For people who view NGDP (Nominal GDP) as important, the latest U.S. GDP report should be seen as very bullish. The headline volume number was upwardly revised from 2.8% to 3%, but the terms of trade adjusted was upwardly adjusted even more, from 2.4% to 2.8% and as domestic price inflation was upwardly adjusted from 0.8% to 1.1%, NGDP was upwardly adjusted from 3.2% to 3.9%.
Almost (yesterday's durable goods numbers were an anomaly) all data suggests that NGDP will increase even faster in the first quarter, reflecting both higher real growth and higher price inflation, driven by the rapid increase in money supply.
The Economist is now removing Argentina's consumer price inflation number from its list of economic indicators because it is so obviously false that the official numbers are of no use, comparable to past budget data from Greece. That seems like the right thing to do, though The Economist seems to have missed that the manipulation of inflation data has implications not just for the inflation numbers themselves, but also for real growth numbers. Since real growth is a function of nominal growth corrected by price inflation, an underestimation of price inflation implies an overestimation of real growth.
Which brings us to Roger Bootle's telegraph column where he repeats the myth that because Argentina boomed after devaluation so would Greece.
In my view, the greatest threat to the euro is that Greece will make a success of default and devaluation. Something like it has happened several times before, notably with Argentina in 2002, when it defaulted and devalued. The country went from an appalling financial crisis to growing by 11pc in the space of 18 months.
Suppose that once the new drachma has fallen by 30pc to 50pc, Greece begins to show signs of growth. How would it then be possible to persuade the electorate of Spain, Portugal, Italy, and even Ireland, that there is no alternative to years of misery?
Well, obviously, if Greece becomes a success after devaluation while Spain, Portugal, Italy and Ireland don't while remaining in the euro, then devaluation will look appealing. But there is no reason to believe that will happen. Britain's and Iceland's economies, for example, have remained weak years after their dramatic devaluations.
Argentina is a misleading example because first of all, as pointed out above, its dramatic underestimation of inflation means that real growth has been far lower than the official numbers indicate. And secondly, to the extent the boom has been real it was as I pointed out in a previous post due to the fact that the prices of Argentina's export commodities coincidentally sky-rocketed in the years after its devaluation.
Jordan Weissman at The Atlantic denies that the Fed is responsible for the recent sharp increase in oil prices by asserting that the dollar has appreciated in value recently and is now stronger than before QE2 started.
His argument is wrong on many levels. First of all, I don't think anyone has claimed that the Fed is the only factor behind the recent increase. Inflationary policies by other central banks and of course the Iran issue have certainly also contributed to this, and that is not just my view but the view of most people who argue that the Fed is at least partly responsible.
Secondly, while it is true that the dollar has recovered from the lows of the summer of 2011, his contention that the dollar is stronger than before QE2 started is flat out wrong. In late August 2010, just before QE2 was announced, the dollar index was trading at around 83, while it closed at 78.4 this Friday, 5.5% lower. Weismann deliberately misleads his readers by ending his chart of the dollar index at the January peak of 82, despite the fact that his article was published yesterday, when the index was more than 4% lower.
Thirdly, and more important, he ignores the point that the contention of Fed critics isn't necessarily that the dollar is weaker than in the past, but that it is weaker than it would have been without the Fed's actions. There have been other factors counteracting the effects of Fed actions, most importantly the European debt crisis that has greatly increased demand for dollar assets because they are seen (irrationally) as a safe haven. If not for the Fed, the dollar's rally between August 2011 and mid-January 2012 would have been even greater, and its declines before and after would have been much smaller or wouldn't have happened at all.
In the end though, Weissman actually concedes that the exchange rate mechanism isn't the only way that the Fed can raise oil prices. However, he gets the story largely wrong. The other mechanism is simply that by increasing nominal demand, prices go up. And because oil and other commodities have perfect price flexibility, being traded at financial markets they will respond quicker than the more sticky prices that exist.
I won't bother to refute all of his points especially since I've already refuted most of them when put forth by others, but I will mention his denial of the claim that the Fed's low interest policy have discouraged savings and encouraged borrowing.
"Consider, for example, a world in which the Federal Reserve conducts monetary policy so that the price level rises steadily at 2 percent a year. Savers, knowing this, will demand a higher interest rate to compensate them for the lost value of their money. If the Fed generates more inflation than they expected, as it did in the 1970s, then savers will suffer and borrowers benefit. If it undershoots expectations, as it has over the last few years, the reverse will happen. The anti-saver redistribution Paul decries is thus not a consequence of monetary expansion per se, but a consequence of an unpredictedly large expansion. For the same reason, monetary expansion does not necessarily lead to less saving. There is no reason to believe that the real burden of home loans would be any larger in a world with 2 percent inflation than in one with 1 percent inflation."
This would be true if price inflation was entirely caused by factors unrelated to monetary policy actions. If that had been the case we would indeed expect periods of time with unexpectedly high price inflation due to for example crop failures to be compensated by periods of time with unexpectedly low price inflation due to unusually good crops.
