Wednesday, June 12, 2013

How Germans Caused The Euro Zone Debt Crisis

By Michael Pettis

One of the reasons that it is been so hard for a lot of analysts, even trained economists, to understand the imbalances that were at the root of the current crisis is that we too easily confuse national savings with household savings. By coincidence there was recently a very interesting debate on the subject involving several economists, and it is pretty clear from the debate that even accounting identities can lead to confusion.

The difference between household and national savings matters because of the impact of national savings on a country’s current account, as I discuss in a recent piece in Foreign Policy. In it I argue that we often and mistakenly think of nations as if they were simply very large households. Because we know that the more a household saves out of current income, the better prepared it is for the future and the more likely to get rich, we assume the same must be true for a country. Or as Mr. Micawber famously insisted:

Annual income twenty pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pound ought and six, result misery.

But countries are not households. What a country needs to get wealthier is not more savings but rather more productive investment. Domestic savings matter, of course, but only because they are one of the ways, and probably the safest, to fund domestic investment (although perhaps because they are the safest, investment funded by domestic savings can also be misallocated for much longer periods of time than investment funded by external financing).

Saving in itself, however, does not create wealth. It is productive investment that creates wealth. Domestic savings simply represent a postponement of consumption.

In a closed economy, total savings is equal to total investment or, to put it differently, whatever we don’t consume we invest (if we produce something that we neither consume nor invest, we effectively write its value down to zero, so the balance remains). In an open economy, if a country saves more than it invests it must export the excess savings. It must also export the excess production.

Notice that by definition if a country saves more than it invests, total consumption plus total savings must be greater than total consumption plus total investment. The former is the sum of the goods and services it creates, whereas the latter is the sum of goods and services it absorbs. That country, in other words, supplies more goods and services than it absorbs, and so it must export the excess.

What is more, by exporting excess savings, the country is providing the funding to foreigners to purchase its excess production. This is why the current account and the capital account for any country must always add up to zero.

In the late 19th Century, as I discuss in my most recent book, economists like John Hobson in the UK and Charles Arthur Conant in the US noticed that the rich countries of the west were exporting large amounts of savings abroad – mostly to what were later called by the dependencia theorists of the 1960s the peripheral nations. Hobson and Conant argued that the reason for this excess savings had to do with income inequality. As more and more wealth is concentrated into the hands of fewer people, consumption rises more slowly than production, largely because the wealthier a person gets, the smaller the share he consumes out of his income. Notice that because savings is simply total production of goods and services minus total consumption, this forces up the national savings rate.

This was a very important insight. Excess savings, they pointed out, was not a result of old-fashioned thrift but rather a consequence of structural distortions in the economy. The consequence of this “thrift”, furthermore, was not greater wealth but rather structural imbalances in the global economy.

In a closed economy there are four ways of resolving the imbalances caused by an increase in the savings rate. First, and most obviously, investment can rise by the same amount.

The private sector, however, may be reluctant to increase investment if it believes the consumption share is declining over the long term, in which case the government can sponsor the increase in investment, for example in infrastructure, so that savings and investment balance at a higher rate. This is sustainable only as long as there are productive investments that can be made, but as consumption declines, the reason for investing should decline too. The purpose of investment today after all is to create consumption tomorrow.

The second way to resolve the imbalance is if the government or the labor unions take steps to redistribute income downwards. As middle class and poor households retain a greater share of total GDP, consumption will automatically rise relative to production (the savings rate declines), even if middle class and poor households save a greater share of their higher income. The savings rate declines to the point at which savings and investment are once again balanced domestically and everything a country makes it consumes or invests.

The third way to resolve this in a closed economy – albeit only temporarily – is to fund a consumption boom among the not-so-rich. How would this work? One way might be, as Conant discusses extensively, that as savings grow faster than opportunities for productive investment in infrastructure and production capacity, more and more of the savings of the wealthy go into speculative investments that drive up asset prices – homes, stocks and bonds. As asset prices rise, households feel richer and they begin to take advantage of the abundance of savings to borrow for consumption, and borrowing is just negative savings.

As home prices or the value of investment portfolios rise there is likely to be not just an increase in consumption but also an increase in investment in new housing. As both of these happen, the reduction in consumption caused by rising income inequality is matched by the increase in consumption caused by credit-fueled purchasing and an increase in housing investment, and once again savings and investment can balance domestically. We saw this happen in the US and in the peripheral countries of Europe in the run-up to the 2007-09 crisis.

The fourth way to resolve the savings imbalance in a closed economy is to force up unemployment (this is what Karl Marx said would eventually happen). As income inequality grows, and so consumption grows more slowly than production, companies are forced to cut production and fire workers. Fired workers of course produce nothing, but they still consume, either out of savings, welfare payments, or handouts from friends and families. This causes total savings to drop so that once again it balances investment, but of course in an economy with rising unemployment, profits are likely to drop, and with lower profits comes reduced investment, so more workers need to be fired and the process can become self-reinforcing.

Open economies have another option

In a closed economy there really aren’t many other ways to balance savings and investment if structural factors force up the savings rate. But we do not live in closed economies. Most of us live in open economies (although the world itself is a closed economy), so there is actually a fifth way to resolve domestic savings imbalances, and this is what Hobson and Conant described as the root source of late 19th Century imperialism.

If domestic savings rates are so high that the country cannot invest it all profitably, it can export those savings, which means automatically that it imports foreign demand for its excess production. Its net export of savings (less net returns on earlier investment) is exactly equal to its net export of goods and services.

In an open economy, in other words, a country’s total savings matters because to the extent that it exceeds investment, it must be exported, and it must result in a current account surplus. Here is where the confusion so many analysts, including economists, have about the difference between national and household savings. Household savings represent the amount out of household income that a household chooses not to consume, and so can be affected by cultural or demographic factors, the existence and credibility of a social safety net, the sophistication of consumer finance, and so on.

The national savings rate, on the other hand, includes not just household savings but also the savings of governments and businesses. It is defined simply as a country’s GDP less its total consumption. While the household savings rate may be determined primarily by the cultural and demographic preferences of ordinary households, the national savings rate is not. Indeed in some cases the household share of all the goods and services a country produces, which is primarily a function of policies and economic institutions, is the main factor affecting the national savings rate.

National savings, in other words, may have very little to do with household preferences and a lot to do with policy distortions. In China, which has by far the highest savings rate in the world, part of the reason for the high national savings rate of course is that Chinese households save a relatively high proportion of their income.

But while China’s savings rate is extraordinarily high, the Chinese household savings rate is merely in line with those of similar countries in the region, and in fact lower than some. Chinese households are not nearly as thrifty as their national savings rate implies. Why, then, is China’s savings rate so extraordinarily high?

The main reason, as I have discussed many times and which now has pretty much become accepted as the consensus among China specialists, is not so much income inequality (although this is certainly a problem in China) but rather the very low household income share of GDP. At roughly 50% of GDP, Chinese households retain a lower share of all the goods and services the country produces than households in any other country in the world.

This is a consequence of policies Beijing put into place many years ago that goose GDP growth by constraining the growth in household income. As a result of these policies, the household share of China’s total production of goods and services has been falling for thirty years, and fell especially sharply in the past decade. It isn’t surprising, consequently, that as households earn a declining share of what China produces, they also consume a declining share. Because savings is simply GDP less total consumption, and most consumption is household consumption, the fall in the household income share of GDP is the obverse of the rise in China’s extraordinarily high savings rate.

Many factors explain this very low household income share in China, including most importantly financial repression, whose characteristics typically include artificially low deposit rates, which, by reducing the amount of money that a saver should earn on his bank deposit, transfers part of his income to borrowers, who are able to borrow very cheaply. In China, this implicit transfer is extremely high, perhaps 5 percent of China’s GDP or more.

Of course the more money that is transferred in this way, the less disposable income the household depositor has, and so he is forced to reduce both his nominal savings and his nominal consumption. We cannot easily predict how this reduced interest rate will affect the household savings rate, but it is pretty easy to figure out how it will affect the national savings rate. If the transfer is substantial, it will reduce the share of GDP retained by households. Unless households reduce their savings rate by more than the reduction in the household share of GDP, it must automatically force up the national savings rate.

Confusing thrift with inequality

China’s extraordinarily high national savings rate, in short, is a function primarily of the extraordinarily low household share of GDP. Even economists who really should know better manage to make some fairly impressive mistakes when they discuss Chinese and other savings imbalances, mostly because their understanding of savings can be hopelessly confused. For a typical example, consider a piece Raman Ahmed and Helen Mees, published last year called, “Why do Chinese households save so much?”

