U.S. Economic Picture Mixed

As I've said before, it seems likely that second quarter growth in the U.S. was higher than the sligtly upwardly revised 0.7% of the first quarter. This is despite the fact that the most important component of personal consumption expenditure will grow far slower than the slightly downwardly revised 4.2% of the first quarter, probably as low as 1.5% as blogger "Calculated Risk" argues on the basis of the personal income and spending release for May.

But on the other hand, business investments (particularly nonresidential construction) will probably grow faster than in the first quarter. Residential investments will probably be a much smaller drag than in the first quarter. And inventories will likely add rather than significantly subtract from growth as in the first quarter. Net exports is the big wild card and I will not try to forecast second quarter growth in any more specific terms than "higher than in the first quarter but probably not dramatically higher" before the May trade balance number is released.

Anyway though, the most interesting question is not really second quarter growth, but the outlook for the third and fouth quarter.

There are two (or in one sense three) conflicting forces in the U.S. economy. On the one hand, the housing sector remains a mess and will probably continue to be a drag for the rest of the year. Househould finances are certainly not in great shape, with the household savings rate at -1.4%. Moreover, rising interest rates, rising oil prices and falling house prices will further worsen household finances. Partially offsetting this is rising stock prices. But nevertheless, consumer spending will likely rise only very slowly at best.

Against this is the great shape of corporate America, where profits remain high, although earnings growth is stagnant in the domestic nonfinancial sector. Are the "stagnant but still very high" earnings enough to keep business investment growing significantly? There have been conflicting signals about this lately. The answer to this question is arguably the single most important factor in determining whether America will fall into a recession or continue with merely slow growth. Other factors, most notably various market signals such as bond yields, stock prices and oil prices is also important, but business leader assessment of whether it is profitable for the to increase investments is arguably the most important factor.

How Government Regulations Make U.S. Health Care More Expensive

The release of Michael Moore's movie "Sicko" which criticizes the U.S. health care system have made the issue of the U.S. health care system a hot topic.

One factor overlooked by both Moore and some of his critics are how the U.S. system is much less free market than it appears and that regulations are an important factor in making the system so expensive. The Economics Focus of the latest The Economist points to a study that argues that regulations cause an additional $169 billion in annual net costs.

And that is the net cost figure. The gross cost is a full $339 billion. The study assumes that somehow $170 billion in benefits is created by these regulations. But many of these supposed benefits, even if for the sake of the argument assumed to be real, will still add to the costs of the system.

What Is Buffet's Problem?

Warren Buffet, who at least before his massive donation was considered the world's second richest man, complains that he pays too little in taxes. He says that he and other rich Americans "must do more to help the less fortunate". Well, since I am comparatively a lot less fortunate I'd be more than happy to take a billion dollars or so off his hands! He can contact me any time he wants to make the arrangement.

And if he specifically wants to give more money to the government, he can easily give away his money to the U.S. government here to the Treasury Department's gift section.

There is thus no reason at all for Buffet to complain that he has too much money as there are more enough private individuals as well as the government who would be willing to accept his money. Could it really be that someone who is such a successful entrepreneur is really that clueless? More likely he is a hypocrite.

Industrial Profits in China Rise 42%

Profits rose a full 42.1% in Chinese industries during the first 5 months of the year. That together with the excess liquidity created by its currency policy indicates the investment boom will continue despite some tightening measures from the authorities.

Ahmadinejad in Trouble

Large riots have erupted in Iran to protest against cuts in subsidies of gasoline (or petrol as the British call it). Despite soaring income from oil, the Iranian government has had economic troubles, not least because of soaring costs of gas subsidies. Iran has littler refining capacity and so they have to export their oil to countries with refining capacity and then import the gasoline. And gasoline consumption has soared in recent years because of the low price and because of a growing population.

For financial reasons, the Iranian government has now decided to ration the amount of subsidized gasoline. But this has proven very unpopular among Iranian motorists who in many cases have started to riot in protest. Of course, an even better way of reducing the budget deficit -not likely to cause much discontent among ordinary Iranians- would have been to cut off funds to Hezbollah, Hamas and other terrorist groups that they fund now. And to really improve the economy, they would have to do away with Islamic dogma forbidding for example interest rates. But none of these measures are likely as long as the Mullahs remain in power.

