December 31

"We understand BoA's problem -- they are completely insolvent!" Chris Whalen, via The Daily Bail.

The end of the oil age. 2011 and beyond: a reality check. Deutsche Bank


other fare:
A stunning year in climate science reveals that human civilization is on the precipice. Climate Progress.

2011: A brave new dystopia. Chris Hedges.

December 25

as opposed to the new normal:
In defense of the "Old Always". James Montier, GMO.

Outlook 2011 and the next decade: is the smart money right on China? Dian Chu.

The opening act to the broader crisis. Scott Minerd, Guggenheim Partners.

The Fallacy of a Pain-Free Path to a Healthy Housing Market. FRB Dallas.

other fare:

Searching for Jesus in the Gospels. New Yorker.

December 24

QOTD:

"Yesterday is history. Tomorrow is a mystery. And today? Today is a gift. That's why we call it the present." ~ Babatunde Olatunji

Things I believe. John Hussman.


ECRI WLI turned positive - the first time since May. dshort.

An inflation - or lack thereof - chart show. David Altig. FRB Atlanta.

Head fake. Bruce Krasting.                           

Outlook 2011: Crude oil and gasoline, escalator up, elevator down. Dian Chu.

Garth Turner discusses how Canadian bankers are no less greedy and no more conservative than U.S. bankers were re: mortages.

December 22

Velocity of money. James Hamilton.
awesome conclusion:

"someone who insists that inflation (P) must go up just because the monetary base (M) has risen may have lost their marbles."

Pref share yield-to-call calculator. Google Docs.


other fare:
A holiday message from Ricky Gervais.

In front of your nose. George Orwell.

Best of rationality quotes.

December 19

All that glitters. Howard Marks of Oaktree, on gold.



other fare:

December 17

"Europe And US Have Learned Nothing From Japan's Lessons And Will Repeat Its Mistakes". Richard Koo.

"I Do Not Really Have One Scintilla Of Doubt That This Will All End In Tears - Again". Albert Edwards.

December 13

Living with low for long. Mark Carney, BoC.

Current turbulence in Europe is a reminder that the crisis is not over, but has merely entered a new phase. In a world awash with debt, repairing the balance sheets of banks, households and countries will take years.

For the crisis economies, the easy bit of the recovery is now finished. Temporary factors supporting growth in 2010–such as the turn in the inventory cycle and the release of pent-up demand–have largely run their course. Fiscal stimulus is turning to fiscal drag and, for some countries, rapid consolidation has become urgent. Household expenditure can be expected to recover only slowly. This all implies a gradual absorption of the large excess capacity in many advanced economies.

This is not surprising. History suggests that recessions involving financial crises tend to be deeper and have recoveries that take twice as long. In the decade following severe financial crises, growth rates tend to be one percentage point lower and unemployment rates five percentage points higher.1 The current U.S. recovery is proving no exception.

In such an environment, very low policy rates in the major advanced economies could be in place for a prolonged period–a possibility underscored by the recent extensions of unconventional monetary policies in the United States, Japan and Europe.

Big numbers from the BIS. FT Alphaville.

The eurozone is in bad need of an undertaker. Ambrose Evans-Pritchard.

What the German people are being asked to do is to surrender fiscal sovereignty and pay open-ended transfers to Southern Europe, taking on a burden up to six times reunification with East Germany. "If we pool the debts of the countries in the south-west periphery of Europe, we are blighting our children’s future: the debt levels are astronomic," said Hans-Werner Sinn, head of Germany IFO institute. Any attempt to prop up the status quo will cement the current account imbalances of EMU’s North and South, to the detriment of both sides. "I doubt that the current leaders of Europe fully understand the economic implications of their decisions. They are repeating the mistakes that Germany made over reunification," he told the Handelsblatt.

Transfers to the East are still running at €60bn a year two decades after the fall of the Berlin Wall. There has been no meaningful East-West convergence for the last 15 years. To those who blithely argue that EMU is a good racket for German exporters because it locks in Germany’s competitive advantage, he retorts that a trade surplus is the flip side of a capital deficit. Germany has seen €1 trillion – or two thirds of its entire savings since 2002 – leak out to fund the EMU party, gutting investment at home. This is toxic for Germany too....

So as EU leaders flounder, the task of saving monetary union falls to the ECB. Yet it too has declined the burden, refusing to go nuclear with bond purchases. "Each country needs to be held responsible for its own debt," said Germany’s monetary avenger at the ECB, Jurgen Stark. He was joined last week by Mario Draghi, Italy’s governor and candidate for ECB chief, who said it was not the job of a central bank to carry out fiscal rescues. "We could easily cross the line and lose everything we have, lose independence, and basically violate the Treaty," he said.

Indeed. Maastricht forbids the ECB from buying the debt of eurozone states except for specific purposes of liquidity management. But this saga no longer has anything to do with liquidity. Southern Europe faces a solvency crisis.

Block those metaphors. Paul Krugman.

What we’ve been dealing with ... is a painful process of “deleveraging”: highly indebted Americans not only can’t spend the way they used to, they’re having to pay down the debts they ran up in the bubble years....

What the government should be doing in this situation is spending more while the private sector is spending less, supporting employment while those debts are paid down. And this government spending needs to be sustained:... spending that lasts long enough for households to get their debts back under control. The original Obama stimulus wasn’t just too small; it was also much too short-lived...

But wouldn’t it be expensive to have the government support the economy for years to come? Yes, it would — which is why the stimulus should be done well, getting as much bang for the buck as possible.... [but] the tax-cut deal is likely to deliver relatively small benefits in return for very large costs. ... Tax cuts for the wealthy will barely be spent at all; even middle-class tax cuts won’t add much to spending. And the business tax break will, I believe, do hardly anything to spur investment given the excess capacity businesses already have.

The actual stimulus in the plan comes from the other measures, mainly unemployment benefits and the payroll tax break. And these measures (a) won’t make more than a modest dent in unemployment and (b) will fade out quickly, with the good stuff going away at the end of 2011.

The question, then, is whether a year of modestly better performance is worth $850 billion in additional debt, plus a significantly raised probability that those tax cuts for the rich will become permanent. And I say no. The Obama team obviously disagrees. As I understand it, the administration believes that all it needs is a little more time and money, that any day now the economic engine will catch and we’ll be on the road back to prosperity.... What I expect, instead, is that we’ll be having this same conversation all over again in 2012, with unemployment still high and the economy suffering as the good parts of the current deal go away.

Reconsidering Japan and Reconsidering Paul Krugman. Truthout.

there is a commonsense aspect to this story that gets lost amid the rhetoric and the headlines. Two lessons of our times are that economic bubbles eventually burst, and that the environmental consequences of unbridled growth in this age of global warming are severe. The world needs to figure out how advanced economies can provide for their people without relying on roaring growth rates driven by asset bubbles. If consumer-driven growth was the order of the day in the post-World War II era, going forward it is going to be steady-state economic growth - growing not too fast, but not too slowly - and learning to do more with less.

Like bulls in a China shop. Bob Janjuah.

A terrible way to fix the economy: households deleveraging through defaulting on debt. rortybomb.

What to make of this? First off, I’m terrified at the idea that national wealth is roughly at the level to pay for the servicing of debt but not necessarily pay off any actual debt. Our household sector is at the point where we can make the minimum payment on our metaphoric credit card without paying any of it down, and the only other choice is to not pay it at all.

other fare:
Human extinction: not the worst case scenario. 3QD.

Civilization has bestowed our species with a distorted self-image. Many people seem to have the impression that we operate independently of nature. We are fortunate that we’ve been able to act as though we are independent for as long as we have. If we don’t adjust our way of living so that it becomes sustainable, however, nature will eventually do this for us.

December 12

Interim Update. Van Hoisington and Lacy Hunt.

Operations by the Federal Reserve, including the start of the second round of quantitative easing (QE2), have increased bank reserves by approximately $1 trillion since the latter part of 2008. Virtually all of this gain is held in excess reserves at the Federal Reserve Banks earning very close to 10 basis points. In other words, the Fed has provided substantial new reserves to the banks and they have, in turn, deposited the funds back with the Fed.

Reserves are not money unless banks turn them into loans and deposits. Loans are made based on bank capital, which continues to erode because of loan write-offs due to increasing delinquency and default.

Market still facing major risks. Comstock Partners.

Banks went into the 2008 credit crisis loaded with toxic assets, and, to a large extent, they still have them. While TARP was originally proposed by Treasury Secretary Paulson as a buyout of toxic assets, the program was almost immediately changed to a generalized bailout. The accounting rule-makers were then pressured to do away with mark-to-market accounting, thereby papering over the problem and leaving most of the toxic assets on the banks' books, where they remain today. This is one of the reasons banks are hoarding cash and are so reluctant to lend. They know what they have.

