Updated Budget Projections: Fiscal Years 2013 to 2023

Karim writes:

No more grand bargain talk?

Maybe, but this is still being said:

For the 20142023 period, deficits in CBOs baseline projections total $6.3 trillion. With such deficits, federal debt held by the public is projected to remain above 70 percent of GDPfar higher than the 39 percent average seen over the past four decades. (As recently as the end of 2007, federal debt equaled 36 percent of GDP.) Under current law, the debt is projected to decline from about 76 percent of GDP in 2014 to slightly below 71 percent in 2018 but then to start rising again; by 2023, if current laws remain in place, debt will equal 74 percent of GDP and continue to be on an upward path (see figure below).

And it all begs the question of whether the proactive tax hikes and spending cuts will through the credit accelerators into reverse, as nominal GDP growth continues to decelerate.

I sat next to Al Gore at dinner at Monty Friedkin’s house in Boca for 45 minutes in front of that election. Cliff was there as well. Al asked me how we should spend the $5.6 trillion surplus projected for the next 10 years. I told him there wasn’t going to be a $5.6 trillion surplus as that implied a reduction of that much of net global $US financial assets, to the penny. Instead, a $5.6 trillion deficit was more likely to bring deficit spending back in line with ‘savings desires’ which I also described. He’s a pretty good student, went through the numbers, and agreed with the logic. He then said something like ‘You know I can’t get up and say any of this’ as he got up and explained how he was going to spend the $5.6 trillion surplus.

Point is, the CBO makes assumptions about growth that don’t recognize that growth can be a function of fiscal balance.

In other words the tax hikes and spending cuts (aka ‘austerity’) initially cause the deficit to fall, but if the deficit is proactively brought down too much then undermines private sector credit expansion/spending causing sales/output/employment to slow sufficiently for the deficit to rise to where it ‘needs to be’ from suddenly falling revenues and rising transfer payments. As demonstrated by proactive fiscal tightening in the UK, Europe, and Japan, for example.

This is not to say the tax hikes and spending cuts in the US have crossed that line.
Nor is it to say they haven’t.
For me the jury is still out.

Today’s Tepper rally apparently was based on the idea that the ‘QE money has to be invested somewhere’ which is of course total nonsense.

(See if you can spot any sign of QE in the attached nominal GDP chart)

But it moved the market nonetheless.

You can see on the chart that year over year the growth in nominal GDP- actual dollars spent- slowed in Q1 2013 from Q4 2012, while ‘real’, price adjusted spending went up.

That is, dollars spent grew at a slower rate while the goods and services purchased grew at a higher rate, all because of year over year changes in prices.

And note that the rate of nominal growth seems to have been modestly decelerating for the last several years as well.

No sign of any ‘run away money printing’ here…
;)

Karim writes:

Lower commodity prices unequivocally positive for U.S. consumers.

Yes, agreed, lower prices in fact help consumers offset the lower rate of nominal income growth.

And yes, the Fed is concerned about the output gap which is real GDP.

And also price stability, as a secondary policy mandate…
;)

A number of people have inquired about this morning’s front page article in the WSJ by Jon Hilsenrath, “Fed Maps Exit from Stimulus.”

This seems constructed by Jon in a way that is very much reminiscent of the three-day inflation scare and talk of early exit he created last year. Note four points:

1. Jon does not have access to policy makers in the way the WSJ beat reporter once had. The days of Wessel and Ip are over. Bernanke was very reluctant to provide informal guidance to begin with, and the practice virtually ceased with the report of the Subcommittee on Communications at the beginning of last year. Essentially, they decided to speak authoritatively in FOMC statements and everyone was free to offer their own view in the public record after that, but not off camera.

2. The first two paragraphs are an extended, bloated, version of the single sentence in the statement that said “The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes.” Those paragraphs don’t say anything more than the Fed has a plan to do its job. This reminds me of the CNBC banner yesterday morning while Bernanke was giving his speech on financial stability. It said “BREAKING NEWS: THE FED IS MONITORING FINANCIAL STABILITY.” It would have been just as informative to run the banner “BREAKING NEWS: THE FED IS STILL IN BUSINESS.”

3. Note that the only two on-the-record, active voices are Charlie Plosser and Richard Fisher. Those two are probably last on the list of reliable co-conspirators for the core of the Committee that makes policy. But those quotes, plus the older Williams’ one, allows Jon to write “Fed officials” to make it sound like he has access to the second floor of the Board. It also lets him bring out the stale dealers survey.

4. Note the inconsistencies in the story. Fed officials want to put more volatility in the market by conveying that QE is a flexible, smoothly adjusting instrument. The problem is that this makes more sense if the effect of QE was on flows, not stocks, which they have studiously denied for four years. By the way, if those conspiring officials want to make clear it won’t be a slow, steady retreat of accommodation, than they better tell Janet Yellen to stop showing the optimal policy path. Good luck to that.

I believe the central message, which is what I have described in earlier notes: Fed officials want to put as much volatility as possible back into the market before starting to raise rates, provided financial conditions otherwise remain supportive to sustained expansion. They’ll take opportunities to do so on the back of an equity market rally. But Jon Hilsenrath is not the means they will do so.

Vincent

Karim writes:
RETAIL SALES

As previously discussed, financial placebos like QE do cause market participants to alter behavior out of either a misunderstanding of the actual fundamentals, or in anticipation of reactions by others presumed to be misinformed. And while the effects of these activities get reversed, however sometimes the effects are more lasting.

And there are also first order and second order effects. For example, a QE announcement could unleash misinformed fears about ‘money printing’ and ‘currency debasement’ and subsequent portfolio shifting that drives down the currency in the fx markets and drives up the price of gold. And the same misguided fears could cause bond yields to go higher in anticipation of a stronger/inflationary economy, even with the Fed buying bonds in an attempt to take yields lower.

