Category Archives: Financial Times

Goldman Sachs trying to broker Greek bonds to China

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I went to high school with Chris Powell where he was a good friend of mine, then lost touch.
We’ve had a few emails discussing GATA. Seems their beef is that the Fed is conspiring to keep the price of gold down, which wrongly hurts the GATA supporters.
Didn’t make a lot of sense to me, but whatever.

Regarding China and the euro-

Note China already owns some Greek bonds, highlighted below?

I was discussing this a while back when China was ‘diversifying reserves’ in that one of the problems with the buying the euro is you have to take national govt credit risk, as there is nothing equivalent to the ‘federal’ securities of the other nations of the world with non convertible currencies where the issuer of the currency is your counter party.

Also, when the likes of China stops buying, say, the $US or the yen, it’s not a credit event for the US like it is when they stop buying the euro, where the national govt’s solvency is a function of their ability to sell their securities.

So the lack of euro buying by sovereigns who were willing to take national govt credit risk puts the entire eurozone at risk of a liquidity crisis beginning with its ‘weakest link.’ Hence the Greek ‘road trips’ to China, which do make sense, in contrast to the Obama/Clinton/Geithner road trips to China which reinforce the notion that they don’t understand the monetary system.

I’ve also passed along the idea that if Greek bonds were to have default provisions that allowed them to be used to pay Greek taxes in the event of default it should lower their interest rates. Don’t know if that got anywhere- no way for me to check.

Goldman Sachs trying to broker Greek bonds to China

Athens Invites Beijing to Buy Bonds

By Kerin Hope and Jamil Anderlini

Link

Greece is wooing China to buy up to E25 billion of government bonds, a move that underlines Beijing’s growing financial power, as Athens struggles to fund soaring public debt.

Goldman Sachs, the US investment bank, has been promoting a Greek bond sale to Beijing and the State Administration of Foreign Exchange (SAFE), which manages China’s $2,400 billion foreign exchange reserves, said people familiar with the issue.

Gary Cohn, Goldman Sachs chief operating officer, has made two trips to Athens — last November and this month — to meet George Papandreou, prime minister, and senior officials.

Beijing has not agreed to such a purchase. Meanwhile, Athens has rejected a suggestion that a Chinese bank should acquire a strategic stake in National Bank of Greece, the country’s flagship commercial lender, according to officials contacted by the Financial Times.

But a more modest deal of about E5 billion-E10 billion ($7 billion-$14 billion) appeared possible after Mr Cohn’s second trip to Athens, officials said on Tuesday.

George Papaconstantinou, finance minister, told the FT he would visit China on a road show next month, but “no target is set” for a debt placement.

China’s foreign exchange reserves grew $130 billion in the last quarter of 2009 alone. But people close to Safe said China already held a “significant amount” of Greek debt and was wary of adding to that.

A senior Greek finance ministry official said Athens would welcome Chinese buyers of its bonds. The official declined to specify an amount, though a figure of E20 billion-E25 billion was raised in talks with Goldman Sachs.

A E5 billion syndicated loan issue by Greece this week attracted bids worth more than E20 billion, but Greece continues to face pressure in financial markets.

Goldman Sachs mooted the sale of equity in NBG to Bank of China, the country’s third-largest commercial lender by assets, and made a similar proposal to China Investment Corp., China’s sovereign wealth fund, according to officials.

Chinese officials said CIC was not interested and that regulators would not let BoC make such a risky investment. Goldman Sachs and CIC declined to comment. A Bank of China spokesman said: “I haven’t heard anything about it.”


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Obama speech

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Obama: Bank Regulators May Have Gotten Too Tough

Jan. 22 (AP) —President Barack Obama said on Friday that regulatory oversight of the country’s banks might now be erring too much on the side of caution, potentially hindering the flow of credit to small businesses.

This is definitely the case. It’s called regulatory overreach, as previously discussed on my website.

“The banks feel as if regulators are looking over their shoulder, discouraging them from lending,” Obama told a town-hall style meeting in Elyira, Ohio during a trip to promote his jobs and health care policies.

Obama said it was not his intention to interfere with bank supervision. But he had told Treasury Secretary Timothy Geithner to make sure that the country has not “seen the pendulum swing too far”, with regulators now being too tough after being too slack in the past.

Including the risk weight rules that require non senior impaired securities to functionally be marked at 0.

On other issues, it was a combative Obama that exhorted Congress to pass a new job-creation bill, taking a populist appeal to America’s recession-racked Rust Belt in an effort to recapture the excitement of his campaign.

Obama weaved us-against-them rhetoric into his appearances, telling a town hall audience that he “will never stop fighting” for an economy that works for the hard-working, not just those already well off.

He said a jobs bill emerging in Congress must include tax breaks for small business hiring and for people trying to make their homes more energy efficient — two proposals he wasn’t able to get into a bill the House passed last month.

