Robert Brusca's GPS for Investors

Fed statement hits all the dove buttons

2012-01-25T13:48:00.000-05:00

The Fed's December 2011 and Jan 2012 statements have some notable differences...

Fed January 2012

http://www.federalreserve.gov/newsevents/press/monetary/20120125a.htm

Fed December 2011

http://www.federalreserve.gov/newsevents/press/monetary/20111213a.htm

The main change between these two reports is thatthe Fed has shifted the period of the ultra-low funds rate end to late 2014 frommid-2013.

Also in the new statementJeffrey Lacker has dissented:

"Votingagainst the action was Jeffrey M. Lacker, who preferred to omit the descriptionof the time period over which economic conditions are likely to warrantexceptionally low levels of the federal funds rate.”

The Fed dropped one of its keystatements about inflation vigilance compared to December. One thing we notedin this month’s inflation report is that core–services sector inflation hascontinued to creep up. The Fed seems to be ready to put up with this inflation up-creepaside for a while.

Aportion of the Fed’s December statement is below. The portion in red is nowgone.

TheCommittee also anticipates that inflation will settle, over coming quarters, atlevels at or below those consistent with the Committee’s dual mandate. However, the Committee will continue to pay close attentionto the evolution of inflation and inflation expectations.

The Fedalso seems to have linked changes in its securities purchase program more directlyto changing views on the economy (see below). Does that mean that it is goingto make shifts more quickly in the future based on a changing economic view?

The Committee will regularly review thesize and composition of its securities holdings and is prepared to adjust thoseholdings as appropriate to promote a stronger economic recovery in acontext of price stability.

Previousthe Fed had said vaguely that it was prepared to use its tools…

The Committee will continue to assess theeconomic outlook in light of incoming information and is prepared to employ itstools to promote a stronger economic recovery in a context of pricestability.

Summary:

The Fed isfor some reason setting aside the pick-up in growth we have seen over the pastfew months. There is little way to understand the Fed’s shift to push outlonger into the future the period for which it thinks rates will remain ultra-low.To me this is a confidence-killing statement.

Moreover,the shift toward less inflation concern suggests a Keynesian view has takenhold and the monetarist view has been set aside along with the observed up-shiftin the highly trend dominate core services inflation rate. Is it true that inflation cannot rise if thereis economic slack or a large GDP gap? Is that the belief that is behind thisshift? Given that the data are going the other direction right now, this conflictbetween Monetarists and Keynesians bears a lot of watching

We do notknow if the Fed made these changes in language because it is pessimistic on theeconomy’s rebound or if it is worried about Europe or the global economy. Itseems to be a policy move that goes in a direction opposite that of the recenteconomic data and weights weakness and risk in Europe relatively more heavily.

We mayfind out more about this later today.

More weather-aided housing strength

2012-01-20T10:47:00.002-05:00

If April showers bring May flowerswhat does a winter warming trend bring? Answer: distorted data. And that continuesto be the story as existing home sales continue the winning streak of recent housingreports with upside surprises.

Existing home sales jumped by 5%in December as all four regions saw sales rise. Prices fell by only 2.5% Yr/yrabout half the drop of one month ago.

It is the highest sales pace forexisting home sales since January

We are cautioning about thehousing data because of the unusually warm weather.

Note that the largest gains thismonth were in the normally cold weather regions of the NE and Mid-west. In theNE sales rose by 10.7%; in the Mid-west they rose by 8.3% despite still pooreconomic conditions. In the South and West sales rose by less than 3% in the month(still a good performance). Winter weather is less a factor in the South exceptfor wetness while the West is a mixed weather region.

Housing has probably beendistorted upward this winter. All the reports have showed strengthrecently and they are not usually in lock-step.

Now that winter has come andwith a vengeance in some places we can look for the housing data to beat aretreat. We are not negative on housing, just wary of the degree ofebullience.

Economic reports point to better times ahead

2012-01-19T17:57:00.001-05:00

Claims plummet

It was another day of positivedata in which people have tried to find bad news. How many of you do this whenyou open your Christmas presents? Do you look at the thing and try to figure whyit isn’t as good a present as is seems?

The day’s jobless claimsdata are unequivocally goods news even we cannot evaluate them fully. Claimsshot up by 27K the week before and now they have plunged by 50K. This is hugevolatility even by the standards of jobless claims. Last week we pondered ifall the progress was slipping though our fingers; this week it looks like progresshas re-accelerated. Well, maybe not, but at least we know that last week’ssignal was false and now, once again, we wait for next week’s report to give usa clue where claims are going to settle in.

The 350K mark is quite goodand is as close to normal as we have seen for some time. Claims rarely get downbelow the 300K level.

Since 1974 the median valuefor claims has been 367K. Also since 1974 claims have been below the 300K levelonly 109 times in 1,985 weeks or only 5.5% of the time. Claims fall below the 350Klevel and stay above the 300K level 38% of the time. But claims are above the 370Kmark 47% of the time. Thus claims are elevated in recession and stay that way in recovery periods. Even though recessionary periods are relatively short, they ratchet claimsup and it takes them a good part of the recovery to get back below the 350Kmark. They take some time before they work down into the ‘normal zone’ leaving the level of claims high (above 370K) much more than they are moderate (350-300K).. Indeed,the high claims Zone is all too normal occurring as it does 47% of the time.

But apart from claimsfalling to 352K in the week of Jan 13 for the previous week when claims spiked,the insured rate of unemployment rate fell to 2.7% its lowest level in this cycle.It was last at 2.7% in Sept of 2008.

Thus there is quite a lot ofevidence that the labor market is improving.

Housing Starts

Housing starts is one of thosereports you know is not going to be too good. It’s like unwrapping a Christmas presentfrom your stingiest aunt. Don’t get your expectations up. Still there can beunexpected positive surprises. While the housing headline was not one of those surprisesthe continuing rise of single family starts was as single family starts continuetheir string of increases. But housingstill has issues. We do not like to put too much emphasis on the winter housingreports because they are so much about the weather rand the weather has beenmild this year and it could example the improved tend over the last few months.Also the lift for single family starts is still quite shallow and only the largestof the multi-unit categories has any real lift to it. The housing report hadsome good news but it was not completely believable.

The Philly Fed MFG Survey -January

The Philadelphia Fed’s January MFG survey ‘disappointed’because its lift was low and it so was its level. The level for December wasrevised down giving January a lower base to spring from. That accounted forsome of the disappointment. And then the January gain itself was not large. Manyof the January categories were weaker notably orders and shipments but the separatelysurveyed barometer did rise month to month. The Philadelphia outlook index alsoadvanced strongly. Despite having some irregularities Philadelphia posted a strongoutlook and showed continued employment and a strong work week gain.

The CPI

The CPI and CPI trends remainin good shape. Headline inflation is onthe strong side year over year at 3% but over six month that is a 0.4% annualrate decline. So the energy induced bulge is dissipating. Core inflation is deceleratingfrom 2.2% to 2% to 1.8% from 12-months to 6-Mos to 3-mos. Inflation seems to be on the run and yet is notrunning too fast to worry the Fed.

Yet, interestingly, the trendfor service inflation is up. The services sector, a lower productivity and moreinflation-prone sector and the center of job creation is showing a persistingrise in inflation. That should be enough to keep the Fed from worrying that deflationis setting in. It might also be the harbinger of less tight times for servicesand evidence that the sector is warming and will take the lid off job growth. And that may be the most tantalizing elementof the CPI report.

PPI, IP and NAHB different wrinkles on the outlook

2012-01-18T18:16:00.003-05:00

Three reports… like threeblind men feeling the elephant...

· The PPI shows inflation trends to be temperedbut it show some inflation is percolating. The Fed is not focuses on this so thisis not analysis for Fed policy but could be something to watch.

· Industrial output has stopped accelerating. It isgrowing nicely in Q4 and there are some hints of slowing down. We know we losemomentum from exports. The thrust for IP will be determined by the consumerhere at home.

· As for the housing sector the NAHB index jumpedbut we think weather distortions were behind it. Beware the effects of weather in the wintermonths

Is the PPI Percolating?

ThePPI head lines is at -0.1% leaving the Yr/Yr still strong at +4.8% Butinflation is declining if we look at sequential growth rate to 2% over sixmonths and to -0.6% over three months (all at annual rates).

Butfor the part of this report that feeds into what the Fed will most care about,the CPI, the trend are worse. Finished consumer goods at the PPI level showtheir core trends to be more stubborn. this month the Core Fin Goods PPI rose by0.4% in December. Over three months the annual rate is 2.5%, compared to 3.3%over six months and 3.6% over twelve months.

Stillthe higher inflation might reflect just a bit more consistent demand. If thosetwo things go together, the Fed will have some choices to make in 2012.

Theeconomy is too weak for the Fed to worry much about that right now- right orwrong that is the Fed's bent. Some are worried that the Fed is lettinginflation and inflation fodder flourish longer than it should. Perhaps thatwill be the unexpected transition in 2012? Will inflation begin to emergefaster than what people think?

Thecore PPI suggests that even after all the trouble of last year core prices forfinished consumer goods in the PPI showed some pressure, rising 3.6% on theyear. If growth picks up in 2012 why should that figure be lower? And when withthat sort of pressure when will it stick in the CPI itself?

Industrial output rises

Afterdropping by 0.2% in November industrial output rose by 0.4% in December 2011 toend the year on a better note.

Stillsequential growth rates are unclear as the growth trends shows 2.9% over12-months, moving up to to 4.7% over six-months and back down to 3% overthree-months.

Momentumhas had its wings clipped, but not deeply severed.

Overalloutput rose at a 1.6% annualized rate in Q4 compared to 1.9% for MFG.

TheMFG slow down may also be seen as a failed speed up as growth is at 3.7% over12-Mo then 5.7% over 6-Mo and 3.9% over three mo. The 3.9% over 3-Mo is slowingcompared to six months but not to 12-months. and 3.9% is not a bad rate ofgrowth at all.

Consumeroutput has slowed. Overall it is to 0.4% over three months from roughly 2% oversix-months and 1% over 12-months. For durables the slowing is to 4% overthree months from over 8% over 6- and 12-months. Nondurables output slowed aswell but the output there is energy goods: non-energy durables picked up overthree-months to a 1.3% pace while output of energy goods plunged at a 4.9%pace.

Excludingtech and transportation business spending has been very stable at around a10%pace. but spending on Vehicles has slowed steadily and sharply while spendingon computers and office equipment plunged to zero in Q4. Materials outputcontinues at a barely reduced pace in the quarter.

Onbalance there is substantial evidence of slowing of output in Q4. But theslowing is not dramatic; its a moderation. Inventories are lean and the outlooksurely will depend on the consumer. US exports are starting to sputter and thatportion of output that gets exported should start to slow.

NAHB

TheJanuary NAHB index jumped to level of 25 (from 21 in Dec) its highest levelsince June of 2007, a 55-month high

Thesingle family sales index rose to 25 in Jan from 22 in Dec.

Thesix month outlook index rose to 29 in Jan from 26 in Dec.

TheJanuary Traffic index rose to 21 in Jan from 18 in Dec.

Byregion the NE made the biggest jump to 23 from 14. The West index spurted to 21from 16. In the South the index advanced from 25 to 27. In the Mid West theindex edged higher to 24 from 23.

Theregional data under score that this index has huge elements of weather in it.In the South where the weather is generally more temperate the index did notmove up by much in the period of abnormally warm weather. In the NE whereweather is a huge winter factor the the index made a giant leap. The West is acombination of cold/warm regions and the index saw a moderate advance. TheMidwest is largely cold but there was little special impact there as the localindex made a small rise.

Weatherseems to be importantly behind the rise in this index. the good weather helpedto get people out as the traffic index made the greatest percentage gain- buteach survey component rose by 3-points.

Can MFG be led to greener pastures by the service-sector state, New York?

2012-01-17T13:31:00.002-05:00

Out of the woods?

Empire State Index jumps

The NY MFG survey turned inan impressive set of readings to start the New Year. The index reading jumpedto 13.48 from 8.14, a large gain. The index now sits squarely in the 48^thpercentile of its queue nearly at its median. More impressive is its outlook index at a level of +54.87 which sitshigh in its queue of values as the fifth highest outlook reading in the last 91months.

New ordersrose sharply in the month to the 75^th percentile of their range and the58^th percentile of their queue. The shipments index a real-timeevaluation of activity advanced to 21.69 from 20.06 and stands in the 73^rdpercentile of its range and the 69^th percentile of its historicqueue. Both are impressive readings. Unfilled orders, however, continue to benegative. They rank near the bottom one-third of their historic queue. Unfilled orders and order backlogs tend tocorrelate with job growth but the jobs metric made a very strong push to 12.09in January from 2.33 in December; jobs are now in the top 20% of their high/lowrange and stand at the 71^st percentile of their historic queue of values(the queue reading at 71 means that the jobs index has been higher than thisonly 29% of the time historically). Average hours worked also have jumped inthe month to 6.59 from -2.33.

Overall itis an impressive performance from New York. Will the service sector state proveto be a bellwether for the nation’s manufacturing sector?

Eternal existential ratings questions

2012-01-16T13:35:00.002-05:00

Or playing the downgrade game…

What is arating? Is it a statement about the credit quality of a country or security RIGHTNOW, or is it about what it will become?

What doesit mean to give a rating and put the country or security on downgrade alert?

Does anegative outlook mean you did not have the guts to take the rating down to whereit belongs, to a level that would make it stable? I think so. Fourteen EMUcounties now have negative outlooks. So why would any investor buy any of thesesovereign debt securities priced at their current rating level, perched on theverge of another downgrade? Is this a fool’s game?

Think ofthis as you might a baseball player’s contract. Albert Pujols is a goodexample. He has been a great player. But in snatching him away from theCardinals, the Angels are going to pay him a very hefty fare. As players getold their statistics deteriorate- you can take that to the bank. Pujols is no SpringChicken. That is very clear, yet Albert now has a 10-year deal worth $254mln. Soevaluating someone or something at its past performance is not simply a problemthat resides with credit rating agencies. It is hard to see how the Pujols dealwill make sense as it ages. How would you rate this deal as far and moneyspent? Could you help your team more by spending $245mln a different way?

So toowith the ratings in EMU… Italy has just been cut by two notches and is put on anegative outlook – overnight! What happened? Bad pasta? Food poisoning?

Is thataction of a TWO-NOTCH cut and a NEGATIVE OUTLOOK S&Ps way of saying, hey,we blew it, we should have downgraded them a long time ago but now it would betoo embarrassing to take them down by THREE notches in one fell swoop?

Is theresomething systemic about downgrading all these EMU countries together (but thenin not downgrading all of them… and not downgrading all of them equally…)? Thereis something to that but in the Zone, indeed one of its fallings, is that thereare still so many individual responsibilities and so little to centralizationother than currency- and monetary policy- sharing.

To settle thisonce and for all, I think ratings should notbe allowed to have an outlook bias. If investors are going to buy sovereigndebt instrument they need to know how you view it now and for ‘the foreseeablefuture.’ If the current rating does not seem to be sustainable then it shouldbe downgraded now, it is the wrong rating.

