Small doubt in two articles

(This post is a little bit dated now, because I made a first draft last week. But anyway I'll post it below.)

I've got a small doubt in two articles (Washington Post, Bloomberg) that I found on Abnormal Returns, which compactly summarized them as

Consumers are reducing indebtedness while corporations begin to spend their cash hoards.

Is that really so?

First of all, I'm not intending to blame Abnormal Returns. It only summarized two articles into one sentence. That's it.

I have a problem in each of two articles.

Let's see a consumer's side, first.

Washington Post claims that

Climbing out of debt, Americans are saving more

The recession that just rocked the U.S. economy happened in part because Americans were borrowing and spending more than they could afford. Now, three years after the downturn began, families are moving faster than many analysts had expected to put their finances in order by paying down debt and boosting their savings.

Not bad as a start. Then, a story goes on.

Compared with the summer of 2008, when consumer debt peaked, Americans now have 7 percent less mortgage debt, 12 percent less in auto loans and 15 percent less credit card debt, according to the Federal Reserve Bank of New York. Loan payments last year were at their lowest level in a decade.

Meanwhile, Americans are saving at nearly triple the rate they did between 2007 and 2009, setting aside 5.3 percent of their disposable income in December, according to the Commerce Department.

It's true that Americans have slashed spending, payed loans back, and increased savings since the financial meltdown in 2008, which has so far curtailed several million jobs.

But at the very moment, Americans resumed borrowing again, and savings rate is slightly declining. In fact, consumer credit compiled by the Fed increased for three consecutive months, the first time since the mid 2008. Moreover, savings rate declined to 5.3% in December, a nine-month low since last May. As the economy turns up, Americans have stopped a thrift life, and returned to the "good old days", though it's very modest compared to the housing bubble period in the early 2000's.

Second, while no one denies that corporations has just started spending again in the US, Bloomberg's reason is questionable.

Corporate America is putting its cash hoard back to work.

In the first decline since mid-2009, Standard & Poor's 500 companies reduced cash and short-term investments to $2.4 trillion from a record $2.46 trillion, according to data Bloomberg compiled from their most recent quarterly reports. Capital spending increased $22.3 billion, the biggest quarter- to-quarter jump since the end of 2004, to $142.8 billion, the highest level in two years.

Budgets are rising for new plants, distribution centers and stores from S&P bellwethers Cisco Systems Inc., General Electric Co. and Coca-Cola Co. While some of the money is being spent abroad, company officials say they are opening the purse strings at home now too. A rebound in economic demand, President Barack Obama's efforts this year to court business leaders, and Republican gains in Congress have helped build confidence to invest and start adding jobs, executives and investors said.

Really? Are you sure?

In my opinion, it's a mysterious theory that companies expand capital spending because the President pleads. If so, the President could readily manipulate the economy through corporate spending in his favor, especially just before the election. It looks like the US is a communist, dictatorship nation.

The fact is, I think, that companies build up investments because the stock market, hence economic prospect, rises.

Look at the graph above, and you'll find that the stock market has a positive correlation with corporate investments. A democratic, capitalist society wouldn't be easy for corporations to increase spending even if it's the President's order.

Be coherent. Think broad.

US foreign policy after the former Bush administration's blunder looks like increasingly tough for anybody to have a say in a critical moment like the current turmoil in the Middle East. Having said that, though, it shouldn't be an excuse to stumble upon one of the most significant public uprisings in the recent history now unfolding in the nations once thought to be under ever unchanging autocratic regimes.

If the Obama administration fails now, it would miss the vital opportunity to regain US's lost image and influence over the region in the past several years, and the later generations of the US as well as the entire globe would have to pay a huge penalty in terms of both political and economic stability in the oil rich region.

Nevertheless, incoherence and uneasiness have been felt among the current team on the Middle East, which isn't a welcome sign to signal that the US has thoroughly changed tack and is now wholly on the side of people, not a corrupt, despotic regime, for mutual benefits defined not by bold national interests but by principle.

The reason is that there is no consensus among policymakers on how to tackle the events. So, everybody talks on what he wants, no matter how different from the chief. State Secretary Clinton especially like to dissent from Obama. It could compromise any efforts to send a clear and coherent message to the region. In the case of Egypt:

Contradictory Language

From his first public remarks Jan. 28, the president sided with calls for change. Speaking after Mubarak's resignation Feb. 11, Obama praised the "moral force" of peaceful protests "that bent the arc of history."

"There are very few moments in our lives where we have the privilege to witness history taking place," Obama said. "The people of Egypt have spoken, their voices have been heard, and Egypt will never be the same."

While Obama's words have been clear and consistent, the message was muddied by multiple U.S. officials who reacted to confusing events in sometimes contradictory language.

On Jan. 25, Clinton said the Egyptian government was "stable." Two days later, Biden declared Mubarak was not a dictator and needn't resign.

The following night in a hastily arranged address, Obama said he told Mubarak to "take concrete steps and actions" toward democracy. Clinton appeared on that Sunday's news shows insisting on an "orderly transition." On Feb. 1, Obama said he told Mubarak that a transition "must begin now."

Stable Transition

The message was repeated for a week before Wisner, whom the administration sent to Cairo to urge Mubarak to step down, told a security conference in Munich that a stable transition might benefit from Mubarak staying in office while elections were planned.

The president was angered by Wisner's message, according to an administration official who requested anonymity to discuss the president's private reaction. It marked a low point in the administration's response, said another official, who also requested anonymity.

Though the administration disavowed Wisner's remarks, Clinton suggested Feb. 6 that an orderly transition would be harder if Mubarak were to resign, acknowledging she had been unaware that his departure might trigger elections in 60 days.

At first, it looked like that Obama has no clue on how to address the sudden uprisings in Egypt, but finally crystallized a position to favor a prompt transition from Mubarak in support of Egyptian's protests. However, his aids including Clinton seemed like to back away from recognizing the fall of a long-time US ally in the region, as much as saying Egypt is "stable". The contradiction of words among the administration can also be seen in Iran's case.

