Why The Excessive Exchange Rate Over-Shooting?

Economists often use two theories to explain exchange rates: the purchasing power parity theory and the interest parity theory. These two theories are in fact mutually exclusive (at least one of them can't be true) if real interest rates are different in different countries.

To see why that is the case consider a case of country A with an interest rate of 6% and an inflation rate of 2% while country B has an interest rate of 3% and an inflation rate of 1%.

If the prediction of the purchasing power parity is true, then the currency of country B should appreciate with 1% per year relative to the currency of country A. But that would mean that the return of investments in country B would have a return of only 4% while investments in country A would have a return of 6% (in terms of the country A currency), clearly contradicting the predictions of the interest parity theory.

If on the other hand the prediction of the interest parity theory would hold true, then we would see the currency of country B appreciate with about 3% per year relative to the currency of country A. But that would mean that the real exchange rate of currency B would appreciate by 2% per year, contradicting the predictions of the purchasing power parity theory.

But despite the fact the interest parity theory and the purchasing power theory cannot possibly both be true in a world with different real interest rates, they are both presented as more or less true in books on international economics.

One theory that tries to combine the two is theory of exchange rate overshooting. This theory was presented after the new area of fluctuating fiat exchange rates began after Nixon ended the Bretton-Woods System in 1971. Exchange rates fluctuated much more wildly than the advocates of fluctuating exchange rates, like Milton Friedman, said they would.

The theory that was put forward to explain these seemingly excessive exchange rate movements was the theory of exchange rate over-shooting. This theory essentially says that if some country increases its money supply this will in the long run cause its price level to increase proportionately, which according to the purchasing power parity theory would also lower its relative exchange rate proportionately in the long run . At the same time it will push down local interest rates, meaning that according to the interest parity theory, investors will require a future appreciation of the currency, meaning that given a certain expected future exchange rate, the current exchange rate must fall. Because both theories in the case of more inflationary policies in one country predict currency depreciation, then this combined theory says that the currency will depreciate more than what either theory alone says.

There is a limited degree of truth in this theory, but it suffers from several shortcomings. The most important is that it really doesn't explain the actual cases of "exchange rate overshootings" in the theory. According to the theory, the more inflationary currency would depreciate with the cumulative purchasing power reduction and interest rate differential, and then appreciate gradually by the difference in annual interest rates. If say an inflationary policy would reduce local purchasing power by 10% and also mean that interest rates were 1 percentage points lower during 10 years, then the currency would immediately depreciate by approximately 20% and the appreciate by 1% per year during 10 years.

Yet real life exchange rate overshootings behave differently. Consider 3 cases. First the U.K. pound versus the euro. Between June 2008 and late December 2008, it fell from about €1.40 to €1.02, a 27% drop in value. But during the first half of 2009, it recovered to about €1.15. Based on interest rates differentials, the pound should have just appreciated 0.5%, while in reality it appreciated nearly 15%.

Secondly, the Swedish krona. Between June 2008 and March 2009, it depreciated from nearly 11 euro cents to just 8.5 euro cents (which means the euro appreciated from 9.3 SEK to 11.7 SEK). Based on interest rate differentials it should have appreciated just a few tenths of a per cent since then. Yet in reality it has appreciated some 15% to 9.8 euro cents

And for an even more extreme example, the New Zealand dollar. It fell from a high of nearly 82 U.S. cents in February 2008 to a low of 49 U.S. cents in early March 2009. Since interest rates in New Zealand always remained significantly above U.S. levels, the interest parity theory would have predicted continued depreciation of the New Zealand dollar. But in fact, it has appreciated about 40% in the less than 6 months that has passed since then.

These dramatic ups and downs are not consistent with the prediction of the official "overshooting" theory where a dramatic depreciation would be followed by a gradual appreciation.

How can the dramatic drops to excessively low levels for the pound of just €1.02, the Swedish krona of just €0.085 and New Zealand dollar to just US$ 0.49 be explained then?

I am quite frankly not sure, but the most likely explanation are the financial market mechanisms that I explained here, which in short says that momentum and quant traders will make market movements greater than what fundamentals would justify.

