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Archive for November, 2010

Trichet statement

Posted by WARREN MOSLER on 30th November 2010

*DJ Trichet: Euro-Zone Govts Are Conscious Of Their Past Mistakes
*DJ Trichet: Efforts To Improve Governance Are Being Underestimated
*DJ Trichet: Ireland And Greece Are Solvent
*DJ Trichet: Euro-Zone Public Finances Compare Well With Japan, US
*DJ Trichet: Real Euro-Zone Economy Has Surprised Positively

As if he doesn’t know the actual analogy is with the US states.

This is shameless, bold faced intellectual dishonesty.

Posted in ECB, EU | 7 Comments »

euro update and why no one is leaving (yet)

Posted by WARREN MOSLER on 30th November 2010

As before, all that’s been done in euro land is highly deflationary.

No new euro will be spent by any govt as a result of the latest goings ons.

In fact, it’s more austerity.

And the ECB continues to do just enough to keep it all muddling through (including dictating that the new facilities be set up and activated) as it dictates terms and conditions.

And with euro zone gdp still growing (modestly) austerity still has room to slow growth before it sends it into reverse.

So why isn’t there more clamor to leave?

Simple, it’s not obvious that the currency arrangements per se are the problem.

Inflation is reasonably low, and interest rates are low, so (to the uninformed, non MMT world) how can that be the problem?

For most, the problem is obvious- same old story- their corrupt, worthless, self serving govts grossly over spent, dished it out to their banker buddies, insiders, etc., on most everything they were involved in, and now the entire nation is paying the price.

And thank goodness there were market forces in place to shut them down and stop them from turning it all into a Weimar scenario!

And this time at least they haven’t had the usual massive inflation where everyone loses their purchasing power, including those still working.

For example, those in Spain with savings can buy a lot more house than before.

The ‘good’ (prudence is considered a virtue) have sort of been rewarded.


And look how good Germany has it.

Unemployment down to 7%, driven by exports, no inflation, and they have near total fiscal domination/control (via the ECB) over the other members where they get to force austerity.

What more could they ask for?

It’s their dream come true.

So it could soon be back to strong euro, slowing growth, muddling through, until they push too far.

But even negative growth is sustainable without insolvency for as long as the ECB keeps funding it all.

Posted in Deficit, ECB, EU, Germany, Government Spending | 11 Comments »

Time for England to complete the conquest of Ireland

Posted by WARREN MOSLER on 29th November 2010

The UK conquest of Ireland began in 1169.

It’s time to finish the job.

All they have to do is offer the following:

Ireland converts all its public debt to sterling.

The UK Treasury takes over the responsibility for all of Ireland’s existing public debt.

(Ireland gets a clean start with no Irish govt. debt and not interest payments)

Ireland taxes and spends in sterling only and has a balanced budget requirement.

Ireland can borrow only for capital expenditures.

The UK Treasury guarantees all existing insured euro bank deposits in Irish banks.

Only sterling deposits are insured for new deposits.

Ireland runs a mirror tax code to the UK and keeps all of its tax revenues.

The UK agrees to fund Ireland’s with a pro rata/per capita share of any UK deficit spending.

St. Patrick’s Day is declared a UK national holiday and everyone over 21 gets a beer voucher.

Posted in Currencies, Deficit, EU, Government Spending, UK | 44 Comments »

euro endgame

Posted by WARREN MOSLER on 29th November 2010

On Sun, Nov 28, 2010 at 7:24 PM, wrote:

I’ve tried to think of a happy ending here and there simply isn’t one.

That’s like thinking for the endgame of the US if you believe the federal budget needs to be balanced. There isn’t one in that case either.

The end game is always for the fiscal authority to run a deficit. Which means the ECB in the euro zone.

They won’t let the Euro collapse which means Germany leaving is out of the question. But Germany won’t just become the funding source for all of these periphery nations.

Right, it has to be the ECB. Just like Texas can’t fund the other states.

I think they should just vote to remove Ireland and Greece with a partial debt restructuring. They’d actually be doing them a huge favor while also avoiding massive collateral damage in the banking system.

Likewise, the ECB has to fund the deposit insurance to make it credible and workable.

Then they could target their efforts on saving Spain and the Euro.

Problem is, they all need to be saved.

As credit sensitive entities like the US states their debt to gdp ratios need to be below 20% to be ‘stand alone.’

The reason Luxembourg is that low is because they never did have their own currency, and so never could get higher than where they were.

The other national govts had their own currencies before joining the euro, and therefore had deficits appropriate for being the currency issuer, which is equal to non govt savings desires. Problem was they joined the euro, turned over the currency management to the ECB, and kept their old debt ratios. The informed way to have merged would have been to have the ECB take over their national debts, and let them start clean. But it happened the way it happened and now they have to move forward from here.

Ireland and Greece go it alone, the world panics for a few months and then everyone realizes that we’re all better off. Then the Euro continues to exist until it causes another crisis in 15 years (assuming no central funding system is created)….

They already have a central funding system in place- the ECB buying nat govt bonds in the secondary markets. While far from my first choice on how to do things for a variety of economic and political reasons, it does function to keep member nations solvent, for as long as the ECB keeps doing it.

My proposal remains the most sensible but not even a consideration- per capita ECB annual distributions to the govts to pay down debt of the member nations beginning with an immediate 10% of GDP distribution. To do this they first have to understand why it’s not inflationary, which means they have to understand inflation on the demand side is a function of spending, and the distribution does not increase govt spending.

That’s a big leap from their inflation expectations theory of inflation. They believe that anything that increases people’s expectation of inflation is what actually causes inflation. And they believe that because they have still failed to recognize that the currency itself is a (simple) public monopoly.

That means the price level is a function of prices paid by the govt of issue when it spends, whether it knows it or not, and not a function of expectations.

So while in fact it is the economy that needs the govt’s funds to pay its taxes, and therefore the economy is ‘price taker’, they instead believe that it is the govt that needs the economy’s funds to be able to spend.

Posted in ECB, EU, Inflation | 6 Comments »

FMOC Minutes

Posted by WARREN MOSLER on 26th November 2010

New Forecasts (central tendency and range of forecasts) in Table 1 below: Long-Run inflation forecast of 1.6-2.0% is basically their target; 2011 and 2012 unemployment forecasts revised up by 0.6-0.7%. Note that low-end of GDP forecast for 2011 is 2.5%. This is above many other forecasters.

Interesting Observations from FRB Staff; Outlook revised up, basically on assumption of improved financial conditions; and in turn inflation higher due to less slack and weaker $

The staff revised up its forecast for economic activity in 2011 and 2012. In light of asset market developments over the intermeeting period, which in large part appeared to reflect heightened expectations among investors that the Federal Reserve would undertake additional purchases of longer-term securities, the November forecast was conditioned on lower long-term interest rates, higher stock prices,
and a lower foreign exchange value of the dollar than was the staff’s previous forecast.

The downward pressure on inflation from slack in resource utilization was expected to be slightly less than previously projected, and prices of imported goods were anticipated to rise somewhat faster.

FOMC Members-Recap of debate of pros/cons of LSAPs; sizing LSAPs; and setting an inflation target, and setting a long-term interest rate target

Although participants considered it quite unlikely that the economy would slide back into recession, some noted that continued slow growth and high levels of resource slack could leave the economic expansion vulnerable to negative shocks. In the absence of such shocks, and assuming appropriate monetary policy

They do assume what they do has quite a bit of influence over the outcomes.

participants’ economic projections generally showed growth picking up to a moderate pace and the unemployment rate declining somewhat next year. Participants generally expected growth to strengthen further and unemployment to decline somewhat more rapidly in 2012 and 2013.

Several noted that the recent rate of output growth, if continued, would more likely be associated with an increase than a decrease in the unemployment rate.

While underlying inflation remained subdued, meeting participants generally saw only small odds of deflation, given the stability of longer-term inflation expectations

They remain steeped in inflation expectations theory as previously discussed.

and the anticipated recovery in economic activity.

Most saw the risks to growth as broadly balanced, but many saw the risks as tilted to the downside. Similarly, a majority saw the risks to inflation as balanced; some, however, saw downside risks predominating while a couple saw inflation risks as tilted to the upside.

Participants also differed in their assessments of the likely benefits and costs associated with a program of purchasing additional longer-term securities in an effort to provide additional monetary stimulus, though most saw the benefits as exceeding the costs in current circumstances. Most participants judged that a program of purchasing additional longer-term securities would put downward pressure on longer-term interest rates and boost asset prices; some observed that it could also lead to a reduction in the foreign exchange value of the dollar. Most expected these changes in financial conditions to help promote a somewhat stronger recovery in output and employment while also helping return inflation, over time, to levels consistent with the Committee’s mandate. In addition, several participants argued that the stimulus provided by additional securities purchases would help protect against further disinflation and the small probability that the U.S. economy could fall into persistent deflation–an outcome that they thought would be very costly. Some participants, however, anticipated that additional purchases of longer-term securities would have only a limited effect on the pace of the recovery; they judged that the economy’s slow growth largely reflected the effects of factors that were not likely to respond to additional monetary policy stimulus and thought that additional action would be warranted only if the outlook worsened and the odds of deflation increased materially. Some participants noted concerns that additional expansion of the Federal Reserve’s balance sheet could put unwanted downward pressure on the dollar’s value in foreign exchange markets. Several participants saw a risk that a further increase in the size of the Federal Reserve’s asset portfolio, with an accompanying increase in the supply of excess reserves and in the monetary base, could cause an undesirably large increase in inflation.

