2013-66 The new normal?

Paul Krugman in the NYT comments on the sad state of the economy. Here is a summary

1. Even before the recession, when there was a bubble in housing and consumers incurred large debts, the economy was not in great shape

2. The recession ended four years ago yet the economy is still weak (this also applies to the Canadian economy)

3. So perhaps we are into a prolonged period of slow growth (he calls it a mild depression).

4. This means that only the monetary policy can help

Why is this happening? Krugman proposes two answers
- slowing population growth
- trade deficits (the second does not apply to Canada, although in recent years we have had fairly large trade deficits)

here are a couple of quotes:

"Again, the evidence suggests that we have become an economy whose normal state is one of mild depression, whose brief episodes of prosperity occur only thanks to bubbles and unsustainable borrowing."

"Why does all of this matter? One answer is that central bankers need to stop talking about “exit strategies.” Easy money should, and probably will, be with us for a very long time. This, in turn, means we can forget all those scare stories about government debt, which run along the lines of “It may not be a problem now, but just wait until interest rates rise.”"

2013-65 Malfeasance part 1576

Now it is currency trading

Before it was LIBOR and numerous problems of US and European banks related to the financial crisis.

Biggest problems - of the biggest bank in the US, JP Morgan

$4.5 billion for mortgage claims settlement
$13 billion tentative agreement
and  $23 billion for legal costs and future fines

By the way, the $23 billion for legal problems is more than total market capitalization of 2/3 of S&P 500

2013-64 Sorry kids

1. we ate it all (just kidding)
2. we did eat it all

You can watch the first but
DO READ THE SECOND
To encourage you, here is an excerpt:

"With graph after graph, they show how government spending, investments, entitlements and poverty alleviation have overwhelmingly benefited the elderly since the 1960s and how the situation will only get worse as our over-65 population soars 100 percent between now and 2050, while the working population that will have to support them — ages 18 to 64 — will grow by 17 percent. "

(the data are from the US, but the numbers in Canada are similar).

2013-63 Huge economic crisis

Huge economic crisis? What can it be?

Canadians do not save for retirement so politicians talk about the need to expand CPP. Right now it provides less than a $1000 a month. The proposals are to more or less to double it.

What is going on? Well, the boomer generation is retiring. So, to put it bluntly, it would like, as it has been doing in the past, extract money from the current young generation (you).

The increase in benefits will be funded by increased  contributions. But CPP is not a fully funded plan. In a fully funded plan, what you get is your contributions plus earnings made on your contributions by investing them. The alternative is a pay-as-you-go plan, whereby current contributions pay current benefits. CPP is a mixture of the two plans.

Bottom line: if CPP is enhanced as proposed, people who will retire within the next 40 years will not have paid in full for the increased benefits. There benefits will be paid, in part, by people who will not retire within the next 40 years.

That is you.

2013-62 An election strategy based on fiscal policy

Note: this is an opinion article.

In the opinion of the author, the federal government's reelection strategy is to:
- put the federal budget in surplus before the election
- cut taxes before the election, eliminating the surplus and leading to a balanced budget.
Why?
- people like tax cuts, so promising tax cuts is an election strategy;
- eliminating the surplus means that if the other parties promise higher spending or lower taxes before the election, they will face a deficit.

This an example of manipulating fiscal policy to the benefit of the party in power.

Now you know why the central bank should be independent.

2013-61. A useful opinion on ECB moves

The article is useful, because it shows how the ECB operated to solve the Euro zone crisis

The Euro area faced the same problems as the US during the financial crisis: the credit market did not function well, there was insufficient liquidity in the system and many banks had troubles meeting their obligations. The Long Term Refinancing Operation (LTRO) introduced by the European Central Bank (ECB) in 2011 aimed at solving the problem. Essentially it allowed banks to borrow near unlimited funds from the ECB at a low interest rate (1%) for a period of three years. Banks could use the funds however they wanted. So they borrowed large amounts and bought higher-yields assets, including government bonds. This helped another problem: high interest rates on debt of Italy and Spain, two weak countries of the Euro area. As banks bought Italian and Spanish bonds, their prices increased, and their interest rates fell. This led to an improvement of the fiscal position of the two countries as they could now borrow at lower rates.

How big was the program? Very big. For example in March 2012 the ECB lent over 500 billion Euro, or over $700 billion.

In August 2012 the ECB introduced another program, specifically aimed at reducing interest rates on long-term bonds of problem countries. Outright Monetary Transactions (OMT) is a program under which the ECB buys directly government bonds maturing in 1-3 years. The purchases are made in the secondary market. The purchases raise the prices of government debt and reduce interest rates on 1-3 year bonds. Through the term structure, they also reduce interest on long - term bonds. They also increase confidence of private investors, raising private purchases of government bonds and further increasing their price and lowering the interest rate.

The lesson from this: apart from setting the short-term nominal interest rate, central banks have many tools at their disposal to affect markets in time of  crisis.

But, as the article points out, the intervention creates moral hazard. By reducing fiscal difficulties of problem countries, it reduces commitment to fiscal reform. 

2013-60 Monetary policy in action

Somewhat unexpectedly, the European Central Bank lowered the short-term interest rate it controls to the lowest level ever (0.25%).

• Why was it unexpected? Of the 23 analysts polled before the decision, 22 thought there will be no change.
• What was the reason for the cut? The apparent reason is that inflation in the Euro - area is very low, at 0.7%. The ECB target for inflation is just below 2%.

As we discussed some time ago, a low rate of inflation, if it falls further, may become deflation. And everyone is afraid of deflation.
Note that, unlike the proposals we discussed in posting 2013-55 and 2013-57, the ECB is not at all aiming for a high rate of inflation. Rather, it wants to bring inflation closer to the target.

• Are there other reasons for the cut? perhaps. The Euro-area economy is weak (except for Germany and a few other countries) and the Euro has appreciated, making life difficult for exporters. Since, as we discussed in chapter 4, a lower interest rate leads to depreciation of the currency, making exports cheaper and imports more expensive.
• Another reason may be that the European economy is weak. Lower short-term interest rate, if it results in lower long-term interest rates, will provide stimulus to the economy. We will discuss the link between short-term and long-term interest rates today.

Indeed, markets think there will be an  improvement in the economy and they are up.

2013-59 Insider trading charges

SAC Capital, the hedge fund owned by S.A. Cohen, admitted to five criminal charges and agreed to pay a fine of $1.2 billion. They have already paid $600 million.

Reason - insider trading

The total fine, $1.8 billion, consists of illegal gains ($900 million) and penalty ($900 million).
As Mr. Cohen owns 100% of the firm, he will pay  the fine himself, leaving him with about $7 billion (he has recently bought a painting for $150 million and property for $60 million).

Why was the firm investigated in the first place? It had returns that were had to believe ( 30% per year).

When did the investigation start bearing fruit? When someone provided information into the workings of the company.

What is "too big to jail? " This is an issue that has been bothering economists and some politicians. Following the Great Recession, nobody went to jail. Typically, firms paid fines and admitted no wrongdoing. So the bankers were "too big to jail".

You will see commentary that the too big to jail is over. But for this really to happen, the government needs to charge the company owner, Mr. Cohen, one of the most powerful people in finance.