About the latest US GDP report

Yesterday's "advance" US GDP report for the second quarter contained several interesting news.

First of all, real GDP growth for 2002, 2003 and 2004 were revised down while inflation was revised up. This meant that while nominal GDP growth was unchanged it came in a more stagflationary form than previously estimated. For 2002 real GDP growth was revised down to 1.6% from 1.9%, for 2003 real GDP growth was revised down to 2.7% from 3% and for 2004 real GDP growth was revised down to 4.2% from 4.4%. Meanwhile, my prefered inflation measure (among government numbers. it too however underestimates inflation somewhat), the price index for gross domestic purchases was revised up from 1.5% to 1.6% in 2002, from 2.0% to 2.2% in 2003 and from 2.4% to 2.9% in 2004.

The prefered measure for Alan Greenspan and others who want to deny the inflation problem, the "core" ( excluding food and energy ) personal consumption expenditure deflator was also revised up with the current year over year increase revised up from 1.6% to 2%. This still greatly underestimates inflation ( primarily because of its exclusion of food and energy and its use of "home owners equivalent rent" instead of actual housing prices) and the inflation-deniers will likely say that 2% is still reasonably low, but since many have viewed 2% a crucial barrier this will clearly weaken their case.

As for the second quarter numbers, they show continued steady (+3.4%, although adjusted for terms-of-trade it was only +2.5%) growth driven primarily by strong private consumption (+3.3%) and a continued investment boom with residential investments increasing 9.8% and business investments increasing 9% . With continued increases in housing prices the boom in residential investments is likely to continue to increase at least for the rest of this year and with continued strong corporate profits business investments will also continue to grow fast at least for the rest of this year, probably well into 2006 as well. This is further underlined by bank lending statistics that shows commerical& industrial loans and real estate loans growing at a 15 to 20% annual rate.

The gross domestic purchases price index grew at a 3.3% rate the highest for years except for the 4+% rate reached during the first half of 2004.

One interesting aspect in this report is how it shows a sharp decline in business inventories. This could explain the unexpected small likely decline in the second quarter trade deficit and likely indicates that the deficit will rise again during the third quarter as inventories is starting to be rebuilt.

This report is highly consistent with the predictions I made in my February 2005 Las Vegas speech "The Outlook for the World Economy"(Or "The Future of the World Economy") where I predicted continued steady growth this year primarily driven by booming business investments. Housing investments have been somewhat stronger than I thought , but otherwise things have developed just as I thought they would and there is no indication now that would cause me to revise the forecast for the rest of the year. And I expect that as long as house prices and corporate profits remain strong growth will continue, although at the price of continued worsening of the imbalances in the form of high debt levels, worsened housing bubble and higher current account deficit, all of which means that problems will arise when the imbalances become just too big to be sustained.

Euro-zone money suppy and credit growth accelerates further

The ECB released this Thursday new statistics which shows that growth of the money supply as measured by M3 rose further to 7.5% in June this year from 7.3%, with M1 and M2 accelerating even faster from 10.1% to 10.5% and from 7.6% to 7.9% respectively.

Credit growth to the private sector also accelarated from 7.5% to 7.9%. This further shows the absurdity in characterising the ECB as inflation hawks and attributing growth problems to "tight monetary policy". In fact the ECB pursues a far too inflationary policy who have created distortions, in the form of for example housing bubbles in many markets, which have weakened the European economy. The ECB should therefore raise rather than cut interest rates. Ultimately though, only a gold standard is likely to prevent this kind of destructive inflationary policy.

Larry Kudlow on currency manipulation

I often disagree with Larry on monetary issues, but his blog post on the issue of "currency manipulation" was great.

About the Chinese currency reform

New blog post at the Mises blog.

Governments using markets to manipulate the economy

New blog post at the Mises blog.

China's rapid growth continues

China's economy continues its extremely rapid expansion with 9.5% growth during the first half of this year, even after the Chinese government has moved to slow growth of credit. The quotas on Chinese textiles will probably slow down growth during the rest of the year, as would a yuan revaluation and/or further protectionist measures in the west if they occur ,but clearly the Chinese economy remains fundamentally strong, thanks to it large supply of cheap labor and its high savings rate, something which in turn is partially a result of its relative lack of a welfare state.

Paying people not to create wealth creates wealth?

Is the best way to ensure that more wealth are created to pay people not to create wealth and finance those payments by taking money from those who stubbornly insists on creating wealth?

Sounds like a absurd contention? If you think so, then you're right, but that is what leading Swedish social democrats actually asserts. In for example this op-ed column in Sweden's third largest news paper, Dagens Nyheter, social democrat Lotta Fogde claims this. The column is written in Swedish which I know most of my readers probably don't understand so I'll summarize its assertions for you:

-Sweden has had far better growth since 1994 than the rest of Western Europe and this is something which the ruling Social Democrats can take credit for.
-Sweden's alleged sucess rests on 3 foundations: openness to the outside world, allowing failed industries to fail and security for the individual [euphenism for welfare payments].
-Cut unemployment benefits and other welfare payments and people will turn protectionist, will demand subsidies to failed industries and wages will fall, something which will throw Sweden into a hopeless competitive race with third world countries where people work for a few dollars a day.

Regarding the first point it is simply false. Adjusted for the deteriorating terms of trade, Swedish growth have actually been slightly lower than the EU15 average during the latest decade.

