Expect some kind of bailout for Greece

Word this morning is that there will be some kind of bailout for Greece. I would expect it to take the form of a guarantee of Greek sovereign euro debt, with some degree of explicitness and a time limit. They have to roll over about 23 billion euros over the next few weeks.

To those who have pointed out that the ECB has no fiscal authority: quite right, but that’s not what’s needed here. The ECB and other authorities can guarantee Greek debt just as they did with interbank loans during the financial crisis. I keep thinking there’s a role for currency swaps with the Swiss National Bank, but I haven’t heard talk of that from anyone else.

As I’ve pointed out before, this never felt to me like the kind of crisis that would produce another 2008. The Eurozone people have way too much invested here, on two fronts. First, they can’t afford for anyone to question the viability of the euro, and possibly risk higher interest rates across the zone. Second, they can’t afford to let the IMF rescue Greece, because it would look like they don’t have things under control.

It’s almost comical to hear the French and Germans say “the Greeks will have to get their fiscal house in order without a bailout.” Hearing that, George Soros must be getting deja vu. Not to mention eager, hungry rumbles in his stomach.

The other big reason to backstop Greece is to prevent a run on southern Europe. If Greece falls, the blood will be in the water and the feeding frenzy will be on.

And don’t think we won’t get involved, although if I were Obama I’d do what I can to keep it quiet. There’s a fortune to be made for Goldman and Citi, underwriting ECB-protected bonds.

Paul Krugman finally comes up with a good line

His latest starts off by comparing the US to Poland in the late 18th century. If you read Krugman (God only knows why I do), you know he has a total hobby horse about the US being “ungovernable” because Senate rules allow Republicans to prevent Democrats from doing whatever Krugman wants them to do.

Today he literally said that the US is in danger of suffering the fate of Poland, whose territory was partitioned by its three large imperial neighbors because their parliament required unanimity and therefore didn’t succeed in actually making any laws. I guess having a Nobel Prize allows you to present faulty reasoning that Krugman himself would never tolerate from anyone else. Time to start looking over your shoulder at Canada and Mexico: they’re gunning for us.

While scoring the White House for responding weakly to Senator Shelby’s hold on nominations, Krugman did come up with this gem, though: “We know how the Obama administration deals with those who would destroy it: it goes straight for the capillaries.” That was good for a chuckle.

You Wish Tim Geithner were a stronger guy

In a press interview that was recorded a few nights ago and broadcast yesterday, Tim Geithner said the kind of thing you want to hear a Treasury Secretary say: the US will absolutely never lose its Aaa debt rating.

Insofar as debt ratings (from Moody’s or S&P for example) measure credit risk, Geithner is on solid ground. The US can not possibly default on sovereign debt, as a matter of law.  We’ll run the printing presses before we default.

That leads to market risk for US debt, as rates may rise with perceptions of higher inflation. But that doesn’t make sense for at least two reasons.

First, look at the world around you. The dollar has been getting stronger and will probably continue to do so. The US is still the location of choice for storing reserves.

Second, and this is speculative: I believe the US will find a pathway to fiscal discipline. I’ll writing here over the next few days about this, but in short, I think that we’ll find a way to put on the large tax increases necessary to fund a huge expansion in entitlement spending without blowing our fiscal position apart.

One way it might happen is for Democrats to give up the dream of nationalized health care and accept market-oriented reforms. In return, Republicans will give up on large cutbacks in Social Security and Medicare commitments.

There’s one very odd thing that we’ll have to consider if we move toward fiscal discipline: if we issue less debt, then what will the Chinese do with their capital-account surpluses? The standard answer is that they’ll start buying up companies and other assets in the US. There just might be enough political pushback against that to force the Chinese to revalue their currency instead.

But you know, those are all reasons for believing Tim Geithner. He’s not a guy who comes off as having independent force of will or conviction. He always seems to be giving out talking points, and to be carrying water for a president who shows no particular interest in what business needs to thrive.

Reasons are all well and good. But markets look for confidence builders too, and those come from guys with real personal force. If Hank Paulson had said something like “A debt downgrade will absolutely never happen in the United States of America,” you’d be a lot more inclined to believe him.

Be Careful When You Read Economic Scare Stories

Here’s one that just crossed my desk. I didn’t get far before having some big questions.

The piece says that overall US indebtedness is at historic high levels, rising fast, and set to sink our economy permanently. But overall indebtedness isn’t increasing. The private sector has rapidly been deleveraging, a trend that began in 2007.

We’re replacing high-cost private debt with low-cost public debt. That creates its own big problems (primarily misallocation of resources, as the government generally makes bad decisions on how to spend money). But it’s wrong to say that overall debt is growing faster than ever.

