Tuesday, February 27, 2007

Today's "Crash"

Stock markets all over the world sold off heavily after a rumor that the Chinese government will impose a capital gains tax. A rather weak argument for the relatively dramatic sell-off we saw today considering 1) That it is just so far a rumour which has yet to be confirmed 2)Chinese equity capital is still relatively insignificant.

Considering the irrational ground for today's sudden move, this would seemingly appear to be a buying opportunity. And indeed, unless the markets are hit with more bad news, a recovery in stock prices seems highly likely.

However, I am not sure I would recommend people to buy stocks as I do in fact expect more bad news.

Update: The Chinese government now explicitly denies the rumour.

And Whose Fault is That?

In my last post that the probability of a U.S. recession during 2007 has risen to 50-60%. In light of today's durable goods numbers, even that number may be too low.

Interestingly, now even Alan Greenspan joins the bearish camp, and argues that there is a risk of a recession by the end of the year. What he neglects to say is that this likely recession will be the result of the bursting of the housing bubble that he himself inflated.

Saturday, February 24, 2007

How Fed Half-Measure Leads America Into Stagflation

As you all(?) presumably know, the Fed stopped its series of rate hikes last year at 5,25%. The Fed at that point, faced a dilemma: raise much more and push America into a recession. Pause, or reverse, and risk accelerating price inflation. The Fed thought they were really smart by pausing at that point. That rate would contain inflation-but not so much that it also pushes America into a recession.

News this week has led me to raise my estimate of the probablity of a recession to 50-60%, up from the "less than 50%, but closer to 50% than zero" estimate of last week.

The news I am refering to is relatively weak economic reports, rising oil prices and most importantly, signs of an emerging meltdown of the American mortgage market, more specifically the so-called subprime mortgage section of it. That is, mortgages issued to people with a high credit risk.

One example of this is the seemingly puzzling fall in bond yields, even as inflation numbers are worse than expected and commodity prices soar. But this appears to be the result, not of generally falling bond yields, but of increased aversion for mortgage related securities, as investors see the increased defaults from sub-prime mortgages. This will, of course, raise mortgage rates even as interest rates on government bonds fall, something which will further depress the housing market and increase the default rate on sub-prime mortgages, which in turn will further raise mortgage rates and so on in a vicious cycle.

For more examples of signs of a subprime mortgage meltdown, see Nouriel Roubini's blog, which have reported extensively about this.

Apparently, another reason for the low bond yields is that traders still hold on to the hope of a Fed rate cut by June. How the Fed will do that while commodity prices soars, and the inflation numbers likely to look awful is a mystery.

So, it looks more and more as though the Fed's attempt to avoid both a recession and inflation by pausing at 5,25% could end up giving America both.

Thursday, February 22, 2007

Bush Education Plan "Gains" Pure Fraud

I told you first nearly a year ago about how the "No Child Left Behind" act that required states to show generally rising school results as well as a narrowing of the gap between racial groups.

Now it is again confirmed that schools are likely faking improvements in order to obtain Federal funding. This article notes that while grades are improving, standardized national test scores are not improving, nor are the racial disparities narrowing. This indicates that teachers have been instructed to lower standards in order to be able to show "better grades".

Kibbutz Abandons Socialist Principles-Partially

In its early days, Israel was relatively socialist (making the leftist hatred of Israel somewhat ironic), with the egalitarian Kibbutz communities symbolizing this. But gradually in the last few decades, the Israeli economy have become more and more capitalist. The kibbutz movement have been increasingly marginalized.

Now Israel's oldest kibbutz, founded decades before the state of Israel was created in 1948, have decided to abandon extreme egalitarianism and link income with work efforts. There will still be some redistribution, but for the first time ever, work efforts will actually be rewarded.

The Fed Still Doesn't Get It

Yesterday's U.S. CPI report were pretty bearish for the U.S. economy. Despite the now reversed decline in energy prices, the CPI actually rose 0.2%, as "core" prices rose 0.3% and food prices rose 0.7%.

And with the price of corn and other commodities rising fast, price inflation is unlikely to recede.

The Fed of course, pretends to be fighting the trend of rising prices. But as Caroline Baum points out, the Fed's money creation is of course the source of all of this. The Fed's inflation reporting, Baum points out, is as ridiculous and misleading as that of Zimbabwe.

