Karim writes:

Takeaway is underlying private demand was stronger than initially reported, government was more of a drag and inventories have more room to expand.

Yes, but note this:

The drag from government and inventories was partially offset by an upward revision to consumer spending, which rose at a 3.4 percent annual rate, up two tenths of a point from the government’s previous estimate. However, a cloud hung over that category, as most of the upward revision was due to higher sales of gasoline. Higher prices at the pump are a burden on consumers, leaving them less money to spend on other things.

And:

After-tax corporate profits fell at a 1.9 percent annual rate in the quarter, the first decline in a year.

Optimism on late 2013 and 2014 growth (Rosengren speech yesterday) stems from government consumption turning from being a drag to neutral sometime in Q3 or Q4, leaving in place the underlying pace of private demand growth of about 3%.

Yes, the question being ‘leaving in place’, as govt spending feeds private sector sales, etc.

So the assumption is the private sector spending that’s been taking place will continue at that pace post tax hikes and sequesters. And note that growth in the credit driven spending (cars, appliances, housing) is showing at least hints of slowing.

Department of Labor reported 5 states didn’t complete their claims count last week due to the holiday, so the rise in claims to 354k to be taken with a grain of salt.

Yes, but here too are at least hints that claims bottomed a few weeks ago and have edged a bit higher since then, and that Non Farm Payrolls peaked in Feb, and if next weeks number prints at 150,000 the three month average is back down to around that level.

And, again, it’s the year end tax hikes and subsequent sequesters that are causing me to look for evidence of subsequent slowing.

This is notable for Italian (and European) growth. Eur10bn (mid-point of estimates below) is worth about a 0.5% add to GDP growth:

EU Recommends Removing Italy From Excessive-Deficit Procedure (Bloomberg) The European Commission recommended today lifting an excessive-deficit procedure against Italy after the government brought its budget shortfall within the European Union limit. “Our task is to respect our commitments with Europe and implement the program the parliament has given its vote of confidence on,” Italian Prime Minister Enrico Letta said. Ending the strict EU monitoring of Italian public spending may free up resources of as much as 12 billion euros, Regional Affairs Minister Graziano Delrio said in an interview with daily La Stampa May 27. “The closing of the procedure alone allows us to boost spending by between 7 and 10 billion euros, 12 billion euros in the most optimistic forecast,” Delrio said in the La Stampa interview.

Yes, this would be helpful, but a deceleration in expected US growth hurts Europe as well.

Initial Claims YTD:

Nonfarm Payroll Change YTD:

Radical fixes needed to make the euro work

Commentary: Warren Mosler has a plan but no takers

By Darrell Delamaide

May 8 (MarketWatch) — If youre ever tempted to think the euro zone has turned the corner and is on the right track, go have a chat with Warren Mosler and hell set you straight.

The former hedge-fund manager and an original proponent of what has come to be known as modern monetary theory gave a talk recently at a wealth management conference in Zurich that took a pessimistic view of the euro righting itself on its current path.

The European slow-motion train wreck will continue until theres recognition that deficits need to be larger, Mosler said at the conclusion of his analysis. The continuing efforts at deficit reduction will continue to make things worse.

Mosler suggested several measures that could turn around the situation in the euro zone, though he acknowledged there is little chance they will be adopted.

The euro authorities need to accept that deficits should be allowed to go up to 8% of gross domestic product, instead of the current 3%, as the only way to create the monetary conditions for full employment and economic growth.

The European Central Bank should make a policy rate of 0% permanent. The ECB, as the source of the euro zones fiat money, should guarantee the debt of all euro countries and guarantee deposit insurance for all euro-zone banks, which would entail taking over bank supervision.

Individual countries in the euro zone, like individual states in the U.S., are trapped in a procyclical monetary and fiscal environment. Because they have no sovereign currency, they must reduce spending in a downturn.

In the U.S., the federal government can operate countercyclically, by running a sufficiently large deficit to provide net savings to the private sector. The ECB is the only institution in the euro zone that does not have revenue constraints and could play a countercyclical role.

Because money is a public monopoly, when the monopolist restricts supply by not running a sufficient deficit, it creates excess capacity in the economy, as evidenced by high unemployment.

Mosler says the deficit can result from lower taxes or increased government spending, whatever your politics prefers. But policies aimed at reducing the deficit are doomed to keep an economy depressed.

And theres more. All successful currency unions include fiscal transfers, Mosler said. In Canada, this is written into the constitution and in the U.S. it is achieved through the federal budget.

In Europe, this would mean that some authority like an empowered European Parliament would direct government spending to the areas with the highest unemployment.

Clearly all of this is well beyond what Europe is currently capable of doing, and the leaders in power have implicitly or explicitly rejected all of these potential fixes.

The reality is, Mosler noted, that there is no political support for higher deficits, no political support for leaving the euro, and beyond reducing deficits the only remaining fixes are taxes on depositors and bondholders like those seen in Cyprus and Greece.

Mosler, who currently manages offshore funds and produces sports cars on the side, says his views, which have been taken up and elaborated by a post-Keynesian school of economics, are based on his experience as a money manager.

