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People power

There’s been a striking change of mood in global financial markets since I left for my summer break: now it’s the US that everyone is gloomy about, and views of the eurozone’s recovery are more upbeat.

But there are two reasons to think that the smart money will sooner or later return to the US.

The first reason is simple – and fairly immediate. As this chart, from Capital Economics, suggests, the business cycle in the eurozone often operates a few steps behind the US.

Source: Capital Economics

Add that historical pattern to the slightly more disappointing business surveys and other data coming out from the Continental economies in recent weeks, and you can see why some think the clouds which hung over the US in the summer will be crossing the Atlantic pretty soon.

That seems all the more likely, when you consider that the eurozone economies have depended on the rest of the world for much of their growth. Of the 1.7% rise in eurozone GDP since the trough of the recession in 2009, as much as 0.8 percentage points is due to net trade. Whereas trade has played a negative role in America’s recovery so far.

The less polite way to put that would be that the US, thanks to its continuing appetite for imports, has once again been acting as a locomotive for global growth – albeit one with less horsepower than in the past.

Most of the eurozone economies have been growing at the rest of the world’s expense: taking more demand from the rest of the world economy than they put in.

The only exception is France: it has grown more slowly than Germany this year, but more of its growth has come from domestic demand: in the second quarter, imports grew by 4.2% versus 2.7% growth in exports.

So, where the US economy goes, you can probably expect the eurozone to follow. But there’s another, more fundamental reason to be less hopeful about Europe’s long-term prospects than America’s, which European politicians are only too familiar with.

It all comes down to demographics – or people power. Put simply: America is going to have plenty of people to help grow its economy over the next few decades; the eurozone, not so much.

Michael Saunders, economist at Citi, put together the numbers in a recent report. It’s not exactly a revelation that Europe’s population is aging, and its labour force is growing more slowly than America’s.

That’s been true for a while: indeed, Germany’s working age population has been falling for some time. But, as he shows, the demographics in certain countries are about to got a lot worse. The news is especially bad for Spain, which you might think had troubles enough.

As we know, the Spanish economy took off after joining the eurozone, growing by 3.7% a year, on average, between 1999 and 2007. We now know that a lot of that growth was built on an unsustainable credit and property boom.

What you may not know is that the growth was also fuelled by rising labour force, itself due to massive immigration. Total GDP may have grown by 3.7 %, but GDP per head only grew by 2.4%.

Mr Saunders reckons that the rise in the labour force pushed up growth by about 1% a year over this period, with greater participation in the labour market by existing workers adding another 1% a year. Both factors are likely to go into reverse in the future. With a dearth of jobs, the migrant workers are going home, and labour force participation is going down.

As recently as 2008, the Spanish government was expecting the working age population to rise by 5% between 2008 and 2018. Now it thinks it will fall by more than 2% over that time, and many think that’s optimistic.

There’s been a similar dynamic operating in Ireland, which saw even more dramatic growth in its labour force before the crisis. Unlike France, Germany and Italy, Ireland’s working age population is going to carry on growing in the next few years, but much slower than before.

Other things equal, the research suggests that declining “labour input” – also known as a declining number of willing workers – is going to cut Spain’s potential growth rate by about 1.5% a year between now and 2020, and cut Ireland’s trend rate of growth by about 1% a year.

Italy is also going to suffer, whereas France and Germany will continue to get none of their growth from rising labour inputs.

The net result, across the eurozone, could be to knock 0.25-0.50% off the eurozone’s long run trend rate of growth. That might not sound like much, but when you’re looking at growth of less than 2% a year, every little helps.

As the chart shows, the story is very different indeed in the US. There, as ever, sheer people power is going to be adding to the country’s potential growth, almost regardless of what happens to the rest of the economy.

Chart showing euro area and US working age

Faster labour force growth can’t solve all of America’s problems, and it certainly can’t guarantee a higher national standard of living. GDP per head might stagnate, even as overall GDP continues to rise. But by making nominal GDP grow faster relative to government borrowing, it makes the long-term debt dynamics for the US a lot easier than Europe’s.

In the short term, it also makes it easier to shoulder the cost of all those baby boomers growing old. And, of course, it adds to the impression that the US is still a young country, whereas most of Europe is growing old.

Demographics aren’t everything. There are plenty of other reasons why one country may grow father than another. But their very different demographic fortunes do provide another reason why investors may end up choosing America over Europe.

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Associated Press @ September 2, 2010

The Demise of the US Empire – The run on the FED (I)

