Thaler’s Corner 28th September 2012: Poor Macro Money Data, Eurozone

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I like this report.
The overnight data does still look to me like there are signs of it all stabilizing
but it also seems like that will only bring more fiscal tightening to ensure the output gap remains wide.

Poor Macro Money Data, Eurozone
 
First a quick point on our asset allocation biases. We are still Risk OFF, despite the over 3% decline on the Eurostoxx and the 1.70% hike on the Bund since we issued our recommendation. The reasons for this Risk Of remain valid and the presentation of the new Spanish government budget yesterday does not change our opinion. I consider the macroeconomic forecasts on which it is based to be unrealistic. Both the hoped for 3.8% hike in tax receipts and the projection that unemployment has peaked this year appear very optimistic in such a depressive context!
 
The earlier examples of “adjustments” imposed by the Troika in eurozone countries who agreed to these bailout plans only demonstrate that the application of harsh austerity treatment in the midst of a severe recession is counterproductive. The decline in the Debt/GDP denominator accelerates the flight of private capital, thereby making the country’s economy all the more vulnerable to “negative disequilibria”.
 
The repetition last Friday morning by Herr (Darth) Schäuble of the main points made in the letter he signed with the Dutch and Finnish finance ministers (legacy assets, etc) highlights how the reticence of eurozone “creditors” is threatening the hopes raided by the European summit of June 29th.
 
However, let’s take a look at the eurozone macro monetary figures published Thursday and Friday because they show that the ECB must remain on high alert since they show a continuous worsening of monetary conditions, despite the measures already taken.
 
And yet, when I see the alarmist statements by Mr Weidmann on the dangers of inflation created by the OMT or those made by Mr Asmussen warning that the ECB would intervene immediately in case of a spike in inflationary risk, I wonder on what planet they are living!
 
I understand these statements are motivated by domestic political consideration: i.e. the need to reassure savers frightened by a reduction in purchasing power stemming from real negative interest rates, especially since these savers mainly vote for Chancellor Merkel’s party, given that they are made up of retirees and others from comfortable segments of society.
 
But a comparison of this approach with that of the Fed, which instead is doing all it can to revive inflationist expectations by using precisely these expectations to contend with “0% Lower Bound”, is more than a bit worrisome.
 
Here are my favorite two graphs updated to included data from August.
 
M3 and Core CPI


 
As readers know, I am anything but a hardcore monetarist, because I consider that the ratio emphasized by the fans of the “Quantity of Money” theory does not account for changes in money velocity (the V in MV=PQ). These monetarists have a “vertical”conception of money in which the central bank is the sole agent of money creation. But M3 is in reality the consequence of the “horizontal” nature of money, i.e. its creation by private-sector banking (Loans make Deposits). The money verticality that does exist is of a totally different nature since it relates to budget deficits whereby the state injects financial assets into the private sector (treasuries) to finance spending. However, the graph above shows just how much the M3 curve has changed since the outbreak of the Great Financial Crisis, with a decline in annual growth from over 8% between 2001 and 2008 to a miserable 1.05% since then.
 
Some people claim that a certain amount of inflation paranoia is validated by the CPI published Friday morning, +2.7% annually, given that the consensus was looking for +2.4%, i.e. higher than the target set by the ECB. Maybe we would be treated to a new hike in key interest rates if Mr Trichet were still head of the ECB. But I think that those currently in charge of monetary policy are conscious of the temporary nature of the effect of indirect tax and commodity price rises and that the inflation index could fall below the ECB target in H2 2013.
 
M3, and loans to businesses and households


 
Much more relevant than M3, and perfectly consistent with our report on money velocity, these two statistics (loans to consumers and non-financial businesses) paint a much grimmer picture of the monetary situation in Europe.
 
Down -2.4% yoy at 31 August, consumer loans are declining at their steepest rate since this figure began publication! The decline has been continuous since the beginning of 2009, which compares to nearly 9% annual growth in mid-2006.
 
No matter how big the interest rate cuts, none of them will persuade people to spend more when they are worried about losing their job and about the possible implosion of the eurozone. In that context, I am utterly baffled when I hear Mr Asmussen declare, as he did just a few minutes ago, that banks are at fault because they are not lending out their surplus reserves!
Remember, banks do not lend their reserves (Loans make Deposits). At best, they can lend to banks short of reserves! In fact, that would reduce the central bank’s balance sheet which continues to play its role as intermediary on the still nonexistent interbank market. This highlights the need to give priority to the recapitalization of struggling banks in the system, even if we have to override the opposition of certain northern country finance ministers.
 
From a qualitative viewpoint, the ECB also released its monthly Euro Money Market Survey Friday morning, i.e. liquidity circulation within the banking system (V).
 
