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November 4, 2011

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Paul Krugman: Oligarchy, American Style

Posted: 04 Nov 2011 12:33 AM PDT

Why does rising inequality matter?:

Oligarchy, American Style, by Paul Krugman, Commentary, NY Times: Inequality is back in the news, largely thanks to Occupy Wall Street, but with an assist from the Congressional Budget Office. ... The budget office ... documented a sharp decline in the share of total income going to lower- and middle-income Americans. ...
So who is getting the big gains? A very small, wealthy minority.

Dist"It's a tiny minority, not a broad class of well-educated Americans,
who have been winning"

The budget office report tells us that essentially all of the upward redistribution of income away from the bottom 80 percent has gone to the highest-income 1 percent of Americans. That is, the protesters who portray themselves as representing the interests of the 99 percent have it basically right, and the pundits solemnly assuring them that it's really about education, not the gains of a small elite, have it completely wrong.
If anything, the protesters are setting the cutoff too low..., almost two-thirds of the rising share of the top percentile in income actually went to the top 0.1 percent...
Who's in that top 0.1 percent? Are they heroic entrepreneurs creating jobs? No... Recent research shows that around 60 percent of the top 0.1 percent either are executives in nonfinancial companies or make their money in finance... Add in lawyers and people in real estate, and we're talking about more than 70 percent of the lucky one-thousandth.
But why does this growing concentration of income and wealth in a few hands matter? Part of the answer is that rising inequality has meant a nation in which most families don't share fully in economic growth. Another part of the answer is that once you realize just how much richer the rich have become, the argument that higher taxes on high incomes should be part of any long-run budget deal becomes a lot more compelling.
The larger answer, however, is that extreme concentration of income is incompatible with real democracy. Can anyone seriously deny that our political system is being warped by the influence of big money, and that the warping is getting worse as the wealth of a few grows ever larger?
Some pundits are still trying to dismiss concerns about rising inequality as somehow foolish. But the truth is that the whole nature of our society is at stake.

"Wall Street Won Another Battle"

Posted: 04 Nov 2011 12:24 AM PDT

 Regulatory capture:

As Regulators Pressed Changes, Corzine Pushed Back, and Won, by Azam Ahmed and Ben Protess, NY Times: Months before MF Global teetered on the brink, federal regulators were seeking to rein in the types of risky trades that contributed to the firm's collapse. But they faced opposition from an influential opponent: Jon S. Corzine, the head of the then little-known brokerage firm.
As a former United States senator and a former governor of New Jersey, as well as the leader of Goldman Sachs in the 1990s, Mr. Corzine carried significant weight in the worlds of Washington and Wall Street. While other financial firms employed teams of lobbyists to fight the new regulation, MF Global's chief executive in meetings over the last year personally pressed regulators to halt their plans.
The agency proposing the rule, the Commodity Futures Trading Commission, relented. Wall Street, which has been working to curb many financial regulations, won another battle.
Yet with ... $630 million in missing customer funds, Mr. Corzine's effort may come back to haunt him.
The proposed rule would have restricted a complicated transaction that allowed MF Global in essence to borrow money from its own customers. ... While such financing is not unknown on Wall Street, it carries substantial risk. ... Regulators are now examining whether these transactions explain the missing money at MF Global. ...

links for 2011-11-04

Posted: 04 Nov 2011 12:06 AM PDT

"Quick Bites"

Posted: 03 Nov 2011 05:49 PM PDT

Tim Duy:

Quick Bites, by Tim Duy: So much news, so little time. A list of items crossing my screen over the last two days, in no particular order:

Greece referendum off, at least for today. Greece Prime Minister George Papandreou backtracked on his calls for referendum, much to the relief of market participants. I hesitate to think this story is over. The citizens of Greece might not react calmly to having democracy snatched back out of hand's reach. It is never easy to put the genie back inside the bottle.

