The Great Recession Has Been Followed by the Grand Illusion

Don't be fooled by the latest jobs numbers. The unemployment situation in the U.S. is still dire

By MORTIMER ZUCKERMAN

The Great Recession is an apt name for America's current stagnation, but the present phase might also be called the Grand Illusion—because the happy talk and statistics that go with it, especially regarding jobs, give a rosier picture than the facts justify.

The country isn't really advancing. By comparison with earlier recessions, it is going backward. Despite the most stimulative fiscal policy in American history and a trillion-dollar expansion to the money supply, the economy over the last three years has been declining. After 2.4% annual growth rates in gross domestic product in 2010 and 2011, the economy slowed to 1.5% growth in 2012. Cumulative growth for the past 12 quarters was just 6.3%, the slowest of all 11 recessions since World War II.

And last year's anemic growth looks likely to continue. Sequestration will take $600 billion of government expenditures out of the economy over the next 10 years, including $85 billion this year alone. The 2% increase in payroll taxes will hit about 160 million workers and drain $110 billion from their disposable incomes. The Obama health-care tax will be a drag of more than $30 billion. The recent 50-cent surge in gasoline prices represents another $65 billion drag on consumer cash flow.

February's headline unemployment rate was portrayed as 7.7%, down from 7.9% in January. The dip was accompanied by huzzahs in the news media claiming the improvement to be "outstanding" and "amazing." But if you account for the people who are excluded from that number—such as "discouraged workers" no longer looking for a job, involuntary part-time workers and others who are "marginally attached" to the labor force—then the real unemployment rate is somewhere between 14% and 15%.

Other numbers reported by the Bureau of Labor Statistics have deteriorated. The 236,000 net new jobs added to the economy in February is misleading—the gross number of new jobs included 340,000 in the part-time, low wage category. Many of the so-called net new jobs are second or third jobs going to people who are already working, rather than going to those who are unemployed.

The number of Americans unemployed for six months or longer went up by 89,000 in February to a total of 4.8 million. The average duration of unemployment rose to 36.9 weeks, up from 35.3 weeks in January. The labor-force participation rate, which measures the percentage of working-age people in the workforce, also dropped to 63.5%, the lowest in 30 years. The average workweek is a low 34.5 hours thanks to employers shortening workers' hours or asking employees to take unpaid leave.

Since World War II, it has typically taken 24 months to reach a new peak in employment after the onset of a recession. Yet the country is more than 60 months away from its previous high in 2007, and the economy is still down 3.2 million jobs from that year.

Bailout Strains European Ties

Cyprus Deal Preserves Euro but Sows Mistrust Between Continent's Haves, Have-Nots

A deal reached Monday in Brussels may have saved Cyprus from becoming the first country to crash out of the euro, but it came at the cost of widening the political mistrust between the strong economies of Europe's north and the weaklings of the south.

By GABRIELE STEINHAUSER , MARCUS WALKER,MATINA STEVIS 

Several officials familiar with talks in Nicosia and Brussels over the €10 billion ($13 billion) rescue for the island described more than a week of chaotic negotiations. European officials cited Cypriot foot-dragging, reversals and dropped communications, a situation one European Union official called "terrifying." Cypriot officials described their European opposites as demanding and inflexible.

The fresh bitterness over the Cyprus mess—which appears deeper than at similar points during Greece's extended financial turmoil—could hamper future attempts to fix the bloc's flaws. Germany, the euro zone's biggest economy, prevailed as it typically has in the negotiations, but at the price of growing resentment over what some Europeans saw as its bullying of a tiny nation.

The accord will see big depositors and other creditors lose large sums following the radical downsizing of the country's biggest bank and the shuttering of its second largest—the first time such a "bail-in" has been seen in the three-year euro-zone crisis.

On Monday, Cypriots waited nervously for banks to reopen after their March 15 closure, wondering whether there would be further deposit flight. The country's central bank said late in the day that all of the country's lenders would remain closed until Thursday, after saying earlier that all but the two largest would reopen Tuesday.

Markets greeted the deal with an optimism that quickly faded when Dutch finance minister Jeroen Dijsselbloem suggested in an interview that big bank depositors and senior creditors may be expected to contribute to future euro-zone bailout packages. Later, after bank shares and other euro-based assets fell on the remarks, he appeared to backtrack in a message from his Twitter account: "Cyprus [is a] specific case. Programmes tailor-made to situation, no models or templates used."

A Better Cyprus Deal

The discipline of failure and loss makes a comeback

by WSJ

Practice still makes imperfect, but Sunday's overnight deal to save Cyprus is a big improvement over the last attempt. Brussels and Nicosia have finally agreed to try an orderly, market-based solution to the country's financial mess—even if it did first have to exhaust every bad idea.

