Bond crash across the world as deflation trade goes horribly wrong

Markets ignored clear warnings in Europe and America that the money supply is catching fire, signalling a surge of inflation later this year

By Ambrose Evans-Pritchard

7:48PM BST 10 Jun 2015

US dollar bank notes are seen in this picture illustration taken in Warsaw
M3 growth in the US has been running at an 8pc rate this year, roughly in line with post-war averages Photo: Reuters
The global deflation trade is unwinding with a vengeance. Yields on 10-year Bunds blew through 1pc today, spearheading a violent repricing of credit across the world.  

The scale is starting to match the 'taper tantrum' of mid-2013 when the US Federal Reserve issued its first gentle warning that quantitative easing would not last forever, and that the long-feared inflexion point was nearing in the international monetary cycle.
Paper losses over the last three months have reached $1.2 trillion. Yields have jumped by 175 basis points in Indonesia, 160 in South Africa, 150 in Turkey, 130 in Mexico, and 80 in Australia.
The epicentre is in the eurozone as the "QE" bet goes horribly wrong. Bund yields hit 1.05pc this morning before falling back in wild trading, up 100 basis points since March. French, Italian, and Spanish yields have moved in lockstep.


A parallel drama is unfolding in America where the Pimco Total Return Fund has just revealed that it slashed its holdings of US debt to 8.5pc of total assets in May, from 23.4pc a month earlier. This sort of move in the staid fixed income markets is exceedingly rare.

The 10-year US Treasury yield - still the global benchmark price of money - has jumped 48 points to 2.47pc in eight trading sessions. "It is capitulation out there, and a lot of pain," said Marc Ostwald from ADM.  

The bond crash has been an accident waiting to happen for months. Money supply aggregates have been surging all this year in Europe and the US, setting a trap for a small army of hedge funds and 'prop desks' trying to squeeze a few last drops out of a spent deflation trade. "We we're too dogmatic," confessed one bond trader at RBS.

Data collected by Gabriel Stein at Oxford Economics shows that 'narrow' M1 money in the eurozone has been growing at a rate of 16.2pc (annualized) over the last six months. You do not have to be monetarist expert to see the glaring anomaly.

Broader M3 money has been rising at an 8.4pc rate on the same measure, a pace not seen since 2008.

Economic historians will one day ask how it was possible for €2 trillion of eurozone bonds - a third of the government bond market - to have been trading at negative yields in the early spring of 2015 even as the reflation hammer was already coming down with crushing force.

"It was the greater fool theory. They always thought there would be some other sucker to buy at an even higher price. Now we are returning to sanity," said Mr Stein.

M3 growth in the US has been running at an 8pc rate this year, roughly in line with post-war averages. The growth scare earlier this year has subsided, as was to be expected from the monetary data.

The economy has weathered the strong dollar shock and seems to have shaken off a four-month mystery malaise. It created 280,000 jobs in May. Bank of America's GDP 'tracker' is running at a 2.9pc rate this quarter.

Capital Economics calculates that hourly earnings have been rising at a rate of 2.9pc over the last three months, the fastest since the six-year expansion began.

Bond vigilantes - supposed to have a sixth sense for incipient inflation, their nemesis - strangely missed this money surge on both sides of the Atlantic. Yet M1 is typically a six-month leading indicator for the economy, and M3 leads by a year or so. The monetary mechanisms may be damaged but it would be courting fate to assume that they have broken down altogether.

Jefferies is pencilling in a headline rate of 3pc by the fourth quarter as higher oil prices feed through. If they are right, we will be facing a radically different economic landscape within six months.

This has plainly been a bond market bubble, one that is unwinding with particular ferocity because new regulations have driven market-makers out of the business and caused liquidity to evaporate. Laurent Crosnier from Amundi puts it pithily: "rather than yield at no risk, bonds have been offering risk at no yield."

Funds thought they were on to a one-way bet as the European Central Bank launched quantitative easing, buying €60bn of eurozone bonds each month at a time when fiscal retrenchment was causing fresh supply to dry up. They expected Bunds to vanish from the market altogether as Berlin increases its budget surplus to €18bn this year and retires debt.

Instead they have discovered that the reflationary lift from QE overwhelms the 'scarcity effect' on bonds. Contrary to mythology - and a lot of muddled statements by central bankers who ought to know better - QE does not achieve its results by driving down yields, at least not if conducted properly and if assets are purchased from outside the banking system. It works through money creation. This in turn lifts yields.

The ECB's Mario Draghi has achieved his objective. He has (for now) defeated deflation in Europe. After six years of fiscal overkill, monetary contraction, and an economic depression, the region is coming back to life.

How this now unfolds for the world as a whole depends on the pace of tightening by the Fed.

Futures contracts are still not pricing in a full rate rise in September. They are strangely disregarding the message from the Fed's own voting committee - the so-called 'dots' - that further rises will follow relatively soon and hard.  

The Fed is implicitly forecasting rates of 1.875pc by the end of next year. Markets are betting on 1.25pc, brazenly defying the rate-setters in a strange game of chicken.

The International Monetary Fund warned in April that this mispricing is dangerous, fearing a "cascade of disruptive adjustments" once the Fed actually pulls the trigger.

Nobody knows what will happen when the spigot of cheap dollar liquidity is actually turned off.

Dollar debts outside US jurisdiction have ballooned from $2 trillion to $9 trillion in fifteen years, leaving the world more dollarised and more vulnerable to Fed action than at any time since the fixed exchange system of the Gold Standard.

Total debt has risen by 30 percentage points to a record 275pc of GDP in the developed world since the Lehman crisis, and by 35 points to a record 180pc in emerging markets.

The pathologies of "secular stagnation" are still with us. China is still flooding the world with excess manufacturing capacity. The global savings rate is still at an all-time high of 26pc of GDP, implying more of the same savings glut and the same debilitating lack of demand that lies behind the Long Slump.

As Stephen King from HSBC wrote in a poignant report - "The World Economy's Titanic Problem"- we have used up almost all our fiscal and monetary ammunition, and may face the next global economic downturn with no lifeboats whenever it comes.

The US is perhaps strong enough to withstand the rigours of monetary tightening. It is less clear whether others are so resilient. The risk is that rising borrowing costs in the US will set off a worldwide margin call on dollar debtors - or a "super taper tantrum" as the IMF calls it - that short-circuits the fragile global recovery and ultimately ricochets back into the US itself. In the end it could tip us all back into deflation.

"We at the Fed take the potential international implications of our policies seriously," said Bill Dudley, head of the New York Fed.

Yet in the same speech to a Bloomberg forum six weeks ago he also let slip that interest rates should naturally be 3.5pc once inflation returns to 2pc, a thought worth pondering.

Furthermore, he hinted that Fed may opt for the fast tightening cycle of the mid-1990s, an episode that caught markets badly off guard and led to the East Asia crisis and Russia's default.

The bond ructions this week are an early warning that it will not be easy to wean the world off six years of zero rates across the G10, and off dollar largesse on a scale never seen before.

Central banks have no safe margin for error.

The Punch Bowl Stays

By: Peter Schiff

Tuesday, June 9,

It is well known that I don't think much of the ability of government officials to correctly forecast much of anything. Alan Greenspan and Ben Bernanke have made famously clueless predictions with respect to stock and housing bubbles, and rank and file Fed economists have consistently overestimated the strength of the economy ever since their forecasts became public in 2008 (see my previous article on the subject). But there is one former Fed and White House economist who has a slightly better track record...which is really not saying much. Over his public and private career, former Fed Governor and Bush-era White House Chief Economist Larry Lindsey actually got a few things right.

Back in the late 1990s, Lindsey was one of the few Fed governors to warn about a pending stock bubble, and to suggest that forecasts for future growth in corporate earnings were wildly optimistic.

