A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Wednesday, May 18, 2011

Transcript: 439 View from both ends, political nonsense rules

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I see abandoned buildings everywhere, businesses closed up, ah, small businesses throughout this nation. Everywhere I’ve gone in the last year, there are empty warehouses, empty commercial buildings, uh, small businesses closed up, out of business. Anywhere in the United States you go right now you’re going to see empty buildings, you’re gonna see empty storefronts. Out of business. Closed. Gone.

TOM ASHBROOK: And families, Willie, families, kids, How they doing?

WILLIE “UGLY” TISEER: Well, you know, everybody’s struggling. I mean, it’s not… The average person in this country is not the $150,000, $200,000 a year family. Out here in the real world that, that ... You know, ask any truck driver. You’re dealing with, ah… the working person in this country I would say averages somewhere between $23,000 and $60,000 is the actual middle working class. It’s not the large city, big money. And the people are hurting. I mean, everywhere you go you’ll find people having trouble paying their bills, kids that aren’t getting fed regularly. There’s people out of work. There’s people standing around that can’t find jobs. And then you have different levels of that. I mean, everybody’s upset. You know, and, and you see it all when you’re out here.

I listen to a lot of radio. Generally, people are upset. They’re tired. They’re tired of hearing promises that aren’t being kept. You know, you go to one radio program and a guy’s yelling about the Right, the Left, the Center, the Liberal, the Progressive, the Democrat, the Republican. It’s a 24 hour a day barrage of people screaming about what’s wrong and how bad we as Americans are. You know, it’s not… people are just depressed. Everywhere you go you can feel like a sense of anxiety, or whatever. People do not know what’s going to happen with this economy. I personally think our economy is going to tank.

That was long-haul trucker Willie “Ugly” Tiseer with Tom Ashbrook.

Partly in response to a listener’s comment on the transcript last week, that’s at DemandSideEconomics.net, we had to reconsider our characterization of a securitization market that has dried up. This is not the case. You will remember the TALF program, a Fed-sponsored scheme providing low cost non-recourse loans to people who would provide student loans, car loans, credit card loans and then submit them to the Fed as collateral. As we understand it, this program was widely popular for awhile, but is now wound down. Apparently with the private market filling the void. We suspect that pension funds and others needing certainty about repayment may have taken advantage of this. It was part of the panoply of Fed-sponsored programs that substituted for the market’s innovations when those innovations came a cropper. The Fed, you will recall, propped up money market funds, commercial paper and every other private credit function for awhile. The TALF’s $1 trillion came in combination with the remarkable $1.25 trillion in purchases of mortgage backed securities.

The propping up of the credit functions is testament to the exhaustion of the consumer economy. The project is doomed. Taken simplistically, consumption does not produce enough value to repay expanded credit. Consumers are already saturated with debt. It has been our theme that the consumer economy is dead, and attempts to float another bubble with zero interest rates and shifting the burden of lending to the Fed is a tortured and rocky road to nowhere. The value that can be created is in public goods – education, climate change mitagation, energy conservation, infrastructure construction and maintenance. You won’t see sexy models stroking them on television tonight, but they are what provides value. And nobody really denies it. They just ignore it.

Take for example, the mantra of innovation leading to economic expansion. Perhaps this is true. But what is not true is that corporations are the seat of innovation. Corporations operate on the Chinese model of copy, adapt, modify and sell for your own account. Actual innovation is made possible only by a huge public investment in education and often a huge public investment in providing the initial markets for innovation. Where would the airplane be without World War II and the military industrial complex? Where would the auto be without the intersate highway system and massive public investment in streets and roads? Where would the Internet be? Where would most advances in medicine be?

And this is exactly where our investment dollars should go now. To education and to direct investment in the products we need for planetary survival. The government’s making a market for energy efficiency and climate-friendly infrastructure will produce those products. Additional tax breaks to corporations so they can modify technology into another consumer gadget will not. We’ve been over this before. Maybe we’ll go there again. But we tire of the lame apologies for the stagnation of the economy when the assumption is a return to consumption-led growth is the only way out. It is a blind alley. The only way out is investment in public goods. It creats the value. Government provides the certainty of repayment of invested dollars that the private economy does not – except with outrageous central bank intervention. AND it provides jobs that cannot be outsourced. You’re not going to ship a road in from China. Nor educate your children in Chinese. Nor retrofit your office building with huge mandibles extending over the ocean.

We ask that you submit the question to your own common sense.


Now, here is James K. Galbraith speaking on the bipartisan molting going on in the nation’s capitol. It was the introduction to a symposium on the condition of cities and counties sponsored by the Economists for Peace and Security and the New America Foundation. Link online.


