Tuesday, May 31, 2011

Today's links

1-- Against Learned Helplessness, Paul Krugman, New York Times via Economist's View

Excerpt: Unemployment is a terrible scourge across much of the Western world. Almost 14 million Americans are jobless, and millions more are stuck with part-time work or jobs that fail to use their skills. ... Nor is the situation showing rapid improvement. This is a continuing tragedy, and in a rational world bringing an end to this tragedy would be our top economic priority.

Yet ... on both sides of the Atlantic a consensus has emerged among movers and shakers that nothing can or should be done about jobs. Instead..., one sees a proliferation of excuses for inaction, garbed in the language of wisdom and responsibility. ...

There’s nothing wrong with our workers — remember, just four years ago the unemployment rate was below 5 percent. The core of our economic problem is, instead, the debt — mainly mortgage debt — that households ran up during the bubble years... Now that the bubble has burst, that debt is acting as a persistent drag on the economy, preventing any real recovery in employment. And once you realize that the overhang of private debt is the problem, you realize that there are a number of things that could be done about it.

For example, we could have W.P.A.-type programs putting the unemployed to work doing useful things like repairing roads — which would also, by raising incomes, make it easier for households to pay down debt. We could have a serious program of mortgage modification, reducing the debts of troubled homeowners. We could try to get inflation back up to the 4 percent rate that prevailed during Ronald Reagan’s second term, which would help to reduce the real burden of debt. ..

2--The Truth About the American Economy, Robert Reich's blog

Excerpt: The U.S. economy continues to stagnate. It’s growing at the rate of 1.8 percent, which is barely growing at all. Consumer spending is down.

It’s vital that we understand the truth about the American economy....During three decades from 1947 to 1977, the nation implemented what might be called a basic bargain with American workers. Employers paid them enough to buy what they produced. Mass production and mass consumption proved perfect complements. Almost everyone who wanted a job could find one with good wages, or at least wages that were trending upward.

During these three decades everyone’s wages grew — not just those at or near the top.

Government enforced the basic bargain in several ways. It used Keynesian policy to achieve nearly full employment. It gave ordinary workers more bargaining power. It provided social insurance. And it expanded public investment. Consequently, the portion of total income that went to the middle class grew while the portion going to the top declined. But this was no zero-sum game. As the economy grew almost everyone came out ahead, including those at the top.

3--What Manuel Zelaya's return means for Honduras, Mark Weisbrot, Guardian

Excerpt: Former Honduran President Zelaya's return home Saturday has important implications for the western hemisphere that, we can predict, will be widely overlooked. Zelaya was ousted from the presidency when he was kidnapped at gunpoint by the military on 28 June 2009. Although no hard evidence has yet emerged that the US government was directly involved in his overthrow, the Obama administration did everything it could to help the coup government to survive and then legitimate itself through elections that most of the rest of the hemisphere, and the world, rejected as neither free nor fair.

Zelaya's return represents a partial reversal of that coup d'etat and Washington's efforts to consolidate it, just as President Aristide's return to Haiti after seven years in exile, on 18 March – despite furious efforts by the Obama administration, and even President Obama himself, to prevent it – is a partial reversal of the 2004 US-organised coup that overthrew the democratically elected government of Haiti. And it is another demonstration of how the western hemisphere has changed: the agreement for Zelaya's return was mediated through the governments of Venezuela and Colombia, with no US involvement or even lip-service support until it was over....

The Obama administration lost a lot of trust throughout the hemisphere as a result of its support for the Honduran coup government, and so it was not surprising that US Secretary of State Hillary Clinton was smart enough to endorse the Cartagena agreement (for Zelaya's return) after it was signed. She had been lobbying, without success for the past year and a half, to get Honduras admitted back into the Organisation of American States, from which it was kicked out after the coup. It is assumed that this new accord will pave the way for Honduras' readmission, so she can spin it as a victory for Washington. But it clearly is not.

The agreement met some of the demands of President Zelaya and his allies, but not others. It allows for the participation of the National Front for Popular Resistance, which struggled against the coup and subsequent repression, as a legal political party. It also states that people can organise plebiscites of the kind that Zelaya was overthrown for organising. And it has guarantees for the safety and security not only of Zelaya, but also of others who fled after the coup and remain in exile; it also contains certain non-enforceable human rights guarantees....

On the positive side, it is good to see Latin American countries taking control of the mediation, with Washington relegated to the sidelines. The biggest mistake they made after the coup was to allow Hillary Clinton, along with Oscar Arias of Costa Rica, to hijack the mediation process. Clinton's goal was the exact opposite of restoring democracy in Honduras, and she succeeded. There will be many struggles ahead for the Honduran pro-democracy movement, and they will need a great deal of solidarity and help from outside, especially in opposing the repression. But this accord is, at least, a step in the right direction.

4--What happens when the government tightens its belt, Naked Capitalism

Excerpt: Spending equals income. Someone has to spend for incomes to exist. For incomes to grow there has to be growth in spending. There are three sources of spending growth in a macroeconomy – the external sector (if net exports are positive); the private domestic sector; and the government sector (if the budget is in deficit).

That is indisputable. Economic growth is defined in terms of production and production only occurs if there are goods and services being purchased. Firms do not produce to hold inventory. Firms may invest in response to their guesses about future sales. These guesses will be heavily influenced by current consumer actions.

So when you get commentators and high-level monetary officials arguing that growth comes from not spending you have to ask why anyone would listen to their views and why they are paid to express them. I don’t mind bloggers who do it for free saying what they like but when highly-paid and highly-visible express views that are not grounded in any economic theory that is comprehensible but nonetheless seek to influence the policy debate then I get angry.

5--Number of the Week: Glut of Vacant Homes Complicates Recovery, Wall Street Journal

Excerpt: 14.3 million: The number of homes vacant year-round as of the end of March 2011

How long will the housing market take to hit bottom? A lot depends on whether people will want to occupy millions of empty homes.

Five years after the housing bust began, the market is still groaning under the weight of a near-record 14.3 million vacant residences. That’s about 3 million more than what was normal before the bust — a glut that could take more than 13 years to eradicate, given the depressed rate at which Americans have been starting new households and assuming construction of new homes remains at April’s low annualized level of only 551,000.

With so many homes waiting to be occupied, it’s hard to imagine how prices nationwide could recover anytime soon (though, of course, the experience of individual local markets can differ). The only hope, and a perverse one, is that many of those homes are actually phantom inventory — built in such awful locations, or in such disrepair, that nobody will want to live in them. Such an outcome could precipitate heavier losses for the people or banks that own the homes, but it could also mean a quicker recovery for the market as a whole.

Even if a big chunk of the U.S. housing stock can be written off, though, that might not be enough to generate a rebound in house prices. The bust has eroded many peoples’ faith in housing as an investment, mortgage loans are harder to get, and the millions of families still in or near the foreclosure process typically won’t be in a position to buy. As more people choose or have no choice but to rent, the U.S. homeownership rate is heading down. As of the end of March, it stood at 66.5%, the lowest point since 1998.

6--Australian Professor Steve Keen explains why private sector debt dynamics drove both the Great Depression and the Great Recession, Credit Writedowns (must watch video...short)

7--Economic Soft Patch Creates Political Problems, Wall Street Journal

Excerpt: Washington politicians are discovering what has been evident to consumers and economy watchers. The U.S. economy is barely growing, and hiring isn’t strong enough to bring down the jobless rate.

If energy prices recede and job growth beats current expectations, the recovery could rev up on its own in the second half. Washington decision-makers don’t appear to want to take that gamble. But they will be caught between a rock and a hard place. Do they keep past promises to reduce government’s role or step in to jumpstart growth?....

The economy is losing momentum. Jobless claims have been above 400,000 mark for seven weeks. Pending home sales — a measure of future home buying — plunged 11.6% in April. And consumers have had to shift more of their money to buying gasoline and food, leaving other spending barely rising.

Yet politicians have to square current talk of more government help with their past comments about the need to cut government spending....

But U.S. businesses are awash in money. They booked a record level of profits in the first quarter – -and layoffs are rising this quarter. Moreover, in the short run, less revenue worsens the deficit — the same issue the GOP has been railing against for more than a year.

One help to growth would be a weaker dollar, which would make U.S. goods more competitive on global markets.

U.S. exports added more than one percentage point to gross domestic product growth last quarter — only to be swamped by a larger gain in imports. If exports can outpace imports, they would boost growth as well as increase job gains.

Congressional leaders and the Treasury secretary, however, continue to recite the mantra that a strong dollar is in the best interest of the U.S. — even if the foreign-exchange markets don’t see fundamentals supporting a stronger currency.

Politicians will have to choose: keep up the current rhetoric about deficit cutting now and letting markets work. Or admit that if the recovery remains tepid, government intervention is needed.

8--More Effects of Austerity in the UK, The Streetlight blog

Excerpt: The outlook for the UK in the midst of its austerity program looks worse and worse. From the FT this morning:

Why the British economy is in very deep trouble

Here’s something for the Chancellor and the Office for Budget Responsibility (OBR) to chew on: a warning from Dr Tim Morgan, the global head of research at Tullett Prebon, that the deficit reduction plan won’t work and the UK is headed for a debt disaster.

Morgan says sectors that account for nearly 60 per cent of UK economic output are critically dependent on debt (public or private) and set to contract rather than expand. This will render economic growth implausible and means the burden of public and private debt will prove too heavy for the nation to carry:

Over the past decade, the British economy has been critically dependent on private borrowing and public spending. Now that these drivers have disappeared – private borrowing has evaporated, and the era of massive public spending expansion is over – the outlook for growth is exceptionally bleak.

Sectors which depend upon either private borrowing or public spending now account for at least 58% of economic output. These sectors are now set to contract rather than expand, which renders aggregate economic growth implausible. And, without growth, there may be no way of avoiding a debt disaster.

...Short of almost unthinkably drastic restructuring, there may be no way out of Britain’s low-growth, high-debt trap.

9--Recession Forecasts? Yield Curve Says No Way, Caroline Baum, Bloomberg

Excerpt: ...the yield curve, is saying there will be no recession anytime soon.

With the Federal Reserve’s benchmark rate at zero to 0.25 percent and the 10-year Treasury note yielding 3.06 percent, the spread between the two interest rates is among the widest in history. It’s the reverse configuration, an inverted yield curve with short rates above long rates, that augurs recession.

The spread -- or the "term structure of interest rates," as it’s known in academic circles -- isn’t some mystical talisman with omniscient powers. It derives its prognosticating ability from the simple fact that one rate is artificially pegged by the central bank while the other is determined by the market. Their relationship encapsulates the stance of monetary policy.

