Fed's Evans: Global Economy Growing Less Than Expected

The global economy is growing less than expected and countries should not bet on exports as a growth driver, Chicago Federal Reserve Bank President Charles Evans said on Wednesday.

"The global economy is not expanding as vigorously as previous forecasts had expected," Evans said in the question and answer session following a speech at the European Economics and Financial Center in London.

"The idea that any country is going to be able to get a leg up by expanding exports seems difficult to imagine in the current environment," he added.

In his speech, Evans said the U.S. Federal Reserve should ease monetary policy further to help the job market.

Evans also said that the U.S. banking sector was doing fine but the demand for loans was not high at the moment.

The Art of Tax War - Economics Theory

The highly charged partisan debate over the future of the Bush tax cuts (scheduled to expire at the end of December) is a kind of war. Whether you term it a class war depends on what you mean by class, but it is certainly a war between the very rich (the top 2 percent of income earners) and a host of other individuals allied with them, against everybody else who gives a darn.

Battlefield success will be largely determined by the outcomes in the coming Congressional elections. A key issue in these races will be public perceptions of President Obama’s proposal to let expire the federal income-tax cuts put in place by the Bush administration for the very rich, while maintaining those tax cuts – and others implemented by his administration – for everybody else.

Voters’ perceptions are not primarily driven by facts. A February CBS poll showed that only 12 percent of voters recognize that the Obama administration has cut taxes. About 24 percent of voters (and about 64 percent of Tea Party supporters) said they believed it had raised taxes.

Many explanations come to mind. The tax issue is often a lightning rod for other frustrations. Most people find discussions of tax policy complicated and boring, and highly charged partisan debates excite some, but upset others, discouraging them from learning more.

The dynamics of collective conflict also come into play. Precisely because they are such a small group, the very rich stand to lose much more per person than others will gain per person from increased tax revenues. They also have more resources to invest in the fight, enabling them to make bigger contributions to Congressional campaigns.

One important strategic goal of this camp is to persuade voters that tax increases at the top will hurt the economy as a whole. Here’s where supply-side economics comes in, with its claims that tax cuts increase revenues and promote economic growth.

Historical trends, including a comparison of trends during the Clinton and Bush administrations, do not support these claims. But in a world in which most people believe their livelihoods depend on rich investors, many people are fearful. As Brit Hume of Fox News put it on July 25, “When’s the last time one of these poor people offered you a job?”

As a corollary, it is strategically important to argue that increased taxes at the top will hurt small business owners, who are generally more liked and better respected than individuals in the economic stratosphere. But as William Gale of the Urban Institute explains, very few small-business owners are in the top 2 percent, and most individuals in that category don’t heavily rely on business income.

In a counterattack, a group called Business and Investors Against Tax Haven Abuse has released a report arguing that corporate tax havens provide an unfair advantage to large chain retailers and financial companies over locally owned retailers and community banks.

This report doesn’t speak directly to the issue of federal income taxes, but nonetheless lands some relevant blows. Apparently Goldman Sachs, taking brilliant advantage of offshore tax havens in 2008, paid federal taxes at an effective tax rate of 1 percent, proffering a sum less than one-third what it paid its chief executive, Lloyd Blankfein.

It seems unlikely that taxing Mr. Blankfein himself at a higher rate would cause any harm.

Another strategic goal of opponents of the tax increase is to split and weaken the coalition favoring it. In this context, it is advantageous to label those receiving public assistance (including unemployment insurance) as slackers and cheats. About 47 percent of Americans owed no federal income tax in 2009, which you might think people opposed to federal income taxes would consider good news. Instead, the conservative radio commentator Rush Limbaugh characterized this as a form of fraud, “worse than anything Bernie Madoff ever thought about doing.”

On the battlefield, in the fog of war, it is often difficult to know exactly what is happening, and why. But those resisting change have the most to gain from fog – or even from blowing smoke – because uncertainty often works in favor of the status quo.

In my view, Citizens for Tax Justice, which describes itself as an advocacy group that strives “to give ordinary people a greater voice” against the “armies of special interest lobbyists for corporations and the wealthy,” offers the most specific and well-documented analysis of the two competing approaches to the Bush tax cuts, those of President Obama and the Congressional Republicans. Unfortunately, it doesn’t seem to have gotten much attention from the news media.

I’m not sure whose fault that is, and if Sun Tzu were alive today, I’m not sure whom he would be working for. But it’s pretty clear that the Republicans would offer him a higher salary.

