[Skip to the end]

I am thinking earnings season should be pretty good this quarter.

Fiscal policy has been more than supportive since year end, fiscal consolidation is currently still all talk.

Negative shock risks are still there, however, California, eurozone banks and/or governments, nukes, etc.

Not sure on timing.

World Outlook: Recovery ahead

For the first time since the beginning of the downturn we have revised up our forecasts for economic growth. We now expect global growth to rise to 2.5% in 2010 compared to 2.0% envisaged in our previous World Outlook from 30 March 2009. The upward revision is due entirely to better prospects for industrial countries, where growth next year is now seen reaching 1.0% compared to 0.3% before.

Most of the upward revision to global growth in 2010 results from a stronger outlook for investment growth (which has risen to 2.0% from 0.1%) and export growth (up to 4.1% from -2.2% before). The improved prospects for exports and investment reflect greater confidence in the effectiveness of authorities’ efforts to restore stability in the financial sector.

In our view the global economic and financial crisis has had two key drivers: (1) the breakdown of the global growth model of the past decade or so, which led to unsustainable international current account imbalances; and (2) the financial crisis, which ensued when the inability of debtors to repay their creditors became evident. As a result, we can expect to see lower trend growth and higher economic volatility, the opposite of what the world economy experienced during the era of the Great Moderation.

[top]

[Skip to the end]

Gasoline demand sort of flat year over year.

And GDP growth still negative, though less so now.

Doesn’t look like there was an serious ‘demand destruction?’

[top]

[Skip to the end]

Don’t think markets are ready for this:

Exporters warn of German credit squeeze

by Ralph Atkins

June 26th (Bloomberg) — Germany’s powerful export industry is warning of a credit squeeze in Europe’s largest economy even after the European Central Bank’s injection this week of one-year liquidity into the eurozone banking system.

The German BGA exporters’ association on Thursday forecast a “dramatic deterioration” in credit conditions in coming months, which would result in “massive financing squeeze”.

[top]

[Skip to the end]

This gets more ridiculous by the hour.
The dependence on China already was zero.

And, as in my previous post, the high savings rate of the non government sector
comes dollar for dollar from the deficit and is not necessarily indicative of
low spending.

If it were, that would imply there is no inflation risk to deficit spending on the grounds that it all gets added to savings.

So once again one of our opinion leaders is making a statement that supports the opposite of what he thinks it supports.

Federal deficit spending is clearly adding to incomes, savings, and spending.

As it always does.

Surging U.S. Savings Rate Reduces Dependence on China

by Rich Miller and Alison Sider

June 26th (Bloomberg) — Saks Fifth Avenue is cutting orders 20 percent after postinglosses in the last four quarters. Kia Harris says some customers at the Washington shoe store where she works are buying one pair rather than three.

Incomes and spending were up in yesterday’s report.

In the recession following a borrowing binge that sent consumer debt to the highest level ever, Americans are shutting their wallets and building their nest eggs at the fastest pace in 15 years.

Non government savings and income is ‘funded’ by federal deficit spending — to the penny

While the trend will put the country’s finances in better balance and reduce its dependence on Chinese investment,

Dependence on Chinese investment remains at zero where it’s always been.

it may also restrain economic growth in 2010 and beyond,

No, in fact the higher income and savings added by the federal deficit tends to expand aggregate demand and real economic growth.

said Lyle Gramley, a senior economic adviser with New York-based Soleil Securities Corp. and a former Federal Reserve governor.

Who would have thought???…

“There’s been a fundamental change in people’s behavior,” he said. “It will affect the economy for years.”

Government data today showed that the household savings rate rose to 6.9 percent in May, the highest since December 1993, as personal spending increased less than incomes. The rate in April 2008 was zero.

1993 was also a year of very high federal deficit spending.

This stuff is not that hard…

[top]

[Skip to the end]

Lending follows the markets.

As the economy improves banks and other lenders figure it out and jump in.

Also, today’s news on personal income is very bullish as well.

It shows fiscal policy ‘works’ as it did for q2 last year.

The concern is that the ‘savings rate’ is high which takes away from spending.

Not necessarily.

The ‘savings’ comes from federal deficit spending.

Net federal spending adds financial assets to someone’s account in the non government sector that can’t ‘go away.’

The federal spending can be spent many times over and savings will still go up by the same amount.

So to me it looks like the deficit spending is currently high enough to have sufficiently restored savings to levels that promote at least modest increases in consumption.

But not yet enough to bring unemployment down as the output gap continues to grow.

