Habeas Data

Acxiom: the company that knows if you own a cat or if you're right-handed - Telegraph

Acxiom: the company that knows if you own a cat or if you're right-handed
Somewhere in Little Rock, Arkansas, there is a database holding 750bn pieces of information on you, me and everyone we know.


By Rowena Mason
Last Updated: 8:19AM BST 28 Apr 2009
John Meyer
John Meyer says data gathering and marketing services company Acxiom is the biggest company you've never heard of Photo: AP

John Meyer is the man in charge of these sensitive details in one of the world's largest consumer information databases: approximately 1,500 facts about half a billion people worldwide.

Surely I can't be on there. I have nothing to do with Acxiom, a little-known, US-listed $700m (£500m) data gathering and marketing services company.


"Oh we do have you on our database. I guarantee you," Mr Meyer assures me. "Your name address, phone number. You have a cat. You're right handed. That sort of thing." This is true. I'm not sure if it's a lucky guess, but I'm impressed.

Mr Meyer, a brash, confident chief executive, explains that while the company has been nervous of promoting its activities in the past, he has no fear of a higher profile.

"We're the biggest company you've never heard of," he grins, with a hint of Southern drawl. "In the past we were afraid of people knowing us, but I'm trying to get business awareness and if consumers have privacy concerns I want to know."

All information on the database has been given away freely by the consumer through anything from registering for services online, to questionnaires or buying magazine subscriptions, Mr Meyer claims.

This is how Acxiom, which had a turnover of $1.38bn last year, is able to supply clients with a list of female skiing fans from Georgia, or right-handed women from Leeds.

It is also the largest player in the credit card market checking customer loan history and it can confirm whether CVs tally with job histories for employers. With a 12pc market share, its nearest competitors are therefore not market researchers like TNS and Nielsen, but information businesses Experian and Epsilon.

Mr Meyer took on the job a year ago after spending 18 months commuting from Paris to his home in Texas as head of global services for technology company Alcatel- Lucent. Under his leadership, the smooth marketeer has rebranded Acxiom as a "global integrated marketing services" company, compiling databases to conduct marketing for clients from Gap to General Motors.

"Not spam," Meyer says emphatically, wagging his finger at me. "People bristle first and then we characterise what we do as limiting junk mail, not sending you junk mail. For spammers, you're just an active email address, period. It's not how to market if you don't want to be hated."

To help soften the anonymity of cold contact, the company makes sure that the marketer at the other end of the phone or email is as close in age, class, gender and interests as possible to the consumer.

One newer use for consumer information is verifying that online exam candidates are the right student by asking four personal questions, such as: where was your father born? What breed of dog do you own? "If you answer them correctly, statistically, you are who you are," Mr Meyer says with certainty.

Smoothing down his bright yellow tie, he tells me of another technology on the cusp of becoming a highly desirable tool: location marketing

"When I walk by a Starbucks, I could get an ad for coffee to my phone," he tells me. "But most of the phone companies thought: 'That's going to scare the consumer. Now they physically know where I am, everywhere I am'." But Acxiom has developed a cunning way of using location-based marketing in public places.

"We did an opportunity with a casino, that wanted to develop a relationship with their big gamers."

When the punter checks in, many give out their mobile numbers to get messages about special offers.

"They have a private network inside the casino, so when you're leaving the casino they're giving you a special offer to bring you back in."

But isn't that still a form of tracking movement that some people could find slightly creepy?

"You as a consumer benefits. The casino benefits," Mr Meyer explains. "But it will be limited to individual forums. It's because of that fear. Are you being tracked?"

He is keen to distance the business from Phorm, the targeted advertising company that has been fiercely criticised for taking data from people online to store anonymously. Acxiom, Mr Meyer says, has a dedicated privacy officer and spends time consulting with consumer watchdogs before launching new products.

But Mr Meyer believes the future of direct marketing is in high-tech data services, predicting that the company's next acquisition will be technology related to interactive television or the internet.

It has recently conducted three pilots into the uses for product placement on US television, where the consumer can select a product, request details and buy it.

People will soon think of these forms of marketing based on information gleaned from a variety of sources as a natural, Mr Meyer argues, especially as the current tech-savvy generation grows up.

"You're using Facebook to say all kind of things that you wouldn't say in public," he says. "My grandmother thought that the phone was an intrusion into her life. Why would this person call rather than knock on the door? Now we just accept it."

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Glup

The capital well is running dry and some economies will wither - Telegraph

The capital well is running dry and some economies will wither
The world is running out of capital. We cannot take it for granted that the global bond markets will prove deep enough to fund the $6 trillion or so needed for the Obama fiscal package, US-European bank bail-outs, and ballooning deficits almost everywhere.


By Ambrose Evans-Pritchard
Last Updated: 8:49AM BST 26 Apr 2009

Comments 46 | Comment on this article

Unless this capital is forthcoming, a clutch of countries will prove unable to roll over their debts at a bearable cost. Those that cannot print money to tide them through, either because they no longer have a national currency (Ireland, Club Med), or because they borrowed abroad (East Europe), run the biggest risk of default.

Traders already whisper that some governments are buying their own debt through proxies at bond auctions to keep up illusions – not to be confused with transparent buying by central banks under quantitative easing. This cannot continue for long.

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Commerzbank said every European bond auction is turning into an "event risk". Britain too finds itself some way down the AAA pecking order as it tries to sell £220bn of Gilts this year to irascible investors, astonished by 5pc deficits into the middle of the next decade.

US hedge fund Hayman Advisers is betting on the biggest wave of state bankruptcies and restructurings since 1934. The worst profiles are almost all in Europe – the epicentre of leverage, and denial. As the IMF said last week, Europe's banks have written down 17pc of their losses – American banks have swallowed half.

"We have spent a good part of six months combing through the world's sovereign balance sheets to understand how much leverage we are dealing with. The results are shocking," said Hayman's Kyle Bass.

It looked easy for Western governments during the credit bubble, when China, Russia, emerging Asia, and petro-powers were accumulating $1.3 trillion a year in reserves, recycling this wealth back into US Treasuries and agency debt, or European bonds.

The tap has been turned off. These countries have become net sellers. Central bank holdings have fallen by $248bn to $6.7 trillion over the last six months. The oil crash has forced both Russia and Venezuela to slash reserves by a third. China let slip last week that it would use more of its $40bn monthly surplus to shore up growth at home and invest in harder assets – perhaps mining companies.

The National Institute for Economic and Social Research (NIESR) said last week that since UK debt topped 200pc of GDP after the Second World War, we can comfortably manage the debt-load in this debacle (80pc to 100pc). Variants of this argument are often made for the rest of the OECD club.

But our world is nothing like the late 1940s, when large families were rearing the workforce that would master the debt. Today we face demographic retreat. West and East are both tipping into old-aged atrophy (though the US is in best shape, nota bene).

Japan's $1.5 trillion state pension fund – the world's biggest – dropped a bombshell this month. It will start selling holdings of Japanese state bonds this year to cover a $40bn shortfall on its books. So how is the Ministry of Finance going to fund a sovereign debt expected to reach 200pc of GDP by 2010 – also the world's biggest – even assuming that Japan's industry recovers from its 38pc crash?

Japan is the first country to face a shrinking workforce in absolute terms, crossing the dreaded line in 2005. Its army of pensioners is dipping into the collective coffers. Japan's savings rate has fallen from 14pc of GDP to 2pc since 1990. Such a fate looms for Germany, Italy, Korea, Eastern Europe, and eventually China as well.

So where is the $6 trillion going to come from this year, and beyond? For now we must fall back on the Fed, the Bank of England, and fellow central banks, relying on QE (printing money) to pay for our schools, roads, and administration. It is necessary, alas, to stave off debt deflation. But it is also a slippery slope, as Fed hawks keep reminding their chairman Ben Bernanke.

Threadneedle Street may soon have to double its dose to £150bn, increasing the Gilt load that must eventually be fed back onto the market. The longer this goes on, the bigger the headache later. The Fed is in much the same bind. One wonders if Mr Bernanke regrets saying so blithely that Washington can create unlimited dollars "at essentially no cost".

Hayman Advisers says the default threat lies in the cocktail of spiralling public debt and the liabilities of banks – like RBS, Fortis, or Hypo Real – that are landing on sovereign ledger books.

"The crux of the problem is not sub-prime, or Alt-A mortgage loans, or this or that bank. Governments around the world allowed their banking systems to grow unchecked, in some cases growing into an untenable liability for the host country," said Mr Bass.

A disturbing number of states look like Iceland once you dig into the entrails, and most are in Europe where liabilities average 4.2 times GDP, compared with 2pc for the US. "There could be a cluster of defaults over the next three years, possibly sooner," he said.

Research by former IMF chief economist Ken Rogoff and professor Carmen Reinhart found that spasms of default occur every couple of generations, each time shattering the illusions of bondholders. Half the world succumbed in the 1830s and again in the 1930s.

The G20 deal to triple the IMF's
fire-fighting fund to $750bn buys time for the likes of Ukraine and Argentina. But the deeper malaise is that so many of the IMF's backers are themselves exhausting their credit lines and cultural reserves.

