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MOSLER'S LAW: There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it.

Archive for February, 2009

Excerpt from Bernanke’s testimony

Posted by WARREN MOSLER on 27th February 2009


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BROWN: Specifically, what worked that Roosevelt did? What did we learn from that? What worked that applies to now?

BERNANKE: Well, there were two things that he did almost within months of taking office that were extremely important. One was the bank holiday and the subsequent measures, like the deposit insurance program that stabilized the banking system.

Yes, deposit insurance allowed banks to fund themselves on an unsecured basis via federal deposit insurance.

The lesson was the liability side of banking is not the place for market discipline.

Which is why I’ve been proposing all along that the Fed needs to get immediate permission from Congress to lend to member banks on an unsecured basis. This would instantly clear up the interbank lending issues.

The problem is the FOMC doesn’t understand reserve accounting and how the monetary system actually works.

And it’s a point I’ve been making all morning, that we need to stabilize the banks.

And they need borrowers to have sufficient net incomes to make their payments. Hence my payroll tax holiday.

The second thing he did was to take the U.S. off the gold standard, which allowed the Federal Reserve to ease monetary policy, allowed for a rise in prices, which, after three years of horrible deflation, allowed for recovery.

Yes, it removed the supply side constraints on the ‘money supply’ with the gold standard this constraint makes it problematic for even the Treasury to fund its deficit spending, as competition to borrow a finite amount of reserves drives up interest rates.

When the currency is instead allowed to float interest rates are then instead set by the government rather than market forces. This allows the Fed to cut rates and the Treasury to deficit spend without risking the loss of gold reserves.

So those were the two perhaps most important measures that he took.

He did some counterproductive things, like the National Recovery Act, which put the floors under prices and wages and prevented necessary adjustment.

Excuse me??? His new Keynesian roots are showing. They believe lower wages will allow labor markets to ‘clear’ when deficits are too small to support demand.

The most controversial issue recently, of course, has been fiscal policy and I think there are two sides to that.

The classic work on this by an old teacher of mine from MIT, E. Cary Brown, said that fiscal policy under Roosevelt was not successful, but only because it wasn’t tried, and he argued that it wasn’t big enough relative to the size of the problem.

True!

Other people, other writers have argued that this wasn’t the right medicine.

So that one is more controversial, but if you ask me what I think the most important things were, I think they had to do with stabilizing monetary policy and stabilizing the financial system.

Which he hasn’t yet been able to do.


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Posted in Banking, Fed | No Comments »

BMA/LIBOR mids

Posted by WARREN MOSLER on 27th February 2009


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Closing at the tights of the day.

One of the only ways to hedge higher tax rates.

BMA/LIBOR mids

Start Term Frequency Gross Net MBA Fwd Hedge Cost Floor Wgt Cap Wgt
5.00 5.00 12 98.74% 90.56% -8.18% 3.996% 60.5 -62.6
5.00 10.00 12 102.13% 92.92% 4.032% -9.21% 65.1 -70.5
2.00 8.00 12 96.91% 86.52% 3.653% -10.40% 58.1 -58.4
7.00 8.00 12 103.55% 93.98% 4.087% -9.57% 66.9 -73.8
5.00 15.00 12 103.83% 93.02% 3.957% -10.81% 67.3 -74.5
10.00 10.00 12 107.48% 93.70% 3.931% -13.78% 72.2 -83.0
15.00 15.00 12 110.80% 90.35% 3.686% -20.45% 76.6 -90.8
20.00 10.00 12 112.13% 88.71% 3.637% -23.42% 78.4 -93.9
15.00 5.00 12 108.82% 90.67% 3.764% -18.15% 74.0 -86.1

Using cap and floor hedge ratios from existing trades:

5.00 5.00 12 98.74% 92.94% 3.996% -5.79% 33.0 -13.0
10.00 10.00 12 107.48% 99.11% 3.931% -8.37% 38.0 -24.0
1.00 15.00 4 99.80% 88.40% 3.637% -11.40% 20.0 -15.0