He also famously predicted that the cost of the 2003 Iraq invasion would greatly exceed the $50 billion promised by then Secretary of Defense Donald Rumsfeld, a dissent that ultimately cost him his White House position. (But even Lindsey's $100-$200 billion forecast proved way too conservative - the final price of the invasion and occupation is expected to exceed $2 trillion).

Now Lindsey is speaking out again, and this time he is pointing to what he sees as a painfully obvious problem: That the Fed is creating new bubbles that no one seems willing to confront or even acknowledge. Interviewed by CNBC on June 8th on Squawk Box, Lindsey offered an unusually blunt assessment of the current state of the markets and the economy. To paraphrase:

"The public and the political class love to have everything going up. We had "Bubble #1" in the 1990s, "Bubble #2" in the 00s, and now we are in "Bubble #3." It's a lot of fun while it's going up, but no one wants to be accused of ending the party early. But it's the Fed's job to take away the punch bowl before the party really gets going."

To his credit, however, Lindsey sees how this is sowing the seeds for future pain, saying:

"The current Fed Funds rate is clearly too low, the only question is how we move it higher: Do we do it slowly, and start sooner, or do we wait until we are forced to, by the bond market or by events or statistics, in which case we would need to move more quickly. By far the lower risk approach would be to move slowly and gradually."

In other words, he is virtually pleading for his former Fed colleagues to begin raising rates immediately. I would take Lindsey's assertion one step further; the party really got going years ago and has been raging since September 2011, the last time the Dow corrected more than 10%.

(That correction occurred at a time when the Fed had briefly ceased stimulating markets with quantitative easing.) Since then, the Dow has rallied by almost 58% without ever taking a breather. With such confidence, the party has long since passed into the realm of late night delirium.

As if to confirm that opinion, on June 8th the Associated Press published an extensive survey of 500 companies (using data supplied by S&P Capital IQ) that showed how corporate earnings have been inflated by gimmicky accounting. Public corporations, upon whose financial performance great sums may be gained or lost, are supposed to report earnings using standard GAAP (Generally Accepted Accounting Principles) methods. But much like government statisticians (see last month's commentary on the dismissal of bad first quarter performance), corporate accountants may choose to focus instead on alternative versions of profits to make lemonade from lemons.

Using creative accounting bad performance can be explained away, moved forward, depreciated, offset, or otherwise erased. Given the enormity and complexity of corporate accounting, investors have deputized the analyst community to sniff out these shenanigans. Unfortunately, our deputies may have been napping on the job.

The AP found that 72% of the 500 companies had adjusted profits that were higher than net income in the first quarter of this year, and that the gap between those figures had widened to sixteen percent from nine percent five years ago. They also found that 21% of companies reported adjusted profits that were 50% more than net income, up from just 13% five years ago.

But with the fully spiked punch bowl still on the table, and the disco beat thumping on the speakers, investors have consistently looked past the smoke and mirrors and have accepted adjusted profits at face value. In a similar vein, they have looked past the distorting effect made by the huge wave of corporate share buybacks (financed on the back of six years of zero percent interest rates from the Fed). The buybacks have created the illusion of earnings per share growth even while revenues have stalled.

So kudos to Lindsey for pointing out the ugly truth. But I do not share his belief that the economy and the stock market can survive the slow, steady rate increases that he advocates. I believe that a very large portion of even our modest current growth is based on the "wealth effect" of rising stock, bond, and real estate prices that have only been made possible by zero percent rates in the first place. In my opinion, it is no coincidence that economic growth and stock market performance have stagnated since December 2014 when the Fed's QE program came to an end (it has very little to do with either bad winter weather or the West Coast port closings).

Prior to that, the $80+ billion dollars per month that the Fed had been pumping into the economy had helped push up asset prices across the board. With QE gone, the only thing helping to keep them from falling, and the economy from an outright recession (which is technically a possibility for the first half of 2015), is zero percent interest rates. Given this, even modest increases in interest rates could be devastating. Lindsey's gradual approach may be equally as dangerous as the rapid variety.

But the quick hit has the virtue of bringing the inevitable pain forward quickly and dealing with it all at once. Call it the band-aid removal approach; it may seem brutal, but at least it's direct, decisive and makes us deal with our problems now, rather than pushing them endlessly into the future.

The last attempt made by the Fed to raise rates gradually occurred after 2003-2004 when Alan Greenspan had attempted to withdraw the easy liquidity that he had supplied to the markets in the form of more than one years' worth of 1% interest rates. But by raising rates in quarter point increments for the succeeding two years, Greenspan was unable to get in front of and contain the growing housing bubble, which burst a few years later and threatened to bring down the entire economy. In retrospect, Greenspan may have done us all a favor if he had moved more decisively.

Today, we face a similar but far more dangerous prospect. Whereas Greenspan kept rates at 1% for only a year, Bernanke and Yellen have kept them at zero for almost seven. We have pumped in massively more liquidity this time around, and our economy has become that much more addicted and unbalanced as a result. Arguably, the bubbles we have created (in stocks, bonds, student debt, auto loans, and real estate) in the years since rates were cut to zero in 2008 have been far larger than the stock and housing bubbles of the Greenspan era. When they pop, look out below. Unfortunately, the gradual approach did not save us last time (worse, it backfired by making the ensuing crisis that much worse), and I believe it won't work this time.

In fact, the current bubbles are so large and fragile that air is already coming out with rates still locked at zero. However, unlike prior bubbles that pricked in response to Fed rate hikes, the current bubble may be the first to burst without a pin. It appears the Fed fears this and will do everything it can to avoid any possible stress. That is why Fed officials will talk about raising rates, but keep coming up with excuses why they can't.

Lindsey will be right that the markets will eventually force the Fed to raise rates even more abruptly if it waits too long to raise them on its own. But he grossly underestimates the magnitude of the rise and the severity of the crisis when that happens. It won't just be the end of a raging party, but the beginning of the worst economic hangover this nation has yet experienced.

06/08/2015 10:41 PM

The TTIP Gap

How a Trans-Atlantic Trade Deal Can Still Be Fixed

By Spiegel Staff
Photo Gallery: Testing TTIP                      
The European Commission is hoping that a major trade agreement with the US will stimulate the EU economy. But many in Europe fear adverse impacts on the environment and democracy. Negotiators ought to consider a third approach.

The branch of Kaiser's in Düsseldorf's Vennhausen neighborhood is a supermarket like many others in Germany. It is open until 10 p.m. on weekdays, farmer's ham sells for €1.49 a pound and Landliebe yogurt for 88 cents a cup.

Nevertheless, there is something special about the supermarket. Once a week, usually on Saturdays, Klaus Müller, the executive director of the Federation of German Consumer Organizations, essentially the top advocate for German consumers, buys a cart full of groceries at the Düsseldorf store.

More than anything else, Müller is currently concerned about the European Commission's plan to conclude a major trade agreement with the United States. These days Müller, an economist, often strolls around his supermarket with a different look in his eyes: as if the agreement already existed.

If it did, Wiesenhof brand chickens from Lower Saxony would be displayed at the meat counter alongside chicken parts from South Carolina and beef from Iowa. The required European certification mark wouldn't be affixed to a drill on sale, but rather a certificate from the applicable US agency.

And Müller might even wonder, more often than he does today, whether the canned corn was genetically modified (GM) or the Black Forest ham might be from Virginia instead of Germany.

The negotiations currently underway in Brussels and Washington affect "a broad range of consumer products," says Müller, noting that more competition could mean that "products become cheaper." At the same time, he adds, it will make things more "confusing for the consumer." Europe is about to see changes as serious as when the European Single Market was created more than 20 years ago.