In the article the authors try to address the causes of China’s high savings rate, but they do so by thoroughly confusing national savings with household savings. For example they set out trying to prove that financial repression has no impact on China’s savings rate, but because they fail to understand that financial repression does this by reducing the household share of income, and not necessarily by reducing the household savings rate, they find:

China’s monumental savings rate is a popular topic of for policy discussion.  It has been blamed for the global financial crisis, currency wars, and the ensuing Great Recession. But what explains the high savings rate?

…Although the savings rate varies significantly per income group, with the lowest income group’s savings rate in urban areas in the single digits and the highest income group’s savings rate at almost 40% of disposable income, we do not find evidence that income inequality as such is a motive for households to save a larger portion of their income, as Jin et al. (2010) have suggested. It would have been the Chinese version of ‘keeping up with the Joneses’, albeit that ‘keeping up with the Wangs’ would not have involved conspicuous consumption but rather conspicuous saving. This would have instigated higher savings rates across the board of deciles of savings rates, with the strongest effect on low-income households. However, using urban data on household savings rates and income inequality from 1985-2009, we do not find this effect present.

There is no evidence that the household savings rate in China is high because of low deposit rates, as Michael Pettis (2012) has asserted time and again, which would indicate that the income effect of lower deposit rates trumps the substitution effect of lower deposit rates. The coefficient of the deposit rate has alternating signs, but is insignificant in every single estimate.

The article purports to discuss what they refer to as China’s “monumental savings rate”, which, according to the authors, has been blamed for the global financial crisis, currency wars, and the ensuing Great Recession, but it focuses on the wrong savings rate. Chinese household savings are not by any definition “monumental”, and they most certainly did not cause the global financial crisis, nor does anyone seriously claim that they did. Chinese household savings rates are high, but not exceptionally high, and because household income is such a low share of GDP, Chinese household savings as a share of GDP, which is what really matters, are even lower than the household savings rate would imply. Chinese household savings are not the problem.

It is China’s national savings rate which is “monumental” and which drives China’s current and capital account imbalances, and the national savings rate is monumentally high because the national consumption rate (which consists mostly of the household consumption rate) is extraordinarily low. The authors have either confused national and household savings rates or they have failed to see that what matters is not the household savings rate but rather total savings. Aside from the fact that there is indeed evidence that Chinese savings are negatively correlated with interest rates, for example a 2011 study done by the IMF, the relationship is one of pure logic.

The important lesson from this article, aside from suggesting just how confused many economists are when it comes to understanding the source of global imbalances, is that national savings represent a lot more than the thriftiness of local households, and as such it has a lot less to do with household or cultural preferences than we think. In fact many factors affect the savings rate of a country, including demographics, the extent of wealth inequality, and the sophistication of consumer credit networks, but when a country has an abnormally high savings rate it is usually because of policies or institutions that restrain the household share of GDP.

This has happened not just in China but also in Germany. In the 1990s Germany could be described as saving too little. It often ran current account deficits during the decade, which means that the country imported capital to fund domestic investment. A country’s current account deficit is simply the difference between how much it invests and how much it saves, and Germans in the 1990s did not always save enough to fund local investment.

But this changed in the first years of the last decade. An agreement among labor unions, businesses and the government to restrain wage growth in Germany (which dropped from 3.2 percent in the decade before 2000 to 1.1 percent in the decade after) caused the household income share of GDP to drop and, with it, the household consumption share. Because the relative decline in German household consumption powered a relative decline in overall German consumption, German saving rates automatically rose.

Notice that German savings rate did not rise because German households decided that they should prepare for a difficult future in the eurozone by saving more. German household preferences had almost nothing to do with it. The German savings rate rose because policies aimed at restraining wage growth and generating employment at home reduced household consumption as a share of GDP.

As national saving soared, the German economy shifted from not having enough savings to cover domestic investment needs to having, after 2001, such high savings that not only could it finance all of its domestic investment needs but it had to invest abroad by exporting large and growing amounts of savings. As it did so its current account surplus soared, to 7.5 percent of GDP in 2007. Martin Wolf, in an excellent Financial Times article on Wednesday on the subject, points out that

between 2000 and 2007, Germany’s current account balance moved from a deficit of 1.7 per cent of gross domestic product to a surplus of 7.5 per cent. Meanwhile, offsetting deficits emerged elsewhere in the eurozone. By 2007, the current account deficit was 15 per cent of GDP in Greece, 10 per cent in Portugal and Spain, and 5 per cent in Ireland.

Employment policies and the savings rate

It is tempting to interpret Germany’s actions as the kind of far-sighted and prudent actions that every country should have followed in order to keep growth rates high and workers employed, but it turns out that these policies did not solve unemployment pressures in Europe, and this is implied in the second sentence of Martin Wolf’s piece. Germany merely shifted unemployment from Germany to elsewhere. How? Because Germany’s export of surplus savings was simply the flip side of policies that forced the country into running a current account surplus.

To explain, let us pretend that Europe consists of only two countries, Spain and Germany. As we have already shown, forcing down the growth rate of German wages relative to GDP caused the household income share of GDP to drop. Unless this was matched by a decision among German households to become much less thrifty, or a decision by Berlin to increase government consumption sharply, the inevitable consequence had to be a reduction in the overall consumption share of GDP, which is just another way of saying that the German national savings rate had to rise. During this period, by the way, and perhaps as a consequence of restraining wages, Germany’s Gini coefficient seems to have risen quite markedly, and the resulting increase in income inequality also affected savings adversely.

As German savings rose, eventually exceeding German investment by a wide margin, Germany had to export the difference, which its banks did largely by making loans into the rest of Europe, and especially those countries that were financially “shallower”. Declining consumption left Germany producing more goods and services than it could absorb domestically, and it exported excess production as the automatic corollary to its export of savings.

Of course the rest of the world had to absorb excess German savings and run the current account deficits that corresponded to Germany’s surpluses. This was always likely to be those eurozone countries that joined the monetary union with a history of higher inflation and currency depreciation than Germany – countries which we are here calling “Spain”. As monetary policy across Europe was made to fit German needs, which was looser than that required by Spain, and as German savings were intermediated by German banks into Spain, the result was likely to be higher wage growth, higher inflation, and soaring asset prices in Spain.

In fact this is exactly what happened. Spain and the other peripheral European countries all saw their trade deficits expand dramatically or their surpluses (many were running large surpluses in the 1990s) turn into large deficits shortly after the creation of the single currency as their savings rates shifted to accommodate German exports of its excess savings.

The way in which the German exports of savings were absorbed by Spain is at the heart of the subsequent crisis. As long as Spain could not use interest rates, trade intervention, or currency depreciation to block German exports, it had no choice but to balance the excess of German savings over investment. This meant that either its investment would have to rise or its savings would have to fall (or both).

Both occurred. Spain increased investment in infrastructure and in real estate (and less so in manufacturing, probably because German growth occurred at the expense of the manufacturing sectors in the rest of Europe), but it seems to have done both to excess, perhaps because of the sheer amount of capital inflows. After nearly a decade of inflows larger than any it had ever absorbed before, Spain, like nearly every country in history under similar circumstances, ended up with massive amounts of misallocated investment.

But this was not all. If the savings that Germany exported into Spain could not be fully absorbed by the increase in Spanish investment, the only other way to balance was with a sharp fall in Spanish savings. There are two ways Spanish savings could have fallen. First, as the Spanish tradable goods sector lost out to German competition, Spanish unemployment could rise and so force down the Spanish savings rate (unemployed workers still must consume).

Second, Spain could have reduced household savings voluntarily by increasing consumption relative to income. Higher Spanish consumption would cause enough employment growth in the services and real estate sectors to make up for declining employment in the tradable goods sector.

Raising consumption

Not surprisingly, given the enormous optimism that accompanied the creation of the euro, the latter happened. As German money poured into Spain, helping ignite a stock and real estate boom, ordinary Spaniards began to feel wealthier than they ever had before, especially those who owned their own homes. Thanks to this apparent increase in wealth, they reduced the amount they saved out of current income, as households around the world always do when they feel wealthier. Together the reduction in Spanish savings and the increase in Spanish investment (in infrastructure and real estate) was enough to absorb the full extent of Germany’s export of excess savings.