When the yield curve is steep, as it is now, it’s an inducement for banks to expand their balance sheets -- borrow short, lend long -- and increase the money supply. That bank credit isn’t growing now owes more to the hangover from a period of excess leverage and new-found religion on lending standards than any restrictive policy on the part of the Fed.....

The time to worry about recession is when the Fed raises the funds rate to the point where the yield curve inverts. Within a year or two, it’s curtains for the economy.

10--The Economy Is Wavering. Does Washington Notice?, New York Times

Excerpt: The latest economic numbers have not been good. Jobless claims rose last week, the Labor Department said on Thursday. Another report showed that economic growth at the start of the year was no faster than the Commerce Department initially reported — “a real surprise,” said Ian Shepherdson of High Frequency Economics.

Perhaps the most worrisome number was the one Macroeconomic Advisers released on Wednesday. That firm tries to estimate the growth rate of the current quarter in real time, and it now says annualized second-quarter growth is running at only 2.8 percent, up from 1.8 percent in the first quarter. Not so long ago, the firm’s economists thought second-quarter growth would be almost 4 percent.

An economy that is growing this slowly will not add jobs quickly. For the next couple of months, employment growth could slow from about 230,000 recently to something like 150,000 jobs a month, only slightly faster than normal population growth. That is certainly not fast enough to make a big dent in the still huge number of unemployed people.

Are any policy makers paying attention?...

The most sensible response for Washington would be to begin thinking more seriously about taking out an insurance policy on the recovery. The Fed could stop worrying so much about inflation, which remains historically low, and look at how else it might encourage spending. As Mr. Bernanke has said before, the Fed “retains considerable power” to lift growth.

The White House and Congress, meanwhile, could begin talking about extending last year’s temporary extension of business tax credits, household tax cuts and jobless benefits beyond Dec. 31. It would be easy enough to pair such an extension with longer-term deficit reduction.

11--More confirmation of a slowdown, Comstock Partners, Pragmatic Capitalism

Excerpt: Our comment of two weeks ago outlined the major headwinds likely to impact both the economy and stock market over the period ahead, while last week’s comment discussed the actual economic slowdown that was already happening. Events of the past week have confirmed these views.

The Chicago Fed’s National Activity Index of 85 coincident indicators for April dropped to minus 0.45, its lowest level since last August. The index has now been below zero for five of the last eight months, as is the three-month moving average. This means that the economy was probably growing below trend in the first quarter, and possibly the second as well.

First quarter revised GDP growth was not revised upward as the consensus expected, but remained at the originally reported 1.8%. Moreover the underlying data deteriorated as consumer spending growth was revised down to 2.2% from 2.7% and inventory accumulation was revised up by $9 billion. Furthermore, major firms have been reducing their second quarter GDP growth estimates to well below 3%. Recall that toward the end of 2010 most pundits were looking for 4% growth in the quarters ahead.

Initial weekly unemployment claims, reported today, rose to 424,000 and have now remained well above 400,000 for the seventh straight week after a period of coming in below that level. This does not bode well for upcoming monthly payroll employment.

The ECRI Weekly Leading Index was down again last week, the fourth decline in the last six weeks, and the lowest since the week of January 15th. A slowdown in this indicator generally suggests a period of tepid growth in the period ahead.

The May numbers for both the Richmond and Kansas City Fed indexes fell sharply, confirming the previously reported results for the Philly Fed and the Empire State Manufacturing Survey. This strong unanimity strongly suggests that industrial production is still extremely sluggish in May. These results are consistent with the April decline in core capital goods orders of 2.6%. Similarly, shipments dropped 1.7%.

Keep in mind that this has happened during a period during which QE2 poured reserves into the financial system, the stock market rallied and fiscal policy was boosted by the reduction in payroll withholding. With all of that we have an economy that is growing below trend and fading rapidly. Now QE2 is ending within weeks, fiscal policy is about to tighten and housing prices are still falling with lots of additional supply still coming.

The stock market has now stalled for over three months and appears to be in the process making a top.

12--Roubini Sees Stock-Correction ‘Tipping Point’, Bloomberg

Excerpt: Nouriel Roubini, the economist who predicted the global financial crisis, said stock markets are at the “tipping point” of a correction as economic growth may begin to slow...

“Until two weeks ago I’d say markets were shrugging off all these concerns, saying they don’t matter because they were believing the global economic recovery was on track,” Roubini said. “But I think right now we’re on the tipping point of a market correction. Data from the U.S., from Europe, from Japan, from China are suggesting an economic slowdown.”

The world economy is losing strength halfway through the year as high oil prices and fallout from Japan’s natural disaster and Europe’s debt woes take their toll....

“Until now, equity prices were supported by better-than- expected earnings, sales and profit margins,” Roubini said. “But all three are under squeeze. With slow global economic growth, they’re going to surprise on the downside. We’re going to see the beginning of a correction that’s going to increase volatility and that’s going to increase risk aversion.”

13--Send In The Cranks, Paul Krugman, New York Times

Excerpt: ... let’s also note that we’ve had a strong test of monetary doctrines these past three years, and the inflation worriers have been proved overwhelmingly wrong. Yes, they’ve seized on the rise in commodity prices since last summer; but they have yet to find any signs of domestic inflation, as opposed to movements in prices determined on world markets and strongly driven by China and other emerging markets.

Look, very early on I tried to explain that “printing money” — what people who say that really mean is increases in the monetary base, which includes bank reserves as well as currency — doesn’t cause inflation, or even a rise in broader definitions of the money supply, when you’re in a liquidity trap. And I illustrated the point with historical examples. Here’s Japan: ("must see" chart)

And I predicted that we’d see the same kind of result — huge increases in the monetary base not translating into rises either in broader money or in prices — this time around. And sure enough:...

So we have the whole Republican party jumping on to a doctrine that has not only been wrong historically, but has been wrong in the very recent past.

14--Greek, Irish Risks Transferred to ECB, The Big Picture

Excerpt: Speigel has an interesting discussion on the Euro:

Since the beginning of the financial crisis, banks in countries like Ireland, Portugal, Spain and Greece have unloaded risks amounting to several hundred billion euros with central banks. The central banks have distributed large sums to their countries’ financial institutions to prevent them from collapsing. They have accepted securities as collateral, many of which are — to put it mildly — not particularly valuable.

Risks Transferred to ECB: These risks are now on the ECB’s books because the central banks of the euro countries are not autonomous but, rather, part of the ECB system. When banks in Ireland go bankrupt and their securities aren’t worth enough, the euro countries must collectively account for the loss. Germany’s central bank, the Bundesbank, provides 27 percent of the ECB’s capital, which means that it would have to pay for more than a quarter of all losses. (charts)

15--Bush-Era Tax Cuts Projected As Largest Contributor To Public Debt [CHART], Huffington Post

Excerpt: If the Bush-era tax cuts are renewed next year, that policy will by 2019 be the single largest contributor to the nation's public debt -- "the sum of annual budget deficits, minus annual surpluses" -- according to new analysis from the non-partisan Center for Budget and Policy Priorities.

These tax breaks, combined with the cost of fighting wars in Iraq and Afghanistan, will account for nearly half the public debt in 2019, measured as a percentage of economic output, the CBPP's analysis shows. Even the cost of the economic downturn, combined with the cost of the legislation passed to stem the damage, won't be as burdensome as the weight of the Bush-era tax cuts, the chart below suggests. See if you can find the debt associated with the Trouble Asset Relief Program and the rescue of Fannie and Freddie:...("eye popping" chart)

Tax cuts for the highest earners were renewed late last year, as part of a deal that extended tax breaks for middle earners and reauthorized unemployment insurance. In an April speech, President Barack Obama laid out a plan to reduce the nation's deficit and debt, suggesting that he would strive to make sure the tax cuts for the highest earners expire naturally in 2012.

If tax cuts do expire as scheduled, that would win significant debt relief for the government, CBPP says:

[S]imply letting the Bush tax cuts expire on schedule (or paying for any portions that policymakers decide to extend) would stabilize the debt-to-GDP ratio for the next decade. While we'd have to do much more to keep the debt stable over the longer run, that would be a huge accomplishment.

Friday, May 27, 2011

Weekend links

1--CBO Says Stimulus Boosted Growth, Will Add More to Deficit, Wall Street Journal

Excerpt: The economic stimulus package passed by Congress in 2009 raised gross domestic product, created jobs and helped lower the country’s unemployment rate this year, but also increased budget deficits by $830 billion over a 10-year span, the Congressional Budget Office said Wednesday.

The Obama administration and Congressional Democrats said the American Recovery and Reinvestment Act, passed while the U.S. struggled to emerge from a severe recession, would save or create 3.5 million jobs while cutting taxes, investing in roads, bridges and other infrastructure, extending unemployment benefits and expanding aid to states....

The CBO report out Wednesday said the plan increased the number of people employed by between 1.2 million and 3.3 million, and lowered the unemployment rate by between 0.6 and 1.8 percentage points in the first quarter of 2011.

The stimulus package also raised gross domestic product, the broadest measure of economic output, by between 1.1% and 3.1% in the same period....

The stimulus package had its biggest impact in 2010, boosting GDP by as much as 4.6% in the second quarter of that year, while increasing employment by 1.4 million to 3.6 million in the third quarter, the CBO said.

By 2012 the act’s impact will be small, the CBO said.

2--Factories’ Breather Will Resonate Through Economy, Wall Street Journal

Excerpt: Recent data point to a slowdown in the once-robust factory sector. A slowdown in goods production virtually guarantees a soft patch for overall U.S. economic growth.

The latest weak note came from Wednesday’s report on durable goods. New orders fell a larger-than-expected 3.6% in April and shipments were down 1.0%.

Some of the weakness in the report reflected auto-plant shutdowns because vehicle makers can’t get parts from Japan. But the April drop was evident in other sectors. Of great concern was the 2.6% drop in new bookings for nondefense capital goods excluding aircraft. These orders are considered a leading indicator for business investment in equipment. Their flat trend so far this year suggests businesses may be holding back on new capital projects.

Manufacturing has powered the U.S. recovery. In 2010, the sector’s value added — a measure of an industry’s contribution to gross domestic product — rose 5.8%, after declining in the two previous years.

The poor news on durable goods followed reports of a drop in U.S. industrial production in April and disappointing reports on May regional factory activity from the Federal Reserve Banks of New York, Philadelphia and Richmond.

After seeing the durable goods report, forecasters at Macroeconomic Advisers lowered their estimate of second-quarter GDP growth to 2.8%, from 3.2% previously. They pointed to the a 1.7% drop in shipments of nondefense nonaircraft capital goods as well as a less-than-expected rise in inventories.