Under Sunday's deal, Laiki Bank, the country's second largest, will go bust immediately. All of its creditors will be wiped out, though insured deposits of less than €100,000 will be protected. Larger depositors will be given equity shares in a "bad bank" that will hold Laiki's more dubious assets. The bank's viable assets will be transferred to Bank of Cyprus, the less troubled of the country's terrible two.

Meanwhile, Bank of Cyprus's uninsured depositors and other creditors will take haircuts sufficient to ensure a 9% capital ratio, likely in the neighborhood of 35%. Not a cent of the EU and IMF's €10 billion rescue will go toward recapitalizing a Cypriot bank. The Cyprus government will be left with debt of 140% of GDP—worrisomely high, but lower than originally envisioned.

All of this doesn't go as far as our suggestion last week that both Bank of Cyprus and Laiki be put into resolution and that uninsured deposits be swapped for bank shares. But Sunday's deal gets most of the way there, while eliminating the worst features of the earlier deal.

By protecting insured depositors, the deal honors a government promise that is an implicit contract. The forced transfer of large deposits into equity is unfortunate, but then it is also a reminder that banks fail and that uninsured deposits are, well, uninsured. This is a useful lesson in the limits of government guarantees and a welcome blow against moral hazard.

The survival of Bank of Cyprus is a political sop to protect Cypriot jobs, though it also means the bank might eventually need another restructuring down the road. Bank of Cyprus will assume Laiki's €9 billion in emergency debt to the European Central Bank, and more borrowers are likely to default as property prices continue to fall. Don't be surprised if Bank of Cyprus needs to take another bite from creditors.

Can It Happen in US?

It already has

By Thomas Sowell

The decision of the government in Cyprus to simply take money out of people's bank accounts there sent shock waves around the world. People far removed from that small island nation had to wonder: "Can this happen here?"

The economic repercussions of having people feel that their money is not safe in banks can be catastrophic. Banks are not just warehouses where money can be stored. They are crucial institutions for gathering individually modest amounts of money from millions of people and transferring that money to strangers whom those people would not directly entrust it to.

Multi-billion dollar corporations, whose economies of scale can bring down the prices of goods and services -- thereby raising our standard of living -- are seldom financed by a few billionaires.

Far more often they are financed by millions of people, who have neither the specific knowledge nor the economic expertise to risk their savings by investing directly in those enterprises. Banks are crucial intermediaries, which provide the financial expertise without which these transfers of money are too risky.

There are poor nations with rich natural resources, which are not developed because they lack either the sophisticated financial institutions necessary to make these key transfers of money or because their legal or political systems are too unreliable for people to put their money into these financial intermediaries.

Whether in Cyprus or in other countries, politicians tend to think in short run terms, if only because elections are held in the short run. Therefore, there is always a temptation to do reckless and short-sighted things to get over some current problem, even if that creates far worse problems in the long run.

Seizing money that people put in the bank would be a classic example of such short-sighted policies.
After thousands of American banks failed during the Great Depression of the 1930s, there were people who would never put their money in a bank again, even after the Federal Deposit Insurance Corporation was created, to have the federal government guarantee individual bank accounts when the bank itself failed.

For years after the Great Depression, stories appeared in the press from time to time about some older person who died and was found to have substantial sums of money stored under a mattress or in some other hiding place, because they never trusted banks again.

After going back and forth, the government of Cyprus ultimately decided, under international pressure, to go ahead with its plan to raid people's bank accounts. But could similar policies be imposed in other countries, including the United States?

One of the big differences between the United States and Cyprus is that the U.S. government can simply print more money to get out of a financial crisis. But Cyprus cannot print more euros, which are controlled by international institutions.

Does that mean that Americans' money is safe in banks? Yes and no.

Cyprus: It’s not over yet

The price of “bailout fatigue”

By Felix Salmon

This was not a good weekend for Russian billionaires. First, Boris Berezovsky was found dead at his English country estate. Now, all the uninsured depositors (read: Russian plutocrats) at Cyprus’s two largest banks are going to be hit much, much harder than they feared they might be when the Cyprus crisis first erupted last week.

Back then — a long, long week ago — Cypriot president Nicos Anastasiades stood firm: there was no way he would allow uninsured depositors to lose more than 10% of their money. What a difference a week makes: now, if your uninsured deposits are at the Bank of Cyprus, you’re probably going to lose about 40% And if they’re at Laiki, you’re going to lose everything.

The agreement between the Cypriot government and the Troika of the EU, IMF, and ECB is a bold and brutal geopolitical power-play. There might be language in the official communiqué about how “The Eurogroup looks forward to an agreement between Cyprus and the Russian Federation on a financial contribution”, but given the billions of euros that Russians are being forced to contribute unwillingly, the chances that they’ll happily throw a bit more money into the pot have to be tiny.

