Thursday, December 30, 2010

Goodbye 2010, Hello 2011!

I have been reading lots of forecasts about 2011 – some in the local South African Sunday papers just say that the emerging economies are the place to put your money, and others, such as the Economist warn that the emerging economies will become more risky as some of them become dangerously overheated and recommend reconsidering the US given the new stimulus from the Tax bill recently passed through the US Congress. The general consensus in terms of investment in stocks is that emerging markets will continue to be the preferred location for stocks, but if US economic policy signals a change towards greater growth in the developed world then this will trigger large capital flows from emerging to developed markets.

In this posting I want to review 2010 in terms of the financial markets and consider the various (geographic) alternatives for a good portfolio strategy for 2011. From an economics perspective, economic growth refers to growth in the size of the economy which should therefore increase the profits of companies in dollar terms as quantities of goods produced increase. Stockmarket prices should be an indication of future profits, so one might expect stock prices and economic growth to be correlated, but interestingly their correlation is not that high. Nevertheless this is more likely due to a variable lag relationship between the two which would not show up in a simple correlation. Common sense tells us that there must be some kind of relationship there, otherwise it would imply complete irrationality on the part of the markets.

There is general consensus now that the US economy is now beginning to recover from the economic downturn, as are the European and Japanese economies. Obviously the continuing US economic recovery is key to a general global recovery given that the US tends to drive global economic growth and therefore the stockmarkets, but there are other considerations for 2011. As of December 15th US economic growth was forecast to be 2.8% for 2010 with stockmarket appreciation of 10%. Growth is likely to accelerate next year, so stockmarket gains should continue into next year, but probably not at an accelerating pace.

The big question marks in terms of where to put your money are Japan and Europe. I do not agree with the cynics on continental Europe and the future of the euro, but stockmarkets are probably not the best place gamble when probabilities are uncertain, as sometimes markets themselves can precipitate crises. In the UK the prospect of cuts and political uncertainties do not make both Southern and middle Europe an attractive proposition in 2011, but northern Europe and in particular the Nordic countries still look very attractive going into 2011, with Sweden the leader of the pack in 2010 ( - growth of 4.6% and stockmarket appreciation of 27%).

Japan, I believe, might be the big surprise of 2011. Japan is still in the throws of deflation with current year over year inflation running at around -2.5%, but growth is now picking up, with the Japanese economy growing at a projected 3.2% in 2010, far ahead of most of Europe, and prices are actually now rising on a month to month basis. Japanese stockmarkets have advanced around 8.3% this year, ahead of all European stockmarkets with the exception of Germany’s DAX index. If this trend continues then Japan may outperform most of Europe, and with a resumption of healthy growth, the Japanese stockmarket could incorporate a sharp upward correction in 2011.

Now to the emerging markets. Although China has been a hot market in 2010 with estimated 10.2% economic growth and its stockmarket up by nearly 22% in dollar terms, I believe that China is now a risky prospect for 2011, with possible strikes, an unfortunate (lack of a coherent) foreign policy, and a rapidly increasing inflation rate. We do not really know what the economic growth rate in China is, as state factories always have an incentive to meet or surpass their targets, so in fact growth may not be as fast as reported. The main point is that a continuing “cultural clash” between the communist run political state and a free market economy could quite possibly lead to greater unrest, human strife and uncertainty in 2011.

Apart from the other smaller South East Asian economies (like Thailand, Malaysia and Indonesia – countries that all experienced double digit stockmarket gains and) which all grew at phenomenal rates in 2010, India with an 8.8% growth rate and a 15.3% (in dollar terms) stockmarket rise, is, in my opinion, a much better long term bet than China. Larger Indian companies are now making their mark in many other emerging markets ( - I’ve seen a surprising number of Tata vehicles on the road in South Africa, for example), and their emphasis on technology and software development all bodes well for the future.

What about the rest of the world? South America continues to surprise, with Argentina, Chile and Columbia leading the pack, and here I would say Brazil is likely the country to watch, as their stockmarket has really not gained this year partly because of fears of overheating, but clearly there is still a lot of potential here. Africa, Eastern Europe and Russia are the wild cards. Africa probably has the greatest growth potential but political instability (as so vividly shown in the Ivory Coast and soon to be seen again in Zimbabwe) is the big problem here. Eastern Europe and Russia also have a lot of potential, but once again politics also plays a big hand, although some countries in Eastern Europe, particularly those that sank fastest and most dramatically in the economic downturn (the Baltic states), are likely to be good places to invest in 2011.

Last, the commodity and bond markets. The commodity markets (and particularly gold) make me nervous right now. There is no real reason for gold to be at the level it is ( - and incidentally that is a good reason not to put money into Australian or South African mining stocks right now), and the fundamentals really do not support further increases in the price of crude oil either. In terms of the bond markets, stay away from developed economy markets as the timing of when interest rates will start to rise are very uncertain, but emerging market bond markets likely will continue to offer good yields, particularly at the long end.

Wednesday, December 22, 2010

South Africa's New Growth Plan - A (non-Nobel) Outsider's Evaluation

Recently the South African ANC government headed by President Jacob Zuma published a New Growth Plan which is to guide policymakers and businesses in terms of the future growth path of the economy. The Economic Development Minister, Ebrahim Patel, got nobel Laureate Joseph Stiglitz to write a review which was widely published in South Africa endorsing the government’s New Growth Plan. Of course getting an endorsement from a Nobel Laureate is always a good strategy to build credibility for what is clearly a new and somewhat controversial direction for South Africa, but Nobel approvals aside, in my humble opinion there are some clear pluses to the plan and some definite minuses and problems with it as well. I deal with the pluses and minuses as I see them below, but where I was most disappointed was with the macroeconomic policy proposals. A copy of the plan is available at

The major pluses as I see them are: i) clearly expressing the government’s strategy in one coherent document with justifications for the choice of “growth-drivers” so that everything is there in detail for all to see – hopefully that will lead to some consensus on certain parts of the Plan and maybe other parts being dropped or re-worked; ii) the acknowledgement that it is the private sector that is the major job creator in the economy, although recognizing the state’s role as a “growth enabler”; iii) the combining of macro and micro policies into one policy document; iv) the inclusion of “stakeholders” in the process for implementing the Plan; v) the concern for rural development, particularly in the previously self-governing “Bantustans”; vi) the emphasis on environmentally sustainable growth; and vii) the idea of establishing a sovereign wealth fund in the mining sector. The first plus is self evident, as is the second, the third is just the economic approach, but perhaps a couple of the latter points require some elucidation.

One of the hallmarks of Germany’s success as an economy is rooted in their “corporatist” approach to economic management – this involves inviting all stakeholders in a business or industry to partake in important decisions, whether it is wage increases (obviously done at the industry level when Unions have significant bargaining power), shift work hours, expansion of operations or product line. Business, unions, state governments or federal government often met to make sure that everyone was “on the same page”, so to speak. This is important as it allowed proper flow of information and led to an avoidance of strikes and better management shop floor relations. If what the government has in mind is more of a “stakeholder” decision-making process in industrial development then it is clearly to be welcomed. After the strikes that hit South African industry in the middle of 2010 and the threat of lower investment from major multinational sources of FDI, if this represents a move to a more “corporatist” economic structure then it is to be welcomed.

The concern for development of the rural areas in South Africa is clearly also stressed in the plan. With the proper policies in place, in fact these areas have the most catching up to do and therefore the greatest potential for economic growth. Allowing private businesses to flourish in these areas requires the agrarian economy to become more streamlined but also the infrastructure needs to be in place to allow non-agrarian businesses to take off. In this day and age this requires good and reliable energy supplies as well as broadband internet connection. This is where competition with government specifying what is required might yield the best results. Financing is also usually a major constraint on the private sector in rural areas so the idea of a state owned bank to stimulate lending in rural communities is interesting and I believe worthwhile considering. But I hope that the government also looks at the idea of what in the US is called a “credit union” or in the UK a “building society”. These are non-state-owned and not-for-profit financial institution models, and might work better in some rural communities than a state-owned bank.

So what about the problems that I see with the report? The biggest problem that I can see here is the lack of analysis of exchange rate regime options. The report clearly advocates managing the exchange rate, but I don’t see any evaluation of what would work best for the country, nor a clear rationale for the “soft peg” option of keeping the currency undervalued in the report. I am guessing that the Chinese model of a managed low and competitive currency is the major inspiration for the new formulation of macro policy, and it is clear that many other elements of the report are subservient to this – in other words lower interest rates are achieved through a more lax monetary policy, and a stricter fiscal policy compensates for this, but to prevent inflation there has to be wage and/or price controls in place (which includes “collective bargaining” and caps on executive pay inflation). But would a policy that works well for China work well in the South African context? And what of the severe criticism that China is facing for its foreign exchange policy? Would South Africa really want to play “currency wars” with other countries? [See for a South African article reviewing this issue].

