•Ben Bernanke, the Fed, and quantitative easing –

Ben Bernanke, the Fed, and quantitative easing – The German and Chinese governments, Republican congressmen, the liberal economist Joseph Stiglitz, and Sarah Palin don’t agree on much. But they’re united in their opposition to the Federal Reserve’s second round of quantitative easing—or, as it’s known, QE2. According to various of the Fed’s critics, QE2—which involves the Fed’s buying six hundred billion dollars in government bonds over the next eight months—could start a global currency war, weaken the dollar, spark inflation, and create price bubbles in asset classes around the world. Next thing you know, dogs and cats will be living together. This huge uproar might make you think that QE2 represents some radical shift in the Fed’s mission. It doesn’t. The Fed’s job is to manage the country’s money supply, and it ordinarily does so by manipulating short-term interest rates, lowering rates when it wants to give the economy a push and raising rates when the economy seems to be overheating and needs to be cooled down. At the moment, though, short-term rates are already near zero and can’t be cut further. So instead the Fed is buying longer-term government bonds. The hope is that this will help keep long-term interest rates low, pump more money into the economy, and make investments other than government bonds more appealing.
 
New Deficit-Cutting Plans to Come From Liberal Groups –  As President Obama’s fiscal commission faces a deadline this week for agreement on a plan to shrink the mounting national debt, liberal organizations will unveil debt-reduction proposals of their own in the next two days, seeking to sway the debate in favor of fewer reductions in domestic spending, more cuts in the military and higher taxes for the wealthy. The proposals from two sets of liberal advocacy groups highlight the deep ideological divides surrounding efforts to deal with the nation’s budgetary imbalances, even as Mr. Obama’s bipartisan commission works to finalize its recommendations by Wednesday — and struggles for a formula that would get the backing of at least 14 of its 18 members, the threshold for sending its proposal to Congress for a vote.
 

A Budget Blueprint for Economic Recovery and Fiscal Responsibility – Demos, EPI and The Century Foundation have produced a budget blueprint for economic recovery and fiscal responsibility. The blueprint prioritizes a strong economic recovery because widespread job creation and robust economic growth are essential to successful deficit reduction. Investing in America’s Future is a project of Demos, EPI and The Century Foundation. More information is available on the project’s homepage at www.ourfiscalsecurity.org. Download the report [PDF] View the report – Related Materials – Executive Summary

Cross-border deleveraging and Europe’s bargaining game –While high-ranking eurozone bureaucrats are ruminating on the appropriate burden-sharing mechanisms of a future Europe, something potentially more momentous has been going at the background: European banks have been cutting back their intra-European exposures… fast! The numbers are pretty stunning: Between December 2009 and June 2010 (the latest data available from the BIS), German banks cut their eurozone claims by $180bn (more than 5% of German GDP). French banks cut their own exposure by near $280bn (10%of French GDP), of which $130bn were claims on Italy and Spain. And Dutch banks cut their eurozone claims by $170bn (about 20% of Dutch GDP), with cuts across the board, from Spain, Ireland and Greece to Italy, Germany and Belgium. One can only assume that the cutbacks have continued in full force post-June. This “deleveraging” has important implications for the core-periphery bargaining game and the future of the euro.

Unsound Money in China – China is looming as a major threat to Australia’s ongoing prosperity. The consensus view in this country is that China is going through a decades long boom and we’ll continue to ride on their coat tails for years to come. I think that is a dangerously complacent viewpoint. Look, anyone with a minor understanding of history and economic development can see that the 21st century belongs to China. Just in the same way that the 20th century belonged to the US. But it wasn’t smooth sailing for the US and it wont be for China either. One of the biggest myths about China is that its huge FX reserves (around US$2.65 trillion at last count) are a sign of strength. They are not. The reserves are a product of a mercantilist policy that is now starting to backfire.
 
