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

And a rate cut only makes it worse, as per the interest income channels:

Germany’s Ifo Drops in April, Raising Odds of ECB Cut

April 24 (Bloomberg) — Germany’s Ifo index dropped in April, in a further sign that Europe’s largest economy is slowing.

The business climate reading came in at 104.4 down from 106.7 in March and expectations of 106.2.

The weak data follows Tuesday’s weaker-than-expected purchasing managers index (PMI) data.

That sparked speculation that the European Central Bank will cut interest rates at its meeting next week on Thursday.

European shares shrugged off the weak Ifo reading, in a sign the market is cheering a possible ECB rate cut.

The euro fell against the dollar after the Ifo data was released.

>   
>   (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.

Warning- a weakening economy will make their deficit go up!
;)

German Manufacturing Output Surprisingly Contracted in March

By Zoe Schneeweiss

March 21 (Bloomberg) — A German index based on a survey of purchasing managers in the manufacturing industry declined to 48.9 this month from 50.3 in February, while a services gauge fell to 51.6 from 54.7, London-based Markit Economics said in an e-mailed report today. A reading below 50 indicates contraction. Economists had forecast a reading of 50.5 for the manufacturing index and 55.0 for the services gauge, according to the median estimates in Bloomberg News surveys.

Just to make double sure unemployment won’t go down?

Germany Defies Calls for Stimulus

Not a good sign.

German Car Sales Risk Fall Below 3m, Bloomberg Industries Says

March 6 (Bloomberg) — German Jan.-Feb. new car registrations, already 9.6% lower ytd, may plunge below 3m this year for only second time since 1990, says Bloomberg Industries analyst Kevin Tynan.

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.

*MERKEL SAYS EUROPE HAS TO LEARN TO ONLY SPEND WHAT IT TAKES IN
*MERKEL SAYS TOO MANY IN EUROPE HAVE LIVED BEYYOND THEIR MEANS
*MERKEL SAYS EU MUST ENSURE THAT IT FIRST EARNS WHAT IT SPENDS
*MERKEL SAYS `DEBT MEANS DEPENDENCY’

As previously suggested, any sign of stabilization will be twisted into ‘austerity works’ rhetoric.

Yes, austerity has pushed deficits up the ugly way- higher unemployment comp and lower tax payments due to the slowing economy- to the point where the deficits gravitate to levels high enough for euro zone GDP to stabilize and even begin to grow a bit. (Presuming they don’t beat it down again with more austerity, which could very well be the case.)

For whatever reason they can’t seem to grasp the notion that it’s the deficits that support growth, as they fill in the ‘spending gap’ caused by taxes and ‘savings desires’ and that they could use deficits proactively to achieve growth from any starting point short of full employment.

German Economic Model Vindicated by GDP Data

By Catherine Boyle

August 14 (CNBC) — Germany’s reputation as the healthy man of Europe has been reinforced by better-than-expected growth in gross domestic product (GDP – click here for an explanation) for the second quarter, as growth contracted in the broader euro zone.

On Tuesday morning, euro zone GDP data for the second quarter shrank by 0.2 percent, as predicted by analysts polled by Reuters.

Germany, Europe’s biggest economy grew by 0.3 percent between April and July – not a huge leap, but better than most of the euro[EUR=X 1.2349 0.0018 (+0.15%) ] zone – as its export strength continued.

“Germany shows to some degree the way forward to other countries,” Daniel Morris, global strategist at JP Morgan Asset Management, told CNBC Europe’s ” Squawk Box” Tuesday.

“Germany’s point is if you run a low budget deficit you can still have economic growth. You can’t depend so much on government spending, fundamentally it has to be about the competitiveness of the economy, and Germany’s shown that.”

More hints from europe that deficits may be high enough to support a bit of GDP growth?

Euro-Region Construction Output Advanced in May, Led by Germany

By Simone Meier

July 18 (Bloomberg) — Euro-area construction output rose in May, as gains in Germany and Portugal offset declining production in Italy, Spain and the Netherlands.

