Category Archives: Credit

Weekly Credit Graph Packet – 06/06/11

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Recognizing that ‘it’s all one piece’
The rest of the credit stack seems to be moving up in yield roughly in line with equities.

The slowdown seems to be getting serious.

Hopefully the euro zone and UK haven’t yet reached the tipping point where austerity shifts from reducing deficits to adding to them (due to induced economic weakness).

And hopefully Japan decides to go with an all out reconstruction plan without increasing taxes or otherwise ‘paying for it.’

And hopefully China’s second half weakness doesn’t get out of hand.

And hopefully the US Congress doesn’t accomplish any serious near term deficit reduction.

And hopefully the Fed informs us all that QE and 0 rates reduce interest income for the economy, as indicated in Bernanke’s 2004 published paper. And therefore, as he indicated, a fiscal adjustment is called for to sustain aggregate demand at congressionally mandated levels.

Credit Graph Packet

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WARNING- Euro Zone Automatic Fiscal Stabilizers Deactivated!

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I now believe that system risk in the euro zone is being grossly under discounted.

The implied assumption for the major currency regions is that during a slowdown the automatic fiscal stabilizers- falling government ‘revenues’ and increased transfer payments- will kick in to increase deficit spending, and thereby add the income and savings to catch the fall and support the next expansion.

This has always been the case, and as we all know, the most accurate forecasts are the ones that assume it’s not different this time.

But the relatively new and evolving euro zone arrangements are qualitatively different.
Spending by euro zone national governments is now market constrained in Greece, Ireland, and Portugal, with the rest looking like they aren’t far away from those same market constraints.

In a slow down, this means as tax revenues fall, markets may not permit government spending to rise, unless the ECB immediately funds all the national governments as well as the banks. Just as we see happening to the US states.

Not that the ECB won’t eventually do that, but that they are unlikely to proactively do it.
In other words, it will all have to get bad enough for the ECB to write the check that only they can write.

This means the euro zone is now flying without a net.

And the potential drop in aggregate demand is far higher than markets are discounting.

And that kind of catastrophic collapse in aggregate demand in the euro zone will have immediate catastrophic global impact.

And the fiscal discussions going on in Japan and elsewhere tell me there is a clear risk even the operationally unconstrained nations will be very reluctant to immediately and proactively move towards fiscal expansion.
Instead, they will let it all deteriorate until their automatic fiscal stabilizers to kick in.
Much like what happened with the 2008 financial crisis, where the lack of a will to engage in an immediate fiscal response let that financial crisis spill over into the real economy.

Can all this be avoided? Yes, and the remedy is both simple, immediate, and would quickly lead to unprecedented global prosperity.

All the euro zone has to do is have the ECB write the check, and announce immediate and annual distributions of 10% of GDP to member nations to pay down their outstanding debts, and at the same time impose national deficit ceilings sufficiently high to promote desired levels of aggregate demand. And the penalty for non compliance would be the withdrawal of ECB support. This would remove credit concerns, without increasing government spending, so there would be no inflationary impact.

And all the rest of the world has to do is recognize that federal taxes function to regulate aggregate demand, and not to fund expenditures per se. And then set taxation and/or government spending at levels that sustain desired aggregate demand.

They need to know the question is not whether longer term the budget deficit is sustainable- as it’s always nominally sustainable- but instead worry about sustaining aggregate demand at desired levels, both long term and short term.

But, unfortunately, I see the odds of a catastrophic collapse in aggregate demand as far higher than the odds of an awakening to a global understanding of actual monetary operations.

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A few Boehnalities and other notables on the US going broke

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Cross currents of right and wrong but always for the wrong reasons.

Bonds Show Why Boehner Saying We’re Broke Is Figure of Speech

By David J. Lynch

March 7 (Bloomberg) — House Speaker John Boehner routinely offers this diagnosis of the U.S.’s fiscal condition: “We’re broke; Broke going on bankrupt,” he said in a Feb. 28 speech in Nashville.

Boehner’s assessment dominates a debate over the federal budget that could lead to a government shutdown. It is a widely shared view with just one flaw: It’s wrong.

