These are links from last week through 8/13/2011. A little hindsight never hurt objective analysis.
Hussman's market commentary beginning of last week.
Grantham last week on global economy, seven lean years, and investing in a corrupt world.
Kudlow Comedy Capers.
Facing reality
Investor flows and 2008 Oil prices.
Index funds and commodity prices.
Equity prices and growth scares.
Down stock market not S&P downgrade but lack of growth.
S&P decision irrelevant. Bill Mitchell
David Levey on S&P downgrade as unwarranted. Rajiv Sethi
Defining economic interests.
Limitations of ECB are its failures.
Market reaction and default. Paul Krugman
Eurobonds or bust.
Slithering to the wrong kind of union.
Stagnant and paralyzed.
Tax Expenditures are big government and should be cut (what the rich do not want to hear).
Target2 & ECB liquidity management.
An experiment in austerity. Bruce Bartlett
An alternative to austerity. L. Randall Wray
Bank of England's substantial risks.
Deficits and defense spending.
The many ways to count Chinese debt.
Eurocrisis reaches the core.
We don't have a long term debt problem. James Galbraith
It is a weak economy not a AAA credit rating downgrade.
Illinois budget does not address pension payment backlog. Moody's
Still waiting for expansionary contraction in UK.
The crisis is unemployment not debt.
Income inequality is bad for rich people. Yves Smith
The FED dissenters.
Failed monetary policy created this crisis. Joseph Stiglitz video interview
The return of the Bear. Steve Keen
Debunking demand and supply analysis. Steve Keen
Fractious national leaders cannot lend stability to Europe.
Irish NAMA bad debt assets.
Freedom is not built on free market corruption.
Europe's rational idiocy. Yanis Varoufakis
Why ECB must issue eurobonds for its own survival. Yanis Varoufakis (I have long advocated need for eurobonds but I do not believe the ECB would be the proper issuer)
Chaos is dawning on dysfunctional governments. Andy Xie
German taxpayers willingly subsidize bankers. Michael Hudson
Germany must defend the euro.
Tea Party not factually correct; a conservative criticism. Simon Johnson
Shorting ban on euro banks and macroeconomic threats.
Will the Swiss franc be pegged to the euro?
Swiss franc exposes foreign currency denominated debt exposure of Hungarian banks.
Unofficial U.S. problem bank list at 988.
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Tuesday, August 16, 2011
German GDP less than Spain GDP Q2 2011
German GDP for Q2 2011 came in at one tenth of a percent growth; five tenths was expected. Spain had a growth of two tenths of a percent.
Eurozone GDP Q2 grew two tenths of a percent; three tenths was expected. The eurozone and German economy are slowing. The French Q2 GDP was unchanged (zero growth). Manufacturing and exports declined and the eurozone trade deficit widen even though imports declined 4.1%.
Yesterday (Monday), a VOXEU paper asked if Germany can be Europe's engine of economic growth and concluded that Germany needs, as many economists have been urging for some time in discussing the current account imbalances within the eurozone, to rebalance sustained growth toward domestic demand with increased domestic investment and higher incomes which implies less unemployment if done right.
Meanwhile the credit crunch in the eurozone periphery continues as European banks struggle to obtain short term funding at a time when lower stock equity from the recent market downturn will require many banks to raise capital.
The European markets are down and you can expect the U.S. markets to open lower.
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Eurozone GDP Q2 grew two tenths of a percent; three tenths was expected. The eurozone and German economy are slowing. The French Q2 GDP was unchanged (zero growth). Manufacturing and exports declined and the eurozone trade deficit widen even though imports declined 4.1%.
Yesterday (Monday), a VOXEU paper asked if Germany can be Europe's engine of economic growth and concluded that Germany needs, as many economists have been urging for some time in discussing the current account imbalances within the eurozone, to rebalance sustained growth toward domestic demand with increased domestic investment and higher incomes which implies less unemployment if done right.
Meanwhile the credit crunch in the eurozone periphery continues as European banks struggle to obtain short term funding at a time when lower stock equity from the recent market downturn will require many banks to raise capital.
The European markets are down and you can expect the U.S. markets to open lower.
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UK Riots and Unemployment Map
Here is a map which provides UK riot incidents information on an unemployment map. You can move it around as if it is a Google map and you can click on individual locations for specific incident information and you can see the color coded unemployment rates on the map. It is not coincidence that these riots took place in high unemployment areas as we have written previously.
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Monday, August 15, 2011
Michael Pettis on Hidden Debt in China
In Michael Pettis' private newsletter received July 31st, I covered the first half on why china needs to buy U.S. bonds here and the second half of his July 31 private newsletter began with "Thinking about balance sheets". Since July 31st, Pettis has also published in the Wall Street Journal an article on why China's export economy cannot continue and will slow down.