But at what cost? The imbalance created within Europe by German policies to constrain consumption forced Spain into increasing consumption and boosting investment, much of the latter in wasted real estate projects (as happened in every one of the deficit countries that faced massive capital inflows). There are of course no shortage of moralizers who insist that greed was the driving factor and that Spain wasn’t forced into a consumption boom. “No one put a gun to their heads and forced them to buy flat-screen TVs”, they will say,

But this completely misses the point. Because Germany had to export its excess savings, Spain had no choice except to increase investment or to allow its savings to collapse, with the latter either in the form of a consumption boom or a surge in unemployment. No other option was possible.

To insist that the Spanish crisis is the consequence of venality, stupidity, greed, moral obtuseness and/or political short-sightedness, which has become the preferred explanation of moralizers across Europe begs the question as to why these unflattering qualities only manifested themselves after Spain joined the euro. Were the Spanish people notably more virtuous in the 20th century than in the 21st? It also begs the question as to why vice suddenly trumped virtue in every one of the countries that entered the euro with a history of relatively higher inflation, while those eastern European countries with a history of relatively higher inflation that did not join the euro managed to remain virtuous.

The European crisis, in other words, had almost nothing to do with thrifty Germans and spendthrift Spaniards. It had to do with policies aimed at boosting German employment, the secondary impact of which was to force up German national savings rates excessively. These excess savings had to be absorbed within Europe, and the subsequent imbalances were so large (because German’s savings imbalance was so large) that they led almost inevitably to the circumstances in which we are today.

For this reason the European crisis cannot be resolved except by forcing down the German savings rate. And not only must German savings rates drop, they must drop substantially, enough to give Germany a large current account deficit. This is the only way the rest of Europe can unwind the imbalances forced upon the region in a way that is least damaging to Europe as a whole. Only in this way can countries like Spain stay within the euro while bringing down unemployment.

But lower German savings don’t mean that German families should become less thrifty, only that the average German household should be allowed to retain a much larger share of what Germany produces. If Berlin were to cut consumption taxes, or cut income taxes for the lower and middle classes, or force up wages, total German consumption would rise relative to GDP and so national savings would fall – without requiring any change in the prudent behavior of German households.

To ask Spanish households to be more “German” by saving more is not only impractical in an economy with 25 percent unemployment (it is hard for unemployed workers to increase their savings), it is counterproductive. Lower Spanish consumption can only cause even higher Spanish unemployment, until eventually Spain will be forced to abandon the euro and so regain control of its ability to absorb or reject German imbalances. This abandonment of the euro will be driven by the political process, as those in the leadership (of both main parties) who refuse to countenance talk of leaving the euro lose voters to more radical parties until they, too, come around:

The latest opinion polls show the PP has lost 10 percentage points of support since Rajoy’s election in November 2011. Support for the main opposition group, the Socialists remains unchanged, while backing has been growing for smaller, more radical, parties. More than 68 per cent of Spaniards say the government is doing a bad or very bad job, while the latest official forecast shows that a quarter of the workforce will still be out of work three years from now.

An article in this week’s Economist suggests that Spain is indeed becoming more “German” and so that this is reason for hope:

Is Spain the next Germany? It may not feel like that to the 26% of Spaniards who are unemployed. GDP shrank by 0.8% in the fourth quarter of 2012. Yet in some ways, Spain resembles the Germany of a decade ago, when Gerhard Schröder brought in reforms to turn the sick man of Europe into its strongest economy. The efforts by Mariano Rajoy’s government to loosen labour laws and cut public spending are aimed at a German-style miracle.

…Joachim Fels, chief economist at Morgan Stanley, is one of several backers of the Germany theory. “Spain is doing a lot of the things Germany did ten years ago, but in a much shorter time span and tougher global conditions,” he says, pointing to falling labour costs, rising exports and booming Spanish car factories. But, he adds, “Spain becoming Germany is really a two- to four-year story.”

The global constraints

The problem with this argument may be, however, that the global conditions that allowed Germany to grow by exporting savings to Spain cannot be replicated. If Spain were to make its workers more competitive by reducing wage growth relative to GDP growth, it would implicitly be forcing up its savings rate to generate employment. To whom would Spain export those savings? The world is awash in excess savings, and unlike in pre-crisis days, there are no countries with booming stock and real estate markets willing to fund another consumption binge. This means that Spain and Europe are expecting to recover by exporting unemployment, but to whom?

In fact this is the great worry that Martin Wolf expresses n the conclusion to his article:

A big adverse shock risks turning low inflation into deflation. That would aggravate the pressure on countries in crisis. Even if deflation is avoided, the hope that they will grow their way out of their difficulties, via eurozone demand and internal rebalancing, is a fantasy, in the current macroeconomic context.

That leaves external adjustment. According to the IMF, France will be the only large eurozone member country to run a current account deficit this year. It forecasts that, by 2018, every current eurozone member, except Finland, will be a net capital exporter. The eurozone as a whole is forecast to run a current account surplus of 2.5 per cent of GDP. Such reliance on balancing via external demand is what one would expect of a Germanic eurozone.

If one wants to understand how far the folly goes, one must study the European Commission’s work on macroeconomic imbalances. Its features are revealing. Thus, it takes a current account deficit of 4 per cent of GDP as a sign of imbalance. Yet, for surpluses, the criterion is 6 per cent. Is it an accident that this happens to be Germany’s? Above all, no account is taken of a country’s size in assessing its contribution to imbalances. In this way, Germany’s role is brushed out. Yet its surplus savings create huge difficulties when interest rates are close to zero. Its omission makes this analysis of “imbalances” close to indefensible.

The implications of the attempt to force the eurozone to mimic the path to adjustment taken by Germany in the 2000s are profound. For the eurozone it makes prolonged stagnation, particularly in the crisis-hit countries, highly likely. Moreover, if it starts to work, the euro is likely to move upwards, so increasing risks of deflation. Not least, the shift of the eurozone into surplus is a contractionary shock for the world economy. Who will be both able and willing to offset it?

The eurozone is not a small and open economy, but the second-largest in the world. It is too big and the external competitiveness of its weaker countries too frail to make big shifts in the external accounts a workable post-crisis strategy for economic adjustment and growth. The eurozone cannot hope to build a solid recovery on this, as Germany did in the buoyant 2000s. Once this is understood, the internal political pressures for a change in approach will surely become overwhelming.

As long as it is part of the euro Spain has no choice but to respond to changes in German savings rates. There is nothing mysterious about this process. It is simply the way the balance of payments works, and thrift has nothing to do with it. If Germany does not take steps to force down its savings rate by increasing the household share of GDP, then either all of Europe becomes like Germany, in which case growth slows to a crawl and some other country – maybe the US? – will be forced to resolve Europe’s demand deficiency either through higher unemployment or through higher debt, or Europe must break apart to free Spain and the other peripheral countries from German savings imbalances.

I don’t imagine the rest of the world can absorb demand deficiency from a Germanic Europe, and if Europe tries to force it the result will almost certainly be an eventual collapse in trade relations, so either Germany rebalances or Europe breaks apart. It is hard for me to see many other options.

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Bismarck versus Bismarck

by Yannos Papantoniou

ATHENS – The centrality of Germany to Europe and, more widely, to world affairs has been amply, and often bloodily, demonstrated over many centuries. Indeed, Germany’s strategic position at the heart of Europe, as well as its huge economic and military potential, made it first a prize to be sought, and then, following Otto von Bismarck’s completion of German unification in 1871, a nation-state to be feared. Bismarck’s legacy was a Germany that dominated European politics until the end of World War II.

This illustration is by Paul Lachine and comes from <a href=""></a>, and is the property of the NewsArt organization and of its artist. Reproducing this image is a violation of copyright law.

Illustration by Paul Lachine

That legacy is now reasserting itself. After the interlude of the Cold War, during which Germany served as the center of discord between East and West, reunification permitted the reassertion of German power within the context of the European Union and, most notably, the eurozone. Today, however, the question is whether Germany is ready and willing to provide leadership in the conduct of the EU’s affairs – and, if so, to what end.

Europe is currently facing its most challenging crisis of the postwar period. After six quarters of recession, the slump is spreading to the eurozone’s core countries. Unemployment, above 12% on average, is at a record high. In Spain and Greece, more than one-quarter of the labor force is jobless, while the unemployment rate hovers around 60% among young people. Despite harsh austerity, large fiscal deficits persist, and banks remain undercapitalized and unable to support a sustained economic recovery.