3--ECB's Balance Sheet Contains Massive Risks, Spiegel

Excerpt: Former Bundesbank President Axel Weber criticized the ECB's program of purchasing government bonds issued by ailing euro member states. In the event of a bankruptcy or even a deferred payment, the ECB would be directly affected.

But even greater risks lurk in the accounts of commercial banks. The ECB accepted so-called asset-backed securities (ABS) as collateral. At the beginning of the year, these securities amounted to €480 billion. It was precisely such asset-backed securities that once triggered the real estate crisis in the United States. Now they are weighing on the mood and the balance sheet at the ECB.

No expert can say how the ECB can jettison these securities without dealing a fatal blow to the European banking system. The ECB is in a no-win situation now that it has become an enormous bad bank or, in other words, a dumping ground for bad loans, including ones from Ireland....

The ECB stresses that the securities will only have to be realized if the banks actually declare bankruptcy. But as the drama in Ireland shows, the central banks are walking a very fine line. By applying a great deal of pressure, ECB President Trichet made sure that the Europeans came to the Irish government's aid so that Ireland was able to protect its banks from collapse. This spared the central bank the embarrassment of having to realize the precarious instruments among its asset-backed securities, which are based on real estate loans in County Longford and elsewhere.

But if the euro crisis rumbles on, the worst-case scenario isn't all that far away. To ensure its national survival, Ireland should reject the European rescue effort and, instead, accept the failure of its banks as a necessary evil, Morgan Kelly recently said. The renowned professor of economics at University College Dublin knows who would be especially hard-hit by such a step: the ECB. "The ECB can then learn the basic economic truth that if you lend €160 billion to insolvent banks backed by an insolvent state, you are no longer a creditor: you are the owner" Kelly wrote in the Irish Times earlier this month.

4--Eurozone: Frankfurt’s dilemma, Financial Times via Automatic Earth

Excerpt: “Events in Greece have brought the euro area to a crossroads: the future character of European monetary union will be determined by the way in which this situation is handled.”

Jens Weidmann, Bundesbank president and European Central Bank governing council member, Hamburg, May 20.

By rights, the ECB could have abandoned Greece long ago. Nothing in the rule book says it must prop up countries at risk of economic collapse. If anything, the architects of the monetary union, launched in 1999, envisaged the opposite. Because members would share a currency but not spending and tax policies, governments were meant to take responsibility for their own finances – the “no bail-out” principle was enshrined in a European Union treaty. Logically, a nation that flouted the rules as recklessly as Greece should be left to its fate.

Faced in recent weeks, however, with the renewed fears of a Greek default, the ECB has balked. With increasing vehemence, the euro’s monetary guardian has warned of catastrophic effects across the 17-country currency union. Jean-Claude Trichet, ECB president – with less than six months before his eight-year term expires – has refused to discuss any debt restructuring for the nation, storming out of a meeting of eurozone finance ministers in Luxembourg this month when it was raised.

His colleagues, including Mr Weidmann of the Bundesbank, have raised the stakes. They warn that if politicians take even a modest step towards a restructuring, the ECB will cut Greek banks off from its lifesaving liquidity supply, triggering a financial collapse that would push the country’s economy into the abyss. It is the central bank equivalent of nuclear deterrence: defy us and we will blow up the world. How the ECB responds to the conflicting pressures created by the Greek crisis matters enormously.

Shunned by financial markets, the country’s banks survive only because the Frankfurt-based central bank meets in full their demands for liquidity against collateral of rapidly declining quality. Early next month, the ECB has to decide whether to continue that eurozone-wide “unlimited liquidity” policy; so far it has said it will last only until early July. The bank also owns about €45bn of Greek government bonds, acquired during the past year as part of efforts to calm financial market tensions.....

Should Greece default, the value of those holdings would decline sharply. The ECB bought the bonds at market prices, which assumed some risk of default, so the immediate losses might be manageable. JPMorganChase calculates that, with €81bn in capital and reserves, eurozone central banks could withstand even a 50 per cent “haircut”, or discount, on Greek bonds. But if write?downs on Portuguese and Irish bonds followed, eurozone governments might be forced to provide billions of euros to rebuild the ECB’s balance sheet.

According to one view, the ECB has been caught by the consequences of actions it took a year ago. “They are basically trapped. They are now like many people in the banking system in calling out for no debt repudiation because they are so exposed,” says Charles Wyplosz of the Graduate Institute in Geneva.

5--Prepare for the "false growth" scare, Pragmatic Capitalism

Excerpt: “We believe that we are going to see more signs of weaker activity from different indicators in the coming months. For example, the US ISM manufacturing index is expected to decline in coming months as indicated by the Philadelphia Fed survey. Declines in PMI in other countries such as Euro Flash PMI for May point to a slowing global industrial cycle, which should become visible in the US as well.

Supporting the case for a stronger decline in the ISM manufacturing index is also that hard data have been much weaker than suggested by the ISM index. Firstly, GDP growth was actually below trend in Q1 rising 1.8% q/q annualised. Last time there was such a large divergence between GDP growth and ISM was in 2004 and subsequently we saw a quite fast decline in the ISM index (see chart on page 1). Secondly, industrial production has already slowed. The three-month annualised growth rate was only 1.8% in April, down from the strong levels in mid 2010 of 9.5%.

We believe this may contribute to another “false” growth scare as we have seen quite a few times, when ISM goes down fairly rapidly. At the same time, though, we look for US GDP growth to recover slowly already from Q2 and especially in H2 to a pace of 3.5-4% AR. This will very much mirror what we saw in early 2005 when ISM continued lower coming from a “too high” level relative to hard data while at the same time GDP growth stayed around 3% growth. The growth scare may be heightened by the ongoing budget discussions culminating in late July as we approach the deadline for a raise of the debt limit. This will put focus on the significant tightening of fiscal policy in 2012 and 2013.

As growth recovers and ISM stabilises during autumn, the growth scare should fade again, though, and we may see some relief that growth has not derailed after all.”

Ultimately, they see three primary factors continuing to power the economy higher – declining oil prices, improving jobs and improving credit trends

6--The fiscal stimulus merely offset the Contractionary effect emanating from the state and local government spending cuts, Econbrowser

Excerpt: This is particularly important to recall, in this time of fears of debt accumulation, that much of the accumulation of debt as a share of GDP occurs because of Bush era fiscal policies and the economic downturn, as highlighted by the CBPP: (chart)

One can see that a large chunk of the debt accumulation is attributable to the 2001 and 2003 tax cuts. The economic downturn is another key contributor.

As Aizenman and Pasricha observed, the fiscal stimulus merely offset the Contractionary effect emanating from the state and local government spending cuts and tax increases. The proposals to cut spending out of the next fiscal year’s budget, without addressing out-year spending and revenue, will merely increase the dark blue component ("economic downturn") in the above graph.

The WSJ economists (not a notably liberal group, when it comes to economics) also do not appear to be strong adherents of the "expansionary fiscal contraction" view (see my views here and here). In the March survey, the response to the question "Will cutting the federal budget by an annualized $100 billion this year help or hurt economic growth over the next two years?", was roughly 50-50. My favorite quote was "Claims that cuts are stimulative in the short run are nonsense." I think we should take this comment to heart, as we wonder if oil prices and other shocks might push us below "stall speed".

7--The War on Inflation, Tim Duy, Fed Watch

Excerpt: That said, it is worth considering that even the Fed doves probably have something of an itchy trigger finger when it comes to tightening. They are willing to stay the course given the lack of pass-through to wages, but one could imagine that changing quickly with the slightest whiff of rising unit labor costs. Which brings to mind an interesting topic. Way back in 2009, spencer at Angry Bear noted that labor payments as a share of output have been falling since the early 1980’s. Can this situation ever be reversed if the Fed steps on the brakes every time workers get a little too confident for their own good?

Mark concludes his review of the Madigan piece with:

We are much too worried about a wage-price inflation cycle breaking out and causing problems. If the Fed is too trigger happy, it could snuff out the recovery it is hoping to bring about.

The Fed is much, much better at slowing the economy down than it is at speeding it up. Thus, if the Feds is going to make an error, it should be biased toward the error it can fix the easiest. That is, in the face of uncertainty the Fed should be biased toward policy that is too loose rather than policy that is too tight -- a policy that is too loose is easier to correct if it's wrong. Unfortunately, I don't think the Fed sees it this way.

No, the Fed doesn’t see it this way. I think I know exactly how the Fed would respond to Mark: You think the 1980’s were easy? The expansion of the balance sheet has given rise to too many fears of the 1970’s within the Fed, and those fears will drive the Fed to try to stay far ahead of the inflation curve. That argues for a premature tightening. This year? Still seems difficult to imagine given the state of the economy. But next year seems reasonable, as further strengthening of the labor market will enhance fears that inflationary wage gains are just around the corner.

8--Poor Americans lose faith in capitalism says survey, The Big Picture

Excerpt: Via the The Economist, consider the chart below covering faith in the free markets. It is at present at a low in the US, the world’s biggest free-market economy:

In 2010, 59% of Americans asked by GlobeScan, a polling firm, agreed “strongly” or “somewhat” that the free market was the best system for the world’s future. This has fallen sharply from 80% when the question was first asked in 2002. And among poorer Americans under $20,000, faith in capitalism fell from 76% to 44% in just one year. Of the 25 countries polled, support for the free market is now greatest in Germany, just ahead of Brazil and communist China, both of which have seen strong growth in recent years. Indians are less enthusiastic despite recent gains in growth. Italy shows a surprising fondness for markets for a place that is uncompetitive in many sectors. France under a third of people believe that the free market is the best option, down from 42% in 2002.

9--With friends at the Fed, you'll never go broke; Goldman edition, Businessweek

Excerpt: “This was a pure subsidy,” said Robert A. Eisenbeis, former head of research at the Federal Reserve Bank of Atlanta and now chief monetary economist at Sarasota, Florida-based Cumberland Advisors Inc. “The Fed hasn’t been forthcoming with disclosures overall. Why should this be any different?”

Congress overlooked ST OMO when lawmakers required the central bank to publish its emergency lending data last year under the Dodd-Frank law.

“I wasn’t aware of this program until now,” said U.S. Representative Barney Frank, the Massachusetts Democrat who chaired the House Financial Services Committee in 2008 and co- authored the legislation overhauling financial regulation. The law does require the Fed to release details of any open-market operations undertaken after July 2010, after a two-year lag.

Records of the 2008 lending, released in March under court orders, show how the central bank adapted an existing tool for adjusting the U.S. money supply into an emergency source of cash. Zurich-based Credit Suisse borrowed as much as $45 billion, according to bar graphs that appear on 27 of 29,000 pages the central bank provided to media organizations that sued the Fed Board of Governors for public disclosure.

