Statistical Notes Wednesday August 31

-Poland saw its GDP grow 4.3% in the second quarter compared to the same period last year, with the annualized quarterky growth being almost the same (4.4%).

-Canada saw quarterly growth fall from 0.9% (3.6% at an annualized rate) to -0.1% (-0.4% at an annualized rate). Taking terms of trade into account improves the picture somewhat, but even then it is clear that the Canadian economy slowed dramatically in the second quarter.

-Spain's current account deficit in June fell to €2.0 billion, from €3.6 billion in June 2010. For the entire first half, the deficit fell from €29.7 billion to €26.3 billion.

-Estonia's boom continues as retail sales in July increase 4% in real terms compared to the previous year and industrial production the same month increases 4.7% compared to June and 22.9% compared to July 2010.

Retail sales in Latvia also increased in July, by 1.8% in real terms compared to June
and by 6.4% compared to July 2010.

-Yearly growth in the Philippines slowed from 4.6% in the first quarter to 3.4% in the second quarter.

-India's GDP growth slowed to 7.7% from 7.8%.

-Israel's labor market continues to strengthen as its unemployment rate fell from 6% in the first quarter to 5.5% in the second quarter, while the employment rate rose from 54% to 54.3% during the same period.

Marketwatch's Misleading Article On Sweden

Marketwatch reporter Polya Lesova has an article on the Swedish economy. Most of what it mentions is correct, but it leaves out the most significant aspect of recent Swedish economic development and is therefore misleading.

The aspect that is omitted is the supply-side, free-market reforms to taxes and social benefits that have been implemented in recent years.

Statistical Notes Monday August 29

-The latest U.S. national accounts report was mixed as GDP growth was revised down 0.3 percentage points, while Gross Domestic Income was revised up.

The durable goods order report was also mixed as the overall number increased, while core capital goods fell. Similarly, real disposable income fell, but because of a big drop in savings, real consumer spending rose.

Meanwhile, initial jobless claims rose.

-Swedish growth shows signs of slowing as real retail sales growth slowed to 1.1%. Meanwhile, money supply fell by 1.9%.

-Annual euro area money supply growth fell from 1.2% to 0.9%. However, the 3- and 6 month change increased somewhat.

Meanwhile, real growth seems to be weakening as both construction spending and factory orders fell.

-GDP growth in Lithuania was upwardly revised from 6.1% to 6.3%.

-Hong Kong's retail sales boom (driven by both domestic consumers and tourists) continued, with retail sales gaining 29.1% in nominal terms and 22.4% in real terms.

A Reminder Of Why Natural Disasters Are Economic Disasters

Eastern United States have -or are soon about too- been struck by two natural disasters. First, an earthquake and now Hurricane Irene. Considering that some Keynesians argue that from a purely economic point of view such events are good, read Art Carden's article that reminds us of why natural disasters are economic disasters too.

The Economy Is Not Like A Sports Game

A good example of a zero sum game is a sports game. In every match or tournament, every team's (or player's in individualist sports like tennis or golf) success comes at the expense of other team's. There can only be 8 teams that for example make it to the quarter finals in the World Cup, meaning that the other 8 teams in the group stage must by necessity lose. And of the 8 teams that made it to the quarter finals, only 4 can make it to the semi finals, meaning that the other 4 teams must lose. And only 2 of the 4 teams in the semi finals can make it to the final, meaning that the other 2 must lose. And in the final, only one team can win while the other must lose.

Now left-liberal blogger Matthew Yglesias thinks that this is a good analogy for the economy. He argues that Estonia's success in turning its economy around can't be replicated in all the other countries with deep economic problems because there is supposedly only a "finite level of demand" that nations are competing for, and that therefore Estonia's success has been achieved at the expense of others, just like victories in sport championships are achieved at the expense of other teams.

There are 3 reasons why this is wrong. First of all, though it is true that trade- and current account balances are zero sum games on a global level it is certainly not one at the Euro area level as the Euro area is only a limited part of the world.
And furthermore, reductions in external deficits in for example Greece and Portugal or increases in the Estonian surplus can be achieved by reductions in the large surpluses of for example Germany, Holland and Finland.

And secondly, Estonia's 8.4% growth has not been achieved through higher net exports. In fact, Estonia's trade and current account surplus has been somewhat lower this year than the previous year.

