Warnings from Japan for the eurozone
Europe has been unwilling to address the structural excess savings of creditor countries
Japan is no longer governed by consensus. This is true at least of its monetary policy. Haruhiko Kuroda, governor of the Bank of Japan, launched still greater “quantitative and qualitative monetary easing” last week, with the backing of only five of the nine members of the Monetary Policy Committee. 
The BoJ plans to purchase Japanese government bonds at an annual rate of Y80tn ($705bn), or 16 per cent of gross domestic product. The balance sheet of the central bank is set to jump towards 80 per cent of GDP (see chart). This would make the BoJ’s balance sheet relatively far bigger than those of the US Federal Reserve, European Central Bank and the Bank of England (see chart). In addition, the BoJ plans to lengthen the maturity of its asset purchases to between seven and 10 years.
The government pension investment fund has also announced that it will reduce its holdings of domestic bonds from 60 per cent of its portfolio to 35 per cent, while increasing its equity holdings (domestic and foreign) from 24 to 50 per cent. As a result, it will increase its holdings of Japanese equities by $90bn and of non-Japanese equities by $110bn. Indirectly, the BoJ is financing this by buying JGBs owned by the GPIF.
To justify its decision, the BoJ stated: “On the price front, somewhat weak developments in demand following the consumption tax hike [in April] and a substantial decline in crude oil prices have been exerting downward pressure.” As a result, it argues, there is a risk that “conversion of deflationary mindset, which has so far been progressing steadily, might be delayed”.

So will this reinforced attempt to end Japan’s entrenched deflation work? To answer, one needs to distinguish the direct effects from the signalling.

The purchases of equities by the GPIF might be significant. But it is hard to believe replacing JGBs with money in private portfolios would make much difference. Central-bank money can also be thought of as non-interest-bearing, irredeemable government debt. But 10-year JGBs yield less than 0.5 per cent. So the difference between the two forms of government “debt” is tiny, particularly since the BoJ intends to reverse its monetary expansion at some point.

This makes the signalling the main channel. The decision is intended to underline the seriousness of the BoJ. But the split in the MPC must undermine the effectiveness of the signal it seeks to give and so weaken its impact.

Japan charts

The BoJ is combating the consequences of a bad policy error that it, alas, supported. The decision to raise the consumption tax this year was mistaken: it was mistimed, since it was introduced before the desired shift in inflationary expectations to an annual rate of 2 per cent had been entrenched; it was a tax on private consumption, of which Japan has too little, instead of on private savings, of which it has too much; and it did not address the structural cause of the latter, which is the chronic financial surplus of the corporate sector (the excess of its gross earnings over investment).

Since Japan’s bubble economy collapsed in the early 1990s, the private sector has run a huge financial surplus, which has been the counterpart of the government’s deficit and the net export of capital (see chart). Today, nearly all that surplus is generated within the corporate sector.

The government will be able to eliminate its own deficit, while avoiding a return to economic depression, if and only if spending rises elsewhere relative to incomes. A jump in net exports would be one possibility. A rise in investment would be another. A shift of income from corporations to households, and a rise in consumption by the latter, would be a third.

Japan charts

Could the BoJ’s monetary policy deliver such outcomes? Only up to a point. Negative real interest rates might permanently raise wasteful corporate investment. Negative real interest rates should also depreciate the exchange rate and so raise the current account surplus. Last week’s BoJ announcement weakened the yen by 4 per cent against the dollar between October 30 and November 4. Yet none of these shifts would directly tackle the structural problem in the corporate sector. Monetary policy would be no more than a palliative. Tax reform is needed – but the reform should include increased taxation of retained earnings rather than the government’s proposed reduction.

An alternative monetary policy does exist: direct financing of fiscal deficits by the central bank (also known as “helicopter money”). This would not eliminate the economic imbalances but would finance their consequences in the most direct way. Given Japan’s public debt overhang, however, such direct monetary financing of the government risks triggering an uncontrollable shift in expectations towards high inflation.

So what lessons should others, particularly the European Central Bank, learn from Japan’s predicament? The answer is: do not start from there.

Japan charts

The Japanese are where they are for three reasons. First, the Bank of Japan pursued too tight a monetary policy, especially in the early 1990s, to punish the sins of the bubble economy.

Second, the government added too rapid a tightening of fiscal policy in 1997. Finally, the Japanese never dealt with structural excess savings in the corporate sector. These mistakes entrenched the disinflationary pressure that the BoJ now seeks to end with its desperate expedients.