**1×15 including 12% rate hedge

Feb-26-09 Change from Feb-25-09 Change from Feb-19-09 Change from Dec-31-08
3M 77.37500 -1.12500 -0.62500 -10.12500
6M 79.75000 -1.25000 -0.75000 -9.25000
1Y 83.62500 -1.25000 -0.50000 -6.87500
2Y 86.12500 -1.25000 -0.50000 -5.37500
3Y 88.25000 -1.25000 -0.50000 -4.25000
4Y 90.12500 -1.25000 -0.50000 -3.37500
5Y 91.50000 -1.25000 -0.50000 -2.75000
6Y 92.43750 -1.12500 -0.37500 -2.56250
7Y 93.37500 -1.00000 -0.25000 -2.37500
8Y 94.00000 -1.08330 -0.33330 -2.41670
9Y 94.62500 -1.16670 -0.41670 -2.45830
10Y 95.25000 -1.25000 -0.50000 -2.50000
12Y 96.75000 -1.25000 -0.50000 -2.25000
15Y 98.5000 -1.25000 -0.50000 -2.50000
20Y 100.37500 -1.25000 -0.37500 -3.37500
25Y 101.62500 -1.18750 -0.43750 -3.75000
30Y 102.87500 -1.12500 -0.50000 -4.12500
40Y 103.87500 -1.37500 -0.50000 -4.3750


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Posted in Credit | 1 Comment »

2009-02-27 USER

Posted by WARREN MOSLER on 27th February 2009


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GDP QoQ Annualized (4Q P)

Survey -5.4%
Actual -6.2%
Prior -3.8%
Revised n/a

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GDP YoY Annualized Real (4Q P)

Survey n/a
Actual -0.8%
Prior 0.7%
Revised n/a

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GDP YoY Annualized Nominal (4Q P)

Survey n/a
Actual 1.2%
Prior 3.3%
Revised n/a

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GDP Price Index (4Q)

Survey -0.1%
Actual 0.5%
Prior -0.1%
Revised n/a

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Core PCE QoQ (4Q)

Survey 0.6%
Actual 0.8%
Prior 0.6%
Revised n/a

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GDP ALLX (4Q P)

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Personal Consumption (4Q)

Survey -3.7%
Actual -4.3%
Prior -3.5%
Revised n/a

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Chicago Purchasing Manager (Feb)

Survey 33.0
Actual 34.2
Prior 33.3
Revised n/a

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NAPM Milwaukee (Feb)

Survey 32.0
Actual 29.0
Prior 33.0
Revised n/a

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U of Michigan Confidence (Feb F)

Survey 56.0
Actual 56.3
Prior 56.2
Revised n/a

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U of Michigan TABLE Inflation Expectations (Feb F)


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Posted in Daily | No Comments »

Obama vs Mosler- The Tale of the Tape

Posted by WARREN MOSLER on 26th February 2009


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Obama vs. Mosler- The Tale of the Tape


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Posted in Articles, Obama | 7 Comments »

2009-02-26 USER

Posted by WARREN MOSLER on 26th February 2009


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Durable Goods Orders (Jan)

Survey -2.5%
Actual -5.2%
Prior -2.6%
Revised -4.6%

 
Karim writes:

  • -5.2% m/m; December revised from -2.6% to -4.6%
  • Ex-aircraft and defense -5.4% m/m and -34.4% last 3mths at an annualized rate

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Durable Goods Orders YoY (Jan)

Survey n/a
Actual -26.4%
Prior -20.1%
Revised n/a

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Durables Ex Defense MoM (Jan)

Survey n/a
Actual -2.3%
Prior -7.5%
Revised n/a

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Durables Ex Transportation MoM (Jan)

Survey -2.2%
Actual -2.5%
Prior -3.6%
Revised -5.5%

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Durable Goods ALLX (Jan)

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Initial Jobless Claims (Feb 21)

Survey 625K
Actual 667K
Prior 627K
Revised 631K

 
Karim writes:

  • Initial claims up 36k to new cycle high of 667k
  • Continuing claims up another 14k to new cycle high of 5112k

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Continuing Claims (Feb 14)

Survey 5025K
Actual 5112K
Prior 4987K
Revised 4998K

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Jobless Claims ALLX (Feb 21)

