Wednesday, May 30, 2007

All You Need to Know About Wall Street Rally

So Wall Street ignored the sell-off in China's stock market. Quite rational since there aren't any good reasons why it should have a significant effect. Yet not only did Wall Street not sell off, it actually soared. Why? Because Fed minutes expressed confidence that the U.S. economy would turn around in the second half of this year. Huh?

That is not only not a rational response, it is a highly irrational response. First of all, regardless of whether you agree with the Fed's view or not, the mere fact that the Fed expresses this view without even putting forth any arguments does not make it more likely or the case for it more persuasive.

Indeed, given the fact that this will further reduce the already non-existent chanse of a rate cut and in fact increase the odds of a rate increase (especially since the Fed expressed concern about inflation), the rational Wall Street response argument would be to sell off, not rally.

When the market is in such a mood, nothing is going to stop stock prices from rising. So as long as this sentiment continues, I am bullish on the U.S. stock market. The only problem is of course to pinpoint when the bullish sentiment ends, because previous similar "all news is good news"-episodes sure haven't lasted forever.

Swedish GDP Growth Slowdown Only Apparent

Sweden's GDP growth seemingly slowed sharply during the first quarter. From a downwardly adjusted 4.2% (4.3% in calendar adjusted terms) during 2006 to 3.0% during Q1 2007. Yet if you look at the details, the slowdown is a statistical illusion.

The reason is the phenomena I discussed here: the issue of terms of trade. What fell from 4.2% to 3.0% was volume growth, which is deflated by the sales prices of producers. The more relevant measure is nominal growth deflated by the prices of the goods and services you buy, not the prices of the goods and services you sell (you don't get richer if you sell more goods and the relative price of it falls even more).

In 2006, terms of trade adjusted growth was 0.3%:points lower than volume growth (In previous years the difference was a lot higher). But during the first quarter, terms of trade adjusted growth was in fact 1.1%:points higher. Meaning that terms of trade adjusted growth, far from falling, rose from 3.9% to 4.1%.

The reason for this improvement in terms of trade can be spelled in one word: oil. This factor has also contributed to improvements in terms of trade in other oil- importing countries too, including America, Germany and Hong Kong.

That is the main bullish aspect of this report. Another bullish aspect is the fact that government consumption continued to fall as a share of GDP, thus helping to reduce the burden of government on the private sector, which in turn should continue to help growth.

There are bearish aspects too consider as well. Growth was largely driven by a surge in inventories; which could dampen growth in the short term. And a more long-term threat is the extent to which growth is driven by credit fueled over investments. Apart from inventories, the strongest factor driving growth was a surge in residential investments. Eerily similar to the situation in America a few years ago. Look for this trend to continue in the coming two or three years, given the rather dovish inclinations of the Riksbank and the housing tax reform. But after that, trouble could arise.

Tuesday, May 29, 2007

Two Interesting Articles

While those bullish on the U.S. economy think the housing recession will be over by the second half of this year, this article points out that because construction were so high in the past, they are unlikely to fully recover until 2011.

This article points out that inflation is likely underestimated by official statistics and that it is the cruelest tax of all.

Increasing Reasons to be Bullish About the Euro

The current account balance of the Euro zone turned positive again after having been negative in 2005 and 2006. This may perhaps appear somewhat puzzling given the fact that the Euro zone is in a cyclical boom and the fact that the Euro have been so strong.

The explanation for this is in part the fact that oil prices (and therefore the cost of oil import) are much lower than last year (particularly in euro terms) and also the German tax reform which effectively shifted taxation from exports to imports. The shift in the Euro zone current account balance is basically entirely a result of Germany's soaring surplus.

The fact that the current account balance is strengthening while domestic interest rates are rising are good reasons to be bullish about the euro.

Increased European Tax Competition

Corporate income taxes are now being reduced in the large European economies following earlier more dramatic tax cuts in for example Ireland and most Eastern European countries.

Because of the higher mobility of corporate investors, the corporate income tax have a much higher negative effect on the tax base than most other taxes, which is why it is now lower than most other taxes.

