Retort To A Good Economist

August 10, 2005

Most economists whose opinions are promoted, or are used to defend public policy, are very shallow, faulty, suspect, and compromised. That has been my opinion for years. Here my usual fare of harsh criticism will soften into mixed criticism. Instead, take the opportunity to give credit to two economists whose work has been made available and is refreshingly adept. Lakshman Achuthan and Paul Kasriel are two excellent economists. Achuthan comes from the Economic Cycle Research Institute. He makes only a few contributions to the websites, most of which reflect solid theory, but with an occasional defense of some mainstream traditional theoretical heresy. Recently he put forth an article to describe "An Unusual Recovery" with numerous factors and relevant effects. Paul Kasriel hails from The Northern Trust Company. He makes more frequent contributions to the websites, full of graphics, which permit readers to learn for themselves and see the proof. Recently, he and colleague Asha Bangalore questioned the US Federal Reserve wisdom under Chairman Greenspan. He believes they might be "Bent on Inducing a 2006 Recession" with not one, but two statements to that effect. This pair of Northern Trust economists makes sound arguments to dispute the Greenspan policy, thought process, and risks from error. They take him to task, and cite downright fallacious claims made by the Good Chairman inflationist before the US Congress. It is my view that Greenspan is a second rate economist, improperly raised to godlike icon status.

Focus here on Achuthan, who has provided numerous generous interviews on the business networks. CNBC interviews are little more than extended sound bites, where certain headlines can be stated, backed up merely by brief arguments. Before they are permitted to conduct a serious point versus counter-point, the segment ends. Twenty minutes are required to adequately cover a given topic of substance, more like what Lou Dobbs grants on CNN. In his article cited above, dated July 28, Achuthan covers a spectrum of issues worthy of discussion.

Achuthan stands out among others in pointing out how the explosion known as "globalization" produced price deflation in "tradable goods and services" despite another explosion, that being of monetary expansion. Most economists focus entirely on low-cost solutions, and the benefit to consumers in money saved. I might add that the monetary and fiscal (federal) stimulus has been gargantuan, not cited by Achuthan, so large in volume that a great many good analysts have incorrectly expected for price inflation to result. It has in every past episode, first the flood occurs, then the entry into pipelines, finally end product prices all rise along with worker wages. This time is indeed different, and Achuthan implies that Asian manufacturing in a "tsunami" is responsible for engulfing the monetary effect. One should take a lesson as a student from this point. The human response on monetary inflation is overwhelmed by the natural economic force of Asian industrial overcapacity! Asian factories snuff out the domestic inflation attempt, since the US system has exported that inflation. The US inflation succeeded mainly in the housing market, which could not be exported. It is like most of the US monetary surge was sent to Asia, where it passed through an industrial filter, and returned transformed to the US Economy in the form of cheap finished products. This entire concept was explained in "Export Inflation, Import Deflation."

Achuthan makes a fine parallel with the dotcom boom in 1999 and the housing boom today, something I have referred to in the past (with my 19 itemized parallels). The mild recession was due in his opinion to that dotcom boom lessening the impact of the 2001 recession. He talks of importing deflation. He recognizes the simultaneous monetary influence (he calls it "cyclical upswing") upward in prices, countered by imported price deflation to bring about a tranquil pricing structure. What he overlooks is what I call "cost inflation" whereby most materials, supplies, commodities, energy products, and foodstuffs have risen in price. On the opposite side, the price which producers are able to sell the finished products are massively influenced by the imported deflation. A profit margin squeeze has occurred, unaddressed by Achuthan, which might be responsible for some of the flattening in the Treasury bond yield curve. Tranquil? Since when is a profit squeeze evidence of tranquility? Add rising health care costs and payroll tax contributions paid by employers, and you have a toxic environment for job growth. This factor is far more prominent to "checking growth in both jobs and wages" than his cited productivity factor.

Achuthan credits strong productivity incorrectly again, in my opinion. Let's be plain. Most mainstream economist earn a "D" grade on productivity comprehension. This topic, with inflation, stand head & shoulders above other topics as primary areas of confusion, poor theoretical grounding, outright deception, with serious downstream consequences from that erroneous base. He believes productivity has resulted in boosting corporate profits. I believe extraordinary money supply growth, extremely accommodative low interest rates, and pathetically easy vendor financing has brought about bigtime growth in corporate balance sheets. The financial sector and financial subsidiaries own the lion's share of that profit growth ending up in balance sheets. Any benefit from the "imported" productivity on corporate profits is severely undermined by the export of the entire supply chain associated with what is imported from Asian factories. Therein lies job loss, flat wages, and the near total destruction of the entire labor union movement.

Achuthan puts productivity with other very relevant factors which reduced long-term interest rates. In no way does productivity directly factor into low price inflation expectations. Indirectly, sure, but only by means of the items stated above pertaining to Asian outsourcing. We share some of what I label the Bond Amigo factors. Although reduced corporate borrowing needs would assist in keeping down the long-term Treasury bond yield, the more important effect is that it would keep down the Treasury-corporate yield spread. In my analysis, labor surplus (considering Asia) and not strong productivity continues to keep both job growth and wages. He acknowledges the importation of price deflation from Asia. However, the simultaneous imported productivity from Asia is overlooked! Of course productivity kept down the price of labor in the US Economy. The US workers were abandoned! The output from foreign labor was imported. Therefore so was the associated productivity. Only Stephen Roach of Morgan Stanley openly discusses imported productivity, from what I read in the available internet journals.