And in any case, even if her assertion had been true (which it again isn't) it is simply absurd to use such a comparison to defend the welfare statist system of Sweden since most other Western European countries have a similar system with high taxes and high unemployment benefits. It is like saying that because East Germany were more successfull than other communist countries this proves that communism is a superior system, even though East Germany where far less successfull than West Germany. If you are going to empirically "prove" a theory (dubious methodology in any case BTW since there are so many different factors affecting growth that simply comparing one factor and total growth between two countries could be misleading) then at the very least you should compare with countries who have a different system. And if you sompare Swedish growth to the least welfare statist Western European countries, Britain, Ireland, Luxembourg and Spain or to most Eastern European and non-European countries, you'll find that Swedish growth is far lower.

Regarding her second point she is of course right that free trade and absence of subsidies to failed industries are good for the economy, although it is not really true that the Swedish government has refrained from such industrial subsidies.

Her claim that unemployment benefits are good for the economy rests on the assertions made in the third point: namely that it is necessary to prevent the other destructive forms of government intervention. But the increased tendency of people to become less anxious to losing their jobs is on the other hand likely to be largely counteracted by the increased statist mentality that follows with the welfare state. Remember that Sweden was relatively free trade oriented decades before the Social Democrats rose to power in 1932 and started to create the welfare state. Also remember that France whose welfare state is as bloated as Sweden's is relatively protectionist and has a extensive industrial policy, while Hong Kong with almost no welfare state is more free trade oriented and more laissez faire regarding industrial policy than Sweden.

Moreover, the lower fear of being out of work in Sweden has resulted in people being increasingly out of work. Both measured as hours worked and the number of employed , employment has steadily fallen in Sweden for the last few decades while the total unemployment rate (including those who have been hidden in early retirement and sick leave) is nearly 25%. That the fact that people are being paid very much not to work while people who do work are punished is behind this fact should be fairly obvious, but she typically refuses to discuss this issue.

Regarding her claim that the lower wages that lower unemployment benefits are likely to result in is meant to be part of a hopeless strategy to compete with China and India with low wages, this is a pure straw man. The low wage jobs meant to be created this way is not meant to come in export industries, but in business which are non-tradable, like domestic services.

Connecting the dots

New blog post at the Mises blog.

US trade deficit stabilizing?

May's U.S. trade deficit came in at $55.3 billion, lower than expected. This is the third month in a row where the trade gap is well below the record $60.1 billion set in February and it means that unless there is a real dramatic increase in the June deficit the second quarter deficit will be lower than the first quarter deficit.

The June deficit is indeed likely to rise, not least because of rising oil prices, but it is not likely to rise sufficiently to make the second quarter deficit larger than the first quarter deficit.

Does this mean that the U.S. trade deficit has finally stabilized. At this point, such a conclusion would perhaps be premature, but it is not really unlikely. The US trade deficit was driven up by extremely loose fiscal and monetary policies, but now both fiscal and monetary policies have in effect been tightened. Real short-term interest rates have (if we are to believe government inflation numbers) been pushed above zero and the government budget deficit has fallen. Both the Euro-zone and Japan now have lower real interest rates and larger government budget deficits, and their current account surpluses are accordingly falling.

European politicians demand more inflation

Europe's politicians are again calling for the ECB to inflate more by following Sweden's central bank, Riksbanken, in lowering interest rates. Belgium's Finance Minister Didier Reynders asserts that

"There is more room [for manoeuvre] on the monetary side than on the budgetary side,"

Actually, it isn't. According to its own rules, the ECB is supposed to hold consumer price inflation below 2%, yet the latest figures show more than 2% increase in the consumer price index. And the ECB is also supposed to hold money supply (M3) growth at roughly 4.5%, yet M3 is currently growing at 7.3% according to the latest figures. Asset price inflation and debt growth also indicate that the current monetary policy by the ECB is far too inflationary. Yet instead of being attacked for pursuing a more inflationary policy than they are supposed too, the ECB is being attacked for being insufficiently inflationary.

You know where there are more room to maneuver, Mr. Reynders? In the bloated European welfare states. If you reduce the incentive for wealth creation through government redistribution the result will inevitably be less wealth creation i.e. lower growth.

New mises.org article

New article by me on the mises.org web site, regarding Greenspan's so-called conundrum.

About the growing Chinese trade surplus

China's trade surplus increases sharply in June, from $1.8 billion June last year to $9.7 billion June this year, reflecting a export growth of 30.6% versus import growth of "only" 15.1%. This is of course bound to increase protectionist hysteria in the West and seemingly strengthen the argument of those who call the yuan"manipulated".

Of course, the yuan is manipulated, but so are all other currencies in today's world, including the US dollar. And fixed exchange rates are no more manipulation than floating exchange rates. If anything it is less manipulation as there would be "fixed exchange rates" (Or actually no exchange rates) under a free market monetary system i.e. the gold standard. And does Nevada have a "manipulated exchange rate" with New York since the "exchange rate" between dollars in Nevada and New York is always constant at 1:1?

China's booming trade surplus reflect a seemingly successfull effort to contain excess investments while China's savings rate has continued to increase for structural reasons (i.e. cultural attachment to thrift and lack of a social safety net). Until early 2004 China's surplus was falling and even briefly turning into deficit during early 2004, just like India has recently gotten a current account deficit despite Paul Craig Roberts' assertion that it has a "absolute advantage in everything".

This is not to say that China should keep the peg. Given current political realities, increased protectionist measures seem inevitable unless the yuan rises significantly in value. A revaluation would damage China less than western tariffs, particularly at the 27.5% level proposed by Senators Schumer and Graham, since it at least would mean lower import prices. Moreover particularly with the large inflow of speculative capital into China betting on a revaluation , this forces China to purchase large quantities of low yielding U.S. government securities to maintain the peg. But it is wrong to argue that China is a bigger currency manipulator than any other country.

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