auteur('Ecopublix');
illustration('vacances');Chers lecteurs, Ecopublix se met en veille pour l’été et reviendra à la rentrée avec des changements, des nouveautés et plein de surprises.
En attendant, toute l'équipe vous souhaite d'excellentes vacances et vous donne rendez-vous en septembre.
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Mental activity halts some of your self-deception and hypocrisy
» Marginal Revolution » [Résumé]The main idea is that when you busy people's minds with a routine task, they are less able to rationalize their own behavior and they are more likely to report the truth about what they are doing. The most quotable excerpt assumes a bit of context
To find out, he and Dr. Valdesolo brought more people into the lab and watched them selfishly assign themselves the easy task. Then, at the start of the subsequent questioning, some of these people were asked to memorize a list of numbers and retain it in their heads as they answered questions about the experiment and their actions.
That little bit of extra mental exertion was enough to eliminate hypocrisy. These people judged their own actions [in assigning themselves the easy task] just as harshly as others did. Their brains were apparently too busy to rationalize their selfishness, so they fell back on their intuitive feelings about fairness.
If you wish, here is the whole piece.
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How much do biofuels drive up food prices?
» Marginal Revolution » [Résumé]Biofuels have forced global food prices up by 75% - far more than previously estimated - according to a confidential World Bank report obtained by the Guardian.
The damning unpublished assessment is based on the most detailed analysis of the crisis so far, carried out by an internationally-respected economist at global financial body.
The figure emphatically contradicts the US government's claims that plant-derived fuels contribute less than 3% to food-price rises. It will add to pressure on governments in Washington and across Europe, which have turned to plant-derived fuels to reduce emissions of greenhouse gases and reduce their dependence on imported oil.
Here is the story, the report is not yet available, at least not to me. Seventy-five percent seems like a high estimate to me, especially since many foods are more expensive but they are not all used for biofuels. Still, the government's estimate of three percent is surely way too low. Biofuels are maybe a good test case for various estimates of government quality: will the bad biofuels still be subsidized five years from now?
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14:20
Overdose d’”everyday economics” ?
» Rationalité limitée » [Résumé]C’est en tout cas ce que certains estiment. On peut effectivement voir dans le graphique figurant dans le billet en lien que les ouvrages de vulgarisation appliquant les raisonnements économiques de base à toute forme de sujet ont proliféré ces dernières années. Bonne ou mauvaise chose ? Pour ma part, je suis partagé. D’un certain côté, [...]
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12:48
Metalworking Business Index Trends
» Mish's Global Economic Trend Analysis » [Résumé]Steve Kline who produces the Metalworking Business Index survey, shared an email with me from a correspondent who wanted to raise capital to expand, but could not get the loan. Let's take a look.Steve,
MBI Sub-Indices
An emerging trend this year is the sudden scarcity of capital from banks & machine tool finance companies. We planned to purchase two new machine tools this year. It now appears that we can obtain financing for just one, in spite of a spotless corporate credit record and continued sales growth. The lenders seem to be over-tightening because of the recent credit crisis. As I told my banker, “You guys seem frightened of your own shadows!”
click on chart for sharper image
New orders are up from May but still in contraction. The increase from May is led by an increase in exports. Prices received are still rising, but not as material prices.
The statement “You guys seem frightened of your own shadows!” is an interesting thought. However, it misses the big picture. Banks are not lending because they are too cash strapped to lend. Many banks are technically insolent and can't lend.
As for the would be borrower, things have been going so well for so long that he must think the odds of a sustained contraction are low. I believe he is wrong. In effect he is saying "It's different here", missing the inevitable slowdown in virtually everything.
Auto Sales Are Dismal At GM, Toyota, Ford, Chrysler, and they are going to remain dismal. The US is in recession. Eurozone Manufacturing Is Contracting. The U.K. is on the verge of collapse. U.K. Manufacturing Has Contracted Most Since 2001. Indeed, Deflationary Hurricanes Will Hit U.S. and U.K.
The table shows Future Business Expectations to be expanding in the face of contracting orders, contracting production, contracting employment, and contracting backlog. Finally, China, India, and Vietnam are all overheating and will have to slow. Ramping up capacity in face of the above factors is quite a dangerous thing to do.
Future Business Expectations optimism is unwarranted.
Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post ListMike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management. Visit http://www.sitkapacific.com to learn more about wealth management for investors seeking strong performance with low volatility.
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What I've Been Reading
» Marginal Revolution » [Résumé]1. Government and the American Economy: A New History, no editor but the book is dedicated to Bob Higgs by Price Fishback. Imagine essays by economic history luminaries, mostly classical liberals, covering many different eras of American economic history. For some this is a gold mine.
2. The Third Domain, by Tim Friend. An overview of archaea, those odd life forms that survive where nothing else can. A fascinating look at a still mysterious topic. It's not as well written as the top-drawer popular science books but since you probably know little or nothing about the topic the amount you will learn is high.
3. Empires of Trust: How Rome Built -- and America is Building -- a New World, by Thomas F. Madden. This book is avowed pro-Roman, pro-American, and sees strong parallels across the two regimes; part of the thesis is that neither wanted to build an empire but had to.
4. The Power Makers: Steam, Electricity, and the Men Who Invented Modern America, by Maury Klein. This is a big, clunky book with lots of poor exposition. It also covers a vital era -- the real Industrial Revolution -- which has remained oddly neglected by too many economic historians.
5. The Race Between Education and Technology, by Claudia Goldin and Lawrence Katz. This is the most important book on modern U.S. inequality to date; here is my previous coverage of their ideas. I'm still waiting for Paul Krugman to write a critique but right now their core hypothesis is looking strong.
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11:38
Ghost Towns In California
» Mish's Global Economic Trend Analysis » [Résumé]Peter Viles is reporting on the Ghost town in Inland Empire.A financial analyst fresh from a tour of construction sites in the Inland Empire is warning Wall Street of a "ghost town" where finished homes sit vacant and additional homes are still under construction.
The bank financing this project will own the entire subdivision when it is complete.
"At several properties, there were a significant number of fully built homes sitting vacant along with a large number of additional homes still under construction," Sandler O'Neill & Partners analyst Aaron Deer wrote today after touring developments in Corona and Ontario. "At one master plan community, the entire development appeared to be vacant -- with the exception of crews working on new construction, it was a ghost town."
More from Deer's note: "The homes all appeared to be empty, and there were no prospective buyers anywhere to be found. Surprisingly, the sales office was open ... but the woman working there had questionable English fluency. When asked how many homes had been sold in the past month she simply responded, 'Uh huh. Thank you. Yes!' and handed us some additional literature on the property."
More: "Perhaps the most interesting aspect to the development was what it revealed about the nature of the housing boom: that at the peak even the most undesirable and remote locations were worthy of expensive, high-end homes."
Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post ListMike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management. Visit http://www.sitkapacific.com to learn more about wealth management for investors seeking strong performance with low volatility.
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Fed Watch: Follow the Money
» Economist's View » [Résumé]Tim Duy syas if you want to understand what's going on in the economy, then "follow the money and see where it leads":
Follow the Money, by Tim Duy: My apologies to Brad Setser for borrowing the title of his blog for the evening.
I am writing tonight while on vacation at a cabin in Central Oregon. I do not have high speed internet access, reverting instead to a telephone modem. Consequently, I have left out some links that I would normally include. Not exactly my most polished piece either. And I probably shouldn’t even be working; it is just my son and me tonight, and he went to bed hours ago. A wise man would have followed and taken the rare opportunity for extended sleep, but I had some stories I just could not get out of my head, so better just to write them down.
During my brief stint at the US Treasury, an economist visiting from Australia requested an informational meeting with some Treasury staff to discuss the results of a paper he was in the process of writing. I recall this visit occurring during the height of the Asian Financial Crisis, about the time that JP Morgan issued a US recession call on the basis of an expected widening of the trade deficit. This economist, whose name I can’t recall, said that a US recession was simply not going to happen. Instead, he predicted that a wave of capital would flow out of Asia to the US, pushing down long term interest rates, which the Fed would accommodate at the short end. The end result would, he anticipated, be highly stimulative.
Not exactly conventional wisdom at the time, but needless to say, this turned out to be a remarkably accurate prediction; the capital flow into the US found traction in the already smoldering information technology sector. The rest is history, both good and bad. The lesson I took away from this episode was to drop your preconceived ideas about what you were sure would happen and just follow the money and see where it leads.
The technology boom was characterized by high rates of investment spending, and although the final push that followed the Asian Financial Crisis saw plenty of excess, one could reasonably argue that the capital inflow was supporting investment spending. This, of course, is the traditional textbook interpretation of a current account deficit/capital account surplus as a mirror of an internal saving and investment imbalance.
I recall one person, however, who was not so convinced. His name also escapes me, but I am pretty sure he was real. He worked for a conservative think tank, and was diligently writing a book on the US trade deficit. I recall attending two think sessions that he organized for people in the policy community to comment on his results, many of which were pretty standard criticisms of sustained, large external imbalances. But I do remember one important distinction – he had the temerity to suggest that those capital inflows were not just supporting investment, but were supporting household consumption. Someone (just to prove I remember something, I am almost certain I could testify in court that it was Catherine Mann, who at that time was at the Institute for International Economics), challenged this, noting that it ran against traditional wisdom.
I will never forget his response: Banks are busy refinancing mortgages, explicitly encouraging homeowners to withdraw equity in the process. These mortgages are then packaged up into mortgage packed securities and sold to overseas investors. In other words, he drew a direct link from an investor in say Zurich to the guy down the street buying a new TV. This insight came in 1999 or 2000. Maybe 2001. The year is not that important, it was simply a long time before most people caught on to this dynamic. Following the money can lead you to unexpected places.
The point of these stories is that while we know capital is flowing into the US, we don’t always know where it will end up; I am not convinced it even has to stay in the US. Since 1980, those capital inflows can be tied to government deficit spending, investment spending, and household consumption. So I now characterize the US current account deficit as simply reflecting an excess of consumption over productive capacities, while often remaining agnostic as to the ultimate demanders – firms, households, or the government – of that consumption. That excess consumption, regardless of the demander, will put a strain on global resources if the rest of the world is unwilling or unable to provide for it.
In the comments to my last piece, Bill Connerly essentially notes that I am using the term consumption loosely as it typically refers specifically to the activities of households:
Tim's comment that we consume more than we produce is not true. We consume plus invest more than we produce. One could just as easily argue that we invest too much as that we consume too much. And yet, we don't mind countries running a trade deficit in order to invest. The U.S. did that in much of the 19th century with pretty good results.
I am wary of the view that capital inflows are simply an innocuous side effect of an effort to sustain high levels of investment spending. This may be true as a general rule in a world of largely private direct investment. But in a world of hot money flows? And flows directly tied to household spending? And as Brad Setser has repeatedly warned us, the vast majority of the net inflows are from the official sector, which clearly has a non-investment objective. Indeed, foreign capital is still being funneled directly to households, just via US Treasury debt rather than mortgage debt.
So, if we follow the money, where does that lead us? Everyone wants to know the answer to that question. I think that it will be difficult for capital inflows to gain traction in the US, essentially the same problem left in the wake of the 2001 recession. Lacking that traction, the money seems to be flowing into commodities. To halt the rise in commodity prices, I suspect that either global monetary policymakers needs to tighten meaningfully or, what I think the Fed is hoping for, the money will spontaneously shift to another, less inconvenient direction, optimally some real, productivity enhancing form of investment. Until we see one of those outcomes, I tend to fall back on that old Wall Street truism: The Trend is Your Friend.
Which is why, as I was leaving for vacation just before the market close, I was not surprised to see oil hovering around $145 and, as also noted at Across the Curve, the 10-years TIPS breakeven had broken out to 261bp. All on the back of a weak, weak jobs report.
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"Revolution of Urban Rebels"
» Economist's View » [Résumé]Edward Glaeser argues urbanization is a catalyst for democracy:
Revolution of urban rebels, by Edward L. Glaeser, Commentary, Boston Globe: The Fourth of July is an opportunity to reflect on the long, difficult path to liberty. The organized uprisings, like the American Revolution, that toppled tyrants were often urban affairs that started with surreptitious meetings in crowded pubs and guildhalls. They were led by creatures of the city: merchants, lawyers, weavers, butchers, and brewers. As we celebrate our freedom at spacious suburban barbecues, we should remember that the road to freedom started on far more crowded city streets.
In the fight for freedom between dictatorship and democracy, dictatorship starts with a big edge.
Dictatorships have a small number of insiders who have strong incentives to fight for their regime. Because the benefits of democracy are so widely shared, no one has particularly strong incentives to fight to create or preserve representative government.
Democracies have a massive free-rider problem where all of us have a natural tendency to let someone else die for our liberty. Solving this free rider problem requires coordination and this is what urban density has done for millennia. Urban density connects citizens and enables them to meet and plan and talk. With enough talking, groups like the Sons of Liberty may even convince themselves that it is worth dying for a common cause. Monarchies flourished in our agricultural past, because effective democratic opposition was far more difficult to organize in a dispersed rural setting. ...
Our revolution had its origins in the urban connections between John Hancock, the two Adams cousins, and assorted other enemies of British colonial policy. Brought together by Boston, a merchant-prince could help finance riots led by a brewer. The lawyers could argue cases and the writers could push pamphlets. David Hackett Fischer's account of Paul Revere taught us that this silversmith was not a lone rider, but part of a dense, urban network that collectively fought for independence. The most important urban interactions of all may have occurred in the Second Continental Congress in the days before July 4, 1776. By connecting in a city, the founding fathers hung together instead of hanging separately.
