Monday, August 22, 2011

Today's links

1--Merkel defies pressure on debt crisis, Financial Times

Excerpt: Angela Merkel on Sunday urged Europe to stand firm in the face of market pressure and the “dramatic crisis” gripping the eurozone, insisting the solution was for states to slash public debt and boost competitiveness.

“Politics cannot and will not simply follow the markets,” Germany’s chancellor said, repeating her refusal to countenance funding indebted nations with a bond guaranteed by all members of the single currency bloc.... her most comprehensive rejection of the idea so far, Ms Merkel spoke of legal hurdles including lengthy ratification of an amended EU Treaty and possibly tricky changes to the German constitution.
“Solving the current crisis won’t be possible with eurobonds and that’s why eurobonds are not the answer,” Ms Merkel told German television.

Instead, states should continue to tackle the markets’ crisis of confidence “at the roots” by pursuing the “extremely difficult task” of improving competitiveness and growth.

“The ‘debt union’ has to be replaced by a ‘stability union,” she said. “This is a hard and arduous path, which we will not be able to avoid by means of some magic bullet, like issuing eurobonds.”

2--Italy’s Debt Burden May Balloon as Austerity Smothers Growth: Euro Credit, Bloomberg

Excerpt: Italy’s austerity drive, enacted in exchange for European Central Bank bond purchases driving down borrowing costs, may backfire as it chokes the economic growth needed to ease Europe’s second-biggest debt burden.

Prime Minister Silvio Berlusconi’s Cabinet approved 45.5 billion euros ($66 billion) in deficit reductions in Rome on Aug. 12, the nation’s second austerity package in a month, to balance the budget in 2013 and convince investors that Italy can trim debt of about 120 percent of gross domestic product. That’s the biggest ratio in Europe after Greece, whose fiscal woes sparked the sovereign crisis last year.

While the back-to-back packages aim to eliminate Italy’s budget gap, spending cuts and tax increases risk damaging the economy at a time when the global recovery is stumbling. The measures, already in effect, require parliamentary approval that starts today as Senate committees review the law before both houses vote in September.

“There are clear downside risks to growth emanating from such a sharp fiscal tightening profile, which could tip Italy’s fragile economy into a recession,” said Vladimir Pillonca, an economist at Societe Generale SA in London. That could “weaken revenue growth and undermine the ongoing fiscal adjustment” in the face of other challenges, such as “shocks to risk premiums and/or interest rates.”

Creating Stagnation

The government is “doing everything to create stagnation -- all this austerity, all the cuts and little investment for the future,” Corrado Passera, chief executive officer of Intesa Sanpaolo SpA, the country’s second-biggest bank, said in a speech today in Rimini, Italy.

3--A run on eurozone banks, Credit Writedowns

Excerpt: The Calafia Beach Pundit raises an interesting question in relation to the recent surge in the US money supply, which he suggests might be a reflection of a scramble for USD assets. More specifically, the argument would seem to be that a silent run on European banks is in the works as money is moved into perceived safe USD liquid assets.

As this chart of the M2 measure of money supply shows, it has gone on to experience a gigantic surge in the past seven weeks. M2 has risen almost $420 billion since the week of June 13th, on average almost 60 billion per week. To put this in perspective, annual M2 growth has averaged about 6% per year since 1995, and growth at this rate would translate into about $10 billion per week. In other words, M2 normally would have grown by $10 billion a week, but instead has grown six times faster. M2 has never grown this fast in a seven week period for at least the past 50 years. No matter how you look at it, this is a major event.

Where is the growth in M2 coming from? Virtually all of the increase can be traced to savings deposits (up $267 billion) and checking accounts (up $148 billion). Now we know why several large banks have announced they will now begin to charge customers who have over $50 million on deposit—they don't know what to do with all the money coming in.

Clearly, the theoretical argument is sound here. In a world populated by different paper currencies, a surge in liquid deposit assets of the reserve currency in times of crisis reflects preference for liquidity and safety. However, the idea that money is now systematically fleeing Europe is new and disturbing. The news last week that the ECB had to supply 500 million USD to an un-named Eurozone bank has added further to the speculation.

4--It is time for an Obama reset, Financial Times

Excerpt: "Barack Obama, like the US economy whose fate is bound up with his own, is in a slump. Since the shameful debt-ceiling battle, events have landed one blow after another: the Standard & Poor’s downgrade, a run of bad economic figures, crashing markets and growing fears of a second recession. With the US longing for new direction and the president’s ratings badly on the slide, Mr Obama headed off on his summer holiday.

Complaints about that last point, of course, are as unfair as they are traditional. By any standards, especially those of his predecessor in the White House, Mr Obama works hard. But the symbolism was a pity. The vacation followed a puzzling campaign-style bus tour of the Midwest, in which Mr Obama stressed two themes: the need to move beyond partisan squabbling and the irresponsibility of the Republican party. Lately the White House message has, to put it charitably, lacked focus.

