European Council President Mr Herman Van Rompuy (aren’t we so lucky to have yet another tier of vastly-expensive management – a President of a country that doesn’t even exist?) said: “Everyone shares the will to go forward together”.
Indeed. It would be rather strange if one or more didn’t share “the will” and preferred to go backwards. But going forwards together infers at the same speed and in the same direction.
The Meeting drew up this plan of action.
greater budgetary discipline (will you tell France and almost every other country that never stuck to the 3% budget deficit or shall I?)
find ways to reduce the divergences in competitiveness between member states (so German IS going to take over Greece then? What fails in war can be achieved in the economy.)
establish an effective economic crisis management mechanism(you mean, prepare to borrow billions more to bail out those who fail in the above two areas?)
strengthen economic governance to be able to act quicker and in a more coordinated and efficient manner to deal with any future economic crises(yes, you could get a bit more efficient than ignoring the rules for 10 years – certainly scope for improvement there.)
Is there any way not to be simultaneously cynical and depressed about Europe at the moment?
Just to try to help put stock market swings into perspective,consider this:
the 347.8 point fall in the Dow Jones Industrial Average last week, from 10868.12 at the start of the trading day on Thursday, May 6, 2010 to 10520.32 at the close of trading, can be COMPLETELY explained by an increase in the perceived cost of capital from 12% to 12.23%.
do the math. Using the constant dividend growth model, a very simplified model of the market value of equity, or Market Value = Current Dividend/(cost of equity capital – dividend growth rate), and assuming a long-term average cost of U.S. equity capital of 12% and average growth rate of 5%, we find that the opening level of 10868.12 = 760.77/(.12 -.05), and the closing level of 10520.32= 760.77/(.1223 -.05).
I think it is entirely possible that the chaos in Greece and surrounding nations, and the interconnections between worldwide supplies of liquidity and financial capital, that an increase in the perceived risk and uncertainty of the returns to equity from 12% per year to 12.23% per year makes perfect sense.
The market’s are working. Market participants, from the individual investor using on-line trading at 2:00 in the morning from their living room to the most sophisticated computerized large-scale institutional trader, understands that a borrower’s ability to pay back its investors depends on the real productivity and growth of private industry, whether the borrower is a company or a country.
The Federal Reserve finally addresses how it plans to unwind trillions in toxic assets
Finally, we hear from the Federal Reserve about how they plan to unwind the billions of dollars of toxic assets they purchased over the last 18 months or so without creating further distortions in the U.S. and world financial markets (Fed lays out exit detail). This after the Fed barely acknowledged one of the most dramatic runups in the money supply in U.S. history.
The announcement came in a speech by Brian P. Sack, the executive Vice President of the Markets Group at the Fed. I am impressed by this guy. He seems to know what he’s talking about and seems to understand how markets and fed policy interact.
In earlier posts I wondered aloud how the Fed might accomplish this tricky task. It is a very delicate balance between reducing the money supply too quickly, which would spike short term rates, and too slowly, which would increase long-term rates due to worries about inflation (which occurs when money growth is higher than the economy’s real growth, even if money growth is falling).
The Fed, the article explains, apparently intends to let $200 billion of the estimated $1.25 trillion in new money supply simply “mature” by the end of 2011 without replacing it. This represents largely toxic assets. The Fed might let another $140 billion of Treasuries it purchased during normal open market operations mature at the end of 2011, but they aren’t committing to that. So that’s about $340/$1,250 or about 35% of the historic increase in money supply that may be vaporized over the next 21 months. What about the rest? It would be nice to know but….
The Fed is doing the right thing by explaining its policy intentions — ANY of its policy intentions — to the markets. Markets want, need, and deserve information from our officials, something that has been sorely lacking of late. With information, lenders and borrowers can plan, they can optimize. Without information, guessing, withdrawing from the market, and fear rule the day. Not a good environment for economic recovery.
When lending is motivated by politics, losses are not far behind.
Years ago, in the summer of 1980, I worked as an intern in the Federal Home Loan Bank Board at the Department of Agriculture. I was a senior in college majoring in business and had been accepted to the University of Chicago doctoral program. I didn’t want to take the internship because I wanted to take more courses over the summer to help prepare me for the rigors of grad school, but my college advisor had openly worried that I was far too serious for a young person. He strongly encouraged me to accept the internship and take a break from academics before I immersed myself in graduate school, and buried myself once again in all things economics!
I agreed, but only after I had arranged to take 6 credits of independent study in D.C. I chose to examine the Negative Income Tax program, one of the largest social experiments in U.S. history. More on that at another time. Today, I want to talk about what I learned from being an employee of the U.S. federal government.
The first thing I learned was that the “problem” with government work is not the people; well, not all the people. There was one man who spent his entire day going back and forth to feed quarters to the parking meter rather than pay for public transportation or do his work. He represented the worst in government employees. Most all of the others I met were hard-working and honest people, trying to do a good job and make a difference.
No, I learned that the real problem was the way the “work” was done in government. I worked for the Federal Home Loan Bank Board (FHLBB) that summer, which was one of the largest lenders in the world. The FHLBB was responsible for small business, rural, agricultural, and economic development lending. My job was to review loan applications from community groups, fairs, farmers’ markets, and various municipal organizations to make sure that they were complete.
We did not analyze the applicants for creditworthiness. Instead, if the application was correct and complete, and satisfied the application process, it was approved. The FHLBB, which was publicly trashed by the first President Bush as being largely responsible for the savings and loan crisis, was abolished and replaced by the Office of Thrift Supervision (OTS) under the Department of the Treasury in 1989.
Little did I know back in 1980 that I was witnessing, from the inside, a government lending process that would lead to the most significant financial crisis since the Great Depression. Looking back, the outcome was perfectly predictable: when politics replaces profits as the motivation of the lender, it should be no surprise that losses result.
What does it mean when the Fed raises the interest rate? It helps to first understand how the Fed raises the rate, which may surprise some people. The Fed does not “set” the interest rate as it might, for example, by declaration or edict or by fixing prices. No, it targets a higher interest rate by contracting the money supply until that money supply intersects the market demand for money at a higher market-clearing rate of interest.
How does the Fed reduce the money supply? Typically by conducting open market operations, which is the purchase or sale of government securities by the Fed. To raise the money supply, it purchases new government securities, paying for them by creating — out of thin air — reserves for the commercial banking system. To reduce the money supply, it sells securities which shrinks the amount of deposits in circulation in the economy. In other words, it reduces the liquidity or amount of credit in the system. This is equivalent to reducing aggregate demand for the goods and services in the economy. (Yes, you heard right — a reduction in the money supply decreases the aggregate demand for goods and services by businesses and consumers.)
Raising interest rates is a contractionary policy decision. It is designed to “slow down” the economy, reducing output and employment, and raising the equilibrium prices of goods and services in the economy. Why would the Fed choose to contract an already anemic economy? To head off inflation, which has it own set of insidious costs and distortions that significantly hurt the economy.
The Fed has always had to tread a very fine line between increasing the money supply enough in the short run to pump up demand and minimize the depth and length of a recession, but not increasing the money supply so much that the increase in demand outstrips the ability of the economy to produce, which creates inflation in the longer run. Excessive money growth is what causes inflation. And over the last two years, the U.S. has witnessed a record-shattering increase in the money supply as policymakers struggled to deal with an unprecedented financial crisis.
I have been saying for months that this behemoth money supply would inevitably lead to significant inflation unless steps were taken to shrink it. I believe the Fed has now begun to take those steps.