New York-based Goldman Sachs’s borrowing peaked at about $30 billion, the records show, as did the program’s loans to RBS, based in Edinburgh. Deutsche Bank AG, Barclays Plc and UBS AG each borrowed at least $15 billion, according to the graphs, which reflect deals made by 12 of the 20 eligible banks during the last four months of 2008.....

Goldman Sachs, led by Chief Executive Officer Lloyd C. Blankfein, tapped the program most in December 2008, when data on the New York Fed website show the loans were least expensive. The lowest winning bid at an ST OMO auction declined to 0.01 percent on Dec. 30, 2008, New York Fed data show. At the time, the rate charged at the discount window was 0.5 percent.

More on Goldman:

As its ST OMO loans peaked in December 2008, Goldman Sachs’s borrowing
from other Fed facilities topped out at $43.5 billion, the 15th highest
peak of all banks assisted by the Fed, according to data compiled by
Bloomberg. That month, the bank’s Fixed Income, Currencies and
Commodities trading unit lost $320 million, according to a May 6, 2009,
regulatory filing.

10--The DOL reports on weekly unemployment insurance claims, Calculated Risk

Excerpt: In the week ending May 21, the advance figure for seasonally adjusted initial claims was 424,000, an increase of 10,000 from the previous week's revised figure of 414,000. The 4-week moving average was 438,500, a decrease of 1,750 from the previous week's revised average of 440,250....

The 4-week average is back to the level of last November when there were fewer payroll jobs being added each month - and that is very concerning.

11--Looking for debt, Michael Pettis, China Financial Markets

Excerpt: Loan growth

Also in the same edition of Caixing is an article on total banking assets:

As of 2010, the total assets of China’s banking industry have grown to 2.39 times the amount of national GDP, breaking records once again at nearly 100 trillion yuan. In comparison, according to OECD data, Japan’s banking assets in 2008 stood at US$ 9.81 trillion, 2.27 times the amount of its GDP, which was US$ 4.32 trillion. Germany, another country representative of economies that rely on banks for financing, had 6.6 trillion euros for banking assets and 2.48 trillion euros for GDP in 2008. Its 2008 banking-assets versus GDP ratio was 2.66, almost the same as it had been in previous years.

The surge in China’s banking assets, which took off in 2009, was attributed to political directives rather than monetary policies. In 2009, huge amounts of loans were made at the order of government. The central bank did not cut interest rates; in fact, it conducted a net absorption of liquidity from the market through its open market operations. Meanwhile, the market capitalization of domestic stock exchanges more than doubled from a year earlier, an indication of too much capital flowing around.

I guess I don’t need to comment much beyond what Caixing says. I have many times argued that historically one of the key indicators that the high-growth investment-driven model has reached its limits as a wealth creator (i.e. is no longer allocating capital efficiently) is when we see an unsustainable increase in debt. Of course whether or not we have reached this point is still much debated, but I would argue that we started to see this at least five years ago. The surge in banking assets doesn’t give much comfort....

The 2011Q1 monetary policy report reiterates that controlling inflation remains the PBoC’s top priority, and it will continue to raise interest rates and reserve requirements when necessary. It is unusual for the central bank to address its policy targets in such a straightforward fashion, which led to concerns in the market about more tightening measures.

The report also revealed that actual lending rates are much higher than the minimum levels set by the PBoC. The weighted-average lending rate was 6.91% in March (72bps higher than at the end of last year) while the 1-year benchmark lending rate was only raised by 50bps from the end of last year. In March, 56% of new bank loans were lent out at a premium to benchmark rates and only 14% of new loans went lent out at a discount. Last year only 40% of these loans were lent at a premium while nearly 30% were lent at a discount to benchmark interest rates. The major causes of this change are the recent property regulation measures and tighter credit quotas.

An unsustainable rise in debt is, for me, one of the key indicators that the investment-driven model has passed its useful life and is generating negative growth while posting positive growth numbers. This is why I spend so much time trying to understand debt levels and the structure of balance sheets. I plan to discuss this a lot more in my next blog entry.

12--High Unemployment 'Most Pressing Legacy' of Financial Crisis, Report Says, New York Times

Excerpt: The world economy is moving into a self-sustaining recovery, but high unemployment remains a threat three years after the financial crisis, a prominent economic research organization said Wednesday.

“The global recovery is getting stronger, more broad-based, more self-sustained,” Pier Carlo Padoan, the chief economist at the Organization for Economic Cooperation and Development, said.

“The private sector is driving growth,” he added, “especially through a pick-up in trade,” while at the same time, support through government spending programs “is being withdrawn slowly.”....

Still, it noted, “high unemployment remains among the most pressing legacies of the crisis,” and that “should prompt countries to improve labor market policies that boost job creation and prevent today’s high joblessness from becoming permanent.”

Unemployment, which affects more than 50 million people in the O.E.C.D. area, is an important political consideration, as evidenced by recent demonstrations in Spain, which, with more than 20 percent of the population out of work, has the highest jobless rate in the European Union.

The O.E.C.D. called on governments to provide appropriate employment services and training programs and to encourage temporary work, while considering employment tax cuts and workshare arrangements.

13--Durable goods orders: more evidence of near-term weakness in the US economy, Angry Bear

Excerpt: They keep calling it a 'soft patch' in my business; but when's the data going to show otherwise? This soft patch is persistent, and durable goods orders confirm it into Q2 2011.....

New orders for manufactured durable goods in April decreased $7.1 billion or 3.6 percent to $189.9 billion, the U.S. Census Bureau announced today. This decrease, down two of the last three months, followed a 4.4 percent March increase. Excluding transportation, new orders decreased 1.5 percent. Excluding defense, new orders decreased 3.6 percent.

We know that the auto industrial production print was influenced by the supply chain disruptions stemming from the Japanese earthquake. This probably affected the durable goods orders and shipments as well. Furthermore, the big monthly drop was driven (partially) by a large 30% decline in nondefense aircraft and parts orders over the month.

But the gist of the report, in my view, was disappointing. Total durable goods shipments fell 1% over the month, while new orders plummeted 3.6%. This is a very volatile series, and the March growth in new orders was revised upward to 4.4% over the month from 2.5%; but the average growth rate in 'core orders' is showing holes

14--Less Income, More Layoffs, Wall Street Journal

Excerpt: The Bureau of Economic Analysis revised its calculation of first-quarter real gross domestic product, but the growth rate remained at 1.8%, the same weak pace reported when the BEA issued its initial GDP report.

The new mix of growth was very troubling, however. More of the growth came from inventory accumulation and less from consumer spending.

Even more alarming for the outlook: The BEA now says real disposable income barely grew over the past three quarters. Previously, income growth looked to be accelerating: the annualized increases were 1.0% in the third quarter of 2010, 1.9% in the fourth, and 2.9% in the first quarter of 2011.

Now, the three-quarter growth string is: 1.0%, 1.1% and 0.8%. Hardly the pace to inspire a shopping spree.

Meanwhile, U.S. businesses are raking in a boatload of cash. The GDP report showed nominal profits economywide jumped 8.5% in the year ended in the first quarter, while companies increased their nominal compensation to employees by just 3.7%.

As a result, the gap between the two U.S. consumer sectors widened further. The smaller segment of households that are invested in the stock market–either directly or via retirement accounts–got through the first-quarter in better shape than the share of households that are totally dependent on paychecks.

Worse still, the latest trend in jobless claims raises questions about jobs and income growth in May.

New filings defied expectations and jumped 10,000 to 424,000 in the May 21 week. The 400,000 mark is seen as the dividing line between a weak labor market and one with strong hiring. Claims have been above 400,000 for seven weeks now.

15--Continuing Equity Outflows Confirm Declining Risk Appetite, zero hedge

Excerpt: After peaking in Q1, retail investment in equity instruments courtesy of ongoing disenchanment with performance continues and as Lipper reports, "for the third week in a row equity fund investors were net redeemers from their accounts, taking out approximately $5.6 billion for the week ended May 25, 2011. The three-week total now stands at -$12.7 billion, the worst figure for this group since August 2010." This follows the latest ICI weekly report which saw a 4th consecutive outflow from domestic equity mutual funds. Which llikely means that as margin account cash continues to drop, margin debt has to offset it. As we disclosed recently, April margin debt grew to a fresh multi year high. Expect this number to grow even more in May, then June, and so forth until the levered beta chase ends in tears.

Thursday, May 26, 2011

Today's links

1-- Greece’s euro-zone membership is at risk, Reuters

Excerpt: European Union Fisheries Commissioner Maria Damanaki (says) Greece’s euro-zone membership is at risk.

“It’s the first we’ve really heard someone explicitly state what could happen,” said Andrew Busch, global currency strategist at BMO Capital Markets....

“People are starting to talk about the elephant in the living room, and that scares the market and reminds them of the precarious nature of what Greece is,” Busch said.

2--QE3? Jeff Harding, Marketwatch

Excerpt: End of QE2 Pits Traders Against the Fed.

I agree with everything he says about the bubble consequences of the money supply expansion. The vast amount of liquidity the Fed pumped into its primary dealers have fueled the stock markets and the current M&A splurge. It has also provided liquidity to the corporate markets which makes borrowing cheap . That is why you see companies like cash rich Google... borrow $3 billion on the bond market at an average of 2.33%.

It makes sense that when the growth momentum of quantitative easing stops, that this will eventually affect the markets, usually six to nine months later.

Shostak sees that this will put downward pressure on credit expansion by banks and thus the money supply will shrink. I think that is correct as well. We have seen some growth in lending activity recently and, as I have written lately on this, it is likely that this will stagnate....

The consequence of taking their foot off the money pedal will lead to higher unemployment and I do not think this is politically acceptable to the Fed or to the Administration. I think they will institute a new round of quantitative easing (QE3) because politicians will demand that the Fed “do something.” Which is, of course, the worst thing they could do. It will lead to more “bubble” activities and higher price inflation....

The Fed is serious about freezing its balance sheet starting in June. They will continue to buy Treasurys as issues mature and are replaced. But, as Shostak points out, the momentum of money growth will slow down and that is the key to understanding what will then happen. If Treasury rates do not take off, then my assumption about domestic and foreign demand for Treasurys will be correct. If they do take off, it will be an indication of a shrinking money supply as Shostak points out which will lead to economic stagnation or even a market bust. On the other hand, I don’t believe the Fed will play “chicken” during an election year, and when things turn ugly they will announce QE3 and that will kick the can down the inflationary road. QE3 may be the last installment of this monetary madness.

3--FHFA: House prices show hardest fall since 2008, Housingwire

Excerpt: National house prices fell 2.5% in the first quarter from the previous period, the largest quarterly drop since the last three months of 2008, according to the Federal Housing Finance Agency.

