Day of reckoning postponed as global recovery builds

Monetary expansion in Europe, America and China all point to stronger growth this year, signalling another leg to the global expansión

By Ambrose Evans-Pritchard

8:05PM BST 04 Aug 2015

US President Barack Obama gestures during his remarks to reporters

US President Barack Obama gestures to reporters. The American economy grew at a 2.3pc rate in the second quarter 
With hindsight it is clear that the world economy came within a whisker of recession earlier this year.
Global shipping volumes contracted by 3.4pc between January and May, according to Holland’s CPB world trade index.
This episode is now behind us. Leading indicators and monetary data in the US, Europe and China point to an accelerating rebound over coming months.

Gabriel Stein, from Oxford Economics, says the growth rate of the world's real M3 money supply – based on the US, China, EMU, the UK, Japan and Canada – rose to a six-year high of 6.2pc in June.

The M3 gauge tends to lead economic growth by 12 months or so, suggesting that the worst may soon be over.

In Europe, the monetary kindling wood of recovery is clearly catching fire. Spain is growing at its fastest pace since the post-Lehman crisis. So is Ireland.

The triple effects of quantitative easing by the European Central Bank, a 12pc fall in the trade-weighted index of the euro in 15 months and the fall in Brent crude prices from $110 to $50, have together lifted Euroland out of its six-year depression.

The property slump is over. Standard & Poor’s expects house prices to rise 3pc in Holland, 4pc in Portugal, 5pc in Germany and 9pc in Ireland this year.

The eurozone money supply is surging

Simon Ward, from Henderson Global Investors, said a key gauge of the eurozone money supply – real six-month M1 – is growing a blistering rate of 12.6pc. This implies a surge in spending later this year. “Monetary policy is too loose in the eurozone. It is highly questionable whether they can really keep going with QE until the end of next year,” he said.

America is slowly weathering the effects of the strong dollar. The economy grew at a 2.3pc rate in the second quarter. Capital Economics expects it to accelerate to 3pc in the second half. Loans are growing at an 8pc rate. It is not a glorious boom, but nor is it the stuff of global meltdowns.

The commodity crash may feel as if Armageddon has arrived but it is, in reality, the tail-end of China’s hard landing, compounded by Saudi Arabia’s political decision to flood the global crude market and strike a blow against Russia, Iran and the US shale industry.

“There has been a sharp drop in the ‘commodity-intensity’ of China’s economic growth,” said George Magnus, a trade expert and a senior adviser to UBS.

“This has sent very chilly winds through parts of the world. Vast swathes of the emerging market universe have lost their export prop."

The synchronized rout that we have seen across the gamut of commodities – from copper, to thermal coal, soya and milk - is certainly hair-raising. The Reuters-Jeffrey CRB index of raw materials has collapsed by almost 60pc from its peak in 2008 and is back to levels first reached in 1971.

There is a risk that this could go too far and metastasize, leading to a second leg of global deflation.

This would play havoc with debt dynamics in a world where debt ratios have risen by 30 percentage points of GDP since 2008, reaching unprecedented levels.

Yet commodity crashes are double-edged. They act as a stimulus for the world economy. The consuming nations are enjoying a $500bn "tax cut" from the OPEC cartel.
The slide may soon touch bottom in any case, if it has not already done so. The Baltic Dry Index measuring freight rates for dry commodities has almost doubled since the start of June. The shipping firm Clarksons said it is being driven by a revival of Chinese steel demand.

The chances are that the growth scare of 2015 will prove to be a false alarm, much like the nasty episodes of 1987 and 1998 when market tantrums – frightening at the time – turned out to be innocuous. The cycle had another two years’ life both times.

Markets over-reacted violently this week to a fall in China’s PMI manufacturing gauge to 47.8 in July, fearing that the economy is now in the grip of such powerful debt-deleveraging that stimulus no longer works. But the survey was distorted by the immediate fallout from the stock market debacle in Shanghai.

Nomura says its "growth surprise index" is signalling a “strong rebound” after touching the bottom in May.

The bank’s "heat map" for China shows that 53pc of the components are flashing “hot”, including electricity output, chemical fibres, non-ferrous metals, chemical fertilizers, real estate investment, car production and M2 money. The "hot" ratio is up from 44pc in May, and 31pc last October.

It hard to know whether premier Li Keqiang misjudged China’s hard-landing earlier this year.

The Politburo is deliberately trying to deflate the country’s $26 trillion credit bubble – up from $9 trillion in early 2009 - knowing that stimulus-as-usual is becomes more dangerous with each stop-go mini-cycle.

Yet the calibrated slowdown may have gone too far. One-year borrowing costs rose from zero in 2011 to 5pc in real terms last year as deflation took hold, a form of passive monetary tightening.
Thanks to China’s dollar peg, the exchange rate has risen 20pc against the euro, 60pc against the Japanese yen and 100pc against the Russian rouble since mid-2012.

At the same time the economy went over a “fiscal cliff” at the start of the year as local governments saw a collapse in revenues from land sales and were prohibited from bank borrowing.

The authorities were slow to respond to multiple shocks but they have finally get their bond market off the ground. Local entities are issuing securities at a pace of $130bn a month, amounting to a shot of stimulus. Real borrowing costs have halved since late last year.