Great bankruptcies change the world. Spain's defaults under Philip II ruined the Catholic banking dynasties of Italy and south Germany, shifting the locus of financial power to Amsterdam. Anglo-Dutch forces were able to halt the Counter-Reformation, free northern Europe from absolutism, and break into North America.

Who knows what revolution may come from this crisis if it ever reaches defaults. My hunch is that it would expose Europe's deep fatigue – brutally so – reducing the Old World to a backwater. Whether US hegemony remains intact is an open question. I would bet on US-China condominium for a quarter century, or just G2 for short.

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USA vs Argentina

Desmond Lachman -- Welcome to America, the World's Scariest Emerging Market - washingtonpost.com

Welcome to America, the World's Scariest Emerging Market


By Desmond Lachman
Sunday, March 29, 2009; Page B01

Back in the spring of 1998, when Boris Yeltsin was still at Russia's helm, I led a group of global investors to Moscow to find out firsthand where the Russian economy was headed. My long career with the International Monetary Fund and on Wall Street had taken me to "emerging markets" throughout Asia, Eastern Europe and Latin America, and I thought I'd seen it all. Yet I still recall the shock I felt at a meeting in Russia's dingy Ministry of Finance, where I finally realized how a handful of young oligarchs were bringing Russia's economy to ruin in the pursuit of their own selfish interests, despite the supposed brilliance of Anatoly Chubais, Russia's economic czar at the time.

At the time, I could not imagine that anything remotely similar could happen in the United States. Indeed, I shared the American conceit that most emerging-market nations had poorly developed institutions and would do well to emulate Washington and Wall Street. These days, though, I'm hardly so confident. Many economists and analysts are worrying that the United States might go the way of Japan, which suffered a "lost decade" after its own real estate market fell apart in the early 1990s. But I'm more concerned that the United States is coming to resemble Argentina, Russia and other so-called emerging markets, both in what led us to the crisis, and in how we're trying to fix it.
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Over the past year, I've been getting Russia flashbacks as I witness the AIG debacle as well as the collapse of Bear Sterns and a host of other financial institutions. Much like the oligarchs did in Russia, a small group of traders and executives at onetime venerable institutions have brought the U.S. and global financial systems to their knees with their reckless risk-taking -- with other people's money -- for their personal gain.

Negotiating with Argentina's top officials during their multiple financial crises in the 1990s was always an ordeal, and sparring with Domingo Cavallo, the country's Harvard-trained finance minister at the time, was particularly trying. One always had the sense that, despite their supreme arrogance, the country's leaders never had a coherent economic strategy and that major decisions were always made on the run. I never thought that was how policy was made in the United States -- until, that is, I saw how totally at sea Treasury Secretaries Henry Paulson and Timothy F. Geithner and Federal Reserve Chairman Ben S. Bernanke have appeared so many times during our country's ongoing economic and financial storm.

The parallels between U.S. policymaking and what we see in emerging markets are clearest in how we've mishandled the banking crisis. We delude ourselves that our banks face liquidity problems, rather than deeper solvency problems, and we try to fix it all on the cheap just like any run-of-the-mill emerging market economy would try to do. And after years of lecturing Asian and Latin American leaders about the importance of consistency and transparency in sorting out financial crises, we fail on both counts: In March 2008, one investment bank, Bear Stearns, is bailed out because it is thought to be too interconnected with the rest of the banking system to fail. However, six months later, another investment bank, Lehman Brothers -- for all intents and purposes indistinguishable from Bear Stearns in its financial market inter-connectedness -- is allowed to fail, with catastrophic effects on global financial markets.

In visits to Asian capitals during the region's financial crisis in the late 1990s, I often heard Asian reformers such as Singapore's Lee Kuan Yew or Japan's Eisuke Sakakibara complain about how the incestuous relationship between governments and large Asian corporate conglomerates stymied real economic change. How fortunate, I thought then, that the United States was not similarly plagued by crony capitalism! However, watching Goldman Sachs's seeming lock on high-level U.S. Treasury jobs as well as the way that Republicans and Democrats alike tiptoed around reforming Freddie Mac and Fannie Mae -- among the largest campaign contributors to Congress -- made me wonder if the differences between the United States and the Asian economies were only a matter of degree.

On Wall Street there is an old joke that the longest river in the emerging-market economies is "de Nile." Yet how often do U.S. leaders respond to growing signs of economic dysfunctionality by spouting nationalistic rhetoric that echoes the speeches of Latin American demagogues like Peru's Alan Garcia in the 1980s and Argentina's Carlos Menem in the 1990s? (Even Garcia, currently in his second go-around as Peru's president, seems to have grown up somewhat.) But instead of facing our problems we extol the resilience of the U.S. economy, praise the most productive workers in the world, and go on and on about America's inherent ability to extricate itself from any crisis. And we ignore our proclivity as a nation to spend, year in year out, more than we produce, to put off dealing with long-term problems, and to engage in grandiose long-term programs that as a nation we can ill afford.

A singular characteristic of an emerging market heading for deep trouble is a seemingly suicidal tendency to become overly indebted to foreign creditors. That tendency underlay the spectacular collapse of the Thai, Indonesian and Korean currencies in 1997. It also led Russia to default on its debt in 1998 and plunged Argentina into its economic depression in 2001. Yet we too seem to have little difficulty becoming increasingly indebted to the tune of a few hundred billion dollars a year. To make matters worse, we do so to countries like China, Russia and an assortment of Middle Eastern oil producers -- none of which is particularly well disposed to us.

Like Argentina in its worst moments, we never seem to question whether it is reasonable to expect foreigners to keep financing our extravagance, and we forget the bad things that happen to the Argentinas or Hungarys of the world when foreigners stop financing their excesses. So instead of laying out a realistic plan for increasing our national savings, we choose not to face up to the Social Security and Medicare crises that lie ahead, embarking instead on massive spending programs that -- whatever their long-run merits might be -- we simply cannot afford.

After experiencing a few emerging-market crises, I get the sense of watching the same movie over and over. All too often, a tragic part of that movie is the failure of the countries' policymakers to hear the loud cries of canaries in the coal mine. Before running up further outsized budget deficits, should we not heed the markets that now see a 10 percent probability that the U.S. government will default on its sovereign debt in the next five years? And should we not be paying close attention to the Chinese central bank governor's musings that he does not feel comfortable with the $1 trillion of U.S. government debt that the Chinese central bank already owns, let alone adding to those holdings?

In the twilight of my career, when I am hopefully wiser than before, I have come to regret how the IMF and the U.S. Treasury all too often lectured leaders in emerging markets on how to "get their house in order" -- without the slightest thought that the United States might fare no better when facing a major economic crisis. Now, I fear time is running out for our own policymakers to mend their ways and offer real leadership to extricate the United States from its worst economic calamity since the 1930s. If we insist on improvising and not facing our real problems, we might soon lose our status as a country to be emulated and join the ranks of those nations we have patronized for so long.

Desmond Lachman, a fellow at the American Enterprise Institute, was previously chief emerging market strategist at Salomon Smith Barney and deputy director of the International Monetary Fund's Policy and Review Department

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How to invest in an inflation environment

Pick Your Poison: Inflation, Deflation, Stagflation - BusinessWeek

Inflation

The most direct way to fight this is to buy Treasury Inflation-Protected Securities (TIPS)—government-backed bonds pegged to inflation via the CPI. (TIPS belong in tax-deferred accounts because they are not tax-efficient.) A study by economic consultancy Peter L. Bernstein Inc. found that, for an aggressive investor who is worried about inflation, a 47%/53% proportion of TIPs to stocks (the study tracked broad stock market indexes) provided the best risk-adjusted real returns over a wide range of inflationary environments.

Among mutual funds, advisers favor the Vanguard Inflation-Protected Securities Fund (VIPSX), which had an annualized return of 5% for the past three years. Other plays include the iShares Barclays TIPS Bond exchange-traded fund (TIP) and Pimco Real Return Fund (PRTNX).

Commodities are another classic hedge. A well-diversified commodity play is the Pimco Commodity Real Return Fund (CRIX), which combines commodities with TIPS. Many advisers also like the SPDR Gold Trust ETF (GLD) and the First Eagle Gold Fund.

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The great economic peril

FT.com / Columnists / Martin Wolf - Is the UK once again the economic sick man?

Is the UK once again the economic sick man?

By Martin Wolf

Published: April 23 2009 20:06 | Last updated: April 23 2009 20:06

Is the UK once again the economic sick man? Or is it, as Alistair Darling, chancellor of the exchequer, argued in his Budget speech on Wednesday, just one of a number of hard-hit high-income countries? The answers to these questions are: yes and yes. The explanation for this ambiguity is that the fiscal deterioration is extraordinary, but the economic collapse is not.