So right now the QE/’monetary policy works if large enough’ placebo is at least partially driving things in both Japan and the US, and today’s announcement of the possibility of the ECB buying asset backed securities is now also at work.

And along the same lines but with a different ‘sign’ is the ideologically driven idea that cutting govt spending in the face of a large output gap- the sequester- is a plus for output and employment. Same for the year end tax hikes.

The underlying fundamental I don’t see discussed is whether private sector credit expansion can continue to sufficiently ‘overcome’ the declining govt deficit spending and satisfy the ‘savings desires’/demand leakages.

The main sources of private sector credit expansion are housing, student loans ($9 billion increase in March), and cars. Since 2009, the private sector credit expansion has managed to stay far enough ahead of the declining govt deficit, which has fallen from about 9% of GDP to about a rate of 6% of GDP by year end (mainly via the ‘automatic fiscal stabilizers’ of higher tax receipts and moderating transfer payments) resulting in about 2% real growth.

The question now is whether the private sector credit expansion can survive the 1.25% of GDP shock of the FICA tax hike and sequesters- which reduce support from the govt deficit to only maybe 4.5% of GDP- and still continue to sufficiently feed the (ever growing) demand leakages enough to generate positive GDP growth.

The stock market is often the best leading indicator of the macro economy, but it has ‘paused’ for two double dips that didn’t happen over the last few years, and it is subject to influence from placebos. Additionally, valuations change as implied discount rates change, and so in this case P/E’s shifting upwards may be discounting interest rates staying low for longer, due to an economy too weak to trigger Fed rate hikes, but strong enough to keep sales and earnings at least flat.

Placebo Surgery Shows Surprising Results

By Kate Melville

Research by Doctor Cynthia McRae of the University of Denver’s College of Education provides strong evidence for a significant mind-body connection among patients who participated in a Parkinson’s surgical trial.

Forty persons from the United States and Canada participated to determine the effectiveness of transplantation of human embryonic dopamine neurons into the brains of persons with advanced Parkinson’s disease. Twenty patients received the transplant while 20 more were randomly assigned to a sham surgery condition. Dr. McRae reports that the “placebo effect” was strong among the 30 patients who participated in the quality of life portion of the study.

“Those who thought they received the transplant at 12 months reported better quality of life than those who thought they received the sham surgery, regardless of which surgery they actually received,” says Dr. McRae. More importantly, objective ratings of neurological functioning by medical personnel showed a similar effect. In the report, appearing in the Archives of General Psychiatry, Dr. McRae writes “medical staff, who did not know which treatment each patient received, also reported more differences and changes at 12 months based on patients’ perceived treatment than on actual treatment.”

One patient reported that she had not been physically active for several years before surgery, but in the year following surgery she resumed hiking and ice skating. When the double blind was lifted, she was surprised to find that she had received the sham surgery.

Although patient perceptions influenced their test scores, when the total sample of patients was grouped by the actual operation they received, patients who had the actual transplant surgery showed improvement in movement while, on average, patients who had sham surgery did not.

Professor Dan Russell at Iowa State, the study’s co-author, says the findings have both scientific and practical implications. “This study is extremely important in regard to the placebo effect because we know of no placebo studies that have effectively maintained the double-blind for at least 12 months. The average length of placebo studies is eight weeks,” according to Russell. Dr. McRae notes that similar results related to the placebo effect have been found in other studies with patients with Parkinson’s disease. She says that there is a need for placebo controls in studies evaluating treatment for Parkinson’s as the placebo effect seems to be very strong in this disease. Dr. McRae also reports that although the sham surgery research design is somewhat controversial and has raised some ethical concerns, the results of this study show “the importance of a double-blind design to distinguish the actual and perceived values of a treatment intervention.”

Knee Surgery Proves No Better Than Placebo

By Katrina Woznicki

July 10, 2002 (UPI) — For individuals suffering from osteoarthritis in their knees, a common type of knee surgery has been found to be no more beneficial than a placebo, a new study revealed Wednesday.

Researchers at the Houston VA Medical Center and at Baylor College of Medicine came to this surprising conclusion after comparing various knee treatments to placebo surgery on 180 patients with knee pain.

The patients were randomly divided into three groups. One group underwent debridement, in which the damaged or loose cartilage is the knee is surgically removed by an arthroscope, a pencil-thin tube that allows doctors to see inside the knee. The second group received arthoscopic lavage, which flushes out the bad cartilage from the healthier tissue. A third group underwent a placebo surgery. They were sedated by medication while surgeons simulated arthroscopic surgery on their knees by making small incisions on the leg, but not removing any tissue.

During a two-year follow-up, researchers found no differences among the three groups. All patients reported improvement in their symptoms of pain and ability to use their knees. Throughout the two years, patients were unaware whether they had received the “real” or placebo surgery.

However, patients who received actual surgical treatments did not report less pain or better functioning of their knees compared to the placebo group. In fact, periodically during the follow-up, the placebo group reported a better outcome compared to the patients who underwent debridement.

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

During the last two post 2008 double dip scares I made the point that the 9% or so deficit was too large for that to happen, and instead recommended buying the dips.

This time the deficit has been proactively cut to maybe a less than a 5% of GDP annual rate, in which case I see a meaningful chance of negative GDP.

And one that is not being discounted by a market that’s remembering that the last two double dip scares didn’t materialize.

This is the current thinking, but the pieces don’t add up?
Hoping I’m being too negative here…

Comments below:

US consumers keep spending despite reduced pay

By Christopher S. Rugaber

April 29 (AP) — This year got off to a sour start for U.S. workers: Their pay, already gasping to keep pace with inflation, was suddenly shrunk by a Social Security tax increase.

