Sunday, April 21, 2013

Today's links

1---EL-ERIAN: It's Official — The World Needs To Worry About The Damage Caused By QE, Business Insider

QE, or quantitative easing, refers to the use of central banks' balance sheets to manipulate financial prices. It follows the flooring of policy interest rates at zero for a prolonged period of time, and also commitment to keep them there for a lot longer.
The idea is simple: manipulate key financial markets in order to "push" investors to take more risk, thus also stimulating spending and investing. With time, improving fundamentals would validate the artificial prices, thus also allowing central banks to exit.

Most investors have responded to QE as very few wished to take on institutions with a printing press in the basement. Yet, despite the manipulation of financial markets, growth and jobs have consistently fallen short of expectations.

Facing insufficient demand, structural impediments and policy uncertainty, the real economy has not responded as envisaged by central bankers. In response, officials have widened the scope and scale of QE.
The G-20 now recognizes what Fed Chairman Ben Bernanke told us back in August 2010: the intended "benefits" of unconventional policies come with "costs and risks."

So, what exactly are these collateral damages and unintended circumstances?

Modern market-based economies are not wired to function well at artificial prices for any prolonged period of time. The pricing system loses its critical signaling role. Markets operate less well. And, critically, resources are misallocated – both in the financial sector and also in certain parts of the real economy.
So, less than five years after a global crisis triggered by irresponsible risk-taking, concerns are again surfacing about bubbles. The worry is heightened by the fact that both governments and central banks now have fewer weapons to counter the detrimental effects of another financial crisis

2---With three exceptions, all of the high-profile domestic terror plots of the last decade were actually FBI stings, naked capitalism

Over the past year, Mother Jones and the Investigative Reporting Program at the University of California-Berkeley have examined prosecutions of 508 defendants in terrorism-related cases, as defined by the Department of Justice. Our investigation found:
  • Nearly half the prosecutions involved the use of informants, many of them incentivized by money (operatives can be paid as much as $100,000 per assignment) or the need to work off criminal or immigration violations. (For more on the details of those 508 cases, see our charts page and searchable database.)
  • Sting operations resulted in prosecutions against 158 defendants. Of that total, 49 defendants participated in plots led by an agent provocateur—an FBI operative instigating terrorist action.
  • With three exceptions, all of the high-profile domestic terror plots of the last decade were actually FBI stings. (The exceptions are Najibullah Zazi, who came close to bombing the New York City subway system in September 2009; Hesham Mohamed Hadayet, an Egyptian who opened fire on the El-Al ticket counter at the Los Angeles airport; and failed Times Square bomber Faisal Shahzad.)
  • In many sting cases, key encounters between the informant and the target were not recorded—making it hard for defendants claiming entrapment to prove their case.
  • Terrorism-related charges are so difficult to beat in court, even when the evidence is thin, that defendants often don’t risk a trial.
“The problem with the cases we’re talking about is that defendants would not have done anything if not kicked in the ass by government agents,” says Martin Stolar, a lawyer who represented a man caught in a 2004 sting involving New York’s Herald Square subway station. “They’re creating crimes to solve crimes so they can claim a victory in the war on terror.”

3----Could QE crash Japan's bond market?, zero hedge

Koo continues, businesses and households in these economies have stopped borrowing money even though interest rates have fallen to zero. And with no one borrowing money and many actually paying down debt, the money multiplier has turned negative at the margin - because of the severe damage caused to balance sheets when the bubble collapse drove asset prices lower while leaving debts intact (so-called balance-sheet-recession).
This suggests that there is little physical or mechanical reason for the BOJ’s easing program to work...

Quantitative easing - whether in Japan, the US, or the UK - cannot directly stimulate the economy or raise the rate of inflation so long as businesses and households refuse to borrow money and spend it.... this hypothesis has already been tested overseas, and the medium and long-term results do not support his conclusion.
Ignoring the reality that...

Clearly, the issue is not how aggressively or quickly the central bank eases, but rather the extent of the damage to private sector balance sheets caused by the bubble collapse. These experiences also underline the fact that a great deal of time is needed for businesses and households to repair their balance sheets....
The underlying cause of a balance sheet recession is a decline in - and ultimate disappearance of - private demand for funds due to a critical shortage of borrowers.

When the problem stems from the lack of willing borrowers, the central bank’s emergence as a new lender is hardly going to improve the situation ...
No financial institutions anticipating inflation could ever lend money at current interest rates. A financial institution that suddenly saw inflation on the horizon could not continue holding 10-year government bonds that yield 0.6%. The resulting rush to sell could trigger a crash in the JGB market, inflicting heavy damage on domestic financial institutions.

The question is how the Kuroda BOJ would respond to such a crash. If it began buying more JGBs, the monetary base would expand, stoking inflation concerns at a time when private demand for funds was already recovering and the money multiplier had turned positive at the margin.

But if the BOJ sold its JGB holdings in an attempt to quell inflation concerns, bonds would drop further, blowing a large hole in the balance sheets of financial institutions and the government.

By that time the monetary base could easily have grown to, say, 15 times statutory reserves. In that case the money supply would continue growing, causing inflation to spiral out of control, unless the central bank reduced the monetary base to about 1/15th of its current level.

I suspect that the BOJ would employ all the tools at its disposal to achieve this, including a sizable increase in the statutory reserve ratio, but all of those measures would serve to push rates higher, resulting in large losses for the BOJ and other JGBs investors.

