Monday, April 16, 2012

Today's links

1--GLOBAL ECONOMY WEEKAHEAD - Fragile world, fractious leaders, Reuters

Excerpt: Growth in emerging economies is slowing and the recovery in the United States could be losing some momentum, worrisome developments when European leaders have yet to complete the repairs needed to shore up monetary union.

The situation forms a vulnerable backdrop for finance officials from the world's leading economies, who gather in Washington this week for the Group of 20/International Monetary Fund/World Bank meetings.

The managing director of the IMF, Christine Lagarde, has offered this blunt description: "The risks remain high; the situation fragile."...

Stock markets have rallied the past few months on relief that Europe averted a major financial crisis at the turn of the year. Credit goes to the European Central Bank for pumping money into debt markets, Greece for striking a debt restructuring deal after long and torturous negotiations, and to Italy, Spain and Portugal for embracing tough budgetary reforms.

But these actions have restored only a tentative calm.

2--Econ Crisis 3 - Double Bubble, you tube

Great 2 minute video summary on financial crisis

3--Europe’s Capital Flight Betrays Currency’s Fragility, Bloomberg

Excerpt: In recent months, even as markets seemed calm, sophisticated investors and regular depositors alike have been pulling euros out of struggling countries and depositing them in the banks of countries deemed relatively safe. Such moves indicate increasing concern that a financially strapped country might dump the euro and leave depositors holding devalued drachma, lira or pesetas.

The flows are tough to quantify, but they can be estimated by parsing the balance sheets of euro-area central banks. When money moves from one country to another, the central bank of the receiving sovereign must lend an offsetting amount to its counterpart in the source country -- a mechanism that keeps the currency union’s accounts in balance. The Bank of Spain, for example, ends up owing the Bundesbank when Spanish depositors move their euros to German banks. By looking at the changes in such cross-border claims, we can figure out how much money is leaving which euro nation and where it’s going.

Capital Flight

This analysis suggests that capital flight is happening on a scale unprecedented in the euro era -- mainly from Spain and Italy to Germany, the Netherlands and Luxembourg (see chart). In March alone, about 65 billion euros left Spain for other euro- zone countries. In the seven months through February, the relevant debts of the central banks of Spain and Italy increased by 155 billion euros and 180 billion euros, respectively. Over the same period, the central banks of Germany, the Netherlands and Luxembourg saw their corresponding credits to other euro- area central banks grow by about 360 billion euros.

The seven-month increase is about double the previous 17- month rise, and brings the three safe-haven countries’ combined loans to other central banks to 789 billion euros, their highest point on record. In essence, the central banks of the three countries -- and, by proxy, their taxpayers -- have agreed to make good on about 789 billion euros that were once the responsibility of Italy, Spain, Greece and others.

The worries about Italy and Spain reflect the inadequacy of Europe’s efforts to stem what has become a combined banking, sovereign debt and economic crisis. The European Central Bank’s efforts to prop up bond markets with more than 1 trillion euros in emergency bank loans have only encouraged Italian and Spanish banks to buy more of their governments’ bonds, tying their fates to those of the afflicted sovereigns. The harsh austerity measures required by Europe’s new fiscal compact are making things worse by stunting the economic growth needed to help the countries reduce their debt burdens. Should markets balk at lending to Italy and Spain, Europe’s bailout fund -- with only about 600 billion euros in spare capacity -- remains far too small to cover the two countries’ financing needs, which amount to more than 1 trillion euros over the next five years.

If Europe’s leaders want to stop the rot, they’ll have to change their approach. The least bad solution, as Bloomberg View has argued, is a combination of overwhelming force and deeper integration....As the capital flight figures demonstrate, the stricken nations of the euro area are bleeding private money and becoming increasingly dependent on taxpayers. In all, the debts of struggling banks and sovereigns to official creditors such as the EU, the ECB and national central banks now exceed 2 trillion euros, much of which would be lost if the debtor nations dropped out of the currency union

4--Spain Not Greece Is the Real Test for the European Union, Bloomberg

Excerpt: The decisive test of the euro area’s plans for economic recovery was never Greece but Spain, and the European Union shows every sign of failing it.

The Spanish government’s new austerity plan hasn’t won investors’ confidence, and this creates a threat not just to Spain but to the whole EU. Europe’s governments need to change course before it’s too late.

An auction of Spanish bonds on Wednesday was the first verdict on Spain’s new budget. It didn’t go well. Demand was poor and prices fell. The country’s borrowing costs rose with 10 year bond yields in the secondary market hitting 5.7 percent, the highest since the beginning of the year. The premium over German government bonds increased to nearly four percentage points, the highest since November.