Which raised a worrisome question: Would consumers stop spending and further slow the economy? Nope. Not yet, anyway.

On Friday, the government said consumers spent 3.2 percent more on an annual basis in the January-March quarter than in the previous quarter the biggest jump in two years. It highlighted a broader improvement in Americans’ financial health that is blunting the impact of the tax increase and raising hopes for more sustainable growth.

Yes, but the ‘slope’ has been negative, with March way down.

Consumers have shed debt. Gasoline has gotten cheaper. Rising home values and record stock prices have restored household wealth to its pre-recession high. And employers are steadily adding jobs, which means more people have money to spend.

Sort of. There have been new jobs, but often at lower pay, and the participation rate has continued to fall. Rising home values are from very low, foreclosure depressed levels, and reports show substantial negative equity remains. And it seems that while total household wealth may be back to the highs, the ’1%’ has benefited disproportionately.

“No one should write off the consumer simply because of the 2 percentage-point increase in payroll taxes,” says Bernard Baumohl, chief economist at the Economic Outlook Group. “Overall household finances are in the best shape in more than five years.”

Yes, better than 08 after the crash, but still marginal. Debt is down, but take home pay vs the cost of living isn’t doing all that well.

Certainly, spending weakened toward the end of the January-March quarter. Spending at retailers fell in March by 0.4 percent, the worst showing in nine months. And more spending on utilities accounted for up to one-fourth of the increase in consumer spending in the January-March quarter, according to JPMorgan Chase economist Michael Feroli, because of colder weather.

Higher spending on utilities isn’t a barometer of consumer confidence the way spending on household goods, such as new appliances or furniture, would be.

Right. Not good and the slope is negative.

Americans also saved less in the first quarter, lowering the savings rate to 2.6 percent from 3.9 percent in 2012. Economists say that was likely a temporary response to the higher Social Security tax, and most expect the savings rate to rise back to last year’s level. That could limit spending.

‘Saving less’ generally takes the form of ‘borrowing more’, in this case to pay utility bills and make up for the income lost to the tax hike, which is not sustainable.

But several longer-term trends are likely to push in the other direction, economists say, and help sustain consumer spending. Among those trends:

Wealth is up

Home prices rose more than 10 percent in the 12 months that ended in February. And both the Dow Jones industrial average and Standard & Poor’s 500 stock indexes reached record highs in the first quarter. As a result, Americans have recovered the $16 trillion in wealth that was wiped out by the Great Recession.

Again, skewed to the higher income groups who’s ‘consumer spending’ wasn’t all that sensitive to income in any case.

Economists estimate that each dollar of additional wealth adds roughly 3 cents to spending.

Or is it every 3 cents in spending adds a dollar of additional wealth?

That means last year’s $5.5 trillion run-up in wealth could spur about $165 billion in additional consumer spending this year. That’s much more than the $120 billion cost of the higher Social Security taxes.

Or the 120 billion tax hike will reduce wealth by $5.5 trillion from where it would have been otherwise?

‘The wealth’ has to ‘come from’ somewhere. In this case, so sustain spending, non govt debt would have to climb that much more just to make up for the tax hike. It’s possible, but working against that happening is the lower after tax income makes it harder to qualify for new debt, even if you wanted to.

Debt is down

Household debt now equals 102 percent of after-tax income, down from a peak of 126 percent in 2007. That’s almost back to its long-term trend, according to economists at Deutsche Bank.

And so why should it grow faster than the long term trend? The burst last time around was from the sub prime fraud. Before that the .com nonsense and the Y2K scare. Before that the expansion phase of the S&L fraud. And it won’t happen this time if we’re careful to not allow a credit expansion we’ll later regret…

And households are paying less interest on their debts, largely because of the Federal Reserve’s efforts to keep borrowing rates at record lows.

And earning less on their savings. Households are net savers.

The percentage of after-tax income that Americans spent on interest and debt payments dropped to 10.4 percent in the October-December quarter last year. That’s the lowest such figure in the 32 years that the Federal Reserve has tracked the data.

And personal income from interest has likewise dropped, and probably more so.

Jobs are up

Employers have added an average of 188,000 jobs a month in the past six months, up from 130,000 in the previous six. Job gains slowed in March to only 88,000.

Yes, negative slope again. And not even beginning to close the output gap.

But most economists expect at least a modest rebound in coming months. And layoffs sank to a record low in January. Fewer layoffs tend to make people feel more secure in their jobs and more willing to spend.

Gas prices are down

Gasoline prices have fallen in the past year and are likely to stay low. Nationwide, the average price of a gallon of gas has dropped 28 cents since this year’s peak of $3.79 on Feb. 27. Analysts expect gas to drop an additional 20 cents over the next two months. Each 10 cent drop over a full year translates into roughly $13 billion in savings for consumers.

Yes, that helps, except gas prices have been going back up most recently.

Loan costs are down

Lower interest rates have enabled millions of Americans to save money by refinancing their mortgages. Mortgage giant Freddie Mac estimates that in the fourth quarter of 2012, homeowners who refinanced cut their interest rate by one-third, the biggest reduction in 27 years the agency has tracked the data. On a $200,000 loan, that means $3,600 in savings over the next 12 months.

And savers are losing that much.

Some economists note that the Social Security tax cut didn’t spur much more spending when it first took effect at the start of 2011. The tax cut gave someone earning $50,000 about $1,000 more to spend each year. A household with two high-paid workers had up to $4,500 more.

Despite the tax cut, Baumohl notes that consumer spending rose only 2.5 percent in 2011 and 1.9 percent in 2012. In the 10 years before the recession began in December 2007, the average annual spending increase was 3.4 percent.

And a study by the Federal Reserve Bank of New York found that consumers spent only 36 percent of the increased income that resulted from the tax cut. The rest went to paying down debt or to savings.

