Flashman Letters

Attempts to reduce wasteful government spending show austerity is a hard nut to crack

So it came to Super Twiggy. The squirrel starred in Web videos in Spain, touting the health benefits of California-grown walnuts. U.S. taxpayers had paid more than $3 million for Spanish walnut promotions, as part of a $200 million-per-year Agriculture Department program that promotes U.S. farm goods overseas.

“The Republican majority was supposed to end this kind of nonsense, not perpetuate it,” said Rep. Tom McClintock (R-Calif.), trying to kill the broader program with an appeal to his party’s small-government soul. “It is a test of the determination and sincerity of the House majority.”

It didn’t work. After other members touted the program’s value to farmers, the cut was rejected, 322 to 98.

There — in a vote and, in fact, in a nutshell — was the story of the American austerity wars in 2013.

Republicans in Congress had forced a historic shift: Washington, for the first time in years, was focused on cutting, not growing, the budget. But then, politicians in both parties choked on the decisions that came next: Where to cut. Who to hurt. What to kill.

Instead, they allowed sequestration, a policy that — at least in theory — cut the good and the bad equally. That created odd contrasts: Meals on Wheels was cut, and Army units reduced training; Washington kept paying for dubious expenses such as a plane that didn’t fly, an airport with no passengers and farm subsidies in Manhattan. And a private industry’s “spokes-squirrel.”

This month, Congress canceled sequestration’s across-the-board cuts and gave itself another chance to demonstrate that legislators can make smarter, more judicious cuts. But so far, it has mainly demonstrated the power of old Washington habits, the political reflexes that make cutting government so hard.

“The only way Congress can make cuts is across the board, because they have trouble making decisions,” said Robert L. Bixby of the Concord Coalition, a group seeking to reduce the federal deficit. “If you’re trying to limit the scope of government, or the function, it doesn’t accomplish that goal at all. It just gives you less money to accomplish the same goals, which is why it doesn’t really work over the long term. [Either] the money grows back, or you provide a declining level of service.”

via www.washingtonpost.com

Christmas Listening - A conversation with Reza Aslan - The Historical Jesus

http://www.cfr.org/religion/conversation-reza-aslan-politics-jesus-first-century-palestine/p32077?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A%20publication%2Faudio%20%28Inside%20CFR%20Events%20%28Audio%29%29#close=1

Only 5 stocks in the S&P 100 are down for the year and none by double digits - thanks HB

A primer on Turkey

http://www.washingtonpost.com/blogs/monkey-cage/wp/2013/12/27/how-erdogan-has-reshaped-turkish-politics-and-what-it-means-for-current-corruption-scandal/

And from the always annoying Dexter Filkins:

http://www.newyorker.com/online/blogs/comment/2013/12/recep-tayyip-erdoan-demise.html?utm_source=tny&utm_campaign=generalsocial&utm_medium=twitter

And just to quibble with his first line:

"The revolution always eats its children: in France, in the Soviet Union, in China, and, now, in Turkey."

While revolutions might eat their children, in China and the Soviet Union, the father's died in their beds.

Lenin quite appropriately of syphilis and Mao a heart attack.

Interesting bit on China

http://globaleconomicanalysis.blogspot.fr/

But as China deleverages, growth in demand must drop sharply. After all, if economic growth over the past several years has been goosed by rapid credit expansion, deleveraging must have the opposite effect. It is strange that economists who acknowledge that the current growth model is overly dependent on debt have failed to understand that its reversal will have the opposite impact. If it did not, it is hard to explain why anyone would consider debt to be a problem in the first place.

If China currently has wasted significant amounts of investment spending, it is clear that much of the accompanying bad debt has not been written down correctly. Bad loans are almost non-existent in the banking system – that is they have not been recognized in the form of reserves or write-downs.

But the failure to recognize the loss does not mean that the loss does not exist. The losses implicit in the bad loans must (and will) be written down over the future, either explicitly, in which case they will result in a direct deduction to GDP growth, or implicitly, in which case they will require implicit and hidden transfers from one part of the economy or another (usually the household sector) to cover the gap between the “real” cost of capital and the nominal (subsidized) cost of capital. This transfer must reduce future growth.