This flies in the face of any understanding of banking and actual monetary operations, as well as recent Fed research.

However, it was noted that the Committee had in place tools that would enable it to remove policy accommodation quickly if necessary to avoid an undesirable increase in inflation.

Participants expressed a range of views about the potential costs and benefits of quantifying the Committee’s interpretation of its statutory mandate to promote price stability by adopting a numerical inflation objective or a target path for the price level. In the end, participants noted that the longer-run projections contained in the Summary of Economic Projections, which is released once per quarter in conjunction with the minutes of four of the Committee’s meetings, convey considerable information about participants’ assessments of their statutory objectives. Participants discussed whether it might be useful for the Chairman to hold occasional press briefings to provide more detailed information to the public regarding the Committee’s assessment of the outlook and its policy decision making than is included in Committee’s short post-meeting statements.

In their discussion of the relative merits of smaller and more frequent adjustments versus larger and less frequent adjustments in the Federal Reserve’s intended securities holdings, participants generally agreed that large adjustments had been appropriate when economic activity was declining sharply in response to the financial crisis. In current circumstances, however, most saw advantages to a more incremental approach that would involve smaller changes in the Committee’s holdings of securities calibrated to incoming data.

Finally, participants discussed the potential benefits and costs of setting a target for a term interest rate. Some noted that targeting the yield on a term security could be an effective way to reduce longer-term interest rates and thus provide additional stimulus to the economy. But participants also noted potentially large risks, including the risk that the Federal Reserve might find itself buying undesirably large amounts of the relevant security in order to keep its yield close to the target level.

No mention at all of the interest income channels, which act to reduce interest income in the economy as rates fall.

Posted in Employment, Fed, GDP, Inflation | 6 Comments »

Next Debt Crisis May Start in Washington: Bair

Posted by WARREN MOSLER on 26th November 2010

She’s as much a part of the problem as any of them.

Also, she continues to support taxing banks for FDIC losses, which works counter to Fed rate setting policy.
Across the board taxes on banks hike rates charged to borrowers, while the Fed is trying to get them down.

Also, why should a good bank be charged for losses of failed banks, when bank assets, lending policies, and operations in general are fully regulated and supervised by the FDIC? She’s making good banks pay for FDIC failures.

Banks are designated agents of the Fed, public/private partnerships established for public purpose, govt. regulated and supervised, and as such should not be charged anything for FDIC insurance. It makes no sense for the govt. to charge one of its agencies for its support.

Next Debt Crisis May Start in Washington: Bair

The US needs to take urgent action to cut its debt in order to prevent the next financial crisis, which may start in Washington, Sheila Bair, chair of the Federal Deposits Insurance Corp. (FDIC) wrote in an editorial in the Washington Post.

The federal debt has doubled over the past seven years, to almost $14 trillion, and the growth is a result of both the financial crisis and the government’s “unwillingness over many years to make the hard choices necessary to rein in our long-term structural deficit,” Bair wrote.

Posted in Banking | 10 Comments »

European Debt/GDP ratios – the core issue

Posted by WARREN MOSLER on 26th November 2010


Financially, the euro zone member nations have put themselves in the position of the US States.

Their spending is revenue constrained. They must tax or borrow to fund their spending.

The ECB is in the position of the Fed. They are not revenue constrained. Operationally, they spend by changing numbers on their own spread sheet.

Applicable history:

The US economy’s annual federal deficits of over 8% of gdp, Japan’s somewhere near there, and the euro zone is right up there as well.

And they are still far too restrictive as evidenced by the unemployment rates and excess capacity in general.

So why does the world require high levels of deficit spending to achieve fiscal neutrality?

It’s the deadly innocent fraud, ‘We need savings to have money for investment’ as outlined in non technical language in my book.

The problem is that no one of political consequence understands that monetary savings is nothing more than the accounting record of investment.

And, therefore, it’s investment that ’causes’ savings.

Not only don’t we need savings to fund investment, there is no such thing.

But all believe we do. And they also believe we need more investment to drive the economy (another misconception of causations, but that’s another story for another post).

So the US, Japan, and the euro zone has set up extensive savings incentives, which, for all practical purposes, function as taxes, serving to remove aggregate demand (spending power). These include tax advantaged pension funds, insurance and other corporate reserves, etc.

This means someone has to spend more than their income or the output doesn’t get sold, and it’s business that goes into debt funding unsold inventory. Unsold inventory kicks in a downward spiral, with business cutting back, jobs and incomes lost, lower sales, etc. until there is sufficient spending in excess of incomes to stabilize things.

This spending more than income has inevitably comes from automatic fiscal stabilizers- falling revenues and increased transfer payments due to the slowdown- that automatically cause govt to spend more than its income.

And so here we are:

The stabilization at the current output gap has largely come from the govt deficit going up due to the automatic stabilizers, though with a bit of help from proactive govt fiscal adjustments.

Note that low interest rates, both near 0 short term rates and lower long rates helped down a bit by QE, have not done much to cause consumers and businesses to spend more than their incomes- borrow to spend- and support GDP through the credit expansion channel.

I’ve always explained why that always happened by pointing to the interest income channels. Lower rates shift income from savers to borrowers, and the economy is a net saver. So, overall, lower rates reduce interest income for the economy. The lower rates also tend to shift interest income from savers to banks, as net interest margins for lenders seem to widen as rates fall. Think of the economy as going to the bank for a loan. Interest rates are a bit lower which helps, but the economy’s income is down. Which is more important? All the bankers I’ve ever met will tell you the lower income is the more powerful influence.

Additionally, banks and other lenders are necessarily pro cyclical. During a slowdown with falling collateral values and falling incomes it’s only prudent to be more cautious. Banks do strive to make loans only to those who can pay them back, and investors do strive to make investments that will provide positive returns.

The only sector that can act counter cyclically without regard to its own ability to fund expenditures is the govt that issues the currency.

So what’s been happening over the last few decades?

The need for govt to tax less than it spends (spend more than its income) has been growing as income going to the likes of pension funds and corporate reserves has been growing beyond the ability of the private sector to expand its credit driven spending.

And most recently it’s taken extraordinary circumstances to drive private credit expansion sufficiently for full employment conditions.

For example, In the late 90′s it took the dot com boom with the funding of impossible business plans to bring unemployment briefly below 4%, until that credit expansion became unsustainable and collapsed, with a major assist from the automatic fiscal stabilizers acting to increase govt revenues and cut spending to the point of a large, financial equity draining budget surplus.

And then, after rate cuts did nothing, and the slowdown had caused the automatic fiscal stabilizers had driven the federal budget into deficit, the large Bush proactive fiscal adjustment in 2003 further increased the federal deficit and the economy began to modestly improve. Again, this got a big assist from an ill fated private sector credit expansion- the sub prime fraud- which again resulted in sufficient spending beyond incomes to bring unemployment down to more acceptable levels, though again all to briefly.

My point is that the ‘demand leakages’ from tax advantaged savings incentives have grown to the point where taxes need to be lot lower relative to govt spending than anyone seems to understand.

And so the only way we get anywhere near a good economy is with a dot com boom or a sub prime fraud boom.

Never with sound, proactive policy.

Especially now.

For the US and Japan, the door is open for taxes to be that much lower for a given size govt. Unfortunately, however, the politicians and mainstream economists believe otherwise.

They believe the federal deficits are too large, posing risks they can’t specifically articulate when pressed, though they are rarely pressed by the media who believe same.

The euro zone, however has that and much larger issues as well.

The problem is the deficits from the automatic stabilizers are at the member nation level, and therefore they do result in member nation insolvency.

In other words, the demand leakages (pension fund contributions, etc.) require offsetting deficit spending that’s beyond the capabilities of the national govts to deficit spend.

The only possible answer (as I’ve discussed in previous writings, and gotten ridiculed for on CNBC) is for the ECB to directly or indirectly ‘write the check’ as has been happening with the ECB buying of member nation debt in the secondary markets.

But this is done only ‘kicking and screaming’ and not as a matter of understanding that this is a matter of sound fiscal policy.

So while the ECB’s buying is ongoing, so are the noises to somehow ‘exit’ this policy.

I don’t think there is an exit to this policy without replacing it with some other avenue for the required ECB check writing, including my continuing alternative proposals for ECB distributions, etc.

