Save More! Save Less!
Mar 09, 2006
Stephen Roach (New York)
NOTE: This essay appeared as column in the 20 March 2006 issue of Fortune.
The two major players in the global economy, the US and China, are operating at opposite ends of the saving spectrum. Thrifty Chinese have taken saving to excess, while profligate Americans have spent their way into debt. Neither of these trends is sustainable — they lead to destabilizing economic and political developments for both nations — and a better balance must be struck. China needs to convert excess saving into consumption, while the US needs to end its buying binge and rediscover the art of saving. The numbers leave little doubt as to the extraordinary contrast between the two economies. Last year China saved about half of its gross domestic product, or some $1.1 trillion. At the same time, the US saved only 13% of its national income, or $1.6 trillion. That's right, the US, whose economy is six times the size of China's, can't manage to save twice as much money. And that's just looking at national averages that include saving by consumers, businesses, and governments. The contrast is even starker at the household level — a personal saving rate in China of about 30% of household income, compared with a US rate that dipped into negative territory last year (-0.4% of after-tax household income). These are extreme readings by any standard. The US hasn't pushed its personal saving rate this far into negative territory since 1933, in the depths of the Depression. And the Chinese rate is higher than it has been at any point in the past 28 years, since its modern reforms began. Similar extremes show up in the consumption shares of the two economies — the mirror image of trends in personal saving rates. US consumption has held at a record 71% of GDP since early 2002, while Chinese consumption appears to have slipped to a record low of about 50% of GDP in 2005. In China's case, relatively weak consumption means its growth dynamic is skewed heavily toward exports and fixed investment. These two sectors account for more than 75% of Chinese GDP and are growing by more than 25% a year. If China stays with this growth mix, any further increase on the export side would be a recipe for trade friction and protectionist responses. That's certainly the direction Washington is heading in these days. Moreover, a continued burst of Chinese investment could lead to excess capacity and deflation at home. The US saving shortfall is equally stressful. American consumers have mistaken bubble-like appreciation of their homes for saving. Facing anemic growth in labor incomes — real compensation paid out by the private sector has lagged behind the norm of past business cycles by more than $360 billion — they have turned to debt-financed equity extraction from their homes in order to keep consuming. And the binge has reached record highs in terms of both the amount consumers owe as a share of their incomes and the interest expenses they incur to service those obligations. America's lack of saving has also put unprecedented demands on the rest of the world, since the US must import surplus saving from abroad in order to grow. America's current account deficit hit a record of nearly 6.5% of GDP in 2005 and could well be headed north of 7% this year. That translates into a lifeline of foreign capital totaling about $3 billion per business day. There is a more insidious connection between the saving postures of China and the US: Chinese savers are, in effect, subsidizing the spending binge of American consumers. In order to fuel its export-led economic growth, China has decided to keep its currency relatively cheap and tightly pegged to the dollar. To do so, it must constantly recycle a large portion of its saving into dollar-denominated financial assets — an investment strategy that helps keep US interest rates low and an interest-rate-sensitive American housing market in a perpetual state of froth. That's dangerous for the US, but it's also an increasingly risky proposition for China because it bloats that country's money supply. This excess liquidity then spills over into the Chinese financial system, leading to asset bubbles such as those in its coastal property markets. China is also exposed to the potential fiscal costs of a sharp markdown of its portfolio of dollar-based assets in the event of a depreciation of the US currency. It is in neither country's best interest to stay the present course. Instead, there must be a role reversal: China's savers must be turned into consumers, and the excesses of US consumption must be converted into saving. This won't be an easy task for either nation, but it sure beats the increasingly treacherous alternatives. In the US, it will take nothing short of a major campaign to boost national saving. That will require a reduction of public-sector dissaving (i.e., outsized federal budget deficits) and the enactment of some form of consumption tax. A national sales tax would be the simplest and most efficient prescription, provided there are exemptions for low- and lower-middle-income families. It would reduce incentives for consumption, freeing up income to be saved, and also help reduce the federal deficit. Sadly, there is little reason to be optimistic that Washington is about to embrace a pro-saving policy agenda. The budget deficit is going the other way, and the lack of political support for tax reform effectively quashes any immediate hopes for private-saving incentives. In China, it will also take major policy initiatives to spark consumption-led growth. Actions are needed on two fronts — the establishment of a social-welfare safety net to deal with job and income insecurity arising from reforms of state-owned enterprises; and the creation of new jobs, especially in the undeveloped services sector, to expand the purchasing power of China's enormous population. The good news is that the Chinese leadership is focused on shifting its growth mix toward private consumption. Pilot projects already have been established setting up a social security system. And under the terms of China's WTO accession, the opening of domestic services to foreign investors in areas like retail and insurance is likely to accelerate over the next three to five years. China's determination stands in sharp contrast to Washington's inattentiveness to saving initiatives. That could spell trouble. As Chinese saving is converted into consumption, it will have less surplus capital that can be used to fund America's saving shortfall. That means China will be reducing its support for the American consumer. And that would raise the odds of a hard landing for the dollar and the US economy, with dire consequences for a still US-centric global economy. The US and China need to get their saving agendas in order before it is too late for them — and for the rest of the world.