And thirdly and perhaps most importantly, it is not true that there is only a finite level of demand and that economic growth is therefore a zero sum game. When new productive activities are performed, it is not just supply but also demand that increases. That is why "aggregate demand" always increases during for example periods of technological progress, and that is also why for example the strong increase in exports in Estonia has been associated with just as strong (in fact, slightly stronger) increase in imports.

That is why following the Estonian role model would be good for Greece, Portugal, Ireland, Italy and Spain-and why that would help and not hurt the rest of Europe as well.

Fraud That Is Similar To Reality

Apparently someone opened a false Google+ account (it has now been deleted, either by the person that created it or by Google when they found out it was fraudulent) claiming to be Paul Krugman and there wrote that:

People on twitter might be joking, but in all seriousness, we would see a bigger boost in spending and hence economic growth if the earthquake had done more damage.

But we don't need fraudulent pages to establish that Keynesians think destruction caused by earthquakes can be a good thing for the economy. Larry Summers did in fact say just that in a genuine TV-appearance about the eqarthquake in Japan.

And indeed, as Carlos Graterol, the person that claims to be responsible for the false page, writes, Krugman have himself really written and said some vary similar things about the earthquake in Japan and about the 9/11 attacks.

Why Inflation Numbers Aren't Always Comparable

Often people (admittedly. even I have occasionally in the past sometimes done it) calculate relative real appreciation of currencies by adding the nominal exchange rate change with the inflation differential (or, more correctly mathematicaly, by multiplying 1+the nominal exchange rate change with 1+the domestic inflation rate divided by 1+the foreign inflation rate). That is however often misleading for several reasons.

First of all, the methodology used isn't always the same, as different countries use various adjustments designed to lower the reported inflation rate, such as "chain-linking" and "hedonic adjustment" to different extent.

And secondly and perhaps even more importantly, the goods and services that are part of the consumer price indexes and the relative weight of the different goods and services tend to differ.

For example, alcoholic beverages are a few percent of the consumer price index in most countries, but in for example Saudi Arabia and Iran they are absent. And while food is a part of all consumer price indexes in all countries, they are a much higher percentage of the index in third world countries because people there spend a lot higher percentage of their income on food. This is one of the reasons why soaring prices of food commodities raises inflation rates in poorer countries more than in richer countries.

The other reason why higher prices of food commodities raises inflation more in poorer countries is because food purchased in poorer countries are processed in food factories to a much lower extent. In poor countries, people usually buy only raw rice or potato or other food commodities, meaning that higher prices of food commodities raises food prices for consumers as much or almost as much. By contrast, in richer countries, consumers usually often buy food items that have to varying extent been prepared or processed in food factories- or in the supermarkets or restaurants. The production cost of food in richer countries therefore too a far larger extent include non-commodity components like the labor cost of those that prepare or process the food. As a result, higher food commodity prices raises food prices a lot less in richer countries than in poorer countries.

A 20% increase in food commodity prices therefore increase consumer food prices by perhaps around 15% in poorer countries but perhaps by say only 5% in richer countries. And because food is perhaps 40% of the consumer price index in poorer countries but say only 15% in richer countries, the increase in the overall consumer price index from the increase in food commodity prices will therefore be 6% (0.15*0.4) in poorer countries but only 0.75% (0.05*0.15) in richer countries.

Note that this differential arose despite assuming identical prices of identical food goods, meaning that even if one assumes that "the law of one price" holds fully, that data collection is flawless and that the same methodology for calculating consumer price inflation is used, increases in the prices of commodities will have greatly different effects on official consumer price inflation in different countries.

But because the law of one price is assumed to hold, this inflation differential will not have any effect at all on "ralative competitiveness" or trade flows. Thus, the fact that for example reported consumer price inflation in China is a lot higher than in the United States, probably doesn't mean that the cost of specific items have risen more, and that thus, the "relative competitiveness" of the U.S. hasn't improved much more than the nominal exchange rate depreciation (And if you also take the Penn effect into account, it might have increased less).

Why Inflation Doesn't Necessarily Benefit Debtors

One common argument for more inflation is that it helps debtors by reducing the real burden of debt. And because reducing the real burden of debt supposedly makes it easier for debtors to repay their debt, inflation might not be so harmful even for creditors as the direct loss from inflation is to a large extent compensated for by a reduction in formal credit losses.

There is a limited degree of truth in this as it is possible for inflation to benefit debtors if it doesn't reduce real income. Assuming a positive, non-existent or only marginally negative effect on real income, inflation does benefit debtors. However, this assumption is often not applicable.

