OVERSOLD RALLY

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Economic Outlook: US jobs revival tempered

By Chris Flood

Published: January 31 2010 16:57

US president Barack Obama’s promise to boost spending on job creation and the big improvement in US economic growth in the fourth quarter has fuelled hopes for a revival in America’s labour market this year.

Employment data for January, due to be published on Friday, are expected to show non-farm payrolls rose 27,000, which would leave the unemployment rate unchanged at 10 per cent.

However, the January release will include some important revisions to the historic data that are likely to show that the fall in US employment since the recession began was larger than previously estimated.

Paul Dales at Capital Economics says the revisions are likely to reveal that US employment has fallen by 9m rather than the present estimate that 7.2m jobs have been lost.

Mr Dales says this is because the payroll survey could be putting too little weight on the tough conditions still being faced by smaller companies, which are continuing to struggle as credit conditions remain tight.

The revised labour market data should also have important implications for the outlook for US interest rates. Most analysts expect the Federal Reserve to begin tightening monetary policy this year, but Capital Economics thinks US interest rates could remain on hold until 2012.

US labour force participation – the number of people employed or actively looking for work – has recorded its largest one-year drop on record with a fall of 1.2 percentage points to 64.6 per cent. Much of the drop is because of younger workers opting for additional education or training.

Andrew Tilton of Goldman Sachs says many of them will begin to look for work, since they have not retired or dropped out of the labour force permanently, so the unemployment rate could rise sharply this year.

“Outright job growth of more than 100,000 per month will soon be needed to keep the unemployment rate from rising further,” Mr Tilton said.

Both the European Central Bank and Bank of England will keep interest rates unchanged at their meetings on Thursday so the main focus will be whether UK policymakers decide to extend their £200bn asset-purchase programme.

The week’s data releases

A calendar of key statistical reports due out over the next seven days from Informa Global Markets
Fourth quarter data showed the UK economy was struggling to escape recession. The risk of a double-dip recession remains significant following the increase in value added tax in January and the disruptions caused by heavy snow nationwide.

The UK has not yet clearly established a sustainable recovery and both the manufacturing and service-sector purchasing managers surveys are likely to show that activity dipped in January because of adverse weather conditions.

However, estimates of economic activity are usually subject to revision, particularly around turning points and inflation is rising so the suspension of the Bank’s asset purchase programme appears likely.

”The fact that the economy could only crawl out of recession in the fourth quarter with markedly less than expected growth of 0.1 per cent has heightened concerns about the strength and sustainability of the UK’s recovery, said Dr Howard Archer, chief european economist at IHS Global Insight.

Dr Archer said that he expected the Bank of England would ”keep the door ajar” by indicating that all policy options remained open and that it would be prepared to act if recovery failed to develop during the early months of 2010.

UK policymakers will have updated growth and inflation forecasts to digest which will undoutedly have a bearing on their decision whether to extend the asset purchase programme or to call a halt.

UK consumer price inflation jumped to 2.9 per cent in December. This has raised concerns that inflationary pressures could be mounting and that the peak for inflation could be higher than the 3 per cent forecast by the Bank of England in November.

Inflationary pressures in the manufacturing sector appear to be rising faster than expected with January’s producer prices, due out on Friday, expected to show the output measure rising from 3.5 per cent in December to 3.7 per cent.

At the start of 2009, the purchasing managers surveys played a vital role in signalling that the global economy was on-track for a recovery just at the time when fears that a prolonged worldwide depression was possible were widespread.

This year, the UK’s PMI survey’s will play a vital role for policymakers’ efforts to assess how well the economy is performing without the aid of quantitative easing.

The consensus forecast for the UK manufacturing PMI survey for January, due out on Monday, is for a marginal fall from 54.1 in December to 54 but the clear risk is a for a sharper decline due to the adverse weather conditions which affected the entire country last month.

The service-sector PMI, due out on Wednesday, has reached its highest level since January 2007 so a modest dip due to the bad weather would not be a surprise. The consensus forecast is for the service-sector PMI to dip from 56.8 to 56.5, indicating a marginal slowdown in th pace of recovery.

Copyright The Financial Times Limited 2010

America can square its fiscal circle

By Clive Crook

Published: January 31 2010 19:42

American voters want more public services than they are willing to pay for. That is the country’s fiscal problem in one sentence. When it comes to public finance, the “live now, pay later” mentality that caused the economic collapse still prevails.

