REINHART: Regarding Hilsenrath//+ Retail Sales

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A number of people have inquired about this morning’s front page article in the WSJ by Jon Hilsenrath, “Fed Maps Exit from Stimulus.”

This seems constructed by Jon in a way that is very much reminiscent of the three-day inflation scare and talk of early exit he created last year. Note four points:

1. Jon does not have access to policy makers in the way the WSJ beat reporter once had. The days of Wessel and Ip are over. Bernanke was very reluctant to provide informal guidance to begin with, and the practice virtually ceased with the report of the Subcommittee on Communications at the beginning of last year. Essentially, they decided to speak authoritatively in FOMC statements and everyone was free to offer their own view in the public record after that, but not off camera.

2. The first two paragraphs are an extended, bloated, version of the single sentence in the statement that said “The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes.” Those paragraphs don’t say anything more than the Fed has a plan to do its job. This reminds me of the CNBC banner yesterday morning while Bernanke was giving his speech on financial stability. It said “BREAKING NEWS: THE FED IS MONITORING FINANCIAL STABILITY.” It would have been just as informative to run the banner “BREAKING NEWS: THE FED IS STILL IN BUSINESS.”

3. Note that the only two on-the-record, active voices are Charlie Plosser and Richard Fisher. Those two are probably last on the list of reliable co-conspirators for the core of the Committee that makes policy. But those quotes, plus the older Williams’ one, allows Jon to write “Fed officials” to make it sound like he has access to the second floor of the Board. It also lets him bring out the stale dealers survey.

4. Note the inconsistencies in the story. Fed officials want to put more volatility in the market by conveying that QE is a flexible, smoothly adjusting instrument. The problem is that this makes more sense if the effect of QE was on flows, not stocks, which they have studiously denied for four years. By the way, if those conspiring officials want to make clear it won’t be a slow, steady retreat of accommodation, than they better tell Janet Yellen to stop showing the optimal policy path. Good luck to that.

I believe the central message, which is what I have described in earlier notes: Fed officials want to put as much volatility as possible back into the market before starting to raise rates, provided financial conditions otherwise remain supportive to sustained expansion. They’ll take opportunities to do so on the back of an equity market rally. But Jon Hilsenrath is not the means they will do so.

Vincent


Karim writes:
RETAIL SALES

  • April retail Sales were strong both in terms of the actual advance and composition. Moreover upward revisions to the control group for Feb and March imply an upward revision to Q1 GDP from 2.5% to 2.8%.
  • The 0.5% advance in the control group for April was more impressive due to the breadth and composition of the gains. In particular, all the major discretionary spending categories were quite strong: electronics 0.8%, clothing/accessories 1.2%, sporting goods 0.5% and restaurants 0.8%.
  • As the chief economist of the ISCS commented the other day on chain store sales for April: It is most likely being boosted by a stronger household wealth effect from higher home and stock market prices. Although it was an improvement of recent months, the pace was still dampened by adverse seasonal weather,
  • With fiscal drag peaking this quarter, and private sector growth maintaining the momentum it has shown since Q4 of last year, its making 3-3.5% growth more plausible in the second half. Most dealer forecasts are still in the 2-2.25% area.

HILSENRATH

  • Technically, Reinhart is correct: Hilsenrath is not the mouthpiece for the Fed and this is not all new news.
  • But, he is piecing together a story that the Fed wants out there. That the last hiking cycle was too predictable in terms of both pace and size (25bps/meeting). So, the idea that they can taper a bit and skip a meeting; or taper a bit and taper at a greater pace at the next meeting, are ideas they probably want out there.
  • My guess is Bernanke outlines these concepts in greater detail next week at his JEC testimony (May 22) and that if we get another 175k or greater in private payroll growth plus another strong month in retail sales for May, we could see some tapering at the June meeting.
  • Also notable was Bernanke’s comment on Friday that the Fed is ‘looking closely for signs of excessive risk taking”.

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Sydney Morning Herald

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Mosler lays down tablets on the economy, stupid

By Peter McAllister

May 11 (Sydney Morning Herald) — Ask US economist Warren Mosler whether the national disability insurance scheme should be paid for by a new levy or by spending cuts, and you’ll get a jarring answer – neither.

