"When the accumulation of wealth is no longer of high social importance, there will be great changes in the code of morals.
We shall be able to rid ourselves of many of the pseudo-moral principles which have hag-ridden us for two hundred years, by which we have exalted some of the most distasteful of human qualities into the position of the highest virtues"

( JM Keynes, "Economic Possibilities for our Granchildren" 1930 )

Sunday, October 24, 2010

Who is Afraid from Deflation??

For many decades economists and policy makers have labeled inflation as the main threat to stability and growth. Accordingly, policies were designed and applied to fight that threat, even when the Big War meant sacrificing other policy goals such as employment. However, the last recession revived the threat of deflation (Generalized decline of prices), until such a point that the “D” word has replaced the “I” word as the main enemy for the economy.

How it comes that Deflation turned to be the new economic “Ghost”? Mainstream economists and media offer various explanations for sudden shift in their attention, some of them to be exposed hereinafter.

The First of all , almost everyone point to the “Japanese Ghost”, a living example of a country that fell into a low growth trap following the bust of an immense asset bubble ( AKA “Lost decades”). That trap was accompanied with a steady decline of prices products and assets as well. Japanese Govt. tried to fight the recession with the accepted medicines ( public debts, lower interest rates) with limited success. The Ghostbuster replies: “True, Japanese ghost hit assets owners quite a bit ( Nikkei is still 35% from its peak in 1990) but unemployment rarely passed the 6% ,a figure unemployed American can only dream about. Anyhow, despite the “calamities” Japan is still one of the most advanced countries in the world . From a methodological perspective, casualty does not mean causality, so the anemic growth can be attributed to other factors such as income distribution... or job security , just to name a few, while falling prices are in classical economics the result , not the cause of the real world. So where exactly is the Ghost?”

From Japan we turn into theoretical “Spiral Ghost”. That theory claims that falling prices induce people to postpone their purchases since the consumer expects to get a better deal later. Since consumption accounts for ap. 70% of the economy, lower consumption means lower sales, less production and more unemployment, pushing prices down in an endless spiral.The Ghostbuster replies :”Unfortunately that Ghost cannot live in the same room with basic economic theory. We were told from the first day in the University that when a price of a product falls, the quantity demanded for it increases (“The Demand Curve”), so deflation ironically should augment consumption, not depress it. The focus on “timing” of that argument is another evidence for shortsightedness and misunderstanding the importance of prices as a market mechanism to calibrate between needs and capabilities. If prices are too high,it´s about time to reduce prices ( and profits.... ) so we all can enjoy prosperity. Sorry I don´t see any ghost around”.

Others mention the “Real Interest” ghost. That argument is focused on investment and consumption and their relation to interest rates and it goes like this : If prices fall, than the real interest on debts goes up. Since nominal interest must be above zero, falling prices mean (G-d Forbid!), positive interest rates. Such rates would restrict consumption and investment, eventually deepening the recession. The ghostbuster, still unemployed and a bit frustrated replies “ The very same pundits have told us that the crisis was provoked by a low interest rates policy held for too long tha fed a consumption and financial orgy which ended in the actual disaster. Now the very same experts want to apply the same poison? And we will end in worst recession nightmare later on? Are these guys serious? In addition, who will invest when 30% of the production capacity is idle?. Next , please ….”

If the Ghosts named above are not so real what is the real motive behind the implacable fight against Deflation? Nobel Laurate P. Krugman was very precise when he explained his vision in favor of inflation ( = against deflation) in an article published two years ago in the NY Times titled “ The case for Inflation”

“It goes like this: even in the long run, it’s really, really hard to cut nominal wages. Yet when you have very low inflation, getting relative wages right would require that a significant number of workers take wage cuts. So having a somewhat higher inflation rate would lead to lower unemployment, not just temporarily, but on a sustained basis”. (NY Times, “The case for Inflation, February 2010)

We should thank Pr. Krugman for his honesty. What he says in simple words is that since accepted ( and contractual) employment conditions of working people are too difficult to overcome, the “solution” is to bypass that obstacle by eroding their purchasing power . Applying Krugman´s logic, if instead of inflation we get a small deflation, real wages will surge . So, if low inflation is the cure which reduces real wages ( his main concern!), than the Ghost is ...high wages! . Eureka! . As a side notePr. K “forgot” to tell us that lower wages imply by definition higher profits to corporations. Well, that is just a “detail”....