He also pitched fiscal responsibility and deficit reduction. Not sure how he proposes to do both, as below.

And he used the word “fight” or some variation of it over a dozen times. The House-passed $174 billion stimulus package faces a stern test in the Senate, in part because it is financed with deficit spending.

He strongly defended unpopular actions he has taken to bail out banks and insurers and to rescue automakers from collapse. Such measures have not gone over well in many quarters, and have been derided as moves that expanded government intervention and swelled the deficit.

The measures were seen as a helping hand for Wall Street while many on Main Street walked the unemployment lines.

Obama said that propping up the financial industry was as much about regular Americans as wealthy bankers. “If the financial system had gone down, it would have taken the entire economy and millions more families and businesses with it,” he argued.

As before, he states his belief in a top down solution.

Similarly, allowing GM and Chrysler to go under might have satisfied calls to force businesses to reap the consequences of bad decisions.

Cleaning up Chrysler to hand it over to Fiat to import Fiats to compete with GM seems a confused strategy to me.

But he also said, “Hundreds of thousands of Americans would have been hurt, not just at those companies themselves, but at other auto companies and at their suppliers and dealers, here in Ohio, up in Michigan, and all across this country.”

Missing the macro benefits by seeing only the very micro results in sub optimal solutions.

“He’s done a lot, but they are all negative things,” said Ray Angell, 65, of Twinsburg, Ohio, a conservative active in the anti-tax Tea Party movement, mentioning the stimulus package and climate change proposals.


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Hedge funds bet on rising yields

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Yet another legend (or two) slips into the ‘better lucky than good’ category.

They may be right, but it will be for a different reason:

Top hedge funds bet on big yields rise

By Henry Sender

Dec. 22 (FT) —The recent rise in long-term US interest rates comes as good news for several leading hedge fund managers, including John Paulson, who have positioned their trading books to benefit from higher yields on US Treasury securities.

Mr Paulson, who made big gains earlier this decade by betting against the subprime mortgage market and whose firm, Paulson & Co, manages $33bn, has said he believes government stimulus efforts will inevitably lead to higher inflation and a corresponding rise in rates.

“It will be difficult for the government to withdraw the economic stimulus,” Mr Paulson said in a speech. “An increase in the monetary base leads to an increase in the money supply, which leads to inflation.”

Bond prices fall as yields rise, and Mr Paulson told the Financial Times last week that he has been hoping to benefit in the Treasury market by buying options that would become profitable if rates headed higher. TPG-Axon’s Dinakar Singh has been making similar options trades, according to a person familiar with the matter.

Julian Robertson, the hedge fund manager, has pursued a related strategy, hoping to benefit from a bigger difference between short-term and long-term interest rates, known as a steeper yield curve, a person familiar with his trades said.

The yield on the 10-year Treasury, which hit a crisis low of 2.055 per cent last year, has moved from 3.2 per cent last month to 3.75 per cent on Tuesday.

Hedge fund managers, however, have been hesitant to engage in short sales of Treasury bonds to profit from the rising yields – and falling prices – because of the Federal Reserve’s heavy involvement in the market. This has led some to buy options – dubbed “high strike receivers” – that would enable them to profit from sharply higher Treasury yields, hedge fund managers say. These trades, which are relatively cheap to execute because they are so out of the money, are based on the thesis that yields could hit 7 or 8 per cent.

“If they are right, and the world ends, they will make a fortune,” said one fund manager who is sceptical of the idea. “If they are wrong, they haven’t lost much.”

Some traders are cautious because many peers lost large sums betting that rates would rise in Japan in the 1990s – as yields fell to less than half a percentage point. The trade was termed the “black widow” because it left so many victims.

“Nobody understood the extent of deflation and economic weakness in Japan,” said Dino Kos of Portales Partners, a research consultancy, who was then a Fed official. “More money was lost on that trade than on any other single trade. Everyone piled in when rates were at 3 per cent and then at 2.5 per cent and then at 2 per cent.”


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Mankiw, you’re welcome…

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By N. GREGORY MANKIW
Published: December 12, 2009

IMAGINE you are a physician and a patient arrives in your office with a troubling and mysterious disease. Some of the symptoms are familiar, but others are not. You have never treated anyone with quite this set of problems.
David G. Klein

Weekend Business Podcast: Greg Mankiw on Fiscal Stimulus

Based on your training and experience, imperfect as it is, you come up with a proposed remedy. The patient leaves with a prescription in hand. You hope and pray that it works.

A week later, however, the patient comes back and the symptoms are, in some ways, worse. What do you do now? You have three options:

STAY THE COURSE Perhaps the patient was sicker than you thought, and it will take longer for your remedy to kick in.

UP THE DOSAGE Perhaps the remedy was right but the quantity was wrong. The patient might need more medicine.