“The U.S. government is not broke,” said Marc Chandler, global head of currency strategy for Brown Brothers Harriman & Co. in New York. “There’s no evidence that the market is treating the U.S. government like it’s broke.”

Wrong reason! Broke implies not able to spend.

The US spends by crediting member bank accounts at the Fed, and taxes by debiting member bank accounts at the Fed.

It never has nor doesn’t have any dollars.

The U.S. today is able to borrow at historically low interest rates, paying 0.68 percent on a two-year note that it had to offer at 5.1 percent before the financial crisis began in 2007.

That’s simply a function of where the Fed, a agent of Congress, has decided to set rates, and market perceptions of where it may set rates in the future. Solvency doesn’t enter into it.

Financial products that pay off if Uncle Sam defaults aren’t attracting unusual investor demand. And tax revenue as a percentage of the economy is at a 60-year low, meaning if the government needs to raise cash and can summon the political will, it could do so.

All taxing does is debit member bank accounts. The govt doesn’t actually ‘get’ anything.

To be sure, the U.S. confronts long-term fiscal dangers.

For example???

Over the past two years, federal debt measured against total economic output has increased by more than 50 percent and the White House projects annual budget deficits continuing indefinitely.

So?

“If an American family is spending more money than they’re making year after year after year, they’re broke,” said Michael Steel, a spokesman for Boehner.

So?
What does that have to do with govts ability to credit accounts at its own central bank?

$1.6 Trillion Deficit

A person, company or nation would be defined as “broke” if it couldn’t pay its bills, and that is not the case with the U.S. Despite an annual budget deficit expected to reach $1.6 trillion this year, the government continues to meet its financial obligations, and investors say there is little concern that will change.

Still, a rhetorical drumbeat has spread that the U.S. is tapped out. Republicans, including Representative Ron Paul of Texas, chairman of the House domestic monetary policy subcommittee, and Fox News commentator Bill O’Reilly, have labeled the U.S. “broke” in recent days.

Chris Christie, the Republican governor of New Jersey, said in a speech last month that the Medicare program is “going to bankrupt us.” Julian Robertson, chairman of Tiger Management LLC in New York, told The Australian newspaper March 2: “we’re broke, broker than all get out.”

A similar claim was even made Feb. 28 by comedian Jon Stewart, the host of “The Daily Show” on Comedy Central.

So much for their legacies.

Cost of Insuring Debt

Financial markets dispute the political world’s conclusion. The cost of insuring for five years a notional $10 million in U.S. government debt is $45,830, less than half the cost in February 2009, at the height of the financial crisis, according to data provider CMA data. That makes U.S. government debt the fifth safest of 156 countries rated and less likely to suffer default than any major economy, including every member of the
G20.

There are two factors in default insurance. Ability to pay and willingness to pay. While the US always has the ability to pay, Congress does not always show a united willingness to pay. Hence the actual default risk.

Creditors regard Venezuela, Greece and Argentina as the three riskiest countries. Buying credit default insurance on a notional $10 million of those nations’ debt costs $1.2 million, $950,000 and $665,000 respectively.

“I think it’s very misleading to call a country ‘broke,'” said Nariman Behravesh, chief economist for IHS Global Insight in Lexington, Massachusetts. “We’re certainly not bankrupt like Greece.”

In any case, the euro zone member nations put themselves in the fiscal position of US states when they joined the euro.

That means a state like Illinois could be the next Greece, but not the US govt.

Less Likely to Default

CMA prices for credit insurance show that global investors consider it more likely that France, Japan, China, the United Kingdom, Australia or Germany will default than the U.S.

Pacific Investment Management Co., which operates the largest bond fund, the $239 billion Total Return Fund, sees so little risk of a U.S. default it may sell other investors insurance against the prospect. Andrew Balls, Pimco managing director, told reporters Feb. 28 in London that the chances the U.S. would not meet its obligations were “vanishingly small.”

Presumably a statement with regard to willingness of Congress to pay.

