The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.

Authors for macroblog are Dave Altig, John Robertson, and other Atlanta Fed economists and researchers.

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March 31, 2005

News O' The Day

There was a lot of it, and Bloomberg has the round-up.

Personal spending rose 0.5 percent in February while incomes rose a less-than-expected 0.3 percent, the Commerce Department said today in Washington. The Labor Department said today the number of Americans seeking first-time jobless benefits jumped in the last weekly tally before tomorrow's monthly jobs report.

That labor market news was not necessarily what you want, but in truth its a pretty volatile statistic week-to-week, so I tend to downplay it. But the news included this observation...

Wages and salaries increased 0.2 percent, the smallest gain since November.

... and the Census Bureau report on February manufacturing shipments, inventories, and orders was a bit of a negative surprise too:

Orders at U.S. factories rose less than forecast in February, restrained in part by a drop in demand for automobiles and appliances, according to another Commerce Department report today. The 0.2 percent increase to $380.4 billion trailed the predicted 0.5 percent median estimate in a Bloomberg News survey. Orders excluding transportation fell 0.1 percent.

If you are having a glass-half-full day, there was this on the price front:

Prices of goods and services bought by consumers rose 0.3 percent last month after rising 0.2 percent in January. They rose 2.3 percent from February of last year compared with a 2.2 percent year-over-year rise in January.

Federal Reserve Chairman Alan Greenspan and other policy makers track the report's inflation figures excluding volatile energy prices. On that basis, the core measure was up 1.6 percent from February of last year, the same as in January

Don't get too comfy, though.  Kash thinks he has a downside of the personal income report for you.

The US's abysmally low personal savings rate has to start rising at some point. There's no getting around that fact. But we clearly have not yet reached that point. Today's release of the February personal income and spending data from the BEA shows no inclination for US households to start saving more. 

Here's what he was talking about (from the BEA report)...

Personal saving as a percentage of disposable personal income was 0.6 percent in February, compared with 0.8 percent in January.

And if that glass isn't drained yet, here's the midday report on oil prices (again from Bloomberg):

Crude oil rose and gasoline and heating-oil surged to records on signs that U.S. refineries lack capacity to make enough fuel and Goldman Sachs Group Inc. analysts predicted that oil could touch $105 a barrel.

Record prices have failed to curtail surging fuel consumption, the Goldman Sachs analysts said in a research note. The firm's upper limit was $80 previously. U.S. supplies of gasoline and distillate fuels, such as diesel and heating oil, fell last week, according to an Energy Department report yesterday.

But I hear its a lovely warm day in Cleveland, so let's not end on that note.

"It's equally likely that oil will touch $105 or $15 a barrel,'' said Jason Schenker, an analyst with Wachovia Corp. in Charlotte. "It's not going to $105 without a major cataclysmic terrorist attack on significant oil infrastructure. It's not a rational expectation.''

There. That's better.

March 31, 2005 in Data Releases, Energy | Permalink


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» Catching my eye: morning A through Z from The Glittering Eye
Here's what's caught my eye this morning: Brad DeLong has a round-up of opinion on the hard/soft landing issue. My uninformed opinion is that it depends on who has the most to lose (and I believe that's the Chinese leadership).... [Read More]

Tracked on Mar 31, 2005 2:05:18 PM

» Why We Need a Consumption Tax from tdaxp
"News of the Day," Macroblog, 31 March 2005, http://macroblog.typepad.com/macroblog/2005/03/news_o_the_day.html (from The Glittering Eye). Because this personal fiscal insanity has to stop Personal spending rose 0.5 percent in February while inco... [Read More]

Tracked on Mar 31, 2005 5:25:18 PM


And today's employment data suggests that we're not going anywhere.

That light at the end of the tunnel...may be the hard crash.

Posted by: Movie Guy | April 01, 2005 at 01:25 PM

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How Monetary Policy Works

Ben Bernanke gave a very nice tutorial on monetary policy to an education symposium in Ohio yesterday.  The material will probably be a bit elementary for veteran students of the Fed, but I think you will find it worthwhile if you are not in that group.  At a minimum, it is worth emphasizing (again and again) this often misunderstood point:

The person in the street might tell you that the Fed "controls interest rates." That statement is not literally accurate. In fact, the Fed has little or no direct influence over the interest rates that matter most for the economy, such as mortgage rates, corporate bond rates, or the rates on Treasury securities. Instead, the Fed affects these key rates, as well as the prices of financial assets such as stocks, only indirectly...

