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What’s ahead of us?

Victor Sperandeo, George Soros’ former trader, commonly nicknamed as trader Vic, himself a wall street legend, shares his views on many interesting issues today: US economy, bond outlook, inflation, US dollar, gold and silver. A very insightful piece. I highly recommend it.

Stagflation v2, it is

Ronald McKinnon, economics professor at Stanford,  thinks the US is already entering stagflation:

'Stagflation" is an ugly word for an ugly situation: persistent high inflation combined with high unemployment and stagnant demand in a country's economy. The term was coined by British politician Iain Mcleod in a speech to Parliament in 1965. We haven't experienced it here in the United States since the bad old days of the 1970s.

Yet with prices on the rise and unemployment still high, the U.S. economy again seems to be entering stagflation. April's producer price index for finished goods, which excludes services and falling home prices, rose 6.8%. The Bureau of Labor Statistics reports that intermediate goods prices for April were rising at a 9.4% annual clip. Meanwhile the official nationwide unemployment rate is mired close to 9%, without counting a large backlog of discouraged workers who are no longer officially in the labor force. So stagflation it is. 

The stagflation of the 1970s was brought on by unduly easy U.S. monetary policy in conjunction with attempts to "talk" the dollar down, leading to massive outflows of hot money that destabilized the monetary systems of America's trading partners. Although today's stagflation is not identical, the similarities are striking.

full text is here.

Is manufacturing necessary for poor countries to become rich?

The traditional growth model for a poor country to become rich has always been a two-stage transition model.  First, transition from agriculture to manufacturing, then from a manufacturing based economy to a modern economy largely based on services sector.  Western European countries and the United States all went through the same growth process.

The intriguing question is, can a country prosper without going through the manufacturing phase?  India so far seems to have defied the conventional wisdom, and its services sector led and powered India's fast growth for the last 15 years or so.  But is India's growth sustainable?  Can the service-led economy generate enough jobs for the poor peasants?  And will India ultimately rely on manufacturing for its growth?

In one of the first efforts to untangle these questions, Economist Magazine recently has a very nice piece summarizing what we have known and not known so far:

INDIA’S services revolution has dazzled businesses in the rich world, turning Indian companies into global competitors and backwater cities such as Hyderabad into affluent, sophisticated technology centres. Yet economists have been less star-struck, clinging to the received wisdom that has prevailed since the industrial revolution: modernisation runs from agriculture through manufacturing and only later to services. Now some have broken ranks.

The logic supporting the conventional path towards an advanced economy is straightforward. Development typically involves moving workers from low-productivity activities such as subsistence farming to high-productivity sectors. That points to a shift into manufacturing because it lends itself to specialisation and economies of scale, both essential for rising output per worker. As first Japan, then Taiwan and South Korea, and now China have demonstrated, manufacturing can also accelerate development because its output can be exported to rich countries.

Services, in contrast, appear to be a graveyard for productivity. Because a haircut or a restaurant meal has to be delivered in person, there is almost no potential to exploit economies of scale and to export. People consume more services not when technological advance lowers their price but when they have reached a level of affluence that satisfies most of their other needs. Indeed William Baumol famously argued in the 1960s that as countries grew richer and their citizens became keener on buying services, their productivity growth would inevitably slow.

That conventional wisdom is now under fire, in a book edited by Ejaz Ghani of the World Bank and a related article he wrote with Homi Kharas of the Brookings Institution and Arti Grover also of the World Bank on the VoxEU website. The authors argue that technology and outsourcing are enabling services to overcome their former handicaps. Traditional services such as trade, hotels, restaurants and public administration remain largely bound by the old constraints. But modern services, such as software development, call centres and outsourced business processes (from insurance claims to transcribing medical records), use skilled workers, exploit economies of scale and can be exported. In other words, they are just like manufacturing. If that is the case, then poor countries should be able to go straight from agriculture to services, leapfrogging manufacturing.

Read the full text here.  For the previous related post, look here and here.

Housing is the business cycle

Housing's double dip does not bode well for the already anemic economic recovery.  People often play down the importance of housing sector and cited housing sector was just 7% of the national economy. 

But according Ed. Leamer, a prominent economics professor at UCLA and an expert on business cycle,  "Anyone playing down the importance of housing at this point in the business cycle is missing the point: Housing is the business cycle."

According to WSJ, the Commerce Department on Tuesday is expected to report new-home sales were roughly flat in April, at a seasonally adjusted annual pace of 300,000. That is woeful by historical standards. Unless sales pick up materially this year, 2011 will mark a sixth year in a row of new-home-sales declines and the fewest sales since records began being kept in 1963. One statistic tells the story: The 323,000 new homes sold in 2010 was less than 60% of the number of new homes sold in 1963, even though the population today is nearly two-thirds bigger.


We are stuck today, as in the 1930s, in a household recession triggered by excessive debt levels. These, unfortunately, can take many years—not months—to fix.

China becomes world’s top gold bug

According a recent piece of WSJ,

China's investment demand for gold more than doubled to 90.9 metric tons in the first three months of the year, outpacing India's modest rise to 85.6 tons, the World Gold Council said in its quarterly report on Thursday. China now accounts for 25% of gold investment demand, compared with India's 23%.

Historically, India has been the largest investment market for gold. In 2007, just before investing in gold began to take off globally, India's physical gold demand accounted for 61% of the world's total. China's was 9%. In terms of total consumer demand, which also included jewelry, India is still a bigger consumer of gold than China, taking in 291.8 tons in the first quarter, compared with China's 233.8 tons.

In developed countries, some investors have switched into physical gold holdings from ETFs. Demand in Germany and Switzerland both more than doubled, while the U.S. had a 54% jump to 22.5 tons during the quarter.

As the world's largest gold producer, China churned out 350.9 tons in 2010, but it wasn't enough to sate total demand— including bullion, jewelry and technology uses—of more than 700 tons, according to the gold council's report. As demand continues to outpace supply, analysts expect China to import more bullion.

Analysis of April Employment Report

John Silvia:

David Rosenberg:

Silver: poor man’s gold, part 2

George Soros identifies asset bubbles by their “parabolic move”.

By this yardstick, silver is trading near bubble territory.  The following chart compares the 5-year performance of ETFs of silver vs. gold, precious metal and commodity index.

(click to enlarge)

So how high is today’s silver price in historical perspective? According to WSJ, silver closed last Thursday at $47.52 a troy ounce, up $1.562, or 3.4%, and just short of the $48.70 record settlement reached in 1980. Adjusted for inflation, that record price would be equivalent to $139.88 today.  After skyrocketing 84% in 2010, silver prices have jumped another 54% so far this year. In comparison, gold is up 7.7%, hitting a new record of $1,530.80 an ounce on Thursday.


Read part 1 of silver story here.


Jim O’Neill on China and the World Economy

Jim O’Neill at Goldman Sachs, who is famous for coming out the acronym, BRIC, discusses with Charlie Rose on the long term growth prospects of BRIC economies, especially on China.

(click to play the video; source: Charlie Rose)