Sovereign debt bubble thread

[Zanza]

Most of the consumer prices' growth in peripheral Europe is made up of tax hikes. The core (notably Germany) is not experiencing significant inflation at all when you factor in energy prices.

We don't have much CPI inflation right now, but there is certainly a housing price bubble forming in Germany. Credit is cheaper than ever and people are afraid about what might happen to their wealth in case of an Eurozone breakup or printing money to finance governments.

[MadImmortalMan]

BOJ is starting up QE9. 20 Trillion yen.

[Zanza]

This time it will work!

[MadImmortalMan]

A Capitalist's Dilemma

A Capitalist's Dilemma, Whoever Wins on Tuesday
By CLAYTON M. CHRISTENSEN
Published: November 3, 2012


WHATEVER happens on Election Day, Americans will keep asking the same question: When will this economy get better?


In many ways, the answer won't depend on who wins on Tuesday. Anyone who says otherwise is overstating the power of the American president. But if the president doesn't have the power to fix things, who does?

It's not the Federal Reserve. The Fed has been injecting more and more capital into the economy because — at least in theory — capital fuels capitalism. And yet cash hoards in the billions are sitting unused on the pristine balance sheets of Fortune 500 corporations. Billions in capital is also sitting inert and uninvested at private equity funds.

Capitalists seem almost uninterested in capitalism, even as entrepreneurs eager to start companies find that they can't get financing. Businesses and investors sound like the Ancient Mariner, who complained of "Water, water everywhere — nor any drop to drink."

It's a paradox, and at its nexus is what I'll call the Doctrine of New Finance, which is taught with increasingly religious zeal by economists, and at times even by business professors like me who have failed to challenge it. This doctrine embraces measures of profitability that guide capitalists away from investments that can create real economic growth.

Executives and investors might finance three types of innovations with their capital. I'll call the first type "empowering" innovations. These transform complicated and costly products available to a few into simpler, cheaper products available to the many.

The Ford Model T was an empowering innovation, as was the Sony transistor radio. So were the personal computers of I.B.M. and Compaq and online trading at Schwab. A more recent example is cloud computing. It transformed information technology that was previously accessible only to big companies into something that even small companies could afford.

Empowering innovations create jobs, because they require more and more people who can build, distribute, sell and service these products. Empowering investments also use capital — to expand capacity and to finance receivables and inventory.

The second type are "sustaining" innovations. These replace old products with new models. For example, the Toyota Prius hybrid is a marvelous product. But it's not as if every time Toyota sells a Prius, the same customer also buys a Camry. There is a zero-sum aspect to sustaining innovations: They replace yesterday's products with today's products and create few jobs. They keep our economy vibrant — and, in dollars, they account for the most innovation. But they have a neutral effect on economic activity and on capital.

The third type are "efficiency" innovations. These reduce the cost of making and distributing existing products and services. Examples are minimills in steel and Geico in online insurance underwriting. Taken together in an industry, such innovations almost always reduce the net number of jobs, because they streamline processes. But they also preserve many of the remaining jobs — because without them entire companies and industries would disappear in competition against companies abroad that have innovated more efficiently.

Efficiency innovations also emancipate capital. Without them, much of an economy's capital is held captive on balance sheets, with no way to redeploy it as fuel for new, empowering innovations. For example, Toyota's just-in-time production system is an efficiency innovation, letting manufacturers operate with much less capital invested in inventory.

INDUSTRIES typically transition through these three types of innovations. By illustration, the early mainframe computers were so expensive and complicated that only big companies could own and use them. But personal computers were simple and affordable, empowering many more people.

Companies like I.B.M. and Hewlett-Packard had to hire hundreds of thousands of people to make and sell PC's. These companies then designed and made better computers — sustaining innovations — that inspired us to keep buying newer and better products. Finally, companies like Dell made the industry much more efficient. This reduced net employment within the industry, but freed capital that had been used in the supply chain.

