Wednesday, April 13, 2011

Today's links

1--Forecasters see dollar weakness as QE2 end looms, The economic Times

Excerpt: The most-accurate currency strategists see no recovery for the dollar in coming months as the Federal Reserve delays raising interest rates after the end of its $600 billion asset-purchase program in June. Wells Fargo & Co , the top forecaster for the second straight quarter, and No. 2 St. George Bank , say America's currency will be little changed through June as the Fed lags behind central banks boosting rates.

"The US would like to keep interest rates as low as possible for as long as it can." While diverging central banks may stop the dollar from appreciating from a 16-month low, the policies are helping the US recover from the biggest downturn since the Great Depression as the Fed begins to drain some of the more than $2 trillion of stimulus it pumped into the economy. US exports have risen each month since August to a record $167.7 billion in January, Commerce Department data show.

2--Inflation Cue: Follow the Money, Kelly Evans, Wall Street Journal

Excerpt: Rising price indexes are just one piece of the inflation jigsaw puzzle. A glance at money-supply growth gives a different picture.... supply may be signaling they actually are being too aggressive. The late economist Milton Friedman famously observed that inflation is always and everywhere a monetary phenomenon. Indeed, in the Great Inflation of the 1970s and '80s, the money supply, wages and nominal U.S. gross domestic product all rose at double-digit annual rates.

Things look a little different in the Western world today. In the U.K., GDP contracted in the fourth quarter and looks roughly flat in the first quarter. The money-supply gauge known as M2, which includes cash, bank deposits and money-market funds held by households, rose 3.4% in February from a year earlier. Only last spring it was rising 6.3%. In Europe, where economic growth is slowing, especially outside France and Germany, M2 was up about 4% as of February. "If Milton Friedman were alive, I think he'd take one look at what [the ECB] is doing and raise holy hell," says MKM Partners Chief Economist Michael Darda.

In the U.S., M2 growth is weaker, up 2.5% in February from a year earlier. Meanwhile, the higher fuel prices rise, the more economists are cutting their economic growth forecasts. Before investors go all-in on an inflationary break out, they may want to follow the money supply.

3--The Dark Side of Strong Corporate Earnings, Kelly Evans, Wall Street Journal

Excerpt: A climbing stock market and strong corporate earnings aren't quite the beacons of light they once were for the U.S. economy.

A strong earnings season could push the S&P 500-stock index to three-year highs in the 1350-to-1400 range, reckons Bank of America Merrill Lynch strategist David Bianco. Typically, stock-market gains are one of the most bullish leading indicators, and yet economists are marking U.S. growth figures down. First-quarter real gross domestic product looks to have expanded at only about a 2% annualized pace, even with the Obama payroll tax cut and the Federal Reserve's $600 billion quantitative-easing program in place.

Growth may firm up later this year. But the relative weakness with each quarter raises a question: Why isn't the U.S. economy accelerating, especially with the corporate sector in such good shape?

Perhaps because corporate earnings aren't being driven by strength in the U.S., but to some degree by its weakness. Companies have shifted production and sourcing overseas to cut costs and to tap demand in faster expanding markets. Capital spending in emerging markets like China and India has more than doubled in the past decade, and surpassed developed markets last year for the first time, HSBC estimates.

That is fostering growth abroad but undercutting prospects in the U.S. The nation's factors of production, such as factories and equipment, or capital stock, actually shrank in 2009 for the first time in postwar history. Business investment did rebound last year, but the 15% increase, which should have generated 380,000 jobs on average a month, created only 78,000, notes UniCredit economist Harm Bandholz. The rebound appears largely to have been maintenance-driven, and investment has leveled off since.

The shifting of investment overseas and erosion of the nation's capital stock are no small matter. They imply a lower potential growth rate for the U.S. and higher structural unemployment. As that reality dawns, the corporate sector's strength may start to lose its luster.

4--Japan Sees Greater Hit to Economy as Nuclear Crisis Deepens, Bloomberg

Excerpt: Japan’s Economic and Fiscal Policy Minister Kaoru Yosano said the March 11 earthquake may result in a larger hit to the economy than previously seen, indicating a greater appetite for stimulus one month after the disaster.

“The damage to the economy may be bigger than we initially expected,” Yosano told reporters today in Tokyo. “In addition to disruptions in the supply chain, we have the added seriousness of the situation with the nuclear power plant,” he said, referring to the Fukushima Dai-Ichi crisis that officials today said has a severity rating matching Chernobyl in 1986.

Prime Minister Naoto Kan may need to turn to additional debt sales or to tax increases in coming months, given opposition at the central bank to funding deficit spending. A record of the Bank of Japan’s meeting last month showed today that officials refrained from any discussion of specific additional monetary stimulus they would be prepared to endorse.

Consumers won’t be willing to spend until funds are deployed to the northeast and government rebuilding take hold, according to economist Noriaki Matsuoka.

5-- U.K. Retail Sales Plunged Last Month, Wall Street Journal

Excerpt: U.K. retailers suffered their worst fall in sales in at least 16 years in March, driving home the fragility of the economy at a time when the Bank of England is considering raising its key interest rate.

The dire news from retailers came a day after the International Monetary Fund cut its growth forecast for the U.K, saying Chancellor of the Exchequer George Osborne's program of spending cuts and tax increases is damaging the economic outlook.

The British Retail Consortium said Tuesday that sales fell 1.9% in March from March 2010, the fastest decline since the survey was first conducted in 1995.

The fall came even though retailers opened new stores. Same-store sales, which exclude that boost, fell 3.5%.

"This is the worst drop in total sales since we first collected these figures," said Stephen Robertson, the BRC's director-general. "This is strong evidence of the pressure customers and traders are under."