Let’s take a step back from this issue for a moment and look at another aspect of the current “problem” with the high value of the rand. As a reasonably frequent visitor to South Africa, I recognize that the exchange rate has appreciated in real terms, but this is nearly all due to capital inflows into the “emerging markets” because of the more rapid recovery from the economic downturn here, combined with the flow of capital into the mining and minerals sector of the economy as commodity prices recover. This will not continue forever, and in fact many economic commentators are expecting these flows to slow and maybe reverse in 2011 ( - see the latest edition of The Economist). In this case the currency may depreciate quite rapidly. So if the exchange rate is perceived to be a problem right now, it may cease to a problem in a year’s time. What is more important though is deciding on what the most appropriate exchange rate regime is for South Africa in the longer term ( - and I am available for a much cheaper rate than a Nobel economist would charge to analyze this!) The main point is that if the exchange rate is to be the anchor for macroeconomic policy, there needs to be a discussion on what the policy should be and how the policy is to be implemented. If you are going to use an anchor, you should make sure you’re using the right anchor, and in the right way!

What about other problems in the plan? The emphasis on “labour-based production methods” is rather strange in this day and age. We live in a world where capital enhances labour productivity and therefore leads to higher wages. Why would a country want to encourage methods that specifically use labour-based methods? I understand the need to reduce unemployment rates, but this is best done by having a booming economy with major injections of capital as China and many other countries in South East Asia have discovered, rather than “labour-based production methods”.

Another problem is that the manufacturing sector strategy is not well-thought out in my view – phrases such as “supporting activities that can generate employment on a large scale and meet basic needs at lower cost in the short to medium term, while sustaining development of more knowledge-intensive industries for long-run growth” when referring to manufacturing industries, do not make a lot of sense to me. The manufacturing sector’s objective is not to create jobs – it is to create products that consumers and other businesses want so as to make a profit. Jobs are the welcome by-product of this objective.

Lastly, I would like to make two suggestions that I hope might help in the micro part of the report. In terms of industrial product development, the establishment and fostering of University-industry linkages has been shown to be very advantageous in many countries (UK, US and Canada, for example). If South Africa is serious about its future then it needs to attract research talent from around the world and make sure that industry can benefit from the research that Universities do. Lastly, I believe that reducing the high cost of access to broadband in South Africa really needs to be an absolute priority if the country’s citizens and businesses are to be able to take advantage of global technological opportunities, and not get left behind, as many African countries will be.

Monday, December 20, 2010

China and Africa – not a win-win situation?

Every time I visit South Africa at some point I end up in a store called Woolworths.  Now for people in the US Woolworths is synonymous with a failed chain of stores that catered mainly to the working classes and might be thought of as the Walmart of the 1960s.  There was also a Woolworths in the UK which went out of business but the Woolworths in South Africa used to be owned by the venerable UK chain store of Marks and Spencers known for its quality merchandise and good value for money.  In the 1980s Marks and Spencers decided to go global opening chains in Canada, South Africa and even France – in South Africa it decided to use the Woolworths brand name. When Marks and Spencers downsized in the 1990s it sold off its Woolworths chain in South Africa but the store still has the reputation of supplying quality merchandise.

On my latest trip to Woolworths I was surprised by certain changes.  For example, on previous visits there were always clothes and other items made in South Africa, Lesotho, Swaziland and Mozambique ( - all Southern African countries) – but this time I struggled to find anything that wasn’t made in China.  I eventually found some linen shirts made in Bangladesh, but absolutely nothing that was made in Southern Africa.  Now to me this is extremely disconcerting.  It means that African manufacturing companies are struggling to compete with Chinese manufacturers.  In fact the latest manufacturing output statistics for South Africa show a decline in output which continues a worrying trend for a country that relies on commodities and should be the manufacturing engine for most of the rest of Africa.  Recent statistics on capacity utilization at also underscore this.  

So why is this?  Unskilled wage rates are hardly high in Africa so this must be mostly to do with the Chinese exchange rate.  Now there has been plenty written about China’s undervalued exchange rate on the US and Europe, but not a lot has been made of the effects of China’s undervalued exchange rate on the rest of the world.  But China’s exchange rate policy has impacted developing countries as well, with Mexico’s maquilladoras struggling to compete and Indian companies also struggling with competing with China’s rapidly expanding industrial complexes. But although the US and Europe have criticized China, not much has been forthcoming on the issue from African politicians.  One of the most important reasons why Africa is not as anxious to criticize China as the developing world is that huge amounts of money have been flowing into Africa to buy up land and upgrade infrastructure – money that probably wouldn’t have flowed to Africa otherwise. 

The trade off with China in Africa (and indeed in other parts of the world) is a different one from that in the developed world.  In Africa the influx of money from China is not in the form of loans to fund the trade deficits run with China by the US and European countries, but instead is in the form of foreign direct investment in mining and mineral companies and land.  Either way the trade off is not a good one – it is a matter of short to medium term convenience to allow China to buy US and European bonds to keep interest rates low in the developed world, but the purchase of land and foreign direct investment in Africa, although supporting factor prices, is not easily reversed and comes with a major decline in the industrial base and also a sizeable loss of manufacturing jobs. Of course this differs by country with some of the extremely poor agrarian African economies benefitting from the inflow but not losing any industrial base ( - as they never had one to begin with), but the losses for other more industrialized countries (like South Africa and Nigeria) are likely to be much more serious in the long term.

In my mind there is another really important question here which is largely ignored by economists.  Is it in the rest of the world’s interest to have so many products made solely in China and hardly anywhere else?  What happens if there is major political unrest in China or striking workers limit output?  With virtually only one (monopoly) producer of certain articles this means that prices for these articles would skyrocket around the world until manufacturing capacity could be expanded elsewhere.  It would then be in the rest of the world’s interest to allow the Communist authorities to suppress any unrest on economic grounds, while on political grounds there would unlikely be much support for what the authorities end up doing ( - given their record on human rights). 

Thursday, December 16, 2010

Thoughts on South Africa's Day of Reconciliation

I am currently in South Africa and today (16th December) is a public holiday to celebrate the 1994 Truth and Reconciliation Commission which was chaired by Bishop Desmond Tutu. The Commission brought together victims of the apartheid regime ( - apartheid literally means “apartness” in Dutch) and some of the implementers of the previous oppressive regimes (particularly the regime under Botha) to tell the truth about what happened during the dark times in South Africa. The Commission is now held up as a model around the world as a way of moving a country forward from vicious divisive regimes towards more egalitarian humanistic and tolerant regimes. Bishop Tutu had to chart a difficult course, not apportioning blame but at the same time allowing reconciliation between oppressor and victim, which usually meant bringing together a white oppressor with a black victim. The world watched in rapt attention as stories of torture, arson, murder and worse were brought in front of a national audience and usually the victims or relatives of the victims.

In my view, Bishop Tutu deserves to be as celebrated a character as Mandela (or “Madiba” as they call him around here) as the Commission itself was an essential part of the bloodless transition from an apartheid government to a multi-racial government, and this public holiday is really a testament to how well Bishop Tutu managed the Commission, allowing the birth of essentially a new nation. And what a country it has become. After successfully hosting the World Cup this year, South Africa is now not only the biggest economy in Africa, but is clearly the most dynamic on the continent. Growth is strong, inflation is under control, migrants flock here from troubled adjacent nations, and the economy is generally still extremely vibrant. Under apartheid, South Africa was once isolated by the rest of the world, but the contrast now couldn’t be greater, with South Africa now incredibly plugged into the rest of the world, with South African leaders such as Thabo Mbeki acting as chief representative to the African Union on the Ivory Coast issue, South Africa being very active in many international organizations, taking a leading role in the World Trade Organization and the United Nations.

