Terrific pair of charts from Ron Griess The excesses in the prior cycle (2001-2006) have made the current run utterly abysmal:
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Click for larger graphs
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All charts courtesy of The Chart Store
Last year, we took a Closer Look at the Second Leg Down in Housing.
Today, the S&P Case Shiller NSA 20 checked in at 139.27; the previous post-bubble low is 139.26.
Here’s the release:
“Data through February 2011, released today by S&P Indices for its S&P/Case-Shiller1 Home Price Indices, the leading measure of U.S. home prices, show prices for the 10- and 20-city composites are lower than a year ago but still slightly above their April 2009 bottom. The 10-City Composite fell 2.6% and the 20-City Composite was down 3.3% from February 2010 levels. Washington D.C. was the only market to post a year-over-year gain with an annual growth rate of +2.7%. Ten of the 11 cities that made new lows in January 2011 saw new lows again in February 2011. With an index level of 139.27, the 20-City Composite is virtually back to its April 2009 trough value (139.26); the 10-City Composite is 1.5% above its low.”
Case Shiller charts:
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click for larger graphs
The Feb S&P/Case-Shiller home price index is back at the low of the cycle reached in Apr ’09 which is the lowest since 2003. It’s down 3.33% y/o/y, about in line with expectations and of the 20 cities surveyed, 19 saw priced declines with the capital of central planning, Washington, DC seeing the only rise, that of 2.7% y/o/y. Phoenix again led the fall and homes there are now the cheapest since 2000. Bottom line, housing prices have double dipped and the only question is whether it breaks to new lows, which is likely and has further implications for bank balance sheets which do not reflect that assumption.
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Source:
Gas Prices Up Because of LEGAL Speculation; Not Manipulation, Consumer Advocate Says
Stacy Curtin
Daily Ticker – April 25, 2011
http://finance.yahoo.com/blogs/daily-ticker/gas-prices-because-legal-speculation-not-manipulation-consumer-174837231.html
Insane:
Hat tip kottke
MACRO TIDES
MacroTides.newsletter@gmail.com
Investment letter – April 21, 2011
THE GAME INSIDE THE GAME
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Macro Factors and their impact on Monetary Policy, the Economy, and Financial Markets
The Federal Reserve is between a rock and a marshmallow. Inflation is climbing and hitting consumers in their pocketbooks every day, which has led to a significant jump in 1 year inflation expectations since the beginning of 2011. They haven’t reached the levels of 2008, but we’re not sure that’s much consolation. Energy and food inflation is the worst kind of inflation. It is unresponsive to monetary policy, since the Fed can’t increase the supply of food or oil. It also depletes disposable income, so consumers have less money to spend on everything else. In an environment of weak overall demand, this is not good. The Federal Reserve has said, and is expected, to end the second round of quantitative easing (QE2) on June 30. However, the Fed must contend with a number of facts. The economic recovery to date has been weak, and the jury is still out on whether it has achieved a self sustaining level of growth. We don’t think it has. The Fed is also aware (we hope) that the economy faces a number of headwinds that are likely to slow growth in the second half of 2011 and early 2012, as discussed in this letter.
Complicating matters further, the political debate in Washington, on how and how much to cut the federal budget deficit, is just starting. It appears to us that we have entered the “It’s a battle of words, and most of them are lies” stage of the ‘debate’. However, deficit reduction will influence monetary policy. The more front loaded the deficit reduction is, the more likely the Fed will feel compelled to offset the fiscal drag from deficit reduction, by maintaining a greater measure of monetary accommodation. It is unlikely Congress will have arrived at a deficit reduction plan by June 30, so the Fed will be left hanging. For all these reasons, we think there is a small chance the Fed will go for QE2 Lite. Rather than going cold turkey, the Fed may opt for a scaled down version in which they only purchase $30 to $40 billion of Treasury bonds each month. This would allow the Fed to wean the financial markets and economy of some of the stimulus, and buy a bit more time, as they watch the debate unfold in Washington. It would also offset some fo the drag on growth that are coming in the second half of 2011, and spare the Fed the ridicule it would endure if it stopped QE2, and then launched QE3 at a later date. Whatever ‘plays’ the Fed calls, they better be good.