And here too, the picture is frightening.
 
The spot (next day) market has contracted 50% in the past year.
On the unsecured market, transactions in Q2 2012 plunged by about an annual 35%, while the secured market declined 15% !
Moreover, the ratio for these latter transactions, compensated by a counterparty clearinghouse (Cedel, Clearnet, etc.), now stands at 55%.
This highlights the degree of distrust in the interbank system. So I will end this letter today with the ECB staff’s own conclusion!
 
The qualitative part of the survey shows that efficiency in the unsecured market was deemed to have worsened markedly in comparison with 2011. Liquidity conditions were also perceived to have deteriorated. As regards the secured segment, the number of respondents giving a positive assessment of the market’s efficiency increased, although liquidity conditions were perceived as being worse than in 2011. For most other market segments, the perception of efficiency was more positive in 2012, whereas it was generally felt that liquidity conditions had deteriorated.
 
Between monetary verticality in free fall (generalized austerity) and evaporated horzontality (nonexistent interbank market), is there still hope?
Central banks cannot solve these problems all by themselves.

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Why prices can go up when demand is low

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http://www.ekathimerini.com/4dcgi/_w_articles_wsite2_1_27/09/2012_463278

Greece’s biggest employers group on Thursday said that rising costs, poor infrastructure, higher borrowing costs and red tape were among the main reasons that the cost of goods in the country has not dropped despite the ongoing crisis.
In a memo sent to the Development Ministry on Thursday, the Hellenic Federation of Enterprises (SEV) set out six reasons for the stubborn prices. These were:

1. Soaring energy costs as a result of higher energy rates, including a special tax tagged on electricity and gas bills.

2. The escalating cost of mostly-imported raw materials.

3. Poor infrastructure services. The report cited the substandard cargo loading and unloading facilities at the port of Volos, in central Greece, as an example.

4. The high transport costs which undermine competition.

5. The extra financial strain caused by the doubling of borrowing costs over the past year, the deterioration of payment terms for imported materials (e.g. packaging materials), the significant increase in taxes, and the long delay in VAT reimbursement.

6. Red tape and a complex administrative structure.

“Compressing labor costs is not fundamental in reducing prices,” SEV said in the memo. “A good example is energy intensive industries where energy costs make up for 40-50 percent of production costs. To offset the recently-imposed 20 percent rise in energy bills you would have to reduce labor costs by 80percent,» it said.

The federation said that the key steps for reducing the prices of manufactured products were lowering taxes, removing regulatory and administrative barriers, and improving the efficiency of the notoriously dysfunctional state apparatus.

Greece’s international lenders, the International Monetary Fund and the European Union, have demanded a reduction in labor costs to make the country more competitive.

But many Greeks, who have seen their disposable income plummet over the last few years, are frustrated that the cost of living has not fallen as well.

Tens of thousands of demonstrators took to the streets of Athens on Wednesday in protest at the anticipated cuts.

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The Concord Coalition Honors Rep. Schwartz’s Leadership on Fiscal Issues

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On Sep 22, 2012 8:31 AM, “Art Patten” wrote:

Dear Congresswoman,

As always, we appreciate your hard work and everything you do for your constituents. But I can’t bring myself to congratulate you on the award from the Concord Coalition, an organization that unwittingly works to undermine public purpose.

Like so many organizations, economists, politicians, and citizens, the Coalition fails to recognize that, as one writer recently put it, ‘Everything changed in 1973 [when President Nixon ended the Bretton Woods monetary system], except the economic textbooks.’

We are no longer on the gold standard. The U.S. government doesn’t ‘owe’ anybody, inside or outside the country, anything but U.S. dollars, which it is the monopoly supplier of.

In our current monetary system, the relevance of the federal deficit is its role in supporting aggregate demand. Whether the deficit is large enough is reflected in GDP growth and the unemployment rate. Inflation, although terribly difficult to measure with accuracy (and probably chronically overstated, in my view), indicates when fiscal deficits are too large.

The Coalition and many other groups witness the large budget deficits of recent years and imagine that the federal government faces the same constraints as any household, business, or state or municipal government. But that simply isn’t the case. The monopoly supplier of U.S. dollars can run deficits indefinitely. And if those other sectors of the economy want dollars to save, invest, or spend (and if other countries want to sell us stuff), they all need the U.S. government to run optimally sized deficits.

Unfortunately, the imaginary concept of a real budget constraint is reflected in harmful economic myths such as the inevitability of ‘crowding out’ and higher interest rates, and the inter-temporal government budget constraint; myths that both parties have elevated to high policy dogma. As a result, the Coalition and others urge us to gnash teeth and rend garments in response to large federal deficits, due to the draconian fiscal future we are supposedly imposing on our children and grandchildren. Many very smart people believe in this narrative. However, in our current monetary system, it is nothing more than the collective imagination run wild.

