Saturday, March 31, 2012

Policy Failure and the Great Recession

The debate about the causes of the financial crisis and the great recession will continue for many years, and the facts and analysis that Robert Hetzel put forth in his new book The Great Recession: Market Failure or Policy Failure? should now be part of that debate. As I said in my comments for Cambridge University Press, “Hetzel applies his experience as a central banker and his expertise as a monetary economist to make a compelling case for rules rather than discretion, showing that 'monetary disorder' rather than a fundamental 'market disorder' is the cause of poor macroeconomic performance. At the same time, he acknowledges and discusses disagreements among those who argue for rules rather than discretion.”

One area of disagreement among those who agree that deviations from sensible policy rules were a cause of the deep crisis is how much emphasis to place on the “too low for too long” period around 2003-2005—which, as I wrote in Getting Off Track, helped create an excessive boom, higher inflation, a risk-taking search for yield, and the ultimate bust—compared with the “too tight” period when interest rates got too high in 2007 and 2008 and thereby worsened the decline in GDP growth and the recession.

In my view these two episodes are closely connected in the sense that if rates had not been held too low for too long in 2003-2005 then the boom and the rise in inflation would likely have been avoided, and the Fed would not have found itself in a position of raising rates so much in 2006 and then keeping them relatively high in 2008. For example, if the Fed had raised the federal funds rate above 1 percent earlier (in 2003 and 2004) then the inflation rate would likely not have picked up as much and the Fed would not have felt the need to take the federal funds rate above 4 percent or keep it high. But in reality the Fed overshot and took the funds rate to 5-1/4 percent and held it there until just before the recession began. This is what I was referring to in Thursday's Wall Street Journal piece when I said the Fed “overshot the needed increase in interest rates, which worsened the bust.”

Hetzel bases his assessment of policy in 2003-2005 on a policy rule which he calls “LAW (leaning against the wind) with credibility.” Conceptually LAW with credibility differs from a Taylor rule in that interest rate changes are based on changes in GDP rather than the level of GDP compared with potential GDP. (The advantage is that you do not have to estimate potential GDP, which of course is difficult to do.)

In his book, Hetzel suggests that using a LAW rule with a given price stability goal does not indicate that policy was too easy in 2003-2004. However, as he argues on page 197 of the book, the Fed seemed to have relaxed its price stability goal at this time, so in this sense policy may have actually been too easy, and in fact inflation did rise. Hetzel was working at the Fed and thus speaks with considerable personal knowledge. Here is how he puts it:

“In 2003-2004, the Greenspan FOMC did make a decision that would later have enormous implications. At this time, the FOMC backed off its long-run objective of returning to price stability and instead adopted an ill-defined objective of positive inflation, perhaps best characterized as 2 percent plus…. Starting in spring 2004, both core and headline PCE inflation moved persistently above 2 percent…. By summer 2008, that overshoot caused the FOMC to allow a growing negative output gap to persist by holding the funds rate unchanged at 2 percent. If the FOMC had maintained its target for price stability….the sustained inflation shock that began in summer 2004 with increases in energy prices would have yielded lower headline inflation. The FOMC in summer 2008 might have then felt comfortable allowing the inflation shock to pass through the price level while aggressively using monetary policy to deal with the worsening recession.”

So with this interpretation, there is a clear connection between the too easy period and the too tight period, much like the connection between the “go” and the “stop” in “go-stop” monetary policy, which those who warn about too much discretion are concerned with. I have emphasized the “too low for too long” period in my writing because of its “enormous implications” (to use Hetzel’s description) for the crisis and the recession which followed. Now this does not mean that people are incorrect to say that the Fed should have cut interest rates sooner in 2008. It simply says that the Fed’s actions in 2003-2005 should be considered as a possible part of the problem along with the failure to move more quickly in 2008.

In this regard Scott Sumner recently raised some good questions about the part of my analysis on the crisis, where I wrote that one possible unintended consequence of the Fed’s large unanticipated interest rate cut in early 2008 was the decline in the dollar and associated jump in oil and gasoline prices (which were clearly a factor in accelerating the downturn). There were many discretionary moves during this period, but in the part of my analysis Sumner refers to I was discussing interest rates. Recall that on January 22, 2008 the FOMC cut the federal funds rate by 75 basis points in one day, which was most unusual and certainly unanticipated. It was not on an FOMC meeting day, which made it particularly unusual.

The Fed was apparently concerned about stock market turbulence which was later associated with a large trading loss and panic selling incident caused by a single trader Jérôme Kerviel at Société Générale. I was concerned that such a discretionary move tied to stock prices could have adversely affected the Fed’s credibility regarding the dollar and thereby affect oil prices. It was one of many discretionary moves I wrote about, emphasizing that “It is difficult to assess the full impact of this extra sharp easing, and more research is needed” Given that more than four years have transpired, more research is still needed, and I appreciate Scott Sumner raising the issue. In my view the issue is best viewed as only one part of a massive switch away from rules and toward discretion over a number of years, and, as Hetzel’s emphasizes in his book, this is the kind of monetary policy that generally leads to poor economic performance.

Spiegel Says "Even a 1-Trillion Euro Firewall Wouldn't Be Enough"; Mish Says "The Bigger the Bazooka, the More Money Will be Lost"

Eurozone bureaucrats keep upping the ante as to how big a "firewall" is needed. And at every critical juncture, German Chancellor Angela Merkel has proven she is nothing but a liar. With every demand for additional firepower, comes an inevitable cave-in from Merkel supporting the move, no matter what she says in advance.

Meanwhile, the entire idea that firewalls can accomplish anything is ludicrous, given the key point that currency unions in the absence of fiscal unions cannot and will not work.

I suspect Merkel understands this, merely wanting to get Germany so deep into bailouts step by step, that it will be reluctant to leave the Eurozone.

It is high time the German Supreme court step in and stop this nonsense.

However, nothing can stop Greece, Portugal, and Spain from leaving, and eventually they will. In the meantime, rest assured that every increase in firepower will be additional money of German citizens' pockets. The end-game will be a currency or banking crisis at the worst possible time.

For now, please consider 'Even a 1-Trillion Euro Firewall Wouldn't Be Enough'
European finance ministers meeting in Copenhagen on Friday agreed to boost the euro-zone firewall to over 800 billion euros. The move marks another U-turn on the part of the Merkel administration, which recently dropped its opposition to increasing the fund. German commentators warn that even the new firewall may still be too small.

German Chancellor Angela Merkel and her finance minister, Wolfgang Schäuble, have been accused of crossing many of the "red lines" that they have set for themselves over the course of the euro crisis, making U-turn after U-turn as the crisis escalated. They officially stepped over the latest red line on Friday, when European Union finance ministers meeting in Copenhagen agreed to boost the scope of the euro zone's firewall to over €800 billion ($1 trillion). Berlin had long rejected such an expansion out of hand.

The Nuclear Option

On Thursday evening, in the run-up to Friday's summit, German Finance Minister Wolfgang Schäuble had said he was prepared to combine the existing bailouts with the new permanent mechanism. He said that the €800 billion capacity was "convincing" and "sufficient."
But not everyone shares his view that the sum is enough. On Thursday, French Finance Minister François Baroin called for the permanent euro bailout fund to be increased to €1 trillion, to shore up market confidence and prevent contagion in the euro crisis. "The firewall, it's a little like the nuclear option in military planning, it's there for dissuasion, not to be used," Baroin said in a radio interview.

'Shifting Sand Dunes'

Opposition parties in Germany were quick to make political capital out of the Merkel administration's many U-turns during a debate on the euro rescue fund and the European fiscal pact in the German parliament, the Bundestag, on Thursday. "Your red lines have, in reality, become shifting sand dunes," Frank-Walter Steinmeier, floor leader for the center-left Social Democratic Party (SPD), said to widespread applause.