President Obama addressed the Iranian demonstrations Tuesday with a large measure of caution, calling on Iran's leaders to allow protesters to express their grievances but stopping short of calling for a change in government.

…

"We were clear then and we are clear now that what has been true in Egypt should be true in Iran - that people should be allowed to voice their opinions and their grievances and seek a more responsive government," Obama said. "What's been different is the Iranian government's response, which is to shoot people and beat people and arrest people."

…

"Each country is different, each country has its own traditions, and America can't dictate what happens in these societies," Obama said, adding that his administration would lend "moral support to those seeking better lives."

This time, while Obama was reluctant to navigate the change in government for Iran, hence showing tepid support for protesters, Clinton quickly expressed her views strongly in favor of demonstrators. Their reaction is opposite to Egypt's case.

Mrs Clinton said they deserved to have "the same rights that they saw being played out in Egypt" and that Iran had to "open up" its political system.

…

Later in Washington, Mrs Clinton told reporters that the US administration "very clearly and directly" supports the protesters.

"What we see happening in Iran today is a testament to the courage of the Iranian people, and an indictment of the hypocrisy of the Iranian regime - a regime which over the last three weeks has constantly hailed what went on in Egypt," she said.

Mrs Clinton said the US had the same message for the Iranian authorities as it did for those in Egypt, where President Hosni Mubarak was forced to step down after 29 years in power by nationwide mass protests.

"We are against violence and we would call to account the Iranian government that is once again using its security forces and resorting to violence to prevent the free expression of ideas from their own people," she said.

"We think that there needs to be a commitment to open up the political system in Iran, to hear the voices of the opposition and civil society," she added.

Obama has a reason why he is careful not to provoke Iranian government.

Obama's caution stems from the same fear that appeared to guide his response in June 2009: that a clear U.S. call for regime change in Iran would allow President Mahmoud Ahmadinejad to cast the protest movement as a creation of Western governments and Israel.

NYT claims that the administration's handling of Iran is at least better than Bahrain, another important US ally across the Persian Gulf, where tens of thousands of people, mainly the Shi'ite, took to the streets, demanding more say in politics in a country dominated by the minority Sunni.

President Obama accused Iran's leaders of hypocrisy for first encouraging the protests in Egypt, which they described as a continuation of Iran's own revolution, and then cracking down on Iranians who used the pretext to come out on the streets. He then urged protesters to muster "the courage to be able to express their yearning for greater freedoms and a more representative government."

But speaking to other restive countries, including Bahrain, Mr. Obama directed his advice to governments, not protesters, illustrating just how tricky diplomacy in the region has become. He said his administration, in talking to Arab allies, was sending the message that "you have a young, vibrant generation within the Middle East that is looking for greater opportunity; and that if you are governing these countries, you've got to get out ahead of change. You can't be behind the curve."

This ambivalence through inconsistent messages threatens to undermine the credibleness of the US government, which is required at the very moment. People might see that attitude as an unshakable evidence that they have still been maneuvered by the US (and Israel, if necessary). It looks like that they have made a firm decision not to be, or to be regarded as, a puppet of the US and Israel. Now it's time for the US administration to show a clear stance that the US is firmly on the side of local people, not a dictator. Clinging to narrow interests would undermine the whole interests. Think broad.

In defence of Brazil (and US) against China

This isn't the first time for a South American country to charge an Asian counterpart with its cheap currency. In fact, as my previous post shows, Brazil, one of the significant emerging powers, repeatedly voiced strong concerns for China's currency policy.

Looking at how its currency, real, is valued in the markets, you'll see Brazil's complaint is well-founded. The real is now one of the most overvalued currencies among major economies. According to the BIS, the real has appreciated nearly 40% in real terms since the start of 2009, while the yuan, China's currency, once devalued 6% in the midst and has not yet recovered the level of the start of 2009. Who could say Brazil is paranoid?

However, Brazil has a problem blaming China: China is now Brazil's number-one export partner, and Brazil has recently had a huge trade surplus with China. It means that a cheap real would help exporters, especially commodity firms, thrive more in the world's fastest growing economy, but increased trade surplus would cause a trade dispute with China, a country that Brazil is fast deepening a tie with.

One of the reasons of Brazil's clamor is that the country's overall trade surplus has abated since 2006. Last year, it's little more than 20 billion US dollars, less than half of 2006, which a strong real supposedly brought about.

FT blog claims that the real's strength comes from breakneck economic growth fuelled by government spending. In that sense, Brazil's problem looks like homegrown. Taking into account that domestic inflation is rising due to the rise of commodity prices over the globe, however, the country has no choice but to raise its policy interest rates to curb inflation, which in turn helps the real appreciate more.

Brazil is planning to slash its government spending to ease pressure on the central bank to raise interest rates, and hence an upward pressure on the real. But the share of government spending in GDP is 19.5% in 2009, no bigger than 20 to 23% in the 1990's. It's questionable that only the cut in government spending could achieve the goal of a stable currency.

Inflation is also rising in China, which has recently led the country to hike its interest rates. Yet, the speed of the yuan's rise has been stubbornly slow so far. Even though the Obama administration refused to label China a currency manipulator, the tide of requirement for yuan's rise looks like not ebbed among US policymakers. Brazil, together with the US, has every reason to grumble over China's currency when no country dares to get on China's nerves.

Bye Bye Deflation, Hello Inflation

As several of my recent posts show, inflation is sneaking upon a daily life around the globe, which has so far provoked riots and protests over the Middle East. This is and should be surprising given that deflation was a major threat facing the world economy for a while ago, and policymakers at the time clamored a slogan "Don't be like Japan." What a change!

In fact, the word "deflation" has been losing an attention of general public, and fading away to a trivial word which isn't searched much on the net. According to Google, the word "deflation" is now searched less than one-fourth of the word "inflation" all over the world. It looks like that deflation is getting back into a category of antiquated, exotic terms which only the Japanese dully look for.

It doesn't mean that pressures are so mounting that prices jump, say, 20% in every corner of the world like the 1970's. In fact, price pressures are still and will be subdued in most advanced economies, because there are too many slacks in resources which are supposed to work to suppress price increase over the economy.

