In looking at bank withdrawals in the eurozone, it is necessary to distinguish between a banking crisis, in which there are bank runs, and a currency crisis, in which foreign investors and depositors withdraw money and domestic households and non-financial corporations draw down monies as the result of unemployment and a poor business loan market.
In Ireland, there was a real estate bubble and banking failures. The ECB threatened the Irish government into guaranteeing senior bond holders, who were core European banks who had financed the real estate bubble, at the expense of the Irish people. Did Irish households and non-financial corporations run with their money?
In looking at the May 2010 to May 2011 yearly figures and the different deposit peaks to May 2011 for Irish households, Irish non-financial corporations, other euro area depositors, and rest of the world depositors, we see vastly different transaction patterns.
The peak deposit of the rest of the world was September 2007 at 91,068,000,000 euro which declined to 43,139,000,000 euro as of May 2011; a decline of 47,829,000,000 euro or 52.52%. The last twelve month decline was 21,666,000,000 euro or 33.43%. The peak deposits of the other euro area depositors in Ireland peaked in June 2007 at 43,388,000,000 euro which declined to 28,984,000,000 euro as of May 2011; a decline of 14,404,000,000 euro or 33.20%. The last twelve month decline was 6,191,000,000 euro or 17.60%. You can see the outstanding balances and monthly transactions here in two tabs of Table A.12.2.
The peak deposits for non-financial Irish corporations was in September 2007 at 45,679,000,000 euro and the peak for households was August 2009 at 99,407,000,000 euro, because households increased deposits from 81,822,000 euro in September 2007. From the September 2007 peak to May 2011, Irish non-financial corporations declined to 31,655,000,000 euro as of May 2011; a decline of 14,024,000, 000 euro or 30.70%. The last twelve month decline was 5,325,000,000 euro or 14.40%. From the August 2009 household depositor peak to May 2011, household deposits declined to 92,133,000,000 euro; a decline of 7,274,000,000 euro or 7.32%. The last twelve month decline was 5,758,000,000 or 5.88%. You can see the outstanding balances and monthly transactions in the two tabs of Table A.1 or Table A.11.1 in the link above.
Irish corporations are struggling for money to continue business operations in which consumers are not spending. There is no pattern of household withdrawals until approximately February 2010 and it is not month to month consistent or accelerating; it does appear to be consistent with growing eurozone and Ireland political crisis, unemployment at 14.1%, which is the highest since 1994, declining property values decreasing home equity, where some prices are down 53%, and increased austerity.
Even with the failure of banks and ECB imposed defense of core European banks which indentured Irish citizens, Irish households and non-financial corporations are showing no runs on Irish banks. The large withdrawals by rest of world depositors and other euro area depositors are consistent with foreign withdrawal of deposits and investments during a currency crisis, which increases liquidity problems.
I have been watching deposits throughout the eurozone countries, not just the periphery, and I intend to write a larger post in the future as withdrawals are not just occurring in the periphery.
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Thursday, July 21, 2011
Monday, July 11, 2011
Michael Pettis on the Trade Imbalances and Debt Dilemma
In Michael Pettis' private newsletter which arrived on 7 July 2011, he begins by observing that creditor nations are worried that obligors will take steps to undermine or erode the value of their obligations just as complaints in Germany voice concern that German banks could lose money if eurozone peripheral countries default and this whole argument strikes him as surreal, because the creditors have totally mixed up the causality of the process. Any erosion in the value of liabilities owed them is the almost certain consequences of their own continuing domestic policies. "It is largely the policies of the creditor countries, in other words, that will determine whether or not the value of those obligations must erode in real terms." The accumulation of U.S. bonds by China and German bank peripheral eurozone loan portfolios "... were simply the automatic consequences of policies in the surplus countries that may very well have been opposed to the best interests of the deficit countries." Net capital exports are the obverse of current account surpluses (trade surpluses) and one requires the other. "If China buys huge amounts of dollars, the US must run a deficit." Likewise with Germany whose recent economic strength has largely rested on its export success. "But for Germany to run a large current account surplus --- the consequence I would argue of domestic policies aimed at suppressing consumption and subsidizing production --- Spain and the other peripheral countries of Europe had to run large current account deficits. If they didn't, the euro would have undoubtedly surged, and with it Germany's exp[ort performance would have collapsed. Very low interest rates in the euro area (set largely by Germany) ensured that the peripheral countries would, indeed, run large trade deficits." The funding by German banks of peripheral borrowing was a necessary part of the deal and, if the deficit countries have acted foolishly, they could not have done so without Germany's support of their foolishness. Consequently, for Germany to insist the deficit countries have a moral obligation to prevent loan portfolio losses is like saying they have a moral obligation to accept higher unemployment in order for Germany to reduce its unemployment. "Whether or not these countries default or devalue should be wholly a function of their national interest, and not a function of external obligation."
There is another reason why it makes no sense to demand deficit countries to act to protect the value of portfolios accumulated by surplus countries and it has to do with the sustainability of policies aimed at generating trade surpluses, because the maintenance of the value of those obligations is largely the consequence of the trade policies in the surplus countries. To explain this, Pettis uses Germany as an example of all trade surplus countries and Spain as an example of all trade deficit countries and it should be remembered going forward that the use of "Germany" and "Spain" are allegorical for the purposes of argument although true for each specifically. Germany and Spain have put into place policies that ensure Germany runs a current account surplus and Spain runs a current account deficit. "As long as Germany runs current account surpluses for many years and Spain the corresponding deficits, it is by definition true there must have been net capital flows from Germany to Spain as Germany bought Spanish assets (which includes debt obligations) to balance the current account balances. The capital and current accounts for any country, and for the world as a whole, must balance to zero."
In the old specie currency days this would have meant gold and silver flowed from Spain to Germany with less gold and silver in Spain being deflationary and more gold and silver in Germany being inflationary until the real exchange rate between the two countries adjusted sufficiently to reverse the trade imbalances as the result of changes in domestic prices. During the imperial period of the late 19th Century, this adjustment mechanism was subverted by a process described by John Hobson in his theory of under-consumption in which "... the imperial centers systematically under-consumed and exported huge amounts of their savings to the colonial periphery, which of course allowed them to run large and profitable trade surpluses against the periphery." The export of money from the imperial countries to the colonial peripheral countries was the primary method of colonial exploitation. The imperial countries "managed" the colonial economies and their tax systems ensuring repayment of all imperial debts. Consequently, large current account imbalances could persist as long as the colony had assets to trade. Pettis discussed this in May using this paper by Kenneth Austin.
Things are different in today's world where there is no adjustment mechanism that permits or prevents persistent current account imbalances. Consequently, if Germany runs persistent trade imbalances with Spain, there can be only three possible outcomes. The first would require a scenario in which Germany is a very small country like Sri Lanka or runs a very small trade surplus than Spain's borrowing capacity would be unlimited as long as its growth in debt is more or less in line with Spain's GDP growth. If Germany is a large country or runs large surpluses, this is not a possible outcome. The second is once Spain's debt levels become a worry, Germany and Spain can reverse the policies which led to the large trade imbalances, i.e., Germany would begin to run a current account deficit and Spain a current account surplus. "In this way German capital flows to Spain can be reversed as Spain pays down those claims with its own current account surplus. Neither side loses." The third possibility is Spain takes steps to erode the value of those claims in real terms by devaluing its currency, by inflating away the value of its external debt, by defaulting on its debt and repaying only a fraction of original value, by expropriating German assets, or by a combination of these actions all of which are not available to any country which is a member of the eurozone monetary union.
In Pettis' opinion, the claims must be eroded, because Spain's debt must grow at an unsustainable pace with respect to GDP growth and it must eventually default not having unlimited borrowing capacity. This is a variation of the Triffin Dilemma. The important point is "Once you have excluded infinite borrowing capacity there are arithmetically no other options." Germany must either reverse its current account balances with Spain or accept erosion in Spanish assets as a consequence of the current account imbalances between the two countries. To Pettis it is obvious the Germanys of the world, like Japan, are doing everything possible to resist reversing the current account balances. In that case the Spains of the world are left with no choice but to erode the value of assets held by creditor countries by devaluation, inflation, or default. Pettis uses the Marshall Plan, which was an economic stimulus not an austerity plan, as an example of a mechanism to facilitate the flow of US current account surpluses to Europe. "The alternative to the Marshall Plan was either the collapse in the US export market, a European default, or a less friendly European expropriation of US assets." Pettis suspects that Germany is hoping and arguing that Spain can reverse its current account deficit without the need of Germany to reverse its current account surplus, but this will not work. China makes the same illogical demand when it insists the US raise its savings rate while China avoids making necessary domestic adjustments, including its currency. It does not solve the problem and pushes the imbalances off into the future or unto another country with the same consequences.
