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INVESTMENT BANKING : BONFIRE OF THE BANKERS / THE ECONOMIST ( A MUST READ )

2012-02-03T04:18:00.006-05:00

Investment banking

Bonfire of the bankers

Profits down, jobs cut, strategy needed

Feb 4th 2012

“IT SUCKED,” says the head of investment banking at one of Europe’s biggest banks, reviewing the fourth quarter of 2011. That succinct assessment will take few by surprise. The sale and trading of bonds and shares slowed to a trickle last year. Analysts at Credit Suisse reckon that investment-banking revenues among the big American banks slumped by a quarter in 2011. Trading bonds, currencies and commodities (activities known as FICC) is the industry’s bread and butter: FICC revenues fell by about 15% in America. Things are even worse in Europe. Credit Suisse reckons that European investment banks will post a 43% drop in revenue for 2011. On February 2nd Deutsche Bank announced a fourth-quarter loss for its investment bank.

The first few weeks of this year also look dire. Markets have recovered relative to December, but there has not been the usual January leap. Analysts at Citigroup gloomily predict a further 10% fall in FICC revenues in Europe this year.

The question dogging the industry is whether these falls are temporary or permanent. “Trading goes up, trading goes down,” Jamie Dimon, the boss of JPMorgan Chase, told journalists in January. “When things come back these numbers will boom again and we’ll be geniuses, and it won’t be because we did anything, it will be because we stayed in the game.”

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If surviving the downturn is the goal, the logical response is to cut variable costs (see chart 1). The banks have been slashing headcounts with vigour. CEBR, an economics consultancy, forecast in October that 27,000 jobs would be lost in London’s financial district in 2011, taking the number of financial employees in the City down to a level last seen in 1998. Not only the City is suffering. Financial News, a specialist newspaper, reckons that 16 of the biggest investment banks have cut 26,600 jobs globally over the past six months. That represents 8% of their total headcount.

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From diets to gastric bands

Times are also grim for those bankers who have kept their jobs. In the past investment banks fired some people but still paid big bonuses to those that remained.

Now costs are being cut more deeply and banks are less concerned about being outbid in pay. “Compensation is going to get crushed,” says the head of one large investment bank. “Investors are concerned about returns.

[Their] bigger concern is about the split between shareholders and employees.” CEBR reckons that the bonus pool in London’s financial district will slump by some 38% this year, leaving it at about a third of the level it was before the financial crisis. On Wall Street banks including Citigroup, Morgan Stanley and Goldman Sachs are said to be cutting pay by anything from 30% to 70%.

Slimming cures are not enough for many banks, however. Some are changing their business models. Under pressure from regulators, banks everywhere are crowding into client-focused businesses which do not eat up as much capital.

Britain and Switzerland in particular are pressing their banks to hold lots more capital; past disasters have also persuaded management to cut their losses. UBS, Switzerland’s biggest bank, is cutting risk-weighted assets at its investment bank by almost half over the next five years and is pulling out of several business lines. Royal Bank of Scotland (RBS), which once had ambitions to be a leading global investment bank, is now shedding assets: on February 1st RBS announced that it was selling its Hoare Govett corporate-broking unit to Jefferies, an American investment bank.

All this will lead to consolidation in two ways. The first is that as some banks pull back, they create an opportunity for rivals to gain market share.

The second is that as banks crowd into capital-light “flow businesses”—trading bonds, currencies or shares—they are likely to drive down margins. That will please banks’ customers but will also lead to a concentration of market share among the biggest firms.

This process is not new. Two decades ago an investment bank could buy a telephone and earn decent margins by quoting bond or currency prices to ignorant customers. These days corporate customers trade electronically and have terminals providing a stream of prices. Although “flow businesses” do not require much regulatory capital, they do need massive investments in computer systems.

Firms with the best systems tend to attract the most liquidity and in turn are able to offer the most competitive rates. That suggests that only a few “flow monsters” can achieve sufficient volumes of trade to cover the costs of their infrastructure. In areas such as currencies, which are almost entirely traded electronically, this consolidation has already largely taken place: JPMorgan, Goldman Sachs and Deutsche Bank already have big market shares. The next frontier will be the move of bonds onto similar platforms: the same handful of banks is likely to benefit again.

Niche work if you can get it.

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With money tight and capital a scarce resource, investment banks must also choose whether to specialise in areas where they are strongest. The very top tier of global investment banks will still hope to generate synergies across diverse businesses—lending a firm money, say, and then helping it to sell shares and to hedge currency movements on the capital it is raising. This elite bunch will probably include Barclays Capital, Deutsche Bank, Citigroup, JPMorgan and Goldman Sachs (see chart 2).

Most banks, however, will slim down. “We’re seeing an additional specialisation in investment banking,” says the head of a bank. “Firms are fundamentally either debt or equity [specialists]. They have debt or equity in their DNA.”

A second area of specialisation will be geographic. All but a handful of the very biggest banks will probably be forced to give up their ambitions of being global and concentrate instead on the regions where they are strongest. The retreat is partly driven by capital and cost pressures at home, partly by the realisation that there is less room than expected for outsiders in many of the fastest-growing emerging markets.

A home bias in investment banking is not new, nor is it confined to emerging markets. Of the top five corporate feepayers in the industry last year, four gave most of their investment-banking work to firms from their country or region, according to Thomson Reuters. But the trend is likely to be reinforced as foreign banks become less willing to make cheap loans to prise open new markets and win investment-banking mandates.

As dire as the outlook is, it would be foolish to underestimate the resourcefulness of the industry. The investment banks are staffed by clever, entrepreneurial people with a knack for inventing new financial products and selling them to the world. Instead of going through a grinding decade of job cuts and restructuring, investment bankers could come up with another big, money-spinning innovation.

But even if markets simply bounce back as Mr Dimon expects, the investment-banking industry will look quite different in a few years’ time. There will be fewer big firms straddling the globe; the rest will try to dominate their own niches. And if revenues do stay flat, shareholders may still benefit as employees make do with less of the pot. For bankers that really will suck.

CARMAKING : IN THE SLOW LANE / THE FINANCIAL TIMES COMMENT & ANALYSIS ( A MUST READ )

2012-02-03T04:16:00.000-05:00

February 2, 2012 3:06 am

Carmaking: in the slow lane

.By John Reed

A sector long seen as an engine of European industry looks increasingly shaky

Last summer, as Europe’s sovereign debt crisis gathered pace, Philippe Varin was sitting in his Paris office, studying disturbing figures from the field. The suave, steely 59-year-old boss of PSA Peugeot Citroën, the continent’s biggest carmaker after Volkswagen, was seeing sales slide for some models – notably the subcompact 207.

Demand for the car had surged in 2009 and 2010, when France and other European countries introduced “cash-for-clunkers” subsidies to bolster the sector after the banking crisis devastated car sales. Scrappage schemes had prompted buyers to trade in old models for small and cheap cars, keeping producers busy making models such as VW’s Polo, Ford Motor’s Fiesta and Fiat’s 500.

Click to enlarge

But with these incentives long discontinued, the 207 was now one of the oldest in a brutally competitive segment. Peugeot’s customers, and some dealers, were pressing for unsustainably deep discounts to match those of other carmakers. Meanwhile, consumer confidence was evaporating in four of Peugeot’s biggest markets: France, the UK, Spain and Italy.

Mr Varin reacted fast. He cut production days at the four plants that make the 207 in France, Slovakia, and Spain. In October the company said it would cut 6,000 jobs and make €800m of cost savings, and that it was heading for a significant second-half loss. The share price dropped.

Peugeot Citroën was the first big victim of the eurozone crisis in the region’s carmaking industry. However, the profit warning presaged what is certain to be a dismal year for the continent’s mass-market industry. Ford Motor reported a fourth-quarter $190m loss in Europe last week; Fiat on Wednesday reported higher 2011 and fourth-quarter earnings, lifted mainly by its US Chrysler unit and sales in Brazil, but acknowledged its mass-market business in Europe had lost €500m last year. France’s Renault and General Motors’ European Opel/Vauxhall arm are expected to report sagging fourth-quarter earnings in coming days.

Europe’s flagging car market – sales fell 6 per cent year-on-year for the month of December and are forecast to fall again this year – has brought the industry’s problems to a head. But the root causes lie deeper, in oversupply issues plaguing a cornerstone industry always under scrutiny from politicians and the public.

Analysts are describing Europe as the sector’s “sick man”, a status held until recently by Detroit’s three carmakers, which restructured deeply during the crisis. “All the European carmakers are running against the treadmill, in some cases with increasing speed,” says Stefano Aversa of AlixPartners, the turnround consultancy whose clients include GM.

Executives warn of coming distress in the sector, which directly employs more than 2m Europeans and comprises some of the region’s biggest employers and exporters. With eurozone unemployment at a record high, at stake are much-needed jobs in a sector that in good times reliably provides them, but in times of crisis can become a liability.

Sergio Marchionne, Fiat chief executive – also vulnerable to the euro crisis because of its exposure both to the troubled Italian economy and to small cars – recently likened the scene to orphans jostling for food. “If you don’t see growth, whoever’s left at the table is going to be left fighting for scraps of food,” he told the Financial Times in Detroit last month.

Europe’s car industry did not heal itself during the financial crisis. Detroit’s producers closed dozens of plants between 2006 and 2009 and now have lean operations supplying a resurgent market.