The point here is that if credit is a problem in China – something no one doubts – it must be a problem because of wasted investment that has yet to be recognized, otherwise it would have resulted in negative GDP growth today. Failure to recognize the investment losses will, of course, artificially boost GDP growth today, but it must also artificially reduce GDP growth tomorrow as the recognition of those losses is simply postponed, not eliminated. The failure of many economists to recognize that wasted investment has a cost – even as they recognize that investment has been wasted – has caused them both to misunderstand the relationship between wealth creation and GDP and to understate the future impact of this overstated GDP.

Debt matters, and the only time it can be safely ignored is when debt levels are so low, and the borrower is so credible, that it creates no financial distress costs and has a negligible impact on demand. Neither condition applies in China, and so any prediction that ignores debt is likely to be hopelessly muddled. In fact I would like to propose a simple rule. Any model that predicts China’s future GDP growth must include, if it is to be valid, a variable that reflects estimates of the amount of hidden losses buried in the banks’ balance sheets. If it does not, it cannot possibly be a valid model to describe China’s economy, and its predictions are useless.

China’s astonishing growth during the past three decades is partly the result of a system that subsidized growth with hidden transfers from the household sector. These transfers are at the root of the current imbalances, and once reversed, so that China can rebalance its economy towards healthier and more sustainable sources of demand, the very processes that turbocharged growth will no longer do so.

If growth has been healthy and sustainable, there would be no need for Beijing to change its growth model – in fact it would be foolish to do so. If growth has not been healthy and sustainable, this is almost certainly because it has been artificially propped up, and if the reforms are aimed at unwinding the mechanisms that artificially propped up growth, then subsequent growth rates must be substantially lower.

Low interest rates, low wages, an undervalued currency, nearly unlimited access to credit for state-owned enterprises, a relaxed attitude to environmental degradation, and other related conditions were both the source of China’s ferocious growth as well as of China’s unprecedented economic imbalances. Reversing these conditions will rebalance the economy, but will do so while lowering growth in the obverse way that these conditions had accelerated growth.-- Richard O'Connell +34 666 24 1104

Michael Pettis on China. Interesting

http://econintersect.com/wordpress/?p=45002&utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+EconintersectCombinedRssFeed+%28Econintersect+Combined+RSS+Feed%29

This is what it means to say that financial repression creates a bifurcation of monetary growth. For households, and net depositors more generally, real monetary expansion is in effect much lower than nominal monetary expansion because of the implicit financial repression “tax”, and so consumption growth and consumer-price inflation will seem abnormally low. For manufacturers, real estate developers, infrastructure investors and other net borrowers, real monetary expansion is in effect much greater than nominal monetary expansion because of an implicit financial repression “subsidy”, and so asset inflation and capacity growth seem abnormally high.

Perhaps one way of thinking about it is to consider how to make a comparable impact in a market system. Imagine if somehow the US were to enact a law whose result was that every time the Fed expanded the money supply, a one-off tax was imposed on households, the proceeds of which were transferred to corporate borrowers. In that case monetary expansion would be much less likely to cause an increase in demand for consumer products, and so would create much less consumer price inflation, and much more likely to cause a surge in production.

This effective “tax” suggests that in a financially repressed system, it is normal that the impact of nominal monetary expansion will seem much greater in one sector of the economy than in another, with the differencing reflecting the net lending or net borrowing position of that sector. The impact of monetary expansion on the behavior of the saver is much lower than it is in a market-based financial system, all other things being the same. The impact of monetary expansion on the behavior of the borrower is much higher than it is in a market-based financial system, all other things being the same.

Under these conditions it is consequently not surprising that the economy can seem to be operating under conflicting monetary systems. Consumption behaves as it would in an economy with much lower monetary growth, and production and asset prices behave as they would in an economy with much higher monetary growth.-- Richard O'Connell +34 666 24 1104