That most economists see the positive effects of inflation for debtors as something that is obviously and universally true comes from their implicit adoption -in this context- of the naive monetarist view of inflation. The naive monetarist view of inflation is that if you increase money supply by x% then all prices and everyone's nominal income will increase by exactly x%.

But that is not how the inflation process works in the real world. In the real world, some prices increase faster and quicker than others, while some prices aren't affected at all. Exactly which prices increases and which prices don't, and how much specific prices increases depends on the specific circumstances of each time and place, but generally speaking, prices of things that are traded in financial markets (like commodities) increases more and sooner than other because they are the most flexible ones, while more rigid prices including in most cases wages increase less and later.

But what does that insight have to do with the issue of the effects of inflation on debtors? The answer is that if the prices of necessities like food and fuel increases while the debtor's income is flat, the debtor will have less, not more money, for debt service payments, meaning that inflation will in this case reduce the ability to handle debt.

If someone has say $200 per month left after debt service payments and all necessities and bills are paid, and if the cost of living then rises by $400 while income is unchanged, then it is obvious that it will be more, and not less difficult to meet debt service payments.

Or assume that oil prices rises substantially. This will certainly raise the rate of price inflation in for example Greece, but because this means that the Greeks will have less money for other things (Greece is an oil importer), including debt service payments, the Greek debt crisis will worsen.

Even if nominal income increases, inflation might still increase the burden of debt if the increase in the cost of payments except debt service payments is greater. Thus, inflation will make it easier for debtors to handle their debts only if it increases their nominal income more than it increases the nominal cost of non-debt service payments. If not, inflation might make it more difficult for debtors to handle their debt.

That condition will be met for most people in the world as a whole, but for a substantial minority of people including majorities in some countries it will not be met. And the people who see a big real increase in income from inflation may not be debtors.

English Isn't Always Like English

As I discussed about 3 years ago, the language in Britain and America are more or less, but there are some differences. This includes the pronounciation of certain words like "can't" (this is of course not noticed in written form), as well as the spelling of some others like "labo(u)r" (this is of course not noticed in spoken form) as well as different words for certain things like gasoline/petrol and different meanings of certain words, like "football".

At the NRO Corner blog, Jay Nordlinger has a few more examples of the latter of a more hilarious kind than "football". My favorite example was that of the English man who asked an American woman whether he could "knock up her tomorrow". By that he meant to ask her whether he could come by and knock on her door tomorrow, but the American woman likely thought that he meant something very different.

The Big Money Demand Surge

Though it fell back the latest reporting week, MZM has still increased sharply lately, being up 14.5% at an annualized rate the latest 3 months (13 weeks), up 13.3% the latest 6 months (26 weeks) and up 9.2% the latest year. For M2 the increases were even greater (13 weeks 24.9%, 26 weeks 14.8%, 52 weeks 10.2%) and for M1 greater still (44.9%/27.2%/20.5%).

Yet recently, we have seen the prices of commodities except for gold drop sharply, as have stock prices. How is that possible? Because the fear of a U.S. recession and the European debt panic have sharply increased demand for money and for Treasury securities which are perceived by investors as being as safe as money.

The money demand increase until a month ago or so was not strong enough to counteract the increase in money supply caused by QE2, so until recently stock prices and commodity prices all soared while the dollar fell, meaning that the money supply increase caused the value of money to drop. But the fears of a weaker economy has caused money demand to spike, something that can only mean two things: Either money supply increase or the value of money increases. The latest month we have seen a combination of the two.

Note that an increase in money demand can increase money supply. When stocks are perceived as too risky and when the yield difference between Treasury securities and bank accounts (where interest rates have been zero or nearly zero for a long time) fall, this leads more people to increase their holdings in bank demand or savings accounts. If you're getting no extra interest (or lower risk), then why reduce the availability of your savings by holding it as something other than bank accounts that can be used as means of payment?

Statistical Notes Thursday August 18

-The British emplyment rate was unchanged at 70.7% in April-June compared to the previous 3-month period. A big increase in the number of people on unemployment benefits in July followed by increases in previous months suggests that labor market conditions have worsened since.

Nominal wages increased at a somewhat faster rate, but at 2.6% it is still way below the inflation rate of over 4%, meaning that real wages continues to fall.

Meanwhile, real retail sales in July increaed 0.1% compared to the previous month while being unchanged compared to July 2010.

-Most economic indicators suggests that economic conditions weakened considerably in the United States in August, including a big drop in the Philly Fed manufacturing index and an increase in initial jobless benefits claims.