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Over the past weeks I have been predicting a renewed shock to the financial system. It became clear that bad economic news will move market participients out of their positions. Some will just realize their gains and wait along the sidelines. But sitting on cash they would have to think on how to reinvest their money, which is the largest challenge in the face of missing alternatives. What the market face right now can be described indeed as a run on the FED.Mistrust took over and monetary policy has lost its magic. The best case for the US could be a Japan like deflation and lost decade like scenario. We explained at earlier, why this is not likely. There are no productive capacities in the US. Dr. Doom Mark Faber has a very matching metaphor to describe the US economy. Loosely quoted: "It’s basically personal-attention-services and beer." With high wheat prices, even beer-brewers might face issues.Let’s make an excercise to describe the current situation without emotions: How would one describe the state of the US economy, looking back ten years from now? We saw a record number of 40 million food stamp recipients. There was an expected drop in house prices and commercial real estate which the government tried to cover up with Fanny Mae and Freddy Mac. The FED hat to buy-up all their failing assets. Unfortunately houses deterioated when they were foreclosed on; so there was no real asset left after a couple of years, at all. The rate of bank failures was still higher than in 2009, despite zero interest rates. The FED has printed tons of money and distributed it. The government received much of this freshly printed money and spent it. Where it actually remained stayed unknown until, today. The US debt burden was higher than that of Greece and its ability to serve interest was depleting rapidly with each new Dollar spent on expanding debt. Investors seemed to ignore that fact. The high tech industry, which is mostly based in California, was facing the issue that they could invent whatever they wanted. It proofed useless without getting price stability on Lithium, Tantalum and all the other important special metals on which China declared an export ban. The state of California soon could not support the security requirements for all the foreign academics and employees, working in those high tech companies. Firefighters and policemen safeguarding the streets during the good times were now laid-off leading to a dramatic increase in crime rate. Governor Schwarzenegger saw those developments in time and announced already a year before the end of his term that he plans a come-back as actor. Many argued so that he never stopped acting. Finally there was the day when investors and the public woke up and what has been the American dream had turned into a real American nightmare. That was, when stock markets and bond markets collapsed and along with this collapse came the collapse of the US Dollar, finally ending the Dollar currency regime some 40 years after Nixon closed the gold window.Of course, there is always the chance for a prolonged cover up! Said so, one has to recognize that foreign investors started to sell Dollar denoted assets. China, once the largest holder of securities, has now lowered them to only ca. $840 billion. The demise of the empire is linked to the demise of its currency. The Dollar, once a signal of strength and trust, has become a weakening currency. When investors will start to get concerned over the Dollar, then it means they are concerned with the FED. That is when the run on the FED will occur.

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Associated Press @ September 2, 2010

The Washington Post Gets Out the Pom Poms

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Unfortunately, I am serious. It has a news article in today’s paper with the headline: “five reasons for economic optimism.” Real newspapers don’t run pieces like this as news stories.

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Associated Press @ September 2, 2010

Is the Washington Post a Serious Newspaper?

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The Post seems to be claiming otherwise in an article that begins with the sentence: “will the U.S. government ever default?” The Washington Post editorial section has been near hysterical in its screaming about budget deficits for most of the last decade. In fact, it was so out of bounds in its rants that it found no space in either its news or opinion section for warnings about the $8 trillion housing bubble. Of course the collapse of this bubble led to the worst economic downturn in 70 years — and sent the deficit soaring.

It is also worth noting that IMF completely missed the housing bubble and failed to warn of the imminent danger that it posed to the United States and other countries. No one at the IMF was fired over this failure and there has been no major restructuring of its staff, so there is little reason to believe that its understanding of economics is any better or its advice more accurate today than it was in the years before the bubble burst.

Of course the basic hypothesis is silly on its face since the United States issues debt in dollars. It can print as many dollars as it needs to pay off its debt. This could create a risk of inflation, but it rules out the possibility of default. Serious economists and reporters understand this simple point.

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Associated Press @ September 2, 2010

Effectiveness of the Stimulus: Washington Post Has Not Heard of the Congressional Budget Office

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Apparently word of CBO’s existence has not made its way to Fox on 15th Street. How else can we explain the Post’s failure to mention CBO’s analysis of the impact of the stimulus in an article reporting on a speech by Christine Romer, President Obama’s departing chief economist?

The article reported Romer’s view that the stimulus helped keep the economy from sliding into a depression and that additional stimulus would boost growth. It then tells readers that Republicans oppose additional stimulus and “argue that Democrats have run up record budget deficits without improving the economy.”

This is where a serious newspaper would report the assessment of the stimulus by independent analysts, most obviously CBO. In an analysis released last month CBO estimated that the stimulus increased output by between 1.7 percent and 4.5 percent. It also calculated that the stimulus lowered the unemployment rate by between 0.8 and 1.7 percentage points. In other words, the CBO estimates imply that unemployment would be between 10.3 percent and 11.2 percent today without the stimulus. This would have been useful information to provide readers.

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Associated Press @ September 2, 2010

Who Are You Going to Believe, the IMF or Your Lying Eyes?

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The NYT reports on a new set of papers from the IMF, one of which warns that many wealthy countries, including the United States, are very close to the limit of their ability to increase their national debt. It is worth noting that this paper’s methodology indicated that Japan and Italy were already well above the limit of their ability to take on debt.

The financial markets apparently assess the situation differently than the IMF since both countries are still able to issue long-term debt at very low interest rates. The fact that the methodology is apparently quite wrong in predicting the situations faced by these two countries might suggest that it is not a very useful methodology for guiding U.S. policy.

It is also worth noting that IMF somehow did not see the $8 trillion housing bubble that wrecked the U.S. economy, nor the bubbles in Spain, Ireland, and the U.K.. There have been no obvious changes in the IMF’s structure that would lead one to believe that it is better at assessing economic prospects today than it was three years ago.

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Associated Press @ September 2, 2010

Nonsense on Hiring, Taxes, and Regulation

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Fool or Liar? That is the question that should be posed of anyone who says that companies are not hiring because of concerns about taxes or regulations.

Exhibit A, the only one necessary to prove the case, is that there has been no unusual increase in average weekly hours. There is some uptick from the low-point of the downturn, but nothing unusual for an upturn, and we are still far below average weekly hours from before the recession.