A Change Of Mindset

By Andy Xie in China International Business:


The biggest policy debate this year has thus far been when and how fast to exit from last year's stimulus policies. Last year, in a moment of panic over the global financial crisis, central banks and governments poured monetary and fiscal stimulus into the global economy. The side effects of these misguided policies are already showing up: asset speculation has engulfed the global financial market again and consumer price inflation is creeping up uncomfortably fast, especially in emerging economies. Despite the visible need for tightening, the consensus is demanding a slow and delayed exit. Japan's "early withdrawal" is touted as an example of what could happen otherwise.

Japan has experienced two decades of economic stagnation since the collapse of the infamous bubble it suffered in the 1980s. The most popular explanations are that Tokyo wasn't aggressive enough in stimulating the economy after the bubble burst, or that it withdrew its stimulus too early – or both. This line of thinking is popular among elite economists in the US, where it is rarely challenged. But few Japanese analysts buy it.

The Americans liken an economy in a slide to a car with a dead battery: it can be jump-started with a forceful enough push. But there's no sound logic behind such thinking. After a big bubble bursts, an economy suffers a terrible misalignment between supply and demand. Through high prices, a bubble diverts investment and labor to needed activities. It takes time for an economy to normalize. The bigger the bubble, the longer it takes to heal.

The argument to "stimulate until prosperity returns" is popular because it doesn't hurt anyone in the short term. When a central bank prints money, its nasty consequence — inflation — takes time to show up. When a government spends borrowed money, repayment is in the future. Nobody feels the pain now. Indeed, when debt is sufficiently long-dated, nobody alive need feel the pain. So analysts who advocate stimulus are popular with politicians because it sounds like a free lunch. Japan's tale is just a nice story that seems to support the argument.

At the peak of Japan's bubble, the biggest in history, the excess value of its property and stock markets was more than five times its gross domestic product – more than the entire world's gross domestic product at that time. In comparison, the excess asset value in the US bubble was less than twice its GDP, or half the global GDP. So how is it possible to just stimulate an economy back to health after such a massive correction?

Japan has run up the national debt equal to 200% of GDP — the greatest Keynesian stimulus program in history — all in the name of stimulating the economy back to health. It has failed miserably. Japan's nominal GDP is about the same as when the stimulus began. Those who advocated the policy blame Japan's failure on either the stimulus being too small or not being sustained for long enough – that is, the dosage, not the medicine itself, was at fault.

The bankruptcy of Japan Airlines is a sobering reminder of what is still wrong with Japan. It stayed with unprofitable routes for years without its creditors or shareholders being able to do anything about it. And by making credit cheap and easy, the stimulus prolonged the airline's business model — actually, an anti-business model — for a long time. Zombie companies that have first claims to resources have trapped the Japanese economy in stagnation for decades. The lack of shareholder rights has given the moribund companies the luxury of being able to disregard capital efficiency. The government stimulus has prolonged this inept business practice.
What ails Japan is a lack of reforms, not stimulus. The prolonged and massive bailout has only allowed a bad situation to continue. As governments around the world look at their own problems, this is the lesson they should draw from Japan – not the wrong one that insists Japan should have spent more.

We are hearing the first major departure from the mainstream consensus; US President Barack Obama has just announced a proposal to limit proprietary trading on Wall Street. This is his first major step to address the root cause of the crisis.

The crisis happened because financial professionals had incentives to bet other people's money in a game they could not lose. With so many getting in on the act, the liquidity they threw into the trades made them effective, turning bankers into heroes, but only for a while.

The crisis showed that their behavior was indeed rational: while the losses to shareholders and taxpayers surpassed all the accounting profits that Wall Street reported during the bubble, those who made the trades are still rich, because they paid themselves bonuses in cash, not derivatives.

Obama has not been well-advised. His so-called accomplishment — stabilizing the financial system — comes from throwing trillions of taxpayers' dollars at financial firms. He has behaved like a Wall Street trader: spending other people's money with no thought of consequences. Anyone can do that. Hopefully Obama has fundamentally changed his approach.

Reform, not stimulus, is the solution. Only by limiting financial speculation can the foundations be laid for a healthy recovery, and to prevent another crisis.

I'm Sure Glad The Recession Ended

Mish's Global Economic Trend Analysis:

"It's a good thing the recession ended. Otherwise, key economic charts might look something like this.

Total Loans and Leases Percent Change From Year Ago



Total Loans and Leases



Total Revolving Credit



Total Revolving Credit Percent Change From Year Ago



Housing Starts



State Income Tax Receipts



State Income Tax Receipts Percent Change From Year Ago



If you believe retail sales are going up because of government reports on Advance Sales, then please think again.

