Monday, October 3, 2011

Today's links

1--Jim Chanos: China Has Tons of Contingent Debt Via State-Owned Enterprises, Economonitor

Excerpt: The overall gist of Jim Chanos‘ comments on Bloomberg yesterday were that China has off-balance sheet contingent liabilities due to its implicit commitment to state-owned enterprises which are knee-deep in land and property speculation. This speculative excess will lead to credit writedowns. Chanos repeated his contention from CNBC last week that he is net short China as a result, a bet Hugh Hendry has also been making – with spectacular results recently. See Michael Pettis piece on The debt-financed investments of Chinese state-owned enterprises for a comprehensive analysis of this problem.

Bottom line: expect a slow down in China – how much of one is still up for debate. Anything above 7% GDP growth should be considered a soft landing though. Below that 7% number, analysts would consider that a hard landing.
P.S. – this is the kinds of excess we’re talking about right here.

Bloomberg Television sent me the following partial transcript:

On the Chinese government’s balance sheet:

“The Chinese government’s balance sheet directly does not have a lot of debt. The state-owned enterprises of the local governments and all the other ancillary borrowing vehicles have lots of debt and its growing at a very fast rate. The assumption is that the state stands behind all this debt. We see that the debt in China, implicitly backed by the Chinese government, probably has gone from about 100% of GDP to about 200% of GDP recently. Those are numbers that are staggering. Those are European kind of numbers if not worse.”

On how a Chinese property bubble will play out:

“I think that will be the surprise going into this year, and into 2012 – that it is not so strong. The property market is hitting the wall right now and things are decelerating. The CEO of Komatsu said last week that he is having trouble getting paid for his excavator sales in China.

Developers are being squeezed. They’re turning to the black market for lending, this shadow banking system that is growing by leaps and bounds like everything in China.

“Regulators over there are really trying to get their hands around the problem. In the meantime, local governments have every incentive to just keep the game going. So they will continue with these projects, continuing to borrow as the central government tries to rein it in.”

2--NEIN, NEIN, NEIN, and the death of EU Fiscal Union, Telegraph

Excerpt: Judging by the commentary, there has been a colossal misunderstanding around the world of what has just has happened in Germany. The significance of yesterday’s vote by the Bundestag to make the EU’s €440bn rescue fund (EFSF) more flexible is not that the outcome was a "Yes".

This assent was a foregone conclusion, given the backing of the opposition Social Democrats and Greens. In any case, the vote merely ratifies the EU deal reached more than two months ago – itself too little, too late, rendered largely worthless by very fast-moving events.

The significance is entirely the opposite. The furious debate over the erosion of German fiscal sovereignty and democracy – as well as the escalating costs of the EU rescue machinery – has made it absolutely clear that the Bundestag will not prop up the ruins of monetary union for much longer.

Horst Seehofer, the leader of Bavaria’s Social Christians, said his party would go "this far, and no further".


There can be no question of beefing up the EFSF to €2 trillion or any other sum, whether by leverage or other forms of structured trickery. "The financial markets are beginning to ask whether Germans can afford all this help. We must not risk the creditworthiness of the German state," he said....

Repeat after me:
THERE WILL BE NO FISCAL UNION.
THERE WILL BE NO EUROBONDS.
THERE WILL BE NO DEBT POOL.
THERE WILL BE NO EU TREASURY.
THERE WILL BE NO FISCAL TRANSFERS IN PERPETUITY.
THERE WILL BE A STABILITY UNION – OR NO MONETARY UNION.

Get used to it. This is the political reality of Europe, since nothing of importance can be done without Germany. All else is wishful thinking....

3--It's Going to Get Worse, Credit Writedowns
Video--More on recession indicators

4--In Greece, Austerity Measures Weaken the Economy, What Did the Post Expect?, Dean Baker, CEPR

Excerpt: They kept spraying water on the wood, but they just couldn't get the fireplace started. The Post wrote the equivalent in an article on the
Greek crisis:

"The government has raised taxes and cut services and is announcing tougher steps every other week. So far it has been to no avail; the economic outlook keeps getting worse, not better."

