Relevant and even prescient commentary on news, politics and the economy.

European policy…really?

This week Trichet laid down the ECB’s hand, (effectively) announcing his intention to maintain inflation at the ECB’s target rather than allow it to overshoot. For all intents and purposes, 2% inflation stabilizes the real exchange rate rather than furthering real depreciation in the Periphery and real appreciation in Germany (or the Core).

Ambrose Evans-Pritchard agrees with my interpretations of Trichet’s speech:

Mr Trichet’s fire-breathing rhetoric can be taken as a signal that the ECB will continue to run monetary policy for German needs and tastes, refusing to accommodate a little slippage on inflation to let Club Med regain lost competitiveness without having to endure the agony of debt-deflation. Indeed, the ECB seems to have picked up some of the worst habits of its mentor.

Only the rebalancing of inter-euro current accounts will bring stable fiscal finances for debtor and creditor countries alike, something made more difficult with 2% average inflation! Trichet, in an interview with German newspaper,, doesn’t acknowledge this fact (bolded by RW):

Let me be very clear: this is not a crisis of the euro. Rather, what we have is a crisis related to the public finances of a number of euro area countries. All governments have to put their finances in order, and above all those governments and countries which have lived well beyond their means in the past.

Really? On the aggregate, Euro zone economies ‘living well beyond their means’ are now doing so in two respects: the current account deficit and public deficits. They’re not the same. Don’t even start with the ‘twin deficit’ story – Rob Parenteau refuted that some time ago.

It’s not about government dissaving, per se. For countries like Spain, or any other Euro area economy with years of accumulated private sector leverage, the only way for the public sector to simultaneously reduce fiscal and private deficits is for Germany foreigners to dissave (foreigners run large CA deficits). (See a previous post of the 3-sector financial balances model here.)

Given the close trade ties in the Euro zone, growing income from abroad effectively means a transfer of saving from the Eurozone Core to the Periphery via the current. This requires real appreciation in Germany, for example, and real depreciation in Spain.

First, real appreciation/depreciation could have been given a fighting chance with a lapse of the inflation target. Trichet made it quite clear where the ECB stands on this front: NEIN.

Portugal, Greece, and Spain have essentially no chance if left to their own accord.

Spain along with other Periphery economies are relatively “closed” compared to the German export powerhouse; that needs to change.

The chart above illustrates the degree of openness across the Eurozone, as measured by (exports + imports) divided by GDP. Spain, Greece, Italy, and France (expected to run budget deficits the size of Spain this year) are the most ‘closed’ of the Euro area (16, not including Estonia). In Greece, Spain, and Italy, the GDP share of export income has decreased over the last decade; furthermore, it’s imports, rather than exports, that make the larger contribution to economic openness.

Export share
(Q3 2010)
Import share
(Q3 2010)
Greece 20.2 26
Spain 26.1 27.5
Italy 27.0 28.5

Even if Spain was more ‘open’, real appreciation is ingrained in the economy, as represented by unit labor costs. Structural reform is required on many fronts, private and public.

Since 2001, Spanish unit labor nearly doubled, +46%, while those in Germany grew just 17%. Recently, unit labor costs in Spain have stabilized. This is due to the contraction of the construction sector, which dragged productivity in recent years. Going forward, more is needed.

The EU made several recommendations in their 2010 Surveillance of Intra-Euro-Area Competitiveness and Imbalances (pg. 78):

Enhancing productivity in a more sustainable way would involve further investment in and enhancing the efficiency of expenditure in research, development and innovation, as well as improving the efficiency of R&D expenditure are crucial for achieving productivity advances. Further improvements of the education and life-long learning systems and investment in human capital should also be envisaged. This may be achieved inter alia, by ensuring the effective, implementation of widespread education reforms in addition to upgrading the skills and increasing mobility of the labour force to promote a swift transition into employment, and reducing segmentation in the labour market.

Nowhere does the report say that competitiveness should be achieved by getting public finances ‘in order’. In fact, I’d deduce from these comments that more, rather than less, government spending is needed.

Without > 2% inflation, these countries don’t stand a chance.

Rebecca Wilder

Appendix: Another measure of relative price competitiveness, the GDP deflator.

The Great Trade Collapse…VoxEU

Richard Baldwin at VoxEU introduces a new book on “great trade collapse” before the WTO meeting occurring shortly.

