The Great Dakota Divergence

In 2012, state personal income grew fastest (for the fifth year in the latest six year period) in North Dakota, as much as 12.4%. Meanwhile, South Dakota saw personal income drop by 0.2% .

Both numbers are before inflation adjustment and compares with a national average of a 3.5% increase (also unadjusted for inflation).

The secret behind North Dakota's spectacular boom can of course be summarized in three letters as "O-I-L". I am however not so sure why South Dakota did so badly this year. but it might just be something temporary as it had above average (though still well below the North) growth last year.

"But This Time We Mean It"...Or Maybe Not

When the euro was created there was a number of criteria countries that wanted to join had to meet, most notably regarding budget deficits and debts. But in the end, they decided to ignore it, as only Luxembourg of the original 11 countries met all the criterias, and neither did Greece when it 2 years later joined even according to the official numbers (as Greece "cooked its books" the real numbers were of course far worse).

And then later, as the two biggest countries, France and Germany, exceeded the 3% limit, they used the political  influence that goes with being the two biggest countries to avoid the punishment they according to the rules were supposed to have, using the argument that the problems were only temporary and that they'll better themselves.

Germany actually did  better itself,  as is illustrated by how Germany has had the highest per capita GDP growth in Western Europe in the latest 5 years and has in sharp contrast to almost all others achieved a balanced budget and dramatically lowered unemployment.

However, France didn't better itself quite as much (and has since Francois Hollande unfortunately became President in fact taken a turn for the worse), and what's worse, this violation of the rules made others, including Greece, feel that they can break the rules as well, causing, together with the fraudulent accounting practices of the Greek government, the Greek crisis, that indirectly created problems elsewhere, and very directly caused the problems in Cyprus.

To supposedly ensure that something like what happened in Greece won't happen again, they decided upon a new "stability pact" which set specific deficit targets for all countries. Now France is violating it again, and it seems like despite the pledges that "this time we're serious" they will again let it pass.

This doesn't mean that France will go unpunished. If there's one thing recent events has told us it is that it is dangerous to engage in fiscal profligacy if you don't have your own printing press, though France so far has gotten away surprisingly and undeservingly easy. But this again illustrates that when governments tries to show their commitment to responsibility by pledging to follow certain rules, it is worth nothing, if the people who evaluate whether the rules are followed are the politicians themselves.

This is a lesson not just applicable to euro area "stability pacts" but also to inflation targets in for example Britain.

Sharp Increase In British CA Deficit

The British current account deficit rose sharply in 2012, from £20.2 billion in 2011 to £57.7 billion in 2012, reflecting both a bigger trade deficit and that Britain's  factor income surplus was nearly wiped out. In the fourth quarter alone, the deficit increased to £14 billion, from £5.3 billion in Q4 2011.

At least three points can be made of this. One is that, just like the high inflation rate it indicates that domestic demand isn't that weak, it's just that it has only resulted in a higher external deficit and inflation. Another is that   the sharp drop in the factor income surplus indicates that national income is even weaker than GDP. And finally, this is another indication that the pound was significantly overvalued last year.

Berezovsky & Trotsky

As I've pointed out, Russia's leader Vladimir Putin is the patron of Russia'a oligarchs. The Russian oligarchs that remains, that is. When Putin established his current semi-dictatorship, he made sure to dispose, one way or another, of all oligarchs that opposed him, such as Boris Berezovsky and Mikhail Khodorkovsky. Berezovsky was exiled in a manner similar to how Joseph Stalin exiled Leon Trotsky and Khodorkovsky was jailed on charges which was probably true, but wouldn't have been put forward if he had pledged his allegiance to Putin. Now Berezovsky, who was exiled in a manner similar to Trotsky's, suddenly dies in exile for unknown causes. Most likely an ice axe wasn't used, as it was in Trotsky's case, and it is of course possible that Putin wasn't involved at all. But the similarity of a key opponent that was exiled and then died are too clear not to at least awaken some suspicion...

