Category Archives: Financial Times

SNB Not Pursuing ‘Beggar-Thy-Neighbor’ Policy, Roth Tells FT

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Looks like he’s been reading my blog.

It is a beggar thy neighbor policy, by definition.

SNB Not Pursuing ‘Beggar-Thy-Neighbor’ Policy, Roth Tells FT

by Simone Meier

Mar 17 (Bloomberg) — Swiss central bank President Jean- Pierre Roth said the bank is ready to stem further gains in the Swiss currency if needed, the Financial Times reported.


“We have clearly shown what our commitment is and the market has reacted accordingly,” Roth said, according to the FT. “We have a clear strategy.”

Roth said Switzerland “would be foolish, as a small and open economy, to try to gain competitiveness through the currency.” He said that it’s “not a beggar-thy-neighbor policy. It’s just to protect the Swiss economy from deflation.”


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Bill Dunkelberg on the Economy

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Some interesting facts, but yet another professor of economics who doesn’t understand the monetary system.

Notes on the Economy

Professor Bill Dunkelberg, Ph.D.

Mar 10, 2009

  • There is good news and bad news from the housing market this week. Housing starts fell to a level of 460,000 units last month, the lowest in decades. This looks bad given that in normal times we need about 1.5 million new starts to meet the demand from new households that are formed each year and deletions from the stock from storms, fire and demolition. We are only building a third of what we need.

    • Yes! The pent up demand has to be enormous. And with inventories as low as they are this could mean a rapid recovery in prices in many areas.

    This is good news because since 2000 we constructed over a million houses more than we needed. These surplus homes are weighing on house prices, driving them down. Under-producing will help get rid of the excess supply. Sales of existing homes have reached a rate of nearly 5 million, almost as many as were sold when the economy peaked in December of 2007. The oversupply problem in some areas such as Florida and California will take longer to resolve but the rest of the country will start to stabilize and construction will resume in the first half of this year.

  • There are a number of factors that are setting the stage for a resumption of economic growth later this year. First, if oil stays under $50 a barrel, we will enjoy the equivalent of a $400 billion dollar stimulus tax cut. It’s already in place.

    • Yes, though somewhat offset by a drop in spending by energy producers whose incomes have been cut drastically.

    As the recession lingers, pools of pent-up demand are building. Car sales have declined to a rate of 9 million cars, while we scrap 15 million from the stock of 250 million cars on the road. Buying will resume soon.

    Agreed.

    Plant and equipment expenditures have been postponed for some time and will soon have to be made. Inventories have been drastically depleted and will have to be replaced.

    Agreed.

    It is the reduced spending of the 140 million workers who still have a job that has slowed the economy to recession levels. The media news and our leadership have scared consumers and business owners. Their lack of confidence has resulted in the postponement of spending. This will begin to reverse itself this year and the private sector, not the government, will restart the economy and lead us out of recession as it always has in the past.

    Do not agree. Personal income and spending turned positive in January, with a large assist from government pay increases, including social security and other CPI Indexed payments. And in the past it has been government via the ‘automatic stabilizers’ that has turned the tide as well. Falling tax revenues and rising transfer payments due to the slowdowns added the financial assets that supported the subsequent expansions.

  • Government spending accounts for 20 percent of GDP and the federal budget alone is equal in size to 25 percent of our output. So, what government does has a large impact on the private sector economy.

    • Agreed! And today, as in the past, it is leading us out of this recession. And it was the proactive Bush fiscal adjustments in 2003 that led us out of that slowdown and assisted the automatic stabilizers, rather than allowing them to play it out in the ‘ugly way’ as we have done currently.

    Currently, the absence of a clear direction and plan from Washington is hurting the financial markets and private spending. The confusion surrounding policies for dealing with our banking problems has driven stock prices for banks to unbelievable lows. The sketchy program for assisting some homeowners with taxpayer money has generated both confusion and outrage. The so-called stimulus package doesn’t have much immediate stimulus in it such as tax cuts and since nobody read it, we don’t know what spending will be done and when.

    For the most part yes. That’s what can happen with a government who doesn’t know how the monetary system works.

    And of course we all worry about how the government will get the $800 billion that it proposes to spend. Remember, the only money the government has to spend is your money. So, tax hikes, supposedly only on rich people, and heavy borrowing are in our future.

    And when the academics also don’t understand how the monetary system works.

    They don’t seem to know that government spending is not operationally revenue constrained.

    They don’t seem to know that taxes function to reduce aggregate demand, and not to provide ‘revenue to spend’.

    They don’t seem to know that government ‘borrowing’ functions as interest rate support, and not to provide ‘revenue to spend’.

    They don’t seem to know that the only source of savings of financial assets for the non government sectors is government deficit spending.

    Everybody is waiting to see what the government is really going to do, waiting to be saved. Our experience in New Orleans suggests this is a bad idea.

    Agreed!

  • Soon consumers will start receiving checks from the so-called stimulus package. If you aren’t rich, you will receive a check for $400. The last time we did this was last year, with $500 checks.

    • And real Q2 08 GDP was up 2.8%

    According to the University of Michigan survey research center, 20 percent of the recipients said they would spend the money, 30 percent planned to save the money, and 50 percent planned to pay off debt.

    If the funds aren’t going to be spent and add to aggregate demand, it means we can ‘enjoy’ even larger tax cuts and/or spending increases until demand is restored to levels that supports desired output and employment.

