Thursday, December 1, 2011

Today's links

1--More Europessimism, Tim Duy, Economist's View

Excerpt: I hate to beat a dead horse, but the situation in Europe is dire, and two issues crossing my desk this afternoon only add to my angst. First, Karl Smith at Modeled Behavior sees that the ECB is losing all control of monetary policy:

Based on entirely different indicators this looks to be the point where the ECB’s control over Eurozone monetary policy began to come unmoored.

At the crux of the problem seems to be the inability to arbitrage away differences in funding costs between institutions and countries because of malfunctioning in the European Repo market.

This malfunctioning appears to be down right mechanical with trades regularly not settling on time, collateral not being delivered, awkward interventions by local regulatory agencies and a host of other deep, deep problems.

Very, very scary - remember that the ECB is the last great hope. But it can't be effective if the European banking system collapses, which looks more likely each day.

2--Aggregate Demand and the Global Economic Recovery, Janet Yellen, FRBSF

Excerpt: At the same time, too much fiscal tightening in the near term could harm the economic recovery. Significant near-term reductions in federal spending or large increases in taxes would impose an additional drag on the economy at a time when aggregate demand is already weak. Indeed, under current law, federal fiscal policy is slated to impose considerable restraint on the growth of aggregate demand next year. We need, and I believe we have scope for, an approach to fiscal policy that puts in place a well-timed and credible plan to bring deficits down to sustainable levels over the medium and long terms while also addressing the economy's short-term needs. I do not underestimate the difficulty of crafting a strategy that appropriately balances short-run needs with long-run considerations, but doing so would provide important benefits to the U.S. economy.

The Key Role of the Emerging Asian Economies

In light of the various factors weighing on aggregate demand in the United States and other advanced economies, I believe it is crucial for emerging market economies, particularly in Asia, to take further steps to boost domestic demand, providing support for their own growth and that of the global economy. Indeed, such policies are a core component of the G-20 nations' commitment to strong, sustainable, and balanced growth....

What are some specific policy measures that could be helpful? First, increased public spending on social services, such as education, health care, and retirement benefits, could spur consumption by reducing the need for precautionary household saving. In China, some redistribution of the profits of state-owned enterprises to the central government through larger dividend payments could provide revenue to support such spending. Second, government support could be shifted away from manufacturing toward encouraging service-sector development, which has typically lagged behind in these economies. Services tend to have a higher non-traded component, so faster growth of this sector would help rebalance growth toward domestic demand. Third, additional development spending could be directed toward these countries' poorest regions; for example, China has recently strengthened its efforts in this area.

The case for boosting investment rates in Asian emerging economies to support global demand is less clear-cut. At about 45 percent of GDP, Chinese investment rates are now so high that the return on new investment may already be quite low in some sectors.....

many emerging market economies, particularly in Asia, have the scope to bolster domestic demand. Such policies would support stronger, more balanced, and more sustainable global economic growth; they would enhance social welfare at home as well. The most profound effect of the Asian miracle of the past several decades has been to lift hundreds of millions of people out of poverty. Further actions to boost aggregate demand in Asia will ensure that this miracle is sustained.

3--US will not decouple from eurozone, The Economist

Excerpt: ...Financial markets are far more integrated than product markets, and they acted as a conduit of contagion from the American banking system to banks abroad. Falling asset prices in one place impact the balance sheet of leveraged institutions in another place. This transmits the crisis, which then impacts the real economy....

Should trouble in the euro zone lead the European banking system to freeze up entirely, the crisis will quickly be transmitted to America's economy; credit will dry up to American firms, and the real economy will lurch downward. That is the big risk to most large, non-European economies. Trade accounts for too little activity in big economies for a European collapse to be too disruptive; the financial spillover, on the other hand, will be dreadful. Where the Federal Reserve could do quite a lot to shield the American economy from the drop in European demand stemming from a deep euro-zone recession, it is more difficult for the central bank to provide insulation against an all-out banking panic.

And so the drama in the euro zone is very, very relevant to those outside the single currency, and even those separated from events by a big body of water. As Mr Krugman also wrote in 2008:

[T]o the extent that we regard falling asset prices and their consequences as a bad thing, which we obviously do right now, this analysis suggests that there are large cross-border externalities in financial rescues.