The FHFA analyzes the mortgage records for Fannie Mae and Freddie Mac to track average house price changes. Over the past year, prices fell 5.5%.

In March, prices dropped 0.3% from the prior month and remain almost 20% below the peak in April 2007.

For the first quarter, prices dropped in 43 states and in all nine Census Bureau divisions. All 25 of the metro areas tracked by the FHFA experienced drops during the quarter ,as well. The steepest came in the San Diego area, where prices fell more than 7% in the quarter.

Several house price indices across the country have already called a double-dip in the housing market as the inventory of distressed and vacant properties lingers.

4--Financial Lobbying and the Housing Crisis, New York Times

Excerpt: The study, by Deniz Igan, Prachi Mishra, Thierry Tressel, three economists at the International Monetary Fund, suggests that implicit subsidies and a lack of regulation helped make it possible for lenders to offer lower rates on mortgages that were increasingly likely to default. My fellow Economix blogger Simon Johnson has also noted the interplay of political influence on regulation and finance.

The study by the I.M.F. economists found that the heaviest lobbying came from lenders making riskier loans and expanding their mortgage business most rapidly during the housing boom. The loans originated by those lenders were, by 2008, more likely to be delinquent.

Most important, lobbying meant access to tax dollars. The lenders lobbying more heavily were 7 percent more likely to receive bailout funds, received larger amounts of those funds, and enjoyed a 27 percent greater increase in their market capitalization in October 2008, the month the bailout program was announced...

Nobody knows for sure how much of the blame for the housing boom can be put on the federal government, but we’re starting to see how political influence was associated with mortgage lending and, ultimately, with taxpayer subsidization of delinquent and defaulting mortgages.

5--Time to PANIC!!: Second-Quarter Real GDP Growth Looks Slow Enough to Put No Upward Pressure at All on the Employment-to-Population Ratio, Grasping reality with both hands

Excerpt: Time to push the panic button.

Macroeconomic Advisers is revising their tracking forecast of real GDP growth in the second quarter. It now looks as though, come July 1, that there will have been no gap-closing in the six quarters since the start of 2010.

That means that it is:

* Time for Quantitative Easing III...
* Time for pulling more spending from the future forward into the present, and pushing more taxes from the present back into the future...
* Time to use Fannie and Freddie to (temporarily) nationalize mortgage finance and fix the ongoing foreclosure crisis...
* Time for a weaker dollar...

6--Unemployment: Why Stimulus Hasn’t Created More Jobs, Mark Thoma, The Fiscal Times

Excerpt: The focus on long-run growth and the shunning of anything that so much as resembles a “make-work” project has made it difficult to deal effectively with the unemployment problem. There are still 11 million people who need jobs, and we are doing very little to help with this problem.

Long-run growth projects are slow to come online, especially when the projects must make it through the political process, and if they are not big enough initially it’s difficult to find the political will to go through the process of implementing another round of spending. Tax cuts are an alternative, but the current stimulus package was just shy of 40% tax cuts and we still have an unemployment problem.

Monetary policy is another option, but the effectiveness of monetary policy is limited when interest rates bottom out as they generally do in severe recessions. Thus, more direct methods of dealing with the unemployment problem are needed.

In the past, we did not pay enough attention to whether the policies used to fight a recession would also help with long-run economic growth. But in the present the pendulum has swung too far in the other direction – long-run growth should not be the only consideration when selecting stabilization policies.

In the future, we must do a better job of attacking the unemployment problem when recessions hit the economy even if it means implementing policies that do not directly have an impact on long-run economic growth. Those who promote supply-side policies above all else might be surprised at how much growth will be helped nonetheless by policies that avoid the long-term problems associated with high and persistent unemployment.

7--Rosenberg: 7 risks brewing, Pragmatic Capitalism

Excerpt: Just in case you were worried that David Rosenberg had turned all bright and happy with regards to the US equity markets – he brings us his 7 major risks brewing:

* China hard landing (PMI down to 51, perilously close to contraction mode)…equity market may have begun to price in some probability of such.

* Contagion sovereign credit risks in Europe (the rating agencies have already begun to take action against Spain, Italy and Belgium).

* Countertrend rally in the US dollar – this is crushing the risk-on carry trades: the unwinding of net speculative short positions in the dollar and long positions in the Euro seem to have further to go based on the latest CFTC data.

* Deepening recession in Japan – still one of the world’s largest economies; spill-over on global production schedules still to be felt.

* US fiscal policy is becoming more radically austere at all levels of government.

* The end of QE2 will be a very big deal given the 89% correlation between the Fed’s balance sheet and the movements in the S&P 500 over the past two years.

* US leading economic indicators are rolling over. The Conference Board Index fell in April for the first time since June 2010; the coincident-to-lagging indicator is down three months in a row; and the ECRI smoothed index is down now for four straight weeks, a streak last seen in July 2010.

8--Bonds are for losers? Pragmatic Capitalism

Excerpt: All of those cries about the bond bubble last year and hyperinflation have turned out to be dead wrong. The current environment is not consistent with past hyperinflations or even periods of high inflation. What is boiling beneath the surface is the balance sheet recession, however, the USA has done enough spending to fend off this beast for the time being. That said, the risk is still not hyperinflation in the USA. In fact, I believe the risk of hyperinflation remains close to nil. At the beginning of the year I said we were likely to experience inflation in the 2.5% range this year – higher than what I had been calling for over the last 2 years, but lower than the historical average. That’s been pretty close to dead right so far. I also think Bernanke is likely to finally get something right – this surge in inflation (mostly due to motor fuel prices) is likely to be transitory.

As for bonds, Rosenberg has nailed it. You can’t be super bearish about bonds unless you believe in one of two scenarios – hyperinflation or booming growth. Ironically, the paper bears don’t understand that the history of hyperinflations (as previously covered here) is not even remotely consistent with the current state of the US economy. So, the only way they will likely be right about bonds is by being wrong (about US economic growth). And while I’d love to be a believer in booming growth I just don’t see the USA experiencing strong economic growth with such enormous slack remaining in the economy and the increasing likelihood of austerity in the coming years. We remain deep in the balance sheet recession and until policy makers recognize that the likelihood of stronger growth is very low. And because of this malaise and persistent government ineptitude (around the globe) US bonds will continue to perform just fine.

Rosenberg: And event, the 3.07% yield level for the 10-year note would represent a key technical break – where the 200 day moving average resides. Mortgage convexity would then very likely take the yield down to 2.9%. And the rally we are seeing of late in the Treasury market is occurring on the back of renewed deflation pressure – the 5-year CDS spreads, measuring US government default risks, actually widened 10bps last week to 51bps.

Of course, deflation is now going to rear its head again. Oil prices are down 13% from the nearby peak. The base metals complex is down 10% from the recent high as well and trading both below the 50 and 200 day moving averages. The agriculture price sphere has corrected 10%. Gold is off the boil and silver has plunged 35%. Deflation is the principal threat, not inflation.”

9--Third Depression Watch, Paul Krugman, New York Times

Excerpt: Last year I warned that we seemed to be heading into the “Third Depression” — by which I meant a prolonged period of economic weakness:

Neither the Long Depression of the 19th century nor the Great Depression of the 20th was an era of nonstop decline — on the contrary, both included periods when the economy grew. But these episodes of improvement were never enough to undo the damage from the initial slump, and were followed by relapses.

We are now, I fear, in the early stages of a third depression. It will probably look more like the Long Depression than the much more severe Great Depression. But the cost — to the world economy and, above all, to the millions of lives blighted by the absence of jobs — will nonetheless be immense.

Brad DeLong points us to Macro Advisers, which has now downgraded its estimates for second-quarter growth. As Brad says, these estimates now suggest that we have now gone through a year and a half of “recovery” that has failed to make any progress toward closing the gap between what the economy should be producing and what it’s actually producing.

And nobody in power cares!

10--Albert Edwards and an afternoon tea-party with the Vestal Virgins, FT.Alphaville

Excerpt: Albert Edwards is bullish.

Bullish on US Treasuries that is, which the SocGen strategist expects to hit record levels before before government profligacy and the Fed’’s printing presses take the world back to both double-digit inflation and bond yields.

From Edwards’ latest Strategy Weekly (emphasis ours):

Many think I am mad. But I am not the only commentator expecting a deflationary bust – the sort of bust that will take the S&P down to 400 from the current 1300. I recently watched John Authers of the FT Lex and Long View columns interview Russell Napier, formally [sic] of CSLA and a leading stockmarket historian....

For those of you who cannot see the video let me try and paraphrase Russell. He believes massive central bank balance-sheet expansion has failed to boost broad money in the west, but rather this huge monetary stimulus has been transferred to emerging markets (EM) via foreign exchange (FX) intervention to peg EM currencies to a weakening US dollar (most notably the Chinese Renminbi). Together with the impact of a weak dollar driving commodity prices higher, the emerging markets’ own version of QE has led to overheating and inflation. EM countries are now far more inclined to aggressive monetary tightening, including allowing currency appreciation, which will halt the flow of EM-driven demand for US Treasuries. The creditor Chinese and other EM nations will tighten global liquidity, not the debtor US. This will cause what Russell terms “The Great Reset” which will drive US real bond yields higher and, amid a deflationary bust send the S&P down to its ultimate bottom – commensurate with levels of compelling cheapness represented on the Shiller PE at around 400 on the S&P.

Where I diverge slightly from Russell is that the world he describes sounds pretty recessionary to me. Clearly the S&P falling to 400 destroys household balance sheets and consumption anew. And EM liquidity tightening could cause hard landings. .... So in my world, 400 on the S&P goes hand-in-hand with lower, not higher US bond yields. Ultimately I would concur that there is also going to be “The Great Reset” on US yields as well, but that will come after a frenzied orgy of balance sheet debauchment (both Fed and Federal) which will make events over the last three years look like an afternoon tea-party with the Vestal Virgins.

Crikey. Fresh lows for government bond yields!

And there was us thinking they might push higher after the Fed’s latest bond buying programme ends in June.

11--Fiscally I'm A Right-Wing Nutjob, But On Social Issues I'm Fucking Insanely Liberal, The Onion (Humor)

Excerpt: The world is a complicated place, and in this day and age, you just can't expect a person to fall on the same political side of every issue he is confronted with. Things are more nuanced than that, and the average American might think one way about one topic, and a completely different way about another. For instance, when it comes to fiscal issues, I consider myself to be a rabid, foaming-at-the-mouth, right-wing lunatic. But on the social front, I'm a completely out-of-his-mind, wacked-out liberal loon.

It's all about striking a balance, really.

