'Cheap Money Mischief' False sense of comfort

This is a mail from Suyodh Rao who points to two articles:
The first by Gillian Tett Financial Times  'Rally fuelled by cheap money brings a sense of foreboding'
The second by Roubini also in the FT 'Mother of all carry trades faces an inevitable bust'


The two put together answer some questions as to why asset prices are rising even though things dont 'feel' so good. Companies are reporting decent results no doubt. I have not looked at Market PE Ratios, that will give a better idea whether equities are reasonably or otherwise priced.
The factor that cannot be ignored is where the money that is being pumped in by govts is finally ending up. One chunk of stimulus money obviously went to shore up financial institutions balance sheets. Leftovers of that stimulus will find its way into either consumer prices or asset prices.
What the articles talk about is how the loose monetary policy & the fiscal stimulus of the US are both fueling worldwide asset price inflation. Realty prices world-over are still on the higher side when one compares them to trend-line relationship with incomes. Incomes (real) are down if anything and should push house prices even lower. As for stock prices, one will have to look at PEs.
The current crop of policy-makers seem to have not read their Economic History texts, or have forgotten them. While that may sound like an audacious statement, I take the support of two statements of two individuals (quoted below) who, in most respects, have had the most impact on economic policy-making in the 20th century (and onwards). In the days when these were written, there weren't the fancy hedge and fence funds of today. Nor was the stock market hogging newsprint. That may have allowed them to give Money Supply the respect that was due to it. There were three variables that they focused on - Employment, Output & Price Level. Today the financial sector employs tens of times more folks (percent of workforce), and that has changed the focus of policy. In my opinion, that is an unwelcome change. But then, the counter-tautological statement would be that if the financial sector goes down the drain, then the real sector is doubly hurt. That statement has its merits. But, since the financial sector doesn't matter, let us tinker with it. Therein lies our mistake.

There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose. 
John Maynard Keynes, 1920


My own studies of monetary history have made me extremely sympathetic to the oft-quoted, much reviled and as widely misunderstood, comment by John Stuart Mill. "There cannot ....," he wrote, "be intrinsically a more insignificant thing, in the economy of society, than money; except in the character of a contrivance for sparing time and labour. It is a machine for doing quickly and commodiously, what would be done, though less quickly and commodiously, without it: and like many other kinds of machinery, it only exerts a distinct and independent influence of its own when it gets out of order".


True, money is only a machine, but it is an extraordinarily efficient machine. Without it, we could not have begun to attain the astounding growth in output and level of living we have experienced in the past two centuries - any more than we could have done so without those other marvelous machines that dot our countryside and enable us, for the most part, simply to do more efficiently what could be done without them at much greater cost in labor.

But money has one feature that these other machines do not share. Because it is so pervasive, when it gets out of order, it throws a monkey wrench into the operation of all the other machines. - 
Milton Friedman, 1968


PS The above has been written on the fly, may miss some connections, but seems to make sense. Hope it does the same when it meets the reader's eye :) If my last para above doesn't make sense at first, read the quote of Friedman and then re-read my para.

What I am saying in essence is that Money Supply increases take time to show their impacts. Asset-price inflation and/or consumer price inflation will follow Money Supply increases. Asset prices have to revert to their historical trend-lines and relationships with other economic variables such as income etc. The reversion will be in Real terms, and very likely in Nominal terms too. When that correction comes, it is not going to be pretty. When the economic history of the first decade of the 21st century is written, the rally of 2009 may not occupy more than a square inch.