George Magnus, senior economic adviser for UBS Investment Bank in London, says the U.S. dollar’s status as the global economy’s unit of account means the U.S. can’t go broke.

That has nothing to do with it.

“You have the reserve currency,” Magnus said. “You can print as much as you need. So there’s no question all debts will be repaid.”

Any nation can do that with its own currency

The current concerns over debt contrast with the views of founding father Alexander Hamilton, the nation’s first Treasury secretary. At Hamilton’s urging, the federal government in 1790 absorbed the Revolutionary War debts of the states and issued new government securities in about the same total amount.

Alexander Hamilton

Unlike today’s debt critics, Hamilton “had no intention of paying off the outstanding principal of the debt,” historian Gordon S. Wood wrote in “Empire of Liberty: A History of the Early Republic 1789-1815.”

Instead, by making regular interest payments on the debt, Hamilton established the U.S. government as “the best credit risk in the world” and drew investors’ loyalties to the federal government and away from the states, wrote Wood, who won a Pulitzer Prize for a separate history of the colonial period.

Far be it from me to argue with a Pulitzer Prize winner…

From Oct. 1, 2008, the beginning of the 2009 fiscal year, through the current year, which ends Sept. 30, 2011, the U.S. will have added more than $4.3 trillion of debt. Despite White House forecasts of an additional $2.4 trillion of debt over the next three fiscal years, investors’ appetite for Treasury securities shows little sign of abating.

It’s just a reserve drain- get over it!

Govt spending credits member bank reserve accounts at the Fed

Tsy securities exist as securities accounts at the Fed.

‘Going into debt’ entails nothing more than the Fed debiting Fed reserve accounts and crediting Fed securities accounts and ‘paying off the debt’ is nothing more than debiting securities accounts and crediting reserve accounts

No grandchildren involved.

Longer-Term Debt

In addition to accepting low yields on two-year notes, creditors are willing to lend the U.S. money for longer periods at interest rates that are below long-term averages. Ten-year U.S. bonds carry a rate of 3.5 percent, compared with an average 5.4 percent since 1990. And U.S. debt is more attractive than comparable securities from the U.K., which has moved aggressively to rein in government spending. U.K. 10-year bonds offer a 3.6 percent yield.

“You are never broke as long as there are those who will buy your debt and lend money to you,” said Edward Altman, a finance professor at New York University’s Stern School of Business who created the Z-score formula that calculates a company’s likelihood of bankruptcy.

Who also completely misses the point.

Any doubts traders had about the solvency of the U.S. would immediately be reflected in the markets, a fact noted by James Carville, a former adviser to President Bill Clinton, after he saw how bond investors could determine the success or failure of economic policy.

No they can’t.

“I used to think if there was reincarnation, I wanted to come back as the president or the Pope or a .400 baseball hitter,” Carville said. “But now I want to come back as the bond market. You can intimidate everyone.”

Only those who don’t know any better.

Republican Dissenters

Republican assertions that the U.S. is “broke” are shorthand for a complex fiscal situation, and some in the party acknowledge the claim isn’t accurate.

“To say your debts exceed your income is not ‘broke,'” said Tony Fratto, former White House and Treasury Department spokesman in the George W. Bush administration.

The U.S. government nonetheless faces a daunting gap between its expected financial resources

It’s not about ‘financial resources’ when it comes to a govt that never has nor doesn’t have any dollars, and just changes numbers in our accounts when it spends and taxes

and promised future outlays. Fratto said the Obama administration’s continued accumulation of debt risked a future crisis, as most major economies also face growing debt burdens.

The burden is that of making data entries.

In the nightmare scenario, a crush of countries competing to simultaneously sell IOUs to global investors could bid up the yield on government debt and compel overleveraged countries such as the U.S. to abruptly slash public spending.

It could only compel leaders who didn’t know how it all worked to do that.

Not selling the debt simply means the dollars stay in reserve accounts at the Fed and instead of being shifted by the Fed to securities accounts. Why would anyone who knew how it worked care which account the dollars were in? Especially when spending has nothing, operationally, to do with those accounts.