Across countries today, there is a robust correlation between urbanization and democracy. This correlation reflects many things, such as the tendency of more urban places to be richer and better educated, but it also surely reflects the role that cities play in supporting the coordinated action that creates and defends democracies. So enjoy your Fourth of July with as much greenery as you like, but also remember that city air made you free.
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links for 2008-07-04
» Economist's View » [Résumé]- National Economic Update - FRB Dallas
- The Everyday Economics Bubble - Zubin Jelveh
- Better Living Through Game Theory: At the Dentist - Economic Investigations
- Income Inequality - St Louis Fed
- Stagflation, Not Strong Growth, Justifies Pause - Gene Sperling
- Natural clusters: Policies promoting agglomeration are unnecessary - Vox EU
- Don’t blame the speculators - Economist.com
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Frederick Douglass: Fourth of July address, 1852 - Comment is free
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3:05
World Bank: Biofuels Increased Food Prices 75%
» naked capitalism » [Résumé]The Guardian has a leaked copy of a World Bank study that finds biofuels to be the biggest culprit in global food price increases. This finding will not only feed calls to scrap biofuels (save perhaps those derived from sugar) but may lead to a recognition that resource challenges cannot be pursued in isolation. In particular, food, water, and energy scarcity are interconnected problems and need to be addressed on an integrated basis. It also disputes the claim that increased consumption of meat in developing economies played a significant role in food price inflation.
A potentially inflammatory element is that the report was completed in April and allegedly deep-sixed so as not to discomfit President Bush.
From the Guardian:Biofuels have forced global food prices up by 75% - far more than previously estimated - according to a confidential World Bank report obtained by the Guardian.
The damning unpublished assessment is based on the most detailed analysis of the crisis so far, carried out by an internationally-respected economist at global financial body.
The figure emphatically contradicts the US government's claims that plant-derived fuels contribute less than 3% to food-price rises. It will add to pressure on governments in Washington and across Europe, which have turned to plant-derived fuels to reduce emissions of greenhouse gases and reduce their dependence on imported oil....
The news comes at a critical point in the world's negotiations on biofuels policy. Leaders of the G8 industrialised countries meet next week in Hokkaido, Japan, where they will discuss the food crisis and come under intense lobbying from campaigners calling for a moratorium on the use of plant-derived fuels.
It will also put pressure on the British government, which is due to release its own report on the impact of biofuels, the Gallagher Report. The Guardian has previously reported that the British study will state that plant fuels have played a "significant" part in pushing up food prices to record levels. Although it was expected last week, the report has still not been released.
"Political leaders seem intent on suppressing and ignoring the strong evidence that biofuels are a major factor in recent food price rises," said Robert Bailey, policy adviser at Oxfam. "It is imperative that we have the full picture. While politicians concentrate on keeping industry lobbies happy, people in poor countries cannot afford enough to eat."
Rising food prices have pushed 100m people worldwide below the poverty line, estimates the World Bank, and have sparked riots from Bangladesh to Egypt. Government ministers here have described higher food and fuel prices as "the first real economic crisis of globalisation".
President Bush has linked higher food prices to higher demand from India and China, but the leaked World Bank study disputes that: "Rapid income growth in developing countries has not led to large increases in global grain consumption and was not a major factor responsible for the large price increases."
Even successive droughts in Australia, calculates the report, have had a marginal impact. Instead, it argues that the EU and US drive for biofuels has had by far the biggest impact on food supply and prices.
Since April, all petrol and diesel in Britain has had to include 2.5% from biofuels. The EU has been considering raising that target to 10% by 2020, but is faced with mounting evidence that that will only push food prices higher.
"Without the increase in biofuels, global wheat and maize stocks would not have declined appreciably and price increases due to other factors would have been moderate," says the report. The basket of food prices examined in the study rose by 140% between 2002 and this February. The report estimates that higher energy and fertiliser prices accounted for an increase of only 15%, while biofuels have been responsible for a 75% jump over that period.
It argues that production of biofuels has distorted food markets in three main ways. First, it has diverted grain away from food for fuel, with over a third of US corn now used to produce ethanol and about half of vegetable oils in the EU going towards the production of biodiesel. Second, farmers have been encouraged to set land aside for biofuel production. Third, it has sparked financial speculation in grains, driving prices up higher.
Other reviews of the food crisis looked at it over a much longer period, or have not linked these three factors, and so arrived at smaller estimates of the impact from biofuels. But the report author, Don Mitchell, is a senior economist at the Bank and has done a detailed, month-by-month analysis of the surge in food prices, which allows much closer examination of the link between biofuels and food supply.
The report points out biofuels derived from sugarcane, which Brazil specializes in, have not had such a dramatic impact.
Supporters of biofuels argue that they are a greener alternative to relying on oil and other fossil fuels, but even that claim has been disputed by some experts, who argue that it does not apply to US production of ethanol from plants.
"It is clear that some biofuels have huge impacts on food prices," said Dr David King, the government's former chief scientific adviser, last night. "All we are doing by supporting these is subsidising higher food prices, while doing nothing to tackle climate change."
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Thomas Palley: Pig Iron versus Cold Steel
» Economist's View » [Résumé]I don't know much about the specifics of this market, but Thomas Palley says it is far from competitive, and a recent Bush administration decision will reduce competition even further.
[There is one point where I'd disagree, though it's not about the market structure point, it's the claim that "rampant" speculative trading is responsible for the run-up in commodity prices generally. I think fundamentals are the main driving force.
A more subtle point is that if, as Thomas claims, market structure is responsible for the price run-up, then "the iron ore market doesn't have speculation yet it's prices went up too" argument against the claim that speculation has caused the run-up in commodity prices is undermined (see the first link above for one example of this argument). However, recent data on inventories in oil markets and elsewhere work strongly against the speculative hypothesis for the commodity price run-up. In addition, since the commodity price run-up looks similar across markets with differing market structures, e.g. from competitive agricultural markets to non-competitive iron ore markets, market structure does not appear to provide a general explanation for the commodity price increases (and market structure is, in general, probably a better explanation of the level of prices than the change). But I'm not sure Thomas intended to make this point, and the lack of attention to non-competitive market structures in recent years is an important point that I don't want to obscure with this discussion.] [Update: Corrected version - fixes pig iron references]:
Pig Iron versus Cold Steel, by Thomas Palley: Iron ore prices have recently been in the headlines, having jumped eighty-five percent. This news is troubling as such price increases threaten to raise steel prices, which will add to cost inflation and further undermine economic activity.
