ISM July 2010 & Data|Can Exports dig Us out of this Recession?

It is always important when analyzing data to consider the relevance and importance of such numbers. So, before looking at the numbers from the lastest ISM reports, let us look at what Briefing.com states about the ISM manufacturing reports at Economic Releases: Ism Index. Under the title "Big Picture" it states the following:

This is a highly overrated index. It is merely a survey of purchasing managers. It is a diffusion index, which means that it reflects the number of people saying conditions are better compared to the number saying conditions are worse. It does not weight for size of the firm, or for the degree of better/worse. It can therefore underestimate conditions if there is a great deal of strength in a few firms. The data have thus not been either a good forecasting tool or a good read on current conditions during this business cycle. It must be recognized that the index is not hard data of any kind, but simply a survey that provides broad indications of trends.

Obviously any report can be overrated if interpreted in the wrong way. One way this report seems to be over used and misinterpreted is by relative changes in the index instead of considering the "breakevens" in practice. For example if the headline ISM index drops by 6 points it is significantly more important if it drops from above 50 to below 50 than if the index drops from the 60s to 50s range. The first signifying a reversal of growth and the second a slowing of the growth rate which might actually be good. That is, instead of an overheated economy with growing number of bottlenecks it may signify a stable growth trajectory.

Since the reports are based on sentiment, then it is true that biases are a big factor to consider but that is also its strength as we are trying to have forward looking indicators of the strength and direction of the overall economy, and this should always be taken along with a look at the "Non-manufacturing ISM" reports also. While it may not be as good at forecasting as Briefing.com may desire, it has provided us clues as to what is not likely to happen. For example, they have not so far indicated a double-dip recession. Inflation for a while has been a concern but that trend has reversed and most indicators show a "slowing economy". It is also worth pointing out that perceptions create reality and what people's sentiment is now about the future is likely to be created in reality.

But it is an important consideration that the index is not weighted by size of firm or the degree of sentiment. Since the reports have been around for a long time {since 1931}, changing the reports now may not be a good idea but it might be nice to have "weighted scores" versus the standard unweighted scores. On some of the individual indicators, they indicate not only the breakdown of the industries that are expanding, contracting and staying the same, but also percentages of firms responding in the three categories. This can help indicate broad expansion or more narrowed. With these things in mind let us proceed to the latest reports.

ISM Reports:
Overall the reports are positive but most definitely no indication of an overheating economy. The links used in this portion of the post are:
1. ISM - Media Release: July 2010 Manufacturing ISM Report On Business®
2. Econoday Report: ISM Mfg Index August 2, 2010
3. ISM - Media Release: July 2010 Non-Manufacturing ISM Report On Business®
4. Econoday Report: ISM Non-Mfg Index August 4, 2010

Both headline indexes were solidly in positive territory with manufacturing {PMI} at 55.5 and non-manufacturing {NMI} at 54.3 which signified 12 months of positive growth for the PMI and positive growth for the 2010 year for NMI. The PMI went down by .7%, but the NMI increased by .5% which showed signs of convergence in the economy, that is slow but steady growth. What may be more significant is that both indexes were above consensus at 54 for PMI and 53 for NMI. NMI was even above the range of 52.8 to 54.0, while PMI was at the top of the consensus range of 52.5 to 55.5. Overall the experts had expected a slower growth rate for July. The respondent statements for the most part on the manufacturing was down and could signify an even slower growth in the future with Fabricated Metal Products respondent being the one positive voice. The non-manufacturing on the other hand was mostly positive or lukewarm at worst.

One significant aspect that has changed in the reports since the June reports is that "Commodities in Short Supply" for both sectors is reporting shortages, while last month no shortages were reported. The non-manufacturing shortages seem of little consequence but manufacturing stated that "Capacitors; Electrical Components; and Titanium Dioxide" were in short supply. Already the list of commodities with rising prices is getting longer and it has greater numbers in the parentheses (number of consecutive months of rising prices). Under neoclassical economics of supply and demand, shortages would indicate greater price pressures to clear the market and some of those commodities already show signs of rising prices. Either way these "bottlenecks" could create a drag on the economy. While sectoral rising {or declining} prices signify to the market to adjust, if too many or too rigid of constraints could prevent the necessary adjustments in the economy. Arguably the labor markets are indicating rigidity in a variety of ways including labor migration has been muted partially because of the housing crisis.

That brings us to the issues of price changes as respondents stated and ultimately the issues of Inflationistas And Deflationistas. After the dramatic drop in the price index of manufacturing by 20 points in the June report, the index rose slightly {.5%} and was still significantly above 50 at 57.5. The non manufacturing price index continued its downward trend by dropping 1.1% to 52.7 which is still above the 50% mark and indicating rising prices overall. The downward trend started in April with an index high of 64.7. One significant difference in the two reports is that breath of the price changes. The industry groups are about par {manufacturing 10-3, non-manufacturing 9-4 for increases and decreases respectively}, but the percentage break down by respondents shows that under 50% are experiencing same price levels for manufacturing and over 70% for non-manufacturing. Thus a much larger percentage are not affected by changing prices in non-manufacturing. Even if the trend continues in non-manufacturing for lower prices as it dips below 50%, it will be narrowly focused and less likely to cause a cascading deflationary spiral. Either way, there should be little concern for both inflation or deflation according to these numbers.