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Chinese Yuan vs. the US demand - Economics Theory

The conventional wisdom is that once the value of the Chinese Yuan is increased, the USA’s trade deficit with China would start falling. This reasoning has prompted many Americans to push for further, faster revaluation of the Yuan even after China changed its currency policy.

For those who endorse this rationale, the Yuan’s value is a paramount factor behind China’s, and their country’s trade balances.

But for John Ross, former deputy mayor of London in charge of economic and business policy, the trade gap between a country and China would widen instead of narrowing down, at least in the short term, if the Yuan’s values go up.

Mr. Ross, a visiting professor at Antai College of Economics and Management in Shanghai Jiaotong University, says that once the Yuan’s value rises the Americans would demand further revaluation, ultimately forcing the Yuan to rise to a level that would not only disrupt China’s trade and economy, but also pose a threat to the entire World’s economy.

Moreover, the number of jobs in the US would not increase unless the federal government changes its economic policy and raises investments, which is the real solution to its problem. Pressuring China to raise the Yuan’s value sharply will not help. “Most people, particularly those abroad, don’t know the real situation. The reason they want the Yuan to be revaluated further is because they think it would reduce China’s trade surplus, this is simply not true.”

From what happened between Y’s 2005 and 2008, when the Yuan rose 21% against the USD, it’s clear that China’s “trade surplus rose, too”, Ross said. Any revaluation of the Yuan raises the price of exports and reduces the price of imports, which means China’s trade surplus would get bigger as its currency rises.

By examining historical data, Ross has found that China’s exports and imports grew simultaneously after Y 2005 in terms of volume, but the prices of exports rose more relative to import thanks to the revaluation of the yuan. “That’s why its trade surplus with the USA is bigger today.”

There’s a big debate among economists over what would happen in the long term if the Yuan rose further, he says. Some people think China’s trade surplus would increase, while others think it would fall in the long run. “But there’s no difference in what they say would happen in the short term.”

Seen from the history of US trade, its overall trade deficit rose at nearly US$70B a month until Y 2006, he says. Then it stabilized before rising again after the passage of the worst period of the Global financial crisis. “That’s why the American people are getting agitated because it has worsened, but it is not rising because of China, for, I’m using US figures, not Chinese figures, the trade surplus of China with the US is rather stable, slightly under US$20B a month.”

In other words, claiming that the trade deficit of the US is rising because of China is simply not true, he says. “It’s because its America’s trade deficit with the rest of the world is rising, too.”

The US has a trade deficit with about 90 countries. “If you reduce its trade deficit with China, all that would happen is that its trade deficit with some other country would increase.”

US hawks, however, have always targeted China and pressured it to dance to the tune of their demand. Even if China has pledged to make the yuan more flexible by reforming its exchange rate mechanism further and peg it to a basket of currencies to better reflect the demand of the market, some US politicians and industrial leaders say it’s “too little too late” and demand the Chinese currency be revaluated by up to 40 percent.

Forcing the value of the yuan to rise would cause further uncertainties in the world economy, which today faces other big challenges such as the European Union debt crisis. “We are not (living) in a normal stable economic environment; we are just about recovering from a very bad financial crisis and what happens in the next 6 to 18 months is very important and would have a very big effect,” he says. “The last thing the world needs at present is a short-term increase in China’s trade surplus because of an increase in the value of the yuan.”

The current economic contraction longest since 1929 Economics Theory

The current economic contraction began in December 2007 with unemployment at 5.0 percent. Joblessness climbed slowly month after month until it peaked at 10.1 percent in October 2009. Today, according to the June report from the Bureau of Labor Statistics, unemployment stands at 9.5 percent. Congress, the White House, and the media have hammered away at this near double-digit jobless rate for months in part because President Obama insisted that joblessness would not climb above 8 percent if his stimulus package were approved. Thus, most Americans including those who have not been personally touched by the economic slump are aware that the last time joblessness reached 10 percent was in the early 1980s. However, the public probably does not know that the current contraction very likely is the longest on record since the 43-month contraction in August 1929-March 1933.

The official agency that dates the business cycle in the United States is the Business Cycle Dating Committee of the National Bureau of Economic Research. Unlike many others, the Committee does not define a recession as two consecutive quarters of a decline in GDP. Instead it defines a contraction as a significant decline in economic activity across the economy that lasts more than a few months as indicated by real GDP, real income, employment, industrial production, and wholesale-retail sales. It has not yet determined the date of the trough in economic activity that identifies the end of the current contraction.

