Economic Reporting Review By Dean Baker You can sign up to receive ERR via email every week by sending a "subscribe ERR" to [EMAIL PROTECTED] You can find the latest ERR at http://www.tompaine.com/news/2000/10/02/index.html . You can find all ERR prior to August archived at http://www.fair.org/err/ and all ERR after August at www.tompaine.com. ******** OUTSTANDING STORIES OF THE WEEK "How Did They Value Stocks? Count the Absurd Ways," by Gretchen Morgenson in the New York Times, March 18, 2001, Section 3, page 1. This article reports on some of the inventive formulas that promoters of Internet and other tech stocks developed to rationalize their extraordinary price to earnings ratios in recent years. "Drug Giant's Spin May Obscure Risk," by Deborah Nelson in the Washington Post, March 18, 2001, page A14. This article discusses the efforts on GlaxoSmithKline, one of the world's largest drug manufacturers, to downplay evidence that a new hepatitis drug had dangerous side effects. The article shows how the industry sought to misrepresent the findings of a researcher on its payroll, noting that this is part of a more general problem with industry funded research. "Downturn May Dim Outlook for Surplus," by Glenn Kessler and Juliet Eilperin in the Washington Post, March 10, 2001, page A4. This article examines the possibility that the downturn in the economy and the stock market may lead to a significant downward revision in projections for the government surplus for this year and next. It is the first article in the Post or Times to call attention to this possibility. It is worth noting the Congressional Budget Office's (CBO) projections for capital gains tax revenue (more than $100 billion annually) are based on the historic relationship between capital gains and the economy, not projections of the stock market. If the stock market remains flat or falls further, most of these projected capital gains will not materialize. But the CBO projections for capital gains would not change even if it were known with certainty that the market would lose half its value over the next three years. GERMANY "German Confidence Is at Lowest Point Since July '99," by Edmund L. Andrews in the New York Times, March 22, 2001, page W1. This article reports on the decline of an index of business confidence in Germany. The headline is misleading, since it implies that the index Measures confidence levels for the nation as a whole, rather than just among business executives. It also is not clear that this index is a very meaningful measure of Germany's economic prospects, and therefore worthy of significant coverage. While the index rose considerably in 1999 from its 1998 level, German GDP growth in 1999 was 1.4 percent, compared to 2.3 percent in 1998. At one point, the article attributes recent slowdown in German economic growth to the fact that it has been slow to liberalize its labor markets. The article also notes that France has been experiencing rapid economic growth. France has also not liberalized its labor markets, as has been frequently noted in both the Post and Times. In fact, France recently reduced its standard workweek to 35 hours, which is a major tightening of labor market regulation. The article also comments that Europe's Central Bank, unlike the Fed, has little room to lower its interest rates because its inflation rate is above its 2.0 percent target. It is worth noting that Europe's inflation rate is approximately 1.0 percentage point lower than the inflation rate in the United States. THE TRADE DEFICIT AND THE DOLLAR "As Stocks Dive and Economy Softens, the Dollar Is Positively Robust," by Jonathan Fuerbringer in the New York Times, March 22, 2001, page C1. This article discusses the recent rise in the dollar. At one point the article claims that "if the dollar plunged, it would take higher interest rates - not the lower interest rates a slumping economy needs -- to attract the foreign capital that covers the trade deficit and helps to service the dollar." Actually, if the dollar plunged, in theory it should take lower, not higher, interest rates to attract money into the country. Foreign investors always worry that the currency in the country in which they are investing may fall in value, reducing the effective return on their investment. However, if the dollar has already plunged, they might have less reason to fear a further decline; in which case they would demand a lower interest premium to compensate for the risk of a falling dollar. It is also important to note that with a lower dollar, the US trade deficit would be much smaller. A lower dollar would discourage imports by making them more expensive to people living in the United States, and it would promote exports, by making them cheaper for foreigners. AUSTRALIAN DOLLAR "The Free Fall of the Australian Dollar Remains a Mystery," by Becky Gaylord in the New York Times, March 23, 2001, page W1. This article discussed the sharp decline in the value of the Australian dollar over the last year. It claims that this drop is a mystery because Australia has "maintained steady economic growth and low inflation in recent years." Actually the drop in the Australian currency is exactly what standard economic theory would predict. Australia has been running very large Current account deficits, which in recent years have exceeded 4.0 percent of GDP. (This is equivalent to a current account deficit of more than $400 billion in the United States.) With