Fratto dismissed the markets’ current calm, noting that until the European debt crisis erupted early last year, investors had priced German and Greek debt as near equivalents.

“Markets can make mistakes,” Fratto said.

So can he. That all applies to the US states, not the federal govt.

$9.4 Trillion Outstanding

If recent budgetary trends continue unchanged, the U.S. risks a fiscal day of reckoning, slower growth or both.

No it doesn’t.

Altman notes that the U.S. debt outstanding is “enormous.” As of the end of 2010, debt held by the public was $9.4 trillion or 63 percent of gross domestic product — roughly half of the corresponding figures for Greece (126.7 percent) and Japan (121 percent) and well below countries such as Italy (116 percent), Belgium (96.2 percent) and France (78.1 percent).

Once a country’s debt-to-GDP ratio exceeds 90 percent, median annual economic growth rates fall by 1 percent, according to economists Kenneth Rogoff and Carmen Reinhart.

Wrong, that’s for convertible currency/fixed exchange rate regimes, not nations like the US, Uk, and Japan which have non convertible currencies and floating exchange rates.

The Congressional Budget Office warns that debt held by the public will reach 97 percent of GDP in 10 years if certain tax breaks are extended rather than allowed to expire next year and if Medicare payments to physicians are held at existing levels rather than reduced as the administration has proposed.

So???

AAA Rating

For now, Standard & Poor’s maintains a stable outlook on its top AAA rating on U.S. debt, assuming the government will “soon reveal a credible plan to tighten fiscal policy.” Debate over closing the budget gap thus far has centered on potential spending reductions. S&P says a deficit-closing plan “will require both expenditure and revenue measures.”

Measured against the size of the economy, U.S. federal tax revenue is at its lowest level since 1950. Tax receipts in the 2011 fiscal year are expected to equal 14.4 percent of GDP, according to the White House. That compares with the 40-year average of 18 percent, according to the Congressional Budget Office. So if tax receipts return to their long-term average amid an economic recovery, about one-third of the annual budget deficit would disappear.

Likewise, individual federal income tax rates have declined sharply since the top marginal rate peaked at 94 percent in 1945. The marginal rate — which applies to income above a numerical threshold that has changed over time — was 91 percent as late as 1963 and 50 percent in 1986. For 2011, the top marginal rate is 35 percent on income over $373,650 for individuals and couples filing jointly.

Not Overtaxed

Americans also aren’t overtaxed compared with residents of other advanced nations. In a 28-nation survey, only Chile and Mexico reported a lower total tax burden than the U.S., according to the Organization for Economic Development and Cooperation.

In 2009, taxes of all kinds claimed 24 percent of U.S. GDP, compared with 34.3 percent in the U.K., 37 percent in Germany and 48.2 percent in Denmark, the most heavily taxed OECD member.

“By the standard of U.S. history, by the standard of other countries — by the standard of where else are we going to get the money — increased tax revenues have to be a part of the solution,” said Jeffrey Frankel, an economist at Harvard University who advises the Federal Reserve Banks of Boston and New York.

So much for his legacy.

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Mortgage apps down

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Still no sign of private sector credit expansion from housing.

US Home Loan Demand Drops, Rates at 10-Month High

February 9 (Reuters) — Applications for U.S. home mortgages dropped last week as the highest interest rates in 10 months sapped demand for home loan refinancing, an industry group said Wednesday.

The Mortgage Bankers Association said its seasonally adjusted index of mortgage application activity, which includes both refinancing and home purchase demand, fell 5.5 percent in the week ended Feb. 4.

The MBA’s seasonally adjusted index of refinancing applications fell 7.7 percent last week.

The gauge of loan requests for home purchases was down 1.4 percent.

Fixed 30-year mortgage rates averaged 5.13 percent in the week, up 32 basis points from 4.81 percent the prior week.

It was the highest rate since the week ended April 9, 2010.