Social malaise is deepening as expectations – and actual prospects – for economic improvement are likely to remain poor for the foreseeable future. Faith in the European project is declining, and, given the eurozone’s lack of cohesion, stagnation and recession may lead to popular rejection of the EU, accompanied by serious challenges to democracy, including the rise of neo-fascist parties.

And yet, despite the risks, European leaders remain remarkably inactive, apparently reassured by European Central Bank President Mario Draghi’s promise to do “whatever it takes” to protect the monetary union from collapse. But prolonged inaction, induced by relative calm in financial markets, will perpetuate stagnation and eventually lead to a breakup of one sort or another. Either gradual attrition, with weaker countries defaulting, will lead to a more restricted German-led club of “virtuous” countries, or Germany itself will choose to pursue a policy of narrow fiscal advantage by seceding from the eurozone.

The political and economic weakness of France and Italy, together with Britain’s gradual withdrawal from EU affairs, highlight Germany’s key role in rescuing the eurozone from the current crisis. But true leadership requires a sense of direction and a willingness to pay up, and, here, Germany has lately been found wanting.

Despite German Chancellor Angela Merkel’s evident political skills and high domestic standing, her government lacks a concrete design for “ever closer Union” in Europe. As a result, it, too, is in a weak position to mobilize the resources and competences required to restore Europe. Instead, Merkel’s Germany has been doing as little as possible, as late as possible, to prevent the euro’s collapse.

This policy cannot endure for long. Either stagnation will lead to the eurozone’s breakup, or circumstances will force a policy change.

So, in which areas must Germany lead? First, European public debt should be partly and gradually mutualized. National banking systems should be unified, in order to separate private losses from sovereign debt, with centralized supervision and resolution authorities, as well as a deposit-insurance scheme, forming the core of a European banking union. Strong central institutions, responsible to a directly elected parliament, are needed to coordinate fiscal and economic policies.

In the shorter term, the single market should be extended to services, and free-trade arrangements should be promoted either multilaterally or bilaterally with major trading partners such as the United States. Austerity should be eased, particularly in the fiscally stronger core economies, and substantial resources should be devoted to boosting youth employment and investment in small and medium-size firms in the over-indebted countries.

Germany’s reluctance to lead on these issues partly reflects historical inhibitions, which are always difficult to overcome. The persistence of pre-Keynesian orthodoxy in German economic thought, with its moral abhorrence of the “sin of borrowing” (and thus its neglect of aggregate demand), does not help, either. The federalist structure of Germany’s political system, moreover, favors parochial approaches over grander designs.

Nonetheless, Germany must accept that the alternative to a democratically unified currency union is German economic hegemony. In the longer run, that outcome would destroy the common European project, in turn undermining Germany’s own economic prosperity and strategic security – a Bismarckian scenario from which Bismarck would have recoiled in horror.

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Fierce Selloff in Emerging Market Currencies; India Intervenes to Stop Plunge in Rupee; Brazil Steps Up Real Intervention; Root Cause of Crisis

by Mike "Mish" Shedlock

I's hard not to laugh at the irony of recent central bank currency actions.

  • After complaining for years about the strength of the Real, the Brazilian central bank stepped up intervention actions hoping to stop a plunge in the currency.
  • Turkey now attempts to attract capital after taking measures for the past four years to stop the flow of money into the country.
  • In India, the central bank seeks to stop a plunge in the Rupee which is at a record low of record low 58.95 to the dollar.

The Wall Street Journal reports Emerging-Market Currencies See Turnaround After Hefty Losses
The South African rand and other emerging-market currencies reversed course to gain against the dollar Tuesday after suffering heavy losses earlier in the session.
These currencies have plummeted rapidly in June, dragged down by expectations the Federal Reserve will taper its bond-buying program later this year. Ultra-accommodative U.S. monetary policy had helped drive investors to seek higher yields in emerging markets in recent years, analysts say.
India's central bank dove into foreign exchange markets Tuesday to stop the rupee's slide at a record low of INR58.95 to the dollar. Pressured to attract capital to the country, a top Indian economic official promised a new round of measures to allow foreign investment in currently restricted parts of the economy. The rupee pared losses against the dollar but still fell 0.3% on the day to trade at INR58.34 per dollar.
Turkey's central bank on Tuesday announced new measures to attract capital after spending much of the past four years trying to stop too much money from flooding into its economy. That helped to stem the lira's fall to near a multi-year low against the dollar as police moved in on protesters in Istanbul. Turkey's capital measures echoed Brazil's move earlier this month to eliminate a 6% tax on foreigners' bond investments.
Brazil's central bank stepped up intervention in the face of the rapid currency depreciation that began on May 28, with a series of foreign exchange swap auctions, including two on Tuesday.
Emerging Market Assets Suffer in Fierce Sell-Off
The Financial Times reports Emerging market assets suffer in fierce sell-off.
Emerging market currencies, stocks and bonds suffered a fierce sell-off on Tuesday on rising investor concerns over the prospect of the US Federal Reserve reining in its programme of bond-buying to drive down long-term interest rates.
The South African rand and the Brazilian real touched four-year lows against the US dollar on Tuesday, and the Indian rupee fell to a record low. Even relatively robust countries like the Philippines and Mexico – long favourites of investors – have been hit by a spate of selling.
The FTSE Emerging Markets index fell 1.7 per cent on Tuesday, taking its decline since its May peak to more than 10 per cent. Shares in Brazil – one of the four big emerging markets – closed 3 per cent in São Paulo on Tuesday. That pulled Brazilian shares into bear market territory – a drop of more than 20 per cent from a peak this year.
Both international and local currency emerging market bonds have been pummelled, sending borrowing costs higher.
Benoit Anne, a senior strategist at Société Générale, said central bank money had arguably inflated a bubble in emerging markets, which was now unravelling as investors priced in a change in Fed policy. “This will not be a short-lived sell-off,” he predicted.
Emerging market fund managers have also been hit by investor redemptions. Asset managers that focus on international bonds last week suffered the biggest investor withdrawal since mid-2007, according to EPFR. Emerging market equity funds were hit with the biggest redemptions since 2011. 

Cause of the Selloff
Both the Financial Times and the Wall Street Journal pinned the blame on the possibility the Fed would stop its QE programs later this year.
I rather doubt that is the cause, and I also doubt the Fed is going to stop QE any time soon.
Instead, I propose this is what happens when bubbles burst. And a huge part of numerous bubbles was widespread belief the growth in China and India will last forever. Hot money plowed into emerging market countries and also commodity producing countries.
Australia is another casualty of the coming bust of China. For details please see Australian Dollar Plunges as Home Loans Dive; Australia Insolvencies Hit Record; Worst is Yet to Come.
To be sure insane amounts of liquidity fueled various bubbles in stocks, in bonds, in emerging markets, but with the global economy rapidly slowing, and with much of Europe in an outright economic depression, the Fed is not that likely to curtail QE soon.
If the Fed does slow QE, it will not be because the US economy is strengthening, but rather realization by the Fed (not admitted of course) that various stock and bond market bubbles pose serious economic risks if allowed to grow bigger.
Root Cause of Crisis
By the way, all this extremely volatile currency action, as well as various equity and bond market bubbles, can be pinned entirely on central banks, fractional reserve lending, and lack of a gold standard.

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Bad Chart: Hedge Funds’ Long Term Gains

by Barry Ritholtz

Source: Moneybeat

I have been in the midst of a big research project that has led to me looking askance at the claims and long term returns of hedge funds.

It began with the research I did for Romancing Alpha, Forsaking Beta, and has led to other interesting places. But as we have learned, some things are not as they appear.

The chart above is a case in point

This is one of those return charts that looks impressive when you first see it, but once you delve deeper you learnt hat it is actively misleading.

It is a time weighted return series, and as such, shows the annual returns of managers regardless of assets under management (AUM).A more honest display would be an asset weighted return series.

Here is why: Imagine a manager who is up 10% every year for 9 years, then down 30% in year 10.  You might think he is creating a lot of Alpha and net net has created a lot of wealth.

But having done some research, I now know quite a few things I did not last year:

1. The Hedge fund industry has swollen, from barely $100B to well over $2T from 1997 to 1012;

2. Hedge fund managers ability to create Alpha typically is inverse to their size;

3. The distribution of Alpha is nonGaussian (not a smooth bell curve)

4.  In 2008, Hedge funds lost all of the profits they had previously made (and then some). Add in 2&20% and hedgies are a poor bet for most investors.

