Tuesday, July 31, 2012

Still Learning from Milton Friedman

We can still learn much from Milton Friedman, who was born 100 years ago today. Here I focus on his role in the macroeconomic debates of the 1960s and 1970s, because they are so similar to the debates raging again today.

Friedman, Samuelson, and Rules Versus Discretion
First, go back to the early 1960s. The Keynesian school was coming to Washington led more than anyone else by Paul Samuelson who advised John F. Kennedy during the 1960 election campaign and recruited people like Walter Heller and James Tobin to serve on Kennedy’s Council of Economic Advisers. In fact, the Keynesian approach to macro policy received its official Washington introduction when Heller, Tobin, and their colleagues wrote the Kennedy Administration’s first Economic Report of the President, published in 1962.

The Report made an explicit case for discretion rather than rules: “Discretionary budget policy, e.g. changes in tax rates or expenditure programs, is indispensable…. In order to promote economic stability, the government should be able to change quickly tax rates or expenditure programs, and equally able to reverse its actions as circumstances change.” As for monetary policy a “discretionary policy is essential, sometimes to reinforce, sometimes to mitigate or overcome, the monetary consequences of short-run fluctuations of economic activity.”

In that same year Milton Friedman published Capitalism and Freedom (1962) giving the competing view on role of government which he then continued to espouse through the 1960s and beyond. He argued that “the available evidence . . . casts grave doubt on the possibility of producing any fine adjustments in economic activity by fine adjustments in monetary policy—at least in the present state of knowledge . . . There are thus serious limitations to the possibility of a discretionary monetary policy and much danger that such a policy may make matters worse rather than better . . . The basic difficulties and limitations of monetary policy apply with equal force to fiscal policy . . . Political pressures to ‘do something’ . . . are clearly very strong indeed in the existing state of public attitudes. The main moral to be had from these two preceding points is that yielding to these pressures may frequently do more harm than good. There is a saying that the best is often the enemy of the good, which seems highly relevant . . . The attempt to do more than we can will itself be a disturbance that may increase rather than reduce instability.”

Resolving the Disagreements
So there were two different views: the Samuelson view versus the Friedman view. The fundamental disagreement was not really over which instrument of government policy worked better (monetary versus fiscal), but rather over discretion versus rules-based policies. From the mid-1960s through the 1970s the Samuelson view was winning with practitioners putting many discretionary policies into practice.

But Friedman remained a persistent and resolute champion of his alternative view. At one time during the 1970s, F.A. Hayek even seemed to be siding with the discretionary approach, at least in the case of monetary policy. But Milton Friedman didn’t waver. In fact he sent a letter to Hayek in 1975 saying: “I hate to see you come out as you do here for what I believe to be one of the most fundamental violations of the rule of law that we have, namely discretionary activities of central bankers.” Fortunately, in my view, Friedman’s arguments eventually won the day and American economic policy moved away from such a heavy emphasis on discretion in the 1980s and 1990s.

The Debate Returns
But this same policy debate is back today. Economists on one side push for more discretionary fiscal stimulus packages. They argue that the stimulus packages of 2008 and 2009 either worked or should have been even larger. They also push for more discretionary monetary policy such as the quantitative easing actions. They are not so worried about discretionary bailout policy, discounting the increased moral hazard that lack of a credible rule implies. In these ways they are descendants of the Samuelson school.

Other economists argue for more stable fiscal policies based on permanent tax reforms and the automatic stabilizers. They also push for a return to more predictable and rule-like monetary policy.They argue that neither the discretionary fiscal stimulus packages nor the bouts of quantitative easing were very effective, pointing to the risks of increased debt or monetization of the debt. They worry about the consequences of the discretionary bailouts. In these respects they are descendants of the Friedman school.

Of course there are many nuances today, some related to the difficulty of distinguishing between rules and discretion. You can see this, for example, in discussions of nominal GDP targeting, where some see it as a rule and some see it as a license to proceed with whatever discretionary action it takes. Interestingly, you frequently hear people on both sides channeling Milton Friedman to make their case.

Resolving the Debate Again
While academics are still the main protagonists, the debate is not academic. Rather it is a debate of enormous practical consequence with the well-being of millions of people on the line. Can the disagreements be resolved? Milton tended toward optimism that they could be resolved, and I am sure that this is one reason why he kept researching and debating the issue so vigorously.

Here people on both sides can learn from him. First, while a vigorous debater he was respectful, avoiding personal attacks and never failing to answer a letter. Second, he had a strong believe that empirical evidence would bring people together. He was influenced by statistician Leonard (Jimmie) Savage: Yes, people would come to the issue with widely different prior beliefs, but their posterior beliefs—after evidence was collected and analyzed—would be much closer. In this way the disagreement would eventually be resolved. I think we saw this in the late 1970s and the basic agreements lasted for at least two decades.

Unfortunately, posterior beliefs in the macro area now seem just as far apart as prior beliefs were 50 years ago. Clearly we have a lot of work to do, and clearly we can learn a lot from Milton Friedman in deciding how to proceed.

Thursday, July 26, 2012

Benefits of More Fed “Action” Do Not Exceed Costs

Both the New York Times and the Wall Street Journal ran front page stories yesterday reporting that the Fed is yet again about to take action. “Fragile Economy Said to Push Fed to Weigh Action” said the Times. “Fed Moves Closer to Action” said the Journal. Both stories report that the benefits of such actions in the past have exceeded the costs, but there is precious little evidence for this. In an interview in the latest issue of MONEY Magazine I was asked about this:

What’s your assessment of the Federal Reserve’s recent actions to help spur the economy?  The Fed has engaged in extraordinarily loose monetary policy, including two round s of so-called quantitative easing. These large scale purchases of mortgages and Treasury debt were aimed at lifting the value of those securities, thereby bringing down interest rates. I believe quantitative easing has been ineffective at best, and potentially harmful.

Harmful how? The Fed has effectively replaced large segments of the market with itself—it bought 77% of new federal debt in 2011. By doing so, it creates great uncertainty about the impact of its actions on inflation, the dollar and the economy. The very existence of quantitative easing as a policy tool creates uncertainty and volatility, as traders speculate on whether and when the Fed is going to intervene again. It’s bad for the U.S. stock market, which is supposed to reflect the earnings of corporations.

On a more technical level, the latest issue of the International Journal of Central Banking published an article by Johannes Stroebel and me raising doubts about the benefits of the mortgage-backed securities (MBS) purchase program (part of QE1), and the costs of the resulting large balance sheet go well beyond concerns about inflation.

Tuesday, July 24, 2012

Record Low Yields Once Again on US Treasuries

Curve watcher's anonymous is noting record low yields across most of the US Treasury yield curve.

US Treasury Curve 2012-07-24

click on chart for sharper image

The above image is just off the absolute lows. The 30-year touched 2.45% and 10-year 1.39%.


  • Brown: $IRX 3-Month Treasury Bill Discount Rate
  • Blue: $FVX 5-Year Treasury Note Yield
  • Orange: $TNX 10-Year Treasury Note Yield
  • Green: $TYX 30-Year Long Bond Yield

Mike "Mish" Shedlock
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Germany in Recession: Private Sector Sees Fastest Falls in Output and New Business Since June 2009; New Export Orders Collapse

The vaunted German export machine is sinking into the abyss. The Markit Flash Germany PMI® shows German private sector sees fastest falls in output and new business since June 2009.
Key Points

  • Flash Germany Composite Output Index(1) at 47.3 (48.1 in June), 37-month low. 
  • Flash Germany Services Activity Index(2) at 49.7 (49.9 in June), 10-month low. 
  • Flash Germany Manufacturing PMI(3) at 43.3 (45.0 in June), 37-month low. 
  • Flash Germany Manufacturing Output Index(4) at 42.8 (44.8 in June), 37-month low.


The seasonally adjusted Markit Flash Germany Composite Output Index fell for the sixth month running in July, to 47.3 from 48.1 in June. The index has posted below the 50.0 no-change value in each month since May, and the latest reading signalled the fastest pace of private sector contraction since June 2009.

Manufacturers suffered a sharper drop in business activity than service providers during July, as well as a greater loss of momentum relative to the situation in June. The latest reduction in manufacturing production was the steepest for just over three years, while new orders received in the sector dropped at the fastest pace since April 2009. Service providers recorded only a marginal decrease in business activity, although the rate of contraction was the joint-fastest in three years.

Across the private sector as a whole, new business intakes fell at the quickest rate since June 2009, with manufacturers and service providers both recording much sharper declines than during the previous month. Lower levels of new work have been recorded in the service economy during each month since April, and the latest reduction was the fastest for exactly three years. Meanwhile, in the manufacturing sector, new export orders declined at the steepest rate since May 2009, which contributed to a thirteenth successive monthly fall in total new business volumes.