Asian peers have plenty of demand to keep them busy. But Europe is still saddled with capacity to make millions more cars than the market wants. Because of political and union pressure, too many high-cost plants have been kept open at home when growth and profits have largely moved overseas.

Worse, the billions of euros of aid extended to European carmakers in 2009-10 – including scrappage and the €6bn French bail-out of Peugeot Citroën and Renault – may have merely postponed much-needed restructuring.

When the US Treasury ushered GM and Chrysler through bankruptcy, it required them to produce crisis-proof business plans and downsize operations. Paris, by contrast, told Peugeot Citroën and Renault to keep plants open as the price of emergency loans.

While GM, Ford and Chrysler closed dozens of plants, in Europe just two factories have shut since 2008: Opel’s in Antwerp and Fiat’s in Sicily. Plants in the countries at the heart of the eurozone crisis – notably France, Italy and Spain – are looking especially extraneous, as bosses search out cost savings. However, in a business that disregards borders, operations in countries from the UK to Slovakia and Romania are vulnerable too.

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Three years on, scrappage programmes also look like an unsustainable quick fix. They cushioned producers from falling demand and trained European consumers to expect big discounts, especially for small cars.
According to Jato Dynamics, an industry research group, dealers and manufacturers between them offer incentives on mass-market cars that average one-third of their suggested retail price.

Arthur Maher of the LMC Automotive consultancy estimates that the European industry now has the capacity to build 10m more cars annually than the market wants – equivalent to 20-25 car plants. Given the forecast severity of the continent’s economic downturn this year, he expects more redundancies. Some carmakers, he says, are postponing investment.

Arndt Ellinghorst of Credit Suisse says: “Weak European mass-makers will get weaker, and balance sheets and liquidity will become a huge issue. Banks are more selective about who they give money to.”

To be sure, Europe’s carmakers will find some relief in emerging markets. But stripped of overseas income, most – except possibly VW, bolstered by its large scale and luxury brands – make only slender profits or lose money.

In any other industry, such losses would have led to rationalisation, entailing some business failures and a return to profits for the survivors. But Europe’s car sector, to its short-term benefit and long-term detriment, is treated by politicians and family or state shareholders as a special case – an employment-generating scheme.

Peugeot’s Mr Varin earned his reputation in steel, an industry like carmaking saddled until recently with overcapacity. At Corus, the Frenchman presided over a deep restructuring and its sale to India’s Tata Steel.

Under Mr Varin, Peugeot Citroën, has diversified away from low-margin small cars and western Europe, launching higher-priced products such as Peugeot’s stylish RCZ roadster or Citroën’s upscale new DS line, which it plans to build in China. Peugeot last year sold 42 per cent of its cars outside Europe, up from 39 per cent in 2010.

But since announcing plans to cut jobs, Mr Varin has had to tread gingerly. Although Peugeot Citroën long ago repaid its bail-out loan, plans for its French plants are under close scrutiny in an election year. When a French newspaper published a company document suggesting Peugeot might close the plant in Aulnay on the outskirts of Paris that makes Citroën’s C3 supermini, it faced accusations from some pundits and politicians of “delocalisation”.

Speaking to a committee in the French national assembly in December, Mr Varin took pains to explain that, for a global carmaker, investing overseas was not a zero-sum game. “I find it normal to have 1,500 people in São Paulo who work on models with specific features that must be adapted for this country,” he said. He pointed out that Peugeot Citroën made twice as many cars in France as it sold there.

Because closing French plants is politically taboo, Peugeot has sought to keep them busy by producing higher-margin models such as the DS. It has also streamlined operations at underused factories in a process it calls compactage.

Similarly, Renault – while investing in plants in low-cost regions such as Morocco – has concentrated production of higher-margin products such as electric cars in France.

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Analysts have long argued that France does not need two carmakers. But the industry’s symbolic status as a repository of national self-worth – combined with the prevalence of powerful family and state shareholders – have hampered mergers.

Thierry Peugeot, Peugeot Citroën’s chairman, in 2009 signalled his openness to alliances but set conditions – notably that the family remain the dominant shareholder. After talks with Fiat, the company failed to reach a deal because of disputes over control and other issues. Mr Varin discussed a cross-shareholding alliance with Japan’s Mitsubishi in 2010 but scrapped talks, claiming they might hurt his company’s credit rating.

In this context he has one of the least enviable jobs in European industry today. “If you were an adviser to Philippe Varin, it would be difficult to tell him what to do differently,” says Stuart Pearson of Morgan Stanley.
“There are constraints politically, from the family, and financially.”

Mr Marchionne of Fiat says he is still hunting for a partner to make small and very small cars, and recently forecast that the eurozone crisis would finally force rationalisation of operations. Last month he met Mr Varin at a dinner at Detroit’s car show, renewing speculation about a merger with Peugeot Citroën. The latter said afterwards that it was “absolutely open” to alliances with a rival, but that conditions were not yet right.

The French company last week tempered the gloom of its downsizing when it launched production of the new 208, a successor to the 207, at its plant in Poissy on the outskirts of Paris. It said it was investing €600m in France, and that the car confirmed its “deep commitment to its home country”. The 208 will feature super-efficient new engines.

But Europe’s oversupplied car market has no lack of good small cars. Analysts say that whatever Mr Varin’s assurances, the group will have to downsize on the continent and invest more overseas. “Eventually, Peugeot will shrink its industrial footprint in France, just as Renault has, and rely on lower-cost locations,” says Stephen Reitman, analyst with Société Générale. “That is inevitable.”

PREMIUM MODELS: Luxury brands speed past industry woes to record sales

While the plants of Europe’s French- and US-owned volume car brands have been cutting production days, most of their German competitors are working at full capacity.

BMW, Mercedes-Benz, Audi and Porsche all saw their brand power and growing presence in emerging markets drive record 2011 sales.
Unlike Peugeot, Renault, General Motors or Ford Motor, who tailor their cars for drivers in Asia and Latin America, opting to build them there to save costs, most German premium cars are made in Europe. Luxury cars are easier to make in one place and then export because they are global products, with minimal regional tweaks. The margins they deliver are fat enough to cover shipping costs and tariffs.

The big four premium brands also like to build close to home because they are spending billions on new and commercially sensitive technology, such as lightweight carbon fibre.

Demand for luxury, extremely profitable cars is high. BMW’s 7 Series and Mercedes’ S-Class are selling at record levels in China, now the segment’s biggest market. Top-end sport utility vehicles, including Audi’s Q5 and Porsche’s Cayenne, sell well everywhere.

Because German products are in such strong demand – and are so globally homogenous – would-be Chinese drivers are in a global buying race that strengthens the brands’ pricing power.

“Effectively, a Chinese consumer is competing with a European consumer and with a US consumer for a 7 Series,” says Stuart Pearson of Morgan Stanley. “BMW can sell to the highest-bidding customer because of their capacity constraints.” Premium carmakers also profit from the strength of the German market – the only big country in Europe where sales are still rising.

But in a business as cyclical as carmaking, even premium brands cannot afford to be complacent. BMW, Mercedes and Audi suffered early in the financial crisis, when the credit crunch wreaked havoc on their large leasing businesses in the US. Mercedes was too slow to cut its production to match falling sales.

Analysts warn that the Germans could be hurt by their growing reliance on China, especially if demand there cools. Serious turmoil in the eurozone would hurt demand for their products in Germany, and a squeeze on credit could dry up their sources of funds.

Peugeot Citroën: Exposed

Where it is: carmaker most exposed to Europe’s structurally declining market is widely seen as likeliest candidate forconsolidation with a rival

Philippe Varin, chief executive, says “we will be in significant loss in the second half of the year, with a negative cash flow”

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Renault: Under pressure

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Where it is: Renault is cushioned by partnerships with Nissan and Daimler but, 15 per cent state-owned, it faces pressure to preserve jobs in France

Carlos Ghosn, chief executive, says “we know that the first quarter of the year is not going to be good ... the order bank has been going down”
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Fiat: Hurting at home
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Where it is: Fiat’s core European small-car business is lossmaking. Chrysler and Brazil, where it is market leader, are keeping the Italian carmaker afloat

Sergio Marchionne, chief executive, says “best prognostication” for Europe until 2014 is “flatline” growth, and he is seeking to form an alliance

GM: Boxed in
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Where it is: restructuring at Opel, GM’s European unit, has led to job cuts (with hints of more to come) and a plant closure. Low emerging market presence

Dan Akerson, chief executive, says third-quarter losses of $292m in Europe are “not sustainable”. Rumours of an Opel sale persist.

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Ford: Discount pressure

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Where it is: recording bumper global profits but losing money in Europe, where it faces pressure to discount. Looking at shedding temporary staff

Alan Mulally, chief executive, says “a deteriorating external environment impacted most of our automotive operations outside of North America”

VW: Solid earner

Where it is: VW’s huge global volumes, trucks, and sales at Audi and Skoda make it Europe’s least at-risk mass producer. But not immune to slowdown

Martin Winterkorn, chief executive, says “2012 will be substantially harder, above all in Europe, and especially in highly indebted countries like Italy”

Copyright The Financial Times Limited 2012.