The other, non ECB funding proposals could buy some time but ultimately don’t work. Bringing in the IMF is particularly curious, as the IMF’s euros come from the euro members themselves, as do the euro from the other funding schemes. All that the core member nations funding the periphery does is amplify the solvency issues of the core, which are just as much in ponzi (dependent on further borrowing to pay off debt) as all the rest.

So what we are seeing in the euro zone is a continued muddling through with banks and govts in trouble, deposit insurance and member govts kept credible only by the ECB continuing to support funding of both banks and the national govts, and a highly deflationary policy of ECB imposed ‘fiscal responsibility’ that’s keeping a lid on real economic growth.

The system will not collapse as long as the ECB keeps supporting it, and as they have taken control of national govt finances with their imposed ‘terms and conditions’ they are also responsible for the outcomes.

This means the ECB is unlikely to pull support because doing so would be punishing itself for the outcomes of its own imposed policies.

Is the euro going up or down?

Many cross currents, as is often the case. My conviction is low at the moment, but that could change with events.

The euro policies continue to be deflationary, as ECB purchases are not yet funding expanded member nation spending. But this will happen when the austerity measures cause deficits to rise rather than fall. But for now the ECB imposed terms and conditions are keeping a lid on national govt spending.

The US is going through its own deflationary process, as fiscal is tightening slowly with the modest GDP growth. Also the mistaken presumption that QE is somehow inflationary and weakens the currency has resulted in selling of the dollar for the wrong reasons, which seems to be reversing.

China is dealing with its internal inflation which can reverse capital flows and result in a reduction of buying both dollars and euro. It can also lead to lower demand for commodities and lower prices, which probably helps the dollar more than the euro. And a slowing China can mean reduced imports from Germany which would hurt the euro some.

Japan is the only nation looking at fiscal expansion, however modest. It’s also sold yen to buy dollars, which helps the dollar more than the euro.

The UK seems to be tightening fiscal more rapidly than even the euro zone or the US, helping sterling to over perform medium term.

All considered, looks to me like dollar strength vs most currencies, perhaps less so vs the euro than vs the yen or commodity currencies. But again, not much conviction at the moment, beyond liking short UK cds vs long Germany cds….

Happy turkey!

(Next year in Istanbul, to see where it all started…)

Posted in Currencies, Deficit, ECB, Employment, EU, Germany, Government Spending | 55 Comments »

China May Set 4% Inflation Target for Next Year, Tighten Policy

Posted by WARREN MOSLER on 26th November 2010

Ch Headlines:

China May Set 4% Inflation Target for Next Year, Tighten Policy
Inflation Expectations Rise on Wages, Resource Prices, PBOC Says

Setting inflation targets, worrying about inflation expectations, reserve requirements, etc.

It’s all monetarist nonsense from the western educated kids now in charge.

Posted in China, Inflation | 3 Comments »

China, Russia quit dollar for transactions

Posted by WARREN MOSLER on 26th November 2010

Doesn’t matter, though most everyone thinks it does.

What matter is what currency a nation saves in, not the numeraire for transactions.

So good this happened, so everyone can get past it and stop worrying about it.

China, Russia quit dollar

By Su Qiang and Li Xiaokun

November 24 (China Daily) — St. Petersburg, Russia – China and Russia have decided to renounce the US dollar and resort to using their own currencies for bilateral trade, Premier Wen Jiabao and his Russian counterpart Vladimir Putin announced late on Tuesday.

Chinese experts said the move reflected closer relations between Beijing and Moscow and is not aimed at challenging the dollar, but to protect their domestic economies.
“About trade settlement, we have decided to use our own currencies,” Putin said at a joint news conference with Wen in St. Petersburg.

The two countries were accustomed to using other currencies, especially the dollar, for bilateral trade. Since the financial crisis, however, high-ranking officials on both sides began to explore other possibilities.

The yuan has now started trading against the Russian rouble in the Chinese interbank market, while the renminbi will soon be allowed to trade against the rouble in Russia, Putin said.

“That has forged an important step in bilateral trade and it is a result of the consolidated financial systems of world countries,” he said.

Putin made his remarks after a meeting with Wen. They also officiated at a signing ceremony for 12 documents, including energy cooperation.

The documents covered cooperation on aviation, railroad construction, customs, protecting intellectual property, culture and a joint communiqu. Details of the documents have yet to be released.

Putin said one of the pacts between the two countries is about the purchase of two nuclear reactors from Russia by China’s Tianwan nuclear power plant, the most advanced nuclear power complex in China.

Putin has called for boosting sales of natural resources – Russia’s main export – to China, but price has proven to be a sticking point.

Russian Deputy Prime Minister Igor Sechin, who holds sway over Russia’s energy sector, said following a meeting with Chinese representatives that Moscow and Beijing are unlikely to agree on the price of Russian gas supplies to China before the middle of next year.

Russia is looking for China to pay prices similar to those Russian gas giant Gazprom charges its European customers, but Beijing wants a discount. The two sides were about $100 per 1,000 cubic meters apart, according to Chinese officials last week.

Wen’s trip follows Russian President Dmitry Medvedev’s three-day visit to China in September, during which he and President Hu Jintao launched a cross-border pipeline linking the world’s biggest energy producer with the largest energy consumer.

Wen said at the press conference that the partnership between Beijing and Moscow has “reached an unprecedented level” and pledged the two countries will “never become each other’s enemy”.

Over the past year, “our strategic cooperative partnership endured strenuous tests and reached an unprecedented level,” Wen said, adding the two nations are now more confident and determined to defend their mutual interests.

“China will firmly follow the path of peaceful development and support the renaissance of Russia as a great power,” he said.

“The modernization of China will not affect other countries’ interests, while a solid and strong Sino-Russian relationship is in line with the fundamental interests of both countries.”

Wen said Beijing is willing to boost cooperation with Moscow in Northeast Asia, Central Asia and the Asia-Pacific region, as well as in major international organizations and on mechanisms in pursuit of a “fair and reasonable new order” in international politics and the economy.

Sun Zhuangzhi, a senior researcher in Central Asian studies at the Chinese Academy of Social Sciences, said the new mode of trade settlement between China and Russia follows a global trend after the financial crisis exposed the faults of a dollar-dominated world financial system.

Pang Zhongying, who specializes in international politics at Renmin University of China, said the proposal is not challenging the dollar, but aimed at avoiding the risks the dollar represents.

Wen arrived in the northern Russian city on Monday evening for a regular meeting between Chinese and Russian heads of government.

He left St. Petersburg for Moscow late on Tuesday and is set to meet with Russian President Dmitry Medvedev on Wednesday.

Posted in China, Comodities, Currencies, Russia | 1 Comment »

Fighting inflation in China

Posted by WARREN MOSLER on 23rd November 2010

Inflation is a political problem, especially in China, where it can mean regime change.

Inflation itself is not so much an economic problem- it doesn’t hurt growth and employment.
But fighting inflation can very much hurt growth and employment.

The first thing the monetarists do is hike rates, which actually more likely makes inflation worse through the cost and interest income channels.

But inflation also generally causes fiscal tightening as nominal incomes, spending, and therefore taxes of all kinds
tend to increase faster than govt spending. (In the US, for example, this led to Carter’s small surplus in 1979.)

And the budget deficit falling as a % of GDP works against domestic demand.
As does the various types of credit controls govts sometimes resort to.

The currency depreciates but trade probably doesn’t go anywhere as costs go up pretty much lock step.

So in the case of China, growth probably slows with the relative fiscal tightening and state lending curbs.

The currency could ‘naturally’ fall and if it does, China will be accused of using it as tool to support exports, so it may intervene some and spend some if its reserves to support it at times.

Not a major problem for the US, but very problematic for the euro zone even if China just stops buying euro debt, never mind sell some to support its own currency.

And, China may be an important factor in commodity prices…

All looking good for the dollar, which is still probably way oversold due to unwarranted QE fears.

Looking ok for bonds as well, not so good for stocks.

(Yes, this post is a bit forced and preliminary.
Haven’t been able to quite see it all through yet.
More later as things develop.)

Posted in China, Currencies, Inflation | 66 Comments »

Canadian success story…

Posted by WARREN MOSLER on 22nd November 2010

Doesn’t look like Canada was all that immune from the crisis to me?

Ok, their banks didn’t fail or need data transfered from one account at the Bank of Canada to another to keep them open for business.

So what? Look what happened to unemployment- real life for real people.

And it’s still a good 2% higher than it was only a couple of years or so ago.

And we are in a resource boom.

Yes, unemployment benefits are said to be generous, so out of work people maybe don’t suffer as much financially as in other places. But taking them at their word, and if history is any guide, they would take a job at reasonable pay and produce useful output if there were jobs available.

Yes, their federal budget deficit remains too small/ unemployment too high.
And they aspire to sustaining a federal budget surplus and high net export revenues, which, if successful, means reduced real terms of trade and a standard of living lower than otherwise.

