Class # 10.
17 March 2015
Class presentation: Egor Pravednikov – G20 and global cooperation
Outcome of class bets. Winner is Egor Pravednikov
Send your presentations to Lena by Friday.
Preparation for final exam – date?
class notes: remaining notes will be posted tomorrow.
Ritzholt’s Succinct Summations for the week ending March 13th:
Positives:
1. Initial jobless claims fell to 289k vs estimates of 305k.
2. CPI in China rose 1.4% y/o/y, higher than expected.
3. NFIB small business optimism index came in at 98.
4. MBA purchase applications rose 1.9%.
5. Import prices fell 9.4% y/o/y, a win for the consumer.
Negatives:
1. The S&P 500, Dow Jones and Nasdaq both fell for the third consecutive week.
2. Core US retail sales fell 0.2% vs an expected rise of 0.3%.
3. Headline PPI fell 0.5%, way more than the expected 0.3% rise. The disinflation theme
continues. Core also fell 0.5%.
4. U of M consumer sentiment fell to 91.2 to a four-month low and below the 95.5
expected.
5. Japan’s Q4 GDP was revised from an initial reading of 2.2% to 1.5%
6. Refinance applications fell 2.9%.
US. FOMC starts its meeting today.
24 central banks have cut their interest rates since the beginning of this year. The latest
is South Korea on March 11.
US dollar shortage. The last time the world was sliding into a US dollar shortage as rapidly as it is right
now, was following the collapse of Lehman Brothers in 2008. The response by the Fed: the issuance of an
unprecedented amount of FX liquidity lines in the form of swaps to foreign Central Banks. The "swapped"
amount went from practically zero to a peak of $582 billion on December 10, 2008.
The catalyst for the 2008 crash was the action of European Commercial banks. They got themselves into
huge trouble by creating a huge mismatch in their asset and loan funding requirements. That led to a global
US dollar shortage which the Fed mitigated using their special swap facility. So the Fed bailed out the rest of
the would at the expense of US citizens.
It is not a shortage of dollars, but a growing unwillingness of dollar holders to lend them out in a crisis that
creates a problem for banks in need of dollar funding.
Five Reasons for Current Dollar Strength
1.
2.
3.
4.
5.
ECB and Bank of Japan are now pursuing aggressive QE
Nearly everyone believes the Fed will hike its interest rate
US 10-Year interest rates are close to 2%, elsewhere they are close to zero percent
US stock market has been a one way bet
Currency speculators have a huge bet on the dollar
ECB dilemma. The ECB is taking on 20% of this risk of Draghi's 1.1 trillion bond buying spree. Countries
have 80% of the risk. Bond traders front-ran the trade. They are all betting on increasingly negative yields.
No one wants credit. Why is that?
Reasons for Lack of Lending
1.
2.
3.
4.
5.
There is too much debt in the system
Creditworthy businesses do not want to expand in a deflationary world
Banks rightfully do not want to lend to credit-unworthy customers
Banks are still capital impaired in spite of what stress tests say
You cannot fix a debt problem with more debt
There are no other possible reasons that would explain the setup we are in. It is not a matter of confidence
as Draghi believes.
The unexpected legacy of the crisis:
1.
The continuing difficulty that advance economies face in
generating robust economic growth and sufficient job creation. More
generally, only a few have decisively overcome the three weaknesses
exposed: inadequate and unbalanced aggregate demand, insufficient
structural resilience and agility, and persistent debt overhangs.
2.
The inadequate policy responses – namely, the large and
persistent imbalance between the hyperactivity of central banks and
the frustrating passivity of other policymakers.
3.
Consequences for EM and developing countries. Having initially
suffered from the financial crisis as much as advance countries did
(indeed, more in terms of output and trade), they staged a remarkable
comeback – so much so that they became the engine of global growth.
In the process, however, they slipped into an unbalanced policy mix
that now threatens their continued growth and financial stability.
4.
The failure to recast major contributors to the crisis in a credible,
sustainable, and socially responsible manner.
What is interesting, of course, is also how policy has reacted:
Going back to the beginning of the debt crisis six years ago, it should
have been clear there were four ways that the situation could develop.
The best hope was for economies to grow their way out of the problem.
But the recovery has been weak and output in the world’s largest
advanced economies has barely recovered to its 2008 levels,
especially in Europe and Japan.
The second route was to inflate the debt away. Headline inflation rates
have risen thanks to commodity prices. But there has been no sign yet
that the authorities are able to generate a 1970s-style wage-price
spiral, even assuming that they want to. There may be some scope for
“financial repression”, whereby investors are channeled towards
government bonds and real yields are held at negative rates for an
extended period, but this is a very slow way of reducing debt.
