Stefan Karlsson
A man prepares a meal near a "help wanted" sign hanging in a restaurant window in San Francisco, California in this file photo. Karlsson argues that service sector growth is as important to the economy as manufacturing. (Robert Galbraith/Reuters/File)
Why the economy needs a strong service sector
Commenting on yesterday's U.S. economic numbers, which showed an increase in employment but also in the trade deficit, Peter Schiff more or less correctly wrote that this showed that the upswing had an unsound basis. To the extent he means that the increase in the trade deficit is a symptom showing that it is driven by the 9.6% gain in money supply and a 12.2% increase in commercial & industrial loans , increases that are unsustainable, he is right.
However, after that he makes false assertion about manufacturing and trade:
Despite some marginal improvement in manufacturing employment, new hires have been overwhelmingly in the service sector. We need a shrinking service sector and a shrinking trade deficit. As it is, newly employed Americans are spending money on imported products that America should be producing.The trade figures are evidence that our spending has increased while our economy has not. It is also shocking to consider that we are importing more with 8.3% unemployment than we were five years ago when unemployment was near 5%. I can only imagine how large the deficit would be if we had even more service sector jobs.
This is wrong in so many ways. A shrinking service sector would be a really bad thing because services constitute wealth, just like goods production. And secondly, there is no connection between the sectoral structure of the economy.There are a lot of services that can be and are in fact exported to a large extent, and there is nothing that says that income generated from services sold to domestic customers must be used on imports rather than domestically produced goods to any greater extent than income generated from domestic manufacturing.
One example of this is Hong Kong. Hong Kong is one of the most, if not the most, service oriented economies in the world with 93% of its economy being in the service sector and only 1.8% in manufacturing (the rest is almost all construction and utility (electricity etc.) production, only 0.1% is fishing and agriculture) as almost all Hong Kong manufacturers have moved their production to mainland China. By contrast, the service sector is only about 65% of GDP in the United States. If Schiff's trade deficit theory was correct, then Hong Kong would have an enormous trade deficit.
But while Hong Kong does indeed have an enormous trade deficit in goods, HK$436 billion (US$56 billion), roughly 23% of GDP it has an ever greater surplus in services, HK$507 billion, slightly less than 27% of GDP. Its overall trade surplus of nearly 4% of GDP is almost as large proportionally as America's deficit.
A commuter drives past a gas station signage displaying current prices for self serve and full serve gasoline in La Jolla, California March 8, 2012. According to Karlsson, the US importation of fuel has dropped dramatically, while it has increased in the UK. (Mike Blake/Reuters/File)
Gas prices: US and Britain's role reversal
As I've explained before, the answer to the question of whether higher prices are good or bad depends on whether you're a seller or a buyer. If you're a seller, then higher prices are good, if you're a buyer they're bad. In the question of oil prices, this means that countries that are net exporters of oil, such as Iran, Saudia Arabia, Russia, Norway and Canada, benefits if oil becomes more expensive, while countries that are net importers, such as China, Japan, Germany, France and Sweden loses if oil becomes more expensive.
Until recently, the United States was a big net importer of oil, while Britain was a small net exporter of oil. This meant that higher oil prices harmed the U.S. economy, but had a slightly positive effect on the U.K. economy.
This is to some extent changing. While the U.S is still a large net importer, a combination of falling consumption and rising production in states like North Dakota has significantly reduced net imports, meaning that while a higher oil price is still negative for the U.S. economy, it has a smaller impact than a few years ago.
By contrast, a dramatic drop in U.K. oil production in recent years means that not Britain has gone from making small gains from a higher oil price to suffering great losses.
This is evident in the latest U.K. industrial production report. While manufacturing alone rose in January by 0.1% compared to the previous month and 0.3% compared to a year earlier, overall industrial production fell by 0.4% compared to the previous month and 3.8% compared to a year earlier because "oil and gas extraction" fell by 3.3% compared to the previous month and 23.9% compared to a year earlier. Compared to 2008, oil and gas extraction is down by 37.5%. While U.K. consumption is also down, it has fallen by far less than production, turning Britain from a net exporter to a net importer.
U.S. President Barack Obama addresses a news conference in the White House Briefing Room in Washington, March 6, 2012. (Jason Reed/Reuters)
Why Obama's recovery won't match up to Reagan's
Paul Krugman claims, both in his latest column and in a recent blog post, that because government spending rose a lot more during the first 10 quarters of the Reagan recovery than the Obama recover that the Obama recovery would have been just as strong if only government spending had increased equally.