The Fed controls very short-term interest rates quite effectively, but the long-term rates that really matter for the economy depend not on the current short-term rate but on the whole trajectory of future short-term rates expected by market participants. Thus, to affect long-term rates, the FOMC must somehow signal to the financial markets its plans for setting future short-term rates.

I would add to that the observation that those trajectories also depend on things quite beyond the control of the central bank -- like real, long-term returns to capital.  These are lessons worth remembering as we watch the path interest rates unfold over the immediate future.

March 31, 2005 in Federal Reserve and Monetary Policy | Permalink


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» Implementing US monetary policy from New Economist
Fed Governor Ben S. Bernanke gave a talk on 30 March to an Ohio symposium on implementing monetary policy. It's not overly technical, and will be particularly useful for people new to the topic. (Hat tip to Macroblog). I'd also recommend the 7 February... [Read More]

Tracked on Apr 1, 2005 7:45:06 AM


I wouldn't be so sure that this information is understood all that well. I've had several people with graduate degrees in economics deny this mechanism to be 'Monetarism in drag':

"The manager of the Open Market Desk and his team bear the responsibility of adjusting the supply of fed funds to maintain the funds rate at or near the target established by the FOMC."

Posted by: Patrick R. Sullivan | March 31, 2005 at 06:20 PM

Yes - I strongly agree with that last comment. Academics have spent a long time modelling economies with the price level (or nominal demand) being a function of the money stock. A very convenient modelling device, and one that can be a very useful simplification in the right context. But not terribly realistic, and potentially very misleading in terms of how monetary policy (or the economy) actually works.

It seems still to be far too easy to come out of an economics degree having been taught that governments control the money supply, that money is neutral in the long run, and that monetarism was basically 'right' except for some inconvenient short term market frictions that go away if you wait long enough. Never mind the non-constant velocity of money, the fact that governments set rates not the money supply, and that monetary booms and busts have very real effects.

More power to those who tell us how it really works. Nice site, by the way.

Posted by: rjw | April 14, 2005 at 06:51 PM

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The Cost Of Labor Market Regulation

Hat tip to New Economist for highlighting a new Boston Fed working paper by Ricardo Caballero, Kevin N. Cowan, Eduardo M.R.A. Engel, and Alejandro Micco.  Here's the summary:

Microeconomic flexibility, by facilitating the process of creative destruction, is at the core of economic growth in modern market economies. The main reason why this process is not infinitely fast is the presence of adjustment costs, some of them technological, others institutional. Chief among the latter is labor market regulation. While few economists would object to such a view, its empirical support is rather weak. In this paper we revisit this hypothesis and find strong evidence for it... We find that job security regulation clearly hampers the creative-destructive process, especially in countries where regulations are likely to be enforced. Moving from the 20th to the 80th percentile in job security, in countries with strong rule of law, cuts the annual speed of adjustment to shocks by a third while shaving off about one percent from annual productivity growth. The same movement has negligible effects in countries with weak rule of law.

The job security measures in the study include indexes of grounds for dismissal provisions, protections regarding dismissal procedures, notice and severance pay provisions, and constitutional protection of employment procedures.  As the authors explain:

The rules on grounds of dismissal range from allowing the employment relation to be terminated by either party at any time (employment at will) to allowing the termination of contracts only under a very narrow list of “fair” causes. Protective dismissal procedures require employers to obtain the authorization of third parties (such as unions and judges) before terminating the employment contract. The third variable, notice and severance payment... is the normalized sum of two components: mandatory severance payments after 20 years of employment (in months) and months of advance notice for dismissals after 20 years of employment... The four components... described above increase with the level of job security.

To give you an idea of the results, the United States is somewhere near the median in terms of the estimated speed of adjustment to sectoral productivity shocks.  (Technically, it is in the third quintile among the 60 countries in the study, where the quintiles are arranged from slowest to fastest.)  Great Britain has an estimated speed near, but slightly higher, than that of the U.S.  Japan and Germany are slightly below the mean of the second quintile.  Belgium has the lowest estimated speed of adjustment, France has the third lowest (just ahead of Kenya).  The highest? Hong Kong, although generally speaking developing countries seem to dominate in the top tier.

March 31, 2005 in This, That, and the Other | Permalink


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Plenty of research has been done on the impact of employment protection legislation on labour markets and the wider economy. But a lot of it has been fairly inconclusive and empirically weak. Not so a recent Boston Fed working paper, Effective Labor Re... [Read More]

Tracked on Mar 31, 2005 2:19:43 PM


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Soft-Landing/Hard-Landing: Kash Debates Himself -- And Wins!