Since all four scenarios under which China can sell U.S. government bonds is unlikely (see link above for the first half of the newsletter), the purchase of U.S. government bonds is going to continue until there is a dramatic change in global imbalances. Despite rumors every six months that they will stop buying U.S. Treasuries, they cannot until they have rebalanced their economy and eliminated their large trade surplus. this will take a long time and PBoC domestic debt is going to rise dramatically. The rise in PBoC domestic debt is going to become an increasing problem for China, which most economists writing about China do not understand, according to Pettis, "...the root causes of Chinese imbalances and the vulnerabilities in the growth model. They do not see the relationship between rising debt, financial repression, and low consumption. What is worse, too many analysts see the problem of local government debt as specific to local governments and caused by misguided polices on their part, whereas in reality it is a systemic problem."
Pettis believes his approach to understanding the Chinese balance sheet is quite different as he tries to understand the development of the system as a whole and then tries to figure out how it will "...logically evolve within balance-of-payments, balance sheet, and monetary constraints." He admits to being addicted to reading about finance and economic history, with understanding historical precedents key to his approach. "Furthermore the work of economists like Hyman Minsky, Charles Kindleberger and Irving Fischer drives my sense of balance sheets and how changes in the structure of balance sheets affect economic outcomes. Among other things it leaves me very skeptical about prospects for financial systems, like China’s, that are engineered to maintain stability at all costs.
Since all four scenarios under which China can sell U.S. government bonds is unlikely (see link above for the first half of the newsletter), the purchase of U.S. government bonds is going to continue until there is a dramatic change in global imbalances. Despite rumors every six months that they will stop buying U.S. Treasuries, they cannot until they have rebalanced their economy and eliminated their large trade surplus. this will take a long time and PBoC domestic debt is going to rise dramatically. The rise in PBoC domestic debt is going to become an increasing problem for China, which most economists writing about China do not understand, according to Pettis, "...the root causes of Chinese imbalances and the vulnerabilities in the growth model. They do not see the relationship between rising debt, financial repression, and low consumption. What is worse, too many analysts see the problem of local government debt as specific to local governments and caused by misguided polices on their part, whereas in reality it is a systemic problem."
Pettis believes his approach to understanding the Chinese balance sheet is quite different as he tries to understand the development of the system as a whole and then tries to figure out how it will "...logically evolve within balance-of-payments, balance sheet, and monetary constraints." He admits to being addicted to reading about finance and economic history, with understanding historical precedents key to his approach. "Furthermore the work of economists like Hyman Minsky, Charles Kindleberger and Irving Fischer drives my sense of balance sheets and how changes in the structure of balance sheets affect economic outcomes. Among other things it leaves me very skeptical about prospects for financial systems, like China’s, that are engineered to maintain stability at all costs.
"Not only do these kinds of financial systems typically sacrifice efficiency for stability but, as any good Minskyite could tell you, regulatory regimes that force stability onto the financial system always result in increasingly destabilizing behavior by the agents within the system. Instability, in other words, is simply repressed and pushed forward, and the financial system must become increasingly inefficient in order to suppress the increasingly irrational behavior of agents within the system. In any financial system, as Minsky famously said, stability is itself destabilizing."
In Pettis' view, it was apparent in 2004-5 that using the balance sheet approach, the rise in Chinese debt argued that within a few years there would be real questions about debt sustainability, because "...there was no logical way for the growth model to continue functioning without an unsustainable rise in debt, and it was already pretty clear that without reform and liberalization in the Chinese financial system we were eventually going to run into another banking crisis. And ignore what you may have heard from other analysts – there has been absolutely no meaningful financial sector reform in the past decade." He then credits Charlene Chu and her team at Fitch with best analysis of the Chinese banking system and creativity in discovering and counting debt as well as Victor Shih at Northwestern and Logan Wright at Medley Advisors.
Pettis specifically cites the Fitch report, "Growth of leverage still outpacing GDP growth" as an example.
Earlier this year, the PBoC unveiled the concept of "Total Social Financing" in an attempt to measure real growth in bank related credit by including various type of important loan growth which had not been included in older measurements. For many years the key measure of credit growth was the new Renminbi denominated loans made by Chinese banks. "By setting annual, quarterly or monthly quotas for the maximum amount of new RMB-denominated loans, the PBoC hoped to maintain some control of credit expansion in China." But it does not work that way, because as the PBoC limited the growth of that kind of credit, the banks found innovative ways around the constraints and pushed new lending into other forms of lending.
When the PBoC produced Total Social Financing numbers earlier this year, the data showed that RMB loans were 92% of total TSF, but by 2010, new RMB loans had dropped to 56% of TSF. "Clearly loan growth, correctly measured, far exceeded the already-very-high numbers that we had all been looking at. Among other things this meant that M2 was even less useful as a measure of monetary growth than in most other economies because much of the growth in deposits had been disintermediated. The real growth in the form of money for which M2 is a proxy was much higher than actual M2 growth."
