The Making of a New Monetary System and Economic Model?!

Without any commentary. A collection of accounts and descriptions of the situation WE are in.

The debt ceiling crisis – Running out of money

Jul 29th 2011, 8:45 by Buttonwood

PERHAPS the oddest thing about the debt ceiling debate to an observer from the east side of the Atlantic is the process itself. In Britain (and in the rest of Europe, as far as I am aware), the government proposes a Budget, the opposition votes against it and that is it. If the government is defeated on a key issue of financing (which the debt ceiling surely represents), then the administration resigns, an election is held and a new government comes to power. Finance is so essential to the nature of government that the idea of separating the budgeting power from the executive branch seems no way to run a country. Yesterday’s shenanigans, where the House spent all day trying and failing to pass a bill that faced automatic rejection in the Senate, resemble a Dickensian satire featuring the Circumlocution Office, a body designed to ensure that nothing gets done.

Anyway, it seems that US may soon have a problem that featured in a column a few weeks ago, running out of money. In the modern world, debt is money and money is debt; the ability to issue debt is essential to the state.

[...]

From a historian’s point of view, what is fascinating is that these problems are re-emerging after 40 years of a shift to fiat money, a change that seemed to remove all constraints on money creation. I have argued before that this shift drove most of the developments of the last 40 years from the rise of the finance sector to asset bubbles, and that the 2007/2008 crisis was a watershed moment (like the 1930s and 1970s) from which a new system will emerge. I assumed it would take a decade or so for the ramifications to work through, but the US Congress seems determined to accelerate the process.

 

Finance and Economics. Jul 30th 2011 | from the print edition

Buttonwood – Running out of options

Governments in the rich world have painted themselves into a corner

 

ECONOMIC policy in the developed world over the past 25 years has followed one overriding principle: the avoidance of recession at all costs. For much of this period monetary policy was the weapon of choice. When markets wobbled, central banks slashed interest rates. A by-product of this policy was a series of debt-financed asset bubbles. When the last of those bubbles burst in 2007 and 2008, the authorities had to add fiscal stimulus and quantitative easing (QE) to the policy mix.

The subsequent huge rise in budget deficits was largely the result of a collapse in tax revenues that had been artificially inflated by the debt-financed boom. Britain and America ended up with deficits of more than 10% of GDP, shortfalls that were unprecedented in peacetime.

Those deficits may have been necessary to avoid a repeat of the Depression. Economists will probably still be debating this issue in 75 years’ time, just as they still discuss whether Franklin Roosevelt’s New Deal programme was effective in the 1930s. But the “shock and awe” approach to Keynesian stimulus has an unfortunate consequence. Any decline in the deficit, even to a still whopping 8% of GDP, acts as a contractionary force on the economy: either the government is spending less or taxing more.

As a result governments are reluctant to cut the deficit too quickly for fear of sending their economies back into recession. But unless there is a rapid recovery, the debt will keep piling on, making the ultimate problem harder to solve.

Turning to monetary policy, interest rates are 1.5% or below in most of the developed world and are negative in real terms (the Bank of England kept rates at 2% or more for the first 300 years of its existence). In a normal recovery central banks would be looking to increase rates from crisis levels by now. But high debt ratios (particularly in the household sector) make central banks very uneasy about raising interest rates for fear of ushering in another round of the credit crunch. With the big exception of the European Central Bank, most have repeatedly postponed the moment at which monetary policy is tightened. The parallels with Japan, where interest rates have been at rock-bottom for a decade, are striking.

As for QE, it is hard to tell how successful it has been as a strategy in reviving the economy although it certainly seems to have helped to prop up equity markets. Central banks seem reluctant to push it much further at the moment. But there is no suggestion that the economy is strong enough for them actively to unwind the policy by selling assets back to the markets.

In all three cases the story is the same. Governments and central banks have thrown a lot of stimulus at the economy and the result has been a fairly sluggish recovery. They have painted themselves into a corner. They cannot go forward, in the sense that there is little political or market appetite for more stimulus. But it is also hard for them to go back.

