Thursday, April 14, 2011

Today's links

Quote of the day: "Two things are infinite: the universe and human stupidity; and I'm not sure about the the universe." Albert Einstein

1--The Bear of Bretton Woods, Barry Eichengreen, Project Syndicate

Excerpt: ....what will ultimately replace today’s dollar-centric international monetary and financial system is a tripolar system organized around the dollar, the euro, and the Chinese renminbi. Despite all of the current wailing and gnashing of teeth in Europe about its future, the euro isn’t going anywhere. And China, for its part, is working energetically to internationalize its currency – and it is making faster progress than most people appreciate.

The world will be better off as a result. The existence of alternatives to the dollar will mean that the issuers of internationally used currencies will feel market discipline earlier and more consistently. When the US again shows signs of falling prey to financial excess, it will not receive as much foreign funding as freely as it has in the past. After all, central banks seeking to accumulate foreign-currency reserves will have alternatives to acquiring dollars, so foreigners won’t give America so much rope with which to hang itself.

The result will be a safer financial world. After all, the ultimate cause of the 2007-2009 financial crisis was the dangerous inconsistency between our multipolar global economy and its still dollar-dominated monetary and financial system.

The good news is that this will change over the coming decade, bringing international monetary arrangements back into line with economic realities. The bad news is that ten years is a long time. If recent history is any guide, salvation could still be three crises away.

2--Oil and trouble, The Economist

Excerpt: THE IMF is rolling out its World Economic Outlook today, and it has already made public two analytical chapters of the report. One is on trends in the market for oil and the potential impact of rising prices on global output. Here's the summary text:

The persistent increase in oil prices over the past decade suggests that global oil markets have entered a period of increased scarcity. Given the expected rapid growth in oil demand in emerging market economies and a downshift in the trend growth of oil supply, a return to abundance is unlikely in the near term. This chapter suggests that gradual and moderate increases in oil scarcity may not present a major constraint on global growth in the medium to long term, although the wealth transfer from oil importers to exporters would increase capital flows and widen current account imbalances. Adverse effects could be much larger, depending on the extent and evolution of oil scarcity and the ability of the world economy to cope with increased scarcity. Sudden surges in oil prices could trigger large global output losses, redistribution, and sectoral shifts. There are two broad areas for policy action. First, given the potential for unexpected increases in the scarcity of oil and other resources, policymakers should review whether the current policy frameworks facilitate adjustment to unexpected changes in oil scarcity. Second, consideration should be given to policies aimed at lowering the risk of oil scarcity....

The most disconcerting part of the IMF analysis is its estimate of the potential impact of declining oil output on world GDP under different output scenarios. In the benchmark case, growth in oil output drops by one percentage point a year and real world GDP two decades from now is about 3 percentage points below where it otherwise would have been. In America, the drop is closer to 4 percentage points. Given greater substitution away from oil, the gap over two decades is closer to 1 percentage point for both the world and the American economy.

But the IMF also considers a more pessimistic scenario in which the annual hit to growth in oil output is 3.8 percentage points. In that case, real world GDP could wind up 10 percentage points below its but-for level. In America, the projected gap is more like 13 percentage points.

That's a serious risk to consider. The dynamics in this market are pretty straightforward: oil is mostly used for transportation, and the key to limiting the impact of increased scarcity is improving the extent to which consumers can substitute away from oil use.

3--Surging margin debt and the instability QE2 has created, Pragmatic Capitalism

Excerpt: As we noted earlier this year, margin debt has tended to correlate fairly closely with the direction of the equity market. And according to the latest data from the NYSE, margin debt continues to move higher. In an effort to ride the coattails of the Fed and QE2′s “can’t lose” environment, investors have dipped into their borrowings to buy equities. David Rosenberg highlights the speculative fervor that this now represents. Current levels of margin debt are now consistent with the Nasdaq bubble and just shy of the levels seen before the credit crisis (via Gluskin Sheff):

“If there is one sure way to tell that the Fed has managed to create and nurture a speculative-led rally in the equity market, look no further than what is happening to investor-based leverage growth – it’s exploding off the page. Yes, that’s right. Debit balances at margin accounts skyrocketed $20.7 billion in February. Only two other times historically have we seen leverage rise so much so fast and both times it was during a manic phase – during the tech bubble of the late 1990s and the credit bubble just a short four years ago.

