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What We Read Today 07 January 2015

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 (and sometimes longer ones) 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.

Euro hits nine-year low as Brent oil goes below $50 (Jamie McGeever, Reuters)  Another day, another 5%.  Brent crude crashed through $50 in Asian and early European trading.  If the Brent price holds at $50 or below the U.S. price for WTI crude could approach or break through $45 today.  The 2008 low around $32.80 keeps getting closer.


UK pension deficits double to more than £100bn (Josephine Cumbo, Financial Times)  Unusually low interest rates used to save banks from "facing the music" are causing may problems elsewhere.  The latest is pension deficits at the UK’s largest companies nearly doubled over the past year to exceed £100bn.


'Alien Earth' is among eight new far-off planets (Jonathan Webb, BBC News)   Nasa's Kepler space telescope has increased its count of "exoplanets" above 1,000.  Eight new planets have been added to the list.  Three of them are in what is called the "habitable zone" of their host star.  One of these is extremely close to earth  in many characteristics including temperature and has become the new holder of the title "most earth-like".  Our new closest twin is called Kepler 438b and displaces Kepler 186f as the "closest to being a twin". 


Articles about events, conflicts and disease around the world

Eurozone

Greece

Italy

France

Nigeria

Turkey

Syria

Iran

Russia

North Korea

Japan

An Analysis of the Appreciation of the Chinese Renminbi Through the Lens of the the Nixon Shock, the Plaza Accord, and the Japanese Yen (Lee Jackson, Department of Economics, Stanford University)  Note that China went through an extreme devaluation of the yuan renminbi from about $0.70 in 1980 to about $0.12 by 1994.  This corresponded to the start (with about 2 years offset) of the rise of the trade surplus for China with the U.S..  See second graph below.  This dramatic devaluation created a currency that was undervalued by accepted analysis methods - see next article.

yuan-dollar-1980-2011

china-and-japan-bilateral-trade-balances-with-us-1955-2003


China's Currency Policy: An Analysis of the Economic Issues (Wayne Morrison and Marc Labonte, Congressional Research Service)  The devaluation of the yuan renminbi from $.70 to $0.12 created a significant undervaluation for the Chinese currency, as shown below.  In early 2009, instead of the $0.14 exchange rate, a free floating yuan should have been (theoretically) around $0.20 according to the estimates quoted in this paper. However, in April 2013 the correct valuation for the yuan would have been $0.16 instead of the actual $0.15 at that time.  The undervaluation of the yuan introduced by 2005 had been largely "worked out" by early 2013. And the strengthening has continued as discussed below.

yuan-undervalued-2008-2013


China’s Yuan Has Hidden Strength (Alex Frangos, The Wall Street Journal)  Because two of its three largest trading partners are Europe and Japan, and because both of those currencies have depreciated so much, the yuan renminbi has appreciated on a trade weighted basis by more than 13% over the past two years (nearly two years - last data her is through November 2014).  The U.S. dollar (on the same basis) has appreciated by 6% through November 2014.  Frangos suggests that a weaker yuan might be considered to help China maintain its high level of exports.  He gives reasons why this might not happen, but does not mention what might be the most important:  a strengthening yuan supports the stated objective of rebalancing the country's economy to a higher level of domestic consumption.  This consideration is discussed further below.

yuan-strength-trade-weighted-2013-2014


Will the RMB Enter A New Round of Depreciation? (Yi Xianrong, China US Focus)  Since the Chinese policy is to regulate the exchange value of the yuan renminbi to remian close to a constant exchange rate with the U.S. dollar, the rapid appreciation of th dollar has presented some specific issues for that country.  The are summarized by Yi as follows:

The issue now is how the Chinese government will weigh the following issues. First is the internationalization of RMB. Since the beginning of this year, RMB internalization has been very fruitful: Britain issued RMB-denominated sovereign bonds, RMB can now be directly converted into Euros, and China signed currency swap agreements between Russia, Canada, and other nations. Because of these agreements, the amount of yuan used in global trade settlements has gradually increased. Without a strong RMB, the yuan will be unlikely to go global. This is why RMB gradually appreciated after its sudden and sharp depreciation in the first half of the year.

Second, if RMB only becomes strong when the U.S. dollar is, the weakening of non-dollar currencies like the Japanese yen will then have a severe impact on China’s export margins. According to China’s recent import and export data, lower exports can lead to a lower trade surplus and, in addition, the overall economic environment can weaken, all of which are unfavorable factors to the maintenance of a strong RMB. Even if RMB does not face a risk of big depreciation, the pressure of its depreciation is rising.

Third, with the gradual appreciation of RMB, international hot money again began to flood into the Chinese market. In order to curb another inflow of international hot money into China, which could cause the prevalence of arbitrage investment with the help of RMB appreciation, China’s central bank is likely to intervene again as it did in this February so as to let RMB depreciate to some extent to fight off the speculative investment.

