The austerity versus spending debate is an ongoing phenomena and has opened a deep chasm between differing ideologies in the spheres of politics and economics. Unfortunately, the debate tends to be coloured more by ideological biases than a focus on evidence based economic experience. It is therefore helpful to understand the issues at hand via a simple real life example – and with that aim in mind I summarise below a note by Paul Krugman on the "Baby-Sitting Co-op" written in 1998 in the context of the Asian Financial crisis, but also very relevant to the current crisis. The note illustrates how economies can fall into recessions and the process by which government stimulus can help the economy recover from them.
-The original story was told in an academic article published in 1978 about the experiences of the two authors (husband and wife) who were part of a baby-sitting co-op in the early 1970s in the Washington area. The story had a big influence on Krugman's economic thinking.
-A group of 150 couples agree to baby-sit for each other, thereby removing the need to hire baby sitters for cash. The arrangement was mutually beneficial as baby-sitting more children in addition to your own was not much of an additional burden, particularly given that you would receive the same service some other evening.
-To ensure that every couple did their fair share, the co-op issued scrip-pieces of paper equivalent to one hour of baby-sitting time. The relevant amount of coupons were exchanged at the end of each baby-sitting session and the system was self-reinforcing – over time each couple would do an equal amount of baby-sitting as it received in return.
-However, technical problem developed as couples (during periods of low social activity) would baby-sit more often to build a reserve of coupons to be used when social activity increased at a later date. Normally this demand would average out over time as one couple staying at home would be offset by another couple going out. But since many couples held reserves, the co-op needed to ensure a large amount of scrips in circulation.
-This particular co-op, however, experienced a sharp drop in circulating coupons (for complicated reasons involving the payment and collection of dues which were paid in scrip). This shortage led to more couples trying to build reserves and were reluctant to go out. But this tendency deprived other couples to earn coupons, further reducing baby-sitting opportunities with couples only going out on special occasions. The co-op experienced a recession.
-A debate began between two groups in the co-op – the lawyers (who wanted to legislate a recovery by passing a rule requiring couples to go out more often) and the economists who wanted to issue more coupons. The economists finally won, more coupons were issued and couples started going out more often. Eventually (of course) the co-op issued too much scrip leading to different problems....
-This simple story illustrates how an economy can fall into a recession (because consumer demand falls – i.e. co-op members go out less often) and how central banks can act to resolve the situation (by monetary easing - i.e. issuing more scrip).
-The story also has an important lesson- that recessions are not a punishment for our sins which we are fated to suffer or because its members are bad and inefficient baby-sitters, nor because of a flaw in their values. They happen because there are too many people chasing too few scrips.
-The story could be extended further – there could be situations where co-op members could find themselves out of coupons because they went out several times in a row, and therefore could not get baby-sitters, even though they were able and willing to do more baby-sitting in the future. To resolve this problem, they could borrow more coupons from the co-op, with a penalty in terms of more coupons to be repaid later.
-Under this system, couples would hold less reserves than before knowing that they could always borrow more if necessary. The co-op could also vary the penalty depending on whether there were an abundant supply of baby-sitters (lower the penalty to encourage more people to go out) or a shortage of baby-sitters (increase the penalty to encourage people to go out less).
-The above co-op would thus have a central bank which stimulates, or cools down, an economy by reducing or increasing the interest rate.
-How do "liquidity traps" occur in this co-op? There could be a seasonality to the demand and supply for baby-sitting – with people preferring to stay at home during dark and cold winter months (to build coupon reserves for more summer social activity). The co-op could even out the seasonality by lower rates in the winter and higher rates in the summer – but this seasonality could become so strong that even at zero interest rates people are more willing to baby-sit than go out leading to (via a self-reinforcing cycle) fewer and fewer baby-sitting opportunities in the winter and a recession.
-"The story of the baby-sitting co-op is not mere amusement – if only people could take it seriously and try to understand the great economic issues at stake, whimsical parables are not a waste of time but the key to enlightenment - it is a story which can save the world".
While this article appeared in 1998, in response to the Asian crisis, it has very relevant applications to the challenges we face today – i.e. a liquidity trap where consumer demand remains anaemic despite zero interest rates. So rather than focussing on practical and tested measures to lift developed world economies out of the liquidity trap, the focus has unfortunately shifted to an expression of ideological biases against "big government" and "debt" and the solution being espoused is even more "austerity" – which has prolonged and deepened the slump. It is also clear that the US Fed, led by Bernanke (who probably understands the implications of the above story well by being a leading scholar of the Great Depression!), is taking steps in the right direction (though arguably not aggressively enough as it is constrained by the political dead-lock in the US) while the ECB remains mired in a morass of ineffective decision making and being held hostage to an irrelevant episode of history (the "Weimar Hyperinflation").
The next few weeks are likely to be critical for global markets– with the EU summit on December 9th and the Fed policy meeting on December 13th. The market is expecting an announcement on a plan for fiscal union for the Eurozone, to be followed by more active intervention by the ECB (and the IMF) to support the government bond markets. This would likely lead to a massive year-end rally which may extend to the early part of next year, but as we have seen innumerable times before, this is also likely to be followed by disappointment with a lack of details and unforeseen problems with the plan. Meanwhile, the Fed seems to be laying the groundwork for a QE (with statements in favour by several governors) , with a focus on the housing market, and there is a high possibility they announce this on December 13th.