BIS Again Publishes "Austrian" Analysis

As reported in the Wall Street Journal, the Bank of International Settlements, an international organiztion for central banks, have published another "Austrian" analysis of the global economy.

This is not the first time they've published an "Austrian" analysis. They did so last year too, as I reported at the time. Given the general "Austrian" attitude towards central banks, there is of course some irony in the fact an organization like the BIS promotes it.

Golden Opportunity to Abolish Farm Subsidies

As I pointed out recently, food prices are soaring. This is particularly true for food commodities such as corn and other grains. And as we're talking about globally traded commodities, this is not just an American phenomenon. As is pointed out in the latest The Economist, there are good reasons to believe that food commodity prices will remain high for several years to come.

One aspect of this that most people -including until now me- have failed to highlight is that this means that now exist a golden opportunity to do away with one of the most evil and destructive government programs: farm subsidies. Why this program is particularly bad is something which I have explained repeatedly in the past and the case for doing away with it would really be just as strong at any time.

But, the problem have always been that certain influential groups, meaning the general farm lobby in America and the government of France in the EU, have blocked any cuts in farm subsidies. These forces remain strong and will likely continue to oppose cuts. But with soaring prices causing farm income to soar, this means that the forces working for a cut should have an easier time. With farmers making more and more money and with the real income of low income urban people being squeezed, the injustice and absurdity of taxing the latter to benefit the former becomes more obvious than ever. If only free market advocates can enlighten people about how they are impoverished by farm subsidies, then enough public anger could perhaps be mobilized to abolish or at least sharply reduce farm subsidies.

Very Weak Swedish Export Growth

The Swedish statistical central bureau reports that the Swedish trade surplus fell from 12.7 billion kronor May 2006 to 9.7 billion kronor May 2007. For the first 5 months of the year, the surplus fell from 70 billion kronor to 57.7 billion. This is perhaps not surprising given the sharp credit driven increase in domestic demand.

But what was surprising was how this seems mainly due to weak exports rather than strong imports. Exports actually fell in May compared to a year before and for the first 5 months; export growth was a mere 4%, which is very weak. This could mean that domestic demand is strong that Swedish companies divert their resources for domestic demand rather or it could mean that some other factor is involved. Or more likely a combination of the two.

While country and commodity breakdown for May is not yet available, the weakness in exports during the first quarter reflected the important "other"-factor of a 52% decline in forest product exports to the United States, presumably reflecting the U.S. housing recession.

Hong Kong Doing Well 10 Years Later

One week from now, it will be the tenth anniversary of Hong Kong's transition from British to Chinese rule. There were many then who feared China would wreck the place. As this article puts it:

"There were fears Chinese troops would be goose-stepping down the streets, muzzling any whisper of political dissent. Masses of peasants would stampede across the border, filling the city with beggars and thieves. And the most talented Hong Kongers would become "yacht people," fleeing to Australia, Canada, America and other places welcoming their business savvy, workaholic ways and cash.

Fortune magazine's headline, two years before the British flag came down, proclaimed "The Death of Hong Kong.""

But this didn't happen:
"Ten years later, the soldiers are here, but are rarely seen in uniform on the streets. Mainland Chinese are pouring in, but as big-spending tourists buying Rolex watches and shark-fin soup. Many rich Hong Kongers are back, resettled in a booming city, happy that their fears have proved groundless."

Although the article points out that many news papers seem to practice self-censorship, there is none of the direct repression that you see in the mainland.

Hong Kong has in the latest decade seen two economic downturns-the first triggered just after the handover by the general Asian financial crisis in 1997-98. The second being triggered by the outbreak of SARS in 2002-03 in places with large ethnic Chinese populations-and that includes Hong Kong of course. Yet Hong Kong recovered quickly and strongly from these brief recessions, with double digit growth following the recessions.

For the period as a whole growth have been fairly strong, significantly stronger than in the West, although far weaker than in the mainland. The economy has continued its transformation with less and less manufacturing and into trade, shipping and financial services. It has taken over Tokyo's position as Asia's financial centre and last year it surpassed New York in initial public offerings, being second only to London in that aspect.

So, things are going fairly well in Hong Kong, as Hong Kong have kept its low tax low spending laissez faire oriented policies. And they will likely continue to do so if China's leaders continue to respect the "one country-two system" principle they agreed to in their deal with Britain in 1984.

