Working Papers

The Bubble in Economics Blogs

I think it has become obvious that economics blogs are in a dangerous bubble.  In March of 2003, there were only a handful of economics blogs.  I know this because a Forbes journalist who contacted me at the time about an article he was writing on economics blogs confessed his relief at finding mine.  Until then, he had been struggling to make up the five he needed for his story.

As of March 2005, Professor Bill Parke is tracking 72 economics blogs at his Economics Roundtable.  So we seem to be adding around 34 new economics-related sites to the blogosphere every year.  This is clearly unsustainable and conclusive proof of the irrationality of bloggers!  Some economics bloggers are even purchasing Google ads in a desperate scramble for market share. 

Clearly government intervention is required to bring order to this sector of the blogosphere and prevent a blog boom-bust cycle from developing.  As a solution, I propose the nationalisation of blogs, starting with John Quiggin, who can then educate us all on the merits of public ownership of the means of blogging.

Marginal Revolution will be broken up by the Justice Department into two separate blogs, one for Tyler and one for Alex, to end its market dominance.

The weaker economics bloggers will be subsidised or given jobs at The Economist magazine writing stories about the dangers of bubbles and how markets, the Fed, home buyers and American voters are all stupid compared to the magazine’s all-knowing leader writers.

posted on 06 March 2005 by skirchner in Economics

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‘Bretton Woods II’ and Sino-Mercantilism

The ‘Bretton Woods II’ appellation for East Asia’s managed exchange rate regimes is misleading in almost every respect.  IIE scholars have been taking issue with ‘BW II’ as a framework for analysis and are appropriately sceptical about its sustainability.  Whereas many see this as a potential problem for the US, it is a much larger problem for those economies in East Asia running managed exchange rate regimes. Morris Goldstein and Nicholas R. Lardy highlight some of the problems the ‘BW II’ framework poses for China:

the revived Bretton Woods system is just another ill-informed employment-oriented case for exchange rate undervaluation…the approach underestimates the costs of sterilization, particularly those associated with financial repression.  If, as seems likely, both the US current account deficit and China’s reserve accumulation, currently $610 billion, (£318 billion), become much larger, these sterilization costs will rise…

The revived Bretton Woods system sets out a faulty development strategy for China. Rather than seeking to promote an enclave economy based on an undervalued exchange rate and on domestic financial repression, China must expedite financial reform, particularly in banking; liberalise interest rates and reduce reliance on administrative controls and guidance. It must move towards greater flexibility in the exchange rate over the medium term, including an immediate 15-25 per cent appreciation of the renminbi relative to a currency basket. These policies will promote domestic financial stability and more balanced employment growth, improve the allocation of investment and the management of the economy, and help ensure continued access for China’s exports.

posted on 05 March 2005 by skirchner in Economics

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Government Loses Spin Control

In the wake of this week’s national accounts and RBA rate rise, JohnGarnaut quotes a ‘government economist’ as saying ‘I don’t know what the hell is going on.’

While I normally take unsourced quotes with a grain of salt, I can well believe this was said.  The PM and Treasurer made a complete hash of spinning this week’s events and give every indication of being poorly briefed.  The Q4 current account deficit, national accounts and RBA rate increase were unambiguous indicators of economic strength, not weakness.  If you believe the economy has ‘stalled,’ as many a headline suggested, then you must also think the RBA is completely insane.

Part of the problem is that the government has long trafficked in simplistic economic rhetoric, not least banging the foreign debt drum when it was in opposition.  You can only dumb things down so much before you get snared by your own nonsense.

posted on 04 March 2005 by skirchner in Economics

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Never Mind the Volumes, Check those Prices

A development often overlooked in the doom-mongering on Australia’s current account is the stunning growth in Australia’s terms of trade, 10% y/y in Q4.  The rising terms of trade were explicitly mentioned in yesterday’s statement by the RBA rationalising its decision to raise official interest rates.

The improvement in the terms of trade reflects strength in export prices relative to import prices, implying an improvement in Australia’s national purchasing power.  Australia has fortuitously become a net consumer of those goods for which prices are in secular decline, like ICT, while remaining a net producer of goods and services for which prices have been rising.

An important implication of the improvement in the terms of trade is that volume based measures such as GDP will understate the gains associated with this improvement in national income.  As import prices fall and volumes rise, this will count as a subtraction from growth, even though we are demonstrably better off from the improvement in national income.