The problem is not that Spain’s new austerity plan is too timid. Just the opposite: Under EU orders, Spain is promising what might be the tightest fiscal squeeze that it or any other European economy has ever faced. The new plan calls for the budget deficit to fall from 8.5 percent of gross domestic product to 5.3 percent this year. Since the economy is already shrinking, this requires a discretionary fiscal tightening of roughly 4 percent of GDP -- with the unemployment rate already standing at about 23 percent.

5--Spring brings signs of hope and renewal — except in the housing market, The Big Picture

Excerpt: The conventional wisdom seems to be that prices have stabilized and are overdue to start rising. The data, however, suggest something else. The most recent Standard & Poor’s / Case-Shiller index of national prices (January) shows prices are still falling, about 4 percent year-over-year.

There are some favorable factors:

• Prices are falling more slowly than they had been earlier.

• Nationally, house prices are back to where they were in 2003.

• The median prices of renting vs. buying now favor buying....

How do asset prices behave following a bubble?

Regardless of the asset class — stocks, bonds, commodities, houses, etc. — assets do not merely stabilize. We have never seen a stock market run up into bubble territory and then revert to fair value. Instead, we careen wildly past that level, to deeply undersold and exceedingly cheap.

That is the marvelous mechanism of markets. It is how assets are repriced, distressed holdings liquidated, capital markets stabilized, fools revealed, speculators punished — and money returned to its rightful owner, the prudent investor.

For a lasting recovery, we need to see houses cheap enough that they fall into “good hands” — long-term owners who can afford their mortgage payments.

Until that happens, houses will stumble along the bottom of the price range. The nation could easily see another 10 percent to the downside — assuming nothing else goes wrong.

This would actually be good news. The government interventions (first-time buyer tax credit, mortgage modifications and foreclosure abatements) have prevented prices from finding their own levels. If they did, houses would be much more affordable, and buyers would come out in droves.

That is how a true housing recovery begins.

6--Time to put the doomed euro out of its misery, Telegraph

Excerpt: The inadequate, piecemeal nature of Europe’s approach to the crisis stems from a wanton refusal to face up to its causes. Europe can’t bring itself to accept that the economics of the single currency doom it to failure. Instead, “Anglo-Saxon” finance is still quite widely blamed, as if Europe would be just fine but for the wicked bankers of Wall Street and the City.

Failing that, EU leaders tend to regard the turmoil as a crisis primarily of excessive public indebtedness, so focus on strengthening the political constraints on government borrowing. Repeated rounds of self-defeating austerity have become the order of the day. Still others see the crisis as one of confidence, which can be addressed by setting up a rescue fund large enough to convince markets that they cannot undo the euro – a “big bazooka”. This, too, is just wishful thinking.

The real cause, as long argued by Sir Mervyn King, Governor of the Bank of England, and now accepted by most leading economists, is a simple, old-fashioned balance of payments crisis. Europe has long been divided into surplus and deficit nations: those that manage to pay their way in the world and those that have to borrow and import from abroad to sustain their standard of living. But since the advent of the euro, these imbalances have got very much worse.

Normally, they would be corrected through the natural market mechanism of free-floating exchange rates. Deficit nations would devalue against surplus ones, bringing trade and capital flows back into balance. But in a monetary union, this cannot happen. In fact, the exact opposite has occurred. A low interest rate designed to help Germany deal with the costly aftermath of reunification encouraged a consumer and construction boom in the underdeveloped periphery. This in turn caused differences in prices, wages and industrial competitiveness to widen.....

To correct the problem, either the Giips must suffer years of nominal wage cuts, deflation and depression-style unemployment, or Germany must accept much higher inflation. Since neither of these possibilities looks even remotely acceptable politically, there’s really only one way this can end.

7--Keen: Instability in Financial Markets, credit writedowns

Video--22 minutes

8--Marginal improvement, Corporate profit margins are extremely high. Can they be sustained?, The Economist

Excerpt: THE past four years have been bad for workers and savers but good for the corporate sector. Profit margins in America are higher than at any time in the past 65 years. That helps explain why the equity market has rebounded so strongly despite a lacklustre economy.

Margins have been boosted by firms’ tight control of labour costs and by a reduction in interest expenses caused by the policies of central banks throughout the rich world. Whether such margins can be sustained is important for equities.

Most stockmarket bulls build their case on the trailing price-earnings ratio for the S&P 500, which stands at 16. But there is a warning sign in the cyclically-adjusted p/e (which averages profits over ten years). At 22, this ratio is well above the historic mean, making the market look a lot less attractive.

Theory would suggest that profit margins will revert to the mean over time. If profits are very low then companies will go out of business, improving the competitive position (and thus the margins) of those businesses that survive. Similarly, if profits are high then more capital will be attracted into the industry (and existing businesses will be tempted to expand) and the resulting competition will cause margins to fall.