Behind these price increases lies the unusual structure of the iron ore market which is best characterized as bi-lateral oligopoly. That structure makes enormously troubling the Bush administration’s decision to give regulatory clearance to a combination of the number two (Rio Tinto) and number three (BHP Billiton) ore producers.
Unlike other commodity markets, iron ore prices are set through annual negotiations between the ore producers (Big Iron) and the ore users (Big Steel). Recent contractual negotiations have resulted in huge price increases that reflect the ore market’s structure.
On one side is Big Steel, consisting of an increasingly few large steel producers. On the other side is Big Iron, made up of an even fewer number of ore producers. Thus, the top three producers – Vale do Rio Doce, Rio Tinto, and BHP Billiton – account for seventy-five percent of total global production. Moreover, the oligopolistic power of the producers is reinforced by geography. Vale do Rio Doce is Brazilian and located in the western hemisphere, while Rio Tinto’s and BHP Billiton’s operations are in Australia. That creates a geographic split that helps Big Iron’s profits.
In recent years steel production has been marked by significant mergers and right-sizing of capacity, combined with growth of state-directed steel capacity in China. The result has been a huge boom in steel profits that is reflected in steel company stock prices. For instance, consider U.S. Steel that traded at twelve dollars a share five years ago, and in June 2008 peaked at one hundred and ninety-six dollars a share.
Big Steel’s earnings rolled in first, being at the end of the production chain. Now, Big Iron is trying to muscle in on the action and grab a share of those profits for itself. It is able to do so because of its bargaining power, and it would be no surprise if there also were some informal collusion among ore producers given their small world.
With limited alternatives, Steel has been forced to cough up some of its oligopoly profits, turning them into Iron’s mining rents. That is a bad switch. Higher earnings in iron ore mining will have negligible impact on their economic plans as the industry was already earning large excessive profits. However, higher ore prices will raise steel prices, undermining manufacturing and causing inflation. Meanwhile, lower steel profits will reduce steel investment.
Lastly, speculation may also have contributed to the jump in ore prices, albeit not the speculation associated with other commodity markets in which speculative trading is rampant. Since iron ore is not traded on global commodity markets, financial speculators cannot be responsible for higher prices.
Instead, iron ore speculation is best characterized as ‘joint speculation” by the ore producers and users about the continuation of steel profits and the ability of steel companies to pass on higher costs. In this light, the jump in ore contract prices can be viewed as a combination of profit capture by the ore producers plus a big bet on future macroeconomic conditions.
Such user – producer speculation is hard to argue against, but one can argue against an oligopolistic market structure that amplifies speculation’s destructive effects. That makes the Bush administration’s decision to approve a Rio Tinto – BHP Billiton combination another terrible public policy decision.
The approval of combination reveals the worst proclivities of the Bush administration, which is peppered with extractive industry boosters, particularly oil. The quest for combination shows that the much maligned Karl Marx was right about capital’s proclivity to combine.
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2:51
Links Fourth of July
» naked capitalism » [Résumé]Acidifying oceans add urgency to CO2 cuts PhysOrg. We've posted about this before, and are encouraged that this issue is getting more attention.
Laptop Losses Total 12,000 Per Week at US Airports Dark Reading
Cost-hit British Airways flies with quarter of seats empty Times Online
Inexperience May Feed the Bubbles Floyd Norris, New York Times
Can the NYT Talk About the Economics of Copyright? Dean Baker
How Lehman lost its way Allan Sloan, Roddy Boyd, Fortune (hat tip Calculated Risk)
Pig Iron versus Cold Steel Thomas Palley. On the role of oligopoly pricing in the runup of iron ore prices.
Antidote du jour:
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Natural clusters: Policies promoting agglomeration are unnecessary
» VoxEU » [Résumé]Philippe Martin, Thierry Mayer, Florian Mayneris, 4 July 2008
Governments spend heavily on industrial clusters. They are wasting their money if firms naturally cluster to reap agglomeration gains. This column presents evidence from France that questions policymakers’ enthusiasm for promoting clusters.
Full Article: Natural clusters: Policies promoting agglomeration are unnecessary
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Victor Niederhoff on Dr. Shinya
» Marginal Revolution » [Résumé]Victor Niederhoffer is speaking to me as this post pops up, so why shouldn't you be taking him in as well?
The book is replete with side facts that will change your life. He recommends that hospitals immediately start feeding surgical patients a full diet of solid food, not the bland mush and cereals usually given. He recommends that babies give up bottles at one year old. He recommends all adults should refrain from ingesting any dairy products. He recommends that no water or any foods be eaten for 5 hours before going to bed. He has a patented method for making all dogs love him— rubbing saliva on his hand (the same saliva so important because of its rich enzymes for proper digestion), and then letting the dog eat it.
Here is the full post.
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0:08
"Futures Prices Determine Physical Oil Prices"
» naked capitalism » [Résumé]It's gratifying when someone takes on a topic I had wanted to address and does a better job than I could have. Various readers have explained how prices are formed in oil markets, most importantly, how for the vast majority of oil sold, prices are specified in long-term supply contracts and the benchmark is not spot but prices in the futures markets.
JD at Peak Oil Debunked (wish the blog has a less partisan name) describes how oil is priced in a straightforward and well referenced post (hat tip reader Michael).
Recall that the role of the futures market in oil prices is disputed. Most people outside the oil business assume that the oil markets work like many other markets: the spot market is a mechanism for price discovery (or trades in reasonable proximity to other markets where price discovery occurs). Near dates futures will similarly reflect expectations of supply and demand because at contract maturity they can be arbitraged to physical. Thus the effect of speculative activity in futures market will be constrained by the ability to take delivery.
Well, it ain't that simple. JD explains:A number of high-profile economists, like Paul Krugman, have recently been making the argument that trading in oil futures can't really influence the price of physical oil because it doesn't remove any oil from the market. Here's a classic statement of this argument by Jon Birger, a staff writer from Fortune:
JD then provides a description of how the spot market became increasingly subject to manipulation, which led oil exporters to turn to the futures market, which was more liquid and hence less subject to games-playing, as the basis for contract pricing. JD cites a paper by Bassam Fattouh of the Oxford Institute for Energy Studies:Here's a suggestion: The next time a Congressional committee wants to hold a hearing on how "speculators" are driving up oil prices, each committee member should first be required to demonstrate - preferably in their opening remarks - a basic understanding of the mechanics of futures trading.
Even better, they should be required to explain in detail how it is that investors who never take delivery of a single barrel of crude - and thus never remove a drop of oil from the open market - are causing record high oil prices.Source
I will now provide that explanation, and in the process show that both Krugman and Birger are grossly misinformed about the way physical crude is actually priced in the global oil market.