RETHINK THE REMEDY Perhaps the treatment you prescribed wasn’t right after all. Maybe a different mixture of medicines would work better.

Choosing among these three reasonable courses of action is not easy. In many ways, the Obama administration faces a similar situation right now.

How hard is it to recognize a shortage of aggregate demand of this magnitude?????

When President Obama was elected, the economy was sick and getting sicker. Before he was even in office in January, his economic team released a report on the problem.

If nothing was done, the report said, the unemployment rate would keep rising, reaching 9 percent in early 2010. But if the nation embarked on a fiscal stimulus of $775 billion, mainly in the form of increased government spending, the unemployment rate was predicted to stay under 8 percent.

In fact, the Congress passed a sizable fiscal stimulus. Yet things turned out worse than the White House expected. The unemployment rate is now 10 percent — a full percentage point above what the administration economists said would occur without any stimulus.

To be sure, there are some positive signs, like reduced credit spreads, gross domestic product growth and diminishing job losses. But the recovery is not yet as robust as the president and his economic team had originally hoped.

So what to do now? The administration seems most intent on staying the course, although in a speech Tuesday, the president showed interest in upping the dosage. The better path, however, might be to rethink the remedy.

When devising its fiscal package, the Obama administration relied on conventional economic models based in part on ideas of John Maynard Keynes. Keynesian theory says that government spending is more potent than tax policy for jump-starting a stalled economy.

Yes, govt spending has a higher ‘multiplier’ than tax cuts, but either way that completely misses the point

With non convertible currency and floating fx. The choice between the two is a political decision. Tax cuts will restore private consumption with income led growth, while spending increases generally first increase public consumption by producing public goods and services. With excess capacity it’s a matter of what we want. Once that’s decided, the ‘multiplier’ only gives some idea of how far to go with either tax cuts or spending increases. The size of the spending and/or tax cuts is of no consequence beyond the effects on the real economy.

Personally, I have a notion of what the ‘right sized’ govt is, and would target that in any case. I’d have it a lot smaller in many areas where it tries to perform tasks directly, while broadening funding intiatives to meet national goals. But that’s another story.

The report in January put numbers to this conclusion. It says that an extra dollar of government spending raises G.D.P. by $1.57, while a dollar of tax cuts raises G.D.P. by only 99 cents. The implication is that if we are going to increase the budget deficit to promote growth and jobs, it is better to spend more than tax less.

This is a disgrace to Professor Mankiw and the rest of the economics profession that might agree and support this view.

The amount to spend and/or the amount of taxes cut per se is of no further economic consequence.

But it is the predominant view thats allowed the US economy to get into this mess in the first place.

Yes, there was a financial crisis, but gross ignorance is the only excuse for letting it spill over into the real economy, and stay spilled over for well over a year.

But various recent studies suggest that conventional wisdom is backward.

Those studies remain ‘out of paradigm’ as well, of course.

One piece of evidence comes from Christina D. Romer, the chairwoman of the president’s Council of Economic Advisers. In work with her husband, David H. Romer, written at the University of California, Berkeley, just months before she took her current job, Ms. Romer found that tax policy has a powerful influence on economic activity.

According to the Romers, each dollar of tax cuts has historically raised G.D.P. by about $3 — three times the figure used in the administration report. That is also far greater than most estimates of the effects of government spending.

Like it matters, as above. It’s the blind leading the blind, and giving each other Nobel prizes along the way.

Other recent work supports the Romers’ findings. In a December 2008 working paper, Andrew Mountford of the University of London and Harald Uhlig of the University of Chicago apply state-of-the-art statistical tools to United States data to compare the effects of deficit-financed spending, deficit-financed tax cuts and tax-financed spending. They report that “deficit-financed tax cuts work best among these three scenarios to improve G.D.P.”

Notice the prefix ‘debt financed’ which is an inapplicable gold standard term.

My Harvard colleagues Alberto Alesina and Silvia Ardagna have recently conducted a comprehensive analysis of the issue. In an October study, they looked at large changes in fiscal policy in 21 nations in the Organization for Economic Cooperation and Development. They identified 91 episodes since 1970 in which policy moved to stimulate the economy. They then compared the policy interventions that succeeded — that is, those that were actually followed by robust growth — with those that failed.

The results are striking. Successful stimulus relies almost entirely on cuts in business and income taxes. Failed stimulus relies mostly on increases in government spending.

All these findings suggest that conventional models leave something out. A clue as to what that might be can be found in a 2002 study by Olivier Blanchard and Roberto Perotti. (Mr. Perotti is a professor at Boccini University in Milano, Italy; Mr. Blanchard is now chief economist at the International Monetary Fund.) They report that “both increases in taxes and increases in government spending have a strong negative effect on private investment spending. This effect is difficult to reconcile with Keynesian theory.”

