Thursday, November 10, 2011

Today's links

1--The End of Loser Liberalism: An Interview with Dean Baker, Naked Capitalism

Excerpt: I argue that the right has quite deliberately structured markets in a way that have the effect of redistributing income upward. The upward redistribution of the last three decades did not just happen, it was engineered.

I’ll give a few quick examples here. It is common to say that the right deregulated finance. This is only partly true. What they did was to take away the restrictions on what financial companies could do, while leaving in place the government insurance – explicit and implicit – that provides the necessary backdrop for a functioning financial market. In effect, they allowed the banks to have insurance without paying for it.

When most of the country’s major banks were literally on the edge of insolvency in the fall of 2008, very few of the “free market fundamentalists” were saying that we should let the market run its course. They were demanding that Congress, the Fed, and the FDIC do whatever is necessary to backstop the banks and keep them operating. The government’s intervention at that point prevented a full-fledged financial meltdown. This was the right thing to do for the economy, but it could have been down in a way that fundamentally altered the financial industry, so that the huge paychecks for top executives and high-flying traders would be rarer and smaller. Instead, the bailouts largely left the financial sector intact....

In short the United States has deliberately put in place a trade and dollar policy that disadvantages the bulk of the workforce for the benefit of employers, importers and those looking to invest overseas. The fact that manufacturing workers have done badly over the last two decades has nothing to do with random market outcomes. It was the result of deliberate policy.

The point of the book is that progressives must focus on these and other ways in which the right has structured the market to benefit the wealthy at the expense of everyone else. The failure to recognize that the market has been rigged to redistribute income upward leads to both bad policy and horrible politics.

We should focus on the key factors that determine market outcomes, not just accepting the outcomes and then using the government to pick up the pieces after the fact. There is a lot to be said for the right’s view of the market. It is an incredibly powerful instrument and we should be looking to structure it in a way that produces the outcomes we desire rather than just abandoning this task to the right. This is where the real action is: tax and transfer policy will always be a very distant second in its implications for income inequality.

2--Fed Watch: Endgame Approaching, Tim Duy, Economist's View

Excerpt: How viable is the idea of leveraging up the EFSF now that Sarkozy and Merkel have openly breached the topic of a breaking of the Euro? Do the Europeans really take the Chinese for such fools that they will save the Euro when the economic backbone of the Continent no longer believes it is worth saving?

A wild card in this disaster is the European Central Bank. The calls for action are deafening, yet they apparently fall on deaf ears. I think we all agree that the ECB can at least put a floor under Italy, and arguably should be doing that to prevent what appears to be largely a liquidity crisis from becoming a solvency crisis. They would also send a strong signal that the Eurozone does in fact have a lender of last resort. Make no mistake, they can't stop the blinding painful recession that is about to descend upon Europe. That is already backed into the cake, and the ECB would put the icing on the top by calling for harsh austerity in any nation receiving its backstop. But they could prevent a depression. And everyone believes they will step up to the plate eventually.

But what if they don't? What if Germany and France absolutely forbid it? If Germany and France are already planning for a new Europe, they certainly don't want it to begin with a central bank holding a massive piece of the debt from those nations they intend to eject from the Euro. As it is, they probably already fear that a Greek default is inevitable in the next few months, and the ECB will be left holding the bag on their Greek debt holdings. Why add further to those potential/likely losses?...

Brad DeLong pleads with the Fed to get in front of the curve:

The Federal Reserve needs to buy up every single European bond owned by every single American financial institution for cash before the increase in eurorisk leads American finance to tighten credit again and send us down into the double dip.

Here too it is probably already too late. The time to move was this summer.

At a minimum, the Fed could be preparing a credit facility to take European sovereign debt as collateral. Beyond that, I find it hard to imagine the Fed making large scale European debt purchases. After all, what will they define as an American financial instituion? Deutsche Bank has a US financial holding company - would a Fed commitment include all of Deutsche Bank's European bond portfolio? I don't think the Fed is ready to make such distinctions, especially after the public relations beating they took for lending to foreign banks during the US financial crisis.