In December, Merkel argued, entirely convincingly, that boosting the euro bailout fund was the wrong course to take. After all, she said, it would reduce the pressure on crisis-stricken states to push through reforms. There was also the question of whether the creditor countries, including Germany, were in danger of being overwhelmed by ever-higher guarantees." "Now, the fund is indeed being expanded, and the coalition government's former concerns have suddenly disappeared. Instead, the administration is attempting to conceal its own U-turn with highly flawed arguments.

The left-leaning Die Tageszeitung focuses on the calls to boost the ESM to €1 trillion:

"One trillion euros is a lot of money, and yet even this huge sum will not be enough. But again, that's nothing new. For months, calculations have been doing the rounds that show that at least €1.5 trillion will be needed. The only interesting question left is how long it will take France and Germany to acknowledge this reality."
No Amount is Enough

For reasons noted at the top, no amount of money (that can reasonably be provided) would be sufficient. After all, there is a limit to what German citizens and taxpayers can stand. Besides, money alone cannot fix structural problems.

Finally, the "nuclear" option is nothing more than former US treasury Hank Paulson's "Bazooka" theory in disguise.

Bazooka Theory vs. Actual Results

"If you have a bazooka in your pocket and people know it, you probably won't have to use it." Paulson said at a Senate Banking Committee hearing. The reference was in regards to Fannie Mae and Freddie Mac.

Paulson believed that if he had the power to bailout Fannie Mae, the market would react to that possibility and no bailout would be necessary.

Now taxpayers have wasted close to $200 billion bailing out Fannie and Freddie bondholders (mainly PIMCO and foreign banks).

Flashback February 12, 2010: EU Leaders Deploy ‘Bazooka’ to Repel Attack on Greece
German Chancellor Angela Merkel and her counterparts yesterday pledged “determined and coordinated action” to support Greece’s efforts to regain control of its finances. They stopped short of providing taxpayers’ money or diluting their own demands for the country to cut the European Union’s biggest budget deficit.

“It’s like Paulson’s bazooka,” said Nielsen, Goldman Sachs’s chief European economist in London. “It’s a difficult balancing act -- saying something comforting to the market without committing money and hoping the market will take their word for it.”

After a three-month long plunge in Greece’s bonds amid speculation it was facing the threat of default, euro-region leaders yesterday ordered the country to slash its budget deficit and warned investors they would be willing to defend the country from speculative attack if necessary.

“This is not money for free,” said Luxembourg Prime Minister Jean-Claude Juncker, who heads the group of euro-area finance ministers. “This is a strong commitment imposed on Greece.”
How Well Did That Idiotic Bazooka Move Work Out?

Bazooka theory does not work, nor did threats to investors that the ECB and EMU would be willing to defend the country from speculative attack if necessary.

The same holds true today. The Bigger the Bazooka, the More Money Will be Lost.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Friday, March 30, 2012

Violence, Firebombings Erupt as Spain Announces €27 Billion Deficit-Cutting Plan; Spanish Economy Will Implode; Spain Headed for Bond Revolt and Bailouts

My friend Bran who lives in Spain writes ...
Hello Mish

Here are thoughts from the last couple of days on the strikes, protests, and violence in the wake of more austerity plans by Prime Minister Mariano Rajoy.

Pro-government news played down the strike to a virtual non-event, giving much criticism of the unions methods and exaggerations. Reality however, is that there is enough support by strikers to shape future politics, especially as austerity starts to bite.

The unions have promised to step up protests. The Indignado 15 Million Movement also protested, but separately from the unions.

One comment stuck out - German Chancellor Angela Merkel said the protests did not represent Spain. Maybe she was trying to be reassuring, but she is taking sides against maybe a million or so people of a foreign population, not very wise at best and otherwise agitating.
Spain Announces €27 Billion Deficit-Cutting Plan

MarketWatch reports Spain Announces €27 Billion Deficit-Cutting Plan
The Spanish government on Friday delivered what it called the biggest fiscal adjustment in the country’s democratic history, unveiling a 27 billion euro ($36 billion) deficit-reduction plan that includes sharp spending cuts across government ministries and higher taxes for corporations.

With images of nationwide demonstrations and strikes against labor reforms still fresh, the weight of the budget appeared to fall on big companies and government spending. Labor unions said nearly 1 million took part in Madrid’s rally alone Thursday evening.

Corporations will be asked to pay higher taxes this year, and their tax breaks will be reduced while the government said value-added-taxes would not rise. It said tax receipts for VAT would fall 2.6% as a result of weak growth in Spain.

Budget Minister Cristobal Montoro said all ministries would need to reduce their budgets by around 17% this year, which was slightly higher than expected, saving a total of up to €65.8 billion. Salaries for public workers will not be reduced, but will be frozen this year.

Electricity prices will rise 7%, to pay off a €24 billion electricity-tariff deficit that accumulated due to the difference between consumer prices set by the state and producer’s costs. Tariffs paid by electricity companies will rise 5%.
Austerity Measures Prompt Spanish Workers To Strike

NPR reports Austerity Measures Prompt Spanish Workers To Strike
Workers walked off the job in Spain on Thursday, halting public transport, closing schools and leaving hospitals with emergency staff only. The general strike was called by unions in response to the conservative government's labor reforms, which let companies opt out of collective bargaining agreements and fire workers more cheaply. But more punishing austerity could still be to come, as Spain tries to whittle down its budget deficit under pressure from Brussels.
Violence Erupts in Spanish Strikes

The Washington Post has a nice 19-image slideshow Violence Erupts in Spanish Strikes. Here are a few images.



March 29, 2012
A demonstrator throws stones next to a burning Starbucks, which was stormed by demonstrators during clashes with police at the general strike in Barcelona. Spanish workers livid over labor reforms they see as flagrantly pro-business staged a nationwide strike Thursday and tried to bring the country to a halt by blocking traffic, closing factories and clashing with police in rowdy demonstrations.
Emilio Morenatti / AP



March 29, 2012
People attend a demonstration in Valencia, Spain, during a national strike.
Jose Jordan / AFP/Getty Images



March 29, 2012
A woman cries after demonstrators smashed a shop window during heavy clashes with police during a 24-hour strike in Barcelona.
David Ramos / Getty Images

Eurozone crisis live: Violence in Barcelona Amid Spanish General Strike

The Guardian has numerous images and videos in its report Eurozone crisis live: Violence in Barcelona Amid Spanish General Strike



Protesters crowd in Madrid's landmark Puerta del Sol square for a closing rally tonight. Photograph: Paul Hanna/Reuters

As many as 900,000 people took part in the march to Madrid's centre square, Puerta del So.

Spanish Economy Will Implode

Labor reforms are badly needed but electricity price hikes of 7%, higher corporate taxes, increased VAT and other tax hikes are not. Spain needs more time not more tax hikes. With unemployment rate already at 23.3% austerity measures are guaranteed to make matter worse, and tax hikes on top of it all will be the nail in the coffin.

Prime Minister Rajoy forecasts the Spanish economy will contract 1.7% and government GDP targets and budgets are based on that. I bet that 3% contraction minimum is in the works if Rajoy enacts the tax hikes and austerity measures as planned.

Things will be much worse if the violence and strikes stay in an elevated state. Unlike the protests a year ago, these strikes have more serious overtones.

Spain Headed for Bond Revolt and Bailouts

The idea that Rajoy will cut the deficit to 5.3% this year and 3% next year are purely Fantasyland proposals.

For now, the bond market has given Rajoy the benefit of the doubt, assuming you call 5.35% on the 10-year bond any kind of "benefit". With the suspension of the LTRO, and a budget targets that cannot possibly be met, look for a substantial move up in Spanish bond yields.

That will also punish any Spanish banks foolish enough to load up on bonds in a misguided carry-trade play. With Spain, nearly everything is worse than the government reports, and the reports are awful.

