China's currency. Yuan goes up, must come down

From: The ECONOMIST
Economics - free exchange
(http://www.economist.com/blogs/dailychart
/2011/07/big-mac-index)

Dec 7th 2011, 11:29 by R.A. | LONDON

BACK in July, a souped-up version of The Economist's Big Mac index indicated that China's currency actually seemed to be near its fair value. That didn't prevent politicians in America and elsewhere from keeping the pressure on China to allow its currency to appreciate faster, even as Chinese labour costs grew rapidly. In October, America's Senate passed a bill that would require the government to consider currency manipulation in judging the fairness of import prices: a step calculated to make it easier to levy tariffs on Chinese goods.

The world has become a much different place since this summer, however. Emerging-market growth is quickly flipping from red hot to worrisomely flat. Chinese factory activity is declining, according to the latest measures, while India's growth is disappointing and Brazil's has vanished, as of the third quarter. At the same time, financial troubles in Europe are contributing to capital outflows from large emerging markets and corresponding declines in currency values.

One might have expected China to dodge these pressures. The yuan has long been deemed undervalued while other emerging markets fretted about the overvaluation of their currencies. China has long run a current account surplus, suggesting that upward adjustment of the exchange rate is necessary, and has enjoyed corresponding reserve growth. And China's capital markets are tightly controlled, making rapid inflows and outflows of capital impossible.

Yet, there are nonetheless signs of an interesting reversal for the yuan. As Josh Noble points out, the yuan has been butting up against the lower edge of its daily trading window. It appears that China may be intervening to support the currency; Chinese reserves have been falling in recent months.

These trends may not trouble China's authorities too much. Inflation may become less of a threat as the global economy slows, reducing the government's need to use the exchange rate as an instrument of policy tightening. And with growth now a key concern, a drop in the value of China's currency is sure to be a welcome boost for exporters facing an ugly 2012 in key export markets, most notably Europe. In any case, I suspect the news will manage to appeal to both China bashers and China sceptics.

In a spin. A bearish perspective on the market in 2011

Dec 29th 2010 | from PRINT EDITION
Economist.com/blogs/buttonwood

BEFORE reality TV ruled the airwaves, the Saturday night schedules on the BBC would often feature a variety show with singers, comedians and novelty acts. One favourite was a man spinning plates on top of poles, an act that involved a lot of dashing about to avoid disaster.

Central banks have been performing a version of that act for the past three years. In 2008 they were racing around trying to save one bank after another, and were unable to prevent a few smashes. In 2010 the fragile plates were the sovereign countries of the euro zone. The authorities just managed to keep them intact.

But the loss of just one tiny saucer could result in a lot of broken crockery. The banks are still in a delicate state with many dependent on the European Central Bank (ECB) for finance. The advice of Walter Bagehot, a 19th-century editor of The Economist, was that central banks should lend freely in a liquidity crisis, against good collateral. But this support was supposed to be short-term, not continuous: a central bank should be an emergency room, not a hospice.

Indeed, for all the efforts of governments and central banks, many of the global economy’s long-term problems have yet to be solved. The banks are weak, the American housing market is still in the doldrums and the global imbalances have not gone away.

Just as the ECB bought time for European banks, rescues have been attempted for the struggling governments of Greece and Ireland. But these seem like temporary expedients: lending the countries money for extended periods at rates neither can afford. The packages have not been sufficient to calm the markets or stop the rot from spreading: 2010 ended with Fitch downgrading Portugal and putting Greece on negative rating watch.

The rest of Europe is now talking about imposing penalties on private-sector lenders in future rescues. That will turn each crisis into a game of chicken as bondholders sell before they get penalised. And financing packages do not deal with an underlying lack of competitiveness in many European economies. Without the ability to devalue, the restoration of competitiveness requires painful austerity measures and wage restraint.

That leads to another potential flashpoint for 2011: the lack of global co-ordination. Gone is the consensus seen at the G20 meeting in April 2009. Europe will be pursuing austerity, China is trying to rein in bank lending but America has opted for another fiscal stimulus. This is a throwback to pre-crisis 2007, with American deficit-financed consumption set against Chinese surplus-creating exports.

It seems certain that the Federal Reserve will continue to accompany fiscal stimulus with the monetary equivalent in the form of near-zero interest rates and further quantitative easing. The need for such extraordinary measures is an indication of how weak the economy continues to be. But while the developed world is still fighting off deflation, the developing world is worrying about inflationary pressures, with gold near $1,400 an ounce and oil back above $90 a barrel.

Easy monetary policy in America also creates the incentive for further speculative money to flow into emerging markets via carry trades and other strategies. That creates a dilemma for developing-country governments: they may want to head off inflation with higher interest rates but that would only encourage the speculators. Some have tried capital controls instead but it is not clear such measures are effective. Bubbles in emerging markets are likely to develop in 2011.

Whether all-out currency wars (in the form of trade protection) will emerge in 2011 is harder to tell. The aim of most developing countries is to prevent their currencies rising against the dollar at a faster pace than the Chinese yuan. Oddly enough, the European fiscal crisis eased some of the strains in late 2010: a weaker euro meant a stronger dollar.