In my opinion, they did not have a choice - the foreign banks are part of the US banking system and thus needed to be part of the emergency lending facilities. And, of course, the interconnectiveness of the European and US financial sectors argues for exactly what Brad proposes, even it if meant taking European debt off the hands of European banks. But isn't that the ECB's job?...

Bottom Line: The tide turned from optimism to pessimism today. Perhaps the opposite happens tomorrow. But ultimately, I believe pessimism will rule the day. The point of no return was reached when Germany and France openly discussed a smaller Eurozone. To be sure, the ECB could still offer upside surprise by serving as the lender of last resort, which would ease the downside pain. I don't anticipate the Fed will take on this role. The Fed is probably still mulling over what they perceive to be the limited US exposure to Europe, just as they did with the US subprime debt. And the relatively painless demise of MF Global probably reinforces that sense of complacency. The Fed will react eventually, but US conditions will need to deteriorate markedly before they do so.

3--Finito?, The Economist

Excerpt: ....SILVIO BERLUSCONI'S promise to resign has done nothing to calm European bond markets. Italian bond yields are soaring today; both the two-year and the ten-year are above 7%. There are rumours that the ECB is in the market and buying heavily. If so, it's not having the desired effect. The ECB can't hope to keep yields reasonable through brute force. It will need to make an expectations-changing announcement. Will it? Italy's yields aren't the only ones rising. Markets are ditching Irish, Spanish, Belgian, and French debt too. The ten-year Treasury is back below 2%.

Yesterday, I wondered why equities weren't falling. Today, they are. But I think Tim Duy is on to something here:

All I can say is that we have been here before. Recall 2007...
By the middle of 2007 the TED spread was exploding, signaling enormous financial turmoil. Yet equities kept heading upward, fueled by data that was just not that bad coupled with ongoing expectations that a solution was just around the corner. And now we find ourselves in almost the exact same position...the news out of Europe is abysmal...There is no solution, no magic summit at hand. At this point, it is a choice between severe recession and depression. There is no happy ending to this story.
I have been examining and re-examining the situation, trying to find the potential happy ending. It isn't there. The euro zone is in a death spiral. Markets are abandoning the periphery, including Italy, which is the world's eighth largest economy and third largest bond market. This is triggering margin calls and leading banks to pull credit from the European market. This, in turn, is damaging the European economy, which is already being squeezed by the austerity programmes adopted in every large euro-zone economy. A weakening economy will damage revenues, undermining efforts at fiscal consolidation, further driving away investors and potentially triggering more austerity. The cycle will continue until something breaks. Eventually, one economy or another will face a true bank run and severe capital flight and will be forced to adopt capital controls. At that point, it will effectively be out of the euro area. What happens next isn't clear, but it's unlikely to be pretty.

Can this cycle be interrupted? I think so. I think that an ECB guarantee to backstop sovereign debt, coupled with massive purchases to establish credibility and a substantial easing in monetary policy, could change the dynamic, particularly if quickly followed up with a major fiscal commitment from core economies to support bail-out efforts and invest in peripheral economies while peripheral economies focus on substantial labour market, public-sector, and tax reforms. How likely does all of that sound? Could the ECB even commit to the above bold actions without facing debilitating criticism, and perhaps intervention, from national governments?

I hate to get this pessimistic about the situation. It feels panicky and overwrought. I can't believe that Europe would allow so damaging an outcome as a financial collapse and break-up to occur. And I still don't understand why, if this is all as obvious as it seems to me, equities aren't down 20% now, rather than 2% or 3%. But the window within which something could be done to prevent it is closing, and fast. I hope to be proven astoundingly wrong in my assessment, but I'm struggling to see alternative outcomes.

4--Abschrift des NachDenkSeiten-Interviews mit James K. Galbraith, Nachdenkseiten

Excerpt: NachDenkSeiten: What do you see those inadequacies as being?

James Galbraith: Well, they are legion, but in some ways it’s quite simple. When sustainable debt relationships build up between two partners, there’s only two ways of dealing with them. One is for one of the partners can continually refinance, and that is what happens between China and the United States. The Chinese are in no position to demand any change in the form of payment they get. And the other is for the creditors to write down the debt, which is what has happened in, let’s say, Latin America, after the crisis of the 1980s. Europe has been resisting both of those alternatives with the result of the attempt to pay the debt crushes the economies of the debtor zones.

