Yale's Swensen Interview

David Swensen, CIO of Yale's endowment, talks to Charlie Rose.

Financial sector in historical perspective

Some really good graphs. I don't need to say more.  The last two graphs are especially interesting. If you are interested in the deeper analysis of the graphs, read this NBER research paper.

 

 

(graph courtesy of Bespoke Investments)

(graph courtesy of NBER and author: Thomas Philippon and Ariell Reshef)

understanding Fed's balance sheet, money supply and inflation

David Altig, senior vice president and research director at the Altanta Fed explains how he looks at the rapidly expanding Fed's balance sheet and its implications to inflation. Mr. Altig clarifies many confusions in the media, espeically on 1) what is exactly the monteary base? One thing for sure is that Fed's balance sheet (asset side) and monetary base are not the same thing; 2) what is money multiplier and money supply: expanding Fed's balance sheet does not necessarily lead to rapidly expanding money supply of the same level, albeit a fast increase. It's a very good piece.

On expanding balance sheets and inflationary policy

Here's a question I hear a lot (most recently during the Q&A portion of a speech delivered yesterday by my boss, Atlanta Fed president Dennis Lockhart): Has monetary policy become so expansive that the central bank's mandate to maintain price stability has been fundamentally compromised? Is the increase in the scale of the Federal Reserve's balance sheet inherently inflationary?

Jim Hamilton covered much of the territory implied by these questions in a very extensive Econbrowser post not too long ago, but the distinction between money creation and Fed balance sheet expansion continues to be confounded. Here, for example, is a passage from the Wall Street Journal's Real Time Economics coverage of Stanford professor John Taylor's (not exactly glowing) review of recent Federal Reserve action, delivered at this year's annual meeting of the American Economic Association:

"The Fed has launched nearly a dozen new programs in the past year to address the crisis. Its strategy is to target specific markets in distress—from commercial paper to asset backed securities to money market mutual funds and stresses overseas—with programs tailored to their problems. It also has gotten deeply involved in rescues of individual firms like Bear Stearns, American International Group and Citigroup.

"The Fed has funded these programs by pumping reserves into the banking system—essentially creating new money. In the process, its balance sheet has ballooned from less than $900 billion to more than $2 trillion."

The record though, as the article goes on to note, is that not all of that $2 trillion represents an increase in the money supply:

Only the blue portion of the graph above represents "pumping reserves into the banking system"—a fact that was covered pretty well in the aforementioned Econbrowser post—and in an even earlier post at News N Economics. In simple terms, the size of the Fed's balance sheet is not the same thing as the size of the monetary base (the sum of currency in circulation and reserve balances kept by banks with the Federal Reserve).

Of course, John Taylor's point was not that all of the increase in the balance sheet has amounted to pumping in reserves, just that a lot of it has, which is clearly true. But even here there may be less to the potential inflationary impact than meets the eye. In his speech at the London School of Economics earlier today, Chairman Bernanke explained:

"Some observers have expressed the concern that, by expanding its balance sheet, the Federal Reserve is effectively printing money, an action that will ultimately be inflationary. The Fed's lending activities have indeed resulted in a large increase in the excess reserves held by banks. Bank reserves, together with currency, make up the narrowest definition of money, the monetary base; as you would expect, this measure of money has risen significantly as the Fed's balance sheet has expanded. However, banks are choosing to leave the great bulk of their excess reserves idle, in most cases on deposit with the Fed. Consequently, the rates of growth of broader monetary aggregates, such as M1 and M2, have been much lower than that of the monetary base."

Last week Greg Mankiw had a nifty graph (courtesy of Professor Bill Seyfried of Rollins College) of the so-called money multiplier precisely illustrating the point:

The money multiplier measures the amount of money in the hands of the public—the M1 measure in this case, which is composed mainly of cash and demand deposits (i.e., checking and debit accounts)—that are created by a dollar of monetary base. That amount fell considerably when the Fed introduced the payment of interest on bank reserves.

That said, despite the fall in the money multiplier, the M1 measure of money has also expanded fairly noticeably since late summer:

The increase in M2—a slightly broader measure of money that adds to M1 items like savings accounts and time deposits—has been somewhat slower but still on the rise:

From December 2007 through August of last year, M1 and M2 grew by about 1.2 percent and 3.9 percent respectively. Since September—after which the rapid expansion of the Fed's balance sheet began and the Fed began to pay interest on reserves—the corresponding growth rates have been 13.4 percent and 5.9 percent.

Are those growth rates substantial? That is a tricky question—whether a particular growth rate of money is substantial or not can only be determined in relation to the pace of money demand (which has almost certainly accelerated as interest rates have fallen and the taste for safe and liquid assets risen). But I take two lessons from our early experience with the asset-oriented policies emphasized in the Bernanke and Lockhart speeches. First, expansions of the balance sheet need not imply expansions of the money supply. Furthermore, as Chairman Bernanke emphasized, the Fed has the capacity to contract reserves going forward:

"… the Treasury could resume its recent practice of issuing supplementary financing bills and placing the funds with the Federal Reserve; the issuance of these bills effectively drains reserves from the banking system, improving monetary control. Longer-term assets can be financed through repurchase agreements and other methods, which also drain reserves from the system."

The second lesson, clear in the M1 and M2 charts above, is that despite the payment of interest on reserves and near-zero federal funds rates, it is still possible to induce increases in the broad money supply through the standard channel of injecting reserves into the banking system.

Whatever direction you think the money supply ought to go, these observations should come as comforting news.

How to get China spending: It's Hard.

WSJ's article today (see below) echoes my earlier post on the difficulty to get Chinese consumers spending, especially during global recession.  In short, changing consumer's behavior in the short term is inherently difficult, if not impossible.  It can't be done overnight --- just consider the unaffordable healthcare cost in China and its lack of social security system in the rural area.

China's Need for Self-Reliance

China needs its consumers to spend. Actually getting that to happen, though, is another story.

The country's long export and investment-led boom has stalled. Fourth-quarter growth in gross domestic product slid to 6.8% on-year, well below habitual double-digit levels.

