December 2010

NAMB ~ Troubled Waters?

Economics focus

All pain, no gain?

In a single currency it is hard to become more competitive and repay your debts

Dec 9th 2010 | From The Economist print edition

BY OFFERING partial bail-outs to countries in the euro area, the authorities are buying time. Time for what? The hope is that over a few years the indebted economies on the continent’s periphery, such as Ireland and Greece, will be able to restore their competitiveness. That would boost their exports and output, helping them to close their fiscal and current-account deficits. Just how realistic is this hope?

Competitiveness is usually taken to mean keen prices: if the price of cars produced in one country falls, foreign demand for them expands. In a monetary union, with the nominal exchange rate irrevocably fixed, it is not possible to gain competitiveness by currency depreciation. The only way is to reduce costs, relative to countries inside and outside the currency area. Economists sometimes refer to this as a “real depreciation” or “internal devaluation”. That requires slower price and wage growth or faster productivity growth than elsewhere. Given today’s low inflation rates, it means outright declines in prices and wages.

In the decade and a half before the crisis, countries such as Greece, Ireland, Portugal and Spain lost a lot of competitiveness. Low interest rates led to a surge in domestic demand. That, coupled with rigid labour markets in some places, led to sharp rises in nominal wages. At the same time productivity growth was not vigorous enough to compensate. By contrast, for a decade after its reunification boom turned sour in the mid-1990s, Germany took bitter medicine, holding wages down and boosting productivity. The result was a steady erosion of the peripheral countries’ competitiveness, especially relative to Germany (see chart).

Somehow the peripheral economies have to reverse this trend. Their reform packages are designed in part to improve productivity: Greece, for example, is trying to cut red tape and break its monopolies. But much of the task lies in reducing wages and prices. Some countries’ efforts seem to be working. In Ireland, labour costs have fallen for two years and inflation has been negative for more than one. Public-sector pay packets are up to 15% lighter and will be lighter still after this week’s budget.

In Greece, however, the picture is less clear. Wages are heading down. But other costs are not falling. The country’s inflation rate, at 5%, is still well above Germany’s, although part of that differential is due to increases in value-added tax. Spain and Portugal, meanwhile, are only slowly waking up to the severity of their competitiveness problems. Even now inflation in these countries remains above the average for the euro area.

Will shock therapy help to restore competitiveness in these countries? There are three big hurdles. The first is history. Under the gold standard, countries used price and wage deflation as a means of adjusting to trade deficits. But a new study by the World Bank* suggests reasons for pessimism, at least in modern economies. Looking at the experiences of 183 countries between 1980 and 2008, it does not find many episodes of sustained deflation.

Argentina provides a telling example. Like the peripheral euro-area countries, it lost competitiveness during the ten years after 1991 when the peso was fixed to the dollar. It endured three years of deflation before its economy and dollar peg collapsed in 2001. The CFA (African Financial Community, formerly French Community of Africa) franc zone supplies another cautionary tale. Median inflation from 1986 to 1993 was 0.3%, and several countries experienced outright deflation towards the end of this period. But this failed to restore competitiveness, and there was a large devaluation in 1994.

A more encouraging conclusion can be drawn from Estonia, Latvia and Lithuania. All three Baltic countries pegged their currencies to the euro in the early to mid-2000s: they enjoyed booms, then lost competitiveness and were hit by the crisis in 2008. Output collapsed but they maintained their pegs and introduced austere policies. They are now showing tentative signs of recovery, based on exports. Anders Aslund† of the Peterson Institute reckons that their resolve reflected the fear among the public and officials that the sovereignty of these newly independent countries could be threatened. It also helped that their economies were so open: this forced them to respond quickly, as Ireland has had to do.

