Economic Reporting Review
By Dean Baker
January 17, 2006
In This Issue:
Stories of the Week
• The Trade Deficit
• Google Stock Price
• 11,000 Dow
• Long-Term Interest Rates
• California Budget
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Outstanding Stories of the Week
In the Treatment of Diabetes, Success Often Does Not Pay
New York Times, January 11, 2006, Page A1
This article, which is part of a 4 part series on the spread of diabetes, examines how the incentives in the health care system often place a low priority on preventing diabetes. Many of the treatments that would reduce the incidence of diabetes, for example counseling by nutritionists, provide little revenue for health care providers. By contrast, treating the disease itself can lead to very large flows of revenue.
Sago Puts Spotlight on Safety Strategy
Washington Post, January 8, 2005, Page A3
This article reports on the reduction in penalties for mine safety violations over the five years. The Sago mine, where 12 miners died in the previous week, had repeatedly been citied for safety violations.
Miners Steering Next Generation To Different Jobs
New York Times, January 8, 2006, Page A1
This article reports on attitudes towards mining among people in West Virginia. It notes that most families of mine workers try to steer their children to other jobs, but there are few good-paying alternatives to mining in the area.
Drug Makers Scrutinized Over Grants
New York Times, January 11, 2006, Page C1
This article reports on the Senate Finance Committee's investigation into "educational" grants by the pharmaceutical industry. The investigators have found that these grants often go to individuals and groups that promote the industry's drugs.
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The Trade Deficit
U.S. Narrowed Gap in Trade Imbalance
Washington Post, January 13, 2005, Page D5
Trade Gap Narrowed in November as Energy Costs Eased
New York Times, January 13, 2006, Page C3
These articles report on the Commerce Department's release of data showing a somewhat smaller trade deficit in November than October. This news should have been given more attention. The trade deficit affects the country in roughly the same way as the budget deficit. The trade deficit is now running at more than a $700 billion annual rate, close to 6 percent of GDP. This shortfall is approximately twice the size of the budget deficit.
In order for the current account balance, and therefore U.S. borrowing from abroad, to reach a sustainable level, the trade deficit will eventually have to fall near zero (this would still leave a deficit on the current account balance). This can only plausibly be accomplished through a decline in the value of the dollar which will raise import prices and lower living standards. This drop in the dollar will have roughly the same impact on U.S. living standards as a $700 billion increase in annual tax payments.
The Post article raises the possibility that a continuation of high deficits will lead to a growth in protectionist sentiment. It is not clear why this should be a cause for concern. The United States already has extensive protections for doctors, lawyers, economists and other highly paid professionals. There is no obvious reason for concern if laws are changed to protect other segments of the labor market.
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Google Stock Price
Is Google a Good Candidate For Rational Exuberance?
Andrew Ross Sorkin
New York Times, January 8, 2006, Section 4, Page 5
This article discusses the prospects for Google's stock price. The discussion focuses exclusively on the past run-up of its price and compares it to other stocks. It never mentions the stock's price-to-earnings ratio, nor the probability that its profits will rise to levels that would justify the price targets discussed.
At its current stock price ($456), Google's market capitalization (the value of its stock) is $140 billion. The article raises the possibility that its stock price could rise to $2000. This would imply a market capitalization of more than $700 billion. If the price-to-earnings ratio of Google's stock at that point were 20 (a higher than normal PE ratio by historic standards), then Google would be earning after-tax corporate profits of $35 billion a year. This is more than 3.5 percent of corporate profits in the United States, at their 2005 level. No single corporation has ever come close to gaining this large a share of total profits. At its peak, General Motors accounted for a bit more than 1 percent of U.S. corporate profits.
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Dow Tops 11,000; First Time Since '01
New York Times, January 10, 2006, Page C1
This article reports on the Dow Jones industrial average crossing 11,000 for the first time since June of 2001. The article treats this event as a major turning point for the stock market. It is important to recognize that the Dow Jones index only includes 30 stocks that are not very representative of the market as a whole. The Standard and Poor's 500 index reflects a much broader segment of the market. This index is currently at 1289, more than 15 percent below the peak of 1528 that it reached in February of 2000.
In making comparisons over time, it is also important to adjust for inflation. Since the S & P 500 hit its peak in 2000, the consumer price index has risen by more than 16 percent. This means that the index would have to reach almost 1780 before it regained its 2000 level.
It is also worth noting that higher stock prices are not necessarily good news for the economy as a whole. Insofar as higher stock prices reflect profit growth that is attributable to a redistribution from wages or tax revenue, they do not necessarily benefit the public as a whole, but only stock owners. In this sense higher stock prices are like higher corn prices; the former are good for stock owners, the latter are good for corn growers. Also, if stock prices are driven higher by irrational exuberance, as was the case in the nineties, then they lead to economic distortions and create the basis for a painful correction.