Four letters are dividing Germany. The planned Transatlantic Trade and Investment Partnership with the United States, or TTIP, is intended to create a uniform economic zone for about 800 million consumers and eliminate many of the hurdles that obstruct trade across the Atlantic today. It sounds like a subject for association officials and standardization experts, but judging by the controversy the plan has unleashed, it could just as well involve the deployment of medium-range missiles or the construction of new nuclear power plants.

  To enlarge graph click here

A Needed Counterweight to Asia?

On the one side are the lawmakers in Brussels, Berlin and Washington who see the deal as a chance to revive the economy and create a counterweight to nascent trade alliances in Asia. But they face a powerful protest movement made up of environmental and social organizations, church representatives, lawyers and local politicians, who view the agreement as a giant fraud.

The anti-TTIP network claims that free trade is being used as a cover to "facilitate privatization," pave the way "for genetically modified food and meat laced with hormones" and "erode democracy." Protests against TTIP were also planned to coincide with this week's G7 meeting in Germany.

There is much at stake. Unlike earlier trade agreements, which consisted primarily of reducing tariffs, the goal of TTIP is to create a common market for European and American companies.

The negotiators are discussing whether drugs licensed in the United States should be approved for sale in Europe, for example. The agreement would make it easier for companies that felt unfairly treated by laws in the United States or Europe to litigate against the regulations. A regulatory body that would enable governments to coordinate proposed legislation is also in the works. And for a large number of products, from car headlights to frozen pizzas, the same standards and rules would apply on both sides of the Atlantic in the future.

In many cases, what economists call "non-tariff trade barriers" are in fact regulations intended to protect health, the environment and consumer interests. Critics suspect that the seemingly harmless rhetoric about harmonization is nothing but a cover for a project that would weaken democratic decisions for the benefit of multinational corporations. Thilo Bode, the former director of Greenpeace Germany and the current head of the consumer organization Foodwatch, calls the agreement a "free trade lie."

Economy Minister Sigmar Gabriel, on the other hand, says the deal will "influence world trade for the next 20 to 30 years." If TTIP fails, he says, "consumer safety and workers' rights will certainly garner less attention" in global markets in the future.

A War of Opinions

Opponents and supporters of the treaty are locked in a war of opinions made all the more acute by the fact that both sides see themselves as defenders of Western values. One side invokes economic common sense while the other insists on the primacy of the political sphere, and both sides are not afraid to use questionable figures and arguments to support their respective causes. Pro-trade industry associations, for example, say Europeans will enjoy growth effects that are not even anticipated by the economic opinions they commission. And in the anti-TTIP movement, many still capitalize on Germans' fear of so-called "chlorine chickens," or birds disinfected with chlorine, even though the European Commission has already made it clear that European hygiene rules will not be modified.

The only question is whether the highly emotional dispute is truly in the interest of consumers. Do Europeans really have to decide between free trade and democracy, or could an agreement be reached that does justice to both principles? Exactly how big are the economic benefits of the project, and how does it threaten health and consumer protection? And, finally, is Europe even in a position to assert its own ideas against the United States, with its improved economic position?

There is great skepticism among Germans. According to a recent poll conducted for SPIEGEL by the TNS Forschung research institute, only 18 percent of Germans support TTIP, while 33 percent are opposed to it. Of course, there is an even greater level of uncertainty, with close to 50 percent of respondents saying that they were "unable to evaluate" the project.

The machines that Carl Martin Welcker sells are true miracles of German engineering. They are the size of a truck trailer and cost several million euros apiece. Welcker opens a sliding door to demonstrate their inner workings: rotating bogies, mechanical gripper arms and a tangle of multicolored cables.

Welcker thrusts his hand into the complex interior and pulls out a spark plug. "The machine spits out one of these every 0.9 seconds," says Welcker, a tall man with a youthful face and white hair.

Welcker is the owner of Alfred-H.-Schütte-Werke in Cologne, a medium-sized manufacturer of metal tools and objects located on the banks of the Rhine River. Spark plugs, injection pumps, artificial knee joins and dentures -- all of these are items made in equipment developed by his company. The 600 employees manufacture machines most notable for their precision. "This socket," says Welcker, "cannot exhibit a variance of more than a hundredth of a millimeter."

Welcker sells his machines around the world, but an invisible boundary splices through his export markets. "Asia isn't a problem," says Welcker. We Germans serve as a barometer for them in every respect." But things become more complicated in the United States where, for example, any safety-related threats in machines are dimensioned in inches, which means more work for his engineers. His machines must also undergo expensive testing to conform to the requirements of individual US states.

Eliminating Drawbacks

If the TTIP strategists have their way, these kinds of drawbacks will be eliminated in the future. The negotiators want to drastically simplify import regulations on both sides of the Atlantic, not just for machines. In virtually every industrial sector today, a large number of different test procedures, certification rules and documentation requirements complicate trans-Atlantic trade. European textile manufacturers often sew their labels into the side seam of shirts, while the "Made in" label has to be in the middle of the collar seam in the United States.

Engineering firms that wish to offer their services in the United States must first register in each individual state. Piano makers are required to provide the authorities with detailed lists of the types of wood they use.

If the list of regulations and requirements were purged, promise TTIP proponents, it would be especially beneficial to small and medium-sized businesses. The smaller a production series, the greater the relative cost of adjusting it to conform to US regulations. "When we sell a machine in the United States," says company owner Welcker, "it costs 15 to 20 percent more than it does here."

Chlorine chickens? Chicken farmer Georg Heitlinger can only laugh. Chickens disinfected in a chlorine bath, as they are produced in the United States, represent the least of his fears over TTIP.

The farmer from Eppingen in southwestern Germany takes us on a tour of his barns to demonstrate the real threat.

The barns, each 90 meters (295 feet) long, are swarming with 28,000 chickens, while another 12,000 birds have access to five hectares (12.4 acres) outside, complete with trees, grass and a lot of sand where they can scratch and peck at things. According to European Union regulations, there can be no more than nine hens per square meter on free-run or free-range chicken farms. In the United States, however, 95 percent of hens are kept in traditional laying batteries. With individual cages stacked up to the ceiling in giant buildings, 23 hens are crowded onto each square meter of space.

This translates into lower-cost production. "We can't compete, given our livestock farming laws," says Heitlinger. Another reason is that most German chicken farmers voluntarily refrain from using genetically modified feed, in contrast to the United States, where chickens are fed cheap, genetically modified soybeans.

Heitlinger isn't worried about the market for fresh eggs at the moment, because German consumers reject eggs from caged chickens and genetically modified feed. Almost half of all eggs are used in the food business and industry, and EU law has no labeling requirements for these eggs. This could mean that German customers will unknowingly be eating pasta or cookies made with eggs from US factory farms, with their inhumane conditions.

As in chicken farming, standards vary widely in all key areas of agriculture. US farmers are allowed to use pesticides that are banned in the EU. Hormones are administered to cattle and pigs in the United States to accelerate growth, a practice banned in Europe. In many areas of agriculture, Europe has stricter environmental regulations than the United States.

Disastrous Consequences?

Ingrid Jansen, head of the Dutch pig farmers' association, predicts disastrous consequences for her industry if TTIP is approved. She suspects that the agreement will facilitate the export of US products to the EU that were not produced in accordance with legal requirements in Europe.

Despite all claims to the contrary, many experts fear the same thing if TTIP results in the "mutual recognition of equivalent standards," and not just in agriculture. According to the EU mandate, the negotiators are mainly searching for "more compatible regulations" to allow industry to reduce costs.

