Wednesday, August 10, 2011

Today's links

1--They still don't get it, VOX EU

Excerpt: When we add up the public debts of Greece, Ireland, Portugal, Spain and Italy, we reach something like €3,350 billion; that is 35% of the Eurozone GDP; 130% of German GDP.
The contagion has spread, and will continue spreading until a real solution is in place.

Italy and Spain probably passed the point of no return.
Belgium and France could be next....

Solutions that won’t work

Plainly, we are facing a very dangerous situation. Eurozone leaders must quickly wake up and realise the severity of the threat they face. Their 21 July plan – which involved the EFSF fixing the problem defined as Greece while Italy and Spain are now the issue – is dead on arrival. There is no way the EFSF can deal with the amounts involved. If it tries we will have a German debt crisis.

This is a continuation of the central mistake made by policymakers – the belief that it is enough to buy a little bit of debts now and then to quiet financial markets until things get better.
What must be done to halt the confidence crisis?

The authorities must jump ahead of the curve and put in place an arrangement that effectively stops the rot. Instead of reacting, policymakers must start acting. There is only one way to stop the cyclone of doubt and falling bond prices. We must put a floor on public debt valuation. The stock of sovereign debt must be divided into two piles – bonds to guarantee, and bonds to default upon. This is how one jumps ahead of the curve.

The only institution in the world that can put up such amounts of money is the ECB. This is why central banks are lender in last resort. In fact, the ECB does not have to spend this money.
Guaranteeing public debts does not have to be expensive. As suggested to me by David Lucca from the New York Fed, the model should be bank deposit guarantees.

In 2008, most countries guaranteed 100% of bank deposits to stem incipient bank runs and guess what? There was no bank run and not one cent had to be spent.

In the case at hand, it is likely that the markets would challenge the ECB, so some money will be spent, but most likely very little.

2--Stagnant and paralyzed, Project Syndicate

Excerpt: What the world is witnessing is a correlated growth slowdown across the advanced countries (with a few exceptions), and across all of the systemically important parts of the global economy, possibly including the emerging economies. And equity values’ decline toward a more realistic reflection of economic fundamentals will further weaken aggregate demand and growth. Hence the rising risk of a major downturn – and additional fiscal distress. Combined, these factors should produce a correction in asset prices that brings them into line with revised expectations of the global economy’s medium-term prospects.

But the situation is more foreboding than a major correction. Even as expectations adjust, there is a growing loss of confidence among investors in the adequacy of official policy responses in Europe and the US (and to a lesser extent in emerging economies). It now seems clear that the structural and balance-sheet impediments to growth have been persistently underestimated, but it is far less clear whether officials have the capacity to identify the critical issues and the political will to address them....

There is little recognition that domestic aggregate demand cannot be restored to its pre-crisis levels except through growth. In fact, the household savings rate continues to rise.

The details may elude voters and some investors, but the focus of policy is not on restoring medium- and long-term growth and employment. Indeed, there is profound uncertainty about whether and when these imperatives will move to the center of the agenda......uncertainty, lack of confidence, and policy paralysis or gridlock could easily cause value destruction to overshoot, inflicting extensive damage on all parts of the global economy.

.... Stability can return, but not until domestic policy in the advanced countries, together with international policy coordination, credibly shifts to restoring a pattern of inclusive growth, with fiscal stabilization carried out in a way that supports growth and employment.

In short, we confront two interacting problems: a global economy losing the struggle to restore growth and the absence of any credible policy response.....

3--Slouching Toward a Double Dip, For No Good Reason, Robert Reich's blog

Excerpt: the government won’t come to the rescue by spending more and cutting most peoples’ taxes because it’s obsessed by a so-called “debt crisis” based on budget projections over the next ten years. That obsession – which serves the ideological purposes of right-wing Republicans who really want to shrink government — has even spread to the eat-your-spinach media, deficit hawks in the Democratic Party, and a major (and thoroughly irresponsible) credit-rating agency that’s neither standard nor poor.

Meanwhile, some lazy (or misinformed) commentators are linking our faux debt crisis to Europe’s real one. But the two are entirely different. Several European nations don’t have enough money to repay what they owe their lenders, or even pay the interest. That’s threatening the entire euro-zone.

But there’s no question that the United States has enough money to pay what it owes. We’re the richest nation in the world and we print the money the world relies on. The only question on this side of the pond is whether tea-party Republicans will allow America to pay its bills when the debt-ceiling fight resumes at the end of 2012....

The most important aspect of policy making is getting the problem right. We are slouching toward a double dip because we’re getting the problem wrong. Despite what Standard & Poor’s says, notwithstanding what’s occurring in Europe, and regardless of U.S. budget projections years from now — our current crisis is jobs, wages, and growth. We do not now have a debt crisis.

