Monday, April 2, 2012

Today's links

1--Pimco's McCulley on liquidity traps, calculated risk

Excerpt: The United States and much of the developed world are in a liquidity trap. However, policymakers still have not embraced this diagnosis which is a problem as solutions to a liquidity trap require specific sets of policies. There are policies that will work, and there are policies that will not work. Correct diagnosis is necessary to prescribe the right policy medication.

A liquidity trap is a circumstance in which the private sector is deleveraging in the wake of enduring negative animal spirits caused by the bursting of joint asset price and credit bubbles that leave private sector balance sheets severely damaged. In a liquidity trap the animal spirits of the private sector cannot be revived by a reduction in short-term interest rates because there is no demand for credit. This effectively means that conventional monetary policy does not work in a liquidity trap.

...This is not to say that the private sector should not deleverage. It has to. It is a part of the economy’s healing process and a necessary first step toward a self-sustaining economic recovery.

However, deleveraging is a beast of a burden that capitalism cannot bear alone. At the macro level, deleveraging must be a managed process: for the private sector to deleverage without causing a depression, the public sector has to move in the opposite direction and re-lever by effectively viewing the balance sheets of the monetary and fiscal authorities as a consolidated whole.

...[McCulley reviews several recent cases]

...These historical cases of acting responsibly, irresponsibly and half-heartedly irresponsibly relative to orthodoxy carry telling lessons for the outlooks of the Eurozone, U.K. and U.S. today.

First, acting responsibly relative to orthodoxy in the Eurozone and following the German “dictat” of sado-fiscalism and internal devaluation are reminiscent of several defining economic episodes and frictions of the interwar gold standard.

...On a more systemic level, Germany’s refusal to inflate at the core while insisting on internal devaluation in the periphery is eerily similar to the frictions caused by the imbalance between gold surplus countries refusing to inflate and deficit countries unable to sufficiently deflate during the 1920s and early 1930s.

Just as laboring classes could not bear the pain of adjustments required by the gold standard’s orthodoxies, laboring classes in peripheral Eurozone economies may not be able to bear the pain of adjustments required by the single currency’s orthodoxies.

If history is our guide, painful adjustments will ultimately lead to some countries abandoning the euro, or politics overruling monetary orthodoxies: (1) legal restrictions against monetizing debt today versus the fixed exchange rate mentality of the gold standard, and (2) the independence of the ECB.

...Second, acting responsibly relative to orthodoxy on the fiscal front, but acting irresponsibly relative to orthodoxy on the monetary front, policies in the U.K. are also unlikely to work.

...Third, to date, the U.S. has acted irresponsibly relative to orthodoxy on both the fiscal and monetary front. This is good.

However, risks are rising that while the monetary authority will remain committed to acting irresponsibly, the government will choose to act responsibly relative to fiscal orthodoxy and adopt austerity.

2--Graph of the Day: Student Debt, the Trillion Dollar Threat to the American Middle Class, blog of the century

Excerpt:... the incredible growth of student debt has sobering implications for the future of the middle class and the U.S. economy. Last year, approximately one million students graduated a four-year college in debt—more than $23,000 on average and nearly $35,000 for those attending a private school. That's one million young people whose entry into the middle class will be delayed by a decade of debt servicing. Unlike the baby boomers, who spent their 20s and 30s buying homes, creating families and investing in the economy, today's youth face a trillion dollars in loan repayments, two-thirds of which is held by people under 39. It's enough to discourage an entire generation.

A weak economy and tough job market have made the situation even worse. Close to 25 percent of recent college graduates are unemployed, up from 19 percent in 2000. Of those employed, less than half work at a job that actually requires a pricey college degree.

The delinquency rate, too, has skyrocketed. Although the number of graduates behind on their payments was initially estimated to be around 10 percent—in line with the delinquency rate for other kinds of debt, like mortgages, car payments and credit cards—a new study by the Federal Reserve Bank of New York puts the true number at 27 percent, far higher than in other sectors of the credit market. As many as 47 percent of student loan borrowers are in deferral or forbearance while they wait for their luck to change.

But it's not just recent graduates who are struggling to repay their loans. Three-quarters of past due student loan balances—$85 billion in total—now belong to people over thirty, many of whom chose to go back to school and learn new skills during the recession. And while investing in an additional degree typically yields high returns in terms of future wages, a greater debt load also means delaying savings and putting normal patterns of consumption on hold. With close to $700 billion of student debt held by people over the age of 30, it may be a long time before we see middle class consumer behavior return to normal.

3--Credit tightening in the EZ, macronomics

Excerpt: We would have to go back to the peak of the crisis to register such a large tightening of terms.

Therefore, both the availability and the cost of credit are currently moving in the wrong direction. This is particularly striking since risk appetite made a strong comeback in Q1."

