High inflation, low inflation

China's central bank just announced a surprise increase of interest rates to help rein in the inflationary pressure.

It said it was raising benchmark rates by 25 basis points, taking one-year deposit rates to 2.5 percent and one-year lending rates to 5.56 percent.

Consumer-price inflation has already crossed above Beijing's 3% target for 2010. In August, the annualized rate was 3.5%.

Over here in the U.S., the opposite has been the case. The core consumer inflation rate is hovering around 1%, and maybe heading lower. In the face of slow growth, deleveraging, and high unemployment rate, this is alarming. Because the economy may be headed for deflation, when prices for goods and services are trending lower in general.

In other words, the economy is too "cold" in the U.S. and too "hot" in China. And higher interest rates in China may serve to attract even more hot money. On the other hand, the Fed's easy money policy would potentially add more liquidity to the world economy, much of which would find its way into China's asset markets, causing more inflationary pressure.

China has so far been quite successful in controlling credit expansion and contraction using adminstrative means, in order to maintain its currency peg to the US dollar. It's perhaps time to change that practice to help balance the world economy. A stronger yuan can help China take on more leadership role.

How can QE help the economy?

The Federal Reserve chairman Ben Benanke's latest speech has made it clear that both the current high unemployment rate around 10% and low inflation rate are inconsistent with the Fed's dual mandate. Therefore further action is appropriate.

Another round of "quantitative easing" (QE) is now widely expected by the market. How much and exactly in what form remain to be seen.

Has QE been successful? How does it help create jobs? Why do we need more large-scale asset purchase by the central bank? Should the Fed be even more aggressive?

Here is an old paper by Joseph Gagnon at the Peterson Institute for International Economics that helps answer some of these timely questions.

QE and global liquidity probblem

The sluggish recovery in the U.S. economy is prompting the Fed to refocus on "quantitative easing" (i.e., buying more long-maturity securities to lower the borrowing costs). That may serve to flood the financial system with even more liquidity. Professor Joseph Stiglitz talks about the potential consequences:




The Fed’s move towards more quantitative easing, conveyed in its recent policy statement issued in September, follows Japanese intervention to weaken the yen and Swiss National Bank actions aimed at its currency.

Increasing exports by weakening the dollar is one channel by which the easing could boost the US economy. But it is impossible for every country to weaken its currency and export its way to higher growth at the same time. So we're looking at the competitive devaluation scenario of global currencies. This is one of the most strong supports for gold prices. More QE would mean even higher gold prices, unless we enter into another recession.

The Fed is facing another major conundrum, not unlike the one faced by Mr. Greenspan back in 2005. Back then, the global "savings glut" was seeking outlets in the U.S., pushing the yields ever lower for the long-term assets. The liquidity found its way to private equities and the real estate market, which led to the financial meltdown of 2007-2009.

The money supply has never gone away. And the Fed is adding to it.

More easing may do very little as the rates are already very low and there aren't many credit-worthy borrowers. On the other hand, there isn't any other option for the Fed to counter deflation risk in the face of high unemployment and consumer deleveraging.

The economy is sick, and drinking more liquid may not help.

It was over

So said the NBER today. The recession was over in June of 2009.

That was when my family was getting ready to move across the country, from the West Coast to the East. It didn't feel that way, although the market was on a rebound and GDP started to go positive.

For us, it took more than a year since then to finally have a sense that our lives are getting back on track, after we bought our house in August.

We've just moved in. Our new neighbors are getting to know us and vice versa. We're receiving welcoming notes and cookies. Our kids are already making friends with the kids in the neighborhood. There are doctors, engineers, businessmen, pilots, professors... mostly professionals. Interestingly, almost half of my neighbors are fairly new to the neighborhood. There have been a lot of turnovers. The new families will be fostering a sense of new community, I think.

But the lingering affects of the recession are visible. Home prices are still dropping... and just as we moved in to our new house, a house across the street was put on the market for sale. Its owner just had a surprise job change. Another home owner told me that he is closing down his business.

I'm still glad our moves are finally over.   

Education and Unemployment Rate

Laura Tyson, my former dean at Haas School of Business, wrote an op-ed piece on NYT in which she argues for a second stimulus spending. Her arguments are inline with some of the discussions I've read from Paul Krugman and Joseph Stiglitz. These practicing Keynesian economists are all for government intervention. So that's not surprising.

What's kind of surprising is she would say things like worrying about deficits and the size of the government is focusing on the wrong things. Wrong things? She probably meant wrong focus.