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New Home Sales (Jan)

Survey 324K
Actual 309K
Prior 331K
Revised 344K

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New Home Sales Total for Sale (Jan)

Survey n/a
Actual 342.00
Prior 353.00
Revised n/a

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New Home Sales MoM (Jan)

Survey -21.%
Actual -10.2%
Prior -14.7%
Revised -9.5%

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New Home Sales YoY (Jan)

Survey n/a
Actual -48.2%
Prior -42.7%
Revised n/a

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New Home Sales Median Price (Jan)

Survey n/a
Actual 201.10
Prior 223.20
Revised n/a

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New Home Sales TABLE 1 (Jan)

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New Home Sales TABLE 2 (Jan)


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Posted in Daily | No Comments »

2009-02-25 USER

Posted by WARREN MOSLER on 25th February 2009


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MBA Mortgage Applications (Feb 20)

Survey n/a
Actual -15.1%
Prior 45.7%
Revised n/a

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MBA Purchasing Applications (Feb 20)

Survey n/a
Actual 250.50
Prior 257.30
Revised n/a

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MBA Refinancing Applications (Feb 20)

Survey n/a
Actual 3618.00
Prior 4472.90
Revised n/a

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Existing Home Sales (Jan)

Survey 4.79M
Actual 4.49M
Prior 4.74M
Revised n/a

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Existing Home Sales MoM (Jan)

Survey 1.1%
Actual -5.3%
Prior 6.5%
Revised 4.4%

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Existing Home Sales YoY (Jan)

Survey n/a
Actual -8.6%
Prior -4.8%
Revised n/a

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Existing Home Sales Inventory (Jan)

Survey n/a
Actual 3.600
Prior 3.700
Revised n/a

 
Foreclosure sales peaked?

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Existing Home Sales ALLX 1 (Jan)

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Existing Home Sales ALLX 2 (Jan)


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Posted in Daily | 1 Comment »

2009-02-24 USER

Posted by WARREN MOSLER on 24th February 2009


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ICSC UBS Store Sales WoW (Feb 24)

Survey n/a
Actual 0.60%
Prior 0.90%
Revised n/a

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ICSC UBS Store Sales YoY (Feb 24)

Survey n/a
Actual -0.80%
Prior -0.90%
Revised n/a

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Redbook Store Sales Weekly YoY (Feb 24)

Survey n/a
Actual -1.50%
Prior -1.40%
Revised n/a

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Redbook Store Sales MoM (Feb 24)

Survey n/a
Actual 0.90%
Prior 0.90%
Revised n/a

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ICSC UBS Redbook Comparison TABLE (Feb 24)

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S&P Case Shiller Home Price Index (Dec)

Survey n/a
Actual 150.66
Prior 154.59
Revised 154.55

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S&P CS Composite 20 YoY (Dec)

Survey -18.30%
Actual -18.55%
Prior -18.18%
Revised -18.20%

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S&P Case Shiller US Home Price Index (4Q)

Survey n/a
Actual 139.14
Prior 150.04
Revised 150.00

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S&P Case Shiller US Home Price Index YoY (4Q)

Survey -17.20%
Actual -18.23%
Prior -16.60%
Revised -16.55%

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Consumer Confidence (Feb)

Survey 35.0
Actual 25.0
Prior 37.7
Revised 37.4

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Consumer Confidence ALLX 1 (Feb)

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Consumer Confidence ALLX 2 (Feb)

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House Price Index MoM (Dec)

Survey -1.7%
Actual 0.1%
Prior -1.8%
Revised -2.0%

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House Price Index YoY (Dec)

Survey n/a
Actual -8.7%
Prior -7.6%
Revised n/a

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House Price Index ALLX (Dec)

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House Price Purchase Index QoQ (4Q)

Survey -2.0%
Actual -3.4%
Prior -1.8%
Revised -2.0%

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Richmond Fed Manufacturing Index (Feb)

Survey -49
Actual -51
Prior -49
Revised n/a

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Richmond Fed Manufacturing Index ALLX (Feb)


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Posted in Daily | No Comments »

