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David Malpass, on the US trade deficit and the so-called bond yield ‘conundrum’:
For decades, the trade deficit has been a political and journalistic lightning rod, inspiring countless predictions of America’s imminent economic collapse. The reality is different. Our imports grow with our economy and population while our exports grow with foreign economies, especially those of industrialized countries. Though widely criticized as an imbalance, the trade deficit and related capital inflow reflect U.S. growth, not weakness—they link the younger, faster-growing U.S. with aging, slower-growing economies abroad…
The trade deficit and a low “personal savings rate” are key parts of the bond market’s multi-year pessimism about the U.S. growth outlook. But just as the high level of U.S. savings is likely to add to future growth—the savings rate is only low if you arbitrarily exclude gains—the trade deficit and heavy capital inflows are also positive parts of the growth outlook. Rather than signaling a slowdown, the inversion of the yield curve—“Greenspan’s conundrum,” in which bond yields are low despite solid growth and rising inflation—is probably the result of this deep underestimate of the U.S. growth outlook, plentiful liquidity, and a backward-looking deflation premium for bonds, the reverse of the backward-looking inflation premium that kept bond yields unusually high in the 1980s.
posted on 21 December 2006 by skirchner in Economics, Financial Markets
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Treasurer Costello and Finance Minister Minchin are quick to raise the spectre of higher interest rates whenever the subject of tax cuts comes up and a justification is needed for continued Commonwealth revenue hoarding. Apparently, the same logic doesn’t apply to new government spending, as Alan Wood notes in relation to the government’s Mid-Year Economic & Fiscal Outlook (MYEFO):
Peter Costello and Finance Minister Nick Minchin have also been making noises about tightening the reins.
So what about Appendix A of the update, headed “Policy Decisions Taken Since the 2006-07 Budget” - that is, over the past six months.
This runs to more than 130 pages of the 250-page mid-year economic outlook.
And guess what the total spending adds up to over four years - $17.3 billion.
In fact, with the budget balance as a share of GDP little changed over the projection period, there is little reason to expect Commonwealth fiscal policy to have any impact on interest rates. This illustrates the point that when revenue collections are coming in much stronger than expected, tax cuts need not be any more stimulatory than the government’s new spending since the Budget. Yet if the government were to announce $17 billion in tax cuts, the ‘tax cuts lead to higher interest rates’ brigade would be out in force and the next interest rate increase would almost certainly be blamed on tax cuts.
This strange double standard is partly a product of the prevailing prejudice against people being allowed to spend their own money. The commentariat are largely of the view that the public are incompetent to spend tax cuts appropriately. Yet there are good reasons for thinking that a good portion of any tax cuts would go straight to the bottom-line of household balance sheets in the form of debt reduction, rather than being spent. The government’s much vaunted surpluses are simply displacing private sector saving, leaving national saving unchanged, with no implications for interest rates.
posted on 21 December 2006 by skirchner in Economics, Financial Markets
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Sebastian Mallaby defends the role of hedge funds in the financial system:
the fear of hedge funds is overblown, based more on ignorance or simplistic caricatures than on actual knowledge. Many of the proposals for new regulation are so vague as to be impossible to evaluate or are poorly suited to address the supposed problems at issue. And even the most serious cause for concern—that hedge-fund operations might generate a “systemic risk” for the financial system as a whole—is neither limited to the hedge-fund sector nor best addressed through regulation of it. Rather than seeing hedge funds as sources of dangerous financial fires, in fact, it is more accurate to see them as the financial system’s benevolent fire fighters—and to let them have the tools they need to do their jobs well.
The long-short equity arbitrage fund is arguably an Australian invention. Australia is notable for regulating hedge funds in the same manner as other managed funds, making them available to retail investors, in sharp contrast to the ludicrous restrictions on retail participation in hedge funds in the US.
posted on 20 December 2006 by skirchner in Economics, Financial Markets
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Nouriel Roubini dusts off his US dollar bear call, relying on that old faithful of structural US dollar bears, the current account deficit:
The large, still growing and eventually unsustainable US current account deficit is the structural gravity force that will keep on weakening the dollar over the medium term.