Beijing's response, so far, has been on beefing up the government's role as consumer, notably through a nearly $600 billion fiscal stimulus plan. Part of its aim is to create jobs to replace those lost in the country's factories.

But that alone won't incentivize Chinese consumers to spend more, and offset a decline in spending on China's exports by recession struck Americans and Europeans.

With Chinese households holding a collective $3.3 trillion in savings, but debt of only $835 billion, China has the opposite problem to the U.S. -- an excess of savings instead of too much debt. Household consumption as a percentage of GDP remains well below that in developed countries and many of China's Asian neighbors.

China's statistics bureau chief Thursday suggested households are starting to eat into those savings to support consumption. But other signs suggest otherwise.

Retail sales growth rates have slipped for six consecutive months now. That figure -- unadjusted for inflation -- isn't widely trusted, but slowing sales of cars and air travel, as well as anecdotal evidence of empty shopping malls, also suggest the trend is downward.

Near-term, consumer confidence is being hit by fear of job losses and pay cuts. The possibility of deflation soon could harm spending also.

Longer term, China's citizens have good reason to hang on to their spare cash, given the lack of an adequate welfare and pension system.

Belatedly, Beijing is responding. A recent cut in the car sales tax, and a three-year plan to spend $124 billion on revamping health care are steps in the right direction. Rural dwellers are being given financial help to buy more household appliances.

Interest rates offered on bank deposits are coming down as well, though this has had little effect in the past. Consumers continued to save diligently even with interest rates below inflation rates in 2007.

So, Beijing will have to do more. A cut in income taxes may not have much effect -- many Chinese are exempt already, while others find ways to dodge payments. Instead, China might benefit from following other Asian countries by offering shopping vouchers, particularly to urban residents.

Whatever the answer, the question is becoming more urgent, if China's growth is to get back on the 8%-plus track so important to its leaders.

The problems of bank nationalization

Bank nationalization may stop the bank run, but it poses two fundamental questions: 1) Is government efficient and competent than private sector to run the financial system? 2) If the government grabs more and more of the economy, how will it impact the economic dynamism (Ed. Phelps' words) and entrepreneur spirit that makes America so great?

Still I would prefer the bad-bank-good-bank rescue model, i.e., strip off all bad assets from bank's balance sheet, let them have a fresh start and get lending going; meanwhile, government sets up a special entity to safe-keep these bad assets --- with market confidence coming back in coming months, and when housing prices stop falling, the prices of these bad assets will come back. Remember a lot of these bad assets are long-term mortgage related securities and you don't want to fire sell those assets during market panic. Government may eventually make money out of this.

The bottom line is: government should stop acting in ad hoc fashion. What is needed is a comprehensive and swift plan to get banks, the vital part of the modern economy, back on track.

Nationalization's Many Problem- WSJ

Drastic solutions always appeal in times of crisis. Witness the growing number of calls for the government to nationalize banks.

Indeed, the recent bank-stock massacre was prompted in part by fears the Obama administration may nationalize part of the financial system.

Granted, nationalization -- the government seizing banks and restructuring them -- may be the best solution for certain lenders. But used for large parts of the banking system, nationalization carries its own problems.

First, there is cost. Governments typically take big losses when they seize banks. To unload assets quickly, they have to sell at fire-sale prices. That can create yet more mark-to-market losses at other banks.

Nationalization could be cheaper if it forced losses on the seized bank's creditors. But that is high-risk. And the U.S. has made it difficult by guaranteeing tranches of bank debt. Creditors were made whole in the Swedish bank nationalization -- often cited as a model for the U.S.

Then there is the problem of finding competent people to run seized institutions. With so many executives tarnished by the crisis, there isn't a long list of seasoned candidates ready to step into the financial storm.

Nationalization also can cause market distortions. The longer banks remain in government hands, the more likely they will be used to further government policies, such as keeping people in homes. That could make them harder to reprivatize.

Propping up a bank with more equity until the economy recovers looks cheaper, at least short term, and easier. Some might respond that such an approach hasn't cleared the instability hanging over markets and the economy. Take Citigroup. Its stock slump suggests the market believes it isn't viable -- even after two government capital injections and a generous loss-sharing agreement. Rather than leave Citi in limbo, why not assume active control and speed up repairs, pro-nationalization people ask.

Recent government actions, like the seizure of Washington Mutual, came after their stock prices flamed out. But policy makers shouldn't assume a stricken stock price means a bank can't make it. Banks can simultaneously have adequate capital and low stock prices, particularly given the government funding guarantees they enjoy. If that is the case, regulators should make it clear for healthy banks under pressure.

Of course, if banks lose large amounts of deposits or access to credit, they need to be seized. And they must still build up more conservative measures of capital like tangible common equity. If that requires a big check from the government, de-facto nationalization might be unavoidable.

But even though the idea of mass bank seizures has a strong emotional appeal -- punish those who got us into this mess -- it provides no easy solution.

Is U.K. solvent?

A short yet insightful analysis of UK's banking sector and the whole economy (source: WSJ):

Even in its darkest moments, the U.K. government can't have imagined a worse reception for its latest bailout package. Far from shoring up confidence in the banks, it has fueled doubts over the solvency of the entire U.K. economy. The collapse in bank shares has spread to sterling, down 5% this week amid talk of downgrades and defaults. Even so, the U.K. is a long way from turning into Iceland-on-Thames.

True, the economy is in a mess -- but that is true of almost every other country. The U.K. has particular drawbacks: a large current account deficit that relies on foreign investors for funding, high private sector debt, and an historic overreliance on finance sector jobs. And the pound is no longer a reserve currency so no one is obliged to own it.

But it also has advantages. Public sector debt is lower than in most developed countries and is forecast to hit around 60% of GDP over the next couple of years -- lower than many countries in the euro zone. Plus the U.K. has already received a substantial monetary and fiscal stimulus. And it still has its own currency, which is now down nearly 30% from its recent peak against a basket of other currencies -- providing another massive stimulus.

The case against sterling rests on the size of the U.K. banking sector, which has liabilities of more than three times GDP. But those liabilities are matched by assets - the bulk of them currently financeable via usual bank funding mechanisms, including deposits, the bond market and central bank repurchase operations. So it is misleading to suggest that bank nationalization would cause U.K. public debt to reach 350%.

