Things That Can’t Go On Forever, Don’t

Ok, the sun is shining nicely down here in Barcelona right now, so maybe this is a good moment to come out and provoke a storm. The euro: something gives, but what? Actually it is perhaps ironic that I have chosen today of all days to write this, since for once it seems the euro may fall rather than rise: well to someone who is accustomed to marching out of step, this almost seems par for the course. Never mind, tomorrow, or the day after, we will be back to normal, and the seemingly unstoppable rise will continue. The only remaining question really is: where is breaking point, and what will happen when we get there?

But lets step back a bit. Let’s go back to the origins of the euro, and part of its raison d’etre. I think it is difficult to avoid here the hard reality that part of the thinking behind the launching of the euro (in addition to the abolition of transaction costs and internal exchange rate risk) was getting a piece of the action that the Americans were perceived as having. You see during more years than it’s worth remembering, the United States has been able to pay for its imports by exporting little pieces of paper known as dollars. We were, as it were, on a dollar standard.

It has been able to do this, not simply because petroleum transactions were denominated in dollars, but because some other countries, and particularly some key Asian ones, were running trade surpluses, and the relevant central banks decided to hold their reserves in dollars.

Then along comes the euro, with the unspoken agenda of in some way replacing the dollar as the international reserve currency. Nothing wrong with that in principle, at times in the nineteenth century there was bitmetallism: a gold and silver standard in parallel. Now all of this might well have run sweet and smoothly had history been a linear process where all thing get to move in one direction only. Unfortunately life, at least economic life, isn’t that simple.

Nations, and economies with them, rise and fall. You only have to look at the last century and do a comparative study of Argentina and Japan to see the sort of thing that can happen.

Now one of the problems with sending out all these dollars and euros (and perhaps it is worth noting that each and every one of them was conventionally signed on the reverse face with a declaration by the central banker to pay the bearer on demand, a declaration which now I take the trouble to look has been conveniently ommited on the euro notes: in their haste this eventuality was obviosly not foreseen) is that it represents a declaration of faith in the idea that economics is a game played out in abstract state space. It is curious indeed to note that many of the best known criticisms of standard neo-classical theory revolve around the question whether market mechanisms unaided reach an optimum output solution. This is an interesting, but IMOH secondary question. There is a much more interesting one which comes from the classics but which has somehow got lost in the wash: whether economics is a game played out in historical time, with evolutionary processes entering as part of the backdrop – is the game structured by meta parameters which lie outside the game (the so called exogenous variables). And what if one of these is our own species reproductive dynamic – our demography. We don’t have any problem whatsoever with this when it concerns the ecological dynamics of other animals, but somehow we are rather retiscent to look carefully at our own behaviour in the reflective mirror.

Well maybe it’s time to start doing this. Because maybe those dynamics are about to make their presence felt. Where for example are the Argentinas of today, and where the new Japans? Well it isn’t too hard to see that, at least in relative terms, Europe and the US are on the way down, whilst China and India are evidently on the way up. So what this means is a major relative re-alignment in currency values. Now this could be unproblematic – if done gradually enough – and if one (or now both) of the downward adjusting currencies weren’t the measure of value of all the others. So here it’s not a particular that’s being corrected, but the measure itself.

The realisation that this was always going to be a problem isn’t new: the American economist Paul Davidson gave a presentation to the G23 finance ministers in 1999 suggesting that it was time to do something about this, a suggestion which he tells me was well received in January, and forgotten in March. Well the problem just came back to haunt us.

So what is happening now, well…….. egged on by all the euphoria about new global powers and outsourcing controversies, a realisation is dawning that the dollar must come down (in fact, that it was ever so high was already a symptom of the problem waiting to happen. The situation is also complicated even further by the quantity of liquidity in the system, all that money waiting to find an investment need. This is not a chance occurence, but must have some relation or other with all those boomers topping-up the pension funds in anticipation of the retirement to come.). But in the coming down there must be a going up, here is the problem. So up goes the euro, in a way which clearly bears no relation to any known economic fundamental. All because of this damned reserve currency business.

We are getting our piece of the action alright, I only hope we’re going to like it.

So what can be done. Well……… again as I suggest at the begining of this post the rise does seem to have halted today. Trichet is letting it be known he might intervene, and the market is ‘reflecting’. Well he may try to stop the rise, but if setting currencies values was that easy central banking would be a doddle – and if you are in doubt on this, please ask the Japanese who are currently spending a fortune, more or less, in vain. Sure the markets will pause for thought, but it seems unlikely that the downward drift of the dollar will be staunched.

This is because behind all of this there lies another unspoken problem (as if we didn’t have enough already!): the real, or perceived, deflation threat. And here matters get well and truly interesting, because there is a kind of seismic divison with a very peculiar line up. On the one side there is Krugman and the ECB who are essentially warning about the looming inflation, on the other is Ben Bernanke, Alan Greenspan, Stephen Roach and yes, little ol’ me. And unfortunately it is impossible to make any sense whatsoever of all this without understanding this backdrop. I guess this must count as one of the most difficult ‘calls’ in recent times, and it is one which really must leave the layperson feeling very economically challenged indeed.

