11/08/2012 05:05 PM

Budget Disarray

US Set to Restage Greek Tragedy

By David Böcking

The US has more in common with heavily indebted southern European countries than it might like to admit. And if the country doesn't reach agreement on deficit reduction measures soon, the similarities could become impossible to ignore. The fiscal cliff looms in the near future, and its not just the US that is under threat.

The US has finally voted and the dark visions of America's future broadcast on television screens across the country -- and most intensively in battleground states -- have come to an end. Supporters of both Barack Obama and Mitt Romney had developed doomsday scenarios for what would happen if their candidate's opponent were to win. Four more years of Obama, the ads warned, would result in pure socialism. A Romney presidency would see the middle and lower classes brutally exploited.

But following Obama's re-election, Americans are now facing a different, much more real horror scenario: In just a few weeks time, thousands of children could be denied vaccinations, federally funded school programs could screech to a halt, adults may be forced to forego HIV tests and subsidized housing vouchers would dry up. Even the work of air-traffic controllers, the FBI, border officials and the military could be drastically curtailed.

That and more is looming just over the horizon according to the White House if the country is allowed to plunge off the "fiscal cliff" at the beginning of next year. Coined by Federal Reserve head Ben Bernanke, it refers to the vast array of cuts and tax increases which will automatically go into effect if Republicans and Democrats can't agree on measures to slash the US budget deficit.

In total, the cuts add up to $1.2 trillion over the next nine years, with half coming from the military and half from other government programs, and with $65 billion coming in the first year alone. They were enshrined in law with the Budget Control Act of 2011, which also increased the debt ceiling.

And though a deadline of Jan. 2, 2013 was set, they were never meant to come into effect. The plan for deep across-the-board cuts was intended as a way to prod Democrats and Republicans into reaching agreement on a long-term plan to reduce America's vast budget deficit.

Not a Bad Thing?

The "fiscal cliff" also includes the expiration of tax cuts for the rich, which were originally passed by President George W. Bush and extended by Obama. The elimination of the lower tax rates would, according to the Congressional Budget Office, result in $221 billion in extra tax revenues in 2013 alone. A temporary 2-percent federal income tax cut would also expire, resulting in an additional $95 billion flowing into government coffers next year.

There are also several other cuts and tax hikes included in the austerity package. Some $18 billion in taxes would come due as part of Obama's health care reform, and welfare cuts would save $26 billion. Should lawmakers not reach agreement prior to the end of the year, the US budget deficit for 2013 would be cut almost in half, to $560 billion.

Which doesn't sound like a bad thing. After all, the US is staggering under a monumental pile of debt and could potentially begin to face the kinds of difficulties that have plunged several euro-zone countries into crisis. It is a viewpoint shared by the ratings agencies -- a year ago, Standard & Poor's withdrew America's top rating, justifying the measure by pointing to the unending battle over the debt ceiling. The agency noted that "the political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed."

From afar, it is difficult to argue; the ongoing battle between Democrats and Republicans in the face of a horrendously imbalanced budget looks catastrophically absurd. As their country heads toward the edge of the abyss, lawmakers preferred to debate whether or not French fries and pizza should be considered vegetables.

Still, a significant element in the dispute is a fundamental conflict that won't sound foreign to Europeans: How much austerity is too much?

Plunging Growth

As good as an instantaneous halving of the budget deficit might sound, the landing after a plunge off the fiscal cliff would be a hard one. Were taxes to be ratcheted up at the same time as state programs were slashed, it would have an enormous effect on the economy. According to the Congressional Budget Office, 2013 growth would immediately drop by four percentage points, making a recession unavoidable. The number of unemployed would be two million higher than without the cuts.

It is an eventuality that doesn't just put fear into the hearts of Americans. In its annual report on the US, the International Monetary Fund (IMF) referred to the fiscal cliff as the largest risk currently facing America.

Investors have already reportedly become more cautious in the face of the looming cuts. Should politicians not agree to a credible plan for reducing US debt, it could ultimately harm the credibility of the dollar as a reserve currency. More immediately, the IMF writes in its World Economic Outlook report published in October, the drastic cuts "would inflict large spillovers on major US trading partners." In other words, an already fragile Europe would become even weaker.

As such, Germany won't be the only country watching closely as US Congress struggles to reach an agreement in coming weeks. Should the US economy radically slow down next year, "it could in the current atmosphere of uncertainty result in a global loss of confidence that would lead to a collapse in investment worldwide," according to the annual report of top German economic advisors released on Wednesday.

Nevertheless, the experts warn, simply postponing measures to address the debt and budget deficit problems "would also have long-term costs in the form of still higher sovereign debt."

The Greek Model?