Mr Obama has promised to announce a detailed initiative on jobs when Congress returns from its own vacation. Unfortunately this may serve only to underline his limited capacity to influence domestic policy, since the plan will go nowhere without backing in Congress – and it is unlikely to get far while Republicans smelling blood control the House of Representatives.

The best the president can do is rally public support for specific new measures. He could have been doing that in the Midwest. He could be doing it this week. Why the delay? Lack of economics heft in the White House may be a factor: the members of a once-outstanding economics team have left and have not been replaced by experts of like calibre. The ability to frame policy and present it authoritatively is not what it should be. In broad terms, the needed elements are plain: further short-term stimulus combined with credible longer-term fiscal restraint. Cut the payroll tax, extend jobless benefits and subsidise new jobs; then curb entitlement spending by raising the retirement age. Neither party in Congress is willing to embrace both sides of that proposal. The only hope of changing this is for Mr Obama to reset his presidency. Be bold. Lead more forcefully. Since all else has failed, put a serious plan to the country and win the argument.

Success in this would be far from guaranteed and the political risk is obvious. But the alternative, tactically and substantively, is worse – and Mr Obama no longer has much to lose.

5--Family finances 'worse than in recession', Independent

Excerpt: Household finances are under greater strain now than at the height of the recession in 2009, new figures issued today reveal, raising further concerns over the recovery of the British economy.

High inflation, high unemployment, rising debt levels and falling take-home pay have led to the fastest drop in household savings and available cash since monthly figures were first collected two and a half years ago.

Markit's Household Finance Index for August hit a new low of 33.2 (readings below 50 signal a deterioration in finances, above 50 an improvement), with two out of five households reporting deteriorating finances over the month compared with just one in 20 recording an improvement.

Tim Moore, a senior economist at Markit, said: "Recent events have made a week seem a long time in economics, and August's survey is the first sign that the slew of downbeat headlines has knocked consumer sentiment. Households reported the sharpest deterioration in their finances since the survey began, exceeding even that seen during the worst point of the recession."

The survey began in February 2009 but August's fall – for the third month in succession – suggests that household finances are deteriorating even faster than when the recession was in full sway. With key costs including energy and public transport set to increase, the future is looking bleaker than ever for families...

"If families are cutting back spending, the recovery risks being choked off," she said. "We need a balanced plan that puts jobs and growth first – more people in work paying taxes and fewer out of work on benefits is the best way to get the deficit down."

6--“It won’t take much for the interbank market to collapse,” Bloomberg

Excerpt: Swedish banks must do more to prepare for a deterioration in Europe’s debt crisis that could freeze interbank markets and cut off funding, said Lars Frisell, chief economist at the country’s financial regulator.

“It won’t take much for the interbank market to collapse,” Frisell, who is also a member of the Basel Committee for Banking Supervision, said yesterday in an interview in Stockholm. “It’s not that serious at the moment but it feels like it could very easily become that way and that everything will freeze.”

Swedish policy makers have been pressing for the nation’s lenders to seek more permanent, longer-term funding after the financial crisis in 2008. Following the collapse of Lehman Brothers Holdings Inc., Sweden’s central bank provided liquidity peaking at $30 billion because the country’s banks weren’t able to borrow in the U.S. currency to repay short-term loans.

While Swedish banks’ liquidity situation has improved since 2008, they still need to “do more” to raise the maturity of their financing, primarily the dollar funding, Frisell said. The banks have also said that their funding has become shorter in maturity because of reluctance from U.S. investors to lend long- term, he said.

7--Big Trouble Ahead,

Excerpt: The underlying structural weaknesses that are roiling markets aren’t a fashion and they are not going to go away any time soon. Here’s a more sober assessment from the guy who is probably the highest paid fund manger in the world (Mo El Erian, CEO at PIMCO, formerly manager of Harvard’s $30b plus endowment):

“The world economy is now in the grips of a damaging feedback loop involving deteriorating fundamentals, lagging policy responses and destabilized financial markets. If policymakers do not act boldly, and do so in a globally coordinated fashion, the world risks slipping into a prolonged recession with worrisome institutional, political and social consequences”....

So the big picture is that of a shrinking or static world economy, a developed world with no gunpowder left in the fiscal or monetary magazines and deep structural issues which remain unresolved. Professor Joseph Stiglitz recently summarized all this as follows:

All of this [gridlock politics in the USA, excessive austerity in Europe] makes it likely the North Atlantic will enter a double dip, but there is nothing magic about the number zero. The critical growth rate is that which stops the jobs deficit getting larger. Problematically, America’s and Europe’s current growth rate of about 1% is less than half the amount required to do this.

When the recession began there were many wise words about having learnt the lessons of both the Great Depression and Japans long malaise. Now we know that we didn’t learn a thing. Our stimulus was too weak, too short and not well designed. The banks weren’t forced to return to lending. Our leaders tried papering over the economy’s weaknesses – perhaps out of fear that if we were honest about them already fragile confidence would erode. But that was a gamble we have now lost.