If the Committee determines that the trough came in May 2009 the current contraction would have lasted 17 months and would become the longest on record since 43-month contraction in August 1929-March 1933. Longer than the 16-month contractions in November 1973-March 1975 and July 1981-November 1982.

Since the jobless rate to date has not fallen below the May 2009 rate of 9.4 percent, Mayo Research Institute expects the Dating Committee to fix the end of the contraction sometime later in 2009, possibly October when joblessness hit 10.1 percent. An October 2009 trough would make for a contraction that lasted 22 months. What sets this contraction apart from the other 12 contractions since 1929-1933 is a combination of a very high unemployment rate and a nearly two-year duration.

Concerns about the size of the federal deficit and the public debt, the still fragile housing and commercial real estate markets, continuing bank failures, cash-laden investors shying away from shaky financial markets, sagging consumer confidence, the weakening of the euro, the future of deepwater drilling, contagion related to the sovereign crisis in Greece that may spill over to Italy, Spain, Portugal, and Ireland, already scheduled higher tax rates starting in 2011, not to mention geopolitical instability in Mideast, make for fears that any economic expansion following the current contraction will be cut short. In other words, we may be headed toward a double-dip recession.

There are two instances of double-dip recessions since the end of World War II: the April 1958 trough that was followed by an expansion phase that lasted only 24 months; the July 1980 trough followed by an even shorter 12-month expansion phase. In sharp contrast the last three expansion phases lasted 92, 120, and 73 months.

With the two double-dip recessions, tax cuts were the prescribed remedy though in the first case President Kennedy’s Keynesian economic advisers justified the cuts in the early 1960s as necessary to strengthen aggregate demand. In the second case President Reagan’s supply-side advisers, having lost confidence in Keynesian economics, argued the need in the early 1980s to bolster aggregate supply.

Is the United States headed toward a double-dip recession? NO, if the necessary market corrections already have taken place and prices across the board have declined sufficiently to clear away surpluses in labor, resource, product, and financial markets. YES, if those surpluses remain in place and further corrections are necessary.

It could be argued that the very duration of the current contraction has provided all the correction needed. But keep in mind that the huge contraction that ended in March 1933 did not provide all of the correction necessary to haul the U.S. economy out of the Great Depression. That 43-month contraction was followed by a 13-month contraction that got underway in May 1937.

Even the best economic analysts see the future as if “through a glass, darkly.” Even so, Mayo Research Institute hazards two forecasts, both based on the historical record. First, whether a double-dip recession is in our immediate future or not, we can say with considerable confidence that the jobless rate will remain high for several more years because economic history demonstrates that labor markets respond slowly to market corrections. To illustrate, it took 14 years for the August 1983 jobless rate of 9.5 percent to drop to 4.9 percent.

Second, whether there is a double-dip recession in our immediate future or not, we can say with even more confidence that there is another contraction further down the road. Leaving aside the war years of the early to mid 1940s, we experienced two contractions in the 1940s, two in the 1950s, one in the 1960s followed by another that began at the very end of the decade and extended into the next, one other in the 1970s, two in the 1980s, one in the 1990s, and two others more recently.

What we don’t know with any measure of certainty is when that contraction will take occur. Mayo Research Institute is inclined to think that next expansion phase will not run as long as the last three which averaged 8 years because all three were driven by the job-creating, entrepreneurial energy of the ICT revolution. Based on the 9 other expansions since the end of World War II, our best guess is that the coming expansion will peak in approximately 4 years. If as we suggested earlier the latest trough is dated sometime around May-October 2009, it follows that the coming expansion phase will top out sometime in 2013.

The historical record establishes clearly that economics has not yet figured out how to prevent a contraction. Further, economics is split on how best to cure a contraction with Keynesians, monetarists, supply-siders, and neoclassicals offering different remedies. At best we are able to alleviate some of its effects through programs like unemployment insurance until the slump ends and expansion sets in. Some argue, however, that by putting off the necessary market corrections alleviative measures such as extending the maximum duration of unemployment insurance benefits from 26 to 99 weeks make the contraction even worse.

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China's Secret Recipe - Economics Theory

BEIJING -- China’s GDP growth this year may approach 10%. While some countries are still dealing with economic crisis or its aftermath, China’s challenge is, once again, how to manage a boom.

Thanks to decisive policy moves to preempt a housing bubble, the real-estate market has stabilized, and further corrections are expected soon. This is good news for China’s economy, but disappointing, perhaps, to those who assumed that the government would allow the bubble to grow bigger and bigger, eventually precipitating a crash.