Nomura says monetary policy is now as loose as in the depths of the post-Lehman crisis. A mini-blitz of a fresh infrastructure spending has begun to plug the fiscal gap.

It is not a return to the manic uber-stimulus of the boom years, but it is unlikely that China will spiral deeper into its slump over coming months. The Communist Party controls the quantity of credit through the state-controlled banks, and it is using that lever to pump-prime the economy.

If need be, it can cut the reserve requirement ratio for banks from 18.5pc to zero, injecting $3 trillion into the system. Only once Beijing has played that final card, should we start to worry. China’s day of reckoning is still far away.

Closing the Sausage Factory

By John Mauldin

Aug 07, 2015

“Bureaucracy destroys initiative. There is little that bureaucrats hate more than innovation, especially innovation that produces better results than the old routines. Improvements always make those at the top of the heap look inept. Who enjoys appearing inept?”

– Frank Herbert, Heretics of Dune

“Economies naturally grow. People innovate as they go through life. They also look around at what others are doing and adopt better practices or tools. They invest, accumulating financial, human and physical capital.

Something is deeply wrong if an economy is not growing, because it means these natural processes are impeded. That is why around the world, since the Dark Ages, lack of growth has been a signal of political oppression or instability. Absent such sickness, growth occurs.”
– Adam Posen, “Debate: The Case for Slower Growth
Today’s letter will be shorter than usual, because I’m at Camp Kotok in Grand Lake Stream, Maine, where the first order of business today is trying to outfish my son (not likely to happen, this year). But I’ve been looking closer at productivity barriers, and I want to give you some points to ponder.
The New Normal?
Like many of you readers, I’m old enough to remember a time when 2.3% annual GDP growth was a disappointment. We always knew America could do better. Not anymore, apparently. 

Some people actually cheered last week’s first estimate for 2Q real GDP growth. It was 4.4% in nominal terms, but inflation brought the figure back down. While certain segments are growing like crazy, for the most part we are muddling along in a slow-growing malaise. You might even call it “stagnant.” 

I for one still think the United States can do more. We have a large population of intelligent people who want to build a solid future for their children. They’re willing to work hard to do it.
If that’s not happening – and clearly it isn’t – some barrier must be standing in their way.

What is this barrier to productivity and growth? There are actually several, but government red tape is one of the biggest. I thought about this after reading an excellent Holman Jenkins column in the Wall Street Journal last week.

Jenkins led me to an audio recording of an interesting discussion on “The Future of Freedom, Democracy and Prosperity,” conducted at a symposium held at Stanford University’s Hoover Institution last month.

Government research & development funding has fallen off considerably from its peak in the 1970s moonshot days. This holds back worker productivity. The federal government is doing too much to slow down business and not enough to boost it.

The three economists who spoke at Stanford all pointed to important productivity barriers emanating from Washington DC.

One of the participants, Hoover economist John Cochrane, spoke of fears that America is drifting toward a “corporatist system” with diminished political freedom. Are rules knowable in advance so businesses can avoid becoming targets of enforcement actions? Is there a meaningful appeals process? Are permissions received in a timely fashion, or can bureaucrats arbitrarily decide your case by simply sitting on it?

The answer to these questions increasingly is “no.” Whatever the merits of 1,231 individual waivers issued under ObamaCare, a law implemented largely through waivers and exemptions is not law-like. In such a system, where even hairdressers and tour guides are subjected to arbitrary licensing requirements, all the advantages accrue to established, politically connected businesses.

The resources that businesses put into complying with government regulations is staggering. I have often envied people outside the highly regulated financial industry for their freedom to operate rationally. In my business we seem to spend half our time – and an ungodly fraction of our money – just maneuvering through the regulatory morass.

Intrusive federal regulations touch every part of the economy:

  • Energy and mining companies have to deal with environmental protection rules.
  • Drug companies and health care providers must satisfy the FDA and Medicare.
  • Cloud technology companies have to process FBI and NSA demands for user information.
  • Retailers and consumer product makers are required to abide by the fine print on millions of product labels.

I could go on, but you get the point. Anything you do attracts bureaucratic oversight now. We may laugh at “helicopter parents” hovering over their children at school, but we all have a helicopter government looking over our shoulders at work.

Before anyone calls me an anarchist, I think some government regulation is perfectly appropriate. We all want clean drinking water. Everyone appreciates knowing our cars meet crash survival standards. I’m glad FAA is keeping order in the skies.

The problem arises when agencies enforce confusing, contradictory, and excessive regulations and try to micromanage the nation’s businesses. Every business owner I know is glad to play by the rules. They just want to know what the rules say, and that is frequently very hard to do.

A few weeks ago, in “Productivity and Modern-Day Horse Manure,” I explained that growth is really quite simple: if we want GDP to grow, we need some combination of population growth and productivity growth.

The US population is growing, thanks mainly to immigration, but the effectiveness of the workforce is another matter. Baby Boomer retirements are rapidly removing productive assets from the economy. To offset that trend, we need to make younger workers more productive.The red tape that constantly spews out of Foggy Bottom is not helping matters.
Regulatory Capture
The red tape hurts the economy overall, but it does help certain parties. The largest players in any niche often “capture” their regulators. Then they use their influence to tilt enforcement away from themselves and toward smaller competitors.