Ideally, the three innovations operate in a recurring circle. Empowering innovations are essential for growth because they create new consumption. As long as empowering innovations create more jobs than efficiency innovations eliminate, and as long as the capital that efficiency innovations liberate is invested back into empowering innovations, we keep recessions at bay. The dials on these three innovations are sensitive. But when they are set correctly, the economy is a magnificent machine.

For significant periods in the last 150 years, America's economy has operated this way. In the seven recoveries from recession between 1948 and 1981, according to the McKinsey Global Institute, the economy returned to its prerecession employment peak in about six months, like clockwork — as if a spray of economic WD-40 had reset the balance on the three types of innovation, prompting a recovery.

In the last three recoveries, however, America's economic engine has emitted sounds we'd never heard before. The 1990 recovery took 15 months, not the typical six, to reach the prerecession peaks of economic performance. After the 2001 recession, it took 39 months to get out of the valley. And now our machine has been grinding for 60 months, trying to hit its prerecession levels — and it's not clear whether, when or how we're going to get there. The economic machine is out of balance and losing its horsepower. But why?

The answer is that efficiency innovations are liberating capital, and in the United States this capital is being reinvested into still more efficiency innovations. In contrast, America is generating many fewer empowering innovations than in the past. We need to reset the balance between empowering and efficiency innovations.

The Doctrine of New Finance helped create this situation. The Republican intellectual George F. Gilder taught us that we should husband resources that are scarce and costly, but can waste resources that are abundant and cheap. When the doctrine emerged in stages between the 1930s and the '50s, capital was relatively scarce in our economy. So we taught our students how to magnify every dollar put into a company, to get the most revenue and profit per dollar of capital deployed. To measure the efficiency of doing this, we redefined profit not as dollars, yen or renminbi, but as ratios like RONA (return on net assets), ROCE (return on capital employed) and I.R.R. (internal rate of return).

Before these new measures, executives and investors used crude concepts like "tons of cash" to describe profitability. The new measures are fractions and give executives more options: They can innovate to add to the numerator of the RONA ratio, but they can also drive down the denominator by driving assets off the balance sheet — through outsourcing. Both routes drive up RONA and ROCE.

Similarly, I.R.R. gives investors more options. It goes up when the time horizon is short. So instead of investing in empowering innovations that pay off in five to eight years, investors can find higher internal rates of return by investing exclusively in quick wins in sustaining and efficiency innovations.

In a way, this mirrors the microeconomic paradox explored in my book "The Innovator's Dilemma," which shows how successful companies can fail by making the "right" decisions in the wrong situations. America today is in a macroeconomic paradox that we might call the capitalist's dilemma. Executives, investors and analysts are doing what is right, from their perspective and according to what they've been taught. Those doctrines were appropriate to the circumstances when first articulated — when capital was scarce.

But we've never taught our apprentices that when capital is abundant and certain new skills are scarce, the same rules are the wrong rules. Continuing to measure the efficiency of capital prevents investment in empowering innovations that would create the new growth we need because it would drive down their RONA, ROCE and I.R.R.

It's as if our leaders in Washington, all highly credentialed, are standing on a beach holding their fire hoses full open, pouring more capital into an ocean of capital. We are trying to solve the wrong problem.


Our approach to higher education is exacerbating our problems. Efficiency innovations often add workers with yesterday's skills to the ranks of the unemployed. Empowering innovations, in turn, often change the nature of jobs — creating jobs that can't be filled.

Today, the educational skills necessary to start companies that focus on empowering innovations are scarce. Yet our leaders are wasting education by shoveling out billions in Pell Grants and subsidized loans to students who graduate with skills and majors that employers cannot use.

Is there a solution? It's complicated, but I offer three ideas to seed a productive discussion:

CHANGE THE METRICS We can use capital with abandon now, because it's abundant and cheap. But we can no longer waste education, subsidizing it in fields that offer few jobs. Optimizing return on capital will generate less growth than optimizing return on education.