Figures show a strengthening recovery in the last quarter of 2009. Welcome as that may be, even a sustained expansion cannot balance the books in the longer term. On current policies, the permanent gap between spending and revenues is at least 6 per cent of output.

Will the administration’s new budget help? Not really. The US budget is not a policy announcement, but a minutely detailed wish-list. The press reports it gravely, in suspended disbelief. Congress then ignores it in whole or in part depending on how the wind is blowing. President Barack Obama’s new proposal, which Congress receives today, will say more about his reading of the political climate than about where fiscal policy is headed.

The wind has in fact shifted a bit. Mr Obama hears voters’ concerns about huge budget deficits and the long-term outlook for borrowing. But, like Congress, he understands that voters oppose the only remedies: lower spending and higher taxes.

Last week Mr Obama trailed two ideas. He called for a three-year freeze on non-security discretionary spending (less than 20 per cent of the budget) from 2011, and a bipartisan fiscal commission to come up with a comprehensive fiscal plan. Neither measure would be more than a beginning. Neither says which programmes need reform or which taxes have to go up. Weak as they are, they hit a wall of opposition as soon as Mr Obama suggested them.

Before Mr Obama spoke, Democrats and Republicans joined in the Senate to block a statutory budget commission, which the White House had (all too belatedly) supported. Mr Obama can still form a commission by executive order and says he will – but this will not bind Congress unless Congress agrees to be bound. Within hours of the State of the Union address, a spending freeze was voted down in the Senate. Democrats in the House served notice that they too are opposed.

For once, this is not a case of a polarised Congress failing to represent moderate opinion. Washington’s paralysis on fiscal policy reflects attitudes in the country. People are concerned about overborrowing – and right to be, since the US is headed for fiscal collapse. But they are also devoted to outlays in excess of revenues. The sensitivity of Congress to public opinion is in most respects a virtue of American democracy. Here, it is the core of the problem.

Cross-party coalitions are impossible to form on other issues, but not when it comes to defending the fiscal status quo. Entitlement reform? Social Security is untouchable. On this, Democrats take the lead. Medicare is untouchable too. Republicans used fear of cuts in the programme to defeat healthcare reform.

Infrastructure is a vital economic asset, say Democrats. You cannot mean to economise on national security, say Republicans. Tax increases on all but the rich are unjust, say Democrats. Tax increases on the non-rich are indeed wrong, say Republicans, but tax increases on the rich are counter-productive. What does the public think? “We agree with all of the above.”

National bankruptcy of the sort that Britain experienced in the 1970s or Latin America in the 1980s would break the impasse, and this is what it might take. This would be my prediction, if I had to make one. But there are better cures for alcoholism than liver failure.

The challenge is to flip the all-party, pro-spending, anti-tax coalition. One way might be to link specific spending more closely with specific taxes. The question to ask voters is not whether they want guaranteed health insurance, which they do, and higher taxes, which they do not. It is whether they are willing to pay higher taxes for guaranteed health insurance.

Slowly, very slowly, interest in a US value added tax is spreading beyond public-finance academics. Comeback America, an excellent new book by David Walker, formerly US comptroller-general and until 2008 head of the Government Accountability Office, includes this among its recommendations. The purpose is partly just to raise money. The book argues that tax increases and spending cuts will both be needed, and the hollowed-out US income tax system cannot deliver. If a VAT were tied to public spending on health, however, it would do more than raise money.

Unlike income tax, which more than 40 per cent of Americans no longer pay, a VAT would ask everyone to pay something. No part of the electorate could vote for guaranteed health insurance entirely at other people’s expense. Some Democrats would recoil at this idea, but there is something in it for them: revenue to support the services they value.

An idea like this needs a champion. Mr Obama would be ideal, but seems unlikely to step forward. Most likely, the existing coalition would prevail, Democrats denouncing an unfair regressive tax, and Republicans opposing any kind of tax. But maybe, just maybe, Democrats could see a way of supporting needed public services. And perhaps Republicans, searching deep into their collective memory, could find a trace of the fiscal conservatism they once represented, and regard a modest broad-based VAT as the lesser evil.

If not, there is always going bust.
Copyright The Financial Times Limited 2010.

Inequality in a meritocracy

By Christopher Caldwell

Published: January 29 2010 20:35

This week, Harriet Harman, deputy leader of the Labour party and the minister for women and equality, released a report called “An Anatomy of Economic Inequality in the UK”. The product of more than a year’s work by 10 university social scientists, it is a strange document. In an effort to combat what the authors call “widespread public ignorance of the scale of inequality”, the government has sponsored a study whose main result is likely to be to turn voters against the government. The report compares those at the top of the economic ladder with those at the bottom. To cite one alarming finding, the richest tenth have accumulated more than 100 times as much wealth as the poorest.

