MacroScope

David Levy says he is bullish on the U.S. economy long term. But for now, the country is effectively stuck in a “contained depression,” the chairman of the Jerome Levy Forecasting Center told Reuters during a recent visit to our Washington bureau.

Still, things could have been much worse, says the third generation economist. For Levy, the interventions of a large and proactive federal government prevented a repeat of the 1930s.

In this corrective process, the reason we haven’t had a collapse in profits as we had in the Great Depression is we have – what nobody seems to like very much – a big government that’s stabilizing it by just simply running these deficits and being a much more active lender of last resort.

We have the institutions to protect our financial system. As much as we have a lot of people upset about the deficit, and there are some long term issues that need to be tackled, I see this deficit right now as something that was going to happen no matter what mix of taxes and spending we had because the private economy would weaken until we basically pumped out enough to support (it).

We’re in an overall period of contained depression here which means expansions are going to be very heavily dependent – entirely dependent – on government deficit spending. […]

Ever since an epic financial crisis hit the United States in 2008, mainstream economists, most of whom utterly failed to foresee the oncoming train wreck, have been scrambling to introduce a financial sector dimension to their models. It was a conventional approach that detached the study of financial stability from macroeconomic variables, the narrative goes, that prevented the experts from seeing the build-up of an unsustainable housing bubble that, when it crashed, took down the economy down with it.

Research by James Galbraith, professor of public policy at the University of Texas at Austin, suggests finance is only one blind spot for the economics profession. Another key and increasingly relevant factor in the public debate that has been largely ignored is the issue of inequality. The first chapter of Galbraith’s latest book, “Inequality and Instability,” begins like this:

In the late 1990s, standard measures of income inequality in the United States – and especially of the income shares held by the very top echelon – rose to levels not seen since 1929. It is not strange that this should give rise (and not for the first time) to the suspicion that there might be a link, under capitalism, between radical inequality and financial crisis.

The opening passage of Hitchhiker’s Guide to the Galaxy, Douglas Adams’ cult book, is remarkably apropos for a world caught in seemingly perennial financial crises and turmoil. It reads:

Far out in the uncharted backwaters of the unfashionable end of the Western Spiral arm of the Galaxy lies a small, unregarded yellow sun. Orbiting this at a distance of roughly ninety-eight million miles is an utterly insignificant little blue green planet whose ape-descended life forms are so amazingly primitive that they still think digital watches are a pretty neat idea.

This planet has – or rather had – a problem, which was this: most of the people living on it were unhappy for pretty much of the time. Many solutions were suggested for this problem, but most of these were largely concerned with the movement of small green pieces of paper, which was odd because on the whole it wasn’t the small green pieces of paper that were unhappy.

That the U.S. Federal Deposit Insurance Corporation (FDIC) insures deposits in people’s bank accounts up to $250,000 is fairly common knowledge. What is less known is that this $250,000 cap is, in many cases, a fiction, because companies and savvy, wealthy depositors can circumvent it, or avoid it altogether.

Two examples of this “the-sky-is-the-limit” insurance are so-called TAG accounts and CDAR accounts. TAG (Transaction Account Guarantee) accounts held about $1.5 trillion as of March 31, according to the FDIC’s latest quarterly banking profile. The accounts pay no interest, so their popularity is derived from their uncapped FDIC insurance which reassures companies who need to keep large amounts of cash at hand to finance inventories and payrolls that their deposits are safe even if something goes wrong at the bank.

The FDIC is funded by the banks it insures. When it closes a bank, it uses money it has already set aside to protect depositors and absorb any losses associated with the failure. TAG accounts were forged in the fire of the 2008 financial crisis by the FDIC, the U.S. Treasury and Federal Reserve Board and unveiled in a joint press conference.

Central banks across the industrialized world responded aggressively to the global financial crisis that began in mid-2007 and in many ways remains with us today. Now, faced with sluggish recoveries, policymakers are reticent to embark on further unconventional monetary easing, fearing both internal criticism and political blowback. They are being forced to rely more on verbal guidance than actual stimulus to prevent markets from pricing in higher rates.

How do the world’s most prominent central banks stack up against each other? The Federal Reserve was extremely aggressive, more than tripling the size of its balance sheet from around $700-$800 billion pre-crisis to nearly 3 trillion today. Still, the ECB’s total asset holdings are actually larger than the Fed’s – it started from a higher base.

The Bank of England, for its part, went even deeper into uncharted territory, with its assets as a percentage of GDP surpassing the Fed’s. By the same measure, the ECB has overtaken the Bank of Japan, which has been grappling with deflation for some two decades and started from a much higher level.

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.

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.

By Robert-Jan Bartunek and Robin Emmott

French statesman Charles De Gaulle once famously said “Treaties are like roses and young girls — they last while they last.” Germany seems to have decided that the European Union’s Lisbon Treaty, which only entered into force after a fair amount of upheaval in December 2009, has lost its perfumes and must be reworked to ensure the euro zone’s debt crisis can never be repeated.

European Council President Herman Van Rompuy’s proposal to modify the treaty via a little-known section called protocol 12 has so far been unable to convince German government officials, who warned against a “bad compromise” of small steps or “little tricks.”

Van Rompuy’s sense is that changes to the protocol, which would strengthen legislation to prevent countries running up big budget deficits, could be agreed quickly and send a message to investors that the euro zone is embarking along a path to bring back confidence and resolve its crisis.

Covering a summit of European leaders is a bit like covering a soccer match with no ticket for the stadium and no live TV broadcast to watch. The only way you have an idea of the scoreline is from the groans and cheers from inside the ground.

With EU leaders meeting on Brussels on Sunday and again on Wednesday to try to resolve the region's debt crisis, the emergency back-to-back summits look like a game of two halves.

A European Commission spokeswoman said as much on Monday, trying to explain why there had been no major announcements so far on solving the debt crisis: leaders had gone in for half time.

Will the euro zone finally act decisively?

Investors are hoping for something big from European leaders at the EU summit on Oct. 23 and of the Group of 20 on Nov. 3. But they also know the 17 nations of the euro have a habit of offering delayed, half-hearted rescues that have cost them credibility.

So there's been a lot of "urging" and "warning" in Brussels lately -- politicians and central bankers have all been demanding Europe act as international alarm grows that its sovereign debt problems may drag the world into recession. "Further delays are only aggravating the situation," said European Central Bank President Jean-Claude Trichet on Tuesday in his last appearance at the European Parliament, before he hands over the post to Mario Draghi on Nov. 1.

A day earlier, Germany's Deputy Finance Minister, Joerg Asmussen, at the parliament to promote his candidacy to join the ECB's board, made his call, saying "cooperation has to be increased," across the euro members, divided as to who should pay to rescue the heavily indebted nations of southern Europe. "I want to see a solution for debt sustainability for Greece," Asmussen said. So do so many others, especially Greek Prime Minister George Papandreou, who in Brussels on Thursday said it was a "crucial element to make the necessary decisions concerning Greece."