JPMorgan, Citigroup Expand in ‘Jumbo’ Home Mortgages

by Jody Shenn

June 26 (Bloomberg) —JPMorgan Chase & Co. and Citigroup Inc. are expanding in “jumbo” mortgages used to buy the most expensive homes, helping revive a market that shriveled amid a three-year jump in homeowner defaults.

JPMorgan resumed buying new jumbo loans made by other lenders this month, after halting purchases in March, spokesman Tom Kelly said. Borrowers must have checking accounts with the bank, he said. Citigroup is again offering the loans through independent mortgage brokers, spokesman Mark Rodgers said.

[top]

[Skip to the end]

Wonder if they’ve used it?

In my humble opinion lending them $30 billion unsecured is a high risk proposition.

U.S. Federal Reserve Extends Swap Line With Brazil Central Bank

June 25 (Bloomberg) — Brazil’s central bank said today it
has extended an agreement to access up to $30 billion from the
U.S. Federal Reserve as part of a coordinated international
effort to shore up shaky financial markets.

[top]

[Skip to the end]

Yes, infinite, in fact.

Put that into your debt to income calculations…

S&P SAYS JAPAN HAS ENOUGH FUNDS TO SERVICE RISING DEBT COSTS

[top]

[Skip to the end]

Looks like they are moving towards higher levels of domestic consumption to sustain output and employment.

(must be reading my blog…)

China’s Central Bank Pledges to Keep Money Flowing

China to Start Trial Rural Pension System to Boost Consumption

China’s Central Bank Pledges to Keep Money Flowing

June 25 (Bloomberg) — China’s central bank pledged to keep
pumping money into the financial system to support a recovery in
the world’s third-biggest economy.

The economy is in a “critical” stage and the central bank
will maintain a “moderately loose” monetary policy, the
People’s Bank of China reiterated in a statement on its Web site
today after a quarterly meeting.

The central bank triggered an explosion in credit by
scrapping quotas on lending in November to back the government’s
4 trillion yuan ($585 billion) stimulus plan. Record lending is
stoking concern that a recovery may come at the expense of asset
bubbles, bad debts for banks and inflation in the long term.

Banks are set to lend more in June than in May, the same
newspaper reported June 22, citing unidentified sources. Last
month, new loans more than doubled from a year earlier.

China to Start Trial Rural Pension System to Boost Consumption

June 25 (Bloomberg) —China, home to 700 million rural
residents, approved a pilot pension program as the government
tries to encourage farmers to spend more to help revive economic
growth.

The new system, which aims to cover 10 percent of rural
counties this year, will help narrow a wealth gap with cities
and spur domestic demand, according to a statement today from
the State Council, China’s cabinet.

China has expanded its social safety net to reduce
precautionary saving by citizens planning for ill health and old
age. Premier Wen Jiabao has pledged to boost domestic
consumption to help the world’s third-biggest economy recover
from its deepest slump in a decade and lessen dependence on
exports and investment.

“The rural pension system has been almost non-existent,”
said Kevin Lai, an economist with Daiwa Institute of Research in
Hong Kong. “Once you build a stronger social safety net, people
will be more inclined to spend without having to worry about the
future.”

The government in late January also announced it would
spend 850 billion yuan ($124 billion) over three years to ensure
that at least 90 percent of its 1.3 billion citizens have basic
health insurance by 2011.

China’s economy grew 6.1 percent in the first quarter, the
slowest pace in almost a decade.

[top]

[Skip to the end]

So how about recommending a suspension VAT for a bit???

King Says U.K. Recovery May Be ‘Long, Hard Slog’

by Robert Schmidt

June 24 (Bloomberg) — “There has to be a risk that it will be a long, hard slog” because of the problems in the banking system, King told lawmakers in London today. “I feel more uncertain now than ever. This is not the pattern of a recession coming into recovery that we’ve seen since the 1930s. Having an open mind and not pretending to foresee the future when it’s so uncertain is important.”

King said that there’s “not much evidence to change our view” since the bank released forecasts in May showing that the economy won’t return to growth on an annual basis until the second half of next year.

[top]

[Skip to the end]

India Should Rely on Lower Rates to Stimulate Growth, OECD Says

by Kartik Goyal

June 24 (Bloomberg) — India should cut interest rates
rather than boost government spending if further measures are
needed to stimulate growth, the Organization for Economic
Cooperation and Development said.

They need to read Bernanke’s 2004 paper which makes it clear lower interest rates are contractionary via the fiscal channel and need to be matched by fiscal expansion to overcome that effect.