NachDenkSeiten: How did this actually get started? We’ve discussed before the trade imbalances of Germany and other countries.

James Galbraith: Well, that was a major theme particularly of Heiner Flassbeck and of Jörg Bibow, the two participants who are from Germany. And what they showed in a very simple graphic form was that since the origin of the euro Germany has pursued a policy of essentially zero wage growth, zero growth in unit labor costs. So you’re having one country that is acting as an outlier in Europe with very low growth of wages. France on the other hand was hitting roughly the targets, two per cent, that were built in to the way that the ECB is conducting business and the other countries were a little bit high, with the result of vast divergence between Germany and everybody else. A vast increase in German competitiveness and a vast increase in the German trade surplus. It’s accounting correspondence is the emphasis of accumulating debts in all of the other countries.
So at some level it is the imbalances that give rise to the problems. The imbalances though are not themselves necessarily problematic, the United States has a massive imbalance with China and there is no crisis. It is the difference in the way in which the imbalances are handled. This is the most important thing.

Most Germans take pride in the fact that they’re the so called “Exportweltmeister”, the export champion in the world. They feel that that’s sort of a sign of German industriousness and they’re loathe to try to cut that back. How would explain to them the necessity of balancing it out to some extent? What would you give them as advice to sort of soothe out the effects of that?

James Galbraith: There is, of course, as Richard Parker pointed out in the conference, a certain reflection of the historic protestant ethic in this view, and many ways one has to sympathize with it, German success is the result of having a highly competitive industrial structure.
But a number of points can be made: First of all the process of European integration itself has moved both industry and agriculture from the peripheral countries to the core countries. This is something which is inevitable in the process of integration. It has happened in the United States, it happened in Latin America, it happened in China in the reform process, one aspect of which was removing the internal barriers of trade. So this is an inevitable process, the European Union understood it would occur, and in principle they understood that there should be compensation, compensating flows going in the other direction, that’s what the structural funds are for. The structural funds however were totally inadequate to deal with the scale of concentration of activity that’s occurred. So more compensation, more of, and I don’t mean that in a valuated sense at all, more offsetting financial flows are required. And the Germans can basically make this happen in one of two ways, or one of three ways, they could of course cut back in their competitiveness, that would be a rather foolish and wasteful thing to do. It’s hardly the case that we should have less, fewer or less good German cars. Nobody would would make that argument sensibly.
German workers could live better and German retirees could live better, in other words the social wage could be increased. Wages for people, who are not in the competitive industries and who are living substantially more precariously in Germany than was the case 15 or 20 years ago, could be increased. So that’s a second possibility, that would increase imports and reduce the amount of the current account surplus in Germany.
And the third possibility is to facilitate financial flows to the countries that are in the debtor position. And that process, which is the recycling of money, can be done, well, there is no operational limit to it. The problem comes when it’s done on terms that involve commercial credit and involve interest payments and an eventual prospect of repayment, which cannot be made, because these conditions are not going to change. As long as Germany has a strong industrial base it’s going to be the surplus country in the euro zone. It’s not going to be the case that there will be, say, in twenty years from now a German deficit and a Spanish, Greek and Italian surplus to offset it. So it has to be offset by either the first two means that I spoke out or by a routinization of the financial flows.

NachDenkSeiten: You mean something like a transfer union?

James Galbraith: Yes, certainly. I mean one way to do it, the United States became a transfer union after the New Deal and especially the Great Society. The New Deal created Social Security, which put pensions in the United States on a continental footing and gave a common standard. The pension payments, Medicare and Medicaid gave a common standard to healthcare provisioned particularly for the elderly and poor Americans. Of course we have a military budget which is regionally redistributed for this greatly supported investment in the south. The New Deal had a large component of regional reconstruction. Tennessee Valley Authority, agricultural adjustment rule, electrification, a whole series of things that basically rebuilt the south of the United States, or built it for the first time and industrialized it and gave that region the standing that it has now as basically an ordinary part of the United States. All of these things were a process of turning a non-functioning bi-regional economy in North America into a single, coherent national entity. And that of course is the process that has not been completed in Europe....

