Bye Bye dollar

US backing for world currency stuns markets - Telegraph

US backing for world currency stuns markets
US Treasury Secretary Tim Geithner shocked global markets by revealing that Washington is "quite open" to Chinese proposals for the gradual development of a global reserve currency run by the International Monetary Fund.

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Understanding quantitative easing

Quantitative easing v credit easing | Money's muddled message | The Economist

Economics focus
Money's muddled message

Mar 19th 2009
From The Economist print edition
Today’s fattened central-bank balance-sheets evoke fears of inflation. Deflation is the bigger worry

BACK in 2002 Ben Bernanke, then still a Federal Reserve governor, declared that “under a paper-money system, a determined government can always generate higher spending and hence positive inflation.” That does not mean it is easy.

On March 18th America’s inflation rate was reported at 0.2%, year on year, in February. The same day the Fed said “inflation could persist for a time” at uncomfortably low levels. Yet some economists and investors insist high inflation, even hyperinflation, is lurking in the wings. They have two sources of concern. The first is motive: the world is deleveraging, ie, trying to reduce the ratio of its debts to income. Policymakers might secretly prefer to do that through higher inflation, which lifts nominal incomes, than through the painful processes of cutting spending and retiring debt, or default. The second is captured by the Fed’s announcement that it plans to purchase $300 billion in Treasury bonds and an additional $850 billion of mortgage-related debt, bringing such purchases to $1.75 trillion in total, all paid for by printing money. It is not alone: around the world, central-bank balance-sheets have ballooned (see chart).
Click here!

This is scary stuff to those who swear by Milton Friedman’s dictum that “inflation is always and everywhere a monetary phenomenon.” But the role of the money supply in creating inflation is less obvious than monetarism suggests.

The quantity theory of money holds that the money supply, multiplied by the rate at which it circulates (called velocity), equals nominal income. Nominal income in turn is the product of real output and prices. But does money supply directly boost nominal income, or does nominal income affect velocity and the demand for money? The mechanism is murky.

Central banks control the narrowest measure of the money supply, called the monetary base—typically, currency plus the reserves that commercial banks hold with the central bank. But the relationships between the monetary base, broader monetary aggregates and nominal income is highly unstable.

Central banks have mostly given up trying to target inflation via the money supply. Instead, they study the “output gap” between total demand and the economy’s potential to supply goods and services, determined by such things as the labour force and capital stock, as well as inflation expectations. When demand exceeds supply, inflation rises. When it falls short, inflation falls, and in the extreme becomes deflation. To influence demand, the central banks move a short-term interest rate up or down by adjusting the supply of bank reserves. Changes in the policy rate ripple out to all interest rates paid by borrowers.

The financial crisis has bunged up that transmission mechanism. Risk aversion, fear of default and depleted bank capital have caused private borrowing rates to deviate sharply from policy rates. Central banks have responded by expanding loans to financial institutions, purchasing private securities and buying government debt. They have financed this growth in their assets through increased liabilities such as commercial-bank reserves, swaps with central banks and other ways of printing money.

Is this monetarism? It depends on whom you ask. The Fed calls its policy “credit easing” to emphasise that, though its policy rate is almost zero, it is using different channels to ease credit and boost spending. Even its Treasury purchases are to “improve conditions in private credit markets”. That these actions expand the money supply is secondary. Similarly, the Bank of Japan is buying stocks and may make subordinated loans to banks to boost their capital and lending capacity; the money supply is not a consideration. The Bank of England, on the other hand, calls its purchases of government and private debt “quantitative easing” and explains it in monetarist terms. It expands investors’ holdings of money, encouraging them to shift to other assets, boosting wealth and investment. It acknowledges this may not work. Indeed, merely the news that it would purchase government debt drove down long-term interest rates, just as the Fed’s announcement did, an entirely conventional stimulus to demand. The rhetoric may be different but the policies are largely the same.

If the unprecedented monetary and fiscal stimulus works, output gaps will eventually close. Then central banks will have to reverse their unconventional policies and raise interest rates. They may hesitate in the face of political pressure or an explicit decision to err on the side of inflation rather than deflation. In that case, inflation will rise.
Go forth and multiply

But for the moment deflation is a bigger threat. If the Fed’s current policies fail, fiscal policy can be employed to boost demand. There, too, the Fed has a role: it could buy the bonds needed to finance tax cuts or government spending, thereby limiting the impact on long-term rates. Such debt monetisation evokes fears of hyperinflation. But inflation would result only if monetisation boosted aggregate demand enough to exceed aggregate supply. Laurence Meyer of Macroeconomic Advisers, a consultancy, reckons America’s output gap will reach 9% of GDP by next year. To eliminate that he says the Fed would have to monetise more than $1 trillion of additional stimulus over two years, assuming standard multiplier effects.

