Monthly Archives: June 2011

Fed Chairman Ben S. Bernanke on Fiscal Sustainability

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This is from the same Ben S. Bernanke that stated the Fed spends by using their computer to mark up numbers in bank accounts.

Now, by extension, he’d propose basketball stadiums have a reserve of points for their scoreboards to make sure the teams could get their scores when they put the ball through the hoop.

If he was a state Governor this would be a pretty good speech. But he’s not.

Comments below:

Bernanke Speech

At the Annual Conference of the Committee for a Responsible Federal Budget, Washington, D.C.
June 14, 2011
Fiscal Sustainability

I am pleased to speak to a group that has such a distinguished record of identifying crucial issues related to the federal budget and working toward bipartisan solutions to our nation’s fiscal problems.

Yes, we now have bipartisan support for deficit reduction. Good luck to us.

Today I will briefly discuss the fiscal challenges the nation faces and the importance of meeting those challenges for our collective economic future. I will then conclude with some thoughts on the way forward.

Fiscal Policy Challenges
At about 9 percent of gross domestic product (GDP), the federal budget deficit has widened appreciably since the onset of the recent recession in December 2007. The exceptional increase in the deficit has mostly reflected the automatic cyclical response of revenues and spending to a weak economy as well as the fiscal actions taken to ease the recession and aid the recovery. As the economy continues to expand and stimulus policies are phased out, the budget deficit should narrow over the next few years.

Both the Congressional Budget Office and the Committee for a Responsible Federal Budget project that the budget deficit will be almost 5 percent of GDP in fiscal year 2015, assuming that current budget policies are extended and the economy is then close to full employment.1 Of even greater concern is that longer-run projections that extrapolate current policies and make plausible assumptions about the future evolution of the economy show the structural budget gap increasing significantly further over time. For example, under the alternative fiscal scenario developed by the Congressional Budget Office, which assumes most current policies are extended, the deficit is projected to be about 6-1/2 percent of GDP in 2020 and almost 13 percent of GDP in 2030. The ratio of outstanding federal debt to GDP, expected to be about 69 percent at the end of this fiscal year, would under that scenario rise to 87 percent in 2020 and 146 percent in 2030.2 One reason the debt is projected to increase so quickly is that the larger the debt outstanding, the greater the budgetary cost of making the required interest payments. This dynamic is clearly unsustainable.

Unfortunately, even after economic conditions have returned to normal, the nation faces a sizable structural budget gap.

The nation’s long-term fiscal imbalances did not emerge overnight. To a significant extent, they are the result of an aging population and fast-rising health-care costs, both of which have been predicted for decades. The Congressional Budget Office projects that net federal outlays for health-care entitlements–which were 5 percent of GDP in 2010–could rise to more than 8 percent of GDP by 2030. Even though projected fiscal imbalances associated with the Social Security system are smaller than those for federal health programs, they are still significant. Although we have been warned about such developments for many years, the difference is that today those projections are becoming reality.

Up to hear he’s discussed the size of the debt with words like ‘unfortunate’ and ‘imbalances’ and finally we here why he believes this is all a bad thing:

A large and increasing level of government debt relative to national income risks serious economic consequences. Over the longer term, rising federal debt crowds out private capital formation and thus reduces productivity growth.

What? Yes, public acquisition of real goods and services removes those goods and services from the private sector. But this is nothing about that. This is about deficits reducing the ability of firms to raise financial capital to invest in real investment goods and services to keep up productivity.

The type of crowding out the chairman is warning about is part of loanable funds theory, which is applicable to fixed exchange rate regimes, not floating fx regimes. This is a very serious error.

To the extent that increasing debt is financed by borrowing from abroad, a growing share of our future income would be devoted to interest payments on foreign-held federal debt.

Yes, if the interest payments set by the Fed are high enough, that will happen. However it isn’t necessarily a problem, particularly with the foreign sector’s near 0% propensity to spend their interest income on real goods and services. Japan, for example, as yet to spend a dime of it’s over $1 trillion in dollar holdings accumulated over the last six decades, and china’s holdings only seem to grow as well. In fact, the only way paying interest on the debt could be a problem is if that interest income is subsequently spent in a way we don’t approve of, and it’s easy enough to cross that bridge when we come to it.

High levels of debt also impair the ability of policymakers to respond effectively to future economic shocks and other adverse events.

There is no actual, operational impairment to spend whatever they want whenever they want. Federal spending is not constrained by revenues, as a simple fact of monetary operations. The only nominal constraints on spending are political, and the only constraints on what can be bought are what is offered for sale.

