Friday, March 30, 2012

Germany the Vampire Squid of Europe

The real story of Germany, to be blunt, is that it is a parasite economy. Its domestic demand lags. It has a labor force with different values than most. It will live with low wage increases and low inflation. It has lured other EMU members into a currency bloc and let them run such persistently higher rates of inflation (with no criticism of it!) that Germany now OWNS any domestic demand that other EMU countries can generate. Germany is like the vampire squid economy of Europe. Now it’s kind of caught in its own huge blinding squirt of ink, since its banks have to lent to these other EMU countries to finance their excessive consumption entangling Germany in their financial problems. But on the real-economy side of things, the German economy is eating their lunch, however, meager.

Some think that the solution is to knock the euro down on FX markets; that is something that might help Spain and Portugal and Italy and others… and it will absolutely enrich Germany with its hugely advantageous competitiveness position in the EMU region.

On one hand it is easy to extol the virtues of Germany for its relative prudence. But its banks helped to recycle funds Germans would not borrow to fuel excess consumption in the other places in the Zone. When there is a crisis, the lesson is that bankers get coddled and the borrower-homeowner gets put on the short leash and gets the lecture and the penalties. That’s exactly how Europe is playing out.

I think that EMU has let inflation differences- parities- get so far from their starting point so that there is no going back. It needs a whole re-benchmarking or split up. Maybe the very strongest (lowest inflation nations) need to leave the Zone. But the Zone seems to have outlived its workability. It is in real need of change and not tinkering. I don’t see how or why financing it to let these disequilibria conditions persist makes any sense. And I don’t see actions being taken to make the less competitive more competitive. I just see austerity piled on top of high indebtedness and that will only lead to ruin.

The fact that Germany is not the engine of growth and will not bear the financial burden of rebuilding Europe as its financial pillar is the real truth of the role of the German economy. It is in EMU to take not to give. EMU is fine as long and it becomes more and more Germanic. And that is the final lesson. It might end when the zone is renamed GMU.

Monday, March 26, 2012

Bernanke rolls the dice on what seems to be a bad bet

Bernanke’s argument that he can push demand harder to reduce unemployment is based on the notion that unemployment is more cyclical than structural. Unfortunately that seems like a bad bet given the evidence. The greatest bulge in unemployment in this cycle is from not-temporary unemployment instead of from temporary unemployment. And that category’s contribution to the unemployment rate is larger than in this expansion at this point than in any previous expansion at the 32-month mark since at least the 1970s.  Ben seems to be rolling the dice on a bad bet. But it’s a bet that gives him a rationale for postponing tightening which is what his Great Depression lesson tells him to do. Right now all we really know is the ‘what’ of his policy ‘not the ‘why.’  

this is the teaser text for My Zero Hedge article and below it, the table that explains the data discussed in the body of that article. 

Go here ( LINK BELOW) to see the article that explains why these data undermine Bernanke's case for saying unemployment is mostly cyclical.

Sunday, March 25, 2012

Europe at odds with the financial gods

Europe at odds with the financial gods
…and out of Greek goats to sacrifice?
Last week we highlighted the apparent snit between Bernanke, as he  called on Europe to ‘get its house in order’ and Draghi who did his best imitation of Alfred E.Neuman’s, “What me worry?” slogan. Draghi, as far as my spies can tell, actually uttered with a straight face the following line… ‘The worst for Europe is behind it.” Or some other such tomfoolery.

Anyone that allegedly ‘thinks’ Europe’s worst is behind it is just letting wishing and hoping and perhaps even praying get the better of thinking.

In the clip below after a short commercial interlude and a first interview with Jay Pelosky I join Pimm Fox on Bloomberg TV (at the 11 ½ minute mark.) to talk about the new revelations on John Corzine. After that we talk about Europe and some of its issues… I will also expand on that in the text below.

Fooling ourselves
The troubles at MF Global in the US, which stem from a separate issue developing after the financial crisis, underline that the financial safety net is not fixed. The fact that Greece got money to plug a financing hole but has did not improve its dire economic circumstance nor has it mended its huge competitiveness disadvantage begs the question of what purpose that bail out served…at least for Greece. Greece is in need for much more help. All this suggests that we are still not above fooling ourselves again and again.