A bond market revolt and bailout are in the cards this year. Ultimately, Spain will not survive in the Eurozone.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Canada Eliminates The Penny

In a welcome, albeit long overdue attack of common sense, Canada Eliminates Penny Costing Penny-and-a-Half to Make.
Canada will withdraw the penny from circulation this year, saving taxpayers about C$11 million ($11 million) annually and forcing retailers to round prices to the nearest nickel, the government announced in its budget today.

The Royal Canadian Mint, which has produced 35 billion pennies since it began production in 1908, will cease distribution this fall due to the coin’s low purchasing power. Production and handling cost for the one-cent coin are a C$150- million drag on the economy, according to a 2006 study by Desjardins, a Levis, Quebec-based financial institution.

Business groups welcomed the move, which follows other countries such as Australia, Brazil and Sweden, and economists said it would have little impact on inflation.

The penny, with two maple leafs on one side and Queen Elizabeth II on the other, can continue to be used in payments. As they are gradually withdrawn from circulation, price rounding on cash transactions will be required, the government said.

Retailers and other businesses can continue to price goods and services in one-cent increments and there will be no need to reprogram cash registers, according to the government.

Catherine Swift, president and chief executive officer of the Canadian Federation of Independent Business, said the move will increase efficiency.

“It has been a long time coming,” she said. “It’s been a real pain more than anything else. We’ve actually polled our members on this and they’re supportive.”
Economists said there would be "little" impact on inflation. Actually, there will be "no" impact on inflation. The penny has not been discarded as a pricing point, rather final transaction costs will be rounded to the nearest nickel.

The US needs to follow suit. Dealing with pennies is a nuisance.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Question on Jobs: How Many Does It Take to Keep Up With Demographics?

John Mauldin pinged me with a question on jobs and demographics from one of his readers.
Hello John.
In past letters you have cited the need to create 125,000 jobs per month to stay even with the growth rate in the labor force. Dick Hokenson of ISI Research has recently published reports suggesting that 75,000 jobs is a more accurate estimate based on his demographic analysis. This difference obviously has profound implications for the pace of recovery and potential improvement in the unemployment rate. Have you seen any of Hokenson's work? Do you have any insights into why his analysis is so different than consensus?
How Many Does It Take to Keep Up With Demographics?

Ben Bernanke has estimated 125,000 jobs a month. That is the number I have been using recently.

However, based on demographics alone, I believe 75,000 is indeed the correct number.

75,000 is a number I arrived at a couple of years ago independently, for the boomer-bust years of 2013-2015.

So why use 125,000 if it only takes 75,000? I do not know Bernanke's rationale, but I can explain mine.

  1. Between January 2008 and February 2010, the U.S. economy lost 8.8 million jobs.
  2. In the last year, the civilian population rose by 3,584,000. Yet the labor force only rose by 1,569,000. 
  3. Millions of people dropped out of the labor force in the last several years and if jobs are available they will start looking again
  4. As soon as people start looking for jobs, the number it will take to hold the unemployment rate steady will rise, perhaps to a number well above 125,000

    Point number 4 above is the key issue.

    Household Survey Data - March 9, 2012



    click on chart for sharper image

    Take a good look at the household survey from the latest BLS jobs report. Recall that the unemployment rate comes from the household survey, and not the headline jobs number.

    Note that 428,000 jobs were allegedly created in February. Also note the unemployment did not change. Why? Because the civilian labor force went up by an even larger 476,000. Thus the unemployment rate actually rose a fractional amount that rounding took away.

    If I would have told you that a rise in 428,000 jobs would not drop the unemployment rate you would have thought I was off my rocker. Yet it happened, assuming of course you believe BLS numbers, complete with amazing seasonal adjustments.

    Back to School Stats

    Let's take a look at some interesting points from Consumer Credit "Demolishes Expectations" Really? No Not Really! The "Non-Bounce" in Non-Revolving Credit
    Non-Revolving credit rose $11.8 billion in December. However, $8.8 billion of that is growth in federal government loans (which just happens to be where student loans are parked).

    Here are some charts I put together stripping out federal government loans.

    Non-Revolving Loans Minus Government Loans



    Non-Revolving Loans Minus Government Loans Detail



    True Bounce in Percentage Terms



    Note that the year-over-year "bounce" has not even gotten back to the zero-line in spite of exceptionally easy comparisons.

    Middle-Aged Borrowers Pile on Student Debt

    Reuters reports Middle-Aged Borrowers Pile on Student Debt
    Educational borrowing is up for every age group over the past three years, but it has grown far more quickly among those between 35 and 49, according to the analysis of more than 3 million credit reports provided to Reuters by the credit score tracking site CreditKarma (CreditKarma.com). That group saw its school debt burden increase by a staggering 47 percent, according to the analysis.

    The average student loan debt for those aged 38 to 41 was the biggest of that group -- about $12,000, up from just under $9,000 in 2009. Young people still carry the biggest student loan burdens; those aged 26 to 29 have an average of $14,000 in student debt. But the increased levels in middle-aged student debt is a new phenomenon.
    Negative Payback on Retraining

    The benefit of going back to school at age 49 is likely negative.

    My friend "BC" comments:
    The payoff for 40- and 50-somethings taking on debt to change occupations or trying to find jobs in "health care" or "education" and compete with Millennials trying to secure similar positions is low or negative.

    Statistically, the benefit to "education" occurs between ages 14 and 22, where one goes to high school and university. Obtaining an MBA, law degree, or another graduate degree after age 26-28 historically has not resulted in a net benefit in terms of job/career prospects or wage/salary income; and this has become particularly the case since the late '90s.

    In other words, the vast majority of people running up debt at universities, community colleges, and for-profit technical schools are wasting their time and money, as well as directing scarce resources to the "health care" and "education" sectors that don't need more misallocation further driving up costs.

    Needless to say, there is no precedent in US history for middle-aged unemployed, underemployed, or unemployable Americans running up debt in an economy that has not created a net new private sector full-time job per capita in at least 10 years.
    Fewer Nonfarm Employees Now Than December 2000

    Here is one key chart (of many) from Fewer Nonfarm Employees Now Than December 2000; Unemployment Rate: Some Things Still Don't Add Up; Obamanomics?

    Total Nonfarm Employees



    There are currently 132,409,000 nonfarm employees. In December of 2000 there were 132,481,000 employees. How's that for job growth?

    Retraining Scam

    Job retraining is scam perpetrated by for-profit universities, fueled by statements from Obama regarding re-training people for new jobs.

    Brick-layers are told they can be "chefs", take $10,000 courses and the universities call it a "success" if they land a job "in their field" at McDonald's. Unemployed roofers are led to believe they can become Java programmers, and they waste collective $billions trying. Meanwhile out of work Java programmers are told to take up a trade like roofing or auto mechanics.

    The cost of education keeps rising because Obama (like Bush before him), keeps adding to the student loan program when the entire student loan scam really needs to be shut down.

    Why Does the Scam Roll On and On?

    1. No politician wants to stand up and tell the truth: Retraining is a waste of money and the odds of launching a new career in other than a low-paying job requiring few skills is simply not likely.
    2. For-Profit universities pad politicians' pockets

    One can always find success stories, but in aggregate, retraining middle-aged workers is a net waste of money.

    To Paraphrase Joe Weisenthal

    Now, to paraphrase Joe Weisenthal: "It's hard to think that the economy is NOT going back into a recession with numbers like these." The difference in viewpoint is understanding what the underlying numbers really represent.
    Hiding Out In School

    All those hiding out in school, including those going back to school for retraining are not counted in the ranks of the unemployed. Nor are discouraged workers, who stopped looking for a job.

    As soon as those folks think there are jobs, they will start looking. Economically speaking, that would be a good thing if it happened, but it would also increase the number of jobs it will take to hold the unemployment rate steady.

