Spanish Collapse Threatens Eurozone

Spain has switched gears from calling for help with some banks to an overall sovereign bailout and the new tack has investors and financial analysts question the stability of the Eurozone. Some wonder whether Germany will stop forking over money to its struggling neighbors, although to do so would be tantamount to giving up on any possible success on the European financial system’s lasting cohesion. Everyone agrees that small bailouts will not work, and that nothing at all will work without exercising fiscal restraint, but no one seems to be able to offer up a feasible plan. For more on this continue reading the following article from Money Morning.

The market red ink Monday around the globe is the result of a usual suspect - Spain.

These days, if someone even sneezes in Madrid, Barcelona, or Córdoba (one of my favorite places, actually), investors go into intensive care all over the world.

This new Spanish influenza has been wiping out paper value from one end of Europe to the other. This morning came word that many of the regions in the country will need help. Attention is now directed from focused support for banks to wider calls for a sovereign bailout.

And that is where the whole matter can turn nasty. Word is that we should now expect some Italian cities to be requesting money in the near future. Seems California and Pennsylvania are not the only locations where cities can go bankrupt.

The accord reached at the end of June by the Council of Europe (the EU member heads of government) to bail out Spanish banks is already derisively referred to as "bailout lite." As the beer commercials attest, this is going to be "less filling."

Unfortunately, it is the heavier version that Europe now needs.

Germany: Eurozone Debt Crisis Savior

Brussels will now have to come up with another, weightier approach.

The problem with all of this, of course, is that at some point the bellwether of Europe will say "enough is enough" and drag its heels on any further largess to disobedient southern cousins.

If Germany throws in the towel, the Eurozone is in real jeopardy.

Some pundits are already talking about such a reaction. Yet there are positively no indications that Berlin is moving in that direction, at least not yet.

The reason is simple - so simple that most doomsayers simply overlook it.

If Spain or Greece goes under, it is not only one economy that has been thrown under the bus. The cross-border held debt and the continent-wide investment and capital programs will be pulled down as well.

Some in Europe may not like it, but it took decades to reach the point where the EU is largely operating on an integrated currency and banking system. There is no way to break up without destroying the last 30 years of joint action.

Talk about a messy divorce where the family china is thrown about...

The Importance of Fiscal Restraint

Europe needs a genuine bailout in return for strictly enforced fiscal and monetary restraint.

The basis for this is already in place, as part of the anticipated approach adopted in late June. In return for the money, there needs to be collective control of commercial banks.

Now, for those who bemoan the fact that this is an interruption of free-market economics, let me simply point out that it was the unfettered transfer of credit, augmented by insufficient bank reserves and indifferent oversight regulations, that got them where they are in the first place.

Regulatory intervention is not the best way to establish market equilibrium. But there are times when it is required. And this is certainly one of those times.

The current call for sovereign bailouts, and we will see more of this as we move forward, misses the mark. Fiscal restraint coming from the central government and monetary restraint issuing from the central bank are essential. Yet they must be contained in a broader longer-term solution that provides some political shelter for those officials making the decisions.

These are not stupid or callous people. These are elected and appointed administrators restrained by a system that has gone awry. There is a very public price to pay for bucking it. Coverage needs to come from Brussels. We can discuss the academic nuances of economic systems and plot hypothetical courses in the best of all preferred worlds.

Unfortunately, Europe is living in this world.

Collective frustrations aside, more concerted and centralized control over the continent's banking system is the likely outcome. Remember, when all is said and done, the overwhelming majority of the European wealth that needs to be protected is not carried around in pockets or stuffed in mattresses. It sits in bank accounts.

Europe needs to be remembered for more than its castles and picturesque, yet closed, town public squares.

This article was republished with permission from Money Morning.

China's Central Bank Lowers Bank Reserve Ratio Requirements

This past weekend, China's central bank reduced the reserve ratio requirements for banks. Even after the .5% reduction, China's reserve ratios are still twice what is required of banks in the United States. This move, however, shows that China is looking for ways to get their economy moving once again, and will have an impact on a global scale. For more on this, continue reading the following post from Tim Iacono.

China’s central bank cutting bank reserve ratios on Saturday in order to spur lending and boost economic growth was one of the weekend’s major stories, that is, along with more Middle East geopolitical turmoil and surging oil prices … perhaps they’re all connected.

Reserve requirements will be reduced from 21.0 percent to 20.5 percent for large banks, leaving China with what are still some of the highest bank reserve ratios in the world. Wikipedia provides a good discussion of this subject that includes the following caveat to the official reserve ratio of 10 percent here in the U.S.:

Effective December 27, 1990, a liquidity ratio of zero has applied to CDs, savings deposits, and time deposits, owned by entities other than households, and the Eurocurrency liabilities of depository institutions. Deposits owned by foreign corporations or governments are currently not subject to reserve requirements.