ECB’s ‘capital’ to become lower-case? (The ‘A’ to ‘a’ function?)
Meanwhile, back in the ‘Oh what tangled webs we weave when we practice to deceive’ Department, the ECB while claiming to be making progress is getting deeper and deeper into its own personal interbank quagmire. The ECB, looking for a solution to the unraveling sovereign debt problem found a way to stopper the contagion by herding banks to the slaughter, although that is not exactly how the ECB describes it. What it has done is to sacrifice its own balance sheet and potentially is own reputation. It extended to banks credit throwing the already troubled banks into sovereign auctions with borrowed money so they could get even more exposure to their local Tier-one capital provider. This has enabled them to ‘bulk-up’ on tier-one exposure before it spawns tears two and three through one thousand. As surely as we watch these developments today much of that Tier-one credit will prove to be another case of fancifully overrated debt, and the true  debt rating will represent a cut and the next round of the Euro-debt crisis will wash over the banks taking the ECB’s reputation with it. Bon Voyage.  Tsunami or Sue-not-me?

LTRO (Losers Taking Risk Onboard)
It’s all been enabled by something called LTRO. What it represents is the most stop-gap of stop-gap plans. If Larry Moe and Curley were bankers they might have tried this. Don’t YOU try this at home; it is for seasoned professionals only… The ECB has played out capital to banks because the ECB cannot buy sovereign debt directly and because some are worried about the ECB amassing debt of sovereigns with questionable credit standing. The Greek experience has had some impact on behavior. Yes some but…not much, and …not enough. So the ECB is seeking shelter (just a shot away, in some sense) by lending the money to banks (i.e. typical ECB ‘customers) who then participate in their local government’s debt auctions and buy the bonds thereby stoppering the auction deterioration that was in train and cutting the threat of contagion.

It worked! Sort of…

Well, this is good!? Hmmm. Well, this has been effective, anyway!? Hmmm. Well, it has been so far…and yes so far… and so far only. But there is NO WAY –NO WAY- that this can end well.

The deli-debt sandwich - no pickle needed!
What we have are sovereign debt problems now weighing even more heavily on the balance sheet so banks and banks owing money to the ECB that is in some sense collateralized by sovereign debt. So it is as though the ECB participated in these auctions and bought this debt it self except banks can use the funds they got for the ECB for other transactions too and except that the banks are now another layer in the sovereign debt stacked too high to fit in your mouth deli-debt sandwich. Could I have a pickle with the debt sandwich please, sir? What’s that? I don’t need a pickle? I’m already in one? Never mind.

From too-big-to-fail to too mammoth to use anything but a Cray
When the Fed got involved in its program of assisting banks in the US crisis it was financing troubled institutions through a period in which assets were trading at temporarily depressed values. The Fed judged the market valuations to be ‘wrong’ at distressed levels. So it took some of these assets as collateral for loans (after imposing haircuts). The Fed just booked $25billion in profit on one of its portfolios. Of course the Fed made its own detour to safety through hostile territory when it ‘saved’ weak banks by letting them merge with strong ones. Now we have some too-big-to-fail banks that are too big to do their accounting with anything but except with a Cray computer.

Welter of problems serving wrong master
The problem I Europe is that its sovereign debt crisis is not going to just go away. It is not a case of a market run that has oversold valuable sovereign assets. The problems of sovereigns in Europe are linked (yes) to excessively large fiscal deficits/debt, governments that are ‘too big,’ pension schemes that are unaffordable, tax revenues that collapsed and will be hard-pressed to grow back, and competitiveness losses that are ingrained and enshrined by the existence of EMU and the single currency.

Not dealing with the consequences (NDWTC) and the consequences of NDWTC
The real problem with EMU is that it is a system set up to glorify the currency. In Europe everything has been done to support the currency. In real economics the currency is there to serve the needs of the economy. In Europe they have turned it upside down. And because they did not have good fiscal backstops (Mass-Trick was a joke, but had they spelled it as I do maybe people would have seen though it sooner). Now, Europe is dealing with the consequences of not having dealt with the consequences. And what it the tact by the ECB? To not deal with the consequences but to push them off onto banks to whom its gives extended loans so that they can continue to avoid the consequences. Pushing consequences into the future usually is not a good idea. The present value of consequence not dealt with today is something that can grow exponentially when marked to 'market' tomorrow.

The causes of the consequences
In the US we may be seeing first big fish of the banking sector caught in a net. John Corzine may yet wriggle out, but for the moment he is flopping around out of water and looking vulnerable. Stanford was caught and Madoff was caught. But no prosecutor has been eager to go after real bankers, let alone banks. This reticence could leave the stink of moral hazard in the air and bring back these bad practices or others like them. It is important to deal with the causes of the consequences as well as the CAUSERS of the consequences.The need to prove 'intent' is a beard best shorn...

