economy eyes

by Linda Beale

The Chicago School–why does anybody still listen to it?
I have frequently written here about the problems of “freshwater” economics–the school personified by Milt Friedman and the extremist “free market” ideology that views government as the enemy, the “markets” as always right, and any public role in economic development as “socialism”. As I’ve noted, this ideology misses many points about the role of government in creating a space where markets can function as they should and where individuals can have maximal personal liberty while pursuing better lives and respecting a societal decision that valuing each individual means allocating society’s resources in ways that support, rather than brutalize, those at the bottom.

The Nieman Foundation, connected with Harvard’s journalism school, has an interesting watchdog website that includes a number of controversial articles raising questions about the way today’s media tend to accept without questioning the “received wisdom” of the past (including the ideological views of the “free market” right). As part of a series on the economic collapse, the site includes an article by Henry Banta (a partner at Lobel, Novins & Lamont) noting the consensus developing among a small but diverse group of economists, professors, and those interested in how the economy works about the failure of efficient market theory. That’s a post worth reading, since it focuses on this issue. (My posts, perhaps to readers’ chagrin, tend to throw these criticisms in as asides in the course of analyzing one position or another being put forrward unthinkingly by proponents of that theory.). Enjoy. Henry Banta, Republicans are locked in a passionate embrace with a corpse and won’t let go, Nieman Watchdog, Feb. 11, 2010.

crossposted with ataxingmatter

Today I was thinking about tightening cycles in emerging markets; and more specifically, about that in China. Because let’s face it, China matters. China matters to the rest of Asia via competition for export income. China matters to Europe via competition for jobs. China matters to Brazil via domestic production via imports. China matters.

The inflation pressures are building in key emerging economies, especially in the BIICs (Brazil, India, Indonesia, and China) – see this previous post regarding my new acronym, and this article at the Curious Capitalist (curiously posted just shortly after my post), which leaves my omitted “R” but relays the intuition behind the second “I”.

Although the inflation is not prevalent in any BIIC except India, really, I wanted to comment about why it will build…quickly.

First round, the construction of consumer prices is heavily weighted toward food and energy costs across the BIICs. Indonesia, India, and China are highly susceptible to food price shocks (either driven by shortages or demand growth). Expect this as a first-round driver of inflation as the global economy recovers further. It’s already happening.

Second round, the BIICs are growing quickly and nearing, or are already at, potential. Annual industrial production growth has recovered or surpassed its pre-crisis rate in China, Brazil, and India, 19%, 16%, and 17%, respectively. This is expected, given the drop-off in world trade (an illustration can be found from this May 2009 pos), but unsustainable as the output gap closes.

Third round, interest rate differentials. This year, the BIICs’ central banks are expected to raise policy rates. In fact, Brazil, China, and India have already boosted reserve requirements. But with US rates expected to stay low for an “extended period”, international interest rate differentials will change and monetary flows will shift. Capital inflows can lead to inflation if not properly sterilized.

To date, inflows are not properly sterilized, as evidenced by the ongoing accumulation of reserves and rising money supply growth (again, I refer you to my previous post on M1 growth rates.

The chart above illustrates the one-year-ahead nominal interest-rate differential between the 2yr forward government rate for each respective BIIC country versus the 2 yr forward US Treasury rate. The forward differentials for China and India are on a steady upward trajectory, while those for Brazil and Indonesia are simply steady. I believe that this appropriately represents the sterilization efforts and monetary policy management on the part of the BIICs’ central banks: more managed in Brazil and Indonesia, not as much in China and India.

So where does this analysis leave us? With a very interesting policy mix in the emerging market space. In fact, in my view this is the riskiest part of the emerging market cycle: the recovery. If policymakers get this wrong, we could see a lot of price action, final goods and assets alike, on the horizon.

This is a guest contribution by Marshall Auerback, Braintruster at the New Deal 2.0

by Marshall Auerback

A new book by Kenneth Rogoff and Carmen Reinhart, “This Time It’s Different: Eight Centuries of Financial Follies”, has occasioned much comment in the press and blogosphere (see here and here)

The book purports to show that once the gross debt to GDP ratio crosses the threshold of 90%, economic growth slows dramatically.

