Friday, September 9, 2011

Weekend links

Today's Quote: “Things are getting worse and the big difference between now and a few years ago is that this time around we’re running out of policy bullets...“There is a 60 percent probability of another economic contraction in most advanced economies.” Nouriel Roubini, chairman of New York- based Roubini Global Economics LLC

1--Rising Fears of Recession, New York Times

Excerpt: Over the last 50 years, every time that job growth has been as meager as it has been over the last four months, the economy has been headed toward recession, in a recession or in the immediate aftermath of one. From early 2010 through this spring, by contrast, employment was growing fast enough to make the economy look as if it were in a recovery, albeit a modest one. ...

A double dip would present obvious political problems for President Obama, whose approval ratings have already fallen below 50 percent and who is scheduled to give a speech to Congress on Thursday outlining a new jobs plan. A weak economy also could threaten incumbents of both parties in Congress, whose approval rating has hovered around 15 percent in recent polls....

But the latest indicators suggest that even if the economy does not continue to worsen, it appears to be too weak to add enough jobs each month — roughly 125,000 — even to keep pace with population growth. Anything less, and the share of the population that is employed will continue to fall.

Over the last four months, job creation has slowed to an average of just 40,000 jobs, or 0.1 percent, according to the Labor Department’s survey of employers. The last time such a meager increase did not coincide with a recession came in the 1950s.

2--Channeling FDR: The Moral Case Against Unemployment, Economist's View

Excerpt: Justin Wolfers:

Channeling FDR: The Moral Case Against Unemployment: My last weekend in D.C. provided a final chance to enjoy my favorite haunts. And so I found myself walking ... through the FDR Memorial, where I stumbled across the ... message below. ... A reminder, if you like, of why we care. ... If my photo isn’t entirely clear, let me reproduce the full quote:

No country, however rich, can afford the waste of its human resources. Demoralization caused by vast unemployment is our greatest extravagance. Morally, it is the greatest menace to our social order.

I’m sure FDR would acknowledge the usual economic case against unemployment—billions of dollars of lost output and rising fiscal pressure. And certainly, we hear this a lot in Washington. But I find FDR so persuasive because he advocates an explicitly moral argument, reminding us of the corrosive and demoralizing effects of unemployment.

This speech continues beyond the parts that were memorialized, and it is just as important:

I stand or fall by my refusal to accept as a necessary condition of our future a permanent army of unemployed. On the contrary, we must make it a national principle that we will not tolerate a large army of unemployed and that we will arrange our national economy to end our present unemployment as soon as we can and then to take wise measures against its return.

3--Was Marx right?, Harvard Business Review

Excerpt: Immiseration. Marx claimed that capitalism would immiserate workers: he meant that labor would be "exploited" — not just in a purely ethical sense, but in a narrower economic one: that real wages would fall, and working conditions would deterioration.....

Crisis. As workers were paid less and less, capitalism would be prone to chronic, perpetual crises of overproduction — for they wouldn't have the means to purchase or invest in enough goods to keep the economy humming. As Marx put it, there was likely to be "poverty in the midst of plenty."...

Stagnation. Here's Marx's most controversial — and most curious — prediction. That as economies stagnated, real rates of profit would fall. How does this one hold up? On first glance, it seems to have been totally discredited: corporate profits have broken through the roof and into the stratosphere. But think about it again, in economic terms: Marx's prediction concerned "real profit," not just the mystery-meat numbers served up by beancounters, and chewed over with gusto by "analysts." When seen in those terms, Marx might be said to have been onto something: though corporations book nominal profits, I'd suggest a significant component of that "profit" is artificial, earned by transferring value, rather than creating it (just ask mega-banks, Big Energy, or Big Food). I've termed this "thin value" and Michael Porter has described it as a failure to create "shared value." Replace "declining real profit" with "shrinking real value" and it's analogous to what Tyler Cowen and I have called a Great Stagnation...

Alienation. As workers were divorced from the output of their labor, Marx claimed, their sense of self-determination dwindled, alienating them from a sense of meaning, purpose, and fulfillment....

False consciousness. According to Marx, one of the most pernicious aspects of industrial age capitalism was that the proles wouldn't even know they were being exploited — and might even celebrate the very factors behind their exploitation, in a kind of ideological Stockholm Syndrome that concealed and misrepresented the relations of power between classes....

4--The euro zone double dip is almost here, Credit Writedowns

Excerpt: The OECD has warned that the economic outlook in developed economies has become significantly worse. The organization now expects a measly 0.3% growth in Q4, as close to recession as could be possible. The OECD has urged central banks to keep policy rates low and to stand ready for further easing.

