Higher U.S. Employment Due To Lower Productivity

It now appears that there wasn't much of a growth acceleration in the U.S. after all. Terms of trade adjusted GDP rose a mere 1.2% at an annualized rate and national income was only slightly stronger during the first quarter.

This means that the somewhat higher employment growth we saw during late last year and early this year didn't really reflect as most people thought, an acceleration of economic growth from the "so low it feels like a recession" level that the "Obama recovery" of the last three years has been characterized by. Instead it simply reflected a decline in productivity

The Case For A German VAT Cut

I have repeatedly (for example in this post) criticized the view that a reduction in the external deficits of Greece and other crisis countries necessarily requires a reduction in the external surpluses of Germany and other euro area surplus countries, because it simply isn't true.

However, pointing this out doesn't mean that I don't also think that it would be good if Germany shifted more of its production towards domestic demand instead of net exports. But how is that to be achieved in a way that doesn't hurt the German economy?

Some people have accused Germany of "wanting" a surplus, but I don't believe that, I think it is more correct to say that they want the income and the jobs generated by exports. If the income can be attained by other means then they wouldn't object to it. Quite the contrary, that would probably be perceived as preferable since that would mean that they wouldn't risk losing it through debt default from the foreign borrowers that they've lent their surplus to. So the question arises, how can the German surplus be reduced without reducing (and preferably in fact increasing) German incomes?

There are actually probably several ways to achieve it, but the best way is arguably for Germany to repeal its 2006 VAT increase from 16% to 19%, and preferably cut it all the way down to the EU minimum level (that minimum level should be abolished, but as long as it exists it does limit how much it can be cut) of 15%.

The 2006 VAT increase didn't directly hurt the German economy as much as I and other feared at the time because it was combined with reduced payroll taxes and other supply increasing reforms. However, it contributed indirectly to aggravating European imbalances and therefore also the current crisis.

As I've pointed out before, the effects of a VAT (and other consumption taxes) is basically identical to the effects of income taxes and payroll taxes on economic transactions which involve a domestic seller/producer and a domestic buyer. Both create tax wedges between the cost for the buyer and the net income of the seller.

However, while basically no difference exist with regard to purely domestic transactions, they have different effects on transactions with foreigners. The difference is that a VAT isn't directly applied to most (one exception is tourism services, which is why VAT increases in tourism dependent Spain and Greece have been destructive) exports but it is applied to imports, while by contrast income/payroll taxes aren't applied to imports while it is applied to exports. This means that if you make the kind of tax reform that Germany did in 2006, it will increase exports relative to imports and thus in Germany's case increase its trade surplus, the flip side of which was bigger deficits in countries like for example Ireland, Spain and Greece.

This also means that the most effective way of facilitating the adjustment in the crisis countries while not hurting or even strengthening the German economy would be to repeal the VAT increase and lower it back to 16% or better yet 15%.. This will increase demand for economic activities based in part on imports , strengthening both the German economy and other economies. Preferably in other not to hurt other activities the cut shouldn't be financed by higher income or payroll taxes (though such a reform would still help painlessly lower the German surplus). Instead Germany should to the extent it needs to be compensated cut government spending, though particularly given today's ridiculously low German bond yields (only 0.05% on 2-year bonds, and less than 1.4% on 10-year bonds) it could afford a short term increase in its budget deficit.

Finally, it could be objected that if higher VAT rates have hurted tourism in Spain and Greece, why won't a lower VAT in Germany also hurt tourism in Spain and Greece since it also represents a higher differential? Well, there are two reasons for this. The first is that a lower VAT in one country will expand the aggregate amount of tourism in two countries while a higher VAT in once country will lower the aggregate level of tourism. The second is that the limited amount of tourism that exists in Germany competes only to a limited extent with the kind of  "warm weather and nice beaches" tourism that Spain and Greece attracts. By contrast, when Spain and Greece have raised their VAT rates they have put them at a disadvantage to countries that attracts similar tourists, like Turkey and Cyprus.

What British Spending Cuts?

Jeremy Warner points out that even as Paul Krugman and others claim that Britain's double dip recession is due to its so-called "austerity", government spending actually increased in the first quarter in Britain even as private sector economic activity (particularly construction) contracted.