Let us start with the economy. According to the International Monetary Fund’s latest World Economic Outlook, the UK economy will contract by 4.1 per cent this year, followed by a further contraction of 0.4 per cent next year. This, it should be stressed, is far worse than the 3.5 per cent contraction in 2009 and 1.25 per cent expansion in 2010 forecast by the Treasury.
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The IMF puts forward the following forecasts for other big economies: -3.8 per cent in 2009 and 0.0 in 2010 for all advanced countries; -2.8 per cent and 0.0 for the US; -4.2 per cent and -0.4 per cent for the eurozone; -5.6 per cent and -1.0 per cent for Germany; and -6.2 per cent and 0.5 per cent for Japan. Thus, the UK’s forecast performance is close to the mean for all advanced countries and better than for Germany and Japan.

The striking feature, indeed, is that the worst-hit economies are not those of profligate, high-spending countries, such as the UK and US, but of prudent, high-saving countries, such as Germany and Japan. People in the latter tend to see this as unfair, because it is undeserved. Well, life is unfair.

The serious answer is that the economic and financial health of sellers and creditors cannot be divorced from that of buyers and debtors. If customers are bankrupt, suppliers are likely to be in the same predicament. This is why Japan has suffered a collapse in manufacturing output comparable to that of the US during the Great Depression: a fall of 37 per cent since the start of 2008.

Now turn to the fiscal position. The IMF forecasts the UK general government deficit at 9.8 per cent of GDP in 2009 and 10.9 per cent next year. In the UK Budget, the Treasury forecasts the general government deficit at 12 per cent of GDP, or over, in 2009-10 and 2010-11. This suggests that the IMF forecasts are much too optimistic. Whether it is equally over-optimistic about other countries’ fiscal positions I do not know.

In any case, the IMF forecast deficit for the UK for next year is the highest in the Group of Seven leading high-income countries. Only Japan, on 9.8 per cent, and the US, on 9.7 per cent come close. Meanwhile, Germany’s deficit next year is forecast at “only” 6.1 per cent of GDP. Moreover, the 8.3 percentage point deterioration in the UK deficit between 2007 and 2010 is also the highest in the G7, with only Japan (a 7.3 percentage points deterioration) and the US (a 6.8 percentage points deterioration) coming close.

Not surprisingly, the UK is also forecast to have a relatively large deterioration in its net public debt, with a rise of 29 percentage points between 2007 and 2010 from 38 to 67 per cent of GDP. This time Japan, with a deterioration of 34 percentage points, is ahead, and the US, with 27 percentage points, just behind. But Germany’s rise is only 16 percentage points. Moreover, the UK’s net debt is forecast to continue to rise thereafter. It could well hit 100 per cent of GDP.

So why has the fiscal deterioration been so severe in the UK, when the economic deterioration has not been?

The obvious answer is that the sectors of the UK economy that have collapsed – housing and finance – are particularly revenue-intensive. As a result the ratio of current receipts to GDP is expected to shrink from 38.6 per cent in 2007-08 to 35.1 per cent in 2009-10 – a fall of 3.5 percentage points.

A deeper answer is that it is the countries where the debt-fuelled spending of the private sector was highest that have seen the largest swings in the balance between private income and spending. The shift in this balance in the UK’s private sector between 2007 and 2010 is forecast (implicitly) by the IMF at 9.6 per cent of GDP (from minus 0.2 per cent to plus 9.4 per cent). The swing in Germany, in contrast, is just 0.6 percentage points.

When the private sector shrinks its spending relative to incomes, either the current account or the fiscal balance must shift in equal and opposite directions. The current account deficit always changes relatively slowly. It is hard to change the economy’s structure quickly. So it has been the fiscal position that has deteriorated massively.

Thus, in the crisis-hit countries themselves, the consequence of the private sector cutback has been the fiscal deterioration. In the export-oriented countries, the result has been a massive contraction in exports and output. The huge fiscal deteriorations in the UK (and US) and the huge declines in manufactured output and exports in Germany and Japan are two sides of one coin.

So where does this leave us? The answer is that the next leg in the crisis, for both sides, will come when (or if) the huge fiscal deficits themselves become unsustainable. This is the great economic peril that lies ahead – and not just for the UK.

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What about V+L?

David Wessel Details Scenarios for the Economy's Path Post-Recession - WSJ.com

There is no doubt where the economy is now. "By any measure, this downturn represents by far the deepest global recession since the Great Depression," the International Monetary Fund declared Wednesday.

But there's more than the usual uncertainty about where it is going. The key is the U.S. Even though its slice of the world economy is smaller than it once was, it's still huge. The U.S. led the world into the abyss, and it will lead the world economy out of it.

But how fast and when?

The alphabet can help to imagine the possibilities and the path of the economy. There's the letter V: the kind of quick rebound that usually follows a deep recession. Or U: a longer recession and slow recovery. There is L: years of painfully slow growth. And W: a temporary upturn as the economy feels the jolt of fiscal stimulus that quickly wears off. Finally, there's the big D, not the shape but another Great Depression.

With history a guide, consider three starkly different scenarios.
The V

The late Victor Zarnowitz, a student of the business cycle, had a rule: "Deep recessions are almost always followed by steep recoveries." The mild recession of the early 1990s and early 2000s were followed by mild recoveries. But the U.S. economy grew faster than a 6% pace in the four quarters after the deep 1973-75 recession and faster than a 7.75% pace after the even deeper 1980-82 downturn.
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What's On the Other Side of the Recession?
2:09

The IMF says this is the worst recession that the world has seen since the Great Depression. So what will happen next? Economics Editor David Wessel discusses three possible scenarios.

"In deep recessions," says Michael Mussa of the Peterson Institute for International Economics, "there is usually a growing sense of gloom as the recession deepens." Then the forces that triggered recession -- say, plunging home prices -- abate. The adrenaline of tax cuts and government spending kicks in. With inventories so lean, the slightest uptick in demand prompts a sharp increase in production, and the natural dynamism of capitalism reasserts itself.

"Experience suggests all of this should work, and I believe it will," Mr. Mussa predicts. Governments have administered huge doses of fiscal and monetary stimulus. Home-building and car-buying are so low they can't fall much further. Many consumers shy away from buying because they're frightened, not broke, and that state of mind can change quickly and liberate pent-up demand.

But the Federal Reserve caused the deep recessions of the 1970s and 1980s when it put its foot on the brake to stop inflation; it ended them when it let up. This time, Fed has its foot to the floor and the economy is still slowing. And so much stock-market and housing wealth has evaporated that a quick turn in consumer spirits seems unlikely. Plus, the repair of the banks remains far from complete, restraining lending.

The odds of the V: 15%.
The Big D

If one asked a roomful of economists two years ago to put odds on a repeat of the Great Depression, nearly all would have said zero. In early March, The Wall Street Journal posed the question to about 50 forecasters -- defining depression as a decline in output per person of more than 10%, four times worse than the decline the IMF anticipates. On average, they put odds at one in seven; several put them above one in four.
[Deeper Decline]

"This is a Depression-sized event," says economic historian Barry Eichengreen of the University of California at Berkeley, citing the global decline in industrial production and world trade. The big difference: In 1929, governments dithered, or worse. In 2009, they've rushed to the rescue.

To go from today's deep recession to a depression something would have to go wrong. It could be a financial catastrophe on the scale of last fall's bankruptcy by Lehman Brothers or another panic-inducing event. Or a crash in the dollar, one that forces interest rates up at just the wrong moment. Or it could be political gridlock that stops governments in the U.S. or Europe from spending enough to fix the banks before a big one fails, or keeps them for doing more on the fiscal or monetary fronts as the economy deteriorates.

Or it could be virulent deflation that pulls down prices and incomes, making debts, which don't fall when prices do, a heavier burden. The textbook remedy is easy money and big government deficits. But so much of that has been tried it's easy to question its efficacy or to imagine resistance around the world to doing.

The odds of the big D: 20%.
The L

For a decade after its stock market and real-estate bubble burst in 1990, Japan bumped along at an annual growth of just 0.5%. It was dubbed the Lost Decade, and it could happen here. The recession ends but the economy plods along, growing too slowly to bring down unemployment for years.

As the IMF observed this week, recoveries following recession caused by financial crises are "typically slower." Those following recessions that occur simultaneously across the globe "have typically been weak." Back in the 1990s, as U.S. banks struggled, the Fed talked a lot about "financial headwinds." Those were zephyrs compared to the gale-force winds that the economy confronts today.

If financial markets stabilize but don't improve steadily, or if housing prices continue to drift down, or if confidence remains shaky, the U.S. economy could languish for a time. American consumers, once known for spending in the face of prosperity or adversity, could finally decide to prepare for retirement by saving more, having just learned that neither 401(k) retirement accounts nor home values rise inexorably. And the U.S. can't count on increasing exports, the solution when emerging-market economies run into financial trouble and the reason Japan didn't do even worse in the 1990s. The rest of the world is in no shape to buy.

An unfolding depression could scare Congress to act boldly, but the L is less ominous -- and perhaps more likely as a result. There would be months when the economy appeared to be strengthening so the temptation to wait-and-see would be strong.

Put the odds of the L at 55%. That adds to 90%. So put 10% odds on the U, less pleasant than the euphoric V but far less painful than a Lost Decade. That's the rough consensus of economic forecasters; it means U.S. unemployment grows for another year and a half.

Bottom line: The odds favor a long slog.

