Friday, December 28, 2007

Krugman on Stolper Samuelson Effects in US Trade

. Friday, December 28, 2007

In case you missed it, Paul Krugman's Friday column focused on the distributional consequences of international trade. He argues that as imports from developing countries have risen during the last fifteen years, trade flows have begun to follow the expectations of standard comparative advantage. Consequently, trade has a more pronounced impact on wage inequality in the US today than it did fifteen years ago.

I am predisposed to the general argument, but am puzzled by the magnitude he claims. He asserts that "it’s hard to avoid the conclusion that growing U.S. trade with third world countries reduces the real wages of many and perhaps most workers in this country...The highly educated workers who clearly benefit from growing trade with third-world economies are a minority, greatly outnumbered by those who probably lose."

He draws on textbook Stolper-Samuelson logic to make the argument: "workers with less formal education either see their jobs shipped overseas or find their wages driven down by the ripple effect as other workers with similar qualifications crowd into their industries and look for employment to replace the jobs they lost to foreign competition. And lower prices at Wal-Mart aren’t sufficient compensation.

Yet, exactly how many workers have lost jobs to "foreign competition?" The competition Krugman emphasizes comes from imports of manufactured goods. The Bureau of Labor Statistics reports that manufacturing employment fell from roughly 17 million in 1997 to 14 million in 2006. That's a reduction of 3 million manufacturing jobs over ten years--300,000 per year on average--in a total labor force of 136 million people. To assert that this displacement imposed a substantial wage reduction on others seems a bold claim to make without providing any evidence to support it.

I look forward to seeing Krugman's research on this question develop. He has posted a few short pieces about the paper he is writing on his blog, here, here, and here. If you want to read what appears to be the state of the art on trade and income distribution, see Robert Lawrence's paper here.

How do We Extract Signal from Noise?


As we head toward the New Year, I offer some fundamental skepticism. In a very cheery examination of the current financial situation, Ambrose Evans-Pritchard seems almost to relish the collapse of the international financial system. He seems uncannily able to find bankers willing to make extreme statements, such as: "Things are very unstable and can move incredibly fast. I don't think the central banks are going to make a major policy error, but if they do, this could make 1929 look like a walk in the park." How's that for a little New Year cheer?

I feature Evans-Pritchard's recent work because it nicely highlights one of two questions I have been pondering for the last two weeks (I will post on the second question tomorrow). How do we humans extract meaningful signal from all the noise? We seem strongly attracted to worse-case scenarios; we compare the current situation to 1929 rather than to other financial episodes that did not produce a global cataclysm (1987, for example, or the bursting of the dot com bubble). The media feeds us quotes with no evidence about where the people quoted fall in the distribution of opinion and analysis. Are the quoted bankers representative of the median view, or is the writer drawing from the gloom-and-doom end of the spectrum? Do the people quoted have incentive (monetary or other) to portray events in a particular manner rather than present "objective analysis?" In short, how does one figure out the "truth" in a world in which the critical question is "what is going to happen?", when the information we have at hand is of uncertain quality and quite possibly biased, but the degree of bias is unknown (and unknowable)?

This seems to be a very hard problem, and yet one we face on a regular basis. For those not interested in the current financial crisis, then ask the same question of global warming. If you are unwilling to fall down the global warming warren hole (and having disappeared into that hole for a full week, I can hardly blame you if you are not), then ask the question of genetically modified organisms. If GMOs do not interest you, then what about economic development? All of these issues pose the same dilemma: we are asked to make decisions today to achieve some future consequence relying on knowledge first produced and then reported by groups of people who may or may not be motivated by the objective quest for truth and that therefore may or may not be biased in ways we cannot accurately measure.

In short, why do we believe what we believe, and should we? How do we extract the meaningful signal from all of the noise, and how do we know that we have extracted the meaningful signal? I don't have the answer, but we seem to believe that the political process is good at selecting the "correct signal." Why do we believe this? Should we?

Thursday, December 13, 2007

Krugman on the Fed and the Financial Crisis

. Thursday, December 13, 2007

"What’s going on in the markets isn’t an irrational panic. It’s a wholly rational panic, because there’s a lot of bad debt out there, and you don’t know how much of that bad debt is held by the guy who wants to borrow your money.

How will it all end? Markets won’t start functioning normally until investors are reasonably sure that they know where the bodies — I mean, the bad debts — are buried. And that probably won’t happen until house prices have finished falling and financial institutions have come clean about all their losses. All of this will probably take years.

Meanwhile, anyone who expects the Fed or anyone else to come up with a plan that makes this financial crisis just go away will be sorely disappointed."

Pushing on a String?


Keynes argued that the Great Depression persisted in part because of a "liquidity trap" wherein banks are unwilling to lend regardless of the nominal interest rate. In such a world, monetary policy is useless--he equated trying to use a monetary expansion to stimulate lending to trying to move a weighty object by pushing on the end of a string.

One might ask if global credit markets have now entered a period in which monetary policy amounts to pushing on a string. Credit markets are frozen because banks are uncertain about which banks among them hold how much bad debt (non-performing sub-prime mortgages and associated instruments). Because no one wants to lend to banks who hold a lot of this debt, and no one knows who these banks are, no one is willing to lend to any banks. Consequently, credit markets freeze. The underlying problem is an information asymmetry of the kind that for which Joseph Stiglitz won a Nobel Prize (well, not technically a Nobel, but you get the point).

Yesterday's announcement that US and European central banks will cooperate to provide liquidity to credit markets is best interpreted in this context. "The Fed has not only opened its vault doors to the banking industry, they are now trucking it to their place of business," said Scott Anderson, a senior economist at Wells Fargo, in a written report. "If that doesn't get the banks excited about lending again, nothing will...The Fed's action attempts to deal with a difficult problem confronting the world's central banks: Financial institutions globally are so worried about losses from U.S. mortgage securities and other exotic investments that they are hoarding cash, unwilling to lend it to each other except at unusually high premiums."

I don't know whether to be scared or reassured by this latest development. That is, does this unprecedented action mean that the central banks have things well in hand, or does it mean that things are worse than we realize?

Wednesday, December 12, 2007

Final Exam Update and Essay Outline

. Wednesday, December 12, 2007

I have completed grading the final and will try to get the final grades to the registrar by Friday. If you are curious about what I was looking for in the essay, keep reading.