"Surprise" ! Irish Tax Increases Boost Cigarette Smuggling

While things continue to be bad in Spain, Portugal, Italy and Greece, and things have taken a dramatic turn for the worse in Cyprus, Ireland is seeing most things improve.

2012 featured a significant drop in unemployment, a faster GNP increase than any non-Baltic EU country and a record current account surplus.

However, the Irish governments attempt to increase revenue by soaking its smokers is not going well:

Cigarette-smuggling continues to soar in Ireland, with new Department of Finance figures showing that tobacco excise tax receipts are falling dramatically short of targets, even though taxes have increased and the number of people smoking has remained constant at 29 per cent of the population...

..Criminal gangs are openly selling smuggled cigarettes on the streets of central Dublin and other cities, door to door and at fairs and markets. Counterfeit cigarettes can be brought to the Irish market at a cost of just 20 cents a pack and sold on the black market at €4.50. The average selling price of legitimate cigarettes is €9.20 a pack....

....Ireland has the most expensive cigarettes in the European Union, meaning that smugglers can make big profits by offering them at cheaper prices. 

Cyprus Is In No Position To Demand Concessions

Two things in combination have, barring extreme altruism or stupidity from other countries, made losses for depositors in Cyprus of some kind almost inevitable (apart from maybe the Russian solution discussed in the end of this post).

First, Cyprus created an extremely oversized banking sector, with balance sheets multiple times its annual GDP, by becoming a haven for Russian oligarchs and other foreigners. This was made possible in part because it had low tax rates, but more importantly because it didn't ask any.questions of how their depositors got their money, enabling so-called "money-laundering".

Second, EU leaders thought that it would be a good idea to "solve" the fiscal problems of Greece by making private bond-holders "agree" to a "voluntary" write-down of the value of its debt- The problem is that one institution's debt is another's asset, and with Cypriotic banks heavily invested in Greek debt due to Cyprus' close ties to Greece, this meant that Cypriotic banks made heavy losses. In short, the "solution" to the Greek problem caused the Cypriot problem we're now discussing.

As a result, Cyprus' banks lost sums of money  that were enormous relative to the small size of Cyprus' economy. It seems in fact that the losses were nearly as large as the size of Cyprus' annual GDP. It's as if America's bank required a capital injection of $15 trillion.

There is simply no way that Cyprus can pay for this on their own. It's government's debt has, quite rightly, been designated junk status so the government can't borrow the money on its own. There are basically only three ways to solve this:

1) Other countries lend Cyprus the money
2) Cyprus decides to formally "haircut" the value of deposits one way or another.
3) Cyprus  reintroduces the Cypriotic pound, and decrees that some arbitrary conversion rate between euros and cypriotic pounds be made, and prints the money to pay for it.

The now rejected deal meant basically two thirds of option number 1 and one third of option number 2. So contrary to the widespread perception that depositors were "sacrificed", it actually meant that Germany and others decided to reduce their pain by two thirds compared to what would have happened otherwise.

While Germany and others have rightly signalled that it is up to the Cypriots to decide the relative distribution of the burden, they would be wrong to make any concessions whatsoever regarding the fact that at least this must be raised. Arguably, they were far too generous to begin with.

The fact is that because Cyprus can't borrow any money on its own, it has no bargaining power at all. If there is no deal, it will be Cyprus who will see its banking system collapse, while the damage to the rest of Europe will be neglible. The alternative, if Cyprus remains in the euro area, is a three times bigger dose of option 2).  We would then be talking about a reduction in deposit value of  at least 20-30%, compared to the 6.75% to 9.9% proposed in the initial deal.

But what if it exits the euro and reintroduces the Cypriotic pound? Well, that wouldn't solve the problem directly if Cyprus follows international law because the deposits are in euros and a reintroduced Cypriotic pound would fall catastrophically in value, especially if the purpose is to monetasize the bank bailout by money printing, causing the debt to quadruple in value in terms of Cypriotic pounds.

