Monday, April 25, 2011

Today's links

1--Tapped out, James Hamilton, Econbrowser

Excerpt: One of the key questions in assessing the effect of the Libyan conflict on world oil prices was the extent to which an increase in Saudi production would offset some of the lost output from Libya. Now we know the answer, and it's not reassuring.....

...this week Saudi Oil Minister Ali Al-Naimi tried to get us to believe that the Saudis have now gone back to lower production levels because there's way too much oil being supplied already.

I kid you not. Here's the quote from Bloomberg:

"Our production in February was 9,125,100 barrels a day," al-Naimi said, as he arrived in Kuwait for a conference. "In March, it was 8,292,100 barrels. It will probably go a little higher in April. The reason I mention these numbers is to show you the market is oversupplied."

Well, if the supply of low-sulfur oil from Libya has decreased, and the supply of high-sulfur oil from Saudi Arabia has increased, equilibrium would require an increase in the price spread between sweet and sour crudes. Between January 7 and April 15, the price of low-sulfur Brent increased by $28.64/barrel. The price of higher-sulfur Saudi light increased by $27.92; in other words, the Saudis allowed the spread to widen by all of 72 cents. And the heavier Saudi grades went up $26.62. The only legitimate meaning one can attach to Al-Naimi's statement is that if the Saudis had wanted to sell 9 mb/d, they would have had to settle for less than a $25/barrel increase in the price of their lower grades....

It's also interesting to evaluate these comments in light of the recent dramatic increase in Saudi drilling efforts, as described by Jim Brown on April 10:

We also heard just over a week ago from Halliburton that Saudi was upping its rig count from 92 to 118 with the majority of those new rigs going to the Manifa field. However, that news prompted even more concerns because the Manifa oil is heavy, sour crude. Why would you escalate production in heavy crude if the real problem facing the world right now is light sweet crude?

And, as if that weren't curious enough, a few weeks ago Bloomberg reported that Saudi Arabia plans to invest $100 billion in renewable energy sources. Jim Brown again:

In theory the country with the largest readily available oil reserves in the world is suddenly considering spending $100 billion on alternative energy so they will have more oil to export. Does that strike anyone else as strange? Wouldn't it be a lot cheaper to just punch a few more wells and produce more oil from the billions of barrels they have in reserve?

Here's Stuart Staniford's answer:

All of this evidence points in the direction of Saudi Arabia being unable to raise production much if at all in the near term.

You may call it unable, or you may call it unwilling. But whatever you want to call it, don't pretend that the Saudis' claimed excess capacity is oil that the world is actually going to use in 2011.

And whatever you want to call it, don't pretend that the current price of oil has nothing to do with supply and demand.

2--The Bipartisan March to Fiscal Madness, David Stockman, New York Times

Excerpt: ...This lamentable prospect is deeply grounded in the policy-driven transformation of the economy during recent decades that has shifted income and wealth to the top of the economic ladder. While not the stated objective of policy, this reverse Robin Hood outcome cannot be gainsaid: the share of wealth held by the top 1 percent of households has risen to 35 percent from 21 percent since 1979, while their share of income has more than doubled to around 20 percent.

The culprit here was the combination of ultralow rates of interest at the Federal Reserve and ultralow rates of taxation on capital gains. The former destroyed the nation’s capital markets, fueling huge growth in household and business debt, serial asset bubbles and endless leveraged speculation in equities, commodities, currencies and other assets.

At the same time, the nearly untaxed windfall gains accrued to pure financial speculators, not the backyard inventors envisioned by the Republican-inspired capital-gains tax revolution of 1978. And they happened in an environment of essentially zero inflation, the opposite of the double-digit inflation that justified a lower tax rate on capital gains back then — but which is now simply an obsolete tax subsidy to the rich....

Representative Ryan fails to recognize that we are not in an era of old-time enterprise capitalism in which the gospel of low tax rates and incentives to create wealth might have had relevance. A quasi-bankrupt nation saddled with rampant casino capitalism on Wall Street and a disemboweled, offshored economy on Main Street requires practical and equitable ways to pay its bills....