Corporate income tax cuts look unlikely in some countries, like America, Japan and Sweden, even though particularly America and Japan have much higher taxes than most European countries. In Sweden the government is too anxious not to be seen as delivering give aways to the rich, so after the abolition of the wealth tax it doesn't dare go any further. In America, the concern is similarly that it will further increase inequality.

Monday, May 28, 2007

The Extent of the Yen's Decline

There is a joke in Swedish that it is always safe to lend to a Japanese because "de betalar alltid i-yen" (they always pay back [the money]), alluding to the phonetic similarity between the name of the Japanese currency and the Swedish word "igen" which in this context means "[pay] back".

In reality though, lending to Japanese have proven to be one of the worst deals around, at least during the latest decade. Not only is interest rates extremely low, but the exchange rate of the yen have been very weak during the latest decade. While the U.S. dollar have fallen against most currencies, including virtually all European currencies and the dollars of Canada, Australia and New Zealand, it have actually risen against the yen. Implying of course that other currencies have risen even more dramatically against the yen. And while the appreciation of the Chinese yuan against the U.S. dollar have been too slow, at least it have changed in the right direction, in contrast to the yen which have changed in the wrong direction.

Interestingly, this depreciation of the yen occurs at the same time as Japan have had much lower inflation than other countries, seemingly putting the purchasing power parity(PPP) theory into question.

The PPP-theory is valid as a basic framework for analyzing long-term trends in exchange rate movements. But one should always be aware of the fact that there are factors which cause deviations from this basic pattern. Or in other words, there are things that cause fluctuations in the real (PPP-adjusted) exchange rate. One of the most important of them is fact that differences in productivity in sectors with traded goods help bid up wages in the non-traded sectors (where productivity is more similar) of high productivity countries and so help raise the price level in those countries. Note that this is a factor which would cause real exchange rate fluctuations inside currency unions as well.

The other highly important factor is asset price differentials, and particularly bond price differentials or in other words bond yield differentials. Unlike the previous one, this factor would not exist in a currency union. Japan's extremely low bond yields have been a key factor in pushing down the real exchange rate of the yen.

There are other factors apart from these two which cause differences in real exchange rates, but they are the most important and relevant for the case of Japan.

So just how big have the yen's decline been? While OECD estimates ( found here) of real exchange rates should be taken with a grain of salt, they are still likely roughly true. While the yen have fallen so that a dollar now costs 122 yen compared to 85 in 1995, the PPP-exchange rate have fallen from 170 to 124 in 2006. And with inflation in Japan running about 3%:points lower than in the U.S., the PPP-exchange rate should fall to about 120 this year. Meaning that in just 12 years the real exchange rate of the yen has been cut in half (from 170/85 to 120/122).

This dramatic decline in the yen's real exchange rate reflects in part that Japan have had lower population- and GDP growth and so helped push down relative domestic prices. But in recent years, the carry trade phenomena have been a important factor in pushing down the yen.

Friday, May 25, 2007

OECD Makes Correct Observation-But Wrong Interpretation

I see here that the OECD observes that deficit reduction based on reduced spending is "deeper and longer-lasting than those founded on increased revenues." So far, so good, but the OECD messes up its interpretation of why that is. The OECD thinks this is because spending cuts somehow lower interest rates more or makes politicians more reluctant to waste the surplus.

But there is no real reason to expect spending cuts to affect interest rates differently than most tax increases (the exception being capital income taxes). Nor is there more reason to expect politicians to not spend surplus/ deficit reductions created by spending cuts than tax increases. If anything, the pressure should be greater in the former case since people are more likely to demand a return to what they are used to enjoying rather than something they never had.

No, the real reason why spending cuts provide more sustainable deficit reduction is this: higher revenues is either due to a cyclical upswing or tax rate increases. In the former case, the revenue windfall is almost by definition unsustainable, in the latter case the tax increases weaken long term growth and undermines the tax base (although the benefits of the deficit reduction will greatly limit this effect in most cases). By contrast, spending cuts will not only not weaken incentives, but will in some cases improve them (such as reductions in unemployment benefits), thus reinforcing rather than limiting the positive effects from the deficit reduction.