Our professor is not alone, as that sort of “analysis” follows a long academic tradition of associating economic crisis to “high wages” or “low productivity” to which the “cure” is self evident :Low wages encourage employers to hire personnel, and reduce unemployment rates. Such “theory” is another sad example of how the “micro” perspective depict a twisted macro picture of the whole economy.

Let me explain. Right ,from a perspective of a small company higher wages mean more costs and probably lower sales. However, a macro economist should ask not only how the stuff will be produced but who is going to buy it .... and if the mass consumer looses purchasing power due to depressed salaries and buy less, the real gain of the capitalist is a Pyrrhic victory..

So the real ghost that bothers policy makers is not Deflation per se but another “D” word, “D”istribution , the possibility that in some point working people can enjoy a bigger share of the global prosperity. Do workers earn “too much”? Well, even Professor Krugman knows that the wage share out of national income ( i.e. the part of the national wealth that goes to the working people) is in record low in historical terms. Conclusion: Working people do not earn too much, I would say that they even earn less than the necessary to absorb the products offered at current prices, and therefore Deflation might be a good step to recalibrate that anomaly.

As any observer knows, the game of Political Economy is also a zero sum game between Capital and Labor . That implies that any worsening of the Labor conditions implies an improvement for Capital.The evidences that the concern of policy makers in favor of Capital are so evident in their last policy debates and actions, that it cannot be avoided but we will leave that for the next post that will deal with the QE2 initiative.

Thursday, October 14, 2010

Hillel´s Forgotten Lesson

That post should have written in Hebrew.

” What is hateful to thee, do not unto thy fellowman;
this is the whole Law. The rest is but commentary”.
( Hillel The Elder , 1st century )

Last week the Israeli cabinet voted through a "declaration of loyalty" a bill which would require non-Jews taking Israeli citizenship to swear loyalty to Israel as a "Jewish and Democratic State" . Although the bill that must still receive the approval of the parliament before it becomes law it is an important step toward legislation as the Government controls the majority in the Knesset.

For an outsider, such a Law might sound a fair decision but, once again, the devil is in the details : First of all , the Oath is required only from non Jews . Second it requires Loyalty to vague terms as “Democratic” “ Jewish” . Needless to say, the Law is controversial and many of its critics appeal to modern values. However, I will try to shed light on that decision from a "Jewish" perspective and show that the Law as proposed also clashes with less modern traditions.

If loyalty can be simplified by a “!” mark, Judaism can be represented by a ”?”. To illustrate that point, I will bring as an example the opening of the Babylonian Talmud ,the central pillar of Jewish tradition. That book commences (in a non typical fashion for a religious text) with a ... question ...in which a scholar raises his own doubts about a former .... question ! Lets have a look on the quote:

“MISHNAH. FROM WHAT TIME MAY ONE RECITE THE SHEMA' IN THE EVENING?....GEMARA. On what does the Tanna ( “Scholar”) base himself that he commences: FROM WHAT TIME?"
( Babylonian Talmud Soncino translation , Tractate Berakhot Page 2).

A few explanations:
Mishnah : Oral Law
Gemara: The book that gathers the debates concerning Oral and Written Law.
Shema: Literally “Hear, O Israel! Adonai is our God! Adonai is One!” The most important part of the prayer service in Judaism, recited twice a day.

I will not get into details about that fascinating discussion, but it serves as an example to the spirit of the Jewish culture. That emphasis on “debate” does not mean that Judaism is alien to loyalty. On the contrary, the above discussion deals with a sort of “Loyalty declaration” an observant Jew must recite twice a day. But even that small piece of evidence reveals many interesting aspects about the nature of loyalty.

