jueves, septiembre 06, 2012

THE QE DEBATE / SEEKING ALPHA



The QE Debate

September 4, 2012

Peter Schiff



There is an ongoing three way debate between those who believe the Fed should do more to strengthen the recovery, those who believe that the recovery is strong enough to continue on its own, and those who believe that the economy has been so fundamentally altered by the recession that no amount of stimulus can succeed in pushing unemployment down to pre-crash levels. As usual, they all have it wrong (although some are more wrong than others).




The false conclusions are being made by the likes of bond king Bill Gross, who has suggested that the economic fundamentals have changed. They argue that a "new normal" is now in place that sets an 8% unemployment rate as a floor below which we will never fall.



This is absurd. America can once again prosper if we put our trust in first principles and let the free markets work. Unfortunately, that is not happening. Government is taking an ever greater role in our economy where its efforts will continue to stifle economic growth. A close second in cluelessness comes from those who believe that we are currently on the road to a real recovery. I'm not sure what economy they are looking at, but in just about every important metric, we continue to be essentially comatose.





More accurate are the opinions of those who believe that without a more serious intervention from the Fed, which can only mean another round of quantitative easing (QE III), the current quasi-recovery will soon fade and the tides of recession will overtake us once again. They are correct. And even though this time the water will be rougher and deeper than it was four years ago, it does not mean that the Fed will do the economy any good by breaking out its heavy artillery once again.




In his widely anticipated speech at Jackson Hole last week, Fed Chairman Ben Bernanke sounded a supremely optimistic note: "It seems clear, based on this experience, that such (easing) policies can be effective, and that, in their absence, the 2007-09 recession would have been deeper and the current recovery would have been slower than has actually occurred."




The simple truth however, is that our economy has a disease that all the quantitative easing in the world can't cure. And while the wrong medicine may make us appear healthier in the short term, we will continue to deteriorate beneath the surface. Not only should the Fed not provide additional QE, but it should remove the accommodation currently in place. Although these moves would most certainly send us back into recession, it would simultaneously provide a needed course correction that would put us finally on the road to a sustainable recovery.




The recession the Fed is trying so desperately to prevent must be allowed to run its course so that the economy that we have developed over the last decade, the one that is overly reliant on low interest rates, borrowing and consumer spending, can finally restructure itself into something healthier.



By enabling this diseased economy to overstay its welcome, QE does more harm than good. To recover for the long haul, the market must be allowed to correct the misallocations of resources that resulted from prior stimulus. Additional stimulus inhibits this process, and exacerbates the size of the misallocations the markets must eventually correct.




In the interim, any GDP growth or employment gains that result from stimulus actually compounds the difficulty in restructuring the economy. Any jobs created as a result of cheap monetary stimulus are jobs that won't be able to survive absent that support. They will require a continual misallocation of resources in order to survive. Unfortunately, these jobs must ultimately be lost before a real recovery can actually begin.




Holding rates of interest far below market levels (which is the goal of stimulus) alters patterns of consumption, savings, and investment. Fed intervention short-circuits the market driven process that resolves misallocations. The more stimulus that is provided, the harder market forces must work to try to restore equilibrium. As the misallocations grow over time, the efficacy of monetary measures diminishes. In the end, the market will overwhelm the Fed. The only question is how long it will take.




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The Fed is trying to build skyscrapers on a bad foundation. Each subsequent structure it builds not only collapses, but also weakens the foundation that much more. The result is that subsequent structures collapse at increasingly lower heights and require more effort to build.




Instead of trying to build, the Fed could concentrate on repairing the underlying foundation. That might delay construction, but in the end the buildings will be much sturdier.




Because the Fed has kept interest rates too low for too long, Americans have saved too little and borrowed too much; consumed too much and produced too little; and imported too much and exported too little. Too much of our labor is devoted to the service sectors and not enough to goods production. Too much capital goes to Wall Street speculators and not enough to Main Street entrepreneurs. We built too many homes but not enough factories. We have developed too many shopping centers, and not enough natural resources. The list of Fed induced misallocations goes on.



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By trying to preserve the jobs associated with this old economy, the Fed prevents the market from creating the ones we actually need. Unfortunately no one seems to understand that, and we continue to chase blindly after failed economic models. Look for such misunderstanding to be on high display this week in Charlotte as Democrats gather to call for even greater intervention to perpetuate a failed economic model.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.