Whether or not the housing correction will hit overall growth depends on how one defines "hit." Lower asset prices may slow total investment growth and GDP, but if the slowdown is (supposedly) from 11% to 9%, China will avoid economic over-heating yet still enjoy sustainable high growth. Indeed, for China, the current annualized growth rate of 37% in housing investment is very negative. Ideally, it would slow to, say, 27% this year!

China has sustained rapid economic growth for 30 years without significant fluctuations or interruption -- so far. Excluding the 1989-1990 slowdown that followed the Tiananmen crisis, average annual growth over this period was 9.45%, with a peak of 14.2% in 1994 and 2007, and a nadir of 7.6% in 1999.

While most major economies in their early stages of growth suffered crises, China’s story seems abnormal (or accidental), and has elicited periodic predictions of an "upcoming crash." All such predictions have proved wrong, but the longer the story lasts, the more people forecast a bad end.

For me, there is nothing more abnormal about China’s unbroken pattern of growth than effective macroeconomic intervention in boom times.

To be sure, both economic development and institutional reforms may cause instability. Indeed, the type of central government inherited from the old planned economy, with its overstretched growth plans, causes fluctuations, and contributed significantly to instability in the early 1980s.

But the central government must be responsible for inflation in times of overheating, lest a bursting bubble fuel unemployment. Local governments and state-owned enterprises do not necessarily have those concerns. They want high GDP growth, without worrying much about the macroeconomic consequences. They want to borrow as much as possible to finance ambitious investment projects, without worrying much about either repayment or inflation.

Indeed, the main cause of overheating in the early 1990s was over-borrowing by local governments. Inflation soared to 21% in 1994 -- its highest level over the past 30 years -- and a great deal of local debt ended up as non-performing loans, which amounted to 40% of total credits in the state banking sector in the mid-1990s. This source of vulnerability has become less important, owing to tight restrictions imposed since the 1990s on local governments’ borrowing capacity.

Now, however, the so-called "animal spirits" of China’s first generation of entrepreneurs have become another source of overheating risk. The economy has been booming, income has been rising, and markets have been expanding: all this creates high potential for enterprises to grow; all want to seize new opportunities, and every investor want to get rich fast. They have been successful and, so far, have not experienced bad times. So they invest and speculate fiercely without much consideration of risk.

The relatively high inflation of the early 1990s was a warning to central government policymakers about the macroeconomic risks posed by fast growth. The bubble bursts in Japan’s economy in the early 1990s, and the Southeast Asian economies later in the decade, provided a neighborly lesson to stop believing that bubbles never burst.

Since then, the central government’s policy stance has been to put brakes on the economy whenever there is a tendency toward over-heating. Stringent measures were implemented in the early 1990s to reduce the money supply and stop over-investment, thereby heading off hyperinflation.

In the recent cycle, the authorities began cooling down the economy as early as 2004, when China had just emerged from the downturn caused by the SARS scare in 2003. In late 2007, when GDP growth hit 13%, the government adopted more restrictive anti-bubble policies in industries (steel, for example) and asset markets (real estate), which set the stage for an early correction.

Economic theory holds that all crises are caused by bubbles or overheating, so if you can manage to prevent bubbles, you can prevent crises. The most important thing for "ironing out cycles" is not the stimulus policy implemented after a crash has already occurred, but to be proactive in boom times and stop bubbles in their early stages.

I am not quite sure whether all Chinese policymakers are good students of modern economics. But it seems that what they have been doing in practice happened to be better than what their counterparts in some other countries were doing -- a lot on "de-regulation," but too little on cooling things down when the economy was booming and bubbles were forming.

The problem for the world economy is that everybody remembered Keynes’s lesson about the need for countercyclical policies only when the crisis erupted, after demanding to be left alone -- with no symmetric policy intervention -- during the preceding boom. But managing the boom is more important, because it addresses what causes crises in the first place.

In a sense, what China has been doing seems to me to be the creation of a true "Keynesian world": more private business and freer price competition at the micro level, and active countercyclical policy intervention at the macro level.

There may be other factors that could slow down or interrupt China’s growth. I only hope that policymakers’ vigilance will prevail (and be improved upon), enabling China’s high-growth story to continue for another 10, 20, or 30 years.

Fan Gang is professor of Economics at Beijing University and the Chinese Academy of Social Sciences, director of China’s National Economic Research Institute, secretary-general of the China Reform Foundation, and a member of the Monetary Policy Committee of the People’s Bank of China.

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