This blog post was republished with permission from Tim Iacono.

China Showing Signs of Economic Weakness

Economist Paul Krugman takes an unflinching look at China’s current economic position, and believes what he sees is a mirror image of Japan in the 80s or the U.S. in 2007: a country that has relied on shady banking practices to sustain a boom in growth that now cannot be supported by domestic consumption or financing. Now, as the bubble is set to burst, the country seems ready to dig in its heels, particularly by issuing punitive tariffs on foreign trade partners. Krugman rightly notes that the last thing the global economy needs is another crisis point, but he also believes that is the direction in which the country is headed. For more on this continue reading the following article from Economist’s View.

Uh-oh?:

Will China Break?, by Paul Krugman, Commentary, NY Times: Consider the following picture: Recent growth has relied on a huge construction boom fueled by surging real estate prices, and exhibiting all the classic signs of a bubble. There was rapid growth in credit — with much of that growth taking place not through traditional banking but rather through unregulated “shadow banking” neither subject to government supervision nor backed by government guarantees. Now the bubble is bursting — and there are real reasons to fear financial and economic crisis.

Am I describing Japan at the end of the 1980s? Or am I describing America in 2007? I could be. But right now I’m talking about China, which is emerging as another danger spot in a world economy that really, really doesn’t need this right now. ...

The most striking thing about the Chinese economy over the past decade was the way household consumption, although rising, lagged behind overall growth. At this point consumer spending is only about 35 percent of G.D.P., about half the level in the United States.

So who’s buying the goods and services China produces? Part of the answer is, well, us:... China increasingly relied on trade surpluses to keep manufacturing afloat. But the bigger story from China’s point of view is investment spending, which has soared to almost half of G.D.P.

The obvious question is, with consumer demand relatively weak, what motivated all that investment? And the answer, to an important extent, is that it depended on an ever-inflating real estate bubble. ...

And there was another parallel with U.S. experience: as credit boomed, much of it came not from banks but from an unsupervised, unprotected shadow banking system..: in China as in America a few years ago, the financial system may be much more vulnerable than data on conventional banking reveal.

Now the bubble is visibly bursting. How much damage will it do to the Chinese economy — and the world? ...

For what it’s worth, statements about economic policy from Chinese officials don’t strike me as being especially clear-headed. In particular, the way China has been lashing out at foreigners — among other things, imposing a punitive tariff on imports of U.S.-made autos that will do nothing to help its economy but will help poison trade relations — does not sound like a mature government that knows what it’s doing. ...

I hope that I’m being needlessly alarmist here. But it’s impossible not to be worried: China’s story just sounds too much like the crack-ups we’ve already seen elsewhere. And a world economy already suffering from the mess in Europe really, really doesn’t need a new epicenter of crisis.

This blog post was republished with permission from Economist's View.

Eurozone Crisis Overshadows U.S. Debt Concerns

The U.S. media and market analysts have been focusing so much attention on the Eurozone debt crisis that similar problems brewing at home in domestic credit markets are not getting any attention, say some critics. Now that the presidential election is in full swing, many argue that the growing U.S. debt debacle will go unattended as politicians focus all their time and energy on staying in – or getting into – office. With the Federal Reserve’s latest announcement that Treasury borrowing rates will remain at historical lows, it appears that policymakers are intent on letting the problem fester rather than making the tough decisions that represent sound fiscal sense. For more on this continue reading the following article from Tim Iacono.

Former Kansas governor Mark Parkinson appeared on CNBC yesterday and made the point that you don’t hear too much anymore these days with European credit markets being such a mess – that the U.S. will someday have a similar crisis.

Unfortunately, with the election season now well underway, officials in Washington are not likely to take any action to make the looming U.S. debt crisis any less menacing, in fact, with borrowing rates so low for the Treasury Department, you get the feeling that we’re whistling past the graveyard louder than ever.

This blog post was republished with permission from Tim Iacono.

Eurozone Eyes Questionable Bailout Strategy

Talks in the Eurozone turn on who is going to accept the loss in a debt restructuring deal, and now architects of the plan are saying private-sector bondholders may not have to take a haircut in the event of a bailout. The news has fueled a short-term rally, but experts criticize the measure as one that will result in the same kind of catastrophe that befell Ireland when it granted banks a blanket bailout that pushed the debt onto Irish citizens and resulted in a staggering collapse of the economy. As European countries scramble to guarantee one another’s debt and lenders seek to avoid paying for bad decisions, ratings agencies are poised to downgrade the entire region. For more on this continue reading the following article from Economist’s View.

