Wednesday, June 8, 2011

Today's links

1--Richard Koo UNLOADS On Paul Krugman: He Got It Wrong On QE2, And Now Obama Has An Awful Situation, Business Insider

Excerpt: It's important here, to note, WHY QE2 doesn't work, according to Koo... essentially all that happened is that by buying up Treasuries, investors were forced to look for returns elsewhere, in places like stocks and commodities. The latter, the commodity gains, ended up slowing down the economy. What's more, QE2 has had no positive impact on bank lending whatsoever.

Koo notes that, because of the current political situation, fiscal stimulus now seems unlikely. Consensus has formed around austerity, and that would need to change for more government spending to be put in place. Standing in the way is Republican opinion, Democrat acquiescence, and ratings agencies who seem prepared to downgrade the U.S.

The alternative, protectionism and dollar devaluation, could be disastrous if history is any example, according to Koo.

The dollar’s plunge began on 25 March, and the US currency dropped ¥15 in six weeks. Japanese investors who had long been buyers of dollar bonds rushed to sell, driving up the yield on the 30-year Treasury bond by 150bp, from 7.5% to 9%. The yields on Japanese government debt simultaneously plunged as Japanese investors repatriated yen and parked the money in the JGB market. As a result, US and Japanese long-term interest rates moved inversely to each other during this period (Figure 1).

This episode, which began late in March 1987, eventually led to the Black Monday stock market crash in October that year. A similar series of events today could have a devastating impact on the US economy—a sharp rise in long-term interest rates at a time when the housing market is already in its worst shape since the Great Depression would have traumatic implications.

Adding to the problems is the fact that the world’s economies—with the exception of Germany and China—have yet to recover from the housing bubble collapse of 2007. Progress in Japan will be delayed even further as the nation struggles to rebuild after the earthquake. For the US to pursue a weak-dollar policy under these conditions would almost certainly invite a backlash and possibly retaliation by trading partners.

2--Christina Romer looks back — and forward, Washington Post

Excerpt: On the administration’s internal fights over the stimulus:

Like the Federal Reserve, the Administration and Congress should have done more in the fall of 2009 and early 2010 to aid the recovery. I remember that fall of 2009 as a very frustrating one. It was very clear to me that the economy was still struggling, but the will to do more to help it had died.

There was a definite split among the economics team about whether we should push for more fiscal stimulus, or switch our focus to the deficit. A number of us tried to make the case that more action was desperately needed and would be effective. Normally, meetings with the President were very friendly and free-wheeling. He likes to hear both sides of an issue argued passionately. But, about the fourth time we had the same argument over more stimulus in front of him, he had clearly had enough. As luck would have it, the next day, a reporter asked him if he ever lost his temper. He replied, “Yes, I let my economics team have it just yesterday.”...

On what should be done:

The answer to low overall demand is to try to get it up. The best solution would obviously be for private sector demand to come bounding back on its own. So far that has not happened and doesn’t look like it is about to. ... My particular favorite additional short-run stimulus would be a cut in the employer side of the payroll tax. Congress cut the payroll tax for employees in the budget compromise last December. A similar cut in what firms have to contribute for payroll taxes would make hiring workers cheaper and would therefore likely be particularly helpful for employment growth. This is just a broader and simpler version of the new jobs tax credit that I thought would be a very good idea back in 2009. And, it has the virtue of being something that I suspect policymakers on both sides of the aisle could support.

I frankly do not understand why policymakers are not feeling more urgency to get unemployment down. People are clearly suffering greatly. Moreover, continued high unemployment is potentially very destructive. Even though I don’t think our normal rate of unemployment has risen much so far, it certainly could. Evidence from a number of European countries in the 1980s suggests that a prolonged period of high unemployment can permanently damage workers prospects and raise normal unemployment. We are seeing today that some firms are putting up ads saying “Only employed people will be considered.” This suggests that there is starting to be a stigma associated with being out of work for a long period.

