Monday, September 26, 2011

Michael Pettis on the Euro, Swiss Franc. RMB trading, and Chinese Debt

In a very long private newsletter received on September 13th, Michael Pettis began with "Slow growth is embedding itself solidly into the US economy and the bond mayhem in Europe continues. The external environment for China is getting worse. This will almost certainly make China’s adjustment – when Beijing finally gets serious about it – all the more difficult. With still weak domestic consumption growth, and little chance of this changing any time soon, weaker foreign demand for Chinese exports will cause greater reliance than ever on investment growth to generate GDP growth.

"Europe’s travails in particular can’t be good for exports. What’s worse, it’s now pretty much official that the euro will fail soon enough."  Pettis saw Merkel's assertion that the euro will not fail as an official government denial confirming that it could fail as in the political maxim, "The first rule of politics is never believe anything until it is officially denied."  Pettis then proceeds to discuss in depth Otto Henkel's proposal ( "A Sceptic's Solution - A Breakaway Currency") for a two currency euro.  Although Pettis thinks there is little likelihood of the creation of two euro currencies dividing the deficit and surplus eurozone countries, he likes the idea, because all the deficit countries will not adjust fast enough as long as they maintain the euro and their economies will continue to contract and debt grow until their electorate rebels.  If those countries will then leave the euro and default and the surplus countries will eat the losses, why shouldn't the surplus countries force the deficit countries to leave the euro now?  Pettis answers his own question.

If a deficit euro country leaves the eurozone and adopts its own fiat currency, Pettis believes it would be caught in a downward currency spiral such as Mexico in 1982 and 1994 and Korea in 1997 suffered, because a substantial portion of Mexican and Korean debt was denominated in foreign currency.  A deficit euro country leaving the eurozone would have its debt denominated in euro.  This would be a foreign currency.

My comment in response to Pettis on the above scenarios is the High euro and Low euro bifurcation would merely create to stage productions of the very same play; one with a short and the other a longer audience length of the play.  Both would suffer the same, inevitable fate of the exporting country economically subjugating the importing countries with no fiscal transfer mechanism to resolve the current account imbalances creating an inevitable currency crisis as the deficit countries are challenged by the bond market one by one since they cannot guarantee payment under such a system.  Any eurozone country which withdraws from the euro must default on all euro debt and immediately redenominate all public and private debt at a fixed conversion to the new fiat currency on a take it or leave it basis and then let the new fiat currency trade freely with the market deciding the devaluation, which must occur.  The euro is a foreign currency to all eurozone countries and it would be irresponsible to leave debt in euro when exiting to a fiat currency; yet, almost all scenarios of such exits assume the debt would remain in euro.  That would be a fatal economic error.

As Pettis well knows, as he continues, to leave debt in a foreign currency means the devaluation may well not be in line with estimates of overvaluation.  It could cause a devaluation of 50% or more, when the overestimate might be only 15-20%.  The external debt would rise as its fiat currency devalues, because it would remain denominated in an appreciating foreign currency.  The credibility question of bond payment would rear its ugly head again and financial distress cost would rise just as they are now.  As domestic borrowers try to hedge the currency risk, investors would flee the new fiat currency in a self-defeating currency crisis involving foreign currency debt.  Default would be unavoidable.

For Pettis, this is not an argument for a deficit country to stay in the eurozone, because, if the deficit country "stays in the euro, we will still arrive at default, but much more slowly, and mainly at first through a grinding away of wages and economic growth over many, many years and a gradual building up of debt as Germany refinances Spanish debt at interest rates that exceed GDP growth rates. The default will occur anyway, but only after years of high unemployment."  He leaves unstated the likelihood of growing social unrest and intra eurozone national distrust of the surplus eurozone countries.

This is why he likes Henkel's two euro currency idea, but with the surplus country (such as Germany) leaving the euro as Marshall Auerback has repeatedly suggested.  The new fiat German currency would immediately appreciate while the euro depreciates, but their banks would still have loans in euro which would cause them significant losses.  Pettis thinks the losses would be less and more orderly than a deficit country leaving the euro.  Either way the surplus country leaving the euro would take a big hit and it is a waste of time trying to avoid it and it is better to face it and deal with it and "as any good Minskyite would tell you, that means we have to pay special attention to the balance sheet dynamics."  Pettis also believes this would set up a two entity Europe of Germany and its associated countries and France and its associated countries.

With respect to the Swiss franc, Pettis believes the Swiss National Bank has decided to become very serious about currency wars.  Switzerland is enduring a large inflow of foreign currency and appreciation of the franc with significant negative impact on Swiss exports.  "The world is seriously deficient in demand compared to capacity and every country is going to try (has already tried) to capture as large a share of that demand as it can. This means every country is going to try aggressively to export capital or limit capital imports."

