An earlier report found that the weak pound is failing to boost UK's manufacturing exports. This corresponds with the results of my own study.

For some unknown reason--perhaps readers can enlighten me--the sensitivity of UK's exports to exchange rate movements is the smallest among a number of economies that I studied. Moreover, this "elasticity" had actually dropped (halved!) in recent years, in contrast to the general increase in the measure that is observed for most other countries.

In August I wrote: "As the economy is recovering faster than expected, the fiscal deficit will narrow. I am optimistic that the unemployment rate will peak much sooner than expected."

Today we learned that November payrolls fell only 11,000 and that the unemployment rate dropped to10% from 10.2%. October factory orders rose by 0.6%, beating street forceast of a flat performance, while the November new orders component of the ISM index rose from 58.5 to 60.3. With more financial companies returning TARP money to the government, the fiscal deficit for the entire year indeed is likely to be lower than earlier forecasts.

Recently, Professor Roubini predicted that the US housing market is still going to head down, notwithstanding recent recovery in prices and in turnover. Whitney Tilson, founder of T2 Partners agreed, saying that he was "confident this is the mother of all head fakes."

Tilson points to the following reasons for the sudden upturn in housing.

As of October 5 the Japanese Yen has appreciated 12.9% against a standard basket of currencies, ahead of the Swiss Franc (10.75%) and the RMB (10.47%) since 2005. This compares with an 8% decline in the US dollar and a 19.3% depreciation in the UK pound. The Yen is presently the world’s strongest currency.

There is still debate about whether the US economy is really recovering, and there is a lot of concern about the sustainability of the recovery.

I have little doubt that the recovery is real, despite the debt and the loss of wealth suffered by many.

The global recession is coming to an end. China grew at 7.9% in the second quarter and expects the pace to pick up to more than 8% in the third quarter. Singapore registered a 20.4% growth rate (annualized) in the second quarter. Hong Kong’s (annualized) growth rate was somewhat less impressive, but still made 13.9%. Japan's real gross domestic product grew at a pace of 3.7% per year. Even in Europe, several economies are showing signs of recovery or have already registered positive growth. The largest two economies, Germany and France, each grew at an annual rate of 1.2%. Even though the UK economy still shrank at an annual rate of 3.2% in the second quarter, it is actually faring even better than most of the other European economies, as it had not declined nearly as much, and as its unemployment rate is much lower too, at 7.8% in the April-June period. More important, the leading indicators are pointing in the right direction, with the manufacturing PMI exceeding 50 for the first time in months, standing at 50.8 in July. New orders were rising for the first time since March 2008, and they were broad-based. The PMI for services was even stronger, hitting 53.2 in July, up from 51.6 in the previous month, suggesting positive growth in the immediate future.

The US dollar jumped at the "strong" job market numbers last Friday. "Strong" was of course only relative to expectations, because the US still lost 247,000 jobs in July. But the-better-than-expected non-farm payroll figures provided the strongest signal yet for an imminent economic recovery in the US.

It is not clear if this is another round of strength for the US dollar or just a temporary surge. If the US dollar does continue to gain strength, however, not only is the US recovery endangered but also the gross global imbalance that has emerged since the eighties probably has to wait much longer to be redressed.

The discussions about green shoots had invited a lot of skepticism. By now, however, the recovery appears to be well under way. There is little doubt that third quarter will bring in positive growth, which should carry over to the last quarter and beyond.

Below are seven fallacies to avoid in assessing the market and the economy:

1. Debt got the economy and the market into trouble. Debt cannot redeem it.

The decline in the stock market in recent weeks, which was mainly driven by some not-so-encouraging news on the economic front, is giving pessimists some ammunition. There are certainly some risks, and in particular I am worried about long term interest rates and exchange rate movements, but the most likely scenario is still a recovery within this year. While the economy could indeed weaken further if long term interest rates continue to rise and if the US dollar keeps rising, a depression-like scenario is not in sight.

Many observers drew the conclusion from the weak June employment figures that the economy is going to collapse again. But the one-month weakening of the employment statistics is not a big cause for concern. As I remarked earlier, the disappointment should be put in context. We had well over 600,000 job losses as recently as April, and we only had 467,000 job losses. And in June, we had GM (GMGMQ.PK) going into chapter 11 and the closing of so many dealerships.