Now the scale of the problem is apparent, a new confidence has emerged: confidence that matters will get worse, whatever action we take. A long malaise now seems like the optimistic scenario”[3]

Pause for stiff drink here if you wish....

8--A decade of economic winter, Business Spectator

Excerpt: The sharp break downwards in global markets towards the end of this week is an expression of strengthening concern that the global economy is slipping back into recession.

It is actually more than that. It is clear the markets are also fearful that what was a sovereign debt crisis in the eurozone is also building into another financial crisis. One of the factors in the sell-off has been reports that a European bank, unable to get funding conventionally, was forced to ask the European Central Bank for $US500 million of emergency funding, raising the spectre of another Lehman-like event.

With the gold price rising and just about everything else falling – US treasuries towards record lows – it is obvious that real fear is again abroad and, given the daily demonstration of the inability of Europe to develop a plan to eventually get its house in order, and the recent evidence of a similar failure of the political system in the US, there is good reason for the markets to be fearful.

The panic evident in markets towards end of the week was initially triggered by investment bank downgrades of the outlook for global growth and then compounded by the reports of a European bank in trouble.

9--The US Jobless Recovery: Assertive Management Meets the double hangover, Economist's View

Excerpt: The disposable worker hypothesis

When the economy begins to sink—like the Titanic after the iceberg struck—firms begin to cut costs any way they can; tossing employees overboard is the most direct way. For every worker tossed overboard in a sinking economy prior to 1986, about 1.5 are now tossed overboard. Why are firms so much more aggressive in cutting employment costs? My “disposable worker hypothesis” (Gordon 2010) attributes this shift of behaviour to a complementary set of factors that amounts to “workers are weak and management is strong.” The weakened bargaining position of workers is explained by the same set of four factors that underlie higher inequality among the bottom 90% of the American income distribution since the 1970s—weaker unions, a lower real minimum wage, competition from imports, and competition from low-skilled immigrants.

But the rise of inequality has also boosted the income share of the top 1% relative to the rest of the top 10%. In the 1990s corporate management values shifted toward more emphasis on shareholder value and executive compensation, with less importance placed on the welfare of workers, and a key driver of this change in attitudes was the sharply higher role of stock options in executive compensation. When stock market values plunged by 50% in 2000–02, corporate managers, seeing their compensation collapse with profits and the stock market, turned with all guns blazing to every type of costs, laying off employees in unprecedented numbers. This hypothesis was validated by Steven Oliner et al (2007), who showed using cross-sectional data that industries experiencing the steepest declines in profits in 2000–02 had the largest declines in employment and largest increases in productivity....

Thus labour’s weakened bargaining situation with changes in management behaviour toward greater emphasis on cost-cutting in recessions accounts for roughly 3 million lost jobs in the current jobless recovery. The other 6.72 million would have been lost even with the earlier responses because the output gap was so large...

Why is aggregate demand so weak?...

Consumption of all types, particularly of durable goods like autos and appliances and services like nail salons and child tutoring, grew faster than income, implying an ever-declining personal saving rate....

The second hangover was the impact of excessive indebtedness.
Just as consumption could exceed income as debts were being run up, so the second hangover required consumption to be below income while debts were paid off. The ratio of total household indebtedness to personal disposable income rose from 90% in 1995 to 133% in 2007 and has since fallen just to 120%. Year after year of saving and underconsumption will continue as households continue to pay off debts....


A change in labour market dynamics accounts for about 3 million of the over 10 million missing jobs in mid-2011. This shift can be traced to weakness of labour and growing assertiveness of management. But even with the labour-market institutions of 1955 through 1985, the weakness of aggregate demand in the recession and recovery would have cost roughly 7 million jobs instead of the 10 million jobs that are actually missing compared to normal economic conditions such as occurred in 2007.

The recession itself is usually and correctly traced to the collapse of the housing bubble and the post-Lehman financial panic. But the recovery has been unusually weak, completely unlike the economy’s rapid bounce-back in 1983–84, and this requires an explanation as well. The best place to start is the double-hangover approach, which explains not just the collapse of residential structures investment but also the continued and growing weakness in consumer spending. Perhaps the most surprising result of this essay is that the spending component responsible for the largest share of the missing jobs is not residential investment but consumer spending on services....

Authors including Hall (2011) focus on the zero lower bound as the crux of the Fed’s problem and ignore the complementary problem of low interest-insensitivity of consumers who are trying to pay off old debt instead of taking on new debt.

The failure of consumer and investment spending (IS) to respond to an ever-lower 10-year government bond rate, which fell below 2.3% this past week, demonstrates that the problem is an IS curve that is very steep if not vertical at an output level far below that necessary to generate a normal level of employment.

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