Withdrawing stimulus is not just risky economically, but hard politically, too. In Britain a sluggish second-quarter growth rate of 0.2% has led to talk that the coalition government needs to slow the pace of its austerity programme. But if you actually look at the data, the government has barely begun its deficit-cutting work. In the first three months of the fiscal year public spending is £5.2 billion ($8.5 billion) higher than in the same period of 2010-11, or £3.6 billion higher if interest payments are excluded. An increase in joblessness, leading to higher benefit payments, is not the cause: the unemployment rate is lower than it was a year ago. A rise in value-added tax may have eaten into consumer demand (tax revenues are £5.3 billion higher than in the same period of 2010-11) but VAT also rose in January 2010 and GDP jumped by 1.1% in the second quarter of that year.

The danger for Britain is not just that its deficit-cutting strategy may have an adverse effect on growth. It is also that sluggish growth may prevent it from cutting its deficit significantly. Tim Morgan of Tullett Prebon, a broker, calculates that if the British economy grows at 1.4% annually, half the expected rate, the budget deficit will still be more than 8% of GDP in 2015.

In a sense, the bill has come due for the past 25 years. A policy of avoiding small recessions has resulted in the biggest downturn since the 1930s. Public finances turned out to be weaker than politicians thought. As a result, they have used up all their ammunition tackling the current crisis. Governments in the rich world will have very few options left if the economy weakens again.

 

Non-independent investment research (Saxo Bank)

STEEN’S CHRONICLE – Another step towards Crisis 2.0? by Steen Jakobsen

[...]

The Keynesian endpoint
Since the crisis hit in 2008, world policy makers have basically operated on the idea that creating more debt could create more growth – the basic tenet of classic Keynesian policy. I am increasingly convinced that we are reaching what some have dubbed the “Keynesian endpoint”, where the failure of this Keynesian approach to turn the economic ship yields to a more balanced approach to monetary- and fiscal policies (rather than bail everything out all the time). This turn will occur not because it makes sense, but because circumstances simply leave no alternative.

Time is up
The second point is the increased likelihood that “time is up”. This idea came from my friend and hedge fund manager Dan Arbess of Xerion Capital : “Here’s the thing. Every politician likes to spend, that’s how they get elected. Republicans don’t like taxes, but boy can they borrow. That game is ending so now, there are no more options for spending without taxing. It’s going to get interesting with two totally different worldviews: Democrats tax and spend, Republicans cut taxes and spend…Democrats tend to think government is the solution, Republicans think it’s the problem”. Well put and time is up for the US spending juggernaut, regardless of how it will be stopped.

If we look at key indicators for the EU and the US there is increasingly clear evidence, to which the market has been paying insufficient attention , that time is indeed up and the alarm bells are ringing:

[...]

The real risk to Italy, Belgium, Spain, Denmark and other countries remains their internal domestic economic- and political agenda: zero growth means by definition that the debt burden will increase when you are running a budget deficit. This you can live with in transition periods, but we are well into the 10th year of below long-term trend growth and in many countries barely even making it to positive growth. There is a price for this: downgrades, increased yields to finance the debt and a desperate need to keep a primary balance at zero or positive (the budget deficit before interest expenses = primary deficit).

[...]

The next few days are important as political events, but the most likely long-term impact is…surprise, surprise: more of the same:

The US dollar will continue to weaken 3-5% per year, the politicians will buy some time into the next election cycle, yields will creep higher and higher for non-core countries, equities will be over-bid relative to bonds as investors are losing faith in governments, and the disparity between the rich and poor will only yawn wider as the latter suffer on the inevitable standard of living declines that are forced upon them by wages that fail to keep pace with cost of living increases.

We have dealt with bigger crises than this before – you only need to go back to your own grandparents – they lived through wars, booms and a depression, and still created wealth beyond anyone’s dream. The big difference? They grew up respecting and expecting hard times, hard work and each other. Today we all want to believe that the last thirty years will be extended by another five to ten years before we start the rebuilding. We are now definitely in Crisis 2.0 early stages, I constantly meet clients and investors who keep complaining I’m too negative – but am I really negative, or am I merely trying to make you aware that the light at the end of the tunnel is not the exit but an approaching freight train? I hope I am wrong. I really do (and I often am) but a touch more reality would help us all.

