Trichet Hikes, Two More Expected; Bank of England Holds; Fundamental Factors Affecting Currencies; Is Trichet's Move the Right Move?

For the first time in 40 years, the European benchmark rate has risen before the US. ECB president Jean-Claude Trichet is concerned about wage growth fueling inflation.

There may be reasons to hike, but wage growth is not one of them. For starters, the only place wages are likely to rise is Germany. Secondly, the idea that wage growth causes inflation is potty.

After months of denial, Portugal is asking for a bailout. The next step is negotiating the terms.

Like the Fed, the Bank of England is standing pat. BOE Governor Mervyn King has placed recovery ahead of inflation. All of these items have been expected.

ECB Hikes Benchmark Rate to 1.25%, More Hikes Expected

Trichet hiked rates as expected. He had been signaling the move for months. Moreover, Trichet Leaves Door Open to Further Rate Moves.

Inflation risks remain on the upside and the ECB’s monetary policy is still “accommodative,” Trichet said at a press conference in Frankfurt after lifting the benchmark rate by a quarter percentage point to 1.25 percent. While “we did not decide it was the first in a series of interest-rate increases, you know from our own doctrine that we always do what is necessary to deliver price stability over the medium term,” he said.

While bonds erased declines and the euro initially fell after Trichet’s comments as some investors pared bets on rapid rate increases, markets still expect the ECB to raise its benchmark to 1.75 percent by the end of the year, Eonia forward contracts show.

The ECB joins central banks in China, India, Poland and Sweden in raising interest rates even as the Federal Reserve remains reluctant to tighten amid divisions among its policy makers. The Bank of England and the Bank of Japan today left their key rates unchanged at 0.5% and 0.1% respectively.

Today’s ECB increase is the first since July 2008 and also the first time in 40 years that Europe’s benchmark has risen before the U.S. equivalent.

“The ECB is setting rates in relation to Germany,” said Vicky Pryce, managing director of FTI Consulting Inc in London and a former adviser to the U.K. government. “It’s a bold move, but a wrong one,” she said, adding Greece, Ireland, Portugal and possibly Spain “need a rate increase like a hole in the head.”

Is Trichet's Move the Right Move?

There is no doubt Trichet has adopted a "One Size Fits Germany" Policy.

Is that the right move?

The answer to the question depends on whether you look at things from the point of view of Germany or from the point of view of Greece, Ireland, Portugal and Spain.

Moreover, and more importantly, Trichet and the ECB should not be making these decisions in the first place. Interest rates should be set by the free market.

Bear in mind that bureaucrats, not a free market dreamed up the EU currency union without fiscal controls, thereby ensuring "one size does not fit all".

Whatever the ECB does, it is highly likely to screw up one or more European countries. Is this any way to set rates?

Portugal Needs $100-$110 Billion Bailout

After months of denial, soaring interest rates forced Portugal's hand. Portugal’s Socialist prime minister, José Sócrates, bowed to market pressures Wednesday night, requesting a bailout.

The New York Times Reports Next Step for Portugal: Negotiating a Bailout

Portugal’s Socialist prime minister, José Sócrates, bowed to market pressures on Wednesday night and requested a bailout from the European Commission, joining Greece and Ireland.

The rescue call, however, comes amid a leadership vacuum in Portugal that might not even be resolved by a general election on June 5. Mr. Sócrates resigned last month when center-right opposition lawmakers led by the Social Democratic Party rejected his austerity package.

One estimate by a European official put Portugal’s needs at about 75 billion euros ($106.5 billion), but some analysts have suggested that the amount could be as much as 110 billion euros. Last year, Greece secured a rescue package worth 110 billion euros and Ireland 85 billion euros.

But consensus among Portugal’s political leaders will not be easy. While opposition leaders agree that Portugal needs a bailout, policy makers in Lisbon know they will must get all sides to support the austerity measures that will be demanded by the international lenders.

To complicate matters, the negotiations are taking place in the midst of an election campaign that will probably be dominated by the question of who is to blame for Portugal’s predicament. The leader of the main Social Democratic opposition party, Pedro Passos Coelho, supported the decision to seek outside help, but he and Mr. Sócrates are blaming each other for forcing Portugal to seek a bailout in the first place.

If the pattern of previous bailouts is repeated, it could take several weeks for a team of Brussels and perhaps International Monetary Fund officials to discuss the conditions of a bailout with Lisbon, which will ultimately need to be approved by European finance ministers.

Bank of England Holds Rates

Bloomberg reports Bank of England Holds Rate, Putting Recovery Before Inflation

The Monetary Policy Committee, led by Governor Mervyn King, set the key rate at 0.5 percent for a 26th month, as forecast by all 57 economists in a Bloomberg News survey. It also left its bond-purchase program at 200 billion pounds ($327 billion), as predicted by all 32 economists in a separate poll.

U.K. gross domestic product rose 0.7 percent in the first quarter after a 0.5 percent drop in the previous three months, the National Institute of Economic and Social Research estimated yesterday. The group, whose clients include the Bank of England and the U.K. Treasury, said underlying growth remains “weak.”

The British Chambers of Commerce this week said first- quarter growth was probably between 0.6 percent and 0.7 percent. It said this is weaker than expected and adds to the argument that the Bank of England should delay raising its key interest rate, which has been at 0.5 percent since March 2009.

At the Bank of England’s March meeting, Andrew Sentance called for a 50 basis-point increase, while Martin Weale and Spencer Dale voted for a 25-basis-point move. Adam Posen maintained his call to expand stimulus with more bond purchases. The minutes of today’s meeting will be published on April 20.

Investors have priced in a 25 basis-point jump in the rate by July, according to forward rates on the sterling overnight interbank average, or Sonia, compiled by Tullett Prebon Plc.

“The MPC is in a very cautious mood, but it will have been a very close call,” Joost Beaumont, an economist at ABN Amro Bank NV in Amsterdam, said before the announcement. “I still hold on to the view they will hike in May. Data have been relatively upbeat recently.”

Mute Market Reaction

All of today's actions were expected.

Currencies are essentially flat across the board but the Euro is down slightly.

Fundamental Factors Affecting Currencies

• Should the ECB not hike twice more as expected, or should the sovereign debt crisis renew with concerns about Spain, expect the Euro to weaken. I believe a sovereign debt crisis led by Spain and Ireland will resurface. Timing is unknown.


• Should the Bank of England delay rate hikes past May, expect the British Pound to weaken.


• Expect the Yen to weaken if Japan does not pass tax hikes to raise money to pay for earthquake, tsunami, and nuclear damage.


• Expect the Australian dollar to weaken if the Reserve Bank of Australia cuts rates. I do expect rate cuts as the Australian housing bust picks up steam.


• Should Republicans manage to cut the US deficit or the Fed to signal a change in stance, expect the dollar to strengthen.


• A Bernanke signal for QE III would certainly be dollar bearish and very bullish for gold. Terminating QE policies would likely be dollar bullish.
  

Finally, sentiment, is amazingly bearish towards the US dollar (I believe unjustifiably so). Extreme sentiment is seldom rewarded, but once again timing is unknown.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Too Many Bureaucrats and They Are Paid Too Much - Part II

In response to Too Many Bureaucrats and They Are Paid Too Much I received an email from reader "Kurt" saying "Please get a grip". Kurt thinks the size of government is not a problem.

Here is the video Kurt was responding to. The video is from Daniel J. Mitchell, Ph.D. Senior Fellow, The Cato Institute. I am a big fan of the Cato Institute. They stand for Individual Liberty, Free Markets, and Peace. Those are three admirable goals.



Proving that some people can neither read nor think, Kurt sent a graph from Calculated Risk regarding Government Employment Since 1976.



Interestingly, the Cato video posted a similar chart then went on to dispute it three ways, first by salary, second by mentioning quasi-government employees, and third by pointing out figures do not include military employees, postal workers, subsidy recipients, or contract jobs.

Here is a chart from the video.



Those numbers are from 2005. Care to guess where those numbers are now?

Here is another way of looking at things

Manufacturing and Construction vs. Government Employment



Quasi-Public Jobs

Bear in mind the government employment numbers do not include "Quasi-Public" jobs.

Please consider Current Decade of Job Losses vs. Great Depression; How Did Quasi-Public Jobs Fare? Who is Whining?

