the European labor market.

Alas, this report is nothing more than European propaganda; and in my view, it was written to assuage the public during a period of heightened political pressure. Pointing out that the US labor market is in worse shape perhaps makes European policymakers “feel” better.

It’s all a mirage, though (see chart below). And furthermore, the European labor market is sure to worsen markedly with fiscal austerity all the rage in Europe.

Back to the point: so why exactly is this propaganda? At 18% of the EU27’s employment in 2009 and 20% of nominal GDP, Germany’s labor policies skew the unemployment rate for the European Union as a whole. From the OECD 2010 Economic survey of Germany:
While the increase in the unemployment rate in the average OECD country was 3 percentage points, the German rate rose by only one half percentage point although the fall in German GDP was above average. This was primarily due to increased flexibility on the firm level that allowed a reduction in labour input by decreasing working hours instead of employment. In addition, the short-time working scheme, whereby the labour office replaces some of the lost income of employees if they work shorter hours, has been used extensively especially as this programme was made more generous during the crisis.
Point: The German government paid firms to hoard workers.

If you take out Germany from the EU27, you get a slightly different picture – one that is not as rosy as the Eurostat report suggests.

In the chart above, I illustrate the reconstructed unemployment rate for the EU27 ex-Germany alongside that for the US and Germany through April 2010 (using the Eurostat data, which is only available through April 2010 on the website although the May unemployment rate has been released).

Clearly, the EU27 unemployment rate is affected by Germany policy. In April the EU27 ex-Germany unemployment rate was 10.3%, which is 0.6% above that of the EU27 as a whole (including Germany). Furthermore, the EU27 ex-Germany unemployment rate surpassed that of the US, rather than the other way around as the report suggests, in January 2010.

Just thought that you should know.

Rebecca Wilder

Wednesday, June 9, 2010

China’s not the answer for the Eurozone

“Go long whatever Chinese consumers buy and go short Chinese capital spending (construction) plays. Consistently, go long tech/short material stocks.”
That is the first sentence of a BCA Research report’s executive summary on China equity strategy (link not available). Rather than a global equity strategy, I’d like to put this into an economic growth context via trade…and with Europe.

Go long Eurozone economies selling to China? Is China the panacea for Eurozone growth? Short answer is no, but we'll attend to that later. Even if the euro wasn't selling off against the majors, China's domestic demand is robust and export income is flowing into the Eurozone - but to where?

The chart below illustrates the dynamics of annual export growth to China for the top 6 countries of the Eurozone measured by GDP in 2009: Germany, France, Italy, Spain, Netherlands, and Belgium. Presumably, the bulk of China’s export demand would flow to these countries.

Since the Eurozone's annual export growth to China bottomed out in May 2009, many of the Eurozone economies (some not shown in chart) have registered, on average, double-digit monthly export growth to China: Belgium 49% Y/Y, Germany 25%, Spain 16%, Greece 19%, Ireland 22%, Netherlands 39%, and Portugal 49%. Only Finland saw its monthly average export income drop over the same period, -10% Y/Y.

(A note of clarification: the statistics in the chart are monthly Y/Y growth rates, while the statistics in the paragraph above represent the average monthly Y/Y growth rate spanning the period May 2009 to March 2010. All of this data can be downloaded from Eurostat, EU27 Trade since 1995 by CN8).

But 75% of the Eurozone’s exports to China flow from just three countries: Germany, 54%, France, 11%, and Italy 10% (average Jan 2009 – Feb 2010 and see table below). This makes sense, given that Germany, France, and Italy are the three largest countries in the Eurozone.

However, compared to the size of their economies, Belgium and Germany are the true beneficiaries of China’s external demand, not Spain, France, nor Italy. And this trade data is truncated before the record decline of the euro.

The table above relates each country’s share of total Eurozone exports to China to its share of Eurozone GDP. I’d say that Belgium is doing quite well compared to its larger neighbors, +2.5% spread on a 3.8% share base. But Germany's out of this world, 26.9% spread on a 26.8% share base. Spain, France, and Italy are faring poorly, as their spreads are wide and negative.

China appears to be the panacea for just a handful of countries, most notably Germany and Belgium. But alas, it’s no panacea for the Eurozone, not even for Germany. Unfortunately, the Eurozone's fragile developed colleagues, the US and UK, are.

The shares illustrated in the chart are calculated for year 2009.

Markets anxiously await China’s every move; but according to the April 2010 IMF World Economic Outlook, China ran the largest current account surplus across the IMF member countries - $284 bn in 2008 – the 20th largest as a share of GDP. That kind of saving is NOT going to get the global economy back on its feet in full very quickly. China is not the answer for Europe.

The Eurozone, in particular, is paying close attention to non-Eurozone (16 countries adopted the euro as their currency) growth alternatives. I leave you with an excerpt from a nice FT article on Europe’s true woes – fiscal austerity measures - featuring the research of Wynne Godley and Rob Parenteau:
Many years ago, he [Wynne Godley] also criticised the institutional arrangements of the European Monetary Union. Writing in The Observer in August 1997, he noted that members of the eurozone were not only giving up their currencies but also their fiscal freedom. Within the union, a government could no longer draw cheques on its own central bank but must borrow in the open market. “This may prove excessively expensive or even impossible,” he warned.

He went on to caution that without a common European budget, there was a danger that “the budgetary restraint to which governments are individually committed will impart a disinflationary bias that locks Europe as a whole into a depression that it is powerless to lift”.
China is not the answer: not for Europe; not for the US; and not for the UK.

Rebecca Wilder