However, the current high level of profits is not leading to a surge in investment. As a proportion of GDP, American business investment is close to 30-year lows. This shortfall has been blamed on many things, from over-regulation in America to uncertainty about the outlook for demand when real incomes are being squeezed by higher fuel prices and the lack of wage growth.

Peter Oppenheimer of Goldman Sachs points out that the high profit share of GDP is simply a corollary of the low share taken by labour. “With high unemployment and further substitution of technology for labour, it is unlikely that this will change dramatically any time soon,” he says.

So the cash is going on other things. Robert Buckland of Citigroup says both American and European companies are choosing to spend their cash on mergers and share buy-backs rather than capital expenditure. As a consequence “while profits remain sensitive to the economic cycle, those waiting for the structural mean reversion in margins will continue to be disappointed,” he says.

Andrew Smithers of Smithers & Co, a consultancy, believes that executives are given incentives to boost margins in the short term at the expense of long-term value for shareholders. Pushing up prices boosts profits quickly, for example, but at the risk of losing market share over time. Similarly, executives might not begin a programme of investment that is vital for a company’s long-term health because of the effect on earnings per share. Woe betide any company that misses its quarterly earnings target.

If Mr Smithers is right, investors may be overpaying for current profits. The earnings forecasts of American equity analysts imply an increase in margins from current elevated levels, since they show earnings growing much faster than nominal GDP. Of course, to the extent that companies sell goods to the emerging markets, the profits of quoted companies can grow faster than domestic GDP. But that requires investment to keep the corporate sector competitive, and capital expenditure has not been happening on a sufficient scale.

Governments would like companies to start spending their cash piles. But as James Montier of GMO, a fund-management group, points out, that depends on their own behaviour. In terms of national accounts, massive government deficits are a counterpart to the surge in corporate profits. The surpluses and deficits of the various sectors of the economy (government, households, foreign and corporate) must balance, so a huge surplus in one sector must be balanced by deficits elsewhere. Governments spend money on goods and services (that are bought from the corporate sector) or borrow money to finance social benefits, which are then also spent on goods and services from the corporate sector.

This is not to suggest that chief executives should wish for permanent government deficits. But it does suggest that, as those deficits fall, profits might come under pressure. There is a “good” way that this could happen, as companies recruit more staff and pay higher wages, boosting tax revenues. But there is also a “bad” way for it to happen, if austerity programmes cause a slump in demand. Pray for the first outcome.

9--Coming Soon: ‘Taxmageddon’, NY Times

Excerpt: ON Jan. 1 of next year, the federal tax bill for a typical middle-class household — making in the neighborhood of $50,000 — is scheduled to rise by about $1,750. This increase, which would come from the expiration of both the Bush tax cuts and the Obama stimulus, would follow a decade of little to no income growth for many people. As a result, inflation-adjusted, after-tax income for the median household could fall next year to its 1998 level, in spite of the continuing economic recovery.

The middle-class tax increase is just the beginning of budget changes set to take effect at the start of 2013

Either way, the changes will affect the vast majority of Americans, given that the deficit reflects a basic disconnect between the government we have and the taxes we are willing to pay. Social Security, Medicaid and Medicare may become less generous. The Pentagon may no longer be able to get just about whatever it wants. Taxes may have to rise from their recent levels, which have been lower, as a share of the economy, than at any point in 60 years. That could mean higher rates. Or, if tax reform actually happens, it could mean smaller tax breaks for health care, housing and retirement savings.

The looming end of billions of dollars in popular government benefits may seem ridiculous. And the fact that Washington keeps delaying a serious deficit plan until another day may seem equally ridiculous. But they make perfect sense in a country where hypothetical solutions are a lot more popular than any actual ones....

Complete gridlock will include not only the expiration of the Bush tax cuts and the payroll-tax cut from the Obama stimulus but also a sharp increase in the Alternative Minimum Tax and cuts to national-security and domestic programs, prompted by Congress’s failure of last summer to reach a deficit deal. Together, the changes would reduce the deficit by more than 60 percent in the 2014 fiscal year, according to the Congressional Budget Office, but would inflict obvious pain.

With Mitt Romney in the White House and a Republican House, the uncertainty might be less. Unless Congressional Republicans and a defeated Mr. Obama somehow came to a deal, they could wait for him to leave town before retroactively extending the Bush tax cuts, so long as they could win over a small number of Democratic senators. Republicans could likewise undo the Pentagon cuts.

To hold down the deficit, Mr. Romney and Congress could then cut domestic programs, including Medicaid, more sharply than Mr. Obama has

And, this from Bloomberg: Negative Yields

Treasury 10-year notes pay negative 0.7 percentage point, after subtracting consumer price increases. The so-called real yields in the U.S. averaged 2.6 percentage points during the past 20 years. It hit a high of 5.9 percentage points in August 2009.

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