These ‘structural gravity forces’ must work differently for Japan, which runs a structural current account surplus while its real effective exchange rate is making 21 year lows:
It seems that ‘gravity force’ doesn’t work at short horizons either:
I am not in the business of predicting high frequency movements of currency over the horizon of a week or a month. But my macro and medium-term perspective tells me that fall of the dollar – over the medium term – has still a very long way to go.
posted on 19 December 2006 by skirchner in Economics, Financial Markets
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Another installment in our on-going series on the fundamentals of house price inflation. The RBA has released a discussion paper, Housing and Housing Finance: The View from Australia and Beyond:
The general conclusion is that financial and macroeconomic developments have increased the demand for the stock of housing. Because the stock of housing is inherently slow to adjust, this has increased its relative price. Although this is a global trend, individual country institutions have affected outcomes, sometimes in ways that are not obvious. The resulting expansion in both sides of the household balance sheet is an important development for policy-makers to monitor, but it is probably not of itself a cause of financial instability.
posted on 15 December 2006 by skirchner in Economics
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Kevin Rudd, like the Labor Party itself, can’t decide whether he is a socialist or not.
As Paul Kelly notes:
It is disappointing that Kevin Rudd has given heart to the economic throwbacks with his rhetoric attacking “market fundamentalism”. This panders to the focus groups, short-term politics and ideological convictions that only consign Labor to a dead end…
Depicting John Howard as a neo-liberal is the staple for “true believer” dinner tables but bunkum as an analysis of Australian politics. Howard has not won four elections by being a neo-liberal.
The task of the next ALP government will be to cut the fat from government spending, expand competition policy, de-regulate the universities, introduce more market signals into health, education, transport and energy, eliminate red tape from business, simplify the tax and industrial systems, cut marginal tax rates, encourage the welfare to work transition, invest more in education and training, encourage entrepreneurs in the market place and aspire for a more competitive economy. Railing about market fundamentalism is a stunt.
Rudd’s choice is clear. He can either present as a serious economic policy-maker or engage in the populist positioning that has damaged Labor for too long.
posted on 15 December 2006 by skirchner in Politics
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Larry Kudlow notes that the US November retail sales report almost single handedly tanks Roubini’s call for zero US growth in Q4:
The key point here is that it virtually eliminates the zero percent Q4 scenario from recession bears like Nouriel Roubini. You can’t get zero here - toss that scenario in the garbage.
This is what my associates at Action Economics had to say about the report:
The U.S. retail sales report should be a game-changer for those positioned for an imminent hard landing for the U.S. economy, with sizable housing sector “pass-through.” Hard landing estimates increasingly need to address why pass-through during the first 15-18 months of the housing correction is taking so long to materialize if it is really going to prove more dramatic than most economists assume.
And time is not on the side of those with a near-term doom-and-gloom view, as both the firming evident in most housing market data since the big June-August downsizing, and the robust uptrend in the MBA mortgage data over the last three weeks and other recent signs of reversal in the real estate market suggest that the correction for sales is likely approaching the end, though there will be lagged construction sector effects.
To be sure, most economists, as well as most FOMC members, have stuck to their guns that pass-through of weakness from the housing sector is thus far limited even if it remains the risk, and that the slowdown is proving orderly, with growth “at a moderate pace” as described in yesterday’s FOMC statement.
Today’s U.S. retail sales report removes much of the controversy associated with this view.
posted on 14 December 2006 by skirchner in Economics, Financial Markets
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A few reasons why you should be reading James Hamilton rather than Dr Strangelove.
Meanwhile, Alex Robson reviews the long-range forecasting performance of some local economists:
Just after John Howard came to office in 1996, several academic economists - including many professors at our best universities - distributed a petition in response to the new PM’s proposal to reduce government spending and cut the size of the commonwealth public service.
The professors claimed that the cuts were economically irresponsible and socially damaging, and would “inevitably cause job losses” due to “downward multiplier effects” that would flow from the public sector to the private sector. They also claimed that “the consequent reduction in jobs and incomes would result in lower tax revenues”. They said there would be “a strong possibility of precipitating a substantial economic recession”.
