Earlier in the week, the economist Tom Duy wrote that he expected Bernanke on Wednesday to address growing inflation expectations while maintaining an unchanged monetary policy. Most people have a very difficult time distinguishing between transitory headline inflation (which hits the wallet hard) and core, sticky inflation which consists of continuing price increases which impact prices and wages throughout the economy. This is why inflation expectations can be an economic problem when transitory inflation exists, because people start expecting real core inflation and saving, which can slow the economy. We have already written that Duy and others were very disappointed in Bernanke's over reaction to inflation expectations as opposed to real core inflation in his remarks and his failure to sufficiently address labor costs and unemployment.
U.S. GDP for Q1 was announced this week at 1.8% (analysts had expected 1.9%). If you take a look at the different segments of GDP and their contribution to the total number, you will see an increase in imports and decrease in government spending which have a negative impact which far outweigh increases in exports and inventories which have a positive impact. Growth this slow can often mean higher unemployment. Until housing (which is on the edge of double dipping) and business investment improve, the trend of economic growth will continue to be slow and disappointing.
One guest writer at dshort.com did a chart on GDP with and without government spending included which, not unsurprisingly, showed that the number of years since 1960 with negative GDP growth more than doubled. The proper purpose of government national deficits is a response to aggregate demand, as we have written, and its resulting in economic growth when there would have been negative growth it what it should do. The dshort.com guest writer is concerned about the resulting debt when it should be the private sector growing, but he appears more concerned about deficit than why the private sector was not otherwise stimulated.
The U.S. also released this week its Personal Income and Outlays report for March which showed personal consumption expenditures (PCE) going up 6 tenths of a percent in March from February on the increase in food and fuel. Personal income rose 5 tenths of a percent, but disposable income only rose one tenth of a percent. Doug Short at dshort.com did updated charts on headline and core CPI and core and headline PCE and comparing core PCE and CPI against each other for two different time periods. While we mere mortals cannot eliminate food and fuel from our consumption, the transitory volatility of food and fuel prices can be misleading in actual sticky inflation. The price increases have to be continuous and impact production prices and wages to be core inflation.
This is also why I pay only passing attention to consumer sentiment, because it is such lagging, old information, which is why while inflation expectations are increasing right now, the consumer sentiment survey showed increased optimism. Transitory inflation hurts, but, if inflation became sticky, the real pain sets in. It is like a child becoming mildly sick but playing to sympathy and the parent does not sort the symptoms and behavior out and over reacts. Going to the doctor, when it serves no good purpose, makes life all that more expensive.
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Friday, April 29, 2011
China: Copper In, Copper Out
We have written on several occasions how copper is being imported into China, placed in bonded warehouses, and used as collateral to gain access to credit. This has led to a significant rise in copper prices.
The bonded warehouse inventories of copper are actually up despite less copper imports in China. This means there may be no real demand for the copper other than as collateral and that it could constitute an oversupply which could negatively affect prices with destocking. It appears that a variety of Chinese businesses, including possibly property developers, have been using copper in bonded warehouses for collateral.
As the holders of these copper inventories find it harder to rollover financing, they are responding by re-exporting copper in larger quantities to the extent that copper exports surged to 36,800 tons in March. The two most popular countries to which the exports are sent are Singapore and South Korea, both of which have LME warehouses. Rather than meeting Chinese productive demand, it appears much of the imported copper is being re-exported after a monetization pit stop in Chinese bonded warehouses. Since it was never sold to a mainland buyer no VAT applied and the import - export transaction is tax neutral.
If the copper is not to meet internal demand which has remained price resistant, this has a direct effect on analysts projections of GDP and on the market price of copper if the import - pit stop for loans - export cycle continues to trend towards less import and larger exports.
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The bonded warehouse inventories of copper are actually up despite less copper imports in China. This means there may be no real demand for the copper other than as collateral and that it could constitute an oversupply which could negatively affect prices with destocking. It appears that a variety of Chinese businesses, including possibly property developers, have been using copper in bonded warehouses for collateral.
As the holders of these copper inventories find it harder to rollover financing, they are responding by re-exporting copper in larger quantities to the extent that copper exports surged to 36,800 tons in March. The two most popular countries to which the exports are sent are Singapore and South Korea, both of which have LME warehouses. Rather than meeting Chinese productive demand, it appears much of the imported copper is being re-exported after a monetization pit stop in Chinese bonded warehouses. Since it was never sold to a mainland buyer no VAT applied and the import - export transaction is tax neutral.