    This is offered by some to discredit the notion that sending out checks will be stimulative, since only 20 cents on the dollar gets spent and the rest goes to savings or debt repayment. That isn’t necessarily bad.

    Right, as above. It’s actually a ‘good thing’.

    20 years ago, we saved over 10 percent of our after tax income but our saving rate fell to 0 in the past few years. At the end of last year, we saved 5 percent, nothing to brag about but an improvement.

    Interesting that it happened as the federal budget deficit went up? While the definition of savings varies, the savings of financial assets added by deficit spending are a substantial portion.

    But it was this sudden increase in savings that led to a huge reduction in retail sales in the fourth quarter, so in the short run, more saving can slow the economy.

    Yes, less spending slows the economy. And that immediately opens the door for a federal tax cut and/or spending increase to sustain demand.

    And if we don’t do that, it happens the ugly way, via the automatic stabilizers which ultimately rescue us from our own ignorance.

    But, if you don’t save and put money in the bank, no mortgage or business loans can be made.

    Yikes! Loanable funds theory! This is fixed FX/gold standard. Completely inapplicable with today’s non convertible currency and floating FX policy.

    The causation is from loans to deposits (and reserves).

    Making these loans results in new investment spending, not just consumption.

    Yes, funds are borrowed into existence.

    This helps to raise worker productivity and income.

    Yes, wise investment raises productivity.

    We have to stop borrowing from foreign savers and rely on our own savings to finance new investment and new home mortgages if we want to rebuild our economy.

    This is what happens when you are mired in loanable funds/fixed FX rhetoric.

    Academics should know that domestic credit funds foreign savings, not the reverse.

    But until you understand loans create deposits you remain part of the problem rather than part of the solution.

  • There are over 8,000 earmarks in the omnibus spending bill passed by congress. Here are some examples: sidewalk construction in Cherryland California, Totally Teen zone in Albany Georgia, school sidewalk in Franklin Texas, bus for Lawrence Kansas and Detroit Michigan and Culver City California, Lemon Street reconstruction in Florida and Vienna Virginia and Williamstown Vermont, 5th and Market Street improvements in Philadelphia, Old Tiger Stadium conservancy in Detroit, and the list goes on for 8,000 items like this.

    I am not offering a commentary on the worthiness of these projects, here’s my issue: why are these 8000 projects a federal matter, why is the Congress of the United States managing this? These are very local issues as are issues related to the quality of education.

    • Agreed, which is why I proposed the Feds in this case simply give the states funding on a per capita basis with no strings attached. This removes the ‘fairness’ issue and moves the fiscal responsibility issue to the state level.

    We send our money to Washington, put on knee pads and beg to get our money back to take care of local problems. Trust me, the overhead charge Congress imposes on your money is huge. Congress loves the power, of course, and loves having governors and business leaders groveling in front of them. This is nonsense, and hugely wasteful of our hard earned money.

    I don’t like this much either.

  • The latest available IRS data for 2006 indicate that tax filers with $200,000 or more in income, about 7 percent of all filers, paid $520 billion in income taxes. That was 60 percent of all income tax revenue paid. So, 7 percent of the taxpayers paid 60% of the income tax revenue collected. The top one percent paid in 40 percent of all tax revenue collected.

    The huge increases in spending now approved are to be funded by an increase in income taxes on so-called “rich” people. Suppose that we in fact take 100% of the incomes of those earning $500,000 or more. In 2006, a strong economic year, this would have produced about 1.3 trillion in tax revenue, less than half of government spending that year. With 4 trillion in spending expected in the 2010 budget and an economy much weaker than in 2006, it should be clear that raising taxes on the rich cannot come close to funding government spending. In 2006, taxing 100 percent of the incomes of those making $75,000 or more would have raised less than $4 trillion dollars.

    • When you recognize taxes serve to reduce aggregate demand, rather than provide funds for federal spending, the entire discussion is fundamentally altered, and much of the above becomes total nonsense.

    Also, if you look at net, after tax income, and if you look at income tax as a way to adjust after tax incomes progressively (as well as to reduce aggregate demand) you get a very different picture.

    That leaves the prospect of a trillion dollars in new borrowing

    And exactly that amount of new savings for the non government sectors. That’s the ‘important’ part.

    and interest on a larger debt for decades to come.

    That’s voluntary as the US could leave its current 0% interest rate policy in place indefinitely, as I have recommended. But that’s another story. (see ‘0 is the natural rate of interest’ on my website)

    Last year, we paid over $400 billion of tax payer money to service the debt. That’s $1,300 per person. This burden is only going to rise in the future as our indebtedness rises.

    First, we can alter that, as above so the point is largely moot.

    Second, interest income is taxable.

    Third, last year it was a bit over 2% of GDP last year but he didn’t phrase it that way to try to be alarmist.

    Not to mention the way federal debt is paid off is quite simple:

    The Fed debits your securities account and credits your bank’s Fed bank account: That’s all.

    Consumers are learning how to be lean and mean and save money (savings rate up to 5% of disposable income after years of 0% saved), perhaps the government should join the party.

    Funny how savings goes up as the Fed deficit goes up???

  • Recently, a well known governor, appearing on the Sunday talk shows, defended the proposal to tax rich people more by suggesting that Clinton’s tax hike resulted in budget surpluses and strong economic growth. It doesn’t take an economist to recognize the absurdity of that statement.

    • The strong economy generated the surplus via those pesky automatic stabilizers, which then caused the coincident drop in saving and the subsequent collapse in GDP.

