Statistical Notes Monday May 31

-Economic news from the United States continues to be bearish, as the Chicago PMI, consumer confidence and house prices. These reports and most other reports suggest that far from acceleratin, growth has decelerated in the first quarter.

-Unlike in Greece and Portugal, the current account deficit in Spain rose somewhat, from €15.9 billion in the first quarter of last year, to €17.7 billion in thethe first quarter this year.

-Sweden's current account surplus rose, from SEK 54.6 billion the in Q1 2010 to SEK 71.1 billion the first quarter this year. This is equivalent to about 8% of GDP. Meanwhile, GDP growth slowed somewhat, but at 6.4% it is still the third highest in the EU, after Estonia and Lithuania.

-Estonia continues to have strong numbers, as retail sales increased 9% and industrial production increased by 31.8%. The strong retail sales numbers could however to some extent be the result of the fact that Easter was in April rather than March this year.

-Hong Kong had even more impressive retail sales growth, up 27.7% in nominal terms and 21.9% in real terms.

-Unemployment fell in Germany in May,to 6.1%, the lowest level since reunification. Employment is up by more than 2% in the latest year. In April, Germany had the fourth lowest unemployment rate in the EU, after Austria, Holland and Luxembuorg.

-Unemployment in Israel fell too, to a new low of 6% in the first quarter, compared to 6.5% in the previous quarter. This decline was in part due to a drop in the participation rate, but the employment rate also rose, from 53.9% to 54%. Combined with Israel's 2% population growth rate, this suggests an increase in employment at an annualized rate of nearly 3%. Part-time employment fell while full time employment rose at an annualized rate pf 6%.

German Nuclear Shutdown Will Damage European Economy

Germany now plans to gradually shut down all of its nuclear plants, with the last being closed in 2022. This is bad news for Europe in general and Germany in particular as it will lead to higher electricity prices, especially given the fact that the anti-"climate change" zeal will prevent or at least limit its replacement with coal.

The decision rested apparently on the tsunami-induced problems of nuclear power in Japan. In other news, following the same logic, Singapore will soon invest heavily in snow removal equipment and Nepal will soon invest in a Navy.

Russia Ends Wheat Export Ban

Good news for both Russia, who will enjoy higher export earnings, and the rest of the world, who will get wheat cheaper: Russia ends its ban on wheat exports.

The ban was never really economically rational (though perhaps politically rational for the Putin regime) for Russia as the gains for its consumers was lower than the losses for its producers. Meanwhile, it was similarly the case that the gains for foreign wheat producers were smaller than the losses for foreign wheat consumers.

Tax Increases As Negative Supply Shocks

What may surprise some is the fact that despite having growth significantly above the euro area average, Germany actually had an inflation rate that was slightly below average (2.7% versus 2.8%). And of all debt crisis struck countries, only Ireland (1.5%) had a lower inflation rate, while Portugal (4%), Greece (3.7%), Spain (3.5%) and Italy (2.9%) had higher inflation rates than Germany and the euro area average.

For several reasons, including the Penn effect, you would expect faster growing regions within a currency area to have higher inflation, yet right now the opposite seems to be the case. Why is that?

The main reason is the fact that as part of their fiscal austerity, the crisis countries have raised consumption taxes, mainly the VAT, but in some cases also excise taxes on for example gasoline, tobacco and alcohol. Such tax increases have an effect similar to a negative supply schock. By increasing the tax wedge between what consumers pay and what producers receive, growth will be hurt which reduces the supply of goods while at the same time prices are increased.

The positive correlation between growth and inflation within currency areas presuppose that there aren't any supply shocks of the positive kind in fast growing countries and that there aren't any supply shocks of the negative kind in weak countries. But in this case there has been negative supply shocks for the weak countries in the form of tax increases.

Ukrainian Hottie About The Dangers Of Obama

Greek Write Down May Be Likely-But It Is Neither Inevitable Nor Desirable

The consensus view among most economic analysts, both those that I normally find sensible and those that I normally don't find senseible, these days is that a debt writedown in Greece is inevitable and perhaps even desirable. I disagree on both counts.

Starting with the issue of inevitability, some argue that the high debt burden makes it inevitable . But that is not true. Countries have had bigger debt burdens historically and have in fact that right now in the case of Japan without there being any writedowns, or in the case of Japan any expectations of writedowns.

Others argue that it is inevitable because Greece has been shut out from the bond markets. But as long as other governments are willing to engage in arbitrage to provide Greece with the needed credit, bond markets are irrelevant and can remain irrelevant for an indefinite period. So as long as governments don't irrationally try to end the arbitrage arrangement which will be profitable for them, no writedowns will be needed.

Of course, given the increased popularity of misinformed populists like the True Finns party in Finland that don't realize that it is a Greek default which would mean subsidies for the Greeks, not the arbitrage loans they oppose (more on this issue below) it is possible and indeed likely that this won't hold and a debt writedown will therefore come, but the point is that if these populists are shut out, as they've been in Finland so far, it is not inevitable.