Pettis hypothesizes that the intention of the PBoC in releasing the TSF data was 1) it needed a way to demonstrate how amazing the expansion of credit has been to the pro-growth faction in the State Council and 2) "...they wanted to reassert control over credit expansion by widening the scope of credit instruments they were monitoring." Pettis immediately made what he believes was an obvious prediction, given his belief "...that growth is determined mainly by increases in investment, which are themselves determined mainly by increases in credit", the the TSF would quickly lose its usefulness by September of this year. However, Fitch has already found additional credit instruments other than those included in TSF which have been expanding quickly and he quotes Fitch: "The main portions of this uncaptured financing include letters of credit (LoCs), credit from domestic trust companies, lending by other non-bank financial institutions (NBFIs) and loans from Hong Kong banks."
The adjusted Fitch TSF numbers are interesting, because they show "RMB loans are down for the first half of the year, with new renminbi bank lending declining by 9.7%, from RMB 4.6 trillion in the first half of 2010 to RMB 4.2 trillion in the first half of 2011.
"TSF is also down for the first half of the year, but of course by a lot less than new RMB loans. It declined by 4.7%, from RMB 8.1 trillion in the first half of 2010 to RMB 7.8 trillion in the first half of 2011.
"So overall credit growth is down, right? Perhaps not. It looks like Fitch’s adjusted TSF is actually up, and this doesn’t even include private lending pools and non-bank sources of lending, which anecdotal evidence suggests is way up." Pettis then relates a communication from a PhD student who had been doing research in Ordos Municipality in Inner Mongolia relating finding a tremendous amount of informal financing schemes with some have monthly interest rates as high as 4%. Pettis is not surprised by this as "The relationship between credit expansion, investment growth and GDP growth means that as long as GDP growth rates are high, credit growth is going to be accelerating." He challenges if you do not see this you are not looking at the right numbers.
One last point he wanted to make was the the LGVF bonds issued by local government financing vehicles are getting hammered in the market, declining in the last month from 2-10% depending on maturities. Pettis believes that less than 10% of LGVF debt is in bonds and roughly 80% in the form of bank loans. He believes this will have implications for debt going forward, because, if one is a newly appointed mayor and how you perform over the next five years will determine future promotions within the political machine and you realize you have inherited a crushing debt burden and few revenues with which to cover the debt, what do you do. Soldier on and hope something turns up within 5 years and you do not get blamed for the revenue shortfalls? Or do you make a big stink about debt immediately to establish it was not on your watch? Could a noise be expected by mid 2012 to have arisen?
Pettis also says it is not clear how many of the LGVFs can meet debt servicing costs and some of their land collateral may have already been pledged more than once.
Sunday, August 14, 2011
Were UK Riots Symptoms of Larger Global Unrest With Austerity and Inequality?
The UK recent riots have been characterized as nihilist acts of thugs, looters, and common thieves, yet, they lasted four days and spread to other neighborhoods in London and other cities and the participants crossed racial lines. Much like the UK riots in 1981, there was a general dislike and distrust of authority and the police. The authorities and mainstream media played the riots as criminal anarchy resulting from poor parenting and a history of government coddling which should be suppressed and order restored in order to proceed with government austerity programs supported by the financial services sector which is seeing a concentration of power in their protected status from failure without regard to systemic risk.
Austerity deepens and intensifies social-economic inequality, which brings into question government austerity programs which slow and destroy growth. As is being seen in Greece, Spain, and Italy, as well as Israel, where protests and demonstrations are becoming common, as well as past UK demonstrations over social and education cuts; just as protests in Egypt, Tunisia, Yemen, Bahrain, Libya, and Syria sought social justice, democracy, and opportunity, when the concentration of power increasingly disenfranchises citizens and/or fiscal consolidation intensifies the likely reaction against corruption and self-serving elitism, historically, is social unrest. Global economic uncertainty in one form or another is a breeding ground for social unrest. When it gets so bad it seems as if you have nothing more to lose and you hate the life from which you have no opportunity to improve, civil disorder gets the attention of those in authority and privilege and it then becomes a question of whether they will eventually listen or if they will keep cutting of the heads of the people to restore order.
Living standards and social-economic inequality have been bad in the UK and austerity has magnified the problem. These UK rioters are being brought before Magistrate's Court for a few minutes of summary hearing before a judge. Some are as young as 11 and many are over 35 years of age; some young adults are voluntarily surrendering when they realize they looted and not just protested as everyone who thinks is asking why rather than condemning. During the riots and currently, there are those in the media, politics, and UK government who are attempting to minimalize and paint the rioters not just as thieves and thugs but leaches on the public dole. This serve no good public purpose in a democracy. The global financial crisis, protection of financial interests, continuing high unemployment, social service, health care, and education cuts limiting survivability, much less quality of life, and access to opportunity and the level playing field of a free society not only breed social unrest seeking justice and equality of opportunity, it also breeds right wing extremism.