If the copper is not to meet internal demand which has remained price resistant, this has a direct effect on analysts projections of GDP and on the market price of copper if the import - pit stop for loans - export cycle continues to trend towards less import and larger exports.
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Wednesday, April 27, 2011
Bernanke Press Briefing
Some people have asked what Bernanke said today at the first ever Federal Reserve Chairman's press conference after a FOMC meeting. The statement of the FOMC meeting had no surprises and even included the "extended period" phrase and sees inflation and unemployment as transitory.
The press conference began with a reprise of the statement and of economic projections. In answering questions, Bernanke always focused on the "medium term". Nothing surprising but it does reiterate his view of the economy and recovery from th4e financial crisis.
The full press conference including questions and answers can be watched and heard in full here.
Update 4/28/2011: The economist Tom Duy takes Bernanke to task for too much emphasis on inflation and little regard for unemployment.
CalculatedRisk sees QE2 as just ending not tapering off, no chance of QE3 with the statements on inflation and unemployment, and interest rates not likely to go up until middle of 2012.
Krugman dismisses Bernanke's concerns about inflation and questions Bernanke's understanding of how serious the unemployment problem is.
Marshall Auerback provides an assessment of QE2 as counterproductive and destructive of the Middle Class.
The Australian economist Bill Mitchell rips Bernanke for his inflation fears, agreement with the S&P deficit warning, and finds the unemployment projections, despite remaining high, as optimistically unrealistic.
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The press conference began with a reprise of the statement and of economic projections. In answering questions, Bernanke always focused on the "medium term". Nothing surprising but it does reiterate his view of the economy and recovery from th4e financial crisis.
The full press conference including questions and answers can be watched and heard in full here.
Update 4/28/2011: The economist Tom Duy takes Bernanke to task for too much emphasis on inflation and little regard for unemployment.
CalculatedRisk sees QE2 as just ending not tapering off, no chance of QE3 with the statements on inflation and unemployment, and interest rates not likely to go up until middle of 2012.
Krugman dismisses Bernanke's concerns about inflation and questions Bernanke's understanding of how serious the unemployment problem is.
Marshall Auerback provides an assessment of QE2 as counterproductive and destructive of the Middle Class.
The Australian economist Bill Mitchell rips Bernanke for his inflation fears, agreement with the S&P deficit warning, and finds the unemployment projections, despite remaining high, as optimistically unrealistic.
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Michael Pettis on China's Inflation & the US Dollar
Michael Pettis' private newsletter arrived by email on Monday and I am only allowed to excerpt from it. Pettis began his newsletter by noting the recent Chinese economic data showing GDP Q1 at 9.7% year on year, CPI inflation at 5.4% in March, which was a 32 month high, and PPI inflation was 7.1% for March. These figures were higher than what most analysts expected. Pettis, however, does not believe these numbers mean much, because he continues to see the same pattern as the last two to three years of government reaction to overheating and then a resumption of acceleration. Consequently, he expect the People's Bank of China to more aggressively raise rates and limit credit growth until those moves bite back. Pettis sees nothing new here and everyone is just playing the expected game until the leadership change next year.
Maybe we will see a faster appreciation of the renminbi, because the market expects it. The demand for renminbi denominated assets is so strong dim sum bonds are trading at negative yields. This is what you would expect if there is speculation of a stronger renminbi.
With respect to Sunday's reserve hike, overall liquidity in the market is still high and he quotes Chen Long of Shenyin Wanguo as saying "Liquidity in the inter-bank system is sufficient as foreign exchange purchases by the PBoC have exceeded expectations despite the trade deficit. Lending quota restrictions, however, have made it harder for borrowers in the real economy to get bank loans." Pettis sees a paradox in the credit conditions, because "By some measures credit is very tight and borrowers are desperate to gain access to the limited loan quotas, and by other measures the market is drowning in liquidity." While the percentage of bank loans as a part of total social financing is down, the proportion of entrusted loans and corporate bonds are up. Credit is expanding faster than loan and deposit numbers would suggest. For Pettis, the credit expansion is so great it is not useful to think of credit conditions as being tight even with so many desperate to access credit. He argues "... that investment --- especially infrastructure, SOE and other official investment --- is so great that it is managing to overwhelm what would otherwise be considered very loose credit conditions. If credit were in fact tight, growth would slow dramatically but at least we would be rebalancing the economy and limiting future demand on household wealth transfers. As it is, I don't think we are rebalancing at all."