Now, the indicator Warner points to is actually "government purchases", which doesn't include the large part of the government budget that consists of transfer payments like pensions and unemployment benefits. But if you look at overall government spending, you get the same picture. During the first 4 months of 2012, government spending increased from £204.7 billion to £212.2 billion, a 3.7% increase that far exceeds the mere 1.9% gain in nominal GDP.

Krugman Contradicts Himself On Devaluations

For years, we have heard Paul Krugman and others assert that Greece etc. can't reduce their current account deficit unless Germany etc. reduces its surpluses. While that would have been true if the world had consisted only of the euro area nations, it is clearly not true in the world we actually live in. Krugman himself lives in a country with an economy bigger than that of the euro area and Japan and China have together a bigger economy than the euro area plus there are nearly 180 more countries including for example Brazil, Saudi Arabia, Turkey, India, Russia, Canada, Australia, Britain, Switzerland, Norway and Sweden, outside of the euro area.

With so many and in some cases so big economies outside of the euro area, and with the euro area trading so much with them it is clearly possible for the aggregate euro area to strengthen its balance, or in other words it is possible for Greece etc. to reduce their deficits without a reduction of the surpluses of Germany etc.. something that is in fact happening as during the last 4 months alone the euro area current account balance has swinged from a €17 billion deficit to a €10 billion surplus.

This shift reflects in part the effects of the euro area austerity measures, and in part it reflects the euro's weak exchange rate. Krugman now seems to implicitly acknowledge that he was wrong when he asserted that the euro area's aggregate balance can't change, because now he argues that it would be wrong if it happened.

Why would it be wrong? Because the three biggest economies outside the euro area, the United States, China and Japan aren't sufficiently strong (he could have also mentioned the fourth biggest economy outside of the euro area, Britain, which is weaker than all three of those countries). But German growth is no higher than growth in these countries, and the second big euro area surplus country, Holland, has fallen into a recession. If it is wrong to increase the U.S. deficit and reduce the Japanese and Chinese surpluses, then it should also be wrong to reduce the German and Dutch surpluses.

Finally, it should again be emphasized that regardless of how much Krugman disapproves of it, it is happening, in part due to the fact that the euro has fallen in value against the U.S. dollar and the U.K. pound. The irrational (but self-fulfilling) investor belief in American and British government bonds as "safe havens" haven't just produced the low yields that Krugman likes to talk about so much, it has also pushed up the exchange rate of the dollar and the pound, something that has contributed to the euro area's swing from an aggregate deficit to an aggregate surplus, while increasing the U.S. and U.K. deficits.

Would Greek Default Necessarily Mean Euro Exit?

Recent opinion polls suggests that many Greeks are listening to the warnings of German leaders that if Greece cancels its austerity measures, Germany and others will stop funding the Greek budget deficit, as the parties that want to keep Greece's commitments are gaining at the expense of the far left wing parties that wants to increase government spending.

But what if the far left end up winning after all and Greece defaults? Would that necessarily mean that Greece would be forced to re-introduce the drachma? Actually, contrary what is commonly assumed that is not necessarily the case. After all, households default around the world all the time yet except in cases of death or emigration they continue to use the same currency as before, so there is no necessay connection between default and exiting a currency. And as polls show that nearly 80% of Greeks want to keep the euro and so does the leading far left party, Syriza, even a far left governments that defaults will try to avoid exiting the euro.

However, if a far left government wants to increase, or simply avoid decreasing, government spending it will have to exit the euro and re-introduce the drachma. Because if Greece tells Germany that not only will it not honor the already dramatically reduced debt commitments, it wants to "borrow" (of course, if you keep "borrowing" while declaring previous debt null and void, you're really not getting loans, you're getting gifts) more so that it can spend more, then there is no way that Germany will agree to that-and rightly so. And since no private creditor will agree to it either, this means that Greece would be forced to immediately achieve primary budget balance, forcing it not only to cancel Syriza's promised spending increases but to cut spending in a disorderly fashion.

The only way this can be avoided, apart from implausible increases in government revenue, is if Greece re-introduces the drachma and starts to finance its budget deficit directly through the printing presses. So while default per se doesn't necessarily imply euro exit, deficit spending requires a euro exit. Meaning that Syriza's pledge to both increase government spending and keep the euro can't be achieved and that if they win they'll have to choose which of these promises they will break.

Krugman Misleads On Sweden

Paul Krugman criticizes Senator Tom Coburn for using Sweden as a good example of a country that has reduced government spending and claims that this is false using a chart showing the change in real government purchases.

