Yes, Incentives Matters

According to the first preliminary U.S. GDP report, nominal GDP increased at an annualized rate of just 0.5%-yet nominal disposable personal income rose at an annualized rate of 8.1%.

How is that possible? Well, in part it probably reflects so-called statistical discrepancy. Expenditure- and income numbers are based on different data sources and this quarter, unlike previous quarters, the expenditure numbers are probably weaker than the income numbers.

The second, and likely far more important, explanation is that companies made large advance payments of salaries and dividends because they expected a big increase in tax rates. The fact that dividend income jumped an annualized $268 billion in December compared to November, and by $302 billion compared to October illustrates the importance of this factor.

This will with near certainty be more or less entirely reversed during this quarter.

One of the lessons of this is that people do respond to incentives. If they hadn't, we wouldn't have seen these large advance payments.of salaries to high income earners, and above all, dividends.

The Canadian Housing Bubble

Interesting article about Canada's housing bubble, that is illustrated with this chart.

House prices relative to rent is for many reasons an imperfect gauge, but not entirely useless either. Canadian house prices is therefore almost certainly way too high.

The article says the Bank of Canada is aware of the problem but are trying to deflate it only gradually by making mortgages less available. The reason why they try that approach instead of raising rates is that they hope this will help them avoid the kind of recessionary aftermath that housing bubbles in for example the U.S. and Spain had. But with debt levels still rising to new record levels relative to disposable income, it seems that they have been unable to start achieving that slow and gradual deflating.

Bashar al-Assad-The Feminist Dictator?

The Middle East, apart from Israel, is generally essentially a black hole for women's rights. The situation is worst in Saudi Arabia, but in most other countries as well they face real systematic oppression, as opposed to the non-oppression that Western feminists complain about, such as underrepresentation in corporate board of directors.

However, another partial exception seems to be Syria, or more specifically the Alawite and Christian parts of the country. Alawites, the ruling group in Syria,  are sometimes described as following an offshoot of Shia Islam, and that is partly true (That is the reason why the Syrian regime is allied with the Shi'ite theocracy in Iran and Lebanese Shi'ite terror group Hezbollah), but they differ from normal Muslims in several aspects, most notably that alcohol is permitted and women have a stronger position and don't wear headscarfs.  The latter is illustrated by this picture of Syria's Alawite dictator Bashar al-Assad and his attractive Western-looking wife.

You're unlikely to find any picture like this of any wife of regular Muslim (whether Sunni or Shia) leaders.

I also found here a link telling how Assad's regime, pressured by the Sunni Islamist insurgency funded mainly by Sunni Gulf dictatorships Saudi Arabia and Qatar (and to a lesser extent also supported by France, Britain and the U.S.) against his regime have started to enlist female soldiers to fight. Until recently, Israel was the only Middle Eastern country to have female soldiers (unless you count Quadaffi's personal bodyguards), but now the Assad regime is starting to mobilize Alawite and Christian women.

Here is a video clip telling of this.

Presumably, most of my readers don't understand Arabic any better than I do, but according to the Washington Post, they chant "Be prepared Syria. Stand up Assad,” and “With our blood and our soul we protect you Bashar.”

Considering the large scale defections of Sunni soldiers from the Syrian military, the Assad regime clearly thinks it is necessary to mobilize as many Alawites and Christians as possible, including female Alawites and Christians. The risk with such a force is however that it might further increase support for the rebels among Syria's majority Sunni population, especially considering reports that some of these female Alawite and Christian soldiers harass Sunni women and rip off their headscarfs.

Higher Government Spending-Falling GDP In Britain

As most analysts, including me, had expected, the preliminary estimate for fourth quarter GDP in Britain shows that it is again contracting. This will likely again cause Keynesians to assert that this proves that David Cameron's "austerity" is failing.

The problem is that there is no evidence that Cameron has ever implemented such a policy. The idea that there has been reductions in government spending in Britain is a pure myth, an urban legend.

In fact, budget numbers shows that in 2012, government spending in Britain was £630 billion, a rise by 3.1%  from the £611.16 billion in 2011. Excluding interest payments, which dropped from £48.8 billion to £45.3 billion as falling yields due to Britain's undeserved "safe haven" status more than offset a rising debt, spending rose from £562.4 billion to £584.7 billion, a 4% increase. Meanwhile, as revenues barely rose  even in nominal terms, the budget deficit rose by nearly £20 billion.

While it is true that government spending rose even faster during previous Labuor governments, it still doen't count as "austerity" or "spending cut" if government spending continues to increase in real terms and relative to GDP.

"Brixit"-Probably Good For Britain But Bad For The Rest Of The EU

So now David Cameron has decided that if the Conservatives win the next election, there will be a referendum on "Brixit"-whether Britain should exit the EU. .