Even the prospect of unsustainable deficits has costs, including an increased possibility of a sudden fiscal crisis.

Where does this come from??? Surely he’s not comparing the US govt, the issuer of the dollar, where he spends by using his computer to mark up numbers in bank accounts, to Greece, a user of the euro, that doesn’t ‘clear its own checks’ like the ECB and the Fed do?

As we have seen in a number of countries recently, interest rates can soar quickly if investors lose confidence in the ability of a government to manage its fiscal policy.

He is looking at Greece!

Although historical experience and economic theory do not show the exact threshold at which the perceived risks associated with the U.S. public debt would increase markedly, we can be sure that, without corrective action, our fiscal trajectory is moving the nation ever closer to that point.

‘That point’ applies to users of a currency, like Greece, the other euro members, US states, businesses, households, etc.

But it does not apply to issuers of their own currency, like the US, Japan, UK, etc.

Is it possible the Fed chairman does not know this???

Perhaps the most important thing for people to understand about the federal budget is that maintaining the status quo is not an option. Creditors will not lend to a government whose debt, relative to national income, is rising without limit; so, one way or the other, fiscal adjustments sufficient to stabilize the federal budget must occur at some point.

Again with the ‘some point’ thing. There is no ‘some point’ for issuers of their own currency, like Japan, who’s debt to GDP is maybe 200% and 10 year JGB’s are trading at 1.15%.

These adjustments could take place through a careful and deliberative process that weighs priorities and gives individuals and firms adequate time to adjust to changes in government programs and tax policies. Or the needed fiscal adjustments could come as a rapid and much more painful response to a looming or actual fiscal crisis in an environment of rising interest rates, collapsing confidence and asset values, and a slowing economy. The choice is ours to make.

Right, the sky is falling.

Achieving Fiscal Sustainability

As if we didn’t already and automatically have it as the issuer of the currency.

The primary long-term goal for federal budget policy must be achieving fiscal sustainability.

What happened to his dual mandates of low inflation and full employment? That’s just for the Fed, but not for budget policy?

Well, if you believe the sky is falling no telling what your priority would be.

A straightforward way to define fiscal sustainability is as a situation in which the ratio of federal debt to national income is stable or moving down over the longer term.

And what does ‘straightforward’ mean? The math is easy? Is that how to set goals for the nation?

This goal can be attained by bringing spending, excluding interest payments, roughly in line with revenues, or in other words, by approximately balancing the primary budget. Given the sharp run-up in debt over the past few years, it would be reasonable to plan for a period of primary budget surpluses, which would serve eventually to bring the ratio of debt to national income back toward pre-recession levels.

All arbitrary measures not tied down to real world consequences apart from being a defensive move to keep the sky from falling.

Fiscal sustainability is a long-run concept. Achieving fiscal sustainability, therefore, requires a long-run plan, one that reduces deficits over an extended period and that, to the fullest extent possible, is credible, practical, and enforceable. In current circumstances, an advantage of taking a longer-term perspective in forming concrete plans for fiscal consolidation is that policymakers can avoid a sudden fiscal contraction that might put the still-fragile recovery at risk.

A glimmer of hope here where he seems to recognize how fiscal adjustments alter the real economy. Unfortunately, with the sky about to fall, he has more important fish to fry.

At the same time, acting now to put in place a credible plan for reducing future deficits would not only enhance economic performance in the long run,

Right, so govt doesn’t crowd out private capital formation with a floating fx regime…

but could also yield near-term benefits by leading to lower long-term interest rates and increased consumer and business confidence.

Yes, long term rates would likely be lower, because markets, which anticipate Fed rate settings, would believe the economy would be weak for a very long time, and therefore the odds of rate hikes would be lower.

While it is crucial to have a federal budget that is sustainable,

Don’t want to crowd out that private capital that gets borrowed from banks where the causation runs from loans to deposits (there’s no such thing as banks running out of money to lend).

our fiscal policies should also reflect the nation’s priorities by providing the conditions to support ongoing gains in living standards and by striving to be fair both to current and future generations.

Living standards are best supported by full employment policy, which happens to be a Fed mandate, in case he’s forgotten.

Interesting question, does the Fed’s mandate extend to influencing policy through speeches as to what others should do, or is it just a mandate for monetary policy decisions?

In addressing our long-term fiscal challenges, we should reform the government’s tax policies and spending priorities so that they not only reduce the deficit, but also enhance the long-term growth potential of our economy–for example, by increasing incentives to work and to save, by encouraging investment in the skills of our workforce, by stimulating private capital formation, by promoting research and development, and by providing necessary public infrastructure.

