The Great Betrayal?

Thomas Friedman writes in today's New York Times about Toyota NA's efforts to block higher fuel efficiency standards now being considered in Congress. Friedman joins environmental groups in dismay that "Toyota, which pioneered the industry-leading, 50-miles-per-gallon Prius hybrid, has joined with the Big Three U.S. automakers in lobbying against the tougher mileage standards in the Senate version of the draft energy bill."

He also thinks he knows why: "Now why would Toyota, which has used the Prius to brand itself as the greenest car company, pull such a stunt? Is it because Toyota wants to slow down innovation in Detroit on more energy efficient vehicles, which Toyota already dominates, while also keeping mileage room to build giant pickup trucks, like the Toyota Tundra, at the gas-guzzler end of the U.S. market?"

One thing I find odd about this is Friedman's implicit assumption that better fuel efficiency by Detroit requires legislated standards, yet simultaneous recognition that Toyota has developed hybrids that beat existing standards. Ergo, innovation has occurred in the absence of and seems to be independent of legislation.

The bigger problem is that Friedman is wrong about why Toyota is lobbying against the proposed regulations. He seems to suggest that Toyota is engaged in activity intended to discourage American producers from "innovating" in order to retain their advantage (using existing technology, e.g., hybrids, is not innovating, by the way, but that's beside the point).

There seems a much simpler and less conspiratorial explanation: Toyota is trying to protect the return on the assets it holds in the United States. Friedman seems to assume that Toyota is one company with a unified balance sheet. That's probably not the right way to look at it. Toyota NA is a subsidiary of Toyota Motor, and as such has a distinct set of productive assets based in the U.S.. Toyota NA's assets (i.e., the plants located in the US) are engaged in the production of cars and light trucks and SUVs. By my simple calculations, each year Toyota produces 361,000 trucks and SUVs in its American plants against 367,000 Camrys and Corollas. About one-third of the Camrys are 6 cylinder, and very few are hybrids. This distribution of production is sufficient to meet current standards: lower-mileage trucks are offset by higher-mileage cars; on average they meet fleet standards.

Sharply increasing fuel efficiency standards will force Toyota to reduce the relative importance of trucks/SUVs to smaller cars in its US production. This is costly. Either some assets now engaged in truck production must be redeployed (at positive cost) or Toyota must make new investments in small car production in the US. Both are costly for Toyota. All else being equal, therefore, Toyota's American assets will earn a higher return without the regulation than with the proposed regulation.

In short, Toyota NA joins Detroit in opposition to the higher proposed standards because its US production structure looks a lot like "American" producers when it comes to the distribution of its productive assets across car and truck production. This is hardly surprising, given that all auto producers have built what Americans have wanted to buy (large inefficient SUVs). Consequently, Toyota's regulatory preferences are quite similar to Detroit's.

Finally, is Toyota's position treasonous to the environmental cause it supposedly champions? Friedman seems to think so (the title, after all, is Et tu, Toyota?). Yet, although the Prius may be green, Toyota did not produce it because it was green. Toyota built the Prius because it believed many people would buy it, and as a consequence it could make money. It turns out they were right. Hence, the factors that now motivate Toyota's resistance to proposed fuel economy regulations are the very ones that led them to produce the Prius. This is not treason; it's business.

Exchange Rates and the Stanley Cup

On the eve of the new NHL season, I focus on two of my favorite things: hockey and exchange rates in order to consider how the U.S. dollar's recent slide against the Canadian dollar will shape competition in this season's NHL.

For those who do not follow pro hockey, Canadian teams have struggled with the triple (quadruple?) burden of being small market (and thus limited earnings), of playing a substantial share of their games in the U.S., and thus having to pay for many of their expenses in US dollars*, needing to pay salaries that are on par with those paid by American franchises, and finally, doing so with a currency that was weak relative to its southern namesake.

But now that the Canadian dollar has strengthened against the USD, Canadian franchises should enjoy a stronger bottom line--their USD dollar expenses will fall relative to their Canadian dollar earnings. Hence, they should be able to attract better players. One might expect, therefore, that Canadian teams will strengthen their rosters over the course of the season via trades and, by doing so, win the Cup. In short, US Dollar devalues, the U.S. exports its top hockey players to Canada. A Canadian team wins the Stanley Cup

Lest you think this silly, notice that the last time that a Canadian team won the Cup (the Montreal Canadiens in 1992-93) came at the tail end of the previous strong loonie era.

Admittedly, this exchange rate theory of Stanley Cup winners breaks down in the mid-1980s, a period that features a weak loonie and a dominant Edmonton Oilers team. Call this the Gretzky exception. But, as Gretzky is an outlier on every hockey dimension (they don't call him "the Great One" for nothing), I hardly think this anomaly undermines my theory.

Thus, I confidently predict that a Canadian team will win the cup this year. Which one? My money is on the Canadiens.

