We kick off another week with some thoughts from the EconoMonitor community. Here is what’s on the minds of the EconoMonitor bloggers. We would love to hear what’s on your mind.
Challenge to Austerity Deepens, the Handwriting is on the Wall
-Daniel Alpert (Dan Alpert’s Two Cents)
This weekend marked the culmination of the anti-austerian fervor that has been building throughout Europe for months. Hollande rises in France; Rutte falls in Holland; Greece is now officially angry, fractured and unstable; and Schleswig-Holstein said a resounding nein to Angela Merkel’s CDU in Germany. The limp handshake of brotherhood that Germany extended to the rest of the Eurozone has been rejected in near-disgust.
This will likely continue to build as Europe descends further into decline and the notion of austerity-led growth finds its audience is shrinking rapidly to the area within the Bundesautobahn surrounding Berlin.
Recent commentary from leading German political leaders (who shall go nameless here, but I have spoken to several of them personally) is increasingly tinged with threats ranging from “be careful what you do if you want our money,” to “the future of the ‘European peace project’ is dependent on the Euro.” Ugly stuff indeed.
Germany is out there selling the world a backstory featuring its own so-called austerity – in wages and business practices – as the underlying discipline that made possible its massive, unbalancing, trade surplus. But the world is wise to the fiction being spun. Germany and, to a far lesser extent, some others in the core have achieved a false prosperity by foolishly funding consumption by nations willing to buy and consume German goods and take core money to do so. What those nations have proven unable to do is to produce enough on their own to match their consumption – much less pay debt service to their lenders. And that is no surprise, given the underlying fundamentals of their economies.
And this weekend they walked into their polling places to express displeasure with the notion of sweating and toiling to repay creditors. It certainly remains to be seen if, in an incomplete union that retains sovereign borders, they really ever will.
I actually heard a German leader tell me last week that the U.S. rating agencies got it terribly wrong by assuming all nations of the Eurozone were similarly creditworthy. The U.S. rating agencies? The ones that regulated and owned core European banks? Where do they come up with this stuff in Berlin and Frankfurt? CDU worship of the “confidence fairy” must be waning as the rating agencies are the ultimate fairy godmothers (but I suppose because they are based in the libertine U.S., the rating agencies are not proper fairy factories in the view of my interlocutor).
Germany self-financed its own so-called economic miracle. It will prove to have been no miracle when the ultimate losses of having done so are netted out. Then we can talk about austerity…apparently the people of Schleswig-Holstein aren’t buying into the handwriting they are seeing on the wall. Germany’s own Gerhard Schroeder put the matter well in his New York Times op-ed last week: “Austerity is Strangling Europe”.
How to Have Your Cake and Eat It
-Edward Hugh (Don’t Shoot the Messenger)
This weekend I was busy thinking about what the Barça Football Club will be like without Pep Guardiola. Then I remembered that elections were taking place in Europe. Marie Antionette told the French that instead of bread they should eat cake, and now Francois Hollande seems to be telling them they can both have their cake and eat it too. Here in Spain people are more skeptical. The popular expression is “pan para hoy y hambre para mañana”, which roughly translated means the bread you eat today is a “swap exchange” for hunger tomorrow. In a country where unemployment is likely to break the 25% mark this year and hundreds of thousands more families are on the point of exhausting their 2 year unemployment benefit allowance, the word “hunger” starts to take on added meaning.
Obviously austerity is not solving the problems on Europe’s periphery, but it is not clear how you practice austerity and pro-growth policies at one and the same time. It sounds very nice, and very politically correct, but what exactly does it mean? After almost five years of crisis, and a problem which is only deteriorating, saying “we are now going to go to work to get your economy back to growth” is the economic equivalent of saying “I am a good person”. The issue is how and when, especially given that the measures adopted so far have manifestly not worked.
Which brings us to that other election which is taking place in Europe, the one which has been less talked about but is surely going to be more decisive, at least in terms of the future of the Euro. I am referring, of course, to the Greek one. Regardless of the outcome, Greece is unlikely to be able to comply with the terms of the new bailout on schedule. Geez, anyone with two fingers worth of forehead-width already knew this when the “Greek correction” started out back in early 2010. We were always coming here once orderly default and devaluation had been ruled out as policy options from the outset. Argentina’s end point may not have been very satisfactory, but leaving the country with little option other than an unruly unwinding of the dollar peg made the outcome inevitable. The frustrating thing is that nothing has been learned, and whether it be at the first or the second Troika revue, disorderly default is what we are likely to see. As Paul Krugman once put it, looking at the Euro’s problems, it’s hard to escape the feeling “we’ve seen this movie before, a decade ago on another continent — specifically, in Argentina.”