As for the desirability issue there are two problems with it. The first is that a writedown would reward the Greeks for their past irresponsible deficit spending as they would be relieved of their debt. The populists who rail against having to bail out irresponsible Greeks would in fact then bring on the very outcome that they say theu oppose, and by allowing the Greeks to be relieved of their debts, this would encourage more irrespomsible deficit spending by Greece and others in the future.

One counterargument against this would be that a writedown while a writedown would reward the Greeks it would punish the banks that irresponsibly lent to Greece. But since no government will allow a bank collapse this means that it would be other governments that would take on the costs, meaning that a debt writedown would in fact be a large wealth transfer from Germany and other well managed countries to Greece, with the banks being mere intermediaries.

And if Greece can get away with being relieved of their debts, other countries like Ireland and Portugal would later want to be given the same give-aways from the rest of Europe at enormous costs for taxpayers in other countries.

Furthermore it wouldn't really solve Greece's underlying problems because for one thing some of the debts is owned by Greek banks and the losses for them would require the Greek government to bail them out, disabling Greece from escaping that part of the debt.

Furthermore, Greece still have a significant primary deficit (deficit excluding interest payments) and that wouldn't go away with a debt writedown. And just who will loan Greece the money to cover that primary deficit is unclear.

Again, because of the increased popularity of the myth that a Greek debt writedown is inevitable and/or desirable, the risk is high that it will in fact happen. But it can be avoided if people realize that it can and should be avoided as it would create more problems than it solves, especially for those of us outside Greece.

GDP Number Overestimated, Not Underestimed, U.S. Growth

When I discussed Caroline Baum's claim that the first quarter U.S. GDP number underestimated growth, I left out her assertion that GDI (Which theoretically should be equal to GDP, but usually isn't due to data collection problems usually formally referred to as "statistical discrepancy") would be stronger than GDP because GDI data wasn't available.

Well, now it is, and it turns out that GDI was even weaker.

Shoplifting-Not Just For Humans

Statistical Notes Wednesday May 25

More weakness from the U.S. economy as durable goods orders and shipments both falls, while the number for the previous month is revised down (the monthly change in March is revised up, but since the February number was revised down even more that still means that the absolute March number is revised down too).

The euro area economy also shows signs of weakening as its preliminary May PMI drops, though the numbers still suggests expansion, only at a slower rate. The official new orders statistics however showed an outright decline.

In both Britain and Germany, more detailed GDP numbers showed that terms of trade adjusted growth was lower than the headline number, presumably reflecting mainly higher oil prices. In Britain, the adjustment lowers yearly growth from 1.8% to 1.0% and in Germany it lowers yearly growth from 4.9% to 3.4%.

Greek new orders data shows a big decline in domestic manufacturing orders, but an increase in export orders, suggesting a continued recession, but a lower current account deficit. The latter is confirmed here, with the deficit falling by a fourth, but to a level that is still far too high for a country that faces severe problem getting credit.

Taiwan's labor market continues to be strong as employment is growing at a an annual rate of more than 2% in a country with barely any population growth, causing the unemployment rate to fall to 4.3%, down from 5.4% a year earlier. That is however still somewhat above the lows of 2006-07 and also higher than in Hong Kong and Singapore, but a lot lower than almost all Western countries.

Hong Kong and Singapore may have low unemployment, but inflation was high in both, 4.6% and 4.5%. By contrast, inflation in Taiwan was a relatively low 1.3%.

Sweden's labor market also strengthened, with employment increasing 2.7%. The absolute level of unemployment is however at 7.9% still a lot higher than in Taiwan.

About Austrian Critique Of GDP

A reader wondered about my view of the Austrian critique of the GDP concept given the fact that I frequently use it on my blog.

Actually though, there's several different, to a large extent mutually exclusive Austrian criticisms of GDP, none of which holds for closer scrutiny. I will here discuss the perhaps 3 most common.

The most radical critique essentially argues that national accounting per se is by necessity misleading since you supposedly can't aggregate things as different as haircuts, burgers, cars and guns. But it is in fact possible to aggregate it because there is a thing called money by which the relative value of these things are revealed.

That is similarly why it is possible to aggregate the profits and financial positions of companies and compare different companies even though they make very different products. A financial statement of a company represents an aggregation of the value of the many different activities of a company similar to how GDP statistics represents and aggregation of the value of the many different activities within a country.

Furthermore, if you thiink that aggregation is impossible you wouldn't be able to analyze the business cycle or economy at all, even in a nonnumerical way like in the Austrian business cycle theory.

A related but slightly different critique is related to price indexes, used to convert nominal GDP changes to real GDP changes, that some view as illegitimate because all prices are unique. Yet when done in a proper way they do reveal useful things about how the purchasing power of money in terms of the goods that are produced changes.

It could be noted that just as there are private sector accounting similar to GDP there are private sector price indexes, such as the S&P 500 stock price index or the CRB commodity price index. Consumer price indexes can be useful for the same reason that the S%P 500 or the CRB indexes can be useful.

Another critique, advanced by for example Mark Skousen accepts the legitimacy of growth statistics, yet argues that GDP underestimates the value of output because of its value added approach. Instead of just including final sales, one should also include intermediary transactions.

Yet that would be misleading because the values of intermediary transactions are in fact included in the value of final sales. And if the intermediary transaction, but not the final sale, is made before the end of a quarter or year it is included as inventory build up in GDP.