Still, the negotiations have been much tougher than anticipated. In the latest round, held in April in New York, the two sides hardly came any closer to an agreement. The legal and cultural traditions on both sides of the Atlantic are simply too different. The biggest sticking point is what is known in Europe as the precautionary principle, whereby materials and processes can only be used once proven harmless.

What might be termed the aftercare principle applies in the United States: Any products can be placed on the market, as long as they pose no scientifically proven danger. If something goes wrong, producers face the prospect of paying substantial damages to injured parties.

For instance, the Americans feel that significant parts of the European food standard, such as the ban on GM technology, meat from animals injected with hormones, meat from cloned animals and the use of chlorine to sterilize poultry, are not scientifically supported and therefore an inadmissible barrier to trade. Animal welfare, according to the US negotiators, is a "moral issue" and "not scientifically supported."

In other words, as long as the mistreated chicken that spends its life in laying batteries doesn't commit suicide, there is no evidence that it is suffering.

A 'Race to the Bottom?'

Dutch pig farmers' association head Jansen puts it like this: The TTIP mechanism of mutual recognition creates incentives to enter EU production standards into a "race to the bottom." This is the risk that TTIP critics see on the horizon in many sectors, from cosmetics to food to healthcare.

A report by the organization Corporate Europe Observatory, which is critical of industry, and by journalist Stephane Horel, shows how successful many industries are today in using TTIP as a political tool. According to the report, the European Parliament decided in 2009 that chemicals that disrupt human hormone balance (endocrine disruptors) needed to be regulated by the end of 2013.

But the industry lobby in question, which included chemical companies BASF and Bayer, managed to keep postponing the European Parliament's orders, partly by applying the TTIP argument.

European and US industry groups argued that the planned reform would jeopardize the talks.
The slapdash manner in which Brussels approved 17 genetically modified food and feed products for the European market in late April also seems suspicious, in light of TTIP. For Martin Häusling, a Green Party member of the European Parliament, it is a clear case of submission. "Apparently the European Commission feels it has to offer the Americans a few enticements in the ongoing TTIP negotiations."

The case is also clear-cut for chicken farmer Heitlinger. "As a farmer, you can't be in favor of TTIP," he says. One reason, he explains, is because customers now value locally produced, high-quality products once again. "For that reason, it makes no sense to drag steaks across the big pond."

Investor Protection

Judd Kessler, a lawyer, owes his job to a coincidence. In the early 1970s, Kessler was working for the US Agency for International Development in Chile when the country's socialist president, Salvador Allende, nationalized copper mines and subsidiaries of US companies. "At the time, no one at the US Embassy knew anything about international law," says Kessler.

Working on behalf of the US government, he tried to win damages for the expropriations -- before Augusto Pinochet came to power, with help from the Americans, and reversed the expropriations.

Kessler's office is in a darkened mansion in Washington. The 77-year-old partner in the prestigious law firm of Porter Wright Morris & Arthur works as an arbitrator for the International Center for Settlement of Investment Disputes (ICSID), which is part of the Washington-based World Bank. If the United States has its way, TTIP will enable lawyers like Kessler to monitor both European and American laws in the future.

No other issue has fueled the debate over the European-American trade agreement as much as the question of investor protection. Brussels and Washington want to grant foreign companies the right to resolve disputes in an international court of arbitration.

Whenever a country that is part of the planned Atlantic trade agreement enacts an environmental law or a consumer protection regulation, it will likely face litigation by private investors, which could assert their rights in private courts. The plan has been met with outrage, especially in Germany.

Ironically, it was the Germans who came up with the procedure in the first place. To safeguard exports and investments in developing countries without reliable legal systems, the German government has concluded close to 130 investor protection agreements with other countries since the 1960s. But the concept has long since turned against its creators. For instance, Swedish energy company Vattenfall is suing Germany for €4.7 billion in damages as a result of the German government's decision to phase out nuclear energy. US companies and their subsidiaries are even more prone to litigation and, therefore, pose a greater threat. Philip Morris Asia appeared before an arbitration court after the Australian government tried to require tougher warnings on cigarette packages.

Arbitrator Kessler is also being kept busy. In an upcoming case, he will be one of three arbitrators who will decide whether Essen-based energy utility RWE is entitled to compensation after Spain's recent decision to cancel planned subsidies for green energy.

A Chilling Effect

An international litigation industry has developed that sounds out national laws to determine whether they provide suitable ammunition to bring suits. The number of cases has multiplied, warns Canadian international law expert Gus van Harten. The wave of litigation has had a chilling effect in his country, even on politicians at the provincial level, who hardly dare to introduce new environmental laws anymore.

In addition, the arbitration courts usually meet behind closed doors. The public is kept in the dark when Kessler and his colleagues meet in a World Bank building in Washington to question witnesses or award damages. Even the court's rulings remain confidential if this is requested by one of the parties. And appeals are usually not part of the process.

There was a significant outcry when it was revealed that the TTIP negotiators were trying to expand the ability to sue governments. Austrian Chancellor Werner Faymann described the plan as creating "dangerous special rights for corporations."

Together with other social democratic party and national leaders, including Sigmar Gabriel, the chairman of Germany's center-left Social Democratic Party (SPD), Faymann is demanding reforms to the controversial procedures under the principles of constitutional law. They are proposing the establishment of a bilateral commercial court with independent, professional judges. They also want the negotiations to be open to the public and to include the right to appeal the court's decisions.

The European Commission reacted by releasing a reform document in early May. It states that appeals against rulings should be possible, and that all documents and proceedings should be public.

The proposal also calls for a fixed list of arbitrators who would have to demonstrate certain qualifications and could not act as attorneys or arbitrators in multiple proceedings, as is the case today.

But this isn't enough for the European Parliament, which will hold a debate on TTIP next week in Strasbourg. The lawmakers are only willing to approve the trade agreement if the Americans agree to the establishment of an international commercial court and the possibility of appeal. The judges presiding over this court would no longer be attorneys, who are often motivated by special interests, but professional judges.

If the members of the European Parliament and Gabriel's supporters stick to their guns in the negotiations, a new standard could develop on both sides of the Atlantic that would be an improvement over the old standard in several ways. It would be a reform that would take investor protection back to its roots. "Countries can regulate," says Kessler, "but they cannot disadvantage foreigners."

A Threat Against Democracy?

The trade negotiators from Brussels and Washington have many adversaries, but the most formidable of them all is a soft-spoken, petite woman with short, dark hair. Pia Eberhardt is the face and brain of the anti-TTIP movement.

As the author of a highly respected study on investor protection in 2013, the 36-year-old political scientist with Corporate Europe Observatory shone a spotlight on the clandestine negotiations. She formed alliances with other non-governmental organizations and, together with her team, ensured that at least a few draft agreements or working documents from the negotiations reached the public. "A small group of unelected representatives of government agencies is being given enormous power to stop regulations even before they are submitted to parliaments for a vote," she says. "This undermines the democratic system."

The mechanism Eberhardt is attacking has an innocuous-sounding name: regulatory cooperation. It suggests an atmosphere of friendship, cooperation and reasonable agreement.

The plans call for a body that would include representatives of the US government and EU agencies.

Draft legislation would be submitted to this so-called regulatory council before being put to a vote in national parliaments, to ensure that it is in conformity with TTIP. At first glance, this resembles the way laws are passed in Germany, with the involvement of a wide range of social forces, from environmental organizations to the pharmaceutical lobby. But the difference is that the regulatory council is not a body in which the interests of the public are weighed against those of industry. Its sole purpose is to eliminate existing trade barriers and avert the creation of new trade barriers.

The regulatory council cannot directly obstruct national legislative power. But merely the threat that a law could potentially be used by companies as grounds for damage suits could lead to its being put on hold, fear TTIP opponents. The European Commission, on the other hand, stresses that will still be able to establish rules for business. According to the Commission, it is merely a question of "informing all interest groups."

