Author: R.A. | WASHINGTON

THE world finally makes sense again:

Paul Kedrosky says this demonstrates “that even the worst bankers struggle to find ways to lose money when short rates are zero, the yield curve is steep, and credit is tight”.

THE New York Times has a fascinating story up today on the internal debate in China over the decision to revalue the currency against the dollar. It seems that leaders ultimately decided that revaluation was in China’s interest, but an actual decision on a shift has been complicated by political factors—the more of a public issue the currency becomes, the harder it is to change course.

The Chinese news media, which have far more freedom to report on economic issues than political ones, have framed the currency issue mainly in terms of protecting Chinese sovereignty. That has prompted a series of assurances by Chinese officials over the past four days that China will not be pushed by foreign pressure into doing anything against its own interests…

Robert Hormats, the U.S. undersecretary of state for economic, energy and agricultural affairs, said during a visit to China over the weekend that a flurry of public discussion about the renminbi late last week had proved “counterproductive.”…

People close to Chinese policy makers say that officials would prefer to do it much sooner, but that it became impossible to act in the days before Mr. Hu’s visit to Washington, as the issue suddenly drew broad public attention.

Mr Hu’s visit wasn’t the only recent complicating event:

An official close to Chinese currency policy makers said that Mr. Geithner’s visit had also made it harder to handle the issue quietly.

Several people close to Chinese policy makers said that the matter had been made complicated by an article last week in The New York Times, of which the International Herald Tribune is the global edition. That article stirred news media interest by reporting that Chinese officials were very close to announcing a shift in currency policy and might even act before Mr. Hu’s Washington visit if no glitch emerged.

This sets up an interesting state of affairs in which it is in the American president’s political interest to make pressure on China a big deal, and it’s in the Chinese president’s political interest to make the currency issue vanish. But it is in both countries’ economic interest for the renminbi to rise, and so ideally one of the leaders takes a political risk to reach an accommodation with the other. Barack Obama did this, in announcing a delay in the publication of a report on currency manipulation, but that hasn’t managed to drive the issue from the headlines.

Still, analysts anticipate that some appreciation will occur by the end of the second quarter.

TODAY brings news on the state of both of America’s big deficits—budget and trade. The Washington Post reports some surprising news on the state of the federal budget; higher than expected tax revenues combined with lower than expected spending on financial rescues to produce a first half fiscal performance than originally forecast. As things stand, the federal deficit is on pace to come in below $1.3 trillion in fiscal 2010, while the administration initially projected a shortfall of about $1.6 trillion.

Budget numbers may yet deteriorate in the second half of the year, but the news is a positive sign for growth, although it also suggests that there is more room in the budget to address continued labour market weakness, which has persisted despite an output recovery.

And then there is the trade deficit. American exports have risen strongly. Total goods and services exports in February were 14.3% higher than their level a year previous. Unfortunately, imports were up more, 20.5%, and so the trade deficit increased. This isn’t that surprising. The American current account position improved significantly through the recession because global trade collapsed, and with a return to global and domestic growth it was inevitable that it would regain most of its previous level. The question is to what extent the structural current account deficit has improved.

It remains to be seen where that glide path will end. If it returns to the level of early 2008, that is not a positive sign for the nature of American recovery.

SCOTT SUMNER writes:

If Greece were not part of the euro, then Greek debt problems would probably not be impacting Wall Street.  I’m not certain exactly why they have recently affected Wall Street, but I would guess that there is worry that the debt problems in Europe may impact the stance of world monetary policy.  Perhaps there is fear that a eurozone crisis would make the dollar stronger, and that this would slow the US recovery.  In the early 1930s the war debt problems made gold stronger, and delayed recovery for any currency still tied to gold.

An interesting point, though I think it’s hard to know what the net effect on monetary policy will be. The FT noted yesterday:

Moreover, the European Central Bank decided last week to prolong the exceptional collateral regime, which allows banks that own Greek bonds to exchange their assets for cheap central bank funds. This was a significant announcement, and will provide Greece and its creditors with breathing space.

The ECB is roped into the rescue, which could reflect poorly on its credibility and lead to increased inflation expectations, or which could spur the ECB to tighten excessively in order to avoid the public perception that its credibility is compromised. Either way, the impact on monetary policy is something to watch.

DON BLANKENSHIP, the sorry excuse for a CEO of Massey Energy whose brushing aside of repeated safety warnings at a West Virginia mine led to a disastrous explosion which killed at least 29 miners, continues to function as a living, breathing exemplar of the need for sound regulation of dangerous industries:

As someone who has overseen the mining of more coal than anyone else in the history of central Appalachia, I know that the safety and health of coal miners is my most important job. I don’t need Washington politicians to tell me that, and neither do you. But I also know — I also know Washington and state politicians have no idea how to improve miner safety. The very idea that they care more about coal miner safety than we do is as silly as global warming.

