China not backing down on the push to export

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This is a few days old but shows all the talk about domestic demand isn’t taking anything away from the desire to export:

China to Take Steps to Boost Exports; Will Keep Currency Stable

May 27 (Bloomberg) — China’s State Council, or Cabinet, said the government will take steps to boost exports while keeping the country’s currency “basically stable,” the state television reported today.

Falling exports are the biggest challenge for the world’s third-largest economy, the council said.

China introduced a 4 trillion-yuan ($586 billion) stimulus package last year as exports slumped and economic growth slowed. Maintaining external demand can create favorable conditions for employment, businesses and domestic consumption, China Central Television said today, citing a council meeting headed by Premier Wen Jiabao.

The nation will keep its currency “basically stable at a reasonable and balanced level,” the council said, without elaborating.

China will take all measures to stabilize overseas demand as shrinking exports are the nation’s biggest challenge, “currently and for some period of time in the future,” the council said.

The government will focus on exports involving intensive labor and advanced technology, according to the report.

The government will arrange $84 billion in short-term export credit insurance for 2009, the council said. The coverage of export credit insurance will also be expanded, it said.

China will allocate additional funds to support exporter guarantees, according to the report. About $10 billion will be set aside as credit for the export industry in 2009, the state television said, without elaborating.


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Professor John Taylor on the exploding debt

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From the good professor who brought us the ‘Taylor Rule’ for Fed funds:

Exploding debt threatens America

by John Taylor

May 26 — Standard and Poor’s decision to downgrade its outlook for British sovereign debt from “stable” to “negative” should be a wake-up call for the US Congress and administration. Let us hope they wake up.

And yet another black mark on the ratings agencies.

Under President Barack Obama’s budget plan, the federal debt is exploding. To be precise, it is rising – and will continue to rise – much faster than gross domestic product, a measure of America’s ability to service it.

Gdp is a measure of our ability to change numbers on our own spread sheet?

The federal debt was equivalent to 41 per cent of GDP at the end of 2008; the Congressional Budget Office projects it will increase to 82 per cent of GDP in 10 years. With no change in policy, it could hit 100 per cent of GDP in just another five years.

Almost as high as Italy and Italy does not even have its own currency.

“A government debt burden of that [100 per cent] level, if sustained, would in Standard & Poor’s view be incompatible with a triple A rating,” as the risk rating agency stated last week.

Now there’s quality support for an academic position…

I believe the risk posed by this debt is systemic and could do more damage to the economy than the recent financial crisis.

‘Believe’? Without even anecdotal support? Is that the best he can do? This is very poor scholarship at best.

To understand the size of the risk,

I think he means the size of the deficit, but is loading the language for effect.

Is that what serious academics do?

take a look at the numbers that Standard and Poor’s considers. The deficit in 2019 is expected by the CBO to be $1,200bn (€859bn, £754bn). Income tax revenues are expected to be about $2,000bn that year, so a permanent 60 per cent across-the-board tax increase would be required to balance the budget. Clearly this will not and should not happen. So how else can debt service payments be brought down as a share of GDP?

This presumes an unspoken imperative to bring them down. Again poor scholarship.

Inflation will do it. But how much? To bring the debt-to-GDP ratio down to the same level as at the end of 2008 would take a doubling of prices. That 100 per cent increase would make nominal GDP twice as high and thus cut the debt-to-GDP ratio in half, back to 41 from 82 per cent. A 100 per cent increase in the price level means about 10 per cent inflation for 10 years. But it would not be that smooth – probably more like the great inflation of the late 1960s and 1970s with boom followed by bust and recession every three or four years, and a successively higher inflation rate after each recession.

Ok. Inflation, if it happens as above, can bring down the debt ratio. How does this tie to his initial concern over solvency implied in his reference to the AAA rating being a risk for our ‘ability to service it?’

And still no reason is presented that 41% is somehow ‘better’ than 82%.

Nor any analysis of aggregate demand, and how the demand adds and demand leakages interact. Just an ungrounded presumption that a lower debt to GDP ratio is somehow superior in some unrevealed sense.

The fact that the Federal Reserve is now buying longer-term Treasuries in an effort to keep Treasury yields low adds credibility to this scary story, because it suggests that the debt will be monetised.

So what does ‘monetised’ mean? I submit it means absolutely nothing with non convertible currency and a floating fx policy.

That the Fed may have a difficult task reducing its own ballooning balance sheet to prevent inflation increases the risks considerably.

And the presumption that the Fed’s balance sheet per se with a non convertible currency and floating exchange rate policy is ludicrous. All central bankers worth any salt know that causation runs from loans to deposits and reserves, and never from reserves to anything.