My proposal- offer a national service job to anyone willing and able to work that pays a bit more than unemployment, and then cut taxes or increase public spending (depending on politics/needs) until that pool of labor in that national service job gets down to maybe 3% of the labor force, which will also coincide with a pretty good measure of what the current full employment deficit is.

Posted in Deficit, Government Spending | 19 Comments »

China rolls out measures to fight inflation

Posted by WARREN MOSLER on 22nd November 2010

PBOC Adviser Says Obama Wrong to Urge Yuan Gains to Curb Surplus

(Bloomberg) Chinese central bank adviser Li Daokui said U.S. President Barack Obama is wrong to urge yuan appreciation to reduce China’s trade surplus with the U.S.

Overly rapid gains in the yuan will hurt both China and the U.S., Li said in an interview with state broadcaster China Central Television today. Overly rapid yuan gains would hurt Chinese employment and it would hurt U.S. consumers as exports become more expensive, Li said.

In other words, he’s maybe telling us “it’s for our own good, so stop trying to kill the goose that’s laying your golden eggs, stupid yankee monetarist. Just enjoy while it lasts and stop acting the fool.” ???

China rolls out measures to fight inflation

(Xinhua) The State Council, China’s Cabinet, announced Sunday a slew of measures to rein in rising commodity prices to ease the economic pressures on the people. Local governments and departments are required to boost agricultural production and stabilize supply of agricultural products and fertilizer while reducing the cost of agricultural products and ensuring coal, power, oil and gas supplies, the State Council said in a seven-page circular. Local governments must also temporarily disburse subsidies, the circular added. Local authorities were also ordered to establish coordinated social-security mechanisms that promise a gradual rise in basic pensions, unemployment insurance and minimum wages. China’s consumer price index (CPI), the main gauge of inflation, rose to a 25-month high of 4.4 percent in the 12 months to the end of October. The hike was mainly due to a 10.1-percent surge in food prices. Food prices have a one-third weighting in China’s CPI calculation.

When food prices go up, the old guard looks to supply side measure to bring them down.

The western educated kids use the ‘monetary policy’ they learned in school- hike rates, etc. and somehow cool demand by adding interest income, etc- so inflation expectations don’t rise while markets are allocating and adjusting via by price.

Apart from the fact that the currency is a public monopoly and inflation expectations don’t particularly matter, what the old guard knows for a fact is that market forces have no qualms about allocating you out of office.

Posted in China, Inflation | No Comments »

Barrons Cover Story Spending

Posted by WARREN MOSLER on 22nd November 2010

>   (email exchange)
>   On Sun, Nov 21, 2010 at 11:50 PM, Bob wrote:
>   Don’t underestimate the amount people will possibly spend this holiday season.
>   90 Percent have jobs, and they are NOT as worried as they were in 2008 and 2009
>   about Losing their jobs. This can create a good environment for stocks going
>   forward.
>   There is a lot of corporate and consumer cash on the sidelines and they could
>   be feeling a bit better about spending it now and going forward.

Moreover, household financial obligations—defined as debt and lease payments, rent, home insurance and property taxes—have fallen to 17% of disposable income, down from an all-time high of 18.9% in the third quarter of 2007 and below the 30-year average of 17.2%, notes James Paulsen, chief investment strategist at Wells Capital Management.

Yes, this is the direct result of the large federal budger deficit.

Reflected in those numbers is a sharp increase in the personal savings rate, which rose to a peak of 8.2% in May 2009 from as little as 0.8% in April 2005. The savings rate—the percentage of personal income that isn’t consumed—since has fallen back to 5.3%.

Yes, this is the direct result of the large federal budger deficit.

The savings rate typically rises during recessions and falls amid recoveries, as the public grows more confident about the future. Economists such as Paulsen expect that the savings rate will plateau around current levels.

Yes, this is the direct result of the large federal budger deficit.

A Better Balance Sheet

Household debt has fallen by about $1 trillion, to $11.5 trillion, since the fourth quarter of 2008…

Yes, this is the direct result of the large federal budger deficit.

If the Bush tax cuts aren’t extended for those making at least $250,000 a year, some $65 billion will start coming out of their paychecks and pockets starting Jan. 1. The potential hit to consumer spending could be significant, because although this group represents only 18% of U.S. taxpayers, they account for 35% of spending, notes ConsumerEdge Research.

Yes, reducing the federal deficit is contractionary.

MANY AMERICAN CONSUMERS still have too much debt, and potential threats such as renewed inflation, rising interest rates and higher taxes could prove formidable obstacles to a recovery in spending. But John Q. Wal-Mart and Jane Q. Saks have worked hard in the past two years—certainly harder than their Uncle Sam—to mend their financial health. They could be in much better shape than you think.

Yes, this is the direct result of the large federal budger deficit.

Posted in Deficit, Government Spending | 12 Comments »

Ireland Seeks Rescue for Banks as EU Struggles to Stem

Posted by WARREN MOSLER on 22nd November 2010

Letting the banks fail would have been a highly deflationary event, that presumably has been discounted to some degree by markets. This would include depreciation of Irish bank financial assets, etc.

This helps remove that deflationary risk, and in that sense is ‘inflationary’ in that it works against those deflationary forces.

Also, as you pointed out, there is as yet no new austerity required for this package.

Also reinforced is the notion that any member nation can have a banking crisis that’s too big for it to support.

This further reinforces the notion that the entire euro zone is ultimately supportable only by the ECB.

In any case, it looks like the will is still there to keep the euro zone muddling through at some minimal degree above crisis level, whatever the cost.

Ireland Becomes Second Euro Nation to Seek Aid

By Joe Brennan and Dara Doyle

November 22 (Bloomberg) — Ireland became the second euro country to seek a rescue as the cost of saving its banks threatened a rerun of the Greek debt crisis that destabilized the currency. The euro rose and European bond risk fell.

A package that Goldman Sachs Group Inc. estimates may total 95 billion euros ($130 billion) failed to damp speculation that Portugal and Spain would need to tap the emergency fund set up by the European Union and International Monetary Fund after the Greece rescue. Moody’s Investors Service said a “ multi-notch” downgrade in Ireland’s Aa2 credit rating was “most likely.”

“Speculative actions against Portugal and Spain are not justified, though it can’t be excluded,” Luxembourg Prime Minister Jean-Claude Juncker said today on RTL Luxembourg radio. “In a moment where financial markets have an excessive tendency to punish those countries that didn’t stick 100 percent to an orthodox consolidation, one can never exclude that similar things will happen.”

The aid, which Irish officials said as recently as Nov. 15 they didn’t need, marks the latest blow to an economy that more than doubled in the decade ending in 2006. The bursting of the real-estate bubble in 2008 plunged the country into a recession and brought its banks close to collapse. With Irish bond yields near a record high, policy makers are trying to keep the crisis from spreading.

Threat to Euro

“Clearly because of the size of their loan books, the huge risks they took, they became a threat not only to the state but to the” entire euro region, Lenihan told Dublin-based RTE radio in an interview today. “The banks will be downsized to the real needs of the Irish economy” to “Irish consumers and Irish businesses. That has to be the primary focus of Irish banks.”

Ireland will channel some aid to lenders via a “contingent” capital fund, Finance Minister Brian Lenihan said.

The euro rose 0.5 percent to $1.3740 at 10:30 a.m. in London. Irish 10-year notes rose, sending the yield down 24 basis points to 8.11 percent. Ireland led a decline in the cost of insuring against default on European debt, according to traders of credit-default swaps. Contracts on Irish government bonds dropped 28.5 basis points to 478.5, the lowest level since Oct. 29, according to data provider CMA in London.

“Ireland had no choice,” said Nicholas Stamenkovic, a fixed-income strategist in Edinburgh at RIA Capital Markets Ltd., a broker for money managers. “The market will still be waiting for the details of the assistance and the conditionality, but there should be a relief rally.”

U.K., Sweden

The U.K. and Sweden may contribute bilateral loans, the EU said in a statement. Lenihan declined to say how big the package will be, saying that it will be less than 100 billion euros. Goldman Sachs Chief European Economist Erik Nielsen said yesterday the government needs 65 billion euros to fund itself for the next three years and 30 billion euros for the banks.

Talks will focus on the government’s deficit cutting plans and restructuring the banking system, the EU said in a statement. Irish Prime Minister Brian Cowen, who spoke at the same press briefing as Lenihan, said the banks will be stress tested. Ireland nationalized Anglo Irish Bank Corp. in 2009 and is preparing to take a majority stake in Allied Irish Banks Plc, the second-largest bank.

Lenihan and Cowen appeared minutes after finance chiefs issued a statement endorsing an aid request to calm markets. Allied Irish emphasized the fragility of the system on Nov. 19, reporting a 17 percent decline in deposits this year.

Stabilizing Situation

“In the short term, it will stabilize the situation, there’s no doubt about that,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland Group Plc in London, who estimates a package of between 80 billion euros and 100 billion euros. “But as we’ve seen in the case of Greece, uncertainty will remain.”

The package for Ireland will total as much as 60 percent of gross domestic product, compared with 47 percent for Greece.

