Explaining Richard Koo to Paul Krugman | SNBCHF.com

George Dorgan writes:

….Prof. Steve Keen’s and Richard Koo’s recipe is to increase public debt, when the private sector is de-leveraging and to reduce public debt when the private sector is leveraging. According to Keen, the Americans are currently doing the complete opposite of what they should do. They should continue reducing private liabilities, but they should increase public spending.

The Fed wants the average American to spend, even deficit spending, while the state is doing austerity. According to Keen, the current increase of private US debt could lead to a new recession.

Read more at Explaining Richard Koo to Paul Krugman, to Austrian Economists and the SNB #Balance Sheet Recession.

The monetary policy revolution

James Alexander, head of Equity Research at UK-based M&G Equities, sums up the evolution of central bank thinking. He describes the traditional problem of inadequate response by central banks to market shocks like the collapse of Lehman Brothers:

Although wages hold steady when nominal income falls, unemployment tends to rise as companies scramble to cut costs. In the wake of the crash, rising joblessness created a vicious circle of declining consumption and investment that proved very difficult to reverse, particularly as central banks remained preoccupied with inflation.

Failure of both austerity and quantitative easing has left central bankers looking for new alternatives:

…..Economist Michael Woodford presented a paper [at Jackson Hole last August] suggesting that the US Federal Reserve (Fed) should give markets and businesses a bigger steer about where the economy was headed by adopting a nominal economic growth target. In September, the Fed announced its third round of QE, which it has indicated will continue until unemployment falls below 6.5% – the first time US monetary policy has been explicitly tied to an unemployment rate. US stocks have since soared, shrugging off continued inaction surrounding the country’s ongoing debt crisis.

While targeting unemployment is preferable to targeting inflation, it is still a subjective measure that can be influenced by rises or falls in labor participation rates and exclusion of casual workers seeking full-time employment. Market Monetarists such as Scott Sumner and Lars Christensen advocate targeting nominal GDP growth instead — a hard, objective number that can be forecast with greater accuracy. Mark Carney, due to take over as governor of the BOE in July, seems to be on a similar path:

Echoing Michael Woodford’s comments at Jackson Hole, he advocated dropping inflation targets if economies were struggling to grow. He has since proposed easing UK monetary policy, adopting a nominal growth target and boosting recovery by convincing households and businesses that rates will remain low until growth resumes.

While NGDP targeting has been criticized as a “recipe for runaway inflation”, experiences so far have not borne this out. In fact NGDP targeting would have the opposite effect when growth has resumed, curbing inflation and credit growth and preventing a repeat of recent housing and stock bubbles.

Read more at Outlook-for-UK-equities-2013-05_tcm1434-73579.pdf.

Debunking austerity claims makes no difference to Europe’s monks and zealots | Telegraph Blogs

Ambrose Evans-Pritchard attacks euro-zone austerity:

Britain’s public debt was 260pc of GDP in 1816 at the end of near perma-wars: Seven Years War, American War of Independence, and the Napoleonic Wars. This was whittled down to 24pc over the next century by the magical compound effects of economic growth. The debt reached 220pc in 1945, the price for defeating fascism. This was certainly a drag on the post-War recovery, but it did not stop debt falling to 36pc by the mid-1990s.

Britain twice recovered from massive debt through a combination of growth and inflation — not necessarily in that order — but they had control of their own currency. The states of Europe are strait-jacketed by a currency dominated by the austerity-minded Bundesbank.

Read more at Debunking austerity claims makes no difference to Europe's monks and zealots – Telegraph Blogs.

Cyprus: The Operation Was a Success. Shame the Patient Died. | Some of it was true…

Pawelmorski (pseudonym for a london-based fund manager) gives this opinion of the EU ‘rescue’ of Cyprus :

How bad is the damage?

Bloody appalling…… Take a moment to realise the scale of what’s been done here. No human agency has achieved so much economic destruction in such a short time without the use of weapons. The combination of laying waste to the financial sector and tearing up the savings of thousands of residents means that Cyprus won’t return to current levels of output for a decade, a funeral pyre which bears comparison only with Greece. There are four shocks happening at once; the bog-standard austerity shock; the trauma of bank withdrawal controls; the wealth shock; and the structural shock of wiping out the financial sector. The bailout bill is certainly going to get a lot higher too, as a larger amount of debt is piled onto a smaller economy.

Read more at Cyprus: The Operation Was a Success. Shame the Patient Died. | Some of it was true….