Meanwhile, consumer price inflation in July was relatively high, with the CPI increasing 0.5% compared to the previous month and 3.6% compared to July 2010. The big recent drop in oil prices means however that price inflation likely fell in August.

-German employment growth remained at 1.4% in the second quarter. The recent slowdown in economic growth was however visible in a slowdown in the rate of increase in hours worked per employee, from 1.2% to 0.2%.

-Latvia's employment growth wasn't quite as impressive as neighboring Estonia's, but still strong at 3.3%. And because Latvia's population is declining at a rate of more than 1%, employment relative to population increased by 4.4%. As a result, the unemployment rate fell from 19.4% to 16.2% despite an increase in the labor force participation rate.

-Hong Kong also saw rapid employment growth, 3.9%, with full time employment increasing even more. As a result, the unemployment rate fell to 3.4%.

The Real Problem With Krugman's Alien Remarks

I have read on some other blogs and been contacted by readers of this blog about Paul Krugman's remarks on CNN that if we started a massive military spending increase to protect us from a possible threat from an invasion by space aliens, then that would end our economic problems. Some have discussed this with the hinted or explicit interpretation being that Krugman believes that we need a massive increase in military spending because the threat of an invasion by space aliens is so great.


But that is a very misleading interpretation. Krugman doesn't in fact say that spending increases are needed to stop space aliens from taking over this planet. In fact in his hypothetical scenario he says that we will eventually discover that the belief that it was necessary was a false alarm, yet discover that the false alarm was good for the economy as it caused us to increase government spending. What he says is simply then the classic Keynesian principle that any spending is good, even if it is for such obviously useless purposes like digging up holes in the ground and then filling them up again (Lord Keynes' classical example) or prepare defenses against non-existent threats from space aliens (Krugman's new example).

The problem is thus not that Krugman exaggerated the threat from space aliens as he didn't do it, just as I haven't exaggerated the chanse of trade relations with space aliens when I have pointed out that an aggregate trade surplus or deficit for the world as a whole is impossible unless we start trading with space aliens.

The problem is instead first of all that he overlooks the lessons from the "broken window fallacy" and secondly that production of useless or unnecessary things are well, useless and unnecessary meaning that even if total production was increased it wouldn't be a good thing. Since it doesn't do any good, we might as well have handed out the money to the workers who were supposed to do these useless things without the useless things being actually performed, meaning that it makes no sense to view these useless activities as progress.

Statistical Notes Tuesday August 16

-Consumer price inflation in Britain again accelelarated in July, to 4.4% from 4.2%.

-Industrial production in the U.S. rose as much as 0.9% in July, owing largely to increased ulitities production due to increased demand for electricity caused by unusually warm weather in parts of the country. However, manufacturing and mining also posted strong gains.

However, the Philly Fed index dropped in August, suggesting a slowdown in manufacturing in August, and the housing sector showed continued signs of contraction.

-According to the first estimate, euro area economic growth slowed more than expected in the second quarter to 0.2% (0.8% at an annualized rate) compared to the previous quarter and 1.7% compared to the same quarter last year.

The biggest disappointments were Germany, Holland and as previously reported France who came significantly below expectations. Spain and Italy also grew relatively slow at 0.2% and 0.3% were also weak, but no more than expected. A few euro area countries did however grow relatively strongly. Apart from Estonia, the highest growth was seen in Finland (1.2%), Austria (1.0%), Slovakia (0.9%) and Belgium (0.7%).

The weak number for Germany in particular is likely to put to rest the prospect of further ECB interest rate increases and further illustrates that particularly the last one was a mistake.

-Swedish second quarter growth was relatively fast (1.0% compared to the previous quarter), but falling June industrial new orders and production suggests that growth will be a lot lower in the third quarter.

-GDP in Japan contracted for a second straight quarter. The contraction is of course mainly attributable to the earthquake/tsunami that struck Japan in March. The strong yen and weakening economies abroad may however mean that the recovery will be slow or non-existent.

-Israeli GDP growth also slowed, but was a still decent 0.8% (3.3% at an annualized rate) compared to the previous quarter and 5% compared to the same quarter last year.

Meanwhile, the increased campaigns against a rising cost of living helped push down consumer price inflation to 3.4% in July from 4.2% in June.

What A Recovery Should Look Like

In another sign of how strong the boom in Estonia is, employment rose as much as 7.8% in the year to the secpnd quarter, helping to push unemployment down to 13.3%, compared to 18.6% a year earlier.