Ok, so the question is whether with the tax hike they will cut spending or consume from borrowing and dipping into savings. Initially that’s what happened, but seems by March the increasing consumption had started to fade?

And the sequesters hadn’t even begun.

Since the tax cut didn’t boost spending that much, its expiration may not drag it down much, either. Economists say temporary tax cuts are often ineffective because many consumers assume that the tax breaks will eventually disappear. So they don’t ramp up spending in response.

As just discussed. It’s not necessarily symmetrical.

Scott Loehrke, 25, hasn’t cut back spending this year. Loehrke went ahead in March with some car repairs that could have been delayed. And he still plans to vacation in May in Mexico with his wife, Jackie.

The couple, who live just outside Cleveland, feel secure in their jobs. Loehrke is a salesman for a company that makes T-shirts, cups, key chains and other promotional products. Business has picked up in the past year as the economy has improved. His wife is a pharmacist.

“Everything that we’ve planned to do we’re still doing,” Loehrke says.

That proves their case!!!
:(

The Loehrkes both have heavy student debt and so are focused on keeping their expenses in check. They both drive used cars. That’s enabled them to build up some savings and made it easier to absorb the tax increase.

New threats have emerged. Across-the-board government spending cuts kicked in March 1. The spending cuts have triggered government furloughs and could lead private companies that do business with the government to cut staff. And the cuts are expected to shave a half-point from economic growth this year.

And that’s just the first order effect.

Even so, most economists are relieved that consumers have proved so resilient so far.

“It’s very encouraging that consumers and thus the broader economy have been able to weather that storm as well as they have,” says Mark Zandi, an economist at Moody’s Analytics.

‘The beatings will continue until morale improves’

This is my overall view of the economy.

The US was on the move by Q4 last year. A housing and cars (and student loans) driven expansion was happening, with slowing transfer payments and rising tax revenues bringing the deficit down as the automatic stabilizers were doing their countercyclical thing that would eventually reverse the growth. But that could take years. Look at it this way. Someone making 50,000 per year borrowed 150,000 to buy a house. The loan created the deposit that paid for the house. The seller of the house got that much new income, with a bit going to pay taxes and the rest there to be spent. Maybe a bit of furniture etc. was bought on credit as well, again adding income and (gross) financial assets to the recipients of the borrowers spending. And increasing sales added employment as well as output, albeit not enough to keep up with population growth etc.

I was very hopeful. Back in November, after the ‘Obama is a socialist’ sell off, I wrote that it was time to buy stocks and go play golf for three years, as, left alone, the credit accelerator in progress could go on for a long time.

But it wasn’t left along. Only a few weeks later the cliff drama began to intensify, with lots of fear of going over the ‘full cliff’. While that didn’t happen, we did go over about 1/3 cliff when both sides let the FICA reduction expire, thus removing some $170 billion from 2013, along with strong prospects of an $85 billion (annualized) sequester at quarter end. This moved me ‘to the sidelines’. Seemed to me taking that many dollars out of the economy was a serious enough negative for me to get out of the way.

But the Jan and then Feb numbers showed I was wrong, and that the consumer had continued to grow his spending as before via housing and cars, etc. Even the cliff constrained -.1 GDP of Q4 was soon revised up to .4. Stocks kept moving up and bonds moved higher in yield, even as the sequester kicked in, with the market view being the FICA hike fears were bogus and same for the sequester fears. Balancing the budget and getting the govt out of the way does indeed work to support the private sector. The UK, Eurozone, and Japan were exceptions. Austerity inherently does work. And markets were discounting all that, as it’s what market participants believed and the data supported.

Then, it all changed. April releases of March numbers showed not only suddenly weak March numbers, but Jan and Feb numbers revised lower as well. The slope of things post FICA hike went from positive to negative all at once. The FICA hike did seem to have an effect after all. And with the sequesters kicking in April 1, the prospects for Q2 were/are looking worse by the day.

My fear is that the FICA hikes and sequesters didn’t just take 1.5% of GDP ‘off the top’ as forecasters suggest, leaving future gains from the domestic credit expansion there to add to GDP as they had been. That is, the mainstream forecasts are saying when someone’s paycheck goes down by $100 per month from the FICA hike, or loses his job from the sequester, he slows his spending, but he still borrows to buy a car and/or a house as if nothing bad had happened, and so GDP is reduced by approximately the amount of the tax hikes and spending cuts, with a bit of adjustment for the ‘savings multipliers’. I say he may not borrow to buy the house or the car. Which both removes general spending and also slows the credit accelerator, shifting the always pro cyclical private sector from forward to reverse. And the ‘new’ negative data slopes have me concerned it’s already happening. Before the sequesters kicked in.

Looking at Japan, theory and evidence tells me the lesson is that lower interest rates require higher govt deficits for the same level of output and employment. More specifically, it looks to me like 0 rates may require 7-8% or even higher deficits for desired levels of output and employment vs maybe 3-4% deficits when the central bank sets rates at maybe 5% or so, etc. And US history could now be telling much the same.

And another lesson from Japan we should have learned long ago is that QE is a tax that does nothing good for output or employment and is, if anything, ‘deflationary’ via the same interest income channels we have here. Note that the $90 billion of profits the Fed turned over to the tsy would have been earned in the economy if the Fed hadn’t purchased any securities. So, as always in the past, watch for Japan’s QE to again ‘fail’ to add to output, employment, or inflation. However, their increased deficit spending, if and when it materialize, will support output, employment, and prices as it’s done in the past.

Oil and gasoline prices are down some, which is dollar friendly and consumer friendly, but only back to sort of ‘neutral’ levels from elevated ‘problematic’ levels And there is risk that the Saudis decide to cut price for long enough to put the kibosh on the likes of North Dakota’s and other higher priced crude, wiping out the value of that investment and ending the output and employment and currency support from those sources. No way to tell what they may be up to.