"But of course it doesn’t work that way. If capital-exporting countries want to increase capital exports in order to acquire a bigger share of global demand, and capital-importing countries want to limit or reverse capital imports, something has to give way. This is basically what we mean by trade and currency wars."
Switzerland has chosen to slow or eliminate foreign capital inflow by capping the rise of the franc.  Pettis believes it cannot work and there will be massive speculative inflows in the Swiss franc on the expectation the inflows will cause the Swiss National Bank to revalue.  In a few months the SNB will have to take even more forceful measures.  When countries continue to desperately export capital to each other while continually crying foul at attempts to import capital, currency wars will roll on as he explain in his recent Foreign Policy article

This also means we should not get too excited about news London may become an offshore trading center for the Chinese RNB currency.  Every time the suggestion is made that the renminbi will become more international, excitement sweeps the world, although nothing ever really happens.  One only has to look at the developing currency wars and understand everyone wants to export capital and no one wants to import it so why would China want its currency to evolve into a reserve currency by trading internationally.

There has also been speculation that a country like Nigeria would want to diversify reserves and hold renminbi, but Pettis thinks this is only a speculative idea based on the renminbi price being heavily subsidized by the PBoC and, therefore, only likely to appreciate.  China is unlikely to allow any but the financially small countries to attempt this and does not want to see it at all, since "The PBoC is required to buy up all the dollars offered in exchange for RMB in order to keep the value of the currency where it is, and any increased foreign demand for RMB bonds automatically means that the PBoC must take the other side of the trade. Its reserves will have to increase by exactly the amount of dollars that Nigeria (or any other foreigner) uses to buy the RMB. And the faster China’s reserves rise, the greater than domestic monetary mayhem and the greater the losses the PBoC will ultimately take on the negative carry and the revaluation of the RMB."  The short version of his discussion of this in his mid-May newsletter was "...that once you exclude intercompany transactions, nearly all the trade activities denominated in RMB consist of Chinese imports, and almost none of it consists of Chinese exports. Why is this important? Because Chinese imports denominated in RMB result in long RMB positions in Hong Kong, whereas exports result in short RMB positions."  Once the speculative demand dries up, there is little real demand for RNB transactions and the off shore RNB market would be very small.

Speculative demand will begin to dry up when the perceptions on the total amount of debt on the Chinese national balance sheet begin to improve.  However, debt levels continue to rise and rise very rapidly.  Most analysts have downplayed the resulting credit impact of China's spectacular growth.  Such an analysis implies China has an infinite debt capacity, which Pettis finds impossible.  What concerns Pettis now is that as analysts have caught on to this, the "horror" stories have begun to multiply out of control about " flow squeezes among SOEs and the smaller banks, about unrecorded guarantees and lending by SOEs, about highly pro-cyclical lending by banks, about a huge variety of dubious transactions in the informal banking sector, with non-transparent links to the banking sector, and so on and so on. Everyone nowadays seems to have horror stories.  For this reason, Pettis advises we remain skeptical.  We should not scare ourselves into overreacting.  Pettis does not see China reaching its "... debt capacity until one of three things has happened:

  1. Depositors flee the banking system because of uncertainty about repayment prospects. I think this is unlikely to happen unless inflation rises sharply and, because of the highly adverse cash flow impact of high nominal rates, the PBoC is unable to raise deposit rates sufficiently.

  1. Household transfers are too high. Debt servicing costs should be met out of the increased economic activity generated by the debt. If they aren’t, the balance one way or another must result in a transfer of wealth from one sector of the economy – usually the household sector. As these transfers rise, the ability of that sector to generate growth becomes smaller and smaller. At some point the transfers are too large to be managed, and investment growth must stop. Of course if the government begins to privatize assets and uses the proceeds to clean up the banks and repay loans, this problem need not happen.

  1. The private sector becomes so worried about the possibility of financial instability and rising of financial distress costs that they disinvest faster than the government can invest."
    Another way to extend debt capacity limits, according to Pettis, would be similar to Brazil in the mid 1970's when it was "saved" by massive petro-dollar recycling and a subsequent lending boom switching domestic debt to external debt, which allowed Brazil to keep investing and growing until the 1982 crisis and a lost decade.  In principle, China could do this, but it is unlikely to become a net foreign borrower as it would also have to reverse its huge current account surplus into a current account deficit.  He thinks there would institutional impediments preventing this from happening.

    Everyone knows by now that Chinese inflation is down to 6.2% in August, but he finds these numbers to be so much within expectation that he has nothing to add.  Inflation appears to have peaked, but the numbers require another month or two of observation and Pettis believes the PBoC also believes this.  There is also growing concern among economically literate policymakers about rising debt and weak consumption, because these are basically the same problem.  He expects to see comments back and forth on inflation, but a number of policymakers are reluctant to support more expansionary credit growth as a credit contraction is politically very unlikely.
    Pettis remains concerned that the Chinese consumption imbalance remains a fundamental problem despite Yukon Huang writing in the Wall Street Journal that consumption is in fact far higher than official government figures and takes issue with Huang's interpretation of the studies cited, because one study actually shows 2/3rds of hidden income accruing to the top 10% wealthiest and almost all to the top 50% and, since the wealthy a much smaller share of income than the poor, it would suggest the consumption imbalance is actually much larger.  Pettis also finds the reported size of the imbalance by Huang to be astonishing.  Just because the NBS data is awfully wrong, this would not increase China's invulnerability from crisis.  In the end, all the possible arguments against the dismissal of the fundamental consumption imbalance problem need not be made, because the balance of payments tell us it is extraordinarily low.  "... China doesn’t have either a current account deficit or a balance of zero. It has instead one of the highest current account surpluses ever recorded. This can only happen if the savings rate exceeds by a huge margin the investment rate – which, remember, was itself by 2008 the highest we had ever seen, and which has soared even further in the past few years