And 100 per cent inflation would, of course, mean a 100 per cent depreciation of the dollar.

He’s got that math right- if prices remain where they are today in the other currencies and purchasing power parity holds. And he also knows both of those are, for all practical purposes, never the case.

Why has he turned from academic to propagandist? Krugman envy???

Americans would have to pay $2.80 for a euro; the Japanese could buy a dollar for Y50; and gold would be $2,000 per ounce. This is not a forecast, because policy can change;

And it assumes the above, Professor Taylor

rather it is an indication of how much systemic risk the government is now creating.

So currency depreciation is systemic risk?

Why might Washington sleep through this wake-up call? You can already hear the excuses.

“We have an unprecedented financial crisis and we must run unprecedented deficits.” While there is debate about whether a large deficit today provides economic stimulus, there is no economic theory or evidence that shows that deficits in five or 10 years will help to get us out of this recession.

Huh? None??? What’s he been reading other than his own writings and the mainstream tagalongs?

Such thinking is irresponsible. If you believe deficits are good in bad times, then the responsible policy is to try to balance the budget in good times.

Ahah, a logic expert!!! That makes no sense at all.

The CBO projects that the economy will be back to delivering on its potential growth by 2014. A responsible budget would lay out proposals for balancing the budget by then rather than aim for trillion-dollar deficits.

‘Responsible’??? As if there is a morality issue regarding the budget deficit per se???

“But we will cut the deficit in half.” CBO analysts project that the deficit will be the same in 2019 as the administration estimates for 2010, a zero per cent cut.

“We inherited this mess.” The debt was 41 per cent of GDP at the end of 1988, President Ronald Reagan’s last year in office, the same as at the end of 2008, President George W. Bush’s last year in office. If one thinks policies from Reagan to Bush were mistakes does it make any sense to double down on those mistakes, as with the 80 per cent debt-to-GDP level projected when Mr Obama leaves office?

The biggest economic mistake of our life time might have been not immediately reversing the Clinton surpluses when demand fell apart right after 2000. And, worse, spinning those years to convince Americans that the surpluses were responsible for sustaining the good times, when in fact they ended them, as they always do. Bloomberg reported the surplus that ended in 2001 was the longest since 1927-1930. Do those dates ring a bell???

The time for such excuses is over. They paint a picture of a government that is not working, one that creates risks rather than reduces them. Good government should be a nonpartisan issue. I have written that government actions and interventions in the past several years caused, prolonged and worsened the financial crisis.

Lack of a fiscal adjustment last July is what allowed the subsequent collapse

The problem is that policy is getting worse not better. Top government officials, including the heads of the US Treasury, the Fed, the Federal Deposit Insurance Corporation and the Securities and Exchange Commission are calling for the creation of a powerful systemic risk regulator to reign in systemic risk in the private sector. But their government is now the most serious source of systemic risk.

Finally something I agree with. Our biggest risk is that government starts reigning in the deficits or fails to further expand them should the output and employment remain sub trend.

The good news is that it is not too late. There is time to wake up, to make a mid-course correction, to get back on track. Many blame the rating agencies for not telling us about systemic risks in the private sector that lead to this crisis. Let us not ignore them when they try to tell us about the risks in the government sector that will lead to the next one.

The writer, a professor of economics at Stanford and a senior fellow at the Hoover Institution, is the author of ‘Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis’

It’s not too late for a payroll tax holiday, revenue sharing with the states on a per capita basis, and federal funding of an $8 hr job for anyone willing and able to work that includes federal health care, to restore agg demand from the bottom up, restoring output, employment, and ending the financial crisis as credit quality improves.


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Niall Ferguson: No One Has The Faintest Idea When The Economy Will Recover

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Harvard AND Oxford Professor, thank you!

Niall Ferguson: No One Has The Faintest Idea When The Economy Will Recover

by Niall Ferguson

May 29 (FT) —He thinks Obama’s economic forecasts are as much of an outlier possibility as another Great Depression. He’s also concerned, as we are, that there’s just not enough money in the world to finance all the borrowing the U.S. and other big countries will be doing over the next few years.

Barron’s: Is the worst over for the global stock markets and the economy?

Ferguson: It may look that way, but appearances can be deceptive. The stock market has actually tracked almost perfectly its downward movements between 1929 and 1931. Now that doesn’t mean that we are going to repeat the Great Depression. I don’t think we will, because the policy responses have been different. It would be excessively optimistic, however, to conclude from a relatively small set of green shoots in the economic data that we are all going to live happily ever after. It is certainly way too early to say the Obama administration is right that the economy is going to grow at 3% next year and 4% in 2011. I find that scenario as implausible as a rerun of the Great Depression…

When will the recovery come?

