Friday, May 8, 2015

UK Election - Quick Thoughts

On the morning after a shocking UK Election result here are a few quick observations on the data. The big winners were the Scottish Nationalist Party (SNP) who picked up roughly 50 seats at the expense of Labour and the LibDems and the Conservatives who won an outright small majority and in the process eviscerated their LibDem coalition partners. In 2010 voters backed the LibDems to some extent as a protest against the pro-war and  pro-banker policies of the Blair era Labour.

This time the protest vote went to the SNP in Scotland and the UK Independence Party in England. Ironically, UKIP which picked up hundreds of thousands of votes over 2010 and finished at 13% - got one seat in Parliament. The SNP which runs candidates only in Scotland, swept every district except three and won an additional 50 seats over 2010.

In a manner typical for British politics after a hard fought contest … heads are rolling as the leaders of Labour, LibDems and UKIP all resigned their posts. More on the travails of Labour and challenges for the next government soon.

Wednesday, February 11, 2015

The BIS Paper on Borrowing and Leverage in OIl

The Bank for International Settlements, the international banking consortium, has done a study of instability in the oil price regime. They find that the drop in prices is not solely related to changes in production and consumption; but rather due to leveraged hedging by producers and the middlemen. Sound familiar? The same tactics that infected the housing market last decade are now at work devaluing oil assets.

Saturday, February 7, 2015

Not the Time to Raise Interest Rates

The January 2015 Unemployment report was released today and it shows continued growth in the number of Americans with jobs. In fact, as the graphic shows we are up almost two million positions from the point of highest employment prior to the recession. This is due to the increase in the activity in the private sector which has experienced some measure of growth for over fifty straight months. Parenthetically, public sector job growth is a NEGATIVE 600,000 over the same period. The government has been implementing restrictive fiscal policy and despite this the economy has seen some growth, though less than we would typically expect coming out of a deep recession. The challenge is that we are barely keeping up with the growth in potential GDP, and haven't made significant progress closing the GDP created by the economic crisis. The positive actor has been the Federal Reserve which has kept interest rates low and for a few years took extraordinary measures to provide liquidity to the economy, keep interest rates grow and to try something to generate growth.

Despite this weakness there is discussion of having the Federal Reserve start to raise interest rates from the zero lower bound and the justification is the normal nonsense about preventing inflation (which is non-existent). But there are other economic headwinds that will be made only worse if US interest rates rise. In the last few months the US Dollar has strengthened against most foreign currencies. Against the Euro alone there has been a shift of about 20% in the favor of the dollar. This trend has deepened because of monetary policies taken abroad which have lowered interest rates or injected liquidity in Europe, Asia and Latin America. The US Dollar has gone from near parity to a 25% premium over the Canadian Dollar during this period.

Not surprisingly, we have already seen the inevitable result of this movement. Growing trade deficits. The US runs persistent current account deficits and if the dollar does not drop in value against foreign currencies those deficits will continue and under current trends … deepen. Having the Federal Reserve raise rates will only make this problem worse. When the currency strengthens against others it worsens our trade position (it makes foreign goods and services less expensive relative to our own) depressing exports and increasing imports. A widening traded deficit means that more income from the US is shifting overseas making it less likely that we will achieve the recovery we need from the crisis of 2007-2009. The Federal reserve should postpone any action that will cause the rebound in private sector employment to abate.

Thursday, January 29, 2015

Ratner and Europe


Apparently the NY Times feels the need to give equal time on their oped page to disgraced investment bankers but I am not sure why we should read the pieces. Today, Ratner is trying the make the case that it is a bad thing if wages rise in Europe. While Dean Baker does a nice take down of his argument I think it points to a deeper issue which is that somehow what is good for workers is bad for business. It is a fundamental rule in economics that one person's expense is another person's income. After all, where is the business supposed to come from? I suppose if our cause for concern is the fortunes of makers of 50 foot yachts you might make the argument that paying skilled blue collar workers better is not going to help sales.

It is not clear from his graphics what his baselines are for "output" and what currency he is measuring. My guess this is just another screed on behalf of oppressed rich investment bankers everywhere.


Tuesday, January 27, 2015

Greece and a Moment for Hope

There was a bright moment this week as voters in Greece opted for radical change from the course that has crippled Europe since the beginning of the economic crisis. The election of a government lead by Syriza, as well as a decent showing for other center-left and leftist parties, holds up hope that a democratic movement might grow across Europe to fight austerity and provide an alternative to the cynicism and despair of the radical right.

But there are those that would stand in the way. The Troika (EU, IMF and ECB) lead by voices from Germany rail against the demands for lessening of the mutual economic destruction pact that is represented by arbitrary deficit goals. In the case of Greece and other countries, the assistance from the Troika to stave off default on sovereign debt came with crippling restrictions. The result has been internal devaluation (severely lower incomes), high unemployment and mass misery. The parties of bigotry, such as the National Front in France or Golden Dawn in Greece or UKIP in the UK, have an appeal that capitalizes on the anxiety of people suffering at the whim of the distant (seemingly anyway) powers.

The parties of the left that have tried to make their peace with austerity have suffered at the polls. Some have suffered division or worse (Pasok the former governing party of the left in Greece is a shadow of its former self). Can the other parties looking at a general election such the Socialists in France or the Labour Party in the UK learn a quick lesson from Syriza and support their cry for a people oriented solution to stagnation and speculation? The next steps by these parties may tell the tale of their fate in elections soon to come.