Felix Salmon:

The eurozone’s terrible mistake, by Felix Salmon: The FT is reporting today that the new fiscal rules for the EU “include a commitment not to force private sector bondholders to take losses on any future eurozone bail-outs”. If this principle really does get enshrined into some new treaty, it will be one of the most fiscally insane derelictions of statesmanship the world has seen — but it certainly helps explain the short-term rally that we saw today in Italian government debt.

Right now, the commitment is still vague...

To understand just how stupid this is, all you need to do is go back and read Michael Lewis’s Ireland article. The fateful decision in Ireland was to take the insolvent banks and give them a blanket bailout, with the banks’ creditors all getting 100 cents on the euro. That only served to put a positively evil debt burden onto the Irish people, forcing a massive austerity program and causing untold billions of euros in foregone growth, while bailing out lenders who deserved no such thing.

Are we really going to repeat — on a much larger scale — the very same mistake that Ireland made? ...

On Ireland, see: Despite Praise for Its Austerity, Ireland and Its People Are Being Battered.

This article was republished with permission from Economist's View.

Eurozone Debt Deal Falters

Economist Tim Duy discusses the weaknesses in the debt deal designed to save the Eurozone, and explains why it was destined to fail. It appears Greek leaders were never comfortable with the parameters of the agreement formed by other European politicians last week, and holders of Greek bonds even less so. It appears bondholders are not as willing to take a 50% loss on investment as once though, and now Spain is showing further signs of weakness as its GDP grinds to a halt. Duy speculates that deal details that were expected to take a few months to iron out will now take much longer while the Eurozone sinks deeper into debt and the U.S. teeters on the edge of another full-blown recession. For more on this continue reading the following article from Economist’s View.

Tim Duy:

Did The European Deal Just Collapse?, by Tim Duy: To be sure, I have been bearish on Europe. From last week:

I remain something of a Euroskeptic at this point. At best, I think the Europeans will be kicking the can down the road for a few months.

It turns out a "few months" might have been wildly optimistic. It was quickly evident that bond markets didn't show the same enthusiasm equity markets expressed for the supposed deal. That was huge red flag. The second red flag was the Bank of Spain announcing a stagnant 3Q GDP. From the Associated Press:

The Bank of Spain suggested that the flat growth calls into question the government's goal of reducing its deficit to 6 percent of GDP in 2011, from 9.2 percent last year...

...It said domestic demand fell because of lower government spending as a result of deficit-reducing austerity measures taken by regional governments and because of a moribund real estate market. Household and business spending posted small increases. Spain's economic woes stem largely from the collapse of a property bubble.

The Bank of Spain said there is still time to meet the deficit reduction target by the year's end but warned that fresh measures may be necessary.

Yes, you read that right...the Bank of Spain blamed missing deficit reduction targets on fiscal austerity and then suggests additional fiscal austerity as the solution. And as all nations in the Eurozone increasingly pursue fiscal austerity, we can only expect the nascent European recession to deepen. Eventually, the European public will have had enough of the downward spiral. How long will it be before Spain decides to aggressively push for a Greece solution of "voluntary" debt relief?

Finally, a lynchpin in the European debt deal - Greece - apparently isn't ready to abide by the terms of that deal. The public pressure is now too much. From the Financial Times:

Greece’s prime minister unexpectedly announced a referendum to approve a second EU bail-out deal for his austerity-hit country, less than a week after it was agreed with international creditors at a European Union summit...

...One senior EU official told the Financial Times that Mr Papandreou had appeared reticent about the components of the bail-out package during talks at last week’s summit of EU presidents and prime ministers but no one was prepared for the referendum announcement that came “like a bolt out of the blue...

...The vote would probably be held in January, when Greek bondholders were expected to sign up for a voluntary 50 per cent haircut being negotiated with the International Institute of Finance, wrapping up the new bail-out package. One Athens banker said: “This is a worrying decision by the prime minister. It could derail the whole process even before it’s properly started.”

Not only are the details of the grand European plan still in flux, but so are the broad brushstrokes! Clearly, the Greeks have just brought back into play all the uncertainty last week's summit was meant to dispel. It is not unreasonable to think the Greek electorate is more willing to technically default and start from scratch than their leaders. Indeed, shouldn't this be our baseline scenario?

Bottom Line: Last week's European Summit accomplished far less than even the reduced expectations going into last week. The cracks began appearing before the ink was dry. More worrisome is that the Greek leadership didn't even believe they were on board in the first place. Simply put, the world economy is no less fragile than it was a week ago. And in that fragility still lies the recession risk for a still struggling US economy.

This blog post was republished with permission from Economist's View.

European Leaders Continue Debt Negotiations

Tim Iacono provides a video clip rehashing the latest meeting between Eurozone leaders regarding how to solve the Greek debt crisis and wider concerns for the stability of the European currency union. Politicians have agreed the European Financial Stability Facility fund should be increased to $1.4 trillion to cover capital expenses that will be faced by banks and investors that are expected to take a as much as a 50% loss in a Greek bailout. The specific financial instrument that will facilitate this is still being debated, however, and one option may involve allowing China and Middle Eastern countries to buy into the debt. For more on this continue reading the following article from Tim Iacono.