What matters is not the future size of the U.K. public sector balance sheet but the scale of the likely losses it might have to absorb via the banking system. These are sure to be substantial, whether the government absorbs them as a result of a guarantee scheme, a bad bank or nationalization -- but not so large as to sink U.K. public finances.

Goldman Sachs reckons the three large U.K. banks -- Lloyds, Barclays and Royal Bank of Scotland -- have between them GBP350 billion of toxic assets, which includes all their commercial property exposure, all leveraged loans and around 10% of unsecured commercial loans. This is the amount it reckons the government would need to remove to feel comfortable the banks could absorb remaining losses from operating profits.

But that wouldn't mean the U.K. was on the hook for GBP350 billion. Assuming a 20% loss rate on secured debts and a 70% loss on unsecured, Goldman estimates losses -- spread over several years -- could hit GBP120 billion, a portion of which would be taken by the banks under the terms of the insurance scheme. But even if the government took all the losses, they amount to just 8% of GDP, leaving U.K. public debt still below the forecast 73% for the euro zone in 2011 and too low to trigger a downgrade.

That doesn't mean the U.K. is safe. Like any highly leveraged entity, it is vulnerable to a loss of confidence. And with net overseas liabilities equivalent to 25% of GDP, there is a limit to how far sterling can fall before a downgrade does become a possibility. But with an AAA rating only recently reaffirmed by S&P and a currency that already looks cheap on a purchasing power parity basis, it's hard to imagine things getting that bad. After all, other currency areas have their problems too.

Unemployment: when to bottom?

Following my previous post on unemployment trend in recessions, here is another comparison (see graph below) across all recent recessions. The question is whether the unemployment rate in this recession will follow the same pattern as seen in the recent two recessions (1991 and 2001), i.e., it takes longer than normal to recover, or "jobless recovery" as termed by Paul Krugman.




(click to enlarge, source: NYT)

China's urban unemployment may reach 30-year high

Reports Bloomberg:

China's official urban unemployment rate jumped for the first time since 2003 and may climb to an almost 30-year high as exports slump and a slowdown deepens in the world's third-biggest economy.

A rate as high as the government's 4.6 percent target for this year, which was announced ... today, would be the worst since 1980, official data show. Premier Wen Jiabao said yesterday that the government must do more to preserve social stability in the face of a "very grim" job outlook.

(graph courtesy of EconomicDATA)


I have to say the title is a little bit misleading because as you can see from the graph the urban unemployment has been trending higher since early 80s due to structural reform of State-Owned-Enterprises (SOEs). The global financial crisis will certainly increase jobless rate relating to export sectors, but don't scare yourself and blame all to this global recession.

Becker on infrastructure spending

Gary Becker raises several sharp questions on using infrastructure to stimulate the economy. Chief among them are: 1) the biggest job loss happened in financial, housing, and manufacturing sectors, however the proposed infrastructure plan concentrates on roads, energy and healthcare, etc. There seems to be a mismatching of skills. Is Obama's plan expecting all financial engineers to become real engineers overnight? 2) the severity of the recession requires a speedy stimulus plan. However, any hasty plans by government will make the stimulus plan less effective --- do we just throw money to fill the holes and can government cherry-pick the right projects?

Infrastructure in a Stimulus Package

Last week we blogged on how much stimulus to GDP and employment might be expected from a version of the Obama fiscal stimulus plan. I concluded that the amount of stimulus from the spending package would be far less than estimated in a study by the incoming Chairperson of the Council of Economic Advisers ("The Job Impact of the American Recovery and Reinvestment Plan", by Christina Romer and Jared Bernstein, January 9, 2009). The activities stimulated by the package to a large extent would draw labor and capital away from other productive activities. In addition, the government programs were unlikely to be as well planned as the displaced private uses of these resources.

The stimulus package's plans for spending on "infrastructure" clearly illustrate both concerns. I put this word in quotation marks because of the many definitions of what is included in the concept of infrastructure. Promoters of various stimulus packages- such as the just released House Committee on Appropriations $825 billion stimulus plan- include in infrastructure not only the traditional categories of roads, highways, harbors, and airports. They also include spending on broadband, school buildings, computers for school children, modern technologies, research and development, converter boxes for the transition to digital TV, phone service to rural areas, sewage treatment plants, computerized medical records and other health expenditures, and many other activities as well.

Some of this infrastructure spending may be very worthwhile-I return to this issue a bit later- but however merited, it is difficult to believe that they would provide much of a stimulus to the economy. Expansion of the health sector, for example, will add jobs to this sector, but it will do this mainly by drawing people into the health care sector who are presently employed in jobs outside this sector. This is because unemployment rates among health care workers are quite low, and most of the unemployed who had worked in construction, finance, or manufacturing are unlikely to qualify as health care workers without considerable additional training. This same conclusion applies to spending on expanding broadband, to make the energy used greener, to encourage new technologies and more research, and to improve teaching.

An analysis by Forbes publications of where most jobs will be created singles out engineering, accounting, nursing, and information technology, along with construction managers, computer-aided drafting specialists, and project managers. Unemployment rates among most of these specialists are not high. The rebuilding of "crumbling roads, bridges, and schools" highlighted by in various speeches by President Obama is likely to make greater use of unemployed workers in the construction sector. However, such spending will be a small fraction of the total stimulus package, and it is not easy for workers who helped build residential housing to shift to building highways.

A second crucial issue relates not to the amount of new output and employment created by the stimulus, but to the efficiency of the government spending. Efficiency is not likely to be high partly because of the fundamental conflict between the goal of stimulating employment and output in order to reduce the severity of the recession, and the goal of concentrating infrastructure spending on projects that add a lot of value to the economy. Stimulating the economy when employment is falling requires rapid spending of this huge stimulus package, but it is impossible for either the private or public sectors to spend effectively a large amount in a short time period since good spending takes a lot of planning time.