I want tosee ratings constructed in such a way that the probably of upgrade is equal tothe probability of downgrade. Then I will admit to ratings being fair. But aslong as credit rating agencies are waiting for huge downgrades and giving adowngrade with a bias I don’t see the ratings as having any veracity.

In the caseof EMU the rating game is more difficult since ratings depend on what thee-Zone will agree to and it is not agreeing to do much of anything. But as longas this is reality it seems that a harsher near term down grade makes all themore sense! It just might be the stuff to get reluctant countries to the bargainingtable to make the tough choices they are refusing to make now.

Oneintrinsic problem with setting current ratings levels, and this is true withall financial variables in fact, is that they are nothing more than the presentvalue of a discounted stream of expectations. Still, it would be wrong to thinkthat ratings are anything more special or different than the securities thatthey rate, since securities prices (stocks, bonds, etc.) have that sameproperty. If a rating agency cannot handilycompress a vector into a scalar-rating maybe it should seek a new profession?

For nowthe ratings game is muddled. The agencies seem to be quite unsure how toproceed. I would make it easy. Anytime a true question arises about whether arating is justified, it isn’t. Any serious question about a security or acountry keeping its rating in the near future means it longer owns its currentstatus; it is borrowing it from its past reputation, like an over-the-hillsports hero.

Thisapproach would also lead to quicker decisions on downgrades and more downgradesand presumably more upgrades too. Right now the system is too rigid, too-ossified.Ratings agencies are too worried about making changes and they procrastinate,thereby putting themselves behind the eight-ball when changes are needed. Whathas just happened to Italy is somewhere between a farce and joke- but it is noshock. It’s no wonder that the Europeans want to move away from using any ofthe findings of the credit rating agencies.

I can understanda sports team overpaying for a baseball player as the Angels have done forPujols. In baseball there is emotion and an assessment that involves the humanfactor. Some players will underperform on the field and yet may be worth morethan their mere numbers suggest at the box office - fan loyalty and infatuation.But the ratings game in markets is a numbers and letters game and we need forthose who play it, to play it fairly, squarely and with a sharp pencil. I don’tsuggest an algorithm to be used without any personal judgment since ratings dorequire some judgment.

I wouldsuggest rating contracts to trade on the CBOT or some other exchange. Thatwould put speculators at an equal risk of upgrade or downgrade risk and would assurethat ratings changes are not delayed. I do not refer to betting on any agency’srating but on a separate set of market determined ratings where investors couldgo long for short the contract and where financial gain or loss would accrue toa change in the markets assessment of the rating. There might still be events that would precipitatetwo-notch changes, but far fewer of them. There might also be a greater dangerof overshooting as we see in times of financial crisis.

Of coursesomeone might note that CDSs are already sort of like this…except they are partof the game not separate from it. Greece (so far) has been able to engineer adefault without triggering CDS payments. That’s a nice thing if you are writingthem, not so nice if you have purchased them. Moreover, CDSs are about an eventcalled ‘default’ whereas ratings are a broader concept. Maybe markets shouldstep in and do something where the ratings agencies seem to be failing. Dollarsto doughnuts Italy would have been seeing the pain much sooner had thispractice been in play. We can blame the ratings agencies for their abruptnessbut we cannot be too critical of where they have currently set most of theirmarkers. But then there is that issue of negative outlooks…

S&P downgrades will haunt e-Zone and divide it

2012-01-14T11:19:00.001-05:00

S&P depreciates much of old Europe: too much or not enough?

The ‘what’ of it all

Standard & Poor's Ratings Services stripped triple-Aratings from France and Austria and downgraded seven others, including Spain,Italy, Portugal, Malta, Slovakia, Cyprus and Slovenia. It retained the triple-Arating on Europe's No. 1 economy, Germany. France and Austria were downgradedby one notch from AAA to AA+; Malta, Slovakia and Slovenia were also downgradedby one notch. S&P lowered the ratings of Italy, Spain, Portugal and Cyprusby two notches. When you have to move your belt over more than one notchat a time it’s a big deal, so too with ratings.

Downgraded for ‘inadequateaction’

In December S&P had placed 15 of the 17 euro-zonecountries on watch for possible downgrades It said Friday it had decided tolower the debt ratings of nine of them because it felt the currency bloc has sofar failed to take adequate action. But does that make sense? In what context are the ratings made? The current Zone? The prospective Zone? Until you know the context ratings are not really possible but S&P has plowed ahead.

Rating upheld for ‘inadequateaction?’

I guess Germany retained its ‘AAA’ for the same reason: the Zonehas done so little. Had it done more, itcertainly would have taken more of Germany’s resources. So in some sense the S&P is rating Germany as if it will stay on the sidelines. In that it is endorsing a certain form of the Zone with Germany's rating. The Zone is left with an EFSF(Europeans Finding Safety For-now) floundering. A fund has a hard-time gettinga rating better than those that back it. And the bulk of the backing for the stillAAA rated EFSF is from less than AAA-rated countries in the aftermath of theS&P downgrades. How long can that last?If it lasts surely it limits any gain in size if the rating is to be upheld.Bye-bye fund flexibility.

Euro takes a hit

The euro fell sharply, hitting an intraday low of$1.2623, its weakest level since late August 2010. The euro has lost more than10% against the dollar since late October. It is one of the main casualties ofthe downgrade process though it’s a casualty that will help to boost growth.

You can’t shrink yourself toprosperity

S&P did have the insight to see the limits to the ‘Germanization’of EMU policy, saying. "We believe that a reform process based on a pillarof fiscal austerity alone risks becoming self-defeating, as domestic demandfalls in line with consumers' rising concerns about job security and disposableincomes, eroding national tax revenues."

2-Tonic is wrong elixir?

EMU’s policy thrust has been Teutonic, well too-Teutonic throughoutthe Obama Presidency. Even the UK adopted it as part of some pied piperprogression (although Wagner does not usually have that effect on people) inthe wake of Obama’s first G-20 summit. Had Europe and the G-20 instead accepted the Obamaplan for stimulus at Obama’s first summit, global growth would be better now andgovernment revenues would be higher. Unemployment would be lower and yes debtlevels higher but debt ratios wouldprobably not be as bad as they are now. And all this angst about it, in all probability,never would have arisen. Countries would not be like a wolf caught in a trappondering gnawing off one foot to go free. But that is what has become ofEurope.

The easy way out

We see this on Wall Street a lot. When a firm gets in troubleand starts missing its earnings it starts cutting expenses. In the financialindustry and many others it is the easiest thing to do. But the trick is to cutin a way that does not harm revenue growth. The real trick when earnings missis to expand sales but few firms have that acumen. Cutting is easier and thatis true for countries too. Got a budget problems Raise taxes! Cut some expenses!Does that hurt growth? Probably but you get some kudos for taking a tough stepeven if it is in the wrong direction. European taxes already are so high theyamong the eight wonders of the world. They are about to get ‘K’ status as a newpeak. But don’t try to climb them.

S&P does Zone disservice

In the END S&P has executed a bunch of downgrades that donot add up to much. The real issue is not that the EMU has not done enough but thatit has no sense of what it is doing and where it is going. Until the Zone has asense of common purpose (other than not drowning and not letting the weak dragdown the strong) it cannot be successful and there will be more downgrades tocome. Germany should not be rewarded for sitting on the sidelines. Keeping itsAAA just gives it something to defend and makes it less likely to throw its lotin with the rest. Germans are going to think that staying on the sidelines is agood policy. It is not. Or to put it another way, it is not, if the e-Zone wantsto survive intact. But what does that mean? Who or what is the ‘e-Zone’ and, in thatsentence, what DOES it WANT? The Zone is not a thing. It is a concept. And eachmember has in its mind a different concept. And that is why in the end itfails. S&P has done EMU no favors especially not by playing favorites with thedowngrades.

A better consumer is more than a rumor! U of M survey jumps

2012-01-13T11:07:00.001-05:00

Expectationsand current conditions rise sharply

The U of MSurvey’s expectations component is make the sharpest rise in all of this recoveryperiod. The five month rise in the expectations reading is the greatest fivemonth rise since the period ending in December 1992. Still, with this gain sentimentis not at a new cycle high. The cycle high stand s at 76.

Currentconditions have improved sharply as well. The five month gain was previously largerin the five month period ended in January 2010. At a level of 82.6 the current indexis also shot of the cycle high reading which is at 86.9.

But the chartstell the story of momentum. And there are aided by stories of corporate leadersfinally getting ready to hire.

CEOS apparentlyare undeterred by the risk in Europe. US consumers not surprisingly are notbeing affected by talk of a Euro collapse. See story (http://www.bloomberg.com/news/2012-01-13/hiring-logjam-breaks-as-ceos-plan-fastest-u-s-growth-since-2006.html).Indeed even Europe is not much affected as its bond auctions have picked up thewake of the ECB giving banks three-year credit lines. Even the recent LEIs (LeadingEconomic Indices) from the OECD did not find a whiff of recession. To be surethe OECD gauges see many slowdowns but they were not projecting recessions asof November data.

Trade datafrom Europe tell a story of an export bulge that is hard to understand. MeanwhileUS trade data show exports are losing momentum. US imports are holding up better but hardly arethey surging, with the exception of oil.

To be surethe global markets are a series of cross currents. But the US consumer data issome of the best stuff we have seen so far. Since December 2006 there have onlybeen two times when the Bloomberg weekly consumer comfort index which has risenin 10weeks by 8points has exceeded such a gain. We can be pretty sure whenvarious measures of confidence using different survey questions and horizons beginto tell a similar story. We know have not really good eye witness news and comecorroborating evidence.

EMU trade surplus surges-jump as reliable as a politician's promise

2012-01-13T10:02:00.000-05:00

EMU seems to have posted a one-offresult. Imports continue to erode in-line with other reports on economic weaknessin the Zone but exports have sprung to life like a thought-to-be-dead vampirespringing up from the grave on a foggy night. Gotcha! But this is unlikely tobe a reversal of trend. Exports and imports have been in a slowdown mode forsome time. Imports actually did strengthen as well going from -0.7% in Octoberto flat in November

Import growth has been weakerthan export growth for some time and this configuration has resulted in a wideningof the EMU trade surplus, a surplus that jumped this month to €6.1bln inNovember from €0.5bln in October. The surplus was the largest since July of2004 and could go a long way toward boosting what has been promising to be weakgrowth in EMU in 2011-Q4.

Still, the bottom line is thatEuropean exports simply have no strong demand to sell into in order to maintheir pace. The global economy is slowing so the month’s result really hangs itshat on the notion of quixotic forces rather than unexpected surgingfundamentals. Indeed, it’s probably more likely that a Zombie will jump out ofhis grave undead than that EMU exports will maintain their strength.

Markets will puzzle over this numberand it is a good number though surprising and beyond belief. The next questionis about December and if December will prove to be an unwind of this spurt thatbrings the average back to earth as timing asymmetries settle back to normal orif some inexplicable bulge in activity will remain. But not get up false hopes on this report.

Oil slickens the deficit path for US trade as exports drop

2012-01-13T09:57:00.002-05:00

UStrade deficit surges on OIL

…erodeswithout it

The tradedeficit in November widened sharply from $43.2bln to $47.7bln. This one month$.4.5blm widening will knock something off GDP unless it comes back to us asinventory gains, which ahs been a common occurrence.

Exportsfell by 1.2% in Nov while imports rose by 1.3%. Excluding petroleum exportsfell by 1.2% and imports snaked up by 0.1% making the point that with orwithout oil the trade deficit got worse.

With this report the ebullience of exports is throwninto question as three-month exportgrowth is now negative and exports are in a clear downward path of decelerationwith growth rates of 10.3% over 12-months, 2.4% over six-months and -0.5% overthree-months. The global growth slowing is hitting the US. Meanwhile, the USgrowth acceleration is boosting imports whose growth is 12.7% over 12-monthsand fell to -0.6% over six months but has sprung back to 4% over three-months.

Landed oilprices rose by 3.7% in the month as the volume of imports surged by 4.5% alethal combination for the deficit. The non-petroleum deficit worsened by about$1.5bln.

Retail sales, Jobless claims, Inventories and LEIs- A less than happy New Year start

2012-01-12T12:56:00.000-05:00

Happy New year…Data show some sputtering

As 2011 closes and we raise the curtain on 2012 economic reports have begun to post some numbers that are more disappointing than encouraging breaking a sting of encouraging reports that has spanned about three-months.

Retail Sales

Retail sales disappointed in December, rising by just 0.1%. While this is a correct characterization it is also only part of the story. The December number is preliminary and evidence is that inflation was very low making that low nominal gains worth more in real terms (or volume terms). Also November was revised to a gain of 0.4% from 0.2% initially. Moreover we has strong September October gains that were built upon and did not reveres making the accumulated gains in the Third and fourth quarters quite good. Year-over year sales are strong as well. While the December numbers disappointed we are best off in not taking that too much to heart- it’s not like December produced a devastating decline after all. Sales are still advancing and the course in the value of sales may very well have fallen through the cracks due to inadequate methodology to capture discount buying.

Jobless claims

Claims rise sharply by 24K and are up to 399k just short of the 400K mark. But in the last few years claims have also been rising early in the year. Claims are notoriously difficult to get right each and every week. We will look for some context and another weeks work of data before we take seriously the degradation in the trend.

Inventories

Inventory data from November write a slightly different story about retail sales. In November retail inventory to sales ratios reached a five year low. Obviously compared to what they were expecting this was been some very good news on sales (though Nov). Clothing and accessories as well as General merchandise retailers had ratios in the bottom 30% of their five year range. These statistics suggest that sale in November left stocks relatively lean ahead of the key December selling season.

OECD LEIs

The OECD LEIs were below 100 for most key nations but that only suggests a slowdown. As of November that Italy was the weakest relative to tis trend and that left the Italian indicator down by just 1.5% relative to trend. China’s trend retailing clung to a trend-even 100 reading. On balance the OECD report which has data though November was not making the call for any recession. In Europe for the most part reports in Europe showed some improvement in December either rising or falling by less. So the OECD still is not pulling the trigger on the recession call even though Germany’s GDP signaled a small decline in its early Q4 estimate.

Mario Draghi and the magical euro-auctions

2012-01-12T11:28:00.001-05:00

Is the ECB’s Draghi too smart by half

…or are we too dumb by full measure?

Auction madness! Markets are breathing a sigh of relief today as Spain’s and Italy’s bond auctions went off strongly. But this is with a huge assist from the ECB. Its 3-Year loans have pumped liquidity into banks who in turn are buying their government’s bonds. So while the ECB is not buying them directly in large amounts as the ECB is prohibited from doing. Thus the ECB is building up large claims on banks whose balance sheets are being stuffed with the same assets the ECB cannot but directly. Is the ECB better off having claims on unsteady banks rather than buying the government paper directly? Who can say. But the ECB also is giving away money for all sorts of uses as well under this program. A number of banks seem to be borrowing then turning around and warehousing it on the ECB balance sheet waiting for more choice opportunities to emerge.

Is anybody really enamored of this strategy?

Who is it fooling?