But it is quite possible that the dollar could suffer another round of weakness in the coming year. After all, the currency has no yield support, a continuing trade deficit and the prospect of endless fiscal deficits. The sorry condition of municipal and state finances could yet be the trigger for a loss of confidence.

This list of problems is the reason why it is so hard for Buttonwood to join the bullish consensus for 2011. The authorities have kept the plates spinning by dint of an enormous effort and some unprecedented monetary measures. But the underlying problems have not been solved. And the law of gravity cannot be suspended for ever.

Economist.com/blogs/buttonwood

from PRINT EDITION | Finance and Economics

New-year irresolution

Economics focus

Dec 30th 2009
From The Economist print edition

How to combat the natural tendency to procrastinate

EACH New Year’s Day lots of people make plans to do more exercise or give up smoking. But by January 2nd many of them have not moved from the sofa or are lighting another cigarette. Such triumphs of optimism over experience are common enough. But like other examples of repeated procrastination, they are hard to explain using standard economic models.

These models recognise that people prefer to put off unpleasant things until the future rather than do them today. Asked on January 1st to pick a date for that first session in the gym, say, you may well choose to start in two weeks’ time rather than tomorrow. But the standard models also assume that your choices about future actions are “time-consistent”—they do not depend on when you are asked to make the choice. By January 14th, in other words, you should still be committed to going to the gym the next day. In the real world, however, you may well choose to delay your start-date again.

In a 1999 paper* on the economics of procrastination, Ted O’Donoghue and Matthew Rabin pointed out that people are often unrealistically optimistic about their own future likelihood of doing things—such as exercise or saving—that involve costs at the time they are done, but whose benefits lie even further ahead. Mr O’Donoghue and Mr Rabin showed that this sort of behaviour can be explained if people are time-inconsistent. “Present-biased” preferences mean that people will always tend to put off unpleasant things until tomorrow, even if the immediate cost involved is tiny. As long as they are unsure of the precise extent of this bias, they believe (incorrectly) that they will in fact “do it tomorrow”. But since they feel this way at each point in time, tomorrow never quite comes. Such a model can therefore explain endless procrastination.

It can also suggest ways to change behaviour. A recent NBER paper by Esther Duflo, Michael Kremer and Jonathan Robinson argues that a tendency to procrastinate may explain why so few African farmers use fertiliser, despite knowing that it raises yields and profits. In trials on the farms of maize farmers in western Kenya, the three economists found that using half a teaspoon of fertiliser per plant increased seasonal profits by an average of 36% per acre, even if farmers made no other changes to their farming techniques. Doing so after it was clear that the seeds had sprouted eliminated most of the risk of paying for fertiliser in a year of poor weather. Only 9% of the farmers believed fertiliser would not increase their profits. Yet only 29% had used any in either of the two preceding seasons.

When asked why, almost four-fifths of farmers said that they did not have enough money to buy fertiliser for the land they farmed. Yet fertiliser was readily available in multiples of a kilogram, so even poor farmers earned enough to buy fertiliser for at least a fraction of their fields. Better intentions made little difference: virtually all farmers said they planned to use fertiliser the following season, but only 37% actually did so.

The reason for this gap between intent and action, the economists argue, is that many farmers are present-biased and procrastinate repeatedly. Right after the harvest, when farmers are cash-rich, most can afford to buy fertiliser. But going to town to buy it imposes a small cost: a half-hour walk, say, or a bus ticket. So farmers postpone the purchase, believing they will make it later. But they overestimate their ability to put aside enough money to do that, ensuring that their plans to buy fertiliser meet much the same fate as a typical new-year resolution.

A model of such preferences generates several interesting predictions. It suggests that a tiny discount—enough to make up for the small costs associated with buying fertiliser—should induce present-biased farmers to make the purchase. The model also suggests that a given discount would be more effective if offered immediately after the harvest rather than just before the next planting period, by which time it would be useful only for those farmers who had no problems with saving money.

Solving St Augustine

The economists devised a scheme in which farmers paid the full market price for fertiliser, but had it delivered to their homes by a non-governmental organisation at no additional cost. A subset received this “discount” at harvest time, while another group were also offered free delivery, but only when planting time was imminent. Still others were offered a 50% subsidy on the market price, an approach commonly taken by governments to encourage fertiliser use. As the model of time-inconsistent preferences predicted, the offer of free delivery early in the season pushed up usage of fertiliser by 11 percentage points over a control group who were not offered anything. The same discount late in the season, however, had a statistically insignificant effect. A 50% subsidy later in the season, a much costlier policy than free delivery, pushed up usage by about as much as the early discount.

Interestingly, nearly half of a group of farmers who were offered a choice picked early rather than late free delivery. Early delivery means advance payment, with any interest that might have been earned in the interim being forgone. Many farmers, it seemed, were well aware of their own tendency to procrastinate and were looking for a way to force themselves to buy fertiliser.

Such devices can help other procrastinators, too. In recent field trials in the Philippines some smokers who wanted to quit were offered a “commitment contract”. Those who signed up put money into a zero-interest bank account. If they passed a test certifying that they were nicotine-free six months later, they got their money back. If not, it went to charity. The contract increased the likelihood of quitting by over 30% over a control group. Those new-year resolutions need not turn to ash.

* See papers referred to in this article at www.economist.com/procrastination