Cash For Clunkers Hangover

While the cash for clunkers program appears to have increased car sales in July and August, this will largely come at the expense of car sales later in the year as many would have bought the cars anyway. Early indications for September are for a plunge in car sales. Meanwhile, it also appears to have contributed to increasing the market share of foreign, particularly Japanese and Korean, cars as a higher percentage of their product portfolio lived up to the fuel efficiency standards required by the government in the program. The end result could be that despite the billions of dollars spent, it will not increase sales of domestic cars for the year as a whole.

Again, Savings Has Not Increased

The New York Times claims that the cause of the economic slump is an increase in savings, with leftist economist Dean Baker further claiming that the increase in savings has been underestimated.

Contrary to what Baker asserts, there is no reason to believe that the income measure of GDP is really more reliable than the production side. Other data measuring for example profits and the labor market is more consistent with the income numbers. And more importantly, even if we for the sake of the argument accepts that the production numbers are 100% accurate, it is still the case that savings has dropped.

In the second quarter of 2006, government (18,8%) and consumer spending (69,4%) totaled 88,2% of GDP, leaving a gross savings rate of 11.8%. In the second quarter of 2009 by contrast government (20,7%) and consumer spending (70,7%) had risen to a total of 91,4%, meaning that the gross savings rate had dropped to 8,6%. Even if we add the government spending classified as investments to the savings rate, that doesn't change the fact that total savings is down, from 14,8% to 12,3%.

Furthermore it should be noted that durable goods consumption is down. As durable goods purchases, unlike purchases of services and non-durable goods, is partly a form of savings that means that the decline in total savings is even larger. If we add durable goods to savings, this means that it has declined from 23,2% to 19,4%.

And note that all of these numbers come from the production based approach. If you find it likely that at least some of the swing in statistical discrepancy reflects that the production approach has underestimated the severity of the recession, then savings has dropped even more. So no matter how you look at it, savings has declined significantly during this slump.

Euro Area Money Supply Growth Up-Credit Down

The growth rate of the European monetary aggregate most closely resembling MZM, M1, increased to 12.2% in July-the highest since 2003. In July 2008, the growth rate was just 0.5%. This increase can be explained by the fact that while the ECB raised its short-term rate from 4% to 4.25% in July 2008, it has since cut it to 1%.

Interestingly though, the ultra-broad M3 aggregate has however seen its growth rate drop from 9.3% to 3%, while lending to the private sector has dropped from 11.1% to 1.8%. Total lending has dropped somewhat less, from 9.1% to 3.3% as government lending has increased.

Because M3 includes almost all forms of financing of credit, it will more closely resemble credit growth than M1. Contrary to what Mish and his followers argue though, money supply (M1)is what matters, not credit (essentially M3), which is why we saw a big drop in economic activity and inflation in the euro area following July 2008 when money supply growth was low and credit growth was high and that is also why we are now seeing a economic recovery in the euro area and will soon see its inflation rate increase dramatically now that money supply growth is high and credit growth low.

Bernanke Reappointed

Not surprisingly (Well, the early timing of the decision was a surprise, but not the decision), Bernanke was re-appointed as Fed chairman by Obama. While the Senate has to approve the appointment, it is highly unlikely to obstruct the decision.

The tradition has generally been to re-appoint Fed chairmans originally appointed by presidents from the other party. Paul Volcker was re-appointed by Reagan, and after Reagan later appointed Greenspan, not only Bush Sr. and Jr. re-appointed him, but also Clinton. So it shouldn't be too shocking that Obama re-appointed Bernanke.

Right now the narrative is that Bernanke "saved America and the world from a depression". Something which ignores first of all how Bernanke as member of the Fed board supported the Greenspan policies which created the problems in the first place, and secondly also ignores how the Fed really hasn't solved the problems.

While it is likely that growth turned positive in the third quarter, the risk is very high of a double-dip recession or a dramatic increase in price inflation-or both.

Quickly Refuted Prediction

In its latest issue, published Thursday last week, The Economist discussed which central bank would be first to raise interest rates again now that the global slump is receding and in increasingly many countries turned into a recovery. Their two primary candidates were Australia and Norway.

Just four days after the publication of that article another country, Israel, came first.

Basic Economics For The Economics Challenged

Menzie Chinn corrects Richard Posner's faulty math about the effect of the stimulus. Chinn is actually basically right about the math in this. Posner appears to assume that growth is calculated in a European way, not in the American way.

