Friday, April 13, 2012

Weekend links

1--The Euromess is back! But it never really went away in the first place, WA Post

Excerpt: Some seemed genuinely shocked about the resurgence of Europe’s debt problems. “Wasn’t Europe Fixed?” asked CNBC. But experts say there’s nothing surprising about the recent turn of events, which has soured bond markets in Spain and Italy and set investors on edge, yet again, about the continent’s future.

This was almost certainly inevitable,” says Henry Farrell, a political science professor at George Washington University. In December and again in February, the European Central Bank had propped up the euro by lending money to banks at significantly discounted rates. The banks in turn bought high-yield bonds in Spain and Italy, which prevented two of Europe’s distressed countries from going off a cliff. But that operation ended in February, as the Economist explains. And the underlying problems remain — and, in some cases, are getting worse.

Spain, for instance, recently revealed that it’s facing a bigger debt crisis than it had initially let on, and the solution that northern countries are likely to demand--more austerity--could slow down the continent’s recovery even further...

2--This Internet provider pledges to put your privacy first. Always., cnet

Excerpt: Nicholas Merrill is planning to revolutionize online privacy with a concept as simple as it is ingenious: a telecommunications provider designed from its inception to shield its customers from surveillance.

Merrill, 39, who previously ran a New York-based Internet provider, told CNET that he's raising funds to launch a national "non-profit telecommunications provider dedicated to privacy, using ubiquitous encryption" that will sell mobile phone service and, for as little as $20 a month, Internet connectivity.

The ISP would not merely employ every technological means at its disposal, including encryption and limited logging, to protect its customers. It would also -- and in practice this is likely more important -- challenge government surveillance demands of dubious legality or constitutionality.

A decade of revelations has underlined the intimate relationship between many telecommunications companies and Washington officialdom. Leading providers including AT&T and Verizon handed billions of customer telephone records to the National Security Agency; only Qwest refused to participate. Verizon turned over customer data to the FBI without court orders. An AT&T whistleblower accused the company of illegally opening its network to the NSA, a practice that the U.S. Congress retroactively made legal in 2008.

By contrast, Merrill says his ISP, to be run by a non-profit called the Calyx Institute with for-profit subsidiaries, will put customers first. "Calyx will use all legal and technical means available to protect the privacy and integrity of user data," he says.

Merrill is in the unique position of being the first ISP exec to fight back against the Patriot Act's expanded police powers -- and win.

In February 2004, the FBI sent Merrill a secret "national security letter" (not an actual court order signed by a judge) asking for confidential information about his customers and forbidding him from disclosing the letter's existence. He enlisted the ACLU to fight the gag order, and won. A federal judge barred the FBI from invoking that portion of the law, ruling it was "an "unconstitutional prior restraint of speech in violation of the First Amendment...

3--Breaking Down Worrying Signs in U.S. Trade Data, WSJ

Audio--- Fact and Opinion Economics Chief Economist Robert Brusca speaks with Tom Ortuso about today’s report showing that the U.S. trade deficit registered its biggest contraction in nearly three years in February.

4--“The Eurozone in Crisis: Origins and Prospects”, econbrowser

Excerpt: The eurozone crisis is the result of at least two key weaknesses in the original project of European monetary integration. First, the common currency and its monetary policy were applied to a set of economies that were very different one from the other. In the lingo of economists, the original group of 12 nations—Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, and Spain—did not constitute an “optimal currency area.” (Greece joined in 2001 between the euro’s establishment and introduction.) The countries were subject to too diverse a set of economic shocks. They were not sufficiently integrated, and they lacked a fiscal union that could smooth out those shocks, compensating hard-hit economies with transfers from better-performing economies. Further, with the euro in place, the monetary policy of the new European Central Bank proved to be too loose for some countries and too tight for others.

The second weakness is that investors interpreted the creation of the union as an implicit guarantee of member countries’ government debt....

In other words, credible precommitment to no-intervention when a massive and systemic financial crisis strikes -- the libertarian prescription -- is not feasible. That means running small budget deficits is not a sufficient condition for avoiding a debt crisis; effective and smart financial regulation is also essential.

What’s our prognosis for the eurozone? From the article:

...While we hope for the early recognition of the need for North-South transfers, recapitalization of the banking system, and accelerated inflation, our observation of the political process makes us pessimistic. Thus far, electorates in the creditor countries do not seem to be convinced that transfers are necessary. As long as this characterization holds true, progress toward a true solution will be elusive.