Public and Quasi-Public Jobs vs. Everything Else



Please see Mandel's article for a state-by-state breakdown.

Who is Doing all the Whining?

Who is doing all the whining and all the pissing and moaning? The answer of course is those who fared the best in the last decade: the police and fire unions, the teachers' unions, transit unions, and public unions in general.

Many in private sector fields have been hammered silly with rapidly rising healthcare costs and lower paychecks (assuming they have a job at all). Meanwhile those with the most benefits and those who have suffered the least are the ones unjustifiably bitching to high heavens about how unfairly they are being treated.

The above chart is from A Decade of Labor Market Pain by Mike Mandel.

March 2000 vs. March 2011

Let's look at this one final way. Let's compare Establishment Data from March 2000 to Establishment Data March 2011.

Government workers in 2000: 20.944 million
Government workers in 2011: 22.547 million

Private workers in 2000: 109.080 million
Private workers in 2011: 107.360 million

In the last 11 years government employment rose by 1.603 million
In the last 11 years government employment rose by 7.65%

In the last 11 years private employment fell by 1.72 million
In the last 11 years private employment fell by 1.58%

Once again, recall that government jobs exclude military, post office, and contract work.

Amusingly the person who wrote me said I need to "get a grip". No Kurt, you need to listen to what the video said, then think.

Anyone who thinks government bureaucracy is not massive is simply not thinking. The same applies to anyone who thinks government workers are not overpaid.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Vibrant to Vacant: Mall Vacancies Highest in 11 Years; Online Retail Sales Hit 12%

Online retail sales keep climbing, big box retailers keep wondering what to do with all their space, and small stores struggle to survive at all. As a result of that nasty brew, Malls Face Surge in Vacancies.

Mall vacancies hit their highest level in at least 11 years in the first quarter, new figures from real-estate research company Reis Inc. showed. In the top 80 U.S. markets, the average vacancy rate was 9.1%, up from 8.7%.

The outlook is especially bad for strip malls and other neighborhood shopping centers. Their vacancy rate is expected to top 11.1% later this year, up from 10.9%, Reis predicts. That would be the highest level since 1990.

In the Denver suburb of Westminster, Colo., city officials are negotiating to buy and raze the 34-year-old Westminster Mall and redevelop it into offices, homes and stores. The 1.2-million-square-foot mall, once home to a Macy's, Trail Dust Steak House and Mervyn's, has seen its sales-tax generation plummet in recent years, to $1.5 million last year from $8.5 million in 2000, city officials say.

The mall went "from a place that was once vibrant to something that is now virtually vacant."

Shopping Center Economic Model

In 2005, the mall-vacancy rate hit a low of 5.1%. For strip centers the boom-time low vacancy rate was 6.7% that same year.

On April 18, 2008 I wrote Shopping Center Economic Model Is History

Lease rates are going to sink, vacancies are going to soar, and the oncoming supply of mall space with no tenants is going to bankrupt many regional banks that funded such construction. The shopping center economic model will soon be history.

Bank Failures

Inquiring minds may be interested in a recap of Bank failures in the United States 2008–2011

2008: 25
2009: 140
2010: 157
2011: 26

Only So Many Shoppers

A couple weeks ago I was contacted by a reporter in Las Vegas about a new mall going up in the city. I told him the obvious: There are only so many shoppers.

What good can a new mall do? During construction it will provide a few jobs. Then what? Then instead of shopping at the old mall people start shopping at the new mall. No one buys any more stuff.

Shopping Center Dynamics

Ironically, is quite common for city councils to give huge tax breaks to new businesses that "create jobs".

Mayors love ribbon-cutting events like mall openings. Then a few years down the road if not sooner, everyone wonders where the jobs are and why expected sales tax revenues did not materialize.

There is no need to wonder. The answer should be easy to spot in all the vacant strip-malls and closed stores elsewhere.

To be sure, there are some city revivals, but those come at the expense of shoppers staying local rather than driving to the nearest town . The reverse also happens. People travel to the new mall in the neighboring city rather than shop local.

This dynamic ensures that malls and strip-malls go up everywhere until there is a crash, which is precisely where we are now.

Online Sales Compound the Mall Problem

A few years back online sales were about 6% of total sales. Online sales hit 12% this past Christmas. State and local governments are more than a bit upset about the lost sales tax revenue.

Malls and big box retailers are upset too. Everyone hates Amazon, except Amazon customers.

Big box retailers have a glut of space and many are starting to shrink the number of items they carry. However, every item they do not carry that someone wants to buy, is another item someone will decide to buy online.

Yet, every online purchase is one less trip and fewer miles on the car. Thus online shopping also impacts gasoline sales, gasoline tax collection, and car maintenance.

Demographics

The population is getting older. In advanced years, much of what people buy is health- or food-related, not gadget-related or travel-related.

A certain set of people never became comfortable with the internet and internet shopping. Younger generations have no aversion to buying online or not buying at all.

Those fresh out of college are deep in debt and struggle to pay that debt off.

As boomers head into retirement many are scared half to death about insufficient savings. Their peak shopping years are now well behind them.

One bright spot lately has been a revival in luxury items. However, that has largely been a result of the stock market revival. Should there be a sustained relapse in the stock market, luxury sales will take another dive as well.

In light of the above, I see no sustainable revival in the shopping center economic model for years to come.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Too Many Bureaucrats and They Are Paid Too Much

Please consider the following YouTube video by Daniel J. Mitchell, Ph.D. Senior Fellow, The Cato Institute.



Here is a link in case the above video does not play: There Are too Many Bureaucrats and They Are Paid too Much

I met Dan Mitchell last week at the Kauffman Foundation. Every year, Kauffman holds a conference for economic bloggers. It's a lot of fun and I have participated 3 consecutive years.

I am a big fan of the Cato Institute. They stand for Individual Liberty, Free Markets, and Peace. Those are three admirable goals.

I just added them to my left sidebar under the heading "Taxpayer Friendly Sites". Inquiring minds may wish to bookmark their site.

Addendum:

Proving that some people can neither read nor think, I received an email from an apparent government sympathizer showing a graph by Calculated Risk on Government Employment Since 1976.

Interestingly, the Cato video posted a similar chart then went on to dispute it three ways, primarily by salary, second by mentioning quasi-government employees, and third by pointing out figures do not include military employees, postal workers, subsidy recipients, or contract jobs.

Here is a chart from the video.



Those numbers are from 2005. Care to guess where those numbers are now?

Quasi-Public Jobs

Bear in mind the numbers also do not include "Quasi-Public" jobs.

Please consider Current Decade of Job Losses vs. Great Depression; How Did Quasi-Public Jobs Fare? Who is Whining?

Public and Quasi-Public Jobs vs. Everything Else



Please see Mandel's article for a state-by-state breakdown.

Who is Doing all the Whining?

Who is doing all the whining and all the pissing and moaning? The answer of course is those who fared the best in the last decade: the police and fire unions, the teachers' unions, transit unions, and public unions in general.

Many in private sector fields have been hammered silly with rapidly rising healthcare costs and lower paychecks (assuming they have a job at all). Meanwhile those with the most benefits and those who have suffered the least are the ones unjustifiably bitching to high heavens about how unfairly they are being treated.

The above chart is from A Decade of Labor Market Pain by Mike Mandel.

Amusingly the person who wrote me said I need to "get a grip". No Kurt, you need to listen to what the video said, then think.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

California Governor to Start Dog and Pony Fear-Mongering Campaign to Raise Taxes

California Governor Jerry Brown is annoyed at Republicans who have blocked his plan for massive tax hikes to balance the budget. In response, the governor plans to take his case straight to the voters.

Please consider Brown Plans California Drive to Keep Taxes as New Cuts Loom

California Governor Jerry Brown said he’ll propose a new budget next month and plans to campaign in Republican districts to win support for a statewide referendum to retain $9.3 billion of higher taxes and fees.

The plan will show how he intends to erase the most- populous U.S. state’s remaining $15.4 billion deficit, said Brown, 72.

Brown will begin a series of events around the state to persuade voters that Republican lawmakers are wrong to block his plan to extend expiring tax and fee increases for five more years to prevent deeper spending cuts to schools and public safety. The temporary increases are set to end in June.