Every time you hear an American politician analogize the nation’s budget to a family budget (as, sadly, even President Obama has done), you should know the politician is not telling the truth. The truth is just the opposite. Our national budget can and should counteract the shrinkage of family budgets by running larger deficits when families cannot.

Americans are more frightened, economically insecure, and angrier than at any time since the Great Depression. If our lawmakers continue to obsess about the wrong thing and fail to do what must be done – and they don’t explain it to the nation – Americans will only become more fearful, insecure, and angry.

We are slouching toward a double dip, with all the human costs that implies. We don’t have to be. That is the tragedy of our time.

4--“Never-Ending Depression” Unless Debt Is Repudiated, Washington's blog via The Big Picture

Excerpt: As I noted last month, economics professor Steve Keen says:

[We’ll have] a never-ending depression unless we repudiate the debt, which never should have been extended in the first place.

Economist Nouriel Roubini writes today in the Financial Times:

Since this is a crisis of solvency as well as liquidity, orderly debt restructuring must begin. This means across the board reduction on the mortgage debt for the roughly half of America’s households that are underwater ….

This Has Always Been a Solvency Crisis, Not a Liquidity Crisis
Roubini is right.

John Hussman says: Our policy makers bailed out bank bondholders instead of focusing on debt restructuring. The bad assets are still in the banking system, millions of families will still lose their homes, the Treasury and Fed have jointly issued trillions in new government obligations, but the bondholders of Bear Stearns will still get 100% of their principal and interest.

Despite the current enthusiasm of Wall Street, this story has probably not ended, and the evidence suggests it will end badly

It has always been a solvency crisis – not a liquidity crisis – since 2008.

5--Downgrading our politics, The Economist

Excerpt: As S&P’s announcement makes clear, the inadequacy of the deal was only one motivation. As important (to me, even more important) was the the reckless and divisive battle that preceded it:

The political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy … [This] weakens the government’s ability to manage public finances …
This is crucial. Sovereigns aren’t like companies. They can’t go bankrupt, and creditors can’t seize their assets. Their creditworthiness depends as much on their willingness as their ability to pay. As Felix Salmon presciently noted before the announcement was made, it’s not our ability to pay that’s in doubt:

America’s ability to pay is neither here nor there: the problem is its willingness to pay. And there’s a serious constituency of powerful people in Congress who are perfectly willing and even eager to drive the US into default. The Tea Party is fully cognizant that it has been given a bazooka, and it’s just itching to pull the trigger. There’s no good reason to believe that won’t happen at some point. ...

It is striking that the proponents of this strategy seem so oblivious to its impact. Our economy is lubricated by a sophisticated and stable credit market whose most vital component is also the most ephemeral: trust. As the crisis amply demonstrated, when trust erodes, the system freezes up. America has built a reputation for responsible and credible management of its finances over the centuries, and that reputation has been reduced to a political football, like a federal judgeship. Henceforth a foreign pension fund or central bank that once mindlessly ploughed his spare cash into Treasurys will have to think twice.

6--ECB Wrote Detailed Letter To Italy "Dictating" Reforms -Report, Wall Street Journal

Excerpt: European Central Bank President Jean-Claude Trichet wrote a secret letter to the Italian government late last week "dictating" what Rome should do by way of economic reforms, Milan daily Corriere della Sera reported Monday.

Bank of Italy Governor Mario Draghi, who will succeed Trichet later this year at the ECB's helm, co-signed the letter, Corriere reported, without citing sources and without citing directly from the alleged letter.

The letter set out to the Italian government what measures it should take and a timetable of their implementation, the paper said, adding that the ECB's suggestions were tantamount to conditions the bank requires in exchange for its purchase of Italian government bonds.

The letter asks for rapid privatization of municipal assets, liberalization of various sectors, and offers "detailed" indications on how to loosen Italy's employment laws, Corriere said.

7--Eurogeddon postponed again as ECB gains three weeks, Telegraph

Excerpt: Now for the hard part. Unless the ECB is willing to back up its new role as lender-of-last-resort with massive purchases of Italian and Spanish debt, it will inevitably be tested by markets. Weak hands will take advantage of rallies to offload holdings onto the ECB, i.e. onto eurozone taxpayers. Frankfurt will find itself underwater very quickly without a legal mandate or EU treaty authority.

RBS calculates that the ECB will have to buy roughly half the outstanding tradeable debt of the two countries to defend the line. RBS calculates €850bn. I would put it nearer €1 trillion.

This is currently impossible. The ECB is acting as a temporary back-stop until the revamped EFSF bail-out fund is ratified by all parliaments over coming months. The EFSF will then take the baton.
Yet as we all know, the EFSF has no money. The parliaments have not even ratified the earlier boost to €440bn. As of today, the fund has barely €80bn left after all the commitments to Greece, Ireland, and Portugal. It remains a fiction.