Why Profits Don't Make Private Operations More Expensive

Robert Murphy used to write mainly for mises.org, but now he also writes for conservative columnist page townhall.com. Needless to say his columns are somewhat less radical on townhall.com than on mises.org, but that doesn't mean they can't be insightful.

He for example here analyses the student loan industry. In accordance with the less radical tone he apparently believes he must have on townhall.com, his discussion isn't about abolishing federal subsidies to it. But it is still interesting as he refutes a common myth, namely that profits make goods and services more expensive for consumers. This is in light of Democratic presidential candidate Barack Obama's argument that the federal government should lend directly to students instead of using middle men.

He points out that profits in the accounting sense can be divided into two parts: pure economic profits and (implicit) interest on invested capital. The latter part will exist regardless of whether the government directly or middle men runs it. Pure profits will only arise if entrepreneurs discover superior techniques that provide higher value or lower costs and is furthermore likely to be temporary as the higher rate of profit will attract competitors. The upshot is that in the long run the cost savings of private businesses will more than well compensate for the "costs" of the profits they make and so they will run things more cheaply than the government.

Pizza Inflation

Soaring cost of cheese and other items forces pizza makers to raise prices. Expect more of this. Because so far, we ain't seen nothing yet in terms of food price inflation. Food commodities have risen 28.4% the latest year (6.7% the latest month). Yet food price inflation in the PPI have risen just 8.6%
the latest year and in the CPI a mere 3.9%. This is in part due to the fact that the cost of other input have risen less and in part likely because competitive pressure have made food stores and restaurants reluctant to raise prices in response to what they believe could be just temporary cost increases. However, as the latter factor implies reduced margins it is likely unsustainable so food price increases at the retail level is likely to increase, and not just in the case of pizzas.

You Read Things Here First

The Economist this week published an editorial that criticized the blind focus on so-called "core" inflation. First, they point out that food and energy prices are less "sticky" than so-called "core" prices and so will better and faster reveal shifts in inflationary pressures. Second, they point out that autonomous increases in core prices due to supply factors will depress other prices and so "core" prices will underestimate inflationary pressures. Third, it is asymmetric to reject the price increases in energy on account of the fact that they are in part caused by factors unrelated to monetary policy (such as increased demand from China), while not taking into account of how factors unrelated to monetary policy have depressed "core prices" (such as the inflow of cheap goods from China).

All of these arguments were raised by me in my classic LRC article attacking "core" inflation from 2005 in slightly different formulations.

I also see that the Swedish statistical central bureau has published a reply (in Swedish) to an article in Swedish business news paper Dagens Industri written by a certain Gunnar Örn on June 8th. The article is not online so unfortunately I cannot link to it, but as my readers fluent in Swedish probably understand from the reply (and can verify if they can access Dagens Industri from June 8th from their local library), the argument in the article was that the column measure of GDP was misleading because it did not take into account terms of trade changes. The article argued that it was more relevant to deflate nominal GDP changes with the prices of the things the inhabitants of a country buy, rather than the things they sell as this is the price index relevant for the development of their real income. The article also pointed out that if you deflate nominal GDP growth with the price index for domestic purchases rather that the GDP price index, the real GDP for 2006 is lower than the headline volume number, while real GDP for the first quarter of 2007 is significantly higher.

These arguments and the numbers presented were nearly identical with the analysis I presented in this blog May 30th. The only difference being that Gunnar Örn wrote that terms of trade adjusted 2006 growth was 3.8% instead of the 3.9% number I presented. The similarities between my post and Örn's article are so great that it seems likely that he read my post and based his article on it without acknowledging from where he got the arguments.

But whether he (and The Economist) had actually read what I wrote or not, one thing is clear. You read things first here, sooner than in the official financial press.

BTW: The reply from the Swedish statistical central bureau to the arguments from me and Gunnar Örn was rather nonsensical. They merely said that there are many kinds of measurements and that both volume GDP and terms of trade adjusted real GDP contained information about the economy. That is true, sort of. Volume GDP could in some situations in some aspects be of some interest (for example in analyzing the causes of changes in standard of living). But that doesn't change the fact that the terms of trade adjusted number is the most relevant. This is perhaps not so much a critique of the statistics bureau, but of the journalists (almost all except Gunnar Örn) and politicians who choose to focus on the volume number.

