This is a post I just wrote over at Yves Smith’s site Naked Capitalism in response to a reader request. Marshall Auerback has already written a reply as well and I will post this later today.

A reader at Naked Capitalism asked us to respond to a recent article from the Christian Science Monitor asking Does US need a second stimulus to create jobs?

Marshall Auerback has already done some heavy lifting. He says emphatically yes. Now I want to take a crack at this. My short answer is no. But before I go into this, as an aside, I wanted to mention Marshall’s new smiling, happy picture up at the great blog New Deal 2.0 where he now writes.  Earlier, when Credit Writedowns was hosted at Blogger, he used a picture best described as a mug shot in his profile, but he has changed that one too (although he smiles there a little less). He thinks we haven’t noticed this sleight of hand.  Well I have! Once upon a time, Marshall wrote with a man I called all bearish, all the time this summer. Take a look at that post; you don’t see him smiling now do you? We have Lynn Parramore, New Deal 2.0’s editor to thank for making Marshall Auerback into an optimist.

Different policy choices

But all teasing aside, I do want to take the opposite side of this trade.  You see I too was a deficit hawk. And while I may have been backing fiscal stimulus, I have felt conflicted for doing so. Here’s how I see it. 

You have four options:

1. No stimulus. Let the chips fall where they may. Yves Smith calls this the ‘Mellonite liquidationist mode.’ The thinking here is that trying to avoid the inevitable bust only makes it that much larger. And the economic policies during recessions in 1991 and 2001 seem to bear that out. The Harding Recession of 1921 is commonly seen as gold standard response.
2. Monetary stimulus only. Quantitative easing mania. My understanding is this is what Ambrose Evans-Pritchard has been advocating.   The thinking here is that the flood of money and the low rates will eventually jump start the economy. No deficit spending needed.
3. Monetary and fiscal stimulus.  Full tilt Keynesian. This is the Krugman view. The thinking here is that one needs to credibly commit to higher inflation and close the output gap to avoid a deflationary spiral. If that is insufficient, then one needs to go full bore on fiscal stimulus aka deficit spending. And if that doesn’t work, subsidize jobs. The New Deal is commonly seen as the gold standard response.
4. Fiscal stimulus only. Deficit spending. I have been talking up this view. The thinking here is that we need to both close the output gap to prevent a deflationary spiral and revive private sector savings in order to promote deleveraging.

There is no magic bullet here.  We are living through a situation unique in time with few historical precedents. And there are a lot of competing ideas being tossed about. So policy makers are groping around, desperately seeking the holy grail of depression-busting economic policy.  In that regard, I don’t envy them. They are certainly going to make a lot of mistakes. It may seem at times that I don’t realize this given the harshness of my critiques, but I do.

Deficit hawks are misguided

However, there are some policies which could work and others which are flat out wrong.  One policy which is flat out wrong is the concept that we need to reduce deficit spending in order to avoid a double dip recession. This flies in the face of basic economics which says that more spending and less taxes equals greater demand and recovery/boom. More taxes and less spending equals less demand and recession/depression.

Now, it’s not as if we didn’t see this line of argument coming. As far back as November 2008, I heard the chatter (see my post here). So you knew this we-have-to-stop-or-we’ll be-bankrupt nonsense was coming. The problem is it’s just not true.  Here are a few data points:

• Private sector debt (incl. financial firms) was 292% of GDP as of Q2 but public sector debt (incl. state and local municipalities) was 67.2%. Who’s more indebted – the private sector by a factor of 4.
• Adding unfunded liabilities to any public debt number when talking about spiking treasury rates is inaccurate and artificially inflates the number. A lot of people do this to make the public debt scenario look worse. The issue at hand is whether a supply/demand imbalance in Treasury securities spikes interest rates. Unfunded liabilities have absolutely nothing to do with this.
• Cash and bonds are fungible. They are both obligations of the federal government to be repaid in full with a specific sum of fiat money. The Treasury could literally stop issuing government debt altogether and just start crediting accounts electronically to ‘fund’ its purchases. There is no operational constraint to government spending. The U.S. government is not going broke involuntarily. See my post here.

The real issue with deficits causing a double-dip has to do with inflation and overheating. If inflation increases because the economy begins to overheat, interest rates spike and the Fed raises rates to choke off inflation. That’s not going to happen any time soon – although it may be a problem down the line.  The issue at hand now is deflation not inflation. At least Morgan Stanley understands this when they take a deficit hawk position.

And as for the Chinese, they are not going to pull the plug on Treasuries unless they want to tank their export boom. The reason they must buy Treasuries is the dollar peg; they must re-invest in U.S.-based assets in order to prevent their currency from appreciating. This has caused a huge rise in their U.S. dollar reserves. If they changed the peg, their currency would almost certainly rise and this would choke off exports.

No more stimulus, just jobs

I have said my piece about the need for stimulus in the past. So I won’t repeat it here. If you are interested, see my December 2008 posts “Confessions of an Austrian economist,” “What does Mises say about trying to stimulate the economy out of recession,” and “A brief philosophical argument about the role of government.”

But, on the whole, I look at long-term deficits in a dubious light. There are practical constraints to deficit spending – and they lead to inflation, currency depreciation and lower standards of living. This is not national bankruptcy, but it is what Murray Rothbard called default by inflation and it makes you and me less well off.

This, of course, is over the long-run. In the short run, it is the spectre of a deflationary spiral we care about. Stimulus was important to stop this. I said in February that Obama was making a big mistake with his stimulus measures.

My view here is that Obama is forging a middle path that leads to a dead-end. The stimulus is not nearly enough by half to get the job done. The proposed deficit reduction measures for 2013 are outright scary as they risk repeating a mistake from the 1930s. And the banking sector and mortgage plans, both of which I failed to mention, are dubious half-measures as well. One needs to act aggressively and proactively or not at all.

If you are going to deficit spend you need to do it in a big way. You need to stop the deflationary spiral.  That means hitting the reset button by promoting private sector savings and deleveraging and purging all built-up malinvestments. The risk in addressing the situation this way, of course, is replacing the imperfect invisible hand of markets with the imperfect hand of politicians and legislative fiat.

This is a risk I no longer see as worth taking. I have bailout and deficit fatigue just like most Americans. It is abundantly clear that this Administration has absolutely zero intention of purging any malinvestment or promoting any deleveraging. All they want to do is continue business as usual and go back to the asset-based economy that caused this mess. This is why we have seen bailout after bailout coupled with easy money. It makes for record profits on Wall Street but it does nothing for the unemployed.

Moreover, the political process in the U.S. is such that any stimulus money will be diverted to pet projects and used to pay off political constituents. While this may increase aggregate demand, it does so at the risk of serious social unrest as the outrage will certainly spill over into populism.

So I say no to a second (third) stimulus package.  What the President needs to focus on is jobs. The reason Obama’s poll numbers are shrinking is because he now owns this economy.  And people are not benefitting from this fake recovery.  They are angry at the bailouts and distrustful of government – and with good reason.

Cut payroll taxes, subsidize job creation, divert some military spending to direct job creation by ending the foreign wars. But stop the madness.

Related posts:

• Japan does not demonstrate the failure of stimulus
• Don’t underestimate the power of printing money, part 2
• Inflation: The strategy that dare not state its name
• The inflation-deflation debate
• Barack Obama: “if we keep on adding to the debt… that could actually lead to a double-dip”

I have written extensively about how I believe the bank bailouts were the worst of all possible solutions – fixes that perpetuate too big to fail, moral hazard and crony capitalism.  That ship has sailed, but the questions still linger – in large part because the fix has not trickled down to common folk to better their lot.  Rising unemployment is but one demonstration of this.

Arnold Kling writes a post that goes beyond banking to AIG, mortgages and Fannie and Freddie. He offers real world solutions that don’t require creating special resolution authority, buying toxic assets or orchestrating bailouts.  While there would certainly be costs to these solutions as well, they would be far less than what we are paying now.

The interesting bit is he proposed them in the moment when the bailouts were ongoing. Don’t let anyone tell you that there weren’t other options available because there were in spades.

1. Existing Mortgages and home owners.

Actual policy: attempts to implement loan modification programs

My policy: pay the moving expenses of homeowners who default on their mortgages. But do not interfere with the foreclosure process.

2. Mortgage Markets

Actual policy: keep Freddie Mac and Fannie Mae going, and we now have 90 percent of mortgage loans made by federal agencies.

My policy: Limit Freddie Mac and Fannie Mae to their existing book of mortgage loans (I wrote this in September of 2008) and not allow them to purchase any new mortgages. Let banks take up the slack in mortgage lending.

3. AIG

Actual policy: creditors bailed out 100 percent.

My policy: Send in a "stern sheriff" to protect the liquid assets of AIG from creditors making "collateral calls." I was thinking of a government-suggested mediator, perhaps a former bankruptcy judge. If the parties did not like it, they could go to court. But my guess is that the parties would have preferred a mediated solution.

4. Big banks

Actual policy: bailouts of nearly all of them

My policy: Triage. Shut down the ones that have clearly failed, using FDIC procedures. Those that are clearly solvent should be allowed to proceed. Those that are neither clearly failed nor clearly solvent should be given forbearance, but with tight supervision to ensure that they do not use this forbearance to expand their risk-taking. Again, this was what I advocated in September of 2008.

Why proposals of this sort were not followed is the subject of much debate.

Source

Was TARP Necessary? – Arnold Kling

Related posts:

• Fannie, Freddie to get $15 Billion from U.S. government
• Federal takeover of GSEs now in the works
• A quick note on corporate bankruptcy and bailouts
• Treasury to Consider Further Measures to Halt Housing Slide
• Dean Baker: I saw this scenario in 2002

This is a crucial question because Devon Energy, the Oklahoma-based independent oil and natural gas producer has just decided to put billion of dollars in Deep sea Gulf of Mexico assets on the market.

Canada’s National Post reported:

Devon Energy Corp. hopes to raise up to US$7.5-billion from the sale of its Gulf of Mexico and international assets as the company moves to restructure itself as a North American on-shore player.

Devon’s chief executive, Larry Nichols, said the company believes the market is not valuing its Gulf of Mexico and international assets properly. Devon hopes to realize between US$4.5-billion and US$7.5-billion from the sale of assets during 2010.

Reporting on the same issue, the New York Times has indicated that the Chinese may well be interested in these assets.

One company that might be interested in taking the risk would be China National Offshore Oil Corporation, known as Cnooc. It recently agreed to buy a stake in some of Statoil’s Gulf assets, the first time that a Chinese company would take an ownership interest in energy assets in the United States.

Only four years ago, Cnooc’s $18.5 billion bid for American oil company Unocal collapsed under pressure from Congress amid concerns about American oil assets falling under the control of the Chinese government. Since then, the Chinese have been wary of bidding on American energy assets and have concentrated their investments on undeveloped fields at home and in Africa, the Middle East and South America.