Nobody has the faintest idea what next year is going to look like. It isn’t clear yet that this is just a common recession. This is probably more like a slight depression. We won’t see a big V-shaped bounce. Much of the consumption growth in the decade up to 2007 was fueled by things like mortgage-equity withdrawal. That game is clearly over. Strip that out, and you are looking at an annual economic-growth rate in the U.S. closer to 1½% to 2% than 4%.

What is your disagreement with New York Times columnist and Princeton professor Paul Krugman about massive government borrowing?

This is one of the most interesting questions of the moment. The view of Keynesians, their Econ. 101 textbooks and the Nobel laureate at Princeton is that the world has an excess of savings over investments and therefore the deficit can be almost any size and it will be financed.

That is the problem with violating ‘Lerner’s Law’ and making the argument in the wrong paradigm. It invariably gets shot down like this:

My sense is that if the U.S. government tries to borrow $1.8 trillion in a year, that is an awful lot of bonds to sell at the same time [as] all the other major governments. It looks to me like a supply-and-demand story, and what tends to happen in those stories, regardless of the macro environment, is that the price of bonds tends to fall. The U.S. 10-year Treasury rate has moved up more than 100 basis points [one percentage point] since January. There is a problem in Britain, where the Bank of England had to protest about fiscal stimulus because it was causing a huge interest-rate problem. It is also happening here.

It is the blind arguing with the blind.

With this attitude it very well may take a world war to generate enough deficit spending to restore output and employment.


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Berlin vote heralds big spending cuts

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More evidence the Eurozone economy will lag the rest of the world

Berlin vote heralds big spending cuts

by Bertrand Benoit

May 29 (FT) —The next German government is almost certain to crack down on spending and drastically raise taxes after the lower house of parliament yesterday adopted measures that come close to banning budget deficits beyond 2016.

The controversial constitutional amendment, part of a reform of federal institutions, will prohibit Germany’s 16 regional governments from running fiscal deficits and limit the structural deficit of the federal government to 0.35 per cent of gross domestic product.

The amendment still requires approval by a two-thirds majority of the upper house of parliament which represents the regions. The vote is scheduled to take place on July 12 and is expected to be approved.

The most sweeping reform of public finances in 40 years was an “economic policy decision of historic proportions”, Peer Steinbrück, finance minister, told parliament shortly before MPs endorsed the amendment with the required two-thirds majority.

The vote underlines Berlin’s determination quickly to plug the holes that the economic crisis, two fiscal stimulus packages and a €500bn ($706bn, £437bn) rescue operation for German banks are expected to blow in the public coffers this year and next.

In 2009 alone, legislators from the ruling coalition expect the federal budget to show a deficit of more than €80bn, twice the current all-time record of €40bn reached in 1996 as Germany was absorbing the formidable costs of its reunification.

This figure does not include the deficit of the social security system, which is expected to rocket too, as unemployment rises to an expected 5m next year.

The constitutional amendment, popularly known as the “debt brake”, allows a degree of flexibility in tough economic times, just as it encourages governments to build cash reserves in good times.

Yet economists have warned the new rules could force the next government to implement a ruthless fiscal crackdown as soon as it takes office after the general election of September 27 if it is serous about hitting the 2016 deficit target.

“Given the massive fiscal expansion we are currently seeing, the ‘debt brake’ will lead to a significant tightening of fiscal policy in the coming years,” Dirk Schumacher, economist at Goldman Sachs, wrote in a note.

In a separate assessment, the Cologne-based IfW economic institute said the federal government would need to save €10bn a year until 2015 through a mixture of tax rises and spending cuts.

Klaus Zimmermann, president of the DIW economic institute in Berlin, said the next government might have to increase value added tax by six points to 25 per cent. This would be the biggest tax rise in German history.

The “debt brake” could complicate Angela Merkel’s re-election bid. Under pressure from parts of her Christian Democratic Union, the chancellor recently pledged to cut taxes if returned to office in September, though she pointedly failed to put a date on her promise.

The Free Democratic party, the CDU’s traditional ally, has made hefty income tax cuts a key condition for forming a coalition with Ms Merkel’s party should the two jointly obtain more than 50 per cent of the votes.

The debate has cut a deep rift within the CDU, which was threatening to deepen further yesterday as opponents of tax cuts seized on the constitutional change to back their arguments.

Günther Oettinger, the CDU state premier of Baden Wurttemberg, said “promises of broad tax cuts are unrealistic… First we must overcome the crisis, then we need more robust growth, and when we finally get more tax revenues, we should use them to repay debt, finance core state activities and for limited, very targeted tax cuts.”


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China policy obamanation

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We do not need China or anyone else to buy our securities and we net benefit enormously from net imports in general.