But what if they say that the accounts should be converted into Cypriotic pounds according to some arbitrary obviously overvalued exchange rate? Well, then it might be possible to formally finance it. But since the new Cypriotic pound would plummet in value by at least 30.-40% against the euro, this means that the value of deposits would be reduced by 30-40%.

And as that would also likely mean a lot of legal problems, that could possibly mean that Cyprus would be kicked out of the EU, causing them to also lose their access to the EU market and all the subsidies from the EU budget.

So, there is simply no option for Cyprus apart from a deal which wouldn't result in losses for depositors that would be multiple times larger than the one negatotiated. Except for perhaps that other EU countries either out of extreme altruism or ignorance of their strong bargaining position caves in , something that would be very unwise for them. And judging by the intial signals from Germany that insight seems to be present.

The only remaining possible solution would be if the Russian state, out of a desire to bail out its oligarchs, step in with the money. If so, then Cyprus and the Russian oligarchs will be happy, but regular Russian taxpayers will rightly feel that they've been ripped off.

The Worst Endorsement Cyprus Tax Opponents Could Get

The key reason why Cyprus, unlike other bailed out countries, has been ordered to impose a steep one time tax on deposit holdings is of course because Cyprus has a reputation for being a bank center for Russian oligarchs of considerable wealth, and considerable crookedness. And so, bailing out the banks of these Russian oligarchs would be interpreted as bailing out the oligarchs. And to say that it would be a "tough sell" to get support for what is perceived as the bailout of oligarchs in the countries bailing out Cyprus is the understatement of the year.

The only way to make a bailout politically acceptable then was to make sure that the oligarchs would pay.

Anyway though, the point is that the more this is perceived as punishing Cypriot savers the more opposition will there be against the tax, and the more this is perceived as punishing Russian oligarchs the more support will there be for it. And so the last thing opponents of the tax needs is anything that creates the perception that opposition to the tax is based on a desire to protect the oligarchs.

And so what does, Vladimir Putin, patron of the oligarchs (those who support him that is, those that didn't have been disposed of) do? Express outrage over the tax! Not what those fighting against it needed....

Regional Differences In Outcome Only Natural

A rather strange discussion has arisen in the "Macromania" blog run by David Andolfatto. Andolfatto notes that Germany has in recent years had a lot stronger growth than most other euro area countries (Though at least three countries, Slovakia, Luxembourg and Austria, has had even stronger growth) and argues that this is an argument against Nominal GDP(NGDP)-targeting, to which one advocate of the rule, David Beckworth argued that this reflects that the euro area isn't a "optimal currency area" and that the ECB has geared toward the German economy.

Both sides mistakenly assume that it is somehow unnatural for there to be regional differences in outcome within currency areas. But it's not. Quite to the contrary, because some behave better or are more lucky (meaning usually that they, like North Dakota, have found rich natural resources) while others behave worse (think Greece) or are more unlucky, it is basically unavoidable for regional differences to develop. And that will happen regardless of whether it is a "one country-one currency" currency area or a monetary union and it will happen regardless of whether the central bank targets NGDP or not.

Within the U.S., for example, cumulative real GDP growth in the period 2008-11 ranged from  29.7% in North Dakota and 7.2% in Texas  to -8.2% for Michigan and -9% for Nevada.  The difference between North Dakota and Nevada is almost as large as the difference between the strongest (Luxembourg) and weakest (Greece of course) euro area country

And such differences doesn't just exist within large countries like the U.S. NGDP growth in Sweden ranged in the 2007-2010 period from 4% in the Blekinge region to 23% in the Norrbotten region.

And even within these areas large geographical differences exists, with the cities in North Dakota that has oil drilling likely growing a lot faster than those without, and the parts of Norrbotten where new mines were opened similarly grew a lot faster than those which had no mining activity.

Indeed, any currency area that consists of more than one person and doesn't impose complete economic equality will have internal differences in economic development. Whatever you may think about NGDP targeting or multi-national currency unions on other grounds, the existence of internal economic differences isn't an indictment of them as that exists in all currency areas, whether they consist of only one state or several, and regardless of whether they target NGDP or not

Why Hasn't Japan Gotten Inflation Yet?