Put simply, new regulations can be great for your business if you are already well established and have the resources to comply with government mandates. New entrants rarely have those resources. The resulting lack of competition boosts profits for the big players but hurts consumers. The competition that would normally lead to better, less-expensive goods and services never happens.

Holman Jenkins makes another great point about how overregulation affects growth.
Another participant, Lee Ohanian, a UCLA economist affiliated with Hoover, drew the connection between the regulatory state and today’s depressed growth in labor productivity. From a long-term average of 2.5% a year, the rate has dropped to 0.7% in the current recovery. Labor productivity is what allows rising incomes. A related factor is a decline in business start-ups. New businesses are the ones that bring new techniques to bear and create new jobs. Big, established companies, in contrast, tend to be net job-shrinkers over time.
Recall our economic growth formula: population growth plus productivity growth.
The US population grew at a peak rate of 1.4% in 1992, and growth has been trending down ever since. Now it is around 0.75% per year. Add that to 0.7% productivity growth, and you see why Jeb Bush’s 4% growth target will be so hard to hit.
Blame Flows Downhill
Business leaders love to complain about the bureaucrats who run Washington’s alphabet-soup agencies. I think the problem goes deeper.

With only a few exceptions, the regulators I’ve met over the years have been competent professionals. They weren’t intentionally trying to hurt my business. Often the regulations confused them as much as they confused me.

The real blame, I think, starts on Capitol Hill. Our legislative process is a sausage factory. Congress passes vague, complicated laws riddled with exceptions for this and zero tolerance for that. The result is superficially attractive but a mess inside. People in the alphabet agencies then have to remove the sausage skin and make sense of the contents.
This would be a tough job for anyone. I certainly don’t envy them.

Jenkins mentions Obamacare’s convoluted waivers and exemptions. Even its advocates admit the law is a crazy mess. But how and why did it get that way?

Like most major programs, the Obamacare law is a giant collection of compromises and favors.

All these provisions were necessary to make Obamacare palatable to various and sundry legislators and the interest groups whose pockets they’re in. Quite literally no one wanted what the process created. The left wing wanted a public option, or “Medicare for everyone.”
The right wing wanted tax credits and across-state-line insurance sales. Nobody wanted the bloated, half-rotten sausage of a law we have now.

The much-hated individual mandate, for instance, wasn’t part of the original plan.
Healthcare reform was a big issue in the 2008 Democratic primary. Hillary Clinton insisted everyone should have to buy insurance. Barack Obama opposed a mandate for adults and wanted it only for children. They argued about this several times in their early debates.

Obama was elected and then didn’t deliver on his preferred option. He changed course and accepted the individual mandate. He may have had no choice – forcing healthy people into the pool was the only way insurers would agree to cover preexisting conditions.

Once the law passed, the IRS then had to enforce the individual mandate and identify who deserved tax credits and how much they should get. They did it the only way they could: by making our tax returns even more complicated than they already were.

That’s only one law. Multiply this by hundreds of similarly convoluted strings of sausage that have emitted from the Congress in recent decades. We can laugh about China’s economic central planning, but here in the US we have the opposite of central planning: our form of government delivers an inefficient, uncoordinated mess.

This isn’t simply wasteful and expensive. Businesses expend precious productive resources trying to follow crazy, conflicting rules. And big companies use regulations to stifle smaller competitors.

All this unproductive effort makes the economy less likely to innovate, grow, and create new jobs. We see the results in persistently low employment, wages, and GDP growth.
A Hopeful Note
Holman Jenkins correctly points out that this mess is the fault of both political parties.
Tea party types talk a good game, but many are dependent on an unreformed Social Security and Medicare, and lately some have rallied to Donald Trump, who distracts them by blaming immigrants without actually offering a solution to immigration or consecutive sentences on any policy question. Meanwhile, the Barack Obama
–Hillary Clinton Democratic Party offers bigger, more intrusive government as the solution to the problems of traditional minorities, the economically insecure, and target blocs like single women or the LGBT community.
Electing the right president or the right Congress isn’t going to fix this. Either party will always do whatever its donor class demands. We might get a slightly different set of problems, but they will be no less problematic for the economy.

Jenkins wraps up on a hopeful note, though. How, he wonders, did the Carter and Reagan administrations manage to deregulate energy and transportation? Voters weren’t demanding those changes, and plenty of big players opposed both moves.
Yet uber-liberal Ted Kennedy led a fight that decontrolled airline fares. What was going on back then?

If we can figure that out, and make it happen again, we might be able to close the Congressional sausage factory. Unfortunately, that isn’t the only big problem on Capitol Hill. 
Starving for R&D
We’ve established that government regulations stifle economic growth. That’s bad enough, but Congress compounds the problem by authorizing too little of the kind of government spending that helps growth.

Government spending helps growth? I know that statement is heresy to some. I, too, would prefer to have government stay completely out of private affairs. In the real world, however, many useful technologies had their origins in federal programs: nuclear power, jet engines, satellites, microchips, the Internet, GPS, and more.

