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Archive for May, 2009

China policy obamanation

Posted by WARREN MOSLER on 31st May 2009

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We do not need China or anyone else to buy our securities and we net benefit enormously from net imports in general.

The profoundly confused China policy comes from an administration that both does not understand the monetary system and does not understand that imports are real benefits and exports real costs:

Policies are being held hostage to Communist China’s demands.

by Adrian Van Eck

May 29 — The communist rulers of China have laid down a threat to the government of the United States of America. They are the largest foreign holders of treasury bonds. They say they fear that the huge Federal deficit this year – four times the record deficit set last year – will bring on inflation of such a magnitude as to threaten the buying power of their treasury holdings. They have said that if Washington does not stop this massive deficit spending (much of it financed with money created by Fed Chairman Ben Bernanke and the Federal Reserve)

All–not some, or most of government spending is a matter of ‘changing numbers in bank accounts at the fed’ (as per Bernanke’s statement last month).
Govt spending adds varying degrees of aggregate demand, government taxing reduces demand, and government borrowing supports interest rates. ‘Financing’ as the word is generally used does not apply to the issuer of a non convertible currency with a floating exchange rate.

they will protect their own interests by dumping all of their holdings of U.S. treasuries on the market for whatever price they can get for them. They say they will do so even if that collapses the U.S. dollar and pulls down not only the American economy but the economy of the entire world.

To date ‘their own interest’ has been that of supporting their export industries by suppressing their real wages.
So this statement would indicate they are threatening to move away from an export led strategy. Possible, but hard to believe and contradicts what follows here.

Apparently Washington has taken this threat seriously. All of a sudden China is being overrun by important officials from the U.S. Government. Speaker of the House Nancy Pelosi is one of the Americans traveling to Beijing. In past years she has been well known in both the U.S, and China as one who dislikes the rulers of Mainland China. A few years ago she barely escaped being arrested by a pack of Party goons as she led a group of Americans protesting China’s policies toward the formerly independent nation of Tibet, which China overran and conquered soon after they won the Chinese Civil War some 60 years ago. A few days ago she was fawning over China’s Government leaders, telling them how we want to cooperate with them in working to protect the environment. (As usual they blamed America for polluting the Earth, ignoring the fact that it is China which is the worst polluter anywhere.) She must have almost gagged on her own sweet words as she talked.

The second important American Government official in China was Secretary of State Hillary Clinton. She has never been thought of as an enemy of China’s communist rulers, so it was easier for her to talk with them. (There were rumors that money from China helped fund her husband’s re-election campaign.) Unfortunately the visit came about as China’s neighbor and close ally – North Korea – exploded a nuclear device reported to be as powerful as the one America dropped on Hiroshima in 1945. They also fired off several rockets. All of this violated the terms of an agreement they signed in 2006 – an agreement that brought them enormous quantities of fuel oil and food. When the nations that negotiated that treaty protested the nuclear explosion, North Korea announced that it was renouncing its agreement to a truce that ended the war in the 1950’s. That again called for Secretary of State Clinton to try and patch up relations without pushing the virtual outlaw nation into crossing the border and attacking South Korea. This made the response to China in threatening America – a definite form of blackmail, as nations such as India and Japan agreed – a secondary issue with Hillary.

That left Treasury Secretary Geithner to absorb the heaviest verbal blows from China’s leaders during his own visit to Beijing. They knew that Geithner, as the president of the independent Federal Reserve Bank of New York, the largest and most important of the privately-owned regional Feds, had himself made threats to China shortly before being confirmed by the Senate to take over the top job at Treasury. He had told the Senate that if China did not stop manipulating the yuan in the foreign exchange market to gain an unfair advantage in its trade he would be in favor of America taking steps on its own to counter this in the foreign exchange market.

What sense does all this make?

China was buying dollars to keep the dollar strong and the yuan weak as part of their strategy to support exports by suppressing domestic costs vs rest of world costs.

Geithner was pushing for a weaker dollar as a way to reduce China’s exports by, in effect, causing prices of goods made in China at Wal-Mart to rise to the point where they wouldn’t sell as well.

Now China is threatening to do the opposite- push the dollar down by selling its USD financial assets, and Geithner is doing the opposite by trying to stop them.

He has since had to swallow those words and now he has to swallow as well threats against America by China.

This administration is in it way over its head and is pursuing a totally confused policy.

We thought it was fascinating that no one in the media mentioned Ben Bernanke or commented on his complete absence from the dialogue with China. So I will take it on myself to make such a comment. Bernanke is, after all, the one man closely tied to the creation of the money that so offends the communists in Beijing and one might have expected him to be involved in current talks with China’s rulers – under normal circumstances. A while back, he went to China as part of a delegation and he was asked to make a speech at a university where China trains many of its economists. Bernanke was brutally candid in his remarks. He pointed out precisely all of the mistakes he felt they were making in their centrally planned economy – and predicted that they were heading for trouble so bad that it might bring the ruling Party and the country down, just as a dozen prior dynasties had come crashing down during China’s long history. The woman who serves as China’s economics minister was livid with rage after his remarks. She took over and screamed insults at him for a half hour. Then she called President Bush and said that Bernanke was “persona non grata,” a diplomatic phrase meaning he would never again be welcomed to China. Months later when a Chinese delegation paid a return visit to Washington, they carefully avoided the Fed’s marble headquarters.

Not a whisper has escaped that anyone knows about from the ideas expressed by Tim Geithner concerning China’s threats if America does not sharply curb its deficit spending.

For China’s export strategy to ‘succeed’ they need high levels of aggregate demand in the US.

Yet it is clear from everything happening in Washington that this Administration has absolutely zero intention of stopping its near reckless abandon of any restraint in Federal spending.

In fact, the deficit spending has not even begun to get high enough to restore aggregate demand to levels where unemployment stops rising, never mind falling.

We need to remove a lot more fiscal drag to restore demand, now the unsustainable (non-government) credit chennels have been capped.

Quite the contrary, as new demands are made they are coming up with more plans to lavish Federal spending on recipients. For example, the latest we are hearing regarding General Motors is that the Federal Government may be willing to hand the company $50 billion on top of the money allocated to them already. But Washington would then want to gain 70% ownership in what critics are calling “Federal Motors.”

The problem here is the administrations looks for public purpose in the ‘input’ side rather than the output side. The public purpose of industry is the output it produces, not how the inputs, particularly labor, get rewarded.

Output is directed by markets working within institutional structure which can be modified to influence output towards public purpose while sustaining full employment at all times. But not with an administration that has it all backwards.

And now we have California’s demand that the Federal Government guarantee $18 billion in State borrowing to fund their own wild deficit spending. Political pressures are building to make this happen. If that does happen, a lot of other states will be lining up at the White House front door to demand the same treatment.

The answer here is to give all states $500 per capita of revenue sharing with no strings attached. California would get about $17 billion.

That way it’s ‘fair’ and there is no ‘moral hazard’ issue.
But, again, this hasn’t even been discussed.

This brings us to a topic that is being brushed aside as being too unlikely to even deserve treatment as a rumor. Thus it is being dismissed out of hand in the national media. Yet it is springing up from several key Washington sources and that makes us suspicious that where there is so much smoke there may be fire. What I am talking about, of course, is the sudden discussion of an American Value Added Tax – another name for a national sales tax. It would apply to goods and services alike. Most nations in the world including China itself now have such a VAT tax. It is called value added because each company is taxed only on the value it adds to raw materials or parts it buys and manufactures or assembles into a product. Trucks and hairdressers and even lawyers would be taxed under a VAT.

Even at a rate as low as 10%, which would be seen as very low in the world, it would raise a ton of money. Some are proposing a rate high enough to allow the income tax to be ended but that idea is being shot down by agents of the Administration. The idea would be sold to conservatives as a way to avoid the huge inflation that China is warning against… and also to make unlikely that America would be forced to go back to pre-Reagan Federal income tax rates of just about double those paid today. And industry would be told that – just as happens in other nations with a VAT – it would be forgiven on any goods or services marked for export. I think these VAT tax rumors are for real and I suggest you keep an eye on this. More next week. Adrian Van Eck.

The VAT is even more regressive than the payroll taxes still on the books.

And with consumption being the entire point of the economics it makes no sense to tax consumption in general.

