Econ 2009

[__HRB__]

Originally Posted by AES

I like aspirin very much for a hangover or allergy headache, but I'm willing to pay more for the research and development of new drugs that actually counteract other ailments.

Nothing wrong with that, but because of regulation a lot of the research is being done on how to change existing formulas and get another patent, which means that the limited number of smart people isn't working on stuff an individual would pay more for.

For example, there is no clinical advantage to switching a patient from loratadine to its metabolite desloratadine. However, it may be an option for patients whose medical insurance no longer covers loratadine if the co-pay is less than the cost of the over-the-counter product.

[ewmayer]

Nouriel Roubini`s latest weekly newsletter begins with a review of the situation in Latvia:

RGE Monitor - Is Eastern Europe on the Brink of an Asia-Style Crisis?: The collapse of the Thai baht in July 1997 helped spark the Asian financial crisis. Could events in Latvia spawn a similar contagion?

Strong trade and financial linkages, not to mention similar macroeconomic vulnerabilities, mean a Latvian crisis would almost surely have knock-on effects on neighboring Estonia and Lithuania... A Latvian crisis would also have negative spillover effects into Sweden via Swedish banks’ heavy exposure to the Baltic trio. The wildcard is how a Latvian crisis would affect the greater Central and Eastern European (CEE) region. Direct trade and financial linkages between Latvia and CEE economies, outside of the Baltics, are limited. Nevertheless, many of these countries – particularly Bulgaria and Romania – share similar macroeconomic vulnerabilities with Latvia, meaning a crisis there could ‘wake up’ investors to the potential for crises in the rest of the region.

What’s the Matter with Latvia?

Once an investor darling, Latvia’s booming, double-digit growth earlier this decade was accompanied by massive imbalances - a current-account deficit approaching 25% of GDP (among the world’s widest) and an external debt load that peaked at over 140% of GDP. The correction in these imbalances would have been challenging under any circumstances, but the global financial crisis and consequent drying up of capital inflows have raised the likelihood of a full-blown balance of payments crisis. Latvia’s currency, the Lat (LVL), is pegged to the euro within a ±1% fluctuation band, and such pegs do not tend to survive harsh economic adjustments like that now underway. In countries with flexible exchange rates, domestic demand does not have to bear the full brunt of correction in external imbalances as currency depreciation can shoulder some of the burden.

Latvia’s economy is currently on life support. Although agreement was reached in December on a €7.5 billion (US$10.4 billion) IMF and EU-led rescue package, the government is now forecasting an 18% contraction in growth in 2009, making it one of the world’s fastest shrinking economies. The immediate focus is on whether Latvia will receive the €1.7 billion (US$2.4 billion) installment of its loan package due in late June. The key stumbling block is Latvia’s ability to meet the 5% of GDP budget deficit limit laid out in the loan terms. The problem is not that Latvia’s government has been spending recklessly. Rather, the issue is that the drop-off in Latvian growth has been so precipitous, far beyond that envisioned when the loan agreement was signed just six months ago, that extreme fiscal belt-tightening is now required to meet the loan terms. A 5% GDP contraction was assumed in the original agreement, as compared to the 18% now forecast.

Latvia has been going to agonizing extremes to make the June payout happen, dramatically slashing public sector salaries. More spending cuts are in the works. As Prime Minister Dombrovskis has pointed out, these belt-tightening measures will likely trigger an even deeper recession. Even with the cuts, Latvia’s budget deficit is still expected to come in above the limit, and it remains unclear whether the IMF and European Commission are willing to relax the loan conditions. As RGE Monitor warned in early May: if Latvia does not receive the latest tranche of its IMF-led loan, the country will likely be facing a double whammy of default and devaluation.

Signs suggest that even with the June payout, Latvia may not avert devaluation...A key part of Latvia’s motivation in keeping its peg was its desire to adopt the euro early next decade. That euro adoption goal, however, increasingly looks like wishful thinking given the current economic woes. Some have argued that Latvia is clinging to its currency peg to avoid mass defaults, due to the high level of foreign currency-denominated lending there (around 90% of total loans). However, as RGE Monitor argued in December, mass defaults will occur, regardless of whether Latvia devalues or adjusts via internal deflation. The key difference is that devaluation will likely lead to a more rapid wave of defaults over a shorter period of time, which could magnify stress on the banking system.