First of all, the Shema call is a personal manifestation which does not imply necessarily a public realm ,let alone the existence of the State or clergy intermediation . The call is external , verbal but reflexive, and in public service it is recited by each and everyone of the prayers, as a sort of special and personal commitment. The main point is that loyalty is in essence a personal choice, not an issue to be imposed from the establishment and which stems from the individual.

Second: The debate above is practical by its nature ( “From what time?” “On What”How? Etc.) as are most of the debates in the Talmud. The Jewish tradition considers big declarations or profound debates as meaningless unless they are accompanied by concrete acts ( the “Mitzvot”). In our modern case, the new law does not specify what does it mean to be loyal to the “Jewish and Democratic” and what are the concrete terms for such loyalty . If the idea is to emphasize the supremacy of Law, than the “loyalty” is useless, since it would be sufficient to declare a personal commitment to obey , protect and defend the Law. If the idea is to emphasize the Jewishness of the State, we may fall into a deep trap : Israel is NOT ruled by the Jewish legal Code, so in that sense it is not a “Jewish” State . If “Jewishness” means a Jewish cultural character or symbols it is a too vague and ambiguous term to demand “loyalty” to. And how do you measure loyalty? Is it a binary term or there are various degrees of “Loyalty” ? And what is exactly Democracy? The rule of majority or also the rights of minorities ? And so on , and so on...

Third : The modern version of “Loyalty” is not only discriminatory ( only non Jews are required to declare ) but alien to the Spirit of the Shema . The obligation to recite the Shema twice a day is imposed on each and every observant, even on direct descendants of King David. From that perspective kinship is just one condition, (...not necessary, let alone sufficient), to guarantee the commitment to the Jewish World. The daily recite is a reaffirmation of the idea that loyalty must be reinforced even among the (apparently) most most loyal.

Back to the first quote to close the circle, Hillel´s comment was a response to a Gentile who asked to understand the whole Torah on one leg ( his rival, Shamai sent away the gentile...) . BTW, Hillel´s line is dominant in almost every dispute between these two scholars . Hillel would ask in our case :What would American Jews say if the US Congress approves a Law which requires non Christians to swear loyalty to a "Christian State" ??? I do not even dare to imagine.... As Hillel stated, the basic principle of the Jewish tradition is the respect for the other and the recognition that you might be some day in other´s people place.

My conclusion is that the proposed legislation is not only contrary to the spirit of a modern Democratic State but reveals a deep misunderstanding or ignorance about Judaism among Israeli rulers.

Sunday, October 10, 2010

"To Freeze or Not to Freeze,... That Is NOT The Question!.

Any impartial observer of the negotiations between Israel and the Palestinian Authority would probably conclude that the ongoing crisis concerning the extension of the temporal settlements´ building freeze is ,for the most, a bad joke. How it comes that such "no issue" has paralyzed a 20 years Peace Process as if the fate of the whole world was depends on it???. Newspapers are filled with question marks: Will Israel freeze? For how long (2 months!! 3 months? 4 and a half?? ) ? What has the US President to say about it ? And the Arab League? What are the recent political maneuvers in Israel? Will Abu Mazen renounce? A genuine Mid East circus….

A somewhat more benevolent spectator would just label all the mess as a weird sitcom. However, if it was only a question of literal tastes, Dayenu*. …. But bearing in mind that this specific Reality Show is very, very real and can easily turn into a tragic “Horror Show” for other anonymous protagonists ( i.e. average citizens) , leaders should be reminded that are playing with fire.

From the outset, the whole idea of a temporal freeze was a bad Salomonic “solution”. Lets analyze the decision by utilizing a simple "What-If" methodology.
Scenario A: If Israel eventually will evacuate the occupied territories, a PERMANENT freezing would turn to be the appropriate measure. Temporal... meaningless.
Scenario B: If Israel does not intend to evacuate the settlements, the real meaning of a temporal freezing is a few months of delay in further construction, turning the freezing into an empty gesture.
However, reality is not a binary game so the freezing should be seen as a gesture of good faith, not a must but a sort of temporal cease of fire while negotiating for peace. Fair enough?