However weak they are, it's important to note that inflation pressures do exist, reflecting two major factors that are now pushing prices upward: food and oil. The situation is not a demand-pull but a cost-push inflation. The primary industry may flourish due to rising sales, but it's uncertain that the effects can spread to the secondary and tertiary industry amid a moderate price increase of final products.

Two-year moving correlation between the CPI growth and two inflation factors (oil and food) shows that price pressures are about to increase and be factored in consumer prices in the US and Europe. So as long as food and oil prices stay high, consumers are going to feel a price increase, however small it is, in a near term.

From deflation to inflation?

The world has recently seen rising prices which are not only a concern for economic stability but also causing deadly riots in North Africa, where Tunisia's Ben Ali was forced into exile after 23 years in dictatorship.

Inflation has been creeping into advanced nations, too. The UK's consumer price index in December increased 3.7% from the previous year, the highest since April 2010. The largest contributor to December's rise was transport which claimed nearly 30% of total increase. Food was the second largest contributor, and restaurants the third.

Likewise, Germany's Harmonised Index of Consumer Prices (HICP) rose 1.9% in December, the biggest since October 2008. About 40% of rise came from energy, which was the largest contributor to nearly two-year high. Traffic and food followed.

Meanwhile, the US is also feeling the rise of inflation, albeit very slowly, even though deflation was perceived as the biggest risk for a little while back. A 1.5% growth of CPI in December is lower than the UK and Germany, but it's the highest in 8 months, nonetheless. Transportation was the largest driver of the increase, beating medical care and food and beverages.

The common factor behind the latest inflation in those three countries is the rise of energy and food price. Transportation is the prime sector that passes through soaring energy costs on fares. Restaurants are also vulnerable to the swing of food prices, and have little choice but to raise retail prices in face of escalating food prices.

The fear of inflation is gradually appearing on a radar screen of European authorities' mind. In the recent interview, ECB President Jean-Claude Trichet brought inflation fighting back to the agenda.

European Central Bank President Jean-Claude Trichet said policy makers are monitoring price developments "very closely" after euro-area inflation breached the ECB's limit in December, Germany's Bild newspaper reported.

"We are always concerned if inflation rises and are following developments very closely," Trichet told the newspaper in an interview. "But the figures for December can be accounted for, above all, by rising energy prices."

Reuters poll indicates that some analysts are anticipating the Bank of England's rate hike in as early as the third quarter of this year, though a majority forecasts a rise in the fourth quarter.

This is all happening when economic activity around the world is still and will be fragile for a while, at least this year. It should be dubious that inflation persists with considerable resources still in slack mode, but the world might have to recall how to tackle and tame stagflation in the 1970's.

China keeps buying Treasuries

A little while ago, a rumor was frequently heard around in the markets that China, the world largest holder of foreign reserves, is going to diversify its portfolio away from the US dollar assets like the Treasury securities in favor of, say, euro bonds like German Bunds. In March 2009, Zhou Xiaochuan, governor of People's Republic of China, dared to argue for a gradual move towards using IMF's Special Drawing Rights as a global reserve currency, criticizing the dollar as too much concentrated in global foreign reserves.

China's intention was to shun the dollar's decline as the Fed launched the first quantitative monetary easing in the mid March 2009, because the country accumulated a staggering amount of the Treasury securities immediately after the Lehman crisis in September 2009 crushed the US stock and MBS markets China heavily invested in. But now it looks like China isn't raising a voice against the dollar.

Why? The reason is simple: the dollar hasn't depreciated so much since then, in part due to the Greek crisis that smacked the euro down to the four-year low in 2010. This enables China to feel safe still buying the dollar assets, especially the Treasuries.

China is using UK custodians to keep its dollar assets, which is reflected in the graph above. Given a steady increase in China's foreign reserves, the UK holdings of US Treasuries would shift to China's in the next revision of statistics, hence lifting the country's holdings upward more in line with foreign reserves.

Nonetheless, China's appetite for euro assets hasn't languished at once. The country bought more than 230 billion yen of Japanese short-term bonds in January to July this year, but sold all of them for only two months of August and September. The reason is that China needed a temporal vehicle to lay aside money to flee from the Greek crisis, so it got back to the euro once the crisis stabilized.

Does China keep investing in the dollar? Nobody knows for sure. However, given the eurozone crisis, which is now involving Spain, the world's ninth largest economy, doesn't seem to subside soon, China's words for diversification would be seen as only a bluff.

Bright news on the next quarter

A bit of good news is coming from, unexpectedly, Japan, which predicts that the next quarter, namely January to March, sees a stronger growth in the world, especially Asia. Unfortunately, it isn't that Japan has finally escaped from a trap of chronicle deflation started in the early 2009, though the consumer price index released today shows that deflation is gradually moderating in the country.

The overall consumer price index rose 0.1% in November from the previous year, the second consecutive month of positive growth after twenty months of decline. The core consumer price index, which excludes volatile products like fresh foods from the overall index, decreased 0.5% from the previous year, but it is the smallest decline in nineteen months. Deflation is, albeit very slowly, on the mend.

Meanwhile, the index of industrial production rose 1.0% in November from the previous month, the first gain in six months. It is the same with a median forecast. A bit of surprise is that manufacturers expect a stronger growth of production in the months ahead according to a survey conducted by the METI. Output is forecast to increase 3.4% in December from the previous month, and 3.7% in January.

It is likely that this strong growth in output is based mostly in Asia's demand, which was evidenced in the last month's exports report. Japan's exports grew 9% in November over the year, the first acceleration in nine months. The biggest contributor is Asia, which claims nearly 80% of total growth, whereas North America's contribution is mere 0.3% and shares a modest 3% of total growth. The US economic recovery is still too anemic to bring a robust support for Japan.

Given a highly positive correlation between Japan's and the US output, the latter is also likely to be underpinned in the next quarter by a strong demand in Asia. The recent rise in the US interest rates would herald a robust growth in the US.

Do you believe this?