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Inflation will prevail

FT.com / Comment / Opinion - Inflation is looming on America’s horizon

Inflation is looming on America’s horizon

By Martin Feldstein

Published: April 19 2009 18:54 | Last updated: April 19 2009 18:54

The US last week showed its first signs of deflation for 55 years, prompting inevitable fears of further deflation in the future. Yet the primary reason for the negative rate of US inflation is the dramatic 30 per cent fall of commodity prices. That will not happen again. Moreover, excluding food and energy, consumer prices are up 1.8 per cent from a year ago. That is the good news: the outlook for the longer term is more ominous.

The unprecedented explosion of the US fiscal deficit raises the spectre of high future inflation. According to the Congressional Budget Office, the president’s budget implies a fiscal deficit of 13 per cent of gross domestic product in 2009 and nearly 10 per cent in 2010. Even with a strong economic recovery, the ratio of government debt to GDP would double to 80 per cent in the next 10 years.

There is ample historic evidence of the link between fiscal profligacy and subsequent inflation. But historic evidence and economic analysis also show that the inflationary effects can be avoided if the fiscal deficits are not accompanied by a sustained increase in the money supply and, more generally, by an easing of monetary conditions.

The key fact is that inflation rises when demand exceeds supply. A fiscal deficit raises demand when the government increases its purchase of goods and services or, by lowering taxes, induces households to increase their spending. Whether this larger fiscal deficit leads to an increase in prices depends on monetary conditions. If the fiscal deficit is not accompanied by an increase in the money supply, the fiscal stimulus will raise short-term interest rates, blocking the increase in demand and preventing a sustained rise in inflation.

So the potential inflationary danger is that the large US fiscal deficit will lead to an increase in the supply of money. This inevitably happens in developing countries that do not have the ability to issue interest-bearing debt and must therefore finance their deficits by printing money. In contrast, when deficits do not lead to an increased supply of money, the evidence shows that they do not cause sustained price increases.

A primary example of this was the sharp fall in inflation in the US in the early 1980s at the same time that fiscal deficits were rising rapidly. Inflation fell because the Federal Reserve tightened monetary conditions and allowed short-term interest rates to rise sharply.

But now the large US fiscal deficits are being accompanied by rapid increases in the money supply and by even more ominous increases in commercial bank reserves that could later be converted into faster money growth. The broad money supply (M2) is already increasing at an annual rate of nearly 15 per cent. The excess reserves of the banking system have ballooned from less than $3bn a year ago to more than $700bn (€536bn, £474bn) now.

The money supply consists largely of government-insured bank deposits that households and businesses are holding because of a concern about the liquidity and safety of other forms of investment. But this could change when conditions improve, turning these money balances into sources of inflation.

The link between fiscal deficits and money growth is about to be exacerbated by “quantitative easing”, in which the Fed will buy long-dated government bonds. While this may look like just a modified form of the Fed’s traditional open market operations, it cannot be distinguished from a policy of directly monetising some of the government’s newly created debt. Fortunately, the amount of debt being purchased in this way is still small relative to the total government borrowing.

The Fed is also creating a massive increase in liquidity by its policy of supplying credit directly to private borrowers. Although these credit transactions do not add to the measured fiscal deficit, the unprecedented Fed purchases of more than $1,000bn of private securities have led to the enormous $700bn increase in the excess reserves of the commercial banks. The banks now hold these as interest-bearing deposits at the Fed. But when the economy begins to recover, these reserves can be converted into new loans and faster money growth.

The deep recession means that there is no immediate risk of inflation. The aggregate demand for labour and goods and services is much less than the potential supply. But when the economy begins to recover, the Fed will have to reduce the excessive stock of money and, more critically, prevent the large volume of excess reserves in the banks from causing an inflationary explosion of money and credit.

This will not be an easy task since the commercial banks may not want to exchange their reserves for the mountain of private debt that the Fed is holding and the Fed lacks enough Treasury bonds with which to conduct ordinary open market operations. It is surprising that the long-term interest rates do not yet reflect the resulting risk of future inflation.

The writer is professor of economics at Harvard and president emeritus of the National Bureau of Economic Research. He chaired the Council of Economic Advisers under President Reagan and is a member of President Obama’s Economic Recovery Advisory Board

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Inflation, not yet

Is inflation the answer? - Paul Krugman Blog - NYTimes.com

Is inflation the answer?

Greg Mankiw says yes. Since that was the answer I arrived at for Japan more than a decade ago, I have to say that it makes sense in principle.

But here’s why it won’t work now, at least not yet: we’re talking about making a credible commitment to fairly high inflation over the medium term, yet you still have distinguished central bankers appalled at the Fed’s 2 percent inflation target.

And again, the inflation commitment has to be credible. So I don’t think we’re ready for this, not yet.

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Soybeans

FT.com / UK - Chinese demand drives soyabeans higher

Chinese demand drives soyabeans higher

By Chris Flood

Published: April 16 2009 10:26 | Last updated: April 16 2009 22:43

Strong gains for soyabeans were the stand-out feature of trading in commodity markets on Thursday with prices reaching their highest levels this year.

CBOT May soyabeans rose 20 cents, or 1.9 per cent, to a session high of $10.55 a bushel, a six-month peak, amid strong demand from China and concerns about production in Latin America.

On Wednesday, the Buenos Aires Cereals Exchange cut its 2009 soyabean production forecast by 6.1 per cent to 37m tonnes, down 19.9 per cent from the previous year, because of drought and crop pests.

The US government on Thursday reported weekly soyabean export sales of 808,300 tonnes, with half heading to China. This strong demand has increased concerns that US soyabean stocks will be severely depleted to less than 100m bushels by the end of the current season.

One trader warned that the US soyabean market could not allow China to maintain its current pace of buying and that further price increases would be required to ration demand.

However, grain production in China was forecast to fall 8m tonnes, or 3.5 per cent, to 220m tonnes this year by the Chinese Academy of Social Science, which did not provide any crop breakdown.

China has also been buying cargos of Brazilian soyabeans, pushing prices in Brazil’s spot market sharply higher and dealers said there was growing concern that exporters were struggling to keep pace with global demand.

India’s imports of edible oils reached 609,553 tonnes in March, up 44 per cent year-on-year, amid concerns that the government will re-impose import taxes after the upcoming parliamentary elections.

Dealers also point out that open interest (active positions) aggregated for the entire US soyabean futures curve has been rising strongly, suggesting capital is flowing into the market in the hope of further price gains.

In Chicago, CBOT May wheat added 1¾ cents at $5.17 a bushel while CBOT May corn lost 2 cents to $3.82 a bushel.

Base metals were mixed after China reported its weakest economic growth in the first quarter since it first started to publish quarterly national accounts data in 1992. However, analysts pointed to stronger-than-expected industrial output and investment spending as evidence that the government’s stimulus package was working, and expressed confidence that the first quarter would prove the low point for China’s economy.

Comments from the International Monetary Fund also contributed to the subdued/hesitant mood on Thursday.

The IMF said that the historically rare combination of a deep financial crisis and a globally synchronised downturn was likely to result in an unusually severe and long lasting recession.

Manoj Pradhan, economist at Morgan Stanley, said global growth would resume in the second half of the year but warned that any recovery was likely be “anaemic”.

Copper fell 1.8 per cent to $4,730 a tonne while aluminium slid 2.3 per cent to $1,480 a tonne and lead lost 3.5 per cent to $1,495.

In oil markets, ICE June Brent rose 62 cents to $53.06 a barrel while Nymex May West Texas Intermediate added 73 cents to $49.98 a barrel.

WTI remained under pressure relative to Brent after US inventories data, released on Wednesday, brought fresh evidence of demand weakness. US crude stocks rose 5.6m barrels last week and have reached their highest level since September 1990 as refineries have cut back on production due to maintenance programmes and weak demand.

Nauman Barakat, of Macquarie, said that the data suggested US demand was not only weak but actually deteriorating and that a combination of high imports and low refinery output was a recipe for further increases in crude stocks.

Gold fell 1.2 per cent to $880 a troy ounce.

