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What Does S&P's Downgrade of Japan's Debt Mean? Print
Wednesday, 24 August 2011 04:58

The NYT reported on S&P's downgrade of Japanese government debt to the 4th highest level. It explained the downgrade by noting Japan's continued weak growth, political problems and concerns about deflation. These are factors that might concern the Japanese public when they vote for their leaders, but it is difficult to see what they have to do with bondholders holding Japanese government debt.

Bondholders are presumably worried about whether they will get paid back. None of the issues raised in this discussion have any direct bearing on whether Japan's government can repay its debt. In fact, since the debt is denominated in yen, it would be difficult to understand how Japan would be unable to repay its debt, unless it forgets how to print yen.

In fact, the concern about deflation undermines one of the arguments that is occasionally made in the context of the U.S. downgrade, that S&P is concerned about inflation eroding the value of the debt. While this story never made sense in any case, if Japan sees deflation then bondholders will actually be repaid in yen that are worth more than the yen they lent. (The credit rating agencies are not in the business of making inflation forecasts. Furthermore, if an increased risk of inflation was the basis for its downgrade then S&P should have downgraded all dollar denominated debt regardless of the issuer.)

It is important for the media to analyze the basis for these downgrades since there are serious questions about the competence of S&P and the other credit rating companies. They rated hundreds of billions of dollars of subprime mortgage backed securities as Aaa. They also gave top investment grade ratings to Lehman, Bear Stearns and AIG until their bankruptcies (or bailout in the case of AIG).

Given their abysmal track record, it is entirely plausible that there is no basis for their downgrades of sovereign debt. There certainly cannot be a prima facie assumption that they have any idea what they are doing. 

Even According to Fed Dogma, Inflation Is Not a Problem Print
Wednesday, 24 August 2011 04:30

The NYT told readers that the Fed will be reluctant to engage in more quantitative easing or take other steps to boost the economy because it is worried about inflation. It then told readers that inflation has been 3.6 percent over the last year, implying that this is a serious problem.

Actually, as a matter of policy the Fed has long focused on the core inflation rate, which excludes food and energy prices. Over the last 12 months, the core inflation rate has been just 1.8 percent, which is below its 2.0 percent target. Furthermore, in prior years the Fed had not even viewed the 2.0 percent core rate as a strict bound. The year over year inflation rate was consistently above 2.0 percent in two decades prior to the recent recession, with the exception of a period in 2003-2004 when the weak economy pushed inflation below this rate. In other words, if Bernanke and the Fed now view 2.0 percent core inflation as an upper bound, then this is a much stricter anti-inflation policy than they have applied in the past.


Furthermore, higher inflation is actually one of the goals of a quantitative easing policy. Higher inflation reduces the real interest rate. Firms are more likely to invest if they expect that they can sell the goods that they produce at a higher price in future years. This is why Bernanke actuallyadvocated that the Bank of Japan deliberately target a higher inflation rate in a paper that he wrote while he was still a professor at Princeton.

This is also the reason that deflation can be a problem as the article notes. However, there is no magic to zero. The problem of deflation is that the the inflation rate is lower than is desired. If the desired inflation rate is 4.0 percent, then the drop of the inflation rate from 0.5 to -0.5 percent is no worse than the drop from 1.5 percent to 0.5 percent. Deflation per se is only a problem when the rate of price decline is so rapid that it undermines the ability to plan. This was the case at the start of the Great Depression when prices were declining at a near double-digit annual rate.

President Obama Blames Darkness on Sunset Print
Tuesday, 23 August 2011 20:15

That is how CBS News would report it. In its discussion of the rise in the deficit in the years that President Obama has been in office it tells its audience:

"Mr. Obama blames policies inherited from his predecessor's administration for the soaring debt. He singles out:

  • "two wars we didn't pay for"
  • "a prescription drug program for seniors...we didn't pay for."
  • "tax cuts in 2001 and 2003 that were not paid for."

He goes on to blame the recession, and its resulting decrease in tax revenue on businesses, for making fewer sales, and more employees being laid off. He says the recession also resulted in more government spending due to increased unemployment insurance payments, subsidies to farms and funding of infrastructure programs that were part of his stimulus program."

It is likely that President Obama blames the recession for the rise in the deficit because it happens to be true. For example, the deficit was 0.4 percent of GDP in 1974. In 1976 it was 4.0 percent of GDP ($600 billion in today's economy). In 1981 the deficit was 2.6 percent of GDP. In 1983, in the middle of the recession, it hit 6.0 percent of GDP. In 1989 the deficit was 2.8 percent of GDP. The recession raised the deficit to 4.7 percent of GDP in 1992. And in 2000 the surplus was 2.4 percent of GDP. The impact of the recession, coupled with the war and the Bush tax cuts, turned this into a deficit of 3.5 percent of GDP in 2003.

