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The Parallax Brief Blog

Stick a Fork in the Eurozone — It’s Done

May 20th, 2010 by The Parallax Brief

A strange thing is happening in the British media at the moment. Papers and commentators are dutifully recording the violent financial and economic earthquake currently rocking the Eurozone, but are not taking their reports to their logical and obvious conclusion.

The Parallax Brief doesn’t mean to say they’re hiding anything in order to further a pro-European agenda — they’re not. But it’s as if they are assiduously chronicling the advance of the Visigoths while not saying what they’re clearly going to do to Rome when they get there.

And make no mistake: the EU is about to be sacked.

Whatever anyone argues, the Parallax Brief simply does not understand how the periphery will be able to regain the 20-30% of competitiveness relative to Germany they need to right their economies. It would be bad enough if Germany was inflating and consuming; but it’s not – it’s deflating, too, which is how its corporatist, wage-bargaining economic system works.

And the ECB isn’t helping. Every euro spent on purchasing sovereign bonds in this bailout package is currently being sterilized back out of the money supply as part of the Bundesbank’s barbarous insistence on deflationary orthodoxy.

This is as textbook a case of the type of debt-deflation that took the world from sharp recession to Great Depression as any hypothetical an economics lecturer could conjure.

Not to mention the percentage of GDP the periphery will be they’ll be paying back to foreign nations to service and pay down their debt: Simon Johnson, the former Chief Economist at the IMF, wrote that, “By 2012 we estimate Greece’s debt/GDP ratio will rise from 114% of GDP to over 150%. The interest payments alone on this would amount to 9% of (more…)

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The Importance of Appearing Earnest on Debt

March 12th, 2010 by The Parallax Brief

Former IMF chief economist Simon Johnson writes on his brilliant blog* that Greek debt is actually a bubble. Bizarre as this may sound for a country whose debt situation has deteriorated to the point where its spread over German Bunds has stretched to near breaking point, the argument is persuasive:

By the end of 2011 Greece’s debt will around 150% of GDP (…based on the 2009 IMF Article IV assessment…) About 80 percent of this debt is foreign owned… Every 1 percentage point rise in interest rates means Greece needs to send an additional 1.2 percent of GDP abroad to those bondholders.

What if Greek interest rates rise to, say, 10% – a modest premium for a country which has the highest external public debt/GDP ratio in the world, which continues (under the so-called “austerity” program) to refinance even the interest on that debt without actually paying a centime out of its own pocket, and which is struggling to establish any sustained backing from the rest of Europe? Greece would need to send at total of 12% of GDP abroad per year, once they rollover the existing stock of debt to these new rates (nearly half of Greek debt will roll over within 3 years).

This is simply impossible… German reparation payments were 2.4 percent of GNP during 1925-32, and in the years immediately after 1982, the net transfer of resources from Latin America was 3.5 percent of GDP (a fifth of its export earnings). Neither of these were good experiences.

Bubble math is easy. Hide all the names and just look at the numbers. If debt looks like it will explode as a percent of GDP, then a spectacular collapse is in the cards.

It’s a frightening thought, especially when one considers that the EU from here is effectively faced with a choice, according to Mr Johnson, of bailing out Greece for not a few billion here or there but for the full EUR180 bln the (more…)

Fiscal Fink Tank

February 16th, 2010 by The Parallax Brief

Danny Finkelstein, the Times columnist and former adviser to William Hague, and Frazer Nelson, the editor of the Spectator, have engaged recently in an internet back and forth regarding the latter’s speech to the Centre for Policy Studies’ Keith Joseph Lecture, in which Mr. Nelson argued that the Conservative Party should be far bolder about cutting spending than it has been, especially regarding its ring-fence guarantee for the NHS.

Rightly, Mr. Finkelstein disagrees.

First, he spells out some political home truths to Mr Frazer, correctly arguing that promising to cut public services has been tremendously unpopular with the electorate. Trimming (or slashing, the verb the Parallax Brief is sure Mr Frazer would prefer used when discussing government spending) public services has traditionally been the kind of political high wire act that sees governments and oppositions topple over to their doom, as, indeed, has happened to the Conservative Party itself in recent elections.

In other words, Mr. Finkelstein concludes with a memorable tartness, it bears remembering “that a party seeking government not simply the paramilitary wing of an oped column.”

This is all very correct, and Mr. Finkelstein could have progressed to make an economic argument against immediate cuts, which if made too early would surely shatter the fragile recovery, reducing GDP and having the perverse effect of increasing the real debt burden.