The profoundly confused China policy comes from an administration that both does not understand the monetary system and does not understand that imports are real benefits and exports real costs:

Policies are being held hostage to Communist China’s demands.

by Adrian Van Eck

May 29 — The communist rulers of China have laid down a threat to the government of the United States of America. They are the largest foreign holders of treasury bonds. They say they fear that the huge Federal deficit this year – four times the record deficit set last year – will bring on inflation of such a magnitude as to threaten the buying power of their treasury holdings. They have said that if Washington does not stop this massive deficit spending (much of it financed with money created by Fed Chairman Ben Bernanke and the Federal Reserve)

All–not some, or most of government spending is a matter of ‘changing numbers in bank accounts at the fed’ (as per Bernanke’s statement last month).
Govt spending adds varying degrees of aggregate demand, government taxing reduces demand, and government borrowing supports interest rates. ‘Financing’ as the word is generally used does not apply to the issuer of a non convertible currency with a floating exchange rate.

they will protect their own interests by dumping all of their holdings of U.S. treasuries on the market for whatever price they can get for them. They say they will do so even if that collapses the U.S. dollar and pulls down not only the American economy but the economy of the entire world.

To date ‘their own interest’ has been that of supporting their export industries by suppressing their real wages.
So this statement would indicate they are threatening to move away from an export led strategy. Possible, but hard to believe and contradicts what follows here.

Apparently Washington has taken this threat seriously. All of a sudden China is being overrun by important officials from the U.S. Government. Speaker of the House Nancy Pelosi is one of the Americans traveling to Beijing. In past years she has been well known in both the U.S, and China as one who dislikes the rulers of Mainland China. A few years ago she barely escaped being arrested by a pack of Party goons as she led a group of Americans protesting China’s policies toward the formerly independent nation of Tibet, which China overran and conquered soon after they won the Chinese Civil War some 60 years ago. A few days ago she was fawning over China’s Government leaders, telling them how we want to cooperate with them in working to protect the environment. (As usual they blamed America for polluting the Earth, ignoring the fact that it is China which is the worst polluter anywhere.) She must have almost gagged on her own sweet words as she talked.

The second important American Government official in China was Secretary of State Hillary Clinton. She has never been thought of as an enemy of China’s communist rulers, so it was easier for her to talk with them. (There were rumors that money from China helped fund her husband’s re-election campaign.) Unfortunately the visit came about as China’s neighbor and close ally – North Korea – exploded a nuclear device reported to be as powerful as the one America dropped on Hiroshima in 1945. They also fired off several rockets. All of this violated the terms of an agreement they signed in 2006 – an agreement that brought them enormous quantities of fuel oil and food. When the nations that negotiated that treaty protested the nuclear explosion, North Korea announced that it was renouncing its agreement to a truce that ended the war in the 1950’s. That again called for Secretary of State Clinton to try and patch up relations without pushing the virtual outlaw nation into crossing the border and attacking South Korea. This made the response to China in threatening America – a definite form of blackmail, as nations such as India and Japan agreed – a secondary issue with Hillary.

That left Treasury Secretary Geithner to absorb the heaviest verbal blows from China’s leaders during his own visit to Beijing. They knew that Geithner, as the president of the independent Federal Reserve Bank of New York, the largest and most important of the privately-owned regional Feds, had himself made threats to China shortly before being confirmed by the Senate to take over the top job at Treasury. He had told the Senate that if China did not stop manipulating the yuan in the foreign exchange market to gain an unfair advantage in its trade he would be in favor of America taking steps on its own to counter this in the foreign exchange market.

What sense does all this make?

China was buying dollars to keep the dollar strong and the yuan weak as part of their strategy to support exports by suppressing domestic costs vs rest of world costs.

Geithner was pushing for a weaker dollar as a way to reduce China’s exports by, in effect, causing prices of goods made in China at Wal-Mart to rise to the point where they wouldn’t sell as well.

Now China is threatening to do the opposite- push the dollar down by selling its USD financial assets, and Geithner is doing the opposite by trying to stop them.

He has since had to swallow those words and now he has to swallow as well threats against America by China.

This administration is in it way over its head and is pursuing a totally confused policy.

