Asset Price Inflation & Consumer Price Inflation

A reader has asked why monetary inflation sometimes, like today, causes asset price inflation and sometimes, like in the 1970s, causes consumer price inflation.

Well, there are several aspects to this issue. First of all, inflation numbers from the 1970s aren't entirely comparable to the current ones because the methodology has been changed repeatedly, with for example "hedonic adjustment" and "chain-linking" something that interestingly has always meant that estimated price inflation has been lowered. Whether you think all, some or none of these changes are justified is irrelevant because regardless this means that in relative terms 1970s numbers are overestimated compared to current ones.

The most important factor determining whether or not monetary inflation will mainly cause consumer price inflation or asset price inflation is simply what the early receivers of newly created money choose to do with them. They essentially got three choices: to simply hold on to the money, to buy financial assets or use them for consumption. If it is the first, then nothing happens, no prices will increase. If it is the second, then we will see  asset prices increase. If it is the third, we will see consumer prices increase. Clearly right now, most early receivers choose to use them to buy stocks and other financial assets.

Then there are other factors that influence the outcome. If we have a negative supply chock regarding for example oil, this will as always mean higher consumer prices, and that influenced outcome of the 1970s. And if politicians pursue deficit increasing policies this will increase consumer price inflation relative to asset price inflation, while monetary inflation combined with "austerity" policies will tend to cause more asset price inflation. The fact that both the U.S. and large parts of Europe pursue deficit reducing policies right now contributes to lower consumer price inflation relative to asset price inflation.

Britain Highly Unlikely To Become Europe's Biggest Economy

Matthew Lynn at Marketwatch claims that his country, Britain, will become Europe's biggest economy. But that is just nationalist wishful thinking from his part. First, let's review the current situation, here was the 2012 GDP in local currency for the three biggest:

Germany € 2,644 Billion
France € 2,028.5 Billion
Britain £ 1,540.5 Billion

(Source, the respective national statistics bureaus)

If you "translate" Britain's number using the current exchange rate of about €1.18/£, this is the result:

Germany € 2,644 Billion
France € 2,028.5 Billion
Britain € 1818 Billion

In other words, the French economy is roughly 11% bigger and the German economy is roughly 45% bigger than the U.K. economy.

Lynn claims that Britain, while doing poorly in absolute terms, is doing much better in relative terms:

Well, economic performance is always relative. It is not that the U.K. is doing particularly well. The economy is struggling to grow at more than 1% a year and may do so for years to come. There is certainly no sign of a sudden acceleration of growth.

But the rest of Europe is doing much, much worse. The euro crisis has locked the continent into a permanent depression. Once you take that point on board, the math becomes relatively simple. If the rest of Europe is stagnant, or getting smaller, then the U.K. makes relative progress just by staying where it is. 

Lynn's assertions, has however no connection to reality. Here is the cumulative growth (or contraction in Britain's case) during the latest 5-year period, 2008-2012

Germany +3.7%
France    +0.4%
Britain     -2.0%

(Source Eurostat)

While it is true that the mistake by the French people in electing crazed Socialist Francois Hollande President will hurt the French economy during the 4 years that remains in his term, the damage will probably not be greater than to prevent Britain from continuing its relative decline, and it will certainly not be great enough to allow Britain to grow 11% in relative terms in 4 years.

And as for Germany, it is far more competitive than both Britain and France and will outperform both, as it has done in recent years. While the too low birth rate in Germany is a problem, that can largely be compensated by immigration of workers. And contrary to Lynn's wishful thinking based assertions, Germany is the country that is seeing a large inflow of workers, attracted by Germany's much lower unemployment rate and better pay (compared to Britain), while net immigration to Britain is declining.

Austerity Reduces Deficit-Proves Calls For Austerity Was Unfounded?

Paul Krugman has really outdone himself this time, arguing that a big reduction in the U.S. federal budget deficit proves that calls for "austerity" measures were unfounded.

But this drop in the deficit comes after austerity measures have been implemented! Remember, the so-called "fiscal cliff" that Keynesians said would trigger a deep slump if implemented. Well, most of the tax increases in the "fiscal cliff" have now been implemented, and the spending cuts of the so-called "sequester" were implemented entirely, though with a two month delay.