Re-posted with attribution:

The Great Trade Collapse

World trade experienced a sudden, severe and synchronised collapse in late 2008 – the sharpest in recorded history and deepest since WWII. VoxEU today posts a new Ebook – written for the world’s trade ministers gathering for the WTO’s Trade Ministerial in Geneva – that presents the economics profession’s received wisdom on the collapse. Two dozen chapters, written by leading economists from across the planet, summarise the latest research on the causes of the collapse as well as the consequences and prospects for recovery.

The world’s trade ministers gather at the WTO next week just as the world’s trade is starting to recover from the “great trade collapse” – the sharpest drop in recorded history and deepest since WWII.

Vox has today posted an Ebook “The Great Trade Collapse: Causes, Consequences and Prospects” that aims to tell the world’s trade ministers what economists’ know about the trade collapse.

The Ebook can be downloaded for free from

Hard copies of the book may be ordered by emailing Anil Shamdasani:

Establishing consensus on the cause

The two dozen chapters establish a consensus on what caused the collapse. In a nutshell, it was caused by the sudden postponement of purchases, especially of durable consumer and investment goods. Trade fell far more than GDP, since the demand shock was amplified by “compositional” and “synchronicity” effects.

•“Compositional effect”: In the 4th quarter of 2008 and 1st quarter of 2009, the Lehman-induced ‘fear factor’ caused consumers and firms around the world – but especially in the US and EU – to freeze; expenditures were postponed until things became clearer. The sales/production of “postponeables” plummeted, dragging down GDP growth rates. However, since the composition of GDP places much lower weight on postponeables than the composition of trade, the same shock had a substantially larger impact on trade than it did on GDP; the lion’s share of trade takes place in manufactures, mostly final durable consumer and investment goods, and related parts and components.

•“Synchronicity effect”: National drops in trade were large – many attaining post-war records – but the world trade drop was much larger than previous episodes, since almost every nation’s trade dropped sharply; there was no averaging out this time. The synchronisation was probably due to the global and instantaneous transmission of the ‘fear factor’, and partly due to the development of international supply chains that reacted “just in time” to the collapse in demand for postponeables.

Other factors
Some of the chapters find evidence for supply-side factors, but other do not. The supply shocks considered include: the impact of the credit crunch on the specialised financial instruments that grease the gears of international trade (e.g. letters of credit), bankruptcy-induced disruptions of international supply chains, and protectionism.

The best available evidence suggests that declines in global trade finance have not had a major impact on trade flows. Policy responses aimed at shoring up trade credit were early and massive; these may have prevented credit from being more of a problem than it was.

There is no evidence that protectionism played a direct role so far; there has been plenty of new protection, but is has been applied to small trade flows.

Finally, there is almost no evidence that supply chains have collapsed. Direct evidence from firm-level data shows that the exits of firms from trade relationships (i.e. the extensive margin) has not played an important role in this crisis.

If the global economy recovers, the recovery of global trade – which seems to have started in mid-2009 – is likely to be rapid, with pre-crisis growth rates being reached next year. This could foster growing imbalances.

Several authors warn that the global imbalances are a problem for the trade system as well as for the macro and financial system. As unemployment in many nations is projected to rise, or at least remain high, pressures for a protectionist backlash could grow over the coming year or two. To avoid this, and to prevent laying the foundations for another global crisis down the road, the US, China and other nations with large trade imbalances should undertake the necessary macroeconomic adjustments, such as exchange rate realignments, and designing credible plans for long term fiscal sustainability.

This article may be reproduced with appropriate attribution. See Copyright (below).

China’s Industrial Policy vs. US Random Behavior…Firedoglake


Firedoglake presents a well written piece on US and Chinese trade policy:

China’s Industrial Policy vs. US Random Behavior

The U.S. China Economic and Security Review Commission has issued its annual report {giant .pdf}. Robert Borosage of the Campaign for America’s Future hosted a conference call for the Co-Chair of the Commission, Carolyn Bartholomew, and Clyde Presotwitz of the Economic Strategy Institute, who was U.S. Trade Representative under Reagan. The call offered these experts an opportunity to talk about China’s industrial policy.