CHANGE CAPITAL-GAINS TAX RATES Today, tax rates on personal income are progressive — they climb as we make more money. In contrast, there are only two tax rates on investment income. Income from investments that we hold for less than a year is taxed like personal income. But if we hold an investment for one day longer than 365, it is generally taxed at no more than 15 percent.

We should instead make capital gains regressive over time, based upon how long the capital is invested in a company. Taxes on short-term investments should continue to be taxed at personal income rates. But the rate should be reduced the longer the investment is held — so that, for example, tax rates on investments held for five years might be zero — and rates on investments held for eight years might be negative.

Federal tax receipts from capital gains comprise only a tiny percentage of all United States tax revenue. So the near-term impact on the budget will be minimal. But over the longer term, this policy change should have a positive impact on the federal deficit, from taxes paid by companies and their employees that make empowering innovations.

CHANGE THE POLITICS The major political parties are both wrong when it comes to taxing and distributing to the middle class the capital of the wealthiest 1 percent. It's true that some of the richest Americans have been making money with money — investing in efficiency innovations rather than investing to create jobs. They are doing what their professors taught them to do, but times have changed.

If the I.R.S. taxes their wealth away and distributes it to everyone else, it still won't help the economy. Without empowering products and services in our economy, most of this redistribution will be spent buying sustaining innovations — replacing consumption with consumption. We must give the wealthiest an incentive to invest for the long term. This can create growth.

Granted, mine is a simple model, and we face complicated problems. But I hope it helps us and our leaders understand that policies that were once right are now wrong, and that counterintuitive measures might actually work to turn our economy around.

[frunk]

The capital investment tax change sounds like a bad idea.  The two reasons you'll pull money out of investment are either you need the money or there's a better investment elsewhere.  In the first case you'll pull the money out anyway, and in the second why encourage the funding of less attractive investments? 

[Zanza]

Yay, we are not alone!

Government Report Reveals China Debt Bomb
Debt-crippled Western nations who have hopes that China will rescue them should think again: a new report from a Chinese regime think tank reveals that China has debt problems of its own.
The State Council Development Research Center's (DRC) Oct. 22 report, "Research on China's Financial Risks," shows the combined central and local government debt at 23.76 trillion yuan ($3.8 trillion), or 59 percent of 2010 GDP. While this number is lower than most Western governments, it is the distribution that is most troubling.
Local governments' short term debt is the most critical, with the highest potential for a financial blow up. In fact, the debt is so high that 78 cities and 99 counties would need to allocate 100 percent of their budget to service it.
A $640 billion central government stimulus plan enabled local governments to borrow heavily in 2009, in the wake of the global 2008 financial crisis. In order to borrow from banks, local governments set up special financial entities that carried out local infrastructure projects, mostly highways and airports.
According to the DRC report, 42 percent of these local debts mature at the end of 2012 and 53 percent by the end of 2013. The report examined 1734 of the special entities and found that more than 26 percent of them are losing money.
Since many local governments are experiencing difficulties in paying the interest on their loans, the probability is low that they will retire the debt on time. Many of the projects aren't generating enough cash to service the debts, so some local governments have taken on new loans to retire old ones, compounding the problem.
It is very likely that the China Banking Regulatory Commission (CBRC) will be forced to introduce a new policy, extending the deadline for entities that cannot pay back the debt, according to the National Audit Office.
There is no sign that investment activity is leveling off, however. On the contrary, it is increasing. Because officials' performance is measured by how much they boost the GDP, the incentive is high for them to overspend in order to create a track record of political achievement, leaving the debt for the next generation.
Wu Jinglian, a well-known Chinese financial scholar and State Council expert, points out that the current investment plan presented by local governments has reached 17 trillion RMB ($2.72 trillion). Addressing the 2012 International Financial Forum, he warned that the Chinese regime's current economic growth stimulus plans are not sustainable, and will create dire consequences if deployed, as this paper reported in a Sept. 19 article.
Speaking in a closed door forum in Shenyang, Liaoning Province, in October 2011, economic scholar Larry Lang predicted that the local debt would cause an economic tsunami, as The Epoch Times earlier reported.
He warned: "Every province in China is Greece. All levels of government will go bankrupt in all aspects."