Fourth, above all, whether RMB depreciate or appreciate lies in how to guarantee the China Central Bank monetary policy initiative. It can be seen that China’s monetary aggregate is not only the largest in terms of scale, but is growing faster than the other major global economies. Its main reason differs from that of the developed markets in the United States and Europe. Europe and the U.S. often expand its monetary aggregate by lowering their benchmark interest rates and purchasing bonds to expand the monetary base. However for China, buying foreign currencies was the major channel through which China enlarged the monetary base in recent years. The China Central Bank monetary base expanded through buying foreign exchange stands as China central bank’s “outstanding funds for foreign exchange.” By the end of 1999, China central bank’s outstanding funds for foreign exchange was RMB1.40 trillion and rose to RMB26.43 trillion by the end of 2013, increasing by nearly 19 times. Outstanding funds for foreign exchange account for 83.3% of China Central Bank’s total assets. It is where the asset structure of China central bank differs most from that of the other central banks
.

Yi suggests that the solution for the rise in the value of the yuan is to allow less control and therefore more depreciation through market forces so that the Chinese currency will better react to changing conditions of the global markets to which China exports.  What Yi does not discuss in this piece is how an appreciation of the yuan strengthens domestic purchasing power, offsetting weakening exports and playing into the avowed strategy of increasing domestic personal consumption toward the developed world median above 50% (currently around 35% for China compared to the U.S. around 70%).

Of course it is not only exports that will need to decline if personal consumption is to increase by say 20%.  For China, exports are more than 26% of GDP, about double the 13.5% for the U.S.  If China were to move closer to the U.S. (say to 15%) then there would still be another 11% of GDP to be taken from another sector to reach 55% personal consumption.  That sector would be investment, the largest GDP component for China.  In 2013 that was nearly 55% (see next article) compared to 15% in the U.S. (which is may be too low - it was about 18% in the late 1990s).  Just returning China's investment to about 42% of GDP (the amount in 2007)combined with a reduction of exports to the upper teens would be more than enough rebalancing to see private domestic consumption reach and even exceed 55% of GDP.

The above discussion goes far beyond the issues discussed by Yi and we feel these points go to the heart of what China is facing today, which is far more than trying to maintain a high level of exports.  In fact, establishing a monetary policy aimed at supporting export industries could well be more than counterproductive - it could be very damaging to China over the period of the next decade and beyond.

China’s investment/GDP ratio soars to a totally unsustainable 54.4%. Be afraid. (Mike Ridell, M&G Investments)  The point here has actually be discussed much over the years and that is that the magnitude of growth is not the important factor but the productivity component of that growth.  The productivity factor is what determines sustainability of growth.  And unsustainable growth for which a continuation is attempted without appropriate rebalancing can lead to collapse.

Click for large image.
gdp-vs-investment-600x480
 

(What’s Left of) Our Economy: Will China Repeat its VAT/Currency Shell Game? (Alan Tonelson, Reality Chek) Tonelson points out that direct devaluation of the yuan renminbi is not the only adjustment that could be used to improve export competitiveness globally.  China could also do something else which would have the same effects on the domestic consumption/export ratio as a weakening of the yuan.  This would be to implement VATs (value added taxes) which would be rebated on all exports.  This would raise the price of goods domestically (as would devaluation) yet allow exporters to nominally deal with a "full value" currency at lower profit margins (or possibly even losses) and get kickbacks for the favor which would keep their accounting in the black.  He points out this type of maneuver was used by China during the Asian crisis of 1998 and was praised by the U.S. for "responsible action".  Clearly, in light of China's stated rebalancing objectives it could not be considered responsible now (unless there is such a thing as a responsible hypocrite.  And isn't this what Japan just did earlier this year?  And didn't that have a crushing effect on domestic consumption growth?


Why Have Dividends been Low the Past Few Decades?  (Ed Easterling, Crestmont Research)  See next article for additional information.

See original page at Crestmont Research.
dividends-pe-crestmont-2015-jan-06


Historical P/E Ratios (Ed Easterling, Crestmont Research)  Ed Easterling has contributed to GEI.  The Crestmont P/E is normalized to the mid-point of P/E across each business cycle and thus provides current insight to expected P/E behavior going forward subject to correct assessment of position in the current business cycle.  It turns out this process yields a result that has a "rough" similarity to the Shiller P/E 10 which uses a fixed time average (10 years)  to smooth business cycle variations.  Referring to the preceding article, P/E has been much above historical levels which means that the low dividend rates in recent decades correlate with the historical relationship with P/E back to1900.

pe-crestmont-shiller-2015-jan-06

Other Economics and Business Items of Note and Miscellanea

What the GOP Could Really Do to Obamacare This Year (The Fiscal Times)

How big is the sexism problem in economics? This article’s co-author is anonymous because of it (Quartz)

Oil Prices Again Buck Economists’ Expectations (The Wall Street Journal) If the "experts" were correct at the beginning of December when oil was around $60, it would have been well above $60 now.

Understanding Bitcoin: Cryptography, engineering and economics by Pedro Franco [Review] (International Business Times)

Fed Names Thomas Laubach New Head of Monetary Affairs (The Wall Street Journal)

The economics at the heart of Israeli settlements (Middle East Eye)  Israeli settlements in the West Bank are fracturing Israel’s relationship even with its allies.

Effects of Intellectual Property Rights Protection and Integration on Economic Growth and Welfare (Economics E-Journal)

Mortgage Affordability (Center for Economics and Business Research) Many holders of variable rate mortgages in the UK are headed for trouble.



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