Friday, November 28, 2014

Fiddling at the Fire

PARIS – Financial markets have rallied since July on the hope that the global economic and geopolitical outlook will not worsen, or, if it does, that central banks stand ready to backstop economies and markets with additional rounds of liquidity provision and quantitative easing. So, not only has good – or better-than-expected – economic news boosted the markets, but even bad news has been good news, because it increases the probability that central-banking firefighters like US Federal Reserve Chairman Ben Bernanke and European Central Bank President Mario Draghi will douse the markets with buckets of cash.

But markets that rise on both good and bad news are not stable markets. “Risk-off” episodes, in which investor sentiment sours, are likely to return if economic news worsens and confidence in policymakers’ effectiveness drops.

In the eurozone, euphoria followed the ECB’s decision to provide support with potentially unlimited purchases of distressed countries’ bonds. But the move is not a game changer; it only buys time for policymakers to implement the tough measures needed to resolve the crisis. And the policy challenges are daunting: the eurozone’s recession is deepening as front-loaded fiscal consolidation and severe credit rationing continues. And, as eurozone banks and public-debt markets become increasingly balkanized, establishing a banking union, a fiscal union, and an economic union while pursuing macroeconomic policies that restore growth, external balance, and competitiveness will be extremely difficult.

Even the ECB’s support is not obvious. Monetary hawks – the Bundesbank and several other core central banks – who were worried about a new open-ended ECB mandate pushed successfully for strict and effective conditionality for countries benefiting from the bond purchases. As a result, they can pull the plug on the program if its stringent criteria are not met.

Moreover, Greece could exit the eurozone in 2013, before Spain and Italy are successfully ring-fenced; Spain – like Greece – is spiraling into depression, and may need a full-scale bailout by the “troika” (the ECB, the European Commission, and the International Monetary Fund). Meanwhile, austerity fatigue in the eurozone periphery is increasingly clashing with bailout fatigue in the core.

Small wonder, then, that Germany, politically unable to vote on more bailout resources, has outsourced that job to the ECB, the only institution that can bypass democratically elected parliaments. But, again, liquidity provision alone – without policies to restore growth soon – would merely delay, not prevent, the breakup of the monetary union, ultimately taking down the economic/trade union and leading to the destruction of the single market.

In the United States, the latest economic data – including a weak labor market – confirm that growth is anemic, with output in the second half of 2012 unlikely to be significantly stronger than the 1.6% annual gain recorded in January-June. And, given America’s political polarization and policy gridlock, we can expect more fights on the budget and the debt ceiling, another rating downgrade, and no agreement on a path toward medium-term fiscal consolidation and sustainability – regardless of whether President Barack Obama is reelected in November. On the contrary, we should expect agreement only on the path of least political resistance: avoidance of tough fiscal choices until the bond vigilantes eventually wake up, spike long rates, and force fiscal adjustment on the political system.

In China, a hard economic landing looks increasingly likely as the investment bubble deflates and net exports shrink. Meanwhile, the reforms necessary to reduce savings and increase private consumption are being delayed. As in Europe and the US, the worst will be avoided in 2012 only by kicking the can down the road with more monetary, fiscal, and credit stimulus.

But a hard landing becomes more likely in 2013, as the stimulus fades, non-performing loans rise, the investment bust accelerates, and the problem of rolling over the debts of provincial governments and their special investment vehicles can no longer be papered over. And, given a new leadership’s caution as it establishes its power, reforms will occur at a snail’s pace, making social and political unrest more likely.

Meanwhile, Brazil, India, Russia, and other emerging economies are playing the same game. Many have not adjusted as advanced economies’ weakness reduces the room for export-led growth; and many delayed structural reforms needed to boost private-sector development and productivity growth, while embracing a model of state capitalism that will soon reveal its limits. So the recent slowdown of growth in emerging markets is not just cyclical, owing to weak growth or outright recession in advanced economies; it is also structural.

Similar dithering is apparent at the geopolitical level as well. The major global powers are still trying negotiations and sanctions to induce Iran to abandon its efforts to develop nuclear weapons. But Iran is playing for time and hoping to reach a zone of immunity. By 2013, an Israel that – rightly or wrongly – perceives Iran’s nuclear program to be an existential threat, and/or the US, which has rejected containment of a nuclear Iran, may decide to strike, leading to a war and a massive spike in oil prices.

Ineffective governments with weak leadership are at the root of the problem. In democracies, repeated elections lead to short-term policy choices. In autocracies like China and Russia, leaders resist the radical reforms that would reduce the power of entrenched lobbies and interests, thereby fueling social unrest as resentment against corruption and rent-seeking boils over into protest.

But, as everyone kicks the can down the road, the can is getting heavier and, in the major emerging markets and advanced economies alike, is approaching a brick wall. Policymakers can either crash into that wall, or they can show the leadership and vision needed to dismantle it safely.