Take finances. It is my opinion that all taxes whatsoever should be abolished, and that everything relating to money in any way should be privatized, including the minting of coinage. Thus, each American should have his own system of currency and his own bank named after him to maintain that currency, and anyone whose personal currency system fails in the unfettered free market should be left to die bleeding and penniless in the street, with his family crying helplessly at his side. Also, corporations should be able to buy whatever and whomever they want, and at the end of every year the richest and most powerful corporation should be allowed to physically demolish 15 other corporations that it wishes to see destroyed, murdering all of the various employees of said corporations in any way it sees fit. I guess you could say I'm a fucking nutcase conservative when it comes to this kind of stuff, but I do believe it's an ideology that has its limits.

Wednesday, May 25, 2011

Meltdown in Greece; Something's gotta give

Stocks dropped on Monday as Europe's sovereign-debt crisis deepened and bond yields across the EU periphery headed sharply higher. The euro fell hard against the dollar ($1.40) while the Greek 10-year bond spiked to 17 per cent before mounting a modest comeback. The situation is getting desperate. Most economists now believe that Greece will have to restructure its debt, but bondholders are doing everything they can to make sure that doesn't happen because they stand to lose billions on their investments. So, they've thrown their weight behind ECB chief Jean-Claude Trichet, EU policymakers, and the IMF, all of which are trying to pressure Greece to accept harsher austerity measures in order to avoid default. But the plan isn't working. Greece's finances are getting worse by the day. Something will have to be done soon or Greece's troubles will send markets into a nosedive.

The problem is simple; the current belt-tightening policy has failed, so it's time to move on to Plan B. But the folks in charge don't want to change policies because then the banks (who own a large share of the bonds) would take a hit on their investments. So, the fiasco drags on while the debts pile up and while peaceful street demonstrations turn into violent conflagrations. The bigwigs at the EU and ECB would rather see cities across the continent descend into a bloody free-for-all than lose one euro on their original investment. Here's how economist Mark Weisbrot sums it up:
"The peripheral European countries are stuck in a currency union where their monetary policy is dictated by the European Central Bank (ECB), which is far to the right of the U.S. Federal Reserve and has little interest in helping them. Since they have adopted the Euro, they also do not control their exchange rate, and their fiscal policy is going in the wrong direction...

“This does not make any economic sense, except from the point of view of creditors that want to make sure that these countries are punished for their “excesses” – although for the most part, it was not over-borrowing but the collapse of bubble growth and the world financial crisis and recession that brought them to this situation. Unfortunately, the view of the creditors is that which prevails among the European authorities....

“When will it end? So long as these governments are committed to policies that shrink their economies, their only hope is that the global economy will pick up steam and pull them out with demand for their exports. This does not look likely in foreseeable future – the rest of Europe is not growing that rapidly and the U.S. economy is still weak." ("Eurozone’s Periphery Needs to Challenge Right-Wing European Authorities", Mark Weisbrot, CEPR)

What Greece needs is a way to dig out, which means debt forgiveness and a hefty fiscal stimulus package to rev up activity and put people back to work. Unfortunately, the EU doesn't have a mechanism for delivering fiscal aid to the weaker states. All they can do is extend loans to the struggling members and encourage them to slash domestic spending as mush as possible. But that just increases unemployment, decreases revenues and makes and even bigger hole. The whole process fuels public outrage which further exacerbates the economic troubles. The best thing to do is nip it in the bud; figure out what needs to be done and then do it. By dragging their feet, the ECB and IMF have only increased the chances of another meltdown.

So, what would happen if Greece defaulted on its debt? Would it be as bad as Lehman Brothers? Here's an excerpt from The Guardian:

"If Athens reneged on its debts it would shatter the markets' confidence in the eurozone project... Given the structure of modern financial markets, with their chains of derivative trades and their pyramids of debt, there is only one answer. Greece could certainly be the next Lehmans. The likelihood that a Greek default would pose a threat to the future of the eurozone as well as to the health of the world economy means it has the potential to be worse than Lehmans. Much worse...."

If Greece goes under, then it could take Portugal, Ireland and (perhaps) Spain along with it. So why is ECB chief Jean-Claude Trichet dilly-dallying? Does he really think the problem is just going to go away? And why did French Finance Minster Christine Lagarde (who is the leading candidate to replace ex-IMF chief Dominique Strauss-Kahn) announce that "that a rescheduling or reprofiling of Greek debt is NOT an option (and that) executing the planned austerity program, proper implementation of privatization, and commitments across the political spectrum in Greece are the key for a solution in Greece"

Talk about throwing gas on a fire! Does Lagarde want to kick off her appointment by sending the markets into freefall?

Things are looking bleaker and bleaker for Greece. Bond yields are widening, the red ink is rising and the ECB is as inflexible as ever. There's a good chance that policymakers will push this austerity-thing too far and bring the whole EU crashing down around them.

Today's links

1--NY & California AGs Are Prosecuting Bank Fraud, The Big Picture

Excerpt: Last week, we heard the announcements by New York Attorney General Eric Schneiderman that his office is investigating fraud in mortgage securitization — originally focused on Goldman Sachs, Bank of America, and Morgan Stanley, this morning expanded to include JPMorgan, UBS, and Deutsche Bank.

Previously, the Florida AG had published a brutal analysis on Florida foreclosure fraud.

We now learn that California is stepping up to the plate: California Attorney General Kamala Harris is creating a 25-person task force to target mortgage fraud of any size. It includes a team of 17 lawyers and eight special agents from the state Department of Justice. The focus will be on three key areas:

• Corporate fraud: including instances in which bundled mortgages were sold as securities to the state or its pension funds under false pretenses, using California’s False Claims Act, which makes false claims submitted to the state a felony;

• Scams: including instances in which consultants, lawyers and others took fees from people in foreclosure, saying they would help the homeowners get loan modifications or other remedies, but delivered nothing.

• Origination Fraud: Fraudulent lending practices, including deceptive marketing, failure to fully disclose loan terms. This includes qualifying people for loans who couldn’t afford the terms.

2--German Engineering and Greece's Debt Crisis, The Street

Excerpt: In all their piety, the barons of Europe -- German politicians and the European Central Bank -- are pressuring Greece to sell off assets, raise taxes and curb spending to resolve its debt crisis. After all, irresponsible southern EU states are in need of rehabilitation and some lessons in Teutonic thrift.

Sadly, selling assets won't lower Greece's debt enough to make it manageable. Further, cutting spending and increasing taxes further will thrust Greece into a deep and prolonged recession and severe deflation. That might raise Greek exports enough to service its euro-denominated debt, but not without turning much of Greece into a Great Depression era Appalachia....

Prosperous Germany, unburdened by an obligation to share significant enough tax revenues with poorer EU states, used the wealth it obtained exploiting a single market to provide generous pensions, gold-plated employment security and jobless benefits, and the shortest workweek on the planet. Meanwhile, governments in Greece and other poorer EU states struggled to keep up, piled up lots of debt and couldn't scale back spending too much without risking political upheaval. Their voters don't understand why the much touted single EU market imposes equal responsibilities without ensuring more equal benefits....

In the end, the only viable option is to restructure its debt -- ask bondholders to accept long maturity and lower interest rates, or a more explicit write-down of amounts owed. The ECB has threatened to abandon Greece's private banks if Athens restructures.

That would force Greece's banks into failure and surely thrust Greece into a depression. And it begs the question: if the ECB won't support the only reasonable solution for Greece, why should Greece remain in the euro?

Thanks to German and ECB intransigence on restructuring, Greece has no choice but to require sovereign and private creditors to take haircuts; abandon the euro and reinstate the drachma; and rethink its welfare state.

3-- Euro-Zone Growth Slows to 7-Month Low, Wall Street Journal

Excerpt: Growth in the euro zone's private sector eased more than expected to its weakest pace in seven months in May, led by a sharp slowdown in manufacturing, the preliminary results of a survey by financial-information firm Markit showed Monday.

The flash reading of the euro zone's composite-output index, a gauge of activity based on partial results of a survey of manufacturing and services firms, dropped to 55.4 in May from 57.8 in April. A reading above the 50 level indicates an expansion in activity. The level of activity is in line with the average of last year, but the fall in the main index was the sharpest since November 2008, Markit said. Economists were expecting the headline reading to drop to 57.4.

The manufacturing-purchasing-managers' index dropped much more than expected to 54.8 in May, from 58.0 the previous month, while the euro-zone services-business-activity index fell to a five-month low of 55.4, from 56.7 in April. Economists had predicted a manufacturing reading of 57.5 and an unchanged services reading of 56.7.

4--The IMF cannot afford to make a mistake with Strauss-Kahn's successor, Joseph Stiglitz, Telegraph

Excerpt: Europe has decided it cannot or will not manage the crisis on its own and has turned to the IMF. But Europe is in an awkward position. Its own Central Bank is at the centre of managing the very crisis that was helped into being by the flawed economic philosophy and policy to which it and the US Federal Reserve adhered.

Those who thought that all that was needed for the euro to succeed was fiscal discipline should have learned their lesson – Ireland and Spain had surpluses before the crisis.

Behind the scenes there is a battle – between those who put the interests of the banks first and those who put the interests of the people first. Debt restructuring would affect the balance sheet of the banks. The longer restructuring is postponed, the more debt moves onto the books of the public, the more the banks are protected.

But there is a high cost of this strategy: the citizens of the country suffer enormously in the interim and taxpayers pay the price in the long run. Even after all this, there are likely to be more crises, especially given the reluctance of those in the US and European Union to adopt adequate financial regulations.

An effective and fair IMF is essential – an institution that looks not just after creditors in the lending countries but after the well-being of all. And whatever the result of the case against Strauss-Kahn, this much is clear - he was an impressive leader of the IMF and he re-established the credibility of the institution.

He breathed fresh air into the IMF as he re-examined old doctrines such as those concerning capital controls. He raised new issues as he emphasized the critical role of employment and inequality for stability. He reasserted the role of economic science, including Keynesian economics, over the mishmash of long-discredited Wall Street doctrines, which had been central to the IMF's failures in East Asia, Latin America, and Russia.

He also listened to the increasingly vocal and informed voices of those in emerging markets. He supported the movement for reforms in the institution, including voting rights and governance.

As the IMF transitions, it is important to maintain the reforms, and carry them forward. But the hard-fought gains of the institution could easily be lost. That's why the choice of the head – and the process by which the choice is made – is so important....

The response to the IMF's major change of course on capital controls is more evidence of the lack of confidence in the institution. A decade ago, the IMF tried to change its Articles of Agreement to allow it to force countries to liberalize their capital markets. Now, it recognizes that at times, capital controls may be desirable.