Krugman's reasoning is like a fat guy who is forced to go on a diet, loses 10 kilos/22 pounds in weight, and then points to the weight drop to argue that the diet wasn't necessary to lose weight.

No, Japan Didn't Have 3.5% Growth

Japan officially reported that quarterly growth was nearly 0.9% (3.5% at an annualized rate) in the first quarter, something that will no doubt be taken as proof that "Abenomics" works.

However, this number presupposes that there was deflation of 0.5% , as nominal GDP only rose less than 0.4%. If we instead use the domestic demand deflator, which was unchanged, to calculate real growth, it was too less than 0.4%. That was less bad than in most European countries, but far from being a strong boom.

Germany's Great GDP-Labor Market Divergence

Germany's first quarter GDP number was less bad than those for France, Italy and Spain, and not surprisingly considering that, also less bad than for the euro area as a whole, but it was still pretty weak with GDP rising only 0.1% compared to the previous quarter and contracting by 0.3% compared to Q1 2012.

But despite the alleged 0.3% yearly economic contraction, employment was actually up by 0.7% compared to Q1 2012, and up by about 0.25% compared to Q4 2012.  But how can employment rise if production falls?

One possible explanation is that productivity is falling. That has been the main explanation for why Britain until the most recent months (in recent months employment has started to drop again in Britain) had a relatively high employment growth of nearly 2% while GDP growth was zero. This was reflected in the fact that average real wages dropped at a 2% rate.

But in Germany, real wages aren't falling, they're rising at a rate of nearly 1%, something that would suggest rising productivity.

This leaves us with two possibilities. One is that the GDP numbers underestimate true economic strength by not adjusting for terms of trade gains and the other is that German corporate profits are falling. My guess is that it's probably a combination of the two.

Interesting Unemployment Chart

As recently as 2008, Germany's unemployment rate was more than twice as high as that in neighboring Netherlands, and higher than the Euro zone average. Now, Germany's unemployment rate is less than half of the average in the Euro zone and a percentage point lower than in the Netherlands.

(Picture comes from the Dutch statistics bureau)

As I've pointed out before, this actually underestimates the strength of the German labor market since the labor force participation rate has risen significantly during this period.

Immigration To Low Unemployment Germany Increases

For years, Germany had slightly negative population growth, due mainly or entirely to negative natural population growth due to a too low birth rate, but also due to the lack of net immigration.

2012 numbers on births and deaths in Germany aren't yet available, but the German statistics bureau has now released migration numbers.(auf Deutsch) It showed that net immigration has increased dramatically, to 369,000, or about 0.45% of the current population. Immigration has increased particularly dramatically from countries like Spain and Greece, but is still small compared to immigration from Poland, from which more immigrants (176,000)  arrived than from Spain (29,000), Portugal (14,000), Italy (42,000) and Greece (33,000) combined.

With the German labor market continuing to strengthen while the Southern European continues to deteriorate, the now still modest inflow from Southern Europe is likely to increase further in 2013. With more than 6 million unemployed the mere 29,000 inflow from Spain in particular is, despite the 45% gain compared to 2011, still remarkably and surprisingly low. This likely reflects that Spaniards in particular are reluctant to move away from homes whose values are now far below what they bought it for and often well below the size of their mortgage loans. In all countries, unemployment benefits and the language barrier also limit emigration.

German immigration statistics has a separate category for migration of ethnic Germans, and for that category, there was actually net emigration, most likely to even richer (and even lower unemployment) German speaking countries Austria, Switzerland and Liechtenstein.

The Left For Redistribution To The Wealthy

The left-leaning Economist's view again declares that "Abenomics"  is a success. That is hardly surprising (they've done that countless times in the past), but what is, or should be, astonishing is the standard by which they think it is an access-namely that the Japanese stock market has had an unprecedented rally, rising some 60% in value in just 6 months.

But why should that be a good thing? Remember any price change isn't intrinsically good or bad for everyone. Higher prices are good for sellers, including future sellers, and bad for buyers, including future buyers. In this case this means that higher stock prices are good for those who already hold stocks. And the people who disproportionately hold those stocks are "the one percent", which is to say the one percent richest. So here we have a leftist website not only cheering on redistribution to the wealthiest, but making it the standard for judging whether policy is successfull!

