The pattern for central banks has been nearly set in stone for years. The overall purpose of the modern central bank is the preservation of monetary stability and what that generally means is controlling inflation. The idea was simply that legislatures had the ability and the desire to stimulate an economy that was wallowing in recession through additional spending. After all, what politician would ever be able to resist bringing home the bacon to constituents in the form of jobs and projects? The hard part was to slow an economy down that was suffering from inflationary pressures. That would require the bank to hike interest rates, change reserve ratios and otherwise restrict access to money and credit. What does a bank do when there is no inflation dragon to fight and little need to boost stimulus? This is the internal battle that is raging in the ranks of the Federal Reserve and within the other central banks as they are all looking at economic activity that is not following the usual script.
Analysis: There are two broad positions within the Fed’s governors and regional leaders. The “traditionalists” are of the opinion that inflation remains an imminent threat and that it could manifest at any moment. The look at the current lack of inflation as an anomaly and they believe that the conditions that have allowed it to stay so low will change soon and that inflation will surge far faster than anyone is really predicting right now. Given that central bank decisions take months to react to, they advocate an extremely cautious approach that errs on the side of keeping rates higher than they have been. This group includes the usual inflation hawks but there are others who have held more moderate positions in the past but worry about the future.
The other group is not quite as united in their reasoning regarding inflation but they agree on the fact rates should not be pushed that much higher – at least in the short term. They are generally of the opinion that something fundamental is different about the current economy. They are supporters of one kind or another of Larry Summers and those economists who talk about an extended period of “secular stagnation” creating a low inflation trap that will be hard to emerge from. The notion is that the usual triggers for inflation are not functioning as they have in the past and they are not likely to. There is some divergence as to which of these factors matter the most but all agree that consistently low oil prices have been one of the most important. In the past, it was oil that spurred inflation hard as nearly everything reacts to these prices. The costs of transportation fluctuate with the price of fuel and this quickly pervades the whole economy. It has also been assumed that low rates of unemployment push inflation as the shortage of workers makes wage growth inevitable. Not this time. The business community struggles to find the people they need and soon face a choice – either pay far more than desired to get the workers they need or invest in technology and robotics instead. A one-time investment in a machine makes a good deal more sense for many than a long-term agreement to pay somebody more than the company can manage (at least for an extended period of time).
All of this means that the Fed and the other central banks are struggling with policy decisions beyond the next few months. There is generally consensus on raising rates another quarter point this year for the Fed and it is likely that the European Central Bank and the Bank of England will agree to some incremental rate hikes within the year but past that there is considerable confusion. There are those who assert that rates will go up two or three times in 2018 and leave the Fed with at least a 2.5% Federal Funds rate but there are just as many who assert that rates will not go past 1.5%. The factor that will shift the opinions of those on both sides of this debate will be the rate of inflation.
The conversation on aid always comes down to whether the money spent is achieving the desired outcome. It would seem that providing aid and assistance to those in need would not be controversial but it always is. There is always the debate over who is “deserving” and who is not and there are legitimate concerns regarding building dependency into a given culture. The most persistent conversation is over effectiveness. Is there a better way to use the aid to get desired results?
Analysis: The assumption has been that foreign aid should be funneled to the larger urban areas where there is a concentration of people needing help but the latest study from Unicef holds that this is not actually the case. The aid that is provided to the more remote rural areas has a much bigger impact in terms of infant mortality and the general health of the population. The difference is not slight – the impact is much more dramatic.
The working supposition is that people in the rural communities have very little in the way of support from anybody. The governments are weak in these regions and there are not enough friends and family members to form any sort of real support group. The urban dwellers generally have more options and opportunities. They have access to more programs and support and thus manage to avoid some of the crisis situations that plague the people in more isolated areas. There are some important lessons here as far as assisting people in a more developed nation like the US. Much of the effort has been focused on providing services where there is the largest concentration of people and this may not be addressing the real needs. The urban dweller has more options and opportunities in the developed world as well and it is often those in the rural areas that have very limited chances to get help and assistance. The most poverty stricken areas of the US are no longer the cities – it is the rural community cut off from any system that can provide assistance – whether that be the government or the family.
The latest data from Markit shows a substantial recovery in the Eurozone and one that may be picking up speed in the second quarter. The numbers in May were at 56.8 and in June they stayed very close at 56.3. The expectation had been for a decline to 55.5 but the growth in France has been impressive and rapid. There is still a good bit of fragility as far as the global economy is concerned and there are still many who suggest the Eurozone recovery is anything but assured but this surge has already had a positive impact on economies outside Europe. The data in the latest PMI suggests there are three motivations for this recovery.
Analysis: The first and arguably the most stable is the surge in the German economy. The slowdown of about six to nine months ago has been replaced with more robust growth and the estimates are that Germany will be able to grow at between 1.5% and 2.0% over the next several quarters. The consumer in Germany is more engaged than they were just a few months ago and there has been a boost in export demand. The trade related growth has been due to better numbers in Europe as a whole but also to the better economic news in the US and Asia. German exports are not oriented towards consumer products and thus Germany needs other nations to be experiencing enough growth to boost their industrial expansion. That has been taking place in much of the world of late. It also helps that German politics seems to have calmed down a little with Angela Merkel back in the lead as far as the upcoming election is concerned. Economic growth is good for Merkel and it seems that Merkel is also good for economic growth.