I have attached below charts which illustrate the year-to-date performances of the major global equity markets and other asset classes. Assuming we get stimulative policy actions across the globe (and there are clear signs that this is beginning to happen with the coordinated central bank actions last week), the markets which are likely to out-perform are the ones which lagged last year- namely: Europe, India, Hong Kong & China, Brazil, Japan and commodities. Sometimes a simplistic approach to investing works far better than complicated analysis!
Global - Economy and Market
Italy PM Monti unveils sweeping austerity package
ROME - Prime Minister Mario Monti will present a 30 billion euro package of austerity measures to parliament on Monday designed to shore up Italy's strained public finances and help to stem a debt crisis threatening to overwhelm the euro zone.
China vice premier calls for trade restructuring
SHANGHAI - China's Vice Premier Wang Qishan on Sunday urged local authorities to stabilise exports and boost imports in the face of growing global economic uncertainties, reiterating Beijing's pledge to transform its trade-dependent economy.
Russia: November manufacturing PMI was up sharply from the previous month, a further sign of a pickup in growth in Q4
The most significant rebound was in the new orders, output and employment sub-components.The output prices sub-component rose, while the input prices sub-component was indicative of a further decline in inflation pressures.
Mexico: The central bank will announce its monetary policy decision today at 10:00am EST; expected to leave the overnight rate unchanged at 4.5%
South Africa: November’s PMI increased to 51.6, but the components were mixed
Taiwan: The Executive Yuan has approved measures to support the economy, aiming at maintaining 2012 GDP growth at 4%
U.S. manufacturing expansion outpaces most other nations
U.S. manufacturing output rose last month, setting the country apart from other developed nations except Russia, the Institute for Supply Management said. The institute's U.S. index rose to 52.7% in November, from 50.8% in October. Russia's index rose 2.2 percentage points, to 52.6%.
India - Economy and Market
Mamata Banerjee says foreign supermarket plan on hold
MUMBAI - The government will put a plan to open up its retail industry to foreign supermarkets on hold until it reaches consensus within the coalition, risking a possible dilution of the policy rather than a change of heart.
RBI says ready to deploy every tool to defend rupee
RBI on Saturday said it will pull all stops to defend rupee if situation warranted and blasted critics questioning its ability to effectively arrest slide, saying selective intervention in recent days should not be "misconstrued" as its "inability" to deal with the challenge.
"We do have the instruments and capacity to enhance the supply of foreign exchange into the market and will use them as appropriate," RBI Deputy Governor Subir Gokarn told a CII event here through a video recording.
New green revolution: Producer comapnies help farmers reap profits
NEW DELHI: Farmers are joining India Inc in mind, body and spirit. In a quiet revolution underway across the countryside, growers are setting up companies, replete with balance sheets, professional CEOs, board of directors, and income tax returns.
By pooling together the land and produce of their shareholders, these companies are signing lucrative deals with large retail chains, food companies and exporters keen to establish reliable supply chains. As many as 200 companies have been formed by farmers from different parts of the country and another 100 are likely to be set up by March next year
Indian shares to drop on profit-taking; UltraTech eyed
MUMBAI, Dec 5 - Indian shares could falter on Monday as profit-taking is seen emerging after the market had rallied the most in nearly two-and-a-half years last week. "I don't see the market going up. It will open in the red and will go down," Kishor Ostwal, chairman and managing director at CNI Research, said. At 0230 GMT, the Nifty India stock futures traded in Singapore were trading down by 0.5 percent, pointing to a lower opening for the Indian market.
Technology News –
Infosys cautious about global IT demand; Wipro, TCS, Cognizant optimistic
While, Infosys is cautious. Tata Consultancy Services (TCS), Cognizant and Wipro were very optimistic on demand for IT products.
Tulip partners Iomega, MindTree for video surveillance service
Tulip Telecom has tied-up with IT firm MindTree and data storage company Iomega to offer video surveillance services to SMEs.
The services will be based on Iomega's storage devices, while MindTree will provide the video management software. The solutions will be rolled out by Tulip.
"The partnership looks to provide India's first video surveillance services based on cloud technology to the SMEs," Iomega President Jonathan Huberman told reporters here today.
Germany's SAP to buy US-based SuccessFactors for $ 3.4 bn
NEW YORK: German business software giant SAP AG has agreed to buy SuccessFactors Inc in an all-cash deal worth $ 3.4 billion.
SAP will pay $ 40 a share for acquiring all common stock of US-based SuccessFactors. This represents a premium of 52 per cent over the closing price of SuccessFactors' shares on December 2, the Germany-based firm said yesterday in a statement.
SuccessFactors, a provider of employee management software, has more than 3,500 customers and over 15 million subscribers in 168 countries.
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Daily_Markets_Eco_5Dec2011.doc
Trading levels for the week (5th Dec. - 9th Dec.)
For the week Crude prices are expected to find Resistance at 5274-5294 levels. Trading consistently above 5300 levels would renew the previous rally initially towards 5377 levels, and then finally towards the Major resistance at 5470 levels.
Support will be at 5070-5050 levels. Trading below 5040 levels would trigger a sharp fall initially towards 4965 levels and then finally towards the Major support at 4896 levels....read levels of Gold, Silver and Copper