When the government pulls money out of the economy by laying off workers, cutting government workers' pay, and raising taxes, the expected result is a weakened economy. This is exactly what has happened in Greece. It is difficult to understand what the Post meant in saying "to no avail."

5--Austerity Measures Are Hurting The Recovery, Seeking Alpha

Excerpt: ...if I had to pick a number one issue, it would be austerity measures at the state and local levels of government.

Cuts in state and local government jobs (police officers, school teachers, firefighters, DMV workers) are putting a drag on employment growth.

Moreover, this picture understates the problem, because total compensation to many state and local workers has been cut.

But I do think fear is part of the problem, at least in one sector of the economy. It seems to me that there are business opportunities in lending that are going unanswered. The pendulum for underwriting has swung so far to caution that, according to the Flow of Funds Accounts, net lending declined in the second quarter of 2011.

More specifically, net bank lending dropped by $181 billion on an annualized basis in the first quarter and by $129 billion in the second quarter. Net lending is the difference between volume of new loans and volume of repayment of old loans. I do find it plausible that one of the sources of the tight lending environment is a fear of regulators.

One more point: If it weren't for lending by the monetary authority, net lending in the second quarter would have fallen by $860 billion on an annualized basis.

6--QE And The 'Crowding Out' Of The Bond Market Vigilante, Business Insider

Excerpt: It will be interesting to see the data for the quarter ending today as no doubt there will be less yellow with end of Q2 on June 30 and more “flight to quality” blue (domestic) and red (rest of world).

Ronald McKinnon, professor of international finance at Stanford University, has an excellent piece in yesterday’s Wall Street Journal about the damage the Fed’s zero interest rate policy (ZIRP) is doing to the U.S. and global economy. One of his main points is the Fed and other central banks, who are not yield sensitive, have been financing the U.S. budget deficit and crowding out the now extinct U.S. bond market vigilante.
As you know the Global Macro Monitor is not a fan of ZIRP and believe it one factor that ails the economy not what will cure it. We take comfort to be the same company of such an intellectual heavyweight as Professor McKinnon. (chart)

7--Prepare for the coming recession, Pragmatic Capitalism CNBC (video)

Excerpt: “Today, we must sound the alarm bells loud and clear. ECRI’s leading indices of U.S. economic activity have turned down in a textbook sequence – first the U.S. Long Leading Index, then the Weekly Leading Index, and finally the U.S. Short Leading Index. Their growth rates are also in cyclical downswings, as are the growth rates of every one of ECRI’s sector-specific leading indexes. Under the circumstances, there is no indication that a reacceleration in economic growth is near at hand.
In the process of scrutinizing the evidence, we examined every one of these leading indexes to check whether they are in pronounced, pervasive and persistent (three P’s) downturns consistent with a ‘hard landing,’ namely, a recession, rather than a non-recessionary slowdown. After examining the three P’s for all of these leading indexes, we found that the overwhelming majority of their trajectories are currently in recessionary configurations. In practice, such a finding is sufficient to justify a recession call.

A useful way to summarize the evidence we see pointing to recession is to examine the spread of weakness among the components of ECRI’s U.S. leading indexes of economic activity… In that context, the recessionary decline in a summary measure of numerous reliable leading indicators, coupled with an ominous drop in a broad measure of current economic activity representing facts, not forecasts, constitutes a compelling recession signal.”

8--Household Worth in U.S. Declines for First Time in a Year, Businessweek

Excerpt: Household wealth in the U.S. dropped in the second quarter for the first time in a year, hurt by falling share prices and declining home values.