We meet today at a moment when the normally useful distinction between sense and nonsense seems to have disappeared on a bipartisan basis. All around us key points of principle have been given up. The political struggle is over what to cut and what to save, over how to bargain, and not over what to do.

In economic policy, magicians and necromancers have taken charge, brewing a toxic vat of program cuts and deregulation, from which they promise that, somehow, jobs will emerge. Serious people cite serious people on the subject of what serious people permit themselves to think. Meanwhile, the crisis in the country deepens, and hopes for a coherent strategic response to it recede.

You can see this in the content just revealed of the latest budget deal, which – as we increasingly face an environmental challenge and an energy crisis – targets the Environmental Protection Agency and the transportation system. And in the service of what? Deficit control and debt reduction. On this subtle, technical and deservedly obscure topic, today everyone is an expert because everyone adheres to the one true thought. We are witnessing one of the greatest waves of mass hysteria of all time, the fruits of one of history’s most intense and successful propaganda campaigns.

As a professional economist and one with a background in political work – I was here on Capitol Hill for many years, worked for the Congress – I am impressed. I am even in awe. Practically every avenue of debate has been closed off. And not by argument. Not even, as was the case thirty years ago when a few of us tried to stand in the way of the juggernaut of the Reagan economic policies, not even by the convinced philosopical positions of effective public intellectuals. But rather by endless repetition of the same slogans, repeated and barely detectable changes in the foundation of the argument, and silence in the face of criticism. That there are many economists, experienced people, impeccable credentials, who don’t buy the line, that history and comparative experience contradict it, is a secret to most people. We are hidden in this discussion behind a wall of invisibility.

Now I am not excessively worried at the moment, to be frank, as an economist by the recent rounds of short-term budget cuts. The lost income, after all, will be offset by falling tax revenues and increasing unemployment insurance, applications for disability, and so forth. And so the overall effect on total income will not be that large, just as the effect of the financial crisis was not that large. The deficit will not decline very much, and things will go on much as before. The regret here is that in most cases, we needed to do what we are not going to do. The environment and transportation are good things, even if an extra engine for a fighter aircraft can be dispensed with. It’s merely foolish to give these things up on the pretense that you are accomplishing something, when you’re not.

What worries me more is the prospect – which I think hangs over us all – that there will be a bi-partisan compromise on so-called “long-term deficit reduction,” the issue which even people who think themselves to be sensible and progressive concede must be dealt with, and that this compromise will do irreparable damage to the well-being of large parts of the American population, to what remains of the basic social infrastructure supporting what remains of the American middle class – Social Security, Medicare and Medicaid.

And for what?

The idea that there is an economic rationale for dismantling these most successful and effective social insurance programs, that have performed well and efficiently, with very low administrative costs, for many decades – close on to 70 years in the case of Social Security; since 1965 in the case of Medicare... the idea that the capital markets, for example, demand such an overthrow of these institutions is plainly absurd. The capital markets tell you every morning at what rate they are prepared to lend to the government of the United States for ten, twenty and thirty years into the future. And if people who have money, have their own money on the line, were seriously worried about the prospect that the United States government could not service its debts, or the prospect that the United States dollar will fall victim to a massive inflation, they would not be willing to lend to the United States government on the extremely favorable terms that everybody can see are now available. There is something wrong with this story.

And the idea that we should frame policy around a set of computer forecasts, produced even by so lofty and irreproachable organization as the Congressional Budget Office when the capital markets don’t take these forecasts seriously, and when anybody examines them, as very few people do, can see they are internally inconsistena and not reflective of any history of our economy, is even more absurd.

Meanwhile, it’s out in the country, and out in our states and our cities, that the immediate consequences of this policy environment are being felt. I live in Texas, and in my home state – which is far from being the worst effected by the financial crisis and the recession – my daughters bring home from school reports of the teachers in their public schools who will not be there next year, who have been laid off because the school district is facing a massive budget shortfall.
What will that do? Of course, it will degrade the quallity of the public programs that my children, many children, are in. What will the teachers do? Well, they will apply for jobs in the private schools to which middle class parents will feel forced to flee. And they will be hired and they will teach what they taught before, but for lower pay and at higher cost. This is supposed to be an economic improvement? Someone should explain to me where it comes from.

We are seeing cuts in Medicaid which I am told by nurses will produce closures of nursing homes. And what will people in those homes do? Many of them don’t have another place to go. So, of course, they will go to the emergency rooms and they will end up filling hospital beds. And guess what? This will be very good for the economy, because the hospital beds are much more expensive than the nursing beds. Hmm?

And I ask you, Where is the rationality in this? Where is the sense of organized purpose? Where is the goal of improving the performance of our economy? Or the living standards of our people? It is nowhere to be seen. In the rush to achieve things which are driven by some metaphysical notions that have become attached to accounting concepts.

