Keeping the golden faith

As was to be expected, the euro has been hit hard by the results of the French referendum, dropping form around 1.26 US$/EUR to 1.23 in two days. This is likely a knee-jerk reaction, but it’s part of a trend that has been running this year (the US$/EUR rate at the end of last year was 1.36). Obviously, the euro zone’s dismal growth performance, which has driven long term rates to around 3.3%, is the main culprit.

This will cause a lot of pain to that most unusual, even cultish group: gold bugs. The price of gold is negatively correlated to the dollar’s value, so its current strength against the euro (and other currencies) has made it –one of the best investments in the past four years—lose its shine. Its price has fallen 6% this year and 4% over the last 30 days.

However, no matter what trials the markets bring, this group is steadfast in its faith: they, along with many others, including Warren Buffet, still see only damnation for the dollar in the long term (see this example).

Airlines: So which is it?

On to today's news:

1. Two headlines, seen on the same page:

Airline Industry Says Fuel Costs, Taxes Have Vaporized Profits

Ryanair posts record profit, outlook improves

2. Today's trip to the twilight zone: Six KFC workers die in Karachi violence

Get this: A Sunni extremist group led to al-Qaeda attacks a Shiite mosque in Pakistan. Shiite youths go on a rampage, burning a .....KFC restaurant? So much for my "enemy's enemy is my friend".

Not quite emerging countries

As a student working for a degree in economics in a large "emerging" country in the early 1990's, I can recall the excitement of seeing wide-ranging liberal reforms being implemented all over the developing world. After surviving the dreary 1980's (aka "The Lost Decade"), it seemed that we were finally starting the dash for growth that would set us on the path for enduring prosperity.

Well, so much for that. In the end, the previous decade ended with a whimper, with crises laying low the nations, such as Argentina and Mexico, that were the toast of the international finance community just a few years back.

The World Bank has just put out a report on economic growth in the 1990's that focusses on the emerging world. I haven't read it in full, but the bits I've looked at are pretty good. In the end, it shows that we still have a lot to learn about what it takes for a country to grow on a sustained basis. It states that in that decade there were 5 major disappointments:

1. The length, depth, and variance across countries of the output loss in the transition from planned to market economies in the former Soviet Union (FSU) and Eastern European countries.

2. The severity and intensity of the international and domestic financial crises that rolled throughEast Asia

3. Argentina’s financial and economic implosion after the collapse of its currency convertibility regime

4. The weakness of the response of growth to reform, especially in Latin America, and the unpopularity of many of the reforms.

5. The continued stagnation in Sub-Saharan Africa, the paucity of success cases there, and the apparent wilting of optimism around the“African Renaissance.”

On the other side of the ledger, the WB states there were 3 pleasant surprises:

1. Bright spots of sustained rapid growth, especially in China, India, and Vietnam, throughout the decade

2. The strong progress in noneconomic indicators of well-being in spite of low growth in some cases.

3. The resilience of the world economy to stresses

One can quibble with the list, but its a fair summary. Needless to say, the main disappointment was that most nations didn't grow as much as initially forecast despite implementing market-friendly reforms. This shows just how hard the business of development actually is.

Rock stars for free trade

I’ve never been a big fan of U2, but I certainly admire Bono, its lead singer, for promoting well-known development issues such as HIV and debt relief. After reading this interview in the London Times, I’m even more impressed by his mature outlook. He’s in favor of doing away with rich nations’ agricultural subsidies that hurt exports from developing countries and he even has nice things to say about George Bush and Jesse Helms.

The times, they are a changin’.

Irreverent weekend morcels

-Recession is a state of mind

Prime Minister Silvio Berlusconi disputed Europe's fourth-biggest economy
was in recession, saying Italy was ``full of prosperity and joy,'' citing the
high number of mobile phone users as evidence of the nation's affluence.
``We have a very high percentage of mobile phones and are playboys and send
our girlfriends 10 text messages a day,'' said Berlusconi during a joint news
conference with U.K. Prime Minister Tony Blair. ``Italy is the most beautiful
country in the world and among the richest in the world.''

Read the orginal here.

- "Vision loss is linked to Viagra"

It turns out old men in the 21st century are being told the same thing that young men in the 19th century were constantly reminded of. Queen Victoria must be pleased.

- "Judges Still Reading Khodorkovsky Verdict"

I sure the disgraced former oil tycoon is no saint. But how can a court take 10 days and counting to read a verdict? I'd wager that Saint Peter didn't take that long to read Hitler's verdict.

The contrarians

The lads over at Morgan Stanley’s Global Economic Forum are in the mood to challenge conventional wisdom today.

First off at bat, Stephen Roach, head economist and high priest of gloom, makes the case for Europe. That's not an easy task, as the Old Continent's list of problems is long: labor rigidity/high unemployment, slow growth, existential angst and growing doubts about the integrationist project, to name a few.

Yet, Roach argues that there is growth, after all, and it’s picking up (albeit to an underwhelming 2% pace in 2006). Reforms are making labor markets more flexible and European corporations are restructuring, increasing productivity through investments in information technology. If the French reject the proposed Euro constitution, the fallout will be very limited (the risks of a deeper Euro rift will rise, but they’re still very low).