Construction in the 17-nation euro area advanced 0.1 percent from April, when it dropped 3.7 percent, the European Union’s statistics office in Luxembourg said today. From a year earlier, construction output declined 8.4 percent.

In Germany, Europe’s biggest economy, construction output increased 3.1 percent from April, when it fell 5.5 percent, today’s report showed. Portugal and France reported increases of 3.6 percent and 0.4 percent, respectively. In Italy, output fell 1.4 percent from the previous month, when it dropped 4.3 percent. Spanish output slumped 3.3 percent after a 3 percent drop in April, and the Netherlands had a decline of 0.7 percent.

In the 27-nation EU, output rose 1.6 percent from April, when it fell 6.9 percent. Ireland and Greece are not required to provide monthly data on construction output.

U.K. Unemployment Rate Hits 9-Month Low, Defying Recession

By Scott Hamilton

July 18 (Bloomberg) — U.K. unemployment fell to a nine- month low in the quarter through May. Unemployment based on International Labour Organization methods fell to 8.1 percent of the workforce from 8.2 percent in the period through April. Jobless-benefit claims rose 6,100 in June. The number of people in work climbed 181,000 to 29.4 million with full- time work accounting for most of the increase. London gained 61,000, partly reflecting hiring for the Olympic Games that open on July 27. The claimant-count rate was 4.9 percent. Claims rose 6,900 in May instead of the 8,100 rise initially reported. June was affected by a rule change that forced more lone parents to claim Jobseeker’s Allowance.

More possible hints that deficits may be large enough to support stability

A little better than expected:

Euro-Area Manufacturing Contracted for 11th Month in June

By Mark Deen

July 2 (Bloomberg) — Euro-area manufacturing output contracted for an 11th straight month in June as Europe’s debt crisis sapped demand across the continent.

A gauge of euro-region manufacturing held at 45.1 in May, London-based Markit Economics said today in a final estimate. That compares with an initial estimate of 44.8 on June 21. A reading below 50 indicates contraction.

A little better than expected:

Italian May Unemployment Rate Declines for First Time in a Year

By Chiara Vasarri

July 2 (Bloomberg) — Italy’s jobless rate unexpectedly fell from a 12-year high in May, the first decline in more than a year.

The unemployment rate decreased to a seasonally-adjusted 10.1 percent, from 10.2 percent in April, Rome-based national statistics office Istat said in a preliminary report today. It was the first decline in the jobless rate since February of last year. Economists forecast an increase to 10.3 percent, the median of eight estimates in a Bloomberg News survey showed.

Joblessness among people aged 15 to 24 rose to 36.2 percent, from 35.3 percent, Istat said.

Better than expected improvement here:

U.K. CIPS Manufacturing Shrank for Second Month in June

By Jennifer Ryan

July 2 (Bloomberg) — U.K. manufacturing shrank for a second month in June as demand “remained weak,” Markit Economics said.

A gauge of factory output was at 48.6 from 45.9 in May, Markit said on its website today. The median estimate in a Bloomberg News survey of 25 economists was 46.5. A reading below 50 indicates contraction.

Some ok Swiss news as well.

Also, sufficient progress at the EU level to give the ECB cover to write checks as needed to get from here to any of the prospective EU measures.

This includes taking forever to get from here to there.

They all seem to understand that the ECB is at least one answer to the solvency issue, and seem to be willing to allow the ECB to provide bank liquidity while they try to finalize an alternative solution. Indirectly that means, at least for now, the member governments will be able to make their payments for the immediate future.

So as previously discussed, they solved the solvency issue, and markets have responded, which leaves them with a bad economy to focus on.

With deficits now perhaps large enough for stability, and maybe a bit of modest GDP growth, I’d at best expect a ‘wait and see’ attitude from an EU that has found it highly problematic to act even in an emergency.

