MacroScope

Europe’s triple threat: bad banks, big debts, slow growth

The financial turmoil still dogging Europe is most often described as a debt crisis. But sovereign debt is only part of the problem, according to new research from Jay Shambaugh, economist at Georgetown’s McDonough School of Business. The other two prongs of what he describes as three coexisting crises are the region’s troubled banks and the prospect of an imminent recession.

These problems are mutually reinforcing, and require a more forceful policy response than the authorities have delivered to date. In particular, Shambaugh advocates using tax policy to lower labor costs, fiscal stimulus from those economies strong enough to afford it, and more aggressive action from the European Central Bank:

It is possible that coordinated shifts in payroll and consumption taxes could aid the painful process of internal devaluation. The EFSF could be used to capitalize banks and to help break the sovereign / bank link. Fiscal support in core countries could help spur growth.  Finally, the ECB could provide liquidity to sovereigns and increase nominal GDP growth as well as allow slightly faster inflation to facilitate deleveraging and relative price adjustments across regions.

All these steps, especially if taken together in an attempt to treat the three crises holistically could substantially improve outcomes. At the same time, institutional reforms to create a true financial union and a common risk free asset could help both solve the current problems and reduce the connections of these crises in the future.  Of course, politics, ideology, or additional economic shocks could all hinder improvement.  The euro area is highly vulnerable and without deft policy may continue in crisis for a considerable amount of time.

Gimme a P, gimme an M, gimme an I

If you have ever wondered why financial markets and economists are interested in purchasing managers indexes, here is why:

Stocks rally not sustainable: Prudential

Want the recent rally in stocks to last? Don’t count on it, says John Praveen of Prudential Financial. The Dow Jones industrial average is up over 20 percent since September, and has gained 7 percent since the start of the year. But Praveen sees too many headwinds for the boom to continue.

The pace of gains thus far in 2012 is likely to be unsustainable and volatility is likely to remain high as several downside risks remain. These include:

1) Greek risks: The second Greek bailout and debt restructuring deal are likely to be a short-term reprieve, with still high Greek debt/GDP burden and Greek elections due in April.  A negative election outcome with no clear mandate and/or a new government reneging on its commitments (to reduce debt) could potentially roil markets.

Employer of last resort, Arab Spring style

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The concept that the government should serve as an employer of last resort in times of economic stress was first floated by the late economist Hyman Minsky. Its modern-day proponents remain largely marginalized, despite the nation’s persistently high unemployment and the extreme damage to the job market that was done by the deepest recession in generations. 

But Ali Kadri, senior research fellow at the National University of Singapore, argues the policy, which works as an automatic stabilizer when economies are struggling, is all the more appropriate for an Arab world that has been plagued by extremely high joblessness and a general lack of infrastructure and development. He says the Arab spring creates an opportunity for a drastic shift in the region’s approach to social and economic policy.

The retention of resources and their redeployment within the national economy are indispensable conditions for development and job creation. Employment policies are best set subject to social efficiency criteria distinct from the salient neoclassical productivity ones. It is highly unlikely, in view of the sheer smallness to which industry and the productive economy have shrunk under neoliberalism, that it would be possible to reemploy the massive redundant labour force on the basis of expanding private sector expansion and productivity gains. A criterion valuing and remunerating social work may be costly in the short term, but the social returns will reimburse initial expenses over the long term.

U.S. retail sector perks up

One month’s data may not a trend make. Even so, this morning’s batch was pretty solid. U.S. retail sales rose 1.1 percent in February, the biggest gain in five months, and January’s numbers were revised up. Some of the rise reflected higher gas prices, but much of it appeared to be real.

The National Federation of Independent Businesses’ small business optimism index also rose, for a sixth straight month.

Eric Green at TD Securities says that as far as potential revisions to GDP forecasts, he’s keeping his powder dry for now:

A recovery in Europe? Really?

