"President Barack Obama is poised to increase the U.S. debt to a level that exceeds the value of the nation’s annual economic output, a step toward what Bill Gross called a “debt super cycle.”
The CHART OF THE DAY tracks U.S. gross domestic product and the government’s total debt, which rose past $13 trillion for the first time this month. The amount owed will surpass GDP in 2012, based on forecasts by the International Monetary Fund. The lower panel shows U.S. annual GDP growth as tracked by the IMF, which projects the world’s largest economy to expand at a slower pace than the 3.2 percent average during the past five decades.
“Over the long term, interest rates on government debt will likely have to rise to attract investors,” said Hiroki Shimazu, a market economist in Tokyo at Nikko Cordial Securities Inc., a unit of Japan’s third-largest publicly traded bank. “That will be a big burden on the government and the people.”
Gross, who runs the world’s largest mutual fund at Pacific Investment Management Co. in Newport Beach, California, said in his June outlook report that “the debt super cycle trend” suggests U.S. economic growth won’t be enough to support the borrowings “if real interest rates were ever to go up instead of down.”
Dan Fuss, who manages the Loomis Sayles Bond Fund, which beat 94 percent of competitors the past year, said last week that he sold all of his Treasury bonds because of prospects interest rates will rise as the U.S. borrows unprecedented amounts. Obama is borrowing record amounts to fund spending programs to help the economy recover from its longest recession since the 1930s.
“The incremental borrower of funds in the U.S. capital markets is rapidly becoming the U.S. Treasury,” Boston-based Fuss said. “Do you really want to buy the debt of the biggest issuer?”"
Rereading my post on the folly of the G20, it seems to me that I didn’t fully convey just how crazy the demand for fiscal austerity now now now really is.
The key thing you need to realize is that eliminating stimulus spending, while it would inflict severe economic harm, would do almost nothing to reduce future debt problems. Here’s the IMF’s estimate of sources of the growth in debt over the next few years: read more
The German government put together the largest austerity package since World War II on Monday, with spending cuts and new business levies aimed at saving 80 billion euros by 2014. Chancellor Angela Merkel says Germany, as Europe's largest economy, must set an example.
The German government on Monday announced plans to reduce spending by €80 billion ($95.7 billion) by 2014 in the largest package of cuts since World War II. The austerity program aims at reducing the budget deficit and helping to protect the euro as it continues its slide.
"We have to save €80 billion by 2014 to put our financial future back on a solid footing," Merkel told a press conference on Monday afternoon. She said the budget cuts for Germany, Europe's largest economy, were a "unique show of strength" that signalled her government's commitment to tackling the European debt problems that have plunged the euro single currency into crisis.
"Germany as the largest economy has a duty to set a good example," she said. A number of European nations have fashioned similar austerity programs, with Spain passing sharp cuts last week and Greece having pushed through far-reaching emergency savings measures earlier this year in a last ditch attempt to avoid bankruptcy. read more
Axel Weber about the causes of the problem and the lessons to be learnt:
If you have low expectations in the European Union and its institutions, this news reports undershoots all of them. The big governance idea coming out from this crisis is another stability pact – with sanctions! Die Welt has obtained a working draft of a paper to be discussed at tonight eurogroup meeting in Luxembourg, and tomorrow’s Ecofin, according to which the big idea is a semi-automated sanctions mechanism that kicks in earlier than previously – and that includes concrete demands about targets for debt-to-GDP ratios. The proposals also include a strengthening of the role of the economics commission within the Commission – to prevent others ganging up on him to push through their national interests. The article also said that Germany’s own balance budget law stands no chance to be implemented at eurozone level. The article also showed how difficult it will be to extend policy co-ordination beyond the stability pact. Silvana Koch Merin, a liberal MEP, said the proposal would effectively mean that other countries have influence on Germany’s economic policies – and was thus unacceptable.
(If you want to get really depressed, read the vox populi comments below the article... read more
The news that the European Commission's Economic Sentiment Indicator fell sharply in May underlines the economic risks the continent is now facing. With governments around Europe moving towards fiscal austerity, at a time when over-indebted households are still reluctant to spend, the danger is that Europe will move back into recession.