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China to the Rescue! Wen Offers to Buy Greek Bonds

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Subtitle:

“Ticker Tape Parade for Trojan Horse”

Ordinarily China’s policy of driving exports to a nation with purchases of their currency is met with resistance. The US, for example,
has been chastising nations buying $US, like Japan and China, calling them currency manipulators, outlaws, etc. But China is getting very clever about it, here coming into the euro zone and buying Greek debt as the savior, and possibly even negotiating informal guarantees of repayment or other forms of support from the ECB, to keep the Greek debt off of the ECB’s balance sheet.

In any case, with Chinese buying, the euro zone is finding support for their funding issues, even as this ‘solution’ further drives up the euro and threatens to put a damper on their exports.

As previously discussed, the euro zone’s export driven model lacks the critical ingredient of being able to buy the currencies of the regions to which they wish to export.

All not to forget that imports are real benefits and exports real costs. So what we are seeing is a battle for export markets between nations who haven’t mastered the elementary art of supporting domestic demand and optimizing real terms of trade.

China to the Rescue! Wen Offers to Buy Greek Bonds

October 3 (Reuters) — China offered on Saturday to buy Greek government bonds in a show of support for the country whose debt burden triggered a crisis for the euro zone and required an international bailout.

Premier Wen Jiabao made the offer at the start of a two-day visit to the crisis-hit country where he says he expects to expand ties in all areas.

“With its foreign exchange reserve, China has already bought and is holding Greek bonds and will keep a positive stance in participating and buying bonds that Greece will issue,” Wen said, speaking through an interpreter.

“China will undertake a great effort to support euro zone countries and Greece to overcome the crisis.”

Greece needs foreign investment to help it fulfill the terms of a 110 billion euro (US$150 billion) bailout. This rescued it from bankruptcy in May but also imposed strict austerity measures, deepening its recession.

Greece, which has been raising only short-term loans in the debt market, has said it wants to return to markets some time next year to sell longer-term debt, although the EU/IMF package llows it to wait until 2012.

“I am convinced that with my visit to Greece our bilateral relations and cooperation in all spheres will be further developed,” Wen told Greek Prime Minister George Papandreou earlier in the day.

Greece and China pledged to stimulate investment in a memorandum of understanding and private companies signed a dozen deals in areas like shipping, construction and tourism.

“Our two countries, both historical and modern, have to strengthen our relations in all sectors, to move on and overcome present difficulties,” said Wen, speaking through an interpreter in televised comments.

The investment memorandum does not target specific investment volumes, an official close to Investment Minister Harris Pamboukis said ahead of Wen’s visit.

“We want to build this strategic partnership with China,” the investment ministry official said. “The purpose is not a signature on something big.”

China has said it needs to diversify its foreign currency holdings and has bought Spanish government bonds. In January, Greece denied media reports it planned to sell up to 25 billion euros of bonds to China.

Wen will address the Greek parliament on Sunday and leave early on Monday for Brussels, where he will attend an EU-China summit before going on to Germany, Italy and Turkey.

Clinching business deals with countries such as China and Qatar would help boost confidence among Greek consumers and businesses, economic analysts said.

With the global economic crisis and competition with other Balkan countries increasing, foreign direct investment in Greece fell from 6.9 billion euros in 2006 to 4.5 billion in 2009, according to Investment Ministry figures.

Chinese investment represents a very small proportion of this, excluding a 35-year concession deal China’s Cosco signed in 2008 to turn the port of Piraeus into a regional hub for a guaranteed amount of 3.4 billion euros, according to port authority figures.

Wen is also likely to deal with international pressure on China over its currency exchange policies during his tour.

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markets looking grim

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>   
>   (email exchange)
>   
>   On Tue, Aug 24, 2010 at 8:32 AM, Seth wrote:
>   
>   stocks look bad
>   looks like another panic
>   

It doesn’t look good technically.

Must be coming out of europe with gold up/euro down dynamic, etc.

Insiders there must be bailing.

Maybe they know something we don’t, or maybe they are wrong.

History is no help as in the past it’s been both.

Austerity is trimming growth there a bit around the edges, but deficits remain reasonably high, so GDP’s are probably at least muddling through, with overall growth probably positive.

The ECB keeps the short term funding channels open for the member nations, but that may not be fully appreciated yet.