In the Europe vs Russia poker game, the Europeans have played the most aggressive move they can, essentially forcing Russian depositors to contribute maximally to the bailout against their will. If this is how the game ends, it’s an unambiguous loss for Russia, and a win for the EU. For one thing, there won’t be any capital controls: that’s a good thing. (Some deposits at Bank of Cyprus will be frozen, which is a kind of capital control, but there aren’t corralito-style barriers on the general movement of euros in and out of the country.) On top of that, public markets have been left unruffled: there’s been no panic on Europe’s bolsas, partly because the biggest hit has been taken by private Russian citizens.

Who Killed the New Majority?

The GOP sealed its own fate with decades of support for war and immigration

By PATRICK J. BUCHANAN

The Republican National Committee has produced an “autopsy” on what went wrong in 2012, when the party failed to win the White House and lost seats in Congress.

Yet, the crisis of the Grand Old Party goes back much further.

First, some history. The Frank Lloyd Wright of the New Majority was Richard Nixon, who picked up the pieces of the party after Goldwater’s defeat had left Republicans with just a third of the House and Senate.

In 1966, Nixon led the GOP back to a stunning victory, picking up 47 House seats. In 1968, he united the Rockefeller and Reagan wings and held off an October surge by Hubert Humphrey, which cut a 13-point Nixon lead to less than a point in four weeks.

In 1972, Nixon swept 49 states. The New Majority was born. How did he do it?

Nixon sliced off from FDR’s New Deal coalition Northern Catholics and ethnics—Irish, Italians, Poles, East Europeans—and Southern Christian conservatives. Where FDR and Woodrow Wilson had won all 11 Southern States six times, Nixon swept them all in ’72. And where Nixon won only 22 percent of the Catholic vote against JFK, he won 55 percent against George McGovern in 1972.

What killed the New Majority?

First, there was mass immigration, which brought in 40 to 50 million people, legal and illegal, poor and working class, and almost all from the Third World. The GOP agreed to the importation of a vast new constituency that is now kicking the GOP into an early grave.

When some implored the party in 1992 to secure the border and declare a “timeout” on legal immigration to assimilate the millions already here, the party establishment repudiated any such ideas.

“We are a nation of immigrants!” it huffed. Well, we sure are now.

And when amnesty is granted to the 12 million illegals, as GOP senators are preparing to do, that should advance the death of the GOP as a national party by turning Colorado, Nevada and Arizona blue, and putting even Texas in play.

Have politicians had a mental blackout?

There’s a real risk of energy shortages in Britain, yet still the political class is obsessed with cutting fossil fuel use

by Rob Lyons 

‘Britain faces gas supply crisis as storage runs dry’, warned Reuters last week. Unseasonably cold weather has meant that demand for gas has shot up just as it should be going down with the arrival of spring. Just to add a little spice to the warnings, tens of thousands of homes were left without power as blizzards knocked out power lines in Northern Ireland and Scotland. A taste of things to come?

As it goes, the claim that gas supplies could run out by 8 April is very much a worst-case scenario. There is normally plenty of supply, from a combination of the North Sea, Europe and shipments of liquefied gas coming from countries further afield, particularly Qatar. Nonetheless, it is daft that a modern, highly developed economy like the UK should even be discussing such things. That we are is the product of years of inertia in central government and an obsession with self-imposed greenhouse-gas emissions targets.

So perversely, just as a set of circumstances was emerging that showed how close to the wind the UK is sailing on energy security, Britain has been closing power stations. For example, on Friday, Didcot A power station in Oxfordshire was disconnected from the National Grid after 43 years. The 2,000-megawatt plant got the chop because it burns coal. Older coal plants are being phased out under EU regulations. Indeed, according to Alistair Buchanan, the boss of energy regulator Ofgem, 10 per cent of the UK’s electricity generating capacity is due to be switched off this month.

Buchanan notes the speed at which plant closures will now kick in: ‘If you can imagine a ride on a rollercoaster at a fairground, then this winter, we are at the top of the circuit and we head downhill – fast. Within three years, we will see the reserve margin of generation fall from about 14 per cent to less than five per cent. That is uncomfortably tight.’ In fact, some of those coal plants are closing ahead of schedule because their remaining operating hours have been used up quickly to take advantage of low coal prices. At a time when complaints about domestic energy costs are getting louder and louder, we are turning our back on the cheapest form of power available.

We’ve known for quite some time that there was the potential for a major shortfall in energy supplies. Coal and nuclear stations have been shutting but alternatives have fallen short. Wind is expensive to build and intermittent in operation. At some of the coldest periods of the year, wind supply can fall to nearly zero. Renewable UK celebrated the fact that wind produced a record proportion of UK electricity in 2012 - but it was still just 5.5 per cent of the total. New nuclear stations should be being built now, but years of political indecision mean that not a single new plant has actually got agreement yet. Even now, suppliers are haggling with government over guaranteed prices, though planning permission for Hinkley Point C - a new station on the site of two older nuclear reactors - has at least been approved. Nonetheless, it will still take eight to 10 years to build the plant.

