George Soro's Tilting At Windmills

George Soros will donate $50 million to fight the "free market fundamentalism" that he believes has dominated economic thought.

As if "free market fundamentalism" implied big increases in government spending, bailouts and subsidies of big business, increased manipulation of the monetary system, most of which have been endorsed by most academic economists.....

What we would really need is not for George Soros to fund more of the same kind of ideas that have dominated public thoughts in recent decades, but for Soros's former business partner Jim Rogers or some other rich advocate of free markets to fund the revival of sound free market economics.

Not That Easy

Dean Baker claims that it would be impossible for markets to be surprised by the September consumption number:

"Those of us who passed third grade arithmetic would look at the number reported for third quarter consumption, then subtract out the numbers on monthly consumption that the Commerce Department had already released for July and August, and voila, we would know what number the Commerce Department was going to release for September consumption."

But that first of all assumes that every analyst in the market is fully rational, something which I wouldn't bet on.

And secondly and more importantly, while you can get a hint of how the number likely developed in approximate terms by doing so, it is not true that you can infer the exact number that way. All that was known was the third quarter number, not the monthly break down. Because previously reported monthly numbers are often revised, you cannot infer with certainty the exact monthly number for September using Baker's methodology. Baker's methodology would have been able to do so only if no revisions occurred, but in reality numbers are usually revised at least somewhat.

And since August PCE was upwardly revised by $10 billion, anyone trying to infer the September number from the quarterly number and previously reported July and August numbers would have indeed been disappointed by the September number. The absolute level was a result $10 billion lower and the monthly change was $20 billion weaker than what would have been inferred using Baker's methodology.

Krugman Misses The Point On Stimulus

Paul Krugman hails the alleged 3.5% growth rate in the third quarter as a vindication of Keynesianism.

Against those non-Keynesians who argue that growth was "artificial" because it was the result of "cash for clunkers" and other parts of the stimulus package, he correctly pointed out that "artificial" (in the sense of being caused by government action) is in fact the intended effect and purpose of the stimulus package. If it didn't cause growth to be higher, it wouldn't make sense to implement it, but if it does cause growth to be higher than it has achieved its intended purpose.

However, while libertarians, objectivists and small-government conservatives may nevertheless oppose government induced increases on growth for non-economic reasons, the economic case against the stimulus does not lie in it being "artificial" per se, but on the fact that it is unsustainable and could create negative after effects.

Take the "cash for clunkers" scheme. No reasonable observer could sincerely believe that it didn’t cause U.S. car sales to be higher than it otherwise would have been during July and August this year. However, the argument was instead that first of all the increases in sales while the scheme was implemented would largely come at the expense of sales after the scheme expired, producing little total increase in sales. The fact that short-term gains produced by monetary or fiscal stimulus is usually unsustainable has always been a key argument against such measures.

And because the scheme raised prices it would also crowd out other activites, reducing even the short-term gains while also creating future problems. And because in this case the scheme meant that older but fully functional cars would be destroyed, it would destroy the value of those cars, destroying even more of the value created by the increased sales resulting perhaps in a net destruction of value..

Recession Indicator Shows Q3 Recession In The US

As I was writing yesterday, there seems to be something fishy about the alleged 3.5% annual rate growth in America in the third quarter. If the real value of production is increasing shouldn't real income increase too? The purpose of production is to generate income-wages/salaries for workers, profits for capitalists and interest for creditors, and theoretically the real value of income should increase as much as the real value of production. Yet real income seems to have fallen in the third quarter judging by the components of national income (all components except corporate profits) included in yesterday's release. There would have to be a real big increase in profits to even make real national income show positive growth-and it would have to be almost impossibly large to produce a 3.5% increase.

Part of this mystery can be explained by a worsening terms of trade (adjusted for that, real GDP rose 2.8%), but most of it seems to be the result of an ever widening "statistical discrepancy". Most likely, the truth lies somewhere in between the negative change of the value of real income and the 3.5% official increase in the value of real production.

Illustrating this fact is that at least two of the five official recession indicators used by the NBER to determine when recessions begins and ends, are still negative. These two indicators are payroll employment and real disposable income excluding transfer payments (Transfer payments are properly excluded because increases or decreases in those have no link to the value of economic activities and is instead the result of fiscal policy decisions).

Real disposable income excluding transfer payments peaked in Q3 2007 at $9,671.1 billion (in 2005 dollars) and has fallen every quarter (except Q4 2008 when the economic slump caused a big increase in real wages while retained corporate earnings dropped sharply) since then. In Q3 2009 it dropped 3% at an annual rate from the previous quarter to $8,967.1 billion. In September, the number was even lower than the third quarter average, at $8,941.7 billion.

While real disposable income excluding transfer payments is not a perfect indicator because it does not take into account fluctuations in retained corporate earnings, it still gives us a good hint about how the economy develops. While retained corporate earnings probably rose from the previous quarter it is difficult to see how it could have risen enough to make real national income increase even close to 3.5% (It would have to have a quarterly rise of $75 billion just to push it above zero) or even 2.8%.

Corporate Welfare In America

Americans have often complained about subsidies given by European governments to European airplane producer Airbus. But while it is true that Airbus has received government subsidies (more in the past than in the present though), the European reply that Boeing receives government subsidies is also true.

The state of South Carolina will give a $170 million grant (which is to say, a pure give-away) to Boeing for investing in South Carolina and they will also receive future tax breaks.

The state of Washington, where Boeing has its main operations has also given similar subsidies to Boeing, which is why the main reason for the move as Mike Shedlock argues may be the uncooperative unions in Washington, but the story nevertheless again reminds us that it is not just Wall Street bankers or Detroit car makers that have received corporate welfare from governments.

In a related story, China has now decided to investigate the U.S. government's subsidies to its car producers. This move is mostly symbolic (and probably meant to be part of China's retaliation for the tire tariffs imposed by the Obama administration) as few cars are exported from America to China.

U.S. corporate welfare (whether it comes from the federal government or state governments) doesn't justify corporate welfare in other countries, but it certainly means that America can't claim to have the moral high ground on this issue.

Strong GDP Report May Be Misleading

According to the first preliminary estimate, U.S. GDP rose 0.9% or 3.5% at an annual rate, compared to the previous quarter while falling 2.3% compared to a year ago.

If we are to believe the numbers then it was clearly a strong report. Yet there are reasons to believe that the numbers could exaggerate actual growth. That is because other numbers do not corroborate this fairly strong number.