However, while the math is right, the economics isn't. The case that stimulus spending really raised growth that significantly depended on four assumptions

1) Not even a partial Ricardian equivalence (increase in private savings in response to budget deficits).
2) No increase (or decrease in decline) in the trade deficit.
3) Despite 1)&2), interest rates did not increase (or fail to decrease)as a result.
4) Prices did not rise (or decline less).

If you take these factors into consideration, even the short-term effect of the stimulus is at best small.

Economists Shocked-Weaker Currency Raises Price Inflation

Economists were shocked by the relatively high U.K. inflation number for July 2009, 1.8%. By comparison inflation is -0.7% in the Euro area and -2.6% in neighboring Ireland. How could price inflation stay that high given the deep slump in the U.K. economy and the dramatic drop in commodity prices from their peak in July 2008 (the base month for this 12 month number)?

Perhaps it could have something to do with, you know, the dramatic depreciation of the U.K. pound. If you look at the individual inflation numbers for European countries, you can see that countries with the euro (or withcurrency pegged to the euro) have generally much lower inflation than those who have their own freely floating currencies. The exceptions being Switzerland and to a lesser extent the Czech Republic, but that reflects that the Swiss franc and the Czech Koruna has been much stronger than other small floating European currencies.

Some might object that while the pound is down dramatically since July last year, it has stabilized and even appreciated somewhat against the euro since its low late December 2008. But this shows just how these economists are deceived by their "perfect market" models.

Assuming "perfect markets", prices adjust immediately. A 10% depreciation will immediately raise import prices by 11.1% so that prices are equal in all countries.
But in reality, companies are reluctant to change local currency prices too often because they fear it could for example lead to permanent loss of market share even though the currency fluctuation is only temporary. So as long as they think that the currency fluctuation might be temporary they will not raise prices even though prices are unsustainably low in the long run. But eventually as the depreciation appears increasingly permanent theu will raise prices. Alternatively, if the depreciation proves temporary they will not raise prices, but they will abstain from the price cuts that you would otherwise expect.

What this means is that the inflationary effect of currency depreciation has a lagged effect on price inflation. Meaning that even though the pound hasn't depreciated any more this year, previous weakness still continues to create upward pressure on prices.

Eventually, the effect of last year's brutal pound depreciation will pass through entirely, and assuming the pound doesn't depreciate any more, this will cause relative inflation in the U.K. to fall. But the lagged effects of the previous pound depreciation, just like the lagged effects of the depreciation of the Swedish krona and other weak European currencies, could continue to put upward pressure on prices for many more months.

Now We Now Why Treasury Yields Dropped In June

After having net sold $22.6 billion in U.S. Treasuries in May, non-Americans bought $100.5 billion in June. Much of the "private" transactions recorded are really private funds acting on behalf of foreign [mainly Middle Eastern] governments not wanting to own the securities directly out of fear that these assets might frozen for political reasons. That would explain why Treasury yields started to drop in late June

European Demographic Economics

Last week, Eurostat released new EU population figures for 2008. Population growth for the EU as a whole was 0.43% and varied from 2% in Luxembourg to -0.5% in Lithuania. Three other countries (Ireland, Spain and Slovenia) had above 1% in population growth while six other countries (Bulgaria, Latvia, Germany, Romania, Hungary and Estonia) had negative population growth.

Ireland differed from the other countries with high population growth in that its population growth was mainly driven by a high birth rate, while population growth in Luxembourg, Spain and Slovenia was mainly the result of immigration. Ireland's birth rate is more than twice as high as Germany's, while its death rate is much lower.

There are several economic implications of this subject. First of all, because the economic growth numbers cited usually refers to GDP and not GDP per capita, this means that people in countries with negative population growth are really doing economically better than the headline number suggests, while people in countries with high population growth are doing even worse than the headline number suggests.

This won't make much difference in the case of the Baltic countries as their drop in GDP was so large that even after adjusting for their shrinking population, their per capita income has dropped more than others. For Germany however, it means that its relative ranking improves. In the year to the first quarter, Germany for example had a bigger drop in GDP than Luxembourg and Sweden (-6.7% versus -5.4% and -6.4%), but because its population dropped 0.2% while Sweden's increased 0.8% and Luxembourg's 2% the drop in per capita GDP was smaller (-6.5% versus -7.3% and -7.2%).