Much more likely will be a process of lurching from one crisis to temporary palliative to the next crisis. In that scenario, recovery will be years off.

5--All quiet on the western front, macronomics

Excerpt: We agree with Bloomberg's editors take that Spain is entering a dangerous deflation trap, given the very significant fiscal tightening requested by the European leaders to achieve an overly ambitious target of 3% in 2013:

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

"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."...

"Lack of funding means that bank will have no choice but to shrink their loan books. If it happens, you will have another credit crunch in weaker European economies, meaning a huge drag on their economic recovery and therefore major challenges for our already struggling politicians.

As a reminder, 50% of banks earnings for average commercial banks come from the loan book: no funding, no loan; no loan, no growth; and; no growth means no earnings."

6--Spain is in denial, naked capitalism

Excerpt: As I have spoken about previously, in the face of mounting balance sheet stress caused by private sector deleveraging, government austerity and pending European capital requirements the Spanish banking system has little choice but to shrink. One of the easiest ways to do that is to simply close up shop and shed staff:

Spain’s banks will have to close another 10,000 to 12,000 branches to adapt to a reduction in demand for loans, Banco Santander SA’s (STD) head of Spanish retail banking said Wednesday, but the country’s top two banks see such a move as an opportunity to boost their market share.

“The banking business just isn’t profitable now,” Enrique Garcia Candelas said at a roundtable meeting during a banking conference in Madrid.

Faced with shrinking demand for credit, difficult financing conditions and a fast-growing pool of bad loans, many of Spain’s lenders have been forced to merge in recent years, and the weakest ones were nationalized. As a result, the number of lenders in the country dropped to 17 from 53 five years ago.

However, banks have so far only closed 5,000 branches–or 12% of their overal capacity–since the financial crisis began in 2008, lowering the total to roughly 40,000.

The big Spanish banks are putting on a brave face due to their non-Eurozone exposure, but 5 years CDS contracts on both BBVA and Santandar are up sharply over the last month showing they are in no way immune to the fallout. The core of the ongoing problem, as we have seen in the case of Greece and Portugal, is that the one-sided austerity becomes counterproductive as it leads to a retrenchment of the private sector’s economic output and therefore national growth. It became more apparent overnight that this is now occurring in Spain:

Spanish industrial output plummeted in February, official data showed Wednesday, as the recession took tighter hold on the unemployment-scarred economy....

In other news, just a quick note that after many months of political and economic turmoil Greece appears to be going to the polls shortly:

Greece will call a snap election for May 6 on Wednesday, government officials said, opening a campaign that may produce no clear result and threaten implementation of the international bailout plan that saved Athens from bankruptcy.

7--Murdoch hacking scandal moves to US, Telegraph

Excerpt: The international hacking scandal that disrupted Rupert Murdoch’s media empire and ended his trademark paper The News of the World is officially coming to America. A prominent British lawyer has confirmed he will be filing related charges in the US.

Attorney Mark Lewis has revealed that he will seek legal action on behalf of three American clients that he believes were targeted in the hacking scandal that almost collapsed Murdoch’s News Corporation last year. The lawyer is slated to arrive in the US on Saturday and the UK’s Guardian has confirmed that he will begin talking to parties in New York next week as he works to bring charges against Murdoch’s group domestically....

Lewis has gone on the record to say that no charges have been filed yet, but he intends on taking that route in the near future after seeking aid from Norman Siegel, a US-based attorney that will work alongside him as they work to develop a case. Siegel formerly served as head of the American Civil Liberties Union and represented many of the families of the victims of the September 11 terrorist attacks.

To the BBC, Lewis claims he will be pursuing leg

al action on behalf of at least three persons, including two sports figures and one other civilian that he chose not to identify, whom he believes had their personal information hacked by parties working at or for News Corp. In a recent interview with the media outlet, the attorney introduced the international implications the News Corp. hacking scandal had outside of the UK.

"The scandal as it is is not just then confined to the United Kingdom or to the United Kingdom companies like News International and News Group Newspapers,” explains Lewis. "This goes to the heartland of News Corporation and we'll be looking at the involvement of the parent company in terms of claims there and that is something that will be taken more seriously by perhaps the investors and shareholders in News Corporation."