In Instanbul: The Rise & Fall of Society

Since the State thrives on what it expropriates the general decline in production which it induces by its avarice foretells its own doom

by Chris Mayer

It’s Istanbul, not Constantinople, as the song goes. In this history is an omen for any powerful state (read: the U.S.). A somewhat obscure essayist knew all about it back in 1959. His little book deserves wider circulation. Below, we’ll take a look.

Constantinople was once the seat of a vast, rich empire. The successor to Rome, it ruled over a land that stretched from the Caucasus to the Adriatic, from the Danube to the Sahara. The Dark Ages were dark only if you ignore the flourishing civilization on the Bosporus.

Historian Merle Severy writes: “Medieval visitors from the rural West, where Rome had shrunk to a cow town, were struck dumb by this resplendent metropolis.” There were half a million people here. Its harbors full of ships, “its markets filled with silks, spices, furs, precious stones, perfumed woods, carved ivory, gold and silver and enameled jewelry.”

This civilization lasted for a thousand years.

Actually, it lasted for 1,123 years and 18 days after Constantine the Great made the city his new Christian Rome. On May 29, 1453, Constantinople fell to the Turks.

Renamed Istanbul, the city would serve as the seat of yet another great empire, the Ottoman. And this one would last nearly five centuries. In the 16th and 17th centuries, the Ottoman Empire was perhaps the most powerful state on Earth. It was on one heck of a roll. After Constantinople, the Ottomans took Athens in 1458. Then it was on to Tabriz (1514), Damascus (1516), Cairo (1517), Belgrade (1521), Rhodes (1522), Baghdad (1534), Buda (1541), Tripoli (1551) and Cyprus (1571).

They almost took Vienna. The powers of Western Europe drew the line in the sand there. Interesting to think what would’ve happened if the Turks took Vienna. All of Western Europe would be at their feet. If they had succeeded, perhaps the majority of Europeans would be answering the call to prayer, echoing from the minarets of cathedrals-turned-mosques…

Yet the Ottoman Empire, too, would crumble. It was constantly at war. By one historian’s reckoning, the longest period of peace was just 24 years in nearly six centuries of reign.

In 1923, with the founding of the Republic of Turkey, Ankara became the seat of government. As historian John Freely notes: “For the first time in 16 centuries, the ancient city on the Golden Horn was no longer reigning over a world empire with only the presence of the monuments to remind one of its imperial past.”

It is not hard to think of the U.S. in the context of these great powers.

*** Enter Chodorov

One of the books I had tucked in my bag that I read while in Turkey was Frank Chodorov’sThe Rise & Fall of Society. This is a slender 168-page book by a great, if somewhat forgotten, essayist and editor. It gives a tightly reasoned answer to the question “Why do societies rise and fall?”

Chodorov’s thesis is that “every collapse of which we have sufficient evidence was preceded by the same course of events.”

The course of events goes like this: “The State, in its insatiable lust for power, increasingly intensified its encroachments on the economy of the nation…” and finally gets to the point where the economy can no longer support the state at the level it is accustomed to. Society can’t meet the strain, so “society collapsed and drew the State down with it.”

The pattern is always the same, regardless of size or ideology. The state can grow only by taking. “Since the State thrives on what it expropriates,” Chodorov writes, “the general decline in production which it induces by its avarice foretells its own doom.”

Chodorov bases much of his thesis on what he calls “the law of parsimony.” In essence, it is simply that people try to get the most satisfaction with the least amount of effort. It is a natural law of human behavior.

Anatomy of the Bank Run

Fractional reserve banks, being inherently insolvent, are uninsurable

[This article is featured in chapter 79 of Making Economic Sense by Murray Rothbard and originally appeared in the September, 1985 edition of The Free Market]

by Murray N. Rothbard
It was a scene familiar to any nostalgia buff: all-night lines waiting for the banks (first in Ohio, then in Maryland) to open; pompous but mendacious assurances by the bankers that all is well and that the people should go home; a stubborn insistence by depositors to get their money out; and the consequent closing of the banks by government, while at the same time the banks were permitted to stay in existence and collect the debts due them by their borrowers.

In other words, instead of government protecting private property and enforcing voluntary contracts, it deliberately violated the property of the depositors by barring them from retrieving their own money from the banks.

All this was, of course, a replay of the early 1930s: the last era of massive runs on banks. On the surface the weakness was the fact that the failed banks were insured by private or state deposit insurance agencies, whereas the banks that easily withstood the storm were insured by the federal government (FDIC for commercial banks; FSLIC for savings and loan banks).

But why? What is the magic elixir possessed by the federal government that neither private firms nor states can muster? The defenders of the private insurance agencies noted that they were technically in better financial shape than FSLIC or FDIC, since they had greater reserves per deposit dollar insured. How is it that private firms, so far superior to government in all other operations, should be so defective in this one area? Is there something unique about money that requires federal control?

