US Retail

Mish's Global Economic Trend Analysis: 200,000 Retail Store Closings Coming in 2009

This Christmas season was the worst ever for many retailers. And with too many stores and too few customers, expect to see A Rash of Retailer Closings in 2009.

The most dramatic pullback in consumer spending in decades could transform the retail landscape, as thousands of stores and whole malls close down. And analysts expect prolonged woes in the industry as the dramatic changes in shopping behavior could linger for another two or three years amid worries about the deteriorating economy and rising layoffs.

"You are going to see a substantial retrenchment in the retail industry," said Rick Chesley, partner in the global bankruptcy and restructuring group at international law firm Paul Hastings. "The downturn has been catastrophic."

The retail casualties, which were first among home furnishing stores and then many apparel stores over the past year or so, are expected to cut across all sectors as shoppers have slashed their spending on non-essentials, from TVs to jewelry.

About 160,000 stores will have closed this year and 200,000 more could close next year, said Burt P. Flickinger III, managing director of consulting firm Strategic Resource Group. That would be the industry's biggest contraction in 35 years. Flickinger expects 2,000 to 3,000 malls to close in March and April.

AlixPartners, a turnaround consulting firm, predicts that 25.8 percent of 182 major retailers it tracks are facing major financial distress or will face a significant risk of filing for bankruptcy next year or in 2010 -- the highest level in the 10 years that the firm has been compiling the figures. That compares with the 4 percent to 7 percent that it predicted would face financial woes in the previous two years.

Wave of Bankruptcies and Closures Coming

International Council of Shopping Centers comes up with a different set of numbers numbers as reported by Bloomberg in Holiday Sales Drop to Force Bankruptcies, Closings.

U.S. retailers face a wave of store closings, bankruptcies and takeovers starting next month as holiday sales are shaping up to be the worst in 40 years.

Retailers may close 73,000 stores in the first half of 2009, according to the International Council of Shopping Centers. Talbots Inc. and Sears Holdings Corp. are among chains shuttering underperforming locations.

“You’ll see department stores, specialty stores, discount stores, grocery stores, drugstores, major chains either multi- regionally or nationally go out,” Flickinger, managing director of Strategic Resource Group, a retail-industry consulting firm in New York, said today in a Bloomberg Radio interview. “There are a number that are real causes for concern.”

Probably 50,000 stores could close without any effect on consumer choice, Gregory Segall, a managing partner at buyout firm Versa Capital Management Inc., said this month during a panel discussion held at Bloomberg LP’s New York offices. Only retailers with healthy balance sheets will survive the recession, according to Matthew Katz, a managing director at consulting firm AlixPartners LLP.

The ICSC predicts, using U.S. Bureau of Labor Statistics data, that 148,000 stores will shut down in 2008. That would be the largest number since 151,000 closings in 2001, during the last recession, according to ICSC Chief Economist Michael Niemira.

Retailers’ pricing models are being challenged by consumers, according to Richard Hastings, consumer strategist at Global Hunter Securities LLC of Newport Beach, California.

“The whole pricing system is becoming an old-fashioned bazaar,” Hastings said today in a telephone interview. “They’re going into the stores and they’re looking at the stuff and they’re saying ‘You know what? I know that that price is way too high,’ and they have figured out that the signage doesn’t mean that much.”

List of Retail Store Closings

Terri Potratz has a List of Retail Store Closings in US. Most will recognize the names on the list.

Evidence is now irrefutable that the Shopping Center Economic Model Is History.

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No Way Out: Inflation

Exit Strategy: Inflation « The Baseline Scenario

The Baseline Scenario

What happened to the global economy and what we can do about it
Exit Strategy: Inflation


We know there is going to be a large fiscal surge in the US (the latest estimate is a stimulus of $675-775bn, which is a bit lower than numbers previously floated). This will likely arrive as the US recession deepens and fears of deflation take hold.

The precise outcomes for 2009 are, of course, hard to know yet - this depends primarily on the resilience of US consumer spending and whether large international shocks materialize. But we can have a sense of what happens after the fiscal stimulus has played out (or its precise consequences become clear). There are two main potential scenarios.

First, the fiscal strategy works. In this case, the US pulls out of recession reasonably quickly (perhaps by the second half of 2009). Once this seems likely, the Federal Reserve will want to cut back on its quantitative easing and perhaps even think about raising interest rates. But this will be hard to do for political reasons - the Fed will feel pressed not to quash an incipient recovery, so it will err on the side of keeping interest rates low and credit available on generous terms. At the same time, a great deal of the fiscal stimulus will be working its way through the pipeline for at least two years. The net effect is inflation and presumably a weakening of the dollar (although the latter of course depends on what others are doing around the world.)

Second, the fiscal strategy does not work. In this case, the US recession deepens and we head into a serious global slump. Some more fiscal stimulus might be offered, but faith in its effectiveness will decline sharply. The next policy move in this case is even more quantitative easing (i.e., essentially issuing even more money). This would not usually be appealing, but the global depression would be fed by and feed into serious deflation, and the consensus will shift from “avoid inflation over 2%” to “any inflation is preferable to deflation”. The net effect is again inflation, at least in the US and probably more broadly.

Of course, there are other possibilities. The fiscal stimulus could reflate the economy just enough, i.e., so that growth returns to potential (whatever that is after a crisis of this nature), but not “too much” - so that prices increase but annual inflation never rises significantly above 2%. This scenario seems rather too ideal, and to require too many things to go right, to be high probability.

It is also possible that in a global depression/deflation scenario even the Fed could not make inflation positive. But this also seems to be quite a remote possibility.

So inflation seems hard to avoid, irrespective of how the upcoming fiscal moves play out.

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Dollar under pressure

RGE Monitor

# Duy: The Fed and Treasury are setting the stage for a disorderly adjustment of the Dollar by ignoring the external imbalance. Without external adjustment in place, pushing rates to zero, flooding the economy with money, and pumping out hundreds of billions of new debt threatens to pull the rug out from under the Dollar. Even more worrisome, however, is that surplus nations respond with competitive depreciations
# FT: A full scale panic out of the dollar would indicate the outside world believes the policy of quantitative easing will fail. On the other hand, if the Fed's policy actions work, Bernanke will be forced to normalize rates to prevent excess inflation - and in the process will inflect massive losses on those buying Treasuries at 2.25%
# Setser: There is a real risk that the adjustment (of global imbalances) won't be gradual
# Bergsten: A renewed fall of the dollar could deepen the housing crisis and economic weakening. Rate cuts would exacerbate dollar weakness. It may be necessary to consider currency intervention in the strategy for responding to the crisis
# BNY: USD policy over the past eight years to 2Q08 could best be characterized as "benign neglect". It seems possible that the appointment of the new Treasury Secretary under Obama could see the revival of the "strong USD" mantra. Given the nation's huge funding needs in the years ahead, a stable to gently rising USD would help keep attracting in much needed capital from abroad (China and Saudi Arabia would likely be happy with this outcome)
# UniCredit: Though a falling dollar risks rising inflation, asset bubbles and loss of macroeconomic control in dollar peg countries, dollar pegs are likely to continue anyway
# PIMCO: Current account deficit will continue to put downward pressure on USD

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Deutsche Bank says yes, do you?

DB Research

Does the IMF have sufficient resources to bail out the emerging markets?

December 29, 2008

It is now difficult to imagine that only a year ago the IMF was going through an existential crisis. Almost all major borrowers had repaid their loans and some pundits were suggesting that the high level of precautionary FX reserves in the emerging markets would make the International Monetary Fund unnecessary as a lender of last resort. The global financial crisis has of course once again turned the Fund into an important and, in many cases, pivotal global liquidity provider. The financial shock has exposed financial vulnerabilities in a number of emerging markets. Over the past few months, the IMF has increased its loan commitments by more than USD 40 bn. Further loan agreements are ready for approval by the Fund Board or in negotiation currently being negotiated (Belarus, El SalvadorLatvia and, Serbia,Turkey) and other countries may yet be forced to request IMF financial support over the coming months. This raises the question whether the Fund will have sufficient resources to deal with the global financial crisis.

aThe massive increase in cross-border financial flows has no doubt made it more challenging for the Fund to counter capital account shocks. In 2002, net private capital flows to emerging markets amounted to USD 170 bn. Last year they reached a staggering USD 1,030 bn. Stripping out more stable FDI flows, net private capital flows exploded from an average of USD 10 bn in 1999-2002 to more than USD 550 bn last year. In gross terms, private cross-border flows also skyrocketed. Gross bank lending to emerging markets soared from USD 117 bn in 2000 to USD 455 bn in 2007, while gross bond issuance doubled from USD 69 bn to USD 142 bn over the same period. Net portfolio equity flows amounted to USD 145 bn in 2007, a ten-fold increase compared to 2000!

