US Recovery, Perhaps the Only Thing Left is Hope

Eddie doesn't seem to be getting much rest in Singapore these days. Now he's taking time out to examine the US recovery situation and the role of tech investment.

THERE'S a lot to hope for, it seems.

The Iraq war is over and the Sars virus subsided quicker than expected. There's relief all round. As United States Federal Reserve chairman Alan Greenspan testified before the US Congress last month, 'expectation for a pick-up in economic activity is not unreasonable'. And the maestro isn't just twiddling his thumbs while waiting for the forecast to unfold. In the past month, Mr Greenspan has engineered a startling drop in US long-term interest rates and a surprisingly large narrowing in the spread between all grades of corporate and government treasury bonds. What is remarkable is that he achieved this loosening of credit conditions before using his main tool, the federal funds rate.

Nobel Prize-winning economist Robert Solow was right when he reasoned in a Los Angeles Times article two weeks ago that, 'one of the good things' left is the US Federal Reserve's flexibility and 'its willingness to think outside conventions'. We are clearly in a unique situation.



The vexing question is: Why hasn't the large cut in interest rates boosted demand as it did in the past?

But first, it is necessary to correct an inaccurate impression. What seems to have been overlooked is that this long-awaited recovery in US investment has actually half arrived. Investment in technology is up, although the rest of manufacturing is still struggling. During the recent three quarters, US investments in computers and peripherals grew at an average rate of 26 per cent. The rate of investment in the first quarter of this year was 24 per cent higher than its previous all-time high reached during the peak of the Internet boom in the late 1990s.

The reason why the technology revival hasn't felt like a recovery in the US is that technology deflation remains vicious. While computers and peripherals are still being bought at a furious pace, they aren't worth as much, and what counts for the bottom line is the value of the investments. Unfortunately, average growth in monetary terms was just 9 per cent during the past three quarters. In fact, weak prices mean the value of investment in computers and peripherals is still some 20 per cent below the peak reached amid the Internet boom three years ago.

But Asia fared better, benefiting from the relocation of production and the outsourcing trend. Singapore's exports of electronics goods rose by almost 9 per cent in the recent three quarters, a decent turnaround after contracting 21 per cent in 2001. Exports of integrated circuits, in particular, jumped 30 per cent. Other Asian economies did better. Thai exports of high-tech goods have been growing an average 19.2 per cent since the middle of last year, while China's computer exports soared 54 per cent last year.

Mr Terence Tan, regional technology analyst with DBS Vickers Securities, says that while there were still some weak sectors in technology, like telecommunications, many Singapore technology companies actually made record profits last year. Unisteel Technology, which supports the disk-drive industry, enjoyed a 62 per cent rise in profits last year on the back of a doubling of revenues. Mr Tan says such companies did well because 'while downward pricing pressures are always present for technology products, this was more than made up by a surge in volume production'. The end demand for disk drives was 'exceptionally strong'.

But he's less optimistic about the outlook, saying: 'It will be hard to sustain already high growth rates.' In other words, this is probably about as good as it gets. Sure, investments in technology are likely to dip in the second quarter of this year and will be made up with a revival in the third quarter. But is it reasonable to expect a significant acceleration? Some of the weak sectors could see a pick-up in growth, but others will find it hard to replicate already robust growth.

So what is Asia waiting for in the second half of the year? Consider the implications of the diverging trends in technology investments. If the US is installing a lot more computing power, that suggests that businesses are still finding value investing in information technology. Quite likely, the rapid growth in productivity the US is enjoying will continue. But this doesn't guarantee that we will see a surge in growth soon. Instead it could suggest that downward price pressures will persist as productive capacity continues to outpace demand. Profitability for Asian manufacturers could come under pressure. The pie just isn't growing very quickly.

After 16 years of massive computer proliferation in workplaces, computer and peripheral manufacturers attract no larger a share of US gross domestic product (GDP) in spending than they did back in the days when singer Rick Astley topped the pop music charts and Ronald Reagan was US president - about 7 per cent of GDP. This trend isn't about to change and could get worse. In a survey of more than 600 chief information officers (CIOs) worldwide earlier this year, Mr Richard Hunter, a research fellow at technology research firm Gartner Inc, reported that, 'CIOs, after years of being asked to do more with more, are being asked in a serious way to do more with less'. The CIOs' top priority is to cut costs, says the survey.