Why Cyprus 2013 is worse than the KreditAnstalt (1931) and Argentina 2001 crises

The Cyprus 2013, like any other event, can be thought in political and economic terms

by Martin Sibileau 

Political analysis: Two dimensions

Politically, I can see two dimensions. The first dimension belongs to the geopolitical history of the region, with the addition of the recently discovered natural gas reserves. The historical relevance goes as far back as 1853, the year the Crimean War began. The Crimean War took place in the adjacent Black Sea, but the political interest was the same: To avoid the expansion of Russia into the Mediterranean. The relevance of this episode was the break-up of the balance of power established after the Napoleonic Wars, with the Congress of Vienna, in 1815. From then on, a whole new series of unexpected events would lead to a weaker France, a stronger Prussia, new alliances and a final resolution sixty years later: World War I.  It is within this same framework that I see Cyprus 2013 as a very relevant political event: Should Russia eventually obtain a bailout of Cyprus (as I write, this does not seem likely) against a pledge on the natural gas reserves or a naval base, a new balance of power will have been drafted in the region, with Israel as the biggest loser.

The second political dimension refers to a point I made exactly a year ago, precisely inspired in the KreditAnstalt event of 1931. In an article titled: “On gold, stocks, financial repression and the KreditAnstalt of 1931” I wrote:

“(The KreditAnstalt event) was triggered because France, a public sector creditor,introduced a political condition to Austria, in exchange for a bailout of the KreditAnstalt. Today, like in 1931, in the Euro zone, the public sector is increasingly the creditor of the public sector. In 1931, England and France were creditors of Austria and demanded conditions that no private investor would have demanded.

Private investors live and die by their profits and losses. Politicians live and die by the votes they get. Private investors worry about the sustainability and capital structure of the borrower, the collateralization and the funding profile of their credits. Politicians worry about the sustainability of their power. It’s a fact and we must learn to live with it.

In 2012, Greece and increasingly other peripheral EU countries owe to other governments, the IMF and the European Central Bank. Private investors have been wiped out and will not return any moment soon. We fear that just like in 1931, when the next bailout is due either for Greece again or Portugal or Spain, political conditions will be demanded that no private investor in his/her right mind would ever have demanded.

Think of it... What in the world had the customs union between Austria and Germany in 1931 had to do with the capitalization ratio of the KreditAnstalt??? Nothing! Yet, millions and millions of people worldwide were condemned to misery in only a matter of days as their savings evaporated! Ladies and gentlemen, welcome to the world of fiat currencies! You have been warned! If months from now you read in the papers that the EU Council irresponsibly demands strange things from a peripheral country in need of a bailout, remember the KreditAnstalt. Remember 1931.

Europe's Cyprus Crisis Has a Familiar Look

When will we learn?

By Peter Coy 

To most of the world, the banking crisis that broke out in Cyprus in mid-March was as abrupt and unexpected as an outbreak of Ebola. For Cypriots, it wasn’t sudden at all. Many opportunities to steer the country in a better direction came along over the years but were missed or never tried. Now the misbegotten decision by European finance ministers to tax the accounts of ordinary depositors to help pay for a bailout of the country’s biggest banks has become a source of continentwide embarrassment.

The bailout mess roiling the capital of Nicosia and the financial hub of Limassol has plenty of only-in-Cyprus color: Russian oligarchs doing biznes in the sunny Mediterranean, a simmering conflict with Turkey, a former president who was educated in Soviet-era Moscow. Underneath the details, though, is a frustratingly familiar pattern. A small country cleans up its act and joins the international financial community. Money pours in from abroad. The cash is spent or lent unwisely under the noses of inattentive or ineffectual regulators. When losses mount, the money flows out as quickly as it came in. In the end, it’s the little guys who lose the most.

Only five years ago, Cyprus seemed to be in a sweet spot. The country had teetered on the edge since a war in 1974 that left the northern third of the island under Turkish control. For years it also had shaky government finances and a reputation as a haven for foreign money launderers and tax evaders. But successive governments worked hard to lose those bad habits as the price for admission to the European club. Cyprus balanced its budget (for two years, anyway). And it tightened banking regulations so successfully that today it’s in better compliance with the 36-nation Financial Action Task Force’s rules on money laundering than Germany, France, or the Netherlands.

Cyprus was the richest of the 10 countries that joined the European Union in 2004. Just four years later it dropped its currency, the pound, in favor of the euro. There was a brief episode of capital flight after the Lehman Brothers failure in 2008, but it was soon reversed.

