Friday, December 16, 2011

Weekend links

1--News From Ireland, Paul Krugman, NY Times

Kevin O’Rourke:

“So, we hear Ireland is recovering”, a French friend said to me last night.

(Mind you, they said something similar in the summer of 2010. Our government has an incentive to sell the Irish good news story, and “Europe” has an incentive to buy it.)

So, here are the latest employment data, reporting the largest seasonally adjusted quarterly fall in employment in two years, and which surely deserve a thread of their own.

2--Europe Still Heading For Collapse, Tim Duy, Fed Watch

Excerpt: Alan Blinder provided the background in the Wall Street Journal:...

Blinder sees three paths out of the resultant mess:

There are three ways for the other countries to close the gap with Germany—and remember, the gap is large. First, Germany can volunteer for higher inflation than its euro partners by, for example, implementing a large fiscal stimulus or ending its wage restraint. How do you say "ain't gonna happen" in German?

Second, the other countries can engineer German-like productivity miracles through structural reforms while Germany, relatively speaking, stands still. Good luck with that. And even if it somehow happens, the timing is all wrong. Reforms take years to bear fruit while financial markets count time in seconds.

Third, the other countries can experience deflation, meaning a prolonged decline in both wages and prices, which is incredibly difficult and painful—and generally happens only in protracted recessions. Sadly, this may be the most likely way out....

From the Financial Times:

But, despite the central bank facilities, the cost of obtaining dollar funding in the private market continues to soar, pointing to a dollar funding squeeze as Europe’s banks head into their all-important year-end reporting period.

The three-month euro-US dollar basis swap dropped to as low as -150 basis points on Wednesday, meaning banks would have to pay an extra 1.5 per cent premium to swap their euros into dollars for a three-month period. The premium has not been persistently below the -140bps region since late 2008, during the depths of the financial crisis....

Bottom Line: I still don't see where this ends well. Play the news cycle if you are so inclined, but keep one eye on the key issue. Is Europe working to resolve their fundamental internal imbalances with anything other than deflation? As long as the answer continues to be "no," be afraid. Be very afraid.

3--Global Growth Struggles, Fed Stands Still, Tim Duy, economist's view

Excerpt: The news from Japan tonight:

Japanese business mood turned pessimistic in the three months to December, the central bank's tankan survey showed, a sign the stubbornly strong yen, Europe's debt crisis and slowing global growth were taking their toll on the export-reliant economy.

Earlier this week:

India's industrial production slid 5.1 percent in October, helping drive the rupee to a fresh record low against the dollar — more signs of the reversal of fortunes in Asia's third-largest economy...

Another one, via Bloomberg:

Brazil’s real fell to a two-week low after data showed Latin America’s largest economy shrank for a third month in October...

..Brazil’s seasonally adjusted economic activity, a proxy for gross domestic product, fell 0.32 percent in October from the previous month, capping its longest contraction since the bankruptcy of Lehman Brothers Holdings Inc. in 2008, according to central bank data. The real fell along with other currencies of commodity-exporting countries such as the Australian dollar and South African rand after the Federal Reserve dashed some investors’ expectations yesterday for monetary easing.

And a depressing global outlook via the Financial Times:

Cargill has become the Dr Gloom of the commodities trading sector.

The Minnesota-based company was the first big trading house to warn about the economic slowdown; its latest quarterly results reflected a sharp drop year-on-year; and now it is firing 2,000 people due to the “continued weak global economy”.

This is no small matter: Cargill is at the centre of global trade, shipping commodities from wheat to beef, and the wide reach of its business network helps it anticipate changes in the economic cycle.

4--The political endgame for the eurozone, VOX EU

Excerpt: Angela Merkel has now made preparations for such a political endgame. At the recent Christian Democratic party conference (Parteitag, see CDU 2011), a resolution was endorsed proposing an elected President of the European Commission. After election, the President can then form a team, including his or her Commissioner for Economic and Monetary Affairs (i.e. the EZ Finance Minister). The Commissioners will need to be approved in hearings by the European Parliament.