Macroeconomic policy coordination never got much traction, largely because economists never could make the case that it was terribly important. Financial policy coordination, however, looks on the face of it much more important.

America can spray fire retardant all over its banks, but if Europe refuses to step in to prevent financial collapse, non-Europeans will face serious consequences.

4--Italy and Japan, The Street Light blog

Excerpt: Consider the following differences between Italy and Japan. Italy has a history of lower budget deficits, as well as forecast budget deficits for the next few years that are dramatically lower than those forecast for Japan:

Italy's debt to GDP ratio has remained roughly constant over the past 15 years, while Japan's has climbed steadily higher:

Both countries have had relatively poor economic growth over the past decade, with little difference between them (charts)

And yet, despite all of this, yields on Japanese 10-year government bonds hover around 1.0%, while yesterday the Italian government was forced to pay nearly 8.0% to borrow money for 10 years. Given how much worse Japan's public finances look when compared to Italy's, it seems unlikely to me that investors are demanding higher interest rates from Italy simply because they are worried about excessive budget deficits or debt.

So what explains the dramatic disparity in investor willingness to lend to Italy compared to Japan? There are three crucial differences between Italy and Japan that, when put together, create a coherent story about what lies at the heart of this crisis:

1. Japan has the ability to create its own currency, while Italy does not.

2. Japan has been running current account surpluses, while Italy has had a current account deficit for the past several years.

3. Japan can borrow at 1.0% while Italy must pay much more to borrow.

Item #1 on this list has helped to cause the crisis for the reasons noted by Paul DeGrauwe: by giving up its own currency, Italy lost the important backstop on its government borrowing costs that countries that can borrow in their own currency have. This was a key prerequisite for this crisis to take hold.....

government deficits in Italy had little to do with getting it into this mess. Which is why all of the stern talk in Europe about setting up firm and credible ways to discipline countries into being fiscally responsible will do nothing to end the crisis in the short run, and nothing to prevent it from happening again in the long run.

5--Another European "Solution" Coming?, Tim Duy, Economist's View

Excerpt: Financial market participants continue to digest what is viewed as generally good news coming out of Europe.....What I don't see here is:

1.A path to true fiscal integration, which would imply direct transfers from relatively rich to relatively poor member states.

2.Similarly, a new path toward internal rebalancing. A commitment to stronger fiscal oversight implies continued pursuit of rebalancing via deflation in troubled economies. Moreover, as Paul Krugman notes, this will be attempted in the context of low inflation, which only exacerbates and extends the pain of adjustment. This path only ensures deeper recession.

3.A coordinated, continent-wide banking sector recapitalization. Note that Moody's just placed European bank debt under review. Downgrades are almost inevitable at this point.

4.An open door for stimulative policies to offset the demand contraction currently underway.

These are not small details. My fear is that European leaders think they can avoid these issues by enshrining fiscal austerity which, when combined with ECB intervention, will end the sovereign debt crisis. Confidence fairies will then fly to the rescue and fix the rest of the problems. To be sure, I think getting the sovereign debt crisis under control is critically important, but that alone will not stop the recession from deepening.

For those still expecting a mild European recession, I offer up Bloomberg's chart of the day - shipping rates from China to the US and Europe. The text:

Slumping shipping costs show exports to Europe from China are “falling off a cliff” as the euro- region crisis chokes off consumer spending, according to RS Platou Markets AS, a unit of Norway’s biggest shipbroking group.

The CHART OF THE DAY shows how the cost of hauling goods to Europe from China is falling faster than rates for deliveries to the U.S. The price for shipments to Europe is down 39 percent to $511 per twenty-foot box since Aug.

6--European Nations Pressure Own Banks for Loans, WSJ

Excerpt: Some European nations, struggling to find buyers for their bonds, are pressuring their own already-stressed banks to fill the gap by acting as lenders of last resort—in certain cases, pushing the amount of risky European debt on those institutions' books even higher.

Italy and Portugal, among other European governments, are leaning on their banks to continue buying—or at least to stop selling—government bonds, according to people familiar with the matter.