So will you by reading his extremely thoughtful analysis.  First, his soft-landing scenario:

When all is said and done, what does this soft landing scenario imply? 1) A couple of years of somewhat high interest rates in the US. 2) A few years of modest economic growth in the US, but no outright recession. 3) A gradual depreciation of the dollar, much as the dollar has experienced on average over the past 35 years. 4) A slow but steady improvement in the US’s CA deficit as a % of GDP, as US import growth slows. 5) Net foreign debt that rises to 40-45% of GDP by 2008 or 2009 (from close to 30% today), but then more or less levels off. 6) Continued economic growth in the Asian economies.

And here is his definition of a hard landing:

So what do I envision as the end results of this hard landing scenario? 1) Interest rates in the US will move sharply higher over a period of days or weeks. Stock markets decline substantially as a result. 2) The dollar will depreciate by a substantial amount against the major Asian currencies. 3) Inflation in the US will jump upward very quickly, though perhaps only temporarily. 4) Household wealth in the US will fall significantly, due to the falling stock market and the bursting of the house price bubble. 5) The US economy will experience a rather sharp contraction, which I imagine to be deeper than either of the past two recessions... perhaps similar to the 1974-75 recession triggered by the first oil shock. 6) As households quickly retrench and reduce consumption, US imports fall, causing a fairly rapid fall in the US CA deficit over the course of a year or two. 7) Most of the Asian economies will also experience recession, with particular economic dislocation in their export industries.

These passages don't do complete justice to his posts.  Be sure to go over to Angry Bear and read both in their entirety.

UPDATE: While you are over at Angry Bear, check out this post from pgl too.

March 31, 2005 | Permalink


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March 30, 2005

Soft Landing, Or Hard: How Do We Know Who Wins?

Something has been bugging me about this hard-landing/soft-landing discussion:  What, exactly, are we talking about?  In particular, what would constitute a "hard landing"?  An outright recession?  A really severe one -- like 73-75 or 81-82?  Or even a relatively mild and short-lived downturn, like 90-91 or 01? 

Or would you call it a hard landing if the U.S. economy were to grow, but substantially below trend? If so, for how long?  Or, perhaps, you would call it a hard landing if the adjustment process results in substantial capital losses, even if the effect on overall economic activity is muted (as in the stock market "crash" of 87)?  How persistent do those losses have to be to constitute a hard landing?

I herewith solicit your opinions on this.  If you are a blogger and choose to post your answer on your site, I will dutifully link to it.

March 30, 2005 | Permalink


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This week's econoblog has breathed some new life into the currency debate. [Read More]

Tracked on Mar 31, 2005 1:09:32 PM


I vote for a hard landing being an outright recession. ANY kind of a landing means we have a slowdown in spending because the root of the problem is that we are spending more than we are producing and borrowing the difference from the foreigners. Fixing this, as in any other country, means some combination of producing more and/or spending less. A hard landing puts more emphasis on the latter while a soft landing stretches the adjustment out longer, allowing for more of the former. This implies a hard landing is faster (and more unpleasant).

If we could get out of this without an outright recession, I would consider it a miracle. But with a CA deficit of 6% of GDP thats a pretty tall order unless everyone is working to achieve it both in the Fed and in the Congress and WH where fiscal policy is decided.

Posted by: steve kyle | March 30, 2005 at 11:04 AM

It's a hard landing if I lose my job, and a soft landing if I don't. I suppose most people will think the same way.

Posted by: Hee Hate Me | March 30, 2005 at 12:04 PM

I am not sure that the difference between a hard landing and a soft landing is the difference between sub-par growth and outright recession. After all stuff like that happens all the time and you can pass from sub-par to recession in one continuous development. Though I do have sympathy for Hee Hate Me's view.

I would suggest that the real difference between hard and soft has to be the presence of a discontinuity.

If economic developments are continuous - basically mathematically speaking -, actors have the possibility to adjust, either because they react continually to the developments or because they are able to anticipate the developments. That's a soft landing, business as usual, a little bit different every day.

Throw in a discontinuity. Something like the Copernician revolution: all the evidence has been in for some time, no one was really paying attention, then suddenly one morning everyone wakes up and the earth is round and it is inconceivable that anyone ever thought otherwise. The world is suddenly conceptually different. That is my definition of a hard landing. In other words you need a highly disruptive event that no one anticipated and for which no one has been able to position himself. A little bit like you were playing football and suddenly you're playing soccer and no one told you the rules of soccer and you have to make them up as you play.