The latest result in Japan's quarterly Tankan survey, which captures business sentiment, is less bleak than anticipated, but at least not encouraging in the sense that the sentiment index for large corporations declined for the first time in seven quarters. But as was written in this blog before, gloomy sentiment among corporations has already been predicted given a negative effect of two major factors on the economy: one is a surging yen, and the other is the expiration of government subsidies to eco-friendly cars.

What's worse is that large corporations see the demand for new products will lessen more both in domestic and foreign markets in March 2011, and hence resource slack will keep on worsening. They are also concerned that production cost will rise more than selling price, thus putting a downward pressure on the performance. You see no good news at all in the coming quarter.

In the meantime, the Tankan survey allows us to estimate a forecast figure of stock markets and the economy for the coming quarter.

The graph above shows a positive relation between the business sentiment index for all industries and the Nikkei stock index since 2000. Using a forecast figure of the business sentiment index as of March 2011, the Nikkei stock index is estimated to be 12106 in March 2011, well above today's closing price of 10303.83.

The second graph illustrates another positive relation between the index of overseas supply and demand conditions for large Japanese manufacturing firms and the yoy growth rate of real US GDP since 2001. The intuition is very simple. The more the US economy grows, the more overseas demand arises for Japanese companies. Taking this relationship into account, the US GDP is forecast to grow 0.9% annually from the previous quarter in October to November 2010 and 3% in January to March 2011. A 0.9% growth of this quarter would be lower given the currently released strong figures of US economic indexes.

What's interesting is that this positive relationship weakens if extended before 2001. One of the reasons is thought to be the increasing reliance of Japan's economic growth on exports since the start of this century. Anyway, Japanese economy might not be jubilant to the end of the coming quarter according to workaholic salarymen.

A question on the US recovery

The headline looks like cheerful on the news that the index of industrial production in the US rose 0.4% in November from the previous month, a four-month high since July. Moreover, you might want to jump for joy to hear that both of overall and core consumer price index climbed 0.1% in November from the previous month, still subdued in a historical standard. Hence, Bloomberg reports:

Industrial production in the U.S. increased more than forecast in November and consumer prices slowed, indicating the recovery is gaining momentum without generating inflation.

Output at factories, mines and utilities rose 0.4 percent, the biggest gain since July, after a revised 0.2 percent drop in October, a Federal Reserve report showed today in Washington. The consumer-price index climbed 0.1 percent in November after a 0.2 percent gain the prior month, the Labor Department said.

Assembly lines are speeding up as business investment and exports grow and consumer spending accelerates, helping to buoy an expansion that Fed policy makers said yesterday isn't strong enough to reduce a jobless rate hovering near 10 percent. Price increases that are below central bankers' goal will boost the case to maintain the Fed's purchases of $600 billion in securities through June to spur growth.

"The manufacturing sector continues to heal itself," said John Herrmann, a senior fixed-income strategist at State Street Global Markets in Boston. "The outlook for business spending on equipment and software remains very positive." Fed Chairman Ben S. Bernanke "is unlikely to withdraw accommodation until he sees a clear upward turning point in core inflation and a downward turn in unemployment."

What should be noted here is, however, that the index of industrial production sank from the previous year for the fifth straight month, the first time since the late 2008 to the early 2009. It doesn't necessarily mean that the economy is falling back into recession at least for now, but the downward trend is not supposed to "indicate the recovery is gaining momentum" right away given that the US economy still remains too fragile that it's far from on the path to a full-fledged recovery.

Let's look at consumption, which claims the biggest part of GDP. Real average hourly earnings for all employees have trapped in the range of $10.38 to $10.4 for seven months. While core retail sales, retail sales excluding volatile products like motor vehicle and parts, increased 1.2% in November, a eight-month high since March, household consumption is not likely to leap dramatically in the coming months if a lackluster growth of income continues.

Furthermore, another concern is arising in bond markets, where the yield of 10-year US Treasury notes reached 3.55% yesterday, a seven-month high since May. What's important here is that the rise in the bond yield is mostly derived from the rise in the real yield, which equals to the nominal interest rate minus the expected inflation rate. The rise in the real yield is considered to worsen the load of corporate debt, hence hindering investment. Private investment hasn't contributed much to the US economy, especially compared to household consumption which has the largest share of GDP. But given that consumption is expected to grow at best modestly due to still high unemployment and devastated housing markets, a lack of help from any source would suck a vigor of, if any, economic recovery.

Growth outlook leads rate hike

Obama's tax deal with the Republicans is causing a massive sell-off in bond markets across the globe. According to a Reuters report,

Benchmark 10-year yields reached as high as 3.33 percent going into the auction, which meant a whopping 40 basis points had been added since Monday's close,

…

The benchmark 10-year U.S. Treasury note US10YT=RR was down 1-1/32, with the yield at 3.265 percent. The 2-year U.S. Treasury note US2YT=RR was down 6/32, with the yield at 0.624 percent. The 30-year U.S. Treasury bond US30YT=RR was down 1-9/32, with the yield at 4.453 percent.

There seem to be several reasons for the rate hike. First, the extension of the Bush tax cut could help boost the economic growth, especially by sustaining households still trapped in a devastating condition of housing markets. Second, some argues that the tax cut could lead to more deficit spending, hence slackening a balance between supply and demand in bond markets. Third, the Fed might end up buying fewer bonds than previously planned due to more bright prospect for the economy.

Those three factors are supposed to have had more or less combined effects on the plummet in bond markets. What's interesting is that the inflation expectation is constrained compared to the real interest rate which is rising almost in tandem with the nominal interest rate. The rise in the real interest rate could swell debt burden for private business sector, thus costing corporate investment. At least for now, fixed investment would play a minor role to drive the US economy.

In the meantime, Japan's third quarter GDP has just been revised upward, outpacing the US and Europe in the same period.

Gross domestic product grew at an annualized 4.5 percent rate in the three months ended Sept. 30, faster than the 3.9 percent reported last month, the Cabinet Office said today in Tokyo. In nominal terms, the economy grew 2.6 percent, less than the 2.9 percent earlier projected, as price declines deepened.