And, he adds, he has a substantial following of asset managers for his ideas because these are people who are paid to get it right.

The current stopgap measures proposed by the ECB notably the putative outright monetary transactions to bail out a country under certain conditions, which has yet to be used have a dubious legal basis and are so much smoke and mirrors, Mosler said.

In this Zurich talk, Mosler did not draw any further conclusions regarding his pessimistic view of the euros current course, but a website devoted to Mosler Economics in Italy, where MMT has a considerable following, spells out what it could mean in a post called 10 reasons to return to the lira.

These reasons include the ability to lower taxes, allow the government to pay off debts to the private sector and implement a works program to provide employment and improve the public infrastructure. Read the post (in Italian).

Lest this all seem like so much pie in the sky, keep in mind that the forces that gave the protest movement of Beppe Grillo a quarter of the vote in Italys recent election will only grow as continued austerity deepens Europes recession.

So remain optimistic if you like, but youve been warned.

If anyone can get a message to him, please tell him that, functionally, negative rates are just a tax on deposits that ultimately reduces spending/output/employment, much like the PSI did in Greece and whatever you want to call the ‘deposit confiscation tax’ in Cypress.

>   
>   (email exchange)
>   
>   This is a bit unexpected
>   

*DRAGHI SAYS ECB TECHNICALLY READY FOR NEGATIVE DEPOSIT RATES

*DRAGHI SAYS ECB TECHNICALLY READY FOR NEGATIVE DEPOSIT RATES

“on the deposit facility rate… we are technically ready. There are several unintended consequences that may stem from this measure. we will address and cope with these consequences if we decided to act. We will look at this with an open mind and stand ready to act if needed”

Good to see Ken, who I’ve never met, and Carmen who I do know, no doubt assisted by her husband Vince, beginning to come clean with this response. While not complete, it’s the beginning of an encouraging, epic reversal and a first step in the right direction!

My comments added below:

Austerity is not the only answer to a debt problem

By Kenneth Rogoff and Carmen Reinhart

May 1 (FT) — The recent debate about the global economy has taken a distressingly simplistic turn. Some now argue that just because one cannot definitely prove very high debt is bad for growth (though the weight of the results still say it is),

They could add here ‘though likely via the reaction functions of govts and not the high debt per se.’

then high debt is not a problem. Looking beyond the recent public debate about the literature on debt we have already discussed our results on debt and growth in that context the debate needs to be reconnected to the facts.

Let us start with one: the ratios of debt to gross domestic product are at historically high levels in many countries, many rising above previous wartime peaks. This is before adding in concerns over contingent liabilities on private sector balance sheets and underfunded old-age security and pension programmes. In the case of Germany, there is also the likely need to further cushion the debt loads of eurozone partners.

Adding here ‘as they are ‘users’ of the euro the way US states are ‘users’ of the dollar, and not the actual issuer of the currency like the ECB, the Fed, the BOE, the BOJ, and the rest of the world’s central banks.’

Some say not to worry, pointing to bursts of growth after the world wars. But todays debts,

Add ‘while they pose no solvency risk for the issuer of the currency.’

will not be dealt with by boosts to supply from postwar demobilisation and to demand from the lifting of wartime controls.

To be clear, no one should be arguing to stabilise debt, much less bring it down, until growth is more solidly entrenched if there remains a choice, that is.

BRAVO!!!! And add ‘as is always the case for the issuer of the currency.’

Faced with, at best, haphazard access to international capital markets and high borrowing costs, periphery countries in Europe face more limited alternatives.

Add ‘as is the case for ‘users’ of a currency in general, including the US states, for example’.

Nevertheless, given current debt levels, enhanced stimulus should only be taken selectively and with due caution. A higher borrowing trajectory is warranted, given weak demand

BRAVO!

and low interest rates,

Add ‘which are confirmation by the CB policy makers who set the rates low that they too believe demand is weak’.

where governments can identify high-return infrastructure projects. Borrowing to finance productive infrastructure raises long-run potential growth, ultimately pulling debt ratios lower. We have argued this consistently since the outset of the crisis.

BRAVO! And add ‘additionally, weak demand can be addressed by tax reductions, recognizing that counter cyclical fiscal policy of currency users, like the euro zone members, requires funding support from the issuer of the currency, which in this case is the ECB.’

Ultra-Keynesians would go further and abandon any pretense of concern about longer-term debt reduction.

Add ‘without a credible long term inflation concern, as for the issuer of the currency inflation is the only risk from excess demand.’

This position has been in the rhetorical ascendancy in recent months, with new signs of weaker growth. It throws caution to the wind on debt

Add ‘with regards to solvency, as is necessarily the case for the issuer of the currency.’

and, to quote Star Trek, pushes governments to go where no man has gone before

Add ‘apart from war time, when the importance of maximum output and employment takes center stage.’

The basic rationale

Add ‘of the mainstream deficit doves (not the ultra Keynesian MMT school of thought)’

is that low interest rates make borrowing a free lunch.