All this has strong echoes today in the eurozone. Not least, the dominant attitudes are needlessly punitive. The eurozone has also been unwilling to address the structural excess savings of creditor countries. Yet what the eurozone should remember is that, regardless of economic outcomes, Japan will remain a functioning country with an utterly loyal citizenry. The eurozone does not possess such powerful advantages. It cannot even risk falling into anything close to Japanese deflation. But it is.

Why There Is No Escape Velocity: Household Spending Is Chained To Income Absent A Credit Bubble

by Jeffrey P. Snider

November 4, 2014

It should not have come as a surprise to convention that the PCE component of GDP was not going to be leading economic gains. The monthly PCE series has been “better” in later 2014 than the winter, but that is far too narrow a context in which to draw any conclusions. No matter how you measure, American consumers continue to be unwilling or, more likely, unable to spend at levels consistent with policy reflections (clogged transmissions and all that).

There has been an curious stability in the spending rate that belies much of the deeper problems that are revealed quite easily by historical comparison.

ABOOK Oct 2014 PCE Income PCE Real PCE

Even with July’s new benchmark, Real PCE continues to be stuck at levels that were consistent with the dot-com recession (and elongated cycle into housing bubble “recovery”). I think that reflection is quite revealing in the lengths at which the consumer remained disengaged and that it was only the last phase of the housing bubble, ultimate mania, that finally “pushed” consumers to increase spending. But even then consumers with the housing bubble as a “tailwind” were only spending at rates previously considered unsatisfactory.

So it took the better part of a few years to move away from the recessionary doldrums and due in almost full part to a bubble of epic proportions. The current elongated cycle has no such bubble, especially as the latest mini-bubble attempt via resident “fixed investment” has seemingly fizzled.

ABOOK Oct 2014 PCE Income FI Residential

Given the domestic economy’s dependence on investment (including residential and business) and consumption, driving the world economy, the lack of “efficient” bubbles is a tremendous hindrance to monetary “transmission”; and the economy is actually fortunate for that (bigger bubbles means bigger crashes, what we have now will likely be bad enough).

ABOOK Oct 2014 PCE Income PCE NominalABOOK Oct 2014 PCE Income PCE CPI

It really is that simple, in that without a debt-fueled substitute of requisite “strength” (the student loan bubble and auto loan bubbles, for example, are not nearly of “sufficient” magnitude nor, it appears, intensity to fully replicate the homes-as-ATM’s effect) there is nothing to drive spending above simple earned income. That is a huge problem given that income continues to follow upon a much lower trajectory than anything seen in the post-war era.

ABOOK Oct 2014 PCE Income Wages CPI

Even the “best jobs market in decades” has only managed a minor improvement in wages and salaries from even earlier this year. It is certainly nothing of the strength and intensity in earned income that marked true recoveries past (and not even favorable in comparison to the relatively lackluster housing bubble mania).

ABOOK Oct 2014 PCE Income Wages CPI Comps

In fact, the latest “improvement” in wages and salaries looks far more like late cycle behavior than anything of a sustainable and accelerating, full recovery.

The effect overall on the cyclical intrusion upon the lack of bubble sustenance is obvious.

ABOOK Oct 2014 PCE Income Real DPI Per Cap

The range of sustained income growth has diminished in each cycle going back to the dot-com bubble era. Again, the housing bubble was “necessary” in that the economy would have likely remained in the 2000’s as it is now – deficient. That would more than suggest monetary experimentation with all these bubbles has been a total failure, as it did nothing to turn the US economy onto a sustainable path, instead only conjuring a short and artificial burst that contributed mightily to the current structural dysfunction. If the bubble “theory” worked, each successive bubble “cycle” would actually leave us better off; that hasn’t happened, in fact the exact opposite. Bubbles do not lead to growth, or even a “nudge” toward potential, but rather consist of permanent alterations amounting to anti-growth over the long run.

The last time we saw successive cycles diminish in actual and sustained income was the Great Inflation, “coincidentally” a period that was perhaps closest in monetary mismanagement to anything seen right now.

Therefore, the spending “problem” is an income problem that goes back to the age of asset bubble formation. Without one, the economy is stuck; which seems to confirm the Krugman/Summers/Yellen thesis of secular stagnation whereby the economy “needs” bubbles to actually grow. The problem of that is as I suggested above, in that bubbles themselves are not economic agents of growth, but anti-growth corrosion.