But what the Parallax Brief was more interested in was Mr. Finkelstein’s implied accusation that Mr. Frazer doesn’t really have an altruistic concern about the budget and sound economics, but is simply furthering a zealous low-tax-low-spending dogma.

“Critics on the right, including Fraser, have spent the last few years before the crisis complaining that the Tories are not fiscally lax enough. They wanted the party to back unfunded supply side tax cuts that they hoped would bring in income through increased growth.

The Cameron-Osborne position that tax cuts came second after stability was ridiculed.”

There is, of course, nothing wrong with demanding tax cuts per se, but it’s a bit rich to demand tax cuts one minute and rebalancing the budget the next. But there are two sides to a budget, revenue and costs, and the right only ever want to decrease the costs. If Mr. Nelson was really concerned about balancing the national books, he would advocate sharp tax rises as well — and he’d certainly not have been advocating tax cuts when Gordon Brown was running a 3% deficit at the peak of the economic cycle from the Treasury.

What’s more amazing is that the right get away with this. It seems to have become the economic norm when a budget deficit needs to be brought under control to argue that there’ll have to be cuts. None of the medjya’s talkingheads ever seem to say, “The budget deficit has reached 12% of GDP, and that means we’re all going to have to pay higher taxes”; but that’s no more preposterous than saying “…and that means we’re going to have to suffer swingeing cuts to the NHS and schools.”

Really, the right isn’t interested in balancing the books, because if you presented them with an argument for doing so with, for instance, increases in estate tax, a new band of income tax for those earning more than a million pounds a year, and increases in VAT on luxury goods and houses costing over two million pounds, they’d balk.

What they’re actually interested in is lower tax and lower public spending.

The Parallax Brief really doesn’t like the idea of tax hikes above the already high burden, and believes it is clear that at some stage in the next parliament the public sector is going to need to be seriously deflated, but the right shouldn’t be permitted to conflate two separate issues.

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The Good, the Bad and the Speculator

February 10th, 2010 by The Parallax Brief

The Parallax Brief has been critical of John Redwood’s hawkish view on monetary policy of late, and given that today Mr. Redwood defends speculators, those oft-mendacious and -pernicious magnets for vitriol, one might expect the Parallax Brief to get stuck in again.

But this time, the Parallax Brief has some sympathy for the MP for Wokingham’s position.

Today Greek and Spanish officials are briefing that bond speculators are bringing down their government debt for no good reason. Apparently investors and markets should go on lending as much as these worthy Ministers and officials want to borrow, so their salaries can be paid regardless of the financial plight of their countries.

It’s tempting to blame speculators for creating market situations that can seem very much like self fulfilling prophecies. Market players bet that a certain currency or bond or equity will fall, which then puts pressure on that security or currency, which then increases the number betting it will fall, which puts more pressure on the currency or security, which forces people to actually start selling, which actually forces the currency or security down, and so on. If only they wouldn’t short so aggressively (or at all), then perhaps things wouldn’t get out of control so badly. Further, these people are ultimately, when it comes to betting on currencies or sovereign bonds, costing the people of the country they’re betting against hundreds of millions, and often billions, of dollars. It seems so cruel.

But there’s a simple solution to this problem: don’t sell government bonds to the market. If governments didn’t run up debt, if they never borrowed from the market, there would be nothing to bet against. Once they do sell bonds to the market, obviously the market will want compensated for loaning its money — otherwise, why not just hang onto it? — and that compensation will have to be commensurate to the risk individual players in the market believe is involved in the loan. “How likely am I to get this money back?”, people reasonably ask.

There’s nothing wrong with that, and no rule to say that governments have to borrow. Got a problem with speculators? Don’t sell bonds that can be speculated on.

But, there’s a caveat.

Exhibit A: A recent article in the New York Times about Goldman Sachs’s part in the AIG collapse. For those who do not wish to read the lengthy investigative piece, the timeline is neatly summed up in the Washington Independent:

The people at Goldman Sachs invested in mortgage-backed securities they expected to decline in value in order to make money off the insurance claims.

Due to a long-standing relationship, they went to AIG for a kind of insurance — credit default swaps — which were not regulated.

They then used other companies, including Société Générale, to purchase more of the unregulated insurance that AIG might not have otherwise underwritten in order to manage its own risk.

When Goldman’s investments declined, they submitted insurance claims for the losses, but insisted on determining the amount of their damages on their own, without any input from AIG, any auditor or the market.