It is going to take something pretty special in the second half of this year if the world is to get what it is waiting for. Perhaps it's better just to hope.
Source: Straits Times Author: Eddie Lee
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Things in Germany are Hotting Up

Two pieces from the FT today give a clear indication that we could have a long hot summer, followed by an even longer cold winter opening up in front of us. First the growing crisis in Germany's life assurance industry:

Germany's financial regulator on Thursday night sent a life assurer into insolvency for the first time in more than 50 years, after losing patience with Mannheimer Lebensversicherung. The assets and liabilities of the life assurance unit of Mannheimer, which is a prominent medium-sized insurer, will be transferred into Protektor, a pan-industry safety net that was set up last year to safeguard policyholders' investments. The move opens up the prospect of other failures among life assurers and is likely to shake up Germany's fragmented insurance sector, concentrating new business among the market leaders, such as Allianz and Munich Re. Analysts said that the move - which followed months of rescue efforts by the company and the GDV, the insurance industry association - was also a black day for chancellor Gerhard Schr?der and his plans to persuade Germans to invest for their own retirement, rather than relying on the state. Wolfgang Rief, credit analyst at Standard & Poor's, said: "For the integrity of the life insurance industry as a whole, nothing is worse than a negative image." Mannheimer's fate was effectively sealed on Wednesday, when the GDV failed to win the 90 per cent approval necessary from its members to launch a Euro370m ($428m) capital raising to which they would subscribe.

Previous attempts to secure a rights issue had been blocked by the company's shareholders, which include Munich Re. Analysts estimated that Mannheimer's failure would trigger a write-down of at least €25m for Munich Re, which had a 10 per cent stake in the group. Under the Protektor scheme - which has until now remained dormant - the customers of Mannheimer will continue to receive a statutory minimum return on their investments. Industry insiders said that the decision by BaFin, the regulator, to call a halt to rescue attempts followed the failure of last-ditch negotiations yesterday between Bernd Michaels, GDV chairman, and BaFin bosses. One person who is close to the regulator said: "We have been in talks for a long time. Finally, we lost patience." Analysts said that the stance was another show of force from a tough new-look regulator that has previously been saddled with a soft reputation. "Jochen Sanio [the head of BaFin] is definitely flexing his muscles," said one observer. In less than a week, BaFin has produced a damning report on the failure of risk controls at WestLB's principal finance unit as well as triggering Mannheimer's demise.
Source: Financial Times
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And now the growing argument over the lack of sympathetic ears:

The European Central Bank president told Germany on Thursday to live up to its fiscal promises and cut borrowing to boost investor confidence.Wim Duisenberg said the 2004 budget plan drawn up by Hans Eichel, finance minister, was a "cause for concern" because it would make government debts rise when they should fall. His rebuke came after Mr Eichel revealed plans that will require a steep rise in net new borrowing to €23.8bn, and are expected to lead to Germany breaching European Union budget rules for a second year.Germany's budget deficit in 2002 exceeded the 3 per cent of gross domestic product limit set by the stability and growth pact and is expected to do so again this year and next. The finances of the eurozone's biggest economy are expected to deteriorate further if Berlin brings forward €18bn of tax cuts next year.

