America’s Strategy Vacuum

Stephen S. Roach

27 February 2013

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NEW HAVENApparently, policymakers at the Federal Reserve are having second thoughts about the wisdom of open-ended quantitative easing (QE). They should. Not only has this untested policy experiment failed to deliver an acceptable economic recovery; it has also heightened the risk of another crisis.
The minutes of the January 29-30 meeting of the Fed’s Federal Open Market Committee (FOMC) speak to a simmering discontent: “[M]any participants…expressed some concerns about potential costs and risks arising from further asset purchases.” The concerns range from worries about the destabilizing ramifications of an exit strategy from QE to apprehension about capital losses on the Fed’s rapidly ballooning portfolio of securities (currently $3 trillion, and on its way to $4 trillion by the end of this year).
As serious as these concerns may be, they overlook what could well be the greatest flaw in the Fed’s unprecedented gambit: an emphasis on short-term tactics over longer-term strategy. Blindsided by the crisis of 2007-2008, the Fed has compounded its original misdiagnosis of the problem by repeatedly doubling down on tactical responses, with two rounds of QE preceding the current, open-ended iteration. The FOMC, drawing a false sense of comfort from the success of QE1 – a massive liquidity injection in the depths of a horrific crisismistakenly came to believe that it had found the right template for subsequent policy actions.
That approach might have worked had the US economy been afflicted by a cyclical disease – a temporary shortfall of aggregate demand. In that case, countercyclical policies – both fiscal and monetary – could eventually be expected to plug the demand hole and get the economy going again, just as Keynesians argue.
But the US is not suffering from a temporary, cyclical malady. It is afflicted by a very different disease: a protracted balance-sheet recession that continues to hobble American households, whose consumption accounts for roughly 70% of GDP. Two bubblesproperty and credit – against which American families borrowed freely, have long since burst. But the aftershocks linger: Household-debt loads were still at 113% of disposable personal income in 2012 (versus 75% in the final three decades of the twentieth century), and the personal-saving rate averaged just 3.9% last year (compared to 7.9% from 1970 to 1999).
Understandably fixated on balance-sheet repair, US consumers have not taken the bait from their monetary and fiscal authorities. Instead, they have cut back on spending. Gains in inflation-adjusted personal-consumption expenditure have averaged a mere 0.8% over the past five years – the most severe and protracted slowdown in consumer demand growth in the post-World War II era.
The brute force of massive monetary and fiscal stimulus rings hollow as a cyclical remedy to this problem. Another approach is needed.
The focus, instead, should be on accelerating the process of balance-sheet repair, while at the same time returning monetary and fiscal policy levers to more normal settings. Forgiveness of “underwatermortgages (where the outstanding loan exceeds the home’s current market value), as well as reducing the foreclosure overhang of some 1.5 million homes, must be part of that solution. How else can the crisis-battered housing market finally clear for the remainder of US homeowners?
The same can be said for enhanced saving incentives, which would contribute to longer-term financial security for American households, most of which suffered massive wealth losses in the Great Recession. Expanded individual retirement accounts and 401K pension schemes, special incentives for low-income households (most of which have no retirement plans), and an end to the financial repression that the Fed’s zero-interest-rate policy imposes on savers must also be part of the solution.
Yes, these are controversial policies. Debt forgiveness raises thorny ethical concerns about condoning reckless and irresponsible behavior. But converting underwaternon-recoursemortgage loans, where only the house is at risk, into so-calledrecourse liabilities,” for which nonpayment would have consequences for all of a borrower’s assets, could address this concern, while simultaneously tempering America’s culture of leverage with a much greater sense of responsibility.
Timing is also an issue, especially with respect to saving incentives. To avoid the shortfall in aggregate demand that might arise from an abrupt surge in saving, these measures should be phased in over a period of 3-5 years.
The main benefit of these proposals is that they are more strategic than tacticalbetter aligned with the balance-sheet problems that are actually afflicting the economy. As the quintessential laissez-faire system, the US has outsourced strategy to the invisible hand of the market for far too long. That has left the government locked into a reactive and often misguided approach to unexpected problems.
Thus, the Fed is focused on cleaning up after a crisis rather than on how to avoid another one. The same is true of US fiscal policy, with an event-driven debate that now has ever-shorter time horizons: the fiscal cliff on January 1, sequestration of expenditures on March 1, expiration of the continuing budget resolution on March 27, and the new May 18 debt-ceiling limit. A compliant bond market, which may well be the next bubble, is mistakenly viewed as the ultimate validation of this myopic approach.
The dangers of America’s strategy vacuum and the related penchant for short-termism have been mounting for some time. Harvard Business School professor Michael Porter famously raised this concern in a 1996 article in the Harvard Business Review. His focus was on corporate decision-making and misaligned incentives leading to a worrisome dichotomy between the short-term tactics of “operational effectiveness” (cost cutting, outsourcing, and reengineering) and the long-term visionary bets that frame successful strategies.
While Porter’s critique was directed at business managers, it bears critically on the current US policy debate. A successful long-term strategy cannot be seen as a succession of short-term fixes.
The internal debate in the FOMC represents a healthy and long-overdue recognition that the central bank may be digging itself into an ever-deeper hole by committing to misguided policies aimed at the wrong problem. A comparable debate is raging over fiscal policy. Can America finally face up to the perils of its strategy vacuum?

