It's going to be painful, and it's going to be nasty

Factories stall worldwide, U.S. jobless claims rise

By Ross Finley and Emily Kaiser

LONDON/SINGAPORE (Reuters) - Manufacturing activity is contracting across Europe and most of Asia, data showed on Thursday, and a Chinese official declared that the world economy faces a worse situation than in 2008 when Lehman Brothers collapsed.

Factory activity shrank even further in the euro zone, reinforcing the view that the debt-strapped region is in recession, while British manufacturing contracted at the fastest pace in two years, raising the risk that the UK economy may suffer the same fate.

This has been the case for much of the developed world for several months, with the exception of pockets of better news from the United States. But the slowdown now appears to be spreading to economic powerhouses of the developing world.

Adding to the gloom, new U.S. claims for unemployment benefits rose unexpectedly last week, popping above 400,000 for the first time in over a month and reinforcing the view that the battered labor market was healing only slowly.

China's official purchasing managers' index (PMI) showed factory activity shrank in November for the first time in nearly three years, while a similar PMI showed Indian factory growth slowed close to stall speed.

Both China and Brazil eased monetary policy on Wednesday. It came alongside coordinated action from the world's biggest central banks to try to prevent another credit crunch by lowering the cost of dollar swaplines.

"The big picture here is this is an unwinding of a 20-year debt bubble," said Peter Dixon, global financial economist at Commerzbank. "It's going to be painful, and it's going to be nasty. What policymakers are aiming for is a smoothing of the path."

But those policymakers appear to be getting more worried.

Zhu Guangyao, China's advance coordinator to the Group of 20 talks and also a vice finance minister, said heavily indebted countries had limited scope to act now, which will make it harder to sustain global growth as the European debt saga drags on.

"The current crisis, to some extent, is more serious and challenging than the international financial crisis following the fall of Lehman Brothers," Zhu said.

"It's keenly important for countries around the world to work together in the sprit of 'co-operating in the same boat'," he added.

After the Lehman bankruptcy, G20 countries committed trillions of dollars to boosting growth and backstopping banks, and central banks cut interest rates to record lows.

But rates are still near zero in the United States, Japan and Britain, and public finances have deteriorated around the world, leaving less policy space to counter a European downdraft.

SPREADING

Fast-growing emerging markets such as China, Brazil and India led the recovery in 2009, and they are still growing far more rapidly than most developed economies. But they are not immune to weak demand from Europe or the United States.

China's official purchasing managers' index for November fell to 49, dipping below the 50 mark that separates growth from contraction for the first time in nearly three years.

The index of new export orders tumbled to the lowest level since February 2009, perhaps not surprisingly given that Europe is one of China's biggest trading partners.

The final euro zone manufacturing PMI was confirmed at 46.4, its weakest level in two years, with factory activity in both of its biggest economies, Germany and France, weakening.

The UK factory PMI fell to 47.6 in November, its lowest since June 2009, further evidence that Britain's economy is in dangerous territory.

"The manufacturing engine has run out of steam," said Rob Dobson, senior economist at Markit, which compiles the surveys.

Similar factory data for the U.S. are expected later on Thursday, coming on the heels of a Federal Reserve report on Wednesday that said there was moderate growth in recent weeks but that hiring and housing market activity remained anemic.

The weaker-than-expected China PMI reading came one day after Beijing lowered banks' reserve requirements by 50 basis points to try to ease credit strains.

"It's time to start reflating China's economy," said Qu Hongbin, co-head of Asian economics research at HSBC.

An HSBC PMI on China also showed manufacturing activity shrank in November as new orders fell. The index dropped to 47.7 from 51 in October.

He predicted China's central bank would cut another 1.5 percentage points off of reserve requirements by mid-2012, and said the European debt crisis along with China's weakening property market would "only add to downside pressure on growth".

Reserve requirements for big banks stand at 21 percent.

Just a few months ago, inflation was the primary concern for most of Asia's economies. But Europe is the top export destination for many countries including China, so when its crisis intensified, Asia's growth prospects dimmed.

South Korea's factory activity shrank for a fourth consecutive month. Its November exports rose faster than expected, although many economists think that won't last because export orders weakened.

In Indonesia, year-on-year export growth slowed in October to 16.7 percent, well below economists' forecast for 22.7 percent and barely one-third of the growth rate recorded in September.

India bucked the trend, reporting a pick-up in export orders, although its overall PMI dipped on weak domestic demand.

Goodbye C++

10 Things I Didn’t Learn in College

By James Altucher

I’ve written before on 10 reasons Parents Should Not Send Their Kids to College and here is also Eight Alternatives to College but it’s occurred to me that the place where college has really hurt me the most was when it came to the real world, real life, how to make money, how to build a business, and then even how to survive when trying to build my business, sell it, and be happy afterwards.

Here are the ten things that if I had learned them in college I probably would’ve saved/made millions of extra dollars, not wasted years of my life, and maybe would’ve even saved lives because I would’ve been so smart I would’ve been like an X-Man.