Last month, Brown said he had broken off negotiations for a statewide vote after being presented with a widening list of Republican demands.

“Rather than continuing to negotiate with Senate Republican Leader Bob Dutton on a bi-partisan budget with long- term solutions, Governor Brown is going on a dog-and-pony show to sell voters on short-term gimmicks and $50 billion in tax increases,” said Jann Taber, a Dutton spokeswoman.

Brown Wants Massive Tax Hikes

The governor wants voters to ...

1. Extend a 0.25 percentage-point increase in personal income-tax rates
2. Boost retail sales taxes by 1 percentage-point
3. Boost auto-registration fees by 0.5 percentage point to 1.15 percent of a vehicle’s value
4. Reduction the state’s annual child tax credit to $99 from $309

The only one of those that is remotely reasonable is number 4. However, in return for number 4, Republicans should ask for passage of right-to-work laws.

Expect Biggest Fear-Mongering Campaign in History

Every public union in the state will throw money at Brown's effort in what will likely be the biggest public union fear-mongering campaign the world has ever seen.

Republicans should preemptively counter with their own statewide referendums to ...

1. Eliminate prevailing wage laws
2. Enact right-to-work laws
3. End defined benefit plans for public workers
   
4. Reduce sales taxes 1 percentage point
5. Reduce state income taxes .50 percentage points

If Brown Wants Referendums, Give Him a Handful

Items 1, 2 and 3 would engage public unions on multiple fronts as well as siphon union ad money from fear-mongering tax hike campaigns.

Besides, you never know. Voters are fed up with tax hikes and public union extravagance. Some of those proposals might pass.

There is one sure way to find out: If governor Brown wants referendums, give him a handful.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

No Path to Prosperity: Ryan's Incredulous Budget-Balancing Proposal, Preposterous Unemployment Estimate

Many Republicans have embraced Paul Ryan's proposal to balance the budget. I can't embrace his plan because it will do no such thing.

I questioned the idea in Government Shutdown Battle to Be Followed by Bigger Fight; GOP wants $4 Trillion in Cuts Over Next Decade; Is that Enough?

The proposal is now up to $6 trillion in cuts. However, $6 trillion over a decade is still not enough.

Congressional Budget Office Reply to Paul Ryan's Proposal

Inquiring minds may wish to consider the Congressional Budget Office reply to to Paul Ryan's Proposal.

Long-Term Analysis of a Budget Proposal by Chairman Ryan

CBO has conducted a long-term analysis of the major provisions of the proposal as described by the Chairman’s staff. The specifications may differ in some ways from the plan released today by Chairman Ryan in The Path to Prosperity: Restoring America’s Promise.

The proposal specifies a path for all other spending (excluding interest) that would cause such spending to decline sharply as a share of GDP—from 12 percent in 2010 to 6 percent in 2022 and 3½ percent by 2050; the proposal does not specify the changes to government programs that might be made in order to produce that path. Total spending under the proposal would be about 21 percent of GDP in 2030 and almost 15 percent in 2050. The proposal also specifies a path for revenues relative to GDP—rising from 15 percent in 2010 to 18½ percent in 2022 and 19 percent in 2030 and beyond.

The resulting budget deficits under the proposal would be around 2 percent of GDP in the 2020s and would decline during the 2030s. The budget would be in surplus by 2040 and show growing surpluses in the following decade. Federal debt would equal about 48 percent of GDP by 2040 and 10 percent by 2050.

No Credible Proposal Can Ignore Interest On National Debt

The CBO reply is 28 pages long but quite frankly the above snip is pretty much all you need to see to understand Ryan's proposal will not balance the budget.

No credible proposal can ignore interest on the national debt. I counted 10 instances of the phrase "excluding interest" in the CBO reply.

To be fair, the alternative proposals "excluded interest" as well. However, that only makes Ryan's proposal better than the alternatives, it does not make it any good.

Surplus by 2040?!

The idea that anyone can estimate out to 2040 is preposterous. Heck it is hard enough to figure out what will happen three years from now.

Here is a set of questions for you: How many recessions will there be by 2020? Does Ryan's plan take any recessions into account? Does the CBO's analysis?

Forget 2040. To be remotely credible, any plan would need to balance the budget by 2020.

By that measure, Ryan's plan fails right up front.

What About Defense Spending?

Can we really be serious about tackling the deficit while doing nothing about defense spending? I think not, and Ryan wimps out big time by failing to address it.

The United States spends more on defense than the rest of the world combined. We have troops in 140 countries. Yet, the simple fact of the matter is the US can no longer afford to be the world's policeman.

If other countries want our troops, perhaps they should pay us. However, it would be better yet if we would simply leave on our own accord.

As long as we are packing our bags, we should pack up and leave Iraq and Afghanistan. It's time to declare the wars are won and leave.

If we do that, and pull some troops home, it should be an easy matter to cut $200 billion a year out of the defense budget. That would save $2 trillion over 10 years. Actually I think we should cut far more, but I am hoping to come up with a number that has a chance.

Sharing the Sacrifice

• Where is the proposal to share the pain?
• How about lowering wages and benefits of those in Congress?
• How about reducing Congressional staff budgets?
• How about making Congress immediately accept the same health-care plan it passed for the rest of the country?
• If everything is on the table, where the hell is defense?
  

People are fed up Congressional hypocrites and actions by both Democrats and Republicans is why.

Ryan's Path to Prosperity

Inquiring minds are reading an Op-Ed in the Wall Street Journal by Paul Ryan. Please consider The GOP Path to Prosperity

The president's recent budget proposal would accelerate America's descent into a debt crisis. It doubles debt held by the public by the end of his first term and triples it by 2021. It imposes $1.5 trillion in new taxes, with spending that never falls below 23% of the economy. His budget permanently enlarges the size of government. It offers no reforms to save government health and retirement programs, and no leadership.

Our budget, which we call The Path to Prosperity, is very different. For starters, it cuts $6.2 trillion in spending from the president's budget over the next 10 years, reduces the debt as a percentage of the economy, and puts the nation on a path to actually pay off our national debt. Our proposal brings federal spending to below 20% of gross domestic product (GDP), consistent with the postwar average, and reduces deficits by $4.4 trillion.

A study just released by the Heritage Center for Data Analysis projects that The Path to Prosperity will help create nearly one million new private-sector jobs next year, bring the unemployment rate down to 4% by 2015, and result in 2.5 million additional private-sector jobs in the last year of the decade. It spurs economic growth, with $1.5 trillion in additional real GDP over the decade. According to Heritage's analysis, it would result in $1.1 trillion in higher wages and an average of $1,000 in additional family income each year.

Preposterous Unemployment Estimate

I have no idea what the normally sane Heritage Foundation is smoking at the moment, but the idea that Ryan's Path to Prosperity will lower the unemployment rate to 4% by 2015 is pure nonsense and I can prove it.

Let's start with a look at the April Employment Report (March Data). The unemployment rate is calculated from the Household Survey.

Household Data From Latest BLS Job Report



In the last year, the civilian population rose by 1,841,000. Yet the labor force dropped by 489,000. Those not in the labor force rose by 2,330,000. Were it not for people dropping out of the labor force, the unemployment rate would be over 11%.

Forget about what the unemployment rate really is, and let's do projections as if 8.8% is realistic.

Parameters

• The civilian labor force is currently 153.406 million (from the above BLS report)
• The current number of employed is 139.864 million (from the above BLS report)
• According to the Census Bureau Population Estimates the US will add about 2.5 million working age (16 years old and up) citizens a year from now until 2020.
• Population numbers vary slightly year to year. I used an estimate of the average summing up the buckets from 16 to 100+ for the years in question and rounding the result.
• Let's give the Heritage Foundation some leeway with its "by 2015" projection, say until March of 2015.
  

Unemployment Math

Now that we have our starting parameters, let's see what it takes to get the unemployment rate to drop to 4% in four years.

Four years from now the labor pool will be larger by 10 million (2.5 million x 4).
10 million + 153.406 million = 163.406 million.

4% of 163.406 million is 6.536 million unemployed.

163.406 million in the labor pool - 6.536 million unemployed = 156.870 million employed.

Thus we need 156.870 million employed by March of 2015 to have the unemployment rate drop to 4%.