For example, employment continues to drop. Production could expand even if employment drops if productivity increases, but if productivity increases so fast then how come real wages are falling? It would be possible with rising productivity and falling real wages if profits are soaring, but as I pointed out in the previous post profits are down sharply too. While the drop I discussed there referred to the yearly, and not the quarterly change, the yearly drop was not significantly smaller than in the previous quarter, making it unlikely that profits rose more than modestly.

For these reasons, it seems likely that real gross domestic income was stagnant (This is confirmed by the fact that the aggregate sum of the income components reported today (all except profits) fell even in nominal terms) and that the so-called "statistical discrepancy" continued to widen. It could of course be that it is gross domestic income that is too low, but it is likely mostly a case of gross domestic product being too high.

Profits Bad-But "Better Than Expected"

3 weeks ago I wrote the following about the then upcoming earnings season:

"1. In absolute terms and in relation to what so-called analysts officially expected just a few months ago, corporate earnings will be really bad.

2. Relative to current official expectations (-25% compared to the already depressed earnings last year), earnings will in most cases, as they nearly always are, be "better than expected", thus promoting the belief that you should buy stocks even though they're objectively expensive."

Today, with much of the earnings season behind us, Bloomberg news writes the following:

"Earnings-per-share have topped estimates at 82 percent of the companies in the S&P 500 that reported third-quarter results so far, which would be a record proportion for a full quarter in Bloomberg data going back to 1993. Still, profits have decreased 19 percent on average for the 236 companies that reported since Oct. 7. Sales have slumped 5.8 percent and surpassed estimates at 64 percent of the companies."

The stock sell-off in recent days indicate that an increasing number of people realize that earnings really were terrible despite beating the rigged "analyst estimates" and that stocks really are overvalued now. That doesn't necessarily mean that the trend has shifted and that stocks will continue to decline in value, but there is a high probability of it and what we can say for sure is that they should do so.

Reviving The U.K. Economy

Matthew Lynn has some good advice on how to revive the weak U.K. economy. And no, it certainly does not include more of the failed Keynesian strategy implemented by Gordon Brown and Mervyn King that Paul Krugman has hailed.

A Baltic Recovery?

Lithuania, the EU country which had the biggest drop in GDP in the year to the first quarter recoverered some of the loss in output in the third quarter as GDP rose 6% compared to the previous quarter, reducing the yearly decline from 19.5% to 14.3% The drop in the second quarter was also revised down from 20.2%.

Similarly, the second hardest hit country, Latvia has seen its industrial production rise in recent months.

The recovery in output combined with the current account surpluses that we have seen makes it increasingly unlikely that the baltic countries will feel the need to devalue.

Weak Currency Ends McDonald's Presence In Iceland

McDonald's has decided to close its two restaurants in little Iceland. While this will improve Iceland's trade balance, it will worsen its real national income.

The reason for the decision is that tiny Iceland (Just roughly 300,000 people or 1,000 times smaller than the U.S.) do not have enough of the commodities to produce the McDonald's meals, meaning that nearly all of the commodities had to be imported from Germany. But with the dramatic downturn in the value of the Icelandic Krona, input costs simply became too high to remain profitable.

Taxes, Government Spending & Marginal Effects

The economic case against taxes centers primarily on how it produces negative marginal effect. By reducing the net income you gain from productive activities it will mean less of these productive activities.

Yet the link between taxes and marginal effects is not as clear cut as it would seem at first for two reasons. First of all, legislators often decide to reduce tax revenues in ways which do not reduce the negative marginal effects. Examples of this are when for example mortgage interest payments and charitable gifts are made deductible.

And secondly, sometimes spending can also produce negative marginal effects. This really applies to all means tested spending programmes, including for example welfare and unemployment benefits.

Tyler Cowen now gives us another potential future example: namely the provision in the planned U.S. health care reform that will attempt to compensate people with low income for the damage that the health insurance mandate inflicts on them, they will receive subsidies. Yet as these subsidies are faced out, this will produce negative marginal effects similar to those that taxes produce. And of course, ultimately these subsidies will have to be financed by higher taxes.

Because of the way taxes and spending are designed now (and even more so how they will likely be designed in the future) in America , the negative marginal effects of these policies are at many income levels relatively high, even though tax revenues aren't particularly high.

Asian Rebound Continues

South Korea saw its GDP expand 2.9% in the third quarter-nearly 12% at an annual rate. Together with the almost as strong growth rate recorded in the second quarter this means that the entire drop in production that we saw during the financial crisis has been recovered. GDP is 0.6% higher than a year ago.

The strong Korean growth report follows similarly strong reports from China and Singapore. It seems likely that other Asian economies, such as Hong Kong and Taiwan, will report robust growth. Even Japan will probably have positive quarterly growth, though its growth will likely not be as strong as in the rest of Asia and unlike in for example Korea, GDP will remain lower than a year ago.

The main source of this strong Asian recovery is as I pointed out earlier, rapid growth in domestic demand in China.

Drawing The Wrong Conclusions About Protectionism

Mark Thoma and Yves Smith points to a study that links the gold standard to protectionist measures during the 1930s on the basis that countries that remained on the gold standard were more likely to restrict trade than those that didn't.

I haven't tried to verify that statement, but I think it is probably true. However, the conclusion that the gold standard caused the restrictions is mistaken. Because just what kind of trade was restricted. I don't think it was exports, but imports. And the reason why it is likely that countries that stuck to the gold standard were more likely to take fiscal measures to restrict imports is that other countries had by leaving the gold standard implemented "beggar thy neighbor" competitive devaluations. And as I pointed out in my report for the European Enterprise Institute, such competitive devaluations are in effect equivalent to combined export subsidies and import tariffs.

The point here is not that counter-measures were really justified (there are good arguments both for and against that), but that the responsibility for creating this situation lied on the countries that tried to distort trade through competitive devaluations as they were in effect protectionist.

Perspective On Energy & Commodity Prices

Liam Halligan provides a perspective on the Chinese car industry and its potential and its implications for the prices of oil and other sources of energy. Here is the particularly interesting part:

"Transport accounts for 70pc of global oil use. And China's car market just became the world's largest – with sales reaching 9.7m during the first nine months of 2009, a jaw-dropping 34pc above the same period last year.

As Chinese workers get richer, such growth is set to continue. There are still only 30 cars per thousand Chinese people – compared to over 800 in the US."


This factor would seem to favor a big increase in the price of oil. However, because of the substitution away from oil caused in part by the price increases, and in part the widespread belief that oil causes harmful forms of "climate change", demand will not increase as much as this implies.

However, that will only mean that demand for other sources of energy will increase. As it is unrealistic that wind or solar power will account for more than a fraction of that increase, this will mean higher prices of agricultural products used for biofuel, for uranium and even for coal (though the aforementioned concern for "climate change" will limit demand for coal).