September 3, 2012
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Fears Rising, Spaniards Pull Out Their Cash and Get Out of Spain
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By LANDON THOMAS Jr.

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LONDONIt is, Julio Vildosola concedes, a very big bet.
 
 
      
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After working six years as a senior executive for a multinational payroll-processing company in Barcelona, Spain, Mr. Vildosola is cutting his professional and financial ties with his troubled homeland. He has moved his family to a village near Cambridge, England, where he will take the reins at a small software company, and he has transferred his savings from Spanish banks to British banks.
 
 
 

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“The macro situation in Spain is getting worse and worse,” Mr. Vildosola, 38, said last week just hours before boarding a plane to London with his wife and two small children. “There is just too much risk. Spain is going to be next after Greece, and I just don’t want to end up holding devalued pesetas.”
 
 
 
 

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Mr. Vildosola is among many who worry that Spain’s economic tailspin could eventually force the country’s withdrawal from the euro and a return to its former currency, the peseta. That dire outcome is still considered a long shot, even if Spain might eventually require a Greek-style bailout. But there is no doubt that many of those in a position to do so are taking their money — and in some cases themselvesout of Spain.
 
 
 

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In July, Spaniards withdrew a record 75 billion euros, or $94 billion, from their banks — an amount equal to 7 percent of the country’s overall economic output — as doubts grew about the durability of Spain’s financial system.
 
 

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The deposit outflow in Spain reflects a broader capital flight problem that is by far the most serious in the euro zone. According to a recent research note from Nomura, capital departing the country equaled a startling 50 percent of gross domestic product over the past three months driven largely by foreigners unloading stocks and bonds but also by Spaniards transferring their savings to foreign banks.
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The withdrawals accelerated a trend that began in the middle of last year, and came despite a European commitment to pump up to 100 billion euros into the Spanish banking system. Analysts will be watching to see whether the August data, when available, shows an even faster rate of capital flight.
 
 


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More disturbing for Spain is that the flight is starting to include members of its educated and entrepreneurial elite who are fed up with the lack of job opportunities in a country where the unemployment rate touches 25 percent.
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According to official statistics, 30,000 Spaniards registered to work in Britain in the last year, and analysts say that this figure would be many multiples higher if workers without documents were counted. That is a 25 percent increase from a year earlier.
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No doubt there is a little bit of panic,” said José García Montalvo, an economist at Pompeu Fabra University in Barcelona. “The wealthy people have already taken their money out. Now it’s the professionals and midrange people who are moving their money to Germany and London. The mood is very, very bad.”
 
 


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It is possible that the outlook could improve if the European Central Bank’s governing council, which meets Thursday, signals a plan to help shore up the finances of Spain and other euro zone laggards by intervening in the bond markets.
 
 
 

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But right now, if anything, Spain’s picture is growing dimmer.
 


 
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On Friday, the government’s bank rescue fund said it would need to pump up to 5 billion euros into the failed mortgage-lending giant Bankia, which the state seized in May. And on Monday, Andalusia became the latest of Spain’s semiautonomous regions to ask the central government for rescue money.
 
 
 


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The wider prospects for the euro zone are also still bleak. Moody’s Investors Service said on Monday that it had changed its outlook on the AAA rating of the European Union to negative, and that it might downgrade the rating if it decides to cut the ratings on the union’s four largest budget contributors.
 
 


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Spain’s gathering gloom comes despite a gradual return of capital to banks in Greece and the relative stability of deposits in those other euro zone trouble spots, Italy, Ireland and Portugal.
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The continued exodus of money and people from Spain could be a warning to European policy makers that bailing out the country — a step now widely expected — may not stem the panic as long as the Spanish economy remains in a funk.
 



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It was a lesson learned in Greece, where despite successive European bailouts, about a third of deposits have been withdrawn from its banks since 2009, as the public worried that Athens might have to return to the drachma.
 



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Spain is still a far cry from a nearly bankrupt Greece: it has a much larger and more diverse economy, lower levels of debt and a bond market that is still functioning.
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It might be more accurate to say that money is leaving Spanish banks at more of a jog than anything close to a sprint.
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Although retail and corporate deposits are down 10 percent compared with those of July 2011, the country remains relatively rich in savings, with 2.3 trillion euros in overall deposits, according to data from Morgan Stanley.
 