The first thing that could be noted about this is that it is very clever politics for the Conservatives. By linking a referendum to his re-election, he will, especially given Britain's "winner takes it all" system, probably be able to convince the vast majority of supporters of the increasingly popular U.K. Independence Party to vote for Tory candidates instead of UKIP candidates.

The second thing that could be noted is that the case is very strong for people to vote for a British exit. Britain is today a large net contributor to the EU budget and would save that money if they exited. Furthermore, they would then no longer have to obey some irrational EU regulations (though the EU might be willing to give Britain exceptions anyway to prevent a British exit).

The only real possible downside for ordinary Britons would be that it might mean more restrictions on trade and free movements with EU countries. However, given that the rest of the EU would lose from such restrictions too, they probably won't be particularly burdensome.

For British politicians another downside would be reduced international influence (which is why Cameron is likely to argue against exit if there is a referendum) but I doubt ordinary Britons really care about that.

However, for the rest of the EU, a British exit would be bad. In part because the absence of the British net contribution is likely to increase the burden for remaining net contributors like Holland, Germany and Sweden and in part because without Britain, the balance of power would shift towards those who want a bigger EU budget, more regulations and more protectionism. This would of course strengthen the case for the politicians in for example Holland, Finland and Sweden who wants their country to exit as well.

Thus, a British exit would kind of be like the possible exit (secession) of Catalonia from Spain. It would be good for those who exit, but bad for those who remain. By contrast, in many other possible cases of exits/secession, such as with Scotland from Britain and Quebec from Canada, it would benefit the parts that remained more than the part that exits.

Why Did Hitler Hate The Jews?

Here's one theory:

How Math Makes Economic Nonsense Appear Impressive To Some

Interesting article (thanks Edward for the tip) about how the use of mathematical formalism make people who do not understand the equations believe that the stydy/analysis is better, even though it is in fact worse. This was evidenced by how Kimmo Eriksson of Mälardalen University in Sweden slapped on some mathematical equations completely unrelated to the subject (being taken directly from psychology papers) to papers in evolutionary anthropology and sociology.  People with degrees in Mathematics and other heavily mathematical subjects who knew the math realized that the equations made no sense in this context and therefore rated it lower, yet people who didn't understand the equations rated it higher, presumably because they believed that the equations somehow made it more "advanced". One psychologist explained it as follows:

"People who know math understand what other mortals understand, but other mortals do not understand them. This asymmetry gives them a presumption of superior ability."

This is likely one of the most important reason why academic economics insists on expressing theories in formal mathematics even though it is a distraction and reduces understanding of how the economy works. They believe that this will make others think they're smarter than they actually are while allowing them to get away with nonsensical theories

No Trillion Dollar Platinum Coin

Despite receiving support from Paul Krugman and most Democratic/liberal pundits, the Obama administration now seems to have decided against using the "platinum coin" option to evade the debt limit.

Which is (probably) good since this might mean that House Republicans will finally be able to get spending cuts implemented  The Obama administration still insists it won't negotiate, but they seem more likely (though not certain) to blink in the coming "chicken race".

The Coming Empirical Test Of "Ricardian Equivalence"

Though "the fiscal cliff deal" meant that much of the planned tax increases or spending cuts in the U.S. were prevented or postponed, there will also be some tax increases taking effect already this month in the form of higher marginal income tax rates and limitations of deductions for the rich and the expiration of the payroll tax cuts for the middle class will in fact be implemented, something that in turn means that real disposable income will fall significantly this month.

When real disposable income falls, people have two choices: either they cut back on their spending or they reduce their saving. If people acted according to the Ricardian equivalence theory, income reductions due to higher taxes and/ or lower government spending, the result will simply be a reduction in the savings rate.

Based on previous experience it seems nearly certain that it will be a combination of the two choices: both the savings rate and consumer spending will fall. The exact proprtion to which savings will fall and consumption will fall is however a lot more uncertain. With the savings rate only about two percentage points above the lows of the housing bubble, it would however seem that there's not much room for big reductions in savings.

Summary Of 2012 Exchange Rate Movements

It has become an annual tradition here to summarize yearly exchange rate movements for some selected major currencies.

In 2012, the U.S. dollar fell against most other currencies, with only the Indian rupee, the Brazilian real and the Japanese yen falling in value against it. The yen's big drop was the by far most dramatic change, followed interestingly by the big increase for the South Korean won. Since Japan's and South Korea's economies are specialiced on very similar things, like electronics, ships, and cars, and because they therefore are direct competitors to each other, this will create some problems for South Korean companies.

It should however be noted that the won's big increase in value relative to the yen comes after several years of big drops, and compared to a few years ago, the won is despite the big rebound in 2012, significantly weaker compared to the yen.