We thought it was fascinating that no one in the media mentioned Ben Bernanke or commented on his complete absence from the dialogue with China. So I will take it on myself to make such a comment. Bernanke is, after all, the one man closely tied to the creation of the money that so offends the communists in Beijing and one might have expected him to be involved in current talks with China’s rulers – under normal circumstances. A while back, he went to China as part of a delegation and he was asked to make a speech at a university where China trains many of its economists. Bernanke was brutally candid in his remarks. He pointed out precisely all of the mistakes he felt they were making in their centrally planned economy – and predicted that they were heading for trouble so bad that it might bring the ruling Party and the country down, just as a dozen prior dynasties had come crashing down during China’s long history. The woman who serves as China’s economics minister was livid with rage after his remarks. She took over and screamed insults at him for a half hour. Then she called President Bush and said that Bernanke was “persona non grata,” a diplomatic phrase meaning he would never again be welcomed to China. Months later when a Chinese delegation paid a return visit to Washington, they carefully avoided the Fed’s marble headquarters.

Not a whisper has escaped that anyone knows about from the ideas expressed by Tim Geithner concerning China’s threats if America does not sharply curb its deficit spending.

For China’s export strategy to ‘succeed’ they need high levels of aggregate demand in the US.

Yet it is clear from everything happening in Washington that this Administration has absolutely zero intention of stopping its near reckless abandon of any restraint in Federal spending.

In fact, the deficit spending has not even begun to get high enough to restore aggregate demand to levels where unemployment stops rising, never mind falling.

We need to remove a lot more fiscal drag to restore demand, now the unsustainable (non-government) credit chennels have been capped.

Quite the contrary, as new demands are made they are coming up with more plans to lavish Federal spending on recipients. For example, the latest we are hearing regarding General Motors is that the Federal Government may be willing to hand the company $50 billion on top of the money allocated to them already. But Washington would then want to gain 70% ownership in what critics are calling “Federal Motors.”

The problem here is the administrations looks for public purpose in the ‘input’ side rather than the output side. The public purpose of industry is the output it produces, not how the inputs, particularly labor, get rewarded.

Output is directed by markets working within institutional structure which can be modified to influence output towards public purpose while sustaining full employment at all times. But not with an administration that has it all backwards.

And now we have California’s demand that the Federal Government guarantee $18 billion in State borrowing to fund their own wild deficit spending. Political pressures are building to make this happen. If that does happen, a lot of other states will be lining up at the White House front door to demand the same treatment.

The answer here is to give all states $500 per capita of revenue sharing with no strings attached. California would get about $17 billion.

That way it’s ‘fair’ and there is no ‘moral hazard’ issue.
But, again, this hasn’t even been discussed.

This brings us to a topic that is being brushed aside as being too unlikely to even deserve treatment as a rumor. Thus it is being dismissed out of hand in the national media. Yet it is springing up from several key Washington sources and that makes us suspicious that where there is so much smoke there may be fire. What I am talking about, of course, is the sudden discussion of an American Value Added Tax – another name for a national sales tax. It would apply to goods and services alike. Most nations in the world including China itself now have such a VAT tax. It is called value added because each company is taxed only on the value it adds to raw materials or parts it buys and manufactures or assembles into a product. Trucks and hairdressers and even lawyers would be taxed under a VAT.

Even at a rate as low as 10%, which would be seen as very low in the world, it would raise a ton of money. Some are proposing a rate high enough to allow the income tax to be ended but that idea is being shot down by agents of the Administration. The idea would be sold to conservatives as a way to avoid the huge inflation that China is warning against… and also to make unlikely that America would be forced to go back to pre-Reagan Federal income tax rates of just about double those paid today. And industry would be told that – just as happens in other nations with a VAT – it would be forgiven on any goods or services marked for export. I think these VAT tax rumors are for real and I suggest you keep an eye on this. More next week. Adrian Van Eck.

The VAT is even more regressive than the payroll taxes still on the books.

And with consumption being the entire point of the economics it makes no sense to tax consumption in general.

‘Sin’ and ‘luxury’ taxes are different- the idea is to limit consumption of those items subject to the tax, and not to raise revenue. The success of the tax is then judged by how few dollars are collected, not how many as with the VAT.

Now more than ever the US would benefit from an administration that understood the monetary system and the simple fundamentals regarding imports and exports.

But this is not going to happen, and we will continue to pay the price.


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Geithner’s got it wrong re: China

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This is what happens with an administration that does not understand imports are real benefits and exports real costs.

This is a proactive move that hurts our real terms of trade and real standard of living.

Geithner to Urge China to Boost Demand, Official Says

by Rebecca Christie

May 28 (Bloomberg) — Treasury Secretary Timothy Geithner
will urge China to boost domestic demand and loosen controls on
the yuan in his first trip to the nation since taking office,
while readying a defense on queries about sinking U.S. bonds.

In meetings with Chinese leaders in Beijing June 1-2,
Geithner will encourage China to move toward a more flexible
exchange rate, a U.S. Treasury official told reporters in
Washington. He will also answering any questions the Chinese may
have about the dollar or the U.S. budget deficit, the official
said on condition of anonymity.