New Zealand's Successful Abolition of Farm Subsidies

Here is an interesting story about how farms in New Zealand remained successful even after farm subsidies were abolished. When subsidies were abolished, farmers were forced to focus on actually meeting consumer demand, and was successful in doing so. Thus, not even from a farm perspective can farm subsidies be justified.

U.S. Congress Combines Worst of Left & Right

When you read about this kind of Congressional bill, you remind yourself about a Republican Congressman according to Peter Brimelow said a few years ago: "In America, we have a two-party system. There is the stupid party. And there is the evil party. I am proud to be a member of the stupid party. Periodically, the two parties get together and do something that is both stupid and evil. This is called—bipartisanship."

So now Congress have approved additional funding for the Iraq war. Democrats at first wanted a timetable for withdrawal, but later decided to appease Bush and cave in to his demands to drop the timetable. This despite the fact that they had the upper hand. Because if no funding bill were passed, then Bush would be forced to end the war immediately. And it would certainly be reasonable to demand at the very least that Bush define how victory look like and put forward a concrete and realistic plan on how to achieve it.

And just to make sure that they didn't just appear spineless but really ridiculous and stupid too, Democratic leader Harry Reid still claimed "The days of blank cheques and green lights for his failed policy are over". So that was why you gave him everything he wanted, the way he wanted it?

Ah, but the Democrats apparently think they can answer the likely anger from their base they managed to insert a minimum wage increase into the bill. Not that this in anyway means a compromise from Bush since it included the symbolic "small business tax cuts" he wanted to have. The Democrats have in other word not gotten a single concession from Bush to approve his policies and they still claim that "The days of blank cheques and green lights" are over? Puh-lease.......

Anyway though, so the end result is that the Democrats agreed to continue the futile neoconservative quest to sacrifice thousands of Americans lives and hundreds of billions of dollars to bring Western democracy to a culture hostile to it, and in exchange, the Republicans "agreed" to increase domestic regulations in exchange. A really bad day for liberty and good day for statism.

Thursday, May 24, 2007

About Time They Figure That Out

Well, I've been telling them for months, but do they the listen to me? No, they knew, didn't they? Just a harmless little bunny, eh?...Or to return to the subject matter, Wall Street finally realized what I told them two months ago: there won't be any rate cuts from the Fed anytime soon. So, the bond market, have sold off big time with the yield rising from the 4,52% it stood at back then to 4.86% now.

In the meantime as bond yields have soared, stock prices have also soared, up 6% since then. Which of course means that the relative attractiveness of stocks have fallen significantly. If this reflected a permanent lowering of risk aversion and therefore the risk premium of stocks,then that would be sustainable. But if not (as seems more likely), then we could be looking at a stock market correction.

Wednesday, May 23, 2007

North American Currency Union?

In sharp contrast to Europe, where for example the British pound and Swedish krona have fluctuated only little against the euro, North America's two currencies, the U.S. and Canadian dollars have fluctuated dramatically against each other. The two months alone have seen a 8% increase in the value of the Canadian dollar against the U.S. dollar. So now, Bank of Canada governor David Dodge argues in favor of a North American currency union.

He does however say that this presupposes free movement of labor. Actually, monetary unions don't presuppose this in order to work as long as prices are reasonably flexible. The real argument against this plan from a Canadian perspective would be if it would really be wise to allow their monetary policy to be run from a central bank with such a inflationary track record as the Federal Reserve.

And in reality, nationalist or anti-globalist sentiment in both Canada and the U.S. is likely to prevent this from happening anytime soon.

Tuesday, May 22, 2007

Latvia Heading For Trouble

These statistics for Latvia look very ominous, to say the least:

"With a current account deficit of 26% of GDP in Q4 2006 (the world’s highest) combined with runaway government spending and booming credit growth (78% in 2006), the Latvian economy looks dangerously close to overheating."

While part of Latvia's growth reflects the catch-up effect versus Western Europe and part reflects the benefits of low flat taxes, these numbers clearly illustrate that part of it reflects an unsustainable boom-bust cycle.

