Greek lesson and impact from the eZone to the US

Riots in Greece. Citizens in a country strapped for funds wrecking the public infrastructure that it will not really be able to afford to repair. Priceless. MasterCard.

Whole industries on strike. Critical businesses like banks operating on skeleton crews.

Protesters are saying that the average man can't pay anything more, get it from the rich.

Ah, yes it should be a familiar theme to Americans where the solution to everything is to tax the rich theses days. But the rich are rich. The rich are mobile. The rich own the businesses that create the wealth and provide employment. Scare them off and you are left with the poor. Try taxing them - alone.

In the late 1960s riots in America decimated Watts in California, Newark, New Jersey and Detroit, Michigan. The reaction was by not just the rich but any middle class person who could afford it; that reaction was to leave. The riots were race-based. But the flight of the 'wealthy' was not. By the way the definition of 'wealthy' is anyone who has more money than you. These three cites were forever marked by these riots and the flight of their tax base. Newark is only just getting itself rebuilt. Detroit is a shadow of its former self and is now being decimated by a new challenge to its key industry, autos.

Rest assured that taxing The Rich is a slogan that like any other seemingly good intention is destined to help pave the road to hell. It may be a great slogan but as a policy it just won't fly.

Greece has overspent in a way that probably benefited public servants the most! But this is the hardest cost to trim from a budget especially in a social welfare state. In New York City as Mayor Bloomberg ran for another term he 'gifted' the MTA with a huge contract. After a transit strike in the late 1970s, the NY unions still got rich contracts. They own the city, almost literally the same way investment bankers 'own,' control or hold hostage their firms and their compensation polices. The municipal unions have power and tend to vote in a block- for you or against you. So politicians cave in to their demands. Municipal unions are powerful forces and all states will have a hard time reining in what has been expanded. Greece - socialist leanings or not - is no different.

Greece's people are rejecting the idea that they have done anything wrong. In their eye, someone else is at fault, call them 'the rich' although everybody who can in Greece hides income and avoids taxes. It's still someone else's fault.

What about the government that hid the country's excesses and did not face the music sooner? Are they at fault? What about hiding the excesses and at the same time not trying hard to compress expenditures so someday Greece could comply with The Rules? What were Greek leaders thinking? Did they think they could roll their ever-growing derivatives contracts forever? Are the people angry? yes! But these were their elected leaders and the people are responsible for their leader's actions.

Beware of Greeks bearing debt and/or protest placards. We already have seen what Icelanders have done when it comes time to pay the piper. What is the new modern legacy Greece will make for itself? Austerity, it's not my job? And if Greece can't get rich Greeks to pay what about the Rich countries of the e-Zone? Isn't that the next most logical step? If there is no need for austerity then everything in Greece must be fine except for the tax revenues to pay for it all. If you can't tax the rich or the poor or the middle class then you need an inflow from outside the country. QED.

Where Greece is heading with this logic is a very bad place. The unwillingness by Greeks to take their medicine is bad sign for all of Europe not just Greece. At some point soon Greek bond debt will be due and given this tilt on the part of Greeks no one will roll that debt over let alone contract for new debt. A country that wont' knuckle down to pay its debts puts itself in a real jam.

Pay what you owe? It's Greek to me. Maybe the Greeks can restore the good name of the Welsh or give Icelanders a run for their money as nonpayers. The trend is unsettling.

Meanwhile the US budget deficit gets bigger and the Administration wants to add another trillion to that load for healthcare coverage (not reform). And big challenges for medical costs and social security costs still lie ahead. Maybe Greece's troubles came just in time to give the US a wake up call. Even the RICH United Sates cannot afford to go off on trillion dollar spending programs- again (Iraq war) and again (Economic stimulus) and again (health care) . A penny spent must be a penny earned. The era of deficit financing in the US must be brought to a close and yes we ALL WE ALL WILL PAY MORE TAXES TO DO THIS. It's not just a vague prescription for Greece.

US debt levels? They are not Greek to me.

Fed's Move in a broader context

The markets seem to have untangled the mystery of the Fed's move that isn't a move.

The Fed's discount rate (or primary credit rate) is not a mainstay for bank funding so hiking that rate is not going to have any clear impact on a bank's cost of funds. Banks try to avoid the discount window.

While markets sold off in the wake of the Fed's announced discount rate hike late yesterday, after some reflection US markets have righted themselves. So we cannot even argue that market rates have been pushed up or equity prices pushed down in reaction to the Fed's move of a largely inconsequential rate- a rate used for leverage in implementing monetary policy.

The fact of the matter is that the Fed is paving the way for a rate hike. It has to get markets back to normal conditions before it can do that. But it will not necessarily hike rates quickly once normal interbank market rate relationships are re-established. But it's fair to say it is unlikely that the Fed would hike rates until it had removed the special facilities and rate arrangements it had put in place to deal with the crisis. In that respect we are now closer to a rate hike than we were before.