 

currencythoughts.com – by Larry Greenberg

Debt Problems and the Currencies July 29, 2011

[...]

The U.S. debt crisis has been framed by analysts and investors around the political stalemate that is real and in everyone’s face day after day. The markets wonder how close to the August 2 deadline will officials delay making a deal, and the possibility of no deal until closer to mid-August emerged this week. Expectations have been lowered regarding the composition of an agreement and how much time it will buy before the next fabricated crisis surfaces as has occurred time and again in the euro area.

But a less discussed dimension of the problem is now pushing its way into the spotlight, and this concerns the tolerance of the advanced economies against fiscal and monetary restraint. Sufficient deficit reduction might not be possible under either an all-partisan Democrat plan or an all-partisan Tea Party plan. These strategies need adequate economic growth to succeed, but the U.S. economy is more crippled than generally realized.

• Real GDP expanded just 0.8% annualized in the first half of 2011 when the bulk of QE2 was provided. A year ago, the FOMC was forecasting a real GDP growth range in 2011 of 3.5-4.2%, and private-sector projections were centered somewhat above 3.0%. The optimism of these estimates highlights that the economy’s usual resilience isn’t as strong as such was.
• U.S. real GDP expanded only 1.6% in the year between 2Q10 and 2Q11 and managed only a 0.2% annualized pace during the four years between the second quarter of 2007 (just before the financial crisis began) and the second quarter of this year.
• Anemic U.S. growth is part of a fairly universal phenomenon among advanced economies. Japan’s “lost decade” between 1Q91 and 1Q01 saw real GDP there climb at a 1.1% annualized rate. In the ensuing decade between 1Q01 and 1Q11, real GDP rose even more slowly, 0.5% per annum. The 20-year growth rate between 1Q91 and 1Q11 was 0.8% per annum. In Britain where a Conservative-led government has begun massive fiscal restraint, real GDP rose less than 1.5% annualized in the first half of 2011 and 0.7% over the four quarters between 2Q10 and 2Q11. Growth since the onset of the global financial crisis four years ago has averaged negative 0.4% per year in Britain. Euroland GDP rose by a decent 2.5% over the latest four reported quarters to 1Q11, but the distribution of results among members was highly diverse and included a drop in Greek output of 4.8%. Moreover, euro area GDP during the past four years averaged just 0.1% per year.

I take away three lessons from Japan’s experience. First, the hangover from a financial system can endure more than a generation. Second, the bigger one is, the harder one can fall, and third, reining in public debt requires more than a will to act. One needs an economy that is sufficiently repaired to tolerate austerity. Otherwise, macroeconomic restraint just digs a deeper hole. The Bank of Japan has wanted to normalize rates for fifteen years but is still stymied against doing so, and Finance Ministry officials were looking for an exit strategy when debt was approaching 100% of GDP and are still waiting for the right opportunity as debt hovers near 200% of GDP now.

The U.K. experience offers more warnings to be heeded. British July purchasing manager survey results will be published next week, but recent trends through June portray a difficult time coping with fiscal austerity. The manufacturing PMI fell from 61.5 in January to 51.3 in May, while the service-sector reading declined from 57.1 at the end of the first quarter to 53.9 in June. Slow growth hampers public-sector revenues, and Britain’s budget deficit was no smaller in the first quarter of the current fiscal year than it had been in the first quarter of the previous financial year.

Economic circumstances in the euro area’s peripheral nations have been very difficult as well. Market players love to mock the “clowns” who decide policy in Europe and America but fail to fully comprehend that in representative democracies, policymakers tend to be sounding boards of viewpoints found in the rank and file citizenry, only they hold such positions more extremely. Excessive household and corporate debt tend to be a pre-existing condition for excessive government debt, and Keynesian economic theory suggests that it’s best that balance sheet reductions not be undertaken on a massive scale simultaneously in all three areas.