The CDU resolution also suggests reforms to the parliamentary side of political union. It proposes a two chamber system. The current European Parliament would continue to be chosen by European citizens, and form the equivalent of the Bundestag, House of Commons, Tweede Kamer, or House of Representatives in the respective national countries.

A new chamber – comprising the Council of Ministers – would be created and form the equivalent of the Bundesrat, House of Lords, Eerste Kamer or Senate. The central idea of such a two chamber system is that the political discussion would be initially held in the main chamber representing the full electorate, and that a separate “chambre de réflexion” would then represent the interests of the separate member countries....


Any complete solution to the euro crisis needs to be political. A technocratic solution will not do. This includes:

•A strong EZ Minister of Finance with budgetary and banking powers.

•An elected president of the European Commission.

•A two chamber parliament representing EU citizens and EU member states.

5--US Housing Prices Mirror Japan’s Experience, Big Picture

Excerpt: (chart) If you want to understand the entire set of US economic problems, this is the chart I would point you to.

The US residential housing market is tracking the Japanese experience, but shifted 15 years. Japan had their boom peak in 1989 — equities and real estate — and suffered for decades afterwards. The US saw a peak in 1999 (income, employment), 2000 (stock market), 2006 (housing) and 2007 (not tech stocks ). We are now a mere decade into the recovery from its credit crisis.

Where the US seems to have differed from Japan was in the willingness to blow a series of ever larger bubbles following the dot com and tech collapse.

This chart does not bode well for the US economy — real estate, employment, retail sales, and more — over the next years . . .

6--Fragile and Unbalanced in 2012, Nouriel Roubini, Project Syndicate

Excerpt: At this point, a eurozone recession is certain. While its depth and length cannot be predicted, a continued credit crunch, sovereign-debt problems, lack of competitiveness, and fiscal austerity imply a serious downturn.

The US – growing at a snail’s pace since 2010 – faces considerable downside risks from the eurozone crisis. It must also contend with significant fiscal drag, ongoing deleveraging in the household sector (amid weak job creation, stagnant incomes, and persistent downward pressure on real estate and financial wealth), rising inequality, and political gridlock.

Elsewhere among the major advanced economies, the United Kingdom is double dipping, as front-loaded fiscal consolidation and eurozone exposure undermine growth. In Japan, the post-earthquake recovery will fizzle out as weak governments fail to implement structural reforms.

Meanwhile, flaws in China’s growth model are becoming obvious. Falling property prices are starting a chain reaction that will have a negative effect on developers, investment, and government revenue. The construction boom is starting to stall, just as net exports have become a drag on growth, owing to weakening US and especially eurozone demand. Having sought to cool the property market by reining in runaway prices, Chinese leaders will be hard put to restart growth....

Private- and public-sector deleveraging in the advanced economies has barely begun, with balance sheets of households, banks and financial institutions, and local and central governments still strained....

At the same time, key current-account imbalances – between the US and China (and other emerging-market economies), and within the eurozone between the core and the periphery – remain large. Orderly adjustment requires lower domestic demand in over-spending countries with large current-account deficits and lower trade surpluses in over-saving countries via nominal and real currency appreciation. To maintain growth, over-spending countries need nominal and real depreciation to improve trade balances, while surplus countries need to boost domestic demand, especially consumption.

But this adjustment of relative prices via currency movements is stalled, because surplus countries are resisting exchange-rate appreciation in favor of imposing recessionary deflation on deficit countries. The ensuing currency battles are being fought on several fronts: foreign-exchange intervention, quantitative easing, and capital controls on inflows. And, with global growth weakening further in 2012, those battles could escalate into trade wars.

Finally, policymakers are running out of options. Currency devaluation is a zero-sum game, because not all countries can depreciate and improve net exports at the same time. Monetary policy will be eased as inflation becomes a non-issue in advanced economies (and a lesser issue in emerging markets). But monetary policy is increasingly ineffective in advanced economies, where the problems stem from insolvency – and thus creditworthiness – rather than liquidity.

