Archive for the Category Eurozone


Our Trumpian Treasury

In Washington DC, all the best and the brightest in both parties are horrified by the prospects of a Trump Presidency.  But perhaps we owe Trump an apology, as in some respects he already controls our trade policy.  Here’s a report from 4 months ago:

The U.S. government is sending a message to countries it believes are manipulating their currencies: We’re watching you.

A Treasury report targets five countries in particular: China, Japan, Korea, Taiwan and Germany. Each meets at least two of the three criteria that “determine whether an economy may be pursuing foreign exchange policies that could give it an unfair competitive advantage against the United States.”

At a time when currency devaluation has become a major tool used by multiple countries to stimulate growth, the U.S. is looking to protect its own interests. The report is an outgrowth of the Trade Facilitation and Trade Enforcement Act of 2015, a bipartisan effort aimed at stemming the global race to the bottom.

The criteria to determine whether a country should be on the “Monitoring List” of countries using unfair currency practices are: a trade surplus of larger than $20 billion, or 0.1 percent of U.S. GDP; a trade surplus with the U.S. that is more than 3 percent of that country’s GDP; “persistent one-sided intervention,” defined as purchases of foreign currency amounting to more than 2 percent of the country’s GDP in a one-year period.

No country meets all three criteria, according to the report, though the five on the list meet at least two.

For those not familiar with open economy macroeconomics, those criteria reach almost Trumpian levels of ignorance.  Where to begin:

1.  If you worry about this sort of thing (and a few respectable economists do) then you would look at a completely different set of criteria.  For instance, the trade deficit is a meaningless data point, if anything, you’d look at current account deficits.

2.  Bilateral deficits with the US are stupidity squared, a data point of no conceivable relevance, even to the most mercantilist economist on Earth.  All that “matters” is overall surpluses or deficits, not bilateral.

3.  If you are looking for “villains”, you would certainly not look at overall surpluses; rather you’d focus on surpluses as a share of GDP, or some similar metric.  Otherwise you’d be biased against large countries.  The current account surplus for China is about $170 per capita, for Switzerland it’s over $8000 per capita.  Even as a share of GDP the Swiss surplus is far higher.

4.  “Intervention” should not be defined as purchases of foreign assets, but rather as high government saving rates.  All government saving tends to have the same effect on the CA balance, whether it is used to buy domestic or foreign assets.

5.  The Treasury singles out Asian countries in a Trumpian fashion, for no apparent reason.  Switzerland has a $71 billion CA surplus, and engages in massive purchases of foreign assets to hold down the value of the SF.  There’s two criteria right there.  Why did it not make the list?  I have no idea, its trade surplus is also well above $20 billion.  Lots of other northern European countries also have massive CA surpluses, and spend lots of money holding down the value of their currencies.  In contrast, China’s recently been trying to hold up the value of its currency.

6.  If you were an American mercantilist, I’d think that you’d be much more worried about Germany’s $300 billion CA surplus, than China’s $250 billion CA surplus.  Germany exports lots of capital goods that might otherwise be bought from America, whereas China tends to export less sophisticated goods, which might otherwise be produced in other Asian countries, or Mexico.  Norway, Sweden, the Netherlands and even Italy have CA surpluses far in excess of $20 billion.  Notice that the Treasury follows in the proud tradition Pat Buchanan and Donald Trump in pointing fingers mostly at Asian countries, even though the logic of their mercantilist argument would suggest we should target the northwest Europeans.  Perhaps Germany was put on the list to try to make the racism appear a bit less blatant.

PS.  I forgot to shed a few tears for the “victims” of all this evil currency manipulation.  There’s Australia, with its $62 billion deficit, and no recessions in 25 years.  The UK, with its $162 billion deficit and the US, with its $473 billion deficit.  Both countries have a 4.9% unemployment rate.  In contrast, those sneaky eurozone members with their $394 billion CA surplus keep stealing our jobs, which probably explains their 10.1% unemployment rate.