Edward Harrison of CreditWritedowns has elegantly summarized the the right wing threat and growing crisis in Europe succinctly in the failure of the EU and the eurozone to confront the obvious defects of the euro and act democratically in unity for a common purpose and common safety to provide eurobonds and insure liquidity in a monetary union in which necessary fiscal transfers and fiscal union are perceived as "taxes" and "costs" rather than the normal resolution of current account trade imbalances within the monetary union.
My graduate and post graduate work has concentrated on social economic changes, not just the turning or tipping points, but the periods immediately prior and after. We are in a period in which the actions of our politicians in all the countries of the world and the citizens of those countries are going to determine in society continues to evolve democratically or if it prefers the neo-feudalism of a corporatist state in which the government and the private financial sector have the same interests. The economist Nouriel Roubini in a recent interview not only assessed the probability of recession at 50%, but also observed that we are at a stage where it is possible that capitalism could destroy itself.
What do you choose? Freedom or security? Access to opportunity or special privilege?
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Austerity deepens and intensifies social-economic inequality, which brings into question government austerity programs which slow and destroy growth. As is being seen in Greece, Spain, and Italy, as well as Israel, where protests and demonstrations are becoming common, as well as past UK demonstrations over social and education cuts; just as protests in Egypt, Tunisia, Yemen, Bahrain, Libya, and Syria sought social justice, democracy, and opportunity, when the concentration of power increasingly disenfranchises citizens and/or fiscal consolidation intensifies the likely reaction against corruption and self-serving elitism, historically, is social unrest. Global economic uncertainty in one form or another is a breeding ground for social unrest. When it gets so bad it seems as if you have nothing more to lose and you hate the life from which you have no opportunity to improve, civil disorder gets the attention of those in authority and privilege and it then becomes a question of whether they will eventually listen or if they will keep cutting of the heads of the people to restore order.
Living standards and social-economic inequality have been bad in the UK and austerity has magnified the problem. These UK rioters are being brought before Magistrate's Court for a few minutes of summary hearing before a judge. Some are as young as 11 and many are over 35 years of age; some young adults are voluntarily surrendering when they realize they looted and not just protested as everyone who thinks is asking why rather than condemning. During the riots and currently, there are those in the media, politics, and UK government who are attempting to minimalize and paint the rioters not just as thieves and thugs but leaches on the public dole. This serve no good public purpose in a democracy. The global financial crisis, protection of financial interests, continuing high unemployment, social service, health care, and education cuts limiting survivability, much less quality of life, and access to opportunity and the level playing field of a free society not only breed social unrest seeking justice and equality of opportunity, it also breeds right wing extremism.
Edward Harrison of CreditWritedowns has elegantly summarized the the right wing threat and growing crisis in Europe succinctly in the failure of the EU and the eurozone to confront the obvious defects of the euro and act democratically in unity for a common purpose and common safety to provide eurobonds and insure liquidity in a monetary union in which necessary fiscal transfers and fiscal union are perceived as "taxes" and "costs" rather than the normal resolution of current account trade imbalances within the monetary union.
My graduate and post graduate work has concentrated on social economic changes, not just the turning or tipping points, but the periods immediately prior and after. We are in a period in which the actions of our politicians in all the countries of the world and the citizens of those countries are going to determine in society continues to evolve democratically or if it prefers the neo-feudalism of a corporatist state in which the government and the private financial sector have the same interests. The economist Nouriel Roubini in a recent interview not only assessed the probability of recession at 50%, but also observed that we are at a stage where it is possible that capitalism could destroy itself.
What do you choose? Freedom or security? Access to opportunity or special privilege?
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Friday, August 12, 2011
Unites States Treasury Auctions After S&P Downgrade
The 3 year Treasury auction for $32 billion this week had a high yield of 0.50% ( the prior auction in July had a yield of 0.670%), a bid-to-cover of 3.24, foreign purchases were 35.36%, and direct purchases were 31.66%.
The 10 year Treasury auction for $24 billion had a high yield of 2.140% (the prior auction in May had a yield of 3.210%), a bid-to-cover of 3.29%, foreign purchases of 46.92%, and direct purchases of 11.09%.
The 30 year Treasury auction for 16 billion had a high yield of 3.750% (the prior auction in July had a yield of 4.380%), a bid-to-cover of 2.08 (average for 6 months is 2.70), foreign purchases of 12.16% (weakest demand in 2 1/2 years --- averages 40%), and direct purchases of 19.62% (from 10.9% last auction).
The yield drops in all three, particularly the 30 year Treasury, were impressive and a strong vote for the strength and safety of United States government bonds. For the yield to come out any lower on the 30 year, it would have meant paying over the face value of the bond. This was only the second 30 year auction in history in which all winning bids achieved par value. While there was some disorderly bidding and a large tail (1.3% in cash terms), unlike European distressed bond auctions where those factors resulted in nightmares, the result for this 30 year U.S. Treasury was a winner's curse.
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The 10 year Treasury auction for $24 billion had a high yield of 2.140% (the prior auction in May had a yield of 3.210%), a bid-to-cover of 3.29%, foreign purchases of 46.92%, and direct purchases of 11.09%.