What GDP does is not counting the value a second time when the retailer (or whoever makes the final sale) sells it to consumers or investment good buyers. In the example of the intermediary sale before the end of the period, the final sale of consumer and investment goods during the next period are added to GDP in the next period while the intermediary goods are subtracted (which formally shows up as inventory reduction) because they no longer exist independently. The purpose of GDP is to estimate the value of what is produced, and the value of a car is only the value that the car buyer pays for it, not the sales price plus the price of steel used in the car plus the value of iron used to make steel and so on.

The absurdity of this approach can be illustrated by the fact that this implies that if the buyer and seller of the car simply sold it back and forth to each other each day then the value of output would increase 365-fold over a year compared to if the original buyers keeps the car! This approach would also imply that if a company instead of outsourcing certain things started to do it themselves, then output will fall significantly despite the fact that the same things are being made in the same quantities.

One response is that GDP is inconsistent since when pure input goods are used it is subtracted, but when investment goods used to make the same final products gradually loses their value that is not similarly subtracted from GDP. This point is actually partially valid, as the reduced value of capital goods in principle the same as the depletion of input goods and that's why Net Domestic Product/Net Domestic Income or in some contexts Net National Product/National Income is preferable, at least assuming similar data accuracy, to GDP since they represent a more consistent application of the value added approach.

However, since depreciation of capital goods is often more difficult to estimate than the use of pure input goods, the accuracy of GDP is probably higher. Moreover, there is usually little difference between the change in Gross and Net Domestic Products so under normal circumstances it makes little difference which one you use.
Only when there is widespread destruction of capital goods, usually due to wars or natural disasters, is the distinction useful, as the far worse values of Net Domestic Product more accurately describes why natural disasters and wars are bad for the economy.

Finally, I should note that though I think that National Accounting in principle is possible and useful, I am often critical about the actual way in which governments makes them and how they are misinterpreted by economists, as for example in the way in which terms of trade changes are ignored in the headline numbers. Furthermore, one should always be aware of the margin of error that inevitably exists because of data collection problems.

Do Companies Benefit From Recessions?

A somewhat odd theory has recently been posted on various left-wing blogs (for example this one) that goes something like this.

High unemployment weakens worker's bargaining powers, helping to reduce wage demands and therefore all else being equal boosts corporate profits.

Recessions and weak recoveries from recessions means unemployment.

Therefore, companies benefits from a weak economy, and the politicians they back will therefore deliberately try to weaken the economy

This might seem at first glance like a good syllogism, but it really isn't since the first premise is misleading. While it is true that weaker bargaining powers for workers will reduce labor income relative to corporate profits, that is not the main effect of recessions on corporate profits. Falling capacity utilization (which increases fixed costs relative to sale) and falling margins because of weak demand will seriously depress profits in a way that greatly overwhelms the positive effect for companies from stronger bargaining powers relative to workers.

The below chart used to prove their point does nothing of the kind, because by using 7-year averages they will at all points include both recessions and booms. This means that it will mainly describe structural rather than cyclical changes. If you look at specific years, you can see that profits as a share of national income tends to fall during recession, while share of national income that goes to workers rises.

Some concede that recessions might not be good for companies, but then argue that weak recoveries are better for companies than strong ones. But that's not true either. During the strong boom following the recession of 1982, corporate profits rose as a share of domestic income from 5.3% in 1982 to 7.2% in 1984, while during the initially weak recovery after the recession of 1991, corporate profits only rose from 6.4% of domestic income in 1991 to 7.1% in 1993.

While other factors that has weakened worker's bargaining power in the United States, both those that the left likes to talk about (like weaker labor unions) and those that leftists don't like to talk about (like immigration), have indeed increased corporate profits relative to labor income, a depressed economy will lower corporate profits even in relative terms (and by definition even more so in absolute terms).

Not A Good Explanation For Strong German Labor Market

Floyd Norris tries to explain the strong German labor market this way:

The relatively small rise in joblessness in Germany may have been partly because of government programs that encouraged companies to keep workers on reduced hours rather than let them go. The rapid recovery reflects the strength of the German export sector, which was enhanced by the fact that many European countries lost competitiveness because of rising labor costs.

The key problem here is that both of these factors were reverted or represented reversals. The decline in hours per workers have been almost entirely reversed, so if that limited the drop in employment during the crisis it should have also limited the gains in employment now as employers can meet increased demand without hiring new workers. Similarly, while German exports are increasing fast now, they dropped fast during the recession.

For the period as a whole, neither the change in hours worked per worker nor exports differ significantly between Germany and other countries, so these factors likely played at best only a very small role. A more important explanation for the strong German labor market is the one I discussed here.

Statistical Notes Friday May 20

BACKGROUND: From now on, I will publish posts that briefly surveys and comments various statistics that are interesting for various reasons from a wide variety of countries. Often, the individual statistics haven't appeared significant enough to merit a post, but together they will be significant, even though they aren't necessarily related. Particularly important statistics that demands deeper analysis will however even in the future get individual posts.