1. How to Program - I spent $100,000 of my own money (via debt, which I paid back in full) majoring in Computer Science. I then went to graduate school in computer science. I then remained in an academic environment for several years doing various computer programming jobs. Finally I hit the real world. I got a job in corporate America. Everyone congratulated me where I worked, “you’re going to the real world,” they said. I was never so happy. I called my friends in NYC, “money is falling from trees here,” they said. I looked for apartments in Hoboken. I looked at my girlfriend with a new feeling of gratefulness – we were going to break up once I moved. I knew it.

In other words, life was going to be great. My mom even told me, “you’re going to shine at your new job.”

Only one problem: when I arrived at the job, after 8 years of learning how to program in an academic environment – I couldn’t program. I won’t get into the details. But I had no clue. I couldn’t even turn on a computer. It was a mess. I think I even ruined people’s lives while trying to do my job. I heard my boss whisper to his boss’s boss, “I don’t know what we’re going to do with him, he has no skills.” And what’s worse is that I was in a cluster of cubicles so everyone around me could here that whisper also.

So they sent me to two months of remedial programming courses at AT&T in New Jersey. If you’ve never been in an AT&T complex it’s like being a stormtrooper learning how to go to the bathroom in the Death Star where, inconceivably, in six Star Wars movies there are no evidence of any bathrooms. Seriously, you couldn’t find a bathroom in these places. They were mammoth but if you turn down a random corner then, Voila! – there might be an arts & crafts show. The next corner would have a display of patents, like “how to eliminate static on a phone line – 1947″. But I did finally learn how to program.

I know this  because I ran into a guy I used to work with ten years ago who works at the same place I used to work at. “Man,” he says, “they still  use your code.” And I was like, “really?”  “Yeah,” he said, “because it’s like spaghetti and nobody can figure out how to modify it or even replace it.”

So, everything I dedicated my academic career to was flushed down the toilet. The last time I programmed a computer was 1999. It didn’t work. So I gave up. Goodbye C++. I hope I never see you and your “objects” again.

2. How to Be Betrayed. A girlfriend about 20 years ago wrote in her diary. “I wish James would just die. That would make this so much easier. Whenever I kiss him I’m thinking of X”. Where X was a good friend of mine. Of course I put up with it. We went out for several more months. It’s just a diary, right? She didn’t really mean it! I mean, c’mon. Who would think about someone else when kissing my beautiful face? I confronted her of course. She said, “why would you read through my personal items?” Which was true! Why would I? Don’t have I have any personal items through my own I could read through? Or a good book, for instance, to take up my time and educate myself? Kiss, kiss, kiss.

Why can’t they have a good college course called BETRAYAL 101. I can teach it. Topics we will cover: Betrayal by a business partner, betrayal by investors, betrayal by a girlfriend (I’d bring in a special lecturer to talk about betrayal by men, kind of like how Gwynneth Paltrow does it in Glee), betrayal by children (since they cleverly push the boundaries right at the limit of betrayal and you have to know when to recognize that they’ve stepped over the line, betrayal by friends/family (note to all the friends/family that think I am talking about them, I AM NOT – this is a serious academic proposal about what needs to be taught in college) – you help them, then get betrayed – how to deal with that?

Then there are the more subtle issues on betrayal – self-sabotage. How you can make enough money to live forever and then repeatedly find yourself in soup kitchens, licking envelopes, attending 12 step meetings, taking medications, and finally reaching some sort of spiritual recognition that it all doesn’t matter until the next time you sink even lower. This might be in BETRAYAL 201. Or graduate level studies. I don’t know. Maybe the Department of Defense needs to give me a grant to work on this since that’s who funds much of our education.

3. Oh shoot, I was going to put Self-Sabotage into a third category and not make it a sub-category of How to Be Betrayed. Hmmm, how do I write myself out of this conundrum. College, after all, does teach one how to put ideas into a cohesive “report” that is handed in and graded. Did I form my thesis, argue it correctly, conclude correctly, not diverge into things like “Kim Kardashian will never be the betrayer, only the betrayed. But this brings me to: Writing. Why can’t college teach people how to actually write. Some of my best friends tell me college taught them how to think. Thinking has a $200,000  price tag apparently and there is  no room left over for good writing.