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Branding

Stumbling and Mumbling

There’s a link between two of the most absurd stories of the last few days - Sainsbury’s attempt to get us to call pollack Colin (pronounced co-lan), and McBride/Draper's efforts to smear the Tories. Both are/were exercises in branding. They are efforts by managers to change perceptions. Sainsbury’s want to change the image of pollack from "ugly thing" to "tasty alternative to cod", and McBride wanted to change our perception of George Osborne from "mature, experienced astute economist and self-made man who’s well-equipped to be Chancellor" (I might have missed something) to "bloke with a mad wife".51245785qn9
However, both efforts might be just managerialist hubris. A new book by Jonathan Salem Baskin - Branding Only Works on Cattle - argues that branding just doesn’t work:
Branding is based on an outdated and invalid desire to manipulate and control consumers’ unconscious. It looks good and feels good to the people who produce it, but it has little to no effect on consumer behaviour…It is the conceit that marketers can convince [consumers] of things that aren’t substantiated by fact or the reality of experience.
What matters, says Baskin, isn’t brand image or awareness or subconscious brand images, but hard fact, and real experience. He quotes a guy from Lenovo:
A brand, over time, will converge with reality. So you manage the brand by managing reality.
A brand name that’s not backed by a quality product or service will fail, however much is invested in “building the brand”: think of Consignia or Dasani. Sainsburys might be able to tempt people to buy pollack once, by generating publicity and displaying it more prominently in its shops. But folk will only buy it a second time if it tastes nice. Branding, ultimately, is trumped by hard fact.
In this context, McBride represents the comic excrescence of the tragedy of New Labour. The New Labour “project” was an attempt to transform a (declining) mass party whose members connected with voters every day in the workplace, social clubs and streets into a centralized top-down organization who connected with the public in the way that advertisers do - by manipulating brand images.
What New Labour forgot, or never knew, was exactly what Lenovo guy knows - that a brand converges with reality. Real votes depend upon people’s actual lived experience: are we getting value for our taxes? Is the country better governed than in 1997? These are questions that are posed day-in, day-out by, in schools, hospitals and our dealing with the police, by real individuals.
McBride, however, represents the managerialist tendency in New Labour - the belief that these real experiences can be over-ridden by top-down exercises in re-branding.
In this sense, he is not an “isolated case”. He is a pustule that is a symptom of a disease - that genuine politics has been infected by managerialism

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US Deficit

Zero Hedge: Bail Out For Dummies - Part 1

the U.S. deficit is increasing at a dramatic and unprecedented pace. The bulk of expenditures are currently going merely to fund the Bail Out program, in essence transferring U.S. sovereign issuance to the Fed's balance sheet which uses the newly minted cash to fund all the incremental and growing support programs. Currently only a small percentage of the guarantees are funded, and as we head to the full funding capacity on all the Bail Out programs ($8.8 trillion), Zero Hedge expects to see as much (not necessarily the full amount) as $7 trillion more of new Treasury issuance as the true "worth" of the assets is realized. All the debate over Agency, CRE, whole loan, etc. write downs are really just a drop in the bucket based on none other than the government's own estimate of just how bad things could really get eventually. In this context the Mark To Market debate is also moot, as is private participation in the PPIP, and the Stress Test: the scale of the problem is simply insurmountable using current mechanisms in place.

As more data emerges, Zero Hedge believe the real risk to the Bailout program is in fact the liability side of the balance sheet. The bottom line is that every dollar printed by the Treasury directly goes to fund (and dilute) a dollar in deposits, bypassing M1-M3. If the $8 trillion pool in total deposits realizes that it is supported by assets which even the government is saying are worth fractions on the dollar, the risk of a wholesale systemic bank run becomes unstoppable even with all the government backstops in place, as the latter will be contingent on continued willing recipients of those rapidly devaluing pieces of paper known as U.S. Treasuries and once that assumption is questioned or outright proven false, all bets are off.

big hat tip to Bank Of America for primary data.

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US banking system

The US Banking System's Terrifying Balance Sheet - Finance Blog - Felix Salmon - Market Movers - Portfolio.com

The US Banking System's Terrifying Balance Sheet

This is a spectacularly good piece of information design, from Tyler at Zero Hedge. It repays a lot of looking at, and manages to encapsulate both the scale of the US banking system and the scale of the solutions which have been announced or implemented to date.

On the asset side of the US banking system’s balance sheet, the $4.8 trillion in mortgages is a problem — but there’s another $3.1 trillion in bank loans and consumer credit which is looking increasingly shaky. Against that there’s less than $1 trillion in common stock, supporting over $12 trillion in liabilities.

Meanwhile, Tyler has neatly lined up the government’s support programs along with the relevant parts of the right-hand side of the banking system’s balance sheet. Add them all up, and they come to just over $9 trillion, or 67% of the banking system’s total assets. It’s an absolutely astonishing amount of support, and it brings home the scale of the problem facing the government.

In a nutshell, the problem is the classic one: on the left-hand side nothing is right, and on the right-hand side nothing is left, at least absent government intervention. Says Tyler:

As the government has the best information about the true sad state of affairs, it is likely that as more and more information about the weakness of the financial system comes to light, more of these support guarantees will become utilized to their full extent. This also means that the asset side of the balance sheet is potentially “inflated” by almost 75% and the net result could be the most dramatic collapse in a banking system’s assets in recorded history as over $8 trillion in “assets” are reevaluated.

This doesn’t need to be probable to be terrifying: it just needs to be possible. And Tyler’s point is that the government has put all of these programs in place precisely because it’s possible. So: fear is entirely rational here.

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Water

Water shortages go global | Sin aqua non | The Economist

It is not the absolute number of people that makes the biggest difference to water use but changing habits and diet. Diet matters more than any single factor because agriculture is the modern Agasthya, the mythical Indian giant who drank the seas dry. Farmers use about three-quarters of the world’s water; industry uses less than a fifth and domestic or municipal use accounts for a mere tenth.

Different foods require radically different amounts of water. To grow a kilogram of wheat requires around 1,000 litres. But it takes as much as 15,000 litres of water to produce a kilo of beef. The meaty diet of Americans and Europeans requires around 5,000 litres of water a day to produce. The vegetarian diets of Africa and Asia use about 2,000 litres a day (for comparison, Westerners use just 100-250 litres a day in drinking and washing).

So the shift from vegetarian diets to meaty ones—which contributed to the food-price rise of 2007-08—has big implications for water, too. In 1985 Chinese people ate, on average, 20kg of meat; this year, they will eat around 50kg. This difference translates into 390km3 (1km3 is 1 trillion litres) of water—almost as much as total water use in Europe.

The shift of diet will be impossible to reverse since it is a product of rising wealth and urbanisation. In general, “water intensity” in food increases fastest as people begin to climb out of poverty, because that is when they start eating more meat. So if living standards in the poorest countries start to rise again, water use is likely to soar. Moreover, almost all the 2 billion people who will be added to the world’s population between now and 2030 are going to be third-world city dwellers—and city people use more water than rural folk. The Food and Agriculture Organisation reckons that, without changes in efficiency, the world will need as much as 60% more water for agriculture to feed those 2 billion extra mouths. That is roughly 1,500km3 of the stuff—as much as is currently used for all purposes in the world outside Asia.

The other long-term trend affecting water is climate change. There is growing evidence that global warming is speeding up the hydrologic cycle—that is, the rate at which water evaporates and falls again as rain or snow. This higher rate seems to make wet regions more sodden, and arid ones drier. It brings longer droughts between more intense periods of rain.

Climate change has three big implications for water use. First, it changes the way plants grow. Trees, for example, react to downpours with a spurt of growth. During the longer droughts that follow, the extra biomass then dries up so that if lightning strikes, forests burn more spectacularly. Similarly crops grow too fast, then wilt.

Second, climate change increases problems of water management. Larger floods overwhelm existing controls. Reservoirs do not store enough to get people or plants through longer droughts. In addition, global warming melts glaciers and causes snow to fall as rain. Since snow and ice are natural regulators, storing water in winter and releasing it in summer, countries are swinging more violently between flood and drought. That is one big reason why dams, once a dirty word in development, have been making a comeback, especially in African countries with plenty of water but no storage capacity. The number of large dams (more than 15 metres high) has been increasing and the order books of dam builders are bulging.

Third, climate change has persuaded western governments to subsidise biofuels, which could prove as big a disaster for water as they already have been for food. At the moment, about 2% of irrigated water is used to grow crops for energy, or 44km3. But if all the national plans and policies to increase biofuels were to be implemented, reckons the UN, they would require an extra 180km3 of water. Though small compared with the increase required to feed the additional 2 billion people, the biofuels’ premium is still substantial.

In short, more water will be needed to feed and heat a world that is already showing signs of using too much. How to square that circle? The answer is by improving the efficiency with which water is used. The good news is that this is possible: vast inefficiencies exist which can be wrung out. The bad news is it will be difficult both because it will require people to change their habits and because governments, which might cajole them to make the changes, are peculiarly bad at water policy.
…nor any drop to drink

Improving efficiency is doable and industrial users have done it, cutting the amount of water needed to make each tonne of steel and each extra unit of GDP in most rich countries (see first chart). This can make a difference. The Pacific Institute reckons that, merely by using current water-saving practices (ie, no technological breakthroughs) California, a water-poor state, could meet all its needs for decades to come without using a drop more.

Still, industry consumes less than a fifth of the world’s water and the big question is how to get farmers, who use 70-80%, to follow suit. It takes at least three times as much water to grow maize in India, for example, as it does in America or China (see second chart). In some countries, you need 1,500 litres of water to produce a kilo of wheat; in others, only 750 litres. It does not necessarily follow that water is being used unsustainably in the one place and not the other; perhaps the high-usage places have plenty of water to spare. But it does suggest that better management could reduce the amount of water used in farming, and that the world could be better off if farmers did so. Changing irrigation practices can improve water efficiency by 30%, says Chandra Madramootoo, of the International Commission on Irrigation and Drainage. One can, for example, ensure water evaporates from the leaves of the plant, rather than from the soil. Or one can genetically modify crops so they stop growing when water runs dry, but do not die—they simply resume growth later when the rains return.