The third path was outright default. This has happened to a limited
extent in Greece Cyprus, and in Iceland but, barring political
miscalculation, the chances of it are remote for countries, like America
and Britain, which can issue debt in their own currencies.
The fourth possibility was stagnation, which might follow the Japanese
example. Plenty of investors and commentators have lost money during
the past decade by predicting that Japanese bond yields would rise
sharply. But even though Japan’s debt-to-GDP ratio is far higher than
those of America and much of Europe, there is no sign yet of imminent
collapse.
So, looking ahead, we also want to explore, in light of the US and
European real growth data, what can be the drivers of real GDP
changes for the rest of 2015.
Some sense of perspective -- the issue is that GLOBALIZATION – now
seems that financial much faster than real economy: Is it in danger?
The tough questions that are being debated:
1) Can the US resolve its political stalemate over debt issues and
allow a “normalization” of the economy as the Fed begins to
withdraw stimulus?
2) What next in the Eurozone between the need centralize if it is to
survive and political inertia?
3) Does China’s GDP growth slow dramatically as it tries to shift
from an investment-led to a consumption-led model?
4) In Japan Abenomics seems like a desperate gamble. Can it work
or does aging Japan finally have difficulty rolling over
government debt at low rates?
5) How does the rest of the world deal with contradictory forces as
most of the large powers attempted to cheapen their currencies,
thus forcing them to let their currencies rise and import capital,
and more recently with capital flight and collapsing exchange
rates?
My thought concerns the general tendency of countries to want their
currencies to depreciate. Everyone would like to boost their growth by
letting their currencies slide and increasing exports. Of course, not all
can succeed. Someone must increase net imports and let their
currency appreciate. The obvious candidate is the Chinese, but they
are unwilling to let it happen (at least at a pace desired by the rest of
the world).
The result is like a game of deflationary “musical chairs” in which the
countries with appreciating currencies eventually feel the pressure,
and try to reverse the trend. Think about Japan pre-Abenomics, or
even more, Switzerland.
What it all boils down to is this: There apparently is no motivation for
global central banks to stop directing capital inflows at the US in an
effort to support mercantilist objectives. If it isn’t China, it will be some
other economy. And equally apparent, there is no motivation among
US policymakers to address such government directed capital flows.
Which will leave politicians falling back on ultimately harmful trade
barriers (see this week’s Economist). The absolute inability of US
policymakers to seriously address a global financial architecture
where a rule of the game is “when in doubt, buy Dollars” will ultimately
have serious consequences via disruptive adjustment when the system
can no longer be maintained, via either external or internal forces.
Currency war (from Petits): there seems to be a general tendency of
countries to want their currencies to depreciate. Everyone would like
to boost their growth by letting their currencies slide and increasing
exports. Of course, not all can succeed. Someone must increase net
imports and let their currency appreciate. The obvious candidate is
the Chinese, but they are unwilling to let it happen (at least at a pace
desired by the rest of the world) – assuming that the US will not stop
the flood of dollar liquidity.
The result is like a game of deflationary pass the parcel in which the
countries with appreciating currencies eventually feel the pressure,
and try to reverse the trend.
Policy response:
1) Pay it back
2) Default/ restructure
3) Inflate it away
Keynes Chap. 12. Assumption of continuity under the logic of
“conventional wisdom”:
“In practice we have tacitly agreed, as a rule, to fall back on what is,
in truth, a convention. The essence of this convention – though it
does not, of course, work out quite so simply – lies in assuming that
the existing state of affairs will continue indefinitely, except in so far
as we have specific reasons to expect a change. This does not mean
that we really believe that the existing state of affairs will continue
indefinitely. We know from extensive experience that this is most
unlikely. The actual results of an investment over a long term of years
very seldom agree with the initial expectation. Nor can we rationalize
our behavior by arguing that to a man in a state of ignorance, errors
in either direction are equally probable, so that there remains a mean
actuarial expectation based on equi-probabilities.”
Lord Rothschild's comments appear to confirm that more muddle through was most
probable but depression possible:
Four main scenarios
For each scenario, the position of the bubble shows the combination of growth
and inflation that we expect to see in the next one to three years.
The size of the bubble illustrates our view on the likelihood of this scenario
occurring – this is subjective, and is intended just to illustrate our thinking.
Growth is expressed in relation to the potential for each country. For example, a
growth rate of 4% would be low for China but very high for Europe. Similarly,
inflation relates to a country’s individual inflation target.
We have adjusted the size of the bubbles to reflect our view that conditions
in the global economy should continue to improve in 2015. We believe the
world could begin to move away from our core “muddling through” scenario towards
“economic renaissance” and that the “new monetary world” situation has become
less likely.