Category Archives: Government Spending

Thaler’s Corner 19th Februaryy 2013: Positive Currency Wars!

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The usual excellent post!

Positive Currency Wars!

19 February 2013


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

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

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

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

United States

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

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

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

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

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

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

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

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

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

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

Europe

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

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

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

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

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

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

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

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

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

Japan

This is where things are really going to play out!

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

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

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

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

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

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

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

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

And that would also benefit its foreign trading partners!

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

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

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

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

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Lombard says unemployment could go over 8%

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If I recall correctly this was/is a ‘monetarist’ shop? Nice to see them recognizing the role of fiscal policy to this extent.

Why Over 8% Unemployment Could Lie Ahead

By Matt Clinch

Feb 18 (CNBC) — Severe fiscal tightening in the U.S. will lead to no growth or a contraction in the first two quarters of 2013 and will push unemployment over the 8 percent level, according to Lombard Street Research.

The knock-on effect will mean pain for the business sector, with corporate profits falling after a hit to consumer spending power, the firm said.

“Our view that unemployment could rise above 8 percent and that profits will be squeezed reflects a forecast of nil to negative 2013 (first quarter) growth, and further stagnation in (the second quarter),” a Lombard Street report released on Friday said.

The view contrasts sharply with that of other analysts who are considerably more bullish on the U.S. economy.

Keith McCullough, CEO of Hedgeye Risk Management told CNBC last week that he thinks employment could actually improve below 7 percent by the fourth quarter, adding that from a housing and employment perspective U.S growth is “pretty solid”.

Lombard Street does not agree.

At the start of the year, the payroll tax that funds Social Security was raised two percentage points to its 2010 level of 6.2 percent. This was the largest component of tax increases approved by Congress in the resolution to the “fiscal cliff”.

Retail sales rose 0.1 percent in January, data released by the Commerce Department showed on Wednesday. These two events together should set alarms bells ringing as tax increases suggest a slowdown in the pace of consumer spending, Lombard Street said.

“Retail sales data encouraged the idea that the payroll tax hike from 4.2 percent to 6.2 percent, worth 1 percent of personal disposable incomes, would pass off with little impact. But the effect of the payroll tax was only partly in January,” it said, indicating that only a modest impact would have been expected for January.

Monetary easing by the Federal Reserve provides few offsets to this drop in demand outside of the housing sector, according to Lombard Street.

“The contribution of housing growth to GDP (gross domestic product) has been about 0.4 percent and promises to continue; that of government spending has averaged -0.4 percent for the past three years, and could easily exceed this in (the first and second quarter),” it said.

This -0.4 percent contribution that the research firm cite is set to be complicated further with extra spending cuts after the “fiscal cliff” resolution and the sequestration – a deadline for automatic government spending cuts – due to kick in on March 1.

“Our assumption is that the sequestration is canceled in favor of further cuts in a new provision. But this means the contribution from public spending to GDP growth could well be more negative than the past -0.4 percent,” Lombard said.

“In February the full effect of the payroll tax hike will be reflected in disposable income, and the initial savings “cushion” is likely to give way, so real consumer spending could be down.”

This real consumer spending could be down by more than 2 percent (annualized), it said, with little recovery in March. Thus for the first quarter a dip of 1.5 percent on an annual rate should be expected, contributing -0.1 to GDP growth.

Inventory building and capital expenditure could prove positive factors on that figure, hence its forecasts that GDP could be flat to slightly down for the first quarter and remain stagnant for the second quarter. Along with the last quarter being negative, three straight quarters of zero growth will lead to a rise in the unemployment rate, the firm said.

“Given underlying labor force growth of about 1 percent, this would add 0.7-0.8 percent to the unemployment rate, which was 7.9 percent in January. Even a less pessimistic view of (first quarter) and (second quarter) would send unemployment over 8 percent,” it said.

The chief risk to the stock market is that a reduction of the budget deficit is likely to be offset largely by cuts in the business sector’s surplus, Lombard said, meaning a hit to corporate profits.

However, this might be considered to be a contrarian view with some seeing U.S. growth stabilizing in 2013.