So my overall view is negative, with serious deflationary risks looming.

And the solution is still fiscal- a tax cut and/or spending increase.
However, that seems further away then ever, as the President is now moving towards an additional 1.8 trillion of deficit reduction.

:(

This plays to investors who think a drop in govt spending is good for the private sector as it ‘gets govt out of the way’ and ‘opens the door’ for that much more private sector growth in short order.

While this could be sort of but not necessarily true at full employment, it is of course not true in any case with with today’s excess capacity.

Seems they forget that today, cuts in govt spending immediately translate into cuts in private sector sales, which are the driver of private sector output and employment.

Yes, private sector credit expansion has (had?) begun to ‘kick in’, somewhat more than replacing the decline in govt deficit spending from the ‘automatic fiscal stabilizers’ of slowing transfer payments and rising revenues from higher incomes. The causation was from more ‘borrowing to spend’ in the economy to less deficit spending.

And that all can accelerate and continue for many years before, left alone, the deficit gets too small (and shrinking) to support the growing private sector credit expansion, as it all becomes unsustainable and implodes.

But at any point during that credit expansion, a pro active dose of govt deficit reduction can remove sufficient income to restrict the private sector’s credit expansion. People who may have borrowed to buy a house or a car, for example, suddenly losing their jobs and those purchases not happening, etc.

So the idea that 3% GDP is a ‘given’ due to private sector credit expansion and therefore a proactive tax hike and spending cut of maybe 1.25% of GDP will lower that to 1.75% growth misses that dynamic, as it presumes the proactive fiscal adjustments don’t throw a monkey wrench into the credit expansion dynamics. Like what’s been happening in the euro zone.

—– Original Message —–
At: Apr 26 2013 07:39:34

The miss was mostly a result of government declining, again. This is really the surprise. Trade was also a drag, but from a surprise perspective government is the winner. In all, gov subtracted a chunky 0.8ppts from the topline – meaning if you add it back Q1 would have printed 3.3%.

Having said that, this a rearview mirror report and what we already know about the handoff to Q2 is that it was weak. Indeed, we are looking for a rather paltry 1% outcome here in Q2.

Finally, in terms of today’s report, no underlying detail is inconsistent with our thinking about the handoff to Q2.

So some was gross, not net, and some unspent:

Nomura: Asia Insights: China: Why GDP growth has weakened despite strong credit growth

• Economic growth in China has weakened surprisingly despite rapid credit growth in H2 2012 and Q1 2013.
• We believe a large part of the new credit supply in Q1 did not go into the real economy. For example, at least 20% of urban construction bond issuance was used to pay off expiring bank loans.
• Recent policy signals suggest credit growth will slow in Q2. We reiterate our view that economic growth will slow in Q2, while the market consensus expects a rebound.

We had expected economic growth in China to rise in Q1 because of very strong credit growth, but GDP growth surprisingly slowed to 7.7% from 7.9% in Q4 2012, and economic activity in Q2 has started on a weak note. This is very different to what happened in 2009, when growth in total social financing picked up from 26.6% y-o-y in Q4 2008 to 114% in Q1 2009 and 121% in Q2 2009, growth in fixed asset investment moved up from 26.8% y-o-y in Q4 2008 to 28.6% in Q1 2009, the HSBC PMI rose to 44.8 from 40.9, and the new orders component in the HSBC PMI jumped to 43.6 from 36.1 (Figures 1, 2 and 3).

But in 2013 it is a very different story. Total social financing rose to an historical high and jumped by 160.6% y-o-y in January and by 58.2% y-o-y in Q1, but fixed asset investment (FAI) growth only picked up slightly to 21.2% y-o-y in January and February, and then slowed to 20.9% in March. GDP growth slowed to 7.7% y-o-y in Q1. The flash HSBC PMI weakened in April despite favorable seasonal factors it has only dropped once in April once during the past seven years. The new orders component of the flash HSBC PMI has dropped as well.

Many investors ask us the same question: where has all the money gone? We believe a large part of the new credit supply in Q1 did not go into the real economy. We do not have comprehensive information, but we provide the following two pieces of evidence. First, we collected public information on the 370 largest issues of urban construction debt that took place in 2012, and found that at least 20% of the money raised was used to repay debt (Figure 4). It is not surprising to us as many infrastructure investments projects are not yet profitable. Therefore, local government financing vehicles need to continue borrowing new funds for debt financing.

Another piece of evidence comes from a recent government policy announcement. According to a Chinese newspaper, First Financial Daily, the National Development and Reform Commission (NDRC) issued a policy notice at the end of March to ensure the funds raised for public housing construction in the bond market are not used for other purposes. We believe this policy may be triggered by cases where some funds were misused. Indeed, risks of such events have been mentioned repeatedly in government documents.

Why didnt money flow into the real economy? We think it is partly because the underlying demand for investment is weak. FAI growth for the manufacturing industry has been on a downward trend since 2011 and dropped sharply in Q1 2013 despite strong infrastructure FAI growth, which should have generated some positive spillover effects for manufacturers (Figure 5). The over-capacity problem in the manufacturing industry has been exacerbated by aggressive policy easing in 2009 and 2012.

We reiterate our view that economic growth will slow to 7.5% in Q2 as credit growth weakens (Figure 6). The consensus expects growth to recover to 8% in Q2, but recent policy signals suggest policy tightening has started and will adversely affect growth. In particular, the government has investigated several high profile corruption cases in the bond market in the past few days, and the Peoples Bank of China held a meeting on 24 April with commercial banks to clean up irregular activities in the bond market, according to a Chinese newspaper Economic Information. This initiative will likely lead to a slowdown in bond issuance and growth in total social financing in the coming months.

