Thursday, July 14, 2011

Today's links

1--Bernanke May Tell Congress Deficits Imperil Decline in U.S. Borrowing Cost, Bloomberg

Excerpt: Federal Reserve Chairman Ben S. Bernanke takes his push for long-term deficit cuts to Congress today as a fiscal-policy deadlock threatens to reverse the decline in borrowing costs he gained through record stimulus.

Should Congress fail to avert a U.S. debt default by Aug. 2, the 10-year Treasury note’s yield, now 2.93 percent, would rise 0.5 percentage point within a month, said Priya Misra, head of U.S. rates strategy at Bank of America Merrill Lynch. Stocks and the dollar may tumble and the 10-year yield would rise to nearly 9 percent during the next decade, former Fed Governor Laurence Meyer said.

“We’re flirting with catastrophe,” said Meyer, senior managing director and co-founder of Macroeconomic Advisers LLC. “Bernanke is going to emphasize that. Irresponsible fiscal policy is a threat to the economy and makes Bernanke’s job more difficult.”

A rise in unemployment last month to 9.2 percent has increased pressure on Bernanke to consider spurring growth with a third round of bond buying, said Allen Sinai, chief global economist for Decision Economics Inc. Yet with the Fed’s balance sheet already at a record $2.87 trillion, Bernanke’s immediate goal will probably be to safeguard the economy’s gains by warning lawmakers about the damage from a default, Sinai said....

So far, the concern about the deficit hasn’t driven U.S. borrowing costs to above-average levels. The yield on the benchmark 10-year Treasury note jumped 6 basis points to 2.93 percent at 11:45 a.m. in London. That’s below the average of 7 percent since 1980 and the average of 5.48 percent in the 1998 through 2001 period, according to Bloomberg Bond Trader....

The economy, which expanded at a 3.1 percent annual rate in the final quarter of 2010, slowed to a 1.9 percent pace in the first three months of this year. The recovery advanced during the second quarter at a 2 percent pace, according to the median forecast of 62 economists surveyed by Bloomberg from June 28 to July 7.

2--U.S. Debt Ceiling Increase Remains Unpopular With Americans, Gallup

Excerpt: Despite agreement among leaders of both sides of the political aisle in Washington that raising the U.S. debt ceiling is necessary, more Americans want their member of Congress to vote against such a bill than for it, 42% vs. 22%, while one-third are unsure. This 20-percentage-point edge in opposition to raising the debt ceiling in Gallup's July 7-10 poll is slightly less than the 28-point lead (47% vs. 19%) seen in May....

Republicans are far more unified in their opposition to raising the debt ceiling (60% opposed, 11% in favor) than Democrats are in their support of it (39% in favor, 21% opposed). Independents tilt heavily against raising the debt ceiling, 46% to 18%, although 36% have no opinion....

Bottom Line

Despite intense lobbying of Congress by President Obama, Treasury Secretary Timothy Geithner, and others in the administration about the economic urgency for raising the nation's debt limit, fewer than one in four Americans favor the general idea of raising it. Also, Americans are significantly more concerned about the budgetary risk of giving the government a new license to spend than they are about the potential economic consequences that would result from not raising the debt limit. Both of these findings put Americans more on congressional Republicans' side of the debate than Obama's -- at least in terms of political leverage as the two sides negotiate a deal. Nevertheless, Americans place Obama and the Republicans in Congress at parity in their preferences for whom they trust more to handle the federal budget deficit and debt ceiling, similar to the close division in U.S. partisanship, more generally.