Right, let’s start making luxury cars

The second reason to be wary is that the chances of reviving exports also depend on the type and quality of goods a country makes and who its competitors are. Not everyone can be Germany, excelling at selling capital equipment and luxury cars, not least to booming emerging economies: this month Mercedes said its sales in China in the first 11 months of 2010 were more than double those in same period last year. This market position is extremely hard to replicate. For peripheral countries that specialise in lower-tech industries, China is less an export opportunity and more a competitive threat (see chart). The worry is that such countries depend on selling commoditised products of which they may never be the cheapest producers.

The last problem for peripheral countries trying to deflate their way to competitiveness is the biggest: debt. The more wages and prices fall, the bigger debt burdens become in real terms. If the economy continues to shrink—nominal GDP dropped by about 30% in Latvia and has fallen by 20% in Ireland—there will be less money to service debts. This is the trap that Europe’s peripheral countries are in. They must become more competitive in order to export, grow and ease their debt burden. But the more they lower wages and prices, the harder that burden is to bear. As Irving Fisher noted almost 80 years ago, the struggle to reduce debts can sometimes increase indebtedness.

The world economy

Three-way split

America, the euro zone and the emerging world are heading in different directions

Dec 9th 2010 | From The Economist print edition

THIS year has turned out to be a surprisingly good one for the world economy. Global output has probably risen by close to 5%, well above its trend rate and a lot faster than forecasters were expecting 12 months ago. Most of the dangers that frightened financial markets during the year have failed to materialise. China’s economy has not suffered a hard landing. America’s mid-year slowdown did not become a double-dip recession. Granted, the troubles of the euro area’s peripheral economies have proved all too real. Yet the euro zone as a whole has grown at a decent rate for an ageing continent, thanks to oomph from Germany, the fastest-growing big rich economy in 2010.

The question now is whether 2011 will follow the same pattern. Many people seem to think so. Consumer and business confidence is rising in most parts of the world; global manufacturing is accelerating; and financial markets are buoyant. The MSCI index of global share prices has climbed by 20% since early July. Investors today are shrugging off news far more ominous than that which rattled them earlier this year, from the soaring debt yields in the euro zone’s periphery to news of rising inflation in China.

Earlier this year investors were too pessimistic. Now their breezy confidence seems misplaced. To oversimplify a little, the performance of the world economy in 2011 depends on what happens in three places: the big emerging markets, the euro area and America. (Yes, Japan is still an economic heavyweight, but it is less likely to yield surprises.) These big three are heading in very different directions, with very different growth prospects and contradictory policy choices. Some of this divergence is inevitable: even to the casual observer, India’s economy has always been rather different from America’s. But new splits are opening up, especially in the rich world, and with them come ever more chances for friction.

On the rise, on the edge, on the never-never

Begin with the big emerging markets, by far the biggest contributors to global growth this year. From Shenzhen to São Paulo these economies have been on a tear. Spare capacity has been used up. Where it can, foreign capital is pouring in. Isolated worries about asset bubbles have been replaced by a fear of broader overheating. China is the prime example (see article) but by no means alone. With Brazilian shops packed with shoppers, inflation there has surged above 5% and imports in November were 44% higher than the previous year.

Cheap money is often the problem. Though the slump of 2009 is a distant memory, monetary conditions are still extraordinarily loose, thanks, in many places, to efforts to hold down currencies (again, China leads in this respect). This combination is unsustainable. To stop prices accelerating, most emerging economies will need tighter policies next year. If they do too much, their growth could slow sharply. If they do too little, they invite higher inflation and a bigger tightening later. Either way, the chances of a macroeconomic shock emanating from the emerging world are rising steeply.

The euro area is another obvious source of stress, this time financial as well as macroeconomic. In the short term growth will surely slow, if only because of government spending cuts. In core countries, notably Germany, this fiscal consolidation is voluntary, even masochistic. The embattled economies on the periphery, such as Ireland, Portugal and Greece, have less choice and a grim future. Empirical evidence suggests that countries in a currency union are unlikely to be able to improve their competitiveness quickly by screwing down wages and prices (see article). Worse, the financial consequences of a shift to a world where a euro-area country can go bust are only just becoming clear. Not only do too many euro-zone governments owe too much, but Europe’s entire banking model, which is based on thorough integration across borders, may need revisiting (see article). These difficulties would tax the most enlightened policymakers. The euro zone’s political leaders, alas, are a fractious and underwhelming lot. An even bigger mess seems all but certain in 2011.

