America has conquered its debt crisis with incredible speed

US Congressional Budget Office expects the budget deficit to drop to 2.8pc of GDP this year, and 2.6pc next year

By Ambrose Evans-Pritchard

12:06AM BST 24 Apr 2014
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A sheet of uncut $100 bills is inspected during the printing process at the Bureau of Engraving and Printing Western Currency Facility in Fort Worth, Texas
Five years after the Lehman crisis, US output is climbing to new peaks Photo: AP

Americans are purging their excesses one by one. Spending by the US Federal government has seen the steepest drop as share of national income since demobilisation after the Second World War.

Claims that President Barack Obama is bankrupting America with a lurch towards hard-Left statism are for tabloid consumption only. Outlays have fallen from 24.4pc to 20.6pc of GDP in five years. Spending is roughly in line with its 40-year average. This fiscal squeeze has been achieved without driving the economy into recession or a Lost Decade, a remarkable feat.

The US Congressional Budget Office expects the budget deficit to drop to 2.8pc of GDP this year, and 2.6pc next year. This is about the same as the eurozone but with a huge difference. The US economy is expanding fast enough to outgrow its debts.

The US energy revolution is of course half the story. It has stoked booms across the Dakotas, Wyoming, Nebraska, Washington, Oregon, Utah and Texas.

Francisco Blanch, from Bank of America, estimates that shale gas and oil have given the US economy an extra tailwind worth 1.9pc of GDP - what he calls the "energy carry" - with effects rippling through the chemical and plastics industries. New investments in ammonia plants are rising at an exponential rate, thanks to natural gas prices that are $4.40 (per BTU) in the US and $15 on Asia's spot market.

The US transferred more than $3 trillion to oil exporters from 2001 to 2008. That chapter is closed. The US is back to where it was in 2000 with an energy deficit well below 2pc of GDP and improving every month, while the eurozone is at -4.4pc and getting worse, and Japan is at -6.3pc.

The US has added 2.5m barrels a day of crude output over the last three years, almost as much as the next three countries combined. America covered a quarter of its oil needs in 2007. It covers well over half today. It has overtaken Russia to become the world's biggest exporter of refined petroleum products, and will soon be an exporter of liquefied natural gas as well.

For more than half a century the US has been losing part of its industry with each recession. A study by the International Monetary Fund found that the pattern has been very different this time. Manufacturing has recovered quickly, led by machinery, computers and electronics. America's global share of manufacturing has stabilised at 20pc. China's share has also stabilised, at exactly the same level. The two superpowers are competing toe-to-toe for factory dominance. China is no longer gaining.

Yet the other half of the story is monetary stimulus a l'outrance - quantitative easing - to offset fiscal tightening and prevent a "pro-cyclical" downward spiral, which is what occurred when the European Central Bank jumped the gun and raised rates twice in 2011 before recovery was entrenched, setting off the catalysmic crisis that nearly destroyed EMU in mid-2012.

This policy mix is no novelty. Britain pursued the same strategy with success after leaving the Gold Standard dollar-peg in 1931 and after leaving the ERM fixed system in 1992, and arguably again over the last five years though the jury is still out this time.

America's public debt has peaked at 72.3pc of GDP (bonds held by the public). The CBO expects the ratio to fall gently for the next three years. Such is the magic of the denominator effect. Economies do not have to cut debt in absolute terms to whittle away debt. The Romanian dictator Nicolae Ceaușescu thought otherwise and assiduously paid off Romania's debts just in time for his own execution in 1989. Those shaping eurozone policy today sometimes seem to be in thrall to this same atavistic belief.

Growth does the job so much faster. US household debt has plummeted from 98pc to 81pc of GDP in four years. The ratio of debt payments to disposable income fell to 9.9pc in March, the lowest since the Federal Reserve's modern data series began in 1980. Most mortgage debt is locked at fixed interest rates so this will not change fast when the Fed tightens in earnest.

Charles Dumas from Lombard Street Research -- author of the America Phoenix in 2011, before it was fashionable -- says the mix of "soaring household wealth" and lower debt burdens leaves the US poised for a surge in consumer-led growth. He predicts a mini-boom, lasting until 2016.