The release of the CPI on Friday underscores the subtlety of that message. The CPI headline was up but the core CPI fell leaving inflation really very tame for right now. GDP growth has been strong mostly on technicalities. Job growth has yet to check in and without job growth the recovery does not look solid. There is no reason to expect that the Fed is already trying maneuver to a rate hike even though we can argue that in some ways we are closer to having one.

Markets seem to have sorted this out. It is the situation as it was presented to us by Fed Chairman Bernanke in a statement made about one week ago. While markets were confused by his statement then, that has changed.

Still, with the rate hike the world has changed, too. We can see that the Fed wants to be prepared to hike rates if conditions warrant and that is different from saying that it plans to hike rates soon. Still the Fed's move carries a message. That is that the need for the emergency tactics is over. The Fed is betting on a continued recovery.

While it is possible for the Fed to use a wider spread to the discount rate to pressure the Fed funds rate higher that would take repeated efforts and a consistent strategy. There is no evidence that the Fed is trying to use the discount rate in that fashion. It is more obviously true that the Fed is trying to restore a normal Fed fund to discount rate spread as it claims.

There is some complaining about the Fed hiking rates in a post-FOMC meeting, making its move more of a surprise. But it is also true that making the move in that way made it look less like a move at an FOMC meeting that has monetary policy implications. Moreover, it was not a true surprise since Bernanke had just told us he wanted to do just that.

All in all it is hard to be critical of the what the Fed has done or how it has done it.

Still the new weakness in the CPI and the weakness in Europe's service sector revealed by its flash PMI for the service sector in February gives us some reason to wonder about not just the US but the global expansion. In some ways the timing of the Fed move is peculiar since growth is not exactly building in a clear way. We can understand the Fed wanting to get the interbank market and official rate structure back to normal as soon as possible. But the economy has been so weak for so long that if there is backsliding the possibility that economic weakness turns to financial catastrophe again is quite high.

So it is in that respect that markets were cheered by the Fed's move to normalize the discount rate. That move told the market that the Fed, at least, thinks the banking sector is more sold and that it can stand up by itself without special facilities or rate configurations. The Fed also is betting on growth. We can all hope that the Fed is right on this one.

Markets sell off on good news again

A week ago the market went down after GDP rose at a 5.7% pace in 2009-Q4 This past week markets shrugged off a drop in the rate of unemployment to 9.7% from 10%.

Why all the pessimism? Why ignore such good news?

The ISMs cooked up improved numbers this past week and showed improvements their respective employment components as well. The MFG report was especially strong. Challenger's announced corporate layoffs remained low for January.

There are lingering financial sector concerns since Greece got in fiscal trouble. Often when something like happens there is thematic selling across the spectrum that sorts itself out in subsequent weeks. It's like Hells's Angels saying, 'Kill 'em all and let God sort 'em out'. OK we've killed them all, isn't it time for the sorting out?

The US jobs picture is much brighter now. We have gains in services jobs. We have gains in manufacturing jobs. Losses in the tiny construction sector - likely the result of harsh winter weather- swamped gains in the two main job sectors of the economy. This month is a good lesson about looking into the details of the report. The unemployment rate fell, average hourly earnings rose and the work week expanded. The economy improved in just about every major labor market respect.

It's time for some optimism to appear.

Tough day for optimism

Feb 4th 2010

We appropriately flagged the Euro data as problematic this morning. The world is linked. Europe is having trouble with debt. Not that the US is sitting pretty; but it has dug itself out before. Europe is untested and not so incidentally, untrusted.

The back tracking in the jobless claims report is unwelcome news. Even the continued progress in the ISMs and their respective employment indices leave us wanting. Jobless claims need to continue to drop to signal strong expansion. Claims instead are now moving sideways. This is not a good development.

Stock market nervousness is sensible in this environment. Of course it's bit odd coming ahead the employment report instead of after it. We are at risk to that report after this stock market sell off. after all there are some good strong reports in addition the one s that are lacking. We are expecting to see a strong downward revision to worsen joblessness in addition to the losses already suffered. In that respect it will be hard for the market to find news that is good enough to rally off once this report is released.

Still markets are sold off now and the news is still mixed. How long before the usual transition to strength shows its hand? Or it it just not going to happen? That now seems to be a more serious question that it was before. It's not one I have asked before.

A hairy reed or a thin one?

Harry Reid is one of the Senators taking aim at Fed Chair Bernanke. His tepid endorsement and implied support in return for a more helpful Fed is repugnant.

The senators angry at the Fed for not printing more money simply don't get it. The Fed has expanded bank reserves at a very rapid pace. But it is banks that turn reserves into money by lending it. Their loans are redeposited by recipients into bank accounts where the funds are relent again. The process repeats in what is known as the multiplier effect.