    Yes, taxes were raised on the rich by a Democrat Congress. Then the democrats were thrown out. Fiscal conservatives gained control which helped control spending. The “politics” of the deficit were negative and the congressional budget office predicted huge deficits through 2000. But several events that are not likely to repeat in many lifetimes took over. Most important was “y2k”, a fear that anything with a chip would fail as the calendar clicked over to 2000. This produced a huge surge in tech spending which was accompanied by a telecom boom (fiber optics etc.) That drove employment to a record high 64.5% of the adult population.

    Fueled by a domestic credit expansion of over 7% of GDP as the surplus sucked financial assets from the domestic sector.

    This had nothing to do with raising taxes on the rich, but since economic growth was so strong, tax revenues came in much stronger than anticipated and several years of budget surpluses occurred.

    And equal drops in savings of financial assets- the equity that supports the credit structure. Which we are still recovering from today.

    Unfortunately all of this came to an end in the last half of 2000 while Clinton was still president. The budget surpluses would have occurred without the tax hike, but were probably larger because of it. A $100 billion of the surpluses was due to capital gains taxes in the best years, unfortunately not a tax on productive income generation. It was just another big redistribution of wealth, for every winner, a loser with government taking a slice along the way.

    Time to get back to the basics, it’s the private sector that creates wealth, not government and taxing working people will not enhance the recovery.

    The government sector can depress economic activity via fiscal drag from overly tight fiscal policy.

    This happens when the government doesn’t spend enough for us to pay taxes and net save as desired.

    With savings desire elevated (reduced desire to go into debt), the government needs to increase deficit spending to reduce the fiscal drag it’s imposing.

    Feel free to send this along to the good professor, thanks!


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    Fears rise on Russian foreign debt

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    Yes, the risk of Russian corporate defaults due to governmental difficulties goes with the territory.

    Fears rise over Russia’s foreign debt

    by Catherine Belton

    Feb 22 (Financial Times) — Western bankers are increasingly anxious about Russian companies’ ability to repay $500bn in foreign corporate debt after the government said this month it was suspending a $50bn bail-out programme due to dwindling reserves. Bankers are demanding clarity after Igor Shuvalov, first deputy prime minister, said in a closed-door briefing this month that Russia was going to switch focus from bailing out tycoons to supporting the banking system.


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    Re: Martin Wolf spot on

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    (email exchange)

    Cliff,

    Martin Wolf is spot on below. Our biggest risk is the reluctance of our leaders to implement the fiscal adjustments on an as needed, size no object, basis to reverse shortfalls in aggregate demand.

    >   
    >   On Fri, Feb 20, 2009 at 11:11 AM, Cliff wrote:
    >   
    >   Warren,
    >   
    >   Many people ask me why Japan did not have large
    >   inflation with their large deficits,
    >   

    They weren’t even large enough to fully offset the deflationary forces.

    >   
    >   and they ask will the U.S. be like Japan or will
    >   inflation recur in the next few years.
    >   

    Depends on crude prices. If they go up inflation as we know it comes back. This is very likely.

    We need a hard policy to cut our imported fuel consumption to prevent ‘inflation’ and declining real terms of trade.

    >   
    >   Please see the article below, and can you
    >   comment on the article and the related two
    >   questions posed above.
    >   
    >   Thanks, Cliff
    >   

    Japan’s lessons for a world of balance-sheet deflation

    by Martin Wolf

    Feb 17 (Financial Times) — What has Japan’s “lost decade” to teach us? Even a year ago, this seemed an absurd question. The general consensus of informed opinion was that the U.S., the U.K. and other heavily indebted western economies could not suffer as Japan had done. Now the question is changing to whether these countries will manage as well as Japan did. Welcome to the world of balance-sheet deflation.

    As I have noted before , the best analysis of what happened to Japan is by Richard Koo of the Nomura Research Institute.* His big point, though simple, is ignored by conventional economics: balance sheets matter. Threatened with bankruptcy, the overborrowed will struggle to pay down their debts. A collapse in asset prices purchased through debt will have a far more devastating impact than the same collapse accompanied by little debt.

    Most of the decline in Japanese private spending and borrowing in the 1990s was, argues Mr Koo, due not to the state of the banks, but to that of their borrowers. This was a situation in which, in the words of John Maynard Keynes, low interest rates – and Japan’s were, for years, as low as could be – were “pushing on a string”. Debtors kept paying down their loans.

    How far, then, does this viewpoint inform us of the plight we are now in? A great deal, is the answer.

    First, comparisons between today and the deep recessions of the early 1980s are utterly misguided. In 1981, U.S. private debt was 123 per cent of gross domestic product; by the third quarter of 2008, it was 290 per cent. In 1981, household debt was 48 per cent of GDP; in 2007, it was 100 per cent. In 1980, the Federal Reserve’s intervention rate reached 19-20 per cent. Today, it is nearly zero.

    When interest rates fell in the early 1980s, borrowing jumped. The chances of igniting a surge in borrowing now are close to zero. A recession caused by the central bank’s determination to squeeze out inflation is quite different from one caused by excessive debt and collapsing net worth. In the former case, the central bank causes the recession. In the latter, it is trying hard to prevent it.

    Second, those who argue that the Japanese government’s fiscal expansion failed are, again, mistaken. When the private sector tries to repay debt over many years, a country has three options: let the government do the borrowing; expand net exports; or let the economy collapse in a downward spiral of mass bankruptcy.