8--Evolution, Impact and Limitations of Unusual Central Bank Policy ActivismArticle Introduction, Pimco viewpoints

Excerpt: For those who are eager to get to the bottom line of my presentation, let me say right here that the analysis will suggest that central banks can no longer – indeed, should no longer – carry the bulk of the policy burden. This is not a question of willingness or ability. Rather, it is a recognition of the declining effectiveness of central banks’ tools in countering deleveraging forces amid impediments to growth that dominate the outlook. It is also about the growing risk of collateral damage and unintended circumstances.

It is high time for other agencies, in both the public and private sector, to step up to the plate. They should – indeed, must – use their better-suited instruments to help lift impediments to sustainable non-inflationary growth and job creation. In other words, it is about improving the prospects for higher economic activity and, therefore, “safe de-leveraging.”

This is not to say that central banks will no longer have an important role. They will. Specifically, in what may gradually morph into an increasingly bi-modal distribution of expected outcomes in some parts of the world (such as Europe), central banks could find themselves in one of two extremes: At one end, they may end up complementing (rather than trying to substitute imperfectly for) policies by other agencies that put the global economy back on the path of high sustained growth and ample job creation. At the other end, they may find themselves having to clean up in the midst of a global recession, forced de-leveraging and disorderly debt deflation.

Finally, there is a real question about how the overall global system will evolve. Most agree that its Western core is weakened and multilateralism is challenged. As a result, the system is likely to struggle to accommodate the development breakout phase in systemically important emerging economie and absorbing the de-leveraging of finance-dependent advanced countries. What is yet to be seen is whether the outcome will be a bumpy transition to a more multi-polar global system, or the healing and re-assertion of a uni-polar one. ...

•Central banks have had to innovate and stretch policy tools and mandates, including the use of liquidity facilities and communication, to render less disorderly a set of fundamental multi-year economic and financial re-alignments.

•While initially successful – indeed, critical to avoid a global depression – the policy stance, both here in the United States and over the Atlantic in Europe, appears now to increasingly involve an unfavorable change in the balance between what Chairman Bernanke has labeled as the “benefits, costs and risks.”4

•Having built a bridge for other policymakers and for healthy balance sheets in the private sector, central banks must now hope that a more timely, comprehensive and effective response will finally be forthcoming (and push for it, as appropriate).

•Should this fail to materialize, central banks risk finding themselves having built expensive bridges to nowhere and, accordingly, will come under severe pressure with implications for the future of central banking itself, as well as for the welfare of economies at the national, regional and global levels.

•Meanwhile, the ripple effects from central bank policies will increasingly be felt in the functioning and, in some cases, viability of whole segments of the financial markets – thus adding to the need for both public and private entities to become more intellectually and operationally agile.

A brief and incomplete snapshot of the unusual activism of central banks

The best way to get a handle on the unusual activism of central banks is to look at Chart 1. Central banks in advanced economies have ballooned their balance sheets to previously unthinkable levels – be it an astonishing 20% of GDP for the Fed or 30% for the ECB....

The problem had to do with the transmission to the real economy. Despite higher valuations, the hoped-for impact on economic activity, be it through the wealth effect or “animal spirits,” has not materialized in the anticipated scale and scope.

The situation in Europe has been even more disappointing. Most economic and financial indicators in the intense crisis countries, particularly Greece, have fallen short of program expectations. As a result, it has taken time for official intervention to reduce contagion risk. And it is not just countries such as Italy and Spain that were affected and faced the risk of liquidity disruptions turning into solvency problems. The disruptions also extended to the core of the eurozone as France lost one of its AAA ratings and CDS spreads also widened there and in other core economies (Chart 7). Even the region’s powerhouse, Germany, risks some erosion in its ability to reap the fruits of years of sustained structural reforms. ...

Europe’s slowness in dealing decisively with its debt crisis means that some banks there continue to confront legitimate questions about asset quality and capital adequacy. And while the ECB has taken care of most of the liquidity concerns via generous facilities, this alone cannot fully restore the normal functioning of the European banking system...

Having succeeded in sharply curtailing the catastrophic risk of a global depression, the challenge for unusual central bank activism is now extending beyond the inability to deliver economic outcomes. There are also genuine concerns that such activism involves a range of collateral damage and unintended consequences, only some of which are visible at this stage. And there will be questioning whether all this continues to be justified by central banks’ impact on the overall economy.

Already, there are visible changes to the characteristics and functioning of certain markets. As an example, consider what is happening to the money markets segment.