But have emerging markets not sharply reduced their financial vulnerabilities over the past few years? This is true for most of the larger, systemically important emerging markets, but is not true for the emerging markets universe as a whole. While emerging markets’ FX reserves have risen dramatically over the past few years, the accumulation has been concentrated in just a handful of countries. FX reserves surged by a staggering USD 1 tr in 2007, but the BRIC countries – and first and foremost China – accounted for over two-thirds of the increase. Emerging markets are also running an aggregate current account surplus, but according to the World Bank one in two registered a deficit in excess of 5% of GDP last year! Not all of these countries depend on private capital flows to finance their current account shortfalls, but many of them do. So the IMF will have its work cut out should the current decline in cross-border financial flows prove more permanent than expected. The longer the global crisis drags on, the greater will be the call on IMF financial resources.

aThe IMF’s lending capacity has improved in recent years following substantial loan repayments by countries such as Argentina and Brazil. As of September, its one-year forward commitment capacity (FCC) amounted to USD 200 bn, not including an additional USD 50 bn under the New and General Arrangements to Borrow (NAB/GAB). In 2002, the FCC stood at a mere USD 74 bn. Nonetheless, the IMF’s financial resources have seen only very modest growth compared to the staggering upturn in private-sector financial flows (e.g. USD 5.7 bn or 1.8% ad hoc quota increase in 2006). The last significant increment took place during the regular, quinquennial general quota review in 1998 when quotas were boosted by 45% (and the NAB was approved). (A second round of quota increases under the quota and voice reform process will, once approved by IMF members, lift quotas by a further 9.6%.)

The Fund’s new short-term liquidity facility (SLF) provides eligible member countries with access of to up to five times their subscribed quota. This means that in a scenario where four of the world’s six largest emerging markets (e.g. Brazil, India, Korea and Mexico) were to draw on the facility at the same time, the IMF’s lending capacity would decline by USD 100 bn overnight. The fact that loans drawn under the SLF are short-term is somewhat of a mitigating factor. We continue to believe that such a scenario is not very likely. But if the past few months have shown anything it is that almost anything is possible and that financial shocks have become more systemic in nature. If in such a scenario several other countries requested substantial stand-by arrangements (or access to the SLF), IMF resources could quickly become stretched.

Would such a scenario spell doom for the emerging markets? If our optimism about the larger emerging markets were misplaced and several of these countries ended up requiring large bail-out packages, several lines of defence would be available. Other multilateral and bilateral funding sources could be tapped in order to alleviate the pressure on the Fund’s lending capacity. Japan has already offered USD 100 bn. China may also be persuaded to provide additional financing. Being very dependent on trade and enjoying a solid financial position, China would have an interest in stabilising a badly shaken global financial system and pre-empting potential threats to the world trade system. Offering the Fund USD 100 bn in financing would not make a difference to China’s financial stability and politically it would give Beijing an opportunity to strengthen its role as an important stakeholder in the global financial and economic system. Beijing could probably be persuaded to provide funding in exchange for an increase in IMF voting rights. At the multilateral level, the World Bank and other regional development banks could provide additional funding to emerging markets and so could the EU, the US and Japan (and China) on a bilateral basis, either by way of loans or further central bank swap agreements (e.g. recent agreement on establishing/ augmenting currency swap facility between China, Japan and Korea).

In conclusion, even if a prolonged global crisis were to substantially reduce the Fund’s lending capacity and impair its lender-of-last-resort function, this would not necessarily spell doom and gloom for emerging markets. Our baseline scenario remains one where the larger emerging markets will manage to avoid tapping IMF financial support and in this scenario the Fund’s resources should be sufficient to cope with the financial problems that emerging markets are and will be facing over the next 12-24 months.

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Why should I read balances Mr Buffet?

Accounting Standards Wilt Under Pressure - washingtonpost.com

By Glenn Kessler
Washington Post Staff Writer
Saturday, December 27, 2008;
World leaders have vowed to help prevent future financial meltdowns by creating international accounting standards so all companies would play by the same rules, but the effort has instead been mired in loopholes and political pressures.

In October, largely hidden from public view, the International Accounting Standards Board changed the rules so European banks could make their balance sheets look better. The action let the banks rewrite history, picking and choosing among their problem investments to essentially claim that some had been on a different set of books before the financial crisis started.

The results were dramatic. Deutsche Bank shifted $32 billion of troubled assets, turning a $970 million quarterly pretax loss into $120 million profit. And the securities markets were fooled, bidding Deutsche Bank's shares up nearly 19 percent on Oct. 30, the day it made the startling announcement that it had turned an unexpected profit.

The change has had dramatic consequences within the cloistered world of accounting, shattering the credibility of the IASB -- the very body whose rules have been adopted by 113 countries and is supposed to become the global standard-setter, including for the United States, within a few years.
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Dollar down, gold up

Hussman Funds - Weekly Market Comment: The Dollar Crisis Begins - December 22, 2008

In the next several months, we're likely to observe one of two things. If the dollar holds steady, Treasury bond prices are likely to plunge; if Treasury prices hold steady, the value of the dollar is likely to plunge. Either way, foreign holders of Treasury securities are facing probable losses, and they know it.

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The Economist predicting deflation

After zero interest rates, where next? | Ground zero | The Economist

Unconventional monetary policy is often called “quantitative easing” because its effect is felt through the quantity rather than the cost of credit. Through an array of lending programmes, the Fed’s balance-sheet has soared from below $900 billion to more than $2 trillion, and is about to grow further.

Will these tactics work? In an exhaustive study of unconventional monetary-policy options in 2000, five Fed staff economists concluded, “These tools have their limitations, and there is considerable uncertainty regarding their likely effectiveness.” The impact of the Fed’s actions to date even on short-term interbank rates is inconclusive; its ability to influence much larger, globally integrated bond markets is even less certain. Still, Vincent Reinhart, who studied such policy options while at the Fed and is now at the American Enterprise Institute, a think-tank, believes they will work if they are big enough. “There is some size of the central bank’s balance-sheet that will restart financial markets.”

The Fed seems to believe its actions matter more for psychology than in influencing the supply of and demand for long-term debt. A senior official says the Fed is not explicitly attempting to lower long-term rates; instead it wants to narrow the unusually wide spread between yields on MBSs and Treasuries. By reassuring investors that a committed buyer is in the market, it hopes to reduce the illiquidity premium pushing yields up.

Psychology does seem to matter. The Fed has not yet bought any MBSs, but their yields have dropped from 5.45% to 3.9% since it proposed doing so. One-quarter of a percentage point of that came after this week’s announcement. If this is sustained, the conventional 30-year mortgage rate should fall to around 5%, says Nicholas Strand of Barclays Capital, from over 6.5% in early November. Still, over two-thirds of the drop in MBS yields resulted from falls in Treasury yields. Even though the Treasury now explicitly supports Fannie and Freddie, MBS spreads remain wide, owing in part to reduced buying by the companies themselves and by foreign investors, Mr Strand says.


Amid falling consumer spending and soaring unemployment there are some hints that policymakers’ actions are making a difference. Home sales are stable and the drop in mortgage rates should help them. A bottom in housing is probably necessary to start the healing process elsewhere in the economy. Share prices have risen since late November.

The Fed’s gung-ho leadership may also nudge other central banks towards easing more aggressively. The dollar fell sharply, particularly against the euro, after the Fed’s action. That may weaken the European Central Bank’s reservations about cutting rates again. Similarly, if the weaker dollar takes pressure off sterling, the Bank of England may be more willing to ease again.

The dollar’s drop may also reflect some fear that the Fed will be slow to reverse course, leading to inflation. That, however, is a worry for another day. Falling petrol prices triggered the largest monthly drop in American consumer prices on record in November. With unemployment likely to increase further, the immediate concern is that inflation could fall too low

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Wolf on Keynes

FT.com / Columnists / Martin Wolf - Keynes offers us the best way to think about the financial crisis

Keynes offers us the best way to think about the financial crisis

By Martin Wolf

Published: December 23 2008 18:06 | Last updated: December 23 2008 18:06

We are all Keynesians now. When Barack Obama takes office he will propose a gigantic fiscal stimulus package. Such packages are being offered by many other governments. Even Germany is being dragged, kicking and screaming, into this race.

The ghost of John Maynard Keynes, the father of macroeconomics, has returned to haunt us. With it has come that of his most interesting disciple, Hyman Minsky. We all now know of the “Minsky moment” – the point at which a financial mania turns into panic.

