Transcript of a Conference Call on USA Article IV Consultation

Washington, D.C.

Friday, July 26, 2013


MR. ANSPACH: Hello, everybody. This is Raphael Anspach, with the IMF’s Communications Department. Thank you for joining this teleconference on the 2013 U.S. Article IV . You’ve seen the documents that we provided to you under embargo. The embargo is on until 10:30 Washington time today. That also applies to the comments made at this teleconference.

With me today to lead this teleconference, I have Mr. Gian Maria Milesi-Ferretti who’s the IMF Mission Chief for the U.S.A. and Deputy Director of the IMF’s Western Hemisphere department and Mr. Roberto Cardarelli who’s the Division Chief of the IMF’s North American Division in the same department.

Before we take your questions, Mr. Gian Maria Milesi-Ferretti will have some introductory remarks and then we’ll be happy to field your questions.

Gian Maria, would you like to start, please?

MR. MILESI-FERRETTI: Thank you all and good morning. I will just say a few words since you’ve had an opportunity to look at the report.

So, if we look at the outlook for the U.S. economy, we have a forecast for modest growth this year, 1.7 percent on a period-average basis, and an acceleration of growth to 2.7 percent next year. Now despite the fact that growth this year is forecast to be quite a bit slower than last year, I would say that overall the tone of our assessment of the outlook is better. We think there is more underlying strength in the U.S. economy, and we think that the reason why growth this year is going to be low is the very large reduction in the fiscal deficit, with tax increases and the expenditure cuts that have taken a toll on economic activity. As this contraction from the fiscal side is forecast to wane over next year, we see more resilient private sector demand asserting itself and growth accelerating to close to 3 percent during this period.

Our assessment of the fiscal situation in the U.S. has had two colors if you want. On one hand there is an underlying improvement in fiscal accounts. Those are reflected both in the fact that overall fiscal deficit has been declining very rapidly, but also that the longer term outlook for expenditures and revenue has improved somewhat thanks to a lower rate of growth in health care costs tan previously forecast and also more buoyant revenues than previously forecast.

Now this is the positive. Still we see two problems. One is that you have excessively rapid fiscal consolidation in the short run. As I mentioned the recovery is still weak, yet you have a very large reduction in the deficit. We think that it would be more advisable to have a slower pace of fiscal consolidation in the short run that would allow the recovery to take hold. And instead what we still need is more action to reduce the longer run pressures on the budget, and those are reflected primarily in spending for entitlements. And we think that reforms that are designed to slow the rate of growth of entitlement spending and to balance with some increase in revenues would help put U.S. public finances finally on a sustainable basis over the longer term. As I said, over the short term, things are looking better, also thanks to the fact that interest costs are very low. But you still have a long-term problema.

Monetary policy has been -appropriately-, extremely supportive of the recovery. It has helped the recovery of the housing market, which is really the key underlying feature of the recovery in private sector demand both because of the recovering construction and because of the positive effects of the recovering house prices on household balance sheets.

We think that the strategy of the Federal Reserve to condition the pace of reduction in its purchases of assets to the performance of the economy is wise and a key to maintain the needed momentum for the recovery. Close attention needs to be paid, of course, to the financial stability considerations in an environment in which interest rates have been low for long. We’ve had a bout of volatility in recent weeks that shows that even with a clear strategy and clear conditions, you can have periods of volatility and financial institutions and, of course, the regulators need to be ready for that.

On the financial sector outlook, I would like to say that over the past few weeks we’ve had a number of important measures that we had been pressing for that have been adopted on a final basis. I would want to mention the Basel III capital requirements with the final regulations issued just a couple of weeks ago. Also the process of designation of systemically important non-bank financial institutions is coming to a conclusion with the first institutions being singled out for enhanced supervision. We think that is very important.

And as you know, the U.S. plays a crucial role in global financial markets, and it is extremely important for good function in the global financial systems that the international financial reform agenda is closely coordinated. And in this regard we are very encouraged by the recent news on the agreement in the area of over-the-counter derivatives that has been reached by the Commodity Futures Trading Commission with international counterparts.

I think I’ll stop here, and I’m happy to take your questions.

QUESTIONER: Yes, good morning and thanks for doing this. My question goes to the political area. The report says that political gridlock in Congress makes problems for legislative action clear, and this obviously will affect or could affect the economic outlook for next year. And the question basically is how much the upcoming political fight about the debt [ceiling] and the deficit reduction could weigh in in this regard, especially because so far it doesn’t seem like there could be an agreement between the Republicans and the Democrats in the White House?