The obstacles are primarily political, not economic. Finance ministers are averse to debt and central banks even more so to monetising it for fear of becoming a tool of the government. That aversion is usually healthy but not when deflation looms. The option should be on the table, as long as there are safeguards for the Fed’s independence. Frederic Mishkin, a former Fed governor now at Columbia University, says the important thing is that the Fed, not the Treasury, be the initiator of such purchases, and only after stating that it is consistent with price stability.

On March 15th Mr Bernanke said that the biggest risk facing the economy now is that “we don’t have the political will, we don’t have the commitment to solve this problem.” At least for the moment, it is not the Fed chief’s gumption that is lacking.

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PowerShift

Niall Ferguson wrote in the Financial Times

We are indeed living through a global shift in the balance of power very similar to that which
occurred in the 1870s. This is the story of how an over-extended empire sought to cope with
an external debt crisis by selling off revenue streams to foreign investors. The empire that
suffered these setbacks in the 1870s was the Ottoman Empire. Today it is the US. …. The US
debt crisis has taken a different form, to be sure. External liabilities have been run up by a
combination of government and household dissaving. It is not the public sector that is
defaulting but subprime mortgage borrowers. As in the 1870s, though, the upshot of this debt
crisis is the sale of assets and revenue streams to foreign creditors. This time, however,
creditors are buying bank shares not canal shares. And the resulting shift of power is from
west to east.
In other words, as in the 1870s the balance of financial power is shifting. Then, the move was
from the ancient oriental empires (not only the Ottoman but also the Persian and Chinese) to
Western Europe. Today the shift is from the US - and other western financial centres - to the
autocracies of the Middle East and East Asia.
…. It remains to be seen how quickly today's financial shift will be followed by a comparable
geopolitical shift in favour of the new export and energy empires of the east. Suffice to say
that the historical analogy does not bode well for America's quasi-imperial network of bases
and allies across the Middle East and Asia. Debtor empires sooner or later have to do more
than just sell shares to satisfy their creditors.

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Affordability

FT.com / Columnists / Martin Wolf - Why saving the world economy should be affordable

Why saving the world economy should be affordable

By Martin Wolf

Published: March 17 2009 19:57 | Last updated: March 17 2009 19:57

Can we afford this crisis? Will governments destroy their solvency, as they use their balance sheets to rescue over-indebted private sectors?

The debate, as it has so often been, is between the US and Germany. Thus, in a speech last week, Tim Geithner, US Treasury secretary, noted that, “The IMF has called for countries to put in place fiscal stimulus of 2 per cent of aggregate GDP each year by 2009-10. This is a reasonable benchmark to guide each of our individual efforts. We think the G20 should ask the IMF to report on countries’ stimulus efforts scaled against the relative shortfall in growth rates.” Needless to say, no such firm pledge was forthcoming, with Germany particularly resistant.


Nevertheless, a great deal of fiscal stimulus has occurred. This is what readers of recent research on the aftermath of financial crises by Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard would expect. These authors concluded from studying 13 big financial crises that the average rise in real public debt in the three years following a banking crisis was 86 per cent. In some of these cases, the increase was more than 150 per cent*.

So, is there good reason to expect huge increases in public sector indebtedness across the globe, not least in triple A rated sovereign borrowers ? The answer is: yes. If so, does this guarantee defaults of some kind? The answer is: no. In a recent paper, the staff of the International Monetary Fund suggest why these are the right answers**.

By 2012, suggests the IMF, the ratio of gross public debt to gross domestic product could be 117 per cent in Italy; 97 per cent in the US; 80 per cent in France; 79 per cent in Germany; and 75 per cent in the UK. In Japan, still scarred by the legacy of a huge bubble, the ratio could hit 224 per cent. Current forecasts are evidently much higher than those made before the crisis hit.

Yet the jumps in indebtedness are not particularly onerous, provided the willingness of governments to avoid default is not in question. Assume, for example, that the real interest rate these highly rated countries pay is 1 percentage point higher than the long-term growth rate of their economies. Then the requirement for stabilising a ratio of public debt to GDP at 100 per cent is a primary budget surplus (surplus before interest) of just 1 per cent of GDP.

Nevertheless, three counter-arguments can be advanced.

First, in some cases, primary fiscal deficits are very large. Among bigger advanced countries, this is particularly true for this year – in the US, forecast at minus 9.9 per cent of GDP; Japan and the UK, both forecast at minus 5.6 per cent; and Spain, forecast at minus 4.9 per cent. The primary deficits of France, Germany and Italy are far smaller, at minus 3.6 per cent; minus 1.1 per cent; and plus 1.1 per cent, respectively. So stabilising debt requires large fiscal adjustment in some countries.

