Working Papers

Ben Bernanke Right on the Money

I have long been a fan of FRB Governor Ben Bernanke.  In his Sandridge Lecture, he advances what he calls an ‘unconventional’ interpretation of the deterioration in the current account balances of the Anglo-American economies (as Bernanke reminds his American audience, this is not a phenomenon unique to the US).  Bernanke is probably being ironic, because there is nothing at all unconventional about his interpretation, except in the sense that it goes against a conventional wisdom that is thoroughly mistaken. 

Despite underselling his case, he makes many good points, but most importantly, he firmly points the finger at the role of forced saving in East Asia as a contributing factor in global imbalances:

current account surpluses have been an important source of reserve accumulation in East Asia.  Countries in the region that had escaped the worst effects of the crisis but remained concerned about future crises, notably China, also built up reserves. These “war chests” of foreign reserves have been used as a buffer against potential capital outflows. Additionally, reserves were accumulated in the context of foreign exchange interventions intended to promote export-led growth by preventing exchange-rate appreciation…

In practice, these countries increased reserves through the expedient of issuing debt to their citizens, thereby mobilizing domestic saving, and then using the proceeds to buy U.S. Treasury securities and other assets. Effectively, governments have acted as financial intermediaries, channeling domestic saving away from local uses and into international capital markets.

Highly recommended reading.

Deepak Lal suggests China could do something more useful with its foreign exchange reserves.

posted on 13 March 2005 by skirchner in Economics

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Current Account Deficit Angst and Behavioural Finance

Terry McCrann on current account deficit angst:

Did any of you spend even a single day in the actual December quarter worrying whether the deficit would be funded by foreigners? Whether “today’s” $230 million had come in on any single business day, so you could retire to the plasma TV that evening “knowing” that Australia was safe from bankruptcy for another day; and another $230 million?

Of course not. That $15 billion was not only funded, but over-funded. More money wanted to come than we needed - so the RBA had to take some of the foreign coin and the Aussie dollar was pushed higher by the excess demand.

The reason most of us don’t lie awake at night worrying about the current account is that we rightly figure that we have taken prudent decisions in relation to our personal finances.  Yet we are also prone to the belief that collectively we are behaving irresponsibly.  Most of those who express public concern about the current account deficit would have personal balance sheets that differ only in degree rather than kind from the current account deficit.

Much of the air of moral panic that surrounds the current account deficit probably stems from the commentariat’s belief that there must be something wrong when the lower middle-class start moving into large, debt-financed homes and enjoying cheap imported goods that were once considered minor luxuries.  When the masses start tapping into what were previously perceived as positional goods that helped set the commentariat apart, there is a natural tendency to assume that economic corners have been cut.

Who said insights from behavioural finance couldn’t be used to support free markets?!

posted on 12 March 2005 by skirchner in Economics

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The RBA as Central Planner

Alan Kohler accuses the RBA of central planning:

the basic problem is that the Reserve Bank does not trust the market. And why should it? It is a regulator whose sole purpose is to offset market forces.

Right now Australia needs market forces to work. There are, it is generally agreed, shortages of skilled labour and infrastructure capacity. There is also general agreement that the only answer to this is to slow “the economy” by lifting interest rates so the demand for these things falls to meet the supply.

This is a strategy straight out of central planning. Forcing the economy to slow so that demand meets an inadequate supply is a policy of despair by those who don’t trust the market.

At least we can be reasonably sure Alan hasn’t been nobbled by any insider relationship with the RBA!  I have a little more sympathy for the RBA’s position.  The current debate about monetary policy is actually a good example of how the RBA’s conflicted, catch-all statutory mandate gets it into trouble.  An independent, inflation targeting central bank is perfectly entitled to wash its hands of structural issues.  A central bank reliant on a letter from the Treasurer for its independence and responsible for ‘the welfare of the people of Australia’ cannot expect to get off the hook quite so easily.  This is why the RBA Governor gets asked about everything but the kitchen sink when he fronts the House Economics Committee.

posted on 12 March 2005 by skirchner in Economics

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Did the Japanese Ministry of Finance Save the World?