Next, there’s a repetition of the standard scare story that 2010 will see another disastrous wave of mortgage defaults, as so-called “option ARMs” reset at higher interest rates. There are many reasons to fear continued instability in housing and commercial real estate this year, but option ARMs resetting isn’t one of them.

Option ARMs generally reset at interest rates calculated as a spread to LIBOR or to a trailing average of short-term US Treasury bill rates. Those rates are now barely above zero, far below the 5% that LIBOR reached in late 2008.

And Ben Bernanke, very well aware of this feature of option ARMs, has kept interest rates at zero in part for this reason. Don’t fear an option ARM explosion in 2010.

A third point made in the piece is that the dollar will collapse. Right now, debt markets are already anticipating higher inflation. You can see it in higher medium and long-term interest rates. If the dollar were getting ready to collapse, then why has it been getting stronger for weeks now?

I stopped reading the piece after three paragraphs.

Friday Afternoon Market Action

Markets have shrugged off the mildly-disappointing jobs report and returned to the dynamic of the past few days. Note and bond rates are down yet AGAIN, stocks are weak, and the dollar is very strong. These are all reverses from early morning trading.

There’s a fairly standard pattern in unsettled times (geopolitically or economically): market participants want to get some sleep over the weekend so they get flat on Friday afternoons. That’s what today’s action looks like to me.

What has markets unsettled going into this weekend? Not the impending snowstorm that will barely touch New York. It’s the fear of a sovereign default (or two) in Europe.

If you want to know what deep yogurt is like, this is it

Japan is up the creek without a paddle. It’s pretty remarkable to hear a Bank of Japan governor saying things that some aggressive hedge-fund guys have been whispering for a while now.

The Japanese political leadership have no ability or desire to cut down on deficit spending. They’ve now gone through most of the past 18 years trying to spend their way out of economic weakness, and they’re deficit-spending big again this year. It’s almost pathetic to hear the BoJ saying that deficits should be for emergencies only.

So now they have a debt load that is 200 percent of GDP. (Ours is now about 50% of GDP and growing fast as lightning. It was about 40% a year ago.)

Japan are financing their debt on the backs of the country’s citizens, who like most Asians tend to save a double-digit percentage of their income. We’re currently saving a bit less than 5%, and have nothing like the savings reserves the Japanese have.

They can keep this up for quite a while longer, but they no longer control their own destiny. If they should ever be forced to pay a higher rate of interest on their public debt (which would happen if Japan’s savers decide they want more than a microscopic return), Japan would be screwed. Their debt payments could easily be larger than their entire current government budget.

Let’s say the US public debt goes from $7.5T now to maybe $16T or more after eight Obama years. Assuming no tax changes and a yield curve that looks like that of early 2007, we’d be paying more in interest than total receipts from the personal income tax, maybe $800 bn a year. That’s also bigger than DoD, and bigger than TARP. (Today’s number, with zero short interest rates, is more like $200 bn.)

That’s the kind of nightmare Japan would face today if yen interest rates were to rise. Japan is in the worst shape, but they’re not unique. Other developed countries, notably in Europe, are facing less-bad versions of the same problem.

Markets can see this coming. The US Treasury yield curve has been steepening. The 10-year note rate traded over 3.70% yesterday.

I Want Some of Whatever David Brooks is Smoking

I’ll admit it. I enjoy reading David Brooks, the columnist who tries to make conservative ideas presentable in polite company. He talks to a lot of interesting people, follows up on interesting ideas, and is literate.

But like most people who marinate in the media’s maelstrom of mushy groupthink, he frequently loses sight of what real life is like. Today, he’s produced a real howler.

Brooks is as much taken with the Tea Party movement as he was with the groundswell of wishful thinking that produced our current administration. While most of our elites dismiss the Tea Party movement as a rabble of bigoted thugs rapidly being taken over by profiteers, Brooks fears it. Accordingly, he’s warned that Obama had better co-opt the Tea Partiers’s message before they tear the country apart, as populist movements have in the past.

This week, Brooks has been thinking about older people. These would be the people that many of you would recognize as grandparents. And grandparents are lovable, not least because they love us. And they want to do things for us. (If you want the sociological terminology for all this, read his column.)

Brooks then goes on to recognize that our society’s commitments to older Americans, quite obviously, are the cause of the impending fiscal disaster that will soon bankrupt our government, and reduce our economic prosperity for the next two decades or so. (Hmm. Maybe seniors are happy because as a class, they’ve gotten a pretty good deal.)

What comes next is the funny part. Brooks thinks that seniors may become energized enough to form a Tea Party movement of their own. They’ll see that we can’t afford our societal commitment to them, and they’ll also see that Washington doesn’t have the nerve to solve the problem by reducing (or at least means-testing) their benefits.

Look out. Those busloads of angry people soon to start pouring into Washington to shiver and demonstrate, will be your grandparents. And they’ll be demanding that our government take away some of what they have, and give it to their children and grandchildren.