    In a vacuum, all things being equal, it would take about 75,000 jobs a month demographically speaking. But things are not equal. Millions of workers want back in the labor force and they will start looking, especially students who at some point will have no choice. It may take 150,000 jobs a month or even 175,000 jobs a month, if those workers come back into the labor force in a 2-year  surge.

    That is still not the end of the story. What if we slip back into recession and people stop looking? How many will it take then? The answer may be closer to 100,000. The middle of the road approach is to stick with the number I have been using recently which is 125,000 a month.

    The irony is, the better the economy is, the more jobs it will take. One way or another, headwinds on lowering the unemployment rate are very strong.

    All things considered, I see no reason to deviate from my "Structurally High Unemployment For a Decade" call made years ago and reiterated in January in Fundamental and Mathematical Case for Structurally High Unemployment for a Decade; Shrinking Job Opportunities and the Jobs Gap; The Real Employment Situation.

    For further discussion please see Where is the Unemployment Rate Headed? Interactive Mapping Lets "You" Set the Parameters, and Plot a Graph

    Mike "Mish" Shedlock
    http://globaleconomicanalysis.blogspot.com
    Click Here To Scroll Thru My Recent Post List

    Thursday, March 29, 2012

    The Dating Game: Michael Pettis Challenges The Economist to a Bet on China

    The Economist says "China’s GDP, measured in nominal dollars, will be the world’s largest by 2018". Michael Pettis at China Financial Markets disagrees and says I would like to make a bet with The Economist.
    I recently read in The Guardian an article by enthusiastic orientalist Martin Jacques in which he says that The Economist has just predicted that China’s GDP, measured in nominal dollars, will be the world’s largest by 2018. Earlier estimates, he says had China becoming the largest economy in the world by 2027.

    I have always been a little skeptical about the 2027 claim ... given how much we would have to assume about the sustainability of Chinese growth, about the likelihood of current GDP numbers not having been vastly inflated by an over-investment boom, and about the unstable range of political outcomes. It seemed to me to be a prediction about as valuable as the world-beating predictions about the USSR in the 1960s or Japan in the 1980s.

    Still, this 2018 prediction deserves I think more than a little questioning — it requires that nominal Chinese GDP growth in dollars outpace nominal US GDP growth by 12% a year.

    So I am wondering whether we could set up a friendly bet — not for too large stakes. I would like to bet that by the end of 2018 China will not be the largest economy in the world.

    If I win, perhaps The Economist could invite a very cool underground Chinese band of my choice to perform at their next big conference, whereas if I lose I could buy four-year subscriptions (student rates, please) to a group of Peking University freshmen. Everybody would end up feeling pretty pleased with themselves no matter who wins, right? So?
    The Dating Game

    Inquiring minds are looking at an interactive chart on The Economist in an article called The Dating Game.
    AMERICA'S GDP is still roughly twice as big as China’s (using market exchange rates). To predict when the gap might be closed, The Economist has updated its interactive chart below with the latest GDP numbers. This allows you to plug in your own assumptions about real GDP growth in China and America, inflation rates and the yuan’s exchange rate against the dollar. Over the past ten years, real GDP growth averaged 10.5% a year in China and 1.6% in America; inflation (as measured by the GDP deflator) averaged 4.3% and 2.2% respectively. Since Beijing scrapped its dollar peg in 2005, the yuan has risen by an annual average of just over 4%. Our best guess for the next decade is that annual GDP growth averages 7.75% in China and 2.5% in America, inflation rates average 4% and 1.5%, and the yuan appreciates by 3% a year. Plug in these numbers and China will overtake America in 2018. Alternatively, if China’s real growth rate slows to an average of only 5%, then (leaving the other assumptions unchanged) it would not become number one until 2021. What do you think?
    Snapshot of The Economist Baseline Assumptions



    The interactive graph is too large for my blog, but the above screen snapshot shows The Economist baseline assumptions. To play around with the numbers, click on the above link.

    I share a viewpoint with Pettis that The Economist is way too generous in their estimate of real GDP growth for China.

    Pettis thinks China will average 3% growth and I already posted I found that number reasonable. As far as Yuan appreciation is concerned, I am not at all convinced the Yuan is undervalued at all, yet I plugged in a nominal 2% annual appreciation.

    Assuming a "Real GDP growth" of 3% and Inflation at 4% yields a chart that looks like this.

    Snapshot of Mish Baseline Assumptions



    Even still, I wonder if the year 2030 is still far too optimistic from the standpoint of China.

    I strongly believe peak oil and energy consumption is going to put a serious damper on Chinese growth, and that is on top a necessary and very painful shift away from an entirely unsustainable growth model based on exports, housing, and fixed investment.

    I share Pettis' view regarding "inflated GDP numbers, an over-investment boom, and the unstable range of political outcomes" adding my own energy concerns and yuan valuation concerns on top of it all.

    Thoughts on Chinese Growth


    I find the arguments by Pettis, the ECRI, and Chanos compelling. Add to that the restraint of peak oil coupled with potential political instability and the proper conclusion is that long-term Chinese growth of 7.5% is Fantasyland material.

    Mike "Mish" Shedlock
    http://globaleconomicanalysis.blogspot.com
    Click Here To Scroll Thru My Recent Post List

    A Little Dynamic Scoring of the House Budget

    In a recently released report the Congressional Budget Office calculated how debt reduction with the House Budget Resolution (which just passed the House today), would affect GNP in the United States. The CBO took the spending and tax parameters from the House Budget Committee staff and computed the resulting deficit and debt. They then compared the debt path under the House budget with the debt path under their "extended alternative fiscal scenario, which is their description of current law and its most likely extensions. They then estimated the effect of the different debt levels on economic output.  This is a "little" dynamic scoring in the sense that other positive effects of lower marginal tax rates and other incentives in the House budget plan are ignored. 

    Nevertheless, CBO reports that the reduced level of debt has large positive economic effects. I created the following "fan charts" to illustrate this.

    The fan charts represent the range of uncertainty as reported by CBO. If you take the midpoint of the fan charts, you will find that GNP is 19 percent greater in 2040 under the House plan and the gap continued to grow after that. That is about $5.6 trillion per year and growing. The difference is three times the maximum annual loss of output under the Great Recession, but it continues year after year.

    The difference in the federal debt as a fraction of the economy under the two scenarios is shown in the next chart. While CBO projections go through 2050 under the House plan, the CBO does not report numbers greater than 200 percent of GDP in the alternative fiscal scenario. In the chart, I estimated the actual percent by extrapolating the 2011 Long Term Scenario and showing the little star. But no matter how you look at it, the effect on the debt and thus the economy is huge. 


    Obama Budget Defeated 414-0; Obama vs. Ryan Budget Showdown Revisited

    Not a single Democrat endorsed the budget proposed by president Obama. The scorecards reads as follows Obama budget defeated 414-0.
    President Obama's budget was defeated 414-0 in the House late Wednesday, in a vote Republicans arranged to try to embarrass him and shelve his plan for the rest of the year.

    The vote came as the House worked its way through its own fiscal year 2013 budget proposal, written by Budget Committee Chairman Paul D. Ryan. Republicans wrote an amendment that contained Mr. Obama's budget and offered it on the floor, daring Democrats to back the plan, which calls for major tax increases and yet still adds trillions of dollars to the deficit over the next decade.

    But no Democrats accepted the challenge.

    Senate Democrats have said they will not bring a budget to the floor this year, though Republicans in the chamber have talked about trying to at least force a vote on Mr. Obama's plan there as well.

    Last year, when they forced a vote on his 2012 budget, it was defeated 97-0.
    National Debt vs. Public Debt

    In my post Obama vs. Ryan: Budget Showdown - Deficit and Total Debt Projections Through 2021 - Interactive map one reader caught a mislabeling of public debt as national debt.

    Mislabeling is corrected. Here is the Budget Showdown once again, this time with the corrected word change.



    Note: Tableau has a server issue right now and the interactive buttons may not be working properly. This should be corrected shortly.