    Despite a loss in wealth of three times GDP and a shift of 20 per cent of GDP in the financial balance of the corporate sector, from deficits into surpluses, Japan did not suffer a depression. This was a triumph. The explanation was the big fiscal deficits. When, in 1997, the Hashimoto government tried to reduce the fiscal deficits, the economy collapsed and actual fiscal deficits rose.

    Third, recognising losses and recapitalising the financial system are vital, even if, as Mr Koo argues, the unwillingness to borrow was even more important. The Japanese lived with zombie banks for nearly a decade. The explanation was a political stand-off: public hostility to bankers rendered it impossible to inject government money on a large scale, and the power of bankers made it impossible to nationalise insolvent institutions. For years, people pretended that the problem was downward overshooting of asset price. In the end, a financial implosion forced the Japanese government’s hand. The same was true in the U.S. last autumn, but the opportunity for a full restructuring and recapitalisation of the system was lost.

    In the U.S., the state of the financial sector may well be far more important than it was in Japan. The big US debt accumulations were not by non-financial corporations but by households and the financial sector. The gross debt of the financial sector rose from 22 per cent of GDP in 1981 to 117 per cent in the third quarter of 2008, while the debt of non-financial corporations rose only from 53 per cent to 76 per cent of GDP. Thus, the desire of financial institutions to shrink balance sheets may be an even bigger cause of recession in the US.

    How far, then, is Japan’s overall experience relevant to today?

    The good news is that the asset price bubbles themselves were far smaller in the US than in Japan. Furthermore, the U.S. central bank has been swifter in recognising reality, cutting interest rates quickly to close to zero and moving towards “unconventional” monetary policy.

    The bad news is that the debate over fiscal policy in the U.S. seems even more neanderthal than in Japan: it cannot be stressed too strongly that in a balance-sheet deflation, with zero official interest rates, fiscal policy is all we have. The big danger is that an attempt will be made to close the fiscal deficit prematurely, with dire results. Again, the U.S. administration’s proposals for a public/private partnership, to purchase toxic assets, look hopeless. Even if it can be made to work operationally, the prices are likely to be too low to encourage banks to sell or to represent a big taxpayer subsidy to buyers, sellers, or both. Far more important, it is unlikely that modestly raising prices of a range of bad assets will recapitalise damaged institutions. In the end, reality will come out. But that may follow a lengthy pretence.

    Yet what is happening inside the US is far from the worst news. That is the global reach of the crisis. Japan was able to rely on exports to a buoyant world economy. This crisis is global: the bubbles and associated spending booms spread across much of the western world, as did the financial mania and purchases of bad assets. Economies directly affected account for close to half of the world economy. Economies indirectly affected, via falling external demand and collapsing finance, account for the rest. The US, it is clear, remains the core of the world economy.

    As a result, we confront a balance-sheet deflation that, albeit far shallower than that in Japan in the 1990s, has a far wider reach. It is, for this reason, fanciful to imagine a swift and strong return to global growth. Where is the demand to come from? From over-indebted western consumers? Hardly. From emerging country consumers? Unlikely. From fiscal expansion? Up to a point. But this still looks too weak and too unbalanced, with much coming from the US. China is helping, but the eurozone and Japan seem paralysed, while most emerging economies cannot now risk aggressive action.

    Last year marked the end of a hopeful era. Today, it is impossible to rule out a lost decade for the world economy. This has to be prevented. Posterity will not forgive leaders who fail to rise to this great challenge.


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    Richard Koo on fiscal policy and interest rates

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    Met Richard years ago. Seems he’s still confused on fiscal policy:

    Bond issues to fund capital injections will not lead to higher interest rates

    Right! The CB sets rates. Too bad he didn’t stop here rather than try to explain the process.

    Japan’s second round of capital injections was four times the size of the first, and some question the ability of US capital markets to absorb such a large emission of government debt. However, the 1989 S&L crisis demonstrated that funds raised for the purpose of rescuing the financial sector will not lead to higher interest rates.

    True!

    This is because, unlike fiscal outlays for public works, money spent to rescue the financial system does not reduce the amount of investment funds available in the financial markets.

    Huh???

    Assume, for example, that the government issues $100 of Treasury bonds to recapitalize a troubled bank.

    And then makes a payment to the bank.

    The bank receiving the capital injection would credit its capital account by $100 and then invest that $100. In effect, there will be $100 in the market to be invested regardless of whether the government issues debt to rescue the bank.

    The $100 gets credited to the banks account at the CB. The bank can leave it there or look for alternatives.

    Purchases of alternatives in the private sector cause the banks $100 to be ‘wire transferred’ to another bank.

    That means the bank’s account at the CB is reduced by $100 and another bank’s account at the CB is increased by $100.

    Because the $100 represents capital, the bank’s investment should be liquid and easily convertible into cash. The asset that best fills this bill is government securities

    Ok.

    If the bank decides to buy government debt with the money, the government will have another $100 to fund a capital injection.

    I assume he means new government debt as he started with the government issuing $100 of bonds and recapitalizing the bank.

    Two rubs.

    First:

    The government would only issue additional bonds if it wanted to (deficit) spend additional funds.

    And it if wanted to issue bonds and (deficit) spend new funds, it would do so whether this particular bank wanted to buy the bonds or not. That is, the bank wanting to buy bonds is not the enabling force for (deficit) spending.