MR. MILESI-FERRETTI: Thank you very much for your question. Yes, there are clearly differences in views on the appropriate strategy for fiscal policy going forward within Congress. I would want to, if you’ll allow me to split your question in two parts. Let me deal first with the debt ceiling. I think we had a major bout of financial instability and a slowdown in growth associated with what happened over the summer of 2011, and we are confident this is an experience that nobody wants to repeat.

And we think, therefore, that there is every reason not to want to create any tension around the creditworthiness of the U.S. government by prolonging an impasse over the debt ceiling. It’s something that is absolutely essential to solve successfully, the earlier the better for the financial markets, but [also] for the real economy [and] confidence. But we are also confident that the importance of this is not lost among decision makers.

The second part concerns the strategy going forward for spending and revenues, and I would think in particular for what is going to happen to the spending cuts known as the sequester. Our assessment is that the sequester is costly in terms of economic growth and an inefficient way to cut spending. And, indeed, it was designed precisely with those features to convince the legislators to come up with budgetary savings under the threat of something that was unpleasant and costly. So I think I’m not saying something that people would strongly take issue with since this was precisely the purpose or the design of this mechanism.

Still, given that at the moment we don’t have a clear indication that the sequester is going to be replaced, we are assuming that the caps on discretionary spending that the sequester imposes will remain in place for 2014. If a solution is found that, say, replaces these tighter caps in spending in the short run with measures that are more back-loaded that take effect more later when the recovery is better established, that would be good news for U.S. growth in our view even though it will imply a slightly larger fiscal deficit next year. That’s something we would very much support.

But I want to say that our forecast at the moment incorporates a continuation of these tight caps on discretionary spending, but we do assume that the debt ceiling is going to be raised without disruption.

QUESTIONER: Thank you for taking my call. I was wondering if you could talk more about the Fed’s asset purchase plan. Do you think that it’s okay for them to start slowing down in September or is that too early?

MR. FERRETTI: We think that the strategy to tailor the pace of tapering to what is happening to the recovery is [the right one] and depending on your outlook and your projections and outturns, of course, you could think that tapering would start a quarter before or a little bit later. Our forecasts for growth are for this year relatively weak. They are a bit weaker than the central forecast in the projection of the FOMC [Federal Open Market Committee], having exactly the same strategy in our policy line of tying the purchases to the outlook for the economy. We have them tapering off early next year, so continuing throughout this year.

But objectively we are talking about out-turns of data, of small differences in how strong the recovery’s going to be for the rest of the year. And one-quarter of difference in the slowing of purchases in terms of how much it should matter from a macroeconomic perspective or the impact on interest rates, we are talking about really small differences.

QUESTIONNER: So you’re saying not to move until December?

MR. MILESI-FERRETTI: Well, this is based on our outlook. The “reaction functionenvisaged by the Federal Reserve is--we think--the right strategy. The issue is how we are going to see how well has GDP done in the second quarter and what are the indications of how the economy’s performing over the third quarter. And based on those considerations, one would take a decision presumably on whether the pace is going to be slowed in September or later in the year.

But I’m saying based on our forecast today, which is for a relatively weak rest of the year, that is what we have. We’d be happy to be wrong.

QUESTIONNER: I have a question regarding the effect of the tapering on emerging markets and the Eurozone. As we saw, just the mentioning by the Fed of this possibility has created some turbulence in the financial markets and this would at the end of the day reflect on lower global growth and it would again affect the U.S. economy. So how much do you think the Fed should worry about the global effect of its policy? Thank you.

MR. MILESI-FERRETTI: I would like to say a couple of things on this. So one thing that we need to take into account is what was the situation in mid-to-late May when the Federal Reserve Chairman mentioned with more precision in time and conditions the tapering of asset purchases. During the previous two months, you’ve had a very strong run-up in asset prices, unusually low volatility, and a number of observers were beginning to express concern about segments of financial markets being excessively frothy. And, indeed, long-term interest rates in the U.S. had declined quite significantly from about 2 percent in March to below 1.7 in May. So part clearly of what happened was also a reaction to a period of extremely low volatility and a very sharp run-up in asset prices. There was a very significant correction.

You saw over the last few weeks that markets have stabilized. You’ve had some increase in interest rates globally, some tightening of financial conditions, but not a dramatic one. What I would want to stress is that the strategy of the Federal Reserve is clearly tied to the expected performance of the U.S. economy. So real interest rates, long-term interest rates, will rise with a faster tapering or a bringing-forward of a normalization of short-term interest rates if the U.S. economy does better and grows faster than expected. And that part, the faster U.S. growth, is clearly good for the U.S. economy and good for the world.

