Wednesday, May 31, 2006

Inflationary Pressures Continues to Accelerate in Europe

The latest statistics all show that inflation is worsening in the Euro-zone and that the ECB because of its far too slow pace in raising rates ( roughly a quarter point every quarter year, it seems) therefore risks "falling behind the curve".

M3 money supply for example, rose with 8.8% in April compared to a year earlier, way above the 4.5% the ECB is supposed to target. Private sector debt growth rose to 11.3%, way above nominal growth levels in output and income.

Mmeanwhile, the preliminary estimate of May consumer price inflation rose to 2.5%, with Spain as usual having the highest number at 4.1%.

The ECB can only blame itself, by keeping down rates at the far too low level of 2% until late last year, and then raising rates far too slowly.

Meanwhile, as "loose" as Euro-zone monetary conditions may be, they are even worse in Sweden, with M3 money supply growth accelerating to 11.9% and bank lending growth accelerating to 17.5%. Consumer price inflation numbers are not yet available for May, but they most likely rose from their multi-year high of 1.8% in April.

Consumer price inflation in Sweden have for the last few years been held down by increased competion and deregulation of the retail sector, but with monetary policy being as loose as it is now, even this factor should not be able to prevent consumer price inflation from rising above the 2% that the Riksbank aims for.

Thursday, May 25, 2006

Mixed News From U.S. GDP Revision

The revised number for U.S. GDP growth for the first quarter came in at an annualized 5.3% versus the fourth quarter of 2005 and 3.6% versus the first quarter of 2005. This was higher than the 4.8% annualized quarterly rate initially reported, but a lot lower than the average market forecast of 5.8% (with some analysts predicting a number of over 6%).

The reason why the number came in lower than predicted was that some of the boost from a downwardly revised trade deficit and upwardly revised inventories was cancelled out by lower consumer spending and business investments.

Looking past the headline number, the details offered both positive and negative news for the U.S. economy.

The big positive was that corporate profits continued to power ahead, with after-tax profits (adjusted for capital consumption) rising 8.8% (which to make the number comparable to the GDP numbers is 40.1% at an annual rate)in nominal terms compared to the previous quarter and 24.8% compared to the first quarter of 2005. At $1155.1 billion, net corporate profits are now over 10% of national income for the first time ever. By comparison corporate profits were 8.3% of national income in 2003, 8.6% in 2004 and 8.9% in 2005. At the previous cyclical peak in 1997, corporate profits were only 8.5% of national income.

This is certainly very bullish for the prospects for business investments, which is indeed booming. However, while corporate profits are one important factor determining business investments, there are other factors involved too. Interest rates is another important factor and that factor is currently working in the other direction. And the sluggish stock market indicates that there is increasing worry that the current high profit levels won't last. Still, the short-term outlook for business investments is nevertheless positive as the record high profitability levels combined with rising capacity utilization outweighs the higher but still fairly low interest rates and the increasing but still not high level of pessimism about the future profit outlook.

There could however be negative political implications from the shift in the distibution of income from workers to the owners of capital that these statistics again confirm. The falling ratings for Bush in terms of handling the economy despite strong growth largely reflects the increasing income inequality that this implies and this could lead the way to large Democratic gains in November's congressional election and in 2008, something which in turn could lead the way for big tax increases, protectionism and increased regulations.

The big negative in the report is that the household savings rate fell sharply, to -1.3% as personal income was sharply downwardly revised. Apart from the low reached during the third quarter of 2005 due to Katrina-related costs, this was the lowest since the Great Depression. This, combined with higher interest rates and higher prices of oil and other commodities does not bode well for consumer spending, which will likely slow sharply again in the second quarter. Although the savings rate is arguably underestimated due to the fact that it does not include individual's stake in retained corporate earnings, it is still ominously low even taking that into account.

Estonian Job Growth: 6.8%(!)

In a very sharp contrast to the dismal employment report from Sweden discussed in the previous post, Estonia reported that job growth was an extraordinary 6.8%(!). This meant that despite a significant increase in the labor force participation rate, the unemployment rate fell from 9.5% to 6.4%.

UPDATE: And the jobs that are being created are, it should be noted, increasingly well paid. Average monthly wages during the first quarter of 2006 rose a full 15.7% and average hourly earnings rose 13.8% (that the monthly number increases more indicates that the average work week increases) compared to a year earlier. Deflated by the 4.4% average inflation rate during the first quarter, this means that real hourly wages rose 9% during the first quarter, with real monthly wages rising 10.8%.

Wednesday, May 24, 2006

Disastrous Swedish Employment Report

Today the Swedish statistical bureau released the employment report (more details in the Swedish language version ) for April 2006 in Sweden. And it was bad, really bad.

What do you mean by "really bad", someone might ask. Employment did rise, albeit only slightly, compared to last year. Yes, but first of all that small increase was in fact lower than the population increase and in fact so small that the increase is within the statistical margin of error. This means that the employment rate in fact fell somewhat.

And as Johnny Munkhammar points out in an op-ed column in Svenska Dagbladet today, this is during a cyclical peak. Global growth is at 5%, well above the average for the last decades, something which have of course benefited the Swedish economy.

Moreover, it could be added that in the case of Sweden, this have been re-inforced by the inflationary policies of the Swedish Riksbank. During the last 2½ years, they have lowered interest rates, while most other central banks have raised them. As a result, money supply and credit growth have been even higher than in the Euro-zone (that saying a lot).