Fear, hope, and great transformations

By LaDawn Haglund Look just about anywhere in the U.S. economy today, and you will find bad news. Emergency after emergency strikes the financial system, resulting in multi-billion dollar taxpayer bailouts of Bear Stearns, Freddie Mac, and Fannie Mae, and now the collapse of Lehman Brothers. The housing market is in free-fall, with foreclosures at record highs. Unemployment is at its highest level since 2003, while underemployment continues to plague the working poor. The “misery index”, that is, the sum of the unemployment rate and the inflation rate, is rising faster than it has in nearly 30 years. Meanwhile, increasingly intense hurricanes fueled by global warming wreck costal cities as we fumble around, hopelessly inadequate to the task of reducing our dependence on fossil fuels, the main culprit behind the acceleration of greenhouse gases. It is at moments like these that I can’t help but remember Karl Polanyi. In his 1944 book, The Great Transformation, Polanyi referred to land, labor, and money as “fictitious commodities.” Applying excessive market rationality to these realms, he argued, distorts the substantive relationship between the economy and society in ways that create insecurity and threaten the social fabric. What we are experiencing is the predictable result of a societal restructuring that made market exchange the key organizing principle in places it doesn’t belong. Eventually something has got to give: business-as-usual is likely to lead to a breakdown in our financial, ecological, and/or human systems. Back here in Arizona, I am living a mild version of this narrative. A steadily increasing cost of living and a stubbornly fixed salary (due to spending cutbacks in education) has made it difficult for me to make my mortgage payments. Expensive gasoline adds to the woes, and not even my Prius can save me (though I am grateful to the Japanese for developing such a nice hybrid vehicle). Recently, when I was really feeling a pinch, I tried to refinance my house. But alas, in this economy—with a burst housing bubble, imploding mortgages, and foreclosures aplenty—my sorry case was met with a kindly “thanks, but no thanks.” So I find myself struggling to make ends meet like millions of other Americans. But what does this admittedly sad but ultimately manageable problem have to do with development economics? After all, at least I have a job, a car, and a house. I am certainly not poor. I have access to credit. And if worse came to worst, I would have numerous options: Look for a better job. Sell the house. Take the bus. These basic possibilities are not available to millions of the world’s poor. But bear with me, dear reader. I will explain. You see, over the last several decades, the United States has been experiencing a rich-country version of the market fundamentalism that was thrust upon the developing world by Washington in the 1980s and 1990s. This fundamentalism led to deregulation of the financial system, the removal of safeguards against speculation and greed, the dismantling of social safety nets, the easing of environmental regulations, and increasingly, the privatization of risk . The exception, of course, is the fiscal austerity policies that forced developing countries to limit deficit spending—the Bush Administration has not held itself to those same pesky standards, especially when it comes to spending on warfare. Given the terrible consequences for humans and the earth, it is particularly perplexing that market fundamentalism has gone so far for so long. As I argue in my manuscript, Limiting Resources: Market-Led Development and the Transformation of Public Goods, it is not just an ideological project spearheaded by political elites. It is at the core of economic thinking. In contrast to popular understandings of “public goods”—where education, health care, water, and infrastructure are ensured by government, with an implicit social agreement to promote well-being and justice for the people—economists are trained to evaluate public goods devoid of social content. “The public” (you and I) is reduced to prisoners’ dilemmas and collective action problems, while state intervention is incorporated mainly as a last resort to remedy market “failure.” One result of this thin understanding of the full social significance of public goods has been a turn to markets wherever possible, via unbundling, contracting, granting concessions, and privatization. At the same time, taxes have been reduced to levels that cannot sustain robust social programs. The resulting excessive reliance on markets has virtually depleted the pool of resources considered “public” and precluded important non-market alternatives, in developed and developing countries alike. The effects of “free” markets in money, land, and human beings (Polanyi’s “fictitious commodities”) in the United States illustrate the danger: Money. The abstraction “money” has only a tenuous connection with the real economy, as any trader will tell you. Regulation is imperative for checking usury and speculative finance, i.e., not allowing money to be just another commodity. The Asian and subsequent financial crises are a stinging reminder that money cannot fill an empty stomach. The current meltdown on Wall Street was preceded by decades of deregulation and the growth of a “shadow banking system” that now reaches far beyond our fair shores. The looming crisis is likely to be equally far-reaching. At this late stage, we can only hope that the severe dislocations resulting from efforts to institute a “self-regulating market system” in the 19th century—World Wars and a Great Depression—do not make a return in the 21st. Land. Despite unequivocal evidence that human-induced global warming is threatening not only stronger storms but also “heat waves, new wind patterns, worsening drought in some regions, heavier precipitation in others, melting glaciers and Arctic ice, and rising global average sea levels,” the Bush Administration has been unwilling to intervene in order to reduce emissions of greenhouse gases, cooperate with other countries on climate change, or invest adequately in alternatives. Though there were some meager incentive programs, these were all designed to not “rock the boat” of traditional market activity and adhered to the twisted logic that growth would ultimately protect the earth and lead to sustainability. Unfortunately, the magnitude of the climate crisis calls for visionary leadership at the highest levels—something that is clearly not going to come from this administration. Human life. Our abysmal, market-based health care system in the United State speaks volumes regarding how well markets protect human life. The United States ranks lower than every OECD country in infant mortality except Turkey and Mexico, and lower in life expectancy than all except Eastern Europe and Mexico. Even countries with much more modest resources, like Cuba and Costa Rica, do better because of public investment, according to a recent World Health Organization report. A litany of horror stories supports the conclusion that a for-profit medical system is inhumane and relatively ineffective in delivering “goods” essential to human life. In terms of labor, we see rising productivity levels being matched with stagnating wages, making it harder and harder for working people to make ends meet. According to Polanyi, society survives the disruption caused by attempts to institute a self-regulating market system through intervention and re-introducing non-economic norms and values to economic activity. This process often entails harnessing the state to ameliorate negative externalities and achieve positive ones. For example, regulation can limit the pursuit of money for money’s sake, as speculators look to “flip that house” (and reap huge profits) or Wall Street brokers demand greater and greater returns. Meanwhile, state-led development and investment in alternative technologies are going to be essential for finding ways to stop abusing the earth—sucking oil from its bowels through a pipeline while suffocating it with stinging pollutants through a tailpipe. Alternative energy is the future, and we need state action to get us there. Finally, state investment in strong social safety nets can help us care for one another where markets do not, and cannot. Rather than leaving us to fend for ourselves in some warped Social Darwinist experiment, we can create institutionalized safeguards to protect our frail bodies and fragile lives from the worst suffering and threats to our well-being. With a U.S. presidential election less than two months away, it is becoming increasingly clear what is at stake. “More of the same” market fundamentalism of John McCain’s party could be very bad for the sound and just management of money, land, and labor. But are Americans ready for the real changes needed to turn this ship around? After all, we are the poster children of over-consumption, and we tend to vote for political leaders with a willful disregard of the catastrophic consequences of our addictions: cheap oil, cheap food, and cheap goods. Let’s hope that the magnitude of the current crisis will awaken us to the issues that really matter. LaDawn Haglund received her Ph.D. in Sociology from New York University in 2005. She is Assistant Professor in the School for Justice and Social Inquiry in the Arizona State University, USA.