The point here is merely that given a certain GDP growth, countries with low population growth are doing better than they might appear to do. But as higher population growth usually causes GDP growth to be higher it is not meant to suggest that population growth is will generally lower the economic standard of living.

It is true that in the short term under certain circumstances (an increase in the number of births and/or immigrants who aren't employed will increase population but not GDP in the short term) population growth can lower per capita income. In the long term however, you will need children and/or (non-elderly) immigrants to provide for current workers when they retire. Japan and Germany are two examples of countries which for long has had a low birth rate and little (almost nonexistent in Japan) immigration. Partly as a result of this they have had stagnant economic growth for some time and now faces an ever increasing burden of providing for their elderly population.

Just as Japan will inevitably be superceded by China as Asia's dominant economy, Germany looks set to lose its dominant position in Europe's economy, though that will happen a lot later than the shift in Asia. Even though Germany still has a lot more people than France and Britain, 82 million vs 64 million and 61 million, the number of babies born in 2008 was a lot lower, 675,000 vs 835,000 and 794,000. This means that it is almost inevitable that France and Britain will eventually have bigger populations than Germany-and also a lot younger. The size of the population is of course far from the only factor determining the size of the economy (if it was, not only China and India but also Indonesia,Pakistan and Bangladesh would have long ago had bigger economies than Japan), but it is a factor, and as per capita income has been roughly similar in Germany, France and Britain and as Germany's lopsided age structure increasingly burdens its shrinking work force, there is every reason to believe that Germany's shrinking relative population size will be accompanied by a decreased relative economic importance.

Shrinking economic importance will, almost by definition, not lower the standard of living to the extent it simply is a result from a smaller population (an increased burden of caring for the elderly because of an ageing population will however have that effect). But it will however have political effects, for example in terms of influence within the EU.

Deflation Ended Months Ago

In the two big currency areas, the U.S. and the euro area, the 12 month price inflation rate reached another low (In countries experiencing significant currency depreciation, like Sweden, no such tendency was to be found), falling into deflationary levels of -2.1% and -0.7% respectively.

However, it should be noted that this was entirely the result of the temporary deflation of late 2008 as you can see if you study the monthly numbers. Between July and December 2008, the U.S. CPI fell from 219.964 to 210.228, a 4.4% decline. Between December 2008 and July 2009 it rose by 2.4% to 215.351. Some of the decrease last year and some of the increase this year was seasonal, but most of it wasn't. As the brief period of deflation gradually disappears from the 12 month comparison, the 12 month increase will rise dramatically. Even if the CPI is unchanged for the rest of the year, the inflation rate will rise 4½ percentage points to 2.4%

Unlike Bob Murphy though, I don't expect the U.S. price inflation rate to rise to particularly high levels (i.e. not much higher than 2 to 3% or so. Perhaps somewhat higher but not much) within the next 6-12 months. The reason for that is that I rely on MZM rather than M1 as Murphy does. And while M1 has grown rapidly (at an annual rate of 18.5% between March and July) in recent months, MZM has increased only moderately (at an annual rate of 3.7% between March and July).

In other countries with higher money supply growth, inflation will likely rise to higher levels than that.

Déjà vu

Gregory Clark, economics professor at the University of California, claims that machines will take all jobs from humans. That sounds very familiar, as the theory of imminent displacement by machines was advanced almost 200 years ago.

Winner Of The Great Recession: Government

Left-liberal journalist Daniel Gross asks which companies or institutions have fared better than others during this "Great Recession". He names McDonald's as one big winner, something which can be explained by how McDonald's is in the non-cyclical business of food and how it is a low price alternative within the "Food away from home" category. Partially countering this is the fact that "Food away from home" (restaurants) is more cyclical than "food at home", but as the example of McDonald's illustrates, the two former factors are usually more important.

The big winner from "The Great Recession" however remains big government. In America, as well as in almost all other countries, government spending has increased dramatically relative to the private sector. Between Q3 2007 (the last quarter before the recession) and Q2 2009, the share of GDP going to government purchases rose from 19.0% and 20.7%, a 9% relative increase ((20.7-19.0)/(19.0)). If you also include transfer payments, the increase in government spending is even larger.

And generally, even though the policies of the government institution known as the Fed (as well as the Fed's fellow central bankers in other countries) was responsible for the crisis, the risk is that government interventionism will be the real winner from this crisis.