Another point in the column worth noting is the decreased relationship between commodity prices and the Western business cycle that the boom in China and other emerging markets implies. Because commodities are much farther away from final consumption than finished products or services and therefore more sensitive to interest rate changes, (Austrian) economic theory predicts that they will be more cyclical than finished products or services.

Empirical data certainly supports this conclusion, but it should be emphasized that the "business cycle" relevant here is the global business cycle. If there is a global slump, then commodities will drop quickly in price, as we saw late last year. This is as true now as it was in the past. The difference between now and the past is that in the past, it was really only the Western business cycle that mattered because it accounted for almost all final global demand. Now however, if the Asian business cycle "decouples" from the Western, it means that commodity prices might rise even though the Western business cycle hasn't turned around. And that is exactly what we've seen now as the Asian economies led by China are booming, while the recovery in the West is feeble at best, or even non-existent as in the case of the U.K.

U.K. Slips To Seventh Place

In 2001, Gordon Brown bragged about how the U.K. under Labour had become the fourth biggest economy in the world, after only the U.S., Japan and Germany, but ahead of France and Italy.

But that was of course just four years after they took power, and during those first four years they pursued basically the same policies that the Conservatives had pursued. Also, the pound was significantly overvalued at that time (at that time it stood at roughly €1.7, now it has dropped to only about €1.1). After that however, Labour started to shift to the left and pushed through dramatic increases in government spending.

Now, however, the U.K. economy is only the seventh biggest, as the economies of China, France and Italy have surpassed it. In the case of China this reflects far higher economic growth, while for France and Italy it primarily reflects the weakness of the pound relative to the euro. Particularly France has however also had a more moderate downturn during the current economic crisis.

U.S. Bank Reserves Rise Above A Trillion Dollars

In the week to October 21, bank reserves (excluding vault cash) rose to a record 1,034.1 billion.In October 21, reserves reached a record $1,056.2 billion. Before September 2008, reserves were just about $40 billion.

Including vault cash and currency in circulation, the monetary base is now approaching $2 trillion, compared to $840 billion in August 2008.

This explosion in the monetary base however has in recent months not affected money supply which after a big run-up in late 2008 and early 2009 has in recent months remained stagnant. The reason for this is the Fed's decision to pay interest on commerical bank deposits at the Fed, something which helps boost profits in the banking industry, but limits the intended inflationary effect.

U.K. Recession Continued In The Third Quarter

U.K. GDP continued to contract in the third quarter of 2009, marking the sixth straight quarter of decline. Compared to Q2 2009, it contracted 0.4% (1.6% at an annual rate), compared to Q3 2008 it contracted 5.2% and compared to the peak level reached in Q1 2008, it contracted 6.0%.

At the same time, numbers for the euro zone looks stronger.

So much for Paul Krugman's theory that the more Keynesian policies in the U.K. gives it a stronger recovery than in other countries.....

Disappointing Growth

China's third quarter growth number was deemed "disappointing"-only 8.9%! Just about any country would love to have that kind of "disappointment".....

China has gone from being dependent on inflationary booms abroad to creating an inflationary boom at home. They would be well-advised to tighten monetary policy now to limit the inflationary excesses, by for example allowing the yuan to appreciate against the dollar again or by increasing reserve requirements.

Why The Weak U.S. Dollar?

The U.S. dollar lost even more ground today, and for the first time in more than a year, the euro rose above the $1.50 level.

While this apparent renewed strength for the euro is causing some European officials, particularly in France, to complain, the fact is that this move really doesn't reflect euro strength, but dollar weakness.

In fact, the U.S. dollar has weakened against almost all currencies this year, with the only exception being the Japanese yen as well as various currencies that are in effect pegged to the U.S. dollar (including the Chinese yuan).

While the dollar has dropped 7.5% against the euro this year. it has dropped 12% against the pound, 13% against the Swedish krona, 15% against the Canadian dollar, 23% against the New Zealand dollar and 25% against the Australian dollar.

That the dollar is so weak right now is all the more surprising given the money supply statistics I recently discussed, as most countries have a lot higher money supply growth than in America. So what is going on here, a lagged effect of previous money supply growth?

It probably to some extent reflects lagged effects of previous money supply increases, but not by much as money supply changes affect financial markets much faster than consumer goods markets. Instead, the most important factor involves demand for currencies, not supply.

The U.S. dollar has in fact become a "negative beta" asset in the minds of investors, just like the yen and to a lesser extent the Swiss franc. "Negative beta" means that it has a negative correlation with stock market movements. Whenever stock markets sell off, it "should" rise in value, whenever stock market rally it should decline in value. A theoretical explanation for this can be found here.

The stock market rally that we have experienced has therefore led to a big drop in demand for the U.S. dollar and the yen, while increasing demand particularly for the dollars of Australia and New Zealand.

Paradoxically, because of this demand factor, high money supply growth outside the U.S. could actually in the short term increase the exchange rate value of the countries with higher money supply growth. The reason for this is that as this could create a short-term boom in those countries, it could cause stock markets to rally, something which might increase demand more than supply. In the long term though, the money supply increase will lower the exchange rate as the increase in demand disappears with the initial boom.

Monetary Timelag In The Baltic States

One of the things that complicate understanding of inflation is the time lag between monetary inflation and price inflation, or in other words the time lag between money supply changes and price changes.

My good friend Daniel Halvarsson estimated based on U.S. data that the time lag to be 1-2 years. It should therefore not be surprising that price inflation is increasing even though money supply has been stagnant for the last few months. Last year inflation dropped faster than normal, but that reflected a sudden and sharp increase in money demand due to increased risk aversion after the Lehman crash. So under normal circumstances, 1-2 years seems like a good estimate.

The Baltic states, which experienced very high money supply growth during their boom, followed by a significant monetary deflation during the current bust, provide a good test of just how long the time lag is.

As I pointed out in my post "Rise And Fall Of The Baltic Boom", money supply growth peaked in early 2006 in Estonia and late 2006 in Latvia, but remained very during early 2007, particularly in Latvia. Money supply growth started to turn negative in early 2008, and has in recent months decreased at double digit percentage rates.

As a result of the high money supply growth during the boom, price inflation increased to very high levels, peaking during mid 2008 at roughly 12% in Estonia and 17% in Latvia.

Since then, price inflation has plummeted, to -1.7% in Estonia and 0.1% in Latvia. This is all the more impressive considering that both countries have increased their consumption taxes during this year. Inflation fell a lot faster in Estonia than in Latvia during late 2008, but has in recent months decreased a lot faster in Latvia, something which was related to the fact that money supply growth decelerated somewhat earlier in Estonia.