Here, in outline form, is what I was looking for in the essay.

1. All global current account imbalances reflect underlying Savings-Investment imbalances.

2. All global imbalances are financed via the deficit (borrowing) country issuing promises to pay the surplus (lending) country(ies) in the future in exchange for loans in the present. The nature of what is promised, to whom, and via what intermediary (if any) varies across episodes. The US telling Germany in the 1960s, "hold dollars today and I will give you gold at $35 an oz next year" is identical in essence to Thai banks saying to Japanese commercial banks, "take my promise to pay you tomorrow what you give me today plus interest." (Though, in the US case it does not promise to pay interest too).

3. Imbalances transform into crises when lenders lose confidence in the borrower's ability to make good on its promise to repay. What triggers the crisis in any given instance will be different, but all crises are triggered by this sudden loss of confidence by lenders in the ability of borrowers to make good on their promises. Dollar overhang, therefore, is not fundamentally different than the popping of the property-market bubble in Thailand. In both cases, borrower's short term liabilities>their available liquid assets.

4. Adjustment plays out in different ways; developing country debtors get pushed into the IMF/WB process and tend to bear the largest share of the adjustment costs; advanced industrialized countries tend to negotiate and the costs do not necessarily end up falling on the debtor country. One might even argue that since 19302, the US has been pretty good at pushing the costs onto other countries ("Our currency, your problem.")

5. Implications for contemporary imbalance. Recognition that the US is vulnerable to sudden losses of confidence, recognition that if that happened it could be a bad thing, and some consideration of:

  • how likely is a sudden loss of confidence in the American ability to make good on its promises?
  • how governments would respond in the event of such a sudden loss of confidence--more like Latin America and Asia, or more like Bretton Woods and Plaza-to-Louvre? Obviously, there is no "right" answer here, but there are good and less good answers.
Most of you wrote reasonably strong answers that focused on these issues. If there was a collective bias, it was toward emphasizing specific details and hence uniqueness of the two episodes you examined, rather than the more general pattern and commonalities. If there was a single area in which I found the answers less developed than I would have liked, it was in the last section (5 above).

Monday, December 10, 2007

Surrealism and Economic Development

. Monday, December 10, 2007

There is something deeply surreal about this:

"Gordon Brown plans to harness at least 20 of the world's biggest multinational companies, including Google and Vodafone, to tackle a "development emergency" in the world's poorest countries and put the international community back on course to achieve seven UN development goals by 2015...Ministers have been holding intensive discussions with the private sector in the hope that firms can be persuaded to use their expertise to improve infrastructure, upgrade skills and provide capital for fresh investment. Although the prominence given to multinationals is likely to be controversial with parts of the development community, Brown believes a lack of enterprise is hindering least-developed countries - especially in sub-Saharan Africa - achieving the development goals."

The episode encapsulates everything wrong with the West's approach to development. First, we assume that we can actually create a plan that eliminates poverty (we can't, sorry J.Sachs). And when we fail to meet arbitrary targets, we declare an "emergency." Second, we think that we can solve "the-lack-of-enterprise-is-hindering-least-developed-countries" problem by forcing unwilling MNCs to invest in developing countries (we can't). Third, we worry about what some ill-defined, anti-market, though well-meaning "development community" will think about encouraging private business to invest in developing countries (we shouldn't, because they are not eliminating poverty either). Fourth, not a word from the impoverished societies we are supposedly "rescuing" (why?).

Friday, December 7, 2007

The ECB, Asymmetric Shocks, and Monetary Policy Dilemmas

. Friday, December 7, 2007

Standard theories of monetary union suggest that they work best when the participating countries experience the same shocks. They work least well when they experience asymmetric shocks. I have always found it difficult to teach this, because until now the EU's monetary union has not really had to deal with a big shock. The fall out from the US sub-prime crisis is imposing an asymmetric shock on euroland. Consequently, we now begin to see the dilemma that EMU creates for its members and its single central bank.

The core problem is that the ECB must choose between inconsistent objectives. As the Telegraph summarizes, "Mr Trichet has to tread a delicate path between the eurozone's Germanic and Latin blocs, pulling ever further apart. The credit and housing booms have begun to deflate in the Club Med region. The Bank of France's governor, Christian Noyer, said this week that Europe was facing a "huge shock" as contagion spread from the US sub-prime crisis...Spain in particular is now in serious trouble, with a "staggering" current account deficit of 9pc of GDP and a huge overhang of unsold property from the housing bubble."

Germany, in contrast, is struggling with rising inflation: "The hard-line bloc [is] led by the two German council members, Bundesbank chief Axel Weber and the ECB's chief economist Jurgen Stark. The latest spike in oil and food costs has pushed German inflation to 3pc, the highest since the launch of the euro and fast approaching the level where it may erode popular support for the currency."

Thus, one monetary policy but divergent economic developments across euroland. Someone has to accept a monetary policy that not only fails to address their current needs but will actually further worsen their situation. The dilemma is complicated by uncertainty; the more German unions question whether the ECB will use policy to keep inflation down in Germany (i.e., the more they believe that monetary policy will target Spain and the Med) the larger the nominal wage increases they will seek. Hence, to keep inflation down in Germany, the ECB must be hard line and build a reputation. But, being willing to raise interest rates to build this reputation risks making things even worse for "club med."

Not surprisingly, this "technical decision" is spilling over into politics, as French and Italian politicians have chastened Trichet for the hard line he is adopting.

It is precisely this problem that caused me to write, more than ten years ago, that EMU is not obviously a very good idea.

Thursday, December 6, 2007

Optimal Currency Areas, or the Costs of a Single Currency

. Thursday, December 6, 2007

The European Central Bank is confronting its first policy challenge. Caught between sagging growth and rising prices, the ECB today kept interest rates steady. Of particular interest is the ECB's fear that rising prices will feed into large nominal wage increases that will in turn exert additional inflationary pressures.

Pre-EMU, wage bargaining in many countries was structured by the interaction between corporatist labor markets and independent central banks. In this context, the independent central bank signalled a commitment to low inflation and unions set their wage demands based on this signal. All of this worked because wage bargaining was highly centralized, and thus unions had an incentive to internalize the short-run trade off between wages and employment.