‘Sin’ and ‘luxury’ taxes are different- the idea is to limit consumption of those items subject to the tax, and not to raise revenue. The success of the tax is then judged by how few dollars are collected, not how many as with the VAT.

Now more than ever the US would benefit from an administration that understood the monetary system and the simple fundamentals regarding imports and exports.

But this is not going to happen, and we will continue to pay the price.


Posted in China, Deficit, Exports | 14 Comments »

Geithner’s got it wrong re: China

Posted by WARREN MOSLER on 29th May 2009

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This is what happens with an administration that does not understand imports are real benefits and exports real costs.

This is a proactive move that hurts our real terms of trade and real standard of living.

Geithner to Urge China to Boost Demand, Official Says

by Rebecca Christie

May 28 (Bloomberg) — Treasury Secretary Timothy Geithner
will urge China to boost domestic demand and loosen controls on
the yuan in his first trip to the nation since taking office,
while readying a defense on queries about sinking U.S. bonds.

In meetings with Chinese leaders in Beijing June 1-2,
Geithner will encourage China to move toward a more flexible
exchange rate, a U.S. Treasury official told reporters in
Washington. He will also answering any questions the Chinese may
have about the dollar or the U.S. budget deficit, the official
said on condition of anonymity.

While delivering a familiar U.S. message on reducing
China’s reliance on exports, the Treasury chief may meet an
unprecedented level of concern about the outlook for Treasuries.
China is the largest foreign holder of U.S. government debt,
which has handed investors the worst loss since at least 1977
this year as forecasts for federal budget deficits ballooned.

“We’re going to be flooding the world with debt for a
while,” said Tim Adams, a former U.S. Treasury undersecretary
for international affairs who helped lead the Bush
administration’s economic policy with China. “We’ve got to hope
that that the Chinese are willing to keep buying.”

China held about $768 billion in Treasury securities as of
March, according to U.S. government data.

U.S. Commitment

The U.S. is committed to reducing its budget deficit and
maintaining deep and liquid markets for government debt, the
official said in a briefing before Geithner’s May 30 departure.

To spur the U.S. economy, Geithner has said the
administration needs to run deficits in the short term. For the
fiscal year that ends Sept. 30, the deficit is projected to
reach a record $1.75 trillion, according to a Congressional
Budget Office forecast.

The widening gap has contributed to the tumble in
Treasuries, which have lost 5.1 percent, including reinvested
interest, so far this year, according to Merrill Lynch & Co.
index data. The dollar has also been hammered, with the Federal
Reserve’s trade-weighted Major Currency Dollar index sliding 3.2
percent so far this year.

Chinese Premier Wen Jiabao in March expressed concern about
the value of the nation’s U.S. investment. Also in March,
central bank governor Zhou Xiaochuan advocated a “super-
sovereign reserve currency” disconnected from any individual
nation, casting doubt about the long-term role of the dollar.

Wen, Hu Meetings

Geithner is set to meet with Wen during his trip, along
with President Hu Jintao and Vice Premier Wang Qishan. In
addition, Geithner will deliver a speech at Peking University on
U.S.-China economic relations and take part in an economic
development event that features U.S. companies.

The Treasury secretary is confident the U.S. dollar will
keep playing an important role as a reserve currency for a long
time, the official said today.

The Beijing talks will include the importance of open trade
and the need for both the U.S. and China to move toward balanced
long-term growth strategies, including a flexible currency
policy, the official said.

Since mid-2008, when China’s leaders began to take measures
to address an economic slowdown, the yuan has hovered around
6.84 per dollar. That rate was reached after a gradual
appreciation since July 2005 from a level of about 8.3 yuan, a
peg China had maintained since 1995.

So far this month, the yuan is little changed, closing
today at 6.829 per dollar.

‘Manipulating’ Label

Geithner has avoided a showdown over China’s currency
policy, declining to repeat comments he made in written remarks
to lawmakers after his Senate confirmation hearing in January
that China was “manipulating” its currency.

In its first semiannual report on foreign-exchange policies
since Geithner became secretary, the Treasury said April 15 that
while the yuan remains “undervalued,” it didn’t meet the
standard for illegal manipulation in the second half of 2008.

China will need to keep buying dollars if it plans to keep
the yuan tethered to the dollar, said Brad Setser, a former
Treasury official who is now an economist at the Council on
Foreign Relations in New York.

“If China insists on pegging to a now-depreciating dollar,
it isn’t clear that China will be doing anything other than add
to its dollar portfolio,” Setser said. “China’s public
expression of concern about its dollar holdings is somewhat at
odds with its policy of pegging to the dollar quite tightly.”

When notes and bonds of U.S.-backed companies such as
Fannie Mae and Freddie Mac are included, China’s holdings of
U.S. debt come to about $1.55 trillion, according to Setser.
“China will certainly raise its concerns in some form,” he

Geithner, 47, will need to “say all the right things”
about the U.S. fiscal shortfall, said Adams, who accompanied
former Treasury secretaries John Snow and Paul O’Neill on trips
to China. “There’s enormous concern about the size and
intractability of the deficit,” said Adams, who is now a
managing director at the Lindsey Group, an investment consulting
firm in Fairfax, Virginia


Posted in China | 17 Comments »

Durable Goods Order/Claims

Posted by WARREN MOSLER on 28th May 2009

Karim writes:

Durable Goods Order/Claims

  • Durables goods orders +1.9% headline; -1.5% ex-aircraft and defense (this is the measure used for the private sector capex component of GDP)
  • Defense up 23.2% m/m; here are the prior 3mths for defense orders in 2009 (-11%;+33%;-40%)
  • Shipments ex-defense -0.3%
  • Inventories -0.8% (unexpected as most felt inventory drawdown was over in Q1)
  • Initial claims fall to 623k from 636k (revised up from 631k)
  • Continuing claims up another 110k
  • Data shows economy still contracting; look for range of estimates for Q2 from -2% to -4%

Posted in Daily, Karim | 2 Comments »

James Grant

Posted by WARREN MOSLER on 28th May 2009

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(email exchange)

>   Hi Warren. I heard James Grant speak yesterday. He was funny, entertaining, articulate
>   and full of historical knowledge, but I found his monetary analysis appalling. He wants
>   the U.S. (and the rest of the world) to be on a strict gold standard.
>   It seems to me that the consequent reduction in flexibility and efficiency could be a
>   death sentence for hundreds of millions of people around the world. What do you think ?


The gold standad wasn’t abandoned because it worked so well!

The gold standard panic of 1907 was so bad they created the Fed in 1913 to keep it from ever happening again.

It happened again and even worse in 1929 to the point gold was dropped domestically in 1934.

No depressions since as the supply side constraints on ‘money’ were eliminated and counter cyclical fiscal policy became viable.

They kept the Fed open anyway and gave it other things to do.

Send this along to Jim, thanks!


Posted in Fed, Government Spending, Recession | 27 Comments »

Obama – “US out of money”

Posted by WARREN MOSLER on 26th May 2009

After a fiscal package that may or may not be sufficient to bring down unemployment, the president is now directly telling us that the next move is to dampen aggregate demand by reducing health care spending (and letting tax rates go higher.)

In a sobering holiday interview with C-SPAN, President Obama boldly told Americans: “We are out of money.”

C-SPAN host Steve Scully broke from a meek Washington press corps with probing questions for the new president.

SCULLY: You know the numbers, $1.7 trillion debt, a national deficit of $11 trillion. At what point do we run out of money?

OBAMA: Well, we are out of money now. We are operating in deep deficits, not caused by any decisions we’ve made on health care so far. This is a consequence of the crisis that we’ve seen and in fact our failure to make some good decisions on health care over the last several decades.

So we’ve got a short-term problem, which is we had to spend a lot of money to salvage our financial system, we had to deal with the auto companies, a huge recession which drains tax revenue at the same time it’s putting more pressure on governments to provide unemployment insurance or make sure that food stamps are available for people who have been laid off.

So we have a short-term problem and we also have a long-term problem. The short-term problem is dwarfed by the long-term problem. And the long-term problem is Medicaid and Medicare. If we don’t reduce long-term health care inflation substantially, we can’t get control of the deficit.


Posted in Government Spending, Obama | 3 Comments »

FDIC undervalued failed banks as suspected

Posted by WARREN MOSLER on 26th May 2009

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As suspected at the time, some (not all) of the failed banks were undervalued by the FDIC to facilitate a quick transfer to other institutions to the detriment of the former shareholders.