Nikkei 38K to 20K inside two weeks was a hard landing. Euro 0.8 to 1.3 in two years against the Dollar is a soft landing.

Posted by: godement | March 30, 2005 at 12:29 PM

David - you ask exactly the right question. We have all sorts of academic discussions prior to what the central policy question really is. I found Kash's summary interesting in that I thought Kash came down on the hard landing side but DeLong just fired off a post that seems to suggest Kash was too far on the soft landing side. OK, Kash is "fair and balanced". I guess I'm closer to Brad on this one but here's a bit of a query - I guess. Go back 20 years. Massive current account deficits and huge Federal deficits. Most economists were saying then we had an overvalued currency and it did devalue a lot in the late 1980's. But no recession. So what's different? I can discuss a few differences but then one needs to ask your question first.

Posted by: pgl | March 30, 2005 at 02:48 PM

I'll give it a shot.

A hard landing in this instance would be a spike in US interest rates such that 20% of home mortgagees default.

Posted by: David Yaseen | March 30, 2005 at 03:12 PM

A hard landing is one in which in 30 years we're teaching Mandarin in the schools. Other than that, I say we got off easy.....

Posted by: donna | March 30, 2005 at 04:04 PM

A hard landing is one in which our imports decline to match our exports before we can replace them by building coal and iron mines, steel and cement mills, generating and synfuel plants, and factories. This is likely.
A soft landing is when we invent a cure for the common cold and sell it at a high price so we can afford to build those mines, mills, plants, and factories before China and India and Russia can reverse engineer and duplicate it. This is unlikely.
Either landing is going to be hard for a high paid high skilled individual who is used to buying his low cost low skilled labor cheap because of immigrants and imports, and whose house is located in a zoning controlled high cost service industry metrocoastal area instead of an unzoned low cost primary and secondary production flyover area.

Posted by: wkwillis | March 30, 2005 at 04:40 PM

Nicely argued, David :)

Posted by: anne | March 30, 2005 at 06:33 PM

Anne, assuming it is THE Anne: I am hurt :).

I kind of like wkwillis's definition of a hard landing: imports fall to match US exports, rather than US exports rise to match US imports. Another, similar definition, investment falls to match US savings, rather than savings rise to match US investment.

Godemont's definition focuses on disorderly market moves, which may or may not lead to landings of some sort in the real economy. There were some big moves in the yen/ dollar in the fall of 98 if memory serves, associated with the unwinding of the positions of a few big hedge funds post russia/ LTCM. But that did not have any big impact on the real economy. I like Rajan's analysis of this issue: from a financial markets point of view, it is often better to get a big move over with fast, so you can move on (assuming the big move doesn't bankrupt anyone). from the real economy side, though, it is better if the adjustment occurs over time. If the markets knew the $ was gonna slide by 50% against a basket of asian currencies over the next five years to bring the US trade deficit down to zero, and the slide was gona be gradual, interest rates would adjust to compensate for the expected slide. If the dollar just fell, existing holder would take their losses, but low interest rates might prevail afterwards. US interest rates would not need to offset an expected depreciation.

I would tend to think several years of subpar growth, with external adjustment coming from a major significant slowdown in domestic demand growth would count, even if there is not an outright recession. in that scenario, external adjustment comes primarily from falling imports, with relatively little offsetting stimulus from rising exports. And, in that scenario, real interest rates a higher than they are now, generating the contraction in domestic demand. and remember, even if the US starts to adjust in 2006, it might still need to borrow 750-800 b. J curves and all. attracting that external financing may be difficult.

sorry that i am being long winded.

Posted by: brad | March 30, 2005 at 07:01 PM

three other quick points.

1) a big difference between mid-80s and today. Then the fiscal deficit was in the 5% of GDP plus range, and the trade deficit was in the 3% of GDP plus range. That is now reversed -- the external deficit is bigger than the fiscal deficit.

2) most of the deficit was with other advanced economies i think (though weak demand in Latam played a part too). emerging economies play a much bigger role now.

3) One development that would clearly falsify the roubini/setser hypothesis. CB dollar reserve accumulation falls way back, to 100 b or even 200 b annually, and it has no major effects on US financial markets. incidentally, this is one point where roubini and dooley et al agree. CB intervention is having an impact.


Posted by: brad | March 30, 2005 at 07:04 PM

If currency values dictate growth it is in the hands of CBs. Japans willingness to recycle export profits into US treasuries enable the games to continue. By US rates staying low it enables China to continue to build capacity to support cheap labor and a surplus of cheap goods to the world. A hard landing will ensue when it stops. Higher oil will most probably lead Japan to stop the intervention game. This will cause China to further build their oil reserves. The rising oil price will work as a tax to slow US consumption. The fed will view the rising oil price as inflationary and raise rates. This will inturn be a double tax. The remaining outcome is to your own imagination. A drop from this height will inevitably hurt.

