Mish's Global Economic Trend Analysis

Obama Embraces Deficit-Cutting Plan of Gang-of-Six Senators; Senator Rand Paul in Hiding
Larry Summers on How to Save the Rich: "No Big Financial Institution in Any Country Should be Allowed to Fail"; Pure Idiocy at its Finest
Gold Reacts With "Big Yawn" to ECB Announcement
ECB Caves in on "Temporary" Defaults and Collateral; Which Country is Next to "Temporarily" Default?

Obama Embraces Deficit-Cutting Plan of Gang-of-Six Senators; Senator Rand Paul in Hiding

Posted: 19 Jul 2011 08:58 PM PDT

Six senators, three from each party had been working for months to come up with a bipartisan proposal to reduce the deficit. The gang broke up in May when Republican Senator Tom Coburn of Oklahoma abandoned the talks over an impasse on Medicare cuts.

Those differences have now been worked out and the gang has a plan that as many as 60 senators and president Obama will support.

Please consider Obama Embraces Senators' Deficit-Cutting Plan

President Barack Obama embraced a $3.7 trillion debt-cutting plan by a bipartisan group of senators that would combine tax increases and spending cuts, saying it could offer a way out of the congressional deadlock over raising the U.S. borrowing limit.

"We now are seeing the potential for a bipartisan consensus," Obama said today at the White House. He called the proposal by the so-called Gang of Six "broadly consistent" with what he has sought and "a very significant step" in so far fruitless negotiations between Republicans and Democrats over boosting the nation's $14.3 trillion borrowing authority before a threatened default on Aug 2.

At the Capitol, the bipartisan group led by Republican Senator Saxby Chambliss of Georgia and Senator Mark Warner of Virginia pitched its plan for an immediate $500 billion in spending cuts followed by a longer-term effort to force bigger reductions and $1 trillion in tax increases. The plan calls for lowering tax rates and limiting the growth of entitlement programs such as Medicare and Social Security.

About 50 senators, roughly evenly divided between the two parties, attended a closed-door briefing on the plan, a sign of potentially widespread support for the kind of "grand bargain" to reduce the debt that Obama is urging. One member of the Republican leadership, third-ranking Senator Lamar Alexander of Tennessee, publicly endorsed the plan.

"In the next 24 hours, you're going to see a significant portion of the Senate come behind this -- bipartisan -- maybe 60 members, and let's see how things roll," said Republican Senator Tom Coburn of Oklahoma, who rejoined the Gang of Six today after he abandoned the talks in May over an impasse on Medicare cuts. "This doesn't solve our problems, but this creates the way forward where we can," he said.

House Majority Leader Eric Cantor, a Virginia Republican, said in a statement issued tonight on the Gang of Six proposal that "while there are still portions that are unclear and need more detail, this bipartisan plan does seem to include some constructive ideas to deal with our debt."

It would institute an initial $500 billion of spending cuts, then lay out targets and enforcement mechanisms for forcing more future reductions, including between $85 billion and $202 billion in Medicare and other health spending, $80 billion from defense, $70 billion from education and labor programs and $11 billion from agriculture programs, according to a summary.
Tax Overhaul

It would also call for a broad tax overhaul that would raise $1 trillion by limiting breaks for health, charitable giving, homeownership and retirement while lowering individual and corporate tax rates. And it would scrap the Alternative Minimum Tax, a parallel system designed to prevent higher- earners from avoiding taxes.

Meaning of "Immediate"

I am wondering about the meaning of "an immediate $500 billion in spending cuts".

Is that "immediate" as in this year, or "immediate" as in a proposed pissy $50 billion a year reduction for 10 years. If it's the former, I endorse the proposal but if it's the latter, the deficit cutting is nothing but smoke and mirrors. I strongly suspect this proposal is smoke and mirrors.

Either way, I would feel a lot better about the deal if it contained provisions to end collective bargaining, scrap Davis-Bacon, and institute national right-to-work laws.

Senator Rand Paul in Hiding

Speaking of right-to-work laws, where the hell is Senator Rand Paul hiding? He should be at the forefront of this battle, insisting provisions like those make it into the deal. It does no good to sit back in hiding when everyone knows something will pass.

The idea is to get as much as possible out of an agreement. Going into hiding solves nothing.

Revenue Hikes Reasonable

On the revenue side, the tax hikes are trivial, and in the right places. Getting rid of the Alternative-Minimum-Tax (AMT) is a good idea and should make the minor give-aways tolerable. However, the housing industry will scream bloody murder.