And of course, looming over these issues, is the ugly question of power. The question really, which we have so vividly seen played out in the state of Wisconsin recently, but present many places in the country, of whether public servants – public employees – in this country have any rights to negotiate the terms of their employment.

Is there hope? I suggest that there is hope only if some of the people who we have assembled today are finally heard from, and if the proposals that they will be offering at this symposium are able to reach out and find a base of support in the country, if their voices can cut through the fog of propaganda and, really, of indifference to what is happening in the country that clouds so much of our policy dialog today. It is not an easy task.

.. but as was said fifty years ago, Let us begin.

Monday, May 9, 2011

Transcript: 438 Nouriel Roubini on how to defuse the debt bomb

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NOURIEL ROUBINI: Well, when you have a high debt problem, there are only four solutions for it. The best solution, of course, is growth. Because if your growth is high, then you can solve any problem, especially a debt problem, because the denominator upward GDP income is rising more than the numerator. Unfortunately, because of the balance sheet crisis, we are not going to have high growth in the Eurozone, in the US, in Europe. So we cannot grow ourselves out of the high debt problem.

The second solution is savings. If you spend less, consume less in the private/public sector, you save more and you reduce your debt. But then you have the paradox of thrift of Keynes. If everybody suddenly stops consuming, there is a recession, output falls, and you fall in the same trap. Or if you are doing fiscal consolidation and too much public savings front-loaded, again that’s recessionary. Output falls, your debt and deficit rise. So you cannot save yourself out of a debt problem.

The third solution is, of course, inflating yourself out of a debt problem. I don’t think central banks are going to take that path, even if you could make an argument that it might be a good idea. Reduce debt deflation, wipe out the real value of private and public debt through high inflation. That’s going to be dangerous in the long run, if we do that. Unlikely it is going to happen.

So, if you cannot grow yourself or save yourself or inflate yourself out of a debt problem, you have to do debt restructuring. That’s what’s going to happen. Debt restructuring of government: Ireland, Spain, Portugal. Debt restructuring of the household sector in countries where they had too much debt and a housing bubble that went bust. Debt restructuring of the banks, like in Ireland. You cannot essentially grow or save or inflate yourself out of a debt problem, eventually you have to have orderly debt reduction and restructuring. We have kicked the can down the road. We have not done it. We started with private debt. We pretended it was a liquidity problem.

We socialized those things. It became a public debt problem. In countries that have lost market access, now you have supernationals bailing out the nationals: Ireland, Portugal, Greece. Nobody is going to be coming from the moon or Mars to bail out the IMF or the ECB or the EFSF. So you cannot go from private to public to supernational debt. Eventually you have to restructure these debts. That’s a tough choice…
Nouriel Roubini. Author of Crisis Economics and one of the people who should be listened to because he was right.

One of the key insights of John Maynard Keynes and other demand siders, Hyman Minsky, Michal Kalecki, Steve Keen, and others, is that capitalism is basically unstable. It is prone to boom and bust. Intrinsically prone. This key insight has been rejected by the current policy framers, who have placed hopes and prayers for stability in the quintessential capitalist institution, the banks. This cannot end well.

And indeed, it is not ending well. The stabilization and bailout of the banks has not resurrected the economy decimated by a bank-led housing bubble. The myriad back-door bailouts, from cheap money and too-big-to-fail insurance to accounting changes and rejection of debt restructuring for households have not led to anything. Monetary policy has been a failure except in creating bubbles in emerging economies and bidding up the prices of liquid financial assets.

Which reminds us, the commodity bubble may have burst. It is fairly easy to tell a bubble after the fact, because there is no plateauing of the price at a level indicated by new supply/demand functions. No, no, no. All the supply and demand stuff is quickly forgotten in grateful praise of mercifully lower oil prices. But did the unrest in the Middle East suddenly subside? Is peak oil now less of a problem? Maybe demand from emerging markets is plummeting?

But it won’t drop fast enough for the cacophony of dunces we’ve captured for today’s Idiot of the Week. Led by head dunce Ken Pruitt of Bloomberg who has seen ten times the inflation that has actually existed and predicted a hundred times that amount.

We’ll hear more from Roubini as well. But first here is James Ferguson, head of strategy at Arbuthnot Securities.

The relationship we’ve seen between QE and inflation expectations, and the way that’s fed into commodities and particularly into stock prices does look very powerful. It’s quite clear that QE didn’t have the effects that Ben Bernanke was expecting, that is the effect on housing and on long bond yields. It has instead has this effect on inflation expectations and stocks.

So we have to expect that if QE II is going to end in June on schedule as now has been indicated that things may change a bit, that is, post-June. We may actually see a change in inflation, commodity-driving sort of market outlook.