PPS.  I don’t put all this on the Treasury; it’s Congress that forces them to engage in this sort of nonsense.

PPPS.  Speaking of Trump, last May I had commenters earnestly informing me that I should support Trump because he favored low interest rates.  Now Trump is slamming Yellen for her low interest rate policy.  Trump reminds me of that anecdote about 100 monkeys typing away.  Yes, there’s a tiny chance they might randomly type out Hamlet, but I’d put my money on something far worse.  There are many more ways to screw up than there are ways to succeed.

And no, this is not “normal” in politics.  Normal politicians lie and change their views on occasion.  Hillary’s not much worse than average (although she is certainly worse.)  But Trump’s just completely off the charts in terms of policy ignorance and personal dishonesty.  I’ve never seen anything close to this in my life, and I’ve been following politics since the late 1960s.  Nixon might have been closest on the honesty criterion, but of course was far more knowledgeable.  And even Nixon tried to avoid statements that were obvious lies. He was a devious liar.  Trump just doesn’t care.  He’ll look you in the eye and tell you that he opposed the Iraq War.  And the reporter who asked the question will be too cowardly to call him a liar to his face.  I almost hope Trump wins.  We deserve him.

I said “almost”, I’m not quite there yet.  🙂

There’s only one AD

Like any single currency area, the eurozone has only one AD.  That’s true despite the fact that it contains 19 countries.  In contrast, China has 4 ADs, for Mainland China, Hong Kong, Macao and Taiwan.  (The Taiwanese constitution says they are part of China, who am I to argue?)

Here is the eurozone unemployment rate:

screen-shot-2016-09-09-at-11-18-11-amThe disastrous policy tightening of 2011 pushed eurozone unemployment up from 10% to 12%.  Then policy eased slightly, and NGDP started growing again. Unemployment fell back to 10%, about the rate of 1999, when the euro was created.

Unemployment is still very high in Greece and Spain, but that fact does not and should not matter to the ECB.  There is only one AD for the eurozone, and it needs to be appropriate for the entire region, not any single country.  By analogy, the unemployment rate in Nevada should have and does have no bearing on Fed policy, which looks at the national unemployment rate.

That doesn’t mean ECB policy is not too tight—after all, they target inflation, not unemployment.  But here again I detect a weird pattern among pundits, to talk almost as if there are two ADs for the eurozone, one for inflation and one for unemployment.  Consider the ECB’s recent action, or should I say non-action:

US and European equities are under pressure as disappointment over the European Central Bank’s decision to stand pat on monetary policy and uncertainty over the Federal Reserve’s interest rate trajectory force up borrowing costs. . . .

Ian Williams, economist at Peel Hunt, said investors appear “rather underwhelmed by the ECB announcement, both the absence of further policy action and the lack of guidance offered by Mr Draghi at his press conference about what may come next”.

Fixed income analysts at Citi said the ECB had introduced volatility by failing to even discuss QE. “The decision not to extend the timetable of QE from Mar-17 weakens forward guidance and is bearish.”

So the ECB tightened monetary policy yesterday—why does that matter?  Here’s why it’s a big deal; roughly 90% of pundits, and even professional economists, don’t seem to have a clue as to what’s going on.  If asked to explain the recent ECB non-action, most would say the ECB is satisfied with the pace of recovery, including the fall in the unemployment rate, and that it expects inflation to rise in the future. They may not agree with that outlook (I don’t think inflation will rise as much as the ECB expects) but that’s why the ECB effectively tightened yesterday, disappointing markets.  So far, so good.

But when the discussion turns to inflation, these same pundits will insist that the ECB is trying and failing to hit its inflation target, and/or they are out of ammo.  In other words, the implicit assumption is that a single monetary policy can target two different ADs, one for inflation and one for employment.  On the employment front, the ECB still does normal monetary policy, tightening when they think the recovery needs no more juice.  But on the inflation front the pundit class insists the ECB is out of ammo.

Of course none of this makes any sense.  Obviously the ECB is not out of ammo, or markets would not have reacted negatively to their recent tightening of policy   So why do so many economists think they are out of ammo for inflation, but not employment?