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Dear all,
I am amazed at how much media coverage since yesterday this study criticizing the Reinhart-Rogoff work is getting thanks largely, apparently, to the Roosevelt Institute research support which I think is great (see below)! Needless to say, I am convinced that there was hardly any error from some incompetent research assistant but that it was most likely an exercise in data mining and selective use of data series that are rampant and that practically all economists engage in … not to mention the causality issue in interpreting the statistical evidence to which many now are also referring.

What bothers me about this is to suggest that the rejection of austerity is predicated on the basis of faulty data series. We know that, regardless of the amount of empirical evidence that one has to disprove a theory, unless there is a coherent alternative that is espoused and around which political forces can coalesce, the theory will remain intact and the proponents of austerity will continue to spew their toxic ideas and implement their destructive measures worldwide. That is why Krugman and his disciples will not get very far with this, since they do not have a coherent alternative to some loanable funds theory. All of them subscribe to some notion of debt stability as being a constraint ultimately on public spending and thus on economic growth. Hence, instead of 90% debt/GDP ratio, they may find some other higher ratio, say, 150% and they will then have to say that Greece and Japan must now still implement austerity measures! The problem here is that they are stuck in a faulty and misleading paradigm that must eventually lead them to austerity. The only viable framework that is truly a paradigm shift is the broad circuitist cum MMT framework. Unless we can get that through to the media, all of this interesting debate over data series will not go anywhere …. much like the conclusions last year on the IMF fiscal multipliers being larger than originally assumed has hardly changed anything in preventing governments from continuing to apply austerity measures internationally.


But there is some hope because at least there is a shake-up in the profession! As Alain undoubtedly would say: Ce n’est qu’un dbut, continuons le combat!

All the best,
Mario Seccareccia

If true, this is very bad:

Researchers Finally Replicated Reinhart-Rogoff, and There Are Serious Problems.

By Mike Konczal

April 16 (Bloomberg) — In 2010, economists Carmen Reinhart and Kenneth Rogoff released a paper, “Growth in a Time of Debt.” Their “main result is that…median growth rates for countries with public debt over 90 percent of GDP are roughly one percent lower than otherwise; average (mean) growth rates are several percent lower.” Countries with debt-to-GDP ratios above 90 percent have a slightly negative average growth rate, in fact.

This has been one of the most cited stats in the public debate during the Great Recession. Paul Ryan’s Path to Prosperity budget states their study “found conclusive empirical evidence that [debt] exceeding 90 percent of the economy has a significant negative effect on economic growth.” The Washington Post editorial board takes it as an economic consensus view, stating that “debt-to-GDP could keep rising and stick dangerously near the 90 percent mark that economists regard as a threat to sustainable economic growth.”

Is it conclusive? One response has been to argue that the causation is backwards, or that slower growth leads to higher debt-to-GDP ratios. Josh Bivens and John Irons made this case at the Economic Policy Institute. But this assumes that the data is correct. From the beginning there have been complaints that Reinhart and Rogoff weren’t releasing the data for their results (e.g. Dean Baker). I knew of several people trying to replicate the results who were bumping into walls left and right – it couldn’t be done.

In a new paper, “Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff,” Thomas Herndon, Michael Ash, and Robert Pollin of the University of Massachusetts, Amherst successfully replicate the results. After trying to replicate the Reinhart-Rogoff results and failing, they reached out to Reinhart and Rogoff and they were willing to share their data spreadsheet. This allowed Herndon et al. to see how how Reinhart and Rogoff’s data was constructed.

They find that three main issues stand out. First, Reinhart and Rogoff selectively exclude years of high debt and average growth. Second, they use a debatable method to weight the countries. Third, there also appears to be a coding error that excludes high-debt and average-growth countries. All three bias in favor of their result, and without them you don’t get their controversial result. Let’s investigate further:

Selective Exclusions. Reinhart-Rogoff use 1946-2009 as their period, with the main difference among countries being their starting year. In their data set, there are 110 years of data available for countries that have a debt/GDP over 90 percent, but they only use 96 of those years. The paper didn’t disclose which years they excluded or why.

Herndon-Ash-Pollin find that they exclude Australia (1946-1950), New Zealand (1946-1949), and Canada (1946-1950). This has consequences, as these countries have high-debt and solid growth. Canada had debt-to-GDP over 90 percent during this period and 3 percent growth. New Zealand had a debt/GDP over 90 percent from 1946-1951. If you use the average growth rate across all those years it is 2.58 percent. If you only use the last year, as Reinhart-Rogoff does, it has a growth rate of -7.6 percent. That’s a big difference, especially considering how they weigh the countries.

Unconventional Weighting. Reinhart-Rogoff divides country years into debt-to-GDP buckets. They then take the average real growth for each country within the buckets. So the growth rate of the 19 years that England is above 90 percent debt-to-GDP are averaged into one number. These country numbers are then averaged, equally by country, to calculate the average real GDP growth weight.

In case that didn’t make sense let’s look at an example. England has 19 years (1946-1964) above 90 percent debt-to-GDP with an average 2.4 percent growth rate. New Zealand has one year in their sample above 90 percent debt-to-GDP with a growth rate of -7.6. These two numbers, 2.4 and -7.6 percent, are given equal weight in the final calculation, as they average the countries equally. Even though there are 19 times as many data points for England.

Now maybe you don’t want to give equal weighting to years (technical aside: Herndon-Ash-Pollin bring up serial correlation as a possibility). Perhaps you want to take episodes. But this weighting significantly reduces the average; if you weight by the number of years you find a higher growth rate above 90 percent. Reinhart-Rogoff don’t discuss this methodology, either the fact that they are weighing this way or the justification for it, in their paper.