    Second:

    The sale of the original $100 of bonds reduced total bank reserves by $100 and the payment of the $100 to the bank added $100 to total bank reserves. So the initial bond issue and the recapitalization left bank reserves offset each other leaving total bank reserves unchanged. Institutionally, issuing new bonds starts a new series of transactions, and, again, that particular bank is not the enabling force.

    If, on the other hand, the government uses that $100 to build bridges or roads, that money will leave the capital markets and be spent on wages or construction materials, producing a corresponding decrease in the amount of investment funds available.

    I don’t follow this distinction at all.

    In this case, as before, the Treasury borrowing $100 reduces bank balances at the CB by $100, and the Treasury spending $100 as above adds $100 to bank balances at the CB, leaving total bank balances (reserves) unchanged.

    In short, money spent on public works projects leads to higher interest rates because it does not find its way back to the capital markets.

    Not the case, interest rates go to where the CB sets them, one way or another.


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    Clinton in Japan

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    Isn’t this sweet???

    Clinton, in Japan, talks of ‘harmony’ in US policy

    by Arshad Mohammed

    Feb 17 (Reuters) — U.S. Secretary of State Hillary Clinton spoke on Tuesday of promoting “balance and harmony” in U.S. foreign policy as she visited Japan, drawing an implicit contrast to the administration of former President George W. Bush.

    Clinton began her first full day in Asia with a visit to Tokyo’s Meiji shrine, where she took part in a purification ceremony at the Shinto shrine dedicated to Emperor Meiji, considered the father of modern Japan.

    Yes, a US democrat honoring emperors and royalty.

    Making her first trip as secretary of state, Clinton plans to consult Japanese officials on how to deal with the global financial crisis,

    If she has any ideas why hasn’t she told us?

    North Korea’s nuclear programs and the war in Afghanistan, a legacy of the Bush administration.

    “I started this morning at the Meiji shrine and was talking to the head priest there who told me about the importance of balance and harmony,” Clinton told about 200 U.S. diplomats and their families at the U.S. embassy.

    “It’s not only a good concept for religious shrines, it’s a good concept for America’s role in the world,” she added, without citing Bush by name or the U.S.-led invasion of Iraq, which polarized global opinion. “We need to be looking to create more balance, more harmony.”

    Reads like she’s broadening her religious beliefs???

    “We’re going to be listening but we’re also going to be asking for more partnerships to come together to try to work with us to handle the problems that none of us can handle alone,” Clinton added, referring partly to the global financial crisis.

    Partnerships to do what? No secrets, please!

    Japan has been especially hit hard by the economic slowdown. Its economy shrank in the final quarter of 2008 at the fastest rate since the first oil crisis in 1974, and economists bet on another big contraction in January-March.

    “These are hard times economically for the Japanese people, just as it is in many places around the world,” Clinton said. “I am absolutely confident we will navigate our way through these difficulties.”

    The blind leading the blind, but this time holding hands?

    China next…


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    Re: The pressure increases on the eurozone

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    These types of articles have gotten respectable and are getting more strident by the hour.

    I do think a banking crisis where the national government can’t or won’t write the check freezes the entire payments system, as no one will want to keep any funds in a eurozone bank, nor will they have anywhere to go other than actual cash.

    Gold had been benefiting by all this, but looks to me like a major bubble that breaks when the eurozone resolves itself one way or another.

    >   
    >   On Mon, Feb 16, 2009 at 5:27 PM, wrote:
    >   
    >   Even the euro enthusiasts are now starting to contemplate the break-up
    >   of the European Monetary Union, which basically would finish the euro.
    >   This problem is becoming evident to more people in the euro zone, but
    >   not reflected yet in policy:
    >   

    Narrow-minded leadership hurts Europe

    by Wolfgang Münchau

    Feb 15 (Financial Times) — “It is justifiable if a factory of Renault is built in India so that Renault cars may be sold to the Indians. But it is not justifiable if a factory … is built in the Czech Republic and its cars are sold in France” – Nicolas Sarkozy, president of France.

    This is a troubling statement indeed. But instead of launching a tirade against Mr Sarkozy, I would like to make an observation that is perhaps not immediately evident: his statement is entirely consistent with the way the European Union has reacted to the financial crisis.

    To see the link between crisis management and the rise in protectionism, look at the initial policy response to last September’s financial shockwaves. European leaders have woefully underestimated the crisis and possibly still do. The European economy is now heading towards a depression, with German gross domestic product falling at an annualised rate of almost 9 per cent. The early misjudgment of the crisis resulted in stimulus packages with two defects. They were initially too small but, more importantly, they were not co-ordinated. One important aspect of the economic meltdown is the presence of strong cross-country spillovers, both globally and inside the EU. The policy response failed to take account of these spillovers.

    For the bank bail-out programmes, the EU managed to set a minimum level of competition rules, but these programmes, too, were national and not co-ordinated. So how does the combined effect of these two unco-ordinated responses lead to protectionism?

    If stimulus money is dispersed at national level, governments naturally try to make sure that the money stays inside their countries. The prospect that consumers might spend the money on imported goods was one of the reasons why eurozone governments were reluctant to cut taxes. Because of EU competition rules, the same logic also applies to government purchases. Under those rules, governments had to open public projects to EU-wide tenders. If you play by the rules, keeping the cash in your country is not easy.