But the procedure isn't nearly as harmless as Brussels is claiming. Even German Chancellor Angela Merkel has now conceded that the TTIP regulators' role goes beyond simply reading draft legislation.

The policy discretion of the EU and its member states could be "somewhat restricted" by the planned regulatory cooperation, according to a letter from Merkel's office to Foodwatch.

The European Parliament also has its reservations. Its members insist on preserving the principle that European institutions alone have to right to enact laws and ordinances. "It must be clearly stated in the TTIP that legislative power cannot be undermined or delayed," says Bernd Lange, chairman of the Committee on International Trade in the European Parliament.

'I Try to Listen to the Opponents'

European Commissioner for Trade Cecilia Malmström, 47, isn't easily flustered. Even when she is sharply attacked by TTIP opponents, the Swedish politician simply smiles and calms the waves, speaking in fluent English, French or Spanish. "I try to listen to the TTIP opponents," she says. "Sometimes they are just worried that they will have to give up their European way of life."

What a difference there is between Malmström and her crusty predecessor, Flemish politician Karel De Gucht, who had difficulty concealing his view of most TTIP opponents as misguided ideologues. Malmström is pursuing the same goals, but she does so with greater sensitivity and persuasiveness, especially in Germany, where her job of campaigning for the trade agreement is especially challenging. "If we don't set the standards," she says, "they will be set by others, who care less about consumer rights."

The others she is referring to are the rising industrial powers in Asia and Latin America, which have fundamentally changed world trade in the last two decades. In the past, trade was shaped by global treaties in which well over 100 countries were involved. But since the mid-1990s, countries are increasingly forming regional economic blocs to promote trade.

The most successful of these alliances is the European Union, which has promoted its domestic market initiative for the last two decades. In Asia, countries like Indonesia, Thailand and Malaysia banded together to form the ASEAN group, and in the mid-1990s the United States, Mexico and Canada formed the NAFTA alliance. About two dozen extensive trade agreements have been added since the turn of the millennium, usually with positive results. Studies by economists show that the deals have promoted trade, led to more competition and lower prices, and increased the average income of citizens.

Undisputed Advantages for Companies

This is what most economists also expect from a TTIP agreement, even though their opinions differ on the extent of the benefits. The advantages for European companies, however, are undisputed. From Siemens to Volkswagen, the agreement would help many large industrial corporations to offset the potential disadvantages that threaten to emerge on the other side of the globe.

While Brussels and Washington negotiate a deal for the Atlantic, nations bordering the Pacific are planning even more powerful alliances. The United States and Japan, Australia and Vietnam are discussing a Trans-Pacific Partnership (TPP), a giant free trade zone for 800 million consumers. China has formed a trade bloc with the ASEAN nations and now wants to join the Pacific union.

If the agreements come about, Europe's industry will be left with nothing. It would have to pay higher duties, while its competitors in large parts of Asia could deliver products at much lower costs. Italian leather producers, for example, would immediately be subject to a price differential of up to 18 percent when selling wallets or belts in Japan.

Europe's chances of shaping the markets of the future would also fade. German industrial companies still dominate production in many parts of the world today. In the future, this will only be the case if Europe and the United States form an alliance, as they did in aircraft manufacturing four years ago. In an extensive agreement reached at the time, Brussels and Washington established technical norms that have become the standard for manufacturers from Canada, Brazil and China. If TTIP is a success, this could also be achieved in other industries.

A World of Trade Alliances

The world of the 21st century is a world of trade alliances. The countries that are members of the largest number of alliances and manage to align themselves with the strongest nations will enjoy the greatest benefits.

As such, the most important question is the direction in which the United States will turn in the future -- toward the rising countries along the Pacific or its traditional allies on the old continent?

If Washington decides against Brussels, the "global equilibrium will tilt heavily toward Asia," says former Swedish Prime Minister Carl Bildt. In contrast, Europe's influence would diminish considerably.

Bildt's fellow Swede, EU Trade Commissioner Malmström, holds a similar view. Last week, she traveled to Berlin to draw conclusions with American chief negotiator Michael Froman. The fact that they met in Berlin was ironic, because it was Chancellor Merkel who helped initiate the TTIP project in the first place. But with growing reservations among Germans, she is now passing the ball to Brussels.

The Swedish EU official sometimes feels abandoned by German politicians. "It isn't my job to explain to the Germans why we need TTIP," she says.

The Third Way

When consumer advocate Müller is asked how he feels about the United States, he thinks of ice cream. As a teenager, he spent two years in the US states of Indiana and Connecticut, and he was amazed by the 33 flavors available at a local ice cream parlor. "The United States is a great country for a young person," he says.

This helps to explain why the head of the Federation of German Consumer Organizations has little understanding for the undercurrent of anti-Americanism some TTIP critics have injected into the current debate. A native of Wuppertal in western Germany, he has been a member of the Green Party for 25 years. He was also environment minister of the northern state of Schleswig-Holstein and shares many of the concerns of the anti-TTIP movement. "When it comes to food or chemicals," says Müller, "cultures in the United States and Europe are simply too different to be able to harmonize quickly or for them to be able to recognize each other."

But Müller is no opponent of free trade -- on the contrary. "As a consumer advocate, I am in favor of freedom of choice and low prices," he says. "But this requires that consumers can clearly and truthfully recognize what they are choosing." The supreme advocate of the interests of the German consumer argues for a third approach in the TTIP debate.

Brussels and Washington should quickly reach a deal on the issues on which they can readily agree, such as industry standards and tariffs. In contrast, the negotiators should set aside issues of food safety and health protection, because the respective legal cultures in Europe and the United States are too different.

His argument coincides with the public mood. According to the TNS survey for SPIEGEL, 42 percent of TTIP critics oppose the treaty because it could water down European environmental and consumer laws, along with labor rights. Only 27 percent fear that it would give corporations too much power.

The numbers show that what Müller calls a "TTIP light" could indeed create a new basis for the negotiations. At the same time, it would offer the Brussels negotiators a way to correct their mistakes of recent months: the lack of transparency and the downplaying of the threats to democracy and constitutional law. Hence, this is what a new TTIP strategy could look like.

To ensure as much openness as possible, the EU needs to make all relevant documents accessible and include all social groups in the conversation.

The EU needs to create a two-sided commercial court for the controversial investor suits. It must also be possible to appeal rulings.

The regulatory cooperation currently envisioned is unnecessary. Mutual information about cooperation, as it exists in conventional trade agreements, is sufficient.

Reestablishing Trust

A TTIP process that is reformed in this manner could not only reestablish the trust the EU has gambled away with its current negotiating strategy. It would also secure the benefits of free trade without jeopardizing democracy.

The TTIP light idea has found many supporters in the professional world. One of them is Gabriel Felbermayr, a trade expert with the Munich-based Ifo Institute for Economic Research, who still believes that a slimmed down TTIP deal will provide substantial economic benefits. "A TTIP light would secure 80 to 90 percent of the expected benefits to trade," he says.

European leaders are also flirting with the idea of a slimmed down agreement. Italian Prime Minister Matteo Renzi proposes an agreement that focuses on less controversial trade issues but is adopted as quickly as possible.

The anti-TTIP movement has achieved a great deal. It has made Europeans aware of the important issues that are being negotiated behind closed doors in Washington and Brussels. It has also shown how dangerous TTIP could become for consumer protection and civil liberties.

Many things have gone wrong, but there is still time to correct the mistakes.