Would the private sector have produced these? That’s a counterfactual speculation that no one can prove or disprove. We do know that government research that depended on support from agencies like the National Institutes for Health (NIH) and the Defense Advanced Research Projects Agency (DARPA) helped drive innovation in the economy. Do we need more of it?

We used to have quite a bit more of it. Expressed as a percentage of GDP, government R&D spending peaked with NASA’s Apollo space program in the late 1960sand early 1970s. It got a little bump from defense spending in the Reagan years and the Human Genome Project launched toward the end of Bill Clinton’s era, but the overall trend is still down. 
At the same time, private-sector R&D grew steadily before retreating in the early 2000s. From there it grew at a more moderate pace as businesses spent cash on stock buybacks and higher dividends. Now it’s jumping even more – I think because businesses recognize the need to boost productivity.

Writing for Bloomberg Businessweek in June of this year, Matthew Philips and Peter Coy found this private investment might be just the ticket to boost economic growth.

Companies have been pouring money into research and development at the fastest pace in 50 years. From November through the end of March, U.S. companies funded R&D at an annual rate of $316 billion, or about 1.8 percent of gross domestic product, the largest share ever for the private sector. That’s up from 1.7 percent last year and 1.6 percent from 2007 to 2014. “If secular stagnation is a ‘thing,’ then U.S. companies are investing like crazy to make sure it doesn’t happen,” says Neil Dutta, senior U.S. economist at Renaissance Macro Research.

After years of spending cash on dividend boosts and share buybacks, U.S. companies may finally be realizing they need to start seeding real innovation. To some economists, this marks a turning point as companies make the transition from engineering short-term profits to devising products and more efficient methods of doing business. “In a way, this is what we’ve been waiting for,” says Torsten Slok, chief international economist at Deutsche Bank. “It’s not quite Godot arriving, but it’s close.”

They go on to say this shift is not a sure thing. The time lag between conducting R&D and selling actual products can be years, even decades. And the government labs that hatched big ideas now hatch them more slowly and they don’t move into the private sector as quickly.

Looking at the chart above, economic growth seems to coincide with periods when both private (blue line) and government (red line) R&D spending rose together.

Right now only the blue line points higher. Will federal R&D spending return to growth?
Frankly, I don’t see how. No matter how next year’s election turns out, the White House and Congress will have to sustain rising entitlement and military spending with little or no additional revenue. They won’t have much slack, and I doubt they will want to expand projects whose payoff is years in the future (or possibly never).

That means private industry will have to pick up the slack. Can it?
Quarterly Mindset
Some US corporations get this. At Facebook, for example, CEO Mark Zuckerberg told shareholders last year not to expect profit growth because the company would make huge investments in new products. He wasn’t kidding.

Companies like Facebook are the exception. Most CEOs give in to shareholder demands for expanded stock buyback programs or higher dividends. This is perfectly logical from these executives’ personal viewpoints: most of their compensation comes from stock options. Share buybacks are what keep that gravy train moving without diluting other shareholders.

Jerry Grantham took the “stock option culture” to task in his most recent quarterly investment letter:

This near-perfect synergy between Fed policy and the stock option culture has, not surprisingly, resulted in most of the corporate cash flow of public companies being used for stock buybacks – a record $700 billion annualized rate this year at the expense of corporate investments in expansion. Thus, well into the seventh year of economic expansion, we have uniquely had no hint of a surge in capital spending, which remains well below average. And why should we be surprised? For how risky it is to build new factories and shake them down in a world where things can go wrong and corporate raiders lurk. How safe it is to buy your own stock [and how easy to raise debt with which to do so, given the wondrous workings of QE-SLF] and how likely that doing so will push prices higher, thus increasing option values (making it easier for CEOs to go from earning 40 times the average worker in 1965 to over 300 times today) and enlarging the Fed's wealth effect at the same time!

But the downside is less corporate expansion; less GDP growth; lower job creation, and hence lower wages. Pretty soon, Mr. Ford, there will be no one to buy your cars. The economy becomes persistently disappointing for yet one more reason.


Sadly, we seem to be at a point where the mindset in the nation’s C-suites is not so different from the mindset on Capitol Hill. Our politicians think ahead no further than the next election, while our business executives think only of the next quarterly and annual reports.

If short-term thinking continues to rule both the public and private sectors, we are going to stay stuck in the mud. The outcome, as Jeremy Grantham says, will be “less corporate expansion; less GDP growth; lower job creation, and hence lower wages.”

A quote came to mind which I believe is attributed to Henry Ford: “If you keep doing what you’ve always done, you’ll keep getting what you’ve always got.”

What we’re doing right now is working well enough to keep the US out of recession. We’re also seeing some mild improvement in employment and consumer spending. If we stay on the present course, we’ll keep getting mild improvement.

The problem is that we’re in a tunnel with a giant debt train chasing us from behind. Doing what we’ve always done will eventually get us run over. Somehow, we have to start running faster.
Fishing for a Candidate
Last night I watched the first Republican primary debate along with much of the group. Our group here at Camp Kotok in Grand Lake Stream, Maine, is very diverse in terms of the political spectrum, so that made for fun watching. Rather than talking about who won and lost, let me offer another thought. The big winner was the process. To everyone's surprise (and certainly if you had asked a year ago), the TV audience was huge. Eight times more people watched than tuned in for the last presidential cycle's first debate. It was the largest cable audience ever for a non-sports event.