So far as we can see in markets the relationship between the timing and the magnitude of QE has been very, very close to the timing and magnitude of changes in the stock market. So one would have to read from that that these things are happening in real time, not really being anticipated. I mean, after all, we’ve never really seen anything like this before, so people are guessing a lot in terms of how these things work themselves through the system.

Over the last sort of 12 to 18 months worldwide in markets, what we’ve seen is the beneficial impact of a quite unbelievably unprecedented amount of public sector balance sheet expansion, an amazing amounts of stimulus in terms of fiscal and monetary policy, which I don’t think people really appreciate how out of the ordinary that is. If you start taking this away… In the UK we have the austerity measures kicking in from this month onwards. In the US, of course, you’ve got your new political fiscal period starting in October, you’ve got the end of QE II in June. All other things being equal, I think, if you take this much stimulus out of the market, it is likely to lead or translate into some sort of a slowdown.

So I think we won’t be seeing more of the same because we’re not going to see the same levels of stimulus. We’re in a position where the authorities can manage the economic data sufficiently so we’re unlikely to have a double dip. Technically speaking to have a double dip we have to have two consecutive quarters of negative GDP growth. And I think if we had one, the authorities would step in pretty fast with QE III, with fiscal stimulation, et cetera. So I think what we’re going to get is we’re going to get a very managed decline, where the authorities basically hold back as much as they can on the stimulus. Which to some extent is getting to dangerous levels now in terms of debt to GDP.

But they’ll also be fine-tuning that with the results as they come in. So I think what we’ve seen is the sweet spot, where we had the stimulus without too much, um, negative attachment to that. Now I think what we’re going to have to be prepared for probably slower levels of growth than most people are used to

Maybe more like one percent growth over time, rather than, say, three or four percent.
James Ferguson

What you hear here is deep concern on the part of this trader that the end of QE II will spell the end of the demand pull on financial assets. What you don’t hear here is the connection between overheating economies and inflation in the developed world.

Let’s step back. As a lead-in to today’s idiot of the week, let’s consider the question: Why inflation?

Answer # 1: The Fed is printing money which is increasing the M in the Monetarists MV = PQ.


No. The Fed is pushing chips into the financial casino, which is bidding up the prices of financial assets which now include commodities plays. That is what has driven cost-push inflation. The V in MV has collapsed, so the M is meaningless.

Answer #2: Commodities are being bid up by the robust growth of emerging economies.


No. Bubbles in emerging economies are coming out of QE II and cheap Fed money fleeing to the latest rising price, but these economies are still small compared to the developed world. Some demand pull, yes, robust growth, no. At least not healthy growth.

Answer #3: The federal government is spending too much.


Answer #4: Inflation is always and everywhere a monetary phenomenon.


I guess that was a gratuitous buzzer in memory of Milton Friedman. See answer #1. Inflation is a general rise in prices. I saw a blogger try to say recently it is a general and continuous rise, but I think that’s a little bit of a stretch.

Answer #5: Inflation is something that can be dealt with by raising interest rates.

What, no buzzer?

ONLY because raising interest rates CAN cool an economy that is overheated by raising financing costs. And in the classic demand-pull inflation where prices are bid up by excess consumer demand, that might be effective. Do we have that now?


Okay. Enough of that noise. Overheated economy? Excess consumer demand over supply? Industrial output straining capacity. No. We don’t have that. We have a very stagnant economy, very slack consumer demand, and we have rising – or HAD rising – commodity prices. If you look just a little further than the end of your nose, you see that commodity prices – oil prices – are themselves a drag on demand and should in themselves crimp consumer demand for other products.

So. When you see inflation hawks talking about raising interest rates to combat inflation, you are seeing them throwing a millstone to a swimmer barely able to support commodity prices. Let me rephrase that. Increasing interest rates increases costs. In normal times, this would mean increasing prices. But financing at two percent vs. zero is not really the issue. The issue is lack of demand. No long-term large investment is being made in this environment, at least domestically, so no long-term large investments are going to be crimped.

What happens with higher food and energy? Households have to cut back. What does headline inflation measure? The aggregate of all prices. What does core inflation measure? All prices less energy and food. Let’s call food a surrogate for all commodities. Core inflation measures wages. Core inflation is stagnant because wages are stagnant.



CARL LANTZ: If you go back to last October, November, even during the summer of last year, we saw consumer spending was sort of flat-lining, industrial production momentum was slowing, and most importantly inflation expectations had fallen quite low – well below 2 percent in, say, ten-year TIPS. And I think the QE program more than anything stabilized those inflation expectations. So you’ve seen quite a dramatic rise to north of two-and-a-half percent. By taking, sort of, deflation off the table, you had risky assets do quite well.