But that’s too simplistic: a ratio is just a number. Debt to GDP is a ratio and the ratio value is a function of both the numerator and denominator. The ratio can rise as a function of either an increase in debt or a decrease in GDP. So to blindly take a number, say, 90% debt to GDP as Rogoff and Reinhart have done in their recent work, is unduly simplistic. It appears that they looked at the ratio, assumed that its rise was due to an increase in debt, and then looked at GDP growth from that period forward assuming that weakness was caused by debt instead of that the rise in the ratio was caused by economic weakness. In other words, they have the causation backwards: Deficits go up as growth slows due to the automatic countercyclical stabilizers.They don’t cause the slow down, etc.

After the Second World War, the debt ratio came down rather rapidly—mostly not due to budget surpluses and debt retirement but rather due to rapid growth that raised the denominator of the debt ratio. By contrast, slower economic growth post 1973, accompanied by budget deficits, led to slow growth of the debt ratio until the Clinton boom (that saw growth return nearly to golden age rates) and budget surpluses lowered the ratio.

From 1991 through 2001 the growth of government debt had been falling and since then rising most recently at a faster pace. The raw data comes courtesy of the St. Louis Fed (and attached spreadsheet).

The Ratio of the rates of change of Debt / GDP is rising faster than the change in Debt indicating that both the increase in Debt and the fall in GDP are contributing to a rising Debt / GDP ratio. For policy makers who obsess about a rising Debt / GDP ratio, they fail to understand that austerity measures that cut GDP growth will cause a rise in the Debt to GDP ratio. Basically, it boils down to this simple observation: it is foolish, dangerous, and thoroughly counterproductive to treat fiscal balances in isolation. In particular, setting a fiscal deficit to GDP target equal to expected long run real GDP growth in order to hold public debt/GDP ratios at a completely arbitrary (indeed, literally pulled out of thin air) public debt to GDP ratio without for a moment considering what the means for the feasible range of current account and domestic private sector financial balance is utterly nonsensensical.

It is crucial that investors and policy makers recognize and learn to think coherently about the connectedness of the financial balances before they demand what is being currently called fiscal sustainability. As it turns out, pursuing fiscal sustainability as it is currently defined will in all likelihood just lead many nations to further private sector debt destabilization. To put it bluntly, if the private sector continues to pursue a high net saving/financial surplus position while fiscal retrenchment is attempted, unless some other bloc of nations becomes large net importers (and the BRICs are surely not there yet), nominal GDP will fall in the fiscally “sound” nations, the designated fiscal deficit targets WILL NEVER BE ACHIEVED (there can also be a paradox of public thrift), and private debt distress will simply escalate.

In fact, if austerity measures are based on measures of debt relative to economic growth there is a very real risk of a downward spiral where economic growth declines at a faster pace than government debt and the rising Debt / GDP ratio leads to ever greater austerity measures. At a minimum, focusing only on the debt side of the equation risks increasing the Debt / GDP ratio that is the object of purported concern is likely to lead to policy incoherence and HIGHER levels of debt as GDP plunges. The solution is to recognize that the increase in the ratio is in some fair measure the result of declining economic growth and that only by increasing economic growth will the ratio be brought down. This may cause an initial rise in the ratio because of debt financing of fiscal stimulus but if positive economic growth is achieved the problem should be temporary. The alternative is to risk a debt deflationary spiral that will be much more difficult (and costly) to reverse.

This article is crossposted with News N Economics

by Linda Beale

Banking Matters–Bing’s Views

The Bing Blog is one of those well-written something about everything we’ve all thought about blogs that everybody should read at least every once in a while. So let me suggest a proper post for your introduction, if you haven’t looked there before. It’s a list of suggestions for what every bank ought to do. I doubt if there’s a soul amongst us who would disagree with any of them–except, perhaps, the bank personnel and especially managers who put the current rules into place. See The Bing Blog, New Banking Rules We’d Like to See, Mar. 2, 2010.

Here’s a sample of the new rules suggested:

I’d like there to be a rule that the bonuses a bank pays to its top 10 executives cannot exceed its profits.