Getting there as previously discussed:

Germany signals shift on 2.3 trillion redemption fund for Europoe

By Ambrose Evans-Pritchard

June 13 (Telegraph) — The German government has begun opening the door to shared debts for the first time in a profound change of policy, agreeing to explore proposals for a €2.3 trillion (£1.9 trillion) stabilization fund in order to stop the eurozone’s crisis escalating out of control.

Mr Merkel rejected the Redemption Pact last November as “totally impossible”, even though it was drafted by Germany’s Council of Economic Experts or Five Wise Men and is widely-viewed as the only viable route out of the current impasse. Photo: Alamy

Officials in Berlin say privately that Chancellor Angela Merkel is willing to drop her vehement opposition to plans for a “European Redemption Pact”, a “sinking fund” that would pay down excess sovereign debt in the eurozone.

“It is conceivable so long as there is proper supervision of tax revenues,” said a source in the Chancellor’s office. The official warned that there would be no “master plan” or major break-through at the EU summit later this month.

Mr Merkel rejected the Redemption Pact last November as “totally impossible”, even though it was drafted by Germany’s Council of Economic Experts or Five Wise Men and is widely-viewed as the only viable route out of the current impasse.

Fast-moving events may have forced her hand. She is under immense pressure from the US, China, Britain, and Latin Europe to change course as the crisis engulfs Spain and Italy, threatening a global cataclysm.

US economy muddling through, growing modestly, particularly given the output gap, but growing nonetheless.

Lower crude prices should also help some.

I had guessed the Saudis would hold prices at the $120 Brent level, given their output of just over 10 million bpd showed strong demand
and their capacity to increase to their stated 12.5 million bpd capacity remains suspect. And so with the Seaway pipeline now open (last I heard)
to take crude from Cushing to Brent priced markets I’d guessed WTI would trade up to Brent.

But what has happened is the Saudi oil minister started making noises about lower prices and when ‘market prices’ started selling off the Saudis ‘followed’ by lowering their posted prices, sustaining the myth that they are ‘price takers’ when in reality they are price setters.

So to date, contrary to my prior guess, both wti and brent have sold off quite a bit, and cheaper imported crude is a plus for the US economy. Which is also a plus for the $US, as a lower import bill makes $US ‘harder to get’ for foreigners.

But the trade for quite a while has been strong dollar = weak US stocks due to export pricing/foreign earnings translations, and also because US stocks have weakened on signs of euro zone stress, which has been associated with a weaker euro. So when things seem to be looking up for the euro zone, the euro tends to go up vs the dollar, with US stocks doing better with any sign of ‘improvement’ in the euro zone.

It’s all a tangled case of cross currents, which makes forecasting anything particularly difficult.

Not to mention possible dislocations from the whale, which may or may not have run their course, etc.

And then there’s the news from Greece.

First, they made a full bond payment yesterday of nearly 500 million euro to bond holders who did not accept the PSI discounts. This is confounding for the obvious reasons, signals it sends, moral hazard, credibility, etc. etc. But it’s also a sign the politicians are doing what they think it takes to keep the euro going as the currency of the euro zone. Same goes for the decision to fund Greece as per prior agreements even when there is no Greek govt to talk to, and lots of signs any new govt may not honor the arrangements.

Even if that means tricking private investors out of 100 billion, rewarding those who defy them, whatever. Tactics may be continuously reaching new lows but all for the end of keeping the euro as the single currency.

It also means that while, for example, 10 year Spanish yields may go up or down, the intention is for Spain, one way or another, to fund itself, even if short term. Doesn’t matter.

And more EFSF type discussions. The plan may be to start using those types of funds as needed, keeping the ECB out of it for that much longer, regardless of where longer term bonds happen to trade.

As for the euro zone economy, yes, growth is probably negative, but if they hold off on further fiscal adjustments, the 6%+ deficit they currently are running for the region is probably, at this point, enough to muddle through around the 0 growth neighborhood. The upside isn’t much from there, as with limited private sector credit growth opportunities, and substantial net export growth unlikely, and strong ‘automatic stabilizers’ any growth could be limited by those automatic fiscal stabilizers. Not to mention that this type of optimistic scenario likely strengthens the euro and keeps a lid on net exports as well.