This is why Pettis finds the moaning and groaning over the erosion of the value of claims accumulated by surplus countries as surreal: "There is only one possible way to avoid the erosion of value, and that requires that the surplus countries work with the deficit countries to reverse the trade imbalances."
Pettis continues with his "obsession" (his word) with the debt story in China. For six years he has been saying it is unsustainable while other analysts ignored the balance sheet problems, Now other analysts are worried about debt in China, but Pettis is unconvinced they recognize the problem is systemic, because the other analysts focus on different sectors of the Chinese economy and look for government plans to address these specific sectors. "Specific debt problems, in other words, are simply the consequences of the underlying imbalances and there is nothing the government can do except shift rising debt from one part of the balance sheet to another. Debt overall will continue to rise inexorably until there is a radical reform of the growth model ..."
Even the least aggressive parts of the Chinese press is no longer ignoring the problem as this article in the People's Daily reports that a potential 3.5 trillion yuan ($541 billion) of local government loans were not discussed and are not covered in a National Audit Office report. Local government debt, according to the article, stands at 10.7 trillion yuan of which 8.5 trillion yuan was funded by bank loans. For Pettis the issue is not the lack of a master plan to solve the problems of local government debt, "The issue is that debt, whether at the local government level, the central government level, or the corporate and SOE level, is going to continue to rise quickly." He then cites this South China Morning Post article (topics.scmp) as closer to understanding the underlying balance sheet problem by discussing that 70% of local government funded projects were not producing enough cash flow to repay debts and listed prominent examples. The article also says there is a disagreement between the national Audit Office report and the PBoC which puts the local government debt figure at 14.4 trillion yuan not 10.7. Different agencies are producing different numbers using different research methods and the article says "The resulting asset writedowns would wreak havoc on bank balance sheets and means they may have to be bailed out by the government." Pettis concludes "The problem, in other words, is borrowing for overinvestment in projects that are not economically viable. Irving Fischer said in his "Debt deflation Theory of the Great Depressions" that "over-investment and over-speculation are often important, but they would have far less serious results were they not conducted with borrowed money." Over indebtedness lends importance to over investment and over speculation is the key point for Pettis as "The resolution of overinvestment with borrowed money pushes the cost off into the future, and so makes it less likely that governments, worried about rising unemployment today, minimize the eventual cost. Debt exacerbates the underlying problem as well as the cost of the adjustment because it tends to force pro-cyclical behavior, both on the way up, when it exacerbates overinvestment, and on the way down, when debt repayments constrains growth even further." By this, I interpret Pettis to be concerned about the misallocation of spending which aggravates a country's balance sheet, which is composed of the private sector, the public sector, and the external sector, problems rather than balance them at zero as a proper direct employment stimulus would, i.e., the money has been diverted to capital projects and not aggregate demand.
Pettis then cites this Caixin article on SOEs (state owned enterprises) becoming private equity funds. Pettis finds it hard to accept a booming private equity industry in China is being funded by SOE's. He does not agree that SOEs are investing as the result of their rising profitability and finacial strength, because we have no very good view of the true structure of their balance sheets. STudies have shown that SOEs are not profitable in meaningful sense as they rely upon monopoly pricing, direct subsidies, and artificially low financing costs which reduces there only way to make money as a massive direct and indirect transfer from the household sector. Pettis would not be surprised, if next year, after the government has clamped down on local government debt, all sorts of problems will be found in the financial operations of the SOEs. Pettis believes the SOEs are actually wealth destroyers, although technically profitable. It still makes no sense for them to be involved in private equity except their access to artificially cheap capital and the real cost of capital is so low that SOEs borrow and invest in anything that moves to make money on capital rather than production. "Capital (for those who can get it) is virtually free and there is absolutely no need for borrowers to worry about whether or not they are investing it productively." It is easier to invest in any hot money sector.
The whole growth money needs to be radically reformed and the cost of capital raised. Pettis believes there is a worried group at the PBoC and State Council who know this, but the last interest rate raises were a response to knowing inflation figures will be higher in June than May. This shows a lack of discipline, because the higher inflation rate means real interest rates are still declining. Even at the higher interest rates, no one with access to credit is going to turn credit down.
Pettis then finishes by citing this article from Caixin on a recent speech by the economist Wu Jinglian, which said "China's 'market forces have regressed' as government agencies have started to play a more obstructive role in resource allocation ... Governments at various levels also have a huge hold over major economic resources such as land and capital ...China lacks a legal foundation that is indispensable for a modern market economy ... Government officials intervene in the market at their will through administrative means ...China's market forces gained vigor when the pricing of goods was liberalized in the early 1990s and million of township enterprise privcatized ...Entering the 2000s, however, the reform of state-owned enterprises suffered a setback, and the SOEs have inhabited an increasingly assertive role in the market at the expense of private businesses ... Wu noted the current growth model is unsustainable and has been built on investment that exploits resources ... Another consequence of strengthened government control over the distribution of resources and active intervention in economic activity is more corruption and a larger wealth gap ..."
Pettis then refers to Mahatma Gandhi complaining that speed is irrelevant if you are going in the wrong direction and finishes with the observation that Temasek Holdings (Singapore state investment fund) is reported to be selling its shares in Chinese bank stocks.
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There is another reason why it makes no sense to demand deficit countries to act to protect the value of portfolios accumulated by surplus countries and it has to do with the sustainability of policies aimed at generating trade surpluses, because the maintenance of the value of those obligations is largely the consequence of the trade policies in the surplus countries. To explain this, Pettis uses Germany as an example of all trade surplus countries and Spain as an example of all trade deficit countries and it should be remembered going forward that the use of "Germany" and "Spain" are allegorical for the purposes of argument although true for each specifically. Germany and Spain have put into place policies that ensure Germany runs a current account surplus and Spain runs a current account deficit. "As long as Germany runs current account surpluses for many years and Spain the corresponding deficits, it is by definition true there must have been net capital flows from Germany to Spain as Germany bought Spanish assets (which includes debt obligations) to balance the current account balances. The capital and current accounts for any country, and for the world as a whole, must balance to zero."
In the old specie currency days this would have meant gold and silver flowed from Spain to Germany with less gold and silver in Spain being deflationary and more gold and silver in Germany being inflationary until the real exchange rate between the two countries adjusted sufficiently to reverse the trade imbalances as the result of changes in domestic prices. During the imperial period of the late 19th Century, this adjustment mechanism was subverted by a process described by John Hobson in his theory of under-consumption in which "... the imperial centers systematically under-consumed and exported huge amounts of their savings to the colonial periphery, which of course allowed them to run large and profitable trade surpluses against the periphery." The export of money from the imperial countries to the colonial peripheral countries was the primary method of colonial exploitation. The imperial countries "managed" the colonial economies and their tax systems ensuring repayment of all imperial debts. Consequently, large current account imbalances could persist as long as the colony had assets to trade. Pettis discussed this in May using this paper by Kenneth Austin.
Things are different in today's world where there is no adjustment mechanism that permits or prevents persistent current account imbalances. Consequently, if Germany runs persistent trade imbalances with Spain, there can be only three possible outcomes. The first would require a scenario in which Germany is a very small country like Sri Lanka or runs a very small trade surplus than Spain's borrowing capacity would be unlimited as long as its growth in debt is more or less in line with Spain's GDP growth. If Germany is a large country or runs large surpluses, this is not a possible outcome. The second is once Spain's debt levels become a worry, Germany and Spain can reverse the policies which led to the large trade imbalances, i.e., Germany would begin to run a current account deficit and Spain a current account surplus. "In this way German capital flows to Spain can be reversed as Spain pays down those claims with its own current account surplus. Neither side loses." The third possibility is Spain takes steps to erode the value of those claims in real terms by devaluing its currency, by inflating away the value of its external debt, by defaulting on its debt and repaying only a fraction of original value, by expropriating German assets, or by a combination of these actions all of which are not available to any country which is a member of the eurozone monetary union.
