Wednesday, November 3, 2010

Today's Best Reads

1--QE2 risks currency wars and the end of dollar hegemony, Ambrose-Evans Pritchard, Telegraph

Excerpt: The Fed's "QE2" risks accelerating the demise of the dollar-based currency system, perhaps leading to an unstable tripod with the euro and yuan, or a hybrid gold standard, or a multi-metal "bancor" along lines proposed by John Maynard Keynes in the 1940s.

China's commerce ministry fired an irate broadside against Washington on Monday. "The continued and drastic US dollar depreciation recently has led countries including Japan, South Korea, and Thailand to intervene in the currency market, intensifying a 'currency war'. In the mid-term, the US dollar will continue to weaken and gaming between major currencies will escalate," it said.

Each case is different. For the 40-odd countries pegged to the dollar or closely linked by a "dirty float", the Fed's lax policy is causing havoc. They are importing a monetary policy that is far too loose for the needs of fast-growing economies. What was intended to be an anchor of stability has become a danger.

Mr Bloom said these countries are under mounting pressure to break free from the dollar. "They are all asking themselves whether these pegs are a relic of the past," he said....

But whatever the rights and wrongs of the argument, the reality is that a chorus of Chinese officials and advisers is demanding that China switch reserves into gold or forms of oil. As this anti-dollar revolt gathers momentum worldwide, the US risks losing its "exorbitant privilege" of currency hegemony – to use the term of Charles de Gaulle.

2--A currency war has no winners, Joseph Stiglitz, The Guardian

Excerpt: It's easy to see why some policymakers hope favorable exchange rates could put America's economy back on track. Amid growing fears of a Japanese-style malaise, the other options are either off the table or likely to be ineffective. Political gridlock and soaring debt have stymied an effective second stimulus, and monetary policy has not reignited investment. But weakening the dollar to boost exports is a risky strategy – it could result in exchange rate volatility and protectionism; worse, it invites a response from competitors. In this fragile global economic environment, a currency war will make everybody a loser.

We know the dangers of devaluation because we've been here before. In the 1930s, beggar-thy-neighbour policies prolonged the Great Depression. In more normal times, the US might be able to make other currencies appreciate against the dollar – and help make US exports cheaper – by maintaining low interest rates and letting loose a flood of liquidity. But others, notably China, have signalled they won't play along.

The US must consider another path. History should be instructive. Forty years ago unilateral action by the US led to the breakdown of the Bretton Woods system, and the shift to the floating rate regime. Since then the global economy has been marked by unprecedented crises. Now the world is on the verge of moving to another regime of managed exchange rates and fragmented capital markets. This is not the result of extensive deliberations over what system would best serve all. Rather, it is the result of some countries taking actions they believe are in their own interest, without regard to others who do what they must to protect themselves.....

As more countries resort to interventions to mitigate the consequences of unbridled monetary expansion -- in the US and perhaps in other advanced industrial countries -- those that try to retain faith in market-determined exchange rates will feel increasing pressure. In the end, the notion of market-determined exchange rates will seem as archaic as Bretton Woods. The result will be an increasingly fragmented global financial market, with almost inevitable spillovers into protectionism.....

A new global reserve system or an expansion of IMF "money" (called special drawing rights, or SDRs) will be central to this co-operative approach. With such a system, poor countries would no longer need to put aside hundreds of billions of dollars to protect themselves from global volatility, and these would add to global aggregate demand.

It's true that, with such a system, the US would no longer enjoy the extraordinarily cheap borrowing that comes with being the minter of the most important global reserve currency. But the current arrangement is an anomaly. The world is at a critical juncture

3--QE in the Great Depression, Paul Krugman, New York Times

Excerpt: there’s a good case to be made that America’s departure from the gold standard and the Fed’s shift in behavior changed expectations of future inflation. And I very much agree with the notion that central banks can gain traction, even in a liquidity trap, if they can credibly promise future inflation.