It looks like they’ve agreed to something over in Europe, though it remains to be seen whether this deal will last any longer than any of the last half dozen or so agreements aimed at keeping the currency union from breaking apart.

Investors have reportedly agreed to take losses of 50 percent on Greek debt and French President Sarkozy told reporters that the EFSF bailout fund is about to be “leveraged up” to $1.4 trillion, the proverbial “bazooka” in the EU’s pocket. It looks like they’re on a roll…

This blog post was republished with permission from Tim Iacono.

Euro Doomed, Says Economist

Economist Paul Krugman is predicting the failure of the euro, and feels that no solution yet offered by Eurozone economic powers will solve the default problem. He points out that Greece is more of a red herring, and that the real problem is the shake financial position of Italy, the Eurozone’s third largest economy. Italy cannot borrow against its own debt to save itself and rigid statutes prevent the type of currency printing trick used by other superpowers to pull themselves out of debt. The only hope for the euro is if the European Central Bank backs Eurozone debt, say Krugman, but leaders have made it clear that option is not on the table and so have sealed the fate of the euro. For more on this continue reading the following article from Economist’s View.

Is the euro system doomed?:

The Hole in Europe’s Bucket, by Paul Krugman, Commentary, NYTimes: If it weren’t so tragic, the current European crisis would be funny, in a gallows-humor sort of way. ...

I’ll get to the tragedy in a minute. First, let’s talk about the pratfalls... Greece, where the crisis began, is no more than a grim sideshow. The clear and present danger comes instead from ... Italy, the euro area’s third-largest economy. Investors, fearing a possible default, are demanding high interest rates on Italian debt. And these high interest rates, by raising the burden of debt service, make default more likely. ...

To save the euro, this threat must be contained. But ... here’s the problem: All the various proposals ... ultimately require backing from major European governments, whose promises to investors must be credible for the plan to work. Yet Italy is one of those major governments; it can’t achieve a rescue by lending money to itself. And France, the euro area’s second-biggest economy, has been looking shaky lately... There’s a hole in the bucket, dear Liza, dear Liza. ...

What makes the story really painful is the fact that none of this had to happen. ... Britain, Japan and the United States ... have large debts and deficits yet remain able to borrow at low interest rates. What’s their secret? The answer, in large part, is that they retain their own currencies, and investors know that in a pinch they could finance their deficits by printing more of those currencies. If the European Central Bank were to similarly stand behind European debts, the crisis would ease dramatically. ...

But such action, we keep being told, is off the table. The statutes ... supposedly prohibit this kind of thing, although one suspects that clever lawyers could find a way to make it happen. The broader problem, however, is that the whole euro system was designed to fight the last economic war. It’s a Maginot Line built to prevent a replay of the 1970s, which is worse than useless when the real danger is a replay of the 1930s. ...

The ... European elite, in its arrogance, locked the Continent into a monetary system that recreated the rigidities of the gold standard, and — like the gold standard in the 1930s — has turned into a deadly trap.

Now maybe European leaders will come up with a truly credible rescue plan. I hope so, but I don’t expect it.

The bitter truth is that it’s looking more and more as if the euro system is doomed. And the even more bitter truth is that given the way that system has been performing, Europe might be better off if it collapses sooner rather than later.

This blog post was republished with permission from Economist's View.

Acceptance No Answer to US Economic Turmoil

Mark Thoma takes issue with economist Mark Spence’s determinative view that Americans must not only consume less, but expect less. Spence feels that international distributional effects have left little room in the low- and middle-class job market, and people must accept it. Thoma argues that while the pre-2008 bubble was responsible for gilding expectations, it is the poor investment of monies and resources into the financial market that is the true distribution problem. According to Thoma, the proper investment of wasted billions back into the jobs market could create growth and employment. For more on this continue reading the following article from Economist’s View.

Michael Spence:

The Global Jobs Challenge, by Michael Spence, Commentary, Project Syndicate: ...The third challenge is distributional. As the tradable part of the global economy (goods and services that can be produced in one country and consumed in another) expands, competition for economic activity and jobs broadens. That affects the price of labor and the range of employment opportunities within all globally integrated economies. Subsets of the population gain, and others lose, certainly relative to expectations – and often absolutely.

Many advanced countries – in fact, most of them – have experienced limited middle-income growth. ... In the United States, income inequality has risen as the upper end of the income and education spectrum benefits from globalization, while the rest experience declining employment opportunities in the tradable sector. ...

What does it mean – for individuals, businesses, and governments – that structural adjustment is falling further and further behind the global forces that are causing pressure for structural change?