And what is good writing? It’s not an opinion. Or a rant. Or a thesis with logical steps, a deep cavern underneath, beautiful horizons and mountaintops at the top. Its blood. Its Carrie-style blood. Where everyone has been fooling you until that exact moment when n0w, with the psychic power of the written word, you spray pig blood everywhere, at everyone, and most of all you are covered in blood yourself, the same blood that pushed you and your placenta out of your mother’s womb, pushed and shot out with you until just the act of writing itself is a birth, a separation between the old you and the new you – the you that can no longer take the words back, the words that now must live and breathe and mature and either make something of themsleves in life, or remain one of the little blips that reminds us of how small we really are in an infinite universe. [See also, 33 Unusual Tips to Be a Better Writer]

4. Dinner Parties. How come i never learned about dinner parties in college. Sure, there were parties among other people who looked like me and talked like me and thought like me – other college students of my age and rough background. But Dinner Parties as an adult are a whole new beast. There are drinks and snacks beforehand where small talk has to disguise itself as big talk and then there’s the parts where you KNOW that everyone is equally worried about what people think about them but that still doesn’t help at those moments when you talk and you wonder what did people think of ME? Nobody cares, you tell yourself, intellectually raffling through pages of self-help blogs in your mind that told you that nobody gives **** about you.

But still, why don’t we have a class where there’s Dinner Party after Dinner Party and you learn how to talk at the right moments, say smart things, be quiet at the right moments, learn to excuse yourself during the mingling so you can drift from person to person. Learn how to interrupt a conversation without being rude. Learn how to thank the host so you can be invited to the next party. And so on. Which brings me to:

5. Networking. Did it really take 20 years after I graduated college before someone wrote a book, “Never Eat Alone.” Why didn’t Jesus write that book. Or Plato. Then we might’ve read it in religious school or it would’ve been one of those “big Thinkers” we need to read in college so we can learn how to think. I still don’t know how to network properly so this paragraph is small. I’m classified under the DSM VI as a “social shut-in”. I’d like to get out and be social but when the moment comes, I  can only make it out the door about 1 in ten times. I always say, “I’d love to get together” but  then I don’t know how to do it. Perhaps because not one dollar of my $100,000 spent on not learning how to program a computer was also not spent on learning how to network with people. [See also, my recent TechCrunch article, "9 Ways to be a Super-Connector"]

Central Banksters of the World Unite Part II

Leaping Toward the Keynesian Dream

By Jeffrey Tucker

The Fed’s latest inflationary scheme sounds like a technocratic innovation. It lowered the costs of currency swaps between central banks of the world, with the idea that the Fed would do for the globe what Europe, England and China are too shy to do, which is run the printing presses 24/7 to bail out failing institutions and economies. In effect, the Fed has promised to be the lender of last resort for the entire global economy.

It’s sounds new, but it is not. Following the Second World War, John Maynard Keynes pushed hard for a global paper currency administered by a global central bank. This was his proposed solution to the problem of national currency disputes. Let’s just take the inflation power away from the national state and give it to a world authority. Then we’ll never have to deal with a lack of coordination again. [1]

The idea didn’t fly, but the institutions that were supposed to administer such a system were nonetheless created: the International Monetary Fund and the so-called World Bank. It didn’t work out that way. Instead, nation-states retained their monetary authority, and the new institutions became glorified welfare providers, conduits for transfer payments and loads to developing nations.

The dream lived on, however. The creation of the euro and its central bank was a step in that direction. So was the Nixon’s closing of the gold window. Each new currency crisis has created the excuse for further steps toward what Murray Rothbard calls the Keynesian dream.

Why hasn’t it happened yet? Many reasons. Nation-states do not want to give up power. The World Bank and the IMF are institutionally unsuited to the task. Many people in the banking world are also downright squeamish about the idea, with full knowledge of the ravages that unchecked inflationary credit can bring to the world economy. Mostly, there hasn’t been a crisis big enough to warrant such extreme measures.

However, that crisis might have finally arrived. Since 2008, the Fed has demonstrated that among all the world’s central banks, it alone is brave enough to embrace gigantic inflationary measures without wincing. The European Central Bank is under some strictures to not act as a monetary central planner. China is unconverted to the inflationary faith. The same holds true for England.

Ben Bernanke, however, is different: He is revealing himself to be an unreconstructed Keynesian with an unlimited faith in the power of paper money to solve all the world’s problems.

What this means is that it is left to the Fed alone to bail out the world. There is a perverse logic to this. After all, if you are going to be a world empire, operating under the assumption that nothing on the planet is outside your political purview, you bear certain responsibilities as well. Foreign aid and troops in every country are just the beginning. You must, eventually, embrace your financial responsibilities, too. A globalized economy addicted to debt needs an institution willing to step up and guarantee that debt, and provide the liquidity necessary to get us through the hard times.

As soon as the announcement of the new Fed measures came, the smart set of the World Wide Web lit up with the obvious observations that these measures come with massive risk of setting off a global inflationary crisis. It could lead to the final crack-up boom.

The Fed assures us otherwise. It “bears no exchange risk” in undertaking such actions. But as economist Robert Murphy explains: [2]

“Strictly speaking, this isn’t true. If the Fed gives $50 billion in dollars to the ECB, which (at those market prices) gives $50 billion worth of euros to the Fed, then the ECB lends out the dollars to private banks, and before they repay the loans, the euro crashes against the dollar…then the ECB has no means of acquiring dollars to repay the Fed. Even though the ECB has a printing press, it is configured for euros, not dollars.”

