Sunday, November 18, 2007

Review of the Week

Because of the infrequent posting earlier in the week, I will now list and briefly comment a few news that I find worthy of comment, besides the items already commented -the essay contest and the issue of asset price targeting-:

-Economic statistics from America were mostly bearish, consistent with a recession. Most notably, industrial production fell 0.5% from the previous month in October. The decline was broad-based, with utilities, mining and manufacturing all declining. The weakness in mining is particularly interesting given the elevated commodity prices. Mining is actually only up 0.4% from a year ago. This indicates that at least in America, there are supply-restraints, which is bullish for metal prices, some of which have fallen recently due to fears of the implications of a recession.

Retail sales were up 0.2% in nominal terms, but as the CPI were up 0.3% this implies a decline in real retail sales. This decline is likely to accelarate sharply in November, as the sharp increase in oil prices will then finally show up as a sharp increase in gasoline prices. Also consistent with this pattern is a rise in initial jobless claims.



The Economist finally figure out in this week's cover story (see also their leader) that a recession is inevitable, and is in fact already likely a fact, and even if it isn't, it certainly will be in coming months.

The Economist thus figure this out before most of their competitors. However, a certain insightful observer figured this out 7 months ago.

-The Economist also has a story about why the effects of rising oil prices have been less stagflationary than in the 1970s. It points to falling oil consumption relative to GDP in the G7 and argues that is the explanation. It also concludes that the impact might be bigger in coming months in particularly America as the rise in oil prices are no longer counteracted fast income growth.

Their explanation is not incorrect, but rather incomplete. One reason oil has fallen relative to the economy is the decline in inflation-adjusted prices since the early 1980s. Now that this is reversing, oil will rise in importance.

Also, the story overlooks how much of the supposedly less stagflationary environment is due to the change in how inflation is calculated. Since the early 1980s, inflation measures around the world, but particularly in America, have been adjusted in various ways to lower the inflation rate, by introducing adjustments meant to account for supposed quality improvements and substitution. Whatever your opinion of the validity of these changes, it remains the case that comparing the 1970s to now is a case of comparing apple to pears. An apple to apple comparison that involves either applying the methodology of the 1970s to current data or applying current methodology to the data of the 1970s would show that the economy has not become as much less stagflationary in relative terms than in the 1970s as statistics show.

-Leftist economist Joseph Stiglitz offers a nearly Austrian explanation of the housing bubble, pointing out that Greenspan are to blame for the housing bubble by increasing "liquidity" too much.

-Euro area inflation rose to 2.6% in October from 2.1% in September and 1.6% in October 2006, just as the initial estimate indicated. Interestingly, it is not "merely" food and energy prices.
"Core" inflation is also up, to 1.9%, up from 1.8% in September and 1.5% in October 2006. This makes the ECB:s refusal to raise interest rates increasingly incompatible with even the appearance of committment to its formal objective of holding inflation below 2%.

-Swedish unemployment statistics has finally been harmonized with the rest of the world and now includes students who would like to work, but are unable to find a job and so instead studies. This raises the unemployment rate by 1.5%:points, to roughly 5.6%. Unemployment has fallen significantly during the latest year due to the Swedish government's reductions in the income tax and unemployment benefits, so the unemployment rate was a lot higher during the previous Social Democratic government's era both compared to now and compared to the numbers published at the time.

-Due to a sharp decline in U.S. bond yields, they are now lower even in nominal terms than Swedish bond yields. 10-year U.S. bonds yield 4.15% versus 4.24% in Sweden, the 2-year yield is 4.07% in Sweden versus 3.33% in the U.S.

Given the higher inflation in America and the far more hawkish stance of the Riksbank compared to the Fed, Swedish bonds provide much higher value than in America, where the real yield is negative. Considering this and considering the fact that Sweden still has a large current account surplus while America has a large current account deficit -albeit shrinking, but not dramatically-, the Swedish krona looks highly undervalued compared to the U.S. dollar.


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