In Pettis' opinion, the claims must be eroded, because Spain's debt must grow at an unsustainable pace with respect to GDP growth and it must eventually default not having unlimited borrowing capacity. This is a variation of the Triffin Dilemma. The important point is "Once you have excluded infinite borrowing capacity there are arithmetically no other options." Germany must either reverse its current account balances with Spain or accept erosion in Spanish assets as a consequence of the current account imbalances between the two countries. To Pettis it is obvious the Germanys of the world, like Japan, are doing everything possible to resist reversing the current account balances. In that case the Spains of the world are left with no choice but to erode the value of assets held by creditor countries by devaluation, inflation, or default. Pettis uses the Marshall Plan, which was an economic stimulus not an austerity plan, as an example of a mechanism to facilitate the flow of US current account surpluses to Europe. "The alternative to the Marshall Plan was either the collapse in the US export market, a European default, or a less friendly European expropriation of US assets." Pettis suspects that Germany is hoping and arguing that Spain can reverse its current account deficit without the need of Germany to reverse its current account surplus, but this will not work. China makes the same illogical demand when it insists the US raise its savings rate while China avoids making necessary domestic adjustments, including its currency. It does not solve the problem and pushes the imbalances off into the future or unto another country with the same consequences.
This is why Pettis finds the moaning and groaning over the erosion of the value of claims accumulated by surplus countries as surreal: "There is only one possible way to avoid the erosion of value, and that requires that the surplus countries work with the deficit countries to reverse the trade imbalances."
Pettis continues with his "obsession" (his word) with the debt story in China. For six years he has been saying it is unsustainable while other analysts ignored the balance sheet problems, Now other analysts are worried about debt in China, but Pettis is unconvinced they recognize the problem is systemic, because the other analysts focus on different sectors of the Chinese economy and look for government plans to address these specific sectors. "Specific debt problems, in other words, are simply the consequences of the underlying imbalances and there is nothing the government can do except shift rising debt from one part of the balance sheet to another. Debt overall will continue to rise inexorably until there is a radical reform of the growth model ..."
Even the least aggressive parts of the Chinese press is no longer ignoring the problem as this article in the People's Daily reports that a potential 3.5 trillion yuan ($541 billion) of local government loans were not discussed and are not covered in a National Audit Office report. Local government debt, according to the article, stands at 10.7 trillion yuan of which 8.5 trillion yuan was funded by bank loans. For Pettis the issue is not the lack of a master plan to solve the problems of local government debt, "The issue is that debt, whether at the local government level, the central government level, or the corporate and SOE level, is going to continue to rise quickly." He then cites this South China Morning Post article (topics.scmp) as closer to understanding the underlying balance sheet problem by discussing that 70% of local government funded projects were not producing enough cash flow to repay debts and listed prominent examples. The article also says there is a disagreement between the national Audit Office report and the PBoC which puts the local government debt figure at 14.4 trillion yuan not 10.7. Different agencies are producing different numbers using different research methods and the article says "The resulting asset writedowns would wreak havoc on bank balance sheets and means they may have to be bailed out by the government." Pettis concludes "The problem, in other words, is borrowing for overinvestment in projects that are not economically viable. Irving Fischer said in his "Debt deflation Theory of the Great Depressions" that "over-investment and over-speculation are often important, but they would have far less serious results were they not conducted with borrowed money." Over indebtedness lends importance to over investment and over speculation is the key point for Pettis as "The resolution of overinvestment with borrowed money pushes the cost off into the future, and so makes it less likely that governments, worried about rising unemployment today, minimize the eventual cost. Debt exacerbates the underlying problem as well as the cost of the adjustment because it tends to force pro-cyclical behavior, both on the way up, when it exacerbates overinvestment, and on the way down, when debt repayments constrains growth even further." By this, I interpret Pettis to be concerned about the misallocation of spending which aggravates a country's balance sheet, which is composed of the private sector, the public sector, and the external sector, problems rather than balance them at zero as a proper direct employment stimulus would, i.e., the money has been diverted to capital projects and not aggregate demand.
Pettis then cites this Caixin article on SOEs (state owned enterprises) becoming private equity funds. Pettis finds it hard to accept a booming private equity industry in China is being funded by SOE's. He does not agree that SOEs are investing as the result of their rising profitability and finacial strength, because we have no very good view of the true structure of their balance sheets. STudies have shown that SOEs are not profitable in meaningful sense as they rely upon monopoly pricing, direct subsidies, and artificially low financing costs which reduces there only way to make money as a massive direct and indirect transfer from the household sector. Pettis would not be surprised, if next year, after the government has clamped down on local government debt, all sorts of problems will be found in the financial operations of the SOEs. Pettis believes the SOEs are actually wealth destroyers, although technically profitable. It still makes no sense for them to be involved in private equity except their access to artificially cheap capital and the real cost of capital is so low that SOEs borrow and invest in anything that moves to make money on capital rather than production. "Capital (for those who can get it) is virtually free and there is absolutely no need for borrowers to worry about whether or not they are investing it productively." It is easier to invest in any hot money sector.
The whole growth money needs to be radically reformed and the cost of capital raised. Pettis believes there is a worried group at the PBoC and State Council who know this, but the last interest rate raises were a response to knowing inflation figures will be higher in June than May. This shows a lack of discipline, because the higher inflation rate means real interest rates are still declining. Even at the higher interest rates, no one with access to credit is going to turn credit down.
Pettis then finishes by citing this article from Caixin on a recent speech by the economist Wu Jinglian, which said "China's 'market forces have regressed' as government agencies have started to play a more obstructive role in resource allocation ... Governments at various levels also have a huge hold over major economic resources such as land and capital ...China lacks a legal foundation that is indispensable for a modern market economy ... Government officials intervene in the market at their will through administrative means ...China's market forces gained vigor when the pricing of goods was liberalized in the early 1990s and million of township enterprise privcatized ...Entering the 2000s, however, the reform of state-owned enterprises suffered a setback, and the SOEs have inhabited an increasingly assertive role in the market at the expense of private businesses ... Wu noted the current growth model is unsustainable and has been built on investment that exploits resources ... Another consequence of strengthened government control over the distribution of resources and active intervention in economic activity is more corruption and a larger wealth gap ..."
Pettis then refers to Mahatma Gandhi complaining that speed is irrelevant if you are going in the wrong direction and finishes with the observation that Temasek Holdings (Singapore state investment fund) is reported to be selling its shares in Chinese bank stocks.
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Friday, June 24, 2011
Does the ECB Use Liquidity as a Weapon?
Interest rates and money markets are moving up in the eurozone. Yet, the ECB has continued to contract its balance sheet which has sporadically forced the EONIA above the ECB refi rate, which would indicate the ECB is contracting liquidity at the very time its member countries need liquidity. Given the current problems with Greece, this is like, as David Beckworth has written, throwing gasoline on the fire.
I have previously questioned whether the ECB has used liquidity to force Portugal into a bailout and definitely used its purse strings to push Ireland into a bailout which nationalized Irish bank debt protecting core eurozone banks as senior bond holders.
As Michal Darda elaborates in Beckworth's post, contracting the ECB balance sheet, contracting liquidity, and raising interest rates may be the right monetary policy for Germany and France, but it is the worst thing that the ECB could do for Greece, Portugal, Ireland, Spain, and Italy. It is one thing to have banks in Ireland who threw risk management out the window and decades of political and private corruption in Greece and it is another to defend austerity to the destruction of the peripheral member countries by driving Portugal to bailout, Greece to the brink of default, and place cross hairs on Spain and Italy. Just as inappropriate deficit reduction and tightened monetary policy in the United States in 1936-37 led to a depression within a depression, the ECB is following a confidence debasing path in the monetary base of its currency, which may very well result in an international loss of confidence in the euro and the need of the ECB to refinance itself. But it is intent on making those outraged Greek "peasants" accept austerity and protect the core eurozone financial system --- at least for awhile.
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I have previously questioned whether the ECB has used liquidity to force Portugal into a bailout and definitely used its purse strings to push Ireland into a bailout which nationalized Irish bank debt protecting core eurozone banks as senior bond holders.