July data pointed to a sharp and accelerated fall in outstanding business across the German private sector. ....
Flashback January 09, 2012: Dimwit Comment of the Day: Christine Lagarde, IMF Director says "Europe May Avoid a Recession This Year"
In what is likely the silliest comment of the year so far, Christine Lagarde says Europe may avoid recession this year
Flashback January 12, 2012: German Economy Contracts in 4th Quarter; Spain's Industrial Output Plunges 7%; UK Trade Deficit Widens; European Banks Wisely Hoard Cash
If Europe heads into a prolonged recession (and it has already started), Germany cannot help but get sucked into it. Approximately 28 percent of German GDP is derived by exporting goods to EU countries and Switzerland.

Think German exports to the rest of Europe are going to rise forever? Think again, starting with a look at the Eurozone's 4th largest economy. ...
Flashback February 23, 2012: Don't Worry, It's Only a "Mild Recession"
The economic clowns in the EU have finally acknowledged something that was blatantly obvious at least six months ago (and a lot longer if one factored in the likely effects of multiple austerity programs in numerous countries).

However, the economists' new conclusion is about as silly as the "no recession" call that preceded it. The new forecast: there will be a recession in the eurozone but not the EU and it will be "mild".
Such nonsense went on for months actually. Economists were behind the curve every step of the way even though it should have been blatantly obvious what was about to happen.

Global Recession Revisited

On July 6 I wrote Plunging New Orders Suggest Global Recession Has Arrived

Clearly I am not changing that prognosis although I do wish to reiterate the definition of "global recession as per my post Case for US and Global Recession Right Here, Right Now; Recognizing the Limits of Madness; Permabears?
Contrary to popular myth, recession does not mean two consecutive quarters of economic contraction. Rather, two consecutive quarters of economic contraction is a sufficient, but not necessary condition.

In the US, the NBER is the official designator of recession start and end points. Many recessions have started with GDP still growing.

The "Conditions for Global Recession" are even looser. "The International Monetary Fund (IMF) considers a global recession as a period where gross domestic product (GDP) growth is at 3% or less. In addition to that, the IMF looks at declines in real per-capita world GDP along with several global macroeconomic factors before confirming a global recession."
Mike "Mish" Shedlock
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Mish on Capital Account: Discussion of Social Media Panic in Italy, Soaring Yields in Spain, and the Upcoming 20th Euro Summit, Bound to be Another Failure

I had the pleasure of being back on Capital Account with Lauren Lyster on Monday for a discussion of social media panic in Italy, soaring yields in Spain, and the end of the line for Greece.

I come in at about the 18 minute mark, but positioned the video to automatically start play at the 17:15 mark, which is the start of the segment.

That way you can hear a brief introduction from Lauren.

For detailed information about the discussion in the above video, please see...

Mike "Mish" Shedlock
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Monday, July 23, 2012

Spanish Finance Minister in Germany Pleads for Temporary Credit Line to Halt an "Imminent Financial Collapse"

Spain faces a bond rollover of €28 Billion in October and is rightfully scared about 2-year bond rates of 6.5%.

El Economista notes the Spanish economy minister is at a meeting in Berlin to discuss Government Request for a Credit Line to Save the Year and forestall an imminent financial collapse.

This is a heavily Mish-modified translation from the article ....
Luis de Guindos will meet with Wolfgang Schäuble to negotiate measures noting the ECB is already 19 weeks without buying debt.

Eeconomy minister, Luis de Guindos, now travels to Germany for talks with German Finance Minister, Wolfgang Schäuble. The appointment is key because Spain is running out of time. With the 10-year bond about 7.5% and the risk premium on the 632 basis points, Guindos nevertheless insisted that Spain will not have to ransom all for a full sovereign bailout.

Instead, he asks for the European Central Bank (ECB) to resume purchases of Spanish bonds in the market.

Guindos believes Mario Draghi is not the problem. Rather, bond purchases have stopped primarily because Germany is opposed. To mutate this position and to convince Schauble to give permission to his emissaries at the ECB, Jörg Asmussen, and Jens Weidmann, Luis de Guindos traveled to Germany

Analysts are unanimous: An imminent financial collapse is at stake. If pressure on Spanish bonds continues and Treasury loses its access to the bond market, Spain cannot cope with the massive debt maturity that awaits him in October, close to the 28 billion euros. Amounts may be even greater if Spain has to funnel money to the regions requesting the help of special liquidity fund.

Therefore, sources close to the government have admitted they are considering other alternatives. For example, the negotiation of a temporary line of credit with which to address the maturity of its debt, and perhaps even financial assistance for Spain's regional governments.

This option is based on a premise well known in the eurozone, of buying time. A credit line would serve to dampen fears today, waiting for the agreements reached at the June summit, including the implementation of a single banking supervisor and an operational Stability Mechanism.
For starters, when it comes to these bailouts, there is no such thing as "temporary". Regardless, I believe Germany will reject the request, thereby forcing Spain into a full sovereign bailout.

Mike "Mish" Shedlock
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Austerity Hits Cisco Systems as 1,300 Layoffs Coming; Chipmaker Renesas Cuts 5,000 Jobs; Investigating Mass layoffs

For the second consecutive year, Cisco Systems is in Austerity Mode, looking to shed 1,300 employees.
Cisco Systems is to lay off around 1,300 workers, as part of the company's ongoing austerity programme aimed at saving $1bn a year.

The firm said the cuts were being implemented to simplify its operations and adjust to changing economic conditions around the world.

The job cuts represent around 2% of Cisco Systems' 65,000 strong workforce.

Last year the firm, the world's largest maker of computer networking equipment, had shed 10,000 posts.

Cisco warned that growing economic uncertainty was creating an environment in which it was becoming increasingly difficult to clinch business deals.
Chipmaker Renesas Cuts 5,000 Jobs

The BBC also notes Chipmaker Renesas Cuts 5,000 Jobs
Renesas Electronics, the world's fifth biggest chipmaker, has announced a restructuring plan that will lead to at least 5,000 job cuts.

It is getting rid of half its 19 plants and cutting 12% of its workforce.

The plan is part of an agreement to get financial help from creditor banks and its three top shareholders: NEC, Hitachi and Mitsubishi Electric.
Investigating Mass layoffs

According to BLS data, Mass layoffs, defined as termination of 50 or more employees simultaneously, have actually been declining and are at the lowest point since 2007.

However, corporations did not exactly go on a hiring spree in the recovery and thus have been running lean.

Should the economy go into a recession (I think we are back in one), companies may have to take it to the chin in profits or in layoffs. I suspect  both.

Mike "Mish" Shedlock
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Social Media Panic in Italy: "Enough of this Agony; Give Us Back the Lira"

Black Monday messages on Facebook and Twitter have gone viral in Italy as people have had enough of austerity, job losses, and uncertainty. La Stampa reports on Panic in the Network.

What follows is a Mish-revised translation of select ideas and quotes from the article. My specific comments are in brackets.
Black Monday breaks early in the morning on websites across the world and social networking spreads alarm. "Withdraw money from bank accounts" is the appeal of Andrew to Facebook friends.

Pseudo-analysis on the alleged benefits of a return to the lira go around the net. "Enough of this sad agony. Bring back the old money", Paul insists.

"In 2000 we had the lira. We were producing more, exporting more, and children were living better, the results of monetary sovereignty" says Magdi Cristiano Allam on Twitter.

"We are on the brink of the abyss and the top EU cazzeggiano [slang for F* around]," accuses Ivan.

The tones on social networks are apocalyptic: "This is not a crisis, it's the end of capitalism." On the forum of the economics of printing a black player sees: "Folks, we begin to pray, after Greece's up to us. We are at the end titles, to every man for himself."

Then there are the usual conspiracy theories regarding the IMF, ECB, Germany, the White House, U.S. investment banks, the Bilderberg and the Trilateral Commission. All guilty of "working for the failure of Italy and Spain." "We must defend ourselves from the American speculation, but Merkel holds us hostage," Roberto tweets.

Everyone looks to Mario Draghi: The "ECB needs to intervene at once" says David Sassoli MEP [Member of European Parliament].

"We're towards the end of the line like Greece and Spain?" Asks Matthew.

The stubborn "spread" climbs the ranking of most used words in the blogosphere. [Presumably spread refers to interest rate differentials between Italy and Germany]

Catherine accuses the government, political parties, unions, and banks. "It takes courage," writes Catherine on the Facebook page of La Stampa. Catherine then rattles off a recipe based on "Electoral Law, priority to industry, limiting immigration, elimination of environmental bulls**t, and zero bureaucracy."

Small investors are bewildered: "If I buy U.S. government bonds and Italy out of the Euro, those are always in dollars, right?" asks Stephanie C. on Facebook.
Schools May Not Reopen After Summer Break

Please note that Italian provinces warn cuts may close schools
Italian regional authorities may not be able to open schools after the summer break if spending cuts planned in the government's latest spending review are carried through, the head of the Union of Italian Provinces (UPI) said on Monday.

"With these cuts we won't be able to guarantee the opening of the school year," UPI President Giuseppe Castiglione told reporters in Rome.