Self-Preventing Prophecies

One often hears about self-fulfilling prophecies. Speech anxiety is an example of this. People get speech anxiety because they are afraid they will say the wrong things and forget things they're supposed to say. But usually they would have no trouble at all saying this to a friend in private, so it is the fear of saying the wrong things in front of a crowd that causes them to sometimes say the wrong things. In other words, hadn't it been for the fear of saying the wrong things they wouldn't have said the wrong things. It is the public speech anxiety itself that causes the things speakers are anxious about.

Another example of self-fulfilling prophecies are the bank runs of the past, before active central banking and deposit insurance. Back then rumours would occasionally appear that a certain bank wouldn't be able to meet its payments. This would cause people saving in that bank to rush to it and withdraw their money. And since fractional reserve banks don't have enough money to pay everyone who in this situation would want to withdraw, this would cause the inability to meet its payments predicted by the rumour!

Less discussed are the phenomena of self-preventing prophecies. One example of this is perhaps seen now. Until a few weeks ago, most investors expected aggresive interest rate cuts by the Fed, which caused bond yields to be as low as 4.5%. These interest rate expectations were based on the expectations of weak economic growth. But now these low borrowing costs was a key factor behind the slight acceleration in U.S. economic growth we've likely seen.

But as most economic reports during the last few weeks have been relatively bullish, an increasing number of investors have realized that there isn't going to be any Fed rate cuts. This have caused bond yields to rise sharply, from about 4.5% to 5.15-5.25% during the latest week.

As this Bloomberg news story (thanks Chris) points out, the sharp increase in bond yields could have devasting effects on the already weak U.S. housing market, which in turn could end the relatively strong growth numbers which the increase in yields based upon!

So, at least as far as the bond market is concerned (in the case of the stock market, whatever effect that is at work is self-fulfilling), predictions about future economic growth are self-preventing.

Riksbank Unexpectedly Hawkish

Just a few days after I published my analysis of the Swedish Krona did the Riksbank board decide to make it out of date.

Based on public statements from Riksbank chairman Stefan Ingves and vice chairman Irma Rosenberg, I believed that the Riksbank had turn far more dovish than in the past. But either they chose to express themselves in a very misleading way or they have been out-voted by more hawkish board members.

At any rate, their interest rate forecast (i.e. their own forecast of their own future decisions) now says that short-term interest rates will rise to 4% by the end of the year and to 4.4% in 2009, up from 3.5% and 3.75% in their February forecast.

As a result of this, bond yields rose sharply, as did the Swedish krona.

While the year end forecast of 4% interest rates will probably hold true, the 2009 forecast of just 4.4% in short term interest rates is way too low. With next year's housing tax reform further fueling monetary inflation and with previous waves of inflation probably increasingly spreading into consumer prices, there is just no way they could keep interest rates as low as that. Especially since the labor unions have pushed through collective wage settlements so high that the government's strategy of pushing Sweden's large unemployed population into work is at risk, meaning that capacity constraints will appear sooner than otherwise.

Once the Riksbank and currency traders realize this, expect the krona to appreciate significantly.

About Time

At last Bush seem to be willing to veto excess spending from Congress. This illustrates why divided government is generally good. When his fellow Republicans controlled Congress, Bush never wanted to confront them about excess spending. Now that Democrats are in charge, Bush seems more willing to have a confrontation.

Source of German Revival

After having been one of the worst welfare states, recent cuts in German government spending now makes it the fourth lowest spender within the Euro zone (after Ireland, Luxembourg and Spain) and within striking distance of Britain.

This is the main reason why the German economy have recovered so strongly recently. This pattern is also found more generally among EU economies, as I recently highlighted.

Being Rich, Old American In 2010 Could Be Risky

As I pointed out in my analysis of the Democrat's management of the Iraq war, President Bush can only veto active decisions from Congress. He cannot, however, veto passive decisions from Congress made by simply not passing any legislation. This is not only relevant with regards to the issue of Iraq but also with regards to taxation.

In order for the tax cuts bills to pass, Bush and his Congressional allies felt it necessary to formally limit them in time, so that they would all expire in 2010. That way, the "cost" of the tax cut would appear smaller and so this helped win over centrist Senators and Congressmen. The only problem is that while 2011 seemed very far away in 2001-2003, it is not so far away any longer. This means that unless an active decision to extend them or make them permanent is made, they will automatically expire, which in effect would amount to a tax increase.

