Two strong Bloomberg comments
I have stated before that I like reading the FT and The Economist but I also enjoy to read the excellent online Bloomberg comlunists. Consequently, this post presents two of the recent ones whose topics are very different yet important and interesting.
Spain and the Eurozone
First off, we have Matthew Lynn's column about Spain's economy and obviously I am going to make this into a rant about the Eurozone but if you bear with me you will understand why. I have argued before that the Eurozone and particularly the single rate interest policy lacked the inherent logical foundation on which it was originally crafted. In short; the ECB's single interest rate policy cannot accomodate the diversity of the Eurozone countries and as such exhibits distorting cyclical pressures on the individual Eurozone economies. In this case I have traditionally looked at the engine room of the Eurozone Germany and how the ECB's policy was too tight to accomodate the fragile German economy; especially an appreciating Euro is not good for the German export. However, Germany is not the only case study on which to show the Eurozone's lack of function ... let us look at Spain; shall we?
(From Matthew Lynn - I have marked the points to watch out for with bold)
'For a decade, the Spanish have been riding a rising tide of cheap money, fuelling a construction, property and now a mergers and acquisitions boom. It can't be long before this tide turns. When it does, it is likely to be messy -- not just for Spain but for the whole of Europe as well.'
(...)
On the surface, the Spanish economy is robust, certainly compared with its neighbors. According to International Monetary Fund estimates, its economy will expand 3.3 percent in 2006, compared with 3.4 percent last year. Over the last decade, the Spanish economy has almost doubled in size, and it has beaten the euro area's average growth rate for 11 straight years. From a relative backwater, Spain has fast closed the gap on the rest of western Europe. Dig a little deeper and the picture is not quite so rosy. The fuel for Spain's rapid growth has mainly been the massive monetary stimulus from joining the euro. The European Central Bank sets interest rates mainly for the depressed German and French economies, not for booming Spain. Interest rates have been held down, allowing the Spanish to load up on debt. Spanish inflation is now 4 percent, while interest rates are 2.75 percent. Given that the interest rate is below the inflation rate, borrowing money in Spain is effectively free.' (...) 'Taking Action Without the euro, the markets would start taking action to correct the imbalance. Investors would sell off the currency, making imports more expensive and exports cheaper -- something along the lines of what has been happening with the U.S., which has a smaller relative deficit than Spain. In Spain, that isn't happening. Inside the euro zone, currencies can't revalue. Externally, the euro has been rising, not falling. The only way for Spain to get its economy back in balance is through a long period of slow growth, rising unemployment, and depressed demand. The most likely trigger? A crash in the property market. If that happens, it isn't just the Spanish who will feel the pain. Europe's Engine In decades past, Spain might have been peripheral to the European economy. France, Germany and Italy were the countries that mattered. Not any more. According to Lombard Street calculations, between 2003 and 2005 39 percent of the growth in the euro-area economy came from Spain. Without it, the euro region would scarcely have expanded at all.'
Sometimes it is nice to get back to the basics and look at some of the traditional questions of economics. Consequently, this is exactly what Caroline Baum does in her recent comment assuring us that we should not worry about stagflation; it is a term thoroughly buried back in the 1970s' oil crises. So what is stagflation and why does this matter? Stagflation is used to describe a situation of low growth and high inflation; e.g. from an oil supply shock as it was the case in the 1970s. It matters first of all because the tale of stagflation and how it crushed the dictum of the Phillips curve hailed the rise of Milton Friedman and the supply side economics (Chicago School of Economics.) So this is an important part of economic history here. Furthermore, economists have a habit of reviving stagflation when the economy slumps and for example supply side shocks loom; indeed I have even succumbed to crying wolf at some point. To that end Caroline's article is an excellent re-cap of what stagflation is and why we should perhaps not worry so much anymore ...
(From Caroline Baum - have marked the points to watch out for with bold) 'Do folks think a case of 2.5 percent real growth and 3 percent inflation -- a likely scenario for the second quarter -- qualifies as stagflation? If they do, they need to revisit those wonder years of the 1970s, when the economy was over-regulated, oil shocks had the ability to paralyze the nation and central bankers still thought there was a trade-off between growth and inflation.' (...) 'Real gross domestic product expanded at an average 3.3 percent rate, but it was hardly a decade of stable growth, featuring two recessions, one of which was the deepest since World War II. Nor was the mix of ingredients particularly tasty. For example, the peak unemployment rate for the decade was 9 percent in May 1975. That same month, the year-over-year increase in the consumer price index was 9.5 percent. It wasn't supposed to be that way. Based on a theory known as the Phillips Curve, the government could use fiscal or monetary policy to goose demand for goods and services, engineering more employment by tolerating a higher rate of inflation. (The 1958 paper by economist A.W. Phillips posited an inverse relationship between employment and wages, not inflation.) In the late 1960s, economists Milton Friedman and Edmund Phelps challenged the idea of a permanent trade-off between unemployment and inflation; the experience of the 1970s would seem to bear them out.' So why should we not worry so much? 'Fast forward three decades, and every central banker worth his pinstripes advocates price stability as a means to achieve maximum sustainable growth. To paraphrase Bruce Springsteen, no trade-off, baby, no surrender. The origin of the word stagflation can be traced to the late Iain Macleod, a Tory member of the British Parliament who held many ministerial posts, including Chancellor of the Exchequer.' (...) '``Back then, the economy slowed but prices didn't decelerate,'' says Joe Carson, director of global economic research at Alliance Bernstein. ``Today, when auto demand weakens, producers cut prices.'' So it really isn't fair to categorize a period of below trend growth, orchestrated by the Fed to offset inflationary pressures, as stagflation. Today's economy is nothing like that of the 1970s. Major industries were deregulated in the 1980s and 1990s -- railroads, trucking, energy, banking, financial markets, telecommunications, to name just a handful. Industries, and businesses within industries, are free to respond to consumer demand with price changes. That the current mix of inflation and growth is tilting toward more of the first and less of the second isn't ideal. The good news is that, unlike in the '70s, the Fed and other central banks now understand now easy money can't generate more oil output. All it will buy is higher inflation.'
Pantom from the Golden Age refers to this in a post about Spain.
'(...) we've already talked about the Spanish situation, and it's the sort of thing that makes you wonder which will come first, euro breakup, dollar collapse, or even, mayhaps, the bankruptcy of Japan's central government, given that it has the highest public debt of any country on the planet, courtesy of its mercantilism and racist resistance to immigration, the latter policy being something we seem bent on emulating.'