The ABS get some major brownie points for highlighting this in a feature article in yesterday’s national accounts release. Extracts from the article can be found over the fold…

continue reading

posted on 03 March 2005 by skirchner in Economics

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‘Gloom & Doom Amid Boom’ Competition Winner!

We have a winner in our competition for the most overwrought commentary on Australia’s Q4 current account deficit. 

Competition was tough.  Stories with headlines screaming ‘banana republic’ were common entries.

I quickly lost count of how many stories made the claim that we are ‘living beyond our means.’  The Opposition Treasury spokesman also claimed ‘we are not paying our way,’ which would come as shock to international investors.  The fact that foreign investors are prepared to underwrite Australia’s consumption and investment make all of these statements demonstrably untrue.  It reflects the mindset behind the old homily, ‘neither borrower nor lender be,’ which taken literally would consign Australia to a state of near autarky.  The implication behind these statements is that we should cut our living standards to match only what we can produce for ourselves, a self-defeating solution to a non-problem.

Variations on this theme were also quite common.  BT Financial Group senior economist Tracey McNaughton said Australia was increasingly reliant on the ‘kindness of strangers’ to fund the deficit.  Tracey needs to brush-up on her Adam Smith: we rely on their self-interest, not benevolence, for our daily bread.

There were also plenty of stories that had the air of moral panic:

Home buyers could be hit by higher interest rates within days after the release of figures showing a nation falling deeper into debt and racking up a massive bill for imported cars, electrical equipment and clothes.

A nation awash in the excesses of cheap clothes from China?  The real story here is of course the enormous expansion in Australia’s consumption possibilities made possible by free trade in goods, services and, most importantly, capital.

The award for the most overwrought commentary, however, goes to…

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posted on 02 March 2005 by skirchner in Economics

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Rust or Bust?  The ‘Bubble’ Brigade Tire of Eating Crushed Glass

If they removed the word ‘bubble’ from the English language, Morgan Stanley’s Stephen Roach and Andy Xie would be left with nothing but sycophantic Sinophilia to irk us with. Fortunately, their colleague Richard Berner is much more level headed and has produced a thoughtful discussion of the outlook for US housing and house prices:

Most macro forecasters — crystal ball gazers all — have eaten a lot of ground glass trying to call a top in housing activity in the past two years, including yours truly.  Likewise, home prices have defied all calls, including mine, for a peak in appreciation, not to mention the bears’ forecasts of a sharp decline…

Importantly, however, a precipitous decline is unlikely: Stronger job and income growth should underpin new and replacement demand…And home prices?  I stick to my view that prices henceforth are likely to rust, not bust.

…neither the pace nor the level of prices is prima facie evidence of a bubble.  As I see it, nationwide housing ‘valuations’ are only back to neutral from being undervalued, consistent with my thesis that home prices will rust, not bust, for the next few years.

I make a similar argument about Australian house prices here.

posted on 01 March 2005 by skirchner in Economics

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The Institutional Economics ‘Gloom & Doom Amid Boom’ Competition!

Australia’s January trade balance has come in with the second largest deficit on record, ahead of tomorrow’s Q4 current account deficit.  I notice Trade Minister Mark Vaile has continued Tim Fischer’s old trick of pointing to exports being at record levels.  The relevant measure is of course the exports share of GDP, which would decline if exports did not keep posting new records in level terms.  It takes alot of cheek to claim credit for a secular trend. 

I am running a competition to find the most overwrought commentary or reporting on the January trade balance or Q4 current account.  The person(s) submitting the winning entry shall receive a free copy of Robert Prechter’s super-bearish Conquer the Crash to really keep them lying awake at night (no jokes about second place getting two copies!)  Email or post in comments (registration required, click on ‘register’ at top right).  Competition will be open until Thursday, by which time interest rate hike hysteria will have taken over from current account moral panic.

posted on 28 February 2005 by skirchner in Economics

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Globalisation and Current Account Balances

McKinsey’s Diana Farrell on globalisation and the US current account:

Roughly one-third of the current account deficit results from US-owned subsidiaries abroad…

Trade between foreign affiliates (as offshore subsidiaries are called) and US companies and consumers can either inflate or diminish the current account balance. When Ford or General Motors produce vehicles in Mexico they sell many to American consumers, causing US imports to rise. But they also sell a significant number in Mexico, generating a positive income flow to the US current account, and they use technologies and components produced north of the border, boosting US exports.

Any net negative impact on the trade balance caused by foreign affiliates is more of an accounting anomaly than a cause for economic concern. Methods for measuring the current account date back to the 1940s, when few companies had operations outside their home countries.

