Despite Declining Deficit, Foreigners Aren’t Bailing Us Out, So the Fed Will Keep QE Going

Bud Conrad, Chief Economist

July 26, 2013 5:45pm

The basic imbalance driving our economy is the government deficit, which spun out of control as a result of the Credit Crisis of 2008/9. But the sequester, improving tax base, lower interest rate, and elimination of stimulus spending have caused the big government deficit, while still extreme, to drop to half its previously nosebleed levels.

Even so, the deficits remain well out of proportion for a sustainable future. Projections for future government expenditures, including those related to the masses of retiring baby boomers, are on track to increase exponentially. Especially given that the deficits are actually much worse than generally discussed. Honest accounting would include the growing liabilities for retirees in the current accruals, resulting in deficits running closer to $5 trillion per year.

Foreigners recycling their trade surpluses have been an important source of purchases for US government debt. As you can see from the chart of long-term securities purchases by foreigners, that buying collapsed during the crisis. And, interestingly, it has recently fallen sharply again.
Offsetting the reduction in purchases of US debt by foreigners, the Fed has stepped in with multiple quantitative easings (QE), buying government securities itself in order to add liquidity and drive interest rates down. The shift into an accommodative policy is easy to see in the big picture of the holdings of Treasuries at the Fed:
Simply, the loss of foreign enthusiasm for US government debt would normally be a red flag for our economy. This time around, the slack is being papered over by the Fed, which is creating money out of thin air in order to buy what is, in essence, most of the new debt being issued by the federal government. By filling the gap left by exiting foreigners, the Fed has been able to sustain low interest rates—for the time being.

As the American public doesn't save much, and because foreigners are stepping away from US government debt, the Fed is left as the buyer of last resort and will have to keep up its QE.
Among a number of problems, the money creation required for the Fed to serve as the government's lender of last resort can be very inflationary once it ultimately bleeds into the economy. For now, most of the new money has been bottled up on the balance sheet of the Fed. With low rates, that is manageable. But if rates rise, as they eventually must in the face of rising inflation and a loss in confidence in the dollar, the interest the Fed pays on deposits rises as well, putting the viability of the institution at risk.

In addition, as rising rates increase the cost of servicing the government's many debts, federal deficits will also rise. And that has the very real potential to create the equivalent of an economic death cycle as foreigners, and pretty much anyone other than the Fed, rush to the exits on US government paper, causing interest rates to rise further.

While it is impossible to say with any certainty when the US government bond bubble, the largest in history, will burst, the recent up-moves in interest rates should serve as a clear warning shot. From the charts, it looks like the foreigners have taken notice.


July 26, 2013, 6:44 p.m. ET

The Real Reason the Once Great City of Detroit Came to Ruin

The politics of Mayor Coleman Young drove out the white and black middle class.



On an August evening in 1976, several hundred gang members descended on a concert in Detroit's Cobo Hall and rampaged through the crowd. The Detroit Police Department, whose ranks had been cut by 20% or nearly 1,000 officers by Mayor Coleman Young, took more than an hour to respond to the mini-riot while teens snatched purses and attacked concertgoers. The melee made headlines and provided stark evidence that in the nine years since the city's 1967 riots, which lasted five days and claimed 43 lives, Detroit's decline had continued.

Today, Detroit sits in bankruptcy court as the largest municipal Chapter 9 case in American history. Much of the commentary about the city's decline has focused on global economic forces that displaced auto manufacturing jobs and public unions whose demands emptied the till as Detroit foundered.

The truth is that Detroit was a failed city long before it became insolvent, thanks to a virtual collapse of its municipal government during Young's 1974-1994 reign as mayor. A radical trade unionist who ran as an antiestablishment candidate reaching out to disenfranchised black voters, Young lacked a plan except to go to war with the city's major institutions and demand that the federal government save it with subsidies. Critics called it "tin-cup urbanism."