To put that $20.7 billion incremental leverage in on month into proper perspective, it represents a 7.2% jump, or an increase of no less than 129% at an annual rate. And, it’s not just February – the rising use of credit to buy stocks has zoomed ahead at a 64% annual rate in the past three months. If and when the markets breaks, the problem in trying to contain the downside momentum is that there are no short left to cover, which actually helps as a shock absorber. The Fed has successfully cleaned out the short community, and the extent to which we see margins being called away may very well accentuate and downside pressure…if it should come.”

The results from QE2 are beginning to look fairly clear. Not only does this program appear to have done very little to help the real economy, but it appears to have sparked a speculative move in risk assets that creates a disturbing level of instability....Source: Gluskin Sheff

4--Small-Business Optimism Declines, Wall Street Journal

Excerpt: Small business owners became more worried about the economy in March, according to data released Tuesday. Even so, hiring remained positive and more businesses planned to increase prices.

The National Federation of Independent Business‘s small-business optimism index fell 2.6 points to 91.9 in March. The report said six subindexes lost growth, while four rose or were unchanged....

Despite worries about future demand, small business owners plan to increase their selling prices. The report said the seasonally adjusted net percentage of owners reporting higher selling prices increased to 9% in March, from 5% in February. The reading has risen 20 percentage points since last September, the report said.

The NFIB said a major force behind the price increases is the elimination of excess inventories. The report also said profits are “badly in need of some price support.”

The report warned that with the economy improving, more of these price increases will stick. The Federal Reserve could have to deal with rising inflation soon.

The increased pessimism among small business owners in March echoes more downbeat views among U.S. consumers that showed up in two major surveys of household attitudes last month.

5--The banking system – still broken, FT Alphaville

Excerpt: Here’s a perfectly nuanced view of how quantitative easing — the programme started by the Federal Reserve to avert depression following an almighty banking bubble — impacts asset prices.

First, envision part of the QE process. The Fed purchases a security — a US Treasury, or a slice of MBS — from an investor. That investor then sends the ensuing proceeds to a bank — generating an extra deposit. The bank can then lend that deposit to someone else to buy another security. So the deposit eventually returns to the bank, and it can then lend 90 per cent of it out again. And so on.

In theory, for every dollar the Fed injects into the economy with its asset purchase programme, banks should be able to leverage this 10 times through the bank multiplier. In practice, though, not so much.

Banks balance sheets have traveled sideways — despite $2,000bn worth of QE.

Here’s Dominic Konstam and Alex Li from Deutsche Bank:

The $2 trillion in purchases have literally gone down a black hole. Required reserves haven’t been required to increase and the Fed reserve add has literally simply been hoarded as cash. Excess reserves at the Fed have subsequently soared by the same. In short, QE has been a spectacular disappointment in its impact on bank lending, whether via whole loans or securities. It was as if the banks conducted the very sterilization of QE that many thought perhaps the Fed should do to “contain” inflation expectations.

If asset prices haven’t been increasing because of increased bank loans, then where have all those surging prices — in things like commodities or junk bonds — come from?

Says Deutsche:

Risky security prices have risen since QE but not Treasuries, the main instrument of QE2. Yet banks’ balance sheets have gone sideways. Effectively investors have marked asset prices higher and circumvented the banks. It is as if the first purchase by the Fed from an investor simply triggered a series of deposit for security switches through the investor base with banks never making an additional loan. This is consistent with a greater concern for risky asset post QE2 end, than Treasuries. The danger for investors is that they confuse the result of higher asset prices as reflecting excess liquidity rather than “irrational” exuberance given that actual liquidity (as broadly defined by the banking system) hasn’t gone up at all.

