Friday, March 4, 2011

Weekend links

1---Why the Dollar's Reign Is Near an End, Barry Eichengreen, Wall Street Journal

Excerpt: The single most astonishing fact about foreign exchange is not the high volume of transactions, as incredible as that growth has been. Nor is it the volatility of currency rates, as wild as the markets are these days.

Instead, it's the extent to which the market remains dollar-centric.....

The greenback, in other words, is not just America's currency. It's the world's.

But as astonishing as that is, what may be even more astonishing is this: The dollar's reign is coming to an end.

I believe that over the next 10 years, we're going to see a profound shift toward a world in which several currencies compete for dominance.

The impact of such a shift will be equally profound, with implications for, among other things, the stability of exchange rates, the stability of financial markets, the ease with which the U.S. will be able to finance budget and current-account deficits, and whether the Fed can follow a policy of benign neglect toward the dollar.
The Three Pillars

How could this be? How could the dollar's longtime most-favored-currency status be in jeopardy?...

Second, the dollar is about to have real rivals in the international sphere for the first time in 50 years. There will soon be two viable alternatives, in the form of the euro and China's yuan.

Americans especially tend to discount the staying power of the euro, but it isn't going anywhere. Contrary to some predictions, European governments have not abandoned it. Nor will they. They will proceed with long-term deficit reduction, something about which they have shown more resolve than the U.S. And they will issue "e-bonds"—bonds backed by the full faith and credit of euro-area governments as a group—as a step in solving their crisis. This will lay the groundwork for the kind of integrated European bond market needed to create an alternative to U.S. Treasurys as a form in which to hold central-bank reserves.

China, meanwhile, is moving rapidly to internationalize the yuan, also known as the renminbi. The last year has seen a quadrupling of the share of bank deposits in Hong Kong denominated in yuan. Seventy thousand Chinese companies are now doing their cross-border settlements in yuan. Dozens of foreign companies have issued yuan-denominated "dim sum" bonds in Hong Kong. In January the Bank of China began offering yuan-deposit accounts in New York insured by the Federal Deposit Insurance Corp....

Finally, there is the danger that the dollar's safe-haven status will be lost. Foreign investors—private and official alike—hold dollars not simply because they are liquid but because they are secure. The U.S. government has a history of honoring its obligations, and it has always had the fiscal capacity to do so.

But now, mainly as a result of the financial crisis, federal debt is approaching 75% of U.S. gross domestic product. Trillion-dollar deficits stretch as far as the eye can see. And as the burden of debt service grows heavier, questions will be asked about whether the U.S. intends to maintain the value of its debts or might resort to inflating them away. Foreign investors will be reluctant to put all their eggs in the dollar basket. At a minimum, the dollar will have to share its safe-haven status with other currencies....

U.S. Impact

In this new monetary world, moreover, the U.S. government will not be able to finance its budget deficits so cheaply, since there will no longer be as big an appetite for U.S. Treasury securities on the part of foreign central banks.

Nor will the U.S. be able to run such large trade and current-account deficits, since financing them will become more expensive. Narrowing the current-account deficit will require exporting more, which will mean making U.S. goods more competitive on foreign markets. That in turn means that the dollar will have to fall on foreign-exchange markets—helping U.S. exporters and hurting those companies that export to the U.S.

My calculations suggest that the dollar will have to fall by roughly 20%. Because the prices of imported goods will rise in the U.S., living standards will be reduced by about 1.5% of GDP—$225 billion in today's dollars. That is the equivalent to a half-year of normal economic growth. While this is not an economic disaster, Americans will definitely feel it in the wallet.

On the other hand, the next time the U.S. has a real-estate bubble, we won't have the Chinese helping us blow it.

2--General Motors: February U.S. sales increase 22% year-over-year, calculated risk

Excerpt: Note: The real key is the seasonally adjusted annual sales rate (SAAR) compared to the last few months, not the year-over-year comparison provided by the automakers. But this is a strong increase for GM ...

From MarketWatch: GM U.S. February auto sales surge 45.8% to 207,028

[GM] said January U.S. sales in February surged 45.8% to 207,028 vehicles from 141,951 in February 2010.

Once all the reports are released, I'll post a graph of the estimated total February light vehicle sales (SAAR) - usually around 4 PM ET. Most estimates are for an increase to 12.7 million SAAR in February from the 12.6 million SAAR in January. Sales in January 2010 were at a 10.74 million SAAR.

I'll add reports from the other major auto companies as updates to this post.