Required Employment (156.870 million) - Current Employment (139.864) = 17.006 million new jobs.

Additional Math

17.006 million jobs (354,000 jobs a month for 48 consecutive months) is the straight up math it would take to get the unemployment rate to 4% by March of 2015.

Unfortunately it is an understatement.

In the past year alone, those "not in the labor force" (from the above BLS report) rose by 2.330 million. Those are people who want a job but are not counted in the labor force because they stopped looking for work.

According to the April 2008 BLS Employment Report (March data) , there were 79.211 million "not in the labor force". Currently there are 85.594 million "not in the labor force".

Thus 6.383 million people dropped out of the labor force in the last 3 years.

Should jobs become available, many of those "not in the labor force" would start looking for a job, and the act of looking for a job would add them back in the labor pool.

That would put upward pressure on the unemployment rate and add to the number of jobs the economy would have to create to get the unemployment rate to drop to 4%.

For the sake of argument, let's assume only those who dropped out in the last year would look. Let's be real generous and assume there will not be an additional huge influx of those hiding out in college.

The labor pool would be 163.406 million + an additional 2.330 million "now looking for work". The revised labor pool is therefore 165.736 million.

Let's crunch the numbers again.

4% of 165.736 million is 6.629 million unemployed.
165.736 million in the labor pool - 6.629 million unemployed = 159.107 million jobs.
159.107 million jobs - 139.864 million current jobs = 19.243 million jobs.

An additional 19.243 million jobs is a very realistic estimate of what it would take to get the unemployment rate to 4% by March of 1015.

19.243 million jobs in 4 years is 4.811 million jobs a year, or 401,000 jobs a month for 48 consecutive months.

Note the absurdity of the Heritage Foundation statement "Path to Prosperity will help create nearly one million new private-sector jobs next year" as if that would put a dent in the unemployment rate.

Monthly Job Growth 1999-2009



The above table shows monthly job growth from 1999 through 2009. I put that table together in November of 2009.

Notice that in the height of the housing boom in 2005-2006, the highest average monthly job total was 212,000 jobs a month. At the height of the internet boom in 1999 with Greenspan stepping on the gas over absurd Y2K fears, the economy added 264,000 jobs a month.

At the peak of the commercial real estate boom in 2006-2007, the economy added somewhere between 96,000 jobs a month and 178,000 jobs a month.

Let's be realistic. The housing boom is not going to come roaring back. Nor is the commercial real estate boom, nor is another internet boom.

Quite frankly it is preposterous to suggest that by cutting spending the economy will add 400,000 jobs a month for 48 straight months. Heck, even the straight up number of 354,000 jobs a month is preposterous.

No Path to Prosperity

Flat out, Ryan's proposal is no path to prosperity. It is a step in the right direction but the best we can say about it is that it delays bankrupting the nation.

Republicans need to take another look at Ryan's assumptions on growth, on jobs, on interest on the national debt, on military spending, on shared sacrifice, and on the idea that budget projections 30 years from now make any sense .

Ryan's plan may be far better than Obama's but neither plan is a "Path to Prosperity".

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Roubini on China’s Unsustainable, Unbalanced Growth Model; China Unexpectedly Hikes Interest Rates to Counter Inflation, Exorbitant Home Prices

In an unexpected move to curb soaring inflation China hiked interest rates for the 4th time since October. Premier Wen noted a threat to social stability and stated “Exorbitant” house price increases in some cities are a top public concern.

Please consider China Raises Interest Rates to Counter Inflation Pressure

China raised interest rates for the fourth time since the end of the global financial crisis to restrain inflation and limit the risk of asset bubbles in the fastest-growing major economy.

The benchmark one-year lending rate will increase to 6.31 percent from 6.06 percent, effective tomorrow, the People’s Bank of China said on its website at the end of a national holiday. The one-year deposit rate rises to 3.25 percent from 3 percent.

The move comes as a surprise to some, after Credit Suisse Group AG, Morgan Stanley and Bank of America-Merrill Lynch said officials may pause in tightening. While Japan’s disaster and Europe’s debt woes are clouding the global outlook, Premier Wen Jiabao’s government is more focused on the estimated 5 percent jump in consumer prices last month, said analyst Shen Jianguang.

It’s “very significant” that China raised rates before the March inflation data has even been announced, said Shen, a Hong Kong-based economist at Mizuho Securities Asia Ltd. who formerly worked for the International Monetary Fund and the European Central Bank. “This is a good preemptive move.”

Premier Wen last month described inflation as “a tiger” that once set free will be difficult to cage, and also as a potential threat to social stability. “Exorbitant” house price increases in some cities are a top public concern, he said.

Today’s announcement contrasted with central bank Deputy Governor Yi Gang saying March 23 that interest rates were at a “comfortable” level and that he was “not too worried” by inflation because price increases will slow in the second half of the year.

China’s Unbalanced, Unsustainable Growth Model

Via Email update, Nouriel Roubini sent out a note regarding China's growth.

I’m writing on the heels of two trips to China during which I met with senior policy makers, bank executives and academics, just as the government launched its 12th Five-Year Plan, intended to rebalance the long-term growth model. My meetings deepened my own impression and RGE’s long-standing house view of a potentially destabilizing contradiction between short- and medium-term economic performance: The economy is overheating here and now, but I’m convinced that in the medium term China’s overinvestment will prove deflationary both domestically and globally.

Once increasing fixed investment becomes impossible—most likely after 2013—China is poised for a sharp slowdown. Continuing down the investment-led growth path will exacerbate the visible glut of capacity in manufacturing, real estate and infrastructure. I think this dichotomy between the high-growth/inflation pressures of the next couple of years and growth hitting a brick wall in the second half of the quinquennium is far more important than the current focus on a “soft landing” amid double-digit growth. A number of local scholars close to policy circles agree that this is the biggest challenge of the next few years, as we’ve been saying for months.

• Despite policy rhetoric about raising the consumption share in GDP, the path of least resistance is the status quo. The details of the new plan reveal continued reliance on investment, including public housing, to support growth, rather than a tax overhaul, substantial fiscal transfers, liberalization of the household registration system or an easing of financial repression.
• No country can be productive enough to take 50% of GDP and reinvest it into new capital stock without eventually facing massive overcapacity and a staggering nonperforming loan problem. Most likely after 2013, China will suffer a hard landing. China needs to save less, reduce fixed investment, cut net exports as a share of GDP and boost consumption as a share of GDP.
• China is rife with overinvestment in physical capital, infrastructure and property. To a visitor, this is evident in brand-new empty airports and bullet trains (which will reduce the need for the 45 planned airports), highways to nowhere, massive new government buildings, ghost towns and brand new aluminum smelters kept closed to prevent global prices from plunging.
• It will take two decades of reforms to change the incentive to overinvest. Traditional explanations of the high savings rate (lack of a social safety net, limited public services, aging of the population, underdevelopment of consumer finance, etc.) are only part of the puzzle—the rest is the household sector’s sub-50% share of GDP.
• Several Chinese policies have led to a massive transfer of income from politically weak households to the politically powerful corporates: a weak currency makes imports expensive, low interest rates on deposits and low lending rates for corporates and developers amount to a tax on savings and labor repression has caused wages to grow much less than productivity.
• To ease this repression of household income, China would need a more rapid appreciation of the exchange rate, a liberalization of interest rates and a much sharper increase in wage growth. More importantly, China would need to privatize its state-owned enterprises so that their profits become income for households and/or massively tax SOEs’ profits and then transfer those fiscal resources to the household sector.

Medium Term Deflationary

Interestingly, Roubini concludes "China’s overinvestment will prove deflationary both domestically and globally."

When viewed from the point of destruction of credit and the wiping out of malinvestments especially in the property sector, I would agree.

The question is how Chinese officials respond and to what degree.

China May Be Slowing More Than You Think

In many respects, Roubini echos the beliefs of Michael Pettis.

As noted in Hidden Losses and Little Reform; China May Be Slowing More Than You Think, Pettis thinks a slowdown in China may have already started.

One difference is that Pettis is not convinced of a "hard landing".

On this score, I side and have sided with Roubini. The case for a "hard landing" is sound. Can anyone cite any instances when there has been this much malinvestment where there has not been a hard landing?

How Will Rate Hikes Affect China's Property Bubble?