By Christoph Pauly, Michael Sauga, Michaela Schiessl and Gerald Traufetter

Translated from the German by Christopher Sultan

Markets Insight

June 11, 2015 5:25 am

What bond turbulence says about inflation

Ralph Atkins in London

Too early to say markets signal decisive move away from deflation

Big shifts in global bond markets play havoc with investors’ portfolios. For real economies, however, they are not necessarily bad news.

That is certainly true of the recent turbulence, which this week saw German 10-year Bund yields leaping above 1 per cent. Higher yields, which move inversely with prices, are consistent with expectations of higher inflation.
So the sharp global rises, led by Bund yields, might tell a positive story — of diminishing fears that Europe is sliding into a dangerous, Japanese-style deflationary slump and of markets — slowly — preparing for the US Federal Reserve to raise interest rates. Where bond markets see gloom, others could see light.
What matters, however, is whether bond markets get the story right; misjudgments could spell greater, more disruptive volatility, especially as the Fed moves closer to policy tightening.

Unfortunately, if you talk to bond strategists you find little conviction that trend falls in inflation globally to worryingly low levels have gone decisively into reverse — which points to large bounds of uncertainty.

What happened in the past two months looks largely to have been a retreat from an extreme position. Eurozone bond yields plummeted as a result of heavy buying under the European Central Bank’s quantitative easing programme, launched in early March.
But German 10-year Bund yields, which in mid-April appeared to be heading below zero, were consistent with an economic disaster scenario. Large chunks of shorter term, north European government debt traded at unprecedented negative yields.

The abrupt subsequent moves were painful for investors but have arguably returned yields to levels more consistent with a eurozone economy the ECB expects to grow by 1.5 per cent this year, with inflation within its “below but close” to 2 per cent target in 2017.
You can almost hear the sighs of relief among policy makers. Higher Bund yields not only point to deflation having been averted. They suggest a panic over Greece, which would have seen a rush for safe German assets, has also been avoided.
If Interest rates have troughed, there would also be less pressure on non-eurozone countries such as Switzerland to think of even more creative ways of loosening monetary policy to offset the effects of a weakening euro.

But it is still too early to claim bond markets are signalling a decisive shift to a less worryingly-low inflation environment. Much of the correction was the result of technical factors, including overcrowded positions. As Mario Draghi, ECB president, pointed out last week, volatility begets volatility if investors sell what have suddenly become riskier assets. Yields could fall again during the summer, when eurozone government net bond issuance will turn firmly negative.
Moreover, the most closely watched indicator of long-term eurozone inflation expectations — what swap markets are pricing for average inflation rates over five years starting in five years — is still flashing warnings. At 1.84 per cent, it is up from January’s lows, but still below levels late last year, when the ECB started planning its QE programme. US inflation expectation gauges remain similarly muted.

True, the stabilisation of eurozone inflation expectations adds to evidence that the region will avoid a worse-case deflation scenario. But there remains the risk of a further abrupt adjustment in bond yields.

An obvious threat is that markets are not yet pricing in sufficiently the possibility of a rate rise by the Fed, which meets next week. The vibe in bond markets remains in tune with the International Monetary Fund, which last week advised the Fed against lifting US interest rates this year.
“Global disinflationary trends and the pass-through from the strengthening dollar are . . . likely to act as important dampening forces to inflation,” the IMF warned. But it is not just Greeks who ignore the IMF — Janet Yellen, Fed chairwoman, may also do so.

More generally, if bond markets can sell off as violently as they have recently without any great shift in global inflation expectations, the disruption could be much greater if the story really did change. A decisive shift from worries about global disinflation or even deflation to benign “reflation” scenarios would be good news for real economies — but not necessarily for bond markets.

Transcript of a Press Conference on the Conclusion of the Article IV Consultation Mission with the United States

Washington, DC

Thursday, June 4, 2015

Christine Lagarde, IMF Managing Director
Alejandro Werner, Director of the Western Hemisphere Department
Nigel Chalk, U.S. Mission Chief
Aditya Narain, Assistant Director of the Monetary and Capital Markets Department
Gerry Rice, Director, Communications Department

MR. RICE: Good morning, everyone, and thank you for coming to this press conference on behalf of the International Monetary Fund. Today the topic is the United States 2015 Article IV consultation as well as the financial sector assessment program. And the press conference is on both topics.

I am very pleased to introduce to you this morning the Managing Director of the IMF, Madam Christine Lagarde. Immediately to her left is our Director for the Western Hemisphere Department, Alejandro Werner. To Madam Lagarde's right is the Mission Chief for the United States, Nigel Chalk and immediately to Nigel's right is Aditya Narain who is with our MCM Department and who has been intimately involved in the financial sector assessment.

We are on the record this morning. You know the topic and I would ask the Managing Director to make a few introductory remarks and then, we will be taking your questions. Thank you.

MS. LAGARDE: Well, thank you very much and welcome to you all for this briefing on the United States. By now, I suppose you will have seen our concluding statement and I will briefly summarize our findings and then, take your questions.

But first of all, let me note that this year, we have focused a lot of the findings on the financial sector assessment. You know, that we do a financial sector assessment every five years for an economy like the United States and all systemically important countries. It's a comprehensive exercise and the overall report of what we call the FSAP will be published on the 8th of July.

So the concluding statement includes some of the key findings but all the details, the work, the underlying assumption, the policy recommendations in the full extent -- to their full extent will be found in that paper which is due to be published on July the 7th. And that I highly recommend to you.

We have also, obviously, commented upon the status of the dollar as a currency and we have also commented quite extensively on the timing of the interest rate hike expected at some stage in the future. And I'll come back to that later. But before we get to policies let me say a few words about how we see the U.S. economic outlook.

Again, we meet against the background of a shaky, first quarter of the U.S. economy. And you will have seen that we have revised our growth forecast down to two point five percent in 2015.

This is largely due to those factors that affected the first quarter. But this is not our main message because we believe that this is conjunctural and does not actually indicate substantive material trends in the U.S. economy.

Our main point is that we still believe that the underpinnings for a continued expansion are in place. The labor market has steadily improved over the last year. Job growth has averaged 260,000 per month and financial conditions remain very accommodative. Moreover, we expect cheaper oil prices to continue taking boosting growth while at the same time taking a bite out of the oil-related investment as we saw in the first quarter.

As always, there are risks and uncertainties to this outlook. For example, further delay of the housing recovery and the strong dollar could be a drag on future growth. Nevertheless, when we look at the whole picture, we believe that growth in the coming quarters will be at an annualized rate of three percent or even higher.

We see inflation pressures as muted, long-term unemployment and high levels of part-time work both point to remaining employment slack. Wage indicators on the whole have shown only tepid growth and when combined with dollar appreciation and cheaper energy costs, we expect inflation to start rising later in the year but only slowly reaching the Federal Reserve's two percent medium term objective by mid-2017.

So over the medium term, as we highlighted last year, there is still much work to be done. Our forecast of potential growth is now around two percent, far away from the three percent average growth rate that we saw before the Great Recession. Given this outlook, I would highlight our policy recommendations in three areas and I would start, of course, with monetary policy.

As we have noted before, the Fed's first rate increase in almost nine years has been carefully prepared and telegraphed. Nonetheless, regardless of the timing, higher U.S. policy rates could still result in significant market volatility with financial stability consequences that go well beyond the U.S. borders.

In weighing these risks, we think that there is a case for waiting to raise rates until there are more tangible signs of wage or price inflation that are currently evident. So in other words, we believe that a rate hike would be better off in early 2016.

Even after this first rate increase, a gradual rise in the federal fund's rates will likely be appropriate.

Such a path may create a modest rise of inflation above the Fed's medium-term goal, perhaps up towards two-and-a-half percent. And we believe that that would be manageable. However, pursuing a cautious and gradual approach to interest rate normalization would provide valuable insurance against the risk of disinflation and needing to cut rates back to zero.