Fed chief Bernanke has previously said that interest rates will be kept low until the unemployment rate reaches 6.5 percent. At the current rate of 150,000 jobs created every month, and 110,000 new entrants to the labor force, that will be around January 2017.

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ECB’S CONSTANCIO SAYS NEGATIVE INTEREST RATES ALWAYS POSSIBLE

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Negative rates are just a tax, of course. Pretty close to a PSI.

With deficits as high as they are, all they need to do is leave it all alone and a modest recovery will quickly materialize. But instead they keep pressing the austerity with a ‘we’ve paid the price to get this far- there’s no going back now’ mentality.

*ECB’S CONSTANCIO SAYS NEGATIVE INTEREST RATES ALWAYS POSSIBLE
*CONSTANCIO SAYS IMPACT OF NEGATIVE DEPOSIT RATE NOT CLEAR
*CONSTANCIO: ECB HAS LOOKED AT NEGATIVE RATES AT OTHER CENBANKS
*CONSTANCIO: ECB IS TECHNICALLY READY FOR NEG RATES IF NEEDED
*CONSTANCIO: ECB HASN’T MADE DECISION ON NEGATIVE DEPOSIT RATE

>   
>   but also – overlooked:
>   

*CONSTANCIO SAYS ECB LOOKS AY FX RATE FOR INFLATION OUTLOOK

>   
>   ECB will revise HICP path at the March meeting
>   

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A question

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>   
>   (email exchange)
>   
>   On Thu, Feb 7, 2013 at 1:06 PM, wrote:
>   
>   There was an almost sensible article by Samuelson in the WP today. What caught my eye
>   was this comment that claims Japan failed at using Keynsian over the years. Can you
>   clarify this:
>   
>   Here is the comment:
>   

The problem is that economists have not recognized the failure of Keynsian economics. I think the uniform failure of deficit spending to promote growth has to be recognized.

They just didn’t run large enough deficits.

If the model worked, we would not be talking about Japan’s lost decade, or more accurately lost generation. Japan’s debt is now over 200 percent of GDP.

So?

Their growth rate in response to an ocean of deficits is uniformly poor.

Because they aren’t large enough to cover their savings desires.

The story is similar in Europe, particularly Southern Europe. There is no way Uncle Sam can continue to borrow 40 cents of every dollar spent.

Why not?

When governments get this far behind, they usually pay off the debt with hyper inflation.

Usually? hardly!

This never ends well. The usual outcome is social disintegration followed by dictatorship. For example, the hyper inflation of Weimar Germany after WWI lead to Hitler.

That was due to deficits of 50% of GDP to sell marks for fx and gold to pay war reparations. Any other examples???

The Federal Reserve’s constant quantitative easing in search of economic growth is going to lead to increasing inflation and interest rates.

Japan’s been doing it for over 20 years and still has no inflation and a strong currency.

They are buying 70 percent of the debt the Federal Governments incurs this month. Once Once interest rates go up, the deficits will balloon, 160 billion dollars a year for each percentage point.

So?

We have got to cut spending and stop the coming train wreck.

What train wreck? The train wreck is the current state of affairs from a deficit that’s too small.

Note that every move towards deficit reduction in Japan made things worse, and every supplementary budget made things better. they just haven’t ever done enough

>   
>   Its a typical RW comment, but what am I missing. How can you keep stating Japan did this
>   wrong for the other reason?
>   

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a word on the euro, US deficit doves, and Japan

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As previously discussed, the euro looks to keep going up until the trade surplus reverses. Problem is the strong euro doesn’t necessarily cause the trade surplus to reverse, at least not in the short term. But it does tend to work against earnings and growth. And there’s nothing the ECB can do about it, short of buying dollars via direct intervention, which would be counter to their core ideology, as building dollar reserves would give the appearance of the dollar backing the euro. The solvency issue has now been behind them for quite a while, and still no sign of any ‘official’ recognition that deficits need to be higher to restore output and employment.

