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August 7, 2012

Latest Posts from Economist's View

Latest Posts from Economist's View

Posted: 16 Jun 2012 12:24 AM PDT
Nouriel Roubini sees trouble ahead:
A Global Perfect Storm, by Nouriel Roubini, Commentary, Project Syndicate: Dark, lowering financial and economic clouds are, it seems, rolling in from every direction: the eurozone, the United States, China, and elsewhere. Indeed, the global economy in 2013 could be a very difficult environment in which to find shelter.
For starters, the eurozone crisis is worsening, as the euro remains too strong, front-loaded fiscal austerity deepens recession in many member countries, and a credit crunch in the periphery and high oil prices undermine prospects of recovery. The eurozone banking system is becoming balkanized, as cross-border and interbank credit lines are cut off, and capital flight could turn into a full run on periphery banks if, as is likely, Greece stages a disorderly euro exit in the next few months.
Moreover, fiscal and sovereign-debt strains are becoming worse as interest-rate spreads for Spain and Italy have returned to their unsustainable peak levels. ... As a result, disorderly breakup of the eurozone remains possible.
Farther to the west, US economic performance is weakening...
In the east, China, its growth model unsustainable, could be underwater by 2013...
Finally, long-simmering tensions in the Middle East between Israel and the US on one side and Iran on the other on the issue of nuclear proliferation could reach a boil by 2013. ...
These risks are already exacerbating the economic slowdown...
Compared to 2008-2009, when policymakers had ample space to act, monetary and fiscal authorities are running out of policy bullets (or, more cynically, policy rabbits to pull out of their hats). Monetary policy is constrained by the proximity to zero interest rates and repeated rounds of quantitative easing. Indeed, economies and markets no longer face liquidity problems, but rather credit and insolvency crises. Meanwhile, unsustainable budget deficits and public debt in most advanced economies have severely limited the scope for further fiscal stimulus.
Using exchange rates to boost net exports is a zero-sum game...
Meanwhile, the ability to backstop, ring-fence, and bail out banks and other financial institutions is constrained by politics and near-insolvent sovereigns' inability to absorb additional losses from their banking systems. ...
Unfortunately, Germany resists ... key policy measures... As a result, the probability of a eurozone disaster is rising.
And, while the cloud over the eurozone may be the largest to burst, it is not the only one threatening the global economy. Batten down the hatches.

Posted: 16 Jun 2012 12:06 AM PDT
Posted: 15 Jun 2012 02:43 PM PDT
Tim Duy:
ECB Ready to Play?, by Tim Duy: Draghi blinks. After dropping the ball and holding rates steady at the last meeting, ECB President Mario Draghi is signaling he is ready to get back into the game. Via Reuters:
The euro zone economy faces serious risks and no inflation threat, European Central Bank President Mario Draghi said on Friday in comments that heightened expectations the ECB could cut interest rates or take other policy action soon.
Draghi also said the ECB stood ready to provide further liquidity to solvent banks, stressing that its provision of ultra-cheap 3-year funds, or LTROs, late in 2011 and early this year had averted a major credit crunch...
...There are serious downside risks here," Draghi told the annual ECB Watchers conference in Frankfurt. "This risk has to do mostly with the heightened uncertainty."
I am not so sure about this "heightened uncertainty" line. It seems pretty certain that Spain is in trouble if rates hold at these levels or head higher, and this is the immediate problem. Draghi might have in mind bringing down rates with another stab at the temporary solution the LTROs provided last year. Helpful, but still only temporary. It would be more helpful if he switched gears to outright quantitative easing via government bond purchases (oddly, though, the expectation is that the Federal Reserve will do more than Europe in response to a European problem).
What would be most helpful is a clear signal that the ECB will not let the Eurozone collapse because default fears are driving unpleasant dynamics. Consider this helpful chart from Frances Woolley:
Woolley comments:
The convergence of bond yields after the Euro was introduced reveals that the pre-Euro yield differences were almost entirely based on inflation and exchange rate risk. No one ever seriously considered the possibility that an EU country might not be able to repay its debt. That's what they were thinking...
Prior to the introduction of the Euro, the presence of independent central banks prepared to serve as a lender of last resort for the fiscal authorities meant that there was no serious default risk. There would, of course, be inflation (soft-default) and exchange rate risk, but no hard-default risk. You can't really default when you can print the currency in which your debt is denominated. After Lehman, though, the possibility of default appears, and the ECB does nothing to dispel such fears. Moreover, the Greek debt restructurings dispelled any remaining doubts about European sovereign debt - the lack of a central bank backstops means serious default risk.
So now we can't rule out a possibility of Spanish default, which drives interest rates higher, which in turn increases the probability of default. This of course then feeds into the dynamics for Italy, and then maybe France. The only entity that can break the cycle is the ECB, but they have been so far unwilling to do so, putting the pressure on fiscal authorities to break the cycle. Unfortunately, the job is simply too big and complicated for the fiscal authorities to complete in a timely fashion, especially when running Merkel's race against the markets.
What we really need is a European Central Bank that can manage exchange rate and inflation risk while also addressing default risk. Without such a fully functional central bank, Europe will at best limp along under constant economic distress. Ultimately, Draghi will need to create such a central bank before the fiscal plumbing is in place if he wants to hold the Eurozone together. Which is why he will always blink first.
Or at least I hope he will.
Posted: 15 Jun 2012 02:34 PM PDT
Another one from Tim Duy:
Communications Failure, by Tim Duy: Reading Cardiff Garcia's preview of next week's Fed meeting, I was struck by this chart from Nomura:
The extensive discussion of options with arguments for and against reminded me of the fog that hangs over this next meeting.  We really have no idea what the Fed is going to do or why they are going to do it.  Reasonable analysis ranges from nothing to massive quantitative easing. 
To be sure, I am certain of some things.  For example, that swap lines will be expanded in the event of a severe market disruption. I am stunned that this was actually considered new information yesterday - it seems that actions along these lines is a no-brainer.  But absent the all-bets-are-off-financial-collapse story, I am a bit shaken by the uncertainty going into this meeting.
This strikes me as a major communications failure on the part of the Federal Reserve.  The problem, I suspect, is that they don't know exactly what they would do if more easing is called for, which is why we  see talk of all possible options - doing nothing, extending Operation Twist, communication changes, and additional assets purchases.  They can't tell us what they don't know.
I worry that the Federal Reserve has spent much more intellectual effort on procedures to tighten policy, and not enough effort on additional easing policy.  Indeed, easing has really been on an ad-hoc basis.  Moreover, we don't really know the triggers for additional easing because officials repeatedly refer to the risk/reward trade off, suggesting that they think the rewards are relatively small at this point, which suggests that the bar must be very high.  But many policymakers seem to have a hair trigger for additional easing, so which is it?  It the bar high or low?  Judging by Federal Reserve Chairman Ben Bernanke's past behavior, I tend to think the bar is pretty high.  Perhaps this is just my pessimism talking.
It would be very helpful if at the next FOMC meeting policymakers could agree to a specific path for additional easing, if needed, and eliminate the ad-hoc approach.  In other words, put as much effort toward explaining how they would move forward as put toward how they would move back.

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