But this is misleading becuase first of all it doesn't put spending in relation to GDP and secondly and even more importantly because it excludes transfer payments such as unemployment and sick leave benefits. The Swedish centre-right government has in fact concentrated their spending cuts to transfer payments so any analysis using only government purchases is bound to be very misleading

If we instead look at total government spending as a percentage of GDP (called "government dispursments in the OECD database) you can see that since 2006, when the current Swedish government was elected, government spending relative to GDP fell from 52.9% in 2006 to 51.8% in 2011. By contrast, during the same period, the OECD average rose from 39.7%  to 44%, and in the United States it rose from 36.1% to 41.9%.

Not All Of Europe Is In A Recession

While Greece in particular, and southern European countries in general remains in a slump, Slovakia, Finland and the Baltic countries are booming, with 5.5% growth in Latvia, 4.3% in Lithuania, 4% in Estonia, 3.2% in Slovakia and 2.9% in Finland.

By contrast, the country that used be in a union with Slovakia, Czechia, has however fallen into a recession and so have Britain, Hungary and Holland, and as stated above various southern European countries.

Some countries including Ireland, Poland, Denmark and Sweden haven't reported first quarter growth.

Peak Peak Oil

Mark Perry has produced this chart on his blogg:

It seems that it's not oil production, but the theory of "peak oil" that is peaking....

Atlas Shrugged In French

The win of crazed socialist Francois Hollande in the French presidential election causes increased exodus of wealthy Frenchmen.

The Euro, The Gold Standard & The Effects Of Devaluation

Aside from Argentina, that I've discussed here, the most popular empirical example used to argue that Greece and other weak euro area countries would benefit from ditching the euro and introduce devalued national currencies, is the experience of the 1930.

Though there are differences between the euro and the gold standard, they are similar in the sense that both means fixed exchange rates and the inability to devalue/depreciate the currency.

And the empirical record of the 1930s is pretty clear. The faster countries got off the gold standard the faster they recovered. Britain and Sweden that devalued first recovered first, the United States devalued somewhat later and recovered somewhat later, while France and Belgium that held on to the gold standard the longest recovered latest of all countries.

This strong correlation was in fact mostly causal. The reason was that bank panics had caused wide scale collapses of fractional reserve banks creating in turn what Hayek called secondary deflation in very high doses, often as high as 10% per year, something that given the inability of nominal interest rates to go below zero meant that real interest rates was as high as 10%-far above the natural interest rate, causing not only malinvestments but also fundamentally sound investments to be liquidated. And when other countries devalued this helped aggravate this secondary deflation.

When those unnaturally high real interest rates were dramatically lowered after the gold standard was abandoned, this caused the economies to recover.

However, in the euro area today we see no secondary deflation. Price inflation is well above 2.5% in the euro area, and even in Greece it is still 1.5%. That is why we can't expect a similar development if Greece or others re-introduce their currencies. Eventually at some point during the coming years they will almost certainly see some form of recovery, but that will happen regardless whether they stay in the euro are or not.

The baltic countries have seen their economies recover strongly ( Estonia's GDP have increased a cumulative 13.9%, Latvia's by 10.5% during the last two years), albeit from a very depressed level, despite not devaluing while Britain and Iceland failed to see any recovery following the dramatic drop in the value of their currencies in 2008, illustrating that devaluations only work if it is made in the context of secondary deflation.

Inflation Increases, Real Production Falls In Britain

Producer price inflation rose more than expected while real output falls more than expected in Britain. Wait a minute, haven't we been told by the Keynesians that higher inflation would increase real growth?

I Know Someone Who Won't Be Getting A Bonus This Year

Single trader called "the London whale" loses at least $2 billion for J.P. Morgan-maybe up to $3 billion. But the trader in question clearly isn't the only one who should get fired. The people that were supposed to oversee him, and allowed him to take such big risks clearly screwed up as well.

France-The Country Of The 49 Employee Firms

One interesting fact is that France has 2.4 times as many companies with 49 employees as with 50. Why? Because once a company reached 50 employees they must initiate profit sharing, create "worker councils" and submit restructuring plans to these councils if they decide to fire workers for economic reasons.