Why are European governments embarking on such a risky strategy? In peripheral economies such as Greece, Ireland or Spain, the governments have no choice: the markets have made it clear that otherwise they will no longer be willing to continue lending to them. Governments have thus had to cut spending and raise taxes at the worst possible time. While this will worsen peripheral downturns, it is what the markets are demanding. And so it must have been utterly exasperating for the Spanish government when, late last week, Fitch downgraded Spanish debt on the basis that Spain's adjustment process will lower its medium run growth prospects. It seems a case of damned if you do, damned if you don't.
What, might Spanish politicians well ask, do markets want? read more
A Greek debt default has still a high probability, as Charles Calomiris points out in an article:
Here are some excerpts:
"Under these assumptions, given the current level of Greek sovereign debt, an average surplus of 4.2% of GDP (before interest payments) would be necessary to avoid sovereign default. With government expenditures other than interest at about 44% of GDP, and tax receipts at about 40% of GDP, that implies that the government must either immediately and permanently cut non-interest spending by about 25%, or immediately and permanently raise taxes by about 28%, or if the two were done in equal combination, cut non-interest spending and raise taxes each by about 14%.
Even being willing and able to embark on such an ambitious agenda of fiscal reform would not guarantee success. First, in the short term, Greece has a massive amount of debt coming due. To avoid default the Greek government must either convince the market immediately that its reform is credible or convince the European Union to roll over the 53 billion euros of its debt that comes due in 2010."
"According to a recently published study by Katsios (2006), Greece has the largest “shadow economy” (untaxed income base) of any OECD country, which the author argues is related to the corruption of the Greek government through various channels4 . In 2006, Katsios estimates the Greek shadow economy at 28% of GDP. Second in line behind Greece in the extent of its shadow economy was Italy, at 26%. The tolerance for corruption in Greece makes it virtually impossible to imagine a significant increase in taxation via higher tax rates; increases in tax rates will simply increase the size of the shadow economy, and could actually reduce tax revenues."
"Without major anti-corruption reform, fiscal policy adjustment must rely on expenditure cuts alone to achieve budgetary balance. With respect to those government spending cuts, however, it is also hard to be optimistic. High corruption is associated with excessive and wasteful spending that is hard to reverse. The existence of corruption reflects a deep inability to coordinate political action in pursuit of policies that would benefit the nation, including reducing wasteful spending."
"Greece has one of the highest levels of “social protection” (i.e., welfare) expenditure in the euro zone. Consider a comparison group of the eight euro zone countries with 2008 per capita annual GDP of less than 27,000 euros, shown in Table 1. Within this bottom half of the 16 euro zone countries, Italy (6,226 euros per capita) and Greece (5,139) show the highest per capita spending on social protection; in contrast, the remaining six countries (Spain, Portugal, Slovenia, Cyprus, Malta, and Slovakia) spend an average of 3,730 euros per capita. Not coincidentally, the average corruption score of 6.1 for those six countries is much higher than those of Greece or Italy."
June 4, 2010
The euro zone is facing a period of zero growth if not recession, and the United States is heading for financial trouble, U.S. economist Nouriel Roubini was quoted as saying on Saturday.
"There is that risk, at least for the euro zone. Growth will fall toward zero. Even if that is perhaps not a real recession, it will feel like one. Greece was just the tip of the iceberg," he said. read more
To make a short story even shorter, the Mankiw Rule suggests that the Zero Interest Rate Policy will continue for quite some time, barring dramatic changes in the inflation and/or unemployment rates.
“The Mankiw Rule” is what I call Greg Mankiw’s version of the Taylor Rule. “Taylor Rule” is now the general term for a rule that sets a monetary policy interest rate (usually the federal funds rate in the US case) as a linear function of an inflation rate and a measure of economic slack. Such rules provide a simple way of either describing or prescribing monetary policy. Unfortunately, there are now many different versions of the Taylor Rule, which all lead to different conclusions. Not only are there many different measures of both slack and inflation; there are also an infinite number of possible coefficients that could be used to relate them to the policy interest rate. In fact, if you ask John Taylor today, he will advocate a very different set of coefficients than the ones he proposed in his original 1993 paper (pdf).