How Israeli Economic Policy Should Have Been

In its early days, Israeli economic policy was quite socialistic. Beginning in the 1980s and particularly during the periods when Binyamin Netanyahu was Prime Minister and Finance Minister, respectively, Israel have pursued free market reforms that have now made it a lot less statist and socialist then it once was. Still, a lot of time was lost, and Israel is still too socialist for its own good. The reason why Israel became relatively socialist was that many early Zionists, including Chaim Weizman (Israel's first President) and David Ben Gurion (Israel's first Prime Minister) were leftists.

Yet as this Jerusalem Post article reveals, the most important original Zionist, Theodor Herzl, author of the Jewish State, was actually a follower of the Austrian School and an advocate of capitalist economic policies. He grew up in Vienna, close to early members of the Austrian School like Carl Menger, and was influenced by their ideas. Had Israel followed his policies, then its economy would have been much stronger, enabling it to become a greater power than it actually has been.

Monday, May 21, 2007

Kuwait Abandons Dollar Peg

Kuwait abandons its dollar peg.Pegging currencies to other paper currencies is in most cases the worst alternative. Monetary unions are the ideal system if based on gold or if it does not mean a more inflationary policy than fluctuating exchange rates. Fluctuating exchange rates aren't good, but they are almost always a lesser evil compared to currency pegs. While currency pegs in some aspects are similar to currency unions, they have one vital flaw: they require massive intervention if the exchange rate is deemed either highly overvalued or highly undervalued. If overvalued, they create the need for capital flow controls or absurdly high interest rates, as we saw with the U.K. pound and Swedish krona in 1992. If undervalued, they created the need for massive accumulation of foreign exchange reserves, as we see now with China and some other Asian and oil-exporting countries. These interventions, who are unneeded both in currency unions and floating exchange rates, will create distortions that far outweigh any benefits from currency stability.

Kuwait will not float its currency, but shift to a currency basket of undisclosed composition. But given likely dollar weakness, it will nevertheless imply some appreciation.

Irish Electoral Campaign: Tax Cutters vs. Anti-Spenders

Interesting story on Ireland's electoral campaign. Ireland's boom have been driven by a combination of sound (low taxes, a budget surplus and favorable demographics) and unsound (high level of inflating from the ECB). While progress on the tax and spending front have largely stalled in the most recent years, politicians are now apparently competing in being the biggest tax cutters.

The incumbent government led by Bertie Ahern is promising that "The next step is to cut income taxes further and wipe out the country's national debt". Meanwhile, opposition parties are attacking the government for "wasteful spending". Of course, one can't rely on politicians keeping their promises, but it is nevertheless a good sign that the public debate is centered around the virtue of tax- and spending cuts. This makes it more likely that the tax- and spending cuts will actually happen.

Saturday, May 19, 2007

Just When You Thought Zimbabwe Couldn't Get Any Worse

Inflation rises to 3732%(!) in Zimbabwe. What is really amazing about this news story is the complete absence of money supply discussions. In the story, hyper inflation is said to be the result of Mugabe's theft of white farms and other various other policies, while Mugabe is said to blame it on foreign governments. Yet while it is certainly true that the land thefts and the other policies have been contributing to the collapse of the economy, the by far most important cause of extremely high price inflation is of course extremely high money supply growth. And the hyper inflation is of course in itself a contributing factor to negative economic growth.

Why Aren't China in G8?

China's shadow hangs over G8 says Yahoo News. Of course it does, given China's increasing importance. The question is, why aren't China included while much smaller economies like Russia and Canada is? Like it or not, China is one of the most important economies of the world and is becoming more important all the time, and if the intention is to gather the world's most influential economic powers it makes no sense to exclude China, while including Russia and Canada.

Australia Lucky Again

This time with the weather, removing the one exception from its lucky streak. After the long drought, rain was actually desperately wanted there.

Tuesday, May 15, 2007

French Growth Lowest in EU

As I recently highlighted, Portugal has for a long time had the weakest growth in Europe. Now it has lost that anything but honorable title. Year over year growth in Portugal rose from 1.7% to 2.1% in the first quarter, while France's growth fell from 2.2% to 2.0%. The third infamous laggard, Italy, saw its growth fall from 2.8% to 2.3%, but that is still higher than in France. Given France's more favorable demographics, this is extraordinarily bad for it to be weakest in the EU. Hopefully, Sarkozy will lead France away from the statist policies that have mired its economy and turn around its economy like Germany did, but that is far from certain.