The economic damage from these rules is somewhat mitigated by the loophole that an entrepreneur can create several small companies that function much like one larger. Still, that create unnecessary bureaucracy and illustrates that France's problem certainly isn't too little government intervention, as newly elected President Francois Hollande believes, but too much.

Time To Give The Greeks A Dose Of Reality

Now that the majority of Greeks have again proven their political immaturity by voting for a bunch of communists and neo-Nazis (abandoning the corrupt establishment only after it started to limit the mooching they've gotten used to ), the rest of Europe must be very clear. There will be no relaxation of terms, period. The terms they've already gotten where they've gotten more than €100 billion in debt forgiveness even as they will continue to get new loans, making it a massive transfer of wealth to Greece, were in my view in fact already far too generous.

So unless they have new elections where they change the results, Greece should be forced to face reality of their choice. There should be no more cash flow payments to Greece. That includes not only the loan packages, but also all the handouts Greece have for decades received from the EU budget. They should be left to fend for themselves. Let them see how things works out when those "oppressive Germans [and other Northern Europeans]" stay out of the picture.

Because Greece has a large primary deficit and because no one will lend to them, this means that they will have to immediately balance the budget. That will force them to make even greater, and far more disorderly and disruptive, budget cuts. And of course with no money from the EU budget that will mean an even greater decline in government spending received. Far from the outcome of "no more spending cuts" outcome promised by Alexis Tsipras, the leader of the biggest communist party in Greece.

And if that leads Greece to re-introduce the Drachma and finance their government through the printing presses, then fine, do go ahead and make our day. Then they will get massive inflation that will give them the real income cuts that they were trying to avoid.

Unfortunately, this will in the short term hit not only the very deserving majority of Greeks but also hit the minority of Greeks who are rational. But that is unavoidable, just as it was unavoidable that more rational Germans would suffer because of other German's election choice in 1932.

France, Greece Votes That Others Should Provide For Them

Both the French presidential and the Greek parliamentary elections yesterday were pretty bad. The  Greek election meant a choice between on the one hand incompetent and corrupt incumbents that have wrecked the country and on the other hand extreme left wing parties and an outright neo-Nazi party who promises that Greece as a nation will continue to be able to live at the expense of other nations. The French election meant pretty much the same choice, except that Sarkozy wasn't as bad as the Greek incumbents and Hollande isn't as bad as the Greek opposition of left-wing extremists and neo-Nazis.

In both cases, a majority of voters decided to throw out the incompetent incumbents and instead go for the even crazier opposition. In a way that is understandable. As one commenter put it, it was basically insolent for Greece's two leading (until this election) parties, New Democracy and Pasok, to ask voters to give them power again after the problems they've caused.  And though France has performed much better than Greece in recent years, the French economy has still been quite weak.

But just because the incumbents are incompetent fools who have wrecked the countries, doesn't mean that the opposition is better, as the people of Germany (and the rest of the world) experienced after they voted out the incompetent and corrupt Weimar German establishment and voted in the National Socialist German Worker's Party (the NSDAP in its German abbreviation) into power in 1932.

And while particularly the French but to a lesser extent the Greek opposition are nowhere near as bad as the German opposition in 1932, the fact remains that they  represents even crazier policies than the incompetent incumbents, as they cling to the illusion that it will continue to be possible for everyone to use the state to live at the expense of others, as France's greatest economist of all time would have put it.

This means that unless the electoral winners break the promises they made to the voters, the European economic crisis is about to become a lot worse because of yesterday's election results.

How Much Will Dividend Tax Hike Lower Stock Values?

Don Luskin points to how in January next years if current law isn't changed, then there will be a big increase in the taxation of dividends in the U.S., something that will send stock prices lower. Luskin believes that stocks could fall by more than a third because the top rate will increase from 15% to 43.4% anad as 56.6% is less than two thirds of 85%.

Luskin is right when he argues that this tax increase, if it isn't repealed before it is implemented, will lower stock prices. However, the effect will be a lot smaller than Luskin thinks for two reasons.

First, because some stock owners will see their after tax return reduced less ( if their total income is less than $200,000 per year) or not at all (if they're foreigners).
And secondly because the value of stocks isn't primarily based on dividends during the coming year, or even the coming few years, but on the present value of all dividends in all eternity, or at least for as long as the company will exist. If investors hope that the dividend tax will be reduced again in the future then the forecasted loss of value will be lower. 