The Federal Reserve lowered the Federal funds rate to 0% to .25% in December 2008. The Fed initiated the first round of quantitative easing in March 2009, since they had obviously run out of room to stimulate the economy further through lower interest rates. The first round of quantitative easing ran through March 31, 2010. Had QE1 and the enormous fiscal stimulus implemented by Congress generated an average post World War II recovery, there would have been no need for a second round of quantitative easing. With the weak recovery faltering last summer, and Ireland threatening a sovereign debt crisis in Europe, the majority of the Federal Reserve members issued an insurance policy on the recovery.
Fed Chairman Bernanke has said that QE1 and QE2 effectively lowered interest rates by the equivalent of .75%. However, the onset and continuation of QE2 has spurred debate and some dissension within the Federal Reserve, since it was announced last August and implemented in November. The Fed’s second round of quantitative easing included purchasing $600 billion of Treasury bonds by June 30, 2011 “to promote a stronger pace of economic recovery and to help ensure that inflation, overtime, is at levels consistent with its mandate.” The Fed has been concerned since 2008 that inflation was too far under its inflation target of 2%, elevating the risk of deflation. Somewhat ironically, the dissenters within the Fed have been more concerned that QE2, and the further expansion of the Fed’s balance sheet, would push inflation above the Fed’s 2% target. A number of regional Fed presidents – Charles Plosser of Philadelphia and Richard Fisher of Dallas – have lobbied to end QE2 early and not spend the full $600 billion. On March 31, Narayana Kocherlakota, president of the Minneapolis Fed said he expected core inflation to rise to 1.3% by year end, up from .8% at the end of 2010. Citing the Taylor Rule, Kocherlakota said the Fed would have to raise the Federal funds rate by more than the increase in core inflation, or by .75%. Both Plosser and Fisher have also suggested they would favor raising rates in the near future.
A number of other regional Fed presidents are more sanguine about inflation and are still concerned about the fragility of the recovery. Janet Yellen, from San Francisco and Sandra Pianalto, from the Cleveland Fed continue to believe the excess slack in the labor market will keep wage increases in check, while the surge from commodity inflation will prove temporary. Theoretically, all 12 Federal Reserve regional presidents are equal. However, William Dudley, president of the New York Fed, is first among equals. It is noteworthy that after the Labor Department announced a 216,000 increase in jobs for March, Dudley said the U.S. is still “very far away” from where policy makers want to be. This view is also shared by Federal Reserve Chairman Ben Bernanke, and is why the Fed is committed to completing its $600 billion of Treasury bond purchases through June 30.
We think the majority of Fed regional presidents and permanent members of the Federal Open Market Committee want to wait as long as possible to assess the sustainability of the recovery. As we have noted, ending QE2 amounts to a tightening of monetary policy, even if the Fed continues to hold the Fed funds rate at 0% to .25%. As we have noted in recent months, the end of QE2 is not the only headwind challenging the sustainability of the recovery.