Now think of the QE2, scheduled to end in fewer than two months:

For all the worries about the end of QE2, the focus should be on how we came about the “risk on” trade and elevated asset prices. It was not through revitalized bank lending. There is no banking system that is standing on its own two feet and propelling growth forward. It remains like a herd of deer in the headlights – ready to hand the cash straight back to the Fed when asked for. If risky asset prices were elevated because of the expectation of a kick start from the banks, they are at risk of falling. Treasuries are immune because no one could buy them as the Fed purchased them. There is no call on loans that funded Treasury positions through QE2. Moreover if the banks slowed the pace of deleveraging (deposit destruction) because of the safety of their cash hoard, there is a risk that they may become even more recalcitrant.

Of course, you could argue that this is exactly what the Fed’s been planning.

You sideline a broken banking system and then depend on bond and stock markets for your recovery. But it’s a plan that itself is dependent on those markets keeping up an irrational exuberance without permanent help from the central bank. Either that, it seems, or banks magically start lending…

6--Fed's Yellen: Inflation Transitory, will not "impede the economic recovery", Calculated Risk

Excerpt: The recent run-up in commodity prices is likely to weigh somewhat on consumer spending in coming months because it puts a painful squeeze on the pocketbooks of American households. In particular, higher oil prices lower American income overall because the United States is a major oil importer and hence much of the proceeds are transferred abroad. Monetary policy cannot directly alter this transfer of income abroad, which primarily reflects a change in relative prices driven by global demand and supply balances, not conditions in the United States. Thus, an increase in the price of crude oil acts like a tax on U.S. households, and like other taxes, tends to have a dampening effect on consumer spending.

The surge in commodity prices may also dampen business spending. Higher food and energy prices should boost investment in agriculture, drilling, and mining but are likely to weigh on investment spending by firms in other sectors. Assuming these firms are unable to fully pass through higher input costs into prices, they will experience some compression in their profit margins, at least in the short run, thereby causing a decline in the marginal return on investment in most forms of equipment and structures. Moreover, to the extent that higher oil prices are associated with greater uncertainty about the economic outlook, businesses may decide to put off key investment decisions until that uncertainty subsides. Finally, with higher oil prices weighing on household income, weaker consumer spending could discourage business capital spending to some degree.....

... while the recent run-up in commodity prices is likely to weigh somewhat on consumer and business spending in coming months, I do not anticipate that those developments will greatly impede the economic recovery as long as these trends do not continue much further.

And her conclusion:

In summary, the surge in commodity prices over the past year appears to be largely attributable to a combination of rising global demand and disruptions in global supply. These developments seem unlikely to have persistent effects on consumer inflation or to derail the economic recovery and hence do not, in my view, warrant any substantial shift in the stance of monetary policy.

7--Sharp Drop in American Enthusiasm for Free Market, Poll Shows, GlobeScan

Excerpt: LONDON—American public support for the free market economy has dropped sharply in the past year, and is now lower than in China, according to a GlobeScan poll released today.

The findings, drawn from 12,884 interviews across 25 countries, show that there has been a sharp fall in the number of Americans who think that the free market economy is the best economic system for the future.

When GlobeScan began tracking views in 2002, four in five Americans (80%) saw the free market as the best economic system for the future—the highest level of support among tracking countries. Support started to fall away in the following years and recovered slightly after the financial crisis in 2007/8, but has plummeted since 2009, falling 15 points in a year so that fewer than three in five (59%) now see free market capitalism as the best system for the future.

GlobeScan Chairman Doug Miller commented: “America is the last place we would have expected to see such a sharp drop in trust in the free enterprise system. This is not good news for business.”