THE WAR ON FINANCE / THE ECONOMIST BUTTONWOOD COLUMN ( A MUST READ )

2012-02-03T04:15:00.002-05:00

Buttonwood

The war on finance

Attacking your creditors is an intriguing strategy

Feb 4th 2012
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THE man who the polls suggest will be the next French president, François Hollande, claims that finance is his “real adversary” in the coming election. Britain has just stripped the former chief executive of the Royal Bank of Scotland of his knighthood. Even Newt Gingrich is attacking the “vulture capitalists” in the private-equity industry. Perhaps the West is set for a “war on finance” along the lines of the “war on terror”, with similar uncertainty about how to define victory.

Politicians seem to have three main beefs with the financial sector. The first is that bankers earn too much. The second is that banks take reckless risks and then need rescuing by governments. And the third complaint is that investors in financial markets have undue influence over an economy through their ability to affect bond yields and equity prices.
The first two problems are really related. People do not worry too much about footballers’ high pay.

The problem with bankers is the extent to which they are subsidised by explicit and implicit taxpayer support. (Of course, you might worry about income inequality in general but that is not specific to banks and can be tackled by redistributive taxation.) It is hard to disagree with Paul Tucker of the Bank of England, who has written that: “Those who most espouse the disciplines of capitalism—bankers and financiers—should live by them.”

The problem of banks being “too big to fail” is being addressed, albeit slowly, by the higher capital ratios being imposed by regulators. Higher capital ratios should mean lower returns on equity; over time, this should lead to less rapid pay growth for bankers. Andrew Haldane, a colleague of Mr Tucker’s, has found that the pay of bank bosses correlated well with returns on equity, but not with returns on assets—in other words, managers prospered by gearing up bank balance-sheets. That is now harder to pull off.

The finance sector has also, in some people’s eyes, had a pernicious effect on politics. Like any other interest group, the industry lobbied on its own behalf and achieved some notable regulatory gains in the 1980s and 1990s, such as the abolition in America of the old Glass-Steagall divide between investment and commercial banking. Its doyens have gained powerful positions in government, although this may be down to the modern assumption that if people are rich they must be smart.

But this influence did not stop Congress passing the Dodd-Frank act, has yet to stop Britain’s planned divide between commercial and investment banking, and has not held up a host of new EU regulations. This suggests that democracy can overcome vested financial interest. Indeed, there are plenty of votes in bashing bankers, as Mr Hollande is only too aware.

The third political beef is a very longstanding complaint: recall, for example, Harold Wilson, a former British prime minister, and his rants about the “gnomes of Zurich” who were speculating against the pound. The German chancellor, Angela Merkel, called for “the primacy of politics over the markets” in 2010.

This seems an odd battle to fight. All euro-zone governments need to borrow money from the markets. The political message seems to be: “We hate private-sector creditors. We will penalise you by defaulting on your debts but not on debts to official creditors. We will endeavour to stop you protecting yourselves against our actions by making it difficult to collect on insurance in the credit-default-swaps market. Now, can we please borrow some money at a very cheap rate?”

The underlying complaint is that speculators drive up bond yields, making it harder for governments to finance themselves. As a result governments are forced into austerity programmes, against the wishes of their electors.

Yet the same markets are more than willing to lend money to governments in America, Britain and Germany at negative real (ie, after inflation) rates. This may be down to the influence of other buyers—central banks, commercial banks, pension funds—who are not that interested in maximising their return.

That suggests the problem might not be with the markets after all. What happens to countries like Greece which lose access to private-sector finance? They become dependent on the largesse of official creditors—the International Monetary Fund, the European Central Bank, other EU nations—which can be even more stringent in demanding austerity programmes. After a few bouts with the ECB, the 57-year-old Mr Hollande may end up wishing that his planned retirement age of 60 also applied to presidents.

OUR IGNORANCE WILL YIELD MORE CRISIS IN CAPITALISM / THE FINANCIAL TIMES COMMENT & ANALYSIS ( VERY HIGHLY RECOMMENDED READING )

2012-02-03T04:14:00.002-05:00

February 1, 2012 7:36 pm

Our ignorance will yield more crises in capitalism

By Kenneth Rogoff

Over the past three weeks, contributors to these pages have engaged in a vigorous debate on the merits of contemporary capitalism. Entrepreneurs who have earned billions, world leaders who have spent trillions, journalists, academics, and even “Occupiers” have all weighed in. A few clear themes have emerged, highlighting points of agreement and controversy.

Virtually everyone defends the market system, albeit some with more unvarnished enthusiasm than others. Failures in financial regulation, environmental and consumer protection, and particularly in regulating income distribution, are all emphasised.

Bill Clinton, former US President rightly argues that markets can be made to work better for charity as well as production. Economist Jeffrey Sachs points to addictive consumer behaviour as a central flaw in today’s growth dynamic, a point with which I strongly agree.

Occupy London argues that regardless of overall income level, higher levels of inequality breed social ills, a very plausible conjecture. But no one is seriously arguing against markets; only for regulating them more effectively and more fairly.

The general enthusiasm for economic markets does not extend to political markets. It is striking that both George Osborne, UK chancellor, and Ed Miliband, leader of the Labour party, highlight short-termism in politics as a key flaw. Although the two politicians highlight problems in financial policies, their arguments could well be extended to a host of other areas, ranging from global warming to world food production. The purchase of influence is hardly unique to the financial industry.

Nor is the problem of excessive political influence by business unique to developed countries. Perhaps China’s greatest challenge in the decades ahead will be to shift away from an investment and export-driven development model to a world in which domestic consumers adjudicate the competition between China’s producers. As China grows it must shift to a domestic-demand driven model where it will be much harder to resist internal political pressures to interfere with competition. The idea that Chinese capitalism, which is evolving and transitional, provides a blueprint for the rest of the world, is an absurd exaggeration. Creating impressive infrastructure eventually runs into diminishing returns, as evidenced by the history of Japan and the Soviet Union.

As Martin Wolf points out, contemporary capitalism, which does such an extraordinary job of generating a cornucopia of private goods, is far less effective at generating public goods, whether it be education, infrastructure, environment or financial stability. Improving political markets – and as a corollary, regulation – is a central challenge facing all countries in the world, not just those in the west.

Europe, along with countries such as Canada, has arguably done a better job balancing public and private goods than either the US or China. Governments at least pay some attention to pollution. For the moment, Europe still has a reasonably strong social safety net. Mass transit systems work, at least when the employees are not on strike. Indeed, many countries around the world look to the Nordic model, which at least according to a variety of surveys produces some of the highest happiness levels in the world. In Europe, of course, the big challenge is dealing with overly generous pension schemes and insufficiently flexible labour markets in the face of the rapid changes emanating from globalisation.

How to strike a balance? One absolutely essential prerequisite is emphasised in Adam Smith’s letter to the Financial Times (as imagined by David Rubenstein): educate, educate, educate. It is really hard to see another way out of the growing sustainability problems that capitalism has given us. Mr Rubenstein focuses on the inadequacies of primary and secondary education, as well as the need to re-educate and retrain adults.

I would take the point much further: Societies need to find ways to make adult education, including economic and financial literacy, far more available and far more compelling. If voters are uninformed and easily swayed towards demagogues peddling short-term ill-considered policies, there is little hope for righting the course of capitalist economies.

The idea that the masses are indifferent to education, and that any broader notion of literacy beyond the three R’s (reading, writing and arithmetic) is a hopeless cause, is nonsense. As someone who has spoken to all kinds of people in the wake of the financial crisis, my sense is that most citizens are starved of information, and would consume it hungrily if offered in a palatable form.

One must admit that followers of the recent political debate in the United States might feel justified in being supremely cynical. But perhaps today’s errant political dialogue is only a symptom of a profound deeper failure of modern societies to pay attention to ongoing adult education and literacy.

Without major changes, including attractive web learning platforms, expanded public radio and television, and greater educational choice for children, it is hard to see a long-term cure for contemporary capitalism’s many political problems. Improved education alone will not resolve the flaws inherent in today’s capitalism, but it is an essential first step down any path to a solution.

The writer is professor of economics at Harvard University and co-author with Carmen Reinhart of ‘This Time is Different’

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Copyright The Financial Times Limited 2012

BEING A CATHOLIC PRIEST -- AND MARRIED / THE WALL STREET JOURNAL OP EDITORIAL ( RECOMMENDED READING )

2012-02-03T04:13:00.001-05:00

HOUSES OF WORSHIP

FEBRUARY 3, 2012

Being a Catholic Priest—and Married

The pope has created a new diocese for bringing Episcopalians into the church.
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By RICHARD CIPOLLA

Last month, Pope Benedict announced the formation of an American "ordinariate," or special diocese for Episcopal congregations that want to move to Roman Catholicism (driven largely by Episcopalianism's liberal drift). These congregations, the pope ruled, could keep some of their Anglican liturgy. More significantly, a small but sizable number of married Episcopal priests will now become married Catholic priests.

As a married Catholic priest ordained in 1984 under a special provision set forth by Pope John Paul II (for individual priests, judged on an individual basis), I have closely followed Pope Benedict's announcement. I rejoice in this catholic and generous gesture by the pope and am overjoyed that these priests and their families will be welcomed into the Catholic Church. But that is not to say it won't bring its own share of challenges.

My experience as a married Catholic priest for 28 years brings to mind several thoughts, both practical and spiritual. First, the church must support new priests' families financially.