Is America following the same path as Japan? Comstock Partners.

The hidden message of the consumer credit statistical release. Gaius Marius.
lies, damn lies and statistics:

this purchase program -- which amounted to the department of education buying privately-originated student loans that were intended to be securitized but now could not be -- was radically expanded in 2009 and 2010, with a purchase amount target of about (you guessed it) $120bn. (the reporting of the actual purchases is here.)

in other words, what is being included in the g.19 as an expansion of student loans (and thereby consumer credit) is really in fact a bailout of several large banks and finance companies stuck with immovable loans.

China's credit bubble on borrowed time as inflation bites. Ambrose-Evans Pritchard.

Warning - An Updated Who's Who of Awful Times to Invest. John Hussman.


other fare:
Tea'd off. Christopher Hitchens.

December 10

Europe's inevitable haircut. Barry Eichengreen.

What once could be dismissed as simply a Greek crisis, or simply a Greek and Irish crisis, is now clearly a eurozone crisis. Resolving that crisis is both easier and more difficult than is commonly supposed.

The economics is really quite simple. Greece has a budget problem. Ireland has a banking problem. Portugal has a private-debt problem. Spain has a combination of all three. But, while the specifics differ, the implications are the same: all must now endure excruciatingly painful spending cuts.

The standard way to buffer the effects of austerity is to marry domestic cuts to devaluation of the currency. Devaluation renders exports more competitive, thus substituting external demand for the domestic demand that is being compressed.

But, since none of these countries has a national currency to devalue, they must substitute internal devaluation for external devaluation. They have to cut wages, pensions, and other costs in order to achieve the same gain in competitiveness needed to substitute external demand for internal demand.

The crisis countries have, in fact, shown remarkable resolve in implementing painful cuts. But one economic variable has not adjusted with the others: public and private debt. The value of inherited government debts remains intact, and, aside from a handful of obligations to so-called junior creditors, bank debts also remain untouched.

This simple fact creates a fundamental contradiction for the internal devaluation strategy: the more that countries reduce wages and costs, the heavier their inherited debt loads become. And, as debt burdens become heavier, public spending must be cut further and taxes increased to service the government’s debt and that of its wards, like the banks. This, in turn, creates the need for more internal devaluation, further heightening the debt burden, and so on, in a vicious spiral downward into depression.

So, if internal devaluation is to work, the value of debts, where they already represent a heavy burden, must be reduced. Government debt must be restructured. Bank debts have to be converted into equity and, where banks are insolvent, written off. Mortgage debts, too, must be written down.

Default, delusion and deceit (and other ways to spring the debt trap). Roger Bootle of Capital Economics, in the Telegraph.

There are five ways of escape [from the debt trap].

First, try to muddle through and hope that years of sustained economic growth will cause the weight of these debts to fall and for the burden to go unnoticed amidst increasing prosperity, so that it is unclear who has picked up the tab. This is far and away the best solution – if you can manage it. But in the vulnerable countries GDP is struggling – or even contracting.

Second, engineer a bout of inflation to reduce the real value of the liabilities. In this way just about everyone in society will pay – but hopefully no one will notice. (Being able to devalue your currency potentially helps you achieve both the first and the second routes.) The trouble is that even if this solution were available for the eurozone as a whole, for each embattled member country it is not, as they do not have their own money.

Third, force those who caused the problems and gained from the years of extravagance to cough up. That would mean the bankers, property developers and politicians. This seems the fairest solution, but it is also the least likely. And, believe it or not, even they do not have enough dosh.

Fourth, slash government spending and make current and future taxpayers pick up the tab. This is the way that Ireland and Greece are trying to go. The trouble is that the situation may be so far gone that attempting a solution this way is impossible. It may even be so deflationary that it proves to be counter-productive.

The fifth way is to default. Perhaps you can make someone not involved in the process by which the government gets elected take a good part of the hit. This is where Johnny Foreigner comes in. You say: "Sorry old chaps, but that money that you thought we owed you is now 'restructured'. In the words of Monty Python, it is an ex-loan."

This is what is going to happen. Huge amounts of money are going to be lost. At the moment, the prospective losers can afford it. But coming up in the lift are Portugal, Belgium and Spain. And then Italy. This looks eerily like the build-up to the financial crisis of two years ago. Perhaps the bail-out of Ireland is the Bear Stearns moment. Spain, or Italy, could be the Lehman moment.

Eclectica Fund: Manager Commentary, December 2010. Hugh Hendry.
subtitled "There are no policy remedies for debt deflation"



other fare:
The decline and fall of the American Empire. Alfred McCoy
also on Salon, provocatively but dumbly entitled How America will collapse (by 2025), and which led a colleague of mine to say, when grabbing the article off the printer, "Oh, this has you written all over it!" Well, maybe so, but I don't believe in collapse, per se; however, its hard to argue with the notion that the debt situation is onerous, or that unfunded liabilities will be a serious challenge, or that climate change and peak oil present potentially problematic possibilities, and that geopolitics and terrorism are serious risks, and even the internal socio-political-economic atmosphere, with high unemployment and the Tea-Partiers, etc., is difficult; so there are some very ominous impediments to the continuation of American "exceptionalism", and each of those issues are ones I find of significant (not just academic?) interest, even if only to acknowledge as risks to our outlook

December 9

The European Council is once again at each others' throats. Eurointelligence.

The three stages of delusion by Dylan Grice and the London Brief by Omar Sayed, both on Europe. via Outside the Box.

Grice: Simply expanding it in its current form so that the ‘solvent core’ commits to raise yet more funds for the ‘insolvent periphery’ fails to address the risk that as more dominos fall the bailers shrink relative to the bailees (Italy and Spain combined – who’s spreads have been blowing out this week – are combined bigger than Germany). At what point does the insolvent periphery include so many countries that markets lose confidence in the solvency of the shrinking core to bail them out. Leaving aside for now the unpleasant reality that the solvent core might not actually be so solvent, perhaps the spread between ‘insolvent’ Greece and solvent France should be narrower? I wish I knew. In the absence of ECB printing, I suspect we’re going to find out.

Sayed: So in order to preserve this unholy union, what options does the EU have?   I see four: (1) the Marshall Plan II; (2) the Treaty of Versailles II; (3) the printing press option and (4) the Icelandic option.  Each has its challenges and problems.

as for me, I think that Texans and Nebraskans have no choice but to support Californians and Illini, as they're already part of a fully-integrated fiscal-monetary-social-policitical union; Germans and Dutch have a choice regarding supporting Greeks and Portugese. Without a true fiscal and political union, how can a monetary union with such disparate member states actually operate effectively over the long-term?

December 2

Default, departures or denial? Buttonwood.

The euro at mid-crisis. Kenneth Rogoff.

probably only at the mid-point of the crisis. To be sure, a huge, sustained burst of growth could still cure all of Europe’s debt problems – as it would anyone’s. But that halcyon scenario looks increasingly improbable. The endgame is far more likely to entail a wave of debt write-downs, similar to the one that finally wound up the Latin American debt crisis of the 1980’s. For starters, there are more bailouts to come, with Portugal at the top of the list. With an average growth rate of less than 1% over the past decade, and arguably the most sclerotic labor market in Europe, it is hard to see how Portugal can grow out of its massive debt burden....

But bailouts for Portugal and Spain are only the next – and not necessarily final – phase of the crisis. Ultimately, a significant restructuring of private and/or public debt is likely to be needed in all of the debt-distressed eurozone countries. After all, bailouts from the EU and the IMF are only a temporizing measure: even sweetheart loans, after all, eventually must be repaid. Already facing sluggish growth before fiscal austerity set in, the so-called “PIGS” (Portugal, Ireland, Greece, and Spain) face the prospect of a “lost decade” much as Latin America experienced in the 1980’s. Latin America’s rebirth and modern growth dynamic really only began to unfold after the 1987 “Brady plan” orchestrated massive debt write-downs across the region. Surely, a similar restructuring is the most plausible scenario in Europe as well....

Here is where the latest Irish bailout is particularly disconcerting. What Europe and the IMF have essentially done is to convert a private-debt problem into a sovereign-debt problem. Private bondholders, people and entities who lent money to banks, are being allowed to pull out their money en masse and have it replaced by public debt. Have the Europeans decided that sovereign default is easier, or are they just dreaming that it won’t happen? By nationalizing private debts, Europe is following the path of the 1980’s debt crisis in Latin America. There, too, governments widely “guaranteed” private-sector debt, and then proceeded to default on it. Finally, under the 1987 Brady plan, debts were written down by roughly 30%, four years after the crisis hit full throttle.