Most crude oil is traded based on long-term contracts, and the prices in those contracts are set by a system known as "formula pricing". In this system, the price of delivered crude is set by adding a premium to, or subtracting a discount from, certain benchmark or marker crudes, namely: West Texas Intermediate (WTI), Brent and Dubai-Oman. Generally, WTI is used as the benchmark for oil sold to North America, Brent for oil sold to Europe and Africa, and Dubai-Oman for Gulf crude sold in the Asia-Pacific market (Source1, Source2).[T]he futures market has grown to become not only a market that allows producers and refiners to hedge their risks and speculators to take positions, but is also at the heart of the current oil-pricing regime. Thus, instead of using dated Brent as the basis of pricing crude exports to Europe, several major oil-producing countries such as Saudi Arabia, Kuwait and Iran rely on the IPE Brent Weighted Average (BWAVE).11...
[11] The BWAVE is the weighted average of all futures price quotations that arise for a given contract of the futures exchange (IPE) during a trading day. The weights are the shares of the relevant volume of transactions on that day. Specifically, this change places the futures market, which is a market for financial contracts, at the heart of the current pricing system.
JD concludes:As you can see, Krugman and Birger are profoundly confused about the way the international oil markets actually function. Futures aren't a paper bet on the direction of prices determined by some independent process. Futures themselves *determine* the price of most physical oil traded today. The futures price (+ or - the differential) literally *is* the price of oil.
He also provides further references on oil pricing.
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0:07
Links for July 3
» Econbrowser » [Résumé]Today we outsource with some interesting links on oil markets and housing.
Lots of useful observations on oil supply and demand from Yves Smith, including the fact that BP's Thunder Horse, which promises soon to be pumping a quarter million barrels per day of crude oil out of the Gulf of Mexico, has finally started production.
Ironman gives us another neat tool to calculate whether it pays to move closer to your worplace.
Phil Miller describes what it's like to find oil in your backyard in North Dakota.
WSJ Real Time Economics surveys various takes (all negative) on today's jobs report.
And the always useful Calculated Risk updates graphs of the price-to-rent ratio and directs us to modern ghost towns among the would-be Los Angeles exurbs.
Source: Calculated Risk
Technorati Tags: macroeconomics, housing, oil
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23:18
$1.2 Billion Reduction in Bear Collateral for $30 Billion Fed Loan
» naked capitalism » [Résumé]Readers no doubt recall that the Federal Reserve loaned $30 billion to JP Morgan against certain Bear Stearns assets to, ahem, induce the bank to go forward with the deal. The arrangement got reworked on the fly, and in the end, the Fed loan was reduced to roughly $29 billion as JP Morgan agreed to assume $1.15 billion of risk. The assets were placed in a holding company to be managed by BlackRock.
There is a bit of disparity in the reports on the state of play. The Financial Times indicates that the Fed's said the loan balance was adjusted last week. The central bank also indicated that the value of the assets was now $28.8 billion (or $28.9 billion, if you prefer Bloomberg's story). Either way, the losses this quarter were conveniently roughly equal to the JP Morgan's first loss position.
Even though mortgage-related securities fell this quarter by more than the amount of the markdown, but recall that the central bank did not take them on at quarter-end. As the Financial Times noted:The Fed marked the securities in the portfolio to current market prices. Analysts said that when the Fed assumed the assets back in March, they were cheaply valued, which would explain why the portfolio remains relatively unchanged.
However, one aspect of the deal that some observers took issue with was that the value used for the assets for the purpose of the loan was Bear Stearns' marks as of March 14, the Friday before the deal was cobbled together. Recall also the deal was renegotiated from a price of $2 per share to $10, and the Fed's loan arrangements were revised during that period. Query why the collateral value was not based on a price the week of March 17.
Thus, there may be nothing amiss here, but the results so far look awfully convenient.
The Bloomberg article includes a wee bit of good news, that there was no use Primary Dealer Credit Facility:The Fed also reported that it had no direct loans outstanding to bond dealers as of yesterday under a program aimed at easing the credit crisis.
Today's lending figures indicate that Wall Street is using the Fed only as an emergency backstop, rather than as a continuing source of funding, said Macroeconomic Advisers LLC senior economist Brian Sack. Treasury Secretary Henry Paulson warned dealers and investors this week they shouldn't operate as if Fed funds were ``readily available.''
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23:12
Rapport Guesnerie sur les SES : plutôt une agréable surprise
» Rationalité limitée » [Résumé]La commision Guesnerie a remis aujourd’hui son rapport sur l’enseignement des Sciences économiques et sociales au ministre de l’Education Nationale. On peut trouver le rapport sur le site des Echos qui, par ailleurs, se fendent d’un article et d’un éditorial sur la question. Comme l’indique Pierre Maura, mieux vaut lire soi-même le rapport tant Les Echos racontent à [...]
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FRBSF Symposium: The Effects of Fiscal Stimulus
» Economist's View » [Résumé]Since the topic of another stimulus package is coming up more and more, e.g. see below, here's a discussion of "Research on the Effects of Fiscal Stimulus" posted today on the SF Fed website:
Research on the Effects of Fiscal Stimulus: Symposium Summary, FRBSF Economic Letter, by Dan Wilson: This Economic Letter summarizes the presentations at a symposium held at the Federal Reserve Bank of San Francisco on May 9, 2008... Presentations are listed at the end, and three of the four are available online.
On February 13, 2008, President Bush signed into law the "Economic Stimulus Act of 2008," which consisted of roughly $100 billion of tax rebates and more than $50 billion of investment incentives for businesses. The act was a response to weakness in the economy and prospects for more substantial deterioration... Its enactment has prompted questions about its potential effects—will consumers spend or save the funds from the rebate checks? will the short-lived tax breaks boost business investment?—and has renewed the broader debate about the use of "activist" countercyclical fiscal policy. ...
Here's one of the four summaries (the other three summarize results by Michael Boskin, Mathew Shapiro, and Alan Auerbach):
...Evidence on the 2001 rebates from credit card and consumer expenditures data What people say they will do and what people do are not always the same, however. As Shapiro points out, the survey evidence should be complemented with data on individuals' actual consumption and savings behavior to get a full picture of the rebates' effects. The third speaker of the symposium, Nicholas Souleles of the University of Pennsylvania, has been at the forefront of the research looking at such individual level data and has coauthored two of the most important papers in this area.
Both studies exploit a little noticed feature of the IRS's rebate disbursement process. To minimize on logistical and mailing burdens, the IRS spaced out the check mailings over several months into separate batches according to the penultimate digit in the recipient's social security number, a digit that is essentially random. This randomness in when people receive their rebates allowed Souleles and his coauthors to isolate the effect on an individual's spending and saving behavior coming from the rebate from any macroeconomic effects that would affect all people at the same time.