What, then, is the solution? In the end, the US could arrive at a compromise similar to the one that appears to be forming for Greece: austerity measures combined with more time to achieve budget deficit reduction targets. The drastic cuts currently looming are essentially a kind of debt brake, but it is one with no flexibility built in whatsoever. The US economist Denis Flower proposed in an interview with SPIEGEL ONLINE that Washington should introduce a law mandating long-term debt reduction, but which allows higher deficits in times of crisis.

US politicians, no doubt, would not be fond of hearing their country compared to Greece. After all, the heavily indebted euro-zone country was used during the presidential campaign as a caricature for the horrors of European-style socialism. But their current finances are not dissimilar, with one difference being that the US can't count on outside help as the Greeks have received.

It remains to be seen how US politicians choose to approach the problem. Republicans, having defended their majority in the House of Representatives, could simply let the country plunge off the cliff in the hopes that it would be blamed on Obama. Or, on the other hand, their willingness to compromise may have been increased by virtue of losing the presidential election badly.

Republican Speaker of the House John Boehner on Wednesday pledged to work closely with the White House as negotiations begin. He said that lawmakers won't be able to solve the country's problems overnight, but said that voters "gave us a mandate to work together to do the best thing for our country."

Greece's economic problems and the resulting austerity packages it has passed have plunged the country into five straight years of recession. Germany, Europe and the world are hoping that the same fate is not in store for the US.


Desperately seeking yield

Investors are gorging on corporate bonds. Is an asset bubble being inflated?

Nov 10th 2012   

THESE are good times for the corporate treasurers of large firms. They can raise money in the bond markets at the lowest cost in living memory (see chart).

Companies have been quick to take advantage of the opportunity. By the end of October global corporate-bond issuance for the year stood at $3.3 trillion, close to the record set in 2009. The pace has not slackened: Abbott Laboratories this week raised $14.7 billion, the biggest deal of the year, at maturities ranging from three to 30 years and with yields as low as 1.2%. The ease with which large companies can raise money is in sharp contrast to the plight of smaller businesses, which are still finding it hard to get finance from the banks.
With the return on cash close to zero, and government-bond yields in many markets near record lows, investors are indulging in another desperatehunt for yield akin to the one that sparked the subprime-mortgage boom before the crisis. According to EPFR Global, a data provider, bond funds have attracted a cumulative $395 billion since the start of this year, and almost $1.1 trillion since the beginning of 2008. In contrast, equity funds and money-market funds have seen net redemptions of $467 billion and $793 billion respectively since the start of 2008.

Those numbers are largely the result of retail flows but bonds also appeal to institutional investors. Corporate bonds are probably the preferred asset class for insurance companies right now,” says Chris Iggo of AXA Investment Managers.

So far this year the bet has paid off. American corporate bonds have returned 9.4% and the high-yield (and thus higher-risk) portion of the market has returned 13.6%, according to Barclays Capital. However, the combination of investor enthusiasm, heavy issuance and very low yields naturally creates the possibility that an asset bubble is being inflated.

For investors, the risks are twofold. The first is that economies will dip back into recession and that more companies will default on their bond issues, forcing investors to suffer write-downs on their holdings. The credit risk of corporate bonds is reflected in the excess interest rate, or spread, they offer over government bonds. At the moment this spread is lower than it was at the start of the year and lower than its five-year average. But it is still well above the levels of 2005 and 2006, when the credit bubble was inflating.

There are some modest signs that companies may be struggling in the face of a sluggish economy. Standard & Poor’s, a ratings agency, has recorded 64 corporate defaults this year, compared with 35 at the same stage of 2011. Over the past 12 months the default rate on global high-yield bonds has been 2.7%, with the American default rate being slightly higher at 3%. But both numbers are well below the long-term average default rate of 4.5%, indicating that spreads are not particularly low given the fundamentals. They are much lower in Japan, where ultra-low returns on cash and government bonds have been a feature of the landscape for a decade.

The second risk facing bond investors is that the economy rebounds sharply. Central banks might start to increase short-term interest rates, prompting government-bond yields to soar and corporate-bond yields to rise (and prices fall) in tandem. One of the worst years for bond investors was 1994, when the Federal Reserve suddenly started to tighten policy after years in which it had held rates low to help the financial system recover from the savings-and-loan crisis.

For the moment, however, the global economy looks fairly sluggish; forecasts for GDP growth are being revised down rather than up. Central banks in the developed world may yet be forced into further policy easing. As a result, it is hard to see an increase in official rates in the near future. The Fed has indicated that it will keep rates low until 2015. Any rise in government-bond yields might well be met by a further round of quantitative easing to drive yields back down again.