Piero Lacorazza, president of the province of Potenza in southern Italy, said the comment was "not an exaggeration", adding that "half of the provinces are in serious financial difficulty".
More Panic in Brussels Than on Social Media

In case you missed it, please consider Ten Major Italian Cities On Verge of Financial Collapse

Also note a Time-Lapse Interactive Graph Shows Stunning Rise in Anti-Euro Sentiment in Italy.

In terms of sheer panic, I bet eurocrats in Brussels are in a bigger state of panic than what you saw on Twitter.

Here is a thought of mine that is worth repeating:

Eventually, there will come a time when a populist office-seeker will stand before the voters, hold up a copy of the EU treaty and (correctly) declare all the "bail out" debt foisted on their country to be null and void. That person will be elected.

Beppe Grillo may be just that person.

Mike "Mish" Shedlock
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Ten Major Italian Cities On Verge of Financial Collapse

The economic situation in Italy has reached a critical phase as Ten major cities face risk of crash

The word "crash" implies bankruptcy. Milan, Naples, and Turin are among the cities. The Association of Municipalities plans to demonstrate in Rome against new cuts, hoping to sends a clear message to prime minister Mario Monti that will "force his hand".

What follows in blockquotes is an "as is" translation from La Stampa.
There are ten major Italian cities with more than 50,000 inhabitants, who are a step away from the crash. Naples and Palermo at the top of the "black list", although a task force for weeks at Palazzo Chigi is doing everything possible to avoid the worst. Then Reggio Calabria, finished in red already in 2007-2008 and is now being investigated by the judiciary. And then so many other governments, large and small (like Milazzo), perhaps far virtuous, could be forced to ask for the "collapse", which means dissolution of the council, entrance of the Court of Auditors and prefectural commissioner.

At risk are at least a dozen large cities' trust in the government technicians who are monitoring the situation. "The situation is becoming more difficult every day," confirms the president of ANCI Graziano Del Rio. Pointing the finger at yet another cut in transfers, against the measures introduced by the spending review, and that raises the alarm of many fellow mayors. "By cutting the residual assets of a sudden it is clear that financial statements do not fit anymore." In itself the principle, Del Rio argues, is not even wrong, "but is more gradual to allow time for the mayors who have used this method to adapt. Why else would even virtuous municipalities, such as Salerno, at this point are at risk."

Based on data available to the Interior Ministry that the phenomenon of Commons have declared bankruptcy in the last two years has literally exploded from 1-2 cases a year has passed about 25, including north-central governments also where this type the phenomenon was unknown until recently. Striking in the case of Alexandria, whose mayor just a few weeks ago, threw in the towel under the weight of 100 million euros of debt. The same fate had previously befallen smaller municipalities like Riomaggiore (SP), Castiglione Fiorentino and Barnsley in the province of Como.

There is a problem of keeping budgets and there is an even stronger cash. Often the mayor in office is empty.

"At 4 months from the closing of accounts 2012 - Del Rio says - even the 500 million cuts to transfers planned for this year are very heavy. They represent a very significant part of our budgets and delete it at once not only creates other problems of cash but also disrupts the objectives of the Stability Pact." For this reason the Association of Municipalities, which will return tomorrow to demonstrate in Rome against the new cuts, sends a clear message Monti: "Attention to force his hand, because this step forward the day when common as Milan, Naples and Turin will leave the Stability Pact will this gesture only plows in the accounts of the entire state. " Del Rio concludes: "We are open to reason, but things should be done wisely. And above all we must take into account that in recent years as municipalities have already given 22 billion euros. "
Eurointelligence sums up the article this way:
Over 10 Italian big cities are on the verge of financial collapse. Debts, derivatives and mistakes: the Italian municipalities are in crisis. After the default of Alessandria, a big city in Piedmont (North-Western Italy), there are several risks for Turin, Milan, Napoli, Palermo, Reggio Calabria and other cities with over 50,000 inhabitants. "Too much debts, over 10 metropolitan cities should ask to Corte dei Conti (the Italian Court of Auditors) for an orderly default," Graziano Del Rio, chairman of Italian Association of Commons, said to La Stampa. In last week the Sicily has asked for a financial support and has claimed over €1bn of credits to Italian government.
Mike "Mish" Shedlock
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Full Spanish Bailout Coming Up; New Record High Yields on Spanish Bonds; Misguided Faith in Can-Kicking

Inquiring minds are watching the implosion of Spanish bonds.

Spain 10-Year Government Bonds

Spain 2-Year Government Bonds

5.76% was the previous close. Yield is currently up 44.5 basis points at 6.2%. The high yield was 6.255%, easily topping the previous high of 6.09%.

Full Spanish Bailout Coming Up

El Pais reports Full Spanish Bailout Increasingly Likely
"The financial credibility of Spain is close to zero. Fiscal credibility is zero. The political credibility is zero. Investors have been sentenced to Spain. The Government has wasted no time in recent months has squandered the credit granting him an absolute majority, has lost some confidence in European institutions and the whole market with a succession of errors, many of them for a bad communication strategy is correct now without success. Too late? Can not say such things in public, but without a change of attitude are you doomed to a full recovery. "

"I see little chance that Spain is free," says Ken Rogoff, a Harvard professor and head of the IMF execonomista. "Spain will continue with serious growth problems and stop until there is a massive deleveraging. This can be achieved with painful structural reforms, especially in the labor market. Also with a sustained inflation in countries like Germany, which can be ruled out given the degree of obsession with the ECB. And take away significant restructuring and debt, the best approach but politically the most difficult. Most likely, this is made more than a decade of anemic growth and high unemployment, combined to a greater or lesser extent with the previous recipes, "says Rogoff, who predicts a sort of social depression (if it is not as friction unemployment 25%).

Wolfgang Münchau, who heads the think tank Eurointelligence Brussels, says the austerity measures at the trough "are really crazy, prolong and deepen the recession even raise the deficit contractionary effect. It is amazing that governments keep repeating mistakes made decades ago. " With these rods, there is little room: "Spain is no longer fully sovereign, because the government can no longer funded. Yes, I expect a complete audit, "says Martin Wolf resounding, economic commentator for the Financial Times header.
Misguided Faith in Can-Kicking

As is typical, that translation is a bit choppy. However, one can surely get the gist of it.

Also as usual, Wolfgang Münchau misdiagnoses the problem. Hiking taxes is a problem, but so is Keynesian claptrap. It is not feasible for governments to spend their way out of problems. Nor is it possible for monetary stimulus to solve the problem.

If such proposed solutions actually worked, Japan would not be in dire straits today.

Keynesian and monetary stimulus proposals are nothing more than gigantic can-kicking exercises. They only appear to work because experience shows the can will be kicked much further than anyone thought possible. The intermediate result is misguided faith in can-kicking.

The final result however, is typically something that ends up like Greece or Japan, with can-kicking proponents like Münchau and Paul Krugman, screaming every step of the way for still more can-kicking as the solution.

Mike "Mish" Shedlock
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Sunday, July 22, 2012

German Vice Chancellor "Very Skeptical" Greece Can Be Rescued, Euro Exit has "Lost its Terror"; Will Defeat Be Snatched From the Jaws of Victory Once Again?

At long last, everyone is willing to wave the white flag on a Greece exit from the eurozone. Please consider German Vice Chancellor ‘Very Skeptical’ Greece Can Be Rescued.
German Vice Chancellor Philipp Roesler said he’s “very skeptical” that European leaders will be able to rescue Greece and the prospect of the country’s exit from the euro had “lost its terror.”

Roesler, who is Germany’s economy minister, told broadcaster ARD that Greece was unlikely to be able to meet its obligations under a euro-area bailout program as its international creditors hold talks this week in Athens. Should that be the case, the country won’t receive more bailout payments, Roesler said.

“What’s emerging is that Greece will probably not be able to fulfill its conditions,” Roesler said today in an ARD summer interview. “What is clear: if Greece doesn’t fulfill those conditions, then there can be no more payments.”
Greece Behind on Asset Sales, Spending Cuts, Deficit Targets

Adding additional details to the above story, Bloomberg makes a nice understatement with
Greece Back at Center of Euro Crisis as Exit Talk Resurfaces
Greece retakes its position at the heart of the European debt crisis this week as its creditors assess how far off course the country is from bailout targets, raising again the specter of its exit from the euro.

Greece’s troika of international creditors -- the European Commission, the European Central Bank and the International Monetary Fund -- will arrive in Athens tomorrow amid doubts the country will meet its commitments and reluctance among euro-area states to put up more funds should it fail.

Greek Prime Minister Antonis Samaras’s three-way coalition, formed last month after a June 17 election ended a six-week political deadlock in the country, has scrambled to assemble budget cuts to convince troika officials.

Finance Minister Yannis Stournaras has identified about 8 billion euros of spending cuts and savings for the next two years out of 11.5 billion in additional cuts required.

The Greek government is also behind on state asset sales, having so far brought in 1.8 billion euros, a fraction of the 50 billion euros it aims to raise by 2020, half from sales in company stakes and half from real estate. The state is unlikely to generate more than 300 million euros this year, short of the about 3 billion euros targeted for 2012, according to the outgoing chief of the state’s asset-sales fund, Costas Mitropoulos.