Putting new infrastructure spending in depressed areas like Detroit might have a big stimulating effect since infrastructure building projects in these areas can utilize some of the considerable unemployed resources there. However, many of these areas are also declining because they have been producing goods and services that are not in great demand, and will not be in demand in the future. Therefore, the overall value added by improving their roads and other infrastructure is likely to be a lot less than if the new infrastructure were located in growing areas that might have relatively little unemployment, but do have great demand for more roads, schools, and other types of long-term infrastructure.

Of course, at some point new taxes in some form have to be collected to pay for infrastructure and other stimulus spending. The sizable adverse effects on incentives of these taxes also have to be weighted against any value produced by the infrastructure (and other) stimulus spending.

The likelihood that such a rapid and large public spending program will be of low efficiency is compounded by political realities. Groups that have lots of political clout with Congress will get a disproportionate amount of the spending with only limited regard for the merits of the spending they advocate compared to alternative ways to spend the stimulus. The politically influential will also redefine various projects so that they can fall under the "infrastructure" rubric. A report called Ready to Go by the U.S. Conference of Mayors lists $73 billion worth of projects that they claim could be begun quickly. These projects include senior citizen centers, recreation facilities, and much other expenditure that are really private consumption items, many of dubious value, that the mayors call infrastructure spending.

Recessions would be a good time to increase infrastructure spending only if these projects can mainly utilize unemployed resources. This does not seem to be the case in most of the so-called infrastructure spending proposed under various stimulus plans.

Ferguson: The Ascent of Money

A highly recommended video program from PBS: Professor Niall Ferguson at Harvard talks about "the ascent of money". And he asks some fundamental questions about the modern banking system we are living in.

Obama's inaugural address 01/20/2009

Obama's historical Presidential inaugural address:

John Bogle on economic outlook

John Bogle, founder of Vanguard on economic outlook. Pay attention to his view on the equity investing for the next decade. He also proposes two taxes: 1) tax on securities transactions in order to discourage speculations, which I think it's a bad idea; and 2) tax on fuel, which I think is a good idea, but the timing may not be great during recession.



(source: CNBC)

John Taylor interview

John Taylor is an economist at Stanford University and he is also the author of the famous "Taylor Rule" in monetary policy.

What Obama can do with the banks?

In a few days, U.S. banks will have a new boss in Barack Obama. What will he demand from his sick subjects? That is a huge talking point among bank-stock investors.

After an incoherent start, the Treasury of Henry Paulson launched multiple bank rescues that settled into something of a pattern. Recipients of government aid issued preference shares with an affordable dividend, and the really sick, like Citigroup and Bank of America, passed a portion of future losses to the taxpayer.

But this approach didn't solve the problem: BofA shares are down 81% in a year, despite two government interventions. Meanwhile, Standard & Poor's said Friday that without government support Citi's credit rating would be four notches lower.

Mr. Obama needs to try something new.

Surprisingly, the incoming administration is discussing plans that resemble Mr. Paulson's ideas. The new team is mulling wider use of loss-sharing agreements and buying toxic assets from banks.

For investors, much depends on the terms attached to assistance granted by the new administration. If they are tough, the stocks could get hit. And they may have to be tough to avoid a public outcry. The Obama team is well aware that throwing taxpayer money at the banks is unpopular with the public.

Just as important is the scale of bad asset purchases and loss guarantees. If they are too small, the banking sector doesn't get cleaned up quickly. But if they are too big, the public purse gets strained and popular opposition intensifies.

Looking at the weakness of balance sheets, there is a good chance that credit losses will pile up and banks' capital needs would overwhelm what the new administration can, or wants, to spend.

An alternative strategy would be to nationalize the sickest and restructure their balance sheets by giving a haircut to the banks' creditors. The advantage: It quickly removes problem banks from the market, and takes restructuring out of the hands of unreliable executives. The downside: It prompts panic in the debt markets, hurting healthy banks.

A variation for the government would be seizing banks and restructuring their balance sheets without hurting creditors, before trying to recapitalize them with private money. Granted, that also would be expensive for the taxpayer, given embedded balance-sheet losses, but it might provide a lasting solution for certain banks.

Whatever path the new administration takes, it is likely to demand concessions from the industry on how it pays its staff and how it lends.

For instance, Friday, the Federal Deposit Insurance Corp. proposed extending the bank-debt guarantee to 10 years from three years, as long as the debt is used to fund consumer loans.

If the administration goes too far down this interventionist road, while keeping banks publicly traded, they could start resembling the old government-sponsored entities, like Fannie Mae and Freddie Mac. Investors may remember how that all ended.

(source: wsj)

World Trade is Collapsing

World into the recession: with rich countries dramatically cutting back their consumption and imports, the exports in Asian countries were brought down to its knees. And the credit crunch further exacerbated the problem by making the letter of credit, which is vital to international transactions, harder to get than ever. Now the shippers are offering ZERO shipping rate trying to get their idled ships put into use.





(source: telegraph)

Shipping rates hit zero as trade sinks

Freight rates for containers shipped from Asia to Europe have fallen to zero for the first time since records began, underscoring the dramatic collapse in trade since the world economy buckled in October.

"They have already hit zero," said Charles de Trenck, a broker at Transport Trackers in Hong Kong. "We have seen trade activity fall off a cliff. Asia-Europe is an unmit­igated disaster."

Shipping journal Lloyd's List said brokers in Singapore are now waiving fees for containers travelling from South China, charging only for the minimal "bunker" costs. Container fees from North Asia have dropped $200, taking them below operating cost.

Industry sources said they have never seen rates fall so low. "This is a whole new ball game," said one trader.

The Baltic Dry Index (BDI) which measures freight rates for bulk commodities such as iron ore and grains crashed several months ago, falling 96pc. The BDI – though a useful early-warning index – is highly volatile and exaggerates apparent ups and downs in trade. However, the latest phase of the shipping crisis is different. It has spread to core trade of finished industrial goods, the lifeblood of the world economy.

Trade data from Asia's export tigers has been disastrous over recent weeks, reflecting the collapse in US, UK and European markets.

Korea's exports fell 30pc in January compared to a year earlier. Exports have slumped 42pc in Taiwan and 27pc in Japan, according to the most recent monthly data. Even China has now started to see an outright contraction in shipments, led by steel, electronics and textiles.