Worse, the FDIC said some of the banks failed due to liquidity and not capital impairment.
This means they failed because FDIC deposit insurance and Fed lending failed to do their job of supporting the liability side of banking as per the business model of this long standing ‘public/private partnership’ called banking.

JPMorgan $29 Billion WaMu Windfall Turned Bad Loans Into Income

by Ari Levy and Elizabeth Hester

May 26 (Bloomberg) — JPMorgan Chase & Co. stands to reap a $29 billion windfall thanks to an accounting rule that lets the second-biggest U.S. bank transform bad loans it purchased from Washington Mutual Inc. into income.

Wells Fargo & Co., Bank of America Corp. and PNC Financial Services Group Inc. are also poised to benefit from taking over home lenders Wachovia Corp., Countrywide Financial Corp. and National City Corp., regulatory filings show. The deals provide a combined $56 billion in so-called accretable yield, the difference between the value of the loans on the banks’ balance sheets and the cash flow they’re expected to produce.

Faced with the highest U.S. unemployment in 25 years and a surging foreclosure rate, the lenders are seizing on a four- year-old rule aimed at standardizing how they book acquired loans that have deteriorated in credit quality. By applying the measure to mortgages and commercial loans that lost value during the worst financial crisis since the Great Depression, the banks will wring revenue from the wreckage, said Robert Willens, a former Lehman Brothers Holdings Inc. executive who runs a tax and accounting consulting firm in New York.

“It will benefit these guys dramatically,” Willens said. “There’s a great chance they’ll be able to record very substantial gains going forward.”

When JPMorgan bought WaMu out of receivership last September for $1.9 billion, the New York-based bank used purchase accounting, which allows it to record impaired loans at fair value, marking down $118.2 billion of assets by 25 percent. Now, as borrowers pay their debts, the bank says it may gain $29.1 billion over the life of the loans in pretax income before taxes and expenses.

Purchase Accounting

The purchase-accounting rule, known as Statement of Position 03-3, provides banks with an incentive to mark down loans they acquire as aggressively as possible, said Gerard Cassidy, an analyst at RBC Capital Markets in Portland, Maine.

“One of the beauties of purchase accounting is after you mark down your assets, you accrete them back in,” Cassidy said. “Those transactions should be favorable over the long run.”

JPMorgan bought WaMu’s deposits and loans after regulators seized the Seattle-based thrift in the biggest bank failure in U.S. history. JPMorgan took a $29.4 billion writedown on WaMu’s holdings, mostly for option adjustable-rate mortgages and home- equity loans.

“We marked the portfolio based on a number of factors, including housing-price judgment at the time,” said JPMorgan spokesman Thomas Kelly. “The accretion is driven by prevailing interest rates.”

Wachovia ARMS

JPMorgan said first-quarter gains from the WaMu loans resulted in $1.26 billion in interest income and left the bank with an accretable-yield balance that could result in additional income of $29.1 billion.

Wells Fargo arranged the $12.7 billion purchase of Wachovia in October, as the Charlotte, North Carolina-based bank was sinking from $122 billion in option ARMs. As of March 31, San Francisco-based Wells Fargo had marked down $93 billion of impaired Wachovia loans by 37 percent. The expected cash flow was $70.3 billion.

The Wachovia loans added $561 million to the bank’s first- quarter interest income, leaving Wells Fargo with a remaining accretable yield of almost $10 billion.

Government efforts to reduce mortgage rates and stabilize the housing market may make it easier for borrowers to repay loans and for banks to realize the accretable yield on their books. With mortgage rates below 5 percent, originations surged 71 percent in the first quarter from the fourth, a pace that may accelerate during 2009, said Guy Cecala, publisher of Inside Mortgage Finance in Bethesda, Maryland.

Recapturing Writedowns

Wells Fargo, the biggest U.S. mortgage originator, doubled home loans in the first quarter from the previous three months, in part through refinancing Wachovia loans.

“To the extent that the customers’ experience is better or we can modify the loans, and the loans become more current, that could help recapture some of the writedown,” Wells Fargo Chief Financial Officer Howard Atkins said in an April 22 interview.

Banks still face the risk that defaults may exceed expectations and lead to further writedowns on their purchased loans. Foreclosure filings in the U.S. rose to a record for the second straight month in April, climbing 32 percent from a year earlier to more than 342,000, data compiled by Irvine, California-based RealtyTrac Inc. show.

Accretable Yield

The companies bought by Wells Fargo, JPMorgan, PNC and Bank of America were among the biggest lenders in states with the highest foreclosure rates, including California, Florida and Ohio. Housing prices tumbled the most on record in the first quarter, leaving an increasing number of borrowers owing more in mortgage payments than their homes are worth, according to, an online property data company.

“We’ve still got a lot of downside to work through this year and probably through at least part of next,” said William Schwartz, a credit analyst at DBRS Inc. in New York. “If I were them, I wouldn’t be claiming any victory yet.”

The difference in accretable yield from bank to bank is due to the amount of impaired loans, the credit quality of the acquired assets and the state of the economy when the deals were completed. Rising and falling interest rates also affect accretable yield for portfolios with adjustable-rate loans.

PNC closed its $3.9 billion acquisition of National City on Dec. 31, after the Cleveland-based bank racked up more than $4 billion in losses tied to subprime loans. PNC, based in Pittsburgh, marked down $19.3 billion of impaired loans by 38 percent, or $7.4 billion, and said it expected to recoup half of the writedown. After gaining $213 million in interest income in the first quarter and making some adjustments, the company has an accretable-yield balance of $2.9 billion.

‘Being Prudent’

“We’re just being prudent,” PNC Chief Financial Officer Richard Johnson said in a May 19 interview.

Johnson said he expects the entire accretable yield to result in earnings. The company has taken into “consideration everything that can go wrong with the economy,” he said.

Bank of America, the biggest U.S. bank by assets, has potential purchase-accounting income of $14.1 billion, including $627 million of gains from Merrill Lynch & Co. and the rest from Countrywide. Bank of America bought subprime lender Countrywide in July, two months before the financial crisis forced Lehman Brothers into bankruptcy and WaMu into receivership.

As market losses deepened, Bank of America had to reduce the returns it expected the impaired loans to produce from an original estimate of $19.6 billion.

Countrywide Marks

“The Countrywide marks in hindsight weren’t nearly as aggressive,” said Jason Goldberg, an analyst at Barclays Capital in New York, who has “equal weight” investment ratings on Bank of America and PNC and “overweight” recommendations for Wells Fargo and JPMorgan.

Bank of America spokesman Jerry Dubrowski declined to comment.

The discounted assets purchased by JPMorgan and Wells Fargo make the stocks more attractive because they will spur an acceleration in profit growth, said Chris Armbruster, an analyst at Al Frank Asset Management Inc. in Laguna Beach, California.

“There’s definitely going to be some marks that were taken that were too extreme,” said Armbruster, whose firm oversees about $375 million. “It gives them a huge cushion or buffer to smooth out earnings.”


Posted in Banking | No Comments »

Vice Chair Kohn on fiscal expansion

Posted by WARREN MOSLER on 26th May 2009

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Yes, he’s got that part very right!!!

>   On Mon, May 25, 2009 at 11:06 PM, Roger wrote:
>   Federal Reserve Vice Chairman Donald Kohn:
>   Interactions between Monetary and Fiscal Policy in the Current Situation
>   [I]n the current weak economic environment, a fiscal expansion may be much more
>   effective in providing a sustained boost to economic activity.
>   Doesn’t say anything about when. Looks like it’s already too late to forestall a pileup.


Posted in Banking, Fed, Uncategorized | 5 Comments »

German debts set to blow ‘like a grenade’-Pritchard

Posted by WARREN MOSLER on 26th May 2009

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Completely agreed about the possibility of a bank blow up.

And it’s also possible the government plan blows up the government.

The eurozone is the region vulnerable to ratings downgrades- both banks and national governments.

Not the UK and US governments where spending is not revenue constrained.

The ECB can ‘save’ the eurozone but only by extending credit beyond that ‘permitted’ by the treaty which in some ways they have already done.