3--China should cap forex reserves at 1.3 trillion U.S. dollars: China banker, Xinhua News

Excerpt: China should reduce its excessive foreign exchange reserves and further diversify its holdings, Tang Shuangning, chairman of China Everbright Group, said on Saturday.

The amount of foreign exchange reserves should be restricted to between 800 billion to 1.3 trillion U.S. dollars, Tang told a forum in Beijing, saying that the current reserve amount is too high.

China's foreign exchange reserves increased by 197.4 billion U.S. dollars in the first three months of this year to 3.04 trillion U.S. dollars by the end of March.

Tang's remarks echoed the stance of Zhou Xiaochuan, governor of China's central bank, who said on Monday that China's foreign exchange reserves "exceed our reasonable requirement" and that the government should upgrade and diversify its foreign exchange management using the excessive reserves.

Meanwhile, Xia Bin, a member of the monetary policy committee of the central bank, said on Tuesday that 1 trillion U.S. dollars would be sufficient. He added that China should invest its foreign exchange reserves more strategically, using them to acquire resources and technology needed for the real economy.

Tang also said that China should further diversify its foreign exchange holdings. He suggested five channels for using the reserves, including replenishing state-owned capital in key sectors and enterprises, purchasing strategic resources, expanding overseas investment, issuing foreign bonds and improving national welfare in areas like education and health.

4--Lost decade? We've already had one, Fortune

Excerpt: rnott says the U.S. economy actually went off the rails more than a decade ago. What's more, many of us have failed to realize it because the most widely watched economic indicator, gross domestic product, actually tracks consumption, irresponsible or otherwise, rather than real wealth generation.

Accordingly, Arnott takes little solace in the observation that inflation-adjusted, per capita GDP has recovered to within just a few percent of its 2007 peak. While that statistic suggests the economy is recovering steadily, if a little less quickly than we'd like, Arnott contends that most of the GDP gains we have seen since 1998 are attributable to debt-financed spending, rather than real wealth creation.

We are, in a word, considerably poorer than we imagine – something politicians of all stripes should, but probably won't, consider as they grapple with our massive deficit.

"GDP that stems from new debt — mainly deficit spending — is phony: it is debt-financed consumption, not prosperity," Arnott writes. "Net of deficit spending, our prosperity is nearly unchanged from 1998, 13 years ago."...

While the solution to that problem surely lies in more responsible policy – lower spending, a less ridiculous tax code -- Arnott says it's imperative we start using more meaningful economic statistics, lest politicians miss the message S&P tried to send this week.

If we continue to focus on GDP, while ignoring (and even facilitating) the decay of our Structural GDP and our Private Sector GDP, we'll continue to borrow and spend, mortgaging our nation's future. The worst case result could include the collapse of the purchasing power of the dollar, the demise of the dollar as the world's reserve currency, the dismantling of the middle class, and a flight of global capital away from dollar-based stocks and bonds.


In an interview, Mr. Hosier said the experience had opened his eyes to the disturbing ways of Wall Street.

“Instead of the financial world being the lubricant for business, they are out there manufacturing products with no utility whatsoever except for generating fees,” he said. “Somebody’s got to do something about Wall Street. It is destroying the country.”

5--Chinese recycling and US interest rates, Michael Pettis, China Financial Markets (very wonkish, but very good)

Excerpt: I know the idea that reduced PBoC purchases will lead to higher US interest rates is part of a very widely-held consensus, and so I am reluctant to disagree too quickly, especially when someone as smart as Martin Feldstein makes the case, but I have to say that there is something about this argument that really bothers me. I don’t think a decline in the amount of capital recycled by China, whether through the PBoC or through other institutions, will likely lead to higher US interest rates at all.

The reason I say this is because if we accept this argument, then it seems to me that we are also saying that one way for the US to reduce interest rates is to allow its current account deficit to explode to significantly higher levels. Why? Remember that foreigners don’t fund fiscal deficits. They fund current account deficits, and they do so automatically. As long as the US runs a current account deficit, in other words, it will receive exactly the same amount of net capital inflows as the size of its current account deficit. So if the US current-account deficit doubles, for example, net foreign inflows will double too.

