12/06/2010 –

Ireland About to Give Another Sop to the Banks, a Bad Assets Fire Sale? Yves Smith – Reader Swedish Lex, who was involved in the famed and generally well regarded Swedish banking industry cleanup of the early 1990s, read an innocuous-sounding Financial Times story the same way I did. Not only are the banks who lent recklessly to Ireland’s overheated property sector being shielded from most of the consequences of their stupidity and greed, but other financiers are likely to make out like bandits on what looks certain to be an unduly rapid sale of bad bank assets. For readers new to how banks get euthanized, an approach generally regarded as sound when dealing with banks that are seriously insolvent (as in their assets are worth less than their debts) is the “good bank-bad bank” approach. The bank is taken over, the board and senior management is fired. The good parts of the bank are usually spun back out as quickly as possible with new management in place. The bad parts, typically the bad loans, are put in a separate entity and disposed of.  Now there are a lot of variants on that theme…

China’s credit bubble on borrowed time as inflation bites – The Royal Bank of Scotland has advised clients to take out protection against the risk of a sovereign default by China as one of its top trade trades for 2011. This is a new twist.  It warns that the Communist Party will have to puncture the credit bubble before inflation reaches levels that threaten social stability. This in turn may open a can of worms.  "Many see China’s monetary tightening as a pre-emptive tap on the brakes, a warning shot across the proverbial economic bows. We see it as a potentially more malevolent reactive day of reckoning," said Tim Ash, the bank’s emerging markets chief. Officially, inflation was 4.4pc in October, and may reach 5pc in November, but it is to hard find anybody in China who believes it is that low. Vegetables have risen 20pc in a month.

Why We Need an Explicit Nominal Target for Monetary Policy – So we learn from the 60 minutes interview with Ben Bernanke that if necessary there will be a QE3: Scott Pelley: Do you anticipate a scenario in which you would commit to more than 600 billion? Ben Bernanke: Oh, it’s certainly possible. And again, it depends on the efficacy of the program. It depends, on inflation. And finally it depends on how the economy looks.This ad-hoc approach is exactly why we need a rules-based approach to QE.  If the Fed had adopted an explicit nominal target–preferably a nominal GDP level target–and forcefully committed to maintain it no matter the cost, it is unlikely the Fed would need to keep announcing new rounds of QE. All the market would need to know is that the Fed is serious about hitting its nominal target.  The rest would take of itself.  The market would do the heavy lifting by automatically increasing nominal expectations to a level consistent with the target. 

Why The Low Interest Rates Mattered: Part II – This is the second of two posts detailing why the Fed’s low interest rate policies in the early-to-mid 2000s was one of the more important contributors to the credit and housing boom.  In the first post I discussed how the low federal funds rate acted as a catalyst in bringing together the other contributors–financial innovation, weak governance, misaligned incentives, and globalization–to create the perfect economic storm.  Here I want to (1) flesh out why the low federal funds rate mattered from a neutral interest rate perspective and (2) discuss how the Fed’s low interest rate policy created a global liquidity glut. (The material in this post is mostly excerpted from a previous one of mine.)
Juncker and Tremonti: “E-bonds would end the crisis” – Eurogroup leader and Italian finance minister present a fully worked-out plan for a single bond; say that this would end the crisis; bond would be subject to a ceiling of 40% of GDP, and a European Debt Agency would offer exchanges of national bonds at a discount; Schauble opposes the move, says it would require significant changes to the European Treaties; Didier Reynders was among a number of officials of over the weekend called for an increase in the size of the EFSF; Wolfgang Munchau says the eurozone is totally “überfordert” with this crisis; Frankfurter Allgemeine says the story that Germany is the main beneficiary of the euro, sounds increasingly hollow; details of the Irish agreement, meanwhile, have emerged, according to which Irish banks will have to sell a large portion of their loan books.[more]

Americans appalled at how much we spend on aid, want to spend 10 times more – This chart is courtesy of Ezra Klein (h/t @viewfromthecave and @laurenist), who summarizes the results from a new World Opinion Poll. The 848 Americans polled guessed, on average, that the US spends 25 percent of the budget on foreign aid, but opined that the figure should be about 10 percent. The actual number, as you Aid Watch readers probably know, is less than 1 percent. The chart will also be interpreted by many as showing that the US should spend more, since many citizens – who have just demonstrated they have no clue what we are currently doing – theoretically have a tolerance for more spending.