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    1. CommentedPartha Sarkar

      Economists on both sides of the ocean have pondered over the Global cool down of the world economy. Central banks all over the world are increasingly pursuing expansive monetary policies to address concerns over financial meltdown. What’s surprising is these policies of easy credit, lax lending standards and destabilization of the monetary base are what caused the financial crisis of 2008 and the subsequent Global meltdown of the world economy. This crisis was engineered by polity pursuing central banks to achieve growth through monetary policy rather than fiscal and structural changes.

      The result is we have a financial system where Central Banks have expanding balance sheets as they continue to monetize Public and private debt. The low interest rates (negative real rates) are wiping off individual investments and incentivizing people to take on more credit and save less. Despite of all this, the Businesses worldwide are not investing in productive assets and instead borrowing for share repurchases, causing further asset bubbles. The DJIA has climbed to prerecession levels since July 2012 without any significant increases to underlying firm’s earnings.

      The average US household, with damaged balance sheet, is deleveraging and will continue to do so. The private sector debt has only come down from 100% of GDP to about 87%. The QE3 is supposed to help the housing sector by decreasing the Mortgage rates for consumers and putting downward pressure on the housing prices. However the transfer of lower rates to consumers is not working because banks are reluctant to lend due to credit risks and high paperwork backlogs. On announcement of QE3 the yields on MBS fell by an average 30 basis points but the average 30 year fixed rate for mortgages did not change. The current spread between MBS yields and 30 Year fixed rate mortgage is at 1.5%. The financial intermediaries are pocketing the 30 basis point increase in spread. So even if Mr. Ben Bernanke wants his QE3 ($40bn a month MBS buyback) to stabilize the housing market, it is only sustaining the asset bubble at the cost of expanding FED balance sheet.

      QE3 in normal times would have buoyed exports as it pushed the dollar down and US stock prices up. However I doubt that this will budge the US current account deficit by much as global demand remains weak.

      From the demonstrated failure of monetary policy alone as a cure for this malice, it is quite understandable why Professor Roubini presents a strong argument for fiscal policy actions and structural reforms from the Polity. However just looking at the polity and the fractured mandate from the Electorate across both sides of the Atlantic, it does not appear that the cure is in order any time soon. So the prospect of a lost decade looms.

    2. CommentedJean-Louis Piel

      What I love with Nouriel Roubini is his sense of devastating humor. He doesn't care to tell you that you are on the edge to die. He is like a doctor who describes your cancer and looks at you with a smile : "eh guy, you have only few days before to die. But of course I could be wrong. Nobody knows everything for sure. Even your death." He is not cynical. He is very human - like Nietzsche. He knows that humans love to hear from time to time the truth.Even when there is no solution - at least known at this day. Except revolutions.

    3. CommentedAvraam Dectis

      "Ineffective governments with weak leadership are at the root of the problem. "


      That is the most interesting sentence of the article.

      What is needed is a new form of governing structure that provides economic strength while preserving efficiencies and improving culture and freedom.

      I have some thoughts on that.

      Avraam J. Dectis

        Commentedpatti wilson

        when government leadership is beholden to a powerful few constituencies then excesses occur and accumulate. Until the power and financial reins are redistributed the problems continue.

    4. CommentedRoman Bleifer

      The author described the terrible picture of the economy. For such assessments have every reason, though, and I think his assessment overly optimistic. That's just not explained what to do. Regular injections nothing good will. Fed only catapulted into the financial sector about $ 2.4 trillions. And if we add to it the resources to maintain demand, obtain the sum of cosmic scale. The economy began to grow steadily, unemployment decreased, increased investment in the real economy? Unfortunately the opposite is true. In this paradoxical picture. Industrial production is decreasing, unemployment is not reduced and the stock indices set new records for many months. No growth of the economy, there is only an increase in speculative bubbles. Continue such a multi-billion dollar infusion with the same success? When finally the politicians would have the political will to understand that the crisis and the financial crisis that is systemic ( ). To select the appropriate tools to deal with the crisis adequately understand what is happening. If politicians do not have enough political will to make decisions, the crisis will adjust everything without them. But this decision will be much more painful.

    5. CommentedDavid Reitz

      Ameican political polarization, which is rightly blamed for the inability of the government to address its financial issues, is caused by increasingly sophisticated gerrymandering. This results fewer competive general elections, with the real competition occuring in the primary, where pandering the extreme gains votes and any hint of compromise with the demonized opposition party losing votes. The result is members of the House are indelibly incapable of addressing issues of any consequence.