That implies that there is an even stronger cyclical element in Swedish growth than in the rest of the world. And yet, during this time, when both strong global growth and a loose domestic monetary policy have pushed growth way above sustainable levels, job growth is still near zero and total unemployment is still increasing slightly.

Imagine then what will happen when global growth slow down and/or rising consumer price inflation forces the Riksbank to significantly raise interest rates.

Some would perhaps explain this in a neo-Luddite way, that technological progress is enabling companies to increase production while still reducing the number of workers. But while it is true that productivity is increasing fast in manufacturing, this does not prevent other countries from experiencing robust job growth. Neighboring Finland for example saw employment growth of 2% and significantly reduced unemployment during the same period.

The reason why job growth is so slow is that the labor-intensive private service sector is inhibited by high taxes, taxes which in effect functions as internal tariffs and destroy private service sector activity for much the same reason that international tariffs decreases international trade. This is re-inforced by high minimum wages and high unemployment benefits.

Until and unless Sweden deals with these structural problems, high unemployment is here to stay and could get even worse during future cyclical downturns.

Tuesday, May 23, 2006

Hong Kong Growth Accelerating Again

Just like in America,where growth slowed significantly in the fourth quarter of 2005 only to increase significantly in the first quarter of 2005, so did Hong Kong growth re-accelerate in the first quarter after slowing down significantly. Volume growth was nearly 10% at an annual rate in the first quarter, after 2.5% in the fourth quarter.

Year over year growth was 8.2% in volume terms or 6.2% in terms of trade adjusted terms, far higher than in all Western countries. One possible source of worry was that the decline in the role of government spending slowed, but given the fact that it is far lower than in the West, that is of lesser importance from an economic point of view.

Meanwhile, mainland China revises up first quarter year over year growth from 10.2% to 10.3%.

Chinese And Indian Boom Benefiting Other Poor Countries Too

A new report from the OECD says that the boom in Asia, particularly China but also India and other in South Asia and East Asia is not only greatly reducing poverty there but also in Africa, a continent where per capita income have fallen behind and poverty risen in recent decades, largely due to the destructive policies of dictators like Robert Mugabe.

Although China and India competes with African countries to some extent, this is -at least for Africa as a whole- more than outweighed by how China and India first of all provides cheap consumer goods, secondly how they provide investment capital for Africa and most importantly how they raise commodity prices. Africa as a whole are net exporters of commodities and they benefit for that reason from rising commodity prices just like Canada , Australia and Norway do.

It could also be added that the higher commodity prices have benefited another poor region, Latin America too, with for example Chile (Copper), Mexico (Oil and Silver), Venezuela (Oil) and Brazil (Agricultural commodities like soya and beef) benefiting from improving terms of trade due to the commidty price rally.

Sunday, May 21, 2006

Germany's Destructive Tax Increase

I have a new article on the recently decided consumption tax (VAT) increase by the German government, where I point out how this will have a negative effect on Germany's already weak economy and that Germany's large budget deficit should be solved by lower spending instead.

Germany should learn from the experience of Japan, whose VAT increase in 1997 sent the economy into a recession, but whose recent deficit reduction through spending cuts have been associated with strong growth.

Denmark's Overrated "Flexicurity"

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Fascinated by business and economics? Check out an online PhDRecently, Denmark have become hailed as a role model for Europe, especially after the meltdown for the proposed modest liberalization of French labor markets. In Sweden, for example by both libertarian Johnny Munkhammar and social democrat Lena Askling. That both "right-wingers" and left-wingers" tries to hail a country is seemingly a sure sign it is successfull-and that it has a mixed bag of policies. Yet as we shall see, while it is true that its policies are mixed , Denmark's success is exaggerated.

Denmark pursues a policy known as "flexicurity"-combining the flexible "hire and fire" system of freer economies and the government-provided security that is traditionally associated with continental European and Scandinavian countries. While it is far easier to fire employees than in France and Sweden, unemployment benefits is in fact even more "generous" than in Sweden (Unemployed gets 90% of their previous pay in Denmark, versus 80% in Sweden).

But while "flexicurity" is certainly preferable to the pure "security" of France, there is no evidence that it is superior to the less "secure" economic systems in most "Anglo-Saxon" countries and East Asia.

While recent numbers show a relatively high GDP growth in Denmark and a official unemployment rate of only about 5%, these numbers mostly reflect a unsustainable housing bubble. If you look at Danish economic performance over a longer perspective, the numbers have been far less impressive. Between 1994 and 2004, Denmark had in fact a slightly lower growth rate than the average of the old 15 EU countries.

As for unemployment, the seemingly low numbers in Denmark reflect in fact the same kind of manipulation of statistics that the Swedish government have been using. While official unemployment in Denmark was only 133,500 or 4.8% in March 2006, there were in the fourth quarter (latest available number in Denmark's statistical data bank )some 117,600 people or 4.2% in so-called "arbejdsmarkedspolitiske foranstaltninger(="labor market political activities", what in Sweden is refered to as "AMS-åtgärder")". This means that Denmark have even more hidden unemployment in that respect than even Sweden, where "only" 3.2% (144,000) were put away in "labor market political activities" . And while the total level of hidden unemployment is still lower than in Sweden as Denmark have less people in early retirement and on "sick leave", hidden unemployment is still a lot higher than in most other OECD countries.

And while employment have increased at a healthy rate during the latest year, as Johnny Munkhammar himself showed in a recent briefing paper, performance seen over a longer time perspective have been far less impressive.In fact, employment growth between 1995 and 2003 was even lower than in Sweden, with only Germany and Austria performing worse among the "old" 15 EU countries.