Unfortunately,

Add ‘the mainstream believes’

ultra-Keynesians are too dismissive of the risk of a rise in real interest rates. No one fully understands why rates have fallen so far so fast,

Add ‘apart from the Central Bankers who voted to lower them this far and this fast, and in some cases provide guarantees to other borrowers.’

and therefore no one can be sure for how long their current low level will be sustained.

Add ‘as it’s a matter of second guessing those central bankers.’

John Maynard Keynes himself wrote How to Pay for the War in 1940 precisely because he was not blas about large deficits even in support of a cause as noble as a war of survival. Debt is a slow-moving variable that cannot and in general should not be brought down too quickly. But interest rates can change rapidly.

Add ‘all it takes is a vote by central bankers.’

True, research has identified factors that might combine to explain the sharp decline in rates.

Add ‘in fact, all you have to do is research the votes at the central bank meetings.’

Greater concern

Add ‘by central bankers’

over potentially devastating future events such as fresh financial meltdowns may be depressing rates. Similarly, the negative correlation between returns on stocks and long-term bonds, while admittedly quite unstable, also makes bonds a better hedge. Emerging Asias central banks have been great customers for advanced economy debt, and now perhaps the Japanese will be once more. But can these same factors be relied on to keep yields low indefinitely?

Add ‘In the end, it’s all a matter of the central bank’s reaction function.’

Economists simply have little idea how long it will be until rates begin to rise. If one accepts that maybe, just maybe, a significant rise in interest rates in the next decade

Add ‘due to inflation concerns’

might be a possibility, then plans for an unlimited open-ended surge in debt should give one pause.

Add ‘if he does not see the merits of leaving risk free rates near 0 in any case, as there is no convincing central bank research that shows rate hikes reduce inflation rates, and even credible theory and evidence to be concerned that rate hikes instead exacerbate inflation.’

What, then, can be done? We must remember that the choice is not simply between tight-fisted austerity and freewheeling spending. Governments have used a wide range of options over the ages. It is time to return to the toolkit.

First and foremost,

Add ‘only’

governments

Add ‘who fail to recognize that these are merely matters of accounting that don’t themselves alter output and employment’

must be prepared to write down debts rather than continuing to absorb them. This principle applies to the senior debt of insolvent financial institutions, to peripheral eurozone debt and to mortgage debt in the US.

Add ‘Additionally’

For Europe, in particular, any reasonable endgame will require a large transfer

Add ‘of public goods production’

from Germany to the periphery.

Add ‘which in fact would be a real economic benefit for Germany.’

The sooner this implicit transfer becomes explicit, the sooner Europe will be able to find its way towards a stable growth path.

There are other tools. So-called financial repression, a non-transparent form of tax (primarily on savers), may be coming to an institution near you. In its simplest form, governments cram debt into domestic pension funds, insurance companies and banks

By removing governmental support of higher rates from their net issuance of debt instruments, particularly treasury securities.

Europe is there already and it has been there before, several times. How to Pay for the War was, in part, about creating captive audiences for government debt. Read the real Keynes, not rote Keynes, to understand our future.

One of us attracted considerable fire for suggesting moderately elevated inflation (say, 4-6 per cent for a few years) at the outset of the crisis. However, a once-in-75-year crisis is precisely the time when central banks should expend some credibility to take the edge off public and private debts, and to accelerate the process bringing down the real price of housing and real estate.

It is therefore imperative for the central bankers to make it clear to the politicians that there is no solvency risk, and that central bankers, and not markets, are necessarily in control of the entire term structure of risk free rates, and that their research shows that rate hikes are not the appropriate way to bring down inflation, should the question arise’

Structural reform always has to be part of the mix. In the US, for example, the bipartisan blueprint of the Simpson-Bowles commission had some very promising ideas for simplifying the tax codes.

There is a scholarly debate about the risks of high debt. We remain confident in the prevailing view in this field that high debt is associated with lower growth

Add ‘but must add that the risk is that of misguided policy response, and not the level of debt per se.’

Certainly, lets not fall into the trap of concluding that todays high debts are a non-issue.

Add ‘as we must be ever mindful of the possibility of excess demand using up our productive capacity’

Keynes was not dismissive of debt. Why should we be?

The writers are professors at Harvard University. They have written further on carmenreinhart.com

Again, very well stated!

Thaler’s Corner

I must admit that I am at a loss for words these days. The analytical items at our disposal describe a situation so complex, given a myriad of contradictory influences, that I find it impossible to develop any sort of reasonable scenario.


I have spent a lot of time in recent weeks exchanging ideas and perceptions with academics, political officials and others in an effort to develop a coherent explanation of the events unfolding before us (Cyprus, wealth tax, etc.), but the conclusions are anything but conclusive!

Changes in financial securities will no longer be determined by purely economic factors but more and more by political decisions, such as whether or not to establish a real European banking union with all that implies in terms of cross-border budget transfer risks.

Whatever, lets take a look at the state of the real economy in the United Sates and Europe, given that it is still a bit early to draw any sort of conclusions about a third economic motor, Japan.

By the way, I strongly recommend that people check out the links in todays Macro Geeks Corner toward the end of the newsletter. It is interesting to see how two fairly divergent schools of thinking (the two first texts) end up with rather similar conclusions.