The frequency of these updates will vary somewhat depending primarily on how many interesting numbers are published but also on how busy I am, but usually it will be at least once a week. Since I will publish many updates per month, the date appears in the name of the post. Here is then the first post:

-Portugal has progress in reducing its current account deficit, from €4.12 billion the first quarter of 2010 to €2.94 billion the latest quarter. As a percentage of GDP it is almost down by half since 2008-but as it is still about 6.5% of GDP, it is still too high.

-The story is in many ways similar with regard to unemployment in Latvia. It fell by 0.3 percentage points from the previous quarter and 3.9 percentage points from the previous year, but at 16.6% it is still unacceptably high.

- In Hong Kong,unemployment increased slightly, but at 3.5% it is still really low. Furthermore, the increase in unemployment was entirely due to a big increase in labor force participation that was slightly higher than employment growth.

-Swedish credit growth slowed in terms of SEK to the lowest level since the first quarter of 2005 in the first quarter, and in percentage terms credit growth was the lowest since 1996.

-Mixed signals from the British economy as both retail sales growth and jobless claims increased. The increase in retail sales could to some extent be related to the royal wedding

-Also mixed, but mostly weak, signals from the U.S. economy as not only did jobless claims fall, but leading indicators, Philly Fed index and existing home sales fell too. The fact that other indicators suggest weakness means that the drop in jobless claims could be related to seasonal adjustment problems.

-Israel's economy had continued fast growth, 1.2% (4.9% at an annualized rate) compared to Q4 2010 and 5.6% compared to Q1 2010. Adjusted for terms of trade growth is less impressive, 3.8%, but that is still higher than most other countries, especially considering that almost all net commodity importers have also seen their terms of trade weaken.

Is Fiscal Crisis Possible With Floating Exchange Rates?

When the comparison is made between the fiscal problems of for example Greece and the fiscal problems of the Unites States, many people argue that the United States could never get into similar problems because it has its own currency and could thus essentially print its way out of any fiscal crisis (unless it is self-imposed because of the debt limit, but that is a somewhat different matter).

It is certainly true that having a printing press makes deficit spending easier, but it is not the case that it makes a fiscal crisis impossible.

If it really had been the case that an own currency makes a fiscal crisis possible, why can we now read that Egypt turns to the IMF for loans? And why has four European countries with independent floating currencies, Iceland, Ukraine, Hungary and Romania also felt compelled to turn to the IMF. Are these governments just uninformed?

More likely is that they are afraid of the downside of financing through the printing press: it could lead to escalating inflation. Unless you're willing to let inflation spiral out of control you must limit your money printing. And that in turn means that you can in fact become unable to finance the deficit.

And even if the government don't care about the inflationary consequences, it might still not be able to finance the deficit through the printing press if inflation increases so much that it becomes hyperinflation, something that might cause a total collapse of the currency, like in Germany in 1923 or Zimbawe in 2009.

These scenarios are highly unlikely in the near future for the United States-or Britain or Japan. But they are not impossible in a more distant future.

Estonia Outperforms Latvia

Estonia's yearly growth rate accelerated to 8% in the first quarter according to the first preliminary estimate, driven by rapid export growth (+54% in nominal terms ). Estonia was therefore likely the fastest growing EU-country during the first quarter. Compared to the previous quarter, GDP was up 2.1% ( 8.7% at an annualized rate).

Latvia's growth was more of a disappointment, with GDP growing only 3.4% compared to a year earlier according to the first preliminary estimate, with quarterly growth being a weak 0.2% (0.8% at an annualized rate.

Why Estonia is doing so much better than Latvia is not clear. One answer is that its exports grows faster, but that begs the question of why its exports grows faster. It could simply be a coincidence related to successful companies producing mineral products and machinery and equipment (the two sectors in Estonia whose exports increased the most).

What Was Presumably Said In The Schwarzenegger Mansion

"This marriage is terminated and totally recalled because of your true lies about your infidelity".

Japan Earthquake/Tsunami Weakening Other Economies As Well

The shortage of parts from Japan is one key factor behind the very weak U.S. industrial production data published today.

British Inflation Reach Post-2008 High

Consumer price inflation in Britain rose to 4.5% in April-the highest since 2008. As a result the 2-year average of inflation rose above 4% while the 5-year average is well above 3%.

However, this year's increase is not the result of recent monetary inflation but rather the lagged effect of previous money supply increases as well as consumption tax (both VAT and excise duties on alcohol and tobacco) increases. By contrast, during the latest year, money supply growth in Britain has been slightly negative.

This means that though the annual rate might rise some more before falling, we will later this year and next year see a significant drop in British pricw inflation. And the sharp drop in real money supply that this implies is anything but bullish for the oulook of British growth.

An Alternative View Of Standard Oil

Alex Epstein has an article about John D. Rockefeller's Standard Oil where he presents facts which if true (which they most likely are, though no sources are presented) certainly refutes the common view of it as parasitical monopolists whose profits were earned at the expense of others.

IMF Boss Attempted Rape Charge Will Directly Only Affect France

As almost all of you no doubt have already heard, IMF boss Dominique Strauss-Kahn has been jailed in New York accused of attempted rape.

