Thursday, August 19, 2010

Headlines, Headlines, Headlines

For those who, like me, regularly browse the finance and economy pages of the news, there are days when you see a shocking collection of headlines. Today, the trawl through the news started with the Telegraph, went on to the Reddit Economics and Economy and Markets pages, at which point I thought I would start the post (I would normally continue on to several other sources). Whilst normally I approach posts with a general theme, today will be different. Today, the point is to just show how utterly dysfunctional/chaotic/unbalanced the world economy actually is. We have seen the masters of the universe pulling on their policy levers, and the result - well, the result is in the news. I will start with the Telegraph.

The Telegraph finance pages lead with the story that 'Wall Street Tumbles' in what they describe as 'shock' data on joblessness and a contraction in factory activity. The most interesting part of this is that anyone might be shocked by the ongoing travails of the US economy. Whilst there may be bounces, there is no way that the US economy might recover until such time as the problems of the credit bubble are finally removed. Whilst government and the Federal Reserve have sought to bury the problems with loose money and fiscal stimulus, there is no getting away from the fact that large sectors of the economy are still unbalanced as a result of the credit bubble. In a simplistic example that I often use, the shiny new shopping malls no longer have the customer base that they once had.

The second headline in the Telegraph that I noted was that Western companies are starting to feel the pressure of rising wages in China. However, the more interesting point is how China is continuing with its policy of currency manipulation in order to maintain exports:

The changing landscape has major implications for Chinese exporters, with an average profit margin of just 3pc. High-tech companies in wind power, solar, and transmission equipment that have recently broken into world markets will face stiffer headwinds. The Shanghai Composite Index of Chinese equities has been lagging all year on fears of a profit squeeze. The bourse is down 20pc since last November.

The erosion of export margins may explain why Beijing is still dragging its feet on a revaluation of the yuan, despite ever louder calls for retaliatory sanctions in Washington. China's currency has fallen slightly on a trade weighted-basis since the dollar-peg was replaced in May by a crawling band, a clear sign that the authorities are worried that the economy is cooling too fast. Beijing has tried cool the property boom with credit curbs but it is hard to use such tools in a surgical fashion without collateral damage. The growth of factory output ground to a halt in July, on a month-on-month basis.

China's foreign investment body SAFE has bought record amounts of bonds from Japan, Korea and other Asian countries over the last three months. While this is part of a normal shift away from the US and Europe, it is also a way for Beijing to hold down its currency against these competitors. It is difficult to separate motives in such a policy.

Indeed, it is difficult to see the motives of China. The problem is that, as Mervyn King recently observed, everyone sees expansion of exports as the way out of economic troubles. Not everyone can, of course, achieve this as somebody must be importing in order for another country to export. With this in mind, China's game will become increasingly contentious. And then there is the Chinese property bubble, with the Telegraph article saying the following:

Meanwhile, China Daily reports that 70pc of all flats in Hainan, 66pc in Beijing, and 51pc in Shanghai are empty, based on a survey of electricity use. They are presumably owned by investors and speculators.
It was something I observed first hand whilst living in China and reported in this blog a couple of years ago. The reason why the apartments are left empty is that Chinese people will pay a premium for an apartment that has had no occupants. This is the reason why they lie empty, rather than being rented out. Of course, had they been rented, then the investment bubble would have popped, as declining rents through excess supply would have (at least eventually) offered a market signal. Thus a peculiarity of the Chinese market has translated into a massive bubble.

The Telegraph, being a UK newspaper, inevitably reports on the UK economy. In one report, the Bank of England is suggesting that the UK economy is extremely fragile, which I thought was stating the obvious. Meanwhile, the government deficit continues to grow, though the article frames the story in terms of not as fast as before. Regardless of the framing, the UK continues to sink ever further into debt. Perhaps, in an odd way, the most interesting story is that the retail chain Poundland is doing well. For readers who are not from the UK, this is a store that stocks very, very cheap goods and they are reporting that all income groups are now using their stores. It is a sign of the times - the new frugality. However, assuming that the shop has not changed greatly since I last visited one, the shop's cheap goods seem to be disproportionately originating in China. In other words, the new frugality plays to the strengths of the emerging economies - low cost.

It is also perhaps symbolic of something that I long ago discussed, the meeting in the middle of the rising middle classes of the emerging economies and the sinking middle classes of the developed world. This point leads me to an article picked up on Reddit, which is a Spiegel Online article:

While America's super-rich congratulate themselves on donating billions to charity, the rest of the country is worse off than ever. Long-term unemployment is rising and millions of Americans are struggling to survive. The gap between rich and poor is wider than ever and the middle class is disappearing.
The article paints a grim picture for the middle classes, of stagnating wages, and growing unemployment. However, the extent of the problem is so broad that:

But even though Federal Reserve Chairman Ben Bernanke continues to pump money into the market, and even though the government deficit has now reached the dizzying level of $1.4 trillion, such efforts have remained unsuccessful.