Prestowitz said something that focused the entire issue for me. He pointed out that labor is not a significant factor in chip manufacture. Why then are so many chip manufacturing facilities located in China? He says it’s because the Chinese wanted these as part of their industrial policy, so they seized the land, built the infrastructure, provided low-cost loans, granted energy and water subsidies, trained a work force, and gave the manufacturers tax breaks. Now they offer more subtle incentives, funding for research and development, refunds of the value added tax and space in industrial parks. As Prestowitz said, the plants are there for financial reasons.

This is Chinese policy. They want to grow their economy by attracting foreign capital and foreign technology. They intend to maintain state control over crucial industries.

China’s overall industrial policy … is characterized by three main parts: (1) the creation of an export-led and foreign investment-led manufacturing sector; (2) an emphasis on fostering the growth of industries such as high-technology products that add maximum value to the Chinese economy; and (3) the creation of jobs sufficient to reliably employ the Chinese workforce, thereby allowing the Chinese Communist Party to maintain control.

Many Chinese subsidies violate the requirements of the World Trade Organization, and the US has sought sanctions, but the Commission says that the WTO rules are meant to deal with narrow issues, not the broad national practices of China. The WTO rules require consultations as well as litigation, and even after a victory, they are able to delay. By the time the US and Canada won a WTO ruling barring favoritism in manufacture of auto parts, many manufacturers had moved production to China, so those jobs were lost.

Don’t think that we will be able to compete with our high tech products. China uses industrial policy to achieve technology transfer. Here’s an example from the call. China had not mastered several crucial issues in the manufacture of jet propulsion blades.

Several thoughts come to mind:

1. Appeals to the notion that command economies fail is not re-assuring at best and grossly misleading at worst. Since 1992 Chinese leaders took a different turn from our old notions of ‘command’ economies of cold-war stories.

2. China is wrenching a pre-industrial economy into the 21st century, at a speed that is breathtaking. The US is struggling with shedding 20th century notions of what we think we are…

3. There is no reason to think that ‘green shoots’ industries are assured in the US as a jobs policy. Such industry building is already occurring in China (and Germany).

4. We insist China re-direct its drive to a domestic consumer orientation, and talk about how the government deliberately keeps the economy as an export platform, but if many times more money is made currently exporting due to high prices for exports than if sold domestically, would you change direction in a hurry? Who is getting the bargain overall? Many Chinese businesses are still learning new standards.

5. Chinese leaders are taking a big gamble. And Chinese society is taking a big hit overall, with great disruption in people’s lives. The US is also experiencing great change…slower perhaps, but we haven’t really accepted the fact nor figured out that we have change to no matter what.

6. Some of the unease on right and left is due to some sort of view of this change. Is it along the lines we are used to, and/or simply myopic?

Trade policy debate to begin for mid-term elections?


Trade policy debate begins in Pennsylvania?

America’s economy is now struggling to recover from the Great Recession. But even when the economy was said to be humming, it did not work for most Americans. Wages were stagnant or declining and the costs of basics – health care, housing, college – were soaring. Growth was built on unsustainable debt, as the country borrowed $2 billion a day from abroad and Americans spent more than they earned. Wall Street captured fully 40 percent of the country’s profits.

President Obama has stated that we can’t go back to the old economy, and shouldn’t want to. We must make more, sell more and consume less. The question is: What is our economic strategy in a global economy?

“The fight for American manufacturing is the fight for America’s future,” Obama has declared. That fight will require a fundamentally different economic strategy, one that will ensure a sustained prosperity that is widely shared, one that will leave the American dream within reach of those who work hard.”

So how do we actually start?

Is it true that foreigners finance American debt?

This is the question raised by Brenda Rosser in a couple of posts at Econospeak Is it true? To which Barkley Rosser (no relation to Brenda and in fact living on the opposite side of the world-it really is an odd and small blogosphere sometimes) replies in part as follows:

The Chinese central bank has been buying lots of US Treasuries to help keep the dollar up and the yuan/rmb down, so that US citizens will continue to buy Chinese exports. It is that simple.

With apologies to Prof. Rosser (a huge ally in the Social Security debate) I suggest that rarely is anything related to such matters ‘that simple’.