The Statoil deal seems to have changed all that. But Devon’s assets could be too much, too soon for Cnooc. It may simply continue to buy small stakes in fields across the region before it is ready to make a major purchase.

The Statoil connection for Cnooc has not made much of a splash up in the mainstream press, but it is significant given the protectionism we witnessed when the Chinese were rebuffed when they outbid Chevron for Unocal, an American company which had largely non-U.S.based energy assets.

Forbes reported on the Cnooc Gulf of Mexico acquisition two weeks ago:

CNOOC Ltd has agreed to buy a minority stake in four prospects in the Gulf of Mexico from Norway’s Statoil, opening crude oil reserves in the U.S. Gulf to China for the first time.

CNOOC will have a 10 percent to 20 percent interest in the four exploration areas, CNOOC spokesman Xiao Zongwei told Reuters.

But, the Devon assets are far more substantial. Moreover, Cnooc comes in after the fact as a minority investor in the Statoil projects. With the Devon sale, Cnooc would be a principal actor and that leaves the door ajar for economic nationalism.

Related posts:

• China wants all of Repsol’s Latin American oil assets
• Should we expect a protectionist China?
• Is China avoiding using US dollars?
• China to diversify out of U.S. dollars
• China company performance

Max Keiser certainly has a way with words. In one of his latest TV appearances, using the colorful analogy of “Warren Buffett’s toilet paper,” he calls the U.S. dollar worthless.

He goes on to say that China is addicted to this worthless paper because they are using it to stimulate their domestic economy. In another memorable analogy, he labels this an “opium” addiction which will cost the Chinese dearly.

While the Chinese (and the Indians) are increasingly turning to gold as a currency alternative, it is fairly clear that China will have to eventually take an enormous haircut on its holdings of U.S. paper assets. One reason the Chinese are refusing to revalue the renminbi is their desire to forestall this eventuality – and with good reason. Last year, the Chinese central bank needed to go cap in hand to the Finance Ministry because the central banks U.S. dollar paper assets had so depleted the central bank of capital.

Keiser has a lot more to say. Very entertaining. Below is the video. It runs just under 5 minutes.

Related posts:

• China “serious about the plan to internationalise” Yuan
• China launches retaliatory investigation into U.S auto subsidies
• Japanese defend dollar’s status while China tears it down
• Quote of the day: China hopping mad about GSEs
• China wants to get rid of the dollar

On the eve of U.S. President Barack Obama’s visit to China, a major Chinese official has criticized U.S. monetary policy in unusually harsh language. Liu Mingkang, China Banking Regulatory Commission chairman said the zero interest rate policy of the U.S. Federal Reserve posed a “new systemic risk.”

Liu, using language reminiscent of warnings by NYU economist Nouriel Roubini and speaking at a financial forum in China’s capital Beijing, said:

This situation has already encouraged a huge dollar carry trade and had a massive impact on global asset prices… It is boosting speculative investment in stock and property markets and will pose new, insurmountable risks to the global recovery and, particularly, to the recovery in emerging markets.

In my view, this is pure political posturing by the Chinese in order to defuse any U.S. criticisms of Beijing’s currency peg. Call it a pre-emptive strike. The U.S. has seen the unemployment rate rise to 10.2% and the trade deficit rise quite dramatically as well. Many are blaming the Chinese and their currency peg to the U.S. dollar.

When Barack Obama visits China this week, the Chinese expect him to focus on the yuan dollar peg. His administration will find it increasingly difficult to hold protectionist pressures at bay given the yuan’s firm peg to the U.S. dollar even while the dollar has plummeted.  To prevent the U.S. from successfully painting the Chinese peg as the sole major risk to the global economic recovery, the Chinese must therefore point to the destabilizing effects from measures taken by the U.S. to reflate its domestic economy.

The Chinese have shown success thus far. Last week, Tim Geithner penned an Op-Ed in the Wall Street Journal along with the Finance Ministers of Indonesia and Singapore which pointed a critical finger at China by asking for “market-oriented exchange rates.” Yet when the APEC (Asian Pacific Economic Cooperation) summit in Singapore ended that same language was cut from the final commiunique.

On the other hand, there has been little change in the prospects of a revaluation of the yuan peg.

Reuters reports:

Chinese Vice Commerce Minister Chen Jian on Sunday played down talk of a shift in the central bank’s currency policy as well as mounting expectations of a rise in the yuan’s exchange rate.

Speculation that China might let the yuan resume its climb after a 16-month pause swirled after a change last Wednesday in the long-standing wording used by the People’s Bank of China to describe its currency stance.

In its third quarter monetary policy report, the central bank failed to refer to keeping the yuan "basically stable at a reasonable and balanced level" when discussing the outlook for the exchange rate.

Asked whether the PBOC was heralding a return to the gradual appreciation of the yuan against the dollar seen from July 2005-July 2008, Chen told Reuters: "I don’t think the central bank meant to say that."

And all indications suggest that we are now returning to the same unbalanced pre-crisis growth model – but with the global economy in a considerably more fragile state. In this climate, the issues of the yuan currency peg and low interest rates in the U.S. will continue to be front and center for some time to come.

Related posts:

• Chinese to start settling trade in Yuan
• China issues bonds to “promote the RMB in neighbouring countries”
• US angling to get Chinese to revalue renminbi
• China slams U.S. profligacy
• Is China avoiding using US dollars?

Is it just me or did Secretary Geithner just talk out of other side of his mouth? Today he wrote an Op-Ed in the Wall Street Journal with two Asian leaders to mark a big meeting of APEC (Asian Pacific Economic Cooperation) in Singapore.

The WSJ article started out with a bunch of diplomatic niceties about how everyone was working together and must continue to do so, so that all may prosper.

We have just lived through the greatest challenge to the world economy in generations. In acting together, policy makers have shown that they understand the most important lesson of this crisis: Our economies are inexorably linked. We must now work together to ensure strong, stable and balanced growth in the future…

We also must keep our sights on maximizing the potential of global markets. Both exports and imports remain critical stimulate the flow of knowledge and innovation that is enabling emerging economies to catch up with developed-world living standards.

Then it went on to re-affirm the utility of APEC, which people like Andy Xie are calling useless.

APEC will play an indispensable role in establishing strong, sustainable and balanced growth. Our 21 members—which include nine members of the G-20—account for 40% of the world’s population, over half of global GDP and nearly half of world trade. Our ranks include the world’s largest and fastest-growing economies.

But, you kind of got the feeling, this was leading to something else. Wait…wait… hold it… there it is – halfway through paragraph six:

Depending on individual economies’ circumstances, a combination of macroeconomic policy adjustments and structural reforms will be needed. Market-oriented exchange rates in line with economic fundamentals will be essential in assuring the resource and sectoral shifts to match and foster the new patterns of demand.

Everyone knows they are talking about the Renminbi. Remember, Secretary Geithner is the same fellow who accused the Chinese of manipulating their currency during his confirmation hearings. And most people think a freer floating Renminbi would be revalued not devalued.

Yesterday, I posted “Geithner impersonates Nicholson – America, you can’t handle the truth” in which Secretary Geithner was saying he supports a strong U.S. currency, but today he is talking about “market-oriented exchange rates.”

C’mon. We’re not that stupid.

Related posts:

• US angling to get Chinese to revalue renminbi
• China “serious about the plan to internationalise” Yuan
• The dollar is rising against floating currencies
• Japanese defend dollar’s status while China tears it down
• Geithner and Summers consolidate power

L. Randall Wray has a post up at New Deal 2.0 which puts forward an idea which is pretty innovative. I would label it a private sector replacement for unemployment insurance. It’s the kind of thinking that might bring Obama out of a policy cul-de-sac as the economy hemorrhages jobs.

Let me present an excerpted version and mention a few concerns one might have with this idea. The link to the full post is at the bottom:

The latest jobs report shows that the official unemployment took a huge jump to 10.2% –15.7 million jobless workers. If we add to those numbers involuntary part-time workers, plus those who have given up looking for work, the unemployment rate is 17.5%. Even that seriously undercounts those who would be willing to work if decent jobs at decent pay were readily available–a number I put at 25 to 30 million…

I am advocating… a universal job guarantee available through the thick and thin of the business cycle. The federal government would ensure a job offer to anyone ready and willing to work, at the established program compensation level (including wages and a healthy benefits package). To keep it simple, the program wage could be set at the current federal minimum wage ($7.25 an hour), and then adjusted periodically as that is raised. The usual benefits would be provided, including vacation and sick leave, and contributions to Social Security.

Let’s call this the Job Guarantee (JG) program.

… A permanent and universal JG program should be decentralized, with projects created and administered locally–where the workers are, and for the benefit of their communities. The federal government would provide the wages, plus a portion of capital and supervisory expenses (perhaps capped at 25% of total wages paid for each JG project). Local governments and nonprofits would propose projects and cover the rest of the expenses. State unemployment offices would be converted to employment offices, helping to match workers and projects.

Project proposals would be submitted to regional councils and, if approved, would be evaluated by state councils and then by a federal council. Wages and benefits would be paid directly to workers (using Social Security numbers and direct bank deposits) to minimize fraud. Organizations submitting proposals would be prevented from replacing paid workers with JG workers. For-profit business would be excluded, because the temptation to substitute would be too great. At the same time, businesses would be protected from unfair competition because all JG projects would have to demonstrate they’d fulfill unmet public purposes. If at some future date, a for-profit firm decided to provide services that a JG project is performing, the JG project could be phased out. There is neither need nor desire for the JG program to compete with the private for-profit sector.

…JG workers will be gaining useful work experience and training, making them more appealing to other employers. When firms hire, they will recruit from the JG program, offering a slightly higher wage.

At the same time, the program’s fluctuation allows it to act as an employed “buffer stock”-or “reserve army of the employed”-helping to attenuate the business cycle while maintaining full employment without setting off a wage-price spiral. An economic boom will shrink the size of the JG program; in a recession the program will grow.

Thus, an effort like the Job Guarantee program I am proposing would act as an automatic stabilizer — a feature most would agree is desperately needed in our current rollercoaster economy.

This is definitely outside the box thinking. It is basically a decentralized counter-cyclical works program to largely replace the unemployment insurance program we presently have.

The benefits I see are that it maintains full employment by putting to work those that would be idle and collecting unemployment insurance.  We have an enormous number of unemployed people who are drawing significant social welfare payments (five million are drawing unemployment insurance according to my latest post). Why not use a lot of that same money and deploy them.

This approach also would employ a huge slew of longtime unemployed workers that have benefits expire and skills languish, making them harder to employ and increasing structural unemployment.  The job guarantee could then reduce the level of structural unemployment that results from a steep downturn (see Mark Thoma’s recent piece on structural unemployment for a cogent explanation of that issue).