Unintended consequences: Rewarding failure

Robert Shiller summarizes the arguments for raising taxes and increasing government spending at Project Syndicate:

……while that [austerity] approach to debt works well for a single household in trouble, it does not work well for an entire economy, for the spending cuts only worsen the problem. This is the paradox of thrift: belt-tightening causes people to lose their jobs, because other people are not buying what they produce, so their debt burden rises rather than falls.

There is a way out of this trap, but only if we tilt the discussion about how to lower the debt/GDP ratio away from austerity – higher taxes and lower spending – toward debt-friendly stimulus: increasing taxes even more and raising government expenditure in the same proportion. That way, the debt/GDP ratio declines because the denominator (economic output) increases, not because the numerator (the total the government has borrowed) declines.

What he does not consider, however, is the message we are sending to government. In much the same way as bailouts increase moral hazard — with too-big-to-fail institutions taking on bigger risks secure in the knowledge that the taxpayer will bail them out if the bets don’t pay off — we encourage bad behavior from politicians if we allow them to raise taxes and increase government spending every time they screw up the economy. Federal government spending in the US economy has grown from 12.5% of GDP in 1950 to nearly 25% of GDP today. Seems like they are getting the wrong message.

Federal Spending as % of GDP

That is like giving someone a promotion or a raise every time they mess up. When politicians fail, they need to get the right message — and not only at the next election. Cutting budgets when the economy is in recession is the right response, but how can we achieve this while saving the economy from a deflationary spiral?

The only way I can think of is to cut taxes and government expenditure, but encourage private investment in productive infrastructure through Treasury-backed low-interest or even interest-free development loans. These could be administered by an independently-elected infrastructure body with representatives from all parties. There are dangers, and the process would have to be closely monitored, but the risks are minor compared to rewarding failure.

Read more at Debt-Friendly Stimulus by Robert J. Shiller – Project Syndicate.

Ray Dalio Explains The Rare Set Of Circumstances That’s Making Him Bearish On Markets | Business Insider

Joe Weisenthal reports on hedge fund guru Ray Dalio’s outlook:

His novel set of circumstances he sees is an economy that faces austerity (due to the Fiscal Cliff, etc.) coupled with a Fed that’s mostly blown its bazooka, and can’t get much more juice out of QE.

  • Yields can’t go down anymore.
  • Austerity is coming.
  • Economy is running out of steam.
  • QE is losing its efficacy.
  • Rate turn probably finally coming late in 2013.

Read more at Ray Dalio Explains The Rare Set Of Circumstances That's Making Him Bearish On Markets – Business Insider.

Reid: Eurozone’s 2013 Nightmare Scenario | Business Insider

In his 2013 outlook, titled In Authorities We (have to) Trust, Deutsche Bank credit strategist Jim Reid warns that Europe is headed for tough times in 2013.

Matthew Boesler at BusinessInsider writes:

Reid highlights three major issues.

To start, European stocks – and stocks in markets around the world, for that matter – are considerably overvalued based on historical correlations to PMI data….

The second problem is austerity. Most accept that austerity measures weigh on economic growth in the short term, yet euro-area governments are moving forward with plans attempting to bring fiscal budgets back into balance anyway.

…. the third problem: namely, that governments have consistently set economic forecasts too high and then failed to meet their own targets.

Read more here Reid: Eurozone’s 2013 Nightmare Scenario | Business Insider.

Europe’s Populists at the Gate by Barry Eichengreen – Project Syndicate

Barry Eichengreen writes:

In focusing on summit declarations and promises of far-reaching reforms of EU institutions, investors are missing the real risk: the collapse of public support for, or at least public acquiescence to, the austerity policies required to work down heavy debt burdens – and for the governments pursuing these policies. Mass anti-austerity protests are one warning sign. Another is growing popular support for neo-Nazi movements like Golden Dawn, now the third-largest political party in Greece.

The rise to power of a “rejectionist” European government – that is, one that unilaterally rejects the policy status quo – would immediately bring the crisis to a head…….

via Europe’s Populists at the Gate by Barry Eichengreen – Project Syndicate.

IMF: Coping with high debt and sluggish growth [video]

The World Economic Outlook (WEO) presents the IMF staff’s analysis and projections of economic developments at the global level, in major country groups (classified by region, stage of development, etc.), and in many individual countries.

