A self-induced recession

Oct 3rd 2011, 17:05 by G.I. | WASHINGTON

YOU know, if it weren't for the politicians, the economy would have a fighting chance. The probability of recession spiked in early August as financial markets around the world swooned and American economic momentum abruptly drained away. Since then, the economic data have not, for the most part, gone into freefall. This morning we learned the Institute for Supply Managements manufacturing purchasing managers index rose to 51.6 in September from 50.6, modestly better than expected; current production is growing but new orders are weakening slightly. Construction spending was also quite a bit better than expected in August, with across the board strength in residential, commercial and government. Third quarter growth rates have been revised up. Indeed, as this chart from Macroeconomic Advisers shows, consensus third quarter growth estimates between late August and last Friday generally edged higher. Update: U.S. auto sales in September came in above expectations, according to Auto data: 13.1m annualized units, v 12.1m in August. But last week the Economic Cycle Research Institute (ECRI), a boutique firm that specializes in business-cycle turning points said America is tipping into a new recession. And theres nothing that policy makers can do to head it off. ECRI is not well known to the general public but at times like this I pay them special attention because their indicators are designed to capture turning points and their track record is pretty good. Their full report is only available to subscribers so Im guessing the recessionary behavior of stock and bond markets is a key contributor to this call. And what bothers me is that financial markets are responding primarily not to economic but to political developments. Europes perverse insistence on austerity, stemming from a wholly erroneous diagnosis of the cause of its crisis (as this article from The Economist succinctly notes), coupled with doubts about their banks' ability to withstand sovereign bond losses, is pushing the continents economy into a completely unnecessary recession.

In America, the biggest policy-related threat is the fiscal tightening that will happen automatically in the next four months as prior stimulus expires and legislated cuts to discretionary spending bite. Barrack Osama has proposed $447 billion in new or renewed stimulus to neutralize that threat, but it requires an ambitious deal in Congress super committee, and odds of such a deal by its November 23rd deadline are shrinking. Democrats are reportedly trying to get it to consider tax hikes immediately, and Republicans are apparently saying that puts a big deficit reduction deal out of reach. A global economy with decent cyclical fuel and no obvious imbalances is being betrayed by politics. Policy has pushed us over the brink in the past when it was for our own good (i.e., inflation was threatening). If it happens now, it will be the first recorded instance of it happening by obduracy instead of by choice.
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China's currency policy

It's complicated
Oct 4th 2011, 17:22 by R.A. | SOMEWHERE IN EUROPE*

ONCE again, America's Congress is considering punitive action against China over its currency policy, and once again a debate is raging over whether this is a good idea. Paul Kurgan is leading the charge yet again, and he's preemptively responding to a number of arguments against action on Chinabut not mine. The issue is not whether a floating Yuan would be, on balance, good for America. It would; the dollar would probably weaken against the Yuan, which would probably result in a reduction in America's multilateral trade balance. This isn't guaranteed, of course. The dollar has been rising against the euro and many emerging-market currencies of late, mostly thanks to broader financial fear. The resulting shifts could offset depreciation against the Yuan, and that's assuming that a China with fewer restriction on capital movements wouldn't be subject to the same capital outflows as other emerging markets. It does seem likely, however, that the American economy would adjust somewhat more easily given a floating Yuan. The policy is also harmful to China. Export-led growth is a useful way to facilitate catch-up development, but China's dollar peg has fueled inflation and led to imbalances that may hasten its entry into a middle-income trap and a growth slowdown. China also bears a significant financial cost in accumulating huge dollar reserves. Joe Gagnon pegs the expense at something like $240 billion a year; in an email to me he argues that the cost may be substantially higher.

So what's the problem? This last data point is telling. Obviously, China's currency peg entails large costs, and it's extremely unpopular with much of the rest of the world. It's difficult to understand why China wouldn't abandon itunless it believed it was getting some benefit out of the thing. It seems likely to me that China understands the costs of its policy and has therefore been willing to accept a managed appreciation, but it may fear the impact of a quick shift in its exchange rate on domestic political and financial stability. If that's right, then there are two potential costs to forcing China's hand on its currency. One is that America may succeed in winning a rapid appreciation, but at the cost of turmoil in China. That could have all kinds of negative effects, from a panic-driven rush to greenbacks that worsens the trade deficit to a negative shock to the global economic outlook. The other potential costs are that America is not successful, China retaliates, and the global economy suddenly becomes a much uglier place to live and do business. The question I'd ask myself if I were Mr. Kurgan is this: is American pressure likely to lead to appreciation over and above the current pace with acceptable costs to the global economy and important international relationships? Now, maybe Mr. Kurgan would argue that the answer is yes. For now, he simply ignores the possibility that anything truly bad could happen as a result of a "get tough" approach in America. That's just not good enough; typically we're somewhat careful about trying to force major economies to do something they clearly are reluctant to do, particularly when the benefits are likely to be relatively small. I'm not sure that what the global economy needs right now is a round of saber-rattling between the two largest economies. (Mr. Krugman would argue that China was the initial aggressor, but ongoingslow, but meaningful Yuan appreciation means that China is effectively disarming.) Mr. Krugman, by contrast, thinks that all options should be on the table: Ben Bernanke, the chairman of the Federal Reserve, said it clearly last week: unemployment is a national crisis, with so many workers now among the long-term unemployed that the economy is at risk of suffering long-run as well as short-run damage. And we cant afford to neglect any important means of alleviating that national crisis. Holding China accountable wont solve our economic problems on its own, but it can contribute to a solution and its an action thats long overdue. I'm uncomfortable with that logic, and you should be too. Unemployment is a national crisis, but that doesn't mean that America should throw cost-benefit analyses out of the window. And in fact, Mr. Krugman spends the first half of his column laying out the benefits of a policy that strictly dominates a dust-up with China: monetary expansion. Based on my reading of the 1930s, the worst thing a country can do is to try and achieve internal adjustments by forcing deflationary policy on others. America should ignore China's pegand its warnings against taking further steps to loosen monetary policyand adequately reflate. That will place pressure on China to revalue, but without putting the country in a position that weakens international institutions and a key diplomatic relationship. And it will have a much, much more salutary effect on the American economy than a stronger Yuanas I suspect even Mr. Krugman would agree.