a current account deficit of this magnitude, unless the amount of money that foreigners are willing to invest in Australia each year vastly exceeds the amount that Australians are willing to invest abroad, the currency will decline in value for the simple reason that the supply (due to the current account deficit) exceeds the demand. This article never mentions Australia's current account deficit. The fact that Australia has steady economic growth and low inflation may be good for its citizens, but it is of little interest to investors. Unless the returns on investments in Australia are substantially greater than the returns available elsewhere (e.g. interest rates are higher), it will not attract the amount of foreign capital needed to offset its current account deficit and its currency will decline in value. If there is any mystery, it would be that the value of Australia's currency didn't fall sooner. ECONOMICS 2001 "Econ 2001: Tips for the Shellshocked," by Richard W. Stevenson in the New York Times, March 18, 2001, Section 4, page 1. This article attempts to present some basic lessons about the economy to readers. One of the lessons is on the virtues of productivity growth. The article asserts that "productivity growth was behind the regular upward revisions in projections of the federal budget surplus." Actually, the main factor behind the upward revisions in projections of the federal budget surplus was an increase in the ratio of tax revenue to GDP, from 18.1 percent in 1994, when President Clinton's tax increase was first in effect, to 20.6 percent in 2000. This increase cannot be readily explained by more rapid productivity growth. The article also extols the virtues of markets in a section under the subhead "markets rule." It asserts that "market forces create a discipline that leads governments, companies and investors alike to think hard about the soundness of their financial decisions." The collapse of the tech bubble has shown that investors have been willing to throw hundreds of billions of dollars at half- baked schemes (see " How Did They Value Stocks? Count the Absurd Ways," by Gretchen Morgenson, New York Times, March 18, 2001, Section 1, page 1). These investors were not punished for their bad judgment, in all the years that the market was rising. As a result, there was a huge misallocation of resources from productive to non-productive uses. GLOBAL WARMING "Bush's Shift Could Doom Air Pact, Some Say," by Andrew C. Revkin in the New York Times, March 17, 2001, page A7. This article reports on the status of the Kyoto Protocol on climate change in the wake of President Bush's decision to renounce a campaign pledge to place restrictions on greenhouse gas emissions. At one point the article reports that the Kyoto agreement would have required the United States and other industrialized nations to reduce their emissions to less than 95 percent of their 1990 level by 2012. Actually, the agreement would not have required reductions anywhere near this large within the industrialized countries. The agreement provided for limits that applied to groups of countries. The group with the U.S. included Russia. As a result of its economic collapse, Russia is emitting far less pollution now than it did in 1990. Russia's lower emissions would go far towards allowing the group of nations to meet its limit under the Kyoto pact, even without anything else being done. The article also asserts that the limits set in place under the treaty for the period 2008-2012 are unobtainable now because of rapid economic growth and an increase in energy consumption. It is also important to note that inaction has played a major role. Because the U.S. government failed to act in 1997 or soon thereafter, nothing was done to promote increased energy efficiency in buildings, cars and transportation, and other areas. As a result, the capital stock put in place in the last four years continues to emit large amounts of greenhouse gases. This makes it far more difficult to try to reach the targets for 2008-2012. FEDERAL HOUSING SUBSIDIES "HUD Will Insure More Loans To Build Affordable Rentals," by Elizabeth Becker in the New York Times, March 21, 2001, page A21. This article reports on a proposal by the Bush Administration to increase the size of a program that subsidizes the construction of moderate- income housing in urban areas with high land costs. According to the article, the proposed increase should lead to an additional 3000 units being constructed. The United States has more than 100 million moderate-income housing units. This proposal will therefore increase the supply of moderate income housing for the national as a whole by less than 0.003 percent. It is questionable whether an initiative of this magnitude deserved the attention devoted to it in this article. THE FEDERAL RESERVE BOARD AND INTEREST RATE CUTS "Fed Rate Cut Leaves Wall St. Unsatisfied," by John M. Berry in the Washington Post, March 21, 2001, page A1. "Fed Lowers Rates By 0.5% and Hints Of Fuurther Rate Cuts," by Richard W. Stevenson in the New York Times, March 21, 2001, page A1. Both of these articles report on the Federal Reserve Board's decision to lower interest rates by 0.5 percentage points. Both articles rely exclusively on economists working at financial firms as sources for their stories. The Times article cites three economists at banks or brokerage houses while the Post article cites two. It would have been helpful to