Thursday, October 22, 2009

Serial Drivel: Someone new to take over for James C Cooper

I stumbled upon this post from Real Clear Markets via ZeroHedge. A quick aside: I have a love hate relationship with ZeroHedge. They produce some great research but they also engage in yellow journalism without real well thought out analysis as well. A la Hearst, this drives a lot of people to their website. For now the balance is well on the former but this link to RCM was clearly the latter.

The author of this piece is John Tamny. It took some extensive searching to find out who the author is. His signature says he is an economic adviser to two companies but not recognizing the companies, please forgive my ignorance, I continued looking about the intertubes. I found this:
Prior to his present work, Mr. Tamny worked at the Cato Institute, and before that in private wealth management for Credit Suisse and Goldman Sachs. Mr. Tamny received a BA in Government from the University of Texas at Austin, and an MBA from Vanderbilt University's Owen Graduate School of Management. He lives in Washington, D.C.

Now I have an MBA, so I definitely understand the value of the degree, but putting up an MBA grad with a Government undergrad versus a Nobel Prize winning economist, well... maybe he will be agreeing with Mr. Krugman.

1st the headline has Paul Krugman's name and the word myth. This immediately sends off warning bells in my head. I generally follow on economic matters, (not so much political)
Brad DeLong’s Krugman rule:

Rule #1. Paul Krugman is always right.
Rule #2. If you think Paul Krugman is wrong, see Rule #1

Here is an excerpt from the article.
As Krugman put it in the
New York Times, "The truth is that the falling dollar is good news." Krugman's reasoning here is that a weak dollar makes it easier for U.S. companies to export. A nice thought at first glance, but what Krugman ignores is that we can't export unless we're importing, and a weak dollar makes imports more expensive. Trade always balances.

Supposedly, according to John's logic, trade always balances. He seems to posit that imports and exports form an identity, similarly to the idea that National Savings must equal Investment and Net Capital Outflow. I couldn't find any literature anywhere that states this is so, perhaps it is a black swan.

Let's examine this a little further. Let's imagine a steel conglomerate who mines its own ore, processes it and then sells it to the highest bidder. A falling dollar makes this conglomerate's goods cheaper. It sells the goods in the export market and then has euros, or yen in exchange. Now here is where John's logic may come into play. Since it has the yen, it then needs to decide whether to purchase something from Japan or sell the yen to gain dollars which it can pay its employees. The latter is where the fungible nature of money comes into play. However, it seems John believes that it can only be the former. I wonder if he has a model or a chart to back up his assertion.

Back to the article: So while a weak dollar might in the near-term make U.S. goods attractive, the globalization of production means that the costs of the myriad imported inputs that go into the creation of U.S. goods will eventually have to rise. Inflation steals the benefits of devaluation...

So I took the change in dollar's nominal exchange rate and compared it to inflation (computed via CPI) in the United States to see if I could come up with a correlation.

There is a very weak correlation of +0.2, meaning that it can explain 20% of the variation. However, it is in the wrong direction. The plus sign indicates that as the dollar's value increases then inflation occurs, and when it devalues this becomes disinflationary. That cannot be correct, right?

Let's look at a common way to gauge commodity price inflation versus the dollar via oil prices.

Very interesting. Correlation= 0.3. This means that as oil induced inflation was striking the globe the dollar rose to counteract the effects of inflation. From 1973 to 1999 as the oil rose in price so did the dollar, the story at the time was that Europeans and Asians would have to bid up dollars to make their oil purchases. . Seems plausible.

From 2000 to 2008 the correlation rose in reverse -0.8. So as oil price has risen the dollar has fallen in value. Now it is in reverse from the previous period. Although, ostensibly the mechanism has not changed, these same areas of the world are not bidding up the dollar to make their oil purchases. So which is it? Not much can be ascertained.

So let us look somewhere else. Perhaps China, we import a lot from them, right?

In the Blue we have the US$/Yuan and the red line is the price level for imports from China. So we have a 21% rise appreciation of the yuan [restated a 21% devaluation of the dollar] from 2004 to 2007 to a 7% appreciation of the price level. Then the Yuan stopped appreciating, and yet even though apples-to-apples same yuan as the exchange rate hold steady due to their sterilization of dollar purchases, the price level fell making the total change in import price level from 2004 to 2009 3%. 21% devaluation equals 3% rise in prices.

If you accept this argument it seems to be a devaluation brings about a very, very slight increase in prices for Americans including American exporters.

As my friend Walter Sobchak said "Donny, you are out of your element."

John then transgresses into how this import induced inflation affects all manners of the US financial and capitalistic system. He makes a litany of errors confusing real and nominal prices, what capital is and is not, what investment is and is not and finally what saving is and is not. However, you can stop reading because as it has been made abundantly clearly in this essay the foundation John rests his argument upon is made up not only of sand, but quicksand at that.

If there is anything you should take away from today it is this:
Rule #1. Paul Krugman is always right.
Rule #2. If you think Paul Krugman is wrong, see Rule #1

Oh and if you are interested, while I was searching for John's credentials I found these nuggets of wisdom that may make you avoid his opinion. (All were found on the 1st page of Google's search results for his name.)

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