Like all prophets, Keynes offered ambiguous lessons to his followers. Few still believe in the fiscal fine-tuning that his disciples propounded in the decades after the second world war. But nobody believes in the monetary targeting proposed by his celebrated intellectual adversary, Milton Friedman, either. Now, 62 years after Keynes’ death, in another era of financial crisis and threatened economic slump, it is easier for us to understand what remains relevant in his teaching.

I see three broad lessons.

The first, which was taken forward by Minsky, is that we should not take the pretensions of financiers seriously. “A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him.” Not for him, then, was the notion of “efficient markets”.

The second lesson is that the economy cannot be analysed in the same way as an individual business. For an individual company, it makes sense to cut costs. If the world tries to do so, it will merely shrink demand. An individual may not spend all his income. But the world must do so.

The third and most important lesson is that one should not treat the economy as a morality tale. In the 1930s, two opposing ideological visions were on offer: the Austrian; and the socialist. The Austrians – Ludwig von Mises and Friedrich von Hayek – argued that a purging of the excesses of the 1920s was required. Socialists argued that socialism needed to replace failed capitalism, outright. These views were grounded in alternative secular religions: the former in the view that individual self-seeking behaviour guaranteed a stable economic order; the latter in the idea that the identical motivation could lead only to exploitation, instability and crisis.

Keynes’s genius – a very English one – was to insist we should approach an economic system not as a morality play but as a technical challenge. He wished to preserve as much liberty as possible, while recognising that the minimum state was unacceptable to a democratic society with an urbanised economy. He wished to preserve a market economy, without believing that laisser faire makes everything for the best in the best of all possible worlds.

This same moralistic debate is with us, once again. Contemporary “liquidationists” insist that a collapse would lead to rebirth of a purified economy. Their leftwing opponents argue that the era of markets is over. And even I wish to see the punishment of financial alchemists who claimed that ever more debt turns economic lead into gold.

Yet Keynes would have insisted that such approaches are foolish. Markets are neither infallible nor dispensable. They are indeed the underpinnings of a productive economy and individual freedom. But they can also go seriously awry and so must be managed with care. The election of Mr Obama surely reflects a desire for just such pragmatism. Neither Ron Paul, the libertarian, nor Ralph Nader, on the left, got anywhere. So the task for this new administration is to lead the US and the world towards a pragmatic resolution of the global economic crisis we all now confront.

The urgent task is to return the world economy to health.

The shorter-term challenge is to sustain aggregate demand, as Keynes would have recommended. Also important will be direct central-bank finance of borrowers. It is evident that much of the load will fall on the US, largely because the Europeans, Japanese and even the Chinese are too inert, too complacent, or too weak. Given the correction of household spending under way in the deficit countries, this period of high government spending is, alas, likely to last for years. At the same time, a big effort must be made to purge the balance sheets of households and the financial system. A debt-for-equity swap is surely going to be necessary.

The longer-term challenge is to force a rebalancing of global demand. Deficit countries cannot be expected to spend their way into bankruptcy, while surplus countries condemn as profligacy the spending from which their exporters benefit so much. In the necessary attempt to reconstruct the global economic order, on which the new administration must focus, this will be a central issue. It is one Keynes himself had in mind when he put forward his ideas for the postwar monetary system at the Bretton Woods conference in 1944.

No less pragmatic must be the attempt to construct a new system of global financial regulation and an approach to monetary policy that curbs credit booms and asset bubbles. As Minsky made clear, no permanent answer exists. But recognition of the systemic frailty of a complex financial system would be a good start.

As was the case in the 1930s, we also have a choice: it is to deal with these challenges co-operatively and pragmatically or let ideological blinkers and selfishness obstruct us. The objective is also clear: to preserve an open and at least reasonably stable world economy that offers opportunity to as much of humanity as possible. We have done a disturbingly poor job of this in recent years. We must do better. We can do so, provided we approach the task in a spirit of humility and pragmatism, shorn of ideological blinkers

As Oscar Wilde might have said, in economics, the truth is rarely pure and never simple. That is, for me, the biggest lesson of this crisis. It is also the one Keynes himself still teaches.

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Dollar outlook from RGE Monitor

Does the U.S. dollar’s December slide
mean the USD has passed its peak? Most likely not. The turn-of-the-year
profit-taking on long USD positions creates a near-term blip in the
dollar's uptrend but doesn't alter the medium-term trend of appreciation versus the euro. The four horseman of the carry trade apocalypse - Deleveraging, Risk Aversion, Growth Differentials and the Dollar's Reserve Currency Status
- would need to retreat before we see a sustained pullback in the
EUR/USD from the slide to near-parity ($1.10-$1.30). Governments, banks
and other firms are still scrambling for dollars to repay their
USD-denominated debt while signs of global recession and credit crisis
spur on the flight-to-safety in U.S. Treasuries. European sovereign bonds offer an alternative but inferior safe haven because of the European bond market’s fragmentation and exposure to emerging Europe.
More aggressive policy response in the U.S. compared to Europe, could
bring the U.S. out of a recession faster than the Eurozone (though
growth will most likely remain subdued for some years to come),
supporting the dollar against the euro. In the longer term, however,
once risk appetite revives, the greenback might lose its defenses in
wake of worries surrounding U.S. public debt expansion and the
potential inflationary effect of quantitative easing.

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Recovery

FT.com / Comment / Opinion - Five ways to start the world economic recovery

Five ways to start the world economic recovery

By George Magnus

Published: December 18 2008 19:27 | Last updated: December 18 2008 19:27

After the Minsky Moment – where euphoria tips into crisis, named after Hyman Minsky – the capitulation of economic activity has been rapid and severe. The outlook is as dark as the doomsayers assert. The only thing that stands between today’s dire economic prospects and a lost decade similar to Japan’s in the 1990s is the competence and authority of macroeconomic policy. We have a long way to go, but for five reasons, even doomsayers can start to feel the force, so to speak.

First, governments have already acted decisively to preserve the integrity of the formal banking system, while the so-called shadow banking system is collapsing. Over $8,000bn (€5,650bn, £5,150bn) of programmes to stem the collapse in credit and housing have been announced but it is too soon to declare victory. To strengthen banks in the recession and sustain lending, European banks will need a further $100bn-$150bn of capital, while US banks, including regional banks, should quickly be allocated most of the unspent Tarp money of $350bn.

Second, governments must continue to facilitate the enormous task of sustaining credit flows and restructuring debt. Bankruptcies are inevitable but additional direct lending programmes, asset purchases and government guarantees are needed to keep liquidity flowing to good corporate and residential borrowers, especially while bank balance sheets are constrained by the need to soak up bad assets that were previously held off-balance sheet. Equity-for-debt swaps will be required for companies with excessive debt.

Third, the full force of fiscal policy needs to be deployed to contain the depth of the recession and credit losses and the impact on jobs and incomes. British, German and French programmes amount to a little over 1 per cent of their gross domestic product, but much of what is being proposed in the eurozone constitutes window-dressing, while the effectiveness of the UK’s value added tax cut is being lost in the sea of retailer discounting. European nations, including Germany, will need to do more in 2009 as the recession deepens.

The forthcoming US programme, expected to be about $600-$700bn (or about 4 per cent of GDP), will compensate for much of the private sector’s withdrawal of spending and borrowing. President-elect Barack Obama intends to create or save 2.5m jobs by the end of 2010 and advocates the nurturing of technology, green and alternative energy projects, as well as healthcare and education initiatives. The effects of such programmes may not be felt until 2010-11, but this is no reason not to implement them.

Fourth, as a period of (hopefully short-lived) deflation looms, we are about to see if the expected potency of monetary policy – in the form of quantitative easing – is a myth. It did not really work in Japan because it was a decade late and was also inadequately pursued. The Federal Reserve has now promised to keep the policy rate at 0.0-0.25 per cent “for some time”, and said it would use its balance sheet “further” to support credit markets and economic activity. Its assets have already grown nearly threefold to $2,200bn since the Lehman failure, and will be over $3,000bn by the end of the year. As European rates tumble towards 0–1 per cent, other central banks will find they also have to adopt unorthodox forms of monetary policy.

Quantitative easing helps to keep short-term rates near zero and could peg longer-term rates too. The Fed, for example, will buy not only securitised assets but also Treasuries in an attempt to lower credit spreads, the cost of capital and all private borrowing rates. It could eventually buy other private assets, including equities. Ultimately, the Fed could purchase Treasuries directly from the government. Public debt would not rise and concerns about future tax burdens would be negated. The new concern would be higher inflation, but this is a convoluted argument and for another day.