Wednesday, February 21, 2007

Robert Samuelsson Finally Gets It

New blog post on the Mises blog.

Tuesday, February 20, 2007

Does Free Trade Require An Extensive Welfare State?

While economists may disagree on many issues, virtually all (with just a handful exceptions, like Paul Craig Roberts) agree that free trade will benefit all countries who pursues that policy. But there is also an almost similarly large agreement that some individuals and companies will benefit from protectionist trade policies. This is similar to other subsidies and regulations where there is usually at least some who benefit financially from it, at the expense of the rest of society.

So, with near unanimous support for the theory that the economy as a whole benefits from free trade while a minority loses from it, an increasing number of economists now seem to think that an extensive welfare state is needed to compensate the losers from free trade. See for example Sebastian Mallaby in Washington Post and here Brad DeLong quoting approvingly Martin Wolf in Financial Times.

This argument for the welfare state because it is necessary for free trade to work basically expresses agreement with the idea advanced by some paleoconservatives, like Paul Craig Roberts and Pat Buchanan, that trade protectionism is linked to limited government. Only the paleoconservatives argues against free trade on account of the virtues of limited government, while left-liberals like Sebastian Mallaby, Martin Wolf and Brad De Long argues for big government on account of the virtues of free trade.

The left-liberal "free trade requires a welfare state" argument is really two arguments-one political pragmatic and one moral. The political pragmatic argument is that in order to ensure support for free trade, a welfare state is needed to bribe the losers from free trade into accepting it. Here they often point to how protectionist sentiment is much stronger in relatively low tax America than in relativeky high tax Scandinavia. But that overlooks that the Scandinavian countries first of allin sharp contrast to America have large trade surpluses, making the false "trade deficit kills jobs" argument against free trade inapplicable. Secondly, the Scandinavian countries are so small that the idea of national self-sufficiency is more obviously absurd than in a very big country like America. That is the real reasons why protectionist sentiment is stronger in America. To test the effect of an extensive welfare state on protectionist sentiment we can look at France, whose welfare state is as extensive or more than the Scandinavian countries. Yet protectionist sentiment is at least as strong as in America.

The other argument is moral. Supposedly, since free trade increases real national income while reducing real income for a few, we should redistribute these gains for the country as a whole so that the losers too can enjoy it too. But this presupposes that the losers from free trade deserve the higher income they have under protectionist trade policies. Neither protectionists nor "free trade requires an extensive welfare state" left liberals have been able to say why they the deserve that income more than others. It would be more accurate to label the losers from free trade the winners from protectionist privilegies. The winners from protectionist
privilegies don't get their higher income by providing better value for others. In that case they wouldn't need protectionist trade policies. Instead, they earn their higher income by monopoly privilegies from the government that prevents other inhabitants of their countries from trading with people that provide better value. Thus, there is certainly no moral obligation to compensate the losers from free trade.

Monday, February 19, 2007

The Cheerfull Anachronism (Aka Greenspan's #1 Pain in the ass)

America's (and probably the whole world's) only elected politician committed to the principle of strictly limited government, Ron Paul, is featured in a Newsweek article by George Will. Paul was of course also Alan Greenspan's most difficult opponent during congressional hearings, frequently reminding him of his Objectivist, pro-gold past.

While Will, being a self-described "big government conservative" ultimately disagrees with Paul and dismisses him as an "anachronism", you can even in him sense a certain degree of respect and admiration for a politician which is actually committed to the founding principles of America.

Sunday, February 18, 2007

Minimum Wage Increase Destroying Jobs in Arizona

While I don't believe the damage from the planned minimum wage increase in America will be particularly great as the minimum wage will still be relatively low compared to other advanced economies, this story clearly illustrates that the net effect will certainly be to reduce employment.

Friday, February 16, 2007

Evolutionary Mechanisms Weeding Out Stupidity

Bearish Turn in U.S. Economic Statistics

The trend in the tone of news about the U.S. economy seems to fluctuate from month to month. After having been mostly bearish in December, and mostly bullish in January, they have again turned mostly bearish in February, as arch-bear Nouriel Roubini pointed out yesterday. And today's report on housing starts and building permits further confirms this bearish picture.