3--Did QE2 help US avoid Japan-like fate?, Richard Koo, Nomura Research Institute via Zero Hedge

Excerpt: St Louis Fed President James Bullard recently appeared on CNN and said there are some at the Federal Reserve who believeQE2 helped the US avoid falling into the same predicament as Japan. In my view, however, this view betrays a complete lack of understanding of what transpired in Japan.It took more than eight years after the bubble burst in 1990 for deflation to make an appearance in Japan. During this period,land prices fell more than 70% from their peak, and the yen climbed as high as 79 versus the US dollar in 1995. Yet pricescontinued to rise.In the US, in contrast, it has only been three and a half years since the housing bubble collapsed at the end of 2007. The dollar has fallen sharply in real effective terms during this period. Nevertheless, the Fed’s preferred measure of inflation—the core personal consumption expenditure deflator—is currently growing at an annual rate of +1.2%, which is almost identical to theyearly average increase of 1.3% in the BOJ’s preferred inflation yardstick—consumer prices ex fresh foods—in 1993, three anda half years after Japan’s bubble burst.

Fed view noted by Bullard most likely wrong...

What concerns me is that in 1993, three and a half years after Japan’s bubble burst, interest rates were not at zero and therehad been no quantitative easing. In the US, where interest rates have been at zero for two and a half years and the Fed hascarried out a massive quantitative easing program, the rate of inflation is still no higher than it was in Japan in 1993.Short-term rates in Japan stood at 2–3% in 1993, while long-term rates were in the 3–4% range. It was not until 1995 that theBOJ cut rates almost to zero and not until 2001 that the central bank embarked on quantitative easing.In summary, US inflation today, three and a half years after its bubble burst, is little different from inflation in Japan in mid-1993also three and a half years after its bubble burst. And the US employment situation is substantially worse—this despite the factthat the Fed lowered interest rates to zero and engaged in a bold program of quantitative easing far more quickly than the BOJ.That suggests a conclusion opposite to the view noted by Mr. Bullard...

In other words, it indicates that neither sharp cuts in interest rates nor quantitative easing have been able to effectimprovements in the economy. That result is also consistent with the lack of gains in economic activity or asset prices in Japanfollowing the BOJ’s own ZIRP and quantitative easing.
Meaningless for West to boast about speed of monetary response

This is important because there are still people in the West who believe that Japan’s recession lasted as long as it did onlybecause the Bank of Japan was slow to ease monetary policy, and that the recession in Western economies will be over soonenough because central banks have eased quickly.Investors in the US and Europe always ask about this issue. The expectations of a quick recovery based on quick central bankactions are shared not only by private investors but also by many senior government officials and economists.That is why they want to believe that QE2 and other forms of monetary accommodation by Western central banks have rescuedtheir economies from deflation. But it makes no sense to compare the rate of inflation in Japan more than a decade after thebubble burst with that in Western economies just three and a half years after the bubble collapsed, and use that as evidencethat Western government policies have successfully avoided deflation. Japan, after all, had no deflation at the same point intime.In my view, it is far more significant that housing prices continue to fall, money supply growth remains stagnant, and the labor market is still anemic in spite of all the easing carried out by Western central banks. This indicates that US and Europeaneconomies are experiencing the same kind of balance sheet recession as Japan did, and that monetary policy is powerlessunder such conditions. Only fiscal policy can help...

4--Murdoch: Dead man walking...(video) Nick Davies interview, naked capitalism

Summary: Were there break-ins? Was there phone tapping of "live" phone calls? As new details are uncovered, no one can be seen as a friend of Murdoch. The pile-on has begun. Be sure to watch last minute and a half of video.

5--Lies, damned lies, and statistics, Billy Blog

Excerpt: ...In the same paper, Modigliani, who introduced the term NAIRU to the economics profession in 1975 (Modigliani and Papademos, 1975) argued that:

Unemployment is primarily due to lack of aggregate demand. This is mainly the outcome of erroneous macroeconomic policies… [the decisions of Central Banks] … inspired by an obsessive fear of inflation, … coupled with a benign neglect for unemployment … have resulted in systematically over tight monetary policy decisions, apparently based on an objectionable use of the so-called NAIRU approach. The contractive effects of these policies have been reinforced by common, very tight fiscal policies (emphasis in original)...

It is clear that a solution to unemployment is to stimulate private spending. The problem is that the neo-liberal period has pushed so much debt onto the private sector that the balance sheet adjustments necessary to reduce the debt exposure will take time. Holding out for a sudden reversal of the investment ratio is poor policy and just forces unemployment to remain higher for longer.