Additionally, in today’s environment, lower rates hurt savers a lot more than the help borrowers. Rates for savers have fallen a lot more than rates for borrowers due to risk perceptions and implied capital costs as net interest margins for lenders have increased to over 4%. This also means reduced aggregate demand and begs additional fiscal measures to sustain GDP.

So while I strongly favor lower rates, I also recognize that one of the benefits of lower rates is that they allow reduced taxes or increased public expenditure to sustain output and employment at desired levels.

[top]

[Skip to the end]

Now that the ECB has demonstrated how it can set term bank rates out to a year (and minimize the need for the interbank markets) the door is open to same for any maturity.

And it also paves the way for other CB’s to do the same as they inch closer to my long standing proposals.

Again, for CB’s it’s about price (interest rates), not quantity (size of operation, CB’s balance sheet, etc).

The effects on the economy are those of the resulting interest rates, and not the quantities involved in the CB’s operations.

[top]

[Skip to the end]

(email exchange)

>   On Mon, Jun 22, 2009 at 9:10 AM, wrote:
>   
>   And reach Wolfgang Munchnau in the FT today. Germany is really going nuts here.
>   German sado-fiscalism!
>   

As he says towards the end, it’s a moral issue.

This type of thing is the largest long term risk to economic well being.

I am starting to call it the federal ‘contribution’ rather than the federal ‘deficit’ hoping that might help.

Berlin weaves a deficit hair-shirt for us all

by Wolfgang Münchau

June 21 (FT) —

A decision was taken recently in Berlin to introduce a balanced-budget law in the German constitution. It was a hugely important decision. It may not have received due attention outside Germany given the flood of other economic and financial news. From 2016, it will be illegal for the federal government to run a deficit of more than 0.35 per cent of gross domestic product. From 2020, the federal states will not be allowed to run any deficit at all. Unlike Europe’s stability and growth pact, which was first circumvented, later softened and then ignored, this unilateral constitutional law will stick. I would expect that for the next 20 or 30 years, deficit reduction will be the first, second and third priority of German economic policy.

Anchoring the stability law at the level of the national constitution is an extreme measure – like locking the door, and throwing the keys away. It can only ever be undone with a two-thirds majority – and even a future Grand Coalition may not be able to deliver this as both of the large parties are in a process of secular decline. It means that future fiscal policy will be in the hands of the justices of Germany’s Constitutional Court. The new law replaces a much softer constitutional clause – a golden investment rule that said deficits can only be used to finance investments. It was not a satisfactory rule, but at least it allowed structural deficits in principle. The new law not only sets draconian deficit ceilings, it also provides a detailed numerical toolkit to implement the rules over the economic cycle.

I can foresee two outcomes. First, Germany might end up in a procyclical downward spiral of debt reduction and low growth. In that case, the constitutionally prescribed pursuit of a balanced budget would require ever greater budgetary cuts to compensate for a loss of tax revenues.

To meet the interim deficit reduction goals, the new government will have to start cutting the structural deficits by 2011 at the latest. There is clear danger that the budget consolidation timetable might conflict with the need for further economic stimulus, should the economic crisis take another turn for the worse. There is still economic uncertainty. Bankruptcies are rising, and the German banks are just about to tighten their credit standards again. I simply cannot see how Germany can produce robust growth in such an environment, not even in 2011. If that scenario prevails – as I believe it will – the new constitutional law will produce a pro-cyclical fiscal policy with immediate effect.

One could also construct a virtuous cycle – the second outcome. If Germany were to return to a pre-crisis level of growth in 2011, and all is well after that, the consolidation phase would then start in a cyclical upturn.

Either of those scenarios, even the positive one, is going to be hugely damaging to the eurozone. In the first case, the German economy would become a structural basket case, and would drag down the rest of Europe for a generation. In the second case, economic and political tensions inside the eurozone are going to become unbearable. Over the past 25 years, France has more or less followed Germany’s lead at every turn, but I suspect this may be a turn too far. Deficit reduction has not been, nor will it be, a priority for Nicolas Sarkozy, the French president. On the contrary: he has listened to bad advice from French economists who told him that budget deficits are irrelevant, and that he should focus only on structural reforms. Budget deficits and debt levels matter in a monetary union. But a zero level of debt is neither necessary nor desirable.

I am a little surprised not to hear howls of protests from France and other European countries. Germany has not consulted its European partners in a systematic way. While the Maastricht treaty says countries should treat economic policy as a matter of common concern, this was an example of policy unilateralism at its most extreme.