In the euro zone, the situation is much worse as the sovereign debt crisis bears down with full force. The euro acts as a gold standard for individual euro zone members. As with the gold standard, euro zone members abdicated currency sovereignty in order to benefit from the price stability of the currency tie. Individual euro zone sovereign states are now currency users with limited policy space, meaning that a recession must be met with the deflationay response of pro-cyclical fiscal policy (budget cuts and tax increases).

Over the medium-term, this decreases demand and reduces economic growth. In a credit crisis, when private sector debt levels are high, debt deflationary forces of reduced output can lead to falling asset prices, debt distress, deflation and depression.

I see the procyclicality as one of the structural flaws of the euro zone; there is no federal agent to do counter procyclical budgeting during a recession. Thus, the euro zone business cycle will invariably be volatile, making current account imbalances a lightening rod for intra-European recrimination....

This does not augur well for the euro zone. In the past few months, I have become negative on the euro zone’s chances of survival. I no longer believe the political imperatives for the euro zone will be enough to overcome the politics of this next downturn.

5--EU banks caught in vicious funding crunch, Pragmatic Capitalism

Excerpt: The banks are caught in a vicious cycle, where concerns about sovereign debt are raising borrowing costs, forcing them to lean on the European Central Bank and Federal Reserve through swap lines set up in 2008 to alleviate credit bottlenecks. The central bank’s actions in turn send signals to investors that banks are having funding problems, raising the cost of borrowing even more.

“As concern about banks’ creditworthiness increases, their difficulty of securing funding grows,” said Brian Smedley, interest rate strategist at Bank of America Merrill Lynch in New York.

Each time the cycle resets, the amount of credit available outside the ECB or Fed is a bit smaller. That raises the risk of banks having to pay more for their funding and a perception that they cannot access the market directly for financing. However, an outright credit market freeze is unlikely because the central banks stand ready with swap lines set up just to prevent such a calamity.

Weaker banks, in particular, have seen their credit default swaps rise, meaning investors are worried about their credit quality. Even their stronger counterparts prefer not to lend to them. Instead, they park their cash with the ECB. Banks deposited EUR169.640 billion overnight at the ECB Tuesday, up from EUR166.848 billion parked Monday, the highest level since August 2010, data from the central bank show. A level above EUR100 billon signals market uncertainty and banks’ wariness in lending to each other
This leaves fewer funds available to borrow in the market, forcing banks to pay a premium for raising money in the open market, either by issuing corporate bonds or lending to investors in the commercial paper market.
If they tap the repo market instead, they need to post higher quality collateral, a difficult objective for some banks in Greece, Ireland and Portugal.

“The ECB has stepped in to fill the void on euro funding,” Smedley said.
Banks borrowed EUR119 million from the ECB Tuesday, up from EUR8 million Monday. On Friday, that figure was EUR14 million, down from EUR18 million on Thursday.

The reliance on the central bank is viewed as a sign of weakness so investors bid up the cost of insuring debt, and the cycle of paying more or leaning on the ECB starts anew. The cost of insuring European bank debt against default is at this year’s highs, according to the Markit iTraxx Europe Senior Financials, which tracks the five-year credit default swaps.
“There is concern in the marketplace that there is another shoe to drop on peripheral debt write-offs beyond what has been written off so far,” said Sassan Ghahramani, president and chief executive officer of SGH Macro Advisors in New York.

6--Corporate profits are in trouble, Pragmatic Capitalism

Excerpt: (Quote) "profit margins have surged due to massive cost cutting, layoffs and benefit reductions"...

Let’s get something straight – corporate profits are a reflection of the economy, not vice versa. There is also a huge difference between corporate profitability based on top line revenue growth and bottom line cost cutting.

Lately, there have been a plethora of analysts talking about the continuation of the bull market due to the expectation of rising corporate profits to record levels in the coming year. I have one question – how?
Corporations depend on sales to consumers to create revenue. “Sales”, and ultimately the “revenue” generated by the sales effort, are at the very top line of the income statement.

That is a decline in revenue in the 1st quarter of 2011 yet profit margins rose. Increases in the amount of net income at the bottom of the income statement can only be achieved by 1) increases of revenue at the top of the income statement; or 2) decreases in the expenses at the bottom of the income statement.

As you can see by the chart revenues have “normally” grown at fairly consistent levels with bottom line earnings prior to the economic recession in 2008-09. Post that recession profit margins have surged due to massive cost cutting, layoffs and benefit reductions – in other words profitability came at the bottom of the income statement. There is nothing wrong with this in the short term, however, it is a method of profit growth that is unsustainable in the longer term and, eventually, either top line revenue grows or profits began to fall. As shown that is exactly what happened in the first quarter of 2011....

There is more to the story. Since the depths of the “Great Recession” the disconnect between sluggish revenue growth and and the explosion of profits is now beginning to subside....