For a time, being inside the EU and the euro zone benefited both Cyprus and foreigners eager to invest there. It made the country—whose population of 800,000 or so is no bigger than that of Jacksonville, Fla.—more attractive as a place to do business. It particularly lured wealthy Russians, who appreciated the country’s strong protection of property rights beyond Moscow’s reach and its 10 percent corporate income tax rate (Europe’s lowest), not to mention the balmy weather and a shared Orthodox faith. The storefronts of Limassol are plastered with signs in Cyrillic. Roman Abramovich, the oligarch whose properties include London’s Chelsea Football Club, operates Evraz (EVR), his steel, mining, and vanadium business, through a limited liability company called Lanebrook in downtown Nicosia. There’s no evidence to support German parliamentarians’ allegations that Cyprus is a haven for tax evaders. In January even Russian tax authorities gave Cyprus a clean bill of health.

When Do We Call It A Solvency Crisis?

Don't pop the champagne corks yet

by Michael Pettis

I got back last week from a two-day trip to London, where I spoke at an interesting event organized by the Carnegie Endowment. The attendees were for the most part senior bankers and investors, and I got the impression that several, though maybe not all, shared with me a certain amount of surprise that European bond markets were up this year. We were even a little shocked that the buoyant markets were being interpreted as suggesting that the worst of the European crisis was behind us. The euro, the market seems to be telling us, has been saved, and peripheral Europe is widely seen as being out of the woods.

I cannot name any of the attendees at the Carnegie event because it was off the record, but one of them who seemed most strongly to share my skepticism is a very senior and experienced banker whose name is likely to be recognized by anyone in the industry. After I finished explaining why I thought the euro crisis was far from over, and that I still expected that absent a serious effort from Germany to boost domestic spending – an effort likely to leave the country with rapidly rising debt – at least one or more countries would eventually be forced off the currency, he told the group that he hadn’t made as gloomy a presentation only because he considered it impolitic to sound as pessimistic as I did.

Neither of us, in other words, (and few in the meeting) felt that the recent market enthusiasm was justified. Never mind that the Spanish economy, to return to the country I know best, contracted again in the fourth quarter of last year, that it is expected to contract again this year, that unemployment is still rising, and that the ruling party is involved in yet another scandal that has driven its popularity down to 20%. Never mind that young Spaniards are emigrating (20,000 a month net), that the real estate market continues to drop, that businesses are still disinvesting and popular anger is extraordinarily high. The ECB, it seems, is willing to pump as much liquidity into the markets as it needs, so rising debt levels, greater political fragmentation, and a worsening economy somehow don’t really matter. This crisis continues to be just a liquidity crisis as far as policymakers are concerned – and not caused by problems in the “real” economy – and the solution of course to a liquidity crisis is more liquidity.

Forget Spain and Italy. It’s France that’s Greece-ifying before our very eyes

The French Economy is Going Down the Drain

By Gwynn Guilford 

France has so far dodged the “problem child” reputations that Spain and Italy have earned. But it looks like that will be increasingly hard to keep up. Data today on France’s business output hinted not just that its economy is decaying—but that it’s doing so rapidly.

Markit’s preliminary March purchasing managers’ index—which measures monthly changes in private-sector output—came in at 42.1 (pdf), down from 43.1 in February. (Anything lower than 50 reflects a drop in output.) That’s the fastest slowdown in business activity France has seen since March 2009. And Jack Kennedy, economist at Markit, says this likely augurs a larger crumbling of the French economy.

“My take is it’s really a continuation of the sharp weakening pattern we’ve seen in recent months—so very much a trend rather than a blip,” Kennedy tells Quartz. “Most of the anecdotal feedback from the survey panel points to a general lack of confidence and clients reining in spending accordingly.”

To frame it in another horrifying perspective, the PMI of the euro zone’s second-largest economy was lower than that of Spain and Italy—and almost down to Greek levels (video), as Reuters’ Jamie McGeever explains.

What’s most worrying is when you look at how France’s data stacked up against the euro zone’s as a whole, which were also published today. While the euro zone’s PMI (blue line) and its GDP growth (orange line) have moved pretty closely in sync, France’s PMI has become unhinged in the last couple of years. And that’s bad because, as PMI reflects business confidence, it’s typically a leading indicator of GDP growth:

One of the biggest sources of concern: France’s service sector, which contributes something like four-fifths of France’s GDP. Even as the pace of decline for France’s manufacturing output slowed, the services PMI hit 41.9, indicating the steepest drop since February 2009.

“Notably in the latest survey we saw service sector future expectations plunging to [their] lowest since [December 2008,] in the wake of the Lehman collapse which really underlines the scale of the worries at the moment,” says Markit’s Kennedy, adding that that “in turn seems to be feeding back into lower activity.”

But even if PMI continues to fall, the chart above shows that France’s GDP has proven fairly resilient—especially compared with the euro zone’s trend. So things should be okay, right?

Probably not. Kennedy chalks this ”puzzling” gap in GDP and PMI up to the difficulty in accurately measuring service-sector output in the official data. The recent blindsiding slump in French industrial production may show official data finally falling back in line with PMI, he says.

