Thursday, April 21, 2011

Is Capitalism Failing the Middle Class?

A comment on Michael Spence’s most recent paper for the Council on Foreign Relations in the Reuters Blog .

The gist of the problem analyzed by Spence and co-author Sandile Hlatswayo:

“The most educated, who work in the highly compensated jobs of the tradable and non-tradable sectors, have high and rising incomes and interesting and challenging employment opportunities, domestically and abroad. Many of the middle-income group, however, are seeing employment options narrow and incomes stagnate.”

Conclusion of the Reuters’ post editor (Chrystia Freeland):

“American politicians in both parties are focused on a budget debate that is superficial, premature and ultimately about something pretty easy to figure out. Instead, we should be working on the much bigger problem of how to make capitalism work for the American Middle class.”

The point is well taken. This is precisely the impression that this European reader gets from the daily browsing of American media. 

Wednesday, April 20, 2011

The End of the Great Recession Confirmed

According to James Hamilton (Econbrowser) “the most recent U.S. recession began in 2007:Q4 and ended in 2009:Q2.” A conclusion already reached by April 30, 2010 here .

It is worth to have a look at the article about “The Econbrowser Recession Indicator Index” that presents a graph showing the recurrence of recessions every ten years, in 1970, 1980, 1990, 2000, and just before 2010 (the 2007-2009 one). There is one notable exception: 1974-1975.   

Tuesday, April 19, 2011

Blogging Fatigue: Scott Sumner and Jeffrey Miron

Is the “daily” grind of blogging too much as Jeffrey Miron puts it in his April 18th post ?

Scott Sumner (The Money Illusion) felt the same. By the end of march he wrote:

“.. I am complete burned out, and have been for months. I’ve blogged an average of eight hours a day, seven days a week, for over two years.  … But now that lots of other people are saying the exact same thing, it’s time for me to take a break. So I’ll stop blogging for a few months …”

We will be missing both their stimulating analyses… until they return.

Greg Mankiw also told a reader asking for more posts that he did not intend to write more often, and many of his present posts refer the reader to his press op eds.

Well, maybe blogging has reached a plateau now. And indeed, there are not events worth commenting on daily.

Sunday, April 17, 2011

Eurozone’s Zombie Banks

“Is a euro held in an Irish bank in Dublin, or in a Portuguese bank in Lisbon, as sound and secure as a euro in a German bank in Berlin?” asks Tyler Cowen in the New York Times .

“This apparently simple question holds the key to understanding why the euro zone may splinter and bring a new financial crisis.” 

Capital flight has already begun in Ireland and could also reach banks in other countries, transforming many euro banks into empty shells. They will require additional government bailouts, on top of the bailouts for the bad real estate loans, but the EU emergency loans cannot reverse the trend of shrinking economies and dwindling confidence.

“At this late point there’s probably no way to escape the mess by cutting government spending in the troubled countries. This year Ireland has a budget deficit of more than 30 percent of G.D.P., whereas in Portugal it is 8.6 percent. Even the best economic reforms can take many years to pay off with conrete results, and with zombie banks a turnaround is even harder and perhaps impossible.”

 This raises another “fundamental question … Why do we so often postpone admitting that short-run patches simply aren’t going to work?”

My suggested answer in a forthcoming book: because of powerful vested interests. 

Wednesday, April 13, 2011

Realistic Bank Reform: Deleveraging and Competition

The British authorities apparently take the task of bank reform seriously enough, which may not be the case of the US or the EU: bigger buffers, smaller banks.

The Vickers Commission interim report, which was released Monday, makes two main recommendations: the big British banks should hold a lot more equity capital against their assets and should rearrange themselves so that their retail banks can survive even if the rest of the bank hits a financial iceberg, on the one hand, and also should beef up competition, on the other hand, in particular by divesting some branches.

Sounds reasonable enough, even though not as radical as the “limited purpose banking” proposal (see Laurence Kotlikoff’s book, “Jimmy Stewart is Dead”) that we consider best.

Read the article in The Economist.

Monday, April 11, 2011

The Euro (Again): Krugman Gets It

Paul Krugman posted yesterday a well-known chart showing unit labor costs divergence in the eurozone from the start (1999=100), here .

I could not agree more: See my March 8, 2010 post  The Nature of the Euro: A Public Choice Perspective  in which I quote the Roubini et al. paper that previously presented this chart of real effective exchange rate divergence within the eurozone: “Real Exchange Rate Movements and Endogenous OCA Analysis: Lessons from the Euro Area for Asia”. 

I also concur with Krugman's conclusion: “the ECB is in effect demanding that all the removal of that competitiveness gap take place via deflation in the south, none of it through inflation in Germany.”

The question then is: for how long can such a disequilibrium persist? The late George Stigler had a saying: “it is a quite general rule that intolerable things are not tolerated.” (Do Economists Matter? Southern Economic Journal, January 1976). This is the topic of my forthcoming book about the euro (in French).

