Category Archives: Economic fundamentals

Michael Hudson: Europe to Pay for the Whole Mess in Ukraine

Yves here. This discussion with Michael Hudson on RT focuses on the real meaning of the Ukraine-Russia gas deal. One point that Hudson makes that readers might doubt is that Russia loves the US sanctions. I’m not sure “love” is the right word, but there is reason to think they aren’t working out as the US had hoped. First, they’ve greatly increased Putin’s popularity. Even the intelligentsia in Moscow, who were hostile to him, have largely rallied to his side in the face of foreign bullying. Second, the Western press may be overstating the amount of damage done to the economy by the sanctions. Arguably the biggest negative is the fall in the price of oil, which came about growth in Europe and China slowing, and the Saudis announcing that they’d allow the price to reset at a much lower level than most analysts anticipated. But the ruble has been falling, which blunts that effect, but increases the drain on FX reserves as Russia tries to keep it falling too far and will increase inflation. Third, the sanctions have allowed Russia to engage in protection of domestic industries as a retaliatory measure, for instance, blocking many food imports from Europe.

Now all good well-indoctrinated neoliberals will say, “Trade protectionism merely allows domestic producers to become inefficient and uncompetitive.” It’s not so simple. Development economists are increasingly of the view that trade restrictions can help smaller economies develop domestic businesses to the point where they can compete in international markets, while if they foreign firms in, they’ll find it nearly impossible to build any local champions.

A colleague who does business in Russia but has no deep loyalties there, says he sees no signs of negative impact of the sanctions in Moscow (he describes it as now looking like any post World War II European capital). This is confirmed by recent surveys in Russia, so the lack of meaningful impact on Russian citizens isn’t an artifact of his seeing only the better parts of Moscow. Note that the latest EU forecasts anticipate very weak growth this year and next, as opposed to outright recession.

This visitor describes how the sanctions are helping Russian businesses. One of his friends has the Papa Johns franchise. They used to get their cheese from the Netherlands, but those supplies were cut off by the Russian sanctions against Europe. So they had to buy cheese domestically. It was cheaper but not as good. So he is working with the local farmers and cheese-makers to bring the cheese up to the standard of the cheese he used to import. So he expects to eventually have cheese that is lower cost than what he brought in and of comparable quality. And if he succeeded, the cheesemakers will be more competitive in Europe when the sanctions are relaxed.

The shorter version of this story is that Russia has a large enough domestic market and enough resources that unlike Iran, it may be closer to being able to function as an autarky when its imports and exports are restricted. The open question is whether it can go through the pain of a reset, with some serious and painful short-term dislocations, and escape the slow strangulation that the US claims it has imposed.

Fed Needs to Stop Asset Acquisitions for a Generation or So

Yves here. Readers will take issue with some of former Fed staffer and banking expert Walker Todd’s comments on monetarism and Fed policy, but he nevertheless reaches the right general conclusions. The monetarist orientation of his post is a bit more understandable when you keep in mind that the central bank is run by monetary economists.

Todd treats quantitative easing as “money printing”. That sounds appealing but isn’t quite apt. The Fed was swapping assets, in this case cash for Treasury bonds or mortgage backed securities held by the public. The central bank seemed to think this would be useful due to its belief in the discredited but nevertheless very much alive “loanable funds” theory. In simple terms, if you make interest rates low enough, people will save less and spend more, and businesses will borrow and invest more because money is on sale.

In fact, what has happened is that many of those people who swapped bonds for cash went out and bought other financial assets, goosing stock prices, lowering yields on risky debt, and sending money sloshing into emerging economies. There appears to have been a modest amount of economic lift from that due to wealth effect among the rich. But big companies for the most part didn’t invest. They borrowed cheaply and are holding wads of cash that they can use to keep propping up their stock prices. Similarly, banks haven’t done much small business lending, in part because institutionally many have exited that business, and smaller enterprises themselves haven’t been too keen to borrow because in most regions and sectors, the recovery isn’t all that robust.

The Fed appears to have recognized that QE was largely a failed experiment before it announced the taper last year, but the market reaction was so lousy that it backed off and then tried again with lots more “we’re watching the market’s back” assurances. Cynics among my readers contend that the GDP figures today benefitted unduly from a 0.9% reduction in the GDP deflator, which would provide financial markets with a tailwind when QE was being halted officially.