(Note: We haven’t even touched upon all of the errors that are on the Hedge fund index — survivorship bias, backfill problem, self reporting issues, etc.).

Which brings us back to our theoretical manager 10% for years with a 30% loss in year 10: Imagine he is a John Paulson like manager, who did really well until he hit the wall.

His best years were when the firm was small — up 10% when its a $50-$150 million fund. His gains are low millions, even 10s of millions. Then after a few big rounds of publicity, the funds he manages swell to several billion dollars. Down 30% wipes out all of the gains of the prior decade — and then some — in asset weighted series.

But in a time-wighted series, he looks pretty good.  Its an epic fail, a colossally misleading returns .

Which is of course why so many managers love them!

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This would be the “Perfect Storm” for portfolios!

by Chris Kimble


"The Perfect Storm" for most portfolios would be... stocks and bonds fall at the same time!

The above 2-pack reflects a couple of key support lines for bonds and stocks are being pushed on very hard!  If this action continues, it would hurt the value of many portfolios!

This odds of this happening are very low....the impact would be very large if the breakdowns take place!

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Corn prices tumble as US stands by big crop idea


Corn prices spiked lower, dragging on soybean and wheat futures too, after US farm officials, in a reassessment of harvest prospects, made only a token cut to their production estimates despite the dismal sowing conditions.

US Department of Agriculture officials acknowledged the setbacks to growers from persistent rains which have left farmers behind on planting corn, despite them managing a record week for sowing progress during a window of dryness in mid-May.

"Despite rapid planting progress during mid-May across the Corn Belt, rains and cool temperatures since have delayed the completion of planting in parts of the western Corn Belt," the USDA said in its much-watched monthly Wasde report on world crop supply and demand.

The delays have "raised the likelihood that seasonally warmer temperatures and drier conditions in late July will adversely affect pollination and kernel set in a larger share of this year's crop".

Pollination is a heat-sensitive period of development for US corn crops – one reason that farmers prefer to sow early, to cut the chances of crop reaching this stage during high summer temperatures.

Smaller-than-expected downgrade

However, the USDA made only a small cut to its forecast for the US corn yield this year, by 1.5 bushels per acre to 156.5 bushels per acre, a lower downgrade than many analysts had expected.

And it made no downgrade at all to the estimate for US corn area, defying market expectations that 2m-3m acres will be either abandoned, and claimed on prevent plant insurance, or switched to later seeded crop such as soybeans.

The overall impact was to cut the harvest estimate by 135m bushels to 14.0bn bushels, well above the 13.8bn-bushel figure that investors had expected, according to a survey.

Thanks to downgrades to consumption estimates, the impact on the forecast for end-2013-14 US corn stocks was even less, a downgrade of 55m bushels to 1.949bn bushels, well above the market consensus of a 1.83bn-bushel figure.

Market reaction

The stocks figure is particularly closely watched by investors as a guide to the availability of supplies, and thus the urgency for buyers to pay up for coverage.

With supplies higher than forecast, the impact was to send Chicago's new crop December corn futures contract tumbling more than 3% immediately after the data were released, to $5.32 ¼ a bushel.

The contract recovered a little ground to stand at $5.38 a bushel at 11:45 local time (17:45 UK time), a drop of 2.3%.

Old crop July futures also lost ground, down 1.1% at $6.52 a bushel, depressed by a small upgrade to the estimate for US Inventories at the end of 2012-13, thanks to a further cut to hopes for exports to 700m bushels.

Mixed signals

Soybeans emerged from the Wasde with fundamentals little altered, as investors had expected, while changes to wheat estimates held support for both bulls and bears.

The USDA surprised investors by upgrading its estimate for this year's US wheat harvest by 23m bushels to 2.08bn bushels, rather than making a small downgrade to account for perceived weather setbacks to crops.

In fact, "higher yields boost forecast production of hard red winter wheat in the Southern and Central Plains and soft red winter wheat across the South and Midwest," the USDA said, with the harvest now in its early stages.

However, farm officials lifted by 50m bushels their estimate for exports, leaving the end-2013-14 stocks figure at 659m bushels, close to where investors had expected it.

And they hacked 5.2m tonnes from their estimate for the world wheat harvest, leaving it 695.9m tonnes – only just above the consumption forecast, meaning little increase in, albeit comfortable, world inventories next season.

'Persistent dry weather'

The world wheat downgrade reflected downgrades to crops in the European Union, Russia and Ukraine, contrasting with some more upbeat comments from within these areas themselves.

Germany's farm co-operatives' association, for instance, on Wednesday lifted its estimate for the domestic wheat harvest, with Ireland and the UK being seen by many commentators as alone in possessing poor output prospects.

"European Union production is lowered 1.3m tonnes with small reductions in a number of member countries," the USDA said.

For the former Soviet Union states, it said that "persistent dry weather in key growing areas of south eastern Ukraine and adjoining areas of southern Russia reduces production prospects 2.5m tonnes and 2.0m tonnes, respectively."

Price moves

Wheat prices extended declines after the data, but failed to match fellow grain corn in standing 1.9% lower at $6.83 ¾ a bushel.

Soybeans for November were 1.2% down at $13.11 ¼ a bushel with the old-crop July lot up 0.4% at $15.46 a bushel.

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The Ultra-Easy Money Experiment

by William Whiteby

BASEL – The world’s central banks are engaged in one of the great policy experiments in modern history: ultra-easy money. And, as the experiment has continued, the risk of failure – and thus of the wrenching corrections and deep economic dislocations that would follow – has grown.

This illustration is by Paul Lachine and comes from <a href=""></a>, and is the property of the NewsArt organization and of its artist. Reproducing this image is a violation of copyright law.

Illustration by Paul Lachine

In the wake of the crisis that began in 2007, policy rates were reduced to unprecedented levels, where they remain today, and measures were taken to slash longer-term rates as well. Nothing like it has ever been seen before at the global level, not even in the depths of the Great Depression. Moreover, many central banks’ balance sheets have expanded to record levels, although in different ways and for different rationales – further underscoring the experimental character of the monetary easing now underway.

The risks implied by such policies require careful examination, particularly because the current experiment appears to be one more step down a well-trodden path – a path that led to the crisis in the first place.

Beginning with the sharp monetary-policy easing that occurred following the 1987 stock-market crash, monetary policy has been used aggressively in the face of every economic downturn (or even anticipated downturn) ever since – in 1991, 1998, 2001, and, with a vengeance, following the events of 2007. Moreover, subsequent cyclical tightening was always less aggressive than the preceding easing. No surprise, then, that policy rates (both nominal and real) have ratcheted ever downward to where they are today.

It can, of course, be argued that these policies produced the “Great Moderation” – the reduction in cyclical volatility – that characterized the advanced market economies in the years leading up to 2007. Yet it can also be argued that each cycle of monetary easing culminated in a credit-driven “boom and bust” that then had to be met by another cycle of easing. With leverage and speculation increasing on a cumulative basis, this whole process was bound to end with monetary policy losing its effectiveness, and the economy suffering under the weight of imbalances (or “headwinds”) built up over the course of many years.

The Swedish economist Knut Wicksell raised concerns about such problems long ago. He suggested that a money rate of interest (set in the banking system) that was less than the natural rate of interest (set in the real economy) would result in inflation. Later, economists in the Austrian tradition noted that imbalances affecting the real side of the economy (“malinvestments”) were of equal concern.

Later still, Hyman Minsky contended that credit creation in a fiat-based monetary economy made economic crises inevitable. Finally, many economists in recent decades have identified how excessive leverage can do lasting damage to both the real and financial sides of the economy.

Looking at the pre-2007 world, there was ample evidence to warrant such theoretical concerns. While globalization was holding down inflation, the real side of the world economy was exhibiting many unusual trends. Household saving rates in the English-speaking economies fell to unprecedented levels. Within Europe, credit flows to peripheral countries led to unprecedented housing booms in several countries. In China, fixed capital investment rose to an astonishing 40% of GDP.

Moreover, similar unusual trends characterized the financial side of the economy. A new “shadow banking” system evolved, with highly pro-cyclical characteristics, and lending standards plummeted even as financial leverage and asset prices rose to extremely high levels.

The monetary policies pursued by central banks since 2007 have essentially been “more of the same.” They have been directed toward increasing aggregate demand without any serious concern for the unintended longer-term consequences.