It is true however that youth unemployment is relatively low in Denmark compared to most other European countries, reflecting how the ease with which employers can fire workers have made them less reluctant to hire young people with little or no work experience. Yet while this reflects the virtues of the "flexibility" part of "flexicurity", the fact that overall unemployment (including hidden unemployment is high) is high shows that it does not take away the damage created by the high unemployment benefits.

If between 1995 and 2003 Denmark performed relatively miserably, why have both GDP and employment growth picked up recently? In part, it is a result of the fact that while the burden of government spending is still far too high in Denmark, it have fallen significantly in recent years, as I pointed out in a recent post. In part, however, it is the result of a unsustainable housing boom.

While Denmark is not formally part of the Euro-zone, it have pegged its currency to the euro, meaning that its monetary policy is de fact decided by the ECB, whose monetary policy have been far too loose. Indeed, monetary conditions have been even looser in Denmark than in the Euro-zone as the robust public finances with a large budget surplus have created such confidence in the Danish currency that the Danish central bank have been
forced to expand the money supply even faster than the ECB in order to maintain the peg to the euro in the face of significant capital inflows. As a result, broad money supply growth was 16.9% in March versus 8.6% in the Euro-zone (And 10.9% in Sweden).

That in turn have resulted in house prices increasing 22% in Denmark, a clearly unsustainable rate of increase. Only Estonia had a higher increase in house prices, but in Estonia these house price increases can to a high extent be justified by the low inital prices and the double digit economic growth. When house price inflation halts or perhaps even reverses, Denmark's recent fast growth will end too.

To summarize, Denmark is not the economic role model or star performer that some people seem to think. Until recently, growth was weak and the recent upswing is mostly cyclical . And while the fact that youth unemployment differs less from overall unemployment than in the rest of Europe indicate that the "flexibility" part of "flexicurity" have helped Denmark, the high level of overall unemployment even during the current unsustainable cyclical upswing indicates that the "security" part of "flexicurity" have nevertheless created distortions.

Friday, May 19, 2006

Japanese GDP Report Mostly Strong

Today, the Cabinet Office in Japan published first quarter GDP numbers . It rose 0.5% (Which expressed as in American growth figures, at an annualized rate, is 1.9%) over the fourth quarter 2005 and 3% compared to the first quarter 2005. While this was weaker numbers than in the fourth quarter, both in terms of quarterly change and year over year change, it was still higher than the average forecast of 1.1% annualized quarterly change from economic analysts polled by Bloomberg News.

Moreover, while the numbers are not as impressive as in the fourth quarter, they are still quite good.

The big negative, apart from the slowdown, is the deteriorating terms of trade, which has been a constant theme in recent years as Japan imports all of its oil and almost all other commodities it need, the price of which have risen sharply in recent years. Meanwhile, Japan have a lot of high tech exports, which tend to fall in price. Adjusted for this, GDP growth was only 0.2% (annualized 0.7%) compared to the previous quarter and 1.7% compared to the first quarter of 2005.

On the other hand, Japan have a soaring investment income surplus, which cancels out nearly the entire effect of the deteriorating terms of trade, so the headline GDP numbers actually do reflect the magnitude of real income gains for Japan.

Moreover, as Japan have a shrinking population this makes any given growth number more impressive than in the EU (whose average population growth rate is 0.5%) and even more so America (whose population growth rate is 1%). Per capita growth have in fact been higher in Japan than in both the U.S. and the EU.

Furthermore, Japanese growth is entirely in the private sector. During the latest year, nominal private sector growth have been 3%, while government purchases have been reduced. This is in sharp contrast to America, where government purchase have increased faster than private sector growth. Thus, despite the fact that year over year GDP growth have been faster in America than in Japan (particularly after the likely upward revision of the American number),the amount of disposable money that the Japanese citizen themselves can spend have thus increased a lot faster than that of the average American citizen because of 1) Japan's investment income surplus have soared, while America's have been turned into a deficit 2) Because America's population growth is more than 1% higher than in Japan 3) Because America's government have expanded its influence in the economy, while Japan's have shrinked not only relative to GDP but in absolute numbers.

Thursday, May 18, 2006

Swedish Tax Authorities Outsources to Low-Tax Estonia

Swedish tax authorities have outsourced the production of commercials calling for people to file their tax returns over the Internet to low-tax Estonia.

When interviewed about the issue, the Tax Authority consultant responsible for this, Björn Ternström , said it was to take advantage of lower costs-something which he was forced to admit was partly because of lower taxes. With even the Tax Authorities trying to evade taxes, what better illustration could you get of the harm created by high taxes?

Wednesday, May 17, 2006

How Norway Contributes To Global Imbalances

Today is May 17th, Norway's national day, celebrating its independence from Sweden in 1905. I have today posted a article on Der Invest Informer about how Norway, being the world's third largest oil exporter with its de facto forced savings policy of recycling all oil revenues in foreign securities contrbute to global imbalances.

Peter Schiff on Why Asian Countries Should Let Their Currencies Rise

Peter Schiff of Euro Pacific Capital have a good article about why China and other Asian countries (including Japan ) should let their currencies rise in value relative to the dollar.

While it is a bit misleading to say that Chinese workers receive no benefit from the current boom as real wages and real retail sales is increasing at an annual rate of about 10% and while he overlooks the short-term disruptions that more expensive currencies would mean, he still stresses the important point overlooked by Asian governments: that stronger currencies would reduce the cost of imports (including oil) and so help boost domestic purchasing power and domestic demand, something which would largely offset the weaker trade balances that stronger currencies would mean.