Big fat fallacy of composition there. Especially from a Princeton professor who should know better.

We cannot reasonably expect to grow our way out of our fiscal imbalances, but a more productive economy will ease the tradeoffs that we face.

Making Fiscal Plans
It is easy to call for sustainable fiscal policies but much harder to deliver them. The issues are not simply technical; they are also closely tied to our values and priorities as a nation. It is little wonder that the debates have been so intense and progress so difficult to achieve.

Recently, negotiations over our long-run fiscal policies have become tied to the issue of raising the statutory limit for federal debt. I fully understand the desire to use the debt limit deadline to force some necessary and difficult fiscal policy adjustments, but the debt limit is the wrong tool for that important job. Failing to raise the debt ceiling in a timely way would be self-defeating

Maybe, but he’s just guessing.

if the objective is to chart a course toward a better fiscal situation for our nation.

The current level of the debt and near-term borrowing needs reflect spending and revenue choices that have already been approved by the current and previous Congresses and Administrations of both political parties. Failing to raise the debt limit would require the federal government to delay or renege on payments for obligations already entered into. In particular, even a short suspension of payments on principal or interest on the Treasury’s debt obligations could cause severe disruptions in financial markets and the payments system, induce ratings downgrades of U.S. government debt, create fundamental doubts about the creditworthiness of the United States, and damage the special role of the dollar and Treasury securities in global markets in the longer term.

All of which has happened to Japan, with no adverse consequences on the currency or interest rates, as is necessarily the case for the issuer of a non-convertible currency and floating exchange rate.

Interest rates would likely rise, slowing the recovery and, perversely, worsening the deficit problem by increasing required interest payments on the debt for what might well be a protracted period.3

Some have suggested that payments by the Treasury could be prioritized to meet principal and interest payments on debt outstanding, thus avoiding a technical default on federal debt. However, even if that were the case, given the current size of the deficit and the uneven time pattern of government receipts and payments, the Treasury would soon find it necessary to prioritize among and withhold critical disbursements, such as Social Security and Medicare payments and funds for the military.

Yes, as congress is well aware, to the point that it’s no longer about a debt default, but about a partial shutdown of the rest of the govt.

This has been yesterday’s speech. Congress has moved on from the risk of debt default to the risk of partial govt shutdown.

Moreover, while debt-related payments might be met in this scenario, the fact that many other government payments would be delayed could still create serious concerns about the safety of Treasury securities among financial market participants.

That doesn’t follow?

The Hippocratic oath holds that, first, we should do no harm. In debating critical fiscal issues, we should avoid unnecessary actions or threats that risk shaking the confidence of investors in the ability and willingness of the U.S. government to pay its bills.

Our reps take a different oath

In raising this concern, I am by no means recommending delay or inaction in addressing the nation’s long-term fiscal challenges–quite the opposite. I urge the Congress and the Administration to work in good faith to quickly develop and implement a credible plan to achieve long-term sustainability. I hope, though, that such a plan can be achieved in the near term without resorting to brinksmanship or actions that would cast doubt on the creditworthiness of the United States.

What would such a plan look like? Clear metrics are important, together with triggers or other mechanisms to establish the credibility of the plan. For example, policymakers could commit to enacting in the near term a clear and specific plan for stabilizing the ratio of debt to GDP within the next few years and then subsequently setting that ratio on a downward path.

Again, the falling sky trumps concerns over output and employment.

Indeed, such a trajectory for the ratio of debt to GDP is comparable to the one proposed by the National Commission on Fiscal Responsibility and Reform.4To make the framework more explicit, the President and congressional leadership could agree on a definite timetable for reaching decisions about both shorter-term budget adjustments and longer-term changes. Fiscal policymakers could look now to find substantial savings in the 10-year budget window, enforced by well-designed budget rules, while simultaneously undertaking additional reforms to address the long-term sustainability of entitlement programs.

In other words, cuts in the social security and Medicare budgets. This at a time of record excess capacity.

If only the sky wasn’t falling…

Such a framework could include a commitment to make a down payment on fiscal consolidation by enacting legislation to reduce the structural deficit over the next several years.

Conclusion
The task of developing and implementing sustainable fiscal policies is daunting, and it will involve many agonizing decisions and difficult tradeoffs. But meeting this challenge in a timely manner is crucial for our nation. History makes clear that failure to put our fiscal house in order will erode the vitality of our economy, reduce the standard of living in the United States, and increase the risk of economic and financial instability.