As Michal Darda elaborates in Beckworth's post, contracting the ECB balance sheet, contracting liquidity, and raising interest rates may be the right monetary policy for Germany and France, but it is the worst thing that the ECB could do for Greece, Portugal, Ireland, Spain, and Italy. It is one thing to have banks in Ireland who threw risk management out the window and decades of political and private corruption in Greece and it is another to defend austerity to the destruction of the peripheral member countries by driving Portugal to bailout, Greece to the brink of default, and place cross hairs on Spain and Italy. Just as inappropriate deficit reduction and tightened monetary policy in the United States in 1936-37 led to a depression within a depression, the ECB is following a confidence debasing path in the monetary base of its currency, which may very well result in an international loss of confidence in the euro and the need of the ECB to refinance itself. But it is intent on making those outraged Greek "peasants" accept austerity and protect the core eurozone financial system --- at least for awhile.
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Tuesday, June 21, 2011
On the Supremacy of The Irrational: Pushing Greece to the Brink of Implosion
While Europeans saw the decision of the eurozone Finance Ministers to back away from a funding plan for Greece and demand an affirmative Greek vote and a further austerity program as a smart political move, other parts of the world saw it as yet another internecine failure to comprehend what is going on in Greece and the conditions of the Greek people. Europeans refuse to consider that it is the euro which has driven Greece to its present state and believe Greece would enjoy no confidence from the international market if it defaulted whether within the euro or by adopting its own fiat currency. Nor do they understand that a default within the euro would be a disorderly default, while a planned (is there enough time?) default with a fiat currency could be orderly. The question of confidence is in how long the euro will continue destroying its current account balance deficit members with its refusal to adopt proper fiscal transfer mechanisms consistent with an economically efficient monetary union.
The essential and fundamental differences between a fiat currency and the euro have confused many commentators and economists, because they do not recognize the euro's failure to provide a fiscal transfer process creates a denial of national fiscal policy and how continued political demands for more and more austerity is destructive of aggregate demand creating a perceived lack of political will which engenders a growing lack of international confidence in the ability of the euro to serve the people of the eurozone.
While John Dizard dismisses Greek protests as just "striking civil servants" who will have no impact on Greek politics and incorrectly assumes that periodic monthly large withdrawals from Greek banks are runs on the banks and a banking crisis when there are no lines of clamoring depositors demanding their money. He assumes a default is coming and that it will be within the euro and it will cause Greek banks to fail, because they own Greek debt, as do many individuals, pension funds, and foreign banks. Wealthy Greeks, beginning for a period in 2010, have and are periodically moving money out of Greece, as well as other assets such as yachts, to avoid taxes and ordinary Greeks have started this year to withdraw deposits in order to maintain living conditions, i.e., they are devouring their savings, as we have written in this recent post. This is consistent with a currency crisis, which is a lack of confidence, rather than a banking crisis. The Greek protestors are a diverse group of union members. unemployed, pensioners, and small business people, who despair over the loss of sovereignty, threats to democracy and human freedom from eurozone proponents who demand political unity at any cost which cannot fix the euro, and living conditions which are spiraling down. They have had enough of austerity and politicians who cannot serve the best interests of the people.
In order to protect the euro, Greece, Ireland, and now Portugal have been forced into austerity and bailout designed to defend core European banks. Ireland was conned into accepting indentured servitude for its citizens. Portugal has been duped into accepting austerity which the ECB demanded and which the Portugese may find unpalatable more quickly than desired. Greece has been pushed and pushed to the brink of enslavement as the eurozone demands absolute fiscal control of Greece as core Europe continues to hide the capitalization needs of its large and smaller banks. At what point will a people not fight back?
If Greece were to default, why would they not do so in an orderly process which includes withdrawal from the euro and redenomination of its debt in its own fiat currency, devalued in relation to the euro, which would protect its banks and citizens? It would not be easy, but, if it were thoroughly planned, the substantive economic damage would be primarily contained to eurozone banks and foreign holders of private debt which would still be income producing. This is not a scenario which I relish, nor one I have advocated, but the eurozone seems committed to implosion as long as it defends the euro as a currency without a fiscal transfer process and demands austerity and human misery of its less economically powerful members even if it means the destruction of sovereign rights to protect its citizenry and democracy. I would much rather see eurobonds, a fiscal transfer mechanism, and coordinated investment from the European Investment Bank, as Rob Parenteau and Jan Kregel have written and/or tranche transfers, as Yanis Varoufakis has proposed, although I wonder if tranche transfers by themselves might just delay the end game. Unfortunately, we do not live in reasonable times. The Irrational rules. Are we doomed to relive the currency crisis of 1931 Germany which was caused by a lack of political will and deficit reduction economic policies, which created an international lack of confidence in Germany's ability, despite a trade surplus, to pay international debts in a currency fixed to the gold standard?
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The essential and fundamental differences between a fiat currency and the euro have confused many commentators and economists, because they do not recognize the euro's failure to provide a fiscal transfer process creates a denial of national fiscal policy and how continued political demands for more and more austerity is destructive of aggregate demand creating a perceived lack of political will which engenders a growing lack of international confidence in the ability of the euro to serve the people of the eurozone.
While John Dizard dismisses Greek protests as just "striking civil servants" who will have no impact on Greek politics and incorrectly assumes that periodic monthly large withdrawals from Greek banks are runs on the banks and a banking crisis when there are no lines of clamoring depositors demanding their money. He assumes a default is coming and that it will be within the euro and it will cause Greek banks to fail, because they own Greek debt, as do many individuals, pension funds, and foreign banks. Wealthy Greeks, beginning for a period in 2010, have and are periodically moving money out of Greece, as well as other assets such as yachts, to avoid taxes and ordinary Greeks have started this year to withdraw deposits in order to maintain living conditions, i.e., they are devouring their savings, as we have written in this recent post. This is consistent with a currency crisis, which is a lack of confidence, rather than a banking crisis. The Greek protestors are a diverse group of union members. unemployed, pensioners, and small business people, who despair over the loss of sovereignty, threats to democracy and human freedom from eurozone proponents who demand political unity at any cost which cannot fix the euro, and living conditions which are spiraling down. They have had enough of austerity and politicians who cannot serve the best interests of the people.
In order to protect the euro, Greece, Ireland, and now Portugal have been forced into austerity and bailout designed to defend core European banks. Ireland was conned into accepting indentured servitude for its citizens. Portugal has been duped into accepting austerity which the ECB demanded and which the Portugese may find unpalatable more quickly than desired. Greece has been pushed and pushed to the brink of enslavement as the eurozone demands absolute fiscal control of Greece as core Europe continues to hide the capitalization needs of its large and smaller banks. At what point will a people not fight back?
If Greece were to default, why would they not do so in an orderly process which includes withdrawal from the euro and redenomination of its debt in its own fiat currency, devalued in relation to the euro, which would protect its banks and citizens? It would not be easy, but, if it were thoroughly planned, the substantive economic damage would be primarily contained to eurozone banks and foreign holders of private debt which would still be income producing. This is not a scenario which I relish, nor one I have advocated, but the eurozone seems committed to implosion as long as it defends the euro as a currency without a fiscal transfer process and demands austerity and human misery of its less economically powerful members even if it means the destruction of sovereign rights to protect its citizenry and democracy. I would much rather see eurobonds, a fiscal transfer mechanism, and coordinated investment from the European Investment Bank, as Rob Parenteau and Jan Kregel have written and/or tranche transfers, as Yanis Varoufakis has proposed, although I wonder if tranche transfers by themselves might just delay the end game. Unfortunately, we do not live in reasonable times. The Irrational rules. Are we doomed to relive the currency crisis of 1931 Germany which was caused by a lack of political will and deficit reduction economic policies, which created an international lack of confidence in Germany's ability, despite a trade surplus, to pay international debts in a currency fixed to the gold standard?
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Thursday, June 16, 2011
Greek Bank Withdrawals Continue
In the first six months of 2010, we saw large withdrawals from Greek banks by what appeared to be wealthy Greek citizens who were taking their money out of Greece and perhaps the euro. Domestic non-financial Greek corporations began a relatively steady withdrawal of time deposits in July 2009. Non-euro residents began their withdrawals in June 2008 accelerating in December 2008. Other euro residents to a lesser degree began a weaker pattern of withdrawals in December 2008. A spreadsheet can be accessed at the Bank of Greece here (choose "breakdown by sector" in part A; then "deposit flows" in spreadsheet).