See also Alvaro Vargas Losas interesting analysis of French economic problems.

German Growth Remains Strong

German GDP growth suprised on the upside, with GDP growing 0.5% compared to the previous quarter-despite the VAT increase. Private consumption fell back as a result of the VAT increase, but a soaring trade surplus helped sustain growth reasonably well.

Moreover, growth in the previous quarters was revised up so that year over year GDP growth in the fourth quarter was 3.9% in calendar adjusted terms, instead of previously estimated 3.7%. That number only fell back to 3.6% in the fourth quarter.

Germany is now in fact the fastest growing G7 country, as it have benefited from its free market reforms, while the other G7 countries are dragged down by cyclical or structural reasons. The cyclical component of growth is less important in Germany than in other parts of the Euro-zone as credit growth have been weaker. But on the other hand, Germany's shrinking working age population means that the expansion in the labor force created by reduced unemployment benefits is unsustainable.

Wednesday, May 09, 2007

Swedish Growth Probably Slowed Significantly During Q1

Last year, Sweden had the strongest growth rate (4.7% in calendar adjusted terms) for a long time, as investments boomed and consumption increased significantly, and yet despite this the trade surplus rose somewhat. This was the result of several factors, both positive and sound ones like favorable demographics and reduced tax and spending burden and not so sound ones, like high monetary growth. Also, strong growth driven similarly by both sound and unsound factors in neighboring countries like Denmark, Norway and the Baltic countries helped boost Swedish exports.

The signs are increasing that growth is slowing. The Swedish statistical bureau now reports that their so-called activity index, which are meant to give a early approximation of GDP, only rose 2.7% in the year to March. While this activity index has not always been reliable, there are severeal reasons to believe that growth has fallen.

In particular, the trade surplus have again started to fall after the somewhat surprising uptick last year. Moreover, retail sales increased somewhat less than before. This is somewhat ominous given the continued strength in monetary growth.

Cyclical growth should again get a boost from the housing tax reform, but the likely weakness in first quarter growth, if sustained, certainly bodes ill for the medium-to long term prospects for the Swedish economy.

German Trade Surplus Increases Sharply

Germany's current account surplus rose from €25.3 billion in the first quarter of 2006 to €36.8 billion in the first quarter of 2007. Which is very strong, particularly given the strong euro. To a large extent, however, this reflects the combined increase in the VAT and reduction in payroll taxes. While both the VAT and payroll taxes taxes domestic production for domestic use, the difference is that the VAT taxes imports but not exports, while payroll taxes taxes exports but not imports. So Germany has in effect raised taxes on imports while reducing them on exports. Given this, one shouldn't perhaps be to surprised that the current account surplus increased despite the strong euro.

The total trade surplus (the current account surplus minus net factor income and net factor income, or alternatively the trade balance in goods plus the trade balance in services and "supplementary trade items") increased even more, from €27.9 billion to €40.4 billion. This implies that foreign trade gave a net contribution to German GDP growth in the first quarter of 2.1%:points. The VAT increase is likely to have reduced consumption significantly, so GDP growth will still likely be lower than the 3.7% it reached during the fourth quarter. But the slowdown will probably not be as dramatic as previously thought.

Tuesday, May 08, 2007

New Study On EMU & Trade

Last year I reported on a study by Swedish economists Harry Flam and Håkan Nordström on the effects of the European Monetary Union. They estimated that Sweden's foreign trade would have been 13% higher if Sweden had abolished the krona and introduced the euro as currency.

Now, a economist by the name of Claes Wihlborg hired by anti-EU party Junilistan have estimated a much smaller effect (like the first study, it is written in Swedish). They argue that trade would have increased a lot less. Only about 10% versus euro zone countries and zero versus non-euro zone countries, meaning a total effect of about 4%.