United States

In the United States, the economy is (logically) slowing as the effects of the Sequester slowly make themselves felt. Only the (increasingly discredited) partisans of Reinhold & Rogoffs constructive austerity thought it would not affect household consumption.

We had to wait for the hike in payroll taxes for the effect to be seen in retail sales figures, down 0.4% in March. Similarly, all the latest leading economic (PMI) and confidence indicators came in below expectations, which augurs for a soft patch in the US.

Moreover, the yens decline can only have a negative impact on America trade balance with Japan as it puts US exporters at a disadvantage, in particular, as they compete with their Japanese rivals on Asian markets. And the pitiful state of the European economy is not going to help this sector of the US economy either.

But there remains one bright spot, namely the residential real estate market, which should remain a powerful support in the quarters ahead. Check out one of my favorite graphs real animal rates.

Real animal rates in the US:

Full size image

These rates are calculated using a proprietary equation I developed, which includes, in addition to terms like mortgage interest rates, recent home price trends, the difference between the reported unemployment rate and that during periods of full employment, and the difference between the average length of unemployment and that existing in times of full employment.

With the Animal Spirits so dear to Keynes and behavioral science in mind, the goal was to factor in items more subjective than simple economic criteria (nominal borrowing rates) in the home purchase decision-making process of a household.

If experience has taught us anything, it is that the factors which most influence a potential homebuyers decision is his degree of job security and the feeling that prices can only rise.

The first point is that the only time these real animal rates dipped into negative territory (in the upper part of graph, transcribed in inverted scale) corresponds perfectly with the great real estate bubble of 1998 to 2006.

This big trend reversal occurred in 2006 when rates resurfaced above zero and thus below the graphs red line.

The only other time real animal rates became negative was in 1989, but that was abruptly reversed by the sharp hike in nominal interest rates.

In the current context, nominal interest rates are unlikely to undergo any such sharp hike in the quarters ahead, and this dip of real animal rates into negative territory should enable the real estate market to continue to recover. This all the more true, given that the yens decline will only strengthen disinflationary trends in North America, which ensure accommodative monetary policies for some time to come!

All you need to do is look at the steep decline in inflationary expectations, as expressed by the TIPS market in the US, to understand that investors seem to have finally realized that QE policies have nothing to do with the so-called dollar printing press. Notwithstanding the ZeroHedge paranoids!

That said, existing home sales in the US, out just a few minutes ago, came in weak, at -0.6% m-o-m (vs expected +0.4%, i.e. 4.92M vs 5M), which explains this afternoon shiver on stockmarket indices.

Now, as the IMF has said in recent days, the main brake on a worldwide recovery is the Eurozone, which remains paralyzed by the obsession of its northern member states on austerity and by the ECBs total and unforgivable incapacity to comply with its own mandate! In todays Macro Geeks Corner, you will find two instructive links on this matter.

Eurozone

Instead of harping on the endless stream of errors made by our beloved European monetary and governmental leaders, I prefer to comment on some far more instructive graphs.

Lets start with our graph on aggregate 2-year Eurozone government bond rates, which have proven to be so useful in recent years for evaluating the ECBs reaction function.

This rate, currently at a record low 0.55%, is now well below the 0.75% set for the refi. This stems from two factors.

First, in view of the state of the economy and the latest comments by certain ECB board members, investors expect that the refi rate will very soon (May or June) be cut to 0.50%.

Second, certainty that short-term interest rates, like the Eonia, which have been stuck between 5 bps and 12 bps for the past 9 months, are not going to rise anytime soon is pushing investors to seek yields wherever they can still find them, like in Spain and Italy where 2-year bonds still fetch between 1.95% and 1.25%, now that they are assured that, henceforth, in case of insolvency, bank depositors will be forced to pay the bill without pushing sovereign issuers into default, as happened in Greece!

Aggregated Eurozone government 2-year rate:

Full size image

However, we have reason to be concerned that the ECB, if it does lower the refi to 0.50%, will be satisfied with what it already deems a low rate and highly accommodative monetary policy. Such is far from being the case, even if we go by the ECBs own obsolete aggregates, like M3, as money velocity continues to skid to a halt, following Cyprus.

And all this has an impact on the real economy, as you can see in the following graphs.

Eurozone Industrial Production

Full size image

The least we can say is that this graph is particularly distressing. Of course, it does not account for the economys industrial aspect, which some call the old economy. But it provides a whole lot of jobs and no economic area can afford to neglect it.

And the impact of Mr Sarkozys renowned Walk of Canossa, following his summons by Ms Merkel in July 2011 to Berlin where the unfortunate decision to create the first sovereign default of a developed country was endorsed (Greek PSI), is very clear on this graph. Together with a hardening of austerity policies and the nefarious consequences of the ECBs hikes of benchmark interest rates in the spring of 2011, this decision torpedoed already distressed economies, with the consequences we all know today.


But if there is one depressing economic indicator, which reflects even more cruelly how austerity affected the Eurozone, it is surely the unemployment curve.