Maybe they are dumb.

More plausibly, pundits and economists are smart, but excessively deferential to the wizards behind the curtain of our central banks.  People like Yellen, Bernanke, Draghi and Kuroda are deserving of our respect.  They are more qualified than most pundits and most economists, including me.  So if they are falling short on inflation, people assume that it must be because they do not have the tools to hit the inflation target.

What’s wrong with this view?  I think it’s a mistake to judge the competence of central banks by the competence of their leaders.  Central banks are complex and powerful institutions, embedded in even more complex and even more powerful political entities.  Assuming that the performance of the central bank represents the competence of their leaders is a big mistake, even if the leaders voted in favor of the recent policy action.  If the central bank heads had been assigned to the position of dictator of the world, we might be seeing an entirely different set of monetary policies.

PS. The ECB currently forecasts 1.6% inflation by 2018, which is close to its target of slightly below 2%.  I think they are too optimistic.  But excessive optimism and lack of ammo are two entirely different concepts, which most people don’t seem to be able to grasp.

Alternative for America

The German political party “Alternative for Germany” was founded in 2013 by a bunch of professors who thought the euro was a mistake, largely responsible for the depression in southern Europe.  Its other views tended to be fairly mainstream conservative.

Not any more.  In just three short years the AfD has morphed into a xenophobic, nationalist, pro-Russian party with nostalgia for the days when East Germany was run by the communists.  Many of its original supporters have abandoned the party:

It is not clear why the AfD is so popular in [low income, eastern] Mecklenburg. Its hallmark is anti-immigrant rhetoric. But Mecklenburg has just 23,000 refugees, or 1.5% of the population. Foreigners make up 3%, and most are Poles or ethnic Germans from Russia. Muslims are a rare sight. Yet even before the refugee crisis, about one in three locals told pollsters that “because of the many Muslims, I sometimes feel like an alien in my own country”.

Mecklenburg does have a longstanding core of far-right voters: it is the only state where the NPD, a party considered neo-Nazi, has seats in the assembly. But the AfD draws more support from former non-voters and The Left, a party descended from East Germany’s communists. In the West, that may seem illogical. But it matches the gut feelings of many locals. One of the AfD’s themes is Ostalgie, “nostalgia for East Germany”. It nurtures a sense of solidarity against all outsiders, including western Germans and cosmopolitan elites.  Since reunification people in the region have felt they were “overrun by the West”, says Mr Holm.

At campaign events Mr Holm evokes 1989, when Ossis marched in solidarity against the communist regime. Now the enemy is perceived political correctness imposed by Berlin. The tone is invariably pro-Russian and anti-American. Asked how they feel about Russia’s invasion of Crimea, supporters compare it with America’s war in Iraq. “If the Ami does it it’s okay, but if Russia does it, it’s wrong?” asks one.

Actually, yes.  We did not annex Iraq.

To give you an idea of just how bizarre this is, imagine an American analogy:

1.  Suppose that in just a few years, the formerly anti-big government Tea Party was taken over by a nationalist faction that favored a xenophobic, soft on Russia, big government, more spending, vastly bigger deficits, anti-trade, anti-free press candidate who railed against political correctness and elites in general.

2.  And suppose the core supporters of this candidate were not in affluent Republican areas, but rather in poor white areas like West Virginia.  And suppose those poor whites of West Virginia were freaking out about immigration, despite the fact that hardly any immigrants want to live in their poor, backward state.

I know, I know, it could never happen here.  But then 3 years ago I would have said there wasn’t one chance in a million that the AfD would suddenly change into a party with nostalgia for East Germany.

Lesson: As I keep saying, it’s not about who wins and loses elections, it’s about the nature of the parties, and how they change over time.  FDR and LBJ made the GOP more moderate (for a while).  Reagan and Thatcher made the Dems and Labour more moderate (for a while), and so on.  That’s what matters.