    "By definition, then, China’s savings rate must be extraordinarily high to allow it both a huge investment rate and a huge current account surplus. Since savings is simply the difference between total production and total consumption, China must also have an extraordinarily low level of consumption in order for the balance of payments to balance. I would argue that it almost certainly does."
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Sunday, September 18, 2011

Is President Obama's Jobs Stimulus Old, Tired, and Purposefully Inadequate?

Enough time has past since President Obama's $467 billion jobs stimulus announcement to provide a re-evaluation of the proposal from different perspectives.  John Quiggin, writing from Australia, believes President Obama has recognized he cannot form a bipartisan  relationship with the Republican Party and rejected the advice of his advisors and proposed a a more substantial plan, although still modest.  Quiggin believes this has set the re-election stage as the Republican Party will reject even this modest package which is one-half the size of the 2009 stimulus and that President Obama has abandoned the speech of austerity presenting a clear choice against the destruction of austerity on unemployment, economic growth, and local and state governments for voters.  I would very much like to believe Mr. Quiggin is right, but he ignores the President Obama is personally a deficit hawk and has not yet grasped the economic seriousness of the more than 16%, including the discouraged workers, unemployed workers in America.

On the other hand in America, Robert Reich, a former U.S. Secretary of Labor, finds President Obama's targeting of Medicare and crafting a $2-3 trillion decrease in spending over the next ten years as odd given the economy will still be anemic in 2013 if we manage to avoid a double dip.  Such spending cuts are likely to make unemployment stratospheric.  Even if the average monthly job growth of the last decade were to miraculously appear, it would still take until 2024 to get official (now at 9.1%) unemployment down to 6%.  He sees President Obama reinforcing the Republican conceit that the deficit --- not unemployment and little economic growth --- is the problem.  The President failed to propose a more audacious plan to get American workers back to work and provide fiscal support promoting economic growth and this is makes it a failure of both parties.

While President Obama's tax cuts will put about $150 billion into the hands of American households, which could theoretically create a relatively small temporary stimulus, these are not ordinary times and history provides evidence that people save when debt is high, jobs uncertain, and the extra money temporary.  What is there to get excited about if unemployment is reduced just a little below 9%?

Macroeconomic Advisers had revised their original estimates of economic impact to GDP growth of 1 1/4% by 2012 by pulling growth forward from 2013, an increase of 1.3 million jobs (the 2009 ARRA provided about 1.2 million jobs), and the spending cuts will cause fiscal drag which will probably not show up until 2013.  In essence, the plan is dependent on shifting growth from the future (2013) forward, when the economy will hopefully be better.  This is macro economically unrealistic.

James Hamilton wants us to rethink what we need to do to exploit our natural resources to spur economic growth without creating a National Fraud and Exploiters Corps.

Bond Girl at Self-Evident points out that the proposed reduction in itemized interest and other deductions could directly effect the municipal bond market, which is the primary vehicle for infrastructure in this country, through reduced demand.  It should be remembered that the ARRA did provide infrastructure projects which were slow to start, but did have some modest temporary stimulus.

If you look at the Georgia Work Program upon which the President will apparently model the unemployed worker training initiative, you will find that the transition time from unemployment to employment is about the same for both those Georgia workers who participated and did not participate, except that those who participated worked 24 hours a week for free and successful hires got jobs which required a high school diploma or less.  This is not creating the type of fair labor social contract a true republican democracy should promote and support.

It should be remembered that small businesses, even more than large businesses which have a more sustainable business model, cannot afford to hire without the sales to demand the need.  Tax incentives to hire are temporary.  Most small businesses cease existence within 5-7 years.  Many small businesses being started are unemployed workers who have no choice and are being run on shoe string financing.  Tax incentives to hire is an hour glass approach.  Tax incentives may create more accounting jobs, but is not likely on a micro economic level, historically, to create demand to hire.  The sad fact is that, as happened in the post 2001 recession, job postings are not picking up in volume.  Management has devised more efficient ways to not need more employees, particularly in a period of slow economic growth and low sales.  In the meantime, the U.S. working age rate of poverty has hit a record high at 13.7% for 18-64, which is up from 12.9% in 2009 and 10.5% in 1966.  Since its peak in 1999, household median income is down 7% or 3800 2010 dollars.  If the elderly are excluded, household median income is down 10% or $6300, including down 2.6% last year, for the largest decline since 1987.  Real  income for working age families is at its lowest level since 1994.  This is a lost decade for the Middle Class which has intensified the wage and wealth inequality in the United States.  This type of inequality has a very corrosive effect on democracy, particularly when 400 families have 50% of the wealth in the United States.