Mr Eichel deflected questions about cuts until this weekend's rare conclave of ministers and coalition party leaders. Reacting to the plans, Pedro Solbes, the EU's monetary affairs commissioner, said Berlin could not count on the commission's support if fiscal rules were breached. But amid fears Germany's stagnating economy, already in technical recession after two quarters of contraction, could sink into a deflationary spiral, Berlin has little option but to ease budgetary reins to stimulate growth. Robert Prior of HSBC said: "It is the only weapon it has left . . . it cannot cut interest rates and it cannot devalue." But Mr Duisenberg said Germany needed "to do everything to generate confidence" to overcome its economic weakness. For that to happen, the government must stick to agreements.
Source: Financial Times
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The terrible incomprehension of Germany's problems revealed in the above is really staggering. I have a horrible feeling we are watching history in the making here. A great tragedy is about to come upon us, and we all seem powerless to stop it. To be sure there is no easy solution, but as Eddie indicated yesterday, sometimes in economics timing is everything, and this is not the time to pin down a German economy already hamstrung by euro commitments. (Come to think of it, why not ask some of the others to 'cough-up' for a change and send 'extra structural funds' back to Germany!!!). The only end-game here will be to instill the fear of god in an already highly risk-averse German population, and no good can come from that. It would almost seem comic to talk of a 'confidence' element here. What we need to do is avoid upping-the-ante on the 'panic' register. Because panic is what we may have to face if, after all the soothing talk that there is nothing to worry about, the combined 'best efforts' of Brussels, Frankfurt and Berlin fail to ease the Titanic back onto its course (or if you prefer trend growth path, although I hesitate to use that term since I fear that that is precisely what the German economy may already be on). It's the potential sense of impotency that worries me, and the associated rage which may then follow.

Should the Fed Have Gone Further?

The Economist asks the question that is on everybody's minds, and seems to come to the conclusion that, like the rest of us, on balance they're not sure. Its finger crossing time, but with plenty of downside risk.

So should the Fed have gone further, or will the latest rate cut do the trick? Answering that question is difficult, partly because there is some doubt about the Fed’s main objective in making the reduction. Before the announcement, which came at the end of the Fed’s regularly scheduled meeting, deflation was the word on everybody’s lips. A series of comments from the Fed chairman, Alan Greenspan, and some of his colleagues, had made it clear that the Fed is concerned about the risk of prices falling in the American economy. Economists and financial-market players expected that the Fed would justify any cut as a pre-emptive strike—what Mr Greenspan recently called a “firebreak”.According to its statement, the Fed remains concerned about deflation. It repeated the view expressed after previous recent meetings: that though the risk of a further fall in inflation is small, it is greater than the risk of a resurgence of inflationary pressures. That clearly implies the scope for further reductions in interest rates—and the Fed has taken advantage of that room for manoeuvre. Since inflation is likely to remain subdued for some time, the Fed’s continued emphasis on deflationary risks also implies that low—and possibly even lower—interest rates are likely to be a feature of the American economy for some time.

But the statement implied that concern about deflation was not the principal motive for the latest interest-rate cut. Instead, the main justification offered was the need for a more accommodative monetary policy to give a further stimulus to the economy. On balance, Mr Greenspan and his colleagues seem a little more upbeat about America’s economic prospects now than they did after their last meeting, in May. They noted some of the improvements signalled by recent economic data. But the Fed statement went on to note that the economy has yet to show signs of sustainable growth. Loosening monetary policy still further will, the Fed hopes, give further support to the recovery it believes is under way.

Of course, concerns about deflation and slow growth are closely interlinked. If the American economy were to slide into deflation, with prices actually falling, hopes for a sustained economic recovery would be dashed. Once prices start to fall, consumers and businesses postpone all but the most essential purchases. What is the point of buying something now if it will be cheaper in a few months’ time? It is easy to see how quickly the economy could slide back towards recession. Japan, in or close to recession for much of the past decade, is now experiencing its fourth consecutive year of falling prices. The economy is moribund.

Buoyant growth is one of the best defences against deflation. Persistent economic underperformance is a breeding ground for the economic phenomenon that last plagued industrial countries on a widespread basis in the 1930s. And that is why the Fed remains anxious about the American economy’s failure to gain momentum now. Since the recovery began, at the start of last year, there have been several false dawns. After 18 months or so, the economic signals continue to be mixed. The stockmarkets have become more optimistic lately—though they lost some ground after the Fed’s latest announcement. But business investment has yet to pick up in the way Mr Greenspan has consistently argued is essential for sustained recovery. And unemployment, at 6.1%, is currently at its highest level for nine years.
Source: The Economist
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Crossing the Gate of Deflationland