But of course progress is always relative. 16 years after the transition from apartheid to a truly democratic society there are still plenty of issues to be addressed. Although there has been a significant transfer of wealth to a newly emerged black middle class here, the vast majority of black South Africans remain uneducated and mired in poverty. In business the Black Empowerment Act requires that a minimum percentage of black South Africans have to be hired in companies with more than 15 employees – and this has certainly helped to transfer this wealth – but in education there is still a divide between the races. Most neighbourhood schools end up serving specific racial communities because apartheid still exists in terms of neighborhoods. Also violent robberies are becoming more widespread, with some shockingly open attacks in very public places – and this doesn’t seem to be a matter of race, but more the lack of effective policing in certain areas.

Unfortunately as well, racism is still alive in South Africa. Much of it is now covert in public, but it is still quite apparent when you speak to older anglos and Afrikaaners in private. For someone usually used to a reasonably multicultural environment, there are certain very obvious signs. First, I haven’t seen any multi-racial couples – I’m sure there are some, but they are definitely not common – and I haven’t seen one in the Port Elizabeth area. Second, despite the transfer of wealth to the new black middle class, the whites still hold the majority of the wealth, certainly in terms of their average per capita income. Third, most places I have been to, either to eat or drink or shop, clearly serve one specific racial community ( - the clear exception being gas/petrol stations). Fourth, land ownership is extremely important in terms of transfer of wealth, and although no one would wish a Mugabe-style forced transfer of farms to black farmers, many land claims by black farmers are still stuck in limbo years after the original claim. So nearly all agricultural means of production clearly still lies in white ( - mostly Afrikaaner) hands.

Like the Civil Rights movement in the US, though, letting the effects of de-segregation filter through to the roots of society will take time, and will probably only take visible effect one generation after the actual initial change. I am positive though that if South Africa can retain its democratic principles, its commitment to good business practices and keep a lid on corruption, it will prosper. South Africa is a country that has a lot for the rest of the world to admire – the weather, the scenery and the incredible cultural diversity here, but I think perhaps the transition to a better, more egalitarian politics is one of the most important things for the future of this country.

Monday, November 22, 2010

European meltdown?

Last week I did a talk for the second time on the European Financial crisis.  Each time I do this talk something nasty seems to happen afterwards. This time it is Irish banks and the impending bailout for the Irish government - last time it was Greece and it's bond market crisis and then the subsequent bailout.  In Europe the din from the masses is increasingly talking of doom and gloom with contagion to Portugal and Spain hitting the financial headlines. Even respected FT commentators are now "twittering" about the demise of the euro (see Gideon Rachman at and Samuel Brittan at 

This is dangerous stuff, as the demise of the euro would indeed have far-reaching consequences way beyond Europe. The ramifications of the most successful example of economic integration to date failing because of market forces and contagion would have global consequences way beyond Europe. The prospects of further Asian economic integration would likely be dashed, and monetary integration that is supposed to occur in South America and Africa would quietly be dropped. Not only that, but the critics of market forces stopping governments ( - who are after all democratically elected) from achieving regional integration objectives would likely spark a big backlash against the financial markets in continental Europe. The British, on the other hand, would likely be thanking their lucky stars that they never took the plunge and joined the euro in the first place.

But despite all the hubris and chatter, there are several important points that the mainstream media appeared to have missed when reporting on Greece and Ireland.  The first is that these are small countries, and that the euro area will remain intact while some countries might decide that it is in their best interest to leave.  As long as these are only small players the euro will likely survive. The second point (outlined in David Mayes's excellent piece on banking regulation that was recently in a review that I edited - now published online at is that with a single market in financial services there is an urgent need for banking regulation at a supranational level.  Hopefully EU member state countries will accept the transference of sovereignty in this area to a supranational banking regulator in the not-too-distant future.  The Irish crisis could easily have been averted had this already been in place.  The third is that given the crisis in public finances within Europe, there will hopefully be some agreement on transference of sovereignty in fiscal matters to the supranational level (just among the euro area member states?) perhaps in the same way that Australia has centralized it's debt issuance for it's states.  The fourth, and probably most important point is that it is in noone's interest to see this crisis spread through contagion as it will affect banks in all member states giving rise to even more problems with public finances throughout the euro area, so that action will likely be much more likely now that European leaders have seen the effects of papering over problems with the Stability and Growth pact or allowing inertia to set in in the ongoing evolution of economic integration within Europe. 

As Jean Monnet, one of the founding fathers of the European Union once said "People only accept change when they are faced with necessity, and only recognize necessity when a crisis is upon them."

Wednesday, October 27, 2010

Dollar delerium?

Last week the Chinese announced that they were going to raise interest rates.  Recently the Fed has been making a case for more quantitative easing (and therefore no rise in interest rates in the US), and the ECB hasn't been making a case for any more quantitative easing there, but guess what, the dollar decides to go up!  This, of course, goes completely against what you'd expect from economics, where higher interest rates usually cause money flows out of other currencies into the higher return currency.   Below we have how many dollars the euro has bought since it was launched in 1999. 

But what is interesting in the recent dollar movements is the fact that the dollar has seemed to be the focus of the markets, particularly because of its impact on monetary policy and commodity prices.  Higher US$ commodity prices are supported by a falling dollar as when converted into foreign currency the price is roughly constant, so the recent fall in commodity prices now implies a higher dollar.  But are commodity prices really headed lower when demand is becoming extremely buoyant in the rest of the world outside of the US?  

My own view is that the current US$ strengthening is only temporary - what with QE2, however you cut it, it implies a weaker, not a stronger US$.  The only caveat I would make though is that if I am wrong on US growth and we see stronger exports as US manufacturers take advantage of the lower US$ to boost their market presence in emerging economies, plus the emergence of another crisis in Europe (perhaps surrounding the Portuguese who cannot seem to agree on their budget - see then this might put a floor under the US$, and might even promote some appreciation.

Thursday, October 7, 2010

IMF World Outlook Growth Rates

Interesting that the IMF sees things pretty much the same way as I do for the world outside of Europe.  This is from their World Economic Outlook which was published yesterday!  It suggests that the best opportunities for stock market or mutual fund appreciation as we start the growth phase of the business cycle lie in South America, Africa, Eastern Europe and South East Asia. 

Tuesday, October 5, 2010

The Developing World and the Recovery Phase

As we enter the recovery phase of the business cycle, it is becoming increasingly apparent that there are big differences from a macroeconomic perspective between what is going on in the developed world and the developing world. The economist highlighted this in a recent issue which talks about the economic advances made in South America (cover on left).

It seems obvious to me that although there is a lot of hand-wringing about what is going on in the US (QE2, November elections, corporate stockpiling of cash), the fact remains that the US housing market has been the source of the global economic downturn, so that means that until that is sorted out and confidence fully returns, US economic growth will remain skittish. 

Of course that is not the case elsewhere.  As the Economist makes clear for South America, things have changed there in the last decade, and the outlook for growth and prosperity is much brighter than it was even 10 years ago.  Lula is now the hero of Brazil, having brought stability and prosperity to a once hyperinflation-plagued country, and despite the media focus on Hugo Chavez of Venezuela, there are other success stories (such as Chile, Belize and Costa Rica) south of the Rio Grande. 

And while I've been enjoying the great 9.4% return on my Latin American mutual fund, I am not unaware of the fact that in other parts of the world growth has been much more spectacular.  India must be the standout here, with even The Economist (once again) highlighting this fact on its most recent cover ( - "How India's growth will outpace China's").  To me, China has always been problematic as a trading partner, not only because it is still officially a communist state, but also because it manipulates its currency and it's virtually impossible to hold any Chinese stocks ( - all the China mutual funds you see are really Hong Kong mutual funds).  So yes, India will likely be the place to be over the next expansion phase of the business cycle.

In all this Africa is a bit of a "dark sheep".  Although South Africa is a great place to invest, and the Zuma government hasn't turned out to be as nasty as it might have been - partly because of people like Helen Zille in the wings, making sure that the government doesn't get away with too much - it's future is more uncertain.  Mandela's influence is clearly waning, and what happens after his moderating influence is absent is anyone's guess.  Hopefully Zimbabwe will not be the example to follow!  Elsewhere in Africa, long-term stability is still not assured.

But what about Europe?  More about this next time.

Tuesday, August 10, 2010

"Double-dips" on each side of the Atlantic?

It's rare in macroeconomics that we get a chance to experiment with economies, but at the moment we have the prospects of exactly that happening over the next 12 months.  And the results of this experiment will, no doubt, be picked over by economists for decades to come. 