Falling U.S. Participation Is Partly Demographic

Yesterday's U.S. employment numbers were even weaker than the headline payroll employment and unemployment rates suggested. The household survey showed an actual drop in employment, lowering the employment to population ratio to a level no higher than a year earlier. The payroll survey meanwhile also showed that nominal wages were flat, implying most likely a drop in real wages.

However, it seems that the change in employment in recent years hasn't been quite as weak as the employment to population ratio suggests. I have previously disputed that, but now I have partly changed my mind because I now realize that I misunderstood how the employment to population ratio is calculated.

I believed it related the number of employed 16- to 64-year olds to the total population of 16- to 64 year olds. However, it turns out that it relates the total number of employed persons older than 16 to the total population older than 16, which is to say it includes everyone who is 65 or older. Because people older than 65 typically have a lot lower employment rate than 16- to 64 year olds this means that demographic shifts that increases the share of the population older than 65 will lower the employment rate even if the job market really doesn't weaken.

The point of using the employment to population ratio instead of the official unemployment rate is to detect the degree of "hidden" unemployment, but if changes in it reflects demographic changes then it too can be misleading. And as the number of people older than 65 is increasing it follows that the decline in the employment rate is exaggerated.

However, while part of the decline reflects that the population is getting older, most of it reflects an increase in unemployment, both official and "hidden" as was shown here.

Level & Change

Paul Krugman continues to discuss his debate with Ron Paul, this time ridiculing Ron Paul for pointing too how the massive reduction in government spending following the end of World War II was followed by massive prosperity.

Yeah, it was a libertarian paradise all right — with a top marginal tax rate of 91 percent, a third of the work force in unions, and a minimum wage much higher relative to the average wage than it is today.

First of all, neither Ron Paul nor anyone else has claimed that the late 1940s was a "libertarian paradise", at least not in an absolute sense. What was pointed out was that the economy was changed in a way that indeed makes 1950 look like a libertarian paradise compared to 1944. Total government (including at the state & local level) spending was in 1944 50.6% of GDP, a number that had dropped to 23.5% in 1950. By comparison, total government spending was by the way 37.3% of GDP in 2011.

That 91% figure (which by the way was in place in 1944 as well) is misleading because although that was the formal top rate, it applied to very few and was paid by even less as there was extensive legal and illegal tax avoidance.  The overall tax- and spending burden was a lot lower in 1950 than in both 1944 and 2011.

Note here that the change in the burden of government is often as important or more important than the level. Sweden still has a relatively high level of government spending and high marginal tax rates, but because it has in recent years reduced those things, it has still been able to have relatively high growth.  Similarly, it wasn't just that the level of spending was much lower than now that produced post-war prosperity, but also that the change was so enormously positive.

Battle Of The Pauls

Most names, including "Stefan" and "Karlsson", are either exclusively first names or last names, but there are also names that could be either. One example of that is "Paul", as is illustrated by the names "Ron Paul" and "Paul Krugman". The two faced off in a debate that one can call "Paul vs. Paul" or "the battle of the Pauls".

Ron Paul managed to hit Krugman good with several of his arguments, including pointing out that late 19th century cyclical slumps are an indictment of the absence of central banks then the inflationist policies of later Roman emperor's that led to the Empire's collapse is an indictment of inflationary policies, an argument that Krugman clearly didn't anticipate, as he simply responded that he didn't endorse Emperor Diocletian's policies, ignoring the points that the Emperor's policies were similiar to the ones he has proposed.

Krugman also falsely claimed that there was no coercion in the use of currency, being either ignorant or deliberately dishonest about the existence of "legal tender laws".

 Ron Paul was however embarrased when he endorsed Milton Friedman, whose view of the depression is that it "should be blamed on the government" because the central bank wasn't activist enough, and also he falsely claimed that "debts were liquidated" after World War II. Perhaps the latter is meant to refer to some debts to Germany, but there was no liquidation, at least not in nominal terms, of the debts of Americans. Krugman however failed to point out Ron's inaccuracy on the latter point.

What is really clear is that Krugman himself believed he lost the debate, since he wrote a blog post arguing that such debates aren't the best way to settle such issues since one can't directly settle disputes over data. That's actually a largely valid point, such face-offs aren't the best way to settle theoretical disputes, but again illustrates that even though Krugman doesn't believe that his arguments were disproven, he does believe that Ron Paul did better in this particular debate.