Closer Look: Repeated Liquidity Crunches Beg a Question: Where'd the Money Go? -

http://english.caixin.com/2013-12-24/100621092.html

Judging by statistics alone, the amount of liquidity the central bank has released was significant, but the market seems to be suffering an increasingly severe liquidity crunch.
This type of discrepancy has been a recurring theme over the past few years, raising a question: Where has all the money gone?
Some analysts say capital has left the country in anticipation of the U.S. Federal Reserve ending its policy of so-called quantitative easing, while others say interest rates have risen as reform deepens. Still others say the money that has been released was looped in a cycle formed by the property sector and the financial market instead of flowing into the real economy.
Perhaps all of these factors are at play. But capital outflows cannot be the primary reason because the data does not support this argument. Nor it is likely because the money did not flow into the real economy.
In fact, the most obvious reason for similar liquidity crunches is that huge amounts of money flew into the real economy and ended up dead there.
An investor friend of mine says credit was being swallowed up by numerous speculators and Ponzi scheme operators like a mythical creature that keeps eating and never needs to, well, visit the restroom.
Another friend who runs a business puts it in more concrete terms. In his line of business, there are some super players with extremely high leverage rates who have been steadily losing money. Despite this, they can always get the support of banks.
My friend said he thought he could hang on until they collapse and business returns to normal. But several years have passed and they remained strong. In fact, many more have followed in their tracks. "I could not afford to wait until they lost, so I gave up," he said.
No one is naïve enough to think banks' balance sheets are as healthy as they are made to look. But the repeated bouts of tight liquidity seem to be a signal that they could be worse than we imagined.
Many toxic assets have not yet shown up on banks' balance sheets but they have already started eroding their ability to lend. This is the ugly truth of the liquidity crunches.-- Richard O'Connell +34 666 24 1104

China same store sales growth 1%? This is probably not good news

Since mid-2010, valuations of Chinese retailers have contracted, while valuations of Chinese consumer staples firms have expanded. Although it may be tempting to expect some mean reversion, we think there are strong reasons for the underperformance in the retail sector, and believe it is likely to continue.

Same-store sales growth has declined to just over 1% for listed Chinese retailers after peaking at more than 19% in early 2011. This downward trend reflects both the broader slowdown in income growth within the economy and the negative headwinds of the spending restrictions. However, what is compounding problems for retailers is that the slowdown in spending has been exacerbated by an increase in supply. This perhaps echoes some of the oversupply issues we’ve seen elsewhere in the Chinese economy, where easy money has fueled an investment boom.

Although industry data is incomplete, our opinion is that in many markets in China, the expansion in physical retail stores is the root of the problem. While rates of department store density in emerging market (EM) countries remain well below those of the U.S. and U.K., China is comfortably ahead of most of Asia, including richer nations such as South Korea and Japan. This supports our view that Chinese retailers have focused on capacity expansion over the last decade without sufficient regard for operating expenses and capital efficiency. This has now come home to hurt performance in the form of declining margins across the sector in 2013.-- Richard O'Connell +34 666 24 1104

From HW Sinn..... Nothing new, but an idea that is gaining currency

Unfortunately, the crisis is far from over. While the insurance that the European Central Bank has offered, free of charge, to buyers of EU members' government bonds has temporarily calmed financial markets, ordinary workers fretting about their jobs look to the future with trepidation. In Greece and Spain, half of all young people not studying are unemployed, as is a quarter of the adult workforce. Particularly worrying is the continuing rise in unemployment in France and Italy, where industrial production has been shrinking and price competitiveness continues to deteriorate.
The euro itself is responsible for this debacle. During the first several years after the EU's Madrid summit in 1995 officially launched the move toward a common currency, too much capital was steered into southern Europe, creating an inflationary credit bubble there. An inordinately lax regulatory environment proved lethal, encouraging northern European banks to pad their balance sheets with southern European government and bank bonds. When the bubble burst, it left in its wake woefully expensive economies that had lost their competitiveness.
Europe should now use the calm between the storm fronts to rethink the European currency union from the ground up. The effort to create a European equivalent of the dollar and impose a fiscal union on top of it, despite the absence of a common European state, is bound to fail. It will turn member countries into debtors and creditors to each other, stoking even more animosity.
The fundamental requirement for functioning monetary and fiscal unions in Europe is the establishment of a United States of Europe, with a real parliament that gives all citizens equal representation, together with a common legal system. Above all, the success of the European peace project requires a common army and a common foreign policy – that is, a genuine, long-lasting mutual-insurance union based on reciprocity in ensuring security and stability. Those who try to anticipate such a common state with a fiscal union will never achieve their goal.
Because France is not yet willing to accept a common European state, we need an intermediate stage to preserve and stabilise the eurozone. This requires sorting out the current mess and introducing a flexible membership system based on hard budget constraints. Four measures are needed to achieve this.
First, a debt conference is needed, with creditors of the southern European governments and banks forgiving part of the debt. The creditors relinquishing part of their claims must include public entities, first and foremost the ECB, that have now largely replaced private lenders.
Second, eurozone members whose path to regaining competitiveness through price and wage reductions is too long and gruelling, and whose societies risk being rent asunder by the necessary imposition of austerity, must temporarily exit the monetary union. The pain of exiting should be cushioned with communal financial help, which would not be necessary for long, because a devaluation of the new currency would quickly restore competitiveness. In fact, a "breathing eurozone" that permits – and regulates – exit and re-accession should be clearly stipulated. Europe needs a system that is halfway between the dollar and a fixed-exchange-rate system like Bretton Woods.
Third, this breathing currency union must include hard budget constraints on its members' national central banks. Specifically, a ceiling must be set on local money creation by establishing the obligation to settle balance-of-payments imbalances with gold or other comparably safe means of payment.
Finally, bankruptcy regulation for countries is essential in order to make it clear to investors from the outset that they are taking on risk. This is the only way to avoid the destabilising credit flows that drove southern Europe to ruin.-- Richard O'Connell +34 666 24 1104