From a memo from Paul Saunders

Posted by WARREN MOSLER on 23rd February 2009


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Paul runs James River Capital Corp and sent this out today:

Everyone, including our public officials running this country, think in terms of the private sector and not the public sector. They are so used to running their own businesses or their own lives, that they are unable to think in terms of how the government works. The private sector, you and me, needs to borrow money or earn money in order to spend. The public sector never needs to earn money or borrow money. The Government prints US dollars and only the Government is able to print US dollars making the US Government the monopoly producer of US dollars. It is strange that so many smart people struggle with this concept. Every dollar that the government spends ends up in the private sector. The only way that those dollars are reduced is if the government taxes those dollars back from you. If the government taxes more than it spends then the Government runs a surplus and the private sector is depleted of its savings which eventually leads to a contraction in the economy. If they spend more than they tax then they run a deficit and the private sector increases its financial savings and this is stimulative to the economy.


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Posted in Uncategorized | 10 Comments »

Bernanke describes jobless recovery

Posted by WARREN MOSLER on 23rd February 2009


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Yes, and this is a massive political risk.

The deficit is getting large enough to stabilize the economy at high levels of unemployment.

With flat employment growth, and 2% productivity growth, real GDP grows at 2% and unemployment stays north of 8%.

And the equity markets are in a very good place with costs under control and sales stabilized and rising.

So the financial sector booms while the real economy stagnates.

And fuel prices move higher as well.

Bernanke Offers Jobless Recovery as Humphrey-Hawkins Hopes Fade

by Craig Torres

Feb 23 (Bloomberg) — Bernanke Offers Jobless Recovery as Humphrey-Hawkins Hopes Fade delivering semiannual testimony required in legislation written by the late lawmakers, will describe a U.S. economy returning to growth next year without generating many new jobs. Even with credit markets thawing, Fed officials see unemployment persisting at 8 percent or higher through the final three months of 2010.


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Posted in Articles | 11 Comments »

Cruzan confusion

Posted by WARREN MOSLER on 23rd February 2009


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Transcript from a local meeting with our non voting representative to Congress. Must be the Democratic Party’s script:

Christensen: Stimulus Will Help, But Won’t Solve All Problems

by Carol Buchanan

Feb 19 (St. Croix Source) — “In her presentation she mentioned that the money for the stimulus package would be borrowed and the first question from the audience was “Who was the money to be borrowed from?”

Much of the U.S. debt is already financed by China through the sale of federal securities such as Treasury Bills, and Christensen assumes that nation will also be the purchaser of new securities floated to finance the stimulus.

That answer was immediately followed by the question, “What if China cuts us off?”

Christensen said that, from what she has heard and read, China and Japan and other nations who purchase United States securities, financing the debt, would not cut off the United States because the United States would then be unable to buy their products. It is in China’s interest for the U.S. economy to be strong enough to buy the goods it produces.”


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Posted in Articles, China | 1 Comment »

Re: Tax cuts may heighten deflation risks – NY Fed study

Posted by WARREN MOSLER on 23rd February 2009


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(email exchange)

It doesn’t make sense in any model this side of sanity. Comments below:

>   
>   On Sun, Feb 22, 2009 at 7:47 PM, Steve wrote:
>   
>   Does this make sense in your model of fiscal policy?….interesting
>   counter intuitive argument…
>   

Tax cuts may heighten deflation risks- NY Fed study

Feb 18 (Reuters) — Cutting taxes to try to stimulate the economy could do more harm than good in a zero interest rate environment as it can heighten the risk of deflation, according to a recent New York Federal Reserve study.

Policies that are aimed at increasing the supply of goods can be counterproductive when the main problem is insufficient demand, New York Fed economist Gauti Eggertsson said in a research paper entitled “Can tax cuts deepen the recession?”

Increasing the supply of public goods is never contractionary. Though wise investment can bring down real costs and prices and thereby increase productivity and our real standards of living.

“The emphasis should be on policies that stimulate spending,” Eggertsson said, adding that his research found the impact of tax cuts is “fundamentally different” with interest rates near zero.