[time: 38 minutes]

Fiscal consolidation in Sweden: A role model? | vox

By Martin Flodén, Associate Professor at Stockholm University

Fiscal austerity was effective during the Swedish economic crisis, but that insight is not particularly helpful today. Austerity would have been more complicated both economically and politically if it had not been supported by currency depreciation and strong external demand, and crisis countries today do not benefit from such developments. Attempts to consolidate before growth had resumed failed in Sweden. One possible interpretation of these observations is that prospects to consolidate are bleak until competitiveness has been restored in crisis economies…….

via Fiscal consolidation in Sweden: A role model? | vox.

Hat tip to Delusional Economics

Milton Friedman’s Advice

In 1997 Milton Friedman commented on Bank of Japan policy following Japan’s deflationary spiral of the early 1990s:

Defenders of the Bank of Japan will say, “How? The bank has already cut its discount rate to 0.5 percent. What more can it do to increase the quantity of money?”

The answer is straightforward: The Bank of Japan can buy government bonds on the open market, paying for them with either currency or deposits at the Bank of Japan, what economists call high-powered money. Most of the proceeds will end up in commercial banks, adding to their reserves and enabling them to expand their liabilities by loans and open market purchases. But whether they do so or not, the money supply will increase.

There is no limit to the extent to which the Bank of Japan can increase the money supply if it wishes to do so. Higher monetary growth will have the same effect as always. After a year or so, the economy will expand more rapidly; output will grow, and after another delay, inflation will increase moderately. A return to the conditions of the late 1980s would rejuvenate Japan and help shore up the rest of Asia.

Austerity measures adopted in Europe are failing and central banks are likely to attempt Friedman’s option in a number of guises. Already, as Gary Shilling points out “competitive quantitative easing by central banks is now the order of the day.” The Bank of Japan last year expanded its balance sheet by 11 percent, the Federal Reserve by 19 percent, the European Central Bank by 36 percent and the Swiss National Bank by 33 percent. Even countries with relatively strong balance sheets, like Switzerland, are forced to respond to prevent appreciation of their currencies from harming exports.

Inflation will remain moderate only so long as central bank balance sheet expansion is offset by deflationary pressures from private sector deleveraging. That is the difficult task ahead: to maneuver a soft landing by balancing the two opposing forces. Failure to do so could lead to a bumpy ride.

ECB’s Nowotny Cautions Against ‘Single-Minded’ Austerity – Real Time Economics – WSJ

“The single-minded concentration on austerity policy (in the 1930s) led to mass unemployment, a breakdown of democratic systems and, at the end, to the catastrophe of Nazism,” said Ewald Nowotny [Austria’s central bank governor and member of ECB governing council] at a financial conference in Vienna. He added that central bankers during the start of the financial crisis had been very keen to avoid the mistakes of the 1930s.

Mr. Nowotny also cautioned against trying to impose a “moralistic” solution to the euro zone’s current debt problems. “It is not about punishing children who have behaved badly,” he said, adding that it was important not to let the concept of moral hazard turn into an excuse for not taking “practical initiatives.”

via ECB’s Nowotny Cautions Against ‘Single-Minded’ Austerity – Real Time Economics – WSJ.

When Austerity Fails

Austerity decimated Asian economies during their 1997/98 financial crisis and similar measures have failed to rescue the PIIGS in Europe 2012. David Cameron’s austerity measures have also not saved the UK from falling back into recession. So why is Wayne Swan in Australia so proud of his balanced budget? And why does Barack Obama threaten the wealthy with increased taxes while the GOP advocate spending cuts in order to reduce the US deficit? Are we condemned to follow Europe into a deflationary spiral?

How Did We Get Here?

First, let’s examine the causes of the current financial crisis.

Government deficits have been around for centuries. States would borrow in order to finance wars but were then left with the problem of repayment. Countries frequently defaulted, but this created difficulties in accessing further finance; so governments resorted to debasing their currencies. Initially they substituted coins with a lower metal content for the original issue. Then introduction of fiat currencies — with no right of conversion to an underlying gold/silver standard — made debasement a lot easier. Issuing more paper currency simply reduced the value of each note in circulation. Advent of the digital age made debasement still easier, with transfer of balances between electronic accounts largely replacing paper money. Fiscal deficits, previously confined to wars, became regular government policy; employed as a stealth tax and redistributed in the form of welfare benefits to large voting blocks.