The 30 year Treasury auction for 16 billion had a high yield of 3.750% (the prior auction in July had a yield of 4.380%), a bid-to-cover of 2.08 (average for 6 months is 2.70), foreign purchases of 12.16% (weakest demand in 2 1/2 years --- averages 40%), and direct purchases of 19.62% (from 10.9% last auction).
The yield drops in all three, particularly the 30 year Treasury, were impressive and a strong vote for the strength and safety of United States government bonds. For the yield to come out any lower on the 30 year, it would have meant paying over the face value of the bond. This was only the second 30 year auction in history in which all winning bids achieved par value. While there was some disorderly bidding and a large tail (1.3% in cash terms), unlike European distressed bond auctions where those factors resulted in nightmares, the result for this 30 year U.S. Treasury was a winner's curse.
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Are French Banks Under Self-Fulfilling Market Attacks?
On Monday August 8th, the cost of CDS and bond yields of both France and Germany went up, when one would have expected them to go down with the ECB buying Italian and Spanish bonds. The euro also declined in value to the Scandinavian currencies, which would indicate the Scandinavian currencies were perceived as safer. Together, France and Germany constitute 1/3 of the equity of the ECB and are the two largest economies in the eurozone. France's AAA credit rating became the target of market rumors that it could be downgraded as the result of the United States downgrade and the realization the ECB bond buying would be a temporary stop gap on Spanish and Italian yields with the EFSF needing significant expansion if it was to have the economic resources to handle intervention into Spain and/or Italy. France has gained the perception of being in the market eurozone crisis crosshairs with the illusion that Germany would be the remaining safe haven, despite its bond yields and CDS also going up. Standard and Poor's was quick to state publicly that France is more serious in addressing its public debt than the United States and is implementing higher taxes and spending austerity, which is not very encouraging because France is suffering from slowing growth just as Spain, Italy, and Germany are to different degrees.
The realization that bond buying by the ECB will only be temporary and the EFSF will need more money and the creation of eurobonds, as we have advocated, may actually be unavoidable has caused overnight lending to tighten and eurozone banks to be perceived as more risky sending bank shares down lead by the French banks SocGen and CreditAgricole. Rumors of a French bank having problems pervaded the market, while the more likely reality was a recognition of broader macroeconomic issues of growth and deteriorating eurozone stability with the euro effectively being shorted and the decline in bank equity values only magnifying the potential need of eurozone banks to raise capital. At least one Asian bank cut the credit lines of French banks. The willingness of banks to lend to each other continued to diminish with more pressure on short term lending raising questions of pressure on the long end of lending and the increasing likelihood the ECB would have to do much more to maintain liquidity besides by sovereign debt.
Commerzbank, which is 25% owned by the German government, announced it's profits would decline 93% on Greek debt writedowns and its shares still went up 4.5% on Wednesday, but the illusion that German banking is strong and Commerzbank (and any other German bank or landesbank that discloses risks or funding needs) is a special case continues to be promulgated. The continuing uncertainty of the eurozone's continued failures in the deepening implementation of austerity and refusal to create a democratic fiscal union with eurobonds is showing itself in the declining equity value of European banks and the need of those banks to raise more capital in what is forming up as a potential global crisis.
Despite statements to the contrary, after the market in the United States closed Thursday, Spain, Italy, Belgium, and France banned short selling.
The euro was defectively constructed with fiscal union and the means to fiscally adjust eurozone internal trade imbalances legally prohibited creating a monetary union with no fiscal union transfer process as a sovereign nation with fiat money has and monetary union in which all of its sovereign nation members were effectively reduced to nations using and financing sovereign debt in a foreign currency (the euro). They are reaping the harvest of that crop.
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The realization that bond buying by the ECB will only be temporary and the EFSF will need more money and the creation of eurobonds, as we have advocated, may actually be unavoidable has caused overnight lending to tighten and eurozone banks to be perceived as more risky sending bank shares down lead by the French banks SocGen and CreditAgricole. Rumors of a French bank having problems pervaded the market, while the more likely reality was a recognition of broader macroeconomic issues of growth and deteriorating eurozone stability with the euro effectively being shorted and the decline in bank equity values only magnifying the potential need of eurozone banks to raise capital. At least one Asian bank cut the credit lines of French banks. The willingness of banks to lend to each other continued to diminish with more pressure on short term lending raising questions of pressure on the long end of lending and the increasing likelihood the ECB would have to do much more to maintain liquidity besides by sovereign debt.
Commerzbank, which is 25% owned by the German government, announced it's profits would decline 93% on Greek debt writedowns and its shares still went up 4.5% on Wednesday, but the illusion that German banking is strong and Commerzbank (and any other German bank or landesbank that discloses risks or funding needs) is a special case continues to be promulgated. The continuing uncertainty of the eurozone's continued failures in the deepening implementation of austerity and refusal to create a democratic fiscal union with eurobonds is showing itself in the declining equity value of European banks and the need of those banks to raise more capital in what is forming up as a potential global crisis.