The second motivator is perhaps the most dramatic as it was not expected at the start of the year. As important as Germany is to the EU economy, France is a very close second and this country has been missing in action for years. The Hollande government seemed incapable of sticking to a policy direction for more than an hour and the growth rate plummeted as joblessness spiked. It was an economy that was dead in the water and that was largely what provoked the rise of populism. The French were convinced that Marine Le Pen and the National Front would come to power in the elections and the business community was in a panic. Nearly everything seemed to stop as the country tried to figure out what that world would look like. In the end, the French handed Le Pen a stunning defeat and Emmanuel Macron became President and shortly after he won control of the National Assembly. Not that any of the underlying issues affecting the French economy have gone away but the opportunity is there and the business community has responded with relief and optimism. Time will tell as far as how much this enthusiasm is justified.
The third motivator is connected to the way that countries are now connected. If there is anything the last few years have taught is that no country can really pull itself out of decline and recession without help. The US economic recovery over the last few months has been rooted in an expanded export role. The US economy is dependent on exports for at least 14% of its GDP but Germany relies on exports for almost 55% and France needs exports for over 45% of its economic growth. Much of the export activity in Europe is between Europeans but it has taken expanded sales to the US and to China for Europe to start pulling itself out of the doldrums.
The enmity between Donald Trump and the majority of the European leadership is pretty obvious by this time. The relationship with Germany’s Angela Merkel could not really be any worse and relations between Trump and Macron have gotten off to a rocky start. There are however states that have a much different opinion of the US President right now and Poland is at the top of that list. The ruling group in Poland is the Law and Justice Party under the leadership of Jaroslaw Kaczynski. He is a populist in the same tradition as Marine Le Pen and those leading the AfD in Germany. He has been at odds with the Europeans throughout his political career and is as antagonistic towards Germany and Merkel as Trump has been. The meeting between Trump and Kaczynski will be a warm one as they both point the finger at “old Europe” as the problem.
Analysis: Poland is however an outlier as far as most of Europe is concerned and the enmity that has been directed at Germany has compromised the investment that once flowed into Poland from the Germans and others. The Poles are rather hoping that the US can pick up that slack but that means getting more US investment in Poland. That, in turn, means jobs going to Poland as opposed to staying in the US. Poland is a manufacturing state and growth here will likely have to come at the expense of the US to some degree. The US has sold a Patriot missile system to Poland on the eve of this visit however and there will likely be more of these deals in the future.
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This screed is clearly an example of preaching to the choir. I am very, very fortunate to have readers like you – the person who has taken the time to read these words. I get quite a few e-mails and comments from readers on an average week and almost none of them could be described as angry or vituperative. There are many who challenge my assumptions and question my conclusions but these are overwhelmingly thoughtful and respectful and I value these interchanges greatly. Nobody learns anything by cutting oneself off from those who disagree. I am lucky that people reading the BIB are curious and engaged and interested in real exchange. I know many other writers who do not have this luxury and face vitriol and hate on a daily basis.
I have read some of these other comments and wonder what goes on in the minds of these “commentators”. Vile language, overt threats to kill and maim and hurt people’s families. Accusations and threats that would make one want to retreat to a bunker. I can only conclude that zealots and crazies fall asleep reading my stuff and can’t muster the energy to attack. Either that or they assume that nobody listens to me anyway so there is no point in making an example of me. Whatever the reason I am grateful. I am rarely subjected to that kind of abuse and instead have the opportunity to communicate with a wide range of people – some who disagree from the left and some from the right. On occasion, there is even someone who agrees with me! This is what discourse is supposed to be. I have changed my mind on issues after these exchanges and some others have changed theirs. Most importantly we interacted with respect and consideration – even as we continue to disagree.
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How Healthy is the Chinese Economy? – China’s economy is one of the key indicators of global growth. Since it produces a tremendous amount of the world’s products, we can use it as a proxy for the global economy and demand. One of China’s PMI readings was released last night, and it came in better than expected. The official PMI (mostly on surveys from large, multi-national companies) came in at 51.7 in June, up from 51.2 in May. This was the 11th straight month of expansion in the Chinese manufacturing sector.
Highlights in the report from Caixin showed that exports (52.0), new orders (53.1), and production (54.4) were all higher and helped push the index up month-over-month. Economists with Caixin reminded readers that China benefitted in June from one extra work-day because of how the Dragon Boat Festival was celebrated this year – which could be helping to boost some of the positive results seen in June. The big number that we all want to focus on is the new export order figure. It moved from 50.7 to 52.0 in June, and signaled that global demand improved in the month. This was a six-month high for the index. Prices in China are confusing. The Producer Price Index fell year-over-year in May to 5.5% (it was 6.4% at the end of April). But, analysts say that downward price pressure on raw materials producers were easing at the same time.
Caixin also reported on China’s services sector. It moved up to 54.9 in June, up just slightly from 54.5 in May.
Construction activity was strong with a PMI reading of 61.4 in June, up from 60.4 in May. Here’s what is most interesting to us: there was a statement in one of the reports that we read from a subsidiary group of economists that provided some interesting insights about the real health of the Chinese economy looking forward. Here’s what the CEBM Group said about the economy:
“CEBM Group, a subsidiary of Caixin Insight Group, said in a report on Friday that the PMI figures show China’s economy in June has continued the positive trend since the fourth quarter of 2016. It expects the country’s GDP to grow by 6.8% in the second quarter, following 6.8% growth in the fourth quarter of 2016 and 6.9% in the first quarter of 2017.However, the CEBM report warned that China’s economic growth may slow gradually, as it still is highly dependent on the driving forces from infrastructure and housing development. “The dwindling stimulus effect from infrastructure construction and property development, as well as the tightening of fiscal and financial policies, mean that it is just a matter of time before economic growth will fall back from the heights seen at the beginning of the year,” the report said, adding that if the tightening continues, the slide may accelerate.” Caixin/CEBM Group
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