    Mike "Mish" Shedlock
    http://globaleconomicanalysis.blogspot.com
    Click Here To Scroll Thru My Recent Post List

    Geithner Wants to Throw Still More Taxpayer Dollars Down the Fannie & Freddie Toilet

    Not satisfied with wasting close to $200 billion of taxpayer dollars bailing out holders of Fannie and Freddie Bonds (notably PIMCO and China), Geithner is back at it with another proposal sure to cost US taxpayers plenty if adopted.

    The proposal this time is for taxpayers to pick up 63% of the cost of mortgage principal reductions. Geithner made the offer to Edward J. DeMarco, Fannie Mae and Freddie Mac’s overseer.

    Bloomberg reports Geithner’s Math Puzzle Beyond Numbers for DeMarco
    Geithner, the U.S. Treasury secretary, is offering new incentive payments to the two government-supported mortgage financiers if DeMarco drops his opposition to principal reductions for homeowners whose loans are backed by the companies.

    It’s not just a question of whether the numbers add up, DeMarco said in an interview at Bloomberg’s headquarters in New York yesterday.

    “We’ve got to consider all of the ramifications of principal forgiveness relative to other tools.”

    Proponents from Martin Feldstein, a chief economic adviser to the late President Ronald Reagan, to activist groups such as MoveOn.org have called on DeMarco to allow writedowns. Congressional Democrats including Rep. Elijah Cummings of Maryland have accused him of blocking a recovery and called on him to resign.

    FHFA is not yet convinced principal reductions are the best answer, DeMarco said, in part because the agency still must examine how offering loan writedowns would affect the behavior of underwater borrowers who are still making their payments on time. Until now, the agency hasn’t specifically focused on the issue of whether loan forgiveness would create a moral hazard by providing an incentive for borrowers to default. That’s because without the extra incentives offered by the government this year, debt forgiveness was more costly than forbearance as most underwater borrowers would stay in their homes if given a low enough payment, according to its analysis.

    Violating Legal Responsibility

    The U.S. government has spent $190 billion to shore up the companies since they were taken into federal conservatorship in 2008 after their investments in risky loans soured. DeMarco said adding to the firms’ costs would be a violation of his legal responsibility to restore them to financial health.

    Using principal forbearance instead of forgiveness so far has been better for taxpayers, DeMarco said. Forbearance reduces monthly payments while requiring borrowers to pay back the full amount of the loan when they sell the house.

    “If the borrower is successful on the modification, allows them to stay in their house and they stay in their house and start making mortgage payments, the taxpayer gets to share in the upside of that borrower’s success,” DeMarco said in the Bloomberg Television interview. “If we forgive the principal up front and the borrower is successful, that upside all goes to the borrower and is not shared with the taxpayer.”
    Vote Buying

    This is not about doing what's right for taxpayers. It's about doing what's right to help Obama's reelection chances. Of course Hedge Funds and PIMCO like the buyback idea because it immediately puts a bid in for Fannie and Freddie bonds they hold.

    Mike "Mish" Shedlock
    http://globaleconomicanalysis.blogspot.com
    Click Here To Scroll Thru My Recent Post List

    Eurozone Retail Sales Contract 5th Consecutive Month, Year-on-Year Sales Decline 10th Month

    Eurozone retail sales fell only slightly this month, but it was the 5th consecutive month, and the worst quarter since the 1st quarter of 2010.

    Please consider Markit Eurozone Retail PMI® March 2012.
    Retail sales in the Eurozone fell only marginally at the end of the first quarter, according to Markit’s latest PMI® surveys. The average rate of decline over the first quarter matched that seen over the final three months of 2011, which was the worst quarter since Q1 2010. The survey data again highlighted marked disparity between growth in Germany and falling sales at Italian retailers, while sales in France were again broadly flat.



    The Eurozone Retail PMI is a single-figure indicator of changes in the value of sales at retailers. The PMI is adjusted for seasonal factors, and any figure greater than 50.0 signals growth compared with one month earlier. The PMI remained below 50.0 in March, signalling a fifth successive monthly drop in sales revenues. Sales have fallen ten times in the past 11 months. But the index rose for the second successive survey, recovering further ground from January’s 35-month low of 42.9 to post 49.1. The latest figure signalled only a marginal decline in sales revenues. The latest PMI figure suggested that the pace of decline in retail sales as measured by the EU’s statistical office Eurostat (on a three-month-on-three-month basis) will ease in the coming months.



    Eurozone retail PMI figures are based on responses from the three largest euro area economies. March data signalled that the Italian retail sector remained mired in a steep downturn, posting a thirteenth successive monthly drop in retail sales. The rate of contraction was slower than January’s record low, but still marked nonetheless.

    German retail sales continued to rise in March, extending the current sequence of growth to 18 months. This is the longest period of expansion since monthly sales data were first collected in January 2004. The rate of growth slowed since February, but was broadly in line with the average for 2011.

    Year-on-Year Sales Decline 10th Month

    Retail sales in the Eurozone continued to fall on an annual basis in March. Year-on-year sales have fallen for the past ten months, the longest sequence since that registered from June 2008 to March 2009. Moreover, the rate of decline accelerated since February, reflecting a sharp reversal in the year-on-year sales trend in France. German retail sales registered the fourth-fastest annual increase in sales since the series started, but Italy posted another substantial decline.

    Other indicators from the latest surveys underlined the ongoing weakness of market conditions in the retail sector. The value of purchasing activity fell for the eighth month running, while retail employment was broadly flat for the second successive month. Retailers’ gross margins remained under substantial downward pressure, and original sales plans were missed again.

    Commenting on the retail PMI data, Trevor Balchin, senior economist at Markit and author of the Eurozone Retail PMI, said:

    “Across the Eurozone, retail sales fell only marginally during the month but were down sharply compared with one year ago. Compounding retailers’ difficulties, wholesales prices continued to rise at a steep rate, squeezing margins which have already been under intense pressure from the need to offer discounts to stimulate sales."
    Markit Clings to Hope

    Once again Markit clings to every bit of hope that things are about to get better. Here is the key sentence: "The latest PMI figure suggested that the pace of decline in retail sales as measured by the EU’s statistical office Eurostat (on a three-month-on-three-month basis) will ease in the coming months."

    Why?

    Why are sales in Europe going to get better? Once again I propose it is far more likely for German sales to slip as its vaunted export machine takes a hard tumble.

    I said the same thing two months ago regarding Manufacturing PMI when Markit was hoping Germany could keep Europe out of recession.

    The no-recession idea bit the dust on March 22 as noted in "Eurozone Slides Back Into Recession" Says Markit PMI News Release; Sharp Decline in German Export Business; Misguided Decoupling Theories.

    Markit then shifted its stance from hoping for no recession in the Eurozone, to hoping for no recession in Germany and I responded with:
    What's with the Markit "Pollyanna" Forecasts?

    This month Markit is talking about Germany avoiding a recession. Even more amazingly, just last month Commenting on the flash PMI data, Chris Williamson, Chief Economist at Markit said:

    “A retreat back below the 50.0 no-change level for the Eurozone PMI is a disappointment, and highlights the ongoing risk that the region may be sliding back into recession.
    That "risk of recession" became a sure thing as Markit threw in the towel on non-recession hopes as noted above.

    On February 22, in Eurozone PMI "Worse Than Expected" and Back in Contraction; Expect German-Periphery Divergence to Resolve to the Downside for Germany I stated:
    Expect German-Periphery Divergence to Resolve to the Downside for Germany

    The idea that Europe can avoid a recession is complete silliness. Europe is clearly in a recession already.

    The amazing thing is things have not deteriorated more than they have. Unlike the Chief Economist at Markit, I expect the divergence to resolve to the downside for Germany, not for the divergence to continue for some time. Given conditions in Europe and Asia, the odds that Germany is immune from the global slowdown are essentially zero.
    Sure enough, German exports took a dive in March, and it's reasonable to assume another dive in April.