He further states what everyone knows but no one is will to say:

“The current round of interventions will not solve the problem. Down the road — probably much sooner, rather than later — the central banks of the world will engage in some further extraordinary measures, again, lest the whole world fall apart. Even so, printing money doesn’t fix the underlying problems. No matter what they do, eventually, the whole financial world will fall apart.”

The speed at which all of this is happening is startling to behold. It was only 36 hours ago that we heard the first public worries about the drying up of credit in Europe. Large corporations were seeing their credit lines tightened. Banks were starting to become more scrupulous in their operations, which is hardly a surprise, given that zero interest rates have made it nearly impossible to make a profit in conventional lending operations.

Where in the fall of 2008, the Fed let the worries about tight credit grow to the point of international mania before it acted, this time, it jumped in to anticipate the inevitable warnings about the imminent death of civilization. Only trillions in paper money can save us now! The Fed saw what was coming and decided to do the deed, even before the demand came. [3]

But rather than settle markets down, the real effect is the opposite. If you go to the doctor with a head cold, and he rushes you to the hospital for surgery, you don’t merely congratulate him for being thorough. You figure that he knows something that you don’t, namely that your condition is way more serious than you thought. Your family is likely to fly into a panic.

For this psychological reason alone, this action is likely to roil markets in crazy ways. The Fed is now paper money printer for the entire world. It’s a new world, and a brave one. If you think that a new era of prosperity, peace and stability awaits, you have been living under a rock for at least a century. There’s not a soul alive who will sleep soundly knowing that Ben Bernanke has elected himself the loan officer of the entire globe.

Central Banksters of the World Unite Part I

The Financial Entangling Alliances Thicken

By Robert Murphy

From CNBC:

The world’s major central banks unleashed coordinated action Wednesday to ease the increasing strains on the global financial system, a move that sent stock markets up sharply.

The European Central Bank, U.S. Federal Reserve [cnbc explains] , the Bank of England and the central banks of Canada, Japan, and Switzerland are all taking part in the operation, which is designed to “enhance their capacity to provide liquidity support to the global financial system.”The ECB said in a statement the banks are making it cheaper for banks to get U.S. dollar liquidity when they need it, starting next Monday.They are also taking steps to ensure banks can get ready money in any currency if market conditions warrant. … Fears of more financial turmoil in Europe have already left some European banks dependent on central bank loans to fund their daily operations. Other banks are wary of lending to them for fear of not getting paid back.Such constraints on interbank lending can hurt the wider economy by making less money available to lend to households and businesses.

You have to like the last part: They’re doing it for the average household, not the big bankers sitting on sovereign debt.

Although the Fed likes to say that it “bears no exchange rate risk” in such swaps, and though (back a few months when they expanded the swap lines with Europe in a different “coordinated central bank action”) they like to stress that the Fed isn’t on the hook when the ECB lends the dollars to European banks, strictly speaking this isn’t true. If the Fed gives $50 billion in dollars to the ECB, which (at those market prices) gives $50 billion worth of euros to the Fed, then the ECB lends out the dollars to private banks and, before they repay the loans, the euro crashes against the dollar…then the ECB has no means of acquiring dollars to repay the Fed. Even though the ECB has a printing press, it is configured for euros, not dollars.

The experts tell us that these types of arrangements are necessary, lest the whole (financial) world fall apart. Back in September 2008, when many of us were vociferously objecting to TARP and Bernanke’s incredible monetary inflation, the experts told us such things were necessary lest the whole world fall apart.

The current round of interventions will not solve the problem. Down the road–probably much sooner rather than later–the central banks of the world will engage in some further extraordinary measures, again lest the whole world fall apart.

Even so, printing money doesn’t fix the underlying problems. No matter what they do, eventually the whole financial world will fall apart.

Europe's original sin

Blame It on Berlin

 The euro bailout caucus wants the Germans to write a blank check.

By WSJ Editors

Which century is this anyway? We ask because elite opinion is once again blaming Germany for ruining the rest of Europe, if not the entire world economy. All that's missing are references to the Kaiser or Herr Schicklgruber, but we hope the Germans don't fall for this global guilt trip.

Berlin's alleged sin is its reluctance to write a blank check to save the euro—either by underwriting a new euro-zone fiscal union, or granting permission for the European Central Bank to buy trillions in sovereign debt. The chant comes in unison from the debtor nations themselves, the bailout caucus in Brussels, an Obama White House concerned about its re-election, and liberal pundits worried that their welfare-state economic model is under assault. Like the "rich" in America who must pay their "fair share," the Germans are supposed to pay up to save a united Europe.

The reality is that the Germans—along with the Dutch and the Finns—are the rare Europeans who understand that saving the euro requires more than a blank check. It requires a new political commitment to better economic policy. Chancellor Angela Merkel and her cabinet are as euro-centric as the French, but they realize that money alone won't solve Europe's more fundamental debt and growth problem.

