Leftovers - Radio Show 1/30/2010

During the show we briefly commented that the Fed is considering a new benchmark rate as the current Fed funds rate policy has not been adequate in providing the Fed with control and flexibility.  When the Fed lowered the interest rate as fast and as low as they did, they left themselves with no room to maneuver and control and they had to respond with quantitative easing.  One possible move would be to raise the deposit rate and have the Fed funds rate trade with a spread to that.  The deposit rate could set a floor under the Fed funds rate and give the Fed direct control over a policy rate rather than just targeting a market rate.  Theoretically, this could give the Fed more control to draw excess reserves from banks and control lending as the Fed begins its exit strategies.  There are, however, those who have reservations that the Fed has not been encouraging lending and that quantitative easing as practiced by the US and the UK  may not be able to control inflation effectively and may have the outcome of encouraging the development of a global currency and central planning.

It should be noted that of the developed countries which have weathered the financial crisis relatively well, Canada has a system of more effective financial regulation, Australia has a higher core inflation target rate and a higher interest rate policy, and France did not engage in significant deficit spending to deal with the current financial crisis.  All of these allowed those countries more control over leverage.


We talked about Greece and its recent well received bond issuance and subsequent on-going attack by speculators who are driving up the cost of Greek credit default swaps and increasing the spread between Greek bonds and German bonds.  Greece has a newly elected government which is trying to cut its deficit budget.  It has a significant deficit to GDP, the past government was not supplying accurate economic information to the EU, bonds outstanding are over 200 billion US dollars, a poor private savings rate, and its economy needs stimulus and job creation.  The Eu has said it does not bailout EU countries but the statements have been contradictory even with respect to EU legal authority to provide a bailout.

Part of the problem is that Portugal has similar problems, including a poor private savings rate, and Spain has a significant deficit and is in the process of cutting public sector wages during high unemployment in Spain.  These countries could well be in line after Greece, particularly Spain.  These countries combined with Italy and Ireland have begun to be referred to as the PIIGS.  One of the problems is the EU rule that member countries deficit to GDP be no more than 3%.  During a global financial crisis, this prevents a country like Spain from the fiscal policy spending it needs to spur economic growth and job creation.  It is almost as if the EU is trying to act as if the Euro is a gold standard currency rather than the fiat money it is.  If the EU wants to control spending in member countries, it needs to be prepared to provide targeted lending from wealthier EU countries to assist in spurring economic growth and job creation in countries which are trying to control spending deficits.


Interestingly enough, the EU member states and the ECB combined are the single largest holder of gold reserves in the world.


We also commented on the need for the UK an Dutch to compromise with Iceland over payments under Icesave to the UK and Dutch governments for payments those countries made to their citizens who sought greedy interest rates in Iceland banks and lost their money.  While not required under international law, Ieland has agreed to make a payment of $5.5 billion, but the legislation was vetoed and must now face a national referendum which will likely fail.  The Nordic countries which have backed the IMF loan to Iceland are demanding Iceland make the payments to continue to receive $2.5 billion in loans.  The Icesave payments would be approximately 2% of Iceland's GDP and carry a high 5.55% interest rate, neither of which Iceland can afford.  Iceland has sought mediation and the UK and Dutch should agree to mediation.  A reasonable, compromise interest rate consistent with the lower treasury rates in the UK and the Netherlands would be more appropriate.

Iceland should not be forced by intransigent forces in the UK to default in self protection.  The global consequences of any national default of any developed European nation would ripple through highly leveraged nations.

Last week I mentioned that the recent NBER dating committee statement implied a double dip possibility.   Now, Edward Harrison of Credit Writedowns, on the basis of an email exchange he had, is offering a re-interpretation of the NBER statement to suggest depression based on similarities between now and 1929-33 role of the gold standard in inducing debt deflation..  Harrison is arguing that more financial assets must be manufactured or the dynamics of debt deflation will kick in.  He sees only two exit strategies: either manufacture more US denominated financial assets or maintain existing money stock despite the credit claims.  Neither of these are desirable as stand alone policies in my opinion.  Targeted spending  to create jobs and stimulate economic growth through small businesses could diminish and possibly negate a deflationary spiral.  My post below, "It's All About Leverage", addresses this issue.

Mark Thoma of Economist's View had a post referencing the research paper at an IMF conference on the influence of lobbyists in defeating financial regulations, which I have previously discussed.  Thoma also provides a link to an article which discusses the failure to provide financial regulatory reform as the result of this current global financial crisis.  The exceptional influence of lobbyists to neuter and defeat financial regulation and the absolute need to provide significant financial regulatory reform is an issue which I find at the core of our current political inability to act in the public interest.  I have commented on this many times and it appears it will be a long continuing subject.  My post, "Corporate Socialism vs Regulatory Reform", is just the obvious possible conclusions of our present political process.  It is important that the public heat on politicians be amped up and maintained if the dollars of the financial industry lobbyists are to become dead weight in the desert of a long period of slow growth and high unemployment.

President Obama has announced a partial three year budget freeze on discretionary spending beginning with fiscal year 2011 in what appears to be a political bone for the deficit hawks.  This political ploy could have disastrous economic consequences with high unemployment sticking for years.  Even those who have concerns about deficits understand the difference between uncontrolled spending  and targeted spending.  This brings up the question of has President Obama's economic advisors (i.e., Larry Summers) forgotten the mistake of 1937 when Roosevelt tried to negate conservative criticism of government spending  and a perception of growing inflation cut government spending significantly and the recession flared back up with a vengeance.  Krugman and other economists as well as i have long maintained the stimulus was too small (only 5% of what was given the banks and AIG in the bailout) and that a second stimulus which more efficiently targets job creation now and small businesses is necessary to avoid the possibility of a double dip.

At the same time Tyler Durden of zero hedge has put forward a detailed argument that it will be more and more difficult to find indiscriminate treasury buyers and sees a $700 billion US funding hole.  His post is very detailed and you should read it completely.  Again, this goes straight to the issue of how leverage should be used in the current financial crisis in this country.  Inefficient deficit spending is destructive while targeted spending which stimulates economic growth and creates jobs now is constructive.

Spain will cut $70.2 billion in public sector wages and take other steps to reduce its budget deficit which is presently at 11.4% of GDP.

Ireland is facing mounting mortgage defaults.

Fed Governor Kohn said banks face interest rate risks if the Fed raises interest rates.

The 16 member EU inflation rate rose less than 1% in Q4.

UK GDP Q4 rose one-tenth of one percent.

Ford posted 2009 profits of $2.7 billion, which was its first full year profit since 2005.

Verizon had a $653 million Q4 loss with EPS falling 11.5% to 54 cents per share and revenue up 10% but below views.  Verizon will layoff approximately 13,000 enployees or 6% of workforce.

Dow Chemical Q4 profit was 44 cents per share beating estimates by 3 cents with sales up 12%.  It raised its 2010 EPS estimate to $2.15 - 2.45.

Whitacre assumed permanent CEO job at GM rather than find an outside successor.  While this may have short term positive results, it will not create the long term changes needed at this company.

Treasury auctions:

2yr Treasury, $44 billion, yield .88%, bid-to-cover 3.15, foreign interest 43.11%.

5yr Treasury, $42 billion, yield 2.37%, bid-to-cover 2.81, foreign interest 52.97%.

7yr Treasury, $32 billion, yield 3.127%, bid-to-cover 2.856, foreign interest 51.06% but foreign interest is usually about 56%.






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