“At zero short-term nominal interest rates, tax cuts reduce output in a standard New Keynesian (economic) model. They do so because they increase deflationary pressure,” he wrote. Eggertsson’s study focused primarily on labor taxes and some sales taxes.

There’s the problem- the standard ‘new Keynesian model’ is garbage.

Cutting payroll taxes, for example, would create an incentive for people to work more. But if there are not enough jobs, this could have a negative effect: creating more demand for work and thus driving down wages.

Huh? First of all, for me personally at least, when my income is cut I tend to work more to at least try to make the same income. And when taxes are cut I certainly don’t work more. But that’s just anecdotal.

The main point is there are already millions of unemployed so even if somehow cutting payroll taxes so people struggling to make ends meet can better do so causes a few more people to seek work the pressure on wages can hardly go up.

And maybe the strongest point, these new people supposedly seeking work due to a cut in payroll taxes will only work at the higher wage as a point of this (convoluted) logic which is far different from a market and wage level pressure point of view than the millions of others willing to work at current wages who can’t find work.

Last, the notion that changes in payroll tax could measurably alter wage seekers is extremely far fetched at best and not statistically significant in any case.

And with interest rates near zero, the Fed cannot cut rates further to fight deflation.

As if cutting rates does or ever has fought deflation.

If anything the causation is reversed. The new Keynesian model has this all wrong.

President Barack Obama on Tuesday signed into law a $787 billion package of measures to lift the recession-mired U.S. economy that included about $287 billion in tax cuts.

Eggertsson’s findings counter the argument that cutting taxes to put an extra buck in consumers’ pockets will boost their spending. Instead, given the current economic backdrop, it is likely people would save money from temporary tax cuts,

Yes, this is likely, and not a ‘bad thing’ as it means taxes can be cut at least that much further and/or spending increased further.

given the recession and expectations that tax increases are inevitable in the future.

This is the ‘Ricardian Equivalent’ argument put forth by some of the ‘new Keynesians’ and has largely been dismissed as nonsensical by most. The idea that tax cuts do nothing because people automatically expect higher taxes later as they ‘know’ the budget must eventually be balanced, taken to the extreme, means totally eliminating taxes does nothing for demand which of course is ridiculous.

He said that while a number of economists have argued that aggressive tax cuts are needed to revive the U.S. economy, policy-makers should “view with a great deal of skepticism” studies that use post World War Two data — a period characterized by positive interest rates.

Interest rates have nothing to do with the effect of tax cuts. And history (and all other theory) has shown that tax cuts add to demand, tax increases lower demand.

The best ways to stimulate spending, according to Eggertsson’s study, is through traditional government spending and a credible commitment to boosting inflation, creating an incentive to spend now before prices rise. (Reporting by Kristina Cooke; Editing by Diane Craft)

Good old ‘inflation expectations theory’ again from the new Keynesians, which is also nonsense. It’s a ‘plug’ due to no other theory of where the price level comes from, as they have yet to recognize the currency itself is a public monopoly, and monopolists are necessarily price setters.


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Posted in Articles | 9 Comments »

Fears rise on Russian foreign debt

Posted by WARREN MOSLER on 23rd February 2009


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Yes, the risk of Russian corporate defaults due to governmental difficulties goes with the territory.

Fears rise over Russia’s foreign debt

by Catherine Belton

Feb 22 (Financial Times) — Western bankers are increasingly anxious about Russian companies’ ability to repay $500bn in foreign corporate debt after the government said this month it was suspending a $50bn bail-out programme due to dwindling reserves. Bankers are demanding clarity after Igor Shuvalov, first deputy prime minister, said in a closed-door briefing this month that Russia was going to switch focus from bailing out tycoons to supporting the banking system.


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Posted in Articles, Russia | No Comments »

Clinton Urges China to Keep Buying U.S. Treasury Securities

Posted by WARREN MOSLER on 23rd February 2009


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We don’t need China or anyone else to buy our securities to finance our stimulus plan. And acting like we do and going on the defensive like this is radically counterproductive at best.

And isn’t she pledged on record to helping US jobs rather than increasing exports? Yet here she’s pushing the notion that China should buy our bonds to help us resume buying their imports?