But it is increasingly clear that ultra-easy monetary policy is impeding the necessary process of deleveraging, threatening the “independence” of central banks, raising asset prices (especially for bonds) to unsustainable levels, and encouraging governments to resist making needed policy changes. To their credit, leading central bankers have stated repeatedly that their policies are only “buying time” for governments to do the right thing. What is not clear is whether anyone is listening.

One important impediment to policy reform, on the part of both governments and central banks, is analytical. The mainstream models used by academics and policymakers differ in important respects but are depressingly similar in others. They emphasize short-term demand flows and presume a structurally stable world in which probabilities can be assigned to future outcomes – thus almost entirely ignoring uncertainty, stock accumulations, and the financial imbalances that characterize the real world.

Recalling John Maynard Keynes’s dictum that “the world is ruled by little else” but “the ideas of economists and political philosophers,” perhaps policymakers need new ideas. If so, the immediate prognosis for the global economy is not good. The latest fashion in policy advice is essentially still more of the same.

The call for “outright monetary financing” involves raising government deficits still further and financing them through a permanent increase in base money issued by central banks. Targeting the level of nominal GDP (or the unemployment rate, as in the United States) is a way of convincing financial markets and potential spenders that policy rates will remain very low for a very long time. All of these policies run the risk of higher inflation and/or still more dangerous economic imbalances.

Sadly, a fundamental mainstream reassessment of how the economy works is by no means imminent. It should be.

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Europe’s Way Out

by Dani Rodrik

CAMBRIDGE – It seems that austerity is out of fashion in the eurozone – at least for the moment. The European Commission has given Spain, France, and the Netherlands more time to comply with the European Union’s 3%-of-GDP deficit ceiling. Even German government officials now concede that something more than fiscal belt-tightening is needed to revive the economies of the eurozone periphery.

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Illustration by Margaret Scott

According to the Commission, that “something more” is structural reform: easing of firing restrictions and other labor-markets regulations, liberalization of closed professions, and removal of controls on markets for goods and services.

But this is merely old wine in a new bottle. From the outset of the eurozone crisis, the “troika” (the Commission, the International Monetary Fund, and the European Central Bank) insisted on such structural reforms as part of any financial-assistance package. Greece, Spain, and the others were told all along that these reforms were needed to spur productivity and competitiveness and help revive growth.

After three years, Greece’s experience is telling. As a new IMF report acknowledges, structural reforms there have failed to produce the intended effects, partly because they ran up against political and implementation difficulties, and partly because their potential to increase growth in the short run was overstated. Nor have Spain’s labor-market reforms worked as expected.

None of this should come as a surprise. Structural reform increases productivity in practice through two complementary channels. First, low-productivity sectors shed labor. Second, high-productivity sectors expand and hire more labor. Both processes are needed if the reforms are to increase economy-wide productivity.

But, when aggregate demand is depressed – as it is in Europe’s periphery – the second mechanism operates weakly, if at all. It is easy to see why: making it easier to fire labor or start new businesses has little effect on hiring when firms already have excess capacity and have difficulty finding consumers. So all we get is the first effect, and thus an increase in unemployment.

There is little new in the European Commission’s approach, and few reasons to be optimistic that its “new” strategy will work better than the old one. Structural reform – however desirable it may be for the longer term – simply is not a remedy for these countries’ short-term growth conundrum.

The eurozone periphery suffers from both a stock problem and a flow problem. It has too large a debt stock, and too little competitiveness to achieve external balance without significant domestic deflation and unemployment. What is required is a two-pronged approach that targets both problems simultaneously. The prevailing approach – targeting debt through fiscal austerity and competitiveness through structural reform – has produced unemployment levels that threaten social and political stability.

So, what can be done differently?

The most direct way to address the debt problem is a write-down, coupled with recapitalization of those banks that will suffer large losses as a result. This may seem extreme, but it simply recognizes the reality that much of the existing debt will not be paid back without new flows of official financing. As the IMF now acknowledges, it might have been better to restructure Greek debts from the outset than to engage in a “holding operation.”

Debt reduction by itself clears the way for growth, but does not directly trigger it. Policies that directly target expenditure rebalancing within the eurozone and expenditure switching within the peripheral economies are also needed. These include: policies to boost eurozone-wide demand and stimulate greater spending in creditor countries, especially Germany; policies that aim to reduce non-tradable prices; income policies to reduce the peripheral economies’ private-sector wages in a coordinated fashion; and a higher ECB inflation target to allow room for movement in the real exchange rate via nominal changes.

These policies would require Germany to accept higher inflation and explicit bank losses, which assumes that Germans can embrace a different narrative about the nature of the crisis. And that means that German leaders must portray the crisis not as a morality play pitting lazy, profligate southerners against hard-working, frugal northerners, but as a crisis of interdependence in an economic (and nascent political) union. Germans must play as big a role in resolving the crisis as they did in instigating it.

France will most likely play a critical role as well. France is big enough that if it threw its support fully behind the peripheral countries, Germany would be isolated and would need to respond. But, so far, France remains eager to separate itself from the southern countries, in order to avoid being dragged down with them in financial markets.

Ultimately, a workable European economic union does require greater structural homogeneity and institutional convergence (especially in labor markets) among its members. So the German argument contains a kernel of validity: In the long run, EU countries need to look more like one another if they want to inhabit the same house.

But the eurozone faces a short-term problem that is much more Keynesian in nature, and for which longer-term structural remedies are ineffective at best and harmful at worst. Too much focus on structural problems, at the expense of Keynesian policies, will make the long run unachievable – and hence irrelevant.

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The bumpy road to transparency in Spain

By José Javier Olivas and Fabrizio Scrollini


The current Euro Crisis has unveiled many political and institutional deficiencies in Spain. Among them, the lack of transparency and free access to public information is one of the most serious. In modern democracies public scrutiny is a fundamental element for good governance. Transparency empowers the citizenship and civil-society to keep the government in check. Many of the problems that have contributed to the built-up of the crisis in Spain (and other European countries), such as opacity in public procurement, absence of reliable policy evaluations, mismanagement of public expenditure and corruption, have been enabled  and aggravated by the lack of transparency. Numerous voices within the Spanish polity, media and civil society are now criticising the passivity of the Spanish governments to redress this situation. They are claiming the pressing need for a new much more ambitious legal framework of access to public information. The Euro Crisis is certainly creating a window of opportunity for reforms such as this one and Rajoy’s government seems to be increasingly willing to implement it. Despite the many obstacles and mixed signals from the government there is still hope. The new law for transparency could become the first step into a real process of institutional regeneration in Spain.

The long siesta of transparency

Transparency has been in the agenda for a long time in Spain, albeit in a ‘dormant’ mode. The strong legacy of the Francoist Law of Official Secrets enacted in 1968 (and only superficially amended in 1978) has decisively contributed to a comparatively very opaque public administration.  To redress this situation, in 2004 Spanish Prime Minister José Luis Rodríguez Zapatero, promised a   transparency law that would enable citizens to request information from public authorities fostering democratic control and accountability. However after much foot-dragging, in 2011 the government announced that the Transparency Law was not a priority anymore for the government. Mr Rodríguez Zapatero‘s party lost the election and the law was never passed.

The failure to enact an access to information law has left Spain in uncomfortable situation. Spain has the dubious honour of being among the three countries (with Luxembourg and Cyprus) not having an access to information regulation in the European Union.  Furthermore in the Ibero-American context, while Spain was once considered an example to follow, now it has been surpassed by countries such as Mexico, Chile or Uruguay.  Transparency activists and civil liberties advocates, such as those  working  in the Pro-Access Coalition, have repeatedly denounced the deficiencies of the initial drafts of the transparency law and the backwards situation of Spain evidenced by the international transparency studies such as those of Access Info, OSCE Representative on Freedom of the Media and Transparency International.

The current situation is in many ways regrettable, as the experience website shows. The website allows Spanish citizens to ask questions to public authorities and the rate of reply is very low. Some of the replies range from patronizing citizens to almost insult them. In a recent development David Cabo the director of the NGO Civio, requested the public expenditure from the Spanish Parliament, and after ignoring his request, the Parlament formally denied the information. The information was finally leaked but in any case transparency, which is a fundamental premise of liberal democracy, was ultimately undermined.