This does not stop talk from the "deflationistas". Paul Krugman, as the easiest target around, gives us his back of napkin analysis at Trending Toward Deflation with the chart below. First, trending is a very tricky science and as such he presents no supporting information to help his arguments. Secondly, he does not provide any historical data to show that a trend as such would continue through the zero point of completely stable prices. While, I think that such a point is highly unstable and would be more like a knife edge, I am just not certain that momentum would work so easily to create an economy of deflation from long term inflation. I think there has to be an impetus for such transitions. For example, rapid increases in technology or productivity could bring on deflation but that is hardly happening at the present time.

New orders slowed abruptly in July, in what is the key headline of the Institute For Supply Management report. New orders fell to 53.5, still above 50 to indicate month-to-month growth but down five points from June to indicate a significantly slower rate of growth. The 53.5 reading is the lowest since the manufacturing sector emerged from recession this time last year. Backlog orders also slowed, to 54.5 for a 2-1/2 point decline and its lowest reading since December.

That was the introductory paragraph from Econoday for the manufacturing sectors. It is one of the reasons for looking beyond just the headline numbers as this could signify even slower growth in the preceding quarters or possibly a double dip recession. But on the positive side the non-manufacturing increased by 2.3% to 56.7 and overall the non-manufacturing had a good report as Econoday stated:

This report is a big positive given the prospect from prior reports for gradual slowing. The double dip is still on hold.

One of the positive aspects of the report on non-manufacturing sectors was employment, as it edged above the 50 mark again, which was twice in 3 months. This signifying that there is no trend but at least treading water. For the 8th consecutive month the employment index for manufacturing was above 50% {positive job growth} at 58.6% which was a rise of 0.8%.

Can Exports dig Us out of this Recession?
Last month, the manufacturing import and export indexes were roughly the same levels with imports slightly higher. This has reversed this month as exports edged higher at 56.5% {+0.5} and imports dropping 4% points to 52.5%. While the non-manufacturing sectors {services} has less effect on balance of trade, the report still was positive as new export orders surged ahead of the break even of 50% with a 4 point gain to a total of 52%, and import index staying below 50 at the same rate as last month of 48%.

Those are certainly positive signs for the question posed above and it is certainly possible. It is a question that I have been asking on this blog for quite some time. Now, it looks like the Democrats and especially Obama also think this might be the answer, as this article from the Washington Post talks about at New Democratic strategy for creating jobs focuses on a boost in manufacturing. But the Democrats have the obstacle of their base not being so keen on "free trade" and more trade agreements. Luckily, I have not heard any more news on Obama's pledge to renegotiate the NAFTA treaty. The Wall Street Journal blog stated the union opposition in the following manner, "Even if the White House may see the benefit of more bilateral trade deals, the administration risks losing support from a core supporter–unions–if it presses forward on a raft of FTAs." at Trade Deals {are} Vital to Meet Obama’s Export Goal. The opening paragraphs also frame the issues in the following manner.

U.S. trade and business groups are skeptical the U.S. can double exports without the Obama administration signing a raft of new free trade agreements.

Although President Barack Obama’s administration is pushing ahead with a South Korean FTA, officials say their strategy focuses less on bilateral deals and more on boosting exports through promotion and more rigorous enforcement of trade rules.

While I fully support any endeavor at expanding trade, I seriously doubt and are skeptical about those two initiatives will do much good. First, all countries are "promoting" export trade and we are already in many ways. Demonizing businesses and claiming that we subsidize outsourcing of jobs is not likely to promote exports also. Secondly, not likely to win friends and influence people {countries} by taking them to the teacher and complaining about them. Trading partners are not likely to give us more without us also giving up something also. Talking is not likely to lead to spontaneous open markets for US manufacturing.

Adam Ozimek thinks it is more like trying to bring back
Glory days. It should be apparent that the US is a post industrial society and we are not going back but that does not mean that exports and thus manufacturing can not lead the way to economic recovery. Three international economists from the Centre for Economic Policy Research {VOX} ask the question Can the US raise employment with more exports?. Their paper is based on standard economic theories which even from the opening their statement provides the framework for their analysis.

Can increasing US exports create US jobs? Manufactures dominate US exports, but US manufacturing employment is declining. This column suggests that increased US exports are unlikely to lead to dramatic manufacturing employment gains, but employment in related services sectors may improve.

The US economy has shifted from production to services.

They do a good job providing some thoughts on the reasons service sectors may benefit more from increases in manufacturing output than actually the manufacturing employment. But let me expand their ideas and bring up 3 reasons that support their contentions.
1. Using simple Keynesian models, any autonomous spending will produce a rippling effect on the economy through the multiplier effect. Increased investment in manufacturing has the same initial effect than an exogenous spending increase by government, but can provide more long term growth potentials.
2. Spillover effects on different sectors of the economy can increase productivity in other sectors and expand their respective output levels. The economists discuss these issues within the framework of upstream and downstream sectors of the economy to manufacturing. While spillovers are a general phenomenon, the more exact economic concept occurring here is linkages. Overall manufacturing tends to have the most "linkages" to other sectors of the economy, and thus they are the easy and most likely candidate for development policies. The economists show how this effect is dramatic with their graph on employment in the three economic segments with manufacturing and its upstream and downstream linkages.