But in reality, central banks create price inflation by lowering the real interest rate. They provide free money for the banks at levels below the natural level (time preferences of the population). This in turn enables the banks to lend more which in a fractional reserve banking system means a higher money supply which in turn creates price inflation. Lower real interest rates isn't just the result of higher price inflation, it is in fact the cause.
But what about his argument that savers will demand a higher interest rate? Well, rational savers will indeed do so, but even assuming that all savers are rational (and that's an implausible assumption), it won't matter, because the banks won't need the savers as the central bank can create all the money needed for the banks to lend. All savers can do is either save in foreign currency accounts (which will lower the dollar's value), buy stocks or fixed assets (like real estate or gold) or not save and consume.
Either way, savers behavior can't change the outcome when it comes to real interest rates, at least as long as the central bank is indifferent (or positive) to the inflaionary impact of their money printing. And it should be obvious that the Fed hasn't been significantly deterred from inflating by the effects on price inflation recently.
This point also affect another of Ponnuru's assertions, that Fed monetary policy hasn't enabled government expansion. Lower real interest rates will encourage not just private individuals, families and companies to borrow more, but also government borrowing. And with federal debt at more than $15.4 trillion, or about 100% of GDP (comparable to Portugal) government borrowing enabled by low interest rates have clearly played a role in expanding the size of government.
Oil prices have recently risen, in part because of inflationary monetary policies and in part because the supply of oil from Iran is falling as the U.S. and the EU targets it with sanctions and as Iran has stopped deliveries to Europe even before the sanctions were formally implemented.
With the WTI oil price at around $105 per barrel still well below the July 2008 peak of $147 per barrel it would seem that things aren't that bad. However, that is misleading for two reasons. First of all, despite being misleadingly touted by the financial media as "the oil price", the WTI price has only a limited real world relevance and the more important Brent crude price is at $120 per barrel a lot closer to the 2008 peak.
Secondly, the dollar was much weaker in July 2008 than it is now. At that time, the dollar was trading at $1.60/€, now it is trading at $1.32/€. Thus, while oil is still cheaper to Americans than it was in July 2008, for Europeans it has returned to the roughly €90 per barrel level that we last saw in July 2008.
That is of course going to put further pressure on European economies (except for Russia and Norway who benefits as exporters of oil), including the crisis hit ones in Southern Europe, while also illustrating the downside of a weak currency. A weak currency may raise nominal export earnings, but it will also make oil and other imports more expensive.
What the debt crisis is ultimately about is the fact that in certain Southern European countries people are spending too much compared to what they earn. With regard to this we are seeing significant progress in Portugal and Italy-but not in Greece.
In Portugal, the current account deficit in December fell from €17.2 billion in 2010 to €11.0 billion in 2011. That is still above 6% of GDP and thus still far too high, but as it is more than a third less than in the previous year (and nearly 50% lower than in 2008) that certainly represents significant progress. The December change was particularly impressive with the deficit dropping from €2.1 billion to €750 million.
Italy saw its December 2010 deficit of €4.9 billion turn into a €400 million surplus. Though some of that reflected a likely temporary increase in current transfer receipts, most of it reflected a genuine reduction in overspending.
By contrast, there is almost no sign of progress in Greece, where the monthly current account deficit rose from €1.85 billion in December 2010 to €2.2 billion in December 2011. Perhaps some erratic one-time items distorted this number, but if you look at the figure for the year as a whole, it's only somewhat better, with the deficit only falling 8.3%, from €23 billion to €21.1 billion. With nominal GDP falling 6%, that's hardly any improvement at all.
The Greeks may be spending less, but they're earning less as well, keeping the relative overspending intact, as all too many of them (but not everyone, to be fair) are too busy striking, rioting and torching buildings instead of trying to do something useful as the people of the Baltic states did and as too a lesser extent the Portugese and Italians are doing now.
In March last year I discussed that the United States has an unusually large gap in rates of employment and unemployment based on the level of education. In most countries such data aren't available, but in two Asian countries where it is available, South Korea and Taiwan, there was virtually no difference at all, at least in unemployment.
The U.S. gap remains very large, but it has actually dropped during the latest year. Between January 2011 and January 2012, the unemployment rate dropped by 1.2 percentage points for high school dropouts from 14.3% to 13.1%, 1 percentage point for people with only a high school diploma from 9.4% to 8.4%, 0.9 percentage points for people with "some college" from 8.1% to 7.2% while being unchanged at 4.2% for people with a bachelor's degree or more.
The trends in the participation rate (which mostly reflects trends in "hidden" unemployment) reinforces these trends, so the difference in the changes for employment rates is even bigger. The employment rate for high school dropouts rose by 1.1 percentage points from 38.6% to 39.7%, for people with only a high school diploma it was unchanged at 54.6%, for people with "some college" it fell from 64.5% to 64.2% while the employment rate for people with a bachelor's degree or more fell from 73.2% to 72.4%.
Given that the big gap was for reasons I explained in my original post mostly irrational, it is good that this convergence happens, at least to the extent that it reflects higher employment and lower unemployment among people with little education. While it is natural that people with a higher education should on average earn more, this should manifest itself in terms of higher wages or salaries for highly educated compared to persons with little education, not higher unemployment for people with little education.