    6. Commentedgligor paramecijum

      It is not a matter of can would be more heavy, but a shoe became more weak. In environment of ,non logical, resource issues leader's acting, energy is blown down. Confusion of copy/paste generation used not to put real efforts to reach the goals is growing up. So called educated experts with no achievements in their job records except criticism of everything, which fit up picture that centralized resource management will solve everything dig the hole of slavery of today human kinds as deep as medicine experts believe that they invented human body. Please stop pay to any manipulation, and try to respect the mind power of creation.

    7. CommentedPaul A. Myers

      Bernanke seemed to indicate that the US economy may be growing or soon will be at around 3.5 percent. If US growth resumes along with China and the Far East, then basically growth in the real economies will backup the monetary expansion in the advanced countries.

      So some, or most, of the increase in world equity markets may be a result of perceived future higher economic growth. (Or maybe it is just the inflation of paper assets powered by monetary expansion. Who really knows?)

      After the US election, a process of increasing revenue and curtailing long-term expenditures will most likely get underway. That would reinforce any positive real economic growth.

      After the election, it will probably be clear that at the final extremity, the US will contain any nuclear aspirations by Iran with deterrence, not war. The American public is not buying Romney's neoconservatism.

      Northern Europe, inside and outside the eurozone, is poised to be an economic powerhouse. At the end of the day, the creditor countries will call the tune and that will be the music of reform. The southern countries are going to be near-term beneficiaries but longer term they have to perform.

      Europe in the future is going to be more of a "workers state" and less of a "welfare state."

        CommentedJames Thomas

        @Mark Pitts

        Good comments by what measure?

        Anyone who believes that the US economy is now or soon will be growing at 3.5% is delusional. The world economy is, if anything, cooling rather than warming.

        In fact I did not read a single assertion in Myers' post that a rational person could reasonably deduce from the current economic and political realities at home or abroad.

        The US, the eurozone and China have all pursued a cheap money policy for years and all except China have doubled down on it within the last month. The money supply in the major industrialized nations has ballooned. And historically, what have generally been the harbingers of impending economic disaster? Cheap money and burgeoning money supply. It's one of the reasons that the fringe right wants a return to the gold standard.

        CommentedJames Thomas

        "After the election, it will probably be clear that at the final extremity, the US will contain any nuclear aspirations by Iran with deterrence, not war. "


        At the final extremity? Deterrence? What precisely do you think escalating sanctions over the last several years are all about? Just what deterrence is left unless the Chinese and Russians buy into the existing sanctions? How does the election - regardless of the winner - bring a realistic increase in deterrence?

        CommentedMark Pitts

        Good comments, but I don't follow you on the increased revenue and reduced spending after the election. The proposed tax increases on high earners are miniscule as a percentage of the deficit. And entitlement reform will surely remain highly unpopular. So, with the political stalemate continuing for 4 more years, why would things change?

        CommentedProcyon Mukherjee


        I have this uncanny feeling about the monetary expansion (I could be wrong though); the size of the Central Bank balance sheet in U.S. and EU put together is moving towards $7 to $8 Trillion over the next one year. What could be the effects of eventual unwinding of these positions, when the interest rates harden and the risks emanating from them? Rational inattention to the fact that interest rates cannot stay at this level forever would lead us to assume that there would be no impact on the economy when this contraction happens.

        Procyon Mukherjee

    8. CommentedLuke Ho-Hyung Lee

      Without being aware of it, we have made a serious mistake in developing numerous real (or physical) transaction systems through the use of information technology and developed too many job-killing machines (mostly by big companies) in real markets over the last 30 years of the Modern Information Age. I believe this is the root cause of the current economic crisis, more specifically, the current job crisis. Please see: “Job-Killing Machines in the Modern Information Age...”

    9. CommentedJames Thomas

      The piper must be paid for a paroxysm of consumption fueled by illusory equity and naked greed. Central bankers are borrowing time but loans always charge interest and history suggests the interest rate will be nowhere near the ZLB.

      What the hell have we done with the economy that 'the greatest generation' bequeathed us?

    10. CommentedPaul Mathew Mathew

      This crisis is a result of a) the end of cheap oil and b) the failure of democracy.

      The price oil, inflation adjusted is up roughly 6x from just a few decades ago. If we are not at peak oil we are certainly at peak cheap oil - actually we are well past it. The moment there is a whiff of growth oil shoots past $100 a barrel. That effectively means we have reached The End of Growth (nothing can substitute for cheap oil)

      As for democracy, this article sums up the problem very well

    11. CommentedRoss Clem

      An excellent description of the "brick wall". However no help in how to dismantle it safely.