Quite so.

ECONOMIST Robert Gordon, a member of the NBER recession dating committee, has released some comments on the decision made last week not to declare an end to the recession. In his view, the recession is clearly finished:

Real GDP has recovered strongly from a trough in 2009:Q2 and by 2010:Q2 (the current quarter) will have reached (or be very close to) its value reached in the peak NBER quarter of 2007:Q4, according to forecasts of private organizations that so far have proved to be remarkably accurate in forecasting real GDP changes a quarter or two in advance.. 

The committee also considers real GDI (the income-side measure of real GDP).  For reference, this appears in the NIPA tables as Table 1.7.6 line 11.  Most macroeconomists think that the BEA should feature this measure more strongly.  Real GDI was at essentially the same level in 2009:Q2 and 2009:Q3, and then rose strongly in 2009:Q4 as did real GDP.  The issue of whether the economy troughed in 2009:Q2 or 2009:Q3 is settled by the average of real GDP and real GDI, which reached its trough in 2009:Q2. 

Real GDI is an important variable.  It reached its peak in 2007:Q4 which ratifies the BCDC decision about the date of the peak.  While it did not rise from 2009:Q2 to 2009:Q3, it rose strongly in 2009:Q4 and will presumably rise strongly in the first half of 2010.

The end date of the recession is equally clear:

The traditional measure of production used by the committee is the Federal Reserve Board Index of Industrial Production (IIP), which reached a well-defined trough in June 2009.  For those who object that the IIP refers only to about 15 percent of the economy, the broader monthly measure real manufacturing and trade sales also reached its trough in June 2009.  The private firm Macro Advisers has constructed a measure of monthly GDP that is available back to 1992, and this also indicates a cyclical trough in June 2009.  While real GDI is flat across 2009:Q2 and 2009:Q3, quarterly real GDP reaches its trough in 2009:Q2, as does the average of quarterly real GDP and real GDI.   Thus we have three monthly measures that reach a trough in June, the average of two measures of aggregate economic activity which reach their trough in 2009:Q2, and no clearly defined troughs occurring later than that in any series other than the traditional lagging data on aggregate hours of work and total employment.

So why didn’t the committee make an official judgment?

The committee viewed the likelihood of a double dip that would take the level of real GDP back below its previous trough of 2009:Q2 as extremely unlikely.  However, the committee thought that, even if that probability was extremely small, it would be very costly to the committee to be proved wrong after the fact. Thus the committee was swayed by the view that the low probability of a double-dip multiplied by the high cost of being wrong in declaring the recession prematurely still amounted to a significant potential cost.

And so it seems likely that once additional data have come in, further reducing the probability of a large and imminent decline in output, the committee may feel comfortable making a declaration about the recession. As it stands, it looks as though the American economy has been out of recession for a solid three quarters.

UPDATE: Incidentally, were the June 2009 trough to hold up, that would make this latest recession, at 18 months, the longest since the 43 month downturn from 1929 to 1933. The previous two recessions were 8 months each, and there were 16 month recessions from 1973-5 and from 1981-2.

THIS is a snazzy animated manifesto from Britain’s Labour Party:

So much nice stuff the Labour Party plans to do for the country. No mention, however, of how to pay for it all. This might not be a problem if the conservatives weren’t making budget issues a key part of their campaign. Shadow Chancellor George Osborne called the prime minister a man who “will say anything and spend anything to cling on to power”. That dovetails remarkably well with the laundry-list-of-programmes approach in the manifesto.

Of course, people like programmes, and they dislike measures to address the deficit. Sadly, you can’t balance the budget with taxes everyone loves, like those on super-strong alcoholic beverages.

A NEW paper by Nicola Gennaioli, Andrei Shleifer, and Robert Vishny explains the dynamics by which financial innovation generates crisis:

Many recent episodes of financial innovation share a common narrative. It begins with a strong demand from investors for a particular, often safe, pattern of cash flows. Some traditional securities available in the market offer this pattern, but investors demand more (so prices are high), or perhaps demand securities with slightly higher returns and no extra risk. In response to demand, financial intermediaries create new securities offering the sought after pattern of cash flows, usually by carving them out from existing projects or other securities that are more risky. By virtue of diversification, tranching, insurance, and other forms of financial engineering, the new securities are believed by the investors, and often by the intermediaries themselves, to offer at least as good a risk return combination as the traditional substitutes, and are consequently issued and bought in great volumes.