What is the rationale for such a decision? It cannot be economic, for there is no rule in economics to suggest that zero is the correct level of debt, which is what a balanced budget would effectively imply in the very long run. The optimal debt-to-GDP ratio might be lower for Germany than for some other countries, but it surely is not zero.

While the balanced budget law is economically illiterate, it is also universally popular. Average Germans do not primarily regard debt in terms of its economic meaning, but as a moral issue. Der Spiegel, the German news magazine, had an intriguing report last week on the country’s young generation. One of the protagonists in its story was a young woman who had borrowed a little money to set up her own company. The company turned out to be a success, and she had began to repay the loan. And yet she said she had not felt proud of having taken on debt.

This general level of debt-aversion is bizarre. Many ordinary Germans regard debt as morally objectionable, even if it is put to proper use. They see the financial crisis primarily as a moral crisis of Anglo-Saxon capitalism. The balanced budget constitutional law is therefore not about economics. It is a moral crusade, and it is the last thing, Germany, the eurozone and the world need right now.

[top]

[Skip to the end]

(email exchange)

>   On Mon, Jun 22, 2009 at 4:32 AM, wrote:
>   
>   ECB President Trichet has warned that governments have no more room
>   for taking on more debt, and should now look to start bringing down
>   budget deficits. “There is a moment where you can’t spend anymore and
>   you can’t accumulate any more debt. I think we are at that moment”.
>   

Similar to the Obama statement that the US has ‘run out of money.’

The difference is that under current institutional constraints Trichet is, unfortunately, probably right.

They are stuck waiting around for their own automatic stabilizers to function, and for exports to improve.

And hope the markets don’t test their banking system deposit guarantees and national government funding abilities.

[top]

[Skip to the end]

This should bring down the term structure of rates at least out to one year, especially if the program is ongoing at this fixed rate.

And, operationally, it’s a similarly simple matter to set ‘risk free’ rates out the entire curve.

So, for example, bringing down rates out to a year could steepen the entire curve, but a follow up program to do the same for longer term rates could then flatten the curve.

And ‘turning the program on and off’ can add volatility as well.

Asikainen : Long Term Repo Operation (LTRO)

Next Thursday, the ECB will offer the market a funding tender which will let members of the system borrow at 1.0% for up to a year. Yes – term funding, secured by the ECB, at bargain-low rates for a year. You can pledge anything that is BBB or higher, and the ECB will fill unlimited supply at 1.00%. If they get EUR100 billion pledged? Filled. If they get EUR 2 trillion pledged? Filled.

[top]

[Skip to the end]

It is something they want but seems there is no viable plan yet.

It is harder than it sounds and what they do come up with if short of a government guaranteed market will have similar risks.

The ‘answer’ is the repo markets add no value to the real economy and therefore there is no public purpose behind creating a ‘better one.’

I would just let the banks continue to price risk for secured lending as they are doing and let the interest spreads (and disintermediation when borrowers and lenders find each other directly) fall where they may due to competitive pressures.

Fed plans repo markets revamp

by Henny Sender and Michael Mackenzie

June 21 (FT) — The US Federal Reserve is considering dramatic changes to the giant repurchase – or repo – markets where banks around the world raise overnight dollar loans.

The plans include creating a utility to replace the Wall Street banks that handle transactions, people familiar with the matter say.

The Fed’s deliberations are partly motivated by concerns that the structure of the US overnight repurchase market may have exacerbated the financial turmoil that accompanied the failure of Lehman Brothers in September last year.

Fed officials plan to meet next month with market participants to discuss reforms.

People familiar with the Fed’s thinking say it is looking into the creation of a mechanism to replace the clearing banks – the biggest of which are JPMorgan Chase and Bank of New York Mellon – that serve as intermediaries between borrowers and lenders.

“The Fed is raising questions about whether the system really protects the interests of all participants,” says one person familiar with the Fed’s thinking.

In the repo markets, borrowers, such as banks, pledge collateral in return for overnight loans from lenders, such as money market funds.

The clearing banks stand between the parties, providing services such as valuing the collateral and advancing cash during the hours when trades are being made and unwound.

Fed officials fear this arrangement puts the clearing banks in a difficult position in a crisis. As the value of the securities falls, clearing banks have an obligation to demand more collateral to avoid losses. But in doing so, they could destabilise a rival.

“The clearing banks fear the positions of the investment banks are so large that a default would be difficult for them to manage,” the person familiar with the Fed’s thinking said.

“[Everyone] is thinking about how to remove conflicts of interest of the clearing banks and the investment banks so that the investment banks aren’t vulnerable to a sudden restriction of credit.”