    Governments have since relaxed those rules. In other words, if you want to make sure that these programmes function in their warped way, you have to dismantle the single market. The same logic applies to the bank rescue packages. If the European Commission tried to block each uncompetitive bank rescue, it would be blamed for causing a financial collapse. Governments have found a way to circumvent the EU, by breaking so many rules at once, that the Commission cannot even begin to react effectively.

    Expect to see three effects with progressively destructive force. The first is that the stimulus is much less effective than it could otherwise have been. When everybody tries to gain a competitive advantage over each other, the effects usually cancel out.

    Second, the stimulus and bank rescue packages harm the single European market directly. The French subsidies are more blatant, as is the protectionist rhetoric of its president. But everybody in Europe plays the same game. It is not as though the single market is the default position for European commerce. Much of the service sector is exempted. Europe lacks an effective pan-European retail infrastructure and retail banking system. Reversing this programme long before it is completed would be a mistake.

    Third, and most destructive, the combined decision on stimulus and financial rescue packages poses an existential threat to monetary union. A blanket loan guarantee to every bank, as most governments have granted, in combination with indiscriminate capital injections and a reluctance to restructure, will mean the transformation of private into sovereign default risk – aggravated further by the economic downturn. Some insolvent banks are now owned by the state, while the bulk of damaged, not-yet-insolvent banks are lingering on, hoarding cash. This programme is a drain of resources with no resolution in sight.

    I would now expect several eurozone countries with weak banking sectors to get into serious difficulties as the crisis continues. There is a risk of cascading sovereign defaults. If this was limited to countries of the size of Ireland or Greece, one could solve this problem through a bail-out. But solvency risk is not a problem confined to small countries. The banking sectors in Italy, Spain and Germany are increasingly vulnerable.

    When European leaders meet for their anti-protectionism summit on March 1, they will produce warm words to reaffirm their commitment to the single market. I suspect they will continue to misdiagnose the crisis. Protectionism is not the root of the problem. The protectionism we are experiencing now is caused by co-ordination failure. It is neither sudden, nor surprising.

    The right course would be to solve the underlying problem – to shift at least some of the stimulus spending to EU or eurozone level and, ideally, drop those toxic national schemes altogether and to adopt a joint strategy for the financial sector, at least for the 45 cross-border European banks. But this is not going to happen. It did not happen in October, and it is not going to happen now. As a result of the extraordinary narrow-mindedness of Europe’s political leadership, expect serious damage to the single market in general and the single market for financial services in particular. As for the eurozone, I always argued in the past that a break-up is in effect impossible. I am no longer so sure.


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    Krugman: Stimulus package is now way inadequate

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    He’s starting to sound more like me. Maybe reading my blog?

    Be interesting if he starts pushing a full payroll tax holiday, though that’s tough for a Democrat ideologically nowadays, even though it’s their constituency that’s the most severely punished by it and needs it the most to stay in their homes, as they would be able to make their payments and thereby end the financial crisis as well.

    Also, he should favor the idea of giving the states revenue sharing on a per capita basis which means it can be ‘no strings attached.’ $300 billion/$1,000 per capita would be a good starting point.

    Feel free to forward this to him, thanks.

    What the centrists have wrought

    by Paul Krugman

    Feb 7 (Wall Street Journal)

    I’m still working on the numbers, but I’ve gotten a fair number of requests for comment on the Senate version of the stimulus.

    The short answer: to appease the centrists, a plan that was already too small and too focused on ineffective tax cuts has been made significantly smaller, and even more focused on tax cuts.

    According to the CBO’s estimates, we’re facing an output shortfall of almost 14% of GDP over the next two years, or around $2 trillion. Others, such as Goldman Sachs, are even more pessimistic. So the original $800 billion plan was too small, especially because a substantial share consisted of tax cuts that probably would have added little to demand. The plan should have been at least 50% larger.

    Now the centrists have shaved off $86 billion in spending — much of it among the most effective and most needed parts of the plan. In particular, aid to state governments, which are in desperate straits, is both fast — because it prevents spending cuts rather than having to start up new projects — and effective, because it would in fact be spent; plus state and local governments are cutting back on essentials, so the social value of this spending would be high. But in the name of mighty centrism, $40 billion of that aid has been cut out.

    My first cut says that the changes to the Senate bill will ensure that we have at least 600,000 fewer Americans employed over the next two years.

    The real question now is whether Obama will be able to come back for more once it’s clear that the plan is way inadequate. My guess is no. This is really, really bad.


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    3 blind mice- nonsense from the BOJ, MOF, and Prime Minister

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    Running with tails cut off with a carving knife:

    This is what you get when the head of the CB doesn’t understand monetary operations and reserves accounting:

    Shirakawa Says BOJ to Limit Asset Buying to Save Balance Sheet

    by Jason Clenfield and Toru Fujioka

    Feb 5 (Bloomberg) — Bank of Japan Governor Masaaki Shirakawa said the central bank will limit its purchases of stocks and corporate debt to protect its balance sheet and the credibility of the yen.

    “We are mindful of the need to eventually end the purchases” as they are “extraordinary measures,” Shirakawa told lawmakers in Tokyo today. Excessive buying would worsen the central bank’s balance sheet and “have a clear impact on the yen’s credibility,” he said.

    This what you get when the Finance Minister, Deputy Party Chairman, and former Finance Minister don’t understand monetary operations and reserve accounting:

    Nakagawa Says Japan Isn’t Considering Printing Money

    by Keiko Ujikane

    Feb 6 (Bloomberg) — Japan’s government isn’t considering printing new money, Finance Minister Shoichi Nakagawa said.