The Japanese yen has fallen sharply in the latest year. The exact percentage differs of course depending on which currency you relate it to, but we're talking about a drop of about roughly 20% against the currencies of the three biggest currency blocs (The United States, the Euro Area and China).

That would normally sharply increase inflation, yet so far there is no sign of it. The yearly change in consumer prices remained below zero in January (-0,2%) and the preliminary estimate for the Tokyo area in February showed an even bigger price decline.

While pro- and antiinflationists disagree over whether more inflation is good or not, few, if any economists dispute that a sharp drop in a currency's value will, other things being equal, raise price inflation.

This is in part because a weaker currency will raise import prices. That will in turn raise consumer prices mostly because imported goods will become more expensive, but also because higher import prices will make domestic producers more likely to raise prices as their competitors prices have risen and as their input costs have risen.

But it is also because it raises nominal incomes of exporters, putting upward pressure on prices.

So why hasn't it happened yet?

One reason is that Japan is a surprisingly closed economy. Both imports and exports constitute only 15% of GDP, roughly in line (slightly higher for exports, somewhat lower for imports) with the percentage for the United States. By contrast, Britain and France for example have trade flows of about 35% of GDP and Sweden and Germany has trade flows of about 50% of GDP As a result, the aforementioned mechanisms will have a lot less impact on the overall economy than a similar sized devaluation would have in typical European countries..

A second reason is that many companies that engage in cross border trade purchases various derivatives to trade away short term exchange rate risk, meaning that the impact on consumer prices will come with at least a few months lag.

A third reason is that companies sometimes apply "pricing to market" principles. If they think that a currency drop will only be temporary they choose not to raise prices to avoid losing market share even if this lowers margins to unsustainably low levels. The companies reckon that if the currency recovers it could be difficult to win back market share so its best not to lose it in the first place. Ultimately the exchange rate movement will however pass through if it is sustained and if it's not the recovery will not result in price cuts so the weaker currency will make future inflation higher than it otherwise would have been.

So, we should still expect the yen weakness to push inflation in Japan back above zero. However, the increase will be a lot smaller than it would have been in a European country and comes with a significant time lag.

Latvia Gets Itself In Euro Through Lower VAT

While there is talk in some euro area countries, , most notably Italy, about exiting the euro, Latvia remains determined to join in 2014. Since Latvia has for a long time pegged its currency, the lat, to the euro this wouldn't mean any loss in monetary policy independence, only that the transaction costs associated with a separate unit would disappear.

However, unlike those who have already joined, Latvia is forced to meet certain criteria. It has no problem meeting the criteria of exchange rate stability, or the fiscal criterias, but it does face the potential problem of having too high inflation. Since it can't have inflation more than 1.5 percentage points above the average of the lowest three EU-countries (including those with independent floating currencies) and since Latvia has the fastest growth in the EU (more than 5% at a time when most other countries have negative growth), and since given a fixed exchange rate higher growth tends to be associated with higher inflation (because of for example the Balassa-Samuelsson effect), this raises a potential obstacle to euro entry.

However, it would seem that there is in fact no problem. Latvia's inflation was only 0.3% in February, the second lowest (after Greece). But how could inflation have fallen so much even as growth was high? Simple, they decided to do the opposite of what the Southern European countries have done and lowered taxes, especially the VAT. A lower VAT will provide a positive supply shock and lower prices while also boosting real income.

That the purpose of this VAT cut was to lower price inflation just in time for when it will be decided if Latvia meets the criteria is evident by the fact that it was implemented in July 2012, just in time for the annual average inflation rate to be lowered when the meeting about Latvia's entry will be held during the early summer. And indeed, Latvian officials are admitting that a key purpose of the VAT cut was to qualify Latvia for the euro.