After Goldman got as much money out of AIG as they thought they could, their stock analysts issued a report about how AIG was bleeding cash and their creditors wouldn’t negotiate, without mentioning that AIG was bleeding cash because of them and that Goldman was the creditor that wouldn’t negotiate. AIG’s stock tanked.

The government stepped in, took an 80 percent share in AIG and then paid Goldman and the other creditors all the money they’d asked AIG for at the start of the negotiations in 2007, without using their power to force AIG’s creditors to negotiate.

This is nothing short of immoral. Is there anyone who can summon a reaction other than fist-clenching contempt after reading this? Does the Parallax Brief need to include details of the Goldman Sachs bonus pool for the last 12 months to ram home the point?

It’s all well and good railing against popularist criticism of speculators, and indeed, Mr. Redwood is right to chasten the Greek government for seeking to transfer the blame that should lie on its own shoulders. But the problem is that speculators are also involved in nefarious activities that deserve every quantum of popular outrage generated.

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A Weaker Pound is a Good Thing

February 8th, 2010 by The Parallax Brief

After egregiously criticizing the Bank of England’s Monetary Policy Committee (MPC), the committee responsible for conducting the United Kingdom’s monetary policy, John Redwood — astonishingly — piles right into an attack on a weakening pound:

“Today the pound opened lower again on the exchanges against the dollar. That means dearer petrol, dearer commodities, dearer imports from dollar related parts of the world including China. We are poorer as a result.

[…]

Months ago I started warning they were overdoing the easy policy which was bound to lead to a lower pound and higher prices… Why can’t they find people who can get it right?”

But in fact, a weaker pound is just what the British economy needs now.

Currently, the country has a large current account deficit, meaning that we currently import – and therefore must pay for – more goods than we export. Or, to put it another way, we spend more than we make.

A weak pound will simultaneously discourage the purchase of foreign made goods, in favour of suddenly relatively cheaper homegrown fare, while making British made goods and services more competitive across the globe.

At one fell swoop, Britain’s current account deficit is helped back toward balance, while our manufacturing sector becomes more competitive at home and abroad, creating jobs.

So while a weak pound might be bad for those who want to buy BMWs, Chinese-made electronics or foreign holidays, it’s good for jobseekers and people who have invested in British factories.

Only if the pound drops precipitously should we worry: at that stage, investors would likely take flight from sterling denominated securities — including gilts — which would have disastrous consequences for the economy.

But we’re nowhere near that yet, and the current state of neglect for the pound really is a benign economic force.

The Parallax Brief suggests that if the Bank of England ever does decide to look for someone who “can get it right”, it will find pretty fallow ground in Wokingham.

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America Gives Succour to Fans of First-Past-the-Post

February 8th, 2010 by The Parallax Brief

There are many faults with the British parliamentary system and the voting procedures which elect its members: the smaller parties are grossly underrepresented in Parliament; the government in power can simply force through any legislation it wants; there is no real separation of the legislative and the executive branches of government, and power has been increasingly centralized with the executive during the ministries of four consecutive prime ministers.

However, one might wonder, looking at the legislative constipation currently clogging the US Congress, whether Britain really wants to abandon a system which so implacably prejudices against minority and coalition governments.

Nobel Laureate Paul Krugman offers some historical context in his New York Times Column today:

A brief history lesson: In the 17th and 18th centuries, the Polish legislature, the Sejm, operated on the unanimity principle: any member could nullify legislation by shouting “I do not allow!” This made the nation largely ungovernable, and neighboring regimes began hacking off pieces of its territory. By 1795 Poland had disappeared, not to re-emerge for more than a century.

Today, the U.S. Senate seems determined to make the Sejm look good by comparison.

Last week, after nine months, the Senate finally approved Martha Johnson to head the General Services Administration, which runs government buildings and purchases supplies. It’s an essentially nonpolitical position, and nobody questioned Ms. Johnson’s qualifications: she was approved by a vote of 94 to 2. But Senator Christopher Bond, Republican of Missouri, had put a “hold” on her appointment to pressure the government into approving a building project in Kansas City.

This dubious achievement may have inspired Senator Richard Shelby, Republican of Alabama. In any case, Mr. Shelby has now placed a hold on all outstanding Obama administration nominations — about 70 high-level government positions — until his state gets a tanker contract and a counterterrorism center.

[…]

In the past, holds were used sparingly. That’s because, as a Congressional Research Service report on the practice says, the Senate used to be ruled by “traditions of comity, courtesy, reciprocity, and accommodation.” But that was then. Rules that used to be workable have become crippling now that one of the nation’s major political parties has descended into nihilism, seeing no harm — in fact, political dividends — in making the nation ungovernable.