Posted by: BE | March 30, 2005 at 10:05 PM


You apparently assume that I was focusing on disorderly financial markets. I was not especially focused on financial markets. A few examples taken from real life will suffice:

1) political discontinuity: when China suffers a gigantic earthquake in the seventies, that is a discontinuity with revolutionary consequences for Chinese politics. That is a hard landing.

2) labor market discontinuity: when Thai workers burn down a Japanese owned factory in March 1997, the Japanese start running from every Asian emerging economy and do not stop until they get home. That is a hard landing.

2) product market: when Opec multiplies without warning the price of oil by 3 in 1973 and suddenly imposes an embargo on the consumers, no actor has time to adjust. That is a hard landing.

The point I am trying to make is that if we want to make this sort of dichotomy between hard and soft landing (and actually I am not personally saying that I want to), there must be a real difference in nature between both. If one says a US recession is a hard landing, I am sorry to say that the US economy suffers hard landings every 5 or 6 years, and hardly ever benefits from a soft landing.

The view that the difference would be an upward adjustment (export growth) as opposed to a downward adjustment (import decline) does not satisfy me either for the simple reason that all adjustments that I have ever witnessed contain a mix of both to a certain extent.

This is the reason why I posit that a necessary component of a hard landing must be a conceptual discontinuity, which does not occur with a soft landing.

Speculatively for instance, one might wonder if a no vote to the Constitutional Treaty in France on May 29th might not constitute a conceptual discontinuity, leading to a real estate market crash in Europe (see, David, I am actually thinking about this as you asked...).

Posted by: godement | March 31, 2005 at 04:12 AM

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Fourth Quarter GDP: No New News

The Commerce Department released the final (for now) statistic on GDP growth for the fourth quarter of 2004, and it looks just like we thought.  Here's the skinny, from Reuters.com:

The U.S. economy ended 2004 with brisk momentum on the strongest surge of corporate profits in three years, the government reported Wednesday, though there were signs that price pressures might be picking up.

Gross domestic product, which measures total output within U.S. borders, expanded at a 3.8 percent annual pace in the fourth quarter, the same as estimated a month ago, the Commerce Department said in its third and final estimate of GDP performance.

This was almost certainly the most unwelcome news:

The revisions in the final estimate of fourth-quarter GDP were minor but they included a slight bump up in a key price measure, which set nerves on edge in financial markets.

There was some evidence that inflation might be perking up. A price index favored by Federal Reserve Chairman Alan Greenspan -- personal consumption expenditures excluding food and energy products -- gained at a 1.7 percent annual rate in the fourth quarter, up from a 1.6 percent estimate a month ago and nearly twice the 0.9 percent third-quarter rate of increase.

Combined with incoming price data, it's maybe understandable that we would get comments like this:

Economist Carl Tannenbaum of LaSalle Bank in Chicago said higher prices were bound to make markets sensitive to the possibility that the Federal Reserve might accelerate the interest rate-rise campaign it initiated in June, which so far has produced seven quarter-percentage point increases in the federal funds rate.

"I wouldn't expect a big reaction but as we accumulate evidence going into the next Fed deliberation, any sign of higher inflation pressures place a higher percentage on the potential remove of that word 'measured'," Tannenbaum said.

UPDATE: James at Capital Spectator has much moreCalculated Risk thinks we should be looking at mortgage debt trends. (CR: What about net worth?)

March 30, 2005 in Data Releases | Permalink


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Nowhere To Run: Will That Sustain The Dollar?

Bloomberg's Caroline Baum entertains that possibility:

Just when everyone on the planet concluded that the U.S. dollar had nowhere to go but down, the dollar rallied.

Whether the reversal of fortune proves to be short-lived or sustained, technical or fundamental, remains to be seen. The forces conspiring to make the dollar the currency everyone loves to hate -- the big, bad current-account deficit, which hit 6.3 percent of gross domestic product in the fourth quarter of 2004, and the record budget deficit, with no newfound religion on spending in sight -- are still with us.      

However, all that needs to happen is for folks to like another currency less. They don't have to learn to love the dollar more.

This is, of course, one of the points I made in my debate with Nouriel Roubini. I may have confused the issue a bit by couching my argument in terms of shifting from dollars to euro in existing portfolios, but the argument holds for new asset acquisitions as long as there are economies out there with high saving rates that are going to run current account surpluses.