This is why the Democrats are content with doing nothing in terms of tax legislation. They know that an active decision to repeal the tax cuts would be met with a veto from Bush. But since the tax cuts are set to expire according to present law, that won't be necessary. All they need to do is not pass any legislation to extend the tax cuts. And since that is a passive decision, Bush can't veto it. And so, if Democrats hold on to Congress after the 2008 elections, then the tax cuts will likely expire. This is to say, taxes will be raised in 2011 if Congress remains Democratic. Even if a Republican candidate becomes president, he can't extend the tax cuts for the same reason Bush can't.

That means for example income taxes, capital gains taxes and particularly taxation of dividens will be sharply increased in 2011. But most perverse will be the effect on inheritance taxation, which just earn its nickname "the Death tax" even more than ever in 2010.

According to present law, the inheritance tax is gradually declining and is set to fall to zero in 2010. But in 2011, the tax is set to return to its high pre-2001 level. As this means that wealth inherited in 2010 will be much more worth than wealth inherited in 2011, this means that some rather perverse incentives for heirs will be created. As Mallory Factor puts it in National Review: "If you’re an older American, you may not want to drink that champagne cocktail your children give you on New Year’s Eve 2010."

What a Difference 0.0002% Can Make

Stocks and bonds rises today after a report showing higher than expected inflation, 0.7% monthly increaase versus 0.6% expected. However, because the Fed ignores this number and only looks at the "core rate", and because the core rate came in at 0.1% versus 0.2% expected, Wall Street still rallied.

It should be noted however, that the actual core increase was 0.1498%, meaning that had it just been 0.0002% higher, the number would have been rounded up to 0.2% and the stock- and bond rally would never have taken place.

One curios detail is the low "home owner's equivalent rent" number. "Home owner's equivalent rent" is supposed to be based on actual rents for tenants, but actual rent rose 0.3% but equivalent rent rose just 0.1%. Usually such a discrepancy is due to changes in fuel prices, but fuel prices were more or less unchanged so it is not clear what caused the discrepancy. Because "equivalent rent" is 30% of core CPI, had it increased 0.3% too, then the core rate would have increased more than 0.2%.

The Democrats & Game Theory

Three weeks ago, I reported about the hypocritical and seemingly cowardly surrender of the Democratic Congress to President Bush. They had the power to stop the Iraq war simply by refusing to renew funding for the war, and since Bush can only veto active decisions, not passive decisions such as not renewing funding, he would be powerless to stop them. And without funding, the U.S. troops would be forced to leave more or less immediately. And since they then had the upper hand, there was no reason for them to surrender to Bush's demands.

So, why did they do it, if they were serious about ending the war? Well, the answer is that they weren't serious about ending the war. That was just something they pretended to do in order to keep their base happy. They may or may not have favored a withdrawal, but that was not their top priority. In reality, this was a cynical, calculated attempt at gaining an advantage for next year's Presidential election.

They counted on the premise that most voters were unaware of the fact that Congress had the upper hand, and so they would falsely believe that the brief battle between Congress and Bush represented a sincere attempt of stopping the war. Creating that image was a key part in this plan. At the same time, it was necessary for them that their "attempt" failed and the war continued.

Because imagine what would have happened if they had stopped the war. Whether violence in Iraq would decrease or increase is far from certain, but it would probably remain at a high level. And then the mess in Iraq would be something which the Republicans could blame on them.

By contrast, now the mess in Iraq will continue to be a Republican mess, started and maintained by President Bush and supported by next year's Republican candidate (except in the unlikely event Ron Paul wins the nomination). And so, as it becomes clear that the Republican strategy is doomed to fail, Iraq will be a major asset for the Democrats. Something which may be a deciding factor that will ensure that the Democratic candidate will win over the Republican candidate, while the Democratic majority in Congress will increase.

So, given the imperfections in the political system and the limited rationality of voters, the seemingly puzzling Democratic "surrender" to Bush might be seen as a brilliant albeit extremely cynical way to ensure victory in next year's election.