Fifth, when trust has been shattered, economic agents need effective leadership and want confidence in public authorities. We cannot plug these into an economic model, but they matter a lot. Expectations about Mr Obama, his macro-economics team, and the Fed mitigating and then reversing our economic predicament, may have become excessive, but why not? The Fed and Mr Obama possess both competence and authority, and seem prepared to embrace the holistic approach, described here, to address this destructive deleveraging recession.

The writer is senior economic adviser, UBS Investment Bank, and author of The Age of Aging (October 2008)

Copyright The Financial Times Limited 2008

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China is showing scary signals

Bloomberg.com: Economy

China Cuts Home-Sales Tax as Property Slump Deepens Slowdown
Email | Print | A A A

By Eugene Tang and Luo Jun

Dec. 17 (Bloomberg) -- China will reduce a tax on home sales to stem a property-market slump that may drive the world’s fourth-biggest economy into the deepest slowdown since 1990.

Sale profits, rather than prices, will now be taxed, the State Council said in a statement on a government Web site.

The measures “are much more significant than those announced in the past few months” and, with interest-rate cuts, are likely to stabilize the property market, said Peng Wensheng, head of China research at Barclays Capital in Hong Kong.

Falling home sales are undermining construction and domestic consumption just as export demand collapses because of recessions in the U.S., Europe and Japan. Building is the biggest driver for China’s expansion, contributing a quarter of fixed-asset investment and employing 77 million people.

The levy will be waived on properties sold two years after purchase, down from five years, the State Council said. The new rules apply for one year, it added, without saying when they take effect.

China’s economy may grow as little as 5.5 percent next year, the weakest pace since 1990, according to CLSA Asia Pacific Markets. That’s less than the 8 percent needed to create jobs and maintain social stability, according to China Banking Regulatory Commission Chairman Liu Mingkang

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Blackhack not down

US interest rates: Mr Bernanke correctly judged the risk of deflation - Telegraph

By Ambrose Evans-Pritchard
Last Updated: 5:55AM GMT 17 Dec 2008


The sort of deflation now spreading across North America, Japan, and parts of Europe is not the benign variety of the late 19th century when prices slid gently for year after year. Debt levels are much higher today, so the deflation effect is that much more dangerous.

The danger is a self-feeding downward spiral as the `real’ burden of debt keeps rising into the slump, as Irving Fisher dissected in his great opus “The Debt-Deflation Theory of Great Depressions”.

US inflation was minus 1.7pc in November, and minus 1pc in October. This entirely vindicates the brave decision by Ben Bernanke at the US Federal Reserve -- and our our own Mervyn King at the Bank of England -- to “look through” the oil spike earlier this year and keep his focus on the underlying forces at work in the global economy.

While Mr Bernanke may have been caught flat-footed by the onset of the credit crisis in the summer of 2007, he has since moved with impressive speed.

The string of emergency rate cuts this year have now brought America to the brink of zero. They may prevent the current credit crash from metastasizing into a full-blown depression. We do not yet know for sure. It takes a year or so for the effects of monetary policy to feed through the economy even when the banking system is functioning. It will take even longer this time. But matters would undoubtedly be worse if the Fed’s backwoodsmen had succeeded in imposing a liquidation squeeze on the US economy, as they did from 1930 to 1932.

Mr Bernanke has not run out of ammunition yet. He has a nuclear arsenal, and has begun to use it. The Fed is already buying mortgage debt. It has infinite means of injecting stimulus into the economy by `quantitiative easing’, if needs be. It can ultimately print money and hang it on Christmas trees.

Mr Bernanke correctly judged the risk of deflation. His critics did not anticipate this price collapse. The burden in now on them to explain why they are sure that deflation can safely be left to run its malign course.

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Should US take or not the inflation pill

A whiff of inflationary grapeshot - Paul Krugman Blog - NYTimes.com

A whiff of inflationary grapeshot

Greg Mankiw suggests that the Fed respond to the crisis by committing to substantial inflation over the next decade. Great idea, wish I’d thought of it. Oh, wait …

Actually, Greg has arrived at the same conclusion I did more than a decade ago, when I tried to model the problems then facing Japan, and now facing us. As I pointed out back then, the essence of a liquidity trap is that the real interest rate is too high, even when the nominal rate is zero. So the theoretically “correct” answer, if you can swing it, is to create expected inflation, pushing the real rate down.

As I put it, perhaps too glibly, the central bank needed to “credibly promise to be irresponsible.”

The thing is, at the time my analysis was widely treated as somehow wild and crazy, even though it came straight out of an extremely buttoned-down theoretical model. Japan was supposed to suffer for its sins, not inflate its way out of them. I wonder if similar proposals for the United States will receive the same reception.

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Fed rate to Zero and what to expect

FT.com / Columnists / Martin Wolf - ‘Helicopter Ben’ confronts the challenge of a lifetime

‘Helicopter Ben’ confronts the challenge of a lifetime

By Martin Wolf

Published: December 16 2008 20:01 | Last updated: December 16 2008 20:01

Central banks may soon resort to their most powerful weapons against deflation: the printing press and the “helicopter drop” of money. It is a time for which Ben Bernanke, chairman of the Federal Reserve, has long prepared. Will this weaponry work? Unquestionably, yes: used ruthlessly, it will eliminate deflation. But returning to normality thereafter will prove far more elusive.

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More on the Baltic Dry Index U-Turn

Baltic Dry Index Floats Shippers | Investment Advice and Investment Research with a Contrarian Point of View

Baltic Dry Index Floats Shippers

The Baltic Dry Index (BDI) is up over 10% to 711 in the past few weeks. It doesn’t mean much, considering it’s down over 93% for the year. In fact, if you consider this move in terms of this summer’s price high of 11,793 - it’s moved barely half a percent.

But that doesn’t mean you shouldn’t be keeping an eye on the BDI.

The BDI is the price used to determine global shipping rates and prices. Like blood pressure does for humans, BDI measures the flow of goods for the economies of the world. And just like us, excessively low or high readings are bad.

Because it isn’t traded, the BDI cannot be moved artificially. It’s one of the best ways to judge the true health of global trade and our economy. It’s why Louis Basenese has been instructing readers to keep an eye on the Baltic Dry Index for weeks.

And looking at the major shippers of the water transportation sector, it appears that the market is paying attention as well. Frontline (NYSE: FRO), Kirby (NYSE: KEX) and Nordic American Tanker Shipping (NYSE: NAT) have all moved up over 15% in the past few weeks. Positive movement from the Baltic will continue to float these shippers.

And it’s not just domestic lines; Asian shippers have been on the move as well. Time will tell if these movements are the start of a new trend or just a bounce. But the water transportation sector could use some good news - it’s down over 37% since October 1st. By comparison, the S&P is only down 25%.

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Baltic Dry Index showing a little bit better signs

Maritime - Baltic Dry Index shows signs of revival

Baltic Dry Index shows signs of revival
By SHARIDAN M. ALI

THE Baltic Dry Index (BDI) has shown early signs of revival as it has gained 40 points or almost 6% from Dec 8 to Dec 11 on the back of surging iron ore transportation demand.

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China supporting local farmers

Bloomberg.com: China

China’s pricing officials, who wrestled with surging inflation in the first half this year, are shifting tasks as sliding prices of crops reduce farming income and planting interest. Falling coal and crude oil costs are giving the government the opportunity to align domestic prices with imports.

Pricing authorities must “strengthen price-control capability and enhance the function of reserves of key commodities including grain, pork, vegetable oil, petroleum, power-station coal and fertilizer,” said the statement, which summarized a weekend meeting of regional pricing administrators.

China this month ended a yearlong temporary price-control measure after global commodity prices tumbled. Reserve officials, under order from the commission, are buying as much as 30.5 million metric tons of grain from farmers as private industry traders shun local crops for cheaper imports.