This warning comes from a financial regulator:

German debts set to blow ‘like a grenade’

by Ambrose Evans-Pritchard

May 25 (Telegraph) — German debts set to blow ‘like a grenade’
Germany’s financial regulator BaFin has warned that the toxic debts of the country’s banks will blow up “like a grenade” unless they take advantage of the government’s bad bank plans to prepare for the next phase of the crisis.

German Chancellor Angela Merkel’s bad bank plan has been heavily criticised Photo: EPA
Jochen Sanio, BaFin’s president, said the danger is a series of “brutal” downgrades of mortgage securities by the rating agencies, which would eat into the depleted capital reserves of the banks and cause broader stress across the credit system. “We must make the banks immune against the changes in ratings,” he said.

The markets will “kill” banks that try to go it alone without state protection, warning that banks have €200bn (£176bn) of bad debts on their books. “We are pretty sure that within a month or two our banks will feel the full force of the sharpest recession ever on their credit portfolios,” he said, speaking after the release of BaFin’s annual report last week.

The International Monetary Fund (IMF) has called for a stress test for Europe’s banks along the lines to the US Treasury’s health screen, saying the region “urgently needs to weatherproof its institutions”.

The IMF said European institutions have written down less than 20pc of projected losses of $900bn (£566bn) by 2010. Euro area banks will have to raise a further $375bn in fresh capital, compared with $275bn for US banks. The Tier one capital ratio is 7.3pc in Europe, and 10.4pc in the US.

The German bad bank plan has been heavily criticised as an attempt to brush the problems under the carpet until after the elections in September. It allows banks to spread losses over 20 years in an off-balance sheet vehicle – much like the “SIVs” that masked their extreme leverage in the first place – and risks repeating the Japanese error of letting “zombie” banks limp on rather than purging the system.

The recession has hit Europe much harder than expected. German GDP has contracted by 6.9pc over the last year, and the eurozone as a whole has shrunk 4.6pc, although there are signs that the economy may be through the worst.

Germany’s IFO business confidence index rose to 84.2 in May, the highest since December, and German exports have started to rise again after a catastrophic fall of 16pc. But Carsten Brzeski from ING said it is too early to celebrate.


Posted in Banking, Germany, Government Spending | 5 Comments »

Commodities speculation

Posted by WARREN MOSLER on 26th May 2009

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I’ve also hear reports that pension funds have been adding to passive commodity strategies:

The green shoots will grow slowly

by David Robertson

May 25 (Business 24/7) — By the middle of this month, copper prices were 60 per cent up on the start of the year and platinum was up by a third. The rebound has been driven by a conviction that these metals were oversold and as construction demand (copper) and automotive demand (platinum) pick up, the price of the metals will return to more sensible levels. However, I bring bad news. Industrial demand is not returning nearly as fast as the London Metal Exchange or London Stock Exchange would have us believe – and that means we are still some way off from seeing a return to the sort of growth levels achieved prior to 2008.

Two things are currently distorting metal prices: Chinese stockpiling and speculation. The Chinese have taken advantage of the low price of metals to fill their warehouses and this has been mistaken for a dramatic ramp up in “real” industrial demand. I have no doubt that Chinese demand from factories and construction companies has increased recently but at nothing like a rate that would support a 60 per cent surge in copper prices.

Speculation has also played a significant role in boosting prices as investors have piled into commodities, partly because they have been fooled by Chinese demand and partly because a lot of people are already thinking about where to stash their cash in the event of rampant inflation next year.

Last week Investec, the South African bank, highlighted the impact speculation was having on market-traded metals by focusing on commodities that are not easily traded. For example, ferrochrome, which is used to make stainless steel, actually fell 13 per cent in price between the first and second quarter of this year and it is off 63 per cent from its high at the end of last year. Manganese contract prices are off 70 per cent and the steel makers are pushing for a 45 per cent cut in iron ore contract prices.

There is no “hot money” in these commodities so they give us a better guide to real industrial demand – and clearly there is little to get excited about yet. As a result, I expect to see a repeat of last year’s oil bubble: everyone will shortly wake up and realise that the shoots are not quite as green as had been hoped and prices will fall back by 20 to 30 per cent (again).


Posted in Comodities, Oil | 2 Comments »

Professor James Sturgeon

Posted by WARREN MOSLER on 26th May 2009

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From Jim Sturgeon

I’ll put in my two cents. The crooks should be convicted as a regular part of the legal system and examples set to deter future attempts. However, the acquisitive heart and I expect the felonious one, beats about the same from generation to generation (to paraphrase JKG the elder). It’s the institutions that change. We should have a way of dealing with crooks as a matter of institutional (no pun) policy. That much it seems goes without saying, although it seems to be rather more difficult to do than it should.

The most recent economic crisis, triggered by a rapid run-up in the nominal (money) price of various assets, is a more difficult institutional adjustment. Warren is correct that whatever real assets were created as we ran up the money price of debt and other monetary instruments are still in place. And whatever scientific/technological knowledge was created is still present and available for use. We are not now dumber than we were in 2000 or 2005. What has been lost is the balance sheet value of some (probably many) wealth holders. But of course if this was never a reflection of the real value of the assets then it is not so much a loss as a readjustment. People feel poorer because they once felt richer; buoyed by the fool’s gold in their portfolio. Feeling poorer, they now pull in on the reins of their consumption with all the well known results. Agreed there is a need for new rules and the enforcement of both old and new ones so as to control and regulate the financial sector. I also think we would benefit by reducing the strength of that sectors siren’s song that lures so many able minded to its call.

There is a relationship between the financial crises and the real economy, but it is of our making. By this I mean we have put in place a system of rules and policies by which the pecuniary forces in the economy animate or arrest the real forces. This frequently contributes to an already poorly functioning labor sector (market). What would help is to readjust this relationship with an eye toward lessening the impact on the real sector due to the exuberance (irrational or otherwise) in the financial sector. This is a matter of policy, law and regulatory changes necessary to adjust the institutional controls. The first and most obvious one is the labor market. The Full Employment Act of 2009 should be written and passed with an ELR provision (build a high speed rail system for openers and then I’ll add about 50 other obvious projects that would build real wealth in the US). This would significantly dampen the effect of the financial sector on the labor market and bring some stabilization to aggregate demand. Economists and others ought to give at least as much attention to the labor market and real sector as they have to the financial sector.

I don’t know if the above is what Warren has in mind when he says it is the response wherein the problem lies, but it seems to me the response so far is mostly framed with the same logic and played with most of the same players that have helped us misunderstand the relationship between finance and production.


Posted in Uncategorized | 4 Comments »

Britain looks to the land of the rising sun with envy

Posted by WARREN MOSLER on 25th May 2009

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Starts off good and then goes bad.

Britain looks to the land of the rising sun with envy

by Ambrose Evans-Pritchard

May 22 (Telegraph) — Perhaps most surprising is that Japan fell in 1998, though it was by then
the world’s top creditor with more than $1.5 trillion of net foreign assets
(now $3 trillion). Lender abroad, it is a mega-debtor at home, the result of
Keynesian pump-priming to fight perma-slump. The stimulus vanished into
those famously empty bridges in Hokkaido.

“The Japanese didn’t take the downgrade seriously,” said Russell Jones, of
RBC Capital, a Japan veteran from the 1990s. “They didn’t think they would
have any trouble funding their debt.”

They were right. Yields on 10-year bonds fell to 1pc by the end of the
decade, and to 0.5pc in the deflation scare of 2003 – confounding those who
expected Japan’s emergency stimulus to stoke inflation and push up yields.

Eisuke Sakakibara, then the finance ministry’s “Mr Yen”, was insouciant
enough to swat aside the Moody’s downgrade as an irrelevance. “Personally, I
think if Moody’s continues to behave like that, the market evaluation of
Moody’s will go down,” he said.

Japan had a crucial advantage: its captive bond market. Some 95pc of
government debt was held by Japanese savers or the big pension funds.

Not! Does not matter. The funds to buy government securities ‘come
from’ the government deficit spending.

Deficit spending adds reserve balances at the central bank,
buying govt securities reduces reserve balances at the same central bank.

It is all a matter of data entry by the central bank its own spread sheet.

The foreign share of UK public debt has risen from 18pc to 34pc over the
past six years. The central banks of Asia, Russia and emerging economies
like gilts because they offered 1pc extra yield over bunds. This was the
“proxy euro” trade.

Does not matter.

“We’re far more vulnerable than Japan ever was,” said Albert Edwards, global
strategist at Société Générale.