Net worth for households and non-profit groups decreased by $149 billion, a 1 percent drop at an annual pace, to $58.5 trillion, the Federal Reserve said today in its flow of funds report from Washington. It rose at a 7.4 percent rate in the previous three months. Housing wealth decreased for a fourth consecutive quarter from April to June.

A loss of $947 billion in real estate assets over the past year was compounded by a drop in the Standard & Poor’s 500 Index last quarter, the first decline in a year. The erosion in wealth, which remains below pre-recession levels, and a stagnant job market may prompt Americans to keep trimming debt and rebuild savings, limiting the spending that accounts for 70 percent of the economy.

“Households’ ability to spend is being constrained,” said Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia. “Consumers are just tired to death of seeing the value of their homes fall.” The decline in wealth “provides the argument for long-term stagnation in consumer spending.”

9--Moral Judgment and Bad Economics from the ECB, The Streetlight blog

Excerpt: It seems that the ECB's policy prescriptions are being guided more by ideology and moral judgment than by sound economics. A very revealing letter from the ECB to the Italian government from August has just been published in the Italian press. The BBC reports:
ECB told Italy to make budget cuts

The European Central Bank told Italy to make sweeping changes to its labour laws and take tough action to cut the deficit, a leaked letter has shown. In the letter, sent to prime minister Silvio Berlusconi in August, the ECB said the severity of Italy's economic situation made "bold and immediate" action "essential".

...In unusually clear language, the signatories told Mr Berlusconi to make deep reforms, including opening up public services and overhauling pay bargaining and hiring and firing rules.

...The letter, published in Corriere della Sera, said Italy should aim to bring the deficit down to 1% of gross domestic product by 2012 and balance the budget by 2013, a year ahead of schedule, "mainly via expenditure cuts".

This is troubling in several ways. First, as the article points out, the timing of things certainly makes it appear as if there was a quid pro quo: the ECB would help only if the Italian government took certain policy steps that the ECB wanted. The ECB has continuously denied that there was any such condition attached to ECB assistance, however -- which is a relief, because otherwise this would look awfully like an instance where a central bank was blackmailing a democratically elected government.

Second, the ECB was apparently expressing a purely ideological preference for Italy to reduce its budget deficit through spending cuts. But shouldn't the size of a country's government, and decisions about whether to use tax increases or spending cuts to reduce a deficit, be determined by the country's democratic process? When Alan Greenspan disguised his opinion that the US budget deficit should be primarily reduced through spending cuts rather than tax increases as the official advice of the Federal Reserve back in 2005, many (including me) where dismayed by this conflation of economic policy advice with ideological preference.

(Bernanke has done a much better job of keeping those two separate, by contrast.) So it's disturbing to find the ECB leadership now directly trying to impose its own apparent small-government inclination on democracies in the eurozone.

But third and most distressing to me is how a central element of the policy prescription that the ECB made to Italy was completely wrong.

Italy's problem is not annual budget deficits; yes, Italy had chronically large budget deficits during the decades leading up to euro adoption in 1999, but Italy actually ran smaller budget deficits than France, Belgium, or even the Netherlands over the past couple of years (see chart below).

Italy's problem right now is low growth, and the fact that such low growth makes it more difficult for Italy to service the massive debt is has left over from 20 or 30 years ago. The recession hit Italy very hard, and the country has been slow to recover (which makes Italy's relatively low budget deficits even more impressive, by the way). The last thing Italy needs at this point is a sharp fiscal contraction...

10--IMF Scrambles To Double Bail Out Capacity To $1.3 Trillion, May Issue Bonds, zero hedge

Excerpt: from Dow Jones ---The International Monetary Fund, looking to assure markets that it has the financial firepower to deal with deepening problems in Europe and also crises elsewhere, is exploring how it can have at least $1.3 trillion in lending power, according to officials involved with the discussions.

The IMF currently has about $630 billion in usable resources; about two-thirds of that could be lent under IMF rules.

Under the plan be considered, the fund would need to make permanent a $590 billion temporary lending facility that was put in place in response to the 2008 financial crisis.