Along with fiscal deficits came easy monetary policy — also known as debt expansion. Lower interest rates fueled greater demand for debt, which bankers, with assistance from the central bank, were only too willing to accommodate. I will not go into a lengthy exposition of how banks create money, but banks expand their balance sheets by lending money they do not have, confident in the knowledge that recipients will deposit the proceeds back in the banking system — which is then used to fund the original loan. Expanding bank balance sheets inject new money into the system, debasing the currency as effectively as if they were running a printing press in the basement.

The combination of rising prices and low interest rates is a heady mix investors cannot resist, leading to speculative bubbles in real estate or stocks. So why do governments encourage debt expansion? Because (A) it creates a temporary high — a false sense of well-being before inflation takes hold; and (B) it debases the currency, inflating tax revenues while reducing the real value of government debt.

Continuous government deficits and debt expansion via the financial sector have brought us to the edge of the precipice. The problem is: finding a way back — none of the solutions seem to work.


Slashing government spending, cutting back on investment programs, and raising taxes in order to reduce the fiscal deficit may appear a logical response to the crisis. Reversing policies that caused the problem will reduce their eventual impact, but you have to do that before the financial crisis — not after. With bank credit contracting and aggregate demand shrinking, it is too late to throw the engine into reverse — you are already going backwards. The economy is already slowing. Rather than reducing harmful side-effects, austerity applied at the wrong time will simply amplify them.

The 1997 Asian Crisis

We are repeating the mistakes of the 1997/98 Asian crisis. Joseph Stiglitz, at the time chief economist at the World Bank, warned the IMF of the perils of austerity measures imposed on recipients of IMF support. He was politely ignored. By July 1998, 13 months after the start of the crisis, GNP had fallen by 83 percent in Indonesia and between 30 and 40 percent in other recipients of IMF “assistance”. Thailand, Indonesia, Malaysia, South Korea and the Phillipines reduced government deficits, allowed insolvent banks to fail, and raised interest rates in response to IMF demands. Currency devaluations, waves of bankruptcies, real estate busts, collapse of entire industries and soaring unemployment followed — leading to social unrest. Contracting bank lending without compensatory fiscal deficits led to a deflationary spiral, while raising interest rates failed to protect currencies from devaluation.

The same failed policies are being pursued today, simply because continuing fiscal deficits and ballooning public debt are a frightening alternative.

The Lesser of Two Evils

At some point political leaders are going to realize the futility of further austerity measures and resort to the hair of the dog that bit them. Bond markets are likely to resist further increases in public debt and deficits would have to be funded directly or indirectly by the central bank/Federal Reserve. Inflation would rise. Effectively the government is printing fresh new dollar bills with nothing to back them.

The short-term payoff would be fourfold. Rising inflation increases tax revenues while at the same time decreasing the value of public debt in real terms. Real estate values rise, restoring many underwater mortgages to solvency, and rescuing banks threatened by falling house prices. Finally, inflation would discourage currency manipulation. Asian exporters who keep their currencies at artificially low values, by purchasing $trillions of US treasuries to offset the current account imbalance, will suffer a capital loss on their investments.

The long-term costs — inflation, speculative bubbles and financial crises — are likely to be out-weighed by the short-term benefits when it comes to counting votes. Even rising national debt would to some extent be offset by rising nominal GDP, stabilizing the debt-to-GDP ratio. And if deficits are used to fund productive infrastructure, rather than squandered on public fountains and bridges-to-nowhere, that will further enhance GDP growth while ensuring that the state has real assets to show for the debt incurred.

Not “If” but “When”

Faced with the failure of austerity measures, governments are likely to abandon them and resort to the printing press — fiscal deficits and quantitative easing. It is more a case of “when” rather than “if”. Successful traders/investors will need to allow for this in their strategies, timing their purchases to take advantage of the shift.

Richard Koo: Where do we go from here?

How austerity will prolong the recession.

Richard Koo, Chief Economist, Nomura Research Institute at the Closing Panel entitled “Overhangs, Uncertainty and Political Order: Where Do We Go From Here?” at the Institute for New Economic Thinking’s (INET) Paradigm Lost Conference in Berlin. April 14, 2012.

Paul Krugman on austerity

It is not often I agree with Paul Krugman. This is one of the few.

….not that I am in favor of big government.

Spain’s Economy Shows Fresh Strain – WSJ.com

Spain’s economy showed fresh strain as retail sales fell at a record pace in April, showing the government’s austerity program is strangling consumption and suggesting deepening recession. Data Tuesday from the National Statistics Institute, or INE, showed seasonally adjusted retail sales fell 9.8% on the year in April, compared with a 3.8% drop in March. The decline was the sharpest since INE started collecting the data in January 2004. Household spending is dropping as unemployment approaches 25% of the work force.

via Spain’s Economy Shows Fresh Strain – WSJ.com.