The world economy

Be afraid

Unless politicians act more boldly, the world economy will keep heading towards a black hole
Oct 1st 2011 | from the print edition

IN DARK days, people naturally seek glimmers of hope. So it was that financial markets, long battered by the ever-worsening euro crisis, rallied early this week amid speculation that Europes leaders had been bullied by the rest of the world into at last putting together a big plan to save the single currency. Investors ventured out from safe-haven bonds into riskier assets. Stock prices jumped: those of embattled French banks soared by almost 20% in just two days. But those hopes are likely to fade, for three reasons. First, for all the breathless headlines from the IMF/World Bank meetings in Washington, DC, Europes leaders are a long way from a deal on how to save the euro. The best that can be said is that they now have a plan to have a plan, probably by early November. Second, even if a catastrophe in Europe is avoided, the prospects for the world economy are darkening, as the rich worlds fiscal austerity intensifies and slowing emerging economies provide less of a cushion for global growth. Third, Americas politicians

are, once again, threatening to wreck the recovery with irresponsible fiscal brinkmanship. Together, these developments point to a perilous period ahead.
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Be afraid Asias new model company Faster than the speed of light The once and future president In praise of chaos Many miles to go

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Slipping and grasping Most of the blame for this should be heaped on the leaders of the euro zone, still the biggest immediate danger. The doom-laden lectures from the Americans and others in Washington last week did achieve something: Europes policymakers now recognize that more must be done. They are, at last, focusing on the right priorities: building a firewall around illiquid but solvent countries like Italy; bolstering Europes banks; and dealing far more decisively with Greece. The idea is to have a plan in place by the Cannes summit of the G20 in early November. That, however, is a long time to waitand the Europeans still disagree vehemently about how to do any of this (see article). Germany, for instance, thinks the main problem is fiscal profligacy and so is reluctant to boost Europes rescue fund; yet a far bigger fund is needed if a rescue is to be credible. The most urgent solutions, such as restructuring Greeces debt or building a protective barrier around Italy, require the most political couragesomething that Angela Merkel, Nicolas Sarkozy et al have yet to exhibit. The chances of a bold enough plan will shrink if markets stabilise. The less scared they are, the more likely Europes spineless policymakers are to jump yet again for a plan that does just enough to stave off catastrophe temporarily, but lets the underlying problem get worse. Much of the world is now paying for their timidity: witness the increasingly dark economic backdrop. A slew of recent indicators suggests the euro area is slipping into recession, as Germanys exports slow, the fiscal screws tighten, confidence slumps and the banks travails imply tighter credit. Even if the euro-zone crisis were to be solved tomorrow, the regions GDP would probably shrink over the coming months.

Americas economy is still limping along, though the summer slump in share prices and consumer confidence suggest future spending will weaken further. The Federal Reserve is trying new ways of support, somewhat half-heartedly. Whatever it does, America is currently on course for the most stringent fiscal tightening of any big economy in 2012, as temporary tax cuts and unemployment insurance expire at the end of this year. That could change if Congress came to its senses, passed Barack Obamas jobs plan and agreed on a medium-term deficit-reduction deal by November. If Democrats and Republicans fail to hash out a compromise on the deficit, draconian spending cuts will follow in 2013. For all the tirades against the Europeans, Americas economy risks being pushed into recession by its own fiscal policyand by the fact that both parties are more interested in positioning themselves for the 2012 elections than in reaching the compromises needed to steer away from that hazardous course. What about the cushion the emerging markets provide? That, too, is getting thinner. Their growth is slowing (as it needed to, since many economies were overheating). Recent falls in emerging-world currencies and stock prices show that financial panic can afflict the periphery too (see article). Some emerging economies, including China, have less room to repeat their 2008-09 stimulus because of the debts that splurge left behind. Monetary policy can be loosened: several central banks have cut rates. But, overall, the emerging world will be less of a buoy to global growth than it has been hitherto. Some of these constraints are unavoidable. Many governments have less room to support weak economies than they did in 2008. Some caution, too, is understandable from central bankers who have waded ever deeper into unconventional monetary policy. But governments are not just failing to act: they are exacerbating the mess. Lacking conviction and courage In the aftermath of the Lehman crisis, policymakers broadly did the right thing. The result was not a rapid return to prosperity in the West, but after such a big balance-sheet recession that was never going to happen. Now, more often than not, policymakers seem to be getting it wrong. Their mistakes vary, but two sorts stand out. One is an overwhelming emphasis on short-term fiscal austerity over growth. Fixing that means different things in different places: Germany could loosen fiscal policy, while in Britain the reins should merely be tightened more slowly. But the collective obsession with short-term austerity across the rich world is hurting. The second failure is one of honesty. Too many rich-world politicians have failed to tell voters the scale of the problem. In Germany, where the jobless rate is lower than in 2008, people tend to think the crisis is about lazy Greeks and Italians. Mrs Merkel needs to explain clearly that it also includes Germanys own banksand that Germany faces a choice between a costly solution and a ruinous one. In America the Republicans are guilty of outrageous obstructionism and misleading simplification, while Mr. Obama has favoured class warfare over fiscal leadership. At a time of enormous problems, the politicians seem Lilliputian. Thats the real reason to be afraid.