That means that the gap you see in the above chart could be about to close. GDP growth for the first quarter of this year could come in surprisingly low. If so the country’s chances for a near-term recovery are receding faster than its leaders may be willing to admit. 

JPMorgan On The Inevitability Of Europe-Wide Capital Controls

EU's Ponzi in imminent danger

With the Cypriot government still 'undecided' about what to 'take' and the European leaders very much 'decided' about what to 'give', the fact of the matter is, as JPMorgan explains in this excellent summary of the state of affairs in Europe, that because ELA funding facility is limited by the availability of collateral (and the haircuts applied to those by the central bank), and cutting the Cypriot banking system completely from ELA access is equivalent to cutting it from the Eurosystem making an exit from the euro a matter of time. This makes it inevitable that capital controls and a capital freeze will be imposed, in their view, but it is not only bank deposits that are at risk. A broader retrenchment in funding markets is possible given the confusion and inconsistency last weekend's decision created for investors relative to previous policy decisions. Add to this the move by Spain, which announced this week a tax or bank levy (probably 0.2%) to be imposed on bank deposits, without details on which deposits will be affected or timing, and the chance of sparking much broader deposit outflows across the union are rising quickly.

By JPMorgan,

Capital Control Risks

What was widely viewed as an ill-conceived Cyprus deal last weekend renewed fears of a re-escalation of the euro debt crisis. The original proposal to hit insured depositors below €100k caused a bank run and set a new precedent in the course of the Euro area debt crisis, with potential negative consequences for bank deposits not only in Cyprus but also in other peripheral countries. Once again, as it happened with the Greek crisis last May, the Cyprus crisis exposes the fragmentation of the deposit guarantee schemes in the Euro area and its inconsistency with a monetary union.

Even if the original deal is eventually revised and the guarantee for depositors with less than €100k is respected, the damage from the original proposal will be difficult to undo, in our view.

Cypriot banks are relying on ECB’s Emergency Liquidity Assistance (ELA) to avert a collapse once they open next week. ELA reflects collateralized borrowing from the national central bank rather than the ECB directly, not only at a more punitive interest rate relative to refi rate but more importantly with much larger collateral haircuts. The ECB is still on the hook under ELA because the national central bank borrows these funds from the ECB, i.e. it generates a liability against the Eurosystem. The ECB’s provision of liquidity via ELA is admittedly not a given but it will be provided to Cypriot banks for as long as Cyprus is looking to finalize its revised bailout plan, the so called Plan B.

Although the ECB always states that it provides liquidity to only solvent and well-capitalized institutions, past experience with Irish and Greek banks and even with Cypriot banks shows that the ECB has tolerated long periods of liquidity provision to undercapitalized institutions. Greece is the most characteristic case. Greek banks had access to ELA even when the bank recapitalization was pending between April and December 2012. And Greek banks had access to ELA in-between the two Greek elections when it was not even clear whether Greece would stay in the euro. Cutting the Cypriot banking system completely from ELA access is equivalent to cutting it from the Eurosystem making an exit from the euro a matter of time. This is a political decision rather than a decision that the ECB can take alone. This would effectively cut the Central Bank of Cyprus off from TARGET2 and force it along with the Cypriot government to eventually issue its own money.

But even assuming that a new deal is agreed between Cyprus and the Eurogroup and ELA continues for the Cypriot banking system after Monday, this does not mean that this ELA is unlimited. ELA is limited by the availability of collateral and the haircuts that the central bank applies to this collateral. The Greek case is the most characteristic example of how punitive haircuts on ELA collateral can be. As of the end of January Greek banks used €122bn of collateral to borrow €31bn via ELA, i.e. an implied haircut of 75%. In contrast, they borrowed €76bn via normal ECB operations posting collateral of €97bn, i.e. the implied haircut on their normal ECB borrowing was 22%. The higher haircut on ELA collateral i.e. is mostly the result of the lower quality of this collateral, typically credit claims, vs. that accepted in normal ECB operations, typically securities. But it perhaps also reflects the higher riskiness the ECB sees with its counterparty, i.e. the national central bank and eventually the sovereign, when a country's banking system has to resort to ELA.

The economics of bubbles, in Cyprus and here at home

If something can’t go on, it won’t

By Conrad Black

Thursday’s federal budget was a commendable effort that plausibly forecasts a modest surplus in two years, along with a federal debt level that amounts to 28% of GDP (barely a quarter of where the corresponding U.S. figure will be). My own view is that the government should further stabilize the country’s finances by raising the sales tax on elective spending and cut the income tax (in a way that also serves to discourage income-tax increases by the provinces). But since the federal fiscal policy generally has been sensible since the Mulroney years, a steady-on course is not a bad thing — especially as the world around us hobbles toward the finish line in the 80-year devaluation of money.