The fiscal health of a majority of state and local governments is not good. After receiving roughly $150 billion in aid from the Federal government over the last two years, states will receive less than $20 billion to plug funding gaps in their 2012 budgets. Despite the aid from the Federal government, state and local governments have cut more than 250,000 jobs during the past twelve months. Since their employment peaks in the summer of 2008, states have cut 82,000 jobs, while local governments have eliminated 416,000 positions. In contrast, the Federal government has added 99,000 jobs since December 2007. It’s fair to say that state politicians have exhausted every penny of their rainy day funds and utilized every accounting gimmick possible in the last two years. According to the Nelsen Rockefeller Institute, states increased taxes by $12.3 billion last year, while sales tax revenue rose 1.9%. Income tax revenue was up 10.9%, primarily due to the rally in the stock market and modest gains in jobs and income. Local tax revenue fell in the fourth quarter of 2010 and the first quarter as real estate taxes declined. The $150 billion in aid received from the Federal governments allowed states to postpone the deeper and more severe cuts that will now be included in their 2012 budgets, which start on July 1. In coming months, job cuts by state and local governments will increase from the 20,000 monthly average of the last year. Real estate taxes will be increased by local governments to offset a portion of the 30% decline in home values since 2006. However, real estate tax revenue will likely fall for at least the next two years, as property assessments catch up to reality. Since real estate taxes fund a large portion of local government revenues, this ongoing squeeze will mean fewer teachers, police officers, and fire personnel. Services for the elderly, poor, and children will also be reduced or eliminated. Needless to say, these cutbacks are going to result in a backlash from those bearing the tax increases and the loss of assistance.
A further deterioration in the debt of Greece, Ireland and Portugal where yields are spiking again to record highs is being met with a yawn by European stock markets, most banks and the euro. The reason seems to be that markets for a while have known what the end result of this situation is, particularly for Greece and that’s a workout of its debt. Now the pressure is intensifying and a German gov’t official said it honestly that Greece “should restructure sooner than later.” Greece’s budget deficit for 2010 was reported higher than initially expected by eurostat today. The euro is up after Trichet reiterated his sole focus on containing the second round effects of higher commodity prices. Asia though traded soft overnight with the Shanghai index down for a 3rd day and the Nikkei fell after S&P put its automakers and suppliers on credit watch negative for the obvious reasons.
Over the years, we’ve occasionally pointed out the absurdities of former NAR economist David Lereah. Our ire at the “Baghdad Bob” of Real Estate multiplied after he left the NAR, when he essentially admitted to being an ethicless huckster during his time there.
You might imagine we would want nothing whatsoever to do with Lereah, including his published books. You likely assume they would be all spin, no truth, less dignity. And you would be right. However, here at TBP, we are big believers in the “Teachable moment.”
The evolution of Lereah’s books show how he adapted over time to the changing housing market, a/k/a utter collapse. We learn that the content of his books are essentially the same — the first two books literally identical — only his publisher slapped on different covers. Thus, like the latest Real Estate porn, shows like A&E’s Sell This House!, we learn all about “staging” — the idea that a few superficial changes can hide even the worst money pit of a house. (Update: A reader suggests that the third book is a lightly edited version of the first two).
Thus, consider how these three books have been staged with different covers:
-Are You Missing the Real Estate Boom? (2005)
-Why The Boom Will Not Bust and How You Can Profit From It (2006)
-All Real Estate is Local (2007)
Lereah, on behalf of his employer, Realtors.org, just wanted to teach people more than how to lose money in residential real estate; he wanted to show how to lose money across different phases of the boom and bust cycle:
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Lereah’s advice for losing money was not limited to Real Estate. In 2000, he published (I am not making this up) The Rules for Growing Rich: Making Money in the New Information Economy. Fantastic timing on all accounts.
(Update: A reader informs us of Lereah’s new venture, posted here)
Over time, the public came to understood that Lereah was totally full of bullshit. The most amusing way they expressed their frustration was by reviewing Lereah’s published books on Amazon. Be sure to note the dates and the number of people who found the review helpful. I also included a sincere 5 star review from 2005 that we can only assume was a case of wishful thinking.
Here are my favorites:
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Superb work of fiction, devastating psycho-drama of highest order, July 2, 2010
This review is from: Why the Real Estate Boom Will Not Bust – And How You Can Profit from It: How to Build Wealth in Today’s Expanding Real Estate Market (Paperback)
That is, the highest order of the knight of the round table, surrounded by the government of the rich for the rich, by the rich, manipulating the psychology of the population into spending their last bits of their spending in a sinkhole plumbed to their bank accounts.
The English is passable, a bit corny, but that appeals to the masses.