ECB goes to Euro Disneyland?
Europe is still in denial about the extent of its problems and the entanglement of its central bank. Maybe Draghi should have the ECB relocated to Euro Disneyland and do its mark-to-market in fantasy land? All this makes ME THINK that what is becoming more likely is that the strong countries like Germany might leave the e-Zone eventually. Some are arguing that Europe will inflate its way out of its mess. But the Germans would never acquiesce to that. This is the whole problem in speculating about the Euro’s value: no one knows if the Zone will stay together and if it does not, who will leave. The Zone and its central bank, once built to emulate the Bundesbank, is looking less and less like something the Germans could be comfortable with.

As a result there New Zone member theme song: Should I stay or should I go? A real clash, pardon the pun…      Click link below


Thursday, March 15, 2012

Key stories from overnight: March 15

Spanish home sales still unwinding

UK rating at risk
Chinese biggie bites the political dust
Got yer’ back buddy: Cameron to Obama…

Here we go again fighting a flow imbalance of unknown duration with a stock; The SPR
Is this the new college major? Whistle-blowing
Markets are discriminating as Spanish stocks lags
More help needed for Portugal and Ireland says Bini Smaghi
US Korea Free Trade starts up today!
Rates in India unchanged

Tuesday, March 13, 2012

Job growth is it enough? Too much?

Is job growth impressive enough to stop worrying?  
A look at unemployment and participation rates

The jobs picture: unemployment and participation rates
The household report, the source report for the unemployment rate calculation, registered 428,000 new jobs in February. It saw 847,000 jobs created in January. That’s nearly 1.3 million jobs in two months. And we still have doubters… And 2.6million jobs have been created according to the Household report in the last seven months.  That’s an average of 371K per month. Private nonfarm payrolls are up by just 1.3million over that seven month period for an average of 191K per month. That’s a lot less than the household figure but not a shabby showing.

Still the labor force participation rate was around 0.66 (66%) before the recession/financial crisis and it is only back to 0.639. So 2.1% - more - of the civilian population over the age of 16 has headed to the side lines helping to suppress the unemployment rate. Note that this is a proportion and in absolute terms the labor force is rising; at a 1.6% annual rate over six months. 

Population growth shows that ’women’ is the fastest growing class of labor followed by ‘teens’; ‘men’ is the slowest expanding class.

The labor force shows its fastest growth for women followed by men with teens the slowest

Employment is fastest growing for men followed by women and teens.  The number unemployed is shrinking fastest for men second fastest for teens but it is still rising for women.  As a result of these trends ‘men’ shows the slowest growth among the not in the labor force groups followed by teens with women having the largest not-in-the-labor-force (NITLF) growth rate.

Men are making the greatest gains since they are being employed faster than other groups have the slowest labor force growth, the fastest reduction in the ranks of unemployed and the slowest growth of being NITLF. Men’s labor force growth is slow even though their employment growth (part of the LF measure) is fast.

Cyclical Trends in Participation

The story of labor force participation rates is being re-written and not just in this cycle. Since 1990 there has been a gradual increase in the tendency for labor force participation rates to drop. In 1990 it was just the young and adult men along with all teens. The teen plus adult men’s rate and the adult men’s rate have steadily been shrinking. But the decline for adult men is accelerating in the business cycle. So is the decline for teen and adult men. The teen and adult women rate has been slowing and is now shrinking at an ever faster pace since 1973. Adult women continue to see their participation rate rise, but the pace of that increase has slowed, and slowed sharply. In an all-inclusive time-series format the adult women’s rate is down from its peak.

So there are several kinds of forces that are in play. There are a number of category-specific longer term trends that are in play. But it is also true that some of these effects are intensifying over the most recent cycles. Women’s participation rates once rising by 2.9 % points at the 32 month mark of recovery are up by just 0.10 pct points in this cycle. Historically, that was one of the important offsets to the long term structural drop in men’s participation rates. The men’s drop has had some vacillation but it has averaged a drop of 1% at the 32-month mark of the expansion cycle. In this cycle the men’s rate has dropped by 1.8 % points. The rate for teens has been dropping in a more accelerated fashion and the drop of five percentage points at the 32-month mark is identical to the drop at this point in the 2001 cycle.