Not All Austerity Is The Same

Alberto Alesina and Veronique de Rugy points out that tax increases are a far worse method to reduce deficits than spending cuts, and that part (Italy also has deep structural problems) of Italy's problem lies in the fact that it has relied almost entirely on tax increases. If Italy is to recover, it needs to reduce spending and tax rates while addressing its structural problems. Unfortunately, the politicians who won in the latest elections are extremely unlikely to do so.

Venezuela, Inequality & Crime

Some leftists might, reluctantly, concede that recently deceased Venezuelan President Hugo Chavez, was somewhat authoritarian in dealing with his political opponents, befriended the worst dictatorships of the world and had a far worse economy than other oil exporters.

But at least he was successful in reducing poverty and inequality, they would counter. That seems to be true. Though Venezuela's economy has been much weaker than other oil exporters, the sky-rocketing price of oil since Chavez took power still means that Venezuela has become richer. And because Chavez has used that oil wealth to spend money on the poor, inequality and poverty has in fact declined. Because of this, Venezuela is according to some estimates the most economically equal country in Latin America now.

Yet, even as inequality has dropped, violent crime has increased sharply (from an already very high level) since Chavez took power. This observation is particularly interesting considering the leftist theory that crime is caused by inequality.

Ding Dong, The Commie's Dead

I know that it is customary to not say anything negative about people who die, but we're talking about someone who the nicest thing you can say about him without lying is, well, "a person that Marxists and various repulsive dictatorships liked".

Hugo Chavez' policies were about as bad you can get, with a foreign policy whose principle was to suck up to Iran, North Korea and various other dictatorships and a domestic economic policy, which turned what could have been a success story considering its oil wealth, in to a big mess with sky-rocketing inflation ans widespread shortages while seriously restricting free speech.

We can only hope that whoever ends up succeeding Chavez is less crazy (or better yet, sensible).

Quote Of The Day

Former Ronald Reagan Budget Director David Stockman describes his investment strategy:

“I invest in anything that Bernanke can’t destroy, including gold, canned beans, bottled water and flashlight batteries,"

It seems to me that practical difficulties in profiting from purchases in canned beans, bottled water and flashlight batteries exists, but the underlying point that real assets is the only safe way to protect invested money from the inflating of Bernanke and other central bankers is certainly a valid one.

Dramatic Drops In Southern European 2012 CA Deficits

The Southern European crisis economies had a really awful 2012 in terms of production and employment, but they at least saw great progress in reducing its external borrowing. Here are the final numbers on current account balances, with the 2011 number in parenthesis

First, in euros
Greece: -€5.6 billion (-€20.7 billion)
Portugal: -€2.6 billion (-€12.0 billion)
Spain: -€8.3 billion (-€37.5 billion)
Italy: -€9.5 billion (-€48.4 billion)

Second, as a percentage of GDP
Italy: -0.6% (-3.1%)
Spain: -0.8% (-3.5%)
Portugal: -1.6% (-7.3%)
Greece: -2.9% (-9.9%)

Italy and Spain saw the biggest drops in absolute amounts, but relative to GDP, Portugal and Greece in particular saw far greater drops. It seems likely that all countries will have surpluses in 2013. Which means that there is "light at the end of the tunnel" for them, as first the Baltic countries and then Ireland saw their slumps end and recoveries start after they had achieved external surpluses.

U.S. Savings Rate Down To Housing Bubble Lows

The U.S. savings rate fell dramatically in January, from 6.4% to 2.4%. This mostly reflected the fact that income and savings was temporarily boosted in December by advance salary and dividend payments in anticipation of higher tax rates, but it also seems that for January, Ricardian equivalence was mostly confirmed.

Indeed, one could argue that it was entirely confirmed as spending didn't fall at all, while the savings rate fell sharply not only from the December level but also from the levels earlier in 2012. However, as some of the salary and dividend payments that were made in advance in December would have normally been made in January, it would seem that underlying income (and therefore also savings) was probably somewhat higher than formal income. We will have to wait a few more months to see if the savings rate recover.

If it doesn't, then it is at a ominously low level, as the household savings rate was 2-2.5% during the housing bubble, the same level as in January.