It's certainly true that the Germans have benefited from the euro, which is one reason they want to preserve it. Their exports have flourished, often to other European countries, thanks to a stable currency and free-trade zone. But one reason for their relative economic success is that Germany is a rare European country that used the early years of the euro to reform its labor markets and improve fiscal policies. While the Greeks and Italians used their years of near-German borrowing rates to live beyond their means, the Bavarians became more competitive.

Until the crisis hit Italy, the rest of Europe still didn't think it had a problem. Politicians said the markets were acting in predatory fashion, rather than sensibly recalibrating the risk of sovereign default. Even now, 18 months into this euro mess, only the recent jump in sovereign bond yields has caused Italy and France to realize they have to shape up.

Europe's original sin in this crisis was not letting Greece default, remaining in the euro but shrinking its debt load as it reformed its economy. The example would have sent a useful message of discipline to countries and creditors alike. The fear at the time was that a default would spread the contagion of higher bond rates, but those rates have soared despite the bailouts of Greece and Portugal.

By now the policy choices are more painful. One option is to let the euro zone break up, one country at a time or all at once, but the costs of dissolution would be very high. At best it would mean a deep recession, as debts and contracts were recalculated in national currencies, and savers and investors fled to the safest havens. This is something no one but doctrinaire devaluationists should want.

The second option is the blank check, starting with the ECB printing trillions in euros to buy up sovereign debt. This might crush bond yields, at least for a while, but the minute those yields fall the pressure for economic reform will also ease.

Meanwhile, the ECB will have sacrificed its independence under political duress, while gambling that printing trillions of euros won't lead to inflation down the road. This would be a short-term palliative to get the French and Americans past the next election.

The third option, and the one the Germans seem to prefer, is a closer fiscal union across the euro zone with stricter rules on debt and deficits. This is the essence of the tentative Franco-German plan leaked over the weekend. In return for issuing euro bonds or perhaps granting countries access to ECB bond purchases, Germany would require those nations to live by German-approved fiscal rules. This has the virtue of distinguishing between countries that follow the rules and those that don't, enforcing good behavior with carrots and bad with sticks.

This is better than the other options, but it too is no panacea. Germany isn't about to send the Wehrmacht to Rome or Athens to enforce fiscal policy. So enforcement would still largely depend on the political will of the countries themselves. Such debt and deficit rules could also be counterproductive if they led to growth-killing tax increases instead of spending cuts and entitlement reforms.

It's no accident that Ireland, with its 12.5% corporate tax rate that has attracted export businesses, is climbing out of its debt hole faster than are Portugal, Spain or Greece. Any new fiscal rules need to allow for tax and labor-policy competition.

The tragedy is that the euro-zone countries failed to abide by their original fiscal rules, a failure that has brought them to this unhappy pass. The Brussels-Washington bailout caucus now wants to extend the damage to monetary policy by printing more euros and worrying about the consequences later.

In opposing that option, the Germans are said to be imposing their Prussian morality on everyone else. But without reforms, the countries of southern Europe will never pull out of their downward debt spiral.

The Germans are at least telling the truth.

"And great was the fall of it"

Official: Panic Time in Europe

By Walter Russell

Olli Rehn, the European Union’s Commissioner for Financial and Monetary Affairs, has a level head and has occupied the hottest seat in Europe during the long financial crisis;  Reuters reports him saying earlier today that:

“We are now entering the critical period of 10 days to complete and conclude the crisis response of the European Union.”

It is crunch time in Europe.  By Christmas and perhaps much sooner we may know the fate of the single currency.

The lies and the half truths on which the euro has been based are quickly dissolving.  The much praised European Financial Stability Fund has turned into a bust as investors turn up their noses at its debt offerings.  Heinz the Ant is unwilling to pay the bills for Zorba the Grasshopper; after so many tricks and so many lies, nobody believes that Zorba will ever reform.

The euro is failing for technical as well as moral reasons; for years observers pointed out that ECB interest rate policies set to cope with conditions in Germany and France were causing credit bubbles in countries like Ireland and Spain.  Those bubbles, and the aftermath when they burst, have as much to do with the euro’s dire straits as the endemic chicanery in Greece.

Ultimately, the euro is in trouble because the peoples of Europe are not a single nation.  West Germans grumbled, but they paid the bills to integrate the former East Germany when unification came because when all was said and done it was a family affair.  They grumble and resist paying the bills for Greece, Italy, Portugal and Spain because those people are just neighbors.

The euro is not dead yet.  Indeed, if the pressures of the financial crisis are felt strongly enough, this could still work out the way the euro’s architects imagined it would.  Many of those who backed the euro understood very well that a monetary union without a political union would sooner or later fall into a crisis.  They assumed and expected that when that crisis came, the various countries in Europe would choose political union to save the currency.

We are going to see very soon whether this trillion dollar bet works out.  The signs now are not good, but this is only the eleventh hour.  Not until the twelfth stroke of midnight will we know whether the pressures of the crisis can force the Europeans into a political union that most of them still want to resist.

