LA Times Gets Real on Trade

This past Wednesday night Barack Obama came to campus. He held a rally near the river on campus--Texas State University is blessed to have spring-fed river that originates on campus--and about 12,000 people showed up. This came right after the debate in Ohio, which for many economists was a little disconcerting given all the NAFTA bashing. I was curious to see if Obama's anti-NAFTA rhetoric would carry over into this rally in Texas. Well, surprise, surprise, he said absolutely nothing about NAFTA. This absence makes political sense, but it is frustrating to watch. What does the real Obama think about trade? Are we just seeing primary season pandering or is this the real deal? As Greg Mankiw said over at his blog "will the real Obamanomics please stand up?"

Mark Thoma provides some links to different commentators who on balance suggest to me Obama is less protectionist than is indicated by his rhetoric. Nonetheless, the Financial Times reports Canada and Mexico, our NAFTA partners, are not pleased with all the anti-trade rhetoric coming out of the Obama camp. So, as Daniel Drezner points outs, "Democrats cannot simultaneously talk about improving America's standing abroad while acting like a belligerent unilateralist when it comes to trade policy" (hat tip Greg Mankiw). This point becomes even more salient if we look beyond Mexico and Canada and consider all the developing economies who are dying to penetrate the U.S. market (or desire to have the U.S. cut its distortionary subsidies to U.S. firms). What are they thinking when they hear such anti-trade talk?

The LA Times had an editorial yesterday that touches on some of these issues and is worth the read.

Deal with the Trade-Offs

The 14-year-old North American Free Trade Agreement has become a hot issue in this year's Democratic presidential campaign -- in Ohio, at least. When Sens. Hillary Rodham Clinton and Barack Obama hit the hustings in the Buckeye State, they compete to be NAFTA’s biggest critic. But when they jet to Texas, which is also holding its primary Tuesday, the candidates have little or nothing to say about the pact

The disparity illustrates two truths about major trade deals: They're a magnet for pandering, and they produce both winners and losers. Ohio, like other states in the Rust Belt, is stinging from the loss of manufacturing jobs in the years since NAFTA took effect. In Texas, however, communities near the border have blossomed with an influx of investment, jobs and workers

And the differences haven't just been regional. The trade deals signed since 1980 have helped spur job growth for some types of workers while decreasing jobs for others. Men at the high and low ends of the career ladder have benefited, but those in the middle have suffered, while the opposite holds true for women, according to a recent study by economist Stephen Rose at the Progressive Policy Institute.

The president's job is to take the long view of what's best for the country as a whole. Although it's hard to pinpoint jobs lost or created because of NAFTA, U.S. employment has grown far beyond even pessimistic estimates of the trade deal's costs. You wouldn't know that listening to Obama, who declared in a recent speech that "trade deals like NAFTA ship jobs overseas and force parents to compete with their teenagers to work for minimum wage." His stance is echoed by Clinton, who scolded Obama's campaign for distributing a flier that said she had called NAFTA a "boon" to the economy.

The centerpiece of both candidates' positions on trade is that future deals must include "good" or "strong" labor and environmental standards. That's vaguely comforting and feel-good-ish, but it's also misleading. Higher standards won't protect jobs and bottle up capital in the U.S. over the long term.

That's why the best course is to embrace free trade and fight for lower tariffs and other barriers to U.S. goods and services overseas. Protecting U.S. workers means giving them the education, training and, if necessary, retraining needed to compete for the higher-paying jobs that result from open markets. The capital and jobs that leave can help U.S. workers too by fostering stronger economies in the rest of the world and thus creating markets in which we can sell our products.

The increasingly global nature of business causes pain, but it's better to adapt to the competition than shake your fist at it.

Where Goes the Oil?

As oil hovers near $100 a barrel, here are some interesting figures to mull over from a BBC report.

Allan Meltzer Goes for the Fed Jugular

Allan Meltzer gets shrill in this Wall Street Journal article. He argues (1) the Fed is becoming more politicized and, as result, (2) is making some decisions that will be very costly in the future. What is really causing Allan all this angst is the specter of 1970s-style stagflation. He experienced this stagflation firsthand and the subsequent 'cleansing' Paul Volker's Fed had to undertake to bring back macroeconomic order. Melzter does not want to see it happen again.

That '70s Show
Is the Federal Reserve an independent monetary authority or a handmaiden beholden to political and market players? Has it reverted to its mistaken behavior in the 1970s? Recent actions and public commitments, including Fed Chairman Ben Bernanke's testimony to Congress yesterday -- where he warned of a steeper decline and suggested that more rate cuts lie ahead -- leave little doubt on both counts

... In the 1970s and again now, Federal Reserve officials repeatedly promised themselves and each other that they would lower inflation. But as soon as the unemployment rate ticked up a bit, the promises were forgotten... People soon recognized that avoiding possible recession overwhelmed any concern about inflation. Many concluded that inflation would increase over time and that the Fed would do little more than talk. Prices and wages fell very little in recessions. The result was inflation and stagnant growth: stagflation.

... One lesson of the inflationary 1970s: A country that will not accept the possibility of a small recession will end up having a big one when the politicians at last respond to the public's complaints about inflation. Instead of paying the relatively small cost of a possible recession, the public pays the much larger cost of sustained inflation and a deeper recession. And enduring the deeper recession is the only way to convince the public that the Fed has at last decided to slow inflation.

... The freezing up of short-term financial markets called for more borrowing... But the rush to bring real short-term interest rates to negative values is an unseemly and dangerous response to pressures from Wall Street, Congress and the administration. The Federal Reserve became "independent" in 1913 so that it could resist pressures of that kind.