The World in 2036: Nassim Taleb looks at what will break, and what won’t | The Economist – A system that is over-reliant on prediction (through leverage, like the banking system before the recent crisis), hence fragile to unforeseen “black swan” events, will eventually break into pieces. Although fragile bridges can take a long time to collapse, 25 years in the 21st century should be sufficient to make hidden risks salient: connectivity and operational leverage are making cultural and economic events cascade faster and deeper. Anything fragile today will be broken by then. The great top-down nation-state will be only cosmetically alive, weakened by deficits, politicians’ misalignment of interests and the magnification of errors by centralised systems. The pre-modernist robust model of city-states and statelings will prevail, with obsessive fiscal prudence. Currencies might still exist, but, after the disastrous experience of America’s Federal Reserve, they will peg to some currency without a government, such as gold. Companies that are currently large, debt-laden, listed on an exchange (hence “efficient”) and paying bonuses will be gone. Those that will survive will be the more black swan-resistant—smaller, family-owned, unlisted on exchanges and free of debt. There will be large companies then, but these will be new—and short-lived.
 

Understanding India’s Microcredit Crisis – As Vivek Nemana reported here, the Indian microcredit industry has pitched into what appears to be a replay of the American subprime debacle. I just spent a week in India, talking to nearly everyone. I learned there were so many complexities—history, politicsinstitutional rivalries— that to just view events through the foreign lens of the subprime crisis is…actually about right.The microcredit industry indeed appears to have grown irresponsibly fast, partly out of pursuit of profit. But this is not a simple morality play. The state government’s response (an October 14 ordinance) is draconian, tantamount to banning mortgages after a mortgage crisis. Why such a crackdown? The rise of private microcredit threatened a big, World Bank–financed government program that provides credit and other services.

How to cut the deficit without raising taxes –There is a way to cut budget deficits without raising tax rates. "Tax expenditures" are the special features of U.S. income tax law that subsidize mortgage borrowing, health insurance, local government spending and more. Although these subsidies are a form of government spending, they are counted as reduced tax revenue rather than increased government outlays. Yet tax expenditures increase the deficit by hundreds of billions of dollars a year, more than the total cost of all non-defense programs other than Social Security and Medicare.  A critical feature of the proposal recently unveiled by Erskine Bowles and Alan Simpson, the co-chairmen of the president’s bipartisan fiscal commission, is to reduce tax expenditures rather than raise tax rates. That would increase revenue without reducing incentives to work, save or invest. Their most extreme suggestion is to eliminate all tax expenditures, raising $1 trillion a year in additional tax revenue, and then use all but $80 billion of that to cut tax rates. I think that devotes too little money to deficit reduction at a time when fiscal deficits are dangerously large.

The Spanish Prisoner, by Paul Krugman – Ireland can’t do all that much damage to Europe’s prospects. The same can be said of Greece and of Portugal, which is widely regarded as the next potential domino. But then there’s Spain. The others are tapas; Spain is the main course.  What’s striking about Spain, from an American perspective, is how much its economic story resembles our own. Like America, Spain experienced a huge property bubble, accompanied by a huge rise in private-sector debt. Like America, Spain fell into recession when that bubble burst, and has experienced a surge in unemployment. And like America, Spain has seen its budget deficit balloon thanks to plunging revenues and recession-related costs.  But unlike America, Spain is on the edge of a debt crisis. The U.S. government is having no trouble financing its deficit, with interest rates on long-term federal debt under 3 percent. Spain, by contrast, has seen its borrowing cost shoot up in recent weeks, reflecting growing fears of a possible future default.  Why is Spain in so much trouble? In a word, it’s the euro.

The Eurozone Endgame: Four Scenarios – Boone and Johnson – In the aftermath of the Irish bailout, the German proposal for a future sovereign and/or senior bank debt restructuring mechanism within the eurozone makes complete political sense to the electorate in stronger European countries.  They do not want to write “blank checks” to weaker countries and to out-of-control financial institutions going forward; creditors to countries that run into trouble will face likely losses. While the details of this “burden sharing” approach remain to be hammered out (after Sunday’s announcements), there is no way for German or other politicians to backtrack on the broad strategic principles.  But once this arrangement is in place, say in 2013 or thereabouts, all eurozone countries will (a) be able to sustain less debt than has recently been regarded as the norm, and (b) become vulnerable to the kinds of speculative attacks in debt markets that we have seen in recent weeks – to reduce funding rollover dangers, they will all need to lengthen the maturity of their outstanding debt.  Ultimately, there will be a eurozone will greater shared fiscal authority, a common cross-border resolution authority for failed banks, and likely greater economic integration.  But there are four scenarios regarding who ends up in that eurozone – and how we get there.

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