Part of this reflects colder weather. Part of it reflects that the fact the unexpectedly strong U.S. GDP number, now appears to have been false, as inventories, net exports and private consumption all are likely to be downwardly revised. Instead it now seems more likely to land near the 2% or slightly above 2% that I predicted in mid January.

With this bearish turn in the tone of economic statistics, the recovery in oil prices, the slowing of corporate profits growth and money supply growth, the risk of a 2007 recession have increased significantly. I still think it is below 50% (although it is certainly closer to 50% than 0%). Instead, the most likely scenario is still a continuation of the weak but still positive growth, we've seen for the last few quarters.

Wednesday, February 14, 2007

Global Warming Meeting Cancelled After Ice Strorm

Euro-zone Growth Heating Up-But France Remains Relatively Cold

Euro-zone economic growth surprised on the upside in the fourth quarter of 2006, with GDP rising 0,9% compared to the previous quarter and 3.3% on Q4 2005. Particularly previous laggards Germany and Italy surprised on the upside.

French numbers, however were not particularly strong. Indeed, year over year growth is now not only lower in France than in Spain and Germany, but lower than in Italy too. Which is pretty remarkable, given the fact that French demographics are far less dire than in Germany and Italy. Except for maybe Portugal, France is now the weakest economy in the Euro zone. I have previously explained why the French economy is so weak.

If socialist Segolene Royal is elected President, France will see an even weaker economy as she pledges to dramatically raise the already high minimum wage and increase government spending and regulation even more than Jacques Chirac.

Saturday, February 10, 2007

Helpful Information

Let me help out the people trying to sort out the mess after the death of Anna Nicole Smith by saying this: I want to say one thing to the American people, and I want you to listen to me, I'm gonna say this again: I did not have sexual relations with that woman, Miss Smith. I never told anybody to lie, not a single time, ever. These allegations are false. And so, I can say, unlike quite many other men, that I am not on the long list of possible fathers of Anna Nicole Smith's daughter.

Top Democrats Understand Economics Better Than Clueless Bush Treasury Secretary

I've had so many post on the weak yen story lately so I thought there would be little more to say. But then I see that top Democrat Charles Rangel -infamous for his call to reinstate the military slavery ("the draft")- seem to understand the economics of currency markets better than clueless Bush Treasury Secretary Henry Paulsson. While I don't agree with everything he writes, it is still far better than what Paulsson said:

"In a letter sent to Paulson on Thursday, House Ways and Means Committee Chairman Charles Rangel, D-N.Y., and other powerful Democratic House members argued that the decline in the Japanese currency, which is sitting near a two-decade low on a trade-weighted basis, is the result of Japanese government policies -- namely artificially low interest rates and failure to stimulate consumer demand.

"These policies increase Japanese reliance on exports to stimulate economic growth," the letter said, likening Japan's tactics to Beijing's economic policies. "In a word, the evidence is clear that it is not a free market setting the value of the yen, but Japanese government policy as well."

Friday, February 09, 2007

India's Disadvantage Relative to China

After the text version of my speech at the Ludwig von Mises Institute conference on financial markets in Las Vegas nearly two years ago was published, I received almost unanimously positive reactions. Except for the angry e-mails from a few people from India who apparently felt I insulted India's national pride by arguing that China's potential economic strength was much bigger. Ii tried to calm them down by pointing out that I still believed that India would grow much faster than the West, only not fully as fast as China. But however offensive some Indians may consider this fact is, it is nevertheless a fact.

China's GDP per capita is more than twice as high than India's, whether measured at current exchange rates or estimated PPP. Yet China have continued to have faster growth, although the growth differential have recently narrowed. And this despite the fact that India's economy is much more overheated, as was noticed by The Economist recently. Money supply and credit growth is much faster than in China, as is consumer price inflation. And in sharp contrast to China and its large current account surplus, India has a significant current account deficit.

The problem for India is that it is the idiot savant of the world economy. While India's IT-sector is of first class quality, it actually employs a a mere 0.5% of India's workforce. India have little of the broad based labor intensive manufacturing that have helped lift hundreds of millions of Chinese out of poverty.

Meanwhile, for most castes in India, the Confucian cultural emphasis on education, thrift and entrepreneurship that underpin's China's boom, is completely alien, making it very unlikely that most Indians will be able to achieve anything like the high productivity of India's small elite of IT-professionals.