The correct thing to do – despite what Paul Ryan thinks – is for the government to expand its share of total spending even further and drive aggregate demand harder at present. It should start by introducing a Job Guarantee and spending on public infrastructure. There is no secret – unemployment is caused by a failure of aggregate demand.

When one or more components fail (private spending) then public spending has to fill the gap. I am sorry it is so simple.

6--The Few, The Proud, The Non-Hysteric, Paul Krugman, New York Times

Excerpt: Martin Wolf:

"It is not that tackling the US fiscal position is urgent. At a time of private sector deleveraging, it is helpful. The US is able to borrow on easy terms, with yields on 10-year bonds close to 3 per cent, as the few non-hysterics predicted. The fiscal challenge is long term, not immediate.
But how can I be a non-hysteric if I’m shrill?"

Once again: if you took basic macroeconomic analysis seriously, you predicted that large deficits could and would coexist with low interest rates as long as the economy was depressed. Everyone who claimed the opposite was either ignorant of basic macro, or was making up new doctrines on the fly to justify his prejudices.

7--Radioactive meat circulating on Japanese market, CNN

Excerpt: A Japanese health official downplayed the dangers Tuesday after cesium contaminated meat from six Fukushima cows was delivered to Japanese markets and probably ingested.
Goshi Hosono, state minister in charge of consumer affairs and food-safety, said he hoped to head off any overreactions.

"If we were to eat the meat everyday, then it would probably be dangerous," Hosono said at a news conference Tuesday. "But if it is consumed only in small portions, I don't think it would have any long-lasting effects on the human body."

The meat, delivered late last month, has made its way to consumers and most likely has been ingested, the Tokyo Metropolitan Government said Monday evening. This was preceded by another recent discovery of radiation in the meat of 11 cows delivered to Tokyo from the same farm.

8--Who will buy all those bonds, Pragmatic Capitalism

Excerpt: On March 3rd I asked “Who Will Buy The Bonds?” I wrote this piece in response to a letter by Bill Gross in which he asked:

“The Treasury issues bonds and the Fed buys them. What could be simpler, and who’s to worry? This Sammy Scheme as I’ve described it in recentOutlooks is as foolproof as Ponzi and Madoff until… until… well, until it isn’t. Because like at the end of a typical chain letter, the legitimate corollary question is – Who will buy Treasuries when the Fed doesn’t?

…I don’t know. Reserve surplus sovereigns are likely good for their standard $500 billion annually but the banks are now making loans instead of buying Treasuries, and bond funds are not receiving generous inflows like they were as late as November of 2010. Who’s left?”

I responded by explaining that the bond auctions will serve as their usual reserve drain. This meant that Treasury and Fed would continue to coordinate bond issuance in accordance with reserves in the system. And the Primary Dealers would execute the reserve drain once QE2 ended. Just like they always do. The auctions would move along just as they always have and the mysterious (non-existent) bond vigilantes would appear to be in a deep slumber again.

Well, today we got the first bond auction since the end of QE2. And what happened? It was as strong as ever. The bid to cover came in at 3.22 with the Primary Dealers submitting bids for 2X the entire auction. Of course, I pointed this same phenomenon out several times before and during QE2, but you still heard the same rumblings today from various skeptics who said that the auction was only strong because of QE3 rumors. Nonsense. The auction was strong for the same reason they always are – the reserves are tracked in the system and hoovered up in accordance with the scheme that the mainstream media calls the “funding of the USA”. Of course, funding is not the purpose of US bond issuance, but explaining a boring old reserve drain wouldn’t make for good TV or political theater.

9--Stimulus withdrawals, Pragmatic Cpitalism

Excerpt: A recent Business Insider story by James Cooper beautifully mapped out the current path the US economy is headed down. With or without debt ceiling austerity, the U.S. economy faces a massive fiscal headwind in the form of stimulus withdrawal. Mr. Cooper explained how the US economy was set for the largest withdrawal of fiscal stimulus in 45 years:

“When 2012 begins, the economy is already scheduled to lose more than $300 billion in federal support, as several programs aimed at propping up growth in recent years expire or fade away by the end of this year. Policy changes now on the books will result in the most severe fiscal tightening in more than 40 years, subtracting an estimated 1.5 percentage points from GDP growth next year, according to an analysis by economists at J.P. Morgan Chase.