3. As productivity in the manufacturing {also farming and resource extraction} sectors increases, this raises the GDP and thus per capita GDP. There is a strong correlation between higher productivity in manufacturing and the average workers pay. The authors provide another important correlation in stating the following.

It is also worth noting that previous research has found that the share of services as an input to a country’s manufacturing exports is significantly correlated with the country’s per capita income (Francois and Woerz 2008).

That is basically self evident, that as more value is added to the end products then income increases. Either theory points out that instead of dreading the demise of the manufacturing job, we should praise the rise in productivity as ultimately we all benefit from this. Most praise the productivity of the American farmer and this same should go for the manufacturers of the US.




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Talking to Mozart about how rapid economic growth is temporary

Why the Doomsayers Are Wrong - WSJ.com

AEI - The Rising Threat of Deflation

July ISM factory index slows to lowest 2010 level - MarketWatch

Misc. Links:
Econoday Report: Construction Spending August 2, 2010

Marginal Revolution: Negative Equity in Underwater Homes

EEF : Manufacturing performance exceeding expectations but road ahead to diverge– EEF/BDO report

We’re Still #1 (Unfortunately)-Compares this recession with others including "Great Depression".

Underneath the GDP report

Mish's Global Economic Trend Analysis: ADP vs. BLS Job Reports - Who to Believe?

Economics Bloggers Turn Sour - The Entrepreneurial Mind
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Economist's View: "Make it in America"

“Make it in America” bills will advance U.S. manufacturing Robert E. Scott

German recovery: Betting on exports | The Economist

Outsource the CEOs|Dweebs at ZNET think outside the Box again.

I just love it when liberals get concerned about issues that they actually oppose. Take for instance the article:. Outsource the CEOs April 06, 2004 By Kevin Danaher. Kevin is basically a "concerned troll". He knows that no company will follow his advice so he posts it on Znet as more tongue in cheek than anything. But since Liberals run around repeating something silly such as this, then maybe I should respond. {Title link to the thread at Thom's forum.}

April 1, 2004 -- As veteran corporate accountability activists, we both have spent years challenging big business to be more responsive to the needs of workers, communities, and the environment. We have picketed outside corporate headquarters, organized sit-ins, sponsored shareholder resolutions and bird-dogged company executives. When it comes to pressuring Corporate America, we've done it as much as anyone.

But the protesting thing is getting old. We figure it's time to give up our placards and trade them in for some PowerPoint presentations. We've decided to drop our commitment to advocacy and adopt a more lucrative career -- consulting.

Haha. Not likely, as otherwise they would have to turn in their "progressive" credentials.

In recent years, hundreds of U.S. companies have generated significant savings by sending high-skilled, well-paid positions to countries such as Singapore, India and the Czech Republic. The economics are clear: If a job can be done equally well somewhere else for less money, then it should be sent abroad. Our consulting firm takes this concept to the next logical step by outsourcing all the way to the top of the corporate ladder.

Why not? After all, equally skilled and experienced chief executives in Europe and Asia earn a fraction of what U.S. executives take home. The average chief of a major U.S. company receives $10.83 million in compensation per year. The typical CEO in Europe receives about $2.7 million. Japanese CEOs are a downright bargain: Your company can expect to pay as little as $300,000 to $500,000 per year for an executive based there, with year-end bonuses averaging just 10 percent. Even if you exclude the value of stock options and bonuses -- which account for the bulk of American CEO pay -- CEOs in the U.S. on average receive twice as much as executives in other industrialized nations.

Well, if the economics is "clear" then I am sure no more Libs will bring up contrary points of view and that outsourcing is good. But we are talking different labor markets so to rectify the fact that once you bring people here for the job then how would you discriminate based on citizenship? ...

We understand that your company may be concerned that off-shoring the CEO could impact performance. That's why we have a Two-for-One Plan. For the same salary you pay one American CEO, you can get a CEO in Europe and one in Asia. By having an executive on each side of the globe, you get uninterrupted service, corporate management around the clock. Instead of putting your back office in Bangalore, you put your front office in Berlin and Tokyo.

Interesting idea but CEOs do not necessarily run the day to day operations like a micromanager. I have more to say about the "front office" later.

The benefits to your company go beyond cost savings alone. When you offshore the boss, you get rid of the person that hourly workers and management employees alike love to hate. Just think how it will boost worker morale to see the CEO booted out the door. The resulting increases in worker productivity will pleasantly surprise you.

Maybe love to hate but also have a vested interest in them so the relationship is not of hate fest but of mutual respect {at least in organizations I have been in}. Not likely that the "workers" really would be more productive since there is less clear indication of who is running the company.

What's good for the goose is good for the gander. If it makes sense to increase profits by outsourcing skilled labor, let's save big money by outsourcing the most uncompetitive worker in the U.S. corporate hierarchy -- the CEO.

Well actually CEOs are quite competitive. It was already mentioned that US CEOs earn a lot more and this will definitely attract more applicants. A person at CEO level would also be eligible for some special immigration status of someone with unique abilities or unique talents. Wish I could find out more about this, but I do not believe companies have any problem getting some CEOs recruited to the USA for work. Here is some articles that talk about immigration of CEOs.
Foreign-born CEOs cite U.S. merit-based system By Del Jones, USA TODAY

"In many companies in Europe and Asia, family connections very often take precedence over performance," says Taurel, who became a naturalized U.S. citizen in 1995.