The informed position is to first recognize that imports are real benefits and exports real costs, and therefore we benefit by foreigners net saving $US financial assets of any type, as it allows us the benefit of more imports and improved real terms of trade.

And this is what happens when you are hopelessly out of paradigm:

Clinton Urges China to Keep Buying U.S. Treasury Securities

by Indira A.R. Lakshmanan

Feb 22 (Bloomberg) — Secretary of State Hillary Clinton urged China to continue buying U.S. Treasury bonds to help finance President Barack Obama’s stimulus plan, saying “we are truly going to rise or fall together.”

“Our economies are so intertwined,” Clinton said in an interview today in Beijing with Shanghai-based Dragon Television. “It would not be in China’s interest” if the U.S. were unable to finance deficit spending to stimulate its stalled economy.

The U.S. is the single largest buyer of the exports that drive growth in China, the world’s third-largest economy. China in turn invests surplus earnings from shipments of goods such as toys, clothing and steel primarily in Treasury securities, making it the world’s largest holder of U.S. government debt at the end of last year with $696.2 billion.

China’s leaders understand that “the United States has to take some very drastic measures with the stimulus package, which means we have to incur debt,” Clinton said. The Chinese are “making a very smart decision by continuing to invest in Treasury bonds,” which she called a “safe investment,” because a speedy U.S. recovery will fuel China’s growth as well.


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Posted in Articles, China | 5 Comments »

Obama: “We can’t generate sustained growth without getting our deficits under control”

Posted by WARREN MOSLER on 23rd February 2009


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I was hoping not to be reading this:

Obama aims to halve deficit by 2013

by Ross Colvin

Feb 22 (Reuters) — Obama wants to slash the ballooning deficit in half by 2013, U.S. officials said Saturday, after massively increasing public spending to stem the worst economic crisis in decades.

The president will outline his ambitious goal when he hosts a summit at the White House Monday on fiscal responsibility and later in the week when his administration presents a summary of its first budget, for the 2010 fiscal year.

“We can’t generate sustained growth without getting our deficits under control,” Obama said in his weekly radio address in which he also announced immediate implementation of tax cuts for 95 percent of Americans as part of the effort to stimulate the economy.

And he may succeed by letting the top tax rates rise in 2010. This would raise taxes for people with relatively low propensities to consume, until the strong economy again drives the budget into surplus and thereby causes the next crash.

If he first allows the budget deficit to get large enough to add the savings that will support the subsequent Obamaboom that brings the deficit down.


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Posted in Articles, Obama | 4 Comments »

Clinton thanks China for buying US Treasury Securities

Posted by WARREN MOSLER on 23rd February 2009


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US, China Agree to Broaden Strategic Dialogue, Clinton Says

by Indira A.R. Lakshmanan and Eugene Tang

Feb 22 (Bloomberg) — Clinton thanked China for its continued purchases of U.S. Treasury notes, demand for which is needed to pay for Obama’s $787 billion stimulus plan.

No it isn’t. It will be a very different world when our leaders somehow come to realize how the monetary system works.

Yang said China, the world’s largest holder of Treasuries, will invest its almost $2 trillion in foreign-currency reserves based on the principles of ensuring liquidity and protecting value.

‘Appreciate Greatly’

“I appreciate greatly the Chinese government’s continuing confidence in U.S. Treasuries,” Clinton said. “I think that’s a well-grounded confidence.”

At an earlier meeting, State Councilor Dai Bingguo told Clinton that she looked “younger and more beautiful” than she appears on television.

Chuckling heartily, Clinton said, “Well, we will get along very well.”

Glad to see the US not saying anything negative about China’s new export subsidies announced last week.


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Posted in Articles, Asia, China | No Comments »

2009-02-23 CREDIT

Posted by WARREN MOSLER on 23rd February 2009


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Weakness in credit matching weakness in equities.