My Comment: The rest of the article discusses the potential for contagion resulting from a Latvian currency devaluation or outright debt default. Latvia alas looks like a very good candidate for the next Iceland-style economic implosion, but the chances for spillover and large-scale social unrest (read: riots in the streets) is much greater.

[ewmayer]

And speaking of onrushing debt crises, let`s turn to a slightly larger debtor on the other side of the Atlantic from the eurozone...

The next great crisis: America`s debt: At this rate, your share of the load will be $155,000 in a decade. How chronic deficits are putting the country on a path to fiscal collapse.

(Fortune Magazine) -- Normally Paul Krugman, the liberal pundit and Nobel laureate in economics, and Paul Ryan, a conservative Republican congressman from Wisconsin, share little in common except their first names and a scorching passion for views they champion from opposite political poles. So when the two combatants agree on a fundamental threat to the U.S. economy, Americans should heed this alarm as the real thing. What`s worrying both Krugman and Ryan is the rapid increase in the federal debt - not so much the stimulus-driven rise to mountainous levels in the next few years, but the huge structural deficits that, under all projections, keep building the burden far into the future to unsustainable, ruinous heights. "The long-term outlook remains worrying," warned Krugman in his New York Times column. Krugman strongly supports President Obama`s spending plans but bemoans the shortfall in taxes to pay for them.

Ryan flays the administration for piling new spending on top of already enormous deficits. "This isn`t a temporary stimulus but a ramp-up in debt followed by a greater explosion in spending and debt," he told Fortune, predicting a day when America`s creditors will start viewing the U.S. Treasury as a risky bet. "The bond markets will come after us with a vengeance. We`re playing with fire." Krugman favors far higher taxes, while Ryan wants to curb spending, but for now what`s so big and so dangerous that it distresses such diverse types as Krugman and Ryan - and should scare all Americans - is the Great Debt Threat.

The bill is far too big for only the rich to pick up. There aren`t enough of them. America will have to lean on citizens far below the $250,000 income threshold: nurses, electricians, secretaries, and factory workers. Within a decade the average household that pays income tax will owe the equivalent of $155,000 in federal debt, about $90,000 more than last year. What the Obama administration isn`t telling Americans is that the only practical solution is a giant tax increase aimed squarely at the middle class. The alternative, big cuts in spending, aren`t part of the President`s agenda. To keep the debt from wrecking the economy, the U.S. would need to raise annual federal income taxes an average of $11,000 in 2019 for all families that pay them, an increase of about 55%. "The revenues needed are far too big to raise from high earners," says Alan Auerbach, an economist at the University of California at Berkeley. "The government will have to go where the money is, to the middle class." The most likely levy: a European-style value-added tax (VAT) that would substantially raise the price of everything from autos to restaurant meals.

My Comment: I urge folks to read the full article - it`s quite an eye-opener. The current housing-bubble and Ponzi-financial crisis is bad enough, but it`s merely a symptom of a much larger underlying structural problem, that of an entire society living recklessly beyond its means for decades, because modern financial engineering allows it do so without facing The Big Reckoning for far longer than should ever be allowed. Which of course has the effect of making the eventual, inevitable crisis much worse than it might have been had the credit lines been pulled earlier.

The prospect of ever-mounting U.S. debt with no credible plan for budget-balancing in sight is causing stress in auctions of U.S. Treasury debt:

Treasuries Drop, Pushing 10-Year Yield to Highest Since October After Sale: Treasuries fell, pushing 10-year yields to the highest level since October, as the government sold $19 billion of the securities and Russia said it may switch some reserves from U.S. debt.

The notes drew a yield of 3.99 percent, the highest since August 2008. The auction was the second of three sales this week that will raise $65 billion, part of the government’s record borrowing program. A Russian central bank official said the nation may buy International Monetary Fund bonds.

“There are an awful lot of Treasuries being auctioned and there’s going to be more and more and more and more,” said Jay Mueller, who manages about $3 billion of bonds at Wells Fargo Capital Management in Milwaukee.

...The dollar fell earlier as Russia’s announcement added to speculation central banks around the world may try to diversify their reserves away from the U.S. currency. While leaders of the nations of Brazil, Russia, India and China talk about substituting the dollar, the so-called BRIC countries have increased foreign reserves at the fastest pace since September. The nations added more than $60 billion in foreign reserves in May to limit currency gains, data compiled by central banks and strategists show.

Many of those reserves are still being plowed into U.S. debt securities, according to data from the Fed. Its holdings of Treasuries on behalf of central banks and institutions from China to Norway rose by $68.8 billion, or 3.3 percent, in May, the third most on record, data compiled by Bloomberg show.