At some point, news reveals that new securities are vulnerable to some unattended risks, and in particular are not good substitutes for the traditional securities. Both investors and intermediaries are surprised at the news, and investors sell these “false substitutes,” moving back to the traditional securities with the cash flows they seek. As investors fly for safety, financial institutions are stuck holding the supply of the new securities (or worse yet, having to dump them as well in a fire sale because they are leveraged). The prices of traditional securities rise while those of the new ones fall sharply.

Sound familiar? These risks seem like an intrinsic part of financial innovation, which means that the costs associated with crises are also an intrinsic part of financial innovation. So the question is, should we still embrace financial innovation? Back in February, Bob Litan assessed a number of financial products to try and determine whether, contra sceptics, financial innovation has managed to produce any socially useful products. It has, he says: credit and debit cards, investment funds, inflation-indexed securities, options and swaps. Other innovations have been less of a boon for the economy, including collateralised-debt obligations (securities built from other securities, pooled and chopped up) and structured investment vehicles (off-balance sheet investment funds used by banks). But, as he notes, socially useful financial innovations can be misused (just as socially useful technical innovations can be misused). He concludes:

I believe that financial innovations in general are much less like drugs and nuclear power, which deserve some kind of preemptive screening or regulation, and much more like virtually all other innovations to which U.S. policy historically has applied a “wait and see” regulatory approach. To be sure, given the various events that led up the recent financial crisis, policymakers must be better prepared in the future than they were before the financial crisis to step in – first with disclosure standards and possibly later with more prescriptive rules – when finance looks like it is taking a wrong turn.

The one area where an exception to this general “be prepared” strategy may be appropriate and even necessary relates to long-term contracts entered into by consumers, such as mortgages (when borrowing) or annuities (for  retirement). There is a strong and growing literature in behavioral finance indicating that individuals are not always rational in their investment decisions. This tendency is dangerous when even well-informed individuals are making long-term financial commitments, with heavy penalties (in the case of mortgages) or perhaps no exit strategies (in the case of annuities) for changing one’s mind later. In these cases, preemptive approval of the design of the financial products themselves may be necessary to prevent many consumers from locking themselves into expensive and/or potentially dangerous financial commitments. But this exception should remain that way and not become the rule.

As Mr Litan admits, his analysis is more qualitative than quantitative, which is too bad. It leaves us arguing more about principles than about costs and benefits. Obviously, there is some benefit to an environment conducive to innovation. But there are also some costs to the creation of new financial products. Some of these costs are minor—stemming from products that give issuing firms new market power, for instance. Others are the large, tail-risk costs associated with crisis. These are painful enough that greater pre-emptive vigilance may be warranted.

Though as Mr Litan also points out, financial regulations can themselves induce financial innovation, to get around bank-profit limiting rules. And because finance is global, innovation that occurs outside a highly regulated market can nevertheless disrupt that market. One can’t just consider the costs of innovation; you also have to understand the extent to which action can limit those costs.

It might not make sense, then, to try and rein in innovation in the financial sector. But it is critical to remember that there is an inherent element of danger in the activities of the financial sector and in financial innovation, and private rewards and government policy should reflect the risk that related costs may well be passed on to the broader economy.

AS MENTIONED in yesterday’s Link exchange, European governments have agreed to a package of loans to Greece to help cover financing needs while fiscal adjustments are made. The package is fairly generous; some €30 billion will be available the first year, with more authorised for 2011 and 2012. But big as that seems, it’s unlikely to be enough. Here is The Economist:

Whether it does convince the markets may soon be clear: On April 13th Greece was due to try to auction a fresh slice of short-term debt. The government needs to borrow about €11 billion by the end of May to roll over maturing debt and service interest charges. All in all, the country may need to borrow more than €50 billion in 2010 (estimates vary)…

Representatives from the commission, the ECB and the Greek government will meet IMF officials on April 12th to discuss the conditions that would be imposed on Greece and the exact size of the IMF contribution. The combined EU-IMF package is a substantial one but few imagine that it will be a one-off: on Sunday Reuters news agency quoted a Greek official as saying the country is likely to need a total €80 billion of loans over three years. If so it will be the largest multilateral rescue of a debt-ridden country yet seen.