“Japan had a huge current account surplus
and a strong currency. The UK is a deficit country, at risk of a sterling

Yes, the currency might go down, but seems to be doing ok for the moment!

Years of UK macro-mismanagement have dragged the UK economy to the
edge of a precipice.”

As the BOE’s Charles Goodhart once responded,
Yes, they have been telling us that for 300 years.


Posted in Japan, UK | 1 Comment »

Saudi Arabian Oil Minister Naimi Says Oil to Reach $75 a Barrel

Posted by WARREN MOSLER on 25th May 2009

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No reason to expect it won’t happen if they want it to happen.

Saudi Arabian Oil Minister Naimi Says Oil to Reach $75 a Barrel

by Adam L. Freeman

May 23 (Bloomberg) — Saudi Arabian oil minister Ali al- Naimi said the price of oil will climb to $75 a barrel when demand picks up.

“We’ll get there eventually,” al-Naimi told reporters in Rome today where he will attend meetings with energy ministers from the Group of Eight industrialized nations. “The trick is keeping it between $70 and $80. It will be achieved as demand rises and the fundamentals are better than they are now.”

To reach that goal, Naimi said he will recommend OPEC members “stay the course” at their meeting in Vienna on May 28. Saudi Arabia is the biggest and most influential member of the Organization of Petroleum Exporting Countries, which produces about 40 percent of the world’s oil.

The group is likely to keep daily output quotas unchanged at 24.845 million barrels at the Vienna gathering, according to a Bloomberg survey.

Crude oil for July delivery rose 62 cents to settle at $61.67 a barrel at 2:45 p.m. on the New York Mercantile Exchange yesterday. The July contract increased 8.2 percent this past week. Oil is up 38 percent this year.

Naimi said oil should keep at about $75 a barrel “because that is what is desired for the world economy.”

Saudi Arabia produced less than its quota of 8 million barrels a day last month, according to a May 13 OPEC report. The Saudis produced 7.9 million barrels of OPEC’s 25.3 million- barrel daily output.

Naimi said last month that helping to keep oil prices at $50 a barrel was his country’s contribution to the world economy, which is fighting the worst recession in six decades. Since he made those comments in Tokyo on April 25, crude prices have climbed more than 20 percent to above $60 a barrel.

Exceed Ceiling

The 12 members of OPEC, which overshot their ceiling by 410,000 barrels last month, will update their policy on oil output at this month’s meeting. At the last summit on March 15, the group decided to leave quotas unchanged and adhere to its earlier commitment to restrict supply by a total of 4.2 million barrels a day from levels in September 2008.

Naimi said his country “very recently” started production at the Nuayyim oil field and it pumping 100,000 barrels a day. He added that even though Saudi Arabia has opened new production global markets don’t need the product.

“The problem is the market, that the demand is only in one place — Asia and that’s all.”

The group’s production rate rose during April, and most members are still producing more than their quota, a report from the OPEC Secretariat in Vienna showed earlier this month.

OPEC cut its 2009 forecast on May 13 and now estimates daily oil demand will fall by 1.57 million barrels, or 1.8 percent, to 84.03 million barrels of oil a day this year.


Posted in Articles, Comodities, Oil | No Comments »

Dollar Is Dirt, Treasuries Are Toast, AAA Is Gone: Gilbert

Posted by WARREN MOSLER on 25th May 2009

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Dollar Is Dirt, Treasuries Are Toast, AAA Is Gone

by Mark Gilbert

May 21 (Bloomberg) —

The odds on the dollar, Treasury
bonds and the U.S. government’s AAA grade all heading for the
dumpster are shortening.

True, but for the wrong reason. There is no solvency issue, but markets are pricing it in anyway.

While currency forecasting is a mug’s game and bond yields
can’t quite decide whether to dive toward deflation or surge in
anticipation of inflation, every time I think about that credit
rating, I hear what Agent Smith in the “Matrix” movies called
“the sound of inevitability.”

Several policy missteps suggest that investors should stop
trusting — and lending to — the U.S. government. These include
the state’s pressure on Bank of America Corp. to buy Merrill
Lynch & Co.; the priority given to Chrysler LLC’s unions over
the automaker’s secured creditors; and the freedom that some
banks will regain to supersize executive bonuses by giving back
part of the government money bolstering their balance sheets.

When you buy treasury securities the government debits your transaction account and credits your securities account at the Fed.

When those securities mature the government debits your securities account and credits your transaction account. That is all there is too it.

There is no solvency issue at the operational level

Currency markets have been in a weird state of what looks
almost like equilibrium for the past couple of months. What’s
really going on is something akin to an evenly matched tug of
war that fails to move the ribbon tied around the center of the
rope, giving the impression of harmony while powerful forces do
silent battle until someone slips.

“All currencies are being debased dramatically by their
central banks at extraordinary speeds and so in relative terms
it appears there is no currency problem,” Lee Quaintance and
Paul Brodsky of QB Asset Management said in a research note
earlier this month. “In reality, however, paper money is highly
vulnerable to a public catalyst that serves to acknowledge it is
all merely vapor money.”

The ‘value’ is the purchasing power of real goods and services.
The largest and deepest thing for sale is labor.
Seems like currency still buys labor at pretty much the same price as the recent past,
And maybe even a bit more.

In fact, it may buy a bit more of just about everything vs a year ago. Particularly houses and land.

But yes, next year can always bring a different story.

Flesh Wounds

Why pick on the dollar, though? Well, not necessarily
because the U.S. economy is in worse shape than those of the
euro area, the U.K. or Japan. The biggest problem is that
external investors — particularly China — have more skin in
the dollar game than in euros, yen or pounds, which makes the
U.S. currency the most likely candidate to meet the cleaver in a
crisis of confidence about post-crunch government finances.

China owns about $744 billion of U.S. Treasury bonds in its
$2 trillion of foreign-exchange reserves.

Chinese exports, though, are dropping as the global economy
weakens, with overseas shipments declining 23 percent in
April from a year earlier, leaving a nation that has already
expressed concern about its U.S. investments with less to spend
in future.

China doesn’t ‘spend’ it’s dollars on real goods and services which is why they
Have a trade surplus in the first place.

They sold things in exchange for ‘dollar balances’ which are financial assets and
then exchanged some of those balances for alternative USD financial assets as they
accumulated $744 billion of financial assets.

‘Heavy Hand of Government’

Those kinds of concerns are starting to surface in a
steepening of the U.S. yield curve, driven by an increase in 10-
and 30-year U.S. Treasury yields.

True, though there is no economic imperative for the treasury to issue a 30 year security in the first place.

In fact, the treasury issuing securities and the Fed later buying them is functionally identical to the treasury never issuing them in the first place.

(note that Charles Goodhart of the Bank of England has recently been proposing the UK do exactly that- cease issuing long securities rather than issuing them and having the BOE buy them.)

The 10-year note currently
yields 3.23 percent, about 235 basis points more than the two-
year security, which marks a near doubling of the spread since
the end of last year.

Yes, though from very low flight to quality yields at the height of the fear of oblivion.

“When the government parks its tanks on capitalism’s
lawns, that spells trouble for those who invest, add value and
create jobs,” says Tim Price, director of investments at PFP
Wealth Management in London. “Trillion-dollar bailouts do not
only leave massive public-sector deficits in their wake, they
also leave the presence of the heavy hand of government all over
industry and markets, so the outlook for government bonds is
less promising than the economic textbooks on deflation would
have us believe.”

A totally confused chain of logic, though government does often reduce shareholder value when it intervenes. But that’s a different point.

Earlier this month, the U.S. reported the first budget
deficit for April in 26 years, with spending exceeding revenue
by $20.9 billion, even though that’s the month when taxpayers
have to stump up to the Internal Revenue Service and the
government’s coffers should be overflowing. So far this fiscal
year, the U.S. shortfall is $802.3 billion, more than five times
the $153.5 billion gap in the year-earlier period.

Those are the ‘automatic stabilizers’ at work, which, fortunately, are out of the hands of
Congress. While they work the ugly way- falling employment and rising transfer payments- they do work to restore net financial assets to the private, non government sectors and thereby reverse the contraction.

Budget deficits = non govt ‘savings’ of financial assets
To the penny
It’s even an accounting identity. Not theory. Ask anyone at the CBO.