Right, I believe putting your money up on the table time is getting near. What is happening now in Germany is clearly a turning point of a kind. The big ship has struck rock, water is coming in, and no-one really knows how to plug the leak. Of course, suggestions abound, mainly of the structural reform kind. Others commentators suggest more aggressive monetary policy, and yet others relaxation of the growth and stability pact. In some measure all of these are necessary, the problem is to what extent, when and how? Most discussion seems to me to suffer from the shortcoming that they assume that Germany has for some reason (normally this remains strangely unexplained, but occasionally it is put down to the impact of re-unification on Labour prices: this is cleary one case where it is asumed that Harrod-Samuelson-Balassa hasn't worked), anyway, as I was saying Germany has come unhinged from a nice clean constant equilibrium path, and therfore what is needed now is the right policy mix to get things nicely back into place. The problem with this line of thought is that it may well in fact be the case that the German economy might is following some kind of 'equilibrium' path, just not a nice one, and one to which it may well revert after the impact of any government induced endogenous shock has subsided.

What I am suggesting is that we may be looking at all this upside down, or through its reverse image. What we take as divergence from normality, may in fact be normality as we are likely to know it, and what we may be trying to do is shift the path to an 'abnormal' and unsustainable one. (Now I know I don't believe in 'paths' in the naieve sense, but I think my meaning is clear: if not please hit me with questions). If that is so we will surely fail to correct a problem we have misunderstood whatever the medicine we apply. The difficult question is where to begin to peel this particular onion. In my book, unfortunately, EMU is part of the problem, not a route to the cure. Whatever else may be said, Germany needs unshackling from the euro. This I take is the point about loosening the growth and stability pact. Without the euro Germany would be free to sink or swim on its own terms. Like Japan it could commence a skywards run-up in government debt. This alone would not resolve anything. But it would open up the option of 'unconventional' monetary policy and fiscal stimulus to try and get the magneto to turn (imagine trying to get the EU institutions to agree to inflation targeting for Germany). Whether this would make and difference or not would depend whether at its advanced age, German society is capable of coming to terms with its identity problem and opening itself and its labour markets to the world. All this may sound very drastic, but it would be a shot, maybe a long one, and maybe the only one available. For make no mistake about it, the deflation which is already arriving will not be benign, and it will be extremely difficult to shake off. It will need courage, imagination and determination. There is no 'easy' solution, but we are still a long way from taking full measure of the problems which lie in front of us. Are our politicians up to making the change, that is the question?

Now over to Steven Roach and the Morgan Stanley crew who have been applying themselves to exactly these topics in a timely and interesting debate.

Stephen Roach: In a recent Forum dispatch ("Euro-Wreck" dated 2 June), I raised what I believe are some serious concerns about the state of the European economy, fearing that an asymmetrical shock in Germany could tip this key region into outright deflation. I also raised the related point that the EMU-based recipe of fiscal and monetary policy, which focuses on average performance in the euro-zone, may be inappropriate to deal with severe country-specific shocks in the region's biggest economy.

Eric Chaney:

There is an asymmetric shock in Emuland, and it's a big one. Your conclusions Steve are fairly consistent with my own (see State of Emergency Calls for Emergency Remedy, May 16, 2003) proposals: giving Germany (and only Germany) its fiscal freedom temporarily (this is possible under the Stability Pact provisions) under the condition of a complete overhaul of the wage negotiation system. These ideas have circulated among policy makers circles and somebody I met at the G30 last Friday told me: "It's a good idea, Eric, which makes a lot of economic sense, but — this is a big but — it is impossible to sell it to politicians". I will try again.