Above all, it means that expectations are broadly inconsistent with reality, and need to adjust, in some cases downward. But distributional effects need to be taken seriously and addressed. The burden of weak or non-existent recoveries should not be borne by the unemployed, including the young. In the interest of social cohesion, market outcomes need to be modified to create a more even distribution of incomes and benefits, both now and in inter-temporal terms. ...

None of this will be easy. ... Nevertheless, the unemployed and underemployed, especially younger people, expect their leaders and institutions to try.

I don't like the call to accept that things will be worse in the future, and to get used to it. It is generally based upon the idea that much of our growth was due to the bubble - it was false growth -- and hence led to the perception that we can grow faster than is actually possible.

But if the resources hadn't have been invested in the financial industry, they wouldn't have been wasted, they would have gone elsewhere. If we had taken all the resources (and talent) that went into the financial sector and directed it elsewhere, it would have promoted growth and employment -- and likely of a far more stable and broad-based variety. In my view the challenge is to redirect these resources into productive uses, and to fix the mal-distribution of income gains. But simply accepting that expectations need to adjust downward -- that the fate of the middle and lower classes is a diminished future -- is not acceptable. We can do better than that.

This blog post was republished with permission from Mark Thoma.

Eurozone Collapse Halted, Still Threatening

Hugo Dixon of Reuters Breaking Views predicts a European Union (EU) financial disaster is still possible, but a more likely development is one where the EU experiences an extended period of zero or negative growth. Dixon argues there is no silver bullet; the situation has unraveled too much for politicians to save it with fiscal reform, and breaking up the EU would be a disaster in itself. The worst thing that could happen, Dixon says, is for the EU to shift toward protectionism in an effort to stimulate its economy, but he does not expect this to happen. For more on this continue reading the following article from Tim Iacono.

Those whose hopes of a much bigger crisis in Europe are about to be dashed after the final approval of the EFSF bailout fund by Slovakia can take heart in this view from Reuters Breaking Views founder Hugo Dixon that the chance of a “total disaster” still exists.

Muddling through with years of zero or negative growth is now seen as the most likely scenario, an outlook that, some time ago, would have been considered a disappointment, but, after the events of the last few months, seems much less of one now.

This blog post was republished with permission from Tim Iacono.

Eurozone Faces Possible Bank Run

Some market speculators are convinced the Eurozone is on the brink of collapse and that the EU may face an actual bank run as individuals, banks and investment houses scramble to secure actual funds, even from one another. The interlinking nature of modern banking and investment infrastructure may lead to a domino effect of collapse. Many feel that the time has come when physical possession of bullion is the only real measure against insolvency if banks begin closing and investment firms continue selling paper gold and silver. For more on this continue reading the following article from The Prudent Investor.

A comatose interbank market and corporate and fund money fleeing Eurozone banks in droves have rung in the countdown to the Eurozone bank run that could become reality as early as next Monday.

The free fall in all major markets and commodities was only negatively outperformed by European banks whose shares fell to new 2011 lows.

Gossip about major institutions like Lloyds of London withdrawing all deposits from Eurozone banks and countless stories in German media about corporations that follow suit are the first indicators about a bank run that may come as soon as Monday when one major Eurozone bank may have to announce its insolvency.

A cascade of downgrades is only more fuel to the market fornication as we have never seen it before. As we are closer to the Endsieg, banks are resorting to a dog-eat-dog strategy, scrambling to save their own skin in a world where the only providers of liquidity are central banks letting their money printing presses spin 24/7.

Mounting rumors expect the announcement of a major bank closing its doors as soon as Monday and market speculation focuses on Unicredit and Societe Generale.

Being asked about the ultimate safe haven I still have only one answer. Precious metals bullion are the only asset that is not the liability of someone else.

Never mind that silver FUTURES dropped 9% on Thursday and gold breached the 50-day moving average. As long as market participants with unlimited credit from the Federal Reserve can sell x,xxx tons of paper gold or paper silver within seconds in regular gold/silver slam scams the ride will be stormy but ultimately the holders of the physical will prevail.

This blog post was republished with permission from The Prudent Investor.

Eurozone Stability Stricken

Economist Ambrose Evans Pritchard is predicting a major Eurozone upheaval as Germany comes to terms with the fact that it can no longer support weaker union partners, particularly Greece. He describes possible scenarios, including the breaking of the EU into separate blocs with Germany introducing new currency in one bloc with France maintaining the euro in the other to avoid EU collapse. Regardless of strategy, he argues it is clear the status quo will not survive and that some type of system overhaul will be necessary to move forward in a positive direction. For more on this continue reading the following article from Tim Iacono.

Now completely back into the swing of things after what seemed like an unusually long absence over the summer, time that was presumably taken for a good long break from focusing on the world’s financial market woes, Ambrose Evans Pritchard at the U.K. Telegraph files this comprehensive report on why Europe is about to go up in flames.