At the same time the reduction in fiscal spending on the national level during a time of financial tightening is the wrong direction and will only make the situation worse.  Jobless claims are rising again; retail sales are down; manufacturing is weaker.  Rather than focusing on jobs we are told the U.S. Postal Service could "default" on it pension payments required by law, because they are losing money in their operations.  We are told rural areas could lose their post offices when the resulting lack of services would be a significant hardship as they are not suburbanites within easy commuting distance of another post office.  It is a federal government agency and, as such, it cannot economically default unless Congress and the President have politically decided to let it default.  This is misplaced direction.  We need to create jobs not find excused to isolate less wealthy Middle Class and poor families from services.

As we pointed out in our prior post on this subject, for $300 billion all unemployed workers could be back working on quality projects in education, infrastructure, health, social needs, and cultural preservation/creativity which would not only create economic growth but enhance the quality of life through the creation of a National Jobs Corps.  This means more wealth for more people rather than a select few while creating sustainable economic growth.  Is this a problem? 

Dear President Obama would you please accept the mantle of leadership and propose an audacious jobs program.

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Saturday, September 17, 2011

Edward Hugh Links: On the Eurozone Crisis

Despite the misplaced hope of the stock markets this past week, the eurozone is headed towards a decision point the leaders of the eurozone do not want to face.  I heavily research the eurozone macroeconomic issues as well as China, because they have global implications.  The eurozone could quite easily unravel with a Greek default within the euro or the need to bailout Spain or Italy.  A currency crisis would ensue and European banks and, quite probably, banks globally could have significant liquidity problems as the interbank market freezes up with the possibility, if nations are not prepared to fund liquidity through their central banks and governments, of some banks failing.

Edward Hugh is an intellectually eclectic British born macroeconomic economist who lives in Barcelona.  Whether one agrees with his conclusions or not, he always has something important worthy of consideration to say.

Here are some observations on eurozone and China PMI showing slower growth.

Ireland is being advertised by the eurozone as a success story to sooth the egos of the newly indentured (to European banks) Irish people.  What is going to happen to Ireland, which is a trade surplus exporting country dependent on exports for its economic recovery, as the global economy continues to slow down?

High Noon is approaching for Greece

Italy has low growth, an aging population, and is the third largest economy in the eurozone.  Can they make the penalty kick?

I have repeatedly stated privately that the breakup of the eurozone into a High euro and a Low euro will only create two stage productions of the same play with different lengths of production and the same tragic ending.  Here is Hugh's take on the subject.

Here he discusses recession risks in Germany.

Here he reviews the recession warning on the eurozone periphery.

Here he covers the flashing red lights for eurozone growth.

Hugh correctly identifies Italy, not Spain, as the elephant in the room.

How can Greece devalue?

Eastern European growth is very dependent on Germany.

Why Spain's economy is more different than you think.

The eurozone crisis is imploding.  If it will not accept a democratic fiscal transfer mechanism the euro is doomed and the international bond markets have recognized this for some time.  The euro is not a fiat currency which can be devalued and as such is a foreign currency, economically, for each and every eurozone country, which means their national debt is denominated in a foreign currency (the euro).  Consequently, no eurozone nation can guarantee its debt.

Being informed on the issues involved requires reading many different viewpoints.  There is a debt crisis, because this is a currency crisis and it could lead to a bank liquidity crisis and potentially to a global depression.

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Tuesday, September 13, 2011

Michael Pettis Links on Global Outlook, Japan, and the U.S. Dollar

Michael Pettis had a recent  article in Foreign Policy continuing his concern that the U.S. dollar as the world's reserve currency is a drag on the U.S. economy.

I have not had the time to write about Pettis' last two private newsletters and here are the abbreviated public versions:  On August 17th, he gave his long term outlook for China, the global economy, and the eurozone (very pessimistic) and, on August 25th, he wrote about Japan in which he disagrees with those who would compare the U.S. and Europe to Japan, because Japan's imbalances in the 1990's were different (I, myself, have maintained Japan is like Japan).  You are not getting the full versions, but are getting the full extent of his thinking.

I particularly encourage readers to look at his eurozone assessment/predictions given the current approach to a horizon event in Europe with Germany, the Netherlands, and Finland poised to pull the trigger on Greece and sacrifice Italy (the third largest economy in the eurozone).

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Monday, September 12, 2011

President Obama's Frankenstein Stimulus of Old Ideas

Is my title too harsh?  I will let you decide.

The President gave a very uninspiring speech that presented old ideas for rejection providing more stimulus ($450 billion) than expected ($300 billion), although it is little to small economic stimulus creating less jobs than needed strung out over too long of a time with little immediate jobs effect whenever begun.  His speech lacked any display of leadership and looks more like a political play to get the political opposition to vote either against a "jobs" bill or come up with another ultimately inadequate stimulus.  The 2009 stimulus is largely acknowledged as having been too small and not fast enough in implementation with $800 billion, reduced from an economic recommendation of $1.2-1.3 trillion, when the recession was actually much deeper and should have required approximately as much as $3 trillion to get the job of resilient recovery done.  The bullet points, without any details of how the points will be developed or implemented, are here as provided by the White House.  Considering some journalists and selected bloggers, such as Krugman, had advance copies embargoed for two weeks, the analysis forthcoming after the speech has not been particularly deep in effort. 