Given that we’ve had three QEs so far, Todd has reason to argue against repeating this experiment. Another thread of his argument echoes that of Audit the Fed, which was the product of a left-right alliance, that the Fed never gave Congress an adequate explanation of the logic and expected effects of QE so it could be held accountable for this experiment.

Class Traitors: How Ideological Brainwashing Gets Rich and Ordinary Americans to Undermine Their Economic Interest

Linda Beale, of ataxingmatter, has written forcefully and persuasively about some of the propagandizing-accepted-as-gospel that the well-heeled use to advocate policies that advance their economic interests. For instance, as most Naked Capitalism readers appreciate, but a remarkably large swathe of the US population does not, tax cuts for big corporations are simply a transfer to the rich. From a post last year:

I’ve argued frequently in the past that there is no there there–i.e., that lowering corporate tax rates will do nothing to create jobs. Instead, I’ve said, it will simply deliver an even higher profit margin to be skimmed off by the highest paid executives and, possibly, shareholders. The higher profit margins are unlikely even to be used to increase workers’ shares of the corporate revenues through higher wages, a place where they could most help the economy other than new jobs created. Thus, the drive for “revenue neutral” corporate tax reform (cut corporate taxes, cut expenditures elsewhere to make up for the decreased corporate tax revenues) is just another example of corporatism as an engine of the modern form of US class warfare

Beale takes up a different theme today: how the rich and poor act against their economic interest. For many in middle and lower income strata in red states, hostility to the government is an article of faith even though those states (and many of those same govement-hating citizens) are significant beneficiaries of Federal programs.

But less well recognized are the ways that the wealthy are undermining themselves. They’ve taken the “increase our distance from everyone else” experiment well beyond its point of maximum advantage, not just to the society around them but also in terms of the costs to the class warriors.

As we’ve pointed out, highly unequal societies have lower lifespans, even among the rich; the shallower social networks of stratified societies and the high cost of losing one’s perch, in terms of loss of friends and status, creates an ongoing level of stress that has a longevity cost. Beale points out something we’ve mentioned occasionally in the past, that creating an underclass with inadequate access to medical services is a great breeding ground for public health problems. The fact that many low income Americans can’t afford to take sick days and health plans generally have high deductibles, which discourage individuals from getting treated until they are sure they are really sick, isn’t a great program design if you want to reduce the spread of infectious diseases.

Gail Tverberg: Eight Pieces of Our Oil Price Predicament

Yves here. As oil prices have come into focus as a result of a recent Saudi decision to facilitate a reset at a lower price per barrel, they’ve come into focus yet again as a critical nexus of economic and political power, and that’s before you get to the complicating overlay of climate change considerations.

This article by Gail Tverberg takes a more sophisticated, multi-persepctive approach than the overwhelming majority of articles on this topic. One of her big messages is that there is no way the world economy is getting divorced from oil any time soon.

Even so, I have some minor points of contention. For instance, she correctly points out that oil producers, even the Saudis, need oil prices to be at a moderately high prices to sustain national budgets. But Riyadh has a very low production break even point, a large cash horde, and plenty of borrowing capacity. The desert kingdom could afford a price war, say to hurt geopolitical enemies or to forestall investment in and development of alternative energy sources. Low oil prices make other energy sources look unattractive, and volatile prices also deter investment, making it well-nigh impossible to forecast cost advantages (if any) and end user takeup.

Wolf Richter: Leading Indicator Amazon Gets Re-Crushed

Yves here. As Matt Stoller wrote recently, Amazon’s business strategy is all about becoming a globally-dominant trading company. It might have helped if Amazon and its investors had studied the closest historical analogue to what Amazon is seeking to become: Japanese trading companies. In their heyday, Japanese trading companies, such as Mitsubishi International Corporation, which intermediated trade for the Mitsubishi zaibatsu, and its post-World War II less-tightly-integrated incarnation, a keiretsu, had an almost impossible-looking financial statements: staggeringly large revenues, extremely thin profits (those went to the industrial companies) and enormous balance sheets with breathtaking leverage.