The results mean that a number of the world’s major emerging economies have now matched or overtaken the USA in their enthusiasm for the free market. The Chinese and Brazilians, 67 per cent of whom regard the free market system as the best on offer, are now more positive about capitalism than Americans, while enthusiasm in India now equals that in the USA, with 59 per cent rating the free market as the best system for the future....

GlobeScan Chairman Doug Miller added: “The poll suggest that American business is close to losing its social contract with average American families that has enabled it to prosper in the world. Inspired leadership will be needed to reverse this trend.”

8--U.S. Economic Optimism Plummets in March, Gallup

Excerpt: Americans' optimism about the future direction of the U.S. economy plunged in March for the second month in a row, as the percentage of Americans saying the economy is "getting better" fell to 33% -- down from 41% in January. It is also down three points from the 36% of March 2010.

Optimism in March essentially matches last year's low points: 32% in July, 33% in August, and 32% in September. However, it remains higher than it was throughout 2008 and early 2009.

Economic Optimism Declines Across Demographic Groups

While upper-income Americans remain more optimistic than their lower- and middle-income counterparts, optimism among both groups declined substantially in March. Despite Wall Street's strong first quarter performance, the percentage of upper-income Americans saying the economy is getting better fell to 41% in March from 50% in January, leaving it at the same level as a year ago. Lower- and middle-income Americans' economic optimism also fell in March, to 32%, from 40% in January.

Gallup's Economic Confidence Index Also Takes a Plunge in March

Gallup's Economic Confidence Index, which includes the economic optimism measure, also plunged in March to -31. This is worse than the -21 in January and about the same as the -30 of a year ago.

The Index is based on two questions, which measure Americans' views of current economic conditions and their future expectations. The sharp decline in the latter brought down the index score in the first quarter of the year. Americans' perceptions of current economic conditions are not much different in March -- with 44% rating the economy "poor" -- than they were in January, when 42% said the same.


Even as economic adversity seems to mount, the U.S. commodity and equity markets remain near their highs for the year. Surging oil and commodity prices mean higher profits for many companies and investors. Further, a weak U.S. economy suggests the Federal Reserve will continue its easing policies despite some tightening in Europe. While the weakening of the global economy may not be good for U.S. exports, the declining U.S. dollar may moderate the negative impact on many U.S. exporters and their stock values.

On the other hand, American consumers face several major challenges. Soaring gas and food prices not only reduce disposable income but also discourage additional spending as the cost of necessities increases. Global events, continued political battles about the budget in the nation's capital, and a weak, if modestly improving job market add to consumer uncertainties. As a result, it is not surprising that consumer confidence plummets even as Wall Street continues to do well.

However, if consumers continue to lack confidence and spending doesn't increase, it is hard to see how the U.S. economy can continue its modest improvement. In turn, it would seem Wall Street and Main Street will have to align at some point going forward. Either Wall Street will prove right and economic conditions on Main Street will improve or the reverse will prove to be the case.

9--Off-the-charts income gains for super-rich, Yahoo News

Excerpt: In recent years, we've been hit with a barrage of statistics, charts, and even full-length books, documenting how inequality is on the rise in America.

But very few of them capture what's happened over the last 30 years or so as well as this image: (see chart)

Put together by the Center on Budget and Policy Priorities, a liberal Washington think tank, the chart is pretty self-explanatory. It shows that the 30 years following the Second World War were a time of broadly shared prosperity: Income for the bottom 90 percent of American households roughly kept pace with economic growth.

But over the last 35 years, there's been an abrupt shift: Total growth has slowed marginally, but the real change has been in how the results of that growth are distributed. Now, the bottom 90 percent have seen their income rise only by a tiny fraction of total growth, while income for the richest 1 percent has exploded by upwards of 275 percent.

One can argue about why this is happening. Some say it's the result of a decline in workers' bargaining power as labor unions have weakened, while others blame the rise of offshoring and outsourcing. But despite the best efforts of some commentators, there's really no serious debate about the overall realignment of income in our age: The already super-rich have vastly increased their share of the pie--at the expense of everyone else.

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