During my first years as a married Catholic priest, there were times when we could not pay the heating bill. When I was ordained, it was made quite clear to me that I should not look to the church as my main source of income but rather to a full-time job outside of the church. My parish duties have thus always been secondary.

Getty Images

Secondly, the new priests must be prepared for the spiritual struggles that come with the territory of being a married priest in the Catholic Church. It is difficult for children of priests to hear everyone call their father, "Father." It is one of my regrets that I could never be a "normal Dad" who was able to attend school functions and sporting events. Priests' wives often bear the brunt of this special status, for they must allow their husbands to be "priest" at a real cost to themselves and their children.

Through the years, I have been the object of a few snide remarks by clergy. There have been uncomfortable confrontations with some who are more traditional than the Tradition. But for the most part, my priesthood and ministry in the Catholic Church have been a source of great joy and grace.

The married priest is not spared the sacrifice that is at the heart of the priesthood. That sacrifice comes not from the vow of celibacy. It comes from what is given up as husband and father for the sake of Christ's church.

Sacrifice is at the heart not only of the priestly life but also of the life of every Catholic. How could it not be so when the primary symbol of our faith is the love of God displayed on the cross of Jesus Christ?

Despite my situation—which is similar to that of other married clergy who have entered the Catholic ranks since the 1980s—I am a firm supporter of the celibacy of the Catholic clergy. Its basis is not found in councils or popes but rather in the person of Jesus Christ. The heart of the Catholic priesthood is sacrifice, and celibacy, in imitation of Christ, frees the priest to give himself totally to the church and its people.

Though many priests do live this life of sacrifice, it is also obvious that celibacy is used by all too many priests to live a life that is selfish and closed off. The sexual scandals of the past decade are a glaring example of the perversion of celibacy.

And the very structures of a parish priest's life often prevent him from achieving the freedom that should be the fruit of celibacy. The lack of deep spiritual friendship between priests; the unreal world they inhabit, at least from the viewpoint of a typical American family; the careerism that is the noxious fruit of the bureaucratic world of the chancery—all this works against the priest using his celibacy to be free for his people.

Reform of the priesthood is sorely needed today. The answer is not married priests. The answer is priests who understand the sacrifice that is at the center of their lives—whether they are married or not.

Father Cipolla is the chair of the classics department at Brunswick School in Greenwich, Conn., and a parochial vicar at St. Mary's Church in Norwalk, Conn.

WHERE IS THE UPRISING FROM THE LEFT / DER SPIEGEL ( A MUST READ )

2012-02-02T04:18:00.002-05:00

02/01/2012 11:03 AM

.SPIEGEL Interview with Francis Fukuyama

.'Where Is the Uprising from the Left?'

Political scientist Francis Fukuyama was once the darling of American neo-conservatives. In a SPIEGEL interview, the author of "The End of History" explains why he now believes that the excesses of capitalism are a threat to democracy and asks why there is no "Tea Party on the left."

SPIEGEL: Professor Fukuyama, you are best known for your essay "The End of History," in which you declared that, after the demise of the Soviet Union, liberal democracy had emerged as the triumphant global model. Now, your latest research claims that the flaws of capitalism and globalization could endanger this democratic model. How do you explain this shift?

Fukuyama: Capitalism is the wrong word to use here, because there is not a viable alternative to capitalism. What we are really talking about is just economic growth and the development of modern economic societies. A combination of factors is beginning to challenge their progress in the United States. We have had a lot of technological change that substituted for low-skill labor and made many people in Western democracies lose their jobs.

SPIEGEL: Which is why countries such as the United States or Britain wanted to turn themselves into "service-oriented" economies.

Fukuyama: We have unthinkingly embraced a certain version of globalization that assumed we had to move very quickly into this post-industrial, post-manufacturing world. Doing so, we forgot that the whole reason real socialism never took off in the US was the fact that the modern economy seemed to produce middle-class societies in which the bulk of the population could enjoy a middle-class status. They worked in industries that were abolished in our countries and transferred to countries like China.

SPIEGEL: Even if members of the middle class held on to their jobs, they saw their income stagnate or even decline, while a few of globalization's winners at the top reaped outsize rewards. The level of income inequality in advanced nations is greater than ever before. What effect does that have on our societies?

Fukuyama: It is not good for democracy. If income is relatively evenly distributed and there are not very sharp differences between rich and poor, you have a greater sense of community. You have a greater sense of trust. You do not have parts of the community that have superior access to the political system that they can use to advance their own interests ...

SPIEGEL: … all of which undermines the democratic process.

Fukuyama: What you are going to see in a democracy with a weaker middle class is much more populism, more internal conflict, an inability to resolve distributional issues in an orderly way. In the United States right now, you do have this return of populism. It should be on the left, but actually most of it is on the right. If you talk to Tea Party members about their feelings regarding the government, they are very passionate. They hate the government. They think they have been betrayed by elites.

SPIEGEL: Americans, however, are beginning to discuss the problem of social inequality much more openly.

Fukuyama: They are slowly beginning to realize it. The recent public focus on inequality and the Occupy Wall Street movement are harbingers of change in that direction. The trouble is that in the United States it is extremely difficult to mobilize people around pure class issues. President Barack Obama was ostracized as a "European socialist" when he brought up the idea of higher taxes on the rich. These class debates are historically unpopular -- except for a very brief period in the 1930s during the Great Depression.

SPIEGEL: The latest financial crisis was often compared to the Great Depression: Why did we not see another case of the left wing rising up against the rich?

Fukuyama: I am at a loss, too. Where is this uprising from the left? This is a crisis that began on Wall Street. It really was rooted in the particular American model of liberalized finance. It hurt ordinary people tremendously, and it benefited the richest part of the country -- the finance sector -- which came through the crisis very well, thanks to government bailouts. You would have thought that this would pave the way for a rise of left-wing populism as seen in the 1930s. A Tea Party on the left, so to speak.

SPIEGEL: Could the Occupy Wall Street movement fill this void on the left?

Fukuyama: I really do not take this movement seriously, because its social base is extremely narrow. It consists mostly of the same kids that were protesting in 1999 in Seattle against the World Trade Organization -- anti-capitalists. The big problem sociologically for the left in the United States is that the white working class and lower middle class, that in Europe would be reliably social democratic in their political behavior, tends to vote Republican or is easily brought into the Republican camp. Until the Occupy Wall Street people can connect up with that demographic group, there is not going to be a big left-wing populist base of support in the US.

SPIEGEL: Has the crisis simply not been deep enough to achieve that?

Fukuyama: Ironically, because the Federal Reserve and the US Treasury acted to support the financial sector, the crisis did not develop into a deep depression with unemployment up to 20 percent like in the 1930s. Back then, President Franklin D. Roosevelt could restructure the big banks. I believe that the only solution to our current problems is to restructure all these big banks, Goldman Sachs and Citigroup and Bank of America, and turn them into smaller entities that could then be allowed to go bankrupt. They would no longer be "too big to fail." But this has not happened so far.

SPIEGEL: One could also make the case that President Obama was simply not as tough as Roosevelt.

Fukuyama: Obama had a big opportunity right at the middle of the crisis. That was around the time Newsweek carried the title: "We Are All Socialists Now." Obama's team could have nationalized the banks and then sold them off piecemeal. But their whole view of what is possible and desirable is still very much shaped by the needs of these big banks.

SPIEGEL: In other words, Obama and his influential advisors, like Treasury Secretary Timothy Geithner, are themselves part of the "1 percent" that the Occupy Wall Street movement rails against.

Fukuyama: They are obviously part of the 1 percent. They socialize with these Wall Street gurus. Goldman Sachs boss Lloyd Blankfein met with Geithner many times during the crisis. Such close contact clearly influences the world view of the White House.

SPIEGEL: But would you seriously argue that Republicans are any less close to Wall Street?

Fukuyama: Oh no. Republican politicians are completely bought by Wall Street. But the real question is: Why do their working class supporters continue to vote for them? My explanation is partly this deep distrust of any form of government that goes back very far in American politics, and is today reflected in political figures like Sarah Palin, which holds against Obama primarily the fact that he went to Harvard. There is a kind of populist resentment in US politics against being ruled by elites.

SPIEGEL: Even the Tea Party movement is largely financed by billionaires who represent everything regular Tea Party members are opposed to.

'Tea Party Activists Mobilize Against Their Own Economic Interests'

Fukuyama: The Tea Party is a genuine grassroots movement, so I do not buy into these conspiracy theories that rich billionaires initiated it. When you go to one of these rallies of Ron Paul supporters, they are very passionate. They all tend to be young, and they have just got this libertarian idea in their minds that the government is really the source of all of our problems. So I think the convictions of Tea Party activists are sincere, they are not manipulated by billionaires. But it is true that they mobilize against their own economic interests and for the interests of elites they should despise. I still do not fully understand why they do that.

SPIEGEL: Why can't Obama reach these frustrated people?

Fukuyama: The president never annunciated a vision of a different kind of economic order that did not just look like a return to a kind of classic big spending, liberal Democratic formula. The Democrats have never articulated an economic philosophy that is not just the return to the 1970s, big government and so forth, or the position of the labor unions which is very hostile to globalization.

SPIEGEL: What else should he do?

Fukuyama: I actually think that the German model should be a very interesting one from an American perspective, because Germany is still the second-largest exporter, but has done a much better job in protecting its manufacturing base and its working class compared to the United States. Somebody needs to articulate a strategy in the US that will say our goal is not to maximize aggregate income. It is to protect the middle class through an engagement with the world with globalization, but one that benefits the broad mass of people. No Democrat has really been able to do this.