In my view, full employment is compatible with free market capitalism. In this approach, a job guarantee is there for anyone who wants it. Any structural unemployment will be largely voluntary.

Here are my questions. I am going to present what I consider the standard questions using the standard terminology – not because these are the exact questions I have but because these are the questions I would anticipate. I have run these same questions by a few economists to generate some answers. I have incorporated most of their answers. But, I still would like to hear your thoughts as well.

1. Isn’t this just an attempt to expand the state i.e. be a move toward big government? Why shouldn’t we expect ‘mission creep?’ Since the idea is designed to fluctuate with changes in the economy, it seems less of a concern. Yes, this is the not-for-profit private sector. But, we would still need to flesh out the safeguards to make sure that it didn’t crowd out investment in the for-profit sector. (You should expect this program to increase the pie and expand investment in aggregate, so that certainly mitigates these concerns as well.)
2. Won’t this misallocate resources and create malinvestment?  Since it is designed to be an automatic stabilizer i.e. countercyclical, it doesn’t necessarily appear so. But, it still might create misallocations by increasing the propensity to spend excessively on infrastructure. Infrastructure spending in the U.S. is probably too low at present.  But, at some point in the future, this will be a concern. The fact that much of it can be administered in the private sector locally is important in this regard.
3. How much will this cost? How do we pay for this? As I understand the idea, it is designed to replace unemployment insurance entirely – and that means we will recoup in taxes lost output from cyclical and structural unemployment. But, as the Federal Government is paying not just wages but benefits, it does not seem to be a deficit neutral strategy in a employer-provided health-insurance world. If health insurance became detached from employers that would be less of an issue. But, that’s not going to happen. (I should also point out criminality and imprisonment associated with lack of job opportunities would be reduced, so that certainly decreases any costs – both social and monetary).

Personally, I am not especially keen on the ‘New Deal’ terminology in the original piece.  That goes to political/philosophical predisposition. So I have stripped it of that language here.

As an aside, of 1920s and 1930s Democrats, I find Al Smith, the Governor of NY and 1928 Democratic Presidential candidate, far more interesting than FDR. Smith and Roosevelt had a very antagonistic relationship in no small part due to FDR’s co-opting of all of Smith’s 1928 ideas for FDR’s 1932 run. Al Smith was a first-generation Irish Catholic who grew up poor on the lower East Side of Manhattan and owed his rise to Tammany Hall. Prejudice is a big reason he lost to Hoover in 1928. Roosevelt was a blue-blooded Harvard-educated Aristocrat who was much more palatable to early 20th-century Americans. Try “Al Smith and His America,” or better yet “Empire Statesman,” for a good read on Smith.

I suspect Wray’s idea will gain more traction if it can be examined it in a politically-neutral frame.

Economists I have talked to who have studied this idea inform me all studies indicate the proposal has a 1-2% of GDP price tag.

Right now, President Obama seems like he is banking on a recovery that will bring unemployment down. But, this may not end up being so. From a purely political perspective, Wray’s suggestion is the direction Obama should go if he wants any traction on the unemployment issue should recovery not bring unemployment down.  But, Wray’s idea also deserves more discussion irrespective of the political ramifications because it keeps a buffer stock of skilled, employed people ready to hand for the for-profit private sector to employ.

Source

Navigating the Jobs Crisis: Time for a New ‘New Deal’ Jobs Program – L. Randall Wray

Related posts:

• Jobless claims dip in most recent week
• ADP Report: 697,000 jobs gone in February
• US unemployment hits 5-year high of 6.1%
• Irish unemployment gaps up by most in 40 years
• Spain: “we need to go back to 2000 wages and prices and start again”

You could see this one coming given the humiliating circumstances under which the German Chancellor learned that GM was pulling out of the Magna deal.

The BBC is now reporting that Germany will give General Motors no aid to restructure it’s business. That’s 4.5 Billion Euros they now need to come up with.

Economy Minister Rainer Bruederle told GM executives that they had to be responsible for restructuring the unit.

Germany had previously offered 4.5bn euros ($6.7bn; £4.1bn) to support Opel and protect German jobs if the company was sold to car parts maker Magna.

On cancelling the sale last week, GM said it would still seek state aid.

The German minister’s comments now raise question marks over whether GM will get it.

"I expressed my expectation that General Motors should basically carry out the financing itself," Mr Bruederle said.

Will Obama now come up with the funds?  If this minister gets his way, there don’t seem to be a whole lot of solutions here.

Related posts:

• Germans reject Chinese offer for Opel
• GM looks to use US and Canadian tax money to bailout Opel
• GM considers keeping Opel, raising capital
• German Press: Fiat to sign a deal with Opel, not Chrysler
• Economic nationalism and GM’s decision to keep Opel and Vauxhall

Tim Geithner has issued a Code Red on the U.S. dollar, but he doesn’t think Americans can handle it.

I believe deeply that it’s very important to the United States, to the economic health of the United States, that we maintain a strong dollar.

Secretary, I have just one more question. If you gave an order that the dollar wasn’t to be touched and your orders are always followed, then why would the dollar be in danger?

I want the truth!

You can’t handle the truth!

I have a greater responsibility than you can possibly fathom. You weep for the dollar, you curse the U.S. Government. You have that luxury. You have the luxury of not knowing what I know – that the dollar’s death, while tragic, probably saved lives. And, my existence, while grotesque and incomprehensible to you, saves lives.

I have neither the time nor the inclination to explain myself to a man who rises and sleeps under the blanket of the very freedom that I provide and then questions the manner in which I provide it.

Did you order the Code Red?

You’re goddamn right I did.

Source

Geithner Says Strong Dollar ‘Very Important’ to U.S. – Bloomberg

Happy Veterans’ Day (especially to my dad, uncles and aunt and all of those no longer with us)

Related posts:

• Geithner and Summers consolidate power
• The U.S. is exporting unemployment with ‘Buy America’
• Rosenberg: The U.S. dollar could be next
• The dollar is rising against floating currencies
• Best Buy and Wal-mart sued over typical Chinese knockoffs

You have probably heard the term money illusion.  I want to coin a related new term called unemployment rate illusion because I think it is significant in light of some of the things David Rosenberg said earlier today about the unemployment rate in the U.S.

Wikipedia’s definition of money illusion is good:

In economics, money illusion refers to the tendency of people to think of currency in nominal, rather than real, terms. In other words, the numerical/face value (nominal value) of money is mistaken for its purchasing power (real value). This is a fallacy as modern fiat currencies have no inherent value and their real value is derived from their ability to be exchanged for goods and used for payment of taxes.

The key here is that behavior changes in accordance with the nominal numbers used as economic signposts in an economy. This is one reason why governments are often accused of manipulating their economic statistics in order to present a more regime-friendly face (see here and here).

The parallel of money illusion to unemployment rate illusion is that a higher posted rate of unemployment can have a serious negative impact on consumer confidence and personal consumption (think balance sheet recession). All else being equal, higher unemployment rates mean lower confidence and consumption. So, a lower unemployment rate is a better unemployment rate as far as incumbent politicians are concerned.

Now, you don’t have to be a conspiracy theorist and think that the government is deliberately suppressing the unemployment rate to understand what I am about to say. You just have to understand economic cycles in the context of the note from David Rosenberg today.

What I am talking about is the second paragraph of a quote I highlighted (bolding added):

But in a nutshell, to be calling for a 12.0-13.0% unemployment rate is meaningless except that it is very likely going to be a headline grabber. The most inclusive definition of them all, the U6 measure of the unemployment rate, which includes all forms of unemployed and underemployed, is already at 17.5%. The posted U3 jobless rate that everyone focuses on is at 10.2% (though if it weren’t for the drop in the labour force participation rate, to 65.1% from 66.0% a year ago, the unemployment rate would be testing the post-WWII high of 10.8% right now). The gap between the U6 and the official U3 rate is at a record 7.3 percentage points. Normally this spread is between 3-4 percentage points and ultimately we will see a reversion to the mean, to some unhappy middle where the U6 may be closer to 15.0-16.0% and the posted jobless rate closer to 12%. This will undoubtedly be a major political issue, especially in the context of a mid-term elections and the GOP starting to gain some electoral ground.

Let me put this quote in unemployment rate illusion terms:

• People pay attention to the posted U-3 rate of unemployment. Right now it is 10.2%, which is high.
• However, it could be much higher – 10.8% – because a lot of people aren’t getting counted. They are dropping out of the labor force and artificially suppressing the labor force participation rate. This will change when recovery takes hold as a better economy brings back those discouraged workers.
• It’s even worse than that because, U-6, the most comprehensive rate of unemployment is sky-high at 17.5% and much higher relative to the posted rate than is normal. Even if U-6 declines to 15-16.%, using a normal gap to the posted rate gets you a posted rate of 12-13%. Nothing has changed, discouraged workers have re-entered the labor force. It is unemployment rate illusion.
• If people see 12-13% in 2010, they will be floored, angry, and looking for someone to blame. As Democrats control Washington, they will get the lion’s share of the blame and lose big time in 2010.
• Making matters worse, this is the kind of shock that causes people to put their checkbooks away and go home for the night a.k.a sending us into a double dip recession.

This is a case where unemployment rate illusion is definitely not a good thing.

What to do? 

Well, if you’re the President, you have to under-promise and over-deliver. President Obama has been doing exactly the opposite. Of course people are going to be angry when you promise 8.0% unemployment and instead we get 10.2%. Right now, Obama should be talking about 13% unemployment.

Moreover, Obama needs to throw his weight around. He should be telling people publicly, “my policy team is telling me that if we don’t get what we want through Congress, this fragile and unsatisfactory recovery will crumble and we will see 13% unemployment or much worse. And it will be the Republicans fault that this happened.”

Then he should turn to the Republicans and say, “give me everything I want or the economy will crumble and I will make sure you get the blame.”  Remember, that’s what Hank Paulson did and it worked brilliantly (a 777-point implosion in the Dow helped). What is the Republicans’ BATNA (best alternative to a negotiated agreement)? Nothing.

If you’re a Republican you should continue on the same course. Obama shot himself in the foot in January and February by not taking the Hank Paulson approach. Now, you get to label him a ‘socialist’ or anything you want. And you get to tell people that stimulus is budget-busting pork designed for the Democrats’ union buddies that doesn’t work and bankrupts America. It’s been working so far. Given the fact employment is likely to rise to a post-Great Depression high, why wouldn’t you continue on the same path? Don’t fix what’s not broken.

…coming soon to a TV screen near you.

Related posts:

• Rosenberg: U.S. unemployment rate headed for 12.0-13.0%
• Comprehensive unemployment rate is 17.5%
• Unemployment: U-6 data versus the Great Depression
• Consumer confidence sinking
• A note on government statistics and unemployment

David Rosenberg thinks the unemployment rate is headed much higher than anyone anticipates.  If you recall, back in January when the stimulus package was crafted, the Obama Administration felt that passing the bill would mean an unemployment rate which would top out at 8.0%. As the situation deteriorated, the President recognized that 10.0% was more likely – a number we just got last week. But Rosenberg is the only one (except Meredith Whitney) who is talking about 12-13%.