This is a syndicated repost courtesy of Alhambra Investment Partners - We Are Different..


Missing the Prime Suspect in the Global Slowdown

World-wide debt as a percentage of GDP has jumped 36% since 2008, to a record high of 212%.

          Getty Images 

By George Melloan
Nov. 2, 2014 6:45 p.m. ET               
‘You want quantitative easing? I’ll show you quantitative easing!” That’s the message Japan’s central banker Haruhiko Kuroda sent to global securities markets Friday, spurring the Dow to a record high. He announced that he will boost asset purchases by up to one-third, snapping up even more debt paper than the Japanese treasury is issuing.

Mr. Kuroda believes he is fighting deflation, an idea that seems to be contagious. The European Central Bank (ECB) also has been buying bonds to stir the continent out of its torpor. And President James Bullard of the St. Louis Federal Reserve Bank urged the Fed to extend its QE purchases of government securities beyond the planned October shutdown last week, advice the Federal Open Market Committee chose not to take. Mr. Bullard told an interviewer that he feared “inflation expectations” were too low, a concern cut from the same cloth as Mr. Kuroda’s fear of deflation.

Many people think low inflation and inflation expectations are a good thing. U.S. consumer prices barely budged in September and the consumer-price index (CPI) was up only 1.7% from a year earlier. Motorists are enjoying the lower cost of filling gas tanks.

But the Fed wants higher inflation, targeting a rate of 2%. That would have certain beauties for the government if not for consumers. Inflation devalues debt, and of particular moment is federal government debt, which has soared well over $4 trillion in the past four years to $17.9 trillion. Inflation expectations are believed to stimulate spending as consumers try to get ahead of price increases, a presumed effect that appeals to the Fed’s Keynesians.

Central-bank worries about deflation may be misplaced. Couldn’t it be that it is the mounting global debt that is dragging down economic growth, not a lack of fiscal or monetary stimulus?

Yet central banks seem wedded to the so-called monetary stimulus course set by the Fed after the stock-market crash of 2008.

The rising debt burden was detailed on Sept. 16 in the annual Geneva Report, vetted by an international assemblage of 70 central-bank officials and other monetary specialists under the aegis of the International Centre for Monetary and Banking Studies (ICMB). The report concluded that central banks “should be slow to raise interest rates” because of the continued and disturbing expansion of global debt. There would seem to be an element of illogic in that advice. An outsider might think that raising interest rates would be the correct way to curb debt excesses, but then outsiders also think that inflation is bad, not good.

The Geneva report is titled “Deleveraging, What Deleveraging?” It says that after the debt explosion of the 2000s contributed to the 2008 crash, there was a widespread expectation that governments, households and businesses would shed debt, or “deleverage.” But that hasn’t happened. While American households have de-leveraged, world-wide debt has continued to grow rapidly, thanks in large part to governmental deficits. According to the report, global debt (excluding that of the financial sector) as a percentage of GDP has risen 36 percentage points since 2008, to a record 212%.

At the same time, “world growth and inflation are also lower than previously expected,” creating a “poisonous combination” of rising debt and slow growth. The growth slowdown makes deleveraging harder while at the same time high indebtedness exacerbates the economic slowdown, a phenomenon the report describes as a “vicious loop.”

Governments are big contributors to the debt boom. The U.S. ratio of public debt to GDP has climbed 40 percentage points to 105% since 2008. The report cites studies showing that high debt levels increase vulnerability to financial crises and give rise to “moral hazard” issues deriving from borrower expectations of government bailouts.

The Geneva report reflects the anxiety that afflicts central bankers around the world at a time when the most important central bank, the U.S. Fed, seems to be at sixes and sevens about where to go next with the highly unorthodox monetary policy it has practiced since 2008 with so little positive effect.

As the global economy slows from an already low rate of growth, despite recent signs of life in the U.S., it should be clear that artificially suppressed interest rates have done little to stimulate growth.

They have discouraged saving, hence retarding capital formation, and have encouraged borrowing, adding to the economic burden of debt service. If, as some economists argue, the Fed is keeping inflation in check despite zero-bound interest rates by exercising its Dodd-Frank powers over bank lending, the equivalence of that to central planning can hardly be considered healthy.