The ECB cuts rates. Better late than never, I suppose. The surprise rate cut by the ECB is also credited with bolstering markets today. Given the worsening economic situation, we should expect more sooner than later. And note that with the benchmark rate at only 1.25%, the zero bound is clearly in sight. How do you say liquidity trap in German?

Red flags in the German data. Germany, the juggernaught of the European economy, looks to be under stress. The German Purchasing Managers Index crossed over into contrationary territory last month for the first time in two years, while German unemployment rose for the first time in two years. From Bloomberg:

"It's too early to call this a trend change in the labor market, but it shows that growth forces are weakening," Lothar Hessler, an economist at HSBC Trinkaus & Burkhardt AG (TUB) in Dusseldorf, said in an interview. "The dynamism of the economic upswing is lessening more than thought."

I am more willing to call a shift in Germany's labor market - the austerity that Germany is fond of foisting on the rest of Europe is coming home to roost.

Italian economy also shifted into low gear. The Italian PMI dropped a whopping 5 points to 43.3, a notch below Spain's 43.9. No wonder Italy's Prime Minister Silvio Berlusconi is having trouble pushing through another austerity package. Rebecca Wilder highlights the importance of growing political risk in Italy:

Another driver of the increasing Italian risk premium is political risk. You can see this in the spread between Italian 10yr bond yields and the Spanish 10yr bond yields, which has collapsed since the summer and is now trading at -70 bps. That means the Spanish sovereign is borrowing at a 10yr yield that is 70 bps cheap to Italy, where it used to pay a premium. Something idiosyncratic is going on with Italy.

It is tough to see how a Europe still struggling to put a ring around Greece can find the time and resolve to get a ring around Italy as well.

More on Europe. Is this the tip of the iceberg? Ambercrombie does complete reversal on the European outlook:

The retailer was hurt by a "slowing trend" in the region, while same-store sales in Japan and Canada continued to decline, according to a statement today. The shares slumped 21 percent to $58.50 at 10:53 a.m. in New York after dropping as much as 23 percent for the biggest intraday loss since Nov. 30, 2000.

Abercrombie & Fitch surprised investors after Chief Executive Officer Michael Jeffries said in August that there was a "strong momentum" in Europe. The retailer is joining a growing list of consumer companies, from Whirlpool Corp. to Kimberly-Clark Corp., that saw a slowdown in the region mired by a sovereign debt crisis.

The US service sector comes in on the soft side. The ISM nonmanufacturing headline number was down slightly, with mixed internals. Production came in down 3.3 points, while new orders dropped 4.1 points. Both measures held above 50. On the postive side, the employment component rebounded, offering some hope for tomorrow's employment situation report. In related new, initial unemployment claims edged below 400k. Overall, Calculated Risk is not impressed, expecting another weak report.

The Fed hold steady. Mark Thoma has the story here. Inexplicably, monetary policymakers slashed forecasts, claimed dissapointment at the state of the economy, and yet choose to take no policy action. The path to additional action is blocked by the lack of clear indications of deflation risks. The economy is bad, just not bad enough.

Another financial casaulty of the European crisis? First was Dexia, next was MF Global. Is Jefferies Group the third to fall? That was concern today as investors took the stock down 20% before it rebounded. More disconcerting is the message the price actions sends about the vulverability of US financial markets to European contagion:

"It is a testament to the fragile nature of the markets that the collapse of MF Global, following a monumental display of bad judgment by that company's management, should generate contagion," said Chris Kotowski, an Oppenheimer & Co. analyst in New York. Jefferies is "a very conservatively run firm where management has enormous 'skin in the game.'"

Bottom Line: This is starting to feel like 2007 all over again. Then, like now, equity markets discounted the smoldering financial crisis, sending stocks higher through much of that year. I continue to think Europe is much further from a solution than American observers appear to believe, and that as the global situation deteriorates further, so too will the US economy. But we have yet to see that story fully emerge in the US data, and thus I understand the hope that the US is able to squeak through this episode with only limited bruising.