Bernanake, Greenspan, Roach and me (we will stand and await reinforcements) clearly think the deflation is the real risk.

This is where Bush’s crazy tax cut really comes in like a billion dollar note pinned to the inside of the Fed’s waistcoat, just for a rainy day. It fits the need like a glove. Of course this wasn’t the original plan……

But the looming monster-tax-cut is focusing everyones eyes – including K’s – on inflation, which is exactly where Bernanke and Greenspan want them to be. (Incidentally my feeling is that Bush is essentially irrelevant here: they are calling the shots down at the Fed). In a way it’s a nice inversion of a set of proposals made recently by IMF economist Gauti Eggerston: only instead of the central bank becoming prisoner of the mad government as he suggests – the mad government is giving everyone the impression of being in control, while the pupeteer (not Malkevitch this time but Greenspan) is really pulling the strings.

What I am trying to say, is that while the US position is far from comfortable, it does seem to be sustainable at a price: since they are not afraid of inflation they can happily keep printing money till the cows come home.

Did I mention that all this pleasure has a price: well yes it does, and it is we in Europe who are destined to pick up the tab. This is where it can all end in tears. Where is the ceiling? $1.40, $1.50? You tell me, but somewhere out there there is a limit, and we are just about to go and give it a test.

Of course, some of you will say, couldn’t this all be sorted out by the various parties acting like gentlemen and sitting round a table to iron things out: well maybe it could, but please remember that other wild card which is lying around on the table: Iraq. Are the European leaders in the present environment in any position to ask the US for a favour, a favour which might mean that it is the US and not Germany which enters deflationland first. I ask you: think again.

Incidentally, the real Bernanke speech you need to read is here. In it you will see among other things, that the Fed even had plans to control what is known as the yield curve, in an attempt to keep long rates below a given threshold. Are they doing this, well they wouldn’t be telling us, now would they?

Anyway this is where you can see what really might be going on. Of course it isn’t in the references to Bernakes other speech, the one he made last week, and which has caused so much confusion in the markets. IMOH if it has caused confusion there is one good explanation: it was meant to.

Now I apologise to those of you who have come this far and are not economists, and I apologise equally to those of you who are and still aren’t with me. These are what they are: my opinions. Now go and check them out with the facts.

This article appears of part of my guest column in the Money Files.

This entry was posted in A Fistful Of Euros, Economics: Currencies and tagged , , , , , , , , , by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

32 thoughts on “Things That Can’t Go On Forever, Don’t

  1. As the U.S. Dollar has been falling against other currencies besides the Euro, it seems to me that the drop in the value of the U.S. currency is more indicative of recognition of a problem with the U.S.’s economic health.

    Until the U.S. gets an administration that’s willing and able to truly address its economic issues, I’d invest elsewhere if I could.

  2. 7% odd growth at an annualised rate doesn’t seem so bad to me Patrick, nor does the 8% productivity rise. Europe on the other hand has been reduced to a crawl, and may well be about to experience one of those notorious ‘double dips’ that Roach keeps going on about. Of course the US is also going to slow considerably now, but even if it manages 3-4% this year it will still be doing a lot better than Europe. I mean what is it? Do you really just not want to see?

    BTW: what exactly would a US administration that was willing to address it’s economic issues be doing that this one isn’t? We’ve had massive short term fiscal stimulus and interest rates at 1%, what else are you calling for (by you here I would also rope in Krugman, since I have no idea at all what his alternative policy is: any of the other readers like to explain. Rhetoric is cheap.)?

    As I have indicated the change I would be looking for wouldn’t be in domestic policy, but rather in a new turn towards multilateralism on things like Iraq, financial architecture, energy etc.

    Oh, you will probably tell me, the tax cut. Well I think I wouldn’t be touching that right now, not unless you want to plunge the whole thing into deflation mode. There will be time to address this, and put things straight, when and if you get the jet out of tailspin. As I say this is a technical question, and I cannot hide my admiration (despite my many substantial differences about theory) for the way Bernanke has been handling it up to now. It’s here in Europe we need the administration willing to face up to the problem.

  3. Where to begin,
    GDP growth is less of a concern to me than job growth, which has been contracting since 2000. The job market contraction has slowed within the past two quarters, but it has not yet shown signs of growth.

    Productivity growth is generally good, or it might be a symptom of labor exploitation. For example, see the missive recently put out by our labor department for employers about ‘legal methods’ to get around overtime pay requirements. Won’t that goose the productivity numbers.

    The inflation rate has been low, but median household income actually dropped last year, the overall effect being rather deflationary in the short term.

    But the administration’s twin fiscal priorities of ever increasing expenditures and decreasing revenues, means that the U.S. is vulnerable to hyperflation, should the credit be cut off as it inevitably will.

    The Bush tax cuts were massive in terms of the revenue removed from the Government’s coffers, but rather paltry in terms of actual economic stimulus. Most of it being aimed at the very wealthy who tend to save rather than spend their last dollar. As a result the multiplier effect was significantly weaker than it would have been had the stimulus been aimed at the lower working-classes.

    A hypothetical private sector recovery this year (the basis for last year’s stock rally) is likely to be undermined by severe weakness in the public sector at the state and local levels, because unlike the federal government, they can’t run a deficit, and the bag of tricks that they used to get through 2003 is essentially empty.

