The euro remains under the cross currents of deflation driven further by the austerity measures that make it stronger.

And portfolio shifting out of euro mainly into dollars and gold out of fears of disintegration and restructuring that are making it weaker.

The latter is currently the stronger force as evidenced by the falling euro and rising price of gold, especially when priced in euro.

It may even be a case of allowing ‘insiders’ to get out and leave the public institutions like banks holding the bag at the point of restructuring at the expense of the remaining shareholders.

The deflation forces are evident in the falling commodity prices, declining equity values, and declining term structures of rates outside of the euro zone, where the politics of fiscal austerity also seem to be getting the upper hand as the world goes the way of Japan.

And each passing day provides more evidence that ultra low overnight rates from central banks are in fact deflationary, probably through the income and cost channels, which allows governments to have a much lower level of taxation for a given level of government spending (higher deficits) to sustain optimal levels of output and employment.

Unfortunately they firmly believe the opposite and continue with their deflationary, overly tight fiscal policies.

And talk coming out of China about ‘monetary easing’ tells me they see reason to be very concerned about their growth as well.

So it looks like the two external threats to the US economy, the euro zone and China, are indeed happening as feared.

Last, on a reread and after discussion, the new Fed swap lines look to be both unsecured and containing rollover language that reads as the foreign central banks being able to roll over their loans in perpetuity meaning they are not loans but one way fiscal transfers from the US to foreign central banks, as repayment is strictly voluntary.

EU Daily

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Trichet Says ECB Plans Time Deposits to Sterilize Buys
ECB Will Give ‘Sterilization’ Details Next Week
Quaden Says Market Reaction to Greece Was Excessive
German Cities’ Deficits to Hit Record in 2010, Rundschau Says
ECB Pares Spanish, Italian Bond Purchases, AFME Says
Constancio Says ECB Will Give Details on Sterilization Soon
Spain’s Core Inflation Turns Negative for First Time

12 Responses

  1. RE: Deflation and Austerity

    Warren, I understand your position vis-a-vis operational realities and how, in your view, we could avoid this deflationary race-to-the-bottom. My argument is that “YOUR” ideas, within the framework of what is considered that status-quo, are frighteningly radical. In your view, the public would need to trust that governments could employ monetary policies [sic] that would HELP them over the long haul.

    HOWEVER…trust in government in general is all but gone, the rich are getting richer and the poor poorer (and government policy is as much to blame for these realities as is the greed of men), and the deflationary power of austerity measures—while precipitating riots in the streets of the nations of the world—is generally accepted by folks who believe that profligacy and lying and moral hazard andf fraud got us into this mess in the first place. When it is called ‘belt-tightening’, ‘fiscal discipline’, etc., there are few arguments against such policies that hold any considerable perceptible validity.

    One more note on DEFLATION. The collapse of credit, which is in its infancy but which is a huge factor in this ongoing crisis, is the MOST deflationary force the world has seen in a century. AND…the era of easy-credit is all but gone.

    1. “the rich are getting richer and the poor poorer (and government policy is as much to blame for these realities as is the greed of men)”

      You know, some day I would really like to see somebody back up an assertion like that with solid evidence. The inflation-adjusted wage data looks like it has been stagnant for the lower middle class, but I think that can be explained by the increasing value of health care benefits.

      And as Thomas Sowell has pointed out, the bottom 40% of the income distribution is not a static group of people. Throughout their lives, people move into and out of various income brackets. Even extremely wealthy businessmen can end up in the bottom income bracket in any given year.

      For the most part, the financial crisis has been a great equalizer in terms of wealth and income. The rich have become a lot less rich, and the various automatic stabilizers have sustained the poor. On top of that, the real estate bubble transferred an enormous amount of wealth from financial institution shareholders to homeowners lucky enough to sell or refinance between 2005-2007. And many people in foreclosure are getting to stay in their homes for years rent-free.

      I disagree with you that the era of easy credit is over. It will come roaring back within a year or two. These things run in cycles because memories are short. It would certainly help if the government didn’t raise taxes next year, but the deficits strike me as high enough to sustain a recovery.

      1. According to David Levy, in his March report.

        Profits are probably rising again in the first quarter and are up sharply from a year ago, but the rate of growth is slowing significantly. The government deficit, inventory investment, and
        equipment spending remain the major sources of profits growth. As the year progresses, business investment strength will likely fade while weaknesses in the economy—notably rising personal saving and falling private construction—will persist, and the profits rise will likely stall or reverse.

        He says the only thing keeping this show on the road is the government deficits, and they won’t be sustained because of politics. And the recovery will fade in the 3rd and 4th quarters.

      2. @ ESM,

        I am willing to stipulate that my statement about the ‘poor getting poorer’ is more rhetorical than demonstrable. Good point. however…

        Poverty as such is complicated. It not ONLY refers to such issues as relative purchasing power, cost inflation, etc., but it also references issue pursuant to changes in perceptions vis-a-vis standards of living and economic self-determination.

        40 million people on food stamps means 15-20 million adults who ‘feel’ (and are) poor. Chronic under-employment (18%) means millions of formerly middle class people who now perceive of themselves (and many who are) as part of the “new poor”. A feeling of hopelessness in the face of staggering wealth (in the financial industry) accrued through the employment of fraud and theft (with a tip of the hat from Capitol Hill—can you say Gramm-Leach-Bliley?). ETC.

        This is the new economic colonialism, and the middle class are both feeling and becoming poorer because of it.


      3. “but I think that can be explained by the increasing value of health care benefits.”