His proof? Well, he argues that this is the case because Keynesian models show that with the multiplier effect from these purchases growth would have been just as strong. But that of course assumes that we buy into the legitimacy of these models, something that Krugman and others have failed to do on a theoretical basis.
But doesn't the empirical fact that the stronger Reagan recovery was associated with a higher increase in government spending prove the accuracy of these models? No, because first of all, you can't establish the legitimacy of theoretical models with such simple comparisons as there are so many other factors involved. And secondly, if you look closer at the chart (below) you'll see that for the first five quarters government spending increased equally.
Yet during those five quarters when government spending increased equally, average annualized GDP growth was 3.1% during Obama and 7.8% during Reagan. During the following five quarters of the recovery when spending increased during Reagan and fell during Obama growth was 1.8% during Obama and 3.7% during Reagan.
So the facts are the following: growth was consistently much higher during the Reagan recovery than in the Obama recovery but exceeded it by a lot more during the phase when government spending increased equally than when spending rose in the Reagan recovery compared to the Obama recovery. If really government spending had the strong effect Krugman imagined we would have expected at the very least that the gap would have been smaller during the period when spending increased equally.
Note also that compared to GDP, government spending fell more during Reagan even for the 10 quarter period as a whole. Government spending may have risen 7 percentage points (3% versus 10%) less during Obama, but the gap in cumulative GDP growth was 9 percentage points (6% versus 15%).
A Canadian flag is pictured on Frobisher Bay in Iqaluit, Nunavut. The nation of Iceland is considering switching its currency to the Canadian dollar. (Chris Wattie/Reuters/File)
Currency: Will Iceland go Loonie?
The Globe and Mail reports that Iceland is considering to adopt the Canadian dollar as currency.
That would be a somewhat odd choice of currency. Normally when countries unilaterally adopt foreign currencies or pegs their currencies to other currencies, it is currencies of countries which you have extensive trade, like El Salvador and Ecuador with the U.S. dollar, Kosovo, Montenegro and Andorra with the euro or Liechtenstein with the Swiss franc. The reason for this is that this creates the largest possible trading gains. Having a common currency with countries that you have little trade can't produce much gains.
Yet in 2010 Canada received less than 0.5% of Iceland's exports and supplied less than 2% of its imports. The Norwegian krone or the euro would be much more natural choices for Iceland.
The Canadian dollar might still be an improvement from a monetary policy point of view given Iceland's inflationist past (which contrary to the widespread myth has not been successful in solving its problems).
A worker counts U.S. dollar bills at a money changer in Manila in this file photo. The NGDP was higher than expected, which s a grat sign forthe economy. (Romeo Ranoco/Reuters/File)
Good news in GDP
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.
A protester waves a Greek flag in front of the parliament during a protest in Athens. Karlsson argues that just because Argentina recovered after its currency devaluation doesn't mean the same will happen for Greece. (Petros Giannakouris/AP)
Argentina doesn't apply to Greece
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.
Gas prices are posted at the Citgo gas station The price of gasoline, which is made from crude oil, has soared as oil prices rise, and Karlsson argues that the Fed can't be entirely cleared of blame. (Alex Brandon/AP)
Oil prices: Yes, Fed can be partly blamed for spike
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.
Republican presidential candidate, Rep. Ron Paul, R-Texas, gestures during a Republican presidential debate Wednesday, Feb. 22, 2012, in Mesa, Ariz. (Jae C. Hong/AP)
What Ron Paul gets right about economics
Ramesh Ponnuru, senior editor of National Review, has an article criticizing Ron Paul for his economic theories, which is to say he is criticizing Austrian economics.
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.
Bobby Thompson, of St. Joseph, Mo., fills is gas tank at the Shop $ Hop at County Line Road and the Belt Highway Monday, Feb. 20, 2012 in St. Joseph, Mo. Oil prices in Europe have risen to near peak 2008 levels. (Todd Weddle/AP/St. Joseph News-Press)
Oil prices in Europe near 2008 peak levels
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.
The Millennium BCP flag and the Portugal's flag are seen at the bank headquarters in Lisbon. Along with Italy, Portugal has significantly reduced its deficit in 2011. The same cannot be said for Greece. (Hugo Correia/Reuters)
Portugal, Italy make debt progress. Not Greece.
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.
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