In this context, the new Prime Minister Mariano Rajoy’s government recently joined the Open Government Partnership, an alliance that seeks to improve participation, collaboration and transparency among country members. In this context the Spanish government promised a new transparency law which would certainly add respectability to his membership. This new law could pave the way for other initiatives much needed to regain the public’s trust. Nonetheless once more the path seems full of obstacles to test the real government’s determination to improve transparency.

A race with many hurdles

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Paradoxically the first hurdle is the secrecy in the drafting of the transparency law. Even when the government is moving forward with the agenda, there is much to be done in terms of increasing consultation with other stakeholders such as civil society organisations. The Spanish government has drafted this law mainly behind closed doors receiving advice from a small group of experts and not opening up to dialogue. Of course, dialogue and consultation are no guarantees of better laws, but a transparency law designed to generate trust in the public, should be at least discussed with the public.  The government has been recalcitrant in terms of not releasing data about several issues such as the implementation of the convention on the fight against corruption, and even the recommendations received from the Chilean Transparency Council on drafts about the law. Oddly enough, the Chilean Transparency Council released the advice under its own law, allowing Spanish people to know better what the Spanish government was planning.  Consultation is not an easy thing to do, but there is so much to be gained from free and frank exchange of opinions about the best way to go forward.

The second obstacle comes from the exceptions to disclose public information. Every transparency law has exceptions such as national security, international relations etc., and those are the rules of the game. Yet the exceptions need to be interpreted in ways that do not thwart the original goal of the law. Furthermore, exceptions should not be absolute: a public interest test should also apply. For instance the fact that information requested is about national security should not mean per se that it should be excluded, but the law should mandate that Spanish government consider if it is really necessary to withhold information, or if it is more to be gained from its release, even if it falls under this category. The fact that the government wants to exclude the drafts and reports used to make decisions from the transparency law is somewhat worrisome.

The institutional resistance to comply with the transparency law has become another salient issue. The main institutions in Spain such as the political parties, trade unions and business associations, the Royal Family and the Bank of Spain are confirmed to be included in the law. However the details on their inclusion are still far from clear and some of these institutions have already expressed their reticence to be subject to the new transparency law.

Finally, institutional design is usually the Achilles heel of several transparency regulations. Good laws without guardians to enforce them are usually a major source of frustration. Spain seems to be opting for a specialist independent institution, the Transparency Council, to move forward this policy. This is good news, and the government should make sure that appropriate funding, a smooth process to solve conflicts and clear competences covering all public sector bodies is in place. This is particularly important in the case of the multi-layered and decentralise Spanish administration.

A new hope?

Transparency cannot be considered as a magical solution to all political problems in Spain. But in the current context of deep institutional crisis, a new ambitious transparency legal framework can be construed as a basic condition to advance into an era of better governance. Transparency and public access to information can help implicating again the disenchanted citizenship in politics. Transparency would certainly strengthen Spanish civil-society and citizens by providing them with more information to monitor and judge the action of the public administration and political actors.

As mentioned above, this reform is likely to continue facing resistance during the drafting process and later at the time of its implementation. Public administrators and political actors may find it unsettling to give up the ‘opacity shield’ that for so many years they have wielded to defend their discretionary powers.  However there are also incentives that can facilitate such a decisive action now. The enactment of an ambitious transparency law would show the government’s commitment to make durable changes. This would be a sign of leadership and credibility vis-à-vis not only its Spanish voters but also the troika and foreign investors who are so closely examining the government’s performance. A wider ‘pact for transparency’ including the main political, social and economic actors although difficult to reach could become a solid ground for a much needed democratic regeneration process in Spain. The question remains whether inertia, party tactics and short-termism can be outweighed by compromise and consensus building.  A test for Rajoy’s leadership, is to live up to this challenge.

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Coffee falls on Brazilian real weakness, big supplies

By Jack Scoville


General Comments: Futures were lower in New York on speculative selling tied to weakness in the Brazilian real, and weakness continued in London due to ideas of big supplies from producers, mostly from Vietnam. Arabica cash markets remain quiet right now and roasters in the US are showing little interest in buying. However, there is very little on offer and that fact has helped hold prices at current levels. There is talk of increasing offers of Robusta from producers as they apparently did not sell when prices were much higher. However, the Arabica market does not show any real changes. Most sellers, including Brazil, are quiet and waiting for differentials or futures to get stronger, and mostly are waiting for futures to move higher. Buyers are interested on cheap differentials. Brazil weather is forecast to show dry conditions, but no cold weather. Current crop development is still good this year in Brazil. Central America crops are seeing good rains now. Colombia is reported to have good conditions.

Overnight News: Certified stocks are near unchanged today and are about 2.746 million bags. The ICO composite price is now 120.48 ct/lb. Brazil should get dry weather. Temperatures will average near to above normal. Colombia should get scattered showers, and Central America and Mexico should get showers. Temperatures should average near to above normal.

Chart Trends: Trends in New York are mixed. Support is at 125.00, 122.00, and 119.00 July, and resistance is at 130.00, 133.00, and 135.00 July. Trends in London are down with objectives of 1800 and 1765 July. Support is at 1800, 1770, and 1740 July, and resistance is at 1830, 1845, and 1865 July. Trends in Sao Paulo are mixed. Support is at 155.00, 153.00, and 150.00 September, and resistance is at 161.50, 166.00, and 170.00 September.


General Comments: Futures were higher in nearby months on ideas that short term supplies available to the market here are very hard to find. Traders are talking about a squeeze right now. The crop progress and condition report was disappointing for the bears as progress remains behind and conditions were lower than expected. Even so, new crop months had trouble rallying as traders waited for a new round of supply and demand estimates from USDA that will be released later today. Trends are up. Ideas of good weather for US crops are still around. Traders are worried about Chinese demand, but there is talk that overall demand increased in the last week. The weather has improved, but it is still too dry in Texas and drier weather is needed for the Delta and Southeast. Dry conditions are forecast for the Delta and Southeast, and dry and warm weather is expected in Texas. Weather for Cotton appears good in India, Pakistan, and China.

Overnight News: The Delta and Southeast will see dry conditions. Temperatures will average above normal. Texas will get dry weather. Temperatures will average above to much above normal. The USDA spot price is now 84.08 ct/lb. ICE said that certified Cotton stocks are now 0.533 million bales, from 0.528 million yesterday.

Chart Trends: Trends in Cotton are up with objectives of 9140 and 9550 July. Support is at 86.50, 85.00, and 84.75 July, with resistance of 91.15, 91.60, and 92.15 July.


General Comments: Futures closed mixed as traders got ready for the USDA reports that will be released later today. USDA could show another drop in production by 1.0 million boxes. Traders are wrestling with more reports of losses from greening disease on the one side and beneficial rains that have hit the state on the other. Greening disease and what it might mean to production prospects continues to be a primary support item and will be for several years. Temperatures are warm in the state. The Valencia harvest is continuing. Brazil is seeing near to above normal temperatures and dry weather.

Overnight News: Florida weather forecasts call for light showers. Temperatures will average near to above normal.

Chart Trends: Trends in FCOJ are mixed to up with objectives of 160.00 and 177.00 July. Support is at 148.00, 145.00, and 144.00 July, with resistance at 154.00, 156.00, and 159.00 July.


General Comments: Futures closed lower due to a weaker Brazilian Real. There was no other real news for the market, and the price action reflected that reality. The UNICA data was considered neutral as Unica notes that production should ramp up again as the harvest weather is dry again. The price action overall remains weak and implies that further losses are coming down the road due to coming Brazil supplies. Traders remain bearish on ideas of big supplies, especially from Brazil. Traders in Brazil expect big production as the weather is good. Demand is said to be strong from North Africa and the Middle East, but starting to fade now as needs are getting covered.

Overnight News: Showers are expected in Brazil. Temperatures should average near to above normal.

Chart Trends: Trends in New York are down with objectives of 1620, 1610, and 1570 July. Support is at 1620, 1600, and 1570 July, and resistance is at 1660, 1675, and 1700 July. Trends in London are mixed. Support is at 474.00, 470.00, and 467.00 August, and resistance is at 481.00, 486.00, and 487.00 August.


General Comments: Futures closed with small losses in consolidation trading. There was not a lot of news for the market, and price action reflected this. It looks like the buying was based on the charts as New York futures could not move to new lows and in fact have held at an important area on the charts. But, ideas of weak demand after the recent big rally kept some selling interest around. The weather is good in West Africa, with more moderate temperatures and some rains. The mid-crop harvest is moving to completion, and less than expected production along with smaller beans is reported. Malaysia and Indonesia crops appear to be in good condition and weather is called favorable.