Cowen plans to announce the government’s four-year budget plan this week and said an agreement with the EU and the IMF will come “in the next few weeks.” Cowen also faces an election in Donegal in northwest Ireland on Nov. 25 to fill a vacant parliamentary seat. The vote threatens to erode Cowen’s majority. He has the support of 82 lawmakers, including independents, compared with 79 for the combined opposition.

The bailout follows two years of budget cuts that failed to restore market confidence as the cost of shoring up the financial industry soared.

Merkel’s Trigger

Lenihan cancelled bond auctions for October and November and announced 6 billion euros of austerity measures for 2011 on Nov. 4 in a bid to restore investor confidence. Those efforts failed after German Chancellor Angela Merkel triggered an investor exodus by saying bondholders should foot some of the bill in any future bailout.

The risk premium on Ireland’s 10-year debt over German bunds, Europe’s benchmark, fell to 523 basis points today. It widened to a record 652 basis points on Nov. 11, with the yield reaching a record 9.1 percent. In 2007, it cost Ireland less than Germany to borrow. Its 10-year spread then fell to as low as 77 basis points less than bunds. The ISEQ stock index has plunged 70 percent from its record in 2007.

Ireland will draw on the 750-billion-euro fund set up by the EU and IMF in May as part of the Greek bailout to protect the currency shared by 16 countries.

Irish Reversal

Irish officials initially resisted pressure from the EU to take any aid, saying they were fully funded until the middle of 2011. European leaders sought to head off contagion from Ireland and reduce pressure on the European Central Bank to prop up the country’s lenders by providing them with unlimited liquidity.

Cowen defended his reversal on the need for aid. “I don’t accept I’m the bogeyman,” he said. “Now circumstances have changed, we’ve changed our policies.”

Yields on bonds of Spain and Portugal have jumped amid concern that fallout from Ireland would spread. The extra yield that investors demand to hold Portuguese 10-year bonds instead of German bunds climbed to a record 484 basis points on Nov. 11.

“It probably won’t halt contagion. The sovereign crisis isn’t yet over,” said Sylvain Broyer, chief euro-region economist at Natixis in Frankfurt. “Ireland is in the middle of a difficult crisis.”

Posted in ECB, EU | 7 Comments »

Comments on BS2 (Bernanke speech #2)

Posted by WARREN MOSLER on 19th November 2010

Rebalancing the Global Recovery

Chairman Ben S. Bernanke

November 19, 2010

The global economy is now well into its second year of recovery from the deep recession triggered by the most devastating financial crisis since the Great Depression. In the most intense phase of the crisis, as a financial conflagration threatened to engulf the global economy, policymakers in both advanced and emerging market economies found themselves confronting common challenges. Amid this shared sense of urgency, national policy responses were forceful, timely, and mutually reinforcing. This policy collaboration was essential in averting a much deeper global economic contraction and providing a foundation for renewed stability and growth.

The main policy response as the automatic fiscal stabilizers that, fortunately were in place to cut govt revenues and increase transfer payments, automatically raising the federal deficit to levels where it added sufficient income and savings of financial assets to support aggregate demand at current levels. And while the contents selected weren’t my first choice, the fiscal stimulus package added some support as well.

In recent months, however, that sense of common purpose has waned. Tensions among nations over economic policies have emerged and intensified, potentially threatening our ability to find global solutions to global problems. One source of these tensions has been the bifurcated nature of the global economic recovery: Some economies have fully recouped their losses

Those who have sustained adequate domestic aggregate demand through appropriate fiscal policy.

while others have lagged behind.

Those who have not had adequate fiscal responses.

But at a deeper level, the tensions arise from the lack of an agreed-upon framework to ensure that national policies take appropriate account of interdependencies across countries and the interests of the international system as a whole. Accordingly, the essential challenge for policymakers around the world is to work together to achieve a mutually beneficial outcome–namely, a robust global economic expansion that is balanced, sustainable, and less prone to crises.

Unfortunately, that would require an understanding of monetary operations and that a currency is a (simple) public monopoly. And with that comes the understanding that the us, for example, is far better off going it alone.

The Two-Speed Global Recovery
International policy cooperation is especially difficult now because of the two-speed nature of the global recovery. Specifically, as shown in figure 1, since the recovery began, economic growth in the emerging market economies (the dashed blue line) has far outstripped growth in the advanced economies (the solid red line). These differences are partially attributable to longer-term differences in growth potential between the two groups of countries, but to a significant extent they also reflect the relatively weak pace of recovery thus far in the advanced economies. This point is illustrated by figure 2, which shows the levels, as opposed to the growth rates, of real gross domestic product (GDP) for the two groups of countries. As you can see, generally speaking, output in the advanced economies has not returned to the levels prevailing before the crisis, and real GDP in these economies remains far below the levels implied by pre-crisis trends. In contrast, economic activity in the emerging market economies has not only fully made up the losses induced by the global recession, but is also rapidly approaching its pre-crisis trend. To cite some illustrative numbers, if we were to extend forward from the end of 2007 the 10-year trends in output for the two groups of countries, we would find that the level of output in the advanced economies is currently about 8 percent below its longer-term trend, whereas economic activity in the emerging markets is only about 1-1/2 percent below the corresponding (but much steeper) trend line for that group of countries. Indeed, for some emerging market economies, the crisis appears to have left little lasting imprint on growth. Notably, since the beginning of 2005, real output has risen more than 70 percent in China and about 55 percent in India.

No mention of the size of the budget deficits in those nations, not forgetting to include lending by state owned institutions that is, functionally, deficit spending.

In the United States, the recession officially ended in mid-2009, and–as shown in figure 3–real GDP growth was reasonably strong in the fourth quarter of 2009 and the first quarter of this year.

Mainly a bounce from an oversold inventory position due to the prior fear mongering and real risks of systemic failure.

However, much of that growth appears to have stemmed from transitory factors, including inventory adjustments and fiscal stimulus. Since the second quarter of this year, GDP growth has moderated to around 2 percent at an annual rate, less than the Federal Reserve’s estimates of U.S. potential growth and insufficient to meaningfully reduce unemployment. And indeed, as figure 4 shows, the U.S. unemployment rate (the solid black line) has stagnated for about eighteen months near 10 percent of the labor force, up from about 5 percent before the crisis; the increase of 5 percentage points in the U.S. unemployment rate is roughly double that seen in the euro area, the United Kingdom, Japan, or Canada. Of some 8.4 million U.S. jobs lost between the peak of the expansion and the end of 2009, only about 900,000 have been restored thus far. Of course, the jobs gap is presumably even larger if one takes into account the natural increase in the size of the working age population over the past three years.

Of particular concern is the substantial increase in the share of unemployed workers who have been without work for six months or more (the dashed red line in figure 4). Long-term unemployment not only imposes extreme hardship on jobless people and their families, but, by eroding these workers’ skills and weakening their attachment to the labor force, it may also convert what might otherwise be temporary cyclical unemployment into much more intractable long-term structural unemployment. In addition, persistently high unemployment, through its adverse effects on household income and confidence, could threaten the strength and sustainability of the recovery.

Low rates of resource utilization in the United States are creating disinflationary pressures. As shown in figure 5, various measures of underlying inflation have been trending downward and are currently around 1 percent, which is below the rate of 2 percent or a bit less that most Federal Open Market Committee (FOMC) participants judge as being most consistent with the Federal Reserve’s policy objectives in the long run.1 With inflation expectations stable, and with levels of resource slack expected to remain high, inflation trends are expected to be quite subdued for some time.

Yes, the FOMC continues to fear deflation.

Monetary Policy in the United States
Because the genesis of the financial crisis was in the United States and other advanced economies, the much weaker recovery in those economies compared with that in the emerging markets may not be entirely unexpected (although, given their traditional vulnerability to crises, the resilience of the emerging market economies over the past few years is both notable and encouraging). What is clear is that the different cyclical positions of the advanced and emerging market economies call for different policy settings. Although the details of the outlook vary among jurisdictions, most advanced economies still need accommodative policies to continue to lay the groundwork for a strong, durable recovery. Insufficiently supportive policies in the advanced economies could undermine the recovery not only in those economies, but for the world as a whole. In contrast, emerging market economies increasingly face the challenge of maintaining robust growth while avoiding overheating, which may in some cases involve the measured withdrawal of policy stimulus.

Let me address the case of the United States specifically. As I described, the U.S. unemployment rate is high and, given the slow pace of economic growth, likely to remain so for some time. Indeed, although I expect that growth will pick up and unemployment will decline somewhat next year, we cannot rule out the possibility that unemployment might rise further in the near term, creating added risks for the recovery. Inflation has declined noticeably since the business cycle peak, and further disinflation could hinder the recovery. In particular, with shorter-term nominal interest rates close to zero, declines in actual and expected inflation imply both higher realized and expected real interest rates, creating further drags on growth.2 In light of the significant risks to the economic recovery, to the health of the labor market, and to price stability, the FOMC decided that additional policy support was warranted.

