MacroScope

High inequality makes it tougher to reform economies: Swedish Finance Minister

Americans are all too acquainted with the shouting-match politics that tends to accompany any debate over economic policy: everyone is yelling and nobody is listening. The toxic political discord in Washington has become so familiar it is almost a cliché.

It turns out high levels of income inequality, which the United States is also famous for, could be to blame. According to Anders Borg, the Finance Minister of Sweden, a large wealth gap makes it harder to achieve political consensus because the debate is poisoned by mistrust. Speaking at the Peterson Institute this week, Borg said high inequality in Southern Europe was a factor preventing those countries from achieving agreement as they struggle with a deep financial crisis:

You need to deal with the social cohesion issue. You cannot have a society where the conflicts that are built in become so strong that you undermine the political ability to deal with problems. If I compared Sweden with Spain or Italy or Greece, one of the reasons we have been able to these reforms is that our income differences are substantially lower which also means that the political tension is on a completely different level.

 

Eurobonds key to financial stability: Nobel economist

There’s no other way. In order for Europe to hold together as a monetary union it must be able to issue a currency region-wide bond. That’s according to Christopher Sims, Nobel-prize winning economist and Princeton University professor, speaking on a panel at the IMF over the weekend:

My view is that the only way to preserve the usual manner of operation of monetary policy in Europe, and the usual operation of financial institutions is to deliver on the Eurobond, and not after years but soon. A Eurobond that could be used as the main instrument of monetary policy in Europe would go a long way to stabilizing the financial system.

This explains why Europe is in trouble while other industrialized nations that also face high debt levels are not seeing anywhere near the same market pressures, Sims said:

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.

Europe’s wobbly economy

Things are  looking a bit unsteady in the euro zone’s economy.  Just ask Olli Rehn, the EU’s top economic official, who warned this week of  “risky imbalances” in 12 of the European Union’s 27 members. And that’s doesn’t include Greece, which is too wobbly for words. 

Rehn is looking longer term, trying to prevent the next crisis. But the here-and-now is just as wobbly. The euro zone’s economy, which generates 16 percent of world output, shrunk at the end of 2011 and most economists expect the 17-nation currency area to wallow in recession this year and contract around 0.4 percent overall. Few would have been able to see it coming at the start of last year, when Europe’s factories were driving a recovery from the 2008-2009 Great Recession. And it shows just how poisonous the sovereign debt saga has become.

Not everyone thinks things are so shaky.  Unicredit’s chief euro zone economist, Marco Valli, is among the few who believe the euro zone will skirt a recession — defined by two consecutive quarters of contraction — in 2012. This year is “bound to witness a gradual but steady improvement in underlying growth momentum,” Valli said, saying the fourth quarter was the low point in the euro zone business cycle.

Risks from ECB debt drip

The abundance of European Central Bank liquidity in the euro zone financial system is making for smoother issuance of shorter-dated debt in the euro zone.

Case in point: Spain. This week the country sold double its previously announced target of three- and four-year government bonds amid solid demand.

But there are risks, particularly if the Treasuries of lower-rated countries get too comfortable issuing at the short-end of the curve. Michael Leister, strategist at DZ Bank, described the potential pitfalls in a telephone interview:

European rescue: Who benefits?

The words “European bailout” normally conjure up images of inefficient public sectors, bloated pensions, corrupt governments. But market analyst John Hussman, in a recent research note cited here by Barry Ritholtz, says the reality is a bit more complicated:

The attempt to rescue distressed European debt by imposing heavy austerity on European people is largely driven by the desire to rescue bank bondholders from losses. Had banks not taken on spectacular amounts of leverage (encouraged by a misguided regulatory environment that required zero capital to be held against sovereign debt), European budget imbalances would have bit far sooner, and would have provoked corrective action years ago.

In other words, even if state actors mishandled government finances, Wall Street was, at the very least, an all-too-willing enabler.

Money funds cut Europe exposure, slowly

Prime U.S. money funds further reduced their holdings of euro zone bank paper in December, although the pace of movement slowed while investors continued to hedge against any bank failures, J.P. Morgan Securities said on Wednesday.  The slower movement out of euro zone bank paper was the result of money funds having already strongly reduced their holdings, J.P. Morgan said in a note to clients.