My Comment: The last sentence shows that the Fed is desperately trying to spin the stress in the bond markets into an alleged "positive". But the spike in the yield on longer-term debt is a clear vote of no-confidence in the U.S. monetary policy. Now, the foreign debtholders can`t simply dump their holdings because that would cause a panic which would hurt not only the other debtholders but the would-be dumper as well, but what they can do is gradually move out of longer-term debt and into short-term debt, commodities, and so forth, and that is exactly what they are doing. (Check the price of oil lately? Think it`s really doubled due to mainly to "investors betting on recovery"?) The higher yields are threatening to torpedo the government`s attempts to goose the housing market by driving borrowing rates to record lows - many of those mortgage rates are tied to yields on the long bonds, and in the past month the rate on a 30-year mortgage has risen a full percentage point as a direct result of the flight from the long bond. Without a housing market recovery, there can be no overall economic recovery - it`s as simple as that.

[Fusion_power]

and what gripes me the most is that the corporate insiders are still figuring ways to line their pockets instead of how to work their way out of this mess. I like this one from dilbert.

http://www.dilbert.com/fast/2009-06-12/

DarJones

[__HRB__]

Originally Posted by Fusion_power

and what gripes me the most is that the corporate insiders are still figuring ways to line their pockets instead of how to work their way out of this mess. I like this one from dilbert.

http://www.dilbert.com/fast/2009-06-12/

DarJones

Money managers (guys that run hedge funds) always get paid around 5%-10% off the principle (even when they lose money) to limit risk-taking, because if a MM only gets paid for performance (like 25-50% of the profits), the investors will end up in the poorhouse. Consider:

Option A: Bet $100 and get $120 with probability 1.
Option B: Bet $100 and get $150 with probability 0.5.

If the contract with the MM is 0% and 50% then the expected payoff for the MM in Option B (0.5*50*0.5=12.5) is higher than for Option A (1.0*20*0.5=10), even though Option B is a money drain.

But, on the other hand, if the contract with the MM is 10% and 50% then the expected payoff for the MM with Option B (0.5*50*0.5 + 150*0.1*0.5=20) is lower than for Option A (1.0*20*0.5+120*0.1=22).

Conclusion:

Unless you know that it won't change an agents behavior, cutting the base pay is asking for real trouble.

[ewmayer]

Bank Rescue Costs EU Governments $5.3 Trillion, Surpassing Germany's GDP: European governments have approved $5.3 trillion of aid, more than the annual gross domestic product of Germany, to support banks during the credit crunch, according to a European Union document.

The U.K. pledged 781.2 billion euros ($1.1 trillion) to restore confidence in its lenders, the most of any of the 27 EU members, according to a May 26 document prepared by officials from the European Commission, the European Central Bank and member states and obtained by Bloomberg News. Denmark, where 13 of the country’s 140 banks were bailed out by the central bank or bought by rivals last year, committed 593.9 billion euros.

The measures, designed to save banks and revive economic growth, surpass Germany’s $3.3 trillion economy, the region’s biggest. They also helped to widen the Euro area’s budget deficit to the most in three years in 2008. The commission, the EU’s executive arm, is seeking to create the first EU-wide agencies with rule-making powers to monitor risk in the economy after the crisis led to $460 billion of losses and writedowns across the continent, according to data compiled by Bloomberg.

My Comment: Wie sagt man "Bailout Nation" auf Deutsch?


News of the Weird:

Very strange and potentially unsettling shenanigans involving Ninjas invading Italy carrying billions in bearer bonds, whose genuineness no one can apparently certify (or refute) yet:

Italy Invaded by Bearer-Bond-Smuggling Ninjas

Milan (AsiaNews) – Italy’s financial police (Guardia italiana di Finanza) has seized US bonds worth US 134.5 billion from two Japanese nationals at Chiasso (40 km from Milan) on the border between Italy and Switzerland. They include 249 US Federal Reserve bonds worth US$ 500 million each, plus ten Kennedy bonds and other US government securities worth a billion dollar each.

Those sound like Bearer Bonds - at least the Kennedy ones do.

We no longer issue those (nor does pretty much anyone else) for obvious reasons - they're essentially money and can be had in VERY large size, making them great vehicles for various illegal enterprises.

But folks: This is $134.5 billion dollars worth.

If they're real, what government (the only entity that would have such a cache) is trying to unload them?

