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What We Read Today 16 May 2014

Econintersect: Every day our editors collect the most interesting things they find from around the internet and present a summary "reading list" which will include very brief summaries of why each item has gotten our attention. Suggestions from readers for "reading list" items are gratefully reviewed, although sometimes space limits the number included.

  • How Narendra Modi can transform economy in 6 months (Swaminathan S Anklesaria Aiyar, The Economic Times) The title promises meat; the article delivers spun sugar. The main theme is that the new prime minister of India, Narendra Modi, has good listening skills and is a good manager. It seems that this author has little in terms of policy suggestions for his "6 months transformation". There is more about what Modi needs to address 'behind the wall' and in an article by Sanjeev Kulkarni at GEI Opinion.

  • New Rules of the Game for Chinaís Renminbi (Arthur R. Kroeber, Brookings Institute) Was the recent quick 3% depreciation of the renminbi against the U.S. dollar currency manipulation aimed at increasing exports? The author thinks not.
The answer is straightforward. China has taken a huge step towards making its exchange rate more flexible and market determined. In doing so, the authorities have clearly signaled their intention to switch from a monetary policy that mainly targets the exchange rate, to one that mainly targets domestic interest rates. The change in renminbi policy is thus part of a broad and ambitious financial reform strategy, reflecting the agenda laid out last November in the "Decision" published following the Third Plenum of the 18th Party Congress. It is all about improving China's macroeconomic management, and has little or nothing to do with boosting exports.
  • EUR/USD Weakens as Investors Gear Up for Fresh ECB Stimulus (James Hyerczyk, FX Empire) A few weeks ago the euro was pushing against 1.40 to the dollar. Now it is 0.03 lower and has not yet established a base. Read a detailed analysis by Cliff Wachtel to be published at GEI Investing later today.
  • Why China and Vietnam's Dispute Is So Ominous (Matt Schiavenza, International Business Times) Anti-China sentiment runs deep in Vietnam as the country has for centuries resisted, sometimes unsuccessfully, domination and even occupation, by China. This past week repeated riots attacked Chinese owned factories and other commercial facilities in Vietnam and Chinese nationals were forced to flee the country. The provocation is China's set up of an oil rig in the waters near the Paracel Islands. For background and a map see GEI News. The long bad history between the two countries casts a ominous shadow on the situation, but it could be even more ominous if China expands its assertive reach to other southeast Asia neighbors.

Today there are 12 articles discussed 'behind the wall'. The last one is a mini-article length discussion sectoral balance accounting relationships.

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  • 6 reasons treasury yields should be higher (Walter Kurtz, Sober Look) Kurtz says that interest rates should be higher because for the first time in years key indicators are all headed higher: Leading indicators, labor markets, small business sentiment, commercial bank credit, inflation and inflation expectations are both ticking up and housing permits have surged to a multi-year high. Two if the graphs are shown below.



  • Japan Is Desperate to Rescue Its Economy from an Early Grave (Dan Kedmey, Time) Japan will suffer an unmanageable economic contraction if the current population trajectory plays ou, driving the country from 127 million today to 87 million by 2060. An increase in the birthrate is unlikely to be sufficient to keep the population above the 100 million the government thinks is the minimum to be viable as a country. Japan needs to change a characteristic that it alone has in the developed world; it needs to raise its immigration rate.


  • A Beginnerís Guide to Repaying Student Loans (Ron Lieber, The New York Times) Many with student loans are behind on payments (1/4 to 2/3 according to some experts) and the author says for many they never should have gotten into this predicament. If you know anyone with student debt send them to this excellent article. If you know anyone contemplating taking on debt for college have them read this as well - it should make them think hard about how to keep debt as low as possible to begin with.
  • The Trick That Makes Google's Self-Driving Cars Work (Alexis C. Madrigal, The Atlantic) A Google self-driving car requires a digital map of every street, road, parking lot, etc. on which it will operate. This sounds like the ultimate big data scenario if the vehicle is to go everywhere.
  • Apple and Google End Patent Fights (Brian X. Chen, The New York Times) Sounds like they will be allowing each other to infringe on patents. If they do not give the same consideration to everyone else does this violate any anti-monopoly laws?
  • India Must Reverse Its Deindustrialization (Amrit Amirapu and Arvind Subramanian, Peterson Institute for International Economics) For many of India's states manufacturing peaked in the last century. The authors think that the years of declining manufacturing will be a difficult trend to reverse.