Again, fear of deflation, especially via expectations theory.

The Federal Reserve’s policy target for the federal funds rate has been near zero since December 2008,

And not done the trick. And no mention that the interest income channels might be the culprits.

so another means of providing monetary accommodation has been necessary since that time. Accordingly, the FOMC purchased Treasury and agency-backed securities on a large scale from December 2008 through March 2010,

Further reducing interest income earned by the private sector.

a policy that appears to have been quite successful in helping to stabilize the economy and support the recovery during that period.

I attribute the stabilization to the automatic fiscal stabilizers increasing federal deficit spending, adding that much income and savings to the economy.

Following up on this earlier success, the Committee announced this month that it would purchase additional Treasury securities. In taking that action, the Committee seeks to support the economic recovery, promote a faster pace of job creation, and reduce the risk of a further decline in inflation that would prove damaging to the recovery.

Although securities purchases are a different tool for conducting monetary policy than the more familiar approach of managing the overnight interest rate, the goals and transmission mechanisms are very similar. In particular, securities purchases by the central bank affect the economy primarily by lowering interest rates on securities of longer maturities,

Very good! Looks like the officials in monetary operations have finally gotten the point across. It’s been no small effort.

just as conventional monetary policy, by affecting the expected path of short-term rates, also influences longer-term rates. Lower longer-term rates in turn lead to more accommodative financial conditions, which support household and business spending. As I noted, the evidence suggests that asset purchases can be an effective tool; indeed, financial conditions eased notably in anticipation of the Federal Reserve’s policy announcement.

Incidentally, in my view, the use of the term “quantitative easing” to refer to the Federal Reserve’s policies is inappropriate. Quantitative easing typically refers to policies that seek to have effects by changing the quantity of bank reserves, a channel which seems relatively weak, at least in the U.S. context.

While the channel is more than weak- it doesn’t even exist- even here his story has improved.

In contrast, securities purchases work by affecting the yields on the acquired securities and, via substitution effects in investors’ portfolios, on a wider range of assets.

Leaving out that they remove interest income from the private sector.

This policy tool will be used in a manner that is measured and responsive to economic conditions. In particular, the Committee stated that it would review its asset-purchase program regularly in light of incoming information and would adjust the program as needed to meet its objectives. Importantly, the Committee remains unwaveringly committed to price stability and does not seek inflation above the level of 2 percent or a bit less that most FOMC participants see as consistent with the Federal Reserve’s mandate. In that regard, it bears emphasizing that the Federal Reserve has worked hard to ensure that it will not have any problems exiting from this program at the appropriate time. The Fed’s power to pay interest on banks’ reserves held at the Federal Reserve will allow it to manage short-term interest rates effectively and thus to tighten policy when needed, even if bank reserves remain high. Moreover, the Fed has invested considerable effort in developing tools that will allow it to drain or immobilize bank reserves as needed to facilitate the smooth withdrawal of policy accommodation when conditions warrant. If necessary, the Committee could also tighten policy by redeeming or selling securities.

Not bad!

The foreign exchange value of the dollar has fluctuated considerably during the course of the crisis, driven by a range of factors. A significant portion of these fluctuations has reflected changes in investor risk aversion, with the dollar tending to appreciate when risk aversion is high. In particular, much of the decline over the summer in the foreign exchange value of the dollar reflected an unwinding of the increase in the dollar’s value in the spring associated with the European sovereign debt crisis.


The dollar’s role as a safe haven during periods of market stress stems in no small part from the underlying strength and stability that the U.S. economy has exhibited over the years.

Further supported by the desire of foreign govts to support exports to the US, but that is a different matter.

Fully aware of the important role that the dollar plays in the international monetary and financial system, the Committee believes that the best way to continue to deliver the strong economic fundamentals that underpin the value of the dollar, as well as to support the global recovery, is through policies that lead to a resumption of robust growth in a context of price stability in the United States.

This is a bit defensive, as it implies he does believe QE itself weakens the dollar in the near term. If he knew that wasn’t the case he would have stated it all differently.

In sum, on its current economic trajectory the United States runs the risk of seeing millions of workers unemployed or underemployed for many years. As a society, we should find that outcome unacceptable. Monetary policy is working in support of both economic recovery and price stability, but there are limits to what can be achieved by the central bank alone. The Federal Reserve is nonpartisan and does not make recommendations regarding specific tax and spending programs. However, in general terms, a fiscal program that combines near-term measures to enhance growth with strong, confidence-inducing steps to reduce longer-term structural deficits would be an important complement to the policies of the Federal Reserve.

Ok, it’s something.

But how about repeating that operationally, govt spending is not constrained by revenues, and therefore there is no solvency problem? That’s not politics, just monetary operations.

He could also explain how tsy secs are functionally nothing more than time deposits at the Fed, while reserves are overnight deposits, and funding the deficit and paying it down are nothing more than shifting dollar balances from reserve accounts to securities accounts, and from securities accounts to reserve accounts.

And he could spell out the accounting identity that govt deficits add exactly that much to net financial assets of the non govt sectors.

In other words, he could easily dispel the deficit myths that are preventing the policy he is recommending.

So why not???

Global Policy Challenges and Tensions
The two-speed nature of the global recovery implies that different policy stances are appropriate for different groups of countries. As I have noted, advanced economies generally need accommodative policies to sustain economic growth. In the emerging market economies, by contrast, strong growth and incipient concerns about inflation have led to somewhat tighter policies.

Unfortunately, the differences in the cyclical positions and policy stances of the advanced and emerging market economies have intensified the challenges for policymakers around the globe. Notably, in recent months, some officials in emerging market economies and elsewhere have argued that accommodative monetary policies in the advanced economies, especially the United States, have been producing negative spillover effects on their economies. In particular, they are concerned that advanced economy policies are inducing excessive capital inflows to the emerging market economies, inflows that in turn put unwelcome upward pressure on emerging market currencies and threaten to create asset price bubbles. As is evident in figure 6, net private capital flows to a selection of emerging market economies (based on national balance of payments data) have rebounded from the large outflows experienced during the worst of the crisis. Overall, by this broad measure, such inflows through the second quarter of this year were not any larger than in the year before the crisis, but they were nonetheless substantial. A narrower but timelier measure of demand for emerging market assets–net inflows to equity and bond funds investing in emerging markets, shown in figure 7–suggests that inflows of capital to emerging market economies have indeed picked up in recent months.

To a large degree, these capital flows have been driven by perceived return differentials that favor emerging markets, resulting from factors such as stronger expected growth–both in the short term and in the longer run–and higher interest rates, which reflect differences in policy settings as well as other forces. As figures 6 and 7 show, even before the crisis, fast-growing emerging market economies were attractive destinations for cross-border investment. However, beyond these fundamental factors, an important driver of the rapid capital inflows to some emerging markets is incomplete adjustment of exchange rates in those economies, which leads investors to anticipate additional returns arising from expected exchange rate appreciation.

The exchange rate adjustment is incomplete, in part, because the authorities in some emerging market economies have intervened in foreign exchange markets to prevent or slow the appreciation of their currencies. The degree of intervention is illustrated for selected emerging market economies in figure 8. The vertical axis of this graph shows the percent change in the real effective exchange rate in the 12 months through September. The horizontal axis shows the accumulation of foreign exchange reserves as a share of GDP over the same period. The relationship evident in the graph suggests that the economies that have most heavily intervened in foreign exchange markets have succeeded in limiting the appreciation of their currencies. The graph also illustrates that some emerging market economies have intervened at very high levels and others relatively little. Judging from the changes in the real effective exchange rate, the emerging market economies that have largely let market forces determine their exchange rates have seen their competitiveness reduced relative to those emerging market economies that have intervened more aggressively.

It is striking that, amid all the concerns about renewed private capital inflows to the emerging market economies, total capital, on net, is still flowing from relatively labor-abundant emerging market economies to capital-abundant advanced economies. In particular, the current account deficit of the United States implies that it experienced net capital inflows exceeding 3 percent of GDP in the first half of this year. A key driver of this “uphill” flow of capital is official reserve accumulation in the emerging market economies that exceeds private capital inflows to these economies. The total holdings of foreign exchange reserves by selected major emerging market economies, shown in figure 9, have risen sharply since the crisis and now surpass $5 trillion–about six times their level a decade ago. China holds about half of the total reserves of these selected economies, slightly more than $2.6 trillion.

It is instructive to contrast this situation with what would happen in an international system in which exchange rates were allowed to fully reflect market fundamentals. In the current context, advanced economies would pursue accommodative monetary policies as needed to foster recovery and to guard against unwanted disinflation. At the same time, emerging market economies would tighten their own monetary policies to the degree needed to prevent overheating and inflation. The resulting increase in emerging market interest rates relative to those in the advanced economies would naturally lead to increased capital flows from advanced to emerging economies and, consequently, to currency appreciation in emerging market economies. This currency appreciation would in turn tend to reduce net exports and current account surpluses in the emerging markets, thus helping cool these rapidly growing economies while adding to demand in the advanced economies. Moreover, currency appreciation would help shift a greater proportion of domestic output toward satisfying domestic needs in emerging markets. The net result would be more balanced and sustainable global economic growth.