Where's the love for the euro gone?  Ms. Baum points to the problem I have been emphasizing (here and here):

While currency analysts have tied the dollar's turnaround to the Federal Reserve's get-tough language on inflation last week, the euro's recent peak against the dollar came a full 11 days before the Fed met, raised the overnight federal funds rate by 25 basis points to 2.75 percent and opened the door to potentially bigger rate increases ahead.         

Is it possible the euro's decline over the past two weeks had something to do with European leaders' measures for "strengthening and clarifying'' the Stability and Growth Pact? The SGP is the 1997 regulation that stipulated the budgetary caps -- a 3 percent deficit- to-GDP ratio and a 60 percent debt-to-GDP ratio -- for countries signing on to the European Monetary Union, caps that were also laid out in the Maastricht Treaty.

What European Finance ministers see as strengthening and clarifying might appear to an outsider as formalizing hanky-panky with the rules.

"The U.S. has major fiscal problems, but they are less significant than those faced by Europeans,'' Kotlikoff says. "Europe is aging more rapidly, and benefit levels relative to living standards or per-capita income are higher.''         

Ultimately that burden will require "tax hikes on a scale unprecedented in peacetime or drastic government spending cuts,'' neither of which is palatable, Kotlikoff and Niall Ferguson wrote in a 2000 Foreign Affairs article, "The Degeneration of EMU.''

That's what I was thinking.

UPDATE: Global Trader is a skeptic.  Be sure to read his comment on this post, below.

And, as Larry Kotlikoff notes:

March 30, 2005 in Europe, Exchange Rates and the Dollar, Trade Deficit | Permalink


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When everyone is in the market is shouting buy, it's usually time to sell. So the contrarian in me was interested in a very bullish report from Bloomberg tomorrow (sic) today that the Dollar may add to biggest quarterly gain versus Euro since 2001 with... [Read More]

Tracked on Mar 30, 2005 5:41:41 PM


I read C. Baum's column as well. She is usually quite good and witty, and did not fail to be on this one. I have myself been making a similar point on Brad Setzer's blog: the Euro is not necessarily a more atractive proposition than the Dollar at this point.

However, I suspect that the reason why the Euro is not so attractive in recent times has little to do with the stability pact's fortunes. After all, that is not news, we have known since early last fall that the stability pact was deceased, the coroner had simply not written its report yet (and currency traders are usually a little bit faster than 6 months). As for the state and prospects of public finance in major European countries, we have known that forever, haven't we, so why today, why not two years ago ?

What I think happened over the past two weeks is that people have suddenly realised that chances are that France will say no to the European Constitutional Treaty. Last fall, opinion polls were giving a yes vote upwards of 65%, gradually decaying. Two to three weeks ago, for political reasons internal to France, opinion shifted violently towards a no vote which now gets 53%-55% in opinion polls. Such an evolution had been predicted by a few politically astute observers, but they were not the majority, and I believe that few outside France were really watching. This shift in polls has suddenly gone to the frontpage in the European press, not just France's. The prospects of a crisis in Europe is surely a negative to the Euro.

Certainly, I would agree with the view that credit spreads between various Euro zone countries have been mispriced in recent years in the sense that there has hardly been any spread to speak of. It would seem rational to expect some re-rating of public debt in various countries because, while the stability pact is dead, you can be sure that one disposition of the Maastricht treaty will keep holding: no bailing out of member countries by other member countries.

Yet, I believe that the discussion, which could revive in the wake of a no vote by France, of the actual unraveling of the Euro, i.e. of countries going back to national currencies, is grossly mis-stated. There is of course no provision for such an occurrence. Therefore the way, the only way to look at the issue is to consider which country could find it in its national interest to decide to leave the Eurozone and go back to a national currency, which would fluctuate against the Euro.

If you look at the problem in this way, you immediately deduct that it cannot be a small country, for three reasons. First, it would likely not deal a deathblow to the euro. Second, a small country will have a giant share of foreign trade in the make up of its GDP, most of it with eurozone members. Thirdly, a small country would loose part of the access to international capital markets that it has by virtue of being part of a large monetary zone. Austria leaving the Eurozone, who cares (why do I always pick on Austria, because they never ever said sorry, we were guilty).

Thus it has to be a large member: France, Germany, Italy or Spain.