(Beale here again) I could add a bunch, but one of the obvious ones Bing leaves out is: “no bank can send out a statement changing its rules to provide even higher fees and service charges in which it touts the rules as though they are for the client’s benefit while setting them to work in ways that will inevitably lead to more profits for the banks.”
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crossposted with ataxingmetter

(Rdan here…as we develop thought on economic issues facing us today, a nod to excellent writing in the past is important. Newcomers need to know past wisdom exists, and readers of five years ago can use this wisdom again as we visit today’s trends in the knowledge of predictions 2003-2005. I also have been reviewing PGL’s and Calculated Risk’s posts here at Angry Bear.)

Are Earnings Rising or Stagnant? Published June, 2005 by Kash

This question is not as easy to answer as it may first appear. In working on various posts last week I came across an apparent contradiction in the official data on compensation: some series show it rising in real terms, while others show it barely able to keep up with inflation. This discrepancy was also noted by a few readers, who deserve credit for their sharp eyes.

So I thought I’d take a bit of time to sort out these conflicting data series for myself. Here’s what I found. (A warning and apology here: what follows is a relatively econ-geeky post about data details that many may find uninteresting… and I won’t be offended if you stop reading here.)

There are three major sources for time series data on earnings: “Hourly Compensation,” from the BLS’s Productivity and Costs (P&C) dataset; the Employment Cost Index (ECI), which provides compensation series broken into the two sub-categories of wage/salary earnings and benefits; and the “Average Hourly Earnings” provided in the monthly employment report as part of the Current Employment Statistics (CES). The following two charts show the behavior of these different series since 1990. All series express hourly compensation rates in real terms.

Note: all series are expressed in real (inflation-adjusted) terms using the PCE deflator.

What explains the sometimes substantial differences between these series? There are several factors that contribute to the discrepancies, but let me point out the most important ones. (For a more complete description of their differences see this paper by Joseph Meisenheimer in the May 2005 issue of the Monthly Labor Review.)

First of all, two of the series – the CES series and the “ECI: wages and salaries only” series – do not include benefits that workers receive. In the charts, those are the pink and green series. Comparing the two ECI series shows that in the past three years or so, a significant gap has opened up between workers’ take-home pay and the amount of compensation that employers are paying, including benefits. I would argue that this is directly attributable to the soaring cost of health insurance since about 2000. Even if workers’ pay has been rising in real terms, nearly all of the increases have been going to pay higher health insurance premiums.

Secondly, the different series include and exclude different types of income and different types of workers. The table below summarizes the different types of workers and income that each series excludes.

Finally, it should be noted that the ECI differs from the other series in that it comes from a survey that is intended to compare the wage rate in a particular job over time, not the wage rate of a person. (The sample is 35,000 specific jobs across the country.) In other words, the survey compares what each job in the sample pays at one point in time to what it used to pay earlier. Furthermore, in constructing the average wage rate across the economy, the ECI holds the number and types of jobs constant at the proportions in the base year (which I believe was just changed from the year 1990 to the year 2000). What this means is that the ECI will not accurately reflect how a change in the composition of jobs in the economy might affect average wages.

Each of the series thus has its own strengths and weaknesses, and there’s no right answer as to which series is best. They each tell us slightly different things, and the differences between them tell us still more. For example, the surge in the P&C measure during the period 1998-2001 probably reflects the large-scale adoption of payments through stock options. The divergence between the wage/salary series and the total compensation series reflects the growing burden of health insurance. And the recent rise of the P&C measure compared to the ECI measure may reflect higher rates of compensation growth in for-profits firms compared to non-profit firms, or large increases in the compensation of self-employed business owners, or a change in the composition of jobs in the economy that the ECI hasn’t caught up with.

A note about income inequality: to the degree that some of the excluded groups (in the table above) may have different levels of income than others, the differences between the series may also suggest something about changes in income inequality. A word of caution about that, however: if you want to find evidence of income inequality, I think there are much better measures (such as the Census Bureau’s income data) than these compensation measures. There is too much else going on in these series to be able to safely attribute anything on the charts above to changes in income inequality.