Of Jobs Lost and Wages Depressed in the Philippines

By Melisa R. Serrano

The “jobs claims-higher wages” model is often used by supporters of free trade to argue for deeper integration and greater openness in trade and financial markets. In fact, neoliberal economists in cahoots with major organisations such as the World Trade Organization, the World Bank and the International Monetary Fund are inclined to push or impose a one-size-fits all deregulated export-led growth and development strategy. Developing countries often have to swallow the bitter pill of full liberalization in exchange for loans from the Word Bank and the IMF and for getting more market access in developed countries.

Trade liberalization is believed to lead to higher wages via price transmission. Free trade economists argue that a reduction of the after-tax or tariff price of imports lowers the prices of imported goods and import substitutes which in turn lead to increase in real incomes. And since a tariff reduction lowers the marginal cost of production (through a reduced cost of imported materials), this is expected to encourage and expand production. This purportedly increases the demand for labor.

But does a regime of free trade always create good jobs and increase wages in relative and real terms? The sad and sorry (and arguably continuing) state of stagnation in the Philippine economy in the heyday of liberalization – 1980 to 2000 – helps to debunk the causal link between trade and financial liberalization and job generating-high wages economic growth. For the Philippines’ dismal economic performance during the heyday of liberalization only brought stagnation, unemployment and declining real wages.

The lost decades in the heyday of liberalization

The period 1980-2000 has been alluded to as the era of rapid globalization when most of the developing world, including the Philippines, opened up further to world trade as part of structural adjustment efforts prescribed by the IMF-WB within the framework of the Washington Consensus. Total trade increase between 1980 and 1999 (49%) – touted as the more globalized decades - was higher than the period between 1960 and 1980 (31%). The dramatic rise of manufactured exports in the Philippines beginning 1981 also indicates the deepening of a free trade regime in the country.