Second, the political willingness to curb deficits, by raising taxes or cutting spending, may come into question. This could become a self-fulfilling prophecy, with flight from debt raising interest rates, necessitating ever more costly (and so less plausible) fiscal tightening.

Third, the ultimate rise in indebtedness could be far bigger than the IMF forecasts. This would be consistent with experience. The primary explanation would be that the world economy is embarked on a prolonged balance-sheet deflation, comparable to Japan’s in the 1990s.

I would argue against these points.

First, markets are optimistic about the fiscal prospects: expected inflation remains well contained in the US and UK and interest rates on conventional 10-year US and UK government bonds are still below 3 per cent.

Second, the cost of meeting the added burden of ageing is far higher than any plausible cost of the crisis. On IMF forecasts, the present value of the fiscal costs of ageing in the US is 15 times the cost of the crisis.

Third, it makes no sense to avoid action that would greatly lower the real economic costs of the crisis now, to eliminate a hypothetical and avoidable fiscal crisis later on. This would be like committing suicide in order to stop worrying about death.

Nevertheless, it is wise to limit longer-term fiscal risks. The most important actions are to curb long-term age-related spending. But there is also a current agenda: rebalancing of world demand.

Surplus countries subcontract to their trading partners the job of spending oneself into bankruptcy, while lecturing the latter on their profligacy. Thus the reason the US, the UK and Spain have huge fiscal deficits is that they are offsetting the collapse of private spending at home and the export of demand abroad. This is unsustainable, in the long run.

The danger now is that the surplus countries expect recovery to come from enormous and sustained fiscal expansion in deficit countries. Some analysts argue that the US should have refused to take fiscal action at all, leaving it to surplus countries. Unfortunately, that would have meant a global depression. Nevertheless, without rebalancing there can be no healthy recovery. On this point, the US is right and Germany is wrong.

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Are you sure?

FT.com / Lex / Energy, utilities & mining - Oil prices

Oil prices

Published: March 16 2009 09:26 | Last updated: March 16 2009 22:15

When might oil prices recover? An important question – and not just for oil producers. Higher energy prices could choke off any global economic recovery. That, indeed, is the main reason Opec decided this weekend against trying to force prices up by cutting back output. Nevertheless, many in the industry, including Opec, still believe that $75 per barrel remains oil’s “correct” long-run price, compared with less than $45 now. That could be wishful thinking.

This year the world will consume some 85m barrels of oil a day – about 1m b/d less than last year. But in the 1979 oil price shock, demand shrank by 2.5m b/d in the first year, and then fell for another two years. That alone suggests the effects of this recession are still to play out. Meanwhile, on the supply side, spare production capacity is rising. Saudi Arabia is adding about 2m b/d, Brazil another 500,000 b/d. Refining capacity is also on the up in China and the Middle East. This reduces the probability of supply bottlenecks and of price spikes. This, at least, removes a risk premium from the market – another reason for prices to stay low.

Furthermore, the shape of demand is changing. Oil is used mostly for transport, with almost a third accounted for by intra-urban commuting. Yet the traditional global car industry looks finished. Gas-guzzling is out; Credit Suisse reckons efficiency standards enacted by the Bush administration will shrink US gasoline use by 2 per cent a year. The shift to hybrid cars will remove a further chunk of demand. Even China wants to reduce its energy intensity by some 20 per cent by 2010. Combine that with the new US standards, and world demand would fall by about 6m b/d. That is a massive amount, equivalent to three quarters of Saudi Arabian output. Oil prices could remain lower for longer than many seem to think