    …back in 1995, the U.S. could afford to intervene economically for a major trade partner; I don’t think that will be true in 2005, no matter the ramifications. And there’s no willingness to do so from this administration in 2004.

  4. Geez Patrick! Can’t you see that Edward is talking about something completely different? You’re reacting as if you know what he’s talking about. The private sector can’t run a deficit? Wake up idiot! Running a credit card bill is the same thing. A company that borrows money from a bank runs a fucking deficit! And states can run a deficit too: California did just that, and that’s why Ahhnold is in office now. You’re thinking in black and white terms, republican vs. democrat. The world isn’t as simplistic as that. And don’t try to wing it by spouting stuff you don’t know much about, because then you really sound like a jerk.

  5. John, you need to settle down a bit.

    It’s obvious that Patrick was refering to State and Local Governemnts and not the private sector when he said they can not run a deficit. And infact they can not legally run deficits because they do not and can not have their own banks. Yes there are a variety of short-term tricks (bond measures) they can employ to cover spending gaps but they are not allowed to spend what they do not have. Patrick is exactly right and you should follow your own advice.

  6. John,
    The governor of California is legally required to balance the state budget. California can sell bonds for a “one time” infusion of cash, but if they do that, they have to squeeze other parts of the budget to pay for the interest on the bonds.

    That’s why the Gropinator is cutting education spending in his proposed budget despite pledging not to during his campaign.

    Lots of states, counties, and municipalities are in the same boat as California, but their numbers aren’t as eye-poppingly big as California’s, so their plight is under the radar.

    If states (etc.) go into drastic cost-cutting mode right about the same time that businesses resume hiring, the net effect is highly unlikely to be a robust recovery for the U.S. economy.

    Stabilizing the state governments by making up for revenue shortfalls is something the Federal Government could have and should have done, until the recovery truly took effect.

  7. Several of Patricks points are right on.

    The structure of the Bush tax cuts is likely to have a profound social effect on the U.S. whether or not spending cuts take place I believe some of this could have been avoided. If I recall, Krugman on several occasions provided alternatives that might have provided at least as much short term stimulus without doing so much collateral damage.

    Yes the inflation hawk/deflation hawk divide is an important one but the equity versus growth divide is also important here and In my opinion when meaningful redistribution through taxation is taken off the table the risks for the lower two-thirds of the U.S. income distribution look unreasonably high.

    The spend but don’t tax fiscal policy of the Bush Administration is given far too little significance in Edward’s analysis but then this blog IS devoted to Europe.

    Still, while from outside of the US the income distribution may appear to be of little consequence I think that Brad Delong is on to something when he is searching for the demand that drives U.S. economic growth over the next year. The well off 1/3 cannot buy everything.

  8. On the subject of an inflation/deflation threat, the article, sortof implies that only one can be possible at any time. A post in Brad DeLong’s blog has some commentry on how it is possible to be at risk of both at the same time,and yes, I don’t remember the post, or the economic logic behind how such a situation can occur.

  9. Michael, Patrick, your both cut from the same fucking cloth. Your kind turn every interesting economic discussion into an opportunity for Bush-bashing. Boring!!!! What the effects of Bush’s policies are for the American voter is not what Edward was referring to, but the effect of American fiscal policy on Europe, and whether or not Europe even realizes this.

    Get your fucking minds out of the black and white world view and realize that not everyone is interested in hearing yet again why Bush is bad. We know. What we don’t know should worry you more. Ask Edward to clarify, instead of telling him he’s wrong because Paul Krugman and Michael Moore are right and nothing will be right unless Bush is gone. Because most likely a new American president will behave just like Bush- in American interests, and not in Europe’s

  10. It’s not clear to me whether Patrick is arguing for deflation in the US, or for hyper-inflation.

    As far as I can see, there’s little risk of hyper-inflation because the overall level of indebtedness in the US is already very high and interest rates would likely skyrocket so far above inflation that the economy would shut down completely at the first sign of rapid inflation.

    Deflation is a potential risk, but here Patrick confuses the US demographic situation with that of Europe. Europe is commiting demographic suicide on a much grander scale than Japan, which was first into the whirlpool. The US has a baby bulge cohort to deal with but the overall US population is growing nicely and will soon pass over the 300 million mark. Many EU nations have fertility rates in the 1.2-1.6 zone, whilst the US hangs in at a relatively robust 2.1.

    Put all of this together and EU bonds become the place to be – deflation in Europe is good for bonds and the enormous CA deficit in the US guarantees the dollar goes down against all major currencies (save the fixed-for-now RMB) for the next 6-9 months.

    Looking back on all this from a post 30 years hence, I’m quite certain that we’ll be looking at Europe and saying, “yep, they’re the Argentina of the 21st century”, though I’m not sure they’ll even fare that well if they keep on importing radical Muslims on a grand scale.

  11. John: What a pity you use such language to say things that are so very true and important.

    Of course you are right that you must realize your own “challenges” (for me it’s not just economy but English as well!) but I don’t think it’s necessary that everyone phrases his or her ideas in the form of questions.

    But you are so very right that political ideologising is so terribly dominating important debates. Even on “fair and balanced” Brad deLong I sense this.