He said the decline partly reflects the Easter sales boost in March 2010, which weakened the annual comparison because Easter is in April this year.

"But this fall goes way beyond anything that can be explained by that alone," he said.

The data will heighten fears that consumer spending is evaporating, posing a real threat to the overall economy. Households' disposable income has been eroded by the combined impact of a high inflation rate, low wage growth and the rise in the value-added tax rate to 20%, from 17.5% at the start of this year.

"Mounting fuel and utility costs, higher VAT and the prospect of more tax rises and job losses left people unwilling to spend unless they really had to," Mr. Robertson said.

The economy shrank 0.5% from October to December and early signs are that any rebound in the first quarter will be modest at best. The BRC figure further diminishes the chances of a strong recovery.

6--Currency Devaluation Is More Essential Than Entitlement Reform, Dean Baker, CEPR

Excerpt: Changes in the currency value is the main mechanism for adjusting trade balances in a system of floating exchange rates. If the dollar is over-valued by 20 percent then this has roughly the same effect as subsidizing our imports by 20 percent and placing a tariff of 20 percent on all our exports. The over-valued dollar has far more impact on our trade balance than all of our trade deals put together.

If the value of the dollar does not fall substantially, then the United States will continue to run large trade deficits. This logically implies that we will have negative domestic savings (i.e. it is an accounting identity, there is no way around it). Low private savings means either large budget deficits or very low private savings or some combination.

In other words, if Mr. Gross does not want the dollar to fall, then he either wants to see large budget deficits and/or very low private savings. Or alternatively, he doesn't understand basic economics.

7--Annals of Well, Duh (Commodity Prices), Paul Krugman, New York Times

Excerpt: The Chicago Fed has a new paper (pdf) showing that shocks to commodity prices do not, in fact, presage higher core inflation. Actually, it’s quite a good little piece — and kudos to Charles Evans, the Chicago Fed’s president, for putting his name on it in these days of fanatical inflation hawks....(chart)

If commodity price rises lead to broader price inflation this time around, it will be a first.

8--Icelandic voters reject Icesave debt repayment plan, The Guardian via Information Clearinghouse

Excerpt: Icelanders have rejected the latest government-approved plan to repay the £3bn owed to Britain and the Netherlands from the crash of the country's banking system in 2008, prompting the prime minister to warn of economic and political chaos.

Final results from five of six constituencies, including the capital, Reykjavik, showed the "no" side taking nearly 60% of the vote, meaning the dispute is likely to end up in a European court.

"The worst option was chosen," said the prime minister, Jóhanna Sigurðardóttir. "The vote has split the nation in two. We must do all we can to prevent political and economic chaos as a result of this outcome."

The debt was incurred when Britain and the Netherlands compensated their nationals who lost savings in online Icesave accounts owned by Landsbanki, one of three Icelandic banks that collapsed in late 2008.

Icelandic politicians in February backed a repayment plan agreed with creditors, but the president refused to sign the bill, triggering the vote. In March last year, Iceland rejected an earlier Icesave repayment blueprint in a referendum.

Economists say uncertainty over the payback deal is hurting efforts to drag Iceland out of recession, end currency controls and boost investment. Many voters cited opposition to taxpayers footing the bill for irresponsible bankers as their reason for voting against the plan.

"I know this will probably hurt us internationally, but it is worth taking a stance," said Thorgerdun Ásgeirsdóttir, a 28-year-old barista, after casting a "no" vote.

9--Bank Regulation: Too Little to Succeed, Mark Thoma, CBS Moneywatch

Excerpt: Would it surprise you to learn that if a bank like Lehman Brothers were to get into trouble today, we would have no choice but to bail it out? The Dodd-Frank financial reform bill includes resolution authority that supposedly allows regulators to avoid a bailout and dismantle large, systemically important banks that get into trouble without endangering the overall banking system. But this legislation does not end the problem of too big to fail banks.

If the banking system is threatened by the failure of a large bank, then resolution authority will not prevent the equivalent of a traditional bank run on the shadow banking system. Depositors can’t be certain that resolution authority will work as advertised, and as soon as they sense their funds are at risk, they will rush to withdraw them from endangered institutions. And as this fear spreads to counterparties worried about the ability of the troubled bank to meet its obligations, and in turn to the counterparties of counterparties, the overall system becomes threatened and the government has no choice but to step in to try to prevent collapse.....

The same requirements can be placed on banks. If banks are forced to post substantial amounts of capital, and that capital is subject to “first loss” provisions, then they will be much more careful about the risks they take. So substantial capital requirements, even higher than required under Basel III, are needed. In addition, better transparency so that investors can monitor what the bank is up to, improved rating of assets, fees to establish a bailout fund and offset potential gains from exploiting too big to fail status, better consumer education, and prosecuting fraud would help as well. Beyond this, regulators also need to develop better early warning systems that tell us when risk is accumulating to dangerous levels.

If prevention fails, then it’s important to limit damages. One important way to reduce the severity of a financial collapse is to reduce the interconnectedness of financial institutions. This makes it more difficult for problems to spread. In addition, reducing leverage also helps to limit the damages in a financial crash. Basel III does impose leverage limits, but they are not strict enough and don’t become fully effective until 2018.

If the banking system gets into trouble, we will bail it out – no politician or regulator wants to be responsible for the next Great Depression. The resolution authority in the Dodd-Frank bill attempts to hide this reality. It avoids the need for strict regulation associated with the promise of a bailout, something that pleases banks, but leaves the system vulnerable to collapse. We should accept that bailouts cannot be avoided, impose the regulatory structure needed to limit problems, and do our best to reduce the damages associated with the inevitable crashes of the financial system.

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