The Fed well remembers what happened in 2006 when belatedly raising rates to a normal level caused pumped-up housing prices to fall. But it perhaps forgets that the most important factor in the 2008 crash was that falling house prices exposed the frailties of the many billions of dollars of toxic securities in circulation, held by the likes of Lehman Brothers, that were based on subprime mortgages engendered by government affordable-housing policies. Had it not been for those faulty debt instruments, the debt bubble could probably have been deflated with relatively little damage.

As the Geneva report suggests, central bankers are now motivated by fear, no doubt hoping that the day of reckoning for the continuing global rise of debt will occur on someone else’s watch. But what if it doesn’t? Might it not be better to take more sensible measures now, like allowing interest rates to rise to a level that would bring saving and borrowing into better balance?

Mr. Melloan, a former columnist and deputy editor of the Journal editorial page, is the author of “The Great Money Binge: Spending Our Way to Socialism” (Simon & Schuster, 2009).

Germany’s Third Largest Political Party Sells €1.6 Million of Gold In Two Weeks

Submitted by GoldCore

11/04/2014 17:11 -0500

 Disillusionment with Europe's single currency continues to grow with the cracks beginning to show in it's heartland, Germany, where the third largest political party is now selling gold coins and bars to raise funds.

In a poll in September Alternative for Germany (AfD) were found to be Germany's third most popular party. The rise of the Alternative for Germany (AfD) party saw it receive 10.6% of the vote in Thuringia and 12.2% in Brandenburg on 14 September. Two weeks earlier it secured its first regional government seats in Saxony.

AfD are not anti-EU per se and have distanced themselves from other eurosceptic parties. They see a future for Germany in the EU and embrace common markets but wish to see the European Monetary Union (EMU) and the euro itself wound up and a return to the Deutschmark.

In the past two weeks, in a bid to gain as much state funding as possible they have entered the gold bullion market with quite a degree of success. In Germany, the federal government will match, up to a value of €5 million, any funds raised privately by a political party. In a bid to get the full allocation of state funding, AfD have started to sell gold bullion online.

In the two weeks since the scheme was announced they have sold gold coins and bars worth a sizable €1.6 million.

There has been strong, broad based demand for precious metals in Germany in recent weeks and months due to concerns about the Eurozone, the Euro, the conflict with Russia and global uncertainties.

AfD have managed to sell a large volume of bullion bars and coins despite being unable to undercut the well established bullion dealers with whom they have been competing. This indicates that their customers are motivated to buy gold from them specifically because they support the party and it's policies.
"I have always warned that we can not compete with the prices of the competition," federal executive of the party Konrad Adam told Spiegel newspaper.  "People should not feel deceived by our offer."

The smash on silver and gold on Thursday and Friday of last week played into the AFD’s hands as it saw German people, both investors and savers, entering the market in droves to take advantage of the low prices.

Gold brokers across Germany described the manner in which demand for precious metals exploded last week as "a run."  Many have seen a sharp increase in demand and found their inventories insufficient to meet demand according to Goldreporter.

Germans have become more knowledgeable vis-a-vis precious metals in the last few years and indeed have a cultural affinity for gold due to the hyperinflation and to Hitler’s banning of gold ownership.

The benefits of owning a tangible, divisible asset that cannot be printed at will by a government is strong in the folk memory. The lack of a response of the Merkel government following the scandal which arose when the Federal Reserve refused Germany's request to have it's sovereign gold repatriated has also motivated many Germans to take matters of wealth protection into their own hands.

They, like many people in the world today, are electing to become their own central bank.

The prudence and patience for which Germans are admired are worthy of emulation in these times. It is wise to do ones own research into owning precious metals and if one does take a position in gold  - be sure to own coins and bars in segregated, allocated vaults in safe jurisdictions such as Switzerland.

Trust in one’s decision and your judgement and view the volatility of the market with equanimity.

The fragile global financial and monetary system is teetering on the edge of collapse and serious inflation and stagflation is likely on the cards.

In the event of a crisis, gold will be there to help protect you which may not necessarily be the case for paper money and digits on a computer screen.

Gold was gold at the dawn of time and will continue to be.

Early Technical Clue that Gold and Silver Prices Have Bottomed Out

Friday November 07, 2014 3:15 PM

(Kitco News) - December Comex gold and December Comex silver futures prices hit contract and four-year lows in early trading Friday.