Just as I was saying, you pay more and open up opportunities to more people and then you would expect more applicants.
Send Us Your Tired, Your Poor, Your Business ExecutivesWhy are big American companies hiring foreign-born CEOs?
Señor CEOMore executive-suite imports.

OK, now going back to the basics of what this entails, the writer of "Outsource the CEOs" seems to want to not only outsource the CEOs but also noted above the front offices. Even in middle size corporations that can be a lot of middle level managers and office staff. I am sure all the small and medium cities that have corporate headquarters would love to have their town die because of outsourcing the front office. It also has to be practical since hiring a CEO in another country also means that he/she needs to be close to a variety of staff and support personnel. It is not like you would dismember the head and all other functions would work out. Also the question of the board would need to be considered since they meet and then you would end up outsourcing the Board Members also.

From my experience of Radio Shack, Fort Worth would practically dry up without its headquarters there. Basically it is just a crazy idea and that if any company followed though would actually be protested by Jason Mark and Kevin Danaher. I might even be there to join them on that protest. Or at least to laugh at them.

Links:
Corporate Donations Increasingly Benefit Left-Wing Causes Monday, February 07, 2000

Obama Backs Down, but Should he Have even if Others Scream Protectionism?

Obama Will Review Buy American Provision in Stimulus
Jan. 30 (Bloomberg) -- President Barack Obama’s administration will examine a "buy American" requirement in economic stimulus legislation that has raised concern among U.S. trading partners, White House press secretary Robert Gibbs said.

The administration "will review that particular provision," Gibbs said today at his regular briefing. The president's advisers understand "all of the concerns that have been heard, not only in this room, but in newspapers produced both up north and down south."

Strangely, this incident of having "buy American" seems to have created a hysteria of the thoughts that this is protectionism. And followed down the usual split between those that support free trade no matter all and those that can not see any protectionism measures under any circumstances as bad. The story continues:

President Obama to water down 'Buy American' plan after EU trade war threat
Last night Mr Obama gave a strong signal that he would remove the most provocative passages from the Bill.

"I agree that we can't send a protectionist message," he said in an interview with Fox TV. "I want to see what kind of language we can work on this issue. I think it would be a mistake, though, at a time when worldwide trade is declining, for us to start sending a message that somehow we're just looking after ourselves and not concerned with world trade."

On the one hand, I am glad that Obama is paying attention to our trading partners. It seems to show that he is willing to consider the needs of other countries. Although besides the other trading partners {other rich countries}, I would doubt if the Bottom Billion will have much sway in Washington now.

On the other hand, I have no problem with any segment of society wishes to emphasize domestic productions including individuals like Sawdust and myself. I and I am sure a lot of Americans consider location as one of many aspects in making purchases. It does not mean that we solely buy US products but that if other things are equal we would choose US products first. And this seems that I would also include in this group any level of government decision making.

On the other hand if it is strictly prohibited by international treaty then that is not something to tamper with.

It seems obvious that consumers should be the deciders in what they purchase. Thus "The Government" when it makes purchases should be free within the confines of a representative democracy should be able to decide who it decides to purchase from and so be it if it is Johnny Lunchbox.

Thus my point was {and maybe not expressed well enough} was that if we have an open bidding process, the government can decide to give preferential bias towards US firms and that would be ok with me. Just as some government jobs give preference to Veterans. When I applied to become a rural mail carrier, Veterans were given either 5 or 10 additional percentage points to their raw scores. Is it fair? Probably not.

So other than taxes {marginally adjusted}, I do not ask others to subsidize Johnny. Just there could be externalities that are not captured by a simple open bidding process and thus the socially optimal solution would not be found.

I do see that you are willing to tax certain transactions to capture some of those externalities {taxes} which might be considered slightly similar to what my contentions are. We might even agree with certain Libertarian Paternalism {Soft paternalism}.
US-EU trade war looms as Barack Obama bill urges 'Buy American'

I remember that Bush also got into trouble with a similar provision, but why should US taxpayers promote other nation's export sectors? US taxpayers are going to pay this back not importers. So as I talked about above, if we want it to stimulate the economy then emphasis on domestic productions would provide more bang for the buck.

This is completely different than the laws enacted during the Great Depression where everything for every segment of the economy was affected.

As far as the Europeans, they understand the leakages of Fiscal Policies and Keynesian multipliers. In their case, the leakages is even greater for each individual country because of no trade restrictions between member states. You may remember when the EU nations were all enacting Fiscal Stimulus and Germany was reluctant to "chip in". I am sure there was some major arm twisting to make sure they enacted a similar fiscal stimulus package. And a couple of articles on their latest stimuli:
FACTBOX-Europe's fiscal stimulus plans to tackle crisis

Fiscal update: Stimulus plans around the world
A stimulus in one state has so many leakages that is nearly impossible to have any effect on the economy of that state. Something one of my first Economics Teachers talked about (her being a woman's studies professor and all).

The difference is that if we feel that we need a fiscal stimulus {and that honestly is still a question to some people} then it should be given the highest "bang for the buck". Much like Krugman and other Economists are saying. I am not sure why, with your knowledge, you can see and identify the basics of Keynesian economics.