We are coming to believe that even a full fiscal union of the eurozone countries would ultimately fail.  The differences between South Carolina and Massachusetts led to a civil war in the American union; the differences among France, Germany, Italy, Spain, Finland, the Netherlands, Ireland and Greece are much deeper and more fundamental than the differences between northern and southern states in the early US.  Fiscal union among the eurozone countries would be as unhappy as their monetary union has been; in the end, the Italians simply cannot and will not live the way the Germans want them to.

We keep thinking of Abraham Lincoln’s riddle: how many legs does a sheep have if you count the tail as a leg?

The answer is four, because calling a tail a leg doesn’t make it one.

At the end of the day, facts speak.  All human institutions must be built on what is real.  Clever compromise, technical skill and sophisticated institution building are all very well, but the foundations must be solid or the building will fall.

Jesus of Nazareth warned about what happened to people failed to ground their construction on solid rock, pointing to the example of a foolish man who built his house on the sand:

And the rain descended, and the floods came, and the winds blew, and beat upon that house; and it fell: and great was the fall of it.

Mt. 7:27

If the euro is built upon sand, the time of its fall is at hand — and great will be its fall.

The beginning of the end of Fiat Money

Fed Lowers Interest Rate on Dollar Swaps

By Scott Lanman and Jeff Black 

Six central banks led by the Federal Reserve made it cheaper for banks to borrow dollars in emergencies in a global effort to ease Europe’s sovereign-debt crisis.

Stocks rallied worldwide, commodities surged and yields on most European debt fell on the show of force from central banks aimed at easing strains in financial markets. The cost for European banks to borrow dollars dropped from the highest in three years, tempering concerns about euro’s worsening crisis after leaders said they’d failed to boost the region’s bailout fund as much as planned.

“It’s supportive but not necessarily a game changer,” said Michelle Girard, senior U.S. economist at RBS Securities Inc. in Stamford,Connecticut. “The impact is more psychological than anything else” as investors take heart from policy makers’ coordination, Girard said.

The premium banks pay to borrow dollars overnight from central banks will fall by half a percentage point to 50 basis points, the Fed said today in a statement in Washington. The so- called dollar swap lines will be extended by six months to Feb. 1, 2013. The Fed coordinated the move with the European Central Bank and the central banks of Canada, Switzerland, Japan and the U.K.

The six central banks also agreed to create temporary bilateral swap programs so funding can be provided in any of the currencies “should market conditions so warrant.” Those swap lines were also authorized through Feb. 1, 2013.

Starting December

The swap lines were previously set to expire Aug. 1, 2012. The new pricing will be applied to operations starting on Dec. 5. Seven-day loans would carry an interest rate of about 0.58 percent, down from 1.08 percent, based on the current one-week overnight index swap rate of 0.08 percent. OIS is a measure of expectations for the benchmark federal funds rate.

“This was in response to increased tension in global financial markets,” Bank of Japan Governor Masaaki Shirakawa said at a press conference in Tokyo today. “Coordinated action will give markets a sense of security.”

The action wasn’t aimed at supporting any specific financial institution, Canadian Finance Minister Jim Flaherty said in a Bloomberg Television interview in New York.

The Standard & Poor’s 500 index jumped 3.5 percent to 1,237.24 at 1:05 p.m. in New York, and the Stoxx Europe 600 Index surged 3.6 percent. The euro strengthened to $1.3449 from $1.3317 late yesterday. The yield on the 10-year Treasury note climbed to 2.06 percent from 1.99 percent.

“When there’s concerted action by central banks, it’s definitely good,” said Jens Sondergaard, senior European economist at Nomura International Plc in London. “But are liquidity injections a game changer when the heart of the problem is in European sovereign debt markets?”

European Banks

European banks gained, with Barclays Plc (BARC) climbing as much as 9.4 percent in London trading. Deutsche Bank rose as much as 7.3 percent in Frankfurt, while BNP Paribas SA and Credit Agricole SA gained in Paris.

Today’s move echoes coordinated actions from the financial panic starting in 2007 to create and expand the currency-swap lines, whose use peaked at about $583 billion in December 2008. The central banks also jointly lowered their benchmark interest rates in October 2008.

Fed policy makers voted 9-1 for the swap action in a Nov. 28 videoconference, with Richmond Fed President Jeffrey Lacker dissenting, Michelle Smith, a Fed spokeswoman, said in an e- mail. Lacker voted in place of Philadelphia Fed President Charles Plosser, who was unavailable for the meeting, Smith said. Laura Fortunato, a spokeswoman for Lacker at the Richmond Fed, didn’t immediately respond to a request for comment.

No Current Difficulties

The Fed said U.S. financial companies “currently do not face difficulty obtaining liquidity in short-term funding markets.”

“However, were conditions to deteriorate, the Federal Reserve has a range of tools available to provide an effective liquidity backstop for such institutions and is prepared to use these tools as needed to support financial stability and to promote the extension of credit to U.S. households and businesses,” the central bank said in the statement.