With policy interest rates floored at zero for such an extended period of time (past and also prospectively, according to recent FOMC statements), this segment will continue to shrink – and will do so mostly from the supply side. Funds are being re-intermediated to the banking sector, with quite a portion ending up in excess reserves at the Fed. In the process, borrowers that previously depended on money market investors (think here of commercial paper issuers as an example) are having to find alternative sources of funding.

The pension industry is also increasingly challenged. At current rates, the extent of underfunding is becoming even more systemic and is only being partially compensated by the increase in equity prices.

This will serve to accelerate a discussion that will be held in many circles in advanced economies: how to deal with the host of promises that were made at a very different economic time and that can no longer be met fully.

The functioning of markets is also changing given the size and scope of central bank involvement. The result is artificial pricing, lower liquidity and a more cumbersome price discovery process. Moreover, participants will tell you that there are signs that the intermediaries have shifted a meaningful part of their balance sheet availability – away from making markets for private sector clients to positioning for both the public sector’s primary issuance and buy back activities – a perfectly rational move given that the latter has more certainty at a time of general uncertainty....

There are also implications for the behavior of market participants. The essence here was captured well in a recent investor remark reported by Bloomberg: “Investors are numb and sedated…. by the money sloshing around the system.”...

Finally, and most controversial, the unusual activism of central banks may, at the margin, have worsened further wealth distribution. This has to do with the distribution and composition of financial wealth – in absolute terms and relative to labor income. To the extent that such policy activism succeeds in bolstering asset valuations but not the real economy, the rich benefit disproportionately more than the poor

8--We see sluggish economic growth for as far as the eye, TrimTabs

Excerpt: For months now we have been harping on the fact that the U.S. economy is growing slower than either the BLS or the BEA are reporting. So Friday’s disappointing result of only 120,000 new jobs when the street was expecting 200,000 was not surprise to us.


In fact, our assessment of the economy has not changed. U.S. economic growth is likely sluggish, in the 2.0% to 2.5% range. The good news is that GDP growth is positive. The bad news, it isnít fast enough to bring down the high level of unemployment anytime soon.

What about wages and salaries. We use real-time income tax withholdings as a more accurate measure of wages and salaries. According to the tax data, wage and salary growth in Q1 2012 was an anemic 3.4% y-o-y, nearly unchanged from the 3.5% y-o-y growth rate in Q4 2011. Since inflation is running at 2.9% y-o-y, wage growth is only slightly higher than the rate of inflation, not enough to propel the U.S. economy anywhere close to robust economic growth.

There is nothing in our economic crystal ball that says conditions are going to change anytime soon. We see sluggish economic growth for as far as the eye can see because of lackluster consumption due to weak wage and salary growth barely above inflation, high unemployment, elevated fuel and energy prices, a lackluster housing market, and a European debt crisis that wonít go away.

9--Inflation: The Secret Answer to the Eurozone Crisis, CEPR

Excerpt: let's imagine that the religious zealots running the European Central Bank (ECB) learned some economics and turned away from their low inflation cult. They could do something like what was recommended by Olivier Blanchard, the chief economist at the IMF. The ECB could target a higher rate of inflation, say 4.0 percent.


If it could convince the markets it was serious about this target -- throwing out as many reserves as necessary to push inflation higher -- it would address all three of these inter-related crises. Higher inflation would directly reduce the burden of sovereign debt.

If inflation averages 4.0 percent over the next five years instead of 2.0 percent (the current target), then GDP will be roughly 10 percent higher, reducing debt burdens proportionately. This means, for example, if Greece is looking at a debt to GDP ratio of 120 percent in five years with the current inflation target, its debt to GDP ratio would be 108 percent in the higher inflation scenario.

Higher inflation will also have the effect of lowering real interest rates and thereby boosting growth. If businesses know that they will be able to sell everything they produce for 20 percent more five years from now, it will give them more incentive to invest. Higher growth will also help to alleviate government deficits and debt burdens.

Finally, the loans on banks' books are likely to look much better in a context where house prices have risen by 20 percent (this is moving in step with inflation -- that is not a housing bubble) and economies are stronger. Stronger growth will also reduce corporate bankruptcies.

The problem really is not that difficult if the people holding the fire extinguishers would use them. Unfortunately, the ECB crew, like Samuelson, seems determined to focus on its inflation fighting even as the house burns down around them.

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