First we learn from planted leaks that Germany is activating “Plan B”, telling banks and insurance companies to prepare for 50pc haircuts on Greek debt; then that Germany is “studying” options that include Greece’s return to the drachma.

German finance minister Wolfgang Schauble chose to do this at a moment when the global economy is already flirting with double-dip recession, bank shares are crashing, and credit strains are testing Lehman levels. The recklessness is breath-taking.

If it is a pressure tactic to force Greece to submit to EU-IMF demands of yet further austerity, it may instead bring mutual assured destruction.
…
Germany’s EU commissioner Günther Oettinger said Europe should send blue helmets to take control of Greek tax collection and liquidate state assets. They had better be well armed. The headlines in the Greek press have been “Unconditional Capitulation”, and “Terrorization of Greeks”, and even “Fourth Reich”.

As one prone to hyperbole, you might think that Ambrose is just doing what he does best (something that, apparently, boosts the Telegraph’s readership), but, maybe not this time.

The problems in Greece seem even more intractable today than they did a month ago or a year ago, so, maybe the Germans are really just doing the world a favor by precipitating a default (and breaking up the euro) sooner rather than later, and the recent resignations by top German banking officials have gone a long way in helping to make that happen.

We have never been so close to EMU rupture. Friday’s resignation of Jurgen Stark at the European Central Bank is literally a kataklysmos, a German vote of no confidence in EMU management. Dr Stark is not just an ECB board member. He is the keeper of the Bundesbank’s monetary flame.

The vehemence of his protest against ECB bond purchases confirm what markets suspect: that the ECB cannot shore up Italian and Spanish debt markets for long without losing Germany.
…
There is a close parallel between 1930s Gold and EMU, both in destructive effect and totemic sanctity. The Gold Standard was more than a currency system. It was the anchor of an international order and way of life.

My solution – like that of Hans-Olaf Henkel, the ex-head of Germany’s industry federation (BDI) – is to split EMU into two blocs, with France leading a Latin Union that keeps the euro. This bloc would devalue but not by 60pc, yet uphold its euro debts intact. The risk of default and banking crises would decrease, not increase.

The German bloc could launch their Thaler, recapitalizing banks to cover losses from rump euro debt. Disruptions could be contained by capital controls at first. None of this is beyond the wit of man. My bet is that aggregate losses would be lower than the status quo, and the long term outcome much healthier. The EU might even carry on, unruffled.

The status quo, however, is not acceptable. EMU’s debt-deflation strategy has trapped half of Europe in depression, with youth unemployment reaching 46pc in Spain and no way out for years.

Perhaps a global coalition of the G20, IMF, China, and the oil powers will combine to rescue Euroland, as some now hope. But how would that bridge the gap between EMU’s North and South? It solves nothing.

Germany and Greece in the same monetary union just doesn’t seem to make any sense anymore (actually, it hasn’t made any sense since the incoming Greek government announced in late-2009 that their predecessors had cooked the books for the last decade). At this point, the sooner they ditch the status quo, the better.

This article was republished with permission from Tim Iacono.

Food Crisis: Result Of Global Warming Or Fed Policies?

The weather has been crazy this year - there is no denying that - but is global warming to blame? Furthermore, is the weather to blame for the dramatic increase to global food prices, or is it really the result of easy-money policies from the Fed? Mark Thoma takes a closer look at Paul Krugman's latest editorial on the topic, in his blog post below.

Are we getting the "first taste" of the political and economic upheaval we'll face if we don't reduce greenhouse gas emissions?:

Droughts, Floods and Food, by Paul Krugman, Commentary, NY Times: We’re in the midst of a global food crisis — the second in three years. World food prices hit a record in January... These soaring prices have had only a modest effect on U.S. inflation, which is still low..., but they’re having a brutal impact on the world’s poor, who spend much if not most of their income on basic foodstuffs.

The consequences of this food crisis go far beyond economics. After all, the big question about uprisings against corrupt and oppressive regimes in the Middle East isn’t so much why they’re happening as why they’re happening now. And there’s little question that sky-high food prices have been an important trigger for popular rage.

So what’s behind the price spike? American right-wingers (and the Chinese) blame easy-money policies at the Federal Reserve, with at least one commentator declaring that there is “blood on Bernanke’s hands.” Meanwhile, President Nicolas Sarkozy of France blames speculators, accusing them of “extortion and pillaging.” ...

Now, to some extent soaring food prices are part of a general commodity boom... But ... food prices lagged behind the prices of other commodities until last summer. Then the weather struck. ...

The Russian heat wave was only one of many recent extreme weather events, from dry weather in Brazil to biblical-proportion flooding in Australia, that have damaged world food production.