And sad that this ‘bullish scenario’ for the euro zone means their massive output gap doesn’t even begin to close any time soon.

For the US, this bullish scenario has similar limitations, but not quite as severe, so the output gap could start to narrow some and employment as a percentage of the population begin to improve. But only modestly.

The US fiscal cliff is for real, but still far enough away to not be a day to day factor. And it at least does show that fiscal policy does work, at least according to every known forecaster with any credibility, which might open the door to proactive fiscal? Note the increasing chatter about how deficits don’t seem to drive up interest rates? And the increasing chatter about how the US, Japan, UK, etc. aren’t like the euro zone members with regards to interest rates?

Same in the euro zone, where discussion is now common regarding how austerity doesn’t work to grow their economies, with the reason to maintain it now down to the need to restore solvency. This is beginning to mean that if they solved the solvency riddle some other way they might back off on the austerity. And now there is a political imperative to do just that, so things could move in that direction, meaning ECB support for member nation funding, directly or indirectly, which removes the ‘ponzi’ aspect.

In case you didn’t think there’s political support for austerity.

Lemming economics firmly in place.

German Majority Ready to Help Pay Down State’s Debts, Poll Shows

By Alan Crawford

May 3 (Bloomberg) — A majority of German voters said they are prepared to help the state pay down its debt, according to a poll that provides backing for Chancellor Angela Merkel’s stance during the financial crisis.

Fifty-nine percent of respondents said they were ready to accept personal sacrifices so that the federal government, the states and municipalities didn’t have to take out new debts, the TNS Emnid poll for the Berlin-based Initiative for a New Social Market Economy showed today. Voter magnanimity didn’t extend to accepting tax increases.

Ninety percent said it was important that the three levels of government are prevented from piling up more debt, with 55 percent saying it was “very important.” More than half the respondents said they would probably or almost certainly vote for a party that advocates savings, even if it meant having a personal impact. Twenty-three percent said they probably wouldn’t vote for a party with such a platform and 16 percent said definitely not.

The results underscore the domestic backing for Merkel’s insistence that deficits must be addressed to get at the core cause of Europe’s sovereign debt crisis even as international calls grow for her to shift away from austerity. The poll results “are a clear message to politicians,” said Hubertus Pellengahr, head of the INSM.

“Whoever seriously sets about tackling the problem of new debt knows they’ll have the majority of voters behind them,” Pellengahr said in an e-mailed release.

Even so, 72 percent of respondents said tax increases were unacceptable to resolve state debts, the poll found. Eighty percent of voters said any cuts needed to reduce debt should focus on administration and 65 percent said subsidies should be targeted. Thirty-one percent identified cultural spending, 27 percent social benefits, 25 percent infrastructure and 12 percent education and research.

TNS Emnid said it surveyed 1,002 voters in April. No margin of error was given.

Typical day for euro zone news.
Slow motion train wreck continues.

Headlines:

EU Finance Ministers to Face Off Over Rules to Implement Basel Ill Standards
France’s Hollande Says He Hasn’t Had Parallel Talks With Merkel
Weidmann Says Reforms Are Best Basis for Growth, Zeit Reports
European Unemployment Rate Rises to Highest in Almost 15 Years
Euro-Region Manufacturing Contracts for a Ninth Month
German Unemployment Unexpectedly Rose in April Amid Crisis
Spain Can Finance Itself, Even If Expensive, Fekter Says

The 10th plague, as the infection spreads to the core?

The surprise is that it took so long, with austerity eroding export markets.
And note the drop in the employment index as well.

German Manufacturing Shrinks at Fastest Pace Since 2009

By Alice Baghdjian

April 23 (Reuters) — Germany’s manufacturing sector unexpectedly shrank at the fastest pace in nearly three years in April, denting hopes it can drive growth in the euro zone and casting a shadow over upbeat business sentiment surveys.

