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Yearly Archives: 2011
Overconfident Ben Bernanke
In the following video, Ben Bernanke answers questions from Paul Ryan (R-WI). Paul asked some really sensible questions. Bernanke remains largely too confident. This is generally not a good sign.
Allan Meltzer, a historian specialized in the Federal Reserve system, in the following WSJ piece, shares his historical view on the Fed and inflation outlook. He thinks Bernanke Fed will put us on another “70s show”.
In the 1970s, despite rising inflation, members of the Federal Reserve’s policy committee repeatedly chose to lower interest rates to reduce unemployment. Their Phillips Curve models, which charted an inverse relationship between unemployment and inflation, told them that inflation could wait and be addressed at a more opportune time. They were flummoxed when inflation and unemployment rose together throughout the decade.
In 1979, shortly after becoming Fed chairman, Paul Volcker told a Sunday talk-show audience that reducing inflation was the best way to reduce unemployment. He abandoned the faulty Phillips Curve thinking that unemployment was the enemy of inflation. And he told the Fed’s staff that while he thought highly of their work, he did not find their inflation forecasts useful. Instead of focusing on near-term output and employment, he changed the Fed’s policy to put more emphasis on the longer-term reduction of inflation. That required a persistent policy that President Reagan supported even in the severe 1982 recession.
We know the result: Inflation came down and stayed down. The Volcker disinflation ushered in two decades of low inflation and relatively steady growth, punctuated by a few short, mild recessions. And as Mr. Volcker predicted, the unemployment rate fell after the inflation rate fell. The dollar strengthened.
That was not unprecedented. The Phillips Curve often fails to forecast correctly. Spanish inflation has increased in the last year while the unemployment rate rose above 20%. Britain also has rising inflation and rising unemployment. Brazil lowered inflation and unemployment together. There are many other examples if only the Fed would look at them.
Throughout its modern history, the Fed has made several of the same policy mistakes repeatedly. Two are prominent now. It concentrates on near-term events over which it has little influence, and neglects the longer-term consequences of its operations. And it interprets its dual mandate as requiring it to direct all of its efforts to reducing unemployment when the unemployment rate rises. It does not have a credible long-term plan to reduce both current unemployment and future inflation, so it works on one at a time. This is an inefficient way to achieve a dual mandate. It failed totally during the Great Inflation of the 1970s. I believe it will fail again this time.
Commodity and some materials prices have increased dramatically in the past year. Countries everywhere face higher inflation. Despite the many problems in the euro area, the dollar has depreciated against the euro, a weak currency with many problems, suggesting that holders expect additional dollar weakness. Imports will cost more.
I believe it is foolhardy to expect businesses to absorb all the cost increases by holding prices unchanged. And loan demand has started to pick up, increasing the amount of money in circulation. It is a big mistake to expect that the U.S. will escape the inflation that is now rising throughout the world.
Because the Fed focuses on the near term, it tends to ignore changes in money-supply growth. This, too, is a mistake. Sustained inflation always follows increases in money-supply growth. Sustaining negative real interest rates (i.e., adjusted for inflation), as we have now, will cause this.
The Fed should make three changes. First, it should increase the short-term interest rate it controls to 1%, which would show that it is aware of the inflation risk and will act promptly to counteract it. Current low interest rates are an opportunity for the Fed to start reducing excess reserves.
China steps up its global currency move
There has been a stream of news on Chinese government's new move to make Yuan global. First, Bank of China recently allowed customers in NYC to open Yuan account; then China is set to allow its firms to trade currency swaps to hedge currency risk starting from March 1st; then foreign firms operated in China, such as McDonald, now will be allowed to issue Yuan-denominated bonds in Hong Kong. According to NYT,
Meanwhile, in Russia, Vietnam and Thailand, some cross-border trades with China can now be settled in renminbi, so that trading partners do not have to convert in and out of dollars. One pilot program lets Russian companies like Sportmaster, a retail chain based in Moscow, buy or sell goods using Chinese currency.
And in New York, the Chinese government has permitted an overseas branch of Bank of China to accept deposits in renminbi. That enables depositors outside China to bet on a currency that is widely expected to appreciate against the dollar over the next few years.
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Robert A. Mundell, a Nobel laureate economist whose research is credited with helping develop the euro, says the renminbi’s rise is all but inevitable.
“The RMB is likely to become a reserve currency in the future, even if the government of China does nothing about it,” Professor Mundell said in an e-mail response to questions. He noted that the renminbi was already a regional currency in Southeast Asia, where China had become the dominant trading partner of many countries.
If China does eventually open its capital market by eliminating currency exchange controls, he said, “the progress of the RMB as an international currency will be assured.”
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As an influence on global financial markets, the renminbi is “still a distant, distant, distant fourth,” said Albert Keidel, a China specialist at the Public Policy Institute at Georgetown University in Washington. “People are going to start holding more renminbi, but it will be at least a decade or two for it to become a leading world reserve currency.”
I expect that, in an optimistic scenario, Yuan will become fully convertible in five to ten years.
Is US manufacturing really declining?
A lot of misconceptions, a lot of wrong facts – you don't find "Made in USA" in consumer goods, but US manufacturing is everwhere in durable and capital goods. According to Jeff Jacoby of Boston Globe:
Americans make more “stuff’’ than any other nation on earth, and by a wide margin. According to the United Nations’ comprehensive database of international economic data, America’s manufacturing output in 2009 (expressed in constant 2005 dollars) was $2.15 trillion. That surpassed China’s output of $1.48 trillion by nearly 46 percent. China’s industries may be booming, but the United States still accounted for 20 percent of the world’s manufacturing output in 2009 — only a hair below its 1990 share of 21 percent.