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JPY by RGE Monitor

Outlook

• DB: Given heightened global risk
  aversion, the plunge in global asset prices and a reduced interest-rate
  disadvantage between major economies and Japan, the JPY may trade
  sideways or even appreciate further over the short-to-medium term
  against the USD and EUR even after its recent rally
• Eisuke
  Sakakibara, formerly Japan's top currency official (via Bloomberg):
  Strong yen is in Japan's national interest, particularly in this
  situation when raw material prices will increase; JPY may rise to 80
  per USD as so-called carry trades unwind
• Lex: Mood music for
  yen remains good, with currency still undervalued in real
  trade-weighted terms. Global investors continue to unwind yen-funded
  carry trades. Japanese retail investors are switching back into yen
  owing to burnt fingers; but questions over continuing strengthening
  remain since Japan is teetering on the brink of recession and its banks
  are exposed to tanking stock market and mushrooming bankruptcies
• Jen:
  While USD/JPY can spike lower in times of extreme risk aversion, it
  cannot stay below 100 for long due to Japan's declining financial home
  bias; 110 for USD/JPY makes more sense than 90 over the medium-term
• MUFJ:
  JPY/USD may fall below 100 in event of a dollar crisis, but won't stay
  there in the long-term due to 1) economic decline from demographic
  shift, 2) large interest rate gap, 3) yen failing to become key reserve
  currency, 4) declining home bias of baby boomers

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Gold

Dollar's decline to drive gold? - MarketWatch

The Australian gold site The Privateer, which takes a severely fundamentalist attitude to matters of money and credit but which is sensitive to charting issues, also noticed the dollar's deadly decline: "... the U.S. Dollar Index has now traced out a series of lower highs and lower lows since its 88.41 peak three weeks ago. This is a STRONG indication that the huge U.S. dollar rally which began back in July, fuelled by U.S. capital repatriation and even more by global debt deleveraging, is over." See Website
The Privateer's crucial $US 5X3 Point and Figure gold chart turned up this week and is close to breaking above the downtrend. See chart
On gold, The Privateer remarks: "The action since then has been wild to an almost unprecedented degree. Last week, gold retreated all the way back to the top of its recent trading range. This week, that entire down move has been retraced - plus a little bit more."
Unfortunately, there is a plethora of reasons to suppose the dollar might slump. Many of these are well documented on Jim Sinclair's very impressive MineSet site. Sample title: "From Money to Hyperinflation -- The Path OTC Derivatives Have Paved." See Website
A significant straw in the wind: The maneuvering of the high-profile and well-informed The Gartman Letter. Short gold at the beginning of the week, and projecting a $620 price objective in some TV interviews, Gartman abruptly cut the entire position early on Wednesday morning --a day which saw gold up some $34.
Gartman is perfectly aware of the monetary debasement argument for gold. He has complained bitterly about the concept of the Fed issuing debt directly, for example.
But he is also thought to be in the rumor flow, aware of moves planned by major operators. And indeed the last three days of the week say determined gold buying. On Friday, writing as usual very early, Gartman was mumbling about buying gold in the $802-7 range as a "disaster hedge."

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Are you sure this is another Great Depression?

Economist's View: Fed Watch: What If the Analogy is Wrong?

What if years of research on the Great Depression have left even the best and the brightest with tunnel vision such that they could not accept that they were wrong?

Bottom Line: The Fed is headed to the zero mark, with another 50bp almost certain this week. It is widely expected that they will give some guidance as to their next steps, pointing us in the direction of an explicit policy of quantitative easing. Fed policy, as well as fiscal policy, assumes that the Great Depression is the most accurate analogy. This assumption ignores the external position of the US, which stubbornly refuses to adjust. If that failure to adjust is relevant, then recent Dollar stability was simply a head-fake. We should see pressure on the Dollar and, ultimately, Treasuries. Policymakers could adjust, but would they? With pursuit of the Great Depression case as the baseline scenario, it seems prudent to keep in mind the risk that this is not the relevant analogy for the US, and that policymakers are not prepared to accept such a possibility.

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Deflation

naked capitalism: "Deflation has become inevitable"

"Deflation has become inevitable"
Listen to this article. Powered by Odiogo.com
I'm reproducing the bulk of a very good (and possibly final) post by London Banker, a former central banker and securities regulator, that takes issue with some of the conventional wisdom surrounding the efforts to remedy our economic crisis via liberal applications of monetary easing and fiscal stimulus.

I happen in general to be sympathetic to minority views (conventional wisdom is generally wrong). And in this case, as I discuss below, I am worried that conventional wisdom rests on a thin and dubious set of data and assumptions.

London Banker's arguments are two-fold: first, deflation is more likely than inflation because the underlying messes have not been cleaned up. Therefore investors will be leery of putting funds into risky investments. Note this differs from the commonly-held view that deflation can be cured without addressing institutional arrangements. Second, he argues that punitively low yields will lead foreign investors eventually to retreat even from government debt. He argues that they will tire at throwing good money after bad, and will prefer to seek returns closer to home.

This claim is hard to prove (one can argue that the high risk spreads are due to deleveraging, not distrust) but it is a serious issue if true. One of the things that worked for years in favor of the US is that it had the most liquid, deepest capital markets, That was due not just to the size of its economy, but also the fact that it had high standards for financial disclosure and generally strong investor protection. If investors come to doubt the fairness of the markets, or think that the rot in its economy is not being cleared out and will undermine growth, that will hold investment back. As Brad Setser has pointed out, foreign capital flows have consisted almost entirely of central bank purchases of Treasuries and Agencies for quite some time, hardly a vote of confidence.

We also have the question of how long the high dollar/low Treasury interest game can go on. Bernanke wants rates low to try to stimulate economic activity and has even broached the idea of long bond purchases to keep yields on the long end of the curve down. But the poster child of deflation and low interest rates is Japan, which due to its high savings rate, was not dependent on external funding. The US should want the dollar cheaper to boost exports, but that risks the ire of our creditors, who would take big losses on their FX reserves (many economists argue this idea is specious, but try explaining the loss in paper wealth to a populace not schooled in such niceties. FX losses, when the dollar was weakening earlier in the year, produced a lot of ire in China, including among bureaucrats). Similarly, even if you subscribe to the deflation outlook, 3%ish 30 year bonds is a pretty risky bet independent of the currency risk. So it looks like our friendly funding sources are likely to get burned one way or another, perhaps both. There is a real risk of a disorderly fall of the dollar, and it is hard to tell what the collateral damage would be.

Now to my doubts about the proposed remedies, namely monster stimulus and monetary easing. First, as mentioned before, the analogy is to the US in the Depression, which we have said repeatedly before is questionable. The US in the 1920s was the world's biggest creditor, exporter, and manufacturer. Our position then is analogous to China's now. Indeed, Keynes in the 1930s urged America to take even more aggressive measures, and argued that it was not reasonable for the US to expect over-consuming, debt-burdened countries like the UK and France to take up the demand slack. So even though most economists are invoking Keynes, it isn't clear he's prescribe such aggressive stimulus for the US and UK now.

Second, the argument is that the US in the 1930s and Japan in its post bubble era failed to engage in sufficiently large stimulus. That is mere conjecture; there is no way to prove that argument (we cannot go back in a time machine and test different remedies in both economies).

In the US, the claim generally made is that the US did not emerge conclusively from the Depression until it engaged in massive wartime spending starting in 1939-40, and therefore a stimulus of perhaps that large a magnitude is required. However, quite a lot happened between 1930 and 1939, including going off the gold standard, the securities law reforms of 1933 and 1934, the creation of the FDIC, refinancing homeowner debt to longer-term mortgages via the Homeowner's Loan Corporation, and the closure of a lot of business, some of which were probably victims of circumstance, but others probably deserved to be put out of their misery.

There is another huge extenuating circumstance with the war spending that observers choose to forget. The US's problem in 1929, like China's appeared to be (at least in part) overproduction, that there might be too much global capacity relative to consumer demand (that is certainly true for the auto industry now, which had managed to forestall the day of reckoning by converting consumers to leases that had them trading in cars after 3 years, when buyers generally keep them longer, Decreasing the effective life of cars was tantamount to increasing demand). In addition, the US suffered a fall in GDP of 11% in 1946 and 1% in 1947 in transitioning off a wartime economy.

But perhaps more important, at the end of WWII, productive capacity in the next two biggest industrialized nations, Germany and Japan, had been destroyed. The US had effectively no competition for its bulked up industrial capacity.

Had the US in 1930 tried monster stimulus, without the painful adjustments of the 1930s, would it have worked? Probably narrowly, in keeping unemployment from rising to horrific levels and containing the fall in GDP. But I question whether it would have been a panacea. The New Deal, contrary to popular opinion, did produce a lot of good results with its workfare, such as the building of parks and roads, the electrification of rural America. if the US had attempted something at twice that scale, would it have been productive? Some argue that it didn't matter, the important thing is to get money into the economy, but I wonder. Japan did engage in pretty heavy infrastructure spending (a lot of bridges to nowhere) and it does not seem to have done them much good.

Note my sophisticated investor buddies disagree, saying this is backwards looking, confident that a US budget deficit of 10% of GDP next year will do the trick, and think inflation/hyperinflation is the bigger risk (note some consider hyperinflation to be operative at 20% per annum; you do not need to get to Weimar scenarios for inflation to start distorting economic decisions in a very serious way).