While delivering a familiar U.S. message on reducing
China’s reliance on exports, the Treasury chief may meet an
unprecedented level of concern about the outlook for Treasuries.
China is the largest foreign holder of U.S. government debt,
which has handed investors the worst loss since at least 1977
this year as forecasts for federal budget deficits ballooned.

“We’re going to be flooding the world with debt for a
while,” said Tim Adams, a former U.S. Treasury undersecretary
for international affairs who helped lead the Bush
administration’s economic policy with China. “We’ve got to hope
that that the Chinese are willing to keep buying.”

China held about $768 billion in Treasury securities as of
March, according to U.S. government data.

U.S. Commitment

The U.S. is committed to reducing its budget deficit and
maintaining deep and liquid markets for government debt, the
official said in a briefing before Geithner’s May 30 departure.

To spur the U.S. economy, Geithner has said the
administration needs to run deficits in the short term. For the
fiscal year that ends Sept. 30, the deficit is projected to
reach a record $1.75 trillion, according to a Congressional
Budget Office forecast.

The widening gap has contributed to the tumble in
Treasuries, which have lost 5.1 percent, including reinvested
interest, so far this year, according to Merrill Lynch & Co.
index data. The dollar has also been hammered, with the Federal
Reserve’s trade-weighted Major Currency Dollar index sliding 3.2
percent so far this year.

Chinese Premier Wen Jiabao in March expressed concern about
the value of the nation’s U.S. investment. Also in March,
central bank governor Zhou Xiaochuan advocated a “super-
sovereign reserve currency” disconnected from any individual
nation, casting doubt about the long-term role of the dollar.

Wen, Hu Meetings

Geithner is set to meet with Wen during his trip, along
with President Hu Jintao and Vice Premier Wang Qishan. In
addition, Geithner will deliver a speech at Peking University on
U.S.-China economic relations and take part in an economic
development event that features U.S. companies.

The Treasury secretary is confident the U.S. dollar will
keep playing an important role as a reserve currency for a long
time, the official said today.

The Beijing talks will include the importance of open trade
and the need for both the U.S. and China to move toward balanced
long-term growth strategies, including a flexible currency
policy, the official said.

Since mid-2008, when China’s leaders began to take measures
to address an economic slowdown, the yuan has hovered around
6.84 per dollar. That rate was reached after a gradual
appreciation since July 2005 from a level of about 8.3 yuan, a
peg China had maintained since 1995.

So far this month, the yuan is little changed, closing
today at 6.829 per dollar.

‘Manipulating’ Label

Geithner has avoided a showdown over China’s currency
policy, declining to repeat comments he made in written remarks
to lawmakers after his Senate confirmation hearing in January
that China was “manipulating” its currency.

In its first semiannual report on foreign-exchange policies
since Geithner became secretary, the Treasury said April 15 that
while the yuan remains “undervalued,” it didn’t meet the
standard for illegal manipulation in the second half of 2008.

China will need to keep buying dollars if it plans to keep
the yuan tethered to the dollar, said Brad Setser, a former
Treasury official who is now an economist at the Council on
Foreign Relations in New York.

“If China insists on pegging to a now-depreciating dollar,
it isn’t clear that China will be doing anything other than add
to its dollar portfolio,” Setser said. “China’s public
expression of concern about its dollar holdings is somewhat at
odds with its policy of pegging to the dollar quite tightly.”

When notes and bonds of U.S.-backed companies such as
Fannie Mae and Freddie Mac are included, China’s holdings of
U.S. debt come to about $1.55 trillion, according to Setser.
“China will certainly raise its concerns in some form,” he
said.

Geithner, 47, will need to “say all the right things”
about the U.S. fiscal shortfall, said Adams, who accompanied
former Treasury secretaries John Snow and Paul O’Neill on trips
to China. “There’s enormous concern about the size and
intractability of the deficit,” said Adams, who is now a
managing director at the Lindsey Group, an investment consulting
firm in Fairfax, Virginia


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Durable Goods Order/Claims

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Karim writes:

Durable Goods Order/Claims

  • Durables goods orders +1.9% headline; -1.5% ex-aircraft and defense (this is the measure used for the private sector capex component of GDP)
  • Defense up 23.2% m/m; here are the prior 3mths for defense orders in 2009 (-11%;+33%;-40%)
  • Shipments ex-defense -0.3%
  • Inventories -0.8% (unexpected as most felt inventory drawdown was over in Q1)

  • Initial claims fall to 623k from 636k (revised up from 631k)

  • Continuing claims up another 110k

  • Data shows economy still contracting; look for range of estimates for Q2 from -2% to -4%

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James Grant

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(email exchange)

>   
>   Hi Warren. I heard James Grant speak yesterday. He was funny, entertaining, articulate
>   and full of historical knowledge, but I found his monetary analysis appalling. He wants
>   the U.S. (and the rest of the world) to be on a strict gold standard.
>   
>   It seems to me that the consequent reduction in flexibility and efficiency could be a
>   death sentence for hundreds of millions of people around the world. What do you think ?
>   

Agreed!