It is also a book of historical importance (not import, but importance, mind you). It draws in first hand account the situation of the mid knots as the powerful orchestrate another cycle with an attendant bubble that will such up the population’s wealth and compress it into tiny golden derivatives that will end up at Goldman’s door.
Buy as many copies and give them to your children as a historical and political lesson. They go and shop till you drop, and buy a house or two on your way to and from the mall so that you can retire on the amazing proceeds it will generate for your great, great, great, grandchildren. You should also spend a lot of money insulating and putting solar panels to be used for cooling, as by the time the need to sell these wonderful, going no-where fast, vehicles, global warming will be toasting everyone’s round cheeks, the exposed ones, and even the ones covered.
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Better than Charmin, June 1, 2010
By Shrinky Dink
Amazon Verified Purchase(What’s this?)
This review is from: Why the Real Estate Boom Will Not Bust – And How You Can Profit from It: How to Build Wealth in Today’s Expanding Real Estate Market (Paperback)
I found the pages much softer than Charmin, though not as soft as Quilted Northern.
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An extraordinary, and extraordinarily important, book, February 25, 2009
This review is from: Why the Real Estate Boom Will Not Bust – And How You Can Profit from It: How to Build Wealth in Today’s Expanding Real Estate Market (Paperback)
I agree with other reviewers who have pointed out that this is, in fact, an extraordinarily important book. In particular, it provides a classic example of the mentality that underlies every asset bubble. The author pulls out every trick in the book – demographic trends, financial innovation, macro trends, etc. – to argue that “this time is different.” Alas, as we all have found out, this time was not different. What goes up for no discernible reason, must come down. If something seems to good to be true, it probably is. You can try to argue that the “fundamentals have changed”, but they rarely do. And when things correct, it can be bloody. (Alas, the difference here was that the hucksters were also able to take the down the financial system, but that’s another matter.)
But why this book is important, and why I’d suggest that every investor read it, is because it illustrates exactly the sentiments that lead to absurd behavior in asset markets. Silly assumptions. The belief that the price of some asset will continue to rise. Desperate rationalizations for those price increases. The resulting behavior is not necessarily illegal or unethical (as some other reviewers have suggested), rather it provides a classic case of the mentality that leads to excesses in asset markets. Read this book and learn from it. Because you don’t want to get caught up in this kind of garbage.
BTW, I pity the author. Not simply because so many people attack him as an idiot or a shill for the realtors, but because his timing was so appalling. Shiller, who became famous for calling the peak of the dotcom bubble, often thanks his publisher for getting his book out at the right time. This guy’s publisher was way way off. (Of course, it also helps if you’re not, in fact, an idiot. Sorry David.)
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HA HA HA HA HA, January 10, 2009
By Surely This
This review is from: Why the Real Estate Boom Will Not Bust – And How You Can Profit from It: How to Build Wealth in Today’s Expanding Real Estate Market (Paperback)
HA HA HA HA HA HA HA HA HA HA
HA HA HA HA HA HA HA HA HA HA
HA HA HA HA HA HA HA HA HA HA
*gasps for air*
HA HA HA HA HA HA HA HA HA HA
HA HA HA HA HA HA HA HA HA HA
HA HA HA HA HA HA HA HA HA HA
ha ha ha ha
ha ha hee hee hee
heh heh
*wipes tears from eyes*
Seriously though, does Amazon.com sell tar and feathers? I know they’ve got pitchforks.
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Funniest Book Ever Read, April 10, 2008
This review is from: Why the Real Estate Boom Will Not Bust – And How You Can Profit from It: How to Build Wealth in Today’s Expanding Real Estate Market (Paperback)
Lereah is a master of comedy. Often while reading Mr. Lereah’s tome i became overcome with laughter, sometimes experiencing convulsions. The convulsions were so severe that i would need to rest for shortness of breath. Thanks for your service Mr. Lereah, you’ve made a significant contribution. This books identifies you as one of the few who were ahead of the curve on the mortgage and credit issues we now confront. Also, I miss your hilarious monthly commentary on new & existing home sales–somehow you were always able to find a silver lining. Proud of you!