In the US there is no sign of tightening on either the fiscal or monetary fronts, and it transpired that this is justified by the miserable jobs data for July which appeared last Friday with 131,000 jobs lost and the unemployment rate stubbornly stuck at 9.5%.  Even stripping out the temporary census worker layoffs, the private sector only managed to add an anemic 71,000 jobs, hardly the post-recession "bounce" that economists would like to have seen (see  This was also underlined by the fact that the change for June was also revised from a loss of 125,000 to a loss of 221,000 jobs.  Despite the fact that public debt levels in the US are headed towards 80% of GDP there is no suggestion that expenditure cuts or tax increases should be foisted upon the general public, until the economic is truly underway.  Of course once this does occur as Clive Crook of the FT pointed out recently ( fiscal tightening is inevitable.

In the UK, the new Conservative/Lib Dem coalition government has taken exactly the opposite position.  Underscored by an apparent "bounce" in the economy in the last quarter (GDP grew by 1.1% in Q2 alone), and up until recently a resumption in house price inflation, the government has already increased the sales tax (or VAT as it's called in Europe) from 15% to 20% and looks to embark upon draconian cuts in public spending (£6.2bn immediately, to be followed by much more swingeing cuts from the fall/autumn onwards) to try to balance the budget from it's current £156bn deficit or in a matter of just a few years (see and,dwp_uuid=716ef204-6808-11df-af6c-00144feab49a.html)

As readers of the FT will no doubt know, the contrast between these two positions prompted Martin Wolf's "austerity vs stimulus" debate (see which really caused a stir in the economics world, but of course no real conclusion as economists are largely divided on the issue. 

The main points that I would like to make though regarding this comparison (and apparent "transatlantic divide" in macroeconomic policy) are as follows:

i) the global recession started in the US, so any recovery has to address the underlying problem that caused the downturn in the first place. Despite some attempts from Congress, this is really not happening, with no withdrawal of the government from the housing market and an excess of housing.  New building now is cheaper in many parts of the US than is buying a "second hand" house.  So excess supply and falling prices look to continue now for an extended period of time.

ii) although both countries possess similar levels of labor mobility, the UK and US housing markets couldn't be more different.  The UK tends to have interest-sensitive mortgages while the US tends to have interest-insensitive mortgages.  That means that for the UK cutting public expenditure will tend to keep interest rates lower than they would otherwise have been (the opposite of "crowding out") which will tend to boost the housing market.  Now the other factor with housing is that in the US there is an abundant supply of land, whereas in the UK there is not.  This means that the UK housing market should recover well ahead of the US housing market.  It also means in the longer term the UK economy should also grow ahead of the US economy as well.

iii) the Conservative/Lib Dem coaltion government in the UK is completely dependent on Lib Dem support for the public expenditure cuts, and it is clear that below the surface the Lib Dems are extremely uncomfortable with what is going on right now.  I would predict that once the Electoral reform referendum is done next May, the current government may collapse in which case some of the public sector cuts might not actually be implemented.  Certainly with spending cuts of up to 25% of government services likely, the employment consequences are likely to be quite severe and the effect on consumer sentiment marked. 

So pulling this all together, a "double dip" recession in the US is now pretty remote in my view.  A mini deep "double dip" in the UK is now a real possibility, depending on how quickly the proposed public expenditure cuts are implemented and whether the Lib Dems withdraw support from the coalition government half way through the fiscal year.  So likely the UK will go into reverse from October through to the middle of 2011, but then another "bounce back" in economic growth will occur, pushing it ahead of the US once again. I'm sure Keynes would favour the US approach, but for this economist, at least, this is going to be a fascinating experiment to watch!

Wednesday, July 21, 2010

Comments in the FT's Austerity vs Stimulus Debate

First, I want to thank the FT for allowing this online "debate" to happen.

I believe though that this can no longer be a "debate" - it is the abject failure of a discipline, and a fundamental crisis for the subject area, with little "credibility" now being given to those in the elite economist "mafioso", as they really don't seem to be providing any intellectual guidance. The Queen's reasonable question of economists ('it's awful - why did nobody see it coming?') points the finger at the "closed shop" that academic macroeconomics has become, and suggests to me that external pressure needs to be applied so that the subject should no longer continue to be highjacked by a narrow group of academics, given their clear failure to predict or provide guidance in the face of a downturn. We hear the same tired voices from the Ivy League schools in the same dialectic debates with no new philosophical approaches. They hire the types of Ph.D.s who follow their thinking and we get stuck in an intellectual quagmire. So in this light the comments of Niall Ferguson are rather interesting - why should Behavioural Finance be the biggest winner so far from this intellectual meltdown in macroeconomics? I don't disagree with him, but shouldn't some new ideas in macro emerge and then save the day? After all that's how Keynesianism first came about, and most schools of thought in economics since that time ( - with the obvious exception of the Austrian school and the Post-Keynesians). My fear is that the way the economics discipline is now so institutionally structured, that is unlikely to occur this time around.

One new direction might be to think about the business cycle more seriously. The business cycle was basically downplayed and dismissed in some quarters during the 80s and 90s ( - the "great moderation"), and now looking back, this was clearly a mistake. Business cycles appear to be "hard-wired" into macroeconomic behaviour, and yet they don't appear explicitly in any of our models, let alone in our academic thinking - they are just treated as a "stylized fact". To date this phenomenon has been explained as the result of "shocks", and although "shocks" can cause recessions (think of the 70s oil price shocks), if we don't have exogenous shocks we now know (after our current downturn) that we can still get recessions. If you take this approach then obviously studying these cycles ( - as I am using frequency domain techniques) might give us a different perspective on these downturns. OK, this is only one approach, but at least it might offer some new direction to the subject, and I'm sure there are others with new and interesting ideas.

The main point here is that academic macroeconomics needs to be more open to ideas that come from both inside and outside the discipline. Most outsiders would be shocked to see how parochial the discipline has become. Hopefully if outside pressure is brought to bear on the discipline this will change, and academics long held back by the "mafioso" will get a chance to present their ideas and make an impact!

Wednesday, June 9, 2010

Time to Plan for a Post-Keynesian Era

Jeffrey Sachs from the Earth Institute at Columbia University recently had a comment published in the FT at entitled "Time to Plan for a Post-Keynesian Era".

Here is my response in the form of a letter to the editor.

Dear Sir,

Jeffrey Sachs’s erudite dismissal of Keynesianism, although intellectually stimulating, flies in the face of much of what Keynes might have thought about the role of governments when confronted by the stylized fact of the business cycle.
Keynes would not have advocated a short-run fiscal boost to counter a major downturn, and nor would he likely have been comfortable about high levels of public debt. I doubt very much that Keynes would have advocated temporary tax cuts or car scrappage schemes, given what we know about the advice he metered out to governments during the Great Depression. On the other hand Keynes would have likely been in complete agreement with Sachs’s analysis of the broken politics which surrounds the US economic situation. US taxes are too low, given what is expected of the public sector, and spending programs are too entrenched to allow the flexibility to be enterprising in terms of public investment. Keynesianism is not dead, and many economists believe it still to be the best solution in the face of an unprecedented downturn in the global economy. And after all, Keynes’s original advocacy of public investment in the 1930s is also one of the hallmarks of the current administration’s emphasis on both stimulus and investment.

The myth that does need to be broken, however, is that there exists “the threat of bubbles if we pursue economic illusions”. This misguided thinking implies that the bubbles which likely cause business cycles can be avoided and are not “hard-wired” into human behavior. Certainly given the regularity of the business cycle, the empirical evidence provides extremely strong evidence to the contrary.

Monday, June 7, 2010

The Heightened Risk of a Double Dip? The euro and the US labor market

We certainly live in interesting times.  Who would have thought that 2010 would see a crisis in the euro area because of one of it's smaller members - Greece, an oil spill that has very uncertain economic consequences, a political crisis on the Korean peninsula, and a coalition government which will likely result in proportional representation in the UK.  And we're not even half way through the year yet!

And in the economics sphere, while I have made the case that the euro area crisis is overdone, it doesn't stop what I call "emotional contagion" taking over in the markets.  There is utterly no logic in thinking that a small country like Greece should precipitate a financial market crisis in Europe or elsewhere, and yet that's exactly what has happened, despite the best efforts of EU policymakers.  I hear on the news that even though Spain's and Portugal's bond yields have increased, reflecting speculation that these countries will default on the sovereign debt, the focus has now moved to Hungary, as fears mount that the sovereign debt crisis could spread further afield.  Last Friday the forex markets used this as a reason to push the euro to under $1.19, a level that really boosts the prospects for euro area export-led growth, particularly in the euro area core. 