For the year ending March 2011, Emporiki, which is a subsidiary of the French bank Credit Agricole, saw its deposits decline 17.8% and Geniki, a subsidiary of the Fench bank Societe Generale, saw its deposits decline 12%.
One of the distinctions between a currency crisis and a banking crisis is that a currency crisis is a lack of confidence that prompts foreign depositors and investors to withdraw money but domestic depositors do not massively withdraw. A banking crisis occurs when domestic demand depositors withdraw their money en masse. The latter has not occurred.
However, since November 2010, Greek household deposits have declined 12,108 million euro through April 2011. While some of this may be further withdrawals by wealthy Greeks, it appears that this series of withdrawals are probably by ordinary citizens for whom it is not efficient to take their money out of Greece. It would appear that ordinary Greek citizens are finding it necessary to use their savings to maintain an acceptable standard of living. With Greek unemployment in March at 16.2% and youth unemployment at 42.5% for Q1 unemployment of 15.9% or an increase of 35.1% from Q1 2010, it is not hard to understand the need of Greek households to reduce savings to live. With austerity imposing higher taxes, higher fees, lower wages, rising prices, and less work, Greece is venturing into the territory of desperation and riots with its government ready to fall as it seeks to pass another, deeper austerity program mandated by the EU, IMF, and ECB.
While you can read about Greek demonstrations when they turn into riots, there has been little to no mention of Greek domestic bank withdrawals in the Greek mainstream or government media. The reports of domestic withdrawals have been in News247 on May 26th and sources citing News247. In fact, there appears to be an official campaign to suppress economic opinions, debate, and information by the government which can only aggravate the tensions in a democracy and promote divisive argument. Given recent proposals within the eurozone to strip deficit countries of fiscal decision making and place it with a central eurozone authority, to what extent is the eurozone becoming a threat to democracy and human freedom?
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For the year ending March 2011, Emporiki, which is a subsidiary of the French bank Credit Agricole, saw its deposits decline 17.8% and Geniki, a subsidiary of the Fench bank Societe Generale, saw its deposits decline 12%.
One of the distinctions between a currency crisis and a banking crisis is that a currency crisis is a lack of confidence that prompts foreign depositors and investors to withdraw money but domestic depositors do not massively withdraw. A banking crisis occurs when domestic demand depositors withdraw their money en masse. The latter has not occurred.
However, since November 2010, Greek household deposits have declined 12,108 million euro through April 2011. While some of this may be further withdrawals by wealthy Greeks, it appears that this series of withdrawals are probably by ordinary citizens for whom it is not efficient to take their money out of Greece. It would appear that ordinary Greek citizens are finding it necessary to use their savings to maintain an acceptable standard of living. With Greek unemployment in March at 16.2% and youth unemployment at 42.5% for Q1 unemployment of 15.9% or an increase of 35.1% from Q1 2010, it is not hard to understand the need of Greek households to reduce savings to live. With austerity imposing higher taxes, higher fees, lower wages, rising prices, and less work, Greece is venturing into the territory of desperation and riots with its government ready to fall as it seeks to pass another, deeper austerity program mandated by the EU, IMF, and ECB.
While you can read about Greek demonstrations when they turn into riots, there has been little to no mention of Greek domestic bank withdrawals in the Greek mainstream or government media. The reports of domestic withdrawals have been in News247 on May 26th and sources citing News247. In fact, there appears to be an official campaign to suppress economic opinions, debate, and information by the government which can only aggravate the tensions in a democracy and promote divisive argument. Given recent proposals within the eurozone to strip deficit countries of fiscal decision making and place it with a central eurozone authority, to what extent is the eurozone becoming a threat to democracy and human freedom?
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Wednesday, May 11, 2011
Oil Plunges, Commodities Rally Snaps 5/11/2011
On Monday, I wrote that it was not unreasonable to expect commodities to rally given the fall last week. That is what happened. On Sunday, James Hamilton wrote that despite increased consumption by emerging countries world oil supply exceeds consumption and in the United States the current oil inventory is significantly above normal. Hamilton projected a decline in gasoline prices based on each dollar the price of oil moves results in a similar move of 2 and one-half cents per gallon of gasoline. On Monday, Noahpinion had a good article on how there is no evidence oil futures speculation raises oil prices (as he admits the data is not sufficient and I would add there has not been sufficient study of ETF/ETNs impact and institutional high frequency trading). Much of the down slide in oil last week resulted from trader's programmed automatic stop-losses kicking in selling and further declines. James Hamilton today noted that stop-loss trading down slide from last week and noted the havoc which can be wreaked on the market by those who always believe they can buy low and sell high. The sad fact is that most people over estimate their ability to recognize risk and under estimate their ability to avoid it. Yesterday, the oil analyst, Stephen Schork, commented that the Monday surge in oil prices was justified based on compelling fundamentals in refinery outages, refinery disruption from Mississippi River flooding, difficult seasonal blends transition, and supplies in important markets are tight, despite lower demand. Olive Capital lost $400 million last week and Astenbeck Capital, run by Andy Hall who is one of the premier oil traders, lost in double digit percentages. Schork's conclusion was that the rise in oil prices was both justified and a dead-cat bounce with the bull's getting too greedy.
Today, oil dropped 4% bringing trading to a temporary halt when the down limit was triggered and continued a slower fall when trading resumed. Gasoline futures also plunged. The weekly oil and gasoline inventory supplies were up more than expected. As I look at futures now (1:28 P.M. Central Time), all energy, metals, and agricultural futures are down except for cattle.
U. S. Trade deficit figures today were worse than expected with the deficit up 6% in March on oil imports and a weak dollar, which is expected to drive import costs up, with imports up 4.1% to the highest since August 2008.
So far the dollar is stronger today. Are we starting to see a new slide in commodities and a stronger dollar, which will lower import costs and commodities? To what extent does the commodities slide and stronger dollar improve, because we are not going to export ourselves to recovery, recovery chances or will they, after the abrupt end of QE2 combined with falling housing prices, result in deflation?
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Today, oil dropped 4% bringing trading to a temporary halt when the down limit was triggered and continued a slower fall when trading resumed. Gasoline futures also plunged. The weekly oil and gasoline inventory supplies were up more than expected. As I look at futures now (1:28 P.M. Central Time), all energy, metals, and agricultural futures are down except for cattle.
U. S. Trade deficit figures today were worse than expected with the deficit up 6% in March on oil imports and a weak dollar, which is expected to drive import costs up, with imports up 4.1% to the highest since August 2008.
So far the dollar is stronger today. Are we starting to see a new slide in commodities and a stronger dollar, which will lower import costs and commodities? To what extent does the commodities slide and stronger dollar improve, because we are not going to export ourselves to recovery, recovery chances or will they, after the abrupt end of QE2 combined with falling housing prices, result in deflation?
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Monday, May 9, 2011
The Disillusioned Reality of U. S. Unemployment
| News reports continue today on the "positive", "encouraging", "better than expected", "stunningly strong" U. S. jobs report last week, because it reported a net gain of 244,000 jobs in April seasonally adjusted. Bottom line, the job gains were more than expected, but they, at best, are only just providing for the jobs needed to meet population growth. It does not seem to make any difference how many accurate evaluations of the U.S. Jobs Report are done, particularly by Calculated Risk, the news media keeps pumping, for instance today, how this "encouraging" jobs reports is spurring a commodities rally in Asia and the U.S., as if the commodities sell off last week would not, in itself, provide the stage for a rally attempt at the beginning of a new week. | . |
In order to start making a dent in the continued high unemployment which went up two tenths to 9.0% (13.7 million), the monthly jobs gain needs to be at least 350,000 and should, for recovery purposes, be over 400,000 minimum per month. Even at the latter rate it would still take five or more years to fully recover to pre-financial crisis employment levels. Those unemployed for less than five weeks increased 242,000, while those unemployed more than 27 weeks and still receiving benefits declined 283,000 to 5.3 million.