Given these advantages of a system of market-determined exchange rates, why have officials in many emerging markets leaned against appreciation of their currencies toward levels more consistent with market fundamentals? The principal answer is that currency undervaluation on the part of some countries has been part of a long-term export-led strategy for growth and development. This strategy, which allows a country’s producers to operate at a greater scale and to produce a more diverse set of products than domestic demand alone might sustain, has been viewed as promoting economic growth and, more broadly, as making an important contribution to the development of a number of countries. However, increasingly over time, the strategy of currency undervaluation has demonstrated important drawbacks, both for the world system and for the countries using that strategy.

First, as I have described, currency undervaluation inhibits necessary macroeconomic adjustments and creates challenges for policymakers in both advanced and emerging market economies. Globally, both growth and trade are unbalanced, as reflected in the two-speed recovery and in persistent current account surpluses and deficits. Neither situation is sustainable. Because a strong expansion in the emerging market economies will ultimately depend on a recovery in the more advanced economies, this pattern of two-speed growth might very well be resolved in favor of slow growth for everyone if the recovery in the advanced economies falls short. Likewise, large and persistent imbalances in current accounts represent a growing financial and economic risk.

Second, the current system leads to uneven burdens of adjustment among countries, with those countries that allow substantial flexibility in their exchange rates bearing the greatest burden (for example, in having to make potentially large and rapid adjustments in the scale of export-oriented industries) and those that resist appreciation bearing the least.

Third, countries that maintain undervalued currencies may themselves face important costs at the national level, including a reduced ability to use independent monetary policies to stabilize their economies and the risks associated with excessive or volatile capital inflows. The latter can be managed to some extent with a variety of tools, including various forms of capital controls, but such approaches can be difficult to implement or lead to microeconomic distortions. The high levels of reserves associated with currency undervaluation may also imply significant fiscal costs if the liabilities issued to sterilize reserves bear interest rates that exceed those on the reserve assets themselves. Perhaps most important, the ultimate purpose of economic growth is to deliver higher living standards at home; thus, eventually, the benefits of shifting productive resources to satisfying domestic needs must outweigh the development benefits of continued reliance on export-led growth.

Improving the International System
The current international monetary system is not working as well as it should. Currency undervaluation by surplus countries is inhibiting needed international adjustment and creating spillover effects that would not exist if exchange rates better reflected market fundamentals. In addition, differences in the degree of currency flexibility impose unequal burdens of adjustment, penalizing countries with relatively flexible exchange rates. What should be done?

The answers differ depending on whether one is talking about the long term or the short term. In the longer term, significantly greater flexibility in exchange rates to reflect market forces would be desirable and achievable. That flexibility would help facilitate global rebalancing and reduce the problems of policy spillovers that emerging market economies are confronting today. The further liberalization of exchange rate and capital account regimes would be most effective if it were accompanied by complementary financial and structural policies to help achieve better global balance in trade and capital flows. For example, surplus countries could speed adjustment with policies that boost domestic spending, such as strengthening the social safety net, improving retail credit markets to encourage domestic consumption, or other structural reforms. For their part, deficit countries need to do more over time to narrow the gap between investment and national saving. In the United States, putting fiscal policy on a sustainable path is a critical step toward increasing national saving in the longer term. Higher private saving would also help. And resources will need to shift into the production of export- and import-competing goods. Some of these shifts in spending and production are already occurring; for example, China is taking steps to boost domestic demand and the U.S. personal saving rate has risen sharply since 2007.

In the near term, a shift of the international regime toward one in which exchange rates respond flexibly to market forces is, unfortunately, probably not practical for all economies. Some emerging market economies do not have the infrastructure to support a fully convertible, internationally traded currency and to allow unrestricted capital flows. Moreover, the internal rebalancing associated with exchange rate appreciation–that is, the shifting of resources and productive capacity from production for external markets to production for the domestic market–takes time.

That said, in the short term, rebalancing economic growth between the advanced and emerging market economies should remain a common objective, as a two-speed global recovery may not be sustainable. Appropriately accommodative policies in the advanced economies help rather hinder this process. But the rebalancing of growth would also be facilitated if fast-growing countries, especially those with large current account surpluses, would take action to reduce their surpluses, while slow-growing countries, especially those with large current account deficits, take parallel actions to reduce those deficits. Some shift of demand from surplus to deficit countries, which could be compensated for if necessary by actions to strengthen domestic demand in the surplus countries, would accomplish two objectives. First, it would be a down payment toward global rebalancing of trade and current accounts, an essential outcome for long-run economic and financial stability. Second, improving the trade balances of slow-growing countries would help them grow more quickly, perhaps reducing the need for accommodative policies in those countries while enhancing the sustainability of the global recovery. Unfortunately, so long as exchange rate adjustment is incomplete and global growth prospects are markedly uneven, the problem of excessively strong capital inflows to emerging markets may persist.

As currently constituted, the international monetary system has a structural flaw: It lacks a mechanism, market based or otherwise, to induce needed adjustments by surplus countries, which can result in persistent imbalances. This problem is not new. For example, in the somewhat different context of the gold standard in the period prior to the Great Depression, the United States and France ran large current account surpluses, accompanied by large inflows of gold. However, in defiance of the so-called rules of the game of the international gold standard, neither country allowed the higher gold reserves to feed through to their domestic money supplies and price levels, with the result that the real exchange rate in each country remained persistently undervalued. These policies created deflationary pressures in deficit countries that were losing gold, which helped bring on the Great Depression.3 The gold standard was meant to ensure economic and financial stability, but failures of international coordination undermined these very goals. Although the parallels are certainly far from perfect, and I am certainly not predicting a new Depression, some of the lessons from that grim period are applicable today.4 In particular, for large, systemically important countries with persistent current account surpluses, the pursuit of export-led growth cannot ultimately succeed if the implications of that strategy for global growth and stability are not taken into account.

Thus, it would be desirable for the global community, over time, to devise an international monetary system that more consistently aligns the interests of individual countries with the interests of the global economy as a whole. In particular, such a system would provide more effective checks on the tendency for countries to run large and persistent external imbalances, whether surpluses or deficits. Changes to accomplish these goals will take considerable time, effort, and coordination to implement. In the meantime, without such a system in place, the countries of the world must recognize their collective responsibility for bringing about the rebalancing required to preserve global economic stability and prosperity. I hope that policymakers in all countries can work together cooperatively to achieve a stronger, more sustainable, and more balanced global economy.

Posted in Deficit, Emerging Markets, Fed, GDP, Political | 55 Comments »

A failure of theory and practice- comments on Fed Chairman Bernanke’s speech

Posted by WARREN MOSLER on 19th November 2010

Emerging from the Crisis: Where Do We Stand?

Chairman Ben S. Bernanke

November 19, 2010

The last time I was here at the European Central Bank (ECB), almost exactly two years ago, I sat on a distinguished panel much like this one to help mark the 10th anniversary of the euro. Even as we celebrated the remarkable achievements of the founders of the common currency, however, the global economy stood near the precipice. Financial markets were volatile and illiquid, and the viability of some of the world’s leading financial institutions had been called into question. With asset prices falling and the flow of credit to the nonfinancial sector constricted, most of the world’s economies had entered what would prove to be a sharp and protracted economic downturn.

By the time of that meeting, the world’s central banks had already taken significant steps to stabilize financial markets and to mitigate the worst effects of the recession, and they would go on to do much more. Very broadly, the responses of central banks to the crisis fell into two classes. First, central banks undertook a range of initiatives to restore normal functioning to financial markets and to strengthen the banking system. They expanded existing lending facilities and created new facilities to provide liquidity to the financial sector. Key examples include the ECB’s one-year long-term refinancing operations, the Federal Reserve’s auctions of discount window credit (via the Term Auction Facility), and the Bank of Japan’s more recent extension of its liquidity supply operations.

He still doesn’t understand that the obvious move is to lend unsecured to member banks in unlimited quantities. The liability side of banking is not the place for market discipline; it’s the asset/capital side.

To help satisfy banks’ funding needs in multiple currencies, central banks established liquidity swap lines that allowed them to draw each other’s currencies and lend those funds to financial institutions in their jurisdictions; the Federal Reserve ultimately established swap lines with 14 other central banks.

He still doesn’t realize what the fed did was to lend approx $600 billion unsecured to foreign governments, for the sole purpose of bringing down LIBOR settings, and that there are far more sensible ways to bring down LIBOR settings. Nor has he realized the public purpose behind prohibiting us banks from using LIBOR in the first place.