The IMF is also counting on member nations to finally enact a doubling of IMF member country dues, totaling $750 billion, which have already been approved in principle. Approvals by national parliaments are expected in early 2012.

As for IMF bond issuance (unclear if it will be century bonds like Greece):
The IMF is also weighing whether to sell bonds in private markets on short notice, a move that could bolster its safety net beyond $1.3 trillion. The IMF has never sold bonds of this sort, and the U.S. and Germany among others have resisted such moves out of concern that the IMF would have too much independence from its major shareholders. It's not clear whether that opposition has lessened with the ongoing global financial turmoil.

11--What drives the economy, Pragmatic Capitalism

Excerpt: Corporations will not spend money on new plants and hire new employees unless they can clearly see consumer demand, which we believe will not be evident until the deleveraging is complete. Also, business investment makes up less than 15% of our GDP. Exports make up 14% of our economy, but remember, the GDP math subtracts imports from exports, and our imports are greater than our exports. Exports will not be a very good substitute for consumer demand and residential construction (which typically drove us out of recessions in the past) unless the U.S. dollar collapses and we are able to sell our goods and services at large discounts to our trading partners. This is not the magic elixir that we need to dig ourselves out of this dilemma, since there are so many other countries that we will be competing with as shown in the “competitive devaluation” section of our “Cycle of Deflation.” Just think about what the Euro Zone and the emerging markets would do as the U.S. forces down the U.S. dollar. China has already pegged the Renminbi to the U.S. dollar just in case we get desperate enough to drive the reserve currency down enough to increase our exports.

Our main point here is that we cannot substitute corporate investments and exports for consumer demand and residential construction. Consumer spending and housing are just too difficult to replace as drivers of the economy. This economy will be very hard to jump-start since the fiscal and monetary stimulus (that will be running-out this year and next) will feel like a tightening to our country. This sure looks like a “double-dip” to us!!

What about Europe?

As far as Europe is concerned, there was another statement from that same show this past Sunday. It came from George Will, a regular guest, “The U.S. Administration and Congress took measure after measure to stop housing from going to its natural level, and it looks as if Europe is making the same mistake with the weaker and more debt-laden countries.” It looks that way to us also! In fact, these weaker debt-laden countries and the U.S. have the same problems as we all are trying to implement austerity measures to cure our balance sheet problems, but the final result is even slower growth in our economies.

12--Game Over: California Attorney General Breaks From “50 State” Mortgage Settlement, Naked Capitalism

Excerpt: We’ve been saying for months that the 50 state attorney general settlement was not going to happen. Despite the vigorous efforts by people on the side of the Federal regulators involved in the negotiations and Tom Miller’s (the AG leading the negotiations’) office to make it seem as if the deal was moving forward, the content of the reports showed otherwise. There was a huge gap between the positions of the banks and even the bank friendly position of the state AGs at the table and the banking regulators. Like the Vietnam War, where negotiations of two fundamentally opposed dragged on till one side capitulated, there was not going to be a settlement that was anything other than an abject sellout with a 11 figure payoff to mask that fact. And there were too many attorneys general who were already troubled by the terms of the deal that Miller had put forward for that to happen.

Now that Kamala Harris, the California state attorney general, has officially abandoned the talks, they don’t mean much, at least from the state side. The departure of such a big state, in population, foreclosure exposure, and Electoral college terms, along with other states (New York, Delaware, Nevada, Massachusetts, Kentucky, Minnesota, likely Arizona) means any settlement has limited practical meaning from the state side and even less credibility. It also considerably raises the odds of other states bolting. And needless to say, this is a major repudiation of the Obama Adminstration “let’s sweep foreclosure fraud under the rug” strategy.
It’s also worth noting that Credo led a major campaign in California to pressure Harris to seek better terms or else abandon the talks. We’ve been generally critical of the left in the US, but it’s important to distinguish that our criticism is of what is probably best thought of at the “establishment left” or the “Rubin/Hamilton Project/Blue Dog/Third Way” let, which is pro corporate but less aggressively so than the right so as to maintain some credibility with the traditional Democratic base. There are some groups like Credo which stand for a just society and are effective operationally which are gaining traction as more people recognize that the Democratic party only occasionally stands up for their economic interests.