There’s a sense of relief among European policymakers that the worst of the euro zone’s crisis appears to have passed. Olli Rehn, the EU’s top economic officials, talked this week of a “turning of the tide in the coming months”. Mario Draghi, the president of the European Central Bank, speaks of “sizeable progress” and “a reassuring picture”.

At last week’s spring summit, EU leaders couldn’t say it enough: “This meeting is not a crisis meeting … it’s not crisis management,” according to Finnish Prime Minister Jyrki Katainen. All the talk is of how the euro zone’s economy will recover in the second half of this year.

But for the 330 million Europeans who make up the euro zone, the outlook has, if anything, darkened. As euro zone governments deepen their commitment to deficit-cutting, and rising oil prices mean higher-than-expected inflation, households can’t be counted on to drive growth. Not only did housing spending fall 0.4 percent in the October to December period from the third quarter, but unemployment rose to its highest since late 1997 in January.

A highly unequal U.S. recovery

No wonder most Americans feel like the recession never ended. A new paper from Emmanuel Saez, a Berkeley professor and expert on inequality, shows the overwhelming majority of income gains – 93 percent – accrued in 2010, the first full year of the U.S. recovery, went to the top 1 percent richest Americans. (Thanks to our friends at Counterparties for bringing the paper to our attention.)

The research suggests economic growth, even if it gathers speed, will not be nearly sufficient to close the income gap that has been the target of national Occupy protests. Instead, only drastic tax reforms of the sort seen during the 1930s might do the trick.

In 2010, average real income per family grew by 2.3% but the gains were very uneven. Top 1% incomes grew by 11.6% while bottom 99% incomes grew only by 0.2%. Hence, the top 1% captured 93% of the income gains in the first year of recovery. Such an uneven recovery can help explain the recent public demonstrations against inequality. It is likely that this uneven recovery has continued in 2011 as the stock market has continued to recover.

Economic recovery may not be a durable good

Ouch. That was the general sentiment after this morning’s strikingly weak durable goods report for January, which suggested the Federal Reserve was right to flag slowing business investment as a worry in its January statement.

Chris Williamson, chief economist at Markit, wonders if this is the start of a trend:

The big question is whether the downturn in January is merely a statistical wobble in what we must remember is a very volatile data series, or whether demand for U.S. goods really slumped at the start of 2012. Reassuringly, other data sources such as business surveys suggest that demand has remained fairly resilient, and it seems unlikely that the disappointing performance will be replicated in coming months. However, these order book numbers remind us exactly why many policymakers are extremely cautious about the underlying strength of the US economy and that the recovery looks set to be a bumpy ride over the coming year.

When 500 billion euros no longer pops eyes

There was a time when 500 billion euros in cash was truly spectacular.

But investors and speculators hoping for an even more eye-popping cash injection at the European Central Bank’s second and most likely last three-year money operation on Wednesday are likely to be disappointed, based on past Reuters polls of expectations.

"Here, have some cash"

Ever since the ECB started offering cheap, long-term loans to keep cash flowing through banks during the financial crisis, a clear pattern has emerged in the forecasts of money market traders attempting to gauge their size.

They have consistently underestimated the size of a given new loan tender the first time it is offered, only to overshoot on subsequent operations of the same maturity.

What’s behind the spike in oil prices?

It’s easy to blame tensions with Iran for all of the recent spike in petroleum prices. But there are other catalysts for the market’s sudden surge. For one thing, U.S. economic data have been consistently surprising to the upside while the European situation appears loosely under control, both factors that suggest the global economy may yet coast along through 2012 without faltering.

Then there are the actual hits to supply taken due to geopolitical events around the world, says Marc Chandler at Brown Brothers Harriman, which in just two months have helped push Brent crude prices more than $20 higher to a 10-month high above $125 a barrel:

There has been a genuine supply shock. Between Sudan, Yemen and Syria, nearly 750k barrels per day (bpd) have been taken out of production due to political instability. On top of this Libyan oil output is about 600k bpd below pre-civil war levels.