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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Chery Unveils Plug-in Hybrid, Trumps GM Volt’s Range


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Good news for cutting crude consumption some day, bad news for GM.

Chery Unveils Plug-in Hybrid, Trumps GM Volt’s Range

by Tian Ying

Feb 20 (Bloomberg) — Chery Automobile Co., China’s largest maker of own-brand cars, unveiled its first plug-in hybrid, touting a range more than twice as far as General Motors Corp.’s planned Volt.

The S18 can travel as much as 150 kilometers (93 miles) using just its batteries, Chery said in a statement posted on its Web site yesterday. GM’s Volt, due to go on sale next year, has a range of 64 kilometers. Chery has no timetable as yet on when the S18 will go on sale, spokesman Jin Yibo said in an interview by phone today.

China has encouraged domestic automakers to develop alternative-energy vehicles to curb oil imports and pollution, as well as to help the local industry challenge GM and Toyota Motor Corp. overseas. BYD Co., the Chinese automaker backed by billionaire Warren Buffett, started selling the world’s first mass-produced plug-in hybrid in December.

The Chinese government plans to support domestic automakers’ research into alternative-energy vehicles in a bid to have 60,000 on the roads of 10 cities by 2012, Science Minister Wan Gang said in November.

Automobiles account for about half of the total oil consumption in China, the world’s largest vehicle market behind the U.S. That may rise to 60 percent by 2020, according to the Development Research Center of the State Council.

Plug-in cars can be recharged from standard household powerpoints. The S18 can be fully charged in as little as four hours and be 80 percent powered via a quick charge at a specialist station in 30 minutes, Chery said.

Subsidies

BYD’s F3 DM can run for 100 kilometers using only batteries. It takes as little as seven hours to fully charge and can be 50 percent powered via a quick charge at a specialist station in 10 minutes.

To help support the development of alternative-energy technologies, the Chinese government plans to give out subsidies of as much as 600,000 yuan ($88,000) per vehicle to public- transport operators and government agencies to help fund purchases of electric, hybrid and fuel-cell automobiles.

Chrysler LLC, the third-largest U.S. automaker, is forecasting sales of battery-powered cars exceeding 100,000 a year by 2013 and GM is counting on selling 60,000 of its first such model in the year after it goes on sale in 2010.

Gasoline-electric hybrids and other electric vehicles made up 2.2 percent of the U.S. market in 2007, according to J.D. Power & Associates, which expects that share to expand to 7 percent by 2015.


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2008 swap line advances as a % of GDP


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Swap lines as % of GDP by CB, year end 2008 (a bit dated now in Feb but anyway FYI).

Swap lines as % of GDP

BANK %S
ECB (16) 2.42%
Swiss 5.11%
BOE 1.07%
BOJ 2.53%
Aussie 2.13%
Sweden 4.87%
Denmark 4.06%
Norway 1.71%
Korea 1.09%

Resp,

Source Federal Reserve Statistical Summary:
“At end-December 2008 swaps outstanding were $553.728 billion: $291.352 billion with the European Central Bank, $25.175 billion with the Swiss National Bank, $33.08 billion with the Bank of England, $122.716 billion with the Bank of Japan, $22.830 billion with the Reserve Bank of Australia, $25 billion with the Bank of Sweden, $15 billion with the National Bank of Denmark, $8.225 billion with the Bank of Norway and $10.350 with the Bank of Korea.”


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Deficit myths are the problem


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Yes, that’s the problem, output and employment can be restored relatively quickly with the right fiscal adjustment, but deficit myths are in the way.

A full payroll tax holiday and $300 billion to the states on a per capita basis with no strings attached would very quickly restore demand, including retail sales and home sales, which would be quickly followed by continuing employment and output gains.

No Ordinary Recession

by Axel Leijonhufvud

Feb 13 (Voxeu) — “Fiscal stimulus will not have much effect as long as the financial system is deleveraging. Even if that problem were to be more or less solved, the government deficit would have to offset both the decline in industry investment and the rise in household saving – a gap that is rising as the recession deepens. Here, too, the public is sceptical and prone to conclude that a program that only slows or stops the decline but fails to “jump start” the economy must have been a waste of tax payers’ money. The most effective composition of such a program is also a problem.”


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2009-02-17 USER


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Empire State Manufacturing Survey (Feb)

Survey -23.75
Actual -34.65
Prior -22.20
Revised n/a

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Empire State Manufacturing Survey ALLX 1 (Feb)

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Empire State Manufacturing Survey ALLX 2 (Feb)

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Net Long Term TIC Flows (Dec)

Survey $20.0B
Actual $34.8B
Prior -$21.7B
Revised -$25.6B

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Total Net TIC Flows (Dec)

Survey n/a
Actual $74.0B
Prior $56.8B
Revised $61.3B

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NAHB Housing Market Index (Feb)

Survey 8
Actual 9
Prior 8
Revised n/a

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NAHB Housing Market Index TABLE 1 (Feb)

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NAHB Housing Market Index TABLE 2 (Feb)


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Steroids for the Rentiers


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1. The size of the TALF from $200bn to $1 trillion is a very big deal. It requires no Congressional approaval and the Fed seems ready to start buying assets this week or next. Not only will this Fed buying guarantee a revival of many securitised credit markets, but the 10 to 1 Fed leverage in the TALF structure will result in a huge expansion of the Fed’s balance sheet, which ought to be good news from a money supply point of view.