And, also as previously discussed, while the future was looking up for the US a few months ago, the caveat of ‘austerity’ has come into play with the year end FICA and other tax hikes, and now the odds are the sequesters are allowed to come into play March 1 as well. Note this has been Japan’s policy as well- fiscal tightening at the first sign of any hope for expansion. Fed policy also looks to remain restrictive as blatantly evidenced by the recent turn over of some $90 billion of ‘profits’ to the Treasury that otherwise would have been earned by the economy.

The headline ‘deficit doves’ pushing for larger deficits with their ‘out of paradigm’ arguments are also serving to continue to support austerity. They have been arguing that the low interest rates are a signal from the markets (as if they know anything about markets) indicating the economy wants the govt to sell more bonds. This is in response to the hawk’s equally out of paradigm argument that financing deficits will eventually drive up interest rates. So now that interest rates have started going higher, the dove’s case is for higher deficits is pretty much gone, removing the resistance to ‘getting our fiscal house in order’ just as the sequester date is approaching. Whether it’s gross ignorance or intellectual dishonesty doesn’t matter all that much at this point- it’s happening. At the same time oil and gasoline prices have been creeping up, taking a few more shekels away from consumers. January and it’s strong equity inflows/allocations and releases of December’s stats ends tomorrow. February’s releases of Jan stats will bring more post FICA hike clarity.

Japan’s weak yen, pro inflation policy seems to have been all talk with only a modest fiscal expansion to do the heavy lifting. Changing targets does nothing, nor does the BOJ have any tools that do the trick as evidenced now by two decades of using all those tools to the max. And while I’ve been saying all the while that 0 rates, QE, and all that are deflationary biases that make the yen stronger, there is no sign of that understanding even being considered by policy makers, so expect more of same. What has been happening to weaken the yen is a quasi govt policy of the large pension funds and insurance companies buying euro and dollar denominated bonds, which shifts their portfolio compositions from yen to euros and dollars, thereby acting to weaken the yen. I have no idea now long this will continue, but if history is any guide, it could go on for a considerable period of time. Yes, it adds substantial fx risk to those institutions, but that kind of thing has never gotten in the way before. And should it all blow up some day, look for the govt to simply write the check and move on.

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Japan’s debt approaches 1 quadrillion yen

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Debt approaching 1 quadrillion, and the highest as a % of GDP anywhere I know of, and still no bond vigilantes in sight!

Who would have thought???

Not to mention decades of 0 rates, massive QE, and in general the BOJ trying as hard as it can to inflate.

Maybe it’s not all that easy for a CB to cause inflation???

Anyway, net fiscal will add a bit to GDP, but nothing serious, and the hawkish rhetoric doesn’t seem to have changed any.

And note the cuts in welfare ‘paying for’ the increases in defense and infrastructure.

Of the Y92.6 trillion yen in spending, Y43.1 trillion will be financed with tax revenues and Y42.9 trillion with issuance of new bonds, adding to Japan’s massive public sector debt that already totals nearly Y1 quadrillion.

The FY2013 budget does show clear differences from those of the previous DPJ administration, with a clear shift away from social welfare toward defense and infrastructure programs.


It calls for a reduction of Y67 billion in welfare benefits over the next three years, an increase of Y712 billion, or 15.6% in public works programs and a Y35 billion, or 0.8% increase in spending for the Self-Defense Forces.

“Adequate amounts have been provided to ensure the safety of public infrastructure and to address public concerns about national defense,” Mr. Aso said.

The LDP’s call for aggressive public works spending got better reception after the collapse of an expressway tunnel in December that killed nine people. Simmering tensions with China have also increased support for spending programs to improve security of Japanese territory.

In a policy address Monday, Mr. Abe vowed to erase fiscal deficits in the medium-to-long term, but stopped short of saying when, leaving the task to his economic advisory panel.

Sayuri Kawamura, a Japan Research Institute economist, is worried that not enough attention has been given to the risk of fiscal implosion.

“As debt piles up, the cost of servicing that debt also goes up, eating deeper into tax revenue, and leaving less and less for policy programs. The government hasn’t explained how they are going to deal with this challenge,” Ms. Kawamura said.

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