If they're fake, this is arguably the biggest counterfeiting operation ever, by a factor of many times. I've seen news about various counterfeiting operations over the years that have made me chuckle, but this one, if that's what it is, is absolutely jaw-dropping.

The cute part of this is that if the certificates are real Italy just got a hell of a bonanza - their money laundering laws provide for a statutory 40% penalty for failure to declare instruments and cash in excess of $10,000 Euros, which means they'd garner a close-to-$40 billion dollar windfall.

That ought to help their budget problems!

Notice, by the way, that the US Media has totally ignored this story - even though the securities in question are allegedly US instruments.

Gee, I wonder why? Might the authorities know they're real and be just a wee bit nervous that disclosure of a sovereign attempting to covertly dump nearly $140 billion in debt could cause a wee bit of panic, given that we're running nearly $200 billion a month in deficits?

Inquiring minds want to know what's really going on here.

My Comment: One of Mish`s readers comments hilariously: "that japanese bearer-bond thing is indeed weird. a potential $38 billion fine! some kind of heinous unspeakable scam arrangement between the most and least inscrutable people on the planet."

[Fusion_power]

Obama is pushing hard for health care reform. The news today is full of different ways to 'save' enough from other programs to pay for the overhaul. There is one major factor that I don't see in their proposals: Inflation.

The predictable result of the "money from nowhere" actions over the last few months is a round of serious inflation. Just run the printing presses long enough and the currency becomes worthless. Zimbabwe is an extreme example of this. For the U.S., the damage done to date predicts an inflation rate of 7 to 10 percent within 5 years. This compares to the relatively low rate of 2 or 3 percent over the last several years.

Why is this important? Well as inflation rises, so does the average lending rate. This means that all financed purchases (such as houses, cars, etc) become more expensive. At the same time, savings are eaten away. Your money may be safe in the mattress, but after 10 years of 8% inflation, it will have lost most of its value.

Going back to the health care overhaul, what happens to the cost of health care if inflation is running 7%? What does this do to the budgetary estimates that currently total a Trillion dollars. If I did my math right, the result could double that amount.

Darrel Jones

[__HRB__]

Originally Posted by ewmayer

My Comment: Wie sagt man "Bailout Nation" auf Deutsch?

Bielefeld-Bethel Nation

[akruppa]

News of the Weird:

Very strange and potentially unsettling shenanigans involving Ninjas invading Italy carrying billions in bearer bonds, whose genuineness no one can apparently certify (or refute) yet:

If those bonds are genuine, which seems unlikely-bordering-on-impossible, I cannot begin to imagine what kind of organization would transfer funds that exceed the GDP of many nations in a suitcase on a regular train. I just wouldn't want to be the one who has to tell Nr. 1 that customs sacked some €40G of his money while they were looking for excess cigarette packs.

Alex

[fivemack]

Originally Posted by Fusion_power

Why is this important? Well as inflation rises, so does the average lending rate. This means that all financed purchases (such as houses, cars, etc) become more expensive. At the same time, savings are eaten away. Your money may be safe in the mattress, but after 10 years of 8% inflation, it will have lost most of its value.

Going back to the health care overhaul, what happens to the cost of health care if inflation is running 7%? What does this do to the budgetary estimates that currently total a Trillion dollars. If I did my math right, the result could double that amount.

Generally, wages and both signs of interest rate track inflation (with margins, but your money loses value much more slowly in the bank than in the mattress, and managed to increase value in the stock market rather than in the bank even in Weimar Germany - inflation favours the tungsten-balled speculator), and so tax take tracks inflation pretty well, and so a commitment that costs a trillion 2009-dollars is as hard to fund in 2019 whether it costs $800 billion or $2000 billion 2019-dollars.

Inflation is a problem for debtors, who find that they agreed to lend the US government a billion dollars instead of buying a dozen oil-tankers with the money, charging interest rates such that when the deal's over they can buy fifteen, and discover that the governments' repayments will only buy them six from a US shipyard, or two from a South Korean shipyard when converted out of dollars; the solution is that debtors will want to make agreements where the US government (or much more plausibly in the near future the Californian government) must pay interest and capital repayments in €, £, ¥ or 元.

[ewmayer]

Originally Posted by akruppa

If those bonds are genuine, which seems unlikely-bordering-on-impossible, I cannot begin to imagine what kind of organization would transfer funds that exceed the GDP of many nations in a suitcase on a regular train. I just wouldn't want to be the one who has to tell Nr. 1 that customs sacked some €40G of his money while they were looking for excess cigarette packs.