Once taboo, the possibility that Greece could exit 17- member monetary union has been voiced by European officials this year who consider the fallout from such a scenario would be the lesser evil against a seemingly perpetual crisis.

Roesler, who is Germany’s economy minister as well as the Free Democratic chairman, told ARD that a curtailment of aid to Greece would lead to a sovereign default, which would in turn lead to “Greeks coming to the conclusion that it is probably wiser to leave the euro area.”
Will Defeat Be Snatched From the Jaws of Victory Once Again?

The ducks for a Greece eurozone exit are lined up once again. Admittedly, every time the ducks had been lined up for default previously, defeat has been snatched from the jaws of victory.

I say that because Greece really does not belong in the euro. Of course, no other country belongs there either because the euro was fatally flawed from the beginning and the sooner this mess goes down the toilet the better off Europe will be.

Comparatively Speaking

I was asked earlier today if I thought Greece would recover if it returned to the Drachma. My answer was something along the lines of "At least it has a chance". For comparison purposes, Greece has no chance of a meaningful recovery in the euro.

In that regard, there is absolutely no point in any further delays, something I correctly said three years ago as well.

In the short-term Greece is likely doomed either way. In the long-term Greece has a chance once it rids itself of the shackles of the euro. Hyperinflation may be Greece's destiny, but if so, I see no point in delaying it.

Mike "Mish" Shedlock
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IMF Seeks to Halt Aid to Greece; September Bankruptcy Awaits; Dominoes Will Fall

According to Der Spiegel, the IMF Wants to Stop Aid to Greece as soon as the ESM is up and running in September. At that time Greece would become bankrupt.

This is a Mish-modified translation from German:
The patience of the International Monetary Fund (IMF) with Greece comes to an end: According to to information obtained by SPIEGEL, senior IMF officials told EU leaders in Brussels that the IMF was no longer willing to provide additional funds for Greece.

The Troika estimates that Greece needs between ten and 50 billion € to meet targets, but many governments in the euro zone are no longer willing to shoulder new burdens. In addition, countries like the Netherlands and Finland, have linked their support because the IMF was involved.

The risk of withdrawal of Greece from the monetary union is now held in the countries of the Euro-zone control. To limit the risk of contagion to other countries, governments want to wait for the start of the new bailout ESM.

The judgment of the German Constitutional Court regarding the ESM on September 12th will come into play.
Dominoes Will Fall

I picked this story up from Ilargi at Automatic Earth. Here are some interesting point of view from Automatic Earth that I generally agree with.
It’ll be a lot of fun seeing the IMF, and European leaders, try to deny the article and its implications. From what I understand, they want to wait until the ESM is effective, and then dump Greece. The article may trump any such intentions. Some things only work in secret, and once Pandora's box is open, they no longer do.

I still think it would be curious that the ESM, supposedly good for €700 billion or so (if not more), would be used to "save" Spain and perhaps Italy, but not Greece. For countries like Portugal and Ireland, dumping Greece would mean they need to get very nervous about being the next one thrown under the wheels and off the back end of the wagon.

The message might become that any and all reform and austerity measures demanded must be adhered to very strictly or else. Politicians in these other "borderline" countries might go along with it all, but will the people? Do the Irish really enjoy the idea of being strangled into submission? And will Spain really be "saved" once real debt numbers are known?

It seems far more likely that getting rid of Greece will be merely the first step in dissolving the entire eurozone. The rest of the dominoes can then fall in rapid succession.
There's more in the AE article including a discussion of the resignation of Peter Doyle, former division chief in the IMF's European Department, who, upon resigning, shared a few of his thoughts on the fund: "After twenty years of service, I am ashamed to have had any association with the Fund at all..."

Everyone Prepared to Pull the Plug

DW has a bit more information in IMF to provide no new funds to Greece 
In an article published on its website, Spiegel cites unnamed senior European Union sources in Brussels who told the news magazine that the International Monetary Fund (IMF) had signaled it would not contribute to any further aid for Greece.

The  report comes ahead of a planned visit to Athens by a team of auditors from the troika of the European Commission, the European Central Bank (ECB) and the IMF. They are to conduct another inspection of the new government's economic program to determine whether Greece is doing enough to comply with the terms of its second international bailout to merit receiving the next tranche of funds.

Just this past week, leading Greek politicians pushed back talks on how to cut almost 12 billion euros ($14.6 billion) from the budget after it became clear that they were far from reaching a comprehensive agreement.

On Friday, the ECB increased the pressure on Greece to comply with the terms of the bailout when it announced that it would stop accepting the country's bonds as collateral in return for ECB funding, at least until after a positive verdict from the troika.

In a further indication that patience may wearing thin among Greece's paymasters, German Foreign Minister Guido Westerwelle on Saturday ruled out the possibility of relaxing the conditions of Athens' second bailout.
Many signs suggest that everyone is finally ready to pull the plug on Greece. Hundreds of billions of euros have been wasted in the last three years attempting to stop the unstoppable.

Mike "Mish" Shedlock
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Saturday, July 21, 2012

Monetary Insanity: ECB Considers Negative Interest Rates, Looking for Clues From Denmark; Anteaters and Hurricanes

The ECB is now pondering monetary insanity: ECB's Coeure says negative bank deposit rate an option
Cutting the deposit rate the European Central Bank offers lenders in the euro zone below zero is an option, ECB Executive Board Member Benoit Coeure said on Friday.

Speaking in Mexico, Coeure said the bank needed to take the rate down 25 basis points to zero to match its cut in the reference rate.

He said policymakers would need to consider whether it could take the deposit rate below zero, which would mean the central bank would start charging banks for the privilege of parking spare cash in the ECB.

"It's still possible," Coeure told students at an event in Mexico City. "It's true that we are hitting a psychological limit at zero. And it's unclear whether markets can function at negative interest rates. Some of them can."

"Some of them apparently can't. So before making the next step, which would be moving the deposit facility to a negative yield, we'll reflect about it," he added.

Denmark introduced a negative interest rate this month and the ECB is watching closely how the move plays out.
Negative Rates in Denmark, Switzerland

The Wall Street Journal discusses Negative Rates in Denmark, Switzerland.
July 6, 2012

For the first time ever, the Danes cut one of their official interest rates to below zero on Thursday.

Struggling against a tide of foreign capital seeking a safe haven, the Danes are trying to keep their exchange rate from rising to the point of throttling domestic industry. Unfortunately, one way or another, the struggle to retain competitiveness is likely to be a forlorn hope.

Denmark’s certificate of deposit rate was chopped by a quarter point to where CDs now yield minus 0.2%. Which is to say holders of these certificates willingly pay the Danish government a fifth of a percentage point for Denmark to hold their money.

Like Denmark, Switzerland is once again struggling against these capital flows, albeit nowadays they’re coming from closer to home.

Market rates on various short-dated Swiss, German and Danish government paper have been negative during the past year. Indeed, what started off as negative rates on the most short-dated bills has been creeping along the yield curve. On Friday morning, yields on the German two-year note, known as the Schatz, dropped to minus 0.01%.

So far, Switzerland and Denmark have managed to limit their currency appreciation. Switzerland has heroically been defending the 1.20 Swiss francs to the euro floor by buying euros frenetically.
Anteaters and Hurricanes

Denmark and Switzerland want to stop capital inflows and currency appreciation.

In contrast, the ECB does not want to stop currency appreciation nor does it want acceleration of bets against the euro. Rather, the ECB wants to stop capital flight specifically from Greece, Spain, Italy, and Portugal. 

Moreover, and also in contrast to the problems in Denmark and Switzerland, the ECB is struggling with dramatically different sovereign bond rates in the Southern Europe (notably Greece, Spain, Italy, and Portugal), than the rest of Europe.

Such conditions only apply to monetary unions, not individual sovereign countries.

The only thing the ECB is likely to achieve if it goes ahead with this ridiculous idea is cause a massive cash withdrawal from money markets in general, not halt capital flight in Southern Europe.

Negative rates sure will not spur lending, another possible goal of the ECB.

Yet, Benoit Coeure wants to study results in Denmark. Good luck with that.

All things considered, studying negative rates in Denmark for application across the entire ECB is like studying anteaters when the problem is hurricanes.

Mike "Mish" Shedlock
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Prepare for Spanish Implosion: Businesses Threaten to Leave Spain Over Tax Hikes; Finance Minister Proposes 56% Tax on Short-Term Financial Transactions

Cristobal Montoro, the Spain's finance minister has made a liquidity destroying proposal to tax short-term financial transactions at an astonishing 56% tax rate. Businesses are already upset over hikes in the VAT and have threatened to leave Spain.

Interestingly, in spite of raising taxes elsewhere, the VAT was lowered on the highly subsidized renewable energy sector.

Why? Here is the answer: "Secretary of State for Finance, Ricardo Martinez Rico, is the leading advisor in the industry".