The numbers of mortgages in negative equity have dropped to 19.4pc from 31.4pc two years ago, according to Zillow Real Estate Research. Over 4.8m households have been liberated. This is accelerating as US home prices claw back most of the 35pc drop from peak-to-trough.

Much of the debt has been cut by defaults, chiefly by home-owners throwing in their keys. You can do this in most US states, and rightly so. America's bankruptcy doctrines evolved with the injustices of colonial debt servitude still in the collective mind.

James Madison argued in the Federalist Papers before the American Revolution that treating debtors as criminals impeded risk-taking and commerce. A series of bankruptcy laws in the 19th Century gradually broke the lockhold of vested interests, levelling the playing field between debtors and creditors, with powerful effects on US economic dynamism.

Much of Europe still clings to late Medieval notions of debt sanctity, with laws to match, though a spate of suicides is forcing reform. In Spain the banks can sieze all your current and future assets if you cannot pay the mortgage - which tends to happens when the jobless rate jumps from 8pc to 26pc - adding the legal costs of foreclosure for good measure. Leaving aside the morality of state coercion to uphold the interests of creditors alone, this practice is inefficient. It blocks the cleansing process of boom-bust cycles, trapping economies in excess debt.

Data from the OECD show that the varied effects of Europe's debt laws, contractionary policies, and a needless double-dip slump, led to jumps in public and private debt (non-financial) by 30pc of GDP in Spain, 33pc in Holland, 34pc in Italy, 51pc in France, 71pc in Portugal and 151pc in Ireland, between 2008 and 2012. Europe's harsh methods have been self-defeating even on their own terms.

It is true that bond yields have tumbled to record lows across the EMU debtor bloc this year but that is not in itself sustainable recovery. What these yields reflect is that EMU is close to deflation and unlikely to grow vigorously for a long time. German Bunds used to be the barometer of such macro-economic judgments

Club Med debt has become a proxy too now that German Chancellor Angela Merkel -- though not the German constitutional court -- has allowed the ECB to back-stop Italian and Spanish debt as a lender-of-last resort.

Five years after the Lehman crisis, US output is climbing to new peaks and unemployment is 6.7pc. Euroland has yet to regain its 2008 output, and the jobless rate is stuck at 12pc. Austerity is not the variable. The US fiscal squeeze has been just as draconian. The Fed kept nominal GDP on an even keel. The ECB did not.

You might say that QE is just a beggar-thy-neighbour policy by stealth, an allegation made by India's central bank governor Raghuram Rajan in a speech this month. The Fed fought back against China and the mercantilist powers by driving the dollar down to a tolerable level, and the US is now enjoying a devaluation windfall. Europe opted instead for a hard-euro policy regardless of circumstances, and has allowed the industrial core of Southern Europe to be hollowed out as a result.

America still has a lot of debt to clear. The errors of the pre-Lehman boom and the fifty year cycle of rising leverage that preceded it have left a debt burden comparable to the effects of a major war.

Yet predictions of inevitable American decline that had such resonance five years ago already look oddly dated, a misreading of underlying economic and geopolitical power. The concept of the BRICS no longer has any economic meaning. Brazil and Russia fell by the way side long ago. India is decades away from any real challenge. Only China counts.

History is full of such false declines. Informed opinion thought Britain finished after losing America, but it was actually France that was ruined by the costs of the Revolutionary War. Britain was just about to embark on its greatest days.

The Roman Empire seemed beyond saving by the start of the Second Century. It was instead the precursor of the Antonines, almost 80 years of stability and wealth. America's governing institutions still work remarkably well. There is no necessary reason why America cannot enjoy its own Antonine revival until the middle of this century


April 24, 2014 1:32 pm


Strip private banks of their power to create money

The giant hole at the heart of our market economies needs to be plugged


Printing counterfeit banknotes is illegal, but creating private money is not. The interdependence between the state and the businesses that can do this is the source of much of the instability of our economies. It could – and shouldbe terminated.

I explained how this works two weeks ago. Banks create deposits as a byproduct of their lending. In the UK, such deposits make up about 97 per cent of the money supply. Some people object that deposits are not money but only transferable private debts. Yet the public views the banks’ imitation money as electronic cash: a safe source of purchasing power.