The system’s complications were evident during Lehman’s collapse. JPMorgan, one of Lehman’s biggest trading partners, acted as its clearing bank in the repo market and – along with BoNY Mellon – served as the clearing bank for the New York Federal Reserve’s credit facility for securities ­companies.

Lawyers for the Lehman estate and for creditors have raised questions about whether JPMorgan acted too aggressively in seizing and marking down Lehman’s collateral.

Hedge funds have bought Lehman debt on the theory that the estate can claw back some of that collateral in court.

Citing confidentiality concerns, JPMorgan declined to comment.

The Fed hopes to have a new repo system in place by October, when its credit facility for securities companies is to close.

[top]

[Skip to the end]

Central bank liquidity swaps (13) 150,282 – 15,574

[top]

[Skip to the end]

Karim writes:

[top]

[Skip to the end]

Rather than let the states cut essential services and lay off employees with unemployment over 9%, I would give all the states an immediate $500 per capita distribution from the federal government.

It is the same voters and the same taxpayers, so per capita is the way to go.

This gives California most of what it needs and also gives the other states the same per capita distribution to use as desired.

That way it is equitable and helps support aggregate demand during this obvious shortfall.

Calif. Aid Request Spurned By U.S.

Officials Push State To Repair Budget

By David Cho, Brady Dennis and Karl Vick

June 16 (Washington Post)— The Obama administration has turned back pleas for emergency aid from one of the biggest remaining threats to the economy — the state of California.

Top state officials have gone hat in hand to the administration, armed with dire warnings of a fast-approaching “fiscal meltdown” caused by a budget shortfall. Concern has grown inside the White House in recent weeks as California’s fiscal condition has worsened, leading to high-level administration meetings. But federal officials are worried that a bailout of California would set off a cascade of demands from other states.

The administration is worried that California will enact massive cuts to close its deficit, estimated at $24 billion for the fiscal year that begins July 1, aggravating the state’s recession and further dragging down the national economy.

After a series of meetings, Treasury Secretary Timothy F. Geithner, top White House economists Lawrence Summers and Christina Romer, and other senior officials have decided that California could hold on a little longer and should get its budget in order rather than rely on a federal bailout.

“After June 15th, every day of inaction jeopardizes our state’s solvency and our ability to pay schools and teachers and to keep hospitals and ERs open,” Gov. Arnold Schwarzenegger (R) said Friday.

California’s budget is also heavily dependent on taxes paid on capital gains and stock options, which have been clobbered during the meltdown of financial markets. State budget analysts made their annual estimate of revenue a month before the crisis spiked in the fall and have been backpedaling ever since.

Consider capital gains — income from sales of stocks or other assets. In California, that income dropped to $52 billion in 2008 from $130 billion a year earlier. It is estimated to be $36 billion this year.

By February, the shortfall was projected at $42 billion over two years.

To close an annual gap now put at $24 billion, Schwarzenegger and leaders of the legislature’s Democratic majority have put aside talk of tax increases to concentrate on cuts.

“A lot of the burden,” Geithner said, “is going to be on them to lay out a path that gets their deficits down to the point where they’re going to be able to fund themselves comfortably.”

[top]

[Skip to the end]

Karim writes:

[top]

[Skip to the end]

This is the exact same line Niall Ferguson is spewing.
He also says the two choices are inflating or defaulting.

The inflation would be from too much aggregate demand and a too small output gap.

That would mean that fatefull day would be an economy with maybe 4% unemployment and 90%+ capacity utilization and an overheating economy in general.

Sounds like that’s the goal of deficit spending to me- so in faccct he’s saying deficit spending works with his rant on why it doesn’t.

And if we do need to raise taxes to cool things down some day, we can start with a tax on interest income if we want to cut payments to bond holders.

Regarding the supposed default alternative to inflation, in the full employment and high capacity utilization scenario that might call for a tax increase to cool it down, I don’t see how default fits in or why it would even be considered.

In fact, with our countercyclical tax structure, strong growth that follows deficits automatically drives down the deficit, and can even drive it into surplus, as happened in the 1990′s. In that case one must be quick to reverse the growth constraining surplus should the economy fall apart as happend shortly after y2k.

Feel free to pass this along to either.

The fiscal black hole in the US

June 12 (FT)—US budgetary prospects are dire, disastrous even. Without a major permanent fiscal tightening, starting as soon as cyclical considerations permit, and preferably sooner, the country is headed straight for a build up of public debt that will either have to be inflated away or that will be ‘resolved’ through sovereign default.

[top]