The Economist has also estimated that €80 billion in adjustement assistance would be necessary. Meanwhile, here is the Financial Times‘ Wolfgang Münchau:

So will this stave off insolvency? It is important to distinguish the near-term insolvency as a result of the failure to roll over existing debt, and the country’s long-term solvency position. This deal, I am confident, will solve the first issue. As I predicted last week, Greece will not default this year. But I am still sticking with my second prediction that Greece will eventually default. The numbers simply look too bad. The adjustment effort Greece is asked to make will be one of the largest in history. But unlike other countries that made a similar effort in the past, Greece cannot devalue; it faces a much more challenging global environment; it has a weak fiscal infrastructure; a low consensus in society in favour of deep reforms; and a fragile financial system. The agreed bail-out terms do not exactly offer much relief, except in the very short-term. It will become clear very soon that this loan agreement represents a net transfer of wealth from Athens to Berlin – and not the other way round.

All this points to an eventual but not imminent default. It is important to remember that default does not usually imply a complete wipe-out. Bondholders usually recover some proportion of their holdings. I would expect that some form of restructuring of the Greek debt is inevitable, whereby bondholders will see a percentage subtracted from the par value of the assets. The 5 per cent interest rate, relative to the market rate, may already be a metric of the size of a future restructuring. It is hard enough to imagine how Greece can get out of a simultaneous debt and competitiveness crisis without falling into some vicious circle – debt deflation, for example, or just extreme public hostility that will thwart the government’s reform efforts. But it is impossible, at least for me, to imagine a situation in which Greece can manage to extricate itself from a pending catastrophe without some debt restructuring.

Without leaving the euro zone, an eventuality which is almost impossible to imagine, Greece can’t devalue against its largest trading partners. But it is a cruel irony for Greece that the announcement of the aid package has boosted the euro, leaving Greek exports still less competitive against the rest of the world’s goods. And Peter Boone and Simon Johnson add a pessimistic note:

Often assistance packages of this nature just help “smart money” to get out ahead of a default.  This could be the case here; 40-45 billion euros total money could last roughly one year.  Both Russia and Argentina got large packages in the late 1990s but never regained access to private markets, so eventually everything fell apart.

Things look better for Greece than they did on Friday. But they still look pretty bad.

AS PROMISED, China’s economy ran a current account deficit in the month of March, the first monthly trade deficit since 2004. Strong imports of natural resources and cars were primarily responsible. On a year-over-year basis, imports rose 66% in March, while exports rose 24%.

Barack Obama will be meeting with Hu Jintao this week, and the currency issue will still be on the table. Some revaluation of the renminbi remains both desirable and inevitable. Economists are indicating that the deficit might just be a one-month blip, and they have a point. But as the following chart, from Menzie Chinn, indicates, the broader trend seems clear:

I think it’s reasonable to be cautiously optimistic about the progress China seems to be making on its internal structural issues.

AN IMPORTANT thing to understand about journalists is that they’re herd animals. It’s reasonable for us to be this way; we want to cover the important stories, which happen to be the ones everyone is talking about. And we want to participate in the ongoing conversation on the day’s hot topic. But this occasionally leads to little news boomlets—stampedes in which the herding itself becomes the story.

So, last week, the New York Times‘ Floyd Norris wrote on the case for optimism about the American economy. And BusinessWeek examined how markets were demonstrating quite clearly that all is now well with the American economy, and Americans are too pessimistic given the data. Today, Robert Samuelson also declares Americans to be too glum about the prospects for a strong recovery. And here is the latest cover of Newsweek:

The trigger for the stories is clear. Economic data have been trending upward for a while, but March’s positive employment report was the catalyst for this rush of pieces. And once out there, the “Americans are too pessimistic” meme takes on a life of its own.

On its own, the cheerleading isn’t necessarily a bad thing. Confidence is a key ingredient to recovery, and if Americans are convinced that it’s once again ok to spend and invest, then the confidence boost to the economy may take on a life of its own. But it’s worth pointing out that after meeting on Friday, the NBER recession dating committee declared that it was not prepared to announced an official recession end date. This doesn’t mean that the economy is still in recession; it could simply mean that they have not yet seen enough data to agree upon a date. But it should indicate that America is not that far removed from contraction.

And optimism could be dangerous if it leads the country to underestimate its continued vulnerabilities—to new financial shocks, to new shocks to household budgets (as from rising resource costs), to new deterioration in housing markets, to continued drag from an unemployment problem that remains very serious. At this point in any recovery, complacency is the enemy. All observers want this to be 1983, but it very well might turn out to be 1937.

IN TODAY’S New York Times Floyd Norris makes the case that the relative pessimism concerning the state of the American economy is overdone, and things are actually looking pretty rosy. I think there is a grain of truth to his analysis, in that expectations tend to lag events, and so the economy will persistently surprise to the downside during contraction and persistently surprise to the upside during recovery. And he’s right that the American economy has almost certainly exited recession (though silly in chiding Barack Obama for being cautious about declaring as much, given the state of the labour market). But I think that worriers are right to approach this recovery as cautiously as they have. Mr Norris writes:

The employment report for March, released a week ago, was a milestone that has been little noted. The household survey, from which the unemployment rate is calculated, showed a gain during the first quarter of this year of 1.1 million jobs, the best performance since the spring of 2005.