And what history might that be? There’s no such thing as a currency issuer ever not being able to make timely payment.

Madison sq garden will not run out of points to post on the scoreboard.

And check out the references. He relies on the information from the group he’s addressing:

References
Committee for a Responsible Federal Budget (2010). The CRFB Medium and Long-Term Baselines. Washington: CRFB, August.

Congressional Budget Office (2010). The Long-Term Budget Outlook. Washington: Congressional Budget Office, June (revised August).

National Commission on Fiscal Responsibility and Reform (2010). The Moment of Truth: Report of the National Commission on Fiscal Responsibility and Reform. Washington: NCFRR, December.

Zivney, Terry L., and Richard D. Marcus (1989). “The Day the United States Defaulted on Treasury Bills,” Financial Review, vol. 24 (August), pp. 475-89.

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Modern Monetary Theory: The Last Progressive Left Standing

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Modern Monetary Theory: The Last Progressive Left Standing

By Warren Mosler

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Gross misunderstandings continue

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He’s completely lost it:

US Is in Even Worse Shape Financially Than Greece: Gross

By Jeff Cox

June 13 (CNBC) — When adding in all of the money owed to cover future liabilities in entitlement programs the US is actually in worse financial shape than Greece and other debt-laden European countries, Pimco’s Bill Gross told CNBC Monday.

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Roubini’s latest

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He must have just read my year end post.

And he left out US fiscal tightening:

Roubini Says a ‘Perfect Storm’ May Converge on the Global Economy in 2013

By Shamim Adam

June 12 (Bloomberg) — A “perfect storm” of fiscal woe in the U.S., a slowdown in China, European debt restructuring and stagnation in Japan may converge on the global economy, New York University professor Nouriel Roubini said.

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Comments on Summers latest

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The deficit hawks have ripped the headline deficit doves to shreds.
The problem is the deficit doves, as previously discussed.
Again, here’s why:

How to avoid our own lost decade

By Lawrence Summers

June 12 (FT) — Even with the 2008-2009 policy effort that successfully prevented financial collapse, the US is now halfway to a lost economic decade. In the past five years, our economy’s growth rate averaged less than one per cent a year, similar to Japan when its bubble burst. At the same time, the fraction of the population working has fallen from 63.1 per cent to 58.4 per cent, reducing the number of those in jobs by more than 10m. Reports suggest growth is slowing.

True!

Beyond the lack of jobs and incomes, an economy producing below its potential for a prolonged interval sacrifices its future. To an extent once unimaginable, new college graduates are moving back in with their parents. Strapped school districts across the country are cutting out advanced courses in maths and science. Reduced income and tax collections are the most critical cause of unacceptable budget deficits now and in the future.

True!

You cannot prescribe for a malady unless you diagnose it accurately and understand its causes. That the problem in a period of high unemployment, as now, is a lack of business demand for employees not any lack of desire to work is all but self-evident, as shown by three points: the propensity of workers to quit jobs and the level of job openings are at near-record low; rises in non-employment have taken place among all demographic groups; rising rates of profit and falling rates of wage growth suggest employers, not workers, have the power in almost every market.

True!

A sick economy constrained by demand works very differently from a normal one. Measures that usually promote growth and job creation can have little effect, or backfire.

A ‘normal’ economy is one with sufficient demand for full employment, so there’s no particular need to promote even more demand.

When demand is constraining an economy, there is little to be gained from increasing potential supply.

True. The mainstream theory is that increased supply will lower prices so the same incomes and nominal spending will buy the additional output. But it doesn’t work because the lower prices (in theory) work to lower incomes to where the extra supply doesn’t get sold and therefore doesn’t get produced. And it’s all because the currency is a (govt) monopoly, and a shortage in aggregate demand can only be overcome by either a govt fiscal adjustment and/or a drop in non govt savings desires, generally via increased debt. And in a weak economy with weak incomes the non govt sectors don’t tend to have the ability or willingness to increase their debt.

In a recession, if more people seek to borrow less or save more there is reduced demand, hence fewer jobs. Training programmes or measures to increase work incentives for those with high and low incomes may affect who gets the jobs, but in a demand-constrained economy will not affect the total number of jobs. Measures that increase productivity and efficiency, if they do not also translate into increased demand, may actually reduce the number of people working as the level of total output remains demand-constrained.

True!

Traditionally, the US economy has recovered robustly from recession as demand has been quickly renewed. Within a couple of years after the only two deep recessions of the post first world war period, the economy grew in the range of 6 per cent or more – that seems inconceivable today.