    ?…….the effect of American fiscal policy on Europe, and whether or not Europe even realizes this.? to me is a keyword of your contribution.

    NO, European politicians don?t even seem to contemplate the effect of American economic policy (apart from trade-war-threats and that kind of stuff) let alone the fiscal policy.
    As a Dutch independent politician (amateur!) I am sometimes in the position to throw some light on the way ?our? finance minister Zalm is speaking out on economic subjects. You can say whatever you want about the guy but at least in Dutch politics (and in European too to a lesser degree) he makes important statements. Well this guy in his own weblog formulated sometime ago that this Keynesian stuff was something from the past; suggesting some surprise that anybody still believed in the soundness of Keynes ideas.
    Inspiring me to a post ?rehabilitating Keynes? about the well-known book of mr Stiglitz (http://www.risq.org/modules.php?name=News&file=article&sid=121#comment )
    Key-sentences:
    ??.Stiglitz described the Asian Development Bank and the ?Asian model? as opposed to the ?Washington Consensus?. Reading this I suddenly realized that at least in the Netherlands (but I am afraid in all of Western Europe) this Asian model has had very limited attention.
    In reaction to market-fundamentalists claiming that less government-involvement with economic affairs implies stronger economic growth, I refer to the role of the governments of the Asian tigers (?NIC?s) for many years now, but did not perceive this role as part of an Asian model.
    It?s a different classification of course, but it made me think of the ?dichotomy? of the Rhineland- vs Anglo-Saxon-economies immediately: this dichotomy served for many years as some kind of paradigm; fixing the debate to a large extend to a small number of issues. A fixation that in my opinion reflects the Dutch and West-European fixation on the political relation with the USA. A fixation that somehow hides important aspects of the macro-economical relation between the USA and (western) Europe.
    I read about Bush? ?debt-increase-law? and on my own website I even made a link between the astonishing plans of the Bush regime to enlarge the national debt by hundreds of billions dollars on one hand and the rigid approach of the ECB vis-?-vis inflation-targets and the stability-pact on the other (Williamson mentions this too in his review of Stiglitz; judging the ECB more extreme then the IMF by the way), but failed to see the link with Keynes.
    Stiglitz makes this link. He makes this link in a most convincing way: throughout the book he refers to knowledge now available in the past 60 or 70 years about how to handle economic crises.
    To me, -and I am afraid that in this aspect I am somehow representative for a lot of politicians in the Netherlands-, Keynesian economical policy had lost a great part of its significance (especially to countries like the Netherlands) because of the ?globalization?. In this way I did ignore the stature of Keynes. This great man not only recognized the impossibility of ?Keynesian? policy for just one (smaller) nation: he worked hard and successfully to face this challenge. Most important in this effort being the stabilizing objectives for the IMF.?

    Maybe not as much as me, but Patrick makes mistakes.
    Still I think this reference

    -?As a result the multiplier effect was significantly weaker than it would have been had the stimulus been aimed at the lower working-classes?-

    is important too, because it?s just not enough (as difficult as it is!) to get the very best economists and statesmen together for a truly multilateral effort towards some kind of global stability and growth pact: we need public support too if we do not want to end with huge lose-lose-lose situations.
    Apart from social considerations: populism and using a wrong perception of other countries / administrations to get support at home, are always near.

  12. John,

    As someone who bashes me (inaccurately no less) after reading three paragraphs of what I have to say. You are not in any position to critize. First, grow up. If you think talking about Bush makes a discussion boring try reasoning with someone who puts “fucking” between every two words.

    Listen I never EVER EVER said the world was black and white. But you do need to make choices in life and sometimes the choices have obvious consequences. I NEVER said Edward who I respect was wrong. I DID say he should deal with the internal domestic equity implications of the Bush tax cuts and I stand by that. If someone actually wants to present an arguement against that I’m listening.

    I am very much aware that it is the unknown that is the scary part but I do know that in ten months a major politcal event is going to happen in the U.S. with global economic implications and one of the big topics will be economic record of George Bush. It IS germaine and it SHOULD be discussed. If you do like that don’t read my posts, kid.

  13. On second thought we shouldn’t be too tough on John. I think he is subliminally trying to address the decline in European Fertility and just forgot to actually subliminate.

  14. “I DID say he should deal with the internal domestic equity implications of the Bush tax cuts and I stand by that.”

    Michael on this no problem. I agree. I am not in favour of the tax cut. I am not in favour of the massive differentials of wealth and income you have in the US. I am a European, and I like the way we do things here in this respect.

    I am saying however that now that it’s on the table the tax cut can be used as a convenient ruse to try and frighten the living daylights out of everyone and put some inflation (limited inflation 2-3% stuff, what the inflation targeting argument is all about) back in the system. In this I agree wholeheartedly with the ‘old’ Krugman: he of the liquidity trap emphasis. I mean we should be talking about subtlety here, not dogma. About pragmatism, and using the instruments we have to hand. Whether this can work is another question, but I fear it may be all we have.