Deathly Deficit

For the fiscal year ending Sept. 30, the Congressional
Budget Office forecasts a record deficit of $1.75 trillion,

That includes the purchase of financial assets which doesn’t add to aggregate demand.

Up until now the fed has always bought the financial assets when government wanted to do that and that hasn’t ‘counted’ as deficit spending for exactly that reason.

This time around the treasury bought financial assets and confused things, much like 1936 when social security first started and was accounted for off budget rather than consolidated as we quickly figured out was the right way to do it and it’s fortunately been done that way ever since.

almost four times the previous year’s $454.8 billion shortfall
and about 13 percent of gross domestic product. Bear in mind
that the target demanded of European nations wanting to join the
euro was a deficit no greater than 3 percent of GDP.

Yes, which is responsible for their poor economic performance as well.

David Walker, a former U.S. comptroller general,

And foremost US deficit terrorist

wrote in
the Financial Times on May 12 that the U.S.’s top credit rating
looks incompatible with “an accumulated negative net worth” of
more than $11 trillion and “additional off-balance-sheet
obligations” of $45 trillion. “One could even argue that our
government does not deserve a triple A credit rating based on
our current financial condition, structural fiscal imbalances
and political stalemate,” he wrote.

As if government payments are operationally constrained by revenues.

They are not, as chairman Bernanke made clear a few weeks ago
when he explained how he makes payments by changing numbers in bank accounts.

That is the only way there is for government to spend in its own currency, which
is nothing more than the process of making spread sheet entries on its own books.

Any constraints on the US ability to make payments in dollars is necessarily self imposed (and
can just as readily be removed by those wanting to spend the money.)

Said another way, government checks don’t bounce unless government decides to bounce its own checks.

If you want to claim govt won’t pay because it will vote not to pay, fine.

But not because ‘deficits can’t be financed’ or any other nonsense like that.

No Default

It is undeniable that the U.S. government’s ability to
finance its borrowing commitments has deteriorated as its
deficit has ballooned.

The ability to deficit spend is the ability to make entries on its own spreadsheets.
Nothing more.
The idea that that can ‘deteriorate’ indicates a fundamental lack of understanding of monetary operations.

Dropping the U.S. from the top rating
grade, though, wouldn’t mean the nation is about to default on
its debt obligations; there’s a subtle distinction between
ability to pay and propensity to fail to pay.

And a less subtle distinction between knowing how it works and not knowing how it works.

There’s also a
compelling argument that no government should be enjoying the
benefits of a top credit grade in the current financial climate.

There’s nothing to ‘enjoy’ or even care about.

Note Japan was heavily downgraded with a debt to GDP ratio triple the US,
With no ill effects as three month rates remained near 0 for the last
15 years and 10 year Japanese govt bonds fluctuated between .5 and 1.5%

Using the definitions outlined by Standard & Poor’s, a one-
step cut into the AA rated category would nudge the U.S.’s
creditworthiness into a “very strong” capacity to fulfill its
commitments, just weaker than the “extremely strong”
capabilities demanded of AAA rated borrowers.

S&P cannot change the actual creditworthiness of the US, or any other
issuer of its own currency. There can be no solvency issue no matter what they do.

That seems an
appropriately nuanced sanction — albeit one that the rating
companies might turn out to be too cowardly to impose.

(Mark Gilbert is a Bloomberg News columnist. The opinions
expressed are his own.)


Posted in Articles, Currencies, Japan, USA | 1 Comment »

Dallas Fed interview

Posted by WARREN MOSLER on 25th May 2009

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Don’t Monetize the Debt

by Mary Anastasia O’Grady

May 23 (WSJ) — From his perch high atop the palatial Dallas Federal Reserve Bank, overlooking what he calls “the most modern, efficient city in America,” Richard Fisher says he is always on the lookout for rising prices. But that’s not what’s worrying the bank’s president right now.

His bigger concern these days would seem to be what he calls “the perception of risk” that has been created by the Fed’s purchases of Treasury bonds, mortgage-backed securities and Fannie Mae paper.

Mr. Fisher acknowledges that events in the financial markets last year required some unusual Fed action in the commercial lending market. But he says the longer-term debt, particularly the Treasurys, is making investors nervous. The looming challenge, he says, is to reassure markets that the Fed is not going to be “the handmaiden” to fiscal profligacy. “I think the trick here is to assist the functioning of the private markets without signaling in any way, shape or form that the Federal Reserve will be party to monetizing fiscal largess, deficits or the stimulus program.”

If he actually understood it I would expect him to say the concept is inapplicable with a non convertible currency and floating exchange rate regime.

Richard Fisher.

The very fact that a Fed regional bank president has to raise this issue is not very comforting. It conjures up images of Argentina. And as Mr. Fisher explains, he’s not the only one worrying about it. He has just returned from a trip to China, where “senior officials of the Chinese government grill[ed] me about whether or not we are going to monetize the actions of our legislature.” He adds, “I must have been asked about that a hundred times in China.”

Without knowing the right answer which is that lending is in no case reserve constrianed.
Causation runs from loans to deposits and reserves, and not from reserves to loans.

A native of Los Angeles who grew up in Mexico, Mr. Fisher was educated at Harvard, Oxford and Stanford.

Must have skipped the classes in reserve accounting.

He spent his earliest days in government at Jimmy Carter’s Treasury. He says that taught him a life-long lesson about inflation. It was “inflation that destroyed that presidency,” he says. He adds that he learned a lot from then Fed Chairman Paul Volcker, who had to “break [inflation's] back.”

Deregulating natural gas in 1978 is what broke the back of inflation as utilities switched from crude to natural gas and even cuts of 15 million barrels per day by OPEC were not enough to keep control of prices.

Mr. Fisher has led the Dallas Fed since 2005 and has developed a reputation as the Federal Open Market Committee’s (FOMC) lead inflation worrywart. In September he told a New York audience that “rates held too low, for too long during the previous Fed regime were an accomplice to [the] reckless behavior” that brought about the economic troubles we are now living through. He also warned that the Treasury’s $700 billion plan to buy toxic assets from financial institutions would be “one more straw on the back of the frightfully encumbered camel that is the federal government ledger.”

In a speech at the Kennedy School of Government in February, he wrung his hands about “the very deep hole [our political leaders] have dug in incurring unfunded liabilities of retirement and health-care obligations” that “we at the Dallas Fed believe total over $99 trillion.”

Hopefully he is worried about possible inflation and not solvency.

In March, he is believed to have vociferously objected in closed-door FOMC meetings to the proposal to buy U.S. Treasury bonds. So with long-term Treasury yields moving up sharply despite Fed intentions to bring down mortgage rates, I’ve flown to Dallas to see what he’s thinking now.

Hopefully he is concerned with the purchases possibly lowering interest rates too much for his liking and not about the size of the fed’s balance sheet.

Regarding what caused the credit bubble, he repeats his assertion about the Fed’s role: “It is human instinct when rates are low and the yield curve is flat to reach for greater risk and enhanced yield and returns.” (Later, he adds that this is not to cast aspersions on former Fed Chairman Alan Greenspan and reminds me that these decisions are made by the FOMC.)

“The second thing is that the regulators didn’t do their job, including the Federal Reserve.” To this he adds what he calls unusual circumstances, including “the fruits and tailwinds of globalization, billions of people added to the labor supply, new factories and productivity coming from places it had never come from before.” And finally, he says, there was the ‘mathematization’ of risk.” Institutions were “building risk models” and relying heavily on “quant jocks” when “in the end there can be no substitute for good judgment.”

Never does mention the role of fiscal policy. Like the massive 2003 retro tax cuts and spending increases that drove the next few years, including housing. Helped of course by the lender fraud.

What about another group of alleged culprits: the government-anointed rating agencies? Mr. Fisher doesn’t mince words. “I served on corporate boards. The way rating agencies worked is that they were paid by the people they rated. I saw that from the inside.” He says he also saw this “inherent conflict of interest” as a fund manager. “I never paid attention to the rating agencies. If you relied on them you got . . . you know,” he says, sparing me the gory details. “You did your own analysis. What is clear is that rating agencies always change something after it is obvious to everyone else. That’s why we never relied on them.” That’s a bit disconcerting since the Fed still uses these same agencies in managing its own portfolio.

Agreed. Can’t have it both ways. And now they are threatening to downgrade the US government as well

I wonder whether the same bubble-producing Fed errors aren’t being repeated now as Washington scrambles to avoid a sustained economic downturn.