... The Fed's recent behavior is in sharp contrast to the European Central Bank. The ECB keeps its eye on both objectives, growth and low inflation. It doesn't shift back and forth from one to the other. The Fed should do the same.

How Low Will Home Prices Go?

This is a question I keep asking myself, not as an economist but as a potential homebuyer. As I have discussed previously on this blog, I recently moved to Texas from Michigan and am now looking to buy a home. A few weeks ago my wife and I aided and abetted the housing recession. Yes, we are guilty as charged of withdrawing an offer we had on a home under the assumption that the housing market has not hit bottom (there were some other factors as well). It is almost surreal to think I am a part of a downward deflationary spiral in the housing market where expectations play an important role. Of course, the Texas housing market is not the same as the Michigan housing market--where I had to bring money to the table to sale my home--and so I need to be careful in assessing how far home prices will fall here.

Still, I ask how far will home prices fall? The S&P/Case-Shiller house price index for select metropolitan areas and the OFHEO national house price index just came out for the end of 2007 and both show on-going declines across the nation. Below is a graph of the these two (nominal) series in year-on-year growth rate form through the end of 2007.

While this graph is interesting, it does not really provide any insight into my question of how low will house prices go. If we look at the series in the levels we get the following graph:

This figure shows in nominal terms that the home prices reached a peak in late 2006 (Case-Shiller) or early 2007 (OFHEO). The figure also indicates there is much more correction needed for nominal house prices to return to pre-2003 trend levels. This simple 'eyeball' analysis is consistent with what Calculated Risk has reported about futures data on housing prices:

... futures data is forecasting a price drop of 11% over the next year, and close to 25% over the next 3 years for the 25 largest MSAs.

As a home buyer, though, I am also sensitive to mortgage rates and recently they have been going up (see this picture over at the Big Picture). The Wall Street Journal explains why this is happening despite ongoing policy rat cuts:

There are two reasons mortgage rates haven't responded more to the Fed's rate cuts. One is that long-term Treasury yields, which are the benchmark for most mortgage rates, have risen recently, perhaps because of increased concern about inflation as the prices of oil and other commodities soar. The other is that the spread between mortgage rates and Treasury rates has widened as investors and banks become increasingly reluctant to make home loans.

The only way for long-term rates to fall now is for there to be more bad economic news. That would help with the inflation concerns, but it would not eliminate the mortgage-Treasury spread. If the Nouriel Roubini's of the world are correct, and if the mortgage-Treasury spread does not dramatically change, then lower mortgage rates await me in the near future.

So, patiently I wait for further housing price declines and more bad economic news.

Update

James Hamilton discusses the latest housing price data over at Econbrowser.

The Next Big Bubble?

We live in interesting times. Oil and other commodity prices continue to rise even as global demand is presumably slowing down. Normally, one would expect commodity prices to slow down with a weakening global economy. What explains these developments? As The Economist notes, it cannot be supply conditions since they have not dramatically worsened recently. James Hamilton believes these developments may indicate the economy will be improving in the near future. The uptick in commodity prices is simply a reflection of their role as a leading economic indicator. Maybe he is correct, or maybe we are seeing the beginning of the next big monetary policy-generated bubble.

Jeffrey Frankel of Harvard University has shown there is an important negative relationship between real interest rates and real commodity prices, with causality running from the former to the latter. Here is one illustrative graph from his work:

One story Frankel tells is that as monetary policy lowers interest rates speculators shift out of treasury bills into commodity contracts. Hence, the recent rate cuts by the Fed are generating a movement of liquidity into commodities. This story gets even more traction when we consider that the other big asset markets--stocks and housing--that would normally attract this liquidity have already been bubbled and popped. Lquidity, then, is looking for a new home to make a bubble and commodities seem to fit the billing this time around.

While this view is only one interpretation of the recent surge in commodity prices, it strikes me as reasonable. If time shows it to be true, the Fed will have unwittingly lived up to its reputation as a serial bubble blower.

Why Trade is Good

From this BBC article comes this striking figure on productivity in the auto industry:

Imagine where productivity in the U.S. auto industry would be if there were no Toyota, Honda, or Nissan. Certainly, the dislocations from trade can be painful, but this graph suggests there are meaningful dyanmic gains from trade.

Recession at the State Level

The Economist recently did an interesting article that examined where the U.S. economy was getting hit the hardest. The article found that economic "misery has been concentrated... in two set of states: the industrial Midwest and those states that was the biggest housing bubble, particularly California, Nevada, Arizona, and Florida." Much of the analysis, however, appears to have been based on unemployment rates in each state. While this is a useful metric, it may not be capturing the full extent of the economic distress given its known shortcomings. Consequently, I went to see what the Philadelphia Fed's state coincident indicator series are saying about regional economic activity. The data is on a monthly basis and the available observations run through December 2007. The fist bit of analysis I did was to simply look at the annualized growth rate for each state in December:

The above table reveals 27 states were contracting, while 23 were expanding. Next, I took the data and plugged it into some mapping software to get the following figure, where black = decline of 3% or greater, dark grey = decline of less than 3%, and light grey = expansion. In short, the darker the shading the greater the economic distress:

A few observations are in order. First, the hardest hit states are not the ones were the housing boom was the most pronounced. Thus, California, Nevada, Arizona, and Florida while experiencing a contraction in their economies are not being hammered as hard as the states in black. Second, while The Economist article showed the Northern Plain states to be doing relatively well, these information indicates otherwise--they are contracting. Third, Wyoming is doing so well relative to the other states and I assume it is because of higher commodity prices. If so, then why why is Kansas and Idaho dosing so poorly?

It will be interesting to see if January's data will show similar patterns.