Overnight News: Scattered showers are expected in West Africa. Temperatures will average near to above normal. Malaysia and Indonesia should see episodes of isolated showers. Temperatures should average near normal. Brazil will get mostly dry conditions and warm temperatures. ICE certified stocks are lower today at 5.118 million bags.

Chart Trends: Trends in New York are mixed to up with objectives of 2480 and 2520 July. Support is at 2325, 2280, and 2250 July, with resistance at 2370, 2400, and 2420 July. Trends in London are mixed. Support is at 1540, 1520, and 1505 July, with resistance at 1575, 1580, and 1600 July.

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More Selling Or More Choppy Trading?

by Tom Aspray

The weak close in the stock market Tuesday was a classic sign that the rebound from last Thursday’s oversold low was over. Most of the index tracking ETFs gapped lower on the opening but then rebounded until just after lunch as the gaps were filled. The afternoon selling resulted in most of them closing on the day’s lows.

Overseas markets are mixed with greater that 1% drops in Hong Kong and Shanghai while the Eurozone markets are slightly higher; nice gains also in the stock index futures with little in the way of economic data today.

The late-day decline was in line with the very weak market internals, especially the NYSE A/D ratios as there were 645 advancing stocks and 3458 declining. The number of NYSE stocks making new lows also surged to 261 with just 35 stocks making new highs. On May 15, there were 517 NYSE stocks that made new highs. The market internals were therefore weaker than prices.

Does this mean that investors should be prepared for a further wave of heavy selling or are we going to see a rebound and more chopping trading instead before stronger levels of support are tested?

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Chart Analysis: The daily chart of the Spyder Trust (SPY) shows that the rally appears to have stalled at $165.40, which was below the stronger resistance in the $166 area.

  • The close was back below the flat 20-day EMA at $163.90 with next support at $162.73 to $161.27.
  • There is more important support still at $159.71 and the April highs. This also corresponds to the daily starc- band.
  • The more important 38.2% Fibonacci retracement support is at $155.94.
  • The NYSE A/D line rebounded back to its flattening WMA and is now testing its uptrend.
  • A decisive break of this support will be consistent with a further decline.
  • The McClellan oscillator rallied from last week’s low of -311 and hit -97 last Friday.
  • The oscillator has now dropped back to -222, and if it turns higher, it will indicate a postponement of a further decline.

The daily chart of the Powershares QQQ Trust (QQQ) shows that Monday’s high at $73.76 was just below the June 4 high of $73.82.

  • Tuesday’s close was back below the 20-day EMA with Tuesday’s low at $72.44.
  • Further support is at $71.47 and then at $70.58-$71 (line d).
  • The 38.2% retracement support is at $69.72 with the weekly starc- band at $69.52.
  • The relative performance is just barely above its WMA after completing a bottom in April.
  • The RS line has short-term support at line f.
  • The volume was high yesterday, and the daily on-balance volume (OBV) has dropped back below its WMA.
  • There is more important OBV support at line g.
  • There is initial resistance now at $73.34 to $73.76.

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The ProShares UltraShort S&P 500 (SDS) is a very liquid double-short ETF that I recommended buying at noon yesterday.

  • The chart shows a possible short-term bottom formation, line b, with Monday’s low at $39.03 and further support at $38.55.
  • The downtrend, line a, is now at $41.40 with the recent high at $41.60.
  • A close above this level will complete the bottom formation with next resistance at $44-$45.
  • The 38.2% Fibonacci retracement resistance is at $46.66.
  • Volume increased yesterday, which pushed the OBV just barely above its WMA.
  • It now shows a minor uptrend, line d.

What it Means: When I started this column, the S&P futures were up four-five points but they are now up close to 10 points with just 60 minutes before the opening.

It is, of course, today’s close that will be most important but the early action does suggest that those on the sidelines are buying. The action of the A/D line does not yet suggest that the correction is over as it is acting weaker than prices, rather than stronger. I would look for this relationship to change before a significant new uptrend gets underway.

A strong close today could signal a rally back to or above Monday’s highs before we see another wave of selling. Choppier trading will help to lessen the recent enthusiasm for stocks. As I discussed in the most recent Week Ahead column, I still think a sharper decline is required to turn the sentiment bearish enough to form a sustainable market bottom.

I would stick with the long position in the inverse ETF and watch the close.

How to Profit: Should be long the ProShares UltraShort S&P 500 (SDS) at about $39.55, per yesterday’s tweet. I would keep the stop at $38.29 for now, which is a risk of about 3.2%

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Greek Television: Holding Out!

By tothetick

Greek television journalists are holding out still today just less than 24 hours after being told that they are off the air.

Condemnation from around the world came as the Hellenic Broadcasting Corp (ERT) was blacked out. Michelle Stanistreet from the British National Union of Journalists stated: “this is a terrible decision. It is a direct assault on democracy at a time when the people of Greece need to be told what is going on. They need a reliable news source at this desperate time for the country, the economic situation and rise of dangerous far-right groups”. But, isn’t it just that that is the problem? Keep the people in the dark just at the worst time in history when the economy is buckling under the weight of the economic stress that is being dished out in shovel-loads on top of the Greeks? What they don’t know can’t hurt them? But it sheds some light on the fact that economics and politics and the circulation of information are intrinsically linked.

Greek journalists have carried on broadcasting in an attempt to tell the people what is happening. They are using digital frequencies and networks. Olli Rehn, the European Commission stated that the budget cuts never included the closing down of national television and radio. But, is it surprising really, that things have taken such a dramatic turn? In a one-foot forward and one-foot back stance Rehn stated that it was never the intention of the European Economic Monetary Affairs Commission to see the broadcaster closed down, but at the same time he wouldn’t want to pass comment on the affairs of state of Greece and decisions of government there. Never interfere in another state’s affairs. Except that’s what we have been doing now for years, isn’t it? Ever since we imposed the crippling debt repayments on a country that would never be in a position to pay them back. Just a few days ago the International Monetary Fund suggested that they might just consider writing off some of the debt of Greece.

Protests are taking place throughout the world today by Greek nationals and supporters. There will be a 24-hour strike tomorrow.

Recognizing that Greece will never get out of the wallowing crisis that has become its daily bread should have been admitted long-ago. Debt that is set to reach 185% of GDP this year. There has been talk of reducing that to below 110% by 2022. It’s not certain that the Greek people will wait that long. Greece has had 240 billion euros and it might be the biggest bail out of all time, but, it’s still not enough.  Closing down the ERT looks like it is politically motivated, but the Greek government is using the debt crisis as a means to sweep clean and remove all opposition. Spokespeople from the Greek government have stated that they are looking to reduce the size of the civil service and cut costs to fall in line with the EU requirements.

Isn’t it during times of economic crisis that the people should be in-the-know as to what decisions their governments are making and what state the economy is actually in? All of this comes in the wake of the US surveillance scandal and data-snooping programs. Things look like they are going from bad to worse, but some will say ‘what did you expect?’.  The Greek television looks like it’s going to be the next thorn in the side of the government (and the rest of the world), as the Greek people stand defiant in the face of democracy. Take their television away, you take democracy away. Take democracy away and you take their economy away too. They are already plunged into darkness that looks like the dark-ages through the debt crisis. This might just be the last straw for the Greek people.  Greece is fast becoming the Crisis Republic that others have played a major role in, isn’t it?

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S&P 500 forming its third Eiffel tower pattern in 15-Years?

by Chris Kimble


Several times the Power of the Pattern has shared that Eiffel tower patterns can be very important to your portfolio construction & management. At the time when most investors were in love with Gold & Apple, I shared that Eiffel tower patterns looked to be forming in these white hot assets.

Gold could be forming an Eiffel tower pattern on 8/23/11 (see post here)  Results....Gold declines over 30% in value. Apple looked to be forming an Eiffel tower pattern on 11/7/12 (see post here)  Results....Apple declines over 30% in value.

The above 5-pack reflects the Gold & Apple Eiffel tower patterns and that three other assets could well be forming similar patterns. Eiffel tower patterns are dangerous because when you experience the left side of the tower, you often experience the right side as well!

The S&P 500 looks to have formed two Eiffel tower patterns since the mid-1990's...100% rallies followed by 50% declines.

The best way for SPY, XLV & XLY to break from these Eiffel tower patterns is to continue to break overhead resistance.  Concern for these assets would come into play in support is taken out!

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