A report by ING yesterday said shipping activity at US ports has suddenly dived. Outbound traffic from Long Beach and Los Angeles, America's two top ports, has fallen by 18pc year-on-year, a far more serious decline than anything seen in recent recessions.

"This is no regular cycle slowdown, but a complete collapse in foreign demand," said Lindsay Coburn, ING's trade consultant.

Idle ships are now stretched in rows outside Singapore's harbour, creating an eerie silhouette like a vast naval fleet at anchor. Shipping experts note the number of vessels moving around seem unusually high in the water, indicating low cargoes.

It became difficult for the shippers to obtain routine letters of credit at the height of financial crisis over the autumn, causing goods to pile up at ports even though there was a willing buyer at the other end. Analysts say this problem has been resolved, but the shipping industry has since been swamped by the global trade contraction.

The World Bank caused shockwaves with a warning last month that global trade may decline this year for the first time since the Second World War. This appears increasingly certain with each new batch of data.

Mr de Trenck predicts Asian trade to the US will fall 7pc this year. To Europe he estimates a drop of 9pc – possibly 12pc. Trade flows grow 8pc in an average year.

He said it was "illogical" for shippers to offer zero rates, but they do whatever they can to survive in a highly cyclical market.

Offering slots for free is akin to an airline giving away spare seats for nothing in the hope of making something from meals and fees.

Market failed to cheer up in 2009 so far

With financial sector continuing to slide:



(courtesy of Bespoke Investments)

Bernanke Q&A session

Bernanke answers questions at London School of Economics:

China's Trade Continues to Plunge

China's exports in December fell 2.8% from a year earlier to $111.16 billion, while its imports fell 21.3% to $72.18 billion, the General Administration of Customs said Tuesday.

Those falls were bigger than in November, when exports fell 2.2% from a year earlier and imports slumped 17.9%.

The drop in December's exports was better than market expectations of a 3.8% decline, but the fall in imports was above expectations of a 19.1% drop, according to the median forecasts of 12 economists surveyed by Dow Jones Newswires.

...

(graph courtesy of BOFIT)

Though the trade surplus in December remained near historically wide levels and was above the $34 billion expected by economists, the fact it was due more to falling imports than strong exports underscored the troubling nature of the data.

The drop in imports is an indicator of further weakness in exports in coming months, because some of the imports are components and raw materials used to make finished products that are then sold to consumers abroad, said Sherman Chan, an economist at Moody's Economy.com.

(source: wsj)

Death of "decoupling"

So long, the "decoupling" theme; the old tale still holds --- "when the US sneezes, everybody catches the cold".

(courtesy of Big Picture)

A country-by-country case:





(courtesy of Infectious Greed)

Bush's record in historical perspective

Bush's 8 years was characterized by slow job growth. Paul Krugman likes to call it "jobless recovery" from 2001 recession and 9/11.

In terms of GDP growth, Bush years were the worst after WWII.

In the area of disposable personal income growth, Bush's record was not that bad: It's better than Truman and his father and at par with Eisenhower.

Krugman: stop talking about "Jump-start"

Paul Krugman thinks jump-start is the wrong word to use when talking about the recovery plan. Instead, policy should be focused on improving employment in longer term because this is going to be a long recession.

read Paul's analysis here at NYT.

The future of American banking

What the Smith Barney/Morgan Stanley joint venture implies on the future of American banking (esp. investment banking) industry:




A very good discussion.

Ponzi and Madoff

Madoff will go down in history as one the biggest scammers.  Maybe we should rename Ponzi Scheme to Madoff Scheme.  Now listen to this interview with Ponzi scheme expert, Zuckoff and his insight on the remarkable similarities between the two.

A little history of Martin Feldstein and his NBER

Six Degrees of Martin Feldstein

by Justin Lahart at WSJ

Martin Feldstein might never win the Nobel for economics, but he may be the most influential economist of his generation.

A Republican who advised Ronald Reagan, the Harvard economist has close ties to many of the economists who have been tapped to work in the Obama administration. Then again, any administration would end up picking economists with close ties to Mr. Feldstein.

As a sophomore, Lawrence Summers, who will head the National Economic Council, was a research assistant for Mr. Feldstein. Mr. Feldstein was later Mr. Summer's dissertation adviser. Douglas Elmendorf, another of Mr. Feldstein's students, is the new head of the Congressional Budget Office. So was, Jeffrey Liebman, a Harvard economist and Obama campaign adviser.

Austan Goolsbee, the Chicago economist who will serve as chief economist on President's Economic Recovery Advisory Board, wasn't taught by Mr. Feldstein, but by James Poterba, the MIT economist who took over from Mr. Feldstein as head of the National Bureau of Economic Research last year.

Mr. Poterba, a Republican who was a member of President Bush's tax advisory panel, was one of Mr. Feldstein's students.

So were Lawrence Lindsey, who directed the National Economic Council from 2001 to 2002, and Glenn Hubbard, who was chairman of the president's Council of Economic Advisors from 2001 to 2003. Harvard's Greg Mankiw, who chaired the CEA from 2003 to 2005 was on the team of young economists that Mr. Feldstein took with him to Washington when he held the job from 1982 to 1984. (Mr. Summers was in that group, too, as was Princeton economist and tireless Bush critic Paul Krugman.)

But Mr. Feldstein's most influential role was as the long-time head of the National Bureau of Economic Research, which he built over three decades into the nation's most important research network for academic economists. Being named an NBER researcher — there are now over 1000 of them — is seen as an important step in an economist's career, and NBER grants and fellowships have helped sustain many top economists as they were starting out. Mr. Feldstein also formalized the NBER's role as the arbiter of business cycles by creating the Business Cycle Dating Committee in 1978.

One of the most important contributions Mr. Feldstein made was in how economics research is disseminated. He started the practice of mailing out collections of yellow-bound booklets of working papers by NBER researchers (known as "yellow-jackets").

"I just wanted to make sure that the research that was being done was being more widely disseminated," Mr. Feldstein says.