Even so, India is again likely to greatly outperform the West. Especially once China moves up the value chain , India should be able to overtake some of the low cost manufacturing jobs currently held by China. And India is expected to have a more favorable demographic situation than China a few decades from now, as China's "one child" policies result in an increasing burden of old age retirees. But despite this, China's prospects are much stronger because it has a culture more conducive for wealth creation than India.

Thursday, February 08, 2007

Lack of Yen Purchases Reveals Japan's Mercantilist Currency Policy

I have in several posts on this blog discussed the negative effects of the weak yen, which is ultimately the result of the near zero short term interest rates in Japan.

I now see via Brad Setser that Financial Times calls for the Bank of Japan to buy yen. The Bank of Japan sold yen (i.e. increased foreign exchange reserves) in massive quantities during 2003 and 2004, when the dollar was under strong downward pressure because of the Federal Reserve's 1% interest rate policy. The official reason cited by the Bank of Japan for this was their alleged comittment to "currency stability" and their alleged fear of "wild exchange rate fluctuations". But as have been illustrated by their failure to buy yen when the yen is falling, that was a lie. What they feared wasn't exchange rate fluctuations per se, but yen appreciation. Yen depreciation is however something they welcome.

Were the yen to suddenly rise sharply, you can be sure that the Bank of Japan would sell yen. All of this certainly make the complaints by European countries about the weak yen justified.

Incentives Don't Matter For Criminals?

I see via Robert Murphy a Slate article discussing a study allegedly showing that harsher sentences won't deterr criminal behavior. They did however acknowledge that prisons reduced crime by keeping the criminal off the street and so disabled them from comitting crime.

Now, since I don't have the full study available and is only able to rely to Slate's account of it and the brief NBER description, I am unable to respond as effectively as possible.

However, even with this limited information, the study seems flawed for several reasons. The study bases its analysis on behavioral changes from the weeks before to the weeks after the 18th birth day of criminals. Yet first of all, punishment aren't really increased that much on account of that 18th birthday. The risk of prison rises from 3% to 17%, meaning that it is still a very low risk, especially since this is only the risk of getting imprisoned if you are caught. If you add in the fact that in most crimes, the criminal won't get caught, the risk of getting caught remains very small. And so since the increase in punishment is fairly small, the effect could hardly be expected to be anything but small.

Secondly, they did in fact find that arrest rates fell from the age of 17 to 19, only they didn't find any acceleration in the rate of decline the first weeks after the 18th birthday compared to the weeks before. Yet looking at only a few weeks is potentially very misleading as mere coincidences could have skewed the arrest rates over such short time periods. Had they tried to compare arrest rates the hours before and after, then the potentially misleading nature of the data would have been even more evident, but this exist here too (albeit to a lesser extent).

Finally, I find the conclusion of the authors that their results show criminals to be "impatient" because they keep committing crimes after they turn 18 to be curious, to say the least. To say they are impatient implies that they rationally should wait, but wait for what? For a time machine that will make them 17 again?

Tuesday, February 06, 2007

Star Wars-The Tool of Satan?

This is probably meant to be a satire of how wacko some Christian fundamentalists are...but then gain it might not be as some fundamentalists really are this crazy. And at any rate, whether intended as satire or not, it really is funny anyway.

End of Global Warming-And U.S. Recovery?

Global warming seems to be over for now. Here in northern Sweden it is -25 degrees celsius ( -13 degrees fahrenheit) right now. And it's very cold in North America too, a cold which has killed at least six people.

The cold snap could have significant economic consequences too. Just a few weeks ago, I told you about how the then relatively mild weather boosted the U.S. economy by reducing oil prices and stimulating outdoor activities normally supressed by the cold. Now after the cold snap, oil prices have recovered and outdoor activities have likely been significant supressed.

Given the relative strength in momentum of the recovery, it seems unlikely that the cold will produce a recession. But it remains a possibility and at any rate economic growth will certainly slow.