Well, if the freezing was not restricted in time, it could be considered as a step toward reconciliation, equivalent to a cease of fire in times of war. Though, the temporality ingredient kills the remains of any possible good faith since it actually imposes a arbitral restriction for the period for negotiations, similar to saying: If Peace is not reached within XX months, we all go home and end the negotiations. What next, G-D only knows ... Whoever is familiar with the Peace Process knows that 10 months is nothing, really nothing and to get an agreement, therefore “Temporality” is a “No Freezing“ de Facto. In light of this perspective the two months extension, as President Obama is asking for, sounds as a pathetic and cynical political maneuver ( Mid Term elections) and nothing more. Furthermore, reality has its own inner watch, so the imposition of a restricted timetable is artificial.

If you needed a definitive confirmation for the meaninglessness of the “temporal freezing”, just open the last week newspapers. The disproportionate attention for a meaningless topic in the media is fed by politicians and their spokesmen. That is a classical political maneuver aimed to deviate the public debate from the core business and their failures to achieve real results from the negotiations. Reminder : Israel still maintains for more than 40 years millions of human beings under military regime without basic civil, human and political rights ( as human beings,,,, national rights is luxury under the current circumstances) . The Palestinian are still divided with a leadership that did not achieve any meaningful result from its current strategy (which is …???) , to alleviate the situation of its people, besides some economic fragile recovery in the West Bank. And finally, the US President did not achieve much of his initial goals in the process as part of a global American strategy toward the Arab world.

So we might get some extended period of freezing but the obstacles will remain in place. The real and not so temporal freezing of the Peace Process can generate a new wave of violence or a false sense of stability before the next round. What is needed is to renew the negotiations and if you wish so , do it under a permanent, genuine and unlimited freezing of any construction activity in the Occupied Territories. The alternatives are so bad that any temporal restriction is meaningless and even harmful.

That is the real deal on the table, the rest is pure hot air that will freeze soon.

*The word "Dayenu" means approximately, "it would have been enough for us", "it would have been sufficient", or "it would have sufficed" (day in Hebrew is "enough", and -enu the first person plural suffix, "to us").

Thursday, October 7, 2010

The XXX Economy

The E= Y equation should be familiar to any person who attended a basic course in Macro Economics. The equation says that the overall production of a National Economy or “Y” is consumed during the same period of time ( Year , month...), represented by the “E” or Aggregate Demand. The identity sets a sort of closed circle by equating the Economy main parameters under any circumstance (Note even non sold products are considered a sort of non voluntary demand , or unemployment so in any case the identity holds... but lets leave that interesting debate for another post ). Whoever studied economics can skiop the next two paragraphs.

The “E” , the Demand, has three main aggregates : Some products are consumed by us as Private demand (“C”), some as Public demand (“ G”overnment) and the rest remains “I” Investments ( in simple words, the products that are used to produce more in forthcoming periods). The basic equation looks like this:

E = C + G+ I = Y

If we add other countries than the picture becomes a bit more complicated as the circle is opened and the country can sell part of its production abroad ,as Export “X” or to bring products from abroad, Imports “M” . The former is added to the demand and the later is another source of products so it is subtracted from the demand. The new equation looks like this

E = C + G+ I + X – M = Y

Now, back to Planet Earth.... the ongoing recession is a classical case of a Demand crisis ,as the capacity to produce goods and services ( Potential Y) is much higher than what actually people are ready to buy. It is important to note that THE ABOVE EQUATION STILL HOLDS but with unemployment, spare capacity , piled stocks etc.