On taxes:

Revenues are going to be another huge issue. Additional revenues are going to be needed if we do not make draconian changes to popular entitlement programs.

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

Excerpt: The potential for repo runs has not been fixed, the scholars write. It’s not addressed by the Dodd-Frank Act, and future crises probably cannot be prevented, but they can be made less severe. Bank runs, on the other hand, have been largely controlled since 1933 by FDIC insurance for deposits.

From the Minneapolis paper:

What happened in September 2008 was a kind of bank run. Creditors lost confidence in the ability of investment banks to redeem short-term loans, leading to a precipitous decline in lending in the repurchase agreements (repo) market. Massive lending by the Fed resolved the financial crisis, but not before reductions in business and household spending had led to the worst U.S. recession since the 1930s.

Just before the September 2008 panic, conditions were ripe for a run, the authors argue.

In August of 2008, the entire banking system held about $50 billion in actual cash reserves while clearing trades of $2,996 trillion per day. Yet every one of these trades involved an uncontingent promise to pay someone hard cash whenever he asked for it. If ever a system was “runnable,” this was it.

The Minneapolis article is “Liquidity Crises – Understanding sources and limiting consequences: A theoretical framework,” by Robert E. Lucas, Jr. and Nancy L. Stokey, May 2011.

4--Obama Brushes Aside Concern About Potential Double-Dip Recession, Fox News

Excerpt: President Obama on Tuesday expressed concern about a weakening economic recovery after a spate of disappointing news last week, but he shrugged off worries about the economy falling back into recession.

"I'm not concerned about a double-dip recession. I am concerned about the fact that the recovery that we're on is not producing jobs as quickly as I want it to happen," he said at a White House news conference in the East Room alongside German Chancellor Angela Merkel....

Gas prices have soared in recent months to $4 per gallon, but they have begun to slightly decrease in the past few weeks. The national average for gas prices were $3.76 per gallon on Tuesday.

As the numbers are added up, the Congressional Budget Office on Tuesday released its accounting of the first two-thirds of the year, which showed the federal budget deficit is $929 billion so far for fiscal year 2011 -- $6 billion less than the shortfall recorded over the same period last year. That may be attributed to a 10 percent increase in revenues over the same period last year, even as outlays are about 6 percent higher.

But with a stubborn jobless rate, weekly applications for unemployment staying well into the 400,000s -- far higher than is needed in a healthy economy -- and the resignation of Austan Goolsbee, one of his top economic advisers, the president is looking to pivot in a new direction.

5--Bernanke's Speech, The U.S. Economic Outlook

Excerpt: U.S. economic growth so far this year looks to have been somewhat slower than expected. Aggregate output increased at only 1.8 percent at an annual rate in the first quarter, and supply chain disruptions associated with the earthquake and tsunami in Japan are hampering economic activity this quarter. A number of indicators also suggest some loss of momentum in the labor market in recent weeks. We are, of course, monitoring these developments. That said, with the effects of the Japanese disaster on manufacturing output likely to dissipate in coming months, and with some moderation in gasoline prices in prospect, growth seems likely to pick up somewhat in the second half of the year. Overall, the economic recovery appears to be continuing at a moderate pace, albeit at a rate that is both uneven across sectors and frustratingly slow from the perspective of millions of unemployed and underemployed workers. ...

On the negative side, households are facing some significant headwinds, including increases in food and energy prices, declining home values, continued tightness in some credit markets, and still-high unemployment, all of which have taken a toll on consumer confidence.

Developments in the labor market will be of particular importance in setting the course for household spending. As you know, the jobs situation remains far from normal....