The question then becomes, what’s behind all this extreme weather?

To some extent we’re seeing the results of a natural phenomenon, La Niña— a periodic event in which water in the equatorial Pacific becomes cooler than normal. La Niña events have historically been associated with global food crises...

But that’s not the whole story. ... As always, you can’t attribute any one weather event to greenhouse gases. But the pattern we’re seeing, with extreme highs and extreme weather in general becoming much more common, is just what you’d expect from climate change.

The usual suspects will, of course, go wild over suggestions that global warming has something to do with the food crisis; those who insist that Ben Bernanke has blood on his hands tend to be more or less the same people who insist that the scientific consensus on climate reflects a vast leftist conspiracy.

But the evidence does, in fact, suggest that what we’re getting now is a first taste of the disruption, economic and political, that we’ll face in a warming world. And given our failure to act on greenhouse gases, there will be much more, and much worse, to come.


This post was republished with permission from The Economist's View.

The Growing Inflation Battle

Inflation is growing in many emerging markets, and a battle is brewing between the US and these countries. The US doesn't seem willing to budge on its current economic path, while the emerging markets are reluctant to allow their currencies to appreciate. Economics Professor, Mark Thoma, takes a closer look at this battle in his blog post below.

Tim Duy notes rising concern about inflation from hawkish central bankers in Europe and elsewhere, and the tension that is building "as emerging markets fight the Fed":

Inevitable Inflation Fears, by Tim Duy: The Wall Street Journal is reporting that ECB head Jean-Claude Trichet is turning increasingly hawkish:

Inflation fears—fueled by spiraling food, oil and raw material prices—are mounting around the globe, prompting the head of the European Central Bank to signal that it could raise interest rates in the future even though some countries have been weakened by the Continent's debt crisis.

In an interview with The Wall Street Journal ahead of this week's annual meeting of the World Economic Forum in Davos, Switzerland, Jean-Claude Trichet warned that inflation pressures in the euro zone must be watched closely, and urged central bankers everywhere to ensure that higher energy and food prices don't gain a foothold in the global economy…

An interesting development in light of the ongoing (or is it never ending?) European Debt Crisis. Rate hikes will just be adding insult to injury for the peripheral nations already struggling with a debt-deflation spiral. The price for being part of the Euro just keeps getting higher.

Inflation fears have yet to grip the Federal Reserve, for good reason. Back to the Wall Street Journal:

While high unemployment and spare capacity are restraining underlying inflation pressures in the U.S. and elsewhere in the developed world, annual inflation in China is almost 5%—and a sizzling 9.8% economic growth rate in the fourth quarter triggered fears of more price pressures ahead. Inflation in Brazil is even higher.

The next inflation crisis is not occurring in the US, as opponents of QE2 thought likely, but in the developing markets instead. To be sure, my sympathy for developing nations wore thin long ago. They will identify the Federal Reserve as the proximate cause of their problems, whereas they have only themselves to blame. Higher inflation abroad was the only outcome if the protocols of Bretton Woods II did not submit to the onslaught of QE2. And the Federal Reserve has very good reason to keep the pedal to the medal. A review of recent inflation behavior:



If inflation abroad is a problem, it is not because the Federal Reserve has set rates too low, but because emerging markets been unwilling to allow their currencies to appreciate sufficiently against the Dollar. See, for example, recent Dollar buying on the part of Brazil. See also Paul Krugman, who illustrates the clear difference in emerging and developed nation industrial production trends. Again, if inflation abroad is a problem, it is one that emerging markets need to tackle themselves.

Expect global tensions to continue building as emerging markets fight the Fed. While the Fed may identify higher commodity prices as a potential concern, policymakers are not likely to reverse course and tighten policy unless higher commodity prices push through to core inflation. Such an outcome appears unlikely given persistently high unemployment. Consider too that the likely outcome of rising commodity prices is to slow US growth, thereby decreasing the odds of pass-through to core.

I have said this before – I do not see how this ends well. Given that the Fed is not likely to back down from this fight, emerging markets need to put the brakes on their internal inflation issues, the sooner the better. Otherwise they will be facing pain of a real inflation crisis, one that requires stepping on the brakes even harder. How this story unfolds this year will determine of the global economy can transition to a sustainable, balanced growth trajectory, or plunges into yet another of the seemingly all-too-frequent crises.

This post was republished with permission from The Economist's View Blog.

Economists Project Modest Growth Ahead For Global Economy

The IMF is cautiously optimistic of a sustainable global economic recovery and have raised their growth forecasts despite modest growth expected from mature economies. The National Association for Business Economics is also optimistic, with recent survey data suggesting that US companies are gaining confidence in the economy, indicating a potential growth in hiring ahead. See the following post from The Capital Spectator.