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116 of 120 people found the following review helpful:
Customers who bought this item also bought…, August 3, 2006
This review is from: Are You Missing the Real Estate Boom?: The Boom Will Not Bust and Why Property Values Will Continue to Climb Through the End of the Decade – And How to Profit From Them (Hardcover)
Your Yugo Will Run Forever and How to Set the Land-Speed Record With It.
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186 of 196 people found the following review helpful:
“He whose bread I eat is the song I sing”, April 28, 2005
By Robert M. Campbell “Author of ‘Timing the Real Estate Market”
This review is from: Are You Missing the Real Estate Boom?: The Boom Will Not Bust and Why Property Values Will Continue to Climb Through the End of the Decade – And How to Profit From Them (Hardcover)
Go back in time to the year 2000 when the NASDAQ was trading at 5,000. Some people said it was a bubble and couldn’t go on forever. Yet the temptation to go with the flow and make was seemed to be easy money was irresistible. Driven by the marketing efforts of those who make their living in the stock market, it was argued that prices would still go higher. If you bought into their line of reasoning, surely NASDAQ 10,000 was not too far away.
I was reminded of those times when I read David Lereah’s book “Are You Missing the Real Estate Boom.” Even after the biggest 5-year run-up in housing prices in U.S. history – where 40% of all homebuyers must now resort to interest-only adjustable rate mortgages in order to qualify for home financing – Lereah tries to convince us that the U.S. real estate market should continue to stay healthy for the next 10 years.
His arguement goes something like this: Even though housing prices are high, the combination of low interest rates, 80 million wealthy baby boomers and their offspring (“echo boomers”) will continue to fuel demand. This is not objective, unbiased advice. As head cheerleader for the Realtor hallelujah choir, Lereah is using the same tactics that have been well-honed on Wall Street: “When the ducks are quackin’, feed ‘em.”
I don’t remember what Lereah was saying about U.S. housing prices in 1998 or 1999 when prices were 30% lower than they are today (and 75% lower in many of the highly populated coastal regions), but I think its safe to say he wasn’t forecasting a coming real estate boom that would last for the next 15 years.
The key to making money in real estate – and keeping it – is to get aboard a rising real estate trend early, not late. While it is true that real estate is a good long-term investment, what Lereah ignores is the cycle nature of real estate. In other words, if you buy an overvalued house late in the market cycle – and you are over leveraged and illiquid like most Americans are today – you may not be around for the long-term.
Robert Campbell
Author of “Timing the Real Estate Market”
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366 of 375 people found the following review helpful:
Better title – “Join the Greater Fools of America Club”, April 19, 2005
By NewYorkBuck
This review is from: Are You Missing the Real Estate Boom?: The Boom Will Not Bust and Why Property Values Will Continue to Climb Through the End of the Decade – And How to Profit From Them (Hardcover)
For me, this was more comic relief than any scholarly analysis. The author has a vested interest in the bubble not bursting, and he’s selling his soul with this book to prove it.
He spins webs of demographics and interest rates, but he never ever addresses the core issues that determine housing values. What is lost here is that housing in itself creates no value, its value is completely predicated upon peoples ability to pay for it. Ergo, housing prices for the last 100 years have tracked income remarkably closely, that is, except for the last five years. Historically, the ratio of housing price to annual income has been 2.1, with very little variation. In many parts of the country, this ratio is now approaching 10.5! Can you say “major correction?” Further, the amount of leverage used to buy homes during this boom has been increased to absolutely unprecidented levels. Even during the last boom of the late 80s/early 90s, the standard was still 30 yr fixed and 20% down. Not anymore. Last year, less than 15% of borrowers put down 20% or more! Further, the 30 yr fixed has been replaced by the IO, or interest only loan. See now, we have the same borrower capable of bidding 30-40% more for a propery without any better credit or ability to repay. Neat trick, but sadly, Lereah at no point addresses any of these fundamentals.