U.S. House Financial Services Committee Chairman Spencer Bachus, an Alabama Republican, said in a statement that the move “is a recognition of the interconnected nature of the global economy” and that it’s in America’s interest to see Europe recover. At the same time, the action “should not and cannot absolve European policymakers from the need to resolve their own problems,” Bachus said.

China Move

Two hours before the Fed announcement, China cut the amount of cash that the nation’s banks must set aside as reserves for the first time since 2008. The level for the biggest lenders falls to 21 percent from a record 21.5 percent, based on past statements.

While today’s move by the six central banks is likely to ease tensions in money markets, it falls short of some calls for the ECB to step up and act as lender of last resort for the governments of the 17-member euro area and buy unlimited amounts of government bonds. Germany, Europe’s largest economy, has resisted the idea, arguing it isn’t the ECB’s job to do so and would only be a temporary fix.

The ECB unexpectedly cut its benchmark interest rate Nov. 3 by 25 basis points to 1.25 percent as the turmoil threatened to drag the euro area into recession. ECB policy makers next meet Dec. 8, while Fed officials gather Dec. 13.

Seven-Day Refinancing

Yesterday, the ECB allotted the most to banks in its regular seven-day refinancing operation in more than two years, lending 265.5 billion euros ($357.5 billion). The ECB offers unlimited funding to euro-area banks against eligible collateral.

“The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity,” the Fed statement said.

Under the dollar liquidity-swap program, the Fed lends dollars to the ECB and other central banks in exchange for currencies including euros. The central banks lend dollars to commercial banks in their jurisdictions through an auction process.

The swap arrangements were revived in May 2010 when the debt crisis in Europe worsened. The Fed three months earlier had closed all swap lines opened during the financial crisis triggered by the subprime-mortgage meltdown in 2007.

Dollar Tender

European lenders asked for a total of $395 million in the ECB’s 84-day dollar tender conducted in coordination with the Fed on Nov. 9. In the first offering on Oct. 12, the ECB lent six banks $1.35 billion for three months. The next three-month loan will be offered on Dec. 7.

The coordinated action “lowers the cost of emergency funding and increases the scope,” Mohamed El-Erian, chief executive officer, of Pacific Investment Management Co. said in a radio interview today on “Bloomberg Surveillance” with Ken Prewitt and Tom Keene.

Central banks “are seeing something in the functioning of the banking system that worries them,” El-Erian said.

It is happening right now

Should the Fed save Europe from disaster?

The dam is breaking in Europe. Interbank lending has seized up. Much of the financial system is paralysed, setting off a credit crunch just as Euroland slides back into slump.

By AMBROSE EVANS-PRITCHARD

The Euribor/OIS spread or`fear gauge’ is flashing red warning signals. Dollar funding costs in Europe have spiked to Lehman-crisis levels, leaving lenders struggling frantically to cover their $2 trillion (£1.3 trillion) funding gap.

America’s money markets are no longer willing to lend to over-leveraged Euroland banks, or only on drastically short maturities below seven days. Exposure to French banks has been slashed by 69pc since May.

Italy faces a “sudden stop” in funding, forced to pay 6.5pc on Friday for six-month money, despite the technocrat take-over in Rome.

German Bund yields have risen to 59 basis points above Swedish bonds since Wednesday’s failed auction. German debt has been relegated suddenly against Swiss, Nordic, Japanese, and US debt. As the Telegraph reported two weeks ago, Asian central banks and sovereign wealth funds are spurning all EMU bonds because they have lost confidence in a monetary system with no lender of last resort, coherent form of government, or respect for the rule of law.

Even if EU leaders could agree on fiscal union and joint debt issuance – which they can’t – such long-range changes cannot solve the immediate crisis at hand. The push for treaty changes has become a vast distraction.

Unless Germany agrees to the full mobilization of the European Central Bank very fast, the eurozone will spiral out of control. As The Economist put it, “The risk that the currency disintegrates within weeks is alarmingly high.”

Theoretically, EMU can limp on though the Winter until the Italian debt auctions of €33bn in the last week of January, and €48bn in the last week of February. The reality is that sovereign contagion to the financial system may well bring matters to a head more swiftly.

If break-up occurs in a disorderly fashion, with Club Med states and Ireland spun into oblivion one by one, the chain reaction will cause an implosion of Europe’s €31 trillion banking nexus (S&P estimate), the world’s biggest and most leveraged. This in turn risks an almighty global crash – first class passengers included.

So the question arises, should the rest of the world take over management of Europe to prevent or mitigate disaster? Specifically, should the US Federal Reserve assume leadership as a monetary superpower and impose policy on a paralyzed ECB, acting as a global lender of last resort?

