With average inflation above 3 percent since 2005, it has been obvious for a while that the Bank of England has in effect unilaterally decided to abandon the 2 percent inflation target the law says it should follow. Now it in effect has created a target for the unemployment rate by saying it won't consider raising interest rates until the unemployment rate falls below 7 percent.
To create the appearance that they're not completely ignoring their legal mandate, they say that if inflation is likely to be above 2.5 percent (whatever happened to 2 percent?) in the next 18 months, they might after all tighten even if unemployment is above 7 percent, but since they've been saying that inflation is likely to be 2 percent in that time range for the last eight years, that's not going to limit their inflating. This probably won't mean much change in actual policy, which was very inflationist to begin with, but the Bank of England now makes its deliberate flouting of its legal mandate to keep inflation at 2 percent explicit.
The most interesting thing about last week's U.S. GDP report isn't that it indicates that second quarter growth was moderate.
The most interesting thing instead that it asserts that first quarter GDP was $551 billion, or nearly 3.5%, higher than previously reported, $16,535 billion instead of the $15,984 billion previously reported.
The upward revision is the result of a previously announced methodological change, which entailed classifying corporate outlays on intellectual property as "investments" as opposed to input cost. This matters because investments are included in GDP while input purchases are excluded.
But as I pointed out in my previous analysis of this issue, this change doesn't make America any richer, because in the long term, investments are in effect input purchases to achieve production. The difference just lies in whether it should be subtracted immediately or gradually through several years through what in national accounting is called "capital consumption" and what in corporate accounting is called "depreciation". In the long term, any re-classification of something as "investment rather than "input purchases" won't increase net income as the increase in "gross income" is cancelled out by an equal increase in capital consumption/depreciation.
And indeed, as Q1 2013 GDP was upwardly revised by $551 billion, capital consumption was upwardly revised by an almost equal amount of $540 billion, from $2,063 billion to $2,603 billion.
There are however two implications of this. One is that it will make cyclical fluctuation look bigger as in the short term in periods of rapid increses in investments, this will briefly raise estimated net income, but once the investment boom is halted capital consumption will catch up.
Another is that unless other countries make the same methodological change this will make America appear richer even as it really isn't. The illusion of increased cyclical fluctuations and the increased international incomparability are two more reasons why economists should stop focus on comparing GDP and instead compare national income/net national product.
As late as 2011, the Euro area only had a very small (€15 billion, or about 0.16% of GDP) aggregate current account surplus, as the large €147 billion surplus in Germany was almost entirely cancelled out by large deficits in countries like Spain, Portugal, Greece and Italy.
The German surplus has continued to increase, but the euro area surplus has increased more than 12-fold, and was €184 billion in the 12 months to May, up from €122 billion in 2012 and as previously stated €15 billion in 2011. That €184 billion number is now higher than the €172 billion German surplus, meaning that the balance excluding Germany has improved from a deficit of €132 billion in 2011 and a deficit of €45 billion in 2012, to a surplus of €12 billion in the 12 months to May 2013.Spain, Portugal and Italy now all have surpluses and though Greece still has a deficit, it has fallen dramatically.
Paul Krugman once asserted that it was impossible for the deficit countries of the Euro area to eliminate their deficits while Germany kept their surplus, but that is exactly what has happened.
I think there are two reasons. One is that although farmers are few they care deeply about farm subsidies because they gain so much per person which means that they will almost all vote on the basis of that issue. By contrast, the majority of non-farmers lose so little per person that almost no one will vote on that issue, and of course many non-farmer voters don't even know about the issue.
A second reason is that a lot of people feel sympathy for farmers. Food is after all the most important product in the economy since we would all die without it, so many feel that the producers of it should be supported. This of course doesn't follow since while it is of course necessary that food is produced, any potential shortage of farmers due to too low incomes for farmers would be self-corrected on the free market with higher prices. However, that is probably how some people think and some perhaps also have a emotional/sentimental sympathy for farmers.
As a result, far from all non-farmers who care about the farm subsidy issue are opposed to it.
It's the beginning of a quarter, meaning that it is time for earnings reports for the preceding quarter. One thing that we can say for sure is that most reports, at least in the U.S., will be "better than expected". The reason I can say this is not because I'm psychic (I'm not, unfortunately) nor because there is evidence to suggest companies really are doing better than expected, but because the official "earnings estimates" produced by official analysts are always lowered just before the reports so that they will almost always be "better than expected."
The case of Alcoa illustrates this. Until recently, the average official forecast was for quarterly per share earnings of about 20 cents, but the report showed a profit of only 7 cents per share. But since forecasts had been reduced to 6 cents just before the report, the headline still said "better than expected."
Why is this done? Because the companies producing these estimates have an economic interest in making people buy stocks. And by presenting most reports as "better than expected" while producing extremely over optimistic forecasts about the future, they hope to make people wanna buy those stocks, hoping that people won't notice how they almost always quietly lower these forecasts shortly before the reports.