How bad is it? It’s so bad that I miss Newt Gingrich.

Readers may recall that in 1995 Mr. Gingrich, then speaker of the House, cut off the federal government’s funding and forced a temporary government shutdown. It was ugly and extreme, but at least Mr. Gingrich had specific demands: he wanted Bill Clinton to agree to sharp cuts in Medicare.

Today, by contrast, the Republican leaders refuse to offer any specific proposals. They inveigh against the deficit — and last month their senators voted in lockstep against any increase in the federal debt limit, a move that would have precipitated another government shutdown if Democrats hadn’t had 60 votes. But they also denounce anything that might actually reduce the deficit, including, ironically, any effort to spend Medicare funds more wisely.

And with the national G.O.P. having abdicated any responsibility for making things work, it’s only natural that individual senators should feel free to take the nation hostage until they get their pet projects funded.

America-watchers will no doubt feel a pang of deja vi writ large: California was last year held hostage by the Republican minority because the state budget had to be voted through the State Congress on a two-thirds majority.

While a country wouldn’t want to become subjugated to the tyranny of the majority, it’s also fair to say that the last thing we need is America’s situation, where parliamentary rules and circumstances allow one minority party — or, worse, individual MPs — to effectively clog the entire legislative system.

Of course, politics here is not as viciously partisan as it is across the Pond — and there is clearly no facsimile of the grossly irresponsible, wantonly contrarian Republican party — but Britain is currently facing a fiscal outlook worse than any since the Winter of Discontent, and even the slightest delay while backroom deals are made, or the merest hint that the bitter medicine Britain needs to swallow to rebalance its books will be watered down to satisfy coalition partners or backbench swing-voters, will be swiftly punished by the bond market, with catastrophic consequences for the economy and the country.

It seems that first-past-the-post might be on the way out just when we need it most.

A Brief History of Quantitative Easing — and Why it is not Inflationary

February 7th, 2010 by The Parallax Brief

Last week, the Bank of England ended it’s quantitative easing (QE) program last week, and the Parallax Brief thought this might be a good time to look at QE, what it’s designed for, and some of the myths spread by those on the conservative right.

QE is a tool available to central banks to further loosen monetary policy beyond zero percent interest rates. Ordinarily, interest rates in Britain are raised when inflation looks as though it will rise above 2%, and are lowered when inflation looks as though it will fall below 2%. Raising rates makes money more scarce, putting the breaks on economic growth and the money in circulation, thus holding down inflation; lowering rates does the opposite, increasing the money in circulation and boosting economic development.

However, during the financial crisis, interest rates reached zero, yet the inflationary situation, and the economic outlook, still demanded looser monetary policy. So, what can the central bank do? It cannot lower interest rates below zero because the one does not accept a fee to take a loan — or, to put it in simpler terms, you wouldn’t expect to get interest from the bank every money to borrow its money! — and yet inflation is still falling. QE is the way around this. What it does, in effect, is further loosen monetary policy by printing money and using that money to purchase government bonds (or other securities), thereby increasing the money in circulation even beyond that which would normally by permitted by zero interest rates and holding down to real cost of borrowing.

Yet the monetary hawks argue that this will inevitably lead to inflation. Print more money, they argue, and more money will be chasing the same amount of goods, and prices will rise, inevitably leading to inflation. Worse, they say ominously, inflationary expectations will rise and the government will have to fight tooth and nail to put the genie of inflation back into the bottle, lest Britain descend into some kind of Weimar-inspired hell hole of hyperinflation.

But is this really the case? No. Britain is in a liquidity trap situation, whereby the extra money does not necessarily find its way back into the real economy, and stays trapped as banks struggle desperately to repair their savaged balance sheets.

The inflation hawks are divorced from reality. Their views are destroyed by one chart. Above is the seasonally adjusted M3 money growth for the last ten years, and we can see it is currently near its ten year low, despite QE.

Being concerned about inflation in a liquidity trap situation is like finding a Mars bar during a famine and worrying about getting fat.

It’s time for the inflation hawks to own up and admit they were wrong.

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Dr InflationDove or: How I Learned to Stop Worrying and Love the Bank of England

January 20th, 2010 by The Parallax Brief

The Parallax Brief has found himself increasingly exasperated with the inflation hawks who have used the recent jump in inflation to 2.9% to holler in panic that these near record lows are harbinger of an impending Weimar-style wage-price death spiral. They themselves admit that inflationary pressures will ease after the first quarter, yet still pen these articles.