Wage bargaining is much more decentralized under EMU, and consequently unions have less incentive to practice wage moderation. The ECB has thus become worried that rising inflation "could be amplified by so-called second-round effects, like demands by unions for hefty wage increases." Earlier in the week, ECB president, Jean-Claude Trichet sharply criticized the German government's imposition of a minimum wage for postal workers that, in many cases, is far more that what they were previously being paid."

'We will not tolerate second-round effects,' Trichet said during a news conference in Frankfurt, implying that the bank would raise rates if it saw such activity."

This suggests that ECB policy is being driven by the desire to build anti-inflation credibility and that the ECB seems willing to risk a recession to earn this reputation.

Across the Channel, the Bank of England leaned the other way. "Higher prices for food and fuel have also nudged inflation in Britain above the 2 percent target set by the Bank of England. But that bank's monetary policy committee said the threat of inflation was overshadowed by the dampening effects of continued turmoil in the credit markets."

Anybody still wonder why the UK opted out of EMU?

Tuesday, December 4, 2007

Hillary, on Trade Policy

. Tuesday, December 4, 2007

"Well what I have called for is a time-out which is really a review of existing trade agreements and where they are benefiting our workers and our economy and where the provision should be strengthened to benefit the rising standards of living across the world and I also want to have a more comprehensive and thoughtful trade policy for the 21st century. There is nothing protectionist about this. It is a responsible course."

I struggle to figure out what exactly she is saying. She wants trade agreements that benefit our workers and economy; is she saying that current agreements do not benefit our economy? And what workers in particular? Workers at Microsoft and GlaxoSmithKline are doing fine under current agreements, while workers at GM and Ford are doing less well. So which group of workers is she talking about? Or are research scientists not workers in the parlance of the Democrats?

I also don't know what she means by strengthening provisions "to benefit the rising standards of living across the world." Quite apart from the tortured synatax, is she implicitly claiming that workers across the world are getting poorer as a result of trade? There is no evidence to support this claim. Moreover, if she cares about improving the standard of living "across the world" then the simple solution is to open the US market to goods produced by low-income people in the rest of the world. But, that seems to cut against her desire to protect the incomes of American manufacturing workers and suggests the need for acceleration of negotiations rather than a pause.

What bothers me more broadly is that in spite of calling for a new trade policy for the 21st century, Hillary neither seems to recognize the nature of the dilemma (how to assist import-competing sectors without killing the export-oriented sectors in the US and the rest of the world) nor offers even the slightest whisper of a policy. And it is not hard to think of a very simple solution to the dilemma: liberalize and use active labor market policies to help people transition out of import competing sectors. We can do this all on our own--no need for a pause, a review, or any lengthy and complicated international negotiations.

Monday, December 3, 2007

So, Just How F***ed are We?

. Monday, December 3, 2007

Of course, the extent to which the economy dominates the '08 election depends on what happens to the economy. To help us figure where we are headed, I share two insights from Paul Krugman. It is always hard to know when he is being intentionally ironic.

Exhibit 1: "Right now, economic statistics are telling mutually contradictory stories. Gross Domestic Product, the usual measure of economic growth, surged in the summer; Gross Domestic Income, which should basically be an alternative measure of the same thing, was sluggish. Estimates of payroll employment grew fairly fast; other data related to employment did not.

The truth is that I often feel that people interpreting economic data are taking a kind of Rorschach ink blot test — what they’re seeing is more of a random pattern than anything else, and their interpretation of that pattern is telling you more about their personal demons than it is about what’s really happening in the economy.

And right now that’s utterly true. Since there are now data telling you more or less whatever you want to hear, you’re free to believe whatever you want."

Exhibit 2: "How bad is it? Well, I’ve never seen financial insiders this spooked — not even during the Asian crisis of 1997-98, when economic dominoes seemed to be falling all around the world.

This time, market players seem truly horrified — because they’ve suddenly realized that they don’t understand the complex financial system they created...“What we are witnessing,” says Bill Gross of the bond manager Pimco, “is essentially the breakdown of our modern-day banking system, a complex of leveraged lending so hard to understand that Federal Reserve Chairman Ben Bernanke required a face-to-face refresher course from hedge fund managers in mid-August.”

The freezing up of the financial markets will, if it goes on much longer, lead to a severe reduction in overall lending, causing business investment to go the way of home construction — and that will mean a recession, possibly a nasty one."

So, are we heading toward recession (and possibly a nasty one), or is that just Krugman's personal demon talking?

Finally, It's the Economy, Stupid


"I care about bringing our troops home...and for the most part, I believe as far as domestic terrorism goes, I think we've got that pretty much under control," Dale Albright says. "But the economy really scares me." A longtime Republican, this election he says he's voting Democrat.

Dale is not alone; as "the surge" has stabilized (temporarily?) Baghdad and the housing market has tanked, economic issues have emerged as priority items. And people seem a bit worried.

"The pessimism ... reflects voters' worries beyond the current business cycle. Early this month, a sobering consensus emerged from a focus group of a dozen Republican-leaning voters in the Richmond, Va., area, sponsored by the nonpartisan Annenberg Public Policy Center at the University of Pennsylvania. The participants unanimously agreed that they didn't think their children's generation would be better off than their own -- breaking with traditional American optimism -- largely due to the debt future taxpayers will inherit."Who's buying our loans?" said former secretary June Beninghove, 67. "Who's going to own us? We are going to give ourselves to another country because of debt."

The non sequitur aside (if people fear their children will not be better off, they have concerns that go well beyond a looming recession), it does suggest that economic insecurity is likely to play an important role in '08.

Sunday, December 2, 2007

US Sneezes; World Gets Sick

. Sunday, December 2, 2007

While the US struggles to manage the sub-prime problem, Europeans are beginning to feel unwell. A story in The Daily Telegraph (UK) nicely spells out the European Central Bank's dilemma--caught between slowing growth and rising inflation and then wonders whether EMU is at risk.