The quarterly trade deficit was driven by commodity imports and was not unexpected as the Spring Festival quarter is always distorted. He expects the trade account to bounce back with a big surplus unless "... a greater share of capital outflows are diverted into commodity stockpiling ...". In fact, despite running a trade deficit, central bank reserves surged. Net inflows were approximately $150 billion. Given a trade deficit, there is renminbi exposure demand, such as those dim sum bonds, and hot money inflows seem to be increasing.
In an opposing view, Patrick Chovanec, who teaches at Tsinghua University, sees China's inflation problem as a problem of the money supply, because China buys all foreign currencies flowing in at a fixed rate and issues renminbi for domestic use. He agrees interest rates are a part of the problem, but he believes the money supply has to be reined in. Then the PBoC has to sterilize the increased money supply by taking money out of the economy by raising reserves. Chovanec believes this is not sufficient to influence interest rates. He sees letting the renminbi appreciate as necessary to establish economic tightening. As low drawn out appreciation will only continue to attract inflows of hot money and the appreciation should be a dramatic one time revaluation of 20-30%. Obviously, Pettis would point out, as he has on several past articles, this would be extremely disruptive of both private savings and consumption, business spending and investment, and wage expectations --- all of which would be not just economically disruptive domestically but potentially politically disruptive.
As Pettis wrote in a recent Financial Times op-ed entitled, "America Must Give Up On the Dollar", he continues his argument in this private newsletter because he believes it has a lot to do with China. He points out that it seems as if every 20-30 years American current account deficits surge and dire warnings about the end of dollar dominance build. "But I think these predictions about the end of dollar dominance are likely to be as wrong now as they have been in the past. Reserve currency status is a global public good that comes at a cost, and people often forget that the cost is much higher than most countries are willing to pay."
Reserve currency status requires at least ample liquidity, central bank credibility, flexible domestic financial markets, deep and open domestic bond markets, and minimal government and political intervention. As such, Pettis sees the euro as the only alternative currency, which I find unacceptable given the continuing eurozone credit crisis, of which I have written extensively, and the many qualities that eurozone credit crisis has consistent with a growing currency crisis. In fact, as I have privately stated, it is almost as if the current account surplus euro nations are in a currency war with the euro current account deficit nations. Pettis admits, however, that Europe would not be willing to pay the price of reserve currency. He also says Switzerland is an example of a reserve currency based on national creditworthiness, but it the fifth most used and that volume is approximately one-half percent worldwide. Additionally, Pettis is ignoring that the liabilities of the Swiss financial system exceed the GDP of Switzerland, which creates a systemically dangerous condition which the Swiss have been dressing with more financial regulation and higher capital reserves.
Still, he believes the United States should be encouraging the world to disengage from the dollar, because the global use of the dollar, in Pettis' opinion, is bad for the US economy and the global imbalances it creates. Pettis sees the cost the United States as the choice between rising unemployment or rising debt. Foreign acquisition of dollars causes the US to run a corresponding current account deficit. The US must accommodate foreign trade policies diverting domestic demand abroad, which means the us must increase domestic consumption and/or investment to counteract the impact on employment. "Without government intervention, there is no reason for domestic investment to rise in response to policies abroad. On the contrary, I would argue that with the diversion of domestic demand, private investment might even decline."
Pettis believes the argument of reserve currency benefits in the form of reduced cost of imports and lower government borrowing costs are seriously flawed. Americans already over consume and lower consumption means higher unemployment. Thus, the US wants to increase exports and make imports somebody else's problem. With respect to lower costs of government borrowing, Pettis sees that as a measure of creditworthiness, which is damaged by the current account deficits resulting from being the reserve currency. "The supposed advantages of reserve currency status are simply the obverse of the cost. As countries accumulate dollars, they force trade deficits onto the US, which the US can only manage by increasing borrowing. This borrowing is financed by the foreign accumulation of dollars."
While that is factually correct, the Australian economist Bill Mitchell would argue that the sectoral balances are not being properly analyzed and there is a lack of appreciation of the inability of a fiat currency sovereign nation to default.
Pettis notes the massive imbalances which have been permitted are destabilizing as Joseph Stiglitz has also argued recently at INET and in the past as a need for a basket of currencies. These are serious concerns but many economists and commentators look not at the imbalances and how to stabilize them, but focus wrongly on debt. Pettis says, "If the world were forced to give up the dollar, there is no doubt that there would be an initial cost for the global economy --- it would reduce global trade somewhat and it would probably spell the end of the Asian growth model." But he believes it would also reduce dangerous global imbalances.