Private consumption, which accounts for about 60 percent of GDP, also fueled the expansion as households stepped up purchases of energy-efficient cars ahead of the expiration of a subsidy program. Japan's economy is now poised to contract this quarter because of slowing exports and an erosion in the outlook for corporate profits after the yen's surge.

The more the third quarter GDP grows, the less the fourth quarter grows given the household has already trimmed down its spending after the government subsidy to eco-friendly cars was over in September. The government has recently decided to infuse 5.1 trillion yen to the economy as an extra budget to counter a strong yen and deflation, adding up to 915 billion yen of stimulus package approved in September which was criticized as too small. Moreover, the Bank of Japan launched another monetary easing in November, supporting the government effort. But so far, the likelihood is increasing that Japan's economy falls back to a contraction this quarter after four successive quarters of growth.

At least, it looks like that underlying economic conditions verify the rise in the US interest rates.

Price may rise, a little bit

The Fed has so far succeeded in turning an "inflation expectation" up at least a little bit in Americans' mind.

According to the latest two regional reports, manufacturers in New York and Philadelphia answered in November that prices will jump in the future. The index of prices received in the next 6 months in New York rose from 20 in October to 35.06 in November, the highest since October 2008. The same index in Philadelphia also increased from 15 to 33.4, the highest since July 2008. Philadelphia manufacturers saw the current prices rising somewhat, while prices in New York declined from the previous month.

This news should be encouraging if the Fed is going to create an "inflation expectation" to avoid deflation given the current inflation rate is hovering as low as around 1%. The problem is that it's not clear how much prices rise, and how long this persists.

Let me give you an example. Since the Fed embarked on QE2 earlier this month, US Treasury securities have been dumped so that the benchmark 10-year note's yield rose to nearly 3%, the highest in 3 months. But this has come mostly from the rise in real yields, not inflation expectation.

My guess is that prices will rise somewhat in the coming months, which is supposed to be reflected in the next ISM reports. The rise in prices, however, would be so small that it takes many months to reach the Fed's implicit price target of 1.7 to 2.0%.

Who bears cost?

The US has every reason to fear disinflation which could spiral into deflation. As the last post shows, core CPI, CPI excluding volatile goods like food and energy, has increased only 0.61% in October over the year, the smallest on record.

Why is low inflation a problem? It appears to be a bonanza for consumers, because they can afford to buy low-priced goods and services, be it from Chinese or domestic markets. But things aren't so easy as is life itself.

One of the reasons why the inflation rate is so low in the US is that given a considerable gap between supply and demand, US companies have failed to pass through costs coming from soaring commodity prices onto consumers. In other words, companies have very weak pricing power over their products.

Businesses have to struggle in a quagmire of low margins, and as a consequence are unwilling to turn to labor markets, which could cap personal income, and hence reduce the purchase of even such low-priced goods. If so, cash-strapped companies would be compelled to cut more costs, and on and on... In the meantime, inflation could die down even into a negative territory, that is, deflation. This "vicious cycle" would continue until a wide gap between supply and demand goes away so that corporations regain control over prices, which would end up as a resumption of, more or less, price increase.

Low inflation environment brings a classical case of prisoner's dilemma for companies. Every company wants to reflect higher costs on selling price, but is afraid to lose when does it because there is no assurance that others follow suit. They might leave prices at the same low level to gain market share and push competitors out of business. Hence, there is a huge incentive to cut cartel agreements on price adjustment.

The comparison with other countries, especially the UK, clarifies how US corporations have lost pricing power in the midst of growing costs.

First, let's look at the CPI, the index of prices that consumers pay. October's CPI in three countries, the US, the UK, and Germany, increased 1.2%, 3.1%, and 1.3%, respectively, over the year. Among them, UK's inflation rate is quite notable compared with the other two.

On the other hand, the PPI, the index of prices that producers sell, rose 4.3%, 4.0%, and 4.3%, respectively, in October from the previous year. Output price increased almost the same across all three countries.

What do these numbers tell us? UK consumer prices grew higher relative to the others while factory prices rose similarly in all three. In other words, UK companies have succeeded in a cost pass-through while the other two have to internalize cost pressure.

Britons may look like paying more than Americans, but the reason is not that British prices are too high, but its domestic demand is just brisker than the counterparts. A storm of cost cut would overwhelm American and German corporations.

Politics, not economics

The US looks like much more paralyzed than before, which would ruin any chance of making an economic policy effective enough to weather one of the toughest times ever in history facing the country.

Recent attack against the Fed's quantitative easing is based on politics, not economics, largely encouraged by a huge gain of Republicans (and a terrible loss of Democrats as the other side of the same coin) in the midterm elections. Winners are ferreting out a pray for revenge. A pray worth while flaunting their new power. Then, the Fed has been chosen as a sacrifice. It doesn't matter whether the Fed Chairman Ben Bernanke is a republican or not.

Bernanke has just received two open letters to him: one from economists and the other from politicians, both of which criticize the latest Fed's move to buy $600 billion of Treasury securities, called QE2, for risking a cheap dollar, an asset bubble, and uncontrollable inflation.

This is not the first time for the Fed or Bernanke to be exposed in political backlash on the course of monetary policy. But it would be really daunting if the Fed is constrained by partisan politics when the US Congress is quite incompetent to churn out a timely policy as a result of the midterm elections, and hence monetary policy is the only way to counter the downturn.

In October, core CPI, CPI excluding volatile goods like food and energy, has increased only 0.61% over the year, the smallest on record. Taking it into account, few would doubt why printing more money is still justified to fend off disinflation or worse deflation which has crippled Japan for years.

By the way, the second smallest is 0.65% in 1961.

China is an irritant?

President Obama, of course, didn't say so, but somebody might want to paraphrase it instead to hint Obama's inner reflection.

U.S. President Barack Obama took aim at China as the Group of 20 summit ended Friday, calling its undervalued currency "an irritant."

The president, speaking at a news conference in Seoul, suggested China bears much of the blame for global trade imbalances, The New York Times reported. He abandoned his usual cautious language on the subject and said China and other countries should not assume "their path to prosperity is paved simply with exports to the United States."