True!

Why?

Inflation dynamics defined the traditional postwar US business cycle. Recoveries continued and sometimes even accelerated until they were murdered by the Federal Reserve with inflation control as the motive. After inflation slowed, rapid recovery propelled by dramatic reductions in interest rates and a backlog of deferred investment, was almost inevitable.

Not so true, but not worth discussion at this point.

Our current situation is very different. With more prudent monetary policies, expansions are no longer cut short by rising inflation and the Fed hitting the brakes. All three expansions since Paul Volcker as Fed chairman brought inflation back under control in the 1980s have run long. They end after a period of overconfidence drives the prices of capital assets too high and the apparent increases in wealth give rise to excessive borrowing, lending and spending.

Not so true, but again, I’ll leave that discussion for another day.

After bubbles burst there is no pent-up desire to invest. Instead there is a glut of capital caused by over-investment during the period of confidence – vacant houses, malls without tenants and factories without customers. At the same time consumers discover they have less wealth than they expected, less collateral to borrow against and are under more pressure than they expected from their creditors.

True!

Pressure on private spending is enhanced by structural changes. Take the publishing industry. As local bookstores have given way to megastores, megastores have given way to internet retailers, and internet retailers have given way to e-books, two things have happened. The economy’s productive potential has increased and its ability to generate demand has been compromised as resources have been transferred from middle-class retail and wholesale workers with a high propensity to spend up the scale to those with a much lower propensity to spend.

Probably has some effect.

What, then, is to be done? This is no time for fatalism or for traditional political agendas. The central irony of financial crisis is that while it is caused by too much confidence, borrowing and lending, and spending, it is only resolved by increases in confidence, borrowing and lending, and spending. Unless and until this is done other policies, no matter how apparently appealing or effective in normal times, will be futile at best.

Partially true. It’s all about spending and sales. We lost 8 million jobs almost all at once a few years back because sales collapsed. Businesses hire to service sales. So until we get sales high enough to keep everyone employed who’s willing and able to work we will have over capacity, an output gap, and unemployment.

The fiscal debate must accept that the greatest threat to our creditworthiness is a sustained period of slow growth.

NOT TRUE!!! And here’s where the headline deficit doves lose the battles and now the war. There is no threat to the credit worthiness of the US Government. We can not become the next Greece- there simply is no such thing for the issuer of its currency. Credit worthiness applies to currency users, not currency issuers.

Discussions about medium-term austerity need to be coupled with a focus on near-term growth.

There he goes again. This is the open door the deficit hawks have used to win the day, with both sides now agreeing on the need for long term deficit reduction. And in that context, the deficit dove position that we need more deficit spending first, and then deficit reduction later comes across as a ploy to never cut the deficit, and allow the ‘problem’ to compound until it buries us, etc.

Without the payroll tax cuts and unemployment insurance negotiated last autumn we might now be looking at the possibility of a double dip.

They certainly helped, and ending work for pay hurt, and even with whatever support that provided, we are still facing the prospect of a double dip.

Substantial withdrawal of fiscal stimulus at the end of 2011 would be premature. Stimulus should be continued and indeed expanded by providing the payroll tax cut to employers as well as employees.

True, except the extension to employers works to lower prices, as it lowers business costs. This is a good thing, but it adds to aggregate demand only very indirectly. To get it right, I’d suspend all FICA taxes to increase take home pay of those working for a living which will help sales and employment, and to cut business costs, which, in competitive markets, works to lower prices.

Raising the share of payroll from 2 per cent to 3 per cent is desirable, too. These measures raise the prospect of sizeable improvement in economic performance over the next few years.

True, as far as it goes. Too bad he reinforces the overhanging fears of deficit spending per se. You’d think he’d realize everyone would like to cut taxes, and that it’s the fears of deficit spending that are in the way…

At the same time we should recognize that it is a false economy to defer infrastructure maintenance and replacement,

True!

and take advantage of a moment when 10-year interest rates are below 3 per cent

Bad statement!!! This implies that if rates were higher it would make a difference with regards to our infrastructure needs during times of a large output gap, as it perpetuates the myths about the govt somehow being subjected to market forces with regard to its ability to deficit spend. Again, this mainstream deficit dove position only serves to support the deficit hawk fear mongering that’s won the day.

and construction unemployment approaches 20 per cent to expand infrastructure investment.

It is far too soon for financial policy to shift towards preventing future bubbles and possible inflation, and away from assuring adequate demand.