And it could be added the point which I have emphasized: namely that with the U.S. economy likely to weaken significantly (perhaps fall into a recession) and with the increasingly protectionist Democrats set to make big gains in this year's congressional election, they are likely to lose exports to America anyway, but with a stronger currency they would at least be to some extent compensated by reduced import costs.

Markets Finally Realizing That Inflation Is Rising

Today there have been a massive sell-off in global bond and stock markets due to today's CPI report which showed a monthly increase of 0.6% in the all-items index and a 0.3% increase in the so-called core index, both of which where 0.1% higher than analyst's expectations.

Had they read this blog, they would have of course already anticipated this number. With the dollar falling, with commodity prices going through the roof, with labor costs increasing faster and with rents rising as the last few year's price boom have made owning a own home increasingly unaffordable, there is really only one way that price inflation can go: up.

So it is really a near certainty that price inflation will continue to rise. While there may be a temporary pause in that trend (at least in the official CPI and PCE deflator numbers) during some month, the above mentioned factors ensure that the trend will remain rising.

That in turn ensures that the Fed will have little choice but to keep raising interest rates, even though it knows that course of action risks sending the U.S. economy into a recession.

Tuesday, May 16, 2006

My Assumption About Luxembourg Was Correct

In several previous post ( see for example here,here and here) discussing the lie promoted by Swedish Finance Minister Pär Nuder and other Swedish Social Democrats that Sweden have had the highest growth in Europe, I pointed out that nearly all of the 10 new EU member states as well as at least 4 of the old (Ireland, Greece, Spain and Denmark) had in fact higher growth. I also wrote that it was almost certain that a fifth "old" member, Luxembourg, also had higher growth.

In the latest report on GDP growth in EU member states from Eurostat, it turns out I was right about Luxembourg. In the year to the fourth quarter, growth was a full 5.7% in Luxembourg, well above Sweden's 2.9%.

Monday, May 15, 2006

Japanese Investment Income Surplus Soars

Usually when I discuss economic growth I use the measure called Gross Domestic Product (GDP), even though it suffers from two short-comings: it does not take into account the losses from capital consumption and it does not take into account the flow of factor income (investment income and income from workers living in one country and working in another)from abroad. Despite my awareness of these problems I still use GDP for simplistic reasons: namely because it is the most readily available gauge (gauges that adjust for one or both of these shortcomings , like Net Domestic Product, Gross National Product and National Income are often hard to find) and because the changes in deductions from capital consumption and net factor income usually aren't big enough to make any significant difference anyway.

There are some exceptions however. When discussing the burden of taxes and government spending , one should always keep in mind that comparisons of them with GDP nearly always significantly underestimates the burden of government. The private sector cannot pay taxes with "income" derived from investments that just compensate for capital consumption. And because capital consumption usually amounts to 10-15%, this means that the real burden of government is about 15% higher than what government to GDP ratios suggest. Still though, as the level of capital consumption is fairly similar in most countries, this have little effect on international comparisons of the burden of government, as the burden of government would have to be upwardly revised to a similar degree in all countries.

And in some cases capital consumption do fluctuate enough to make a significant difference, like in the third quarter of 2005 in America when it rose sharply due to Katrina. This implied that growth was greatly exaggerated during the third quarter while being underestimated in the following quarter.

And in some cases, the flow of net factor income is significant enough to make a difference. One obvious example is Ireland, whose GDP is to a significant extent accounting fiction created by foreign (mainly American) companies that have founded holdings in Ireland to "buy" their own products for cheap from their continental factories (without shipping) and selling them for profit via Ireland - thereby reducing their taxes and increasing Irish GDP. GNP, which deducts these artificial profits, is therefore a much better measure of Ireland's economy ( who even after taking this distortion into account have been a great success story).

Meanwhile, some countries have a higher GNP than GDP. Switzerland for example have a higher GNP than GDP despite a negative income balance to foreign workers due to the massive investment income surplus.

In today's balance of payments report from Japan's Ministry of Finance, we can see how Japan's GNP is now increasing a lot faster than GDP due to a surging investment income surplus, in part the result of rising profits of the subsidiaries of Toyota and other large Japanese companies and in part the result of rising interest income from Japanese bond holdings.

In March 2006, the current account surplus rose to 2.4 trillion yen ($22 billion) from 1.8 trillion yen ($16.4 billion) in March 2005. Nearly the entire increase was due to a increase in the factor income surplus from 1.03 trillion yen ($9.4 billion) to 1.61 trillion yen ($14.6 nillion).

For the entire first quarter, the current account surplus actually fell somewhat, from 5.63 trillion yen ($51.2billion) to 5.32 trillion yen ($48.4 billion) due to a trade deficit in January related to the Chinese New Year. The investment income surplus, however, rose sharply from 2.926 trillion yen ( $26.6 billion) to 4.107 trillion yen ( $37.3 billion). With Japan having a quarterly GDP of roughly 130 trillion yen, this 1.2 trillion increase in the investment income surplus means that whatever the GDP increase (preliminary figures, which most analysts expects will show a significant slowdown from the very strong fourth quarter, are due on Friday), the more relevant measure of GNP will have increased 0.9%:points more.