In the 1990, 2001, and 2008 cycles participation rates have been more prone to drop than in earlier post war cycles. Interestingly 1960 is an exception.

People are screaming about the high rate of unemployment and the Fed has swerved its policies to try to reignite growth. Job growth is in gear again but participation rates channel much broader trends. The Fed needs to be careful about being pushed to achieve objectives that are beyond its grasp.

The metrics for participation by educational attainment do not have a long history. But in this recovery period the rate for those with less than a high school diploma is up by 0.4% points from the recession end (yes, that’s UP). But for all other educational; classes it is lower!  For participants with a high school diploma but not college the participation rate is lower by 3.8% points. For those with some college but no degree the participation rate is lower by 2.3% points. For those with a college degree their participation rate is lower by 1.4% points.   

The declines in the unemployment rates have favored the less educated. For the least educated group (no high school diploma) the drop in the unemployment rate since the recession ended is 2.6% points; for high school grads it is -1.5% points for those with some college it is -0.8% and for college grads the drop is 0.6% pts. Now this also reflects the fact that the level of the unemployment rate is highest for the least educated. But they still have had the greater proportionate drop. 

                                                                  Caution Fed caution!!

The table above breaks down unemployment rate progress by different categories of unemployment: BY REASON. Job losers probably most come to mind when think of this category. They make up 55% of it and included workers on temporary layoffs and on permanent layoff (factories closed, out of business etc). Job leavers made up another 8%, of the unemployed with re-entrants to the labor force accounting for one quarter of the unemployed. New entrants are currently about 10% of the pool of unemployed. 

Compared to historic norms the group ‘not temporarily unemployed’ is quite large. It makes up 46% of the unemployed pool right now compared with a normal proportion of 37% and a previous high of 40% (1990 and 2001). The proportion unemployed temporarily is 8.7% compare to an average of 12.1% and a previous low of 10% (1970).

One implication here is that a large bulk of the unemployed reflects people that are not simply going back to their old jobs when the economy picks up.

The Fed may take its dual mandate seriously. But these data suggest that a great big chuck of the main unemployment problem is not simply cyclical. ‘Job leavers’ is at a low proportion historically making up only 7.9% of total unemployment compared to 12% on average at this point in the recovery cycle . But ‘re-entrants’ and ‘new entrants’ are at a near-normal proportion of total unemployment. Job leavers may be few in numbers because, with such high unemployment, not many are willing to leave jobs. So fewer wind up being unemployed. This low reading is not a mark of success. The low quit rate reinforces this view.

There is another way to assess unemployment by reason and that is to look at the contribution to the rate of unemployment. Looked at through this lens the categories for unemployment are all within one standard deviation of the previous mean for unemployment by category at this point of the cycle except for ‘not temporary job losers.’ Of course this means that the overall category that includes this measure, Job Losers, also is distorted up. But the other component of job losers, ‘temporary job losers’ is actually normal. What stands out it that the unemployment rate is elevated by about 1.4 percentage points (it could be 6.9%) except for the excessive strain on the category ‘not temporary job losers’. The reading for this category is three standard deviations above the mean., a reading that makes it impressively significant. And this category is a proper target for fiscal policy not for monetary policy. 

The Fed, as much as it wants to boost growth, will have to be aware that this large crop of ‘permanent’ unemployed may be harder for the labor market to absorb. Having said that, the table above show that the current level of permanently unemployed as a percentage of the recession end peak is only 75% which is the second lowest among all these cycles. Thus progress in reducing ‘permanent unemployment’ has been quite good. But this has also been a very large pool of unemployed by historic standards. Temporary unemployment is at 65% of its peak and that is about normal at this point of the expansion.  

Job leavers are 26% above their peak level but this class averages a higher number; at his stage the expansion the average rise should be more like 11% not 26%.

Re-entrants are ‘doing well’ by historic comparison as their ratio to their end recession level is low. It is up 1% from its recession-end level and the norm would be to rise by 3% to 4%.

New entrants unemployed are up 39% from their recession-end level while the norm is somewhere between 16% (average) and 25% (median).  New entrants are struggling to get back into the labor market.

On balance a number of factors are in play in understanding participation rates and unemployment rates. Many of them are out of the Fed’s control. Some are structural and others are demographic. The danger is if the Fed pushes too hard to try and get the unemployment rate down it could backfire. This past week we did see unit labor costs elevate and they are up for two quarters running and are up to 3% Yr/Yr. This may not be a sign that the Fed has reached its limits but job growth is getting stronger has become more reliable with nearly all job gauges giving off consistently firm readings. Still, the Fed is obsessed with its multi-mandate. We can only hope that it will recognize, not just that it is pushing on a string, but that it is pouring stuff into a punch bowl that is already overflowing.