The interbank market is a Japanese lunch box not a bowl of soup- One thing the large ECB deposits tell us is that banks still do not trust one another. Yet the ECB is funneling HUGE amounts of money to government bond markets by means of taking the credit of these same banks as intermediaries.

Mixed signals with a clear message- But since banks are buying Euro-govy bonds hand over fist we are led to believe (wink, wink) that the crisis is over or losing intensity! But the Euro-depositing at the ECB tells us just the opposite does it not?

Who is being played for the fool?

Typo knows best- Let me share an inside joke with you. When I wrote this the first time I found a typo. I had written that the ECB has ‘pimped’ money into the markets. Of course, I hurried to correct that. But, on second thought, that typo reflects better economic analysis than saying it pumped it. What do you think?

Euro auctions Vs US auctions which are more telling? - Indeed, contrast the Euro auctions to the US where the 10-year government note auctions, with somewhat less direct help in the US, set a new auction-yield low on a high bid-cover ratio (over three and above the average of the last ten 10-Yr auctions). Here in the US the economy is (...well until today it was) spitting out nothing but strong numbers and the investors are STILL clamoring to buy them at historic yield lows! What does that tell you about competitor markets where yields are higher and banks are getting bashed with the stick and fed with the ECB carrot-loans?

The slippery slope to fund grandmother’s bank- We can wonder about how much the Germans like the ECB’s under the table and through the markets approach to investing in Grandmother’s bank and her sovereign bond market. It may be better than arguing dysfunctional capital markets that are short-circuiting monetary policy in order to justify large direct purchases of government bonds by the ECB. But probably not… Now the ECB has arranged a situation in which not only are there a lot more govy-bonds in the market but the ECB is entangled with more banks and banks of poor credit quality.

How can that be good?

Rules are rules; write outside the lines at your own peril…and ours - The bottom line is that Europe must get its house in order. The more it finds another end-run around rules enabling it to inject funding into places where market players left to their own devices would not go, the worse off we all are.

Draghi and his baggage- So is Draghi really that smart or is he too smart by half. Oh, he is an ivy-league US trained economist. But we have seen what a lot of those guys do and what they know. They do know ‘their stuff’ they also know the politics and have their own good-ole boy network. And Draghi seems to be working his overtime.

God bless him/God Help him…but, good God, stay way from what he is doing!

His policies are kind of a drag…hi.

The ECB and Fitch have their Deja-What? moment

2012-01-11T10:59:00.000-05:00

ECB and Fitch have their Deja-What? moment

The ECB should buy more member debt? Really? I don’t understand the reverence for the rating agencies. I don’t even know what Fitch thinks is its mandate. But whatever it is I don’t see how today’s Fitchism makes any sense or helps to restore the shine to the reputation of credit rating agencies. If Fitch thinks it is carrying the ball for them, Oops! It just stepped out of bounds.

The ECB is a central bank that has been built on the model of the old Bundesbank. Fitch is aware that the Germans do not want the balance sheet expanded, risking the viability of the currency and the integrity of the central bank.

So why has Fitch steeped into the Euro-spat to holler for the ECB to do more?

Certainly someone in Europe needs to do more. But what not scream at the Germans or at the French or at EcoFin for not making some better arrangement? Or the member countries themselves for not using the IMF? Granted the ECB is a financial institution that could snap its fingers and do this bidding. But as Freddie Prince used to opine, ‘hey, man it’s not my job.’ And it isn’t. Not one thinks that some ECB bond buying is going to stoke inflation now but that is not the issue.

The whole opposition by the Germans to this balance sheet expansion and the opposition by those here in the US and within the Fed (and outside) to blowing up a balance sheet now, and to erode the credit quality of its holdings, is to avoid engaging central banking in fiscal policy. This action gets the politicians off the hook to do something and later embroils the central in the criticism of political meddling. Central banks should only jump into this breech when there is a clear and present danger and systemic risk.

Indeed, in the case of the ECB, it is prohibited by its charter from doing exactly what Fitch asks of it ( Duh!?). The ECB’s current buying of so much sovereign debt rests on a very thin, very tenuous assumption that the very different yields in different government bond markets reflects a distortion in the monetary transmission mechanism. RIGHT. Actually nothing could be farther from the truth. It is evidence that markets are in fact working, Investors are discriminating. What it represents is the perception and existence of greater credit risk in some government markets compared to others. So why should the ECBC go there if other sovereign governments or the IMF will not make loans and if countries will not adopt stringent enough austerity programs?

Why is Fitch urging the ECB to do something now for which it may later castigate the ECB and ratchet down its credit rating later?

It beats the heck out me, how about you?.

European revival: what Sarkozy, Merkel, Greece and others must come to terms over

2012-01-10T14:25:00.000-05:00

Rules for European revival

When it comes to Europe’s problems there are several clear steps it can take to relieve its stress. It does not take these steps because Europe’s problems stem less from an economic misunderstanding of what it needs than from political divisions on what member states want or can agree to.

The simplest way to reform EMU would come from the usual approach to problem-solving: do not be too committed to what you have. But France is too-committed. France views the euro as Europe and as Europe’s future, thinking that if the euro fails Europe fails. It’s a view that is a bit dramatic and certainly not true. But if that view takes hold it will limit growth and restrict options for fixing Europe.

We maintain that until the name ‘euro’ stands for EUROPE instead of for the name of a currency (the ‘euro’), Europe cannot win. No country should make subservient its goals to the preservation of a currency. That is backwards. The currency or currency zone needs to serve the needs of those who use it, not the other way around.

For Europe it is a simple problem to fix the currency Zone that was an experiment that wound up with a lot of failures if Europe learned from them. In that case it can move to fix those problems and go on. But some of these failings are not completely understood or accepted by those who are members.

We think that the easiest way to fix this thing is to START OVER. Sometimes a policy is so poorly designed that it is better to start over. This is sometimes true in business too. For example, a piece of software may have thousands of lines of code and a business may want to keep all that work that has been put into it. But if the application does not work or is buggy it may be best just to start from scratch rather than to debug and rearrange things. I compare Europe to a flawed piece of software that needs to start from square one. But Europe is not there yet…

What are some of the antecedents of e-Zone failure? Solutions? Prospects?

1. Europe’s fiscal rules were lax; Europe’s fiscal rules were not enforced

2. When members were clearly drifting from their original currency parities (in real terms as some members ran persistently higher inflation) no country or institution in the Zone did anything about it.

3. Euro economies were too insulated from one-another.

4. Labor markets were too inflexible (Spain’s unemployment rate is over 20% while Germany is experiencing a post reunification low rate of unemployment!)

5. Given the huge social policy and productivity differences there almost has to be some supranational fiscal policy to bridge differences.

6. Euro.1.0 suffered from ‘the Japanese lunch box effect’. The Zone was not run as a whole but as an amalgam of independent regions with a common currency and central bank. Yet the needs and operations of all economies mix together in a currency zone and no country can ignore problems in a fellow member.

7. IF…IF… Europe want to go ahead and ignore problem #6 (Germany’s stance more or less) then it will need VERY strict fiscal rules to make each nation accountable and to make deviations in inflation, productivity, growth and fiscal policy actionable to bring trends back into common alignment.

8. On the other hand, with a supranational fiscal authority a stick AND carrot approach could be used when members’ paths began to diverge.

9. Europe needs to decide if it wants to be ‘European first’ or not.

10. IF it wants to be European first it then has to decide if it can get to that result in the context of one Zone or if it need to split up to let some of its more challenged members join together in a separate pool and try to make the changes that will eventually make them acceptable in a single zone.

11. IF countries cannot drop their national demands the Zone will break apart and these decisions will be taken from the members and made by the markets. While some Euro countries are critical that outsiders do not understand the insiders’ commitments to the Zone, what the insiders do not understand is that by being insiders they are too close to the issues and that they have too much of a personal view that they think they can convince others to accept. The Zone needs rules all members can abide: not France’s rules or Germany’s rules. There is some flexibility, here but there are some clear needs for a Zone to succeed. There is too little attention in the e-Zone on those matters that a Zone must have to survive and too much emphasis on what the large countries insist upon.

12. Europe may not be one nation, one vote. But without a clear vision a common vision shared by all members, every single one, it will not survive.

The list above is about suggesting the sorts of things that the e-Zone got wrong, that it needs to do and places where it needs to weigh and balance in order to survive.

In the end the e-Zone is a system. And like any system there is action and reaction. The Zone must resilient for a wide variety of repercussions. The Zone may need to break apart in order to stay together. If a few countries leave the euro is there still a Euro? If counties are allowed to leave with the option to mend some their flaws then be readmitted is that a bad development? Does letting one country leave damage the Zone forever because it sets the precedent that country can leave? That is a possibility. But if the Euro adopts a strong internal fiscal rule with vigilance and actionable oversight the trick will be to keep members in the middle of the fairway so that speculation about getting off track will not build. That is the way to deal with moral hazard if the Zone is allowed to break up.

For those who are worried about the Zone breaking up because of the current rules and their implications, take warning! Let’s remember that there are all sorts of rules that explain why a country will not leave EMU because it then can’t be in EU and to be in EU it must be committed to EMU (with two exceptions, Denmark and the UK). But take one step back! If EMU decided to divide, it would likely change these rules! Never bet against the person that can re-write the rules of the game while it is still in progress!

Wholessale inventories slow faster than sales is that good?

2012-01-10T12:16:00.000-05:00

Inventories slow in November

Inventories rose by just 0.1% in November after soaring by 1.2% in October. The sharp slowdown is reassuring. As of November over the last three months inventories are growing faster than sales in 40% of the wholesale sectors that implies that in 60% of them we have the more healthy situation of sales growth matching or exceeding inventory growth. That is good news as far as it goes. But sales are still slowing over 70% of the sectors. The aggregate durables less autos category has ratcheted down its pace of sales to a -2.5% growth rate over three months compared to a +8% rate over 6-months But on the nondurable goods side of the ledger, nondurable goods sales excluding petroleum are up at a 12.3% pace over three-months compared to -6.7% over six months. .

All of nondurables have accelerated and sharply over three-months a phenomenon that seems likely to be more related to inflation developments and their knock-on effects. Durable goods major categories have seen no sales accelerations over 3-mos compared to six months but before despairing that result vehicle sales are up at a 17% pace over 3-months, still strong but slowing as the bump up from the Japanese tsunami effects unwinds.

On balance the inventory build-up that saw a 1.2% gain in Oct against sales of 0.8% for wholesalers has been stopped. But since the pace of sales is slowing and since inventory to sales ratio patterns across sectors are sporadic it is not a good time to be too complacent about inventory trends.

A lot of what happens will be determined by end of the year spending patterns and these patterns so far are mixed.

For retailing, a report for which we are still waiting, chain store sales seem to be evaluated as ‘strong’ the overall retail sales gains expected for December are still modest month-to-month and the auto sales while having recovered from weaker levels earlier in the year retreated of slightly month to month.

As a result of these trends we remain cautious about the assessment of inventories. Our own anecdotal experience with post-Christmas shopping was that in the aftermath of Christmas stores still carried an awful lot of merchandise. The usual cat and mouse consumer-retailer game of full price Vs discount makes it look like the best prices were available before Christmas in many stores. So while, to me, (in my personal unscientific, narrow New York observation of trends) inventories did not seen to have been made lean by bulging Christmas sales, yet the post-holiday sales period did not show any evidence of retailers having stress over having too much stock on hand.

So we remain cautious on inventory evaluation.

EMU hope or false promise..again? The case of France

2012-01-10T10:24:00.001-05:00

Bank of France Biz indicator shows some hope

The Bank of France has reported an increase in its industry sentiment index for December. This goes hand in hand with an unexpected rise, separately reported, in French industrial output, the later a gain of 1.1% for the month of November.

After months of EMU economic reports going from good to bad, the year-end has brought a certain respite especially to reports from France and Germany. The December readings for the MFG PMIs in the e-Zone have displayed a slight improvement in those readings across nearly all reporting EMU countries. Even so the MFG PMIs remain below the level of ‘50’ for all the observations in December, indicating only that the decline has slowed its pace and not that there is any real revival in progress since values below 50 tell of continuing slippage. Similarly, the EMU PMIs for services showed some bounce in December with only EMU members France and Germany having readings above 50, readings that indicate some growth in the services sector.

Still the Zone is beset with economic pressures and while there has been some revival in markets today and a bounce in banks shares for several key European banking institutions, the fact remains that austerity rules the euro-roost still, tilting EMU to weakness. The only really ‘pro-growth’ development of the past moth has been the continuing slide of the euro which has enhanced competitiveness among the members versus countries outside the zone and that is a silver lining a darkening euro-cloud.

Zone developments per se remain guarded with only a few slightly positive remarks coming from leaders who have been engaged in negotiations. Leading members continue to pressure Greece, a nation that already is under so much pressure that its real surprise is that it has not yet exploded.

France’s revival is depicted in its December PMI data the December bank of France pick-up and an outsized November jump in industrial output.

The BoF report, while showing month to month gains, still leaves the index at a weak position standing only in the 23.7 percentile of its historic queue of values (in other words the index is stronger 76% of the time). Industry orders stand in the bottom 12 percent of their historic rank. Overall demand is put in the 44^th percentile, closer to neutral, but foreign demand stands in the lower 14 percentile of its historic queue. While the latest production result is still in the lower 21.9% of its queue, the outlook is just as weak in the bottom 21.6% of its queue. On balance there may be some stirring of economic data at year end but there is no real confirmation of any significant revival. Given the way data are, especially at year end, it is not clear that these machinations are anything more than statistical noise.

The zone remains under pressure and France is likely bracing to lose its AAA rating. These reports and survey results taken broadly rather than confirming that the Zone is bottoming, clearly bear too many hallmarks of a euro-disease spread to France. At these low levels of economic standing in the BoF survey and other surveys we are wise not to make much of them until they show some real trend and until those trends show some staying power. So far we have only one observation, not nearly enough. Markets often refer to one-off data reversals as ‘a dead cat bounce.’ So is this cat alive or not?

Europe..again the trade-offs

2011-11-29T18:15:00.000-05:00

Europe: Irresistible farce meets the immoveable subjective

As we look at the assessments these are the polar opposite arguments. One group argues that Europe cannot come apart. The other holds that Europe must come apart. The euro-unity camp argues that it is nothing short of the future of Europe that is at stake (they are right but for all the wrong reason). The EMU-breakers argue several facts ranging from the high and different debt levels, cultural differences, differences in work ethic, the inability to make austerity work and the severe loss of competitiveness that has been suffered within the Zone.

As we look at these two cases and consider some of the arguments about how painful a break up would be, we need to look only at the Greek episode to see how little thinking has gone into the e-Zone analysis. There are many more than two possible cases here.

In the recent case of Greece, it negotiated a default that was not a default and did not trigger credit default swaps to pay. Granted Greece is now back at it, asking for an even larger haircut, but that is a separate issue (as well as part of the main issue, of course). The point is that when push comes to shove the rules change. It’s like the final seconds of a basketball game when the referees all but swallow their whistles (and with the NBA is set to play again we may get to witness more of that). Suddenly, you are playing under different rules. We should have no misconception that if the Zone is under stress and needs to blow out a few members that it will be done under existing rules without any changes. That, in fact, seems the least likely result to me.