The world might also be better off, at least in terms of water, if trade patterns more closely reflected the amount of water embedded in traded goods (a concept called “virtual water” invented by Tony Allan of King’s College London). Some benign effects happen already: Mexico imports cereals from America which use 7 billion cubic metres (m3) of water. If it grew these cereals itself, it would use 16 billion m3, so trade “saves” 9 billion m3 of water. But such beneficial exchanges occur more by chance than design. Because most water use is not measured, let alone priced, trade rarely reflects water scarcities.

To make water use more efficient, says Koichiro Matsuura, the head of UNESCO, the main UN agency dealing with water, will require fundamental changes of behaviour. That means changing incentives, improving information flows, and improving the way water use is governed. All that will be hard.

Water is rarely priced in ways that reflect supply and demand. Usually, water pricing simply means that city dwellers pay for the cost of the pipes that transport it and the sewerage plants that clean it.

Basic information about who uses how much water is lacking. Rainwater and river flows can be measured with some accuracy. But the amount pumped out of lakes is a matter of guesswork and information on how much is taken from underground aquifers is almost completely lacking.

The governance of water is also a mess. Until recently, few poor countries treated it as a scarce resource, nor did they think about how it would affect their development projects. They took it for granted.

Alongside this insouciance goes a Balkanised decision-making process, with numerous overlapping authorities responsible for different watersheds, sanitation plants and irrigation. To take a small example, the modest town of Charlottesville in Virginia has 13 water authorities.

Not surprisingly, investment in water has been patchy and neglected. Aid to developing countries for water was flat in real terms between 1990 and 2005. Within that period, there was a big shift from irrigation to drinking water and sanitation—understandable no doubt, but this meant less aid was going to the main users of water, farmers in poor countries. Aid for irrigation projects in 2002-05 was less than half what it had been in 1978-81. Angel Gurría, the head of the Organisation for Economic Co-operation and Development, talks of “a crisis in water financing”.

As is often the way, business is ahead of governments in getting to grips with waste. Big drinks companies such as Coca Cola have set themselves targets to reduce the amount of water they use in making their products (in Coke’s case, by 20% by 2012). The Nature Conservancy, an ecologically-minded NGO, is working on a certification plan which aims to give companies and businesses seals of approval (a bit like the Fairtrade symbol) according to how efficiently they use water. The plan is supposed to get going in 2010. That sort of thing is a good start, but just one step in a long process that has barely begun.

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A long contraction

FT.com | Willem Buiter's Maverecon | The green shoots are weeds growing through the rubble in the ruins of the global economy

back buttonBack to Willem Buiter's Maverecon homepage
The green shoots are weeds growing through the rubble in the ruins of the global economy
April 8, 2009 3:20am

The Great Contraction will last a while longer

This financial crisis will end. The Great Contraction of the Noughties also will come to an end. But neither the financial crisis nor the contraction of the global real economy are over yet. As regards the financial sector, we are not too far - probably less than a year - from the beginning of the end. The impact of the collapse of real economic activity and of the associated dramatic increase in defaults and insolvencies by non-financial enterprises and households on the loan book of what is left of the banking sector will begin to show up in the banks’ financial reports at the end of the summer and in the autumn. By the end of the year - early 2010 at the latest - we will know which banks will survive and which ones are headed for the scrap heap. With the resolution of the current pervasive uncertainty about the true state of the banks’ balance sheets and about their off-balance-sheet exposures, normal financial intermediation will be able to resume later in 2010.

Governments everywhere are doing the best they can to delay or prevent the lifting of the veil of uncertainty and disinformation that most banks have cast over their battered balance sheets. The banking establishment and the financial establishment representing the beneficial owners of the institutions exposed to the banks as unsecured creditors - pension funds, insurance companies, other banks, foreign investors including sovereign wealth funds - have captured the key governments, their central banks, their regulators, supervisors and accounting standard setters to a degree never seen before.

I used to believe this state capture took the form of cognitive capture, rather than financial capture. I still believe this to be the case for many, perhaps even most of the policy makers and officials involved, but it is becoming increasingly hard to deny the possibility that the extraordinary reluctance of our governments to force the unsecured creditors (and any remaining non-government shareholders) of the zombie banks to absorb the losses made by these banks, may be due to rather more primal forms of state capture.

History teaches us that systemic financial crises are protracted affairs. A most interesting paper by Carmen M. Reinhart and Kenneth S. Rogoff, “The Aftermath of Financial Crises”, using data on 10 systemic banking crises (the “big five” developed economy crises (Spain 1977, Norway 1987, Finland, 1991, Sweden, 1991, and Japan, 1992), three famous emerging market crises (the 1997–1998 Asian crisis (Hong Kong, Indonesia, Malaysia, the Philippines, and Thailand); Colombia, 1998; and Argentina 2001)), and two earlier crises (Norway 1899 and the United States 1929) reaches the following conclusions (the next paragraph paraphrases Reinhart and Rogoff).

First, asset market collapses are deep and prolonged. Real housing price declines average 35 percent over six years; real equity price declines average 55 percent over a downturn of about 3.5 years. Second, the aftermath of banking crises is associated with large declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle which lasts on average over four years. Output falls (from peak to trough) an average of over 9 percent, but the duration of the downturn averages around 2 years.

Nothing more can be expected as regards a global fiscal stimulus. Indeed, the G20 delivered nothing in this regard. It would have been preferable to maintain the overall size of the planned (or rather, expected) global fiscal stimulus but to redistribute the aggregate (about $5 trillion over 2 years, as measured by the aggregated changes in the national fiscal deficits) in accordance with national fiscal spare capacity (I believe the World Bank calls this ‘fiscal space’). This would mean a smaller fiscal stimulus for countries with weak fiscal fundamentals, including the US, Japan and the UK, and a larger fiscal stimulus for countries with strong fiscal fundamentals, including China, Germany, Brazil and, to a lesser degree, France.

The effect of the Great Contraction on potential output growth

Furthermore, a likely consequence of the fiscal stimuli we have already seen or are about to experience is a negative impact on the medium- and long-term growth potential of the global economy. The reason is that, if fiscal solvency is to be maintained, there will have to be some combination of an increase in the tax burden and a reduction in non-interest public spending in most countries when this contraction is over. The inevitable effect of the crisis and the contraction is a higher public debt burden and therefore a larger future required primary government surplus (as a share of GDP). Almost any increase in the tax burden will hurt potential output - just the level of the path of potential output if you are a classical growth groupie, both the level and the growth rate of the path of potential output if you are an adept of the endogenous growth school.

In the study of Reinhart and Rogoff cited earlier, the authors conclude that the real value of government debt tends to explode following a systemic financial crisis, rising an average of 86 percent in major post–World War II episodes. The principal cause of these public debt explosions is not the costs of “bailing out” and recapitalizing banking system. The big drivers of these public debt burden increases are rather the collapse in tax revenues that comes with deep and prolonged output contractions (the operation of the automatic stabilisers) and discretionary counter-cyclical fiscal policies.

For political expediency reasons, cuts in public spending are likely to fall first on maintenance, public sector capital formation and other forms of productive public expenditure, including spending on education, health and research. Welfare spending in cash or in kind is likely to be the last to be cut. The result is again likely to be a lower level (or level and growth rate) of the path of potential output.

The risk of ’sudden stops’ in the overdeveloped world

In a number of systemically important countries, notably the US and the UK, there is a material risk of a ’sudden stop’ - an emerging-market style interruption of capital inflows to both the public and private sectors - prompted by financial market concerns about the sustainability of the fiscal-financial-monetary programmes proposed and implemented by the fiscal and monetary authorities in these countries. For both countries there is a material risk that the mind-boggling general government deficits (14% of GDP or over for the US and 12 % of GDP or over for the UK for the coming year) will either have to be monetised permanently, implying high inflation as soon as the real economy recovers, the output gap closes and the extraordinary fear-induced liquidity preference of the past year subsides, or lead to sovereign default.

Pointing to a non-negligible risk of sovereign default in the US and the UK does not, I fear, qualify me as a madman. The last time things got serious, during the Great Depression of the 1930s, both the US and the UK defaulted de facto, and possibly even de jure, on their sovereign debt.

In the case of the US, the sovereign default took the form of the abrogation of the gold clause when the US went off the gold standard (except for foreign exchange) in 1933. In 1933, Congress passed a joint resolution canceling all gold clauses in public and private contracts (including existing contracts). The Gold Reserve Act of 1934 abrogated the gold clause in government and private contracts and changed the value of the dollar in gold from $20.67 to $35 per ounce. These actions were upheld (by a 5 to 4 majority) by the Supreme Court in 1935.

In the case of the UK, the de facto sovereign default took the form of the conversion in 1932 of Britain’s 5% War Loan Bonds (callable 1929-1947) into new 3½ % bonds (callable from 1952) on terms that were unambiguously unfavourable to the bond holders. Out of a total of £2,086,000,000 outstanding, £1,500,000,000, or something over 70%, was converted voluntarily by the end of 1932, thanks both to the government’s ability to appeal to patriotism and joint burden sharing in the face of economic adversity and to ferocious arm-twisting and ‘moral suasion’.

