SCM: Economic Musings

Some random musings based on the week’s news flows…

First is two important economic datapoints from this morning, initial unemployment claims, and final first quarter GDP. Initial claims were largely unchanged, both week over week and four week moving average. GDP for the first quarter of the year was revised upward slightly. Financial firms actually turned a small profit in the quarter, while information technology and petroleum producers were the only profitable non-financial industries, despite the positive contribution of exports to GDP. Bottom line is that things seem to be moving sideways for now.

Second is a House Ways & Means subcommittee hearing on IRAs, in the broader context of retirement savings, social security, etc. This may be a positive development, and Congress is demonstrating some good intentions. We’ll have to dig into the final legislation to see.

Third is a big easing in expectation of USD monetary tightening, which appears to be putting a bid under inflation sensitive commodities and securities, and may also be contributing to the downward pressure on the broader equity markets. Other factors reported to be playing a role are analysts downgrades of some blue chip names, plus comments from Libya and from the President of OPEC that are supporting higher oil prices.

Finally, a speech by IMF Director Dominique Strauss-Kahn caught our attention, because it shows how the global political economy is harmed by policy errors in the U.S. (not to mention bad advice from the IMF), and how this contributes to international ill will:

"In many countries in Latin America where domestic demand growth has been very strong, existing policies risk amplifying the price shocks. Failure to act decisively now will increase the eventual output and social costs of adjustment," Strauss-Kahn said.

For this reason, he added, "social protection should not be used to justify a retreat into protectionism, or a delay in measures to cool domestic demand. Many countries in the region have painstakingly built up macroeconomic credibility over the past decade. That should not be jeopardized now." During discussions, many ministers emphasized the importance and the challenges of keeping expectations of inflation under control. [emphases added]

The two emphasized phrases are IMF-speak. What Strauss-Kahn is actually suggesting to the governments of Latin America is that to lower inflation, they (1) raise taxes and (2) allow their currencies to appreciate against the world’s major currencies. The underlying global context is that developed countries are growing more slowly than developing ones; and because legislators in developed countries are unwilling to commit to policies that would close this ‘growth gap’, they have to rely on their central banks to lower the value of their currencies in order to support flagging domestic demand. This creates inflationary pressures in other countries and regions, especially in those that lack the size and the institutional capabilities to run monetary policies independently of the U.S., the E.M.U., or to a lesser extent, Japan. Because of this, the IMF has a greater opportunity to dispense toxic advice to developing economies. The end result is a slower rate of overall global economic progress, the very thing that institutions like the IMF are supposedly pursuing. Instead, it ends up acting as a proxy for legislators in developed economies who seem increasingly unwilling to grant their subjects at home a bit more economic freedom.

The U.S. provides the best example at the moment (although Japan’s been at it for much longer, nearly two decades). Since taking office in 2007, Congress has steadily and persistently caused overall economic expectations in the U.S. to become more pessimistic–rising taxes, regulatory burdens, and trade barriers have been on the agenda since the ballots were counted in the fall of 2006, and they do not appear to have softened much. Occurring against the backdrop of an over leveraged and highly securitized consumer finance system, the results have not been pretty, as everyone knows. The Federal Reserve has ridden to the rescue by dramatically lowering the marginal cost (value) of the USD. The inevitable result has been global inflation, showing up first in raw materials, and now working its way through the price structure of the global economy. The greatest impact of inflation is being felt in places where those basic materials, especially food and energy, represent a large proportion of people’s expenditures or incomes.

This phenomenon is occurring because of a widely held but erroneous axiom of contemporary economics: that monetary and non-monetary policies are largely interchangeable. They are not. The effects of monetary poliy, as Robert Mundell and others have demonstrated (and as the world seems to have to re-learn every 10-15 years), are primarily global, while the effects of taxes, regulations, and trade policy have a more purely domestic impact. Of course, there are feedback effects from both that cause them to have both global and domestic impacts. But their fundamental differences should be very clear. And now the IMF is arguing, not that it’s the responsibility of the U.S. government to improve the long term economic outlook for the U.S. economy, but rather that the citizens of Latin American and other emerging countries need to shoulder much of the burden. That the usual rhetoric of growth and stability has to be tossed aside (or perhaps more accurately, covered up) when making such recommendations seems not be noticed. It seems clear to us that anti-growth legislators in large donor countries like the U.S. have more influence over IMF actions than the current and future well-being of its client countries.

Who really needs to shoulder the burden? Policymakers do, especially in the U.S. and Japan. That means that legislators and executives in both countries need to get off their butts and enact measures that will improve the economic prospects of their respective countries. At that point, monetary policymakers will be free to pursue the optimal objective of monetary policy, which is to keep the value of their currencies stable. In that scenario, we’d get the best of both worlds–receding inflation and higher growth.

Alas, it seems unlikely to happen for a few years. Yes, the Obama campaign’s red meat rhetoric has softened. And the House’s current focus on expanding the use of IRAs may portend a better direction for Congressional policy. But it’s still not much to hang our hopes on. Moreover, U.S. policies risk becoming less competitive with the rest of the world even by standing still. At some point, the American electorate may have to reshuffle the political deck before economic policies can take a decisive turn for the better. And that means that the social and economic costs associated with global inflation may be with us for some time.