I don't know whether he is guilty or not, though most evidence presented so far indicates that he is probably innocent. At any rate though, it is really only France that is likely to be directly (indirectly other countries will however of course be affected by what happens in an economy as large as that of France) affected by this, because unless hard evidence that Strauss-Kahn was deliberately framed appears, his bid to become President of France next year is over.

By contrast, the rescue packages of Greece, Ireland and Portugal aren't likely to be affected because Kahn-Strauss' views on this matter don't differ significantly from the views of others within the IMF.

Yuan Use Increases In Hong Kong

Interesting story here about how the yuan is increasingly used in Hong Kong, creating troubles both for Hong Kong and mainland China.

With the Hong Kong dollar strictly pegged to the U.S. dollar while the yuan gradually appreciates, it seems that the only reason why anyone in Hong Kong would want to have their savings in Hong Kong dollar accounts is the expectations that the peg won't last and that the Hong Kong dollar will be revalued and pegged to the yuan instead.

Ultimately, I believe that this will happen, as a first step towards the inevitable ditching of the Hong Kong dollar replaced by a monetary union between Hong Kong and mainland China. The only question is when this will happen. Despite the clear economic irrationality of the U.S. dollar peg, Hong Kong politicians seems to want to postpone change for as long as possible. However, an increased use of the yuan in capital markets as investors want to benefit from the appreciation of the yuan could force Hong Kong politician to move sooner than they want.

Growth Numbers Can Be Confusing

Dean Baker makes a point similar to the one he has made in the past and that I have also made repeatedly in the past (for example here), namely that it is misleading when European quarterly growth numbers are reported in American press without annualizing them.

Hence, some readers might mistakenly believe that America has stronger growth than Germany because it's quarterly growth was reported by the media as 1.8% while Germany's was reported as 1.5%. But in reality German growth was far stronger because the American number was the annualized quarterly change while the German number was the nonannualized quarterly change. Expressed in the same way, growth in Germany was 1.5% in non-annualized terms while America's was 0.45%, and expressed in annualized terms Germany's growth was 6.1% while America's was 1.8%.

Baker correctly points out that the media's reporting of European and American growth numbers is as misleading as if American media would tell its audience that the temperature was 20 degrees in Europe on some July day, creating the false impression that Europe had freezing weather in July because 20 degrees Fahrenheit (the equivalent of -7 degrees Celsius) represents freezing weather, or if European media similarly would tell its audience that New York in December has temperatures of 30 degrees, creating the misleading impression that New York had hot summer weather in December whereas in reality 30 degrees Fahrenheit (the equivalent of -1 degree Celsius) is slightly below the freezing point.

One can wonder why financial journalists are less aware of the need to translate the different ways of Europe and America in expressing growth than weather journalists are of the need to translate the different ways of Europe and America in expressing temperatures.

Yet even Baker misleads unintentionally his readers about the German growth numbers because he commented the yearly increase of 4.9% that was also reported by saying it probably represented some seasonally adjusted version of the quarterly change. Had he read the original press release from the German statistical office, he would have known that the 4.9% number reflected the change between Q1 2010 and Q1 2011, whereas the 1.5%/6.1% numbers reflected the change between Q4 2010 and Q1 2011.

Germany Has Now Recovered Fully From 2008-09 Recession

Numbers released today showed strong growth from Germany, with GDP rising 4.9% in adjusted terms compared to a year earlier and 1.5% (6.1% at an annualized rate). Some of this quarterly growth represents, like in Britain, a bounce back from the weather depressed fourth quarter, but unlike in Britain, who had zero growth between Q3 2010 and Q1 2011, Germany's GDP grew a total of 1.9% during this period. So the German economy is definitely a lot stronger than the British

And unlike the British economy whose output remains significantly below pre-crisis levels, Germany had in the first quarter finally recovered all of the output reduction during the 2008-09 recession. And unlike some other economies that did that already the previous quarter, like Sweden and the United States, Germany has had slightly negative population growth, meaning that per capita income is unlike in Sweden and the United States already above pre-crisis levels. That is one of the reasons why Germany is one of the few countries that has an unemployment rate below pre-crisis levels.

MZM Rises Above $10 Trillion

My prefered measure of money supply in the United States, Money of Zero Maturity (MZM), rose above $10 trillion for the first time ever. During the latest 12 months, it is up by 6% while during the latest 3-month period it is up by 2.5%, which translates into an annualized rate of more than 10%.

Whether this high rate of increase can be sustained once QE2 ends (in the sense of no more expansion, not in the sense of reversal) remains to be seen.

Meanwhile, official consumer price inflation rose above 3% for the first time since 2008.

Demand Drops Following Oil Price Gain

As I've written repeatedly in the past, the price elasticity of demand (and supply) increases as time passes. In the short run, people may not have a choice in changing driving patterns or changing from SUV:s to hybrids, but after a while that happens. And furthermore, the higher oil prices will generally with a few months time lag weaken most economies, reducing demand.

Also, physical constraints may prevent oil producers from immediately increasing production, but in the medium term some new oil may be released where spare capacity exists. And in the longer term, higher prices will increase total capacity and thus total supply.