    “there’s little risk of hyper-inflation because the overall level of indebtedness in the US is already very high and interest rates would likely skyrocket so far above inflation”

    While I agree with your assessment anarchus, I don’t buy the reason. As michael says this isn’t really a US economy blog, so we can’t go into it all here, but I just posted on Bonobo about the fact that – for a variety of reasons – the world’s central banks seem to be ready and willing to buy (and even print money to do so) the debt of other governments. Under these circumstances Bernanke doesn’t have to intervene to smooth the yield curve: the Chinese and the Japanese are doing it for him.

    Given this, short term it is very difficult to see a dramatic rise in long rates.

    The implications of all this are hard to see, and I’m even going to say something shocking here: I don’t think anyone fully comprehends yet what they will be. I for one – as I say in my post – am simply thinking aloud, trying to fathom it.

    The best that can be said is that Keynes ‘in the long run we’re all dead’ might actually be truer than we imagine – if the we here is Japan, the US and Europe – since in the long run people will switch to Chinese and Indian assets big time, and then we could all be ‘Argentinas’. What I’m saying is that somewhere out there in front of us lies a ‘tipping point’ – la partage des eaux.

  15. “Europe is commiting demographic suicide on a much grander scale than Japan, which was first into the whirlpool. The US has a baby bulge cohort to deal with but the overall US population is growing nicely and will soon pass over the 300 million mark. Many EU nations have fertility rates in the 1.2-1.6 zone, whilst the US hangs in at a relatively robust 2.1.”

    Yep Anarchus, I think you’ve got it. I had noticed you as one of the few people on Brad’s threads who was getting this.

    Ironically short term this is one of the factors contributing to the softness in the labour market, since you have the completely opposite situation to the European and Japanese ones: significantly more people trying to enter the labour market than are trying to leave. This makes it harder to create sufficient jobs, but long run it’s a lot healthier.

    Incidentally, we’re all busy knocking Bush on lots of topics, but what about this proposal to make it easier for immigrants to come and work (and what about Scott’s post on Chirac and headscarves?). I know one could use a type M argument here and say he’s looking for votes, but in a democracy isn’t that what politicians are supposed to do? Anyway whatever the reasons, and whatever the deficiencies in the proposal, it will be interesting to see how Democrats like Dean and Clark field this one. Thinking about it, I imagine that is why he’s thrown it in: to cause problems in the opposition camp.

    “GDP growth is less of a concern to me than job growth, which has been contracting since 2000.”

    Ok Patrick, I think you’ve made a serious attempt to answer. I’ll deal with the main points in a bit, but I would like to link this one with Michael’s: “internal domestic equity implications “.

    You see one of the difficulties with the traditional way of looking at all this is the limitation imposed by ‘nation state’ thinking.

    I mean if we are thinking not of ‘internal equity’ or of the ‘US labour market’ but rather on a global scale then it is clear that there is a massive redistribution of equity going on, and hurray for that. And if we are looking at job growth globally then what is happening is very positive, since lots of people in countries that previously didn’t have many opportunities, indeed lots of people who previously had to emmigrate to find quality work, can now find those jobs in their own countries. So again hurray!

    Now, what we should be looking for, I will readily agree, are policies from our own politicians which recognise this new and positive reality (and how can any self respecting economist not think in terms of global, and not local, optima – or does belief in the market stop at ones own front door) and which try to find as equitable and as reasonable a solution as possible for their constituent populations. Here I would certainly agree with both of you that Bush is in no way shaping up to confront these issues, but then neither are any of the politicians over on this side of the pond.

  16. Ok Patrick, you made an attempt at an answer and it deserves a response.

    “The job market contraction has slowed within the past two quarters, but it has not yet shown signs of growth.”

    This is a complicated question, but actually Bernanke is with you:

    “The third unusual factor is the persistent softness of the labor market……………Why has the labor market remained relatively weak, despite increasingly rapid growth in output? I addressed the causes of the “jobless recovery” in an earlier talk (Bernanke, 2003). Although many factors have affected the rate of job creation, I concluded in my earlier analysis that the rapid rate of productivity growth, already discussed in relation to unit labor costs, has also been an important reason for the slow pace of recovery in the labor market. All else equal, strong productivity gains allow firms to meet a given level of demand with fewer employees. Thus, for given growth in aggregate spending, a higher rate of productivity growth implies a slower rate of growth in employment.”

    Now the interesting question here is why there isthis extraordinary explosion in productivity in the US. Two arguments are being advanced, one by productivity guru Robert Gordon ( and also Brad Delong), the other by people like Stephen Roach and me. The first is that the ICT revolution (and in particular the fusion of the browser with broadband connectivity – and I personally would definitely add and with ‘smiley face’ instant messaging) is only now really begining to show its long term productivity potential, and for how long this will run is anybody’s guess.

    The other, and it is this that really complicates the postition for Patrick’s argument in my book, is the leveraging of these technologies towards outsourcing and global supply chains. This means that much of the labour intensive work is shipped abroad, which gives short term job creation problems back home. The trick is to get the economy growing fast enough to be able to handle the job loss this creates, and the extra demographic increase in job demand.

    Now I’m not saying more couldn’t be done in the US on this score, I’m not on the ground over there, and it’s hard to see. But it is a very tricky situation, and one should be wary of simplistic remedies.

