Economic Reporting Review
By Dean Baker
June 6, 2005
In This Issue:
• Outstanding
Stories of the Week
• Social
Security
• The Fed and
the Housing Bubble
• The European
Economic Model
• Immigration
• Income
Growth
• Japan
Please note: ERR will not be
published during the next 2 weeks. The next issue will
be published and circulated on June 27, 2005.
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Outstanding
Stories
of the Week
Despite Vow, Drug Makers Still
Withhold Data
Alex Berenson
New
York Times, May 31, 2005, Page A1
This article examines the disclosure practices on drug trials
by the major pharmaceutical companies. It notes that many of the largest
companies are still concealing most information about their trials, in spite
of official commitments to openness.
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Income Rose in April, But Barely Beat Inflation
Nell Henderson
Washington
Post, May 28, 2005, Page E1
This article reports on the Commerce Department's release of
data on income and spending for May. It analyzes this data carefully, noting
that it implies that income growth is barely keeping pace with inflation.
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A Bane Amid the Housing Boom: Rising Foreclosures
Michael Powell
Washington
Post, May 30, 2005, Page A1
This article reports on the unusually high rates
of mortgage foreclosure that the country is currently experiencing and discusses
the situations that lead families to default on their mortgages.
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Social
Security
GOP Lawmakers Acknowledge Uphill
Fight on Social Security
Jonathan Weisman
Washington
Post, May 30, 2005, Page A5
This article
assesses the prospects in the current session of Congress for President Bush's
Social Security proposal. The article repeatedly refers to claims that there is
a rising public awareness of Social Security's problems.
Actually, recently polls have
shown that the public is largely unaware of the actual nature of the long-term
shortfall facing the Social Security system. An April New York Times poll
found that 68 percent of people under age 45 thought that Social Security would
be unable to pay them any benefit. There are no projections that support this
view. Both the projections from the Social Security trustees and the
Congressional Budget Office show that the program will always be able to pay
retirees a higher benefit (in today's dollars) than what current retirees
receive.
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Bush's Road Tour Rolls On in Push to Sell Social Security Changes
David Sanger
New
York Times, June 3, 2005, Page A20
This article reports on a trip
by President Bush in which he sought to promote his plan for privatizing Social
Security. At one point it quotes Mr. Bush as saying that the trust fund is
simply I.O.U.'s because the government has spent the tax dollars that people
paid to Social Security.
It is worth noting that this is
exactly what happens with all bonds (which can be called I.O.U.'s) in both the
public and private sector. It is standard practice for the borrower to spend the
money lent to them. This is the way the economy has worked for hundreds of
years. There is no problem whatsoever for Social Security unless the government
defaults on its debt. Even President Bush has not proposed having the government
default on its debt.
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The
Fed on the Housing Bubble
Fed Debates Pricking the U.S. Housing Bubble
Edmund L. Andrews
New
York Times, May 31, 2005, Page C1
This article examines
the issues that the Fed must consider in deciding whether to deliberately burst
the housing bubble. At one point it compares the current situation of the
Federal Reserve Board with the situation it faced with the stock market bubble
in the late nineties, at one point noting the public statement of former
Vice-Chair Benjamin Bernanke, that it is difficult to recognize a financial
bubble.
Actually, it should have been very easy for any economist or financial analyst to recognize the stock bubble. Price to earnings ratios in the market eventually exceeded 30. Given projections for future profit growth from the Congressional Budget Office, the Office of Management and Budget, and most private forecasters, the price to earnings ratios of the late nineties implied real future stock returns of just over 3 percent, approximately the same return that was available on government bonds at the time. This means that unless investors were willing to hold stock at returns that gave them no premium over the return available on government bonds, or future profit growth would prove to be far more rapid than almost any forecaster predicted, then the stock market was experiencing a bubble.
In a speech at the American
Economic Association in January of 2004, Mr. Greenspan actually claimed that he
had recognized the existence of the stock bubble all through this period. (This
claim is supported by the transcripts of the Fed's meetings.) However, he chose
not to take any action to defuse the bubble, opting instead to address the
problems created by the bursting of the bubble. Given his behavior with regard
to the stock bubble, it is worth noting that Mr. Greenspan thought it was
appropriate to warn people about the potential dangers from the housing bubble.
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Low Mortgage Rates Defy Expectations
Nell Henderson
Washington
Post, June 2, 2005, Page D1
This article
discusses the fact that long-term interest rates have been declining, even as
the Fed has raised short-term rates by two full percentage points over the last
year. Several explanations for the persistence of low long-term interest rates
are inaccurate.