From the Los Angeles Times (hat tip Marcy Wheeler):

California Atty. Gen. Kamala Harris will no longer take part in a national foreclosure probe of some of the nation’s biggest banks, which are accused of pervasive misconduct in dealing with troubled homeowners.

Harris removed herself from talks by a coalition of state attorneys general and federal agencies investigating abusive foreclosure practices because the nation’s five largest mortgage servicers were not offering California homeowners relief commensurate to what people in the state had suffered, a person familiar with the matter said.

The big banks were also demanding to be granted overly broad immunity from legal claims that could potentially derail further investigations into Wall Street’s role in the mortgage meltdown, the person said.

The removal of California from the discussions is a major blow to fraying efforts by the 50-state coalition that has been trying to strike a settlement deal with the big banks for months. The move by Harris to reject the settlement talks is also a key departure from efforts by the Obama administration, which has been pushing for a fast resolution to the so-called robo-signing scandal that erupted last year.

For California homeowners, the move means that gone is the chance for quick relief stemming from revelations last year that banks improperly foreclosed on troubled borrowers. Key reforms to mortgage-servicing and foreclosure practices pushed by the attorneys general may also be delayed, affecting hundreds of thousands of Californians facing the loss of their homes…

Among the states with the highest foreclosure rates, California led the pack in new foreclosure proceedings last month, with an increase of 55% over July, according to data from Irvine-based RealtyTrac. Metro areas in the inland parts of California posted big jumps in August, with Riverside and San Bernardino counties soaring 68%, Bakersfield 44% and Modesto 57%.
In rejecting the 50-state talks, California also widens the riff among law enforcement officials nationwide over the best approach to pursuing banks for mortgage misdeeds.

13--ECRI Recession Call: ‘You Haven’t Seen Anything Yet, Kathleen Madigan, Wall Street Journal

Excerpt: The U.S. is headed back into recession. That’s the word from the widely respected Economic Cycle Research Institute, which uses economic indicators to put together leading indexes.

On its Web site, ECRI said the U.S. economy is “indeed tipping into a new recession. And there’s nothing that policy makers can do to head it off.” (Take that, Federal Reserve Chairman Ben Bernanke and President Barack Obama.)

The forecasting firm relies on dozens of specialized leading indexes to support the warning “If you think this is a bad economy, you haven’t seen anything yet.”

Consumers, however, aren’t so ready to throw in the towel. They expect some small ray of sunshine to peek through the gathering dark clouds.
Within Friday’s Thomson Reuters/University of Michigan consumer-sentiment survey, the index covering six-month expectations rose to 49.4 at the end of September from a preliminary reading of 47.0, while the current-sentiment index edged up only slightly.

The question is whether the slightly better outlook is based on positive trends consumers are experiencing now — or just wishful thinking. The Michigan survey suggests households may be viewing economic weakness as the new norm.

“When specifically asked how they expected the unemployment rate to change, 89% expected the unemployment rate to remain unchanged at its current high level or to increase during the year ahead,” the report says.
Households as a whole fell behind in August. Nominal personal income fell 0.1% last month as job growth and pay raises stalled. When prices and taxes are included, real disposable income dropped 0.3% in August following a 0.2% drop in July.

So far in the third quarter, real consumer spending is growing at a 1.4% annual rate. That’s up from second quarter’s 0.7%, but it could hardly be described as strong.

Clearly, the U.S. and global economies are at risk. The two key uncertainties are the protracted debate over the euro-zone sovereign debt problem and future U.S. job growth.

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