The prospect of increasing fiscal drag on the recovery highlights one of the many difficult tradeoffs faced by fiscal policymakers: If the nation is to have a healthy economic future, policymakers urgently need to put the federal government's finances on a sustainable trajectory. But, on the other hand, a sharp fiscal consolidation focused on the very near term could be self-defeating if it were to undercut the still-fragile recovery. The solution to this dilemma, I believe, lies in recognizing that our nation's fiscal problems are inherently long-term in nature. Consequently, the appropriate response is to move quickly to enact a credible, long-term plan for fiscal consolidation. By taking decisions today that lead to fiscal consolidation over a longer horizon, policymakers can avoid a sudden fiscal contraction that could put the recovery at risk. At the same time, establishing a credible plan for reducing future deficits now would not only enhance economic performance in the long run, but could also yield near-term benefits by leading to lower long-term interest rates and increased consumer and business confidence....

the Federal Reserve's actions in recent years have doubtless helped stabilize the financial system, ease credit and financial conditions, guard against deflation, and promote economic recovery. All of this has been accomplished, I should note, at no net cost to the federal budget or to the U.S. taxpayer.

6--The ECB’s stealth bailout, VOX

Excerpt: The Eurozone crisis lingers on. This column argues that the Eurozone payments system has been operating as a hidden bailout whereby the Bundesbank has been lending money to the crisis-stricken Eurozone members via the Target system on the order of €300 billion. Urgent corrective action is needed, the author argues, as the scope for this sort of transfer is limited. If markets sense the end of the line, the Eurozone may face a crisis like the one Britain faced in 1992.

The parliaments of the Eurozone struggle to find an agreement about the future European Stability Mechanism (the €700 billion bailout system for the Eurozone’s stricken economies) hoping that their rescue package will solve the problems of Europe’s periphery once for all. They should know, however, that they are not the first to set up such a package. Theirs will just be a replacement for another rescue package worth more than €300 billion that the ECB has been operating for the past three years.

The ECB’s bailout system is buried in the so-called Target claims and liabilities in the national central banks’ balance sheets. Target is an acronym Trans-European Automated Real-time Gross Settlement Express Transfer System. At first glance, Target seems to be an irrelevant technicality, part of the mechanics of daily transfers of money among Eurozone banks – nothing more than a settlement system for inter-bank transactions. This impression is wrong.

* The Target balances are interest-bearing public loans that are being used to finance current-account deficits. In fact, the balances come close to short-term eurobonds.

* Moreover, their size dwarfs the parliament-approved bailouts extended to Greece, Ireland and Portugal.

Understanding the ECB’s tough stance

The situation is as dangerous as the one in 1992. That was when the British pound collapsed because the Bank of England had fewer deutschmarks and francs to sell than Gorges Soros was buying. True, the central banks could sell their gold and currency stocks to sterilise the money flows, but this would lead to a public outcry. Even with this, the ECB would only gain at most six more years (given the stocks of gold and foreign currency in the system); in 2018 it would be over for good. After that, the ECB system could no longer compensate for the fresh money issued by the GIPS with withdrawals of money from the rest of the Eurozone. That would make inflation inevitable.

The impossibility of continuing this policy is the reason why the ECB is now taking such an aggressive stance when it comes to providing more liquidity to Greece and the other GIPS countries. And it explains why Germany acquiesced to channeling new public loans through the European Stability Mechanism.
Time to move on

As the Great Recession is now over, it is time to stop the surrogate lending by the ECB system. This could be done by applying the US rules, for example.

7--What is the Obama presidency about?, The Economist

Excerpt: Given the lame proposals emerging from the White House these days, it's hard to imagine how he won't be. According to some polling, perceptions of the president's handling of the economy are at their worst ever.

I don't know why Mr Obama has been complacent. Christina Romer talks here about the battle between forces within the administration wanting to focus on growth and those most worried about the deficit. That Mr Obama moved so decisively, and so early, toward a deficit-cutting orientation suggests that over-optimism has been part of the problem. But by now, that optimism should have dimmed in the face of the facts on the ground.

Mr Obama isn't doomed, and it's not hard to imagine an economic scenario that works for the president....But there are enormous downside risks. America's government is one of them. Government spending cuts are now a drag on growth, and new cuts in any debt-ceiling agreement will add to these headwinds. If a deal isn't immediately reached, the situation could be worse still; efforts to avoid default would produce unprecedented cuts to spending—shock austerity—and actual default would spur a financial calamity. If America's government doesn't produce a crisis, another one somewhere else just might. And there's also the risk that America's economy will lapse back into falling growth expectations, as it did last year, and that the Fed will prove reluctant to act again.