We see now the first signs that the great oil price schock earlier this year caused by the war in Libya in combination with QE2, has started to reduce demand, something that in turn is helping to reduce the increase in oil prices.

Weaker Dollar Causes Short Term Trade Deficit Increase

The U.S. trade deficit rose to $48.2 billion in March-the highest since late 2008. Note that this happens after a dramatic weakening of the U.S. dollar's exchange rate.

This may be surprising to some as we hear all the time from various pundits that a weaker dollar will "solve" the trade deficit. The truth is that this only happens under special conditions and even then only in the long-term.

The special conditions I am referring to is that the currency weakness can't be the result of inflationary monetary policies. Inflationary monetary policy discourages savings while encouraging investments, two effects which will both increase the trade deficit and which will cancel out the exchange rate's deficit reducing effect.

Furthermore, even when the exchange rate falls for some reason unrelated to monetary policy the deficit will be reduced only in the long tern. In the short term, the effect of a weaker currency is usually to increase the deficit because import prices jump faster than export prices while volumes haven't yet been affected in a significant way. The increase in the trade deficit in the last few months is a good example of this as it is almost entirely the result of oil becoming more expensive (Though for the latest month, Libya was the key factopr driving this).

Because of the effect on the incentives for savings and investments and because of the short-term price effect, it seems certain that the increase in the trade deficit is in fact the result of the Fed's weak dollar policy. Later during the year, as the effects of the exchange rate on volumes begin to kick in, this net increase effect will largely dissipate.

UPDATE: A reader points out that I overlooked that there was a temporary spike in the trade deficit in June 2010 to $49.9 billion. Especially considering that it was only a temporary spike (it fell back to $42.2 billion the next month) , this doesn't however really affect the point of this post.

Why Tax Revenues Often Don't Reflect Economic Growth

Caroline Baum argues that economic growth in the U.S. is underestimated by the official GDP numbers.

Her arguments aren't that convincing though. When she for example argues that the defense spending decline reported contradicts other reports, she seems to have missed that the other report was a forecast from March, not an estimate based of available data.

Other arguments are somewhat contradictory as she first claims that individual income tax receipts are a good way of measuring labor income and then overlooks corporate income tax receipts (which rose only 4%) when estimating corporate profits.

As it happens, there are at least two reasons why the change tax receipts may differ from economic growth. First of all, tax laws may change. And that was indeed a reason why individual income tax receipts rose sharply as the "Making Work Pay" tax credit expired and it was also the reason why social insurance tax receipts fell as the payroll tax was reduced.

Another reason is that in a system with progressive taxation, an increase in inequality will increase tax revenues relative to GDP because the incomes of the rich which face higher tax rates rise relative to the incomes of everyone else. A decrease in inequality will of course for similar reasons reduce tax revenues relative to GDP.

If you make the reasonable assumption that inequality has increased following QE2, then economic growth is a lot lower than the increase in tax revenues.

Wanting To Repeal Laws Of Arithmetic Isn't Foolish?

Paul Krugman now writes that it is wrong to blame the voters for the American budget mess. That sure is a big change of mind, as he less than 3 months ago wrote that a large majority of voters in effect wanted to repeal the laws of arithmetic by at the same time opposing tax increases for them, opposing spending cuts in almost all programmes and wanting to eliminate the $1.5 trillion deficit immediately.

Krugman is also wrong in asserting that the Bush tax cuts for the wealthy and the war in Iraq are key factors behind the deficit. The upper income tax cuts costs just $70 billion per year even assuming a static analysis (no effects on behavior) while the cost for the Iraq and Afghanistan wars was $160 billion, and these days, Afghanistan operations costs more than half of that $160 billion. Ending the Bush tax cuts for households earning more than $250,000 and withdrawing from Iraq would thus reduce the deficit by less than a tenth.

Krugman would perhaps argue that the total cost of the Bush tax cuts was a lot more, but that's only if you include the middle class tax cuts, and those cuts are unlike the upper income tax cuts very popular.

The Obama Non-Recovery

This graph over the employment to population ratio, the most relevant measure of labor market progress since it takes population growth into account and since it includes hidden unemployment illustrates just how pathetically weak (nearly non-existent) the recovery in the U.S. has been:

Contrast this with the recoveries from the other two really deep post-World War II recessions, the ones in 1973-75 and 1981-82.  First the recovery beginning 1975:

And here's the recovery beginning in 1983:

Thus, in the 2 first years of recovery from the 1973-75 recession, most of the losses had been recovered while in the 2 first years from the 1981-82 recession, all of the losses and more had been recovered. But despite the fact that the losses in the 2007-09 recession were even greater, almost none of it has been recovered.

This doesn't by itself disprove the contention made by Obama supporters that conditions were much tougher this time and that without Obama's policies things would have been even worse, or the contention made from people to the left of Obama, like Paul Krugman, that Obama erred in not pursuing his policy of increased deficit spending even more boldly. But it does show that the current recovery has been extraordinarily weak and that Obama has failed to prevent this weakness.

Americans Better Be Careful About Picking Up Pennies On The Street

Doing so will violate federal minimum wage laws if it including putting it in your purse takes more than 6.15 seconds, Ezra Klein points out.