    12. CommentedZsolt Hermann

      Yes, politicians have their own calculations, they think about their personal legacies, the next elections, what the party line is, what the powerful lobby groups, sponsors want, but in general they are not evil people intentionally wanting to destroy the world or their own countries.
      They seem weak, they "kick the can" because simply they have no idea what to do with the crisis.
      I actually feel sorry for them since from their position they certainly see the direction the world goes, and most probably they are much more aware of the potential catastrophic events waiting for us if we do not change course.
      And they have no idea how to change course.
      This is because a fundamental shift happened within the conditions we exist in, and their whole upbringing, attitude, the methods and the tools set they
      possess have become obsolete, moreover destructive.
      Everything they know, the Nobel prizes given to eminent economists, the whole financial structure, political ideology is based in a linear, polarized, fragmented world.
      In that system there are friends, enemies, there are open markets and free, mostly ruthless competition, the stronger survives, and rules, and so on.
      All this thinking has become irrelevant as if we woke up on a different planet.
      Today our living system has become round, global and integral, which means we are all totally interconnected as cells of the same body, or cogwheels of the same machine, and there is nothing we can do about it, it happened as part of our evolution, we simply cannot separate.
      Thus we need totally new concepts, ideology in politics, economics, and finances, the whole human system needs to be rearranged not along the lines of previously knows "isms", leftist, rightist agendas, but based on a full research and understanding of this new global interdependent system.

        CommentedEdward Ponderer

        Mr. Hermann, you've hit upon something fundamental here. That is that there is no solution that any of our standard problem solving methods -- in economics or any other field -- can arrive at. It is a vastly complex, nonlinear, instability problem -- beyond the range of our minds, no matter how empowered by computers.

        Computers can only help us to find simplifying symmetries -- where to stand to see the trees in neat understandable rows in an orange grove. But when there are no real rows to look for -- when the data is to vast a square peg to be squeezed into the round hole of a simple enough model for the human mind to work with -- there is no way to extend our individual minds. -- Except one.

        That is to do what nature does from the cell, to megacolonies of bacteria, to insect swarms, and to higher animal and even plant life.

        What is that? Well, its not to use a computer, but to become one -- what is known as a neural network computer. The only ingredient is mutual concern -- mutual responsibility. With this bond of interaction at the "nodal" level, the network as a whole will learn the complex balancing act necessary to survive and prosper with it own interdependence, and new relationship with the natural world.

        So our only job is to care about one another -- the old-time religious motto of "Love thy fellow as thyself," now brought into evolutionary biology itself. It is that easy -- and that hard. But if we really care about ourselves and our loved ones -- we'll make the effort to make everyone the loved ones, and care about the Whole.

    13. CommentedRichard Dolan

      "Ineffective governments with weak leadership are at the root of the problem. In democracies, repeated elections lead to short-term policy choices."

      True. Monetary moves cannot solve problems in the real economy -- low-to-no growth, labor market rigidities, disincentives to investment, and on and on. It also remains true that there is and never has been a free lunch. A prosperous style of life must be earned, whether by an individual or a society -- by 'the sweat of thy brow' says Genesis, and that surely is right. Neither Bernanke nor Draghi has any magic that could change that iron law. As NR says, more quantitative easing on monetary side is just kicking the can down the road.

    14. CommentedGary Marshall

      Right on Nouriel. Here comes hell. The have no answers though they are right in front of their narrow, prejudiced, big government wasting doctrines.

      Its the end of Keynesian economics.


    15. Commentedjoe verkuyl

      Even in Canada, it's been harder for immigrants to increase productivity in the economy, as they face many hurdles in the workforce:

    16. CommentedProcyon Mukherjee

      The article is mired with an unusual dosage of skepticism and pessimism, although not so uncommon that tradition has seen in Roubini, but it does strike a chord around monetary easing that we see unleash with a cheer from the markets, while the leading indicators hardly give any respite to the staggering discomfort that the aggregate demand factors are not turning the corner.

      Fed's dual role of price stability through inflation targeting by the Taylor's rule and full employment acheivement through a number of proxy instruments has only seen partial response in the latter objective, while the former has raised the price expectation of certain asset classes; the stocks have been the most powerful instrument of delivery.

      ECB actions by and large have restored confidence in the Spanish bonds, and even the Greek bonds have followed suit; Germany as the chief creditor nation has been the biggest beneficiary of such action. The biggest remiss is that nations like Greece or Spain who continue to defy the convergence conditions of the Mastricht treaty find in this action not only the backstop for continuity of profligate actions, but would actually make others follow suit; moral hazard would continue.

      China still holds the key, undeniably, the world's hope, together with Germany, where competitveness continues to be the fundamental driver of change.

      Procyon Mukherjee

        CommentedGary Marshall

        Hello PM,

        Of course its all doom and gloom from the usual suspects. Things are going so well and all we have are these abjectly anxious ninnies. Why prospects have not been this bright in decades.

        None can find growth within, so it must come from without. Lower taxes spurring growth -- who needs it when China is everyone's saviour.

        When they call on the Chinese for economic salvation, you know the morons, so prevalent in economics and economic commentary, haven't got a hope.

        See you after the collapse.