The gold standad wasn’t abandoned because it worked so well!

The gold standard panic of 1907 was so bad they created the Fed in 1913 to keep it from ever happening again.

It happened again and even worse in 1929 to the point gold was dropped domestically in 1934.

No depressions since as the supply side constraints on ‘money’ were eliminated and counter cyclical fiscal policy became viable.

They kept the Fed open anyway and gave it other things to do.

Send this along to Jim, thanks!


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Obama – “US out of money”

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After a fiscal package that may or may not be sufficient to bring down unemployment, the president is now directly telling us that the next move is to dampen aggregate demand by reducing health care spending (and letting tax rates go higher.)

In a sobering holiday interview with C-SPAN, President Obama boldly told Americans: “We are out of money.”

C-SPAN host Steve Scully broke from a meek Washington press corps with probing questions for the new president.

SCULLY: You know the numbers, $1.7 trillion debt, a national deficit of $11 trillion. At what point do we run out of money?

OBAMA: Well, we are out of money now. We are operating in deep deficits, not caused by any decisions we’ve made on health care so far. This is a consequence of the crisis that we’ve seen and in fact our failure to make some good decisions on health care over the last several decades.

So we’ve got a short-term problem, which is we had to spend a lot of money to salvage our financial system, we had to deal with the auto companies, a huge recession which drains tax revenue at the same time it’s putting more pressure on governments to provide unemployment insurance or make sure that food stamps are available for people who have been laid off.

So we have a short-term problem and we also have a long-term problem. The short-term problem is dwarfed by the long-term problem. And the long-term problem is Medicaid and Medicare. If we don’t reduce long-term health care inflation substantially, we can’t get control of the deficit.


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FDIC undervalued failed banks as suspected

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As suspected at the time, some (not all) of the failed banks were undervalued by the FDIC to facilitate a quick transfer to other institutions to the detriment of the former shareholders.

Worse, the FDIC said some of the banks failed due to liquidity and not capital impairment.
This means they failed because FDIC deposit insurance and Fed lending failed to do their job of supporting the liability side of banking as per the business model of this long standing ‘public/private partnership’ called banking.

JPMorgan $29 Billion WaMu Windfall Turned Bad Loans Into Income

by Ari Levy and Elizabeth Hester

May 26 (Bloomberg) — JPMorgan Chase & Co. stands to reap a $29 billion windfall thanks to an accounting rule that lets the second-biggest U.S. bank transform bad loans it purchased from Washington Mutual Inc. into income.

Wells Fargo & Co., Bank of America Corp. and PNC Financial Services Group Inc. are also poised to benefit from taking over home lenders Wachovia Corp., Countrywide Financial Corp. and National City Corp., regulatory filings show. The deals provide a combined $56 billion in so-called accretable yield, the difference between the value of the loans on the banks’ balance sheets and the cash flow they’re expected to produce.

Faced with the highest U.S. unemployment in 25 years and a surging foreclosure rate, the lenders are seizing on a four- year-old rule aimed at standardizing how they book acquired loans that have deteriorated in credit quality. By applying the measure to mortgages and commercial loans that lost value during the worst financial crisis since the Great Depression, the banks will wring revenue from the wreckage, said Robert Willens, a former Lehman Brothers Holdings Inc. executive who runs a tax and accounting consulting firm in New York.

“It will benefit these guys dramatically,” Willens said. “There’s a great chance they’ll be able to record very substantial gains going forward.”

When JPMorgan bought WaMu out of receivership last September for $1.9 billion, the New York-based bank used purchase accounting, which allows it to record impaired loans at fair value, marking down $118.2 billion of assets by 25 percent. Now, as borrowers pay their debts, the bank says it may gain $29.1 billion over the life of the loans in pretax income before taxes and expenses.

Purchase Accounting

The purchase-accounting rule, known as Statement of Position 03-3, provides banks with an incentive to mark down loans they acquire as aggressively as possible, said Gerard Cassidy, an analyst at RBC Capital Markets in Portland, Maine.

“One of the beauties of purchase accounting is after you mark down your assets, you accrete them back in,” Cassidy said. “Those transactions should be favorable over the long run.”