"Precisely because of China's success, it's very important that it act in a responsible fashion internationally," Obama said. "And the issue of the renminbi is one that is an irritant not just to the United States, but is an irritant to a lot of China's trading partners and those who are competing with China to sell goods around the world."

At the G20, Obama and other leaders agreed to pass along checks and balances of international trade to the International Monetary Fund to study.

The leaders asked the IMF to find "indicative guidelines composed of a range of indicators" that would "serve as a mechanism to facilitate timely identification of large imbalances that require preventative and corrective actions be taken," The Wall Street Journal reported.

The final agreement said countries with "overvalued flexible exchange rates" would be permitted to take "carefully designed macro-prudential measures."

But leaders clearly balked at putting teeth in the communique that would measure or correct trade imbalances this year.

"The idea is not to stall on solutions that would be put on the table too early," said French President Nicolas Sarkozy, who will chair the next G20 summit next year.

Canadian Prime Minister Stephen Harper said, "I think we've got everyone talking the same language, everyone understanding longer term what has to be done."

It's a very harsh word for a Nobel Peace Award winner. Nonetheless, it's not difficult to see that his irritation is coming from a declining support for the administration, which has just been demonstrated as a historical defeat in a mid-term election.

In spite of a lot of speculations beforehand like "the new Plaza Accord", the G20 meeting in Korea didn't cut any policy or agreement but for a mundane communique, presenting us how deeply the world is divided on the currency issues.

Anyway, I'm very much interested in a following blog post by Los Angels Times, which should be a concluding remark for the G20.

Seems like the country has been enjoying a little vacation from President Obama during his month-long trip to Asia the last eight days.

He'll be back home Sunday, talking up more storms. But today he was back briefly, if only from South Korea.

The G-20 summit of world leaders that concluded today in Seoul, South Korea, was so productive in the area of economic solutions that at his departure news conference (full text below, as usual), the first thing President Obama chose to talk about was Iraq.

He wanted to call attention to yet another "milestone" over there, the not-really-quite-completed-but-we're-really-still-making-progress-in-months-long-negotiations on yet.... ...another national government. It seems like over all these years we've passed so many important "milestones" there that we ought to be reaching a destination pretty soon. Even if they do use kilometer stones.

Anyway, talking about Iraq again about sums up the value of the Seoul summit.

Brief comment on employment report

I don't have much to add on the employment report released yesterday, which showed a staggering increase of US employment by 151,000 in October, the first gain in five months. The consensus of forecast was an increase by 60,000. According to a Bloomberg report, it exceeded "all estimates in a Bloomberg News survey of economists."

Everybody has, I guess, already been done with investigating thoroughly the details of statistics, which has little left to me for reading up the current labor condition in the world largest economy.

This employment statistics, especially establishment survey data, is quite notorious for subject to revision upside and down month by month. For instance, the change in employment for August was revised up from -57,000 to -1,000, and the change for September was also revised up from -95,000 to -41,000. But August change was just revised "downward" in September from -54,000 to -57,000.

I have been thinking that August and September employment should increase at least given a downward trend of initial claims for unemployment insurance. So, the large spike in October looks like including three-month growth. I guess October number would be revised down a bit next month, while August and September would see an increase in employment.

President Barack Obama described the current report as "encouraging" but "not good enough." What would Fed Chairman Ben Bernanke think about it? Some analysts criticized QE2 as being too little and too late, but should the job increase continue, markets would feel comfortable enough to support QE2 or the Fed would even start to consider pulling the Treasury purchase back for an exit strategy.

Bank of Japanization of Fed

My capacity of English severely constrains how to make up a new word, but it seems to me that the Fed is clearly going to follow after the BoJ, in the sense that the next move would be nothing less than the de-facto inflation targeting where the BoJ is on the way.

At the FOMC meeting, the Fed decided to buy $75 billion of long-term Treasury securities per month by the end of June in 2011, which totals $600 billion. At the time of QE1, the Fed purchased $300 billion over 6 months. The magnitude and term of QE2 is at least larger than QE1.

A little bit interesting to me is that the Fed will keep reinvesting principal payments from its securities holdings. The Fed is now buying about $30 billion of long-term Treasury securities per month as a reinvestment of principal payments. It's not much compared with the new purchase, but the Fed's intention would be that there is no reason to stop it right now.

It would be better to gauge the impact of the mid-term election, where the Democrats were heavily blown, on the economy, but it's beyond my ability. My guess is that the congress will be so paralyzed that the next big push from fiscal arena is difficult to be taken into account as a reliable and expected economic policy. So, the next Fed's move would be far bolder and greater than thought to make up for fiscal inability.

If the Bank of Japanization means the incompetence of monetary policy, what would be left to stimulate the economy? Could paralyzed congress save the country? The US seems to be getting into a very, very hard time.

In favor of manufacturing

It looks like the age of manufacturing has come back at last after its long losing battle against service industry, especially finance. Recent results in Purchasing Manager's Index or PMI, which captures current business condition, showed more bright pictures for manufacturers in the US, the UK, and China, indicating that unexpected recovery led by manufacturing now under way is strong enough to maintain the economy for some time.

However, one has to understand that the reason of a sharp recovery is not the same across the three countries. Meanwhile, major central banks are in no mood to rush to an exit strategy, taking on disinflation or deflation with another round of quantitative easing at hand. Let's look at one by one. The keyword is "Global rebalance".

According to a Bloomberg report, manufacturing picked up a sudden momentum in October in the UK, a country known for its finance-centered economy.

U.K. manufacturing growth unexpectedly accelerated in October and hiring improved as export orders increased.

A gauge based on a survey of companies by Markit Economics and the Chartered Institute of Purchasing and Supply rose to 54.9 from 53.5 in September, according to an e-mailed statement today in London. The median forecast of 25 economists in a Bloomberg News survey was for a decline to 53. A measure above 50 indicates expansion.

Manufacturing is gaining traction after a drop in the pound since the start of 2007 boosted demand for British exports, and economic growth in the second and third quarters was the strongest for two consecutive quarters since 2000. Still, the Bank of England will probably keep its asset-purchase program at 200 billion pounds ($322 billion) this week as the government prepares the biggest public-spending cuts since World War II.