SPIEGEL: Do you want the American left to draw lessons from former German Chancellor Gerhard Schröder's "Agenda 2010," a controversial package of labor and welfare reforms which overturned the classic social democratic model?

Fukuyama: What the Social Democrats in Germany have done is increase the degree of flexibility in labor markets and make the German welfare state more friendly to capitalist competition. The old traditional agenda that we are just going to have more and more social protection no longer rules in Germany, and that is a good thing. Part of the problem in Europe is that similar reforms have not happened in France and Italy.

SPIEGEL: Would that protection of the middle class include a new form of global protectionism?

Fukuyama: We should never have permitted the Chinese to deindustrialize a large part of the world. The Chinese have managed to play one Western country against another, stealing their technology basically. They succeeded because everybody in the West has got this short-term view saying: "I may be clobbered by the Chinese down the road, but if I do not make my money now, somebody else will get in. So I make business with them even if they rip me off." This view is very short-sighted. We should have been much tougher with China.

SPIEGEL: Could that trend still be reversed?

Fukuyama: It is too late, at least in the United States. We have lost all crucial manufacturing industries to China.

SPIEGEL: A feeling of helplessness also prevails in Europe. Every time EU politicians try to present new solutions to the euro crisis, they fail to convince the financial players around the world. Is political leadership still possible, given the outsize power of global financial markets?

Fukuyama: The political leadership problem stems not simply from the pressure by the markets. All modern democracies have a disease, which is that the democratic process tends to be captured by well-organized groups that are not representative of the general public. This is the whole problem with Greece. The pharmacists and the doctors and the civil servants and the architects, and every other social group in that country, has organized itself into a closed corporation that controls prices while largely avoiding taxation. They make a fortune, but the national bankruptcy is bound to happen.

SPIEGEL: Unelected technocrats and advisers from outside are now being brought in to reform the Greek system. What does that mean for democracy?

Fukuyama: If I had to bet my own money on this, Greece is going to leave the euro, because ultimately any outside intervention is going to be regarded by the Greek public as a non-democratic imposition of policies that they do not want. Greeks are just never going to behave like Germans, right?

SPIEGEL: Can Europe, in its desperate attempts to rescue the euro, still be democratic?

Fukuyama: The entire European project was very elite-driven from the beginning. The evidence of this was every time a country held a referendum where they voted against signing on to further EU regulation ...

SPIEGEL: ... that referendum was simply repeated.

Fukuyama: The EU elites said: "Oh, you just got it wrong this time. We will keep voting until you get it right." Virtually every European country now has got a right-wing populist party. They are anti-EU, anti-immigrant, and it has exactly the same cause, because there is a perception that the elites in Europe do not really address their issues.

SPIEGEL: Authoritarian systems, on the other hand, appear to be getting more and more popular. When German businesspeople travel to communist China, for example, they are enamored with the system there. They rave about how quickly important decisions can be made.

Fukuyama: I hear that from American businesspeople too. The Chinese system is particularly striking when you contrast it with Europe and the United States where you currently just cannot get a decision made.

SPIEGEL: So authoritarian China will emerge as the new global model -- which would totally contradict your thesis from "The End of History" that democracy has become the default option around the world.

Fukuyama: No. China is never going to be a global model. Our current Western system is really broken in some fundamental ways, but the Chinese system is not going to work either. It is a deeply unfair and immoral system where everything can be taken away from anyone in a split second, where people die in train accidents because of a rampant lack of public oversight and transparency, where corruption rules. We are already seeing huge protests in all parts of China ...

SPIEGEL: ... which Communist Party officials fear are reminiscent of the Arab Spring.

Fukuyama: When its leadership stops delivering the current level of economic growth, it has got this huge moral vulnerability. Liberal democracy still really is the only game in town worldwide, in spite of all of its shortcomings.

SPIEGEL: Professor Fukuyama, we thank you for this interview.

Interview conducted by Hans Hoyng and Gregor Peter Schmitz

BILL GROSS EXPLAINS WHY " WE ARE WITHNESSING THE DEATH OF ABUNDANCE" AND WHY GOLD IS BECOMING THE DEFAULT "STORE OF VALUE" / ZERO HEDGE ( A MUST READ )

2012-02-02T04:17:00.003-05:00

Bill Gross Explains Why "We Are Witnessing The Death Of Abundance" And Why Gold Is Becoming The Default "Store Of Value"
.
Submitted by Tyler Durden
.
on 02/01/2012 08:44 -0500

While sounding just a tad preachy in his February newsletter, Bill Gross' latest summary piece on the economy, on the Fed's forray into infinite ZIRP, into maturity transformation, and the lack thereof, on the Fed's massive blunder in treating the liquidity trap, but most importantly on what the transition from a levering to delevering global economy means, is a must read. First: on the fatal flaw in the Fed's plan: "when rational or irrational fear persuades an investor to be more concerned about the return of her money than on her money then liquidity can be trapped in a mattress, a bank account or a five basis point Treasury bill. But that commonsensical observation is well known to Fed policymakers, economic historians and certainly citizens on Main Street." And secondly, here is why the party is over: "Where does credit go when it dies? It goes back to where it came from. It delevers, it slows and inhibits economic growth, and it turns economic theory upside down, ultimately challenging the wisdom of policymakers. We’ll all be making this up as we go along for what may seem like an eternity. A 30-50 year virtuous cycle of credit expansion which has produced outsize paranormal returns for financial assets – bonds, stocks, real estate and commodities alike – is now delevering because of excessive “risk” and the “price” of money at the zero-bound. We are witnessing the death of abundance and the borning of austerity, for what may be a long, long time." Yet most troubling is that even Gross, a long-time member of the status quo, now sees what has been obvious only to fringe blogs for years: "Recent central bank behavior, including that of the U.S. Fed, provides assurances that short and intermediate yields will not change, and therefore bond prices are not likely threatened on the downside. Still, zero-bound money may kill as opposed to create credit. Developed economies where these low yields reside may suffer accordingly. It may as well, induce inflationary distortions that give a rise to commodities and gold as store of value alternatives when there is little value left in paper." Let that sink in for a second, and let it further sink in what happens when $1.3 trillion Pimco decides to open a gold fund. Physical preferably...

From PIMCO's Bill Gross:

Life – and Death Proposition

Recent central bank behavior, including that of the U.S. Fed, provides assurances that short and intermediate yields will not change, and therefore bond prices are not likely threatened on the downside.

Most short to intermediate Treasury yields are dangerously close to the zero-bound which imply limited potential room, if any, for price appreciation.

We can’t put $100 trillion of credit in a system-wide mattress, but we can move in that direction by delevering and refusing to extend maturities and duration.

Where do we go when we die?
We go back to where we came from
And where was that?
I don’t know, I can’t remember
Virginia Woolf, “The Hours”

I don’t remember much of this life, and like Virginia Woolf, nothing of the herebefore. How then, could I expect to know of the hereafter? I know at least that we all exist at and of the moment and that we make up those moments as we go along. I became a grandfather for the first time a few months ago and proud son Jeff asked for some fatherly advice as to how to go about raising his baby daughter Caroline. “We all do it in our own way, Jeff, you’ll make it up as you go along,” I said. Parenting, and life itself, is one giant experiment. From those first infant steps, to adolescent peer testing, flying from and departing the parental nest, gene replication and family building of our own, maturity and acquiescence, aging, decay and inevitable death – we experiment as best we can and make it up as we go along.

That death part though, oh where do we go after we have done all the making? There was another Jeff in our family, beloved brother-in-law Jeff Stubban who was as kind a man as there ever could be. Dying within three months of an initial diagnosis of pancreatic cancer, our family sobbed uncontrollably at his bedside as his breath, his spirit, his soul, departed almost on cue while a priest recited the rosary. Where had he gone, where is he now, what will become of him and all of us? Like many grieving families we look for signs of him and in turn for clues to our own destination. A lucky penny in the street, a random mention of his beloved New Orleans, an exterior resemblance of his shiny bald head in a mingling crowd. Where are you, Jeff? Tell us you are safe so that we might meet again.

Having now matured to trust reason more than faith I offer not so much a resolution, but an alternative to the unanswerable question of Virginia Woolf and the departed souls of Jeff Stubban and billions of others. If we don’t meet again – up there – then perhaps we’ll meet once more – down here. After all, the one thing I know for sure is that we got here once – and because we did, we could do it again. Rest easy, dear Jeff, and welcome to this world, dear Caroline. We’ll all just have to make it up as we go along.

The transition from a levering, asset-inflating secular economy to a post bubble delevering era may be as difficult for one to imagine as our departure into the hereafter. A multitude of liability structures dependent on a certain level of nominal GDP growth require just that – nominal GDP growth with a little bit of inflation, a little bit of growth which in combination justify embedded costs of debt or liability structures that minimize the haircutting of or defaulting on prior debt commitments. Global central bank monetary policy – whether explicitly communicated or not – is now geared to keeping nominal GDP close to historical levels as is fiscal deficit spending that substitutes for a delevering private sector.

