Euro Crisis?

The Euro fell further today on continuing worries about financing of Greek, Spanish and Portugese government debt. But it is really a crisis? ECB President described the rising of the Euro against the dollar as "brutal" in 2004. That was when the Euro rose to $1.2930. It seems that Europeans are unhappy when the Euro rises and more unhappy when it falls. The real victims here are the Chinese which will find it harder to import goods into Europe since their currency is pegged to the dollar.

Overall, the volatility in the currency markets makes it hard to plan business internationally but that merely reflects the desire of each country to retain its sovereignty over. The Greeks will either cut their deficit enough to get it financed or they won't. A default will not be the end of the world or of the Euro. A bail-out, on the other hand, would only spread the question of solvency to the entire Euro area. European leaders only make themselves look incompetent by suggesting that a default couldn't happen.

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Links For Week Ending 2/06/2010

• South Korea Jan exports miss forecasts, China eyed
• A drying out of the stratosphere may help explain recent temperature trends at the Earth’s surface
• Never short a country with $2 trillion in reserves?
• Commodity inflation update
• Fed Watch: Devil's Advocate

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Yield Spread

The spread between short term rates and long term rates (the yield spread) is an important economic indicator. Some use the spread between 2-yr notes and the 30-yr bond. Others prefer the 3-mo T-Bill for the short side or the 10-year note on the long side. A negative yield spread (where short term rates are higher than long term rates) often precedes a recession.

Currently, the yield spread is at record levels. Many interpret this a indicating future inflation. It is true that when inflation is rising, it will cause the yield spread to widen. But the real long term rate is already high. The yield spread is not behind the curve, trying to catch up to inflation; it is ahead of the curve, anticipating inflation that hasn't arrived. This is very deflationary.

The problem is that incomes will not grow fast enough to absorb available production. But the high yield spread rewards delaying consumption, which increases the disconnect between incomes and available production. The resulting slow down in production further crimps the growth of income, leading to greater demand for credit, higher rates and further delays in consumption.

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December Personal Income

Personal Income for December rose 0.4% . Personal Income Less Transfers rose 0.3%. This numbers is still 3.33% less than the peak value in August of 2008, so at this rate it will take 11 more months to regain the incomes levels on a nominal basis. Below is a graph of Personal Income (left scale), Transfers (right scale) and Personal Income less Transfers (left scale).

The good news is that we are beginning to see a sustained improvement in the growth of private incomes. This is even more important as government stimulus spending peaks over the next few months. By March, we should see positive job growth which should accelerate income growth, though I suspect much of that will go into improving the savings rate, which is not a bad thing but implies a slower growth in consumption.

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Links For Week Ending 1/30/2010

• Obama to Propose Three-Year Freeze on Some Spending
• South Korea Fourth-Quarter GDP Growth Eases to 0.2%
• Bank of China, Construction Bank Start Curbing Credit
• The myth of China’s blithe consensus
• Fed Watch: Dissent
• Europe Lays Plans for How to Bail Out Greece

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Balancing Expectations

In economics as well as in politics, appearances matter. Many of the wild swings that strike economies occur because expectations are out of synchronization with reality. Expectations for house price departed from what most people were able to pay during the housing bubble. It is likely that house prices will bottom below the optimum price because of expectations for house prices declines will become entrenched.

After the election this month, the administration is focusing on jobs but also trying to address the fears about the deficit. Obama Says Cutting U.S. Budget Deficit ‘Critical’ for Economy - BusinessWeek

Obama said government needs to behave more like families and business owners, who have to follow “certain core principles” when setting their budgets.

“They don’t spend what they don’t have, and they make do with what they’ve got,” Obama said. “It’s time their government did the same.”

Obama has to provide some hope to the nearly 20% of Americans that are unemployed or underemployed but at the same time reassure the 80% of who still have jobs that the cost of his promises will not explode, since they will bear the brunt of this cost. Fortunately, we currently have a President who prefer balance and nuance over strident rhetoric.

Presidents don't matter as much as commentators like to paint. They are on the whole captives of the institution; trying to work through Congress and the bureaucracy. But presidential style does matter; it does set the tone and agenda for the debate. At the moment, Obama's style is in tune with the needs of the country. Let's see what he can do with this advantage.

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4th Quarter GDP

The BEA announced the preliminary estimate for GDP for the 4th quarter of 2009. Growth is estimated at 5.7% primarily due to a slowdown in the decline of inventory. Final demand grew by 2.2% but much of that may be due to stimulus spending. I expect the revision to reduce the estimate for growth as December was weaker than November and those result will be incorporated in the next revision.

Below is an updated graph comparing GDP for several countries since the recession began in the U.S. For each country 100 represent GDP in the fourth quarter of 2007. All number for 2009 Q4 are preliminary.
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