It remains to be seen if the House goes along with this plan, but it is a better option than simply handing the reins over to president Obama as Republican leader Mitch McConnell proposed.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Larry Summers on How to Save the Rich: "No Big Financial Institution in Any Country Should be Allowed to Fail"; Pure Idiocy at its Finest

Posted: 19 Jul 2011 04:07 PM PDT

Larry Summers has a mistitled as well as horrendously flawed op-ed in the Financial Timed on How to save the eurozone.

A more appropriate title would be "How to save the rich". Please consider a few galling snips.

US policymakers were applauded for about 12 hours for their willingness to let Lehman go bankrupt. The adverse consequences of the shattering effect that had on confidence are still being felt now. The European Central Bank is right in its concern that punishing creditors for the sake of teaching lessons or building political support is reckless in a system that depends on confidence.

No one wants to punish creditors simply for the "sake of teaching lessons" but rather to prevent moral hazards that accompany bailouts. The simple fact of the matter is that in a capitalistic system, money will be misappropriated unless failure is allowed.

A few economic bloggers like me applauded, but Bernanke called it his biggest failure. I think the collapse of Lehman is about the only thing Bernanke did right.

Banks acted recklessly because they thought they would be bailed out, and they were.

Those who let Lehman go believed that because time had passed since the Bear Stearns' bail-out, the market had learnt lessons and so was prepared. In fact, the main lessons learnt were on how best to find the exits, and so uncontrolled bankruptcies had systemic consequences that far exceeded their expectations.

The main lesson is that bubbles burst and it is best to prevent bubbles not blow them, unless of course there is a guarantee that reckless behavior will be bailed out.

On such a guarantee, the proper course of action for any "too big to fail" organization is to blow as big a bubble as humanly possible.

Now let's consider Larry Summers' solutions.

First, for programme countries, interest rates on debt to the official sector should be reduced to a European borrowing rate, defined as the rate at which common European entitities backed with joint and several liability by all the countries of Europe can borrow. A default to the official sector will not be tolerated, so there is no reason to charge a needless risk premium that puts the whole enterprise at risk.

With that set of statements, Larry Summers just embraced the European Nanny State solution.

Second, countries whose borrowing rate exceeds some threshold – perhaps 200 basis points over the lowest national borrowing rate in the euro system – should be exempted from contributing to bail-out funds. The last thing the marginal need is to be pulled down by the weak.

Why should any country in the Eurozone be forced to bail out any other country? Bear in mind it is taxpayers bailing out the sovereign debt of other nations.

Third, there must be a clear commitment that, whatever else happens, no big financial institution in any country will be allowed to fail. The most serious financial breakdowns – in Indonesia in 1997, Russia in 1998, and the US in 2008 – came when authorities allowed doubt over the basic functioning of the financial system. This responsibility should rest with the ECB, with the requisite political support.

This proposal of Larry Summers is pure idiocy at its finest. As stated above in a capitalistic system, money will be misappropriated unless failure is allowed. What would a bailout guarantee do other than promote more reckless behavior?

Fourth, countries judged to be pursuing sound policies will be permitted to buy EU guarantees on new debt issuances at a reasonable price, payable on a deferred basis.

Once again I ask, Why should taxpayers in any country be forced to bail out any other country?

It is hard to find so much gall, arrogance, and stupidity in one place as in that article. I picked the post up from Arthur Fullerton who wrote Only Poor People Can Be Allowed to Fail

Trying to create a world financial system where "no big financial institution in any country will be allowed to fail" is an unsustainable act of hubris and is itself doomed to failure.

Precisely, and for the exact reasons I stated.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Gold Reacts With "Big Yawn" to ECB Announcement

Posted: 19 Jul 2011 08:47 AM PDT

Earlier today the ECB Caved in on "Temporary" Defaults and Collateral.

It is important to note that the ECB did not "allow" a default, rather the bond market forced the ECB to accept default. The stock market reacted as if the announcement meant something, but gold gave a big yawn.

Gold Daily Chart

Gold Weekly Chart

Of course there are so many problems it is hard to know what gold is or is not reacting to.

Partial List of Problems

Sovereign debt default crisis in Eurozone PIIGS: Portugal, Ireland, Italy, Greece, and Spain.
US debt ceiling concerns
US fiscal deficit concerns
US total debt concerns
Reckless, unsustainable credit growth in China
Rampant inflation in Brazil, Russia, India, and China, the BRIC countries.
Yuan peg to the US dollar
Debt and deficit concerns in the UK
Japan interest rate and total debt concerns
Massive global trade imbalances

I could easily add another 10 items related to global housing bubbles, demographics, unfunded future liabilities, state pension plans etc.