As a result, economic research has become available much more quickly to a much wider audience than it was when it only appeared long after the fact in often obscure journals. When the Internet took hold, Mr. Feldstein was quick to begin posting working papers to the NBER's website. One of the reasons that academic economists have been so quick in their analysis of the economic crisis is that the ties they established through the NBER and the Centre for Economic Policy Research (a European research network set up in imitation of the NBER) allowed them to work with far-flung colleagues. And the tradition of providing research online that Mr. Feldstein pioneered allowed them to broadcast their ideas.

The popularity of economics in recent years also owes something to Mr. Feldstein. Under his leadership, the NBER focused on empirical work that is often far more accessible to the general public than the more theoretical areas that some economists work on. And the availability of research on the NBER's website meant that reporters had easier access to it. They were quick to pick up the sexiest papers, of course — the stuff written by Chicago economist Steve Levitt, of Freakonomics fame.

Mr. Levitt, by the way, was a student of Mr. Poterba. Who studied under Mr. Feldstein.

Read a collection of writing by Martin Feldstein.

Oil Bubble: How we got there

Now with oil bubble deflated, 60 Minutes yesterday had a nice review of how we got there.  The conclusion is that it was largely driven by speculations and deregulation.  

Like any other bubbles, this oil bubble had a nice attractive story/theme: demand from China and India. But what eventually drove oil price to $147 peak was not supply-demand equation, but human's greed.  Investment banks and deregulation just facilitated it. 

When comes to digesting this oil boom and bust, I find it always useful to read Jim Hamilton's paper on understanding oil prices, and of course, you can always review my earlier posts on this topic here and here.

C.Romer explains recovery package

Christina Romer, Chairman of the incoming Council of Economic Advisers, further explains how she came up with the job estimate I posted yesterday.

I feel one good thing about this incoming administration is they try to communicate with the public and get their message out. This is vital in restoring consumer and market confidence.

China's economic challenge

A good discussion about the economic challenge China is facing. (This is a 35 mins radio show with Tom Ashbrook, host of On Point).

Time to rethink China's banking development strategies

With the 3-year lockup period expiring, Western banks are selling their stakes in Chinese banks to fill the hole on their own balance sheet. Chinese banks are rethinking their development strategies (source: WSJ):

Decisions by Bank of America Corp. and other institutions to sell down their stakes in Chinese banks signal more trouble for Beijing's strategy of using foreign expertise to build a world-class banking system.



Since 2005, foreign financial institutions have pumped more than $25 billion into Chinese banks as part of a grand bargain engineered by Chinese regulators. Foreign investors would gain access to China's banking market and in return teach Chinese banks how to operate profitably.

But the momentum for cooperation has been slowing. Now foreign banks, desperate to replenish balance sheets weakened by the global financial crisis, are starting to cash out.

On Wednesday, Bank of America trimmed its holdings in China Construction Bank Corp. to 16.6% from more than 19%, selling 5.6 billion Hong Kong-listed shares in a placement that raised $2.8 billion. In November, Bank of America paid $7 billion to almost double its stake in the Chinese bank.

Meanwhile, a foundation established by Hong Kong's wealthiest tycoon, Li Ka-shing, is selling two billion shares in Bank of China Ltd. to raise as much as $524 million for the charitable group, according to a term sheet. A spokesman for the Li Ka Shing Foundation noted that the foundation still holds three billion shares in Bank of China, which "are part of our long-term holding and won't be sold for a long time."

Last week, UBS AG sold its entire 1.3% stake in Bank of China Ltd. for $808 million.

Banking analysts believe that other foreign banks are planning to unload stakes, though they say that such sales don't necessarily point to problems in the relationship with Chinese partners. Bank of America and China Construction Bank have had one of the better relationships, analysts said.

Since taking its initial stake in 2005, the Charlotte, N.C., bank has assigned about 60 employees to work with China Construction Bank on an array of projects, from revamping its technology systems to updating branches to improving communications strategies, according to Bank of America spokesman Robert Stickler.

"We definitely will continue to be a long-term major shareholder of CCB and a long-term strategic partner," Mr. Stickler said. "The fact that we sold a few shares doesn't change that."

Last month, Bank of America called off a similar sale, prompting speculation that it held back for political reasons. But Mr. Stickler said that wasn't the case then, or now. "We have a very close relationship with CCB management and the Chinese government," he said. "Nothing we were doing was a surprise to them."

Investments by foreign banks with global reputations eased the way for Chinese banks to successfully list their shares overseas in 2005 and 2006. But three-year lockup periods, during which foreign investors weren't allowed to sell their shares, are expiring.

The scramble to exit highlights the difficulties of Chinese-foreign banking partnerships that have suffered from mismatched expectations. Holger Michaelis, a partner at Boston Consulting Group in Beijing, said a major letdown has been technical assistance, such as with risk-control systems.

Chinese bankers are often frustrated by foreign advisers who have rich international knowledge and experience but can't solve local problems because they don't understand local conditions. That is altering Chinese bankers' expectations that foreign advisers can offer immediate solutions, Mr. Michaelis said.

Some foreigners have bristled at their limited influence over bank operations and inability to gain ownership control. For years, foreign strategic investors have been anticipating a lifting of the 20% cap on foreign stakes in Chinese banks, but that hasn't happened.

And there has been rivalry. In 2007, Bank of China announced an "exclusive partnership" with Royal Bank of Scotland Group PLC's private-banking arm, only to start its own proprietary wealth-management business later.

Unlike many of their Western peers, Chinese banks have had relatively little exposure to subprime-mortgage-related assets or agency debt, issued by entities such as Fannie Mae and Freddie Mac. That puts them in a better position to weather the global financial crisis, despite the slowing Chinese economy.

Zhao Xijun, the deputy director of the School of Finance at Renmin University of China, doesn't believe the foreign sales represent a wholesale retreat. "Undoubtedly, foreign banks will continue to expand their footprints in China," he said. "But they will be more focused on developing their own business rather than buying into a Chinese lender."

Until five years ago, Chinese lenders were considered technically insolvent. After a cleanup that cost the government an estimated $500 billion, foreign strategic investors took the plunge. Three of China's four largest commercial banks -- ICBC, Bank of China and China Construction Bank -- have since gone public overseas.