But in the 30s, we were mainly talking about ending expectations of deflation, or at most creating expectations of a rise in the price level to where it was before the Depression; remember that even in 1938, prices were well below 1929 levels:

That’s very different from trying to create expectations of inflation looking forward with no actual deflation in our past....So yes, the US experience of the 30s is useful to consider. But I don’t see how it engenders easy optimism about the effectiveness of quantitative easing now.

4--Squeezing the Working Class, Vincent Navarro, counterpunch

Excerpt: The Making of the European Union

It is quite understandable that large sectors of the working class in most E.U. countries believe that the deterioration of their standard of living is a consequence of constructing the European Union. For many years they have been told by the European establishments (such as the European Council, the European Commission, and the European Central Bank) that high unemployment is a direct result of excessive rigidity of the labor market, excessive generosity of social benefits, and excessive public expenditures. As a consequence, these E.U. establishments have pressured national governments to deregulate labor markets, restrain and reduce public expenditures, and reduce social benefits. This last measure reached an outrageous level when the European Commission even had the audacity to propose increasing the work week to 65 hours! Fortunately, this was stopped by massive worker protests.

To make matters even worse, these policies were taking place within a framework dictated by the Stability Pact, which established that national public deficits must not exceed 3 per cent of GDP, and public debt must not be larger than 60 per cent of GNP. The Pact was imposed on the European Union by the German banks as a condition for replacing the German mark with the euro. The other pillar of the European framework was the Central European Bank giving priority to control of inflation over economic stimuli and job creation.

So, this is the framework for the E.U. establishment’s policymaking, with the final objective of tilting the balance between capital and labor in capital’s favor. The reduction of salaries is presented as a condition for retaining jobs.

5--The Myth of Charter Schools, Diane Ravitch, The New York Times review of Books

Excerpt: The message of these films has become alarmingly familiar: American public education is a failed enterprise. The problem is not money. Public schools already spend too much. Test scores are low because there are so many bad teachers, whose jobs are protected by powerful unions. Students drop out because the schools fail them, but they could accomplish practically anything if they were saved from bad teachers. They would get higher test scores if schools could fire more bad teachers and pay more to good ones. The only hope for the future of our society, especially for poor black and Hispanic children, is escape from public schools, especially to charter schools, which are mostly funded by the government but controlled by private organizations, many of them operating to make a profit...

Some fact-checking is in order, and the place to start is with the film’s quiet acknowledgment that only one in five charter schools is able to get the “amazing results” that it celebrates. Nothing more is said about this astonishing statistic. It is drawn from a national study of charter schools by Stanford economist Margaret Raymond (the wife of Hanushek). Known as the CREDO study, it evaluated student progress on math tests in half the nation’s five thousand charter schools and concluded that 17 percent were superior to a matched traditional public school; 37 percent were worse than the public school; and the remaining 46 percent had academic gains no different from that of a similar public school. The proportion of charters that get amazing results is far smaller than 17 percent.Why did Davis Guggenheim pay no attention to the charter schools that are run by incompetent leaders or corporations mainly concerned to make money? Why propound to an unknowing public the myth that charter schools are the answer to our educational woes, when the filmmaker knows that there are twice as many failing charters as there are successful ones? Why not give an honest accounting?

According to University of Washington economist Dan Goldhaber, about 60 percent of achievement is explained by nonschool factors, such as family income. So while teachers are the most important factor within schools, their effects pale in comparison with those of students’ backgrounds, families, and other factors beyond the control of schools and teachers. Teachers can have a profound effect on students, but it would be foolish to believe that teachers alone can undo the damage caused by poverty and its associated burdens. (There's much to mull over in this interesting article)

6--Personal Income Declines While Consumer Spending Rises, Seeking Alpha

Excerpt: The Bureau of Economic Analysis reported that Personal Income decreased by 0.1% in September, compared with a 0.4% increase in August.... while Real consumer spending, which is spending adjusted for price changes, increased 0.1%. The personal savings rate expressed as a percentage of disposable personal income was 5.3%, lower than the 5.6% rate in August.