 
 


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But once under way, the flight of bank deposits can easily overwhelm rational facts and analysis. Setting off the flight was the failure of Bankia, which came as a shock to Spanish savers who had been assured by government officials that the bank was in good shape.

 
 
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Instead of calming fears, the state takeover prompted comparisons to Argentina in 2001, when peso bank accounts denominated in dollars were frozen in order to stem the flight of deposits.
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The corralito, or corral, as the Argentine action is known, has become part of the public conversation in Spain. The million-plus Argentines who have since immigrated to Spain have provided ample and gory stories of desperate legal battles and wiped-out savings.
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Eduardo Pérez, a Spaniard who was working in Argentina during that period, remembers the events all too well. He said he lost four-fifths of the money he had kept in an Argentine savings account, though he declined to say how much money was involved. 
 
 

 
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Some of my friends lost everything,” Mr. Pérez said. “So yes, everyone in Spain knows about the corralito.”
 
 
 
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Recently, Mr. Pérez, who lives in the northern city of Bilbao, removed about a third of his euros from his Spanish savings account and sent them to Singapore, converting them to Singapore dollars
 

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Having lost his job at a multinational company a few months ago, Mr. Pérez, 48, is trying to make ends meet by focusing on his travel Web site and blog, which aggregate Spanish-language travel videos.

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But as the job outlook worsens, he is contemplating following in the path of his savings and starting a new life in Singapore with his wife.
 
 

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Two years ago, we never would have thought of this, but now I have real fears that there will be a breakup with the euro,” he said. “And when you keep hearing people saying, ‘Don’t worry, it’s not going to happen’ — well, that is when you have to start worrying.”  
 

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Analysts said that the record-high outflow from Spain in July was probably spurred in part by July’s being a taxpaying month for many corporations, which prompted them to withdraw cash from deposit accounts
 

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Also playing a role were investment funds that moved cash reserves to foreign banks in light of the credit downgrades at Spanish banks.  


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Still, as the examples of Mr. Vildosola and Mr. Pérez show, individual deposit flight is becoming more pronounced.


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Some people are willing to fly to London for the day just to open an account there, as most banks in the city require such transactions to be made in person.  

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Spanish bankers working for British financial institutions say they have been hit with a barrage of questions about how to open savings accounts in London 


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“It seems as if everyone I know in Spain is getting on an easyJet to come to London and open a bank account,” said one such banker, who spoke on condition of anonymity, citing his company’s policy. 
 

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That is what Mr. Vildosola did before he took the more drastic step of moving his family to England.  
 

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“It’s sad,” he said. “But I just don’t think there is a future for me in Spain right now.”




The problem with Obama’s arithmetic

Glenn Hubbard

September 5, 2012



 

The release last month of the Congressional Budget Office’s update to the budget and economic outlook for the next decade rightly draws attention to the “fiscal cliff” – the large tax increases and spending cuts that are currently scheduled for January 1. But there’s more to the CBO report than its analysis of what may happen in the next few months.
 
 
 
 
The CBO analysed the consequences for deficits and debt over the next decade of keeping tax and spending policy on autopilot. Relative to the agency’s baseline, deficits would increase by almost $8tn over the next decade. And debt held by the public would reach about 90 percent of gross domestic product; its highest level since the second world war.




Elevated federal spending is the source of the widening deficits over the next decade. The CBO estimates that revenues as a share of GDP would average about 18 per cent, roughly their 40-year average. Federal spending at 23 per cent of GDP would stand at about 10 per cent higher than its 40-year average, 21 per cent.




Higher debt levels crowd out private investment. And they reduce household and business spending on account of higher expected future taxes to close the budget gap. The debt problem that the CBO identifies will get worse after the next decade with large and growing shortfalls in Social Security and Medicare. It is not an understatement to observe that the challenge of avoiding a high-debt, low-growth economy is the key domestic policy issue.



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So what are the approaches of Governor Mitt Romney (who I advise) and President Barack Obama (who speaks tonight at the Democratic convention) to this central challenge?
 