One has to ask oneself if the time has not come to start taking a few chips off the table....

As one can see, Spain has experienced a massive growth of households and corporate debt whereas the public debt as a whole has decreased since 1997 (During the boom years of 2004-08, construction & real estate activities explained more than half of the increase in bank lending to the corporate sector source IMF Article IV, 2011).

The burst of the housing bubble means there is a significant debt hangover for households, and the significant level of unemployment is not helping the deleveraging process...On a final note, as indicated in a recent report by Barclays, the pace in the fall of Spanish real estate prices is accelerating, explaining the significant rise in Non-Performing loans on Banks Balance sheets...

4--The limits of monetary policy, Narayana Kocherlakota - President

Federal Reserve Bank of Minneapolis

Excerpt: there are two distinct types of demand shocks: labor demand shocks and product demand shocks. The labor demand shocks reflect factors such as adverse credit conditions and increased uncertainty that lead firms to demand fewer workers at a given real wage. The product demand shocks reflect factors such as a loss of wealth and a higher risk of job loss that lead households to demand fewer goods at a given real interest rate. Each of these shocks leads to a fall in employment, with the decline in employment magnified by slow adjustments in the real wage.

When considering these shocks, it is important to distinguish how monetary and non-monetary policies influence the level of output and employment. In the model I employ, the Federal Reserve controls the real interest rate; lowering the real interest rate increases the demand for goods and services, and thereby influences national output and employment.

The first implication of the model is that monetary policy can offset the impact of the product demand shocks on employment, but it cannot offset the employment loss due to the fall in labor demand and any associated slow real wage adjustment. As a result, the level of “maximum employment” achievable through monetary policy is less than the “full employment” of labor resources.

A second implication is that non-monetary policies specifically designed to stimulate the demand for workers (such as government subsidies for hiring) can offset some of the employment loss due to the labor demand shocks, but only if accompanied by monetary easing. That is, monetary and non-monetary policy must work in concert to reduce the impact of a decline in labor demand; neither can do it alone.

Returning to the question posed at the beginning, this model suggests that the Federal Reserve is performing about as well as it can on both mandates. The Federal Reserve’s accommodative policy has offset much of the impact of product demand shocks and so has kept inflation near target. However, this policy has been unable to offset the large adverse shocks to labor demand. The model implies that, in terms of employment, there are limits to what monetary policy can achieve on its own.

5--Exodous at Merrill, The Big Picture

Excerpt: The following comes from a senior long time Merrill asset manager, recently retired. You may assume he left on good terms, and that he is not happy with what has become of his Mother Merrill.


The defections are coming fast and furious at Merrill Lynch. Nary a week goes by without an “On the Move” item crossing the wires about a producer or team leaving Merrill for the competition.

In what has become an idiotic, zero-sum, circle-jerk known as broker poaching, Merrill has wound up on the short end of the stick more often than not....So, you take the guys who have been the “bright spot” in your business, and you try to crush them. Makes sense to me. Of course, maybe that Countrywide division will start turning a profit some time soon and become the firm’s “bright spot,” thereby rendering moot for the firm the mistreatment of its advisors. But I wouldn’t hold my breath.

6--How to Prevent a Financial Overdose, NY Times

Excerpt: As federal officials struggle to write rules required by the Dodd-Frank law, some in Congress are trying to circumvent them. Last week, for instance, the House Financial Services Committee approved a bill that would let big financial institutions with foreign subsidiaries conduct trades that evade rules intended to make the vast market in derivatives more transparent.

7--Europe’s Periphery: A postmodern version of Britain in the 1930s?, Yanis Varoufakis

Excerpt: Europe’s Periphery ended up in a situation not dissimilar to that Britain had found itself in in 1929. Just like Britain in the 1920s, Europe’s Periphery had entered into a currency union at a daft exchange rate. Moreover, to secure entry into that eurozone in the first place, each and every one of these nations had to impose upon itself a hidden, slow-burning recession: reductions in real wages and a substitution of investment away from manufacturing toward import-heavy services and real estate development (especially in countries like Ireland and Spain, or public works in places like Greece) were the price of admission that they paid.

Once inside the common currency, investment (excluding real estate development) began to fall rapidly, labour unit costs to rise, and the only thing that stood between them and a run on the countries’ bonds (the equivalent to a run on their currency once they had given up their currencies) was the ‘exorbitant exuberance’ of the large foreign banks which kept flooding the Periphery with the loans that masked the underlying recessionary process.

In short, just like Britain before 1929, Europe’s Periphery was being secretly buffeted by a slow-burning recession (which did not show up in their national statistics, courtesy of real estate, white elephant developments and unlimited credit) well before 2008. Labouring under an overvalued currency, their industries were being depleted in exchange for phoney growth in real estate and finance. And when the Crash of 2008 burst these bubbles, Europe’s Periphery, unlike Britain and the US, found itself in a situation very close to that which Keynes was trying to study in Britain in the 1930s.