In the first study, Johnson, Parker, and Souleles (2006), the authors looked at data on household expenditures from the Consumer Expenditure Survey. They found that, in terms of spending on nondurables, a little more than one-third of the average rebate was spent in the first quarter after receiving the rebate, a result closely matching the direct survey results of Shapiro and Slemrod. However, in contrast to those results, Souleles and his coauthors found that more than two-thirds is spent by the end of the third quarter after receipt.
In a second study, Agarwal, Liu, and Souleles (2007) looked at credit card data from a large, national credit card company. Using a representative sample of card customers over the 2000-2002 period, the researchers separated individuals in the sample according to the penultimate digit of their social security numbers. This allowed them to identify when each individual received the 2001 rebate check. They then looked at what happened to credit card spending and debt pay-down for the average credit card holder in the month of, as well as several months after, the receipt of the rebate. The results reveal that the typical credit card holder primarily paid down debt in the first couple of months but then began increasing spending and reaccumulating debt, returning to pre-rebate debt levels by six months after receiving the rebate.
These results suggest that the 2008 rebates could in fact provide a substantial boost to consumer spending. Souleles noted, however, that the 2008 rebate effect could be smaller because consumers' overall balance sheets are weaker in 2008 given the declines in housing wealth. ...
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Detroit fact of the day
» Marginal Revolution » [Résumé]Among cities with more than 500,000 residents, Detroit has the safest drivers, with accident rates that are 20 percent below the national average.
For cities with more than 1 million residents, Phoenix has the safest big-city commuters, with accident rates about equal to the national average.
Here is much more, Philadelphia is a disaster and L.A. isn't so safe either. I wonder to what extent these rankings simply proxy for traffic density. Here are some charts. Overall Sioux Falls, Tucson, and El Paso seem to be relatively safe cities for driving.
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The Employment Situation
» Economist's View » [Résumé]Today's employment report includes news that the employment to population ratio is falling:
Brad DeLong: Dean Baker is first out of the gate with his take on these June job numbers:
Employment Rate Drops as Economy Sheds 62,000:
The employment to population ratio (EPOP) ratio fell to 62.4 percent in June, its lowest level in more than three years, as the economy lost another 62,000 jobs in June. This was the sixth consecutive month in which the economy lost jobs. The private sector lost 91,000 jobs in June. With the April and May numbers revised down by 76,000, the job loss in the private sector over the last three months has been 273,000, an average of 91,000 a month. The private sector has now shed 578,000 jobs since employment peaked in November. ...
pgl adds:
This from the BLS is really fascinating:
The employment-population ratio was 0.6 percentage point lower than a year earlier.
This ratio was 63.0% as of June 2007, was 62.6% as of May 2008, and now stands at 62.4%. So why didn’t the unemployment rate rise? It seems the labor force participation rate fell from 66.2% as of May 2008 to 66.1% as of June 2008. Then again – it was 66.1% as of June 2007.
That's not good news. In the past, a fall in the employment to population ratio has been a pretty reliable indicator (and one of the signs) of a recession:
There is lots of talk about another stimulus package. In that regard, I want to go back to my last Marketplace:
<p><p><p><p><p><p><p>HTML clipboard</p></p></p></p></p></p></p>
Have policymakers reacted properly? ...[F]iscal policy - the tax rebates we are about to get - was inadequate. Fiscal policymakers should have recognized that employment has tended to recover sluggishly in recent recessions and implemented policies that are known to create jobs. But they didn’t, and it’s too bad that one policy error, the failure of regulators to prevent the problems in the first place will be compounded be another, the failure of fiscal policy to come to the aid of unemployed workers.
If we decide another stimulus package is needed, and the graph above is compelling in that regard, can we make employment rather that Republican ideology about tax cuts one of the primary goals (and challenge Bush to veto it rather than caving with the mere threat of a veto)? It wouldn't hurt to think about infrastructure either. As noted here:
If we had included ... infrastructure spending as part of the initial stimulus package, then the effects would kick in on a sustained basis over time rather than as a one-time hit as with the tax cuts. Thus, this type of spending could have provided the continuous stimulus [the economy needs]...
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Why Not?
» Marginal Revolution » [Résumé]I was just invited to a conference -- a very good one in fact -- where the price of registration rises by $150 for every week that passes. This encapsulates at least two principles of behavioral economics. First, it combats our natural tendency to procrastinate. Second, if you register early you feel you have won a bargain when in fact it still costs something. This is of course also a planning externality if they know the number and nature of attendees sooner rather than later.
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The male and female privilege checklists
» Marginal Revolution » [Résumé]Here is the male privilege checklist. Here is the female privilege checklist. Robin Hanson, scientist, continues: "The next obvious step is to assign point values to such privileges, so we can add them up and compare totals." You can imagine how much fun we had at lunch on this topic and yes a woman was there too.
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Why Chinese pollution is such a tough problem
» Marginal Revolution » [Résumé]Alex is back, alive and well. But he still has a raspy voice from sucking in all that air pollution. Here is one reason why, as explained by Brad Plumer:
China's central government is well aware that its blackened rivers and sunless skies are a problem, not just because they're sparking riots and social unrest, but because out-of-control environmental degradation is imperiling the country's economic growth. Lately, Beijing has issued a slew of bold--at least on paper--environmental regulations. But the laws are doing little good because the central government can barely enforce them in its own provinces. This structural problem will remain the key to China's environmental dilemma, and, as countries attempt to push Beijing toward a cleaner future, they'll discover that the capital is the least of their troubles.
The central government has passed some fairly "green" laws but often to little avail:
Beijing is aware of this local lawlessness, but has had little success handling it. "China used to send in swat teams from the central government," says Barbara Finamore, who directs the Natural Resources Defense Council's (NRDC) China program. "I've seen these campaigns going on for twenty years-- they'll come in, shut down some factories, and, when they leave, they'll open up again."
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Has "The Long Tail" been refuted?
» Marginal Revolution » [Résumé]Prof. [Anita] Elberse looked at data for online video rentals and song purchases, and discovered that the patterns by which people shop online are essentially the same as the ones from offline. Not only do hits and blockbusters remain every bit as important online, but the evidence suggests that the Web is actually causing their role to grow, not shrink.
Here is the summary article. Here is the Elberse paper. Here is Chris Anderson's response. Overall I cannot call this one for Elberse. If you take a genre as given, the web looks less revolutionary but part of the long tail is the creation of new genres. We have blogs now, for instance, and we didn't fifteen years ago, even though blog readership is quite concentrated among the top sites. Or maybe the "Quickflix rental distribution" isn't so skewed to the left (the least-rented titles aren't so popular) but where were Quickflix, Netflix, and other such services fifteen years ago?
Static estimation by deciles and related measures is often misleading since in part the "long tail" effect is to make the top deciles thicker than before, not necessarily to raise the status of the bottom decile relative to the top. In his response, Chris Anderson nails this point:
The best example of this is in what she describes as a growing "concentration" of sales around a relatively small number of blockbuster titles. In the Rhapsody data, she finds, the top 10% of titles (out of more than a million in that data sample) accounted for 78% of all plays, and the top 1% account for 32% of all plays. That sounds pretty concentrated around the head, until you reflect, as she notes, that "one percent of a million is still 10,000--[...]equal to the entire music inventory of a typical Wal-Mart store."