 
 
 
Mr Romney’s budget (for which I wrote the foreword) focuses on reducing debt burdens and enhancing economic growth through spending restraint and tax reform. Mr Romney proposes to reduce federal spending as a share of GDP to 20 percent by 2016 and gradually reduce the growth in Social Security and Medicare spending, particularly for more affluent households. The GOP candidate would reform the corporate and individual income taxes, reducing marginal tax rates by just under one-third for the corporate tax and by 20 per cent for the individual income tax, while broadening the tax base to make up lost revenue. The Romney plan addresses the deficit and debt challenge comprehensively, though both spending restraint and tax reform pose political challenges.
 
 
 
 
Mr Obama has proposed to continue current elevated levels of federal spending, while raising taxes on higher-income households and businesses to reduce the deficit and debt consequences of higher spending.
 
 
 
 
Indeed, Larry Summers, the president’s former chief economic adviser, recently argued in the Financial Times that reducing federal spending as a share of GDP is not achievable. Mr Summers pointed to demographic change (population aging), higher interest payments on the large public debt (which has increased substantially in the past few years) and increases in the relative price of health (a significant component of government spending). This view is consistent with Mr Obama’s budget, which assumes elevated levels of spending over his presidency and thereafter.
 
 
 
 
In contrast with Mr Romney’s plan, the president’s plan does not address medium-term and long-term deficit and debt problems. Taken at face value, the Obama plan will require acceptance of the costs of much higher levels of deficits and debt or substantial tax increases on all Americans. The CBO’s report shows the consequences for deficits and debt over the next decade of such continued budget inaction.




But the president is proposing higher tax burdens on certain households and businesses. Will those tax changes close the budget gap? No.




The president says he will raise marginal tax rates on upper-income workers and business owners (against the grain of tax reform efforts over decades, including his own Fiscal Commission, which argued for lower marginal tax rates financed by broadening the tax base). His proposed revenue increases include the “Buffett rule” (effectively a new alternative minimum tax on high-income taxpayers), tax increases on dividends and capital gains, plus raising the top income tax rate to its pre-2001 level.
 
 
 
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What are those tax increases? The Buffett rule imposes a minimum effective tax rate on taxpayers with annual incomes over $1m (most of whom already face a higher tax rate). For higher taxes on saving and investment, the president would raise taxes on capital gains to 20 per cent from 15 per cent and on dividends to 39.6 per cent from 15 per cent. Next, the president calls for restoring the pre-2001 tax rates for high-income individuals, including increasing the top marginal income tax rate to 39.6 per cent from 35 per cent.



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In addition, the president’s budget also calls for phasing out exemptions and lower-bracket tax rates for higher-income taxpayers, raising marginal tax rates further. And the president would limit certain tax deductions for individuals with incomes over $200,000.




Adding up the proposed tax increases on upper-income taxpayers should raise $148bn per year in additional revenue, according to US Treasury department estimates. Viewed next to proposed additional spending by the president of roughly $500bn per year, Mr Summers’s claim that federal spending will remain high, or this year’s federal budget of $1.1tn, the president faces an arithmetic challenge.




Assuming the Obama administration wanted to close the budget gap – to be comparable with the lower deficits in the Romney plan – what additional tax increases would be required? To begin, let’s call the maximum additional revenue from upper-income taxpayers $148bn per year, as the administration has not identified more tax increases on those taxpayers.




To close the budget gap, one could raise additional revenue by broadening the tax base. But the president’s proposals already accomplish much of that for upper-income taxpayers. Additional tax base broadening would be required for middle-income taxpayers. Of course, the administration could propose an increase in marginal tax rates. Unless, though, the administration wants to raise marginal tax rates further on high-income individuals, marginal tax rates would have to be raised – and substantially – on middle-income taxpayers. Of course, the deficit and debt could simply be allowed to rise, not a sustainable long-term solution for the country.


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The choices of the size of government and how we pay for it are fundamental ones. They are also the ones we should be analysing and debating. Mr Romney has proposed a plan of fiscal consolidation and tax reform.


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Accomplishing it will require reducing the growth of federal spending and broadening the tax base. These changes will not be easy. Mr Obama proposes a larger government with explicitly higher taxes on high-income taxpayers but, by the arithmetic of higher spending levels, eventually higher taxes on all Americans.





Glenn Hubbard is dean of Columbia Business School and former chairman of the Council of Economic Advisers under President George W. Bush.