Perhaps you think that I am jumping to conclusions and am attributing the Democrats with more intelligence and cynicism than they actually have? Well, that might be, but consider the fact that leading Democratic presidential candidates, Senators Hillary Clinton and Barack Obama, refused to state an opinion on the Democratic surrender bill that granted unconditional funding to the Iraq war, until they were certain it was going to pass. Then they voted against it. That way, they made sure that the war would go on and continue to be a pain in the ass for the Republicans, while still ensuring that they by voting against would gain credentials to please "anti-war" activists within the Democratic Party.

Seems It Was Only Yesterday.....

...or actually it was more like 8 months ago, but anyway, it wasn't very long time ago that I reported that the Chinese yuan rose above the 15 yen barrier. As I pointed out then, that represented a significant increase from the mere 12.5 yen the yuan cost back in early 2005. But as the yean have fallen against most currencies -reaching record lows against the euro and 5 year lows against the U.S. dollar- due to the so-called carry trade, the yuan have steadily increased -albeit only slowly- against the U.S. dollar. As a result, the yuan today broke through the 16 yen barrier.

The steady appreciation of the yuan versus the yen , if continued, means that the shift in economic power in Asia from Japan to China is going very fast. Japan's likely 2007 GDP is in yen terms 22 times China's GDP in yuans. Which at a yuan/yen exchange rate of 15 means that Japan's GDP is 37.5% bigger than China's. With an annual rate of appreciation of 10% and with nominal yuan GDP growth in China being 10% higher than nominal yen GDP growth in Japan, China could overtake Japan as Asia's biggest economy as early as 2009.

But then again, this presupposes that the current yen weakness will go on, which while certainly possible is far from certain.

Michael Mandel's Phantom "Phantom GDP"

Although, unlike some of the more extreme Austrians, I view GDP and national income as valid concepts in principle, I am certainly open for criticizing these statistics as actually performed by statistics bureaus.

For example, price inflation is likely often underestimated in these statistics, which in turn means that real growth is lower. And I have criticized the fact that nominal production growth is deflated by selling prices, rather than the prices of the goods the inhabitants of a country buy.

I now see, via Paul Craig Roberts, that Michael Mandel of Business Week argues for a systematic overestimation of GDP growth in America, which he calls "phantom GDP". Being interested in the subject of possible distortions, I read his more detailed explanation of this alleged distortion with great interest. Uultimately, however, his argument fails.

His argument is in short that when production moves offshore and the price of the good falls as a result, the price fall results in an increase in real private consumption. But because the produced goods had not previously been imported no price adjustment are made to imports, meaning that real imports aren't increased the way real consumption are increased. And as real GDP is calculated by adding real exports and real domestic demand and subtracting real imports, an upward adjustment to real domestic demand (including real private consumption) but not to real imports implies an upward adjustment to real GDP.

So far he is right in his analysis, but he is wrong when he argues that this paints a misleading picture of economic growth. The reason why it is right to adjust upwards the real value of consumption given a certain level of nominal consumption if prices fall is because this means consumers have more real goods and services. But there is no need to make the same adjustment to imports. The reason for this is that if we get more goods from foreigners without paying them anymore this means that we don't give them more of our goods and services in return, and so there is no need to subtract more from domestic demand in order to arrive at the real value of what we produce and earn. We are, in that scenario, making a terms of trade gain, and as terms of trade gains implies that our real income and real production increases, this means that it is quite proper not to subtract more from our GDP if the price of imports is lower.

Mandel is only right in the sense that according to the standard method of deflating GDP with the prices we produce, this represents a distortion. But as that method in itself represents a distortion, this "distortion" only means that official numbers distort less than they would have if the standard method were more consistently used.

Russia-New Buyer Of Last Resort

One seemingly puzzling thing about recent trade statistics have been that nearly everyone's trade balance seems to have strengthened recently. America's deficit has fallen by several billions of dollars per month compared to last year. Meanwhile, the trade- and current account surpluses of East Asia's two giants, China and Japan have both increased significantly. And the Euro-zone has seen its deficit turn into a surplus due to the soaring surplus in Germany. But how is this possible? I mean, considering the fact that trade balances by necessity are zero sum games.

While I knew the surpluses of the Scandinavian countries have fallen somewhat, they are far to small to account for more than a fraction of the strengthening balances of the US, the Euro zone, China and Japan. While statistical errors cannot be ruled out, one partial explanation seen in actual statistics seems to be a falling surplus in Russia, where imports rose a full 50% (!) while exports only rose 8.6%. The decline in the surplus is not fully as dramatic as those numbers would first suggest since exports were more than twice as high than imports to begin with (now somewhat less than twice as high), but still the surplus fell with $10 billion compared to last year, or $2.5 billion per month.