You owe it to yourself to read Retail Sales Rise: Where? Let's Take a Look; Expect Nothing Less Than Panic.

After you click on and read the above link, take a good hard look at that last chart and ponder the implications in regards to union salaries, school budgets, pension promises, medical benefits, etc.

Next think about what the massive wave of boomer retirements might do to boomer spending habits and future tax revenue.

Next think about the implications on consumer spending habits were tax hikes attempted to cover any shortfalls.

Then please consider just what might happen if the US stock market went sideways for five years.

Finally, please consider just what might happen if the US stock market were to mimic the Japanese Nikkei like this.

Nikkei Monthly Chart



click on chart for sharper image

But hey, not to worry, after all the recession is over, the above charts are a mere figment of everyone's imagination, and what happened in Japan cannot possibly happen here.

Or can it?

Mike 'Mish' Shedlock
http://globaleconomicanalysis.blogspot.com

The economic forecast is simple: the next 10 years are going to be a drag

Larry Elliott in The Guardian writes very nice post about the change of NICE period for DRAG time.


Get ready for the austerity decade. Forget all thoughts that the economic storm of the past 30 months is about to blow over. We've had what Mervyn King once called the NICE period of non-inflationary constant expansion but now we face a long DRAG – deficit reduction, anaemic growth. The lessons of economic history, the current configuration of the economy, and inescapable long-term challenges that have to be faced provide the same message: it's payback time.

Let's start with a trip down memory lane. The post-war era has been characterised by three distinct phases in the global economy. There was a 25-year boom that ended with the quadrupling of oil prices in the autumn of 1973 during the Arab-Israeli war. There was another long boom – very different in its shape and in the division of the spoils – that also lasted for a quarter of a century, between 1982 and 2007. In the middle, there was a nine-year period in which policymakers grappled with stagnating growth and rising inflation.

It's tempting to treat the current crisis as simply another of the mini-problems that punctuated the 1982-2007 upswing, but this is different from the stock market crash of 1987, the US savings and loans debacle of the 80s, the mild recession of the early 90s or any of the crashes in emerging markets during the 90s. All the previous crises could be alleviated by cheap money policies to create a bit more debt or shrugged off as peripheral events. This crisis is different; it has gone to the heart of the global economy, it has left the financial sector in a zombie-like state, and it has caused the same sort of existential crisis for the Chicago school of economists as stagflation caused for Keynesians in the 70s.

The profound nature of the shock means that the adjustment period will be just as long as it was in the 70s and early 80s, when the occasional flash of blue sky was quickly blotted out by a new thundercloud. In the 70s, it took a long time for policymakers to understand that the old levers were no longer working, and the same applies now. The response to the crisis has been unprecedented, and thankfully has helped prevent a deep recession from turning into something much worse. There is some comfort to be drawn from the V-shaped recovery enjoyed by China and some of the other Asian economies, which suggests a decoupling between the developed economies of Europe and North America and the fast-growing emerging world. But not much. The sobering fact is that the structural weaknesses that caused the crisis – the imbalances between creditor and debtor nations, an over-reliance on debt, a financial sector that has lost sight of its real purpose – remain untackled. We are – as King noted last week when calling for reform of the banks that would prevent retail banks on the high street speculating with their customers' money – living in a fool's paradise.

Turn now to the immediate outlook. Financial markets have been wobbling since the turn of the year, fearful that the pick-up in activity from the spring of 2009 was merely a prolonged dead-cat bounce. There is plenty for the bears to be worried about. The strength of the recovery in the United States is flattered by businesses rebuilding stocks run down during the early, savage months of the downturn. The housing market is weak and will remain so until unemployment starts to come down. Officially, the US has a jobless rate of 10% but it is much higher once the number of part-time workers who would prefer to work full time is taken into account. Unsurprisingly, consumer confidence is low.

Europe is already into the second phase of a double-dip recession. The economic convergence that the single currency was designed to bring about has happened: unfortunately the fast-growing countries on the fringe have been dragged down to the slow pace of those at the core rather than vice versa.

As for the UK, don't be misled by the upward revision to growth in the final three months of 2009. Downward revisions to previous quarters of last year mean that the peak to trough fall in output was even bigger than previously thought at 6.2%, while the boost to activity between October and December was partly the result of strong government spending and partly the result of consumers bringing forward spending to beat the return of VAT to 17.5%. There is a real possibility – looking at the latest official data for high-street spending and for unemployment – of a relapse in the first quarter of 2010. King and many of his fellow members of the Bank of England's monetary policy committee certainly think so, judging by recent comments.