"Good" News From Latvia

GDP fell "only" 19.6% in the second quarter 2009 from same quarter the previos year. That this was interpreted as good news says a lot about how deep the economic slump in Latvia and the other Baltic countries has been.

Still, the fact that the drop in output is slowing, while the previous imbalances in the form of high inflation and large external deficits have turned into dramatic disinflation and external surpluses, means that the worst may be over for Latvia. And that Latvia and the other Baltic countries, Estonia and Lithuania, will probably be able to avoid devaluation.

Why A Stock Market Sell-Off Is Imminent

I have frequently disagreed with Mike "Mish" Shedlock in the past, but I agree with him in his assessment that stock prices are bound to fall soon.

Because unknown factors can appear and influence events, one can never be sure of what will happen in the future. But we can say what is likely to happen and what is not likely to happen given available information. And right now, all available evidence suggests that a big sell-off is underway.

What evidence am I referring too?

Beginning with fundamental analysis, we can note that compared to a year ago, earnings are down 30% while stock prices are down only 20%. Meaning that stocks have become approximately 15% more expensive than a year ago. If stocks had been undervalued a year ago that may not have been so bad, but the fact is that stocks were more expensive than the historical average already last year, and are even more expensive now.

While most companies did do "better than expected", that only reflected that "expectations" had been discretely and conveniently lowered just before the releases.

As is noted in this column, stocks are now more expensive than the historical average, particularly relative to the actual earnings during the latest year, but also relative to the 10-year average.


Bulls would presumably respond by pointing to how interest rates are lower than normal. That is true, but on the other hand I would argue that growth prospects are more dismal than normal.

Continuing then with technical analysis, we can see that stocks are now more over-bought than at anytime before the latest 8 years.

If we continue with an analysis of the monetary situation, we can see that the rapid money supply growth that started in September 2008 after several months of stagnant money supply, again turned stagnant after March. MZM has since mid-March grown at about only 4% at an annual rate. With bank credit continuing to decline, it is difficult to see any acceleration in money supply growth. Even so, this indicator is the most bullish one, indicating stable stock prices assuming all else is equal. But as this indicator isn't everything, and the other indicator clearly indicating an imminent sell-off, the overall assessment must be that a stock market sell-off will come soon.

A Debt Limit That Isn't A Debt Limit

What's the point of having a "debt limit", when you're simply going to raise it everytime you approach it? That really makes it meaningless. They should either make sure to take it seriously and limit the deficit or anolish the so-called debt limit. Having a "debt limit" that never limits the debt is just silly, to put it mildly.

The Logic of Say's Law

Say's law has come under discussion, so I will now explain what it means and what it doesn't mean and why it is true.

Say's law in essence means that there can never be deficient aggregate demand, something which also means that there can't be general overproduction. The reason for that is we always have unfulfilled desires, and thus always want more goods and services. That is essentially always true, and is if anything even more true during recessions when people are compelled to cut back on their purchases because of lower income. The only possible context where this would not be the case would be in some hypothetical world where everyone already has what they want, either because of super abundance or the spread of some anti materialist philosophy. But in that case it wouldn't really be a problem, so even then aggregate demand wouldn't be deficient.

This however, does not mean that there can't be any economic crisis, of course. While aggregate demand can't be too low, demand for certain products are often too low. And when there is a significant mismatch between the structure of production (supply) and the structure of demand, then recessions or depression will be the result. But that does not in any way contradict Say's law.

Keynesians often retort that during deep slumps all industries suffer problems (Actually, this is not strictly true, there are some goods and services that boom during recessions and depressions). Doesn't this prove that aggregate demand is deficient? No, this is in fact the result of inadequate supply of goods that people want. Inadequate supply is another way of describing falling income resulting from the overproduction in selected cyclical industries (which is to say capital goods and consumer durables). That means that the workers and capitalists in those industries don’t produce anything which workers and capitalists in relative non cyclical industries want. It is a decline in aggregate supply (income) which causes a decline in aggregate demand.