In other words, this is not a debatable point. Recessions lead to deficits, and severe recessions, like the one that accompanied President Obama's move to the White House lead to large deficits. Reporters should know this and if they do, they should identify this as a fact to their audience, not an assertion by a politician to be viewed with skepticism.  

Alan Greenspan Insists That He Knows Nothing About the Economy Print
Tuesday, 23 August 2011 19:31

That's what the Dow Jones effectively told readers today. The article reported that in response to a question at a conference:

"Greenspan also said he believes that the sharp rise in gold prices is due to market concerns about inflation taking off in the long run. He noted how there has never been such a major expansion of credit in U.S. economic history."

Let's look this one up. There is an organization called the "Federal Reserve Board" that puts out really good data on credit. If we look at its most recent Flow of Funds accounts, we see that credit for the economy as a whole expanded at a 3.0 percent annual rate in 2009, a 4.2 percent annual rate in 2010, and a 2.3 percent annual rate in the first quarter of 2011, the most recent quarter for which data is available.

Has there ever been "such a major expansion of credit in U.S. economic history?"

Well, actually credit expanded more rapidly than the 4.2 percent rate in 2010 in every single year that Greenspan chaired the Fed. In fact, it expanded more rapidly in every year in this series (going back to 1976) and probably every year since the Great Depression. In other words, for Alan Greenspan night is day, up is down, he is looking at an extraordinarily slow pace of credit expansion and telling reporters that is the fastest on record.

Of course, Greenspan is probably not familiar with the Flow of Funds data. If he had been, he probably would have noted the historic drop in the ratio of homeowners' equity to market value that occurred even as house prices were soaring to record levels. (Rising house prices translate one to one into equity. Other things equal, rising house prices should have meant a rising ratio of equity to value.) This was a very clear warning sign about the housing bubble to those familiar with the Fed's data.

A serious news service should not be passing along such ill-informed nonsense to its readers uncorrected, except if its purpose is to point out that the person who chaired the Fed for almost two decades doesn't have a clue about the economy.

Maybe Reuters Should Have Talked to Someone Supporting a Financial Transactions Tax Print
Tuesday, 23 August 2011 08:14

A Reuters article on plans by the European Union to impose a tax on foreign exchange transactions (actually the proposed tax would apply to a wide array of financial transactions, not just foreign exchange) reads like an editorial against such a tax. It tells readers that the tax could cause traders to leave the London market, that it would reduce liquidity and thereby increase volatility and also disrupt efforts to develop algorithms for intraday trading. It describes these as unintended consequences of the tax.

If it had talked to a proponent of the tax, she would have noted the size of the taxes being discussed would just raise transactions costs back to where they were in the 80s or 90s. The cost of trading has plummeted in the last 3 decades due to computers. This tax will simply reverse some of this decline. There was already an extremely well-developed market in foreign exchange in the 80s.

The effect of a tax on volatility is unclear. While it reduces the incentive for arbitrage, it will also make speculation less profitable. This could make large speculative swings of the sort that we have seen in financial markets in recent weeks less likely.

Finally, it is not clear why it views the fact that the tax will make it more difficult to construct trading algorithms as an unintended consequence. These algorithms may provide large profits to the people who develop them, but the benefits to the economy and society are likely to be near zero. If a transactions tax discourages skilled mathematicians and computer programmers from developing complex formulas for financial arbitrage and instead has them work in a productive area of the economy, then the tax will have been a great success.


[Addendum: Reuters does go a small bit of the way back toward saving its soul by running this column from my friend Mark Thoma.]

Technology Transfers to China Help the United States Print
Tuesday, 23 August 2011 05:03

The Post had a front page article that implied that we should be concerned about the possibility that GE and other companies were transferring sophisticated technologies to China. Actually, the same argument that holds the United States benefits from importing low cost manufactured goods from China would also hold that it benefits from importing low cost high tech products from China. The latter would put downward pressure on the wages of engineers and other highly-skilled workers, but lead to lower prices for high tech products and thereby free up money for other consumption.

It is interesting that the Post so explicitly expresses its concern, in the news section, about losing high skilled jobs due to trade, but applauds the loss of less-skilled skilled jobs.