The rest, as they say, is history:
After fifteen years of uninterrupted growth, Australia’s quiet economic boom shows no signs of ending. The longest expansion in Australian history, it has seen wealth more than double, average income increase by half as much again, and unemployment tumble to a rate last experienced more than quarter of a century ago.
posted on 13 December 2006 by skirchner in Economics
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Sinclair Davidson laments the appointment of Kim ‘Il’ Carr as shadow industry policy spokesman:
Where will Rudd’s fork in the road take us? So far, it looks to be heading backwards. Reintroducing industry policy in any guise is poor economics. Putting a socialist in charge of a poor economic program must be poor politics.
Rudd opposes “market fundamentalism” and is worried about family relationships. Will his solution involve reregulating the economy, reregulating working conditions and imposing draconian shopping hours? It appears a return to anti-market and anti-consumer choice policies may be on the cards.
Meanwhile, the CIS crew discuss the implications of the federal government’s so-called ‘market fundamentalism:’
Nine out of 10 families therefore now receive a fortnightly welfare payment from the Government.
There is an argument, which we broadly support, that families with dependent children should be treated more favourably than other households earning equivalent incomes, for they have more mouths to feed.
But the best way to do this is to reduce their tax burden. The way the Government does it is to tax them as stringently as everybody else but then compensate them with handouts from Centrelink.
posted on 12 December 2006 by skirchner in
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Ed Prescott tackles five macroeconomic myths, including some of this blog’s favourite targets:
Myth No. 3: Americans don’t save. This is a persistent misconception owing to a misunderstanding of what it means to save. To get a complete picture of savings we need to investigate economic wealth relative to income. Our traditional measures of savings and investment, the national accounts, do not include savings associated with tangible investments made by businesses and funded by retained earning, government investments (like roads and schools) and business intangible investments.
If we want to know how much people are saving, we need to look at how much wealth they have. People invest themselves in many and varied ways beyond their traditional savings accounts. Viewing the full picture—economic wealth—Americans save as much as they always have; otherwise, their wealth relative to income would fall. We’re saving the right amount.
posted on 11 December 2006 by skirchner in Economics
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Alan Wood references my Policy article on the Future Fund in this weekend’s Australian.
posted on 10 December 2006 by skirchner in Economics, Financial Markets
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Jeremy Siegel considers Alan Greenspan’s ‘irrational exuberance’ speech 10 years on:
Now that we have 10 years of economic and financial data, we can now accurately determine whether the market was indeed “irrationally exuberant” in December 1996. The answer is decidedly no. Had the market been overvalued, it would have shown poor return in the following decade. But it did not.
The compound rate of return from Mr. Greenspan’s speech through the end of November 2006 on the broadest index of U.S. stocks, the Dow Jones Wilshire 5000 Index, was 8.2% per year, while the return on the Dow industrials was even higher. International stock returns have been almost as good, with the Morgan Stanley EAFE index of international stocks returning 7.6% per year. All these returns include the bear market of 2001-2002 and were far greater than what was available on government bonds or cash over the last 10 years. Even taking inflation into account, these rates of return were very close to that achieved in long-term equity studies. There is no evidence that the market was overvalued at the time of Mr. Greenspan’s speech…
Looking back in August 2002, Mr. Greenspan was perfectly right when he said, at the annual Kansas City Fed economic conference in Jackson Hole, that “Historical data suggest that nothing short of a sharp increase in short-term rates that engenders a significant economic retrenchment is sufficient to check a nascent bubble. The notion that a well-timed incremental tightening could have been calibrated to prevent the late 1990s bubble is almost surely an illusion.” Had the Fed tightened further in late 1999 or early 2000, there would be little doubt that “brick and mortar” firms, as the non-tech stocks were called, would have borne the brunt of the tightening and pushed their valuations even lower. The subsequent recession when the tech bubble finally burst would have been far worse.
History has exonerated Alan Greenspan’s policy during the late 1990s. There is no good evidence that the market was in a bubble when he uttered his famous line 10 years ago, and he was wise in stepping back from it. Irrational exuberance finally did hit the stock market, but not at the time or in the scope envisioned by his critics.