If you make a pact with the devil, and allow your favorite party to be taken over by evil people, and vote for them anyway as the “lesser of evils”, you’ll find out that in the long run you’ve only made the opposition stronger, and you’ve completely discredited your favored ideas, which won’t even be adopted by the usurper who stole your party.  No, your ideas will not be adopted.  But when he or she fails, as he surely will, your ideas will be blamed, and discredited.

The next president will be a failed president, and will be rejected by the voters in 2020.  The election you really want to win is the 2020 election, which will offer the possibility of dramatic policy reform.  What shape do you want your party to be in at that time?  Do you want it to be a discredited party, about to be steamrollered by the opposition?  Or the eager opposition party, about to take charge?

If I were a Republican (I’m not), I’d pray for Hillary to be defending her record in 2020

The most important election this fall?

You can make a pretty good argument that the most important elections this fall are the various state referenda over pot legalization.  If they pass in California and elsewhere, the momentum to legalize pot will become unstoppable.  But coming up fast is the Italian referendum on constitutional reform, which will be held sometime before the end of October.  Over at Econlog, I have a new post discussing how this referendum has taken on much greater importance after the Brexit vote, and could trigger a major eurozone crisis.

Some commenters made much of the fact that European stocks rallied after the “knee jerk” post-Brexit plunge.  They scolded me for putting so much weight on the market’s instant analysis.  What they fail to understand is that all market moves are provisional—we do the best we can with the information we have.  And would I be out of line to point out that the brief rally in eurozone stocks has unraveled, and that they are back down to the levels of that supposed “knee jerk reaction”?  Of course further changes will occur, and I have no idea whether we are going up or down from here. But I’m confident that the 14% decline in Italian stocks since the Brexit vote is telling us something important about both the health of the Italian banking system, and the risks of the October vote.  Ditto for the global plunge in yields on safe bonds.

Given the recent fallout from Brexit, if things continue to get worse in Italy and the eurozone between now and October, it’s not hard to imagine an intense international focus on the Italian referendum, with a no vote seen as likely to lead to an unraveling of the euro.  I’m not saying that will happen (the risks still seem less that 50-50 to me).  But I find the timing of that momentous referendum kind of interesting, given the timing of our own election, and given the anti-EU views of one of our candidates.  At the very least this is something to watch for.

PS.  Note that the Italian political system appears incapable of doing anything, and thus the silver lining of a no vote is that this incompetence would continue.  Incompetence is normally a bad thing, but if you are dealing with a government that wants to exit the EU, it’s actually good.

Currency depreciation doesn’t offset tariffs

One of my few remaining thoughtful commenters (ChrisA) left the following comment:

On the UK exports being affected by tariff’s after Brexit – couldn’t that be taken care of by a fall in the pound vs the Euro? I don’t actually think a tariff war between the UK and the EU is actually going to happen, since the trade deficit is so much in favour of the EU they have a strong incentive to be sensible. But even in the worst case we couldn’t be talking about tariffs of more than 10%, which is easily taken care of by the fall in the pound that has happened over the last week. And remember that applies to all of the exports of the UK to all of the world, not just to the EU.

I see this claim quite often, but it doesn’t hold up to close scrutiny.  Tariffs on imports are essentially a tax wedge on trade, which reduces both imports and exports.  When people talk about using “currency depreciation” as a policy tool, they are often referring to an expansionary monetary policy.  However, although monetary stimulus does reduce the nominal exchange rates in both the short and long run, it only reduces the real exchange rate in the short run, until wages and prices have adjusted.  After that, the price level rises to restore the previous real exchange rate.

There’s no getting around the fact that trade barriers make economies less efficient, by diverting output from the tradable to the non-tradable sector.  This conclusion is not affected by whether the UK has a trade surplus or deficit, so I don’t agree that the EU has an “incentive to be sensible”.  Indeed, an import tariff might well reduce exports by just as much as it reduces imports, even if one’s trading partners do not retaliate.

Some commenters also criticized claims of a skilled labor shortage in Spain.  Over at Econlog, I have a new post that explains why they are wrong.