…Expiring programs will help to reduce 2012 deficit but at a heavy cost to the economy, especially in the first half of the year. So far the private-sector, which has grown by a modest 2.9 percent over the past year, has not shown the oomph needed to absorb a 1.5 percentage point hit to GDP growth while also supporting a growth rate strong enough to reduce unemployment. For example, for the economy in 2012 to make the mid-point of the Federal Reserve’s 3.3-to-3.7 percent growth projection, private-sector GDP would have to grow 5 percent, a pace not achieved since the tech-stock boom more than a decade ago.”...

“The underlying problem was not that rates were too high or that there were no stimulus packages already in place – the real underlying problem was that there was too much debt at the private sector level. That problem still exists and had already spread throughout the system by the time the Fed began to act. Nothing was done about it. All we’ve done is inject the patient with enough Percocet to put an elephant to sleep. In other words, the patient feels better, but the cancer is still there.”

So what’s beginning to happen now is that the patient is still suffering from the same disease, but is experiencing horrible withdrawals as the drugs wear off and the sick patient is once again revealed. This is frighteningly reminiscent of 1937 and the repeated mistakes of fiscal withdrawal in Japan. It’s incredible to me how Japan has essentially given us the playbook for this crisis and we are simply repeating many of their mistakes. Granted, we are Japan on fast forward, but that doesn’t make the lack of a rational policy response any more excusable.

For now, it looks like the budget deficit remains large enough to sustain below trend growth that results in a muddle through economy and what will continue to feel very much like a recession as private sector de-leveraging impedes growth. But as we head into 2012 the risks are skewed to the downside. If austerity from the debt ceiling debates turns out to be material, we could find ourselves confronting a very Japanese-like future. ( be sure to see charts)

10--More or not more, The Big Picture

Excerpt: Following the good 3 yr note auction yesterday, the 10 yr today was good as well. The yield was 1-2 bps below the when issued and the bid to cover of 3.17 was above the 12 month average of 3.11. Direct and indirect bidders totaled 55.9%, about in line with the prior two. Today’s auction had the influence of Bernanke’s comments on doing EVEN MORE, the weak payroll report and the obvious mess in Europe. In terms of QE3, or QE4, QE5, etc…, keep one thing in mind. Just as an alcoholic needs more and more booze each time to get drunk, each successive form of money printing from here on out has to be even greater for it to have an impact similar to the one before. Thus, it is not just the possibility of more, but the size of it that will matter compared to QE2. In terms of even lower interest rates mattering to the actual real world economy at this point, we know it doesn’t anymore. Asset prices again would be the only thing to benefit at the same time the US$ continues to lose purchasing power. What’s nuts and disturbing about this whole discussion is that its not even 2 weeks since QE2 ended.

Not to long after Bernanke today reiterated what was in yesterday’s FOMC minutes, that ‘more’ is always on the table, voting member Fisher is sounding like he will be one of the dissents on this. While he complained about QE2 over the past 6 months but still voted each time for continuing it, in a speech today he sounds like someone in the Fed saying ‘no more.’ He said, “I firmly believe that the Fed has already pressed the limits of monetary policy. So-called QE2, to my way of thinking, was of doubtful efficacy, which is why I did not support it to begin with. But even if you believe the costs of QE2 were worth its purported benefits, you would be hard pressed to now say that still more liquidity, or more fuel, is called for given the more than $1.5 trillion in excess bank reserves and the substantial liquid holdings above the normal working capital needs of corporate businesses…US banks and businesses are awash in liquidity. Adding more is not the answer to our problems.” I thus reiterate again and for last time as not to further annoy, while QE3 is always possible with this Fed, the bar is high and it won’t happen, I believe, unless we see a sharp downward move in both stocks and the economy.

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