Which could rapidly lead to...

If the government bond market crashed, losses on the BOJ’s JGB portfolio would be subtracted from the money it transferred to the national treasury, adding to the fiscal deficit. And if the portfolio was large enough at the time of the crash, it could even raise doubts about the viability of the Bank’s balance sheet.

The inflation fears and the talk of large losses at the central bank could then undermine confidence in the Japanese currency 

4---Guantanamo hunger strike; No limits to the barbarism, antiwar

Five of the inmates have been hospitalised, although none faces "life-threatening conditions," House said.
The facility, which houses 166 detainees, has been hit by hunger strikes since February 6, when inmates claimed prison officials searched their Korans for contraband.
Officials have denied any mishandling of Islam's holy book.
The hunger strikers are protesting their incarceration without charge or trial at Guantanamo for the past 11 years.

5---The economy will not manage itself, at least not in a good way, economists view

As John Maynard Keynes shrilly stated back in 1926:
Let us clear… the ground…. It is not true that individuals possess a prescriptive 'natural liberty' in their economic activities. There is no 'compact' conferring perpetual rights on those who Have or on those who Acquire. The world is not so governed from above that private and social interest always coincide. It is not so managed here below that in practice they coincide. It is not a correct deduction from the principles of economics that enlightened self-interest always operates in the public interest. Nor is it true that self-interest generally is enlightened… individuals… promot[ing] their own ends are too ignorant or too weak to attain even these. Experience does not show that… social unit[s] are always less clear-sighted than [individuals] act[ing] separately. We [must] therefore settle… on its merits… "determin[ing] what the State ought to take upon itself to direct by the public wisdom, and what it ought to leave, with as little interference as possible, to individual exertion".

6---There’s basically no evidence that fast austerity programs, or ones undertaken during economic downturns, are even good at reducing the debt burden, WA Post

Reinhart-Rogoff is, for now, in question at the very least, as the changes identified by researchers at the University of Massachusetts-Amherst indicate that there’s little evidence that there’s a debt tipping point, even if there’s a relationship between debt and growth. The researchers left out a number of countries, including Belgium and late-1940s Canada, Australia and New Zealand, that had high debt burdens and low growth, and made some strange decisions around weighting. Once those are corrected for, it’s not clear the relationship they identified remains.

Moreover, it’s still not clear that that paper shows that debt causes slow growth as opposed to the other way around. Arindrajit Dube, also an economist at UMass Amherst, has a great post demonstrating that high debt loads are better correlated with slow growth before the debt gets that large as opposed to after, indicating that it’s the slow growth causing the debt and not the other way around ...

For questions about whether or not economic stimulus works, the key question, then, is what’s the multiplier? It’s pretty clear that it has been significantly positive in the U.S. and other developed countries since the downturn. The IMF, for instance, thought the multiplier in Europe was 0.5 before the crisis hit, but has since admitted it was wrong and that the multiplier was more like 1.5. So there isn’t really much doubt about whether fiscal stimulus could be used to boost growth in the economic conditions of the past few years. According to most of the literature on the American Recovery and Reinvestment Act, the fiscal stimulus approach worked.

The corollary of that finding is that in the kind of weak economy that gives you a high multiplier, budget cuts and tax increases hurt growth in the short run. What’s worse, they might even add to the debt burden. Take the IMF’s estimate of a multiplier of 1.5. That means that if you cut spending by 1 percent of GDP, the economy would shrink by 1.5 percent as well. And because the economy is shrinking by more than the debt burden is growing, the debt-to-GDP ratio would actually go up. Even if you think that high debt-to-GDP ratios cause slower growth, the answer may not be short-term austerity.

It’s for reasons like this that economists such as Larry Summers and Brad DeLong have argued that the stimulus package will end up paying for itself. All the economic growth it generated means more tax revenue and less welfare spending, and perhaps enough to pay for the whole shebang.....

A better method was pioneered in a 2010 paper by Berkeley’s Christina and David Romer (the former of whom, you’ll recall, was Obama’s first Council of Economic Advisors chair). The Romers use historical data to isolate cases where policymakers have chosen to adopt austerity as a means of reducing the debt load, rather than for any other reason.

Their paper is mainly focused on tax changes, but a follow-up IMF working paper by Jaime Guajardo, Daniel Leigh and Andrea Pescatori took a broader look. They concluded that a 1 percent reduction in spending or increase in taxes reduces real GDP, on average, by 0.62 percent. That suggests that it may be possible to reduce the debt burden through austerity, but that the effect on growth is, again, negative on average. Moreover, their results held up even in countries with heavy debt burdens, suggesting that this is a pretty universal effect of austerity.

Another recent IMF paper by Nicoletta Batini, Giovanni Callegari and Giovanni Melina confirms Guajardo et al’s findings. “Spending cuts initiated during recessions are contractionary over the entire simulation horizon,” which is to say in both the short and long run, they write. ...

To sum up: There’s basically no evidence that fast austerity programs, or ones undertaken during economic downturns, are even good at reducing the debt burden. It’s very clear they’re bad for growth. Austerity through spending cuts may help growth in the long run, but so do a lot of things, and if those cuts are to things known to boost growth, like early childhood education or research, they could be counterproductive. But for the time being, austerity is the wrong prescription for advanced economies.

7---NY Fed chief lays it on the line, for bankers and for the rest of us, Repowatch

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