I believe both defaults were eminently justified. There is no case for letting the interests of the holders of sovereign debt override the interests of the rest of the community, regardless of the financial, economic, social and political costs involved. But to say that these were justifiable sovereign defaults does not mean that they were not sovereign defaults. Similar circumstances could arise again.

While I consider an inflationary solution to the public debt overhang problem (and indeed to the private debt overhang problem) to be more likely in the US and even in the UK than a sovereign default (or ‘restructuring’, ‘conversion’ or ‘consolidation’, as it would undoubtedly be referred to by the defaulting government), neither can be dismissed as out of the question, or even as extremely unlikely.

Central banks: a mixed bag

Central banks, with the notable exception of the procrastinating ECB, are doing as much as they can through quantitative easing and credit easing to deal with the immediate crisis. Unfortunately, some of them, notably the Fed, are providing these short-term financial stimuli in the worst possible way from the point of view of medium- and longer-term economic performance, by surrendering central bank independence to the fiscal authorities.

When the Fed lends on a non-recourse basis to the private sector with only a $100 bn Treasury guarantee for a possible $1 trillion dollar Fed exposure (as with the TALF), when the Fed purchases private securities outright with just a similar 10-cents-on-the-dollar Treasury guarantee or when the Fed is party to an arrangement that transfers tens of billions of dollars to AIG counterparties - money that is likely to be extracted ultimately from the beneficiaries of other public spending programmes or from the tax payer, either through explicit taxes or through the inflation tax - the Fed is acting like an off-balance sheet and off-budget special purpose vehicle of the US Treasury.

When the Chairman of the Fed stands shoulder-to-shoulder or sits side-by-side with the US Treasury Secretary to urge the passing of various budgetary proposals - involving matters both beyond the Fed’s mandate and remit and beyond its competence - the Fed is politicised irretrievably. It becomes a partisan political player. This is likely to impair its ability to pursue its monetary policy mandate in the medium and long term.

The G20 wind egg

The global stimulus associated with the increase in IMF resources agreed at the G20 meeting earlier this month will be negligible unless and until these resources actually materialise. The statements, declarations and communiqués of the G20, including the most recent ones highlight the gaps between dreams and deeds.

Even the promise of an immediate increase in bilateral financing from members of $250 bn is not funded yet. Only $200 have been promised firmly - $100 bn by Japan and $100 bn by the EU. Prime Minister Brown announced that the PRC had committed another $40 bn, but apparently he had forgotten to clear this with the Chinese.

As regards the plan to incorporate in the near term, the immediate financing from members into an expanded and more flexible New Arrangements to Borrow would be increased by up to $500 billion (that is by another $250 bn). Unfortunately, nobody has volunteered any money yet. It therefore has no more substance than past commitments by the international community to fund the achievement of the Millenium Development Goals.

Then there is the promise that the G20 will consider market borrowing by the IMF to be used if necessary in conjunction with other sources of financing, to raise resources to the level needed to meet demands. That is classic official prittle-prattle - suggesting the IMF borrow without providing it with the resources (capital) to engage in such borrowing.

There is also $6 bn for the poorest countries, to be paid for by IMF gold sales and profits. Nice, but chicken feed.

Finally there is the decision to support a general allocation of SDRs equivalent to $250 billion to increase global liquidity, $100 billion of which will go directly to emerging market and developing countries. The problem is that this requires the approval of the US Congress, which is deeply hostile to any additional money for any of the Bretton Woods institutions. A special allocation of SDRs is also out of the question, because the US has not yet ratified the fourth amendment to the IMF’s articles (approved by the IMF’s Board of Governors in 1997!).

So apart from the $240 bn (or perhaps only $200 bn) already flagged well before the G20 meeting, the only hard commitment to additional resources (or to resources that have any chance of being available for lending and spending during the current contraction) is the $6 bn worth of alms for the poor from the sale of IMF gold. That’s what I call a bold approach!

The Multilateral Development Banks may well be able to increase their lending by $100 bn as announced by the G20, even with existing capital resources.

The increase in trade credit support announced at the G20 meeting is very modest indeed - $250 bn could be supported (mainly through guarantees, I suppose) over the next two years.

As regards protectionism, we must be grateful for the vast difference between today’s relatively mild manifestations and the virulent protectionism of the 1930s. But again, the last few G20 meetings have yielded not a single concrete protectionism-reducing measure.

Conclusion

There are signs that the rate of contraction of real global economic activity may be slowing down. Straws in the wind in China, the UK and the US hint that things may be getting worse at a slower rate. An inflection point for real activity (the second derivative turns positive) is not the same as a turning point (the first derivative turns positive), however. And even if decline were to end, there is no guarantee that whatever growth we get will be enough to keep up with the growth of potential. We could have a growing economy with rising unemployment and growing excess capacity for quite a while.

The reason to fear a U-shaped recovery with a long, flat segment is that the financial system was effectively destroyed even before the Great Contraction started. By the time the negative feedback loops from declining activity to the balance sheet strenght of what’s left of the financial sector will have made themselves felt in full, financial intermediation is likely to be severely impaired.

All contractions and recoveries are primarily investment-driven. High-frequency inventory decumulation causes activity to collapse rapidly. Since inventories cannot become negative, there is a strong self-correcting mechanism in an inventory disinvestment cycle. We may be getting to the stage in the UK and the US (possibly also in Japan) that inventories stop falling an begin to build up again.

An end to inventory decumulation is a necessary but not a sufficient condition for sustained economic recovery. That requires fixed investment to pick up. This includes household fixed investment - residential construction, spending on home improvement and purchases of new automobiles and other consumer durables. It also includes public sector capital formation. Given the likely duration of the contraction and the subsequent period of excess capacity, even public sector infrastructure spending subject to long implementation lags is likely to come in handy. A healthy, sustained recovery also requires business fixed investment to pick up.

At the moment, I can see not a single country where business fixed investment is likely to rise anytime soon. When the inventory investment accelerator goes into reverse and starts contributing to demand growth, and when the fiscal stimuli kick in, businesses wanting to invest will need access to external financing, since retained profits are, after a couple of years of declining output, likely to be few and far between. But with the banking system on its uppers and many key financial markets still disfunctional and out of commission, external financing will be scarce and costly. This is why sorting out the banks, or rather sorting out the substantive economic activities of new bank lending and funding, that is, sorting out banking , must be a top priority and a top claimant on scarce public resources.

Until the authorities are ready to draw a clear line between the existing banks in western Europe and the USA, - many or even most of which are surplus to requirements and have become parasitic entities feeding off the tax payer - and the substantive economic activity of bank lending to non-financial enterprises and households, there will not be a robust, sustained recovery.

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Ten principles for a Black Swan-proof world

FT.com / Comment / Opinion - Ten principles for a Black Swan-proof world

Ten principles for a Black Swan-proof world

By Nassim Nicholas Taleb

Published: April 7 2009 20:02 | Last updated: April 7 2009 20:02

1. What is fragile should break early while it is still small. Nothing should ever become too big to fail. Evolution in economic life helps those with the maximum amount of hidden risks – and hence the most fragile – become the biggest.

2. No socialisation of losses and privatisation of gains. Whatever may need to be bailed out should be nationalised; whatever does not need a bail-out should be free, small and risk-bearing. We have managed to combine the worst of capitalism and socialism. In France in the 1980s, the socialists took over the banks. In the US in the 2000s, the banks took over the government. This is surreal.

3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus. The economics establishment (universities, regulators, central bankers, government officials, various organisations staffed with economists) lost its legitimacy with the failure of the system. It is irresponsible and foolish to put our trust in the ability of such experts to get us out of this mess. Instead, find the smart people whose hands are clean.

4. Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks. Odds are he would cut every corner on safety to show “profits” while claiming to be “conservative”. Bonuses do not accommodate the hidden risks of blow-ups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives: capitalism is about rewards and punishments, not just rewards.

5. Counter-balance complexity with simplicity. Complexity from globalisation and highly networked economic life needs to be countered by simplicity in financial products. The complex economy is already a form of leverage: the leverage of efficiency. Such systems survive thanks to slack and redundancy; adding debt produces wild and dangerous gyrations and leaves no room for error. Capitalism cannot avoid fads and bubbles: equity bubbles (as in 2000) have proved to be mild; debt bubbles are vicious.

6. Do not give children sticks of dynamite, even if they come with a warning . Complex derivatives need to be banned because nobody understands them and few are rational enough to know it. Citizens must be protected from themselves, from bankers selling them “hedging” products, and from gullible regulators who listen to economic theorists.

7. Only Ponzi schemes should depend on confidence. Governments should never need to “restore confidence”. Cascading rumours are a product of complex systems. Governments cannot stop the rumours. Simply, we need to be in a position to shrug off rumours, be robust in the face of them.

8. Do not give an addict more drugs if he has withdrawal pains. Using leverage to cure the problems of too much leverage is not homeopathy, it is denial. The debt crisis is not a temporary problem, it is a structural one. We need rehab.