From London Banker:

For a while now I have been on the fence on the inflation/deflation issue .... I’m now coming down on the side of deflation for a very simple reason: there is no longer any incentive to save or invest, and so debt and investment cannot increase much beyond current bloated levels.

In Lombard Street, Bagehot’s seminal tome on fractional reserve central banking, Bagehot advises any central bank facing a simultaneous credit crisis and currency crisis to raise interest rates. By raising rates they will ensure that foreign creditors remain incentivised to maintain the general level of credit available while the central bank resolves the local liquidity crisis through liquidation of failed banks and temporary liquidity support of stressed banks.


Yves here. For the UK, the currency crisis issue is a real concern. Recall that the pound has taken a huge dive in recent months, and Willem Buiter has taken to comparing Britain to Iceland. Back to the post:

The very opposite policies have been pursued by central banks in the US, Europe and UK ...They have cut policy rates drastically, and as the crisis escalated and spread, the yield on government debt has dropped to negative territory. Meanwhile they have shielded those responsible for the creation of record levels of bad debt from any regulatory accountability, relaxed transparency of accounts, and provided massive taxpayer-funded financial infusions to prevent failure and liquidation.

While in the short term these policies have expediency and the maintenance of market “confidence” on their side, in the longer term these policies must undermine any confidence a rational and objective saver or investor might have that savings or investment in the US, EU or UK will be fairly remunerated at an above-inflation rate, or that savings and investments will be protected by effective oversight and regulation from the sorts of executive debasement and outright misappropriation and fraud that are beginning to colour our perceptions of the past decade...

If US, EU and UK had substantial domestic savings to fund their banks (as in Japan in 1990), then perhaps the consequences would not be so imminently disastrous. Lacking sufficient domestic savings, however, their actions will likely make foreign creditors in Japan, China, the Gulf and elsewhere question whether it is worthwhile to keep pumping scarce savings into such flawed and reckless economies...

The determination to avoid any accountability for failed banks, failed business models, failed regulatory systems and failed academic rationales for all the above invites anyone with spare cash – an increasingly select crowd – to withhold it from further depredations. It is this instinct, more than confidence in the government, which is driving so many to seek the temporary safety of short-dated government securities.

The result of discouraging domestic and foreign creditors and investors must be inevitable deflation as debt levels become increasingly hard to finance and ultimately contract. Irresponsible central banks and governments can try to bail out the failed banks, businesses and municipalities at the centre of every popped bubble, but the bubble economies are ever more certain to deflate with each bailout. Each bailout further undermines the market discipline which is bedrock to a saver or investor’s decision to part with hard-earned cash by trusting it to the intermediation of the management of a bank or business.

It’s this simple: I won’t invest in a country that bails out failure and punishes savers. I won’t invest in the US or UK until they change course and protect savers and investors, ensuring a reasonably predictable positive return. In the EU, I will be very selective, preferring those conservative states like Germany that never embraced the worst excesses, although sadly still have fall out from individual banks' stupidity in buying into foreign excess. I will know when it is safe to reinvest when policy interest rates, bank/intermediary oversight and accounting standards give me confidence I am better protected than the corporate or financial elite.

While it may take the Asian and the Gulf State investors longer to embrace my analysis, I have no doubt that they too will eventually conclude that parting with their savings under the terms now on offer will only deepen their losses. They would be better off keeping the money at home, investing locally under local laws and vigilance, and letting the US and UK implode.

The argument against this has always been that with trillions already invested in the US during the deficit years, the Chinese and Gulf States would suffer even more horrible losses from a collapse of the western economies. This is accurate, but not complete, as it ignores the relative value of cash investment at the top and bottom of a bursting bubble. Once the collapse has bottomed out, so long as a globalised economy survives, there will be even better opportunities for those with savings to invest selectively in businesses with clearer prospects and more certain profitability under regulatory frameworks which have been restored to a proper balance of investor protection and intermediary oversight.

Right now survival of businesses in the West depends largely on political pull and access to regulatory forbearance and central bank or treasury finance. The market has failed, and officialdom is collaborating in perpetuating that failure...

I think it took me so long to feel confident about predicting deflation because the floating currency system under dollar hegemony and Bretton Woods II distorts the workings of both inflation and deflation. Despite the US being the epicentre of all the failed debts, failed securitisations, failed credit derivatives, failed rating agencies, failed banking businesses, failed corporate governance, failed accounting standards, failed capital adequacy models, and failed regulatory forbearance, the US dollar has recently strengthened as deflation globalised. The US exported inflation in the boom years, and now exports deflation in the bust years.

Since spring 2008, as US investment banks sold off assets, imposed margin calls, and used access to unsegregated wholesale assets in custody in the rest of the world to upstream liquidity to their US-based parents and affiliates, the dollar has strengthened relative to other currencies. The media reports this as a “flight to quality”, but it is more like a last looting of the surrounding countryside before dangerous brigands hole up in their hilltop fortress. The brigands appear temporarily wealthy compared to the peons left stripped and penniless and facing winter. When the brigands have eaten all the stolen grain and livestock, however, they will have no means to replenish except to use force to raid the countryside again. The peons can always hunt, forage, farm and carefully husband a surplus to gradually increase their wealth. If the brigands raid too thoroughly or too regularly, the peons have no incentive to grow crops or keep herds (negative savings returns) and everyone starves (deflation).

In the meanwhile, the peons just might wise up, hide any surplus more securely and organise mutual defense against further attacks to ensure that their peon children prosper and the brigands die off. That would be the end of Bretton Woods II, and the rise of China, India, the Gulf and other productive and/or resource rich states which invest surplus in domestic productivity and regional growth...

Only when that deflation has played out and rational policies that reward market-based management and returns are restored will it be worthwhile to invest again. In the meanwhile, any wealth saved securely from state seizure will "swell" to buy more assets in future - a key aspect of deflation and a key means of restoring the control of the economy into the hands of more farsighted savers and investors.

I have quoted Mr John Mill before, but it bears repeating: ““Panics do not destroy capital; they merely reveal the extent to which it has been destroyed by its betrayal into hopelessly unproductive works.” The extent to which capital has been betrayed in the past quarter century under Bretton Woods II, bank deregulation and the Basle Capital Adequacy Accords is unrivalled in the history of fiat banking. The bankers, lawmakers, regulators and academics who collaborated in the betrayal still hold power, like the well-armed brigands in the fortress, and their continued collaboration to prevent accountability must inevitably discourage honest savers from risking further loss. Even so, it is the savers/peons who hold the ultimate power as they can starve the brigands.

Some day soon savers will revolt at financing further depredations. They will refuse to buy even government securities, gagging at the quantities of issue forced upon them under terms of only negative return. When that final massive bubble bursts, deflation will follow its harsh corrective course and clean out deficit-financed “unproductive works”.

When that happens, if reason is restored in markets with effective oversight, I might consider investing again, very selectively, in whatever productive works might then be on offer and only when secure in realising - and retaining - a positive yield.

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Deflation

Employment, Interest, and Money: Deflation, Recession, and Aggregate Supply

Stopping deflation should not be very hard at all, if you’re willing to accept the side effects of your deflation cure. Most discussions of this topic have focused on the demand side: the Fed could get people to start buying things by dropping money from a helicopter; or it could buy stock and increase demand by corporations and stockholders; etc. But when it comes to stopping deflation, demand policies are the hard way. To continue my side effects metaphor: if you insist on using the less powerful drug that has fewer side effects, you may have to give ridiculously high doses before the patient responds. The easy way to stop deflation – the drug to try once hair loss and vomiting become less of an issue than the disease itself – is to reduce supply rather than increase demand.

During normal times, economists and policymakers spend a lot of time trying to figure out ways to increase supply. It’s not an easy task. Cut taxes, to improve incentives for private investment? Raise taxes, to stop consumer spending from crowding out private investment? Invest more in public infrastructure to make the economy more efficient? Invest less in public infrastructure, to make the resources available to the private sector? It’s a tough game.

The game gets a lot easier when your objective is to let the other guy win. One obvious way to reduce supply, for example, is to encourage the formation of cartels. That’s something that Roosevelt tried, though some of his programs were struck down by the Supreme Court. Scholars can debate what the overall effect was on economic growth, or whether, after already devaluing the dollar, such additional measures against deflation did more harm than good, but it’s hardly open to question that encouraging cartels will tend to raise – and in the context of a deflation, stabilize – prices.