    He was responding to a report in the Financial Times that ruling party lawmakers would today propose printing 50 trillion yen ($549 billion) of a new currency to be used to pay for stimulating the economy.

    “The idea of the government printing money isn’t in my mind,” Nakagawa said at a press briefing in Tokyo today.

    “Japan’s economy is worsening rapidly so some people are discussing various ways of financing business activities and daily life.”

    Yoshihide Suga, deputy chairman of the ruling Liberal Democratic Party election strategy council, is among the group of politicians that will suggest using 30 trillion yen of the money on projects such as doubling the size of Tokyo’s Haneda airport, the Financial Times reported. The other 20 trillion yen would be for government purchases of stocks and real estate.

    Bank of Japan Governor Masaaki Shirakawa said Feb. 3 such a plan would hurt the credibility of the yen and lead to an increase in long-term yields by raising concern about the government’s ability to pay back the debt.

    Former Finance Minister Bunmei Ibuki, speaking at a meeting of ruling LDP factions, said currency printed by the government rather than the Bank of Japan would devalue the yen and invite inflation, according to the Yomiuri Newspaper.

    Discussions about the printing the money weren’t in the public interest, Ibuki said.

    This is what you get when the Prime Minister doesn’t understand monetary operations or reserve accounting:

    Japan May Consider 50 Trillion Yen in Scrip, FT Says

    by Dave McCombs

    Feb 6 (Bloomberg) — An aide to Japan’s Prime Minister Taro Aso and some lawmakers will today propose printing 50 trillion yen ($549 billion) worth of a new currency to be used to pay for stimulating the economy, the Financial Times reported, citing Koutaro Tamura, an upper house Diet member.

    Yoshihide Suga, deputy chairman of the ruling Liberal Democratic Party election strategy council, is among the group of politicians that will suggest 30 trillion yen of the scrip for programs for new industries and projects such as doubling the size of Tokyo’s Haneda airport, the report said. The other 20 trillion yen worth of the new currency would be allocated to government purchases of stocks and real estate.


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    Fed swap lines finally getting attention

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    Europe’s Growing Crisis Puts the Fed at Risk

    by Jack Willoughby

    Jan 31 (Barrons) — European central banks are at risk of defaulting on their currency swaps with the U.S. Federal Reserve, unless major banks on the Continent can find some way to stabilize their deteriorating balance sheets.

    TO AID THEIR AILING COMMERCIAL banks, central banks in Europe have relied on huge currency swaps, borrowing nearly $400 billion from the U.S. Federal Reserve. But as European commercial banks and European currencies deteriorate, repaying all that money to the Fed is becoming ever more difficult.

    “[Fed Chairman Ben] Bernanke’s assurances aside, I don’t see how they can easily be repaid,” warns Gerald O’Driscoll, senior fellow with the Cato Institute and formerly with Citigroup and the Dallas Fed.

    Here is how the swaps work. The Fed and, say, the European Central Bank agree to exchange a set amount of each other’s currencies at a certain exchange rate for six months, with a provision to renew the terms at maturity. The ECB uses the money to help aid bank-bailout packages for countries like Belgium, Finland, Hungary and Ireland that have troubled dollar-based assets. (Asian central banks are also part of the program, but haven’t utilized it nearly as heavily.) The Fed gets a promise from the ECB to repay the debt in six months.

    A big hitch: Europe’s commercial banks have more exposure to wounded emerging markets than U.S. counterparts. By one estimate, European banks provided three-quarters of the $4.7 trillion in cross-border loans to the Baltic countries, Eastern Europe, Latin America and emerging Asia. Their emerging-markets exposure exceeds that of U.S. lenders to Alt-A and subprime loans.

    THE SWAPS MAY MERELY delay the inevitable major shake-up of Europe’s banking system, O’Driscoll fears, and move the U.S. Fed beyond its original operating brief. Adds Neil Mellor, currency strategist at Bank of New York Mellon: “The aftershocks of the current global credit crisis are continuing to induce huge turbulence in the foreign-exchange markets, which is only now being more keenly felt in the eurozone and Britain.”

    You can debate the merits, but not the size of the swaps program. It is big. The Fed’s currency swaps have expanded from zero a year ago to $506 billion. Of the 14 central banks involved, the ECB by far has been the biggest counterparty to date, drawing down $264 billion (versus Mexico’s $33 billion drawdown via a similar program at the height of the 1995 peso crisis). Skeptics contend that the swaps are thinly disguised spending that was carried out without Congressional approval.

    “A case can obviously be made for [swaps] in the current global crisis,” says Al Broaddus, a former president of the Federal Reserve Bank of Richmond. “But these swaps always struck me as uncomfortably close to the Fed making fiscal policy. That is why, whenever they came up for authorization, I voted against them.” Last week, current Richmond Fed President Jeffrey Lacker voted against the Fed’s targeted-credit programs. It is rare for a Fed official to openly oppose the Federal Reserve Board.

    Traditionalists would prefer that the Fed stick to guiding interest rates and controlling the money supply. Fiscal policy, by contrast, forces the bank to decide who gets what, which can become a political calculation.

    In a Jan. 13 speech at the London School of Economics, Bernanke said the joint actions of the Fed and foreign central bankers “prevented a global financial meltdown in the fall.” Were these loans not made, he said, there would have been a much greater risk of crossborder financial collapses that would have left the global economy in even worse shape.