Rather than responding enthusiastically to this long overdue change, emerging markets and developing countries have said: "Keep out of this. Today, you may be open, but at any moment you can be recaptured by Western financial markets that have done so well by these unstable capital flows, making money as funds flow in, and making more money in the aftermath of the havoc created as funds flow out."

5--Fed scholars: A run on the repurchase market caused the financial crisis and will probably happen again, Repowatch

Excerpt: The authors draw five lessons from the panic of 2008. Here are brief summaries:

-Bank regulation can reduce the likelihood of liquidity crises, but cannot eliminate them entirely.

-During a liquidity crisis, the Fed should act as a lender of last resort.

-The Fed should announce its policy for liquidity crises, explaining how and under what circumstances it will come into play.

-Deposit insurance is part of the answer, but has a limited role.

-The Fed’s lending in a crisis should be targeted toward preserving market liquidity, not particular institutions.

Avoiding liquidity crises altogether is probably more than we can hope for. What we can do is put in place mechanisms to make such crises infrequent and to make their effects manageable.

6---As Lenders Hold Homes in Foreclosure, Sales Are Hurt, New York Times

Excerpt: The nation’s biggest banks and mortgage lenders have steadily amassed real estate empires, acquiring a glut of foreclosed homes that threatens to deepen the housing slump and create a further drag on the economic recovery.

All told, they own more than 872,000 homes as a result of the groundswell in foreclosures, almost twice as many as when the financial crisis began in 2007, according to RealtyTrac, a real estate data provider. In addition, they are in the process of foreclosing on an additional one million homes and are poised to take possession of several million more in the years ahead.

Five years after the housing market started teetering, economists now worry that the rise in lender-owned homes could create another vicious circle, in which the growing inventory of distressed property further depresses home values and leads to even more distressed sales. With the spring home-selling season under way, real estate prices have been declining across the country in recent months.

“It remains a heavy weight on the banking system,” said Mark Zandi, the chief economist of Moody’s Analytics. “Housing prices are falling, and they are going to fall some more.”

(From Calculated Risk: Although REO inventory might be overstated in the story, the number of loans in the foreclosure process is much higher than 1 million. The MBA reported last week that 4.52% of homes with first-lien mortgages were in the foreclosure process. There are approximately 50,000,000 homes with first-lien mortgages, and 4.52% would be 2.25 million. There are another 1.8 million homes were the borrower is more than 90 days delinquent.)

7---FHA tipping point, Dr Housing Bubble

Excerpt: “(NY Times) In the first quarter, 17.7 percent of new loans were F.H.A., according to Inside Mortgage Finance, an industry data provider, while P.M.I. had a 5.4 percent market share. Applications for F.H.A. loans jumped 20 percent in the month preceding the price increase, then tumbled when it went into effect, according to the Mortgage Bankers Association.

In addition to lower minimum down-payment requirements, F.H.A. has laxer rules for credit scores and debt-to-income ratios. Right now, it also has lower interest rates, said Thatcher Zuse, the president of Sound Mortgage, a lender and broker in Guilford, Conn. “Almost as a rule, as the rates stand right now, the less equity you’re putting down, the better the F.H.A. deal becomes.”

The toxic loan market in terms of Alt-A and option ARM loans is largely nonexistent but there is no doubt that we have a questionable loan products through FHA insured loans. The default rates are soaring because giving loans to people with very little down payment makes absolutely no sense especially when household incomes are so fragile. I’m surprised how many people come to defend the FHA as it inches closer and closer to a bailout. Why not agree on the fact that if FHA’s mission is for lower income households why not cap it at the median U.S. home price? Look at this insanity reported from the CBO regarding the FHA’s missions:

“(CBO) To target the program toward low- and moderate-income borrowers, the law limits the size of a mortgage that may be insured. The limits vary by geographic region a depend on such factors as the ceilings that apply to mortgages that are legally eligible for purchase by Fannie Mae and Freddie Mac, appreciation in home prices, and the cost of living in an area. Currently, the limit for a one-unit property in most areas is $271,050, although in some high-cost areas FHA can insure loans up to $729,750.....

How in the world is $729,750 a price geared to low to moderate income buyers? This is the kind of mentality that led us into the bubble in the first place. The higher limit will come down but it is absurd to think that this product is somehow for the “working” people of the country. It is merely another shadow bailout to protect the banking interests to keep loan volume churning.

8--When Austerity Fails, Paul Krugman, Commentary, New York Times

Excerpt: Europe’s troubled debtor nations are, as we should have expected, suffering further economic decline thanks to those austerity programs, and confidence is plunging instead of rising. It’s now clear that Greece, Ireland and Portugal can’t and won’t repay their debts in full, although Spain might manage to tough it out.

Realistically, then, Europe needs to prepare for some kind of debt reduction, involving a combination of aid from stronger economies and “haircuts” imposed on private creditors... Realism, however, appears to be in short supply.

On one side, Germany is taking a hard line against anything resembling aid to its troubled neighbors, even though one important motivation for the current rescue program was an attempt to shield German banks from losses.

On the other side, the E.C.B. is acting as if it is determined to provoke a financial crisis. It has started to raise interest rates despite the terrible state of many European economies. And E.C.B. officials have been warning against any form of debt relief...

If Greek banks collapse, that might well force Greece out of the euro area — and it’s all too easy to see how it could start financial dominoes falling across much of Europe. So what is the E.C.B. thinking?

My guess is that it’s just not willing to face up to the failure of its fantasies. And if this sounds incredibly foolish, well, who ever said that wisdom rules the world?

9--Puru Saxena on Why QE3 is Inevitable, The Big Picture (video)

Why QE3 is inevitable

Tuesday, May 24, 2011

Today's links

1--Beating a Dead QE2, The Streetlight blog

Excerpt: I thought I had suffered through enough of these types of stories over the past six months to last me a lifetime, but apparently not. Hasn't this innocent, blameless, and very dead horse been beaten sufficiently by now? And yet... some masochistic streak in me forces me to read it:

QE2 was a bust:
Economic data is worse than before

BOSTON (MarketWatch) — It‘s cost $600 billion of your money. And it was supposed to rescue the economy. But has Ben Bernanke’s huge financial stimulus package, known as “Quantitative Easing 2,” actually worked as planned?

QE2 is being wound down in the next few weeks. Fed Chairman Ben Bernanke has said it has left the economy “moving in the right direction.” But an analysis of the real numbers tells a very different story.

I've only snipped the first two paragraphs from this story, but that much is enough to contain two fundamental and oft-repeated errors which I've resisted commenting about in the past, but can resist no longer.

Correction #1. You can't tell if QE2 worked by simply looking at actual economic data. Why? Because you need to compare it to something. So in order to tell the effects of any particular policy you have to compare actual economic data with what would have happened in the absence of the policy. I have yet to see a critic of QE2 attempt to make the correct comparison.

Correction #2. QE2 didn't cost anything. Nothing. Nada. All that happened was that the Fed bought a bunch of long-term assets. The money didn't disappear. The Fed still has that $600 billion; it's just in the form of long-term bonds now.

2--The Importance of Fiscal Versus Monetary Stimulus, Wall Street Journal

Excerpt: Countries suffering balance-sheet recessions, like Japan faced during the 1990s and the U.S. and U.K. are struggling through now, need fiscal life support for a long time, he argues.

That’s because demand for the sort of credit that accompanies normal expansion is depressed. Households and banks want to rebuild their capital, so the former don’t want to borrow and the latter don’t want to lend. In this circumstance, aggregate demand remains below potential and the economy struggles until equilibrium is regained. That adjustment can take a decade or longer. During the past couple of years, the shortfall in aggregate demand was made up by massive amounts of government spending, everywhere.

So far the play book has been following Japan’s example. By 1996, the Japanese government was running a fiscal deficit of 5.2% as it tried to lift its economy out of the post-bubble doldrums, having steadily expanded the size of the shortfall from a surplus in 1992. GDP growth responded, rising from a muted 0.9% in 1994 to 2.6% in 1996. But then the Japanese government took fright at the size of the deficit it was running and raised sales tax the following year.

3--Beware the ‘Splash Crash’, Izabella Kaminska, FT.Alphaville

Excerpt: Introducing ‘the splash crash’.

Like the flash crash but worse because it involves the “flash” spreading cross-asset class to everything from forex to commodities.

The idea springs from John Bates, More…

Introducing ‘the splash crash’.

Like the flash crash but worse because it involves the “flash” spreading cross-asset class to everything from forex to commodities.

The idea springs from John Bates, the chief technology officer of Progress Software, as cited by Jim Mctague in Barron’s this week, and the worry is that investors currently do not appreciate the level of cross-asset algo-influence in the market.

As Mctague writes:

I’ve recently heard from a computer-trading expert warning of the very real possibility of a more widespread and catastrophic “splash crash,” a dislocation by high-speed trading computers that could simultaneously splash across many more asset classes and markets. Imagine our metaphorical jet buried in the earth up to its tail.

The possibility of a splash-crash nightmare springs from John Bates, the affable chief technology officer of Progress Software a $1.89 billion company whose worldwide headquarters is in Bedford, Mass. Bates has an impressive résumé, including a doctorate in computer science from Cambridge University. He’s also a member of a panel of technology experts that advises the Commodities Futures Trading Commission.

“I think there is an extreme risk of seeing this because we’re not serious about putting measures in place to police against it,” says Bates, who freely acknowledges that his company has computer programs that it would like to sell to securities and commodities regulators to address this very issue.

4--Housing Double Dip: Why Prices Will Keep Dropping, Fiscal Times

Excerpt: Before housing can recover, a couple of things have to happen. The first and most important is jobs. “The housing market will pick up when there are more jobs,” says Beth Larson, principal at Evermay Wealth Management. Second, foreclosures have to peter out and the market has to work through the excess housing inventory. “We have so many bad loans in the pipeline that are still going to go through the foreclosure process,” says Newport. “That’s going to continue to drive prices down.” More than 219,000 foreclosure filings were reported in April, and 1 in every 593 housing units is in foreclosure, according to RealtyTrac. Total housing inventory at the end of March rose 1.5 percent to 3.55 million existing homes available for sale, or about an 8.4-month supply, according to the National Association of Realtors.

Newport predicts that home prices will fall an additional 7 percent this year, while Capital Economics economist Paul Dales has them dropping at least 5 percent further. Zillow economist Stan Humphries says prices will bottom out sometime in 2012. In other words, the housing market still has a way to go before the worst is behind it....

5--Spain's Icelandic revolt, Press Europe

Excerpt: After passively submitting to the crisis, young Spaniards have finally taken to the street. Breaking out on the eve of municipal elections, the protests of recent days have been inspired by those in Iceland that led to the fall of the government in Reykjavik....