One particular form of cartel encouragement, which would certainly go over well with some of the current government’s constituents, would be to strengthen labor unions (one thing that Roosevelt did). Under normal conditions, some economists might argue that labor unions, despite their cartel aspect, often increase supply by such means as improving morale and decreasing unnecessary turnover. But it’s certainly true that unions are particularly loath to accept cuts in wages. In the context of a deflation, the stabilization of wages would tend to stabilize prices, since it would make it unprofitable for firms to cut prices. (Paul Krugman touches on this issue in some recent blog entries. He mentions a recent academic paper, but I like to give credit to Brad DeLong and Larry Summers – in a paper that I read nearly 20 years ago before it was published – for making intellectually respectable the idea that labor unions can help the economy by helping protect against deflation. I should also acknowledge James Tobin, who worked out the theory underlying the “death spiral” concept as discussed above.)

Another way to reduce aggregate supply is by inducing inflationary expectations to replace deflationary ones, so that producers are less willing to sell at low prices. This is largely a psychological issue, but if the Fed shows a willingness to take demand-side policies to extremes, even if the extremes are still not enough to solve the demand problem, they may affect supply. For example, when James Hamilton suggests (somewhat whimsically and just for the sake of argument) that the Fed could buy up the entire national debt, one might think of it as a demand-side policy, but I would suggest that its supply-side impact would be more important. With Treasury interest rates, even for long-term bonds, already quite low, it’s not clear that reducing them to zero would have much effect on demand. But when people observe the Fed buying up the entire national debt, the perception that “Helicopter Ben has gone wild” can’t help but make an impact.

And so on. Figuring out ways to produce less, rather than more, shouldn’t be very difficult. Naturally, reducing aggregate supply – trying to make the economy produce less at any given price – is not going to be directly conducive to economic recovery. But by reversing deflation and thereby making traditional demand-side tools more effective, it could be indirectly beneficial.

The death spiral should be pretty easy to avoid. The problem is that, once you get to the point where you have to make avoiding the death spiral a priority, you end up with this conflict between policies that reverse deflation and policies that increase production. It’s not the 1930’s, but it’s an experience I would hope to avoid.

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Debt deflation

Irving Fisher's debt-deflation theory: its relevance to current conditions -- Wolfson 20 (3): 315 -- Cambridge Journal of Economics

he essence of Irving Fisher's debt-deflation theory was an interactive process whereby falling commodity prices increased the debt burden of borrowers. Despite the absence of falling prices today, this paper argues that a modified debt-deflation process is still possible. As the 1987 stock market crash demonstrates, the modern debt-deflation process encompasses falling asset prices, debt repayment difficulties, a reluctance to lend, a financial crisis, the impact on the banks, and the inter-dependency of the financial system. Recent debt-deflations have been aborted by lender-of-last-resort intervention and government support of the financial system

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Yes, Switzerland

Switzerland may have to print money to stave off deflation - Telegraph

Switzerland may have to print money to stave off deflation
The Swiss National Bank has cut interest rates to 0.5pc and opened the door for emergency stimulus, becoming the first country in Europe to flirt with zero policy rates.

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Fear

Fear triggers gold shortage, drives US treasury yields below zero - Telegraph

Fear triggers gold shortage, drives US treasury yields below zero
The investor search for a safe places to store wealth as the financial crisis shakes faith in the system has caused extraordinary moves in global markets over recent days, driving the yield on 3-month US Treasuries below zero and causing a rush for physical holdings of gold.


By Ambrose Evans-Pritchard
Last Updated: 9:26AM GMT 11 Dec 2008

"It is sheer unmitigated fear: even institutions are looking for mattresses to put their money until the end of the year," said Marc Ostwald, a bond expert at Insinger de Beaufort.

The rush for the safety of US Treasury debt is playing havoc with America's $7 trillion "repo" market used to manage liquidity. Fund managers are hoovering up any safe asset they can find because they do not know what the world will look like in January when normal business picks up again. Three-month bills fell to minus 0.01pc on Tuesday, implying that funds are paying the US government for protection.

"You know the US Treasury will give you your money back, but your bank might not be there," said Paul Ashworth, US economist for Capital Economics.

The gold markets have also been in turmoil. Traders say it has become extremely hard to buy the physical metal in the form of bars or coins. The market has moved into "backwardation" for the first time, meaning that futures contracts are now priced more cheaply than actual bullion prices

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Expectations

Real Time Economics : Inflation Concerns Remain High in Latest WSJ/NBC Poll

Inflation Concerns Remain High in Latest WSJ/NBC Poll

PollAmericans are still plagued by concerns over the economy and inflation falls surprisingly high on that list of worries.

The latest WSJ/NBC News survey showed that 25% of respondents said savings are the number one concern for their families. But a close second, at 21%, was inflation.

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Velocity

FT Alphaville » Blog Archive » The velocity of money and the US dollar

The velocity of money and the US dollar
Posted by Izabella Kaminska on Dec 11 08:44.

MV = PY, that’s the formula for the theory of money. M is the quantity (or supply) of money, V is the velocity of money, P is the price level and Y is the aggregate economic output.

Interesting to note currently, according to Standard Chartered, is the V part of the equation and where exactly it’s contracting. The theory initially assumed that V was constant. Of course, the Great Depression showed that that was in fact not true, because the velocity of money fell.

Standard Chartered says that while the Fed may be losing a few battles here and there, it will eventually win the war. This is largely because it understands the V part of the equation. What’s troubling, however, is what’s happening to V elsewhere:

In Asia, money supply growth continues to slow in China, India and South Korea, albeit from high levels. In Japan, M1 is contracting (again). Although suitable data is not readily available, it seems reasonable to assume that Asian velocity of money is declining due to the global credit crisis. The same could be said for the Eurozone.

Standard Chartered remains hopeful though. The Fed may have been the first to respond to the problem, but others will follow suit. Inevitably, however, all of this is a major negative for the US dollar as global money supply growth is mostly USD-denominated. But timing the dollar’s descent will be tricky. Standard Chartered says:
What we do know is that the world‟s central banks, not just the Fed, are actively debasing the value of their currencies to support money supply growth and thus overall economic activity. For this precise reason, we think that USD weakness in 2009 will be slow and gradual.

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From Carpe Diem

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China cannot hide its problems

Bloomberg.com: Worldwide

Dec. 10 (Bloomberg) -- China’s exports fell for the first time in seven years, more evidence that recessions in the U.S., Europe and Japan are driving the world’s fourth-largest economy into a slump.

Exports declined 2.2 percent in November from a year earlier, the customs bureau said in a statement on its Web site today. Imports plunged 17.9 percent, pushing the trade surplus to a record $40.09 billion.

China’s leaders pledged “more forceful measures” to help small companies and create jobs in statements within hours of the trade report. The export collapse intensifies pressure on the government to add to last month’s steepest interest-rate cut in 11 years, extend a 4 trillion yuan ($581 billion) spending plan and let the yuan depreciate.

“The figures are horrifying,” said Lu Zhengwei, chief economist at Industrial Bank Co. in Shanghai. “Plunging imports show that on top of faltering global demand, domestic demand is also shrinking as the economy cools.”

The yuan closed at 6.8633 against the dollar at 5:30 p.m. in Shanghai, from 6.8601 before the data was released.

Imports fell by the most since at least 1995, when Bloomberg data began, as commodity prices declined and weakness in manufacturing and construction cut demand for raw materials. The previous decline was seven years ago.

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Dry bulk can´t stay afloat

FT.com / MARKETS / Commodities - View of the Day: Shipping’s struggle to stay afloat

View of the Day: Shipping’s struggle to stay afloat

Published: December 9 2008 17:46 | Last updated: December 9 2008 17:46

The economic crisis has resulted in a fall in demand for freight transport, threatening the survival of many ship owners and operators, says Axel Pierron of Celent, the research consultancy.

Mr Pierron says a “huge financing requirement for shipbuilding order books” has emerged because banks are reluctant to finance vessel purchases, provide guarantees for payments to shipyards or to guarantee payments for goods, especially in the dry bulk sector which represents 55 per cent of all sea-borne trade.

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Chinese deflation

FT.com / Lex / Macroeconomics & markets - Chinese economy

Chinese economy

Published: December 10 2008 09:27 | Last updated: December 10 2008 10:05

The accident waiting to happen has happened. China, having helped propel global growth by tooling up and churning out cheap goods for much of the past decade, is crumpling. Official data released on Wednesday removes any doubt. Foreigners are investing and buying less: November foreign direct investment fell by a third from a year earlier while exports fell 2.2 per cent, the first year-over-year decline since February 2002. Deflation is even a possibility, with annual producer price inflation plunging to 2 per cent in November, less than one-third the October reading.

China held out longer than most; much of the developed world is already in recession, after all, and a number of developing countries are teetering on the brink. Now that the brakes are coming on in China, however, a ripple effect is inevitable as demand for oil, iron ore and all the other commodities required to industrialise the country shrinks. Australia is an early casualty. Within 24 hours of central bank chief Glenn Stevens flagging the China risk, Aussie miner Rio Tinto unveiled plans to slash 14,000 jobs.