Bernanke: Without Fed’s actions, unemployment rate might have hit 25% – From the CBS 60 Minutes interview: Fed Chairman Bernanke On The Economy  CBS: In the panic of 2008, the Fed put up $3.3 trillion. And just this past week, the Fed revealed who got emergency help. … it was a historic transfusion of cash in a global system that was bleeding to death. We asked Bernanke what would have happened if the Fed hadn’t acted.  Fed Chairman Bernanke: Unemployment would be much, much higher. It might be something like it was in the Depression. Twenty-five percent. We saw what happened when one or two large financial firms came close to failure or to failure. Imagine if ten or 12 or 15 firms had failed, which is where we almost were in the fall of 2008. It would have brought down the entire global financial system and it would have had enormous implications, very long-lasting implications for the global economy, not just the U.S. economy.
Bernanke: China “Risking Inflation” With Currency Policy – Federal Reserve Chairman Ben Bernanke said China is “risking inflation” in its own economy, while threatening other nations, by not allowing its currency to appreciate. In an interview with CBS’s “60 Minutes” posted on the program’s Web site, Mr. Bernanke said China’s policy was “not even in their own interest” in addition to hurting others. “Keeping the Chinese currency too low is bad for the American economy, because it hurts our trade,” he said. “It’s bad for other emerging market economies. It’s bad for China. Because among other things, it means that China can’t have its own independent monetary policy.” “If they fix their currency to the dollar, then they have to have the same monetary policy, essentially, that the United States has,” Mr. Bernanke said. “Now, the United States needs and has a relatively supportive monetary policy. China is growing very quickly. They’re risking inflation by importing U.S. monetary policy. And that that’s a problem for them.”

 China declares shift to "prudent" monetary policy – China’s non-manufacturing purchasing managers’ index fell to a nine-month low in November as accelerating inflation eroded service companies’ margins.  The index dropped to 53.2 from 60.5 in October, according to a statement today by the Beijing-based National Bureau of Statistics and the Federation of Logistics and Purchasing. A reading above 50 indicates an expansion. A separate service PMI released by HSBC Holdings Plc fell to 53.1, a near two-year low. Policy makers have raised benchmark interest rates and banks’ reserve ratios, and threatened to impose price controls, in a drive to rein in inflation that reached a two-year high in October. Higher prices may challenge the government’s plan to boost consumption, with a consumer confidence index last month showing the first drop in six quarters because of rising costs.

Marshall Auerback: What Happens if Germany Exits the Euro? As far as European Monetary Union goes, the prevailing thought has been that one of the weak periphery countries would be the first to call it a day (in Ireland’s situation, one could make a good case for it on the grounds of persistent spousal abuse). It may not, however, work out that way: All of a sudden, the biggest euro-skeptics in Europe are not the perfidious English, but the Germans themselves. Take a look at these headlines Germany and the euro: We don’t want no transfer union | The EconomistJenkins: Where Are the Business Europhiles Now? – WSJ.com. And even a book by Hans-Olaf Henkel, formerly of IBM (Germany), and hitherto one of Germany’s great euro-enthusiasts: English translation: “Return our Money”So let’s consider what happens if Germany decides to follow Herr Henkel’s advice. On the plus side, given Germany’s historic reputation for sound finances, the country will likely emerge with a strong Deutschmark, a global safe haven

Employment Report Emphasizes Need for Government to Get Out of the Way – The lack of employment growth is startling given corporate profits growth. Year-over-year, the net income of companies in the S&P 500 grew by 23.8%, excluding financials. Rather than putting this money to work in the form of employment growth or investment spending, companies have instead build up massive cash reserves. Moody’s estimates large corporations have $1 trillion of excess cash on balance sheet. Data from the Fed show that U.S. nonfinancial businesses hold over $2.4 trillion in cash in aggregate. This sort of cash hoarding is unprecedented, especially considering that nonfinancial businesses do not need the cash to reduce debt levels. The argument that corporations won’t hire or invest due to a lack of household demand is specious. Causality seems to run in the opposite direction. Household spending has held up remarkably well given the employment situation. Prior to the employment report, confidence of a turnaround was high due to the 6% rise in retail sales – the fastest growth since the business cycle peak in 2007. If the problem is not inadequate household spending or a reduction in liquidity facilities, why are businesses holding cash instead of hiring or making new investments? The best explanation is that the uncertainty created by current fiscal and regulatory policies has sapped business confidence.

U.S. food in pictures

Europe Update: The launch of "E-Bonds"? – The European finance ministers meet this week in Brussels. Some ministers are pushing to increase the bailout fund and others are arguing for "E-bonds" – joint European government bonds. Although the key 10-year bond yields fell sharply last week (Ireland, Portugal, Spain), the crisis is far from over. A couple of articles: From the NY Times: Pressure Rises to Bolster European Bailout Fund European finance ministers are under mounting pressure to significantly increase the €750 billion rescue fund for the currency union when they meet Monday. … Didier Reynders, the Belgian finance minister, suggested over the weekend that the fund … will have to be increased when it is made permanent after 2013, From the Financial Times: Europe’s leaders at odds over bond plan  Jean-Claude Juncker, Luxembourg’s prime minister who also chairs meetings of eurozone finance ministers, and Giulio Tremonti, Italy’s finance minister, argue in Monday’s Financial Times that the launch of “E-bonds” would send a clear message to financial markets and European citizens about the “the irreversibility of the euro”.


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