(The changes below are changes relative to the U.S. dollar)

South Korean won: +9%
Norwegian krone: +7.3%
Singapore dollar: +6%
New Zealand dollar: +5.9%
Swedish krona: +5.6%
British pound: +4.7%
Swiss franc: +2.4%
Canadian dollar: +2.1%
Euro: +1.6%
Australian dollar: +1.4%
Yuan: +1%
Indian rupee: -3.4%
Brazilian real: -9%
Yen: -11.1%

Would $1 Trillion Platinum Coin Be Inflationary?

Now that "the platinum coin option" for circumventing the debt ceiling that I discussed in the previous post has been become increasingly popular among leading liberal pundits, the economic consequences of such a move should be considered. More specifically, what is the effects on inflation.

At first glance it would appear that this must be very inflationary. After all, such a move would constitute direct money printing (or minting more accurately) to finance deficit spending. However it should be noted that because the coin would be left in the Federal Reserve, it wouldn't really be part of money supply, and would therefore not mean a direct expansion of money supply.

It would however become a part of the monetary base, and an increase in the monetary base will ultimately cause money supply to increase, something that of course would be inflationary. However, if the Fed decides to counteract this by selling bonds from their current $3 trillion holdings of bonds, the monetary base would be unaffected meaning that this wouldn't have any inflationary implications.

However, if the Fed did that then we would in fact have a government agency selling bonds to finance the deficit, same as if the debt ceiling had been increased, except that it's the Fed selling the bonds instead of the Treasury department, illustrating how the debt ceiling is effectively repealed, using the Fed and that platinum coin as a loophole.

On The U.S. "Debt Limit" & "The Platinum Coin Option"

Now that the U.S. debt limit has been reached again depite being raised by $2.1 trillion (to $16.4 trillion) less than 1½ years ago, the limit and possible ways for Obama to evade it if House Republicans refuse to raise it have been debated, so I will offer some thoughts on the issue here.

On the one hand, I sort of agree with those liberal critics who argue that it makes no sense for Congress to on the hand make certain taxation and spending decisions and then to make a decision about debt unrelated to that. Since the change in debt is an arithmetic result of the difference between spending and revenue, making two decisions could be seen as a denial of the laws of arithmetic.
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However, this doesn't necessarily mean that the debt limit is illegitimate, it could just as well imply that the decisions authorizing unlimited deficit spending are illegitimate. After all, most people have actual or potential debt limits in terms of how much creditors are willing to lend them. This means that one has to try to increase one's incomes or reduce spending once one comes near the limit. Regardless of whether one thinks that would be a good policy for the government or not, it is certainly consistent with the laws of arithmetic to adjust revenue and spending policies instead of doing away with the debt limit.

And as it happens, the debt limit represents the best chance of achieving what the talks of the "fiscal cliff" utterly failed to achieve (indeed, they in fact quite to the contrary resulted in higher spending): namely lower spending in exchange for a higher debt limit. That was in fact what happened at the latest drama over the debt limit in 2011, though none of the cuts have actually been implemented yet.

However, "best chanse" doesn't mean it will actually happen. Obama and the Senate Democrats have in fact several options to prevent spending cuts. One is to simply refuse to negotiate, which is the current White House official policy, and hope that Republicans, out of fear of being blamed for the negative consequences,  will simply surrender once all established tricks to evade the debt limit has run out, This will however most likely not work.

 There are two ways of evading the limit that have been widely dsicussed. One is to envoke the 14th amendment to the U.S. Constitution, that says “the validity of the public debt of the United States, authorized by law… shall not be questioned.”. It is doubtful that this can really be used to ignore the debt limit. After all, tax revenues are more than enough to pay for interest oayments  so there is no need to default on debt payments even if the ceiling isn't raised. To use this amendment in this context one would have to consider Social Security and Medicare payments, and other decided upon spending, as "debt", and that seems like a long shot in legal terms. And for the moment at least, Obama seems to have decided against invoking this amendment with his spokesman Jay Carney clearly stating "This administration does not believe that the 14th Amendment gives the president the power to ignore the debt ceiling–period,"

Another way of evading the debt limit that have been proposed is to mint a (or several) trillion dollar coin(s), Mostly, only the Federal Reserve has the legal power to create money out of "thin air", and although the Fed is essentially a government agency it isn't so formally, meaning that it's money printing can't be used to evade the debt limit.

However, for some unexplained reason, the U.S. Constitution has left a loophole, allowing the U.S. Treasury to mint platinum coins of whatever denomination it likes. This could indeed be used by the Obama administration to finance spending even if the debt limit isn't raised. This option has recently been endorsed by several leading liberal pundits, including Matthew Yglesias and Paul Krugman. Though the Treasury's ability to mint platinum coins clearly wasn't created for this purpose, nothing, as I understand it, in the law actually forbids it from being used that way, and the law says it can be denominated in any denomination, this seems like a more realistic option for Obama than invoking the 14th amendment. Whether Obama will actually do it remains to be seen however. Though Yglesias, Krugman and many other leading liberals support it, Obama might view this option as too unorthodox.