Prepare for Spanish Implosion

Here is the "as-is" Google translation of the El Econimista article Waiting for the Intervention. Emphasis in bold not added.
The Bundesbank is opposed to the purchase of deduda, the only thing that can save Spain and Italy. Autonomy, conflict, power and government crisis rumors complicate everything.

The situation is out of control. The government approved last week the biggest adjustment of his story in hopes that it would serve to calm the markets. But it was not. The risk premium yesterday overcame the barrier of hundred basis points, something never seen, and the bond closed at 7.27 percent. The first question that arises is what should make efforts so painful as the increase in VAT or removal of the extra pay of officials if markets continue to punish us hard. It would be naive to think that just announced a big cut, things would begin to change. There are still many uncertainties that sow mistrust.

The fine print of 65,000 million adjustment shows that there is more emphasis on income than expenditure. Tax revenues provide about 38,000 million, compared to 27,000 in less spending. This, coupled with the rise in income tax, makes Spain one of the countries with the highest direct and indirect tax burden on the planet Earth. Economists warn that this tax increase may cause a contraction in gross domestic product (GDP) higher than expected by the Government. Especially in 2013, in which the drop exceed 1 percent, twice the official estimate.

Apart from the contradictions of the official figures of the adjustment and the controversy, was put in doubt the 22,000 million in revenue under VAT, only so far this year has accumulated a fall of 10 percent. The increase will boost the economy submerged and can neutralize the expected increase in revenue, defended himself as finance minister, Cristobal Montoro, as opposed to undertake this measure. The general impression is that more cuts are to be decided. Montoro himself fed this thesis to warn this week in Congress that state coffers are empty.

The other settings should focus on the regions and aim to remove 427,000 employees created by them during the last ten years (see story on Monday in elEconomista). However, this week has been strong resistance from regional governments to make further cuts. The call of the President of the Generalitat, Artur Mas, a regional rebellion against the Government is a paradigm for stimulating this international distrust.

Many people wonder, moreover, what moral authority left to the PP's general secretary, Maria Dolores de Cospedal, to convince the rest of communities governed by their party, when his government of Castilla-La Mancha is among reprimanded. No, of course.

I do not think right now an investor in and outside our borders who believe in the autonomy will obey Montoro. The finance minister was guilty of naivete in advance at the beginning of the year 5.176 million for half of the estimated settlement funding system because it has stopped to tighten their belts. In addition, ICO 15,000 million in loans to cover the debt did not help anything.

In the energy sector also confusion reigns. Vice President, Soraya Saenz de Santamaria, yesterday attributed the delay in reforms that several ministers were outside Spain, including Industry, José Manuel Soria. But the reality is that Soria travel left after slamming the door and refuse to accept the distribution of tax burden and renewable power on the table by Montoro. Some companies threatened to move the headquarters of their business outside Spain to avoid the very strong tax hike planned by the minister of finance.

The reduced charge provided for solar energy, although it is one of the most subsidized, and the fact that former Secretary of State for Finance, Ricardo Martinez Rico, is the leading advisor in the industry, Abengoa, raises many critical and casts suspicion on the cleaning process. If autonomy is not yet speak openly of rebellion, in power so clearly.

To add more uncertainty, Montoro announced his willingness to levy confiscatory rates close to 56 percent of the purchase or sale of short-term securities. An initiative incomprehensible allegedly coming from a government liberal or right, we like a capricious regime such as the populist Venezuelan President Hugo Chavez.

To complete the clinical astonishing about our rulers, the rumors of clashes between the ministers of finance and economics, Luis de Guindos, or between it and the head of the Economic Office, Alvaro Nadal, have given way to a possible government crisis to designate a single responsible in economic affairs. The recent article by Foreign Minister, Jose Manuel Garcia-Margallo, El Pais, dedicated to solving economic problems rather than addressing the many international crises, pitted the bonfire of the vanities. Margallo with Josep Pique are the secrets to a hypothetical vice presidential candidates economy. It is true that in Europe caused a great embarrassment to the current division of responsibilities between the Treasury and between them and the Economic Bureau, which serves as a minister in the shade to chair the Executive Committee for Economic Affairs in the absence of Rajoy.

The spark that triggered this Molotov cocktail on black economic forecasts and instability of the government team is highly liquid Treasuries. The data show that the mattress is exhausted debt issued earlier this year at affordable prices, so from now the Treasury must pay prohibitive prices, which make untenable the vote.

The mere request of the autonomous community of Valencia to qualify for the liquidity fund announced by the Treasury market sparked fears and attacks on the risk premium. The alarm was given by the auction on Thursday, because it showed no there is a demand for government debt beyond the lyrics to one year. With banks in retreat, because they have run out of ammunition delivered earlier this year by the ECB, nobody can predict how they will renew the 28,000 million coming due next October.

The German Parliament gave strong support for the bank bailout. But the statements by Bundesbank President Jens Weidmann, the end of last week, encouraging all to seek the intervention Rajoy, are a sign of strong opposition within the ECB to resume purchases of debt of Spain and Italy, all that could save us. It is also an indication that Germany is not aware of the risk to the single currency. Experts predict that if Spain is operated, the eye of the hurricane will move over Italy and eventually destroy the entire European project. The countdown to self-destruction of the euro is already underway. We'll see if we can stop it.
Countdown To Self-Destruction

Some of that translation is a bit choppy, but it is certainly easy enough to understand the entire gist of the article.

My Take

Spain certainly needs reforms such as shedding government workers, removing subsidies, and revising work rules to make it easier to fire (and thus hire) workers.

However, Spain does not need increased VAT taxes and it certainly does not need a 56% tax on financial transactions.

In short, Spain is resisting the measures that would be productive, and implementing those measures that will do the most harm.

Spain Set to Implode

Spain is set to implode. I agree with the author that "a countdown to self-destruction" is underway. Also see Death Spiral in Spain; Six Spanish Regions Seek Aid; Bankrupt Spain to Bail out Bankrupt Regions

Mike "Mish" Shedlock
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Death Spiral in Spain; Six Spanish Regions Seek Aid; Bankrupt Spain to Bail out Bankrupt Regions

Yields on 30-year and 5-year bonds in Spain hit a euro-era record on Friday as the Valencia region of Spain filed for financial assistance.

Bloomberg reports Spain Bonds Slide as Valencia Aid Request Deepens Crisis
Spain’s bonds fell, sending five- and 30-year yields to euro-era records, as the region of Valencia prepared to seek a rescue, deepening concern policy makers are failing to find solutions to the debt crisis.

“Valencia’s request for assistance underlines fears as to the central government’s ability to bring wayward regions to heel,” said Richard McGuire, senior fixed-income strategist at Rabobank International in London. “That puts Spain under a considerable degree of pressure.”

Spanish five-year yields jumped 47 basis points, or 0.47 percentage point, to 6.88 percent at 5:21 p.m. London time, after touching 6.903, the most since the euro started in 1999.

Valencia will tap Spain’s financing facility for regional governments, the area’s administration said in a statement on its website today. The funding mechanism was created last week to inject liquidity into the cash-strapped regions.
‘Death Spiral’

The Spanish 30-year bond yield climbed as much as 17 basis points to 7.35 percent, a euro-era record. The 10-year yield rose 26 basis points to 7.27 percent, having jumped 61 basis points this week. The euro-era record is 7.285 percent. The extra yield investors demand to hold Spanish 10-year securities instead of bunds widened to 613 basis points, the most since Bloomberg began compiling the data in 1993.

Spain faces a “death spiral” as higher yields push up borrowing costs, and that adds to concern the nation won’t be able to services its debt, McGuire said.
More Spanish Regions Seek Aid

On Saturday, Bloomberg reported Six Spanish Regions May Seek Bailout After Valencia
The Balearic Islands and Catalonia are among six Spanish regions that may ask for aid from the central government after Valencia sought a bailout, El Pais reported.

Castilla-La-Mancha, Murcia, the Canary Islands and possibly Andalusia are also having difficulty funding themselves and some of these regions are studying plans to tap the recently created emergency-loan fund that Valencia said it would use yesterday, the newspaper said, without citing anyone.

Spain created the 18 billion-euro ($23 billion) bailout mechanism last week to help cash-strapped regions even as its own access to financial markets narrows.
Regional Revenue Plunges

These translated paragraphs from El Pais tells the grim story.
Regional governments are choking. In recent weeks, some banks have slowed lending to communities waiting for the Government to launch the Autonomous Liquidity Fund (FLA). The autonomous liquidity has evaporated.

Although most communities have taken a severe pruning in regional expenditure, revenue is in freefall. Noninterest income of the regions fell 6.15% during the first quarter, according to the budget implementation of the regions in the first quarter of 2012. Revenues from the transfer tax and stamp duty (ITP and AJD), one of the most important to communities because they manage themselves, has fallen nearly 23% between January and April this year.

This cash has dried communities are beginning to look cobwebs in their safes. An example of the agonizing situation is suffering the autonomy of Catalonia, two weeks ago had to formalize a loan of 500 million to pay the summer bonus to its employees.
Bankrupt Spain to Bail out Bankrupt Regions

There are 17 Autonomous communities of Spain of which at least six have applied for or are expected to apply for aid.