I have thought a lot about mobility of labor, and I agree with the basic tenets of the analysis that free mobility of workers is desirable within the confines of a Liberal Democracy to decide who enters. But whatever is decided will need to be under a "gradualist" approach to your utopia. Also just because capital and labor is mobile between states and localities, does not mean that the Federal Government may not have a role in distributing wealth or creating incentives to bring about more socially optimal solutions, and again through soft paternalism.

Anyway, under this one situation, I think the Europeans and the critics are wrong. And the readers should know by now, I do not want any trade restrictions aside from those that a Liberal Democracy decides including punishing "bad countries". The Bottom Billion should have ZERO trade restrictions for imports to the USA.

If the consumer in this situation is the Government? Then the ultimate consumer is the Taxpayer as we seem to agree on. Thus through our representative bodies, "we" should decide how to spend our money.

But are we willing to subsidize the paycheck of steelworkers in China, Japan...???
OK, so let us look at the multiplier effect as we talked about earlier. Let us say we have a project and it requires a bid with a competent US firm bidding 1 million and a comparable foreign firm bidding 900 thousand. Under your analysis we should hire the foreign contractor. Right, V???

So what are the effects on the economy and the Federal Budget?
The economic effects on the Foreign purchase will not give provide any multiplier effect on the economy as the content we will assume is 100% foreign and the transportation revenue I will count as insignificant.

Now what are the effects from a "Buy America-First"?
First let me assume 80% content on the steel and 100% of that will be reflected in higher wages or retained earnings in our economy of the 80%. Thus we have a first round effect on the economy of $800,000 and with a 18% overall revenue from the economy we could see that the Fed could generate tax revenues of $154 thousand. Also if we look at the Keynesian multiplier of 1/(1-MPC) then this $800K would translate into 5 times this amount into the economy at $4 million. This is with the assumption of leakages are savings at around .1 and imports of around .1, we could change these numbers but we still get a significant multiplier effect. Thus the $4million in increased economic activity could translate to $720,000 of increased tax revenues.

Who is subsidizing whom?

Foreign contract: $900k
Domestic: $1 million-$720K

As far as the rules of the WTO, do you have some proof of the exact wording of such clauses. Does this limit the Pentagon from purchasing domestic products? And what about US States that have the same practice including state businesses? Do they violate WTO?

I seriously doubt that they would retaliate since they probably practiced the same thing with their fiscal stimuli and secondly they know the Keynesian multiplier effect as much as anyone so just jumping on the band wagon to prevent anything looking like protectionism. They just like us are not sure about the empty suit...

UNDERSTANDING THE WTO: THE AGREEMENTS Non-tariff barriers: red tape, etc

"Rules of origin" are the criteria used to define where a product was made. They are an essential part of trade rules because a number of policies discriminate between exporting countries: quotas, preferential tariffs, anti-dumping actions, countervailing duty (charged to counter export subsidies), and more. Rules of origin are also used to compile trade statistics, and for "made in ..." labels that are attached to products. This is complicated by globalization and the way a product can be processed in several countries before it is ready for the market.

The Rules of Origin Agreement requires WTO members to ensure that their rules of origin are transparent; that they do not have restricting, distorting or disruptive effects on international trade; that they are administered in a consistent, uniform, impartial and reasonable manner; and that they are based on a positive standard (in other words, they should state what does confer origin rather than what does not).

Still do not see any way that the USA is breaking this rule, anymore than any other country is as noted above.

Links:
AGREEMENT ON GOVERNMENT PROCUREMENT

FE102|Question 7

Explain and discuss the principles of monetary unions in the light of European experience.

The first step in creating a monetary union is the setup of a currency bloc which is defined as when the currencies of all the countries are united by fixed exchange rates. This is hard to do at first so ‘Snakes’ are usually set up that maintain the exchange rates within bands usually defined as a percent change. In addition member countries attempt to follow compatible macroeconomic policies through policy coordination. This was used by most Western European countries during the 1970’s.
Eventually a single currency can replace the individual ones, and this arrangement becomes a monetary union. This system though must have coordinated monetary and fiscal policies encompassing all members. And in the system one state usually assumes the leadership role and as the key currency within the system (trading currency). For the EU experience it was the German State (especially in monetary policy) that members attempted to follow and the Deutschemark was the key currency during the process.

The European Monetary System (EMS) was setup during the 1980’s to arrange for co-operation between members through Exchange Rate Mechanism. ERM attempted to stabilize the cross exchange rates of a wider group of countries and again tied to the Deutschemark.

But some setbacks came when Britain abandoned fixed exchange rages with its partners in 1992.

Hierarchy of the three types of coordination: 1. exchange of information 2. acceptance of mutually consistent policies and 3. joint action. This is versus coordination with no implied significant modification of national policies and thus little more that ‘consultation’.

In 1971, the Snake (other EEC (European Economic Community) countries) in the Tunnel (USA exchange rate) and Belgium/Netherlands being the worm inside the snake.
In 1979, the European Monetary System was established to provide a ‘zone of monetary stability’. The ERM consisted of two parts: 1. bilateral exchange-rate bands (parities) 2. individual currency band against the ECU. The grid in #1 required mutual agreement to make changes and thus Finance Ministers of the currencies participating in the ERM decided these issues.