A vast amount of “stuff’’ is still made in the USA, albeit not the inexpensive consumer goods that fill the shelves in Target or Walgreens. American factories make fighter jets and air conditioners, automobiles and pharmaceuticals, industrial lathes and semiconductors. Not the sort of things on your weekly shopping list? Maybe not. But that doesn’t change economic reality. They may have “clos[ed] down the textile mill across the railroad tracks.’’ But America’s manufacturing glory is far from a thing of the past.
US Housing price sinks further
The Wall Street Journal’s latest quarterly survey of housing-market conditions found that prices declined in all of the 28 major metropolitan areas tracked during the fourth quarter when compared to a year earlier.
As of Nov. 2010, housing prices declined in all major cities except for Los Angeles, San Diego, and Washington DC. See the chart below (courtesy of CalculatedRisk).
(click to enlarge)
It seemed that the earlier government’s home buying credit stalled the normal housing market correction. Now the law of physics kicks in again.
As a side phenomenon, the housing woe fuels a surge apartment rental market. The slow recovery in labor market and the direction of housing price are the major culprits. People rationally substitute rental for owning a house – which tends to create a negative feedback loop and dent the housing price further.
WSJ reports, with millions of families switching from being homeowners to renters, apartment-building values have soared. Investor demand is so intense, prices of some properties are approaching values last seen in mid-2007…Values of apartment buildings rose 16% in 2010, according to brokerage firm Marcus & Millichap, after falling 27% between 2006 and 2009.
When I moved out of Boston in the summer of 2009, the apartment rental market was quite dismal. I spent a few month trying to sublet my apartment and eventually I took a hit of at least 20% . But now the fortune reversed.
In a longer term perspective – after a big bubble, it’s no longer profitable to use housing as an investment. Or you have to be very very patient. Buying a house will just be buying a house; don’t expect to make money by flipping it. No more.
Here below is a long-term housing price chart, from Bob Shiller. It’s quite telling: you can see the recent housing bubble was really an anomaly by historical standards.
Finally, I included an interview by Bob Shiller at Davos, Swiss. He gives you an update on his view on the housing market trend.
The economic roots of Egypt’s revolt
Zachary Karabell analyzes the economic roots of the revolt, and compares it with China's experience:
The mass movement engulfing Egypt exposes a fact that has been hiding in plain sight: In a decade during which China has brought more people out of poverty at a faster rate than ever in human history, in a period of time where economic reform has been sweeping the world from Brazil to Indonesia, Egypt has missed out.
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The country ranks 137 in the world in per-capita income (just behind Tonga and ahead of Kirbati), with a population in the top 20. And while GDP growth for the past few years has been respectable, averaging 4%-5% save for 2009 (when all countries suffered), even that is at best middle of the pack in a period where the more competitive dynamic nations have been surging ahead.
Egypt has long been famous for crony inefficiency. Yet Hosni Mubarak was graced with nearly $2 billion in annual U.S. aid, another $5 billion from dues from the Suez Canal, and $10 billion in tourism, so he could buy off a considerable portion of the 80 million Egyptians.
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In recent years, Mr. Mubarak seemed to realize that the complete absence of economic reform wasn't tenable. He watched as China surged ahead without loosening the control of the state over political life. He made overtures to regional trade blocs. In fact, a few days before the protests erupted, Mr. Mubarak hosted the second Arab Economic, Development and Social Summit in the resort of Sharm al-Shaikh, calling for more Arab economic integration, regional transportation infrastructure and trade.
What allows China to thrive for now (and Brazil and India and Indonesia, among many others) is that its citizens believe they have some control over their material lives and a chance to turn their dreams and ambitions into reality. They have an outlet for their passions that is not determined for them, and an increasing degree of economic freedom.
The young in Egypt—two-thirds of the population is under the age of 30—believe that they have no future, and in many ways they are correct. Under Mr. Mubarak, their food and housing is subsidized and they are placed in jobs or left in unemployed limbo, not starving but without any hope of anything but years of numbing sameness.
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Meanwhile, China ignored the dialectic in the West—which placed political opening at the top of societal imperatives—and plunged into an experiment of hypercharged economic development without political change. Its phenomenal success to date is impossible to refute, just as its future course is impossible to predict.
But Egypt managed to forestall both paths, and its lesson is simple: You can have economic reform, or you can have political reform. You cannot have neither.
China to invest in US infrastructure
Chinese firms are encouraged by both Beijing and Washington to invest in the US infrastructure projects, according to WSJ. To avoid political rhetoric, Chinese firms will only take minority share and remain passive investors. And these projects should be mutual beneficial to the two countries: for China it’s a good way of diversifying its foreign exchange reserves; for the US, these infrastructure projects will bring jobs while not increasing government spending, which helps to improve government budget situation.
In general, this is a smart move on both sides.
Jim Rogers update on commodities
Jim Rogers gives an update on commodity investing. Watch his comment on Obama’s policy proposal.
Marc Faber: cracked-up boom set to fall
Bloomberg interview of Marc Faber. He thinks in short term, emerging markets and US stock market are going to have correction, bonds and US dollar are places to be.