On a mark to market basis bank capital is probably below requirements, and they may not realize that doesn’t have to matter to the real economy for as long as the ECB continues to fund them.

Lower crude oil prices support consumption of other things. With US crude oil product consumption up and Saudi output rising, demand must be ok. Maybe Saudis are worried and want lower prices to help world growth as well. Hard to ever say what they are actually up to. They may see the Iraqi production coming on stream and are trying to engineer an increase in demand. Again, no way to tell what they are up to.

The lower 10 year rates reflects expectations of ‘low for longer’ from the Fed due to high unemployment and falling rates of inflation as measured by the Fed. And the possibility of more QE that could flatten the curve further.

There is also the notion that there’s nothing left that the Fed can do of any consequence regarding aggregate demand, and Congress thinks it’s run out of money, which means flying without a net. That increases the weight of the downside in the balance of risks.

If markets and Congress knew that fiscal policy had no nominal limit and deficit spending was not dependent on being able to borrow from the likes of China to be paid by our grandchildren, the balance of risks would be viewed very differently. But they don’t know that.

With the elections coming and California reverting to vouchers again, the time is right for my per capita revenue sharing. But it’s not even a consideration.

Q3 and Q4 GDP estimates are looking more like 1.5%, and Q2 looks to be revised down toward 1% Friday. Not a double dip but no drop in unemployment either as productivity might be at least that high. That’s worse politically than it is for equities, and adds support for a ‘second stimulus’ type of reaction. But that’s way down the road. More likely it causes most of the expiring tax cuts to be extended.

Thursday’s claims can make a big difference as well. The jump to 500,000 last week added an element of fear internationally.

Also, in thin summer markets technicals often cause exaggerated moves. Volume is very low, and a given size buying or selling causes larger moves to find someone willing to take the other side, and momentum type traders can easily overwhelm investors.

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UK News — Summer Sales Drive Credit Card Spending

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Possible sign of a ‘hand off’ to private sector credit growth as double digit deficit spending replenishes savings and eases debt service and debt service ratios.

Austerity measures will take a bit off growth at some point but probably not drive it anywhere near negative.

UK Headlines:
U.K. House Prices Increased 0.1% in July, Acadametrics Says
UK Summer Sales Drive Credit Card Spending
UK Government Bonds in Demand

UK Summer Sales Drive Credit Card Spending

Aug. 13 (Telegraph) — It might be less than a year since
the end of the worst recession since the 1930s but consumers seem
to have already forgotten the lessons of the credit crisis.

Spending on credit and debit cards rose 9.9pc in July as
consumers ignored fears of a double-dip recession and hit the
high street, according to figures from Barclaycard.

The year-on-year increase was achieved as retailers enticed
shoppers with summer discounts.

“If consumer confidence is taking a hit, it’s not happening
on the high street,” said Stuart Neal of Barclaycard. “If
spending remains at this level compared to last year, 2010 could
prove to be a very good year for retailers.”

July was the third month in a row that the annual growth
rate in sales was above 9pc, according to Barclaycard.

The report said that spending last month was 1.9pc higher
than in June, partly reflecting an earlier start to the summer
sales season.

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M3 falling works for me

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With sufficient deficit spending private credit isn’t needed at all to sustain growth and employment, so the shift from private sector credit growth (falling M3) to 3% growth sustained by deficits of 10% of gdp is perfectly sustainable.

In fact, I’d prefer, for a given size govt, lower taxes rather than higher private sector credit growth. And a larger trade deficit means we can have taxes that much lower still. And cut out much the military expenditures for Afghanistan and cut taxes that much more, thanks! etc!

Unfortunately 3% growth doesn’t close the output gap, but that’s another (very ugly) story, but with the same answer. Agg demand is about a trillion a year short of potential right now, hence my proposal for a full payroll tax (FICA) holiday to restore private sector sales, output, and employment.

US money supply plunges at 1930s pace as Obama eyes fresh stimulus

By Ambrose Evans-Pritchard

May 26 (Telegraph) — The M3 money supply in the United States is contracting at an accelerating rate that now matches the average decline seen from 1929 to 1933, despite near zero interest rates and the biggest fiscal blitz in history.