Depending on whether you connect the peak level in price inflation with the peak level in money supply growth or the end of the period of abnormal money supply growth, we can see that the time lag was 1½ to 2 years in Estonia and 1 to 2 years in Latvia. Between the shift to negative money supply growth and price deflation, the time lag was somewhat shorter, but still above 1 year.

Halvarsson's 1 to 2 year estimate seems to fit relatively well for the baltic states as well. While it shouldn't be seen as a "quantitative law" (as no such things exists except for purely functional ones), it does seem to describe how long the monetary time lag is in modern economies under normal circumstances.

The Other Side Of The Real Wage Argument For Inflation

One of the few valid arguments for inflation is that if nominal wages are rigid downwards, or in other words cannot be lowered, then inflation can help bring about the needed real wage adjustment, something which will help create (or prevent the destruction of)jobs and therefore also help boost output. (Strangely though many of the economists that advances this argument contradicts themselves by saying in other contexts that wage cuts will not increase employment)

The most common counter-argument to that has been that workers, or unions or minimum wage setting governments won't be fooled by this and will demand higher nominal wages to compensate for inflation. This counter-argument is indeed to some extent true, as wage demands will indeed be higher if workers, unions and governments expects price inflation than if they expect price stability or deflation. This will limit the employment increasing effects of inflation.

However, because of the phenomena known as money illusion, nominal wage increases will likely not be fully as high as inflation.

Money illusion arises because people have difficulty linking their pay to general increases in prices. Their particular consumption portfolio might increase less or more than the consumer price index, making it difficult to link to monetary policy, as opposed to specific factors that might affect certain prices. Fuel price increases could be blamed on "speculators", "greedy oil companies" or whatever, food price increase could be blamed on bad weather and so on. But while non-monetary factors indeed affect the movements of specific prices, and even the consumer price index, the specific factors increasing the prices of some goods are usually cancelled out by specific factors decreasing the prices of other goods.

The point is that because of the difficulty in understanding the issue workers will have difficulty in demand compensation.

Moreover, some people fells psychologically better of with a 2% nominal wage increase combined with 2% inflation than a frozen nominal wage combined with 0.5% deflation, even though the rational choice is clearly the latter.

And so the conclusion is that inflation can in fact do some good by lowering the excessive real wages of some.

However, what is forgotten is that while this positive effect exists, inflation is associated with many negative side effects. That includes the fact that the same mechanism can make real wages too low.

Workers could perhaps because of money illusion be content with a 5% wage increase even though they could have negotiated a 6% increase.

It is not a law of economics that real wages should be as low as possible. They could be too high as well as too low. What damage do too low real wages create then?

Well, clearly the effect will first of all be redistribution from workers to corporations and their owners. That is of course something which many, particularly with a socialist leaning will find ethically wrong in itself. But from an economic point of view the main problem is instead that it will fuel malinvestments. While bubbles and inflationary booms are usually associated with too high P/E ratios for stocks, the problem is also that the boom makes the "E" (corporate earnings) in the P/E ratio artificially and unsustainably high, something which also helps contribute to make the "P" (stock prices) too high, and which helps fuel malinvestments. Eventually, when malinvestments becomes too great and/or the central bank has to contain its inflation, real wages rises back to normal levels, exposing the bubble.

In short, why there is no point in trying to deny that inflation can reduce excessive real wages, real wage manipulation could also create problems by making real wages too low.

Forget "Analyst Estimates"

Anyone who has followed financial reporting, specifically about "analyst estimates" for corporate earnings for a longer period of time should have noticed two things:

1) Estimates about future earnings are almost always far too optimistic.
2) Estimates about earnings in the quarter that just ended are almost always far too pessimistic (the only exception that I can recall were for financial companies in 2008 due to large write downs).

Why do these systematic errors arise? Well, simply because these "analysts" are employed by companies that want people to buy stocks. It suits their purposes if people hear that "earnings are better than expected" and at the same time hear that rapid earnings growth is projected in the future. No matter how bad the earnings really were in an absolute sense, hearing that they were "better than expected" and will increase in the future will make people unaware of the phony and biased nature of the "estimates" more willing to buy stocks. This is the purpose of these so-called “estimates”.

The current earnings season have proven to be no exception. Just as I predicted before it started, most companies have reported falling earnings, but since earnings were higher than "analyst estimates" in most cases, it was still interpreted by many as a reason to buy stocks.

Of course, the move from 1) to 2) requires that estimates are revised down significantly in the meantime, but that is made in a very quiet way that few notices.

RBA: Low Interest Rates Imprudent

The Reserve Bank of Australia (RBA), whose short term rate of 3.25% is the highest among significant advanced economies, now says that the current low interest rates are "imprudent", in one of the most unequivocal signals yet that the RBA plans to implement more rate hikes.

Just how imprudent then are the zero (or near zero) interest rates in many other economies?

My Report Available Online

As I expected, my report on free competition, globalization and the EU that I presented at a European Enterprise Institute seminar in Brussels Wednesday last week has now been made available online. Read it here I haven't had time to read through the online version, but I assume that it is basically the same report that I submitted to the EEI. It's long but if you have the time I think you'll find it worthwhile reading.

Most of the content should provide few surprises for regular readers, but I should immediately comment on two things which some readers might find controversial.

First, that I use the "perfect competition" model to illustrate the benefits of increased competitive pressure. I did in the report note several reasons why it is not perfect and can't be used to justify strict anti-trust laws. In hindsight, I should also have mentioned a greater possibility for so-called price discrimination. However, having made those caveats, the model does in fact provide a good explanation of why increased competitive pressure is a good thing, other things being equal.

And secondly, my endorsement of the euro (the European Monetary Union) as a way to promote free competition and globalization, and therefore by extension also economic growth. There's not much to be added here to that except that you should read the arguments that I put forth and that I therefore believe it to be no doubt that it enhances structural growth. The one caveat to the benefits of monetary unification is if an independent monetary policy would be significantly sounder, as I discussed here.

Paul Krugman Can't Make Up His Mind On Bank Lending

In today's column, Paul Krugman makes two contradictory assertions.

On the one hand he claims that banks are "too reluctant to lend". Before we go to his other assertion, we must ask ourselves, just to whom are banks reluctant to lend? Most likely to loan applicants deemed risky.

But on the other hand Krugman also says that "financial reform" (whatever that is supposed to mean) is desperately needed, or otherwise banks will start taking risks.

First he argues that banks are too reluctant to make risky loans and then he argues that we need to act to stop them from making risky loans.....