Who knew the Republican primary could be a reality show? Sadly, it took The Donald to make that happen, but it is worth suffering through his bloviating to get the audience to listen. What they heard were 4-5 very good potential candidates, although there was some vigorous disagreement in the room here over who made up the top four.  I bet you and I might have a different list as well.

That is beside the point. The Republican primary is now Survivor. People will start watching to see who gets voted off the island. I bet this even boosts the ratings for the Dems. Maybe they could get George Clooney to run and then beat the GOP numbers. Just saying.

Your hoping we can learn to make better sausage analyst,

John Mauldin

Letting China’s Bubble Burst

Michael Spence

JUL 29, 2015

NEW YORK – The problems with China’s economic-growth pattern have become well known in recent years, with the Chinese stock-market’s recent free-fall bringing them into sharper focus. But discussions of the Chinese economy’s imbalances and vulnerabilities tend to neglect some of the more positive elements of its structural evolution, particularly the government’s track record of prompt corrective intervention, and the substantial state balance sheet that can be deployed, if necessary.
In this regard, however, the stock-market bubble that developed in the first half of the year should be viewed as an exception. Not only did Chinese regulators enable the bubble’s growth by allowing retail investors – many of them newcomers to the market – to engage in margin trading (using borrowed money); the policy response to the market correction that began in late June has also been highly problematic.
Given past experiences with such bubbles, these policy mistakes are puzzling. I was in Beijing in the fall of 2007, when the Shanghai Composite Index skyrocketed to almost 6,000 (the recent peak was just over 5,000), owing partly to the participation of relatively inexperienced retail investors.
At the time, I thought that the greatest policy concern would be the burgeoning current-account surplus of over 10% of GDP, which would create friction with China’s trading partners. But the country’s leaders were far more concerned about the social consequences of the stock-market correction that soon followed. Although social unrest did not emerge, a prolonged period of moribund equity prices did, even as the economy continued to grow rapidly.
In 2008, it was a combination of exploding asset prices and excessive household-sector leverage that fueled the global financial crisis. When such a debt-fueled bubble bursts, its effects are transmitted directly to the real economy via household-sector balance sheets, with the reduction in consumption contributing to a decline in employment and private investment. It is much harder to find circuit breakers for this dynamic than for, say, that caused by balance-sheet distress in the financial sector.
Yet the Chinese authorities seem not to have learned the lessons of either episode. Not only did they fail to mitigate the risks, underscored in the 2007 collapse, that new retail investors introduce into the market; they actually exacerbated them, by allowing, and even encouraging, those investors to accumulate leverage through margin buying.
Making matters worse, when the current stock-market correction began in early June, Chinese regulators relaxed margin-buying restrictions, while encouraging state-owned enterprises and asset managers to purchase more stocks. The authorities, it seems, were more interested in propping up the market than allowing for a controlled price correction.
To be sure, China’s stock-market bubble did not emerge until recently. Last October, when the Shanghai Composite Index was in the 2,500 range, many analysts considered equity prices undervalued. Given relatively strong economic growth, rising prices seemed justified until about March, when the market, driven by mostly thinly traded small- and mid-cap stocks, shot to over 5,000, placing the economy at risk. (And, in fact, many still claimed that the rally was not unsustainable, as the stock market was trading at a forward price-to-earnings ratio of about 15, consistent with its ten-year average, in mid-April.)

But it was a bubble – and a highly leveraged one at that. While periodic bubbles may be unavoidable, and no bubble is without consequences, a highly leveraged bubble tends to cause far more damage, owing to its impact on the real economy and the duration of the deleveraging process.
This is reflected in the persistently sluggish recovery in the advanced economies today. Even the United States, which has fared better than most since the crisis, has recorded GDP growth of little more than 10% since the start of 2008; over the same period, China’s economy grew by about 66%.
Of course, with China’s household sector holding a relatively small share of equities compared to real estate, the current stock-market slump is unlikely to derail the economy. Nonetheless, as in 2007, the prospect that lost savings will trigger social unrest cannot be dismissed, especially at a time when tools like social media enable citizens easily to share information, air grievances, and mobilize protest.
As previous crises have shown, and as the current downturn in China has highlighted, steps must be taken to mitigate market risks. Specifically, China needs prudential regulation that limits the use of leverage for asset purchases. Here, the country already has an advantage: relatively high levels of equity and low mortgage-to-value ratios typically characterize real-estate purchases by China’s household sector.
Moreover, once a market correction begins, the authorities should allow it to run its course, rather than prop up prices with additional leverage – an approach that only prolongs the correction. If Chinese regulators allow the market to correct, sophisticated institutional investors with a long-term value orientation will ultimately step in, enhancing the market’s stability. In the interim, the use of public balance sheets to purchase enough equity to prevent the market from over-correcting may be justified.
As China’s markets expand – the capitalization of the Shanghai and Shenzhen markets is on the order of $11 trillion – they are increasingly outstripping policymakers’ capacity to manage prices and valuations. The only practical way forward is for the Chinese authorities to focus on regulatory and institutional development, while following through on their commitment to allow markets to play the decisive role in allocating resources.