Despite statements to the contrary, after the market in the United States closed Thursday, Spain, Italy, Belgium, and France banned short selling.
The euro was defectively constructed with fiscal union and the means to fiscally adjust eurozone internal trade imbalances legally prohibited creating a monetary union with no fiscal union transfer process as a sovereign nation with fiat money has and monetary union in which all of its sovereign nation members were effectively reduced to nations using and financing sovereign debt in a foreign currency (the euro). They are reaping the harvest of that crop.
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Thursday, August 11, 2011
Michael Pettis on Why China Needs to Buy United States Debt
In Michael Pettis' private newsletter which arrived July 31, he discussed two issues: 1) why China needs to buy U.S. debt and 2) hidden debt in China. I intend to cover why China needs economically to buy U.S. debt in this article and cover hidden debt in China in another article if time permits.
Pettis notes the growing concern over a possible U.S. default, which is unlikely, in China as political positioning since it would be a economically non-event for China. There has been speculation on whether China would sell its U.S. bonds in Chinese media, but Pettis' is emphatic that will not happen and the speculation is based on a fundamental misunderstanding of how China's purchase of U.S. bonds is a necessary function of its trade policy. "You cannot run a current account surplus unless you are also a net exporter of capital, and since the rest of China is actually a net importer of capital (inward FDI and hot money inflows overwhelm capital flight and outward FDI), the PBoC must export huge amounts of capital in order to maintain China’s trade surplus. In order the keep the RMB from appreciating, in other words, the PBoC must be willing to purchase as many dollars as the market offers at the price it sets. It pays for those dollars in RMB."
When China buys those U.S. dollars it must put in a market large enough to absorb the money and whose economy is willing and able enough to run a trade deficit. "This last point is what everyone seems to forget when discussing Chinese purchases of foreign bonds. Remember that when Country A exports huge amounts of money to Country B, Country A must run a current account surplus and Country B must run the corresponding current account deficit. In practice, only the US fulfills those two requirements – large and flexible financial markets, and the ability and willingness to run large trade deficits – which is why the PBoC owns huge amounts of USG bonds."
If China were to decide it no longer wants to hold U.S. government bonds, there are only four possible choices if decides to purchase fewer U.S. government bonds:
With respect to #2, purchasing non-U.S. assets which would most likely be foreign government bonds, of which Europe is the only market large enough, there are only two ways the Europeans could react. One is the Europeans would turn around and buy a similar amount of U.S. assets and the U.S. and China trade balances would remain unchanged. Europe, however, might be unhappy with this, because it would probably be transacted through the ECB and cause an increase in the money supply, according to Pettis. If Europe was to not purchase U.S. assets, then the U.S. imports from Europe must go down that amount while the imports to Europe must go up that amount. This will actually improve the U.S. position and be expansionary for the U.S. economy by the creation of jobs. "This is the key point. If foreigners buy fewer USD assets, the US trade deficit must decline. This is almost certainly good for the US economy and for US employment. When analysts worry that China might buy fewer USG bonds, they are actually worrying that the US trade deficit might contract. This is something the US should welcome, not deplore." For Europe it is another story, because as the US trade deficit declines the European trade surplus must decline while China's remains unchanged. "This deterioration in the trade account will force Europeans either into raising their fiscal deficits to counteract the impact of fewer exports or letting domestic unemployment rise. Under these conditions it is hard to imagine they would tolerate much Chinese purchase of European assets without responding eventually with anger and even trade protection."
With respect to #3, in which China buys hard commodities, the scenario is the same as above except the exporters of those hard commodities will face the same choices Europe would face. The exporters can either buy U.S. assets or absorb the deterioration in their trading account, perhaps through a reduction in manufacturing capacity. This scenario also has problems for China since stock piling commodities is a bad strategy since commodity prices are volatile and that volatility is inversely correlated with the needs of the Chinese economy. It would be a good investment for China only if China grows rapidly. This would be the wrong national economy balance sheet position any country could engineer as it would exacerbate underlying social economic conditions and increase economic volatility, which is never a good thing for the poor.
With respect to #4, in which China intervenes less in the currency and does not buy anything else, China's surplus will decline by the same amount and the U.S. trade deficit will decline by the same amount. The net change on U.S. financing costs would be unchanged, while China's unemployment would rise unless it increases its own fiscal deficit, which is politically undesirable.