And one of the other impacts of the QE program that I think is often underestimated is that by committing to this somewhat controversial program, the Fed made it very clear that they were a very long way from raising rates. So it was really less about driving long-term rates down as it was about stabilizing expectations around the timing of Fed hikes and the probability of deflation.

KEN PRUITT: Well, yeah, and well you say, last year it was the possibility of deflation, not enough inflation in the system. Now, and I’ve pointed this out before, you know, Carl, somebody listing to this, driving home from the supermarket with a stop at the gas station, doesn’t believe it when Mr. Bernanke says its only a temporary problem.


LANTZ: Well, I can sympathize. I just filled up the tank, and I didn’t realize this, but the credit card machine shut off at $100 in a twenty-six gallon tank.



… It was over four dollars, so I didn’t even fill up. Um. Yeah. That’s what we refer to as repeat purchases. We tend to buy gas quite frequently and food quite frequently, so that’s what influences our inflation expectations.

PRUITT: Well, I usually don’t pay that much attention. But I did notice yesterday I was spending twenty-two cents a gallon than I was a week ago.



LANTZ: Yeah. You can’t not notice it. You know, that’s part of the reason that QE II is going to end on schedule is, you know, the public for the most part has ignored the Fed over the years, and doesn’t really understand monetary policy. But I think this is a unique time in American history where the Fed is in the center of the sort of whole political debate about debt and deficits and inflation.

And, uh, I think that more than usual the public is perceiving inflation problems and it is being attributed to the Fed, with the help of some, you know, U-Tube cartoons and editorials. The Fed is in this difficult position of not wanting to raise rates, but having to talk tough when it comes to inflation expectations. So we’ve seen a lot of hawkish comments from the usual suspects. Even the doves, I think, are what I would say are conditionally hawkish. They say, “If this is more than transitory, we’ll do something.” But that begs the question, What is transitory?

LAKSCHMAN ACHUTHAN (ECRI): Right. The doves, one of them, I think the New York Fed president kind of got in an interesting discussion about this, that food and energy prices are rising, and I think he was trying to make the point that the broad basket of inflation hasn’t really risen very much.

But that is lost on the public because you’re buying food and energy. And they’re still maintaining…. Some key Fed officials are still maintaining a relatively dovish view. And when you look at the tea leaves on the FOMC, you know, and all the, you know, the doves and the hawks. Is there a shift going on, or are they all staying in their camps?

LANTZ: I think it’s more complicated than just the two camps. It seems to me that around this issue of energy and commodity prices there is a robust discussion about to what extent the Fed is contributing to it. And the party line from the core is that they are not. But I would refer people back to the March FOMC statement where they mention rising commodity prices only in the context of inflation. And they said they expected it to be transitory – in parenthesis, you know, they hope it’s transitory – but they didn’t emphasize it as a drag on growth, which some of the doves might have historically preferred to characterize it in those terms. So I think the hawks are making some headway with the argument that the Fed can’t just assume that it’s all external to monetary policy.


Let’s cleanse the palate with some more observations from Nouriel Roubini, here speaking to the potential virtue of inflation, but with a caution. And you haven’t heard that caution from Demand Side, who has seen inflation as a way of helping reduce the real value of the debt burden. Roubini makes some telling points here. But remember, the successful recoveries from previous post-war recessions have entailed some inflation. Also remember from Kalecki and Minsky that inflation or reflation is inevitable with any meaningful increase in investment, because the new workers in the investment goods sector will be competing with the consumption goods workers for the output of the consumptions goods sector. This will be true whether the investments are in new factories for private goods or – much better – in infrastructure, energy, education and climate change mitigation – the public goods we need.

But here, responding to the question, Yes, we shifted the debt from the private to the public sector and are now shifting it to the IMF and supernational institutions. Couldn’t we then go to inflation?
TOM KEEN: Can’t we go from private to public to supernational to inflation?

ROUBINI: We could do that. That’s an option. I would say on two counts, on a normative one it is not desirable for three reasons, and on a positive one it is not likely. It is not desirable for three reasons. One , if the inflation genie gets out of the bottle, then you’re going to need a nasty Volcker-style recession to break the inflation expectation and bring back the genie into the bottle. Or as Premier Yen, Wen said the other week, “Once the inflation tiger is out of the cage, bringing it back in is going to be very difficult.” That’s the first problem.

Secondly, inflation can reduce the real value of nominal debt at fixed rates. But most of the liabilities in the system today are short term at variable rates. Liabilities of the banking system, of the household sector, of government. As soon as you rise expected inflation through inflationary policy, all that stuff gets repriced. And unless you have hyper-inflation, then debt reduction doesn’t occur through inflation.