August 4, 2015 11:17 am

New world of work: political cost of Spain’s recovery

Tobias Buck in Madrid

Price of economic revival is rise in number of workers on precarious contracts

epa04385376 A teacher welcomes her pupils at Virgen Blanca public school on the occasion of the begining of the school year in Pamplona, northern Spain, 05 September 2014. EPA/JESUS DIGES©EPA
Even those in traditionally secure professions such as teaching have found themselves on short-term contracts
When Ana Martín gets in touch with one of her clients these days, she usually has good and bad news. The good news is that there is a job offer. The bad news is pretty much everything that comes next.
Ms Martín works at a job placement centre in Villaverde, a low-income district in the south of Madrid. Before the crisis, many of its residents found steady work on building sites and other sectors that benefited from Spain’s decade-long construction boom. But that kind of work disappeared years ago. What is on offer now are jobs that Ms Martín passes on with a heavy heart.
“You just cannot make a living with some of these contracts,” she says. Every single vacancy is for temporary jobs that will come to an end after three months, a month or even a week. Most are for part-time work only, with monthly pay of as little as €285. “We are seeing a fundamental change: People here used to work to live. Now they work to subsist,” says Jesús Díaz, a job mediator who works in the same office.

Over the past two years, Spain has won international admiration for turning around its once-shaky economy. At the height of the crisis, Madrid pushed through unpopular austerity measures and painful economic reforms, including a sweeping overhaul of the labour market.
Wage costs fell and exports boomed, allowing the rest of the economy to recover as well.
Employers and business leaders said reform helped companies regain competitiveness lost during the boom years. Spain is now on course to grow by more than 3 per cent this year, twice as fast as Germany, and jobless numbers are falling at last.

The price of that recovery, however, is a notable rise in the number of workers who labour in precarious conditions.
The numbers of those in temporary employment — whose numbers fell during the crisis partly because of their vulnerability — is on the rise again. In July, the Spanish unemployment roll dropped by 74,000, the best July since 1998. But of the 1.8 million labour contracts that were signed during the month, only 6.9 per cent of the contracts were for permanent positions. Despite the reforms, Spain’s two-tier labour market remains entrenched.

With a general election looming later this year, this is set to emerge as a key political battleground. While the government is trumpeting the sharp decline in unemployment, opposition parties are hammering away at the fate of the working poor.

This could be one reason why the government of Mariano Rajoy is struggling in the polls, says Pablo Simon, a professor of political science at Madrid’s Carlos III University. “The important thing for elections is not economic growth, but the perception of economic growth. And if there is a lot of inequality, then the way people perceive a recovery will also be unequal.”

According to official data, one in eight Spanish workers — or 2.28m in absolute numbers — earns only the minimum salary or less. Before the crisis, the number of workers bringing home such little pay was just one in 12. Salaries have dropped across the board, but especially so for those forced to move into the temporary sector: according to a recent study by Fedea, the economics think-tank, a worker who used to have a permanent contract and now works on a temporary basis will on average earn 48 per cent less than before.

“The working poor are a reality in Spain now,” says Marcel Jansen, a professor of economy at Madrid’s Autónoma University.

Spain is creating plenty of jobs — about 1.4m contracts are signed every month — but only a tiny fraction of these are for stable, open-ended positions. In April, for example, one out of four contracts lasted a week or less. In 2007, the year before the property bubble burst, it was one in six. Over the same period of time, the average duration of all contracts fell from 78 to 55 days.

Once the preserve of low-skilled seasonal workers in sectors such as tourism and farming, temporary contracts have now become commonplace, even in middle-class professions such as teaching. Last year, for example, more than 174,000 teachers lost their jobs between May and August, only to be rehired once the new school year was under way. By October, the overall number was almost exactly back to where it was before the summer.

“Companies and employers are shifting the risks they face on to their workers — and to the state itself,” says Prof Jansen. “There is now a culture of precariousness in the minds of employers — they have simply gotten used to it.”

The trend towards precarious work may improve the bottom line in the short term. For the economy as a whole, however, the constant churn of workers on short-term contracts makes little sense, argues José Ignacio Conde-Ruiz, a professor of economy. “Where is the incentive for a company to invest in its human capital? They know they will fire their workers after maximum two years anyway. So behind all this is also the issue of productivity.”

For the unemployed in Villaverde, the immediate challenge is to find a steady job with a decent salary. But, as Mr Díaz points out, the harsh new demands placed on workers go beyond pay and working hours. Some restaurants, for example, now demand that waiters bring their own uniforms.

Whatever the conditions, all vacancies are ultimately filled. “We have millions of unemployed in Spain,” remarks Mr Díaz. “There is always someone who says Yes.”

Don’t Look Now, But Market Inflation Expectations Are Falling

Jon Hilsenrath

Market expectations for U.S. inflation appear to be sagging again. This could complicate the Federal Reserve’s deliberations about raising short-term interest rates as soon as September, though the central bank’s earlier reactions to similar movements suggest that by itself it won’t derail a move.