As for boosting it further to €2 trillion or more – as suggested by Citigroup, RBS, and the European Parliament – we face a little local difficulty across the Rhine. Bavaria’s Social Christians said they will not back one bent Pfennig for extra bail-outs, and the FDP Free Democrats are almost of the same mood. Angela Merkel’s CDU base is more mutinous by the day. In any case, such an expansion of the EFSF would set off its own chain-reaction as France and then Germany lost their AAAs and slithered into the swamp.

8--Full Text: G7 Finance Ministers' and Central Bank Governors Statement on Financial Markets, Credit Writedowns

From the statement: In the face of renewed strains on financial markets, we, the Finance Ministers and Central Bank Governors of the G-7, affirm our commitment to take all necessary measures to support financial stability and growth in a spirit of close cooperation and confidence.

We are committed to addressing the tensions stemming from the current challenges on our fiscal deficits, debt and growth, and welcome the decisive actions taken in the US and Europe. The US has adopted reforms that will deliver substantial deficit reduction over the medium term. In Europe, the Euro area Summit decided on July 21 a comprehensive package to tackle the situation in Greece and other countries facing financial tensions, notably through the flexibilisation of the EFSF. We are now focused on the quick and full implementation of the agreements achieved. We welcome the statement of France and Germany to that effect. We also welcome the statement of the Governing Council of the ECB.

We are committed to taking coordinated action where needed, to ensuring liquidity, and to supporting financial market functioning, financial stability and economic growth.

These actions, together with continuing fiscal discipline efforts will enable long-term fiscal sustainability. No change in fundamentals warrants the recent financial tensions faced by Spain and Italy. We welcome the additional policy measures announced by Italy and Spain to strengthen fiscal discipline and underpin the recovery in economic activity and job creation. The Euro Area Leaders have stated clearly that the involvement of the private sector in Greece is an extraordinary measure due to unique circumstances that will not be applied to any other member states of the euro area.

We reaffirmed our shared interest in a strong and stable international financial system, and our support for market-determined exchange rates. Excess volatility and disorderly movements in exchange rates have adverse implications for economic and financial stability. We will consult closely in regard to actions in exchange markets and will cooperate as appropriate.
G7 Finance Ministers' and Central Bank Governors Statement on Financial Markets

9--An Experiment in Austerity, New York Times

Excerpt: We are about to run just such an experiment by tightening fiscal policy and cutting spending significantly below baseline projections at a time when the economy is weak. As I pointed out in a July 12 post, we performed this experiment once before, in 1937. The budget deficit was sharply reduced and a recession immediately followed.

Since the beginning of our recent economic woes, there has been a theoretical debate among economists about the proper governmental response. I think it is reasonable to say that most supported the idea of fiscal stimulus in principle, although there certainly were different opinions about the size and structure of the February 2009 Recovery Act. But there were also conservative economists arguing that the stimulus was a bad idea for the same reasons they urged Franklin D. Roosevelt to balance the budget in 1937. Funds that the government borrows would be better invested by the private sector, they said.

Conservatives lost the first round, but have launched a counterattack. Their primary argument is that Congress enacted a $787 billion stimulus package and two and a half years later the economy is still in neutral. Stimulus supporters, like this paper’s columnist Paul Krugman, have long argued that the stimulus was too small to do more than moderate the downturn and wasn’t large enough to offset the negative economic momentum that the Obama administration inherited....

The European Central Bank has published a number of papers over the last several years strongly endorsing the idea that fiscal contractions can be expansionary. Its latest study was published on July 12 and finds that the economy’s reaction to higher spending depends critically on expectations. If it is expected to be reversed in the future it is expansionary, but if it is expected to continue indefinitely then it is contractionary. If the results are symmetrical, then cuts in spending viewed as temporary may be contractionary while those viewed as permanent may be expansionary.

The International Monetary Fund has also published a considerable amount of research on this topic. Its latest study was published on July 6 and found that analyses which show fiscal contraction to be expansionary have misspecified the relevant changes in the fiscal balance. They lumped deficit reductions resulting from nonpolicy-driven factors, like stock market booms that raised government revenues, together with those explicitly engineered by policy makers. The I.M.F. study concluded that when the analysis was limited to policy-driven fiscal contractions, they were all economically contractionary. It found that a 1 percent of gross domestic product fiscal consolidation reduces real private consumption by 0.75 percent and real G.D.P. by 0.62 percent over the next two years.....

My point is not to exhaust the issues involved in calculating the economic effects of fiscal contraction; only to show that it is complicated. Readers should be skeptical of simplistic studies that cherry pick their examples, fail to control for variables other than the deficit as a share of G.D.P. and don’t make any effort to explain examples that don’t prove their point.

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