Our stock/housing pattern appears remarkably similar to the one Japan had 20 years ago. First the stock market busted. Right after, the real estate market rallied, and it busted too. The current Japanese real estate market is in a 14 year slide to date, and houses are going for roughly their 1980 value.
Keep talking Dave – we’ll need the comic relief soon!
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3 of 78 people found the following review helpful:
A breath of fresh air!, July 22, 2005
This review is from: Are You Missing the Real Estate Boom?: The Boom Will Not Bust and Why Property Values Will Continue to Climb Through the End of the Decade – And How to Profit From Them (Hardcover)
Unlike many of today’s naysayers, this book takes a shot at analyzing the current RE market and it’s future trend by assessing facts. It’s simple for others to write articles claiming a “bubble about to burst” based on an unprecedented “run up”, but this Author backs his assessment with real facts, that quite frankly, set my mind at ease and even may have even motivated me to invest in some more property! Thank you for your efforts Mr. Lereah!! This was money well spent!!!!
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Previously:
Are You Missing the Real Estate Boom? 2.0 (October 30, 2006)
Latest Lereah Book (January 4 2008)
Former NAR Economist David Lereah is a Jackass (January 6 2008)
What’s a Central Bank to Do?
April 25, 2011
Bob Eisenbeis
www.cumber.com
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Faced with largely the same set of facts when it comes to their inflation outlook, some of the world’s major central banks have come to markedly different conclusions about the appropriate policy.
The ECB began to exit from its accommodative policy by increasing its policy rate by 25 basis points to 1.25% on April 7. The ECB noted that growth was improving moderately, but inflation had increased to 2.6% and was up from 2.45% the previous month. The rise was largely due to increases in energy, food, and commodity prices. The concern was the potential second round effects and that these increases could become embedded in inflation expectations.
The same day, the Bank of England kept its policy rate at 0.5%, despite the fact that inflation had been running well above its target rate of 2% for more than a year and was likely to remain so through 2011. Again, the Committee noted that the near term path for inflation was higher due to energy, imported commodities and other goods. Concern was also expressed about inflation expectations having risen in the UK, the US and the euro area relative to what they had been before the financial crisis. Finally the UK real economy was softer than that of the EU generally with output having declined by 0.5% in the fourth quarter of 2010.
While the FOMC will meet this week, Chairman Bernanke and Vice-Chair Yellen have already signaled that they view the recent increases in commodity, energy and food prices as transitory. Governor Yellen in particular provided an extremely thorough and detailed dissection of the inflation data and her views on the real economy and employment in her April 11th speech in New York. She indicated clearly that the causes of the run-up in food, energy and commodity prices were rooted in increases in global demand, combined with energy supply shocks and uncertainty about oil flow from the Middle East. Like the Chairman, she expressed the view that the increases were transitory. Most notably she attempted to debunk the widely discussed view that accommodative policies in the US were the cause of the increase in global prices. She was very clear that the main concern was for the US expansion and employment situation, that the current stance of policy was appropriate, and that QE II would be completed as scheduled. So we don’t expect any notable news coming from this week’s FOMC meeting.
These three views on the appropriate stance of policy and how individual-country central banks may think about policy shows a growing disconnect between traditional approaches to monetary policy and globalization. For example, the US economy historically has been largely isolated from the rest of the world. International markets were not particularly significant (exports and imports were roughly balanced and accounted for less than 13% of GDP). Inflation was largely a domestic issue and could be directly affected by changes in US policy rates. From the 50s through 70s, the main channel for monetary policy was through housing: when interest rates exceeded the Reg Q ceilings that banks and thrifts could pay for funds, the supply of funding to housing was cut off. Then construction declined and the effects rippled through the rest of the economy. Most of the economic models have that structure and international isolation embedded within them. Yet this is not the world that policy makers are now dealing with, as the above descriptions of the causes of the current inflation aptly illustrate.