Not being an expert here I fall back on the only tools I really have. Which is to say official government data sets and a calculater. In this case I am going to start with this table which shows holdings of US Treasuries by month from Sept 2007 to Set 2008 MAJOR FOREIGN HOLDERS OF TREASURY SECURITIES. And after a little examination of the numbers it would appear that the answer to Brenda’s question is not in fact ‘Well, duh’ but instead ‘Well lets see if we can make sense of the actual numbers’.

Because as usual everything is simple if you ignore the complexities.

The first thing to note is that while China was indeed the largest foreign single holder of Treasuries in Sept 2008 that is actually something new, for every other month shown Japan actually held more. Nor do the numbers show that China was buying aggressively, in four of the months in the table their net holdings actually dropped. If we would have been having this discussion in July (with data through June) the answer to Brenda’s question, at least in relation to China would have been ‘Well not really’ with Chinese holdings increasing on average $4 bn a month over a nine month period. (Social Security’s cash surplus loaned to Treasury over this period would have been about double that and its accumulated balance right at 4X that of China).

Still obviously China is the biggest single current player, after all in the three months from June to September they added $81 billion to their portfolio. On the other hand over that same period ‘Carib Banking Centers’ added $63 billion to theirs, while the UK (which includes tax sheltering Channel Islands) added $58 bn. Now given banking secrecy laws in these countries it is impossible to know how much of these asset purchases were on behalf of Americans or American based MNCs, but clearly it is a number well north of zero.

If we proceed to look at these numbers in percentage terms China is essentially holding steady, maintaining right at 20% of all such foreign holdings. That is as the U.S. stepped up borrowing they stepped up lending but only in proportion to the new debt being issued. Nor were they getting backstopped by the rest of East Asia: Japan, Hong Kong, Taiwan, Thailand all reduced their holdings modestly, while Korea and Singapore held fairly steady over this period.

If we back up and look at who dramatially stepped up over the course of the year we get some unexpected suspects, particularly is we look at the percentage increases: UK $120 bn to $338 bn, Carib Banking $99 bn to $185 bn, Oil Exporters $137 bn to $182 bn (no surprise there), but then we have Luxembourg going from $58 bn to $91 bn, Russia from $32 bn to $70 bn, and Norway from $22 bn to $52 bn. Now some of this can be explained by oil prices but by no means all, I don’t recall that either the Caribbean or Luxembourg as being particularly dotted with oil wells. Nor would they seem to be huge net exporters to the U.S.

It is easy to get mesmerized by the sheer size of China and the fact that just about everything sold at WalMart (and most everywhere else) comes from East or Southeast Asia. But those who would explain everything by pointing to current trade accounts or the Chinese desire to prop up the yuan/rmbi have some explaining to do. Because there is a sea of money flowing to Treasuries (totalling up to more than 80% of the new demand) from outside Asia. And the question of how much of that money ultimately has American fingerprints on it is a good one, after all we know there are huge tax avoidance games going on, and some of that cash will inevitably end up in foreign held Treasuries.
While I am at it can we get some overall perspective on the debt? If we visit the Treasury’s Debt to the Penny we can see the following totals:
Debt held by the Public $6.4 trillion
Intragovernment holdings $4.2 trillion
Total $10.6 trillion Okay that is a lot of change. On the other hand it includes some $2.3 trillion in Social Security asset/liabilities/Special Treasuries/’phony IOUs’ (pick one) that will not start being redeemed until 2023. In some sense our ‘real debt’ (that which could be dumped on the market tomorrow) is limited to that $6.4 trillion.

Still a lot of change. But to keep an apples to apples approach what was that number on Sept 30th? $5.8 trillion (my Hank P has been busy). How much of that was held by (ostensibly) foreign holders? $2.86 trillion. By China? $585 billion. Or 10% of all debt then held by the public, 5.5% of all total debt.

Frankly the notion widely promulgated over the last few years that the U.S. was hopelessly exposed to some decision by the CCB to dump Treasuries always seemed overblown. And the ability of Treasury to raise even more than that over a two month period ($5.8 trillion to $6.4 trillion since Sept 30th) seems to have proved the point. I am not so naive as to believe that the world will continue to effectively lend money to the U.S. for returns that are effectively negative for unlimited periods of time. But I do suggest that to reduce everything to the Current Trade balance with China and the willingness of the PRC to prop up exports by buying dollars is just that: reductionism that does in fact ignore the complexities, in part by not putting the numbers in context.