    Conditions in Europe are deteriorating badly, and a general strike looms in Italy. Spain, Greece, and Portugal are basket cases.  The odds that weakness does not spill over into Germany are near-zero.

     Mike "Mish" Shedlock
    http://globaleconomicanalysis.blogspot.com
    Click Here To Scroll Thru My Recent Post List

    Egyptian Opposition to US Aid Hits 82%; So Why Did Obama Restore Aid, and Why Did Hillary Insist Upon It?

    A Gallup Poll in Egypt shows 82% of Egyptians Do Not Want US Aid.
    Egyptians' opposition to U.S. economic aid continued to climb in early 2012. More than eight in 10 Egyptians in February said they opposed U.S. economic aid, up 11 percentage points since December and up 30 points since April 2011 when Gallup first posed the question.
    Poll Question



    So Why Did Obama Restore Aid?

    The New York Times reports Once Imperiled, U.S. Aid to Egypt Is Restored.
    An intense debate within the Obama administration over resuming military assistance to Egypt, which in the end was approved Friday by Secretary of State Hillary Rodham Clinton, turned in part on a question that had nothing to do with democratic progress in Egypt but rather with American jobs at home.

    A delay or a cut in $1.3 billion in military aid to Egypt risked breaking existing contracts with American arms manufacturers that could have shut down production lines in the middle of President Obama’s re-election campaign and involved significant financial penalties, according to officials involved in the debate.

    Since the Pentagon buys weapons for foreign armed forces like Egypt’s, the cost of those penalties — which one senior official said could have reached $2 billion if all sales had been halted — would have been borne by the American taxpayer, not Egypt’s ruling generals.

    The companies involved include Lockheed Martin, which is scheduled to ship the first of a batch of 20 new F-16 fighter jets next month, and General Dynamics, which last year signed a $395 million contract to deliver component parts for 125 Abrams M1A1 tanks that are being assembled at a plant in Egypt.

    Mrs. Clinton’s decision to resume military assistance, which has been a foundation of United States-Egyptian relations for over three decades, sidestepped a new Congressional requirement that for the first time directly links arms sales to Egypt’s protection of basic freedoms. No new military aid had been delivered since the fiscal year began last October, and Egypt’s military has all but exhausted funds approved in previous years.

    Mrs. Clinton’s decision provoked sharp criticism from lawmakers across the political spectrum, as well as human rights organizations. Senator Rand Paul, Republican of Kentucky, criticized it as “beyond the pale.”

    Referring to Egypt’s recent decision to prosecute four American-financed international advocacy organizations, Mr. Paul added, “It sets a precedent that America will not punish its aggressors but instead give them billions of our taxpayers’ dollars.”

    The M1A1 components are built in factories in Alabama, Florida, Michigan, Ohio and Pennsylvania, several of them battleground states in an election that has largely focused on jobs. Because the United States Army plans to stop buying new tanks by 2014, continued production relies on foreign contracts, often paid for by American taxpayers as military assistance.

    Senator Patrick J. Leahy, Democrat of Vermont, who added the certification requirements to legislation authorizing military aid to Egypt, called the decision to waive them regrettable, and the resumption of aid “business as usual.”
    Let's piss away billions of dollars on aid to countries that don't even want it.

    Note that Mrs. Clinton waived a requirement that she certify Egypt’s protection of human rights as a condition of aid.

    Yes indeed, this is "business as usual", so much so that even Democrat senators are complaining about it.

    Mike "Mish" Shedlock
    http://globaleconomicanalysis.blogspot.com
    Click Here To Scroll Thru My Recent Post List

    Question of the Day: What is the Commodities Sector Seeing that the Stock Market Doesn't?

    Please consider a series of chart my friend "BC" put together of various indices vs. the Morgan Stanley Commodity Related Equity Index ($CRX).

    $SPX vs. $CRX


    click on any chart for a sharper image

    $CYC vs. $CRX



    $TRAN vs. $CRX



    $DJUSRR vs. $CRX



    What is the Commodities Sector Seeing that the Stock Market Doesn't?

    The answer from my friend Pater Tenebrarum who also saw these charts is "the coming economic bust in China - which has likely already begun."

    That idea is in-line with several of my recent posts ...



    Mike "Mish" Shedlock
    http://globaleconomicanalysis.blogspot.com
    Click Here To Scroll Thru My Recent Post List

    Wednesday, March 28, 2012

    "Healthwreck": Obamacare May Go Down Entirely; Medicaid Funding in Question; Justice Scalia Joked Reading Entire Bill Would be "Cruel and Unusual Punishment"; Wrecking Operation or Salvage Job?

    Weak arguments presented by "team Obama" lawyers supporting Obama's healthcare legislation took a beating yesterday, and the beating continued even more so today.

    Please consider Day 3: ObamaCare at the Supreme Court by the Illinois Policy Institute.
    Today was the final marathon session of oral arguments over ObamaCare. It began this morning with the question of what to do with the rest of the law if the individual mandate is struck down, a very real possibility after yesterday's hearing.

    On this issue, both sides agree that if the mandate falls, at least some of the other provisions must fall with it. Most of the Justices seemed skeptical that the entire law should be thrown out, but where to draw the line was a question the Court was clearly struggling with.

    Some of the justices hinted that the difficulty in drawing that line could mean disaster for the whole law. Others noted that the Court has never struck down the heart of a statute but left an empty shell. At one point, Justice Kennedy expressed his concern that it might be worse to pick and choose which parts to strike down than to just overturn the whole law. Justice Scalia joked that forcing the Court to go through the law's thousands of pages and provisions one by one would be cruel and unusual punishment.

    The day ended with the question of whether the President can force states to expand their Medicaid programs to millions of new enrollees. As I explained earlier this week, Medicaid expansions have already failed the most vulnerable populations in Illinois, and ObamaCare is only going to make the problem worse.

    The four liberal justices appeared highly critical of the state's argument that conditioning pre-existing Medicaid funding on new expansions is too coercive. The conservative justices also expressed some skepticism that the forced expansion was unconstitutional, though they did press the administration to define the outer limits of that power.
    Justices Ask if Health Law Is Viable Without Mandate

    The New York Times reports Justices Ask if Health Law Is Viable Without Mandate.
    On the third and final day of Supreme Court arguments over President Obama’s health care overhaul law, several justices on Wednesday indicated a reluctance to pick and choose among the law's other provisions should the requirement that most Americans have health insurance be struck down.

    The questions from the justices indicated that at least some of them were considering either striking down just the requirement, often called the individual mandate, or the entire law.

    Paul D. Clement, representing 26 states challenging the law, urged the court to overturn the entire law. Edwin S. Kneedler, a deputy solicitor general, took a middle ground, suggesting that the court remove the mandate and only a couple of other provisions.

    The court separated the day’s arguments into two sessions. After the morning session, which focused on the effect of overturning the mandate, the afternoon's hearing dealt with the law’s expansion of Medicaid, part of its attempt to reduce the number of Americans without health insurance.

    In the second argument, the court’s more conservative justices expressed concern that the law’s Medicaid expansion was unduly coercive to states.

    “My approach would be to say that if you take the heart out of this statute,” Justice Antonin Scalia said, “the statute’s gone.”

    Justice Scalia, who suggested that the whole law would have to go, appeared to go further than some of the other justices, but many of them expressed skepticism that the rest of the law could remain intact if the court ruled the mandate to be unconstitutional.

    Justice Ruth Bader Ginsburg called the court’s task, should the key provision fall, a choice between “a wrecking operation” and “a salvage job.”
    Wrecking Operation or Salvage Job?

    There is nothing of merit to salvage in Obamacare. Even if there was, the Supreme Court should not have to read through thousands of pages to find it.