Reach for the stretch pants, Barack

America’s economy, too, will shift, but in a different direction. Unlike Europe’s, America’s macroeconomic policy mix has just moved decisively away from austerity. The tax-cut agreement reached on December 7th by Barack Obama and congressional Republicans was far bigger than expected. Not only did it extend George Bush’s expiring tax breaks for two years, but it also added more than 2% of GDP in new breaks for 2011 (see article). When this is coupled with the continued bond-buying of the Federal Reserve, America is injecting itself with another dose of stimulus steroids just when Europe is checking into rehab and enduring cold turkey.

The result of this could be that American output grows by as much as 4% next year. That is nicely above trend and enough to reduce unemployment, although not quickly. But America’s politicians are taking a risk, too. Even though their country’s long-term budget outlook is famously dire, Mr Obama and the Republicans did not even try to find an agreement on medium-term fiscal consolidation this week. Various proposals to fix the deficit look set to gather dust (see article). Bondholders, who have been very forgiving of the printer of the world’s chief reserve currency, greeted the tax deal by selling Treasuries. Some investors, no doubt, see faster growth on the way; but a growing number are worried about the size of America’s fiscal hole. If those worries take hold, the United States could even see a bond-market bust in 2011.

How much does this parting of the ways matter? The divergence between the world’s big three will compound the risks in each one. America’s loose monetary policy and concerns about sovereign defaults in the euro zone will encourage capital to flow to emerging economies, making the latter’s central banks reluctant to raise interest rates and dampen down inflation. Over the next five years emerging economies are expected to account for over 50% of global growth but only 13% of the increase in net global public debt. Rather than rebalancing, the world economy in the immediate future will skew even more between a debt-ridden West and thrifty East.

The West avoided depression in part because Europe and America worked together and shared a similar economic philosophy. Now both are obsessed with internal problems and have adopted wholly opposite strategies for dealing with them. That bodes ill for international co-operation. Policymakers in Brussels will hardly focus on another trade round when a euro member is about to go bust. And it bodes ill for financial markets, since neither Europe’s sticking-plaster approach to the euro nor America’s “jam today, God knows what tomorrow” tactic with the deficit are sustainable.

Of course, it does not have to be this way. Now they have splurged the cash, Mr Obama and Congress could move on to a medium-term plan to reduce the deficit. Europe’s feuding leaders could hash out a deal to put the single currency and the zone’s banking system on a sustainable footing. And the big emerging economies could allow their currencies to rise. But don’t bet on it. A more divided world economy could make 2011 a year of damaging shocks.


Mortgage Rates Jump to 6-Month High
As yields on government bonds continue to go up, average rates on 30-year mortgages rose for the fourth-straight week.
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5 Predictions for 2011
A forecast from Freddie Mac suggests that housing could turn a corner in 2011.
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Advocacy Group Urges FHA Reform
The Center for Responsible Lending on Thursday called for the FHA to apply certain rules to prevent abuses in mortgage lending.
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Agencies Clash Over Mortgage Relief
The FHA and FHFA do not see eye-to-eye on a new program designed to help underwater borrowers.
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ACLU Appeals Decision to Bar Robo-Signer Video
The American Civil Liberties Union filed a motion with the Florida state appeals court to reverse a decision that forced a law firm to remove videotaped depositions of foreclosure “robo-signers” from YouTube.
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Manhattan Real Estate Veteran Debuts Venture
A seasoned New York practitioner is opening a new firm that will emphasize service and technology.
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So who won this week?