    Probably the US should be looking to do more in the way of raising revenue, but……..and this is a big but, while this may be desireable on equity grounds, it would probably only serve to make the job creation process more difficult. What I am trying to say is that it is basic econ 101 stuff that anything which adds to costs will tend to subtract from employment – this is the big difficulty Europe is going to have in taxing to maintain health and pensions while trying at one and the same time to create jobs in a globalised market.

    So raising more revenue will be problematic from an employment point of view in my judgement, unless, of course you want to raise revenue and spending.

    But that is a different argument, an argument for a shift in economic activity from private to public, and this policy perspective, as I am sure you already know Patrick, isn’t especially popular with posters on this blog. It seems to imply that what is arguably the most successful economy on the planet should change course – on economic grounds – to make itself more like some of the less successful ones. I’m not convinced.

    OK, this has been a lot of stuff about the US economy, what I hope to have achieved at least is convince people that you can’t understand what is happening to the euro if you don’t understand Bernanke and what US policy is all about. The euro rise is a consequence and not a cause.

  17. Edward,
    Is it truly a rise in the Euro, or a fall in the value of the Dollar ? I argue that it’s a fall in the value of the Dollar by comparing it to the Canadian and Australian Dollars and the Japanese Yen.

    Oh and btw, it looks like Japan gave up trying to support the Dollar back in September after over a year of trying to hold it to within 10% of its Jan 2002 level.

  18. It’s a rise in the Euro and a fall in the dollar too. You can have both, y’know.

    Yes, the dollar has fallen even faster against the Australian dollar; but that’s not exactly a major world currency. Better comparisons are with the yen and the Canadian dollar (not a major world currency either, but of interest because it should be so closely bound to the dollar).

    Those two have risen by about 18% and 20%, respectively, since the beginning of 2002; and IMO this reflects the “real” decline of the dollar. The Euro has risen by about 30% against the dollar (and 10% against the yen) over the same period.

    Doug M.

  19. Are we all still right to live in a “The dollar is our currency and it is your problem” mode? Wasn’t (one of) the point(s) of the euro to partly insulate eurozone economies from outside shocks? The degree of openness of the EU or even the Eurozone is quite close to that of the US today, I seem to remember (I do not have the exact figures, but something like exports representing 10% of GDP).
    The effect of a rising euro vs the dollar has an impact on trade between the two zones and on the relative price competitivity of European products vs American (and other dollar-indexed) ones, which is potentially damaging to European exports, but it also brings cheaper imports (especially for non subsituable raw materials as well as for all other US abnd Chinese products), which is a good thing for European consumers. But what is the net overall effect? Do we actually know what it is in the (still new) context of the euro or are we using models which were built when we had DM,FF, etc and exchange rates were way more important than now?
    The BCR is treated with contempt for taking the fall of the dollar with such calm, but could it not be that they are right and that the impact on the European economy is overestimated? Are we working on old asumptions whereas they are trying to actually consider what happens to the Euro zone today? Many commentators agree when the BCR says that France and Germany are not doing enough to tackle the structural problems of the two countries, why do they not agree that in that context with the BCR position that the euro rate is not yet a problem ?

    As far as “Argentina” is concerned, we need to make a distinction between relative decline (having a smaller share of the world economy because the others are growing faster) and absolute decline. Argentina can arguably be said to fall in the second category; Europe still is in the first.

  20. Edward,
    With regards to productivity gains…If those gains primarily benefit the rentier class, as seems to have happened in the U.S in 2003, you have your work cut out convincing me that society as a whole truly benefits. It’s too analogous of that anecdote about Bill Gates in a homeless shelter making everybody in the room a billionaire, on average.

    To address something else you said:
    It seems to imply that what is arguably the most successful economy on the planet should change course – on economic grounds – to make itself more like some of the less successful ones. I’m not convinced.

    In my experience (U.S., Western Europe, Canada), there are a number of countries roughly equally economically advanced as the U.S., though each seems to have its unique mix of strengths and weaknesses. That these countries (even the arguably most successful) can’t learn from the others’ strengths and weaknesses for their own situations, strikes me as a false argument.

  21. The dollar is sinking (because of the easy money policy of the Fed): too many dollars means a dollar is worth less.

    The euro is stable: look at euro vs. gold, for instance. Gold has been in a trading range of 300 to 330 euro for a long time.

  22. Edward: correct me if I’m wrong but… wouldn’t the pressures on the euro be eased if there was more domestic demand within Europe? (I seem to recall Schr?der recently urging for more consumer spending). It seems to me that the dream of having a counterweight to American – and the dollar’s – hegemony was always predicated on the assumption that American economic strength was based on the unified market, when in fact it may be based on the abundance of after-tax spending money within a unified market. If so, could Europe counter American moves by simply taxing their consumers less?

    Of course, this probably would entail scaling back the welfare state… and perhaps Europe’s politicians are simply not up to that task, beneficial as it may be.

    By the way, thank you for an excellent post.

  23. Any comment on today’s ECB decision not to lower rates, and on Trichet’s press conference remarks? Seems to me, anyway, that these guys are remarkably stubborn about adapting to the way the world is now.