The Amazon 2.0 version has a lot of improved features, the biggest being impressive cash flow, since it manages to get income before it has to pay for goods. However, Amazon, like its Japanese forebearers, is interested in dominance above all. For the Japanese trading companies, that made sense because they were the sales arms for the companies in their group, so the objective wasn’t for them to prosper but to merely get by. But for Amazon, plowing its vast cash flow into growth looks less and less sensible as losses gap up. It’s one thing to incur large costs to obtain a monopoly or oligopoly position, since high margins are expected to come later. Amazon has gotten away with no profits because, in reality, cash flow generation is in many ways a better measure of the true productivity of a business. But in Amazon’s case, its hugely positive cash flow is entirely dependent on its collection v. when it pays suppliers. If suppliers, which Amazon is also squeezing on cost, start to push back this hugely successful machine will look a lot less pretty. And this ins’t a theoretical concern; Justin Fox at the Harvard Business Review points out that Amazon of late hasn’t been able to stretch payables as much at it once could. Amazon is moving on so many fronts where establishing a dominant position is far from assured, which could call its entire model into question.

Forward Guidance: Human Plans and Divine Laughter

ves here. VoxEU has come to serve as a wonky alternative to the Financial Times comments section, which is Brit-speak for op-eds. While most FT comments are at least interesting and timely, now and again the pink paper serves as a venue where real policy players put a stake in the ground, sometimes in exclusive interviews but also in opinion pieces.

This article by David Miles of the Bank of England is clearly intended to reach a wider audience than the normal VoxEU piece. In it, he calmly and methodically tries to tell finance people that what they want from central bank forward guidance is tantamount to having their cake and eating it. Admittedly, the unreasonable expectations for what forward guidance can accomplish is partly central bankers’ own creation. In keeping, this piece suggests that a retreat from efforts at precision in forward guidance would probably be a plus.

Goldman Makes It Official That the Stock Market is Manipulated, Buybacks Drive Valuations

It’s remarkable that this Goldman report, and its writeup on Business Insider, is being treated with a straight face. The short version is current stock price levels are dependent on continued stock buybacks. Key sections of the story:

The Mixed International Picture on Poverty and Inequality

Yves here. As much as readers may already have an intuitive grasp of the story told in this post, data can help define its contours better. Here we see that the rising tide of global growth has not lifted all boats. The gains of the once-poor in China and India have come at the expense of the what used to be the middle class in more developed countries. Reducing poverty has not been a zero sum game. This post also omits another key piece: the rise and rise of an uber-wealthy class.

WalMart Makes Empty Gesture to End Minimum Wage Pay While Cutting Pay Levels

WalMart just announced that it will at some unspecified point down the road end minimum wage-level pay for its workers. As we’ll demonstrate, there is way less here than meets the eye. In fact, all in pay levels, including benefits, are falling for WalMart workers, not rising.

Markets Panicked Over Deteriorating Fundamentals (Updated)

The “Fed can fix everything” premium has left the market.

The S&P 500 has been falling even more while I compose this this short post. It went from down over 2.2% to off 2.9% of this writing and the Dow went from down 2.1%. to down 2.6%, Ten-year Treasury yields dropped to below 2%. Oil fell sharply overnight.

Bono: Tax Haven Salesman for the Celtic Paper Tiger

Yves here. Pop star Bono is a case study in hypocrisy thanks to his use of corporate-friendly tax dodges and and advocacy of creating tax havens as a viable form of economic development. Ireland exemplifies of how well, as in badly, this approach has worked.

Wolf Richter: Toxic Mix for Fracking – Oil Price Collapse & Junk Bond Insanity

Yves here. As oil prices have collapsed, the fundamentals of fracking, which was overhyped given the short productive life of individual wells, now looks even more dubious at current energy price levels. And given how risky the sector has become, cheap debt, even in this time of ZIRP, is no longer freely available either.

Bill Black: EU Austerity Witch Doctors Attack Each Other

As things go from bad to worse in the eurozone the putative adults have begun to fight openly in front of the kids. The putative adults, of course, have refused to act like adults for six years and instead have lived in a fantasy world in which austerity – bleeding the patient – is the optimal response to a recession. As many of us have been warning for six years, this is a great way to create gratuitous recessions and even the Great Depression levels of unemployment in three nations of the periphery with 100 million citizens.

Saudis Deploy the Oil Price Weapon Against Syria, Iran, Russia, and the US

Asian stock markets continued to fall today, propelled at least in part by the adverse reaction to the Saudi announcement yesterday that they would let oil prices fall to $80 a barrel. And further reports indicate that the Saudis intend to keep oil prices low enough to force a realignment of prices not just among various grades of crude, but also for intermediate and long-term substitutes.

It is critical to remember that the Saudis have no compunction about imposing costs on other nations to maximize the value of their oil resource long term and hence the power they derive from it. Their oil price cut looks to be a strategic masterstroke.