"The lights are going out all over America," Nobel economics laureate Paul Krugman wrote last week, and described communities that couldn't even afford to maintain their streets anymore.

The problem is that many Americans can no longer spend money on consumer products, because they have no savings. In some cases, their houses have lost half of their value. They no longer qualify for low-interest loans. They are making less money than before or they're unemployed. This in turn reduces or eliminates their ability to pay taxes.

I suggest reading the article in full. However, in the same list of headlines, I also found a very similar story in the Guardian:

America appears to be a society splitting down the centre, shattering the middle class that long formed the cultural bedrock of the country and dividing it into a country of haves and have-nots. "A once unthinkable level of economic distress is in the process of becoming the new normal," warned Nobel-prize winning economist Paul Krugman in a recent New York Times column. Or, as Steven Green, an economics lecturer at Baylor University, put it to the Observer: "We are really in a tough spot right now."
These articles paint an ugly picture, and it is only getting worse. It is worth remembering that it was not that long ago that people were painting a picture in which the actions of the US government to 'save the economy' were working, that the bailout of the financial system saved the world economy.

So how is the world economy? I will return to the Telegraph, this time to the economics section, for a snapshot of the news. There is the unsurprising headline that the Greek crisis refuses to go away, with reports of capital flight out of Greece, and growing doubts about whether the EU bailout might work. Furthermore, it is not just Greece as an exception, according to an article about Moody's assessment of the situation:

"Genuinely adverse debt dynamics were only expected to materialise in 15 to 20 years. The crisis has 'fast-forwarded' history, eroding all the time available to adjust, " said the group's quarterly Sovereign Monitor.

Moody's fears that the US will crash through its safety buffer by 2013 if growth falters (adverse scenario), with interest payments topping 14pc of tax revenues. The debt-to-revenue ratio has already doubled in three years to 430pc.

The US, UK, Germany, France, and Spain are all at risk of an "interest rate shock", either because they must roll over a cluster of short-term debt (US, France, Spain) or because deficits are so large.

Countries that "fail to demonstrate the level of social cohesion required to stabilise debt" will lose their AAA rating. "Intra-generational" conflict between young and old requires careful handling. States that delay pension reform risk spiralling downwards.

Moody's said the world had changed since Europe's debt crisis. None of the large sovereign states can still assume it is credit-worthy. "The burden of proof now falls on governments," it added.

And then there is the headline about China's ongoing rise, as it finally overtakes Japan's GDP, with economists predicting that China is set to become the world's largest economy, but just arguing over timing. However, my final article comes from a link to the Economist in Reddit, concerning the rivalry between India and China:

Autocrats in Beijing are contemptuous of India for its messy, indecisive democracy. But they must see it as a serious long-term rival—especially if it continues to tilt towards America. As recently as the early 1990s, India was as rich, in terms of national income per head. China then hurtled so far ahead that it seemed India could never catch up. But India’s long-term prospects now look stronger. While China is about to see its working-age population shrink (see article), India is enjoying the sort of bulge in manpower which brought sustained booms elsewhere in Asia. It is no longer inconceivable that its growth could outpace China’s for a considerable time. It has the advantage of democracy—at least as a pressure valve for discontent. And India’s army is, in numbers, second only to China’s and America’s: it has 100,000 soldiers in disputed Arunachal Pradesh (twice as many as America will soon have in Iraq). And because India does not threaten the West, it has powerful friends both on its own merits and as a counterweight to China.
So what can we make of these headlines? Was the world economy saved when money was poured into the financial system, when government debt exploded to support flailing economies, when the policymakers tugged on their levers to save the world economy?

The headlines I have chosen are selective, but they are not unusual. What we see is instability, and ongoing shifts in the shape of the world economy. The emerging economies are getting richer, but are also unstable. The developed world economies teeter on the brink, and none of the policy levers seem to actually work. Tensions between the emerging economies, and between emerging economies and developed economies are rising. Alongside the economic rebalancing, there is a rebalancing of power.

If we jump back in time again, none of this should be happening. The masters of the universe were supposed to have known what they were doing. Have they really saved the world economy, or have they simply created ever more chaos. Take a look at the stories above, and I think you may be able to answer the question yourselves.


  1. You are right on as usual. I live outside Birmingham, AL U.S. and have been following your post for a long time. Thanks for publishing your insights.

  2. Was the world economy saved when money was poured into the financial system, when government debt exploded to support flailing economies, when the policymakers tugged on their levers to save the world economy?

    Yep – we didn’t get the Great Depression II. The empirical evidence on how government intervention stopped the slide into a depression is overwhelming:

    Double dip recessions and stagnation will be bad, but fully fledged depression woudl have been much worse.

    And while we are on the subject of whether policy intervention “worked”, where is the mythical hyperinflation?

    In the UK, there is continuing disinflation and it looks like the US might slide back into deflation.

    How many commentators were predicting hyperinflation in 2009? Remember the predictions that the US and the UK were on the road to Zimbabwe?