So you have two aspects to it, the positive impact that is going to come from faster growth that is going to be tempered to some extent by the fact that interest rates are going to rise, reflecting again the strength of the U.S. recovery. But if you look at where rates are today, even in countries in the Eurozone, the increase in rates relative to increasing rates in the U.S., is considerably more modest.

QUESTIONNER: I have a question about the monetary policy, especially about the policy rates. In your scenario you said policy rates assumed to remain until early 2016. And also the large majority of FOMC members expect such increase to occur during 2015. I’d like to ask more specifically the reason why you said the rate remains at zero until early 2016.

MR. MILESI-FERRETTI: Thank you for your question. Again, it’s a good question, but it’s also one that is easy to answer for us. We think we have a slightly slower pace of recovery in our forecast than the majority of FOMC members. So we have the decline in unemployment that in our view would trigger the first increase in interest rates a few months later than what is assumed in the forecast of the FOMC. So that is the reason for the difference. We simply expect the recovery to be a little bit slower. Again, we are talking about the few months down the road, two years from now.

MR. ANSPACH: All right. So if there are no further questions, I would like to thank you for listening in, and to remind you that the comments and the report are embargoed until 10:30 today.


IMF fears Fed tapering could 'reignite' euro debt crisis

The tapering of stimulus by the US Federal Reserve risks reigniting the eurozone debt crisis and pushing the weakest countries into a "debt-deflation spiral", the International Monetary Fund has warned.

By Ambrose Evans-Pritchard

2:07PM BST 25 Jul 2013

The Fed, Federal Reserve Bank, Washington DC. Main entrance on Constitution Avenue near the National Mall
Early tapering by the Fed "could lead to additional, and unhelpful pro-cyclical increases in borrowing costs within the euro area", the IMF said. Photo: Alamy

"The macroeconomic environment continues to deteriorate," said the Fund in its annual `Article IV' health check on the eurozone.
"Recovery remains elusive. Growth has weakened further and unemployment is still rising, and the risks of prolonged stagnation and inflation undershooting are high. Mounting social and political tensions pose an increasing threat to reform momentum."
The report warned that the onset of a new tightening cycle in the US had already led to major spill-over effects in the eurozone, pushing up bond yields across the board.
Early tapering by the Fed "could lead to additional, and unhelpful, pro-cyclical increases in borrowing costs within the euro area. This could further complicate the conduct of monetary policy and potentially damage area-wide demand and growth. Financial market stresses could also quickly reignite," it said.
The Fund said the European Central Bank must take countervailing action to prevent "a vicious circle setting in," ideally by cutting interests, introducing a negative deposit rate, and purchasing a targeted range of private assets.

It should launch "credit-easing" policies to alleviate the deepening lending crunch in Spain, Italy, and Portugal, where borrowing costs for firms are 200 to 300 basis points higher than in Germany, with small businesses struggling to raise any money at all. The IMF said the more the Fed tightens in the US, the more the European authorities need to offset this with other forms of stimulus.

The report came as fresh data from the ECB showed that loans to the private sector contracted by €46bn in June, after falling by €33nbn in May , and €28bn in April. The annual rate of contraction has accelerated to 1.6pc.

The M3 broad money supply is also fizzling out, with growth dropping to 2.3pc year-on-year. There has been almost no growth in M3 since October 2012.

The money data tends to act as an early warning indicator for the economy a year or so ahead, and therefore casts doubt on recent claims by EU leaders that the crisis is over.

"Today's figures put serious question marks over the strength of the nascent recovery," said Martin van Vliet from ING. The data is at odds with the recent rebound in industrial output and rising PMI survey indexes for manufacturing.

The IMF said the eurozone economy would shrink by 0.6pc this year, the same as in 2012. It is expected to grow by 0.9pc next year but this will not be enough to make a dent on unemployment, and could easily be thrown off course by a fresh global shock.

"There is a high risk of stagnation, especially in the periphery. Such an outcome could push the periphery toward a debt-deflation spiral," it said.

The report said that it may take years to unwind the colossal credit boom of the early EMU years. "Historically, almost all of the run-up in household debt tends to be reversed. But in the euro area, the reduction in debt-to-GDP ratios has barely started, and the boom was more pronounced."

