Monday, October 24, 2011

Today's links

1--There's a hole in the bucket, Paul Krugman, New York Times

Excerpt: The torments of the euro would be funny if they weren’t so tragic. At this point the urgent need is for a big Panzerfaust — a bailout fund big enough to head off a self-fulfilling liquidity crisis for Italy. But such a fund would be backed by the credit of the euro area’s remaining AAA governments, basically Germany and France — yet at this point the euro situation has deteriorated sufficiently that taking on another commitment would undermine French credit. There’s a hole in the bucket, and every attempt to fix that hole ends up being stymied because, well, there’s a hole in the bucket.

The answer to the whole conundrum is to back the rescue, not with French guarantees, but with the power of the printing press — to put the ECB behind the effort. But the ECB won’t and maybe can’t (under current rules) do that.

And meanwhile, austerity programs are leading to severe slumps in Greece and elsewhere. Who could have imagined that?

What a tragedy. A rich, productive continent, which has produced arguably the most decent societies in human history, is tearing itself apart because its elite insisted on embarking on a dubious monetary project, and now can’t bring itself to take the steps necessary to give that project a chance of working.

2--Number of the Week: GDP 6.7% Below Potential, WSJ

Excerpt: 6.7%: The gap between U.S. GDP and its potential.

It looks as if, despite everything, gross domestic product picked up in the third quarter, easing fears that the U.S. was on the cusp of another recession. But that doesn’t mean the economy is anywhere near where it needs to be.

Economists expect Thursday’s GDP report from the Commerce Department will show the economy grew at a 2.7% annual rate in the third quarter. That would still leave economic output 6.7% below what the Congressional Budget Office estimates its potential is. In other words, in a world where employment and economic activity were as high as they could be without the economy running into inflationary trouble, the U.S. would be producing about $900 billion more in goods and services a year than it is now.

Experts quibble about exactly where potential GDP is these days, and that’s especially true in light of all the damage the economy has suffered. Companies have invested less on new plants and equipment, unemployed workers’ skills have eroded, and some people have exited the work force for good — all things that have likely lowered the economy’s potential. But even so, everyone agrees it is still much, much higher than we're getting now.

3--Recovery before reform, Robert Skidelsky, Project Syndicate

Excerpt:The financial crisis that started in 2007 shrunk the world economy by 6% in two years, doubling unemployment. Its proximate cause was predatory bank lending, so people are naturally angry and want heads and bonuses to roll – a sentiment captured by the current worldwide protests against “Wall Street.”

The banks, however, are not just part of the problem, but an essential part of the solution. The same institutions that caused the crisis must help to solve it, by starting to lend again. With global demand flagging, the priority has to be recovery, without abandoning the goal of reform – a difficult line to tread politically....

Glass-Steagall aimed to prevent commercial banks from gambling with their depositors’ money by mandating the institutional separation of retail and investment banking. The result was 65 years of relative financial stability. In what economists later called the “repressed” financial system, retail banks fulfilled the necessary function of financial intermediation without taking on suicidal risks, while the government kept aggregate demand high enough to maintain a full-employment level of investment.

4--‘Tread Lightly in Stocks’ as TED Spread Widens: Chart of the Day, Bloomberg

Excerpt: Investors ought to “tread lightly in stocks” because credit markets have yet to show the kind of optimism that lifted share prices this month, according to Gina Martin Adams, a Wells Fargo & Co. strategist.

The CHART OF THE DAY highlights an indicator that Martin Adams used to draw her conclusion: the TED spread, or the gap between what financial companies and the U.S. government have to pay for three-month loans. The chart compares the spread with the Standard & Poor’s 500 Index since 2009.

During the first two weeks of October, the differential widened by four basis points, or 0.04 percentage point. The S&P 500, in contrast, recorded its biggest two-week gain since July 2009 by climbing 8.2 percent.

“Credit markets have not confirmed the positive tone of equities,” Martin Adams, who is based in New York, wrote in the report. That’s “usually a warning sign worth noting.”