If the major causes of inflation are external to an economy, and policy makers have domestic tools and targets for inflation and local employment, either explicitly or implicitly, then how should they respond to externally generated causes of inflation? What is the link between the central bank’s domestic policy interest rate tool and the external causes of price increases? These key questions are not currently addressed within contemporary policy frameworks employed by the FOMC, the ECB, or the Bank of England, as best one can determine.
In the current inflation environment, one can justify any one of three alternatives, and some of these are clearly being adopted. Furthermore, all can be mostly right or mostly wrong. First, a policy maker could attempt, as the US did during the 1970s oil crisis, to insulate the real domestic economy from the contraction supply shock by keeping rates low. This policy seemed appropriate and was politically acceptable, especially since the price increases were viewed as temporary. But it clearly failed, and we paid the cost with higher inflation.
Second, if one believes that the energy, food and commodities price increases are transitory, then no response is called for; and this can justify focusing on domestic employment, as is currently being done in both the US and UK. Even if the increases are permanent, doing nothing may be the appropriate policy. Permanent increases in energy, commodity, and food prices will shift these prices relative to other goods and services and generate substitution and accommodative responses by business and consumers. We may, for example, drive less and adopt more hybrid transportation alternatives – moves that are already beginning to take place – than we would if the energy price increases were viewed as being temporary. But doing nothing also has its own risks. Maintaining an accommodative policy too long risk overheating an economy and fueling both an increase in domestically-produced goods and services prices and passing along the increased prices of external goods and energy prices as second round effects. As always, timing is everything when it comes to exiting from an accommodative policy.
Third, a central bank can move to increase its policy rate to choke off inflation, as the ECB has begun to do. But this policy has certain risks associated with it. If the causes of the inflation are external to the economy, then one would not expect those prices to be responsive to a policy move by a domestic central bank. But the increase in rates will clearly impact those domestic and non-international activities that are affected by rising interest rates. Economic activity in those areas will contract, including production, employment, and prices. So the impact of responding to an external inflation source is to force a decline in an aggregate price index by contracting domestic economic activity. This seems a risky path indeed. Right now it may appear less so because policy, as ECB President Trichet stated, is still viewed as being extremely accommodative.
So what is a central bank to do, especially when policy is overly accommodative? While Vice-Chair Yellen may argue that the increase in world prices is not our fault, it is undeniable that the world’s central banks collectively have flooded world financial markets with liquidity by printing money. This situation is likely to become even worse in the near term if Japan resorts to inflation as a means to finance the cleanup and rebuilding necessitated by the recent earthquake, tsunami, and nuclear disasters. When domestic economies are no longer insulated from international markets and forces, individual central banks can no longer go-it-alone with their policy decisions. In such a world, perhaps the best policy is to remove the distortions cause by current policies, and then attempt to avoid extremes. Unfortunately, how to get from here to there in a non-disruptive way is not at all obvious, as the ECB may soon find out.
What this means for investors is that market uncertainty is likely to remain high for some time to come, and attempting to play in international markets carries with it huge foreign-exchange and real risks that need to be hedged.
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Bob Eisenbeis is Cumberland’s Chief Monetary Economist. Prior to joining Cumberland Advisors he was the Executive Vice President and Director of Research at the Federal Reserve Bank of Atlanta. Bob is presently a member of the U.S. Shadow Financial Regulatory Committee and the Financial Economist Roundtable. His bio is found at www.cumber.com. He may be reached at Bob.Eisenbeis-at-cumber.com.
A Credible Solution to Europe’s Debt Crisis: A “Trichet Plan” for the Eurozone
Gary Evans* and Peter Allen*
April 25, 2011
Executive Summary
In April 1989, Mexico’s external debt negotiator, Angel Gurria, asked his country’s commercial bank creditors for a 55 percent haircut. This was the opening pitch of the newly created Brady Plan, which finally addressed both the debt overhang of developing countries and the weak balance sheets of their commercial bank creditors, ultimately resolving the LDC Debt Crisis.