He surprises me by siding with the deflation hawks. “I don’t think that’s the risk right now.” Why? One factor influencing his view is the Dallas Fed’s “trim mean calculation,” which looks at price changes of more than 180 items and excludes the extremes. Dallas researchers have found that “the price increases are less and less. Ex-energy, ex-food, ex-tobacco you’ve got some mild deflation here and no inflation in the [broader] headline index.”

Mr. Fisher says he also has a group of about 50 CEOs around the U.S. and the world that he calls on, all off the record, before almost every FOMC meeting. “I don’t impart any information, I just listen carefully to what they are seeing through their own eyes. And that gives me a sense of what’s happening on the ground, you might say on Main Street as opposed to Wall Street.”

It’s good to know that a guy so obsessed with price stability doesn’t see inflation on the horizon. But inflation and bubble trouble almost always get going before they are recognized. Moreover, the Fed has to pay attention to the 1978 Full Employment and Balanced Growth Act — a.k.a. Humphrey-Hawkins — and employment is a lagging indicator of economic activity. This could create a Fed bias in favor of inflating. So I push him again.

“I want to make sure that your readers understand that I don’t know a single person on the FOMC who is rooting for inflation or who is tolerant of inflation.” The committee knows very well, he assures me, that “you cannot have sustainable employment growth without price stability. And by price stability I mean that we cannot tolerate deflation or the ravages of inflation.”

Mr. Fisher defends the Fed’s actions that were designed to “stabilize the financial system as it literally fell apart and prevent the economy from imploding.” Yet he admits that there is unfinished work. Policy makers have to be “always mindful that whatever you put in, you are going to have to take out at some point. And also be mindful that there are these perceptions [about the possibility of monetizing the debt], which is why I have been sensitive about the issue of purchasing Treasurys.”

Yes, seems the Fed is worried about perceptions they know not to be true, but struggles to come with a way to communicate the operational realities.

He returns to events on his recent trip to Asia, which besides China included stops in Japan, Hong Kong, Singapore and Korea. “I wasn’t asked once about mortgage-backed securities. But I was asked at every single meeting about our purchase of Treasurys. That seemed to be the principal preoccupation of those that were invested with their surpluses mostly in the United States. That seems to be the issue people are most worried about.”

As I listen I am reminded that it’s not just the Asians who have expressed concern. In his Kennedy School speech, Mr. Fisher himself fretted about the U.S. fiscal picture. He acknowledges that he has raised the issue “ad nauseam” and doesn’t apologize. “Throughout history,” he says, “what the political class has done is they have turned to the central bank to print their way out of an unfunded liability. We can’t let that happen. That’s when you open the floodgates. So I hope and I pray that our political leaders will just have to take this bull by the horns at some point. You can’t run away from it.”

Does not sound like he understands, operationally, what that is currently all about, but instead still uses gold standard rhetoric.

Voices like Mr. Fisher’s can be a problem for the politicians, which may be why recently there have been rumblings in Washington about revoking the automatic FOMC membership that comes with being a regional bank president. Does Mr. Fisher have any thoughts about that?

This is nothing new, he points out, briefly reviewing the history of the political struggle over monetary policy in the U.S. “The reason why the banks were put in the mix by [President Woodrow] Wilson in 1913, the reason it was structured the way it was structured, was so that you could offset the political power of Washington and the money center in New York with the regional banks. They represented Main Street.

Yes, there is a power struggle going on in the Fed

“Now we have this great populist fervor and the banks are arguing for Main Street, largely. I have heard these arguments before and studied the history. I am not losing a lot of sleep over it,” he says with a defiant Texas twang that I had not previously detected. “I don’t think that it’d be the best signal to send to the market right now that you want to totally politicize the process.”

Speaking of which, Texas bankers don’t have much good to say about the Troubled Asset Relief Program (TARP), according to Mr. Fisher. “Its been complicated by the politics because you have a special investigator, special prosecutor, and all I can tell you is that in my district here most of the people who wanted in on the TARP no longer want in on the TARP.”

At heart, Mr. Fisher says he is an advocate for letting markets clear on their own. “You know that I am a big believer in Schumpeter’s creative destruction,” he says referring to the term coined by the late Austrian economist. “The destructive part is always painful, politically messy, it hurts like hell but you hopefully will allow the adjustments to be made so that the creative part can take place.” Texas went through that process in the 1980s, he says, and came back stronger.

This is doubtless why, with Washington taking on a larger role in the American economy every day, the worries linger. On the wall behind his desk is a 1907 gouache painting by Antonio De Simone of the American steam sailing vessel Varuna plowing through stormy seas. Just like most everything else on the walls, bookshelves and table tops around his office — and even the dollar-sign cuff links he wears to work — it represents something.

He says that he has had this painting behind his desk for the past 30 years as a reminder of the importance of purpose and duty in rough seas. “The ship,” he explains, “has to maintain its integrity.” What is more, “no mathematical model can steer you through the kind of seas in that picture there. In the end someone has the wheel.” He adds: “On monetary policy it’s the Federal Reserve.”

Ms. O’Grady writes the Journal’s Americas column.


Posted in Articles, Fed, Inflation, Interest Rates | 1 Comment »

Personal interest income in free fall

Posted by WARREN MOSLER on 22nd May 2009

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Looks to me like this is going to be a strong headwind for a while, that is offsetting some of the fiscal expansion. It should be a ‘good thing’ as it means tax cuts and/or increased government spending is in order, but that’s not in the cards.

The non government sectors are large net savers to the tune of the cumulative government budget deficit spending.

Savers are continuously getting recouponed lower as fixed rate CD’s, tsy secs, etc. mature. This reduces aggregate demand.

Borrowers are helped some but not as much as borrowing rates remaining high due to the price of risk.

Net interest margins for banks and other lenders remain high and are drains on aggregate demand as banks are not spending their operating profits on goods and services, but instead adding to reserves.

Personal Income Graph


Posted in Banking | 36 Comments »

Singh May Set Record in India Asset Sales After Election Victory

Posted by WARREN MOSLER on 22nd May 2009

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>   On Fri, May 22, 2009 at 8:52 AM, Michael Pede wrote:

>   Singh May Set Record in India Asset Sales After Election Victory

Asset sales are deflationary.

>   Taiwan’s Unemployment Rate Climbs to Record 5.77%
>   Vietnam’s Central Bank Keeps Key Rate Unchanged at 7%
>   Philippines Can Meet 2009 GDP Growth Target, Central Bank Says
>   Indonesia Says Recovery in India, China to Add to GDP Growth


Posted in Uncategorized | No Comments »

Geithner takes the pledge

Posted by WARREN MOSLER on 22nd May 2009

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Score one for the deficit terrorists
This is one of the largest risks to the recovery:

Geithner Pledges to Cut Deficit Amid Rating Concern

by Robert Schmidt

May 21 (Bloomberg) — Treasury Secretary Timothy Geithner said the Obama administration is committed to reducing the federal budget deficit after concerns rose that the U.S. debt rating may eventually be threatened with a downgrade.

“It’s very important that this Congress and this president put in place policies that will bring those deficits down to a sustainable level over the medium term,” Geithner said in an interview with Bloomberg Television. He added that the target is reducing the gap to 3 percent of gross domestic product or smaller, from a projected 12.9 percent this year.

The dollar, Treasuries and American stocks slumped today on concern about the U.S. government’s debt rating. Bill Gross, the co-chief investment officer of Pacific Investment Management Co., said the U.S. “eventually” will lose its AAA grade.

Geithner, 47, also said that the rise in yields on Treasury securities this year “is a sign that things are improving” and that “there is a little less acute concern about the depth of the recession.”

Benchmark 10-year Treasury yields jumped 17 basis points to 3.37 percent at 4:53 p.m. in New York. The Standard & Poor’s 500 Stock Index fell 1.7 percent to 888.33, and the dollar tumbled 0.8 percent to $1.3890 per euro.

Gross’s Warning

Gross said in an interview today on Bloomberg Television that while a U.S. sovereign rating cut is “certainly nothing that’s going to happen overnight,” financial markets are “beginning to anticipate the possibility.”

Britain saw its own AAA rating endangered earlier today when Standard & Poor’s lowered its outlook on the nation’s grade to “negative” from “stable,” citing a debt level approaching 100 percent of U.K. GDP.