Banking is therefore not a normal market activity, because it provides two linked public goods: money and the payments network. On one side of banks’ balance sheets lie risky assets; on the other lie liabilities the public thinks safe. This is why central banks act as lenders of last resort and governments provide deposit insurance and equity injections. It is also why banking is heavily regulated. Yet credit cycles are still hugely destabilising.

What is to be done? A minimum response would leave this industry largely as it is but both tighten regulation and insist that a bigger proportion of the balance sheet be financed with equity or credibly loss-absorbing debt. I discussed this approach last week. Higher capital is the recommendation made by Anat Admati of Stanford and Martin Hellwig of the Max Planck Institute in The Bankers’ New Clothes.

A maximum response would be to give the state a monopoly on money creation. One of the most important such proposals was in the Chicago Plan, advanced in the 1930s by, among others, a great economist, Irving Fisher. Its core was the requirement for 100 per cent reserves against deposits. Fisher argued that this would greatly reduce business cycles, end bank runs and drastically reduce public debt. A 2012 study by International Monetary Fund staff suggests this plan could work well.

Similar ideas have come from Laurence Kotlikoff of Boston University in Jimmy Stewart is Dead, and Andrew Jackson and Ben Dyson in Modernising Money. Here is the outline of the latter system.

First, the state, not banks, would create all transactions money, just as it creates cash today. Customers would own the money in transaction accounts, and would pay the banks a fee for managing them.

Second, banks could offer investment accounts, which would provide loans. But they could only loan money actually invested by customers. They would be stopped from creating such accounts out of thin air and so would become the intermediaries that many wrongly believe they now are. Holdings in such accounts could not be reassigned as a means of payment. 
Holders of investment accounts would be vulnerable to losses. Regulators might impose equity requirements and other prudential rules against such accounts.

Third, the central bank would create new money as needed to promote non-inflationary growth. Decisions on money creation would, as now, be taken by a committee independent of government.

Finally, the new money would be injected into the economy in four possible ways: to finance government spending, in place of taxes or borrowing; to make direct payments to citizens; to redeem outstanding debts, public or private; or to make new loans through banks or other intermediaries. All such mechanisms could (and should) be made as transparent as one might wish.

The transition to a system in which money creation is separated from financial intermediation would be feasible, albeit complex. But it would bring huge advantages. It would be possible to increase the money supply without encouraging people to borrow to the hilt. It would end too big to fail” in banking. It would also transfer seignorage – the benefits from creating money – to the public. In 2013, for example, sterling M1 (transactions money) was 80 per cent of gross domestic product. If the central bank decided this could grow at 5 per cent a year, the government could run a fiscal deficit of 4 per cent of GDP without borrowing or taxing. The right might decide to cut taxes, the left to raise spending. The choice would be political, as it should be.

Opponents will argue that the economy would die for lack of credit. I was once sympathetic to that argument. But only about 10 per cent of UK bank lending has financed business investment in sectors other than commercial property. We could find other ways of funding this.

Our financial system is so unstable because the state first allowed it to create almost all the money in the economy and was then forced to insure it when performing that function. This is a giant hole at the heart of our market economies. It could be closed by separating the provision of money, rightly a function of the state, from the provision of finance, a function of the private sector.

This will not happen now. But remember the possibility. When the next crisis comes – and it surely will – we need to be ready.


Copyright The Financial Times Limited 2014.


Alarm Bells in Asia

Brahma Chellaney

APR 24, 2014
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Newsart for Alarm Bells in Asia

NEW DELHIThe deteriorating situation in Ukraine and rising tensions between Russia and the United States threaten to bury US President Barack Obama’s floundering pivot” toward Asia – the world’s most vibrant (but also possibly its most combustible) continent. Obama’s tour of Japan, South Korea, Malaysia, and the Philippines will do little to rescue the pivot or put his regional foreign policy on a sound footing.

In fact, Russia’s aggression in Ukraine is just the latest reason that the pivot – which has been rebranded as a “rebalancing” – has failed to gain traction. A slew of other factors – including America’s foreign-policy preoccupation with the Muslim world, Obama’s reluctance to challenge an increasingly assertive China, declining US defense outlays, and diminished US leadership on the world stage – were already working against it.