The problem is none of them have the fundamental understanding of how a currency works to be capable of understanding what they have compiled.

Do they seriously believe, for example, that if govt went out and hired 10 million people private investment spending would go down, all else equal? Any of you want to take that bet???

These studies point toward tax policy as the best fiscal tool to combat recession,

Again with the word ‘best’ that implies taxing less than spending per se is ‘bad.’

particularly tax changes that influence incentives to invest, like an investment tax credit. Sending out lump-sum rebates, as was done in spring 2008, makes less sense, as it provides little impetus for spending or production.

The main incentives for investing are a backlog of orders and cost cutting.

And while the lump sum rebates were not anywhere near the top of my long list for policy options, they did add to aggregate demand and kept things from being even worse.

Like our doctor facing a mysterious illness, economists should remain humble and open-minded when considering how best to fix an ailing economy. A growing body of evidence suggests that traditional Keynesian nostrums might not be the best medicine.

N. Gregory Mankiw is a professor of economics at Harvard. He was an adviser to President George W. Bush.

Feel free to send this along to him, thanks.


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Goodhart on narrow banking

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He’s correct in a world that doesn’t know how to use fiscal adjustments to sustain demand.

If we had had a full payroll tax holiday and per capita revenue sharing for the states introduced immediately after the real economy started experiencing the drop in demand associated with the Lehman failure and the Masters commodity liquidation, and all along had fed funded $8/hr jobs for anyone willing and able to work, the real economy would likely not have sustained anywhere near the damage it did. Unemployment may have risen a percent or so, and the economy would have quickly recovered.

And no one outside of investors caught with bad investments would have much cared about the financial crisis.

As long as the real economy is sustained, any financial crisis is far less of a concern- 1987, 1998, Enron, etc.

Narrow banking is not the answer

By Charles Goodhart

The proponents of narrow banking focus, almost entirely, on the liability side of banks’ balance sheets, and their concern relates to the need to protect retail depositors and the payments system. While this concern is entirely valid, it has been notable in the recent crisis that virtually no retail depositors lost anything, and the payment systems continued at all times to work perfectly. The crisis was not much about that, and policies served to protect these key elements satisfactorily.

The key problem that developed, and to some large extent remains, is that the fragility was experienced in the availability of credit to the real economy, companies and households. The modern economy cannot do without credit, and the need to maintain credit flows has been uppermost in the minds of the authorities.

Credit can be replace by income, and with income restored and sustained, credit quickly follows. Unfortunately, modern governments lack the understanding of their monetary systems to adjust incomes through counter cyclical fiscal policy.

The narrow banking proposal would shift virtually all such credit flows out of narrow banking into those parts of the financial system outside the narrow banking boundary, because the narrow banks would be required to invest in safe assets. So had a narrow banking system been in place, the crisis would have been even worse, with a virtually complete cessation of credit flows to the real economy.

Banks are public private partnerships implemented presumably to serve public purpose

‘Narrow banking’ can include bank lending for home mortgages, automobiles, credit cards, and any other assets deemed to suit public purpose to help isolate those sectors from lender related issues.


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Carry trade

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The article completely misses the point.

There is no ‘cash pouring into’ anything.

Nor is there a constraint on lending/deposits in any non convertible currency.

It is not a matter of taking funds from one currency and giving them to another.

There is no such thing.

Yes, the interest rate differential may be driving one currency high in the near term (not the long term) due to these portfolio shifts.

But the nation with the currency seeing the appreciation has the advantage, not the other way around.

Imports are the real benefits, exports the real costs, which the author of this piece has backwards.

The nation with the stronger currency is experiencing improving real terms of trade- more imports in exchange for fewer exports.

The most common way to realize this benefit is for the government to use the currency strength to accumulate foreign currency reserves by ‘pegging’ its currency to sustain it’s exports. This results in the same real terms of trade plus foreign exchange accumulation which can be of some undetermined future real benefit.

Better still, however, is cut taxes (or increase govt. spending, depending on your desired outcome) and sustain domestic demand, employment, and output, so now the domestic population has sufficient spending power to buy all that can be produced domestically at full employment, plus anything the rest of the world wants to net export to you.

Unfortunately those pesky deficit myths always seem to get in the way of anyone implementing that policy, as evidenced by this
article below and all of the others along the same lines. Comments in below:

>   
>   Steve Keen pointed me to it. Talks about the carry trade in US$ over to AUD$.
>   There are not Federal unsecured swap lines, would be interested in your take.
>   

Foreign speculation on our currency is a bubble set to burst

By Kenneth Davidson

Oct. 26 (National Times) — The pooh-bahs running US and British hedge funds and the banks supporting them are more than capable of reading the minutes of the Reserve Bank of Australia board meetings and coming to the conclusion that RBA Governor Glenn Stevens is committed to pushing up the cash rate from the present 3.25 per cent to 4 to 5 per cent if necessary.

