Wednesday, February 9, 2011

Today's links

1-- WikiLeaks cables: Saudi Arabia cannot pump enough oil to keep a lid on prices, The Guardian

Excerpt: US diplomat convinced by Saudi expert that reserves of world's biggest oil exporter have been overstated by nearly 40%

The US fears that Saudi Arabia, the world's largest crude oil exporter, may not have enough reserves to prevent oil prices escalating, confidential cables from its embassy in Riyadh show.

The cables, released by WikiLeaks, urge Washington to take seriously a warning from a senior Saudi government oil executive that the kingdom's crude oil reserves may have been overstated by as much as 300bn barrels – nearly 40%.

The revelation comes as the oil price has soared in recent weeks to more than $100 a barrel on global demand and tensions in the Middle East. Many analysts expect that the Saudis and their Opec cartel partners would pump more oil if rising prices threatened to choke off demand....

One cable said: "According to al-Husseini, the crux of the issue is twofold. First, it is possible that Saudi reserves are not as bountiful as sometimes described, and the timeline for their production not as unrestrained as Aramco and energy optimists would like to portray."...

Jeremy Leggett, convenor of the UK Industry Taskforce on Peak Oil and Energy Security, said: "We are asleep at the wheel here: choosing to ignore a threat to the global economy that is quite as bad as the credit crunch, quite possibly worse."

2--Lacker's rebellion; Richmond Fed president says "No" to QE2, Bloomberg

Excerpt: Federal Reserve Bank of Richmond President Jeffrey Lacker said the quickening U.S. recovery means policy makers need to take “quite seriously” their commitment to review a $600 billion monetary-stimulus program.

“The distinct improvement in the economic outlook since the program was initiated suggests taking that re-evaluation quite seriously,” Lacker said today in a speech in Newark, Delaware. “That re-evaluation will be challenging, because inflation is capable of accelerating, even if the level of economic activity has not yet returned to pre-recession trend.”

Higher consumer spending, along with business investment in equipment and software, point to U.S. growth this year of “pretty close to 4 percent,” Lacker said.

Fed policy makers pledged in November to buy $600 billion of Treasuries through June to spur growth in a second round of so-called quantitative easing, building on the $1.7 trillion first round of purchases of mortgage and government debt that ended in March 2010....

“I expect noticeably stronger growth in overall activity this year than last,” Lacker, 55, said in prepared remarks at an economic-forecast forum at the University of Delaware. The inflation outlook is “benign,” and he projects price increases this year of 1.5 percent to 2 percent.

3--Rich Get Richer When Governments Tout Austerity, Matthew Lynn, Bloomberg

Excerpt: Remember all that stuff about how the credit crunch was going to usher in a new age of austerity? The financial industry would shrink; the gulf between the haves and the have-nots would close; and taxes would rise for the top earners, forcing them to contribute more to society.

Well, guess what? It didn’t happen.

In fact, we just had a “rich-get-richer” recession. U.K. data suggest the gap between the wealthy and the poor has widened. We can give up any idea that it is going to close by itself. The government usually bails out the rich; the wages that the highly skilled can command are rising all the time; and globalization means the well-off increasingly occupy a whole different economy than the rest of the country they live in....

First, the bailouts just help the wealthy. Governments used to subsidize manufacturing industries. Now they rescue the banking industry, where most of the wealthy work. Central banks use quantitative easing to try and revive the economy. Yet that mainly works by boosting asset and commodity prices. If you invest in hedge funds trading oil futures, you’ll have done well from QE. If you are just the average guy who pays more to fill up the fuel tank of your car, then you’re the loser. In effect, banking bailouts and QE use the state to help mostly the rich.

4--Misquoting Keynes, John P. Hussman, Ph.D., Hussman Funds

Excerpt: Carnegie Mellon economist Allan Meltzer, who is a well-respected monetary economist and former chair of the "Shadow Open Market Committee", wrote a piece last week in the Wall Street Journal ( Ben Bernanke's 70's Show ), which argued for an immediate increase in short-rates to about 1%. Meltzer noted "Current slow growth and high unemployment is not a monetary problem. The financial system has more than ample liquidity... perhaps most importantly, we need a new Fed policy to prevent 1970's-style inflation. Inflation is coming. Now is the time to head it off."