So what’s my answer to the title question of this post? Personally, if I had to choose just one series to use it would be the P&C series. In addition to being arguably the most complete series, it seems to have done the best job of matching my sense about how the economy has done over the past 20 years. When asked, I think that most people would agree that income growth was indeed much lower during 2002 and 2003 than it had been during the late 1990s; the P&C series bears that out, while the ECI series doesn’t. Meanwhile, the CES series excludes benefits, which I think are a major part of the story today.

But let me reiterate the point that I have made several times now: just because real compensation is rising, that doesn’t mean that people are better off, particularly if nearly all of the gains are just going to paying higher health insurance premiums. This data persuasively illustrates that nearly all of our real compensation gains today (and I do think we’re seeing them) are being eaten up by the monster that we call a health care system in the US. Until we address the profound inadequacies of our health care system, this trend will only get worse.

Kash

by cactus

A NonReview of Yves Smith’s Econned, Plus Some Questions About Selling Books

I’ve been swamped – a lot of work at work, deadlines for my book (more on that below), and family issues to contend with so for the past few weeks I’ve been cooped up with zero downtime. Friday I managed to crawl out of my hole… at least for the time being. I remembered that Yves Smith’s book, Econned, was due out. Yves’ blog, Naked Capitalism is one of my daily reads and I’ve been looking forward to her take on the whole Great Recession.

Long story short, I visited two bookstores – both had sold out. I placed an order for the book at Barnes and Noble and was told it would be available this week.

All that is a good sign for Yves Smith, and I wish her well. But I was wondering… what can one do to make one’s book more likely to do well? Obviously, with a book coming out later this year – in August – its something I have an interest in knowing. (The book is already for sale at some online locations. Here’s the Amazon link to the book. As an FYI, given how little the bio of me is, there’s a surprising amount that’s incorrect.)

The book is – we think – a bit unique. We looked at a how a large number of issues – from abortion to crime to the economy – evolved over the length over each administration from Ike to GW. (In a few instances, where the data is reliable, we go back to Hoover.) And we let the data speak, as regular readers can imagine from the posts I’ve written. I’ll give you an example – my own political views, as one can imagine from the fact that I occasionally post at Angry Bear, are generally slightly left of center. And when this project started some years ago, I hewed closely to what one might term a slightly left of center view on crime, namely that the way to reduce crime is to focus more on rehabilitation. But the data shows that the Presidents under whom crime fell by the most were the ones who, once you account for demographics, put cops on the street, locked people up, and threw away the key. And that is precisely what we show.

I’m not sure I’m happy that the results on crime are what they are. Philosophically, I’d be a lot more comfortable being able to state that we should spend more time and effort and resources on rehabilitation relative to punishment, but the data shows what it shows. And my comfort level, frankly, is irrelevant, when it comes to determining what reduces crime. And the one thing my co-author and I agreed on from the start was that we would post the data (in a nice graphical format thanks to Nigel Holmes, a brilliant artist the publishing company hired to make our graphs look nice), whatever it showed.

Now, that is going to cause a major problem. See, on some issues, there doesn’t seem to be much of a relationship between a governing philosophy and outcomes. For instance, stock market performance seems to be unrelated to the president’s party, or even to how well the economy did. But (its not exactly a surprise to readers of this blog) on a lot of issues, particularly the economic ones, Democrats tend to outperform Republicans. And we think we’re able to nail the cause of this disparity. We also feel we’re able to do a good job of showing that the cause is related specifically to the occupant of the White House, as opposed to, say, Congress, God’s will, the public’s voting patterns, or whatever else.

And as regular readers know, stating that politicians that followed a certain policy produced better economic outcomes than politicians who followed the opposite policies seems to leads to uncomfortable conclusions for some people. As uncomfortable, for instance, as my epiphany on looking at the data on crime. But some people simply refuse to give up cherished beliefs. Its easier to attack the messenger. So though we call it like it is, and we call it for Republicans when Republicans have the better argument, I have zero doubt whatsoever that our book is going to labeled “liberal.” Which is a pity, because the book is not intended to cheerlead. In fact, its intended to poke and prod both sides into keeping what works from their side and giving up what doesn’t.