What we may need to consider is a break up that keeps Europe together. That is a novel concept.

First of all if a nation goes bankrupt it is not certain that it would have to leave the Zone. But in a number of countries the problem is not only debt, it is competiveness. Let them declare bankruptcy and write down their debt and they are still uncompetitive. I see a lot of proposals for EMU-bonds and other financing devices but these are putting the cart before the horse. Greece has lost some 25% in competitiveness to Germany, Spain has lost about the same. Portugal has lost a bit less. Italy has lost about 10%- all since EMU has been formed and the outlet of currency depreciation has been removed.

These are competitiveness losses that would be hard to make up if the Zone stays together. If it breaks up, then countries could form a second block and try to regroup within that framework and to maintain a link to the rest of the zone depreciate their currency and restore their competitiveness.. They might even get assistance since they could all remain in the same EU mechanism and thereby have a split that is in currency terms only.

The countries that left the Zone would then be able to regroup, try to reestablish their competiveness under a new currency basis and possibly reenter the Zone at a later date. Greece and Spain and Italy and Portugal could issue a new common currency or each could to retreat to its own former unit.

It is important is to realize that all these arguments that are made about the Zone are less than resourceful – some are made by ideologues rather than argued from the facts. It is highly likely that once faced with the eventuality of break up that the Zone rules would change to allow the dead weight to leave on modified terms. It is also likely that the countries that left would get some aid and would leave on ‘good terms’ with either an option or a mandate to return to the fold in due time.

Ironically, a break-up may simply be the best vehicle for Europe to stay together.

It may not be too tidy and it would cause some trouble and legal issues. Imagine contracts written in terms of euros in a country that adopts its own and former unit. What are the grounds for altering that contract or not? Magnify that thousands of times. You might not be able to keep the contract in euros but neither could you redenominate it ‘as is’ since a local currency did not previously exist and one could not assume that two parties would have agreed to the same deal on different currency terms. For example, one assumes that there would be more inflation, at least initially, under a new unit as debt problems were inflated away and as the new unit sunk to a point that reflected the true parity for the new currency relative to the euro (since we are assuming here that the least competitive countries leave EMU).

So yes break up has a lot of technical issues that will become clearer if Europe goes down that path. If it does not, maybe it is not the end of the world either, despite all those arguments to the contrary.

Maybe the lost competitiveness in the South is not an issue because they simply will have industries that will not compete with Germany, the low cost EMU member. Maybe the Zone will come to specialize more. The US, after all, does not have the same industries uniformly spread across the nation. We have farming states, natural resource states and industrial states and all sorts of specialization. We also have high-cost states and low-cost states. If Europe is willing to reorganize itself along those lines maybe ‘not coming apart’ can work.

But I do not see how Europeans stay together and pretend that the lost competitiveness regions are going to catch up. Economics rules out miracles.

If Europe becomes more of a single economic unit we will not have to worry about the structural trade and current account imbalances that have developed within the Zone. Italy Spain, Portugal and Greece are running persistent balance of payments deficits; that will not be an issue when/if EMU finances are blended with the countries that run chronic surpluses. In this view Europe will move to a model of regional specialization instead of a model of free-standing countries sharing a currency but with independent financial issues each trying to run a balanced economy.

It should be clear that the choices Europe is about to make will have far reaching consequences.

This is why having a new treaty with voting makes sense. Most euro-leaders do not want to do it because there are factions at home that want to claw-back rights from ‘Brussels.’ But Angela Merkel has pushed for a new treaty vote for good reason. As the above discussion demonstrates, what is being contemplated- whatever road Europe takes- has far reaching consequences. It is important that all members are truly on board. It would be a really bad choice if the ‘euro-leaders’ were to gin together some deal that would bridge the financing issues without coming eyeball to eyeball with the broader socio-economic issues which lie at the bottom of the Euro-imbroglio.

Let me emphasize that coming up with a check to fund Europe near term, as difficult as that has proved to be, is a much easier thing than having Europe come face to face with what its identity will become. Pretending that you can stretch out financing and not dealing with what that time will buy is absolute nonsense. And that is why the German position has been so hardline. Germans want their money to buy results: a harder reality.

The Germans are the most solvent of the European nations and Germany has the most solid bond market. Germans are in the euro-cat-bird seat. But they are not out of danger. And that is why they shoot down one harebrained scheme to finance things after another. The Germans want financing to lead to a stable end game. And most of the financial schemes do not do that because many of them take a lot of the pain out of the process and without pain there will not be the kind of enduring progress that is needed.

I think this is a much more productive way to think about Europe, than heads it’s unified, tails it’s busted up. Europe needs to decide its identity that is the issue.

It is not about financing. It is about Europe deciding what it will be when it grows up. Heck people get divorced and then remarry! What can’t the Zone break-up over currencies and keep other common elements and plan to relink under better-understood circumstances in the future? What is so sacred about keeping the currencies fixed when it is so clear that the fix has gone bad? Who is looking at this and thinking about what it means to stay fixed in one zone instead of being flexible in one union?

In a piece on the future of the euro-Zone written by Niall Ferguson, the British historian, he, interestingly, has the UK pulling out of the EU and being joined by Ireland. He has Greece staying in. Then, years on, Greeks would still be undergoing high unemployment and still muddling through with huge transfer payments to support their lifestyle underwritten by Germans! Science fiction is one thing, but Greek political fiction is something else.

It’s not a result that I can see happening (sorry Niall); but it is consistent with what could happen if the Zone is kept together without a clear view of what that means for everyone. Would the Germans give in and support high unemployment in an uncompetitive Greece? Or would they force a long, long, period of austerity on Greece? And if that were done, would Greece have the staying power to stick it out within the Zone or would it choose to leave? This is why a treaty vote is so crucial and why those who would change the game must also change the vision so people know the consequences of their vote.

But Europe is also a place where leaders are used to leading their people by herding them into certain situations. Some it seems would prefer to kick the can down the road in a certain way to make the eventuality of a certain decision more likely. This is contrivance and manipulation. I am opposed to this path for Europe. Horse first. Cart second. It should not do it the other way around. The choice and its implication should be made clear.

Those are the thoughts that lurk behind any analysis of where the Europe is going. Europe must decide first what it wants, then arrange to finance that identity. It should not finance staying together for a while longer while they all try to figure it out. That time has passed.

Euro-procrastination makes no sense to me. It’s not buying time, or renting time; it is squandering it. Time to step up and pick your future.

WSJ Blunders over Romney smack-down on Free Trade

2011-09-18T08:15:00.000-04:00

Open letter to WSJ over Romeny free-trade put-down

Dear sir,

Your asserting that Romney has made a blunder ( WSJ September 17, 2011 “Romney’s China Blunder”) is supported by the most vacuous logic.

You take Romney to task for not assesses the facts you then address those facts then dismiss them.

You say:

‘Any serious argument that China is running a mercantilist trade policy needs to look at the Chinese trade surplus with the rest of the world. That has grown dramatically over the last decade, due to policies that we have criticized. The crux of the issue is not the value of China's currency—every country has the right to pursue exchange-rate stability, and dozens of countries peg or somehow adjust their currencies to the dollar.’ (Emphasis added)

This is the warped logic of ‘free trade’ that actually undermines free trade.. For trade to be ‘FREE” and for the good things that flow from FREE TRADE to occur, exchange rates must be at their proper parity values not arbitrary or self-selected levels. Countries really DO NOT have the ‘right’ to choose any stability system they wish to choose or to peg to the dollar. This notion is sheer folly. It may be current practice but it still is folly. How can a competition-loving paper like the WSJ endorse national ‘price fixing’ as a means to free trade? What more important price to ‘fix’ than the exchange rate? The international trade literature is replete with papers about the damage from misaligned exchange rates and yet you dismiss it with a few taps on your keyboard and proceed to ignore all the evidence that misaligned trade is causing damage..

I’m sure after a few nanosecond of thought this is a position you will want to ‘re-think.’

Want more facts to support Mr. Romney? Exchange rate fixing is why developing nations own three-quarters of the world’s foreign exchange reserves. They buy dollars and other currencies to keep their own currencies competitive. This is why the US Current Account averages a deficit of 2.1% of GDP since 1971 when Bretton Woods collapsed, and why the US current account has not been in surplus in any quarter since 1991. If you believe in markets how is such a result consistent with exchange rate equilibrium?

Romney has a Tiger by the tail. Your lot would be better cast by getting on his side. The argument that China’s own domestic monetary policy has to blow up to get the Journal to realize that China (and others) are engaged in anti-competitive practices that WTO does not even address - practices that have helped to prevent the US current account from ‘ever adjusting’ - is an idea that stretches the limits of credulity. Free trade and exchange rate alignment are worth thinking about especially by a candidate for the office of president..

So many want to ‘perish the thought’ (actually, perish any thought) about the dollar because at the end of the day it leads to the conclusion that they do not want to make: that the dollar is STILL too strong. Or, put another way, US productivity is not high enough for the dollar to stay at this level. But these persisting current account deficits are signals from the marketplace. Do not ignore a lump in your breast or a persisting hacking cough or sustained current account imbalances: they all are valid signals of something gone wrong. Moreover, do not deny all the investment in China and the rest of Asia over the past twenty years that clearly has raised their productivity and should therefore raise the values of their respective currencies (and lower that of the dollar by implication).

This language that the WSJ uses that is dismissive in nature about how US firms have subsidiaries abroad to get the lowest prices is all just an end run around reality. Why aren’t those operations instead in AMERICA? That’s the real question! That they have to be overseas is the exact thing that is at issue here. That is not a part of the argument to ‘take for granted.’

Why do US firms have $2tln on their balance sheets they will not spend with US unemployment over 9%? Why do they invest overseas instead of in the US? Why does China have $3trln of foreign exchange reserves? And why did they raise those reserves by 30% over the past year all the while complaining about the dollar? SNL had some great skits about their dollar-investment angst yet they pilled on more dollars. Why doesn’t China, a poor country, spend those vast reserves at home and raise living standards? Why do countries pour $500-$600 bln into the US as capital flows each year while US banks have billions in excess reserves they can’t find borrowers for? What do foreign investors ‘know’ that our banks do not?

Give up the fantasy that the dollar is properly aligned ( and the yuan and so on…) and these question begins to have answers. Do that and many of our ‘vexing problems’ have solutions.

The drop off in US manufacturing output is the start of severe crisis. The US needs to pay for its foreign exchange and we will never do that even if services jobs come back. The US needs to export to earn its foreign exchange (that’s how it’s done) and that means manufacturing. Pretending that trade restrictions are the only impediment to better US trade performance just stands in defiance of the sorts of huge numbers we need to marshal to solve our current account financing problem. The real problems is competitiveness.

If the Journal really supports free trade it needs to support the formation of a world environment in which truly free trade can blossom- not a system in which China and other developing nations suckle at the teat of US wealth until it runs dry. Because it will run dry. No country can run current account deficits forever. Foreigners are not running up what may prove to be a stack of ‘worthless IOUs’ instead they are starting to OWN us. And that can’t be good

America needs to be competitive. Let’s BRING BACK free trade!

Mr. Romney is much more right in this debate than he is wrong. You, sir, need to look closer at the arguments that you make to dismiss him - and to look harder at the facts, even when that is uncomfortable. Intellectual honesty is not about comfort. It is often painful. But in the pain is often wisdom and that, too is a lesson from markets.

Trade, the real fool’s game

2011-09-08T17:58:00.000-04:00

Trade, the real fool’s game

I would like to underline one aspect of the trade report that is not getting much attention- well ANY attention.

Although the deficit fell this month, at $44bln it can be annualized to a deficit of $528bln.

When we have a deficit in our trade account (more correctly, the current account) we obtain an equal amount of capital inflows to finance that deficit.

So here is the question:

So,why, when US banks have billions and billions of dollars in excess reserves, empowering them to make billions and billions of dollars in loans which they DO NOT MAKE are foreign investors pouring capital into the US at a pace of over $500 bln per year?

How do you reconcile that paradox?

We argue that there is no great attraction that 'pulls' foreign funds into the US. Instead we view capital flows as being 'pushed' by foreign investors who have other objectives.

That is we do not think that 'high US interest rates' are sucking capital in or that 'high rates of return in business investment' or in 'real estate' are attracting inflows.

We see the inflows as the result of foreign government's decisions to accumulate dollars in order to support the dollar at a relatively high level so they can pursue a policy of export led growth by keeping their currencies relatively weak and exports cheap.

These policies have caused the US current account deficit to persist. Developing countries have amassed the build-up of world foreign exchange reserves an action that can only be regarded as one that supports them in achieving their objective of keeping their respective currencies 'too cheap' and the currencies that they buy 'too strong'. Developing countries do not need FX reserves as much as they need to put those monies to work in their own countries to further their development. But they don't do that...

China's FX reserves rose 30% over the past year and stand at $3trillion. How does that accumulation not act to keep the yuan too weak and to perpetuate the US-with-China trade deficit? How else can it be interpreted?

By 2007 China had comprised over 30% of the annual US trade deficit and in 2009 and 2010 that percentage has moved up to 44%. Despite the US need to buy oil at high world prices China takes up 44% of the US global trade deficit.

A proper functioning exchange rate system would not keep a country's current account in a state of perpetual deficit. Yet, since 1971 the US current account has been in deficit for all by 24 quarters (24 out of 159; or 15%). The current account has averaged since 1971 a deficit that is 2.1% of GDP. The US has not seen a current account surplus since 1991Q2 a twenty year span. Currently, the current account deficit is 3% of GDP after reaching a peak percentage of 6.5% of GDP in in 2005. Interestingly the US had shrunk is current account deficit to 2.4% of GDP by the end of the recent recession, but in recovery even with GDP growth at 2.2% the current account deficit relative to GDP is rising again.

Since 1982 the US current account has been in surplus only two quarters. The ONLY progress in shrinking the deficit has come as the economy has slowed either just ahead of a recession or in a recession. For example from Q3 of 2006 to Q3 of 2007 when recession started, the US current account deficit shrank because GDP growth slipped below 2.5% and then the economy fell into outright recession. That caused the current account to shrink much faster. But it remains in deficit and a larger deficit than what has been normal. Since the last US current account surplus in 1991 the summation of the current account relative to GDP is 65%- no compounding.

Clearly this international monetary system is not working. It may not need to equilibrate the US current account immediately but we do need some signs of progress and improved fundamentals to support progress in that direction. The US current account deficit is huge and is hardly getting better; at 3% of GDP it is 50% above its average since 1971. Pumping the US economy full of debt is not helping. Even S&P can see the risk. The danger is that only debt saturation will stop this madness (bankruptcy). That is what happens if a well-functioning exchange rate system cannot be imposed on this dysfunctional process that perpetuates US debt accumulation (current account deficit). No wonder gold bugs are trying to push a gold standard. It would stop this madness, but would create and entirely new madness. Imagine moving to a gold stand and losing $500bln of gold reserves a year (the current account deficit). What sort of recession would you have to run to eradicate that and to stop losing gold? And with unemployment already at 9%?