We can eliminate Italy immediately as Italy has such a huge government debt that, almost by definition, it would have to decide to leave a relatively stable currency to adopt an unstable one. Italians may be from the Mediterranean, but they are not fools (when I asked a high official in the Italian Treasury some years ago about joining the Euro, he said to me "the way we see it, we have a choice, be part of Europe or part of North-Africa"!).

We can also eliminate Germany immediately for geo-political reasons. For Germany to do this and scutter the Euro, it would be considered as a massive act of aggression in Europe. They would become pariahs again and would have to face deeply hostile neighbors (hell, France would redeploy its short range nuclear missiles in a minute). No German politician is going to even entertain the thought in his most private moments. They have stopped doing this 60 years ago, forever. German economic commentators are another matter but then, they are, like me, irresponsible.

We are left with exactly two countries, Spain and France.

Spain has benefited enormously from its membership of the European Union. 20 years ago, it was, maybe not a dirt-poor country, but certainly large parts of Spain were dirt-poor. Today Spain is wealthy, Madrid has nothing to envy to Paris or Milan, the countryside of Spain has been transformed and is very successful. Why would they want to risk the unraveling of Europe? And could they expect to benefit from the same low average interest rates over the length of the cycle as they have since the inception of the Euro (inflation close to 4% presently...)?

The only country which could conceivably decide to leave the Euro would in the end be France. But it simply does not fit. I think de Gaulle once (in the sixties) explained to one of his ministers, Peyrefittes, his reason for creating the European Community. It went along these lines: we used to dominate the world, now we don't and we cannot re-achieve this position alone. However, through the European Community, we can dominate the world by proxy (hey, before you start laughing, i'm not saying that I subscribe either to the view or to the ambition !). This view is still prevalent today, in a different form, in a milder way. So my view would be that France will never see it in its national interest to leave a European institution. It may see it in its interest or may inadvertently create a crisis in Europe with a view to achieve further influence, and this may eventually diminish its influence (if it is a miscalcultaion). But that is a different thing altogether, its a negociating strategy.


- yes, the euro is weaker against the dollar due to jitters regarding the Constitutional Treaty, with reason.

- yes, some re-rating of sovereign credit may be warranted whithin the Eurozone.

- yes, the euro could unravel, there may be pundit discussion of it. The risk is in reality zero.

Posted by: godement | March 30, 2005 at 12:08 PM

"Just when everyone on the planet concluded that the U.S. dollar had nowhere to go but down, the dollar rallied."

I don't think it is a coincidence that the current dollar rally started when the S. Korean CB bought $2 bn to shore up the won overnight on Mar. 10.

The market, absent the CBs, certainly wants to take the dollar lower and is not seeing the value in other currencies that these sources you site do. Until the market turns without intervention it looks like the pressure is building rather than being relieved.

Posted by: michael | March 30, 2005 at 12:38 PM

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March 29, 2005

Some Good News From Brazil

From the Wall Street Journal Online (subscription may be required):

In another milestone in Brazil's comeback from the brink of financial collapse, the government said it won't renew its standby-credit accord with the International Monetary Fund...

Finance Minister Antonio Palocci announced yesterday that Brazil's strong recent economic performance made renewing the pact unnecessary. In 2004, Brazil posted its fastest economic growth in a decade, a record trade surplus, a strong budget surplus and the first drop in its level of debt-to-gross domestic product since 2000.

Not only that,

Brazilian Treasury Secretary Joaquim Levy said the nation owes the IMF $23.2 billion, and said all money owed is "currently available in government reserves." He added that Brazil is due to repay the money in full by 2007.

March 29, 2005 in Latin America/South America | Permalink


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New Currency Honcho In China

In light of the weight many folks are placing on the course of Asian central bank policy  in determining whether the immediate future is bright or bleak for the U.S., I found this report, from The Wall Street Journal Online, interesting:

A woman who has consistently called for overhaul of China's capital controls -- although not adjustment in the yuan's exchange rate -- was named to head the agency that carries out the country's currency policy.

Hu Xiaolian moves to the State Administration of Foreign Exchange [SAFE] from China's central bank, where she had been one of three deputies to central bank Gov. Zhou Xiaochuan since August...

In public comments, English-speaking Ms. Hu has said repeatedly that China needs to adjust the controls on its currency to better reflect supply and demand. A fixed exchange rate such as that which China has had since 1994 leads to economic distortions, she has said, while stopping short of saying the exchange rate itself should be adjusted. Instead, as she did in a 2002 speech in New York, Ms. Hu has said rule changes on who can buy or sell yuan are a way that China's currency policy can be made to "reflect the changing world."

That certainly sounds like a change's a'coming, but then there was this...