Unemployment is still unacceptably high, but it is being brought down remarkably fast, and if this continues it will fall below the EU average within the coming year.

Why Different Outcome To Austerity?

In the debate over the effects of fiscal austerity on growth, all sides can point to examples that seems to help their case.

Those who argue that deficit reduction can help growth can point to the Baltic states who pushed through even tougher measures than for example Greece and Portugal, and who are now booming, with Estonia seeing GDP increase 8.4% compared to a year earlier, Lithuania 6.1% and Latvia 5.3%.

On the other hand we can see that growth in for example Britain and Portugal has slowed considerably, and in Greece we have seen a 6.9% contraction the latest year (that came after a 4% contraction in the year to Q2 2010).

How can this difference be explained? Floating exchange rate advocates often claim that a floating exchange rate is vital for successfull fiscal consolidation but that is clearly not a theory supported by these facts as the Baltic states have all had fixed exchange rates to the euro, with Estonia recently formally adopting the euro as currency. There are 3 explanations.

The first is initial position in the business cycle. The Baltic states had in 2009 suffered a full blown depression with GDP dropping around 20% and unemployment increasing to nearly 20%, while Greece in 2009 had only had a very mild contraction, with countries like Britain and Portugal coming in between. Most of the malinvestments had been cleaned out in the Baltic states, while the process had only started elsewhere.

The second is the type of austerity implemented. While all countries had a mix of tax increases and spending cuts, the Baltic states had more emphasis on spending cuts while Greece had a big emphasis on consumption tax increases that hurted the competitiveness of its vital tourist industry

The third and perhaps most important factor is the response of the population. The prospect of no longer being able to live at the expense of others through the state have provoced large parts of the Greek population to act as spoiled cry babies in adult bodies in the form of riots and strikes that have scared away tourists and in other ways crippled the Greek economy, thereby only greatly aggravating the economic suffering of the people in Greece. As I've written before, if the purpose of the riots and strikes was to prevent their standard of living from falling, then the response of the Greek protestors was about as smart as turning up the heat because you think it is too warm.

Milder versions of this has also been seen in Portugal and Britain (though in the most recent week, small groups of hooligans in Britain have as most of you have probably heard resorted to more violent and disruptive means).

By contrast, the people of the Baltic states have realized that the tough measures are necessary and reacted in a rational and constructive way to help improve their economies. There were no riots and strikes in reponse to the austerity measures in the Baltic states, only increased efforts to increase exports and perform other productive activities. The reward for that rational response has been the strong recovery we now see there. One can only hope that Greeks, Britons and others learn from their example.

Statistical Notes Friday August 12

-Money supply growth in the United States continued to accelerate, with M1 increasing at an annualized rate of more than 20% the 6 months (26 weeks), and M2 and MZM increasing more than 10%.

Meanwhile, the U.S. trade deficit increased as exports fell, something that if the net revision of other factors are zero will result in a downward revision of second quarter GDP.

-Employment was unchanged in Australia in July, with full time employment falling. This however follows a strong June increase, and compared to a year earlier employment is up 1.7%.

-French GDP growth stalled in the second quarter, being unchanged compared to the previous quarter and increasing just 1.5% compared to a year earlier.

-Greece performed far worse, as its GDP contracted by 6.9% compared to a year earlier.

-Estonia, by contrast, as hinted yesterday saw its economy boom, with GDP increasing 8.4% in the year to the second quarter.

-Hong Kong like Estonia saw continued strong growth, as GDP grew by 5.1% in real terms compared to a year earlier in the second quarter. This however is a lower increase compared to previous quarters.

-Machinery orders in Japan rose, indicating that Japan is recovering from its tsunami-induced slump.

An Illustration Of The Uselessness Of The Credit Rating Institutes

Which of these two countries best deserve the highest credit rating?

Country number 1, who has a budget deficit of nearly 10% of GDP, a government debt of nearly 100% of GDP, a large current account deficit and 1% growth. Or country number 2 that has a balanced budget, a government debt of 7% (no, the absence of a zero behind the 7 is not a typo) of GDP, a current account surplus and 8% growth.

Most people would probably pick country number 2, but not the credit rating institutes. They give country number 1 (the United States) AAA or AA+ ratings while they give country number 2 (Estonia) AA-, A+ or A1. The way of thinking that gave AAA rating to packages of subprime mortgage backed securities is clearly still alive and well at the credit rating institutes.