So, who is right? Well, actually both have faults in their logic. First, let us make clear that the effect on monetary unification on internal trade is unambiguously positive. There are no theoretical reasons to expect it to be negative while there are good theoretical reasons to expect it to be positive. The effect on trade outside the currency zone is by contrast theoretically ambiguous. On the one hand, increased specialization could have a spill-over effect on countries outside the monetary union. On the other hand, the reduced internal trade barrier that monetary unification constitutes could have a trade diverting effect away from trade with third countries.

However, while we know from theory alone that monetary unification will increase internal trade we don't know by how much. And as far as external trade goes, we don't know from theory which of these effects will be bigger. This is why empirical studies are needed.

Given the fact that the effect on external trade is theoretically ambiguous, the estimate of Flam & Nordström that the positive net effect was as much as 12% seems implausible. Not impossible, but certainly implausible.

On the other hand, Wihlborg's arguments against Flam& Nordström's estimates of internal trade are not persuasive either. He argues that improved macroeconomic stability in some of the countries are one explanation. Just what he means by "macroeconomic stability" is not clear, but there is no reason at all to think that any macroeconomic variable other than the exchange rate would impact relative trade intensiveness. And the effect of the elimination of exchange rates is of course what this discussion is all about. He also argues that cyclical fluctuations rather than absolute levels of GDP growth should be used as a statistical control variable. But there is no reason to expect that cyclical fluctuations in growth should result in anything else than fluctuations in trade. The theoretically correct control variable is in fact as Flam & Nordström argued absolute levels of GDP growth.

Moreover, his argument that it is strange that so much of the positive effect happened already in 1999 is not a good one. Supposedly he would argue that it takes time for companies to initiate the investments and trade stimulated by the euro. But it's not like the imposition of the euro was something that took people by surprise on New Year's Day 1999. The final decision was made already in 1997, giving companies plenty of time to invest.

These errors, particularly his use of cyclical fluctuations rather than absolute levels of growth is the main reason why he landed at a estimate of increased internal trade that was a third less than Flam & Nordström. But as Flam & Nordström's control variable was more theoretically correct, their estimates must be considered more credible.

On the other hand, their estimate of the boost external trade certainly seems implausibly high. But, and this needs to be emphasized, this would make little difference as with regard to the total boost to trade. The reason for this is that the boost to internal trade was calculated by dividing it to the boost to external trade. Internal trade in euro-zone countries increased 26% relative to internal trade in the control group. So, the 13% estimate was derived by dividing the 26% boost to internal trade with the 12% increase to external trade. But if the 12% estimate of external trade boost is revised down, while the 26% relative increase in internal trade is left unchanged, this means that the estimated boost to internal trade from a Swedish EMU-entry must be revised up by an equal amount. And while non-EMU trade is 1.5 bigger than Swedish trade with EMU, the net effect of revising down the estimated boost to external trade is very little. Indeed, even assuming zero effect would leave the estimated boost to total Swedish trade at 10.4%. While that is lower than the 12-13% that Flam & Nordström estimated, it is far above Wihlborg's 4%.

Monday, May 07, 2007

More on Wall Street-U.S. Economy Decoupling

Michael Shedlock has an interesting post which after arguing the case for a recession highlights how it may come even in the face of continuing robust money supply growth. M3 is likely growing at more than 10%, and another broad money supply indicator, MZM, is up 8% over the last year and an annualized 11% over the last 6 months. This is of course one of the explanations of how bond yields can stay low while the stock market surges even though earnings growth is slow. Rapid monetary growth is prevalent not only in America, but also in most other countries except for Japan, which of course is why both stock and commodity prices have increased so much.

The rapid monetary growth is likely to mean two things with regards to the recession: first it will make it milder than it otherwise would have been at least in the beginning, although it is also likely to make a recovery later more difficult. Second, it implies that the recession will be a case of stagflation, not some Keynesian "weak aggregate demand" recession.

Meanwhile, while profits for large U.S. corporations have been much weaker than stock prices, they have nevertheless been positive, despite the deteriorating U.S. economy. The reason for this is found in this Bloomberg News story. Companies in the S&P 500 index received 48.6% of their revenues from non-U.S. sources last year, up from 30% as late as 2001. The reason for this is both the fact that slower economic growth and a falling dollar have decreased the relative importance of the U.S. economies and the increasing general globalization.