    The swap lines, Bernanke continued, were necessary and will be self-liquidating, running off the Fed’s book like some of its commercial-paper programs already have. “Liquidity provision by the central bank reduces systemic risk by assuring market participants that, should short-term investors begin to lose confidence, financial institutions will be able to meet the resulting demands for cash without resorting to potentially destabilizing fire sales of assets,” Bernanke said.

    Yet in recent weeks, the situation seems to have worsened for European banks and their home countries alike. The Dow Jones Euro Stoxx Banks Index is off 66% since Bernanke spoke. The Royal Bank of Scotland (ticker: RBS) is now a government property, as is Belgium’s Fortis (FORB.Belgium).

    “I would say that most of the big banks in Europe are insolvent,” says Dory Wiley, president of Commerce Street Capital, a money-management firm that invests in banking stocks. “That is what made them great — but unpredictable — shorts. They represent major components in those country funds everyone buys.” The danger is that governments, being the prime backstops for their commercial banks, will be forced into default or be downgraded. One hedge-fund manager advises retail investors to simply steer clear of Europe.

    Particularly vulnerable to further decline seem to be: Switzerland’s Credit Suisse (CS) and UBS (UBS), as well as Britain’s Barclays (BCS), Austria’s Erste Bank (EBS.Austria), Sweden’s Nordea (NDA.Sweden), the Netherlands’ ING (ING), Belgium’s Fortis and Spain’s Banco Santander (STD). These highly leveraged banks have huge emerging-market exposure, and reside in European countries whose financial resources are small relative to the assets of the giant banks they host.

    Little wonder that countries have had a difficult time selling their own debt to investors worried about both general economic conditions and the possibility that the banks’ problems may overwhelm their governments’ ability to cope with them. Moody’s Investors Service recently downgraded the credit ratings of Latvia, and commented on Greece; the agency cited, in part, bank problems in both countries. Ireland was just put on credit watch with a view to downgrade by Moody’s because of its banking crisis.

    How can the governments raise the cash to repay the Fed? The possibilities include printing more currency, thus undermining the euro’s value and increasing inflation; selling more sovereign debt; or raising taxes. None is a pleasing prospect.

    The Bottom Line:

    European banks face a new round of challenges. Most vulnerable: Credit Suisse, UBS, Barclays, Erste Bank, Nordea, ING, Fortis and Banco Santander.

    A further complication: Countries such as Ireland must go along with whatever currency policy the European Central Bank chooses, even if it isn’t necessarily the right one for the nation. Those outside the ECB currency regime — like Switzerland — can custom-tailor their monetary response. Ireland has gone so far as to threaten to leave the monetary union unless it gets more help.

    RECENTLY LATVIA, WHOSE central bank has bailed out the country’s banking system, was the scene of demonstrations and populist rhetoric aimed at granting borrowers relief on loans from Swedish banks — which have a big presence in the Baltic nation. If the Latvian government grants this relief, it would seriously hurt Swedish lenders, whose central bank has borrowed $25 billion from the Fed in these currency-swap lines.

    “This is the kind of fiscal pressure that can easily rip the European Union apart, and cause the kind of civic upset that leads to revolution,” says Sean Egan, co-founder of Egan-Jones, a credit-rating firm in Pennsylvania.

    And some of the most stable countries are involved. Switzerland, whose banking system has assets valued at eight times the nation’s annual economic output, is in hock to the Federal Reserve to the tune of $20 billion, a massive amount for a small country. Britain, with its highly leveraged financial system, has had to bail out its banks three times so far, yet must repay the Fed $54 billion.

    These pressures are starting to affect sovereign borrowing, too: Germany recently auctioned 10-year government bonds — but the government was left holding 32% of the offer, in what analysts regarded as a failed deal.

    Economists Carmen Reinhart of the University of Maryland and Ken Rogoff of Harvard have studied sovereign defaults going back to the 14th century, and found that mass sovereign defaults tend to run in waves when currencies begin to melt down. Says Reinhart, “We’ve found that global banking crises cause the kind of turbulence that leads to sovereign defaults. It’s just beginning.”

    Lee Hoskins, former president of the Cleveland Fed, in the early ’90s led a move to stop the U.S. central bank from using swap agreements to warehouse foreign currencies to help the Treasury implement its foreign-exchange policy. Hoskins views the Fed as pursuing a policy of credit allocation rather than targeting monetary aggregates or interest rates. Hoskins believes the Fed should let some of the banks here and abroad go under. “Unless we stop the forbearance and dispose of the insolvent banks, the problems are only going to get worse,” says Hoskins.

    Meanwhile, Bernanke says he isn’t so much managing the money supply on a quantitative basis, but rather pursuing “credit easing,” focusing on a mix of loans and securities affecting household- and business-credit conditions. Emergency loans and swap lines made to central banks will essentially be repaid once things return to normal for the big banks.

    Walker Todd, a former lawyer for the New York Fed, would prefer that Congress review these swap lines and the agreements behind them — to make sure they were made with the proper authority.

    Bernanke concedes that the banking sector is far from saved at this point: Worsening growth prospects, continued credit losses and markdowns will keep pressure on the capital and balance sheets of financial institutions.

    “More capital injections and guarantees may become necessary to ensure stability and the normalization of credit markets,” says the Fed chief.

    But shouldn’t Congress have a say in how much more the Fed lends to Europe?


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