Tough choices

Energy poverty is even more acute for the three billion people – almost half of the world’s population – who burn dung, cardboard, and twigs indoors to cook and keep warm. The WHO estimates that while outdoor air pollution in developing-country cities may be ten times higher than in advanced-country cities, average indoor air pollution, caused by burning wood and dung, is a hundred times higher. Indeed, indoor air pollution kills 3.5 million people each year, making it the world’s deadliest environmental problem.
CommentsThe world’s three billion energy-poor people need cheap electricity to cook and keep warm. And, for the foreseeable future, that electricity will be generated by fossil fuels.
CommentsSome environmental campaigners argue for cleaner stoves. But, while this might be part of the solution, it is essentially telling the poor to live with slightly less polluting open fires in their homes. Moreover, studies indicate that even significant air-pollution reduction starting at high levels will have only a minor impact.
CommentsOthers claim that renewables are the way to go. Green energy, especially wind, can indeed help African countries, for example, get some electricity to remote, rural areas; but the grid will do the most good for the most people. According to a recent World Bank study, distributed renewable energy “will be the lowest cost option for a minority of households in Africa, even when likely cost reductions over the next 20 years are considered.” Popular solar lights cost almost $2 per kWh. Using hydro, gas, and oil, the grid cost for the main population centers in Ethiopia, Ghana, and Kenya will likely be $0.16-25 per kWh. In South Africa, where coal powers 90% of electricity, the cost is just $0.09 per kWh.
CommentsTrue, electricity from coal will cause extra air pollution. But pollution from indoor air pollution, which would disappear with electrification, accounts for 16% of outdoor air pollution. Even assuming (unrealistically) that coal produces all of the world’s air pollution, we could generate 250 kWh/year with coal for every one of the three billion energy-poor people and still end up with lower air pollution. Moreover, it is easy and fairly cheap to cut coal pollution 90% or more with scrubbers.
CommentsFor many opponents of coal, the issue is global warming. According to Christiana Figueres, the United Nations climate chief, coal-fueled development has “an unacceptably high cost to human and environmental health.” She argues that we need to close 75% of the planet’s coal-fired power plants, including all of South Africa’s, because they emit too much CO2. Al Gore’s climate adviser, James Hansen, argues that if we allow developing countries to “come up to the level of the developed world, then the planet is done for.”
CommentsYes, the world needs to address global warming (mainly through higher investments in green research and development, and by promoting exploitation of cheap, less-polluting shale gas). But global warming will cause damage worth possibly 1-5% of GDP by the end of the century, when the UN expects developing-world incomes to have risen by 1,400-1,800%.
CommentsMeanwhile, poverty is killing millions right now, with an impact on global GDP that is likely an order of magnitude higher. And too many people, however well-intentioned, are unwilling to acknowledge the tradeoffs needed to improve poor people’s lives.
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