Given all of this, what is Mr Obama's plan? When Americans look at him now, what does he want them to see? Having bought so completely into the story that immediate deficit-cutting is necessary, Mr Obama can't easily demand new stimulus. At best, he can argue that his painful cuts are better in some way than those proposed by Republicans. "I'm not as bad as the other guy", is not a winning incumbent message when voters are upset....

Right now, the Obama administration seems short of economic ideas and (perhaps worse still) uninterested in labour market troubles. His Republican challengers aren't offering anything better. But Mr Obama has made himself extraordinarily vulnerable on the economy, and if he loses his job as a result he has only himself to blame.

8--Top 5 Charts on the Bush Tax Cuts, Economist's View

Must see charts

9--Housing Prices Have Already Fallen More than During the Great Depression ... How Much Lower Will They Go?, Washington's blog

Excerpt: I noted in January that the housing slump is worse than during the Great Depression.

The Wall Street Journal noted Tuesday:

The folks at Capital Economics write in with this gloomy tidbit: “The further fall in house prices in the first quarter means that, on the Case-Shiller index, prices have now fallen by more than they did during the Great Depression.”

By their calculations, prices are now down 33% from their 2006 peak, compared with the 31% decline during the Depression.

The Independent agreed on Wednesday:

The ailing US housing market passed a grim milestone in the first quarter of this year, posting a further deterioration that means the fall in house prices is now greater than that suffered during the Great Depression.

The brief recovery in prices in 2009, spurred by government aid to first-time buyers, has now been entirely snuffed out, and the average American home now costs 33 per cent less than it did at the peak of the housing bubble in 2007. The peak-to-trough fall in house prices in the 1930s Depression was 31 per cent – and prices took 19 years to recover after that downturn.

How Bad Could It Get?

The above-quoted Wall Street Journal also notes:

The remarkable thing about this downturn is that even though prices have fallen by more than in the Great Depression, the bottom has yet to be reached. We think that prices will fall by at least a further 3% this year, and perhaps even further next year.

10--The Economy Is Worse Than You Think, Martin Feldstein, Wall Street journal

Excerpt: The drop in GDP growth to just 1.8% in the first quarter of 2011, from 3.1% in the final quarter of last year, understates the extent of the decline. Two-thirds of that 1.8% went into business inventories rather than sales to consumers or other final buyers. This means that final sales growth was at an annual rate of just 0.6% and the actual quarterly increase was just 0.15%—dangerously close to no rise at all. A sustained expansion cannot be built on inventory investment. It takes final sales to induce businesses to hire and to invest.

The picture is even gloomier if we look in more detail. Estimates of monthly GDP indicate that the only growth in the first quarter of 2011 was from February to March. After a temporary rise in March, the economy began sliding again in April, with declines in real wages, in durable-goods orders and manufacturing production, in existing home sales, and in real per-capita disposable incomes. It is not surprising that the index of leading indicators fell in April, only the second decline since it began to rise in the spring of 2009.

The data for May are beginning to arrive and are even worse than April's. They are marked by a collapse in payroll-employment gains; a higher unemployment rate; manufacturers' reports of slower orders and production; weak chain-store sales; and a sharp drop in consumer confidence....

As for the "stimulus" package, both its size and structure were inadequate to offset the enormous decline in aggregate demand. The fall in household wealth by the end of 2008 reduced the annual level of consumer spending by more than $500 billion. The drop in home building subtracted another $200 billion from GDP. The total GDP shortfall was therefore more than $700 billion. The Obama stimulus package that started at less than $300 billion in 2009 and reached a maximum of $400 billion in 2010 wouldn't have been big enough to fill the $700 billion annual GDP gap even if every dollar of the stimulus raised GDP by a dollar.

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