From MarketWatch: Ford U.S. February auto sales up 13.8% to 156,626

From MarketWatch: Chrysler sales rise 13% in Feb.

3--The Rearview Mirror, Tim Duy, Fed Watch via Economist's View

Excerpt: The rearview mirror is looking pretty good this week. The ISM manufacturing index extended January’s impressive gains, again with improving internals. Note declines in the inventory measures, which suggests manufacturing momentum is set to continue. One can wring their hands over the Personal Income and Outlays report, which revealed a very small 0.1 percent decrease in real spending. This should be taken in context of likely weather-related issues rather than some impending consumer slowdown. Bolstering that view is the 0.4 percentage point gain in the saving rate; bank accounts swelled a bit as weather restrained shopping activity. Moreover, the February spending report will get a boost from autos, with car dealers reporting well-above-expectations sales of 13.44 million units, SAAR. No wonder consumer confidence was up in February. Buying new cars makes people happy....

What could upset Bernanke’s optimism? Commodity prices, of course. If commodity prices work their way deep into inflation expectations in an environment of improving final demand, the Fed will be pushed to reverse policy. And if inflation truly took hold, forget about fine-tuning and tapering; think outright reversal. That, however, I think is less likely than the recessionary implications of a sharp run up in commodity prices, the odds of which seem more likely by the day. For now, Bernanke can only sit on the sidelines and see how it plays out.

Bottom Line: If the Fed continues to drive by the rear view mirror, they will happily bring the current $600 program to conclusion as expected. Assuming the data continues to hold, and momentum builds in the job market, they will shift to "normalizing" policy, with rate hike possible early next year. But if they turn their attention to the front windshield, they will see the commodity price truck starting to slide out of control. But until the slide turns into an outright wreck, they just will not know which way to swerve.

4--US deleveraging and consumption, in progress, FT Alphaville

Excerpt: There was some good news in this morning’s Personal Income and Outlays report for January, though not quite enough to get excited about.

Personal income climbed 1 per cent, well above expectations, and the savings rate increased for the first time since last July, from 5.4 per cent in December to 5.8 per cent.

Largely owing to the tax cut compromise, income climbed enough that the impressive rise in the savings rate was simultaneous with another increase in spending (of 0.2 per cent).

This is something to watch, because as we mentioned in our recent, long discussion of household deleveraging, personal consumption has carried a heavy burden in getting the US economy out of its mid-year 2010 slump.

Among the possible causes behind the slowdown in the rate of spending growth last month are a post-holiday hangover, bad weather, people not realising that they have more money in their bank accounts, or simply a reversion towards the 6 per cent savings rate at which people had seemed to settle until the recovery picked up at the end of last year.

There’s another issue here that might rile up the political watchers among you.

We mentioned a few times at the end of last year that although the tax cut compromise would help prevent a contractionary shock to household incomes, it was also poorly constructed as a stimulus package (primarily because higher-income earners were likely to save more of their windfall than those down the ladder).

Well, January was the first month after the compromise passed, and the savings rate has shot upward anyways.

Indiviglio reckons that 70 per cent of the rise in personal income was a result of the tax cut. Should we be puzzled that so much of it was saved, or was the mildness of the January rise in spending partly the inevitable result of the tax cut bill’s flawed design?

5--In Search of the Confidence Fairy, Paul Krugman, New York Times

Excerpt: In the debate over the budget, Republicans seem to be leaning on the claim that austerity will actually increase employment, because it will raise business confidence...

But how’s that going in Britain, where the Cameron austerity program was supposed to lead the way?

Most of the discussion of Britain I’ve seen focuses on GDP numbers, with the debate then centering on how much of the decline in the 4th quarter was weather-related. But a lot of things affect GDP. Why not look directly at confidence? The BDO has a convenient survey of business optimism (pdf); numbers for December and January here.

Austerity seems to have hurt, not helped, business confidence; as the BDO says, “Private sector unprepared to fill the hole left by public sector cuts.”

Why do we think the US experience — with the GOP proposals far less serious and responsible than Cameron’s — would be any better?

6-- Breaking News: Tax Revenues Plummeted, David Cay Johnston, Economist's View

Excerpt: We take you now to the official data for important news. ... Lowered tax rates did not result in increased tax revenues as promised by politician after pundit after professional economist. And even though this harsh truth has been obvious from the official data for some time, the same politicians and pundits keep prevaricating. ...