The participation rate (employed or unemployed and looking for work) remained unchanged at 64.2%, which is a 25 year low and below the average of 67%, for the fourth month. The employment-population ratio was 58.4%. The involuntary part-time workers was little unchanged at 8.6 million. (See charts.) Total unemployed including discouraged workers was officially up 2 tenths to 15.9%. If one used the 1994 methodology for calculating total unemployment including discouraged workers, it would be approximately 22.3% rather the current 15.9%. This employment recession is the worst since World war II in percentage terms and the 2nd worst in unemployment rate (the 1980's had a peak of 10.8%).
While the employment gains cut across the different segments of the private sector (temporary jobs and government did not increase), they were not high paying jobs. Despite the increase in private employment, the work week was unchanged with aggregate hours only increasing two tenths of a percent to 100.7 and average hourly earning increased only 5 cents (two tenths of percent) to $19.37.
Doug Short at dshort.com has a monthly update (the content of the update changes monthly but the html address does not --- I urge you to visit his website) on the jobs report which contained these three graphs:
In reference to this last graph, Doug Short said, "The inverse correlation between the two series is obvious. We can also see the accelerating growth of two-income households in the early 1980's. The recent ratio low of 58.2% in November 2010 and December 2009 was a level not seen since August 1983. In fact, those recent lows were almost back to the 58.1% ratio of March 1953, when Eisenhower was president, the Korean War was still underway, and rumors were circulating that soft drinks would soon be sold in cans. The latest ratio, for April 2011, is 58.4%, down 0.1% from last month."
If the truth be told Wall Street and corporate America profit from high unemployment, because it keeps wage increases down and boosts earnings margins. Despite the Fed's dual mandate, high unemployment also keeps the Fed on the sidelines, because it aids in keeping inflation and interest rates low. However much we blame the Fed for continued high unemployment, the Fed cannot significantly attack unemployment without effective application of governmental fiscal policy. For over two years, I and many others have been adamant that the economic stimulus, which has since ended, was too little, not long enough in duration, and not focused on creating employment.
With respect to the current Administration, it has failed the American people by not tackling continued high unemployment, while throwing regulatory privileges and money at the corporate and financial sectors. We need a second, more focused economic stimulus to create jobs and reduce continued high unemployment to sustained economic recovery and renewed growth. As Marshall Auerback has recently advocated , we need a new, modern Job Guarantee program. If we do not, we risk high unemployment becoming entrenched. At present, the unemployment problem is obviously cyclical and not structural (although I would argue, if the data existed, those over 55 years old and unemployed are least likely to be re-employed, if ever, in positions consistent with their education, experience, and current skills). Unemployment in early career for young people will fundamentally limit their lifetime earnings ability and income. As the Australian economist Bill Mitchell has written and argued, full employment can be achieved without setting off inflation and at any level of aggregate demand. The choice is clear: support the corruption of corporatism and slow growth flirting with stagnation and potential double dip spawned by the next financial sector crisis or sustained economic growth with full employment and individual freedom.
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Sunday, May 8, 2011
What Michael Pettis Really Said About Copper in China
One commentator, in a widely republished post, alleged that in last week's private newsletter from Michael Pettis that Pettis disclosed a Ponzi Scheme in the import of copper to China, which appears to be used as bonded collateral for financing. This is a sensationalistic depiction and not an accurate interpretation.
As we quoted Pettis from his private newsletter last week, the imported copper, which is stored in bonded warehouses, is being used as collateral to obtain convoluted and more expensive financing. As the financing becomes more difficult to rollover, the copper is exported, the financing paid off, and the transaction closed.
As we wrote in "China: Copper In, Copper Out" on April 29th prior to Pettis' private news letter last week, the importing of copper, use as collateral, and then re-exported may eventually have a negative impact on real GDP. It is creative financing; it is not a Ponzi Scheme in any manner, fashion, or form of the imagination.
The far more important and lengthy part of Pettis' last private newsletter was, as we wrote, about how China is not rebalancing, which he documents with how interest rates are not getting it done, how China's currency has not appreciated as much as thought in real terms when inflation is properly considered, and wage increases are improving and aiding rebalancing, but not enough and for the wrong reasons.
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As we quoted Pettis from his private newsletter last week, the imported copper, which is stored in bonded warehouses, is being used as collateral to obtain convoluted and more expensive financing. As the financing becomes more difficult to rollover, the copper is exported, the financing paid off, and the transaction closed.
As we wrote in "China: Copper In, Copper Out" on April 29th prior to Pettis' private news letter last week, the importing of copper, use as collateral, and then re-exported may eventually have a negative impact on real GDP. It is creative financing; it is not a Ponzi Scheme in any manner, fashion, or form of the imagination.
The far more important and lengthy part of Pettis' last private newsletter was, as we wrote, about how China is not rebalancing, which he documents with how interest rates are not getting it done, how China's currency has not appreciated as much as thought in real terms when inflation is properly considered, and wage increases are improving and aiding rebalancing, but not enough and for the wrong reasons.
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Thursday, May 5, 2011
Michael Pettis on Rebalancing Through Wage Increases in China
In Michael Pettis' most recent private newsletter, from which I am only allowed to make excerpts, which arrived by email yesterday, he brings up in the beginning the question of what is going on in copper in China and comes to the same conclusions I did in my April 29 article, "China: Copper In, Copper Out". He observes, "What is happening here in China is not that credit growth is too slow, but rather that infrastructure and real estate investment is so high that it has overwhelmed the available sources of credit ... Borrowers are resorting to some fairly convoluted and expensive ways of obtaining short-term credit largely because they cannot obtain financing from the local banks ... That doesn't mean there isn't liquidity in China. There is tons of it, but much of the credit is being disintermediated because of constraints on bank lending ... So Chin's problem isn't that liquidity is tight --- how could it be with so much credit expansion and hot money inflow? The problem is that much of the real investment growth seems to be funded outside the normal lending channels ... The weird distortions in the banking system, where credit isn't rationed by price but by quantity and hierarchy, has turned China, at least temporarily, into a revolving door for copper imports and exports."
In response to Jeremy Grantham's newsletter, on which I commented as part of my article, "Where Is the Global Economy Going?", he provides a revised set of tables comparing Chin's contribution to world GDP as opposed to its consumption of food and non-food commodities:
He observes that these tables show "... the disproportion between China's share of global GDP and China's commodity consumption" and "The tables give a very good sense of what might happen to global demand for various commodities as China rebalances." If Chinese demand declines 10%, world global demand will decline nearly 5%. However, he is stressing non-food commodities, because "... food consumption will continue rising as Chinese households move up the income scale."
He then asks is China currently rebalancing? Rebalancing would have to consist of three segments: rising wages, appreciating currency, and interest rate hikes. "... rebalancing means eliminating and reversing the wealth transfers from the household sector to the state and corporate sector. The most important of these transfers has been the undervalued exchange rate, the lagging wage growth, and artificially low interest rates." In the last year this has begun to reverse with the currency appreciating, interest rate hikes, and wages surging. To the question of have we "... seen an improvement in the underlying economy caused by a rising consumption share", his answer is no. He cites the most recent (April 2011) World Bank quarterly report on China from which he quotes a summary citing resilience in moving towards macroeconomic normalization with fiscal and monetary contribution, with which Pettis does not agree. He does, however, think the rest of the quote about the slow down in consumption growth in 2011 is key. The World Bank said, "Consumption growth slowed in early 2011. But overall domestic demand held up well, supported by still strong investment growth. Real estate investment has so far remained robust to measures to contain housing prices—a policy focus. Reducing inflation is the other policy priority, after inflation rose to 5.4%, largely on higher food prices." For Pettis, "Growth has been propped up by what I think are very unhealthy increases in investment, and you can always increase growth in the short term by increasing investment, but its sustainability is really questionable." It should be understood that "increasing investment" is referring to state owned enterprise (SOE) investment as opposed to private small companies. This imbalance is creating an unsustainable situation which is causing a slow down in consumption growth that one would not expect (as shown by this World Bank graph) if rebalancing growth was taking place with GDP growth.