From 1981 to 1985, a tariff reform program was adopted in the Philippines that narrowed down tariff rate structures. At the same time, an import liberalization program was launched which did away with non-tariff import measures. Beginning 1991, tariffs were gradually lowered over a five-year period until 1995. Overall, average tariff rates went down by a whooping 65% from 1994 to 2000.

Between 1993 and 1996, trade liberalization was vigorously pursued by locking in the country to international trade regulation and deeper integration through the ASEAN Free Trade Area (AFTA) in 1993, the World Trade Organization (WTO) in 1995, the Asia Pacific Economic Cooperation (APEC), and various bilateral trade agreements. A high degree of capital account liberalization was achieved in 1993 after being initiated in 1991 through the passage of the Foreign Investments Act. These reforms eased the entry and exit of foreign capital, largely in the form of short-term debts and portfolio investments (unhedged dollar borrowings or “hot money” used to finance real estate, construction, speculative and manufacturing activities), setting the stage for the country’s participation in the Asian financial crisis.

This regime of openness was marked by increasing frequency and depth of bust-recovery cycles pointing to a more volatile movement and a seemingly shorter cycle length compared to previous periods (Lim and Bautista, 2002). As a corollary, the country’s dependence on imports and unsustainable (private and short-term) foreign capital flows (or “hot money”) had been attributed to more frequent and shorter growth and recession cycles and the lack of macroeconomic development.

The result was devastating. It was only in the period 1980-2000 – the “lost decades”, a term coined by Bill Easterly in 2001 to refer to the growth performance of developing countries in the 80s and 90s - that the Philippines experienced negative growth. From a 66% rise of real per capita GDP (in 1985 US$) in the period 1960 to 1980, the country plummeted to -1% in the period 1980-2000 (Weisbrot et al 2001). The forgone increase in per capita GDP during the “lost decades” was estimated at 68%.

Does free trade create jobs? Challenging the “jobs claims” model

There is an abundance of economic literature pointing to the positive impact of trade liberalization on employment and wages. Neoliberal economists argue that although tariff reductions do have a negative impact on wages and levels of employment, any adverse effect can be wiped out by a tariff reduction’s effect on reducing domestic prices. However, as Akyuz (2005) points out, simulations done by the World Bank highlighting the benefits that developing countries could reap from further liberalization under the Doha Round are bereft of reality. These studies use “general equilibrium models” that assume automatic market clearing, rapid redeployment of resources and full or equal employment after liberalization. However, factors of production, including labor, capital and land are often sector or product specific and thus immobile. Expansion in sectors benefiting from liberalization requires investment in skills and equipment, rather than simply reshuffling and redeploying existing labor and equipment. Thus, like the case of the Philippines, the overall impact of rapid trade liberalization could be unemployment, deindustrialization and growing external deficits despite a significant increase in export growth.

The Philippines’ export participation in high-technology manufactures through international production networks (IPNs) involves mere assembly of components that adds little value and utilizes labor, the most abundant and least mobile factor. The bulk of Philipino exports are import-intensive, particularly electronics and garments. The high import intensity of these two sectors implies that they add very little value and have a moderate employment impact. In 2000, these sectors generated a meager 6.9% of total gross value added and 5.7% of total employment. A declining trend is similarly observed in employment growth rates between 1980 and 2000. Between 2000 and 2002, it is estimated that the annual layoff rate in the electronics sector was between five and 10 percent as a number of establishments have either closed down or reduced their workforce.

Does free trade lead to higher wages?

Between 1980 and 2000, increased frequency and depth of bust-recovery cycles brought about by the uncertainties of a trade and financial liberalization regime wreaked havoc on wage patterns, resulting in wage stagnation since the late 1980s. On average, the real wage rate in the Philippines in 2002 was around three quarters of what it was in the early 1980s. Felipe and Sipin (2004) note a clear downward trend of labor share at 0.6 percentage points per year during the period 1980-2002. The authors conclude that labor in the Philippines has lost at least 10 percentage points of its share in value-added during the last two decades. Although export performance was generally robust during the period, “strong increases in the manufacturing exports of developing countries – particularly those participating in IPNs – may have taken place without commensurate increases in incomes and value added” (UN 2006:75).

