Geo-Graphics

The Governing Council of the European Central Bank meets on May 2, with a possible rate cut in the offing. Yet a rate cut is not the no-brainer the Bank’s critics often suggest, as today’s Geo-Graphic shows. The ECB’s official inflation-rate target is “below, but close to, 2%.” Both Portugal and Greece have inflation under 1% , but the transmission mechanism from ECB rates to business borrowing rates in those two countries has been virtually severed by the crisis. In short, they need a rate cut, but the ECB can’t deliver them one. In those Eurozone countries where the monetary transmission mechanism is still working normally—Austria, Finland, France, Germany, and the Netherlands—the GDP-weighted-average inflation rate is 1.8%, right near the ECB’s target. France, with 1.1% inflation and 10.8% unemployment, would appear a strong candidate for a rate cut, but not the others. Germany has 1.8% inflation and only 5.4% unemployment. The other three all have above-target inflation rates: Austria at 2.4%, Finland 2.5%, and the Netherlands 3.2%. Austrian unemployment is low, at 4.8%. Dutch unemployment is a moderate 6.4% Only Finnish unemployment is high, at 8.2%. Some will argue that a bout of robust inflation in the north is just what is needed to restore competitiveness in the south. But the ECB will have to willfully ignore its price-stability mandate if it is to justify a rate cut right now, and it will almost certainly need to apply more radical tools if it is to aid the south quickly. “The ECB is obviously in a difficult position,” German Chancellor Angela Merkel said on April 25. “For Germany, it would actually have to raise rates slightly at the moment, but for other countries it would have to do even more for more liquidity to be made available and especially for liquidity to reach corporate financing.” Yes indeed. This is Draghi’s Dilemma. Geo-Graphics: Is the ECB Draining Its Own Powers? Financial Times: Merkel Speech Highlights European Divide Reuters: Merkel Says Germany Would Need Rate Rise Wall Street Journal: Bleak Europe Data May Prompt ECB Action

Paul Krugman recently dismissed concerns about America’s large international debt.  “America’s debtor position,” he writes, “isn’t actually that deep, because of capital gains.” When Krugman talks about “America’s debtor position” he is referring to the net international investment position (NIIP), which is the difference between the value of the U.S. portfolio of foreign assets and the value of the foreign portfolio of U.S. assets.  Krugman demonstrates that the NIIP is fairly flat over the period 2002 to 2010, which presumably shows that concern over U.S. debt is uninformed or disingenuous.  Or does it? As with Krugman’s “Icelandic Miracle” posts, his conclusion is just an artifact of the starting and ending dates he chooses.  In today’s Geo-Graphic above, note what happens to the trend line when Krugman’s data are brought up to date – adding the data, which he had easy access to, for 2011 and 2012.  Now, the trend is decidedly downward – considerably worse than his. And what about when we back up the starting date to the mid-1980s, as we do in our graphic?  Now we can clearly see the effect of Krugman’s chosen data period – it wipes off the steep decline in U.S. NIIP before 2002 and after 2010. Note that in 2009 the U.S. portfolio of foreign securities, which is riskier than the foreign portfolio of U.S. securities, outperformed the foreign portfolio by such a significant margin that the NIIP shrank by nearly $1 trillion – this despite the fact that foreigners continued to buy more assets in the U.S. than the U.S. bought abroad.  This is captured in Krugman’s data.  But in 2011, which Krugman leaves out, this U.S. outperformance was reversed and then some: the NIIP deteriorated by a whopping $1.6 trillion, bringing the NIIP to a record negative $4 trillion.  It continued further down to a record negative $4.4 trillion in 2012. Which all goes to show that not all graphics are as reliable as Geo-Graphics . . . Krugman: America the Debtor Wall Street Journal: For U.S., Big Foreign Investment Is a Mixed Blessing Chart Book: Foreign Ownership of U.S. Assets BEA: Quarterly and Year-End Update on U.S. Net International Investment Position

Prominent economic commentators have argued the cases for significantly weaker currencies in each of the world’s major economies – in particular, the United States, the eurozone, Japan, and the UK. As these four economies represent over half of the global economy, it’s clear that they can’t all accomplish this feat. It’s also far from clear that they should all want to. Take the UK, where the FT's Martin Wolf has led the charge for “further depreciation of the real exchange rate.” John Maynard Keynes, belying his reputation as a devaluationist, had argued passionately against a weaker pound in 1945 on the basis of terms of trade: that is, the UK would, broadly, have to give up more domestic goods in return for the same quantity of foreign goods. “In [our] circumstances, you can’t imagine anything more foolish,” he said, “than to be trying to sell [our] exports at quite unnecessarily low prices.” Today he might highlight inflation. As shown in today’s Geo-Graphic, currency depreciation is likely to have a much more adverse effect on inflation in the UK than in the United States, the eurozone, or Japan, owing to much higher imports relative to GDP. UK consumer price inflation is already running at a relatively high 2.8%, and the Bank of England’s own analysis suggests that a 20% sterling depreciation risks pushing the price level up 6 percentage points higher than it would otherwise be. Steil: The Battle of Bretton Woods Bank of England: Inflation Report February 2011 Wolf: Weaker Pound Is Welcome but No Panacea Financial Times: Weakening Pound Raises Stagflation Fears