Stephen S. Roach was Chairman of Morgan Stanley Asia and the firm's Chief Economist, and currently is a senior fellow at Yale University’s Jackson Institute of Global Affairs and a senior lecturer at Yale’s School of Management. His most recent book is The Next Asia.

The sad record of fiscal austerity

By Martin Wolf

Published: February 26 2013 19:45
Last updated: February 26 2013 19:45


At the Toronto summit of the Group of 20 leading economies in June 2010, high-income countries turned to fiscal austerity. The emerging sovereign debt crises in Greece, Ireland and Portugal were one of the reasons for this. Policy makers were terrified by the risk that their countries would turn into Greece. The G20 communiqué was specific: “Advanced economies have committed to fiscal plans that will at least halve deficits by 2013 and stabilise or reduce government debt-to-GDP ratios by 2016.” Was this both necessary and wise? No.

The eurozone was at the centre of the sovereign debt crisis frightening the world. Rapid fiscal tightening was judged essential for troubled governments. That view, in turn, persuaded those not yet subject to market pressure to tighten pre-emptively. That was very much the position of the UK’s coalition government. The idea that being Greece was around the corner gained traction in the US, too, notably among Republicans. Today’s battle over sequestration is partly a product of that concern.

A leading and, in my view, persuasive proponent of a contrary view is the Belgian economist, Paul de Grauwe, now at the LSE. He has argued that eurozone countries’ debt crises resulted from European Central Bank policy failures. Because of its refusal to act as lender of last resort to governments, they suffered liquidity riskborrowing costs rose because buyers of bonds lacked confidence they would be able to resell easily at all times. That, not insolvency, was the immediate peril.

Today, argues Professor de Grauwe in a co-authored paper, the decision in principle of the ECB to buy up the debt of governments in trouble, through the so-calledoutright monetary transactions” (OMT), allows one to test his hypothesis. He notes that the chief determinant of the reduction in spreads over German Bunds since the second quarter of 2012, when OMT was announced, was the initial spread (see charts). In brief, “the decline in the spreads was strongest in the countries where the fear factor had been the strongest”.

What role did the fundamentals play? After all, nobody doubts that some countries, notably Greece, had and have a dreadful fiscal position. One such fundamental is the change in the ratio of debt to gross domestic product. The paper makes three important observations. First, the ratio of debt to GDP increased in all countries even after the ECB announcement. Second, the change in this ratio turned out to be a poor predictor of declines in spreads. Finally, the spreads determined the austerity borne by countries. Paul Krugman of The New York Times adds an extra point: austerity was costly for the afflicted economies: the greater the tightening between 2009 and 2012, according to the International Monetary Fund, the bigger the fall in output (see charts).

By adopting OMT earlier, the ECB could have prevented the panic that drove the spreads that justified the austerity. It did not do so. Tens of millions of people are suffering unnecessary hardship. It is tragic.

Nevertheless, I can see two arguments for the ECB’s behaviour. The first is that help could only follow a demonstrated willingness to embrace austerity. Second, as the latest European Economic Advisory Group report rightly notes, the real problems have been destabilising capital flows, external imbalances and worsening competitiveness, not fiscal deficits. But one can justify fiscal austerity, brutal though it is, as the only way to force adjustments of relative costs and the needed labour market reforms.

My colleague, Wolfgang Münchau, argues that the opposite is true. But I wonder whether the eurozone will survive its cure. Countries in the core would be better off themselves if they gave the weaker more time to adjust.

Countries outside the eurozone have been in a very different position. They had no need to fear the rising spreads of eurozone members because they did not face similar liquidity problems. To a first approximation, the yield on UK or US sovereign bonds should reflect expected future short-term rates of interest, with a small risk premium, since outright default is inconceivable. The widely held view that yields could soar is a bet on a surge in inflation. While inflation has been stickier than many expected, such a surge seems unlikely. 

Monetarists can note that the growth of broad measures of the money supply is low. Keynesians can note the excess savings of the private sector. Neither points to rising inflationary pressure.