Calculated Risk provides a succinct synopsis of the parts and money breakout.  Kash Mansoori sees a larger stimulus than I do in the extension of unemployment benefits, extension of payroll tax cuts, infrastructure spending, state and local government jobs, and mortgage refinancing, while finding the employer payroll tax cut, extending 100% financing for businesses, and tax credits for hiring veterans negatives.  Mike Konczal, while noting the Obama Administration has been overly optimistic, provides a more deliberative appraisal of the parts, but he believes the tax credits will substantially boost employment, which I do not.  Mark Thoma found the proposals bolder than expected, but worries, correctly, that the spending is being funded by front loaded budget cuts which negatively impact aggregate demand which slows growth.  The wrong thing to do at this point in time.

We have already written several times on the problems of continuing high unemployment and slowing growth, including the most recent August unemployment figures.  Lets take a some additional looks at where we are on growth and unemployment besides our article above.  Between 2007 and 2010, the United States ranks just below Portugal and just above Iceland, Spain, and Ireland in the negative percentage of change in total civilian employment.  The post recession job picture shows substantial job contraction in all employment sectors except mining and logging, temporary help, motor vehicles and parts, and manufacturing (although at a significantly slower rate of growth).  In comparing past jobless recoveries in 1991 and 2001 with 2009, the 2009 jobless recovery comes out much worse and ineffective.

The American Jobs Act is designed to cease at the end of 2012.  Menzie Chinn believes it will stimulate GDP and cites the textbook approaches.  Extended unemployment and infrastructure spending will help sustain aggregate demand.  He refers to Macroeconomic Advisers and their projections of a $300 billion stimulus estimating 1.3 million new jobs (remember the inadequate ARRA of 2009 created 1.2 million jobs) by the end of 2012 and a 1.3% boost in GDP.  At $450 billion, the boost in GDP might be closer to 2%, but the effect would tail off quickly.  Chinn also quotes extensively from Ezra Klein's summary of economist's reactions.  Chinn does lament that Congress has done little to nothing in regard to real financial reform to prevent a new financial crisis.

Felix Salmon is fully in favor of mortgage refinancing, which is another part of the proposal that has no detail as to how it would be done, and believes the benefits out weigh any costs to the government if it paid off the bondholders, because he believes the CBO study on the subject assumes 100% pay off to the holders of the mortgage backed securities.  Calculated Risk finds the CBO study reasonable in its conclusions.  That is the problem of not having the details to perform any analysis.

Private sector critics have dismissed the idea that any tax break or incentive will spur employment, because businesses hire when there is a demand for their products or services and the demand is not present.  This is consistent with my observations. In my observations, I have also provided other sources who do not find the payroll tax cuts providing enough stimulus to be meaningful in promoting sustainable employment and economic growth.  The infrastructure bank concept, which also lacks any detail, could be a good idea, but most concepts in this regard do not include sewage and water supplies.  The construction jobs will primarily be getting construction workers back to work or full time work.  Much of the infrastructure may also require public-private initiatives which could mean privatization of public enterprises.  For instance, high speed rail in Illinois means Union Pacific gets to keep all the improvements (and their current employees are doing all the work) and has no contractual or legal obligation to yield to passenger trains making high speed passenger trains half speed trains and, in the case of the State Capitol, dividing the City down the middle of it business district, medical district, and historic areas with two sets of tracks endangering the flow of emergency traffic and diminishing the quality of medical and historic sites.  It is all in the details.

Bottom line, what we are seeing here is a lot of old ideas being trotted out with little detail on how the parts would actually work and be implemented. Additionally, the implied attack on Social Security and Medicare through the payroll tax cuts and citing need for reform is unreasonable.  The problem with Medicare is the high costs of health care, provider fraud, and Part D having been purposefully designed with no government discount directly benefiting the pharmaceutical industry (for whom the author of Part D now works).  In my prior observations on what the President should say, I voiced my concern that pensions, such as Social Security, are deferred compensation not entitlements and health care is a basic human need of which the deprival is a violation of human liberty and life.

If you want to create jobs now, it is relatively simple.  Government becomes the employer of last resource providing real work and training on quality projects (not make work) in a variety of sectors for a base wage.  They could be part time jobs as well as full time jobs and jobs for teenagers as well as adults.  We would not have to worry about discrimination against older workers or veterans.  The Australian economist Bill Mitchell has tackled the issue of government being the employer of last resource and the economic arguments for and against and finds it efficient and simple.  In doing so, Bill Mitchell refers to the plan of two American Economists, Randall Wray and Stephanie Kelton, which would create a National Job Corps putting all unemployed Americans to work for approximately $300 billion; not the $450 billion proposed by President Obama which might create 1.3 million jobs by the end of 2012.