IG On-the-run Spreads (Feb 23)

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IG6 Spreads (Feb 23)

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IG7 Spreads (Feb 23)

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IG8 Spreads (Feb 23)

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IG9 Spreads (Feb 23)


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Posted in Credit | No Comments »

Swap lines in a narrow range

Posted by WARREN MOSLER on 20th February 2009


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Central bank liquidity swaps (13) $379,687 – $9,984


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Posted in Fed | 16 Comments »

Re: Martin Wolf spot on

Posted by WARREN MOSLER on 20th February 2009


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(email exchange)

Cliff,

Martin Wolf is spot on below. Our biggest risk is the reluctance of our leaders to implement the fiscal adjustments on an as needed, size no object, basis to reverse shortfalls in aggregate demand.

>   
>   On Fri, Feb 20, 2009 at 11:11 AM, Cliff wrote:
>   
>   Warren,
>   
>   Many people ask me why Japan did not have large
>   inflation with their large deficits,
>   

They weren’t even large enough to fully offset the deflationary forces.

>   
>   and they ask will the U.S. be like Japan or will
>   inflation recur in the next few years.
>   

Depends on crude prices. If they go up inflation as we know it comes back. This is very likely.

We need a hard policy to cut our imported fuel consumption to prevent ‘inflation’ and declining real terms of trade.

>   
>   Please see the article below, and can you
>   comment on the article and the related two
>   questions posed above.
>   
>   Thanks, Cliff
>   

Japan’s lessons for a world of balance-sheet deflation

by Martin Wolf

Feb 17 (Financial Times) — What has Japan’s “lost decade” to teach us? Even a year ago, this seemed an absurd question. The general consensus of informed opinion was that the U.S., the U.K. and other heavily indebted western economies could not suffer as Japan had done. Now the question is changing to whether these countries will manage as well as Japan did. Welcome to the world of balance-sheet deflation.

As I have noted before , the best analysis of what happened to Japan is by Richard Koo of the Nomura Research Institute.* His big point, though simple, is ignored by conventional economics: balance sheets matter. Threatened with bankruptcy, the overborrowed will struggle to pay down their debts. A collapse in asset prices purchased through debt will have a far more devastating impact than the same collapse accompanied by little debt.

Most of the decline in Japanese private spending and borrowing in the 1990s was, argues Mr Koo, due not to the state of the banks, but to that of their borrowers. This was a situation in which, in the words of John Maynard Keynes, low interest rates – and Japan’s were, for years, as low as could be – were “pushing on a string”. Debtors kept paying down their loans.

How far, then, does this viewpoint inform us of the plight we are now in? A great deal, is the answer.

First, comparisons between today and the deep recessions of the early 1980s are utterly misguided. In 1981, U.S. private debt was 123 per cent of gross domestic product; by the third quarter of 2008, it was 290 per cent. In 1981, household debt was 48 per cent of GDP; in 2007, it was 100 per cent. In 1980, the Federal Reserve’s intervention rate reached 19-20 per cent. Today, it is nearly zero.

When interest rates fell in the early 1980s, borrowing jumped. The chances of igniting a surge in borrowing now are close to zero. A recession caused by the central bank’s determination to squeeze out inflation is quite different from one caused by excessive debt and collapsing net worth. In the former case, the central bank causes the recession. In the latter, it is trying hard to prevent it.

Second, those who argue that the Japanese government’s fiscal expansion failed are, again, mistaken. When the private sector tries to repay debt over many years, a country has three options: let the government do the borrowing; expand net exports; or let the economy collapse in a downward spiral of mass bankruptcy.

Despite a loss in wealth of three times GDP and a shift of 20 per cent of GDP in the financial balance of the corporate sector, from deficits into surpluses, Japan did not suffer a depression. This was a triumph. The explanation was the big fiscal deficits. When, in 1997, the Hashimoto government tried to reduce the fiscal deficits, the economy collapsed and actual fiscal deficits rose.

Third, recognising losses and recapitalising the financial system are vital, even if, as Mr Koo argues, the unwillingness to borrow was even more important. The Japanese lived with zombie banks for nearly a decade. The explanation was a political stand-off: public hostility to bankers rendered it impossible to inject government money on a large scale, and the power of bankers made it impossible to nationalise insolvent institutions. For years, people pretended that the problem was downward overshooting of asset price. In the end, a financial implosion forced the Japanese government’s hand. The same was true in the U.S. last autumn, but the opportunity for a full restructuring and recapitalisation of the system was lost.