Sunday, May 14, 2006

EU Would Be Foolish To Bar Lithuania From the Euro

Next week, the EU Commission will present its opinion about whether or not the two countries that have applied for entry into the euro-zone in 2007, Slovenia and Lithuania, should be admitted. They are widely expected to recommed approval of Slovenia's application, but recommend denial of Lithuania's application. Estonia and Latvia had wanted to join by next year too, but they gave up in advance knowing their inflation was too high to have any chance of approval.

The reason given for denying entry to Lithuania is that Lithuania had a too high inflation rate, 2.7% on average in the 12 months to March 2006, compared to the upper limit of 2.6% derived from adding 1.5% to the 1.1% average inflation rate of the three lowest inflation countries in the EU -Poland, Sweden and Finland- that month.

Lithuanian officials have protested that apart from the breach being so small (just 0.1%), this was calculated from a mean that included the two non-euro countries Poland and Sweden. Had they instead used the 1.5% average of the three lowest euro-zone countries -Finland, Holland, Austria-, they would have made it. Jean-Claude Juncker, head of the eurogroup agreed with them and said that it should be based on the average of the three euro-zone countries with the lowest inflation. Since it is ultimately EU finance ministers and not the EU Commission that decides, it is still an open question as to whether Lithuania will be admitted or not (That they will follow the recommedation to admit Slovenia seems like a foregone conclusion).

Many Lithuanians would also add the hypocricy of shutting out Lithuania over a mere 0.1% in inflation when three existing euro-zone countries (Spain, Greece and Luxembourg) had even higher inflation than Lithuania yet they are not thrown out of the euro-zone. Similarly, countries like Greece, Portugal, Italy, Germany and until recently France have regularly ignored the 3% of GDP budget deficit limit, yet they are not punished in any way.

But the more fundamental issue here is not really whether Poland and Sweden or Holland and Austria should be used as comparison, nor whether new applicants are put to a higher standard than existing members, the most fundamental point is that the whole inflation criteria really makes no sense.

When some country or some region have higher real growth rate than others, they usually tend to experience a higher real exchange rate. This could either express itself as a higher nominal exchange rate or as a higher inflation rate (or a combination of the two). And as Lithuania whose growth is the third highest in the EU after its fellow Baltic countries Estonia and Latvia have a fixed exchange rate versus the euro, this means that they must have a higher inflation rate than the rest of the EU. This relatively higher inflation is very much a natural process, similar to how any adjustment within a fixed exchange rate system, including the free market monetary system known as the gold standard, would operate (Although due to the ECB's far too loose monetary policy, the absolute level of inflation is too high). This ois similar too how fast growing Ireland, Spain, Greece and Luxembourg within the euro-zone experience higher inflation than the more stagnant parts of the euro-zone.

As the relative difference in inflation is natural and more or less unavoidable for fast growing countries given the fixed exchange rate that is also a requirement, this criteria makes no sense at all and it will effectively shut out all rapidly growing countries like the Baltics. That might perhaps be intentional as inclusion of these countries would raise the average of both real growth and inflation for the Euro-zone and thus make the ECB raise rates faster. But given how small these countries (The economies of the three Baltics are together smaller than Ireland) are, they won't make much difference in the aggregate Euro-zone statistics and in any case, it would only be healthy both for the existing Euro-zone countries and for the Baltics (who due to their fixed exchange rates have to follow ECB policy anyway) if the ECB raised its far too low interest rates.

By shutting out the Baltics, the ECB is only hurting the reputation of the Euro who despite Ireland, Luxembourg, Greece and Spain, is associated with low growth due to the weak growth in Germany and Italy. Were the Baltics included (Which they de facto already are with their fixed exchange rate) the Euro would too a higher extent be associated with high growth, something which would help them convince voters in the U.K. and Sweden to join. Not that this would be a valid line of argument. The Euro per se have very little effect on growth, and Ireland and Estonia would be successful with or without the euro, just as Germany and Italy would be unsuccessful with or without the euro. But despite not being really valid, it would still be effective in public perception as most people are still convinced by such associations of one economic factor and economic success.

Friday, May 12, 2006

Aussie Tax Cut Could Intensify Kiwi "Brain Drain"

Australian Treauserer Peter Costello recently announced tax cuts worth A$37 billion (US$28.5 billion), in the form of raised thresholds for each tax bracket and lower rates for many brackets. The top rate will for example be reduced from 47% to 45%.

Not surprisingly, this was condemned by communist web site "World Socialist Web Site" as a "blatant appeal to the rich".

Notwithstanding the communist objections however, this is a smart move which will help the Aussie economy sustain strength even when the commodity price boom ends.

As Bloomberg News reports, this will likely increase the emigration of skilled workers from New Zealand to Australia, as the Aussie advantage in tax rates widens. After the changes, a worker earning $75,000 in Australia will pay $17,850 in taxes, versus $20,520 in New Zealand. New Zealand's left-wing Finance Minister Peter Cullen have rejected calls for following Australia's tax cuts, claiming that tax rates don't matter very much and that quality of education and health care is just as important. As if increased government spending have any proven positive effect in those areas.

Decline in U.S. Trade Deficit Likely An Abberation

The U.S. Trade deficit unexpectedly declined in March to $62.0 billion from $65.6 billion in February, contrary to expectations from me and most other analysts that it would rise. This largely reflects the somewhat curious fact that the price actually paid of imported oil fell during that month, even though the traded market price rose sharply. But this of course reflects that the price paid for oil was set in previous months. In coming months, prices actually paid will increase to market price levels which is currently more than $20 per barrel higher than the $52.26 paid on average. That alone will ultimately raise the monthly trade deficit with more than $6 billion per month. The full effect of this will not be evident until May or June, but already in April this was enough to raise the import price index by 2.1%.