“The global economy seems to be recovering,” the chairman of the IMF’s Financial Committee meeting said at press conference over the weekend. "The worst is definitely behind us," advised Youssef Boutros-Ghali, who's also the Egyptian finance minister in his day job.

But most bouts of macro optimism come with caveats these days, and Boutros-Ghali's cheerful commentary was no exception. "We are not out of the woods yet," he added. "We see a strengthening of economic recovery, but we also see an unevenness in this recovery, unevenness within countries, and unevenness between countries."

Earlier in the week, the IMF revised up its global growth forecast to 4.2% for 2010 from January's estimate of 3.9%. Leading the expansion: emerging market economies, Boutros-Ghali emphasized in his Saturday chat with the press. The IMF projects that emerging nations will grow by more than 6% this year and next.

By comparison, economic growth in mature economies is expected to be relatively modest at roughly 2% to 2.5%. Not too shabby on its face. The problem is that the advanced economies need something better than average for an extended period in the wake of the Great Recession. As the IMF's chief economist, Olivier Blanchard, explained on the IMF's blog a few days ago: The 2%-plus outlook for growth in advanced economies

...is just not enough to make up for the ground lost during the recession. Output for these countries is now 7% below its pre-crisis trend, and this “output gap” is expected to remain large for many years to come. Associated with this prolonged output gap is persistent high unemployment. We forecast the unemployment rate in advanced economies to reach 8.4% in 2010, and to only decline to 8.0% in 2011.

The main factor behind this weak performance and this prolonged output gap is weak private demand. In the United States, consumers, who were the drivers of the economy before the crisis, are being more prudent. In Europe, where banks play a central role in financial intermediation, the weak banking sector limits credit supply. In Japan, deflation has reappeared, leading to higher real interest rates, and putting in danger an already weak recovery.

But while there's a risk of growth that's not quite up to the challenge in the developed world, some analysts think the hazards of a fresh round of economic contraction have diminished. "In the United States, there is a growing consensus that the risk of a double dip recession has abated which is positively impacting markets," the Blackstone Group said in a statement this past week.

In fact, it's easy to find forecasts of modest growth for U.S. GDP for the year ahead. BMO Capital, for instance, projects the U.S. economy will expand by roughly 2.5% to 3.0% at an annual pace in the coming quarters. MFC Global Investment Management expects even stronger results, albeit with that annoying caveat again:

We forecast a robust economic recovery, as job growth will drive incomes and consumer spending, which in turn fuel a resurgence of business investment. The process of rebuilding inventories, which pushed GDP growth to almost 6% in Q4 2009, is not over yet. In addition, more than half of last year’s stimulus package is still to come, while a synchronized global expansion is boosting exports.

But this is not the whole story. Another wave of mortgage defaults and foreclosures threatens renewed declines in home prices, while commercial real estate seems on the verge of a major slump. More losses for banks would only make a constrained lending environment even worse, potentially limiting the normal growth of spending.

Meantime, the always cautious, circumspect and widely followed Jeremy Grantham, chief strategist of GMO, writes in his latest quarterly letter to clients:

The economy is limping back into action, but faces some tough long-term headwinds that I collectively call “seven lean years.” Mortgage defaults in housing, steady repayments of consumer debt, and refinancings in commercial real estate and private equity, are all problems that linger, as do many others, on what is becoming a long, boring list. We may get very lucky and have a strong broad-based economic recovery.

Boring but no less relevant. The next several months are sure to be a test of the economy’s capacity from transitioning from crisis mode to something resembling stable-growth mode. The outcome will likely be determined by the prevailing winds in the labor and housing markets, both of which were crushed by the economic turmoil in recent years. In both cases, there are nascent signs of stabilization, which may be a prelude to a bonafide recovery.

One reason for thinking so comes from a new survey of U.S. companies, which are becoming more confident that the economy will grow, which inspires plans for more hiring and less firing. As the National Association for Business Economics reports today:

Job creation increased for the first time in the past two years of this NABE survey. The percentage of firms increasing payrolls rose to 22% from 13% in the January survey. The percentage of firms cutting jobs moved lower—from 28% in January to 13% in April. The share of respondents expecting their firms to add employees over the coming six months rose to 37%, up from 29% in the previous survey.

Cautious optimism seems to be the sentiment of the moment. Even assuming that's accurate, what does it mean for the market? Have stocks fully priced in the expected recovery? "If the economic recovery is slow and if unemployment drops slowly," writes Grantham, "then [Fed chairman] Bernanke will certainly keep rates very low, as he has promised in as clear a way as language permits. In that case, stocks and general speculation will very probably rise from levels that are already overpriced."

The margin for error, in other words, is getting uncomfortably thin. That doesn't mean equities won't climb higher. But the potential fallout from any negative surprises isn't getting any smaller.

This post has been republished from James Picerno's blog, The Capital Spectator.