As an aside, it was interesting to hear Whitney at about 3:15 into the third video in the link above from July. Right before she gives us the dreaded 13% number, she admits to lowballing her house price decline estimates in order not to be dismissed as wildly out of step with consensus. That pressure is something I discussed here.

Here’s what Rosenberg says:

There are serious structural issues undermining the U.S. labour market as companies continue to adjust their order books, production schedules and staffing requirements to a semi-permanently impaired credit backdrop. The bottom line is that the level of credit per unit of GDP is going to be much, much lower in the future than has been the case in the last two decades. While we may be getting close to a bottom in terms of employment, the jobless rate is very likely going to be climbing much further in the future due to the secular dynamics within the labour market.

But in a nutshell, to be calling for a 12.0-13.0% unemployment rate is meaningless except that it is very likely going to be a headline grabber. The most inclusive definition of them all, the U6 measure of the unemployment rate, which includes all forms of unemployed and underemployed, is already at 17.5%. The posted U3 jobless rate that everyone focuses on is at 10.2% (though if it weren’t for the drop in the labour force participation rate, to 65.1% from 66.0% a year ago, the unemployment rate would be testing the post-WWII high of 10.8% right now). The gap between the U6 and the official U3 rate is at a record 7.3 percentage points. Normally this spread is between 3-4 percentage points and ultimately we will see a reversion to the mean, to some unhappy middle where the U6 may be closer to 15.0-16.0% and the posted jobless rate closer to 12%. This will undoubtedly be a major political issue, especially in the context of a mid-term elections and the GOP starting to gain some electoral ground.

As I indicated when the employment numbers came out last week, we should expect the labor force participation rate to increase during recovery as discouraged workers come back into the labor force. The fact that the opposite is still happening means the unemployment rate will move higher (although 13% is sure to induce a double dip and I am not seeing this as a base case at this time).

Rosenberg’s political calculus also seems accurate.  In my post, “the politics of economics” I said that President Obama needs to take more blunt measures to deal with the unemployment situation head on.  Indirect measures are not going to be effective enough to prevent Democratic losses in 2010. Moreover, a recent poll released by Gallup today says that Republicans have now edged ahead of Democrats for 2010. If we see 12 or 13% unemployment, it will be much, much worse than that for the Democrats – and if Obama thinks getting his agenda through now is difficult, wait until 2011 when he may have to contend with more Republicans in Congress.

More of Rosenberg at the link below.

Source

Breakfast with Dave, 11 Nov 2009 (pdf) – David Rosenberg, Gluskin Sheff (free requires registration)

Related posts:

• Unemployment rate illusion
• Rosenberg: “the mother of all jobless recoveries”
• Unemployment Report: biggest rise in rate in two decades
• Comprehensive unemployment rate is 17.5%
• Spain: Bleak forecast puts unemployment at 22% in 2010

Andy Xie thinks the Fed is on an inflationary path.  Last month, he wrote an article in Caijing which says that ‘stagflation lite’ is the Federal Reserve’s preferred outcome. What’s interesting is his recent article about the need for China and Japan to join forces under an ASEAN umbrella, rejecting the APEC umbrella shared with the U.S.

In last month’s article, Xie said:

The bottom line is that, regardless what central banks say and do, the world will be awash in a lot more money after the crisis than before — money that will lead to inflation. Even though all central banks talk about being tough on inflation now, they are unlikely to act tough. After a debt bubble bursts, there are two effective options for deleveraging: bankruptcy or inflation. Government actions over the past year show they cannot accept the first option. The second is likely.

Hyperinflation was used in Germany in the 1920s and Russia in late 1990s to wipe slates clean. The technique was essentially mass default by debtors. But robbing savers en masse has serious political consequences. Existing governments, at least, will fall. Most governments would rather find another way out. Mild stagflation is probably the best one can hope for after a debt bubble. A benefit is that stagflation can spread the pain over many years. A downside is that the pain lingers.

If a central bank can keep real interest rates at zero, and real growth rates at 2.5 percent, leverage could be decreased 22 percent in a decade. If real interest rates can be kept at minus 1 percent, leverage could drop 30 percent in a decade. The cost is probably a 5 percent inflation rate. It works, but slowly.

If stagflation is the goal, why might central banks such as the Fed talk tough about inflation now? The purpose is to persuade bondholders to accept low bond yields. The Fed is effectively influencing mortgage interest rates by buying Fannie Mae bonds. This is the most important aspect of the Fed’s stimulus policy. It effectively limits Treasury yields, too. The Fed would be in no position to buy if all Treasury holders decide to sell, and high Treasury yields would push down the property market once again.

I certainly agree with him. You don’t have to be in the hyperinflation camp like Marc Faber to think the Fed takes Ken Rogoff’s suggestions about 6% inflation seriously. In a May post, I said:

Basically, the Fed wants to inflate our way out of this depression – that’s the dirty little secret.  There is really no other policy choice because the mountain of debt in the United States is immense.  And I think Bernanke, Geithner and Summers have proven they are willing to do anything to reflate this economy and avoid debt deflation dynamics.

And when I say anything, I mean create asset bubbles that are being given intellectual cover by the likes of Frederic Mishkin. This is a policy of economic weakness.

So what should the Asians do?  China is desperate to employ its tens of millions of countryside transplants cruising its cities in search of urban employment. That’s a major reason it keeps its exchange rate fixed to a plummeting dollar, making not just Americans but Europeans irate?  Japan has been in a modern day depression for twenty years. Its sovereign debt-to GDP is now over 200%, risking a downgrade.

Xie says the two should join forces – in part as a rejection of the U.S., which he basically calls a fading power (although the paragraph above points to serious weaknesses in China and Japan as well).

Here is an excerpt of Xie’s article:

Yet the fundamental case for Japan to increase integration with the rest of Asia and away from the United States grows stronger every day. Despite high per capita income, Japan remains an export-oriented economy, having missed an opportunity to develop a consumption-led economy in the 1980s and ’90s. In the foolish belief that rising property prices would spread wealth beyond the industrial heartland in the Tokyo-Osaka corridor, the government of former Prime Minister Kakuei Tanaka pursued a high-price land policy, discouraging the middle class from pursuing a consumer lifestyle as they saved for property purchases…

The point is that Japan has a strong and genuine case that favors more integration with East Asia. The United States is unlikely to recover soon and with enough strength to feed Japan’s export machine again. There is no more room for fiscal stimulus. Devaluing the yen to gain market share is not an option as long as Washington pursues a weak dollar policy. Without a new source of trade, Japan’s economy is doomed. Closer integration with East Asia is the only way out…

Five years ago, I wrote an op-ed piece for the Financial Times entitled China and Japan: Natural Partners. At the time, a prevailing sentiment was that China and Japan were antithetical: Both were still manufacturing export-led economies and could only gain at the other’s expense. I saw complementary demographics and capital: Japan had a declining labor force and China needed to employ tens of millions of youths migrating to cities from the countryside. China needed capital and Japan had surplus capital. And their trade relations indeed tightened, as Japan had increased the Chinese share of its overall trade to 17.4 percent in 2008 from 10.4 percent in ‘04.

Today, the situation has changed. China has a capital surplus rather than a shortage. Demographic complementarity is still good and could last another decade. As China shifts its development model from resource intensive to environmentally friendly, a new complementarity is emerging. Japan has already made the transition, and its technologies that supported the transition need a new market such as China’s. So even without a new trade agreement, bilateral trade will continue growing.

An FTA between China and Japan would significantly accelerate their trade, resulting in an efficiency gain of more than US$ 1 trillion. Japan’s aging population lends urgency to increasing the investment returns. On the other hand, as China prepares to make a numerical commitment to limiting greenhouse gas emissions at the upcoming Copenhagen summit on global warming, heavy investment and rapid restructuring are needed for its economy. Japanese technology could come in quite handy.

An FTA involving Japan and China would be a serious threat to American economic power. You can imagine that policy makers in Washington are opposed to this idea.  Let’s watch to see what kind of rhetoric comes out of Barack Obama’s China trip to see if this issue is discussed.

Xie’s article in its entirety is at the link below.

Source

Andy Xie: Why China and Japan Need an East Asia Bloc – Caijing

Related posts:

• Stephen Roach: Downturn in Asia less severe, but recovery later
• China: reflation play spells trouble for rest of the world
• Chart of the day: Aussie – Yen cross
• The Dollar
• China warns that the west’s quantitative easing is inflationary

In the wake of a few significant elections in the American states of New York, New Jersey and Virginia, a lot of pundits are putting their spin on what these elections mean for Barack Obama and his political agenda. On the whole, I find most of the conclusions partisan leaps of faith.

So, I wanted to take this issue on and outline my thoughts on American politics and the feedback loop with the economy. I will then try to take on what the election last November and just this past week mean in regards to Obama’s political agenda and the missteps I believe he made early in his tenure as President.

Confabulation and the human need to explain

First, let me start off with a basic concept of behavioral psychology: confabulation.  Back in April, I quoted from an article in New Scientist about how people will develop false narratives to explain away decisions already made. This is called confabulation. The article says:

As anyone who has ever been in a verbal disagreement can attest, people tend to give elaborate justifications for their decisions, which we have every reason to believe are nothing more than rationalisations after the event. To prove such people wrong, though, or even provide enough evidence to change their mind, is an entirely different matter: who are you to say what my reasons are?

But with choice blindness we drive a large wedge between intentions and actions in the mind. As our participants give us verbal explanations about choices they never made, we can show them beyond doubt – and prove it – that what they say cannot be true. So our experiments offer a unique window into confabulation (the story-telling we do to justify things after the fact) that is otherwise very difficult to come by. We can compare everyday explanations with those under lab conditions, looking for such things as the amount of detail in descriptions, how coherent the narrative is, the emotional tone, or even the timing or flow of the speech. Then we can create a theoretical framework to analyse any kind of exchange.

What experimenters here have shown is that there is a real human need to explain. Things happen for a reason, don’t they?  Why did the stock market rally? Why did Harry do that? Why didn’t we do something to stop this? Why did I vote for that guy back then, when I now don’t like him as much?

To the degree there is an explanation void, it will be filled. The question is: filled with what?

Confirmation bias and the psychology of politics

In politics, how the void gets filled has much to do with philosophical/political predisposition and one’s world view.

Drew Westen, a professor of psychology at Emory University, published an interesting book a few years back called “The Political Brain.” Recently, Westen has had some important things to say about the psychology of the health care debate (see Washington Post article here). But, in the book, the most memorable political psychological experiment Westen described is very much related to confabulation. I quoted from Wikipedia’s synopsis of this experiment to explain confirmation bias in the econoblogosphere back in May:

In January 2006 a group of scientists led by Westen announced at the annual Society for Personality and Social Psychology conference in Palm Springs, California the results of a study in which functional magnetic resonance imaging (fMRI) showed that self-described Democrats and Republicans responded to negative remarks about their political candidate of choice in systematically biased ways.