http://www.theepochtimes.com/n2/china-news/government-report-reveals-china-debt-bomb-307579.html

[Count]

http://www.bloomberg.com/news/2012-11-08/ecb-holds-rates-as-economy-worsens-spain-resists-aid-request.html

The European Central Bank kept interest rates on hold today as the economic outlook worsens and Spain resists asking for a bailout that would open the door to ECB bond purchases.
Policy makers meeting in Frankfurt left the benchmark rate at its historic low of 0.75 percent, as predicted by 62 of 63 economists in a Bloomberg News survey. One forecast a cut to 0.5 percent. ECB President Mario Draghi will brief reporters on the decision at 2:30 p.m.
Draghi yesterday fueled speculation that the ECB might put rate reductions back on the agenda, saying the debt crisis is starting to hurt Germany -- the pillar of economic strength in the euro area -- and inflation risks are "very low." Still, Draghi has acknowledged in the past that rate moves are less effective than they should be because distorted financial markets are interrupting the transmission of ECB policy.
"In normal times, with the economic outlook in Europe, a rate cut would probably be justified," said Nick Kounis, head of macro research at ABN Amro Bank NV in Amsterdam. "But we're not in normal times and a rate cut won't achieve anything."
The Bank of England today left its key interest rate at a record low of 0.5 percent and refrained from expanding its quantitative-easing program.
Spanish Reluctance
While the ECB's pledge to buy government bonds has calmed markets and reduced borrowing costs in Spain and Italy, Spanish Prime Minister Mariano Rajoy is resisting making a request for aid from Europe's bailout fund, a pre-requisite for the ECB to consider intervention.
Rajoy said on Nov. 6 he needs to know how much the ECB would push down Spain's bond yields before his government applies for aid and signs up to the conditions attached.
"We fully expect Mr. Draghi to continue to emphasize that the decision on calling for help rests solely in the hands of the Spanish government," said Nick Matthews, senior European economist at Nomura International Plc in London.
Spanish bond yields rose today after Market News International, citing unidentified Eurosystem and European Union officials, said the ECB hopes it doesn't have to use its bond- purchase program and that Spain is unlikely to seek aid this year.
Spain's 10-year yield climbed six basis points to 5.75 percent. It's still down from 7.62 percent on July 24, two days before Draghi declared he would do whatever is needed to preserve the euro.
Euro-Area Recession
Economic confidence in the 17-member euro area fell to a three-year low in October, adding to signs that the region is in recession after gross domestic product shrank 0.2 percent in the second quarter. Third-quarter GDP is due on Nov. 15.
In Germany, Europe's largest economy, reports this week suggested growth is grinding to a halt. Exports, factory orders and industrial production all fell more than forecast in September. Last month, business confidence dropped to a 2 1/2 year low.
"Germany has so far been largely insulated from some of the difficulties elsewhere in the euro area," Draghi said at a conference in Frankfurt yesterday. "But the latest data suggest that these developments are now starting to affect the German economy." In the euro area, "overall economic activity is weak and it is expected to remain weak in the near term," he added.
Rate Cut?
"In the past two weeks, the euro-area economy has taken a turn for the worse," said David Kohl, deputy chief economist at Julius Baer Group in Frankfurt. "A rate cut is needed and sensible. The earlier it happens, the better."
The European Commission yesterday lowered its 2013 growth forecast for Germany to 0.8 percent from 1.7 percent and said the euro-area economy will expand just 0.1 percent after contracting 0.4 percent this year.
At least five of the 17 euro nations are in recession, including Spain and Italy, and there are still concerns that Greece will be forced to leave the bloc as it struggles to meet the conditions of its bailout.
Greek Prime Minister Antonis Samaras yesterday gathered the support of enough lawmakers to pass austerity measures needed to unlock European funds, after more than 50,000 protestors surrounded Parliament.
Approval of the austerity bill, which raises the retirement age by two years to 67 and cuts wages and pensions a second time this year, is the first of the votes required by Nov. 12 to get a 31 billion-euro ($40 billion) aid tranche and avert a financial collapse that may drive the country from the euro.