The ECU was a weighted basket of the 12 member currencies, and from this was an ‘indicator of divergence’. The idea was that it would single out the currency that was diverging from the average agreed parities before bilateral action was required, which in essence was an alarm bell to tell which country needed to take action.
The EMS also established the European Monetary Cooperation Fund (EMCF) where members deposited 20% of their gold dollar reserves in exchange for ECUs that were to be used for exchange market interventions instead of the US dollar. And like any other bank members could draw upon the funds to defend their exchange-rate parities and manage transitory BoP problems.

Results of EMS: Exchange Rate Stability, Anti-Inflation Zone.
Two main components of a Monetary Union; an exchange-rate union and complete capital market integration. More specifically the former means that the countries agree to no margin of fluctuation and thus by all intents and purposes creates a single currency. Complete market integration means that all obstacles to free movement of financial capital are removed and that financial capital is treated equally in all member states.

Implicit requirements: members harmonize their monetary policies, single union central bank, and central bank needs to be invested with a pool of reserves of third-country currencies (US dollars, Japanese Yen...).


A History of the Road to European Monetary Union:
The Rome Treaty of 1957 created the European Economic Community (No Monetary Union) and a priority was the creation of a customs union. The CU involved the adoption of a common tariff policy for third party countries and removal of trade barriers between members.

Hague Summit in 1969 the 6 agreed in principle to establish complete economic and monetary union commencing 1971 and expected completed by 1980. This set up the Werner Report (1972) which the main result was the snake in the tunnel which failed by 1978. This was because of the wide differences in how the economy was handled in each country as a result of the oil crisis and external supply shocks to the system of embargoes. Single European Act (1986) was aimed to create a single market by 1992. Delors report (1989) broadly outlined a proposal for achieving EMU which was initiated by the EEC in 1988 and was to commence in three stages:
1. Greater cooperation and coordination in fiscal and monetary policies as well as removal of financial integration which was the creation of a ‘Single Market project’. (90-93)
2. Phase II was the readying of the eventual permanent fixing of exchange rates and the amendment of the Treaty of Rome which resulted in the signing of the Maastricht Treaty. Established the European Monetary Institute which was to assist progress on economic convergence (European System of Central Banks) and make preparations for the final phase (Statute of the E Central Bank, European System of Central Banks). (1994)
3. Creation of a single monetary policy set by the ECB. 1999

Some acronyms used:
European Union (EU), European Monetary Union (EMU), Exchange Rate Mechanism (ERM), European Currency Unit (ECU), European Monetary Fund (EMF).

Kuwaiti Dinar

This seems to be a tempest in a teapot, but wanted to see what others here think about the situations with the Kuwaiti Dinar and maybe more broadly in the GCC union.
Kuwait abandons US dollar currency peg

Kuwait on Sunday removed its currency peg to the US dollar, throwing plans for a Gulf currency union by 2010 into doubt and raising the prospect that other oil-producing states might abandon long-held dollar pegs.

Sheikh Salem Abdelaziz Al Sabah, governor of the Central Bank of Kuwait, told the official Kuwait news agency that the decision had been made owing to the "detrimental effects of the pegging system to the national economy".

Since late last year, Kuwaiti officials have hinted that the country would revert to a basket of currencies to prevent the sliding dollar increasing the cost of imports, which has stoked inflation to more than 4 per cent, double the historic average. This has encouraged speculators to plough billions of dollars into the dinar over the past few months, betting that the central bank would allow the dinar to appreciate.

On Sunday, the dinar traded up 0.4 per cent as the central bank replaced the peg with a basket of undisclosed currencies. The central bank had allowed the currency to vary up to 3.5 per cent from the peg, but the dinar had been at the top end of the approved trading band for a year owing to the continuing weakness of the dollar and the strength of Kuwait's oil-driven economy.

The dollar is expected to make up about 75-80 per cent of the new basket, reducing the third largest Arab oil exporter's exposure to the weakening dollar.

Kuwait dropped its currency basket in 2003, adopting a dollar peg as part of the Gulf Co-operation Council countries' drive to create a unified economic block with a single currency by 2010. But doubts over the ability of the GCC economies to harmonise have arisen, with one member of the six-nation council, Oman, saying it would not meet the convergence criteria.

"There have already been a lot of question marks over currency union taking place; this raises an additional one," said Simon Williams, an economist with HSBC in Dubai.

Kuwait's move may come as a surprise to other GCC states, such as Saudi Arabia and Bahrain, which have been repeating their commitment to the peg in recent weeks, saying that any revaluation should be agreed collectively by the GCC.

Mr Williams did not believe other GCC states would follow suit on revaluation quickly, as these countries have clung to dollar pegs since the early 1980s.

But other GCC states - Saudi Arabia, the United Arab Emirates, Bahrain, Qatar and Oman - are studying the move as an option to mitigate dollar weakness.

Really nothing of major ground-breaking stuff.
Pegging a nations currency eliminates or so severely restricts monetary policy to make it nearly ineffective, thus exposing the country to the whims of the world wide economic fluctuations-especially with respect to inflation.

So 0.4 percent is really nothing. And even after the basket is changed it will still contain 75-80% US dollars. So a little less trading in dollars to maintain its basket equilibrium.