As the city's government became increasingly less effective, whites and then middle-class blacks fled. "He left the city a fiscal and social wreck," the eminent political scientist James Q. Wilson wrote in a 1998 article in The New Republic, "The Closing of the American City."

Young was right that Detroit needed reform to deal with problems sparked by the migration of poor Southern blacks into the city in the 1950s. He and others, White and black, criticized the political power structure in Detroit, and especially its police department, as racially insensitive. The 1967 riots, sparked by a police raid on an after-hours club in a black neighborhood, generated legitimate calls for change.

Elected ostensibly as a reform mayor in 1973, however, Young made things worse. He divided the police department along racial lines, creating separate layoff lists of white and black officers.

He and his handpicked police chief, William Hart, made clear that policing that resulted in too many arrests or citations in the black community would not be tolerated. "I wouldn't write tickets for black kids," one black officer told journalist Tamar Jacoby in her 1998 book "Someone Else's House: America's Unfinished Struggle for Integration."

When residents complained about a lack of law enforcement, Chief Hart called the protests "racism and sour grapes." Mayor Young declared that "law and order was code for 'Keep the n-----s in their place.'" Detroit became one of America's most violent cities.
Former Detroit Mayor Coleman A. Young
Young's divisive brand of governing extended to economic policy, such as it was. When General Motors agreed to build a new plant in the 1980s to help the city's revival, Young and GM targeted the still vibrant, largely white ethnic neighborhood of Poletown to locate the facility. In one of the nation's most infamous cases of eminent domain, the city sued in 1981 to raze some 1,500 homes and 144 businesses and displace 3,500 people.

As some Poletown residents hung on, hoping that court challenges would overturn the takings, Young withdrew services. Residents lived among demolition crews by day and looters by night. Documentary filmmaker George Corsetti described the chaotic last days of Poletown in a 2004 article in CounterPunch: "The night air was always smoke-filled and people slept with guns nearby."

Young benefitted politically from his very ineffectiveness. As the economists Edward Glaeser and Andrei Shleifer write in their study of urban ethnic politics, "The Curley Effect" (named after Boston's early 20th-century mayor James Michael Curley), as whites fled Detroit, Young's margin of electoral victory grew because his electoral base of poor blacks became a larger share of the city's population.

Meanwhile, the increasingly distressed city became a fiscal ward of the state and federal governments. As Ms. Jacoby wrote, by the late 1970s federal grants paid the salaries of up to one-third of Detroit's workforce.

Young's legacy haunted Detroit long after he retired (he died in 1997). He opposed the election of his successor, well-regarded black State Supreme Court Justice Dennis Archer, who won in 1993 without a majority of the black vote. Young allies blocked Mr. Archer's agenda, including efforts to reduce patronage in city government, and they even tried to recall him.

Mr. Archer was followed by Kwame Kilpatrick, dubbed by admirers the "hip-hop mayor," a supposedly authentic black voice in the mold of Young. Elected in 2001, Kilpatrick served until he was indicted for obstruction of justice and resigned under pressure in 2008. This year he was convicted on 24 federal counts committed during his mayoralty, including mail fraud and racketeering.

When former NBA star David Bing succeeded Kilpatrick in 2009, he called the city "near bankrupt financially, ethically, and operationally." While Young was not directly responsible for the public-pension obligations that led to the city's bankruptcy, his poor governance and hostility toward the middle class drove the tax base away.

Today, Detroit is an estimated $18 billion in debt including a $3.5 billion pension shortfall. Its population has shrunk to under 700,000 from 1.84 million in 1950. Unemployment is at 16.3 %, and the number of jobs in Detroit has declined by more than half since Young became mayor in 1974. The city's auto manufacturing base has shrunk despite the bailouts of GM and Chrysler, as those jobs moved to the likes of Kentucky and Alabama.