Parsimony suggests that a good Taylor rule should have 3 characteristics: it should be as simple as possible; it should use robust, easily defined, and well-known measures of slack and inflation; and it should fit reasonably well to past monetary policy. Also, to have credibility, such a rule should have “stood the test of time” to some extent: it should fit reasonably well to some subsequent monetary policy experience after it was first proposed. The Mankiw Rule has all these characteristics. It uses the unemployment rate and the core CPI inflation rate as its measures, and it applies the same coefficient to both. This setup leaves it with only two free parameters, which Greg set in a 2001 paper (pdf) so as to fit the results to actual 1990’s monetary policy. As you can see from the chart below, the rule fits subsequent monetary policy rather well, although policy has tended to be slightly more easy (until 2008) than the rule would imply. read more
European governments are considering the issue of common "eurobonds" for the first time as part of their huge exercise in staving off a sovereign debt crisis across the Mediterranean and shoring up the single currency.
EU finance ministers are to meet in Luxembourg on Monday to establish the workings of the €750-bn (£650bn) safety net agreed last month following weeks of crisis and dispute.
The ministers, from the 16 of 27 EU countries in the single currency, are to haggle over two options for the operations of the rescue fund – borrowing on the markets to lend to a country in distress, or guaranteeing the borrowing of the cash-strapped country. The first option amounts to eurobonds, senior officials told the Guardian.
The "eurobond" issue is acutely sensitive, especially in Germany which is allergic to any hint that the lending vehicle will enshrine budget transfers from the stronger to the weaker eurozone members. Sceptics fear it would entail mutualisation of public debt, and Germany fears jeopardising its liquidity and low borrowing costs. But in agreeing to supply up to €148bn of €440bn for the eurozone rescue fund, Berlin is already committed. read more
The German cabinet approved a draft bill to ban naked short selling of euro zone government bonds and German shares Wednesday, but an outright ban has been postponed.
Transparence in ECB's transactions would be a prerequisite for improvement. Confusion seems to be dominating:
"This is what happens when policy lacks transparency. We briefly referred to this Spiegel report yesterday, but since it has making big waves, we want to go back into some of the details. The report alleges that French banks, the largest holders of Greek, have been dumping their Greek bonds at the ECB, while the German banks have agreed with the finance ministry to hang on to their bonds until 2013. The article, whose are anonymous central bankers in Germany, says the Bundesbank wonders why the ECB was still buying Greek paper at a time when the financial shield is already in place. The answer is that they suspect a French conspiracy, according to the article, a presumption that French banks are using the ECB purchase programme to clean their balance sheet. The article then takes to the conclusion, and calls the ECB a “bad bank” . The article goes on to ask, whether and how the ECB can get out of this, because stopping the purchase programme would lead to a collapse in prices – as the ESCB is the only buyer. And if Greece were to restructure (which is what everybody who has looked into the numbers in some detail) knows, then the ECB itself would need to be bailed by the German taxpayer.
We assume that this article is unlikely to win a Franco-German friendship prize. French newspapers have picked up on it, including Le Monde, which said yesterday that “a perfume of divorce float between the Germans and the ECB” (i.e. Trichet). Please also note that the source of Der Spiegel’s information do not hail from France. They are German central bankers, who voice their suspicions. So do not treat it as fact that French banks are selling, and German banks are not selling. But the article raises an interesting question: how to prevent moral hazard arising in this situation? And if the ECB were to reveal what it bought in its open market operation, we would know a lot more. At present, the only information ordinary Germans have is the Spiegel report."
Source: EuroIntelligence (see link above)
Airtime: May 26, 2010
When the recession first hit, and the need for government action became apparent, a debate began over the steps the government should take to try to turn things around. One point of contention was whether tax cuts or increases in government spending would have the largest impact on the economy.
Tax cuts have an advantage over increases in government spending since they can be implemented relatively quickly. Government spending programs take more time to put into place.
But there is also a disadvantage. Unlike government spending, which has an initial impact on demand that is certain and one to one, tax cuts give households and incentive to spend more, but there’s no way to ensure that the tax cuts won’t be saved instead of spent. And if they are saved instead of spent, then they don’t produce the desired increase in aggregate demand. However, if the tax cuts are well targeted, then the amount that is spent rather than saved will go up, but even then the impact on demand is still less certain than for government spending. read more
Airtime: May 26, 2010
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