OK. So there it is. That’s what the book is about. How do we sell it? Anyone have concrete ideas? Bear in mind, this has to be something we can do. People always tell me to go on the Daily Show or some similar program. I don’t exactly have any media exposure (my co-author does), but I’d love to do it. However, there are a lot of people trying to go on TV to peddle their wares or their opinion. Heck, even people who know they’re going to get publicly humiliated by Jon Stewart show up with big smiles on their face. And my guess is that a lot of people think, like I do, that they have something unique that can change the world if word gets out. So what do I do from here?

A few minor steps I’ve taken…
1. I took out websites in my name and the book’s name. What should go on them at this time?
2. I took out twitter accounts in my name the book’s name. I’ve never used twitter before in my life. What do I do with these now?
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by cactus

The Fed of San Franciscon just published a note on “Okum’s Law and the Unemployment Surprise of 2009″
http://www.frbsf.org/publications/economics/letter/2010/el2010-07.html

In the paper they conclude that strong productivity was the main reason employment growth was weaker than the traditional relationship in Okum’s law implied.

Of course, we at Angry Bear have long known this because I have published this chart that shows that roughly before 1974 that a one percentage point growth in real GDP generated
a 0.3 percentage point growth in employment. This is what Okum’s law is based on. But during the era of low productivity growth, 1974 to 1995 a percentage point growth in real GDP generated almost a 0.5 percentage growth in employment. But since productivity growth
rebounded in 1995, every percent increase in real GPD was accompanied by almost a 0.9% gain in productivity so that employment barely rose 0.1% — a significantly lower rate than Okum thought.

The data in the chart is the long term trend and ignores the cyclical pattern in productivity where productivity growth peaks in a recession or early recovery period and slows as the expansion continues. That is why productivity growth has long been widely considered a leading indicator. It is also why you get patterns like in 2009 that the San Francisco Fed found and why we now seem to have jobless recoveries.

by Daniel Becker
I came across a presentation called Make Markets be Markets sponsored by the Roosevelt Institute which is tied to New Deal 2.0.

Yesterday I argued that Latvia’s cost-cutting efforts are evident compared to a cross-section of European Union countries. Latvia’s efforts, while commendable, were very much a function of the emergency IMF loan in December 2008 and the ensuing recession in 2009.

After an email exchange with Marshall Auerback, and thinking more about the cross-section of Europe, I now see a very scary trend emerging across Europe: the fight for exports.

To be sure, Latvia’s efforts are of note, as the acceleration in hourly labor costs dropped from a 22% pace spanning 2007-2008 to just 2.8% in the first three quarters of 2009 compared to the same period in 2008 (the Eurostat data are truncated at Q3 2009).

But look at the similar wage-cutting behavior occurring across the European Union, especially in the Eurozone hopefuls (Latvia, Lithuania, and Estonia are preparing to adopt the euro in coming years).

The battle for exports has begun. Compared to the same period in 2008, Q1-Q3 2009 annual hourly labor cost growth is down 4.9% in Lithuania, 0.8% in the U.K., and 0.5% in Estonia. In fact, every country across the 26 countries listed except Belgium, Germany, Greece, and Spain, saw the rate of hourly wage growth decrease since 2008. The currency is pegged, so the only mechanism to increase external competitiveness is through price (wages) declines. To be sure, this growth model cannot work for the Eurozone as a whole.

Latvia’s model: drop wages to increase export income. Greece: drop wages to increase export income. France, Germany, Spain, Portugal, etc., etc. It’s impossible that the whole of the Eurozone will drop wages to increase export income. It’s especially bad for countries like Latvia or Hungary, where the lion’s-share of trade occurs withing the boundaries of Europe.

And what happens when export income does not provide the impetus for aggregate demand growth? Well, there’s not much left. Can’t devalue the currency (via printing money), and tax revenues will fall faster than a ten-pound weight: rising deficits; rising debt; rising debt service (via surging credit spreads). Sovereign default seems like a near-certainty somewhere in the Eurozone!

This article is crossposted at News N Economics

Rebecca Wilder