While I have no desire to offend avid readers of the astrology page, I am becoming more and more concerned about the grounding of today’s macroeconomic forecasting.
In today’s crisis, some appear to be jettisoning hard macroeconomic data and causality (astronomy) for the troubled waters of fantasy (astrology), based on turn of the millennium fears, such as Weimar Republic style hyperinflation and a future world dominated by the BRIC countries (minus the R).
While (the very numerous) proponents of these theories claim to rely on harsh reality (the incredible cash injections by central banks and the size and robustness of the BIC countries), they have a disquieting tendency to take in only part of currently available data.
As part of their relentless attack on the bloating of the Fed’s balance sheet, they hyperventilate about the danger of “hyper” (inflation) by quoting Milton Friedman:
“Inflation is always and everywhere a monetary phenomenon”. (A Monetary History of the United States 1867-1960)
However, they also convenient forget the guru of monetarism’s analysis of the reasons for the Great Depression, which, in reality, validates the monetary policy carried out by the Fed in the past year:
“The Fed was largely responsible for converting what might have been a garden-variety recession, although perhaps a fairly severe one, into a major catastrophe. Instead of using its powers to offset the depression, it presided over a decline in the quantity of money by one-third from 1929 to 1933 ... Far from the depression being a failure of the free-enterprise system; it was a tragic failure of government”. (Two Lucky People)
I think you will find this interview with the Nobel Prize laureate very interesting in that he deals with the above-mentioned matter as well as his proposals for reducing the rate of poverty and legalising the sale of drugs in US urban centres.
As for the BICs new role as economic motor, although we have regularly acknowledged the support to the world economy by the flood of Chinese credit (Thaler's Corner 14-07-09: The word for Champagne in Chinese is Tsing Tao!), I cannot emphasise enough the troubling parallel between the tenants of a new era and the believers in the end of the American empire.
And truth be told, the way in which US authorities have managed certain matters, such as the decisions to let some firms go under (Lehman) while saving others (Bear Sterns, AIG) by compensating certain counterparties (AIG CDSs) and infringing on the rights of others (UAW given precedence over GM’s priority creditors) raises the question: how can we make long-term investments in countries where private-sector financial transactions can be retroactively abrogated by the government (Chinese companies arbitrarily breaking derivative contracts with Western investment banks), where the domestic currency in manipulated (yuan) or where taxes on capital are imposed overnight (Brazil)?
That’s my two bits on geopolitics today. Back to hard macro data:
· In Japan, price indices published Friday evening leave no doubt as to the scale of the deflationist trap.
While the core CPI came to -2.3% in September, versus -2.4% in August, there is not much to rejoice about. Preliminary figures for October, derived from those of Tokyo (-2.2% vs -2.1%), continue to point in the wrong direction, despite the boost provided by the massive stimulus plan in China.
As such, the BoJ declared this morning that it was ending its corporate bond and commercial paper buyback plan, since these markets no longer need the support, but that it was extending until the end of March its unlimited quantity liquidity injections at 0.10%.
· In the US, many interpreted the better-than-expected GDP figures (+3.5%) as a signal that the recession is over.
Aside from the fact that such an analysis ignores the backdrop of the low basis of comparison, it is interesting to note the extremely cautious comments by government officials, who have in the past been much more optimistic.
Perhaps, their prudence stems from the end of the Cash for Clunkers and Home Tax Credit programme (which, as it turns out, may be extended and even increased!)
Personal spending, just out, fell back 0.5% in September, and the PCE deflator came to -0.5% on an annual basis with the core at +1.40%, i.e. very far from the Fed’s targets -- consistent with the commitment to keep interest rates low for some time to come.
· Last but not least, in Europe, statistics just out for Germany help us better understand the government’s spectacular Keynesian about-face!
In the first place, it is patently obvious that the Kurzarbeit plan to subsidise companies who keep staff who would have otherwise been laid off, since the unemployment rate remains contained at 8.1% in October, versus an expected 8.3%.
While some observers consider this measure to be too Keynesian (thus inflationary?), it has in fact turned out to be a bulwark against disinflation, which should warm the hearts of ECB officials, who are engaged in a frontal assault on the problem of Hysteresis!
For central banks, this notion of causality in physics is, in fact, a secondary measures of the output gap because it describes the impact of rising unemployment on potential non-inflationary growth.
It is based on the observation that when people remain unemployed too long, they may not acquire the new skills needed by companies as they come out of a recession, thereby, limiting the pool of available staff and causing strains in hiring.
As such, the Kurzarbeit plan is a good way to resist this phenomenon, as are the various efforts to “train people throughout their life” announced on a regular basis in Germany.
However, this does nothing to resolve the country’s other problems (and those of the eurozone as a whole), as highlighted by the country’s very disappointing retail sales for September, -0.5% (expected +1%), bringing the yearly contraction to -3.9%, vs expectations of -2.2%.
In the meantime, inflation in Europe came out once again in negative territory (but, remember, we can’t say “deflation”!).
And then there is the euro’s strength (just look at Airbus’s problems), which is evoking increasingly virulent comments, such as:
Jean- Claude Juncker: “On that point I will see again the political and monetary authorities in China, with Mr. Trichet and Commissioner Almunia, to tell them that they have to change their attitude.”
Christian Noyer: « The very strong fluctuations are worrying for the whole G-7 because of the peg of the Renminbi to the dollar, which is an anomaly
In this context, Mr Quaden comments, below, make a lot of sense:
“It’s probable that in the coming months inflation will remain very weak and the economic recovery fragile,” “Conclusions to draw for the monetary policy stance seem very obvious.”
But the real hawks continued to hover about:
Axel Weber: Banks should prepare for a gradual withdrawal of the medicine provided by central banks.
We won’t wait until employment picks up or unemployment rates fall to tighten.
That would definitely be too late. Our monetary policy must be ahead of the curve, not behind.
Mr Stark: A further overrun in public finances could have grave consequences for long-term interest rates, economic developments, the stability of the Eurozone and not at last for the monetary policy of the European Central Bank,
Signs of an economic recovery next year are becoming increasingly evident
Oh, lucky us, we are saved at last! (but not what little remains of their credibility …)
Disclosure : Long 20 years OAT 0% Coupons, EDF Corp 5 Years 4.5%.