Specifically, when Republican test subjects were shown self-contradictory quotes by George W. Bush and when Democratic test subjects were shown self-contradictory quotes by John Kerry, both groups tended to explain away the apparent contradictions in a manner biased to favor their candidate of choice. Similarly, areas of the brain responsible for reasoning(presumably the prefrontal cortex) did not respond during these conclusions while areas of the brain controlling emotions (presumably the amygdala and/or cingulate gyrus) showed increased activity as compared to the subject’s responses to politically neutral statements associated with politically neutral people (such as Tom Hanks).[2]

Subjects were then presented with information that exonerated their candidate of choice. When this occurred, areas of the brain involved in reward processing (presumably theorbitofrontal cortex and/or striatum / nucleus accumbens) showed increased activity.

Dr. Westen said,

None of the circuits involved in conscious reasoning were particularly engaged… Essentially, it appears as if partisans twirl the cognitive kaleidoscope until they get the conclusions they want… Everyone… may reason to emotionally biased judgments when they have a vested interest in how to interpret ‘the facts.’[3]

The study was published in the Journal of Cognitive Neuroscience 18:11, pp. 1947–58, a peer-reviewed scientific journal.[1]

Even before being peer-reviewed and published, Michael Shermer used the presentation by Dr. Westen as the basis for his July 2006 Skeptic column[4] in the magazine Scientific American.

In essence, political partisans with a well-developed political world view were confronted with data that did not fit their particular view.  This created cognitive dissonance and mental stress (remember, the brain areas for reason were not activated here, emotions were at play).  Their brains, rather than trying to resolve the conflict objectively, looked for ways to incorporate the new information into the previous pre-conceived view. When the subjects successfully accomplished this back flip, they were massively rewarded by the areas of the brain for pleasure.

In sum, our brains are NOT hard-wired for non-confirmatory evidence. We are not rewarded for seeking non-confirming data. Therefore, we generally seek confirmatory evidence after we have made any decision.

When you read the narratives of the recent election results, you should realize that confirmation bias is very much at play in tweaking the conclusion to fit a preconceived world view.  A perfect example is a recent piece by Charles Krauthamer in the Washington Post.

Speaking of a huge Democratic loss in Virginia, Krauthamer says:

In the aftermath of last year’s Obama sweep, we heard endlessly about its fundamental, revolutionary, transformational nature. How it was ushering in an FDR-like realignment for the 21st century in which new demographics — most prominently, rising minorities and the young — would bury the GOP far into the future. One book proclaimed "The Death of Conservatism," while the more modest merely predicted the terminal decline of the Republican Party into a regional party of the Deep South or a rump party of marginalized angry white men.

This was all ridiculous from the beginning. The ‘08 election was a historical anomaly. A uniquely charismatic candidate was running at a time of deep war weariness, with an intensely unpopular Republican president, against a politically incompetent opponent, amid the greatest financial collapse since the Great Depression. And still he won by only seven points.

Exactly a year later comes the empirical validation of that skepticism. Virginia — presumed harbinger of the new realignment, having gone Democratic in ‘08 for the first time in 44 years — went red again. With a vengeance. Barack Obama had carried it by six points. The Republican gubernatorial candidate won by 17 — a 23-point swing. New Jersey went from plus-15 Democratic in 2008 to minus-four in 2009. A 19-point swing.

Obama also benefitted in 2008 from unique circumstances with the recession and economic crisis favoring a change candidate. That uniqueness can be seen in the huge drop in young and black voters last week as well as the switch in independent voter allegiance from Democrat to Republican. I guarantee you we would have seen similar results in favor of George W. Bush had the recession of 2001 and 9/11 occurred one year earlier. None of these factors favored Democrats in 2009.

Krauthamer goes on to make some partisan claims about left-leaning agendas, hubris and taxation that I found unconvincing (Clive Cook also does this). I wished he had stopped here because he makes a valid point: the 2008 election was not some magical moment in American history in which we saw a sea change in political alignment at one moment in time. That’s confabulation, pure and simple.

What happened is Americans voted for those people who they felt would change course because they felt the country was headed in the wrong direction. That’s certainly what exit polling told us in November 2008.  Making up some other explanation is not necessary.

I know change when I see it and this is not it

So, what Charles Krauthamer and Clive Cook are doing along with Frank Rich and Paul Krugman is filling the explanation void. I agree with the analysis, but some of the conclusions are more dubious. I have done my share of filling that void (I see Frank Rich’s narrative as the one closest to mine).

But, for a moment, let’s leave the explanations aside. The great thing is humans are capable of complex decision-making and thought without having to explain those decisions. We know how to distinguish a frog from a prince and a pig from a princess – no explanation required.

And so it is here again. If you asked 1000 people in those exit polls from November 2008 – or even last week, “what would make you know America was headed in the right direction,” you probably would have gotten 700 different answers.

But, one thing is clear: Since January 20th, a lot of people are saying to themselves, “I know change when I see it and this is not it.” That’s what all polls are saying. So, whatever Obama and the Democratically-controlled Congress are doing, it’s not working.

Enter the Demagogue

That’s where demagoguery comes into play. Demagogues love an explanation vacuum.  Since time immemorial, where there has been public disenchantment with the status quo, there has always been some demagogue waiting in the wings with a ready-set explanation of what’s wrong and how they were going to fix it. These are people who are considered fringe elements in good times, but when economic hardship comes their ready-made explanations and confabulation become a toxic mix which propels them to prominence. (For the record, I am not connecting the gentlemen mentioned above with demagoguery. I am making a separate point here).

I would argue, that’s where we are right now. The global economy has just experienced an incredible shock. In the United States, more than one in six is unemployed or underemployed. Personal bankruptcies and foreclosures are still happening in record numbers. The economic situation is, in a word, grim.

Therefore, people are going to more open to a wider range of ideas and this is a prime opportunity for demagogues to advantage themselves and their allies. It also should make any incumbent politician very afraid of losing their job.

With this in mind, I look back to the early days of Barack Obama’s tenure and I can’t help but conclude that his economic strategy was too timid, too much aligned with the status quo. It’s not as if this should be a shocker; I pointed this out in January and again in February. His economic team erred in believing, as the Bush Administration had done, that the economic and financial situation was better than it was.  Remember, Obama’s stimulus plan was based on a forecast of 8.0% unemployment.

Future policy decisions

But that ship has sailed and here we are a year after Obama’s election in a technical but unsatisfactory statistical recovery. What should Obama do going forward?

Well, first of all, what he needs to do is give voters a sense that the recovery is for real. And that means unemployment, foreclosures, and stagnant personal income must be attacked. On some level, the health care debate is a net negative in that it consumes a lot of political capital without any obvious and immediate economic benefit. The bailouts and financial reform agenda also have been net negatives as well for similar reasons but also because they have not been seen as fundamental change and they further disenchantment.

Moreover, we know that the explanation vacuum is being filled by voices decrying big government and socialism. If you listen to people like Charles Krauthamer, you are likely to see Obama as a dangerous shift in America to the left. He makes a compelling argument which will sway those who are constitutionally predisposed to hating big government or deficit spending. So this means Obama is now constrained. In my view, fiscal stimulus is a political non-starter.

So, I see jobs as the first area for Obama to attack. The question is whether he does this directly via some modified private-sector controlled W.P.A.-type program or indirectly via something like a payroll tax cut. After jobs comes foreclosure. Personal income and taxes are the least important area going forward (especially as any tax cuts will either increase deficit spending or have to be made up by tax increases elsewhere).

If the economy turns up vigorously and permanently, we can put some of these thoughts to rest. You have to believe many fewer people would be yelling socialism or corporate communism if we were in a robust upturn. However, I don’t think that is a likely economic scenario. Even so, the unique circumstances of 2008 are unlikely to be repeated. That spells trouble for the Democrats in 2010 and 2012 unless they start doing something dramatically different.

Other sources

People Sometimes Seek The Truth, But Most Prefer Like-minded Views – Science Daily

Humans prefer cockiness to expertise – NewScientist (think demagogue here)

Related posts:

• Through a glass darkly: the economy and confirmation bias in the econoblogosphere
• Loss aversion and finding a bottom
• What motivates Hillary? Part 2
• Peer pressure and bubbles
• US Senate passes Economic Patriot Act 74-25

For those of us interested in seeing more robust and knowledgeable regulators in government service, the recent news that Rick Bookstaber is joining the SEC is quite welcome. While I disagree vigorously with much of recent economic policy, I view the Bookstaber news as a signal that the Obama Administration is serious about overhauling America’s regulatory infrastructure.

Bookstaber is a market veteran who has a long and storied history of achievement. He worked at Bridgewater Associates, ran the Quantitative Equity Fund at FrontPoint Partners and was in charge of risk management at Moore Capital Management amongst other things.

Here is how Rick put it at his website:

I will be working in the SEC’s new division of Risk, Strategy and Financial Innovation as Senior Policy Adviser to the Director. Here is a brief article and the SEC announcement. We are facing a critical time for defining the future of the financial system; an opportunity for financial reform that comes only once in a generation (if that), and I am excited to be part of this.

I will still be able to write posts from time to time, but obviously with limits on topics and with appropriate disclaimers. How much free time I have to do so, though, remains to be seen.

I won’t be able to publish comments for this post related to the SEC.

Congratulations to Rick. Let’s wish him success is in this important role.

Related posts:

• Guest post: Regulation in Defense of Capitalism
• Guest post: Why do bankers make so much money?
• Bhagwati: The U.S. is underestimating inflation risk
• Ken Lewis is out as Chairman of Bank of America
• Tonight’s US Presidential debate

The Canadian daily National Post has a good piece out today that highlights how the ‘Buy American’ provision is being seen in Canada.  Many see it as an affront that America could and would favor domestic firms over those of its largest trading partner and next-door neighbor despite the North American Free Trade Agreement.

For the second time in six months, pipe fittings in California are being ripped from the ground because they were stamped "Made in Canada," a move manufacturing companies say hurts both sides of the border.

Cambridge Brass Inc., a Canadian brass fittings manufacturer, discovered Thursday that it stands to lose more than $1.5- million in this most recent fallout from the Buy American protectionist measure.

Greg Bell, vice-president of sales and marketing for the Cambridge, Ont., company, received a call Thursday from the City of Sacramento, where the parts were being fitted into the public water system. He was told his product was no longer acceptable because it was not made in the United States.

"It’s disheartening. (The city) wants American-made products and there’s nothing I can do about it," Mr. Bell said. "Business is tough enough these days without having to deal with these roadblocks."