Therefore, if EPS is a reflection of GDP it is highly likely that as the economy continues to remain in a slower growth environment that earnings, and ultimately profits, will also began to become more sluggish. This in turn leads to the concern of the markets generating lower rates of annualized returns for investors as prices adjust to reflect lower profit growth.

With an already weak economy it is only a function of time before the markets began to adjust for lower profit growth. With the year over year profit growth of companies on the verge of going negative; asset prices will have to adjust to meet the decline in profitability. Since companies have already slashed head counts to the bone, cut back on inventories and are staffing with temporary workers; it will be exceedingly difficult in the future to mask declining profits with further cost cutting.

7--Mortgage rates fall to record lows, Calculated Risk

Excerpt: From Freddie Mac: Mortgage Rates Attain New All-Time Record Lows Again

Freddie Mac today released the results of its Primary Mortgage Market Survey® (PMMS®), showing mortgage rates, fixed and adjustable, hitting all-time record lows amid market and employment concerns and economic uncertainty. The previous record lows for fixed mortgage rates, and the 1-year ARM, were set the week of August 18, 2011. The 5-Year ARM matched its all-time low set last week at 2.96 percent.

30-year fixed-rate mortgage (FRM) averaged 4.12 percent with an average 0.7 point for the week ending September 8, 2011, down from last week when it averaged 4.22 percent. Last year at this time, the 30-year FRM averaged 4.35 percent.

8--German court curbs future bail-outs, bans EU fiscal union, Telegraph

Excerpt: Germany's constitutional court has at last delivered its Solomonic judgment on Europe's rescue machinery....
in reality the professors extracted language that kills off any prospect of a debt union, or an EU treasury and fiscal federalism, for the foreseeable future.

"The Bundestag's budget responsibilities may not be transferred through open-ended appropriations to other actors. In particular, no financial mechanisms can lead to meaningful fiscal burdens without prior approval," said the opinion.

"No permanent treaty mechanisms shall be established that leads to liability for the decisions of other states, especially if they entail incalculable consequences," it said.

The ruling is "a clear rejection of eurobonds", said Otto Fricke, finance spokesman for the Free Democrats (FDP) in the governing coalition.

Above all, the court ruled that the Bundestag's fiscal sovereignty is the foundation of German democracy and that Article 38 of the Basic Law prohibits transfer of these prerogatives to "supra-national bodies".

By stating that there can be no further bail-outs for the eurozone without the prior approval of the Bundestag's budget committee, the court has thrown a spanner in the works and rendered the EFSF almost unworkable.

It restricts the ability of Chancellor Angela Merkel to strike rescue deals at EU summits, leaving it unclear how she or any future Chancellor could respond to the sort of crisis that blew up in late July of this year when Italian and Spanish bond yields reached danger levels above 6pc.

9--Corp Profs At All Time High, Jared Bernstein, On The Economy

Excerpt: On “This Week” this morning, I mentioned that cutting corporate taxes was unlikely to boost hiring because their after-tax profits are already at an all-time record high, going back the beginning of the data series in 1947.

Here’s the picture. The top line is pretax, which is also historically high, but the record-breaking (by a long shot) bottom line reflects both higher profits and lower (effective) tax rates—i.e., we may have a high statutory corporate rate (35%) in international terms, but there are so many exemptions and loopholes that the average rate is much lower; see the table at the end of this doc showing how US firms went from paying a high share of GDP in corporate taxes in the 1960s to among the lowest today. (chart)

Clearly, if corporations can achieve this level of profitability without much hiring, or for that matter, putting much of it into American paychecks (the compensation share of GDP is at a 55 year low), then why would even higher after-tax profits lead them to do so?

10--The Profession and the Crisis, Paul Krugman, Eastern Economic Journal

Excerpt: Dark Age Macroeconomics (Quote: "We’ve entered a Dark Age of macroeconomics, in which much of the profession has lost its former knowledge, just as barbarian Europe had lost the knowledge of the Greeks and Romans."

Text: Early in 2009, when the Obama stimulus was under discussion, I was stunned to read statements from a number of well-regarded economists asserting not merely that the plan was a bad idea in practice — a defensible idea — but that debt-financed government spending could not, in principle, raise overall spending. Here's John Cochrane:

“If the government borrows a dollar from you, that is a dollar that you do not spend, or that you do not lend to a company to spend on new investment. Every dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private spending. We can build roads instead of factories, but fiscal stimulus can’t help us to build more of both. This is just accounting, and does not need a complex argument about ‘crowding out.’”

I won’t go into detail here about why that's wrong. Let's just say that statements like this reveal a complete ignorance of almost 80 years of macroeconomic analysis. Even the simplest multiplier model tells you that while it's true that S=I, that equals sign cannot be replace with an arrow running from left to right.