This whole situation is fast becoming a bit of a farce as far as the euro area is concerned, as Hungary isn't even in the euro area and doesn't qualify to join it any time soon according to the Maastricht criteria.  I suspect that some forex traders have rather a lot at stake here, and need the euro to depreciate so have begun to grasp at straws.  But with the euro at current levels it does have ramifications for the US, where this type of "overshooting" becomes yet another reason to add to the growing list of the reasons as to why the US economy is edging towards a "double dip" recession. 

Which brings me to the US unemployment figures from last Friday.  While the census workers dominating the figures is old news, what was telling to me is that the sector that added most jobs was the manufacturing sector - a sector that is heavily reliant on export markets ( - think planes, machinery and equipment, etc etc).  So if the euro stays at these levels or moves lower even the current net new jobs we are seeing might slow leaving very little new net job creation.

Watching TV on Friday I then saw several economists talking about the probability of a double-dip recession now at about levels of 50% - this is not good either as I think that it might encourage consumers to become fearful (as the stockmarket has appeared to have done) and baton down the hatches again.  We all know that market psychology is important - but consumer psychology transmitted by the media is also an important transmission mechanism that is really unexplored.  I guess that is probably one of the biggest unknowns now going forward.

Sunday, May 9, 2010

Will the Greek crisis end in tragedy?

The glitterati of the economics profession have been out in full force to comment on the Greek crisis, what with Paul Krugman (, Greg Mankiw (, and Nouriel Roubini ( wading in to give their opinions.

OK, so things have erupted in Europe with the Greek debacle continuing to unfold - but the main question now revolves around 3 things: first, whether the EU bailout ( - I know Germany is contributing to this, but officially it is an EU initiative) is enough to "plug the dyke" in Greece's public finances; second, whether the EU measures will be enough to stop contagion taking place across Europe thereby threatening the euro area; and third whether Greece can remain in the euro area.

I pose these three questions separately on purpose, because as we all know, whether the actual bailout is big enough to stop financial panic is not how financial markets behave - they behave according to fear and irrationality as we saw in the Mexican peso crisis in the 1990s when panic swept across quite a few South American countries that were nowhere near to defaulting on their public debt obligations.  The last question is a matter of politics as well as economics, so I will also address that as it is now on the radar screens thanks to Paul Krugman.

But let's start at the beginning.  In the Maastricht Treaty, which was the original blueprint for the euro area, Article 104 specifies that "Overdraft facilities or any other type of credit facility with the ECB or with the
central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Community institutions or bodies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments."  This is known as the "no bailout" clause, and clearly states that the ECB cannot bailout Greece.  But in Article 103a it states that "Where a Member State is in difficulties or is seriously threatened with severe difficulties caused by exceptional occurrences beyond its control, the Council may, acting unanimously on a proposal from the Commission, grant, under certain conditions, Community financial assistance to the Member State concerned." 

So that is what is happening this weekend - the euro area finance ministers are huddled together to hammer out an agreement to effectively lend Greece €110bn through "Community financial assistance" over what is rumoured to be a 3 year period.  At the same time the Greek government has put in place austerity measures to try to reduce it's budget deficit, hence the riots in Athens.  But today there are also signs that the Finance ministers want to "ring fence" the Greek problem by providing an enhanced (€110bn) fund to get Greece, Portugal and Spain through what was the €60bn emergency facility that allowed Latvia, Hungary and Romania to get through their balance of payments difficulties last year.

Let's now go back to the key questions we asked at the beginning.  Is this enough to "plug the dyke" that is the mess with the Greek finances.  The answer is an unequivocal "yes".  First, remember that the Greek economy represents only roughly 3% of the euro area economy.  If you look at the Greek Finance Ministry's last report on public debt (see which rather mysteriously ends at the end of last year, and hasn't been updated yet for Q1 2010) you'll see the following chart (click on it to bring up a bigger version), which shows the redemption schedule and term structure of the public debt in Greece. 
As you can see, total Greek public debt at the end of last year was reportedly just under €300bn with only 10% rollover due to take place in 2010, and 50% rollover required more than 5 years away.  So all this talk about debt restructuring, while it will make it easier for Greece in the short term, is nowhere near the order of magnitude that the media is hyping it up to be.  Now I'm not denying that debt in Greece is high, but at 120% of GDP this really is not wholly exceptional - take a look at Japan, which has debt levels approaching 200%.  But the main point to be made is that the €30bn plus to be either paid off or rolled over in 2010 can be funded through EU borrowings, so the amount provided through the EU is definitely sufficient to avoid a default. 

So to the second question - whether this is enough to stop contagion to the other euro area member states.  Of course what the financial markets don't like is surprises, and the public debt figures are higher for Greece than reported above (as some of the debt wasn't reported and was "hidden") so that the figure of €300bn is actually €356bn  - that, in my opinion, is the main reason for the panic - the financial markets cannot trust the Greek government to report the debt figure honestly or accurately.  Is there a similar situation in Portugal and Spain?  No, there isn't.  So although bond yields have spiked for Portuguese and Spanish public debt, the problem is not qualitatively similar to Greece's, so the concern about contagion is overdone in my opinion. 

As an aside, I'm not saying that there is a linear relationship between debt/GDP levels and financial crisis either, as Rogoff commented a few days ago in the FT (see What matters is that you have not offended the markets recently, and of course a country like Japan (with public debt levels approaching 200% of GDP), even with anemic growth, can still make it's bond payments because of low interest rates due to market confidence. Even a speculator extraordinaire like George Soros doesn't see Greece defaulting on it's sovereign debt. And there is little reason to think that either Portugal or Spain would follow suit even if Greece did.  Of course that doesn't stop speculators speculating on it, and that's exactly what happened at the end of last week (see  Incidentally, I think this is exactly the time to start buying EU stocks as clearly the euro will bounce back once this crisis is over - certainly if I had millions of dollars that's what I'd be doing right now!

So the next question, is whether Greece will  leave the euro area.  Krugman even goes as far as to state, after going through 3 options that Greece would have to consider to stay in the euro area, that "What remains seems unthinkable: Greece leaving the euro. But when you’ve ruled out everything else, that’s what’s left."  I think Krugman underestimates the political will of the larger members of the euro area to keep the show on the road.  The EU has always risen to the occasion when crisis hits, and this time will be no exception.  And let's face it, this is not a crisis of confidence in the euro itself, just a crisis of confidence in the economic policies of one of it's member states, Greece, and in the Stability and Growth pact and it's ability to control public debt issuance in profligate euro area member states. 

So Greece, in my opinion, will remain in the euro area but will face some really dark years ahead, particularly if EU growth does not pick up soon.  The main point I would make though is that the EU needs to start thinking a little more strategically about how the institutional structure of its design can weather different economic scenarios rather than what is the most feasible solution from a political standpoint.  The Stability and Growth pact (see my previous post on this blog) is a perfect case in point. 

There will definitely be a period of deep reflection in EU circles after this crisis is over, and hopefully it will lead to some decisive action, otherwise the EU is doomed to lurch from crisis to crisis, making rushed decisions in response to market forces rather than constructing an EU that is resilient in the face of economic shocks and downturns.

Saturday, May 1, 2010

The SGP ramifications of the Greek Crisis

I was just at a conference of Europeanists in Montreal a couple of weeks ago, and although many of them didn't show because of the lack of transatlantic flights due to the Icelandic volcano ash clouds, there were enough delegates to get a good guage on what Europeanists are thinking about in terms of the future of the European Union and the euro and the ongoing Greek crisis.

The main ramification that I got from chatting with other delegates is that the Stability and Growth Pact (SGP) is essentially dead, with the Greek situation putting the final nail in the coffin!!  The SGP was originally a German idea back in 1997, which was meant to allay German fears that they were giving up their beloved Deutschmark for something not as robust and that they had less control over.  The main condition in the SGP (which was actually just a continuation of the main Maastricht criteria for fiscal policy) was the budget deficit criteria which specifies that member states need to keep their government budget deficits below 3% of GDP. 

Academics like Willem Buiter had already criticized the budget deficit criteria as a little meaningless, not just because it was seemingly an arbitrary number, but also because it is usually debt that matters for fiscal sustainability rather than deficits.  For example you can have a very low debt and then have some kind of event where you need to stimulate your economy big time - Finland went through something like this in the 1990s, and the US is clearly going through something similar right now - so that your budget deficit balloons during that period.  To put this more simply, it is like focusing on the most recent additions to your credit card debt (if you have any!), rather than focusing on the total that you owe.  Clearly the total is the most important figure, not what you've just added to the total. 