"Furthermore, in past deleveraging episodes, the debt reversal was largely facilitated by high inflation and growth, and supported by expansionary fiscal policy. Because these factors will not contribute much to the ongoing deleveraging process in the euro area periphery, the adjustment is likely to be protracted and have to rely more on reductions in nominal debt. The contrast with history is similarly sobering when it comes to corporate debt," said the Fund, adding that the EMU periphery has the daunting task of triple deleveraging by governments, households, and firms all at the same time.

The Fund said it is crucial that the eurozone deliver on pledges from a proper banking union and resolution fund capable of "swift decisions on burden sharing".

While polite in tone, the authors appear exasperated by "incomplete or stalled delivery of policy commitments" and seemingly endless foot-dragging by EMU leaders.

"The hurdle for reaching a collective agreement is always high. Moreover, building political support for such decisions can take considerable time, especially when they involve thorny issues such as burden-sharing or ceding national control. Hence, making swift progress on completing the banking union and moving toward greater fiscal integration are proving exceedingly difficult."

In a comment clearly aimed at Germany and the key creditor powers, the IMF said "unwavering political backing for institutional reforms remains critical and is in the interest of all EMU members."

Shortages, warehouses and misinformation: Comex gold explained

A primer on how physical gold stocks are held for Comex contracts, and what stock changes mean...

Author: Miguel Perez-Santalla

Posted: Thursday , 25 Jul 2013

LONDON (Bullion Vault)- THERE HAS been a lot of misinformation recently about Comex warehouse gold stocks.

Most notably, there's confusion about how this year's sharp drop in the quantity of gold bullion held in Comex warehouses might point to some looming shortage of metal to settle gold futures contracts, or even signal an outright default by sellers to buyers.

But there is no mystery or hidden agenda of how Comex works. In this article our goal is to explain how the Comex works in the simplest fashion. Having been involved in the physical gold markets for thirty years – both making and taking delivery on the exchange, as well as through off-exchange deals for miners, refiners, fabricators and investors – I hope I'm in a position to share a true "insider" view, the better to inform this debate properly.

First question: How does gold get into warehouse stocks of the futures exchange? Although it's a lengthy process, the answer is actually quite simple. Gold is recovered either from mine output or scrap jewelry and other products, such as bars and coins, at a refinery. The refiner then produces gold bars to the standard and specification of the exchange, in this case the CME Group.

These gold bars belong either to the refiners themselves, meaning they have bought and own the gold. Or they belong to the refiner's customers, who bought and owned the gold at the refinery, hiring it to make that metal into saleable bars.

Now, for this particular refinery to deliver metal onto the commodities exchange, it must be a registered acceptable brand, such as Heraeus, Johnson Matthey or Metalor Technologies to name a few.

Once these gold bars are produced, the metal must then be transported to the warehouse by exchange-approved carriers such as Brinks Inc., Via Mat International or IBI Armored Inc. There is no other way for the gold to get onto the exchange. Gold may move between Comex-approved warehouses, such as those operated by HSBC Bank, Brinks Inc., and Scotia Mocatta Depository. But any moves made between these warehouses must be made using the same approved carriers. No gold can enter the marketplace from outside of this refining loop.

Once gold is removed from an exchange-approved warehouse and held somewhere outside of this circle of integrity, there is no way for the CME exchange to guarantee the bar's quality. This means that once a person or investor removes bars from the warehouse, then to return them to the exchange they would need to start at the beginning again. By going through the hands of the gold processor and refiners, this provides guarantee of the standard and quality of the material being delivered on the exchange.

So with the gold inside the warehouse, second question: When is the gold considered eligible or registered on the commodities Exchange?

Answer: When acceptable bars are brought into an exchange-approved warehouse they become "eligible" for settlement of gold futures contracts traded on the exchange. So at this point, the owner of the bars may deliver them onto the Exchange, and warehouse receipts are created. That is when the gold bars become "registered" stocks.

Eligible gold stocks may or may not ever become registered stocks. Why? Because the warehouse is still a warehouse and the owner may simply want to vault their metal securely, before using it to meet demand elsewhere – for manufacturing, or from investors in another marketplace, such as Asia. This eligible gold may belong to an investor, a refiner, a hedge fund, a bank or producer.

Many times these people are holding the metal for their end customers. And it may move at any time, and is much more flexible than the warehouse receipts that are registered stocks.

The CME, the exchange, does not have any direct control over nor interest in the size of eligible stocks. Registered stocks however are officially recognized by the CME for good delivery on the exchange. That means that this inventory exists and is set aside to make delivery against gold futures contracts. Traders who stand for delivery, rather than cash payment, when their contract settles take delivery of the warehouse receipt. This does not change the quantity of registered stocks inside the warehouse. It remains registered, but the receipt changes ownership.