If China is doing all of the right things --- raising wages, the exchange rate, and interest rates, Pettis asks, why isn't the economy rebalancing? For Pettis, the key is the difference between real and nominal changes, because the nominal changes are not what matters. Since last June the currency has appreciated approximately 5% since last June. "On an annualized basis that's around 6% in currency appreciation since June. But changes in a currency's real value reflect more than just changes in its nominal value. They also depend crucially on inflation growth differentials and productivity growth differentials." If Chinese inflation is higher than US inflation, then "... the RMB is appreciating in real terms even if its nominal exchange value hasn't changed. Conversely, if US inflation is higher than Chinese inflation, then the RMB is depreciating in real terms." Pettis then engages in an analysis of inflation in China and dismisses the argument that the higher inflation in China means is being appreciated by 8-9% annually by a combination of nominal appreciation and inflation and the 25% undervaluation of the renminbi could be eliminated in three years, because it would "... only be true if there were no differences in the productivity growth rates between the two countries." But the Chinese worker productivity is growing faster than the American worker productivity and Chinese CPI inflation has not been in the tradable good sector but almost all in the food sector. Pettis believes there has been relatively low inflation in the price inputs to both the US and Chinese tradable goods sector making the relevant price differential relatively small. "In other words we can probably ignore the impact of inflation on the real changes in the currency." Pettis obviously disagrees with those who believe China's relatively high CPI means China's appreciation is not as low as it seems and is two or three percentage points higher.
With respect to productivity growth differentials, Chinese worker productivity has been growing annually at two to three percent faster than US worker productivity and maybe even more depending on how one measures it. This would mean the renminbi should nominally appreciate 2-3% just to keep from depreciating in real terms. "Real appreciation, in other words, is less than nominal appreciation because of China's more rapid productivity growth." He concludes there may have been some real appreciation against the US dollar but not very much. Given the dollar is the world reserve currency and the renminbi is pegged to the dollar and the sharp depreciation of the dollar against the euro and other major currencies, the renminbi has also probably depreciated depending on the period at which you look. "So what does this mean? Just this: the claim that one of the key components of rebalancing --- an appreciating currency --- has been occurring may be vastly overstated or even simply wrong. There has been little or no real appreciation of the RMB and there may actually have been some depreciation."
Just because interest rates have gone up since October does not mean rebalancing either. While lending rates have gone up 100 basis points, depending on maturity rate, inflation has gone up 200-300 basis points, depending on the construction of the inflation index and focus on components. "Real interest rates, in other words, have actually declined steeply. Borrowers can obtain financing at lower real costs than ever, and depositors are suffering a significant and growing real loss on the money they leave in the banks. This just increases the transfer of wealth from net depositors, who are households for the main part, to net borrowers, who are the state and corporate sector." In fact, the imbalances from interest rates have been exacerbated.
With respect to wage growth, wages have been growing very quickly in the last year, but, given inflation, real wages have been growing less quickly than nominal wages. Pettis believes that real wages have probably risen faster than productivity, which means that household wages have comprised a growing share of GDP. Pettis' concern is the reason for the rising wages may be "... that demand for workers is driven primarily by unsustainable and unhealthy increases in the past two years in real estate and infrastructure development ..." However unhealthy the reason, if it continues, the problem of lagging wage growth to productivity growth may be eliminated and reversed.
Pettis summarizes that the undervalued exchange rate has not changed much and has not contributed to rebalancing, excessively low interest rates have gotten worse and significantly exacerbated the imbalances, and wage growth has gotten better and has contributed to rebalancing. He sees no real way to compare the impact of these variables to judge the net effect. He believes all one can do is look at household consumption, its relationship to GDP growth, and infer the net impact. If, as the World bank suggests, household consumption is slowing, it might infer the imbalances are getting worse or it might mean there is a lag in the positive impact of rising wages and we will just have to wait until the end of 2011 to make an assessment.
Pettis has more surety in knowing, if wages are rising and interest rates are declining, there would be more real wealth transfers within the economy from corporates to households in the form of wages and from households to corporates in the form of lower interest rates. This "... means that labor-intensive industries are bearing more than the full cost of whatever adjustment may be happening and capital-intensive industries are bearing a negative cost." he then anecdotally relates he is hearing from his students, many of whom are the children of the owners of SME (small and medium enterprises), which tend to be labor intensive, that they are raising wages as fast as they can and still losing workers to the SOE's, which are capital intensive. For SME's, wages are a significant portion of the business expenses, particularly if the cost of borrowing is declining. It is Pettis' position the small businesses have driven real and sustainable growth in China, while SOE's and government investment have promoted growth by pumping wasteful levels of unsustainable investment. For me, this brings up the question of why the SMEs and SOE's are competing for the same workers given the unemployment problem in China and the use of infrastructure projects to put people to work. I am just surmising, but it would appear the SOE's may be raising wages faster than the SME's, leaving the SME's the job of training new employees. If that is so, then government infrastructure projects are not hiring the unemployed and training them as much as such projects would warrant. All of which goes back to Pettis' problem with the SOE's privileged existence.
For Pettis, the hope is not for smaller companies to grow faster to facilitate the reduction of investment growth, but the necessity to engineer the reduction of investment growth. "The more important the capital-intensive sector is to the economy, and the more addicted these companies become to cheap capital that can be flung into wasteful projects, the harder it will be to rebalance the economy." It will only make rebalancing transfers more difficult.
It is clear to Pettis that China is not rebalancing. Beijing's growth model implies to Pettis that rebalancing cannot happen in theory except with a sharp contraction of investment growth. It is not happening. Pettis thinks, if there is another year or two of stagnant consumption as a share of GDP, maybe policymakers will wake up. Until then do not expect the SME sector to prosper. You can expect more of the same.
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In response to Jeremy Grantham's newsletter, on which I commented as part of my article, "Where Is the Global Economy Going?", he provides a revised set of tables comparing Chin's contribution to world GDP as opposed to its consumption of food and non-food commodities:
Share of global GDP | |
China’s GDP | 9.4% |
China’s GDP (PPP basis) | 13.6% |
Non-food commodities | Share of global demand |
Cement | 53.2% |
Iron Ore | 47.7% |
Coal | 46.9% |
Steel | 45.4% |
Lead | 44.6% |
Zinc | 41.3% |
Aluminum | 40.6% |
Copper | 38.9% |
Nickel | 36.3% |
Oil | 10.3% |
Food commodities | Share of global demand |
Pigs | 46.4% |
Eggs | 37.2% |
Rice | 28.1% |
Soybeans | 24.6% |
Wheat | 16.6% |
Chickens | 15.6% |
Cattle | 9.5% |
He observes that these tables show "... the disproportion between China's share of global GDP and China's commodity consumption" and "The tables give a very good sense of what might happen to global demand for various commodities as China rebalances." If Chinese demand declines 10%, world global demand will decline nearly 5%. However, he is stressing non-food commodities, because "... food consumption will continue rising as Chinese households move up the income scale."
He then asks is China currently rebalancing? Rebalancing would have to consist of three segments: rising wages, appreciating currency, and interest rate hikes. "... rebalancing means eliminating and reversing the wealth transfers from the household sector to the state and corporate sector. The most important of these transfers has been the undervalued exchange rate, the lagging wage growth, and artificially low interest rates." In the last year this has begun to reverse with the currency appreciating, interest rate hikes, and wages surging. To the question of have we "... seen an improvement in the underlying economy caused by a rising consumption share", his answer is no. He cites the most recent (April 2011) World Bank quarterly report on China from which he quotes a summary citing resilience in moving towards macroeconomic normalization with fiscal and monetary contribution, with which Pettis does not agree. He does, however, think the rest of the quote about the slow down in consumption growth in 2011 is key. The World Bank said, "Consumption growth slowed in early 2011. But overall domestic demand held up well, supported by still strong investment growth. Real estate investment has so far remained robust to measures to contain housing prices—a policy focus. Reducing inflation is the other policy priority, after inflation rose to 5.4%, largely on higher food prices." For Pettis, "Growth has been propped up by what I think are very unhealthy increases in investment, and you can always increase growth in the short term by increasing investment, but its sustainability is really questionable." It should be understood that "increasing investment" is referring to state owned enterprise (SOE) investment as opposed to private small companies. This imbalance is creating an unsustainable situation which is causing a slow down in consumption growth that one would not expect (as shown by this World Bank graph) if rebalancing growth was taking place with GDP growth.