The Fed does not create money. The Fed creates reserves which are the raw material for money supply. Interest rate policy is used to assist banks and the public in the expansion or retardation of loan growth and money growth. In this episode, the Fed has done all it can. Short of becoming like China, a bank that tells its banks to whom to lend, the Fed has done all it can. Those that castigate the Fed for not doing enough to grow the money supply are wrong and confused.

In the economic text books it is noted that when it is time to stimulate the economy the Fed's policies are hampered. Its attempts to stimulate are like pushing on a string. That is the problem, not Bernanke or that he has not done his job correctly or prudently. Oddly, those who want him do more are trying to lynch him for his role in in his activist stance under the previous Fed chairman. There is no ideological consistency to this criticism - it's all for political theater.

The view that Bernanke is damaged goods because he served under Greenspan misses the point that it was Greenspan who was the Chairman. No one ever accused Greenspan of sharing too much power. This never ending blaming of Bernanke for advocating low interest rates in the last cycle misses the point too. Low rates did not destabilize the economy. They stabilized it. With good lending practices the damage from low rates would have been minimal. The economy was not undone by 'too much lending' but by lending of a very poor quality and by too much leveraged lending.

It was Congress and it's pushing to extend home ownership- regardless of prudence that was at fault to a large extent. Banks engineered derivatives that were poorly constructed and not understood. that was their own error. A whole industry was set up to remain in denial and to defend the status quo of home loan production.

The SEC was in charge of securities regulation, not the Fed. The Fed's mandate was narrower than the SEC's. Yet the Fed did uncover mortgage irregularities and Greenspan stopped it from pursing those findings. How is that Bernanke's fault?

Perhaps the most amazing thing through all of this is that Greenspan seems to remain as a respected former Chairman despite his key role in all that went wrong while some in Congress have decided to go after Bernanke! The House Financial Services Committee and Senate Banking Committee were in the thick of making wrong policies especially regarding the missions of Fannie Mae and Freddie Mac. Yet these are the committees that have conducted the witch hunt. Read the WSJ Journal Op Ed then re-read this. The WSJ has it all wrong. The Witch hunters have it all wrong.

Bernanke is and was the right man for the job. There is little to blame him for. His innovation and consistency in sticking to the Fed's mission saved the economy. We should seek out those who attack the Fed and explore their ulterior motives. that would be the most productive tact at this point - after reappointing Bernanke, of course.

http://online.wsj.com/article/SB10001424052748704562504575021704013095196.html

Financial Crisis Inquiry Committee

First of all I recommend looking at the picture in the WSJ of the four CEOs with their hands up taking an oath to be truthful. Is this the most board, lackadaisical set of oath postures you have ever seen? If you were taking an oath to tell the truth would you want to look a bit shaper and crisper and seem a little less board than say Lloyd Blankfein? Lloyd looks like he thinks he is operating a hand puppet. B of A's Moynihan looks like he has the stop sign on. Morgan Stanley's Mack seems to be waving as you would to some youngsters, arm bent, less than shoulder high. Only Dimon seems to be somewhat serious in his posture for the oath.

See link below for picture

http://online.wsj.com/article/SB10001424052748704362004575000752756113586.html?mod=WSJ_hps_LEFTWhatsNews

I think body language matters

Blankfein was careful in this responses never to commit to anything. That sort of caution is a bit too cagey for me. I thought you were supposed to go to these sorts of hearings prepared.

Blankfein also was repeating the phrase about the 100 year s storm and being prepared for it. He cautioned about setting the whole financial system to be prepared for such an unlikely event.

It's an interesting tact on his part but it's wrong and the analogy is wrong too. It was a 100 years' flood not an uncontrollable, rogue, storm. Moreover, the financial firms were operating the sluice way and doing so in such a fashion that they mismanaged the dam's flood waters and wound up having to let the flood gates open full bore, imperiling everyone. This was no exogenous event. This was an event in which market participants laid their own ground work and they could have seen it coming if they had been paying attention instead of telling everyone that everything was fine. Fine it was not. Blank they were; fine it wasn't.

Jamie Dimon said that in their various stress tests or scenarios he did not consider that house prices might fall.

Really?

Now Alan Greenspan set the stage for such idiocy by saying that house prices never had fallen on a national basis in the US. As a 'stylized fact' Greenspan was right. But he was also so far off the true mark. It's a bit like saying Jack the Ripper was a nice guy because he never shot anyone. So he stabbed and sliced them? He didn't shoot anyone.