The M3 figures – which include broad range of bank accounts and are tracked by British and European monetarists for warning signals about the direction of the US economy a year or so in advance – began shrinking last summer. The pace has since quickened.

The stock of money fell from $14.2 trillion to $13.9 trillion in the three months to April, amounting to an annual rate of contraction of 9.6pc. The assets of insitutional money market funds fell at a 37pc rate, the sharpest drop ever.

“It’s frightening,” said Professor Tim Congdon from International Monetary Research. “The plunge in M3 has no precedent since the Great Depression. The dominant reason for this is that regulators across the world are pressing banks to raise capital asset ratios and to shrink their risk assets. This is why the US is not recovering properly,” he said.

The US authorities have an entirely different explanation for the failure of stimulus measures to gain full traction. They are opting instead for yet further doses of Keynesian spending, despite warnings from the IMF that the gross public debt of the US will reach 97pc of GDP next year and 110pc by 2015.

Larry Summers, President Barack Obama’s top economic adviser, has asked Congress to “grit its teeth” and approve a fresh fiscal boost of $200bn to keep growth on track. “We are nearly 8m jobs short of normal employment. For millions of Americans the economic emergency grinds on,” he said.

David Rosenberg from Gluskin Sheff said the White House appears to have reversed course just weeks after Mr Obama vowed to rein in a budget deficit of $1.5 trillion (9.4pc of GDP) this year and set up a commission to target cuts. “You truly cannot make this stuff up. The US governnment is freaked out about the prospect of a double-dip,” he said.

The White House request is a tacit admission that the economy is already losing thrust and may stall later this year as stimulus from the original $800bn package starts to fade.

Recent data have been mixed. Durable goods orders jumped 2.9pc in April but house prices have been falling for several months and mortgage applications have dropped to a 13-year low. The ECRI leading index of US economic activity has been sliding continuously since its peak in October, suffering the steepest one-week drop ever recorded in mid-May.

Mr Summers acknowledged in a speech this week that the eurozone crisis had shone a spotlight on the dangers of spiralling public debt. He said deficit spending delays the day of reckoning and leaves the US at the mercy of foreign creditors. Ultimately, “failure begets failure” in fiscal policy as the logic of compound interest does its worst.

However, Mr Summers said it would be “pennywise and pound foolish” to skimp just as the kindling wood of recovery starts to catch fire. He said fiscal policy comes into its own at at time when the economy “faces a liquidity trap” and the Fed is constrained by zero interest rates.

Mr Congdon said the Obama policy risks repeating the strategic errors of Japan, which pushed debt to dangerously high levels with one fiscal boost after another during its Lost Decade, instead of resorting to full-blown “Friedmanite” monetary stimulus.

“Fiscal policy does not work. The US has just tried the biggest fiscal experiment in history and it has failed. What matters is the quantity of money and in extremis that can be increased easily by quantititave easing. If the Fed doesn’t act, a double-dip recession is a virtual certainty,” he said.

Mr Congdon said the dominant voices in US policy-making – Nobel laureates Paul Krugman and Joe Stiglitz, as well as Mr Summers and Fed chair Ben Bernanke – are all Keynesians of different stripes who “despise traditional monetary theory and have a religious aversion to any mention of the quantity of money”. The great opus by Milton Friedman and Anna Schwartz – The Monetary History of the United States – has been left to gather dust.

Mr Bernanke no longer pays attention to the M3 data. The bank stopped publishing the data five years ago, deeming it too erratic to be of much use.

This may have been a serious error since double-digit growth of M3 during the US housing bubble gave clear warnings that the boom was out of control. The sudden slowdown in M3 in early to mid-2008 – just as the Fed talked of raising rates – gave a second warning that the economy was about to go into a nosedive.

Mr Bernanke built his academic reputation on the study of the credit mechanism. This model offers a radically different theory for how the financial system works. While so-called “creditism” has become the new orthodoxy in US central banking, it has not yet been tested over time and may yet prove to be a misadventure.