Coding Error. As Herndon-Ash-Pollin puts it: “A coding error in the RR working spreadsheet entirely excludes five countries, Australia, Austria, Belgium, Canada, and Denmark, from the analysis. [Reinhart-Rogoff] averaged cells in lines 30 to 44 instead of lines 30 to 49…This spreadsheet error…is responsible for a -0.3 percentage-point error in RR’s published average real GDP growth in the highest public debt/GDP category.” Belgium, in particular, has 26 years with debt-to-GDP above 90 percent, with an average growth rate of 2.6 percent (though this is only counted as one total point due to the weighting above).

Being a bit of a doubting Thomas on this coding error, I wouldn’t believe unless I touched the digital Excel wound myself. One of the authors was able to show me that, and here it is. You can see the Excel blue-box for formulas missing some data:

This error is needed to get the results they published, and it would go a long way to explaining why it has been impossible for others to replicate these results. If this error turns out to be an actual mistake Reinhart-Rogoff made, well, all I can hope is that future historians note that one of the core empirical points providing the intellectual foundation for the global move to austerity in the early 2010s was based on someone accidentally not updating a row formula in Excel.

So what do Herndon-Ash-Pollin conclude? They find “the average real GDP growth rate for countries carrying a public debt-to-GDP ratio of over 90 percent is actually 2.2 percent, not -0.1 percent as [Reinhart-Rogoff claim].” Going further into the data, they are unable to find a breakpoint where growth falls quickly and significantly.

This is also good evidence for why you should release your data online, so it can be probably vetted. But beyond that, looking through the data and how much it can collapse because of this or that assumption, it becomes quite clear that there’s no magic number out there. The debt needs to be thought of as a response to the contigent circumstances we find ourselves in, with mass unemployment, a Federal Reserve desperately trying to gain traction at the zero lower bound, and a gap between what we could be producing and what we are. The past guides us, but so far it has failed to provide an emergency cliff. In fact, it tells us that a larger deficit right now would help us greatly.

Schauble on U.S. Anti-Austerity Push:

Nobody in Europe sees this contradiction between fiscal policy consolidation and growth, said Mr. Schuble. We have a growth-friendly process of consolidation.

A while back I’d written about how the global economy had become leveraged to net exports to the US, which has turned out to be the case. And now with US imports of crude and products falling, another leg of this process seems to be underway, and in a world where no one runs high enough deficits to sustain domestic demand at reasonable levels.

A rough guess is 15x leverage? A US trade deficit of $500 billion is sustaining about $7.5 trillion in global ‘equity value’? More?

Karim writes:

It looks like the inventory rebuild has peaked,

Agreed, pay back from Q4 caution might have masked underlying weakness from tightening fiscal which intensifies some into Q2 as sequesters kick in, driving the deficit down to maybe 5% of GDP. The lesson of Japan may be that with 0 rates and QE, 5% might not be enough for anything more than stagnation.

but demand related indicators (employment, exports, imports) holding up.
The employment index is now at a 9mth high.

Karim writes:

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

The usual excellent post!

Positive Currency Wars!

19 February 2013


Financial markets are today being buffeted about by a slew of highly complex and changing influences. As readers may recall, at end-January (Thaler’s Corner 31/01: Too Cloudy), we advised people to favor Risk Off positions (references 2725 Euro Stoxx and 141.85 Bund), but this morning we returned to a neutralization of asset allocation biases (references 2635 and 142.85).

Not only do European markets seem to have lagged too far behind their American and Japanese peers, but, above all, I consider the current jitters about currency wars to be completely off the wall!

That said, there are still dark clouds hovering over Europe, mainly the eurozone, which is why we have yet to join the clan of the optimists.

Let us examine the macroeconomic situation area-by-area.

United States

The Fed is pursuing its easy money policies, the target QE, and I do not see them ending these policies any time soon. Despite the prevailing conventional wisdom, these policies are not boosting inflation at all, quite the contrary!

By continuously removing treasuries and MBS from the private sector via its QE asset-purchasing program and by replacing them with base money reserves, the Fed is in reality absorbing the interest that the private sector would have received on these bonds, as base money does not pay a coupon! The best illustration of the absorption carried out by the government is the amount of profits earned and transferred to the Treasury, a total of €335 billion since 2009!

This QE program functions like a tax, or more specifically, a savings tax somewhat like the French ISF or wealth tax (except that it is not at all progressive). It is nonetheless “progressive” in that it has helped the federal government, among others.

The 0% interest rate policy is certainly supposed to help reignite the American economy by making its easier for investment projects to achieve profitability, but at a time when the private sector feels overloaded with debt (deleveraging), its “inflationist” aspect is limited to the value of financial assets.

As long as US government budget policy remains frankly expansionist, with cumulative deficits totaling over $5 trillion since 2009, this deflationist aspect of the QE has little importance. However, not only have US budget deficits been trending downwards since 2009 (at a record high of $1.415 trillion), falling from 10.4% to 6.7% of GDP, but the latest budget measures raise concerns that the trend will accelerate.

In the first place, the hike in the payroll tax has had a direct impact on the American consumer. This 2% decrease in take-home income, for which employees were hardly prepared, led Wal-Mart Vice President Jerry Murray to declare February sales figures to be a “total disaster”:

“In case you haven’t seen a sales report these days, February MTD (month-to-date) sales are a total disaster. The worst start to a month I have seen in my seven years with the company. Where are all the customers? And where’s their money?”

Moreover, if sequester negotiations between Congress and the White House do not lead to a deal by the beginning of March, the ensuing decline in spending would represent about 1% of GDP and thus a new tightening of budget policy.

In contrast, the real estate market continues to give encouraging signs of a rebound. I will provide you the stats fresh February 22nd publication date.