And they are already betting tens of billions of dollars on what has so far been a sure bet.

But is always high risk, and not permitted for US banks by our regulators, though no doubt some gets by.

These foreign financial institutions are up to their old tricks. After getting trillions of dollars out of their respective governments to avoid GFC-induced bankruptcy – which was largely engineered by their criminal greed – because they are ”too big to fail”, they are already using their influence to maintain ”business as usual”.
Why funnel the money gouged out of American and British taxpayers into lending to their national economies to maintain employment when there are richer pickings elsewhere?

As above, these transactions directly risk shareholder equity. The govt. is not at risk until after private capital has been completely eliminated.

Two of those destinations are Brazil and Australia. Their resource-rich economies are still doing well compared with most other countries because they are riding in the slipstream of the strong demand for commodities from China and India.

Cash is pouring into these economies, not for development, but to speculate on the local currency and the sharemarket. The rising value of the Brazilian real and the Australian dollar against the US dollar has had a disastrous impact on both countries’ non-commodity export and import competing industries.

Yes, except to be able to export less and import more is a positive shift in real terms of trade, and a benefit to the real standard of living.

Brazil’s popular and largely economically successful left-wing Government led by President Lula da Silva is meeting the problem head on. It has decided to impose a 2 per cent tax on all capital inflows to stop the real appreciating further.

Instead, it could cut taxes to sustain full employment if that’s the risk they are worried about.

Arguably, the monetary strategy adopted by Stevens has compounded Australia’s lack of international competitiveness for our manufacturing and service industries, especially tourism. Since the end of 2008 our dollar has appreciated 27 per cent (as of last week). This means that financial institutions that invested money at the beginning of January are enjoying an annual rate of return on their investments of 35 per cent.

Tourism is an export industry. Instead of working caring for tourists a nation is better served taking care of its people’s needs.
And those profits are from foreign capital paying ever higher prices for the currency.

US and British commercial banks can borrow from their central banks at a rate less than 1 per cent. The equivalent RBA rate is 3.25 per cent and many pundits are forecasting the rate could go to 3.75 per cent before the end of 2009. This will increase the differential between Australian and British and US interest rates and make the scope for speculative profits even higher.

They are risking their shareholder’s capital if they do that, not their govt’s money, at least not until all the private equity is lost.
And the regulators are supposed to be on top of that.

Since the beginning of the year, $64 billion has poured into Australia in the form of direct and portfolio (share) investment and foreign lenders have switched $80 billion of foreign debt payable in foreign currencies to Australian currency. Most of the portfolio investment ($41 billion) has gone into bank shares. Banks now represent 40 per cent of the value of shares traded on the stock exchange, and while shares in the big four bank shares have increased by about 80 per cent (as measured by CBA shares), the Australian Stock Exchange Index has risen by only 30 per cent.

When anyone buys shares someone sells them. There are no net funds ‘going into’ anything.

Also, portfolio mangers do diversify globally, and I’d guess a lot of managers went to higher levels of cash last year, and much of this is the reversal. And it’s also likely, for example, that Australian managers have increased their holdings of foreign securities as well.

Foreigners have shifted out of Australian fixed interest debt and into equities because as interest rates go up, the capital value of fixed debt declines. By driving up interest rates to curb inflationary expectations and the prospect of a housing price bubble the RBA is in far greater danger of creating a stock exchange asset price bubble as well as an Australian dollar bubble. Once foreigners believe interest rates have peaked, the bubbles are likely to be pricked as financial speculators attempt to realise their gains. This could lead to a stampede out of Australian denominated securities.

Markets do fluctuate for all kinds of reasons, both short term and long term. The Australian dollar has probably reacted more to resource prices than anything else. But again, the issue is real terms of trade, and domestic output and employment.

With unemployment expected to continue to rise, and the level of unemployment disguised by growing numbers of workers being forced to work part-time, there is little chance of the underlying inflation rate, already below 2 per cent, increasing as a result of a wages break-out. The last wages breakout (leaving aside the explosive growth in executive salaries in the past three decades) occurred in 1979.

This gives the govt. cause to increase domestic demand with fiscal adjustments, including Professor Bill Mitchell’s ‘Job Guarantee’ proposal which is much like my federally funded $8/hr job for anyone willing and able to work proposal.

The world has moved on but the obsessive debate about wage inflation and union powers hasn’t. Since the beginning of the ’80s, the problem has been periodic bouts of asset price inflation. It is the biggest danger now.