The reality is that rising anxiety among Asian countries about China’s increasingly muscular foreign policy has presented the US with an important opportunity to recapture its central role in the region by strengthening old alliances and building new partnerships. But the US has largely squandered its chance, allowing China to continue to broaden its territorial claims.

Indeed, over the last two years, America’s Asian allies and partners have received three jarring wake-up calls, all of which have delivered the same clear message: the US cannot be relied upon to manage China’s rise effectively.

The first such signal came in the form of Obama’s silence when China seized the disputed Scarborough Shoal from the Philippines in July 2012. The movewhich established a model for China to annex other disputed territoriesoccurred despite a US-brokered deal for a mutual withdrawal of Chinese and Philippine vessels from the area. Obama’s apparent indifference to America’s commitment to the Philippines under the 1951 mutual-defense treaty, which it reaffirmed in 2011, encouraged China to seize the Second Thomas Shoal, which is also claimed by the Philippines.

America’s Asian allies received a second wake-up call when China unilaterally established an air defense identification zone (ADIZ) covering territories that it claims (but does not control) in the East China Sea – a dangerous new precedent in international relations. China then demanded that all aircraft transiting the zone – whether headed for Chinese airspace or not submit flight plans in advance.

Instead of demonstrating its disapproval by postponing Vice President Joe Biden’s trip to Beijing, the US government advised commercial airlines to respect China’s self-declared ADIZ. Japan, by contrast, told its carriers to disregard China’s demand – an indication of the growing disconnect in US-Japanese relations.

The third wake-up call comes from Ukraine. The US has responded to Russia’s illegal annexation of Crimea by distancing itself from the “Budapest Memorandum,” the pact that US President Bill Clinton signed in 1994 committing the US to safeguard Ukraine’s territorial integrity in exchange for relinquishing its nuclear arsenal.

The first two wake-up calls highlighted the Obama administration’s unwillingness to do anything that could disrupt its close engagement with China, a country that is now central to US interests. The third was even more ominous: America’s own vital interests must be directly at stake for it to do what is necessary to uphold another country’s territorial integrityeven a country that it has pledged to protect.

The world is witnessing the triumph of brute power in the twenty-first century. Obama was quick to rule out any US military response to Russia’s Crimea takeover. Likewise, as China has stepped up efforts to upend the regional status quo – both territorial and riparian – the US has dithered, doing little to reassure its jittery Asian allies.

Instead, the US has pursued a neutral course, which it hopes will enable it to avoid being dragged into a military confrontation over countries’ conflicting territorial claims. To this end, the US has addressed its calls for restraint not only to China, but also to its own allies.

But America’s own restraint – whether in response to Russia’s forcible absorption of Crimea or to China’s creeping, covert warfare – has brought no benefits to its allies. In fact, its efforts to avoid confrontation at all costs could inadvertently spur game-changing – and potentially destabilizinggeopolitical developments.

Most important, America’s sanctions-driven policy toward Russia is likely to force the Kremlin to initiate its own pivot toward Asiaparticularly toward energy-hungry, cash-rich China. At the same time, a showdown with Russia will compel the US to court China more actively. In a new Cold War scenario, China would thus be the big winner, gaining a wide diplomatic berth to pursue its territorial ambitions.

While the US propitiates China, countries like Japan, India, the Philippines, and Vietnam are being forced to accept that they will have to contend with Chinese military incursions on their own. That is why they are stepping up efforts to build credible military capabilities.

This trend could lead to the resurgence of militarily independent Asian powers that remain close strategic friends of the US. In this sense, they would be following in the footsteps of two of America’s closest allies – the United Kingdom and France – which have built formidable deterrent capacities, rather than entrust their security to the US. This would be a game-changing development for Asia, the US, and the entire world.


Brahma Chellaney, Professor of Strategic Studies at the New Delhi-based Center for Policy Research, is the author of Asian Juggernaut, Water: Asia’s New Battleground, and Water, Peace, and War: Confronting the Global Water Crisis.