For my own defence of Greenspan, see here.
posted on 06 December 2006 by skirchner in Economics, Financial Markets
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It is long time since we have heard the traditional industry policy mantra about Australia becoming ‘more than a farm and a quarry.’ One reason for this is that it is not even remotely accurate as a characterisation of the sectoral composition of the Australian economy. Agriculture and mining combined accounted for less than 10% of gross value added in the year ended in September. Moreover, the rationale for Australia adopting strategic industry policies designed to promote the manufacturing sector is weaker than ever. Global manufacturing is grossly over-supplied and this is reflected in declining prices for manufactured goods. While many people have highlighted the contribution of the commodity price boom to the improvement in Australia’s terms of trade, declining prices for imported manufactured and other goods has also made an important contribution to the increase in national welfare represented by the record level of the terms of trade.
So it was disappointing to hear newly elected opposition leader Kevin Rudd revive the old mantra with his stated desire for Australia to be ‘more than a mine for China and a beach for the Japanese.’ Unfortunately, as Alan Wood notes, industry policy remains alive and well in Rudd’s Australian Labor Party:
Rudd, as with Crean and Beazley before him, denies he is interested in protectionism or, although he doesn’t use the expression, picking winners. He says, rightly, that he has sound free-trade credentials.
Even so, his promise of a “detailed manufacturing blueprint out from us in the months ahead” has a disturbing echo of policies past.
Rudd acknowledges his belief in industry policy “may be heretical in some quarters”. But, as he also says, he has been a long-term believer in industry policy and government intervention in markets. It is a central theme of his maiden speech to parliament in 1998.
As Treasury Secretary Ken Henry has pointed out, in a fully employed economy, resources diverted into manufacturing by government policy are resources that are necessarily denied to other sectors with more highly valued uses. Kevin Rudd is proposing to lower Australia’s standard of living for the sake of his manufacturing fetish.
Industry policy is not the only blast from the past when it comes to the new ALP leadership team. As Andrew Norton notes, when it comes to higher education policy, Rudd and his new deputy are offering little more than Whitlam era nostalgia.
posted on 06 December 2006 by skirchner in Economics
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Stephen Jen, on why it’s dangerous to write-off the USD:
For two-and-a-half years, I have strenuously warned investors not to under-estimate the dollar. The current dollar sell-off is, to me, a cyclical, not structural development. The dollar index is fairly valued, and financial globalization should keep the US external imbalance well-financed. Many investors worry about wholesale central bank diversification. I am more skeptical: it is still hard to find good liquidity in markets outside major economies. Even compared to Euroland, the US offers much larger risky asset markets. Also, if central banks really have begun to diversify out of USD assets, there should be traces of this in US bond markets.
On the cyclical front, the US is likely to go through several quarters of sub-potential (i.e., sub-3.0%) growth. What this means is that the unemployment rate is likely to rise in the period ahead, which is likely to be another negative for the dollar. But I believe that the Fed is right that the US economy will eventually re-assert itself, most likely in the second half of 2007: I keep reminding myself that, since 2002, the Fed has had the best record of anyone at forecasting US growth.
posted on 05 December 2006 by skirchner in Economics, Financial Markets
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More of what Nouriel Roubini won’t tell you about the US economy, from my associates at Action Economics:
The U.S. Q3 GDP revision to 2.2% from 1.6% reflected all the component revisions that were expected, but an over-sized bump to inventories and trade, and a bonus upward revision to consumption of services. The revision eliminated the “1-handle,” and will go a long way toward marginalizing the market’s recession fears given the more optimistic spending trajectory as we enter Q4.
The service consumption boost will help close the income/spending gap through October, as will downward Q2 income revisions in this report. The mix leaves a more persistent and seemingly bullet-proof broad down-trend in the saving rate, despite the price-impacted “pop” we should see in the October personal income data tomorrow. The combination will reinforce our forecast of a robust outlook for Q4 consumer spending, and considerable upside risk to the consumption reports over the November-January period as the savings rate moves back toward trend.
We continue to expect a 2.6% GDP growth rate in Q4, and a 3% rate by Q1, as the growth undershoot of the middle quarters of 2006 scrolls by, and is replaced with trend-growth in the 3%-3.5% area. Indeed, we see upside risk to these estimates despite the market’s focus on signs that downside risks are emerging.
posted on 01 December 2006 by skirchner in Economics
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