Markit’s manufacturing Purchasing Mangers Index (PMI) fell sharply to 46.3 from March’s 48.4, according to a flash estimate released on Monday, well below the 50 mark which would sign al growth in activity.

It marked the fastest rate of contraction since July 2009 in the sector, which has been hit by a decline in some exports as the debt crisis in the euro zone has choked demand from key trading partners.

Reports are that sales to southern Europe are particularly weak, so there is some evidence of troubles in the periphery (of the euro zone) spilling over to the core,” said Chris Williamson at Markit, adding that global trade was also sagging.

Germany produces exports that people want to buy when growth is good but cut back on when there are worrying signs, and that’s what we’ve got at the moment,” he said.

Germany’s export-driven economy, the largest in Europe, recovered swiftly from the 2008/09 global financial crisis, interrupted only by a 0.2 percent contraction in the final quarter of last year on weak exports and private consumption.

Many economists now believe this to be just a hiccup and that Germany will avoid a recession, generally defined as two consecutive quarters of contraction.

But worries about the finances of big euro zone economies such as Spain and Italy have unsettled markets in recent weeks, despite tentative signs at the beginning of the year that Europe’s more than two-year debt crisis was easing.

The manufacturing reading undershot expectations for an increase to 49.0 in a Reuters poll, with a number of indices within the survey contracting at a faster rate than in the previous month.

The PMI’s composite index, a combined measure of services and industry, fell to 50.9 from a final reading of 51.6 in March, hovering just above stagnation. Employment fell for the first time in more than two years with the employment index dipping to 49.2 from 51.7 in March.

UPBEAT SURVEYS

A companion survey, however, showed the pace of growth in the services sector increased slightly to 52.6 from 52.1 in March.

It beat the consensus forecast of 52.3 in a Reuters poll.

The German consumer has got some confidence in his spending so that’s helping the domestic economy, certainly at the moment,” Williamson said, adding further deterioration of the headline PMI figures could dent growth in the services sector.

Confidence in Europe’s bulwark economy has so far shown resilience to recent disappointing industry data.

In February, German industrial orders rose less than expected, although strong demand from non-European countries provided some momentum, and industrial output fell more than expected due to cold weather.

Last week the closely-watched ZEW index charting analyst and investor sentiment reached its highest level in nearly two years and the Ifo business climate survey inched to its highest level since July 2011, despite expectations that confidence would wane this month.

I’m surprised that (the surveys) are staying so buoyant at the moment,” Williamson said, adding that the PMI usually turns down before the confidence-based surveys.

There is an inflection point now where companies have a reasonable amount of business in their pipeline, but they are reducing that. You’ll soon see those overall indicators from Ifo start to come down again, I think it will be quite soon.”

Composite PMI input prices eased but still grew faster than output prices.

German companies say they expect challenges for the year ahead, with German car maker Volkswagen (VOWG_p.DE) bracing for a very demanding year” as the European debt crisis weighs on auto markets and global economic growth slows.

Williamson said he did not see output prices rising for some time until demand picks up.

They will compensate for that (cutting selling prices) probably through staff cost reductions, which is why we are seeing employment start to fall now,” he said.

They will simply have to fight to stay alive,” he said.

Euro-Area Construction Declines for Third Month Led by Germany
Bundesbank Says Euro Nations Must Set Aside Growth Concerns
Merkel Gives Spain No Respite, Says Debt Cuts Key to Yields
Germany wants IMF funding raised to $1 trillion
IMF Lowers Additional Funds Target To $400bn-Plus: Lagarde
Spain weighs financing options
Spain Reduces Flexibility of Labor Reform, Expansion Reports
Bank of Spain Questions Budget Forecasts, Calls for Prudence
Spain Is Back in Recession, Central Banker Warns
Spanish Banks to Set Aside $71 Billion for Real Estate Cleanup
IMF’s Lagarde Sees Scope for ECB Monetary Easing, FAZ Reports
IMF sees Italy missing budget deficit targets
Italy Probably Shrank 0.7% in First Quarter, Bank of Italy Says