When Greenspan first made his now infamous statement on house prices I was immediately incensed. What and idiot I thought. Since the 1960s there have been several recessions and some of them deep (notably 1973 and then 1980 and 1981). But house prices had not fallen. Still the reason for that seemed quite clear to me: inflation. Inflation cooked in those recessions and real house prices did fall on a national level. Greenspan has glommed onto the WRONG statistic. I wrote several papers pointing that out. But he had the bully pulpit and most of Wall Street was a like a bobble head doll on his dashboard nodding even when the Great One hit a speed bump. No one was critical of G- Span and being critical of him did not get you much attention - far from it.

Nonetheless I wrote that we have seen real house price declines (house prices that rose more slowly than inflation). I extrapolated from this and argued that with inflation now low that meant we were more at risk than ever to a nationwide decline in NOMINAL house prices. No one listened.

This was simple economics but no one seemed to see it. It makes me wonder just how the street used economists. This cross-industry-wide mistake on house prices suggests that economists either were not used, were bullied, or were incredibly stupid in applying and thinking about what was going on in housing. It is hard for me to see how you could have been an economist specializing in that data and not catching on to that simple point about prices declining let alone carrying that train of thought to a broader and deeper conclusion based upon the ongoing lending recklessness. But apparently nobody did. That is Mr Dimon's version.

Dimon's assertion that house price declines were not even considered suggests strongly that no serious thinking about any negative consequences was in train: stressless-stress tests.

On balance the testimonies of these CEOs was not very reassuring. Moreover, they hardly come off looking like the smartest guys in the room as you might have expected of Corporate Titans paid the way these guys have been.

Bernanke's Speech and its implications

What the world needs now?

It’s not love sweet love.

Bernanke in the speech he gave today, besides looking at the circumstances of Asian economies in the business cycle, the ostensible topic of his speech, returned to a theme he has visited in the past. This is the danger of persisting imbalances: surpluses and deficits alike.

While he was very vague about how this should be approached, he was again clear on what needs to be achieved. High savings countries need to consume more and reduce the gap between savings and investment at home. High spending countries need to save more. There is a little something for everyone.

At the same time there is little evidence that any country is taking up a stand to pursue these objectives. Yet the risks are growing

Perspective on imbalances

One issue is that under the gold standard there were rules to the game. Deficit countries were forced to adjust because under the gold standard they lost gold reserves if they let current account deficits persist. No one wanted to run out of gold. So deficit counties usually hiked interest rates and slowed their economies down, contracting imports in the process to rebalance their trade, maybe they even ran a recession. While that system was disciplined it was also confining and it had the side effect that it rewarded countries that had gold mines. The current loose FX system that has few rules and none enforced has been short on discipline – very short. Hence imbalances have arisen, persisted and become enlarged in way that they never could under the gold standard.

G-20 not up to the challenge

The G-20 tried to consider a US treasury proposed to accomplish these same ‘Bernanke’ objectives when it last met. The proposal got lip service only. Absent some concerted effort to accomplish the goals of adjusting savings/investment imbalances, the pressure for adjustment will fall on the exchange rate.

Connections and linkages

The imbalances are one of the reasons for the dollar to be losing ground. The exchange rate is a remedy for US BOP ills since a weaker dollar will choke off US exports and spur US imports. But the dollar’s drop brings other tensions to the surface. Moreover, it is unlikely that the dollar can fall enough to purge the US structural deficit problem. The need for some sort of coordinated effort involving the realization of enlightened self-interest is long overdue. Yet the world’s most important economies are not about to cut any deals. Each sees its current state as in some way optimal for its own needs even though the whole picture is one of a very dysfunctional economic community.

The risk

History suggests that the sorts of problems that arise in the wake of these huge imbalances persisting and being extended are not minor inconveniences. Yet there is no agreement even on pursuing the goals that Bernanke has spoken of repeatedly and that were put on the table at the recent G-20 meeting. Growing payment imbalances have ended badly whether it was due to OPEC countries’ rising wealth, rising Japanese trade surpluses or China’s huge foreign exchange reserve accumulation. We can only wonder if the fallout from these imbalances will get worse as the imbalances themselves get bigger and they are getting bigger - in absolute terms and larger relative to GDP.

Can’t have your Egg Foo Yung and eat it too

China has goals that are bizarre. They are mutually inconsistent. It wants a weak currency to keep its competiveness in tact yet it does not want to keep accumulating dollar assets of which it has in abundance. But if it does not purchase those dollar investments, its currency will rise in value. The lack of a foreign exchange system with clear rules allows China to act like this lost soul with deeply conflicted goals.

The point, the risk, the dysfunction

To be sure Bernanke’s point is a sharp one. No one can tell you when we must get off this path onto one like the one Bernanke urges. By not adjusting, and letting a normal business cycle recovery occur led by US growth with surging US imports and a widening US current account deficit we are playing with fire. It’s a prescription for something bad to happen. It’s like high blood pressure. No one knows what price you pay for it, but we know it puts you more at risk to various health issues. So why leave this problem untreated when we have options and when better systemic health is in everyone’s best interest? That is the unanswered question.