............the risk I see is that we are not witnessing just another recession. Instead, we might well be crossing the gate of Deflationland, without knowing whether this will be benign and temporary (maybe necessary, as Joachim thinks) or the first symptom of the “quagmire” described by Paul Krugman, the last thing Europe needs. In addition, I am very far from advocating a fiscal stimulus in Germany. I am just saying that circumstances are indeed exceptional and that Germany should only recover the full use of its fiscal stabilisers, instead of trying pathetically to plug gaps in order to get a satisfecit from Brussels. At the end of the day, Germany will enter deeper in deflation and have an ever bigger public deficit. That is the cruel lesson of the Japanese debt deflation. The Pact (this brainchild of Theo Waigel, as you had wittily named it, if I remember well), mentions an outright recession, measured on an annual basis, as a case for not capping deficits. I am sure that you would agree with me on the fact that what matters is not the annual growth number, but the cumulated change in the output gap. German GDP growth was 0.6% in 2001, 0.2% in 2002 and, on our estimates will be around 0% this year. Even assuming that German potential growth is only 1%, then the increase in the output gap since the end of 2000, will be 2.2% at the end of this year. If all that had happened in one year, it would have been much more spectacular and even our dear Mr. Solbes would have conceded “extraordinary circumstances.” The most unrealistic part of my story is to free up Germany while keeping France and others under the Caudine Forks of the Pact. Impossible to sell it to politicians, I am told in Paris. The law is Nash, not co-operative equilibrium. Don't ask me why, maybe because there is another law saying it is forbidden to be intelligent. That is why I think we will go to deflation, and live a re-foundation crisis. Either the EMU will break up, or we will be wise enough to re-think the macro management of EMU. The theoretical solution to cases of externalities is to create a market where the causes of externalities can be traded. A refunded and innovative Stability Pact would allow governments to trade “rights to pollute,” sorry, I meant “rights to run excessive deficits.”

Stephen Roach: What a great debate. The intensity of the exchange is very gratifying. It shows how much we all agree on the importance of this problem and the stakes it holds for Europe and the broader global economy. In the great spirit of free and open intellectual engagement that we have long cherished at Morgan Stanley, you certainly won't find the pabulum of consensus thinking in this group. While I don't pretend to have the final word, I would like to offer just one point of clarification:

The German-specific policy efforts that I support reflect my deep concerns over the risk of a serious asymmetrical shock that could quickly spread to the rest of Europe. They do not represent a wholesale retreat from the long-term discipline of EMU. But one-size policies do little to deal with the extremes that are now evident if Germany is treated the same as Ireland. I would welcome runaway inflation in the latter if that is what it takes to pull Germany away from the abyss. The American analogy that is often used to assess the stresses and strains of Europe is not appropriate. The United States of Europe is very different from the United States of America. California, America's largest state, accounts for 10% to 11% of the US economy. Germany is fully one-third of Euroland and accounts for about 30% of the cross-border linkages that knit Euroland together. As Germany goes, so goes Europe. The risk of a destabilizing shock in Germany is growing larger, in my view. As insurance against that risk, the rules of EMU should be temporarily suspended while Germany gets some powerful medicine. My sympathies to the "Irelands" of Europe, but under the circumstances I'm afraid that such a concession may be well worth the price.
Source: Morgan Stanley Global Economic Forum
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One Swallow Doesn't Make a Summer

Before everyone gets up on their seats and starts cheering, it would be well to bear in mind that in the same way that one swallow doesn't make a summer, one months good news on the US deflation front doesn-t mean the alert's over. Certainly looking at the US stock market this week you would think the recovery was, by now, a foregone conclusion. The reality is it isn't, by a long way. The markets are reaching the upbeat conclusion because it has to happen sometime, doesn't it. And with bags of stimulus, and historically super-low interest rates, that sometime should be now. But what if things are a bit different this time round. What if in a world where the number two and number three economies are mired in enduring low\negative growth problems and many other economies look extremely lacklustre, what if in this world things proved to be a bit out of the ordinary for the US too. Time, as they say, will tell.

A rise in lodging and housing costs pushed underlying U.S. inflation up in May at the fastest rate in nine months, the government said on Tuesday in a report that soothed deflation fears. At the same time, falling energy costs kept overall consumer prices steady. Separate reports showed heavy industry struggling last month, but the housing sector buoyant. The Consumer Price Index, the most widely used gauge of U.S. inflation, was unchanged last month, the Labor Department said. But the so-called core CPI, which strips out volatile food and energy prices, advanced 0.3 percent. It was the biggest rise in the core index since a matching gain in August last year.