Pettis ends his private newsletter with a a lengthy discussion of Kenneth Austin's recent article, "Communist China's Capitalism" published in World Economics (which is subscription read only), which is a re-reading of John Hobson's theories on underconsumption, which so many current students of economics under appreciate or are not sufficiently exposed to appreciate his contributions to modern economics. Pettis finds it important and fascinating. Austin finds the basic idea is that oversaving causes insufficient demand for economic output and in a closed society, excess savings cause recessions. Basically Austin, according to Pettis, is arguing that under consuming countries like China are able to use the dollar today in the same manner that European countries used colonialism in the past to export capital and import foreign demand.
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Maybe we will see a faster appreciation of the renminbi, because the market expects it. The demand for renminbi denominated assets is so strong dim sum bonds are trading at negative yields. This is what you would expect if there is speculation of a stronger renminbi.
With respect to Sunday's reserve hike, overall liquidity in the market is still high and he quotes Chen Long of Shenyin Wanguo as saying "Liquidity in the inter-bank system is sufficient as foreign exchange purchases by the PBoC have exceeded expectations despite the trade deficit. Lending quota restrictions, however, have made it harder for borrowers in the real economy to get bank loans." Pettis sees a paradox in the credit conditions, because "By some measures credit is very tight and borrowers are desperate to gain access to the limited loan quotas, and by other measures the market is drowning in liquidity." While the percentage of bank loans as a part of total social financing is down, the proportion of entrusted loans and corporate bonds are up. Credit is expanding faster than loan and deposit numbers would suggest. For Pettis, the credit expansion is so great it is not useful to think of credit conditions as being tight even with so many desperate to access credit. He argues "... that investment --- especially infrastructure, SOE and other official investment --- is so great that it is managing to overwhelm what would otherwise be considered very loose credit conditions. If credit were in fact tight, growth would slow dramatically but at least we would be rebalancing the economy and limiting future demand on household wealth transfers. As it is, I don't think we are rebalancing at all."
The quarterly trade deficit was driven by commodity imports and was not unexpected as the Spring Festival quarter is always distorted. He expects the trade account to bounce back with a big surplus unless "... a greater share of capital outflows are diverted into commodity stockpiling ...". In fact, despite running a trade deficit, central bank reserves surged. Net inflows were approximately $150 billion. Given a trade deficit, there is renminbi exposure demand, such as those dim sum bonds, and hot money inflows seem to be increasing.
In an opposing view, Patrick Chovanec, who teaches at Tsinghua University, sees China's inflation problem as a problem of the money supply, because China buys all foreign currencies flowing in at a fixed rate and issues renminbi for domestic use. He agrees interest rates are a part of the problem, but he believes the money supply has to be reined in. Then the PBoC has to sterilize the increased money supply by taking money out of the economy by raising reserves. Chovanec believes this is not sufficient to influence interest rates. He sees letting the renminbi appreciate as necessary to establish economic tightening. As low drawn out appreciation will only continue to attract inflows of hot money and the appreciation should be a dramatic one time revaluation of 20-30%. Obviously, Pettis would point out, as he has on several past articles, this would be extremely disruptive of both private savings and consumption, business spending and investment, and wage expectations --- all of which would be not just economically disruptive domestically but potentially politically disruptive.
As Pettis wrote in a recent Financial Times op-ed entitled, "America Must Give Up On the Dollar", he continues his argument in this private newsletter because he believes it has a lot to do with China. He points out that it seems as if every 20-30 years American current account deficits surge and dire warnings about the end of dollar dominance build. "But I think these predictions about the end of dollar dominance are likely to be as wrong now as they have been in the past. Reserve currency status is a global public good that comes at a cost, and people often forget that the cost is much higher than most countries are willing to pay."
Reserve currency status requires at least ample liquidity, central bank credibility, flexible domestic financial markets, deep and open domestic bond markets, and minimal government and political intervention. As such, Pettis sees the euro as the only alternative currency, which I find unacceptable given the continuing eurozone credit crisis, of which I have written extensively, and the many qualities that eurozone credit crisis has consistent with a growing currency crisis. In fact, as I have privately stated, it is almost as if the current account surplus euro nations are in a currency war with the euro current account deficit nations. Pettis admits, however, that Europe would not be willing to pay the price of reserve currency. He also says Switzerland is an example of a reserve currency based on national creditworthiness, but it the fifth most used and that volume is approximately one-half percent worldwide. Additionally, Pettis is ignoring that the liabilities of the Swiss financial system exceed the GDP of Switzerland, which creates a systemically dangerous condition which the Swiss have been dressing with more financial regulation and higher capital reserves.