"Interest rate spreads between government bonds in France, Spain, Germany and Italy have lately got wider and wider. In other words, believe it or not, the markets are increasingly betting on the eurozone breaking up – as political tensions rise, and the needs of inflation-averse nations like Germany can’t be reconciled with much weaker debt-driven members like Ireland and Spain. Could it happen? Why not? Every other currency union in the history of man has broken up – unless, like the US and UK, it has been preceded by generations of political union, and held together with a federal tax system. It sounds far-fetched, I know. But the ultimate victim of this sub-prime crisis could be nothing less than the single currency’s existence."

Wishful thinking from a euroskeptic? Perhaps, but this is the first real test of the EU's ability to weather a real economic problem (and an asymmetric shock) with a single monetary policy.

A thousand miles north, a tiny Norwegian town above the Arctic circle struggles to recover from the losses it suffered from investing in assets derived from sub-prime mortgages. The town government invested a quarter of its annual budget of $163 million, and lost a substantial share of the investment (how much is not fully clear).

Residents are unhappy: "As the losses begin to bite, the political finger-pointing has begun. Down the hall from Ms. Kuvaas, the town’s opposition leader, Torgeir Traeldal, is calling for an investigation of how and why Narvik could have made such an ill-advised investment. “Heads are going to roll,” Mr. Traeldal said, repeating the phrase a few times to drive home his point."

Thursday, November 29, 2007

Real Estate Bubbles, Moral Hazard, and Financial Systems

. Thursday, November 29, 2007

NPR had a nice piece on the financial impact of the deflating housing market bubble. Offers a straight forward explanation of how lenders package mortgages for sale in the secondary market.

Be sure to read the accompanying article that explores the moral hazard question prompted by the Fed's recent injection of liquidity into the market. Bottom line here is simple:

  • A federal bailout of shaky subprime lenders would amount to a "subsidy for risky behavior," says Christian Stracke, a senior credit strategist at the research firm CreditSights. "You would encourage future risky lending and borrowing by signaling that in extreme circumstances, the government … will bail out bad lenders," he says.
  • but some industries, indeed some companies, are so integral to the U.S. economy that they cannot be allowed to fail — nevermind how they got into trouble in the first place, argue others. The "too big to fail" theory came into play a decade ago, when the Federal Reserve intervened to rescue the giant hedge fund Long Term Credit Management. The fund, initially a huge success when it was founded in 1994, lost more than $4 billion in 1998. The Federal Reserve put together a bail-out by the major creditors to avoid a wider collapse in the financial markets.
Three related notes:
  • "Credit flowing to American companies is drying up at a pace not seen in decades, threatening the creation of jobs and the expansion of businesses, while intensifying worries that the economy may be headed for recession."
  • The Fed injected $8 billion into credit markets in preparation for the holiday season
  • Bernanke hinted today, in line with his deputy's hint yesterday, that the Fed is likely to cut interest rate cuts soon (again).

Wednesday, November 28, 2007

Petrodollars '00 Style

. Wednesday, November 28, 2007

Petrodollars played a key role in the genesis of the Latin American debt crisis during the 1970s. Today's NYT examines how oil exporters are using their windfall from the current oil price rise. How big a windfall, you ask? "In 2000, OPEC countries earned $243 billion from oil exports, according to Cambridge Energy Research Associates. For all of 2007 the estimate was more than $688 billion, but that did not include the last two months of price spikes." On average, oil exporters are earning $1.8 billion per day.

Seems that oil exporters are pursing a more diversified investment strategy today than they did during the 1970s; rather than deposit the funds in Citibank, they are now buying big shares of Citigroup (Abu Dhabi is now the single largest share holder). More broadly, "the oil-rich nations are...investing more in real estate, private equity funds and hedge funds, analysts say, and increasingly they are investing the money on their own, bypassing the major financial institutions of the United States and Europe."

Interestingly, oil exporters, like China, are a bit uncertain about what to do in response to a weakening dollar. Some advocate shifting out of dollar-denominated assets in response to the falling dollar; others fear that shifting into euro-denominated assets will cause the dollar to weaken further, thereby reducing the value of the dollar-denominated assets they have accumulated.

Thursday, November 22, 2007

Happy Thanksgiving

. Thursday, November 22, 2007

As we gather with our families today to give thanks, let's take a moment to consider the origins of the feast. The tradition we continue today began almost 400 years ago as destitute immigrants gathered in Virginia and Massachusetts to give thanks for their safe arrival (Virginia) and a bountiful harvest (Plymouth). In many important respects, therefore, Thanksgiving celebrates a fresh start of the first wave of immigrants that built the US.

Then, as now, the native population did not always welcome the new arrivals (e.g., the Indian Massacre of 1622). At other times, however, the native population helped the new arrivals adapt. This native uneasiness toward new residents has shaped America's approach to new arrivals ever since. Those who come early and become "native" grow wary of those who follow in their wake. Current unease about "illegals" is thus only the latest manifestation of a centuries-old pattern.

All of which leads me to suggest that as we gather to feast today try to remember how it is we came to be here; most of our ancestors came to this country to escape a life of grinding poverty by moving to a land of seemingly unbounded opportunity. So too with today's new arrivals.

Monday, November 19, 2007

Le Compression Grand

. Monday, November 19, 2007

Paul Krugman makes much of the "Great Compression" , which is his term of choice for the dramatic reduction of income inequality that occurred in the United States between 1935 and 1945. He attributes this equalization of income to FDR and the New Deal. "So what happened to the rich? Basically the New Deal taxed away much, perhaps most, of their income" (Krugman COAL, page 48)

One of the scholars whose research Krugman cites produced a similar series on income inequality for France. The graph for French income inequality (click for larger image) between 1920 and 1945 looks strikingly similar to the graph for American income in the same period.

Surprisingly, Piketty does not attribute France's Great Compression to the New Deal. Instead, he concludes: "the decline in income inequality that took place during the first half of the 20th century was mostly accidental. In France and probably in a number of other developed countries as well ... the secular decline in income inequality is for the most part a capital income phenomenon: holders of very large fortunes were severely hit by major shocks during the 1914-1945 period, and they were never able to fully recover from these shocks, probably because of the dynamic effects of progressive taxation on capital accumulation and pre-tax income inequality" (page 29).

In short, financial crisis, depression, and global war reduced inequality by greatly reducing wealth and the return on wealth; postwar tax rates kept it from re-emerging (for a while). If this pattern is common across the industrialized world, just how important was FDR?