No matter how many times advocates of lower tax rates said it, tax rate cuts did not pay for themselves, did not spur economic growth, did not increase jobs, and did not make America better off.

Now that the news has been broken, let's see how many political leaders start speaking facts instead of fairy tales. And let's also watch to see how many Washington reporters, news anchors, talk show guests, and syndicated columnists use the actual figures. It's called holding politicians accountable, and it used to be a mainstay of journalism, where the first rule is to check it out and the second is to cross-check until you know what is going on and can give context....

7---Deflation, debt, and economic stimulus, VOX via Economist's View

Excerpt: The US, Japan, and Ireland are suffering from deficient private demand, rising debt, and a tendency to deflation. This column is asks what can be done about it....

Beyond some point, further rises in bond prices could set the stage for a sell-off of US government bonds, particularly when quantitative easing bond purchases are completed, resulting in potential disruption to financial and exchange rate markets.

Working toward an artificially flat yield curve based on a near-zero interest rate (through excessive quantitative easing), could impart misleading information about underlying risk structures, distort time-dependent investment/purchasing/selling decisions, encourage banks to take on higher-risk positions to maintain profitability, and artificially create illusory, “bubble-like”, share market gains.

To the extent that quantitative easing is successful in reducing longer-term interest rates, there will be an increased incentive for “carry trade” and other cross-border capital flows. The likely effect on capital outflows, and the exchange rate, could be relatively large in open economies where medium-term interest rates approach their lower bound. Foreign jurisdictions may be disadvantaged as domestic inflation there could increase, asset price bubbles could develop, and local exchange rates could rise. This could complicate global economic adjustments and international policy coordination....

The alternative approach involves the central bank printing new money to directly finance fiscal stimulus. This neglected policy option – apparently largely overlooked by officials during the global economic crisis – is likely to be appropriate for countries where prices are falling (or inflation drops toward zero), private demand is deficient, interest rates are already too low and where public debt is excessive.

Policy B provides a capacity to:

* finance budget deficits without raising public debt levels further;
* simultaneously stimulate private demand; and
* retreat from deflation....

If monetary policy is considered on its own then there could be a case for terminating current quantitative easing programmes. This would steer Japan and the US away from the shoals of triple jeopardy (Leijonhufvud 2011).

Quantitative easing could be replaced with a policy of printing new money with an explicit objective to assist in the financing of future budget deficits (see suggested money-financed tax cut: Bernanke 2002 and analysis by Corden 2010). The deployment of new money creation in this manner would take some pressure off the need for severe fiscal austerity measures (at a time when continued stimulus is still required); minimise further increases in public debt; provide clear signals of policy intent (in relation to interest rate objectives, the method of financing deficits and the approach to delivering economic stimulus); and be more effective, have fewer adverse side-effects, and deliver stronger economic stimulus than further quantitative easing.

Countries experiencing a deflationary tendency and deficient private demand that introduced laws in times of high inflation which preclude the printing of new money to finance budget deficits, and the ability of central banks to lend directly to Ministries of Finance, could consider repealing them.

8--Bernanke’s Prognosis & Prescription for State, Local Governments, Wall Street Journal

Excerpt: The state and local fiscal crisis is going to get worse before it gets better, says the nation’s most powerful economist, Federal Reserve Chairman Ben Bernanke.

But, the former member of a local school board in New Jersey adds: Don’t starve education. It is vital for future economic growth

“Despite the many difficult adjustments to date, state and local fiscal repair is far from complete, and governors, mayors, and legislators will confront more tough decisions as they develop their budgets for fiscal year 2012,” the Fed chief said in a speech to New York City’s Citizens Budget Commission Wednesday evening.

“Although the economy is recovering,” he said, “it is still operating well below potential and unemployment remains high. Stimulus grants from the federal government are winding down this year and will largely have ended by 2012,” he added. “Demands on Medicaid and other social service programs will likely remain elevated. Moreover, reserve funds are low, and the list of unused one-time fixes has been substantially depleted.”

“If the economy continues to strengthen at about the pace projected by the Federal Reserve and many private forecasters, states and localities may start to get a little breathing space,” he said. “Tax collections will rise with income and spending, and the use of Medicaid and other income support programs should ease as the labor market improves.”

But his bottom line was far from upbeat: “Because the pace of near-term economic growth expected by most forecasters is relatively modest given the depth of the downturn, some time will likely be required before state and local fiscal conditions return to something approximating normal.”