Yet the imagination and management of the transition ushers forth a plethora of disparate policy solutions. Most observers, however, would agree that monetary and fiscal excesses carry with them explicit costs. Letting your pet retriever roam the woods might do wonders for his “animal spirits,” for instance, but he could come back infested with fleas, ticks, leeches or worse.

Fed Chairman Ben Bernanke, dog-lover or not, preannounced an awareness of the deleterious side effects of quantitative easing several years ago in a significant speech at Jackson Hole. Ever since, he has been open and honest about the drawbacks of a zero interest rate policy, but has plowed ahead and unleashed his “QE bowser” into the wild with the understanding that the negative consequences of not doing so would be far worse. At his November 2011 post-FOMC news briefing, for instance, he noted that “we are quite aware that very low interest rates, particularly for a protracted period, do have costs for a lot of people” – savers, pension funds, insurance companies and finance-based institutions among them. He countered though that “there is a greater good here, which is the health and recovery of the U.S. economy, and for that purpose we’ve been keeping monetary policy conditions accommodative.”

My goal in this Investment Outlook is not to pick a “doggie bone” with the Chairman. He is makin’ it up as he goes along in order to softly delever a credit-based financial system which became egregiously overlevered and assumed far too much risk long before his watch began. My intent really is to alert you, the reader, to the significant costs that may be ahead for a global economy and financial marketplace still functioning under the assumption that cheap and abundant central bank credit is always a positive dynamic. When interest rates approach the zero bound they may transition from historically stimulative to potentially destimulative/regressive influences. Much like the laws of physics change from the world of Newtonian large objects to the world of quantum Einsteinian dynamics, so too might low interest rates at the zero-bound reorient previously held models that justified the stimulative effects of lower and lower yields on asset prices and the real economy.

It is instructive to mention that this is not necessarily PIMCO’s view alone. Chairman Bernanke and Fed staff members have been sniffin’ this trail like the good hound dogs they are for some time now. In addition, Credit Suisse, in their “2012 Global Outlook,” devoted considerable pages to specifics of zero-based money with commonsensical historical comparisons to Japan over the past decade or so.

The following pages of this Outlook will do the same. At the heart of the theory, however, is that zero-bound interest rates do not always and necessarily force investors to take more risk by purchasing stocks or real estate, to cite the classic central bank thesis. First of all, when rational or irrational fear persuades an investor to be more concerned about the return of her money than on her money then liquidity can be trapped in a mattress, a bank account or a five basis point Treasury bill. But that commonsensical observation is well known to Fed policymakers, economic historians and certainly citizens on Main Street.

What perhaps is not so often recognized is that liquidity can be trapped by the “price” of credit, in addition to its “risk.” Capitalism depends on risk-taking in several forms. Developers, homeowners, entrepreneurs of all shapes and sizes epitomize the riskiness of business building via equity and credit risk extension. But modern capitalism is dependent as well on maturity extension in credit markets. No venture, aside from one financed with 100% owners’ capital, could survive on credit or loans that matured or were callable overnight.

Buildings, utilities and homes require 20- and 30-year loan commitments to smooth and justify their returns. Because this is so, lenders require a yield premium, expressed as a positively sloped yield curve, to make the extended loan. A flat yield curve, in contrast, is a disincentive for lenders to lend unless there is sufficient downside room for yields to fall and provide bond market capital gains. This nominal or even real interest rate “margin” is why prior cyclical periods of curve flatness or even inversion have been successfully followed by economic expansions. Intermediate and long rates – even though flat and equal to a short-term policy rate – have had room to fall, and credit therefore has not been trapped by “price.”

When all yields approach the zero-bound, however, as in Japan for the past 10 years, and now in the U.S. and selected “clean dirty shirt” sovereigns, then the dynamics may change. Money can become less liquid and frozen by “price” in addition to the classic liquidity trap explained by “risk.”

Even if nodding in agreement, an observer might immediately comment that today’s yield curve is anything but flat and that might be true. Most short to intermediate Treasury yields, however, are dangerously close to the zero-bound which imply little if any room to fall: no margin, no air underneath those bond yields and therefore limited, if any, price appreciation. What incentive does a bank have to buy two-year Treasuries at 20 basis points when they can park overnight reserves with the Fed at 25? What incentives do investment managers or even individual investors have to take price risk with a five-, 10- or 30-year Treasury when there are multiples of downside price risk compared to appreciation? At 75 basis points, a five-year Treasury can only rationally appreciate by two more points, but theoretically can go down by an unlimited amount. Duration risk and flatness at the zero-bound, to make the simple point, can freeze and trap liquidity by convincing investors to hold cash as opposed to extend credit.

Where else can one go, however? We can’t put $100 trillion of credit in a system-wide mattress, can we? Of course not, but we can move in that direction by delevering and refusing to extend maturities and duration. Recent central bank behavior, including that of the U.S. Fed, provides assurances that short and intermediate yields will not change, and therefore bond prices are not likely threatened on the downside. Still, zero-bound money may kill as opposed to create credit. Developed economies where these low yields reside may suffer accordingly. It may as well, induce inflationary distortions that give a rise to commodities and gold as store of value alternatives when there is little value left in paper.

Where does credit go when it dies? It goes back to where it came from. It delevers, it slows and inhibits economic growth, and it turns economic theory upside down, ultimately challenging the wisdom of policymakers. We’ll all be making this up as we go along for what may seem like an eternity. A 30-50 year virtuous cycle of credit expansion which has produced outsize paranormal returns for financial assets – bonds, stocks, real estate and commodities alike – is now delevering because of excessive “risk” and the “price” of money at the zero-bound. We are witnessing the death of abundance and the borning of austerity, for what may be a long, long time.

$5 TRILLION AND CHANGE / THE WALL STREET JOURNAL REVIEW & OUTLOOK ( A MUST READ )

2012-02-02T04:16:00.002-05:00

REVIEW & OUTLOOK

FEBRUARY 1, 2012

$5 Trillion and Change

Obama's four years have seen the four highest deficits since 1946.

The political strategy behind Obamanomics was always simple: Call for "stimulus" to rescue the economy, run up the debt with the biggest spending blitz in 60 years, and then when the deficit explodes call for higher taxes. The Congressional Budget Office annual review released yesterday shows this is all on track.

CBO reports that annual spending over the Obama era has climbed to a projected $3.6 trillion this fiscal year from $2.98 trillion in fiscal 2008, or more than 20%. The government spending burden has averaged 24% of GDP, up from an average of about 20%. This doesn't include the $2 trillion tab for ObamaCare.

All of this has increased the federal debt by about $5 trillion in a mere four years. Thanks to higher revenues, the federal deficit will decline to $1.08 trillion in 2012, or 7% of GDP. But that is still the highest deficit since 1946—except for the previous three years. In other words, the four years of the Obama's Presidency will mark the four highest years in spending and deficits as a share of the economy since Harry Truman sat in the Oval Office.

EPA

And don't forget the national debt held by the public—the kind we have to pay back. On President Obama's watch, CBO says public debt will climb this year to 72.5% of the economy from 40.3% in 2008. This isn't as high as Italy or Greece, but it's rising fast toward the 90% level that begins to debilitate an economy.

We pause from this gloom for some good news: Despite the abuse they've taken, House Republicans have made some fiscal progress. CBO estimates that overall federal spending in 2012 will grow by only $3 billion, or less than 1%, which compares with double digit increases during the Obama-Pelosi years. Republicans have also tried to reform entitlements, but Democrats wanted a $1 trillion tax hike ransom for even modest cuts, which was wisely rejected.

The other part of the fiscal story is that revenues have been in the tank for five years. In 2012 revenues will hit $2.52 trillion down from $2.57 trillion in 2007. Revenues are still only 16.3% of GDP, about two percentage points below the norm.

The drought has two main causes. First, the anemic recovery in jobs and investment isn't spinning off enough new output (1.7% growth last year) to boost tax receipts anywhere near their historic level.
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Second, a series of non-stimulative tax cuts—tax rebates in 2008 and 2009, and payroll tax holidays in 2011 and this year—have depleted the Treasury with little economic benefit. These tax cuts don't change the incentive at the margin to work or invest, and they thus have little feedback effect in revenues from faster growth.

The most amusing part of the CBO's report is its projection that the deficit will fall to $269 billion by 2015, or a mere 1.5% of GDP, if current law holds. But this is a fiscal fantasy because current law never holds.

CBO predicts, for example, that all the Bush tax cuts will go away next year. The Alternative Minimum Tax will supposedly be allowed to hit 30 million tax filers (up from four million now) with an income as low as $75,000 a year. Under those assumptions total federal revenues rise by $1 trillion over the next three years, $1.5 trillion over five years, and $3.6 trillion over 10 years. You can't get anywhere near that level of revenues without a much bigger tax increase on the rich and the middle class, or an extended boom in the range of 5% to 6% annual growth.

Even the Keynesians who run CBO concede that the 2013 tax hike—on capital gains, dividends, estates and small business—would knock economic growth down to 1% next year and raise unemployment to 9.1% (from 8.5%). That means about 750,000 more jobless Americans. You can't have such a lousy economy and cut the deficit in half.

CBO also indulges in the fantasy that discretionary spending will fall by nearly $2 trillion over the next decade—with almost all the cuts after 2015. About $1.25 trillion of those cuts come from the automatic across-the-board reductions that Congress and Mr. Obama agreed to last year. But wait. More than half of those cuts will come from the military budget and even Defense Secretary Leon Panetta has said these reductions could be "devastating" to national security.