However, both markets then made solid price rebounds to close higher and nearer their daily highs. Both gold and silver futures markets also produced daily trading ranges that had lower lows and higher highs than Thursday's trading session, with both creating a bullish "outside day" up on the daily bar chart, with their higher daily closes on Friday.

Importantly from a technical perspective, given that new contract lows were scored in both gold and silver futures Friday morning, the bullish outside days up  are also termed a more technically significant bullish "key reversal" up. A key reversal up is one early, significant chart clue that at least a near-term market bottom is in place.

Better technical evidence of a market bottom being in place would be if there is follow-through upside price strength in the market the following trading session, which in this case is Monday. 

Therefore, Monday's price action in the gold and silver markets will be very important.

Heard on the Street

Solid Jobs Don’t Put Fed on Firm Footing

Lackluster Wage Growth May Slow Any Actions on Rates

By David Reilly

Nov. 7, 2014 11:28 a.m. ET 

The Fed, led by Janet Yellen, may stay cautious as it deliberates when to raise its overnight lending rate in 2015 off the near-zero bound. European Pressphoto Agency

The Federal Reserve wants more inflation. To be specific, it wants wage inflation.

And it’s still not getting it.

Friday’s jobs report for October offered up some solid gains. Nonfarm payrolls increased by 214,000 and now have averaged 229,000 a month so far this year. The unemployment rate fell to 5.8%.

But the data were lacking when it came to wage growth. Average earnings for private-sector workers rose by just 0.1% versus the prior month, just half of what was expected. And, on a year-over-year basis, wage growth has stagnated at around 2% for five years. Adjusted for inflation, year-over-year wage gains have risen above 1% in just one month so far in 2014.

This indicates that despite the marked decline in the unemployment rate, now nearing Fed policy makers’ majority view for the fourth quarter of 2015 of 5.4% to 5.6%, there is still enough slack in the labor market that employers aren’t feeling compelled to pay employees more.

Granted, there is anecdotal evidence that momentum is building. The broader employment cost index is showing signs of life. And, as UBS economists wrote Friday, “Small firms are increasingly reporting wage increases and difficulty finding qualified workers, which suggests eventually increasing wage pressure in average hourly earnings.”

But given the economy’s recent history of false starts, the Fed could require firmer evidence to prod it into earlier or more vigorous action. That argues for the Fed staying cautious as it deliberates when to raise its overnight lending rate in 2015 off the near-zero bound. It also argues for it moving slowly once it takes that step.

This should reinforce the view that rates ultimately will settle at a peak that will be lower than in past cycles. Without an uptrend in wage growth in place, as Eric Green of TD Securities noted Friday, “the Fed will (and should) drag their feet in raising rates.”

The overall strength of the latest jobs report keeps the Fed on its current policy track toward increasing rates. But it isn’t about to board a fast train.

Op-Ed Columnist 

The World Is Fast

Recent Elections Missed the Biggest Challenge of All

Thomas L. Friedman
NOV. 4, 2014

We’ve just had a nonsense midterm election. Never has more money been spent to think so little about a future so in flux. What would we have discussed if we’d had a serious election? How about the biggest challenge we’re facing today: The resilience of our workers, environment and institutions.
Why is that the biggest challenge? Because: The world is fast. The three biggest forces on the planet — the market, Mother Nature and Moore’s Law — are all surging, really fast, at the same time. The market, i.e., globalization, is tying economies more tightly together than ever before, making our workers, investors and markets much more interdependent and exposed to global trends, without walls to protect them.

Moore’s Law, the theory that the speed and power of microchips will double every two years, is, as Andrew McAfee and Erik Brynjolfsson posit in their book, “The Second Machine Age,” so relentlessly increasing the power of software, computers and robots that they’re now replacing many more traditional white- and blue-collar jobs, while spinning off new ones — all of which require more skills.
And the rapid growth of carbon in our atmosphere and environmental degradation and deforestation because of population growth on earth — the only home we have — are destabilizing Mother Nature’s ecosystems faster.
In sum, we’re in the middle of three “climate changes” at once: one digital, one ecological, one geo-economical. That’s why strong states are being stressed, weak ones are blowing up and Americans are feeling anxious that no one has a quick fix to ease their anxiety. And they’re right. The only fix involves big, hard things that can only be built together over time: resilient infrastructure, affordable health care, more start-ups and lifelong learning opportunities for new jobs, immigration policies that attract talent, sustainable environments, manageable debt and governing institutions adapted to the new speed.
That’s just theory, you say? Really? Look at one aspect in one country: Mother Nature in Brazil. On Oct. 24, Reuters reported this from São Paulo: “South America’s biggest and wealthiest city may run out of water by mid-November if it doesn’t rain soon. São Paulo, a Brazilian megacity of 20 million people, is suffering its worst drought in at least 80 years, with key reservoirs that supply the city dried up after an unusually dry year.”