9--Oilquake in the Middle East, Michael T. Klare, Counterpunch

Excerpt: Whatever the outcome of the protests, uprisings, and rebellions now sweeping the Middle East, one thing is guaranteed: the world of oil will be permanently transformed. Consider everything that's now happening as just the first tremor of an oilquake that will shake our world to its core.

For a century stretching back to the discovery of oil in southwestern Persia before World War I, Western powers have repeatedly intervened in the Middle East to ensure the survival of authoritarian governments devoted to producing petroleum. Without such interventions, the expansion of Western economies after World War II and the current affluence of industrialized societies would be inconceivable.

Here, however, is the news that should be on the front pages of newspapers everywhere: That old oil order is dying, and with its demise we will see the end of cheap and readily accessible petroleum -- forever.

Ending the Petroleum Age

Let's try to take the measure of what exactly is at risk in the current tumult. As a start, there is almost no way to give full justice to the critical role played by Middle Eastern oil in the world's energy equation. Although cheap coal fueled the original Industrial Revolution, powering railroads, steamships, and factories, cheap oil has made possible the automobile, the aviation industry, suburbia, mechanized agriculture, and an explosion of economic globalization. And while a handful of major oil-producing areas launched the Petroleum Age -- the United States, Mexico, Venezuela, Romania, the area around Baku (in what was then the Czarist Russian empire), and the Dutch East Indies -- it's been the Middle East that has quenched the world's thirst for oil since World War II....

The critical player is Saudi Arabia, which just increased production to compensate for Libyan losses on the global market. But don't expect this pattern to hold forever. Assuming the royal family survives the current round of upheavals, it will undoubtedly have to divert more of its daily oil output to satisfy rising domestic consumption levels and fuel local petrochemical industries that could provide a fast-growing, restive population with better-paying jobs.

From 2005 to 2009, Saudis used about 2.3 million barrels daily, leaving about 8.3 million barrels for export. Only if Saudi Arabia continues to provide at least this much oil to international markets could the world even meet its anticipated low-end oil needs. This is not likely to occur. The Saudi royals have expressed reluctance to raise output much above 10 million barrels per day, fearing damage to their remaining fields and so a decline in future income for their many progeny. At the same time, rising domestic demand is expected to consume an ever-increasing share of Saudi Arabia's net output. In April 2010, the chief executive officer of state-owned Saudi Aramco, Khalid al-Falih, predicted that domestic consumption could reach a staggering 8.3 million barrels per day by 2028, leaving only a few million barrels for export and ensuring that, if the world can't switch to other energy sources, there will be petroleum starvation.

In other words, if one traces a reasonable trajectory from current developments in the Middle East, the handwriting is already on the wall. Since no other area is capable of replacing the Middle East as the world's premier oil exporter, the oil economy will shrivel -- and with it, the global economy as a whole.

Consider the recent rise in the price of oil just a faint and early tremor heralding the oilquake to come. Oil won't disappear from international markets, but in the coming decades it will never reach the volumes needed to satisfy projected world demand, which means that, sooner rather than later, scarcity will become the dominant market condition. Only the rapid development of alternative sources of energy and a dramatic reduction in oil consumption might spare the world the most severe economic repercussions.

10--Fed Policy Makers Signal Abrupt End to Bond Purchases in June, Bloomberg

Excerpt: Federal Reserve policy makers are signaling they favor an abrupt end to $600 billion in Treasury purchases in June, jettisoning their prior strategy of gradually pulling back on intervention in bond markets.

“I don’t see a lot of gain to reverting to a tapering approach,” Atlanta Fed President Dennis Lockhart told reporters yesterday. “I don’t think that is necessary,” Philadelphia Fed President Charles Plosser said last month.

Central bankers, who next meet March 15, are about half way through their second round of bond purchases. To bring the program to a full stop in June, they must be confident that the economy is strong enough to endure higher long-term interest rates and rising expectations of an exit from the most expansive monetary policy in Fed history, said Dan Greenhaus at Miller Tabak & Co. LLC in New York.

“If this is a self-sustaining recovery that can withstand higher interest rates, then why not get the hell out?” said Greenhaus, Miller Tabak’s chief economic strategist. “Still, I am nervous about their ability to withdraw from this policy without broader disruptions.”

The Fed announced in November that it would buy $600 billion of Treasuries through June in a bid to boost the recovery and reduce an unemployment rate lingering near a 26- year high. The program, known as QE2 for the second round of so- called quantitative easing, followed $1.7 trillion of asset purchases that ended in March 2010.