Still, he believes the United States should be encouraging the world to disengage from the dollar, because the global use of the dollar, in Pettis' opinion, is bad for the US economy and the global imbalances it creates. Pettis sees the cost the United States as the choice between rising unemployment or rising debt. Foreign acquisition of dollars causes the US to run a corresponding current account deficit. The US must accommodate foreign trade policies diverting domestic demand abroad, which means the us must increase domestic consumption and/or investment to counteract the impact on employment. "Without government intervention, there is no reason for domestic investment to rise in response to policies abroad. On the contrary, I would argue that with the diversion of domestic demand, private investment might even decline."
Pettis believes the argument of reserve currency benefits in the form of reduced cost of imports and lower government borrowing costs are seriously flawed. Americans already over consume and lower consumption means higher unemployment. Thus, the US wants to increase exports and make imports somebody else's problem. With respect to lower costs of government borrowing, Pettis sees that as a measure of creditworthiness, which is damaged by the current account deficits resulting from being the reserve currency. "The supposed advantages of reserve currency status are simply the obverse of the cost. As countries accumulate dollars, they force trade deficits onto the US, which the US can only manage by increasing borrowing. This borrowing is financed by the foreign accumulation of dollars."
While that is factually correct, the Australian economist Bill Mitchell would argue that the sectoral balances are not being properly analyzed and there is a lack of appreciation of the inability of a fiat currency sovereign nation to default.
Pettis notes the massive imbalances which have been permitted are destabilizing as Joseph Stiglitz has also argued recently at INET and in the past as a need for a basket of currencies. These are serious concerns but many economists and commentators look not at the imbalances and how to stabilize them, but focus wrongly on debt. Pettis says, "If the world were forced to give up the dollar, there is no doubt that there would be an initial cost for the global economy --- it would reduce global trade somewhat and it would probably spell the end of the Asian growth model." But he believes it would also reduce dangerous global imbalances.
Pettis ends his private newsletter with a a lengthy discussion of Kenneth Austin's recent article, "Communist China's Capitalism" published in World Economics (which is subscription read only), which is a re-reading of John Hobson's theories on underconsumption, which so many current students of economics under appreciate or are not sufficiently exposed to appreciate his contributions to modern economics. Pettis finds it important and fascinating. Austin finds the basic idea is that oversaving causes insufficient demand for economic output and in a closed society, excess savings cause recessions. Basically Austin, according to Pettis, is arguing that under consuming countries like China are able to use the dollar today in the same manner that European countries used colonialism in the past to export capital and import foreign demand.
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Tuesday, April 26, 2011
Saudi Oil & Libya: Is It Important?
Jim Hamilton in the Econbrowser blog has a post on Saudi oil production and the Libyan conflict. He correctly clarifies that the Saudi public statement in February that they were going to increase production had actually been implemented months earlier and had nothing to do with the conflict in Libya, although it made them look good. He points out that Saudi production has gone back to lower levels. Since the price for both Saudi light and heavy oil has gone up, Hamilton surmises that the price would be lower if the Saudi's had kept production up as announced. Hamilton finds it interesting that the Saudi's plan to increase the number of oil rigs in the Manifa oil field, while planning to spend $100 billion dollars on alternative energy. Hamilton concludes that the Saudi's are not able to increase production and their comments about oversupply and fear of high prices does not mean that their claims of excess capacity are going to be seen any time soon.
The failure of the Saudi's to increase overall oil production does not to me seem to an overall supply problem. As I have pointed out in my post "Europe & Libyan Oil", Libya produced 3% of the world's supply and it was primarily sold to Europe, which has reserve supplies. WTI storage at Cushing, Oklahoma is almost at capacity and its inefficient pipeline distribution system is well documented, accounting for higher gasoline prices in the center of the United States with imports from Canada. Despite this oversupply, there has no price diminishment as might have been expected a month ago.