As we all know, Britain responded quite swiftly, after 1929, by being the first to abandon the common currency (i.e. the Gold Standard) that was dragging it down years before the Crash. Today, the Periphery cannot do this. We no longer have currencies that we can de-link from Gold, from the dollar, from a foreign means of exchange and stock of value. Recreating currencies from scratch will be the equivalent of tearing down the European Union and all it symbolises , both economically and politically.

8--Corporate insiders are bailing out of stocks, zero hedge


9--Consumers in U.S. Boost Spending as Confidence Rises, Bloomberg

Excerpt: Americans increased their spending by the most in seven months as an improving labor market boosted confidence, adding to evidence the world’s largest economy is gaining strength.

Purchases climbed 0.8 percent in February, Commerce Department figures showed today in Washington, exceeding the 0.6 percent median gain forecast in a Bloomberg News survey of economists. The Thomson Reuters/University of Michigan’s final index of consumer sentiment rose to 76.2, the highest since February 2011, from 75.3 last month.

Employment gains are helping sustain the consumer spending that accounts for 70 percent of the economy, lifting sales at companies such as Nike Inc. Another report today showed business activity held near a 10-month high, indicating that the U.S. economy is weathering rising fuel costs.

“Consumer spending is going to hold its ground,” said Chris Christopher Jr., a senior principal economist at IHS Global Insight in Lexington, Massachusetts. Economists at IHS were the second-best forecasters of personal spending in the two years through February, according to data compiled by Bloomberg. “There seems to be a positive feedback between better employment numbers and spending,” Christopher said...

“There is some stability easing back into the broader marketplace as consumer confidence moves higher in some parts of the world,” Chief Executive Officer Mark G. Parker said in a March 22 conference call....

More Active Role

American households may be poised to take a more active role in the expansion as the biggest payroll gains since 2006 underpin confidence. While wages are climbing, other forms of income like interest receipts are lagging behind, raising the risk that higher fuel costs will limit gains in consumer spending....

Saving More

While the saving rate has declined, Americans are still putting more money away then they did before the onset of the 18-month recession in December 2007. The saving rate that month was 2.6 percent, and it rose as high as 8.3 percent in May 2008.

A firming labor market is helping household sentiment. The jobless rate held at a three-year low of 8.3 percent in February, according to data from the Labor Department.

10--WHY MINSKY MATTERS, economonitor

Excerpt: Financial Instability Hypothesis

This pro-cyclical behavior amplifies the business cycle, increasing the thrust toward instability. Minsky’s theory can be summarized as “an investment theory of the cycle and a financial theory of investment”; the first is the usual Keynesian view, and the second stresses that modern investment is expensive and must be financed—and it is the financing that generates structural fragility. During an upswing, profit-seeking firms and banks become more optimistic, taking on riskier financial structures. Firms commit larger portions of expected revenues to debt service. Lenders accept smaller down-payments and lower quality collateral. Financial institutions innovate new products and finesse rules and regulations imposed by supervisory authorities. Borrowers use more external finance (rather than retained earnings), and increasingly issue short-term debt that is potentially volatile (it must be “rolled-over” so there is risk that lenders might refuse to do so). As the boom heats up, the central bank hikes its interest rate—and with greater use of short-term finance, borrowers face higher debt service costs.

Minsky developed a famous classification for fragility of financing positions. The safest is called “hedge” finance (note this is not related to so-called hedge funds). In a hedge position, expected income is sufficient to make all payments as they come due, including both interest and principle. A “speculative” position is one in which expected income is sufficient to make interest payments, but principle must be rolled-over. It is “speculative” in the sense that income must increase, or an asset must be sold to cover the principle payment. Finally, a “Ponzi” position (named after a famous fraudster, Charles Ponzi, who ran a pyramid scheme—much like Bernie Madoff’s more recent fraud) is one in which even interest payments cannot be met, so the debtor must borrow to pay interest (the outstanding loan balance grows by the interest due). Speculative positions turn into Ponzi positions if income falls, or if interest rates rise. Ponzi positions are inherently problematic as default is avoided only so long as the lender allows the loan balance to grow. Beyond some point, the lender will cut losses by forcing default....

Employer of Last Resort

While Minsky’s work on poverty and unemployment is not well-known, from the 1960s through the mid 1970s he actually wrote as much on this topic as he did on financial instability. At Berkeley he worked with labor economists to formulate an anti-poverty strategy focusing on employment rather than welfare. Minsky criticized the Kennedy-Johnson War on Poverty, warning that without a significant job creation component it would fail to reduce poverty even as it created a welfare-dependent and marginalized class. He showed that offering one full-time job per low income household instead–even at the minimum wage—would raise two-thirds of all poor families above the poverty line. Further, he estimated that the output created by putting people to work would more than provide for the extra consumption by increasing GDP by a multiple of the extra wages.