But in addition to this, the Parallax Brief also believes that even if inflation did increase to four or five percent, it wouldn’t be anything to worry about. Indeed, after some hunting around this morning, he discovered an article from Scott Sumner, professor of economics at Bentley University, which argued that inflation at 5% may be optimum, citing Australia as an exemplar:

Interestingly, I know of only one country that stayed away from the ever lower inflation obsession of the major central banks. The Bank of Australia. Australia had about 4% inflation in their GDP deflator and 7.4% NGDP growth between 2000:2 and 2008:2. With a much higher inflation and NGDP trend rate going into the crisis, they we able to avoid the zero interest rate bound. And by the way, for those who think nominal shocks don’t explain real events like the recent recession, Australia was the only major developed economy to avoid a recession last year. Indeed they haven’t had one since 1991. They are called ‘the lucky country,” but I have argued that their culture lacks our puritanical obsession with inflation.

That makes sense. And, indeed, if Britain did have inflation at around 4%, it would certainly do more to help our debt situation than at 1 or 2%.

So why on earth the trembling knees from the hawks on the right?

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Deflating the Great Inflation Scare

January 20th, 2010 by The Parallax Brief

John Redwood MP (Con, Wokingham) joined the Great Inflation Scare yesterday, posting a blog, ominously titled “Inflation Soars”:

“December’s inflation figure was as bad as I feared – and that’s before the force of higher VAT kicks in in January.

The Consumer Price Index, the government’s preferred measure, rose by 2.9%, just a whisker below the level where the Bank of England has to write a letter of apology and explanation to the Chancellor. The Retail Price Index (including mortgages) rose to 2.4%, whilst the RPI excluding housing hit an alarming 3.8%.

The Monetary Policy Committee has a lot of explaining to do.

[...]

Their defence will be twofold. They say inflation will come down again after a further rise in the first quarter of this year. That is likely to be true unless there is another devaluation and a further difficult surge in the price of commodities and fuel.”

This encapsulates the Parallax Brief’s objections to the inflation hawks. Mr. Redwood fumes about inflation, but it is actually near post-war lows; he then admits later in the very same article that inflationary pressures will probably ease after the first quarter. But still he pens a blog entry front loaded with language like, “inflation soars”, “[the figures were] as bad as I feared,” and “[the MPC] has a lot of explaining to do”. Amazing!

And Iain Martin, the deputy editor of the Wall Street Journal Europe, did exactly the same yesterday on his blog, admitting that the Bank of England — which, the Parallax Brief would like to remind his readers, is an independent institution — was probably right to say the figures were nothing to worry about, but then going on the claim that inflation as it stands could lead to a resurgence of militant trade unionism. Astonishing!

Inflation is only 2.9%, a figure that almost every single government between the war and 1993 would have killed for. Second, these hawks actually admit themselves that inflationary pressures are likely to ease in the second quarter.

Yet here they are whipping up support for the idea that we should be panicked about a non-existent threat that, even if it did exist, might not even be a threat, as opposed to, say, concentrating on real problems that actually exist now.

The Efficiency of the Market

January 20th, 2010 by The Parallax Brief

Everybody knows that only the market can effectively price assets, and that the market is on the whole perfectly efficient, right? From the FT:

The old General Motors died in a US bankruptcy court last summer. But its shares remain very much alive. So alive that as the rest of Wall Street took its biggest tumble of the year on Friday, shares of the old GM, now known as Motors Liquidation Company, gained another 3 per cent, giving the legacy company a market value of close to $500m (£306m). In spite of repeated warnings from the restructured GM, the Securities and Exchange Commission and others that the shares are worthless, Motors Liquidation has surged from 47 cents at the start of the year to 77 cents on Friday. Someone has made a tidy killing.

“It’s been a challenge to get through to people that these are not shares in the new company,” GM said. The Motors Liquidation name was adopted as part of the effort to distinguish the old and new GMs.

The new GM is a private company, with almost three-quarters of its equity held by the US and Canadian governments, and the rest by a union healthcare fund and old GM bondholders. A public share offering is possible later this year, if all goes well.

“[Motors Liquidation] could discover oil on one of their properties, weird things can happen,” Mr Coulson says sardonically. “A market can’t regulate the intelligence of investors.”

Hat tip to Brad De Long..

The Parallax Brief’s first thought upon reading this was that somebody must have made an absolute mint on this little ride. His second thought was to remember the John Maynard Keynes quote:

“…professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view.”

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