Central banks also worked to stabilize financial markets that were important conduits of credit to the nonfinancial sector. For example, the Federal Reserve launched facilities to help stabilize the commercial paper market and the market for asset-backed securities, through which flow much of the funding for student, auto, credit card, and small business loans as well as for commercial mortgages.

Nor has the fed understood how to utilize its member banks, which are public private partnerships, to further public purpose. Rather than buy the collateral in question for its own portfolio, the Fed could have empowered its member banks to do it by such means as, for example, allowing them to put that specific collateral in segregated accounts where the fed would cover losses. This is functionally identical to the fed buying for its own account, but without the costly need for the fed itself to establish trading desks, back office operations, and other associated support structure.

In addition, the Federal Reserve, the ECB, the Bank of England, the Swiss National Bank, and other central banks played important roles in stabilizing and strengthening their respective banking systems. In particular, central banks helped develop and oversee stress tests that assessed banks’ vulnerabilities and capital needs. These tests proved instrumental in reducing investors’ uncertainty about banks’ assets and prospective losses, bolstering confidence in the banking system, and facilitating banks’ raising of private capital.

They did this entirely because they were concerned about the banks’ ability to fund themselves, which again misses the point of the liability side of banking not being the place for market discipline. Again, the right move was to lend fed funds to the banks in unlimited quantities on an unsecured basis.

Central banks are also playing an important ongoing role in the development of new international capital and liquidity standards for the banking system that will help protect against future crises.

Again, misses the purpose of capital requirements, which is the pricing of risk. Risk itself is controlled by regulation and supervision.

Second, beyond necessary measures to stabilize financial markets and banking systems, central banks moved proactively to ease monetary policy to help support their economies. Initially, monetary policy was eased through the conventional means of cuts in short-term policy rates, including a coordinated rate cut in October 2008 by the Federal Reserve, the ECB, and other leading central banks. However, as policy rates approached the zero lower bound, central banks eased policy by additional means. For example, some central banks, including the Federal Reserve, sought to reduce longer-term interest rates by communicating that policy rates were likely to remain low for some time. A prominent example of the use of central bank communication to further ease policy was the Bank of Canada’s conditional commitment to keep rates near zero until the end of the second quarter of 2010.1 To provide additional monetary accommodation, several central banks–among them the Federal Reserve, the Bank of England, the ECB, and the Bank of Japan–purchased significant quantities of financial assets, including government debt, mortgage-backed securities, or covered bonds, depending on the central bank. Asset purchases seem to have been effective in easing financial conditions; for example, the evidence suggests that such purchases significantly lowered longer-term interest rates in both the United States and the United Kingdom.2

Yes, with little or no econometric evidence that lower rates added to aggregate demand. Nor is there any discussion of this controversy.

In fact, it looks to me like lower rates more likely reduced aggregate demand through the interest income channels, and continues to do so.

Although the efforts of central banks to stabilize the financial system and provide monetary accommodation helped set the stage for recovery, economic growth rates in the advanced economies have been relatively weak. Of course, the economic outlook varies importantly by country and region, and the policy responses to these developments among central banks have differed accordingly. In the United States, we have seen a slowing of the pace of expansion since earlier this year. The unemployment rate has remained close to 10 percent since mid-2009, with a substantial fraction of the unemployed out of work for six months or longer. Moreover, inflation has been declining and is currently quite low, with measures of underlying inflation running close to 1 percent. Although we project that economic growth will pick up and unemployment decline somewhat in the coming year, progress thus far has been disappointingly slow.

Yes, the Fed continues to fail to deliver on both of its dual mandates.

In this environment, the Federal Open Market Committee (FOMC) judged that additional monetary policy accommodation was needed to support the economic recovery and help ensure that inflation, over time, is at desired levels.

That is, they were concerned about falling into deflation.

Accordingly, the FOMC announced earlier this month its intention to purchase an additional $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. The Committee also will maintain its current policy of reinvesting principal payments from its securities holdings in longer-term Treasury securities. Financial conditions eased notably in anticipation of the Committee’s announcement, suggesting that this policy will be effective in promoting recovery. As has been the case with more conventional monetary policy in the past, this policy action will be regularly reviewed in light of the evolving economic outlook and the Committee’s assessment of the effects of its policies on the economy.

Note that comments from FOMC members have repeatedly shown they lack a fundamental understanding of actual monetary operations, and are promoting policy accordingly

I draw several lessons from our collective experience in dealing with the crisis. (My list is by no means exhaustive.) The first lesson is that, in a world in which the consequences of financial crises can be devastating, fostering financial stability is a critical part of overall macroeconomic management. Accordingly, central banks and other financial regulators must be vigilant in monitoring financial markets and institutions for threats to systemic stability and diligent in taking steps to address such threats. Supervision of individual financial institutions, macroprudential monitoring, and monetary policy are mutually reinforcing undertakings, with active involvement in one sphere providing crucial information and expertise for the others. Indeed, at the Federal Reserve, we have restructured our financial supervisory functions so that staff members with expertise in a range of areas–including economics, financial markets, and supervision–work closely together in evaluating potential risks.

Systemic liquidity risk comes from the fed not realizing it should always be offering fed funds at its target rate in unlimited quantities.

That limits risks to bank shareholders (and unsecured debt which is functionally part of the capital structure), and to the FDIC/taxpayers where it has failed to adequately regulate and supervise and losses exceed private equity.

Second, the past two years have demonstrated the value of policy flexibility and openness to new approaches. During the crisis, central banks were creative and innovative, developing programs that played a significant role in easing financial stress and supporting economic activity. As the global financial system and national economies become increasingly complex and interdependent, novel policy challenges will continue to require innovative policy responses.

Unfortunately, it also demonstrated the consequences of not understanding monetary operations and bank fundamentals. For example, there was and continues to be a complete failure to recognize that the treasury buying bank capital under tarp was functionally nothing more than regulatory forbearance, and not an ‘expenditure of tax payer money’

Third, as was the focus of my remarks two years ago, in addressing financial crises, international cooperation can be very helpful; indeed, given the global integration of financial markets, such cooperation is essential.

It is not. This is another example of failure to understand banking fundamentals and monetary operations. The US is best served by independent banking law, regulation, and supervision.

Central bankers worked closely together throughout the crisis and continue to do so. Our frequent contact, whether in bilateral discussions or in international meetings, permits us to share our thinking, compare analyses, and stay informed of developments around the world. It also enables us to move quickly when shared problems call for swift joint responses, such as the coordinated rate cuts and the creation of liquidity swap lines during the crisis. These actions and others we’ve taken over the past few years underscore our resolve to work together to address our common economic challenges.

Sadly, it’s the blind leading the blind, and we all continue to pay the price.

Posted in Banking, ECB, Fed, Government Spending, Uncategorized | No Comments »

And They’re Off!!!!!

Posted by WARREN MOSLER on 19th November 2010


12 billion won’t break the economy but it’s a bad start for sure.

And they still have to act soon to stop the tax hikes coming at year end before withholding goes up.

Unemployment Aid Extension Blocked in House Over Cost Concerns

By Brian Faler

November 18 (Bloomberg) — A bill to extend jobless benefits for three months was defeated today in the U.S. House, increasing the odds that some of the nation’s long-term unemployed will start losing aid.
The measure fell short of the two-thirds majority needed for approval under an expedited process. The vote on the bill was 258 in favor, 154 opposed.

Republican lawmakers complained that the bill’s $12 billion cost would be added to the government’s budget deficit. They demanded offsetting savings elsewhere in the budget.

The vote was a replay of a partisan dispute earlier this year that led to benefits being cut off for some jobless people for more than a month. Aid again is set to expire Nov. 30 for some of the unemployed.

No firm number of those who would be affected was available, though Representative Sander Levin, a Michigan Democrat and chairman of the House Ways and Means committee, estimated almost 2 million Americans could see their aid cut off by the end of this year if Congress does not act.

The nation’s unemployment rate in October was 9.6 percent.

Congress will be out of session next week for the Thanksgiving holiday, which means lawmakers will have little time to find agreement by the end of this month.

“This bill is like déjà vu all over again, and not in a good way,” said Representative Charles Boustany, a Louisiana Republican. “We all want to help those in need but the American people also know someone has to pay when government spends money, and it shouldn’t be our children and grandchildren.”
Levin said, “I don’t see how we can go home for Thanksgiving when as a result of a failure of benefits, hundreds of thousands of people may not have a turkey on their table because they can’t afford it.”

Posted in Deficit, Government Spending, Political | 4 Comments »

Glad to see the word getting around!

Posted by WARREN MOSLER on 18th November 2010


Smart Taxes Network

Posted in Uncategorized | No Comments »

Wray article on QE

Posted by WARREN MOSLER on 18th November 2010


QE2 Two: Equivalent to Issuing Bills in the First Place

Posted in Uncategorized | 3 Comments »

ECB was in the market buying a small amount of Greece and Portugal bonds (but not Ireland)

Posted by WARREN MOSLER on 18th November 2010

Just in case anyone thought the ECB has changed course

Posted in ECB | 4 Comments »