The fact that picking up pennies on the street might be illegal illustrates the irrationality of either minimum wage laws or the continued existence of pennies after inflation has reduced its value to significantly below the cost of producing it-or in my opinion both.

UPDATE: On second thought, I think Klein overestimated how long you can take in picking up a penny. The current minimum wage is $7.25 per hour, or 725 pennies per hour. And as an hour is 3600 seconds (60 seconds per minute times 60 minutes per hour),  this means that minimum wage laws says that you must have a penny every 4.97 second. 5 seconds to pick up a penny is thus enough to violate the federal minimum wage laws.

U.S. Employment Surveys Diverge More And More

Today's U.S. employment report was quite weak -or relatively strong depending on whether you focus on the household survey or payroll survey.

The household survey showed a net job loss of 190,000, causing the employment rate to drop from 58.5% to 58.4%. It is now in fact lower than the 58.7% in April 2010 as the 0.2% employment gain is a lot lower than the population increase. Meanwhile, the unemployment rate rose from 8.8% to 9% during the latest month. And while that is lower than the year before this is entirely and more due to a drop in the labor force participation rate.

The payroll survey by contrast showed a relatively strong gain of 244,000 for the month and a 1% gain during the latest year, with the numbers looking even stronger if you only look at private sector employment. The only thing that was weak was that the gain in nominal wages was so small that real wages likely declined.

There has always been some divergence between the two surveys, but it is unusual that the payroll survey shows as much as 0.8% more job growth during the latest year.

Since the two surveys are supposed to describe the same thing and since there can only be one truth about that thing, this means that at least one of them is wrong. The payroll survey is regarded by most economists, including me, as more reliable when it comes to describing monthly changes, so the truth is probably a lot closer to the payroll number about the latest month. However, that the household survey was so weak indicates that it is more likely that the payroll survey overestimated than underestimated the increase. Furthermore, when it comes to yearly changes the household survey is more reliable than it is for monthly changes, making it even likelier that the payroll survey during the latest year greatly overestimate job growth

Why Money Isn't Irrelevant

Matt Rognlie attacks monetarism and more broadly the belief that money matters, which Austrians also believe indeed, even more so than the so-called monetarists. I am more of an Austrian than a Friedmanite, so I feel no need to defend Friedman's theories, but I do want to defend the idea that money matters.

In his first paragraph he argues that the traditional monetarist accounting identity MV=PY, where M is money supply, V is "velocity" and PY is nominal output, is a tautology. That is sort of true since V is defined as PY/M, or in other words the number you get when you divide nominal output with money supply, and the equation is then created by multiplying both V and PY with M. However, to the extent it highlights that money demand and money supply both influence inflation and growth, it is more than just a tautology.

In his second paragraph he claims that because V isn't entirely stable since money supply growth and nominal GDP growth sometimes differ, nominal GDP growth "does its own thing" which I assume means that neither money supply nor money demand influences. But that doesn't follow at all. All it shows is that M=PY would be an incorrect assumption, and that money demand also matters. The reason why there is V is in fact because M is not equal to PY. If V had been stable by contrast, it would have been more useful to formulate it as M=PY, but since it's not, we formulate it as MV=PY.

He later argues that nominal interest rates is sufficient in considering whether monetary conditions are "easy" or "tight". But that is not true because nominal interest rates can be low for very different reasons, including:

1) Low inflationary expectations (including expectations of deflation).
2) High savings rate
3) Low investment demand
4) Falling demand for money
5) Higher supply of money

This is very relevant since this illustrates the difference between the low nominal interest rates that we saw in the U.S. during the housing bubble, which was a result of factors 4 and 5, and the low nominal interest rates that we saw in Japan during that same period which was a result of factors 1 and 3. In the cases of 4 and 5, the result is as we saw in the U.S. price inflation, including asset price inflation, in the cases of 1,2 3 by contrast there will not be any price inflation, as we saw in Japan.

Fed Policy Causing Arab Revolts

In this article Andrew Lilico at The Telegraph shows a strong correlation between the Fed's QE2 and global food prices.

The fact that the food price boom started before QE2 might lead some to deny the link, but this overlooks that the mere expectation of QE2 caused commodity prices to rise and that the drought in Russia that raised wheat prices had only a transitory effect which should have faded out long ago.

The sharp increase in food prices, which hurts poor people disproportionately as they spend a much larger share of their income on food, likely contributed to the Arab uprisings which have toppled the governments of Egypt and Tunisia (it is still unclear just what will replace them) while causing widespread violence in Syria, Yemen and Bahrain and starting a war in Libya

More Chinese Realize That Currency Policy Fuels Inflation

I have long maintained that China should let the yuan increase in value against the U.S. dollar-not primarily for America's or any other foreign country's sake. but for its own sake as the current policy of a semi-peg to a weak currency fuels high inflation.

According to this article,.this realization is spreading in China. So far however, it has not spread enough to bring on a sufficiently great policy change.