Thus the panic that justified the UK coalition government’s turn to a long-term programme of austerity was a mistake. Had its members never heard of the paradox of thrift? If the domestic private and external sectors are retrenching, the public sector cannot expect to succeed in doing so, however hard it tries, unless it is willing to drive the economy into a far bigger slump. While short-term factors have played a real part, it is not surprising that the UK’s recovery has stalled and the deficit is so persistent. It is consequently also not surprising that downgrades are on the way, not that these tell one anything very useful in the case of an issuer with access to its own money-printing machine.

As Oxford university’s Simon Wren Lewis notes, “after the panic of 2010 was over, when it became clear that the debt crisis was really a eurozone crisis and UK long-term interest rates declined with the fortunes of the economy, we should have had a major change of policy”.

What would that change of policy consist of? The answer is simple. First, serious attention needs to be paid to why the UK non-financial corporate sector is running what seem to be structural financial surpluses, as Andrew Smithers of London-based economic advisers Smithers & Co points out.

Second, the austerity on current spending needs to be made explicitly contingent on the economy: more when the economy grows faster and less when the economy grows more slowly. Third, every effort must be made to accelerate any structural reforms that might encourage higher investment by the private sector.

Fourth, the banking sector must come clean on losses and accept needed recapitalisation so that it starts lending again. Finally, the government must recognise that current rates of interest provide a once in a lifetime opportunity for higher public investment.

In the long run, the fiscal deficit must close. In the short run, the UK has the chance to push growth. It should take it. So should the US.



February 26, 2013 8:42 pm
US budget: Another crisis looms
If the White House and Republicans cannot agree on how to fund $1.2tn in deficit reduction, the fallout will be dire
An aircraft carrier on the way to the Middle East has been held in Virginia because of sequestration
An aircraft carrier on the way to the Middle East has been held in Virginia because of sequestration

Washington’s fiscal fights over the past two years have come with names that blend budget arcana with the drama of a Hollywood blockbuster. The failedgrand bargain” in 2011 was followed by the “debt ceilingshowdown, the “supercommittee” and the battle over the “fiscal cliff”, which reached its climax as the clock struck midnight to usher in the new year.

But sequestration, as the bloodless word suggests, is an altogether different animal. Unlike other budget confrontations between the White House and congressional Republicans, the $1.2tn in spending cuts, which start on Friday, take effect slowly, over 10 years.

Click here to enlarge

President Barack Obama used sequestration to get himself out of a hole in tense budget negotiations with Republicans in August 2011. Now he is struggling to unwind it, precisely because the measure does not land with the drama and impact that accompanied previous budget battles.

“We don’t want it. We think that it’s bad policy. It was designed to be bad policy. That was the whole point,” said Jay Carney, the White House spokesman. “The sequester was written in a way that would ensure that Congress would never let it happen.”

Deadlocked over lifting America’s borrowing limit in 2011, the White House agreed to an initial $1tn in spending cuts over a decade, under pressure from Republicans. But the two sides were unable to agree on how to fund a second tranche of $1.2tn in deficit reduction and sent the measure to a bipartisan congressionalsupercommittee” to be sorted out.

To make sure the 12-member panel found a formula to reduce the deficit, the White House added the threat of automatic cutshalf from discretionary programmes and half from defence – if they failed to reach a deal.

But since then, the political landscape has shifted in ways that the White House did not anticipate.

The Obama administration was convinced that the threat of large defence cuts, on top of reductions in the Pentagon budget settled in 2012, would bring the generally hawkish Republicans back to the negotiating table and force them to accept the higher tax revenues Democrats were seeking.

But so far the desire of the Republicans to cut the budget and keep taxes low has overwhelmed the defence hawks in the party. And they have been joined by some dovish Democrats, who have long wanted to cut Pentagon spending.

Some of our people see this as their best chance in decades to force a reduction in military spending,” said a senior Democrat on Capitol Hill.

The White House and Republicans are divided along the same lines that have split them for the past two years. Mr Obama insists that the $1.2tn includes additional taxes; the Republicans say Mr Obama already secured a tax rise on the wealthy this year and that all the savings must come from lower spending.

Unlike the past episodes of fiscal brinkmanship, however, no one is holding their breath for another one-minute-to-midnight agreement on the eve of Friday’s deadline. This is because for all the US political leaders involvedRepublicans, Democrats and the White House alikesequestration is arguably the most economically tolerable place to pick a fight and stand firm on principles.

A default on US debt, which hung over the 2011 negotiations, or the huge tax rises of the “fiscal cliff”, or even a government shutdown, are seen as far more irresponsible and politically less palatable outcomes.