Eventually most, if not all of those regions will request aid. Spain itself needs a bailout (which it still denies but the market is going to force any time now). The plan in place now is for the bankrupt to bail out the bankrupt.

Mike "Mish" Shedlock
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Friday, July 20, 2012

Expect Strikes and Protests to Spread to Italy; Another Look at Why Italy Will Exit the Eurozone Before Spain

Anti-euro sentiment in Italy is already very strong and about to get stronger. Eurointellihence has some interesting comments today regarding Italy.
The demonstrations and protests [in Spain] are very likely now to spread  to Italy. The country’s largest union, CGIL, said there would be a public-sector strike in September to oppose the Italian government latest austerity plan, Il Fatto Quotidiano reports.

According to Susanna Camusso, CGIL head, its union will launch "a general strike of the public sector against the umpteenth measure." The cuts, to avert a 2% increase in VAT scheduled for September, include a 10% reduction of staff and 20% reduction of managers of public-sector.

The complete package, result of the spending review conducted by Mario Monti, will save over €26bn until 2014. The measure, which will go before the Parliament at the end of July, was approved by the cabinet two weeks ago.
Eurozone Exit Sentiment in Italy

In regards to factors that might lead to a eurozone exit, there are two major differences between Italy and Spain.

The first difference is anti-euro sentiment in Italy is already at a convincing threshold. Please see Six Reasons Why Italy May Exit the Euro Before Spain

Here is a pertinent chart.

The net difference between those who think the euro is a good thing minus those who think it is a bad things is -4 percentage points in Spain, but -14 points in Italy. That is the biggest negative spread in the eurozone.

Elections - Mario Monti Gone in 2013

The second difference between Italy and Spain is in regards to elections.

Italian prime minister Mario Monti will be gone no later than general elections in 2013. In contrast, Spanish prime minister Mariano Rajoy is not scheduled to face general elections until 2015.

Whether Rajoy's government can hang on that long is another question.

Rise of the Five Star Movement

In Italy, it is highly likely anti-euro candidates take over at least some of Italian parliament. A Time-Lapse Interactive Graph of the Popularity of an Anti-Euro Party shows just that.

Please click on the link to learn about the rise of the "Five Star Movement".

Former Italian Prime Minister Seeks to Dump Euro

Recall that former Italian Prime Minister Silvio Berlusconi said "Italy should dump the euro unless the European Central Bank agreed to inject more cash into the economy".

See Italy "Gasping Like Beached Whale"; Berlusconi Reiterates Euro Exit "Not Blasphemy"; Beppe Grillo Discusses "Taboo of the Euro"

The collapse of the Spanish bond market and the rise of protests in Spain are both very serious matters. There is every reason to believe those reactions will spread to Italy.

And with elections pending, the rise of anti-euro sentiment in Italy is extremely important. Monti may even be ousted before 2013 via failed vote-of-confidence.

Every day that passes, the more strength the Five-Star Movement will gain. The irony is that it would be in the best interest of the eurocrats to hold elections now rather than later, before the anti-euro movement becomes politically unstoppable.

Mike "Mish" Shedlock
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Demand for Spanish Bonds Collapses; "No Money Left to Pay Services" says Treasury Minister; Massive Protests Over Austerity; Two-Year Yield soars 60 Basis Points

On yet another Friday, Europe is overlooking a gigantic bond-market precipice. Yield on the Spanish two-year government bond is up a whopping 60 basis points to 5.76%

Yield on the Spanish 10-year bond is up 26 basis points to 7.27%.

Italy is participating in the bond debacle as well. Yield on the Italian 10-year bond is up 17 basis points to 6.17%.

Yield on the Italian 2-year bond is up 39 basis points to 3.95%

This action in the face of another "we are saved" moment less than two weeks ago tells a dramatic story elsewise.

Massive Protests in Spain Over Austerity Measures

The Guardian reports Spanish take to streets in protest as MPs pass €65bn austerity package
Protesters took to the streets of 80 Spanish cities on Thursday night after prime minister Mariano Rajoy's People's party (PP) pushed a €65bn (£51bn) austerity package through parliament and the country paid record prices to borrow money from sceptical markets.

More than 100,000 people were estimated to have joined in demonstrations called by trades unions, with about 50,000 gathering in Madrid. Police fired rubber bullets to disperse the protesters in Madrid.

Angry civil servants had blocked traffic in several main Madrid avenues earlier in the day, with protesters puncturing the tyres of dozens of riot police vans, amid growing upset at austerity, recession and 24% unemployment.
"No Money Left to Pay Services"

If you are looking statements to incite violent protests, then look no further than comments of treasury minister Cristobal Montoro, who called for years of hard sacrifice, while making a claim “There is no money left to pay for services.

Ambrose Evans-Pritchard has the details in his Telegraph piece, Spanish debt crisis returns as Germany nears bailout fatigue

“Demand for Spanish paper is collapsing, even for shorter-dated debt which is very worrying and raises the spectre of Spain losing market access,” said Nicholas Spiro from Spiro Sovereign Strategy.

Marchel Alexandrovich from Jefferies Fixed Income said the markets are already bracing for second bigger rescue of around €400bn. “A few more weeks like this and Madrid is going to decide to it has nothing more to lose and call for a full sovereign bail-out,” he said. “Then we will find out if there really is any money in the EU kitty.

“If the ECB goes on holiday without doing anything more, this is going to snowball. We’re way past point where any country can deliver fiscal measures on its own. People are not going to buy Spanish and Italian debt right now whatever ever they do. There has to be a circuit breaker.”

“There is no money left to pay for services,” said treasury minister Cristobal Montoro, calling for years of hard sacrifice. “We have to raise VAT to stay in Europe. There is no other option. All alternatives are worse. This has gone beyond ideologies.”
Beyond Ideologies

Please read that last paragraph carefully. I disagree strongly with the finance minister. This is not "beyond ideologies". Instead it is precisely about the foolish ideology of staying in the eurozone at all costs, including 25% unemployment and tax hikes upon tax hikes.

Also note the misstatement (or misquote), the VAT need to be hiked to "stay in Europe". I assure you Spain will stay in Europe regardless of what happens, and it can stay in the European Union as well.

The correct alternative, is for Spain to leave the European Monetary Union. Stubborn ideology, unfortunately, is still in the way.

At some point, however (and this could be it), Spain is going to hike the VAT one time too many. At that juncture, the willingness of Spanish voters to stay on the euro will fly right out the window.

Mike "Mish" Shedlock
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S&P Revises Pennsylvania's Outlook to Negative Citing Public Pensions; Compton CA Ponders Bankruptcy; Victorville, Montebello, Los Angeles, Oakland Coming Up Eventually

As part of a growing trend, Compton California is on the verge of bankruptcy. When it files (and it will eventually), it will become California's 4th city to do so.

The Huffington Post reports Compton Will Run Out Of Funds By September 1
Compton, Calif. could be the fourth city in the Golden State to seek bankruptcy protection.

At a city council meeting Tuesday, officials announced that Compton is set to run out of funds by Sept. 1. Compton, which has only 93,000 residents, faces a deficit of $43 million after having depleted a $22 million reserve, reports Reuters.

"I have $3 million in the bank and $5 million in warrants due in the next 10 to 12 days," said city treasurer Doug Sanders during the live-streamed city council meeting. "By then, the council will have a decision to make: don't pay the bonds, default on them, or have a serious talk about bankruptcy."

Standard & Poor's put Compton's revenue bonds on a negative credit watch last Friday, citing concern over allegations of "abuse of public moneys" and fraud, reports the Los Angeles Times.

S&P also warned that unless they receive independently audited financial information from Compton, the city's ratings -- already at BB, or "junk" status -- could be withdrawn or suspended.

Compton may not be able to meet S&P's demands in time. The city's independent auditor, Mayer Hoffman McCann, recently declined to sign off on the city's financial statements and quit the account entirely, reports the Times. The firm stated that they couldn't get anyone at the mayor's office to cooperate with the audit inquiry.
What's to Consider?

Compton is clearly broke so there is noting to consider. The LA Times has more grim details in Compton on brink of bankruptcy.
City officials announced that Compton could run out of money by summer's end, with $3 million in the bank and more than $5 million in bills due.

A longer-term problem is a $43-million deficit that the city amassed after years of improperly using money from water, sewer and retirement funds to balance its general fund. Compton will have to pay the money back at a time when it has no reserves and has been frantically cutting costs.

The state of these cities underscores the complexity of the fiscal crisis roiling California municipalities this year, with Stockton and Mammoth Lakes already in Chapter 9 bankruptcy. While ballooning public pensions and falling property tax revenues have hit many cities hard, bad accounting practices and improper use of funds have also taken a toll.

In many cases cities resorted to these measures because they could not balance their books or raise revenues but were loath to make cuts.