In conclusion, it remains to be seen how useful the debt limit will be. If Obama thinks "the platinum coin option" is too unorthodox to , he will be forced to agree to spending cuts, which would be good. If however he fears spending cuts, not to mention being considered a weakling and a pushover by his fellow Democrats more, then it could instead simply mean a new powergrab by the President

The Issue Of Latvia's Recovery

Today statistics Latvia reported that both retail sales and industrial production in Latvia increased by more than 1% in real terms in November compared to October. Compared to November 2011, retail sales increased 8.7% and industrial production increased 3.9%. For industrial production, it would have increased a lot faster had not the largely weather-controlled utility production declined so much, manufacturing alone increased 3.5% compared to the previous month and 7.9% compared to a year earlier. This clearly suggests that Latvia's strong recovery didn't slow during the fourth quarter.

Which brings us to recent the controversy over how Latvia's strong recovery should be interpreted.
Both Paul Krugman and Matthew Yglesias criticize again the view that Latvia shows that austerity can lead to economic success, using the argument that GDP and employment is still significantly below the 2007 peak levels. However, as I wrote a few months ago:

 But the issue here isn't whether or not Latvia should be content with the current state of affair in its economy, as far as I know no one has asserted that they should be (and I certainly don't think they should be content). The issue is what effect the austerity measures had, and when you evaluate a certain policy, you should compare current GDP and unemployment not with some previous cyclical peak, but with the point in time when the policy was implemented. And Latvia didn't implement austerity in 2007 or 2008, they implemented them mostly in 2010 and 2011. And GDP grew and unemployment fell significantly in both 2010 and 2011.

Krugman really just pretends to not understand this, because he has tried to make a similar argument about Iceland. Iceland like Latvia had a deep slump, from which it has, again like Latvia, partially but only partially recovered. Yet the fact that the recovery has only been partial hasn't stopped Krugman from using it as evidence for the conclusion that currency devaluation works. That is despite the fact that the actual data provides no support for that causal analysis as most of the slump came after the devaluation, and recovery started only nearly two years after the currency had stabilized .

BTW, Yglesias is wrong in stating that Latvia's cumulative recovery has only been 5%, it's actually been more like 15%

Obama On Increasing The Debt

Here is Obama on increasing the national debt:

The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. It is a sign that the U.S. government can’t pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance our government’s reckless fiscal policies. . . . Increasing America’s debt weakens us domestically and internationally. Leadership means that ‘the buck stops here. Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better.

Of course, when he said that he was a Senator and the President was Bush Jr. Yet later as President, Obama has under 4 years increased the debt by $5.8 trillion, from $10.6 trillion to $16.4 trillion, almost as much as the $5.9 trillion increase during an 8 year period under Bush Jr.,and more than the $4.7 trillion that all previous Presidents before Bush Jr. and Obama. Now tell us again, Obama, what was the increases in debt and debt limits a sign of?

The Giant Absurdity That Is Washington D.C.

Here is Obama's statement on the "fiscal cliff" deal:

This agreement will also grow the economy and shrink our deficits in a balanced way – by investing in our middle class, and by asking the wealthy to pay a little more.

What's more, today's agreement builds on previous efforts to reduce our deficits. Last year, I worked with Democrats and Republicans to cut spending by more than $1 trillion. Tonight’s agreement does even more by asking millionaires and billionaires to begin to pay their fair share for the first time in twenty years.  As promised, that increase will be immediate, and it will be permanent.

There’s more work to do to reduce our deficits, and I’m willing to do it. But tonight’s agreement ensures that, going forward, we will continue to reduce the deficit through a combination of new spending cuts and new revenues from the wealthiest Americans.

Come again? This deal means that revenues will be lower and spending higher compared to existing legislation. It therefore increases the deficit, yet Obama depicts it as a deficit reducing agreement.  I wonder if Paul Krugman who criticized Starbucks CEO Howard Schultz for a similar misleading statement will criticize Obama for it too. Somehow I doubt it.

Yet even as they make a deal to increase the deficit and therefore also the debt, they didn't raise the debt ceiling. The politicians in D.C. seems to think they can decide to spend a lot more than what they earn without increasing their debt. In other words, they don't think the laws of arithmetic apply to them.

But of course, they do apply to them, which is why we will see another one of these absurd spectacles of last minute "negotiations" in a few months again, which will probably just mean more multi trillion dollar increases in the so-called debt limit combined with promises of future spending cuts that themselves will be stopped in yet another last minute spectacle just before they're about to be implemented.