Another factor which indicates that the trade deficit will rise sharply from the March low is that China's trade surplus rose sharply in April.

Even so, this decline still means that first quarter growth will likely be upwardly revised, although the extent (if any) of this depends on how other components are revised. It should however be noted that as the BEA assumed a decline in the trade deficit, the contribution from trade will be limited. The BEA assumption was for a $1.3 billion decline, whereas the preliminary number was $3.8 billion (including the $0.1 billion downward revision of the February deficit). The $2.5 billion discrepancy in a $3.25 trillion quartely GDP is 0.08% or 0.3% at an annual rate. Assuming zero net revisions in other components, this implies a revision from 4.8% to 5.1%.

UPDATE: According to this Marketwatch article inventories, business investments and construction spending have also been stronger than expected, all of which according to the article would raise the number to 6% or more. At the same time however, personal income growth have been revised down.

Thursday, May 11, 2006

Inflation Rising In Sweden Too

It's not just in America and the Euro-zone that consumer price inflation is rising, now inflation is rising in Sweden too. The price index used domestically rose 1.5% in the year to April, up from 1.1% in March, while the underlying inflation rate that the Riksbank tracks rose from 1.2% to 1.5%. The harmonized index of consumer prices which is the relevant one for comparisons with other countries, rose 1.8% in the year to April, compared with a annual increase of 1.5% in March.

These numbers were all higher than the markets had expected and they were also much higher than what the Riksbank had forecasted. This means that the Riksbank will have a easier time motivating raising interest rates from their current extremely low level of 2%.

Japan Needs to Let the Yen Rise

Just as I predicted back in January, the dollar have fallen this year against most currencies, including the Japanese yen, with a dollar now costing only about 110 yen. This is causing discomfort among politicians and big business leaders in Japan, who see the value of exports and foreign investments fall with the dollar. Politicians now threaten to resume active currency interventions to keep the dollar from falling further.

Yet that would be a big mistake. The Bank of Japan have already invested too much in U.S. government bonds to prop up the dollar. Because of years of deflation in Japan cmbined with significant inflation in America, the real exchange rate of the yen is still very low on a historical basis. It is in fact arguably the most undervalued currency around, and while currency interventions and threats of currency intervention could limit its rise in the near future, it is near inevitable for it to continue to rise. And investing more in dollar assets would then just ensure that the losses from a falling dollar would just become greater.

Moreover, it would be well advised for the Japanese and other Asian countries to lessen their dependence on exports to America by letting the dollar fall. With a recession in America looking increasingly imminent, and with the increasingly protectionist Democrats looking set to make big gains in November's congressional elections, America would likely respond with protectionist measures to efforts by Japan, China and other Asian countries to prevent the dollar from falling. All of which would imply far greater losses for the Asians than the losses from a falling dollar (which again is ultimately inevitable).

Italy Outperforms Germany

Today was a "big bang" day in terms of Euro zone growth statistics, with four (Germany, Italy, Spain and Holland) out of the five biggest economies plus Finland issuing the first estimate of first quarter GDP. Growth was lower than expected in Germany, Holland and Finland, while being stronger than expected in Italy.

Worth noting is that growth was 2.4% at an annual rate in Italy versus 1.6% in Germany. And while quarterly changes tend to be somewhat erratic, the 12 month change too was slightly higher in Italy than in Germany (1.5% versus 1.4%. All numbers are calendar adjusted). This again illustrates the fallacy of the widespread theory that it is relative unit labor costs that is the root of Italy's problem. As the case of Germany with its falling relative unit labor costs illustrates, lower unit labor costs may strengthen the sector with tradable goods, but it also increases relative costs for the domestic sectors.

The Fed Would Be Unwise to Pause

A expected, the Fed raised rates again yesterday. The issued statement was as ambigous as it could be, saying more or less that there is an equal chance of a pause and a further hike, and that the final decision will be made on the basis of the incoming data between now and the next meeting.

It seems clear to me, however that the Fed simply cannot afford to pause. With the price of oil, gold and other commodities going through the roof, with the dollar declining and with the spread between regular bonds and the TIPS reaching new highs, with wage increases at a new high, it is clearly obvious that consumer price inflation is on the rise. Any pause would undermine Fed credibility and force them to take even more drastic actions later.

Of course, continued hikes are on the other hand likely to push the U.S. economy into a recession as the over-indebted U.S. households can't afford the increased interest burden, but this just illustrates that this inflationary boom is no more sustainable than the previous ones.

Monday, May 08, 2006

Stephen Harper Better Than Expected So Far

In late January, I dismissed Canada's newly elected conservative prime minister Stephen Harper as a Bush clone with regards to economics, based on his election promises to both cut taxes and to increase government spending at the same time.

Yet according to this story in The Economist, Harper have so far been better than he said he would be. While he have kept his pledge to cut taxes, he have contrary to his election pledges reined in spending. Because of this and because the commodity price boom have made tax revenues surge, he will now be able to reduce tax rates and still pay off billions of dollars of the Canadian national debt.

Because of these relatively wise policies, and because Canada started out with a surplus in both the government budget and the current account balance and because Canada benefits from the commodity price boom, the loonie (aka the Canadian dollar) looks set to continue its upward trend against the greenback (aka the U.S. dollar) and is likely to reach parity (1 loonie=1.00 greenbacks )within the coming year, especially if (as is likely) the greenback continues to fall against the other major world currencies.