But never fear. We are told, endlessly, that Britain is well-placed to take advantage of the recovery in the global economy. The depreciation in sterling means that the focus of growth will be switched from domestic demand to exports. This would be funny if it were not so serious. Here's the reality. More than half of Britain's visible exports go to a part of the world – Europe – that is barely growing. Less than 5% go to the big emerging markets of China, India and Brazil. UK exporters have certainly been helped by the drop in the value of the pound, but have responded by fattening their profit margins rather than by selling more goods. The extra cash flow is keeping them in business but not prompting additional spending on new kit. Last week's investment figures were truly horrific, with capital expenditure in manufacturing down by more than a third between the fourth quarter of 2008 and the same period of 2009.

The lack of investment will show up in Britain's trend rate of growth – the rate at which the economy can expand without inflationary pressures surfacing. In the pre-crisis period, the Bank and the Treasury thought the trend rate of growth was about 2.5%-2.75%, but the recession has left deep scars. Capital has been scrapped and is not being replaced. The trend rate of expansion will have fallen at a time when there is a need to reduce the mountain of public debt. That will make the deficit cutting process even longer and even tougher.

All this comes at a time when pressures on public spending are bound to intensify as a result of higher medical and long-term care costs of an ageing population, and the need to "brain-up" the workforce. Andrew Dilnot, principal of St Hugh's college Oxford and former director of the Institute for Fiscal Studies, says the greying of the baby boomer generation and extra NHS/care costs will add one percentage point per decade to the structural budget deficit.

So while the fragility of the economy means it would be unwise to start tightening fiscal policy immediately, an eventual squeeze is inescapable. Apart from anything else, the interest payments on the national debt are rising fast, and every pound spent paying off the UK's creditors is a pound unavailable for schools, hospitals and care homes.

As a result, the next decade will be marked by higher taxes and restraint on public spending. Consumer demand and government investment will grow far more slowly than in the boom years. Eventually, resources will be diverted into investment and exports. But this is a sick economy, and it will take a long, long time.

CLSA's Chris Wood "In Five Years The US Dollar Paper Standard Will Collapse"

Zero Hedge: "

Chris Wood, who publishes the famous Fear and Greed newsletter, which Zero Hedge has republished on many occasions in the past (and whose latest edition can be found here), has some very scary things to say about the dollar in his interview by the CNBC lunch brigade. While Wood is still optimistic on Asia, and specifically China, due to lack of deflation in the region (for now), and expects an appreciation of the yuan soon, he is about as pessimistic on the dollar and "developed" economies as they come.

My view is that there is an inevitable endgame as a result of all this massive spending of taxpayer money in the West and Japan to bail out bankrupt banking systems, so in my view unfortunately the end game will be systemic government debt crisis in the western world. It will probably happen in Europe and will climax in the US, and i am expecting on a five year view the collapse of the US Dollar paper standard...The key reason why that is the endgame is that this credit crisis we
saw in the west in 2008 and 2009 has simply been deferred, because 95%
of the so-called government policy solutions to deal with this crisis
have simply been to extend government guarantees. So the problem has
been transferreWd from the private sector to the public sector. It is just a matter of time before investors revolt against these sovereign guarantees...The crisis is going to happen first in Europe, the US will be the endgame.

Wood is more optimistic on Japan and its 200% debt/GDP as the bulk of the debt is held by Japanese investors, which is not a new topic and has been discussed previously by SocGen's Dylan Grice, who however comes to the opposite conclusion. And to be sure, Chris' optimism on China has recently met with some stern opposition, including some of the most respected hedge funds, who see a simmering crisis in the world's most populous country which will make all existing bubble seem tame in comparison.

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The world economy has no easy way out of the mire

Financial Times:


By Martin Wolf
Published: February 23 2010 21:49


Anybody who looks carefully at the world economy will recognise that a degree of monetary and fiscal stimulus unprecedented in peacetime is all that is prodding it along, not only in high-income countries, but also in big emerging ones. The conventional wisdom is that it will also be possible to manage a smooth exit. Nothing seems less likely. So let us consider the endgame, instead.

We must start from the reverse side of the stimulus coin: the private sector is now spending far less than its aggregate income. Forecasts in the Organisation for Economic Co-operation and Development’s latest Economic Outlook imply that in six of its members (the Netherlands, Switzerland, Sweden, Japan, the UK and Ireland) the private sector will run a surplus of income over spending greater than 10 per cent of gross domestic product this year. Another 13 will have private surpluses between 5 per cent and 10 per cent of GDP. The latter includes the US, with 7.3 per cent. The eurozone private surplus will be 6.7 per cent of GDP and that of the OECD as a whole 7.4 per cent.