Yields on 10-year Treasury notes have dropped from near 2.5% in mid-June to 2.16% on Friday, a sign investors demand less compensation for expected inflation than a few months ago. In Treasury Inflation-Protected Securities (TIPS) markets, where expectations can be measured more precisely, the compensation that investors demand for expected inflation in five to ten years dropped to 2.01% on Friday, down from 2.25% in late June, according to estimates by Barclays. These premiums are near where they were when the Fed started signaling its second round of bond purchases in 2010 and they are lower than they were when the Fed launched its third round in 2012. Nearer-term measures of inflation compensation in TIPS markets are under 2%.

Fed officials have said they want to be reasonably confident that inflation will rise toward 2% before they start raising short-term interest rates. Official measures of inflation have run below the target for more than three years. It is hard to see how falling inflation compensation in bond markets adds to that confidence. Still, the Fed has a complicated relationship with the whole idea of inflation expectations. As a result these bond market measures can’t be extrapolated straight into Fed actions.

In theory the central bank places great weight on where investors, households and business believe inflation is heading. Expectations can become a self-fulfilling prophesy. When inflation expectations rise sharply -- as happened in the 1970s -- households and businesses can demand more compensation in anticipation of a move up and push prices up in reality. When the reverse happens and expectations fall, it could become a weight on inflation.

In 2010, in the lead-up to the Fed’s decision to launch a second round of bond buying, drooping measures of expected inflation in bond markets got their attention, in part because these measures were coupled with a weak economy and still very high unemployment. The jobless rate in the summer of 2010, when the Fed started signaling moves toward a second round of bond purchases, was near 9.5%. It was 5.3% in July.

When inflation compensation in bond markets moved down again last year and stayed low early this year, Fed officials took a highly nuanced view. They noted independent survey measures of households, such as by the University of Michigan, showed inflation was expected in the public’s mind to stay stable. The distinction between surveys and markets has made its way into Fed policy statements. Bond market measures, officials have added, were being influenced by transitory movements in oil prices. In a press conference in December, Fed Chairwoman Janet Yellen drew a distinction between the inflation that investors actually expect and the premiums they demand for the risk of inflation. Her suggestion was that market risk premiums might fall for reasons other than shifts in expected inflation. The broader point was that Fed officials, though watching shifts in market expectations for inflation, weren’t getting very alarmed about it the downdraft.

Drops in market measures of expected inflation now could well make officials more reluctant to move aggressively once they have started pushing up short-term interest rates this year. But given their response earlier this year, it would probably take a much bigger move, or other signs of a shift in the economic outlook, to make them rethink their plans for a first increase.

Here Comes The Next Trillion-Dollar Bailout

By: John Rubino

Monday, August 3, 2015

As boxers like to say, it's the punch you don't see that knocks you out.
In a world where a growing part of the financial system is hidden from view and excluded from official statistics, those are words to remember.
A couple of examples from the 2008-2009 crisis:
  • Fannie Mae and Freddie Mac were private companies through which the federal government funneled a lot of mortgage debt and to which it granted a kind of de facto backing, though it asserted confidently that this would never be needed. When the real estate bubble (inflated in large part by Fannie and Freddie) popped, government -- read taxpayers -- had to assume responsibility for pretty much the whole $10 trillion US housing sector.
  • Over-the-counter derivatives are largely hidden by bank and hedge fund accounting tricks, but when that market blew up in 2008 it turned out that AIG, the world's biggest insurance company, had enough of the instruments to bring down the whole financial system. The result was another huge bailout with taxpayer cash.
Since bubbles tend not to repeat in exactly the same form, it's reasonable to assume that the next Fannie or AIG will be something very different -- like state and local pension plans, which for years have been putting away too little to cover the coming wave of retirements and are now starting to beg for help:
New Jersey legislator seeks federal loans to bail out state pensions 
(Reuters) - A top New Jersey Democrat wants the federal government to create a low-interest loan program to rescue states with big public pension problems. 
State Senate President Steve Sweeney called on Wednesday for a nationwide pension debt restructuring plan under which the U.S. Federal Reserve would offer low-interest loans to state governments to pay down unfunded pension liabilities. 
The country has racked up nearly $1 trillion of unfunded liabilities altogether in its state-run retirement systems, according to the latest estimate from Pew Charitable Trusts. Other projections have put the number even higher. 
New Jersey's badly underfunded pension system was cast further into the spotlight last year when Governor Chris Christie, now a 2016 Republican presidential candidate, slashed the state's contribution because of a revenue shortfall. 
Labor unions sued, saying the cuts violated a promise Christie himself made, in 2011 pension reforms, to ramp up to full contributions. 
But Christie won the battle in the state's highest court. The decision provided breathing room for the stressed state budget, but the pension problem lingers long term.
New Jersey would have to pay $6 billion on average annually for 30 years to pay off its existing $51 billion unfunded liability, the third largest in the nation, Sweeney said. 
But under his proposal, the Garden State could take out a $50 million federal loan at a low 1 percent interest rate, putting the proceeds into its retirement system. If that happened in fiscal year 2017, it would cut annual pension contributions, including the loan repayment, in half to about $3 billion, he said.
This means three things:
  • The national debt of most developed countries is grossly understated because it doesn't include these and other liabilities that will soon be dumped onto the public balance sheet.
  • Individual taxpayers responsible for their governments' debts are actually far less well-off than they think because their true net worth includes these huge, inevitable negatives.
  • The currencies of most major countries aren't backed by anything like the wealth that people -- and most governments -- assume. When the next bailout wave crests, the math will be deadly for the yen, euro and dollar.