In my view, Meltzer is right, but I would qualify the timing of inflation pressures by carefully monitoring the level of short-term interest rates relative to the outstanding monetary base. If the Fed indeed completes QE2 and pushes the monetary base to $2.4 trillion, we'd better see the 3-month Treasury yield at roughly 0.05%. Even a yield of 0.25% would be incompatible with that level of monetary base, and would place upward pressure on inflation. Worse, any exogenous pressure (loan demand, reduction of default concerns, etc) pressuring short-term yields to even 1% without a corresponding contraction in the monetary base would generate near term upward pressure on the GDP deflator of about 20%, and a longer-run inflationary pressure of close to 90% - that is, a near doubling in the level of U.S. prices. Frankly, I doubt that we'll observe that, but that's another way of saying that the Fed is likely to be forced into a very hard reversal of its present course unless economic conditions stay weak enough, and credit fears remain strong enough, to hold short-term interest rates at roughly zero.

5--Underground world hints at China's coming crisis, Telegraph

Excerpt: There, in the city's vast network of unused air defence bunkers, as many as a million people live in small, windowless rooms that rent for £30 to £50 a month, which is as much as many of the city's army of migrant labourers can afford. ...

Such vast discrepancies between house prices and earnings are creating social and economic difficulties for China's government – the discontented poor can't find a decent place to live while the rich look to store their wealth in a speculative, bubble-prone property market. Not for nothing did Li Daokui, an adviser to China's central bank, tell the World Economic Forum in Davos last week that rising property prices were the "biggest danger" to China's economy.

With inflation and wage pressures also mounting, a growing number of investors are starting to question the long-term sustainability of China's investment-heavy growth model. A survey of global investors by Bloomberg last week found that 45pc of them expect a financial crisis in China within the next five years, with another 40pc anticipating a crisis after 2016....

Those with a bearish outlook, such as Michael Pettis, professor of finance at Beijing's Peking University, question whether China's leaders will dare hit the brakes hard enough when so much of China's economy relies on property investment to hit its politically sacrosanct annual growth targets.

6--Steeper every day, Pragmatic Capitalism

Excerpt: If the Fed has succeeded at just one thing, it has been to create a steep yield curve. The spread between the 10 year treasury yield and the 2 year yield is flirting within basis points of its all time high of 2.91% set in February 2010....

Sit on cash earning 0% or lock up a the money by taking advantage of the steep yield curve. This is exactly the dilemma that the Fed wants you to face. They want you to become an investor further out on the yield curve which allows all debt burdened entities to term out their debt at lower yields. It also fuels speculation as financing becomes dirt cheap for everyone with a pulse – “Just promise me a return greater than zero….”

7--Political shift poses test for Warren,

Excerpt: Harvard law professor Elizabeth Warren’s biting criticism of Wall Street won her fans across the country and a powerful appointment from President Obama to oversee a new consumer protection agency.

But now that Warren has settled into her office near the White House and as she readies the agency to enforce rules on banks, loans, and credit cards that could affect every American family, she finds herself operating in a dramatically changed political climate. The Obama administration has shifted from bashing Wall Street “fat cats’’ to courting some of the same groups that fiercely opposed Warren and her agency.

That has left Warren with a pair of challenges: being a tough industry watchdog in what is now characterized as a business-friendly administration and trying to quickly assemble and manage an agency when her skills are rooted in the proverbial ivory tower at Harvard Yard....

Obama appointed a new chief of staff, William Daley, a former executive at JPMorgan Chase, which like other banks openly opposed a new consumer agency. Today, Obama is slated to address the US Chamber of Commerce, which spent millions of dollars trying to defeat the proposal for Warren’s agency. Obama is expected to use the appearance for his most direct appeal yet to business interests.

The consumer agency is designed to crack down on questionable lending practices that are blamed for helping drive the economy into the worst recession since the Great Depression. It will have broad authority to issue regulations on products including payday loans, student loans, car loans, and mortgages. Many expect a lobbying frenzy when the agency begins writing rules July 21...

To avoid a potentially lengthy and contentious confirmation battle in the Senate, Obama did not nominate her as director of the agency but appointed her as an assistant to the president and special adviser to the treasury secretary. That means the president will still have to nominate a director. If the director’s job goes to someone other than Warren, it is unclear whether she would stay on as an adviser.