Imminent Eurozone default: how likely? Simon Johnson.

The prevailing consensus – and definite official spin – is that over the weekend European leaders backed away from the German proposal to impose losses on creditors as a condition of future bailouts, i.e., from 2013. The markets, in this view, should and likely will calm now; there is no immediate prospect of any kind of sovereign default... But a close reading of the Eurogroup ministers’ statement from Sunday suggests quite a different interpretation... [I]t has potentially momentous consequences – as it envisages dividing future eurozone crises into two kinds. “For countries considered solvent, on the basis of the debt sustainability analysis conducted by the [European] Commission and the IMF, in liaison with the ECB, the private sector creditors would be encouraged to maintain their exposure according to international rules and fully in line with the IMF practices. In the unexpected event that a country would appear to be insolvent, the Member State has to negotiate a comprehensive restructuring plan with its private sector creditors, in line with IMF practices with a view to restoring debt sustainability. If debt sustainability can be reached through these measures, the ESM [European Stability Mechanism] may provide liquidity assistance.”

Translation: if it is decided your country is “insolvent”, rather than illiquid, then you have to restructure your debts. But who exactly will decide?... the bombshell: “On this basis, the Eurogroup Ministers will take a unanimous decision on providing assistance.”

In other words, any one member of the eurozone can veto a country being determined merely illiquid – thus cutting them off from cheap and endless credit (from the ECB or ESM or any window to be named later). So now Germany effectively has a veto – as do other fiscally austere countries. Most likely we will witness the creation of an Austere Coalition (actually a modified Hanseatic League) of Germany, Austria, Finland, Estonia, and a few of the smaller countries.

The man with the magic words. Richard Smith.
Monday/Tuesday, panic re: Euro; Wednesday, all calm. why? Trichet soothed markets, suggesting ECB will buy PIGS debt, but also that a monetary federation, which they have, is not enough, that they "need a quasi-budget federation as well"; but is that do-able? is there political wherewithal? or, more likely, will Merkel and Weber rile markets up again? either way:

ECB funding programmes won’t fix any of that. Handouts or haircuts: the next stage of the political debate in Euroland will have to deliver a choice, and a plan

More thoughts on the ECB decision. Marc Chandler.

European officials must have known they were going to disappoint the market with the decision to simply postpone draining liquidity. The firewall around Greece failed. The firewall around Ireland has failed. The politicians have dropped the ball and the left Trichet holding the bag. Many from the periphery appeared to lobby the ECB to help out. Trichet in essence says there is little it can do and that it is really up to the governments. What Trichet announced today seems like the bare minimum of what it could do without immediately intensifying the crisis

Are the banks insolvent? Fair question, given this... Karl Denninger.

The big economic story, and why Obama isn't telling it. Robert Reich.

Albert Edwards: China's leading indicators are flashing warning light. zero hedge.

Viral! Rick Bookstaber.
discusses the age of private information, the age of too much information, and the age of viral information:

The new, viral world means more surprises and more volatility; and not because of market shocks precipitated by content, but because of the randomness in what might happen to catch on and reverberate through the internet.

other fare:
Sarah Palin wasn't the only one: Tom Flanagan, an advisor to PM Harper, in a live TV intereview, also called for the assassination of Wikileaks founder, Julian Assange. Telegraph.

December 1

QOTD:

Politics is the art of looking for trouble, finding it everywhere, diagnosing it incorrectly and applying the wrong remedies. Groucho Marx.

Edward Harrison summarizes Bill Gross' latest, and offers some of his own views, including:

There are four ways to reduce real debt burdens:

• by paying down debts via accumulated savings.
• by inflating away the value of money.
• by reneging in part or full on the promise to repay by defaulting
• by reneging in part on the promise to repay through debt forgiveness

Right now, everyone is fixated on the first path to reducing (both public and private sector) debt. I do not believe this private sector balance sheet recession can be successfully tackled via collective public sector deficit spending balanced by a private sector deleveraging. The sovereign debt crisis in Greece tells you that. More likely, the western world’s collective public sectors will attempt to pull this off. But, at some point debt revulsion will force a public sector deleveraging as well.

And unfortunately, a collective debt reduction across a wide swathe of countries cannot occur indefinitely under smooth glide-path scenarios. This is an outcome which lowers incomes, which lowers GDP, which lowers the ability to repay. We will have a sovereign debt crisis. The weakest debtors will default and haircuts will be taken. The question still up for debate is regarding systemic risk, contagion, and economic nationalism because when the first large sovereign default occurs, that’s when systemic risk will re-emerge globally.

Ireland's reparation burdens. Barry Eichengreen.

The Irish “rescue package” finalized over the weekend is a disaster. You can say one thing for the European Commission, the ECB and the German government: they never miss an opportunity to make things worse.

The rough politics of European adjustment. Michael Pettis.

I have no doubt that enormous amounts of scotch tape, paper clips, and chewing gum are going to be deployed quickly to hold the whole thing together, and that perhaps in a week or two we will be all throwing sighs of relief as policymakers firmly announce that Europe was put to the ultimate test and proved itself manfully. But does that mean we can stop worrying – was this really the ultimate test? No, of course not. If previous history is any guide, this crisis will re-emerge in different places every few months until it is truly resolved...

Unfortunately it is going to require a lot more than emergency liquidity loans, no matter how plentiful, to arrive at a final resolution. These loans simply paper over the financing gap until the next big refinancing exercise, and each new loan effectively shortens the duration of the debt or claims a higher level of seniority, so that the capital structure becomes increasingly risky. As the capital structure becomes riskier, it takes a smaller and smaller event to set off the next crisis.

Hangover theory and morality plays. Steve Waldman. 

Austrian-ish “hangover theory” claims, plausibly, that if for some reason the economy has been geared to production that was feasible and highly valued in previous periods, but which now is no longer feasible or highly valued, there will be a slump in production.... There is no school of economic thought I know of that suggests increased prosperity and consumption in and of themselves require a painful purge. The claim is that some patterns of economic activity create the appearance of prosperity and enable temporary consumption that cannot be sustained, and that moving from a period during which such patterns obtain to a more “sustainable pattern of specialization and trade” involves adjustments that are difficult.... 

It is not technocratic economists who will win the day and pull us out of our cul-de-sac, but angry Irishmen and Spaniards who challenge, on moral terms, the right of German bankers to impose vast deadweight costs on current activity because they lent greedily into what might easily have been recognized as a property and credit bubble.

European Leaders Should Focus on the Banks, Not the Sovereigns. Peter Atwater.

The market is saying “when” not “if” any more. To stop the spreading contagion, European leaders need to stop focusing on the sovereigns and start focusing on the banks. As we have already seen, troubled sovereign nations can be kept alive for an extended period of time, but banks can’t. But rather than growing sovereign double leverage even further -- in which a troubled nation, like Ireland, borrows from the EU to put equity capital into its banks -- if the EU is serious about stopping the growing banking contagion, it is going to have to consider its own pan-European TARP/FDIC program for Europe’s largest banks. And whether Europe has the stomach for that we’ll soon find out. But until Europe divorces banking strength from sovereign strength, they will both go down together.

Bankers gone wild... in Ireland AND Germany. Marshall Auerback.

Much ink has been spilled in the press over the Irish problem and the laxity of the country’s southern Mediterranean counterparts in contrast to the highly “disciplined” Germans. But perhaps we have to revisit that caricature. Not only has the Irish crisis blown apart the myth of the virtues of fiscal austerity during rapidly declining economic activity, but it has also illustrated that Germany’s bankers were every bit as culpable as their Irish counterparts in helping to stoke the credit bubble.....

All of the rescue plans that have been introduced in Ireland or Greece thus far rest on the assumption that, with more time, the eurozone’s problem children could get their fiscal houses in order — and Europe could somehow grow its way out of trouble. But the fiscal austerity being offered as the “medicine” is turning out to be worse than the disease. It has exacerbated the downturn and unleashed a horrible debt deflation dynamic in all of the areas where it was reluctantly implemented.

‘Insolvent’ Portugal Needs Loans Soon, Buiter Says. Bloomberg.

“Despite the recent drama, we believe we have only seen the opening act, with the rest of the plot still evolving,” Buiter wrote. “Accessing external sources of funds will not mark the end of Ireland’s troubles. The reason is that, in our view, the consolidated Irish sovereign and Irish domestic financial system is de facto insolvent.”

Why the Irish crisis is such a huge test for the eurozone. Martin Wolf, FT.