Dec 10th 2010, 14:13 by Lexington

EVERYONE has at least one answer. But anyone who still thinks Barack Obama simply “caved” over the Bush tax cuts ought to read Charles Krauthammer’s column this morning, in which this unrelenting critic of everything Obama bemoans the president’s  “swindle of the year”. It is a splenetic confirmation of the gathering consensus that – politics being the art of the possible – the president was quicker than his party to grasp the reality of the new balance of power on Capitol Hill, played a weak hand pretty well, and outwitted his Republican opponents:

In the deal struck this week, the president negotiated the biggest stimulus in American history, larger than his $814 billion 2009 stimulus package. It will pump a trillion borrowed Chinese dollars into the U.S. economy over the next two years – which just happen to be the two years of the run-up to the next presidential election. This is a defeat?

However, a far more interesting, and positive, take on the White House’s manouevres comes from my former colleague, John Heilemann, who argues in the New York Magazine that this was the pivotal week of Mr Obama’s presidency, less because he outwitted the Republicans than because he has at last asserted himself against the Democrats in Congress, to whom he had so far deferred excessively. The congressional Democrats, he says,

are primarily to blame for putting Obama in the position where he had to make the trade he did. Although the White House didn’t push the matter hard, the president is correct when he says that he preferred to see Congress deal with the tax-cut extension issue in the fall, before the midterms, in which all but certain Republican gains might rob him of his negotiating leverage (as they did). Congressional Democrats, however, were fearful of taking a controversial tax vote in the heat of an election season. Out of sheer cowardice, they postponed that vote until the lame-duck session — and now they are whining about an unpalatable situation of their own creation.

In essence, John argues, the president’s news conference amounted to

a declaration that he is divorcing himself politically from the congressional wing of his party. On background, White House aides were thrilled with the performance, believing that it began the process of establishing their preferred leitmotif for the months ahead: that in a town full of petulant and posturing adolescents, the president will stand as the presiding adult.

It’s an excellent piece. Read the whole article here. Furthermore, with the president now putting the case for comprehensive reform of the tax code, and the Republicans striking odious positions on the DREAM act and DADT (Don’t Ask, Don’t Tell), Mr Obama now has every hope of repositioning himself in the centre of politics, from where he stands a far better chance of re-election in 2012. This was, admittedly, a terrible week for those who worry about the deficit. But (provided of course that he can get the deal through) it was not a bad one for the president.

Purchase Applications Rose for Third Week

Applications for mortgages to purchase homes rose 1.8 percent last week compared to the previous week on a seasonally adjusted basis. On an unadjusted basis, purchase applications rose 21.3 percent compared to the previous week, which included Thanksgiving. Applications were up 12 percent compared to the same week a year ago.

This is the third week that applications to purchase homes have increased, reaching the highest level since early May.

The average contract interest rate for 30-year fixed-rate mortgages increased to 4.66 percent from 4.56 percent, while 15-year fixed-rate mortgages increased to 3.98 percent from 3.91 percent.

Source: Mortgage Bankers Association (12/08/2010)

Holiday Decor Can Catch a Buyer’s Eye

Tastefully done holiday decorations can be the eye candy that captures a buyer’s interest, says Lee Ralph, an associate with Coldwell Banker North Tampa (Fla.).

“We even negotiated a contract on Christmas Day last year,” Ralph says.

Ralph suggests using elegant themes and warns against over-decoration. “That may keep the buyer from being comfortable and able to visualize the home as their own,” Ralph says.

Designer Rick Davies, co-owner of Lafayette & Rushford Home, a home decor store in Dunedin, Fla., makes these suggestions:

· Work with what can’t be changed. Work carefully with the color, style, and age of the home.

· Consider proportions. Don’t put a huge wreath on a tiny door.

· Light the way. Simple pathway lights are a gracious way to greet potential buyers.

· Be subtle. Choose contemporary colors, including bright greens, lemongrass, golds, and ambers.

· Natural is in. Natural-look and organic materials are in vogue, including berries, artichokes, moss, twigs, acorns, and feathers.

Source: St. Petersburg Times, Terri Bryce Reeves (12/04/2010)

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