Australia's Strong Dollar Policy

Interesting article in The Australian about how the Australian central bank, the Reserve Bank of Australia (RBA), seems to have no problem with continued appreciation of the Australian dollar. The Australian dollar is already up more than 50% against the U.S. dollar since the October 2008 lows of US$0.61/A$, and up more than 30% since New Year's Eve level of US$0.70/A$, yet when asked what to do if the Aussie dollar continued to appreciate to for example US$1.10/A$, then RBA chairman Glenn Stevens simply said it would simply reflect the strength of the Australian economy and that the RBA would have no problem with it.

This can be contrasted with the explicit attempts by the Bank of England, the Bank of Canada and the Reserve Bank of New Zealand to "talk down" the values of the pound and the dollars of Canada and New Zealand.

While I continue to believe that further upside potential for the Aussie dollar is limited, the fact that the RBA seems happy about a strong Aussie dollar is certainly bullish for it.

China Continues To Drive Global Growth

There can be no doubt at all at this point that the Chinese recovery is real (in the sense that output is expanding significantly). Here are just some of the news indicating this:

-Exports fell by only 15.2% in September from a year ago, the smallest drop in a year. Meanwhile imports fell even less at only 3.5%. Adjusting for the drop in price, real imports likely rose from a year ago. As a result the Chinese trade surplus dropped by more than 50% to $12.9 billion.

-Electriciy consumption rose 10.2%.

-Passenger car vehicle sales in September rose a full 84% compared to a year ago, rising above 1 million (12 million at an annual rate) for thr first time ever, strengthening China's position as the world's largest car market.

The much smaller decline in China's imports was mirrored by a big drop in the rate of decline in South Korea's exports, which fell by 6.6%, the by far smallest amount during the latest year. As Korea's imports fell by 25%, this means it went from a balance in trade to a surplus of more than $5 billion. China's boom will however not only help lift South Korea, but also other Asian countries, and to a lesser extent the rest of the world.

That makes it all the more worrisome that the Chinese boom is partly built on excessive money supply growth, which according to the M2 measure was as high as 29.3%.

While I remain long term bullish on China for reasons explained here, this means that some form of medium term setback looks increasingly likely, which given the current dependence on increased Chinese demand would spread to the rest of the world, particularly other Asian countries.

Yearly Commodity Price Change Turns Positive

Three (one only barely so, though) out of four commodity price indexes listed on the Bloomberg News web page is now higher than a year ago. Early this year, these indexes posted 30 to 40% yearly declines. Most of this recovery is simply a base effect as more and more of the brutal commodity price drop between July and December 2008 is removed from the comparison (Commodity prices are still significantly below the July 2008 peak levels), but commodity prices have in fact risen quite a lot from the lows of December 2008, with for example oil being more than twice as expensive in U.S. dollars as in December 2008.

This will be followed by a similar increase in the yearly rate of consumer price change, which I discussed here.

The stagnant money supply growth in the most recent months has so far not been able to stop the commodity price rally, in part because of a drop in money demand and also because of a big increase in demand for commodities outside America, particularly in China

Who Could Have Imagined That?

Having the government give money directly and indirectly to wealthy Wall Street bankers makes them even wealthier at the expense of the rest of society.

A New Fed Attempt To Exonerate Itself From Responsibility For Crisis

David Altig at the Atlanta Fed tries to deny the Fed's role in the economic crisis with this argument:

1) The actual Fed funds rate follows (since 1988) some model that he has devised and which appears to be largely intended to follow actual Fed funds rate.
2) The Fed was successful in the late 1980s and the 1990s.
3) Because the Fed pursued such good policies in the past with this rule, they can't be blamed for current problems.

Since he doesn't provide much actual details of the calculations and since it is not in my view important anyway, I won't dispute point number 1.

Point number 2 however is incorrect. A smaller bubble did arise in the late 1980s, and in the 1990s we saw the great tech stock bubble, so I do not think Fed policy was successful then.

Point number 3 does not hold either. Not just because it can't be said that the Fed was successful with it, but also because it doesn't necessarily follow that because something was successful in the past it will be successful in the future. Having no heating will work well as long as the weather doesn't turn cold. And moreover, Altig's model wasn't actually used in the past, he just constructed it to fit the data.

The Economist's Experiment

For years, The Economist had a policy of publishing selected articles of its print issue on the web, while reserving most articles to subscribers.

Then apparently, they came to believe that the profit maximizing policy would be to have free access for everyone to all articles, in the hope that the larger number of visitors would generate enough additional advertising revenue that it would compensate (or even more than compensate) the loss in subcription fee revenue caused by some readers deciding that they don't need a subscription if they can read it for free on the Internet.

But now The Economist has made a 180 degree reversal and will not allow any print article to be read by non-subscribers, an even more restrictive policy than before.

This clearly indicates that the increase in advertising revenue was nowhere near enough to cover for the loss in subscription revenue. It remains to be seen however whether this complete reversal will also mean a reversal in the downward trend for revenue. The New York Times failed "Times Select" experiment wasn't exatly succesful either.

Rent & House Prices-Substitutes

After having risen relatively much, the "rent" (and "owner's equivalent rent"-component) in the CPI falls for the first time in 17 years, after having been stagnant for several months. This shift comes interestingly enough after house prices started to recover, after a long time of significant drops.

Add to that the fact that rent increases were relatively modest during the bubble, and it becomes clear that the cost of the different forms of housing costs are negatively and not positively correlated.

This need not be the case. If there is a general increase in demand for housing, due to for example an increasing population or increased preference among the young for moving from their parents, or an increased preference among the wealthy for having multiple homes, then this should raise both rents and house prices.

However, if we look at another theoretical scenario where the focus is on housing consumers having big shifts in relative preference for owning and renting, then the two prices should indeed move in opposite direction. When the preference for owning increased due to low interest rates then demand for rented housing fell, putting a downward pressure on rents.

After the housing bubble bursted, people became increasingly reluctant to own houses and instead increasingly preferred renting their homes something which helped push up rents.

Now the preference for owned housing is again increasing, pushing upward pressure on house prices and downward pressure on rents.

So, we have two different theoretical scenarios, one concerning general demand for housing and one concerning relative demand for owned and rented housing. While it under under circumstances would be possible for the first scenario to be more important, it is clear that in the recent decade the second has been more important in America.

I'm Back

I'm back from Brussels now. I can't really say that I liked the city (Among other things, I disliked that too many people were unable to understand English, despite Brussel's status as "capitol" of both the EU and NATO), but I did meet a lot of interesting and nice people (including for example fellow seminar participants Fredrik Segerfeldt and Gunnar Hökmark and event organizer Emelie Boman), and attended many interesting meetings. It would have been far better though if Johnny Munkhammar had not been prevented from participating due to participate due to his terrible cancer disease.