A recent grand jury report found that the High Desert city of Victorville used a series of disparate, possibly illegal measures to stave off insolvency. Those included dipping into sanitation funds to help keep the city's treasury afloat, loaning water agency funds to bail out the city's electric utility and siphoning $2 million in airport bond funds to buy land for a city library.

The inter-agency borrowing was so questionable — with $69 million sloshing around City Hall as of June 2011 — that the Securities and Exchange Commission launched an investigation, which is ongoing.

In Montebello, state auditors last year said they were troubled to learn that the city regularly used money designed for specific purposes to balance its budget — in apparent violation of the law.

"It appears that the City moved money wherever it wanted, whenever it wanted, regardless of the law or the intended purpose of those taxpayer dollars," Controller John Chiang said in a statement.
Victorville, Montebello, Los Angeles, Oakland

It's a safe bet to add Montebello and Victorville to the list. Moreover, some of the big guns will eventually go under as well.

Unsound pension problems will be the death of many cities. I consider Oakland and LA to be sure things. It's just a matter of time.

Delays in filing will only waste more taxpayer money. Eventually cities will catch on and there will be a flood of bankruptcies.

S&P Revises Pennsylvania's Outlook to Negative

Citing pension problems and a slowing economy, S&P Revises Pennsylvania's Outlook to Negative
Standard & Poor's Ratings Services changed its outlook to 'negative' from 'stable' for Pennsylvania's general obligation debt because of growing spending pressures, particularly for public pensions, and a slow-growing state economy, the agency said on Thursday.

S&P affirmed the 'AA' credit rating on the state's general-obligation debt, but said it could lower that rating a notch in the next two years if Pennsylvania does not enact pension reform.
Mike "Mish" Shedlock
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Thursday, July 19, 2012

Tech Sector Layoffs Surge to Three-Year High

I am starting to think the next jobs report is going to be downright miserable. New orders have plunged and mass layoffs are on the rise.

Please consider Tech sector layoffs surge to three-year high
During the first half of the year, 51,529 planned job cuts were announced across the tech sector, representing a 260 percent increase over the 14,308 layoffs planned during the first half of 2011. Things are so bad so far this year that the figure is 39 percent higher than all the job cuts recorded in the tech sector last year.

Hewlett-Packard proved to be the major force behind this year's uptick in planned layoffs, after the company announced in May that it would cut 30,000 jobs. Those layoffs will be completed by the end of fiscal 2014, and shave off 8 percent of HP's entire workforce.

It was also a tough beginning of the year for Sony and Nokia, both of which said they would lay off 10,000 employees. Panasonic and Olympus are also eyeing layoffs to make their operations more nimble.

The issue in the tech sector, according to the outplacement firm, is that success is increasingly finding its way to a short list of companies. All others are hoping they can stay afloat or revive their operations around new ideas. And all of that could lead to more cuts across the industry in the coming months.

"We may see more job cuts from the computer sector in the months ahead," John A. Challenger, CEO of Challenger, Gray & Christmas, said today in a statement. "While consumers and businesses are spending more on technology, the spending appears to favor a handful of companies. Those that are struggling to keep up with the rapidly changing trends and consumer tastes are shuffling workers to new projects or laying them off altogether."
Mike "Mish" Shedlock
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Job Losses and Unemployment Skyrocketing in China; Thinner, Taller iPhone 5

In the video below Jefferies Managing Director Peter Misek discusses the coming iPhone 5 with Emily Chang on Bloomberg TV.

Misek reports the iPhone will be significantly thinner and taller because of new technology he did not expect to be available for at least another year.

What really caught my eye, however, was a segment in the middle of the video regarding grim statistics on sales and employment in China starting at about the 2:26 mark.

Link if video does not play: Details on iPhone 5 Emerge

Partial Transcript

Emily Chang: Another thing you say is smart-phone and PC demand in China is dropping off significantly. What exactly is going on there?

Peter Misek: We came back from China really depressed, I have to say. It appears that mainland China is correcting significantly. The statistics the government publishes, frankly we think are largely fabricated. So you have to rely on other statistics such as retail sales, electricity usage, mall traffic, etc. And what we saw, and what we heard was pretty grim. We think consumer electronic sales could be falling double-digits year-over-year in June and thus far in July. And we think the catalyst frankly is job losses. The premier of China was on this morning basically saying the labor situation is severe, meaning job losses are accelerating and unemployment is skyrocketing. That is causing the Chinese consumer who naturally saves more than we do, to save even more.

Plunging New Orders Everywhere

The rise in Chinese unemployment ties in perfectly with my July 6 report Plunging New Orders Suggest Global Recession Has Arrived.

The grim data also fits in with the email yesterday from Michael Pettis yesterday: "China Rebalancing Has Begun"; What are the Global Implications?

Mike "Mish" Shedlock
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U.S. Treasuries a Buy or a Short?

I had a nice conversation the other day with Lacy Hunt at Hoisington Investments. We agree on many aspects of the global economy and I have a few excerpts of Hoisington's latest forecast below.

First, let me state that if you are looking for someone who has called the US treasury market correct this past decade, look no further than Hunt.

While I have been US treasury bullish (on-and-off ) for years (more on than off), and I can also claim to have never advocated shorting them (in contrast to inflationistas running rampant nearly everywhere), Lacy has correctly been a steadfast unwavering treasury bull throughout.

Will Hoisington catch the turn?

That I cannot answer. However, one look at Japan suggests the actual turn may be a lot further away than people think.

For a viewpoint remarkably different than you will find anywhere else, please consider a few snips from the Hoisington Quarterly Review and Outlook, for the Second Quarter 2012 (not yet publicly posted but may be at any time).
Abysmal Times Confirm the Research

In the eleven quarters of this expansion, the growth of real per capita GDP was the lowest for all of the comparable post-WWII business cycle expansions. Real per capita disposable personal income has risen by a scant 0.1% annual rate, remarkably weak when compared with the 2.9% post-war average.

It is often said that economic conditions would have been much worse if the government had not run massive budget deficits and the Fed had not implemented extraordinary policies.

This whole premise is wrong.

In all likelihood the governmental measures made conditions worse, and the poor results reflect the counterproductive nature of fiscal and monetary policies. None of these numerous actions produced anything more than transitory improvement in economic conditions, followed by a quick retreat to a faltering pattern while leaving the economy saddled with even greater indebtedness. The diminutive gain in this expansion is clearly consistent with the view that government actions have hurt, rather than helped, economic performance.

Economic conditions have been worse in euro-currency zone countries, the UK, and Japan. All three of these major economies have also resorted to massive deficit financing and highly unprecedented monetary policies, and all have substantially higher debt to GDP levels than the United States.

The UK and much of continental Europe is experiencing recession to some degree. Whether Japan is in or out of recession is a pedantic point since the level of nominal GDP is unchanged since 1991. Even such prior stalwarts of the global scene such as China, India, Russia and Brazil are plagued with deteriorating growth. In such circumstances a return to the normal business cycle of one to two rough years, followed by four to five good years, remains highly unlikely in the United States or in these other major economic centers.

Based upon the historical record of effects of excessive and low quality indebtedness, along with the academic research, the 30-year Treasury bond, with a recent yield of less than 3%, still holds value for patient long-term investors. Even when this bond drops to a 2% yield, it may still have value in relation to other assets.

If high indebtedness is indeed the main determinant of future economic growth and further government “stimulus” is counterproductive, then a prolonged state of debt induced coma may so limit returns on other riskier assets that a 30-year Treasury bond with a 2% yield would be a highly desirable asset to hold.
Those were the ending paragraph of Hoisington's four-page 2nd quarter review. I added paragraph breaks for ease in reading.

Are US Treasuries "Undervalued"?

I will respond to my own question with another question: Undervalued compared to what?

Certainly I would not advocate blindly buying 30-year year US treasuries with the intention of holding on to them for 30 years. Nor would Lacy Hunt.

Likewise, I see no real value in holding 10-year US treasuries for the next 10-years either.

Then again, I have stated the US may go in and out of deflation for as long as a decade. If that does happen, treasuries may easily outperform for that entire period.

One look at the Japanese stock market shows what might happen.

Three Lost Decades

click on chart for sharper image

I do not believe that is the path for US equities. However, I may very well be wrong. It is always important to consider what happens if you are wrong. Few bother to do just that.

If I am wrong (and that is certainly a decent chance), then what does that say about the potential for US treasuries?

Rather than advocating buying or shorting treasuries here, I am advising people to do something different:


Please consider all aspects of a trade, and in this case, what might easily happen to the widely espoused notion "US Treasuries are a Short". Also think about who is on the other side of the trade and why.

Short-term, US treasuries are overbought. Otherwise, they are hugely unloved.

People have been saying Japanese treasuries are a short for at least two decades. They will eventually be correct, and in my opinion much sooner than US treasury shorts (ignoring short-term US volatility).

Think about this: Bull markets do not end with the asset class being universally despised except by dedicated funds and foreign governments (the latter primarily for balance-of-trade purposes only).

Rather, bull markets end with nearly everyone becoming a believer.