So what, against this background, needs to be done by individual countries and the eurozone? Not what was done in Ireland, is one answer. The Irish banking system is worse than too big to fail; it is too big to save. The first duty of the state is to save itself, not to load its taxpayers with obligations to rescue careless lenders. If the eurozone is not a “transfer union”, that has to work both ways: taxpayers of one state should not rescue those of others from having to save their banks from their follies.

The Irish state should have saved itself by drastic restructuring of bank liabilities. Bank debt simply cannot be public debt. If bank debt is to be such debt, bankers should be viewed as civil servants and banks as government departments. Surely, creditors must take the hit, instead.

That leaves the sovereigns. What is needed here, as eurozone leaders recognise, is a combination of generous funding with restructuring: the former is to reverse self-fulfilling panics; the latter is to recognise the realities of insolvency. Managing this combination would be very tricky.

Endgame. Eurointelligence.

The EU’s credibility is sinking with each agreement. We are now fast approach default time... We at Eurointelligence consider a default of Greece, Ireland, and Portugal a done deal. The question is only now whether Spain can scrape through.

Can the eurozone afford its banks? Robert Peston, BBC.

For Europe's very biggest banks, the ratio of their assets to their equity capital is 50% greater than for the UK's banks and 100% in excess of the so-called leverage ratio of big US banks, according to Bank of England calculations. Or to put it another way, Europe's giant banks appear to be taking far bigger financial risks than US and UK banks in relation to the reserves they retain as protection against potential losses.

So here's the big question. O'Neill may well be right that a reformed, integrated eurozone could cope with the aggregated sovereign debts of its members. But it is altogether another question whether even Germany could afford to underwrite the liabilities of the eurozone's monster banks, if creditors started to seriously question whether those banks have sufficient capital.

If Ireland doesn't take the bailout. Gonzalo Lira.

the problem in Ireland really isn’t so much the state’s deficits—rather, it’s the state’s guarantees of the Irish banks. That is what led to this mess. Yes, the Irish public sector is bloated, but it’s the banks that are busting the fiscal budget.

The Irish government allowed the banks to grow too big for too long, and to get mixed up in too many dicey deals—and so when the crisis hit in 2008, instead of letting them fail, Brian Cowen and his Fiana Fáil government backstopped those banks.

Much like in the United States in 2008, the Irish confused an insolvency issue with a liquidity issue. They thought their banks were having a cash crunch, when really, they were broke.

Cowen is reaping what he sowed: Even if the 2008 crisis had been a cash crunch and not an insolvency issue, Cowen never should have backstopped those banks—not when their combined liabilities were twice the GDP of Ireland...

Right now, the Irish people know that they are footing the bill so that British, German and American banks don’t suffer for having been foolish enough to be caught with Irish bank bonds. Rightfully, the Irish people are pissed.

November 29

Taking von Mises to pieces. Buttonwood, The Economist.

policymakers seem to show a lot less interest in the economic ideas of the "Austrian school” led by Ludwig von Mises and Friedrich Hayek, who once battled Keynes for intellectual supremacy. Yet the more you think about recent events, the odder that neglect seems. A one-paragraph explanation of the Austrian theory of business cycles would run as follows. Interest rates are held at too low a level, creating a credit boom. Low financing costs persuade entrepreneurs to fund too many projects. Capital is misallocated into wasteful areas. When the bust comes the economy is stuck with the burden of excess capacity, which then takes years to clear up.

other fare:
The next great crash will be ecological - and nature doesn't do bailouts. Johann Hari.

Margaret Atwood interview. Guardian.

November 25

Hamping Europe's periphery. Paul Krugman.

European defaults and Chinese inflation. Michael Pettis.


other fare:
Nassim Taleb looks at what will break, and what won't. The Economist.

Most traffic-congested cities in North America. Paul Kedrosky.

November 23

Zombie bears. Barry Ritholtz.

Failure to consider constraints. Mish.
skim thru the first part about his predictions, but the rest of the post is good review

Shadow over Asia. Interview of Vitaliy Katsenelson by David Galland.

I am a big believer that in the boxing match between a visible and an invisible hand, though the invisible hand may lose a few rounds, it will win the match every time....
There are no shortcuts to greatness. As long as they keep building new bridges [to nowhere], the economic numbers will register that there is growth, but at some point the piper will have to be paid, and these projects have a negative return on capital....
The problem with China is pretty much the same as with any bubble. Though it may have had a solid foundation under it, it is simply a good thing taken too far.... the actions taken by the Chinese government, especially after the recent global recession, have basically supersized the bubble that was already forming.... The government can drive this bubble further than a rational observer would expect....
In the case of Japan, their government basically ran out of chips. I think the Chinese government still has enough chips to keep the bubble going awhile longer. These bubbles usually last longer than the reputation of the person who predicts their demise.

November 22

CoreLogic: Shadow Housing Inventory pushes total unsold inventory to 6.3 million units. Calculated Risk.

Banks face another mortgage crisis. Barron's.
But Chris Whalen of IRA thinks the exposure of the banks is much greater than Barron's says.

Fannie Mae, Freddie Mac and the Coming Wave of Foreclosure Buybacks. RealtyTrac.

There will be blood. Paul Krugman.

Call Their Bluff, Mr. President. David Cay Johnston.



sorta related fare:
Obama the house negro --- pity the man who walks on his knees (and the nation he leads from that position). Evert Cilliers aka Adam Ash, 3QD.

However, this was but a screwup in a teacup compared to what the Dems did, which was wreck their chances for making any more “reforms” for the next two years or more. And a silent fart in a huge cathedral compared to what our President has wrought, which was wreck his chances for re-election. Just like the Republicans have successfully obstructed anything that can do the country any good over the last two years so they can blame everything wrong on the Democrats, they are now going to make damn sure nothing good happens at all so they can blame everything wrong on the president, and replace him with Mitt Romney (maybe even Sarah Palin). Simple election strategy, and amazingly effective.

totally other fare, especially for basketball lovers:
When David beats Goliath: When underdogs break the rules. Malcolm Gladwell, The New Yorker.

Some thoughts, with references

I share the views of the world of:

Richard Koo, Paul Krugman, Mark Thoma, etc., w.r.t.:
the unique, persistent nature of balance sheet recessions, as distinct from normal cyclical recessions; the need for more government intervention to get unemployment down; the liquidity trap, which causes normal transmission channels of monetary easing, which normally induce housing-led recoveries, to be no better than pushing on a string; and, therefore, the primacy of fiscal policy to fill the gap in aggregate demand in order to achieve the objectives of reducing unemployment and increasing inflation; but, in the absence of sufficient fiscal policy, the necessity for further monetary policy easing, however non-traditional and (in-)effective that may be;

Irving Fisher, Steve Keen, Gary Shilling, Van Hoisington and Lacy Hunt, David Rosenberg, Felix Zulauf, Ray Dalio, Albert Edwards, etc., w.r.t.:
the huge excess of unsustainable debt growth built up over two decades, and the concomitant excessive spending, represented enormous pulling-forward of aggregate demand, which ultimately must be paid for with future savings from income and therefore lower future demand in the same scale as past excess consumption; that that process of debt accumulation appeared to be sustainable not due to income growth but due to the chimera of wealth enhancement due to elusive/temporary asset-price appreciation in the housing market; the credit expansion created excess claims to underlying real wealth; once the asset-price bubble burst, i.e. the Minksy moment, the resultant debt-deflation dynamics, including the paradox of thrift, deleveraging, declining money multipliers and monetary velocity, deflation of broadest measures of effective money supply, which, contrary to the views of many traditional economists, critically includes credit (which dwarves traditional measures of money supply, like M2) (i.e. deflation is a decrease in money and credit relative to available goods and services); and resultant disinflation of wage and price levels; in this deleveraging, disinflationary, low-growth environment, there's no evidence that the secular bull market in bonds has expired, as the phenomenon of lower yields for the last 25 years has been consistent with declining rates of nominal GDP growth, which persists --- i.e. yields have yet to see their lows

Kenneth Rogoff and Carmen Reinhart, et al, w.r.t.:
the costliness of economic recessions that are coupled with financial crises, both in terms of share of GDP and recovery time, particularly given the hits to the consumer due to the debt burden mentioned above and the housing recession; that recovery is extended until the debt overhang is absolved or resolved

