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Outstanding Stories of the Week

As Doctors Write Prescriptions, Drug Company Writes a Check
Gardiner Harris
New York Times, June 27, 2004, Page A1

This article reports on the practice among many drug companies of effectively giving doctors kickbacks for prescribing their drugs to patients. It also reports on other unethical practices by drug companies, such as requiring doctors to exclusively use their own drugs in clinical trials. This is exactly the sort of behavior that economists predict when government-enforced patent monopolies raise prices far above the cost of production.

Underclass of Workers Created in Iraq
Ariana Eunjng Cha
Washington Post, July 1, 2004, Page A1

This article discusses the working and living conditions of some of the immigrant workers in Iraq. It reports that some of the subcontractors to U.S. firms have hired workers from South Asian countries and hold them as virtual slaves, not providing them with adequate food and housing and reneging on wage commitments.

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Economic Growth 

Preaching Jobs, Kerry Lands in Ohio
Lois Romano
Washington Post, June 26, 2004, Page A3

This article reports on a campaign stop by Senator John Kerry in Ohio, in which he criticized President Bush's record on the economy. At one point the article quotes a spokesperson for the Bush-Cheney campaign, who criticized Kerry for "talking down the fastest-growing economy in 20 years."

This is not the fastest growing economy in 20 years. The 3.9 percent growth rate of the last quarter is good, but not extraordinary. Over the last four quarters the growth rate has averaged 4.8 percent. This is impressive, but not quite as good as the 4.9 percent growth rate from the second quarter of 1999 to the second quarter of 2000.

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The Economy and the Stock Market

Advice for Investors: Don't Panic Over Rates
Alex Berenson
New York Times, June 28, 2004, Page C1

This article reports on the near-term prospects for the economy and the stock market. The article asserts that analysts are almost unanimous in recommending to investors that they "stay the course" and remain invested in the stock market. It then quotes two economists who both see the economy continuing to grow at a healthy pace.

It is worth noting that analysts were also nearly unanimous in the belief that the economy would remain strong in the fall of 2000, just before the onset of the recession. Not one of the "Blue Chip" 50 forecasters saw the recession coming.

It is also worth noting some of the implications of the analysts' predictions. For example the prediction of one analyst, that profits will grow 15 percent in 2004 and 10 percent in 2005, implies that real wages will likely fall slightly in 2004 and be virtually flat in 2005. (Since the economy is only projected to grow 4.0 percent for these years, profit growth at this rate implies substantial redistribution from wages to profits.) If real wages remain flat or decline, it is questionable whether consumption growth can continue at a rate sufficient to sustain the predicted growth rate.

Another questionable statement from the analysts is the assertion that interest rates have risen because the economy is strong. While this is one possible explanation, it is also possible that higher inflation - partly attributable to a falling dollar, and partly attributable to a worldwide increase in commodity prices - is the main factor pushing up interest rates. With the annual rate of inflation exceeding 5.0 percent in the first quarter, investors would be reluctant to hold long-term bonds at rates that fell as low as 3.05 percent in 2003. A nominal rate of interest below the rate of inflation implies that investors are getting a negative real rate of return.

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The Fed and Interest Rates

Fed's Expected Rate Rise May Well Offer a Respite For Other Central Banks
Mark Landler
New York Times, June 30, 2004, Page C1

This article examines the impact that an increase in interest rates would have on other central banks. At one point the article quotes an economist as saying that the increase would allow China to raise its own interest rates, which it previously could not do because its currency is linked to the dollar. It then quotes another economist as saying that the Fed's rate hike will make it easier for China's central bank to allow its currency to rise against the dollar. These are contradictory positions.

The Fed's rate hike, other things equal, puts upward pressure on the dollar relative to China's currency. However, China's central bank has been intervening massively in currency markets - buying more than 100 billion dollars last year - in order to keep its currency from rising against the dollar. If the central bank wanted the currency to rise against the dollar, it only needed to reduce its intervention. This could have been done at any point. It is not clear how the rate hike by the Fed would make this decision easier.

The article also neglects two of the most important impacts of higher rates around the world. Many other countries also have a housing bubble, most notably England and Australia. By putting upward pressure on interest rates worldwide, the Fed may be moving forward the collapse of these bubbles.

The second major impact will be in heavily indebted developing countries like Brazil and Turkey. A worldwide rise in interest rates will be very costly for these economies, as an even larger share of output will be committed to paying interest to foreign creditors. This impact could be even bigger if investors respond by moving out of emerging market bonds. This happened when the Fed raised interest rates in 1994-95, and a series of financial crises in developing countries, beginning with Mexico, followed.

Federal Reserve Raises Key Rate a Quarter Point
Edmund L. Andrews
New York Times, July 1, 2004, Page A1

This article reports on the Federal Reserve Board's decision to raise the federal funds rate by one quarter of a percentage point. At one point it refers to the factors that led the Fed to keep the interest rate at extraordinarily low levels for so long. It does not include the stock market crash, which caused the recession and subsequent period of weak growth, on this list.