The real burden we are imposing on future generations (and today’s lower and middle classes) is not some future date with the fiscal pied piper, but long-term and completely unnecessary opportunity costs, due in large part to the myth that we must reduce and limit federal deficits. Millions of households are earning less than their combined talents are truly worth as underemployment remains mired at 1930s levels. Our public infrastructure continues to deteriorate. There’s still much more we can do for veterans and the needy. The list goes on. And by any of those metrics, the current federal deficit remains too small. That means either federal tax revenue is too high or spending too low, and the Coalition and other groups like them are misguidedly placing the highest priority on what should be among our least important concerns today.

Sincerely,
Art Patten
Jenkintown, PA

P.S. I’m attaching “Seven Deadly Innocent Frauds” by Warren Mosler. You can also find it online here. It is a quick but powerful read, and one that you could get through in a single train trip to Washington. As a member of a household that has been periodically underemployed since at least 2008, (and overtaxed when we’re fully employed! :)) I implore you to give it a look. Warren is running for Congress in the USVI this fall. He’s a wonderful guy, and if all goes well, perhaps you two can sit down and talk about this stuff next year. Best regards.

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QE follow up

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It’s been about a week, and the initial reactions are already wearing off and markets settling in.

The lasting effects are those of the income lost to the economy as the Fed earns the interest on the securities it buys instead of the economy. This reduces the federal deficit and is a ‘contractionary’ force. At the same time the Fed removes securities/duration/convexity/vol from the economy which tends to lower the term structure of risk free rates some and further reduce volatility as well.

Initially the long end sold off on the presumption that QE works to lower the output gap/restore growth and employment, which means the Fed would, down the road, be hiking rates in response to the improving economy.

However, as the reality that QE doesn’t work to support aggregate demand sinks in, long end yields can come down on the anticipation that future growth prospects are not good, increasing the odds that the Fed will be keeping rates low that much longer.

Likewise, it’s a mixed bag for stocks, though overall modestly supportive. QE doesn’t improve earnings prospects, and serves to keep growth down, but the lower interest rates help valuations, and high unemployment along with productivity increases work to keep unit labor costs down.

Europe has solved the solvency issue, but it’s all conditional on bringing deficits down, and so far it looks like they are all working to keep doing exactly that, and with no prospects for material private sector credit expansion or export growth,
GDP can continue to be negative.

Then there’s the US fiscal cliff. Everyone agrees deficit reduction slows things down, which is why they say we shouldn’t do it now. But they also therefore know it will slow down things whenever they do it in the future. So how hard should it be to come to recognize that slowing things down is actually the point of deficit reduction, and is appropriate only for that reason? Apparently it’s impossible. And the fiscal cliff is already taking its toll as anticipated contracts for next year along with purchases are being delayed.

So without some kind of fiscal paradigm shift I don’t see much good happening, and even the muddle through scenario is now at risk.

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Mafin 2012 Genova, Italy presentation

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Very good!
One suggestion, in caps:

In reality, BECAUSE AN OVERDRAFT AT A CENTRAL BANK *IS* A LOAN FROM THAT CENTRAL BANK, central banks have no option other than supplying the amount of reserves banks require to settle payments through standard operations, bilateral lending, or intra-day overdrafts.

Yet, it can unilaterally set the interest rate on reserves borrowing and reserves holding.

Revising the quantity theory of money in a financial balance approach

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JPM Household wealth report

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The unemployment line is the evidence the federal deficit is too small given conditions.
This at least partially explains why the full employment deficit is much larger this time around:

From JP Morgan:

Executive Summary

Households lost $16 trillion worth of wealth during the crisis from late 2007 to early 2009, but they have recovered 70% of the loss since then.

However, the recovery has been uneven across wealth groups. The wealth of the top 10% has fallen back to 2004 levels, but median wealth has fallen back to 1992 levels, in real terms.

As a result wealth inequality has increased sharply after the crisis, which may have some effect on the upcoming elections.

Across age groups, the 25- to 44-year old group has experienced the most significant wealth losses after the crisis. This has been primarily due to house price declines, as younger households are more leveraged in housing.


House prices are not expected to revert back to pre crisis levels in real terms for a very long time. If younger households decide to rebuild their lost housing wealth, this will have long term growth implications.

We estimate that the 25- to 44-year old group has lost $2 trillion housing wealth and rebuilding this lost wealth over 10 years implies that GDP growth will be 1.3 %-pt less than it otherwise would be.

This may explain the slow demand growth we have experienced following the crisis.

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