True, the more widely reported numbers from the survey of employers are not as good. But those numbers are subject to heavy revision as better data becomes available. At the turning points for employment after the last two downturns, those numbers turned out to be far better than was reported at the time.

He’s right about the employment gain. But employment remains about 7.5 million jobs below the peak level of November 2007. And in the meantime, population has grown. So here’s what that employment recovery looks like, adjusted for growth in the total population:

That’s the evolution of the employment-population ratio. Feel the good vibes? And that, essentially, is the whole of Mr Norris’ argument. That while the scale of the job loss in this recession has been easily the worst in the postwar period, that while the age-adjusted unemployment rate has been easily the highest of the postwar period, that while the share of unemployed in the category of long-term unemployment is easily the highest of the postwar period, there has nonetheless been an increase of in employment of 0.8% over the last quarter. He also mentions that stock prices are up. True, but the jobless recovery has provided a boost of sorts there, as higher productivity and stagnant wages have goosed corporate profits.

The broader economy is all right. Housing is weak enough to still be dangerous, but recovery looks fairly safe for the moment. Those with full-time jobs are much less likely to lose them than they were a year or six month ago. But there are 15 million unemployed Americans, and hiring is at record low rates. That suggests a long and grinding end to above-normal unemployment. Mr Norris closes:

In 1982, Democrats scoffed at a surging stock market and thought a severe recession would last for a very long time. They were confident that the economy would doom Ronald Reagan’s re-election campaign in 1984. All they had to do was make clear they offered a stark alternative to the failing policies of the incumbent.

Change a few words (Reagan to Obama, Democrats to Republicans, 1984 to 2012) and you have an accurate description of the current political climate. Could the Republicans be as wrong now as the Democrats were then?

Mr Reagan was re-elected, and frankly, the odds for Mr Obama’s re-election look pretty good. It’s worth pointing out that the change in the unemployment rate is as important to public opinion as is the level. But remember, the election of 1984 came two full years after the end of recession, and those were two years during which economic growth was far more rapid than anything being forecast for America by any reputable organisation. Annual real economic growth in 1984 was 7.2%. And the share of long-term unemployed workers in total unemployment peaked at half the current level in the recession of the early 1980s. And in November of 1984, the unemployment rate was still 7.2%. When this recession began, the unemployment rate was 4.7%. In the last recession, the unemployment rate never got above 6.2%.

The state of the labour market is a real worry, and the effect of the drag from high levels of long-term unemployment is difficult to predict. Now is no time to declare victory and take a vacation.

NICK ROWE hasn’t seen “Avatar”. I’m assuming that’s why he’s making this argument:

The policy problem in Avatar is that some blue people own all of some valuable natural resource, and won’t let anybody else have any.

Lloyd George, as UK Chancellor of the Exchequer, addressed the same policy problem in his 1909 “People’s Budget”. The British aristocracy owned the land, just as the blue people owned the valuable natural resource in Avatar. I don’t know if the blue people in Avatar used it for hunting foxes; probably they had peculiar customs of their own.

Inheritance taxes, and taxes on undeveloped natural resources, could have solved the problem in Avatar just as well as in the UK. Wealth taxes could have worked also. The blue people would have needed to sell off some of the valuable stuff, just to pay the taxes on it.

Progressives generally support such taxes. I don’t know why Hollywood made such a reactionary movie. Maybe the blue people are just cuter than the British aristocracy, so we ought to be on their side, against progressives like Lloyd George.

Why are our ethical views so ethereal? Why are we all such suckers for framing?

The “blue people” are residents of a planet not earth. Humans show up to this planet, want the valuable substance, and begin taking it. Mr Rowe is indicating here that the humans should have just taxed the blue people, but that seems like a pretty problematic suggestion. They would first need to obtain the right to levy a tax on people who are occupying what we might infer is a sovereign planet.

The situation is not like a Britain, in other words, in which there are lots of Britons but only some of them have land. Instead it’s like a world in which Americans would like Saudi Arabia’s petroleum and therefore decide to levy a tax on Saudi Arabia. Or, it’s kind of like sailing over to America when the occupants were all Native Americans and demanding that they pay a tax and oh, by the way, if you want to sell us your land so that you can afford to pay the tax that’s fine by us. Taxation, set up this way, is basically the same thing as just taking the land or resources you want. So, you know, progressives aren’t being suckers, at least in this case.