Meanwhile, in Spain and other European countries, the quantities of loans banks are doling out to local and national governments have been rising sharply.

7--More on the Fed's swap lines, credit writedowns

Excerpt: The cut in the rates dollar funding can be secured through the Fed’s swap lines today is noteworthy. It may address some funding pressure, but the forces on the other side seem stronger still. Downgrades and asset sales and credit line reductions all point to continued funding challenges.

There is also a stigma to accessing those swap lines. Part of the reason they were not used may be partly because of price, but in recent days the cross currency swap appears to have been risen to levels that made the punitive rate from the Fed more competitive.

European banks need to refinance an estimated 800 bln euros next year. More valuable than the cut in the swap rate today would have been follow through on the European promise for an EU-wide bank guarantee scheme like they had in 2008-2009.

Banks, including Spanish, French and Italian banks, have relied more on borrowings from the ECB. Banks have also used liquidity swaps to create billions of euros of assets that can be used as collateral to borrow even more from the ECB. The FSA has identified these liquidity swaps as a transmission mechanism for systemic risk.

8--Company Bond Sales Plunge as Trust in Banks Fades, Bloomberg

Excerpt: European companies are selling the fewest bonds in six years as the sovereign crisis sidelines cash-rich treasurers increasingly wary of the region’s banks....

European companies sitting on 540 billion euros of cash reserves, the most in at least nine years, are shunning bond markets even with yields near the lowest levels since November 2010. Investors who view corporate bonds as a haven because they’re less affected by the euro-region crisis are driving yields lower, while banks are being hurt because they’re the biggest holders of government securities.

“Yields are low, it’s tempting, but then when you think what you’d do with that cash, then a lot of that temptation goes away,” said Tony Kendall, the group treasurer for U.K. gas supplier Centrica Plc in Windsor, England. “Almost any bank could fail, depending on the circumstances, so for that reason we’re less comfortable having money with banks.”

9--Vital Signs: New Home Sales Stuck at Low Level, WSJ

Excerpt: New home sales inched up last month. There were 307,000 new homes sold, at an annual rate, up from 303,000 in September. With little new construction, the inventory of new homes remained at 162,000 — the lowest level on records going back to 1963. At October’s sales pace, it would take a half year to exhaust that supply; in 2005, it would have taken less than two months

10--DeLong: The 70% Solution, economist's view

Excerpt: The 70% Solution, by J. Bradford DeLong, Commentary, Project Syndicate: Via a circuitous Internet chain – Paul Krugman of Princeton University quoting Mark Thoma of the University of Oregon reading the Journal of Economic Perspectives – I got a copy of an article written by Emmanuel Saez, whose office is 50 feet from mine, on the same corridor, and the Nobel laureate economist Peter Diamond. Saez and Diamond argue that the right marginal tax rate for North Atlantic societies to impose on their richest citizens is 70%.

It is an arresting assertion, given the tax-cut mania that has prevailed in these societies for the past 30 years, but Diamond and Saez’s logic is clear. The superrich command and control so many resources that they are effectively satiated: increasing or decreasing how much wealth they have has no effect on their happiness. So, no matter how large a weight we place on their happiness relative to the happiness of others – whether we regard them as praiseworthy captains of industry who merit their high positions, or as parasitic thieves – we simply cannot do anything to affect it by raising or lowering their tax rates.

The unavoidable implication of this argument is that when we calculate what the tax rate for the superrich will be, we should not consider the effect of changing their tax rate on their happiness, for we know that it is zero. Rather, the key question must be the effect of changing their tax rate on the well-being of the rest of us.

From this simple chain of logic follows the conclusion that we have a moral obligation to tax our superrich at the peak of the Laffer Curve...

1 comment:

  1. As Thom Hartman has pointed out from his own business experiences, when tax rates are high he invested into his companies to build them instead of taking the profit and paying taxes on them.. When rates are low enough he would take the money and run.. Seems simple , raise the tax rates of the rich and corporations , put in place some import tariffs , tax profits brought back from foreign business , sit back adn watch the economy boom... This just for openers , I have many more things to do..