Why anyone thinks the opinions of credit rating institutes has any value at all is beyond me.

Swiss Franc Rapidly Approaching Parity With Euro

After the Fed's "AE" announcement, the Swiss franc approached US$1.40 in value, an incredible 5% gain in just one day, and more than 50% gain in less than 14 months. While the euro has during both periods also gained in value against the U.S. dollar, it too has dropped sharply against the Swiss franc, who is now rapidly approaching parity against the euro.

That is very extraordinary, given the fact that it only 14 months ago costed 1.4 francs to buy a euro and given the fact that for example a Big Mac costs nearly twixe as many Swiss francs in Switzerland to buy as one Big Mac costs in the euro area. The Big Mac is of course only one good, and can sometimes therefore be misleading in cost of living comparisons, but the OECD:s official PPP-estimate basically corrobarates this estimate as it says that the domestic purchasing power of the euro was 88% higher than that of the Swiss franc.

Given Switzerland's higher income level and the Penn/Balassa-Samuelsson-effect a somewhat higher price level could be justified. But when it is nearly double as high, the franc is clearly overvalued from a fundamental point of view.

The Fed's AE Causes Negative Real 10-Year Yield

There was no new round of "quantitative easing" from the Fed. The Fed did however implement what one could call "pledge easing" or "anticipation easing"(AE), by specifying in its statement that they would keep the Fed funds rate low until mid-2013. As a result, treasury yields fell sharply while the stock market rally (the latter has now partly been reversed).

The effect of this has thus been similar to what would have happened if there had been a new round of quantitative easing.

One interesting fact is that not just that the inflation-indexed 5-year Treasury but also the inflation-indexed 10-year Treasury has a negative yield. The spectacle of investors voluntarily paying the U.S. government to borrow is disheartening.

Statistical Notes Wednesday August 10

-Britain saw new signs of economic weakness as falling exports increased the trade deficit and industrial production was unchanged compared to the previous month after having previously fallen.

-Germany's trade surplus fell due to falling exports.

-Latvia seems to be catching up with its rapidly growing Baltic neighbors as GDP rose 2.2% (9% at an annualized rate) in the second quarter compared to the first and 5.3% compared to the second quarter of 2010.

-China saw both its consumer price inflation rate and trade surplus increase. Since a stronger yuan would reduce both, this will likely induce Chinese policy makers to allow the yuan to appreciate faster against the U.S. dollar.

-South Korea saw employment increase by 1.4% in July compared to the previous year, resulting in an increase in the employment to population ratio and a drop in the unemployment rate. The rate of increase was however lower than in the previous month.

-Israel saw average real wages rise a mere 0.1% compared to the same month the previous year, while employment increased a more robust by 2.9% during the same period.

QE3 Coming?

After the recent market rout, more and more people speculate that the Fed may launch QE3.

Given that the significant increase in risk aversion and money demand has undone some of the price inflation previously created by QE2, QE3 is certainly a possibility.

QE2 did cause an increase in money supply and [therefore] increase commodity prices, stock prices, consumer price inflation and corporate profits. However it also reduced real wages and total real economic growth was actually significantly lower in the three quarters after it than in the three quarters before it. There is little reason to believe that QE3 would be more succesful in increasing real economic growth.

Illogical Markets

We now see the first effects of the S&P credit downgrade on the markets. It seems that the main effects, apart from a big rally in gold and sell-off in oil, is that the stock markets falls and Treasury bonds rally (causing yields to drop).

This really makes no sense at all. If you care about what credit rating institutes thinks (I don't think you should, but clearly many people do) then the only effect should be to make U.S. treasuries less attractive relative to other assets because they are now viewed as more risky, something that in turn should raise Treasury yields.

I know of course that the reason Treasury yields have fallen is because the stock market has sold off, and that this could overwhelm the increased risk premium. But since the rating was about Treasuries and not the cyclical outlook for the U.S. economy or the riskiness of stocks, there is by contrast really no reason for the stock market to sell off, and therefore definitely no reason for Treasuries to rally.

This is like car customers reacting to news that one particular dealer defrauds and rips off his customers by shunning other dealers and instead buying more cars from the particular dealer who were shown to be fraudulent.

So apart from the gold rally, today's market movements are completely irrational, except perhaps to the extent they were reacting to other news.

Swiss Currency Intervention Losses Illustrated

A reader sent me this graph, illustrating how the losses from its exchange rate interventions of the Swiss National Bank has destroyed most of its equity.