Today, too, Young's brand of urban revival, which viewed cities as victims that require federal aid, is no longer in favor. Few expect new urban spending from a financially troubled federal government. Texas Sen. John Cornyn recently introduced legislation that would bar the feds from bailing out Detroit or any other municipality.

In the early 1990s a new brand of reform mayorMilwaukee's John Norquist chief among them—emerged and argued that cities were the center of American dynamism and innovation. New York's Rudy Giuliani argued that effective municipal government was essential to urban revival, and he took to quoting the ancient Athenian Oath of Fealty, in which citizens and leaders pledged to "Transmit this city not only not less, but far greater and more beautiful than it was transmitted to us."

That's not something Coleman Young could ever claim to have accomplished.

Mr. Malanga is a senior fellow at the Manhattan Institute.

Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved

domingo, julio 28, 2013



Commodities Corner


Copper Due for More Pounding


There's a ton of the metal and a real shortage of buyers. China's slowdown is not helping.

DJ-AIG Commodity Indexes

Copper futures are trading near two-and-a-half-year lows after tumbling 15% this year, but don't bet on a rebound any time soon.

Prices are getting squeezed on both the supply and demand sides, which will likely continue for the next six to 18 months.

On the demand side: The warning signs flashed by the copper market in its recent tumble were touched off by the economic slowdown in China, by far the world's top consumer of copper.

China's economy grew 7.5% in the second quarter—a mind-boggling pace for the rest of the world, but a major slowdown from the double-digit growth the nation posted throughout much of the last decade, and even down a bit from the first quarter's 7.7% growth. The world's second-largest economy is expected to see an expansion of 7.5% this year, its slowest growth since 1990.

"With China accounting for about 45% of base metals consumption, this lower-growth potential at a time of improved supply suggests prices will stay under pressure," said Gayle Berry, a commodities analyst with Barclays.

Barclays was among several banks that cut their copper price forecasts in response to the Chinese growth outlook. The bank now expects copper to average $3.30 a pound in 2013—that's down 8.2% from its prior forecast.
September-delivery futures settled Friday down 8 cents, or 2.5%, at $3.1055 a pound on the Comex division of the New York Mercantile Exchange.

The supply outlook is equally bearish. Production from new and expanding mines continues to grow while demand slows. New mines like Rio Tinto's (ticker: RIO) Oyu Tolgoi project in Mongolia and Glencore Xstrata's (GLEN.U.K.) Antapaccay mine in Peru will add around 570,000 metric tons of copper production to the global market, according to Citi analysts. Meanwhile, the world's total copper supply will increase 5.4% or 900,000 tons this year, up from 3.2% growth in 2012, they add.

At the same time, production disruptions in the copper industry have been unusually light this year, helping to ramp up output. None of the mega-mines in Chile, which supplies about a third of the world's copper, have suffered a protracted setback in 2013.

Analysts typically expect between 5% and 8% of expected supply to be lost to various disruptions. Even a massive landslide in April at Rio Tinto's Bingham Canyon mine didn't dent much of the output onslaught. Work restarted just 17 days later. The company initially estimated it would lose about 100,000 tons of output due to the accident, but analysts now say lost production is likely to be a quarter of that.

ALL OF THIS POINTS TO A SURPLUS of copper for this year, the first such overhang since 2009. HSBC recently doubled the amount of excess copper it expects to be produced in 2013 to 320,000 tons, from an earlier forecast of 156,000. The bank also cut its price forecast to $3.27 a pound, from $3.63.

Despite these problems, mining companies may be aggravating the situation. Prices remain higher than the cost of production, which Goldman Sachs estimates at $2.63 a pound, giving mining companies few incentives to reduce output in the near term.

Goldman says that companies and other market participants will be stirred to cut back production only if copper prices drop to between about $2.70 and $2.95 a pound, which it expects in the next six to 18 months. 

TATYANA SHUMSKY covers commodities and other topics for The Wall Street Journal.

Copyright 2013 Dow Jones & Company, Inc. All Rights Reserved