In early February I was wondering How will Rate Hikes Affect China's Stock Market and Property Bubbles?

Currently it is taking credit growth 3-4 times GDP growth to achieve China's growth target.

Something has to give. Can China grow 10% without huge investment-driven growth, without rampant credit expansion? What about speculation in the stock market?

Michael Pettis at China Financial Markets expects the Chinese stock market to be firm until President Hu Jintao and Premier Wen Jiabao retire next year.

I am not so sure. It is quite possible a series of hikes weighs on the market. Besides, stock market rallies per se will not help China achieve its GDP targets.

When Do Imbalances Matter?

At some point, China will be forced to address massive imbalances in its investment-driven growth model, make numerous market-driven changes in its banking system, and address the untenable nature of its growth targets in general.

Will the stock market and China's economy wait for a leadership change or will the market force some changes via CPI spikes before then?

I suspect the latter. Moreover, it's entirely possible the series of quarter point baby steps hikes weighs on the equity markets sooner than expected, especially if the frequency of those hikes increases faster than expected, even if credit growth continues unabated.

Implications of the Hard Landing

I spoke about a Chinese hard landing in February in Speculation, Investment Scandals, Fraud, and China's Hard Landing; Miracle of Chinese High-Speed Rail will be Reduced to Dust; Peak Oil Doomsday Clock. Inquiring minds will want to take a look.

In case you missed it, also consider World's Biggest Property Bubble: China's Ghost Cities Revisited; 64 Million Vacant Properties.

The video in the link immediately above is a "must see".

Those who believe or hope China's growth will continue unabated will at some point see those beliefs crash on the hard rocks of reality.

Roubini, Pettis, and I are all guessing as to when these imbalances matter, to what degree, and how hard the landing, but I will leave you with a couple of questions, one I asked earlier: Can anyone cite any instances when there has been this much malinvestment where there has not been a hard landing?

While pondering that question, also ponder the implications for commodities as discussed in Anatomy of Bubbles; Negative Returns for a Decade Revisited; Is Gold in a Bubble?

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Fed Lending Increases Ultimate Cost of Bank Failures; 111 Banks Fed Lent Money to Failed

Via emergency lending mechanisms recently released data shows that 111 banks the fed tried to keep alive via emergency lending procedures ultimately failed.

Please consider the New York Times article Fed Help Kept Banks Afloat, Until It Didn’t

During the frenetic months of the financial crisis, the Federal Reserve stretched the limits of its legal authority by lending money to more than 100 banks that subsequently failed.

The loans through the so-called discount window transformed a little-used program for banks that run low on cash into a source of long-term financing for troubled institutions, some of which borrowed regularly from the Fed for more than a year.

The central bank took little risk in making the loans, protecting itself by demanding large amounts of collateral. But propping up failing banks can increase the eventual cleanup costs for the Federal Deposit Insurance Corporation because it keeps struggling banks afloat, allowing them to get even deeper in debt. It also can clog the arteries of the financial system, tying up money in banks that are no longer making new loans.

The discount window is a basic feature of the central bank’s original design, intended to mitigate bank runs and other cash squeezes. But access to it historically has been limited to healthy banks with short-term problems.

Those limits moved from custom to law in 1991, when Congress formally restricted the Fed’s ability to help failing banks. A Congressional investigation found that more than 300 banks that failed between 1985 and 1991 owed money to the Fed at the time of their failure. Critics said the Fed’s lending had increased the cost of those failures.

The central bank was chastened for a generation but in 2007, facing a new banking crisis, the Fed once again started to broaden access to the discount window. It reduced the cost of borrowing and started offering loans for longer terms of up to 30 days.

More than one thousand banks have taken advantage. A review of federal data, including records the Fed released last week, shows that at least 111 of those banks subsequently failed. Eight owed the Fed money on the day they failed, including Washington Mutual, the largest failed bank in American history.

Charles Calomiris, a finance professor at Columbia University who has studied discount window lending during previous crises, said the Fed had not released enough information for the public to determine whether some of the recipients were propped up inappropriately and should have been allowed to fail more quickly.

Marvin Goodfriend, a professor of economics at Carnegie Mellon University, said that such lending placed the Fed in the inappropriate position of deciding the fate of individual banks, choices that he said should be made by elected officials.

“What I think is the lesson from this is that the Congress needs to clarify the boundaries of independent Fed credit policy,” Professor Goodfriend said. “There should be a mechanism so that the Fed doesn’t have to make these decisions on behalf of taxpayers.”

Boundaries are Not the Problem

The Fed does not care about boundaries or what is legal or not. The obvious implication is mechanisms to define Fed boundaries would be futile. We need to eliminate the Fed itself.

Fed Uncertainty Principle Revisited

Inquiring minds and new readers are noting the Fed Uncertainty Principle, written April 3, 2008, predicted this event well before things got seriously out of hand.

Uncertainty Principle Corollary Number Two: The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.

Uncertainty Principle Corollary Number Four: The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it's easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.

FDIC 's Role in the Mess

The irony in blaming the Fed for increasing the mess for the FDIC, is that the FDIC itself is fraudulent.

I have made that case repetitively, most recently in Fed Releases 895 PDFs in Response to Court Order; Fed Does Not Disclose Collateral for Loans; Why Secrecy is a Problem; FDIC's Role in the Mess

Notice the misguided policies of the Fed and FDIC. By preventing all bank runs for decades, the Fed instilled an artificial and undeserved confidence in banks.

It would be far better to disclose banks in trouble, let them go under one at a time quickly, rather than have a gigantic systemic mess at one time.

Secrecy, in conjunction with fractional reserve lending is an exceptionally toxic brew. Overnight trust can change on a dime, system-wide, and it did.

Moreover, by keeping poor banks alive (and my poster-boy for this is Chicago-based Corus Bank for making massive amounts of construction loans to build Florida condos), more money pours into failed institutions further increasing toxic loans.

Failure of FDIC

FDIC is a part of the problem. When the government guarantees deposits, everyone believes in every bank no matter how poorly they are run or what risks those banks poses. No one has any incentive to seek a bank with good lending practices. Instead they seek a bank that pays the highest yield because it is guaranteed.

Driving deposits to banks that take the most risk is no way to run a system. Yet, that is precisely what the FDIC does, up to the FDIC limit of course.

People look at FDIC as a big success because there was no crisis for decades. Instead, we had one gigantic crisis culminate at once, hardly a fair tradeoff for periods of artificially low problems.

FDIC is Fraudulent

No only is FDIC a problem, it is outright fraudulent to guarantee deposits that cannot possibly be guaranteed in a fractional reserve Ponzi-scheme system.

For further discussion of the problems with fractional reserve lending please see Central Bank Authorized Fraud; Fractional Reserve Lending Problems Go Far Beyond "Duration Mismatch"

Also see an excellent discussion on the Acting Man blog: Fractional Reserve Banking Revisited

Ending the secrecy is easy. Simply abolish the Fed. However, that not the only thing that needs to happen. For a look at solutions, please consider Geithner's Blatant Lies at the G20 Meeting; Four-Pronged Solution

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Dear Treasury Secretary Geithner, With All Due Respect Please "Go To Hell"

Treasury Secretary Geithner is not happy the Republicans have held the debt ceiling hostage to budget negotiations. In response, Geithner has embarked on a fear mongering campaign via a Debt Limit Letter to Congress promising financial Armageddon if the debt ceiling is not raised.

Here are a few of Geithner's fear-mongering snips from the letter:

The Honorable Harry Reid
Democratic Leader
United States Senate
Washington, DC 20510

Dear Mr. Leader:

I am writing to update you on the Treasury Department’s projections regarding when the statutory debt limit will be reached and to inform you about the limits of the available measures at our disposal to delay that date temporarily.

In our previous communications to Congress, we provided regular estimates of the likely time period in which the debt limit could be reached. We can now make that projection with more precision. The Treasury Department now projects that the debt limit will be reached no later than May 16, 2011.

If the debt limit is not increased by May 16, the Treasury Department has authority to take certain extraordinary measures, described in detail in the appendix, to temporarily postpone the date that the United States would otherwise default on its obligations. These actions, which have been employed during previous debt limit impasses, would be exhausted after approximately eight weeks, meaning no headroom to borrow within the limit would be available after about July 8, 2011. At that point the Treasury would have no remaining borrowing authority, and the available cash balances would be inadequate for us to operate with a sufficient margin to meet our commitments securely.