11--February Employment Report: 192,000 Jobs, 8.9% Unemployment Rate, calculated risk

Excerpt: From the BLS:

Nonfarm payroll employment increased by 192,000 in February, and the unemployment rate was little changed at 8.9 percent, the U.S. Bureau of Labor Statistics reported today.
The change in total nonfarm payroll employment for December was revised from +121,000 to +152,000, and the change for January was revised from +36,000 to +63,000.

The unemployment rate decreased to 8.9%....The Labor Force Participation Rate was unchanged at 64.2% in February ...The current employment recession is by far the worst recession since WWII in percentage terms, and 2nd worst in terms of the unemployment rate (only the early '80s recession with a peak of 10.8 percent was worse).

This was about at expectations for payroll jobs. Adding January and February together gives 255,000 jobs or about 127 thousand per month.

12--How to Kill a Recovery, Paul Krugman, New York Times via Economist's View

Excerpt: The economic news has been better lately. New claims for unemployment insurance are down; business and consumer surveys suggest solid growth. We’re still near the bottom of a very deep hole, but at least we’re climbing.

It’s too bad that so many people, mainly on the political right, want to send us sliding right back down again.

Before we get to that, let’s talk about why economic recovery has been so long in coming. ... The bubble economy of the Bush years left many Americans with too much debt; once the bubble burst, consumers were forced to cut back, and it was inevitably going to take them time to repair their finances. And business investment was bound to be depressed, too. Why add to capacity when consumer demand is weak and you aren’t using the factories and office buildings you have?

The only way we could have avoided a prolonged slump would have been for government spending to take up the slack. But that didn’t happen: ... an underpowered federal stimulus was swamped by cuts at the state and local level.

So we’ve gone through years of high unemployment and inadequate growth. Despite the pain, however,... in the past few months there have been signs of an emerging virtuous circle. As families have repaired their finances, they have increased their spending; as consumer demand has started to revive, businesses have become more willing to invest; and all this has led to an expanding economy, which further improves families’ financial situation.

But it’s still a fragile process, especially given the effects of rising oil and food prices. These price rises have little to do with U.S. policy;... things will be much worse if the Federal Reserve and other central banks mistakenly respond to higher headline inflation by raising interest rates.

The clear and present danger to recovery, however, comes from politics — specifically, the demand from House Republicans that the government immediately slash spending on infant nutrition, disease control, clean water and more. Quite aside from their negative long-run consequences, these cuts would lead, directly and indirectly, to the elimination of hundreds of thousands of jobs — and this could short-circuit the virtuous circle of rising incomes and improving finances.

Of course, Republicans believe, or at least pretend to believe, that the direct job-destroying effects of their proposals would be more than offset by a rise in business confidence. As I like to put it, they believe that the Confidence Fairy will make everything all right.

But ... it’s hard to see how such an obviously irresponsible plan ... can improve confidence. Beyond that, we have a lot of evidence from other countries about the prospects for “expansionary austerity” — and that evidence is all negative...

Which brings us back to the U.S. budget debate.

Over the next few weeks, House Republicans will try to blackmail the Obama administration into accepting their proposed spending cuts, using the threat of a government shutdown. They’ll claim that those cuts would be good for America in both the short term and the long term.

But the truth is exactly the reverse: Republicans have managed to come up with spending cuts that would do double duty, both undermining America’s future and threatening to abort a nascent economic recovery.

13--Bernanke's plug for Early Childhood Education? New York Times

Excerpt: Budget balance and budget stability are important fiscal issues. In the long run, though, the most important fiscal issue is whether the structure and composition of the government budget best serves the public interest. Certainly, most people would support the goal of fostering healthy economic growth. Government can contribute to this objective in a number of ways. One critical means is by ensuring an adequate investment in human capital — that is, in the knowledge and skills of our people. No economy can succeed without a high-quality workforce, particularly in an age of globalization and technical change. Cost-effective K-12 and post-secondary schooling are crucial to building a better workforce, but they are only part of the story.

Research increasingly has shown the benefits of early childhood education and efforts to promote the lifelong acquisition of skills for both individuals and the economy as a whole. The payoffs of early childhood programs can be especially high. For instance, preschool programs for disadvantaged children have been shown to increase high school graduation rates. Because high school graduates have higher earnings, pay more taxes, and are less likely to use public health programs, investing in such programs can pay off even from the narrow perspective of state budgets; of course, the returns to the overall economy and to the individuals themselves are much greater.

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