To sum it all up, CBO's facts plainly show that Mr. Obama has the worst fiscal record of any President in modern times. No one else is even close.

SURVEY OF BANKS SHOWS A SHARP CUT IN LENDING IN EUROPE / THE NEW YORK TIMES ( VERY HIGHLY RECOMMENDED READING )

2012-02-02T04:15:00.004-05:00

February 1, 2012

Survey of Banks Shows a Sharp Cut in Lending in Europe

By JACK EWING

FRANKFURT — Banks in the euro area cut lending sharply at the end of 2011, according to data published Wednesday, raising concern that Europe was on the verge of a credit crisis that could lead to a deeper recession than expected.

A quarterly survey of commercial banks by the European Central Bank showed a surge in the number of institutions that were becoming more restrictive about who they lent to, because the banks themselves were having trouble raising money and were under pressure from regulators to reduce risk.

The survey, which covered the last three months of 2011, provided more evidence of the harmful effect that the sovereign debt crisis was having on the banking system. It also somewhat validated the European Central Bank policy of providing big emergency loans to euro area banks in an attempt to stave off a full-blown lending drought.

“A credit crunch would tip the euro zone back into a severe recession,” Marie Diron, an economist who advises the consulting firm Ernst & Young, said in a statement.

There is also evidence that the problems in Western Europe are spilling over into the developing economies of Eastern Europe.

For example, lending to Poland from outside the country fell by $12 billion, the Bank for International Settlements in Basel, Switzerland, reported last week. The decline is surprising because Poland’s economy continues to grow briskly. It suggests that hard-pressed West European banks have started withholding resources from their subsidiaries in Eastern Europe.

“It is obvious that we see a deleveraging, a retrenching process unfolding,” Thomas Mirow, the president of the European Bank for Reconstruction and Development, said in an interview last week. He said the figures from the Bank for International Settlements showed “this is not just perception but reality.” The reconstruction bank provides credit to support the development of free markets in the former Soviet bloc.

In December, the European Central Bank radically expanded lending to euro area banks, providing 489 billion euros ($643 billion) at 1 percent interest for three years. Previously, the central bank offered loans for no more than about a year. That infusion of cash has been credited with easing the strain of the sovereign debt crisis.

It will offer another round of three-year loans at the end of this month, a move that analysts expect to further guard against a credit crisis. Still, some warned that the situation remained perilous.

“For the sovereign crisis to truly abate, we need to see that governments are able to deliver austerity, and the economies can still grow in the face of it,” Karen Ward, senior global economist at HSBC, wrote in a note to clients. It would be wrong to assume that the central bank lending was “a panacea for the euro zone sovereign crisis,” she wrote.

Banks tightened their lending standards for businesses as well as for individuals, according to the central bank. Of the banks surveyed, 35 percent said they were applying stricter criteria to business loans compared with 16 percent in the previous quarter. Banks also became more reluctant to provide mortgage loans. And they said they expected credit to become more scarce in months to come.

Germany was an exception. Lending there remained steady, according to separate data published Wednesday by the Bundesbank, the German central bank.

One reason banks in the euro area are reluctant to lend is that they have their own problems raising money. About half said they were still having trouble getting access to money markets, the central bank said. Funds in the United States and elsewhere that lend large sums to banks remain wary of the health of many euro area institutions because of their holdings of European government bonds.

The data may be seen as partly confirming complaints by banks that regulator pressure is raising the risk of a credit crisis. The European Banking Authority and national regulators are leaning on banks to increase their reserves and reduce risk. One way for banks to do so is to reduce lending.

A fifth of banks surveyed said that the need to raise their capital reserves had forced them to restrict lending. But twice that many banks said the flagging euro area economy was the main reason for tighter credit standards.

SUSTAINABLE HUMANITY / PROJECT SYNDICATE ( VERY HIGHLY RECOMMENDED READING )

2012-02-02T04:14:00.001-05:00

Sustainable Humanity

Jeffrey D. Sachs

2012-01-31
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ADDIS ABABA – Sustainable development means achieving economic growth that is widely shared and that protects the earth’s vital resources. Our current global economy, however, is not sustainable, with more than one billion people left behind by economic progress and the earth’s environment suffering terrible damage from human activity. Sustainable development requires mobilizing new technologies that are guided by shared social values.

United Nations Secretary-General Ban Ki-moon has rightly declared sustainable development to be at the top of the global agenda. We have entered a dangerous period in which a huge and growing population, combined with rapid economic growth, now threatens to have a catastrophic impact on the earth’s climate, biodiversity, and fresh-water supplies. Scientists call this new period the Anthropocene – in which human beings have become the main causes of the earth’s physical and biological changes.

The Secretary-General’s Global Sustainability Panel has issued a new report that outlines a framework for sustainable development. The GSP rightly notes that sustainable development has three pillars: ending extreme poverty; ensuring that prosperity is shared by all, including women, youth, and minorities; and protecting the natural environment. These can be termed the economic, social, and environmental pillars of sustainable development, or, more simply, the “triple bottom line” of sustainable development.

The GSP has called for world leaders to adopt a new set of Sustainable Development Goals, or SDGs, that will help to shape global policies and actions after the 2015 target date for achieving the Millennium Development Goals (MDGs). Whereas the MDGs focus on reducing extreme poverty, the SDGs will focus on all three pillars of sustainable development: ending extreme poverty, sharing the benefits of economic development for all of society, and protecting the Earth.

It is, of course, one thing to set SDGs and quite another to achieve them. The problem can be seen by looking at one key challenge: climate change. Today, there are seven billion people on the planet, and each one, on average, is responsible for the release each year of a bit more than four tons of carbon dioxide into the atmosphere. This CO2 is emitted when we burn coal, oil, and gas to produce electricity, drive our cars, or heat our homes. All told, humans emit roughly 30 billion tons of CO2 per year into the atmosphere, enough to change the climate sharply within a few decades.

By 2050, there will most likely be more than nine billion people. If these people are richer than people today (and therefore using more energy per person), total emissions worldwide could double or even triple. This is the great dilemma: we need to emit less CO2, but we are on a global path to emit much more.

We should care about that scenario, because remaining on a path of rising global emissions is almost certain to cause havoc and suffering for billions of people as they are hit by a torrent of droughts, heat waves, hurricanes, and more. We have already experienced the onset of this misery in recent years, with a spate of devastating famines, floods, and other climate-related disasters.

So, how can the world’s people – especially its poor people – benefit from more electricity and more access to modern transportation, but in a way that saves the planet rather than destroys it? The truth is that we can’t – unless we improve dramatically the technologies that we use.

We need to use energy far more wisely while shifting from fossil fuels to low-carbon energy sources. Such decisive improvements are certainly possible and economically realistic.

Consider the energy inefficiency of an automobile, for example. We currently move around 1,000 to 2,000 kilograms of machinery to transport only one or just a few people, each weighing perhaps 75 kilograms (165 lbs.). And we do so using an internal combustion engine that utilizes only a small part of the energy released by burning the gasoline. Most of the energy is lost as waste heat.

We could therefore achieve huge reductions in CO2 emissions by converting to small, lightweight, battery-powered vehicles running on highly efficient electric motors and charged by a low-carbon energy source such as solar power. Even better, by shifting to electric vehicles, we would be able to use cutting-edge information technology to make them smart – even smart enough to drive themselves using advanced data-processing and positioning systems.

The benefits of information and communications technologies can be found in every area of human activity: better farming using GPS and micro-dosing of fertilizers; precision manufacturing; buildings that know how to economize on energy use; and, of course, the transformative, distance-erasing power of the Internet. Mobile broadband is already connecting even the most distant villages in rural Africa and India, thereby cutting down significantly on the need for travel.

Banking is now done by phone, and so, too, is a growing range of medical diagnostics. Electronic books are beamed directly to handheld devices, without the need for bookshops, travel, and the pulp and paper of physical books.
Education is increasingly online as well, and will soon enable students everywhere to receive first-rate instruction at almost a zero “marginal” cost for enrolling another student.

Yet getting from here to sustainable development will not just be a matter of technology. It will also be a matter of market incentives, government regulations, and public support for research and development. But, even more fundamental than policies and governance will be the challenge of values. We must understand our shared fate, and embrace sustainable development as a common commitment to decency for all human beings, today and in the future.

Jeffrey D. Sachs is Professor of Economics and Director of the Earth Institute at Columbia University. He is also Special Adviser to United Nations Secretary-General on the Millennium Development Goals.

EUROPE IS STUCK ON LIFE SUPPORT / THE FINANCIAL TIMES COMMENT & ANALYSIS ( A MUST READ )

2012-02-01T04:18:00.001-05:00

January 31, 2012 6:42 pm

Europe is stuck on life support

By Martin Wolf

Economic decision-makers are more optimistic than two months ago. The main reason is the belief that the European Central Bank, under the shrewd leadership of Mario Draghi, has eliminated the risk of a financial implosion in the eurozone. As Mark Carney, the respected governor of the Bank of Canada and Mr Draghi’s successor at the Financial Stability Board, remarked at the World Economic Forum in Davos: “There is not going to be a Lehman-style event in Europe. That matters.”

Spreads on credit default swaps on Italian and Spanish banks have fallen since the introduction of the ECB’s three-year long-term refinancing operations in December. Spreads between yields on debt of some vulnerable sovereigns and German Bunds have also eased.