From the end of July through the end of last week, the TED spread more than doubled to 39.5 basis points. The gap tends to widen as concern about credit risk increases, and vice versa.

5--U.S. Economy Trapped by Its Circle of Strife, WSJ

Excerpt: Bursts of enthusiasm aren't uncommon in bear markets. But they should be watched with caution.

Consider Japan. Just when the nation's stock market finally seemed to have stabilized, in the fall of 1991, another downdraft began.

The Nikkei 225 index, already down 35% from its December 1989 peak, went on to drop another 35% by the following summer. But even that wasn't the bottom. Nor was the next low in mid-1995. Nor the following one in late 1998.

The Nikkei, in fact, didn't bottom until it reached 7607 in April 2003. The 80% decline took 13 years to fully play out. And just when the deflation finally appeared to be over, the global financial crisis hit and pushed stocks to a fresh low again.

There are many important differences between Japan's experience and the U.S. today. But both instances, along with the Great Depression, are classic examples of credit booms turned bust. These are fundamentally different from garden-variety recessions and expansions triggered by inventory or demand shocks.

They are supercycles in terms of both time frame and scope. They are marked by asset-price bubbles that, upon reversal, trigger financial crises as the banking system struggles to stay afloat. And importantly, these financial crises tend to occur at the start—not end—of the debt-shedding process that can take years or even decades fully to play out.

6--Workers Lose Pricing Power, WSJ

Excerpt: Competition drives down prices. This is as true in the labor market as with any other marketplace.


Labor Department figures out Tuesday showed the number of U.S. job openings fell in August for the first time in four months, to about 3.1 million. At the same time, the number of unemployed rose to nearly 14 million. In other words, there were roughly 4.6 job seekers for every opening in August, up from 4.3 in July.

Little wonder that the average hourly earnings of workers declined during the month. In fact, intense competition for jobs is a key reason why U.S. incomes broadly are under so much pressure. There were never more than three job seekers per opening even during the worst of the last jobless recovery. That figure shot as high as seven during the worst of the recession in 2009. Today, it has yet to recover to anything like the average of two seekers per opening during the expansion of 2004-07.

This helps explain the sharp recent worsening of U.S. household finances—and sentiment. A study by two former Census officials released Monday showed that in real terms, the annual income of the typical U.S. household has fallen from $55,309 in December 2007 to $49,909 as of June, a drop just shy of 10%. This is partly because of the higher unemployment rate. Even for households headed by a full-time worker, however, median income has fallen by more than 5%.

And as Credit Suisse economist Henry Mo points out, even if all U.S. job vacancies were filled overnight, nearly 11 million workers would still be unemployed—and that doesn't include the nine million working part-time who would prefer full-time work and the 1.2 million who have given up looking altogether. Although the pace of layoffs has slowed, there simply aren't enough new positions to go around. In fact, separate Labor Department figures show the average number of people employed by new firms has been on a downward trend for two decades.

Given all this, deflationary pressure on incomes is likely to persist. While that helps companies control costs, it will also constrain consumer spending. That is because prices of certain household necessities, like food and gas, haven't been deflationary enough. The global commodity market is much tighter than the U.S. labor market. This, unfortunately, is the new normal.

7--Greek haircuts and Greek myths — the details, FT Alphaville

Excerpt:s ...FT Alphaville has also taken a look at “Greece: Debt Sustainability Analysis”, an assessment prepared by European Commission economists for discussion on Friday among European finance ministers.

The headline: it suggests private bondholders will be pushed to take 50 or 60 per cent haircuts.....

The assessment shows that debt will remain high for the entire forecast horizon. While it would decline at a slow rate given heavy official support at low interest rates (through the EFSF as agreed at the July 21 Summit), this trajectory is not robust to a range of shocks. Making debt sustainable will require an ambitious combination of official support and private sector involvement (PSI). Even with much stronger PSI, large official sector support would be needed for an extended period. In this sense, ultimately sustainability depends on the strength of the official sector commitment to Greece....