Pettis concludes this first half of his private newsletter with "It's about trade, not capital", which is counterintuitive to many people who do not understand how the global balance of payments works, because "...countries that export capital are not doing anyone favors unless incomes in the recipient country are so low that savings are impossible or unless the capital export comes with needed technology, and countries that import capital might be doing so mainly at the expense of domestic jobs. For this reason it is absurd for Americans to worry that China might stop buying USG bonds. This is what the Chinese worry about." Despite the U.S.-China trade dispute about China buying U.S. government bonds and the U.S. not wanting them to do so, in reality, if China's trade surplus declines then the U.S. trade deficit declines, which means China buys less U.S. government bonds and, contrary to what you may read or hear, this reduction is purchases of U.S. government bonds would not cause the U.S. interest rate to fall. To insist otherwise is to say, if a country's trade deficit rises, its domestic interest rates decline which is patently false. Pettis brings up a standard argumentative response to his observations on trade and capital exports writing "...someone will indignantly point out a devastating flaw in my argument. Since the US makes nothing that it imports from China, they will claim, a reduction in China’s capital exports to the US (or a reduction in China’s trade surplus) will have no impact on the US trade deficit. It will simply cause someone else’s exports to the US to rise with no corresponding change in the US trade balance. In that case, they say, less Chinese buying of USG bonds will indeed cause an increase in US interest rates.
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Pettis notes the growing concern over a possible U.S. default, which is unlikely, in China as political positioning since it would be a economically non-event for China. There has been speculation on whether China would sell its U.S. bonds in Chinese media, but Pettis' is emphatic that will not happen and the speculation is based on a fundamental misunderstanding of how China's purchase of U.S. bonds is a necessary function of its trade policy. "You cannot run a current account surplus unless you are also a net exporter of capital, and since the rest of China is actually a net importer of capital (inward FDI and hot money inflows overwhelm capital flight and outward FDI), the PBoC must export huge amounts of capital in order to maintain China’s trade surplus. In order the keep the RMB from appreciating, in other words, the PBoC must be willing to purchase as many dollars as the market offers at the price it sets. It pays for those dollars in RMB."
When China buys those U.S. dollars it must put in a market large enough to absorb the money and whose economy is willing and able enough to run a trade deficit. "This last point is what everyone seems to forget when discussing Chinese purchases of foreign bonds. Remember that when Country A exports huge amounts of money to Country B, Country A must run a current account surplus and Country B must run the corresponding current account deficit. In practice, only the US fulfills those two requirements – large and flexible financial markets, and the ability and willingness to run large trade deficits – which is why the PBoC owns huge amounts of USG bonds."
If China were to decide it no longer wants to hold U.S. government bonds, there are only four possible choices if decides to purchase fewer U.S. government bonds:
- "The PBoC can buy fewer USG bonds and purchase more other USD assets.
- "The PBoC can buy fewer USG bonds and purchase more non-US dollar assets, most likely foreign government bonds.
- "The PBoC can buy fewer USG bonds and purchase more hard commodities.
- "The PBoC can buy fewer USG bonds by intervening less in the currency, in which case it does not need to buy anything else."
With respect to #2, purchasing non-U.S. assets which would most likely be foreign government bonds, of which Europe is the only market large enough, there are only two ways the Europeans could react. One is the Europeans would turn around and buy a similar amount of U.S. assets and the U.S. and China trade balances would remain unchanged. Europe, however, might be unhappy with this, because it would probably be transacted through the ECB and cause an increase in the money supply, according to Pettis. If Europe was to not purchase U.S. assets, then the U.S. imports from Europe must go down that amount while the imports to Europe must go up that amount. This will actually improve the U.S. position and be expansionary for the U.S. economy by the creation of jobs. "This is the key point. If foreigners buy fewer USD assets, the US trade deficit must decline. This is almost certainly good for the US economy and for US employment. When analysts worry that China might buy fewer USG bonds, they are actually worrying that the US trade deficit might contract. This is something the US should welcome, not deplore." For Europe it is another story, because as the US trade deficit declines the European trade surplus must decline while China's remains unchanged. "This deterioration in the trade account will force Europeans either into raising their fiscal deficits to counteract the impact of fewer exports or letting domestic unemployment rise. Under these conditions it is hard to imagine they would tolerate much Chinese purchase of European assets without responding eventually with anger and even trade protection."
With respect to #3, in which China buys hard commodities, the scenario is the same as above except the exporters of those hard commodities will face the same choices Europe would face. The exporters can either buy U.S. assets or absorb the deterioration in their trading account, perhaps through a reduction in manufacturing capacity. This scenario also has problems for China since stock piling commodities is a bad strategy since commodity prices are volatile and that volatility is inversely correlated with the needs of the Chinese economy. It would be a good investment for China only if China grows rapidly. This would be the wrong national economy balance sheet position any country could engineer as it would exacerbate underlying social economic conditions and increase economic volatility, which is never a good thing for the poor.
With respect to #4, in which China intervenes less in the currency and does not buy anything else, China's surplus will decline by the same amount and the U.S. trade deficit will decline by the same amount. The net change on U.S. financing costs would be unchanged, while China's unemployment would rise unless it increases its own fiscal deficit, which is politically undesirable.