Eurozone Unemployment

Full size image

Here again, no comment is needed. I included earlier in this newsletter the graph comparing the US and Eurozone curves, but even that is no longer all that relevant. If people are happy to underperform the United States, who cares? If the Eurozone wants to try liquidationist economic policies to help drive home the morality message, it has every right to do so, just as its citizens merit the leadership they elect.

But to go from there to creating a situation of hysteria, leading to an increasingly large segment of the active population being ejected from the labor market, is a big step that must never be taken.

In some countries, the figures are just horrifying, with nearly 30% general unemployment and over 50% for those under 25 years of age. It is incredible that some continue to boast the merits of such policies for countries like Ireland while ignoring the daily siphoning of the population due to massive immigration to seek jobs elsewhere!!

I wonder if those responsible for such policies have forgotten the consequences of such an approach in Europe and the breakdown in the social fabric during the Great Depression, especially now, with so many leaders spicing their speeches with anti-German references?

This pathetic situation, reflecting month after month of economic policies based on no worthwhile or credible foundations, be it on a theoretical or empirical basis, explains why I am having a hard time re-establishing a decent pace of publication.

This is especially so in that the conflict between this depressive macro situation and the strong efforts undertaken by the Fed and the BoJ (among others) to reignite economic activity leave no space for laying out clear asset allocation biases.

We continue to enable our clients to take advantage of opportunities on option markets which make it possible during these troubled times to make bets on the cheap but without any real conviction.

Has our asset allocation strategy, dating from 2007 (a bit early, I know), of favoring government debt came to maturity with German 10-year rates at 1.23%, i.e. more than 30 bps below those of the United States?

Will European stock markets continue to suffer from our big fear, the Japanese syndrome? Or will popular pressure push the ECB and the Austrian School proponents to realize that they have a modern currency at their disposal and that reversing their entire intellectual edifice is possible?


Despite all my efforts, studies, reading and discussion, I am totally incapable of responding to these questions, which a great lesson in humility. Sorry for the consequences in terms of this newsletters clarity and frequency of publication, but if anyone has any ideas, I am all ears!

The Macro Geeks Corner:

Dear Northern Europeans Monetary easing is not a bailout

A factual rebuttal of remarks of ECB chief Jrg Asmussen, made at the Bank of America/Merrill Lynch Investor conference

Breaking bad inflation expectations

>   
>   (email exchange)
>   
>   Dijsselbloem made very clear that the shareholders, then the bondholders and then the
>   uninsured deposit holders are at risk when a bank gets into problems.
>   

Yes.

>   
>   Looks like eur / usd will go down until Draghi comes out and says that the ECB will do
>   whatever it takes to protect depositors. How do you see eur / usd now that this Cyprus
>   precedent is set and Dijsselbloem’s clear statements?
>   

Good question! Technically the euro goes down from portfolio shifts. But the euro also gains fundamental support from the coercive reduction of net financial assets.

The yield spreads adjust to discount the risk of confiscation, further supporting the German premium regarding member nation debt.

It would be the same with bank deposits but for the ECB’s lending to banks capping funding costs. So more deposits shift to German banks and ECB lending increases.

The Greek PSI was declared a one and only event but now the credibility of that and any other proclamation is gone.

‘Whatever it takes’ now clearly includes taxing bank deposits as well as bond holdings, and not to forget transactions taxes.

All for the further purpose of debt reduction, also known as the reduction of net financial assets of the non government sectors.

And worse.

The very promise of the euro has turned from harmony and growth to blood sweat and tears without end, and without further public purpose.

All begging the question:

‘So what’s the point?’

>   
>   On Monday evening there was a long interview with Dijsselbloem on Dutch TV after the
>   markets reacted so heavily in the afternoon after his remarks. He did not take one word
>   back. Indirectly his statements made very explicit that the deposit guarantee system in
>   the euro zone has its limits due to the limits of the member states that are not
>   monetarily sovereign anymore. When the interviewer asked him if the 100K limit is not
>   too high, He admitted that it is very high. He did not yet make the step that only a
>   guarantee from the ECB would be credible and able to cover 100% of deposits.
>   

Not good.

Proposals from earlier today:

ECB guarantees deposits for .25% annual fee
ECB takes over regulation, supervision, enforcement of banking regs etc.

This becomes the model for regulating all EU banks

I finally got a quick minute to add some color to the above proposals from earlier today.

With about 70 billion in assets, the banking system has negative capital of about only 2 billion, or about 3% of assets. And that no doubt includes markdowns on EU member nation debt that ‘goes away’ with the ECB ‘doing what it takes’ to sustain solvency.

With ECB deposit insurance the liquidity issue goes away, so the approx 10 billion in loans won’t be applicable, and ‘regulatory forebearance’ can then obviate the need for the rest of the proposed and highly controversal and problematic ‘rescue package.’

Additionally, the cost of funds goes down, so net interest margins widen to promote internal capital rebuilding.

ECB regulation will include ‘regulatory forebearance’ where the banks are allowed to operate with current levels of negative capital under strict ‘tarp like’ terms and conditions- no dividends, salary and bonus controls, credit quality criteria, etc. etc. and not to neglect thorough investigations into criminal activity and prosecution.