The World Shortage of Financial Assets

 Brad DeLong summarizes the presentations of Carmen Reinhardt and of Richard Koo at last weekend conference in Bretton Woods. Is there a world shortage of savings vehicles of moderate and long duration, as argued by Richard Koo, or is the world desperately short not of savings vehicles but rather, due to overleverage, of safe financial assets, as explained by Carmen Reinhardt? 

In the first case households and businesses cut back on their spending in order to rebuild their balance sheets, and since the interest rates could not fall any further (being close to zero for the short term) to clear the market for savings vehicles, recession followed. In the second case households and businesses cut back on their spending to try, in vain, to build up their holdings of safe financial assets that just were not there. Hence recession.

DeLong believes that governments should provide the necessary assets by spending, investing, and borrowing “in order to boost the market supply of savings vehicles”. But Reinhardt would then conclude, according to DeLong, that “if the government tries to do so it will crack its status as a safe debtor and we will have a bigger sovereign debt crisis on our hands which will make the recession worse. Basically, we are all Austria and it is 1931.” 

I find these conclusions overly pessimistic. Indeed an economic recovery is already under way in several countries, including the US. But it is clear that there is a global supply of savings, especially from China and other emerging countries, in search of investment opportunities. This flow has contributed to asset markets booms in developed countries through excess leverage, at a time when real investment opportunities became rather scarce. Hence the following purges when leverage proved unsustainable.

An adjustment process is already under way, however, with China encouraging more consumption at home, less lending abroad, and with a forecast of reduced growth rate in several emerging economies. As in the thirties, the full adjustment will take time because the deleveraging process is slow and the creation of new assets has to wait for the next innovation wave on the one hand, and the institutional changes that will allow more creation of relatively safe assets in emerging countries, on the other hand.  But the time will come for both.   

Friday, April 8, 2011

The Shifting Phillips Curve

There is an interesting post on Noahpinion blog about the shifting, short run Phillips curve. 

My comment: Since the present position of the curve is in the low inflation range it is a good time to have some inflation, in order to accelerate the pick up of growth and the reduction of unemployment without incurring too much inflationary risk. Indeed the low inflation-high unemployment mix for 2010 (not represented on the chart) is situated on the right extremity of the lowest curve. Thus a little bit more of inflation should buy a significant increase in employment.

Here is the chart:

And the complete post is here.

Who’s Paying For the Eurozone Bailout?

See the daily chart in  The Economist .
Basically, Germany and France (and Italy), with the help of the largest IMF members. 

Monday, April 4, 2011

Warning: China’s Saving and Global Interest Rates

A key feature of China’s new five-year plan “is to shift official policy from maximizing GDP growth toward raising consumption and average workers’ standard of living” writes Martin Feldstein Project Syndicate (March 29).

The future reduction in China’s savings will mean a reduction in its current-account surplus, and thus in its ability to lend to the US and other countries:

“If the new emphasis on increased consumption shrank China’s saving rate by 5% of its GDP, it would … completely eliminate China’s current-account surplus. … China would no longer be a net purchaser of US government bonds and other foreign securities. Moreover, if the Chinese government and Chinese firms want to continue investing in overseas oil resources and in foreign businesses, China will have to sell dollar bonds or other sovereign debt from its portfolio. The net result would be higher interest rates on US and other bonds around the world.”

The net effect on interest rates would be the greater if the Americans’ demand for housing picks up and businesses want to increase  their investment. 

Friday, April 1, 2011

Euro Exit: Now?

“Greece, Ireland and Portugal Should Restructure Their Debts Now.
They’re bust. Admit it” writes The Economist.

While Portugal’s credit rating was slashed to near-junk status on March 29th and ten-year bond yields have risen above 8%,

“the economies of both Greece and Ireland, Europe’s two “rescued” countries, are shrinking faster than expected, and bond yields, at almost 13% for Greece and over 10% for Ireland, remain stubbornly high. Investors plainly believe the rescues will not work.

They are right. These economies are on an unsustainable course, but not for lack of effort by their governments.  … At the EU’s insistence, the peripherals’ priority is to slash their budget deficits regardless of the consequences on growth. But as austerity drags down output, their enormous debts … look ever more unpayable, so bond yields stay high. The result is a downward spiral.

As if that were not enough, the European Central Bank in Frankfurt seems set on raisong interest rates on April 7th, which will strengthen the euro and further undermine the peripherals’ efforts to become more competitive.”

Conclusion: debt restructuring is ultimately inevitable. It is time for the IMF to “push Europe’s pusillanimous politicians into doing the right thing”.

I cannot agree more, but restructuring will not cure these ailing economies’ underlying problem if not accompanied by substantial exchange rate realignements in order to restore their long-term competitiveness. The prime responsibility is that of the euro’s increasingly unbalanced  “implicit intra-zone real exchange rates” and its one-size-fits-none monetary policy.

The same conclusion is reached, regarding Greece, by three German economists, Wilhelm Hankel, Wilhelm Nölling, Joachim Starbatty, and a professor of law, Karl Albrecht Schachtschneider, in a Financial Times article, “A euro exit is the only way out for Greece” (March 25th).

But one should not delude oneself: removing Greece from the euro will not “provide a way … of ensuring the survival of monetary union.” It will lead to a radical reappraisal of its viability.