Unfortunately, the report about free competition, globalization and it's relationship to the EU that I presented at the seminar doesn't appear to be online yet, but I'm sure that it will be made so soon.

About The Economics Price

I had only very limited knowledge of the works of this year's Economics nobel price winners, Elinor Ostrom and Oliver Williamson, but based on the official explanation here and the positive reviews here"> and here, it appears that they are worthy winners, in sharp contrast to the Peace price winner.

What appears to be particularly promising about Ostrom is that her work is not based on the kind of absurd mathematical formalism that dominates economice departments, but on a more realistic method of analysis.

Where I'll Be On Wednesday

From the European Enterprise Institute web page:

Invitation: The Financial Crisis and Globalization

There are signs of recovery. When will growth and jobs return?

What are the effects of the crisis on globalization and global poverty?

These are two of the issues to be discussed at the

European Enterprise Institute

Breakfast Seminar with André Sapir



Time: 14 October, 8:30-10:30, breakfast will be served from 8:15.

Venue: Residence Palace, Rue de la Loi 155, Brussels

R.S.V.P. to eei.liaison.brussels@gmail.com before 12th of October.

A confirmation email will be sent out in the week prior to the event.

We look forward to seeing you there!

Programme

8:30 Introduction, Gunnar Hökmark

8:40 Crisis and recovery, André Sapir

9:10 Globalization is still a good thing, Stefan Karlsson

9:30 The crisis and the poor, Fredrik Segerfeldt

09:50 Discussion with questions from the audience

10:30 End of seminar

------

As a result, there will be little or no postings from Tuesday to late Thursday. There might be something posted later today, assuming I get my preperations finished in time.

Explaining Empirical Macro Trends With Theory

Having studied the detailed data over movements of components in the GDP of different EU countriess some observations can be made:

1) In all countries, investment spending was weaker than private consumption and GDP. If durable goods consumption had been included in investments, the relative weakness of investments would likely have been even greater.

2) In all countries except Poland, government consumption was stronger than GDP. And in all countries except Poland, Malta and Austria, government consumption was stronger than private consumption.

3) In all countries foreign trade activity dropped dramatically(especially if we exclude Ireland, whose trade statistics is distorted by internal corporate pricing encouraged for tax reasons).

4) All countries except Poland experienced a reduction in GDP.

Can these consistent or almost consistent empirical trends be explained by sound economic theory? Yes, it can.

Observation number one can be explained by the Austrian business cycle theory, which says that investment spending is more cyclical than consumption because it is more sensitive to interest rates and therefore to monetary policy.

Observation number two largely reflects that fact too, and also the fact that since governments can maintain consumption with borrowed money in the event of income shortfall, government consumption is likely to be even less cyclical than private consumption.

And observation number three reflects in part the fact that because the less cyclical sectors of services and non-durable goods are less tradable than durable goods, trade should fluctuate up and down than output. This causal relation in effect says that fluctuations in output will cause a bigger fluctuation in trade because of differences in sectoral composition between GDP and international trade In part it also reflects that with reduced trade, the benefits from comparative advantage will be reduced, reducing the real value of output. This causal relationship in effect says that reductions in trade flows both in and out will reduce real GDP even if the net export variable in the accounting standard used to determine GDP is unchanged, or in other words that the reduction in trade flows causes a reduction in output.

What about the Polish exception noted in observations number two and four? Well, as I noted here, this likely in part reflects that Poland's economy has a less cyclical sectoral composition than most other countries (and unlike many other countries it never had a housing bubble), and also the fact that the Polish government focused on reducing tax rates as a way to fight the crisis.

Nobel Peace Price- A Specific Example Of Government Failure

I previously discussed the issue of government failure in this post in more general terms. Today a more specific example of this could be seen. While the Nobel prices are financed by the estate of Swedish industrialist Alfred Nobel, the peace price is (for complex historical reasons) decided upon by a committee of Norwegian politicians appointed by the Norwegian parliament. Given the fact that Norway's parliament has a slight left-wing majority (despite a majority in the popular vote for the centre-right) this means that a bunch of Norwegian leftists gets to decide who gets the peace price.

So whom do they give the peace price to? To someone waging war without any credible plan on how to end it. And that someone hasn't contributed peace anywhere in the world, or stopped the spread of nuclear weapons to countries like Iran and North Korea-or has any credible plan on how to achieve either. It is not just a case of not having achieved anything, it is a case of not having achieved anything nor knowing how to achieve it

In short-he has achieved nothing positive at all. Yet the Norwegian government agency deciding on the price because he has in his teleprompter based speeches said that he generally thinks "diplomacy" and "nuclear disarmament" are good things. For that "achievement", they could have picked any random beauty queen....

No [Serious] Chinese Bubbles-Yet

In another interesting The Economist story, it is argued that the loose/inflationary monetary policy of the People's Bank of China hasn't yet created any bubbles there.

Assuming the Chinese housing price statistics are correct, there clearly isn’t any bubble there. Even if price increases are underestimated somewhat it doesn't appear to be any bubble. While the rate of price change has increased from last year, the increase isn't dramatic and reflected a recovery from last year's price decrease.

The stock market is a more complex story. The Chinese stock market has rallied dramatically from last year's lows, but the P/E ratio remains well below the historical average. On the other hand, that historical average is higher than in other countries. And it should also be noted that inflationary monetary policies will likely in the short term boost corporate profits (in both absolute terms and relative to for example labor compensation). And if the "E" in the P/E ratio is artificially high, then the "P" may be too high even if the P/E ratio isn't high.

Even so, the stock market doesn't appear to be significantly overvalued yet, as the increases so far mostly appears to reflect recovery from previously depressed levels. However, if monetary conditions stay as loose as they are, bubbles will likely arise.

The Perils Of A Baltic Devaluation

The Economist has an interesting story about how a hypythetical devaluation would dramatically increase the Baltic debt burden, as most mortgages in particularly Latvia and Estonia are denominated in foreign currencies (euros or swiss francs). The same goes for much non-mortgage debt, including government debt. As a result, the case for a weaker currency is far weaker than in other countries. A more general discussion of the devaluation issue can be found here.

Aussie Dollar Rises Above 90 U.S. Cents

Following the recent interest rate hike by the Reserve Bank of Australia and today's strong Australian employment report, which showed that employment rose by more than 40,000 in September (the equivalent of more than 560,000 in America), the Australian dollar rose above 90 U.S. cents for the first time since August 2008. It was as low as 61 U.S. cents in late October 2008 and 70 U.S. cents on New Year's Eve.

