GROWING WORRIES IN ATHENS
A Greek Default Would Hit the ECB Hard
Hopes that Greece can be saved are dwindling. Athens had hoped to reach a deal with its creditors on a 50 percent debt haircut, but banks have now made it clear that efforts to reach an agreement could fail. Should the country go bankrupt, the European Central Bank stands to lose the most.
Summers Abandons His Economic Views – Editorial, Wall Street Journal
Even when we disagree with Larry Summers, we’ve long thought of him as a better economist than politician. But after reading his nearby letter to the editor, we may have to reverse our judgment. The senior White House aide is abandoning his former economic views to serve the Democratic Party’s current political purposes.
Earlier this week, we quoted an essay by Mr. Summers published in 1999 in which he explained that unemployment insurance creates an incentive for workers to delay going back to work. The share of America’s jobless out of work for 27 weeks or more reached a new record of 44.1% in March, and Mr. Summers’s past writing offers one likely reason.
The paragraph we quoted followed a subhead, “What Causes Long-Term Unemployment?” Here is how the passage reads in more complete form:
“To fully understand unemployment, we must consider the causes of recorded long-term unemployment. Empirical evidence shows that two causes are welfare payments and unemployment insurance. These government assistance programs contribute to long-term unemployment in two ways.
“First, government assistance increases the measure of unemployment by prompting people who are not working to claim that they are looking for work even when they are not. The work-registration requirement for welfare recipients, for example, compels people who otherwise would not be considered part of the labor force to register as if they were a part of it. This requirement effectively increases the measure of unemployed in the labor force even though these people are better described as nonemployed—that is, not actively looking for work. . . .
“The second way government assistance programs contribute to long-term unemployment is by providing an incentive, and the means, not to work. Each unemployed person has a ‘reservation wage’—the minimum wage he or she insists on getting before accepting a job. Unemployment insurance and other social assistance programs increase that reservation wage, causing an unemployed person to remain unemployed longer.”
In his letter, Mr. Summers says we took his words out of context, but readers will note that he doesn’t deny that he linked jobless insurance with longer periods of joblessness. Mr. Summers skips over that point and instead resorts to that all-purpose economic explanation known as “aggregate demand.” In 2010 as opposed to 1999, the harmful incentive effects of extending jobless payments to an unprecedented 99 weeks don’t matter. He says the point now is to stimulate the economy by increasing consumer “demand.”
This is worth parsing because it gets to the heart of what’s wrong with Obamanomics. The Summers argument is that increasing unemployment insurance increases aggregate demand and thus reduces unemployment. This is because he and the neo-Keynesians believe that the impact on macroeconomic demand of this jobless spending outweighs the microeconomic harm on individual incentives.
In other words, if government pays people for not working, then more people will work. Subsidize unemployment and you will somehow get less of it. But if this were true, we could lower unemployment even more if we increased jobless benefits to $100,000 a year per person to cause an even greater surge in demand.
The evidence is building that global growth has stalled. And it’s about to get much worse.
I think the most notable development this week was Thursday’s big release of global factory activity surveys. It wasn’t pretty. Overall, the JP Morgan Global Manufacturing PMI dropped for the third straight month and fell below the 50 level — the line of demarcation between growth or contraction in monthly factory activity — for the first time since recession was descending upon us back in early 2008. Scary stuff.
Although U.S. activity was buoyant (no doubt a remnant of the sentiment tailwinds enjoyed from the market rally in October), we cannot remain an island of tranquility as Asia and Europe fall into the abyss.
Here are the highlights (any reading under 50 indicates a drop in activity):
*Brazil PMI: 48.7 vs. 46.5 prior
*Ireland PMI: 48.5 vs. 50.1 prior
*Sweden PMI: 47.6 v. 49 estimated
*Norway PMI: 48.6 vs. 50.2 estimated
*Denmark PMI: 47.7 vs. 43.6 prior
*Poland PMI: 49.5 vs. 51.7 prior
*Spain PMI: 42.8 vs. 43.9 prior
*Swiss PMI: 44.8 vs. 46.6 estimated
*Czech PMI: 48.6 vs. 51.7 prior
*Italy PMI: 44 vs. 42.8 estimated
*France PMI: 47.3 vs. 47.6 estimated
*Germany PMI: 47.9
*Greece PMI: 40.9 vs. 40.5 prior
*South Korea PMI: 47.1 vs. 48 prior
*Taiwan PMI: 43.9 vs. 43.7 prior
And, now for the big boys:
*Eurozone PMI: 46.4 — lowest reading since recession ended in July 2009
*U.K. PMI: 47.6 vs. 47 estimated — lowest since June 2009
*China PMI: 49 vs. 49.8 estimated — lowest reading since February 2009
*China HSBC PMI: 47.7 vs. 51 prior — 32-month low
In addition to signs of economic weakness — which was enough for a Chinese vice finance minster to say the global economy faces a “worse situation” than in 2008 — there was evidence that the financial system remains under severe stress despite the freak out over Wednesday’s move by the Federal Reserve to lower dollar funding costs for foreign banks (which, as I discussed at the time, wasn’t really a game changer). The European Central Bank reported that eurozone banks borrowed nearly €9 billion in overnight emergency cash — up from €2.7 billion earlier this week. Not good.
Other signs of strain could be seen in the way German 12-month bill yields dropped below zero on Wednesday as European investors were willing to pay Berlin for the luxury of lending it money. The motivation is that, if you’re holding a big wad of euros, German short-term debt is one of the few “sure bets” left out there. It’s a sign of extreme risk aversion and fear.
Of course, the epicenter for all this is Europe.
Adding to concerns were comments this week from new ECB chief Mario Draghi that while downside risks to the economic outlook have increased, he cannot ride to Europe’s rescue by engaging in unmitigated money printing and bond buying; instead, it must adhere to its founding principles, including an inability to engage in monetary financing of government debts (exactly what the likes of Italy would love right now).
Draghi’s comments were akin to yelling “fire” in a crowded theater before announcing all the fire extinguishers are empty. Whoops.
According to the team at Capital Economics, based in London, the eurozone economy is on track to contract by 1% next year and by 2.5% in 2013, with risks to the downside for both forecasts. Recession will only deepen the budget deficits at the center of the eurozone debt crisis. The only way out is growth. And the only way the likes of Greece, Portugal, and Italy can restore growth is via massive currency depreciation and domestic inflation — something that’s not going to happen as long as they’re in the eurozone.
Sure, there will be distractions like Wednesday’s move by the Fed or additional stimulus measures out of places like China and Brazil. That’s just how the market gods like it. All the better to keep the masses confused and complacent as the fundamentals just get worse and worse.
To put it differently: When you look around the theater, everyone’s still focused on center stage blissfully unaware what’s happening around them. Turn around. The balcony level is in flames.
The Economy Is About To Get A Lot Worse – Anthony Mirhaydari, MSNBC