Most investors who are buying corporate bonds need the income right now. They may well feel they can worry about the prospect of monetary tightening in 2015 much nearer that date. Of course, that creates its own risks. When the market does turn everyone will want to head for the exit at once, as was the case with mortgage-related bonds in 2007. That might turn a retreat into a rout.

Of the two big risks, then, the credit risk associated with an economic downturn looks the greater danger in the short term. But it is not great enough yet to deter investors—which means the menace from interest-rate risk will only grow.

Asian economies
Asia’s great moderation
Some of the world’s stablest economies are Asian. Time to worry?
Nov 10th 2012

LAOS, a poor country of 6m people wedged between Vietnam and Thailand, has no openings to the sea and few routes to world attention. But it is now enjoying a rare moment in the sun. Last month it won approval to join the World Trade Organisation. This week it hosted the ninth Asia-Europe meeting, which brings together leaders from the world’s most and least dynamic regions.

Its small economy, which exports gold, copper and hydropower, is distinguishing itself. Its growth rate is not only one of the fastest in the world but also one of the steadiest.

From 2002 to 2011 growth fluctuated within a remarkably narrow range, never falling below 6.2% and never rising above 8.7%. Only three countries have recorded a steadier growth rate (as measured by its standard deviation) over that period. Two of them are also Asian: Indonesia and Bangladesh. Growth in developing Asia is now steadier, as well as faster, than growth in the “matureeconomies of the G7 (see chart 1). It was more stable in 2002-11 than over any other ten-year span since 1988-97.

The “Great Moderation” is the name given to the era of economic tranquillity that prevailed in America and elsewhere in the rich world before the financial crisis. Should the label now be applied to Asia?

Asia’s economies are better known for their speed than their stability. From 1996 to 1998, for example, growth in five big South-East Asian countries (Indonesia, Malaysia, the Philippines, Thailand and Vietnam) swung from 7.5% to minus 8.3% as the Asian financial crisis struck. Even now some highly open economies, such as Thailand, Singapore and Taiwan, remain more volatile than the global average. Exposed to international trade flows, their industrial output fluctuates like a twirling ribbon with every twitch of demand.

But developing Asia (which excludes rich economies like Hong Kong, Singapore, South Korea and Taiwan) is dominated by populous countries that rely increasingly on domestic demand to drive their economies. Household consumption contributed half of the growth of just over 6% Indonesia enjoyed in the year to the third quarter (its eighth consecutive quarter of growth at that pace). Exports have fallen from about 35% of GDP ten years ago to less than a quarter in 2011. Developing Asia’s combined current-account surplus, which reflects its dependence on foreign demand, more than halved from 2008 to 2011 and is expected to fall further this year.

Asia’s stability also owes something to demand management. During the Asian financial crisis policymakers faced a dilemma. They could defend their exchange rates by raising interest rates. But that would cripple borrowers. Or they could let their currencies fall and ease rates. But that would inflate the burden of foreign-currency debt, crippling borrowers too.

In the aftermath of the crisis the region worked its way out of this trap. Most countries accumulated an impressive stock of hard-currency reserves and weaned themselves off foreign-bank loans in favour of foreign equity and local-currency bonds. Because these liabilities were denominated in their own currency, they did not rise in value when the currency fell.

That has freed policymakers to cut interest rates when the economy slows. Indonesia’s central bank, for example, slashed rates by three percentage points from December 2008 to August 2009. It cut rates by another point from October 2011 to February 2012. Thanks in part to its responsive central bank, Indonesia’s year-on-year growth rates over the past 20 quarters have been the most stable in the world.

Wise monetary policy was also one of the reasons cited for the Great Moderation enjoyed by the G7 economies. Another was the supposed depth and sophistication of the rich world’s financial systems, which, it was said, allowed households to smooth their spending, firms to diversify their borrowing and banks to unburden their balance-sheets. Both of these pillars of stability proved false comforts. Economists had not quite settled on an explanation for the Great Moderation before it inconveniently ceased to exist.

Worryingly, Asia’s great moderation has also been accompanied by sharply rising credit. According to Fred Neumann of HSBC, leverage is now higher than at any time since the Asian financial crisis (see chart 2). This credit expansion may represent healthy “financial deepening”, which many economists believe is a cause of growth and stability. But rising leverage can also be a threat to stability. The late Hyman Minsky, among others, argued that drops in volatility allow firms and households to borrow more of the money they invest. Stability, in Minsky’s formulation, eventually becomes destabilising. Overleverage does not require excessive optimism, merely excessive certitude; not fast growth, merely steady growth.

Fortunately, Asia’s policymakers never shared the West’s faith in self-correcting financial systems. The region has pioneered “macroprudential” regulations, designed to curb excessive credit and capital flows even without raising interest rates. In March, for example, Indonesia tightened loan-to-value ratios on mortgages and imposed minimum downpayments on car and motorbike loans.