He’ll also tell you the question shows both the government and the opposition don’t really understand how public services are funded in a modern economy.

”Julia Gillard’s DisabilityCare does not require a tax at all,” Mosler says. ”Despite what most of us think, no modern capitalist government ever taxes to raise money to spend. Their real motive, even if they don’t know it, is to reduce aggregate demand and slow the economy.”

That means Tony Abbott’s insistence on spending cuts to return the budget to surplus is wrong too. ”When the economy is at less than full employment, spending cuts can only make matters worse.”

What’s really needed, Mosler adds, is both a simultaneous cut in taxes and an increase in spending to cover NDIS costs. That will restore what ought to be an essential fixture of Australian, and world, economies: good, healthy, productivity-enhancing deficits.

Welcome to the strange world of Warren Mosler, creator of Modern Monetary Theory.

The fact that Mosler – a tall, spare and super-rich Connecticut Yankee – dresses in nondescript slacks and T-shirts, and speaks in soft, matter-of-fact tones, only adds to the mind trip. He was recently in Australia to lay that trip on Northern Territory Treasury officials at a seminar organised by Charles Darwin University’s Centre for Full Employment and Equity, COFFEE for short. What they made of his message that deficits, like their $867 million budget hole, should be bigger, not smaller, is anybody’s guess.

”Budget deficit” is still the phrase that dare not speak its name in Australian politics. Mosler, however, says this will change. The world economic crisis, which is highlighting the bankruptcy of austerity economics and our obsession with surpluses, will force a rethink on deficit financing in Australia too. ”Current economic thought has it exactly backwards,” he explains. ”Government surpluses are not an economic plus – they’re a drag on performance because they always represent monetary savings withdrawn from the economy.” Mosler claims that, in fact, most financial crises in the modern era were caused by a preceding run of surpluses.

If that seems hard to absorb, you’re not alone. The longer Mosler talks, the longer the list of big-name economists and public officials who he says are wallowing in similar economic confusion. The chairman of the US Federal Reserve, Ben Bernanke, for example ”didn’t understand how the Fed worked in the US economic crisis; he disrupted recovery for six months by failing to realise he could lend freely to US banks on an unsecured basis”. Similarly, Paul Krugman, Nobel prizewinning economist, ”still hasn’t realised that regulating the economy through interest rates doesn’t work because cheaper credit is inevitably cancelled out by lower interest income”.

Their real error, however – and one shared by RBA governor Glenn Stevens – is the exaggerated importance they place on government debt.

”They don’t fully understand that where a government issues its own currency it doesn’t matter how large its debt grows, it can always pay it.” By extension, Mosler says, that guarantees future generations can pay it too, meaning our fears of passing a debt burden to our children are misplaced.

”We’re all still behaving as if our currency were linked to the gold standard, as it was before 1971,” Mosler complains. ”We’ve yet to adjust to the government’s new role as the economy’s scorekeeper, with money as nothing more than the points.”

Yet the game, he points out, really has changed. ”Not only can the government no longer run out of money, it also can’t drive up interest rates through higher levels of debt because its own central bank necessarily sets those rates, not market forces,” he says.

Likewise, Mosler adds, there is nothing to fear from the legendary ”bond vigilantes”, who supposedly police rising government debt through refusal to buy it. ”Since the government doesn’t, in reality, ever borrow to obtain funds, but rather to support interest rates, private refusal to buy securities actually results in a benefit to the treasury.” No issuer of currency, Mosler insists, is ever at risk from bond vigilantes; only users of currency, such as state governments, are.

These are certainly radical views – the question is should the world accept them? What separates Mosler from the myriad crackpot bloggers filling the digital airwaves with wacked-out and ruinous economics prescriptions?

Well, the evidence, possibly.