[Grallon]

So has the domino effect of economic collapse started yet?




G.

[Count]

I'm in a room with literally dozens of people (two dozen, roughly) watching Jan Kregel speak. He started off by saying he learned under Joan Robinson and I could only think of the Languishite.

http://www.modernmoneyandpublicpurpose.com/seminar-4-real-vs-nominal-economy.html

[Count]

I'm in a room with literally dozens of people (two dozen, roughly) watching Jan Kregel speak. He started off by saying he learned under Joan Robinson and I could only think of the Languishite.

http://www.modernmoneyandpublicpurpose.com/seminar-4-real-vs-nominal-economy.html

And he just mentioned Meyer Minsky! I think I've found the real JR. 

(or these are just big names in econ, but my familiarity with them stems entirely from languish)

[Sheilbh]

For some reason despite discovering that they underestimated the fiscal multiplier of austerity the EU and IMF have chosen to use the old one in their latest report on Greece

The expected proceeds of privatisations in Greece have been halved in the new report and, apparently, the IMF is sceptical that even that's attainable.  The report also doesn't include the debt sustainability section because there's arguments within the Troika about it, apparently the IMF think debt will be 160% of GDP by 2020 and the EU 140% (remember that the Troika thinks 120% is sustainable - based on Italy - which is the official target by 2020 (the EU as argued by Jean-Claude 'we all know what to do, we just don't know how to get re-elected after we've done it'-'when it becomes serious, you have to lie' Juncker) or by 2022 (as Lagarde argued for in their public spat)).

One interesting thing - and I really regret the media narrative of feckless Greeks - is that the EU Council's 2010 decision only foresaw the need for a fiscal consolidation of 10% by 2014.  Due to the declining economy and the need to make deeper cuts so far the Greeks have cut it by 13% of GDP and are now projected to go over 15% by 2014.  Apparently the primary budget deficit is now only 1.5%, from over 10% a few years ago.

From what I can tell it looks like the Greeks are definitely getting two years more, but there's no agreement on how to pay for it.  They'll need an extra €32 billion or so to cover that (there's some jiggery-pokery going on to cover their needs through November) another bailout simply adds to their debt and goes against the policy of trying to reach a sustainable level of debt some time in a decade or so.  But the creditor countries are entirely opposed to official sector haircuts.

One other note is how feeble this has been.  The Troika was supposed to provide quarterly updates on Greece to enable decision making and monitoring.  This is the second report produced in 2012 and even then it's only a leaked and unfinished version.  I don't think it helps that, from what I remember, politicians in the summer were saying they wouldn't make any decisions until after the EU Council meeting, then it was after the Troika's report which then got repeatedly delayed as the date when they'd have to make a decision was pushed further into the future.  Even now I'd read that the bills due on 16 November would mean there'd have to be a decision by then, but reportedly there's now a plan to provide the Greeks short-term financing to cover that.

[The Minsky Moment]

I'm in a room with literally dozens of people (two dozen, roughly) watching Jan Kregel speak. He started off by saying he learned under Joan Robinson and I could only think of the Languishite.

http://www.modernmoneyandpublicpurpose.com/seminar-4-real-vs-nominal-economy.html

The intellectual lineage of that modern money crowd is Hyman Minsky and the Cambridge crowd around Keynes whose names I keep using.  (plus Abba Lerner who was at LSE but turned apostate)

[citizen k]

One other note is how feeble this has been.

It's called "kicking the can" down the road.

[Iormlund]

Yet another general strike today. Maybe the unions thought third time's the charm.

[The Minsky Moment]

For some reason despite discovering that they underestimated the fiscal multiplier of austerity the EU and IMF have chosen to use the old one in their latest report on Greece

Gee I wonder why.
Greece is proving to be a useful experiment in the limitations of austerity as a debt reduction program; too bad for the human guinea pigs who pay the price.