Alex

The U.S. media have remained curiously silent on this story, aside from this small June 12th Bloomberg-Asia piece. I googled "billion dollar bonds italy japanese smuggle" and got not a single U.S. major paper link in the top 100 results. Here is the German Die Welt paper saying the bonds are authentic in their Saturday edition:

Die Welt | Geschmuggelte Anleihen sind wohl echt: Volltreffer für die Zöllner: Die geschmuggelten Wertpapiere im Wert von 134 Milliarden Dollar sind offenbar echt. Die italienische Finanzpolizei hatte zwei Japaner ertappt, die im doppelten Boden eines Koffers milliardenschwere Anleihen in die Schweiz schaffen wollten. Von dem Fund profitiert das hochverschuldete Italien.

Zumindest ein Teil der Anleihen im Wert von 96 Milliarden Euro, die zwei Männer über die italienischen Grenze in die Schweiz schmuggeln wollten, ist wahrscheinlich echt.

Das erklärte ein Vertreter der italienischen Finanzpolizei Como am Samstag. Zu dem Fund gehören zehn sogenannte Kennedy-Bonds zu je einer Milliarde Dollar (715 Millionen Euro) und 249 US-Staatsanleihen mit einem Nennwert von je 500 Millionen Dollar (rund 358 Millionen Euro).

Die Zöllner hatten die wertvollen Papiere am 3. Juni im doppelten Boden eines Koffers entdeckt. Die im Zug Richtung Schweiz reisenden Besitzer - den Angaben nach zwei Japaner über 50 - waren vorläufig festgenommen worden.

"Was die Echtheit der Kennedy-Bonds angeht, haben wir noch Zweifel, aber die US-Staatsanleihen im Wert von rund 358 Millionen Euro scheinen glaubwürdig. Sie sind aus Filigranpapier von ausgezeichneter Qualität", erklärte Oberst Rodolfo Mecarelli. Außerdem liege den Papieren eine umfangreiche Bankdokumentation im Original bei.

Die Prüfung der Wertpapiere ist allerdings noch nicht abgeschlossen. Die "Guardia di Finanza" ermittle zusammen mit dem amerikanischen Geheimdienst. Mecarelli zufolge hat der italienische Zoll bisher gefälschte Wertpapiere mit maximal bis zu einer Milliarde Dollar Wert aufgestöbert.

My translation:

Die Welt | Smuggled Bonds are Likely Authentic: Bulls-eye for Customs: The smuggled bearer bonds valued at $134 Billion are apparently genuine. The Italian Finance Police arrested two Japanese nationals who were attempting to smuggle the billion-dollar into Switzerland in a suitcase with a false bottom. Deeply indebted Italy stands to profit from the find.

At least a part of the bonds valued at 96 Billion Euros that two men wanted to smuggle over the Italian border into Switzerland is probably authentic, as explained by a representative of the Italian finance police in Como on Saturday. The trove includes ten so-called Kennedy bonds in a value of $1 Billion each (715 million Euro) and 249 US government bonds with a nominal value of 500 million dollars (approximately 358 Million Euro) each.

The customs officers had discovered the valuable papers on the 3rd of June in the double bottom of a suitcase. The owners traveling in the train direction Switzerland - witness accounts say two Japanese nationals over 50 - had been arrested provisionally.

"With regard to the authenticity of the Kennedy bonds, we still have doubts, but the US government bonds in the value of approximately 358 Million Euro seem genuine. They consist of filigree paper of excellent quality", explained chief commissioner Rodolfo Mecarelli. The government bonds are accompanied by extensive original bank documentation.

The testing of the securities is however not yet finished. The "Guardia di Finanza" is continuing to investigate in conjunction with the American secret service. According to Mecarelli the Italian customs had previously tracked down counterfeit securities with a maximal value of up to a billion dollar.

My Comment: Was thinking about this story over the weekend ... the one thing that occurred to me was: Who would even attempt to counterfeit such a bond? The values are so large that anyone attempting to "cash" them must know that the bond would be subjected to rigorous scrutiny, not just of the paper quality etc. but but also the document's provenance. These ain`t $100 Ben-Franklins we`re talking about here ... so there`s a huge strike against the counterfeiting hypothesis right from the start.

Karl Denninger is similarly puzzled, but as always is not shy to speculate.