But those voices calling for real democracy are not just being raised in Iceland, a country of about 320,000 inhabitants. Here in Spain, the umbrella organisation for various Spanish movements – Democracia Real Ya (Real Democracy Now) – already lists among its proposals some 40 points ranging from controlling parliamentary absenteeism to reducing military spending through to abolishing the so-called Sinde law (a law restricting on-line infringements of copyright).

The demonstrations have broadened spontaneously, as was the case for those who rallied under the umbrellas of the "alternative globalisation" movements, and have evolved, one decade after the World Social Forum in Porto Alegre, Brazil, on a more modest stage than the one demonstrators faced in the past at the World Economic Forum of the global elite in Davos, Switzerland.

All this is happening at astonishing speed via the Internet, which has amplified the echo of discontent and opened the lanes of cyberactivism to groups such as Anonymous, notable for intervening against companies like PayPal and Visa during the advocacy campaign for Wikileaks chief Julian Assange. Yet it was also there at the beginning of the revolts in the Arab world, to help people get round the censorship of the Tunisian and Egyptian dictatorships.

“When we grow up, we want to be Icelanders!" cried one of the leaders of the organisation during the march on Sunday May 15 before a column of young – and not so young – parents and children, students and workers, the jobless and pensioners. Many Saturdays in Iceland were needed before citizens won the changes they had demanded. Spain’s first Sunday has taken place, and was followed by a Tuesday [May 17]- but there’s still a long way to go.

6--Greece Bond Yields increase as Policymakers Disagree on Restructuring, Calculated Risk

From the Financial Times: ECB’s political tensions flare over Greece

This week, the ECB’s fierce opposition to Greece’s delaying debt repayments has erupted into a full-blown and public dispute. ... Jean-Claude Juncker, the Luxembourg prime minister who also chairs meetings of eurozone finance ministers, floated the idea of a “soft” restructuring ...In response, ECB policymakers accused him of “using meaningless phrases”.

7--Fed Fears of Wage Increases Carry Risks, Kathleen Madigan, Wall Street Journal via Economist's View

Excerpt: Windfall for commodity producers, no problem. Bigger paychecks for U.S. workers, now wait a minute…

That’s one reading of the minutes from the Federal Reserve‘s April 26-27 Federal Open Market Committee. The strategy makes sense from an economics’ standpoint; but it carries risks on both the political and growth fronts.

According to the minutes, Fed officials continue to think the impact from higher commodity prices will be “transitory.” The bigger concern would be if wage increases took hold. After all, labor remains the biggest expense for most U.S. businesses. If wages were to increase rapidly, companies would be under more pressure to raise their selling prices — which would cause workers to ask for bigger raises to cover the higher prices.

So far, the Fed sees little evidence of that inflationary cycle — mostly because there is so much slack in the labor markets. ... And as long as the pressures on labor costs remain muted, “a large, persistent rise in inflation would be unusual,” the minutes added. In other words, higher prices concentrated in energy and raw materials won’t bring a response from the central bank. But if wages pick up, the Fed may step in.

In theory, the policy is sound, given the dominance of labor costs to pricing decisions. ... But don’t expect the public to welcome the idea that wage gains need to remain “subdued.” The Fed could face more threats of greater oversight from Washington politicians if central bankers are seen as turning a deaf ear to the wants of working voters. Congressional meddling would complicate the Fed’s job.

Second, the price increases being tolerated by the Fed are wreaking havoc on household budgets. ... Without faster real income growth, consumers won’t provide the demand needed to power the recovery. Keeping the recovery going is another ball the Fed needs to keep juggling.

8--Making Things in America, Paul Krugman, New York Times via Economist's View

Excerpt: ...what’s driving the turnaround in our manufacturing trade? The main answer is that the U.S. dollar has fallen against other currencies, helping give U.S.-based manufacturing a cost advantage. A weaker dollar, it turns out, was just what U.S. industry needed.

Yet the Federal Reserve finds itself under intense pressure from the right to make the dollar stronger, not weaker. ...

And then there’s the matter of the auto industry, which probably would have imploded if President Obama hadn’t stepped in to rescue General Motors and Chrysler. ... And this ... would have undermined the rest of America’s auto industry, as essential suppliers went under, too. Hundreds of thousands of jobs were at stake.

Yet Mr. Obama was fiercely denounced for taking action. One Republican congressman declared the auto rescue part of the administration’s “war on capitalism.” Another insisted that when government gets involved in a company, “the disaster that follows is predictable.” Not so much, it turns out.

So while we still have a deeply troubled economy, one piece of good news is that Americans are, once again, starting to actually make things. And we’re doing that thanks, in large part, to the fact that the Fed and the Obama administration ignored very bad advice from right-wingers — ideologues who still, in the face of all the evidence, claim to know something about creating prosperity.

9--Let's demolish this poor housing policy, Dean Baker, The Guardian

Excerpt: The Obama administration's reform of Freddie Mac and Fannie Mae would merely subsidize mortgage middlemen with our taxes.....The more basic question is why the government feels the need to create a special financial system to subsidize housing....

However, the worse junk mortgages were not bought and securitised by Fannie and Freddie. These were packaged and sold by the investment banks, Goldman Sachs, Lehman, Citigroup and the rest. Fannie and Freddie got into junk mortgages late in the game, and even then, their primary motive was to regain lost market share. It had little to do with a desire to promote homeownership among moderate income households.

But even if Fannie and Freddie were not the primary culprits, the crisis and their collapse gives us a serious opportunity to rethink housing policy. Fannie Mae, when it was originally created in the Depression, served a useful purpose. It created a secondary market in mortgages, allowing banks to sell their mortgages and get the capital necessary to issue new mortgages. This reduced the disparity in interest rates across regions, ensuring that homebuyers had access to mortgages at a reasonable price....

Since we can use tax policy to make homeownership subsidies as generous as we want, why should the government also subsidise homeownership through a second channel in the financial system? Furthermore, even if the government were going to subsidise housing finance, why have the subsidy only apply to mortgage-backed securities?

The policy being considered by the Obama administration, which would guarantee the mortgage-backed securities issued by mini Fannie and Freddies, is effectively handing taxpayer dollars to the intermediaries in the housing finance process. That's a good policy if the point is to give taxpayer money to financial intermediaries; it makes zero sense as housing policy.

10--Goldman Braces for Federal Subpoenas, Housingwire

Excerpt: Goldman Sachs Group Inc. executives expect to receive subpoenas soon from U.S. prosecutors seeking more information about the securities firm's mortgage-related business, according to people familiar with the situation.

Officials at the New York company believe the Justice Department will demand certain documents and other information, possibly within days, these people said. Spokesmen for Goldman and the Justice Department declined to comment Thursday.

11--Can the Greek People Teach the Central Bankers Economics?, Counterpunch

Excerpt: The latest projections from the IMF show that Spain's GDP will not recover its pre-crisis peaks until 2013. It will take Ireland until 2015, and Portugal and Greece until 2016. Furthermore, given the consistent patterns of downgrading growth projections over the last few years, it is likely that it will take these countries even longer to regain their lost output on their current policy path.

This raises the possibility that governments of the heavily indebted countries will soon find it impossible to agree to the never-ending demands for austerity coming from the ECB and the IMF. The refusal to come to terms will inevitably lead to a financial crisis, as anyone with assets will seek to withdraw them from the banks of a country facing such a standoff.

In such circumstances, leaving the euro and re-introducing a domestic currency becomes a realistic prospect. No government would ever go this route unless it had no choice, because it is almost inconceivable that it could re-introduce a domestic currency without bringing on a financial crisis. However, if the crisis is already there, then the domestic currency route would suddenly look much more appealing.

Argentina provides the model for this situation. Its government had supposedly created an unbreakable peg between its currency and the dollar in the early '90s. When interest rates in the United States rose in the late '90s, and the value of the dollar rose as well, Argentina's situation became untenable....

If Greece were to leave the euro, there would undoubtedly be considerable short-term pain, but with its own currency it would at least have a route to resume growth in a reasonable period of time. Greece's departure would also pave a path for other countries to follow. This may be the lesson that the ECB needs in order to develop more realistic policies for dealing with the enormous imbalances that it allowed to develop in the last decade. Maybe the ECB bureaucrats can still learn some basic economics before they take Europe's economy even deeper into a hole.

12--Systematic Collapse, Total Assault On Culture

Excerpt: The current economic crisis is a combination of structural design and the inherent contradictions between the limitless search for profit, through speculation, and an interest-based economy in which production is dwindling, harbouring an excess of credit. The logic of the market, combined with neo-liberal doctrines, have brought it to the point where it is buoyed up on faith alone: capitalism is form of monotheism with its own attendant myths. The danger then comes then not when the fictitious bubbles burst, but when the very real infrastructure is sold off and dismantled. The threat is no longer fictitious, but historically realised through privatisation — a degradation of the social sphere and dispossession of people’s rightful common assets.

This is systemic, due to various documentable factors, not so much greed, as a naivety and faith in partially understood market processes. What has changed between now and since the mid-seventies is that risks are more evenly spread so that devaluations are visited on the poorest and least able to bear them. The middle-classes, co-opted by conservative rhetoric and in cahoots with finance, divested the working-classes during previous profit squeezes. In effect, they saw them as the principle barrier to profitability during previous contractions and in effect abetted a return of power to the ruling-classes, rather than see a more horizontal distribution of wealth.

Firstly, we should understand the system as an organic one, that mutates spasmodically to circumvent crises brought about by its own internal contradictions. It is a process of motion and fluidity and moreover it’s a system of relations. Capital is no longer capital if it is not moving; it becomes inert. And when things stop, value disappears. Money, most importantly, is the lubricant of this exchange (liquidity).

It is not a lack of money that causes a crisis, but on the contrary, it is the crisis that causes a lack of money. Liquidity and capital are not the same thing. There is a crisis in the overaccumulation of capital (as represented by the habouring of an excess of bad credit in the system, and as we know: bad money drives out good). It is exactly because of the ‘flood’ of finance capital of unknown quality that there is a crisis of liquidity. The crisis of overaccumulation brings about limits to the flow of capital, i.e. stasis in the money markets.

The liquidity crisis is very real and is causing, or about to cause, a huge shortage in the means of payment. All loans and debts are being called in, in return for money. The next phase — as banks refuse to extend lines of credit to businesses in the real economy and the demand for loanable funds drives up interest — is that ordinary working people get sacrificed on the altar of capitalist irrationality. Then comes inflation as a form of devaluation and the subsequent wage struggles that precede a rise in class consciousness.

This crisis will not remain in the world of finance for very much longer.