Instead of controlling the unions, there should be control of financial institutions. The Australian dollar bubble and the incipient housing bubble should be micro-managed. Capital inflow could be dampened by a compulsory deposit of 1 to 2 per cent to be redeemed after a year to stop speculative inflow. Home ownership has become a tax shelter. The steam could be taken out of the rise in house prices if negative gearing was limited to new housing. This would obviate the need for higher interest rates that affect everyone.

The Job Guarantee offers a far superior price anchor vs our current use of unemployment as a price anchor. Also, I strongly suspect that the mainstream has it wrong, and that it is lower rates that are deflationary.


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Buiter blog

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The economics profession is a disgrace. None of them seem to fathom monetary operations.

Fiscal expansions in submerging markets

By Willem Buiter

This morality tale has important consequences for a government’s ability to conduct effective countercyclical policy. For a fiscal stimulus (current tax cut or public spending increase) to boost demand, it is necessary that the markets and the public at large believe that sooner or later, measures will be taken to reverse the tax cut or spending increase in present value terms.

Not true. This is some kind of ricardian equivalent twist that is inapplicable. For example, govt spending to hire someone is a direct increase in demand. And any dollar spent due to a tax cut increases demand by that dollar. (these are minimums)

If markets and the public at large no longer believe that the authorities will assure fiscal sustainability by raising future taxes or cutting future public expenditure by the necessary amounts, they will conclude that the government plans either to permanently monetise the increased amounts of public debt resulting from the fiscal stimulus, or that it will default on its debt obligations.

In fact that has already happened. As evidenced by the price of gold in an otherwise deflationary environment.

Permanent monetisation of the kind of government deficits anticipated for the next few years in the US and the UK would, sooner or later be highly inflationary.

‘Monetization’ alters interest rates, not inflation. Only to the extent that interest rates influence inflation does monetization influence inflation. And there’s not much evidence rates have much to do with inflation, and mounting evidence they have no influence on inflation. Not to mention my suspicions that lower rates are highly deflationary.

This would raise long-term nominal interest rates

Not directly- only to the extent market participants believe the fed will raise rates over the long term.

and probably give risk to inflation risk premia on public and private debt instruments as well.

Has already happened in many places.

Default would build default risk premia into sovereign interest rates, and act as a break on demand.

This has already happened and has not functioned as a break/brake? On demand or as a constraint on deficit spending.

Beacause I believe that neither the US nor the UK authorities have the political credibility to commit themselves to future tax increases and public spending cuts commensurate with the up-front tax cuts and spending increases they are contemplating,

Since taxes serve to moderate agg demand, this implies that when economies ‘overheat’ the authorities won’t tighten fiscal policy. However, the automatic fiscal stabilizers conveniently do that for them, as tax revenues rise during expansions faster than even govt can spend. And this fiscal consolidation does induce contraction and ends the expansion. It was the too low deficit in 2006 the slowed aggregate demand and began this latest down turn, with a little help from the drop in demand when the housing frauds were discovered.

I believe that neither the US nor the UK should engage in any significant discretionary cyclical fiscal stimulus, whether through higher public spending (consumption or investment) or through tax cuts or increased transfer payments.

There is no other way to add to aggregate demand, except by letting the auto stabilizers doing the exact same thing the ugly way- through a deteriorating economy- rather than proactively which prevents further decline.

Instead, the US and UK fiscal authorities should aggressively use their fiscal resources to support quantitative easing and credit easing by the Fed and by the Bank of England (through indemnities offered by the respective Treasuries to the Fed and the Bank of England to cover the credit risk on the private securities these central banks have purchased and are about to purchase).

Qe is just an asset shift that does nothing for aggregate demand, except possibly through the interest rate channel which, as above, is minimal if not counterproductive.

The £50 bn indemnity granted the Bank of England for its Asset Purchase Facility, by HM Treasury should be viewed as just the first installment on a much larger indemnity that could easily reacy £300 bn or £500 bn.

Purchasing financial assets doesn’t alter aggregate demand.

The rest of the scarce, credibility-constrained fiscal resources

Fiscal resources are not credibility constrained.

Japan today forecast deficits of over 200% of GDP with no signs of market constraints. In fact, their 10 year JGB’s trade at about 1.3%, and they were downgraded below Botswana.

of the US and the UK should be focused on recapitalising the banking system with a view to supporting new lending by these banks, rather than on underwriting existing assets or existing creditors.

Govt capitalization of banking is nothing more than regulatory forbearance. Bank capital is about how much private capital gets lost before govt takes losses. In the US, having the Treasury buy bank equity simply shifts the loss, once private equity is lost, from the FDIC to the Treasury, which funds the FDIC in the first place.

Other available fiscal resources should be focused on supporting, through guarantees and insurance-type arrangements, flows of new lending and borrowing. As regards recapitalisation and dealing with toxic assets I either favour temporary comprehensive nationalisation or the ‘good bank’ model. Existing private shareholders of the banks, and existing creditors and holders of unsecured debt (junior or senior) should be left to sink or swim without any further fiscal support, as soon as new lending, investment and borrowing has been concentrated in new, state-owned ‘good banks’.