Making Greek debt sustainable requires an appropriate combination of new official support on generous terms and additional debt relief from private creditors: · Large, long-term, and sufficiently generous official support will be necessary for Greece to remain current on its debt service payments and to facilitate a declining debt trajectory.....

Under the assumptions used, the time required to get back to market could be significant, generating a potential need for additional official financing ranging up to €440 billion (i.e. under the worst case of the scenarios studied here, the faster macro adjustment shock)....

The results show that debt can be brought to just above120 percent of GDP by end-2020 if 50 percent discounts are applied. Given still-delayed market access, large scale additional official financing requirements would remain, estimated at some €114 billion (under the market access assumptions used). To get the debt down further would require a larger private sector contribution (for instance, to reduce debt below 110 percent of GDP by 2020 would require a face value reduction of at least 60 percent and/or more concessional official sector financing terms). Additional official financing requirements could be reduced to an estimated €109 billion in this instance. Of course, it must be noted that the estimated costs to the official sector exclude any contagion-related costs....

Depressing, sure — but also necessary and achievable, though it’ll still take more than what’s in this document.

For what the report doesn’t seem to cover is — unsurpisingly — the role of official creditors. As UBS economists noted earlier this week, even 50 or 60 per cent haircuts won’t be enough. A 110-120 per cent debt to GDP by 2020 (as suggested in the scenario) remains highly dangerous.

Indeed, there appears to be concern, to put it lightly, at the ECB about the scenarios used in the report. Scenarios that get a little close to home, perhaps. Here’s an interesting footnote to the last quoted paragraph:

The ECB does not agree with the inclusion of these illustrative scenarios concerning a deeper PSI in this report.
Because, as FT Alphaville’s Joseph Cotterill adds in an email to us, “either the official creditors take haircuts too (ha!) OR they’ll be discussing 90-100 per cent private haircuts soon enough.”

8--More on that looming crunch de crédit, FT Alphaville

Excerpt: The looming European credit crunch may not be the first thing on European leaders’ minds this weekend, but it’s coming, at least according to Citigroup....

The ECB, of course, announced on 6 October that it was reintroducing longer-term refinancing operations (LTROs), but that won’t be enough to stop a downward spiral of asset shedding, capital raising, loan contraction and reduced growth, suggests Citi.

From the note, emphasis ours:

Banks to shrink their balance sheets to replenish their capital buffers...

We suspect that the flow of loans to the private sector (see Figure 5) will be reduced to a trickle, as it was in the six quarters ending in Q1 2010...

We believe that unless investors’ perception of risk related to bank debt diminishes significantly over the next few months, a larger net proportion of banks will tighten lending standards and the supply of loans will decline. The magnitude of the resulting credit squeeze will be determined by the extent to which this phenomenon is concomitant to a contraction in demand....

Compared to the consensus, we are pessimistic about the ability of the euro area to grow in 2012, not only because we do not expect a solution to be found at the Euro summit that will solve the crisis, but also because we fear that the deterioration in macro leading indicators has further to run. We expect a mild recession in 2012, with negative quarterly GDP growth from Q4 2011 to Q3 2012. While most core countries might avoid a technical recession, we believe that the size of the fiscal tightening effort in financially-supported countries will lead to a sizeable fall in economic activity in those countries, hence dragging down the Euro zone aggregate.

9--Deck Chairs, Titanic, Paul Krugman, New York Times

Excerpt: OK, yes, European banks do need more capital. But their problems are a symptom of the underlying sovereign debt problem, which can only be resolved, if at all, with ECB lending AND a commitment to reflate. Without that, the losses on sovereign debt will blow right through any amount of newly raised bank capital.

So when I read

Europe’s big banks will be forced to find €108bn ($150bn) of fresh capital over the next six to nine months under a deal to strengthen the banking system agreed by European Union finance ministers.
I think, this is a band-aid — and one that’s going to be applied gradually, over six to nine months! — when the patient is at risk of dying in a few weeks from damage to his internal organs.

No comments:

Post a Comment