Some empirical support for Mosler’s radical views is surfacing. The controversy over the Reinhart-Rogoff analysis of growth rates in high debt-to-GDP ratio countries, for example, has established that there is, apparently, no growth penalty for high government debt. (Where there is, says Mosler, it is not from the debt itself but from the misguided contractionary measures governments take to reduce it). Then there is Mosler’s 2006 prediction that the current euro crisis would be the certain result of the PIGS countries’ surrender of their ability to issue currency and finance through government deficit.

There is also the small matter of the multibillion-dollar Bush tax cuts and spending increases, the second tranche of which, Mosler casually reveals, were inspired by his 2003 meeting with Andy Card, White House chief of staff to then president George W. Bush.

Most persuasive, however, is the man himself. If only three people actually understand global finance, Mosler might well be the only one to also understand international bond markets. He has, after all, traded in them for more than 40 years, managing billions in funds and making millions in profit. It was during his most profitable trades – on Italian government bonds in the 1990s – Mosler says, that he had his epiphany.

”We made a lot of money by betting the Italian government wouldn’t default even though their debt-to GDP ratio had exceeded 110 per cent,” Mosler recalls. ”I knew no country that issued its own currency ever had defaulted, nor had they ever had to ‘print money’ to pay, but I didn’t know why. Eventually it hit me: buying securities from a country’s central bank or its treasury are both functionally the same.”

They’re supposed to be different, Mosler points out: central banks sell securities in order to drain reserves, while treasuries supposedly do it to raise expenditure. ”But the end result is exactly the same – a pile of money sitting in securities accounts at the country’s central bank,” he says. ”The inescapable conclusion is that treasury sales of government debt don’t actually raise funds: they too simply drain reserves. That means that it is government spending and taxing that actually impacts the economy, not managing the debt.”

To paraphrase Dick Cheney, deficits do matter, says Mosler. ”And your persistent unemployment in Australia is telling you yours are far too small and need to be much larger.”

Large enough, perchance, for the NDIS, Gonski and Abbott’s parental leave scheme combined? Now that would be the end of politics as we know it.

Dr Peter McAllister is a journalism lecturer on the Gold Coast campus of Griffith University.

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Fitch: Why Sovereigns Default on Local Currency Debt

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Seems like subversive propoganda to me.
They deliberately ignore the obvious fixed vs floating fx distinction, for example.
A few comments below:

Fitch: Why Sovereigns Default on Local Currency Debt

May 10 (Fitch) — Fitch Ratings says in a newly-published report that the popular perception that sovereigns cannot default on debt denominated in their own currency because of their power to print money is a myth. They can and do.

Local currency defaults in the recent era include: Venezuela (1998), Russia (1998), Ukraine (1998), Ecuador (1999), Argentina (2001) and Jamaica (2010 and 2013). Nonetheless, we recognise that local currency defaults are less frequent than foreign currency defaults and are unlikely for countries with debt mainly denominated in local currency at long maturity.

Russia and Argentina, for example, had headline, well publicized fixed exchange rate policies, where they fixed the value of their currency to the $US. Failing to recognize that in this report is intellectually dishonest.

To assess the capacity which sovereigns have to inflate away their debt, this report uses our debt dynamics model to illustrate how much surprise inflation might be required for three hypothetical scenarios. For a country with a large primary budget deficit, gains to the debt to GDP ratio from even quite high inflation would be short-lived. While for a country with a debt to GDP ratio of 100%, primary deficit of 1%, real growth equal to the real interest rate and a 10-year average debt maturity, it would take a jump to 30% inflation (from our 2% baseline) for three years and 10% thereafter to bring the debt ratio below the 60% Maastricht threshold.

There is no such thing as ‘inflate away their debt’ as govt debt represents the global net savings of financial assets of that currency. So all that can be said in this context is that ‘savings desires’ are, for all practical purposes, always going to be there as some % of GDP.

Undoubtedly, higher inflation can be used to raise seigniorage (the difference between the value of money and the cost to print it)

This is nonsensical with floating exchange rate policy ( non convertible currency) as, for example, all US govt spending can be called ‘printing’ as it’s just a matter of the Fed crediting a member bank account. Likewise, taxing is ‘unprinting’ as it’s just a matter of debiting a member bank account. With fixed fx policy, it’s the ratio of convertible currency outstanding vs the actual fx reserves at the CB, a very different matter.

and remittance of central bank profits to the government, up to a point. Nevertheless, in the long run, the ratio of government debt/GDP will rise if the government is running a primary budget deficit (excluding interest payments and including seigniorage), assuming the real growth rate does not exceed the real interest rate, irrespective of the inflation rate.