Sunday, November 18, 2007

G20 and Global Imbalances

. Sunday, November 18, 2007

It is nice when world governments act so quickly to illustrate the processes we discuss in class. Last Thursday we focused on macroeconomic policy coordination as a solution to global current account imbalances. The Group of 20 met this weekend in South Africa and agreed the following:

"We also agreed that an orderly unwinding of global imbalances, while sustaining global growth, is a shared responsibility involving: steps to boost national saving in the United States, including continued fiscal consolidation; further progress on growth-enhancing reforms in Europe; further structural reforms and fiscal consolidation in Japan; reforms to boost domestic demand in emerging Asia, together with greater exchange rate flexibility in a number of surplus countries; and increased spending consistent with absorptive capacity and macroeconomic stability in oil-producing countries."

Craziest Sentence I Read Today


“The fall of the dollar is not the fall of the dollar — it’s the fall of the American empire.” Hugo Chavez.

This one is a close second: “The U.S. dollar has no economic value.” Mahmoud Ahmadinejad

The Best Sentence I've Read Today


(or How to Begin a Book Review)

"William Easterly has a problem on his hands--he's just not very rock 'n roll. While Easterly's developmental economics arch nemesis Jeffrey Sachs is living it up with the likes of Bono, Easterly is quietly plugging away, delivering an unpopular and decidedly uncool message. His message? The West's quest to end poverty is ill informed and misguided at best and detrimental to the poor at worst."*

Makes you want to read the rest, doesn't it?

*Written by a student in POLI 442, fall '07; name withheld.

Friday, November 16, 2007

China's Current Account Surplus and the Yuan

. Friday, November 16, 2007

"If you think U.S. President George W. Bush's administration had a tough time dealing with China, the next occupant of the White House may have it worse." So claims yesterday's International Herald Tribune.

The article offers a clear explanation for the mechanism through which pegging the yuan to the dollar reinforces the savings - investment gap that underlies China's current account surplus.

It also hints at the dilemma the Chinese monetary authorities now face. Pegging the yuan requires continual purchases of foreign assets, which in turn expands the money supply, which in turn generates inflation. Stemming inflation requires higher interest rates, which may well pull in additional capital flows, thereby forcing the central bank to accumulate still more foreign exchange reserves, additional monetary expansion, and more inflation. In short, the desire to keep domestic prices stable is not easily reconciled with the desire to maintain the pegged exchange rate.

One obvious solution to this dilemma is to allow the yuan to float. No sign that this is likely to happen any time soon.

The Distributive Consequences of International Trade


Dani Rodrik points out that trade economists often stress the gains from trade and de-emphasize its domestic distributional consequences. I have always found it puzzling that while political scientists have made the Stolper-Samuelson theorem the workhorse of their models of trade politics, trade economists have tended to downplay the domestic distributional consequences of trade. Rodrik points to recent papers by Josh Biven and Robert Lawrence that simulate the impact of trade between the US and developing countries on the relative wages of low and high skill workers in the US.

The Biven paper in a nutshell:
"This paper revisits the insights of Stolper-Samuelson and estimates the impact on American wages of trade flows between the rich U.S. economy and a poorer global economy...Despite a rather conservative methodology, this paper finds that:
• Trade with poorer nations had by 1995 led to a rise in relative earnings of skills vis-à-vis labor of just under 5%,
relative to baseline of no trade with poor nations. This is an amount roughly equal to 12.5% of the dramatic increase in earnings inequality that happened between 1980 and 1995.
• By 2006, trade flows between the U.S. and its poorer trading partners increased relative earnings inequality by just under 7% relative to a no - trade baseline."

The Lawrence paper reaches different conclusions: "while increased trade with developing countries may have played some part in causing greater wage inequality in the 1980s, surprisingly, over the past decade the impact has been too small to show up in aggregate wage data."

Wednesday, November 14, 2007

The Soaring Euro: Imitation is the Sincerest Form of Flattery

. Wednesday, November 14, 2007

American exchange rate policy during the last 40 years has leaned heavily on a simple strategy: unwilling to use US monetary policy to influence the dollar's external value, it has sought to induce other governments to alter their policies. The logic, of course, is simple. All bilateral exchange rates are a function of the interaction between two monetary policies, and thus the exchange rate can be influenced via changes in either policy. During the 1960s and early 1970s, the US pressured (or, as one of my current [German exchange] students put it in class, coerced) Germany to accumulate and hold dollars to shore up the Bretton Woods System. During the 1980s, the US pressured Japan and, to a lesser extent Germany, to realign the mark-yen-dollar triangle. Currently, the US pressures the Chinese to revalue.

The EU seems to be embracing this policy as if they had invented it themselves. Sarkozy, during his recent visit to the States, scolded Congress and demanded the US take steps to stem the dollar's slide or face a trade war. An EU delegation is headed to China to pressure (coerce?) the Chinese to revalue the yuan. All of this on the heels of the ECB's decision that it prefers to keep interest rates steady, thereby refusing to use interest rates to stem the euro's rise.

EU tactics seem a direct consequence of monetary union. Fifteen years ago the French would have screamed at the Germans and then probably devalued the franc. Now, it does no good to scream at the Germans (althought Sarkozy did try that first, I guess old habits die hard), and the French can't devalue. Nor can they directly control ECB monetary policy. The only way to influence the euro's external value, therefore, is to pressure other governments to adjust their policies.

I had always considered American policy a consequence of American structural power and isolationism. The EU's embrace of this strategy makes me wonder if American policy isn't also a product of institutions, especially the independence of the Federal Reserve.

Monday, November 12, 2007

Krugman on the Dollar and Current Account Adjustment

. Monday, November 12, 2007

I do like it when Paul Krugman uses his platform to talk about the things he knows best, in this case, current account adjustment and the falling dollar. It also is not everyday that one sees a public discussion about the savings-investment gap, so it's worth checking out for that reason alone..

Krugman has written two recent blog posts on this topic, one that emphasizes the need for a depreciating dollar in conjunction with rising savings, and another on the reasons for the dollar's current slide. The basic message is that current account adjustment without recession requires a rise in savings and a fall in the dollar. He elaborates these views in greater detail in a recent Economic Policy article (a shorter piece apparently derived from this by Robert Baldwin is also available).