Three, and more importantly, the last time we used the inflation tax to wipe out our private and public debt, in the 70’s twice, we were a net creditor country, and we were a net lender country. We were running a current account surplus. Today we are the biggest net debtor in the world, to the tune of $3 trillion, and we are the biggest net borrower in the world. Our current account deficit is still half a trillion a year. So we have to borrow from the rest of the world.

And our creditors who are still financing us are not going to bend over and accept a massive capital levy on the holding of dollar assets if we are going to wipe out the real value of these dollar assets through inflation and debasement of the currency. There will be a run against the dollar, a collapse of the dollar, a spike of long rates.

Those are telling points. What they mean to me is that inflation as a strategy is not in the cards. How would it be done when the money supply is not available as a useful tool? I don’t know. They might try more of the QE stuff, shoving cheap chips to the financial players. But the inflation incident to new investment may be palatable, since it would be more contained and would be accompanied by growth.

Thursday, May 5, 2011

Transcript: 437 German banks in worse condition than the Greek state?

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That was George Magnus of UBS speaking to Bloomberg, admitting, more or less under his breath, that the hysteria around sovereign debt in Europe has not been about the sovereigns, but about the banks. If you have been following Demand Side for long, you are aware that we pegged this early on. Further, it is not the bonds that are restructured that is the problem, but the derivative credit default swaps that will reallocate all this paper according to wagers made in other times. After all, when you buy a bond, you are getting paid for taking a risk, so the eventuality of restructuring is in the picture from the beginning. The absurdity is that many times the value of the actual bonds have been “insured” by credit default swaps, so the financial players are looking at a far more significant event than the state of Greece. And the fact of restructuring is almost assured, at least for Greece, by the change in the language. It is now “restructuring” instead of “default.”
Why now? The new Greek budget deficit came in worse than forecast. Quelle Surprise. Austerity failed to produce prosperity. According to the Wall Street Journal
Greece's budget deficit in 2010 was 10.5% of gross domestic product, significantly larger than forecast ... Lower-than-expected government revenue was the main culprit behind the higher deficit number. ...

The missed target was "mainly the result of the deeper-than-anticipated recession of the Greek economy that affected tax revenue and social security contributions," the Greek government said in a statement.

As Calculated Risk said trenchantly, “More austerity coming - the beatings will continue until morale improves!”

Also on today’s podcast, Robert Kuttner with more on the nonsense economics of austerity, Robert Reich pointing out that not everyone is suffering under high oil – witness Exxon-Mobil, Econ Intersect’s Rick Davis on the suddenly slowing GDP numbers, Steven Hansen and Doug Short, also of Econ Intersect, on how price is inflating seemingly solid PCE numbers, Keith Jurow on the high end strategic defaults that could spell serious trouble for any housing recovery, Elliot Morss on the Gini measurements of income inequality which put the U.S. in the wrong neighborhood, the melting GDP projections from Ben Bernanke and the Fed, the silliness of the Conference Board’s leading economic indicators LEI – which point to the sky as the economy trips on the ground, Calculated Risk on the outlook for residential and nonresidential investment, and Dennis Altig of the Atlanta Fed on the latest plan to unwind the Fed’s trillion dollar plus purchase of mortgage back securities – it’s a bad bank! I kid you not. Following on from Allan Meltzer, it is to spin off the garbage purchased from the financial sector into a bad bank. The Fed as a bad bank. What a concept.

Let’s get going.

Robert Kuttner, of Demos and American Prospect, pointed out correctly last week that austerity will only slow down the recovery. “The idea that a steeper path to deficit reduction will somehow restore business confidence and thus more than offset the hit to purchasing power is just blarney. And with both parties committed to some version of austerity, we could easily have the worst of both worlds -- increasing inflation coupled with persistent stagnation.”


“Can the president shift to a rhetoric and policy that emphasizes the need for more jobs and a stronger recovery, and soon? Let's hope so. There is nothing like an election hanging to concentrate a politician's mind.”

Robert Reich, the former labor secretary, wants us to remember that Exxon-Mobil’s first quarter earnings of $10.7 billion are up 69 percent from last year. That’s the most profit the company has earned since the third quarter of 2008 — perhaps not coincidentally, around the time when gas prices last reached the lofty $4 a gallon.
This gusher is an embarrassment for an industry seeking to keep its $4 billion annual tax subsidy from the U.S. government, at a time when we’re cutting social programs to reduce the budget deficit.

Demand Side notes that 2008 is the year of the great financial crash, and asks you to remember our call on the oil and commodity bubble in November of last year, when we predicted it would trigger – not cause, but trigger – a new leg down.