Meanwhile, can I say that it’s somewhat annoying when economists (and other pundits) draw conclusions about the things people believe based on the movies they enjoy, and specifically based on the heroes they adopt? Many, many people rally behind film heroes who do terrible, terrible things. That doesn’t make them suckers with ethereal ethical views. It makes them folks trying to enjoy a movie.

KEVIN DRUM is wondering how Texas managed to avoid a housing bubble. He considers the arguments pertaining to Texas’ tight regulation of mortgage markets, but says:

[D]oes this explain how Texas avoided the housing bubble? There’s no way to say for sure, but I’m skeptical. Can a 12-day waiting period really be enough to put the kibosh on exotic mortgages? It doesn’t seem like enough — and anyway, my guess is that it was the bubble that drove the growth of exotic mortgages, not the other way around. So we’re still left with a question: why didn’t the housing boom ever take hold in Texas even though it seems to have all the usual sunbelt characteristics that drove the bubble in places like California, Arizona, Nevada, and Florida? It’s still a bit of a mystery.

I’ve said this before, but it hasn’t sunk in so I’ll say it again. The bubble was not, repeat not, a Sunbelt phenomenon. Not. A Sunbelt phenomenon. Here is a chart:

Have a look at the above image, of seasonally adjusted home price indexes for nine different housing markets (the dotted line is the 20-city average), and tell me which set of lines contains Sunbelt markets. Have you guessed? It’s a trick question! They all are!

The red lines correspond to Miami, Los Angeles, Washington, Las Vegas, and Phoenix. The blue lines correspond to Charlotte, Atlanta, and Denver. The black line is Dallas.

Thinking of the bubble as a Sunbelt phenomenon is a bad idea because it’s not correct, but also because it generates confusion over what characteristics were important in driving bubble inflation. So it’s important to note that outside of the Sunbelt, there were many other bubble markets, primarily on the east and west coasts—San Francisco, Portland, and Seattle, New York and Boston. What these markets all have in common, and have in common with Los Angeles and Washington, is that housing supply is relatively limited. So what emerged in these markets, initially, was a healthy price signal. This, incidentally, is how basically every bubble begins: with a healthy price signal. Demand for these coastal markets was high and rising, and housing supply was not keeping up. Therefore, prices rose. The bubble took shape thereafter, as rising prices combined with growing enthusiasm and rapid credit expansion, which fueled the growth of a bubble mentality.

Now, as prices rose, some housing demand shifted to other markets with strong local economies, including Phoenix, Atlanta, and Dallas. These markets tend to have very elastic housing supply, and so price increases translated into rapid construction, which prevented prices from rising and kept the bubble at bay.

Except that in Florida and the desert southwest, it didn’t. So has our housing supply model failed?

Not necessarily. As it turns out, you can “catch” a bubble from elsewhere. Migration to Las Vegas and Phoenix came overwhelmingly from Southern California. Residents of Los Angeles would cash out their homes and move east, buying one or two properties in cheaper markets, investing in those properties, and generally transmitting the bubble mentality that characterised the real estate markets of the California coast. Analysis of price movements has identified ripple effects from the Los Angeles property market to the Las Vegas property market, and thence on to the Phoenix property market. It seems likely that a similar phenomenon took place in Florida, which absorbed a great deal of migration from bubbly northeastern markets.

These “caught” bubbles were incredibly damaging, because they combined rapidly rising prices with rapidly rising inventory, leading to massive housing overhangs and price declines up to and greater than 50% from peak. But other Sunbelt metropolitan areas managed to avoid them, perhaps because they absorbed more workers from declining markets elsewhere in the south or northeast or midwest. Housing supply growth then prevented any big initial increase in prices which might have led to the enthusiastic growth in credit that triggered bubbles elsewhere.

YESTERDAY, I linked to a Democracy in America post highlighting results from the latest Economist/YouGov poll. In it, Americans expressed support for spending cuts as a means to deficit reduction, but the only cuts on which a majority of participants could agree were those to foreign aid. Which makes up less than 1% of spending. Meanwhile, Larry Kudlow seems to think that the best way to cut the deficit is to slash pay for federal employees. Paul Krugman notes that most people just don’t understand what government spends its money on:

The basic picture of the federal government you should have in mind is that it’s essentially a huge insurance company with an army; Social Security, Medicare, Medicaid — all of which spend the great bulk of their funds on making payments, not on administration — plus defense are the big items. Salaries aren’t.

That’s basically right. Some would-be reformers want to wipe out earmarks, but that spending is pretty tiny, too. If you add up all non-defence discretionary spending, you get to maybe a fifth of the total budget, and much of that goes to things that people don’t like to see cut, like transportation funding, or enforcement of critical regulatory policies.