The United States is paralyzed with dysfunctional politics from both political parties and the President is not providing leadership in forming the political will necessary to get things done and to get them done for the American people.  President Obama could be a great President, but he has been too personally concern with deficits to face the harsh reality of over 16%, including discouraged workers, of the population being unemployed.  Jobs and growth come hand in hand and with growth comes increased government revenue, increased private spending, and less need for government spending to replace missing private spending to sustain aggregate demand.

Have we been too harsh on President Obama and will he step up to the leadership required of our times?  Has President Obama set his eyes on political compromise with a political opposition which would oppose compromise as each jockey for an election campaign advantage?  Will he end up ranking somewhere between Franklin Pierce and Herbert Hoover?  Even Franklin Roosevelt had to overcome his economic prejudices to deal with the times in which he lived and he learned some of his lessons the hard way as well as from mistakes.

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Saturday, September 10, 2011

Guest Blogger: Rob Parenteau on Slaughtering PIIGS - Greek Default

Rob Parenteau is the sole proprietor of MacroStrategy Edge which provides macroeconomic analysis to institutional and hedge funds for U.S. equity and global balanced portfolio strategies.  He is a a Research Fellow at the Levy Economics Institute and the editor of the monthly Richebacher Letter. 

Revisiting the PIIGS Led to Slaughter Perspective: Implications of a Greek Default

Last year we provided an analysis (on the Naked Capitalism blog and elsewhere, including the Levy Economics Institute Annual Minsky Conference, and CBC interviews), based on the financial balances approach that suggested a number of problems could arise with the eurozone’s pursuit of what are called “expansionary fiscal consolidations”. Without a large and sustained swing into a current account surplus, the financial balance approach revealed that the pursuit of fiscal consolidation would undermine the ability of the private sector to service the debt loads it had built up during the prior decade of currency union. Simply put, higher taxes and lower government spending drain cash flow from households and firms, and that increases the financial fragility of economies.

For a number of reasons, there appears to be a glaring blind spot with regard to private debt as investors and policy makers remain focused on reducing public debt growth. There is little or no recognition of how changes in fiscal policy may influence the sustainable paths available for the private sector to manage its financial obligations. For example, with regard to the case of Greece, the household debt to GDP ratio soared during the past decade, and is now on par with the rest of the eurozone. However, private sector nonfinancial debt stopped growing in 2008 as the Global Financial Crisis hit, and we have since witnessed the onset of a nominal income contraction since 2009, when fiscal policy became hamstrung by what amounts to a bond investor capital strike.

We currently have in hand an extreme case of this interaction of public and private financial conditions. Investor and policy maker attention is now focused squarely on the prospect of an imminent Greek public debt default. But the issue of a Greek government debt default immediately raises the issue of Greek bank solvency (since much of the Greek public debt is held on their books), and hence provokes the question of how the necessary bank recapitalization could proceed. I doubt the EFSF or ECB (or Qatari investors, for that matter, who must feel like Prince Alwaleed with his Citi holdings) will be in the mood for subsidizing a Greek bank recapitalization if Greece has defaulted on its public debt.

Oddly enough, the level of Greek bank write-offs has been falling since the turn of the year, and private loan growth is once again contracting on a year/year rate as of June. This makes no sense given that nominal GDP growth was contracting at more than a 5% year/year rate through mid year 2011. So what happens if Greek private debt outstanding starts shrinking because Greek banks not only have stopped making new loans, but they can no longer roll the old loans, and in fact, have to shrink their loan books through distress sales of existing assets because they are a) insolvent and b) unable to be recapitalized by the public sector? With regard to the latter, remember that in all likelihood, the Greek government will have to reduce expenditures to match the level of incoming tax revenues if it adopts the default option. Accordingly, there will be little room for them to bootstrap their own bank recapitalization. Possibly if they went completely AWOL, they could reconfigure the Greek central bank to somehow recapitalize the banks, but by then we are on to the new drachma.

I submit with Greece, the world is in all likelihood about to witness yet another case study in Irving Fisher's debt deflation dynamics, which he described a lifetime ago after losing his shirt in the Great Depression – an experience that led him to rethink his conviction that markets are generally self-stabilizing in a general equilibrium fashion. The attempt to move toward zero public debt growth can have very destabilizing results on economies in which the private sector has spent the prior decade leveraging up. This follows from the simple application of double entry book keeping to macroeconomics. As policy authorities who work with the financial balance approach must know, it is a conclusion that depends on no high macroeconomic theory, Keynesian or otherwise. Whether German PM Schauble will be able to recognize that, even as the Greek debt deflation plays out in front of his own eyes, is debatable. Whether the Reinhart and Rogoff Bible will be re-examined for errors or omissions is also debatable. Whether we are about to see “failed nation states” emerge in the eurozone as a result of blithely ignoring these simple principles of double entry book keeping remains to be seen.