In the U.S., the state of the financial sector may well be far more important than it was in Japan. The big US debt accumulations were not by non-financial corporations but by households and the financial sector. The gross debt of the financial sector rose from 22 per cent of GDP in 1981 to 117 per cent in the third quarter of 2008, while the debt of non-financial corporations rose only from 53 per cent to 76 per cent of GDP. Thus, the desire of financial institutions to shrink balance sheets may be an even bigger cause of recession in the US.

How far, then, is Japan’s overall experience relevant to today?

The good news is that the asset price bubbles themselves were far smaller in the US than in Japan. Furthermore, the U.S. central bank has been swifter in recognising reality, cutting interest rates quickly to close to zero and moving towards “unconventional” monetary policy.

The bad news is that the debate over fiscal policy in the U.S. seems even more neanderthal than in Japan: it cannot be stressed too strongly that in a balance-sheet deflation, with zero official interest rates, fiscal policy is all we have. The big danger is that an attempt will be made to close the fiscal deficit prematurely, with dire results. Again, the U.S. administration’s proposals for a public/private partnership, to purchase toxic assets, look hopeless. Even if it can be made to work operationally, the prices are likely to be too low to encourage banks to sell or to represent a big taxpayer subsidy to buyers, sellers, or both. Far more important, it is unlikely that modestly raising prices of a range of bad assets will recapitalise damaged institutions. In the end, reality will come out. But that may follow a lengthy pretence.

Yet what is happening inside the US is far from the worst news. That is the global reach of the crisis. Japan was able to rely on exports to a buoyant world economy. This crisis is global: the bubbles and associated spending booms spread across much of the western world, as did the financial mania and purchases of bad assets. Economies directly affected account for close to half of the world economy. Economies indirectly affected, via falling external demand and collapsing finance, account for the rest. The US, it is clear, remains the core of the world economy.

As a result, we confront a balance-sheet deflation that, albeit far shallower than that in Japan in the 1990s, has a far wider reach. It is, for this reason, fanciful to imagine a swift and strong return to global growth. Where is the demand to come from? From over-indebted western consumers? Hardly. From emerging country consumers? Unlikely. From fiscal expansion? Up to a point. But this still looks too weak and too unbalanced, with much coming from the US. China is helping, but the eurozone and Japan seem paralysed, while most emerging economies cannot now risk aggressive action.

Last year marked the end of a hopeful era. Today, it is impossible to rule out a lost decade for the world economy. This has to be prevented. Posterity will not forgive leaders who fail to rise to this great challenge.


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SOV CDS Indicative Levels

Posted by WARREN MOSLER on 20th February 2009


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Thanks!

Germany and France touch 100, up from 5 cents not long ago and climbing rapidly.

Ireland on the verge of going parabolic.

SOV CDS Indicative Levels

Country 5yr CDS/10yr CDS
Austria 235/260 -10/0
Belgium 143/153 -5/0
Finland 80/95 -1/+2
France 88/100 -3/0
Germany 88/100 -1/+1
Greece 240/270 -20/-8
Ireland 355/380 -60/25
Italy 184/194 -10/0
Netherlands 123/135 -5/0
Norway 50/60 -3/+2
Portugal 140/150 -10/-2
Spain 148/160 -10/-2
Sweden 136/150 -5/0
UK 150/165 -5/0
US 90/105 -3/0


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Paying off China for Dummies

Posted by WARREN MOSLER on 20th February 2009


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So how do we pay off those Treasury securities held by China?

Treasury securities are held in accounts at the US Federal Reserve.

Let’s assume $1 billion of Treasury securities held by China comes due tomorrow.

Here’s what would happen tomorrow:

  1. The US Federal Reserve would lower the amount of Treasury securities still held by China by $1 billion.
  2. The US Federal Reserve would increase the number of dollars in China’s bank account at the US Federal Reserve by $1 billion plus interest.

The US Federal Reserve keeps the books and increases and decreases these balances just by changing the numbers on its books.

That’s how it is and has always been.

Paying off the Federal debt is nothing more than debiting a securities account and crediting a member bank account at the Fed.


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