Bush Is Taxed

See Albanians stealing his watch while greeting a crowd of supporters in Albania (Who love him because of his support of Albanians in the conflict with Serbia over Kosovo). In the beginning it is there, then it the end it isn't.....

Something Rotten in Economy of Denmark

Denmark has often been hailed, particularly in the recent two years, as an economic success story. Yet while Denmark still has a relatively high level of per capita income, this relies on old achievements (Denmark was third richest country in 1970, after the United States and Switzerland) and in recent decades growth have been below average. Only briefly, during 2005-2006, when a housing price boom (with money supply and house prices increasing over 20%) fueled domestic demand did growth briefly exceed the average in the EU and the OECD.

Now, however, growth has again dipped significantly. The latest numbers shows a mere 1.8% in annual growth, far below the EU average. That number was surprisingly low, so at first I thought the real number must be higher on account of terms of trade effects. But according to the details in the data bank, terms of trade deteriorated in fact somewhat.

This low growth number makes the fact that according to the same release, hours worked rose by 3.1% even more startling. This implies that productivity must have fallen by roughly 1.5%. If this is not some form of statistical error related to GDP growth being underestimated and/or employment growth being overestimated, that is certainly ominous for the future of the Danish economy. Also ominous are the increasing tendencies of overheating as implied by high money supply and house price increases and a current account balance falling into a deficit despite a large government budget surplus.

End of Stock Market Rally?

Global stock markets sell off after sharp increase in bond yields as investors finally realize what I've been saying for some time now: that there won't be any Fed rate cuts and that interest rates elsewhere is going up.

And of course, the combination of stock prices increasing much faster than profits and higher interest rates that we've seen implies that stocks have become overvalued. An increasing number of investors now seem to realize it.

Aussie Economic Growth Accelerates

Australia's economic growth rose to 1.6% in the first quarter, which expressed the way growth is expressed in America means a 6.5% annualized growth rate. Expressed in Swedish terms, i.e. change compared to the same quarter the previous year, growth was 3.8%.

Taking into account the improvement in terms of trade, growth is actually even higher than what the above numbers suggest. On the other hand, Australia's population growth is very fast (1.5%), meaning that per capita income growth isn't as high as total growth.

The Australian Bureau of Statistics doesn't provide you with many details, so we have to wait until the Reserve Bank of Australia's publication of the numbers to make a more thorough analysis.

However, it is clearly evident that what drives the Australian economy is first and foremost the commodity boom. This is what drives the improvement in terms of trade and this is what drives the massive increase in investments. As long as it continues, Australian growth will remain strong. If and when it ends, however, the record long boom in the Australian economy will likely end too. Especially since Australia have some of the imbalances seen in America.

U.S. Economic Outlook

The tone of economic reports from the U.S. during recent weeks has been decidedly more bullish than in the previous month. This makes it a virtual certainty that economic growth during the second quarter will be higher than the mere 0.6% recorded during the first quarter. It also means that the probability of the bearish scenario that I've argued for have fallen. Strong optimism still dominates Wall Street and to a lesser extent most other parts of the economy except housing. And if this sentiment remains in place, then a recession is highly unlikely.

However, if it falters, then the economy is likely to fall into a recession due to the following weaknesses:

-Residential investments as a share of GDP remains above the historical average and far above the lows reached in previous recessions (except the 2000-01 recession). This means that there is a lot more room for decline in this sector.

-The household savings rate remains negative, at -1.3%. With housing prices being stagnant or falling (depending on which survey you use), this means that consumer spending depends on a continuation of the stock market rally. A stock market correction would mean that consumer spending would have to fall.

-Profitability in the domestic nonfinancial sector fell between the first quarter of 2006 and the first quarter of 2007. The entire increase in profits of U.S. companies was in the financial sector and in the foreign operations of U.S. companies. But what matters for the U.S. investment outlook is the domestic nonfinancial sector, where profits are falling. While the absolute level of profits are still high, and certainly high enough to support investments if corporate executives are sufficiently optimistic, this means that investment spending could falter quickly if optimism wanes.

