"Kee" Points with Jim Kee, Ph.D.


It was pretty hard to find any bad news last week! US manufacturing and non-manufacturing (services) Purchasing Managers Indices (PMIs) both posted numbers in positive expansion territory, and the payroll numbers (jobs created) came in at 217,000 for May. That’s four weeks in a row of monthly job gains exceeding 200,000, which has kind of become the “benchmark to beat” for this recovery. Total nonfarm employment at 138 million jobs has just now surpassed its prior peak back in 2008. You will often hear this stated as “the economy has finally recovered the jobs lost during the great recession.” And you might find this interesting… according to the Bureau of Labor Statistics (BLS), the sectors where jobs lost still overwhelm jobs gained since 2008 are Construction and Manufacturing, while those where jobs gained have swamped jobs lost since 2008 are Education and Health Services, Leisure and Hospitality, and Professional and Business Services.


Other economies seemed poised to deliver positive policy responses. In Europe, European Central Bank head Mario Draghi announced the bank’s decision to provide up to $540bb in cheap loans to Eurozone banks in an attempt to stem tight credit conditions and boost lending there. This is in addition to cutting key interest rates in order to encourage lending of bank reserves (Financial Times). Concerns in Europe center around deflation, and Draghi has stated that there will be more in the way of monetary stimulus. Europe is expected to grow by about 1 percent this year.


China too has announced a cut (50 basis points) in the reserve requirements for certain Chinese banks in order to encourage lending. As an aside, banks hold a portion of all deposits as “reserves” in order to meet day-to-day cash demands of depositors. The rest is loaned out. Banks make money by (in addition to charging fees!) earning a higher rate of interest on these loans then they have to pay for the deposits. Every country requires banks to hold a certain portion of its deposits as reserves, so lowering that reserve requirement means more money for potential loans. Other economic numbers from China, particularly exports, also looked encouraging last week, and most analysts expect China to hit its 7.5 percent GDP growth target this year.


In Japan, first quarter GDP growth came in a bit stronger than expected. Japan had raised its sales tax from 5% to 8% in April (could hit 10% by 2015), though Prime Minister Shinzo Abe has expressed an interest in cutting Japan’s corporate tax rate, which is among the world’s highest. These measures are part of Abe’s “second arrow” of fiscal reform, with the first arrow being monetary stimulus. The third arrow, aimed at broader reform, including an overhaul of corporate governance and reforming Japan’s public pension fund, is, in my opinion, the most important.


Japan’s third arrow:  I won’t rehash the need for corporate governance and pension reform in Japan here (I have discussed it in prior Kee Points) except to reiterate that every economy has to figure out what to do, and how to do it. Japan is very good at the “how to do it” part, but not so good at the “what to do part,” which is really the economic problem. As Nobel Laureate Friedrich Hayek used to say, people think of “the economic problem” in terms of how best to build a bridge (for example). But that’s not an economic problem, it’s a technical problem. The economic problem is whether or not to build a bridge at all, given competing uses for the resources… like building another hospital instead of a bridge, or a toy factory, or a cement plant. Economies organized around the concepts of profit and loss, like the US, are very good at solving the economic problem. If you don’t get the economic problem right in the US, that is, if you build or produce things people don’t value, you don’t stay in business long. Nobody will lend you their capital. And shareholders will sell your stock and outsiders will perhaps consider taking over your firm – legally by buying a controlling number of shares – and firing you (corporate governance). These mechanisms are weak to nonexistent in Japan. Abe’s third arrow promises to change that, and, if meaningful, I think it would be a big global event for investors, similar to what could potentially happen in India (also discussed in prior Kee Points).