Richard Duncan, one of the many ‘US Dollar Crisis’ hysterics, argues that Japan’s intervention to weaken the yen in 2003 saved the world and even goes so far as to suggest this might have been a policy coordinated with the US:

Intentionally or otherwise, however, by creating and lending the equivalent of $320 billion to the United States, the Bank of Japan and the Japanese Ministry of Finance counteracted a private sector run on the dollar and, at the same time, financed the US tax cuts that reflated the global economy, all this while holding US long bond yields down near historically low levels.

In 2004, the global economy grew at the fastest rate in 30 years. Money creation by the Bank of Japan on an unprecedented scale was perhaps the most important factor responsible for that growth. In fact, ¥35 trillion could have made the difference between global reflation and global deflation. How odd that it went unnoticed.

Unfortunately, this subject is getting too much notice.  Duncan is not alone in exaggerating the importance of the recycling of East Asian current account surpluses through USD asset markets.  There is now a veritable cottage industry of blogs dealing almost exclusively with this subject.  But while the amounts sound impressive in flow terms, they are trivial in relation to the total turnover in USD asset markets.  Even daily turnover in foreign exchange markets is in the trillions.  East Asian financing of the US current account deficit has at best a marginal influence on the USD and bond yields, because they trade in such deep and liquid markets.  The idea that the US is some how completely dependent on this very small subsidy from East Asian central banks is ludicrous.

Peter Hartcher’s excellent book on the Japanese Ministry of Finance was subtitled ‘How Japan’s Most Powerful Institution Endangers World Markets,’ which comes much closer to the truth.

posted on 10 March 2005 by skirchner in Economics

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The Reserve Bank-Ross Gittins Nexus

‘Ernie Economist’ attributes the Treasurer’s ban on Gittins to his role as unofficial front man for the Reserve Bank:

What you have to understand about SMH Economics Editor Ross Gittins is his own undeclared role as a virtual media liason officer for the Reserve Bank. Because of the lack of transparency from our central bank (it does not release minutes of its meetings, does not hold media conferences and its governors do not grant interviews), it manages its public image through a couple of well chosen media pundits - Gittins being one of them.

But in return for this privileged access to our most important economic policy-making institution, Gittins tends to represent the bank’s views to the wider public. This role is critical at a times, such as now, when the bank is at odds with the government and the economic commentariat. And that is exactly what Gittins is up to now - doing the bank’s bidding by justifying an increase in interest rates that the government and a lot of independent commentators have good reason to believe is a high risk gamble.

The point here is that if Mr Gittins is going to use his columns to depict himself as some of kind of cleanskin (and there’s no denying a lot of points he makes are on the money), he should really front up about his ‘insider’ arrangement with the RBA. And the bank itself should clean up its own act and face its critics directly, rather than hide behind newspaper columnists.

I highlight some of the problems with RBA governance and transparency here.

posted on 08 March 2005 by skirchner in Economics

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American Job Creation Act Repatriation Flows

Action Economics chief economist Mike Englund on the impact of repatriation flows under the American Job Creation Act, something which is getting little attention outside of financial markets:

US repatriation of funds in 2005 related to legislation passed last October should reach $350 bln. This will relieve FX intervention pressure on foreign central banks that are defending the dollar, boost U.S. debt and equity markets at the expense of foreign counterparts, directly contribute to U.S. economic growth.  Repatriation will have an enormous impact on the “direct investment abroad” and “foreign official asset” components of the U.S. capital account data in some of the quarters of 2005, with details depending on how the BEA specifically chooses to treat the payments…

It appears that the BEA is unlikely to boost the “direct investment receipt” component of the U.S. current account export measure but, rather, will reveal two offsetting component adjustments on “distributions” and “reinvested income” that will leave U.S. receipts, or “factor income,” unaffected by the payments. This means that the payments will not directly impact the headline current account or GNP figures for each of the quarters of 2005. But, the payments will depress the “U.S. direct investment abroad” figures in the U.S. capital account by the size of the quarterly dividend payments.

The magnitude of these potential flows highlights a broader issue: growing cross-border ownership and control of equity capital requires greater sophistication in interpreting current account data. 