Some critics have further argued that Say's law assumes no hoarding, or at least no increase in hoarding, and that if people decide to increase hoarding of money, then Say's law will not hold. But what hoarding means is in effect that people want higher real cash balances, which in turn is a desire for higher future demand for goods. That means that there is a relative overproduction of current consumer goods and a relative underproduction of investment goods that will enable that higher future demand for goods. The relative overproduction is in turn a sign that prices are too high and need to come down. People still want these things, but at current prices, they provide less value than future goods, meaning that prices must come down in order to raise real cash balances that way and begin the adjustment process. But again, this is simply another example of a mismatch between the structure of supply and the structure of demand in accordance with Say's law.

Talk About A Pathetic Defense

Robert Lucas, one of the key architects of the extremely useless and misleading "New Classical" macroeconomics model here tries to defend the New Classical model despite its obvious failures.

"The Economist’s briefing also cited as an example of macroeconomic failure the “reassuring” simulations that Frederic Mishkin, then a governor of the Federal Reserve, presented in the summer of 2007. The charge is that the Fed’s FRB/US forecasting model failed to predict the events of September 2008. Yet the simulations were not presented as assurance that no crisis would occur, but as a forecast of what could be expected conditional on a crisis not occurring."

Get that? The forecast was not really meant to be a forecast even though it was presented as a forecast and requested for the purpose of forecasting, but simply a description of what would happen if it happened.....

Well, just about anything can be posed as happening if it happens, including theoretically absurd things like pigs flying by flapping their ears, cats going vegetarian or all prices being fully flexible. Indeed, the whole "New Classical" macroeconomic model is really nothing but a mixture of a few sensible theories with many really absurd assumptions (like full price flexibility) formulated for the purpose of making the model mathematical.

The bottom line is that New Classical models have no real world applicability or relevance. And since the New Classical models are often presented as the only alternative to [New] Keynesian models, they are doing a lot of harm by making the harmful Keynesian models appear relatively more credible.

The Broken Car Fallacy

Caroline Baum points out in her latest column column the relationship between the "cash for clunkers" program to "the Broken window fallacy" that my favorite historical Frenchman, Frederic Bastiat exposed. She mentions many of the key points that Bastiat made, but she doesn't however mention one of the key points that Bastiat made, namely that even if output of windows (cars) was increased, no real wealth creation was made since it in both cases depended on the destruction of existing windows/cars.

Another Thing About Texas-California

In a follow-up on the previous post that I analyzed here, Krugman now argues that economic policy really doesn't matter and that differences in economic growth are simply the result of presumably coincidental differences in economic structure.

Saying that economic policy is irrelevant is very interesting coming from him since he operates under the opposite theory when it comes to federal policy making. Even so, he is partly right as different states are affected in different ways by for example Fed policy making and other factors that states have little or no control over. However, it should be noted that for example the relative success of Texas is not entirely a cyclical phenomenon. Texas grew faster than California before the start of this recession and had a lower unemployment rate.

Moreover, part of the reason why California saw a much bigger increase in house prices (and therefore also a bigger housing bust now) despite the fact that growth was higher in Texas, was because of the building restrictions enacted in California but not in Texas. The reason why California had such restrictions was related to the environmentalist ideology of California's ruling Democrats, meaning that the bigger bubble related problems in California are in fact partly related to local policy.

You Know It's A Recovery When....

Recently, macroeconomic news from around the world has indicated a recovery, or at least a milder rate of contraction. One sign of this is that even the two European economies that have suffered the most, Latvia and Ukraine, are now presenting statistics showing rising industrial production compared to the previous month (though both are still showing big declines compared to 12 months earlier). It remains however to be seen just how sustainable that will be, just as it remains to be seen how sustainable the positive "second derivative" will be in the rest of the world economy.

Paul Krugman's Misleading Tax Comparison

Paul Krugman has noted the fact that "Red State" Texas is doing a lot better than "Blue State" California, something which I discussed here. Yet he argues against the obvious conclusions by pointing out that some "Red States", like South Carolina, have problems too.

While it is true that some "Red States" have problems too, Krugman is still misleading his readers big time. First of all, the question here isn't whether the state was "Red" or "Blue" but whether they pursue free market policies. While "Red" States generally are more free market oriented than "Blue" states, exceptions to this rule do exist. For example, taxation is a lot lower in New Hampshire than in South Carolina(the top income tax rate is 7% in South Carolina versus 0% in New Hampshire(for wage/salary income)), despite the fact that New Hampshire was won by Obama and South Carolina by McCain in the latest election.