The report showed prices a bit firmer than Wall Street had expected. Economists had looked for the overall CPI to drop 0.1 percent and the core rate to gain 0.1 percent. "The concerns about deflation will be softened after this number," said Rick Egelton, deputy chief economist at BMO Financial Group in Toronto. Stock prices initially rose as deflation fears eased, while Treasury prices fell as investors scaled back bets the Federal Reserve would act boldly to head off the threat of falling prices. The White House weighed in, saying deflation -- a decline in the overall level of consumer prices that can hobble an economy -- was not a serious worry at this time. In a separate report, the Fed said output at factories, mines and utilities edged up 0.1 percent last month after a 0.6 percent plunge in April. But industry continued to be burdened by idle capacity. The so-called capacity use rate held steady at 74.3 percent for a second straight month -- the lowest figure since June 1983. While the U.S. industrial sector struggled, a third report showed housing remained an economic bright spot. The Commerce Department (news - web sites) said housing starts rose 6.1 percent to a seasonally adjusted annual rate of 1.732 million units, slightly above analysts' expectations.

Core inflation had slowed sharply this year, fueling worry the economy could tip into deflation. But May's gain helped pull the 12-month change in the underlying inflation rate up to 1.6 percent, a tick above the 37-year low reached in April. The department pinned most of May's rise in the core index to a 0.6 percent climb in shelter costs, which include lodging away from home and the cost of housing for homeowners. It was the biggest gain in shelter costs in more than 12 years. Lodging costs rose a steep 4.1 percent, the largest gain on records beginning in December 1997. Lodging costs had fallen sharply earlier this year, a drop many economists attributed to a falloff in tourism ahead of the war in Iraq . Homeowners' housing costs, which account for more than one-fifth of the overall CPI, rose 0.2 percent after a flat April reading. Energy costs fell 3.1 percent, the second straight monthly drop, as prices boosted by war worries continued to ease. The cost of gasoline plummeted 6.8 percent and fuel oil prices slid 6.3 percent. Natural gas costs fell 1.6 percent.
Source Yahoo News
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Hong Kong: Plumming the Bottom of Deflation


Some pretty depressing news from Morgan Stanley's Denise Yam looking into the realities of deflation, Hong Kong Style.

Consumers are heading to shopping malls again as SARS is brought under control. Tourist groups are arriving again. Is it business as usual already? Far from it. Business volumes may be seeing a noticeable rebound, but the top and bottom lines are not, as deflation once again deepens in Hong Kong. Special promotions, which are not fully captured in conventional CPI statistics, suggest that we may be underestimating deflation and are overoptimistic on corporate earnings this year. The aftermath of the SARS crisis is yet to be fully reflected in the labor market. Higher unemployment and reduction in spending power can be expected to continue to haunt business receipts for some time to come.

A price-conscious consumer like myself can hardly recall many retail purchases in the last few months that did not come with special offers, discounts, free parking coupons or loyalty cash rebates. However, not all of these popular customer-luring offers are accounted for in the CPI. The data collection methodology traditionally involves recording the “ticket price” that is available to all customers, although the Census and Statistics Department has, recently, in response to the increasing dominance of discounted sales, tried to incorporate the adjusted prices to the extent possible. The price of an item is normally taken at face value, with a limited adjustment for bulk-buying / credit card discounts depending on the proportion of customers taking advantage of the benefit. Nevertheless, coupons for parking and other gifts still cannot be accounted for. On the other hand, surveys generally cover similar outlets every month, and therefore give limited room for consumers capitalizing on viable and sensible substitutions. It is not possible to estimate the “true” extent of deflation with the limited availability of data on the increasingly innovative consumer choices and complex consumption patterns. In our view, the official CPI, which posted a drop of 1.9% YoY in January-May, likely underestimates the broad improvement in living standards resulting partly from “special promotions” and the availability of lower-priced alternatives relative to household income trends. How representative it is of the cost of living is therefore questionable.