  24. “The effect of a rising euro vs the dollar has an impact on trade between the two zones and on the relative price competitivity of European products vs American (and other dollar-indexed) ones, which is potentially damaging to European exports, but it also brings cheaper imports (especially for non subsituable raw materials as well as for all other US and Chinese products), which is a good thing for European consumers.”

    Jerome is absolutely right here. If this was the mid 80′s I’d say take this argument and run with it. A strong euro would be a good thing.

    But it isn’t the mid 80′s: so things aren’t necessarily on a ‘business as usual’ basis. Internal eurozone consumption is flat to declining – which also brings us to Markku’s point (and thanks for the compliment!).

    You see the big error I think most conventional economists are making is to assume that there is something called a business cycle out there is some abstract state space, which just keeps repeating itself in a sort of eternal (if slightly modified) run of the same. So most of the emphasis is on the cycle as the regulatory mechanism, with a few caveats thrown in for safe-keeping about every cycle being unique. This is effectively why Trichet didn’t lower rates yesterday – he’s looking at what they call the projected trend growth and assuming we are in a recovery phase with a reasonably well understood structure. (the other two reasons he did nothing seem to be that his reputation as an obsessive inflation fighter seems could be well founded – he thinks the big risk in Europe is inflation, and since a major recovery is just round the corner, then better err on the side of caution, and secondly he at least had the intelligence to recognise the fact that when you really can’t do very much, it is better not to make this fact too obvious).

    What I am arguing is that if you set up the question in a different way, and ask what may be changing, and in what ways will these changes make their presence felt, then you come up with some different answers.

    I have been arguing that I can see three factors which make today very different from twenty years ago: demography (the fact that all the OECD countries have a higher average age today than they did 20 years ago), global rebalancing (especially the rise of China and India, but probably also later Brazil, Indonesia and Turkey among others – simply the demography tells me this), and the fact that we are living in the middle of an ICT driven productivity revolution of enormous and as yet still undetermined proportions.

    All these three factors are deflationary in their impact in my book. There are 180 million bodies looking for gainful employment in China alone. There are an unknown number of brains in India just waiting to be trained and connected-up. In a fully globalised labour market – thanks of course to the internet – how can anyone seriously imagine this isn’t going to have a major downward impact on prices. The only comparable epoch in history you could compare this with is at the back-end of the 19th century, and just look what happend.In fact the biggest part of the ‘growth spurt’ both in India and China still lies in front, and remember each of these countries is already seriously into systematic outsourcing to yet cheaper countries in order to maintain their competitivity.

    Back to Markku’s point about internal consumption in Europe. As everyone now recognises the numbers are more preoccupying in Europe than the US.(and incidentally have a look at this: http://economist.com/world/asia/displayStory.cfm?story_id=2342430 from the economist, which is finally waking up to the extent of the problem in Japan.)

    Now this guy (US economic historian Jeffrey Williamson)

    http://www.bos.frb.org/economic/conf/conf46/conf46h1.pdf

    explains quite well how saving and consumption is age related. In fact it is really only necessary to extrapolate a bit from Modigliani’s ‘Life Cycle Model’ or Friedman’s ‘Permanent Income Hypothesis’to see what should really be obvious (I don’t think you need rocket science): as Williamson argues excessively young societies do virtually no saving (this is why it is so difficult to get capital formation and hence growth), youngish societies do a lot of consuming, borrowing from the bright future (70′s, 80′s 90′s OECD style), middle aged societies start to notice a slow but steady decline in consumption, a rise in saving, an excess of liquidity (Germany post 1995 Japan post 1990).And elderly societies: well we don’t know yet, we still haven’t quite got there.

    I posted yesterday on the Living in India page a fuller exposition of all this, in this case oriented to explaining why the Indians have grounds for cautious optimism.

    http://www.livinginindia.com/archives/000129.html

  25. “With regards to productivity gains…If those gains primarily benefit the rentier class, as seems to have happened in the U.S in 2003, you have your work cut out convincing me that society as a whole truly benefits.”

    In fact Partick I wasn’t saying anything about who benefits, simply that it was happening, and that this was a major issue for economic policy. The very scale of the productivity boom in itself generates issues. But if you have productivity growth whose benefits are not widely enough distributed, the answer is not to put the productivity engine in reverse gear. Maybe we need some new creative ideas on this, I am just saying I haven’t seen any on the table so far.

    “The euro is stable”

    Look the point is this, everything here is relative: if I jump out of the window, is my body going downwards, or is the building moving up?

    We need to think about Krugman’s ‘new trade theory’ here. The most important trade for us is that between the US, Europe and Japan. In this league the US companies just got a reasonably big price adantage. Also, China is another important factor, and the Chinese currency is going in the same direction as the dollar, the benefits of leveraging Chinese ousourcing just went up dramatically here in Europe, and the problems of selling European as against US technology in China just became even greater.

  26. Edward,
    “”The euro is stable” Look the point is this, everything here is relative: if I jump out of the window, is my body going downwards, or is the building moving up?”

    To the jumper it doesn’t matter anymore, but for the other occupants of the building, they best not react as if the laws of physics were being violated, lest they suffer the same fate. :-)

    “”With regards to productivity gains…If those gains primarily benefit the rentier class, as seems to have happened in the U.S in 2003, you have your work cut out convincing me that society as a whole truly benefits.”