True! But, as above, he’s already defeated himself by reinforcing the fears of deficits and borrowing.

The underlying rate of inflation is still trending downwards and the problems of insufficient borrowing and investing exceed any problems of overconfidence. The Dodd-Frank legislation is a broadly appropriate response to the challenge of preventing any recurrence of the events of 2008. It needs to be vigorously implemented. But under-, not overconfidence is the problem, and needs to be the focus of policy.

Policy in other dimensions should be informed by the shortage of demand that is a defining characteristic of our economy. The Obama administration is doing important work in promoting export growth by modernising export controls, promoting US products abroad and reaching and enforcing trade agreements. Much more could be done through changes in visa policy to promote exports of tourism as well as education and health services. Recent presidential directives regarding relaxation of inappropriate regulatory burdens should also be rigorously implemented.

Too bad he’s turned partisan here, as I’m sure he’s aware of how exports are real costs, and imports real benefits, and how real terms of trade work to alter standards of living. So much for intellectual honesty…

Perhaps the US’ most fundamental strength is its resilience. We averted Depression in 2008/2009 by acting decisively. Now we can avert a lost decade by recognising economic reality.

First we need to recognize financial reality, and unfortunately he and the other headline deficit doves continue to provide the support for the deficit myths and hand it all over to the deficit hawks. Note that, as per the President, everything must be on the table, including Social Security and Medicare. To repeat, fearing becoming the next Greece is working to turn ourselves into the next Japan.

The writer is Charles W. Eliot University Professor at Harvard and former US Treasury Secretary. He is an FT contributing editor

(Feel free to distribute, repost, etc.)

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Major Banks Likely to Get Reprieve on New Capital Rules

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The real problem is if you understand what a bank is, you wouldn’t be trying to use capital ratios to protect taxpayer money.

First, notice that the many of the same people clamoring for higher capital ratios have also supported ‘nationalization’ of banks, which means there is no private capital. So it should be obvious that something other than private capital is employed to protect taxpayer money.

Taxpayer money is protected on the asset side (loans and other investments held by banks) with lending regulations. That includes what type of investments are legal for banks, what kind of lending is legal, including collateral requirements and income requirements. That means if Congress thought the problem in 2008 was lax and misguided lending, to further protect taxpayer money they need to tighten things up on that side. And that would include tightening up on supervision and enforcement as well.

(Of course, they think the current problem is banks are being too cautious, but Congress talking out of both sides of its mouth has never seemed to get in the way before. Just look at the China policy- they want China to strengthen its currency which means they want the dollar to go down vs the yuan, but at the same time they are careful not to employ policy that might cause China to sell their dollars and drive the dollar down vs the yuan.)

So what is the point of bank capital requirements? It’s the pricing of risk.

With an entirely publicly owned bank, risk is priced by government officials which means it’s politicized, with government officials deciding the interest rates that are charged. With private capital in first loss position, risk is priced by employees who are agents for the shareholders, who want the highest possible risk adjusted returns on their investment. This introduces an entirely different set of incentives vs publicly owned institutions. And the choice between the two, and the two alternative outcomes, is a purely political choice.

With our current arrangement of banking being public/private partnerships, the ratio between the two is called the capital ratio. For example, with a 10% capital ratio banks have 10% private capital, and 90% tax payer money (via FDIC deposit insurance). And what changing the capital ratio does is alter the pricing of risk.

Banks lending profits from the spread between the cost of funds and the rates charged to borrowers. And with any given spread, the return on equity falls as capital ratios rise. And looked at from the other perspective, higher capital ratios mean banks have to charge more for loans to make the same return on equity.

Additionally, investors/market forces decide what risk adjusted return on investment is needed to invest in a bank. Higher capital requirements lower returns on investment, but risk goes down as well. But it’s not a ‘straight line’ relationship. It takes a bit of work to sort out all the variables before an informed decision can be made by policy makers when setting required capital ratios.

So where are we?

We have policy makers and everyone else sounding off on the issue who all grossly misunderstand the actual dynamics trying to use capital requirements to protect taxpayer money.

Good luck to us!

For more on this see Proposals for the Banking System, Treasury, Fed, and FDIC

Major Banks Likely to Get Reprieve on New Capital Rules

By Steve Liesman

June 10 (CNBC) — The world’s major banks may get a break from regulators and be forced to set aside only 2 percent-to-2.5 percent more capital rather than the 3 percent reported earlier, officials familiar with the discussions told CNBC.