But a country of Kuwait should not peg its currency unless it is trying to join a monetary union. It might be interesting looking more into the GCC. As I remember a monetary union has a lead country that pegs its currency to another stable currency (US Dollar) or a basket and all others countries peg to that lead country.
Kuwait reviewing exchange rate, dollar peg

BENEFITS OF THE PEG
“Inflation is one of the drivers,” Humaidhi said, adding the government expected annualised inflation in 2007 to match the 3.1 per cent recorded last year. “Kuwait moved from a basket (of currencies) to the dollar. We are considering whether this is the right idea and what benefits we are from getting this,” he said.

Kuwait switched the dinar’s peg from a basket of currencies to the dollar in 2003 to prepare for monetary union with Saudi Arabia, the United Arab Emirates and three other Gulf oil producers. With the monetary union timetable in doubt after Oman, one of the six, opted last year not to meet the 2010 deadline, speculation has grown that some Gulf states would revalue their currencies. Kuwait was named as the top candidate for a revaluation in a Reuters poll of analysts in March. Standard Chartered’s Brice said he expected Kuwait to revalue the dinar by 1 per cent. Deutsche Bank expects the currency to appreciate 3 per cent in six months.

Speculators piled pressure on the dinar in the runup to a Gulf central bankers meeting in April that was expected to hammer out a deal to revive the monetary union plan. The talks ended inconclusively. In March Kuwait’s central bank warned speculators against betting on an appreciation of the dinar and followed up by cutting key interest rates to make dinar-denominated assets less attractive.

But the one thing about having a peg or in this case a trading band, speculators such as George Soros have a one way sure bet. This does not look to be much of a reward though at 4% for a 6 month span. Now it becomes a question if the real interest rates are higher than the rest of the world.

And the last sentence is funny since cutting interest rates could lead to inflation and defeating the purpose of changing the exchange regime.

And what does the IMF think:

"Significant progress toward regional integration has already been achieved through elimination of barriers to free movement of goods, services, capital, and national labor; and a common external tariff. All GCC countries continue to have strong macroeconomic fundamentals characterized by large surpluses in the fiscal and external current account positions, credible pegged exchange regimes, and low nominal interest rate environments. I continue to strongly support the objective of establishing a GCC monetary union by 2010. Achieving this important objective within the agreed timeframe will however require accelerating the preparatory work to put in place the necessary institutional framework and infrastructure. The Fund stands ready to assist by providing policy advice and technical assistance in our areas of its expertise." IMF Managing Director Rodrigo de Rato Welcomes the Large Investment Programs in the GCC Countries and Highlights the Importance of Planned Monetary Union

A very nice review of the economy of Kuwait is from the IMF of course:
Kuwait: 2006 Article IV Consultation—Staff Report;

Neoliberalism Part 1|(global social pathogen)

I had the following list of Neoliberalism traits presented to me recently and it is derived from an article entitled: What is Neoliberalism? A Brief Definition for Activists. So let me go through them one at a time and express my thoughts:

1. THE RULE OF THE MARKET. Liberating "free" enterprise or private enterprise from any bonds imposed by the government (the state) no matter how much social and environmental damage this causes.

Yes, liberating but not completely "Free" but more like "Freer" as Jagdish Bhwagwati would say. And NO-ONE wants no bonds, only sensible ones vs. like financial repression.

2. CUTTING PUBLIC EXPENDITURE FOR SOCIAL SERVICES like education and health care. REDUCING THE SAFETY-NET FOR THE POOR

Strange nothing I read indicates that sort of intentions. Now of course the IMF denies that it supports Neoliberalism but it opponents seem to say that they do, but...

Social Issues
The program seeks to protect the living standards of the most vulnerable social groups. Spending on social safety net programs will be increased by 1 percent of GDP in 1996. A transportation subsidy was introduced to avoid an immediate increase in public transportation fares resulting from the rise in gasoline prices, and the social safety net will be improved further with the assistance of the World Bank and the Inter-American Development Bank.Press Release: IMF Approves Stand-By Credit for Venezuela

Now of course this is just one example but the IMF has shown an interest in the social safety net as soon as 96 as this shows.

3. DEREGULATION. Reduce government regulation of everything that could diminish profits, including protecting the environment and safety on the job.

Yes, it is true that many of the policies are aimed at reducing regulation not necessarily the elimination of regulations. It may be that we can not explain what bad regulation is but we sure can tell what it is when we see it-again like Financial Repression.

4. PRIVATIZATION. Sell state-owned enterprises, goods and services to private investors.

Yes, but under a realization that there needs to sold at a decent price. And no where have I seen that all state owned enterprises must go, mostly ones that are draining resources from the government that could actually help the poor more effectively.

5. ELIMINATING THE CONCEPT OF "THE PUBLIC GOOD" or "COMMUNITY" and replacing it with "individual responsibility."

No, public good or the commons is there in every society. And I do not see anyone advocating these points.

And now let us see what the Policies Advanced by Neoliberalism are.

The definitive statement of the concrete policies advocated by neoliberalism is often taken to be John Williamson's[3] "Washington Consensus" , a list of policy proposals that appeared to have gained consensus approval among the Washington-based international economic organizations (like the IMF and World Bank). These reforms are described by Dani Rodrik[4] as:

* Fiscal rectitude, meaning that governments would cut expenditures and/or raise taxes to maintain a budget surplus

OK, so sound Fiscal discipline. And no mention about where and how cuts to expenditures are to be made. Silva when he came into office cut the defense spending budget. The IMF also helps with devising tax schemes that will be the least distorting to the market and at the same time widen the tax base.