A New Deal for Debt Overhangs?

Kenneth Rogoff

AUG 4, 2015

Greek Parliament

CAMBRIDGE – The International Monetary Fund’s acknowledgement that Greece’s debt is unsustainable could prove to be a watershed moment for the global financial system. Clearly, heterodox policies to deal with high debt burdens need to be taken more seriously, even in some advanced countries.
Ever since the onset of the Greek crisis, there have been basically three schools of thought.
First, there is the view of the so-called troika (the European Commission, the European Central Bank, and the IMF), which holds that the eurozone’s debt-distressed periphery (Greece, Ireland, Portugal, and Spain) requires strong policy discipline to prevent a short-term liquidity crisis from morphing into a long-term insolvency problem.
The orthodox policy prescription was to extend conventional bridge loans to these countries, thereby giving them time to fix their budget problems and undertake structural reforms aimed at enhancing their long-term growth potential. This approach has “worked” in Spain, Ireland, and Portugal, but at the cost of epic recessions. Moreover, there is a high risk of relapse in the event of a significant downturn in the global economy. The troika policy has, however, failed to stabilize, much less revive, Greece’s economy.
A second school of thought also portrays the crisis as a pure liquidity problem, but views long-term insolvency as an outside risk at worst. The problem is not that the debt of countries on the eurozone’s periphery is too high, but that it has not been allowed to rise nearly high enough.
This anti-austerity camp believes that even when private markets totally lost confidence in Europe’s periphery, northern Europe could easily have solved the problem by co-signing periphery debt, perhaps under the umbrella of Eurobonds backed ultimately by all (especially German) eurozone taxpayers. The periphery countries should then have been permitted not only to roll over their debt, but also to engage in full-on countercyclical fiscal policy for as long as their national governments deemed necessary.
In other words, for “anti-austerians,” the eurozone suffered a crisis of competence, not a crisis of confidence. Never mind that the eurozone has no centralized fiscal authority and only an incomplete banking union. Never mind moral-hazard problems or insolvency. And never mind growth-enhancing structural reforms. All of the debtors will be good for the money in the future, even if they have not always been reliable in the past. In any case, faster GDP growth will pay for everything, thanks to high fiscal multipliers. Europe passed up a free lunch.
This is a fully coherent viewpoint, but naive in its unqualified confidence (for example, in the polemical writings of the Nobel laureate economist Paul Krugman). As a result, the anti-austerian view masks strong assumptions and risks. In fact, piling loans atop already-high debt burdens in the eurozone’s periphery entailed a significant gamble, particularly as the crisis erupted.
Political corruption, exemplified by the revolving door between Spain’s government and financial sector, was endemic. Dual labor markets and product-market monopolies still hobble growth, and oligarchs have disproportionate power to protect their interests. In reality, Germany could not have underwritten all of the European periphery’s debt without risking its own solvency and creditworthiness, particularly in the absence of a functioning system of eurozone-wide checks and balances. Expansive and open-ended guarantees might have worked, but if they didn’t, the economic rot from the periphery could have spread to the center.
A third point of view is that, given the massive financial crisis, Europe’s debt problem should have been diagnosed as an insolvency problem from the start, and treated with debt restructuring and forgiveness, aided by moderately elevated inflation and structural reform.

This has been my viewpoint since the crisis began.
In Ireland and Spain, private bondholders, not Irish and Spanish taxpayers, should have taken the hit from bank failures. In Greece, there should have been faster and larger debt write-downs.
Of course, national governments would have had to use taxpayer funds to recapitalize northern European banks – especially in France and Germany – that lent too much to the periphery.
And transfers would have been needed to recapitalize the periphery banks. But at least then the public would have understood the reality of the situation, while restructured and recapitalized banks would have been in a position to start lending again.
Unfortunately, too many policymakers in advanced economies allowed themselves to believe that such heterodox policies are only for emerging markets. In fact, advanced countries have resorted to heterodox policies to reduce debt overhangs on many occasions. Debt restructuring would have given Europe the reset it needed. Yes, there would have been risks, as IMF chief economist Olivier Blanchard has pointed out, but running those risks would have been well worth it.
So what is the way forward? Deeper European integration, stricter equity requirements for banks, and deeper but homegrown structural reforms are certainly key elements of any solution. Further aid to the European periphery is still badly needed.
But, beyond that, Europe’s experience ought to spur a full rethink of the global system for administering sovereign bankruptcies. That could mean bringing back older IMF proposals for a sovereign bankruptcy mechanism, or finding ways to institutionalize the Fund’s recent stance on Greek debt. There is no free lunch in Europe, and there never was; but there are much better ways to deal with unsustainable debt.