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Inflation

Food, Gas Prices Offset Increases in Income
Nell Henderson
Washington Post, June 29, 2004, Page E1

Higher Rate Doesn't Mean Much Higher
Nell Henderson
Washington Post, June 30, 2004, Page E1

These articles discuss the current economic situation and the evidence that inflation poses a problem. Both articles includes assertions that inflation is very low. In fact, all measures of inflation show that it has accelerated considerably over the last year. The inflation rate is now higher by some measures (the annual rate of inflation rate in the consumer price index has been over 5.0 percent for the last three months), than the rates that the Fed has viewed with alarm in the past.

It is also worth noting that inflation will almost certainly be pushed higher in the not too distant future by a falling dollar. The over-valuation of the dollar is leading to a current account deficit that is close to 6.0 percent of GDP ($660 billion a year). A deficit of this size is clearly not sustainable, and will inevitably lead the dollar to fall against other currencies, thereby raising the price of imported goods and services.

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The European Central Bank

Europe's Central Bank Declines to Follow Fed
Mark Landler
New York Times, July 2, 2004, Page W1

This article reports on the European Central Bank's (ECB) decision to keep interest rates steady, after the Fed raised its short-term rate. The article discusses this decision exclusively in the context of European inflation. It never raises the issue of the impact that interest rates have on growth and unemployment. Many economists, including those at the IMF, have identified the ECB's high interest rates as one of the factors contributing to high European unemployment.

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Tax Rebates

Economic Growth Estimates Revised
Nell Henderson
Washington Post, June 26, 2004, Page E1

This article reports on a downward revision to data on first quarter GDP growth. At one point the article asserts that the quarter's growth was boosted by tax cuts, which gave consumers more money to spend. While rebates resulting from last year's tax cuts did increase the amount of money that consumers had available to spend in the first quarter, this was almost completely offset by higher capital gains taxes. The stock market showed substantial gains in 2003 for the first year since 1999. This meant that investors owed considerably more in capital gains taxes than they had the prior three years.

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Cotton Production in Brazil

Brazil's Big Stake in Cotton Likely to Become Bigger
Todd Benson
New York Times, June 29, 2004, Page W1

This article reports on the rapid growth in Brazil's cotton production in recent years. The article asserts that there are large openings for even further growth, since the W.T.O. recently ruled that U.S. subsidies to cotton producers violated rules, and therefore are likely to be cut back or eliminated in the next few years.

It is important to note that the impact of a removal of cotton subsidies is likely to be largely offset by a decline in the value of the dollar against other currencies. At present, the United States is borrowing more than $600 billion a year from abroad, primarily because of its massive trade deficit. There is no economist who believes that the United States can continue to borrow at this rate indefinitely. The only plausible way to reduce the size of the deficit to a sustainable level is for the dollar to decline. It would take a decline on the dollar of between 20 to 30 percent to bring the trade deficit down to a sustainable level.

A fall in the dollar of 20 to 30 percent would lower the price of cotton produced in the United States, and sold on the world market, by 20 to 30 percent. A price decline of this magnitude would roughly offset the impact of the elimination of cotton subsidies, leaving Brazilian producers in roughly the same position relative to U.S. producers as they are today.

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Jobless Claims

Factory Index Strong, but Jobs Claims Increase
Bloomberg News
New York Times, July 2, 2004, Page C2

This article reports on the release of new economic data. At one point it notes that new filings for unemployment insurance have averaged 347,200 a week in 2004, about 55,000 fewer than in 2003. The article then quotes Joseph Shapiro, chief United States economist at MFR Inc., as saying that "we don't think claims can get much lower in a market of this size. "

In 1999, new jobless claims averaged 298,000 a week. In 2000, they averaged 301,000 a week. There were more people employed in 2000 than are employed now.

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Intellectual Property Claims

Glickman Succeeds Valenti at MPAA
Jeffrey H. Birnbaum
Washington Post, July 2, 2004, Page E1

This article reports on the selection of former Dan Glickman, a former Secretary of Agriculture, as the president of the Motion Picture Association of America (MPAA). At one point the article describes one of Mr. Glickman's main challenges as finding a way "to reduce the growing piracy of movies in the United States and around the world. "

This is an inaccurate description of the agenda of the MPAA. "Piracy" refers to unauthorized copying that occurs in violation of existing laws. The MPAA has been actively working to change laws (both in the U.S. and around the world) to extend copyright to new domains and to restrict the development of technologies, including new software and computer devices, that facilitate the transfer of recording material. This effort has imposed enormous costs on consumers, since items that could be exchanged at no cost in a free market are made quite expensive as a result of copyright protection.

Such protectionist efforts are requiring ever greater amounts of government repression. There have been many cases of law enforcement officials breaking into homes and college dorm rooms looking for unauthorized copies of recorded material. In one case, a software engineer was jailed for a talk he gave at an academic conference.

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Canada

Liberals Hold Onto Power In Close Election in Canada
Clifford Kraus
New York Times, June 29, 2004, Page A6

This article reports on the outcome of the parliamentary elections in Canada. At one point it discussed the possibility that the ruling Liberal party will form a coalition government with the New Democrats. It describes the New Democrats as "suspicious of free trade." This characterization would apply to all major political parties in Canada, since they all support protectionist measures that benefit powerful interest groups. For example, all the parties support patent protection that benefits the pharmaceutical industry and copyright protection that benefits the entertainment and software industries. It would have been more accurate to identify the New Democrats as a party that has been opposed to many recent trade agreements, or the recent path of Canadian trade policy.