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Long-Term Interest Rates
The World Isn't Flat, but Its Yield Curve May Be
New York Times, January 8, 2006, Section 3, Page 3
This article reports on the flattening of yield curves (the gap between long-term and short-term interest rates) around the world. In discussing this flattening in the United States, the article attributes it to "a huge trade deficit that spurs heavy purchases of long-term government bonds by foreign investors."
Actually, there is nothing about the trade deficit which should lead foreign investors to buy long-term U.S. government bonds; it should be expected to have the opposite effect. Virtually every economist agrees that the large U.S. trade deficit cannot be sustained for long. The main mechanism for correcting a trade deficit is a decline in the value of the dollar. This means that investors should be anticipating that the dollar will be worth considerably less at some point in the not-too-distant future. As a result, the value of a long-term bond denominated in dollars will be worth less. In addition, a falling dollar will cause import prices to rise, which will cause the inflation rate to increase. A higher inflation rate is usually associated with higher interest rates.
For these reasons, countries with large trade deficits, like the United States, usually face high long-term interest rates, as investors are demand high returns in order to compensate for the risk that the value of the currency will fall and inflation will rise in the future. In this respect, contrary to the assertion in the article, the other wealthy countries are in a fundamentally different position. Japan and most European countries enjoy trade surpluses. This means that their currencies are likely to remain strong and possibly rise in the future. As a result, anyone holding bonds denominated in yen and euros are likely to get the benefit of a rising currency value in addition to the interest on their bonds. For this reason, low long-term interest rates in Japan and Europe are much easier to understand than low interest rates in the United States.
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Md. Senate Overrides Veto on "Wal-Mart Bill"
Washington Post, January 13, 2005, Page A1
Maryland Sets A Health Cost for Wal-Mart
New York Times, January 13, 2006, Page A1
These articles report on the vote of the Maryland senate to override the governor's veto of a bill requiring that large employers pay an amount at least equal to 8 percent of their wage bill towards health insurance. Since the provision would only apply to large employers, and most large employers already provide their workers with health insurance, the company that is most likely to be affected by the bill is Wal-Mart.
Wal-Mart has lobbied vigorously against the bill. According to the Times article, a spokesman for Wal-Mart claims that it already spends on amount of health care that is close to the 8 percent mandated by the law. If this is true, the bill would have very little effect on Wal-Mart.
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Many Companies Ending Promises For Retirement
Mary Williams Walsh
New York Times, January 9, 2006, Page A1
This article reports on the growing tendency among large employers to eliminate defined benefit pension plans. The article describes this as an effort by employers to avoid risk, however IBM recently announced that it expected to save $3 billion by freezing its defined benefit pension. If the elimination of defined benefit pensions is simply an effort by companies to reduce risk, then it should not result in any savings on average. The statement by IBM implies that the company sees the freezing of its pension as a way to increase profits by decreasing employee compensation. This may have been a more important motive than reducing risk.
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Trade Surplus Tripled in '05, China Says
New York Times, January 12, 2006, Page C1
This article reports on the release of data by the Chinese government showing that its trade surplus had tripled in 2005 from its 2004 level. At one point the article comments that when the year's GDP data is compiled, China is likely to rank fourth or fifth in the world, passing France, Italy, and possibly Britain.
Actually, China's economy is already more than 3 times the
size of any of these economies. Using a purchasing power parity measure of GDP -
the standard that most economists would consider appropriate for international
comparisons of this type - China' economy is already more than $8 trillion. This
puts the size of China's economy at approximately two-third the size of the U.S.
economy and far larger than the economy of any other country in the world.
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Bahrain Pact Signed by Bush
New York Times, January 12, 2006, Page C6
This article reports on President Bush's signing of a new trade agreement with Bahrain. The article describes the agreement as a "free trade" agreement. The agreement does not actually promote free trade. It increases some protectionist barriers, specifically in the case of patents of copyrights. Politicians like to call trade agreements "free trade" agreements because it makes them sound more appealing to the public; however this description should not be used in a news article except in quotes.
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Schwarzenegger Budget Calls for Billions in New
John M. Broder
New York Times, January 11, 2006, Page A16
This article reports on California Governor Arnold Schwarzenegger's budget proposal for 2007. At one point it reports that he is proposing a $222 billion multiyear program to modernize the state's infrastructure. The article does not indicate the time period over which this money will be spent. It is impossible for readers to assess the importance of this spending request without knowing whether it refers to projected spending over a 2-year period or a 10-year period.
It also would have been helpful if this proposal and the others discussed in the article were expressed a share of California's budget rather than simply in dollar terms. This information would make the importance of the programs in question much more apparent to readers.
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Dean Baker is Co-Director of the Center for Economic and Policy Research in Washington, D.C.