NEW$ & VIEW$ (16 NOVEMBER 2012)

Left hug Right hug  How to Get to a Grand Bargain  By James Baker

Start with a mechanism guaranteeing that spending cuts actually follow tax increases.

It is unrealistic to think that Congress could negotiate a far-reaching fiscal “grand bargain” during its brief lame-duck session this winter. Lawmakers’ first order of business, then, should be to postpone all elements of the Jan. 1 fiscal cliff—spending cuts, revenue increases and the debt limit—for three months, until March 31. This would provide Washington enough time to negotiate a responsible compromise.

One way to generate the necessary political will for a deal would be to establish a mechanism guaranteeing that any agreed-upon spending cuts actually happen—and then remain in place after taxes are raised. Absent a balanced-budget amendment with a tax-limitation provision (something that isn’t politically feasible at this time), it is very difficult to create effective mechanisms for spending restraint. That is because one Congress cannot bind the actions of future Congresses. So budget agreements often lead to tax increases that are real but spending cuts that fail to materialize.

I propose an enforcement mechanism linking the revenue increases and spending cuts that make up the grand bargain. The parties would agree to cap federal spending at a certain percent of gross domestic product. Were a future Congress to increase spending above that cap, then the tax increases set by this compromise would automatically be rescinded. Conversely, should future Congresses keep spending at or below the cap, then the tax increases would stay in place (unless a future Congress were to raise or lower taxes without increasing the debt). (…)

imageInteresting, but the relative spending cap was tried before without much Democratic interest. Mr. Baker’s view that it’s too late for a grand bargain before next spring is good news, bad news. Can kicking once more. But what about the debt ceiling which will be reached mid-February, early March?

As this chart from BCA Research illustrates, moderation is not fashionable these days.

Meanwhile, in the real world: 

The CEOs I speak to in my area are in ‘crouch mode’, says one regional Federal Reserve president. “They are frozen. Defensive.” (From Gillian Tett’s FT column)


Because of the government debt market’s once unrivalled ability to intimidate policymakers, Bill Clinton reportedly claimed that if he were to be reincarnated he would like to return as the “bond market”. However, the Fed’s now extraordinary commitment to rein in Treasury bond yields has sapped the bond market’s influence. Quantitative easing has effectively “socialized” the Treasury bond market. In a sharp break from the past, the Fed, as opposed to other holders of US Treasury obligations, has the final say over where Treasury bond yields will reside.

As long as the Fed stands ready to buy US Treasuries, Washington can run up deficits galore and not put much upward pressure on benchmark borrowing costs. The bond market vigilantes of yore would be helpless in the face of the Fed’s superior firepower. Today, it’s up to the equity market to effectively regulate policymakers.

imageThe US equity market may now be in the process of putting policymakers on a short leash. If the equity market does not like the content of any resolution of the impending “fiscal cliff”, substantially lower share prices could force Washington to reconsider the solution. Similarly, policies may need to be revised if concerns regarding the impact of other government programs prompt a potentially disruptive sell-off of equities.

Why should the equity market’s response to government policies matter? In view of how deflated home prices, sluggish incomes, and diminished job opportunities have lessened the buying power of lower- to middle-income households, upper-income households now serve as the lead driver of consumer expenditures. Because spending by upper-income consumers is likely to be more sensitive to equity price swings than that of other Americans, the equity market may now wield greater influence over household expenditures compared to previous recoveries.

Indeed, even before the latest erosion of middle-class buying power, pronounced contractions by household wealth were associated with economic distress. Since 1960, whenever real household net worth sank by at least 2% from a year earlier, recessions occurred‘


In addition, businesses are likely to respond to significantly lower share prices and wider credit spreads by curbing outlays on equipment and staff. Now sluggish revenues and profits make it all the more difficult for businesses to dismiss the warnings implicit to cheaper equities. (Moody’s)

U.S. Consumer Prices Increase Marginally

Consumer price inflation eased last month. The overall consumer price index ticked up an expected 0.1% (2.2% y/y) following two successive 0.6% increases. The easing was due to a 0.2% (4.0% y/y) decline in energy prices following two sharp monthly increases. Food price inflation, however, firmed a bit with a 0.2% rise (1.7% y/y). Prices excluding food & energy rose 0.2% (2.0% y/y) following three 0.1% monthly gains.

For goods alone, prices excluding food & energy fell 0.1% (+0.7% y/y). The decline mostly reflected a 0.9% decline (-2.1% y/y) in used car prices and a 0.1% dip (+1.0% y/y) in new vehicle costs.