It’s “critically important” to bring down the American deficit, Geithner said.

Ten-year Treasury yields have climbed about 1 percentage point so far this year, in part after U.S. economic figures indicated that the worst of the deepest recession in half a century has passed. The yield on 30-year bonds has jumped to 4.31 percent, from 2.68 percent at the beginning of the year.

The Treasury chief said it’s still “possible” that the unemployment rate may reach 10 percent or higher, cautioning that the economic recovery is still in the “early stages.”

‘Very Challenging’

“The important thing to recognize is that growth will stabilize and start to increase first before unemployment peaks and starts to come down,” he said. “These early signs of stability are very important” although “this is still a very challenging period for businesses and families across the United States.”

Initial claims for unemployment insurance fell by 12,000 in the week ended May 16 to 631,000, according to Labor Department statistics released today. Still, the number of workers collecting unemployment checks rose to a record of more than 6.6 million in the week ended May 9.

As of April, the unemployment rate was 8.9 percent, the highest level since 1983. The economy has lost 5.7 million jobs since the recession started in December 2007.


Posted in Deficit, Government Spending, Obama | No Comments »

Galbraith video

Posted by WARREN MOSLER on 22nd May 2009

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In Every Way a Good Thing”: The Upside of Soaring Federal Budget Deficits

by Aaron Task

With the federal budget deficits expected to exceed $1.8 trillion this fiscal year and borrowing expected to top $9.3 trillion over the next decade, it’s no wonder many policymakers, politicians, economists and everyday Americans fear the worst.

But rising federal budget deficits are “in every way a good thing,” according to University of Texas professor James Galbraith.

Higher budget deficits are a natural result of declining tax revenues and rising unemployment and serve as a “great stabilizer” to the consumer and the economy as a whole, he argues — as you’d expect from the son of famed Keynesian economist John Kenneth Galbraith.

The government’s bailout of the banks was an “unproductive use of Federal borrowing,” but Galbraith is otherwise fully supportive of the administration’s borrow-and-spend efforts so far.

Furthermore, he believes those calling for the government to reverse course soon are being “terribly imprudent,” noting it took more than 20 years for the private sector to fully recover after the 1929 crash.


Posted in Articles, Deficit, Government Spending, Video | 1 Comment »

My 2002 letter on the ratings agencies downgrading of Japan

Posted by WARREN MOSLER on 21st May 2009

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Hi David- been a long time, seems nothing has changed!

(See my 2002 letter to you below)

You downgraded Japan below Botswana, their debt/GDP went to over 150% with annual deficits over 8%, and all with a zero or near zero interest rate policy for over a decade, cds traded up, and 10 year JGB’s were continually issued in any size they wanted at the lowest rates in the world.

This is no accident. It’s inherent in monetary operations with non convertible currency and floating exchange rates. Your analysis is applicable only to fixed exchange rate regimes regarding defaulting on their conversion clauses.

Do the world a favor, reverse your position, and explain the reason for your current and prior errors, thanks!

All the best,



Flawed Logic Destabilizing the World Financial System

Repeated downgrades of Japan by the ratings agencies due to flawed logic have been destabilizing both Japan and the financial world in general. Their monumental error can be traced to a lack of understanding the operational realities of a Government that issues its own currency. For the Government of Japan, payment in yen, its currency of issue, is a simple matter of crediting a member bank account at the BOJ (Bank of Japan). There is no inherent operational constraint for this process. Simply stated, Government checks (payable in yen) will not bounce. The BOJ has the ABILITY to clear any MOF check for ANY size, simply by adding a credit balance to the member bank account in question. Yes, the BOJ could be UNWILLING to clear ANY check, but that is an entirely different matter than being UNABLE to credit an account. Operationally, concepts of the BOJ not having ‘sufficient funds’ to credit member accounts are functionally inapplicable.

As a point of logic, the concept of ABILITY to pay being inherently revenue constrained is not applicable to the issuer of a currency. Any such constraints are necessarily self-imposed (including various ‘no overdraft’ legislation in some countries for the Treasury at the Central Bank). The issuer can always make payment of its currency by crediting the appropriate account or by issuing actual paper currency if demanded by the counter party.

An extreme example is Russia in August 1998. The ruble was convertible into $US at the Russian Central Bank at the rate of 6.45 rubles per $US. The Russian government, desirous of maintaining this fixed exchange rate policy, was limited in its WILLINGNESS to pay by its holdings of $US reserves, since even at very high interest rates holders of rubles desired to exchange them for $US at the Russian Central Bank. Facing declining $US reserves, and unable to obtain additional reserves in international markets, convertibility was suspended around mid August, and the Russian Central Bank has no choice but to allow the ruble to float.

All throughout this process, the Russian Government had the ABILITY to pay in rubles. However, due to its choice of fixing the exchange rate at level above ‘market levels’ it was not, in mid August, WILLING to make payments in rubles. In fact, even after floating the ruble, when payment could have been made without losing reserves, the Russian Government, which included the Treasury and Central Bank, continued to be UNWILLING to make payments in rubles when due, both domestically and internationally. It defaulted on ruble payment BY CHOICE, as it always possessed the ABILITY to pay simply by crediting the appropriate accounts with rubles at the Central Bank.

Why Russia made this choice is the subject of much debate. However, there is no debate over the fact that Russia had the ABILITY to meet its notional ruble obligations but was UNWILLING to pay and instead CHOSE to default.

Note that even Turkey, with lira debt in quadrillions, interest rates in the neighborhood of 100%, annual currency depreciation in the neighborhood of 50%, little ‘faith’ in government, and only inflation keeping the debt to gdp ratio from rising, has never missed a lira payment and never had a lira ‘funding crisis.’ Turkey has had problems with its $US debt, but not with its ability to spend lira. Government spending of lira is limited only by the desire to purchase what happens to be offered for sale. It is not and cannot be ‘revenue constrained.’ Operationally, Turkey has the same unlimited ABILITY to pay in its own currency as does Japan, the US, or any other issuer of its own currency.

The Turkish example, and many others, makes it quite obvious that ABILITY to pay in local currency is, in practice as well as in theory, unlimited. ‘Deteriorating debt ratios’ and the like do not inhibit a sovereign’s ABILITY to pay in its currency of issue.

So why have the ratings agencies implied that default risk for holders of Japan’s yen denominated debt has increased to the point of deserving a downgrade? Do they understand that ABILITY to pay is beyond question, and therefore are basing their downgrade on the premise that Japan may at some point be UNWILLING to pay? If so, they have never mentioned that in their country reports.

A few years back, due to political disputes, the US Congress decided to default on US Government debt. The only reason the US Government did not default was because Treasury Secretary Robert Rubin was able to make payment from an account balance undisclosed to Congress. The US Government clearly showed an UNWILLINGNESS to pay that Japan has NEVER shown or even hinted at. Furthermore, again unlike Japan, the US continues this behavior just about every time the self imposed US ‘debt ceiling’ is about to be breached. And yet the ratings agencies have never even considered downgrading the US on WILLINGNESS to pay.

Therefore, one can only conclude 1) Japan has been downgraded on ABILITY to pay, and 2) The logic of the ratings agencies is flawed. In a world where currently there are serious ‘real’ financial problems to address, the ratings agencies have introduced a ‘contrived’ financial problem of substantial magnitude, as many regulations regarding the holdings of securities specify ratings assigned by the leading ratings agencies. Governments have chosen to rely on the ratings agencies for credit analysis, and downgrades often compel banks, insurance companies, pension plans, and other publicly regulated institutions to liquidate the securities in question.

Japan’s yen denominated debt qualifies for a AAA rating. ABILITY to pay is beyond question. WILLINGNESS to pay has never been questioned, even by the agencies engaged in recent downgrades. The destabilizing downgrades are the result of flawed logic.


Posted in Deficit, Government Spending, Japan | 2 Comments »


Posted by WARREN MOSLER on 21st May 2009

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Karim writes:


  • Initial claims down to 631k (last week revised up from 637k to 643k)
  • Continuing claims up another 75k; up every week this year
  • Need to see initial claims (which represent layoffs) move back to 350-400k to signal no further job losses
  • Continuing claims reflect lack of hiring and is more correlated to unemployment rate as well as duration of unemployment


Posted in Karim | No Comments »