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The Weather Channel
Mar 09, 2006
David Greenlaw (New York)
We have made an adjustment to our forecast for February payroll employment. We now look for jobs to rise by 100,000 — versus our preliminary estimate of +50,000. The change reflects the slightly lower-than-expected result for initial unemployment claims and the lack of any noticeable elevation in continuing claims. However, note that even our revised estimate of +100,000 is well below the consensus expectation of +200,000. While we concur that the underlying trend in employment growth is probably somewhere in the neighbourhood of +200,000 at this point, we expect weather-related factors to temporarily depress payrolls in February. Specifically, our estimate reflects an assessment of the combined impact of the blizzard that hit the Northeast right at the start of the survey period as well as payback from unusually mild conditions that prevailed across much of the nation during January. Statistics collected by the National Climactic Data Center (an agency of the US Department of Commerce) show that this past January was the mildest in more than a century. Moreover, this followed on the heels of a ‘normal’ December. Indeed, a proxy that we often use to gauge the impact of the weather on employment data — the ‘not at work due to bad weather’ component of the household survey — posted its first December to January decline in the past 20 years. In fact, the only other such period registering an outright decline in the 30-year history of these data was in 1986. In that case, the payroll figures showed some hint of a weather-related payback in February. Payrolls rose only 107,000 in February 1986 versus an average of 151,000 in the surrounding six months (note: another sign of a negative, weather-related impact on the February 1986 data was a 4,000 dip in construction jobs — the first drop registered in that sector in a full year). The point is that even were it not for the February blizzard, we would expect the upcoming jobs report to show a payback of 50,000 or so on payrolls following the unusually mild January. But, that’s not all. What about the impact of the blizzard that battered the East Coast right at the start of the February survey period? While there are well-known metrics used to gauge the severity of tornadoes and hurricanes, only recently have researchers developed a tool to classify snowstorms. The Northeast Snowfall Impact Scale (NESIS) developed by Paul Kocin of The Weather Channel and Louis Uccellini of the National Weather Service characterises and ranks high-impact Northeast snowstorms. These storms have large areas of 10-inch snowfall accumulations and greater. Most importantly, the NESIS is a population-weighted index, with scores that are a function of the area affected by the snowstorm, the amount of snow, and the number of people living in the path of the storm. The January 1996 blizzard is legendary in many ways — including its impact on the economic data. In that month, payrolls were originally reported to have declined 201,000 followed by a 705,000 rebound in February (note: over the years, these data have been smoothed out and the official series now shows -8,000 in January and +435,000 in February). That storm was also associated with some swings in weekly jobless claims. Presumably claims were below trend in the week ended January 13 because some state offices were closed and transportation was disrupted. The elevation in the following week no doubt captured some of the storm-related job loss. Admittedly, the severity of the 2006 blizzard did not match the January 1996 event. But, the recent initial claims data do show some evidence of a similar pattern around the survey period. The storm hit on February 12-13 and filings may have been temporarily depressed by weather-related dislocation in the week ended February 18. Claims rebounded in the latest week, which may have reflected some job loss associated with the blizzard. Keep in mind that many of the workers impacted by the weather might be part-timers who are employed only one or two days per week. In general, such individuals would not be eligible for unemployment insurance. So, we don’t need to see a sharp spike in claims to validate our view of a potentially significant weather-related impact on payroll employment — just an indication of at least a slight elevation in job loss. Admittedly, we are a bit puzzled by the lack of any apparent upside in continuing claims, and this is why we shaved our estimate of the negative weather impact and pushed our employment forecast up a bit. However, it’s worth noting that continuing claims is a notoriously volatile series, often subject to significant revisions, and we still think that a powerful case can be made for some weather-related influence on the next round of employment data — especially if we look at some other storms on the NESIS list. For example, there was a very significant impact on the employment data in March 1960. Payrolls fell nearly 200,000 (adjusted for census workers) in that month and then rebounded 350,000 the following month. The impact on overall payrolls in January 1964 was not as clear-cut, but construction jobs did decline 86,000 in that month followed by a rebound of 136,000 in February. The experience that may be most similar to the current one — at least in terms