Chris Whalen, Josh Rosner, Janet Tavakoli, William Black, John Hussman, etc., w.r.t:
the disastrous policy of rescuing the banks rather than rescuing the banking system, i.e. following the failed Japanese model rather than the successful Nordic model of responding to a financial crisis; that fundamentally nothing that caused the credit crisis has gone away or improved (and in fact have gotten worse when it comes to commercial real estate), only that the inherent problems on bank balance sheets have been glossed over or hidden from public view but remain there (e.g. all of the nation's banks jointly earned $22billion in Q2, thanks largely to reducing reserves against losses by $27billion compared to a year earlier), making the banks into zombie banks and effectively nationalizing the whole mortgage market, but without having done anything to help homeowners with mortgages, the root of the problem; and that without proper debt restructuring (haircuts, debt-for-equity swaps, etc.), the problem will persist and fester; the government's notion that re-capitalizing the banks would result in a multiplier effect (each dollar of capital injected into banks by the government would result in $8 of new lending to families!) proclaimed by Obama was either naive idiocy or duplicitous crony capitalism; that extend-and-pretend merely postpones the necessary adjustments and extends the adjustment period

Joseph Stiglitz, Paul Krugman, Simon Johnson, Paul Volcker, Robert Reich, Mervyn King, William Black, Dean Baker, etc etc etc, w.r.t:
the TBTF banks are not TBTF; until they are broken up and until the paper-ponzi-pushing egomaniac CEOs of those TBTFs lose their sway over policy via their lapdogs, policy-makers will stick with their failed strategies, to the detriment of the economy; the financial sector of the economy is a tax on the productive sectors of the economy

Meredith Whitney and Chris Whalen w.r.t:
the likelihood of states and municipalities defaulting on their debt

Gary Shilling w.r.t.:
the housing recession is not over; house prices remain too high based on price-to-income and price-to-rent metrics, and will fall further thanks to high vacancy rates, tight credit, nonexistent income growth, high unemployment, poor supply-demand dynamics, fraud-closure problems, shadow inventory; reduced housing construction has not yet compensated for too-long a period of over-building, etc.

Warren Mosler, Marshall Auerback and Randall Wray w.r.t.:
on the fiscal side, that, operationally, government spending is not constrained by revenues, there is no solvency problem for the federal government, or any government that issues its own currency; on the monetary side, that QE is not money printing, it is an asset swap (though the monetary base will increase, and, in this very limited sense QE could be construed as money printing, the monetary base does not constitute a full measure of money, which in aggregate will be unaffected); QE is thus not inflationary; it is functionally equivalent to the government issuing T-bills rather than long bonds; excess reserves do not get lent out; expansion of the monetary base is a result of increased lending, not a cause of increased lending; unintended consequences of monetary ease include that ZIRP reduces income for savers, and QE pulls yet more interest income out of the private sector of the economy, neither of which helps the situation; therefore, as per above, I disagree vehemently with the likes of Alan Meltzer who complain that the "enormous increase in bank reserves [caused by QE] will surely bring on severe inflation if allowed to remain" --- though I also disagree with the Fed's notion that it is the paying of interest on reserves that "breaks the link between the quantity of reserves and banks' willingness to lend"

Michael Pettis, w.r.t.:
China's huge trade surplus means that although it accounts for a significant share of global growth, it does not actually contribute significantly to global growth; i.e. its trade surplus means that it absorbs much more demand than it supplies; in fact, China's policy of perpetuating both existing global imbalances and also internal imbalances will make the inevitable adjustment processes that much more difficult and painful; China has been able to maintain high rates of growth by mercantilist export-led growth strategies, which parasitically rely on consumption growth in OECD countries, thereby making the trading partners that China relies on that much weaker (i.e. by appropriating other countries’ demand), and also by continually investing in excess productive capacity (65% of GDP accounted for by fixed-asset investment), which is already well out of line with global demand (akin to the significant over-building in U.S. residential and non-residential construction); massive overinvestment and misallocation of capital seldom ends well; that China is fundamentally not all that dissimilar in nature to Japan circa-1980s (when Japan was considered a miraculous economic success story, and keiretsu were all the rage, as was Japanese innovation and work ethic and MITI-central planning, etc., and when its share of global GDP went from 7% in 1970 to 18% in 1990 --- but has subsequently fallen back to 8%); Chinese consumption growth has been far short of its GDP growth, such that consumption has fallen to just 36% of GDP in 2009, from an already low 46% in 2000, an unhealthily small share of GDP, and is reflective of household income growth, which, while robust by developed country standards, has trailed GDP growth; this internal imbalance will require a period of difficult re-balancing, which, though not necessarily imminent, is inevitable; the question is whether income and consumption growth can exceed GDP growth with that latter being sustained in the prevailing range of 8-10%, which would be inconsistent with historical precedents, or the rebalancing would require GDP growth to fall below household income and consumption growth

Jim Chanos, w.r.t.:
China = Dubai times 1000; China = Enron; China's lending bubble, real estate bubble, stock market bubble, aura bubble

Chanos, Dylan Grice and Peter Gibson, w.r.t.:
every single financial crisis in the last 150 years has been preceded by rampant credit growth; there is a Chinese financial crisis in the making

Marshall Auerback and Albert Edwards w.r.t.:
that beggar-thy-neighbour geopolitics has become the norm, and portend the a potential nasty trade war, particularly given domestic U.S. political considerations and also given China's consistent policy of always doing what's in its own best mercantilist interest; that "Chimerica" has been a chimera; the Fed's attempt to trash the dollar may be motivated by a desire to force the Chinese, who have no wish to revisit the inflation-induced social unrest of 1989, to revalue the yuan sooner rather than later if QE causes commodity and food-price inflation to get out of hand (its unlikely that the Chinese are unaware that food price inflation was a primary contributor to social unrest at the start of the Iranian, Russian and French Revolutions)

Ambrose Evans-Pritchard, w.r.t.:
Europe's "gamble of launching a premature and dysfunctional currency without a central treasury, or debt union, or economic government to back it up, and before the economies, legal systems, wage bargaining practices, productivity growth and interest rate sensitivity, of [the Teutonic] north and [Club Med] south Europe had come anywhere near sustainable convergence, may now backfire horribly" due to its one-size-fits-none arrangements; problems in Ireland and Greece and Portugal cannot be ring-fenced, because Spain will be next in line and it is big enough to bring the whole house of cards down

Dean Baker, Jeremy Grantham, etc., w.r.t.:
the precariousness of the housing market in Canada; that it is naive to believe that "conservative" Canadians could not have bid house prices up much too high just because subprime lending is not endemic here as it was in the U.S., or because mortgages are non non-recourse and mortgage interest payments are not tax-deductible; none of these things changes the fact that most people now own too much home, evidenced by price-to-income, price-to-rent and debt-to-income ratios well above historic norms

John Hussman, etc., w.r.t.:
the over-valued, over-bought, over-bullish stock market, which is discounting far better results than the economy can produce; that market participants were apparently making the assumption in early 2010 that the economy would return to normal as per typical post-war recoveries, implying that profits would return to 2007-"normal" and earnings growth would continue at 1990-2006 rates, allowing for aggressive valuation metrics; that their expectations were quite validly shaken by the Euro debt crisis in the spring and the economic evidence that this recovery would not follow the path of typical recoveries; that the recent bounce back is a sugar-high, under-pinned only by psychology and not fundamentals; and, given prevailing economic and market conditions, is susceptible to a steep drop with little warning



without reference, in my own view:

contrary to popular opinion, stocks do NOT generally earn 10% over the long-run; the historical average has been half that

Earnings growth is typically lower than nominal GDP growth; earnings are currently elevated relative to economic growth; analysts are extrapolating historically high profit margins indefinitely into the future

Modest nominal GDP growth prospects (IMHO) portend modest prospective earnings growth

Stock-holders do not ultimately get paid with “operating” earnings, they get paid with total (reported) earnings; the recent convention of focusing on operating earnings is a perversion of proper valuation analysis; furthermore, forward earnings estimates are unreliable indicators of even future operating earnings, much less reported earnings

Forward P/Es are therefore irrelevant; stocks always look cheap on forward P/E basis, and do nothing to forecast returns on a trailing P/E basis, stocks are moderately expensive (P/E of 16.5 vs long-term median of 14.3), but this assumes the last year’s earnings are representative, and it too has been a very unreliable indicator of future returns On a normalized P/E basis, stocks are 40% overvalued (P/E of 23.7 vs historical median of 16.9) Historically, when normalized P/E ratios were as rich as they are currently, 10-year forward price returns have been not much above zero, with significant volatility in the interim


Other thoughts:

the U.S. economy has received the biggest peacetime stimulus it has received in 75 years but it has resulted in nothing more than lacklustre growth; with final sales so weak, even without a further drop in the cyclical sectors of housing or consumer durables, even a modest dip in inventories could be sufficient to send the economy into a double dip; the usual catalysts for self-sustaining growth have been absent in this recovery; debt deleveraging, with no end in sight, has offset fiscal and monetary stimulus, the former of which does have an end in sight, and the latter of which is pushing on a string, while inventory-led growth, which surprised me by persisting in Q3, is nonetheless not sustainable;