Friday, May 05, 2006

Strange Market Reaction to U.S. Labor Market Data

Sometimes financial markets react to news in a really irrational way. Case in point are the reaction to today's labor market report from the Bureau of Labor Statistics.

While it is true that employment growth was relatively weak, increasing only 138,000 versus the expected 200,000 (The household survey showed an even weaker increase of 47,000), every other number were extremely strong. For example, with average work week increasing from 33.8 hours to 33.9 hours, total hours worked increased 0.5%, which is very much for just one month.

Moreover, and perhaps even more importantly average hourly earnings rose by a full 9 cents to $16.61 and the March number were upwardly revised by 3 cents. Moreover, with hourly earnings increasing much faster in the labor intensive service sector than in manufacturing, this will have even stronger implications for consumer price inflation numbers.

This acceleration in wage growth, adding to the effects of soaring commodity prices and a falling dollar, makes a continued acceleration in consumer price inflation almost certain.

Given this, you should expect at least bonds to fall (the effects on stocks of such data are more ambigous as they will benefit to the extent this kind of strong numbers indicate higher growth). But no, instead both bonds and stocks rallied, even though not even traders who only read the news media reports about this could hardly have missed the average hourly earnings number.As the CNN Money story puts it: "Bond investors have been concerned that the strong labor market will drive up wages and increase inflationary pressures, but on Friday they seemed to focus on the softness in the overall payroll number.". A highly irrational focus as the reason why the Fed would care about payrolls are in its effect on wages (and by extension prices).

Of course, the traders who buy bonds on these kind of irrational premises are bound to get punished when bond prices later fall, as price inflation data will show continued acceleration which in turn will force the Fed to tighten even more. That in turn of course creates an opportunity for people who are in a position to go short on bonds to do so and so make money from today's irrational market reaction to the U.S. labor market data.

Thursday, May 04, 2006

BIS Publishes Semi-Austrian Monetary Policy Analysis

New blog post at the Mises blog (Note that it is post number 5000).

Stephen Roach's Strange Conversion

Stephen Roach, who for the last few years have been the most bearish of all Wall Street economists have suddenly become bullish, which is a rather curious conversion. After all, he started warning about worrisome economic imbalances in America all the way back in 2001, when imbalances were much smaller than they are today. Then housing prices were far lower, the current account deficit was for example only about 4% of GDP compared to 7% of GDP today, the household savings rate was about 2% versus -0.5% today and household debt was less than 100% of disposable income versus 124% in the fourth quarter of 2005 (a number which likely grew further in the first quarter this year). The indicators that worried Roach then have all become much worse.

So, how does Roach explain his conversion? G7 and the IMF, he says, have admitted that there is a problem and is working to resolve it. But merely admitting that there is a problem won't solve it. Roach however added that something is done about this, by which he refers to the normalization of interest rates that have at long last begun. But while he is right that this is a good thing, it should be obvious that this is simply too little, too late to stop the imbalances from growing. Eventually, if interest rates continue to rise, this will stop the imbalances from growing further, but only at the cost of sending the U.S. economy into a recession.

As Peter Schiff points out in his commentary on the Euro Pacific Capital web site, this conversion is particularly strange, since we are now starting to see the beginning of the end of the bubble. As Schiff puts it:

"The most interesting aspect of his fox-hole conversion is his timing. Never before has his doomsday scenario been so close to unfolding or his bearishness so close to vindication. With the dollar resuming its fall, foreign central banks raising rates and seeking to diversify their reserves, housing supply overwhelming demand, and gold and other commodity prices soaring out of control, one would think Mr. Roach would finally be in the enviable position of saying "I told you so." Instead he has changed his tune, and now sings in near perfect harmony with Wall Street's "All Bulls Choir."

Why an intelligent man like Stephen Roach would do such a strange thing is truly puzzling, but it will only be himself that he will be hurting. Interestingly, Roach says that the last time he was bullish was in 1999. Which is to say, just before the tech stock bubble bursted.

More Idiocy From U.S. Politicans On Energy Prices

The U.S. House of Representatives voted with a majority of 389 to 34 (Ron Paul was of course one of these 34) to outlaw "price gouging" of energy products. What is really funny about this legislation is that these congressmen in this legislation instructs the Federal Trade Comission to define "price gouging". That's right, these 389 congressmen voted to outlawing something they don't even know what it is.

Any honest and intelligent observer would agree that high energy prices is not due to "gouging" (however that is defined), but global supply and demand. And that policies from the U.S. federal government (including bans on drilling in Alaska, failed Mideast war policies, a pork-laden energy bill and punitive import tariffs on cheap Brazilian ethanol) have contributed to reducing supply and therefore to raise prices. But of course, we can't expect politicians (except for Ron Paul and a few others) to recognice facts, particularly not facts that indict government interventions. It is so much easier in the short-term perspective to blame "greedy oil companies". That won't solve the problems of course, but it is more beneficial for the politicans who can turn another one of their failures into something which expands their power.

Wednesday, May 03, 2006

China's Current Account Surplus $160.8 Billion

I see via the Morgan Stanley daily global digest that China's current account surplus in 2005 reached a full $160.8 billion, which is as high as in Japan, who until now have had the largest surplus in absolute terms.

That is higher than most analysts had expected. While a large surplus was a virtual certainty given the large trade surpluses already reported, it was somewhat surprising to see the significant factor income surplus. Surprising given how so much of Chinese exports are from factories owned by foreign companies (For this reason, this post showed a deficit from 1993 to 2004). But apparently, this was overwhelmed by the large portfolio investment income.