Mike "Mish" Shedlock
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Wednesday, July 18, 2012

"China Rebalancing Has Begun"; What are the Global Implications? Michael Pettis on China Rebalancing, Chinese Price Deflation, and Spain Exit from Euro; Target 2 Revisited

Michael Pettis at China Financial Markets has some interesting comments via email regarding much needed China rebalancing and a timeframe for a possible Spain exit from euro.

Pettis On Spain Exit ...
How will Spanish households react to a default on preferred shares and subordinated bonds, or even a very public discussion about the possibility of such a default?  I don’t know, but I assume that it will speed up deposit withdrawals from the banking system even more.  For that reason it continues to be a very good idea to keep an eye on Target 2 balances.  These serve as a pretty good proxy, I think, for the behavior of depositors.

Things are evolving in Spain exactly as we would expect them to evolve according to the sovereign-debt-crisis handbook.  Unless we get real fiscal union in Europe, or Germany leaves the euro, or Germany stimulates its economy into running a very large trade deficit, or the euro depreciates by 15-20% against the dollar in the next year – all very unlikely, I think – I really see no reason to doubt that Spain will leave the euro and restructure its debt within the next few years. 
Mish Comments on Target 2

Target 2 stands for Trans-European Automated Real-time Gross Settlement System. It is a reflection of capital flight from the "Club-Med" countries in Southern Europe (Greece, Spain, and Italy) to banks in Northern Europe.

Please see Target2 and the ELA (Emergency Liquidity Assistance) program; Reader From Europe Asks "Can You Please Explain Target2?" for a more compete description.

There is much misinformation floating around on how Target 2 works, what Germany's liabilities are, so please click on the above link if you are interested in target 2 balances.

The following chart from PIMCO article ​​TARGET2: A Channel for Europe’s Capital Flight shows the capital flight through March. The problem has accelerated since then, because of fears in Spain and Italy.

Pettis On China Price Deflation...
China’s official GDP growth rate has fallen sharply – on Friday Beijing announced that GDP growth for the second quarter of 2012 was a lower-than-expected 7.6% year on year, the lowest level since 2009 and well below the 8.1% generated in the first quarter. This implies of course that quarterly growth is substantially below 7.6%.  Industrial production was also much lower than expected, at 9.5% year on year. 

In fact China’s real GDP growth may have been even lower than the official numbers.  This is certainly what electricity consumption numbers, which have been flat, imply, and there have been rumors all year of businesses being advised by local governments to exaggerate their revenue growth numbers in order to provide a better picture of the economy.  Some economists are arguing that flat electricity consumption is consistent with 7.6% GDP growth because of pressure on Chinese businesses to improve energy efficiency, but this is a little hard to believe.  That “pressure” has been there almost as long as I have been in China (over ten years) and it would be startling if only now did it have an impact, especially with such a huge impact occurring so suddenly.

Adding to the slow economic growth, the country may be tipping into deflation.  Last Monday the National Bureau of Statistics released the following inflation data:

In June, the consumer price index (CPI) went up by 2.2 percent year-on-year. The prices grew by 2.2 percent in cities areas and 2.0 percent in rural areas. The food prices went up by 3.8 percent, while the non-food prices increased by 1.4 percent. The prices of consumer goods went up by 2.3 percent and the prices of services grew by 1.9 percent. In the first half of this year, the overall consumer prices were up by 3.3 percent over the same period of previous year.

In June, the month-on-month change of consumer prices was down by 0.6 percent, prices in cities and rural went down by 0.6 and 0.5 percent respectively. The food prices dropped by 1.6 percent, the non-food prices kept at the same level (the amount of change was 0). The prices of consumer goods decreased by 0.9 percent, and the prices of services increased by 0.3 percent.

My very smart former PKU student Chen Long, who follows monetary conditions in China as closely as anyone else I know tells me:

The most interesting thing is that even if CPI remains stable month-on-month, it will turn negative year-on-year in January 2013.  And if it continues to decline month-on-month at current rates, we could see negative year-on-year CPI as early as August/September.  

Unlike some other analysts, in other words, I am not concerned about deflation persisting for long unless the PBoC cuts interest rates much more sharply than any of us expect.  I know this may sound strange – most analysts believe that cutting interest rates will actually reignite CPI inflation – but remember that the relationship between inflation and interest rates in China is, as I have discussed many times before, not at all like the relationship between the two in the US.  It works in the opposite way because of the very different structure of Chinese debt and consumption.
Pettis On China Rebalancing... 
After many failed attempts, over the past six months we may be seeing for the first time the beginning of China’s urgently needed economic rebalancing, in which China reduces its overreliance on investment in favor of consumption.

Regular readers of my newsletter may be surprised to see me say this.  For the past four or five years analysts have been earnestly assuring us that the rebalancing process had finally begun, and I had always insisted that it couldn’t have begun yet.

Why?  Because as I understand it rebalancing is almost arithmetically impossible under conditions of high GDP growth rates and low real interest rates.  Once the real numbers came in, it always turned out that in fact imbalances had gotten worse, not better.  Typically many of those too-eager analysts have resorted to insisting that the consumption data are wrong, although even if they are right this does not confirm that rebalancing had taken place since errors in reporting consumption have always been there.

But this time seems different.  Now for the first time I think maybe the long-awaited Chinese rebalancing may have finally started. 

Of course the process will not be easy. With China’s consumption share of GDP at barely more than half the global average, and with the highest investment rate in the world, rebalancing will require determined effort.
How to rebalance
The key to raising the consumption share of growth, as I have discussed many times, is to get household income to rise from its unprecedentedly low share of GDP.  This requires that among other things China increase wages, revalue the renminbi and, most importantly, reduce the enormous financial repression tax that households implicitly pay to borrowers in the form of artificially low interest rates.

Forcing up the real interest rate is the most important step Beijing can take to redress the domestic imbalances and to reduce wasteful spending.

And this seems to be happening.  [Yet] Beijing has reduced interest rates twice this year, and reluctant policymakers are under intense pressure to reduce them further.  [However] The students in my central bank seminar at PKU tell me that there are new rumors about the way the cuts were implemented.  “Usually it is the PBoC that submits a proposal of rates cut to the State Council,” one of them wrote me recently, “but this time (July 5th) it was the State Council who handed down to the PBoC the decision to cut rates, so that the PBoC was not fully aware of the rates cut before July 5th.”

If my student is right (and this class has an impressive track record), this suggests that monetary easing is being driven by political considerations, not economic ones, which of course isn’t at all a surprise.  But even with the rate cuts, perhaps demanded by the State Council, with inflation falling much more quickly than interest rates the real return for household depositors has soared in recent months, as has the real cost of borrowing.  China, in other words, is finally repairing one of its worst distortions.

China bulls, late to understand the unhealthy implications of the distortions that generated so much growth in the past, have finally recognized how urgent the rebalancing is, but they still fail to understand that this cannot happen at high growth rates.  The problem is mainly one of arithmetic.  China’s investment growth rate must fall for many years before the household income share of GDP is high enough for consumption to replace investment as the engine of rapid growth.

As China rebalances, in other words, we would expect sharply slowing growth and rapidly rising real interest rates, which is exactly what we are seeing.  Rather than panicking and demanding that Beijing reverse the process, we should be relieved that Beijing is finally resolving its problems.

As an aside, we need to make two adjustments to the trade surplus in order to understand what is really going on within the balance of payments.  First, one of the causes of last month’s weak imports has been a sharp decline in commodity purchases.  I have many times argued that commodity stockpiling artificially lowers China’s trade surplus by converting what should be classified as a capital account outflow into a current account inflow.  If China is now destocking, then China’s real trade surplus is actually lower than the posted numbers.

Second, we know that wealthy Chinese businessmen have been disinvesting and taking money out of the country at a rising pace since the beginning of 2010.  One of the ways they can do so, without running afoul of capital restrictions, is by illegally under- or over-invoicing exports and imports.  This should cause exports to seem lower than they actually are and imports to seem higher.  The net effect is to reduce the real trade surplus.

Since these two processes, commodity de-stocking and flight capital, work in opposite ways to affect the trade account, it is hard to tell whether China’s real trade surplus is lower or higher than the reported surplus.  But once de-stocking stops, we should remember that the trade numbers probably conceal capital outflows.

How does all this affect the world?  In the short term rebalancing may increase the amount of global demand absorbed by China, but over the longer term it should reduce it.  Rebalancing will inevitably result in falling prices for hard commodities, and so will hurt countries like Australia and Brazil that have gotten fat on Chinese overinvestment.  Rising Chinese consumption demand over the long term and lower commodity prices, however, are positive for global growth overall, and especially for net commodity importers.  Slower growth in China, it turns out, is not necessarily bad for the world.  The key is the evolution of the trade surplus.
There is much more in his email that I wanted to use, but I stretched the bounds of fair use already.

Those wishing to see more can follow Michael Pettis on his blog China Financial Markets which I consider one of the very few "must read" sites.

The above report should appear on his blog shortly, with more details. Thanks Michael!

Mike "Mish" Shedlock
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