For example, the article claims that foreign central banks of oil exporting counties are holding large amounts of dollar reserves because oil is priced in dollars and oil prices have risen sharply. The fact that oil is priced in dollars is meaningless. The foreign exchange market is the largest market in the world and has very low transactions costs. According to some experts, the transactions costs on large volumes is less than 0.01 percent, which means that if oil producers did not want to hold dollars, it would be almost costless for them to switch into another currency. Similarly, if they wanted to hold dollars, it would be almost costless for them to buy dollars, even if oil were priced in a different currency.
The article also asserts that 10-year treasury bonds provide a safe return in uncertain times. This is not true. The interest rate on 10-year bonds when this article was written was 3.9 percent. If interest rates were to rise to 4.5 percent, which is still a historically low rate, then a bondholder would lose more than 11 percent of the value of the bond.
The article also claims that inflation has been "extremely low" in recent years. Actually, inflation by most measures is considerably higher than it was in the period from 1994-95 when Greenspan raised the federal funds rate to 6.0 percent. For example, the overall CPI has risen 3.5 percent over the last year; it only rose by 2.4 percent from January of 1994 to January of 1995. Virtually every other measure of inflation also shows that inflation is higher today than in the mid-nineties.
Finally, the article asserts that
foreign central banks, who are buying up dollars in order to keep up the value
of the dollar against their own currency (thereby supporting their exports) must
hold long-term bonds to keep a balanced mix of assets. Actually, these central
banks are not interested in returns (otherwise they would not have been holding
dollars); they have no reason to be holding long-term bonds, except to keep U.S.
interest rates low. The decision by foreign central banks to hold long-term U.S.
treasury bonds is presumably part of a deliberate effort to counteract the Fed's
monetary policy, and to keep interest rates in the United States low in order to
sustain demand for their exports.
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The
European Economic Model
A German Contender Is Hard to Read
Richard Bernstein and Mark Landler
New
York Times, May 29, 2005, Page A4
This article discusses the political career and agenda of Angela Merkel, the
German Christian Democratic Party's candidate for chancellor. It discusses the
ongoing political battles over rolling back the German welfare state. It then
refers to "the inevitability of fundamental changes to the social welfare
state."
The article does not indicate how it determined that fundamental changes to the German welfare state are inevitable. There are several countries in Europe with welfare states that are as generous as the one in Germany, such as Denmark, Sweden, and Austria, whose economies are performing quite well. These countries have unemployment rates that are comparable to the unemployment rate in the United States.
While some economists have argued that welfare state protections are responsible for high unemployment in countries like Germany and France, the evidence does not support this claim (see "Unemployment and the Case for Labor Market Deregulation.").
The most obvious reason that
Germany and other European countries are experiencing high unemployment is the
contractionary monetary policy of the European Central Bank (ECB). While the
Federal Reserve Board lowered its short-term interest rate to 1.0 percent to
counteract the economic downturn in 2001, the ECB never lowered its short-term
rate below 2.0 percent. Virtually all economists agree that growth in the United
States would have been slower, and unemployment would have been higher, if the
Fed had not acted so aggressively to counteract the downturn. Given the refusal
of the ECB to act more aggressively to boost the economy, it is not surprising
that Europe is experiencing slower growth and higher unemployment than the
United States.
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French Voters Soundly Reject European Pact
Elaine Sciolino
New
York Times, May 30, 2005, Page A1
Euro Bruised By Rejection Of New Pact By France
Mark Landler
New
York Times, May 31, 2005, Page C1
These articles report on the vote in
France rejecting the European constitution. Both articles contrast the European
welfare state with what they describe as unbridled free market capitalism in the
United States. For example, the article by Landler at one point asserts that
American-British style economic policy has an "emphasis on competition and
untrammeled markets."
This is an inaccurate characterization of the U.S. model. The United States economy is actually highly protectionist. It has rigid barriers to provide job security and large salaries to highly educated workers like doctors and lawyers. The government imposes licensing requirements and other professional restrictions to prevent these workers from having to compete with lower paid workers in developing countries or even professionals in other rich countries. As a result of these protectionist barriers, doctors in the United States earn twice as much as doctors in other rich countries, costing the economy $80 billion a year. The U.S. model only forces low and middle income workers to face severe competition.