Nor does showing that most of the sales are in the top of the distribution refute the claim. Arguably it is the middle tail which is suffering and the long tail, and the best sellers, are growing in import. That seems compatible with Anderson's core thesis. The long tail hypothesis may be oversold but the data in the Elberse piece don't really dent it.
Elberse wants to define the Long Tail hypothesis as claiming there is more money to be made in the niches than in the blockbusters; while I believe you might find a quotation to that effect from Chris Anderson the more general idea is simply how important the niches are becoming. Elberse concedes a lot at one point:
It is undeniable that online commerce has significantly broadened customers’ access to products of all varieties, including the most obscure. However, my findings suggest that it would be imprudent for companies to upend traditional practice and focus on the demand for obscure products.
You could have rewritten that as "The Long Tail hypothesis is basically true, just don't sell to the Long Tail alone." On that we should all be able to agree.
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10:48
Jobs Decline 6th Consecutive Months
» Mish's Global Economic Trend Analysis » [Résumé]Before taking a look at the monthly jobs data, let's take a look at weekly claims. The US Department of Labor is reporting Initial Unemployment Insurance Claims continue to rise.Seasonally Adjusted
Jobs Decline 6th Consecutive Months
In the week ending June 28, the advance figure for seasonally adjusted initial claims was 404,000, an increase of 16,000 from the previous week's revised figure of 388,000. The 4-week moving average was 390,500, an increase of 11,250 from the previous week's revised average of 379,250.
Unadjusted
The advance number of actual initial claims under state programs, unadjusted, totaled 368,876 in the week ending June 28, an increase of 10,503 from the previous week. There were 300,348 initial claims in the comparable week in 2007.
This morning, the Bureau of Labor Statistics (BLS) released the June Employment Report. Jobs were negative for a 6th consecutive month. My target of 6% or higher stated unemployment by the end of the year remains on track. Here is a synopsis of that report.
Nonfarm payroll employment continued to trend down in June (-62,000), while the unemployment rate held at 5.5 percent, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. Employment continued to fall in construction, manufacturing, and employment services, while health care and mining added jobs. Average hourly earnings rose by 6 cents, or 0.3 percent, over the month.
Establishment Data
click on chart for sharper image
The establishment data was the 6 consecutive decline.
Highlights- 43,000 construction jobs were lost
- 33,000 manufacturing jobs were lost
- 8,000 retail trade jobs were lost
- 51,000 professional and business services jobs were lost
- 7,000 service providing jobs were added
- 24,000 leisure and hospitality jobs were added
- 29,000 government jobs were added
Last month education and health services added 54,000 jobs, this month 29,000. One month does not make a trend but this will be interesting to watch.
These are clearly recession totals yet still we have pundits debating whether or not we are in recession.
Birth/Death Model From Alternate Universe
This was a very weak jobs report. And once again the Birth/Death Model assumptions are from outer space.
click on chart for sharper image
Every month I say the same nearly the same thing. The only difference is the numbers change slightly. Here it is again: The BLS should be embarrassed to report this data. Its model suggests that there was 29,000 jobs coming from new construction businesses, 22,000 jobs coming from professional services, and a whopping 177,000 jobs in total coming from net new business creation. The economy has slowed to a standstill and the BLS model still has the economy expanding quite rapidly.
Repeating what I have been saying for months now, virtually no one can possibly believe this data. The data is so bad, I doubt those at the BLS even believe it. But that is what their model says so that is what they report.
BLS Black Box
For those unfamiliar with the birth/death model, monthly jobs adjustments are made by the BLS based on economic assumptions about the birth and death of businesses (not individuals). Those assumptions are made according to estimates of where the BLS thinks we are in the economic cycle.
The BLS has admitted however, that their model will be wrong at economic turning points. And there is no doubt we are long past an economic turning point.
With housing falling like a rock and commercial real estate now following suit, the BLS is assuming that 29,000 new jobs were added in construction. With lenders blowing up and countless self employed real estate professional exiting the business the BLS is assuming 22,000 jobs from professional and business services. The total number of jobs added in May by these absurd assumptions was 177,000 jobs.
No doubt you will see some who will subtract 177,000 jobs from -62,000 jobs and conclude that 239,000 jobs were lost in June. Such math is inaccurate.
Here is the pertinent snip from the BLS on Birth/Death Methodology.- The net birth/death model component figures are unique to each month and exhibit a seasonal pattern that can result in negative adjustments in some months. These models do not attempt to correct for any other potential error sources in the CES estimates such as sampling error or design limitations.
- Note that the net birth/death figures are not seasonally adjusted, and are applied to not seasonally adjusted monthly employment links to determine the final estimate.
- The most significant potential drawback to this or any model-based approach is that time series modeling assumes a predictable continuation of historical patterns and relationships and therefore is likely to have some difficulty producing reliable estimates at economic turning points or during periods when there are sudden changes in trend.
Table A-12
Table A-12 is where one can find a better approximation of what the unemployment rate really is. Let's take a look
click on chart for sharper image
If you start counting all the people that want a job but gave up, all the people with part-time jobs that want a full-time job, etc., you get a closer picture of what the unemployment rate is. The official government number remained 5.5% after May's huge jump, but U-6 (the most inclusive number) rose .2 to 9.9%. To the average Joe on the street unemployment feels more like 10% than 5.5. Both numbers are poised to rise.
This report was the 6th consecutive contraction. Service jobs were only positive because 29,000 government jobs were created. Yesterday in Downward Spiral In Jobs I commented on interesting stats from the ADP Small Business Report giving a breakdown of jobs by size of firm. Inquiring minds will want to take a look.
Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post ListMike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management. Visit http://www.sitkapacific.com to learn more about wealth management for investors seeking strong performance with low volatility.
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10:02
Jedi's links [12]
» Comprendre [cɔ̃.pʀɑ̃dʁə] : v. tr. » [Résumé]Un nouveau Jedi's links ! C'est pour Gizmo qui est la seule lectrice de ce blog à me faire remarquer quand il n'y a plus de "liens du jeudi". Aujourd'hui on parle de SES, de l'enseignement de sciences économiques et sociales au lycée, et aussi des IUFM, Instituts Universitaires de Formation des Maîtres.
Au milieu du flux médiatique (la libération d'Ingrid Bétancourt, le probable maintien de Raymond Domenech, l'augmentation des taux de la BCE...), la commission Guesnerie remet aujourd'hui au ministre Xavier Darcos un rapport sur les manuels et les programmes de SES (Téléchargeable ici). Je vous propose d'en lire le commentaire réalisé par l'Apses, l'association des professeurs de SES.