8--Still Nearly 5 Unemployed Workers for Every Opening, New york Times

Excerpt: There were still nearly five unemployed workers for every job opening in the United States in December, according to a Labor Department report released today.

During the recession, the pain in the job market was initially caused by a surge in layoffs. More recently, layoffs have returned to their prerecession levels, and the problem instead has become a reluctance to hire workers (including, of course, the millions laid off during the recession). This can be seen in the disappointing trends in job openings and new hires.

In July 2009, right after the recession officially ended, the ratio of unemployed workers to job openings peaked at 6.3. It has fallen since, to about 4.7 in both November and December of 2010. That’s better, of course, but it’s still historically high and doesn’t provide much hope that the labor market can quickly absorb the nation’s millions of idle workers.

9--What will the Fed do?, The Economist

Excerpt: But to move toward the point, the latest employment report has some economists wondering whether the Fed will keep to its planned QE2 purchases. The message of that report was far from clear, but the changes in the household survey, including the near 600,000 job rise in employment and the drop in the unemployment rate to 9.0%, seem meaningful. This has Macroeconomic Advisers increasing its inflation forecasts and reiterating its warning that Fed tightening may come sooner rather than later. And Tim Duy has the Fed shifting its bias from more easing to tightening. Are they right?

I wish they weren't, but I suspect that they are. If we go back to January of last year, when economic figures were improving, and the Fed was mostly talking about its exit strategy preparations, we see a Fed forecast for 2011 unemployment of between 8.2% and 8.5%—almost identical to the forecast in November of 2009. I think we have to conclude that the Fed was basically happy with the trajectory of falling unemployment that it saw at that time. I think it was wrong of the Fed to be happy with this level of unemployment, but that's beside the point.

It's my feeling that the Fed will quickly grow concerned about inflation if the unemployment rate drops to 8.5% during the first half of the year. Ben Bernanke isn't going to draw any conclusions about policy from the mixed January report, but I agree with Mr Duy that his biases may have shifted, and February and March data will quickly indicate whether the January trend is real. Again, I think the Fed should still be biased toward expansion, and that it should tolerate a period of catch-up inflation, but that's beside the point.

There's one other point on this issue worth mentioning. A year ago, the Fed was forecasting long-run unemployment of 5.0-5.2%. In June of last year, it was forecasting long-run unemployment of 5.0-5.3%. In November, however, the forecast changed to 5.0-6.0%. This tells me that within the Fed there is some growing concern that the natural rate of unemployment has risen—that structural factors have raised the level to which the Fed can lower unemployment without generating an accelerating rate of inflation. And this is potentially important. The combination of a faster than foreseen drop in unemployment and a rise in the estimate of NAIRU represents—to Fed officials—that labour market slack is shrinking fast.

It's a little hard to square this with inflation data, or payroll employment figures, or jobless claims, or anecdotal evidence from labour markets. On the other hand, other economic variables are showing fast and accelerating growth. It's a little hard to believe given where the conversation was a few months ago, but if February jobs data come in strong, there could be a big change in message at the March FOMC meeting.

10--State Budget Problems Will Push Against the Recovery, Mark Thoma, Moneywatch

Excerpt: budget problems at the state and local government level could push against a recovery:

States Cutting Jobs, Hurting Economic Recovery, CBPP: Cuts in services at the state and local level continue to act as a drag on economic growth, and will continue to do so in the coming year…

Friday’s jobs report from the Bureau of Labor Statistic … estimates that states, cities, counties, school districts, and other units of government cut another 12,000 jobs in December, bringing to 426,000 the number of jobs lost since August 2008. Here’s the breakdown:

* Local school districts have cut 154,000 education jobs since August 2008.
* Cities, counties, and other local governments have cut 202,000 jobs.
* State governments have cut 69,000 jobs.

This bad situation may get even worse. Economist Mark Zandi told a Congressional committee last Thursday that he expects a new round of spending cuts at the state and local level to shave another 0.4 percentage points off GDP growth over the course of 2011. Goldman-Sachs similarly predicts a similar impact of 0.5 percentage points. …

Recessions lower revenues and increase the demand for state and local services, and this pushes state and local governments into the red....Thus, the extent to which Congress chooses to shift costs or reduce payments to the states as a remedy to federal budget problems could be an important factor in the recovery.

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