At the time, the thinking was that foreigners would help improve Chinese management standards, transfer technology and know-how, and co-build new fee-earning businesses such as credit cards and wealth management. One of the most urgent aims was to fix a weak link in the local banking system: risk governance.

Still, banking analysts said, Chinese regulators are debating what benefits can be gained from Western financial institutions rocked by the financial crisis. "Definitely, there is a rethinking among [Chinese] banks, insurance companies and asset-management companies as to what is the best model for the long term," said Kang Yan, a partner at Roland Berger Strategy Consultants in Beijing.

Paulson's Farewell

Mankiw: Still suspicious about government spending, rightly so.

Source: NYT

WHEN the Obama administration finally unveils its proposal to get the economy on the road to recovery, the centerpiece is likely to be a huge increase in government spending. But there are ample reasons to doubt whether this is what the economy needs.

Arguably, the seeds of the spending proposal can be found in the classic textbook by Paul A. Samuelson, "Economics." First published in 1948, the book and others like it dominated college courses in introductory economics for the next half-century. It is a fair bet that much of the Obama team started learning how the economy works through Mr. Samuelson's eyes. Most notably, Lawrence H. Summers, the new head of the National Economic Council, is Mr. Samuelson's nephew.

Written in the shadow of the Great Depression and World War II, Mr. Samuelson's text brought the insights of John Maynard Keynes to the masses. A main focus was how to avoid, or at least mitigate, the recurring slumps in economic activity.

"When, and if, the next great depression comes along," Mr. Samuelson wrote on the first page of the first edition, "any one of us may be completely unemployed — without income or prospects." He added, "It is not too much to say that the widespread creation of dictatorships and the resulting World War II stemmed in no small measure from the world's failure to meet this basic economic problem adequately."

Economic downturns, Mr. Keynes and Mr. Samuelson taught us, occur when the aggregate demand for goods and services is insufficient. The solution, they said, was for the government to provide demand when the private sector would not. Recent calls for increased infrastructure spending fit well with this textbook theory.

But there is much to economics beyond what is taught in Econ 101. In several ways, these Keynesian prescriptions make avoiding depressions seem too easy. When debating increased spending to stimulate the economy, here are a few of the hard questions Congress should consider:

HOW MUCH BANG FOR EACH BUCK? Economics textbooks, including Mr. Samuelson's and my own more recent contribution, teach that each dollar of government spending can increase the nation's gross domestic product by more than a dollar. When higher government spending increases G.D.P., consumers respond to the extra income they earn by spending more themselves. Higher consumer spending expands aggregate demand further, raising the G.D.P. yet again. And so on. This positive feedback loop is called the multiplier effect.

In practice, however, the multiplier for government spending is not very large. The best evidence comes from a recent study by Valerie A. Ramey, an economist at the University of California, San Diego. Based on the United States' historical record, Professor Ramey estimates that each dollar of government spending increases the G.D.P. by only 1.4 dollars. So, by doing the math, we find that when the G.D.P. expands, less than a third of the increase takes the form of private consumption and investment. Most is for what the government has ordered, which raises the next question.

WILL THE EXTRA SPENDING BE ON THINGS WE NEED? If you hire your neighbor for $100 to dig a hole in your backyard and then fill it up, and he hires you to do the same in his yard, the government statisticians report that things are improving. The economy has created two jobs, and the G.D.P. rises by $200. But it is unlikely that, having wasted all that time digging and filling, either of you is better off.

People don't usually spend their money buying things they don't want or need, so for private transactions, this kind of inefficient spending is not much of a problem. But the same cannot always be said of the government. If the stimulus package takes the form of bridges to nowhere, a result could be economic expansion as measured by standard statistics but little increase in economic well-being.

The way to avoid this problem is a rigorous cost-benefit analysis of each government project. Such analysis is hard to do quickly, however, especially when vast sums are at stake. But if it is not done quickly, the economic downturn may be over before the stimulus arrives.

HOW WILL IT ALL END? Over the last century, the largest increase in the size of the government occurred during the Great Depression and World War II. Even after these crises were over, they left a legacy of higher spending and taxes. To this day, we have yet to come to grips with how to pay for all that the government created during that era — a problem that will become acute as more baby boomers retire and start collecting the benefits promised.

Rahm Emanuel, the incoming White House chief of staff, has said, "You don't ever want to let a crisis go to waste: it's an opportunity to do important things that you would otherwise avoid."

What he has in mind is not entirely clear. One possibility is that he wants to use a temporary crisis as a pretense for engineering a permanent increase in the size and scope of the government. Believers in limited government have reason to be wary.

MIGHT TAX CUTS BE MORE POTENT? Textbook Keynesian theory says that tax cuts are less potent than spending increases for stimulating an economy. When the government spends a dollar, the dollar is spent. When the government gives a household a dollar back in taxes, the dollar might be saved, which does not add to aggregate demand.

The evidence, however, is hard to square with the theory. A recent study by Christina D. Romer and David H. Romer, then economists at the University of California, Berkeley, finds that a dollar of tax cuts raises the G.D.P. by about $3. According to the Romers, the multiplier for tax cuts is more than twice what Professor Ramey finds for spending increases.

Why this is so remains a puzzle. One can easily conjecture about what the textbook theory leaves out, but it will take more research to sort things out. And whether these results based on historical data apply to our current extraordinary circumstances is open to debate.

Christina Romer, incidentally, has been chosen as the chairwoman of the Council of Economic Advisers in the new administration. Perhaps this fact helps explain why, according to recent reports, tax cuts will be a larger piece of the Obama recovery plan than was previously expected.

•

All these questions should give Congress pause as it considers whether to increase spending to stimulate the economy. But don't expect such qualms to stop the juggernaut. The prevailing orthodoxy among the nation's elite holds that increased government spending is the right medicine for what ails the economy.

Mr. Samuelson once said, "I don't care who writes a nation's laws or crafts its advanced treaties, if I can write its economics textbooks."

The coming stimulus bill, warts and all, will demonstrate brilliantly what he had in mind.

N. Gregory Mankiw is a professor of economics at Harvard. He was an adviser to President Bush.

Consumer deleveraging has only just begun

Courtesy of Mike Panzner:

Yesterday, the Federal Reserve reported that outstanding consumer credit for November fell a worse-than-expected $7.9 billion, lending support to the notion that the consumer is deleveraging.