An unanticipated burst of inflation can reduce the real value of government debt as long as the debt is not of short maturity (as higher inflation is quickly reflected in the marginal cost of funding), index linked or denominated in foreign currency (as the exchange rate would depreciate). Thus countries with such characteristics – which give them ‘monetary sovereignty’ – do have some capacity to inflate away their debt.

Linking govt payments to an index is a form of fixed exchange rate policy and yes, govts can and do default on these types of fixed exchange rate ‘promises.’

Inflation is economically and politically costly.

Politically costly, yes, but economically, there are no studies that show real costs to the economy from inflation.

Thus, even if a sovereign has a capacity to inflate away its debt, it might choose not to. It is also far from clear how much money would need to be printed to deliver the ‘right’ inflation rate, as the current debate over quantitative easing highlights. Instead a sovereign might view a Distressed Debt Exchange (DDE) as a less bad policy option. Fitch classifies a DDE as a default.

This is a confused rhetoric and a display of total ignorance of actual monetary operations.

The myth that sovereigns that can print money cannot default on debt in their own currency has also fed the proposition that such local currency ratings are irrelevant.

Fitch is again refusing to distinguish convertible and non convertible currency policy.

Fitch disagrees that default is inconceivable or impossible. The agency agrees that countries with strong monetary sovereignty and financing flexibility are unlikely to default and these are important factors in Fitch’s sovereign rating methodology that affect both local and foreign currency ratings.

A sovereign’s local currency rating is closely linked to its foreign currency rating. It is typically one or two notches higher, owing to the sovereign’s somewhat greater capacity to pay debt in local currency, as taxes are usually paid in local currency and it may have better access to a stable domestic capital market, as well as some capacity to print money. It may also be more willing to service local currency debt if more of it is held by local banks and other residents.

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Wholesale sales

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Though a bit old, this March release is yet another indicator that shows signs of rolling over.

With the tax hikes and spending cuts, it’s up to private sector credit expansion to rise to the occasion. Should the lost income and lost jobs cause it instead to roll over, we’re looking at negative GDP.

How well do stocks forecast this risk?
Note, for example, the last time private sector credit expansion went into reverse, the S&P rallied to an interim peak of over 1,400 mid May of 2008, in front of a 50%+ sell off.

Not at all that it will happen again, but that markets aren’t all that good at forecasting private sector credit acceleration going into reverse.


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Fannie Mae to send $59.4 billion to U.S. Treasury

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Profits turned over to Tsy are a tax/demand leakage, just like $ from the Fed.

Fannie Mae to send $59.4 billion to Treasury

May 9 (Reuters) — Fannie Mae, the nation’s biggest mortgage finance company, said on Thursday it will pay $59.4 billion in dividends to the U.S. Treasury after a record profit in the first quarter that reflecting a multibillion dollar gain from reversing an earlier writedown of tax benefits.

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A word on jobless claims

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For example, unemployment could be 10% with no employees being dismissed and filing for new claims, and 150,000 new hire just in line with workforce growth so as to keep unemployment at 10%, and Thursday’s claims number would be 0.

Point is a falling claims number can refect ‘quietness’ and ‘stability’ and not ‘improvement’ and therefore not be forecasting increased growth and employment. Once ‘quiet times’ are achieved, it’s just a measure of turnover.

However/likewise, rising claims indicate ‘less quiet times’ with active dismissals on the rise. With a lag, a breakdown in the private sector credit accelerator due to the proactive austerity measures
should be evidenced (again with a lag) by a slowdown in the growth of credit/slowdown in sales/output/employment. This generally gets reversed by the automatic fiscal stabilizers of rising unemployment comp and falling tax revenues that increase the federal deficit to the point where the demand leakages are sufficiently offset.