Say what? São Paulo is running out of water? Yes.
José Maria Cardoso da Silva, a Brazilian and senior adviser at Conservation International, explains: The drought hit a landscape that had been stripped of 80 percent of the natural forest along the Serra da Cantareira watersheds that feed six artificial reservoirs sustaining São Paulo. The Cantareira supplies nearly half of São Paulo’s water. The forests and wetlands have been replaced by farmfields, pastures and eucalyptus plantations. So today the pipes and reservoirs that gather the water are still in place, but the natural infrastructure of forests and watersheds has been badly degraded. The drought exposed it all.
“Natural forests act like giant sponges soaking up rain and gradually releasing it into streams,” he said. “They also protect watercourses and maintain water quality by reducing sediment and filtering pollutants. The forest loss in Cantareira increased erosion, caused the decline in water quality, and changed seasonal water flows, reducing the resilience of the entire system against climatic extreme events.” The Cantareira system has fallen below 12 percent of capacity.
Sadly, deforestation increased under Brazil’s newly re-elected president, Dilma Rousseff, but this was also barely an issue in Brazil’s election. Yet Reuters quoted Antonio Nobre, a leading climate scientist at Brazil’s National Space Research Institute, arguing that “global warming and the deforestation of the Amazon are altering the climate in the region by drastically reducing the release of billions of liters of water by rainforest trees. ‘Humidity that comes from the Amazon in the form of vapor clouds — what we call ‘flying rivers’ — has dropped dramatically, contributing to this devastating situation we are living today,’ ” Nobre said.
Paul Gilding, the Australian environmentalist and author of “The Great Disruption,” emailed from Brazil to say that the lack of a serious Brazilian response “reinforces to me that we’re not going to respond to the big global issues until they hit the economy. It’s hard to imagine a stronger example than a city of 20 million people running out of water. Yet despite the clear threat, the main response is ‘we hope it rains.’ Why such denial? Because the implications of acceptance are so significant, and we know in our hearts there’s no going back once you end denial. It would demand that the country face up to the urgency of reversing rather than slowing deforestation” and “the need to prepare the country for the risks that a changing climate presents.”
When changes in the market, Mother Nature and Moore’s Law all get this fast, opportunities and stresses abound. One day, we’ll have an election about how we cushion, exploit and adapt to them — an election to make America and Americans more resilient. One day.

Health & Wellness

Are You Bathing Your Baby Too Much?

Improper Care of Infant’s Skin May Increase Risk for Eczema

By Dana Wechsler Linden

Nov. 3, 2014 11:19 a.m. ET

New thinking on the cause of eczema is prompting some scientists to investigate whether how parents care for their infants’ skin has contributed to the disease’s growth.

How often a baby gets a bath, what is in the baby wash and shampoo and whether the skin is properly moisturized after bathing are things that could help bring on eczema, recent studies suggest. Researchers say many babies may be getting too many baths, and two to three a week is enough. Eczema causes patches of dry, itchy, inflamed skin that usually starts in early childhood.

Scientists increasingly believe that environmental factors, such as bathing, pollutants and indoor heating, can disrupt the skin’s ability to keep moisture in and allergens and microbes out. A weakened skin barrier—the outermost layer—allows outside irritants to penetrate the skin and spark an immune-system response. Other research has found that genetic variations in some eczema patients also can compromise the skin barrier.
‘The more we understand about the causes of eczema, the more it seems how we take care of the skin of babies may be relevant,’ says Dr. Eric Simpson, associate professor of dermatology at Oregon Health & Science University. Oregon Health & Science University

Eczema was long believed to begin as an allergic reaction, perhaps to something a child ate or encountered, that then led to skin inflammation. But experts say decades of viewing allergies as the primary culprit behind eczema yielded few preventive strategies.

“The more we understand about the causes of eczema, the more it seems how we take care of the skin of babies may be relevant,” says Eric Simpson, associate professor of dermatology at Oregon Health & Science University in Portland. “Are the things we’re doing that we think are good for our babies causing eczema?” he says.