Another lesson for the United States from Europe is that whatever is done to cauterize the debt problem proves insufficient in the eyes of market players, who pass judgement with their money. To be sure, euro zone leaders have offered up a series of packages that treat symptoms rather than causes of the region’s fiscal mess. It has been said that if half of the concessions made eventually had been taken early in the crisis, market order would have been restored, meaning reduced peripheral bond yield spreads. I suspect not and believe also that nothing the Congress and Obama Administration undertake in the next week or two will manage to correct America’s structural problems or satisfy investors for more than a transitory while.

 

Documentary “Overdose – The Next Financial Crisis”

I just noticed that the documentary about the next financial crisis (sovereign debt + fiscal and monetary policy) was picked-up by Journeyman Pictures and the production company removed it from YouTube (Facebook). Just wanted to let you know that you still can watch it *for free* as some people have made their copies already …

This 46-minute documentary is a fast-paced look at how we got into the financial crisis and how our way of dealing with it is setting the stage for the next crisis. It is co-written and narrated by Cato senior fellow Johan Norberg, author of In Defense of Global Capitalism and Financial Fiasco: How America’s Infatuation with Home Ownership and Easy Money Created the Economic Crisis.

History doesn’t repeat itself, but it rhymes. *Mark Twain

Official Trailer – [What happens when Countries or Currencies fail?]

ReasonTV – Overdose Director Martin Borgs on the Next Financial Disaster

A short comment to the intro (President Barack Obama and his words that ‘the worst of the storm has passed’)

The mainstream economists and analysts currently define ‘the worst time during this first global recession’ was autumn 2008 into the spring of 2009 because of the intensity (increasing speed of single failures) and short time frame. But that is short-sightedness and a fallacy. Failure was and is a reactions to the underlying problems of the system. Like organ failure after your kidneys and liver shut down. Symptoms were patched over (home buyers tax credit, cash for clunkers, bailouts, stimulus package aka pork barrel and ear marks, wars in the middle east as abstract energy and economic policy). The patient is still sick, chronically sick. And it is not only the USA any more, the disease got airborne during the 70′s.

Markets do not spare cowards. They take advantage of them.

Fresh from the wire. Mohamed El-Erian CEO and co-CIO of Pimco writes (emphasis mine):

[L]ate-moving sellers have been looking over the past few days to reduce their holdings of Greek bonds. This has accentuated market volatility and illiquidity. Combined with this week’s downgrades in the credit ratings of peripheral European countries, the result has been a dramatic sell-off in European equities, a further disorderly widening in sovereign risk spreads and pressure on the euro.

Meanwhile, the disorderly market moves of recent days will place even greater pressure on the balance sheets of Greek banks and their counterparties in Europe and elsewhere. The already material risks of disorderly bank deposit outflows and capital flights are increasing. The bottom line is simple yet consequential: The Greek debt crisis has morphed into something that is potentially more sinister for Europe and the global economy. What started out as a public finance issue is quickly turning into a banking problem too; and what started out as a Greek issue has become a full-blown crisis for Europe.

[...]

The numbers involved are large and getting larger; the socio-political stakes are high and getting higher; and the official sector has yet to prove itself effective at crisis management.

The Greek debt crisis is now morphing into something much broader. No wonder the European Union and the International Monetary Fund are scrambling to regain control of the rapidly deteriorating situation. There is talk of a bigger bailout package for Greece. The heads of the European Central Bank and IMF have made the trip to Germany that is reminiscent of the Ben Bernanke–Hank Paulson trip to Congress in the midst of the U.S. financial crisis.

“It has become a full-blown crisis.” They could not contain it.

On April the 8th I wrote on my tumblr – Does Europe need his own Ben & Hank duo?! It “Could Turn Into The Endgame.”

I see it.

We’ve found the Apple cart. I wrote on the 13th of April after looking at the US stockmarket on the 9th of April;

[I]t is always impossible to know what developments will surface to upset the applecart. It could be Greece (PIIGS) or even UK. It could be China. It could be a trade war or a currency depreciation cycle. Or rising prices (inflation in general) of resources like oil, copper, steel which take a break on the recovery.

And as early as February, I compared the situation already with the Asia 1997 and hoped for an contingency plan.