* note; players signed by teams based in Canada are paid in US dollars. Consequently, they reap the gains and suffer the losses from exchange rate movements. I wonder whether existing contracts adjust salaries to compensate for the historic "Canada premium" such that two players of equal value but playing on opposite sides of the border have the same purchasing power (i.e., lower USD contract for the Canadian team player; higher USD contract for the US team player). I also wonder whether this practice will change...

Car Imports, Gas Prices, and Counter-productive Protectionism

Americans are again buying lots of imported cars. The graphic on the right suggests that Americans care more about the fuel efficiency of the cars they buy when gas prices rise (gee, who would have thought?).

Two additional facts of interest. One, the first figure (which excludes imports from Canada and Mexico) reflects increased imports from Japan and South Korea. Two, the cars that Japan and Korea produce and export from home are smaller and more fuel efficient (think Prius) than the cars and trucks they produce inside the U.S.

Conclusion? Americans have responded to higher gas prices by shifting away from large gas guzzling cars and trucks that happen to be produced in the U.S. toward small and more fuel efficient cars that happen to be produced overseas. The solution for American auto producers would thus seem to be, shift production to the small fuel efficient cars that Americans now want to buy.

Yet, in a non sequitur of massive proportions, "Senator Carl Levin, a Michigan Democrat, is...vexed," because this trade imbalance reflects a lack of market openness in Asia. "Citing Census Bureau data and his staff’s calculations, Mr. Levin argues that “immense barriers” erected by Japan and South Korea keep down vehicle exports from the United States to those countries. Car, truck and parts imports from Japan, for example, reached $60.2 billion last year, he said, while similar exports to Japan from the United States were a tiny $2.3 billion. He put the Korean imbalance at $12.4 billion versus $751 million."

Does anybody who does not represent Michigan in Congress really think that the desire of Japanese consumers to drive Hummers, Suburbans, and Excursions through Tokyo is being foiled by trade barriers? That is, do we really expect Asian consumers to behave differently than Americans when it comes to buying cars? And with Americans less eager to buy large gas guzzling American cars, wouldn't one think that Asians would also be less eager?

The broader concern is the following: Levin and other congressional trade skeptics focus on this imbalance in auto trade as reason to oppose the FTA with So. Korea. Yet, free trade with Korea (and Japan, for that matter) would, by reducing the cost of more fuel efficient cars, promote environmental objectives that Democrats favor. Restricting this trade would thus increase emissions relative to what is possible. Hence, more trade is also good for the environment (though to be sure one would have to compare the extra emissions generated by shipping from Asia to the emissions saved via the shift to more fuel efficient cars).

Restricting trade in autos, therefore, is not only bad trade policy, it is also bad environmental policy given the Dems' stated environmental goals.

Doha Update

Negotiations are again underway in Geneva. The most recent summary contains optimistic news, as the U.S. has indicated a willingness to accept a lower-than-previously-stated binding on trade-distorting agricultural subsidies.

"US agriculture negotiator Joe Glauber suggested that Washington could accept capping its trade-distorting farm payments at between $13 and 16.4 billion dollars, the range for a potential deal outlined in July by the chair of the WTO agriculture talks."

There is also less encouraging news concerning the congressional constraint:

"An even more formidable obstacle than finding consensus on a Doha tariff and subsidy package might be getting it through the US Congress in the foreseeable future.

House agriculture committee chair Collin Peterson (Democrat-Minnesota) has vowed to oppose deeper farm subsidy cuts barring dramatically expanded market access elsewhere, despite the soaring value of US agricultural exports. The Democratic leadership is loath to risk fragile support in newly-won rural districts by pushing farm reform. Extra cuts to cotton subsidies appear to be an especially hard sell.

(Maybe a WTO agreement requires proportional representation and a parliamentary system in the United States.)

The Financial Times suggests that the current view on much of Capitol Hill is that between the Bush administration's diminished political capital and Democrats' scepticism about economic globalisation, the Doha Round will have to wait until a new administration takes control of the White House in 2009."

That last statement seems a bit of a non sequitur: Put a Democrat in the White House as well as the majority party and the Dems become more enthusiastic about globalization? I don't understand that logic.

Puzzling Commentary on the Dollar's Decline

Stephen S. Roach, chairman of Morgan Stanley Asia, wrote yesterday on the dollar's depreciation . "The dollar, relative to the currencies of most of America’s trading partners, is off about 20 percent from its early 2002 peak. Recently it has hit new lows against the euro and a high-flying Canadian currency." (Maybe we need to stop calling it the looney and start calling it the "goose").

I have always had a lot of respect for Roach's commentary, but two things about this particular article struck me as a bit odd:

1. Roach calls the dollar depreciation " the functional equivalent of a tax hike on consumers." Except, it isn't functionally equivalent to a tax increase. A tax increase would generate revenue that the government could spend on services (or investment). Why not instead simply call it what it really is, a reduction in real income. The fall won't be 20 percent, but it will be real.

2. Roach then asserts that a Chinese revaluation constitutes a tax increase: "{Pressuring China to revalue] would...be an egregious policy blunder ... but it would also amount to Washington taxing one of America’s major foreign lenders." Except, this isn't a tax either--if a devaluation reduces US income, doesn't a revaluation raise China's income?