The problem with banking is the borrowers can’t afford their payments. This needs to be fixed from the bottom up with payroll tax holiday or VAT holiday, not from the top down as he suggests.

It is true that, despite the increase in longer-term Treasury yields from the extreme lows of early December 2008, recent observations on government bond yields don’t indicate any major US Treasury debt aversion, either through an increase in nominal or real longer-term risk-free rates or through increases in default risk premia – although it is true that even US Treasury CDS rates have risen recently to levels that, although low by international standards, are historically unprecedented.

Yes, and 10 year rates in Japan are 1/3 of the US rates, and their debt is 3 times higher. He’s barking up the wrong tree.

In a world where all securities, private and public, are mistrusted, the US sovereign debt is, for the moment, mistrusted less than almost all other financial instruments (Bunds are a possible exception).

And Japan even less mistrusted with triple the deficits?

But as the recession deepens, and as discretionary fiscal measures in the US produce 12% to 14% of GDP general government financial deficits – figures associated historically not even with most emerging markets, but just with the basket cases among them, and with banana republics –

Only because those numbers include the tarp which is only a purchase of financial assets, and not a purchase of goods and services. Ordinarily tarp would have been done by the fed and the deficit lower, as it’s the Fed’s role to purchase financial assets. But this time it didn’t happen that way except for maiden lane and a few other misc. Purchases.

I expect that US sovereign bond yields will begin to reflect expeted inflation premia (if the markets believe that the Fed will be forced to inflate the sovereign’s way out of an unsustainable debt burden) or default risk premia.

That’s all priced in the TIPS and I don’t see much inflation fear there.

The US is helped by the absence of ‘original sin’ – its ability to borrow abroad in securities denominated in its own currency –

A govt doesn’t care which holders of its currency buys its securities. Deficit spending creates excess reserve balances at the Fed. The holders of those balances at the fed, whether domestic or foreign, have the option of doing nothing with them, or buying Treasury securities, which are nothing more than interest bearing accounts also at the Fed. The other option is spending those balances, which means the fed transfers them to someone else’s account, also at the Fed.

and the closely related status of the US dollar as the world’s leading reserve currency. But this elastic cannot be stretched indefinitely. While it is hard to be scientifically precise about this, I believe that the anticipated future US Federal deficits and the growing contingent exposure of the US sovereign to its financial system (and to a growing list of other more or less deserving domestic industries and other good causes) will cause the dollar in a couple of years to look more like an emerging market currency than like the US dollar of old. The UK is already closer to that position than the US, because of the minor-league legacy reserve currency status of sterling.

Meaning what? Just empty rhetoric so far.

Under conditions of high international capital mobility, non-monetised fiscal expansion strengthens the currency if the government has fiscal-financial credibility, that is, if the markets believe the expansion will in due cause be reversed and will not undermine the sustainability of the government’s fiscal-financial-monetary programme.

It’s a function of nonresident ‘savings desires’ of US financial assets.

If the deficits are monetised, the effect on the currency is ambiguous in the short run (it is more likely to weaken the currency if markets are forward-looking),

Because it’s a non event for the fed to buy financial assets, apart from small changes in term interest rates.

but negative in the medium and long term. If the increased deficits undermine the credibility of the sustainability of the fiscal programme, then the effect on the currency could be be negative immediately.

Ok, lots of things can turn traders against anything that’s traded. No news there.

The only element of a classical emerging market crisis that is missing from the US and UK experiences since August 2007 is the ’sudden stop’ – the cessation of capital inflows to both the private and public sectors.

With non convertible currency and floating fx there is no such possible constraint on federal spending and/or federal lending. The private sector, and other users of the currency, is a different story, and always vulnerable to a liquidity crisis.

Hence the ECB was bailed out by the fed with unlimited swap lines (functionally unsecured dollar loans from the Fed) when its member banks got caught short dollars last year.

That was their ‘sudden stop’ and it happened only because of foreign currency issues, not euro issues, and it happened to the private sector, not the public sector. Not to say current institutional arrangements don’t make the euro national govts subject to liquidity issues, but that’s another story.

There has been a partial sudden stop of financial flows, both domestic and external, to the banking sector and the rest of the private sector, but the external capital accounts are still functioning for the sovereigns and for the remaining creditworthy borrowers.

Yes, it’s about credit worthiness for borrowers who are users of a currency and not govts. In their currency of issue.

But that should not be taken for granted, even for the US with its extra protection layer from the status of the US dollar as the world’s leading reserve currency. A large fiscal stimulus from a government without fiscal credibility could be the trigger for a ’sudden stop’.

The fact that this article has any credibility speaks volumes.