What is unclear is why the government should be alarmed about this now. It is a tautology to say that the very rich are richer than the very poor. Britain is relatively unequal for an advanced country, but it is by no means the most unequal. Italy, Poland, Portugal and the US all have larger gaps between rich and poor, and New Zealand and Ireland have comparable ones. The report asserts (and several graphs make plain) that British society grew rapidly and significantly less equal in the 1980s, and that little has changed since then. The social ground rules have been stable for at least a quarter-century.

One must read between the lines to discover the source of Ms Harman’s alarm. The six “strands” of inequality that the National Equality Panel studied – gender, age, ethnicity, religion, disability and sexuality – have all been covered by civil rights legislation since Tony Blair and Labour came to power in 1997. Equality is important, Ms Harman writes in her foreword, because “the economy that will succeed in the future is one that draws on the talents of all, not one which is blinkered by prejudice and marred by discrimination”. It is oppression that Ms Harman’s academics are looking for.

The problem is that the report’s conclusions are implicit in its definitions, which are false ones. It takes “inequality” as a synonym for “prejudice and discrimination”, which it very often is not. If there is one theme that the study’s authors stress with consistency, it is that inequality within groups in the UK is just as severe, or nearly as severe, as inequality between groups. The case that rising inequality is driven by sexism or racism (or some other prejudice) is weak, although the authors are indefatigable in trying to insinuate it. “Compared to a White British Christian man with the same qualifications, age and occupation,” they write, “Pakistani and Bangladeshi Muslim men and Black African Christian men have pay 13-21 per cent lower.” (The idiom of the report frequently resembles the dockside pidgin spoken in the novels of Joseph Conrad.) But not all of their evidence goes in this direction: on average, Hindu and Sikh (but not Muslim) Indians, Caribbean blacks and Chinese men have higher hourly wages than the ethnic-religious majority, and the earnings of Jewish men are about 25 per cent higher. The British-descended majority, if they really meant to exploit or exclude, would probably not relegate themselves to such a low position on the economic ladder.

Nor is the gap between men’s earnings and women’s an open-and-shut case of prejudice. The authors note that, while women aged under 44 have, on average, more education than their male contemporaries, they earn 21 per cent less. The problem, they opine, is the treatment of part-time work, which many women resort to when they start families. “Low pay for part-time work is a key factor in gender inequality,” they write. “It reflects the low value accorded to it and failure to create opportunities for training and promotion.” But the low value attached to part-time work is a function of economic common sense, not contempt. If work is part-time, then either the demand for it is less pressing or the supply of it is less reliable. A milkman who delivers milk a few days a week on a flexible schedule is less valuable per delivery than one who delivers it regularly.

Unable to show racism or sexism, the study retreats to the concept of class, noting that “economic advantage and disadvantage reinforce themselves across the life cycle, and often on to the next generation”, and calling for government intervention to counteract it. But the inequalities that exist are obviously not the programme of a self-conscious class. Consider the openness of Britain’s educational system. According to the report, at practically every level of scoring on the General Certificate of Secondary Education, all ethnic minority groups attend university at higher rates than white Britons. Now, ethnic prejudice is not the only form of disadvantage, but its absence – and even a powerful impulse to affirmative action – is a sign that there is no systematic attempt to seize institutions for the benefit of an in-group, as in a real class system. It is not advantage but prosperity that is self-reinforcing. The class problems that progressive governments make it their business to manage have mostly been solved.

The problems that remain are problems of meritocracy, of which inequality is a natural result. As long as economies are growing, people are content to see others get a bit more relative income. When economies stagnate, there is more political agitation for redistributing the goods that remain, and society grows less meritocratic. Ms Harman makes an unconvincing argument for more equal distribution of income and wealth among citizens. In the present climate, however, the public is unlikely to require any convincing at all.

The writer is a senior editor at The Weekly Standard

Copyright The Financial Times Limited 2010.

Regulating America's banks

Stage prop

Jan 28th 2010
From The Economist print edition

The White House’s latest salvo against banks misses the target

AP FOR investors the most dangerous words in the English language are “this time it’s different.” For governments and financial policemen they are “never again.” Yet that is what Barack Obama promised on January 21st when he announced proposals to stop banks trading on their own account and to limit their involvement in hedge funds and private equity: “Never again will the American taxpayer be held hostage by a bank that is too big to fail.” Can he live up to this promise? Or is it destined to become a YouTube classic, played endlessly in half a decade or so, after another banking implosion?

