Views from The Economist

Three articles from the most recent edition of The Economist are deserving of some attention today. They are available at Economist.com for those with subscriptions and they have been reproduced in the preceding post for those who are not regular readers of this fine magazine.

Normally great respect is heaped on the work done at this publication which maintains such a storied history going back over 150 years. It seems their only failing is that many of their writers are indeed economists - they think like economists and say things that you would expect economists to say, particularly when writing about economics. And, for that, they must be taken to task.

The first story, Decoupled ($), touches on some of the dark matter themes discussed in these pages recently, a subject that has become a real wonk-fest on econoblogs all around the world (see the Blogroll on the right side bar and you'll find dark matter discussions on many of these blogs).

For those new to the discussion, "dark matter" is the most recent attempt to explain how global economic imbalances are really not as they appear - that the global economy is, in fact, well-balanced.

The reason that this claim is now made is that the robust earnings of large U.S. multi-nationals is viewed in some circles as offsetting our enormous trade deficit via some statistical slight-of-hand. While this may help square the books in the minds of some, it does nothing to address lackluster job growth here at home. Some economists are quick to recognize this disconnect, or decoupling, between the success of companies and the success of an economy.

The success of companies no longer guarantees the prosperity of domestic economies or, more particularly, of domestic workers. Fatter profits are supposed to encourage firms to invest more, to offer higher wages and to hire more workers. Yet even though profits' share of national income in the G7 economies is close to an all-time high, corporate investment has been unusually weak in recent years. Companies have been reluctant to increase hiring or wages by as much as in previous recoveries.

This is the "elephant in the living room" aspect of the dark matter discussion which is conveniently omitted in the current account squaring logic espoused by its proponents because, in the end, all that really matters is jobs. After that come all the other "nice-to-have" economic statistics like growth, inflation, productivity, and their ilk. But without jobs, politicos do not get re-elected.

If a large part of the spurt in profits comes from foreign operations, it is less likely to be used to finance investment or extra job creation at home. If they reason that the recent past is a fair guide to the immediate future, companies are likely to plough their extra profit into further investment abroad.

This is one of the critical differences between Japan in the 1980s and China in this decade. While Japan was largely closed to outsiders, China has been amenable to foreign companies operating in China earning profits which are then sent back home to corporate headquarters in America.

Manufactured goods go east across the Pacific, jobs go west, profits return back to the east, and investment dollars are directed back across the ocean. This provides an increasingly unbalanced prosperity in the U.S - the corporate haves and the working have-nots.

So far, so good. Enter Pollyanna.

Workers can still gain from rising profits if they own shares, either directly or through pension funds.
...
If profits (and hence executive pay) continue on their merry way, while ordinary employees' real wages stand still and their health benefits and pensions are eroded, workers might well expect their governments to do something to close the gap. It's not hard to think of ideas that would be popular—higher taxes on profits, restrictions on overseas investment, import barriers, or making it harder to lay off workers. The trouble is, in a globalised economy such measures would also be suicidal. Firms would simply move operations' head offices to friendlier countries.
...
The clear lesson is that policies aimed at penalising companies will fail to spread the rewards of corporate success to the wider economy. The only sure way to boost national economic prosperity is to make labour and product markets work more efficiently and to improve education, to make the home country a more attractive production base.

Education was Alan Greenspan's ace-in-the-hole for many years when testifying before Congress, "We must better educate our workforce so that we are more able to compete in the global economy". But this completely misses the point that there are smart people all over the world and the smart people in China and India get paid a lot less than the smart people in the U.S.

Education will not save American jobs, but it is all too easy to point to as something that needs improvement where elected representatives can hang their heads and say, "You're right".

The unspoken truth, which another economist fails to acknowledge here, is the dark side of globilization - the real dark matter, as it were - the leveling of living standards around the world. What's missing from this discussion is the long painful adjustment, now under way in the U.S., where we become much more equal with workers around the world.

ooo

Next up is an intriguing take on the Japanese deflation saga, which many believe may be coming to an end. In Out, damned D word ($), the classic view of Japanese deflation and how it relates to modern economic theory is neatly stated.

Japan, the first economy to suffer prolonged deflation since the 1930s, has lived with its painful economic consequences. Falling prices mean that real interest rates cannot be negative when required to reflate a sick economy. Falling prices also inflate the real burden of debt. This, in turn, depresses spending, which further intensifies deflation. And so on, in a vicious spiral.

Central bankers have long known how to fight inflation, but have been flummoxed by deflation.

Of course, remember that in one of Fed Chairman Bernanke's most famous writings about making sure deflation doesn't happen here, there did not seem to be much flummoxing. There are apparently quite a few ways to avoid deflation, many of them having nothing to do with helicopters.

But then it really depends upon how the 'flation is measured.

Japan's core rate overstates inflation, because unlike in other countries, it includes energy prices, which are surging.

Got that? Inflation is now defined as core inflation, and in Japan it is overstated because it includes energy. So, in the mind of this economist at The Economist, inflation now officially excludes both housing and energy. It seems that maybe economic data collectors and statistical conjurers could just as easily make the reported 'flation what they want it to be and be done with it - two percent.