Mr Neumann is, however, sceptical that regulatory tightening can substitute for the monetary kind. Macroprudential controls are not watertight, he notes. As long as capital remains cheap, money will leak. If the regulator lowers mortgage loan-to-value ratios, for example, banks may simply raise the appraised value of a home. If regulators impede foreign purchases of property, as Hong Kong just did, foreigners will seek inventive ways around the rules.

Hong Kong’s freedom to raise rates is constrained by its currency’s fixed link to the dollar, one of the few pegs to survive the Asian financial crisis. Other central banks do not have that excuse. Currency flexibility has given them the freedom to cut rates when growth slows. It should also allow them to raise rates when financial excess threatens—even if rates remain near zero in America, Europe and Japan. If stable growth allows lenders or borrowers to become overstretched, it can “sow the seeds of its own destruction”, Mr Neumann argues. Nothing great about that.

The Special Interests Won Again
Paul Craig Roberts
November 7, 2012


The election that was supposed to be too close to call turned out not to be so close after all. In my opinion, Obama won for two reasons: (1) Obama is non-threatening and inclusive, whereas Romney exuded a “us vs. themimpression that many found threatening, and (2) the election was not close enough for the electronic voting machines to steal.

As readers know, I don’t think that either candidate is a good choice or that either offers a choice. Washington is controlled by powerful interest groups, not by elections. What the two parties fight over is not alternative political visions and different legislative agendas, but which party gets to be the whore for Wall Street, the military-security complex, Israel Lobby, agribusiness, and energy, mining, and timber interests.

Being the whore is important, because whores are rewarded for the services that they render. To win the White House or a presidential appointment is a career-making event as it makes a person sought after by rich and powerful interest groups. In Congress the majority party can provide more services and is thus more valuable than the minority party. One of our recent presidents who was not rich ended up with $36 million shortly after leaving office, as did former UK prime minister Tony Blair, who served Washington far better than he served his own country.

Wars are profitable for the military/security complex. Israel rewards its servants and punishes its enemies. Staffing environmental regulatory agencies with energy, mining, and timber executives is regarded by those interests as very friendly behavior.

Many Americans understand this and do not bother to vote as they know that whichever candidate or party wins, the interest groups prevail. Ronald Reagan was the last president who stood up to interest groups, or, rather, to some of them. Wall Street did not want his tax rate reductions, as Wall Street thought the result would be higher inflation and interest rates and the ruination of their stock and bond portfolios. The military/security complex did not want Reagan negotiating with Gorbachev to end the cold war.

What is curious is that voters don’t understand how politics really works. They get carried away with the political rhetoric and do not see the hypocrisy that is staring them in the face. Proud patriotic macho American men voted for Romney who went to Israel and, swearing allegiance to his liege lord, groveled at the feet of Netanyahu. Obama plays on the heart strings of his supporters by relating a story of a child with leukemia now protected by Obamacare, while he continues to murder thousands of children and their parents with drones and other military actions in seven countries.

Obama was able to elicit cheers from supporters as he described the onward and upward path of America toward greater moral accomplishments, while his actual record is that of a tyrant who codified into law the destruction of the US Constitution and the civil liberties of the American people.

The election was about nothing except who gets to serve the interest groups. The wars were not an issue in the election. Washington’s provoking of Iran, Russia, and China by surrounding them with military bases was not an issue. The unconstitutional powers asserted by the executive branch to detain citizens indefinitely without due process and to assassinate them on suspicion alone were not an issue in the election. The sacrifice of the natural environment to timber, mining, and energy interests was not an issue, except to promise more sacrifice of the environment to short-term profits.

Out of one side of the mouth came the nonsense promise of restoring the middle class while from the other side of the mouth issued defenses of the offshoring of their jobs and careers as free trade.

The inability to acknowledge and to debate real issues is a threat not only to the United States but also to the entire world. Washington’s reckless pursuit of hegemony driven by an insane
neoconservative ideology is leading to military confrontation with Russia and China. Eleven years of gratuitous wars with more on the way and an economic policy that protects financial institutions from their mistakes have burdened the US with massive budget deficits that are being monetized. The US dollar’s loss of the reserve currency role and hyperinflation are plausible consequences of disastrous economic policy.

How is it possible that “the world’s only superpower” can hold a presidential election without any discussion of these very real and serious problems being part of it? How can anyone be excited or made hopeful about such an outcome?

Paul Craig Roberts was Assistant Secretary of the Treasury for Economic Policy and associate editor of the Wall Street Journal. He was columnist for Business Week, Scripps Howard News Service, and Creators Syndicate. He has had many university appointments. His internet columns have attracted a worldwide following.