"Exports are very much the engine of growth within manufacturing at the moment," David Noble, chief executive officer at CIPS, said in the statement. "It's difficult to predict the impact of fluctuations in export markets so the recovery may continue to be bumpy. What is clear is that manufacturing looks set to drive further gross-domestic-product growth in the fourth quarter."

The pound rose as much as 0.3 percent against the dollar after the report was published, and traded at $1.6086 as of 9:32 a.m. in London.

Employment Boost

Glasgow, Scotland-based Weir Group Plc, the world's biggest maker of pumps for the mining industry, said today it expects profit for the fiscal year 2010 will be slightly ahead of previous forecasts.

New export orders rose at the fastest pace in five months in October, CIPS said, with companies reporting sales increases to Europe, Latin America, the Middle East and Africa. Employment rose at the fastest pace since June, while average input costs rose for a 14th month.

The U.K. economy grew 0.8 percent in the third quarter, double the forecast of economists in a Bloomberg survey. Growth was 1.2 percent in the second quarter, the fastest in nine years.

"This report confirms that the improving picture painted by last week's good GDP data has continued into the final quarter," James Knightley, an economist at ING Financial Markets in London, said in an e-mailed statement. "With the pain yet to bite from government spending cuts, we remain cautious and see growth slowing through 2011."

The government's spending reductions will eliminate 490,000 jobs in a bid to wipe out a record budget deficit by 2015. The cuts will peak at 81 billion pounds in 2015.

Thirty-eight economists in a Bloomberg News survey forecast the Bank of England will maintain the size of its bond-purchase plan, while two predict increases. All 60 economists in a separate poll say the bank will keep the benchmark interest rate at a record low of 0.5 percent. The bank announces the decision at noon in London on Nov. 4.

One might find it difficult to locate where 'Made in UK' products are sold outside the country. Aside from it, this result has two important implications, which would be a harbinger of transformation in the economy.

First, manufacturing is finally gaining its ground in the country, which has lost factories to overseas and deferred to finance over the years. According to ONS, manufacturing GDP lost its value in the last 20 years, while business service GDP has kept expanding by 3.8% per annum.

Second, exports could contribute to the economy more profoundly than before, reflecting weaker domestic demands. The share of exports in GDP, though not yet restored the pre-Lehman shock level, is gradually soaring since the mid-2009, in part due to weak pounds.

The UK is far away from rebalancing its economy, but those two features can be a sign for the country tilting toward a more manufacturing- and export-driven nature.

Rebalance needs a partner to offset a country's surplus or deficit. The world's biggest surplus country, in turn, showed the acceleration in manufacturing driven by internal demand amid subdued exports.

The official purchasing managers' index (PMI) rose to 54.7, from 53.9 in September and 51.7 in August. Readings above 50 indicate expansion.

The result was driven by rising transport and general equipment orders, thanks to strong state-sponsored investment in infrastructure.

The trends were confirmed by a separate report from HSBC bank.

Like the official PMI from the China Federation of Logistics Purchasing (CFLP), the HSBC report on China produced by data services company Markit "suggests strong growth momentum in domestic demand," said HSBC chief economist for China, Qu Hongbin.

He predicts a 9% growth rate in the fourth quarter - moderately slower than the 9.6% already announced for the third quarter - despite the "still soft increase in new export orders".

Price pressures

The official CFLP report has remained above 50 - indicating expansion of the manufacturing sector - for all of the last 20 months, as the government pushed an investment splurge to offset the effect of the global recession.

Spending on new projects in the first nine months of this year was up 25% on a year ago.

The data was particularly strong as it coincided with an annual week-long national holiday, which normally causes a small drop in the index during the month of October.

Stock markets reacted well, with the Shanghai Composite index ending the day up 2.5%, while Hong Kong's Hang Seng rose 2%.

But it will add to concerns about rising inflation at China's central bank.

The People's Bank of China raised interest rates by 0.25% last week, in the hope that - along with moderate strengthening of the yuan - this may stabilise rising prices.

However, the CFLP report showed that manufacturers continue to report a high and rising cost of raw materials, particularly for cotton and rubber.

Contrasting fortunes

Data from other big Asian economies gave a more mixed picture.

Like China, India saw further growth in manufacturing in October, according to HSBC.

The bank's PMI for India rose to 57.2 from 55.1 the month before.

As with China, the expansion was fuelled by growing domestic demand, while exports remained relatively subdued.

South Korea and Japan in contrast showed further signs of a possible contraction.

In Japan - where the government warned last month of an economic standstill due to the strong yen - car sales fell 27% compared with a year ago, to their lowest October level on record.

The drop was in part due to the expiry at the end of September of a government subsidy for environmentally friendly cars.

Meanwhile, South Korea's manufacturing PMI, also commissioned by HSBC, fell to 46.7 in October from 48.8 in September, indicating that the sector's contraction steepened in the month.

While current exports have risen some 30% over the last year, the survey indicated that new export orders for Korean firms contracted in October for the first time since February last year.

Note, again, that China's expansion "was fuelled by growing domestic demand, while exports remained relatively subdued." The country is notorious for its export-driven economy powered by the cheap currency, condemned by some as one of the main culprits of global imbalance which is widely believed to give birth to the current recession. Unfolded in the recent PMI reports is, however, an economy transforming itself to extend domestic demand instead of searching for foreign markets.

Manufacturing activity also expanded in the world's largest deficit country, the US, in October. It's no doubt that the cheap dollar is playing a major part to enhance manufacturing through exports.

Manufacturing activity expanded last month at the fastest pace since May, driven by demand in the United States and abroad for cars, computers and other goods. 

The report signals that U.S. factory output, which slowed over the summer, remains a strong player in an otherwise weak economy. A separate report on Monday showed that manufacturing in China, the world's second-largest economy, also grew.

The Institute for Supply Management said Monday that its manufacturing index read 56.9 in October, up from 54.4 in September. It was the 15th straight month of growth. A reading above 50 indicates growth.