In Australia’s case, the net income deficit is the main contributor to the current account deficit over time.  Like the more cyclical balance on goods and services, it can also be interpreted as a measure of the relative performance of the Australian economy.

When the Australian economy outperforms, the foreign owners of the stock of Australian equity capital will be repatriating profits, while Australian-owned companies abroad will be performing less well.  This effect is becoming more pronounced, because while foreigners control a large part of Australia’s stock of equity capital, in flow terms, Australia has become a net exporter of direct investment capital in recent years.  At least part of Australia’s current account balance is funding the globalisation of Australian business. 

Extensive cross-border control of equity capital associated with globalisation requires that we re-think our views on current account balances and leave behind the ‘balance of payments constraint’ mindset that is a hang-over from Bretton Woods-era institutional arrangements.

posted on 08 March 2005 by skirchner in Economics

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Ross Gittins Off Treasurer’s Guest List

Ross Gittins gives economists a serve for failing to go beyond the headline number in last week’s national accounts release:

Similarly, the literalists happily believe that during the period in which the economy slipped into near recession:

consumer spending grew by almost 4 per cent, business investment by 10 per cent and public sector spending by about 5 per cent.

Indeed, the only area of spending that was weak was housing construction, which contracted by 2 per cent, leaving domestic final demand growing by a rapid 4 per cent.

Sound like a sick economy to you? And while the economy was in the doldrums, credit (private sector debt) grew by 12.5 per cent and the stockmarket rose 23 per cent.

Why are so many otherwise sensible people so willing to take implausible figures literally? The media do it because they don’t want to spoil a good story. The financial markets don’t want to spoil a good betting opportunity.  What’s the business economists’ excuse?

The demand for economic commentary comes largely from the media and the ‘literalism’ Ross is railing against is largely media-driven.  Market economists are often made to look superficial, but this is more a function of how the media presents the story rather than a lack of sophistication on the part of those supplying the commentary.  As for the media, they see the economy as subordinate to politics and so interpret economic numbers largely in terms of political rivalry.  Their interest in substantive economic issues is typically fairly limited.

The fact that many journalists see the economy as being subordinate to politics goes directly to Ross’ other complaint about being discriminated against by the Treasurer:

When I wrote a few weeks ago that Peter Costello’s ire was easily incurred, I little imagined I’d be the next recipient. All the nation’s senior economic journalists were invited to attend a recent dinner that Mr Costello addressed at a closed Treasury conference - except me.

Ross accuses the Treasurer of more generalised bullying and intimidation, something for which Paul Keating was also famous when he was Treasurer.

The problem is not that Ross and others are critical of the government, but that they are often critical for the wrong reasons.  They also sometimes give the impression of being partisan because of the political overlay they give to their stories, even when their intentions are otherwise.  Many journalists also see themselves as players in the political process.  It is hard to feel much sympathy when they get treated accordingly.

posted on 07 March 2005 by skirchner in Economics

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The Reserve Bank and Industrial Relations ‘Reform’

The old joke about the Australian economy was that the Reserve Bank set interest rates and the Industrial Relations Commission set the unemployment rate (through its determination of minimum wages).

Now the government wants the RBA to help set the unemployment rate too, with a proposal before Cabinet to have representatives of the RBA and Treasury sit as members of the Commission.  The government seems to think that the RBA and Treasury will help secure more moderate wage increases:

Senior government ministers are believed to be privately concerned about the impact on inflation - and flow-through pressure on interest rates - if the current labour market shortages lead to wage rises.

The implication here is that the RBA should control inflation, not just through monetary policy, but through direct participation in centralised wage fixing.  It is becoming painfully apparent that the government’s idea of ‘reform’ across a wide range of areas is simply to further centralise power in the hands of the feds.

While on the subject of labour markets, Professor Charles Baird will be speaking to ABE on 23 March in Sydney on the ‘The American Labour Market: Lessons from Deregulation.’  See the ABE web site for details, where a copy of the paper will most likely be posted after the event.

posted on 07 March 2005 by skirchner in Economics

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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…

continue reading

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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