If Congress does not act by May 16, I will take all measures available to me to give Congress additional time to act and to protect the creditworthiness of the country. These measures, however, only provide a limited degree of flexibility—much less flexibility than when our deficits were smaller.

As the leaders of both parties in both houses of Congress have recognized, increasing the limit is necessary to allow the United States to meet obligations that have been previously authorized and appropriated by Congress. Increasing the limit does not increase the obligations we have as a Nation; it simply permits the Treasury to fund those obligations that Congress has already established.

If Congress failed to increase the debt limit, a broad range of government payments would have to be stopped, limited or delayed, including military salaries and retirement benefits, Social Security and Medicare payments, interest on the debt, unemployment benefits and tax refunds. This would cause severe hardship to American families and raise questions about our ability to defend our national security interests. In addition, defaulting on legal obligations of the United States would lead to sharply higher interest rates and borrowing costs, declining home values and reduced retirement savings for Americans. Default would cause a financial crisis potentially more severe than the crisis from which we are only now starting to recover.

For these reasons, default by the United States is unthinkable. This is not a new or partisan judgment; it is a conclusion that has been shared by every Secretary of the Treasury, regardless of political party, in the modern era.

Identical Letters to House Speaker, Others

Geithner sent identical letters to John A. Boehner, Speaker of the House; Nancy Pelosi, House Democratic Leader; and Mitch McConnell, Senate Republican Leader.

Geithner copied key budget chairmen and others in Congress.

Unfortunately, No Serious Repercussions Until July 8

One disappointing aspect of the the situation is nothing terrible happens until July 8. At that time I assure you, Geithner would find another 2 months or even 4 months if necessary.

Unfortunately, long before July 8, I expect Republicans will cave in to Geithner's fear-mongering tactics.

Not being a politician, I can say what many Republicans undoubtedly want to say but won't.

Dear Treasury Secretary Geithner, "Please Go to Hell"

Polite Way of Saying "Go to Hell"

If Geithner really believes what he is spouting, Republican ought to take advantage. They can do so far more politely than I suggested.

A politically correct "polite" response would be along these lines:

Dear Treasury Secretary Geithner

In the vital interest of preserving the US dollar and to restore fiscal sanity to the United States of America, we intend to reduce the budget deficit within 10 years.

In the interim, we will not increase the debt limit unless and until the President and Congressional Democrats are willing to cooperate.

In return for raising the debt limit, Congress must pass and the the president must sign legislation that will...

1. Scrap Davis Bacon and all prevailing wage laws.
2. Pass national right-to-work laws
3. Reduce the budget deficit by $5 trillion in 8 years
   
4. Balance the budget in 10 years

Given the unmistakable sincerity in your assessment of the damages that may occur should Congress fail to increase the debt ceiling, we anticipate equal sincerity in your willingness to work with Republicans to balance the budget in 10 years so that Congress will not have to go through these maddening debt-ceiling exercises in years to come.

We await your reply and look forward to working with the Obama administration towards solving our budget crisis.

"Yes We Can" work together.

To prove our sincerity, we will hike the debt ceiling. In return, all you have to do is agree to the four points above with additional limits on the amount of budget balancing that can come from tax hikes.

Cordially and With Utmost Respect

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Spanish Prime Minister Drops 2012 Reelection Bid; Trichet Transforms Into Hawk; What Does it Mean for the Euro? The Dollar?

Spanish Prime Minister Jose Luis Rodriguez Zapatero, has decided to not seek reelection in the March 2012 election. Zapatero has been the driving force behind various austerity measures in Spain.

Will Zapatero will push for even stronger austerity measures before his term expires? That seems doubtful although by dropping out, concerns he may have had regarding voter backlash would shrink. His austerity measures have been very unpopular with voters in general but investors have cheered.

Conviction to Stay the Austerity Course in Question

Will the next government have the political will to stay the austerity course?

Please consider Spain’s Deficit Fight Risks Setback as Zapatero Quits Election

Spain’s efforts to reduce its budget deficit and rebuild investor confidence may suffer a setback as Prime Minister Jose Luis Rodriguez Zapatero bows out of next year’s election.

Zapatero, 50, said on April 2 he won’t seek a third four- year term, forcing his party to select a new candidate a year before March 2012 elections. The Socialists, which are trailing the opposition in opinion polls, will hold primaries after regional and local elections on May 22, Zapatero told party members in the capital Madrid.

Investors had rewarded Zapatero’s austerity package, Spain’s toughest in three decades, sending the country’s borrowing costs lower even as bond yields in neighboring Portugal soared to euro-era records. The currency bloc’s fourth- largest economy now faces a period of political uncertainty that may disrupt measures crucial to Spain’s fiscal survival.

“The politics are turning more difficult,” said Stuart Thomson, a Glasgow-based fund manager at Ignis Asset Management, which oversees about $120 billion. “There has been a lot of money coming into Spain; it started to underperform on Thursday and Friday and I suspect that underperformance will continue as a result of this.”

Spain is the latest in a list of euro-area countries facing political upheaval after voters in Ireland ejected the Fianna Fail government from office in the wake of a bank crisis that left it in need of an 85 billion-euro ($121 billion) bailout. In Germany, Chancellor Angela Merkel’s Christian Democrats have been punished in local elections as voters balk at the prospect of funding bailouts elsewhere in Europe.

Portuguese Prime Minister Jose Socrates resigned on March 23 after failing to win support for austerity measures.

Zapatero, a Socialist who in 2005 said he slept with his union card by his bed, made a policy U-turn in May amid Greece’s fiscal crisis. He cut public wages 5 percent, reduced pensions and benefits and pushed labor-market reforms that made it cheaper for companies to fire workers.

Those measures, while popular among investors, prompted the first general strike in eight years and undermined the ruling party’s popularity. The highest unemployment rate in Europe, at more than 20 percent, has also eroded support for the Socialists.

The number of people registering for jobless benefits rose for a third month in March, the Labor Ministry said today. Consumer confidence in March declined to the lowest level this year, according to a separate report from Instituto de Credito Oficial.

The opposition People’s Party led by Mariano Rajoy enjoys 44.1 percent voter support, compared with 28.3 percent for the Socialists, according to an April 3 El Pais poll.

Poor Economy, Poor Prospects

By resigning, Zapatero has prematurely made himself a lame duck. The odds he could win support for additional austerity measures seems slim.

Regardless of what Zapatero does in the interim, the next prime minister will inherit a poor economy, and an even worse setup, especially in regards to policy Spain has no control over.

ECB president Jean-Claude Trichet seems hell-bent on hiking rates and that cannot possibly help prospects for a Spanish recovery.

Trichet Seen Burying Ailing Nations With Rate Rise on Inflation

Please consider Trichet Seen Burying Ailing Nations With Rate Rise on Inflation

Jean-Claude Trichet’s shot against inflation may end up inflicting collateral damage on Europe’s most cash-strapped economies.

Primed to raise its benchmark interest rate this week for the first time in almost three years, President Trichet’s European Central Bank again faces the conundrum that its monetary policy rarely suits all 17 members of the euro area, where the kaleidoscope of growth ranges from record expansion to recession paired with a sovereign-debt crisis.

The upshot may be that the normalization of rates from a record low of 1 percent will disproportionately hurt Spain, Greece, Portugal and Ireland, while failing to nip inflation threats in Germany. Such uneven fallout risks exacerbating the two-speed European recovery and dealing further damage to the bonds of so-called peripheral nations. Credit Suisse Group AG is warning investors away from the region’s stocks and banks partly because of concern the ECB is making a policy mistake.

“As the ECB continues to tighten, it increases the risk that the sovereign-debt crisis comes back,” said Gavyn Davies, chairman of London-based hedge fund Fulcrum Asset Management LLP, which oversees about $1.5 billion in assets. “It will manifest itself with the troubled economies moving into slower growth rates, and the fiscal arithmetic will worsen again.”

Economies from Ireland to Spain are buckling under record debt burdens and the bursting of property bubbles, even as Germany expanded 3.6 percent last year, the strongest pace in two decades. In forecasting euro-zone growth of 1.6 percent this year, the European Commission predicts expansion of 2.4 percent in Germany, three times the anticipated rate for Spain, where unemployment is 20 percent, the highest in the region.