Faith based economics is a funny thing that way - although at the moment, it does not look like Zorba is about to get the last laugh, at least not until the debt deflation sewage from the periphery backs up all the way to German banks and German exporters. A Greek public debt default will place the question of the necessary eurozone wide bank recapitalization at the head of the line, which is where the IMF’s Lagarde was trying to place it a week ago before EU officials reeled her back in this week. Even if governments are able to swiftly execute publicly assisted bank recapitalizations in the wake of Greek default, it is high time to recognize that attempting a multi-year, multi-country fiscal consolidation against the backdrop of high private debt to income ratios is bound to produce rising private debt distress, with all that means for the ability of the private sector to generate the income growth necessary to service existing private debt load and higher taxes, and with all that means for the ability of financial institutions to remain solvent. Perhaps this is a lesson best relearned sooner, rather than later. It cost Irving Fisher his fortune, and then his house, before he was prepared to learn that lesson. We need not be so stubborn this time around.
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Wednesday, September 7, 2011

What President Obama Should Do About Jobs

There has been a lot written about what President Obama should say in his speech this coming Thursday.  There has been speculation for weeks, because the continuing high unemployment attests to the inadequate 2009 stimulus.  It has been argued that the ARRA of 2009 merely shifted employed individuals form one job to another and I have stated many times that the construction stimulus merely kept construction workers employed, but the ugly fact is the unemployed are staying unemployed and the older the unemployed individual the less likely they will find employment as they are subject to not only the discrimination of being unemployed but of being older.  Surveys of the unemployed show they are losing hope and see a dismal future not only for themselves but for the country and their children.  Aggregate demand is contracting and where there is no demand or less demand you do not find job creation.  With the growing economic indicator evidence that the U.S., European, and global economies are slowing down to crawl, pre-recession speeds, unemployment is poised to increase if not surge upon any economic shock.

Many commentators have been dismissive that the President will say anything meaningful, while others have weighed in with their opinions as Warren Mosler did in a post and Robert Reich did in this post. Let me tell you what I think President Obama should do and then I will tell you what I think he will do.

Create an infrastructure program which is ongoing to address the inability of cities and states to build and maintain roads, municipal and regional transportation systems, bridges, schools, sewer systems, and water supplies.  Water, in particular, is becoming a valuable and increasingly scarce commodity.  This will keep construction workers busy and reduce future infrastructure maintenance costs.  No significant new immediate jobs here and it will take one to two years to begin.

Create a government run program to restructure underwater home mortgages to reflect true value and get the housing market moving through the FHA and bankruptcy laws.  Depressed housing prices are a significant factor in the very slow economic growth and deflation.  The current program run through banks has a well documented record of failure and delay.  It needs to get done.

Provide funds, perhaps in the form of loans, to local governments and school systems to insure adequate police, fire, and teaching staffing is maintain for the safety and to insure an adequately educated youth for future growth.

Increase Social Security and Medicare payroll "taxes" to apply to all levels of earned income.  Social Security is not an entitlement, it is a pension in the form of deferred compensation and the top income level for contributions has never been inflation adjusted.  At some point in time, it will have to be admitted that the totally inadequate PPACA will have to be folded into an expanded Medicare program for everyone, because health care is a right to life and denial of adequate health care is ultimately murder.  Payroll tax cuts have little economic stimulus effect as it is little noticed by workers in their paycheck and people are saving and paying down debt not splurge buying; business tends to save tax reductions rather than spend when demand for their services and products have not increased.

Concentrate on efficiency cuts in government.  Government exists to provide services to its citizens.  It is one thing to provide services and another to provide them efficiently.  Any business can tell you this.

Create a National Job Corps.  This is the only way to create jobs now. It has worked in the past and it can work more efficiently now

Extend unemployment to those who have lost part-time jobs.  Many people, according to the unemployment statistics, are captive to involuntary part-time employment, because they cannot find full time positions. The loss of a part-time job can be devastating.  With a National Job Corps, unemployment benefits should be temporary transition funds only.

Unfortunately, the political debate within the U.S. is dysfunctional.  The two political parties are engaged in opposition at all costs with a President who holds personal deficit hawk views and who is timidly attempting compromise when, if the President proposed the opposition party's political platform, he would be opposed by that very same party.  The President needs to lead and let those who vote against jobs reap the harvest of their constituency at the next election. This political dysfunction and the President's personal deficit cutting sympathies has lead the President and his advisers to flounder economically as they seek politically acceptable policies which do little or nothing rather than what needs to be done.  These political concerns have caused the President and his advisers to court the wrong constituency.  The economic crisis is not debt; it is jobs and income inequality.  The wealthiest top 1% of the population have too much power as can be evidenced from no banker going to jail for the mortgage frauds or engaging in financially and systemically (globally) dangerous trading and business activities.  In fact, we bailed them out financially.  In a period of aggregate demand contraction (less consumer and business spending), government is the spender of last resort.  When politicians stop an economy from growing with deficit cutting at the wrong time, the economy tanks and misery sets in.  If you are one of the wealthiest 1%, you suffer, but you also benefit from opportunities for more control and wealth.