Minsky argued a legislated minimum wage is “effective” only with an “employer of last resort”, for otherwise the true minimum wage is zero for all those who cannot find a job. Hence, he proposed that the national government stand ready to fund a job for anyone ready and willing to work at the minimum wage. Only the national government can afford to offer an “infinitely elastic” supply of jobs at the minimum wage...

the relative stability of the first few decades after WWII encouraged ever-greater risk-taking as the financial system was transformed into “money manager capitalism”, where the dominant financial players are “managed money”—lightly regulated “shadow banks” like pension funds, hedge funds, sovereign wealth funds, and university endowments—with huge pools of funds in search of the highest returns. Innovations by financial engineers encouraged growth of private debt relative to income, and increased reliance on volatile short-term finance.

The first US postwar financial crisis occurred in 1966 but it was quickly resolved by swift government intervention. This set a pattern: crises came more frequently but government saved the day each time. As a result, ever more risky financial arrangements were “validated”, leading to more experimentation. The crises became more severe, requiring greater rescue efforts by governments.

Finally, the entire global financial system crashed in fall 2008—with many calling it the “Minsky Moment” or “Minsky Crisis”. Unfortunately, most analyses relied on his FIH rather than on his “stages” approach. If, as Minsky believed, the financial system had experienced a long-term transformation toward fragility then recovery would only presage an even bigger collapse—on a scale such as the 1929 crash that ended the finance capitalism stage. In that case, what will be necessary is fundamental—New Deal style—reforms.

11--Big Part of Consumer Spending Paid by Uncle Sam, WSJ

Excerpt: Many Americans say they don’t want the government meddling in the economy. What they fail to realize is that fiscal support remains a big source of spending money–maybe even in their own extended families.

Government transfer payments continue to rise this year, pushed up by demographic shifts in the U.S. population and by some unemployed workers filing for disability or opting for early retirement. Social security, Medicare and Medicaid are hitting new records. Veteran’s benefits are also increasing, as troops return from combat. Meanwhile, jobless payments are falling as the unemployed max out their benefits or find work.

In February, transfer payments accounted 17.7% of all personal income. Before the recession, the share hovered around 15%.

Dan Greenhaus, chief global strategist of BTIG, points out the share has come down from its recession high, but that has “more to do with [other] income gains than any pullback in transfer payments.” He says transfer payments have fallen less than 0.5% from their peak.

“Put simply, while people are making more money they aren’t receiving less support from the government. This has no doubt been a boost to consumption,” Greenhaus says.

Consumer spending rose a larger-than-expected 0.8% in February. Households had to slow their savings rate to finance the increased purchases, but the advance means the consumer sector is adding to first-quarter economic growth.

Even after taking into account the impact of higher gasoline and other prices, real consumer spending–which accounts for the lion’s share of U.S. economic activity–is on track to grow above an annualized rate of 2% this quarter.

Government spending has gotten a bad rap. But without the safety net of transfer payments, the consumer sector and overall economy would be doing a lot worse right now.

12--Support for Afghan War Hits New Low,

Excerpt: A majority of Americans say the U.S. should withdraw all of its troops from Afghanistan before the 2014 deadline set by the Obama administration, according to a new poll.

The CNN/ORC International survey released Friday indicated only 25% of Americans support the war in Afghanistan, a new all time low. Most Republicans even voiced opposition to it, an unprecedented detail in the entirety of the decade-long war.

The steep decline in support for the war has something to do with a number of high profile outrages occurring one after the other. In recent months, U.S. soldiers were video-recorded urinating on Afghan corpses, U.S. soldiers burned Muslim holy books, prompting nationwide protests, and the latest controversy comes from the savage massacre of 17 Afghan civilians by Staff Sgt. Robert Bales and possibly several more unnamed criminals.

13--What does a rigged market look like?, Jesse

Chart 14--Nearly 13 million Americans are without a job, long-term unemployment is at post-World War II highs, and the uptick in employment has been largely based on a nationwide campaign of wage- and benefit-cutting, spearheaded by the administration’s imposition of a 50 percent wage cut on all newly hired General Motors and Chrysler workers.

Recent data shows that real median household income in the US fell 2.3 percent in 2010, and US manufacturing labor costs per unit of output that year were 13 percent lower than a decade earlier. While poverty, hunger and homelessness are rapidly rising, corporate profits are setting new records and the financial elite is monopolizing a bigger share of the national wealth than ever before....

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