Will that cause US interest rates to decline? Yes, if US borrowing, especially US government borrowing, stays the same. But will it? Probably not. If the US current account surplus rises because of a surge in US investment, then I would argue that the increase in the amount of savings the US imports is matched by an equivalent increase in the need for savings, and so the impact on US rates is likely to be minimal. Of course if soaring US investment (and with it soaring jobs) cause Americans to feel richer and so increase their consumption, interest rates might even rise.

What if the rise in the US current account deficit is caused not by an increase in US investment but rather by a reduction in foreign (e.g. Chinese) consumption, as might have happened in the past decade? In that case the diverting of demand from the US to China should cause a rise in US unemployment and a reduction in US growth. Washington would try to counteract the diverted demand and rising unemployment with an increase in the fiscal deficit, just as it is doing now, or the Fed might try to counteract it by keeping rates low and encouraging a surge in consumer financing, as happened before 2007. Either way US debt levels would surge.

In that case what would happen to US interest rates? If the increase in the fiscal deficit or consumer borrowing was large enough, rates are as likely to rise as to fall. And remember that rising unemployment should reduce the household savings rate, which would counteract to some extent the increased amount of global savings the US is importing through its current account deficit.

I guess this is just a long way of saying that an increase in the US current account deficit can be contractionary for the economy, and if it results in declining interest rates, we should be clear about why. It is not because the US is lucky enough to have eager foreigners lending it money. It is because a rising current account surplus can slow the economy and weak growth is likely to be associated with low interest rates....

So yes, the PBoC, and foreigners more generally, would be buying fewer US government bonds, but the US government would also be issuing fewer government bonds, in which case it is not at all obvious whether US interest rates will rise or not. In fact I don’t think it would make any difference, except to the extent that it impacts US growth. If a consequence of a reduction in China’s current account surplus is much faster US growth, then probably interest rates would indeed rise in the US, but this doesn’t seem like a bad thing at all to me. At any rate whether or not interest rates do indeed rise would depend on Washington’s fiscal and monetary reactions to the growth.

Regular readers of my newsletter might wonder if I am not just making a variation of my old Beijing-is-not-Washington’s-banker argument. In fact I am. The idea that PBoC purchases of US government bonds is part of a discrete lending decision by Beijing, and that Washington must worry that one day Beijing might pull the plug on this lending, is almost utter nonsense. Chinese purchases of US assets are an automatic consequence of the trade balance between the two countries.....

Most of us would assume that a contracting trade deficit is expansionary for the US economy and therefore a good thing. In that case fewer purchases of US dollar assets by the PBoC and other foreigners must also be a good thing because one is simply the obverse of the other.

But it’s not necessarily a good thing. It depends how it happens. If the US trade deficit contracted because soaring US unemployment caused investment to collapse (i.e. faster than nominal savings decline), it would undoubtedly be very painful for the US. But if the US trade deficit contracted because Chinese consumers imported more US goods, I think everyone would be pretty pleased about it, and the interest rate consequences be damned.

6--Farmer: Don't Let Banks Gamble with Taxpayer Money, Economist's View

Excerpt: Current opinion among financial regulators is that the problem of financial instability can be solved by imposing higher capital requirements on banks. But higher capital requirements cannot prevent banks from taking excessive risks. In the 2008 crisis, commercial banks speculated in the US housing market by buying low grade mortgage backed securities that were mistakenly rated as triple A by the US ratings agencies. Somebody was asleep at the wheel.

I am not opposed to financial institutions taking risk. Risk is an integral part of the engine of capitalist growth. But Barclays, and other deposit taking institutions, should not be allowed to gamble with private deposits that are insured by government guarantees. There is a strong case to be made that effective reform requires the complete separation of retail and investment banking. That separation should be accompanied by restrictions on the assets that can be held by any institution that relies on government guarantees. Restrictions of that kind were part of the Glass-Steagal act that led to 60 years of relative economic stability. Dodd-Frank and the Vickers report make significant steps towards restoring the protections of Depression-era legislation. In my view, they do not go far enough.