In order to increase the E and thereby the Y and employment , governments have tried to work with the equation above : First by increasing the “G” generating huge deficits in their accounts ( 800 billions in the US and so on) ended with austerity measures . Another policy applied was to encourage “I” by reducing interest rates ( only yesterday the Bank of Japan announced that it will reduce its interest rate to 0 ) and consumption “C”- ended with record balance obligations in Central Banks loaded with dubious stuff . Least and not last the explicit attempts to maintain asset prices is aimed to sustain “C” (If people feel rich , they consume more ,,, that at least what the theory says) - the end is a more poor consumer , with less employment and less wealth. .

It is natural that All these policies seem to have some influence, but very limited due to the special circumstances and because they do not address what THIS BLOG AND OTHER PEOPLE have been saying for a long time : ONLY A POLICY OF REDISTRIBUTION CAN GURARANTEE A BALANCED, JUST AND SUSTAINABLE ECONOMY. Please read previous posts in case you don´t believe....

Since the above policies are deemed to fail ( as predicted ) and the evidences are against the Green Shots illusion are piling, the last bullet in the policy makers arsenal is to try and get some demand form the outside world , i.e. encouraging Exports (X). The new paradigm is X X and More X ! Though, since it impossible to force sovereign countries to buy your stuff, you must try to convince them by lowering your prices which is equivalent to make your currency cheaper.

It is not that simple to manage currency rates since currency markets are supposed to be “floating” and “free”. Therefore Central banks make use of a serie of methods to lower their currency : Announcement of lower interest policies ( QE 2 in US ) , Lower interest rates ( Japan) , Purchasing of currency ( Japan, Switzerland, Israel) or direct control of exchange rates ( China) . That is what I call the XXX economy, since the export lead recovery is just another pathetic XXX sign , a sort of “we know what it´s there but we don´t want to know about it “ attitude. Nude reality is there after all.

These steps are part of the background for the last violent in the currency markets ( Euro Dollar from 1.6 to 1.18 and back to 1.38 in question of months... high value of the Japanese Yen despite the weakness of its economy ... etc. ) in the last months, and the best is yet to come. Anyhow, the managers of that game are conscious that their efforts are futile : If all the countries are trying to make use of export as a way out of the crisis and all of them apply the same devaluation policy, we will be soon back in the starting point and no effective devaluation will take place.

The futility of currency devaluations lead to an escalation of the attempts to generate demand, tht time by avoiding competition from abroad in stead of looking for new markets . History tells us that in the end some countries simply close their gates to foreign competition in order to maintain some internal demand for its industry. According to some economists, that “Beggar Thy Neighbor “ policy in the 30 reduced drastically the international commerce and exacerbated the impact of the financial crisis as Former US Secretary of Labor R. Reich recently said
“Smoot-Hawley here we come. Willis Hawley and Reed Smoot, you may recall, sponsored the Tariff Act of 1930 that raised tariffs to record levels on more than 20,000 imported goods. The duo said this would protect American jobs and revive the economy. It did the reverse, plunging the nation ( AND THE REST OF THE WORLD .... Blogger note ) into an even deeper depression....”

I could not find better words to end that blog. Despite the gloomy perspective we should not forget that a progressive and reasonable way-out is available. It´s only a matter of consciousness and choice.

Sunday, October 3, 2010

The Dark Side of the Yuan

The political debate in America concerning the “unfair manipulation” of the Yuan by the Chinese Authorities is intensifying . Last week (Sept. 2010) in the House of Representatives a huge bipartisan majority approved legislation that would potentially pave the way for sanctions against China over its currency policy.
Trade Wars? Not yet, to me it looks more as “Election wars” , that sort of initiatives launched a few weeks before elections aimed to appease a furious a population still bearing the burden of a false “Recovery”.

However, the pressures on China to modify its currency policy and adjust it to "market values" are more serious and persistent than a populist gesture. According to many American political and academic voices, the Chinese policy of pegging its currency to the USD has distorted the trade terms between the countries which brought about the loss of millions of American jobs and trade imbalances that helped to create the pr recession financial bubble. According to that view, the artificial low value of the Yuan turns to be an unfair competitive edge which reduces manufacturing costs in Dollar terms at China, forcing local companies to transfer production and jobs abroad. The trade loss is compensated by a flow of money back to USA , inflating the financial bubble.