News of the potential reprieve—which would affect major global banks such as JPMorgan , Citigroup , Bank of America , Wells Fargo , UBS and HSBC —helped stocks pare losses Friday afternoon.

The new rule, which would force the world’s biggest financial institutions to set aside more capital as a cushion against potential losses, is being imposed after the recent credit crisis nearly caused the collapse of the banking system.

The increased capital buffer would be in addition to a seven percent capital increase for all banks, which was negotiated at last year’s Basel III meeting.

The officials, who asked not to be named, made their comments after global banking regulators met this week in Frankfurt. The US has proposed a tougher three percent charge for big banks, but there has been pushback from some European nations, especially France. Negotiations are continuing.

The news comes after JPMorgan Chief Jamie Dimon rose in an Atlanta meeting this week and directly confronted Fed Chairman Ben Bernanke over the numerous new banking regulations, including a new surcharge for the biggest banks.

Officials say there is a more formal meeting in two weeks of regulators in Basel, Switzerland, where the actual percentage should be formalized as a proposal to global leaders.

Sources caution that the situation is still a moving target, with the U.S. apparently holding out for a higher global surcharge if other countries push lower forms of capital, other than common equity, to be used to meet capital requirements.

Earlier this week, U.S. Treasury Department Secretary Tim Geithner suggested that the higher the quality of capital, the lower the surcharge can be.

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Saudis to pump 10 million bpd

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The Saudis don’t sell in the spot markets, they only post prices to refiners and then take orders at those prices.

That is, they post price and let quantity vary.

So the only way they could definitively get to 10 million bpd would be to change policy and sell in the spot market, which would let loose a downward price spiral until some other producer decided to cut production to stop the fall.

As always, it’s their political decision, and no telling what they might actually do.

Saudi Shows Who’s Boss, to Pump 10 Million Barrels Per Day

June 10 (Reuters) — Saudi Arabia will raise output to 10 million barrels day in July, Saudi newspaper al-Hayat reported on Friday, as Riyadh goes it alone in unilaterally pumping more outside OPEC policy.

Citing OPEC and industry officials, the newspaper said output would rise from 8.8 million bpd in May. There was no immediate independent verification of the story.

The report suggests Riyadh is asserting its authority over fellow members of the Organization of the Petroleum Exporting Countries after it failed to convince the 12-member cartel to lift output at an acrimonious meeting in Vienna on Wednesday.

“The Saudi intention is to show that they cannot be pushed around,” said Middle East energy analyst Sam Ciszuk at IHS. “Either OPEC follows the Saudi lead or they will have problems.”

A proposal by Saudi and its Gulf Arab allies the UAE and Kuwait to lift OPEC production was blocked by seven producers including Iran, Venezuela and Algeria.

The two sides blamed each other for the breakdown in talks. Saudi Oil Minister Ali ali-Naimi called those opposed to the deal obstinate. Iran’s OPEC governor Mohammad Ali Khatibi responded by saying Riyadh had been overly-influenced by U.S.-led consumer country demands for cheaper fuel.

“The hawks in OPEC called their bluff and now it is up to Riyadh to show that they were not bluffing — that they will go ahead unilaterally if pushed,” said Cizsuk.

Saudi Arabia has not pumped 10 million bpd for at least a decade, according to Reuters data, production having peaked at 9.7 million bpd in July 2008 after prices hit a record $147 a barrel. It is the only oil producer inside or outside OPEC with any significant spare capacity.

Asked in Vienna on Thursday whether Saudi would reach 10 million bpd Naimi said: “Just send the customers, don’t worry about the volumes.”

Gulf delegates said Riyadh was planning to pump an average 9.5-9.7 million bpd in June.

Saudi is already offering more crude to refiners in Asia, which, led by China, is driving a global rise in oil consumption.

Forecasts from OPEC headquarters show demand will increase about 1.7 million bpd in the second half of the year from recent cartel output of about 29 million bpd.

Brent crude rose to a 5-week high of $120 a barrel after the OPEC talks broke down. Prices eased after Friday’s Saudi news, last dipping 63 cents to trade near $118.94 a barrel.

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China GDP history

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This is year over year ‘real’ GDP growth.

Note the recurring first quarter spikes followed by dips, presumably due to front loading annual state spending and lending.

Not much of a spike this year, due to cutbacks in state spending/lending, but the reduced spending/lending that resulted in the reported growth was likewise front loaded for 2011.

Question now is what the traditional second half dip will look like.
Seems to me it could get pretty ugly.