Given the relative strength of the Australian economy, more interest rate hikes are likely in Australia. It is less certain to what extent that will translate into further strength for the Australian dollar as the markets have already priced in further rate hikes and as the Australian dollar no longer at this point looks undervalued from a goods market point of view (which it certainly was when it traded at or below 70 U.S. cents). It could rise a bit more before it reaches its high, but probably not by much, especially if stock prices fall.

Two Predictions About The Earnings Season

1. In absolute terms and in relation to what so-called analysts officially expected just a few months ago, corporate earnings will be really bad.

2. Relative to current official expectations (-25% compared to the already depressed earnings last year), earnings will in most cases, as they nearly always are, be "better than expected", thus promoting the belief that you should buy stocks even though they're objectively expensive.

Australia's Rate Hike

The Economist wasn't strictly right about which country would raise interest rates first, but one of their two main candidates, Australia, did come in second.

Given that the Aussie economy is one of the world's strongest, and the fact that its money supply growth is relatively high, this move is certainly justified.

Because of the dramatic 26% appreciation of the Australian dollar versus the U.S. dollar this year, Australia's economy's main challenge will however likely not be increased consumer price inflation but increased asset price inflation and increase in its current account deficit.

Partly because favorable commodity price contracts have expired and partly because of the dramatic appreciation of the Aussie dollar, the trade surpluses that Australia saw late last year and early this year have ended, and turned into deficits.

Dollar Pricing Of Oil To End?

The subject of replacing the U.S. dollar with something else as the currency with which to price and settle oil trades is again raised.

Robert Fisk at The Independent claims that talks are underway to replace the dollar by a basket of different currencies, something which is denied by the Saudi central bank governor and others that Fisk claimed were involved.

I find the story implausible. While it is likely that the dollar will eventually lose its current dominant role, that won't happen for a very long time. And it will then likely be replaced by some other currency, most likely the euro or the yuan, not by some basket of currencies which no one uses in other contexts and is difficult to understand.

I here discussed the impact of such a possible future shift.

The Chicago School Circle Is Now Complete

In former University of Chicago professor Milton Friedman's influential 1953 essay "The Methodology of Positive Economics", he argued that we shouldn't care about whether theories are realistic or not, but whether or not they yield non-truistic predictions about phenomena’s not yet observed:

"The ultimate goal of a positive science is the development of theory” or “hypothesis” that yields valid and meaningful (i.e., not truistic) predictions about phenomena not yet observed. Such a theory is, in general, a complex intermixture of two elements. In part, it is a “language” designed to promote “systematic and organized methods of reasoning.” 5 In part, it is a body of substantive hypotheses designed to abstract essential features of complex reality.

Viewed as a language, theory has no substantive content; it of tautologies"

This has served as justification for using wildly unrealistic assumptions, such as continued arbitrage activity despite the absence of any gains for such activities. When questioned these assumptions have been justified as necessary to provide for mathematical models that can be used for precise forecasts.

The problem has always been that partly because these assumptions have been unrealistic, their predictions have usually been wrong, or at least no better than the predictions of someone picking scenarios randomly.

Now that some people like Paul Krugman (whose prediction track record is hardly better BTW) pointed this out, University of Chicago professor John Cochrane turns Milton Friedman's old doctrine on its head and declares:

"It’s fun to say we didn’t see the crisis coming, but the central prediction of the efficient markets hypothesis is precisely that nobody can tell where markets are going — neither benevolent government bureaucrats, nor crafty hedge-fund managers, nor ivory-tower academics. This is probably the best-tested proposition in all the social sciences."

But if we can't make any predictions about not yet observed phenomena’s, then how could deliberate unrealism in theoretical reasoning in order to enable theories to be expressed in the forms of advanced mathematical models be justified? The circle is now complete and the neoclassical mathematical Chicago school is exposed as having both unrealistic assumptions and useless models.

It should be noted that while this inconsistency is most blatant in the Chicago school, it is also present in almost all non-Austrian school, including Krugman's Ne Keynesianism.

BTW: The alleged conflict between realism of theories and their usefulness in predictions is of course false. No one can predict the future perfectly even with correct theories, but by using the correct theories the predictions will be true more often than not.

Shortcomings Of The "Birth/Death" Model Finally Recogniced?

While I didn't mention the "birth/death" model used by the U.S. Bureau of Labor Statistics in my latest post about U.S. employment reports, I have mentioned it in quite a few posts in the past (for example this one). And I have always been critical to it since that model appears to assume (The BLS refuses to tell the rest of us how the model is calculated) that not only will new businesses started ("births") increase during recessions, but that this increase will be big enough to cancel out the increase in business failures/liquidations ("deaths"). Or in other words, they assume that the difference between new businesses and failed businesses will not decline when the economy goes from a boom to a bust, a very unreasonable assumption.

While that is not inconceivable, it is highly unlikely, creating an obvious "bullish" bias in recessions (on the other hand, it also probably creates a "bearish bias" during booms, but that is not relevant for analysis of the current economic situation).

The fact that the latest annual revision showed a record big downward revision illustrates the "bullish bias" created by the "birth/death" model.

It also means that the more recent numbers probably underestimated job losses. While I and other have long argued for this view, this Bloomberg story could mean that many in the financial press is finally understanding it too.

Monetary Divergence

While money supply growth (Whether you prefer the M2 or MZM measure) in America has been slightly negative for the last few months, the story is different in most other countries.

For example, in Sweden, the M1 measure of money supply (which is much broader than M1 in America and more similar to M2/MZM) rose to 9.1%, the highest since late 2007 and up from a low of 1.9% in October 2008.

In the euro area, M1 growth increased to as much as 13.6% , up from a mere 0.5% in the year to July 2008.

In China money supply rose by a record 28.5%.

In Australia, money supply growth (defined as M1 + "other" other deposits) has remained firm at about 13%.

In the U.K., money supply growth has remained more or less unchanged, but only moderately positive at only about 3%. Similarly, in Japan money supply growth has increased somewhat but is only moderately positive.

Two caveats should be immediately inserted here: First of all, in most countries seasonally adjusted money figures are not available, meaning you have to use changes in the annual change, and the risk with using that there is a risk that changes in money supply growth could reflect base effects rather than real increases. But usually it does.

And secondly, comparing absolute levels of money supply growth is not always fair as there are structural differences in economic growth and therefore also structural differences in sustainable money demand growth. China for example has a far higher structural economic growth rate than Japan.

Even so, it seems fair to say that at least in the first 4 examples (Sweden, the Euro Area, China and Australia) money supply growth is strong, while being weaker (but not weakening) in the U.K. and Japan.