include a wider range of sources, for example, economists working in academia, government, labor unions, policy oriented research institutes, or even industrial firms. Not all experts would have the same opinion of the Fed's monetary policy as those representing financial firms. THE STOCK MARKET "Wall St. Ends an Awful Week As All Eyes Turn to the Fed," by Jonathan Fuerbringer in the New York Times, March 17, 2001, page A1. "If the Fed Cuts Rates, Will History Again Be Kind to Stocks?" by Kenneth N. Gilpin in the New York Times, March 17, 2001, page B1. These article discuss the likelihood that stocks will recover if the Federal Reserve Board lowers interest rates aggressively. Both articles report on stock without examining the connection between the stock market and the economy, even in the long-run. No economist holds the view that stock prices can consistently grow more rapidly than corporate profits. The Congressional Budget Office and other major forecasters project very low profit growth over the course of the next decade. If these forecasts prove anywhere close to accurate, then it is very difficult to describe a scenario in which stock prices would bounce back and remain high. JAPAN "Fading Yen Casts a Shadow On Japanese Leader's Visit," by David E. Sanger in the New York Times, March 17, 2001, page A9. "Japan's Economy Lurks Low on Agenda as Bush and Prime Minister Meet," by David E. Sanger in the New York Times, March 19, 2001, page A8. "Bush and Japanese Leader Talk but Reach No Agreement on Economic Growth," by David E. Sanger in the New York Times, March 20, 2001, page C2. These article discuss Japan's economic situation in reference to a meeting last week between Japanese Prime Minister Yoshiro Mori and President Bush. At one point, the first article presents a quote from an economist at the Brookings Institute, that "Japan has few, if any, easy policy options left to revitalize its economy." All three articles are largely presented from this standpoint. Actually, there is at least one obvious policy option remaining to Japan. Princeton professor Paul Krugman, one of the world's most prominent economists, has long recommended that Japan pursue a course of moderate inflation (e.g. 2-3 percent annually), as a way to stimulate its economy and reduce the debt burden of firms, banks, and the government. This would seem far easier and more practical than some of the other measures that have been put forward, such as a financial collapse (see "As Japan's Economy Sags, Many Favor a Collapse," by Clay Chandler, Washington Post, March 9, 2001, page A1). After the meeting between Mori and Bush, the Japanese central bank actually announced that it would move in the direction of the policy advocated by Krugman. It announced that it would begin to expand the money supply as much as necessary in order to end deflation. ELECTRICITY DEREGULATION IN CALIFORNIA "800,000 Lose Power in California As Blackouts Roll Across the State," by William Booth in the Washington Post, March 20, 2001, page A8. "Rolling Blackout Affects A Million Across California," by Todd S. Purdum in the New York Times, March 20, 2001, page A1. These articles report on another set of electricity blackouts across California. Both articles attribute California's electricity problems to the fact that it only partially deregulated its electricity market, allowing wholesale prices to be determined by the market, while retail prices were frozen. In southern California the state actually did completely deregulate its market. The result was that electricity prices more than doubled and political pressure forced the re-regulation of electricity prices. The evidence indicates that California's problems stem from its decision to deregulate electricity, rather than the particular system put in place in the northern and central part of the state. ENERGY SUPPLIES "U.S. Faces An Energy Shortfall, Bush Says," by Eric Pianin in the Washington Post, March 20, 2001, page A1. "Energy Chief Sketches Plan To Curb Rules Limiting Supply," by Joseph Kahn in the New York Times, March 20, 2001, page A18. These articles report on proposals by the Bush administration to increase the amount of oil and natural gas produced in the United States. The Bush administration has repeatedly claimed that increased oil supplies will make the U.S. more energy independent. In fact, increased oil production in the United States would have virtually no visible impact on the price and availability of oil to U.S. consumer. There is a single world market for oil. If the U.S. increases its domestic production then it will have no greater effect on the world price of oil, or the price of oil in the United States, than if Kuwait or Kazakhstan increased their production of oil. The only difference is that by taking oil out of the ground now, the United States would be eliminating a reserve that would otherwise be available in the future, if the country is denied access to sufficient foreign oil at some point. Both articles include references to a study by the National Association of Manufacturers, which supposedly shows that the recent rise in oil prices reduced GDP by approximately one percent over the last year and a half. The implication of this study would be that the drop in oil prices in 1997 and 1998 added approximately the same amount to GDP. Therefore, the economy is approximately in the same position as if oil had remained constant at its mid-nineties prices.