In essence, the US would do for EMU what it did in military and strategic terms for the Europe in the 1990s when Washington said enough is enough after squabbling EU leaders had allowed 200,000 people to be slaughtered in the Balkans. The Pentagon settled matters swiftly with “Operation Deliberate Force”, raining Tomahawk missiles on the Serb positions. Power met greater power.

Personally, I have not made up my mind about the wisdom of a Fed rescue. It is fraught with dangers, and one might argue that resources are better deployed breaking EMU into workable halves with minimal possible damage.

However, debate is already joined – and wheels are turning in Washington policy basements – so let me throw this out for readers to chew over.

Nobel economist Myron Scholes first floated the idea over lunch at a Riksbank forum in August. "I wonder whether Bernanke might not say that `we believe in a harmonized world, that the Europeans are our friends, and we know that the ECB can't print money to buy bonds because the Germans won't let them. And since the ECB will soon run out of money, we will step in and start buying European government bonds for them'. It is something to think about," he said.

This is not as eccentric as it sounds. The Fed’s Ben Bernanke touched on the theme in a speech in November 2002 – “Deflation: making sure it doesn't happen here” – now viewed as his policy `road map' in extremis.

"The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt. Potentially, this class of assets offers huge scope for Fed operations," he said.

Berkeley’s Brad DeLong said it is time for Bernanke to act on this as the world lurches straight into 1931 and a Great Depression II. “The Federal Reserve needs to buy up every single European bond owned by every single American financial institution for cash,” he said.

The Fed could buy €2 trillion of EMU debt or more, intervening with crushing power. The credible threat of such action by the world’s paramount monetary force might alone bring Italian and Spanish yields back down below 5pc, before one bent nickel is even spent.

One presumes that the Fed would purchase both the triple AAA core and Club Med in a symmetric blast of monetary stimulus across the board, avoiding the (fiscal) error of targeting semi-solvent states. In sense, the Fed would do quantitative easing for the Europeans, whether they liked it or not.

David Zervos from Jefferies has proposed an extreme variant of this, accusing Germany’s fiscal Puritans of reducing Europe’s periphery to “indentured servants” and driving the whole region into depression with combined fiscal and monetary contraction.

“We in the US need to snuff out these sado-fiscalists and fast, they are a danger to the world. The US can force monetisation at the ECB. We should back up the forklift and buy Euro area bonds. Lots of them,” he said.

Some of the purchases could be achieved by tapping the Fed’s euro account at the ECB, flush with funds as a result of currency swaps provided by Washington to help Europe shore up its banks. Ultimately mass EMU bond purchases would cause a sudden and potentially dangerous spike in the euro against the dollar. There lies the rub. If the ECB failed to loosen monetary policy drastically to offset this, the experiment could go badly wrong.

A pioneering school of “market monetarists” - perhaps the most creative in the current policy fog - says the Fed should reflate the world through a different mechanism, preferably with the Bank of Japan and a coalition of the willing.

Their strategy is to target nominal GDP (NGDP) growth in the United States and other aligned powers, restoring it to pre-crisis trend levels. The idea comes from Irving Fisher’s “compensated dollar plan” in the 1930s.

The school is not Keynesian. They are inspired by interwar economists Ralph Hawtrey and Sweden’s Gustav Cassel, as well as monetarist guru Milton Friedman. “Anybody who has studied the Great Depression should find recent European events surreal. Day-by-day history repeats itself. It is tragic,” said Lars Christensen from Danske Bank, author of a book on Friedman.

“It is possible that a dramatic shift toward monetary stimulus could rescue the euro,” said Scott Sumner, a professor at Bentley University and the group’s eminence grise. Instead, EU authorities are repeating the errors of the Slump by obsessing over inflation when (forward-looking) deflation is already the greater threat.

“I used to think people were stupid back in the 1930s. Remember Hawtrey’s famous “Crying fire, fire, in Noah’s flood”? I used to wonder how people could have failed to see the real problem. I thought that progress in macroeconomic analysis made similar policy errors unlikely today. I couldn’t have been more wrong. We’re just as stupid,” he said.

Needless to say, reflation alone will not make Euroland a workable currency area. Nor will fiscal union, Eurobonds, and debt pooling down the road.

"Even if they do two years of fiscal transfers, and the ECB buys all the bonds, and the problems are swept under the carpet, we are still going to be facing a crisis at the end of it," said professor Scholes.

None of the “cures” on offer tackle the 30pc currency misalignment between North and South, the deeper cause of this crisis. What Fed-imposed QE for Euroland can do is make a solution at least possible stoking inflation deliberately.

This means inflicting a boomlet on the German bloc, while allowing the South to take its fiscal punishment without crashing further into self-defeating debt deflation. It forces up prices in the North, compelling the neo-Calvinists to accept their share of the intra-EMU price readjustment.

The Germans will not like this. If inflation causes them rise up in revolt and leave EMU to the Latins, so much the better. That is the best solution of all.

What we know for certain is that Europe’s current policy settings must lead ineluctably to ruin and perhaps to fascism. Nothing can be worse.