However, based on the accompanying graph of year-over-year changes in consumer credit and mortgage debt relative to GDP, it seems like deleveraging has hardly begun.

Digest Obama's Recovery Package

How the recovery package will change employment outlook?



Where the jobs will be created?




Read more about the plan here.

Why developed countries aren't saving?

No doubt, we are in the process of correcting the global imbalances, but don't forget to ask the fundamental question, "Why developed countries aren't saving? Why do developing countries tend to save too much?"

Let's first look at the chart below:




The chart shows that with the exception of Canada, the savings rates in almost all developed countries have declined over time and remain well below 10%. In contrast, China's saving rate is around 40%.


My 2 seconds in thinking about this question:

1. Savings rate is tied to country's development level, especially in two aspects:
1) level of financial system development -- i.e., whether consumers have relatively easy access to credit;
2) welfare system --- i.e., whether a country has the basic social security and healthcare system, and whether her citizens feel safe NOT to save for precautionary purpose.

2. Saving is habitual in nature, and its level tends to persist and can't be adjusted overnight.

What are the implications? --- It's naive to expect Chinese to jump start their consumption soon, not in five years, at least; for the same token, it's premature to predict that Americans will increase their savings rate dramatically. It'll be nowhere near, say 10% level. American consumers will certainly spend less because credit is harder to come by these days, but I don't expect a dramatic jump in savings rate. Saving is the last thing government wants you to do anyway ("Paradox of Thrift", anyone? )

Charlie Rose: A conversation with Stiglitz and Feldstein

Charlie Rose talks to the two leading economists from both sides on government's stimulus plan: Joe Stiglitz (the 'liberal'), and Marty Feldstein (the 'conservative').

Stiglitz proposes a homeowner Chapter 11.

Unemployment rate reaches 7.2%

Economists' reactions to today's job report and the outlook:

Obama outlines his economic plan

Years ago, my political science professor noted to me that Democratic Presidents often deliver better speeches than Republican Presidents. This one is no exception. Looks like at least we are going to have faster broadband and more "green" jobs.

Longest recession since 1933

With no end in sight, the current recession may well be the longest recession since 1933.

(source: wsj)

Feldstein AEA interview

I did not post in the last several days as I was away for the annual AEA meeting in San Francisco. And I am also looking for jobs. Here is the excerpt of the interview with Martin Feldstein, former head of NBER, during the meeting.

Government direct intervention in equity market?

Roger Farmer thinks it is an effective way to restore market confidence by buying index such as S&P 500 (source: FT):

The US recession that began in December 2007 resulted in 403,000 lost jobs in September, 320,000 in October and 533,000 jobs in November. Projections for 2009 are ominous.

The global financial system is undergoing a meltdown that has not been seen since the 1930s and nobody seems to know what to do about it. How did we get to this point and how can we move forward?

Since world war two, economic policy in most western democracies has been based on Keynesian economics.

But although policy makers still rely on Keynes' ideas, academics gave up on his theories 40 years ago and went back to classical economics: Keynesian theory could not explain how unemployment and inflation can coincide. The result has been 40 years of disconnect in which policy makers are tinkering with the engine without a manual.

The US stock market has lost 40 per cent in the past three months and this is a good performance by the standards of many global markets.

In classical economics, the prices of stocks are determined by fundamentals and the fundamentals of the economy are sound. The US had the same stock of factories and machines in August that it had in July and the US workforce has not been afflicted by a sudden attack of contagious laziness. Although Keynes didn't manage to work out all of the details of his theory he was right on one point: In the real world; psychology matters for the behaviour of markets!

When households believe that assets are not worth much, they spend less; unemployment increases and the belief becomes self-fulfilling. This is why households and firms are not spending today; they are forecasting further falls in asset prices and there is a real danger that these gloomy forecasts may turn out to be correct.

We have seen economies stagnate for a decade or more in the past – the UK in the 1920s, the US in the 1930s and Japan in the 1990s – and it would be presumptuous to think that this cannot happen again when the existing dominant paradigm says that it could not happen in the first place.

Classical economists argue that falling wages will restore equilibrium; but this is based on the belief that the labour market works like an auction in which employment is determined by demand and supply.

It ignores the very real frictions involved in searching for a job by both households and firms that can lead to many possible equilibrium employment levels just as Keynes argued in the General Theory.

For much of the post-war period, the US Federal Reserve has been relatively successful at combating recessions by lowering the interest rate to stimulate aggregate demand. The policy was unavailable in the 1930s because the interest rate on treasury securities was already near zero, just as it is today. It is this fact that makes the current crisis more like the Great Depression than any other of the post-war recessions.

So where do we go from here? The only actor large enough to restore confidence in the US market is the US government. The current policy of quantitative easing by the Fed is a move in the right direction but it does not, as yet, go nearly far enough.

It is time for a greatly increased role for monetary policy through direct intervention of central banks in world stock markets to prevent bubbles and crashes. Central banks control interest rates by buying and selling securities on the open market.

A logical extension of this idea is to pick an indexed basket of securities: one candidate in the US might be the S&P 500, and to control its price by buying and selling blocks of shares on the open market.

Even the credible announcement that a policy of this kind was being considered should be enough to boost the markets and restore consumer and investor confidence in the real economy.

Critics will argue that this policy is dangerous socialist meddling. But I am not arguing that the government should pick winners and losers: only that it should stabilise a broad basket of stocks.

This policy would still allow poorly run firms to fail but it would not allow all firms to fail at the same time. Although the free market is very good at deciding how many left and right shoes to produce, it cannot prevent systemic risk that arises from the psychology of herd behaviour. This is a job for Uncle Sam.

Prof Roger E. A. Farmer is vice chair for graduate studies in the department of economics at the University of California Los Angeles and the author of two forthcoming books on economics: Expectations, Employment and Prices and How the Economy Works and How to Fix it When it Doesn't

2008 Performance

(courtesy of Bespoke Investments)



(Courtesy of NYT)




(Courtesy: Chart of the Day)