Autre point important dans l'actualité de l'éducation, la réforme du recrutement des enseignants. C'est le Fait du jour dans l'expresso du Café Pédagogique de ce matin. En conseil des ministres hier, Valérie Pécresse et Xavier Darcos ont esquissé ce qui devrait être le mode de recrutement des enseignants à partir de 2010.
Les concours Capes et Agreg seront maintenus (jusqu'à quand ?), mais seront passés à Bac+5 (Master). Les lauréats des concours seront placés en situation devant des élèves à temps-plein. Aujourd'hui un enseignant stagiaire effectue l'équivalent d'un mi-temps devant les élèves et poursuit sa formation dans les IUFM. Ceux-ci sont voués à disparaitre corps et biens, et l'année de formation professionnelle avec. Plus de sociologie de l'éducation, de psychologie de l'adolescent, de formation pédagogique propre à sa discipline, etc... Seulement un "compagnonage" auprès d'un collègue expérimenté.
Nier la nécessité d'une formation professionnelle, cela revient à nier le fait qu'enseigner est un métier qui s'apprend. Cela revient à penser comme au siècle dernier, que maîtriser une discipline scientifique suffit pour parvenir à la transmettre, à transposer des connaissances scientifiques en des savoirs scolaires que les élèves pourront acquérir.
J'imagine que les ministres Pécresse et Darcos prévoient l'intégration dans les formations universitaires spécialisées de modules de socio de l'éducation, de psychologie, de placement de voix, de communication, de pédagogie, épistémologie, etc...
Lecture et pétition- La tribune de Philippe Meirieu sur le site du Café Pédagogique : Un tour de passe-passe
- L'appel Pour une formation des enseignants de haut niveau dans des IUFM rénovés
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"China and Wal-Mart: Champions of Equality"
» Economist's View » [Résumé]Christian Broda argues that globalization has not increased inequality. The argument is that "China and Wal-Mart have increased the purchasing power of the poor more than the rich," and this offsets unequal changes in income. [My response is here and here. The response argues that a full assessment of the change in worker circumstances should include factors such as changes in economic security (see recent headlines about job layoffs), employer based health care and retirement programs, debt burdens, etc., "and when you do that, it is far less clear that workers have benefited overall even if you take the Broda and Romalis result as given."] [Update: Brad Delong says "Like many people, I am still somewhat puzzled and confused by Christian Broda and John Romalis." See his discussion, and his
L clipboard
Multisector Stolper-Samuelson Finger Exercise]:China and Wal-Mart: Champions of equality, by Christian Broda, Vox EU: The U.S. presidential campaign has sometimes sounded like a contest to prove who despises trade the most, as Willem Buiter and Anne Sibert point out in their recent Vox column. Media reports of job losses to China and the destructive effect of Wal-Mart on local business are ubiquitous. In recent weeks, Lawrence Summers and Martin Wolf have highlighted the dangers of having high-income countries turn against globalisation. This public debate has taken for granted that inequality in these countries has risen as a result of globalisation.
But has it really? In a recent paper, co-authored with John Romalis from the University of Chicago, I argue that it hasn’t.[1] The reason is simple. How rich you are depends on two things: how much money you have and how much the goods you buy cost. If your income doubles but the prices of the goods you consume also double, then you are no better off. Unfortunately, the conventional wisdom on US inequality is based on official measures that only look at the first half, the income differential. National statistics ignore the fact that inflation affects people in different income groups unevenly because the rich and poor consume different baskets of goods.
Inflation differentials between the rich and poor dramatically change our view of the evolution of inequality in America. Inflation of the richest 10 percent of American households has been 6 percentage points higher than that of the poorest 10 percent over the period 1994 – 2005. This means that real inequality in America, if you measure it correctly, has been roughly unchanged. And the reason is just as dramatic as the result. Why has inflation for the poor been lower than that for the rich? In large part it is because of China and Wal-Mart!
Poor families in America spend a larger share of their income on goods whose prices are directly affected by trade – like clothing and food – relative to wealthier families. By contrast, the higher your income, the more you spend on services, which are less subject to competition from abroad. Since 1994 the price of goods in the U.S. has risen much less than the price of services – and, yes, this includes the recent surge in food prices. Paradoxically, focusing only in the last few quarters of high relative food prices misses the fact that the main trend we have observed for decades is exactly the opposite (Figure 1).
Figure 1.
This trend can partly be explained by China. In U.S. stores, prices of consumer goods have fallen the most in sectors where Chinese presence has increased the most. Take canned seafood or cotton shirts, for instance. Exports of China to the rest of the world in these categories have increased dramatically over this decade. Inflation in these sectors has been negative over the last decade, while in other sectors with no Chinese presence inflation has been over 20 percent. Moreover, as China produces goods of relatively low quality, sectors with strong Chinese presence are disproportionately consumed by the poor.
The expansion of superstores – like Wal-Mart and Target – has also played an important role in accounting for the inflation differentials between rich and poor. Superstores sell the same products as traditional shops at much lower prices. Today the poor do roughly twice as much of their buying of non-durable goods in these stores than the rich. So poor consumers have been the biggest beneficiaries of Wal-Mart coming to town.
Figure 2.
What is really worrying is that, despite these facts, we have had a backlash against China and Wal-Mart in America. Trade sceptics who suggest that there is no point in buying cheaper goods if you have lost your job should check America’s unemployment rate again. It’s around 5 percent, close to its record low.
We need to remind politicians and the public that the gains from trade are broadly shared. Every time the discussion over trade is diverted towards the problems facing specific producers, be they farmers in France or textile workers in the U.S., we miss the central point. Trading allows everyone, and especially the poor, to buy things that they could not otherwise afford. Without better public understanding of these facts, governments will not only keep supporting policies aimed against China and Wal-Mart but may receive the uninformed support of many consumers who are benefitting from trade.
Editors’ note: An abbreviated version of this column appeared in the Financial Times on 3 June 2008.
Footnotes
1 Christian Broda and John Romalis (2008). “Inequality and Prices: Does China benefit the Poor in America?” University of Chicago mimeograph.
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links for 2008-07-03
» Economist's View » [Résumé]- Moodys/REAL Commercial Property Price Index (CPPI) - MIT CRE
- Recession and the oil shock of 2008 - Econbrowser
- McCain plays dumb on economics ignorance - Crooks and Liars
- Prospects for more oil Supplies? - RGE Monitor
- Official poverty measure undercounts the nation's poor - EPI
- Surging wage growth for topmost sliver (inequality) - EPI
- The founders' rights stuff - Los Angeles Times
- Global Action to Save Global Growth - washingtonpost.com
- Google-Yahoo Partnership: Justice Is Looking Closer - New York Times Blog