of weather-related impact — is December 1960. The economy was the midst of a recession at that time, but it still appears that the bad weather was associated with about 50-75,000 job losses. Payrolls fell 220,000 in December, including a 75,000 drop in construction jobs. In the following month, jobs declined only 60,000, with the construction sector posting about a 50,000 rebound (note: unfortunately, the weekly unemployment claims data start in 1967 and thus we can’t examine the relationship between claims and payrolls in these earlier instances). Any estimate of the monthly employment data should be viewed with caution, in our view. Indeed, while we once had a fair degree of confidence when it came to forecasting the job numbers, our models broke down starting around late 2003/early 2004. Since then, estimating the swings in monthly payroll employment has turned into a real crap shoot — and we have the scars to prove it. However, from our standpoint, it’s quite surprising to see that the consensus estimate for February payrolls (+200,000) does not appear to incorporate any weather-related influence at all. While we have low confidence in assigning a specific value to the magnitude of the distortion, we strongly suspect that there will be at least some noticeable impact on the February jobs report. And, since we believe that the underlying state of the labour market is quite healthy, we would expect any negative weather-related impact on the February data to be recouped in March. Finally, we would note that other components of this month’s employment report — such as hourly earnings and the average work week — are also likely to be impacted by the weather.
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A Big Step Forward, but Much Left to Do
Mar 09, 2006
Robert Alan Feldman (Tokyo)
What’s new: big step forward toward inflation-targeting I believe that the BoJ’s new framework for monetary policy is a huge step forward toward policy credibility and market stability. That said, the inflation guideline band (0-2%) remains very wide, and is of limited help to investors, in my view. Moreover, the legal basis for BoJ setting a guideline is ambiguous to me. Conclusions: market jitters to drop a lot Despite the broad band, the BoJ has raised the clarity of the policy decision process. That said, some jitters are likely to remain, until the BoJ clarifies several points: (a) which price index it will use, (b) the period over which it will reduce excess reserves, and (c) the rules it will use to trigger an exit from the zero rate policy itself. Risks: width, legality and leaks Market risks could return, if the inflation guideline band turns out to be too wide, if the legality of the BoJ-set target is questioned, and if leaks from the Board discussions are not treated harshly. The BoJ announced a desired range for inflation of 0-2%. I see this as an enormous step forward from the negative attitude about inflation-targeting widely reported to exist at the BoJ up to only a few days ago. Responding to the market jitters, the BoJ Policy Board took very seriously the view that a numerical guideline would be the best way to communicate intentions clearly. As a result of this step forward, much worry about disruptions from monetary policy debate will subside, in my view. However, today’s decision leaves many questions unanswered: (a) How fast will the BoJ allow excess reserves to fall? (b) How should the phrase “around zero” (ohmune zero), which the BoJ used to characterise its new monetary policy, be interpreted? (c) How will the BoJ signal the likely path of interest rates? Until these questions are answered, I expect some market jitters to remain. Beyond these questions, there are two deeper issues that merit attention: whether the 0-2% band is a good one, and whether the BoJ’s guideline has a solid legal foundation. Half-empty, half full: is 0-2% a good target? From the BoJ announcement, the decision to have a wide band — 0% to 2% — for the inflation guideline seems wide to me. That said, even the BoJ itself tried to clarify the message from the band by noting that the Board members’ views on appropriate inflation centred on 1%, and that the costs of deflation were so asymmetric that “the accommodation of slight inflation may be deemed consistent with an understanding of price stability in the conduct of monetary policy”. Moreover, recognising that conditions may change, the Board agreed that it should review the target annually. The problem with the wide band lies in its weak signal. Say that measured inflation is 0.3%. Will markets be able to read the likely direction and timing of monetary policy? Since, at this level, inflation is inside the BoJ band, one might conclude that policy could move either way. Or, since the BoJ said that 1% was in the centre of Board members’ views, should investors conclude that the BoJ sees inflation risks as low? Or that it sees a risk of deflation? My conclusion is that the introduction of an inflation ‘guideline’ will help markets understand how policy is being set, but will not give a strong signal for where BoJ will move next, or when it will move. Thus, considerable attention to BoJ statements and economic data will be necessary before conclusions on the likely course of policy can be drawn. Another problem with the band is that it is not explicit on which indicator of inflation will be