Paul Ashworth at Capital Economics said the decline in M3 is worrying and points to a growing risk of deflation. “Core inflation is already the lowest since 1966, so we don’t have much margin for error here. Deflation becomes a threat if it goes on long enough to become entrenched,” he said.

However, Mr Ashworth warned against a mechanical interpretation of money supply figures. “You could argue that M3 has been going down because people have been taking their money out of accounts to buy stocks, property and other assets,” he said.

Events may soon tell us whether this is benign or malign. It is certainly remarkable.

On Thu, May 27, 2010 at 12:04 PM, Marshall wrote:

Yes! For some odd reason there is a myth about the Great Depression that could not be more removed from the reality of the time. Most people believe the economy crashed between 1929 and 1932 and then remained depressed until the Second World War which finally mobilized the economy’s idle resources and brought about a full recovery. That’s complete bunk if you calculate the unemployment data correctly. Even leaving aside that fact, it is true that, once the Great Depression hit bottom in early 1933, it embarked on four years of economic expansion that constituted the biggest cyclical boom in U.S. economic history. For four years real GDP grew at a 12% rate and nominal GDP grew at a 14% rate. There was another shorter and shallower depression in 1937 CAUSED BY RENEWED FISCAL TIGHTENING. It was this second depression that has led to the misconception that the central bank was pushing on a string throughout all of the 1930s until the giant fiscal stimulus of the war time effort finally brought the economy up from depression. The financial dynamics of that huge economic recovery between 1933 and 1937 are extremely striking. Despite their insistence that changes in the stock of money were behind all the cyclical ups and downs in U.S. economic history, even Freidman and Schwartz in their “Monetary History of the United States” conceded that the money aggregates did not lead the U.S. economy out of the depression in 1932-1933. More striking, private credit seemingly had nothing to do with the take off of that economy. Industrial production off the 1932 low doubled by 1935. By contrast, bank credit to the private sector fell until the middle of 1935. Because of the collapse in nominal income during the depression, the U.S. private sector was more indebted than ever on the depression lows. Yet, somehow it took off and sustained its takeoff with no growth in private credit whatsoever. The 14% average annual increase in nominal GDP from early 1932 to 1935 resulted in huge private deleveraging because nominal income outran lagging private.

Fiscal policy is going to undergo a complete reversal as the $850 billion fiscal stimulus package wanes and the scheduled tax increases at the Federal level come into play early next year. It may be much worse if financially strapped state and local governments have to cut expenditures and raise taxes over the same time period – which is highly likely, especially as we get to the states’ budget year end which is mainly to June 30th. By then, if they haven’t got to their mandated balanced budgets, they’ll cut more staff off the payroll as that will temporarily get them to balance (from an accounting perspective). That will exacerbate the double dip, which is coming straight on schedule, as Randy predicted last year in his piece with Eric.

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US Home Refinancing Jumps While Purchasing Slumps

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Looks like a better functioning refi market with new construction and prices remaining relatively low as the tax credit ends.

No sign of credit growth coming from this sector any time soon.

US Home Refinancing Jumps While Purchasing Slumps

By Julie Haviv

May 26 (Reuters) — U.S. mortgage applications to refinance home loans jumped to a seven-month high last week as rates neared record lows, but purchase demand remained stuck at a 13-year low.

Interest rates on 30-year fixed-rate mortgages, the most widely used loan, reached their lowest level since late-November 2009, the Mortgage Bankers Association said on Wednesday.

Low mortgage rates may prove to be the saving grace for the housing market as it copes with the expiration of popular home buyer tax credits.

The MBA said its seasonally adjusted index of mortgage applications, which includes both purchase and refinance loans, for the week ended May 21, increased 11.3 percent.

The four-week moving average of mortgage applications, which smoothes the volatile weekly figures, was up 4.4 percent.

“Refinance application volume jumped last week as continuing financial market turmoil related to the budget crises in Europe extended the opportunity for homeowners to lock in at historically low mortgage rates,” Michael Fratantoni, MBA’s Vice President of Research and Economics, said in a statement.

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