In the beginning of 2011, Estonia had the highest growth in Europe at 9.5%. This rate of yearly increase has now slowed down dramatically to 4% in the fourth quarter, with the quarterly change from the third quarter actually being negative.
The reason for this weakening in growth is of course the fact that the overall European economy is weakening dramatically. More specifically it seems to be the slowdown in Sweden that is weakening Estonia's economy. In January (2011), exports to Sweden grew 128% to €162 million, but in November exports to Sweden actually declined from a year earlier, by 27% to €122 million.
The numbers may seem small but remember first of all that we are first of all talking about monthly numbers so at annualized rates these numbers are 12 times bigger, and secondly that Estonia is a really small country with only slightly above 1.3 million people and a GDP of only about €15 billion, which can be compared with about €11.5 trillion for the United States and about €400 billion for Sweden. The difference in the size of the economies of Sweden and Estonia is roughly the same as the difference between the United States and Sweden.
So, at annualized rate the gain exports to Sweden was €1.1 billion (12*(162-(162/2.28)) in January while the loss in exports in November was €500 million (12*(122-(122/0.73)). The swing from rising to falling exports to Sweden was thus €1.6 billion at an annualized rate, more than 10% of GDP for Estonia! To the extent the value added of these products reflected imported inputs, the loss in value added for Estonia was less than that, but even so it seems clear that both the initial boom and even more so the dramatic slowdown now in Estonia reflects largely if not entirely developments in exports to Sweden.
Why did the change in exports to Sweden change so dramatically then? It seems that it reflected in part that the Swedish economy has slowed down dramatically too and in part that during late 2010 and early 2011 a few orders of a one time nature of electronics equipment were delivered to Sweden, deliveries that had a great impact on Estonia's economy because it is so small.
Ralph Musgrave posted this comment to my post about minimum wages:
You claim that the text books say that “higher minimum wages will increase unemployment if set above the marginal productivity of more workers.” I suggest the latter statement is meaningless (or it’s a circular argument) because minimum wages themselves (along with union wages and other factors) determine what level of remuneration corresponds to the marginal worker. I’ll explain.
As unemployment falls, the marginal product of labour falls because it becomes increasingly difficult for employers to find suitable labour amongst the unemployed. And employers will continue hiring from the ranks of the unemployed till the marginal product equals the minimum wage / unions wage, etc. At which point employers tend to begin poaching labour from each other, rather than hire from the unemployed.
Well, first of all, let's make it clear what "marginal productivity" is. Marginal productivity has nothing directly to do with the actual pay received by workers. Marginal productivity is the value added that a particular worker's work effort creates (or could create in cases where the worker is unemployed). To what extent this value goes to the worker or the employer is irrelevant for the issue of how big this value is.
And as for the idea that marginal productivity of workers fall as unemployment falls, it seems plausible and could in some circumstances be right, but only under certain circumstances. First of all, employers must always hire the best persons, something that probably and hopefully is usually true, but definitely not always, either because employers have too little information, or because the job seekers is not as good at applying for jobs as performing jobs or because employers might have irrational hiring practices.
And secondly, employers might not pick employees on the basis of their marginal productivity, they could pick them on the basis of how costly it is to hire them. A profit maximizing employer wants to maximize the difference between his workers marginal productivity and pay, but that can be maximized both by maximizing marginal productivity and minimizing pay.
And thirdly, to the extent that falling unemployment reflects rising demand or lower supply for labor rather than lower pay, this means that the perceived marginal productivity of workers (again defined in the term of how much value added a worker's efforts creates) rises generally.
Furthermore, the idea that hiring of the best unemployed during a period of falling unemployment means that marginal productivity falls is in a way true, but misleading because it confuses "generic marginal job seeker that can be hired" with individual workers. If the most productive unemployed gets hired it won't affect the (potential) marginal productivity of either any of those that gets hired and those that don't. It simply means that one shifts from more to relatively less productive workers.
Paul Krugman notes that only about 2% of America's GDP consists of goods exports to Europe and argues that even after increasing that number by 25% (to 2.5% of GDP) to take service exports into account that means that there is little reason to expect a downturn in the European economy to affect the U.S. economy.
But first of all, while no country or region specific data for service exports exists, total service exports is more like 40% of goods exports as goods exports was $126.6 billion while service exports was $51.3 billion. America's exports consists of services to a much higher extent than most other countries (with some exceptions like Britain and Hong Kong).
Still, with a 2.8% of GDP estimate for total exports, even a 25% decline in exports would at most reduce GDP by only 0.7%, less to the extent that the value of exported goods consists of imported input goods.
However, while America because of its size is less sensitive to developments in Europe, and other parts of the world, than most other countries, a severe recession in Europe would affect it beyond the direct effect on exports to Europe for two reasons.
One is that because other countries in the world also export to Europe, their economies will weaken too, weakening U.S. exports to those countries as well.
The second, and more important is the effect that globalized financial markets create. When there is panic in one market, other markets usually panic as well. Europe experienced that in 2008 after the Lehman meltdown. And if there is a similar meltdown now in Europe, America will experience it too.