The argument that, in a deregulated export-led growth, job loss in the “restructuring” process results in greater efficiencies and new jobs with higher wages will replace old ones is flawed according to Ranney and Naiman (1997). This assumption is based on a situation of full employment. The market is seldom able to replace lost employment with comparable jobs. Even if new jobs were created, people who lose jobs often do not get the new ones. Moreover, many of the replacement jobs are of inferior quality. It should also be noted that higher wages in the export sector could be due to high unionization, labor shortages in specific occupations, or higher productivity. Moreover, imports can depress wages in certain industries and occupations.

The way forward

Clearly, the IMF-WB sponsored market liberalization prescriptions and the country’s obedience to such diktats, proved to be devastating as the Philippines went from being a poster girl of the WB-IMF to the basket case in the East Asian region. Unlike its more successful neighbors where liberalization took place gradually and cautiously over the past two decades after a period of successful industrialization and development, the Philippines pursued big bang liberalization as a way of getting out of its debt and development crisis without the necessary industrial or manufacturing base.

What is now certain is that the stagnation of developing countries during the “lost decades” was a major blow to the optimism surrounding the Washington Consensus. In fact, the IMF had already conceded in 2003 that, at least for many developing countries, capital market liberalization did not lead to more growth but to more instability. Unfortunately, this acknowledgment came after the dreadful effects of capital markets liberalization in many developing countries.

There are crucial factors for an economy to be able to reap economic benefits from external trade and financial liberalization. The major ones are: (1) producing export products with high technological content (high value added) located in growing global markets; (2) creating domestic linkages for these exports; (3) capacity to capture a share of value added in international production networks; (4) attracting greenfield FDI that is anchored in the domestic economy; (5) coherent industrial or production sector strategies that promote industrialization and/or support structural transformation of economies (macroeconomic policies, investments in physical infrastructure, incentives and support for innovation, protection of infant industries, selective policies targeting specific sectors or firms); and (6) timing and speed of liberalization (gradual integration is preferable to a big bang or premature approach). Unfortunately, these factors are still missing in the Philippines’ economic constellation.

Bibliography

Akyüz, Yilmaz. 2005. “Trade, Growth and Industrialization: Issues, Experience and Policy Challenges,” in www.twnside.org.sg/title2/t&d/tnd28.pdf

Felipe, Jesus and Grace C. Sipin. 2004. Competitiveness, Income Distribution, and Growth in the Philippines: What Does the Long-run Evidence Show? ERD Working Paper No. 53, Manila: Asian Development Bank, June.

Lim, Joseph Y. and Carlos C. Bautista. 2002. “External Liberalization, Growth and Distribution in the Philippines,” Paper presented for the international conference on “External Liberalization, Growth, Development and Social Policy,” January 18-20, 2002, Melia Hotel, Hanoi, Vietnam.

Ranney, David C. and Robert R. Naiman. 1997. Does `Free Trade’ Create Good Jobs? A Rebuttal to the Clinton Administration’s Claims. Chicago: The Great Cities Institute, January.

United Nations. (2006). World Economic and Social Survey 2006 – Diverging Growth and Development. Geneva: United Nations Economic and Social Affairs.

Weisbrot, Mark, Dean Baker, Egor Kraev and Judy Chen. 2001. “The Scorecard on Globalization 1980-2000: Twenty Years of Diminished Progress,” Center for Economy and Policy Research (CEPR), July 11, in www.cepr.net/publications/globalization_2001_07.htm.

Melisa R. Serrano is University Extension Specialist/Researcher in the School of Labor and Industrial Relations, University of the Philippines (U.P. SOLAIR). The article is part of a paper she presented at the International Conference on “Labour and the Challenges of Development”, 1-3 April 2007, University of the Witwatersrand, Johannesburg, South Africa, convened by the Global Labour University. Melisa holds two Masters degrees, one in Labour Policies and Globalization (from the Global Labour University, University of Kassel and Berlin School of Economics) and another in Industrial Relations (from U.P. SOLAIR). Melisa’s present research is on agrarian reform and labor and alternative development.