The SGP then specified that if you ran a deficit above 3% you would attraction the attention of the European Commission and then a complex process would begin such that you would have time to put your house in order and if you didn't you'd first be sanctioned and then fined.  There were let-outs for recessions and other uncontrollable events, but essentially during normal times a member state's budget deficit was supposed to be under 3% of GDP.

The way the SGP was supposed to work was that governments would report their deficits and debts to the Commission and then they would decide what the situation was, and then the Commission would prepare a report and if any action was needed would pass this on to the European Council for a decision - and some of these decisions were supposed to be almost automatic.  Back in 2004 both France and Germany were found to be violating the 3% limit and the European Council decided to do nothing, violating the spirit of the SGP and prompting some soul-searching on what kind of conditions should allow a member state to run deficits that were greater than 3%.  The so-called SGP II was launched, which was softer on member states when they ran deficits and also had a greater focus on debt, but essentially it was the same "monster", wrapped up in a little more sensible clothing.  But apart from the aforementioned problems, there were other fatal flaws with it ( - described in many of my earlier papers on this topic). 

First, the EU member states did the public accounting to construct the measures needed for the SGP - so as Greek did, you could easily "fix" the figures and the Commission would be none the wiser.  It seems to me that if the SGP was to be taken seriously the Commission should at least have had a representative working in every finance ministry in the euro area.  They didn't.  When the IMF needs to evaluate what is going in a country, a team is sent out - and obviously the veracity of the figures is evaluated at the same time.  There is no Commssion equivalent.

Second, it was all stick and no carrot.  Where was the reward for being good?  With the IMF if you do what they say you get in the form of a loan that you desperately need.  With the European Commission you got nothing more than you otherwise likely would get - so there is basically no incentive to be good.

Third, even if the SGP was mostly stick, the stick was hidden from view, as there was a tacit acknowledgement that the penalties would (likely) never be used - to fine a member state that was already running a deficit seems a little counterintuitive - shouldn't the rest of the EU be helping them, not punishing them?

Fourth, having the SGP gave the financial markets more "comfort" than they should have had, as it probably hindered them from properly evaluating the risk of default from any one member state.  So when there was a realization that the Greek situation was much worse than thought, the yield on Greek bonds really took off. 

So the Greek situation has really broken the SGP - and good riddance to it in my opinion.  Monitoring member states and reporting back on their fiscal situation seems like a sensible idea, but it has to be constructed in a way that makes sense and the SGP never made a lot of sense to me, not only in its essential ingredients, but also in the way it was implemented.

Wednesday, April 7, 2010

April US interest rate outlook

The Fed minutes were released yesterday (see and showed that (apart from one member) the FOMC was not worried about inflation quite yet, but it obviously doesn't stop the hawks ruminating on when the current "super-easy" monetary policy will be reversed.  Clearly this is now on the market's mind, and with impeccable timing a  friend recently pointed me to a site which has an interesting graph of 30-year bond yields breaking out from a 17-year declining trend.  Several comments are in order from a macro perspective.

First, a declining trend cannot continue forever - a break was inevitable, it is the timing that is interesting - we are at a point where clearly the balance of risk is beginning to shift from deflationary pressures to inflationary pressures.  This has clear implications for investors - while the US bond market was a great place to be during the downturn, it will not be such a great place to be anymore!!

Second, the inflation hawks really need to relax - there are so many uncertainties as to how and when the US economy will really pick up steam that it really doesn't make a whole lot of sense to worry about inflation quite yet.  An orderly withdrawal by the Fed and a falling US budget deficit will help to ease pressures as well, so the pressures are likely to be moderate at best.

Third, if this were a short, sharp recession (like the early 1980s recession), then I would say that indeed there is a risk of a strong bounce back which could put the authorities off balance, but given the depth of the recession and the mixed economic signs that we continue to see coming out of it, this looks like it is going to be a slow recovery, which will allow policymakers to make adjustments in a timely fashion which will put the lid on runaway inflation.

Friday, April 2, 2010

US Unemployment Figures for March

Even though the US financial markets are closed today for the Good Friday Easter public holiday, the US unemployment figures were released by the US Department of Labor for March using the Current Population Survey and the Establishment survey (see The figures have caused some economists to say these are optimistic for US economic recovery (see Brian Wesbury's (First Trust Bank in Chicago) comments on NPR this morning at and of course the administration is going to put a glean on the figures as Christina Romer did this morning as well.  But read behind the figures and things are still not good in the US labor market.  As the FT said this am (see even though private sector payrolls increased by a very encouraging 123,000 new jobs which has caused all the "turning the corner" comments in the media and in markets (see Planet Money's comments at 

One of the things that was largely overlooked by the media on the positive front is that the January and February figures were revised to positive figures, which means that in fact employment has been growing now for the past 5 months. 

But there are still some really worrying aspects to the figures here - first, the U6 "alternative" unemployment rate which I reported on a few posts back continued to head upwards, to 16.9 percent (nsa), not quite the highest it's been bit still not encouraging about what's going on in the wider US labor market.  Second, it is a mystery to me as to where all these new jobs are coming from - the employment report says the medical services sector added 27,000 new jobs, some in ambulatory services and others in residential healthcare.  My real question is whether these new jobs are transitory, and relate to the new healthcare legislation or whether it could be because of demographics as the baby boomers need more care.  Certainly the addition of new manufacturing jobs is good news, but does depend on the exchange rate, which has been on it's way up recently, so that might not hold out either.  Third, despite the fact that productivity zoomed up last year, average hourly earnings fell 2 cents last month - not a whole lot, I grant you, but still it reflects that employers are really squeezing labor right now, despite the productivity gains.  Fourth, there was an increase in the numbers of unemployed crossing the "artificial threshold" time of 27 months on the dole from 40.9 to 44.1 percent of the unemployed.  This is not good news, however you try and sugarcoat it.

I think the real worry here (as I told my intermediate macroeconomics class last week), is whether we are seeing either just a very slow recovery to a "natural rate of unemployment" (the average level of unemployment over the business cycle) or whether this is a sign that the US labor market is going through a permanent change such that we'll never get down the low levels of unemployment that we've enjoyed in booms over the past 2 decades.  This is not just "pie-in-the-sky" fanciful thinking - in Europe they went through a definite shift in their "natural rate of unemployment", and economist are still arguing as to why this happened.

So if I had to sum up the report I certainly wouldn't call it a "turning point" - I would call it "treading water" - some good news and some bad news -  but there is no definite sign of recovery in the US labor market in the figures, and although things are not getting worse, for most in the US labor market they are certainly not getting palpably better on a permanent basis - and that's what matters.  15 million workers unemployed and no drop in the unemployment rate is hardly something to cheer about!!

Sunday, March 28, 2010

US healthcare

So now that the US healthcare debate has resulted in a bill being passed, and hopefully the rhetoric subsides, I wanted to take a broad look at what this bill is really all about.  What I will contend is that this bill extends healthcare to nearly all Americans, and it levels the playing field between those with and those without insurance in terms of costs.

Any Canadian or British (or European) person will tell you that they look on in horror when they see the high prices that Americans are forced to pay for healthcare and are thankful that they don't have to endure those types of expenses.  On the other hand of course, the US has some of the lowest tax rates on income in the world ( - despite what most Americans think) and instituting a single payer tax system would definitely cause those taxes to rise.  But given that healthcare is probably the most important thing in our lives, there are many who think this is the "first best" alternative.  What I think most Americans fail to realize is that in Canada and Britain (and elsewhere), the government doesn't take over healthcare - it basically takes over the insurance roll in the system.  British doctors set up privately in practices, and although their rates are set by the government, they can see patients privately if they wish, and indeed there is a thriving private medical insurance scheme in the UK as an alternative to the National Health System (NHS). 

So what was passed last week?  In my opinion it was a bill that extends private health insurance to nearly every American and therefore lowers the cost of healthcare for us, the population.  It is a "second best" option, but it is better than what we had, and for good reason.  How?  Well as one of my friends recently told me: "I was in hospital for 4 days and the bill came to $28,000.  Once I had handed over the bill to my insurance company, they negotiated it down to under $7,000.  I ended up paying my deductible of $200".  Now for that particular incident , look at the potential costs: if she had been an uninsured patient she would have been on the hook for $28,000; but as she was insured she ended up paying $200 - more than 100 times smaller bill for the hospital stay.  Although noone is refused treatment in a public emergency room, those people who do not qualify for medicare or medicaid can quickly face bankrupcy if they don't have insurance, and sometimes even if they do have health insurance.  Hopefully the bill will fix some of the limitations on insurance and more tightly regulate coverage. 