Sunday, May 06, 2007

"Holistic" Approach

When affirmative action were first introduced in the 1960s in America it was presented as a temporary measure to compensate for past injustice against Blacks. That logic was initself faulty for several reasons even then, but now more than four decaded later its absurdity is all too apparent. Especially since recently immigrated Hispanics are also included in this privilege system along with Blacks, while recently immigrated Asians are also displaced along with Whites by this system.

As a result, resentment among both Whites and Asians have increased and so referendums in for example California and Michigan have decided that affirmative action should be ended.

However, the "legacy of slavery"-nonsense have now been replaced by a new nonsense called "diversity" in which supposedly proportional representation of all racial groups are considered vital for the learning environment. A theory which have also spread into some parts of corporate America. Never mind that there is no evidence at all to support that either racial homogenity or diversity somehow promotes learning.

But as it have turned into a quasi-religion that diversity for its own sake is vital and more important than meritocracy and as any heretic who insists on the meritocratic principle treating individuals on their individual merits is considered a "racist", universities in America remain undeterred by the popular votes demanding an end to affirmative action.

After these referendums, universities are unable to explicitly discrimate against Whites and Asians. Instead, they now resort to a "holistic" approach in admissions. In practice that means that they continue with affirmative action by taking background in Black or Hispanic neighborhoods as a unofficial ground for admission.

Not surprisingly, the result of the "holistic" approach is to increase the number of Black and Hispanic students.

"High schools in California are rated according to the Academic Performance Index, a 10-point scale with higher scores awarded to higher-performing schools.

From fall 2006 to fall 2007, the admit rate for black students coming from high schools with API scores of 1 or 2 jumped from 12 percent to 27 percent.

The rate for Latino applicants from these schools rose from 25 to 27 percent in the same time frame.

Ramon said these figures are testaments to the success of holistic review.

“That’s a sign of how the holistic admissions is working,” she said. “You have to really take into account all these other (non-academic) factors ... so that your students have a true college experience ... where they’re learning from each other.”

Not suprisingly, this was followed by a increasing gap in real merits:

"In fall 2006, before UCLA switched to holistic admissions, black and Latino applicants’ average SAT scores were 255 and 246 points lower than the average for their white and Asian counterparts.

That gap seemed largely unaffected by holistic review – in fall 2007, black applicants’ SAT scores were on average 293 points lower than those of white and Asian students, and Latino applicants’ scores came up 249 points short."

The clueless reporter didn't seem to notice that the gap was in fact affected-increased that is. Which is what you expect from a "holistic" approach that says other things than proven intellectual ability is important.

The racial character of the "holistic" approach is even more evident when you consider this:

"But at the same time, the admit rates for white and Asian students from low-performing high schools fell.

In fall 2006, 35 percent of Asian students and 41 percent of white students from California high schools with API scores of 1 or 2 were admitted to UCLA.

In fall 2007, those numbers dropped to 31 percent and 33 percent, respectively."

Just how these "holistically" admitted students will perform remains to be seen, but past experience is for students admitted through affirmative action to drop out and fail at a much higher rate than others.

Friday, May 04, 2007

Mixed Signals From U.S. Economy

This week's economic statistics in the U.S. have been almost completely reversed to the numbers presented last month. Last month, the factory orders data, new home sales and the ISM Manufacturing and non-Manufacturing indexes fell, while the existing home sales and employment data showed strength. This month, the numbers have been the exact opposite. Factory orders data, new home sales, the ISM Manufacturing and non-Manufacturing indexes all strengthened while existing home sales and today's employment data came in very weak.

The factory orders and new home sales data were still pretty weak in absolute terms and only represented a recovery from really weak to only relatively weak. The ISM indexes, while not being particularly impressive in absolute terms either nevertheless showed much more strength than the other data. The other data is certainly consistent with my view that the U.S. economy is slipping into a recession, while the ISM indexes indicates that the U.S. economy is continuing with its slow but positive growth. So, the flow of data is clearly a case of mixed signals.