If China is doing all of the right things --- raising wages, the exchange rate, and interest rates, Pettis asks, why isn't the economy rebalancing? For Pettis, the key is the difference between real and nominal changes, because the nominal changes are not what matters. Since last June the currency has appreciated approximately 5% since last June. "On an annualized basis that's around 6% in currency appreciation since June. But changes in a currency's real value reflect more than just changes in its nominal value. They also depend crucially on inflation growth differentials and productivity growth differentials." If Chinese inflation is higher than US inflation, then "... the RMB is appreciating in real terms even if its nominal exchange value hasn't changed. Conversely, if US inflation is higher than Chinese inflation, then the RMB is depreciating in real terms." Pettis then engages in an analysis of inflation in China and dismisses the argument that the higher inflation in China means is being appreciated by 8-9% annually by a combination of nominal appreciation and inflation and the 25% undervaluation of the renminbi could be eliminated in three years, because it would "... only be true if there were no differences in the productivity growth rates between the two countries." But the Chinese worker productivity is growing faster than the American worker productivity and Chinese CPI inflation has not been in the tradable good sector but almost all in the food sector. Pettis believes there has been relatively low inflation in the price inputs to both the US and Chinese tradable goods sector making the relevant price differential relatively small. "In other words we can probably ignore the impact of inflation on the real changes in the currency." Pettis obviously disagrees with those who believe China's relatively high CPI means China's appreciation is not as low as it seems and is two or three percentage points higher.
With respect to productivity growth differentials, Chinese worker productivity has been growing annually at two to three percent faster than US worker productivity and maybe even more depending on how one measures it. This would mean the renminbi should nominally appreciate 2-3% just to keep from depreciating in real terms. "Real appreciation, in other words, is less than nominal appreciation because of China's more rapid productivity growth." He concludes there may have been some real appreciation against the US dollar but not very much. Given the dollar is the world reserve currency and the renminbi is pegged to the dollar and the sharp depreciation of the dollar against the euro and other major currencies, the renminbi has also probably depreciated depending on the period at which you look. "So what does this mean? Just this: the claim that one of the key components of rebalancing --- an appreciating currency --- has been occurring may be vastly overstated or even simply wrong. There has been little or no real appreciation of the RMB and there may actually have been some depreciation."
Just because interest rates have gone up since October does not mean rebalancing either. While lending rates have gone up 100 basis points, depending on maturity rate, inflation has gone up 200-300 basis points, depending on the construction of the inflation index and focus on components. "Real interest rates, in other words, have actually declined steeply. Borrowers can obtain financing at lower real costs than ever, and depositors are suffering a significant and growing real loss on the money they leave in the banks. This just increases the transfer of wealth from net depositors, who are households for the main part, to net borrowers, who are the state and corporate sector." In fact, the imbalances from interest rates have been exacerbated.
With respect to wage growth, wages have been growing very quickly in the last year, but, given inflation, real wages have been growing less quickly than nominal wages. Pettis believes that real wages have probably risen faster than productivity, which means that household wages have comprised a growing share of GDP. Pettis' concern is the reason for the rising wages may be "... that demand for workers is driven primarily by unsustainable and unhealthy increases in the past two years in real estate and infrastructure development ..." However unhealthy the reason, if it continues, the problem of lagging wage growth to productivity growth may be eliminated and reversed.
Pettis summarizes that the undervalued exchange rate has not changed much and has not contributed to rebalancing, excessively low interest rates have gotten worse and significantly exacerbated the imbalances, and wage growth has gotten better and has contributed to rebalancing. He sees no real way to compare the impact of these variables to judge the net effect. He believes all one can do is look at household consumption, its relationship to GDP growth, and infer the net impact. If, as the World bank suggests, household consumption is slowing, it might infer the imbalances are getting worse or it might mean there is a lag in the positive impact of rising wages and we will just have to wait until the end of 2011 to make an assessment.
Pettis has more surety in knowing, if wages are rising and interest rates are declining, there would be more real wealth transfers within the economy from corporates to households in the form of wages and from households to corporates in the form of lower interest rates. This "... means that labor-intensive industries are bearing more than the full cost of whatever adjustment may be happening and capital-intensive industries are bearing a negative cost." he then anecdotally relates he is hearing from his students, many of whom are the children of the owners of SME (small and medium enterprises), which tend to be labor intensive, that they are raising wages as fast as they can and still losing workers to the SOE's, which are capital intensive. For SME's, wages are a significant portion of the business expenses, particularly if the cost of borrowing is declining. It is Pettis' position the small businesses have driven real and sustainable growth in China, while SOE's and government investment have promoted growth by pumping wasteful levels of unsustainable investment. For me, this brings up the question of why the SMEs and SOE's are competing for the same workers given the unemployment problem in China and the use of infrastructure projects to put people to work. I am just surmising, but it would appear the SOE's may be raising wages faster than the SME's, leaving the SME's the job of training new employees. If that is so, then government infrastructure projects are not hiring the unemployed and training them as much as such projects would warrant. All of which goes back to Pettis' problem with the SOE's privileged existence.
For Pettis, the hope is not for smaller companies to grow faster to facilitate the reduction of investment growth, but the necessity to engineer the reduction of investment growth. "The more important the capital-intensive sector is to the economy, and the more addicted these companies become to cheap capital that can be flung into wasteful projects, the harder it will be to rebalance the economy." It will only make rebalancing transfers more difficult.
It is clear to Pettis that China is not rebalancing. Beijing's growth model implies to Pettis that rebalancing cannot happen in theory except with a sharp contraction of investment growth. It is not happening. Pettis thinks, if there is another year or two of stagnant consumption as a share of GDP, maybe policymakers will wake up. Until then do not expect the SME sector to prosper. You can expect more of the same.
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ECB's Trichet Less Inflation Hawkish
In a press conference today, Trichet indicated the ECB is still concerned and watching headline inflation, but there would be no increase in the interest rate since the 25 bps increase in April. In his introductory statement, this was a key paragraph:
"To sum up, based on its regular economic and monetary analyses, the Governing Council decided to keep the key ECB interest rates unchanged following the 25-basis point increase on 7 April 2011. The information that has become available since then confirms our assessment that an adjustment of the very accommodative monetary policy stance was warranted. We continue to see upward pressure on overall inflation, mainly owing to energy and commodity prices. A cross-check with the signals coming from our monetary analysis indicates that, while the underlying pace of monetary expansion is still moderate, monetary liquidity remains ample and may facilitate the accommodation of price pressures. Furthermore, recent economic data confirm the positive underlying momentum of economic activity in the euro area, with uncertainty continuing to be elevated. All in all, it is essential that recent price developments do not give rise to broad-based inflationary pressures. Inflation expectations in the euro area must remain firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2% over the medium term. Such anchoring is a prerequisite for monetary policy to make an ongoing contribution towards supporting economic growth and job creation in the euro area. With interest rates across the entire maturity spectrum remaining low and the monetary policy stance still accommodative, we will continue to monitor very closely all developments with respect to upside risks to price stability. Maintaining price stability over the medium term is our guiding principle, which we apply when assessing new information, forming our judgements and deciding on any further adjustment of the accommodative stance of monetary policy."
The full video of the statement and Q & A are here.
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"To sum up, based on its regular economic and monetary analyses, the Governing Council decided to keep the key ECB interest rates unchanged following the 25-basis point increase on 7 April 2011. The information that has become available since then confirms our assessment that an adjustment of the very accommodative monetary policy stance was warranted. We continue to see upward pressure on overall inflation, mainly owing to energy and commodity prices. A cross-check with the signals coming from our monetary analysis indicates that, while the underlying pace of monetary expansion is still moderate, monetary liquidity remains ample and may facilitate the accommodation of price pressures. Furthermore, recent economic data confirm the positive underlying momentum of economic activity in the euro area, with uncertainty continuing to be elevated. All in all, it is essential that recent price developments do not give rise to broad-based inflationary pressures. Inflation expectations in the euro area must remain firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2% over the medium term. Such anchoring is a prerequisite for monetary policy to make an ongoing contribution towards supporting economic growth and job creation in the euro area. With interest rates across the entire maturity spectrum remaining low and the monetary policy stance still accommodative, we will continue to monitor very closely all developments with respect to upside risks to price stability. Maintaining price stability over the medium term is our guiding principle, which we apply when assessing new information, forming our judgements and deciding on any further adjustment of the accommodative stance of monetary policy."
The full video of the statement and Q & A are here.
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