On managing China's reserves, Ms. Hu has suggested in the past a bias for holding U.S. dollars. She said in the 1990s that China held large amounts of U.S. dollars as a backing to its weak banking system. As recently as 2001, she said holding euros didn't make sense for China because most of its trade with Europe is denominated in dollars.

and this...

Meanwhile, a Chinese media report yesterday said growth in the reserves that SAFE manages has slowed. The China Business News reported that reserves were valued at $642.6 billion at the end of February, as $32.7 billion was added during the first two months of 2005 combined. Reserves grew at a far faster rate in 2004, with the monthly increase averaging $34.5 billion. A SAFE representative told Dow Jones Newswires that first-quarter data are to be unveiled in mid-April.

Put it all together, I'm not sure what it means. (I'll resist the temptation to say "Hu knows.")  But we'll keep watching.

March 29, 2005 in Asia, Exchange Rates and the Dollar | Permalink


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More Hurrahs For Free Trade

Cafe Hayek brings to our attention a fascinating-sounding paper by Erwin Bulte, Richard Horan, and Jason Shogren.  The results are summarized at Newswise:

Creating a new kind of caveman economics in their published paper, they argue early modern humans were first to exploit the competitive edge gained from specialization and free trade. With more reliance on free trade, humans increased their activities in culture and technology, while simultaneously out-competing Neanderthals on their joint hunting grounds, the economists say.

Archaeological evidence exists to suggest traveling bands of early humans interacted with each other and that inter-group trading emerged, says Shogren. Early humans, the Aurignations and the Gravettians, imported many raw materials over long ranges and their innovations were widely dispersed. Such exchanges of goods and ideas helped early humans to develop “supergroup social mechanisms.” The long-range interchange among different groups kept both cultures going and generated new cultural explosions, Shogren says.

Pretty cool.  Moving to a more modern example, the Dallas Fed reviews recent economic successes in Mexico, putting free trade front and center:

The success of Mexican macroeconomic policy can be seen in the course of recent history.  Together with the North American Free Trade Agreement and the opening of Mexican markets to trade, it contributed to the rapid recuperation of the Mexican economy after  1994–95. And it was essential in limiting the 2001 Mexican downturn to a mild recession, a landmark in a country where every downturn of the prior 30 years had been accompanied by a financial crisis.

March 29, 2005 in Latin America/South America, This, That, and the Other | Permalink


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" Archaeological evidence"? This isn't research but pure speculation, spouted in the interest of a free-trade ideology that drapes itself in a quasi-darwinian scientism. In other words, total cr*p.

Posted by: camille roy | March 30, 2005 at 01:26 AM

Geez Camille, that seems a little harsh. I admit I have not read the article yet -- I intend to -- but archaeological evidence is where we get most of our evidence on the social behaviors of ancient peoples. It's speculative, for sure, but it doesn't seem much more foolish than, say, forecasting the course of current account adjustments.

On a related note, I just started reading Jared Diamond's new book "Collapse: How Societies Choose to Fail or Succeed." Two of his case studies are the Polynesian Island societies on Pitcairn and Henderson Islands. He claims -- using archaelogical evidence! -- that a prime culprit in the total demise of those populations was a loss of their major trading partner, Mangareva, to its own problems. Diamond definitely does not put sole weight on trade -- it is but one of the factors he emphasizes, with environmental irresponsibility being something like first among equals in a list of five key factors. (The other three are exogenous climatalogical catastrophy, hostile neighbors, and the social institutions in place when the stress hits.) But trade is definitely an important piece in some cases. Is that really that hard to swallow?

Posted by: Dave Altig | March 30, 2005 at 08:27 AM

As an non-economist outsider, I see much interesting and significant data collection and interpretation in the field. But I am frequently annoyed by the way economists don't seem to understand that their models are not science and can never be science. What economics needs is not an injection of darwin-styled scientism, which mystically absorbs the characteristics of natural selection as a justification for free markets, but rather a serious reading and application of the principles of social science and history. One of the best historians I know (my father, a world-renowned anthropologist) told he regarded the historical analysis in Jared Diamond as second-rate, because he doesn't understand history and uses biologically based models in ways that are simply inappropriate.

Posted by: camille roy | March 30, 2005 at 10:42 PM

Hmmm. That's worth a discussion. Is there a written critique somewhere that cogently lays out Diamond's mistakes? Or any misdirection in the Bulte et al article?

PS -- As an economist insider, I really do support the application of the principles of social science and history. And I welcome the opportunity to be educated.

Posted by: Dave Altig | March 31, 2005 at 01:58 AM

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