Europe’s Economic Suicide – NYTimes.com

Paul Krugman: If European leaders really wanted to save the euro they would be looking for an alternative course. And the shape of such an alternative is actually fairly clear. The Continent needs more expansionary monetary policies, in the form of a willingness — an announced willingness — on the part of the European Central Bank to accept somewhat higher inflation; it needs more expansionary fiscal policies, in the form of budgets in Germany that offset austerity in Spain and other troubled nations around the Continent’s periphery, rather than reinforcing it. Even with such policies, the peripheral nations would face years of hard times. But at least there would be some hope of recovery.

What we’re actually seeing, however, is complete inflexibility. In March, European leaders signed a fiscal pact that in effect locks in fiscal austerity as the response to any and all problems. Meanwhile, key officials at the central bank are making a point of emphasizing the bank’s willingness to raise rates at the slightest hint of higher inflation.

via Europe’s Economic Suicide – NYTimes.com.

Mark Carney: Growth in the age of deleveraging

Today, American aggregate non-financial debt is at levels similar to those last seen in the midst of the Great Depression. At 250 per cent of GDP, that debt burden is equivalent to almost US$120,000 for every American (Chart 1).

US Debt/GDP 1916 - 2011

…..backsliding on financial reform is not a solution to current problems. The challenge for the crisis economies is the paucity of credit demand rather than the scarcity of its supply. Relaxing prudential regulations would run the risk of maintaining dangerously high leverage – the situation that got us into this mess in the first place.

As a result of deleveraging, the global economy risks entering a prolonged period of deficient demand. If mishandled, it could lead to debt deflation and disorderly defaults, potentially triggering large transfers of wealth and social unrest.

Managing the deleveraging process

Austerity is a necessary condition for rebalancing, but it is seldom sufficient. There are really only three options to reduce debt: restructuring, inflation and growth. Whether we like it or not, debt restructuring may happen. If it is to be done, it is best done quickly. Policy-makers need to be careful about delaying the inevitable and merely funding the private exit.

……Some have suggested that higher inflation may be a way out from the burden of excessive debt. This is a siren call. Moving opportunistically to a higher inflation target would risk unmooring inflation expectations and destroying the hard-won gains of price stability.

…..With no easy way out, the basic challenge for central banks is to maintain price stability in order to help sustain nominal aggregate demand during the period of real adjustment. In the Bank’s view, that is best accomplished through a flexible inflation-targeting framework, applied symmetrically, to guard against both higher inflation and the possibility of deflation.

The most palatable strategy to reduce debt is to increase growth. In today’s reality, the hurdles are significant. Once leverage is high in one sector or region, it is very hard to reduce it without at least temporarily increasing it elsewhere.

In recent years, large fiscal expansions in the crisis economies have helped to sustain aggregate demand in the face of private deleveraging. However, the window for such Augustinian policy is rapidly closing. Few except the United States, by dint of its reserve currency status, can maintain it for much longer.

…..The route to restoring competitiveness [in the euro-zone] is through fiscal and structural reforms. These real adjustments are the responsibility of citizens, firms and governments within the affected countries, not central banks. A sustained process of relative wage adjustment will be necessary, implying large declines in living standards for a period in up to one-third of the euro area.

…..With deleveraging economies under pressure, global growth will require global rebalancing. Creditor nations, mainly emerging markets that have benefited from the debt-fuelled demand boom in advanced economies, must now pick up the baton. This will be hard to accomplish without co-operation. Major advanced economies with deficient demand cannot consolidate their fiscal positions and boost household savings without support from increased foreign demand. Meanwhile, emerging markets, seeing their growth decelerate because of sagging demand in advanced countries, are reluctant to abandon a strategy that has served them so well in the past, and are refusing to let their exchange rates materially adjust. Both sides are doubling down on losing strategies. As the Bank has outlined before, relative to a co-operative solution embodied in the G-20’s Action Plan, the foregone output could be enormous: lower world GDP by more than US$7 trillion within five years. Canada has a big stake in avoiding this outcome.

Mark Carney: Growth in the age of deleveraging.

Comment: ~ One of the most important papers I have read this year. Mark Carney, Governor of the Bank of Canada and Chairman of the Financial Stability Board — established by the G-20 in 2009 to further global economic governance — maps out the hard road to recovery from the current financial crisis.