Welcome to the Capital Note, a newsletter about finance and economics. On the (abbreviated — Andrew Stuttaford is busy with other projects) menu today: a spike in new-business formation and a reevaluation of exchange rates and international trade.
Spike in New Business Formation
The wreckage of the Covid pandemic is not enough to stop Americans from opening up new businesses. The Department of Commerce reported a massive spike in new-business applications in the third quarter. While partially a reflection of the backlog in applications that built up during the lockdowns earlier this year, the spike is a surprising sign of the ability of the U.S. economy to weather the storm of the pandemic.
It also shows how unusual this year’s recession is. After the 2008 financial crisis, new-firm formation fell by roughly 25 percent, bringing real per capita GDP growth down by 2.5 percent. Despite a massive decline in real GDP this year, new businesses have increased in quantity and quality, according to Goldman Sachs Research:
[N]ew business applications have surged in Q3, with “high-propensity to succeed” business applications—those with similar characteristics to those that have historically led to firm creation—reaching their highest quarterly level on record, following a sharp virus-driven decline in March and April.
In large part, the surge in business formation reflects the forceful policy response to the pandemic. Near-zero interest rates, as well as an increase in personal income thanks to the CARES Act, have made it relatively easy for entrepreneurs to open new firms. It’s also a response to the changes ushered in by the pandemic, such as remote work and the increasing digitization of services.
Along with good news on payrolls and vaccines, the business formation numbers suggest a relatively swift labor-market recovery: Goldman Sachs researchers expect the unemployment rate to drop to 7 percent by the end of this year and to 5.6 percent by the end of 2021.
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In the second quarter, for the first time, the net foreign asset accumulation of the PBOC and the state banking system looks to have returned to close to $100 billion—a sum roughly equal to the current account surplus. The PBOC added about $20 billion to its reserves (at least in the balance of payments data) and I would add the mysterious “other, other, assets” in the balance of payments data to that total. The net foreign asset position of the state banks increased by about another $50 billion (including trade credit) and the banks also account for the majority of the $14 billion or so in Chinese purchases of foreign bonds.
Scientists developing a compact version of a nuclear fusion reactor have shown in a series of research papers that it should work, renewing hopes that the long-elusive goal of mimicking the way the sun produces energy might be achieved and eventually contribute to the fight against climate change…
Fusion, in which lightweight atoms are brought together at temperatures of tens of millions of degrees to release energy, has been held out as a way for the world to address the climate-change implications of electricity production.
Like a conventional nuclear fission power plant that splits atoms, a fusion plant would not burn fossil fuels and would not produce greenhouse-gas emissions. But its fuel, usually isotopes of hydrogen, would be far more plentiful than the uranium used in most nuclear plants, and fusion would generate less, and less dangerous, radioactivity and waste than fission plants.
Epic contends that Apple’s “walled garden”—in which iPhone software can only be downloaded via the App Store—stifles competition. In 2018 Epic launched its own PC games store, where it charges a 12% commission. Shortly after, Steam, the dominant store, dropped its cut from 30% to 20% for top-selling games. Tim Sweeney (pictured), Epic’s feisty boss, argues that Apple’s restrictions make it impossible to try something similar on iPhones.
Apple retorts that those who dislike its rules have plenty of alternatives. “Fortnite” is available on desktop PCs, games consoles and smartphones that run on Android, a rival operating system made by Google. In a statement, Apple accused Epic of forcing its hand and “putting customers in the middle of their fight”. It has counter-sued Epic for breaching its App Store contract.
The conventional wisdom in trade economics holds that, all else being equal, a country whose currency depreciates will see exports grow, as it can price goods more competitively abroad. If a Chinese exporter is selling goods in Brazil and the yuan loses value, Brazilian consumers can spend the same amount of money on more of the Chinese exporter’s products.
In practice, however, the vast majority of international trade is invoiced in the U.S. dollar, and most exporters set prices in the dollar. This means that the relevant exchange rate for international transactions is not the rate between two trading countries’ currencies, but that between those countries’ currencies and the U.S. dollar. In a transaction between a Chinese and Brazilian firm, the exchange rate between the yuan and the real won’t have meaningful effects on the terms of trade if the dollar exchange rate remains constant.
A recent paper in the American Economic Review explains the implications of this “dominant-currency paradigm”:
First, at both short and medium horizons the terms-of-trade should be insensitive to exchange rate fluctuations. Second, for non-US countries, exchange rate pass-through into import prices (in home currency) should be high and driven by the dollar exchange rate as opposed to the bilateral exchange rate. For the United States, on the contrary, pass-through into import prices should be low. Third, for non-US countries, import quantities should be driven by the dollar exchange rate as opposed to the bilateral exchange rate. In addition, US import quantities should be less responsive to dollar exchange rate movements as compared to non-US countries. Fourth, when the dollar appreciates uniformly against all other currencies, it should lead to a decline in trade between countries in the rest of the world (i.e., excluding the United States).
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