Many economists reject this analysis and blame the US for its 'addiction' to debt but I see the US being force-fed debt because foreigners will not let the US mount any consistent export growth. In short the US does not enforce its exchange rate, on the markets. Markets do the ‘enforcing’ and right now markets are being manipulated by foreign governments. The foreign capital inflows (debt accumulation) by the US and the accumulation of massive foreign exchange reserves by foreign exporter countries far in excess of needs are the forensic evidence, the finger prints, of this ongoing currency manipulation.

The excess bank reserves are evidence that those flows are not being attracted by an insatiable US appetite for debt. We could slake that thirst at home with the banks.

If this were CSI I'd be ready to go to court.

Root of all evil (well, most of it anyway...)

In other words, this is not free trade. This is not fair trade. This is a fool's game and it is coming to an end one way or another. It is a process that is responsible for many other Ills in the economy that the fiscal deficit folk and the monetary mavens are trying to solve. It is at the root of our many and varied asset bubbles. But we are unlikely to fix either US fiscal policy or monetary policy until we deal with international monetary problem because it greatly exacerbates the other problems. Don't look for the G-7 to go there because no one seems to have a clue.

New CEA head and more...

2011-08-30T08:38:00.000-04:00

Lots of criticism over the new Obama head of the council of economic advisers (CEA). People say he is too far to the left...

so did you expect Obama to appoint a Republican's economist to the post?

We have a BIG budget problem nothing should be off the table- no not even a national sales tax which Alan Krueger supports (a tax, by the way, that Democrats hate, Republicans despise and State Governors (and many mayors) abhor-all for different reasons. To Democrats the tax is too regressive, to Republicans it is too powerful, to Governors and mayors, sales taxes have been their exclusive province for 'fund raising')...

Cutting entitlements is 'job one' to get the deficits in line. But not job one through 'n.' All this Republican whining about taxes is misplaced. Tax reform and more taxes are almost surely part of a real workable solution. But enlightened tax reform, not vicious now-you-are-going-to-get-yours tax reform. America does not need class (or classless) warfare, Everyone should be paying taxes, everyone should pay their 'fair share.' The tax code already is progressive. suck it up and write the check but pare the obligation down to a workable profile that is American in nature. We are not the social welfare economy that Europe has become and is struggling to maintain.

Europe is no role-model for American

There is all too much spin doctoring about our problems and our dilemma and not enough willingness to take the bull by the tail and look the situation square in the err...'eye' and deal with it.

Deficits did not spring fully born out of the head of Obama as in some tale of Greek mythology. 'W' -remember him? ran TWO unfunded wars (cha-ching!) added a large drug benefit to medicare (Cha-ching!) and added a new cabinet post, Homeland Security (Cha-ching!). He handed over to the O-man an economy that was losing jobs at a pace of nearly 1-million PER MONTH ( Kur-Plunk!) in the early months of his nascent Presidency. The economy was not just weak, it was spiraling out of control. (here take the wheel I'm outta here....) While I do not give Obama good marks for his fiscal plans (or results!) I think we need to be careful where we put the blame and to whom we ascribe the bulge in the deficits. Hey is that a big deficit in your pants or are you just happy to see me? Let me be clear. Deficits emerge in response to something-something done or not done. They do not spring forth out of nowhere. The Obama deficits merged the context of great stress on the economy.

The Bush contributions to the deficit were all policy-induced and not executed in the midst of a crisis. His famed tax cuts propelled the economy to nowhere but are staunchly defended by the faithful. Choose the altar where you plan to worship carefully...Bush's tax cuts based on results were no success story. Still, this is no defense of Obama who, based on his current body of work, does not deserve reelection. (Has any Nobel Prize winner ever failed to be elected the very next time he faced the public?)

Only look to Europe to see what I call the quadriplegic strategy: Cutting and cutting will not really get you anywhere but stuck some place from which you cannot move. It's medicine is slow-acting. It is structural not counter-cyclical. We do not need to shrink government to free up up resources for the private sector: what to you call 9% unemployment if not free resources? We need enlightened minds in both parties and instead we have friggin ideologues ON BOTH SIDES OF THE AISLE.

We need to focus not on policies that will add former government workers to the ranks of the unemployed but on policies that will spur growth, add to output and add to job rolls. We do need hard core nonthinking redistribution plans from the Democrats or shrink-o-nomics from the Republicans.

So, here is an appeal to the religious right: God help us.

Learning from Irene

2011-08-29T11:00:00.000-04:00

Irene good night,

Irene good night

Good night Irene

Good night Irene I’ll see you in my dreams (nightmares)

About Irene and what we can learn from her passage…

While Irene was a bust of disaster in most of Manhattan it did wreak some havoc in the surrounding areas, some very real property damage and five deaths are being reported. The New England States appear to have gotten hit hard.

The more general disruption of business from airlines to trucking to package delivery business and much more has been enormous. But some of the losses will be made up. Some will not. The storm’s hitting at month-end could mean August activity is reduced and September’s is boosted. Coming so late in the month we may still be seeing come recovery effects extended to the week of the 12^th of September, the week that serves as the survey basis for the nonfarm jobs report. It could be artificially boosted. Municipalities, already short on funds, will be forced to spend monies they don’t have for needed repairs, tree removal and repair of damaged infrastructure and so on.

From my vantage point on the Upper Wet Side (former Upper West Side) of Manhattan, it was a lot of rain and not even that much wind. It might have been too much wind to fly a kite but it was not blowing of a worrisome sort. All my neighborhood stores closed and the subways did not run. I was officially stranded. I took pictures both up and down West End Avenue with NO TRAFFIC at all, just like in a Sci-Fi movie. It was Sci-Fi except no Zombies- just rain. My local grocery store (soon to be renamed Wet-side Market) did more business on Saturday as the storm approached than it may ever have done ever before (in my estimation). Going through the store when it managed to open with a bare-bones crew on Sunday morning I had never seen such bare shelves. Moral: some kinds of businesses benefited.

I was amazed on Saturday as stores were shuttering ahead of the pending subway shut down, that a high end women’s shoe store in the neighborhood was still open… Never underestimate the need for more shoes (with very high heels) as rain and the threat of flooding gets real. Fashion is never to be discounted (except at Loemann’s).

The church on the corner of West End Ave and 77^th put up notices on Saturday that there would be no Sunday service. Meteorologists scared the Hell into people that day; that is the moral of that story. In the end, Sunday was a fine day on the Upper West Side of NYC despite the fact the 8AM was supposed to be the time of the storm’s closest reach to my neighborhood. By 10AM the sun was out and instead of disaster we had a very fine day.

We cannot say the same for the states North and East of us or for the economy as a whole. This was a very odd event. Is this more of the effects of ‘global warning’ that many seem to not believe in? On balance is it another warning shot (a warming shot?) about the future? And it is another blow to property and casualty insurance companies. Have the winds of change really shifted so much?

If nothing else it is a good lesson of the role that expectations play. I do not criticize the Mayor or the Governor for their actions. NY it seems was ‘spared;’ the storm’s true severity has been amply demonstrated tough its impact on the suburbs. As it went through our area and did worst damage North and East of us as well as south of us. And the greater NY area took enough of a pounding for it to be a real wakeup call about future prospects. But people acted as though and were forced to act as though things would be worse. My local church sure could have held services. Few people in the neighborhood take the subway to their local church. But no one knew. So when you look at the economy let this be a lesson about how people act on their expectations and how risk aversion interacts with those expectations.

The economy’s poor performance since Barack Obama has been President stems in no small measure from his decision to have run as the ‘Yes we can candidate’ but to govern as the ‘what the heck was that’ President. I believe his desire was to see that Republicans were blamed for the bad economy he inherited (knowing full well that that was what he was getting). He even set himself up as an economic know-it-all in contrast to John McCain who admitted he was not an economic expert in the campaign for office, so don’t cut Barack too much slack here. Meanwhile, Obama has been out-maneuvered by savvier Republicans who saw he was President and knew where the buck would stop for a too-weak economy. Economists were pessimistic from the get-go forecasting a double dip before we had even a single–scoop. We had a perfect storm of soured expectations and it has played out that way in the real world, almost as it did on the Upper West side of NY this weekend when the subways were closed. Doing that killed it even for the optimists as well as for those who were in in denial. People could not get to work; stores were closed and it was a ghost town.

This economy as been an example of what partisan politics can do to the economy when each side pursues its own agenda at the expense of the economy and at the expense of the welfare of the American people. It’s as though our politicians shut down the subway without the threat of a storm. Our government can isolate us. It can also help us. Ronald Reagan made the phrase, ‘I’m from the government and I’m here to help you, into a laugh line. Government is powerful. It needs to be mindful of its power when it flexes its muscle. Now government itself is in the middle of the debate about the economy. Has IT been the problem? As it been new policies and restrictive rules that have hammered growth, or has it been mostly the conduct of public officials killing off optimism? How much of it is still the lingering effects of financial crisis with tis complex bi-partisan causes? Unfortunately, this debate is not like tropical storm, It does not pass and the sun does not automatically come out. There is still a bitter taste in the mouths of politicians from both sides. Each side still smells the other’s blood in the water- not even the storm washed that away. And there is so much more politicking to do. Yet the economy is need of near term help. What will it be? More government or less? Who will win? The answer is not an easy one. Neither side will capitulate. So be afraid, Be very afraid. ‘This' is not over, this political storm has more damage yet to wreak.

Deficits turn policy upside-down and calls for hard choices

2011-08-14T17:50:00.000-04:00

I have two recent articles published elsewhere you may wish to read:

CNBC on the pluses and minuses of a national sales tax
http://www.cnbc.com/id/44108811

MarketWatch on the sad political charade and its upside-down logic

http://www.marketwatch.com/story/debt-spat-takes-cake-pineapple-upside-down-cake-2011-07-27?dist=countdown

AMERICA’S DARKEST HOUR

2011-07-14T14:32:00.000-04:00

I do not mean this to be hyperbole. There is no greater danger than the one that comes from within. And it is in play.

No Give and take- Democrats and Republicans can have their spats; it is part of the game. But the ballet in Washington now puts the nation and its finances squarely at risk –and over what? It seems that a number of Republicans ran for office on the pledge of no new taxes, but when push comes to shove and deal making requires taxes they are more concerned about their own necks than about the fate of the country. Such is the stuff that patriotism is not made of.

The obscure prize- And what of taxes, that powerful elixir that drives this insanity? Let’s look at a seven year moving average of the top margin tax rate Vs real GDP growth:

OOPs the chart does not want to print, you'll have to request that from me

Surely THIS can’t be what they are fighting over? The correlation between high tax and high growth is 0.46. That’s right. In the post-war period the higher the top margin tax rate the stronger was growth.

Now I know blood is going to start to boil over this. We know it’s the taxes you pay that matter but the tax rate you avoid is pretty important too. And the simple point here is that the simple tax rate is not a powerful predictor, is it? So what is this tax debate really about? It’s about re-election. Period.

That is not to say that I think high taxes are ‘good.’

It’s all about MEEee - It is simply clear that taxes are not the end of life for growth like drinking poison. It may be the end of the line for those who overpromised to get into office, however. And we should not mortgage our future for their sake. They are now putting the country under extraordinary stress because they have set up huge spending cut targets and want to give nothing in return. Has politics ever worked like that? No. Only if you have really big leverage can you do such a thing. And they are holding hostage the United States of America.

Cartoon Economics: Ron Paul is the real character is this whole charade that I would most like to eject from the discussion. He may not be so influential but he is spewing the most incredible lies about our country. He gets paid his deference as he is a senator and he chairs the all-important Senate banking committee. How did a guy with such warped views of the US economy get to hold such an important position? His economic statements and knowledge are severely wanting. In a recent interview (click link below)

Ron Paul tells it like it ain’t:

http://www.bloomberg.com/video/72444680/

Mr. Paul was asked about the importance of the US AAA rating. His response was evasive and then he made outrageously false statements. He first says that ratings lag and the US has not been worth that rating for some time. Then he says the US is bankrupt. Then he says that the rating could be kept in the short run but that it would eventually be lost.

None of this is true.

Still numero uno- The US is still the wealthiest most productive nation on the plant. When its leaders tell lies like this it depresses the American people and makes them feel helpless. Some may even believe it. And if they do it’s not surprising that they go for Mr. Paul’s idea which is to not defend our rating; he has even said that the US should repudiate its debt! And he is a financial leader of this country. Why has his own party not locked him away in a closet somewhere?

Uncle Scrooge? - Why should the richest county in the world not pay its bills? What is to be gained in doing (not doing) that? What would happen to the rest of the world if we did that? And what would happen to our own most conservative institutions if treasury debt were to go into a true default, not a technical one, which is Mr. Paul’s idea?

It’s hard to go down that road but the Great Depression might seem like a picnic in comparison. The great recession would be known as the minor precursor.

Hard deadlines/soft thinking- The game being played about the August 2 date not being hard deadline is a real fool’s game. And as such only real fools should play it. As the Fed Chairman points out, that is a dangerous thing to do. Just think about it: here is what is being proposed- To prioritize debt payments for tax revenue and then pay other bills as the treasury ‘can.’ It does not take much of a financial expert to see that this would lead to cascading lay-offs first in government and then spreading elsewhere. Other kinds of payments ‘defaults’ and would weaken the economy and future tax revenues to the point that the government cuts would have to get even deeper. This is not a plan it’s a guarantee of a severe recession and worse. I don’t think Aug 2 is a drop dead data in the sense that if we do not lift the limit on that date the US will default and the world will come to an end. But it’s an important date and the legislators/politicians should respect instead of trying to ‘fool’ with it.

Whose deficits are theses? - Republicans blaming the Democrats for the weak economy is just not reasonable since both parties were responsible for the financial excesses that led to the financial crisis and the economic recession. Both parties are failing in getting the economy in gear. I do fault the Obama administration for a poorly constructed stimulus plan but that is only one part of it.

Desperation demands grow- On balance we have little balance. As the impasse has dragged on the Republicans seem to up their demands. The recent one: Boehner’s call for a balanced budget amendment. The Fed Chairman has come out against such a thing because it would be too inflexible. As upset as you are with current policy imagine if such a rule were in place today and the recession was causing not just state and local governments to pare down activities and fire people but the Federal government as well.

The debt ceiling BELONGS to Republicans too- Republicans keep getting heated up about cutting as much spending as we hike the debt ceiling. But that is a huge target. Democrats clearly want something in return after all Republicans act as though the debt ceiling is a Democrat objective and should compromise all sorts of stuff to hike that ceiling. The Republicans have vastly misjudged their leverage and position and are struggling to find a way forward.

Debt is a legacy- The nation’s debt simply reflects all the spending that has occurred that Congress, both Republicans and Democrats, has authorized in excess of revenues. What now is this opposition to hiking the debt ceiling? Is it bait and switch on the part of those who oppose the hike? Is this some cruel trick by Congressmen and women who voted vote for all these spending programs now want to vote to not fund them and blame Democrats? Apparently tax hikes and closing tax loopholes are not on the table either. With what are the Democrats supposed to bargain? Obama seems to have been quite flexible in trying to get some revenue raisers in compromise but not calling them tax hikes.