used. Perhaps the BoJ Board has not decided yet which is most appropriate. The Board did state outright that “there seems to be no significant bias in the Japanese consumer price index”. This statement is a touch bizarre to me, in light of research work by the BoJ and others over the years noting large biases. Moreover, the Board mentioned no special indices, such and the CPI excluding fresh food, which it has used heretofore. There will have to be clarification from the Board on how it will treat highly volatile categories of goods, in order for investors to read the direction of policy more accurately from monthly data. Finally, the ‘New Framework’ announcement from the BoJ says that “the Bank of Japan is responsible for realising price stability through an appropriate conduct of monetary policy”. This is a questionable position, for two reasons. First, the BoJ Law — as mentioned in the very same statement — stipulates that the goal of policy is sound development of the nation economy, and that price stability is a method of getting there. That is, price stability is a tool, not a goal. Second, the notion that BoJ is “responsible for realising price stability” ignores the important contributions that other parts of the government need to make. The painful lesson of the 1990s was that non-monetary problems (such as poor corporate governance and a weak financial system) can have huge consequences for the price level. The BoJ cannot be solely responsible — and should not present itself as solely responsible — for an outcome over which it has only partial control. Is a BoJ-set target legal? A deeper problem with the BoJ announcements today concerns the legal basis for the BoJ itself setting an inflation guideline. The BoJ Law gives three goals to the institution: (a) issuance of bank notes and implementation of currency and monetary control (Art 1 section 1); (b) ensuring stable monetary and financial conditions (Art 1, section 2); and (c) contributing to the sound development of the national economy through price stability. However, the Law gives the BoJ autonomy in only one area, currency and monetary control. Moreover, Article 4 says that the BoJ must communicate closely and frequently with the government, so that “currency and monetary control and the basic stance of the government’s economic policy shall be mutually harmonious”. In short, the Law and the government set the goals, and the BoJ has autonomy in helping to achieve these goals through the tools of currency and monetary control. This distinction between goals and tools raises a thorny problem. Is the inflation guideline from the BoJ merely a tool for currency or monetary control? Or is it a goal? A common sense interpretation would be the latter. After all, inflation and deflation affect many complex social issues, which are usually considered the prerogative of the legislature and the government. Nothing in the BoJ Law delegates the power to set an inflation guideline (much less a target) to the BoJ. If, on the other hand, the BoJ regards the inflation guideline as merely a tool for currency and monetary control, it should explain why this is the case. If this problem is ignored, a major disruption might occur. For example, say the Cabinet decides that the appropriate inflation band for Japan is 1-3%. According to the BoJ Law, the BoJ is obligated to ensure that currency and monetary control are aimed at that target. It will be hard to do so, when the Board has declared that its own sense of appropriate inflation is a band between 0% and 2%. At the very least, the matter of appropriate inflation needs to be discussed at the Council for Economic and Fiscal Policy (CEFP), the highest advisory body to the PM. If the CEFP recommends that setting an inflation guideline be delegated to the BoJ, and if the PM agrees and the Cabinet orders so, then the issue will be settled. If not, there could be fireworks. Investors will have to continue to watch the debate between the the Diet, the government and the BoJ over this issue. An interim report from the LDP’s subcommittee on monetary policy is due this month, and should merit close attention. Has the BoJ opened itself up as a target of attack from the Diet? Today’s big step forward by the BoJ reduces the risk of an open confrontation. Indeed, one reason that the BoJ was more aggressive than expected in setting a numerical inflation band may have been to avoid such a confrontation. However, given the legal ambiguity of the BoJ inflation-target range, there could still be trouble. The leaks problem Finally, leaks again marred an important BoJ announcement. Some press sources reported the content of the BoJ Policy Board Decision well before the actual announcement by the BoJ itself. The reports (e.g., that Governor Fukui had tabled a proposal to lift quantitative easing, and that a target range of 0-2% would be adopted) turned out to be correct. Those concerned with fair dissemination of information by the BoJ must wonder how this information reached the press before it was announced officially. More darkly, some investors may be concerned that the information may have leaked elsewhere. The leaks left a very poor impression, particularly since the topic is so crucial. The BoJ can help stem market jitters on this matter by investigating the leaks thoroughly, and disclosing the content and results of the investigation.