An examination of the writing of a British 18th Century author such as Dr. Johnson, and a writer from 100 years later, such as Charles Dickens, reveals that there was no increase in that time in the cost of a loaf of bread or the rental of a simple but respectable residential room in London. There were soaring economic bubbles and bone-cracking depressions, and prices followed supply and demand, but the essential currency value was constant. Unfortunately, that would change: There was no way to pay for the appalling hecatomb of the First World War, where almost the whole populations of all the Great Powers except the United States and Japan were at total war for over four years, except to increase the money supply by printing more of it.

In the Roaring Twenties, the New York stock market, especially, was a bubble, fed by the fraudulent notion that permanent growth was assured, and based largely on borrowings secured, in circular fashion, by the stock that was acquired with the borrowed funds. As soon as the market turned, it came down hard. Forced sales of the pledged stocks accelerated and broadened the plunge. Eventually, governments inflated the currencies by flooding the private sector with borrowed money.

The profusion of new, unearned money generates increased demand and starts to push prices and wages higher, but in currency of deteriorating value. This practice has stalked and haunted the world ever since.

This is essentially the trade-off that our civilization has made: Destitution will be spared all but a few people, but savings, investment, and the quest for security will be an endless treadmill on which he who earns and tries to accumulate wealth is in a constant race with the deterioration in the buying power of the currency in which he measures his wealth. Meanwhile, most useful, durable assets, such as homes and fine arts, given some astuteness on the part of the acquirer, increase in value, though they endure severe fluctuations in marketability, according to changing tastes and economic conditions.

Let us be under no illusions about the implications of these trends. Even a Cézanne painting of a bowl of fruit costs 200 times what it did 50 years ago. And, at the risk of seeming an unutterable philistine, great artist though Cezanne was, his bowl of fruit was not a better depiction than the real thing, which with a comparable bowl could be replenished with fresh fruit from the local super market, at today’s prices, for 200,000 years for less than what the Cézanne canvas would cost.

In other important news

Lockheed Martin Moves Closer to Affordable Water Desalination

Lockheed Martin has been awarded a patent for Perforene™ material, a molecular filtration solution designed to meet the growing global demand for potable water. 

The Perforene material works by removing sodium, chlorine and other ions from sea water and other sources.

“Access to clean drinking water is going to become more critical as the global population continues to grow, and we believe that this simple and affordable solution will be a game-changer for the industry,” said Dr. Ray O. Johnson, senior vice president and chief technology officer of Lockheed Martin. “The Perforene filtration solution is just one example of Lockheed Martin’s efforts to apply some of the advanced materials that we have developed for our core markets, including aircraft and spacecraft, to global environmental and economic challenges.” 

The Perforene membrane was developed by placing holes that are one nanometer or less in a graphene membrane. These holes are small enough to trap the ions while dramatically improving the flow-through of water molecules, reducing clogging and pressure on the membrane. 

At only one atom thick, graphene is both strong and durable, making it more effective at sea water desalination at a fraction of the cost of industry-standard reverse osmosis systems.  

In addition to desalination, the Perforene membrane can be tailored to other applications, including capturing minerals, through the selection of the size of hole placed in the material to filter or capture a specific size particle of interest. Lockheed Martin has also been developing processes that will allow the material to be produced at scale.

The company is currently seeking commercialization partners.

The patent was awarded by the United States Patent and Trademark Office.

Yet another prescription for a far greater disaster

Mario Draghi’s Opiate of the Markets

By Luigi Zingales

From the standpoint of European stability, the Italian elections could not have delivered a worse outcome. Italy’s parliament is divided among three mutually incompatible political forces, with none strong enough to rule alone. Worse, one of these forces, which won 25% of the vote, is an anti-euro populist party, while another, a Euro-skeptic group led by former Prime Minister Silvio Berlusconi, received close to 30% support, giving anti-euro parties a clear majority.

Despite these scary results, the interest-rate spread for Italian government bonds relative to German bunds has increased by only 40 basis points since the election. In July 2012, when a pro-European, austerity-minded government was running the country, with the well-respected economist Mario Monti in charge, the spread reached 536 basis points. Today, with no government and little chance that a decent one will be formed soon, the spread sits at 314 points. So, are markets bullish about Italy, or have they lost their ability to assess risk?

A recent survey of international investors conducted by Morgan Stanley suggests that they are not bullish. Forty-six percent of the respondents said that the most likely outcome for Italy is an interim administration and new elections. And they regard this outcome as the worst-case scenario, one that implies a delay of any further economic measures, deep policy uncertainty, and the risk of an even less favorable electoral outcome.

The survey also clearly indicated why the interest-rate spread for Italian government bonds is not much wider: the perceived backstop provided by the European Central Bank. Although investors believe that the backstop is unlikely to be used, its mere presence dissuades them from betting against Italy. In other words, the “outright monetary transactions” (OMT) scheme announced by ECB President Mario Draghi last July has served as the proverbial “bazooka” – a gun so powerful that it does not need to be used.