Does this mean the eurozone crisis is over? Absolutely not. The ECB has saved the eurozone from a heart attack. But its members face a long convalescence, made worse by the insistence that fiscal starvation is the right remedy for feeble patients.

Last week’s downgrading of its forecasts by the International Monetary Fund shows the dangers. The IMF now forecasts a recession in the eurozone this year, with a decline of 0.5 per cent in overall gross domestic product. GDP is forecast to fall sharply in Italy and Spain, and stagnate in France and Germany. This is a terrible environment for countries seeking to cut fiscal deficits. Forecasts are far from satisfactory for other high-income countries. But the eurozone is the most dangerous part of the world economy: only there do we see important governments – Italy and Spain – menaced by a loss of creditworthiness.

Elsewhere, governments of high-income countries can continue to support their economies, largely because they possess a central bank and an adjustable exchange rate. This combination has given them the ability to run large fiscal deficits. In post-crisis conditions, such deficits are both the natural counterpart and the principal facilitator of necessary private sector deleveraging.

The eurozone has no such internal mechanisms. When private external financing dried up, as happened to a number of countries, affected members needed both financing – in the short run – and a mechanism for adjusting their external accounts – in the longer run – other than via deep slumps. The eurozone lacks both capacities. It has turned out, as a result, to have limited ability to cope with the global financial disease. As Donald Tsang, chief executive of Hong Kong, remarked in Davos: “I have never been as scared as I am now.” Astute observers have a sense that little stands between them and a wave of sovereign and banking defaults inside the eurozone, with ghastly global repercussions.

The ECB has reduced the risk of an immediate collapse of the banking sector. But the demand of informed outsiders is for stronger firewalls against the possibility that a collapse of, say, Greece, perhaps including its exit from the eurozone, would lead to a panic over prospects for far more important countries. Christine Lagarde, managing director of the International Monetary Fund, made that one of her three imperatives, along with stronger growth and deeper integration, in a courageous speech in Berlin last week.

What these outsiders want to see is a commitment that vulnerable eurozone countries will be given the time and the treatment they need to recover. Naturally, they also want to see a commitment of resources by the eurozone that makes clear the determination of its members to secure this outcome.

Only then would it make sense for an enhanced IMF to add its own contribution. Why indeed should a relatively poor country, such as China, be expected to contribute to rescuing a eurozone that has shown little will or ability to heal itself?

Alas, the problem is not just one of will. It is one of a lack of a correct diagnosis. This is a problem the ECB cannot correct. Germany, as creditor country, opposes a “transfer union” and insists that fiscal discipline is everything. It is right on the first point and wrong on the second.

A long-term transfer of resources to uncompetitive members would be a disaster, enfeebling recipients and bankrupting providers. But fiscal indiscipline is not all. Just as it was not the dominant cause of the collapse, but rather sloppy lending and improvident private borrowing, so fiscal discipline is not the cure. This attempt to vindicate the catastrophic austerity of Heinrich Brüning, German chancellor in 1930-1932, is horrifying.

The perspective embodied in the fiscal compact– itself an attempt to revive the failed stability and growth pact – lacks the necessary understanding of the dependence of output in one member country on demand in others, of the role of payments imbalances and of the fact that competitiveness is always relative. If Italy and Spain are to become more competitive within the eurozone then Germany or the Netherlands must become less so.

Moreover, if the private sector is running a structural financial surplus to lower its debt, policymakers can eliminate structural fiscal deficits if and only if the country runs a structural current account surplus. Germany should understand this because that is precisely what it is doing. Countries hit by financial crises almost always have large structural private sector financial surpluses. If these countries are indeed to eliminate structural fiscal deficits, they, too, must run structural current account surpluses, just like Germany. Yet every country cannot run such surpluses, unless the eurozone as a whole is to do so.

It is impossible for individual countries to heal without offsetting changes elsewhere. As Ms Lagarde said in Berlin: “Resorting to across-the-board, across-the-continent, budgetary cuts will only add to recessionary pressures.” Fiscal tightening must be selective. More important, the indication that the adjustment process is working – so making unnecessary the long-term fiscal transfers Germany rightly detests – would be buoyant demand in the core of the eurozone, with inflation well above the eurozone average – a mirror image of what happened before the crisis.

The strongest note of optimism on the eurozone I heard in Davos rested on the dire results of a break-up. Yet desperate people do desperate deeds. Members now need the time and the opportunity to adjust. Strong firewalls should give the time, but only shifts in competitiveness will give the opportunity. Without both, the crisis will surely return.

THE CHANCELLOR WHO PLAYED WITH FIRE / PROJECT SYNDICATE ( A MUST READ )

2012-02-01T04:17:00.001-05:00

The Chancellor Who Played with Fire

Joschka Fischer

2012-01-31
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BERLIN – German Chancellor Angela Merkel should be happy nowadays: her party’s approval ratings aren’t bad, and her own are very good. She no longer has serious rivals within the center-right Christian Democratic Union (CDU), while the left opposition is fragmented into four parties. Her response to the European crisis has prevailed – or at least that is the impression that she conveys, and that most Germans believe. So everything is fine and dandy, right?

Not so fast. Two issues could complicate Merkel’s re-election bid in the autumn of 2013.

Domestically, her coalition partner, the liberal Free Democrats (FDP), is disintegrating. Even if the FDP survives the next election (which is by no means certain), the current coalition is unlikely to retain its parliamentary majority, leaving Merkel increasingly dependent on the Social Democrats (SPD). While this need not matter to her too much as long as she retains the chancellorship, in Sigmar Gabriel, the SPD’s leader, she faces – for the first time – an opponent whom she would underestimate at her peril.

But the real danger to Merkel is external: the European crisis. If she is unlucky, the crisis will come to a head at the start of the German election year, and all previous calculations could be moot, because, despite Germans’ frustration with Europe, the electorate would punish severely those who allowed Europe to fail.

The European Union’s economy is sliding into a severe and, in all likelihood, long-lasting recession, largely self-inflicted. While Germany is still trying to banish the specter of hyperinflation with strict eurozone austerity measures, the EU crisis countries are facing a real threat of deflation, with potentially disastrous consequences. It is only a question of time – no longer very much time – before economic destabilization gives rise to political instability.

Hungary, where democratic backsliding appears to be taking hold, provides a foretaste of a Europe in which the eurozone crisis and deflation persist. The mood in the Mediterranean EU members, as well as in Ireland, is heating up, owing not only to the tightening squeeze of austerity, but also – and perhaps more importantly – to the absence of policies that offer people hope for a better future. The explosive nature of current trends, which point to eventual re-nationalization of sovereignty from the bottom up, is greatly underestimated in Berlin.

The crisis has now reached Italy and is threatening to spread to France. With Mario Monti’s premiership, Italy has mobilized its best people, and neither Italy nor Europe will get a better government for the foreseeable future. If Monti’s administration is toppled – either in parliament or in the streets – the EU’s fourth-largest economy could come crashing down. Monti is urgently calling for help. Where is it?

Developments in France (the second-largest eurozone economy) should also not be underestimated in this presidential election year. If a majority of the French come to believe that a course of action is being imposed on them from outside – and by Germany, no less! – they will respond with traditional Gallic stubbornness.

What is at stake is less the election’s outcome than the margin between President Nicolas Sarkozy and the far-right National Front leader, Marine Le Pen – and whether she overtakes him to qualify for the second-round run-off against the Socialist candidate. While she would be unlikely to win the presidency, she could reshape and realign the French right. For that reason, a Sarkozy debacle would drastically reduce his Socialist successor’s room for maneuver on European policy, fundamentally altering France’s position in Europe.

But, while the French election’s outcome will hinge to a crucial extent on European crisis politics, Germany’s government acts as if this were none of its concern. Instead, the main – almost exclusive – topic in Berlin is the upcoming election. And the central question is not, “What needs to be done now in the interest of Europe?” Rather, it is, “How much can people in Germany be expected to accept – in particular, how much honesty?”

No one will act in a way that jeopardizes their electoral prospects, at least while there are still alternatives. So it is conceivable that Germany is not at all interested in a serious effort to resolve Europe’s crisis, because that would mean taking big risks and investing a lot of money.

The CDU-FDP coalition prefers to sugarcoat the situation by convincing themselves of an Anglo-Saxon conspiracy, abetted by those in the European crisis countries unwilling to perform and reform and whose only purpose is to make the Germans pay. So far, Merkel’s coalition is like someone driving against traffic, dead certain that everyone else is going the wrong way.

Europe’s disintegration has already advanced much further than it might appear. Distrust and national egoism are spreading rapidly, devouring European solidarity and common purpose.

Institutionally, Europe has been on the right track since the last summit, but it threatens to disintegrate from the bottom up. To save the euro – which is essential, because the European project’s fate depends on the success of monetary union – Europe needs action now: in addition to indispensable austerity measures and structural reforms, there is no way to succeed without a viable economic program that will assure growth.

That won’t come cheap. If Merkel’s government believes that paying lip service to growth is enough, it is playing with fire: a euro collapse in which not only Germans would be badly burned.

Joschka Fischer, Germany’s foreign minister and vice-chancellor from 1998 to 2005, was a leader in the German Green Party for almost 20 years.

Copyright: Project Syndicate/Institute for Human Sciences, 2011.