I am also of the view that higher capital requirements alone -- especially as proposed -- won't be enough to stop bank failures and threats of systemic meltdown. I also don't believe that resolution authority will fully close off one of the main channels through which systemic breakdown occurs, runs on the shadow banking system (Economics of Contempt disagrees, but I think that the uncertainty over whether resolution authority will stop a systemic breakdown will lead to runs on the shadow system at the fist sign of widespread trouble).

7-- Have We Won the Empirical Debate About Economic Policy, Matthew Yglesias, via Economist's View

Excerpt: Yglesias: Pity For The Rich: You can tell something’s happening in the economic policy debate when you start reading more things like AEI’s Arthur Brooks explaining that it would simply be unfair to raise taxes on the rich. Harvard economics professor and former Council of Economics Advisor chairman Greg Mankiw has said the same thing. And of course Representative Paul Ryan is both a fan of Books and a fan of the works of Ayn Rand. Which is just to say that we used to have a debate in which the left said redistributive taxation might be a good idea and then the right replied that it might sound good, but actually the consequences would be bad. Lower taxes on the rich would lead to more growth and faster increase in incomes.

Now that idea seems to be so unsupportable that the talking point is switched. It’s not that higher taxes on our Galtian Overlords would backfire and make us worse off. It’s just that it would be immoral of us to ask them to pay more taxes even if doing so would, in fact, improve overall human welfare.


8-- Fund Giants Take Competing Stands On US Bond Outlook, Wall Street Journal

Excerpt: The 10-year note's yield has already risen to 3.4%, from 2.62% on the day QE2 was announced last November. Thirty-year mortgage rates, which track 10-year note yields closely, have risen to 4.8% from 4.24% last November, doing little to help a struggling housing market.

The direction of interest rates after the Fed ends its bond-buying program is crucial for the economy. The issue will be in sharp focus this week, when Fed policy makers hold a two-day policy meeting, starting Tuesday, to discuss their efforts to steer the economy between the shoals of recession and inflation.

They face an economy that has shown signs of losing momentum in recent months, with first-quarter economic growth now widely believed to be less than 2% annualized.

At the same time, soaring commodity prices have raised inflation alarms. The spread between short-term and long-term interest rates has widened, and demand for inflation-protected securities has picked up, suggesting inflation concern is rising among investors.

The Fed's policy makers this week will likely vow to stick to their plan to end the purchases of Treasurys by the end of June.

But that's where the certainty ends.

One yardstick for the immediate future of Treasury yields after QE2 could be QE1, which included a $1.25 trillion Fed buying spree of mortgage bonds from late 2008 to March 2010.

The mortgage-bond market felt barely a ripple when the Fed stopped buying. Treasurys, some observers reason, may follow the same path.

Treasury yields "moved up significantly at the onset of QE1 but then fell precipitously when it ended," Mr. Rieder says. "So it's not a given that Treasury yields will rise this time either."

The New York Fed, which operates the QE2 program, declined to comment.

What worries some is that the Fed has been buying almost all of the Treasurys the government has been issuing on a regular basis.

So far the Fed has bought $548 billion worth of Treasurys under QE2, according to a Barclays Capital tally, with maturities ranging from 1 1/2 to 30 years, and inflation-protected securities as well. The buying has made up more than 85% of the net $638 billion of bonds the government sold between November and March.

9--Commodities May Swing as Fed Steps Aside, Wall Street Journal

Excerpt: One of the biggest impacts of the end of the Federal Reserve's bond-buying program may be felt in the commodities markets, where the injection of liquidity has helped send prices of metals, grains and energy to multiyear highs....

As the Fed prepares to end its $600 billion bond-buying program, known as quantitative easing, or QE2, some money managers are preparing their own withdrawal....

Commodities under management, including mutual funds and exchange-traded funds, have seen a record inflow of $48.8 billion since the Fed's QE2 announcement last August, with total managed assets in commodities hitting $412 billion by the end of March, according to Barclays Capital.

Given how profitable and crowded the markets are, "once the liquidation begins, you don't know how far it will run," he said.

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