The FinancialTimes and WSJ reports that “its 10-year borrowing costs, are now more than twice as high as those of the German government.” Thus, it is a reasonable argument to have a Plan B C after the Lehman and Northern Rock debacle. Because this problem of out-of-whack government debt, in the EU zone, feels like history but with other features (as always).

Why could they not contain it?

I will be very brief;

• Europes’ political landscape scrambled to get its treaties ratified, could not find a common denominator in a reasonable time-frame, and most of them are career politicians primarily reporting back to their constituency at home – not Europe.
• Coordination within the political landscape, regional central banks and ECB is during these times is dysfunctional. The feedback-loop is too slow, too slow in general.
• Day-to-day politics and home-turf politics still shape the discussion.
• The problems of independent fiscal responsibility, same monetary policy and currency, vastly different societal and cultural background and differences between member states.
• Greece cheated too often.
• ‘Frau Nein’ aka Angela Merkel. Instead of showing leadership capabilities, she and her party (coalition, current and past) tends to sit things out. This one was one too much. Instead of taking care of ‘contagion risk’, she cared more about regional politics (NRW) and polls. Her career and the future of the defunct coalition with the FDP. But I guess it is too much to ask for, that politicians learn fast from the events not older than two years ago.
  • On the same account you can blame France President Sarkozy and Finance Minister, Trichet & Crew, and Spains’ Finance Minister who told the IMF some weeks ago they know how to handle the problem.

Looking back, in February 2009 – it all seemed so clear what to do. But this week, Europe got its own Dump Japan (97/98) moment. Dumb junk, dump Europe. Jürgen Stark, who is a member of the board of the European Central Bank, stated, “We may already have entered into the next phase of the crisis: a sovereign debt crisis following on the financial and economic crisis.”

I posted lots about Greece in the last months leading up to this moment on my Tumblr (search Greece).

Update 1st of May 12:31pm:

Via Scott Mather (Managing Director, Portfolio Manager). Global Disparity Presents Post-Crisis Risks, Opportunities (emphasis mine):

In the wake of the recent economic crisis, new risks and opportunities lie ahead as countries are forced to grapple with a changed economic environment. Important fundamental differences will increasingly drive economic and financial markets in disparate ways across countries. Historically, debt growth has been used as an economic stabilizer in times of need and helped to level economic activity among countries. But going forward, the unprecedented accumulation of sovereign debt will increasingly limit policy flexibility and further push countries apart in terms of economic performance. Many countries are already very near a tipping point, having exhausted maneuvering room during the recent economic crisis.

Much of the last few decades can be characterized as a period of increasing “sameness”: Economic and market correlations rose between countries even as the overall volatility of growth and inflation fell. This development masked growing imbalances and future sources of instability. Some of these imbalances were exposed in the economic crisis. But owing to differences in initial conditions and policy choices made throughout the economic crisis, the decades of growing sameness to which we have been accustomed have likely ended. Many old vulnerabilities remain unaddressed and many new sources of instability are surfacing. Differences between countries will grow much larger in the years ahead.

The founding of INET. Challenging the subject of economics to evolve.

Well, who knew that ‘New Economic Thinking’ will catch on so fast. George Soros founded INET, short for Institute for New Economic Thinking, some months ago. The first hub just opened is Cambridge.

Back in the summer of 2009, when I re-started this blog (michaeljung.wordpress.com) which was just about me, technology, and what was happening. I thought I need to give this blog a bit more meaning in order to challenge myself. So I came up with the title “New Economic Thought – Observing by holding everything else not constant.” In the about page I wrote something like a mission statement:

Trying to bring the field of economics back, from being purely quantitative about GDP, growth, inflation, unemployment et cetera, to being a multi-disciplinary field. Making it more versatile and appealing for others to use the ‘economic thought and analysis’ in other areas.

I thought and still think, for me personally at my level, that this is really good for a start, but now George Soros (Wikipedia entry) kicked the ball out of the park, going for the fences, and created INET. I only can applaud.