Secondly, since no one has claimed that taxation is the only factor determining unemployment, one can expect that the empirical correlation will be imperfect and that exceptions to the rule will exist.

And thirdly, the data that Krugman relies on is seriously messed up. It claims for example that Wyoming is the highest taxed state in the country, even though Wyoming is one of the few states that has no state income tax on either individual or corporate income. Another alleged high tax state, Alaska, has a corporate income tax but not an individual income tax. And Alaska lacks not only an income tax but also a sales tax, yet Krugman (by citing that sources) wants us to believe that the people of Alaska face a higher tax burden than California, with a top state income tax rate of 10.55% and a sales tax of 8.25%.

This matters because Alaska, and much more so Wyoming, has a lower unemployment rate than the national average.

If we now look at the specific "taxes" included here, we can see that Krugman's source in its "State Taxes by source" has a category called "other", alongside "property", "selective sales" (for example alcohol or tobacco excise taxes), "sales", "individual income" and "corporate income" taxes. As it turns out, a full 84% of Alaska's income comes from the "other" category, with Wyoming (46.6%), North Dakota (41.4%) and Delaware (38.6%) also receiving extraordinarily high proportion of their income from those sources. The "other" source is not explicitly defined, but judging by the states involved it looks like income from the extraction of oil and other natural resources. This means that the tax burden on normal business activities is greatly overestimated by Krugman's chosen gauge. And that matters, as all four of these states have unemployment rates below the national average (that goes particularly for North Dakota and Wyoming).

Jobless Benefit Numbers Underestimate Unemploymen

Recently, jobless benefit claims numbers in America have turned down somewhat, with the 4-week moving average going down from 6.67 million in the week to July 4 to 6.42 million in the 4 weeks to July 18. And the weekly number for July 18 was even lower, 6.20 million. Does that mean that unemployment is falling?

In short: No. Though it likely means that the rate of deterioration is slowing.

The reason why jobless benefit numbers are now falling is that jobless benefits have a time limit. In America, that limit for the regular programmes are 26 weeks (or 6 months). And since we've had very high level of jobless benefits for more than 6 months now, this means that many of those that applied in December 2008 or January 2009 are now seeing their regular benefits disappear, meaning that they are removed from the jobless benefit claims numbers.

However, it should be noted that the actual number that receives jobless benefits is a lot higher than the 6.20 to 6.67 million mentioned above. As Congress has passed legislation enabling people to receive benefits longer than 26 weeks, and as the above numbers excludes people receiving benefits longer than 26 weeks, the actual number of people receiving benefits is even higher. The number of people receiving extended benefits is still rising.

Even so, the drop in the official number has been bigger than the increase in the number of people receiving extended benefits, so the true number of recipients is still falling. However, as is noted here in the New York Times, an increasing number of people are losing even their extended benefits. Some of them might have gotten jobs, but many will remain jobless. We should therefore expect Friday's employment report to show another increase in the unemployment rate.

Leftist Oil Contradictions

Alex Epstein at the Ayn Rand Institute blog points out that by the logic of the leftists that demanded a "windfall profit tax" on oil companies when their profits were unusually high, oil companies should now get a "windfall loss tax credit" based on the unusually low profits they now have. A good example of Epstein's point would be Exxon Mobil, that had a profits of just $4.5 billion in the first quarter down from $10.9 billion in the first quarter of 2008 and an average of $9 billion per quarter as early as 2005. And in the second quarter of this year net profits fell further, to just $3.95 billion.

The main cause of the big decline in Exxon Mobil's profits, and profits of other oil companies, is of course the big decline in the price of oil from the elevated levels of the first half of 2008.

One related point that could be here is the fact that when oil prices were at extremely high levels, one of the most popular leftist explanation of this blamed it on "greed" from oil companies (I discussed the other popular leftist explanation, speculation, here). I take it then that leftists would now say that oil companies are no longer "greedy"....

On the other hand, given the leftist concern about "global warming" caused by use of oil and other fossil fuels, and given the fact that higher prices discourage consumption , shouldn't the left now argue that "greed is good" and that the big problem right now is insufficiently greedy oil companies?

The answer is that they should if they want to be logically coherent in their arguments that high fuel prices are caused by oil company greed and that fuel consumption needs to be curbed for the sake of the environment. But as they don't argue that, the conclusion is instead that they are logically incoherent.