Thinking Fast and Slow About Inflation
-Ed Dolan (Ed Dolan’s Econ Blog)
Whenever I do a post on inflation, I’m amazed by the number of commenters who insist that inflation is too high right now, that it is causing a steady decline in living standards, and it is behind the rise in inequality. None of those things are really true, as Tim Duy documents in his nice post on the distributional impacts of inflation.
I have noticed that the commenters are especially infuriated when I cite the Cleveland Fed’s 16-percent trimmed-mean inflation index. That index removes the 8 percent of prices that increase most in the month and the 8 percent that increase least (or decrease most). This week I have been reading Daniel Kahneman’s Thinking Fast and Slow, and it has given me a clue about the thinking of the inflationphobes.
Kahneman explains why people would find the Cleveland Fed’s procedure very strange. He points out that our “System 1” brain—the fast-thinking part—is programmed to pay attention only to elements in our environment that change and to ignore what doesn’t change. That is exactly the opposite trim—throw out the 84 percent in the middle, look only at the extremes.
Next, add another feature Kahneman attributes to our System 1 brain—loss aversion. People pay more attention to things like price increases, which cause losses, than those like price decreases, which cause gains. Put the two together, and it suggests that all those outraged commenters are working with an implicit 92 percent trimmed-mean index that pays attention to nothing but the outliers in the consumption basket that rise the most each month.
Kahneman constantly uses the abbreviation WYSIATI—what you see is all there is. Well, there you have it. When it comes to inflation, it seems that the price of gasoline is all there is.
Turkey: Markets versus Rating Agencies
-Emre Deliveli (The Kapalı Çarşı:Emre Deliveli’s blog on the Turkish economy)
I discuss the details of the decision and my own thoughts in my latest Hürriyet Daily News column, and I will have a detailed addendum to that over at the blog in the next 24 hours, but one interesting observation is the seemingly difference in perception regarding Turkey between the rating agencies and markets.
To show the “unfairness” of Turkey’s credit rating, the country’s credit default swaps are compared to peers, and the two countries most often cited are A-rated Poland and BBB-rated Russia. Turkish five-year CDS spread was 230 basis points (bp) on Friday, not significantly higher than Poland’s (202 bp) and Russia’s (189 bp). You can put these CDSs into perspective by calculating implicit default probabilities. Here’s the relevant graph, compliments of Deutsche Bank Research, with a recovery rate of 40 percent:
You could question whether the 0.5 percent difference in annual probability of default between the two countries and Turkey justifies Turkey’s much lower rating. But once you start with this kind of exercise, you’ll find all kinds of anomalies. For example, investment-grade Croatia’s spread was 429 bp on Friday. Of course, “CDS spreads also depend on other factors such as market liquidity, counterparty risk and the global financial environment, in particular US interest rates and global risk appetite”, as Deutsche explains. There is no reason to think that these factors affect each country in the same manner.
In any case, even if you think Turkey’s credit rating is too low, a positive outlook would mean the possibility of a rating upgrade in a year or so. Who would be bold enough to upgrade Turkey given the uncertain global outlook and the country’s own vulnerabilities?
-Lincoln Ellis (GMac)
Sub-par means sub-par and investors are now being asked to gauge what that means for their forward looking earnings outlooks.
The question that seems to be reopened each time this year is whether or not investors are really seeing sustainable growth or if in fact we’ve entered into some kind of new paradigm.
It’s a relatively light data week with the sleeper number of importance coming late Monday afternoon by way of consumer credit. Expansion here is NOT a good thing. More deleveraging needs to occur before one finds a positive in credit expansion.
Bonds are artificially inflated by fear and central bank intervention. Cash, as we have suggested for six weeks, looks like a much safer place to park opportunity.
Volatility remains misprinted and we are looking at Japanese small caps and German non-bank sector for defensive value.