Achuthan does not subscribe to the popular notion that higher energy prices will be part of the larger equation of higher prices for end products. He did not address the issue here. In past cycles, the US Economic was more a closed system. As material prices rose, all prices rose. The Federal Reserve monetized higher energy prices in the 1970 decade. The USFed has been monetizing everything under the sun since 2001. Many economists, not Achuthan, have fallen into the price pipeline trap with everything getting pushed along. In this decade, as he adeptly points out, China has interrupted the normal cyclical process.

Achuthan calls it a silver lining, wherein low mortgage rates are likely to keep housing prices aloft. Consumer confidence is tied to housing, as he states. Such confidence has a longer history of being tightly correlated to the S&P stock index. This phenomenon has been clear since the entire 1990 stock boom. Confidence is double edged. Consequently, he believes the economic expansion will continue in coming months with resilience. I disagree. In this kneejerk forecast assessment, he stands in sharp contrast to Kasriel, who directs focus on the rising interest rate climate. What about the flattening yield curve? What about the flattening Treasury versus Fed Funds rate spread? The man from Northern Trust sees a slowdown from the indicators he cites, not cited by Achuthan. There is not much to critique about Kasriel. In my view, Paul Kasriel is among the premier economists who make their analysis publicly available.

Achuthan latches onto the tired old factors limiting Eurozone development, monetary and fiscal strictures. Too easy. He refers to the European Monetary Union guidelines on 3% limits for federal deficits. Heck, the EU economy was humming along at 2% for several quarters until the euro currency exchange rate grew to become a problem. It has been my contention that GDP growth in the EU and USA had been nearly equal for two years. We in the USA lie through our teeth with hedonic adjustments to lift GDP by a false 1%. We lean quietly on a pathetically low unrealistic GDP Deflator (off by 2% more), which has the net effect of not reducing much of ANY nominal price inflation. Turn off the deflator, and watch the GDP rise wrongly. See "Three Great Big Lies" for some details on how much US claimed economic growth is merely untreated price inflation. The euro currency had risen from under 100 in late 2002 to over 130 in late 2004. How could that be overlooked? That essentially killed off much of European exports in a svelte swoop. We in the USA tend to forget that some nations in the Western world actually possess an export trade, led by Germany. One factor almost singlehandedly pushed the EU economy into recession, or onto its edge, and that was the rising euro.

Lower bond yields in Europe have done little for their economy, as he says. That is because, despite a housing boom on the continent, they do not participate in lunatic home equity extraction abuse like their North American counterparts. Conversely, the Europeans do not live with the risk of negative home equity like we do, should housing prices go into decline. As Kurt Richebächer stated to me, "Americans have two blind spots, currencys and macro-economics." Achuthan misses the entire currency factor. Low rates lift US economic activity because of zero percent finance deals and household willingness to extract equity from homes to spend stupidly. Recall that most 0% deals in the United States are to purchase a depreciating asset! Europe stagnated instead. Achuthan, like most US economists, does not realize how lower bond yields actually slow an economy, as it works both ways. Almost twice as much bond income is generated as interest payments are made on an aggregate basis.

A glaring heresy is hidden in another comment. Achuthan implies that an upturn in industrial growth might negate the key cyclical factor keeping inflation down. This is pure heresy. Growth does not cause rising prices; reckless money and debt growth do. Growth on the demand side is accompanied by growth on the supply side. American economists fall victim to this absurd notion, as though they slept through the college monetary inflation course in its entirety. This clownish notion has a corollary heretical NAIRU notion, such that if the jobless rate falls too low, price inflation will rise systemically. Pure rubbish.

Achuthan lastly puts a seal of approval on yet another adolescent economic practice, one pertaining to the "soft indexes." Who cares about sentiment? It takes care of itself when the valid and meaningful factors are aligned properly with health and progress. Consumer expectations, business expectations, consumer sentiment, confidence index, what a boatload of crappola! These mental snapshot images have supplanted legitimate measures like debt growth, debt-asset ratios, size of the manufacturing sector, business investment, savings rate, trade deficits, foreign TBond ownership, and more.

Achuthan dismisses the narrowing yield spread to claim a recession this year is unlikely. What about early 2006? I thought an economist enlists for the job of forecasting five or six months forward, which would take us to January. By dismissing the yield spread warning, Achuthan has sidestepped one of the most reliable recession indicators. Kasriel points to it, displayed here with my own personal label touch. It highlights the spread between the 10-yr TNote yield and the Fed Funds rate dictated by the US Federal Reserve. A couple more numbnut hikes by the Greenspan Fed and the signal of 2006 recession will be loud & clear. The key spread would reach the critical stage. Or should we lean on consumer sentiment???

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