When capital ratios are brought into compliance with BASIL levels either through earnings and/or raising new equity the ECB can remove the ‘special requirements and restrictions’ imposed due to insufficient capital.

The ECB, like all central banks, will ultimately insure all bank deposits and also do the regulation. It’s already pretty much doing this indirectly. Cyprus is an opening to do it directly, and get the process down there first before expanding to the rest of the ECB’s member banks.

Karim writes:

Euro PMI (white) vs U.S. ISM Mfg (orange) and Services (yellow): link

The Crossroads Workshop

PDF: Presentation

Many have proposed negative interest rates as further ‘easing’ to help the economy.(too many, actually)

The proposed deposit tax in Cypress is functionally a one time negative interest rate. So maybe if they made it annual- just like the negative interest rates proposed elsewhere- it would help the economy?

So as previously discussed, I still see it in a spectrum. Positive rates are a govt subsidy and negative rates a tax. And so the Fed’s rate cuts and QE removed the prior subsidy, for example.

:(

As suspected the PSI/bond tax/deposit tax has become more attractive politically than other tax hikes and spending cuts. And it is also deflationary/contractionary, though less so than other taxes. And yes, it destabilizes the banking system in general.

After Negotiations, Cyprus Agrees to a Euro Zone Bailout Package

In the early hours of Saturday morning, after 10 hours of talks, finance ministers from euro area countries, the International Monetary Fund and the European Central Bank agreed on terms that include a one-time tax of 9.9 percent on Cypriot bank deposits of more than $130,000, or 100,000 euros, and a tax of 6.75 percent on smaller deposits, European Union officials said.

How stupid is this?
Unless they want to reduce funds available to distribution to the members?

Bundesbank Almost Doubles Risk Provisions on ECB Crisis Measures

By Jeff Black & Stefan Riecher

March 12 (Bloomberg) — Germany’s Bundesbank almost doubled its risk provisions in 2012, citing increased potential for losses stemming from the European Central Bank’s monetary policy.

The Frankfurt-based central bank increased provisions for general risks by 6.7 billion euros ($8.7 billion) to 14.4 billion euros, it said in an e-mailed statement today when releasing its 2012 annual report. Due to higher interest income, the Bundesbank’s profit rose to 664 million euros from 643 million euros in 2011. The increase in provisions stems from the ECB’s enhanced support of the financial sector over the course of the year, the Bundesbank said.

“The past year had seen an overall increase in counterparty credit risks stemming from refinancing loans and purchasing bonds,” Bundesbank President Jens Weidmann said in the statement.

The ECB injected more than 1 trillion euros into the banking system with two three-year refinancing loans designed to avoid a credit crunch. Some 22 percent of those loans have since been paid back as the ECB’s pledge to buy unlimited government bonds if certain conditions are met eased tensions on financial markets.

Weidmann reiterated in a foreword to the annual report that the Bundesbank is critical of some of the measures taken by the ECB because “they blur too much the responsibilities of monetary and fiscal policies.”

So how about just letting the ECB fund them all at 0%???

Transactions taxes reduce transactions by making them costly,
which is exactly what this one will do.

So if that’s the outcome they want they should go ahead and do it.

And if they want deficit reduction, well, if they were working for me I’d replace them.

But they’re not, so expect more of same.

French and Italian debt chiefs warn on EU Tobin Tax

By Ambrose Evans-Pritchard

March 6 (Telegraph) — Both France and Italy have been keen advocates of the new Financial Transaction Tax (FTT) proposed by Brussels last month, claiming that it will raise money and curb speculation. But they may have overlooked the unintended effect on their own borrowing costs.

Maya Atig, acting chief of French debt agency, said the European Commission’s internal documents acknowledge that the FTT could drain liquidity in the bond markets by 15pc, an effect that would push up yield spreads and raise debt costs.

Brussels estimates that the tax will raise €30bn to €35bn each year for the eleven EU states taking part, but Mrs Atig told a Euromoney conference in London that any revenue would offset “the extra costs that we might have to pay”.

She said the French government is searching for ways to ensure that the tax does not “perturb” the bond market. “This something still to be discussed.”

Maria Cannata, director of Italy’s debt agency, said her country already has a version of the Tobin Tax but has been careful to exempt sovereign debt, adding that policy-makers must bear in mindful the “importance of not damaging the government bond markets”.

The proposal – now in the hands of working groups – is to come into force in early 2014. It will raise a fee of 0.1pc for shares and bonds, and 0.01pc for derivatives.

These rates are far higher than the Swedish tax in 1989 that led to an 85pc crash in bond sales, a 98pc fall in bond futures, and shut-down of options trading, before the experiment was abandoned.

Gabriele Frediani, head of the electronic fixed income market MTS, said the tax would cause repurchase or Repo trades to plunge by 99pc. “The Repo market would disappear overnight,” he said.

The Repo market serves as a vast pawn shop allowing banks to raise funds on money markets by pledging assets. It is a key source of short-term finance for firms, but by its nature it involves fast turn-over.