In the first quarter, the US economy shrank by a revised 5.5%, lower than the 6.3% in the last quarter of last year, and the 5.7% that was estimated earlier. Of note is the fact that real personal consumption expenditures increased 1.4 percent in the first quarter, in contrast to a decrease of 4.3 percent in the fourth.

Business investment, in contrast, contracted sharply. Real nonresidential fixed investment decreased 37.3 percent, nonresidential structures decreased 42.9 percent, equipment and software decreased 33.7 percent, real residential fixed investment decreased 38.8 percent. Interestingly, corporate profit before tax increased $157.2 billion in the first quarter, in contrast to a decrease of $499.2 billion in the fourth.

The financial market is currently very nervous. While good news and a strong equity market were reinforcing one another in what I had called the “cheer cheer spiral,” there are lingering worries, and fear-mongers still abound warning that the economy is yet to fall into a deeper recession and even possibly a depression soon.

The UK and Australia were the countries that most aggressively relaxed their monetary policy in response to a perceived serious recession. These are also the countries that show the earliest recovery from the recession, showing clearly that monetary policy is still very effective in reinvigorating a frail economy.

With the equity market flying and consumer confidence rising, some people are suggesting that perhaps we can dispense with the Public Private Investment Program--the plan to lift toxic assets off banks' books. However, to drop the PPIP at this point will prove highly risky for the economy, not least because housing prices have yet to stop falling.

It has been pointed out that Alt-A and option ARM resets are expected to rise in the near term, and with housing prices still declining, there may well be another wave of defaults and foreclosures, potentially causing ruinous effects on banks' balance sheets.

Earlier in the year, University of Chicago's Casey Mulligan wrote in the New York Times' Economix Blog that there is nothing unusual about this recession's decline in real investment, compared to other postwar recessions.

His figures are right, but as pointed out in Atlanta Fed's macroblog, once investory investment is taken out, and thus focusing on fixed investment alone, this recession has indeed been the most serious among all postwar recessions.

The cheers in the market is based on forward looking indicators, in particular: the declining inventories, the PMI reported in a number of countries, the equivalent of the ISM index in the US, and rising factory orders.

China had been the first to report PMI above 50, and that was for March this year, 50 being the demarcation point for expansion versus contraction. In April it rose further to 53.5 percent, up 1.1 percentage points.

The year to date is part of what I call the preparatory phase for a recovery. Mortgage rates are falling, helping the housing market to begin to stabilize. The decline in consumption has slowed or shown a reversal. Inventories are falling. Factory orders are beginning to pick up. Confidence is slowing picking up.

In an earlier article I wrote:

....Of course, these policies take time to show their positive effects, just as the terrible lapse of regulation took time to show their terrible effects. Once market psychology changes, the fear-fear spiral will give way to a cheer-cheer spiral. I had been championing a housing buy-back program as a ‘fail-safe’ way to prevent the deterioration of bank balance sheets. They certainly would have accelerated the recovery. But I had argued that a successful lifting of toxic assets off the troubled banks’ balance sheets will still be effective.

Michael Lewis of Bloomberg wrote in a recent commentary:

…when AIG itself pays out $165 million in bonuses -- money it is contractually obliged to pay -- the entire political system goes insane. President Barack Obama says he's going to find a way to abrogate the contracts and take the money back. A U.S. senator says that AIG employees should kill themselves.

Governor Zhou Xiaochuan of the People’s Bank of China is proposing to reform the international monetary system through the creation of an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run.” He suggested that “special consideration should be given to giving the SDR a greater role. The SDR has the features and potential to act as a super-sovereign reserve currency.” The suggestion closely resembles my proposal for a “world currency unit (WCU)".

The WCU is just a standardized basket of market economy currencies that is weighted by GDP, but with the proviso that each of the constituent currency is indexed against the inflation of that economy. In a substantive sense, the WCU is an “index unit of account” that stands for a unit of real global purchasing power. Bonds denominated in the WCU would yield a real rate of return equal to the nominal rate.