Trichet statement

*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.

euro update and why no one is leaving (yet)

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.

etc.

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.

Time for England to complete the conquest of Ireland

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.

euro endgame

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.

FMOC Minutes

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.

Next Debt Crisis May Start in Washington: Bair

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.

European Debt/GDP ratios – the core issue

Review:

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…)

China, Russia quit dollar for transactions

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.

Fighting inflation in China

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.)