Thursday, January 22, 2015

Deflation and the current economy, Part II - The Swiss Case

Today the other shoe dropped in that the European Central Bank announced its formal program for extraordinary measures to combat economic stagnation and the spectra of deflation. The size of the program, 60 Billion Euro per month for at least 18 months, should certainly impress the markets. Whether they will accomplish the goal, is another question. Again the central bankers are trying to inflate the economy to push back on levels of unemployment that are deemed to be too high. However, because they and so many "very smart people" are pushing further into an age of austerity the normal lever of fiscal policy is not being used in Europe.

While fiscal policy in the US is nothing to write home about it has been used a bit, whereas in Europe the concern over sovereign debt has lead governments to cut back worker pay and therefore standards of living. This contributes to the deflationary pressure in Europe which is spreading to other parts of the world. In part the Euro common currency is to blame. Since 19 European countries are part of a single currency, those that need a devaluation like Greece or Spain, could not get it because their partners included Germany which wanted to keep the currency stronger. The currency devaluation makes the countries (or zones) products less expensive and is designed to help balance trade through higher exports and lower imports. For countries that needed a rebalancing they were forced to internally devalue through lower wages, lower social benefits and higher taxes. Theoretically, this gets them to the same place but it requires sacrifices by specific members of society rather than the across the board cuts if a currency was revalued.

The shoe that dropped last week was Switzerland. The Swiss (not part of the EU or the Euro Zone) years ago pegged their currency to the Euro in order to maintain a stable exchange rate. The method of maintaining the peg involved going into the currency markets to purchase Euros and supplying Swiss Francs in order to bolster the value of the Euro, versus the Franc. This action resulted in that more or less stable rate that the Swiss banking authorities wanted but ballooned the balance sheet of the Swiss central bank as they accumulated more and more foreign currency. Last week, in the face of the effective devaluation of the Euro (QE and lower interest rates will decrease the value of the Euro versus other currencies) the Swiss gave up on the peg and let the currency rise to a market level. The change was a drop of over 20% (see the cliff graphic above).

The pressure for the rise in value of the Franc comes from the fact that Switzerland has been running persistent trade surpluses with the rest of the world for many years. Economic theory tells us that under this circumstance the country's currency should rise and that will make their products more expensive and exports will fall and imports rise (they can buy more from overseas) and the balance will be reestablished. This is great for economists but not so great for politicians as they have a hard time explaining to people their recessionary activities to create balanced international trade. But the Swiss are not going to get away free here as they were already facing deflationary pressure (their CPI peaked in 2010 and has been declining since) and the strengthened currency will only make it worse.

Switzerland has a very low unemployment rate at 3.4%  but they have seen a small upswing since the summer when it was at 2.9%. The currency float should force some higher levels of unemployment in the near term. Why didn't they continue their peg? Too much foreign currency. Why didn't they just use the currency for something like a sovereign investment fund? They are Swiss after all and don't like entanglements in other countries.

We will see bad things happen to companies with Swiss HQ and operations abroad. The currency will make foreign profits disappear. The deflation (that everyone is facing) will put pressure on profits and prices everywhere. More unemployment will result from the contracting economies. All because Europe refuses to take the more direct path to recovery … reverse austerity. End a very bad idea.

Wednesday, January 21, 2015

Deflation and the current economy, Part I

As part of The Great Moderation mainstream economists thought they had rid themselves of the scourge of inflation. Since the double recession of the early 1980's the US inflation rate has operated within a band that did not cause policymakers to react harshly to price fluctuations. In fact, the Federal Reserve has acted in order to prevent the rise in price level (see late 1980's and 1990's increases in interest rates). These actions which constrict the money supply are designed to increase interest rates and raise unemployment. All in order to hold the line on prices.

Since the technical great recession ended in 2009 the thrust of central bank action in the US has been to try to get around the monetary policy restrictions of the zero lower bound by trying extraordinary action called Quantitative Easing (QE). This involved purchases of government bonds and mortgage backed securities, a process that ended last year. The hope is that the increased purchases would help lower longer term interest rates and spark investment in depressed areas of the economy (housing) and business expansion. Its effectiveness is still under debate.

Other parts of the world basically rejected that approach. Until now. The European Central Bank is working this week on a plan to engage in its own form of QE. But as always they are cowed from doing the important things correctly because of pressure from Germany. Why the concern? Deflation. Yes, a spectre is haunting Europe (and the rest of the world). Deflation. As we see from the above chart of the US we have been seeing disinflation here … lower and lower rates of inflation. We are on the path to deflation too.

Why the deflation? Because of the premature rush to austerity that the world engaged in since 2009 economies have absorbed that by lowering public expenditures, lowering incomes and lowering prices. So the problem with deflation is that it means lower incomes too. This is what has plagued Japan (much of the period since 1990 has seen low rates of inflation or outright deflation), Europe and perhaps soon the US and China.

This problem intensified The Great Depression. It is now wrecking the living standards of Europe particularly in those countries suffering from internal devaluation. Remember that the same people that thought that inflation was a solved problem came up with this cure that is looking worse than the problem. What can we do about this?