The U.S. model also includes
government-imposed monopolies, in the form of patent and copyright protection,
to benefit the pharmaceutical, software, and entertainment industries. These
monopolies cost the economy hundreds of billions of dollars every year by
raising prices in these sectors by 400 percent, or more, above the free market
price.
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2 'No' Votes In Europe: The Anger
Spreads
Richard Bernstein
New
York Times, June 2, 2005, Page A2
This article
examines the political situation created by the rejection of the European
Union's constitution by voters in France and the Netherlands. At one point it
notes the problem that EU countries will face if renewed growth will require
labor market liberalization, but voters refuse to support labor market
liberalization. Every person cited or quoted in the article presents this point
of view.
It would have been helpful to present the views of economists who hold a different perspective, such as Nobel Prize winner Robert Solow and Harvard labor economist Richard Freeman. If the contractionary monetary policy of the European Central Bank is a major factor explaining slow European economic growth, then further labor market liberalization along the lines advocated in this article would just make the unemployment problem worse.
At one point the article describes Germany as having an unemployment rate above 12 percent. This figure is based on the official German government definition of unemployment, which is very different from the U.S. definition. Using the OECD's standardized measure of unemployment, Germany's unemployment rate is under 10 percent. (It is approximately 8 percent in former West Germany; the part of the country that used to be East Germany still has an unemployment rate close to 20 percent.)
Articles in the New York Times
have frequently used the official German government definition of unemployment
instead of the OECD measure, without ever explaining that the German measure is
very different from the U.S. measure. There is no obvious reason not to use the
OECD measure, since it would be more understandable to most readers. It is
readily available on the OECD
website.
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Immigration
A Battle Raging Against Illegal Workers Has an Unlikely Driving Force
Timothy Egan
New
York Times, May 30, 2005, Page A11
Published online with the title "A
Battle Against Illegal Workers, With an Unlikely Driving Force"
This article discusses
a political debate in Idaho over the impact of immigrant workers on the economy.
The article presents the view that immigrant workers drive down the wages in
some occupations, and the view that immigrant workers are necessary to keep many
firms in business, as opposing views. In fact, these claims are entirely
consistent.
Immigrants are often willing to work at far lower wages than U.S.-born workers. Many businesses have taken advantage of the availability of these low cost workers. The opportunity to hire immigrants at low wages can be seen as a subsidy, comparable to getting free rent or electricity. Without this subsidy, many of these businesses could not survive.
Since U.S.-born workers in some
occupations must compete with immigrants who will work at lower wages, they
experience a decline in their wages. If the flow of immigrants were curtailed,
it is likely that workers in many of the occupations that have the largest share
of recent immigrants would see an increase in their wages. This would also be
associated with the closing of many businesses that are heavily dependent on
immigrant labor.
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Income
Growth
U.S. Incomes Rose in April, Lifting Consumer Spending
Bloomberg News
New
York Times, May 28, 2005, Page B4
This article reports on the
Commerce Department's release of data on income and spending for May. It focuses
on the growth in nominal income, ignoring the fact that inflation rose almost as
rapidly, leaving real income only slightly higher for the month. The article
also refers to a "rebound" in consumer sentiment. This is based on an
increase in the Michigan consumer confidence index to 86.9 for the month of May
from a preliminary reading of 85.3. (It is down from a reading of 87.7 in
April.) An upward change of this magnitude is too small to be statistically
significant and tells almost nothing about the state of the economy.
At one point the article notes
that the savings rate is near zero, then points out that the savings rate does
not include income from "borrowed money, income from investments, or
withdrawals from prior savings." It is of course reasonable that the
savings rate does not factor in borrowed money or prior savings. It does in fact
include income from investments, except capital gains income. It also excludes
capital losses, such as the trillions of dollars lost in the stock market crash
in the period from 2000-2002.
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Japan
Japan's Unemployment Rate Fell to 6-Year Low in April
Todd Zaun
New
York Times, June 1, 2005, Page C7
This article reports on the release of data by the Japanese government that
showed its unemployment rate falling to 4.4 percent in April. The article
reports that the data showed Japan's economy adding 410,000 jobs in the month.
This figure is not seasonally adjusted. Much of this increase was attributable
to the fact that workers in seasonal occupations like construction returned to
work in April after the winter. Typically, only seasonally adjusted numbers are
reported. These seasonal adjustments are designed to remove changes that happen
every year, so that analysts can focus on the changes that are attributable to
purely economic factors.
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Dean Baker is Co-Director of the Center for Economic and Policy Research in Washington, D.C.