From Economist.com, “Grossly distorted picture“:

However, the single best gauge of economic performance is not growth in GDP, but GDP per person, which is a rough guide to average living standards. It tells a completely different story…

GDP growth figures flatter America’s relative performance, because its population is rising much faster, by 1% a year, thanks to immigration and a higher birth rate. In contrast, the number of Japanese citizens has been shrinking since 2005. Once you take account of this, Japan’s GDP per head increased at an annual rate of 2.1% in the five years to 2007, slightly faster than America’s 1.9% and much better than Germany’s 1.4%. In other words, contrary to the popular pessimism about Japan’s economy, it has actually enjoyed the biggest gain in average income among the big three rich economies. Among all the G7 economies it ranks second only to Britain (see left-hand chart).

Related to this is my earlier post where Warren Buffett echoed the same view that if recession is measured by decline of GDP per capita growth, the U.S. was already in recession.

With soaring food and oil prices worldwide, Malthus’ pessimistic predictions come alive again, just like 70s. I feel fortunate I am an economist, a.k.a. an optimist.

Need not say more:

(click to enlarge)

Should I just ride bicycle?

(source: slate.com)

Cash-strapped drinkers are starting to switch to lower-priced beers. Since January, Miller Brewing Company has seen a shift from higher-priced, premium beers to less expensive brands such as Miller High Life and Milwaukee's Best. (source: NPR)

Forget cheap imports. China's rise will soon be a force on Wall Street and Main Street and in Silicon Valley.

By Geoff Colvin

(Fortune Magazine) — Back in 2001 when the International Olympic Committee chose Beijing as the site of this summer's games, the event was meant to mark China's debut as a player on the global economic stage. But a recent study by the economist Angus Maddison projects that China will become the world's dominant economic superpower much sooner than expected – not in 2050, but in 2015.

While short-term investors are already cashing in on China's growth by playing the global commodities boom, smart long-term thinkers are contemplating what happens when China matures from an exporter of cheap goods to a competitor in sectors where the U.S. is dominant – technology, brand building, finance. China has almost wiped U.S. makers of low-value items like toys and socks, but by 2015 it may threaten Apple (AAPL, Fortune 500), J.P. Morgan Chase (JPM, Fortune 500), and Procter & Gamble (PG, Fortune 500). It will increasingly influence the S&P 500 and the mutual funds in our 401(k)s. So it's worth looking at how that will happen, what it means, and what anyone can do in the seven years before the baton is passed.

Just using the exchange rate to convert China's GDP into dollars isn't helpful in comparing the two economies, because China controls its exchange rate; by that method, China's economy might not pass America's for decades. Exchange rates apply only to tradable products and services; they aren't very useful in valuing nontradable goods in a country like China that is much poorer than the United States. So we need some way to compare the real value of China's economic output with America's, and economists have developed one. It is called purchasing power parity.

For example, Chinese construction workers earn a whole lot less than Americans do, yet they can still build top-quality buildings. If we used the exchange rate, the value of a new skyscraper in Shanghai would count much less toward China's GDP than an identical building in Chicago would count toward America's, which makes no sense. Purchasing power parity corrects the problem.

Will China take the crown?

Angus Maddison's forecast (which uses purchasing power parity) isn't built on outlandish assumptions. He assumes China's growth will slow way down year by year, and America's will average about 2.6% annually, which seems reasonable. But because China has grown so stupendously during the past decade, it should still be able to take the crown in just seven more years.

If that happens, America will close out a 125-year run as the No. 1 economy. We assumed the title in 1890 from – guess who. Britain? France? No. The world's largest economy until 1890 was China's. That's why Maddison says he expects China to "resume its natural role as the world's largest economy by 2015." That scenario makes sense.

China was the largest economy for centuries because everyone had the same type of economy – subsistence – and so the country with the most people would be economically biggest. Then the Industrial Revolution sent the West on a more prosperous path. Now the world is returning to a common economy, this time technology- and information-based, so once again population triumphs.

So how should we make the most of our seven-year grace period? For companies: Focus on getting better at your highest-value activities. Just because the Chinese will be fighting you in the same industries doesn't mean you'll lose. (Investors, remember that China bought $3 billion of Blackstone (BX) at the IPO price of $31 last summer, and the firm is now trading at $19.) It only means you'll have to work harder to win.

For individuals: You can avoid competition with Chinese workers by doing place-based work, which ranges in value from highly skilled (emergency-room surgery) to menial (pouring concrete). But the many people who do information-based work, which is most subject to competition, will have to get dramatically better to be worth what they cost. For government leaders: Improve U.S. education above all.

Those are the issues in China's becoming No. 1 that we most need to focus on. And as with so much else in China's recent history, we'll need to worry about them much sooner than we expected. 

Bubbles emerge at times when investors profoundly disagree about the significance of a big economic development, such as the birth of the Internet. Because it's so much harder to bet on prices going down than up, the bullish investors dominate.

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Manias can persist even though many smart people suspect a bubble, because no one of them has the firepower to successfully attack it. Only when skeptical investors act simultaneously — a moment impossible to predict — does the bubble pop.

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Bubbles don't spring from nowhere. They're usually tied to a development with far-reaching effects: electricity and autos in the 1920s, the Internet in the 1990s, the growth of China and India. At the outset, a surge in the values of related businesses and goods is often justified. But then it detaches from reality.

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One who believes a stock is too high can short it, borrowing shares and selling them in hopes of replacing them when they're cheaper. But this can be costly, both in the fees and in the risk of huge losses if the stock keeps rising. Many big investors rarely short stocks. When differences between bullish investors and bearish ones are extreme, many of the bears simply move to the sidelines. Then, with only optimists playing, prices go higher and higher.

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At some point in a bubble, optimists' enthusiasm runs its course. Prices turn down. There's an expectation that at this point, investors who were skeptical may see prices as more reasonable and start buying. If they don't, that's a signal that prices had gotten way too high — and then they tumble.

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The insights of bearish investors "are more likely to be flushed out through the trading process when the market is falling, as opposed to when it's rising," Mr. Hong and Harvard's Jeremy Stein write. They say this explains why prices fall more rapidly than they go up. Over 60 years, nine of the 10 biggest one-day percentage moves in the S&P 500 were down.

Greg Ip has a nice piece on wsj summarizing the ongoing heated debate whether the Fed should prick bubbles using monetary policy and whether monetary policy itself is the culprit for creating bubbles.

William Buiter argues in the case of financial crisis that involves cross-border banking activities where reponsibilities cannot be clearly defined, ECB, lack of backing of fiscal authority of a single sovereign country, cannot function as the lender of last resort. Something needs to be done about it.