        The *costs* of health care have indeed risen. The *costs* of autos, housing, and college tuition have also risen. Lots of indisputable data about this.

        But arguing that the *value* has increased is double-speak. Value does not enter into questions of distribution, by definition.

        There is a pot of X goods. Before you, got .5X, now you get .2X. Arguing that the current “X” is larger than the previous X is irrelevant to the question of distribution. And the claim here is about distribution.

        The reason why distribution is important is that someone, at the end of the day, must also spend X in order to buy those goods. And when wages stagnate, then the goods will only be bought if the middle class borrows to buy them. The wealthy are not going to consume them. So you get into an unstable economic situation, in which rapidly rising debt growth is a pre-requisite to maintaining full employment and full output. This is purely a financial/distributional problem, not a “value” problem.

      4. RSJ,

        My point was that health care insurance represents a significant and growing percentage of worker compensation. Yet it is not reflected in the wage data that many people cite as proof that the lower middle class has stagnated in inflation-adjusted income over the last 10 years, or even 30 years. As a society we are spending a growing percentage of GDP on health care. There are lots of perverse reasons for this (one of them ironically being the fact that so many people get health insurance through their employer), but certainly there are rational reasons as well, and so my use of the term “value” is justified.

        Workers do value the health care benefits provided by their jobs immensely. I’ve seen unions threaten strikes over proposals to increase copays by as little as $5. Workers love being able to see a doctor for less than it costs to get a haircut, and to get an MRI for less than it costs to find out why their car is making a grinding noise. It is a big part of compensation, and yet it is left out of the discussion. To me that is due to either ignorance or deceit.

        As for your point about distribution, I think your financial analysis is too simplistic. Suppose a small subset of the population (say 1%) makes a tremendous leap in productivity (which I think it has with the advent of the internet). As a consequence, productive capacity in areas such as telecommunications has quadrupled, and the wealth created from that production accrues to the top 1%. I think you’re claiming that it’s a problem if the other 99% of the people are making exactly the same income as they were before because they can’t afford to purchase the new goods and services without borrowing. You’re missing two things: 1) the price of the new goods and services will come down to the point where the masses can buy them through substitution; and 2) perhaps the new goods and services make the masses more productive so that they net save money and can support any debt incurred to make the purchases.

        This is not just a theoretical point. I believe it happens all the time with the introduction of new technology. Following the introduction, there is tremendous price deflation and a rise in productivity among the adopters of the technology. Some, perhaps most, of this rise in productivity does not show up in increased income. It could show up in reduced consumption of other (perhaps obsoleted) goods and services, or in an increased standard of living that is not reflected in GDP statistics.

      5. ESM,

        health care insurance […] is not reflected in the wage data that many people cite

        So what? Even accounting for total compensation, there has been a huge growth in wage inequality.

        I think your financial analysis is too simplistic. Suppose a small subset of the population (say 1%) makes a tremendous leap in productivity (which I think it has with the advent of the internet).

        OK, I’m with you. And I agree that often 1% makes all the difference in invention and innovation. Unfortunately, the free market does not work to compensate the 1% unless the 99% have income to buy the goods. That means that the money you make is dependent on the salaries of others, even if you think they don’t contribute as much as you do. In that case, you have only two options: the first is to accept convince them to borrow to pay you, and now you hold claims on them (which will go bust when the borrowing stops), or to accept a lower income in the first place, even you are convinced that you are absolutely brilliant.

        That is the difference between a fairy-tale partial equilibrium analysis and the cold hard fact that for every seller there must be a buyer, regardless of how brilliant or important the seller is.

        1) the price of the new goods and services will come down to the point where the masses can buy them through substitution;

        Alas, we don’t live in that world. We live in the monopolistic competition world, in which there is a downward sloping demand curve. We don’t live in the perfect competition/perfect substitution world in which there is a horizontal demand curve. This is where you must abandon the morality tales and look at data about prices and elasticities.

        Every time someone borrows to buy a good, they are increasing the price above and beyond the sustainable price. When the household sector in aggregate borrows more and more, then prices increase above and beyond the ability of wages to support those prices. Discussions about very talented people deserving to be wealthy don’t change these basic mathematical constraints about what is sustainable and what is not.

  2. the collapse of credit is a good thing in that it means for the same size govt. we can have even lower taxes and shift to spending income rather than via expanding debt, at least while it lasts.

  3. Interesting article from M. Pettis:’s-stop-and-go-measures/

    According to one report, after surging in early April, property prices in Beijing dropped a shocking 31% in the past month. I don’t know whether this is believable – I am always nervous about taking any of these numbers too seriously given the amount of manipulation that occurs – but clearly there is nervousness in the Beijing market:

    The average transaction price of commercial residential properties in Beijing for the week ended May 9 fell 1,790 yuan per square meter or 9.6 percent week-on-week to 16,898 yuan per square meter, reports The Beijing News, citing statistics released by Beijing Real Estate Information Network.

    Compared with the week ended April 11, the average transaction price of commercial residential properties in Beijing plunged 31.43 percent to 7,744 yuan per square meter. In the last weeks of April, the transaction volume of commercial residential properties in Beijing decreased by 10.34 percent, 11.39 percent and 30.82 percent respectively. Average transaction price was flat at between 22,000 yuan to 23,000 yuan per square meter.

  4. ESM, benefit is not wage or compensation. Or you have to show me how you can buy food or new ipad with your health care insurance.

    100% of GDP is income of people. And so what?

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