    I wonder whether these people are going to admit they were, as yet, totally wrong.

  3. "How many commentators were predicting hyperinflation in 2009? Remember the predictions that the US and the UK were on the road to Zimbabwe?"

    That's because hyperinflation is generally caused by the destruction of productive capacity. Fortunately we haven't destroyed that much capacity in the West - largely thank to the fiscal intervention of the governments.

    I don't think we will get a double dip - the private sector has paid enough off its loans thanks to the deficit and is willing to move forward again, but the recovery will be flat and probably jobless.

    "Meanwhile, the government deficit continues to grow, though the article frames the story in terms of not as fast as before. Regardless of the framing, the UK continues to sink ever further into debt."

    I do get fed up with this pejorative 'mired in debt' nonsense. If you want a country 'mired in debt' have a look at Japan. And you'll find that they have a massive standard of living and an economy that is flat but relatively stable.

    Then examine the economic theories you subscribe to and see if they explain that. If they don't (and monetarism doesn't however much they try and bend it) throw them out and get some new ones.

    The deficit is the other side of the national balance sheet to 'net savings' - without the deficit more productive capacity would have to be destroyed to allow people to pay their loans back.

    National debt is never paid back for the fairly obvious reason that it is the other side of the balance sheet to national assets, ie our houses, pension plans and savings. If you reduce the national debt, you reduce our national wealth by exactly the same amount.

    When a government spends in its own currency it will always get its money back as well as the thing it bought in the first place. The power to enforce a tax ensure that. The only question is when.

    The rate of tax merely determines how many taxable transactions a unit of spending stimulates before it ends up taxed out of existence. Tax is monetary friction.

    The timing differences between spending and the tax doing its recovery job is what is described as the 'deficit' and merely tells you how much people using the economy are saving in aggregate at the moment.

    The treasury could if it wanted issue its own 'permanent non-interest paying bonds' in exchange for its own 'temporary interest paying bonds' in a large asset swap. The former is usually known as 'cash' and the latter 'gilts'.
    None of that would change the asset position of the holders by one penny.

  4. Lord Keynes

    No we didn't gt the great depression 2... YET.

    Everything governments are doing today to paper over the cracks will make our problems worse further down the road.

    Nobody was predicting hyper inflation in 2009 that I know of. That is something to look forward to over the next 5 to 10 years.

    The worst is yet to come buddy.

  5. I believe the phrase "deficit denier" that has recently been coined fits well with some of the comments.

    Meanwhile, Lord Keynes, captain of the good ship Headinsand directs the vessel on into dark and stormy waters.

    "But the tractor stats from this obscure writer suggest the weather will be fine..."
    Meanwhile, the lightning continues to flash overhead.

  6. Reply to Niknaknoo

    Nobody was predicting hyper inflation in 2009 that I know of.

    Then clearly you weren’t looking hard enough:

  7. The world has moved from card games where you can count the cards and make close guesses to pure gambles where you cannot count them, they are shuffled every time, and there a lot of jokers and strays from happy families in there.

  8. And a couple more cracking headlines in today's Telegraph:

    Interest rates 'may hit 8pc' in two years.
    Interest rates may rise to 8pc within two years to choke off soaring inflation, according to radical new research.

    'True' UK debt is £4.8 trillion
    Institute of Economic Affairs says deficit is £78,000 for every person.

  9. Lemming,

    Regarding the article "Interest rates 'may hit 8pc' in two years", you might note the caveat the end:

    Mr Lilico, a monetarist at the right-of-centre think tank, is close to the Coalition but his ideas are considered extreme.

    His analysis is based on the flawed theory of monetarism, with the rotten quantity theory of money. On why it's wrong see here:

  10. On the universal over-optimism of economists and the media:

  11. Here's another article that looks at the issues from a historical/cultural/societal perspective:

    Really there's no point in analysing what's happening purely in terms of "economics" or what is the best fiscal or monetary response. If you can't recognise that the system is fundamentally corrupt then you aren't even going to begin to understand it.

  12. Gareth Cheeseman said...Aug.22 2010 4.28pm.

    "Really there's no point in analysing what's happening purely in terms of "economics" or what is the best fiscal or monetary response. If you can't recognise that the system is fundamentally corrupt then you aren't even going to begin to understand it."

    Exactly! this is what I was saying two years ago. Nothing has changed, still pressing the buttons, pulling the levers, still kicking the tyres whilst the world goes to hell in a hang basket.

  13. The fact that some predicted hyperinflation in 2009, and it hasn't happened, is rather similar to those that predicted house price falls in 2004/5/6/7. They were wrong for a considerable amount of time. But were right in the end.

    We are nowhere near the end of this little episode yet.

  14. Reply to Sobers

    The fact that some predicted hyperinflation in 2009, and it hasn't happened, is rather similar to those that predicted house price falls in 2004/5/6/7

    Not really, those who predict hyperinflation subscribe to a deeply flawed economic theory.

    The fact that Japan never had hyperinflation - despite its QE - also shows this.


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