Rick Davis at Econ Intersect dissected the disappointing GDP number for Q1 2011. The BEA’s advance estimate put it at 1.75% down significantly from the 3.11% growth rate reported for the fourth quarter of 2010. Davis unpacks the lower growth into: somewhat weaker consumption of durable goods, weaker fixed investments, substantially weaker overall trade numbers, and increased contraction in governmental expenditures. The only improving factor was stronger inventory growth, which reverted to form after an anomalous fourth quarter reduction (most likely driven by a noisy, if not aberrant, price “deflater”).
The BEA’s “Advance” GDP growth estimate differs on average about 1.2% from their eventual third (i.e., “Final”) growth estimate. In July they will restate previously reported growth rates dating back to the first quarter of 2003. “Those restated growth rates are not necessarily minor,” says Davis. “Last July we learned that the “Great Recession” was worse (by as much as a percent in nearly every quarter) than previously reported, and that the bottom of the recession occurred a quarter earlier than we had been previously been told.”
Doug Short and Steven Hansen of Econ Intersect point out that March 2011 Personal Income and Consumption Expenditures from the BEA look good until cost increases are considered. Most of the increases are due to rising prices.
At Minyanville – and this is one of the few links we have online for today’s podcast –

Keith Jurow posted under the title “Strategic Defaults Revisited: It Could Get Very Ugly.”
According to Wikipedia, a strategic default is “the decision by a borrower to stop making payments (i.e., default) on a debt despite having the financial ability to make the payments.”
Jurow defines a strategic defaulter to be “any borrower who goes from never having missed a payment directly into a 90-day default.”

When home prices were rising rapidly during the bubble years of 2003-2006, it was almost inconceivable that a homeowner would voluntarily stop making payments on the mortgage and lapse into default while having the financial means to remain current on the loan.

Things have changed, particularly in those major metros where prices soared the most during the housing bubble. Homeowners who have strategically defaulted share three essential assumptions:

• The value of their home will not recover to the original purchase price for years.
• They can rent a house similar to theirs for considerably less than what their mortgage payments.
• They could sock away tens of thousands of dollars by stopping mortgage payments before the lender finally got around to foreclosing.

A last point on Jurow’s article. The high end underwater homeowner is more likely to choose strategic default. That is, although by far most defaults occur at the lower end, if you are in a high end home, you are less likely and willing, though presumably more able, to stick it out if you are under water.
Demand Side has from the very beginning, actually following the lead of Robert Kuttner, advocated use of the Home Owner’s Loan Corporation model and writing down the principle on loans to avoid the mess we are now witnessing. Since the big banks and others would have had to take a hit, to realize risk was not just a cherry on top of their returns, that idea has so far been quashed. Some form of mortgage bankruptcy is necessary for recovery.

Elliott Morss looked at the the Gini coefficient across countries. A measure of income inequality developed by Italian Corrado Gini a century ago, a coefficient of 0 means everyone earns the same income; a Coefficient of 1 denotes total income inequality. The range of better to worse among nations begins in Sweden and runs roughly from Northern Europe, through Central Europe, Southern Europe, Canada, Australia, India, Japan, and China before finally arriving in the United States. The US at 45 is in a cohort with China and Singapore in the 40s. No other developed nation is above 34. Full list online

Baffled Ben Bernanke held a news conference. Seemed to go well. People bought what he is selling. Things are sadly slow, but stable. Yes, we have zero percent interest rates, and we’ve actually been forcing money into the financial sector. But look, the stock market is up. And better to pay attention to our predictions and projections than the way things actually turn out. You’ll feel better.

But GDP is melting already for 2011. The Fed’s ideas for unemployment are holding up well. They are helped by the continuing weakness in the denominator – participation – as well as by the fact that the 2011 number is defined as the average in the fourth quarter, and we aren’t quite there yet.

April 2011 Economic projections of Federal Reserve Governors and Reserve Bank presidents
2011 2012 2013
Change in Real GDP 3.1 to 3.3 3.5 to 4.2 3.5 to 4.3
Previous Projection (Jan 2011) 3.4 to 3.9 3.5 to 4.4 3.7 to 4.6
Unemployment Rate 8.4 to 8.7 7.6 to 7.9 6.8 to 7.2
Previous Projection (Jan 2011) 8.8 to 9.0 7.6 to 8.1 6.8 to 7.2
PCE Inflaton 2.1 to 2.8 1.2 to 2.0 1.4 to 2.0
Previous Projection (Jan 2011) 1.3 to 1.7 1.0 to 1.9 1.2 to 2.0
Core PCE Inflation 1.3 to 1.6 1.3 to 1.8 1.4 to 2.0
Previous Projection (Jan 2011) 1.0 to 1.3 1.0 to 1.5 1.2 to 2.0

FOMC definitions:
1 Projections of change in real GDP and in inflation are from the fourth quarter of the previous year to the fourth quarter of the year indicated.
2 Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year indicated.

Calculated Risk picks up a report showing that in a March survey almost half of the housing market is now distressed properties.