Anything already in the ground will have to be ripped back up at Cambridge Brass’s expense, Mr. Bell said. Between the costs of losing the project, pulling up the pipes and legal fees, he estimates his company stands to lose money in the seven-figure range.

Cambridge Brass has been based in southern Ontario for more than a century and has survived two world wars and the Great Depression, but Buy American may be what finally causes the company to bid farewell to the province.

Mr. Bell said losing a major project like this would mean more layoffs for the already suffering company.

It has already lost a supply distributor in Maine, and it has had to lay off half of its own employees in Cambridge – from a workforce of 140 it is now down to 77 – since the introduction of Buy American policies this year.

And if these protectionist measures continue, he said, the company will likely be forced to move its manufacturing to the United States in order to stay in business.

America seems clueless at how protectionist policies build rage that politicians abroad must quell or heed through retaliation. It’s as if only American politicians want to protect jobs.

It bears repeating because some people don’t get it: it’s not the act of protectionism itself which is so damaging, it is the retaliation and escalation that results.

"The government has got to stand up and propose some serious retaliation," said John Hayward, president of Hayward Gordon Ltd., noting the Halton Hills, Ont.-based industrial-pump manufacturing company has been barred from bidding on U.S. products. He said he has had to switch manufacturing from three Canadian plants to U.S. sites in order to stay in business, a survival decision that has resulted in local layoffs.

Read the full account below.

Source

‘Buy American horror stories’ building – National Post

Related posts:

• ‘Buy American’ will translate into a 21st century Smoot-Hawley
• Canada is furious about U.S. protectonism
• China launches retaliatory investigation into U.S auto subsidies
• The absurdities of ‘Buy American’
• China: we “will take steps to protect the interests of our domestic industries”

China on Friday accused the US of protectionist and biased trade policies less than a week before president Barack Obama’s first visit to Beijing.

In a stinging rebuke to Washington, China’s commerce ministry promised to take measures to protect its domestic industry after the US slapped anti-dumping duties on $2.6bn of Chinese steel pipe imports. The duties are part of a growing roster of trade conflicts between the two countries, despite a high-level meeting last week in China aimed at reducing tensions.

“China resolutely opposes such protectionist practices and will take steps to protect the interests of our domestic industries,” Yao Jian, ministry spokesman, said on its website.

I see this coming to a head.  More here.

Related posts:

• China launches retaliatory investigation into U.S auto subsidies
• China: reflation play spells trouble for rest of the world
• China issues bonds to “promote the RMB in neighbouring countries”
• Beijing starts a ‘Buy China’ policy
• Free trade is dead: victim of a poor economy

The Obama Administration is captured. To understand why it has acted as it has, one doesn’t have to take the view that its efforts to save the banking industry were a deliberate attempt to line bankers’ pockets by transferring money from taxpayers to the banking industry. One need merely read the last post I wrote on this topic.

In their wildly optimistic view, the banking industry is solvent and always has been. All that was needed to ‘solve’ than banking crisis was a lot of liquidity, government backstops and, most importantly, time. This blinkered view sees a looting of taxpayer money to bailout the banking industry as necessary to save banks whose credit is the ‘lifeblood of our economy.’

They are wrong. The banks did not need to bailed out. The banking industry industry needed to made solvent again. There is a big difference between those two sentences (banks versus banking industry and liquidity versus solvency) that goes to the core of the captured and politically damaging world view we have seen on display by the Obama Administration.

Change you can believe in

Think back some 18 months when Senator Obama was in a horse race with Hillary Clinton to see who would go up against John McCain in the Presidential election. If you asked any reasonable individual who had the least experience and the thinnest political resume of the three, he or she would have said Barack Obama. If Americans wanted someone long on inside-the-beltway experience, they would have chosen John McCain – or, at a minimum, Hillary Clinton, not Barack Obama.

So, Barack Obama did not best both Hillary Clinton and John McCain and get to the White House because Americans felt him more qualified for the job.  Rather, Americans believed the U.S. was on the wrong path and wanted a qualified person to lead the country who would also change course. They believed that person was Barack Obama.

And when it came to the economy, the presence of two men, Paul Volcker and Warren Buffett, born some 80 years ago, gave one the sense that, despite Barack Obama’s perceived relative youth or inexperience, he had the ablest of wise old men who would be his and our counsel in resolving this crisis.

Bailing out the banks

So when Barack Obama took office, it came as a rude awakening for many that he chose to bail out the too big to fail institutions with little or no strings attached, allowing them to later make record profits and pay record bonuses, while the economy was in a deep slump and ordinary Americans were being bankrupted and losing their jobs and homes at record rates. This was not change you can believe in.

What could or should the Obama Administration have done?

If you had listened to the chatter inside the beltway early this year, you would realize that Obama’s team believed it was not politically feasible to ‘nationalize’ Citigroup or Bank of America and force top executives to resign as was done at RBS, Bradford and Bingley or Northern Rock in the UK. This was a blinkered view which can only be described as captured (if not outright disingenuous).  We need look no further than Fannie Mae and Freddie Mac to see that nationalization was an option.

But this is not the kind of solution we needed.  What we needed was a solution by the Administration to take prompt corrective action in seizing bankrupt institutions, dismissing management, punishing any misdeeds and setting up a timetable to sell off the institution’s assets. That is change you can believe in.

I laid this out fairly comprehensively in February in my post “America needs a pre-privatization plan.” So I am not going to cover that ground here except to quote the key relevant passage in that post:

To my mind, there are three ways to deal with an insolvent financial institution:

• Bankruptcy. Allow the  institution to collapse (like Lehman Brothers)
• Nationalization. Seize the assets of that institution and nationalize it (like Northern Rock, AIG, or Fannie Mae)
• Bailout. Inject capital into the institution in order to allow it breathing room until it can meet capital adequacy levels.

As you can see, governments have tried all three solutions.  However, there are vast differences between the three.

The bailout solution is the most ‘anti-free market’ choice and seems to be the favored solution of governments everywhere.  It props up organizations, giving them an unfair advantage at the expense of other more prudent institutions.  It also acts as a subsidy, which favors domestic institutions over foreign rivals.  Bailouts increase moral hazard by rewarding risky and reckless lending practices.  And they are often the result of crony capitalism due to the power of the financial services lobby. There are many other problems with bailouts. All around, bailouts are a poor solution.

So what we have here is a case of crony capitalism and kleptocracy, plain and simple – whether by design or not is immaterial. And the American people are on to this. That is why people are resistant to other changes this Administration has put forth.

Don’t let the media’s spin fool you: Washington insiders are on to this too. Politicians in Congress realize that Obama’s bailouts have cost him political capital  and they are challenging his policy agenda as a result. This is why the health care bill, which Obama wanted passed before the summer recess, may not see the light of day before year’s end.

Are we home safe?

I would advise the Obama Administration not to run any victory laps about having slayed the beast. The lingering effects of crisis are still there. The Fed’s liquidity is still liquid. Impaired assets are still impaired. And zombie banks are still zombies. As I indicated in my depression piece:

In reality, the problems of high debt levels in the private sector and an undercapitalized financial system are still lurking, waiting for the government to withdraw its economic support to become realized.

Since I covered this ground in that article, I will leave you to read my further thoughts there. What I want to turn to now is the ‘why.’

The Cheney-Rumsfeld replay

Now, I am not writing off Barack Obama’s presidency. I do worry he still could see a recessionary relapse which would cause him to seem more Herbert Hoover than Franklin Roosevelt.  But, despite his Nobel Prize, it is much to early to know what his legacy will be.

Nonetheless, I believe he has wasted a lot of political capital and this will make ushering through a meaningful legislative agenda very difficult.

Why did Obama throw it all away?

Here’s my answer: I call it the Cheney-Rumsfeld replay.

When historians look back at the Bush 42 presidency, it will be defined by 9/11 and the wars in Iraq and Afghanistan.  While George W. Bush was politically pre-disposed to the Neo-con world view, it was really advice from Dick Cheney and Don Rumsfeld which made Afghanistan and Iraq possible. George W. Bush was famously not well-versed in foreign affairs, having almost never travelled abroad.  He was completely dependent on Dick Cheney and Donald Rumsfeld to make foreign policy (although he could have listened more to Colin Powell, his actual Secretary of State; again it goes to predisposition).

So, I see George W. Bush’s presidency as having been defined by foreign policy and the War on Terror and, by extension, on Rumsfeld and Cheney.

Fast-forward to Barack Obama’s presidency and you have an almost identical situation, this time with the economy instead of foreign policy and Tim Geithner and Larry Summers instead of Donald Rumsfeld and Dick Cheney.

But, as with George W. Bush, it goes to pre-disposition. Paul Volcker was a critical member of the Obama 2008 campaign. He also was a key member of Obama’s economic policy team. But, he has been speaking a very discordant message that is not in sync with team Obama. So, as with Bush and his marginalization of Powell, one has to believe Barack Obama has chosen to side with Geithner and Summers over Volcker. Why anyone would do so given Volcker’s experience is beyond my comprehension.

The obvious conclusion, therefore, is that Barack Obama shares the blinkered and captured view of his policy makers and that this is why he has decided to go down this chosen path. And when it comes to Obama’s other ‘change’ decisions on the Guantanamo closure, torture, rendition, state secrets, and health care, the same logic also applies.

Is this change we can believe in? I will leave that for you to decide.

Related posts:

• The wildly optimistic view of Treasury’s handling of the crisis
• Bush Administration turns the TARP over to Obama
• The 3 a.m. moment – McCain blows it
• Greenspan: “If they’re too big to fail, they’re too big”
• Automakers likely to be bailed out

I have been reading press accounts of the GM decision to back out of the Opel/Vauxhall sale to the Magna/Sberbank consortium from various countries. There are a lot of different perspectives on this event in the U.S., Belgium, Spain, Germany, Russia, the U.K and elsewhere, because a lot of players are involved.

The conclusion I come to is that economic nationalism is the driving motivator behind much of what you read. To the degree, we continue to experience a soft global economy, this should be seen as a warning of how individual actors will respond in future.

Easy decision to keep Opel

GM’s decision to keep GM Europe is fairly straightforward in my view. The cars and technology in GM Europe is something General Motors never wanted to part with. They only did so because of the need to raise cash in a weak economic environment. Now, things at GM (and Ford) are looking much better and GM has exited bankruptcy. There is no desperate need to sell.

Moreover, the EU was asking GM a lot of questions about the subsidy deal they struck with the German government in order to effect the sale of Opel. Other European nations, Spain and the U.K. in particular, were livid because they suspected an unfair subsidy of German jobs over Spanish or British jobs. But, it goes far beyond those two nations as GM Europe employs 55,000 people in places like Sweden, Poland and Belgium.