So what didn't the healthcare bill do?  Several things:

First, for any American who has been to a doctor in Britain or in Europe, what is most surprising is that when you walk into the doctor's office, there is much less of a front office.  There is no triage, and rather shockingly, the doctor usually walks to the waiting area to meet you after calling your name.  So the doctor's offices in Canada and Europe tend to be much more efficient - but why is this so?  It's partially due to the fact that medical lawsuits in the US have frightened doctors into checking for everything.  This bill changed nothing in this arena - and yet there is still a lot of saving to be made by curtailing lawsuits and this would mean much less costs in what is now an obviously bloated system.

Second, it didn't curtail the health insurance industry, and if anything it gave them more business.  Next time around I think we should either get rid of the healthcare insurance companies and have a single payer system or heavily regulate them like we do banks. 

Third, it didn't cover all small businesses.  I really don't understand why small businesses with less than 15 employees are exempt - their employees should be covered in my opinion, and some kind of voluntary pools should have been set up to ensure that every American can get reasonably priced health insurance.  These are the people that will still be left out, so we are not going to stop hearing horror stories about people having trouble paying their healthcare bills and facing bankrupcy, but hopefully we'll hear them much less!

Thursday, March 18, 2010

Dallas Fed The Euro and Dollar in the Crisis and Beyond - March 17, 2010.

I attended a two day euro/dollar event over the last couple of days, with Wednesday's session a general policymaker day on the markets/government policies and the fallout from the financial crisis and the Thursday an academic workshop on European Integration. 

First, on the Wednesday there was a lot of interesting stuff but there were a few points missing from the debate.  See the agenda at

The President of the Federal Reserve Bank of Dallas, Richard Fisher, closed out the day by hitting the nail on the head, in my opinion, with his comments on the recent financial crisis.  He said ( - and here I'm paraphrasing - ) that these events occur with regularity and are just part of human behavior - and we probably will not be able to predict the next adverse event, and have to deal with it when it occurs.

I would go one step further though.  What most people missed at this conference was that this financial crisis was the result of the housing crisis, and has led to a recession, which is just part of the regular business cycle.  In other words although the Great Depression and the current downturn have serious social and political consequences, they are still essentially part of the regular downturns that we have in the macroeconomy known as the business cycle.  The business cycle is just a fact of macroeconomics and until we find a way to stop it occurring with such regularity, we need to just accepted it for what it is - a cycle!!

So why isn't the current downturn different from others as we are constantly being told that this is almost a depression (and has already been called "the great recession" by economic pundits)?  Because it resulted from a bubble in a market ( - the housing market), just like the Great Depression also resulted from a bubble in a market ( - the stockmarket).  What happened in both the Great Depression and the current recession is that both downturns spread to the financial sector, exposing a fault line or two, and causing a financial crisis which then spread to the rest of the economy.  The big difference though is that in the current recession the Fed and the Federal government have done the right thing - they have learned from the mistakes they made at the beginning of the Great Depression and have averted a major disaster.  The thing about most bubbles is that they i) usually don't spread to other sectors in the way they did this time through the financial sector and ii) they usually are not as deep as the current one as they exposed some major weaknesses in the financial services sector.

So shouldn't economists seek to stop what happened recently from happening again?  Most non-economics educated people would say "of course"!  I mean why would a doctor want a cold to reoccur again if they could stop if from happening?  But that's what recessions are - they are basically a mutating virus that hits the economy in different ways each time and can be particularly nasty if the body is physically run down.  But the economy isn't quite like a body - the recession also "cleans out" what economists call "malinvestment" - the bad investments that were done in the previous boom, so that the economy can begin to grow again in a healthier fashion.  Economists who think like this, by the way, are usually labelled "Austrians" after the group of economists who originated in Austria before the second world war. 

So when Adam Posen says "we all made mistakes with the financial services sector", I am not sure I agree.  Noone was going to change the regulatory structure in the US financial services sector without a crisis, so actually this gives the politicians a reason to act.  But the mistakes that were made were made by politicians years ago when they set up the patchwork regulatory framework that allowed "regulatory arbitrage" with also hardly any regulation for financial derivatives.

The big mistake we made, I believe, is not paying enough attention to what happened in Japan in the early 1990s.  Japan is still suffering from the mistakes that were made back then, and luckily we haven't fallen into the same traps as they did...but still it is not a pleasant experience for those people who have lost their jobs, and we are far from being out of the tunnel yet!!

Sunday, March 14, 2010

Economics and the stockmarket

OK, so much for posting every 1-3 days.  I just have too much going on right now - and my career unfortunately (or maybe fortunately) doesn't depend on this. 

So some random thoughts today from my own thinking about the current state of the global economy and the financial markets. 

First, unlike most of the previous economic downturns, the US caused this downturn, so coming out of the current recession will require the banking sector regulatory framework to be fixed so as to instill some confidence in both domestic and foreign firms and investors that nothing like this will happen again.  Also the US housing market is still not good and there is a threat of a collapse in the commercial real estate market which makes things risky in terms of a new wave of corporate bankrupcies.  In this sense the US is likely to come out of the recession late compared to other countries.  Put in economic language, the US usually drives the international business cycle, but this time it will lag the international business cycle.

Second, the state of the euro area is in flux right now.  There is no certainty about a European Monetary Fund (EMF) coming into existence, which would calm the markets and also instill some confidence in the future of the euro area.  There is also considerable doubt about how sustainable the Greek fiscal austerity measures will be from a political perspective, so this still creates some risk of contagion to other euro area member states.

Third, the Chinese economy has done remarkably well over the past few years, but the housing market there is precarious, and the bubble could burst quite easily, creating asset deflation and causing some banks and loan providers to be in serious trouble. 

So what does this all mean for where to put your money?  If you're keeping it in the US right now I'd put it into technology stocks as this is where the US clearly has a comparative advantage and will benefit from the pick up in economic activity that will clearly come first in the rest of the world.  Other than that I'd pick a Canada fund if you really want to be in North America as the Canadian dollar tracks the US dollar, and also the Canadian economy really doesn't have the (fiscal and real estate) downsides of the US economy.

I would take a sizeable amount of what you have and put it abroad - the emerging economy funds, Eastern European, Japanese and Gold funds are all good and will likely give you a better return over the next few years than you'd get from a US stock fund.  Nordic funds are also probably a good bet as apart from Finland none of them are members of the euro area, and also African funds will likely do well (if you can find any!) as the Chinese are continuing to buy up land and develop resources there.

Anyway, please let me have any comments you might have...I am actually thinking of starting a website solely devoted to offering this type of service!!

Friday, March 5, 2010

The U6 unemployment rate and the US labor market

So the unemployment figures for February stayed constant ( - see, confounding those economists who had expected the rate to rise because of the winter storms up the east coast.  So that's the good news - despite the bad weather unemployment rates haven't risen.

But there was some bad news - 36,000 jobs were still lost across the nation last month and the unemployment rate hides the fact that there are now a lot of "discouraged workers" out there - people who have dropped out of the labor force because they aren't looking for a job anymore - yes, they're the people who have given up hope.  And it's hardly surprising they've given up hope when you look at the duration statistics - 6.1 million of the unemployed have now been out of work for more than 6 months. 

The Bureau of Labor statistics defines these discouraged workers as "marginally attached" - and actually produces statistics for these workers - they are estimates of course - but they really don't look good right now - an indication of how bad things are out there in the US labor market.  The trends in the "marginally attached" workers were described as follows:

"Among the marginally attached, there were 1.2 million discouraged workers in February, up by 473,000 from a year earlier. (The data are not seasonally adjusted.) Discouraged workers are persons not currently looking for work because they believe no jobs are available for them. The remaining 1.3 million persons marginally attached to the labor force had not searched for work in the 4 weeks preceding the survey for reasons such as school attendance or family responsibilities."

So what is missing from the mainstream media reports is that if you roll these workers into the statistics, it really doesn't look quite so pretty.  I decided to take the data and plot it myself from the stats that the BLS issues itself, and this is what it looks is the unemployed plus discouraged workers plus marginally attached plus part-time workers for economic reasons (the underemployed) as a percentage of the civilian labor force plus marginally attached.