The idea this announcement solved anything is complete silliness and gold's reaction with a big yawn was well deserved.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

ECB Caves in on "Temporary" Defaults and Collateral; Which Country is Next to "Temporarily" Default?

Posted: 19 Jul 2011 07:27 AM PDT

As Greek 2-year debt yields hit 39.15% the bond market finally forced the ECB's hand, and Trichet comes out looking foolish, not only on his "we say no to default" stance, even temporary defaults, but also on his ridiculous bluff repeated for the nth time just 2 days ago regarding the acceptance of Greek bonds as collateral.

Bloomberg reports Austria Central Bank Head Signals ECB May Bend on Greece

European Central Bank council member Ewald Nowotny suggested the bank may compromise and allow a temporary Greek default as officials scramble to fix a sovereign debt crisis that's spreading to Italy and Spain before a leaders' summit in two days.

As Spanish financing costs surged at a 4.45 billion euro ($6.31 billion) treasury bill auction today, policy makers are trying to ease a split that's pushed interest rates on Spanish and Italian 10-year debt above 6 percent for the first time since the euro debuted 12 years ago. The ECB has until now argued that any Greek default could spark a new financial crisis, derailing a German push to make investors help foot the bill for a second bailout of the country.

Nowotny, who heads Austria's central bank, issued a statement today concerning the "interpretation" of his earlier comments in an interview with CNBC. He is in "complete agreement" with ECB President Jean-Claude Trichet that the aim is to "avoid any situation that would make it impossible for the ECB to continue to accept Greek sovereign bonds as collateral," the statement said.

In the CNBC interview broadcast this morning, Nowotny said there's "a full range of options and definitions, from a clear- cut default, selective default, credit event and so on."

"This has to be studied in a very serious way," he said. "There are some proposals that deal with a very short-lived selective default situation that will not have major negative consequences."

The comments helped boost financial markets amid speculation a solution to the crisis will be found. The euro rose to $1.4197 at 12:20 p.m. in Frankfurt, up from $1.4028 yesterday. Yields on Spanish and Italian 10-year bonds retreated from euro-era highs as stock markets rallied.

Spanish yields fell 17 basis points to 6.10 percent as of 12:35 P.m. in London, while Italy's yield dropped 23 basis points to 5.72 percent. Greek two-year yields surged to 38.5 percent.

European Union leaders are meeting on July 21 to hammer out a solution to the Greek debt crisis, which has already spread to Ireland and Portugal. While Germany wants private investors to participate in a second bailout package for Greece, Trichet says the central bank won't accept Greek government bonds as collateral for loans in the event of a default or "credit event."

"It is our own responsibility, our own decision," he told CNBC. "We have proved this in the case of Ireland, Greece and Portugal, with regard to what kind of collateral we accept. So there is a certain case for independence.

Greece 2-Year Government Bond Yield

S&P 500 Futures

The market it giddy on the news as it is every time the ECB announces something of essentially no importance.

I have lost count of these opening gaps above the previous high or below the previous day's low, many producing "island reversals".

If the market does not quickly sell off today, we have the potential for another island reversal tomorrow.

ECB's Reversal

On Sunday I commented Trichet Repeats Nuclear Threat to Reject Greek Bonds as Collateral; Verbal Discipline or Big Bluff?

Verbal Discipline or Big Bluff?

Does anyone believe Trichet? Would the ECB dump its holdings of Greek bonds in a panic market?

I am suspicious about the wording "normal eligible collateral".

What about abnormal collateral, conditional collateral, temporary collateral?

The idea that verbal discipline works is nonsense. One look at sovereign debt yields in Greece, Ireland, Spain, Portugal, and Italy is proof enough.

I believe Trichet will look for some excuse to not dump Greek bonds into a panicked market should the rating agencies rule Greek debt in default. Regardless, the sooner the market puts Trichet's verbal discipline to the test, the better off Europe will be.

Trial Balloon

Statements by Central Bank council member Ewald Nowotny were likely a "trial balloon" to see how the market would react. Given that the market has not panicked over them, indeed bold yields of the PIIGS are sharply lower except for Greece, Trichet will go along.

Nothing Solved

Details are not even out yet. Then again, short of a common bond "nanny state" the details are essentially irrelevant.

In spite of the stock market euphoria, nothing has been solved in any sense of the word. All of the structural problems remain.

Ireland, Spain, and Portugal are waiting on deck for the next bat at "temporary" defaults

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

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Tuesday, July 19, 2011

Mish's Global Economic Trend Analysis

Mish's Global Economic Trend Analysis

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