In my view this is the Republican’s gambit.

Their risk- They are the ones talking about shutting down government and about not hiking the debt ceiling. If anything bad happens they will be blamed. Their tactics already may have cost them dearly among moderate voters. One thing these newbie Republicans do not seem to understand is that the voters want spending cut but none of their benefits cut. So Republicans may yet see a backlash from their single-minded interpretation of their election mandate which, on close inspection, is much more complicated then they admit.

In all of this I fear for the nation. We have some real kooks in positions of power and I fear that the Republican leadership is not in control of its own forces as the newbies are driving the leadership to a hardened position that could prove fatal.

The story behind the debt eight-ball

2011-06-04T19:15:00.000-04:00

The economic data have been weaker in recent weeks than their counterparts for the year to date. This past week the degree of weakness became exaggerated. It does not point to declines in output (yet?) but it is very weak and disturbing. If you are not wary or confused about the outlook you are not paying attention.

With actual negative events in the mix we have reason to think that this week’s data reflect more than simply volatility-the economy is being pushed by something. The degree of weakness is extreme with the two ISMs each making falls of historic proportion over the past two months. The drop off in job growth is large. The unemployment rate trend which was moving lower has been stopped and set in motion in reverse. Consumer attitude surveys are not uniform on the month but all are clearly very weak – they agree on the big picture if not on the details.

Events in Washington really are worrisome.

Let me repeat something here that I think is important and worth saying AGAIN. The deficit and debt problems are not economic problems as much as they have solutions that have become political issues. We could put in place a VAT tax (think national sales tax) to raise money to narrow the budget gap. Easy as 1% 2% 3%. Even Alan Greenspan is calling for higher taxes. The Tea Party types continue to stone-wall as if any tax hike is like the Ebola virus… Painful? Yes. Deadly? No. There are simple solutions out there but none without some pain or repercussions.

I continue to wonder why, in a nation with such varied costs of living and varied housing costs/prices the income tax continues to be the centerpiece of tax policy and the rhetoric of ‘tax the rich’ is used in conjunction with income flows that have such differing purchasing power from state to state. Will we ever learn or wake up? Or is this sort of class warfare based on a fundamental falsity just part of the American way? Way? No Way! In America $100K ≠$100K. It depends in what state you live when you earn it how well you would live on such an income. So what base tax policy on such an uneven benchmark?

We know that with longer life expectancy we must push back the retirement age for Social Security. A fifth grade math class could demonstrate that to you. A fixed date for retirement makes no sense when every successive generation is living longer. Yet we can’t do this…

Finally, medical care simply cannot be offered for free any more than can any other service or good without demand for it being abused. Is medical care something different or special? To some extent, yes, still you can’t make it free without real financial consequences. AARP be damned.

Moreover if the government is going to subsidize or provide medical care it must use its clout to get reduced costs. Medical lobby be damned.

The economic logic here is clear. But the political will is splintered because each party has a different idea of how to make change and each wants to use this time of conflict as a springboard to more political gains.

So no one wants to alienate old people (AARP). No one wants to alienate the drug companies (use government buying clout) or the medical lobby or the insurance lobby- so nothing gets done. We kick the can down the road until it kicks our cans back and we are getting closer to that. At some point, it’s THEM OR US. WHO WILL IT BE?

You can see this at work with the financial crisis having come and gone-well maybe not yet gone-and the power of the financial lobby whereby real reform just can’t be had.

Oh, by the way…I have invented a new glue much stronger than ‘Super Glue.’ I am going to call it ‘Financial Lobby’ because nothing in the world is stronger than that…

As far as I can see much of the hoo-ha about the debt/deficit is largely being done by the two political parties that run things here in America. We voters are just the baubles they redecorate with every two or four years. They call it ‘democracy’ but after the election is over and we see the actual ‘pig’ we bought in that poke it feels much more like ‘hypocrisy’.

Right now the two parties are wrecking the economy with their various threats instead of fixing it. The cynic in me wonders if Republicans would push so hard to cut spending if they were in the White House and running for re-election this time around. Would the need to cut spending so much so soon, seem as compelling if their administration were on the line?

I don’t know if any of that makes you feel any better about what is happening. Having politicians who claim they are willing to let the US default on its debt when it could well afford to pay it may be worse than finding that you do not have the means to pay it at all. A politician unwilling to pay a bill to achieve his political end is a danger 100% of the time not just when times get tough.

This is not an argument for not doing debt and deficit and spending reform, just to put the tactic and need in context. Doctors too can stop the spread of disease and ‘cure’ patients by letting them die. It’s a simple solution and not really very effective when you think about the end result Vs the goal. Similarly, how does wrecking the US economy fix it? Riddle me that Bat man…

EMU takes a new hit; frazzled outlook

2011-05-23T12:54:00.000-04:00

Main EMU sectors hit major air-pocket- The EMU MFG and Services indices are sharply lower. The MFG index fell by 2.9 points while the services index fell by 1.43 points. Those drops are huge in the histories of those respective series. For MFG the drop ranks as the fourth largest in the series’ history. For services the setback was the 14^th largest. This ranking makes the MFG drop an event that occurs only about 2% of the time; the services drop is an event that occurs only about 10% of the time, a little more than one a year. The services sector last saw a drop larger than this is in September of 2010. Still it’s a large drop, but the MFG drop is enormous. MFG last fell by more last in November of 2008.

While we have seen the EMU metrics on growth show setbacks in recent months, the step-back this month is severe.

Level readings for sector as not a problem- Still at 54.85 the MFG index is still showing growth and is well above its average value of 51.62. Services at 55.40 also are still showing growth and are above their average mark as well. The dividing line between growth and contraction on this metric is 50 and both are well above that so it’s not a growth setback we worry about, at least not yet. The values still sit in the 79 percentile and the 69 percentile in the MFG and Services high-low ranges, respectively. These are still adequate-to-firm readings.

NO recession worries…yet - The levels of their headlines are not a problem at this time but the momentum of the sectors is an issue and the severity of the one-month drop is as well. Both indices still seem to be on the same growth plateau that they reached early in 2010. We have even seen somewhat similar losses of momentum in this recovery period and we have seen the sectors rebound from that weakness.

Escalated debt crisis worries? - But this time there are new factors in the mix. Europe’s debt problems are emerging again, this time a warning to Italy is in the mix. That is an escalation of the threat. A week ago the IMF warned that the debt problems in the Zone could spread from the periphery to the core. Is that now happening?

Euro-politics- Spain, a large EMU member country that has fought off further attacks after some rough spots early in the year has just had a big election set back. In Germany Angela Merkel, banker to the EMU-bailout schemes, lost support sharply in a small state election. The German electorate is not pleased with its role backstopping Europe. The economic situation remains difficult in Europe as the political situation becomes even more confused. In Italy Silvio Berlusconi has been under his own cloud of mistrust for some time, due his own sex scandal. In France Nicolas Sarkozy who was lagging in the polls now finds himself free of his most potent challenger due to a sex scandal involving the former IMF director who was to be his nemesis. Let’s not forget Finland whose new government is against any more bailouts in the Zone. Finland is one of only six AAA-rated sovereign states in the 17-nation euro zone

Can’t make this up- Quite honestly you can’t make this stuff up. If you look at the political map in Europe it is in chaos. The ECB itself is due for a changing of the guard later this year and it appears to have selected an Italian to follow in the footsteps of Trichet. Right now it’s looking like a tough time for transition.

Like Post WWI...again? All of this reminds me a lot of the financial strains that emerged in the wake of World War I. At that time Germany had lost the war and the reparations placed on its back were too heavy a load for it to bear but the victors wanted to make Germany pay. This time around, it’s not a war but a financial crisis and there has, one again, been misdeeds. This time it is the Germans with the financial muscle to help and yet they do not really want to. Then again if they do help, they want their pound of flesh from the Greeks and anyone else that has gone astray. This is one ‘safety net’ that you don’t want to fall into.

Muddles interests and a complex blame-game- Asking for too much penance to eliminate the risk of moral hazard can backfire and it has done so in the past. Will Europe wake in time to see the risks? Or are Europeans so set in getting revenge or in making those who strayed pay, that it will cut off their own nose to spite their face? This is a risk, a real risk. What makes this more of a muddle is that Germany is not simply being asked to be altruistic or to turn the other cheek to help out the already too cheeky. If euro-sovereign finances go sour en mass, it is the German, French and UK banks that will suffer the most. The Germans do have skin in the game and yes, it is their own. But in Germany this is not the way German financial involvement is being portrayed. That is probably because, like Americans, Germans get little satisfaction from a policy to take expensive steps to protect the interests of their own banks.

Get a CLUE! And so the Euro game will continue to play out like a giant game of Clue™. If EMU goes down, or is clobbered with debt and refinancing issues, who will be to blame? The Greeks, at home, in the overpriced Olympic stadium? The Germans in their beer garden by their unwillingness to help? The German bankers, with their troubled portfolios by the means of bad loans sprinkled everywhere? Who is your candidate for blame? How did they do it? Where was the ‘crime’ committed? It’s a fun game. Play it.

2011-04-30T15:51:00.000-04:00

Dizzying dollar dip or delightful drop?

When clubs are trump - Donald Trump doesn’t like it, so maybe it’s good after all. Trump, with a focus on real estate and the value of his holdings, while battling other real estate groups wants his dollar assets as strong as possible to keep him high on the global scale of wealth rankings. But a declining dollar does more than just redenominate the value of ‘The Donald’s’ wealth. It sets our prices in other currency terms and as our prices drop US workers become more competitive and foreign goods become more expensive; this is the process by which the trade gap narrows. Is it really so bad?

The weak dollar: how weak? - The broad dollar index is presented the in the chart above. The dollar is dropping to just about its lowest point since exchange rates were set to ‘float’ in the early 1970s. This chart shows a more compressed recent history. One thing it reminds us of is that the dollar had been weak ahead of the financial crisis and a flight to safety cut the dollar’s drop short.

Dollar reverts to pre-crisis path - But now, as the recovery continues to spread, the dollar has been unwinding its rise and is back to its pre-crisis neighborhood which is a very weak point of valuation.

Benefits and risks of a strong dollar -As the dollar falls, imports become more expensive and Americans have to work longer hours to afford to buy the same goods made abroad. That is a reduction in US welfare. Meanwhile, foreigners can more easily afford US-made goods. In welfare terms the dropping dollar has ‘bad’ consequences as we are giving our goods away for less and paying more for what we buy abroad. That it is why economists generally ‘like’ a strong exchange rate and why a strong exchange rate is more than just a ‘symbol’ of American power. But, at the same time, if the exchange rate is ‘too strong’ while we continue to reap the benefits of exaggerated purchasing power in trade we also begin to erode the basis for the exchange rate’s continuing strength by running progressively larger trade deficits which is also what the US has done.

Too-strong dollar/temporary benefits- In seeing that you can appreciate this period of an overvalued dollar as creating conditions akin to a special sale, like the old-fashioned K-Mart blue-light specials. These ‘specials’ were temporary sales that came and went. K-Mart’s managers would erect a blue light in the store and switch it on; it would pulsate like a light on top of a police car and announce to everyone in the store that the items under the light were subject to special temporary discounts. The policy was meant to bring people into the store since you never knew what would go on sale or when. Of course K-Mart has since been relegated to a much lower tier on the retailing scale and has been replaced by Wal-Mart that advertises ‘everyday low prices’. But for Wal-Mart to deliver on this policy it needs the dollar to be too-strong every day as well. The drop in the dollar (to the extent that it involves a drop Vs China’s yuan) will cause Wal-Mart’s everyday low prices strategy to reflect higher prices than it did before.

Foreigners finance our excess- And so it is with the dollar. When it was ‘overvalued’ we could buy things cheaper, but only temporarily. Since we have run a huge trade gap foreigners have effectively been lending us the funds to make all these great purchases. Now they are beginning to balk. We all know that the period of running up the credit card is a lot more fun than the period in which we pay down the balance, but here it comes. Well, not literally; we are going to continue to ‘run up the balance’ but at a slower pace as the US current account deficit should get smaller but will remain a deficit.

If a high exchange rate is so good why do countries pursue weakness? There are great ‘welfare’ reasons for wanting the exchange rate to be overvalued, but, as we look at history, we find so many cases of countries being involved in the opposite strategy of pursing policies of competitive devaluations. In fact the one clear example of a country trying to fix its exchange rate ‘too high’ is a story of economic failure. It is the case of the UK trying to return sterling to its pre-war parity to gold in the inter-war period. Instead, of this sort of tact we find most countries pursing the strategy of making their currencies weaker to promote their own exports even though that approach makes imported goods more expensive and reduces their wealth in foreign currency terms. Why do that?

Benefits of a lower-value currency- A weak currency approach is a pro-growth strategy that is largely without clear domestic cost or opposing constituency (except for a price-stability-loving central bank, perhaps). It is a relatively effective way to tap into foreign demand and to divert foreign production from satisfying that demand by making your own country’s production cheaper so it can supplant foreign producers in their home market or in sales to ‘third’ markets. The trade-off for a weak currency is to gain output and therefore employment at the cost of having consumers pay higher prices. Consumers pay more for their imported goods and for ‘domestic-made’ goods using foreign-sourced inputs. When growth is hard to attain, a cheaper currency is a vehicle to attain it. This is why the strategy of using ‘competitive devaluations’ is called a beggar-thy-neighbor policy.

Attraction for developing economics -With this insight we can see the repercussions as the US has run a series of huge balance of payments deficits. We have been afforded the opportunity buy stuff from abroad that was cheap to us. In turn exporting nations have been able to grow faster and ride the tide of their strong and rising exports to the US to improve their development. Since some of these countries were not as developed as the US many of them found the expanding jobs market more than ample compensation for the fact that workers there were not being paid fully what their goods were worth. Indeed, some of these countries were so underdeveloped that their domestic wages still rose sharply and despite that remained well below the wage level that exists in the US. Such is the magic of development

The financial angle- Various US trade partners used the technique of acquiring massive quantities of foreign exchange (dollars) to keep their surpluses in trade from creating a dump of dollars on the market that would have reduced the dollar’s value and would have short circuited their export boom. Now some of these same countries bemoan their huge stash of dollars as the dollar’s value has dropped. But all of that has been their doing, just as the weak dollar is an eventual consequence of a too-strong dollar policy.

No sense of pain for developing economics- The strategy of a keeping your currency cheap seems to work best in less developed countries. There the domestic work force does not know what its currency is worth and the spread of jobs creates a boom. That boom results in the increase in wages to levels that will still not pay those workers properly for their services but nonetheless represents a better place than they previously were. To them a cheap currency seems to be a win/win situation as jobs expand and wages rise.

Pain to be felt in the US- But the US is going through this dynamic to a cheaper currency with a bit more pain. We have been used to having an overvalued dollar and to having great purchasing power. We are just finding out what reduced purchasing power means as foreign prices rise. Since we know what prices used to be we feel the drop in welfare more than do workers in a developing country whose ‘welfare shortfall’ created by their undervalued currency comes about relative to a hypothetical situation they never had experienced. But since we in the US have experienced the greater purchasing power of the dollar we will notice when it when it goes away as the dollar drops.