C + I + G + X - M
absent income growth or credit growth, consumption growth will be absent;absent signs of demand growth, and with prevailing excess capacity, investment growth will be absent;the waning of fiscal stimulus by itself detracts from growth, and, with political gridlock, the prospect of further stimulus, with the exception of the likely extension of the Bush tax cuts, which are unlikely to have much impact on aggregate demand, is remote;net exports, particularly if the greenback's depreciation persists, is the one component of GDP that seemingly offers much prospect for growth, though to some degree will be provided by lacklustre import growth, which, though a mathematical contributor to growth, would be reflective of weak growth of the first three components (C, I and G); meanwhile, if the European situation worsens, not only will the weaken, but the impact on risk appetites generally would likely cause general US$ appreciation, and, in any case, there’s not much prospect of significant revaluation of the yuan, implying that the largest component of the U.S. trade deficit will be relatively immune to currency impacts

though both the ECRI WLI and Consumer Metrics Institute gauge are not as negative as they were two months ago, they both herald a double dip

ISM new orders minus inventories foreshadows a decline in ISM to well below 50

inflation expectations have historically been highly correlated with the ISM, so when the ISM falls to 45, that would be consistent with inflation expectations falling from 2% to 1%, which would be positive for bond prices

Ben B does not heed own advice -- says Fed does NOT seek inflation above 2%; didn’t he tell Japan to target high inflation in order to convince the public the BoJ really meant to reflate?

Ben Bernanke said to Milton Friedman "you're right, we did it; we won't let it happen again"; but, ironically, it could very well be that QE is the destabilizing force that causes the next crash; if QE-induced commodity and food price inflation force China's hand, prompting it to break its unbridled expansion of credit, which could cause, given that the market's broad-based resurgence of confidence is seemingly predicated on the emerging markets and commodity prices themes, a re-evaluation of global risk appetite, and if higher food and oil and gas prices in the U.S. impose a tax on the consumer that further slows discretionary spending

Fed needs negative real interest rates to reflate --- but with Fed funds constant and inflation falling (particularly the type of inflation that matters from a debt deleveraging perspective, wage inflation), real interest rates are getting less negative over time

state and local governments will continue to act like 50 little Hoovers; is California (or Illinois or New Jersey) any different than Ireland?

inordinately high corporate cash balances exemplify the type of cash hoarding that goes on when monetary velocity declines

to stimulate the economy, the government could increase aid to the unemployed, reduce employers' payroll taxes, allow expensing of investment costs, provide further state aid, invest in infrastructure, or offer income tax cuts; this list of options is in descending order of effectiveness according to the CBO; and yet the first option has already been kaiboshed, and the only option that is politically feasible in the near future, the extension of the Bush tax cuts, will be least effective option

there are falling pressures on each component of M*V = P*Q

the credit crisis was not an issue of liquidity, but one of solvency; liquidity issues have been temporarily "solved" by glossing over the solvency issues, which have not been alleviated (debtors have too much debt relative to the means to repay it; creditors at risk);

the Fed estimates that the shadow banking system was $20 trillion in size at the start of the crisis, relative to the $11 trillion size of the traditional banking system, and has now fallen to $16 trillion, still in excess of the now $13 trillion size of traditional banking



US = Japan2

November 20

QE2 is equivalent to issuing T-bills. Randall Wray.

QE dynamics one more time: its about price, not quantity. Warren Mosler.

Debt, deleveraging and the liquidyt trap: A Fisher-Minsky-Koo approach. Paul Krugman.

Debt: there is no jubilee. Hinde Capital.

What happens if Chinese growth slows. Michael Pettis.


other fare:
Peak oil: why the Pentago is pessimistic. Le Monde.

November 17

The inimitable John Hussman, as always, provides great insights (and is always able to come up with new ones) and has a wonderful way with words. Read his whole commentary, The Cliff; but I couldn't resist excerpting this:

From my perspective, an "economic recovery" that requires a tripling in the Fed's balance sheet, continues to average 450,000 new unemployment claims weekly, and relies on fiscal stimulus to counter utterly stagnant personal income, is ipso facto (by the fact itself) not a "standard" economic recovery. We have swept an enormous volume of bad debt under rugs, behind dams, and in back of curtains (not to mention in off-balance sheet vehicles such as Maiden Lane that were created by the Federal Reserve). But it is all effectively still there, festering. Meanwhile, our policy makers are trying to reignite financial bubbles in order to create an illusory "wealth effect" to propagate spending patterns that were inappropriate in the first place.
It is a bizarre notion that a credit crisis can be solved by bailing out lenders while doing nothing about the obligations on the borrower side. Think about it - what we have said to lenders is, here you have these homeowners who can't pay for their houses. Foreclose on them, sell the homes at half the price, and the public will make
you whole (largely through Treasury bailouts to Fannie and Freddie, made necessary by Federal Reserve purchases of these securities).
Heck, if the public is going to be on the hook anyway, at least notice that at equivalent cost to the public, the mortgage could simply be written down to half its value, with the homeowner now able to pay the balance off and the lender getting the public handout to make up the difference. But of course, that would reward the homeowner. So instead, we simply make the lenders whole while people lose their homes and foreclosure investors flip the homes at a profit in return for providing liquidity at the auction. That way, the same amount of public funds can be spent through the back door without Congress even getting involved.
Memo to Ben Bernanke - throwing money out of helicopters isn't monetary policy. It's fiscal policy. How is this not clear?
The proper way to deal with a major debt crisis - indeed, the only way nations have ever successfully dealt with major debt crises - is through debt-equity swaps, restructuring and writedowns. There are numerous ways to achieve this with mortgages. My preference would be swaps of principal for pooled property appreciation rights (administered, but not subsidized by the Treasury). In any event, until our policy makers wake up to the need to restructure debt, so that the obligation is modified for both the debtor and the creditor, our financial system will
increasingly tend toward a giant Ponzi scheme. We are racing toward the financial equivalent of a mathematical singularity, where the quantities become so large and outcomes become so sensitive to small changes that the whole system becomes unstable.

November 15

A PIGS 5-fer:
Europe stumbles blindly towards its 1931 moment. Ambrose Evans-Pritchard.
love this quote:

“This is a breath-taking mixture of suicidal irresponsibility and farcical incoherence”

which for some reason reminds me of Martin Luther King, Jr.'s quote:

"Nothing in all the world is more dangerous than a sincere ignorance and conscientious stupidity."

Sovereign default system makes sense. John Dizard, FT.

Within a month or so, the seize-up in the peripheral bond markets will lead to serious and immediate operating issues for the financial system. So the political leadership has no choice but to clarify how Europe will deal with sovereign default, and banking system insolvency.

Europe’s Monetary Cordon Sanitaire. Simon Johnson and Peter Boone, Project Syndicate.

Given the vulnerability of so many eurozone countries, it appears that Merkel does not understand the immediate implications of her plan. The Germans and other Europeans insist that they will provide new official financing to insolvent countries, thus keeping current bondholders whole, while simultaneously creating a new regime after 2013 under which all this debt could be easily restructured. But, as European Central Bank President Jean-Claude Trichet likes to point out, market participants are good at thinking backwards: if they can see where a Ponzi-type scheme ends, everything unravels.

Portuguese hint at euro exit as cost of debt soars and Greek debt crisis 'worse than ever'. both from the Independent.


Wow -- Check Out How Blatantly Our Government Misled Us With The October Jobs Numbers! Henry Blodget. NFP surprised to the upside because BLS changed its seasonal adjustment factor

Open letter to Ben Bernanke. WSJ. the authors of this letter lost all credibility once they included Malpass as a signatory! and (Dow 36,000) Kevin Hassett! And Michael Boskin (who blamed Obama in late 2009 for the stock market crash)!

other fare:
Obama to switch party. Michael Collins.

QE outlook

The early evidence: QE does more harm than good. TPC.