    The only things to "salvage" if key provisions are struck down, are Obama's inflated ego and his ability to say he passed healthcare legislation.

    Memo to Nancy Pelosi

    Hello Nancy: It seems the Supreme Court does not want to read the bill to find out what's in it.

    Sorry Team Obama, your bill was more like "Healthwreck" than "Healthcare".

    By the way, I have to ask: If the Supreme court strikes Obamacare, does it strike any provisions of Romneycare that passed in Massachusetts?

    Mike "Mish" Shedlock
    http://globaleconomicanalysis.blogspot.com
    Click Here To Scroll Thru My Recent Post List

    Bill Gross Predicts QE3 and Operation Mortgage Twist

    PIMCO founder and co-CIO Bill Gross spoke with Bloomberg Television's Margaret Brennan today, telling Bloomberg TV that the Fed will likely shift focus to mortgage securities to keep borrowing rates low when Operation Twist ends in June.



    Link of video does not play: Bill Gross on Pimco ETF Ticker Change, Bonds, Fed

    Partial Transcript
    On Gross’s view that we may see a sign from Bernanke in April that QE3 will be rolled out:

    "I think [Chairman Bernanke] is very satisfied…I think the Fed is outcomes-oriented. They want an outcome in terms of a higher stock market, in terms of housing starts and lower unemployment. What [Bernanke] said on Monday, in terms of the employment, he suggested that up until now, we've done very well in terms of reducing unemployment but it’ll be tougher going forward if only because of structural impediments that he outlined. Going forward, he's looking at jobs, at unemployment and the housing markets. You know, future QEs will the outcome-oriented type of strategy which seeks to provide jobs and provide higher housing prices and housing starts to continue on."

    On the tool that Gross thinks the Fed might deploy in April:

    "I have a sense that they'll continue with the Operation Twist, but not necessarily in terms of buying longer-term bonds and selling shorter dated Treasuries. I think that's basically been played out and the pension market itself in terms of liability structure has been damaged to some extent by lower 30-year yields. I think [Bernanke] will try to do is Twist in the mortgage market. Basically, buy current coupon mortgages in agency spaces and then basically Twist by repo-ing out the Treasuries that they currently own in short-term space. So, you know, a twist on another Twist I suppose, going forward."

    On the ticker change for PIMCO’s new ETF (to BOND):

    "It is easy to recognize. I told my wife about it last night and in the middle of the night she started saying something about James. I hope she was referring to the ETF but you get the point… It's more easily recognizable. In this business you want to go with a ticker and a sticker that people can recognize and pass on to their neighbors."

    On Gross’s warnings to investors about management fees:

    "We've noted that for a long time. This is simply a cautionary element that suggests that when interest rates come down close to zero and when the discounting of those interest rates and equity prices and other financial assets produce a perspective of 4-5% total return for the combined asset class is in our view, then it's incumbent upon a manager to keep expenses low and to alert investors as to the importance of expenses relative to lower returns in this new financial world that we speak to."

    On investor appetite for PIMCO’s new ETF:

    "We wanted to be able to give investors a choice. We recognized the tremendous importance of the retail distribution network for PIMCO and for the Total Return Fund, which is now $253 billion. Thank you very much, we don't to discourage that. But there are investors in the $10,000-$20,000 category, who find it difficult to buy PIMCO Total Return. We thought this would be a good way to do this in the actively managed ETF space. By the way, we're outperforming the market in the first month or so by a good 200 basis points."

    On PIMCO's appetite for Treasuries:

    "We have an average appetite in terms of duration space. And to the extent that five-year Treasuries, which are being issued today and seven-year Treasuries tomorrow - they reflect a relatively firm commitment on the part of PIMCO, which reflects a relatively firm commitment on the part of the Fed that they'll keep interest rates firm until late 2014. Bernanke mentioned yesterday that that wasn't a commitment in total but it's subject to a relatively slow economy and contained inflation, which is what we see now. A five-year security at slightly above 1%, to our way of thinking, as it rolls down the yield curve and becomes a four-year, produces close to a 2% return and is that a super, deeper attractive type of return? Well it's up to history. No, it's not….but it's certainly better than nothing."

    "We have reduced our Treasury commitment slightly. From the standpoint of duration, we have average duration of an average maturity across the board but we have been reducing Treasuries and investing in shorter duration corporates and rather heavily in the agency mortgage market. You can get, with a Fanny or a Freddie coupon that is a 4% coupon, you can realize 3% as opposed to the 2% or 1% - I mentioned in terms of five-year space. We're really focusing on spread and the lack of volatility going forward for the next two to three years which is really the domain of 30-year and 15-year mortgages."

    On finding investing opportunities in developing countries:

    "Where is that attractive growth? Countries like Brazil, countries in Asia, China-related of course. These countries don't come without risk. They don't come without a rather volatile situation in terms of inflation or potential currency disorder. If an equity investor is looking for growth, you want to go developing as opposed to developed. Even a bond investor, if you are looking for higher real rates such as in Brazil, you want to go to developing as opposed to developed."

    On buying hedges against fat tail possibilities:

    "What we're suggesting now is not an extremely negative possibility. That would be the fat left tail. But also the fat right tail, we've had a fat right tail in equity markets for the past 3-6 months…On the left-hand side, you know, the bi-model possibility in terms of a downturn are simply a reflection of the high degree of leverage, the high degree of debt and the policy coordination which may or may not be helpful in terms of producing this smooth, rather bell-shaped mode or median we're all used to."
    No Real-World Point to Mortgage Twist

    Note that Bill Gross' call on QE3 is not what he thinks the Fed should do, rather his take on what the Fed will do.



    click on chart for sharper image

    Mortgage-rate table from Bloomberg.

    30-year mortgages are below 4% and 15-year fixed mortgage rates are near 3%. Other than goosing financial markets that are already back to nose-bleed level (if not outright bubble territory), there is no real-world point to an "Operation Twist" for mortgages.

    Mike "Mish" Shedlock
    http://globaleconomicanalysis.blogspot.com
    Click Here To Scroll Thru My Recent Post List

    Another Weaker Than Expected Durable Goods Order Portends Weaker Than Expected GDP

    Inquiring minds are investigating Trends in Durable Goods Orders.

    Key Durable Goods Numbers

    1. February orders increased 2.2 percent but economists expected a 3 percent rise.
    2. January durable goods orders fell 3.6 percent.
    3. Orders for non-defense capital goods excluding aircraft rose 1.2 percent. Analysts' expected of a 2.0 percent gain.
    4. Non-defense capital goods' orders fell 5.2 percent in January.
    5. Excluding transportation which had an unsustainable sharp increase in civilian plane orders, durable goods orders were only up 1.6%. 
    6. Boeing received 237 aircraft orders in February, up from 150 in January, accounting for the 3.9 percent jump in transportation orders.
    7. Motor vehicles and parts orders rose 1.6%.
    8. Inventories of manufactured durable goods rose for the twenty-six consecutive month and are now at the highest level since the series was first published on a NAICS basis in 1992

    High inventories and falling demand for non-defense capital goods' orders does not portend well for future GDP growth.

    Mike "Mish" Shedlock
    http://globaleconomicanalysis.blogspot.com
    Click Here To Scroll Thru My Recent Post List

    Tuesday, March 27, 2012

    Train Wreck for Obama's Healthcare Mandate; What Obama's Lawyers Couldn't Answer; Obamacare Going Down the Tubes?

    Tuesday was a rough day for the Obama administration in oral arguments in the Supreme Court over mandated insurance.

    The Illinois Policy Institute comments on What Obama's Lawyers Couldn't Answer.
    If the government can force you to buy health insurance, what can't they force you to do or buy?

    That was the question posed by a number of Supreme Court justices throughout today's oral argument on the constitutionality of ObamaCare. And that was the question President Obama's lawyers couldn't seem to answer.