Adjustments all around- The challenge for the countries with less undervalued currencies will be to redirect output toward serving their own now-larger domestic demand in order to keep from losing the employment gains made by their export boom.

One paradise lost but the paradise gained is more growth- And that reveals the benefit that the US will get for giving up some purchasing power. As we have documented in previous reports the US economy is now experiencing the second –strongest revival in GDP goods in this recovery compared to any recovery since 1960. The goods sector is flying and the weaker dollar is one reason why.

Weak dollar is no panacea- The services sector is still lagging, however, and since that sector does not compete with overseas workers the weak dollar is doing nothing to make service sector workers seem cheaper. They sell their output to a domestic audience that is fully encapsulated in the domestic economy except to the extent that these workers may toil in a sector that sells increasingly expensive goods that were made abroad. A weak dollar has not encouraged hiring in services.

The marked STUPIDITY of the double-dip thesis - Ironically, all of the time that the US economy has been in recovery the dollar has been off its cycle peak and this has provided an ongoing boost to output that has been completely misread by the US growth pessimists who have continued to harp about the risk of double dip. Meanwhile, the prospect of a double dip has been becoming more remote with each drop in the dollar’s value. More curious has been the assertion that the drop in the dollar (a drop that extends and cements US competitiveness and stimulates exports as it deflects imports and therefore further stimulates domestic output) has in some way enhanced the prospect of a double-dip! This, of course, is lunacy and has the whole process backward/upside down.

Short circuit thinking- The situation of our enduring balance of payments deficits (which are referred to as a big risk to us) and the condition of the dollar’s strength and ‘over-valuation’ are quite clearly linked. They are part of the same process. And people who bemoan deficits but want the dollar to remain strong simply don’t ‘get it.’

China wants to have its egg-foo-yung and eat it too - This is part of the same puzzle in which China threatens to commit the economic paradox because it wants to have its cake and eat it too. China wants the US to mop up its deficits but it wants the yuan to remain undervalued… Huh- how does that work? Doesn’t China ‘know’ that its import penetration of the US market is due to its extremely low prices made possible by an undervalued yuan and enforced by a policy of continuing to bulk up on FX reserves (i.e. dollar buying). That’s why China’s rants are so toothless. China cannot pursue its development (commercial policy) strategy if it makes good on its financial threat to sell or stop buying dollar assets. In the end China is jawboning and trying to confuse the situation buy making the US seem responsible for what has been China’s foreign exchange-commercial policy of using export-led growth driven by persistent currency weakness. Of course, when China buys these dollars it is expanding the stock of yuan in circulation and to the extent it over-buys dollars it also over-stimulates the yuan money stock. That creates inflation. It explains why China has an inflation problem which it’s not the fault of US policy, despite Chinese protestations. The US has warned China for years that this inflation side-effect was coming while China ignored the warnings.

The good, the bad; avoiding the ugly - So as we consider the dropping dollar and what effect it has, compare it to the period of having had a strong reading. I hope that the interested reader can now see why the strong dollar is ‘good’ but also why a ‘too-strong’ dollar is ‘bad’ and how a period with a ‘too-strong’ dollar takes a toll on the US economy and how that process creates stimulus for competitor economies that must eventually be withdrawn. The dollar–valuation and BOP-deficit issues are both part of the same knotty problem; these are not separate issues.

Pot calls Kettle ‘Black’ -- While China usually presents the situation of large US trade deficits as an issue of US ‘over-consumption’ and of insufficient savings, Fed Chairman Bernanke has presented it as evidence of over-savings and insufficient consumption on the part of China and other counties (the Chairman has not singled out China that I am aware, but I will stay with this example). The effect on the US savings rate occurs partly through the relative price effect because as imported goods are made too cheap relative to ‘true value’ that stimulates consumption causing it to become preferable to savings and crowding saving out. Meanwhile, imported capital makes the excess spending possible without causing interest rates to rise as savings fall. And since an overvalued exchange rate creates a temporary condition of goods that are ‘too-cheap’, over-consuming actually makes sense for a while. But at some point all this excess must find equilibrium again. We can’t keep over-consuming and under saving with an overvalued exchange rate and with China and others on the ‘under-side’ of all these measures where we have overages. At some point the chickens come home to roost and macro-economic policies have to be altered. So our current obsession with cutting the fiscal deficit is becoming linked to this exchange rate issue through the fiscal/international deficit linkage which again is being put in a common spotlight.

Strong dollar policy=wrong dollar policy - At the end of the day I like to remind people that in economics linkages are, in some sense, everywhere. Disturb equilibrium in one place and you will create disequilibria ripples in another as markets to try and deal with the original disturbance. We have been in a dysfunctional persistent disequilibrium for some time. Now, as we are in the process of trying to heal the distortions from our past policy mistakes, try to understand the process that is in train. The polemics of the gold standard or of ceaseless pursuit of a ‘strong dollar’ do not do us any good here. What will do us some good is to understand the right policy and to pursue it without the ceaseless threat of how imperiled the economy has become to a double dip. Nothing in fact could be further from the truth. What would jeopardize the US economy would be to pursue a policy of a persistently misaligned exchange rate, like one that is persistently too strong.

Not all equilibriums are created equal - Economists like to have things in equilibrium, not too-strong and not too-weak. But reality is a bit like dieting in that a period of over-eating sometimes has to be followed by a period of under-eating to restore balance. To follow a period of over-eating by a period of balance is only to make the new weight gain permanent. An overvalued dollar creates that same sort of excess; consider the deficit as the undesired ‘weight-gain’ side-effect. Now we need to put the dollar on a diet to solve our deficit bulge. It’s way too soon to talk about equilibrium because one ‘disequilibrium’ breeds another and we may have to stay in this new disequilibrium mode for some time to work off the accumulated debt excess. And, this ‘diet’ will have consequence for other countries and will impact their policies. Some of them already are screaming with pain. But that is part of their process as well. All who have been part of this process will be part of the new solution and its growing pains as well.

The dollar’s true value- some perspective - We can see this point about equilibriums being different in the chart above (contact me if you want to see this chart) . There we define the dollar’s proper value, or its purchasing power parity level (PPP), as the mean of the real trade-weighted dollar index since exchange rates stopped being fixed rates in the early 1970s. The idea here is that while the float has been ‘dirty’ (with exchange market intervention) exchange markets should get the dollar’s value right over time. Although with persistent foreign exchange accumulation there could be an upward bias to where this chart puts dollar parity. Still what is clear is that the the dollar is now is about as far below parity as it has ever been. Also we can see that the dollar gets to be much more overvalued than it gets to be undervalued. Its peak of overvaluation is +35% while its peak of undervaluation is -15%. Because of this the equilibrium calculation for PPP requires that the dollar stay undervalued for a longer period to make up for its shorter periods of extreme overvaluation. If this history is a guide to the future it is suggested that this is GOOD place to buy dollars since the dollar has not in the past eroded faster than its inflation differential when it has been this weak. On the other hand, maybe the dollar will reach a new lower low in the period ahead since the balance of payments misalignments are huge in the world economy. Moreover, this chart is multilateral and it does not address this issue of against which currencies the dollar might fall and against which it might yet rise.

Bernanke Press Conference

2011-04-27T23:03:00.000-04:00

What he said…and what he didn’t

The Fed will be pleased with the Bernanke performance at the press conference. He did not send any obvious confused signals. He embellished on the policy notes in the Fed’s policy statement. He clarified that his remarks were meant to reflect the committee and to reflect divisions where they existed. He took responsibility for his own remarks. It was a stand up and professional performance. He made the Fed’s decisions to continue to maintain the size of its portfolio and to complete the QEII process the feature of this presentation. He followed that with a discussion of the Fed’s outlook. Then he took questions.

Stylized facts and the Fed’s stable inflation expectations hypothesis

The Fed’s Q&A went smoothly. But there were some issues of interest. This is always the case at a press conference. A written statement is controlled but in answering questions sometimes an undiscovered truth slips out. For example, the Chairman toed the line on the notion of inflation expectations being stable except for late in the Q&A when he let it slip that inflation expectations had risen somewhat. This of course did not get into the FOMC statement. Such an admission is the hobgoblin of all Fed fears. As pat of the Fed’s written text it would have an explosive impact. But in the flow of the Q&A give-and-take the impact is different. Bernanke admitted this in a context of an answer to a related question; he actually said that expectations are up a little and that the Fed has some limitations in what it can do. So this is something that the Chairman said and at the same he did not say it. He said it in a context that allowed it to slip by, as part of a response to a different question. But like a ticking bomb in an Alfred Hitchcock movie that the audiences sees and no one else is aware of, it is there in the background, ticking away.

What this reveals is that the FOMC statement and minutes are caricatures of the economy or if you prefer a presentation of ‘stylized facts’. The Fed does not portray each variable exactly as it is but in the way that the Fed construes it sort of Alice in Wonderland style ("When I use a word, it means just what I choose it to mean -- neither more nor less." -Humpty Dumpty). So if expectations are a bit elevated but not so much that they are a ‘clear’ problem the Fed may choose to continue to refer to them as subdued or anchored even as the moorings are loosening. The Fed has made it clear that it is not going to be as preemptive as its rhetoric once-sounded. It is willing to see expectations slip a bit because it is relatively more worried about high unemployment. For that reason it will accept the risk that is implied by the up-creep in expectations. On direct questioning Bernanke would never admit this trade off but it is implicit in what he said and the way he responded in the Q&A session. This is precisely the problem with adoption of a dual mandate, it creates dueling mandates and one keeps getting in the way of the other.

The Dollar

The question about the Fed’s role in the decline in the dollar came up; the Chairman deferred, saying that the Treasury Secretary is the spokesman for the dollar. That is correct. Then he added that the Fed was in favor of a strong dollar and a strong economy adding that to strengthen the dollar the Fed was keeping inflation low and acting to strengthen the economy.

The real fact is that the dollar is weak and that is boosting the economy. A weak dollar raises inflation risks as well. But it is true also that the dollar is in some sense not as much weak from the Fed’s actions as it is back to where it was before the financial crisis began. During the crisis a flight-to-quality boosted the dollar’s value then as recovery took place the dollar went back to where it was before the recession’s onset. It does not require any reference to the Fed’s low interest rate policy or to QE to explain it.

Risk management meets spin

2011-03-30T10:06:00.000-04:00

It' always 'the same' and 'always different'.

The trick is figure out which is which.

Right now risk and solvency are linked. There are concerns, perhaps as never before that borrowers are not just 'too indebted' and could be forced to reschedule their debt in response not just to some future (unknown) shock but that even in a best case scenario we would see reschedulings for countries like Greece and Portugal and maybe Spain.

...and oddly the Germans are funding the so-called bailout fund that may be more painful to fall into than to miss.

Meanwhile Ireland took on a load of bank debt to save its banks but that bankrupted the whole country. Germany is playing like it is the nice guy in all of this when, in fact, if countries or banks defaulted the result would be swamp German banks with bad debt - and more than they could stand. Germany's bailout fund for Europe is a back-door bailout of German banks that allows German citizens to rail at financial excesses in other European nations instead of storming down the doors of their own banks!

What is so surprising these days is that today’s debtors seem to extract so few concessions from the Germans given the German plight.

Latin American borrowers played the Debt Card in the 1970-s and 1980s with much more aplomb.

As for other types of risk the main issues (to me) seem to be that for a while we thought we had quantitative systems to disperse risk that instead it turned out to concentrated it.

Risk management (identification) systems (like rating agency ratings) failed also

As a result risk today is not greater it is just more of an unknown and is thought to lurk in places where it should not be and that naturally changes the game.

When you are used to having a gun shoot only one way out of its barrel, then it shoots the other way on occasion, it makes the weapon more difficult to use even in your own defense.

Why we keep spinning our wheels

2011-02-14T17:19:00.000-05:00

In economics there is always a lot that we do not know. But it is just as dangerous to ignore what you do not know as to let others know what little you do know. Doctors are good at this. We have some of the poorest nutritional guidelines and most doctors buy into them even though they are wrong. But doctors do not brook renegades. Being a doctor is about respect and you get that by staying in line. So in the science of nutrition we have a great stagnation but doctors who are giving bad advice on diet and exercise continue to be revered. Is that a better state of affairs than we have in economics? Maybe not with the except that most people are unaware of it..

In economics this problem of knowledge and credibility manifests itself in two ways. There are the arrogant ‘you’re wrong and I’m right’ economic presentations. And then there are the ne’er do well know-nothings that offer competing forecasts based on odd-ball contrarianism since, hey, even brainy economists don’t know it all- maybe they don’t even know enough (...to make themselves useful).

The lack of a real perceived wisdom in economics has manifested itself in another sort of perversion which is the politicization of economics. Economists have gotten to be like lawyers. They are in fact the expert witnesses of politicians. They are on one side or another and become the talking head du jour for the cause du jour of the politician du jour. Economists like politicians are divided into schools of thought. You know the conclusion of their research before you read their studies. Like politicians you know where economists stand on an issue, before they answer the policy question.

What this has led to is a lot of confusion. We need to get back to economics and to deal fairly with what we know Vs what we THINK WE KNOW and what we NEED to know.

For example, in my view all this warning about double dip in this recovery was very little about anything we knew. The misplaced worry has served to make the recovery weaker. Democrats, not appreciating the extent of the weakness, attacked the problem with half-effective stimulus program that favored spending that benefited its constituents. The President worsened matters by denying it was a recovery from the VERY FIRST DAY because he wanted to rub the Republican’s noses in ‘their’ recession. That kept people for shifting gears into an optimistic mode.

But on closer look it was the Democrat controlled banking committees that oversaw Fannie and Freddie and pushed them to lending standards that set this crisis in motion in the name of ‘broadening home ownership’. Ratings agencies that wanted fees more than than truth did not help. Banks that wanted their fees and played a treacherous game of hot potato with bad credits were another feature as were the clueless foreign investors. Fed Chairman Alan Greenspan contributed to the view that a house was a house and that even with all the new-fangled lending rules their future behavior and stable investment characteristics would remain the same –against all logic.

Wrapping a bow around and slapping a nice label on a septic tank does make it a nice gift for the one you love. Do not go there this Valentine’s Day. Yes we can find many failings to explain the crisis. But don’t excuse those who have opinions for fees on any level. Don’t think for one minute one party was responsible and the other was not. Don’t think that anyone has been focused on what to do to help the RECOVERY be the best possible. It has been about politics and factions and ideology.

Independent thought and opinion is very little sought out on Wall Street- I can attest to that in my own business. Investors want the current spin and to stick with it. The lesson of the last financial crisis is that there is safety in numbers and in size as well as in sophistication even when it isn’t at all safe at all. A good ‘bad business model’ is like a tumor with more tentacles than can be safely removed. The patient must learn to live with it until it becomes too debilitating. That is what derivative mortgage products were.

So if we now try turn our heads to the economy and what is wrong what do we find from the conventional wisdomists? To the extent that there is a consensus it is this: the economy is too slow. It won’t create jobs. We need more growth. Consumers have been sitting on their wallets and so on.