The lower savings rate suggests that unless consumer credit expansion is funding the spending increase, there is not much upside in the coming months.... The preliminary consumer credit numbers for July and August suggest that consumer credit expansion is not the case.

7--Are Insiders Trying To Tell Us Something?, Benzinga

Excerpt: Insider selling has surged to highs of the past few months, with $662 million in stock sold last week, as opposed to just $1.6 million in stock purchased. This information comes via Bloomberg and Zerohedge.

Selling occurs for a wide variety of reasons, whether it be tax purposes, options expiration, etc. Yet, this ratio is a little bit troublesome if you are bullish on the markets, with insiders selling at a staggering 423 sales to every buy. (Traders do not seem to be optimistic about QE2)

8--Lessons from a Lost Decade, John P. Hussman, Ph.D., Hussman Funds

Excerpt: Over the short run, two policies have been primarily responsible for successfully kicking the can down the road following the recent financial crisis. The first was the suppression of fair and accurate financial disclosure - specifically FASB suspension of mark-to-market rules - which has allowed financial companies to present balance sheets that are detached from any need to reflect the actual liquidating value of their assets. The second was the de facto grant of the government's full faith and credit to Fannie Mae and Freddie Mac securities. Now, since standing behind insolvent debt in order to make it whole is strictly an act of fiscal policy, one would think that under the Constitution, it would have been subject to Congressional debate and democratic process. But the Bernanke Fed evidently views democracy as a clumsy extravagance, and so, the Fed accumulated $1.5 trillion in the debt obligations of these insolvent agencies, which effectively forces the public to make those obligations whole, without any actual need for public input on the matter.

Notably, what kicked the can was not quantitative easing per se, but rather the effective guarantee of Fannie and Freddie's debts. In and of itself, QE did nothing but to provoke a decline in monetary velocity proportional to the expansion in the monetary base, with little effect on either real GDP or inflation. When QE was pursued in Japan, it did nothing but to provoke a decline in monetary velocity proportional to the expansion in the monetary base, with little effect on either real GDP or inflation. In our view, an additional round of quantitative easing will do nothing but to provoke a decline in monetary velocity proportional to the expansion in the monetary base, with little effect on either real GDP or inflation.

We do anticipate inflation over a longer horizon, but most likely not until the second half of this decade. Meanwhile, financial assets such as stocks, bonds and the U.S. dollar largely reflect expectations of a large and sustained volume of QE, as well as success of that policy in provoking real GDP growth. But just as in Rudiger Dornbusch's model of exchange rate overshooting, it is unanticipated policy that produces price shifts in the asset markets - not the follow through of anticipated policy. It is difficult to see what unanticipated, positive surprises the market continues to await.


Excerpt: The most glaring example of failed QE is in Japan in 2001. Richard Koo refers to this event as the “greatest monetary non-event”. In his book, The Holy Grail of Macroeconomics, Koo confirms what the BIS states above:

“In reality, however, borrowers – not lenders, as argued by academic economists – were the primary bottleneck in Japan’s Great Recession. If there were many willing borrowers and few able lenders, the Bank of Japan, as the ultimate supplier of funds, would indeed have to do something. But when there are no borrowers the bank is powerless.”

In the same piece cited above, the BIS also uses the example of Japan to illustrate the weakness of QE. The following chart (Figure 1) shows that QE does not stimulate borrowing (and the history of continued economic weakness in Japan is coincidental):

“A striking recent illustration of the tenuous link between excess reserves and bank lending is the experience during the Bank of Japan’s “quantitative easing” policy in 2001-2006. Despite significant expansions in excess reserve balances, and the associated increase in base money, during the zero-interest rate policy, lending in the Japanese banking system did not increase robustly.”

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