• Austerity everywhere keeps domestic demand in check and export channels muted
• Non govt credit expansion pretty much stone cold dead in the US and Europe
• Rising oil energy prices subduing global aggregate demand
• US federal deficit just about enough to muddle through with modest GDP growth
• Rest of world public deficits also insufficient to close output gaps, including China which has calmed down considerably
• Zero rate policies/QE/etc. in the US, Japan, and Europe doing their thing to keep aggregate demand down and inflation low as monetary authorities continue to get that causation backwards
• All good for stocks and shareholders, not good for most people trying to work for a living
• Europe still in slow motion train wreck mode, with psi bond tax risk keeping investors at bay and ECB waiting for things to get bad enough before intervening

So still looking to me like a case of

‘Because we fear becoming the next Greece, we continue to turn ourselves into the next Japan’

The only way out at this point is a private sector credit expansion, which, in the US, traditionally comes from housing, but doesn’t seem to be happening this time. Past cycles have seen it come from the sub prime expansion phase, the .com/y2k boom, the S&L expansion phase, and the emerging market lending boom.

But this time we’re being more careful of ‘bubbles’ (just like Japan has done for the last two decades). So I don’t see much hope there.

Still watching for the euro bond tax idea to surface, which I see as the immediate possibility of systemic risk, but no real sign yet.

And not only no change in fiscal policy, but more of same. As the carpenter said about his piece of wood, ‘no matter how much I cut off it’s still too short.’

Fertile ground for the ‘bond tax’ (PSI) for the next round of austerity, to reduce the need to further cut public services and raise domestic taxes.

Karim writes:

This data should certainly push up the probability of an ECB policy rate cut in May or June.

In regard to the euro zone officials insisting there will be no further haircuts:

‘The lady doth protest too much, me thinks.’

Mr. Dallara and the rest of the euro mob have as yet not come up with any reason any one nation wouldn’t be better off, as evidenced by Greece, with a whopping big tax on bond holders vs the usual tax hikes and spending cuts otherwise demanded.

Rest of Europe Shouldn’t Follow Greek Bailout: Dallara

By Margo D. Beller

Mar 9 (CNBC) — Charles Dallara, who represented bond holders in the Greek debt talks, told CNBC Friday he doesn’t expect other troubled EU countries such as Italy, Portugal and Ireland to need a similar bond swap.

“I would strongly discourage other governments, other peoples of Europe from going this route,” he said, adding the Greek situation “cast a cloud over the entire euro zone.”

None of these other countries “have the same extraordinary high levels of debt and deficits and none of them have quite the same distortions in the economic system. They are on the right path and should maintain the path of reform.”

Greece’s problems were unique, he said, and the resulting financial crisis was “extremely painful for the citizens of Greece” and “prevented the building of confidence” throughout the euro zone.

Dallara, managing director of the U.S.-based Institute of International Finance, was the chief negotiator representing private-sector holders of Greek debt in the largest bond restructuring in history.

He said he was “quite pleased” that 83.5 percent of the bond holders voluntarily accepted losses of some 74 percent on the value of their investments in a deal that will cut more than 100 billion euros from Greece’s crippling public debt.

“To see so many bondholders voluntarily deliver their bonds into this exchange is remarkable” and speaks to the desire for Europe and investors to “turn the page” on the whole European sovereign debt problem, he added.

Athens had said it would enforce the deal on all its bondholders, activating collective action clauses on the 177 billion euros worth of bonds regulated under Greek law.

That would potentially trigger payouts on the credit default swaps that some investors held on the bonds, an event which would have unknown consequences for the market.

Dallara said activating the collective action clauses was “one of the unfortunate dimensions” of the debt swap, but stressed it shouldn’t stop foreign investment in European sovereign debt.

“The issue is not just one of legal risk in investing in sovereign debt, it’s better credit analysis,” he said. “You have to understand the underlying credit risks.”