Brussels said it had changed the text after listening to concerns. Repo trades will be treated as a single transaction instead of two, halving the tax. Short-term loans with collateral will be exempted.

It said the FTT will cover the secondary market for bonds only, insisting that good yield on long-term debt will “still leave enough room for profit after the tax is applied”.

Markus Beyrer, head of the pan-EU industry lobby BusinessEurope, said he was “very disappointed” by the draft text, calling it a threat to growth and jobs.

The text includes an “issuance principle”, meaning that the tax will cover bonds and other assets issued in the eleven countries taking part, even if they are traded in London. This may breach “extra-territoriality” codes.

The Chancellor, George Osborne, said the FTT scheme would amount to a tax on pensioners and cost up to 1m jobs across the EU “without costing bankers a penny”. The traders would migrate to the US or Asia, taking the financial industry with them.

EU Headlines:
Euro-Area Inflation Slowed More Than Estimated in February

With catastrophic unemployment prices are still rising. Seems a rethink of their model assumptions are in order.

ECB’s Constancio Says Barnier Plan Not Enough for Bank Failures

Right, the ECB must insure deposits and ensure liquidity and therefore do the regulation.

Europe Relying too Much on ECB, Fuest Tells Handelsblatt

No, not enough. The ECB, like all CB’s, directly or indirectly, ultimately/necessarily provides unlimited bank liquidity and supports member nation debt.

Euro-Area Unemployment Climbs to Record as Recession Deepens

And they all believe in deficit reduction, including Italy’s ‘anti establishment’ Grillo who’s merely proposed default (aka psi, bond tax) rather than other tax hikes and spending cuts.

German Retail Sales Post Biggest Monthly Jump in Six Years

From low levels for a nation presumably doing ‘very well’. It also highlights fact that any currency union requires some form of ‘fiscal transfers’ to sustain full employment. And unfortunately they don’t understand fiscal transfers for the production of public goods and services in fact imposes a real cost on the region with the high unemployment, and therefore hold back on doing it.

Italy Unemployment Rate Rises to Highest Since at Least 1992

The entire culture is being destroyed. It’s a slow motion train wreck. And all the proposals, including default, only add to the deflationary pressures, making it even worse. Call it a self inflicted crime against humanity.

I wonder if any of the early models had this much ‘inflation’ with this large of an output gap…

Euro-Area Inflation Rate Declined in January on Energy, Services

By Angeline Benoit

February 28 (Bloomberg) — The euro-area inflation rate fell in January, led by slower price growth for energy and services.

Annual consumer-price growth slowed to 2 percent from 2.2 percent in December, in line with an initial estimate on Feb. 1, the European Union’s statistics office in Luxembourg said today. In the month, prices fell 1 percent.

The European Central Bank will probably maintain its benchmark interest rate at 0.75 percent next week, according to a Bloomberg News survey of economists. The ECB will update its December economic forecasts after the euro area’s recession deepened in the fourth quarter. The European Commission sees inflation at 1.8 percent this year and 1.5 percent in 2014.

The annual core inflation rate, excluding volatile costs such as energy, alcohol and tobacco, fell to 1.3 percent in January from 1.5 percent a month earlier, today’s report showed. The cost of energy rose 3.9 percent after a 5.2 percent annual gain in December, while services-price growth slowed to 1.6 percent from 1.8 percent. Food, alcohol and tobacco costs rose 3.2 percent.

European Union car sales last month fell to the lowest level for a month of January since the data series began in 1990. Manufacturers in the region have announced 30,000 job cuts and five plant shutdowns since July, with Renault (RNO) and Peugeot outlining domestic workforce reductions of 17 percent.

The Grillo factor

Beppe Grillos Five Star Movement received over 25% of the vote exceeding all expectations. Though Berlusconi and Grillo are both populist and anti-austerity, in many ways, theyre also each others antithesis one representing the old sclerotic system, the other a new, impulsive anti-establishment future. Grillo is clearly a new breed in Italian politics. He has been very critical of Italys euro membership, and wants a referendum to decide whether the country should leave the single currency. Hes also suggested that Italy should consider refusing to pay back at least part of its huge public debt.

As previously discussed, the PSI has irresistible political appeal?

Negative rates are just a tax, of course. Pretty close to a PSI.

With deficits as high as they are, all they need to do is leave it all alone and a modest recovery will quickly materialize. But instead they keep pressing the austerity with a ‘we’ve paid the price to get this far- there’s no going back now’ mentality.

*ECB’S CONSTANCIO SAYS NEGATIVE INTEREST RATES ALWAYS POSSIBLE
*CONSTANCIO SAYS IMPACT OF NEGATIVE DEPOSIT RATE NOT CLEAR
*CONSTANCIO: ECB HAS LOOKED AT NEGATIVE RATES AT OTHER CENBANKS
*CONSTANCIO: ECB IS TECHNICALLY READY FOR NEG RATES IF NEEDED
*CONSTANCIO: ECB HASN’T MADE DECISION ON NEGATIVE DEPOSIT RATE

>   
>   but also – overlooked:
>   

*CONSTANCIO SAYS ECB LOOKS AY FX RATE FOR INFLATION OUTLOOK

>   
>   ECB will revise HICP path at the March meeting
>   

>   
>   (email exchange)
>   
>   On Thu, Feb 7, 2013 at 1:06 PM, wrote:
>   
>   There was an almost sensible article by Samuelson in the WP today. What caught my eye
>   was this comment that claims Japan failed at using Keynsian over the years. Can you
>   clarify this:
>   
>   Here is the comment:
>   

The problem is that economists have not recognized the failure of Keynsian economics. I think the uniform failure of deficit spending to promote growth has to be recognized.