But what became clear in the policy debate after the 2008 crisis was that many economists — including many macroeconomists — don’t know the simplest multiplier analysis. They literally know nothing about models in which aggregate demand can be determined by more than the quantity of money. I’m not saying that they have looked into such models and rejected them; they are unaware that it's even possible to tell a logically consistent Keynesian story. We’ve entered a Dark Age of macroeconomics, in which much of the profession has lost its former knowledge, just as barbarian Europe had lost the knowledge of the Greeks and Romans.

As long as monetary policy could bear the burden of macroeconomic stabilization, this didn’t seem to matter too much: even as equilibrium business cycle theory became increasingly dominant in graduate study, central banks, like medieval monasteries, kept the old learning alive. But once we were hit with such a severe banking and balance sheet crisis that monetary policy hit the zero lower bound, it was crucial that the economics profession be able to weigh in knowledgeably and coherently on other possible actions. And it turned out that it couldn’t.

You often hear people saying that the crisis has revealed the need for new economic thinking, for new ideas about macroeconomics. Yet the first priority seems to be to resuscitate old ideas. Brad DeLong describes an interview of Larry Summers by Martin Wolf as follows: “Asked to name where to turn to understand what was going on in 2008, Summers cited three dead men, a book written 33 years ago, and another written the century before last.” And in my view, Summers basically got it right.

How did all this knowledge get lost? Well, being the age I am, I was able to watch the transformation of macroeconomics in real time, and I’d say that what happened was a runaway social process.

First, success in academic economics came from publishing “hard” papers — meaning papers that used rigorous and preferably difficult mathematics. This in itself biased publication toward equilibrium business cycle models, as opposed to the ad hoc modeling typical of what I consider useful macroeconomics. Graduate education, in turn, became increasingly focused on the kind of work that could get published and lead to tenure. Successive cohorts of students were trained only in the newly rigorous version of macro, which had lost touch with the field's previous intellectual achievements.

And as these cohorts became professors in their turn, they closed off both publication and promotion to anyone who questioned the dominant academic approach. Robert Lucas wrote more than 30 years ago — approvingly! — about how participants in seminars would “whisper and giggle” when someone presented a Keynesian analysis. No wonder that any non-equilibrium ideas dropped out of the curriculum and the conversation.

All of this would have been OK if the triumph of anti-Keynesianism was justified by superior empirical success. But it wasn’t. As I read the history of the equilibrium approach, it's a story of failing upward. Lucas-type models clearly failed to account for the duration of slumps; rather than reconsider flexible prices and rational expectations, Lucas's followers moved on to real business cycles (RBC). RBC models failed to generate any strikingly successful predictions, and in fact lost whatever plausibility they had once productivity started becoming pro-cyclical rather than counter-cyclical. But by that time the people doing these models didn’t know that there was any alternative.

And the result was that faced with a severe economic crisis, the profession spoke with a cacophony of voices. Or maybe a better way to put it is that the policy debate of 2009–2010 was virtually indistinguishable from the policy debate of 1931–1932. Long-refuted doctrines that should have been consigned to the dustbin of history were stated as if they were fresh new ideas — and they were fresh and new to many economists, because our profession had lost so much of its heritage.

In short, in responding to the crisis, the profession presented a sorry spectacle of unnecessary ignorance that didn’t even recognize itself as ignorance, of bitter debate over issues that were resolved many decades earlier. And all of this, of course, made the profession mostly useless at a time when it could and should have been of great service. Put it this way: we would have responded better to this crisis if macroeconomics had been frozen at the level of knowledge it had in 1948, when Paul Samuelson published the first edition of his famous textbook. And the result has been to leave actual policy discussion without any discipline from the people who should be shaping that discussion: politicians and officials have been free to follow their prejudices and intuitions, never mind the lessons of history and analysis. Economists have failed to fulfill their social function.

11--OECD says growth outlook has got much worse, Reuters

Excerpt: The outlook for economic growth in developed countries has got much worse in the last three months, the OECD said on Thursday and urged central banks to keep rates low and be ready to pursue other forms of easing.

The latest estimates marked a sharp slowdown from the Paris-based organization's last forecasts in May but used different methodology so were hard to compare precisely.

The Organization for Economic Cooperation and Development forecast growth across the G7 group of major industrialized economies would average 1.6 percent on an annualized basis in the third quarter before slowing to just 0.2 percent in the final three months of the year.

"With respect to three months back the growth scenario looks much worse, one would say that growth is stagnating," said OECD chief economist Pier Carlo Padoan.

"We are witnessing a growth slowdown across OECD countries."

The slowdown would hit Germany particularly hard, according to the OECD's estimates, forecasting that Europe's biggest economy would see annualized growth of 2.6 percent in the third quarter before contracting 1.4 percent in the fourth.

The U.S. economy, meanwhile, would see annualized growth of 1.1 percent in the third quarter slowing to 0.4 percent in the fourth quarter.

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