Brazil's Development Conundrum

by Paulo Gala Currently in Brazil heterodox economists form the majority in President Lula's government. This is a very different situation compared to Lula's first term. Brazilian Keynesians and development economists are now in key positions in the Brazilian Development Bank (BNDES), Finance Ministry, research institutes, at the World Bank and even the IMF. To name a few, Guido Mantega has been historically connected to developmentalism and so have economists in his team such as Nelson Barbosa. BNDES' president: Luciano Coutinho is one of the country's leading industrial policy specialists. Marcio Pochman, Joao Sicsu and a number of others are now the leading thinkers at IPEA: one of the most important government institutes for long term planning and research in the country. The Brazilian representative at the IMF, Paulo Nogueira Batista, is a long time critic of the Central Bank and neoliberal policies in Brazil. The President's small circle of influential advisors are also composed of hetorodox economists. Delfim Netto is a former USP (University of Sao Paulo) professor and was "czar" of the economy during the Brazilian miracle in the seventies. Luiz Gonzaga Belluzo is a former UNICAMP's (Universirty of Campinas) professor and long time critic of neoliberalism in Brazil. Conceicao Tavares is a former UFRJ's (Federal University of Rio) professor and has been advising the President since his first term. But the overwhelming presence of heterodox economists in these influential positions does not mean that developmentalist policies are comprehensively adopted. This is particularly because the central bank remains orthodox with total control over monetary and exchange rate policies. Though quantitatively in the minority these economists remain very powerful because of their close connection to the President and the fears of inflation that still haunt him. As some say, the Central Bank is the bunker of orthodox economists in Brazil today, the ones that survived from Lula's first term. Backed by the Bank's President Henrique Meirelles, these economists have been dictating key pillars of economic policy for a long time now. One cannot find a single economist close to a developmentalist viewpoint on the board of directors of the Central Bank. With a fully orthodox team, the central bank's main objective is to keep inflation under control. The result of this ambiguous composition of government is a twofold economic policy, as some have observed. Dialogue between the Finance Ministry and the Central Bank is harsh, to the extent that it exists at all. Policies adopted by the Ministry usually run in the opposite direction to what economists in Bank are doing. This has reached the stage where in a recent interview Guido Mantega mentioned that for every basis point of interest rate increase by the Bank, the Ministry levies taxes of the same amount on capital inflows to avoid exchange rate appreciation. This tax (the IOF) has been raised to 1,5% this year. It goes without saying that the economists in the Bank couldn't disagree more with these measures. The same phenomenon can be observed with respcet to fiscal policy. Through the new "Plano de Aceleração do Crescimento" (PAC) the central government has been increasing public investment in infrastructure, thus stimulating demand and growth. The Central Bank fears overheating of the economy and has been arguing for budget cuts, particularly with respect to government consumption. Actually, this is where most Brazilian economists seem to be in agreement. A cut in government consumption expenditure (as opposed to investment expenditure) would help manage aggregate demand. It would avoid the negative consequences of further interest rate hikes in the form of exchange rate appreciation and disincentives to investment in tradable sectors of the economy. President Lula doesn't seem to like this kind of reasoning, though. On April 16th, the Brazilian Central Bank decided again on the level of interest rates. There is a wide consensus among economists in the financial sector that the rate should be raised by at least 0.25 bps. According to some, inflation might be going out of control again. There is a chance that the target of 4.5% per year imposed by our inflation targeting system will not be met. According to the economists in the Finance Ministry there is no need to increase short term rates now because capital accumulation is growing strongly in the country (15% per annum). Installed capacity will increase in the near future which is the main guarantee for keeping inflation rates under control in the long term. But once again, the Central Bank and development economists don't agree on this. In conclusion, it seems fair to say that economic policy in Brazil has been split by the president into two often contradictory parts. The developmentalists in the Finance Ministry manage fiscal policy and the orthodox economists in the Central Bank manage monetary and exchange rate policies. The outcome of this arrangement will be neither developmentalist nor monetarist. Rather it will result in moderate growth and moderate inflation.

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Paulo Gala received Master and PhD degrees in Economics from the Sao Paulo School of Economics, Getulio Vargas Foundation. He is the author of several papers, articles and book chapters on the following subjects: Macroeconomics, Development Economics and Economic Methodology. Currently, he is a professor at the Sao Paulo School of Economics, Getulio Vargas Foundation.pgala3@gmail.com