7--The ECB Fear Factor, Philippe Legrain, Project Syndicate

Excerpt: Banks are struggling to stay afloat – their capital providing little buoyancy as funds drain away – while businesses that rely on credit are in trouble, too. All signs point to a eurozone recession.

Left unchecked, this panic about sovereign solvency will prove self-fulfilling: just as a healthy bank can fail if it suffers a run, even the most creditworthy government is at risk if the market refuses to refinance its debt. One can scarcely bear imagining the consequences: cascading bank and sovereign defaults, a devastating depression, the collapse of the euro (and perhaps even that of the European Union), global contagion, and potentially tragic political turmoil. So why aren’t policymakers doing whatever it takes to avoid catastrophe?

Ever since Italian bond yields first spiked in early August, I have believed that only an open-ended commitment by the European Central Bank to keep solvent governments’ bond yields at sustainable rates could calm the panic and create the breathing space needed to implement confidence-boosting reforms. Everything that has happened since then has only confirmed this view.

Now that the crisis has reached the “core” of the eurozone, the resources needed to backstop weaker sovereigns exceed the limited fiscal capacity of stronger ones. Financial wizardry cannot disguise that, while throwing a bigger lifeline risks dragging everyone down. Piling everyone on to the same life raft – through Eurobonds backed by joint and several guarantees – is not legally feasible for now, and would be politically toxic if attempted prematurely. Nor can a systemic crisis be resolved by individual governments’ actions – not least because the panic is outpacing politicians’ ability to respond. Only the ECB has the unlimited wherewithal to save Europe from the abyss now....

Granted, Article 123 of the Lisbon Treaty prohibits the ECB from purchasing bonds directly from public bodies, but intervening in the secondary market is permitted. The ECB has long been doing so through its Securities Market Program. Where in the treaty does it say that extending the SMP is prohibited? Indeed, a credible open-ended commitment to contain interest-rate spreads would actually require fewer purchases than the ECB’s current limited and temporary program does....

Exceptional times demand exceptional measures – and I believe that the ECB will feel obliged to act if the eurozone is pushed to the brink. But the longer the ECB delays, the greater the hit to people’s jobs and savings, the deeper the enduring damage to investors' confidence in the eurozone financial system, and the bigger the risk of a catastrophic mishap. The time to act is now.

8--The Euro in a Shrinking Zone, Robert Skidelsky, Project Syndicate

Excerpt: The agreement reached in Brussels forecloses any possibility of Keynesian demand management to fight recession. “Structural” budget deficits would be limited to 0.5% of GDP, with (as yet undisclosed) penalties for violators.

This is the wrong cure for the eurozone crisis. The Merkel doctrine holds that the crisis is the result of government profligacy, so only a “hard” balanced-budget rule can prevent such crises from recurring.

But Merkel’s analysis is utterly wrong. It was not deficit spending by governments that fueled the economic collapse of 2007-2008, but excessive lending by banks. Government’s mounting debts have been a response to the economic downturn, not its cause. What ought to have been hard-wired into the EU’s institutional structure was not permanent fiscal austerity, but tough financial regulation. Of this there is little sign....

The reason why recovery from the crash of 2007-2008 has been so anemic is straightforward. When an economy shrinks, government debt grows automatically, because its revenues decline and its expenses rise. When it cuts spending, its debt grows even more, because its cuts cause the economy to shrink further. This makes the government more, not less, likely to default.

In the eurozone, most government debt is held by private banks. As this debt increases, the value of banks’ assets falls. So the crisis of the sovereigns engulfs the banks. To put weakened governments on iron rations, as Merkel did, was to make a financial crisis inevitable. To continue to preach salvation through austerity as the economy declines and banks collapse is to repeat the classic mistake of German Chancellor Heinrich Brüning in 1930-1932....

The idea that a country can achieve a trade surplus by importing nothing is as fanciful as the idea that a government can repay its debt by starving itself of revenue. One person’s spending is another person’s income...

