MacroScope

from The Great Debate:

A free lunch for America

By J. Bradford DeLong
The opinions expressed are his own.

Former US Treasury Secretary Lawrence Summers had a good line at the International Monetary Fund meetings this year: governments, he said, are trying to treat a broken ankle when the patient is facing organ failure. Summers was criticizing Europe’s focus on the second-order issue of Greece while far graver imbalances – between the EU’s north and south, and between reckless banks’ creditors and governments that failed to regulate properly – worsen with each passing day.

But, on the other side of the Atlantic, Americans have no reason to feel smug. Summers could have used the same metaphor to criticize the United States, where the continued focus on the long-run funding dilemmas of social insurance is sucking all of the oxygen out of efforts to deal with America’s macroeconomic and unemployment crisis.

The US government can currently borrow for 30 years at a real (inflation-adjusted) interest rate of 1% per year. Suppose that the US government were to borrow an extra $500 billion over the next two years and spend it on infrastructure – even unproductively, on projects for which the social rate of return is a measly 25% per year. Suppose that – as seems to be the case – the simple Keynesian government-expenditure multiplier on this spending is only two.

In that case, the $500 billion of extra federal infrastructure spending over the next two years would produce $1 trillion of extra output of goods and services, generate approximately seven million person-years of extra employment, and push down the unemployment rate by two percentage points in each of those years. And, with tighter labor-force attachment on the part of those who have jobs, the unemployment rate thereafter would likely be about 0.1 percentage points lower in the indefinite future.

The impressive gains don’t stop there. Better infrastructure would mean an extra $20 billion a year of income and social welfare. A lower unemployment rate into the future would mean another $20 billion a year in higher production. And half of the extra $1 trillion of goods and services would show up as consumption goods and services for American households.

Don’t fight the Turkish central bank

Stop fighting the Turkish central bank. Since a shock interest rate cut earlier this month, the front end of Turkey’s bond yield curve has collapsed over 80 basis points, with two-year yields hitting seven-month lows of 7.84 percent. The curve is flattening as the 10-year sector starts feeling the heat as well. Whether it reflects investors’ faith in the central bank’s ability to safeguard economic growth while bringing down a record wide current account gap is another matter altogether. Bond investors have in fact been uneasy with the central bank’s experiments, fearing that overly loose monetary policy will cause an inflation shock down the road. But with more rate cuts clearly on the cards, investors are finding that Turkish rates, especially at the front end, are too attractive to miss. Especially as the central bank is shoring up the lira with daily dollar sales.

“Its difficult to go against the central bank. It’s been six months of mixed policy and finally international investors are getting the message,” says Luis Costa, head of CEEMEA currency and debt strategy at Citi. “Logically you should be paying long-end rates but it’s a challenging environment for that as the central bank bank is forcing the curve to be extremely flat.”
Markets are now pricing in another interest rate cut next week. How will markets react? The difference from the surprise rate cut on Aug. 3  is that other emerging central banks, fearful of a growth collapse, also now appear to be gearing up for policy easing. A dimming euro zone outlook means a poor outlook for exports from Turkey and other emerging markets. “There’s some realisation that the Turkish central bank may not be all that wrong,” says Zsolt Papp, who helps manage Swiss private bank UBP‘s emerging debt portfolio.

Investors have in fact realised Turkey is not overly concerned about inflation and that allows it more room to ease policy, Papp says, adding the moves in the Turkish curve indicate that is being priced in. Citi’s Costa agrees. “Policy is now clearly being driven by growth and that’s a massive game changer.”

Historic downgrade: U.S. loses AAA

Standard & Poor’s on Friday downgraded the United States’ prized credit rating, a move that is likely to compound recent instability in financial markets. Here is S&P’s statement explaining the decision:

United States of America Long-Term Rating Lowered To ‘AA+’ Due To Political Risks, Rising Debt Burden; Outlook Negative

We have lowered our long-term sovereign credit rating on the United States of America to ‘AA+’ from ‘AAA’ and affirmed the ‘A-1+’ short-term rating.

Italy suddenly looks “peripheral”

Italy is the latest victim of market contagion in Europe’s ongoing debt crisis. The country has one of the largest public debts in the world, making investors worried it could be the next domino to fall given poor economic growth and domestic political tensions.

Both the country’s stock and bond markets have been under pressure. Italy’s short-term borrowing costs have already surpassed Spain’s, and long-term rates are well on their way to doing the same.