They just didn’t run large enough deficits.

If the model worked, we would not be talking about Japan’s lost decade, or more accurately lost generation. Japan’s debt is now over 200 percent of GDP.

So?

Their growth rate in response to an ocean of deficits is uniformly poor.

Because they aren’t large enough to cover their savings desires.

The story is similar in Europe, particularly Southern Europe. There is no way Uncle Sam can continue to borrow 40 cents of every dollar spent.

Why not?

When governments get this far behind, they usually pay off the debt with hyper inflation.

Usually? hardly!

This never ends well. The usual outcome is social disintegration followed by dictatorship. For example, the hyper inflation of Weimar Germany after WWI lead to Hitler.

That was due to deficits of 50% of GDP to sell marks for fx and gold to pay war reparations. Any other examples???

The Federal Reserve’s constant quantitative easing in search of economic growth is going to lead to increasing inflation and interest rates.

Japan’s been doing it for over 20 years and still has no inflation and a strong currency.

They are buying 70 percent of the debt the Federal Governments incurs this month. Once Once interest rates go up, the deficits will balloon, 160 billion dollars a year for each percentage point.

So?

We have got to cut spending and stop the coming train wreck.

What train wreck? The train wreck is the current state of affairs from a deficit that’s too small.

Note that every move towards deficit reduction in Japan made things worse, and every supplementary budget made things better. they just haven’t ever done enough

>   
>   Its a typical RW comment, but what am I missing. How can you keep stating Japan did this
>   wrong for the other reason?
>   

It’s a policy designed to drive exports.
A form of protectionism.
It reduces consumption of imports to the extent domestic prices are helped by lower labor costs where domestic goods a compete directly with imports, which is probably limited.

And of course without further support of fx intervention (dollar and yen buying etc.) it makes the currency go up to the point where the effects are offset/no gains in employment, etc.

And if one nation does it the currency move hurts the others who don’t so it opens up a race to the bottom.

Recap:
It hurts low income consumers
It helps corporate profits
It supports the currency
And so those are the people that support it.
:(

Am I missing something?

Harvards Gopinath Helps France Beat Euro Straitjacket

By Rina Chandran

Feb 6 (Bloomberg) — When French President Francois Hollandeunveiled a plan in November for a business tax credit and higher sales taxes as a way to revive the economy, he was implementing an idea championed by economist Gita Gopinath.

Gopinath, 41, a professor at Harvard University in Cambridge, Massachusetts, has pushed for tax intervention as a way forward for euro-area countries that cannot devalue their exchange rates. Fiscal devaluation is helping France turn the corner during a period of extreme budget constraints, former Airbus SAS chief Louis Gallois said in a business- competitiveness report Hollande commissioned.

She advocated fiscal devaluation for Europes currency union in a 2011 paper she co-authored with her colleague Emmanuel Farhi and former student Oleg Itskhoki, an assistant professor at Princeton in New Jersey.

Despite discussions in policy circles, there is little formal analysis of the equivalence between fiscal devaluations and exchange-rate devaluations, they wrote. This paper is intended to bridge this gap.

The paper examines a remarkably simple alternative that doesnt require countries to abandon the euro and devalue their currencies, Gopinath said. By increasing value-added taxes while cutting payroll taxes, a government can create very similar effects on gross domestic product, consumption, employment and inflation.

The higher VAT raises the price of imported goods as foreign companies pay the levy. The lower payroll tax helps offset the extra sales tax for domestic companies, reducing the need for them to raise prices. Since exports are VAT exempt, the payroll-cost saving allows producers to sell goods cheaper overseas, simulating the effect of a weaker currency, according to the paper.

The policy also can help on the fiscal front, as increased competitiveness can lead to higher tax revenue, Gopinath said.

Hollande is seeking to revive Frances competitive edge by offering companies a 20 billion-euro ($27 billion) tax cut on some salaries as he attempts to turn around an economy that has barely grown in more than a year. He also will lift the two highest value-added tax rates. The plan was inspired partly by Gopinaths paper, said Harvard professorPhilippe Aghion, an informal campaign adviser to Hollande, who was elected president in May.

Aghion, who co-wrote a column in Le Monde newspaper last October advocating Gopinaths theory, said Gallois proposed to Hollande that its the right strategy for France. Gallois is slated to become a member of the board at automaker PSA Peugeot Citroen this year.

We contributed to the adoption of the policy by Hollande, and Gallois called to thank me, Aghion said in a telephone interview. There is wider interest in the policy. Italy, Spain, Greece — they should all be interested. Its an idea that would work.