I guess he is trying to say that a revaluation would reduce the yuan-denominated return on the dollar-denominated assets China currently holds. But again, that's not a tax, it's a reduction of income and a loss of wealth (the yuan value of the 1 trillion + China currently holds would also fall). But, that loss would be offset by the income gains from improved terms of trade. Hence, goods and foreign assets will cost less in real terms in the future. Moreover, I suspect that as the dollar falls the rate of return needed to attract foreign capital rises; hence, an initial negative wealth shock may well be at least partially offset by cheaper assets and higher returns.

How that all of this nets out--increased real value of wages, salary, and interest income minus the reduced nominal interest income and the wealth shock of current dollar-denominated asset holdings--is more complicated than I can figure out, but I doubt it is negative.

More broadly, I wish Roach had taken advantage of his opportunity to explain in clear and direct terms what is happening to the dollar, why it is happening, and what the consequences will be. The piece he did write does more to confuse than clarify.

Greenspan on Greenspan

Alan Greenspan appeared on the NPR interview program "Fresh Air" yesterday. He defends his decisions as Fed Chairman against charges that the low-rate policy caused the current sub-prime mortgage problem and discusses other things concerning central banking. The interview is about 40 minutes long.

Perhaps the most interesting part (IMHO) comes about 33 minutes in when Terry Gross queries him about how a libertarian can assume the most powerful economic position in government. He answers by arguing that contemporary central banking is essentially about trying to replicate the functioning of the gold standard.

Words to Live By?

As the Fed considers whether and how much to cut rates today, here is Ben Bernanke reflecting on the lessons to be learned from the Great Depression in an interview he gave in 2005:

Are there any lessons from the Great Depression that need to be relearned?

...The two main lessons which I think have been learned to a large extent, but always can be re-emphasized, are first that a central bank’s primary responsibility is the maintenance of price stability, to provide low and stable inflation in the medium term, to avoid sharp inflations or deflations and particularly to avoid the instability of expectations associated with an unanchored price level. The second lesson is that the financial industry is a special industry in terms of its role in macroeconomic stability. Major upheavals in the financial system can be extremely disruptive to the economy as a whole and therefore the central bank and other government institutions have a particular obligation to make sure that financial stability is preserved. (pages 65-66).

Hat tip to Mankiw.

How Fragile We Are

One might have hoped that after the weekend pause saner heads might prevail. But, the run on Northern Rock continues into the new week. The Telegraph had some interesting coverage over the weekend, providing a glimpse of the underlying mentality of the "panickers": As one man standing in line said, "It's my life savings," he said. "I think the risk is pretty low but you never know." Right, when a long line forms at your bank, the safe thing to do is join.

What I find most puzzling is that the amounts that people claim to have deposited with Northern Rock are invariably less than the maximum deposit the British government insures. Hence, even if NR is insolvent,depositors don't lose. We are not talking about huge investments being pulled from uninsured hedge funds, after all, but thousands of pounds being withdrawn from fully-insured institution. At worst depositors are moderately inconvenienced (become illiquid until the government check arrives). So, does this rush to withdraw mean that they don't trust the British state to make good on its promises either?

I guess this shows how rapidly people cease acting rationally. Especially when financial institutions that hold their life savings seem about to fail. Makes you wonder how bad things can get if we lose collective confidence in those parts of the financial system that are not federally insured. As Hayek once said, in commenting upon the 1929 crash and its ugly aftermath, "we did not know just how fragile our society was."

Panic on the Streets of London?

Customers line up to enter a branch of Northern Rock in southeast London. Extra credit if you can name the band that inspires the post title...

Another Outbreak of Foot in Mouth Disease

As long as I am poking fun at central bankers, did anyone else notice the following?

On Wednesday, Mervyn King, Governor of the Bank of England was all self righteous about his bank's steadfast refusal to inject additional liquidity into the market. "Unless the economy was in danger an injection of funds to encourage banks to lend to each other would reward reckless behaviour. Mervyn King said the closure of the money markets was the result of the mis-pricing of risk in the financial system rather than the state of the economy, though he warned that the supply of credit to households and businesses may tighten and borrowing costs would rise." So, a governor who actually admits in public to belief in moral hazard.

And then I awake today to the following news: "The Bank of England Thursday provided extra short-term funds to the money market through its weekly open market operation and sharply widened its reserve-requirement range for banks' accounts at the BOE." They followed this up on Friday by "rescuing [a] mortgage lender by providing emergency funds after Northern Rock was unable to finance its operations in the money markets." Can anyone say bailout?

Maybe the BOE bailed out Northern Rock at penalty rates, I haven't seen the details. Even so, it remains a pretty big about face in two days. And while it is tempting to make fun of pompous central bankers, one must also wonder, what did Mervyn learn that caused the 180? Should we be worried?

Update: "The Bank of England emphasized Friday that its lending to Northern Rock would be conducted at a premium to market interest rates."