And as it happens, these interventions have proven to be futile as the Swiss franc have reached new record highs against both the U.S. dollar and the euro.

U.S. Debt Downgrade Is Too Little, Too Late

So Standard & Poors finally decided to downgrade the credit rating of the U.S. federal government, something that has angered many left-wing commentators. Robert Reich for example commented it with a question that is meant to be rhetorical.

"who gave Standard & Poor’s the authority to tell America how much debt it has to shed, and how?"

Now, I am definitely not a fan of credit rating institutes, and for opposite reasons of Reich as I will explain below, not really even a fan of this new rating, but the whole point of credit rating institutes is in fact to make assessments about how the level of borrowing affects . That is, and has always been their [a part of their] job description.

One can of course disapprove of that job and say that credit rating agencies are like witch doctors or astrologers, but as it happens government regulators have artificially propped up their business by coming up with accounting rules where assets are balued according to the ratings of "Nationally Recognized Statistical Rating Organization" including Standards & Poors. So it is in fact the federal U.S. government that gave them that authority.

It gets even funnier when Reich argues that the federal government should get a AAA-rating because they haven't missed their payments and then blasts the agencies for having given AAA-rating to mortgage backed securities during the housing bubble. As it happens, the mortgage backed securities hadn't missed payments either when they held AAA-rating, meaning that by Reich's logic, they did the right thing by giving the mortgage backed securities AAA-rating.

Personally, my view is this downgrade is a case of "too little, too late". The U.S. fiscal situation, with a debt as large as GDP is in fact as bad or worse than some of the distressed countries in Europe, and it is therefore outrageous that they should receive a AAA-rating or even a AA+ rating as the S&P now awards them. Because of its printing press, the U.S. is still unlikely to formally default, but all the more likely to have a de facto default through inflation, as they have done repeatedly in the past.

U.S. Employment Survey Discrepancy Increases

Markets reacted positively (initially) on today's U.S. employment report. And the payroll survey was indeed strong-at least by the standards of the last few months. Payroll employment increased 117,000 and even more impressive was a 0.4% increase in average hourly earnings. This suggests a nominal increase of 0.5% (6% at an annualized rate) in aggregate labor income.

By contrast, the household survey showed a loss of 38,000 jobs that together with the increase in population reduced the employment rate to 58.1%, even lower than the previous low of 58.2% reached in December 2009 (and November 2010 and June 2011). The drop in the unemployment rate was thus entirely the result of a continued decline in the labor force participation rate as more and more unemployed view the prospect of getting a job so low that it's not even worth trying to apply for jobs (only people who actively apply for jobs are officially counted as unemployed), even though they would still prefer to have a job.

The markets, as usual, only focus on the payroll survey and more specifically on the number of jobs reported there. That might seem sensible since the payroll survey is probably more reliable when it comes to monthly fluctuations than the often in the short term erratic household survey. However, over longer periods of time the household survey is more reliable and the fact that during the latest year, it has reported nearly a million less new jobs (household survey employment is up just 305,000 during the latest 12 months, compared to the 1.258 million increase in the payroll survey) suggests that the payroll survey likely overestimates the strength of the U.S. labor market.

Gold Is The Only True Safe Haven

Because of the problems in the euro area, the U.S. and the U.K., investors are fleeing assets denominated in their currencies. Some are fleeing to gold and other precious metals, others are fleeing to the two fiat currencies that have managed to gain "safe haven" status, the Swiss franc and the yen. The latter reaction is in some way understandable, since historically (the last decades) Switzerland and Japan has had the lowest rates of inflation on average.

A key difference between gold and the franc and the yen is that the two latter functions as currencies of real economies, while gold doesn't. This means that when gold rises, exchange rates between countries are unaffected (at least not directly). By contrast, when investors flee to the franc and the yen, companies in Switzerland and Japan see their competitiveness vanish. Though other people in Switzerland and Japan benefit, these exchange rate shocks are usually not good for Switzerland and Japan, especially when they are as dramatic as now, with for example the franc appreciating 45% against the U.S. dollar and 30% against the euro in less than 14 months.

As a result, the central banks of Switzerland and Japan have used various means to limit the appreciation of their currencies. I discussed the latest Swiss actions yesterday and today we can read that Japan is also acting to lower the value of its currency.

Because of the active measures from the Swiss and Japanese central banks to lower the value of their currencies, the franc and the yen are not as good as safe havens as gold is. While it would be possible for central banks to lower the price of gold as well, no central bank see any interest in that right now. Indeed, as I discussed two days ago, central banks are unintentionally acting to increase the price of gold as they increase their gold reserves.