This is the U6 rate, and it's movement mirrors the unemployment rate for the most part, rising rapidly throughout 2009, but interestingly the drop going into 2010 seems to have ticked up again in February with the rate moving from 16.5% to 16.8% with most of this upward move due to discouraged workers jumping from 1.06 million to 1.2 million, and the number who are underemployed jumping from 8.3 to nearly 8.8 million.

What bodes well is that at least some of these underemployed workers still have jobs, otherwise the unemployment rate could be a lot worse: but on the other hand some of them could have been in full time jobs that were converted into part-time jobs which wouldn't be good. But what is definitely not good is the increase in discouraged workers - these workers have given up looking for the moment - and if the labor market begins to improve these workers could come back into the market very quickly making the recovery in the jobs market look slower. 

Wednesday, March 3, 2010

Soros on the euro - but what about the other flaws??

On Fareed Zakaria's CNN show this week we had the privilege to hear the views of the billionaire financier George Soros (see on a variety of issues.  What caught my ear though was his comment that the euro was "fundamentally flawed" as the European Union doesn't have a Treasury to enble fiscal transfers to occur, so as to offset the asymmetric shocks ( - unexpected events that occur which affect one member state much more than the others).  This is of course just one of the basic problems with the euro's architecture, and Soros is right in pointing out that this is probably the most obvious flaw to think about in the light of the Greek debacle.

But what really got my attention was that Soros then went on to say that "either Europe takes the steps to make up for it's institutional deficiency or it may not survive" ( - I assume he means the euro here).  So I want to add a little to what Soros said, by i) talking about other things that might be wrong with the euro and ii) by thinking a little about what form these institutional measures might take. i) I'll do today and I'll leave ii) to tomorrow.

So let's start with the other flaws. 

First, the "Maastricht criteria".  These were the hurdles which member states had to negotiate to become a member of the euro club.  The rewards for negotiating these hurdles were significant, as it meant lower interest rates, added credibility internationally, and to be blunt, a seat at the heart of the European integration project. It's like the local neighborhood clubhouse - who wouldn't want to become a member unless they didn't like their neighbors too much (for example the UK).  So if you have to fulfill certain criteria (like having a certain minimum salary - to continue our clubhouse analogy) you would maybe manipulate things a little to get in.  The Commission was aware of this, particularly when certain member states asked if they could sell gold to lower their budget deficits, and so the Commission made up quite strict rules about how to measure budget deficits, which all the "northern" (read less corrupt and less politically manipulated) member states duly abided by.  Southern (read generally more corrupt and more politically manipulated) member states of course stayed relatively silent on this, and now we see why.  Countries like Italy got in because of statistical anomalies and Greece actually didn't get in first time around, so realized what it needed to do the second time around.  The main point here is that the Maastricht criteria were flawed to begin with - the statistics which were used to base the entry decision on were produced by each individual member state - so they depended on the quality and honesty of the statisticians and politicians involved in the production of the stats.  The result is that if you have flawed entry criteria you're going to get problems at some point along the way as members don't live up to expectations.

Second, "surveillance".  The European Commission made a big song and dance about member state surveillance back in 2004 when the Stability and Growth pact (or SGP - see was revised to soften the actual criteria (because Germany and France had run up against the deficit limits that were supposed to trigger sanctions).  Clearly they haven't worked, and not because it wasn't a good idea, but because the Commission can only monitor what is produced by the member states.  Once again its the member states that produce the statistics, or manipulates the statistics for political purposes, so this wouldn't be detected by the "surveillance" process. 

Third, and probably most importantly, the ECB's treatment of public debt in monetary transactions.  There is no mechanism whereby the ECB can basically "grade" the member states on their fiscal policy. Now of course this doesn't happen in the US, and in the case of Canada there are provisions for it to happen (a line item in the Bank of Canada's balance sheet) but it has never happened.  The reason is that both Canada and the US (and I presume other monetary unions) have federal debt issuing capabilities.  So when the Federal Reserve does open market operations it uses US federal bonds and notes, but in the case of the ECB, it has to use member state bonds because there is no EU federal debt.  So the rules are that the ECB cannot discriminate between different member state bonds.  So this means that the member states do not feel the fury of the markets because there is always a buyer (and therefore a "backstop") for Greek bonds in the form of the ECB.  And from the individual investor perspective this clearly poses an adverse selection problem.  If I'm holding German, French and Greek bonds and the ECB is looking to buy euro-denominated bonds for its monetary policy transactions, which am I going to sell?  It's a no-brainer!! 

OK, so given that the euro design is flawed, what should happen now?  More on this next time in part II!!

Sunday, February 14, 2010

The Robin Hood Tax

On Facebook the other day a couple of my friends had signed up for a group which called for implementation of a “Robin Hood tax”. Now judging by the slick video they produced (which features Bill Nighy of Harry Potter fame, which you can see at, this is a UK campaign (with website which isn’t a big surprise given the outrage of banker bonuses has been a few notches higher than in the US. The website states that among others, supporters of such a tax include the leaders of the UK, France and Germany, Lord Turner (Chair of the UK Financial Services Authority) President Zenawi of Ethiopia, Nancy Pelosi (Speaker of the US House of Congress), Joseph Stiglitz, Jeffrey Sachs, George Soros and Warren Buffet. Not exactly lightweights, so I guess we should take this proposal seriously!!

And the bankers have. Recent newspaper reports from last week (see indicate that Goldman Sachs possessed one of two computers that allegedly “spammed” the internet poll with more than 4,600 “no” votes in less than 20 minutes on Thursday. And reading through some of the comments underneath the Daily Telegraph’s article, there was lots of debate, and some obviously thought what was being proposed was the same thing as a Tobin tax. Even in today’s Financial Times (see the issue just won’t go away – with one reader calling the tax hypocritical.

So what actually is being proposed here, and isn’t it similar to the Tobin tax and therefore fraught with the same types of problems that the Tobin tax would suffer from? For those that have heard of the Tobin tax and know what it is, please jump to the next para. The Tobin tax was proposed by the Yale nobel economist, James Tobin, in 1972 so as to dampen speculative foreign exchange transactions and to raise revenue for economic development. The proposal met with derision from most economists and bankers simply because it was obvious that unless we got everyone agreeing to levy this tax, then no one would levy it. Why? Because the foreign exchange market is the largest market in the world, and although it is centred on London, it could be highly mobile in terms of where the transactions were done. So if one country didn’t participate, all the business could be done in that location, thereby circumventing the tax.

This time around we have a proposal for a financial tax on all wholesale transactions. So it would cover all financial transactions, whether foreign exchange related or not, plus it would only apply to financial institutions, and not to other multinationals, say General Electric or Walmart. The logic is that it should be levied on the financial services sector as they were the ones that caused the mess that we’re in, and it would be levied at a rate of 0.05% and generate up to £200 billion.

So, what’s wrong with it? As a concept, nothing at all. As a practical way to raise money for government, though, it would be a complete disaster. Why?

First, because the assumption here is that nothing else changes - in other words what economists term as “ceteris paribus”. Of course everything would change – bankers might still work in London, but they’d move all their business accounts offshore where they’d escape the tax. Now, you might say that 0.05% is a really small tax, and you’d be right – on a £10 (roughly $15) transfer, it would come to half a penny (or roughly three fourths of a dollar), but these amounts are not what bankers deal with – try £10 million, and even that is not large for them, and you get at least £5,000, which doesn’t look quite so small, so try a few hundred of those sizes of transactions per day, and then it becomes understandable why quite a lot of business would inevitably shift offshore.

OK, so say there is a worldwide effort to introduce a similar tax elsewhere. The second reason it wouldn’t work is simply because not everyone will agree to levy such a tax. If just one country decided not to levy the tax, then a lot of business would instantly flow to that country as it would be tax exempt. All countries know this, so there is an incentive not to get involved in the tax and so benefit from all the new incoming business.

And the third and last reason it won’t work is because if it is instituted, the bankers won’t let it work. I have worked with these people and know that the last thing they want to do is to give money to the government, for whatever reason. Also they know full well that if it is seen to work, then who knows, the government might at some point in the future need more revenue, and so will raise the tax. No, better to have it fail right at the start will be the logic, so that they don’t mess with us again. So if the bankers find that indeed they are paying this tax, they will pass it on to us the consumer. If the banks end up paying it, we the consumers will end up paying higher bank charges in one way or another. In turn I don't think consumers will like that, so if the bankers make this clear to government right from the start, will any sane government introduce such a tax?

It would all make a great script for "Yes, Minister"...if the BBC comedy were still around!!

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