5--Snap Reactions To Italy's €5 Billion Bill Auction, Which Reeks Of Illegal ECB Intervention, zero hedge

Excerpt: Earlier today Italy sold €5 billion in 1 year Bills at an average yield of 6.087%, the highest since September 1997, and almost 3% higher compared to a month ago, when it prices at 3.570%. Yet there was a stunning twist: the 1 Year was trading at a whopping 7.75% in the gray market minutes before the auction, or almost 200 bps wide of the auction result, something which never happens under normal conditions unless the invisible hand of the central bank has anything to say about it. Now we know already that the ECB stepped in to aggressively mop up Italian bonds in the secondary market immediately after the auction to bring 10 year yields below 7%, however briefly: the bond has since widened above that level once again. Yet what is shocking is the primary market strength for the 1 year: since the ECB is prohibited by law from intervening in the primary, auction market, we wonder just what illegal backdoor funding scheme the ECB has concocted with friendly banks in order to have the auction price where it did, and how much money was transferred by back door channels to keep Europe from imploding one more day. Considering that the EURUSD was trading below 1.35 just prior to the auction at around 3 am, and has since regained losses, just as we expected yesterday, please remind us to add this latest illegal central bank intervention feature to the list of things to uncover once Europe blows up and the ECB's secret trading records are laid out for all to see. In the meantime, here is the Wall Street snap reaction to the Bill auction.

From Reuters:


"This represents the highest such yield since September 1997 and although favourable relative to that of the Oct. 12s, which had briefly broken through 8.0 percent in the secondary market this morning, certainly does nothing to dispel the concern that Italy's debt costs have moved firmly into unsustainable territory."

6--Cautious Rebound amid ECB's Containment Strategy, Credit Writedowns

Excerpt: European stocks, Italian bonds and market sentiment in general are rebounding into the black after signs that Italy is speeding up the passage of its austerity bill, together with a decent Italian BTP auction and containment from the ECB. The Italian 10-year generic yield is currently at 6.92%. Sentiment is also improving amid fresh talk of an unscheduled ECB meeting today to authorize unlimited bond purchases. As a result, European bank shares are marginally higher, up 0.3%, though the long-term concerns remain as Germany’s CDU party is exploring ways for countries to exit the euro zone without leaving the EU. US S&P futures indicate a positive open, up over 1%. The BoE, as expected, left the repo rate at 0.5%.

Political uncertainty in the euro zone continues to dominate price action. Indeed, as we have argued this continues to be a crisis of confidence that in turn is weighing on economic activity. Today’s weaker than expected Italian and French September industrial production data underscore this point. But amid the chaos it is important to keep in mind that Italy is not Greece. Italy's existing debt carries a relatively low interest rate of 4% and the average maturity is seven years. That means the rise in market rates will take quite a while to filter through. What’s more, even if 10-year yields remain at 7% this is still well below the highs of the 1980s and 1990s. Italy, unlike Greece, is already running a primary budget surplus, so the austerity measures needed to make the Italian fiscal position more sustainable are much less severe than needed elsewhere. That means in the near term, Italy can cope with the uptick in market rates, but the developments highlight that sustainable budget policies have become are necessary to restore confidence. This is equally important for economic growth as well. From here, in the very short-term to restore it will be absolute necessary that Italy approves the recent fiscal measures and moves forward with either a coalition or technocratic government. Yet a much more committed intervention strategy from the ECB may also be required as the EFSF is unlikely to be up and running anytime soon. Altogether, more aggressive bond buying from the ECB could ease some pressures, causing both euro and risk appetite in general to consolidate.

7--EU Bailout Fund Stumbles Amid Bond Losses Clash, Bloomberg

Excerpt: European efforts to speed the setup of a permanent rescue fund have lost momentum amid a clash between Germany and France over provisions to force bondholders to share losses, three people involved in the negotiations said.