If a gold futures buyer wants to take physical delivery of the gold and "break" the receipt then this is possible. But it is a process and takes time. Once broken, if the gold remains in the exchange circle of integrity meaning the exchange-approved warehouse – then those bars become eligible stocks. But if the gold bars are removed from the exchange-approved warehouse then they no longer are eligible and are no longer tracked in any way.

Third question then: How do the warehouse receipts work?

A warehouse receipt is a bearer instrument much like a check. It can be endorsed from one party to another. The holder of the receipt pays the storage costs. Most times when people take delivery of a warehouse receipt they leave it with their brokers. In some cases people may want to take possession of the warehouse receipt themselves. This is rare, just like with equity or bond certificates; no one actually takes delivery of the documents any longer. But it is still possible for a fee.

If a person owns a warehouse receipt, the gold that it represents is still in the registered stocks, even if they have taken physical delivery of the document. They can always redeliver these receipts onto the exchange by selling contracts.

How does the gold futures exchange work? CME Group is the largest futures exchange in the world. Many commodities, of which gold is one, are traded on this exchange. The gold exchange – which is often still referred to as the Comex, its original name prior to being bought by the CME – is the largest gold exchange by volume in the world.

On the exchange, futures contracts are traded. These contracts are agreements to deliver a specified quantity and grade of metal at a specified time. Because of the ability to margin these contracts, meaning to pay a deposit on a greater value of gold, there is a lot of liquidity in the market.

Much of this liquidity is provided by speculators who are trying to make money on the direction of the gold price. This enables the gold industry – the mine producers, refiners, manufacturers and retailers – to protect themselves from market risk, hedging their exposure to price movements by trading contracts for prices in the future. This is the reason that the gold futures market exists.

Most commodity futures contract positions are closed prior to the delivery period. This means that more often than not, the people that contract to trade on the exchange liquidate their contractual commitments prior to having to take delivery. But this does not mean that all that business is founded only on speculation. For example, a jewelry manufacturing firm may contract to sell a gold contract as they physically buy gold. Perhaps because the product they are making has not been sold to a customer yet.

For simplicity's sake, imagine a jeweler needs 100 ounces of gold to make four hundred gold rings. The process may take him two weeks, and in that time period he may not want to take the price risk.

So the jeweler decides to sell one gold contract (100 ounces) on the CME at the same time as he buys the physical gold for production. In this way he is hedged, which means he no longer has price risk. In two weeks' time, when the rings are ready and he has found the buyer, he sells the rings to the buyer and at the same time buys back the contract.

In this instance there is no settlement of physical via the commodities exchange. There are many examples similar to this one that are used every day, one way or another, for hedgers of commodities.

A main factor in the gold market is that typically, when gold registered stocks are falling, that means the gold price is falling too. This indicates that gold is being better used off the market, instead of being held on the exchange. As for the total quantity of eligible and registered stocks in CME warehouses, it also tends to track prices higher and lower. When gold prices rise, it attracts more investors, who make use of gold by holding it as a store of value.

This metal itself needs storing, and it's important to remember that, as we saw above, the Comex warehouses are used to do just that, alongside their role in vaulting gold bars for futures contract delivery.

The higher gold prices go, in short, the more people want to own it. So the more metal there will be held in warehouses on behalf of investors. And when prices fall, as they have in the last nine months and more, some owners of metal will find better-rewarded uses elsewhere, outside Western investment stockpiles, and converted for instance into the smaller kilobar products favored by Asian investors currently paying $20 per ounce over international prices in China.

As you can see, there's little urgency or importance in the 2013 plunge in Comex warehouse gold stocks. Gross quantities are lower, but they are greater than any period prior to 2005. Just looking at the level of warehouse stocks, it is difficult and presumptuous to extrapolate market fundamentals from the holdings of eligible or registered gold at any one time. There is still plenty of metal, and there are hundreds of millions of dollars of gold traded every day off of the Comex, by thousands of different participants each with their own motivations.

Yes, there are lots of good reasons to buy gold today, I believe. But misunderstanding the basics of what is in truth a simple part of the global market shouldn't be one of them.

Miguel Perez-Santalla is vice president of business development for BullionVault, the physical gold and silver exchange founded a decade ago and now the world's #1 provider of physical bullion ownership online. A fierce advocate for retail investors, and a regular speaker at industry and media events, Miguel has over 30 years' experience in the precious metals business, previously working at the United States' top coin dealerships, as well as international refining group Heraeus.