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Credit Card Crunch

RGE Monitor

# Overview: In January, credit card delinquencies and charge-offs breached all-time highs for the second consecutive month and Moody's predicted numbers to increase in later months. Indeed, on March 16 AmEx reports worse February numbers, Capital One better ones. Meanwhile the $5trillion in outstanding credit card lines (of which $800bn is currently drawn upon) are being trimmed even for credit worthy borrowers with Meredith Whitney estimating that over $2 trillion of credit-card lines will be cut in 2009 and $2.7 trillion by the end of 2010. Research shows that unemployment is one of the most important drivers of credit card and auto loan loss rates. RGE (Kruettli) estimates that credit card charge-off rate could reach 13% in the worst case scenario.March 16: AmEx says U.S. credit card delinquencies rose in February to 8.7% from 8.3% in January as job losses accelerated and the economy deteriorated. The rate for loans at least 30 days delinquent increased to 5.30 percent from 5.10 percent.--> see AmEx Gets Access To TARP
# BNP March 16: AAA ABS Benchmark Spreads Improve In View of $1000bn TALF liquidity program , Fixed Rated ABS Spreads Stay High.
# Fitch March: In January, credit card delinquencies breached all-time highs for the second consecutive month according to the latest Fitch Credit Card Index results. At January month end, the 60 plus day delinquency rate was 4.04%. The results come amid an unending parade of troubling economic data from surging unemployment to steeper declines home and equity market values.
# Moody's: January credit card charge-offs reached a record-high 7.74%, and with an increasing number of borrowers falling behind on their credit card payments charge-off rates will almost certainly increase in the coming months. The seasonal post-holiday rebound in payment rates did not materialize this January, leaving the payment rate index, which has been falling since early 2007, near a five-year low. The payment rate has been falling since early 2007. (research recap)
# Meredith Whitney (via WSJ) March 10: Currently, there is roughly $5 trillion in credit-card lines outstanding in the U.S., and a little more than $800 billion is currently drawn upon. Just six months ago, I estimated that at least $2 trillion of available credit-card lines would be expunged from the system by the end of 2010. However, today, that estimate now looks optimistic, as available lines were reduced by nearly $500 billion in the fourth quarter of 2008 alone. My revised estimates are that over $2 trillion of credit-card lines will be cut inside of 2009, and $2.7 trillion by the end of 2010.--> see Credit Card Reform: What Impact On Consumers? On Banks? On Investors?
# cont.: Currently five lenders dominate two thirds of the market.
# SIFMA: Q4 2008 marked the first time ever that four of the major sectors
(home equity, credit card, student loan, and equipment leases) had no issuance.
# Graef (Deutsche Bank): Credit card debt grew strongly in absolute terms but was comparatively stable in relation to disposable income. In light of the virtually unchanged ratio of credit card debt to disposable incomes we cannot detect a credit card bubble-->we do not expect an above-average increase in credit card defaults, particularly in view of substantially lower credit card interest rates compared with earlier years.
# White (NBER/UCSD): Ratio of consumer debt to median income increased to 4.5 in 2007 from 1 in 1980 compared to a ratio of 3 for mortgage debt/median income--> "high debt/misuse of credit cards" is the primary reason for increase in bankruptcy filings since the mid-1980s.
# Wieting (Citigroup): Households shifted expensive credit card debt to less expensive, tax-deductible mortgage credit in the early/mid 2000s. Revolving credit grew at an average 4.3% year/year pace in 2002-2007 vs 12.4% for mortgage debt. As such, credit card delinquencies have been closer to “cyclical norms,” unlike housing. However, we believe the employment downturn will now drive cyclical delinquencies in cards too. Expect unemployment to rise to 8-10%.
# Mathias Kruettli (RGE): Given that lending standards are being tightened across the board, a jump in the unemployment rate is likely to increase the default rate on credit card debt, which might lead to higher write-downs on the banks credit card portfolios.
# cont.: The paper comes to the conclusion that write-downs in 2009 are likely to be significantly higher than in2008 (50 billion USD). In the worst case scenario the credit card receivable write-downs could be as high as 146billion USD in 2009. In the best case the write-downs will be around 64 billion USD. Currently, there are about $2.5T ABS receivables outstanding, incl. credit card, auto loan, HEL (SIFMA estimate as of Q2 08)
# Fitch, DBRS: report addresses the sensitivity of auto and credit card transactions to unemployment, one of the most important macroeconomic indicators for consumer finance. Results:
- Changes in the unemployment rate are strongly correlated with changes in auto loan losses and credit card chargeoffs;
- Auto loan and credit card ABS loss rates are expected to increase proportionately to the increases in unemployment rate;
- Prime credit card chargeoffs are expected to increase on a 1:1 basis wrt unemployment. Accordingly, a 100% increase in the base unemployment rate, from 5% to 10%, would lead to a 100% increase in the prime credit card chargeoff index, from 6.18% (April 2008) to 12.36% over the next 12 months;
- Subprime credit card chargeoffs and prime and subprime auto loan net losses are expected to increase at a rate closer to 1.2−1.3:1, meaning a 100% increase in unemployment could lead up to a 130% increase in losses;
- Consumers are more likely to default on credit cards more immediately than they default on auto loans following shocks to the labor markets;
- While, on average, the ‘BBB’ or ‘AAA’ bonds could withstand an unemployment rate of up to 11% or 20% respectively before a default occurs, downgrades during these stresses would be inevitable.

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Soundness

September 15, 2008
WASHINGTON — Treasury Secretary Henry Paulson said the American people can remain confident in the "soundness and resilience in the American financial system."
March 15,2009
WASHINGTON -Obama says investors should have `absolute confidence' in soundness of US

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