In the coming months, continued clear and effective communication by the Fed will be more important than ever. Last year, we made some recommendations on the communication toolkit such as scheduling press conferences after each FOMC meeting and publishing a quarterly monetary report. We recognize the difficulties with adding more communication but we continue to believe that it merits consideration.

Turning to financial stability, our team has taken a detailed and comprehensive look at the health of the financial sector and our financial stability assessment program. Much has been done over the past several years to strengthen the U.S. financial system. It will be important to ensure that that progress including the legislative advances under the Dodd-Frank Act is not rolled back.

Diluting the important progress made would clearly be undesirable. It also seems clear that risks have built up during the long period of exceptionally low interest rates. Nevertheless, today the data point towards a system with pockets of vulnerabilities, so pockets of vulnerabilities rather than with broad-based excesses across the whole sector.

But those pockets of vulnerabilities should not be minimized. They could create serious macro-relevant sources of financial instability both here and abroad. Some of our concerns the migration of intermediation to so-called shadow banks or non-bank financial institutions and the potential for insufficient liquidity in a range of fixed-income markets particularly as these markets come under stress.

I know that U.S. authorities are investing heavily in understanding and assessing these issues.

Some key policy recommendations to reduce financial stability risks that I would highlight include, first of all, giving all members of the Financial Stability Oversight Committee, the FSOC, an explicit financial stability mandate so as to further strengthen the effectiveness of the FSOC.

Second, undertaking a concerted effort to provide the FSOC and the Office of Financial Research with all the data they need to build a comprehensive view and analysis of systemic risk.

Third, updating the regulatory regime in the insurance sector to create an independent and well-resourced body that has a nationwide remit.

There are further details in the concluding statement and, as I have said, it is explained in great details in the document that will be released on July the 7th. Let me now turn to fiscal policies.

We've said that before given our forecast of a steady rise in public debt to GDP ratio it remains critically important to adopt and implement a credible, medium-term fiscal plan. This requires action on tax reform, Social Security reform and steps to contain healthcare costs.

If these fiscal challenges, the medium-term challenges that I'm referring to, were tackled, it would provide scope to expand the near-term budget envelope for measures to support future growth, job creation and productivity. And here I would prioritize infrastructure spending, better education spending and policies that raise labor force participation including steps like subsidized childcare facilities.

So in conclusion, we believe that near-term U.S. growth prospects are good notwithstanding the very bad first quarter that we saw yet again. Muted inflation pressures suggest that interest rate hike can wait a little and that such interest rate hike would be better off in 2016. Even after this initial step is taken, we believe that a gradual rise in the federal fund's rate will likely be appropriate.

And although, we recognize that very important progress has been made to strengthen the U.S. financial system, there is more to be done to address the pockets of vulnerabilities that I have just mentioned. So with that, I'm very happy to take your questions preferably on the U.S. economy.

Thank you.

MR. RICE: Thank you, Madam Lagarde. And if you could keep your questions as brief as possible, we'll try and take as many as possible. Yes, sir?

QUESTIONER: Ian Talley, Wall Street Journal. I assume you have spoken with your friend, Janet about your proposed plan. I'm wondering whether this will solidify your friendship or cause -- does she agree? And secondly, I cannot help but ask about the topic du jour, Greece.

Can a bailout of Greece really credibly go forward without any sort of serious debt relief and should that be part of the current proposal?

MS. LAGARDE: Thank you. You know, we essentially agree with the President of the Fed in that the interest rate hike must be data dependent and based on sound and as detailed and granular data analysis as is possible which is clearly the line that has been articulated by Chairman Yellen over and over.

So we totally agree with that. What we are seeing in the data that the team has analyzed, is analyzing, is that the inflation rate is not progressing at a rate that would warrant, without risk (and I can come back to that in a second) a rate hike in the next few months which is why to make the point we are saying that the economy would be better off with a rate hike in early 2016 when hopefully, the inflation data and numbers will have consolidated.

And even if it is to a risk of a slight over-inflation relative to the two percent rate that is mandated under the Fed's rules. Because we believe that the tradeoff between starting too early and risking disinflation and having to return to a lower rate is higher than the risk of slightly above two percent inflation going forward. That's the position.

On Greece: First of all, we certainly welcome the constructive meeting which has taken place yesterday between the Greek Prime Minister and the President of the European Commission and the President of the Euro Group. It clearly opens a window of time during which we can hear in details from the authorities, their response, their comments, their views on the joint proposal that was proposed to them yesterday.

That joint proposal agreed between the European Commission, the IMF and the European Central Bank as clearly demonstrated significant flexibility on the part of the institutions relative to the previous program in order to take into account the political situation and the social situation in order to mitigate and soften the consequences of the necessary measures that have to be taken to allow Greece to return to stability and to a sustainable growth and economy.

So we welcome all that and the flexibility that I have just mentioned touches on all sorts of issues including the labor market, including the pace of fiscal consolidation, including the timeframe over which that fiscal consolidation takes place. And it's really very much intended to ease the adjustment and to facilitate this implementation for the people of Greece.

So we look forward to the position of the Greek authorities and we stand ready to do technical work, look at potential alternatives in order to reach the targets that have been set. As long as all that is consistent with likely solid implementation. And I would totally endorse the three points made by President Draghi yesterday which is that that recovery process must be conducive to growth, to economic and financial sustainability, as well as to social acceptability in the country.

MR. RICE: Thank you. Yes, the lady in the second row.

QUESTIONER: Thank you, Gerry, Madam Lagarde. So I want to ask a little bit more about the international context given the recent weakness from the global economy. So what impact does the IMF see of the weaker demand from Japan and Europe and also slowing Chinese economy on the U.S. economic recovery. So how much of a role does that factors play in slowing maybe the progress of Fed's normalization of the monetary policy?

And also, does the -- because there's a Federal Reserve, officials said yesterday were -- sorry, one day before that the Federal Reserve might place a little bit too much importance on the boost from the falling oil prices on consumption. So does the IMF share the same view? Thank you.

MS. LAGARDE: You know what? Given that your question is so heavily technical, I'm going to turn to the Mission Chief of the U.S. team so he can take you through the details of the assessment of the various parameters into the CPE so that you have a fully technical information response.

MR. CHALK: Okay, so certainly the slower growth in the global economy is weighing on the U.S. It's very hard right now to disentangle that from the effects of the stronger dollar and the effects of the West Coast port strike on the trade data. I think we were quite encouraged that the trade data released yesterday was relatively positive but it's just one data point. And I think we are likely to see some weight, some headwind on the U.S. economy from both weaker growth in the global economy and the trading partners and also from a stronger dollar.

So it is a factor. It's feeding into our forecasts. I can't tell you exactly how much of our change in forecast is due to that because we -- there's obviously been a lot of moves in oil, in the currency, in global growth so we don’t split it out. In terms of the boost to oil prices, I think we have been somewhat disappointed by the increase in household consumption that we had expected from a lower oil price.

That's still a puzzle. I think that's a puzzle we discussed with our counterparts in the U.S. Government. That's also a puzzle for them. And then, at the same time, the decline in oil sector investment has been much stronger and much faster than I think we had anticipated a few months ago.

So oil is definitely having a big effect on the U.S. We're expecting in the latter part of this year, remainder of this year, that we will start to see more consumption effects from oil, from lower oil prices, but it's definitely a risk to the U.S. economy if that oil windfall is saved then we will see lower growth than we're currently expecting. Thank you.

MR. RICE: Yes, sir. In the second row.

QUESTIONER: Hi, Madam Lagarde. I also have a double barrel question, one on U.S. and one on Greece. First of all, in the U.S., in your report you note that the U.S. dollar is, I believe, moderately overvalued. What is your expectation over the coming months of where the U.S. dollar will head? Do you anticipate it remaining overvalued? Do you anticipate it returning to equilibrium in some kind of way?