Also, Japan’s earthquake looks to have weakened world growth more than originally expected. And it’s all probably path dependent, meaning growth simply resumes from the lower, post quake base, especially in light of their reluctance to increase their deficit spending.

Europe is also weakening due to self imposed austerity.

And the US is heck bent on doing same as both parties agree on the need for multi trillions of deficit reduction, while Fed policies continue to work to reduce govt. interest payments to the economy and continue to shift income from savers to bank net interest margins.

H2 is still looking hopeless to me, and also looking like we’re flying without a net.

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OPEC indecision of no consequence

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It doesn’t matter what OPEC decides with regard to increases.
The only ones with excess capacity, for all practical purposes, are Saudis.
The others have always pumped all they could and let the Saudis be the swing producer.

Historically, the hard part has been to get anyone other than the Saudis to cut production when the Saudis needed help to keep a floor under prices. Invariably the others would cheat and produce to capacity, letting the Saudis carry the burden of reduced sales.

In any case, the Saudis will continue to post their prices to their refiners and fill any and all orders at those posted prices.
And the rest of OPEC will likely keep producing at near max levels.

And most expect Lybia to be back on line in a few weeks or so, in which case Saudi production will ‘automatically’ fall back.

OPEC Talks Break Down, No Deal to Lift Oil Supply

June 8 (Reuters) — OPEC talks broke down on Wednesday without an agreement to raise output after Saudi Arabia failed to convince the cartel to lift production.

Secretary General Abdullah El-Badri said the effective decision was no change in policy and that OPEC hoped to meet again in three months time. No date has been set for another meeting.

“Unfortunately we are unable to reach a consensus to reduce or raise production,” El-Badri told reporters.

Gulf Arab delegates said Iran, Venezuela and Algeria refused to consider an output increase. Non Gulf delegates said Saudi Arabia had proposed an increase on top of April supplies that was too high for them to contemplate.

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Moody’s Analyst: Weak Growth, Fiscal Slips Could Lose UK ‘AAA’

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The wonder is how Moody’s keeps it’s prized credibility and Sarah Carlson her prized job.

Moody’s Analyst: Weak Growth, Fiscal Slips Could Lose UK ‘AAA’

Jun 8 (MNI) — The UK could lose its prized ‘Aaa’ credit rating if growth remains weak and the coalition government fails to meet its fiscal consolidation targets, a senior analyst at ratings agency Moody’s has told Market News International.

Sarah Carlson, VP-Senior Analyst at Moody’s, told MNI that weak growth and fiscal slippage could see the country’s ‘debt metrics’ deteriorate to a point that would trigger a downgrade.

“Although the weaker economic growth prospects in 2011 and 2012 do not directly cast doubt on the UK’s sovereign rating level, we believe that slower growth combined with weaker-than-expected fiscal consolidation efforts could cause the UK’s debt metrics to deteriorate to a point that would be inconsistent with a Aaa rating,” she said.

Carlson also said that due to their sheer size the UK’s austerity plans have a degree of ‘implementation risk’.

“As is true of any large fiscal consolidation effort, the government’s austerity plans entail some implementation risk. Moreover, a multi-year austerity programme of this magnitude is a political challenge,” she said.

Carlson’s comments come in a week of frenzied debate as to whether UK Chancellor of the Exchequer George Osborne’s fiscal consolidation plans are working.

At present, the government aims to close Britain’s structural deficit will by the end of 2014-15, slashing departmental budgets by almost stg100 billion over four years.

But a weaker-than-expected Q1 GDP outturn and a slew of disappointing economic data since then, has led several economists to question the wisdom of such a rapid deficit-reduction plan while others have said there is no other choice.

On Sunday, a group of leading economists led by Prof. Tony Atkinson of Oxford and centre-left pressure group Compass wrote a letter to the Observer newspaper questioning the wisdom of the current plan.

Carlson said that the government’s creation of a cross-departmental committee to monitor progress in public spending cuts could be useful in reinforcing commitment to consolidation.

“The creation of the Public Expenditure Cabinet Committee (PEX) – a cross-government spending committee that will monitor the progress of individual departments against their budget plans – has the potential to be a promising institutional change that could further bolster confidence in the government’s ability to follow through with its ambitious austerity programme.”

On Monday, a group of centre-right economists wrote a letter to the Telegraph newspaper which argued against relaxing austerity measures.

In its Article IV Consultation Report on the UK released Monday, the IMF said that there had been unexpected weaknesses in UK economy over the past few months but labelled the troubles temporary and advised the government to keep to its current deficit-reduction plan.

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