The situation is a “precise reverse” of the period before December 2005, when the ECB last began raising rates, said Nick Kounis, head of macro research at ABN Amro Bank NV in Amsterdam. Then Germany was weak, with growth of 0.8 percent that year, while the Irish and Spanish economies expanded 6 percent and 3.6 percent.

“We were in a world where rates were much too accommodative for the periphery and much too tight for the core,” Kounis said. “Now, the situation is the same, only the countries are different. It’s a problem with their one-size-fits-all policy.”

One Size Fits Germany

I wrote a similar column on March 8, 2011: ECB's "One Size Fits Germany" Policy

Trichet Transformation Into Monetary Hawk

Bloomberg reports Euro Has Best First Quarter as Trichet Transforms Into Hawk

The euro, seen as a potential failure 10 months ago, had its strongest start to a year on record as German growth accelerates and policy makers prepare to boost interest rates.

The currency appreciated 3.5 percent through March, the most since the final three months of 2008 and the best first- quarter performance since the region’s single currency began trading in 1999, according to Bloomberg Correlation-Weighted Index data. It rose from its lowest level since 2002 in January as German Chancellor Angela Merkel and French President Nicolas Sarkozy said they would do whatever is needed to support the 17- nation monetary union.

While Portuguese bonds show increasing speculation for a default and regulators said four Irish banks need to raise 24 billion euros ($34.1 billion) in capital, currency concerns have faded since last year, when former Federal Reserve Chairman Paul Volcker and billionaire investor George Soros said the union may dissolve.

“The euro is extraordinarily strong under the circumstances,” said Alan Ruskin, global head of Group-of-10 foreign-exchange strategy at Deutsche Bank AG in New York. “Does it look more capable of stumbling along than it did a year ago? Yes, to the extent that the core does seem to have made a commitment to fund bailouts.”

“For some countries a rate hike doesn’t fit, especially for Portugal and Greece, but also partly for Spain, where there is a problem with mortgages,” said Ulrich Leuchtmann, head of foreign-exchange strategy in at Commerzbank AG in Frankfurt, who expects the euro to end 2011 at $1.32 as the Fed begins to reduce its aid to the economy. “We’ll have a rate hike, and this will obviously create problems.”

John Taylor, chairman of New York-based FX Concepts LLC, the world’s largest foreign-exchange hedge fund, predicted in January that the euro may fall below parity with the dollar this year. Now he says the current rally may not last. Taylor, whose firm oversees about $8.5 billion, profited in the first half of 2010 betting on a slide in the currency.

“I’m sounding pretty stupid; but on the other hand, I’m not ashamed and I’m sticking with it,” Taylor said last week in a telephone interview. “Europe, with all the tightening that’s being forced on these countries, will be in a recession by the end of the year. There’s going to be a restructuring and default of the European debt.”

“The market can whip you up into a frenzy where you become irrational,” said David Bloom, the global head of currency strategy at HSBC Holdings Plc in London, who said in June the euro would end 2010 at $1.35. “The difference this time around is that there is a mechanism in place. The break-up premium has come out of the euro.”

Sympathy of the Euro Bears

I sympathize with the Euro bears, after all, I have been one too. The Euro has risen in expectation ....

• The European sovereign debt crisis is over
• Trichet will hike multiple times regardless of what it does to the European economy
• Trichet will hike regardless of what it will do to the PIIGS
• Spain will not need a bailout
• Ireland, Greece, Spain, and Portugal will not default
• Bernanke will start QE III
• US Congress will do nothing to solve the deficit
• Other Central banks will hike, leaving Bernanke isolated
  

That is a lot of ifs. I do not think Bernanke will start QE III any time soon and if he does it may be in the context of central bankers in general engaging in widespread debasement of their currencies.

Certainly I do not expect Congress to solve the budget deficit. However, I do think Congress will make some progress. Is any progress priced in?

Please see Government Shutdown Battle to Be Followed by Bigger Fight; GOP wants $4 Trillion in Cuts Over Next Decade; Is that Enough? for a discussion of budget battles.

For now, Ireland Caves in to Trichet. In response, Nouriel Roubini said "Eventually, the back of the government will be broken." The same applies to Irish taxpayers.

How long will Irish taxpayers put up with bailing out the German, French, and British banks that foolishly lent Ireland money?

Moreover, it's not just the Euro that is overpriced. Chinese banks are as insolvent as they come and China is likely headed for a market-imposed slowdown. For a discussion, please see Hidden Losses and Little Reform; China May Be Slowing More Than You Think.

The love affair with the Australian dollar given its property bubble that is imploding now certainly seems questionable. Look for the Australian retail sector to follow the housing market lower. If so, I suspect the next rate move by Australia's central bank will be lower, not higher. If the Reserve Bank of Australia starts cutting rates, that would be net negative for the Australian dollar.

That Japan will print more in wake of its nuclear crisis seems a given. Unless Yen printing will be balanced by more Japanese tax hikes, the Yen setup is also net dollar friendly.

Finally, anti-dollar sentiment is once again near record highs.

Sentiment itself is not a timing mechanism as things can always get more extreme. However, a lot of things need to happen to merit increased strength in the Euro, the Yen, the Yuan, and the Australian dollar.

For now, the market has other ideas, but I like the setup here for renewed dollar strength.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Hidden Losses and Little Reform; China May Be Slowing More Than You Think

In his latest Email review, Michael Pettis at China Financial Markets discusses financial reform (actually the lack thereof in China), as well as an observation on China's Growth.

Pettis writes ....

Three months ago during their 2010 Q4 conference, the PBoC said that they believed that the global economic recovery would continue in 2011, although they acknowledged a great deal of uncertainty.　 The PBoC also said that stabilizing the price level was their top priority, and the central bank planned to control the “main gate” of liquidity inflows and to bring credit growth to “normal” levels.　

Chen Long at SWS notified me yesterday of a change in tone.　 In their 2011 Q1 conference earlier this week the PBoC said that the fundamental basis of the global recovery is not very solid.　 The central bank still acknowledges that stabilizing price levels is an important task, but they only refer to “managing liquidity efficiently”.

What does this imply? I suspect it means that policymakers are becoming a little more concerned with slowing growth and a little less concerned about domestic overheating.　 As I argued in the past few newsletters, growth may be slowing more quickly than Beijing would like, and combined with the very volatile external environment, I suspect they are going to be cautious about too much more tightening.　 We will see how many more interest rate hikes and reserve requirement hikes we are likely to get in the next quarter.

Whether or not we have reached the point in China in which investment is misallocated and debt levels rising is clearly a matter for heated debate – I think we have already passed that point – but clearly we are tending in that direction.　

In the last ten years the combination of socialized credit risk, very low interest rates, state-directed lending and tremendous pressure on the part of SOEs and local and municipal governments to generate employment and growth in the short term has increased the probability that the Chinese financial system may be misallocating capital on a dangerous scale.　

Aside from the many studies I’ve cited showing that profitability in many of China’s largest companies is substantially less than the value of the financing and other subsidies, and anecdotal evidence of unnecessary real estate and infrastructure projects, just imagine what would happen to banking deposits and stock prices if the government credibly removed all guarantees on loans extended by the banks, and furthermore removed interest rate controls.　 I suspect most investors and depositors would assume, correctly in my opinion, a surge in non-performing loans that would wipe out the banks’ capital base, and so would sell their stocks and withdraw their deposits.

The fact that this is unlikely to happen is irrelevant.　 It just means that the losses are hidden and transferred to the state, and via the state, to households.　 If that is the case, then since the banking system can no longer easily identify economically viable projects and is in fact wasting money, the usefulness of the bank-as-fiscal-agent model is much reduced.　 We need now to have banks in China that can correctly identify economically useful projects in which to invest and limit their credit growth to those projects.　

This is, I think, pretty clearly the attitude of financial regulators at the PBoC and the CBRC.　 They are concerned about the pace of credit growth, which would not be a problem at all if credit were going to economically viable projects.　 After all, I would guess that the only significant systemic risks that banks take on are credit risk and maturity mismatch, and Chinese banks don’t have to worry about the latter (no bank runs).