With the Libyan conflict, what the Saudi's did was reduce heavy crude production and increase production of its different grades of light oil blends, because they saw an opportunity to make more money on higher prices from European buyers speculating on (or worried about) the length of the Libyan conflict and damage to the oil fields and distribution system. While total world wide oil production may have fallen approximately 6 tenths of one percent as the result of Libya and the prices are in the same area as 2008 oil shock, I do not see this as the result of significant lower overall Saudi production as Stuart Staniford does, but it is rather the increase in light oil blend production to harvest the even higher prices of European demand for light oil blends as opposed to the higher prices for Saudi heavy oil. While this is supply and demand at work as Hamilton points out, it is also prices reacting to stockpiling and speculators piggybacking, as is to be expected in the futures market.
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The failure of the Saudi's to increase overall oil production does not to me seem to an overall supply problem. As I have pointed out in my post "Europe & Libyan Oil", Libya produced 3% of the world's supply and it was primarily sold to Europe, which has reserve supplies. WTI storage at Cushing, Oklahoma is almost at capacity and its inefficient pipeline distribution system is well documented, accounting for higher gasoline prices in the center of the United States with imports from Canada. Despite this oversupply, there has no price diminishment as might have been expected a month ago.
With the Libyan conflict, what the Saudi's did was reduce heavy crude production and increase production of its different grades of light oil blends, because they saw an opportunity to make more money on higher prices from European buyers speculating on (or worried about) the length of the Libyan conflict and damage to the oil fields and distribution system. While total world wide oil production may have fallen approximately 6 tenths of one percent as the result of Libya and the prices are in the same area as 2008 oil shock, I do not see this as the result of significant lower overall Saudi production as Stuart Staniford does, but it is rather the increase in light oil blend production to harvest the even higher prices of European demand for light oil blends as opposed to the higher prices for Saudi heavy oil. While this is supply and demand at work as Hamilton points out, it is also prices reacting to stockpiling and speculators piggybacking, as is to be expected in the futures market.
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Deficits Are About Aggregate Demand not Default
In our last post, "S&P's Rating Folly", we dealt with the misperceptions of deficits in a fiat currency sovereign nation and that default is only possible as a political choice.
On Sunday an Associated Press article was published in local newspapers across the United States on how a United States default would be disastrous for the economy. This was not a news article. The economic assumptions behind its "facts" are, at best, debatable if not flat out wrong. The AP article is an opinion piece and its being run as a news article was incompetent, if not journalistically unethical.
The political debate in the United States has been turned away from the causes of the financial crisis and the financial reforms needed to prevent another financial crisis to self-defeating economic myths which are perpetuated by their continuous repetition despite refutation and destructive consequences. The working men and women poor, and the Middle Class of America have been targeted as the Evil Ones rather than the managers of the financial sector who caused the financial crisis and have so vastly profited and grown in systemic danger from the financial bailout. Pensions, public workers, and unions have been targeted to divide them from the rest of working America that do not have pensions (about 76%), do not have the advanced education of many public employees, and do not benefit from collective bargaining.
As the Australian economist Bill Mitchell has said, "The ultimate aim at the macroeoconomic level is not to collect 'more taxes' to balance a budget but to ensure that aggregate demand is regulated to avoid inflationary growth in nominal spending." Aggregate demand drives whether a sovereign government should increase or decrease spending. ".. if the economy is suffering a major aggregate demand shortfall then not replacing the increased tax revenue overall (in the name of fairness) with expansionary spending measures is a mistake." It does not make any difference whether these calls for taxes with spending cuts or tax cuts with spending cuts come from conservatives or progressives, it adds up to the same destructive policy of austerity which will only aggravate continuing high unemployment and slow economic growth if not recession. We do not need friends like these and we do not need political leaders who refuse to follow an educated path dedicated to the well being of the people consistent with a republican democracy.
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On Sunday an Associated Press article was published in local newspapers across the United States on how a United States default would be disastrous for the economy. This was not a news article. The economic assumptions behind its "facts" are, at best, debatable if not flat out wrong. The AP article is an opinion piece and its being run as a news article was incompetent, if not journalistically unethical.
The political debate in the United States has been turned away from the causes of the financial crisis and the financial reforms needed to prevent another financial crisis to self-defeating economic myths which are perpetuated by their continuous repetition despite refutation and destructive consequences. The working men and women poor, and the Middle Class of America have been targeted as the Evil Ones rather than the managers of the financial sector who caused the financial crisis and have so vastly profited and grown in systemic danger from the financial bailout. Pensions, public workers, and unions have been targeted to divide them from the rest of working America that do not have pensions (about 76%), do not have the advanced education of many public employees, and do not benefit from collective bargaining.