The goal of putting an end to governments’ blanket implicit guarantee of banks is a good one. Politically the guarantee is poisonous: accusations of a “socialism for the rich” are hard to refute when bailed-out bankers enjoy fat bonuses during a severe recession. Economically it makes another crisis more likely by giving banks every incentive to grow bigger and take more risk. The political theatre of grand declarations has something to be said for it too. Voters cannot be sold technicalities. They want to feel that their anger has been heard.

Technicalities matter, however, and Mr Obama’s proposals do not live up to their billing. To talk, as some commentators have done, of a new Glass-Steagall act, the Depression-era law that split commercial and investment banking until the 1990s, is wildly off the mark. The administration seems to define proprietary trading narrowly, as the stand-alone “prop desks” most banks have for betting their own money (anything broader would be unworkable). It’s easy to see why they do not deserve a public subsidy. It’s hard to see why banning them makes banks much safer. Prop desks are a small part of most firms’ activities and the same is true of banks’ investments in private equity and hedge funds. These activities did not play a leading role in the crisis.

It’s not that simple

The proposals also betray a desire to ring-fence deposit-taking firms and let everything else fry. However understandable, the reality is that investment banks, credit-card operators, insurers and even carmakers’ finance arms had to be bailed out. The system was too interconnected. The administration says that if a firm wants to continue prop trading (as Goldman Sachs might) it will lose the privileges banks get, such as federal deposit-insurance and access to the Federal Reserve’s discount window. So what? Changing the label and culling symbolic perks would not make a firm less of a threat if it failed. As things stand the state would still have to step in.

The administration appears to have broken ranks with regulators elsewhere in the world. But in truth, like them, it is relying on new capital and liquidity buffers to do most of the work of making banks safer. For the average bank, these will probably succeed. But no one has yet found a convincing mechanism to deal with outliers whose losses in a typical crisis are far too great for any reasonable safety buffer. What is needed is a way of pushing losses onto creditors without sparking a run that endangers the whole system.

One option is to break banks into bits that can default without dragging down other firms. Mr Obama is being advised by Paul Volcker, a former chairman of the Fed and a fan of this approach. But a Glass-Steagall split, forcing commercial banks to ditch their investment-banking arms, is pointless if investment banks still have to be bailed out. And banks might have to be ground into gravel rather than just broken in two. The smallest firm subject to the Fed’s stress tests in May had risk-adjusted assets of about $100 billion. If this were the minimum size of a systemically important firm, then America’s four big banks would need to be split into 48 separate companies to be small enough to fail. American policymakers will be acutely aware that there is almost no appetite anywhere else, except Britain, for breaking up banks.

The alternative is to find ways to allow a controlled default of part of banks’ balance-sheets. That will require the rejigging of their liabilities to include new forms of debt, as well as the creation of resolution authorities with enough power to impose losses on some creditors, but not so much that they terrify counterparties into running. That is a big task, which some banks will resist and which has been given no particular emphasis in the swamp of proposals being considered by Congress. If the president wants to keep his promises, this would be a good place to start.

Copyright © 2010 The Economist Newspaper and The Economist Group. All rights reserved.

1929-32 Market Decline Has Almost Been Repeated

by: John Lounsbury

January 30, 2010

The 10-year bear market in stocks has accelerated in the past two years. What about the bull market from 2003-07, you ask? It didn't exist if you use gold (GLD) as your medium of exchange. This can be seen in the following graph from ChartOfTheDay.com:
We are currently about 79% below the market top of late 1999 to early 2000. At the market low in March, we were down about 82%. At that point, we were close to the 89% decline of 1929-32, when the market was actually traded in gold due to the gold standard for the U.S. dollar.

The following graph shows the relationships between the Dow-listed value and gold for an 89% decline from the market top - the Dow as of Jan. 29, 2010 and as of the recent market low in March 2009.
In an Instablog today, I suggested that making comparisons of today to the start of the Great Depression had more curiosity value than utility. I received some criticism for that remark.

In this analysis, the curiosity value has more utility than most comparisons (at least for me) because it shows how close we have already come to repeating the market decline of 1929-32. The parameters can be read from the chart for an exact reproduction. For example, Dow at 10,000 and gold at $2,200 or Dow at 7,000 and gold at $1,500 produce a loss of 89%.

Disclosure: Currently own GLL (short gold).