Another 0.3% increase (2.5% y/y) in core service prices reflected an improved 0.3% rise (2.3% y/y) in shelter costs (32% of the CPI). Owners equivalent rent of primary residences rose 0.2% (2.1% y/y).

Basic inflation remains in the 2.0-2.5% range in the U.S.:

According to the Federal Reserve Bank of Cleveland, the median Consumer Price Index rose 0.2% (2.3% annualized rate) in October. The 16% trimmed-mean Consumer Price Index increased 0.1% (1.7% annualized rate) during the month. Over the last 12 months, the median CPI rose 2.2%, the trimmed-mean CPI rose 1.9%, the CPI rose 2.2%, and the CPI less food and energy rose 2.0% image


Lightning  Euro-Zone Economy Shrinks

The euro-zone economy contracted in the third quarter, offering little hope for the worsening global environment as rising unemployment and fiscal austerity across much of Europe undermine the region’s fortunes.

Germany and France, the euro-zone’s two largest economies, posted modest growth in the quarter. But GDP for the 17-member currency union as a whole slid 0.2% from the previous quarter, at an annualized rate, according to calculations by J.P. Morgan based on figures from the European Union’s statistics agency. GDP fell 0.7% in the second quarter.

Tighter Squeeze

This is for Q3. Q4 seems set to be awful.

image image


Storm cloud  Chinese banks’ bad loans rise Non-performing loans among Chinese lenders have increased for four consecutive quarters — the longest period of asset-quality deterioration since 2004.

Data from the China Banking Regulatory Commission on Thursday showed soured loans rose by 22.4 billion yuan ($3.6 billion) from July to September, to 478.8 billion yuan.

The NPL ratio against total outstanding loans stood at 0.95 percent by the end of September, up by 0.01 percentage point from three months earlier.

Storm cloud  Hong Kong Growth Trails Estimates as City Cuts 2012 Outlook  Hong Kong’s economy expanded less than estimated in the third quarter as export gains stalled and retail sales rose at a slower pace. The government also cut its forecast for full year growth.

Gross domestic product rose 1.3 percent from a year earlier in the third quarter, the government said today. That compared with the 1.7 percent median forecast in a Bloomberg News survey of 16 analysts and 1.2 percent in the three months through June. The economy grew 0.6 percent from the previous quarter on a seasonally adjusted basis. (…)

The government today lowered its estimate for full-year growth to 1.2 percent from an August projection of a range of 1 percent to 2 percent. That would be the slowest pace since 2009 when the economy contracted 2.6 percent. GDP increased 5 percent last year and 7.1 percent in 2010.

The city’s exports increased 15.2 percent in September from a year earlier, rebounding from a 0.6 percent increase in August and a drop the previous month. The gain was helped by an improvement in demand from China and the U.S. and what the government described as a “distinctly low base of comparison” in the same month last year.

Storm cloud  Singapore Sees 2012 Growth at Low End of Forecast on Exports

The economy will grow 1 percent to 3 percent in 2013 after expanding about 1.5 percent this year, the Trade Ministry said in a statement today. It had previously forecast growth of as much as 2.5 percent in 2012. Gross domestic product contracted 5.9 percent last quarter from the previous three months, worse than the 1.5 percent decline estimated earlier.




FT Alphaville quotes Mario Draghi yesterday:

As you know, in recent months I have repeatedly stressed the irreversibility of the euro. This was precisely the sentiment of one of Tommaso’s most noted quips. Speaking in 2004 about the “EMU”, an abbreviation for Economic and Monetary Union, he remarked that it was also the name of an Australian bird rather like an ostrich. And he added: “Neither of them can go backwards”.

FT Alphaville reacts:


Know who’s also clever? That Gary Jenkins over at Swordfish Research:

Yes Mr Draghi but a cynic might say that the real resemblance between Economic and Monetary Union and an Ostrich and Emu is that it sticks its head in the sand at the sign of trouble and in its current format has little chance of taking off…


2 thoughts on “NEW$ & VIEW$ (16 NOVEMBER 2012)

  1. “In a sharp break from the past, the Fed, as opposed to other holders of US Treasury obligations, has the final say over where Treasury bond yields will reside.”

    Warning…this is the most dangerous false assumption out there today with impact across yield oriented assets.

Leave a Reply

Your email address will not be published. Required fields are marked *