As the Australian economist Bill Mitchell has said, "The ultimate aim at the macroeoconomic level is not to collect 'more taxes' to balance a budget but to ensure that aggregate demand is regulated to avoid inflationary growth in nominal spending." Aggregate demand drives whether a sovereign government should increase or decrease spending. ".. if the economy is suffering a major aggregate demand shortfall then not replacing the increased tax revenue overall (in the name of fairness) with expansionary spending measures is a mistake." It does not make any difference whether these calls for taxes with spending cuts or tax cuts with spending cuts come from conservatives or progressives, it adds up to the same destructive policy of austerity which will only aggravate continuing high unemployment and slow economic growth if not recession. We do not need friends like these and we do not need political leaders who refuse to follow an educated path dedicated to the well being of the people consistent with a republican democracy.
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Friday, April 22, 2011
S&P's Rating Folly
On Monday April 18th, the S&P credit rating agency lowered its outlook on the United States to negative citing the deficit and a political climate unlikely to produce agreement on a debt reduction path. The stock market fell over 200 points before recovering to 140 points down, the dollar rose in value, and Treasury bond interest rates fell as the market professionals rejected the outlook as meaningless. The next day the New York Times ran eight short reactions by commentators which were overwhelmingly of the opinion that the rating change was unwarranted and economically unjustified. One of the commentators, Yves Smith, on her blog followed up with a post noting other comments and dismissing the idea that China would stop buying US Treasuries by citing Michael Pettis' public blog post on US interest rates and the effects of Chinese inflation and policies of which I had a week earlier written in detail from his earlier and more extensive private newsletter.
Paul Krugman was quick to point out that when Japan lost its triple A credit rating in 2002 it had no lasting negative effect on Japanese bond rates (notice in the just linked chart that Japan has a fiat currency and the other countries do not). The S&P was criticized for its failure to understand that a fiat currency nation does not have the same credit, inflation, and solvency risks of a country which does not have a sovereign fiat currency. Marshall Auerback also used the Japanese comparison as well as citing Bill Mitchell's, who has written extensively on budget deficits, observation that it is not logical to assume insolvency default when a nation has sovereign debt denominated in its own currency. The only possible default of a sovereign fiat currency nation is a political decision to default. The S&P concern about budget deficits was quickly shown as out of perspective if not warped. If the United States risked default, then all debt in US dollars would be at risk; yet, the S&P warning did not address that obvious issue. Even the big banks know the United States is not even close to being broke if one just considers US household net worth in comparison to government debt..
Besides continuing Michael Pettis' observations that US debt funding is not dependent on foreign government policies, Yves Smith also noted that the actual S7P statement contained a section on additional risks which cited the risks of the US financial sector to be higher than 2008 and the potential costs of the US government bailing out the financial sector again to be 34% of GDP as opposed to 26% estimate in 2007.
Bruce Bartlett observed that the only possibility of the US defaulting would be if Congress made the political decision to not raise the debt ceiling. In fact, the United States may be the only country in the world which has a legal debt ceiling and it has some asking why the United States would not be better off economically without a debt ceiling. Still there are those who politically find the deficit politically advantageous and those who are under the mistaken belief that US debt is economically unsustainable. The sad fact is that the world has not yet recovered from the 2008 financial crisis and it is still in dire need of global economic growth which is not going to come from an austerity driven recession. While budget deficits should always be reviewed for efficiency gains in the delivery of publicly desired services and for private pressures, such as the astronomical increase in healthcare (including insurance) costs, the primary cause of the current deficit is the financial crisis and the worst thing that could happen is to derail economic growth with austerity. What this all means is what the politicians have been ignoring and what the financial sector wants ignored is that, until unemployment is brought down and not purposefully used to hold interest rates down, the economy will never be normal again and the financial sector will be larger and larger and dictate its "too big to fail" mantra as the purpose of government with the people relegated to essentially serf status.
The ratings agencies discredited themselves in the financial crisis by aiding and abetting the financial sector's massive financial fraud, which caused the financial crisis, and the S&P warning is now lighting the fires of the debt vigilantes, which deflects public opinion from the failure to create meaningful financial reforms which would prevent another financial crisis and the failure to prosecute the highly paid and highly placed financial managers who not only caused the financial crisis but profited from it at the public's expense, and is stoking the austerity fires which could ensure the next economic crisis.