I do not believe that QE will have any positive impact on the broader economy, and, as per last, and as with past examples of unintended consequences of ill-advised government policy, will likely cause more damage than benefit; to wit:

- QE has had a psychological impact on asset prices, including equities and commodities, but has not changed fundamentals in any way
- if QE does not help the economy, then the boost to stock prices will have been ill-founded and subject to downward revision
- the dollar-debasement-fear impact on commodity prices will help commodity producers, but will impair margins for commodity-user-companies and will effectively impose a tax on consumers
- companies will therefore be less inclined to expand their workforce and consumers will be less inclined to expand their discretionary spending
- aggregate demand will continue to be lacklustre and hence below aggregate supply
- upside commodity price shocks have historically caused economic slowdowns; the last commodity price shock preceded the recession; this time around, the economy is much more vulnerable, given that core CPI is already below 1% and U6 is already near 10%
- propping up asset prices to revive the economy was the failed strategy of the 2000s (housing); the definition of insanity is doing the same thing over and over again and expecting different results
- excess reserves do not in any way motivate bank lending; deleveraging will persist, driven by both reluctant lenders and reluctant borrowers
- theoretical wealth effects from stock prices have been disputed (Shiller), and, in any case, to the extent that household wealth remains below the past peak, even with recent stock price gains, it is quite likely that homeowners are still perceiving a negative wealth effect (though the hole might not be quite as deep now that stocks are up 10%, they're still in the hole)
- meanwhile, aging baby boomers are a few years closer to their hoped-for retirement age, are twice-bitten, thrice shy of stocks (ICI reports that as of Nov 10 there were 27 straight weeks of outflows from domestic equity mutual funds), and need to continue to save to replenish their coffers
- interes rates are very low, so interest income has been degraded, implying that even more has to be socked away
- misguided concerns that QE is money-printing means dollar debasement could provide a near-term boost to export growth as U.S. export-products become more attractively priced in foreign currencies, but (a) yuan is not budging much, so will not help trade deficit with China, (b) euro has appreciated, but outlook for euro area is not promising and implies risk of currency turnaround, and, most importantly, (c) geopolitical tensions about QE could cause real trade frictions and protectionist backlash
- to the extent that easy monetary policy gets exported to emerging market nations, principally w.r.t. asset prices, those emerging market nations may be forced to impose domestic monetary restraint which will at the margin impair global growth, offsetting *any* "expansionary benefits" of unconventional Fed easy money policies


all in all, though the Fed likely does WISH to reflate the economy, there is little evidence to support the assumption that they have the CAPACITY TO DO SO --- not until the unsustainable debt burden built up over the last decade has been whittled down to levels that are manageable given prevailing income levels and given the demographic outlook; if this viewpoint is reasonable, then this is not likely to be a 2-5 year process but one that lasts rather longer


what if I'm wrong? what should we look for as signs of successful reflation?
- broad-based increase in cap-ex
- sustained increase in lending
- consistent increases in hiring (evidenced in both the household and institutional surveys) in excess of population growth

November 11

must read explanation of QE:
Just what is Bernanke up to? L. Randall Wray.

With QE2, the Fed proposes to buy longer-term treasuries. Since these are not toxic, it will not help the banks. It is like transferring funds from CDs they hold at the Fed to their checking accounts, thereby reducing their interest earnings. I suppose the idea is that the Fed is going to reduce bank income, impoverishing banks to the point that they will finally throw caution to the wind and begin to make loans to struggling firms and households. It is simultaneously a strange view of banking and also a scary remedy to a financial crisis that was created by excessive bank lending to those who could not afford the loans. It’s sort of like sending a covey of nymphomaniacs to the hospital bed of a nonagenarian suffering from myocardial infarction initiated by an age-inappropriate tryst.

Fasten your seatbelt. John Taylor.

On the day after the Fed’s move, [Bernanke] wrote in a Washington Post editorial piece that QE2 would push up the equity market, bonds, and other risky securities thereby stimulating consumption and economic activity. Even Greenspan did not publicly proclaim his “put,” but now Bernanke has made it the centerpiece of US strategy. Equities are already overpriced, with profit margins at all-time highs and PE ratios far above average. Speculation is now more American than apple pie – but this is a very risky time to practice it.

It’s Going to Be Another Long, Hard Winter in Housing. Zillow Real Estate Research.

Annual State of the Residential Mortgage Market in Canada. CAAMP.



other fare:
Robert Reich makes some excellent points about why Obama should take a stand, but Reich is naive if he thinks Obama will do so --- he's clearly gonna cave in.

Oh, look at that, it might as well be official --- the Huffington Post says White House gives in on Bush tax cuts.

November 10

Steve Keen And Chris Martenson Explain Why "It's All About The Debt". zerohedge.

IEA acknowledges peak oil. Early Warning.

November 9

Bernanke: Chumps! Bruce Krasting.

I got a laugh out of the $600b number. The dealers were polled on their expectations last week. The response was an even half trillion. So with that as a bogie the Fed does 600 large. They wanted to do just a bit more than was actually expected. So they added on an extra 100b. They gave the market what it wanted and a little bit of extra cream on the top.

Understanding the mechanics of a QE transaction. Pragmatic Capitalism.

Recent Decisions of the Federal Open Market Committee: A Bridge to Fiscal Sanity? Richard Fisher, FRB of Dallas.

I agree that we are indeed in what is referred to in economic parlance as a liquidity trap. Yet, I think it worth noting that we already have low interest rates, and spreads against risk-free instruments are historically narrow. Despite their theoretical promise, reductions in interest rates to Lilliputian levels have not done much thus far to spark loan demand. Loans are desirable when business see an opportunity for tapping credit markets to earn a return on investment that significantly outpaces the cost of credit and other risk factors. Even with the low rates that already prevail, businesses lack confidence that they will earn a superior ROI by investing so as to expand their domestic workforce, in comparison to what they might earn from alternative investments abroad or by buying in their stock or cleaning up their balance sheets. For their part, consumers will borrow when they believe it makes sense to shift consumption forward. But after the sobering experience of the past
three years, they are restrained by a lack of confidence that their future income streams will be sufficient to cover their payment obligations.
On the supply side, we know that businesses are floating on a sea of liquidity. Banks already hold over $1 trillion in excess reserves; holdings of government securities as a percentage of total assets on bank balance sheets are growing; loans as a percentage of assets are declining.
If we had a level of bank reserves or liquidity in the marketplace that was binding or inhibiting loan growth, I could understand the impulse to relieve that stricture. Further quantitative easing through additional asset purchases will surely increase the level of bank reserves, lower rates marginally and add more liquidity to markets while weakening the dollar. The more germane question is whether this works to the benefit of job creation and wards off financial excess....
The remedy for what ails the economy is, in my view, in the hands of the fiscal and regulatory authorities, not the Fed. I could not state with conviction that purchasing another several hundred billion dollars of Treasuries—on top of the amount we were already committed to buy in order to compensate for the run-off in our $1.25 trillion portfolio of mortgage-backed securities—would lead to job creation and final-demand-spurring behavior. But I could envision such action would lead to a declining dollar, encourage further speculation, provoke commodity hoarding, accelerate the transfer of wealth from the deliberate saver and the unfortunate, and possibly place at risk the stature and independence of the Fed.

Bubble, Crash, Bubble, Crash, Bubble... John Hussman.

The Japan syndrome goes global. Stephen Roach, Morgan Stanley.

Warning: retirement disaster ahead. Brett Arends, WSJ.

Bank of America edges closer to tipping point. Jonathan Weil.

Halloween

Why Ponzi finance has always failed. TPC, referencing Richard Koo.


A few from Paul Krugman:
More on Friedman/Japan. & The moral equivalent of stagflation. & Accounting identities. & Sex and drugs and markets' role.

October 29

Misguided love affair with China; China's massive monetary expansion and crack-up boom. Mish.

The problem with QE2. Comstock Partners.

POMO still matters. Jim Bianco.


I wouldn't normally be this liberal in extensively excerpting from another author's post, but the IRA's weekly letter is only freely available for one week, after which time it goes behind a subscription firewall, and I thought this post worthwhile enough to have recorded:
Triple Down: Fannie, Freddie, and the Triumph of the Corporate State. Chris Whalen, IRA.