The Case For Getting Quebec Out Of Canada

An English speaking Canadian reader of my blog agrees with my comments about the Canadian election results and offers the following very interesting supporting arguments for my view that Quebec should be separated from the rest of Canada:

I very much agree with your point about English speaking Canada declaring itself independent from Quebec. I've been saying that for ten years since I read Read Scowen, Time to Say Goodbye: the Case for Getting Quebec Out of Canada (1999) (the 2nd edition had a new subtitle: Building a Better Canada without Quebec). Pierre Trudeau's Liberals entrenched a policy of funnelling massive transfer payments through the federal government to Quebec. To appear fair, they are also made to other smaller, have-not provinces but half of the total goes to Quebec. With these massive transfer payments, Quebec has developed the so-called "Quebec model" of economic development, which looks exactly like 1970s era Western European socialism. Quebec, awash in money mostly transferred from the wealth-generating provinces, then looks down its nose at the Rest of Canada (ROC) as having a more "progressive" distinct society. But they could never afford to be so spendthrift and avoid dealing with their own economic stagnation without the other provinces' money. This has been the galling situation since the mid-1960s. And then they regularly threaten to separate if they don't get even more federal money.

I've said for ten years that, the next time Quebec has another referendum to separate from Canada (which I think is just a treat to get more from Canada and not a serious option in their collective mind), I want the ROC to vote on the question, too, and to vote for separation. And it's a serious position. There need not be civil war, as some people warn, in order to accomplish separation. How about the Norway referendum of 1905 or the Saar Treaty of 1956? Peaceful transition is possible. And so long as free trade is maintained between the two new nations the economic dislocation during the transition can be minimized. Of course, Quebec would lose the transfer payments but that's the price of being distinct.

By the way, although Quebec gets more than half of the transfer payments from the federal government, the same economic distortions from large subsidies afflict the other recipient provinces. There's a good book that analyzes the economic deleterious affects of this transfer policy by Brian Lee Crowley, Fearful symmetry : the fall and rise of Canada's founding values (2009)

Good News From Canada

Stephen Harper's Conservative Party won a majority of seats in the Canadian parliament, meaning that they won't have to rely on minority support anymore.So far, their minority-rule has been somewhat imperfect, but hopefully (but unfortunately not necessarily) they will improve now that they won't have to compromise anymore.

However, the best thing isn't really that the Conservative Party won, but that the left-wing New Democratic Party lost. It's policy of broad based tax increases would have hurted the Canadian economy, as would its environmentalist limitations on oil extraction. In a time of high oil prices, the latter would have been especially harmful for those of us who aren't Canadians.

I note BTW that support for the New Democratic Party to a disproportionate extent came from French speaking Quebec. For decades there has been a movement in Quebec to declare it independent from Canada. Perhaps the time has come for the rest of Canada should declare itself independet from Quebec.

About Hayek's Comments On Sweden

A reader asked me to comment on Friedrich Hayek's 1977 comments about Sweden in a Reason Magazine interview, re-published on Brad DeLong's blog. Here is the relevant part:

Reason: If big government is really the culprit, why do Sweden and many Scandinavian welfare states seem to be prospering?

Hayek: Well, we mustn't generalize. Sweden and Switzerland are the two countries which have escaped the damages of two wars and have become repositories of a large part of the capital of Europe. In Switzerland, there is still some traditional instinct against government interference. Switzerland is a marvelous example where, when the politicians become too progressive, the people hold a referendum and promptly say, "No!"

Reason: Yet Sweden is reasonably successful...

Hayek: Yes. But there is perhaps more social discontent in Sweden than in almost any other country I have been. The standard feeling that life is really not worth living is very strong in Sweden. Although they can hardly conceive of things being different than what they're used to, I think the doubt about their past doctrines is quite strong...

I didn't even exist in 1977, so I have obviously no personal experience of "the standard feeling" in Sweden in 1977, but judging from what I've heard from my parents and others that did live in Sweden in 1977, I am quite sure that the situation wasn't anywhere near as grim as Hayek claimed it was. Sweden was one of the richest countries in the world then and people in general clearly felt that life was worth living and there wasn't more social discontent than elsewhere. As for "doubt about past doctrines" I am not sure just what "doctrines" he is talking about.

A far better to Reason's question would have been the one that I gave here a few years ago, and that in short was that Sweden's success came in the 1870-1950 period when Sweden was a relatively free economy that managed to stay out of the wars that devastated much of Europe. By the 1970s, Sweden was still relatively rich thanks to the massive progress in the 1870-1950 period, but by then the increasing socialism had caused growth to fall to lower levels than most other countries.

Bin Laden Was Already A "Has-Been"

Markets reacted to the killing of Osama bin Laden by raising the price of stocks while lowering the prices of silver, gold, oil and the yen. Presumably, the markets thinks that his death will reduce the terror threat significantly.

But while bin Laden deserved to die and while to the extent this makes any difference it is definitely good news, I really don't think it will make any significant difference in practical terms (in stopping terror), though it will to many have great symbolic value as an act of justice and revenge.

The reason why it won't make much difference in terms of stopping jihadist terror is that because bin Laden knew that so many governments intelligence agencies were looking for him, he had only a very limited ability to communicate with the outside world.

Al-Quaeda have for long been highly decentralised and its cells around the world have been working entirely or almost entirely without his involvement for the past few years so their ability to carry out terrorist acts will not be significantly reduced by his death.