This all should make sense. Deficit-cutting is popular, and there are only a few million federal employees. If the deficit could be meaningfully reduced by cutting pay for (or firing) surplus government staffers, then the political calculus would mean that those workers would be cleaning out their desks yesterday. Politicians tend to do popular things that are easy to do. But deficit cutting is a popular thing that’s very, very hard to do.

HERE was the state of things last night:

Things looked to be nearing some sort of critical point. But here‘s this morning’s news:

European Union officials said they are ready to rescue Greece if needed as economists at UBS AG said that a bailout may be imminent as the country’s financing costs surge.

“A support plan has been agreed and we are ready to activate at any moment to come to the aid of Greece,” French President Nicolas Sarkozy told reporters in Paris. The EU is “ready to intervene,” Herman Van Rompuy, the president of the 27-member bloc, was cited as saying by Le Monde today.

And Greek bond spreads are back down to 400 basis points—still very high, but considerably better than yesterday. But we’ve seen this before; European officials have reassured markets that they would step in if needed multiple times, and each time they subsequently seemed to get cold feet. And even if a bail-out is announced, it’s far from clear that the size of the aid will be sufficient to calm markets or actually give Greece room to stabilise its debt.

But what does seem notable is that the spike in Greek bond spreads has not been associated with similar spikes for other debt-ridden European nations. That would appear to indicate that markets are not too concerned with the prospects of the Greek end-game leading to some sort of European contagion, which is the most dangerous risk of the Greek crisis.

LAST week, Joe Stiglitz wrote a piece arguing that confronting China over the dollar peg would be a bad idea, as it would risk a trade war over a policy change with uncertain benefits. Regarding the benefits of appreciation, he said:

Many factors other than exchange rates affect a country’s trade balance. A key determinant is national savings. America’s multilateral trade deficit will not be significantly narrowed until America saves significantly more…

The meaning of this passage seems very clear to me. The first sentence indicates that exchange rates do affect trade balances, but are just one of many factors influencing that balance. The last sentence suggests that while an RMB revaluation will likely narrow the deficit, but it won’t eliminate it until other structural factors change. Nowhere does he say, or even hint, that it is impossible for an exchange rate shift to influence trade balances.

But Paul Krugman refers to:

…the fallacy — which both Steve Roach and, I’m a bit shocked to say, Joe Stiglitz — have fallen into: the belief that appreciating the renminbi can’t reduce the US trade deficit unless US savings increase.

Mr Stiglitz never expresses any such belief! He’s not “getting it wrong”. He’s saying that writers like Mr Krugman, who appear to expect an RMB revaluation to eliminate America’s current account deficit at a stroke, are sure to end up disappointed!

Antonio Fatás has some thoughts worth reading on the matter:

I will not resolve the debate here but there is something that I cannot understand in Krugman’s argument. His argument is that current account imbalances cannot be corrected without an exchange rate change. While he does not say so, he almost implies that current account imbalances are always the result of exchange rate misalignments. This position is too extreme…

[H]ere is an interesting piece of data: while both the US and the Euro area have a large bilateral trade deficit with China (which can be interpreted as a signal of the undervaluation of the Renminbi), the Euro area has an overall current account surplus while the US has a current account deficit. You can argue that for the Euro area, an undervalued Renminbi shifts demand from other countries goods to Chinese goods. But this does not get reflected in the overall current account balance. Clearly there is more than an undervalued Renminbi in the dynamics of the current account in the US and the Euro area.

Meanwhile:

The Chinese government is set to announce a revision of its currency policy in the coming days that will allow greater variation in the value of its currency, combined with a small but immediate jump in its value against the dollar, people with knowledge of the consensus emerging in Beijing said Thursday.

While there remains a possibility of a last-minute glitch that could delay the announcement, China’s central bank appears to have prevailed in its arguments for a stronger but more flexible currency, these people said. They insisted on anonymity because of the sensitivity of the issue in Beijing.

Matt Yglesias says that the hardliners are likely to claim victory by saying that the appearance of an angry horde of pundits and politicians calling for punitive trade measures against China boosted the president’s bargaining power on the issue. Perhaps so. I’m just glad that such measures haven’t actually been adopted, as they could easily prove very costly. And I’d point out that any time you create a furore over an issue like this, there’s always the chance that someone will act in earnest on your bluster. This was a dangerous time to be calling for tariffs, and we should all be very relieved that the diplomatic path seems to have prevailed.