We saw what happened to ING, RBS and Lloyds due to the EU’s rules on competition. One could reasonably expect a similar crack down in the auto sector. Details will emerge at some juncture, but one could conclude that GM did a cost-benefit analysis in which the wrangling with the EU weighed heavily on their decision to back out of the Magna deal.

And, in the end, should we expect the restructuring GM performs to be qualitatively any different than what Magna’s consortium would have done? They too have announced 10,000 job cuts, a figure in line with what was expected under Magna’s control. So, on the surface, this looks like a net benefit for GM, a net loss for the Magna-led group, and a wash for workers and politicians.

Enter economic nationalism

But, unfortunately, that’s not how it is likely to be seen. Let’s look at it from a German perspective.  Germany’s Chancellor Angela Merkel went to bat for the Magna deal, winning what was widely seen as a measure of security for German workers at a critical time during economic weakness. This bolstered her election chances. As a result, the center-left SPD has now been replaced by the Libertarian-minded FDP in a coalition reminiscent of the Helmut Kohl days. Consider this a move to the right in Germany.

Nevertheless, Merkel has stuck with her allegiance to Barack Obama. In fact, as a result of this relationship, she was the first German Chancellor in 50-odd years to deliver an address before Congress just two hours before she learned of GM’s backing out. What’s more is the U.S. Government is the majority owner of General Motors. One would think the Obama Administration had some insight into the decision-making at GM. Either the Administration didn’t know and is being recklessly hands-off in an enterprise where it has sunk tens of billions or it did know and did Angela Merkel a disservice by not informing her of what was to come well before her speech to Congress.

So, you have an American company owned by the American government backing out of a signed agreement and potentially thousands of jobs at risk. Talk of plant closures at Eisenach, Bochum (and Antwerp in Belgium) and the loss of jobs is rampant in the German press. GM Europe’s head John Smith says, "if they like the Magna plan, they will also like the GM plan." That is not an argument likely to gain sway in a period of economic uncertainty.

The Germans are livid.  German workers have gone on strike. Meanwhile, you have the UK Business Secretary Lord Mandelson warning that the division of job cuts must be ‘fair.’ And the Spanish Opel workers had just OK’ed the Magna plans two weeks ago. This is a bit of a zoo, isn’t it?

It is every nation for itself – precisely what one would expect with a shrinking economic pie and a deep downturn.

Going forward

GM has mishandled this affair quite badly I believe. At least with the Magna deal, the Germans were in the driver’s seat. Now, all of the individual European nations are angling for their say in this matter. Yes, GM had little choice given the likely scrutiny it was under via Neelie Kroes, but it certainly could have handled the political aspects of this much better.

However, now that this situation is out, it gives us a bird’s eye view into how nations respond when a division of the spoils becomes an issue.  And what we have seen does not give confidence that a coordinated approach will prevail. I take this affair as a clear indication that economic nationalism is alive and well and very much a threat to our collective well-being.

Related posts:

• Germany gives GM a stiff arm on state aid
• GM board decides to keep European Opel unit
• German Press: Fiat to sign a deal with Opel, not Chrysler
• Germans reject Chinese offer for Opel
• GM considers keeping Opel, raising capital

Fitch, the credit rating agency, has just downgraded the sovereign debt ratings for the Republic of Ireland from AA+ to AA-.  That is two notches and is proof-positive that the ratings agencies are worried about the hole in Dublin’s finances.

If you read the Irish press this morning, it is all doom and gloom and has a lot to do with the banks and budget deficit.  It is not just about the ratings downgrades.

The EU has just released figures putting in doubt Ireland’s rosy scenario for cutting budget deficits.

The Irish Independent says:

Next month’s Budget may set the economy back further, but without it the country’s national debt could reach 100pc of output (GDP) by 2011, the EU Commission has said in a new analysis.

The Commission is forecasting a decline of 1.4pc in Irish GDP next year. But Brussels is not taking the impact of next month’s Budget into account, because the details are not yet known.

"Depending on the specific measures that are eventually implemented, a dampening effect on consumer demand cannot be excluded," the Commission says in its autumn economic forecast.

Correction

On the other hand, it says that faster correction of the economy’s problems might give more support to consumption and investment by helping confidence.

The Government’s plans include a correction of 4.3pc of GDP — around €8bn — in the Budgets for 2010 and 2011.

Unless there is a compensating boost from confidence, this could also reduce the modest 2.6pc growth forecast for 2011.

These forecasts are higher than those in the Commission’s estimates last May, but it warns of the struggle facing the Irish economy in trying to return to strong growth.

Another top headline in the Irish Independent has the OECD warning that the Irish government should not rule out nationalising banks in addition to its bad bank programme, NAMA.

The Government shouldn’t rule out temporarily nationalising the country’s banks as they may require more capital to cushion against surging bad debts, the Organisation for Economic Cooperation and Development said.

The Government is setting up the so-called bad bank that will buy €77bn of property loans from banks at a discount of 30pc. Losses on those assets may leave the lenders needing extra capital.

“Further recapitalisation may be necessary as assets are being purchased below book value,” the Paris-based OECD said in a report today. “Temporary nationalisation would have a number of drawbacks, but it should not be ruled out altogether.”

The Government has already guaranteed all deposits at banks and some of their debts, pumped €7bn into Allied Irish Banks and Bank of Ireland and seized Anglo Irish Bank.

“Substantial” banking losses are likely to be met by the taxpayer and nationalisation should only be undertaken with the “utmost reluctance,” the OECD said.

The FT’s Stacy-Marie Ishmael has a piece out doubting the maths used in NAMA, which bolsters the OECD view that the bad bank may not be enough.

So you have a trifecta of bad news coming out of Ireland: a two-notch downgrade by a major ratings agency, a warning from the EU that the economy will be weak for sometime to come and that deficits targets will not be met, and another warning from the OECD that the banking situation in Ireland is still very grave.

Quite frankly, it is not looking good for an Irish recovery at this time without the help of the IMF. This all brings me back to my question one year ago: Is Ireland the next Iceland? They will be if the EU, IMF and Irish government do not take today’s bad news seriously and take drastic action to bolster the Irish banks, economy, and government finances.

Who said the financial crisis was over? It is not.

Related posts:

• Ireland: Next stop – IMF
• Ireland guarantees bank deposits at six banks
• Irish government unveils plan to recapitalise banks
• Ireland nationalizes Anglo Irish bank
• Is Ireland the next Iceland?

The power grab at the Federal Reserve is a topic I first broached back in February when the Federal Reserve was creating its alphabet soup of liquidity programs to pull us back from the brink of financial disaster. I was troubled about Fed policy then and I am still troubled today.

I am equally disturbed by what is happening in shift in the balance of power to the executive branch. The Obama Administration seems to be following in the footsteps of the Bush Administration and making its own power grab and Congress has only just begun to wake up to this and start to push back.

At the risk of making this post overly broad, I want to make a few general comments about how executive power in government operates before I take on the specifics of the cases at hand. Everyone who has studied political science is aware that dictators and oligarchies use crises to invoke fear that allows them to usurp power using the cloak of ‘national security’ as a Trojan horse to consolidate power.

I would argue, this is what has just happened in the U.S. post-9/11 and again after the Panic of 2008. I see these developments undermining Americans’ faith in the political process and I hope an appropriate restoration of the checks and balances laid out in the Constitution can be restored. Having made my editorial statement, let me move to the specifics.

Executive Branch power grab

In September, after Lehman Brothers failed, US Treasury Secretary Hank Paulson asked for and received a blank check to disburse $700 billion to former colleagues and rivals in the financial services industry as he and his staff saw fit. In a brilliant act of cunning, Paulson had gotten approval to do anything he wanted from a gutless Congress more interested in loading the bill with sweeteners. This bill was not unlike the Patriot Act, passed after the 9/11 attacks, in that it increased the executive branch’s ability to intervene in the economy as they saw fit. I called it the Economic Patriot Act.

Originally, the Economic Patriot Act was about marking to market. However, once Gordon Brown started recapitalising Britain, Paulson made an about-face and proceeded to dispense the money in a similar fashion (albeit with much fewer strings attached than in the UK).

When the Obama Administration came to town, the modus operandi were not much different. Other support programs were forthcoming and bailouts at Citi and BofA ensued.

With the economy and banks on sounder footing and much of the money returned to taxpayers, the Obama Administration has turned to regulatory reform – and, what do you know – they are looking for a blank check again to do as they please in resolving too big to fail institutions that run into trouble. Again, as with Bush in 2002, if Congress gives the executive branch any blanket authority, it will be used and Congress will be cut out of the process. This is NOT how the American system of government is supposed to be run.

The Fed is grasping for the brass ring too

Enter the Federal Reserve. The Fed has been engaged in a policy of acting in concert with the Executive Branch in a non-arms length fashion since this crisis began. All of the liquidity programs and backstops the Fed has implemented are not just about liquidity, they are subsidies that lower the cost of capital and increase profits in the banking sector. As such, these subsidies are actually a part of America’s fiscal policy – stimulus, if you will. It is a clear no-no for the Federal Reserve to inject itself into fiscal matters. And to top it off, the Fed is refusing to be transparent about the process. Why would we make it the Systemic Risk Regulator?

Willem Buiter says it best so I will just quote him verbatim from his article, “Should central banks be quasi-fiscal actors?”:

Any action going beyond that, such as the recapitalisation of insolvent banks through quasi-fiscal subsidies, ought to be funded by the Treasury.  The central bank should be involved only as an agent of the Treasury – an expert assistant.  It should not put its own conventional or comprehensive balance sheet at risk.

The two arguments against the central bank acting as a quasi-fiscal agent are, first, that acting as a quasi-fiscal agent may impair the central bank’s ability to fulfil its macroeconomic stability mandate and, second, that it obscures responsibility and impedes accountability for what are in substance fiscal transfers.  In the US such actions subvert the Constitution, which clearly states in Section 8, Clause 1, that the power to tax and spend rests with the Congress: “The Congress shall have Power to lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States.”.

If, as happened in the USA on a vast scale, the central bank allows itself to be used as an off-budget and off-balance-sheet special purpose vehicle of the Treasury, and refuses to provide to the Congress some of the information essential for the quantification of the fiscal transfers it has made, the central bank not only subverts the constitution.  By attempting to hide contingent commitments and to disguise de-facto subsidies by not divulging relevant information on the terms on which the central bank has offered financial assistance, it undermines its own independence and legitimacy and impairs political accountability for the use of public funds – ‘tax payers’ money’.  It is surprising that a country whose creation folklore attributes considerable significance to the principle of ‘no taxation without representation’ would have condoned without much outcry such a blatant violation of the equally important principle of ‘no use of public funds without accountability’.  This indeed amounts to a quiet usurpation of the power of the legislature by the central bank.

Qualitative easing, or whatever you call it, must end.  With the FOMC starting its two-day meeting tomorrow, and with the Reserve Bank of Australia having already hiked twice, it will be interesting to see if the Fed retracts its “extended period” language as many of us expect. While I think it premature in regards to the robustness of the economy, the Fed needs to show it is an independent actor.