A price-conscious consumer like myself can hardly recall many retail purchases in the last few months that did not come with special offers, discounts, free parking coupons or loyalty cash rebates. However, not all of these popular customer-luring offers are accounted for in the CPI. The data collection methodology traditionally involves recording the “ticket price” that is available to all customers, although the Census and Statistics Department has, recently, in response to the increasing dominance of discounted sales, tried to incorporate the adjusted prices to the extent possible. The price of an item is normally taken at face value, with a limited adjustment for bulk-buying / credit card discounts depending on the proportion of customers taking advantage of the benefit. Nevertheless, coupons for parking and other gifts still cannot be accounted for. On the other hand, surveys generally cover similar outlets every month, and therefore give limited room for consumers capitalizing on viable and sensible substitutions. It is not possible to estimate the “true” extent of deflation with the limited availability of data on the increasingly innovative consumer choices and complex consumption patterns. In our view, the official CPI, which posted a drop of 1.9% YoY in January-May, likely underestimates the broad improvement in living standards resulting partly from “special promotions” and the availability of lower-priced alternatives relative to household income trends. How representative it is of the cost of living is therefore questionable.

Deflation has lasted for four and a half years - so far - in Hong Kong, longer than anyone expected, and does not seem to be coming to an end yet. Consumer prices, based on the composite CPI compilation, have fallen by 13.8% from the peak in May 1998. However, the CPI, though the most common measure of inflation / deflation, only represents a cost-of-living index for households according to the prevailing consumer spending patterns, with the weights updated every five years. The domestic demand and GDP deflators derived from the national income accounts, which gauge economy-wide price trends, on the other hand, have fallen 18.3% and 20.5%, respectively, from the peak in 4Q 97, suggesting how severe deflation had been in Hong Kong over the past five years following the collapse in the asset bubble. On the whole, prices have proved to be rather flexible in Hong Kong’s free market economy, and this flexibility is what is vital under the 20-year-old fixed exchange rate system that is often blamed as the cause of the asset bubble and the subsequent collapse and economic hardship.
Source: Morgan Stanley Global Economic Forum
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Whither Goes the 'Coalition of the Willing?


Just in case you were thinking that Bonobo was getting a bit low on economics content today, here's a really interesting piece from Stephen Roach:

On the surface, the policy bet isn't hard to understand. The world's major central banks are now taking dead aim at that once "nonexistent" risk - deflation.......American investors are taught, “Don’t fight the Fed.” Does anyone dare to confront the collective firepower of this international “coalition of the willing”?

Yet in the end, the policy bet may well be the weakest link in this daisy chain. History tells us that macro policy has had a truly terrible track record in dealing with deflation. That’s been the case since the 19th century but has been especially evident in so-called modern times. The worldwide deflation of the 1930s, to say nothing of the more recent Japanese experience, are grim reminders of stunning policy failures in dealing with this most corrosive of all macro diseases. Yet this time, we’re all being asked to believe it’s different -- that policy makers have learned the lessons of history and will never allow deflation to occur again. None other than Fed Governor Ben Bernanke -- the intellectual force behind America’s anti-deflation battle -- has said this in no uncertain terms. Recently, at Milton Friedman’s 90th birthday celebration, he honored the world’s most well-known monetarist by thanking him for showing us all the way. The “way” is Bernanke’s belief in the power of the printing press as the central bank’s antidote to deflation. It is at the core of the Fed’s purported last line of defense against deflation. It’s also as pure a monetarist prescription as you could ask for. Fed Chairman Alan Greenspan has echoed this confidence, boasting repeatedly of the Fed’s possession of the unlimited ammunition of monetary creation as the means by which the anti-deflationary battle ultimately will be won. It’s the ultimate compliment of a Friedmanesque view the world -- that fluctuations in the aggregate price level are first, and foremost, a monetary phenomenon.

The markets are up, and many an economic forecaster is joining the celebration. But a new note of caution is now in order: The same intellectual deception that was in vogue in the 1980s has returned with a vengeance. This is not the time to embrace the seductive promises of failed theories. Policy traction in a post-bubble and increasingly deflationary climate is not about the quick fix. That’s the lesson from history that keeps me awake at night. And yet that’s the very possibility that ever-bullish markets are now ignoring.
Source: Morgan Stanley Global Economic Forum
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