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Voyage with Opaque Chart
Mar 09, 2006
Takehiro Sato (Tokyo)
Today’s lifting of QE and some smoothing measures are mostly in line with our expectations. As for the numerical target, the main focus of attention, the BoJ’s stance of looking for the normalisation of the monetary policy, has become clearer by its indication that inflation of around 0-2% would be desirable, which encompasses the core current inflation rate of 0.5%. Also, the BoJ is likely to continue campaigning for the lifting of ZIRP, because it included even zero inflation within the range of the desirable rate. Also, please note that the wording of ‘core’ is carefully avoided in the statement. In this regard, we do not exclude the possibility of an earlier rate hike by the end of this year, which is earlier than we had forecast. (Basically we had assumed this would occur in early F2007.) Meanwhile, we still look for the future policy path to be determined by the basic economic fundamentals, and we assume that the downside risk to prices will become more apparent in the near future. In this regard, for the BoJ to set the centre of the desirable inflation rate at around 1% invites considerable controversy. Also, the market expectation of a future rate hike is likely to swing with a wider margin than generally assumed, since we expect stronger political pressure in the event of the lifting of ZIRP. In this regard, we think that the market is overreacting to the current BoJ campaign, which is likely to be corrected by economic fundamentals. Key points 1. Measures to restrain the interest rate volatility in lifting QE They are almost within the expectation. It's a bit surprising to see the policy target “at effectively zero %” in the statement. Namely, the BoJ is likely to continue providing ample funds to realise the zero rate. Other notable points are as follows: 1) The current account balance is likely to be reduced in a few months. However, in Japanese text, it is written as several months. So we are afraid that the statement to foreign investors is more hawkish in tone. 2) Enhancement of the effective usage of Lombard lending facility will be maintained “for some time”. 3) Rimban value will be maintained as expected. Anyway, the wording of “for some time” suggests that the BoJ strongly intends to keep its free hand despite political pressure. 2. Numerical target: It’s a bit surprising for the bank to allow a zero inflation rate. Considering the bias of the CPI, it looks highly debatable because the BoJ is seen to love moderate deflation. Other notable points are as follows: 1) The range of the desirable inflation rates is “approximately from zero to 2%” with around 1% as the central case. However, it is unclear whether it indicates the core or the headline inflation rate. 2) In order to prevent these numbers from taking on a life of their own, these numbers are carefully positioned as an inflation rate to represent price stability from a medium-to-long-term viewpoint, rather than as a target. In this sense, whether it indicates core or headline is largely irrelevant. Also this is a shift of the policy framework from a backward-looking to a forward-looking stance, in which stagnant prices would not necessarily be a major impediment to a future rate hike. Market implications The stock market is concerned about the excess liquidity drying up (the unwinding of yen carry trades) on a global basis. But we remain sceptical as to whether such a global carry trade position is really accumulating like in 1998. Thus, we assume that concerns that liquidity may dry up provide the opportunity to buy on dips, if any, because the BoJ declared that it would continue providing ample liquidity in order to realise a zero rate for the time being. We think the bond market is likely to remain cautious, having been carried away by the BoJ’s active campaign and the support of a higher core CPI rate during the Jan-Mar quarter. But we look for a retreat of expectations for excessive rate hikes, due to the shrinkage of the core CPI margin after the end of May. Accordingly, this should also provide an excellent opportunity to buy on dips, in our view.