Finance ministers this week failed to bridge divisions over the European Stability Mechanism, lessening the chances of activating its 500 billion-euro ($680 billion) war chest next July, said the people, who declined to be identified because the talks are in progress. Officials had hoped to bring the ESM’s start date forward to mid-2012 from its ultimate deadline of July 2013, the people said.

Germany and the Netherlands are resisting pleas by France, Spain, Portugal and Ireland for the bondholder-loss provisions to be stripped from the ESM treaty, the people said. It’s possible that officials will still beat the 2013 deadline, the officials said.

European officials are scrambling to pull together as much money as they can to show investors they can stamp out the region’s worsening debt crisis. Operating the ESM in combination with the 440 billion-euro temporary fund next year would potentially boost Europe’s anti-crisis resources to 940 billion euros.

8--Once Again, Its Sweden (Sweden!) Showing the Way, The Big Picture

Excerpt: Over these past few years of watching Banks collapse, get bailed out, and then falter again, I have had a consistent take on the matter: The banking system is more important than any single institution; If you as a banker are so incompetent as to blow up yourself and your firm, you should not be saved; instead, prepackaged bankruptcy, a/k/a temporary nationalization, is the preferred route to protect the overall system.

The choices are stark: Emulate either Japan or Sweden. In the US, we have a hybrid (Perhaps we should call it Swedenese or Jaden).

The Swedish approach — Save the System! –is embodied in the FDIC, which has real dollars at risk as the insurer of depository accounts. They follow the Swedish model in that banks they determine to be insolvent are to be liquidated and or sold off top the highest qualified bidder.

The Japanese approach — Save the Banks! — is a result of their Keiretsu, and is the model embraced first by the Bush White House, and the Federal Reserve, than by Congress, and lastly by the Obama White House. I have argued this approach is in large part why the post-crisis economy has been so moribund, with sub-par GDP and Employment the rule.

This policy-making error is based on a refusal to take the loss. Indeed, Capitalism recognizes that failure is normal, and denying that, rejecting a fundamental premise of market based economies equals embracing socialized losses caused by the reckless. The approach of Socialism for bankers, Capitalism for everyone else is a philosophy that Keynes, Hayek and Friedman would all heartily reject en masse.

As the error or our (and the Japanese) ways becomes increasingly obvious to fair-minded observers, the Swedish approach continues to find new adherents. The latest is this piece in Bloomberg Business Week:

“Sweden’s bank rescue model has protected taxpayers, turned a profit and left the Nordic country less indebted than when the financial crisis started in 2007.

It’s the opposite of what’s happening in the U.K., where the government’s debt burden has doubled in the past four years and taxpayers are still footing the bill to bail out banks . . .

As lenders across the globe resist stricter regulatory controls they say will hurt earnings, Sweden’s commitment to enforcing rigorous standards has paid off. Companies like Stockholm-based Nordea Bank AB (NDA) are better capitalized than most of their European and U.S. rivals, and have better access to funding markets and a lower risk of default. Tougher controls enacted during the Swedish banking crisis of the 1990s also have protected the state budget, which will be in surplus this year.”

We are presented with a stark simple choice when confronted with a financial collapse. We can save the system or we can save individual banks. Astonishingly, we keep choosing wrongly . . .

9--Original Sin And The Euro Crisis, Paul Krugman, NY Times

Excerpt: One question that keeps coming up is, how can I reconcile my scorn for warnings about bond vigilantes with what is happening to Italy? This seems especially pointed because I have in the past used Italy’s ability to carry debt exceeding its GDP as an illustration that debt concerns were overblown.

The answer lies in the concept of original sin. Not the Pope’s kind, but the economics kind — the long-standing notion that developing countries were especially vulnerable to financial crises because they borrowed in foreign currency. (Yes, the linked paper actually raises some distinctions between currency mismatch and original sin; never mind for now).

The key point is that by joining the euro, Italy took a bite of the apple — it converted its advanced-country status, as a nation issuing debt in its own currency, into original sin, with debts in someone else’s currency (Europe’s in principle, Germany’s in practice). That is the root of its new vulnerability.

More on all this later, I hope.

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