Pettis concludes this first half of his private newsletter with "It's about trade, not capital", which is counterintuitive to many people who do not understand how the global balance of payments works, because "...countries that export capital are not doing anyone favors unless incomes in the recipient country are so low that savings are impossible or unless the capital export comes with needed technology, and countries that import capital might be doing so mainly at the expense of domestic jobs. For this reason it is absurd for Americans to worry that China might stop buying USG bonds. This is what the Chinese worry about." Despite the U.S.-China trade dispute about China buying U.S. government bonds and the U.S. not wanting them to do so, in reality, if China's trade surplus declines then the U.S. trade deficit declines, which means China buys less U.S. government bonds and, contrary to what you may read or hear, this reduction is purchases of U.S. government bonds would not cause the U.S. interest rate to fall. To insist otherwise is to say, if a country's trade deficit rises, its domestic interest rates decline which is patently false. Pettis brings up a standard argumentative response to his observations on trade and capital exports writing "...someone will indignantly point out a devastating flaw in my argument. Since the US makes nothing that it imports from China, they will claim, a reduction in China’s capital exports to the US (or a reduction in China’s trade surplus) will have no impact on the US trade deficit. It will simply cause someone else’s exports to the US to rise with no corresponding change in the US trade balance. In that case, they say, less Chinese buying of USG bonds will indeed cause an increase in US interest rates.
"No it won’t. Unless this other country steps up its capital exports to the US and replaces China – which is pretty unlikely, and which anyway would mean the same amount of foreign purchasing of USG bonds – it must cause a reduction in the US trade deficit."
The basic point is a reduction of Chinese exports to the U.S. would be matched by increase in the same amount of exports to the U.S. from a another foreign country which would then have the impact of either lowering that foreign country's exports to other countries (if it enjoyed full employment) or a rise in imports or the foreign country (if it has unemployment). What Pettis leaves unconsidered it what would happen if there is a global contraction.
Wednesday, August 10, 2011
Yves Smith: S&P Broke Law in Leaking US Downgrade
Yves Smith at NakedCapitalism wrote that the S&P leaked information of the US downgrade prior to the public announcement to banking clients on Thursday and hedge funds on Tuesday with Twitter alight with the information Friday morning effectively allowing the banks and hedge funds to pre-trade on the information, which was not publicly released until after the market on last Friday (8/6/2011). Such an act is specifically prohibited under SEC Rules.
I have been unable to find any other news coverage or discussion of this allegedly illegal conduct except, interestingly enough at Fox News in an article by Charlie Gasparino and a video of Gasparino on Fox News disclosing the leaks by S&P. EconProph is the only other source commenting on this and extensively quoted from Yves Smith's article.
This only reinforces my previous questions as to whether S&P has a political agenda in combination with other major players in the financial sector.
Given the failure to bring prosecutions against the bankers and ratings agencies who provided us with toxic derivatives and deadly mortgage fraud as well globally risky trading activities --- all of which were profitable for those financial companies, including the ratings agencies, I am not going to hold my breath that Standard and Poor's will suffer from this allegedly illegal conduct as the financial sector is evidently too important and special to go to jail. Jail is for people who protest social injustice.
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I have been unable to find any other news coverage or discussion of this allegedly illegal conduct except, interestingly enough at Fox News in an article by Charlie Gasparino and a video of Gasparino on Fox News disclosing the leaks by S&P. EconProph is the only other source commenting on this and extensively quoted from Yves Smith's article.
This only reinforces my previous questions as to whether S&P has a political agenda in combination with other major players in the financial sector.
Given the failure to bring prosecutions against the bankers and ratings agencies who provided us with toxic derivatives and deadly mortgage fraud as well globally risky trading activities --- all of which were profitable for those financial companies, including the ratings agencies, I am not going to hold my breath that Standard and Poor's will suffer from this allegedly illegal conduct as the financial sector is evidently too important and special to go to jail. Jail is for people who protest social injustice.
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Who Owns United States Debt?
The Australian economist Bill Mitchell has been following data sets to analyze US debt and who owns it and, as of March 2011, the largest owner of US debt is the US government, which owns 41.7% (including the FED which is not an actual government agency but a private bank authorized by Congress) of its own debt. China is third at 8% behind private domestic owners at 26.9%. He also provides in the link above not only a pie chart, but a succinct macroeconomic explanation of sovereign debt and how it is not like a household (you and me) or a city, county, or other form of regional government (such as the State of Illinois) which are revenue constrained but have a guaranteed revenue stream (unlike you and me) in taxes and fees which make it easier for them to borrow. Since sovereign debt is not the same as household debt macroeconomically, it is very counter intuitive for most people no matter how educated they are. Consequently, there is much useless discussion in public debate from individuals on both sides of the political abyss who do not understand what they are talking about.
Mitchell also has come unrelated comments at the end on the UK social unrest including the belief that it would be possible to forecast social unrest by mapping the failure of governments to provide services, good education, and jobs.
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Mitchell also has come unrelated comments at the end on the UK social unrest including the belief that it would be possible to forecast social unrest by mapping the failure of governments to provide services, good education, and jobs.
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