"Negative Real Interest Rates"

Posted: 03 Nov 2011 12:33 PM PDT

David Andolfatto notes that the real interest rate is near zero, even negative in some cases, and says "Surely there are public infrastructure projects that can be expected to yield a real return higher than zero? This is a great time for the U.S. treasury to borrow":

Negative real interest rates, Macromania: ...In macroeconomic theory, the nominal interest rate plays second-fiddle to the so-called real interest rate. The real rate of interest is ... a relative price. It is the price of output today measured in units of future output... So, if the risk-free annual interest rate on an inflation-indexed U.S. treasury is 2%, then one unit of output today is valued at 1.02 units of output in the future....
Economists typically focus on the real interest rate because people presumably care about output and not money (they care about money only to the extent that it may be used to purchase output). ... The higher the real interest rate, the more output is valued today vis-a-vis future output. A high real interest rate reflects the market's strong desire to have you part with your output today (in exchange for a promise of future output). Unlike the nominal interest rate, however, there is nothing that naturally prevents the real interest rate from becoming negative; see Nick Rowe. And indeed, this appears to have happened recently in the U.S. The following diagram plots the real interest rate as measured by the n-year treasury inflation-indexed security (constant maturity) for n = 5, 10, 20; see FRED.

Prior to the Great Recession, real interest rates are hovering around 2% p.a. and the yield curve is upward sloping (long rates higher than short rates), at least until early 2006 (when it flattens). Following the violent spike up in real interest rates (associated with the Lehman event), real interest rates have for the most part declined steadily since then. The 20 year rate is below 1%, the 10 year rate is basically zero, and the 5 year rate is significantly negative. What does this mean?
The decline in real rates that has taken place, especially since the beginning of 2011, is a troubling sign. ... This premium may be signaling an expected scarcity of future output. If so, then this is a bearish signal.

The decline in market real interest rates is consistent with a collapse (and anemic recovery) of investment spending (broadly defined to include investments in job recruiting). For whatever reason, the future does not look as bright as it normally does at the end of a recession. To some observers, this looks like a "deficient aggregate demand" phenomenon. To others, it is the outcome of a rational pessimism reflecting a flow of new regulatory burdens and a potentially punitive tax regime. Both  hypotheses are consistent with the observed "flight to safety" phenomenon and the consequent decline in real treasury yields.
Unfortunately, the two hypotheses yield very different policy implications. The former calls for increased government purchases to "stimulate demand," while the latter calls for removing whatever barriers are inhibiting private investment expenditure. There seems to be room for compromise though. Surely there are public infrastructure projects that can be expected to yield a real return higher than zero? This is a great time for the U.S. treasury to borrow (assuming that borrowed funds are not squandered, of course).
In the event of an impasse, can the Fed save the day? It is hard to see how. The Fed's influence on real economic activity is usually thought to flow through the influence it has (or is supposed to have) on the real interest rate. One could make the case that real interest rates are presently low in part owing to the Fed's easing policies. But this would be ignoring the fact that the Fed's easing policies were/are largely driven by the collapse in investment spending. (I am suggesting that in a world without the Fed, these real interest rates would be behaving in more or less the same way.)
In any case, real interest rates are already unusually low. How much lower should they go? Is it really the case that our economic ills, even some of them, might be solved in any significant manner by driving these real rates any lower? My own view is probably not. If there is something the Fed can do, it is likely to operate through some other mechanism. ...

David also looks at inflation expectations and concludes:

there is no evidence to suggest that inflation expectations are whirling out of control, one way or the other. I'm not sure to what extent this constitutes success. At the very least it is not utter failure.

I am more confident that David is that the Fed can still help the economy, but it can't do it on its own and too much focus on the Fed takes the pressure off of Congress to do its part to help to overcome the unemployment crisis. Members of Congress need to be worried that their own jobs are at risk if they don't do something to help the unemployed (and they shouldn't be allowed to get away with claiming that cutting the deficit by cutting social insurance programs is a means to this end). That's one of the reasons I keep calling for fiscal policy as well -- both sets of policymakers need to feel as much pressure to act as possible.

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