Done. Why all the fuss?

What's all the commotion about prices going down anyway? We've had deflation in imported goods for many years now, and that doesn't seem to have slowed down the sale of wide-screen TVs or inexpensive apparel and footwear. It neatly offsets the roaring inflation in domestic services, energy, and housing and most people won't figure it out on their own when "two percent inflation" is repeated over and over and over and over.

In fact, as the price of imported goods goes down, we Americans buy more of them, so what danger really is there in falling prices? We Americans are used to them and we like them. The business model of the most successful retailer in history, WalMart, is based on falling prices.

But, back to Japan.

There was a little stumble back in 2000 when the Bank of Japan tried to raise rates at about the same time that the Nasdaq was imploding, and no one wants to stumble any more.

The Bank will be more cautious about raising rates this time, but sooner or later it will need to withdraw its unprecedented injection of liquidity if it is to prevent a future asset bubble. As Japan's economy becomes more normal, it is natural to expect a more conventional monetary policy. In economics, a bit more normalcy can be a jolly good thing.

Yes, Japan must be careful about asset bubbles lest the late 1980s equities and real estate orgy be repeated. When recovering from deflation, be careful not to proceed directly to the next asset bubble.

And, normal would be a good thing?

This term, along with "conventional monetary policy" are casually bandied about as they relate to fifteen years of penance for one good decade that seemed so right at the time. Does anyone know what normal is anymore? Monetary policy that is conventional in an era of asset bubbles?

ooo

Lastly, in Gold and the Bundesbank ($), the German central bankers appear to be at odds with the political leadership when it comes to the relevance of gold in modern banking systems. To at least one economist at The Economist, the discussion of the relevance of gold appears to be irrelevant.

A TRUCE was called last week in a battle between Germany's Bundesbank and federal government over the country's 3,400 tonnes of gold reserves. The central bank is proud of having stood up to the finance minister. However, it is hard to see what it has gained.

The gold is worth about €50 billion ($60 billion) according to the Bundesbank (valuing its stash at recent market prices). Every finance minister for the past two decades has been trying to coax the central bank into selling some. Although an agreement between central banks, sealed in 2004, would allow it to unload 120 tonnes a year until 2009, the Bundesbank won't budge.

Most Bundesbankers see themselves as custodians of the people's wealth. Selling some of it, especially to fill part of the gaping hole in the public finances, would both erode that wealth and damage the central bank's fiercely guarded independence. So when Peer Steinbrück, the new finance minister, proposed that the Bundesbank should keep the capital proceeds of any gold sales but that the interest should go to the budget, he was sent away with a flea in his ear.

A "flea in his ear". You've got to love some of those expressions by the speakers of the Queen's English. We'll assume that Mr. Steinbück was sent away mad because the deal he was proposing made perfect sense to he and his economic advisors, but for some reason the dense German central bankers just didn't get it.

You see, gold earns no interest and with the entire world having foolishly bid up the price of gold for who knows what reason, the precious metal sitting in German vaults should be dumped in favor of the more sophisticated interest bearing fiat money. Simple. Then the tone turns condescending.

The days when journalists would invariably describe the Bundesbank as “mighty” are long gone. With other euro-zone central banks, it handed monetary policy over to the European Central Bank when the euro was born in 1999. In the past four years the Bundesbank's staff has been reduced by over 20%, to 12,300. It will fall to 11,100 by the end of 2007. That is still too many for what is now merely one member, albeit the biggest, of the euro club. And its eight-man board is too big, a concession to regional politics. Nevertheless, it is a founding principle of the euro area that national central banks be independent of their governments. This gives Axel Weber, the Bundesbank's president, a strong hand in any disputes with ministers.

Although Mr Steinbrück was seen off, the Bundesbank looks a little ridiculous. Under last week's truce, Bundesbankers' supplement will be phased out, but gradually, to be replaced with increases in basic pay; the bank's top officials in Frankfurt will still get a 9% top-up. But under the existing Bundesbank law the proceeds of any gold sales go to the government anyway, as do all the central bank's profits. This week Mr Steinbrück unveiled a budget which foresees that €3 billion will come in from the Bundesbank this year. Meanwhile, one parliamentarian has proposed putting Mr Steinbrück's proposal into law anyway.

So, to spite Mr Steinbrück, the once-mighty Bundesbank has simply robbed itself of flexibility. It risks hoots of derision if it now sells an ounce of gold.

The discussion of the relevance of gold in the world's monetary system is truly perplexing. On the one hand gold is irrelevant, and on the other hand, as stated on several occasions by none other than Alan Greenspan, gold may be needed by central banks in times of distress.

How can these two views be reconciled?

Even more astonishing than the hubris of many western economists is how the discussion of gold changes depending where you are in the world. In the U.S., there is nary a mention of gold by either the elected leaders or the central bank. It is simply irrelevant. It is as if vaults at Fort Knox were empty.

In Europe, there is continuing discussion about gold sales, as the precious metal leaves central bank vaults at a slow and steady pace under the Washington agreement.

In emerging economies, however, there is little talk about the relevance of gold or the sale of gold. Rather, there are whispers and rumors about central banks buying gold.