Euro zone bank paper continued to roll off in December from prime money fund portfolios but has seen some slowing as nearly 70 percent of these exposures have been eliminated from prime fund portfolios over the course of the past year. In spite of continued reductions in euro zone bank exposures, prime fund assets under management were basically flat for the second consecutive month reflecting some level of investor comfort in the level of risk in price fund portfolios as much of the cash that left euro zone bank paper has been reinvested in non-European banks and other high-quality products.

The prime money funds had small net outflows of $2.6 billion in December after net inflows of $4 billion in November, according to J.P. Morgan.

Please take my money: The zero-yield bill

Wall Street firms are begging the U.S. Treasury to take their cash, at least judging by the latest auction of short-term Treasury bills. Treasury sold $30 billion of four-week bills at a “high rate” (pause for laugther) of 0.000% on Wednesday, a mix of strong demand for year-end portfolio shuffling but also a reflection of ongoing fears of a credit crunch emanating from Europe.

It was the fourth straight sale in as many weeks that brought a high rate of zero. The zero percent rate means buyers of the debt will receive no interest at all, sacrificing any return simply to hold cash in the safest of investments.

A rise in repo financing costs is “a sign the year-end demand for short, safe assets has begun,” said Roseanne Briggen, our New York-based colleage at IFR Markets, a unit of ThomsonReuters.

from Global Investing:

Hungary’s Orban and his central banker

"Will no one rid me of this turbulent central banker?"  Hungarian Prime Minister Viktor Orban may not have voiced this sentiment but since he took power last year he is likely to have thought it more than once.  Increasingly, the spat between Orban's government and central bank governor Andras Simor brings to memory the quarrel England's Henry II had with his Archbishop of Canterbury, Thomas Becket, over the rights and privileges of the Church almost 900 years ago. Simor stands accused of undermining economic growth by holding interest rates too high and resisting government demands for monetary stimulus.  The government's efforts to sideline Simor are viewed as infringing on the central bank's independence.

So far, attacks on Simor have ranged from alleging he has undisclosed overseas income to stripping him of his power to appoint some central bank board members. But  the government's latest plan could be the last straw -- proposed legislation that would effectively demote Simor or at least seriously dilute his influence. Simor says the government is trying to engineer a total takeover at the central bank.  "The new law brings the final elimination of the central bank's independence dangerously close," he said last week.  
 
The move is ill-timed however, coming exactly at a time when Hungary is trying to persuade the IMF and the European Union to give it billions of euros in aid. The lenders have expressed concern about the law and declined to proceed with the loan talks.  But the government says it will not bow to external pressure and plans to put the law to vote on Friday. That has sparked general indignation - Societe Generale analyst Benoit Anne calls the spat extremely damaging to investor confidence in Hungary. "I just hope the IMF will not let this go," he writes.

Central banks and governments often fail to see eye to eye. But in Hungary, the government's attacks on Simor, a respected figure in central banking and investment circles,  is hastening the downfall of the already fragile economy. For one, if IMF funds fail to come through, Hungary will need to find 4.7 billion euros next year just to repay maturing hard currency debt. That could be tough at a time when lots of borrowers -- developed and emerging -- will be competing for scarce funds.  Central European governments alone will be looking to raise 16 billion euros on bond markets, data from ING shows. So Orban will have to tone down his rhetoric if he is to avoid plunging his country into financial disaster.

Europe’s clear and present danger to U.S. economy

Jason Lange contributed to this post.

Suddenly the shoe is on the other foot. The financial crisis of 2007-2008 had its roots in the U.S. banking system and then spread to Europe. Now, it’s Europe’s political debacle that threatens economic growth in the United States.

A recent raft of better U.S. economic data, including a steep drop in weekly jobless claims reported on Thursday, have pointed to a swifter recovery. But such signals seem a bit futile when there’s a risk of another major global financial meltdown lurking.

Yet just what is the likely impact of the euro zone’s morass on the United States? Economists at Goldman Sachs ran some figures through their models, and the results were not pretty: overall, Europe’s crisis is likely to shave a full percentage point off U.S. economic growth.  In a world where economists have come to expect the “new normal” for U.S. growth to be around 2.5 percent, that could mean the difference between a decent recovery and one that is highly fragile and vulnerable to shocks.