If might do a better job of policy recognition error if is not as guilty as I am in mixing its metaphors.

Thursday, March 8, 2012

New Fed Policy, old policy, right one, wrong one?

New Fed Policy?
Same old Fed policy?

The Fed has a new plan. It’s to do something then to blunt the impact of what it has done. Is this better than doing nothing? Or is nothing better than more of this too clever-by-half seemingly sophisticated Fed fiddling?

The plan is to allow the Fed to continue to buy long term securities (Treasuries or mortgage paper) even if oil prices rise. To blunt the impact of the stimulus from reserve creation the Fed would do matched sales (reverse repos) an operation in which the Fed takes out the same reserves it just put in with the long-term securities purchase. The Fed gets an interest bearing loan secured by market paper from its dealers in the short term markets and ‘presto-chango’ nothing has happened with reserves. Well something has happened but not with reserves. The amount of reserves in play remains the same. There are fewer long term securities and more short-dated paper for the dealers. It looks a lot like Operation-Twist with an extra twist (actually one twist fewer). So maybe since this is lacking part of the twist operation we should call it ‘operation twit’ and lose the ‘S’? Just a thought…

In the Fed’s Operation Twist its focus is on two different securities on the treasury yield curve one long-dated, the other short. The Fed buys the long term security and sells the short one trying to ‘twist’ the yield curve lower.  For this new operation the Fed would use one Treasury security (or mortgage bond) and a short term collateralized loan. As with Op Twist there would be no reserve impact.

On balance there would seem to be some yield curve effects from an operation of this kind. The Fed would be taking duration and perhaps some credit risk out of the market. But the Fed blunts the reserve effect the same as it does with Twist. And since the reverse RP’s can be rolled over (or not) the Fed gains a mechanism it can use to manage reserve effects if it wants to.

What is odd about this operation is that it is another way for the Fed to try and stimulate the economy. This new plan comes at a time that the economy is doing better. The reverse RP would be just be another thing to get in the way of the Fed when it finally needed to shrink its balance sheet. This is also to say that the long term security purchase envisioned by the Fed goes in the wrong direction if the economy is improving. But this plan tells of the Fed’s biggest fear. It is not yet dealing with the idea of shrinking its balance sheet.   

With Bernanke having just testified before the Senate and the House committees and with the take-away having been that he did not seem too eager to do another QE, it is odd that the Fed would come up with another Operation-Twist type of transaction.

With the economy doing better it is still possible that there will be some unexpected backsliding. But is a real unravel the biggest risk? The big issue we know the Fed has to prepare for is to shrink its balance sheet and this proposal goes in the other direction.

At the end of the day, the Fed is doing everything it can to convince us that it is willing to stay easy for a long time and that it has many different options for policy to help the economy. But it is doing very little to convince us that good times are just around the corner.

As the Fed makes further preparations for never ending sluggish growth, the economy is doing better. Job growth has picked up. The Non MFG ISM just this week has been quite strong. And unit labor costs are now rising more than they have in some time gaining 2.8% Q/Q annualized on the back of gaining 3.9% in Q3. We have to go back to Q3 and Q4 of 2008 to find two stronger quarters for ULC growth. But those quarters saw falling productivity push up ULC. We are seeing ULC rise in the face of still growing productivity.  ULC are up by 3.1% yr/yr the highest since Q4 2008. Still, the Fed’s focus has been on how it could do more to stimulate the economy.

The rise in unit labor costs has economists buzzing if not anyone else. Job growth has picked up and yet, the unemployment rate is still very high. Still, we are getting these wage pressures. Some are wondering if the NAIRU unemployment rate might be higher than the 5.5% the Fed talks about. It’s possible.

But this ULC/productivity report is a reminder that the economy does not conform to stereo-type views of it. We have had stagflation (low growth and with high unemployment and high inflation). Just because the economy has slack does not mean it cannot create some price pressures. Some theory might say that it can’t but the fact of it is that it is happening. We are making policy in the real world. This appearance of elevated labor costs will be something to watch very closely; it’s not a development that would have the Fed expanding its balance sheet further. But that is still the way that Fed policy tilts. Is the Fed getting behind the curve? If this keeps up, that question will asked more often.