And secondly, in Greece, in the nearer term, how confident are you that Greece will make its scheduled payment to the IMF tomorrow?

MS. LAGARDE: On your question about the U.S. dollar and its positioning, we do conclude that the U.S. dollar is moderately overvalued which is a change compared with our previous assessment. And that is clearly as a result of the constant appreciation of the U.S. dollar by about 13 percent over the last 12 months relative to other currencies.

Continued over appreciation is a potential risk and should not be discounted. But we do not believe that it has so far affected negatively the growth of the U.S. economy considering the oil price decline which has been a bit of a tradeoff to that circumstance of appreciation of the dollar.

Incidentally, not that it matters so much but it matters for the overall economy, this movement has also benefitted economies that were suffering of very low inflation and currencies that have taken the benefit of under appreciation which, hopefully, would facilitate their growth and therefore, would be good for the global economy. And I'm thinking here, particularly, of the Euro Zone and countries like Japan.

On the issue of the repayment, I can only listen to what the membership tells us. Greece is a member of the institution and had indicated including as late as night from the Prime Minister himself that payment had been honored and would be honored. I think his words were do not worry. So I'm confident that that will continue to be the case.

MR. RICE: Okay, swinging back around, gentleman in the front row.

QUESTIONER: Just following up on Greece a little bit, has there been a discussion about bundling this month's payments? Have you had any discussion with the Greek authorities about that? Has there been a request from Greek authorities? And secondly, just back to the issue of debt relief, do you think that debt relief is needed in order to have a sustainable or a practical bailout or a working bailout?

MS. LAGARDE: You know, on your first point, it is not a matter that we actually discuss publicly when a member state requests a particular set of conditions. I'm not aware of such thing but it's not something that we debate and discuss.

And asked about payment on Friday, the Prime Minister said do not worry. So, you know, au contraire, you can deduct easily that the unbundling is not in the cards.

Second, you know, I don't want to isolate one component because everything, as been mentioned by us at the IMF, everything has to add up at the end of the day which is why we, as far as we're concerned, we have demonstrated flexibility and we continue to be flexible in assessing the measures that contribute to the fiscal targets that have been proposed.

But clearly, if there was to be slippages from those targets, for the whole program to add up, then financing has to be considered. And financing is a factor of the level of the debt which, itself, is a factor of the maturity and interest rates at which debt has been accumulating.

MR. RICE: Thank you. Yes, the lady in the second row? Yes, ma'am?

QUESTIONER: Thank you. Recently, our stream of data have shown that personal consumption has shown signs of weakening in the U.S. As we see the lower oil prices have failed to -- so far has failed to translate into bigger purchasing powers and people are talking about the financial crisis have left some lasting imprint on U.S. consumer behavior.

So I would like to know from your point of view, do you expect weakening consumer consumption will become a long-term trend in the future and how should we consider growing the U.S. economy if the U.S. consumers tend to spend less? Thank you.

MS. LAGARDE: I would like to commend you on the analysis of the situation. It's exactly what we conclude as well but I don't know whether we draw sort of medium to long-term consequences from that short-term analysis as to what will be the behavior of consumers going forward.

Nigel, do you want to address that?

MR. CHALK: I think certainly you've seen big structural changes in household behavior in the U.S. since the crisis. You know have a demographic that's aging. You have a young population that has a high level of student debt. You have low rates of household formations so people aren't building wealth as they used to do by owning houses. I think all of these things are going to feed into long-term consumption behavior. And certainly, I don't think we believe we're going to go back to the kind of consumption and saving behavior we saw pre-crisis which clearly proved to be unsustainable.

However, I think what we've seen in previous periods when we've had oil price declines is that the initial impact is that saving will go up and the people wait to see, one, if those oil gains are permanent or temporary. And, two, they want to actually see it affect their sort of daily household income, credit card bills and then, they adjust their consumption behavior.

So we should expect consumption behavior to adjust later this year. We should expect saving rates to come down but certainly, they're not going to go back to what the level of consumption was pre-financial crisis.

MR. RICE: Thank you. I do see a number of colleagues from the Greek Press so I'm going to call upon one colleague from the Greek Press.

QUESTIONER: Thank you for that. We do have a question on Greece and one on the U.S. economy.

So on the U.S. economy, how much do you consider the external factors of risks like Greek default or Greek exit influencing the U.S. economy and in specifically the financial sector given that you analyze the financial sector extensively in this review? And are you in contact, Madam Lagarde, with the U.S. Secretary of the Treasury, Jack Lew, about Greece? Has he conveyed a message to you about how he views -- has he conveyed any message to you about how he views the situation? Are you in contact with the Secretary of the Treasury on Greece? Thank you.

MS. LAGARDE: Okay, on the impact of the Greek crisis on the U.S. economy, we don't believe that it is a significant risk. But having said that, there is so much uncertainty around this risk realization and the extent to which it would affect nationally, regionally, internationally the financial markets.

I sort of phrase that risk assessment with a strong caveat. However, given the various tools available to the Europeans, we don't grade that risk on the U.S. economy as very high.

I'm in contact with many treasury secretaries around the world including, obviously, the U.S. Treasury Secretary, Jack Lew. We had a very good session yesterday on the Article IV on the U.S. economy and we talk about international stability around the world which includes, of course, a discussion on the current proposals and discussions taking place between the institutions and the country.

MR. RICE: Thank you. Looking for other questions? Yes, sir, just -- yes.

QUESTIONER: Thank you very much. Madam Lagarde, when you spoke at the Atlantic Council when you talked about the United States you again underscored your disappointment with Congress not acting on the rules change that you want for the governance of the IMF. And you said, you continue to speak to members of Congress in this country.

Could you give us an update on that and do you have anything different or positive to report on your dealings with the lawmakers?

MS. LAGARDE: I think the IMF membership continues to be disappointed with the five-years' delay in implementing the governance reform that was actually decided back in 2010 and largely advocated by the United States of America where the only critical step lagging or missing, rather, is ratification by the U.S. Congress of such ratification.

I continue to have discussions with various members of Congress on that particular matter. I very much hope that this ratification will take place in due course. I think that in many instances we have demonstrated our ability to mobilize resources, to provide technical assistance, to give support as was the case, for instance, in the three Ebola-stricken countries recently, as was the case in relation to Ukraine recently as well, as is the case with Nepal where I think the IMF is going to be one of the first institutions to consider some disbursement for that country affected by natural disaster.

So I very much hope that by demonstrating day-after-day, country-after-country, program-after-program that we actually produce public good helpful for the economy of the United States Congress members will be convinced that it is worth a ratification.

MR. RICE: Thank you. This is going to be the last question. All right, sir, you have it. It's going to be Greece.

QUESTIONER: Ms. Lagarde, I have to admit that I always listen to you with greater attention and I really need to know your answer on this. For the last five years I ask the same question, if Greece can make it. You answer it many times but five years I think is too long of a time and I wanted to know what went wrong and who is responsible for this human disaster in Greece?

MS. LAGARDE: You know, my hope is that by combining all the reforms and not just fiscal consolidation based on a narrow base of people who suffer a much higher burden than on the more equal basis, by enforcing the structural reforms, by really embracing all the objectives of the program, the country can pull itself out of a situation that has lasted for too long. And we are available to help in that process. We have demonstrated flexibility but it's also a question of putting the economy on a sustainable path where jobs will be created, where the unemployment rate will go down and where ultimately the country will be able to finance itself using normal investors and not necessarily the IMF and other institutions.

MR. RICE: Thank you very much and thank you all for coming today.
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