But that is not to say that there will be little or no damage from the sequestration. According to economists, it could affect US growth by 0.3-0.6 percentage points in 2013 and maintain the unemployment rate close to 8 per cent for the rest of the year.

Federal employees, including 800,000 civilian Pentagon workers, will be sent home without pay and a broad swath of government programmes will be slashed. This would be a considerable blow at a time of rising oil prices and the potential for renewed instability in the eurozone in the wake of the inconclusive Italian election.

The expectation in Washington is that after a few weeks of sequestration, as the consequences begin to be felt, Republicans and Democrats could be cajoled into a deal to fix the problem, just in time for the next fiscal deadline of March 27, to extend funding for federal government agencies.
However, given the bleak record of rolling budgetary battles ending in unsatisfactory agreements, there is little hope that America’s fiscal path will be cleared any time soon. The US governs by crisis these days, and neither side seems capable of doing anything about it.

Copyright The Financial Times Limited 2013.

Gold, Silver and Miners Remain Junk Grade Investments

Chris Vermeulen

February 27th, 2013 at 8:43 pm


Since silver and gold topped in 2011 investors have been struggling with these positions hoping this cyclical bull market for metals continues. The simple truth is no one knows for sure if prices will continue and make new highs and those who say its a for sure thing we all know deep down is full of bull crap.

All investments move in cycles, waves or trends which ever you want to call it. The market has 4 simple yet distinct stages each require a completely different skill set and trading tactics to navigate.

Stage 1After a period of decline a stock consolidates at a contracted price range as buyers step into the market and fight for control over the exhausted sellers. Price action is neutral as sellers exit their positions and buyers begin to accumulate the stock.

Stage 2 Upon gaining control of price movement, buyers overwhelm sellers and a stock enters a period of higher highs and higher lows. A bull market begins and the path of least resistance is higher. Traders should aggressively trade the long side, taking advantage of any pullback or dips in the stock’s price.

Stage 3After a prolonged increase in share price the buyers now become exhausted and the sellers again move in. This period of consolidation and distribution produces neutral price action and precedes a decline in the stock’s price.

Stage 4When the lows of Stage 3 are breached a stock enters a decline as sellers overwhelm buyers. A pattern of lower highs and lower lows emerges as a stock enters a bear market. A well-positioned trader would be aggressively trading the short side and taking advantage of the often quick declines in the stock’s price. More times than not all of stage 2 gains are given back in a short period of time. I do show some of my trade setups using these exact stages free here.

Now that you know the stages and what it looks like its time to review the gold, silver and miners charts.

Gold Chart – Weekly

Gold has been in a bull market for several years but is starting to show its age in terms of the size of the price patterns, volume levels and extreme bullish sentiment. Back in 2011 a week before price topped we exited precious metals because the short term charts and volume levels were warning of a sharp drop. Since then I have not done many trades in either gold or silver because I do not like shorting in bull markets. Waiting for a bullish setup/price pattern before getting involved is my focus.

Gold has pulled back with a bullish 5 wave correction the last 5 months and at key support. While the long term charts are pointing to higher gold prices you must be aware that if gold and silver start to breakdown things will likely get ugly quickly. To be honest I do not care which way it goes, I just want it to either rally from support here and make new highs or breakdown and crash. Both will be very profitable if traded properly.

Silver Chart – Weekly

Silver has a very similar chart to that of its big sister (yellow gold). This shiny metal has the energy of a 3 year old making it a very volatile investment. I have touched on the topic of gold and silver being so called safe havens and if you have been reading my work for a while you know that any investment that can move 18-45% in value within 1 month is NOT a safe haven.

While it has done well in the past decade and boosted a lot of retirement accounts the day will come with these things collapse and most people holding them will give back most if not all the gains they had simply because people get attached to large positions and most do not know when to just exit a position.

Gold Miners Chart – Monthly

This chart gives me cold sweats because I know how many people own gold mining stocks and I know how fast these things can move. If the price closed below the green support line the bottom could fall out and be very painful for those who get paralyzed by denial and do nothing but watch their accounts lose value week after week.


Precious Metals Investing Conclusion:

In short, this report is to show you the very basics of how investments move in stages. It is also to show a warning that precious metals are technically very close to a major breakdown which the big money players are watching closely. This thinly traded sector can move extremely fast when everyone rushes for the door.

Do not get me wrong, I am not saying a crash is about to happen, actually it’s the opposite. All I am doing is planning the idea in your subconscious so that if prices continue to move lower you will remember that these price levels and take action with your investments. Remember, you can always buy the investment back at any time again if the outlook changes in a week, month or year.