The ‘money supply point of view’ is meaningless with non convertible currency. In fact, adding to the Fed’s portfolio takes income from the rest of us. A $5 trillion portfolio with a 3% coupon removes $150 billion a year in private sector income, for example. Any good the lower interest rates do can be more than offset by the removal of interest income.

2. The public-private partnership (PPP) for acquiring toxic assets is simultaneously too complicated and lacking in detail. But a couple of things do seem clear: This will effectively be a “bad bank” designed to “cleanse” $1 trillion worth of “legacy” assets from bank balance sheets. The surprising element is that Geithner thinks he will be able to capitalize this bad bank partly with private money. This presumably implies that the toxic assets will enjoy some pretty generous government guarantees, which ought to be good news for existing bank shareholders.

Yes, investors will benefit risk free which adds nothing to aggregate demand, meaning unemployment will remain high and borrowers continue to struggle with their payments, while investors profit. And this is from the far left!

An alternative possibility is that the PPP will buy toxic assets very cheaply (which would of course be bad news for the disposing banks. This seems unlikely however because of the third and most important element explicitly stated in the Treasury’s background briefing, though not mentioned by Geithner in his speech (presumably because he did not want to sound like he was being too generous to the banks):

3. A Financial Stability Trust (FST) will inject convertible “contingent equity” into banks once they have cleansed their balance sheets by selling toxic loans to the PPP. This contingent equity will be available in unlimited amounts to banks with consolidated assets of over $100 billion. The most crucial point is that pricing looks very generous. “The conversion price [will be] set at a modest discount from the prevailing level of the institution’s stock price as of February 9, 2009”. In other words, if a bank needs to raise additional equity from the US government, this equity will be priced in line with this week’s market values and will not be grossly dilutive to existing shareholders like the capital injections into Fannie and AIG. This seems very generous to bank shareholders, especially as the Treasury is offering to buy bank equity at this price in unlimited amounts (although looking at the performance of US regional banks yesterday, the market clearly took a different conclusion).

More funds for the investor class.

4. Another generous element of the FST package is the approach to “stress testing” bank balance sheets: “The Treasury Department will work with bank supervisors and the Securities and Exchange Commission and accounting standard setters in their efforts to improve public disclosure by banks. In conducting these exercises, supervisors recognize the need not to adopt an overly conservative posture or take steps that could inappropriately constrain lending.” In other words, banks will be allowed to continue using “hold to maturity” accounting, if the alternative is “overly-conservative” accounting which “inappropriately constrains lending”.

5. Finally, the purpose of the Treasury stress-tests will be to establish whether banks have enough capital to continue sufficient lending even “in a more severe decline in the economy than projected”. After these stress-tests, the Treasury will effectively insure banks against such a deeper-than-expected recessions by providing a “guaranteed buffer” of contingent capital (as described in 4 above). In other words, it looks as if the Treasury will provide a catastrophe insurance policy against a deeper than expected recession, probably at a pretty low price to the banks (certainly at a much lower price than infinity, which is what an insurance policy against economic depression would cost in the markets today).

And yet another distribution to the investor class.

This is trickle down economics that would make even Reaganites blush.

Seems working people have no representation whatsoever.


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RBOB moving up


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Even as spot crude prices remain low, and the front contango extreme, RBOB (unleaded gasoline) has been steadily moving up, and the crack spread widening substantially.

This fits with anecdotal reports of gasoline consumption remaining reasonably firm with year over year declines under 4%.

It’s not going to take much of a recovery to give the Saudis cover to get crude prices back up to whatever price they want them to be.


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Keynes on payroll tax cuts


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Interesting how much of what I say turns out to have been written by Keynes:

Greg Mankiw, Keynes and the Payroll Tax:

The Mature Keynesian Perspective II
As I previously noted, the older (and presumably wiser) John Maynard Keynes was skeptical of using infrastructure projects as a countercyclical tool. NYU economist Mario Rizzo now brings to my attention that the mature Mr Keynes also favored the payroll tax as a countercyclical policy instrument:

In correspondence with the economist James Meade in 1942 Keynes says he is “converted” to Meade’s idea of altering the social security payroll tax over the business cycle. Here are Keynes’s words:

I am converted to your proposal…for varying rates of contributions in good and bad times.

(June 16, 1942). Keynes, Collected Writings, vol. 27, p. 208.

…[Y]ou are able to show fluctuations in income of an order of magnitude which is significant in the context… So far as employees are concerned, reductions in contributions are more likely to lead to increased expenditure as compared with saving than a reduction in income tax would, and are free from the objection to a reduction in income tax that the wealthier classes would benefit disproportionately. At the same time, the reduction to employers, operating as a mitigation of the costs of production, will come in particularly helpfully in bad times.

(July 1, 1942). Keynes, Collected Writings, vol. 27, p. 218.”


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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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