Whatever Brooks is smoking, I want some.

Fascinating Story on What Banks Invest In

Last week, I mentioned to several friends that there’s a big set of assumptions built into the behavior of large US banks these days. They’ve spent much of the past year executing an extremely profitable “carry trade.”

Basically, they borrow money on an overnight basis, which the Fed thoughtfully provides to them for free. And then they lend the funds to the US Treasury at substantially higher rates of interest.

They do this by buying the midcurve and long-dated notes and bonds that Treasury issues in gargantuan quantities to fund the budget deficit. The banks are essentially investing in the long end of the yield curve, even as foreign investors and central banks are generally doing the opposite, moving leftward along the curve.

Built into this strategy is an assumption that interest rates will stay low. If there should be an uptick in medium and long rates, these banks will be in a really interesting bind. They’ll either get out of the trade at lightning speed, which would cause a big spike in rates and a break in the stock market. Or else they’ll get stuck sitting on massive capital losses, making them even less able to expand business and consumer lending.

Now this morning, there’s a story about a bank (Wells Fargo) that saw this coming half a year ago, lightened up on the carry trade, and passed on about a billion dollars in trading profits. Other banks are reportedly repositioning now.

This intersects with Fed policy in some ticklish ways. The Fed, of course, directly controls only the shortest interest rates, but undertook to keep midcurve rates low through its “quantitative easing” initiatives that are now nearing their expiration. Medium-term interest rates are the ones with the most impact on how business investments behave in the real economy, and putting downward pressure on them was a way of inducing an economic recovery.

But now that economic indicators are rising, the market may be setting up to decide that inflation will finally make a comeback. (This will be possible even if the recovery does NOT produce a decline in unemployment.) The mere anticipation of this outcome will be enough to raise midcurve rates and make the Fed’s job a lot more complicated.

The US Treasury note and bond market has been violently unchanged since about the middle of January, with lots of near-term volatility but no discernible trend. This trading pattern often portends a coming decline. Keep an eye out for the possibility of significantly higher rates ahead.

Listening to the People: The Party of Opportunity

The stories dominating recent news have a common thread: How can we make the American national government start working again?

Dismay over the Massachusetts special election has given way to good feelings that the president is still good at making speeches, to elation over the Texas-style ass-whuppin’ he is considered to have given Congressional Republicans in their own meeting.

But the undercurrent to all this is a (correct) sense that official Washington has seized up. There’s no evident pathway to passing any major new legislation this year.

It would be churlish of me to point out that much of this is because of procedural miscalculations by Democrats at both ends of Pennsylvania Avenue, and a paralysis born of gathering dread that many of them will lose their jobs this coming November.

Instead, the rapidly-congealing conventional wisdom is that the Republican Party is to blame for the lack of progress. Let’s take this apart a little.

Democrats have controlled Congress since 2006 and the White House since 2009. They’ve long believed that they had a very small window of time in which to push through a massive package of progressive “reforms,” that would move our government into a more commanding and aggressive position in all aspects of national life.

Indeed, one now hears talk in the world’s salons of a “Beijing consensus,” an incipient sense that one-party states, unbeholden to the will of their people and staffed by the best-educated technocrats, are more able to deliver national prosperity than states modeled on our messy democracy.

In a striking way, the thinking beneath this view also appears in the American context. We hear: “We’ve just elected the most popular president in our history, who is still deeply loved by everyone who really matters. We have overwhelming majorities in both houses of Congress. And yet we can’t get anything done!”

In that, what I hear is: “We effectively have one-party rule, at least until time and tide bring a Republican resurgence. So why isn’t the Beijing style working for us?”

It’s easy for the elite classes to ask in disbelief why the Democrats have done so little with their golden opportunity. It’s less easy for them to recognize that, in all our national affairs, the people retain their voice.

And the people speak not only through polls, but at the ballot box. And in our remarkable and unique political system, this has a powerful effect on our elected representatives, who care as much about their own job security as any of the rest of us do.

(Of course, in their craven arrogance, our representatives consider themselves ill-used when people dare to compete against them. For this reason, you should expect to see a legislative attempt to roll back the Supreme Court’s recent Citizen’s United decision, which powerfully affirmed our right to free speech.)

One often-heard corollary to all this is: “Ram through Legislation XYZ regardless of popular sentiment. Then the people will thank us when they see that it is good.” This is a deeply seductive fantasy, born by projecting the technocratic mindset onto the people at large. Elites think that the popular desire is “Do something, anything!” But it really is much closer to “Do the right thing!”

Congressional Republicans are making political hay in this season of spotty sunshine, and they’re doing so by keeping the Democrats from getting anything done. But it doesn’t occur to our elites that this strategy would be a disaster, as it has in the past (the 1995 government shutdown comes to mind), if it didn’t match the mood of the people.