Support could also come from a reduction of the demand leakages, including a reduction in net imports, but in the case of the US those are highly unlikely to change anything near term.

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update on fiscal forecasts

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Tax hikes larger than I thought, says $185 billion below:

Commentary for Thursday: For the past four years, the annual federal budget deficit has exceeded $1 trillion. However, due to a combination of improving economic conditions, tax increases and fiscal austerity, the deficit is poised to shrink considerably in 2013 and 2014. In fact, it already appears to be ahead of target for 2013 relative to the Congressional Budget Offices estimates from earlier this year. Previously, most of the fiscal improvement was due to stronger tax revenue as the economy mended; however, more recently outlay reductions have caught up- revenues were up $72 billion in Q1 versus yearago levels, while outlays were down $78 billion. Revenue is being propelled by a combination of hiring gains, as well as the tax increases implemented at the start of the year. The expiration of the payroll tax holiday was worth about $135B, and higher tax rates for upper income brackets totaled roughly $50B. Individual income taxes, corporate income taxes and social insurance/ retirement receiptsaccount for the vast majority (92%) of federal receipts, and all three sources are highly cyclical. Thus, the best prescription for higher tax revenue is a sustained improvement in the pace of economic growth. If the economy accelerates along the profile we project for 2013 (thereby pushing year-on-year real GDP growth from +1.7% to +2.8%), the CBOs projected deficits for fiscal years 2013 and 2014 should prove to be too large. This makes sense since the CBO only projected 2013 real GDP growth at +1.4% (half of our projected rate). The figure below shows the difference between the 12-month rolling sums of federal receipts and outlays, which is a useful proxy of the federal deficit. As of March, it was running at -$911 billion, and as the chart illustrates, the deficit is shrinking rapidly. Over the past six and twelve months the rolling deficit estimate improved by an average of $28-$30 billion per month. Thus, if this pace is maintained through the end of the fiscal year, the deficit is likely to shrink to approximately -$735 billionconsiderably better than the CBOs deficit projection of -$845 billion. (CBO projects -$616 billion for fiscal year 2014.) However, since the budget sequestrations are only beginning to take hold, the pace of outlays will probably shrink more quickly in the months ahead. Outlays are down 2.8% on a 12-month rolling average basis, but Q1 was down 8.1% (year-on-year) and March was down 20.8%. Receipts also appear to be strengtheningthey rose +14.2% in Q1, compared to +10.0% on a 12-month rolling average basis. In light of these trends, we trimmed our 2013 deficit projection to $700 billion

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placebo’s doing their thing

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As previously discussed, financial placebos like QE do cause market participants to alter behavior out of either a misunderstanding of the actual fundamentals, or in anticipation of reactions by others presumed to be misinformed. And while the effects of these activities get reversed, however sometimes the effects are more lasting.

And there are also first order and second order effects. For example, a QE announcement could unleash misinformed fears about ‘money printing’ and ‘currency debasement’ and subsequent portfolio shifting that drives down the currency in the fx markets and drives up the price of gold. And the same misguided fears could cause bond yields to go higher in anticipation of a stronger/inflationary economy, even with the Fed buying bonds in an attempt to take yields lower.

So right now the QE/’monetary policy works if large enough’ placebo is at least partially driving things in both Japan and the US, and today’s announcement of the possibility of the ECB buying asset backed securities is now also at work.

And along the same lines but with a different ‘sign’ is the ideologically driven idea that cutting govt spending in the face of a large output gap- the sequester- is a plus for output and employment. Same for the year end tax hikes.

The underlying fundamental I don’t see discussed is whether private sector credit expansion can continue to sufficiently ‘overcome’ the declining govt deficit spending and satisfy the ‘savings desires’/demand leakages.

The main sources of private sector credit expansion are housing, student loans ($9 billion increase in March), and cars. Since 2009, the private sector credit expansion has managed to stay far enough ahead of the declining govt deficit, which has fallen from about 9% of GDP to about a rate of 6% of GDP by year end (mainly via the ‘automatic fiscal stabilizers’ of higher tax receipts and moderating transfer payments) resulting in about 2% real growth.