Despite examples of the success of restructuring with F and even General Motors, the invidious cowards who inhabit Washington are unwilling to restructure the largest banks and GSEs. The reluctance comes partly from what truths restructuring will reveal. As a result, these same large zombie banks and the U.S. economy will continue to shrink under the weight of bad debt, public and private. Remember that the Dodd-Frank legislation was not so much about financial reform as protecting the housing GSEs. Because President Barack Obama and the leaders of both political parties are unwilling to address the housing crisis and the wasting effects on the largest banks, there will be no growth and no net job creation in the U.S. for the next several years. And because the Obama White House is content to ignore the crisis facing millions of American homeowners, who are deep underwater and will eventually default on their loans, the efforts by the Fed to reflate the U.S. economy and particularly consumer spending will be futile. As Alan Meltzer noted to Tom Keene on Bloomberg Radio earlier this year: "This is not a monetary problem."
Indeed, the public embrace by the Federal Open Market Committee of further quantitative easing or "QE", instead of calling for the immediate restructuring of the largest zombie banks, actually threatens to push the U.S. into a deeper and far more dangerous economic path. According to the Q2 2010 Bank Stress Index survey conducted by IRA and our review of the Q3 2010 earnings results, the financial condition of smaller lenders is actually improving. While the FDIC now has over 800 banks on its troubled list, the righteous banks for which we currently have "positive" outlooks in The IRA Advisory Service are showing better earnings and less credit stress.
Part of the reason for the improvement is that the FDIC and state regulators have taken a very hard line with smaller banks, pushing many into resolutions and distressed asset sales. But for the healthy lenders that survive and investors that buy failed banks, there will be a lot of money left on the table -- profits that will come back into earnings via recoveries and other windfalls and help to boost the private economy. Resolution and liquidation is how a free market economy regenerates. The trouble is, the approach taken with the large banks and the GSEs is precisely the opposite of that applied to smaller lenders. The policy of the Fed and Treasury with respect to the large banks is state socialism writ large, without even the pretense of a greater public good.
Forget Treasury Secretary Tim Geithner lying about the relatively small losses at American International Group (AIG); the fraud and obfuscation now underway in Washinton to protect the TBTF banks and GSEs totals into the trillions of dollars and rises to the level of treason. And the sad part is that all of the temporizing and excuses by the Fed and the White House will be for naught. The zombie banks and GSEs alike will muddle along until the operational cost of servicing bad loans engulfs them. Then they will be bailed out -- again -- or restructured....
So why did our BSI measure show rising stress in Q2 2010? Over the past several years, the large zombie banks actually looked better on our BSI survey than the average, this due to overt subsidies, QE and low interest rates. But now the larger lenders are sinking under the weight of rising servicing costs, falling asset returns and other problems linked to mortgage securitizations. So while the Fed continues to try to revive the largest banks via massive monetary ease, the FOMC is at the same time preparing to do further damage to solvent lenders, insurers and other investors via QE2.
The IRA has spoken to a number of executives in banks and life insurance companies about the impact of QE and Fed zero interest rate policy on their income statements and balance sheets. The universal message: If rates do not return to "normal" levels by year-end, the pain in terms of reduced earnings on assets and the resultant negative cash flow will start to become so apparent that the financial markets will actually notice. In particular, we have been told that by year end several of the largest publicly traded banks and life insurers could show significant declines in net interest earnings due to QE -- declines driven by falling net interest income that may provoke ratings downgrades. And when this next systemic crisis comes -- whether in December or later in 2011 --- the full blame will belong to the members of the Bernanke Fed and the Obama Administration.....
Walter Bagehot believed that central banks should lend aggressively in times of financial insolvency, the rate of the loans should be very high -- not zero as is the current FOMC policy. John Hussman wrote: "Bagehot's name has surfaced in a few editorials in recent weeks, but they have invariably focused on the "lend freely" portion of his advice, while overlooking Bagehot's admonition to impose costs, capital requirements, and other safeguards where public funds are concerned. In short, liquidity should be available to Fannie Mae and Freddie Mac, but the interest rates charged should be very high."
Of course the problem of adopting Bagehot's rule regarding high real credit costs is that you immediately expose all of the insolvent financial institutions -- including the US Treasury. This the Obama Administration, Treasury Secretary Geithner and the functionaries on the FOMC will not do. But the examples of Ford, GM and the smaller banks in the U.S., most of which have restructured without bankruptcy, suggest that the path to economic renewal requires reorganization and losses to creditors.
In the case of the large banks and GSEs, this means a great deal of pain for investors and taxpayers alike when, no, if, these institutions are finally restructured. But that is the good news and thereby lies the path to national recovery. What we need from the Fed is some leadership on the issue of making the White House take responsibility for restructuring the economy.

The Bank of Canada's revised forecasts

The Bank of Canada's Monetary Policy Report (MPR) released last week laid out its latest views on the economy, which substantiated why it left rates unchanged at 1%.

For starters, after trekking along from 2000-2007, the economy suffered a severe drop-off in 2008/09 which hasn't even come close to being re-couped.

Through June 2010, real GDP remains 4.9% below trend growth, which is up from the 6.6% gap as of June 2009.

And though the economy has turned up since troughing in May 2009, the continuation of that rebound isn't turning out to be as robust as the Bank had hoped and thought.

After growing at an annualized rate of 4.9% during the fourth quarter of 2009, the economy expanded 5.8% in the first quarter of this year, which trailed the Bank's forecast of 6.1%; and then growth decelerated in the second quarter to just 2%, lagging the Bank's forecast of 3%.

The Bank has now revised its growth forecasts down for each of the next five quarters, though it increased its forecasts for the five quarters after that. (This, by the way, is par for the course for the Bank ---- every time it revises its forecasts for growth in the near-term, it must, by the necessity of its mandate, revise its forecasts for later-term growth commensurately in the opposite direction. More on this later.)

Just for point of comparison, I think its worth noting how this forecasted growth, if it materializes as now expected, would compare to trend growth.



Though it does show how underwhelming this recovery has been and is projected to be, obviously trend growth from last decade doesn't hold much relevance as far as the Bank is concerned.

What the Bank is concerned with is how actual economic activity compares to what the Bank views as potential output. And growth of potential output these days is much lower than trend growth of the economy was for the last 5-10 years, because of a slowdown in the growth of the economy's rate of labour utilization, and, more particularly, of labour force productivity.




Canada entered the recession with the economy in a situation of excess demand (actual GDP above potential), but is now experiencing excess supply (actual GDP below potential).

As of July, the Bank believed that the output gap would be eliminated (actual GDP would converge on potential) by the end of 2011. Despite lowering its estimates for the growth of potential output (1.6% in 2010, 1.8% in 2011 and 2.0% in 2012), the Bank now forecasts that the output gap won't be eliminated until the end of 2012.

Here's why this is telling.

The Bank's job is to try to get CPI on target by the end of its forecast horizon, which in this case is to the end of 2012. It therefore needs to eliminate the output gap during that time period.

It previously had thought that it would have CPI on target by early 2012, by virtue of having eliminated the output gap by the end of 2011.

As of July, the Bank was forecasting that growth in 2012 would be 2% because (a) it believed that the output gap would be eliminated by then, (b) it wanted to keep CPI on target, and (c) it believes that the growth rate of potential output would be about 2% in 2012.

Therefore, to keep inflation on track, it would need to keep actual economic activity consistent with the economy's potential growth. Presumably, in order to do that, it would have needed to return to neutral monetary policy in 2011.

But by downgrading its views on economic growth for the last two quarters plus the next four quarters, the Bank is faced with the situation of having to engineer more growth nearer to the end of its forecast horizon in order to meet its objective.

In other words, because monetary policy works with a lag of at least 12 months, its economic growth forecasts for the next four quarters must be based in part on where it has its overnight rate set right now. So, despite remaining extraordinarily accomodative, the Bank doesn't think economic growth will be either (a) as strong as it had previously thought, or (b) strong enough to close the output gap.

Though year-over-year growth of 3.8% in 2010 followed by 2.7% in 2011, which were its forecasts as of the July MPR, would have done the job, growth of 3.0% this year (compared to 1.6% potential growth) followed by 2.4% next year (compared to 1.8% potential growth), which are its current forecasts, won't.

Therefore, the Bank will be required to enhance growth opportunities in 2012 in order to achieve the growth rate of 2.8% (compared to 2.0% potential growth) required to close the output gap.




Given that the Bank forecasts the output gap will not be closed until a year later than earlier projected, it seems safe to assume that the Bank will not return to neutral monetary policy until a year later than it earlier would have assumed.

As such, if its base case scenario had been that once it started hiking its overnight interest rate in July it would do so in sequential meetings until rates had been normalized, it seems that, based on currently available information, a resumption of that projected path of interest rates will likely wait a year.

Personally, given my expectations for deterioration in the U.S. economy (due to continued household deleveraging, continued reluctance on the part of banks to increase lending, fiscal spending headwinds rather than tailwinds, the end of the inventory bounce, spending cutbacks at the state and local levels, reluctance on the part of the business sector to make capital expenditure investments given its overcapacity, and no imminent rebound in the housing market or in the labour market), plus concerns about the unsustainability of household spending in Canada, as well as the prospect of global forces of competitive currency devaluation impairing Canadian trade balances, I am reluctant to believe that the Bank will be successful at closing the output gap over its forecast horizon.

In any case, on a breakeven basis, the current 2-year yield of 1.43% would be consistent with a time-path of overnight rates that involved the Bank staying on hold at 1% until October 2011, at which time rates would be hiked in four consecutive meetings to get to 2%.