The yen’s decline (currency wars) is a positive factor, which I will examine in the conclusion.

Europe

The eurozone is the world’s weakest economic zone, with the economic outlook as desperate as ever. The zone is suffering from an unfortunate mix of pro-cyclical budgetary policies and monetary policy, which refuses to use all the means available to counter recessive austerity.

Aside from their crazy devotion to Ricardian theories, supporters of “expansionist austerity” do not seem to take into account that the rare examples of such policies being successful are with very open small economies who, boasting their own currency, devalue their money and cut interest rates while defaulting on or restructuring foreign debt!

As for the distressed eurozone countries, which mainly trade with their neighbors, they not only lack their own currency and thus the possibility of devaluation, but also, in addition, suffer from a euro that remains high compared to the currencies of its trading partners!

And that’s leaving aside monetary policy and how its non-transmission to peripheral countries is making their economies even worse.

In addition, there are the problems specific to the zone, as exemplified by the Cypriot turmoil, the Italian elections, the protest movements in Spain and Portugal and the painful establishment of a common banking solution, etc.

But a ray of hope may be on the horizon, with the restructuring plan of the Promissory Notes just established by Ireland. Without going into the highly technical details, you can believe me when I say that this is the closest thing to fiscal financing ever carried out by a central bank on the eurozone or even in a developed country!

Quite simply, the Irish state has issued very long-term bonds, at very low interest rates, directly into the capital of the restructured bank, which then refinances it with the Irish central bank. The state thus skirts appealing to markets; this is monetary financing, albeit indirectly so. In any case, it would have had a hard time raising capital on such good terms with the public.

And Mario Draghi’s apparent nod to this operation, limiting himself to stating the ECB board had unanimous taken note of the deal, augurs well! We will not be surprized to hear the screams of alarm from Mr Weidmann and the Bundesbank, but they seem to have definitely lost control.

In short, while the euro’s rise is a drag on European exporters in the short term, reflecting more far more restrictive monetary and budgetary policies than those of our trading partners, this is also a case of the tree hiding the forest, as I will explain in the case of the Land of the Rising Sun.

Japan

This is where things are really going to play out!

The latest comments by Japanese government officials suggest that the next BoJ President will not only be a lot more dovish than his predecessors but that he will also work much more closely with the government.

Such coordination is absolutely necessary in times of deflation when the country has been faced with 0 Lower Bound for so many years. Check out the excellent paper written by Paul McCulley and Zoltan Pozsar on this topic in MG.

If a country in the midst of severe deflation/recession, like Japan, whose trade balance has deteriorated so abruptly since 2011, does not have the right to use all the tools at its disposal to pull itself out of this quagmire, who does?

I would farther than the prevailing discourse, with its focus on Japanese-style quantitative easing, and say flat out that the country should electronically print money!

Screams of a Weimer situation aside, such an approach would technically change little, since it would amount to injecting the budget deficit into the economy in the form of Monetary Financing instead of JGBs (Bonds Financing), which are nearly identical to cash (floor rate and possibility of going through the repo market).

In contrast, one thing is for sure: the fears generated by such an announcement would be enough to send the yen back to 110 vis-à-vis the dollar, which is in no way catastrophic. Bear in mind that this parity averaged 118.40 between the two shocks of 1987 and 2008!

These jitters would also fuel inflationist expectations, which is precisely the goal of a country in which the latest statistics show the economy stuck in deflation.

But the main reason I say that such a monetary and budgetary turnabout by Japan would be good for the rest of the world is that one of its main goals is to reignite domestic consumption, a natural corollary of easier monetary conditions and higher inflationist expectations.

And that would also benefit its foreign trading partners!

We are not witnessing so much a race to competitive devaluation (currency wars) as a race to more accommodative monetary policies, under the impulsion of the Fed and the BoJ, not to mention the BoE and the SNB, among others.

And all this will end up influencing the ECB, which, if it does not change its policies, will end up with a euro climbing toward 140 against the yen and 1.45 against the dollar. Let’s not forget that in 2007-2008, the euro was trading at 170 against the yen and 1.60 against the dollar, mainly due to the ECB’s intransigence, with the results we all know.

As Mr Draghi has declared that he will take the euro’s level into consideration, not as a target, but as a variable in monetary policy, we can only hope that it will continue to appreciate and thus force our central banks to carry out its own Copernican revolution and enter into concertation with the world’s central banks managing modern currencies.

In conclusion, thanks to these monetary hopes stemming from the Japanese initiatives, I have decided to put between parentheses the still heavy clouds, cited above, and advise clients this morning to abandon the Risk Off bias to capture profits offered by the last market shifts and to, at minimum, put ourselves in a position of maximum reactivity.

Very informative set of charts, particularly in regard to fiscal drag

GS Economic Outlook

Skipping the pros and focusing on the cons regarding the economy:

1. 0 rates (including QE) continue to be a highly deflationary bias that require deficits to be that much higher.

2. The FICA hike’s a serious setback that reduces growth from 3 or 4% to 1.5 or 2.5% or less.

3. Corporate cash building, foreign dollar accumulation, pension fund rebuilding, etc. are demand leakages

4. Past expansions were fueled by things we won’t do again- sub prime fraud, tech/y2k bubble, S&L expansion leg, emerging market fx debt fueled bubble, etc.- and that Japan has been careful to avoid.

5. Global austerity, where, in general, everyone of consequence thinks the problem is deficits are too large when in fact they are far too small for current credit conditions.

The January ‘bounce back’ from avoiding the cliff, debt ceiling delay, ideologues angry at the election results, etc. and the head fakes from the accelerated dividends and bonuses in Dec, seasonal issues with claims, the strong euro, some relatively modest China strength, and a few other things, is all fading fast.