    In fact Partick I wasn’t saying anything about who benefits, simply that it was happening, and that this was a major issue for economic policy. The very scale of the productivity boom in itself generates issues. But if you have productivity growth whose benefits are not widely enough distributed, the answer is not to put the productivity engine in reverse gear. Maybe we need some new creative ideas on this, I am just saying I haven’t seen any on the table so far.”

    It’s too soon to know if the recent U.S. productivity gains are actually sustainable productivity growth. But the benefits seem to be going not to the ones who are increasing their productivity, but at their expense, and that’s just not sustainable.

    The downside from incorrectly assuming that this will prove sustainable is rather greater than upside from incorrectly assuming that it won’t.

    “We need to think about Krugman’s ‘new trade theory’ here. The most important trade for us is that between the US, Europe and Japan. In this league the US companies just got a reasonably big price adantage. Also, China is another important factor, and the Chinese currency is going in the same direction as the dollar, the benefits of leveraging Chinese ousourcing just went up dramatically here in Europe, and the problems of selling European as against US technology in China just became even greater.”

    I seem to recall a lot of American companies rushing to establish a European beachhead in the early nineties, “before the walls of Fortress Europe go up”. If so, their European presense means that they have European expenses which may limit their ability to undercut European companies.

    More to the point, I think it’s the productivity improvements in the manufacturing sector that are going to squeeze people out of that area, just as has happened in agriculture. Manipulating currencies to brake this trend is ultimately futile.

    I don’t believe that undercutting the U.S. dollar while simultaneously financially propping up the U.S. Government as china and Japan are doing, to the tune of a trillion dollars a year is long-term sustainable. It’s an inefficient way of subsidizing their manufacturing sectors.

    The economic winners in the post-agricultural, post-industrial 21st century will be those who manage to figure out “Now what?” socio-economically.

  27. “The economic winners in the post-agricultural, post-industrial 21st century will be those who manage to figure out “Now what?” socio-economically.”

    On this point Patrick we finally have agreement: and if I were a betting man, I’d be looking to India as the most likely venue.

  28. I can see how India is well positioned too. Please Correct me if I am wrong o0n any of the following.

    1) More Democratic than China
    2) Better Investment Track Record than China
    3) Descent rate of improvement in key skills areas.
    4) Stabilizing Population.
    5) Reasonably Competent Civil Service

    If there is a long-term accord with Pakistan there could be a big boom, right?

    I think another big wild card is the enfranchisement of Women in India. India has always seemed a tad schizoid on that one. I will go look at Living on India now.

  29. I think you have it right Michael. Actually what I can tell you is that from the blogging end, women are more active in both China and India than in Europe or the US. There is an interesting difference in the topics thay blog about. Chinese women are blogging about sex: Muzimei etc, and in particular have a vision of men as creatures to be ‘used’. India is different. As one perceptive Indian female blogger put it:

    “It seems that Indian women bloggers are undressing their minds, while Chinese women bloggers are undressing their bodier”.

    If you want to see the difference go try Hard Candy, who is now our very own Muzimei on LiC, and read Divya, or Charukesi, or Nancy, or Dina on the India page.

  30. On this ( http://www.j-bradford-delong.net/movable_type/2003_archives/003017.html ) post at Brad deLong’s place one Camille Roy makes a very “interesting” point about the the huge sex-ratio imbalance in certain countries, esp China and India.

    I added my hypothesis:
    More abortions on female fetuses and even infanticide on baby-girls is indeed one of the most disgusting aspects of China and (as far as I know: even more) India getting so little press-coverage: the number of males exceed the number of females with millions; still I don’t believe the effect on demography won’t be very big. (or is this some indirect wish that it can not be THAT horrific?)

    Unfortunately the sentence in brackets was right. It turns out that Amatrya Sen has written on the subject of “100 Million Missing Women”.
    The utter realpolitiker in me however could still question if this disgusting practices (Camille refers to ” *…One of the important causes of sharp decline in sex ratio is the unregulated use of pre natal diagnostic technologies”) influence the demografy in a way that has major economic influence.
    Would be interesting to hear comments from the female Indian bloggers.

  31. Frans, this last topic, demographic imbalance, is very important.

    We had some debate about it on the old India Economy Watch:
    http://indiaeconomywatch.blogspot.com/2003_10_19_indiaeconomywatch_archive.html#106680925997813056

    http://indiaeconomywatch.blogspot.com/2003_10_26_indiaeconomywatch_archive.html#106732131363726911

    http://indiaeconomywatch.blogspot.com/2003_10_26_indiaeconomywatch_archive.html#106740645762601471

    http://indiaeconomywatch.blogspot.com/2003_10_26_indiaeconomywatch_archive.html#106741419079211033

    My main feeling is that one of the consequences of having 10s of millions of excess men roaming the planet will be more aggression, and more problems like terrorism and war. So we really all need to be thinking about this. It is another example of a local problem which is about to become a global one.

    What we lack are really systematic global statistics. My feeling is that this has always been happening in agricultural societies, and that those centuries of European wars may have had something to do with this too. But this is only a guess, since I haven’t seen any explicit investigation of this practice in a European context.