    That question didn't seem to bother the four liberal justices, who appeared ready to uphold the law. At one point, Justice Breyer suggested that the government could force you to buy things such as cellphones and burial insurance. The remaining justices, however, appeared highly skeptical of the government's argument. Justice Kennedy and Chief Justice Roberts, largely believed to be the "swing votes" in this case, pressed the administration's lawyer hard for any kind of limit to the President's theory.

    Chief Justice Roberts harshly noted that the type of insurance ObamaCare forces people to buy was completely different from the type of health care these people actually use. Justice Kennedy countered the administration's argument by saying that the government will say that every market is "unique."

    The fact that the Obama administration didn't have a good answer for these questions could spell doom for the President's signature legislation. That doesn't mean the law will ultimately be struck down. After all, the government needs to convince only one of the conservative justices. But today's hearing illustrated just how uncomfortable they are with a law that, as Justice Kennedy proclaimed, "changes the relationship of the federal government to the individual in a very fundamental way."
    Train Wreck for Obama

    The Hill reports Rough day for Obama health law: Kennedy among mandate skeptics
    The Obama administration’s health insurance mandate faced severe skepticism Tuesday from conservatives on the Supreme Court during a pivotal morning of oral arguments on the landmark legislation.

    Justice Anthony Kennedy, the court’s most consistent swing vote, repeatedly voiced doubts about the mandate’s constitutionality, suggesting he could side with the court’s four staunch conservatives to overturn President Obama’s healthcare law.

    “That changes the relationship of the federal government to the individual in a very fundamental way,” Kennedy said.

    Jeffrey Toobin, a lawyer and legal analyst who writes about legal topics for The New Yorker called Tuesday a “train wreck for the Obama administration.”

    “This law looks like it’s going to be struck down. I’m telling you, all of the predictions, including mine, that the justices would not have a problem with this law were wrong,” Toobin said Tuesday on CNN. “I think this law is in grave, grave trouble.”

    Supporters of the law had seen Chief Justice John Roberts and Justice Antonin Scalia as possible supporters of the mandate in addition to Kennedy, but the two offered aggressive questions during the two hours of arguments.The debate hinged largely on whether the mandate requires people to enter the market for health insurance or regulates the market for healthcare. Verrilli argued that everyone either uses healthcare or is at risk of unexpectedly ending up in the market for healthcare services. The mandate simply ensures that those services are paid for, he said.

    Scalia wasn’t buying it.

    “I don’t agree with you that the relevant market here is health care. You’re not regulating health care. You’re regulating insurance,” Scalia said. “It’s the insurance market that you’re addressing and you’re saying that some people who are not in it must be in it.”

    Following an exchange between Verrilli and Scalia, Justice Sonia Sotomayor spent a full two minutes outlining the three main elements of the Justice Department’s position, then she asked Verrilli, “Which of these three is your argument? Are all of them your argument?”

    Roberts pressed Verrilli to explain where Congress’s power to issue new mandates would stop. The lack of a “limiting principle” has dogged the Justice Department’s case throughout the process, prompting one lower-court judge to question whether Congress could also require citizens to buy broccoli, because a healthy diet would cut down on healthcare costs.

    The Supreme Court justices revived the broccoli analogy and ran through several more, asking whether the government could mandate the purchase of cellphones, gym memberships, cars, prescription drugs or burial insurance.

    Conservative judges in lower courts have upheld the mandate on the grounds that healthcare is unique, due to the risk of accidents and the nature of its cost-shifting. Although other goods also get more expensive when people don’t buy them, there are few parallels to the requirement to treat uninsured patients.

    The mandate is also considered essential to effectively implementing other parts of the healthcare law. Provisions requiring insurance companies to cover sick people, and prohibiting them from charging those patients higher prices, could dramatically raise the price of insurance if not counterbalanced with the mandate.

    “That seems to me a self-created problem” that could be solved by not imposing those regulations, Scalia said.
    Senator Lee Says 5-4 Ruling Against Individual Mandate

    Senator Mike Lee, Republican, Utah Expects 5-4 Ruling Against Individual Mandate
    Sen. Mike Lee (R-Utah) predicted Tuesday that the Supreme Court will rule against President Obama's signature healthcare legislation and declare the individual mandate unconstitutional.

    "Based upon the questions from the bench, I am predicting that there's likely to be a 5-4 ruling in this case. I tend to think it's a 5-4 ruling holding that the individual mandate is unconstitutional," said Lee on Fox Business Tuesday.

    Lee said that he sensed Kennedy, who is considered the traditional swing vote on the court, appeared "very skeptical" about the Justice Department's argument in defense of the mandate.

    Lee, who clerked for Supreme Court Justice ‪Samuel Alito ‬on the U.S. Court of Appeals for the Third Circuit Court, also noted that today's hearing was uncharacteristically "lively."
    Interview With Senator Lee



    Link if video does not play: Senator Lee on Healthcare

    The Illinois Policy Institute asks the correct question "If the government can force you to buy health insurance, what can't they force you to do or buy?"

    Regardless of whether or not one thinks we need national healthcare, legislation ought to pass strict constitutional muster. Obamacare doesn't, and thus deserves to be flushed down the toilet. Congress can try again.

    Mike "Mish" Shedlock
    http://globaleconomicanalysis.blogspot.com
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    Mish vs. Jo Weisenthal: Debate on Capital Account Regarding Gold

    In response to a Tweet by Capital Account host Lauren Lyster regarding my post Ben Bernanke: Inflationist Jackass, Devoid of Common Sense, and Clueless About Trade, Debt, History, and Gold, Jo Weisenthal at Business Insider proposed a debate.

    We had that debate yesterday and here is the video.



    Link if video does not play: Mish vs. Weisenthal: Bernanke's Class Lecture on Money Leads to After-School Blog Brawl

    In the course of a quick 15 minute debate broken into a series of 30 second sound bites, it is sometimes difficult to get everything said that needed to be said. One point I did not get a chance to mention again, but I did bring up in my Blog rebuttal to Weisenthal, is that central bank planning of money supply and interest rates is in and of itself ridiculous. Repeat bubbles and bailouts prove it.

    Soviet Style Planned Economies Do Not Work

    It makes as much sense for a group of guys in a room to attempt to set a price and amount of money as it did for inept Soviet-style central planners to run an economy, setting the price and amount of steel production and other goods - precisely none.

    Certainly the Greenspan Fed ignored (cheerleaded is a better word), the housing bubble every step of the way. Bernanke defended the housing bubble and failed to see its consequences.

    Stability and Flexibility

    The most amazing, and galling thing, is Bernanke has the nerve to preach about "price stability" in the wake of that collapse.

    Jo wants the flexibility for the Fed to step in and cleanup messes. I don't want the flexibility of fractional reserve lending and fiat currencies because that is what created these messes in the first place.

    Mike "Mish" Shedlock
    http://globaleconomicanalysis.blogspot.com
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    US Promotes "Market-Determined Exchange Rates" at WTO Forum; Translation: "China Float the Yuan"

    In a move that is likely to get general agreement, yet go absolutely nowhere fast, United States Promotes Market-Determined Exchange Rates at World Trade Organization Forum.
    Deputy U.S. Trade Representative Michael Punke and Treasury Deputy Assistant Secretary for International Monetary and Financial Policy Mark Sobel today began a two-day series of meetings at the World Trade Organization’s (WTO) seminar on the relationship between exchange rates and trade, where they will advocate for market-determined exchange rates as a foundation of an open global trading system.

    U.S. participation in the WTO seminar is premised on the importance of trade liberalization and recognition that persistently misaligned exchange rates and competitive devaluations undercut an open trading system.

    Ambassador Punke stated: "Real exchange rates that are aligned with fundamentals are a necessary foundation for the global trading system."
    The discussion is useless. China will float the Yuan when it is ready and not before.

    Mike "Mish" Shedlock
    http://globaleconomicanalysis.blogspot.com
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