9. Citizens should not depend on financial assets or fallible “expert” advice for their retirement. Economic life should be definancialised. We should learn not to use markets as storehouses of value: they do not harbour the certainties that normal citizens require. Citizens should experience anxiety about their own businesses (which they control), not their investments (which they do not control).

10. Make an omelette with the broken eggs. Finally, this crisis cannot be fixed with makeshift repairs, no more than a boat with a rotten hull can be fixed with ad-hoc patches. We need to rebuild the hull with new (stronger) materials; we will have to remake the system before it does so itself. Let us move voluntarily into Capitalism 2.0 by helping what needs to be broken break on its own, converting debt into equity, marginalising the economics and business school establishments, shutting down the “Nobel” in economics, banning leveraged buyouts, putting bankers where they belong, clawing back the bonuses of those who got us here, and teaching people to navigate a world with fewer certainties.

Then we will see an economic life closer to our biological environment: smaller companies, richer ecology, no leverage. A world in which entrepreneurs, not bankers, take the risks and companies are born and die every day without making the news.

In other words, a place more resistant to black swans.

The writer is a veteran trader, a distinguished professor at New York University’s Polytechnic Institute and the author of The Black Swan: The Impact of the Highly Improbable

Copyright The Financial Times Limited 2009

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Hunger

FT.com / Global Economy - G8 warns of hunger threat to stability

G8 warns of hunger threat to stability

By Javier Blas in London

Published: April 6 2009 23:37 | Last updated: April 6 2009 23:37

The world faces a permanent food crisis and global instability unless countries act now to feed a surging population by doubling agricultural output, a report drafted for ministers of the Group of Eight nations has warned.

The policy document, prepared by the G8’s Italian presidency for its first ministerial meeting on agriculture and seen by the Financial Times, says “immediate interventions” are needed.

It warns that global agriculture production must double by 2050 for the world’s fast-growing population to have enough to eat and to deal with the effects of climate change. Otherwise, the report says, the food crisis of the past two years in much of the world “will become structural in only a few decades”.

The report says that further food crises will have “serious consequences, not merely on business relations but equally on social and international relations, which in turn will impact directly on the security and stability of world politics”.

Agriculture ministers from G8 nations are due to meet this month in Italy. The meeting was prompted by last year’s spike in the prices of agricultural commodities, including wheat and rice, which triggered riots in more than 30 countries, from Bangladesh to Haiti.

Global food pricesAlthough agricultural commodities prices have since fallen by as much as 40-50 per cent, they are still well above their pre-crisis levels. Domestic prices in many developing countries remain close to last year’s records and have risen even further in some African countries.

“The issue of price volatility remains a crucial element for the world’s food security,” the report says. “There is a need for a fast increase of agricultural production in developing countries.”

James Bolger, chairman of the World Agricultural Forum and former prime minister of New Zealand, said the G8 meeting on agriculture was “hugely” significant. Political unity on agriculture was critical to avoid “random efforts by individual countries to secure their own food security”, he said

Tom Vilsack, US agriculture secretary, said Washington planned to double financial aid for agriculture development in poor countries to $1bn next year.

“We face the reality of a world population that’s growing by 79m people each year, a rate that may ... challenge our capacity to grow and raise enough food,” he said yesterday ahead of the International Food Aid Conference in Kansas City.

Copyright The Financial Times Limited 2009

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Food

Greed, Green and Grains: Questions about Climate Change, Agriculture and Food Security

Monday, April 6, 2009
Questions about Climate Change, Agriculture and Food Security
For an "Environment and Society Class" a student from UNC Chapel Hill interviews me, via email, on potential impacts climate change on food security. Here are her questions (in italic) and my answers:

What do you think the biggest climate change-induced threat to agriculture is for the future of food security?

This is a good question and one I think about a lot. Climate change poses many potential threats to food security. Many and perhaps most of these threats may well be resolved in one way or another, but it’s hard to tell. At this point in time, I have a hard time ranking the threats. But here are the ones I think about most:

* Agronomically, the regions likely to be hardest hit from climate changes are countries in the tropic and sub-tropic regions of the world. These regions are also where most very poor countries reside. This is bad news and poses a big potential threat.
* It is very important to remember that we live in a global world and food prices are connected. So poor countries in tropical and subtropical regions will be affected strongly by impacts in richer countries with more temperate climates and more robust agricultural production. This means climate change impacts in countries like the U.S., the world’s largest producer, are also very important. Indeed, I would argue that one should focus first on the world’s potential production under climate change rather than how production impacts align with countries’ current wealth or ood security. Now, and even more so in the future, food will spread around the globe via trade. It is the aggregate sum of impacts that matters most, in my view.
* My own research with Wolfram Schlenker suggests climate change impacts on the U.S. could be much more severe than previously believed. This web page includes another paper that explains why we believe some earlier results were misleading, links to some other papers, and a lot of data.
* Despite the first and third bullets, the global impacts of climate change remain unclear. I would guess that Northern Europe, Ukraine, Northern China, Canada, and perhaps other parts of the world, will gain tremendously from warming. And scientists might develop more drought/heat resistant crops.
* Undoubtedly, the face of agriculture will change dramatically as the planet warms. We will grow different things in different places. I think trade is going to be essential. In light of these changes, a large potential threat is political instability. In the future, like the past, severe food shortages, malnutrition, and starvation will likely stem from political obstacles that prevent trade and delivery of food aid.
* If it turns out that climate change will be have a large negative impact on food production globally (which remains uncertain), a key obstacle to food security could be severe income inequality. Even with sharp declines in food production, there will be enough to feed the world if we choose to eat different things, and in particular, less meat. It takes 5-10 calories of grass and grains to make one calorie of meat. So if we were to consume more plants and less meat, there would almost surely be enough food for everyone. I believe this kind of adjustment would happen naturally through a market system if income inequality were not so high. As grain calories become scarcer, price would rise, meat prices would rise even more, and we’d all substitute toward a more sustainable more plant-based diet (healthier too, it seems). But incomes are very unequal. So unequal that if the price of grains triples, this pushes many of those living on less that $2/day (about half the world) into severe malnutrition. At the same time, the price of a Big Mac would go up very little, in relative terms, maybe 0.25 cents. This won’t cause much substitution of corn meal for beef by relatively rich consumers in the United States. So, good global development policy is probably good climate change policy. It surely would make adjustment to warmer temperatures a lot easier.

Do you believe that those with the least food security (particularly in lower latitudes) will suffer disproportionately from the negative impact of climate change on agriculture? Why or why not?

Yes, they probably will. I think this has more to do with the fact that they are poor than the fact that the poor tend to live in regions of the world that will likely be adversely effected by climate change, but both matter.

Do you think that GMOs and hybrid crops are the best way to counteract the increasing occurrence of droughts, floods, etc.? What are some alternatives?

I think the easiest way to adapt to climate change is to simply change the locations and seasons where and when crops are grown. GMOs may help. But I think there is a lot of uncertainty about GMOs at this point. I’ll believe it when I see hard data. So far we just have lofty promises. I believe technological changes can be amazing. But it also seems those innovations tend to be in places we don’t always expect.

I believe the greatest potential for GMOs is for poorer developing countries. In a nutshell, GMOs can make it a lot easier to grow a high-yield crop. This means less-educated farmers with fewer skills or access to key inputs can grow a crop more like those in richer countries. This has been proven. Unfortunately, there is less incentive for seed companies to market to poorer countries. That might change.

How will declining agricultural productivity in the tropics affect the development of countries such as India and China?

It’s hard to say. India and China are huge success stories (or at least were before the current crisis). I would think there is a lot of potential in these countries, but they will likely face their own challenges with climate change. I guess I’d say India and China are the greatest hopes and the greatest uncertainties. I should also say I have a lot more to learn about these countries, both economically and agronomically speaking.

How will shortened growing seasons in the tropics and lengthened growing seasons in higher latitudes change political relations between developing and developed nations in terms of access to water and food?

I’m bad with politics, but your question underscores my point above: trade and political stability are currently essential and will be even more important in the future and with climate change. Income equality probably has a lot to do with political stability.

I’ll repeat: Whatever makes for good development policy is probably good climate-change policy. I’m not sure what good development policy may be—it’s difficult and controversial subject with widely varying points of view.

What policies could we implement or change to help reduce the negative impact that climate change has had on water supply?

This sounds like a local issue, and one not necessarily tied to climate change, since you use the words “has had”. Up to this point, outside of the arctic regions, it’s hard to say which droughts are due to human-induced climate change and which would have happened anyway. Let’s just say projected changes are much bigger than anything seen yet.

Population growth puts natural strain on water resources too. So, if you're thinking about local water issues in North Carolina, well this is a very different can of worms. Water policy gets complicated quickly and really depends on the location. I come from California where things are probably much worse and more complicated legally and politically than they are here in North Carolina.

While it’s easier said than done, I would say that, in general, it is important to have water policies that work toward pricing water appropriately. In a drought, or if water becomes generally more scarce, water should have a very high price, for residences, businesses and for farmers. And that price should be the same for all users. Usually that’s not the way things are done. For many, the price is literally zero. Pricing water appropriately is difficult to do given the way surface water rights have been historically allotted and the fact that groundwater extractions are not typically monitored or priced.

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