Quantitative easing, combined with public investment, would impart the growth impetus that the eurozone sorely needs to bring about a gradual reduction in its aggregate debt burden. But it is almost certain that neither policy, much less both, will be implemented.

The ECB is stealthily buying government bonds on the secondary market, but its new governor, Mario Draghi, insists that such intervention is temporary, limited, and intended solely to “restore the functioning of monetary transmission channels.” No one at the recent EU summit suggested making the EIB an engine of growth. So the bleeding will go on.

This means that the eurozone is beyond saving; the euro will survive, but the zone will shrink. The only question is the scale, timing, and manner of its breakup. Greece, and probably other Mediterranean countries, will default and regain the freedom to print money and devalue their exchange rates.

9--It’s the balance of payments, stupid, FT Alphaille

Excerpt: (must see charts) Just in case the point has not been hammered home over the last few years, or even the last few days, here’s a chart showing how quickly and dramatically the external debt imbalances got out of hand in the eurozone: More…

Just in case the point has not been hammered home over the last few years, or even the last few days, here’s a chart showing how quickly and dramatically the external debt imbalances got out of hand in the eurozone (chart)...

Carney believes the global “Minsky moment” has arrived, and a combination of debt restructuring, inflation and growth need to be deployed. He sums up:

The market cannot be solely relied upon to discipline leverage. It is not just the stock of debt that matters, but rather, who holds it. Heavy reliance on cross-border flows, particularly when they fund consumption, usually proves unsustainable.

As a consequence of these errors, advanced economies are entering a prolonged period of deleveraging.

Central bank policy should be guided by a symmetric commitment to the inflation target. Central banks can only bridge real adjustments; they can’t make the adjustments themselves.

Rebalancing global growth is the best option to smooth deleveraging, but its prospects seem distant.

10--Berlin Remains Stoic in the Face of Growing Crisis, Der Speigel

Excerpt: Several Warning Signs

The need for immediate action would appear to be obvious. The euro fell below the $1.30 mark on Wednesday for the first time in almost a year. Furthermore, Italian borrowing costs remain high, with the country having to pay almost 6.5 percent interest on a Wednesday issue of five-year bonds. It was the most Rome has had to pay for five-year bonds since the inception of the currency union.

There are several other warning signs as well. The Financial Times reported on Thursday that US depositors are pulling their money out of European banks in favor of domestic institutions. Indeed, foreign banks in the US have seen the largest six-month drop on record, from well over $1.1 trillion to $879 billion.

In addition, revised forecasts for Germany's economy indicate that most leading economists believe that growth in 2012 will be less than 1 percent -- with the country's Ifo Institute forecasting just 0.4 percent growth -- and that the euro zone is facing a recession.

Furthermore, the European banking industry is facing significant uncertainty as a new financial crisis continues gathering steam. On Wednesday, Germany's parliament voted to reactivate a 2008 bank bailout fund, perhaps in preparation for injecting much needed capital into the country's second largest bank, Commerzbank. Furthermore, the ECB offered up dollars to banks in need. The huge demand showed just how difficult it has become for European banks to access the capital they require. Ratings agency Fitch downgraded five banks on Wednesday, including French giant Credit Agricole, and Standard & Poor's reiterated that it currently has 25 European countries and 42 European banks on its watch list.

11--Trading EU summits: Hope to despair and back again, Reuters

Excerpt: Eight times this year, European Union leaders have met to tackle their deepening sovereign debt crisis, raising hopes in financial markets that a solution could be close.

All eight times, the meetings have ended without a plan of action comprehensive enough to give more than a few days comfort to investors, often turning initial gains in stocks, the euro and European government bonds into declines within days.

"I guess that's why they call them summits. You sort of go up on one side and come down the other," said Gary Baker, European equity strategist at Bank of America-Merrill Lynch.

Investors' lack of confidence in European leaders has become so ingrained that the time it takes for traders to begin dumping euro zone assets after each summit has grown shorter and shorter.

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