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Shipping keeps going down

FT.com / Companies / Shipping - US clothing slump hits shipments

US clothing slump hits shipments

By Jonathan Birchall in New York

Published: December 9 2008 19:12 | Last updated: December 9 2008 19:12

The slump in US clothing sales since the summer has led to a precipitous drop in the number of overseas factories shipping to the US, import documents show.

Panjiva, a firm that analyses information drawn from shipping manifests filed with US Customs, said the number of global suppliers actively serving the US market fell from 22,099 in July to just 6,262 in October, a decline of more than 70 per cent.

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Chinese exporters feel the pain

Bloomberg.com: Exclusive

Chinese exporters are the latest victims of the global recession as sales slow and buyers in the U.S., Europe and Japan drive prices lower. At the same time, employee wages and benefit costs are rising following demands from customers, including Wal- Mart Stores Inc., that they enforce new labor laws.

The crunch may close a fifth of Guangdong’s factories and leave 6 million migrants without work next year, according to the Institute of Contemporary Observation, a labor rights group in the province. That would further slow the world economy because Guangdong accounts for 12 percent of the nation’s gross domestic product and China is the biggest driver of international growth.

The World Bank last week slashed its forecast for China’s economic expansion next year to 7.5 percent, the lowest in almost two decades, citing reduced overseas demand. China has averaged 9.9 percent annual growth for the past 30 years.

Exports Fell

Two-thirds of China’s small toy exporters closed in the first nine months of 2008, according to government statistics. Exports in November fell for the first time in more than seven years, Fan Gang, an adviser to China’s central bank, said at a forum in Beijing today.

“The bankruptcy of small and medium-sized exporters is going to have a huge effect on China’s economy,” says Guan Anping, a former trade official who is now managing partner at the law firm Anjin & Partners in Beijing.

Some 95 percent of exporters with assets of less than 40 million yuan ($29 million) may fail in the next three years, Guan estimates. China’s 42 million businesses of that size provide three-quarters of China’s urban jobs and 60 percent of GDP, according to the government.

Growth in Guangdong slid to 10.4 percent in the first three quarters, 4.3 percentage points less than the same period last year. Signs of the squeeze are littered across Dongguan, which is dotted with factories sitting empty behind padlocked gates.

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The Telegraph on the BIS report and the collapse in global lending

http://preview.tinyurl.com/6mewol

By Ambrose Evans-Pritchard

In its quarterly report, the BIS warned the US Federal Reserve, the Bank of
England and other central banks that near-zero interest rates and emergency
monetary stimulus may come at a cost.

By opening the cash spigot, the authorities risk displacing the money markets
and may "discourage banks from lending to other banks".

The money markets are a crucial lubricant for the financial system, but they
cannot function if rates fall too low. The sector can wither away, as Japan
discovered during its "Lost Decade".

The BIS also hinted that the European Central Bank and Sweden's Riksbank may
have blundered by raising rates

this year to contain the oil shock. It said short-term energy spikes have no
lasting effect on inflation or wage deals.

"Evidence suggests an absence of strong second-round effects on
inflation. The temporary inflationary impulse will soon drop out," it
said.

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Must read

Deflation virus is moving the policy test beyond the 1930s extremes - Telegraph

Deflation virus is moving the policy test beyond the 1930s extremes
Debt deflation is tightening its grip over the entire global system. Interest rates are creeping towards zero in Japan, America, and now across most of Europe.


By Ambrose Evans-Pritchard, International Business Editor
Last Updated: 10:13PM GMT 06 Dec 2008

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China social picture

BBC NEWS | Asia-Pacific | China 'faces mass social unrest'

Rising unemployment and the economic slowdown could cause massive social turmoil in China, a leading scholar in the Communist Party has said.

"The redistribution of wealth through theft and robbery could dramatically increase and menaces to social stability will grow," Zhou Tianyong, a researcher at the Central Party School in Beijing, wrote in the China Economic Times.

"This is extremely likely to create a reactive situation of mass-scale social turmoil," he wrote.

His views do not reflect leadership policy but highlight worries in elite circles about the impact of the economic slowdown.

Mr Zhou warned that the real rate of urban joblessness reached 12% this year and could reach 14% next year as the economy slows.

China's annual GDP growth has already slowed to 9% in the third quarter, from 10.1% in the second. Some forecasters see growth slowing to 7.5% next year.

The government has launched a stimulus package and cut interest rates to boost the economy.

Unrest warning

Last month, China's top planner warned that the economic slowdown in China could fuel social unrest.

Zhang Ping, head of the National Development and Reform Commission, said the impact of the global crisis on China's economy was deepening.

"Excessive bankruptcies and production cuts will lead to massive unemployment and stir social unrest," he said.

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Printing money goes local

Milwaukee neighborhoods could print own money -- chicagotribune.com

Milwaukee neighborhoods could print own money
2 neighborhoods consider printing own currency for exclusive use in local stores

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Lets sale stuff to the stupids

China and U.S. pledge cooperation after robust talks | Reuters

Among the few concrete results of the two-day meeting, the governments agreed to make an extra $20 billion of credit available to finance U.S. and Chinese exports to developing countries that are struggling to get access to trade credit.

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Let´s say 25, or 15. maybe 5

FT.com / MARKETS / Commodities - Merrill warns oil prices could fall to $25

Merrill warns oil prices could fall to $25

By Chris Flood and Javier Blas in London

Published: December 4 2008 11:51 | Last updated: December 4 2008 13:56

Merrill Lynch warned that oil prices could fall as low as $25 a barrel next year if the recession affecting the US, Europe and Japan extended to China, the main driver of demand growth in commodity markets in recent years.

Francisco Blanch, head of commodities research at Merrill Lynch, said his main scenario was for oil prices to average $50 a barrel next year, but warned: “A temporary drop below $25 is possible if the global recession extends to China.”

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Panic

Bloomberg.com: Worldwide

Dec. 4 (Bloomberg) -- D.E. Shaw & Co. LP, the investment firm run by David Shaw, and Farallon Capital Management LLC limited withdrawals by clients, joining more than 80 hedge-fund managers to impose restrictions in the past two months.

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The Economist on Rogoff comments about inflation

And indeed, he's right. Not only would inflation reduce the value of
non-indexed debts, it would also help housing markets clear and prices
stabilise, and it would encourage households and financial institutions
to stop sitting on their money. As Mr Rogoff mentions, we're also on
the way to adopting the necessary policies—benchmark interest rates are
moving toward zero, fiscal stimulus is in the cards, and the Federal
Reserve is buying securities. As Mr Rogoff also mentions, the fact that
all these actions have barely held off deflation, so far, suggests that
a much more aggressive approach may be necessary.

There is a risk
to such a policy, namely, that inflation will get out of hand,
requiring a painful disinflationary recession at some point in the
future. But frankly, at this point, the odds of inflation getting out
of hand look slim, and the prospect of a disinflationary recession at
some date in the future, non-threatening.

Still, I would wager
that conditions would have to worsen significantly for Ben Bernanke to
make the kind of commitment Mr Rogoff recommends. Helicopter Ben has,
as yet, seemed reluctant to pull out all the available stops.

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Shorting gold

Wednesday December 3, 7:30 am ET
BETHESDA, Md.–(BUSINESS
WIRE)–ProFunds Group, the world’s largest manager of short and
leveraged funds,1 announced today that it is launching the first
exchange traded funds in the United States to provide short or
leveraged exposure to gold or silver. The four new ETFs will begin
trading on the NYSE Arca today. They join a line-up of four other
Commodities ProShares that launched last week.



http://biz.yahoo.com/bw/081203/20081203005253.html?.v=1

ProShares		Ticker		Index/Benchmark		Daily Objective*
Ultra Gold		UGL		Gold Bullion price, London p.m. fix		200%
UltraShort Gold		GLL		Gold Bullion price, London p.m. fix		-200%
Ultra Silver		AGQ		Silver bullion price, London fix		200%
UltraShort Silver		ZSL		Silver bullion price, London fix		-200%
Ultra DJ-AIG Commodity		UCD		Dow Jones-AIG Commodity IndexSM		200%
UltraShort DJ-AIG Commodity		CMD		Dow Jones-AIG Commodity IndexSM		-200%
Ultra DJ-AIG Crude Oil		UCO		Dow Jones-AIG Crude Oil Sub-IndexSM		200%
UltraShort DJ-AIG Crude Oil		SCO		Dow Jones-AIG Crude Oil Sub-IndexSM		-200%

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