JPMorgan bought WaMu’s deposits and loans after regulators seized the Seattle-based thrift in the biggest bank failure in U.S. history. JPMorgan took a $29.4 billion writedown on WaMu’s holdings, mostly for option adjustable-rate mortgages and home- equity loans.

“We marked the portfolio based on a number of factors, including housing-price judgment at the time,” said JPMorgan spokesman Thomas Kelly. “The accretion is driven by prevailing interest rates.”

Wachovia ARMS

JPMorgan said first-quarter gains from the WaMu loans resulted in $1.26 billion in interest income and left the bank with an accretable-yield balance that could result in additional income of $29.1 billion.

Wells Fargo arranged the $12.7 billion purchase of Wachovia in October, as the Charlotte, North Carolina-based bank was sinking from $122 billion in option ARMs. As of March 31, San Francisco-based Wells Fargo had marked down $93 billion of impaired Wachovia loans by 37 percent. The expected cash flow was $70.3 billion.

The Wachovia loans added $561 million to the bank’s first- quarter interest income, leaving Wells Fargo with a remaining accretable yield of almost $10 billion.

Government efforts to reduce mortgage rates and stabilize the housing market may make it easier for borrowers to repay loans and for banks to realize the accretable yield on their books. With mortgage rates below 5 percent, originations surged 71 percent in the first quarter from the fourth, a pace that may accelerate during 2009, said Guy Cecala, publisher of Inside Mortgage Finance in Bethesda, Maryland.

Recapturing Writedowns

Wells Fargo, the biggest U.S. mortgage originator, doubled home loans in the first quarter from the previous three months, in part through refinancing Wachovia loans.

“To the extent that the customers’ experience is better or we can modify the loans, and the loans become more current, that could help recapture some of the writedown,” Wells Fargo Chief Financial Officer Howard Atkins said in an April 22 interview.

Banks still face the risk that defaults may exceed expectations and lead to further writedowns on their purchased loans. Foreclosure filings in the U.S. rose to a record for the second straight month in April, climbing 32 percent from a year earlier to more than 342,000, data compiled by Irvine, California-based RealtyTrac Inc. show.

Accretable Yield

The companies bought by Wells Fargo, JPMorgan, PNC and Bank of America were among the biggest lenders in states with the highest foreclosure rates, including California, Florida and Ohio. Housing prices tumbled the most on record in the first quarter, leaving an increasing number of borrowers owing more in mortgage payments than their homes are worth, according to Zillow.com, an online property data company.

“We’ve still got a lot of downside to work through this year and probably through at least part of next,” said William Schwartz, a credit analyst at DBRS Inc. in New York. “If I were them, I wouldn’t be claiming any victory yet.”

The difference in accretable yield from bank to bank is due to the amount of impaired loans, the credit quality of the acquired assets and the state of the economy when the deals were completed. Rising and falling interest rates also affect accretable yield for portfolios with adjustable-rate loans.

PNC closed its $3.9 billion acquisition of National City on Dec. 31, after the Cleveland-based bank racked up more than $4 billion in losses tied to subprime loans. PNC, based in Pittsburgh, marked down $19.3 billion of impaired loans by 38 percent, or $7.4 billion, and said it expected to recoup half of the writedown. After gaining $213 million in interest income in the first quarter and making some adjustments, the company has an accretable-yield balance of $2.9 billion.

‘Being Prudent’

“We’re just being prudent,” PNC Chief Financial Officer Richard Johnson said in a May 19 interview.

Johnson said he expects the entire accretable yield to result in earnings. The company has taken into “consideration everything that can go wrong with the economy,” he said.

Bank of America, the biggest U.S. bank by assets, has potential purchase-accounting income of $14.1 billion, including $627 million of gains from Merrill Lynch & Co. and the rest from Countrywide. Bank of America bought subprime lender Countrywide in July, two months before the financial crisis forced Lehman Brothers into bankruptcy and WaMu into receivership.

As market losses deepened, Bank of America had to reduce the returns it expected the impaired loans to produce from an original estimate of $19.6 billion.

Countrywide Marks

“The Countrywide marks in hindsight weren’t nearly as aggressive,” said Jason Goldberg, an analyst at Barclays Capital in New York, who has “equal weight” investment ratings on Bank of America and PNC and “overweight” recommendations for Wells Fargo and JPMorgan.

Bank of America spokesman Jerry Dubrowski declined to comment.

The discounted assets purchased by JPMorgan and Wells Fargo make the stocks more attractive because they will spur an acceleration in profit growth, said Chris Armbruster, an analyst at Al Frank Asset Management Inc. in Laguna Beach, California.

“There’s definitely going to be some marks that were taken that were too extreme,” said Armbruster, whose firm oversees about $375 million. “It gives them a huge cushion or buffer to smooth out earnings.”


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