So, in conclusion. The increased optimism means that I am less bearish on the U.S. economy than I was two months ago, at least with regard to the short term outlook. But the economy remains highly vulnerable to any swing to a more pessimistic sentiment on Wall Street and among corporate executives.

Conflict in ECB Over Role of Money Supply

Interesting Bloomberg News report about a supposed internal split within the ECB over the significance of money supply growth.

I would like to add two observations. First, contrary to the impression of the report, money supply has in practical policy been nearly ignored. Even though money supply has always been above the supposed 4.5% target, the ECB have been hesitant to raise rates or been holding them constant or even lowering them.

Second, while it is true that the link between money supply growth and consumer price inflation have been weak, this doesn't mean that money is irrelevant. Instead it means that money supply growth have to an increasing extent been causing asset price inflation rather than consumer price inflation.

Why Productivity Slowdown is Likely Largely Illusory

Some bearish commentators, such as Nouriel Roubini, Paul Kasriel and Michael Shedlock argues that employment growth is overestimated due to the flaws of the so-called birth/death methodology the Bureau of Labor Statistics use. They're probably right. However, unless output growth is lower, a lower employment growth only implies higher productivity growth. Output growth in itself may be overestimated due to the likely underestimation of inflation in official price indexes, but considering the more positive tone of private sector indicators, it seems reasonable to assume that growth is still positive, if only slightly.

Anyway, there are increasing signs that employment growth was probably underestimated back in 2002-2005, while it is likely overestimated now. Something which in turn implies that productivity growth was overestimated in 2002-2005 and underestimated now. The reason for this, aside from the birth/death model, is the factor of illegal immigration. In 2002-2005, employment growth was much higher in the household survey than in the payroll survey. Given the fact that most of the employment growth was concentrated to hispanics, it seems reasonable to assume that employed illegal immigrants not reported by employers made up the difference. But while employment growth was underestimated, output growth was not underestimated, meaning that the alleged productivity boom in 2002-2005 was largely an illusion.

Now however, we see how construction spending is falling-while construction employment have increased somewhat. Most of the productivity decline is a result of this surprising statistic. With illegal immigrants being overrepresented in construction, this probably reflects that they're the ones losing their jobs now-after having received all the jobs during the housing bubble.

This is also confirmed in the fact that the hispanic employment rate have fallen a lot more than the overall employment rate. Between January and May, it fell from 65.5% to 64.6%, compared to a overall decline from 63.3% to 63.0%.

Between January 2002 and January 2007, the hispanic employment rate rose more than average (despite a lot faster population growth), from 64% to 65.5%, compared to the overall increase from 62.7% to 63.3%.

All of this indicates that the productivity slowdown is largely a statistical illusion, with productivity growth being overestimated in the past and underestimated now.

Why Aid to Africa Should End

Ilana Mercer has an excellent column on the evils of foreign aid to Africa, where the people due to an irrational culture waste the aid given to them. An excerpt:

"In “Aid: Can It Work?” a frustrated Kristof has detailed many a failed effort to convince Southern Africans, for example, “to grow sorghum rather than corn, because it is hardier and more nutritious.” But because it has been given “out as a relief food to the poor… sorghum [has] become stigmatized as the poor man's food, and no one wants to have anything to do with it.” Hand out infant formula to HIV-infected women so they don't transmit the virus to their babies via breast milk, and the women, without exception, all dump the formula before they reach home: “Any woman feeding her baby formula, rather than nursing directly, is presumed to have tested positive for HIV, and no woman wants that stigma.” As a former AIDS counselor in South-Africa, I was told by my female clients what the use of prophylactics portends: African patriarchs don’t like protection; African women risk battery, and worse, should they insist on their, “like, reproductive freedoms.”

“In the heart of poverty-stricken Congo,” avers Kristof, “wrenching malnutrition exists side by side with brothels, beer joints, and cigarette stands.” Kristof admits reluctantly that the men spending their money in these fleshpots cannot be persuaded to put it, rather, toward their children. Kristof cites disturbing research suggesting education programs in Africa, also the cornerstone of anti-AIDS efforts, are ineffective. Giving people a pill, conversely, works quite well—only there is no pill against HIV/AIDS. In Africa, HIV/AIDS is a sexually transmitted disease afflicting heterosexuals, predominantly. The fight against it invariably entails the teaching of caution, restraint, and the curbing of instant gratification, to which too many Africans appear indisposed."