Matt Nolan

Protectionism: What the ….

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The US is pushing to start introducing duties on Chinese goods to make a “level playing field” given the currency “misalignment.

Hold up a second.  China maintains a “low” exchange rate by “saving” too much – and using that savings to do things like by US currency and bonds right.  Any subsidy on Chinese exports is “implicit”.

If  this is indeed the case, introducing duties is not the way to go about things – and by ignoring the central issue it will at best lead to an uncomfortable situation and poorer US consumers, and at worst will lead to a full scale trade war and a severe economic crisis.

If you think that having China save excessively creates risks to your own economy (as that sort of subsidy actually sounds pretty welfare enhancing in a direct sense – so we need to think about risks), then deal with it directly – eg by taxing capital flows from that specific country.  Don’t start rubbish protectionism.

Matt Nolan

Why I’m in a bad mood

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Agnitio asked me what has been going on recently, as I was complaining its a mess.  I emailed him my summary, so I thought I’d also put them down here:

The ECB announced that its going to accept some things as collateral – but dump others.  Leaving markets confused about what the hell was going on, and what it means for sovereign debt purchases.

The US followed this up by saying that they would buy a smaller amount of long-term debt than forecast, sell short-term debt, and flatten the yield curve.  They say it will be stimulatory because NK models say so – however, a flat yield curve is a bit dodgy, given that it’s formed by expectations of either weak growth or weak inflation in the future.  In essence NK models say “get the long-run real interest rate down as much as possible” which you do by increasing inflation expectations, not nominal rates – so markets collapsed after that.

US government decided to get involved by refusing to extend the debt limit AGAIN, if they can’t make up by Sep 30 the US will default.

Then the European commission decided that it was a good time to say they were going to introduce a financial transactions tax – just when financial markets are panicking – and for good measure they said they hadn’t figured out what level it would be at, or what would be taxed yet, just to add to uncertainty.

While all this is happening Italy and Greece have continued to say they’ll get their fiscal situation in order – but they keep delaying introducing actual policies.  Given Greece is effectively insolvent, the dithering by them, other European governments, and the ECB, makes it unclear who holds the liability the entire European financial system is at a stand still.  Given the exposure of Australian banks to this, we have seen funding costs rise considerably (luckily no-one in NZ is actually borrowing anything).

With Europe having fluffed around while the crisis has been in full swing over the past 2 months, purchases from China have pulled back, seeing activity there slow as well.  A slowdown in China will have the impact of lowering our export prices.

Party.

This mix of awesome factors has seen the cost of insuring against default in Australian banks increase to within a whisker of their Lehman Brother peaks.  It has seen uncertainty measures push at new highs.

Unlike the Lehman Brother’s collapse there is no reason for these indicators to be high solely based on the financial fundamentals – the debt burden, and who holds what, is known.  However, while policy makers were trying to improve outcomes during the crisis in 2008, they seem more interested in trying to cause a crisis this time around.

Matt Nolan

The EU needs to get its priorities straight

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Seriously.  These guys have been fluffing around for so long that the entire financial system is in a panic.  So they decide its a good time to announce they are going to start taxing financial transactions – but they haven’t decided the level yet or the full scope yet.

Is Europe’s motto, during times of uncertainty add more uncertainty?  This is ridiculous.

If we have another financial crisis here, the blame mainly falls on the politicial systems in Europe (and to a lesser extent the US).  When everything I try to say to people regarding the outlook for the economy is conditional on politicians being sane, its hard to really believe that what I’m saying is damned right.

FYI, I’m against a Tobin tax.  At some point this deserves a fuller post, I have a couple of little guys sitting around here and here and here  though.

Matt Nolan

Stumbling to another crisis?

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Operation Twist hasn’t gone down particularly well has it.  It could be that the policy was smaller than expected, it could be that growing political angst has made the idea of further Fed stimulus seem more unlikely, but either way a drop in asset prices and falling inflation expectations isn’t what we want to see following a Fed announcement – especially in the middle of a financial crisis.

I think that the general idea would work, akin to this.  However, for some reason the actual announcement has disappointed markets.

In terms of NZ, our dollar has dropped reasonably sharply following the announcement.  I’m hoping this is because the dollar is seen as an “asset price” and people are just moving out of it because they are less willing to take on risk – given lower than expected accommodation of monetary policy by the Fed. {Update:  In terms of the dollar it seems that comments by Dr Bollard last night also had an impact}

Worst case, the drop in the dollar is a signal of lower export prices.

New Zealand policy makers have done a damned good job the last few years, but its hard for them to do much in the face of incompetence around the world – given that we are a small open economy.

Matt Nolan

Papers on the old new financial crisis

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Brad Delong links to a number of interesting papers regarding the US/global financial crisis of 2007-2009.  I recommend the optional ones.

I’m not sure I completely agree that the bailing out of Bear Stearns made matters worse – but it was an interesting perspective.

In any case, its a good idea to try and understand what happened then – in order to figure out whether the debt crisis in Europe will lead to similar global pain.

IMO when Greece does default, who holds the associated liabilities is widely know – as a result, my hope would be that nothing will really happen.  With nothing happening, the rest of the world will just move on.  The risk is that Greek default actually knocks out a big bank (it looks less likely now that it will knock out a sovereign government – although that remains the big fear in Europe).  Fluffing around in Europe has kept credit conditions tight for at least 18 months longer then they would have been, in the absense of European debt issues – it is starting to feel like some people will have to accept some loses before this crisis can end, and some semblance of global confidence can return.

Matt Nolan

Terms of trade: An Australian perspective

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Institutional Economics has some good points on the boost to Australia’s terms of trade – points we can keep in mind over here.

Relative to what we pay for our imports, Australia now gets higher prices for its exports than at any time since at least 1870. This was illustrated by Reserve Bank Governor Glenn Stevens’ observation that ‘five years ago, a ship load of iron ore was worth about the same as about 2,200 flat screen television sets. Today it is worth about 22,000 flat-screen TV sets.’

This increased international purchasing power is attributable not only to rising commodity prices, but also lower prices for imports, not least manufactured goods. The flip side of Australia’s terms of trade boom is the collapse in the terms of trade for countries like Japan.

So a higher terms of trade allows us to buy more imports for the same quantity of exports – something that is important to keep in mind when we bang on about “rebalancing” the economy.  Furthermore:

Our best response to the terms of trade boom is to become even more open to inflows of foreign labour and capital and to reduce the government’s command over resources so that the mining industry can expand with less pressure on other sectors. While the non-mining sectors will contract relative to mining, they can still expand in absolute terms if we continue to remove government-imposed resource constraints to overall economic growth.

The industries that aren’t experiencing higher returns should be expected to fail – proping them up is a policy that will just lead to worst outcomes from everyone.

So much of what has happened to New Zealand has been due to massive changes in the terms of trade – both in the 1970’s and in the 2000’s.  Asking for the “balance” of the economy to return to some past point doesn’t make sense – when the “prices/values” that dictate this point have changed … a change in economic structure is what NEEDED to happen.

It is possible some things may have gone a bit far – but it is better for us to try and understand why, where, and how before introducing policy, rather than aiming to meet some magical level of tradable to non-tradable GDP (or real consumption as a share of GDP).  If you want more details on the why, where, and how – look around the blog (pro-tip search imbalance), or contact me directly.