# Competitive exchange rates, whereby governments would accept market-determined exchange rates, as opposed to implemented government-fixed exchange rates, as had prevailed under the Bretton Woods System

Yes the IMF has been promoting this, and many do not follow their advice (Venezuela). But it must be pointed out that the BWS or more specifically the IMF was established primarily to establish the Fixed Exchange regime tied to a stable US dollar. Without fixed exchange rates then much of the reasons for the IMF also disappears.

In accordance with the above, to shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members. (Article I - Purposes IMF)

No balance of payment problems if a country is on a floating exchange rate.

Free Trade, which means the removal of trade barriers, like tariffs and regulatory trade barriers

Yes, that sounds good, but must be realized that gradualism is probably the better option than shock therapy. Isolationist Ignorance in Action summarizes some of what I feel about isolationists especially Lou Dobbs.

Privatization, which means the transfer of previously-public-owned enterprises to the private sector.

Again this can be very good for the government, especially money losing enterprises that free markets can handle better.

Undistorted Market Prices, meaning that governments would refrain from policies that would alter market prices

For example Financial Repression, but again drastic changes overnight can disrupt the market, so gradualism and sequencing may be more important than getting there the fastest.

Limited Intervention, which the exception intervention designed to promote exports, education or infrastructural development.

Yes, and most include also a safety net for those displaced and/or are poor.

Well nothing to me indicates a "Global Social Pathogen".

In Defense of Globalization/Jagdish Bhagwati

At the same time, the evidence against an inward-looking or import substitution trade strategy is really quite overwhelming. In the 1960s and 1970s, several full-length studies of the trade industrialization strategies of over a dozen major developing countries, including India, Ghana, Egypt, South Korea, the Philippines, Chile, Brazil, and Mexico, were undertaken at the Organization for Economic Cooperation and Development (OECD) and the National Bureau of Economic Research, the leading research institution in the United States. These studies were very substantial and examined several complexities that would be ignored in a simplistic regression analysis across a multitude of nations. Thus, for instance, in examining whether the 1966 trade liberalization in India worked, T.N. Srinivasan and I wrote a whole chapter assessing whether, after making allowance for a severe drought that blighted exports, the liberalization could be considered to ahve been beneficial compared to a decision to avoid it. Only after systematic examination of the actual details of these countries' experience could we judge whether trade liberalization had truly occurred and when; only then we could shift meaningfully to a limited regression analysis that stood on the shoulders of this sophisticated analysis. The result was to over-turn decisively the prevailing wisdom in favor of autarkic policies. Indeed, many of us had started with the presumption that inward-looking policies would be seen to be welfare-enhancing but the results were strikingly in the opposite direction, supportive of outward orientation in trade and direct foreign investment instead. Why? (Page 61)

* The outward-oriented economies were better able to gain from trade. The layman finds it hard to appreciate this because, as the Nobel laureate Paul Samuelson has remarked, perhaps the most counterintuitive but true proposition in economics has to be that one can specialize and do better.

.....................................................................................

Third, consider the contrasting experience of India and the Far East. From the 1960s to the 1980s, India remained locked in relatively autarkic trade policies; the Far Eastern countries--Singapore, Hong Kong, South Korea, and Taiwan, the four Little Tigers--shifted to outward orientation dramatically. The results speak for themselves: exports and income grew at abysmal rates in India, at dramatic rates in the Far East. India missed the bus. No, it missed the Concorde!

Of course, the trade strategy has to be put into the full context of other policies that enabled it to translate into gigantic growth-enhancing outcomes for the Far East and into tragic shortfall for India. To see this, consider the East Asian "miracle," as economists christened it: it is not surprising that the practitioners of the dismal science call a splendid economic performance a miracle! This spectacular performance was, it is widely recognized now, due to very high rates of productive investment almost unparalleled elsewhere. Sure enough, the Soviet-bloc countries had experienced similar rates of investment, but it had all turned out to unproductive investment. The "blood, seat, and tears" strategy of getting Soviet citizens to forgo consumption in the interest of investment and growth of income had proven to be a failure. (Page 63)

Writing in regard to historian E.H. Carr on the Soviet dilemma of "socialism in one country":

If a single nation, even if the government is popularly elected, shifts to radical policies, financial capital may leave; even the bourgeoisie ("human capital") may emigrate, voting with its feet. At the same time, fresh foreign funds may dry up, exacerbating the crisis. Government, contemplating such an outcome, may shun leftward policy shifts, or if they try them, they may be forced to retrace their steps amid chaos. Evidently, if socialism obtains everywhere, rather than just in just one country, the prospects are better for it to manage a sharp lurch to the left since there is no capitalist safe haven to worry about. Page 97

From the Economist:

If any cause commands the unswerving support of The Economist, it is that of liberal trade. For as long as it has existed, this newspaper has championed freedom of commerce across borders. Liberal trade, we have always argued, advances prosperity, encourages peace among nations and is an indispensable part of individual liberty. It seems natural to suppose that what goes for trade in goods must go for trade in capital, in which case capital controls would offend us as violently as, say, an import quota on bananas. The issues have much in common, but they are not the same. Untidy as it may be, economic liberals should acknowledge that capital controls-of a certain restricted sort, and in certain cases-have a role. (Page 207)