More than twenty years later, Europe is in the midst of a similar sovereign debt and banking crisis. The EU is in a destabilizing feedback loop that it cannot control. Sovereign credit is deteriorating and this is reducing confidence in national banking systems, causing or increasing the likelihood that sovereigns will have to assume bank liabilities. This further impairs the sovereign credit and increases the lack of confidence in the banks.
We review the basic tenets of the Brady Plan in the context of our personal experience working on many of these sovereign restructurings and how they could apply in a comprehensive solution for the European debt crisis. The markets and the Eurozone desperately need a positive confidence shock in the form a comprehensive plan that simultaneously addresses the sovereign debt overhang and the balance sheets of European commercial banks.
Introduction
It will be twenty-two years ago this month when Mexico’s external debt negotiator, Angel Gurria, now Secretary-General of the OECD, fired the first pitch of the Brady Plan, named after the Treasury Secretary of new administration of President Bush #41. President Carlos Salinas of Mexico had taken office just four months earlier and stated his administration’s debt policy while campaigning: “If we don’t grow, we don’t pay.” He believed that only after addressing the debt overhang could Mexico return to stable economic growth.
The LDC debt crisis (Less Developed Counties) erupted seven years earlier in August 1982 when Mexico declared a 90-day moratorium on external debt payments. Tight monetary policy in the U.S. had driven up interest rates and, coupled with falling commodity prices, impaired the capacity of these countries to refinance their external debt. Most of the debt was medium term loans at floating rates of interest (three or six-LIBOR plus a spread) to commercial banks in France, Germany, Japan, Italy, Switzerland, the UK and the US.
Twenty or so sovereigns in the developing world lost access to new bank loans at this time. Some of them, like Mexico, had relatively low debt ratios when the crisis started, but had to assume large stocks of private debt, including interbank lines, that increased their debt to the neighborhood of 100 percent of GDP. After the Mexico shock, these sovereigns got new foreign loans in amounts equal only to their interest payments due and had to accept austerity policies that brought economic growth to a halt. This situation was unsustainable and was not resolved until they secured debt relief under the Brady Plan framework beginning in 1990. Soon after completing their Brady Plans, capital began flowing back to these countries in a big way.
Economic and Political Crisis
Similar to the current situation in the Eurozone, the LDC debt crisis was really two major problems, which, in its early stage created an unstable feedback loop. It was first an economic problem which morphed into a political crisis for many highly indebted sovereigns. Second, it was a banking crisis.
The collapse of external credit and investment spending was a “brutal turning point” for economic growth in the developing world. This complicated the countries’ fiscal imbalances, as large deficits became larger even with deep cuts in spending. Deficits had to be financed by central banks, causing a cycle of inflation, capital flight, exchange rate weakness and recession, in short, a “Lost Decade.”
Years of austerity sparked political unrest in some countries, such as Brazil, Argentina and Peru and some of these stopped external debt payments all together after 1984. Mexico continued to work with the international financial community to remain current on interest payments. The banks rewarded the government of Mexico for its effort by allowing it to be the first in line for debt reduction under the Brady Plan.
Commercial Banking Crisis
"Markets can remain irrational longer than you can remain solvent." —John Maynard Keynes
After 3 quarters in a row that averaged just 1.2%, Q4 GDP grew 2.8%, a touch below expectations of 3.0% BUT Nominal GDP grew well below forecasts. Because the price deflator was up just .4% vs the estimate of 1.9%, Nominal GDP was up 3.2% vs the estimate of 4.9%. Personal Consumption rose 2.0% vs the forecast of 2.4%. Fixed Investment rose 3.3% helped by a 5.2% increase in equipment and software spending and residential construction rose by 10.9%. Trade was a slight drag on GDP growth and government spending was as well led by a 12.5% decline on national...
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