Nick Bullman, founder and managing partner of CheckRisk, told Reuters Insider that Europe’s bank “stress tests” were way too soft on Italy’s banks. He argues Unicredit and Intesa could need a minimum of 4.4 billion euros to plug the capital holes they face.

from Global Investing:

Jean-Claude Trichet, EM c.bankers’ new friend

What a friend emerging central bankers have in Jean-Claude Trichet. Last month the ECB boss stopped euro bears in their tracks by unexpectedly signalling concern over inflation in the euro zone. Since then the euro has pushed steadily higher  -- against the dollar of course, but also against emerging currencies. The bet now is that interest rates -- and the yield on euro investments -- will start rising some time this year, possibly as early as this summer.

That's ptrichetrovided some relief to central banks in the developing world who have struggled for months to stem the relentless rise in their currencies.

Being short euro versus emerging currencies was a popular investment theme at the start of 2011, partly because of EM strength but also because of the euro zone debt crisis. "What that also means is that people who were short euro against emerging currencies had to get out of those positions really fast," says Manik Narain, a strategist at investment bank UBS. Check out the Turkish lira -- that's fallen around 5 percent against the euro since Trichet's Jan 13 comments and is at the highest in over a year. South Africa's rand is down 6 percent too. Moves in other crosses have been less dramatic but the euro's star is definitely in the ascendant. The short EM trade versus the euro  has more room to run, Narain reckons.

Banking on a Portuguese bailout?

portgualprotest.jpgReuters polls of economists over the last few weeks have come up with some pretty firm conclusions about both Ireland and Portugal needing a bailout from the European Union.

Portuguese 10-year government bond yields have hovered stubbornly above 7 percent since the Irish bailout announcement, hitting a euro-lifetime high and giving ammunition to those who say Lisbon will be forced into a bailout.

And of those who hold that view, it’s clear that bank economists have been most vocal in expecting Ireland and Portugal to seek outside help.

from Global Investing:

Solar activities and market cycles

Can nature's cycles enrich our finance and market theories?

Market predictions based on the alignment of the sun, moon and the earth and other cycles could help investors stay disciplined and profit in economic storms, says Daniel Shaffer, CEO of Shaffer Asset Management.

SPACE/SUN

Shaffer writes that sunspot activities show that the sun has an approximate 11-year cycle and as of March 31, 2009, sunspot activity has reached a 100-year low (this, interestingly, coincides with a cycle low in equity markets, reached sometime mid-March in 2009).

But a low in solar activity seems to be followed by a high. Scientists are predicting a solar maximum of activity in sunspots in 2012 that could e the strongest in modern times, according to Shaffer.

from Jeremy Gaunt:

And the investor survey says…

Reuters asset allocation polls for August are out. They show very little change from July, which suggests investors are still cautious and uncertain about what is happening.

One big difference, month-on-month, was a large jump into investment grade corporate debt.  Andrew Milligan of Standard Life Investments reckons this  may in part  have been because  sovereign debt rallied so much over summer that returns from government bonds are now too meagre.

Here is the big picture:

Poll

ECB’s Stark takes aim at euro bears, rating agencies

Reuters/Ralph Orlowski

Reuters/Ralph Orlowski

Top European Central Bank policymaker Juergen Stark took aim at investors and ratings agencies for playing up worries about the future of the euro zone, accusing credit agencies of irresponsible behaviour and saying there was “no alternative” to the single currency.

“Markets are clearly, in the current circumstances, overshooting,” he told a Reuters Insider panel discussion in Frankfurt, saying investors were not taking the region’s economic fundamentals into account when they drove down the euro and drove up the cost of some countries’ debt.

Credit rating agencies compounded the problem by downgrading countries even as they announced ambitious plans to cut costs and debt, he said, pointing darkly to the possibility of  “vested interests” at work.

Lessons for Europe from the U.S. single currency

The euro zone is not the only large currency union in the world.  There is also the United States. While it may be pushing things to see California as Germany and Mississippi as Greece, there is still a disparity in the potential of the economies of the U.S. States.

Harvard economics professor Martin Feldstein, the former chairman of  Ronald Reagan’s Council of Economic Advisors, reckons the dollar zone could offer some help to the euro zone. U.S. state deficits are minimal compared with Europe’s, he says in an op ed piece for The Washington Post. Even cash-strapped California’s is only about 1 percent of state GDP.

The secret, according to Felstein , is that all U.S. states have constitutions prohibiting borrowing for operating purposes. Bonds for infrastructure projects, yes. For salaries, services or transport payments, no.