Dollars per Second for High-Earning Americans


According to Ken Rogoff, "The latest Forbes list of America’s wealthiest individuals showed that last year’s highest nine earners, whose ranks include New York City’s mayor, Michael Bloomberg, managed to increase their wealth by $5-9 billion last year. Yes, that is just the annual increase in their wealth. Collectively, their $55 billion in earnings outstripped the entire national income of more than 100 countries. To put these astronomical numbers in perspective, ... to be among the top nine earners in the United States, you had to pull in at least $150 per second , including time spent eating and sleeping. That is $9,000 per minute, or $540,000 per hour."

(hat tip to Greg Manikw)

Friday, November 9, 2007

Time Erodes all Meaning, or the Irony of TV

. Friday, November 9, 2007

One of my all-time favorite movies is on tonight--the Wizard of Oz. Maybe it is just me, but it seems rather bizarre that the chief sponsor of this broadcast is the board game, "Monopoly."

Congress Votes on the Peru FTA


The Times has a pretty cool interactive map depicting House votes on the US-Peru Free Trade Agreement. The map depicts every district, shows party, vote for and against, and allows you to look at votes in "high" and "low" income districts.

Pretty cool, though, I wish they would have meaningful district demographic characteristics--education level, for example, or economic structure.

Oh, the agreement passed. Who would have thought?

The Dollar and the Housing Market, Again


1. One simple expectation: a real exchange rate appreciation raises the return to non-traded goods relative to traded goods. The intuition is straight forward: as the currency gains value, prices of manufactured goods (traded goods) fall, while prices of goods and services that do not readily cross borders (houses, for example) do not. Consequently, as a currency appreciates, people ought to invest less in the traded goods sector and more in the non-traded goods sector.

2. Two Simple Graphs:
A. Graph 1 (top) shows the dollar's substantial appreciation in real terms between 1995 and 2003; the dollar remained high relative to the early 1990s until 2005.
B. Graph 2 (bottom) shows the substantial increase in housing prices that began in 1995 and peaked in 2005.

3. One simple hypothesis: The real estate bubble was at least in part a consequence of the dollar's sharp real appreciation between 1995 and 2005.

4. One simple extension of temporal scope: Notice that the 1980s real estate boom also occurred in a strong dollar era.

5. Broader point: the Fed's current dilemma--target the dollar's external value or target the financial system--is merely the continuation of a deeper problem. The low-interest rate policy of the early 00s fed the housing bubble, but higher interest rates at that time would have yielded an even stronger dollar (and hence stronger incentives to shift into non-traded goods). Lower interest rates might have slowed the dollar's rise, but also fueled an investment boom somewhere else. Hence, pick your poison.

The deeper problem, of course is that the Fed has two policy targets (the exchange rate and the domestic economy) and only one policy instrument. The policy appropriate to meet one target is not always appropriate (and can have perverse consequences) for the other.

Wednesday, November 7, 2007

Weak Dollars, Subprime Messes, and Monetary Policy Dilemmas

. Wednesday, November 7, 2007

When does the dollar's depreciation become serious? When Chinese officials start talking in public about shifting its $1.43 trillion of reserve holdings out of dollars and into other currencies. The markets are already a bit skittish; loose talk does not help.

Can the U.S. do anything to bolster the dollar? It appears that the U.S. is caught between the classic rock and hard place. On the one hand, domestic financial difficulties resulting from the subprime mortgage mess has encouraged the Fed to cut rates and inject liquidity to ease market conditions. Rate cuts and extra liquidity, however, weaken the dollar. If the Fed wants a stronger dollar, the required higher rates will squeeze financial institutions. Not much of a choice; bolster the dollar at the short-term cost of worsening the financial crisis; inject liquidity at the short-term cost of a weaker dollar.

The Fed's current dilemma is hardly unique. It is not fundamentally different than the dilemma Thai and Indonesian governments faced in 1997; not fundamentally different than the dilemma Austrian authorities faced in 1931. Not fundamentally different from the dilemmas posed by financial crises throughout history (the 1907 and 1894 panics come to mind as well). In all of these cases, monetary authorities had to choose between actions that saved key domestic financial institutions and actions that stabilized the currency. Yes, the contemporary US is different--no fixed exchange rate as a focal point for speculation; no precious metal reserve constraint--yet still, it must choose between internal and external objectives.

What surprises me is that even those at the Fed who oppose further rate cuts make no mention of the dollar as a reason for their resistance.

Subsidizing the Royal Farm


Each semester I ask my students to look closely at the distribution of US agricultural subsidies. They are often surprised by the realization that most payments go to a small number of high-income "farmers." Today's IHT suggests an identical pattern in the EU.

The most delightful tidbit: the British Royals are among the big winners from the Common Agricultural Policy. "Data from the 2003-2004 farming year indicated that the queen [of England] and Prince Charles received €360,000; the Duke of Westminster €260,000; and the Duke of Marlborough €300,000...The queen and Prince Charles received a total of more than £1 million, or $2.1 million, in EU farm subsidies over two years."

Not surprisingly, recipients of large payments via the CAP have sufficient political influence to block reform.

If you wish, you can track EU recipients and US recipients. I am struck by the lack of transparency in the EU

Tuesday, November 6, 2007

Government Debt Clock

. Tuesday, November 6, 2007

This, the self-proclaimed "Best Debt Clock in the USA," is mesmerizing--how long until the GDP reaches 14 trillion?

Monday, November 5, 2007

Who Exactly are the Vultures?

. Monday, November 5, 2007

To read on vulture funds, check out a recent piece in Foreign Policy. More on this topic in a later post. If you wish to read more, check out Felix Salmon's spirited defense of vulture funds.

Sunday, November 4, 2007

Globalization and Inequality

. Sunday, November 4, 2007

The World Economic Outlook (an IMF publication) dedicates a full chapter to exploring globalization's impact on income inequality. "Over the past two decades, income growth has been positive for all quintiles in virtually all regions and all income groups during the recent period of globalization. At the same time, however, income inequality has increased mainly in middle- and high-income countries, and less so in low-income countries."

The study highlights the distinct causal forces exerted by trade and foreign direct investment. Trade and trade liberalization reduce inequality; foreign direct investment increases inequality.