I expect President Obama to announce spending cuts.
I expect him to propose incentives to businesses to hire workers.
I expect him to announce a job training program in which workers are trained on the job and the government pays them, much like the State of Georgia is doing and nothing like what Germany does. 
I expect him to announce an infrastructure program to build schools.
I expect him to appeal to bipartisanship.
I would not be surprised if he broached the subject of cutting/modifying Social Security and (maybe) Medicare.
I expect him to say, like Hoover, what the financial/banking sector wants him to say.
I expect the amount to be inadequate, say only $300 billion, covered by spending cuts.

We deserve better.

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Monday, September 5, 2011

Jobs = Growth: We Have Neither: Unemployment August, 2011

Real men (and women) want real jobs.  They want to provide shelter, clothing, and food for their families.  It is the 18th Century concept of the pursuit of happiness and some people who have loved and fought for freedom thought of it as a God given inalienable right of all free men.  What we have seen, since the beginning of the 1960's particularly, is the accrual of GDP growth primarily to the top 1% wealthiest in society at the expense of the remaining 99% of society.  We can talk about confidence --- and there appears to be less in the United States, Europe, and globally, but economic data on confidence is always past tense when received.  In the final analysis it comes down to real wages and personal income.  The myth that increases in the minimum wage increase unemployment has been repeatedly shown by economic studies to be false with moderate increases in the minimum wage having no appreciable effect on jobs.  Worker productivity has grown 80% since 1980 while real compensation has only grown 8% and real wages only 7% of which 23.5% of the income went to the top 1%.

The August, 2011 Unemployment report was unchanged (zero net job growth) with unemployment remaining unofficially at 9.1% and total official discouraged workers at 16.2% an increase of one tenth.  Using the older 1994 BLS calculation, Shadow Statistics estimates (this graph will change monthly) the total discouraged workers at approximately 22.8%.  The number of unemployed remained unchanged with no jobs added, because the participation rate went up to 64% and the employment-population rate went up to 58.2%.  The number of workers who could only find part-time work rose to 8.826 million from 8.396 million.  The average work week declined to 34.2 hours and the average hourly wage declined one tenth.  The participation rate is edging up for older age groups including those 55 years of age and older and it appears it will be getting older.  As for education, it appears that educational level is not significant in the ability to find new employment when unemployed and the diffusion index is at 52.2 (below 50 is contractionary) across all industries and is at its lowest level since last September.  For a full set of employment graphs at Calculated Risk go here.

Worse, the prior two months were revised down and the major indicators around those who have jobs are weak  The average duration of unemployment has dropped while the median has increased, which means that more people are dropping out of the labor force discouraged.  There is little remaining the Fed can do leaving the bulk of necessary action in the domain of the government's fiscal policy.  The continuing high unemployment is a direct result of the inadequate stimulus applied in 2009 and the destruction of education jobs will have a serious future effect on the ability of the United States to be competitive and to grow economically.

In an extensive analysis of the United States unemployment figures, the Australian economist Bill Mitchell finds a staggering loss of unemployment, increased under employment, a stagnant labor market, and declining economic growth heading towards recession as the result of the inadequate 2009 stimulus and political bickering which is abandoning U.S. workers to oblivion.

If you look at this link from the economist James Hamilton on the current economic condition with respect to the most recent economic reports, you will see that the United States has been making little meaningful progress in recovering from the global financial crisis and has only very slow growth to look forward to in the next six months.

In graphs from Calculated Risk, you can see several measures of recession and where we are in the terms of slow growth.  Using some different GDP per capita variations, Doug Short looks at recession indicators in a series of graphs and comes to the conclusion we have not yet fallen back into recession, but we are surely in the a second great contraction.  The Consumer Metrics Institute in their August 30 News, which has not yet been posted to their website, argues that the BEA deflators are not correctly portraying nominal GDP in real numbers.  By reverse engineering the BEA numbers, the Consumer Metrics Institute says, "When we recast the GDP growth rates using the BLS sourced deflaters we can build the following table showing the past 10 quarters of growth in "nominal" GDP, "real" GDP using the CPI or PPI tables (as appropriate for each individual GDP line item), the per-capita "real" GDP similarly calculated and the per-capita "real" disposable income (again most recent quarter on the left):

"Annualized GDP Growth Rates Past 10 Quarters

2Q-20111Q-20114Q-20103Q-20102Q-2010 1Q-2010

"Nominal" GDP 
Annualized Growth

BLS Derived 

BLS "Real" 
GDP Annualized 

BLS Per-Capita
"Real" Annualized 
GDP Growth

BLS Per-Capita
"Real" Disposable 
Income Growth


Consumer Metrics Institute provides several graphs in the August 30 News asserts the double dip has already occurred with this chart below, which is one of several in the August 30 News, and you can find a larger version of it at the Consumer Metrics link above:

The Consumer Metrics Institute bottom line is the revised data shows Q1 2011 was far worse than recognized but the data shows moderation in the contraction rate but the full effect of the contraction has yet to be felt and deflating commodity prices can have a sudden positive impact on the economy.

The failure of government to create jobs now, not just down the road, has become morally inexcusable.  

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