Monday, February 05, 2007

Netanyahu Advancing, Olmert Collapsing

The Economist reports that Binyamin Netanyahu's Likud Party has advanced significantly in the poll, to the equivalent of 32 Knesset seats (they recieved 12 in the latest election) while the grossly incompetent Ehud Olmert's Kadima party and his main partner, Labour, have nearly collapsed, getting a support equivalent to just nine seats each (compared to 29 and 18 seats in the latest election). Given Olmert's incompetent handling of both the Lebanon war and the economy, the collapse in polls is certainly well deserved. To bad the next election won't be held soon, so that Olmert can be replaced by Netanyahu quicker.

Sunday, February 04, 2007

More on Yen Carry Trade

Nouriel Roubini and Brad Setser of RGE Monitor have both written interesting posts on the damage and distortions created by the yen carry trade of certain hedge funds. Aside from the distortions created already today, it could create big problems if it is suddenly reversed, as happened in 1998.

U.S. Treasury Secretary Henry Paulson however is completely clueless on the subject, dismissing European complaints about yen weakness by saying it is priced on a "competitive market". Are interest rates -the basis of the carry trade holding down the yen- set by "competitive market forces"? I don't think so. But I guess it is to much to ask from someone who is only Treasury Secretary to understand such a elementary economic truth.

Useless "Terror Free" Gas Station

This is a good example of what happens when you don't understand economics. You embarrass yourself by starting a business which is based on a completely meaningless idea.

A group calling itself Terror Free Oil Initiative will open gas stations that only sell oil that comes from other parts of the world than the Middle East. This is based on the observation that Iran and certain Arab oil exporters sponsor jihadist terror groups.

But had they understood economics they would have realized that it completely meaningless to try to only sell non-Mid Eastern oil. The reason for that is that oil is fungible, priced at global financial markets. If they increase demand for oil produced in North America or Norway or Russia, this will only mean that other oil consumers, in say Europe, Japan, China and India will buy less from there and more from the Middle East.

The only way to hurt Iran and Saudi Arabia at the gas station is by buying nothing at all and so reduce global demand for oil.

Saturday, February 03, 2007

Red Heat

Arnold continues his path to the left by funding a far-left think tank. I really liked him a lot better as an actor.

Record Number of British Insolvencies-Despite Boom

The U.K. economy is growing at a fairly decent rate-yet personal insolvencies still rose 59% last year, to a new record high. The reason is of course the ever growing debt burden. This is another example of how strong economic economic growth fueled by structural factors and/or further credit expansion can mask an increasing number of malinvestments.

Friday, February 02, 2007

Good News-Bad News Employment Revision

Today's employment report were relatively weak, at least with regards to December-January changes. Payrolls rose less than expected and the household survey employment number rose even less. As a result, unemployment rose from 4.5% to 4.6%. Meanwhile, hours worked fell back and average hourly earnings rose a mere 0.2%.

However, far more interesting than the December-January changes was the revision of previous data. Payroll employment were upwardly revised by 894,000, while total hours worked were upwardly revised by 0,9%.

This is both good news and bad news for the U.S. economy. On the one hand, this means that the supposedly relatively weak employment growth of the last few years wasn't so weak after all. On the other hand, as output levels have not been upwardly revised, a increase in hours worked also means that the supposedly strong productivity growth wasn't so strong after all. This means that either real hourly compensation of workers or corporate profits must be downwardly revised. Given the fact that average hourly earnings were not downwardly revised in this report (they were in fact slightly upwardly revised), most, if not all, of it will probably represent lower corporate profits.

Thursday, February 01, 2007

Official vs. Real Expectations

Google profits are higher than "analyst expectations", yet the stock still falls in after-hours trading. Standard & Poor analyst Scott Kessler comments by saying "No matter how you look at it, they notably exceeded expectations. It's just that all the good news is already priced into the stock.". But if people have already priced in good news, doesn't that mean that their real expectations are much higher than their official expectations?

This is not a phenonema limited to Google. Just about every earnings season (i.e. every quarter) many, usually most, companies beat official expectations, with almost all remaining companied meeting official expectations, and only a handful missing official expectations. One would have thought that this systematic downward bias in official expectations would have induced Wall Street to re-evaluate their methods-unless, of course, it is deliberate so that every earnings season will be associated with "good news" no matter how bad the earnings are in a absolute sense, so that people will be more willing to buy stocks, using the brokerage services of the bank and brokerage firms that hire the analysts whose low forecast ensure that earnings will be "better than analyst's expectations".