These numbers, which reflect China's extremely high savings rate, is of course likely to add on to the pressure for China to significantly raise the foreign exchange value of its currency, the yuan. That however could prove counterproductive due to the somewhat childish need of the Chinese government to show that it does not give in to foreign pressure.

Tuesday, May 02, 2006

Structural Reforms Damned If Unemployment Goes Up, If It Goes Down

When the French government proposed a all too modest liberalization of its strict labor laws, we saw the almost unbelievably stupid argument that because unemployment is so high now under the current system, we should oppose reform of the system. Now, Swedish Social Democratic Prime Minister Goran Persson offered the opposite argument in his May Day speech:

"How could it go so wrong that the centre-right put in their attack on the unemployed when unemployment is falling? Why hunt the unemployed when Sweden is doing better than ever? The centre-right didn't believe that we would have an election campaign at a cyclical stage when things are going the right way." [Hur kunde det bli så tokigt att de borgerliga satte in stöten mot de arbetslösa när arbetslösheten faller? . Varför jaga de arbetslösa när det går bättre för Sverige än någonsin? De borgerliga trodde inte att vi skulle driva en valrörelse i ett konjunkturskede när saker och ting gick åt rätt håll.]

Let's set aside for the moment that the centre-right parties have quietly and cowardly withdrawn their proposal to reduce unemployment benefits in any significant way. And let's also set aside that the so-called reduction in unemployment he refers to is pathetically small (Only 789 people less than a year ago). Persson's argument still makes somewhat more sense than that of the French "students". Clearly, if unemployment falls, the case for liberalization of the labor markets become weaker.

But while somewhat less confused than that of the French left-wingers it is still confused, as he himself admitted that the current economic upswing in Sweden is cyclical, not structural. Cyclical means, more or less by definition, that it is first of all unsustainable and more importantly, that it is unrelated to structural factors like labor regulations and unemployment benefits. So the fact that Sweden because of the low interest policy of the Riksbank and the global cyclical upswing is in a cyclical upswing, definetly do not prove that the need for structural reforms have been reduced.

You can always count on socialists to use such illogical arguments, as it is obvious to anyone thinking in rational terms that strict labor laws and high unemployment benefits will raise unemployment. What is disheartening is that so few are pointing out the fallcy of their arguments.

Finally, to really illustrate the cyclical nature of the current Swedish upswing, today it was revealed that M3 money supply rose a full 15.1%, while private sector debt rose 13%. Monetary policy in Sweden are thus even looser (more inflationary) than in the Euro-zone, where money supply growth was "only" 8.6%.

Monday, May 01, 2006

Ilana Mercer on China, Savings And The Welfare State

Ilana Mercer have an excellent post on the issue of the high savings rate in China. An excerpt:

"For the past few days I’ve heard assorted American economists and commentators—socialists all—complain bitterly about the Chinese saver. Yes, the Chinese may have a democracy deficit, as American politicians never cease to remind them, but they don’t believe in debt, personal or national, as do wastrel Americans and their political overlords.

This is one reason why the Chinese economy is exploding: savings, capital accumulation, and investment are the very lifeblood of a healthy economy. Solvency and fiscal prudence are virtuous qualities, and, in the long run, lucrative.

The Chinese save up to 40 percent of their Gross Domestic Product. In fact, they behave exactly like individuals in a truly free-market would behave; they save like there is no tomorrow. Or, more appropriately, like there is no welfare state, which, indeed, the Chinese don’t have. Or if they do have social programs, these don’t meet American standards of socialism.

Or so our leading lights have been claiming throughout the week of President Hu Jintao’s visit: The reason the Chinese save so energetically is because they don’t have an adequate welfare system, the pointy-heads have puled.

Yes, this is the message from the land of rugged individualism: develop more government programs. Of course, these do no good, other than for the bureaucrats that administer them. They are, moreover, based on immoral distribution. Yet this is what we wish on China.

I guess it’s a case of “leveling the playing field”—another expression that is often lobbed at the Chinese. Translated, it means wanting to see one’s rival sapped of his vitality too.

That the Chinese plan their lives as though there were no government hand-outs to rely on has incensed American economists and commentators (at least the ones I’ve had the misfortune to hear this week). They want Bully Bush to put pressure on Hu Jintao to set up some programs for his people, and, by so doing, make them more like us: inclined to spend, because of the knowledge that Uncle Hu will pick up the tab (like Uncle Sam does so magnificently. Think Katrina)."

I wrote last year on the constant nagging from representatives of "the free world" to "communist" China that they must become more socialist.

More Evidence Price Inflation Is Picking Up

The evidence is clearer than ever that price inflation in the U.S. is picking up significantly. Even the so-called PCE deflator, which is generally the inflation measure showing the lowest reading, saw a 0.4% increase on the month before in March. Given the sharp increase in oil prices in the latest month, it is a virtual certainty that the increase is going to be much bigger in April. And, the "core" PCE deflator -which the Fed have indicated it follows- saw a unusually large increase of 0.3%.

Meanwhile, the ISM price index in its manufacturing survey rose to 71.5 from 66.5.

The latest market developments, with commodity prices soaring across the board and the dollar falling against most other mayor currencies is likely to continue to put further upward pressure on price inflation. As I wrote yesterday, the Fed will "fall behind the curve" and see price inflation get out of hand if it pauses soon. Indeed, they might just do it even if their gradual tightening continues.