NEW data on weekly jobless claims came out today, and initial claims rose back to 460,000 last week, while the four-week moving average ticked upward as well. Here’s the longer run picture:

Claims seem to have stabilised. Unfortunately, they’ve done so at a level well above pre-recession norms. The March payroll employment figures generated a lot of optimism about a potential turnaround in the labour market, but it’s difficult to reconcile sustained strong gains with this kind of performance.

Next, Mark thoma posts a chart from the Atlanta Fed:

These data only go through the end of 2009, but the deterioration in the hiring rate during the recession indicates the nature of the growth in unemployment. Sackings rose, but the biggest problem was that the rate of exit from unemployment was so low. And because unemployment was mainly driven by a large decline in the hiring rate, the end to heavy lay-offs hasn’t meant a substantial decline in the unemployment rate.

Combine job losses sustained at a higher-than-normal level and continued weakness in hiring, and the outlook for a strong recovery for labour markets seems pretty poor.

SOMEONE managed to take apart the iPad:

Materials for the iPad, which went on sale on April 3, include a touch-screen display that costs $95 and a $26.80 processor designed by Apple and manufactured by Samsung Electronics Co., according to El Segundo, California-based ISuppli…

Once it took one apart, ISuppli found more silicon chips than it had expected to power interactions with the iPad’s 9.7- inch screen.

“Because of the sheer scale of this device, we’re seeing more here than we expected,” Rassweiler said. Apple uses three chips to control the iPad’s touch screen, for example.

Flash memory chips, obtained from various suppliers including Samsung, account for $29.50 in costs on the 16- gigabyte model, $59 in the 32-gigabyte version and $118 in the 64-gigabyte model, Rassweiler said. These chips push the cost of manufacturing the 32-gigabyte version of the iPad, which sells for $599, to $289.10. They boost the cost of the 64-gigabyte version, which sells for $699, to $348.10.

Interesting stuff. The piece also notes that as Apple continues to produce iPads, it will get better at economising on components, allowing the firm to bring down its price.

But hey, why doesn’t it bring its price down right now?

Analysis by ISuppli indicates that components of the lowest-priced, 16-gigabyte iPad amounts to 52 percent of its retail price of $499. That leaves the iPad on par with other Apple products, including the iPhone 3GS. A high-end 64-gigabyte version of the iPad, which retails for $699, contains components that cost $348.10, according to ISuppli.

One answer is that materials costs don’t begin to cover the full scope of the investment it took to generate a product. Microsoft Office can cost hundreds of dollars and comes in packaging worth less than a sawbuck (and if you download it, less than a cent). Production of the iPad involved thousands of man hours devoted to research, design, and programming, the cost of which is incorporated into the price of each device.

And one can’t forget the demand side. Apple can charge for iPads what the market will bear. It has also become quite good at price discriminating. It has higher margins on the most expensive models, which may appeal to the set of technophiles who must have the top of the line product nevermind the cost. And Apple realises that early-adopters will pay a premium to have an iPad now, and after some interval of time it can lower the price to attract more value-minded customers.

What one wouldn’t expect to see much of in the cost details for the iPad is marketing expense, as the press has handled that job pro bono, present company included. Still waiting for the pro quo, Apple (cough cough).

TIM GEITHNER is making an unexpected trip to Beijing to meet with officials ahead of next week’s summit in Washington, between Barack Obama and Hu Jintao. Mr Geithner will be speaking with Vice-Premier Wang Qishan, and the currency issue will obviously be front and centre. Speculation is rising that a deal of some sort is in the works, in which an appreciation of the renminbi is combined with an increase in the role of the Chinese currency in the global economy, a shift Mr Geithner has described as a “healthy, necessary adjustment”.

Analysts are also assuming that this high profile diplomacy wouldn’t be taking place unless a deal was likely. The Obama administration has faced considerable criticism at home after delaying the release of a report on currency manipulation, and is no doubt looking for something to show critics for its efforts. The president and the Treasury secretary have made a bet I have endorsed—that an emphasis on diplomacy and multilateralism is far more likely to generate results than a policy of confrontation and unilateral punitive action. So far, the diplomatic course seems to be the right one:

China has begun to prepare the ground publicly for a shift in exchange rate policy, days after the US Treasury said it would postpone a decision on whether to name China a “currency manipulator”.

A senior government economist told reporters in Beijing yesterday China could widen the daily trading band for the renminbi and allow it to resume the gradual appreciation it halted in July 2008 in response to the global credit crisis…

And RMB forwards have continued to rise. Hopefully, the buzz is accurate. A dearer RMB would provide a small but significant boost to the global economy. But perhaps more importantly, a real revaluation would go a very long way toward defusing populist anger in Washington. If China is unable to make good on American diplomatic efforts with a meaningful appreciation, there will be no holding back the demands for punitive tariff measures.