The bottom line, however, is that technological change rather than globalization per se is the main cause of rising income inequality.

The Natural Resource Curse


The NYT Sunday Magazine has a terrific piece on Chavez's oil-financed Bolivarism, highlighting all of the classic elements of the natural resource curse. What is most striking, as my excerpts below highlight, is how predictable it all is...

The Cash Spigot:
"...Pdvsa is no longer an oil company...It now exists to finance Chávez’s transformation of Venezuela. The integration is illustrated by the fact that Rafael Ramírez, the minister of energy and petroleum, is also president of Pdvsa. “The Pdvsa that neglected the people and indifferently watched the misery and poverty in the communities surrounding the company premises is over,” Ramírez has said. “Now the oil industry takes concrete actions to deepen the revolutionary distributions of the revenues among the people.” If the Pdvsa of the 1990s thought it was Exxon, today’s Pdvsa amounts to the president’s $35 billion petty-cash drawer."

The Dutch Disease: "Oil caused the bolívar to be overvalued. Farms and factories are in trouble. They can’t export and must compete at home with products imported at the official exchange rate, which is now about a third of the market rate. And so the country is awash in artificially cheap imported products, from basic foodstuffs, like Brazilian cooking oil, to fancy cars."

Rent Seeking: "The disparity between the official exchange rate (2,150 bolívars to the dollar) and the black-market rate (6,200 bolívars at press time) has created a new class known as the Boliburgesía. Bankers, traders, anyone who works in finance or commerce, can get very rich manipulating the exchange rates. Buy all the imported whiskey and Hummers you want, is the message. Live a life of wild excess. Just don’t try to produce anything."

The Pattern: "This is classic oil curse, and Venezuela has seen it before. In 1973, and in 1981, Venezuela spent oil money wildly, without controls. Each time a boom ended, it left Venezuela worse off than before it began — per capita income in 1999 was the same as in 1960.

The Question: Are the gains sustainable this time around? And what happens if and when the spigot runs dry?

Wednesday, October 31, 2007

Who Sets American Exchange Rate Policy?

. Wednesday, October 31, 2007

A reader posed a question in a comment on an earlier post: "LeMonde today had a long op-ed on the European reponse to the high Euro and in it the author claimed that "La politique de change americaine est du seul ressort de la Maison Blanche, la Fed n'ayant pas son mot a dire sur le sujet." (Exchange rate policy is a White House resort only, the Fed does not say a thing about this). This confuses me. I thought interest rates were the main leverage of nations to impact exchange rates and those are clearly left to the Fed. So how can the White House be responsible for the exchange rate if they cannot regulate it in anyway?"

This is a good question; the short answer is that the Treasury and the Fed have separate authority to engage in foreign exchange market intervention. Treasury (executive branch) appears to have the upper hand. Yet, the Fed also has legal authority over interest rates. Practically speaking, then, the question of who controls exchange rate policy depends upon whether forex intervention is an effective instrument. As most economists seem to agree that it is not (which is why the US rarely engages in forex intervention), then practical authority would seem to lie with the Fed via their control of interest rates.

It is not altogether clear who has final say in the event of a conflict between exchange rate and domestic monetary objectives--can the Treasury force the Fed to expand the money supply to depreciate the dollar? Can the Fed force the Treasury to accept a dollar value in order to achieve its domestic monetary goals?

I think that exchange rate policy in the euro zone is similarly ambiguous; the ECB controls monetary policy while the Council of Ministers has the authority to set broad exchange rate objectives. What happens, who has ultimate authority, when they conflict is unclear. (on the ECB and Council, see here, Article 109).

Here's a longer (and more authoritative) answer from the New York Federal Reserve Bank (page 87):

By law and custom, the Secretary of the Treasury is primarily and directly responsible to the President and the Congress for formulating and defending U.S. domestic and international economic policy, assessing the position of the United States in the world economy, and conducting international negotiations on these matters. At the same time, foreign exchange markets are closely linked to money markets and to questions of monetary policy that are within the purview of the Federal Reserve. There is a distinct role and responsibility for the Federal Reserve,working with the Treasury and in cooperation with foreign central banks that operate in their own markets. For many years, the Treasury and the Federal Reserve have recognized the need to cooperate in the formulation and implementation of exchange rate policy.

The Treasury and the Federal Reserve each have independent legal authority to intervene in the foreign exchange market. Since 1978, the financing of U.S. exchange market operations has generally been shared between the two. Intervention by the Treasury is authorized by the Gold Reserve Act of 1934 and the Bretton Woods Agreements Act of 1944. Intervention by the Federal Reserve System is authorized by the Federal Reserve Act. It is clear that the Treasury cannot commit Federal Reserve funds to intervention operations. It also is clear that any foreign exchange operations of the Federal Reserve will be conducted,in the words of the Federal Open Market Committee (FOMC),“in close and continuous cooperation with the United States Treasury.” In practice, any differences between the Treasury and the Federal Reserve on these matters have generally been worked out satisfactorily.

Cooperation is facilitated by the fact that all U.S.foreign exchange market operations are conducted by the Foreign Exchange Desk of the Federal Reserve Bank of New York, acting as agent for both the Treasury and the Federal Reserve System.

Monday, October 29, 2007

Taxi! Taxi! Merde, pas de Taxi

. Monday, October 29, 2007

Interesting factoid of the day: "There are considerably fewer cabs in Paris today than there were in the 1920s, because of strict limits on new licences set by the drivers themselves."

Why, you might ask, are there fewer taxis today than in the 1920s? It turns out, to drive a taxi you need a license. If you want a free license to drive a taxi in Paris, you will have to wait for 17 years. If you are the impatient sort, then you can put up $263,000 to purchase a license today.

Why, you might ask, is it so costly to attain a license to drive a taxi in France? Because taxi drivers are unionized. France's reformers say that getting rid of the costly licenses would create 150,000 new jobs. The head of the taxi union, Alain Estival, is not enthusiastic; cab drivers "already saved France once when Paris' taxis brought troops to the front in the First World War -- they're not going to sacrifice themselves again to save the French economy."