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Less Mis?rables
Mar 09, 2006
Serhan Cevik (Paris)
Macroeconomic stability is leading to an improvement in economic conditions. Thanks to the consolidation of the fragmented political landscape, which has allowed the implementation of prudent economic policies and structural reforms, the Turkish economy has enjoyed a marked reduction in macroeconomic and financial volatility and therefore an above-trend output growth in the post-crisis period. Even though far-reaching structural changes in the economy (such as the productivity revival and the transition from labour-intensive sectors to capital-intensive production) limit employment growth in the short run, the overall performance is getting better and indeed leading to considerable improvements in socio-economic conditions. It is still too early to start celebrating across-the-board increases in Turkey’s living standards, but the latest figures clearly show less misery and despair at an aggregate level. Misery indices have declined to the lowest level in decades. The original misery index — developed by Arthur Okun and based on the sum of inflation and unemployment rates — is a simple gauge to evaluate macroeconomic progress. A combination of higher unemployment and inflation rates indicates a deterioration in economic performance and thus an increase social affliction. In Turkey’s case, with inflation declining from an average of 77.5% in the 1990s to the single-digit territory and a gradual recovery in the labour market, the misery index has shown a sustained improvement in the post-crisis period. According to our calculations, it declined from an average of 142.1 in the 1990s and 102.1 in 2001 to 29.5 last year. In addition to Okun’s gauge, we have also constructed an alternative, more comprehensive misery index to better assess the effectiveness of economic policies in improving living standards. Our version of the index — consisting of the public-sector borrowing requirement, interest rates and output growth along with inflation and jobless rates — presents a more striking improvement from 147.6 in 2001 (and an average of 139.1 in the 1990s) to 22.8 last year. Most of this correction is due to fiscal consolidation, disinflation and interest-rate compression, but even the unemployment rate, after increasing from 5.5% in 2000 to the post-crisis peak of 12.3%, declined to 10.3% last year. Structural changes affect the rate and composition of employment growth. In addition to policy mistakes like above-inflation increases in the minimum wage, structural adjustments and underlying rigidities have resulted in an agonisingly slow and concentrated recovery in the labour market. Nevertheless, the most recent figures show a number of buoyant signs including robust employment growth in all sectors except agriculture. The total number of employed increased by 1.2% year on year to 22 million last year, but non-farm employment surged by 12.0% from 65.2% of total employment in 2004 to 70.5% last year. As a result, the non-farm jobless rate declined from 14.7% in 2004 to 13.6% at the end of 2005, even as the headline rate remained unchanged. On the whole, although the economy is still struggling to create enough jobs for a growing working-age population, the pattern of job creation is encouraging in terms of the pace of growth as well as the quality of employment. The eradication of misery requires improving the economy’s labour absorption capacity. If everything goes well, Turkey’s labour force participation rate should rise on a secular basis. That would be great news, but the fall in unemployment would be limited as long as the economy’s labour absorption capacity does not improve. Hence, going forward, the eradication of ‘misery’ requires active labour-market policies and a range of reforms aiming to boost employment growth above the rate of increase in working-age population. This is a complicated task, particularly when the economy experiences a reduction in the cost of capital and a transition from labour-intensive to capital-intensive industries. To start with, Turkey needs greater labour-market flexibility and a pro-growth tax regime to reduce the cost of labour below the marginal productivity of labour (see If You Want to Create Jobs, Get Rid of Distortions, September 1, 2005). That may sound like a daunting challenge, but it is actually the easy part compared with taking care of the problem of mismatch between workers’ skills and the needs of capital-intensive manufacturing and service sectors in today’s globalising economy. In our opinion, that calls for a complete overhaul of the education system that has long failed to improve the quality of Turkey’s young and growing workforce.
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