The ratings agencies primary clients are the big banks. The US financial "reforms" have not addressed the problems in the credit ratings agencies business model. Yet, the public world wide depends on their ratings in evaluating the revenue constrained debt of US local and state government and the eurozone member nations. In 2010, the EU proposed tightening credit rating agency rules to increase the availability of rating analysis information and transparency in response to ratings which fueled bond vigilante's profits and increased European credit insurance and debt costs. In response the ratings agencies threatened to black out Europe and not provide credit ratings for debt issuance and rating the credit worthiness of European nations. These 2010 proposed EU rules have yet to be adopted.
Bottom line, the United States is not anywhere close to insolvency and a fiat currency sovereign nation with sovereign denominated debt cannot default unless it politically chooses to do so. Worse, the current deficit problems are financial crisis driven and the US has done little yet to correct high unemployment. Austerity would derail economic growth and foster unemployment. Just look at the failure of austerity in the eurozone and the increasing social disturbances and growth of political extremism.
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Paul Krugman was quick to point out that when Japan lost its triple A credit rating in 2002 it had no lasting negative effect on Japanese bond rates (notice in the just linked chart that Japan has a fiat currency and the other countries do not). The S&P was criticized for its failure to understand that a fiat currency nation does not have the same credit, inflation, and solvency risks of a country which does not have a sovereign fiat currency. Marshall Auerback also used the Japanese comparison as well as citing Bill Mitchell's, who has written extensively on budget deficits, observation that it is not logical to assume insolvency default when a nation has sovereign debt denominated in its own currency. The only possible default of a sovereign fiat currency nation is a political decision to default. The S&P concern about budget deficits was quickly shown as out of perspective if not warped. If the United States risked default, then all debt in US dollars would be at risk; yet, the S&P warning did not address that obvious issue. Even the big banks know the United States is not even close to being broke if one just considers US household net worth in comparison to government debt..
Besides continuing Michael Pettis' observations that US debt funding is not dependent on foreign government policies, Yves Smith also noted that the actual S7P statement contained a section on additional risks which cited the risks of the US financial sector to be higher than 2008 and the potential costs of the US government bailing out the financial sector again to be 34% of GDP as opposed to 26% estimate in 2007.
Bruce Bartlett observed that the only possibility of the US defaulting would be if Congress made the political decision to not raise the debt ceiling. In fact, the United States may be the only country in the world which has a legal debt ceiling and it has some asking why the United States would not be better off economically without a debt ceiling. Still there are those who politically find the deficit politically advantageous and those who are under the mistaken belief that US debt is economically unsustainable. The sad fact is that the world has not yet recovered from the 2008 financial crisis and it is still in dire need of global economic growth which is not going to come from an austerity driven recession. While budget deficits should always be reviewed for efficiency gains in the delivery of publicly desired services and for private pressures, such as the astronomical increase in healthcare (including insurance) costs, the primary cause of the current deficit is the financial crisis and the worst thing that could happen is to derail economic growth with austerity. What this all means is what the politicians have been ignoring and what the financial sector wants ignored is that, until unemployment is brought down and not purposefully used to hold interest rates down, the economy will never be normal again and the financial sector will be larger and larger and dictate its "too big to fail" mantra as the purpose of government with the people relegated to essentially serf status.
The ratings agencies discredited themselves in the financial crisis by aiding and abetting the financial sector's massive financial fraud, which caused the financial crisis, and the S&P warning is now lighting the fires of the debt vigilantes, which deflects public opinion from the failure to create meaningful financial reforms which would prevent another financial crisis and the failure to prosecute the highly paid and highly placed financial managers who not only caused the financial crisis but profited from it at the public's expense, and is stoking the austerity fires which could ensure the next economic crisis.
The ratings agencies primary clients are the big banks. The US financial "reforms" have not addressed the problems in the credit ratings agencies business model. Yet, the public world wide depends on their ratings in evaluating the revenue constrained debt of US local and state government and the eurozone member nations. In 2010, the EU proposed tightening credit rating agency rules to increase the availability of rating analysis information and transparency in response to ratings which fueled bond vigilante's profits and increased European credit insurance and debt costs. In response the ratings agencies threatened to black out Europe and not provide credit ratings for debt issuance and rating the credit worthiness of European nations. These 2010 proposed EU rules have yet to be adopted.
Bottom line, the United States is not anywhere close to insolvency and a fiat currency sovereign nation with sovereign denominated debt cannot default unless it politically chooses to do so. Worse, the current deficit problems are financial crisis driven and the US has done little yet to correct high unemployment. Austerity would derail economic growth and foster unemployment. Just look at the failure of austerity in the eurozone and the increasing social disturbances and growth of political extremism.
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