The statistics she cited about education and unemployment rate is very interesting:

Consider how the unemployment rate varies by education level: it’s more than 14 percent for those without a high school degree, under 10 percent for those with one, only about 5 percent for those with a college degree and even lower for those with advanced degrees.

Education in the U.S. does help cushion workers against the general and severe downturn. This is consistent with the outsourcing movements over the last decades: low-paying jobs that require little or no education moved mostly to countries like India and China. What U.S. should do is indeed to make college education more prevailent among its population of over 300 millions. But that cannot be accomplished in a few months or a few years.

In contrast, college degrees in China may not mean high level of employment. I have not seen any good statistic, but casual observation suggests that family background and connection play a much more important role in landing a stable job, preferrably in government or state-own companies,  in China.

Brain is still valued a lot more in the U.S.

   

Buying a house

We've been renting a house since we moved from SoCal to Penn last year. Renting was a good choice, as we needed to get to know the new area, and make sure the schools and neighborhood would work for us.

We rented our old house to a family moved down from NorCal to SoCal. They rented out their house too.

So for the first time in my life, I've become both a landlord and a tenant at the same time. It was quite an experience.

We tried to be open and communicative to our tenants, and stayed on top of all necessary repairs. I let them know all the things they should know to live in our house comfortably, especially anything that may become a safety issue. In turn, our tenants have done their best to take care of our property. We appreciate their paying on time and being proactive on any repair issue. In a difficult year, this relationship worked out quite well.

Our landlord, on the other hand, had been avoiding direct communication at the outset. If there is any repair issue, they would rather not be bothered... eventually, as one would expect, this kind of relationship ran into problems. We paid a generous above-market rent for them, in return we got almost no help from the owners who had lived here for a long time. Moreover, when it was time to renew the lease, they wanted to raise our rent, despite the softening market.

These problems pushed us towards buying. That aside, the economics appears to become more and more favorable for buying: home prices have been dropping steadily over the last year, mortgage rate has hit historical low and got lower. For a bigger house in the same neighborhood, our rent would more than cover the mortgage payment. With tax savings taken into account, we would be roughly ahead by the amount of principal payment we would pay against the house. That is, with a little bit of work as a homeowner, we would be building up equity every month. That equity would be totally gone to the landlord if we continue to rent.

In other words, if we buy the house we're renting now at market price, and rent it out as an investment property, we would be generating a small positive profit at year 1. Bear in mind this is one of the best neighborhoods in this area. Usually people tend to want to own, not rent. In such neighborhoods, it's usually hard to break even with rentals at the beginning. So this is a clear sign that it's about time to buy if one has a stable job. The housing may not have hit bottom yet, but it should be fairly close.

We found several houses we like. As we got into the market and started making offers, I quickly realized how thin the market was. You rarely see multiple offers. Very few buyers. At one point, our withdrawal on one house affected the pricing of some nearby properties immediately... Sellers have to price it right, or risk sitting on the market for months after months, and going through multiple reductions.

We didn't get the home purchase tax credit. Interstingly, the expiration of the tax credit have benefited us far more than $8000: The market had become markedly softer and the mortgage rate had gone down even more dramatically since June.

As I write this, we're getting ready to settle this week. After this local move, the turmoil of 2009 which had affected us in a big way will finally be behind us.      

Job creation as the leading indicator

Another Friday employment situation report, another disappointment.

Private-sector employers added just 71,000 jobs in July, according to a report released Friday by the Labor Department, fewer than the 100,000 plus jobs that economists were hoping for. Moreover, it also said private firms hired fewer workers in June than it had previously reported, as it revised that estimate down from 83,000 to 31,000 jobs.

The small increase in private-sector employment was more than offset by the loss of 143,000 temporary census jobs, and the nation's unemployment rate remained unchanged at 9.5 percent. Overall, the nation shed 131,00 jobs in July.

Remember when this measure, private job creation, fell off a cliff in May (reported early June) the stock market took a dive. Today's report also added pressure on the market which has been recovering quite well in July.

Recovery in housing market and consumer spending is now largely dependent on jobs. It's only logical that private job creation had become something of a leading indicator for the current economic recovery.

Corporate profit no longer seems to indicate job creation. And there aren't obvious leading sectors to point to that are creating many jobs.

Overall this year, private-sector payrolls have grown by 630,000 jobs, but about two-thirds of that increase occurred in March and April. After that, corporations have become more cautious in hiring.

Meanwhile, the strained state and local governments have shedded 48,000 jobs in July.

The sluggish job recovery is adding pressure to deflation.