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.

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