According to some, such as Jacques Delpla, an economist on the commission established to help Sarkozy identify barriers to growth in France, the taxi problem is symbolic of the bigger French problem: you have to pay for working. And once you do, you have strong incentive to prevent any change to the rules of the game.

Sunday, October 28, 2007

Stagnant Incomes for the Middle Class?

. Sunday, October 28, 2007

Common wisdom tells us that incomes for "the rest" have failed to rise much in the last thirty years, while incomes for the lowest quintile have actually lost ground. Recent research by Terry J. Fitzgerald, senior economist at the Minneapolis Fed, questions this common wisdom and reaches some quite different conclusions.

In a nutshell, Fitzgerald finds that "labor income per hour for middle America has not stagnated. Rather, the economic compensation for work for middle Americans has risen significantly over the past 30 years."

It seems that the conclusion one reaches about real income growth rest heavily upon what price deflator one employs and how one treats non-wage benefits. If one uses a consistent deflator and includes non-wage fringe benefits as part of compensation, real hourly wages have risen by 25 to 30 percent since 1975. Not huge gains over thirty years, but also not consistent with the commonly-state claim that incomes are falling.

Friday, October 26, 2007

Remittances and Migration

. Friday, October 26, 2007

Sometimes life is serendipitous. The issue of remittances arose in class yesterday, and this morning the Times has a long article on just this issue.

Two points are interesting. First, according to Times figures, remittances to developing countries total more than $300 billion per year. Total official development assistance (foreign aid) peaked at $130 billion in 2005.

Second, the Times suggests that the current US effort to stem inward migration from Mexico is slowing the flow of remittances from the US to Mexico.

It strikes me that this is likely to have perverse consequences. Squeezing remittances will reduce disposable income in the households that had been benefiting from these transfers. As their income falls, many more might try to move across the border, thereby creating additional migration.

Moreover, as the border patrol cracks down on migration, the carrying trade becomes seedier. "As tighter security makes crossing the border trickier and more hazardous, the traditional mom-and-pop operations in Mexico that used to ferry people across have been replaced by larger, more-professional criminal gangs, often with ties to the illegal drug trade."

To summarize, the crack down on migration stems remittances, increases poverty and migration, and fuels criminal activity. This is not good policy.

Friday, October 19, 2007

Wedding Day

. Friday, October 19, 2007

I am sorry for my sporadic posting this past ten days. I have been busy making final preparations for my wedding (which is tomorrow). I return to work Thursday, October 25, and will resume a posting thereafter.

Thursday, October 11, 2007

Passing the Buck to Square the Circle

. Thursday, October 11, 2007

So, as the dollar weakens and the euro strengthens, an interesting dilemma arises. The Americans remain strangely quiet, happy about the dollar's depreciation but not trumpeting the fact. The Europeans are divided about what to do. The French want the European Central Bank to take steps to weaken the euro; other European officials celebrate the strong euro.

"France has complained loudly in recent weeks about the strength of the euro, with clear support from Italy, but Germany, the world's top exporter, kept its distance. German Finance Minister Peer Steinbrueck did so again as the ministers convened on Monday, telling journalists as he entered the Luxembourg meeting: "I prefer a strong euro." His Dutch and Austrian colleagues took a similar line."

Unable to agree upon a policy for the euro, it seems they decided to pressure China. "At a meeting dominated by worries about the strength of the euro, Jean-Claude Juncker, who is chairman of the group of euro zone finance ministers, described the concerns of the officials as being "first point, China; second point, dollar; third point, yen."

Thus, unable to agree on coordinated management of the dollar-euro rate, look for the US and the EU to agree to gang up on China at the forthcoming G-7 conference.

Wednesday, October 10, 2007

Travel Tip

. Wednesday, October 10, 2007

Don't travel from Durham, NC to Trondheim, Norway and back in four days unless you have one of these. 44 hours on planes, in airports, and in transit to and from airports. Eight separate flights; two canceled flights; three hour-plus delays. 34 hours in Trondheim.

Friday, October 5, 2007

Travel Time

. Friday, October 5, 2007

I'm off for a long weekend in chilly Trondheim, Norway. I'll post if I have time and internet access. Back on Wednesday.

Thursday, October 4, 2007

Upside Down World

. Thursday, October 4, 2007

Twenty years ago, developing countries were highly skeptical about participation in the global economy while western nations were enthusiastic participants. Now, it appears, as developing countries become increasingly supportive, western nations (especially the U.S.) become more uncertain.

"[A] survey of more than 45,000 people in 47 countries this past spring found large majorities everywhere saying trade was a good thing, particularly in countries lifted lately by trade-based growth, like Jordan and Argentina." (Click the image to the right for summary findings; Find the full survey here).

"But recent years have seen erosion in support for trade in advanced Western countries including Germany, Britain, France and Italy — and most sharply in the United States."

This is broadly consistent with the Stolper-Samuelson theorem's core prediction: abundant factors (developing country workers) gain from and support trade; scarce factors (western labor) lose from and oppose trade. Can it be as simple as that?

A puzzle: how can Americans be more favorable to free markets than to free trade (see the chart)?



"By a nearly two-to-one margin, Republican voters believe free trade is bad for the U.S. economy, a shift in opinion that mirrors Democratic views and suggests trade deals could face high hurdles under a new president."

Wednesday, October 3, 2007

The Great Betrayal?

. Wednesday, October 3, 2007

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.

Tuesday, October 2, 2007

Exchange Rates and the Stanley Cup

. Tuesday, October 2, 2007

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...

Sunday, September 30, 2007

Car Imports, Gas Prices, and Counter-productive Protectionism

. Sunday, September 30, 2007

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.

Thursday, September 27, 2007

Doha Update

. Thursday, September 27, 2007

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.

Wednesday, September 26, 2007

Puzzling Commentary on the Dollar's Decline

. Wednesday, September 26, 2007

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] 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.

Wednesday, September 19, 2007

Greenspan on Greenspan

. Wednesday, September 19, 2007

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.

Tuesday, September 18, 2007

Words to Live By?

. Tuesday, September 18, 2007

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.

Monday, September 17, 2007

How Fragile We Are

. Monday, September 17, 2007

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."

Friday, September 14, 2007

Panic on the Streets of London?

. Friday, September 14, 2007

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."

International Political Economy at the University of North Carolina: 2007




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