While certain people have predicted the end of the euro ever since the trouble in Greece began in late 2009, these predictions have yet to materialize. Not only hasn't it ended, not a single country has exited, with one country, Estonia, in fact joining in 2011 and with Latvia now set to join as well on January 1 next year.
Estonia's and Latvia's entries have/will strengthen the northern German-led faction in the ECB, as they have demonstrated a commitment to sound public finances even in a crisis, also likely making them supporters of the German sound money policies.
However, apart from the influence Latvia will gain in the ECB governing council, this move won't change anything in terms of exchange rates and monetary policy as Latvia has had during a long time a fixed exchange rate against the euro for its currency.
This also means that as the number of euro area countries increases from 17 to 18 (excluding micro states Andorra, Monaco, San Marino and the Vatican as well as Kosovo and Montenegro which have unilaterally adopted the euro without being formal members) the number of EU countries with a national currency with a fixed exchange rate drops from four to three, with the remaining being Lithuania, Bulgaria and Denmark. Of these remaining three, Lithuania seems eager to follow the path of their fellow Baltics and adopt the euro, while Bulgaria and Denmark are content with the status quo of a national currency pegged to the euro.
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"Ireland’s economy lurches back into recession" says the headline in The Irish Times, based on a drop in GDP. The problem is that for Ireland, GDP is misleading.
The reason for that is that because of Ireland's low corporate income tax rate, multinational companies, tend to attribute too much of their profits to Ireland, by having their Irish subsidiaries charge their non-Irish subsidiaries unreasonably high prices when supplying them with goods & services and similarly having their non-Irish subsidiaries charge their Irish subsidiaries unreasonably little. Yet apart from the (at most)12.5% of the profits that is paid in corporate income tax, those profits goes to foreigners, not the Irish. And because those alleged profits only reflect tax avoidance, it gives a misleading picture of how much value is produced there. For this reason, GNP, which subtracts the profits of foreign companies in Ireland, provides a more accurate picture of the Irish economy than GDP.
And for some unknown reason, foreign companies have sharply reduced the profits they attribute to their Irish subsidiaries during the latest year. As a result, even as real GDP fell by 0.9% real GNP rose by as much as 6.1%!
That 6.1% number seems implausibly high considering that the unemployment rate has fallen by only 1½ percentage points, something that probably reflects price index problem. Nominal GNP rose by only 4.8% meaning that the real GNP number assumes 1.3% deflation, even as consumer prices rose by about 1%.
Still, while growth was almost certainly lower than 6.1%, it was clearly far above zero, meaning that Ireland has joined the Baltic countries in recovering from the slump.
In a separate report, BTW, Ireland's current account surplus rose to a record €9 billion, or nearly 7% of GNP, in the year to the first quarter.
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Both bonds and stocks, not just in the U.S. but interestingly in most other countries as well, have sold off heavily after the Fed expressed optimism about how the U.S. economy would develop, something that was interpreted as a signal that it might reduce its bond purchases.
I however doubt that they will actually do that anytime soon. The U.S. economy is expanding, but very slowly, so slowly that the employment to population ratio was no higher in May 2013 than in May 2012.
And though Bernanke may have hinted that the criteria for drawing down QE is a 7% unemployment rate, the official statement keeps mentioning the 6.5% rate, along with expected inflation of 2.5%
Furthermore, the negative market reaction to the possibility of reduced QE may prove to be a case of "self-preventing prophecy". The large sell-off to the hint of such policy change could deter the Fed from actually going through with it.
The popularity of "Abenomics" among non-Japanese pro-inflationists is puzzling for many reasons. One is, as I've noted before, the fact that Japan with its 4% unemployment rate was already very close to full employment, so even using Keynesian models there is little it can do to boost growth.
Another fact which should make it less popular is that while it will cause inflation to increase in Japan, it will lower inflation elsewhere.
The reason for that is the key result of it so far has been to dramatically lower the value of the yen, by about 20% against the U.S. dollar and 25% against the euro. Unless reversed, this dramatic exchange rate drop can result in three different outcomes:
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1) Raise prices in Japan
2) Lower prices elsewhere
3) Result in a permanently lower real exchange rate for the yen ( Continue… )
At first after "Abenomics" was launched, the already very low yields on Japanese government bonds fell further, from about 0.8% to 0.35%, which kind of made sense since Abenomics meant mass purchases of government bonds, and increased demand on something will of course mean a higher price, which in turn in the case of bonds implies lower yields.
However, lately, yields have started to move up again, rising above the pre-"Abenomics" level to 0.91% as of this writing, something that worries many Japanese officials. But how could yields rise when the Bank of Japan makes record large purchases? Well, because private demand has collapsed as investors have increasingly started to believe that the Bank of Japan through its purchases will actually achieve its new stated inflation target of 2%, a slump in demand that some have called a "bond buyer's strike."
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And if inflation is going to be 2% why would anyone in their right mind want to hold bonds that have nominal yields of less than 1%? The answer is of course that no one should and that investors should protect their savings by investing in fixed assets instead. ( Continue… )