From a rather simplistic perspective the above description sounds plausible, albeit its logic chain is based upon a serie of debatable hypothesis, one of them related to the concept of a “ fair value” for a currency . In order to overcome that "fairness "obstacle economists developed the denominated “Power Purchasing Parity” (PPP) parameter, a tool that establishes the value of exchange of currencies according to what they are able to really buy instead of their current market value. For example if a cup of coffee in Barcelona costs 1.2 € and the same cup of coffee in America costs 1.2 $ , the effective exchange rate should be 1 (1.2/1.2) and not 1.35.

How it is possible to calculate that figure ? PPP measurement method is applied to the overall economy by translating the production of the country from local currency ( Prices x Quantities = GDP ) to USD ( at current USD) and to PPP ( at PPP USD)as well. Since GDP is Quantities multiplied by Prices , we can subtract the quantities from both equations and remain with the ratio between PPP and current USD. A value of 1 would indicate a fair value of the currency and below that a underestimated currency.

With that question in mind I took IMF figures for 2009 and compared between GDP at current and PPP values for the Chinese economy. The result was a ratio of 0.56 , which means that a Greenback in China is able to buy almost the double of products than in US, or that the the Yuan is a “weak” currency since it can buy less products than the USD. The conclusion is that the Americans are right in that specific claims. In any case, the currency exchange value is just part of the story and if we have the whole picture it might change our perception.

First of all, the actual unfair value of the Yuan is a 16 years old , to be precise since the first mandate of President Clinton, and was maintained along recessions, buoyant years, bubbles... and somewhat eased app. 3 years ago, before the crisis emerged ( 23% devaluation). Therefore, in a wider perspective to claim that the currency "manipulation" is the reason for the actual crisis is a bit strange and dubious claim. On the top of it, the US itself was ( and is still !) interested in that mechanism since it became a central piece in maintaining a steady pressure on local prices , wages and inflation. That mechanism ( including the purchasing of Debt) is one of the explanations to the low inflation and low interest rates in the Western economies along the last 30 years, much more than the Genius of central bankers

Second Point is to analyze the wider context : Is the Chinese low value policy so singular ? According to IMF figures it looks that China low value currency policy is the rule rather than the exception, as most of the countries maintain a low currency lower than the “fair” value. ( see graph)

The third point is related to the distributional aspect of the global economy : As can be seen from the next graph, the low value of the currency is common among poor countries and less common among rich countries. It is not a coincidence : The low value of the currency is equivalent to reducing the international value of the work of the country´s citizens and increasing in relative terms the purchasing power of currencies abroad. Is like giving a subsidy to the foreigners.

This should not take us by surprise. Any tourist who traveled to developing countries has probably asked himself how it comes that the same product or service is sold for such low prices ( in comparison to her country). The same question applies when you shop in the Supermarket and can buy an African pineapple for Christmas Eve at a lower price than a cup of coffee.. The answer is partially related to currency values.

The above graph shows that for the 85% of the humanity, the trading terms of their work is lower than should be , while 15% are above that line. In a less political correct parlor, the exchange rate system seems to be just another mechanism that serves 15% of the world population to exploit the remaining 85% : The work of , for axample a Bangladeshi embedded in the exported products is sold in cheaper terms than it should be while he buys the fruit of rich country products in dearer terms than should be. Good deal, isn´t it?

That detail , that huge advantage for the American consumer will be lost if Chinese appreciate their currency. I guess that Congressmen didn´t mention that,and why should they? After all they don´t get their votes or contributions for the campaign from Shanghai , Cairo or Minsk workers and the cry for "jobs" is nowadays above all. However that is the most serious evidence for the real state of affairs.

Nevertheless, the trading terms should be accommodated to reflect a more just and fair distribution of the fruits of the human labor. I would suggest to improve the working conditions, the social security and the wages in China and everywhere in the third world . Such a policy will not only improve the competitiveness of the American worker but open new markets for the American industries .But that is for another ( or many ) post....