A similar argument can be made in relation to Australia.  Since Australia has become a net exporter of direct investment capital in recent years, this implies that at least some of Australia’s current account deficit is being used to fund the globalisation of Australian business.

Meanwhile, Cato’s Dan Griswold argues why the last thing you want is a trade surplus:

By the most basic measures of economic performance - GDP, manufacturing output and the unemployment rate - the US economy performs better in years when the current account deficit is rising than in years when it is shrinking. And it performs especially well in years when the current account deficit is rising most rapidly…

Those who seek the Holy Grail of a trade surplus should be careful what they wish for. Germany last year racked up a global surplus of almost $200bn. Not entirely coincidentally, its unemployment rate reached 11.4 per cent in December and the number of unemployed reached a post-unification high of 5m people. The last time America’s jobless rate was that high was 1982 - when its own current account deficit was a measly $5bn.

America’s trade deficit is essentially an accounting abstraction. Our attention should focus on what really matters - economic growth, job creation, industrial output, and the free and open markets that promote real growth.

posted on 26 February 2005 by skirchner in Economics

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The Myth of US Overstretch

David Levey and Stuart Brown’s article in Foreign Affairs, which we linked to earlier in op-ed form.  Read the whole thing, as they say.

posted on 25 February 2005 by skirchner in Economics

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Another US Current Account Beat-Up

You can’t help but be suspicious of a story reporting on a speech by Australian Treasury Secretary Ken Henry with the headline ‘US deficits risk crash: Treasury.’  My suspicions deepened when the report contained only two direct quotes from Henry. 

Henry’s actual speech is nothing exceptional and does not use the word ‘crash’ once.  The Australian Treasury has in fact argued persuasively for the sustainability of large US current account deficits.

Australia routinely experiences cyclical deteriorations in its current account balance as a share of GDP that make the current US deficit look small by comparison.  The Australian Treasury has long been converted to the consenting adults view of the current account.  If it views the US differently, it is because of the public sector contribution to the US deficit, which is a fiscal policy issue, not an external imbalance problem.

Next week, Australia is likely to report a monster Q4 current account deficit.  I will be running a competition for the most melodramatic and silly reporting of, or commentary on, this number.  Send me your sightings by email or post them in comments.

UPDATE:  Terry McCrann also notes that:

Henry was not setting out to ring the alarm on the “coming crash”, and would probably have been surprised—pleasantly or otherwise—to read words on the front of a national newspaper that would inevitably be dished up to the Prime Minister and/or the Treasurer.

posted on 25 February 2005 by skirchner in Economics

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House Price Inflation without the Froth

When confronted with asset price inflation, many economists are all too ready to declare a ‘bubble,’ which saves them the bother of actually having to think seriously about the economics underlying asset prices.  Fortunately, the BoE MPC’s Kate Barker is not one of these people.  In a speech to the IEA, she carefully examines the relevant fundamentals and puts them in a broader context, noting:

In previous speeches I and other MPC members have set out why it is generally undesirable to target asset prices when setting interest rates – particular reasons being the wide range of uncertainty around the equilibrium for any asset price, and the dangers to credibility of diverting policy from the goal of achieving the Government’s inflation target.

While RBA Governor Macfarlane has also highlighted the dangers of using monetary policy to target asset prices, the RBA’s public comments on house prices and private sector credit growth have diverted attention from its inflation target and confused the public and markets.  The RBA’s mistake was to express a strong (and arguably mistaken) view on house prices and private sector credit growth, but without being willing to actually take responsibility for outcomes in relation to these variables.  This was the right policy choice, but calls for a more agnostic public stance on these issues so as to keep the inflation target centre stage.

(thanks to Mark Harrison for the pointer)

posted on 24 February 2005 by skirchner in Economics

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Markets in Everything: The PAM Rides Again

Remember the Pentagon’s ill-fated Policy Analysis Market?  Intrade is now offering a contract on the timing of US air strikes against states sponsoring terrorism:

The contract will be expired at 100 if the USA officially launch and execute an overt Air Strike against land facilities in any of the listed countries on or before June 30, 2005.

The countries involved and currently listed as States known to sponsor terrorism are: Cuba, Iran, Libya, North Korea, Sudan & Syria.  Only these six countries count for expiry purposes. An overt Air Strike against a land facility will be defined as an air attack officially announced by the Pentagon or the US Department of Defense. It will not include any covert operations, accidental border clash, etc. The contract will be paused and subsequently expired once such an attack has been reported to have taken place against a land facility in any of the named countries.