I find this argument compelling. Most European nations are in an unsustainable position. You cannot have a generous welfare state with a rapidly aging population and labor market rigidities that keep unemployment high and labor participation low. Something has to give and my bet is that, like it or not, Europeans will realize they have to work more. Combined with high and rising productivity, this will lead to a significant acceleration in growth.

The markets certainly seem to agree: MSCI’s Europe index is up 1.5% in local currency terms since the end of March, when it became clear that the “Non” camp was winning in the French referendum, and is up 5% so far this year. Sure, the euro has fallen from the highs reached at the end of 2004, but it’s still quite a bit above the average level seen last year.

Not to be outdone, Richard Berner brings calm and sense to the housing bubble debate. Like Alan Greenspan, he’s a longtime skeptic of the bubble theory who has recently changed his mind somewhat (to the group that sees ‘froth’ in the market). Berner mentions that prices are not rising as fast as mentioned if house quality and the composition of the market are taken into account and that other metrics, such as the number of houses sold for investment purposes, are biased. As a result, he expects prices to ‘rust’, with perhaps some regional pops. However, he warns that any adverse shocks will mainly affect lenders, not borrowers.

Finally, Andy Xie pours cold water on the notion that the world is on the brink of an outburst of China-related protectionism. As always, he flatly denies that a revaluation of the yuan is in China’s interest and expects its government to ignore U.S. and European pressure to let the exchange rate rise. But Xie also states that the threats to raise trade barriers against Chinese products are hollow: most of these don’t compete directly with U.S. products, U.S. firms capture most of the value chain associated with Chinese imports and, in the end, reducing these imports won’t really cut the huge U.S. trade deficit.

I hope all of them are right.

Do you invest as well as your pension fund?

By now, it’s pretty clear that defined-benefit pension plans are an endangered species (see this article). Even relatively healthy firms are switching to defined-contribution plans to transfer investment risk to workers.

Is this a good thing? Sure, if the average Joe was equipped to make smart financial decisions. However, there’s a lot of research that suggest the average investor makes plenty of costly mistakes, such as overlooking costs (this piece provides a nice summary). In that regard, traditional company pension funds, which are usually large and managed professionally, may provide better performance.

I took a look at four large pension funds –two for public sector workers (Calpers and NY State Common), and two company funds (IBM’s and GE’s). Over the last ten years, they averaged a 10.2% annual compound return (the range was very narrow: between 9.9% and 10.6%).

It’s not an extraordinary result. A portfolio made up of Vanguard’s S&P 500 and Total Bond Market index funds, split on a 65-35 per cent basis, would’ve delivered basically the same performance.

Yet, one has to wonder how many people actually earned these returns. My bet is that, on average, they would’ve earned a between one and two percent less, simply from paying higher management fees or from excessive trading. So spare a tear for your traditional pension fund, which in most cases offered workers a decent deal.

Postcards from the housing bubble

· According to a new report, existing home prices are rising at a 15% annual clip and existing home sales rose nearly 7% above year-ago levels. With these figures, even Alan Greenspan, chief housing bubble denier, isn’t sounding too confident nowadays.

· In 2002, 5.6 million existing homes changed hands. With the median home price at 156,000 dollars, the value of residential real estate transactions was roughly 880 billion dollars. Given the figures this year, that number will rise to over 1.5 trillion dollars (figures taken from the NAR).

· The membership of the National Association of Realtors grew 37% between 2001 and 2004 and now stands at 1.1 million. During the same period, non-farm payrolls actually dropped.

· If the bubble does pop, Robert Shiller’s proposal to create house price derivates to enable home owner to hedge against falling values will surely get the attention it deserves.

Culture and economic performance in the Arab world

Moisés Naím argues in this editorial that the success of Arab Americans –they have higher levels of education and income than average—disproves the notion that “Arab culture” is somehow responsible for the relative backwardness of the Middle East. (Thanks to Dan Drezner for the pointer –don’t miss his take and the comments).

On a practical level, Naím’s article has a gaping hole: the national and religious mix of Arab Americans is very different than the ones found in the Middle East and Europe (more details here). He’s comparing apples to oranges.

But it’s worth going back to the culture issue. In this context, it’s such a broad term that it’s virtually meaningless, so one needs to break it down.

If by “culture” we mainly mean “religion”, once can say with certainty that it’s totally irrelevant. The economic performance of many Christian nations is very poor (Latin America, Philippines), while there’s no evidence that Islam per se impedes economic growth (Marginal Revolution has a lot on this topic, check out this post and this one).

But if we include such aspects as institutions, politics, etc. in “culture”, it’s impossible to deny that they have an impact on a nation’s prosperity. In this regard, most Middle Eastern nations do have one thing in common: they were part of the Ottoman empire for centuries. While I’m no expert on this topic, it’s fairly clear that the Ottoman’s were good warriors but very incompetent economic managers (more on this topic here) who didn’t put in place a decent institutional framework.

A currency mystery solved

Bombarded as we are every day by articles on China’s currency dilemma, I couldn’t help but wonder what that currency is called. Some pieces refer to it as the renminbi, while others refer to it as the yuan.

So which is it? Actually, both are correct. According to this explanation, renminbi can be literally translated as “people’s currency”, while “yuan” is the main unit of measurement. Hence, in banknotes the amounts are expressed in yuan (or

In the West, we don’t distinguish between both terms (it’d be awkward to say “the chocolate bar costs one United States currency unit”), but that doesn’t mean it can’t be done. I, for one, will stick to yuan.