The purpose of the institute is to bring some change to this profession, ‘as the dominant paradigm has obviously not worked’, not knowing what this change will look like in two or three years. The agenda is very broad, as the subject of economics is itself. To highlight just some;

• rebuilding the reputation of the subject as guide for society,
• reopening the subject to its roots of Adam Smith and alike (YT),
• being open and considering alternatives,
• using and combining the different strengths of the branches of the subject,
• challenging the subject to evolve.

From the about page:

The Institute recognizes problems and inadequacies within our current economic system and the modes of thought used to comprehend recent and past catastrophic developments in the world economy. The Institute embraces the professional responsibility to think beyond these inadequate methods and models and will support the emergence of new paradigms in the understanding of economic processes.

The Institute firmly believes in empowering the next generation, providing the proper guidance as we challenge outdated approaches with innovative and ethical economic strategy.

[...]

The Institute was conceived during the first half of 2009 through a series of discussions that culminated at a summit in July of 2009 in Bedford, NY.

Here is the video giving a background about the beginnings of the Institute for New Economic Thinking (YT).

Reflections on George Soros

Advice to Young Economists

Still, we don’t know what makes the difference. – Joseph Stiglitz

They have uploaded some key notes of the inaugural conference which was held at Cambridge UK from the 9th to the 11th of April. Here are two snippets from Richard Koo. A note on Koo; I am still stuck with the last chapter of the 2nd Edition of ‘The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession.’ Will try to finish it soon and put up a review.

The Financial Crisis – Common Cold or Pneumonia

Richard Koo – About the Balance Sheet Recession

Follow-up:

• YouTube Channel of INET
• Homepage of INET
• Bloomberg about INET
• George Soros about his latest book (Dec 2008) via NY Review of Books

h/t [via Paul Kedrosky][via Mark Thoma]

[YouTube] Joseph Stiglitz Talks About US Economy, Dollar, And Rescue Efforts

The part in the Q&A where he mentions ‘giving out the insurance money for a burned down house which didn’t burn down’ is here (I think).

A.I.G.’s insurance commitment stood at “only” $302 billion in part because the government has already voided $62 billion of the protection A.I.G. had written on pools of especially toxic securities. The underlying collateral on those contracts, valued at about $32 billion or so, now sits in a facility that the Federal Reserve Bank of New York oversees and which we, the taxpayers, own.

In order to rip up those contracts, the taxpayers had to make A.I.G.’s counterparties whole by buying the debt that A.I.G. had insured and paying out — in cash — the remaining amount owed to the counterparties.

Of the $302 billion in insurance outstanding at A.I.G., about $235 billion was sold to foreign banks and covers prime home mortgages and corporate loans. The banks that bought this insurance did so to reduce the money they must set aside for regulatory capital requirements.

Here is more (ForaTV) of Joseph Stiglitz at the beginning of 2008, and on ForaTV at the end of 2008 and here again. Here @Google Talks in 2006 with his book ‘Making Globalization Work’. Here @Google Talks with his more recent book ‘The 3 Trillion Dollar War’.

• Joseph Stiglitz and his works (Econlib.org)
• Joseph Stiglitz bio (Econlib.org)

RE: Regulation Of Executive Compensation Schemes

Nobel Prize Economist of 1992, and receiver of a Presidential Medal of Freedom, Gary S. Becker wrote yesterday again about the recent discussions, historic perspectives, and possible implications of regulated compensation schemes for Bank Executives who are employed by a bank who receive any form of government aid. He made some very important historic notes and reasoning of why compensation didn’t really cause the financial crisis; (Bold my emphasis)

One irony is that, as pointed out by Yale’s Jonathan Macey in a recent Wall Street Journal op-ed piece, Congress in a 1992 Act prevented corporations from deducting as a normal business expense any salaries that exceeded $1 million. As a result, corporations were encouraged to shift their pay to stock options, which received more favorable tax treatment.

I have not seen convincing evidence that either the level or structure of the pay of top financial executives were important causes of this worldwide financial crash. These executives bought large quantities of mortgage-backed securities and other securitized assets because they expected this to increase the average return on their assets without taking on much additional risk through the better risk management offered by derivatives, credit default swaps, and other newer types of securities. They turned out to be badly wrong, but so too were the many financial economists who had no sizable financial stake in these assets, but supported this approach to risk management.