The question now is whether the private sector credit expansion can survive the 1.25% of GDP shock of the FICA tax hike and sequesters- which reduce support from the govt deficit to only maybe 4.5% of GDP- and still continue to sufficiently feed the (ever growing) demand leakages enough to generate positive GDP growth.

The stock market is often the best leading indicator of the macro economy, but it has ‘paused’ for two double dips that didn’t happen over the last few years, and it is subject to influence from placebos. Additionally, valuations change as implied discount rates change, and so in this case P/E’s shifting upwards may be discounting interest rates staying low for longer, due to an economy too weak to trigger Fed rate hikes, but strong enough to keep sales and earnings at least flat.

Placebo Surgery Shows Surprising Results

By Kate Melville

Research by Doctor Cynthia McRae of the University of Denver’s College of Education provides strong evidence for a significant mind-body connection among patients who participated in a Parkinson’s surgical trial.

Forty persons from the United States and Canada participated to determine the effectiveness of transplantation of human embryonic dopamine neurons into the brains of persons with advanced Parkinson’s disease. Twenty patients received the transplant while 20 more were randomly assigned to a sham surgery condition. Dr. McRae reports that the “placebo effect” was strong among the 30 patients who participated in the quality of life portion of the study.

“Those who thought they received the transplant at 12 months reported better quality of life than those who thought they received the sham surgery, regardless of which surgery they actually received,” says Dr. McRae. More importantly, objective ratings of neurological functioning by medical personnel showed a similar effect. In the report, appearing in the Archives of General Psychiatry, Dr. McRae writes “medical staff, who did not know which treatment each patient received, also reported more differences and changes at 12 months based on patients’ perceived treatment than on actual treatment.”

One patient reported that she had not been physically active for several years before surgery, but in the year following surgery she resumed hiking and ice skating. When the double blind was lifted, she was surprised to find that she had received the sham surgery.

Although patient perceptions influenced their test scores, when the total sample of patients was grouped by the actual operation they received, patients who had the actual transplant surgery showed improvement in movement while, on average, patients who had sham surgery did not.

Professor Dan Russell at Iowa State, the study’s co-author, says the findings have both scientific and practical implications. “This study is extremely important in regard to the placebo effect because we know of no placebo studies that have effectively maintained the double-blind for at least 12 months. The average length of placebo studies is eight weeks,” according to Russell. Dr. McRae notes that similar results related to the placebo effect have been found in other studies with patients with Parkinson’s disease. She says that there is a need for placebo controls in studies evaluating treatment for Parkinson’s as the placebo effect seems to be very strong in this disease. Dr. McRae also reports that although the sham surgery research design is somewhat controversial and has raised some ethical concerns, the results of this study show “the importance of a double-blind design to distinguish the actual and perceived values of a treatment intervention.”

Knee Surgery Proves No Better Than Placebo

By Katrina Woznicki

July 10, 2002 (UPI) — For individuals suffering from osteoarthritis in their knees, a common type of knee surgery has been found to be no more beneficial than a placebo, a new study revealed Wednesday.

Researchers at the Houston VA Medical Center and at Baylor College of Medicine came to this surprising conclusion after comparing various knee treatments to placebo surgery on 180 patients with knee pain.

The patients were randomly divided into three groups. One group underwent debridement, in which the damaged or loose cartilage is the knee is surgically removed by an arthroscope, a pencil-thin tube that allows doctors to see inside the knee. The second group received arthoscopic lavage, which flushes out the bad cartilage from the healthier tissue. A third group underwent a placebo surgery. They were sedated by medication while surgeons simulated arthroscopic surgery on their knees by making small incisions on the leg, but not removing any tissue.

During a two-year follow-up, researchers found no differences among the three groups. All patients reported improvement in their symptoms of pain and ability to use their knees. Throughout the two years, patients were unaware whether they had received the “real” or placebo surgery.

However, patients who received actual surgical treatments did not report less pain or better functioning of their knees compared to the placebo group. In fact, periodically during the follow-up, the placebo group reported a better outcome compared to the patients who underwent debridement.

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