The contract has yet to trade, but market depth is pointing to an implied probability in the low teens.  This contract would have been more informative if it were based on individual countries, rather than such a disparate group.

posted on 23 February 2005 by skirchner in Economics, Economics/Financial Markets

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More on Pop Austrianism and the Business Cycle

A key element of the pop Austrian critique of contemporary monetary policy is that the inherent unevenness of the process by which newly created base money and inflation work their way through an economy creates a structure of production that a free market economy would not otherwise support (the Ludwig von Mises Institute has plenty of examples of this sort of claim).  In the Austrian view, growth in broad money, credit aggregates and even asset prices is built on a house of cards: fiat money leveraged through fractional reserve banking.  Even those Austrians who accept fractional reserve banking consequently see almost any central bank policy action as inherently destabilising. 

A major problem with this view is that there is no necessary connection between interest rate targeting by central banks and the money base (although in practice they are usually closely linked by the operating procedures currently favoured by monetary authorities).  In principle at least, we could have a market-determined money supply and even non-centralised clearing of overnight inter-bank lending and yet still have a central bank successfully targeting an official short term interest rate through its willingness to buy and sell relevant instruments at given prices.  Unless we define free banking as the complete absence of a central bank, there is no reason why the two institutions could not co-exist.

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posted on 22 February 2005 by skirchner in Economics

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The US Net IIP: Non-Hysterical Version

Much of the hysteria surrounding the US current account deficit reflects a basic lack of faith in US institutions and growth prospects.  David Levey and Stuart Brown have a refreshingly different perspective:

While the NIIP will continue to grow for many years to come, future dollar depreciation and market adjustments in interest rates and asset prices will mean that its increase will be far less dramatic than many fear. Moreover, focusing exclusively on the NIIP obscures the United States’ institutional, technological and demographic advantages. The classic doomsayer argument - that growing foreign indebtedness results from too little savings by Americans - neglects the fact that savings and investment are seriously undervalued in U.S. economic accounts. When you include capital gains, 401(k) retirement plans, and home values, U.S. domestic saving is around 20 percent of GDP, the same as in most other developed economies. And when you consider “intangible” investment (like new-product development and design experimentation) as part of total, the supposed increase in consumer
spending as a share of GDP turns out to be a statistical artifact.

Indeed, much of the explanation for chronic current account deficits relates to the U.S. economy’s strong fundamentals, not fatal structural flaws.

The country with the world’s strongest external investment position is Japan, which achieved this dubious distinction by trashing its potential growth rate and the returns on domestic investment through state-sponsored forced saving and the overcapitalistion of its economy. 

(thanks to Jack S. for the pointer)

posted on 20 February 2005 by skirchner in Economics

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Steve Hanke’s Currency Board Fetish

Steve Hanke is nothing if not consistent.  His fetish for currency boards seems to have spilled over into a love of almost any fixed exchange rate regime.  He even has the audacity to call the proponents of greater exchange rate flexibility in East Asia mercantilists. 

Hanke’s defence of HK’s currency board relies on financial instability that occurred more than 20 years ago.  The costs HK’s currency board has imposed on its economy in recent years are completely ignored (Singapore has done relatively better because of its more flexible approach to exchange rate management).

In relation to Japan, Hanke maintains:

Japan has been under mercantilist pressure, primarily from the U.S., to ratchet up the yen’s value against the dollar. Tokyo has complied. Consequently, the economy has suffered from strong-yen-induced recessions and hasn’t yet recovered from the enormous deflation of the 1990s. And the mercantilists in the U.S. remain agitated because Japan continues to register large trade surpluses.

Hanke has things exactly backwards.  Japan has not seen a yen-induced recession since 1985-6.  It has been Japan’s mercantilist attempts at resisting the secular appreciation of the yen, by laundering its massive current account surpluses through USD asset markets, that has landed its economy with a massive overhang of excess capacity.  China risks suffering the same fate, especially if its demographics ultimately turn as toxic as those of Japan.

Given the terrible havoc fixed exchange rate regimes have wrought in emerging market economies in recent years, and within the euro zone, it is incredible that anyone still defends them.  It is even more incredible that these hold-outs for Bretton Woods-era monetary regimes can still find a home within classical liberal think tanks.

posted on 18 February 2005 by skirchner in Economics/Financial Markets

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