This trend is likely to continue as a backlog of foreclosures and mortgage defaults make their way through the housing pipeline.
Survey respondents reported mixed opinions on traffic for the winter and spring housing market. “January, February and March sales were characterized by a wait and see attitude of buyers.
[S]hort sales boomed in the month of March and the proportion of damaged REO fell. REO is property owned by banks. Damaged is damaged, by situation or condition.

Calculated Risk also points out that residential investment and non-residential investment in structures are at record lows as a percentage of GDP. Residential Investment (RI) decreased in Q1, and as a percent of GDP, RI is at a post-war record low at 2.21%.

Non-residential investment in structures is at a record low of 2.48% of GDP, and will probably stay depressed for some time.

Residential investment (RI) is the best leading indicator for the economy. This isn't perfect - nothing is - but RI is usually a strong leading indicator for the business cycle.

In 2011, CR says, residential investment will make a positive contribution to the economy for the first time since 2005. The five years of drag on GDP from RI (2006 through 2010) is the longest period on record, breaking the previous record of four years from 1930 to 1933 (yeah, the Great Depression). The positive contribution this year will mostly be due to a pickup in multifamily construction (apartments) and in home improvement. However single family housing starts will continue to struggle.

And still CR is positive on the economic prospects. Demand Side is not. We note that most states are within striking distance of their high marks for the current recession in terms of unemployment rate.

On the darker side of reality, we find the The Conference Board Leading Economic Index® (LEI) for the U.S. LEI increased 0.4 percent in March to 114.1 (2004 = 100), following a 1.0 percent increase in February, and a 0.2 percent increase in January.
Says Ataman Ozyildirim, economist at The Conference Board: “The U.S. LE’s continued increase in March points to strengthening business conditions in the near term. The March increase was led by the interest rate spread and housing permits components, while consumer expectations dropped. The U.S. CEI, ® a monthly measure of current economic conditions, also continued to rise, led by gains in industrial production and employment.
Yes, indeed, we have liftoff at the Conference Board, but as EconIntersect points out,
“It is confusing—“ EconIntersect’s word – “confusing why The Conference Board does not comment on the historically unprecedented monetary measures (the monetary measures set by the Fed) which are creating a forward looking index which has questionable forward looking ability.”

“Confusing” and “Questionable”, nice neutral words. Particularly since in other news, the NFIB’S Small Business Optimism Index fell again, Consumer Metrics says flatly “consumer weakness continues,” and current data is being revised downward.

Now to the Bad Bank solution

Posted by Dennis Altig at macroblog, but referring to star idiot of the week Allan Meltzer’s op-ed in the Wall Street Journal, which says, among other things:

"One of the Fed's recent errors was increasing the money supply by buying more than $1 trillion of mortgage-backed securities as part of its 'quantitative easing' policy. Its hefty balance sheet now threatens to finance further inflationary increases in the money supply. How can it be unwound in an orderly way?"

"One idea is for the Fed to create its own version of a 'bad bank.' The Fed should promptly put the $180 billion of its long-term government debt and more than $1 trillion of its mortgage-backed securities into a separate entity. The long-term government debt and mortgage-backed securities would be the new bank’s assets. (The $1 trillion in Fed-created 'excess' bank reserves as a result of quantitative easing would become the liabilities of the bad bank.)

"The Fed would make a commitment not to sell any of the bad bank's mortgage-backed securities and Treasurys until they mature. Almost half of the Fed's currently held assets, more than $1 trillion, have 10 or more years until maturity, so all of them would be off the table as far as financing inflation during the gradual economic recovery. As the mortgages mature and are paid off, the bad bank's assets decline.

The reduction in the bad bank's assets means that its liabilities, the excess reserves, would also decline—though that would be years away. Letting the market know precisely when the mortgage-backed securities would be sold makes the adjustment to the future elimination of excess reserves manageable."

Altig says it sounds okay. Demand Side says, I dunno. Let’s see, we bought these things to push money into the economy and force interest rates down. Why don’t we sell them if we are worried about inflation. If inflation rears its ugly head, just sell the stuff, take that money right out of the economy like that.

Oh, Right, nine-tenths of it is garbage. You can’t sell it. There is no market for it. That’s what it means when Altig says, “ winding down of the mortgage-backed securities (MBS) and long-term Treasury securities on the Fed's balance sheet should be conducted in a way that avoids market disruption and distortion as much as possible.” Code for junk. When we can’t sell it, that means, let’s get the right coded language here, “the excess reserves held in the banking system—the liability side of the Federal Reserve’s balance sheet—have to be removed or "locked up" as needed to avoid an inflationary expansion of broad money and credit.”

Bad Bank!

The best idea is, of course, to make the sellers take it back because it is not at all what it was presented to be.

Oh, yeah, that’s the other bad banks.