Once lost, independence will not be easily restored.

Related posts:

• The Federal Reserve bails out AIG
• Plosser: The Fed must stop qualitative easing
• Geithner testifies before Congress on financial reform
• Bush: ever the opportunist, lifts oil drilling ban
• Geithner and Summers consolidate power

Josh Rosner, a Managing Director at Graham Fisher & Company, an independent research for institutional investors in financial service assets, has some pretty strong words for the reform legislation proposed by the Obama Administration and now making its way to Congress. On Bloomberg, he said it favors large too big to fail institutions and hurts smaller community banks. In sum, he calls it “the single worst not-yet passed piece of legislation” he has ever seen in financial services. Pretty harsh words.

Tim Geithner defended the proposal to a skeptical Congress yesterday, saying that we need large institutions to compete internationally and that the companies should be regulated rather than broken up. When asked why Obama is not proposing that systemically dangerous firms be broken up, Rosner says it’s regulatory capture (something Arianna Huffington and Eliot Spitzer have argued for months).

Rosner also notes that the proposal increases the power of the executive branch giving them “unlimited authority,” which Congress pushed back on during Geithner’s testimony yesterday.

The most worrying charge that Rosner levels has to do with what he sees as an implicit government subsidy for TBTF institutions that puts them in a situation akin to Fannie and Freddie before the crisis. This gives them a large funding advantage over smaller firms, allowing them to generate excess profits and/or take higher risk.

See also “Guest Post: Conservatives and Liberals Agree: Proposed Bank Oversight Bill Will Make Things Worse” on Naked Capitalism.

Rosner’s video is below.

Related posts:

• Video: Geithner calls for single agency to oversee systemic risks
• Obama caves to pressure on consumer financial protection
• Why not protect the homeowner?
• Greenspan: “If they’re too big to fail, they’re too big”
• The U.S. financial system is effectively insolvent

Robert Johnson, director of the Economic Policy Initiative of the Roosevelt Institute, has been extremely critical of the US Government’s handling of matters related to financial services.

This past October 7, he gave testimony at the House of Representatives financial Services Committee expressing some of his concerns.  Not only was his testimony cut short, but his prepared remarks failed to be entered into record (hat tip reader Tom). This is outrageous and a deliberate attempt to expunged his testimony from record. Read the excerpt from Harper’s below (emphasis added):

Predictably, witnesses at the hearing trotted out positions urging caution in regard to the matter of reform…

[Robert] Johnson, who came last, offered the only serious critical viewpoint, saying that the American public had been “quite demoralized by…the bailouts that we experienced last fall.” After about five minutes of his testimony, Congresswoman Melissa Bean—another industry-funded committee member who chaired the hearing because [Barney] Frank was absent—had heard enough. “I’m just going to ask you to wrap up because we’re running out of time,” she told Johnson.

Johnson gamely continued. “When I hear the testimony today that are largely financial institutions and end users, I believe that I represent a third group that comes to the table, which is the taxpayers, the working people of the United States,” he said.

“I do need a final comment,” Bean interjected seconds later.

That put an end to Johnson’s testimony. “I was just called to this hearing last night, so I will provide detailed comments on your bill and a statement for the record that will finish my comments,” he concluded.

About five days later Johnson submitted his full testimony to the committee, to be included on its website along with the statements of the other eight panelists. When it wasn’t posted, Johnson asked Lynn Parramore, editor of the Roosevelt Institute’s blog, to see what was up…

Finally, she was informed that the committee’s general counsel would not allow posting of the testimony because Johnson had not submitted it during the hearing. (Of course, since Johnson had been invited at the last minute it was impossible for him to fulfill this pointless requirement.) So you still can’t read Johnson’s prepared testimony at the committee website, but you can check it out on the Roosevelt Institute’s blog.

Meanwhile, Frank’s committee has put forth its “reform” bill. “Too tepid, too weak, too late,” Johnson says of the legislation. “Very industry influenced. We had a crisis and they are pandering to the perpetrators.”

Read the full gory details below.

Source

An Object Lesson in Governmental Failure: Derivatives reform – Harper’s

Note: this post originally erroneously stated it was Simon Johnson and not Robert Johnson whose testimony was at issue.

Update: the testimony is now also embedded below for you to read.

Robert Johnson Financial Services testimony: 2009-10-07

Related posts:

• Obama caves to pressure on consumer financial protection
• A conversation with Robert Caro on Charlie Rose
• S.E.C. complicit in Madoff fraud, whistleblower says
• Geithner testifies before Congress on financial reform
• Simon Johnson: Too big to fail is “too big to exist”

When it comes to the housing meltdowns in the richest economies, the US has been matched only by Spain, Ireland and the UK. All four countries have seen spectacular losses of wealth in the housing sector over the last two years.

The response by all four governments was to apply as much stimulus as they reasonably could to prevent their economies from descending into free fall. This has opened up gaping holes in each countries’ government accounts. However, in contrast to the United States or the UK, both Spain and Ireland have the Euro as an external constraint which limits their policy choices.  This has resulted in credit downgrades for the sovereign debt in Ireland and Spain.

Looking at Spain, there was massive over-building in the property sector, which attracted a lot of labor to Spain. Now that these jobs have been vaporized, the unemployment rate has soared to near 18%. The problem is quite acute and there are few policy solutions. Reinforcing this point for me was a discussion I had with Spain-expert Edward Hugh, who writes at the blogs Global Economy Matters and A Fistful of Euros, in the wake of some downbeat comments by Paul Krugman about the country.

Edward wrote:

The problem is Spain can only create jobs through exports. The problem is, with Brussels prices we cannot attract investment to build new factories to create high volume unskilled employment. At this stage in the game we are not in competition with Brussels, but with Bratislava. That may not be a pleasant truth, but it is simply like that. We have attracted a large quantity of people here to work in unskilled low-value employment. The industry that gave them work just permanently disappeared out of sight. We need, urgently to find alternatives since we cannot pay them all 420 euros a month for ever. This is more than a simple academic exercise, it is now a question of life and death for the Spanish economy.

Basically we need to go back to 2000 wages and prices and start again. Maybe you don’t like this idea, but can you point me to anyone who has an alternative?"

Obviously, a huge cut in nominal wages is never going to fly in any country because wage prices are sticky. Call it “money illusion” or call it a desire to maintain a decent standard of living, across-the-board nominal wage cuts are a political non-starter. But, this is what is needed in Spain.

Edward does address the standard-of-living problem this presents:

This is not simply about bringing down wages. It is about simulating a devaluation by bringing down prices AND wages together. So you as an employee should be in the same situation as before. The only realistic way to do this is through a pact between employers, unions and political parties, everyone.

The only real problem is with the debts, since they will also need adjusting down, but see another thread here on this.

But OK, I’m not saying this is going to be easy, just that we have no alternative. We shouldn’t have inflated the housing bubble in the first place.

Of course, being able to devalue the currency is one way to achieve this. But, Spain does not have that option. These are the very real policy cul-de-sacs faced in the aftermath of a debt-fueled asset bubble. And since another one seems to be inflating right now, I reckon the U.S. and the U.K. will be joining Ireland and Spain on this dead-end street in due course whether their currencies are weak or not.

Related posts:

• European House Prices are slowing
• Spain and Ireland ‘thrown to the wolves’ after ECB move
• Spain intervenes to save Caja Castilla La Mancha
• UK real wages falling
• Spain gets deflation

I am listening to Treasury Secretary Tim Geithner answer questions before the House Financial Services Committee and he seems to be talking the talk, but his Administration is not walking the walk. 

The bill he is aggressively defending calls for putting a resolution process in place which ostensibly allows the cost of the failure of a too big to fail to not be passed on to taxpayers or the wider economy.  The sentiments he expresses are the right ones. But, he is rightly being questioned about whether this proposal gives the executive branch power which it could abuse.

Meanwhile, just in the last 24 hours we learned that GMAC was effectively nationalized and non-government equity was inexplicably not wiped out.  The testimony and the actions are in direct contradiction with one another.

Congress is fully aware of this dichotomy. They seem to have a bit of bailout fatigue. That makes them mistrustful of Geithner’s intentions. As a result, he is facing some tough questions from Democrats and Republicans alike.

Related posts:

• Rosner: Financial Stability Act “single worst not-yet passed piece of legislation”
• Chanos: I warned Brown and Geithner of financial calamity
• Weekend Video: A Conversation with Tim Geithner at CFR
• My initial reactions to President Obama’s financial regulation proposal
• Is Bernanke Toast? If he is, Summers is a shoo-in

China has sent yet another public signal that it is unhappy with the U.S. and its trade policy by prepping an investigation into alleged illegal auto subsidies by the U.S. government.  The timing of this announcement puts a spotlight on the bailout of GMAC, the auto financial company which effectively has been nationalized the firm. This may be by intention.

The Financial times reports:

China is preparing to launch a trade investigation into whether US carmakers are being unfairly subsidised by the US government, according to people familiar with the matter.

The move comes at a time of heightened trade tensions between the two countries after the US imposed duties on Chinese tyres last month. Many warned this would prompt Beijing to retaliate.

Few vehicles are actually exported from the US to China, but the move would have symbolic power by turning the tables on Washington.

US labour groups have long accused Beijing of unfairly subsidising its exporters. However, through a “countervailing duties” investigation, China would assess whether the US was open to the same charge. The investigation could lead to import duties.

General Motors and Chrysler have received about $60bn in government bail-out funds, though Ford has received nothing.

Yes, General Motors has a large presence in China and its bailout by the government has an impact on its ability to operate competitively in China. But, because the U.S. does not export many cars to China, one might see this as a strange action on China’s part.  In my view, China is telling us with this action that “what is good for the goose is good for the gander.”

I find this story a bit curious because China already said in September that it would investigate autos and chicken in retaliation for U.S. tariffs on tires. But, we should look at this in a wider context. The US is also angling to get Chinese to revalue renminbi. The Chinese are resistant to this and their actions here can also be seen as a warning to the U.S. that any and all protectionist threats will be met with retaliation.

Elliot Feldman, head of international trade at Baker & Hostetler, the law firm, said his firm warned the USTR last January that the approach the US was taking towards China and other countries over subsidies was dangerous in the light of the US’s own support for carmakers, banks and financial institutions.

“We warned that other countries could apply to the United States the same principles the United States was applying to them,” he said. “Apparently we have arrived.”

The problem with protectionism is not that it can protect sectors, but that it leads to retaliation and escalation. This is now what is beginning to occur.

Related posts:

• China: we “will take steps to protect the interests of our domestic industries”
• Should we expect a protectionist China?
• Beijing starts a ‘Buy China’ policy
• Tariffs: Other industries may line up for sanctions against China
• China detains Rio executive on suspicion of espionage