Eczema, formally known as atopic dermatitis, usually appears on the face and scalp of babies and in the crooks of elbows and backs of knees in older children. Prescription ointments can reduce the itching and redness but there isn’t a cure.

The condition usually develops before the age of 18 months, when a baby’s skin is still developing. It can come and go for months or years and often disappears by adolescence. Occasionally it persists into adulthood. The American Academy of Dermatology estimates 10% to 20% of children get eczema, up from just 3% in 1960. It isn’t clear if the rate is still rising.

Skin Protection

Recent research suggests proper care of infants’ skin may help reduce the risk for eczema. Here are some tips:

For the first year, give baths no more than two or three times a week to avoid drying out the baby’s skin.

Apply moisturizer liberally immediately after the bath. Putting it on when the skin is still moist will seal in the water.

Use mild, non-soap cleansers designed for a baby’s skin.

Fragrance-free is best. Even herbal ingredients can be irritating to the skin.

Thicker or oily moisturizing products are better at keeping the skin moist.

Consider products with the National Eczema Association’s seal of acceptance. These don’t contain ingredients that are known irritants to sensitive skin.

In a recent study, Dr. Simpson and a team of investigators from the U.K. looked at whether protecting the skin barrier of infants with a moisturizer could help prevent eczema. They divided 124 newborns at high risk for eczema because of family history into two groups. Parents of the first group were instructed to apply a fragrance-free moisturizer all over their babies’ body once a day. In the other group, parents were asked not to use moisturizer. When the babies were 6 months old, the incidence of eczema in the moisturized group was about half that of the controls, or 22% versus 43%.

The study is published in the current issue of the Journal of Allergy and Clinical Immunology. Another small study in the same issue, by a group of Japanese researchers, also found a greatly reduced rate of eczema among babies whose parents applied daily moisturizer. That study involved 119 babies.

“There hasn’t been much ever before that’s been shown to alter the chances of a child to develop eczema,” says Seth Orlow, chairman of the Ronald O. Perelman Department of Dermatology at NYU Langone Medical Center in New York. “This suggests we can do something low-tech and change whether a child gets this disease. Wow, that’s pretty exciting if so,” says Dr. Orlow, who wasn’t involved in the research on eczema and moisturizers.

Dr. Simpson says he is planning, with funding from the National Institutes of Health, a large, multicenter trial to test whether the early results hold up. He will include a few other skin-care practices he expects could help prevent eczema, including bathing the infant no more than two or three times a week and using only small amounts of mild, fragrance-free cleansers.

The American Academy of Pediatrics recommends on its website bathing an infant three times a week or less, and applying a fragrance-free, hypoallergenic moisturizing lotion immediately after the bath to help keep the skin from drying out.

Fragrances and some soap and shampoo ingredients, such as sodium lauryl sulfate, can irritate the skin, experts say. They recommend using moisturizers that are thick or oily, because these can do a better job at sealing moisture in.

“We’ve become more aware how important the skin barrier is,” says Megha Tollefson, one of the authors for the academy of a coming clinical report on eczema. “It’s definitely one of the most important areas we should be looking at for eczema,” says Dr. Tollefson, an assistant professor of dermatology and pediatrics at Mayo Clinic.

Many parents appear not to be following the academy’s recommendations. In a report published online in the journal Pediatric Dermatology in September, Dr. Simpson analyzed the usage of baby-skin-care products in the U.S. based on data collected by market-research firm Mintel Group. Households reported using baby wash and shampoos around five times a week on average.

“People are bathing their babies too much,” Dr. Simpson says. “If you expose skin to water and let it air dry, that leads to dryness—like the bottom of a river bed that cracks open when it dries.”

Researchers in recent years have also found genetic links to eczema. One gene variation appears to reduce the amount of a protein called filaggrin, which helps the skin barrier hold in moisture. Studies have shown roughly half of people with moderate to severe eczema have filaggrin deficiency, while mild to moderate cases are much less likely to have the genetic problem.

Experts believe a breakdown of the skin barrier, either because of genetic or environmental factors, may explain in part the growth in the rate of eczema. Also important is the body’s immune response to allergens and other irritants. Some studies have shown that giving probiotics to women during pregnancy may reduce the risk of eczema, probably by changing the babies’ immune response.