WRONG. Wrong. Wrong.

Here is a fact a FACT that will amaze you. There is a set of data on GDP that segments the economy into goods and services and structures; it does this for the whole economy not just consumer goods. If we take these data and covert them to indices in the various business cycles guess what we find?

Are you ready?

This recovery, yes this weak and feeble recovery, has produced the SECOND strongest PERCENTAGE increase in GDP-goods of any recovery from the 1960 recession’s recovery onward. Only the recovery from the 1981-82 recession was stronger for the goods sector. Yes, the goods sector in the 2007-2009 recession’s recovery has been better than the 1973-75 recession’s expansion. At the six quarter mark this recovery’s net output of goods lags behind the strongest recovery’s goods output by 17% but is ahead of the next best spending and output by 28%. This has been very impressively strong. GROWTH in spending and output HAS NOT BEEN THE PROBLEM. The problem has been the composition of spending and output.

While Republicans and Democrats chew at one another’s ankles like packs of rabid rats, the truth of the expansion and the economy has gone unheeded and the remedy unexplored.

The truth of the expansion and its disappointing nature is this: the expansion from the 2007-2009 recession has seen the greatest weakness in the services sector of any expansion since at least the 1960 recession. Services spending in the sixth quarter of the expansion is up by 1.3% compared to an average of 5% at this time of the expansion for previous cycles and a median gain of 4.6%. Even the two ‘weak’ recoveries from the 2001 and 1990 recessions posted service sector spending gains of 3.2% and 4.2% respectively at this same time of their respective cycles. What are we doing to kill off growth in our jobs producing sector? This question should be on everyone’s lips. It’s not just that we can’t create jobs but that we are killing growth in the sector that creates jobs best.

So the real question should be not why is spending so weak but why is spending on SERVICES so weak? Until we ask that question we will get nowhere. That is THE crucial question since that is the sector where the jobs are- and for now aren’t.

When you spend a dollar on goods its impact on the economy is deflected almost immediately. Economists call this a leakage. There is a leakage of income abroad because some of the goods you buy were made overseas so the payment to some of the factors of production geos to an overseas entity. Thus ‘leakage; out of the US spending stream diminishes the multiplier for domestic expenditure. Moreover, if you buy a good the proportion of the spending that stays here is more substantially due to the efforts of capital than to labor (in comparison with spending on services). There is less in the way of job creation when monies are spent on goods in place of services even looking just at domestic dollars spent. So if jobs are the issue you want monies spent on services where nearly 100 cents on the dollar spent stays here in the US and in a sector where productivity is lower. Lower productivity means that when you expand that sector you naturally create employment. That sector’s growth has been cut short in this cycle.

So that is the problem. Have either Republicans or Democrats offered solutions based on stimulating services-based businesses? NO. But since services business are land-bound the increased focus on property taxes and mandatory medical coverage (remember these are people intensive businesses) have hurt the services sector relatively more. A manufacturer can locate a plant overseas to avoid these costs or a firm can outsource some production but services cannot do this because they tend to be point-of-delivery operations.

I am against the FORM of this medical ‘reform.’ If heath care is important and if it is construed as a modern ‘right’ then it must be provided and paid for... But why saddle employers with that cost when employers use labor unequally? Doesn’t anyone recognize that when you tie costs to labor it makes labor relatively more expensive and firms will opt away from that added cost? This division in the growth between the two key economic sectors (goods VS services) is all the proof we need that making labor more expensive is a really crappy idea.

When we look at the role of healthcare ‘reform’ on labor costs remember that the program did not save us any money it will cost us money. It pushed more responsibilities on to businesses. Legislation should NOT be permitted to legislate its own cost estimates as this bill did and tie the hands of analysts at the CBO. There are some things we do know about economics and when we do our analysis we should reference those things rather than being prohibited from using them.

When we take on this idea of adversely impacting growth it opens a real can of worms. One added thing that may never be changed is the idea of taxing income. But let’s begin to challenge the idea that taxing income is good or even fair. In a study offered up in early 2009 the folly of income is clearly revealed (see links below).

These studies show that to live the life style of a $123,000-a-year middle class person in Manhattan you need only make $50,000 if you live in Houston Texas…Houston I think we have a problem, to quote Tom Hanks (in Apollo-13 out of context, of course)… or $63,400 if you are from Chicago (Mr Obama), or $72,772 if you are in Boston (Mr Frank)...even living in Queens NY cuts your cost to $85,918 compared to being in Manhattan.

If this is true what are graduated income taxes all about? The regional differences in the cost of living explain a great deal of the variation in incomes. So why treat a guy in Houston at $50K as struggling and guy in Manhattan at $125K as rich?

And what is rich?

Oddly, ‘rich’ is a stock concept and ‘income’ is a flow concept but to get at the rich someone decided to attack income. Interestingly many of the people who make high incomes this year are not the same as the ones who made it the last year. There is a great deal of turnover in the high income ranks- not the upper-upper tiers - but in the space between middle class and ‘THE Rich’ where ’affluence’ comes in varying shades of gray. That’s yet another reason not to tax high incomes. Let the poor guy who makes a high income for one year in five keep more of it.

There is also the need for tax reform for a lot of small businesses that are not incorporated and whose owners apply the individual tax rate. Their treatment should be different under the tax laws than that of the investment banker who is an employee and earns big bucks but who employs no labor. When you hike taxes on the small businessman that does directly go to his bottom line and affect his hiring decision. May of these small businessmen log incomes that count them as ‘rich’ when, in fact, they employ a lot of capital and labor in order to earn their pay.

On balance I hope I have used this space to OPEN SOME EYES. This is not about being a Republican or a Democrat. I dislike both parties. I have been a member of each of these parties at different times in the past. I think John Adams was right and we should not have used them. But now that we have THEY OWN US. The US political system is a duopoly (with some respect to the Tea Party) and it acts like it.

We need to look at what we have become and how this has affected what we are and our economy is. We need to look at it through the clear lens of analysis not from the perspective of a partisan. Banks that everyone claimed were responsible for the financial crisis have recovered first, have gotten the most government help and have restored their bonus pools to what they were in the days of olde. How can that be? Yet people still tell me it will be years before banks are willing to lend freely again because of all the damage done to them in the recession and financial crisis… how is that? Are those low interest rates just feeding banker bonus pools?

What have we created? Why is our political system so little for the people? Why are so many elected representatives millionaires? Why is there no clear analysis brought forth on what the problem is? Why to our elected officials go to Washington only so they can get elected again instead of to enact reforms? Why do we elect such gutless self-centered wonders that they will not look at the facts of an over generous unaffordable Social Security system and deal with how to make it solvent again?

It is not true that we ‘cannot solve our problems’. It is because our leaders will not face them that we do not even address them. They will not admit we have them because if they did they would have to fix them. And if they did than we, the electorate, would get angry and we would not re-elect them. So there it is. It all comes back to us and for whom we vote. And I don’t think it is as simple as elect a Democrat or elect and Republican or to dis-elect an incumbent. It’s much more complicated than that. And as voters we need to figure it out.

Soon.

End for now

New Fed voters- Do they matter?

2011-01-24T10:10:00.000-05:00

Sometimes we make too much of the changing of the guard at the Fed. All Fed members are available and contribute to the discussion at all the meetings. But when it comes time to vote only the eligible voters have their say.

It is sometimes easier to be a vocal critic on the sidelines than to be a voter who must cast a public ballot. Moreover, when you know others may dissent that may make one a bit more reluctant to cast a vote in dissent because we know that having one dissenter is not an issue at the Fed but having more than one is much more so an issue. One dissent happens and can be written off to someone being eccentric, hard-headed or doctrinaire. But having two dissents is more of an issue, and hints at a schism. Having three dissents is an indication of severe divisions within the Fed. After all if three dissent how many more may had disagreed but not crossed that line? Were any other dissenters placated to not cross the line? Three is bad number. AND seeing three dissents this year is a possibility…not a certainty but it’s possible. Zero also is possible, but not likely.

Still, for all this talk about dissent and possible dissenters, there seems to be little chance that Bernanke will wind up voting as part of the minority any time soon. In a big picture sense there is a lot of worry about ‘nothing.’ A dissenting vote does not by itself do anything to the Fed or the Chairman’s ability to pursue the policy he desires... unless having a dissent or two …or more bothers him.

A dissenting vote may not even be a sign that the Fed is split in a way that impedes its ability to act. There are some functions that are reserved for the Board of Governors and are not for the FOMC. Since Bernanke has much more agreement and backing on the Board the potential for dissent, which comes mostly from new voting district bank presidents, does not have the same ability to disrupt Fed policy for those decisions that are relegated to the Board (for example, deciding to accept or reject discount rate change requests from the district banks – that is Board decision not an FOMC decision). Decisions at the Fed are by majority - period. The minority dissenting members on the FOMC get to issue separate statements about their dissent and sometimes that can be a bit ‘embarrassing’ but it does not impact policy directly.

The board members include two economists and four others with banking, legal, regulatory or Wall Street experience. Bernanke and Yellen are the economists. For the most part Yellen is identified with liberal causes and is expected to be a supportive of the Fed’s path for continued accommodation. The other board members are not monetary policy specialists and are unlikely to have strong views on the subtle macroeconomic arguments du jour. They are most likely to support the Chairman and his judgment.

Among the district bank presidents we have more economists and more with ideology. Bullard, Pianalto, Ronsengren and Hoenig cycle off the vote. Evans, Plosser, Fisher and Kocherlakota cycle on. All except Fisher are economists. Of the new voters Plosser and Evans are conservative and their economic views characterized as ‘monetarist.’ Fisher has a financial markets background and is less ideological in that sense but he is a ‘hard money’ guy. Kocherlakota has moved over from academics and had written or said things that sounded somewhat divisive with respect to the Fed’s current policy tact; but he has since has said rather pointedly that it is his desire to more or less fit in suggesting that he is not intending to make his point via hard-nosed ideology and dissent.

That raises another issue. Evans who taught at the U of Chicago is a clear conservative monetarist; nonetheless he took the most extreme ‘dove’ position on the Fed (not as a voter as he did not vote , but in his public speeches). He positioned himself to the ‘left of’ Bernanke calling for a raised inflation target ‘for a time’. I nonetheless label him a doctrinaire monetarist given his background. Yet, he found compelling evidence for the Fed to push for more accommodation. Indeed, Bullard who had voted in the last round, was in favor of using the Fed balance sheet as a policy instrument (surrogate monetary base measure) and to apply a sort of monetarist approach to tis size in a novel way. His idea would have provided protection on the upside if the economy began to perform. Bullard, also a monetarist, found a way to support the Chairman although he wanted somewhat more of a framework around policy than just an ongoing ‘easy money’ bent. Therefore as an assenting monetarist, Evans does not stand alone. His stance is unusual but so are the times. As a voter it is unlikely he will turn this view on dime- even on an inflated one. But he does have a framework that could change his vote if the economy were to shift gears fast enough and shift the risks. His stand comes from an ideology that interacts with his perception of the economy’s position – and the economy’s position can change.

Beyond the rhetoric of dissent, the real question is of Bernanke and how much consensus he will seek. One thing dissenters have is the ability to bargain a vote in dissent for some change in language in the Fed’s statement. If there are enough dissenters the Fed Chairman may prefer to try and alter the Fed’s language rather than to risk more ‘widespread’ dissent and the appearance of there being a schism which could cost the Fed ‘something’ in terms of market reaction to its polices.

For now Plosser and Fisher emerge as the most likely to take up the mantle of Hoenig as dissenter. Whether there is one dissent or more than one remains to be seen. If the risks in the economy shift to more growth and less inflation slippage Evans could be pulled out of the dove camp. But it will take some time for him to undergo that transformation. Kocherlakota will remain an enigma until we see how he settles in and if he can find a space of influence as part of the discussion. As we mentioned at the start all members are contributors to the discussion. But if the Chairman is interested in avoiding dissent he will have to listen more closely to those who vote than to those who do not. In the event that Kocherlakota’s views harden or that he thinks the committee is not taking his side of the argument to heart he is a potential candidate to go the way the way and to dissent eventually, though he does not come in with a chip on his shoulder.

More broadly it is the economy that will decide policy. There is already a good deal of debate on how quickly the Fed might actually shift gears. For the moment, Bernanke is full bore on completing the Fed’s Q-easing program. For that program to have full impact this is the right posture for him. But should the economy gain momentum, should job gains begin to look more solid, should the flirtation with deflation (really, with disinflation) take a turn the other way, various changes in view could be put into play.

We have a malleable Fed, at least at the district bank level. The Board seems to be more devoted to the Chairman with the possible exception of Yellen, although time will tell on that one. It would be ‘awkward’ for the chairman and vice-chair to disagree; we say it happen when Paul Volcker was Chairman but he eventually was dealt with a BOARD by the president himself that would disagree with him. Volcker had district bank presidents that supported him and that combination proved to be his undoing. Bernanke is on more solid ground with what seems to be full board support – at least for now.

I could see events beginning to shift votes or to harden dissents if policy did not shift quickly enough as the economy did. I still don’t’ see the economy or risks turning fast enough for the Chairman to lose the support of the Board. That is to me one of the least likely developments for 2011.

Bernanke remains in control. But how much dissent he gets and how he chooses to deal with it are still issues that remain clouded they are the exact pins on which the Fed’s actual policy pronouncements will turn.

Debit ceiling. help me from myself!

2011-01-17T17:10:00.001-05:00

Bubble, bubble toil and shovel - The US has -when push has come to shove - shoveled money at its problems. When democrats and republicans are at loggerheads they come up with pile of cash and divide it between their respective interests and distribute it among their faithful followers and let the balance ride in the capital markets. So the US rolled tax cuts forward and it extended unemployment insurance WITHOUT any pledge to get its house in order in the future as 2010 came to close. There was no money to do this, of course, so it all comes out of the capital markets and now we have some oddballs who deign to call themselves conservatives arguing that they will hold the debt ceiling hike ‘hostage’ to some future pledge and action to curtail spending. Oh God, please save me from myself!

Stupid is what stupid does - You can’t do that with the debt ceiling. The plan for future fiscal reform is a good idea, one that is well overdue. Tying it to a debt ceiling hike is a disastrously bad idea. Debt ceiling legislation is STUPID. How does not paying our bills count as a conservative fiscal strategy?

Debt ceiling! The debt ceiling legislation is nothing but an opportunity for grandstanding; for those who have overspend to suddenly sound like they have religion, like a quit-smoker who would lecture current smokers then sneak out for a puff or two on the sly. Congress acts like somebody else agreed to all that spending that requires the ceiling to go up. No, one else agreed to it; Congress itself did it. Congress is acting like it’s bi-polar instead of in bi-partisan denial. You can’t spend then not agree to finance your efforts! Moreover, fooling with the debt ceiling is playing with fire. It is a juvenile act to try to threaten anyone with it. Such threats are the economic equivalent of threatening nuclear war. It’s the one threat you don’t dare follow through. Yet once it’s made it may get people to thinking and wondering… The electorate should take names and remember anyone that joins this movement to use the debt ceiling for political gain. Such people cannot be trusted to hold office.