Do Not Believe Morning Edition: Spain Did Not Build Up Huge Debt Print
Tuesday, 23 August 2011 04:29

Morning Edition told listeners that Spain has built up huge debt. This is not true. Spain actually was lowering its debt prior to the collapse of its housing bubble in 2007. The recession that resulted from this collapse has led the country to run large deficits, however with four years of large deficits its debt to GDP ratio is still just 52.6 percent of GDP, well below the level in the United States.

It then interviewed an economist who said that Spain's main need was to reform its labor market. While there may be useful labor market reforms that Spain can implement, arguably its biggest problem is the contractionary monetary policy of the European Central Bank (ECB). The ECB is run by a perverse cult that worships 2.0 percent inflation and is prepared to sacrifice almost all other economic goals to meet this target.

This is especially harmful to countries like Spain with large trade deficits. Since Spain shares a currency with the rest of the euro zone, the most effective way for it to gain competitiveness is to have its wage growth lag the growth in surplus countries like Germany.

If overall inflation were 3-4 percent, as advocated by many economists, it would be possible for Spain to increase its competitiveness with low positive wage growth. However, with inflation near zero, Spain must actually see wage declines in order to increase its competitiveness. This process of deflation tends to be slow and painful, involving high unemployment for long periods of time. It would have been helpful if Morning Edition had made this basic point to its listeners.

Joe Nocera, Jobs, and Illegal Threats Against Unions Print
Tuesday, 23 August 2011 04:05

Joe Nocera's NYT columns are usually well worth reading, but he really misses the boat in today's complaint about the National Labor Relations Board (NLRB) costing jobs. The basic story is that the NLRB is obstructing Boeing's efforts to move production facilities from their unionized facilities in Washington State to non-union South Carolina.

There are several aspects to the issue that are misrepresented in the column. First, this is an issue about the transfer of jobs, not the creation of jobs. The jobs that would be created in South Carolina would come at the expense of jobs in Washington State. Boeing is not becoming less efficient in the production of planes -- it will not require more workers per planes. Nor is likely that it will have any boost in orders, or at least not any time soon. This means that we are debating a transfer of jobs, not arguing over job creation.

The second point is that Nocera unduly credits Boeing for keeping jobs in the United States. Like almost all corporations, Boeing sets up its operations where it expects to minimize its costs.

It actually has outsourced a large amount of work to overseas facilities in the last two decades. This has proven to be a problem for Boeing since it has made it difficult to maintain coordination and quality control. News reports have blamed Boeing's dispersion of production for delays in meeting its delivery schedules. In other words, it has not been patriotism that has led Boeing to keep much of its production in the United States. It was an effort to ensure that it could produce its planes to acceptable standards in a timely manner.

Finally, Nocera misrepresents the issue at hand. No one disputes that Boeing has the right to relocate its operations in a state with few unions and anti-labor laws, like South Carolina. The issue is whether the move to South Carolina was part of an explicit threat directed against the union.

The situation is exactly analogous to moving a plant overseas. A company has the legal right to relocate a facility to Mexico or China in order to reduce its costs. However, it does not have the right to threaten to move if its workers vote to join a union. An explicit threat of this nature would be a violation of labor law, since it would imply that it is punishing its workers for joining a union.

The question in this case is whether the move to South Carolina is part of a threat against its unions. This involves an examination of the record of negotiations and discussions between management and Boeing's unions. Without knowing this history, it is not possible to make an apriori assumption that the NLRB case has no merit, as Nocera does in his column.  

Economists Who Missed the $8 Trillion Housing Bubble that Sank the Economy Prefer Spending Cuts to Tax Increases Print
Monday, 22 August 2011 08:54

CNBC told its audience that 56 percent of the economists who responded to a National Association of Business Economists Survey thought that spending cuts were better than tax increases for reducing the deficit. It would have been worth reminding people that almost all of these people were too incompetent to see the $8 trillion housing bubble that crashed and wrecked the economy.

This is an important piece of information since there is no reason to assume that these economists know any more about the economy than they did four years ago.

Why Doesn't Biden Tell China That U.S. Bonds Are a Bad Investment? Print
Monday, 22 August 2011 06:58
It happens to be true, since the dollar will almost certainly fall if they ever choose to unload their bonds. However more importantly, buying up government bonds is the way that China props up the value of the dollar against the yuan. Ostensibly the Obama administration's policy is that it wants the dollar to fall against the yuan. So why isn't Biden encouraging China not to buy up so many government bonds, and why isn't the Post asking this question?
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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.