Leave for others to debate the merits of a massive fiscal stimulus to jump-start job creation, far-reaching bank regulation, government plans to seed green industries, health care reform, and of course broad new taxes to pay for the looming entitlement wave.

The people do very much want to see these problems solved. What they’re emphatically telling all of us is: “Don’t spend all of our money in the process.”

This matters greatly, because all of the proposals that elites would like Democrats to simply ram through by dint of overwhelming majority and presidential popularity, depend on massive increases in government spending. Not just deficits, but total spending. For decades, the government has averaged an 18% share of the national economy, but in the past year it suddenly leapt to 24%. Many elites are on record recommending that we go to 28% or even more.

On strictly utilitarian terms, you could well argue that this makes sense. Remember how I formulated the “Beijing consensus” above: authoritarian states are better able to deliver economic prosperity.

But there’s more to national life than economic prosperity, hard as that may be to grasp by elites who seek electoral advantage in a time of widespread economic distress.

The people are telling us that they want the national government to be more frugal with resources that, after all, are delivered to it by the people. The people are saying, in the old-fashioned New York style, “Don’ do me no favors!”

The people are operating from a deep sense, however inchoately expressed, that the salvation of this country is through the people themselves, and how they capitalize on the unique opportunities presented to them just by being Americans.

Americans want to enjoy the blandishments of freedom, a desire that elites discount at their deep peril.
The people don’t want a major revitalization of government power because they sense its limits, its frightening potential for corruption (the root of the anger against “Wall Street banks”), and its ability to bankrupt them for little or no tangible benefit. In short, the Democratic program may not work, and the elites who push it are the very last to see this.

It now looks like we’re going to have a quiet year, legislatively. This isn’t a good thing, as we still face major problems. But from out here in businessland, the continuous flailing over big new legislation looks like more and more uncertainty. And uncertainty paralyzes economic activity.

What will happen if we realign politically this fall, and return a weakened Democratic majority to Congress and the country’s statehouses and legislatures?

Then it will be time to think about legislative solutions that better match the mood of the people: “Get out of our way and let us find our own way to muddle through this!”

This means that next year, the Republicans, God help them, will need to find the leadership ability to partner with Democrats to arrive at lighter-weight, market-oriented solutions to the health care problem, as well as broad-based tax increases to defuse the entitlement bomb.

That will be a start, at least. If it also means handing the current president enough success to make his case for re-election, then so be it. At least we won’t be hearing any more garbage about how a crisis is a terrible thing to waste.

And what about the optics, how this all is presented to the people?

The Democrats are the party of government, of ambitious, expensive programs, and one-party rule by the Beijing Consensus.

What are the Republicans? Well, the elites portray them as the party of no-government. In other words, of anarchy, political bomb-throwing, bigotry, and all the rest.

No. Republicans are and should be the Party of Opportunity. The party that trusts the people’s sense of what is the right role and the right size for government. The party that gets the government out of the people’s way, so we can get back to the business of fixing the economy, providing for our children, and deciding for ourselves what the good life is all about.

The Party of Opportunity. Repeat it to yourself a few more times. And remember it.

Toyota Motor Company Hits a Snag

Very interesting story re Toyota, which as far as I know has now edged out GM as the world’s largest automaker. (They were on track to do that at a 10 million vehicle global-production rate in 2008, when the subject changed abruptly.)

So they recalled and stopped manufacturing eight models in the US, including their two best-sellers, due to quality problems. (To wit, gas pedals that get stuck in the carpeting.) WOW, now that’s cutting off your own balls.

Come to find out that the Obama Administration put them up to it. Transportation Secretary LaHood claimed the scalp, saying that they forced Toyota to do the recall, and Toyota followed up voluntarily with the production halt.

Over in Japan, they’re hand-wringing about the impending demise of Japan’s reputation for world-beating manufacturing. They can stop being drama queens. Japan’s real problem is that it has no visible way of paying the interest on its sovereign debt after interest rates go up.

Nothing wrong with regulators being aggressive on quality issues. But this could have been handled in a less dramatic fashion. Keep in mind that Toyota now has to either furlough or pay out all the Americans who assemble these cars. Obama better not come back to us and tell us he’s pro-business.

The deeper story for Toyota is something they’ve long feared. Their unique (and widely-admired) approach to quality assurance has an inherent scalability problem because it depends fundamentally on their management personnel to be top-quality at all levels of the enterprise. But good managers are almost as hard to find as honest politicians.

Apparently when you’re making 10 million vehicles a year in a raft of different countries, there aren’t enough top-notch managers to go around and you start running with the B team. Toyota has been hitting these intermittent quality issues for several years now.

- February 9, 2010 -

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