  • Triple Whammy Hitting Property Market, Investment Banker Says (Yu Hairong, Caixin) Ha Jiming, Goldman Sachs vice chairman for China, says aging population, rising prices and oversupply are causing the housing market slowdown in China. He says the trends are long-term and even aggressive urbanization efforts cannot change the direction now established for real estate.
  • The top ten global warming 'skeptic' arguments answered (Dana Nuccitelli, The Guardian) It turns out that the questions are mostly based on provably false premises. For example, one question is "If we don't know how much of recent warming is natural, then how can we know how much is man made?" The premise of the question is false because multiple researchers have publish just that data.


  • Five things the government needs to do to revive growth (ET Bureau, The Economic Times) This article indicates that beating inflation is the number one challenge for incoming prime minister Narendra Modi and connects that strongly to the fiscal deficit. While there may be some important relationships, the picture is much more complex than the article is able to convey in just a few words. In the two graphs below we can see a general trend correlation between inflation and fiscal deficits. See also a longer article at Project Syndicate which has more words but still wrestles with the sand contradictions.



The article:

*ties inflation to the fiscal deficit (sounds reasonable - more money, more inflation),

*ties high interest rates to high inflation, (sounds reasonable - lower future value of currency requires higher interest to compensate),

*ties high interest rates to lower consumption (sounds reasonable - consumers reduce use of credit when interest rates are high),

*ties high fiscal deficit to current account deficit (too complex a relationship for clear statement), and

*ties lower fiscal deficit to higher public savings (if we read this as higher savings by the public it is wrong).

With regard to the last bullet above, this is an argument based on the theory that public borrowing (by the government) "crowds out" private borrowing (by the private sector - which we think the ET has referred to as "public") [sorry for the confusing terminology, it comes with territory]. In the absence of private savings then investment is only increased by increasing private debt. If there is increase public savings (savings in the private sector) then there is less private sector debt for the same level of investment. This is gibberish if you do not have a good grasp of sectoral accounting (see below).

Note: Regarding the next to last bullet above, the current account deficit has two components, trade and monetary transfers (largely investment income related, combining transfers in from earnings of foreign investments by India and transfers out for income in India repatriated by foreign investors). This causes a complication relating government deficit to the current account deficit. The usual sectoral balance relationship (see discussion appended below) includes domestic investment and trade balance. For a more precise definition two modifications should be made. (1) The trade balance should be replaced by the current account balance (includes monetary transfers in addition to goods and services trade). (2) Domestic investment should be increased (decreased if negative) by the capital account which consists of all FDI (foreign direct investment in India) and all foreign investments by India. With these changes made (they are relatively minor) a more precise understanding of the fiscal tasks in front of India can be achieved.

Review of sectoral balance accounting (applied to economies with their own sovereign currency):

Y = C + I + G + (X - M) (Eq. 1)

where Y is GDP(national income), C is consumption spending, I is private investment spending, G is government spending, X is exports and M is imports (so X - M = net exports, an income component). Using words for the spending which produces the national income:

GDP = Consumption + Private Investment Spending + Government Spending + Net Exports

In simplified terms, GDP (national income) is the sum of domestic spending plus income received from abroad. Note: There are complications buried here: For one, net exports would more exactly be the current account balance which adds international money transfers to the trade balance.

A second equation can be written for the use of national income:

Y = C + S + T (Eq. 2)

where new terms are S, total saving and T, total taxation.

Combining Eq. 1 and Eq. 2 and rearranging we can obtain

(S - I) = (G - T) + (X - M) (Eq. 3)

In Eq. 3 there are two terms that one might think should be equal: S (savings) and I (investment). In this case they are not (necessarily) equal although it would be interesting to discuss the implications if they were (not pursued here). The term S (savings) is defined as what is left after subtracting total consumption and total taxes paid from national income: Whatever isn't spent is saved. From rearranging Eq. 2:

S = Y - C - T (Eq. 4)

The term I (private investment) is defined as what is left after subtracting private consumption spending, government spending and trade balance from national income (rearranging Eq. 1):

I = Y - C - G - (X-M) (Eq. 5)

Combining Eq. 4 and Eq. 5 produces Eq. 3 in case you have any confusion.

If savings equals investment then it is required that:

G - T = X - M Eq. (6)

In words, a government deficit is required if there is a trade deficit and a government surplus is required when there is a trade surplus when savings = investment.

Rearranging Eq. 3:

(G - T) = (X - M) - (S - I) (Eq. 3, rearranged)

If the net of the RHS is positive then the LHS is positive and the government is required to run a deficit. In such a case a trade deficit can only exist if - (S - I) is larger than (X - M) which means that I > S: the private sector is increasing debt.

Only if there is a trade surplus larger than - (S - I) can the government sustain a budget surplus.

If you want to reduce private debt then you must either increase government debt, increase (X - M) or increase the two factors in combination sufficiently. See Eq. 3.

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