"This was a very positive report, and it suggests that the U.S. manufacturing sector is beginning to reap the benefits of the weak dollar," Eric Green, an economist at TD Securities, wrote in a note to clients. A weak dollar makes U.S. goods cheaper overseas.

Manufacturing helped drive the U.S. economy out of recession last year, but growth had slowed in recent months. The ISM's manufacturing index rose to 60.4 in April, the highest level since June 2004. The index had bottomed out at 32.5 in December 2008, the lowest since June 1980.

The jump in October could ease concerns that companies are almost through rebuilding their stockpiles — a trend that appeared to be slowing factory output growth in recent months.

"The U.S. manufacturing sector is getting a second tail wind," Green said.

Manufacturing activity in China also improved last month. A survey affiliated with the government said its measure rose to 54.7 in October from 53.8 in September.

Brian Bethune, an economist at IHS Global Insight, said China's growth is important for the U.S. economy. China's manufacturing sector is key to the rest of Asia's economy, and the region as a whole is a leading destination for U.S. exports.

Still, much of the U.S. economy's health depends on consumer spending and the gains in manufacturing can't be sustained unless that picks up.

The dollar has been weakened by the Fed's ultra loose monetary policy, sending the yen to nearly a 15-year high. A cheap currency surely helps boost exports,

which leads manufacturing activity to compensate for declining imports due to soft domestic demand. The US, along with the UK,  is on the way to rebalance the economy with benefit of weak dollars.

All results above indicate that rebalancing is under way among major economies, but questions remain on how to stop competition for cheaper currencies to keep afloat.

What Obama expects from China

One might see it as sheer coincidence that the US Treasury Department was scheduled to release a currency report in which China would be accused as a currency manipulator on the same day when China's Communist Party leaders meet to discuss the country's next five-year plan. But Treasury Secretary Timothy Geithner, again, decided to delay the release.

The U.S. Treasury Department said it will delay a report on international currencies, including China's, while citing progress in the acceleration of the yuan's rise.

The report will be delayed until after meetings of the Group of 20 nations in the coming weeks, according to a statement from the Treasury today.

Treasury Secretary Timothy F. Geithner "recognized China's actions since early September to accelerate the pace of currency appreciation, while noting it is important to sustain this course," according to the statement.

Geithner has increased pressure on China to allow the yuan to strengthen, saying last week the nation is contributing to a "damaging dynamic" of countries keeping their currencies weak to spur exports. Record imports from China are fueling calls by U.S. lawmakers for action to protect American jobs as next month's elections approach.

China's yuan has surged by about 2.8% from late July so far. Geithner's message is absolutely clear: we need more. You, China, appreciate the currency much more till the coming big events. At this point, time schedule is important. According to the Treasury statement,

The Heads of State, finance ministers, and central bank governors of the G-20 and the Asia-Pacific region will participate in several important meetings over the coming weeks. These meetings provide an opportunity to make additional progress on the important challenge of securing stronger and more balanced growth.

The Treasury will delay the publication of the report on international economic and exchange rate policies in order to take advantage of the opportunity provided by these important meetings. 

Hmm, let's check out the schedule.

The Treasury statement shown above implies that the G20 meeting, be it Finance Ministers' or Summit, is important for both the US and the world. But it's no doubt that Obama's priority lies in the US midterm election held in 2 November, which the Democrats are on the brink of losing amid increasing frustration for the administration's economic policy among the public. So, the de facto deadline must be 2 November.

China's Central Party Committee meeting runs through 15 to 18 October. Its main theme is to approve a new 5-year plan for the country. BBC explains:

The ruling CPC is expected to endorse a new economic model of "inclusive growth", a model that stresses not just on GDP growth at any cost, but on balanced development across the different sections of the society and different geographic regions.

A widening wealth gap is fuelling social tensions and threatening the power of the CPC.

So the conference will be discussing improved income redistribution and social reform. At the same time, international pressure is mounting for China to stimulate its domestic consumption rather than relying on exports.

The meeting is also expected to confirm Xi Jinping as the vice-chairman of the party's Central Military Commission, paving the way for him to succeed Hu Jintao as the next leader of China in 2012.

To achieve balanced economic growth, China might endorse another round of yuan's appreciation, which I think the Obama administration expects. We'll see next week.

Vice Chairman dissents

Janet Yellen said the super low rates would prompt risk-taking.

Janet Yellen, in her first public remarks as the Federal Reserve's vice chairman, said low interest rates may give firms the incentive to engage in excessive risk-taking.

"It is conceivable that accommodative monetary policy could provide tinder for a buildup of leverage and excessive risk-taking in the financial system," the 64-year-old central banker said in a speech today in Denver.

Yellen warned that Fed policies may in some cases be encouraging firms to "reach for yield" and could present officials "with difficult tradeoffs" if "emerging threats to financial stability become evident."

She was just sworn in as vice chairman of the Federal Reserve Board a few days ago, filling a void left by Donald Kohn who served the Fed for 40 years. Earlier this month, Steven K. Beckner of iMarketNews.com suggested that

Yellen has not spoken publicly in months, but hers has been a consistent voice warning about the dangers of excessively low inflation in a weak economic environment.

His assessment on Yellen is consistent with her yesterday's remarks. The question at this moment is; Why now? We have three weeks before the next FOMC, so there is ample time to discuss what to do at the FOMC. But Bernanke looks like sure to head for QE2, and inflation rates are not about to rise significantly for now. Donald Kohn would not dissent from chairman's idea. Is this the new vice chairman's way of steering monetary policy? I have no idea, but we have to see how they cooperate at the FOMC.

Two Nobels (hopefully) in the team

The 2010 Nobel Prize for economics was awarded to three professors; Peter Diamond of MIT, Dale Mortensen of Northwestern, and Christopher Pissarides of LSE.

Peter Diamond has, I think, been among the candidates since at least a few ago. The other two are a little bit surprising, but their pioneering work in search theory deserves the award.

Obama administration is having two Nobel laureates; Obama himself for peace and Diamond for economics. The problem is that Diamond's nomination to the Fed governor has been postponed by the GOP who thinks that there is a "mismatch" between his experience and the Fed's job. Can his theory solve this problem?