However, the case for the recessionary scenario remains strong with residential investments still having a lot of more room to fall, with business investments looking weak with profits from domestic operations declining and with private consumption looking weak with weak income growth and less mortgage equity withdrawals.

Against this is oil prices which are well below year ago levels and a falling dollar and booming foreign economies which helps boost net exports and profits for U.S. multinational companies (and thus stock prices).

Which of these counteracting forces will prevail remains to be seen, although the fact that the forces of weakness are much bigger certainly means that they are the most likely winners. Regardless of whether growth falls below zero or not, the fact that there are two counteracting forces at works means that growth is not likely to be much above zero if a recession is avoided- and that a recession is not likely to be that severe.

Thursday, May 03, 2007

Strong German Job Growth Continues

It is increasingly evident that most economists -including me- underestimated just how big the positive effects of the German free markets reforms would be. During the latest year, employment growth has been 1.6%. Now, that may not sound particularly impressive, but considering the fact that this happens in a country with a shrinking working age population, it is actually really impressive.

The employment to population ratio rose 1.6%:points, from 67.7% to 69.3%, meaning that employment rose in effect 2.4% relative to the working age population. This is the equivalent of a 3.4% employment growth in America (or a monthly employment gain of 400,000). As a result, unemployment is falling dramatically, from 8.8% the year before to 7.2% now.

This however, implies that the current relative strong economic growth rate is unsustainable. Not only because it is partly (although probably to a lesser extent than in other euro zone countries) fueled by unsustainably low ECB interest rates, but also because the shrinking work force means that labor shortages will soon appear.

CRB Spot Index Above 400

The CRB Spot index, one of the many commodity price indexes, rose above the key 400 threshold yesterday, again illustrating the excess liquidity around the globe. The CRB Spot index is up 24% since a year ago, with The Economist's commodity price index showing similar increase. The third important commodity price index, the CRB Futures index is a lot weaker, however, mainly because it includes energy prices which have fallen during the latest year. Even that is however up more than 4%, a lot higher than the official consumer price indexes.

This excess liquidity is also evident in the stock market rally. The S & P 500 for example is up more than 15% during the latest year, far higher than the increase in profits of 7%. This, and the fact that the market looks overbought on technical grounds, means that the probability of a significant correction is high.

Wednesday, May 02, 2007

Efficient Market Hypothesis Again Proven Wrong

Anyone who has actual experience of financial markets is not likely to find the Efficient Market Hypothesis particularly realistic. I have explained the theoretical grounds why it isn't true here.

Here is a practical example of how some investors are sometimes really irrational. Some morons have actually paid money for the stock of Delta airlines, even though it went bankrupt in September 2005 and even though it has long been clear that not even bondholders are going to get more than a fraction of their money. And bondholders are legally entitled to be paid back in full before stockholders can get a single penny.

And with some investors being this irrational, this implies that more rational investors have a chanse to make money the Efficient Market Hypothesis claims they cannot make.

Tuesday, May 01, 2007

They Expected Their Expectations To Be False

Procter & Gamble has disappointed investors. You see, they met the expectations of official analysts. But that wasn't good enough for the analysts. The analysts, however, expect companies to report higher earnings than their expectations. They expect more than they expect, in other words.

That of course sounds like a self-contradiction, but only for people unfamiliar with Wall Street. In reality, as I've reported about in the past, the official expectations are systematically downward biased so that every quarter, the financial press will be able to report that for most companies, earnings exceeded "expectations". It never fails. I've followed Wall Street earnings seasons every quarter for more than a decade and one thing that I've always been able to count on with absolute certainty is that no matter how bad the earnings are in an absolute sense, they will always -always- be reported as being "better than expectations" for most companies. Anyone who is positively surprised by this and buys stocks on the "better than expected" earnings is either a dishonest liar or an inexperienced fool.

And so, it must be emphasized, the main reason why stocks rose so much in April was hardly the official financial press spin of "better than expected" earnings as I don't think there enough naive inexperienced investors to account for the entire increase. Instead, there was simply a positive trend driven by technical factors and increased liquidity. Also, the falling dollar likely created expectations(in the genuine sense of the word) that the trend of rapidly increased foreign earnings for U.S. companies will continue.