That would suggest that the euro, Swedish krona and the Australian dollar are likely to weaken in coming months, while the USD should strengthen. The Chinese yuan's exchange rate is directly controlled by the central bank, so unless it changes its exchange rate policy or reins in money supply growth there we should instead see a big pick-up in China's relative inflation rate and a reduction its trade surplus.

The latter will probably limit but not completely cancel out the fall-out for the world economy from the renewed American economic weakness.

Robert Wenzel's Irrational Attack Post

Robert Wenzel appears to be angry-at me. Why? Well, because of two posts where I argued that it is highly likely that the U.S. economy soon will or already has started to contract again. He seems very upset about these posts and even goes as far as implying in true "People's Front of Judea vs. Judean People's Front"-spirit that I am worse "than [the] worst economist[s alive like] Krugman and Mankiw" and being a "data dog pack" (Whatever that is supposed to mean].

The origin of this attack is very surprising and irrational since first of all I at least until now held Robert Wenzel in high regard [While not agreeing on every detail, but few if any do that with anyone] and since secondly this subject rarely causes people to get worked up. And third of all considering that Wenzel basically agrees with my conclusion in the posts, his attack post is even more irrational and odd.

So, what is his problem? Well, it appears that he thinks that by not stating my forecast of a double-dip in a sufficiently self-certain way and in the first of the two posts not mentioning money supply (I did do it in the second), I betrayed the Austrian business cycle theory.

In hindsight I clearly didn't formulate every sentence written in the best possible way, but that really goes for just about everyone who writes, including Robert Wenzel. Or does he sincerely believe that every post he has written could not have been written better by any hypothetical god-like entity equipped with omniscience and infallibility?

And what the reservations in the two quoted posts really meant to say is that there cannot be 100% certainty about any scenario, much less the exact timing and quantity of any scenario, and that too includes Robert Wenzel. That is in part due to the fact that every social (including economic) phenonenom is affected by several different causal factor and since many of these factors (and their effects on aggregate outcome) aren't known and in some cases counteract each other. And related to that fact, that while the Austrian business cyle theory does describe accurately real world causal factors, it is not the only factor involved. Meaning that money supply movements can't give you the exact date and magnitude of future aggregate economic events.

More specifically, there are loads of other factors except for money supply that affect short-term trends, including government fiscal policy, trade and tax policies, supply schocks, money demand and so on. While money supply is one of the most important, or even the most important factor, it is clearly not the only factor determing economic growth.

This is similar to how the fact that while a low calorie diet will clearly reduce weight, we can't expect (because of differences in for example genetics and the amount of exercise) a perfect empirical correlation between such a diet and weight.

Or is his problem that I referenced economic data without formal reference to theory? Well, setting aside the issue of whether that should always be necessary to repeat what you've already said in theoretical issues countless times, we can see that Robert Wenzel himself doesn't appear to think that it is really necessary, since he in his very next post that he published after attacking me for not mentioning Austrian Business Cycle Theory discussed economic data without any reference to theory:

"Nonfarm payroll employment continued to decline in September (-263,000), and the unemployment rate (9.8 percent) continued to trend up, the U.S. Bureau of Labor Statistics reported today. The largest job losses were in construction, manufacturing, retail trade, and, most interestingly, government.

The unemploymant level is at the worst in 26 years.

Since the start of the recession in December 2007, the number of unemployedpersons has increased by 7.6 million to 15.1 million, and the unemploymentrate has doubled to 9.8 percent.

The decline in government workers is a sign that falling tax revenues at the state and local levels are impacting those governments' abilities to maintain payrolls. Thus, government employment was down by 53,000 in September, with the largest decline occurring in the non-education component of local government(-24,000)."

Can you see any reference to Austrian business cycle theory there? I can't.

U.S. Employment Report Even Worse Behind The Headline

Yesterday I wrote that the employment report was as weak as I expected, it would confirm that the U.S. economy is again contracting after a very brief and very weak upswing during the summer.

It turned out to be just as weak as I expected, indeed slightly weaker.

First of, the household survey showed an even bigger decline in jobs than the payroll survey, 785,000 versus 263,000. While the household survey is less reliable than the payroll survey with regard to monthly fluctuations, the fact that it for the second month in a row showed much weaker numbers suggest that the payroll survey probably underestimates the drop in jobs at least somewhat.

Related to the previous point is that the unemployment rate would have risen a lot more than just 0.1 percentage points if it hadn't been for a big drop in the participation rate. Had the participation rate stayed unchanged, the unemployment rate would have risen above 10%.

Secondly, average hourly earnings increased less than 0.1% on the month and just 2.5%. Combined with a drop in the average work week, this means that average weekly earnings dropped by 0.25%. Combined with a drop in the number of employed this suggests a big drop in aggregate labor income, a coincident indicator.

And the drop in the average work week is also significant because the average work week is considered to be a leading indicator. The slight upswing in that indicator in July was hailed by bulls as a sign of a future recovery, but now that upswing has been reversed.

Probability Of A Double Dip Increases

A few days ago I listed a few reasons to believe that at least in America, we will see a so-called "double-dip recession".

Most data since then have supported that case.

Data from the housing sector have been relatively bullish, with house prices, pending home sales and residential construction all increasing after years of decline. Given the fact that the housing sector is particularly cyclical, this is an argument for the bullish case.

However, housing has not always been very useful as a leading indicator, and particularly not during the latest decade. During the 2001 recession, it didn't contract at all, and while housing did contract before the 2007-09 recession started, it started to contract as early as late 2005 and early 2006, almost two years before the overall economy started to contract. This means that even if housing has bottomed, it could take a long time before the overall economy recovers in a significant and sustainable way.

Just about all other news about the economy have at the same time been negative:

-The ISM Manufacturing index fell back.
-Non-residential construction continued to drop.
-Car sales fell dramatically.
-Real disposable income, both excluding and including the effects of transfer payments and taxes, continues to decline.
-Jobless claims increased.
-The ADP survey showed continued private sector job losses.
-After having increased in the previous weeks after previous big declines, money supply dropped again.

Clearly, the numbers suggests a renewed downturn in all sectors except housing, something which in turn most likely means a renewed overall downturn.

Tomorrow's employment report may perhaps settle the case, or if it is unexpectedly strong increase uncertainty. Remember however, that contrary to what most financial journalists suggests, the most important number from a macroeconomic perspective is neither the unemployment rate nor the change in payrolls. The most important number will instead be something which is not formally presented, but which can be easily calculated using other numbers. The most important number is aggregate labor income. That is a function of two other numbers presented: namely the number of payrolls and average weekly earnings. The latter is in turn a function of two factors: average work week and average hourly earnings.

The Economist On The Bearish Case

The Economist has an interesting article on the bearish view of the stock market. While I don't agree with everything in it, it is nevertheless interesting.