Note that higher stock prices can either reflect higher profits, or higher valuations (or both). In the case of higher profits this could in turn either reflect higher economic growth or a higher profits share of national income. The author of the article would probably defend himself by arguing that the rally reflects the former, but there is no sign of that in actual data as for example industrial production shrank by 7.3% in the year to March, a steeper decline compared to when "Abenomics" was launched. And historically, while corporate profits and stock prices have usually moved in the same direction as economic growth, the movements in economic growth has only been a small fractions of the movements in stock prices and even profits. And this link has been progressively weaker in recent years as stock markets have rallied even as economic growth in most countries have been weak at best, and often even negative. And in the latest months, the stock market rallies in Japan and elsewhere has had no connection at all to indicators of economic growth, which if anything has weakened.

So, this leaves us with two possibilities: that the profit share of national income is increasing or that valuations are increasing. To the extent it is the former, this simply means redistribution from usually low or moderate income workers to disproportionately wealthy stock owners. To the extent it is the latter, it also implies redistribution to wealthy stock owners, except that the people who lose from it isn't mainly workers, but savers who are trying to build up wealth by buying stocks. Higher valuations now imply a lower dividend yield and therefore less value for people who now and in the future (unless the really is reversed)  buy stocks, making it more difficult for them to become rich. Being rich will to a higher extent be a matter of inheriting wealth, not building it up.

In short, to the extent a stock market rally is unrelated to economic growth (as it is entirely now) it will mean a significant increase in economic inequality as well as a decrease insocial mobility, the very things the left claim to be opposed to

U.S. Employment Report Not As Strong As People Think

I always find it fascinating how single minded financial markets, and financial journalists, are in their focus on only the number of jobs according to the payroll survey while ignoring other indicators who are at least as important.

Case in point is how the markets now rally in response to how the payroll job number was a few tens of thousands higher than expected ,which is to say a few 1/100 of a percentage points higher, while ignoring how average weekly pay fell by 0.4% (as the average work week fell by 0.6% while average hourly earnings rose 0.2%). This means that total income received by workers fell, yet the report is still treated as a sign of economic strength.

The household survey confirms the picture of more people working, but at fewer hours, as the number of full time unemployed continued to drop while the number of part time unemployed (people who have part time jobs and want to work more hours but can't find a full time job) increased both compared to the previous month and compared to April 2012.

There is no doubt that the U.S. economy is recovering, but this report confirms that the pace of recovery remains very slow.

The West Shouldn't Intervene In Syria

Steve Chapman here argues against intervening in Syria. Actually, the case against intervention can most easily be summarized by the fact that intervention means intervening for one group against another. So which side should we intervene for?

Should it be the Sunni Islamist rebels or should it be the Shia Islamist allied Assad regime? Either way, we'll support Islamists and we really have no interest in intervening in a sectarian conflict of different Islamists. This is not a war pitting bad guys against good guys, this is a war between two groups of bad guys.

The consensus in the West seems to be to support the rebels, but I don't see any reason to prefer Sunni Islamists over their Shi'ite rivals. Does 9/11 ring a bell?

Those who favor supporting the rebels on "humanitarian" grounds should remember that when governments like Assad's are overthrown in the Middle East it tends to lead to sectarian violence and persecution. In Iraq, 10 years after the fall of Saddam Hussein's regime, they still have suicide bombings killing tens of people on a n almost daily basis (it is so common that it is no longer considered newsworthy in Western media) and hundreds of thousands of Christians have felt compelled to flee from Islamist terror and persecution.

Things would end up at least as bad in Syria if Western intervention brings down Assad. Alawites would likely be massacred and persecuted on a widespread scale  because Assad is an Alawite and Christians would likely be terrorized and persecuted at least as much as they have been in Iraq the latest decade.

Yes, Assad is a bad guy, but no more so than the rebels. Supporting the rebels in any way, even by only supplying them with weapons is therefore a terrible idea. Unfortunately, the American, British and French governments still seems committed to doing so, and doing so even more than they have so far, undeterred by the disasters created by their previous interventions, and the simple facts stateb above that makes it obvious unlikely that it will be less disastrous this time.

The one form of intervention that could be justified would be to take action to prevent chemical weapons from falling in to al-Qaida or Hezbollah hands, but as Chapman notes in his columns there are great practical difficulties associated with that.