As I see it financial reform in China really means four things, none of which have been seriously implemented:

1. Interest rates must be liberalized so that the true cost of capital is reflected in evaluating the worth of a project.　 All central banks intervene in interest rates, if only to smooth out seasonal and temporary volatility, but PBoC artificially sets the rates for all maturities at least 400-800 basis points too low.　 By keeping the cost of capital so low, it disguises the true cost to China of capital and permits investment in projects whose returns are simply not justified.

2. Corporate governance must be reformed, and this means in part a significant reduction in the number of projects whose risks are socialized.　 Borrowers and banks must act on economic rather than non-economic issues, and as long as risk is socialized – implicitly or explicitly – there is no need to worry about the riskiness of repayment prospects.　 Remember how a much milder socialization of credit risk, the so-called “Greenspan put”, distorted lending and investment decisions in the US.

3. The regulatory framework must be stabilized and government intervention should become much more predictable, at least on economic grounds.　 Investors should be in the business of predicting what economical value will be created, not what steps the government will take next.

4. Information quality must be sharply improved – macroeconomic information as well as financial statements.　 It is pointless to ask investors to make decisions about the future if they have poor or systematically biased information with which to work.

To take the last point first, I would argue that the National Bureau of Statistics and the People’s Bank of China have done great jobs in improving the quality of macroeconomic and financial sector data, but there still is a long way to go, especially in the quality of financial statements.　 In that sense, there has been some real reform of the banking and financial systems in the past decade.

On the other three matters, however, I would argue that there has been very little change at all, expect maybe some backward movement in corporate governance in the past three years.　 There is from time to time some talk about eventually liberalizing interest rates, but interest rates are as controlled as they have ever been (in fact real rates have declined in the past several months to seriously negative rates) and I don’t think anyone expects anything to happen soon on that front.　

Banks compete heavily for deposits, but they cannot compete on price, and any attempt to get around the system – for example when banks offer gifts to attract deposits – is prohibited.　 Many would argue that the PBoC cannot liberalize interest rates now because if they did, and rates soared as they would be expected to do, we would see a surge in bankruptcies.　 This is true of course, but it is equally true that the longer we wait, the more difficult it becomes for exactly that reason.

Duration Mismatch Everywhere

Pettis describes problems at every central bank not just China. I note with interest his discussion regarding duration (maturity) mismatch that I discussed at length twice recently:

• Central Bank Authorized Fraud; Fractional Reserve Lending Problems Go Far Beyond "Duration Mismatch"


• The Next Borrow-Short Lend-Long Guaranteed to Blow Up Bank Lending Scheme; Citigroup, Chase, Bank of America CD Ripoff

Question of Stability

Pettis comments "The current Chinese financial system, even more than Japan, is clearly one in which the purpose of the financial system is to act as the state’s fiscal agent and in which banking stability is guaranteed by the state. It is also clearly one in which capital misallocation can become a huge problem."

Certainly misallocation of capital was a huge problem in the Anglo-Saxon model as well. We saw it spades during the DotCom and Housing busts, something Pettis admits. We also saw it in Greece, Spain, Ireland, Iceland, Portugal, the Baltic states, the UK, etc.

We too socialized the losses at taxpayer expense for the benefit of the wealthy. Places like Ireland, Spain and Portugal were especially hard hit. Taxpayers will continue paying a price for another decade.

Also note that the "stability" provided by the FDIC in which there were almost no bank failures for decades, came at the expense of thousands of bank failures at once. Was this a good tradeoff? I think not.

Allocation of Capital Over the Long Term

Pettis argues that in spite of the housing blowup the Anglo-Saxon banking model has done "a pretty good job in allocating capital productively over the long term".

I disagree.

Under the Greenspan and Bernanke Fed we have seen serial bubble after serial bubble with increasing amplitude of booms and busts. Moreover, I would question whether we have given sufficient time to say just how poorly the system has performed.

Many mistakes have been massed over as households shifted from one wage earner to two and as the baby boomer cycle progressed. We are now at a state where those boomers are starting to retire and the system is not prepared for the transition.

I do not think the credit bust has fully played out. Moreover, I strongly suspect the US will suffer another lost decade.

Therefore, I suggest the "long-term" to which Pettis refers has not yet happened and the decades since Nixon closed the gold window provide an insufficient window to judge.

Nonetheless, I would agree with Pettis that the perverted fractional reserve fiat-credit model we are in will likely be better over the long haul than any command economy. However, that does not mean the model is any good.

China's Starting Point For Growth

One advantage of starting with little infrastructure as China did decades ago, is that there is a huge supply of economically viable projects. China was able to grow without fueling inflation because the growth was backed by a solid expansion in productive assets.

That is no longer the case today as evidenced by vacant apartment, vacant malls, and even vacant cities. As a result, inflation has soared. China is clearly overheating.

Pettis noted his belief "that policymakers are becoming a little more concerned with slowing growth and a little less concerned about domestic overheating."

I am not in a position to disagree with Pettis on that belief. However, regardless of whether Chinese officials are "a little less concerned about domestic overheating" several facts remain

• Inflation is still huge problems in China whether there is lessened concern or not
  
• Chinese interest rates are too low
• Price for the malinvestment and unwarranted infrastructure building is yet to be paid
• China's growth is still unsustainable
  
• Peak oil is a limiting constraint
• China has the world's biggest property bubble and it will bust
  

For more on China's property bubble please see

World's Biggest Property Bubble: China's Ghost Cities Revisited; 64 Million Vacant Properties

Speculation, Investment Scandals, Fraud, and China's Hard Landing; Miracle of Chinese High-Speed Rail will be Reduced to Dust; Peak Oil Doomsday Clock

China and commodity bulls keep repeating the China growth story. It's important to consider the other side as presented above.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Ireland Caves in to Trichet; Backs of Irish Taxpayers Will be Broken

Costs to bail out bondholders of Irish banks has now soared to $142 billion. Worse yet, the new Irish government completely caved in to the EU and ECB and will attempt to balance the entire amount on the backs of taxpayers.

Please consider Ireland Bows to Trichet on Bondholders as Bank Rescue Reaches $142 Billion

Ireland yielded to the European Central Bank to protect bondholders even as its bailout bill for the region’s worst banking crisis moved to as much as 100 billion euros ($142 billion) after stress tests.

The ECB in Frankfurt was “solidly opposed” to imposing losses on investors in senior bank debt, Finance Minister Michael Noonan told broadcaster RTE today. The ECB agreed to provide “ongoing” funding for the banks, he said.

Ireland agreed yesterday to inject as much as 24 billion euros into four banks, while leaving bondholders untouched. The government already funneled 46.3 billion euros into the financial system and set up an agency that paid more than 30 billion euros to assume risky property loans. The total equates to about two-thirds the size of the Irish economy.

During an election campaign last month, Eamon Gilmore, now deputy prime minister, dismissed ECB President Jean-Claude Trichet as a “civil servant” who would answer to politicians. As recently as March 28, Agriculture Minister Simon Coveney said the government planned to impose losses on senior bondholders in the banks to cut the costs of its bailout.

“Taking all of the losses of the banking system and putting them on the balance sheet of the government doesn’t make sense,” Nouriel Roubini, co-founder of Roubini Global Economics LLC, said today in an interview from Cernobbio, Italy, with Maryam Nemazee on Bloomberg Television’s “The Pulse.” “Eventually, the back of the government will be broken.”

“Rather than go after over 20 billion euros in unguaranteed bonds, the government is making ordinary citizens bear the burden of this debt,” Gerry Adams, leader of nationalist party Sinn Fein, said in statement today. “Rather than act in the interests of the Irish people they are acting in the interest of the banks.”

Backs of Irish Taxpayers Will be Broken

What is the point of throwing the bums out in a massive repudiation of government policy if the new bums have the identical policies as those they replace?

The Euro reacted positively to this turn of events and also to expected interest rate hikes by Trichet. Those hikes with further exacerbate the problems of Greece, Ireland, Portugal, and Spain.

I am sticking to my long-held position "what can't be paid back, won't." The timing is uncertain, and Roubini phrased it well: “Eventually, the back of the government will be broken.”

I might add, so will the backs of taxpayers. The pertinent question is how long the taxpayers put up with another set of politicians who cave in to bankers.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List