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Plutonomies

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>   
>   (email exchange)
>   
>   On Sun, Oct 18, 2009 at 12:01 PM, Russell wrote:
>   

Plutonomies

>   
>   I don’t know if the very wealthy support consumption.
>   

As a point of logic yes, it can be done, and we’ve been moving in that direction.

>   
>   I was always under the impression it was the mass of the people
>   not the mass of wealth. Gillian Tett supports your thinking on this.
>   

Yes:

The essential thesis is that plutonomies arise when there are factors such as “disruptive productivity gains, financial innovation, capitalist-friendly governments, overseas conquests and dopamine-heavy immigrants, the rule of law, patent protection and great complexity exploited by the wealthy of the time”.

This description has applied to countries such as the US, UK, Canada and Australia recently: in the US, for example, the top 1 per cent control almost a quarter of the wealth. And that has big implications for consumer spending or global financial flows.

For while economists tend to watch factors such as unemployment to predict consumption, Mr Kapur thinks this can be misleading because it is the elite rich – not the middle class – who tend to drive consumption.

Last year, for example, this elite cut spending and raised saving because their assets plunged in value. However, in the next year, Mr Kapur is expecting plutonomists to make a comeback. As a result, he expects spending to reappear.


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Godley letter to FT

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Thanks, will distribute and post on my blog.

Known Wynne for quite a while.

He’s been doing sector analysis for maybe 50 years and has often been the UK’s top forecaster because of it.


Immediate cuts to budget deficit will worsen recession

Oct. 9 (FT) — Sir, George Osborne is committing himself unconditionally to making very large cuts in the budget deficit. I think he may be very seriously mistaken.

If these cuts were all to be made immediately he would obviously make the present recession very much worse than it already is.

To make sense of his proposed cuts it must be assumed that there is a rise in private expenditure relative to income (ie, a fall in net private saving) that roughly matches them in both scale and timing. But it is quite likely that private saving will not fall nearly enough. If, as I foresee, it does not do so, then Mr Osborne’s cuts will be much too large.

Wynne Godley,
King’s College,
Cambridge University, UK


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Krugman in NYT Blog

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>   
>   (email exchange)
>   
>   On Tue, Sep 29, 2009 at 11:20 AM, Joshua Davis wrote:
>   
>   moving in the right direction for sure, but for partly
>   the wrong reason…he still misses the point that we’re
>   not on a gold standard…
>   

Yes, very much so. Does not seem like it would take much to set him straight.

If anyone on this list knows him, please email him a copy of ‘the 7 deadly frauds’ thanks!

The true fiscal cost of stimulus

By Paul Krugman

Sept. 29 (NYT Blog) — As I get ready for the CAP and EPI events, I’ve been thinking more about the issue of crowding in. (See also Mark Thoma.) And I’m coming more and more to the conclusion that the public debate over fiscal stimulus, which views it as an agonizing tradeoff between possible benefits now and certain costs later, is wildly off base.

Just to be clear, we’re talking about fiscal stimulus in a liquidity trap — that is, under conditions in which conventional monetary policy has lost traction, in which the Fed would set interest rates much lower if it could. Under more normal conditions the conventional view of stimulus is more or less right. But we’re in liquidity-trap conditions now, and will be for a long time if official projections are at all right. So what does that imply?

First of all, as I and others have pointed out, fiscal expansion does not crowd out private investment — on the contrary, there’s crowding in, because a stronger economy leads to more investment. So fiscal expansion increases future potential, rather than reducing it.

And yes, there’s some evidence to that effect beyond the procyclical behavior of investment. The new IMF analysis of medium-term effects of financial crisis finds that

    the evidence suggests that economies that apply countercyclical
    fiscal and monetary stimulus in the short run to cushion the
    downturn after a crisis tend to have smaller output losses over
    the medium run.

So fiscal expansion is good for future growth. Still, it does burden the government with higher debt, requiring higher taxes or some other sacrifice in the future. Or does it? Well, probably — but not nearly as much as generally assumed.

Here’s why: first, in the short run fiscal expansion leads to higher GDP, which leads to higher revenues, which offset a significant fraction of the initial outlay. A billion dollars in stimulus probably leads to only $600 million or a bit more in additional debt.

But that’s not the whole story. Crowding in raises future GDP — which raises future tax revenues. And the rise in revenues relative to what they would have been otherwise offsets at least some of the burden of debt service.

I’m not proposing a fiscal-stimulus Laffer curve here: it’s probably not true that spending money actually improves the government’s long-run fiscal position (although that’s certainly within the range of possibilities.) What I am suggesting is that fiscal stimulus under current conditions, where theFed funds rate “ought” to be around -5 percent, does much, much less to hurt that long-run position than the headline number would suggest.

And that, in turn, means that penny-pinching on stimulus is deeply, destructively foolish.


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