Moreover, the shift in the private sector balance between 2007 and 2010 is forecast to exceed 10 per cent of GDP in no fewer than eight OECD member countries (see chart). It is also forecast to exceed 5 per cent of GDP in another eight. In the US, it is forecast to be 9.6 per cent of GDP. In the eurozone, it is forecast at 5.5 per cent of GDP and in the OECD at 7.3 per cent. Depression threatened.

Note that such huge shifts towards frugality will have occurred, despite the unprecedented monetary loosening. While the latter helped prevent a still-greater collapse in private spending, the huge fiscal deficits, largely the result of automatic stabilisers, have been no less important. If governments had tried to close fiscal deficits, as they attempted to do in the 1930s, we would be in another Great Depression.

So how do we exit? To answer the question, we need to agree on how we entered. A big part of the answer is that a series of bubbles helped keep the world economy driving forward over the past three decades. Behind these, however, lay a credit super-bubble, which burst in 2008. This is why private spending imploded and fiscal deficits exploded.

William White, former chief economist of the Bank for International Settlements, is a leading proponent of the view that monetary policy errors, particularly by the Federal Reserve, have driven the world economy. Richard Duncan offers a similar, but more radical, critique in his thought-provoking new book, The Corruption of Capitalism.

At the 75th birthday conference of the Reserve Bank of India this month, Mr White gave a lucid version of his critique. With inflation kept down by supply shocks, inflation-targeting central banks kept interest rates too low too long. The result, he argued, was a series of imbalances, not dissimilar to those in the US in the 1920s and Japan in the 1980s. In particular, with the real interest rate well below the rate of growth of economies, the expansion of credit was effectively unconstrained. Debt duly exploded upwards (see chart).

Mr White pointed to four imbalances: asset price bubbles, notably of stocks in the 1990s and houses in the 2000s; the explosion of the balance sheet of the financial sector and increase in its exposure to risk; what “Austrian school” economists dub “malinvestment” – soaring consumption of durables in high-income countries and booming construction of housing and shopping malls in countries such as the US, and of export-oriented factories in China; and, finally, trade imbalances, with capital pouring into the US and other high-spending countries.

I do not agree that monetary policy mistakes were responsible for all of this. But they played a role. In any case, all this had to end. Now, after the implosion, we witness the extraordinary rescue efforts. So what happens next? We can identify two alternatives: success and failure.

By “success”, I mean reignition of the credit engine in high-income deficit countries. So private sector spending surges anew, fiscal deficits shrink and the economy appears to being going back to normal, at last. By “failure” I mean that the deleveraging continues, private spending fails to pick up with any real vigour and fiscal deficits remain far bigger, for far longer, than almost anybody now dares to imagine. This would be post-bubble Japan on a far wider scale.

Unhappily, the result of what I call success would probably be a still bigger financial crisis in future, while the results of what I call failure would be that the fiscal rope would run out, even though reaching the end might take longer than worrywarts fear. Yet the big point is that either outcome ultimately leads us to a sovereign debt crisis. This, in turn, would surely result in defaults, probably via inflation. In essence, stretched balance sheets threaten mass private sector bankruptcy and a depression, or sovereign bankruptcy and inflation, or some combination of the two.

I can envisage two ways by which the world might grow out of its debt overhangs without such a collapse: a surge in private and public investment in the deficit countries or a surge in demand from the emerging countries. Under the former, higher future income would make today’s borrowing sustainable. Under the latter, the savings generated by the deleveraging private sectors of deficit countries would flow naturally into increased investment in emerging countries.

Yet exploiting such opportunities would involve radical rethinking. In countries like the UK and US, there would be high fiscal deficits over an extended period, but also a matching willingness to promote investment. Meanwhile, high-income countries would have to engage urgently with emerging countries, to discuss reforms to global finance aimed at facilitating a sustained net flow of funds from the former to the latter.

Unfortunately, nobody is seized of such a radical post-crisis agenda. Most people hope, instead, that the world will go back to being the way it was. It will not and should not. The essential ingredient of a successful exit is, instead, to use the huge surpluses of the private sector to fund higher investment, both public and private, across the world. China alone needs higher consumption.

Let us not repeat past errors. Let us not hope that a credit-fuelled consumption binge will save us. Let us invest in the future, instead.