Statistical Notes Wednesday August 3

-Purchasing manager indexes for July gave mixed signals of U.K. economic growth as The manufacturing PMI fell from 51.4 to 49.1, while the non-manufacturing PMI rose from 53.9 to 55.4.

-By contrast, both the manufacturing and the non-manufacturing indexes for the U.S. fell back.

-Similarly, the euro area's manufacturing and non manufacturing PMI:s both fell back. Meanwhile. euro area retail sales recovered in June, but not enough to make up for May's decline so retail sales was still below April's level.

-Sweden's purchasing manager index fell to 50.1, barely below above the threshold for expansion, indicating that the previously very high growth rate is slowing dramatically.

-Industrial production in Latvia in June rose 4.1% compared to the previous month and 15.2% compared to June 2010, indicating that Latvia might finally catch up with the very high growth in neighboring Estonia and Lithuania.

-Retail sales in Australia rose slightly in June in real terms while the trade surplus fell.

-The extreme boom in retail sales in Hong Kong continued, increasing 28.8% in nominal terms and 22.2% in real terms in June compared to the same month last year.

Switzerland Goes For Zero

In a bid to limit the rapid and relentless appreciation of the Swiss franc against particularly the euro and the U.S. dollar, but also against pretty much all other currencies as well, the Swiss National Bank reduced its key interest rate from 0.25% to "as close to zero as possible" and also initiating "quantitative easing".

The move will limit the franc's gains but probably not stop it entirely as long as for example the euro area, Britain and the U.S. has deep problems. It is a cheaper way of limiting the gains than the extremely costly foreign asset purchases. Doing like Brazil and tax foreign capital inflows would also limit the gains, but not be as effective as in Brazil because of the large current account surplus and it may not at any rate be compatible with Switzerland's free trade agreements with the EU.

Given the fact that Switzerland indeed has a very large current account surplus, it could be argued that the super-strong franc is a good thing that will reduce global imbalances. But in practice exchange rates aren't as effective as commonly assumed in reducing imbalances and the extreme magnitude of the gains (up 45% against the U.S. dollar and 30% against the euro since June 2010) is having a clearly disruptive effect on the Swiss economy.

Debt Deal Was Setback For Big Government

Was the debt deal a win for Republicans or Democrats, or more specifically for small- or big government advocates? Left-wing opponents and right-wing advocates say that Republicans won while right-wing opponents and left-wing advocates say that Democrats won-or at least got a fair deal.

The answer to that question depends on what gauge of spending you rely on. Cato Institute's Chris Edwards points to the fact that discretionary spending will continue to rise in nominal terms. But apart from using a very misleading graph (that starts at $900 billion and goes up to $1,300 billion, which makes an annual average increase of 1.9% look like big boom), Edwards' use of nominal numbers are misleading for the same reason that it would be misleading to say that countries with hyperinflation are experiencing unprecedented booms. It is the amount of real goods and services that matters, not the nominal numbers.

It is also misleading not to take economic growth into account. The level of economic freedom is essentially a function of (average) tax rates, and tax rates in turn are a function of high government spending is relative to the size of the economy.

Thus, assuming that average annual nominal growth stays at the 4% level America had during the latest decade, a 1.9% average annual increase in nominal spending will mean a big reduction in the cost for the private sector of government spending , meaning that taxes can be reduced without an increase in the deficit-or more likely in this case that the deficit can be reduced without an increase in taxes.

For this reason, the debt deal did in fact mean progress for the cause of limited government and a setback for the cause of big government.

South Korea Buys Gold

South Korea's central bank, the Bank of Korea, bought 25 tonnes of gold at a value of $1.24 billion during the last two months. This is one of many examples of how central banks these days a lot more often buys gold rather than selling it in the past. In hindsight it would have of course have been a lot smarter to buy in the past and sell now rather than the other way around (Gordon Brown's infamous gold sale when gold was at $250 per ounce won't exactly go down in history as a wise move), but that doesn't necessarily mean that it is wrong to buy now.

The fact that central banks are buying gold is in fact bullish for two reasons. First of all because these purchases means directly that demand is higher. And secondly because that makes inflationary policies look more likely as central banks will profit from higher gold prices. This means that the purchases could be a signal that central banks intends to create more inflation and it also increases the likelihood that they will later create more inflation.